Commentary - The End is Near

I struggled all weekend to come up with a title that would truly capture what I felt after last week's, worst week ever for the stock market. Finally, I decided to call this commentary "The End Is Near." You better sit down before you read this, as this is the day many of you thought would never come from me. Well it has!

Right about now, you probably are thinking which "end" is near? Is it the end of the world as we know it? Remember those people in the 1960's with long hair and beards that used to carry around signs that proclaimed "The End is Near"?  Were they right?

Or is the "end" that I am referring to the end of this bear market? What began as a teddy bear has quickly turned into a grizzly bear and history very well may record it as one of the worst bear markets in the history of the stock market. I will let you decide for yourself which "end" I am talking about after you read my commentary.

Worst Week Ever
Words can't even begin to describe last week's complete collapse in our stock market.It was the worst week ever for the Dow (Dow Jones Industrial Average) which was down 18% for the week. Prior to last week, the Dow's worst week was in 1933 during the Great Depression. In case you are wondering what "the big one" feels like, it feels exactly like this. Also Friday marked the most volatile single day in the Dow since it was created back in 1896.

I was in the Fox Business News studios in New York on Friday morning. I arrived there about 9:30a.m. Eastern Standard Time as the stock market opened. It quickly fell almost 700 points (697 to be exact); this was on the heels of Thursday's 678 point collapse. By the time I was live on the set and being interviewed at 10:10 a.m. Eastern Standard Time, the market already recouped that loss and was positive. After I spoke, the market continued to take off (I am not taking credit for that unless you want to give me some). At one point, the market was actually up 322 points for the day. It eventually closed down -128 for the day. However, that one-day swing of 1,018.77 from (-697 to +322) is the largest single day swing (from low to high or high to low) ever. What does it feel like to be a part of history?

Same Week, Historic Public Policy Response
It is almost impossible to comprehend that the entire panic sell-off in the stock market occurred in the very same week that we witnessed historic governmental and public policy responses regarding this crisis. Think about it.

On Monday, came the announcement that the Federal Reserve (Fed) would pay interest on reserves. This policy allows the Fed to expand the amount of reserves it provides without affecting its target interest rate. On Tuesday, the Fed announced it will buy high quality 3-month commercial paper outright with the establishment of the Commercial Paper Funding Facility (CPFF). The sharp drop in commercial paper activity was threatening to cause even larger disruptions in the real economy as rates were spiking, and the market was drying up. To prevent these disruptions, the CPFF, set up in conjunction with the Treasury, will purchase commercial paper directly from both financial and non-financial companies.

Then, Wednesday took an international turn, as central banks around the world performed a coordinated global rate cut as the Fed cut rates 50 basis points- a cut that was matched by the Bank of England, the European Central Bank, and the Bank of Canada. The Swedish Riksbank and the Swiss National Bank joined their larger colleagues and also cut rates by 50 basis points. The Bank of China lowered rates 27 basis points (their standard increment). And meanwhile, the Bank of Japan did not lower rates, but expressed support.

This was followed on Thursday by central banks in Hong Kong, South Korea and Taiwan joining their Western counterparts in reducing interest rates in a coordinated effort to prevent the credit crisis from potentially triggering a global recession. And throughout the week, policymakers clearly intimated that the authority granted under the TARP might be used to purchase equity directly in financial institutions. And despite all the promised interventions, the stock market had its worst week in history.

This is what it feels like when fundamentals don't matter and everyone makes their investment decisions based on fear.

Fear Turns to Panic
And from my perspective, we are now being driven by panic. As I travel around the country, I have often talked about how "fear and greed" drive our investment decisions. "Greed" mistakenly urging us to "buy high" and to think that markets can go only higher. And "fear" mistakenly urging us to "sell low" and to think that markets can only go lower. How upside down can we get? We are supposed to "buy low" and "sell high," yet when fear and greed take over our mental state, we do  the opposite.

I actually think that we have moved beyond "fear" to "panic."  We witnessed a massive 3% liquidation of the entire money market industry in one day that was a run on the bank, just like the Great Depression, only we didn't see it. In photos taken during the Great Depression, all we saw were people lined up around banks, getting their money out. Well, there was no line of investors waiting to get their money out of money markets. They either went "online" or got out on their own by picking up the telephone or telling their financial advisor to get them out. Just because you didn't see it, doesn't mean it didn't happen.

Need some proof that we are now in a "panic-driven" market? Of the 9,194 stocks tracked by Standard & Poor's Computstat Research, 3,518 are trading at less than 8 times their prior year's earnings. The historic average for stocks is to trade 16 times their prior year's earnings. This stock market is not just on sale, it is the K-mart "blue light" special. This is a 50% off fire sale. So where are the buyers?

