Financial topics

[burt]

Dear Bertrand,
Your words appear to contradict each other. If there's a 10-20%
correction, and the "people will be so panicked," then there will
indeed be a stock market panic and crash.
John

Thank you for your very quick comment, but when people become VERY pessimist, then you are at a low, almost each time.
When they are VERY optimist your are at a high. As most people are optimist about 2011, it makes me feeling we are at a temporary high.

The panic phase is BEFORE, just before people become disgusted. When they are getting lost, they sell, NOT when they are disgusted.
That is one reason why panic phase are VERY short, usually 1 week, as in 2008, or one day, as in 1987.

Then it takes a lot of time for the market to come back at the level it had BEFORE the panic, and after the panic it doesn't mean that we are at a low, see 2008 the panic lasted one week, but the low was in march 2009.

Look at this year, people were VERY optimist in April, and suddenly VERY pessimist in july (people were afraid of a double-dip in economy, even if there is NO link between the Stock Market and the economy (I can write about that), even when the ECRI numbers were not so bad), and there was a small crash in may.
This is a sequence: Optimism, Top, Panic and Crash, Pessimism, Low, again Optimism (there could be a buying panic too, that is what I'm waiting for IF the market goes down 5 or 10 %), and so on.
When people are, in fact, pessimist, the room for the panic is very small, because of the action of the "contrarians".

The high level of change in the humor between April and Today, tells me that people SAY that they are optimist BUT that in fact they are very anxious, so NO ROOM for an important low YET.
We'll see...

But the so called "Stock market" is NOT a market, but a poker game, and you have to apply rules of the poker, there is STRCTLY NO RATIONAL in it (on the medium term). On the long term I do not know, but the so-called "market" gives you the time to be "dead" even if you are "right".

Regards

[Higgenbotham]

Dear Bertrand,

> My own remark is that there is NO known possibility for a true
> crash YET (it is much too early), but, at the same time ALL
> technical indicators mean that a correction of 5-10% is due right
> now.

> We’ll see, I think that if we have a 10% correction, people will
> be so panicked that they will become so pessimist that the market
> will be ready to move higher, and much higher.

Your words appear to contradict each other. If there's a 10-20%
correction, and the "people will be so panicked," then there will
indeed be a stock market panic and crash.

John

This is a great topic for further discussion. I'll start with some empirical observations.

Panic Number 1 was the November 26, 2009 Dubai panic. The S&P futures fell about 50 points overnight. I was out of town and turned the TV on the next morning when I got up. The newscasters were in complete, utter panic. I called my brokerage office and the woman who answered was hyperventilating and babbling. She's been in the business for decades, so that really surprised me. That was the end of the panic. It lasted less than a day.

Panic Number 2 started on January 20, 2010 and lasted until February 5, 2010. This panic mostly concerned Greece as an isolated issue. The S&P fell 110 points during this panic. The initial part of the panic was very sharp and lasted 3 days. By the time the panic ended, the mood on the Internet trading boards that weekend was black black. Everyone was sure the market was going to crash. That was the end of the panic.

Panic number 3 started on April 27, 2010 and lasted until July 1, 2010 (or possibly May 25, 2010). This panic concerned Greece and more generally European debt. The S&P fell 210 points during this panic. The initial part of the panic was very sharp and lasted 10 (calendar) days. I don't know much about the end of the panic because I had covered all my shorts a few days before and wasn't trading. But we can be pretty sure that the mood at the end of the panic was similar to the first two.

Having stated these facts, I'll move into the interpretation and opinion portion. To begin with, there's a very obvious pattern. During each panic, twice as many points are lost on the S&P as during the previous panic. When I said 400 points could be lost in the next panic, I hadn't considered that. But we can see that the pattern indicates that the next panic could be that severe. Another obvious pattern is that most of the loss occurs during the first few days of the panic. So it can be readily seen that if previous patterns hold, nearly 400 points could be lost on the S&P within 30 days.

The next obvious point for discussion would be: How in the world could nearly 400 points be lost on the S&P within 30 days? I'll go into that separately later, but let's see what everyone thinks about the above first.

[vincecate]

To begin with, there's a very obvious pattern. During each panic, twice as many points are lost on the S&P as during the previous panic. When I said 400 points could be lost in the next panic, I hadn't considered that. But we can see that the pattern indicates that the next panic could be that severe. Another obvious pattern is that most of the loss occurs during the first few days of the panic. So it can be readily seen that if previous patterns hold, nearly 400 points could be lost on the S&P within 30 days.

