Yesterday the DOW fell over 400 points and today the US market averages are poised to gap down over a percent before the open. Here we go again you must be thinking to yourself.
Well actually what started a few weeks ago when the DOW fell over 1,000 points in three days never came to an end. Yes we saw a bounce for a bit after that big drop that brought new hopes to some, but when a market falls that much that fast it causes damage that makes it virtually impossible to simply turn around and go straight back up to its 52-week highs. Bottoming after a drop is a process that usually take two weeks to play out.
The problem is many investors off all stripes - including institutional investors - don't think in terms of probabilities - they simply make decisions based on fear. And when it comes to investing the fear of missing out on possible gains always trumps the fear of losing money for most. That is why people buy into tops and sell into panics over and over again. It is as if they can be involved in the financial markets for years and never learn anything.
They aren't the only people who cannot learn.
Right now it is problems in Europe that are really dragging down the US markets. Most European countries are on the brink of recession and the threat of the debt problems in Greece and Ireland have now spread to Italy and Spain. A recession in Europe will not help an already fragile US economy.
Two weeks ago European regulators did a very dumb thing. They issued a decree banning short selling in bank stocks.
That almost guaranteed a big sell-off in bank stocks would occur and it did yesterday. Across the board European bank stocks fell 5-10% and this morning before the US markets open they are down a similar amount.
Back in 2008 right before the October stock market collapse the SEC and US regulators put a ban on short-selling. It was part a political ploy to make it look like they were on top of things and to also blame market declines on short-sellers instead of the reality that the largest US banks were so overleveraged with subprime garbage that they were practically bankrupt.
The problem is short-sellers actually buy stocks when they go down. Short-sellers take positions against stocks on rallies and cover their position by buying stocks when they decline. Short-sellers actually help to make the market less volatile not more. So short-sellers are buyers during market dumps and big down days.
By eliminating the short-sellers from the market in 2008 US regulators helped to contribute to the market collapse. They helped to create a condition of low liquidity in the October selling dump.
And now European regulators have made the same exact mistake all over again.
So it isn't only traders who don't learn from markets but regulators too.
The problem is traders just lose their money or their jobs when they mess up while regulators can ruin entire economies.
The recent ban on short-selling was one of the dumbest things to come out of Europe this year. And today American investors holding on to their stocks for dear life are going to pay the price at least this morning.
When you ban short-selling you create a situation where short-sellers aren't there to buy on big market declines. You create a complete mess.
Yesterday the VIX closed above 40 while the ratio of down to sell volume on the NYSE and Nasdaq went above 9:1. It was a day of selling panic.
The good news is at this point a double bottom for the US market averages is likely. The market is right now essentially heading for its recent lows and panic and big selling accelerated yesterday. The averages are far enough away (about 300 points on the DOW) that they are likely to put in a new bottom above those recent lows.
That would lead to a better rally over the next 6-8 weeks and then another big trading range for the market averages that probably won't be broken out of either way until the first quarter of next year - and at this point the risks favor a breakdown to the downside then.
So if you want to buy stocks you may want to just average in now. Personally I don't think this is an exciting time to be doing much buying as we are in bearish conditions that I think will continue for another 8-12 months, but most people feel they must be in the market. If that is you now is the time to get in - not two weeks ago but now. I don't really see any sectors that look better than others and simply buying a market average ETF like SPY or SSO would be a simple thing to do.
Going forward I still expect gold to be the best game in town. I'll have more specific ideas and sector analysis for Power Investor members over the weekend.