Bullish, But Four Reasons for Caution

It is, at best, a confusing time for investors. The damage has happened faster than at any other time that I can recall. In 1987, we had the biggest one-day drop, but in 2008, the succession of down days has been unlike anything anyone has ever seen before. September brokerage and retirement-plan statements were a nightmare, leading many to exit equity portfolios. Wait until investors see October's values.

I wrote several times last month that a down close for the month would give us the fourth down quarter in a row, a condition that led to additional 30% declines the last time it happened. I had no idea it would happen in three weeks!

Those of us who focus on value are having a particularly difficult time right now. I am seeing the types of results from my screens of value names that are consistent with previous bottoming phases of the stock market. While many claim to focus on just valuations and ignore the market backdrop, I think that could be costly in today's environment. That worked in the past. However, conditions are very different right now.

The simple truth is that because of governmental actions, it is different this time. The nature of the markets themselves has been changed, probably permanently by the government. The pea soup of new initial agencies and facilities is unprecedented in financial history, making the nature of the banking and investment industry far different than it was just a year ago.

How this plays out and the implications for the stock market are unknowable right now. We are already seeing signs that the money that was made available to banks so they could begin lending is instead being used to acquire other banks and shore up their own balance sheets. This is far from what we were told would happen with the money. The long-term interest rate, tax and market structure implications of these actions are, in my opinion, negative.

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At the time of publication, Melvin was long Darling International, Ashland, Cleveland Cliffs and CBS, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.