RealMoney Silver - OK -- Things Are Bad. Now What?

OK -- Things Are Bad. Now What?
By Tim Melvin
RealMoney.com Contributor
3/14/2008 3:06 PM EDT

I am so relieved. The Fed has come with a miracle plan to rescue Wall Street and all the money will trickle down to Main Street and save the day. The government will engineer a solution to the housing crisis, and calm and prosperity will return to the markets.

That seemed to be the mood of the day around Wall Street yesterday, and I am somewhat incredulous that so many highly educated individuals think this path will possibly come to fruition. The selloff reversed Thursday on news that the mortgage writedowns will end someday, as announced by Standard & Poor's. Of course, they said raised their estimate of the total of all the writedowns another $20 billion to $285 billion, but that was overlooked.

The end to the carnage is "in sight." Who cares if nearly a third of a trillion dollars has been wiped out? It's almost over. Happy days are here again! Tuesday's rally is pointed to as a sign that the market is ready to bottom. Does anybody really think that was real long-term investment buying? It was short-term speculation and a massive dose of short-covering at best -- neither of which marks a real fundamental market bottom in my opinion.

The rest of the news is not bad. It is horrible, especially for the real estate market. Foreclosures are rising at an unprecedented rate. According to the research firm RealtyTrac, the number of homes that have received at least one late notice was up a stomach churning 60% in Febuary. 223,000 homeowners are at least one payment behind right now. A total of over 46,000 homes were taken back by lenders nationwide.

There is no sign of improvement either. Mortgage applications for new homes fell by almost 2% and refinance applications fell by almost 5%. Since cash-out refinance has been one of the major sources of consumer discretionary cash, I do not see how any of this bodes well for an economic or stock market turnaround anytime soon. To add insult to injury, mortgage rates are rising as longer-term bonds sell off on continued inflation fears.

Judging by prices in many commodities markets, those fears are justified. Gold is over $1,000 an ounce and oil has risen to over $110 a barrel. Gas at the pump averages $3.25 a gallon right now. A report from the World Bank says that all over the globe the cost of heating your home and feeding your family is spiraling. Wheat is up a double-digit percentage, rice is up over 20% in price and coffee went up 15%. That's just in February, by the way.

While the cheerleaders in the U.S. may think that happier times are ahead for the domestic economy, the rest of the world does not agree. The dollar continues to fall, reaching new all-time lows against the euro and 12-year lows against the Japanese yen. Whether the Fed cuts rates by 50 basis points or 75 next week doesn't matter. Either way, the lower short-term rates available here in the U.S. is going to have a further negative impact on the level of the dollar against the major foreign currencies. As for the long rates, which have increased somewhat, forget it. No one has any interest in 20- and 30-year bonds of a nation that appears to be facing a very real risk of stagflation. With the dollar so weak, an investor with that long of a time frame will buy real assets, such as companies and possibly at some point commercial real estate.

So, it is a little bleak. I do not see the type of negativity that I have historically associated with a bottom. When all the talking heads are negative or waiting tables, I will get very bullish.

What does an investor or trader do until then? If you are a trader, sell the rallies, particularly in the groups that have the most exposure to economic weakness. My favorite, as you know, is the investment banks and broker/dealers. Not only do they face the prospect of weak earnings, they have some very real potential liabilities from the mortgage mess. When we get large selloffs marked by a string of big down, days be aware of the prospect for the sharp, quick, bear-market rallies and position yourself accordingly.

Investors should remain very cautious. If you are fairly aggressive, as I am, with your longer-term investments, you can use combination trades to take advantage of relatively high option volatility. You can do this right now on many of the stocks I have talked about, such as Ford (F) , Assured Guaranty (AGO) and Borders Group (BGP) . Buy the stock and sell both puts and calls on the position. You agree to sell the stock higher, or buy more at lower levels. Make sure you like the stock and want to own it, however. There is a good chance of getting put the stock lower!

Always be looking for the too-cheap-to-ignore stocks that have gotten beaten up to the point you do not care what the price does in the short term. I call these my five-year stocks. Some names like this that I have mentioned are Charming Shoppes (CHRS) and Hilltop Holdings (HTH) . I am not a permabear by any stretch. I cannot wait to be cheerfully buying stocks again, and I am salivating at the prices I will be able to buy my favorite little local banks for in the months to come. But I don't think it is time yet for unabashed bullishness. I would rather miss a rally than get caught in a collapse right now.