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Cashing in on Bad News

July 16, 2008



Click here to watch a video of Toby's rant. Or click here to listen.

I've been searching for some good news in the markets, and here it is: Bear markets give us a wonderful opportunity to buy great secular growth companies at 40% to 50% discounts.

In other words, the seeds of tomorrow's profits are sown in the depths of bear markets.

Unfortunately, right now I can't come up with any scenario that would lead me to call a bottom. Instead, I see evidence of 10% more downside in the major indices, and another 30% to 40% downside for the financial services companies. These wounded institutions are only about 40% of the way through the trillion dollars worth of bad loans that need to be written off.

There is no reason to believe that this bear market will be an average one -- i.e., a 30% fall from the previous market highs that lasts about a year and a half -- because none of its causative elements are average.

Bear markets that anticipate recessions are typically caused by the Federal Reserve raising short-term interest rates too high to fight inflation, or by the bursting of an asset bubble like we saw in 2000-2003.

It's true that this bear market and economic slowdown were caused by an asset bubble bursting -- subprime mortgages and the housing market in general -- but this time the Fed has no silver bullets left to get the economy back on track.

We're sailing in uncharted economic waters, folks. Let's call it the first bear market of the global age.

Traditionally, when the Fed cuts rates significantly, it kick-starts a homebuilding cycle, which boosts the durable goods cycle, mass layoffs turn into mass hiring, automobile sales take off, and this all gives way to a new economic expansion.

Yet, we have none of those economic catalysts today.

Rather, we have 12 months worth of housing inventory (the normal level at a recession bottom is about two months), $4-per-gallon gasoline (it cost $2 per gallon in 2003), and a credit rot that has spread to credit cards, auto loans and home equity loans.

So, we're missing the near-term catalyst that could create the next expansion.

The Fed could lower short-term interest rates to 1%, but with the amount of credit banks are extending to customers down 9% year-over-year, credit is not getting to the market. Plus, further cuts would hurt the U.S. dollar, which would cause oil prices to go even higher.

And with deleveraged financial institutions, lower short-term rates are not translating into lower mortgage rates, especially in jumbo loans.

That's all bad news, but it shouldn't stop you from making money now. As a matter of fact, we're making a ton of money taking advantage of these tough times.