vaughnwoods

Now that the banking bailout bill has been passed and signed by the President, let’s review (a) the damage that has been unleashed by the freeze up in the financial markets (b) how this damage compares to other bear markets and (3) a look at what appears to be a best of strategy practice going forward.

Peak to trough this market has fallen 29.7% as of this writing. This compares with an average peak to trough decline of 28% when accounting for all bull–bear cycles since 1945. According to value research analysts at Credit Suisse, the S&P 500, which traded at 52-week high of 1576.09 in 2007, represents good value now. Estimates now call for a worst case scenario in which the S&P 500 falls to 1040. If analysts are correct we are only 4.5% above the 1040 mark as of this writing. It may seem foolish to pick a floor in this market. Escalating fear can cause investors to overshoot fair value on the downside. However, if downside overshoot occurs policy makers will act quickly. An additional rate cut is expected soon anyway.

Given the increasing likelihood that a buy strategy offers more value than a sell strategy, the following set of conditions are being watched carefully as a prudent entry point.

• a) S&P 500 hits at around 1050
• b) The European Central Bank cuts rates (or it appears imminently obvious they will shortly).
• c) There is a clear private sector solution to banks; that is, the reverse auction strategy is workable and accounts for some form of public participation at some point.
• d) Certain standard deviation capitulation measures are breached

At this point we are close in all four categories, though some time is necessary for these forces to come together. Historically, bonds outperform stocks for two-three months after a major financial bailout, after which stocks begin to outperform. Bonds offer better value than stocks in the months following investor panic. During the previous three banking lifeboats (the US based RTC, a Swedish bailout and Japan bailout) banks troughed three months to 3. 5 years after the implementation of the bail-out. In the last Resolution Trust Corporation bailout, US banks rallied by 23% in absolute terms over 6 months -between the announcement of the RTC and its implementation.

Enough moral hazard has been seen in both the debt and equity markets to ensure these mistakes will not be quickly repeated. Politicians and attorneys will invest the next four years tweaking old rules and inventing new ones to make sure this never happens again. In summary, with a Federal Reserve rate cut forth coming, step one is an increase in interest sensitive investments. This will be a short lived and thereafter include equity value propositions since both bonds and equities offer good value at this time.

Contact us to learn more about working with Vaughn Woods Financial Group.

Best Regards,

Vaughn L. Woods, CFP®, M.B.A.

*Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views off Delta Equity Services Corp. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0020

**Credit Suisse, Market Edge