Are we crashing? Dow Jones is below 10,000!

Although it could feel like we are crashing, stocks are likely readjusting to an overwhelming amount of negative data covering the credit market, the financial sector, and the underlying economy. The fact is that we are seeing stock market moves of historic proportions.

Justifiably, we are living in historic times. Some analysts say that this market move is a result of the “buy the rumor, sell the news” phenomenon following the approval of the rescue plan. It is likely that the news of a rescue plan was relatively holding up stocks over the short-term (even with the impressive declines). The market was clearly aware that there was no such thing as a one time miraculous rescue plan. (This just makes me wonder how immediate the stock market decline would have been without the plan and what the consequences would have been.) Now the markets are going back to evaluating the true damage in the credit system and the economic slowdown.

The good thing about these generalized declines is that it is generating some cheap stocks, or buying opportunities. Share prices are falling so much that price to earnings ratios as well as dividend yields are becoming very attractive. During regular market times, these “special offers” would be gobbled up immediately by investors. However, now there is lots of uncertainty. There seems to be many bargains out there, however, the ratios are based on past earnings estimates and we could not be too sure of how accurately these reflect company performances. All this market turmoil will undoubtedly affect the underlying economy, we just need to know how much it will affect the demand for company products and services. If companies do not perform much worse than estimates and if we believe that the economy will start its recovery sooner rather than later, then there could be some really big buy opportunities.

The other threat to the buy opportunities presented by high dividend yielding stocks are that the economic troubles could cause these companies to lower their dividend payments, another uncertainty. In that case, it would be important to limit our focus to companies with large amount of cash. To summarize, the currently attractive p/e ratios and dividend yields could be short-lived because they are lagging indicators since estimates will be based on how the underlying economy holds up (which is very uncertain).

We must keep in mind that there is another reason why this could be a good time to buy “cheap” stocks. The reason for such large drops to the stock market is the major outflux of capital to alternative and safer investments. Big institutions will be unable to incur the same risk levels as before, so capital will flee to low risk assets. This means that there are less funds competing for company stocks and, as individual investors, we could grab some good deals. Those funds will eventually return when the outperforming stocks become more apparent.