Stock Market Contagion: Dan Amoss / August 10, 2007

The pleas for the Fed to bail out the deteriorating financial markets are growing. Fed fans expect the inflationary institution to “fix” a problem caused by too much monetary inflation -- with even more monetary inflation. In his morning economic briefing, economist Ed Yardeni writes, “The Fed needs to wake up. Perma-pause is over. It’s time to ease. I think they will do so at the September 18 FOMC meeting, though probably sooner given how quickly credit conditions are seizing up.”

Apparently, many hedge fund managers are liquidating the winning, liquid positions sitting in their portfolios because they expect a wave of redemption requests from their investors. In a crisis environment, the correlation coefficient across the broad spectrum of asset classes heads toward “1,” meaning anything with any sort of risk component -- even if it’s cheap and faces a very bullish outlook -- will encounter selling pressure. This is an unfortunate consequence of the hyper-trading, short term performance-oriented mentality shared by the majority of fund managers.

But they don’t all share this mentality. Managers like Warren Buffett love these types of environments. Once the market is consumed by fear, he compiles a shopping list of the most attractive companies to buy and hold for decades. I advise that you maintain a Buffett-like mindset when everyone else is losing their heads. I’m not changing my views on any of the recommendations I’ve made in Strategic Investment, including my long-held view that financial stocks must be avoided.
— Dan Amoss

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