Tag Archives: crash

Blame the computers? Bah humbug.

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Did the computers drive the Dow down 25% in a week in May 1940 (no, there was no major war news that would have justified such a move):

TD Ameritrade

Here’s the Dow for the duration of the last depression. Quite a few crashes in there:

TD Ameritrade

The fact is, markets just fall out of bed sometimes. It’s normal, and they don’t need the kind of reasons you can read about in the paper. Greece had nothing to do with it.

A move like this off a top does not mark the end. If we had plunged hard and reversed like this after we were already reading oversold on sentiment and momentum gauges, it could mark a bottom, but not right off the top — that is what should scare people today. This was not like Black Monday ’87 — it’s more like the Black Thursdays of ’29 and ’08 (huge intraday crashes with recoveries, followed the next week by the real crashes), or the Friday before the ’87 crash (down 5%). It’s likely a kickoff to more downside. New highs are possible, but looking less and less likely, and we doomsayers might be right after all these months…

You can’t predict a crash, but you can tell probabilities, and the probability of a decline was high as of last week. We had an extremely, extremely depressed put:call ratio, momentum was rolling over, mutual funds were all-in, and just about every measure of sentiment showed that complacency and bullishness were off the charts.

All this in the face of a depression. Yes, we are still in a depression — that’s what steady 17% unemployment is. Obama and friends conjured up some positive GDP by abusing the Treasury market’s generosity, and that spending is counted as “product,” but tax revenue, real estate prices, rental property vacancies, and unemployment tell the real story: this is a fragile environment. Dow 1500 is still on the table.

And how about gold? I gave up shorting it and suspected a rally after it failed to follow through on that drop from $1200 and sentiment got really bleak. Maybe real money will win sooner than I thought, or maybe this is a 2008 replay and gold will turn once the waterfall gets underway. Anyway, it gives me some hope that the companies in my mining stock database might not all go broke.

What comes after a sugar high?

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Sugar futures are down about 20% in one month (ahem):

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Look at that contracting triangle last fall — it is a thing of beauty and foretold higher prices, especially since DSI was only 20% by the end.

Let’s put this in perspective:

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I was stopped out of my short from 29 cents at 24 last week after tightening the stop too much. Once more the market schools me to let my winners run. I’ll be looking for a re-entry before long since there is a lot of dowside left.

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Here’s an earlier post from last fall with some historical charts.

1987

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Since Graphite senses some parallels here, I thought I’d throw up a chart of the run-up to the crash of ’87:

prophet.net

I was just a kid, but I remember watching the news that evening. Upon hearing that the market had crashed 22% in a day, I thought to myself, “that doesn’t sound so bad – people still have most of what they had yesterday.”

The distinct possibility of a crash

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Technical trading is a game of probabilities involving indicators, patterns and history. There are times, like near the peak last month, when the odds of a certain outcome are very high, since you have so many indicators in positions that have been followed by the same outcome. There are other times, like right now, when you don’t have strong odds of any particular outcome, but you do have a higher than usual chance of a rare outcome: in this case, a violent resumption of the deflation trade from relatively oversold conditions. A hard decline from oversold conditions can lead to panic, since it feels like the market “just isn’t going to stop falling.”

I still very much like the summer 2007 analogue, since this winter, as then, the market fell hard off of a very long and calm stretch of gains on low volatility and extreme complacency (the “Goldilocks era”). What I see now is a market that, with yesterday’s rally to 1080 and this week’s little ramp in DSI bullishness, has corrected its oversold condition just enough to resume the decline. Stock bullishness now has 20% or so of downside to go before reaching the level seen at the bottom of declines of this nature (hard first plunges from long periods of complacency: May-June 2006, Feb-March 2007, July-August 2007, Oct-Nov 2007).

The VIX has the room to spare, as does the put:call ratio. I see in early trading this morning that several markets are showing weakness as they approach support. It is still possible that they bounce and we charge ahead towards 1100 and beyond, but I would not count on it. Like I said a few days ago, and Daneric actually mentioned last night, perhaps this decline resembles the start of wave 3 of primary 1 (May-July 2008), a stair-step process of small rallies just big enough to keep people guessing, followed by new lows.

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I’ll be away from the markets for the next few hours, unfortunately, but I have sell-limit orders in place for the above possibility. This of course would negate the Euro rally I’ve been considering.

Deflation trade returning?