Here is some even more compelling proof. A total of 876 of the 9,194 stocks (or nearly 10%) are actually trading below the value of their per share holdings of cash. That is simply impossible to be happening. A company at the very least has to be worth the cash it has in hand, doesn't it? This is exactly what "panic- selling" looks like. Or viewed another way, it is what a buyers' strike looks like.

Did you ever wonder why stocks are the only product that retail investors refuse to buy when on sale? That's not the way we buy cars. We won't even go into a showroom, unless the sign in the window says "deep discounts available," and, even after that, we negotiate for an even lower price. We buy our clothes on sale as well as our shoes and our groceries on sale. As US consumers, we typically buy anything that's on sale - anything that is, except stocks. Maybe what we need to do to turn this market around is to hang a huge banner from the New York Stock Exchange that says "40% - 50% off". Maybe then, investors will realize the unbelievable buying opportunity this is.

Things Appear Worse Than They Actually Are
While I am the first to admit this is the worst market I have seen in 30-plus years in and around this industry and that history may record this as one of the most challenging investment environments, I also want you to know that it also appears worse than it is, especially if all you do is focus on these unprecedented point drops in the Dow.

After all, on Monday, September 29, 2008, the day the original T.A.R.P. legislation failed to pass the House of Representatives, the Dow fell 777 points, becoming the single largest one-day drop in history. And just this past Thursday, when the Dow plunged 678 points, it became the second largest one-day point drop in history. In fact, of the top 20 single-day largest point drops in the history of the Dow, eight of them have occurred this year. That means 40% of the single worst point drops (or the top 20 most point drops) occurred this year in 2008.

If however, instead of just focusing on the headline-grabbing "shock and awe" point drops in the Dow, you instead focused on the single-day largest percentage drops in the Dow; we would see a much different picture. In fact, of the top 20 largest single percentage point drops in the history of the Dow, only two have occurred this year. That would be 10%.  Somehow 10%, doesn't appear quite as bad as 40% now does it? Things aren't always as bad as the "shock and awe" headlines make it appear.

Let's Reform the G-7 as well
While we are fixing things, what about fixing the G-7 (or Group of 7) as well? While all eyes were poised on Washington D.C. this weekend as top finance officials from around the world came together, my eyes were on the make-up of the G-7. Remember if you will that the G-7, originally the organization of the seven leading industrialized nations of the world, was formed so that the leaders of the world's richest nations could come together and talk about economic development. The seven members of the G-7 are the US, Japan, Canada, the United Kingdom, Italy, France and Germany. So we are facing what is clearly a global crisis and we don't even have the right global players at the table?

In my opinion, we should at least include countries that have  $1 trillion economies. After all, a trillion here and a trillion there actually starts to add up to real money. Under my trillion dollar plan, it would mean China, India, Mexico, South Korea, Russia and Brazil would also need to be added, because all six countries have annual gross domestic product (the broadest measure of the economy) exceeding $1 trillion.

If we are really serious about fixing things, let's fix the make-up of the G-7 to reflect the changing global landscape. It's time for the G-7 to go global, go global and go even more global.

In closing, I am so happy that the end is near. And yes, the end I am talking about is the end of this "panic-driven," grizzly bear market. That doesn't mean that everything will turn around quickly. It will take time to fix the problems that greed, leverage, and a lack of recognition and measurement of risk created, but we will. Now more than ever, it is important for investors to stay broadly diversified among all asset classes. And when the markets return to being rationale that is where I believe investors are likely to be best rewarded. Let me tell you what my wife Cheryl and I are doing with our investment portfolio during this "panic-driven" crisis. We have not taken our money out of the bank and placed it in our mattress. We have not sold our investments in the US  stock market. We have not sold our investments in the international stock markets. We have stayed the course in the bond market. We are still invested in real estate, commodities and infrastructure. I think that it is important that you know exactly what we are doing with our money so you don't view me as just some "talking head" on television that says one thing, and does something else with my own money.

When all is said and done, I believe that good will win over evil. And I believe that right will win over wrong. I also believe that a bull market will win out over a bear market.  And I believe that a positive attitude is the single most important attribute in life.

Have a great day, keep a positive attitude and please join me in resolving to remain a long-term investor in a short-term world.

Oh, and in case you still think the world is coming to an end today, remember it's already tomorrow in Australia.

Dr. Robert J. Froehlich is Vice Chairman of DWS Investments and serves as Chief Investments Strategist.  DWS Investments is the US retail brand of Deutsche Bank’s global asset management division.

All investments involve risk, including the possible loss of principle.The opinions and forecasts expressed are those of Dr. Robert J. Froehlich and not necessarily those of DWS Investments. All opinions and claims are based upon data at the time of the publication of this article, October 13, 2008, and may not actually come to pass. This information is subject to change at any time, based on economic, market and other conditions and should not be construed as a recommendation.