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This is Sy Harding's weekly (Fridays) newspaper column, which appears in newspapers as well as on several financial websites. Other websites may use this article as content for their own site as long as full credit is provided exactly as worded at the bottom of the article.

BEING STREET SMART

by Sy Harding

Unfavorable Season Not Pretty So Far! August 10, 2007. 

Investors have had a fairly nervous time of it since the stock market's peak a month ago. Even after triple-digit gains on Monday and Wednesday of this week, the Dow, S&P 500 and Nasdaq are still down roughly 6% over the last four weeks.

But it hasn't been the declines so much as the brutal volatility. Eleven of the last 16 trading days have seen triple-digit closes by the Dow. Seven were to the downside for a total of 1,708 points, while four were to the upside for a total of 689 points.

For the most part, wealthy investors in hedge funds have had it worse. Most don't even know how much they may have lost. Hedge funds have varying degrees of leveraged exposure to exotic derivatives backed by mortgages, which produced large profits for them during the housing boom. But the mortgage defaults of recent months have significantly decreased their value. The bigger problem is that no one knows what those holdings may be worth at this point. With virtually no market for them, where buying and selling would determine the price, all any one knows is that they are worth less than a year ago, or even six months ago. And with the positions leveraged, it doesn't take much of a decline to totally wipe out a fund's value.

A six percent decline in the stock market would be nothing to worry about if it were not for those surrounding conditions. The market has been overdue for a normal 10% correction for some time. Bull markets recover from those fairly quickly and go on to new highs.

But even Wall Street's confidence that this will be a brief pullback has been fading under the continuing bombardment of bad news. Every day seems to bring news of some hedge fund or mortgage firm closing up, more evidence of the freezing up of financing for homes, for LBOs, and more concerns of a potential system-wide credit crunch.

Donald Trump weighed in on the bear side Friday predicting on CNBC that the nation is headed into a recession even if the Federal Reserve cuts interest rates, and something worse than a recession (he didn't say what's worse) if the Fed does not step in. Countrywide Financial, the largest home mortgage lender in the country warned that "unprecedented' problems in the secondary home-mortgage market pose a serious threat to its financial condition, and that it now expects the housing slowdown to last at least until 2009. Polls show the majority of Americans believe we are already in a recession or soon will be.

The Federal Reserve has not exactly been on top of the situation. In fact, this week the Fed looked like it had just woken from a year-long sleep. On Tuesday, it held its periodic FOMC meeting, and emerged with an announcement that it was leaving interest rates alone, that while it is aware of the market volatility and tightening in credit markets, it remains more concerned about inflation than the economy.

Two days later, on Thursday, the Fed seemed to wake up, and panic. Three hedge funds in France announced they were closing due to losses caused by "the complete evaporation of liquidity in certain segments of the U.S. securitization market, which has made it impossible to value certain assets fairly, regardless of their quality or credit rating". And a report was published that several large 'quant' funds (funds that base their positions on computer models), had double-digit losses in July, and others may be having the same problems. Before the U.S. markets could open, the awakened Fed intervened by injecting an extra $20 billion of liquidity into the banking system. Unfortunately, it did nothing to calm the renewed panic created by the news of still more financial firms in trouble. The Dow closed down a big 387 points for the day.

By Friday morning it was known that markets in Asia and Europe had plunged sharply again overnight, in spite of their central banks also injecting additional $billions of liquidity into their banking systems. And U.S. stock futures were pointing to another ugly day. The Fed intervened again to add liquidity. But the market began Friday to the downside anyway, with the Dow soon down more than 200 points. Twice more during the day on Friday the Fed poured more liquidity in, a total of $38 billion for the day. And the markets calmed down. The Dow recovered enough  to close down only 31 points.

But will the Fed's almost panicked intervention in the financial market after its 'no problem, folks' FOMC report on Tuesday, convince markets that the worst is over? Or will it raise concerns that the Fed has learned there are still more time bombs ticking out there, and is suddenly worried.

Sy Harding is president of Asset Management Research Corp. which publishes Sy Harding's Street Smart Report, the financial website www,StreetSmartReport.com, and the free daily www.SyHardingblog.com.

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