Dow drops 3.29%

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Today all our major market indices lost more than 3% on the day – the worst intraday loss for the Dow, the S&P 500 and the NASDAQ since March 24th, 2003. All 30 Dow stocks lost ground today. All but 4 stocks in the S&P 500 lost ground. The NASDAQ didn’t crash, but it sure came unplugged from its year-to-date gains.

It was ugly.

All the indices regained measurable lost ground in the final hour of trading (the Dow regained nearly 200 points having shed 545 points, a 4.3% loss, at its nadir). But that’s just a silver lining, and I don’t expect it to insulate us from further sell-offs in the near-term. In fact, I think that today’s sell off that was triggered by a sell off in the Asian and European markets earlier in the day is likely to continue back across the global markets tonight, setting the stage for a vicious circle that could poison tomorrow’s well and will no doubt make for exceptionally volatile days ahead.

That said, there are no trades recommended for any of our portfolios. Here’s why.

Our Portfolios Are Designed With Bad Weather in Mind

Our portfolios remain well diversified and well founded upon our proven risk-adjusted investment discipline which has weathered much bigger storms than today’s gale. Our proprietary manager ranking system which rewards managers equally as much for losing less in downdrafts as it does for gaining more on the upswings is at the core of our portfolio construction. Our defensive maneuvering in January will look a bit smarter after today, but it hasn’t hindered us from gaining measurably better ground relative to the markets at home and abroad year-to-date, last year, over the past 3-, 5- and 10-years. Simply put, Fidelity Investor’s portfolios are designed with bad weather always in mind.

Sell Off Not Welcome, But No Surprise

Hopefully, last week’s Hotline paved the emotional way for what happened today, making the sudden sell off a bit less unnerving, albeit not more welcome. I said, “The markets have been buoyed by a continuation of five mega-trends; reasonably good earnings, moderately declining oil prices, mergers and acquisition news, the Fed’s soft landing, and a general status quo on all geopolitical fronts. If any one of these trends hits a bump in the road, look for the markets to get a flat and have to pull off to the sidelines fairly quickly; here, there, anywhere, a sell off of 10% inside of a month or two’s time frame wouldn’t surprise me a bit. And even if all the above trends remain in place, I wouldn’t be surprised to see the markets give up some measurable ground; we’re now on the second longest winning streak for the Dow in its history, and all other major market indices are at recent or historical highs (even the S&P 500 is at a 6 ½ year high), meaning they’re prone to a pullback.”

Today, the markets at home and abroad got that flat tire and then some.

Why a Pullback Is Not a Setback … Yet

Over the last several months we’ve been talking about the positive trends supporting current price levels in the markets at home and abroad, from reasonably good earnings, a Goldilocks economy, domestic and global economic growth, and jobs chief among them. We’ve also been highlighting the troubling near-term signs, from escalating oil prices, to geopolitical impingements, to the ongoing correction in the housing market. But the one area I’ve most focused on most has been the fairy tale rally’s promise of a happy ending. The fact is that even including today’s sell off we’re still on the second longest winning streak for the Dow without a 10% correction in its history; the longest winning streak was snapped on October 19, 1987, dubbed Black Monday because the market lost over 22% on the day.

As I said last week, “Since all our major market indices are at recent or historical highs, they’re prone to a pullback”. Today, given the current economic underpinnings for sustained slow growth here at home and for manageable growth abroad, it’s unlikely that this is a anything more than a healthy pullback along the way to higher highs by year-end. It may be very tough sledding between now and then – but together, we’ll make it through any tough times safe and sound.

What Triggered Today’s Pullback?

Economic News: the markets being ahead of themselves for one. For another, the Durable Goods report (a report which reflect sales of big ticket items meant to last 3 or more years – such as cars, refrigerators, and technology). The Durable Goods Orders were down more than twice as much as consensus estimates; even if you back out a steep decline in Aircraft orders (which were down 60% compared to the prior month) making it basically a seasonal blip, ex-transportation durable goods fell slightly more than 3%. The key number inside the report from my perspective is the one that relates to business spending which was down 6%. That is a troubling sign since business spending is the safety net beneath consumer spending. If both slow or decline then recession looms larger than currently is thought or priced into the stock and bond markets. (An exhibit of this: the Fed funds’ futures chances of an interest rate cut doubled from 20% to 40% on the durable goods news.)

China Shanghaied Our Markets: I have been mentioning for over a year that I expect China’s breathless growth pace to have to slow. When it does, I’d look for most markets to stumble and energy to free fall. Today, we saw the Shanghai index experience its largest single day drop in a decade (losing nearly 9%), but that sudden sell off was set against the backdrop of the prior 6 trading days which saw that index soaring over 13%, so it looks like little more than profit taking as opposed to a macro-economic review of China’s current growth rate stalling. Nevertheless, the markets abroad and at home viewed the sell off as if it were confirming such a slow down. Time will tell.

What the Former Fed Said: another catalyst for today’s sell off was a speech delivered a few days back when the former Fed Chairman Allan Greenspan intimated that our economy could enter recession by the end of this year. The markets ignored that talk yesterday, but revisited it with urgency in light of the Durable Goods Report today. A correlated concern emerged today, namely that our Fed equivalents in Europe and Japan may be tightening too much, too quickly and hence running an increased risk of slowing growth too much.

Silver Linings

The sell off overrode a few economic reports; consumer confidence rose to its highest level in five-and-a-half years amid optimism that the nation’s economy is creating enough jobs, a private research group said Tuesday. (Home prices fell in December, but were still up net, net for 2006.) Also, existing home sales rose 3% in January, the biggest percentage gain in 2 years, according to the National Association of Realtors. Credit the price correction and continued low mortgage rate environment.

Looking Ahead

I’m putting the finishing touches on your March newsletter, wherein you’ll get the answer to the question I posed last month: should we or shouldn’t we add our first new model portfolio in 10 years? Your input in making this decision was invaluable (and I’ll make sure and share a varied sampling of it). Also, timing is everything! Our FidoFiles blog is now live – a perfect forum to vent, fret, and provide solace to members in the event of today’s aftermath, and for all future events. As always, I’ll be here through thick and thin, looking for ways to maneuver if we must, or batten down the hatches in order to keep to our profitable long-term course. Chin up!