The next obvious point for discussion would be: How in the world could nearly 400 points be lost on the S&P within 30 days? I'll go into that separately later, but let's see what everyone thinks about the above first.

Very interesting pattern.

Interest rates were moving up and my thinking is that they should keep going up. To me this will trigger the crash, maybe when 30 year treasuries get to 5%. At the moment interest rates are about where they were 30 days ago. I still think they will continue upward sometime soon.

[weak stream]

There is indeed the possibility of a panic at any time now as so many potential triggers from the Euro mess to Japan sliding to oblivion to a panic in China. I don't think, however, we are that close to the "Big Kahuna" that will bring us to Dow 3000 or thereabouts yet. The reason is that most market participants believe wholeheartedly in the Federal Reserve's ability to stop any slide. When this faith begins to fade, all hell is going to break loose.

[vincecate]

The reason is that most market participants believe wholeheartedly in the Federal Reserve's ability to stop any slide. When this faith begins to fade, all hell is going to break loose.

It is amazing how many people believe that interest rates are just set by the Fed, rather than that the Fed is a big player in a market. When interest rates really start to go up then people will start to lose this faith.

[John]

Higgie - The S&P fell 572 points from 9/19/2008 to 3/6/2009, following
the Lehman bankruptcy. How does that fit into your pattern?

John

[Higgenbotham]

This reminds me of some of the peak oil debates I read about in 2005. There were two camps. One said growth can continue at about the same pace even if oil supplies stagnate. The other camp said growth can't continue in the face of stagnant oil supplies and therefore the economy will crash.

My thought at the time was to wonder how that could be measured. What I found was the the "energy intensity" or the efficent use of energy improves by a few percent each year. When there was plenty of oil, it might have improved by around 1.5% per year (I can't remember the exact numbers) and when there was an oil shortage in the 1970's it improved by about 2.0% per year. So I told people that if oil suppplies stagnate there won't be a way to get 3.5% growth. The numbers don't add up.

I would definitely agree that trying to determine how many points the stock market can lose in a possible panic and how quickly it can happen is much more difficult. I can't think of a good way to do it. At least, not something that is as clean as the above measurement of energy intensity.

If the Dow has a fundamental value of 3000 at present, just to throw out a number, history tells us that it is not possible for the Dow to crash to 3000 in a short period of time. It might take years. One thing that can be done is to look at some initial crashes with respect to their starting and ending points, and the ultimate resolution of the longer term move down.

Just to throw out one idea I just made up (as an aside, that's why I like a forum - it forces people to justify what they are thinking). In April 1930, the Dow reached 298, crashed to 210 by June, and ultimately ended up at 41 two years later. Without any interpretation on my part, I'll just rotely use those numbers and the 3000 ultimate value for the Dow mentioned.

April 1930 is a valid historical reference point because that was the rebound high in the Dow from the 1929 crash after the Fed intervened. In those first 2 months, the Dow lost 34% of its overall loss. Just for round numbers, if the Dow were to get to 12,000 and has an ultimate target down the line of 3,000 then it could lose 3,000 points during an initial 2 month crash from the rebound high.

Doing that exercise really surprises me. The S&P 500 is valued at about 10% of the Dow and tends to be a bit more volatile. Therefore, an initial loss of 300 points from the rebound high of the S&P or possibly even a little more actually seems to be supported by historical evidence.

[Higgenbotham]

Higgie - The S&P fell 572 points from 9/19/2008 to 3/6/2009, following
the Lehman bankruptcy. How does that fit into your pattern?

John

In 2007, the S&P rallied to somewhere around 1460 by late February. The initial warning stage of the subprime panic took it down to somewhere around 1370 by March. The S&P then rallied to about 1560 and dropped to about 1370 again during the second warning stage of the subprime panic in August. The Fed then intervened and that drove the S&P up to its all time high of around 1580.

It seems possible that the subprime pattern from 2007 could be compared to the sovereign debt pattern from 2009 and 2010. The 2007 range was roughly 1370 to 1570, while the 2010 range has been roughly 1040 to 1240.

I haven't thought about this before either, but it can be readily seen that the S&P is not vibrating at equal percentages to the pre collapse 2007 vibration, but is instead vibrating by the same number of points. So my guess without thinking too much about it is that the sovereign debt crisis will ultimately result in an equal point loss in the S&P. Therefore, the ultimate target of the S&P due to the sovereign debt collapse will be 340.

