Financial topics

[Higgenbotham]

I'm guessing that the stock market rally from the August and October lows may be terminating. Though I see historical possibilities indicating that it could extend a few days and, certainly, it seems it is also theoretically possible.

My feeling is that the August low overshot previous parameters by 4 calendar days or 2 trading days. So not only was the fact that the market fell in August indicative of disorder to me, the severity of the fall was disorderly. It would seem that any counter trend move up must also overshoot normal parameters and seem disorderly. It may also give the false indication that this is the beginning of a new bull market. I always tell myself, when I've thought as hard as I can, to think a little harder.

While the move up is running into an area where it may fool a lot of people into thinking it is a real move higher, there may be more coming (see below). I've gone 200% short but am not at all confident that is a good move. My philosophy on making speculations is that's it's not a bad idea to pretty much assume that they'll be flat out wrong.

Going back to that 10 month cycle on the diagram:

10 months ago: Fukushima March 11, 2011
20 months ago: Rebound high 7 days after the Flash Crash False Panic May 13, 2010
30 months ago: Market begins to rocket higher July 11, 2009
40 months ago: Lehman Brothers September 15, 2008

I would say over the next 4 days or so things could get VERY interesting. We don't have a natural disaster showing up yet. There hasn't been a false panic in the past week. The market seems to be trying to rocket higher but not really. And no major financial event seems to be on the horizon 4 days hence.

Cyclically speaking, we do have the 2007 and 2011 stock market highs that are about 40 months apart. Going back to 2009, it was pretty much universally accepted that the strong July rebound was a good shorting opportunity. Now in 2011 seems to be well accepted that this rally is the start of a new leg up. At the same time, with the crisis appearing to be so well contained, a major financial event say, this weekend, seems to be a remote possibility. Could the stock market rally all week in accordance with some of the past cycles, only for a major financial event to manifest over the weekend? I have no idea, not a clue.

[Trevor]

The stock market in the 1930's didn't fall overnight; it was over about a 3-year period, with numerous analysts continuing to say that the worst is over. I don't expect a disaster imminently, if that means in the next month or so.

One thing that works in our favor is that we haven't done anything as profoundly stupid as Smoot-Hawley. Course, that could end up changing in the future.

Seems like every couple of weeks, some European country is getting downgraded. Greece's economy is continuing to contract, and the growth for the eurozone is for all intents and purposes nonexistent. As for China, I'm not seeing a full-scale collapse this year, but their problems will continue and get worse, helping to drag down everyone else.

When the true collapse finally occurs, it's looking more like it's going to happen over a very short period of time, like around 12 months or so, similar to 1857.

[Marc]

When the true collapse finally occurs, it's looking more like it's going to happen over a very short period of time, like around 12 months or so, similar to 1857.

While we all know that it is hard to predict the nature of a future financial collapse with certainty, your prediction strikes me as the most plausible outcome from a logical and behavioral-finance standpoint. With the heroic job that is being done with finding Band-Aids and kicking the can down the road, I would think that any "grand-finale collapse" would occur when we have utterly run out of Band-Aids and can-kicking, and thus experience a collapse that isn't necessarily an "overnight collapse," but is of fairly short duration. What also makes a rapid collapse more likely, I feel, gets at what John has been stating in regards to the same managers/administrators still being in their same positions, and doing the same old thing. (Actually, it looks like they're not only doing the same old thing, but in many instances, figuring out how to do it on steroids, so to speak.)

Thanks for the good insights. —Best regards, Marc

[Trevor]

this kind of goes without saying, but it will take everyone completely by surprise, maybe happening just as they think they've finally solved the problem. What else can they do but kick the can? It's not like they can tell people there's nothing we can do to stop it, although it's true.

even so, I do think the collapse will be triggered by an official Greek default, whenever that may happen.

[Marc]

It is certainly possible that a Greek default could trigger the penultimate global financial collapse. However, I respectfully tend to think that someway, somehow, Greece will be "covered for," via shadowy means if necessary. The reason I think this is that Greece requires "merely" several hundred billion dollars to cover for it. I tend to think that there will instead be a case of "the global credit card being totally maxed out" — when credit-line increases or overlimit allowances are simply not possible anymore — that we'll then see something of an endgame scenario. But, there are so many variables, including military-conflict variables, that it is, again, hard to predict with certainty. Thanks again for sharing the thoughtful insights. —Best regards, Marc

[Trevor]

you've also got Spain and Italy, who are far bigger problems and they're going to need bailouts as well. If all three need bailouts at the same time, which is certainly possible, and that's going to be extremely difficult to find enough money for. Even if you do, how long will it take for them to need another bailout?

