Special ML Hotline for 8/8/11

Below is a Special Hotline we released after yesterday’s 635 point decline in the DJIA. Guidance provided by MONEYLETTER’s Chief Economist Walter Frank. — BWK
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The question you all are undoubtedly asking is “what do I do now?” Our advice in this hugely oversold market is hold tight. Yes, we know, that was our advice many S&P points ago. But today is not the end of market history. We are not looking for a bull market to develop miraculously overnight, and the downside momentum is very powerful. But this is a market that has sold off in these later devastating stages on fear, not on some solid fundamental grounds. Let us explain.
The market had been selling off before today for three reasons. One was the weak economy, leading to fears of recession. Another was the debt-ceiling wrangle, leading to fears of default. Finally, Europe’s debt crisis resurfaced, leading to fears of a breakup of the European Monetary Union.

The debt-ceiling agreement eliminated the default fear, but it added to the recession fear by imposing an estimated 1.5% drag on U.S. GDP growth. Over the past weekend, Wall Street’s economists cut their estimate of GDP growth over the last half to 2% from an expansionary 3.5%. As they did so, they also raised the issue of a possible recession with odds of about one in three.

As if that were not enough, S&P chimed in with its cut of the Treasury bond rating from AAA to AA+. All this hit a badly slumping market, and today’s rout was the result. As we have often noted, the market is a discounting mechanism, and the question to ask is what is the market discounting? At this level and this oversold, the market is discounting a good-sized recession in our opinion.

We acknowledge that the effects of the market’s plunge, added to the economy’s current weakness, have raised the odds of a very low-growth economy persisting for some time. At the very same time, oil prices have also plunged. If the new prices hold, the plunge will be the equivalent of a significant tax cut, offsetting some of market-induced weakness.

The bottom line for us is that domestic stocks, already cheap, are now selling at bargain prices. We are not about to change our allocations overnight, but we do see today’s rout as providing a buying opportunity for more aggressive investors. For the rest of us, we need to swallow hard and resist the temptation to give bargains away.