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While Americans were on holiday, the last couple of days have seen some exciting market action. Stock indexes around the world declined roughly 3-8%, “safe” US and German government bonds rallied, and the dollar plunged to a new low then rebounded very strongly. Gold made a new all-time dollar high at $1196 as the dollar made its low, but when the buck turned yesterday gold plunged to $1130 as US stocks futures (which traded round-the-clock through the holiday) wiped out two weeks of gains in about 24 hours. Higher yield currencies such as the Aussie, Kiwi and South African Rand fell 3-4%, oil extended its decline to under $75, and copper got smacked $0.20 off its new high. One spot of green was natural gas, which extended its bounce to 14% off an area of strong technical support.

Gold showed us what can happen to a levered market after a parabolic move breaks its uptrend. In the wee hours today, it fell $55 in just two hours before rebounding right to resistance (the previous support at $1180, which when broken, precipitated the crash). Here’s a chart of the last two days:

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Commentators blame the Dubai default for this week’s gut-check, and the event may have acted as a catalyst, but the fact is that the risk/reflation trade had reached new heights over the last couple of weeks on a wave of complacency. Early this week the VIX nearly hit the teens and the daily put:call ratio put in a super-low print, while the Nikkei, Treasuries and yen offered warnings that all was not well. Browsing through the world index charts on Bloomberg, it is striking how few other markets have followed the Dow to new highs this month. The troops have been losing heart since summer as the generals kept charging ahead, a classic case of inter-market non-confirmation, which can also be seen in the weak action in small-caps and sector indexes like the transports, financials and utilities.

In last few trading hours of the week (this morning), many markets staged a very sharp recovery, as you can see here in this 1-month view of S&P futures:

Source: Interactive Brokers

Today’s pattern played out in nearly identical fashion in oil, gold, silver and other stock indexes. The stall point offered a clean spot for initiating or adding shorts, and those who did so were rewarded nicely in the last 30 minutes of trading as everything sold off quickly.

Next week should be very interesting. The risk trade plateaued for the last two weeks and went through the usual distributive action, so I have been expecting a down leg of some magnitude. Wouldn’t it be nice if this were the one to finally put a nail in the reflation coffin? I am sick of this market, as would be anyone who understands how far out of line these prices are with value or economic reality.

As Dubai’s default reminds us, this credit bust is far from over. There are still trillions and trillions in bad debt out there, and nearly every major bank in the world is still bankrupt and contracting lending (down another 3% in the US in Q3). We have all the hotels, condos and strip malls we’ll need for ages, and the consumer culture of the late 20th and early 21st century is just an unfortunate historical blip. Don’t tell that to Wall Street equity analysts, though — they still think the S&P will earn over $60 next year, just like in boom-time 2005.

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PS — check out Dave Rosenberg’s latest essay for a good commentary on the week’s action. You have to sign up, but it’s free.  Click here.

The bears capitulate

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I usually am not so sure about things, but the markets are looking very stretched at the moment. Sentiment among bears is of capitulation. Everywhere I go on the blogosphere, I see posts and comments about how the market is rigged by Goldman or repo desks or the PPT, and that trading against robots is a no-win situation. I hear that fundamentals don’t matter, that the bulls are in control, that the transports have confirmed the industrials, that China will drive copper the moon and still buy it all, yada, yada, yada. The upshot is that traders seem to think that the bears will be totally crushed no matter what.

Well, what exactly have the bears experienced during the 50% rally from March 6 to today? I’d say that is about as severe a drubbing as you can take in the market, the polar opposite of what the bulls got last autumn and winter. It is time for a reversal, and not a small one. This is Spring 1930 all over again:

Above chart of the Dow Industrials from Yahoo!

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Everybody has seen these before, but here are a few quotes from that post-crash reprieve:

December 28, 1929
“Maintenance of a general high level of business in the United States during December was reviewed today by Robert P. Lamont, Secretary of Commerce, as an indication that American industry had reached a point where a break in New York stock prices does not necessarily mean a national depression.” — Associated Press dispatch.

January 1, 1930

RESERVE BANK AREAS FORECAST NEW YEAR
Despite the obvious slackening of the pace of business at the close of the year, leaders in banking and industry throughout the country maintain an optimistic attitude toward the prospects for 1930.
January 13, 1930
“Reports to the Department of Commerce indicate that business is in a satisfactory condition, Secretary Lamont said today.” – News item.