This fits very well with the Dow 3000 value mentioned, as the Dow is now at about 11,700 while the S&P is at about 1270.

[Carl Lieberman]

I find the mathematical patterns to be interesting, but I do not think that they are determinative. I'm with John that there is going to be a generational panic as the markets drops dramatically. But I subscribe to the Nassim Taleb view that completely unknowable and unpredictable events are what drive history. Who can say what event or series of events will set off the panic? The stage has been set historically for a fourth turning winter, but it is not as predictable as a winter solstice.

[Higgenbotham]

Now I'll continue with the opinion portion of how I think the S&P could lose 400 points, say, by the end of March.

First, I had stated earlier that I believe the probability of that happening is much higher than anyone thinks. That includes me. Based on the analysis I've done, it won't happen. On the other hand, I am starting to see ways that it can.

One reason. Somewhere I think I mentioned that the world economy held together for quite awhile after the stock markets made their highs in October 2007. Commodity prices rose well into 2008 and the economies were strong enough to absorb the price increases. So there was a bit of a "grace period" before the "false" panic began perhaps 5 months after the stock markets made their all time highs. That would have been the Bear Stearns panic in March 2008, if I remember everything correctly, and it was contained to Bear Stearns. Contrasting that with what we've seen lately, in the past few weeks, we've seen that the Euro has started to weaken and has dropped to new lows for the past few months, the dollar is going up, and commodity prices are weakening. That wouldn't be happening so soon if we were seeing a repeat of the 2008 "grace period". It's my hunch that employment and wages aren't strong enough to pay for $3 gasoline for too long.

Second reason. Up until recently, it has appeared that the sovereign debt problems were relatively well contained, just as the mortgage debt problems appeared to be relatively well contained until and even past March 2008. Even when Bear Stearns went down, it took another 6 months for that to turn into a systemic problem. Today everyone is focusing on recent Federal tax policy and saying that will provide temporary relief going forward. However, at the same time, I am reading that Illinois can't pay their vendors. They are broke and it seems like I read that there is a proposal to double Illinois state income taxes. There are several states and municipalities that appear to be in that same predicament but I think Illinois has the most immediate problem. For example, I read just a couple weeks ago that Illinois has been unable to pay the rent for some of their state legislators and the legislators have been evicted from their offices for nonpayment of rent. Second, while the early episodes in Europe were clearly on the periphery as were the early subprime problems, it appears that may not be the case now. The severity of the early sovereign panics I believe were partly due to fear of the crisis spreading to the countries that really matter, those that are too big to fail such as Spain and Italy. When that didn't happen, the panic subsided. Recent action in the Euro currency may be indicating that a major sovereign default is on the horizon. Along with that, there is a recent e-mail from a European financial insider posted on Mish Shedlock's web site indicating that he believes that Italy is on the verge of trouble. Bottom line, if any large US state or large European country fails that will cause a full blown panic. Small panics like those that were seen in 2007 and 2010 are about what might happen or how things might spread to large entities, but when they actually do spread to those critical financial institutions in the case of 2007 or those critical US states or European countries or something else then that is when the real panic will start. In the meantime, the Fed is indeed playing poker. Part of the goal is to wipe out every short on the planet so they will have nothing left to short the market when the real panic comes. The message the Fed is sending is, "You don't short the market because if you do, we will destroy you." It really is financial warfare. This elevates the risk further because it raises stock prices above what they would otherwise be.

I'm not saying a panic of this magnitude is more likely than not by the end of March, but early signs that it can happen are starting to take shape. While the market seems to be putting the odds at well below 1%, I would guess that it might be as high as 10%. It could begin to rise exponentially.

It's important to have some ideas about what might be seen that would make such a thing more likely. My guesses would be: lower commodity prices, a lower Euro, a rising dollar, local news stories about major US states and municipalities being in trouble, and rising CDS prices of major US states and/or European sovereigns would all be incoming data that would indicate trouble. I think being on the lookout for information like this and posting it here would be valuable.

One last comment. I actually don't believe Ben Bernanke will bail out the US states and municipalities. He'd like to have you believe he will but I don't think he can. The fundamental reason is that the purpose of bailouts is to suck money out of the periphery of the system and into the center. Large US states and mid sized European sovereigns are not central to the system and I don't believe the Fed will risk the center of the system to try to save them. So oddly enough, Bernanke has been painted into a corner where he had to tell the truth. He wants to print more money but he knows he can't because the risk of doing so will exceed the reward. At the same time, he can't lie and promise a bailout if he can't deliver.