As Bailout Looms, Fear Is Market's Biggest Problem

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    NEWSLETTERS

    The government rescue plan may help cure some of the ills that are afflicting the banking industry, but it's unlikely to remedy Wall Street's greatest malady right now: Fear.

    As investors watch the crumbling of some of the biggest financial names in the world, there's a pervading sense that even a $700 billion injection into the industry won't provide real relief.

    "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.

    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."

    Is the End in Sight?

    Market analysts have been looking for a bottom 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 (Chicago: VIX) creeping near 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."

    Even the consistently bearish Boyle believes the market could see a strong rally at least on the short term.

    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 (AMEX: TWM), which bets against the small-cap index; and ProShares Ultra Short S&P 500 (AMEX: SDS). 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.

    How to play the bailout. Watch video at left.

    "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," says Michael Kresh, president of M.D. Kresh Financial Services in Islandia, N.Y. "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 are going to open up anytime quickly."

    Investor Behavior

    Selling obviously was rampant Monday as Wall Street pondered both whether the rescue plan would gain approval and if it would be enough to address what ails the market and the economy.

    Yet many long-term investors sat comparatively tight, checking asset allocations and re-examining their priorities.

    "My clients are not running in terror. Many of the advisors I've spoken to are in similar circumstances," Kresh says. "A lot of this movement is possibly hedge-fund money that can move very quickly and tends to distort the overall marketplace but does add to the perception of a bigger problem."

    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.

    "It appears to me that this is not regular selling taking place or individuals panicking," Kimmel says. "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."

    "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."

    For more stories from CNBC, go to cnbc.com.