Bailout Failure Intensifies Fear in Stock Market

The government's failed rescue plan has heightened Wall Street's greatest malady right now: Fear.


Even before the House of Representatives rejected the bill, investors watching the crumbling of some of the biggest financial names in the world felt that government intervention wouldn't cure the biggest ills in the economy.

The failure of the bill only heightened the dour mood.

"I'm at a loss at this moment of what to do," Michael Kresh, president of M.D. Kresh Financial Services in Islandia, N.Y., said after the bailout vote. "It never entered my mind that there was a possibility this would not be passed."

Investors already had been jittery before the vote, worried who the next casualty of the credit crisis would be.

"People are confused and they are scared. Baby boomers are remembering what their parents told them about the Depression and they're afraid they'll be next," says Kathy Boyle, president of Chapin Hill Advisors in New York. "Everybody's worried about their money, everybody's worried about their future, everybody's worried about whether their retirement is safe."

The deep concern stems primarily from two sources: That more banks are doomed to fail and those that don't will continue to refuse to lend; and that the global economy is just now starting to feel strains that have been present in the US for the past year and will doom the emerging markets trade so popular just a few months ago.

"I think there's very little that we can do to protect our clients in this scenario," said Kresh, who had expected a relief rally once the bill was passed. "The bigger problem is that without the relief rally there's no opportunity for credit markets to open up and do something to take pressure off what is very likely going to be a severe first-quarter recession."

For investors, it is a tenuous time. Many of them are contacting their advisers wondering how the pounding on Wall Street will affect their investments.

"Investors are very nervous," Boyle says. "You have to stop them from doing harm to themselves, liquidating on days like this where they just get completely panicked."

The only beacon seemed to be a sense that the House could vote again on the legislation. Republican leaders said part of the charge against the bill stemmed from a highly partisan speech from House Speaker Nancy Pelosi.

"I think they're anticipating that there'll be another vote," Bill Gross of Pimco told CNBC right after the vote. "Because if there is no package, there will be a tremendous hole in credit markets. This must be passed."

"The stock market is in many respects a sideshow, but that's the most visible thing," added Alan Blinder, former vice chairman of the Federal Reserve. "The invisible things are what's going on in the credit and money markets. That's much more important."

Still Looking For a Bottom

Market analysts have been grasping for a capitulation ever since the Bear Stearns-induced chaos that came when the venerable Wall Street investment banker failed in March.

They thought the Bear case might mark a bottom, then again when the government had to step in and bail out mortgage giants Fannie Mae and Freddie Mac in July. The process has repeated itself as a slew of financial titans--Lehman Brothers, Merrill Lynch, Washington Mutual among them--have disappeared over the past several weeks.

This time, they say, it at least be a jumping off point for a bottom. With the Volatility Index roaring past 40, the market appears to be in near-full panic mode.

"Everyone I speak to, whether they're in the business 20 years or 30 years, are saying this is the single worst sentiment they can remember," says hedge fund manager Jordan Kimmel, of Magnet Investing. "This level of pessimism is really how bottoms get made."

"We've gone through already a solid year of torture, and from here I would expect not a return to a strong bull market but clearly a violent snapback. Where you saw a couple weeks ago only financials being covered, you'll see a short-covering of the mining and all kinds of global trade plays that are being decimated right now."

The consistently bearish Boyle believes the market could see a strong rally at least on the short term once the selloff from the bailout's failure ceases.

Boyle has been snapping up exchange-traded funds that reward investors double for moves downward in various indexes. Most recently she bought the ProShares Ultra Short Russell 2000 , which bets against the small-cap index; and ProShares Ultra Short S&P 500. She also has picked up modest positions in ETFs that bet against China and the Nasdaq tech index but plans on trimming some short positions soon.

"We didn't go full-boat because we think we're getting close to the end of this," she said. "We feel the market will enter a period where it's oversold and we're anticipating a rally into Oct. 15. Then we're looking at another selloff."

Indeed, no rally is likely to be sustained as long as banks refuse to lend.

"Any rally is going to be a relief rally," Kresh said. "The goal was to get this (bailout) passed as quickly as possible to take the fear out of the credit markets. We're not necessarily sure anymore that even with this passed the credit markets (were) going to open up anytime quickly."

Investor Behavior

Selling intensified Monday as Wall Street pondered what the economy faces ahead without the bailout package in effect.

Before the bailout vote, many long-term investors were sitting comparatively tight, checking asset allocations and re-examining their priorities. Immediately after the "no" vote from Congress, the selloff hit 721 points off the Dow--the second biggest intraday Dow move--but tempered a bit.

At Chapin Hill, Boyle says she's guiding her clients through careful analyses of portfolio performance as well as in making sound personal finance decisions as a recession of uncertain depth and length looms.

In the trading arena, there's also a feeling that while things may not be quite as bad as they seem, it's a time to make careful decisions.

"I believe that there are some funds under liquidation and redemption and it's exaggerating the move down in a few of the sectors that had up until now held up the best," Kimmel says.

"Each sector's going to have to heal one by one," he adds. "You have to remember, this ends up not being a regular pullback, this ends up being a devastating bear market in which there was no sector left undamaged. When you see this shortage of new highs and this amount of new lows, whether there's another leg down coming or not, this is where significant rallies erupt from."