When too many countries require bailouts, that's when I think we'll see it. It might happen this year, and it might not, but I don't know how much longer we can put this off.

[Higgenbotham]

The assumption you guys seem to be making is that the triggering financial event needs to be sovereign debt related. Am I right in saying that? For what it's worth I happen to share that view.

It seems like all the triggering events in 2007 and 2008 were subprime related.

There was a high in the market in July 2007 and that week, it was reported that some Bear Stearns subprime hedge funds were worth maybe 12 cents on the dollar. The stock market came down and then went back up to a slightly higher high in October 2007. In March 2008, Bear Stearns was bankrupt and then the Lehman event was in September 2008.

If we think of the Bear Stearns hedge funds as like a precursor financial event near the stock market high which acts as a warning of a larger future event then I can think of no similar precursor event that occurred near the May 2011 stock market high.

The first big wave down from the 2007 stock market high coincided with the Bear Stearns bankruptcy.

The first big wave down from the 2011 stock market high coincided with the US debt downgrade. And it may well be, then, that the precursor event to that may have been the idea that the US was going to be downgraded and no similar precursor warning event to 2007 manifested near the 2011 high.

As the market recovered off of the March 2008 low into the May 2008 high, there was no financial shock event.

The market may be recovering into a similar high to the May 2008 high now. As such, it would seem that a financial shock event is not due for some months.

Another way to look at it would be to observe that the Bear Stearns bankruptcy happened 5 months after the 2007 market high, and the Lehman event was 6 months after that.

The US downgrade was 3 months after the 2011 market high. The next triggering event similar to Lehman might thus be due to occur perhaps 6 months after the downgrade to 11 months after the stock market high (sometime between February and April).

Back to 1857. Near as I can tell, though my old charts are very fuzzy, the 1857 stock market rebound high occurred in January 1857 and of course Ohio Life was August 24, 1857. NH Wolfe was announced as being bankrupt on August 11, 1857. I'm thinking that the October 27, 2011 MF Global event was similar to NH Wolfe. It's sort of a canary in the coal mine that bigger things are on the horizon.

[Marc]

you've also got Spain and Italy, who are far bigger problems and they're going to need bailouts as well. If all three need bailouts at the same time, which is certainly possible, and that's going to be extremely difficult to find enough money for. Even if you do, how long will it take for them to need another bailout?

When too many countries require bailouts, that's when I think we'll see it. It might happen this year, and it might not, but I don't know how much longer we can put this off.

Indeed, Spain and Italy will (and do) need bailouts, too, and indeed their bailout requirements are much larger than Greece's are. And, as you allude to, just one bailout for any of these three countries (even a rather robust one) is not too likely to do the trick. I think that a combination of bailouts and backstops for the public and private sector, coupled with the needs/expectations regarding social welfare and military spending in the West and elsewhere, will create, as you likely also feel, the eventual tipping point which finally can't really be financially rescued. Again, I respectfully feel that it probably won't happen this year — but respectfully allied to your feelings, I don't feel that we can keep kicking the can on all this beyond what might be considered the short-to-medium-term horizon. Thanks again for your cogent thoughts. —Best regards, Marc

[Trevor]

oh, there are numerous things that can trigger a new crash: the stock market, the massive debt and deficit, a Greek default, China's economy collapsing, and I'm sure there are others I probably overlooked on this list.

Right now, we've got a lousy, stagnant economy as we're making every effort to keep everything afloat. The DJIA on average seems to be hovering around 11,000-12,000 over the past several months, although it's occasionally gone below that.

One thing i do wonder is if the length of the bubble is going to make a difference between this and the Great Depression. Still, what I think is the greatest risk at the present time is a Greek default.

[Marc]

The assumption you guys seem to be making is that the triggering financial event needs to be sovereign debt related. Am I right in saying that? For what it's worth I happen to share that view.

I do kindly tend to agree with that. As large private entities get into trouble, the sovereigns (or allied appendages to them) need to do the bailing-out of the private entities. Beyond that, the public sectors of the sovereigns collectively have huge debts that, independent of bailouts and backstops, are likely growing exponentially.

So, ultimately, the sovereigns are simply being grossly overloaded in what they are being asked to do, even compared to, say, a "credit event" which triggers several trillion dollars (notional value) of private-sector derivative swaps and which makes massive initial demands on private entities. That hypothetical credit event would come screaming to the front or back door of the sovereigns for help; the sovereigns would likely do whatever they could to help out on this sort of thing until they simply couldn't do it effectively anymore. Just my theoretical hunches there.... —Best regards, Marc