The market is down over 500 points in two days and suddenly all the market commentators are cautious and advising getting defensive. I think it’s a little late for that now. At Dow 14,000 and even 13,000, it was certainly prudent to get defensive – now it’s just stating the obvious. And while I outlined the Bull vs. Bear case back in May, I had concluded that smart investors like Buffett and Soros invest in good companies without being influenced by short-term market turns. The recent correction is long overdue and any “trader” who has not taken profits during the markets 25% run since last July should use this as a lesson.

Meanwhile, for investors, this opportunity is one to avail. The S&P 500 trades at 16 times earnings and second quarter earnings growth is clocking in at above 6% with the ratio of companies that meet or beat vs. those that miss estimates running at over 2.5. Moreover, corporate balance sheets of companies are as clean as they have ever been with plenty of cash on hand.

Let’s examine the two headlines that have prompted this correction - Mortgage Meltdown and Tightening Credit. Remember that the biggest loss predicted due to the mortgage meltdown (notice I am not using the word “subprime meltdown” since this is not a subprime problem as outlined by my friend Rob Bernabe last week) is $200 billion, which is about 1.5% of our $13 trillion plus economy. Additionally, this headline is not entirely new. The housing market has been screaming warnings, as have people like me in blog posts and opinion columns. In fact, following are some points I made against the housing and mortgage sector last September in a post titled “Is the Housing Market Doomed?”

• The number of people defaulting on the very first payment is sharply higher these last couple of months. Shows that people refinancing at current rates or buying at these prices cannot afford the rates they are getting and homes they are buying.
  
• Housing inventory levels are at multi-year highs. It takes time for municipalities to issue permits for new residential development. Such permits are finally being issued for applications submitted 12-18 months ago, causing supply to rise at a time when demand is low due to high prices.
  
• Wage growth has not kept up with increase in home prices, rising rates, gas and energy prices and inflation.
  
• Home Builders desperate to lure doubtful buyers are offering major incentives like free upgrades, appliances or 6 months no interest financing much like auto manufacturers. Look what happened to the auto business.
  
• Consumers are finally tapped out. They used equity in their homes to off-set lack of wage growth. Now they don't have any equity, in fact, if they sell their homes, they will owe more than their home is worth.
  

Add to this that foreclosures are growing at over 50% over last year, and it is not so surprising to see the mortgage industry including lenders, their creditors and buyers and sellers of mortgage backed securities are not faring too well.

As far as the tightening credit affecting leveraged buyouts are concerned, that is a valid issue, but a lot of these deals are being done for cash, so in most cases, credit is a non-issue. For other deals, if they don’t get done, and for the most part they are, this might be a problem, but using these headlines to create panic in the market is merely a way to explain the market correction – not a predictor of where the market is headed. Back in February/March of this year, the Chinese market correction was the headline that explained our US market weakness and paying attention to the underlying panic-stricken tone of such headlines cost you the run up to Dow 14,000. In fact, back then, the correction was worth approximately 750 points on the Dow and while the drop since Dow 14,000 is also worth the same so far, in percentage terms, it stands a little lower at 5.35% vs. the previous decline at 5.85%. One thing that I keep hearing is that companies have run up in anticipation of being bought, but I’d love readers to tell me the names of such candidates. Most of them drop back to pre-rumor levels within a week or two.

My point is that these headlines are not new. Despite their constant presence, the market looks the other way until it doesn’t. Then the same headlines are used to explain the change of sentiment despite having no impact leading up to the change. Yet, it is important to read the headlines and perhaps there is some contrarian advantage to be had. When Dow reached 13,000, there were headlines in WSJ, Barron’s and various websites and publications that were predicting the next milestone and the timeline to get there. And as the Dow approached 14,000, the bullishness became a little giddy and Barron’s even dared to put Dow 15,000 on the cover, albeit a little tentatively as opposed to under the flare and drama of their usual cover stories. It is always prudent to get a little defensive when such strong bullish sentiments are being expressed by an overwhelmingly majority.

The moral of this piece is that headlines try to predict the market and 9 out of 10 times they can’t. The one time they get it right, they jump all over it with the “I Told You So’s”.

I once heard Warren Buffett speak and he claimed that an advantage of living in Omaha, Nebraska is that he is away from all the noise on Wall Street - noise that can affect his investing decisions. I think this is a very important point, one that is often overlooked by the investing public.

-- Faisal Laljee