After a violent 3 week sell-off from record levels on July 16th, US stocks turned in a positive week last week and are sharply higher this morning. Last Thursday morning, European, and then US markets were slammed by the news that certain European hedge funds were suspending redemptions as a result of their losses from credit derivatives based on US mortgages. The US Federal Reserve Bank intervened in the credit markets by absorbing certain mortgage backed securities issues through the repurchase market. The repo market is a mechanism for injecting cash into the banking system by buying bonds on condition that the bonds be sold back to the seller either overnight or in subsequent days at a pre-determined price. By focusing on the MBS issues, the Fed was able to establish prices for those securities so that traders could mark their portfolios to market (and determine exactly how much money they had lost, which is better than not knowing.)

A tug of war is still going on between investors who are frantically dumping stocks to raise case to cover losses in their credit strategies, and investors with cash who are eager to snap up bargains. We believe that the combination of solid earnings growth for US corporations, solid economic growth in the US and worldwide, and low inflation despite record prices in many commodities favors the bulls, so we’re staying fully invested. We believe that the current correction will be in the rear view mirror by the end of September, with the S&P 500 closing out the year up 8-10%.

Strategy
Some of our clients have asked, “if we saw the sub-prime meltdown coming, should we have sold stocks in advance and bought back at the lows?” Unfortunately, it’s impossible for us to determine exactly what is the tipping point that will cause investors to go from wildly bullish to wildly bearish. We have been waiting for the US housing market to break since 2004, but if we had sat out of stocks that whole time, we would have left returns totaling about 25% on the table. However, in anticipation of crises like this one, we always position our portfolios so that we never forced to sell when we don’t want to.

As always, please don’t hesitate to call with questions and concerns.