Commentary for the week ending 5-7-10

Despite a beautiful week here at the TPC Sawgrass for The Players golf tournament, it was a downright awful week on Wall Street as stocks sold off sharply and volatility increased. At the close on Friday, the Dow dropped 5.7%, the S&P lost 6.4%, and the Nasdaq plunged by 8.0%. Gold rose to a new high for the year, while oil dropped back to the mid-70’s level.

Source: MSN Moneycentral

Odds are you have already heard about the record drop in the market on Thursday. Stocks had been trending lower all week, but the selling intensified that afternoon. In a matter of minutes, the Dow plunged several hundred points, putting it down nearly 1,000 points for the day and just below the 10,000 level. Many stocks were down 30 or 40%, while some even fell to just one penny. It was certainly a nervous, but also exciting, moment for us. Within a few minutes, stocks recovered and rose substantially, as you can see in the chart above.

So what happened? Markets were already nervous as images of the Greek riots reached the U.S. Investors are worried that the debt problems with Greece will spread to other European countries, and in this modern global economy, it will affect the United States. As these riot images were shown, selling intensified and the market dropped. Some believe the catalyst was a trader accidentally hitting the ‘B’ button instead of ‘M’ for million when entering a sell order. This triggered panic selling and computers programmed to sell at certain levels were firing rapid sell orders. All this pushed the markets sharply lower.

This explanation makes sense, but we still have reservations. A typo between the ‘M’ and ‘B’ buttons would certainly be rare, but not completely unheard of. Still, this is the first time it happened? And it took down the entire market? Again, we, nor investigators, know what the main culprit was, or if there even was a culprit. Hopefully our market system is not so fragile that a simple mistake could bring it down like we saw Thursday.

As mentioned earlier, the drop was an exciting event for us, too. By our nature, Bluefin tends to have a value-investing theme, meaning we like to buy stocks when their prices are lower and showing signs of future growth. A week like last week gives us more opportunities to find and buy undervalued stocks. We don’t know what the market will do in the future, but having a long term focus and buying stocks at low levels is usually a recipe for outperformance.

Despite the negative mood on the Street at the moment, we received several encouraging economic reports that continue to show strength in the economy. Manufacturing continues to strengthen. Employment increased by 290,000 last month, with Census workers comprising a smaller portion of that than we anticipated.

Additionally, banks appear to be loosening lending standards, so business lending should be rising in the future. However, we believe that this may be the catalyst to higher inflation. Since the credit crisis ended, banks have been steadily increasing their excess reserves, aided by the easy money policies of the government. As money was being printed at record levels, the money supply has remained relatively flat. This excess money has been going to the banks, plugging up the losses from bad loans and building excess reserves. Once the bank begins lending these reserves out (and considering the money multiplier), the money supply will jump and inflation will ultimately rear its head.

Next Week

Next week we continue to receive corporate earnings and several economic releases that could impact the market. Inventories, import prices, retail sales, and industrial production are some of the reports we will be receiving. Despite the macro events currently in focus, any surprises here would certainly impact the market.

Where are we investing now?

Markets are clearly trending lower and we won’t pretend to know how long it will last. As stocks become cheaper, they become more attractive to us and we will step in and buy. As we have said in past reports, we are optimistic through the end of 2010 since the easy money and stimulative measures will help push the markets higher. Higher interest rates, higher taxes, increasing government involvement in the private sector, and a still-high unemployment rate have us worried for the longer term.

In equities, we are focusing on higher-quality and multi-national stocks. We continue to avoid banking and insurance sector stocks. TIPs are important as we expect inflation to increase in the future, while U.S. treasuries are a sector we are very bearish (pessimistic) on as yields will increase over time. Commodities remain a longer term favorite, as inflation will also impact prices to the upside. Government policies will weaken the dollar over time, despite its recent rise. Municipal bonds will play a more important role in our portfolios over the coming months and years as higher tax rates take effect. Finally, we are optimistic about international stocks, as emerging markets (excluding China) are areas we favor.