January 21, 1930
“Definite signs that business and industry have turned the corner from the temporary period of emergency that followed deflation of the speculative market were seen today by President Hoover. The President said the reports to the Cabinet showed the tide of employment had changed in the right direction.” – News dispatch from Washington.

January 24, 1930
“Trade recovery now complete President told. Business survey conference reports industry has progressed by own power. No Stimulants Needed! Progress in all lines by the early spring forecast.” – New York Herald Tribune.

March 8, 1930
“President Hoover predicted today that the worst effect of the crash upon unemployment will have been passed during the next sixty days.” – Washington Dispatch.

May 1, 1930
“While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover. There is one certainty of the future of a people of the resources, intelligence and character of the people of the United States – that is, prosperity.” – President Hoover

June 29, 1930
“The worst is over without a doubt.” – James J. Davis, Secretary of Labor.

July 6, 1930

‘BUSINESS CYCLE’ SEEN AT NEW PHASE; Bankers Hold Downward Trend in Markets Indicates Recovery Is Near. DENY ANALOGY TO 1920-21 Economists Point to Superior Credit Conditions Now, Holding Easy Money Points to Revival.

August 29, 1930
“American labor may now look to the future with confidence.” – James J. Davis, Secretary of Labor.

September 12, 1930
“We have hit bottom and are on the upswing.” – James J. Davis, Secretary of Labor.

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The bears were down but not out in June, and quite a few armchair traders jumped in to have another go at the fast money they found when they jumped on board the sell train in October and February. Well, 100 points in about 12 trading days left them flabbergasted, and toasted more than a couple of levered accounts. When traders are flabbergasted, they tend blame manipulation, and concluding the game is rigged, all but the gamblers bow out.

Well, this trader is not flummoxed. I’ll freely admit traded this rally poorly by thinking I should only buy at 620 and then not jumping aboard when we took off on huge breadth and volume from 666, and then by shorting high-flying junk and starting to buy my long term puts too soon, but I can chalk those up as trading school tuition fees. Nothing that has happened this year should surprise anyone these days, when it is so easy to look at 80 years of daily Dow closes on Yahoo. If this is 1988 and not 1930 I will eat the Tom McKans my wife hates so much and take up a respectable profession like welding.

Speaking of 1987 and expectations for a depression, Trader, the cult documentary on Paul Tudor Jones, is finally up on Youtube. People were recently paying $1000 bucks for this thing on VHS. I can’t say that it is worth that kind of dough, but it is definitely worth an hour of your time to watch one of the contemporary greats in his element as he trades what he thinks is the analogue of 1928-29.

UPDATE: Trader is gone. The producer had it taken down. But, it is still out there if you know where to look… a certain renegade financial site has posted a link. I’ll leave it up to readers to figure out which.

Some thoughts on the bear market.

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This post started as an email that got way too long. I added some charts and put it up here:

The rally has not surprised me (on March 31 I expressed the opinion that we would hit 900 or higher by summer:

…more likely in my mind is a protracted rally extending to 900 or higher by summer, then rolling over to meet a date with 400 next winter. Look at last year’s rallies from March to May and July to August for an idea of what this might look like, though on a larger percentage and time scale because we are correcting a larger sell-off. The case for such a move is bolstered when you hear major investment banks’ strategists calling this a dead cat bounce. Too many people are still afraid to call a bottom, and they need to be suckered into long positions before this is over (along the same lines, too many traders are embracing the dead cat bounce and need to be shaken out before it can get back to leading the buy-and-holders to slaughter).

That said, I was leaning closer towards 900 than 1050:

I am highly skeptical, though respectful, of calls for a the mother of all bear market rallies. Robert Prechter and some other Elliott Wavers, as well as Tim Knight (slopeofhope.com) seem to be anticipating a 6-month or longer rally to as high as 1050. I simply don’t see why that is necessary in this environment. This is a depression, and the last one was accompanied by bear market that, after the first 6 months, maintained the momentum of a cruising supertanker. Rallies of 20 percent and 2 months were about all you got from April 1930 to July 1932 as the Dow dropped from about 295 to 41. That deflation-driven event was a much more orderly bear market than the jagged trajectory of the dot-com crash, which occured while the credit bubble continued to expand. Interestingly, the 1966-1982 secular bear (a brutal 75% loss in real terms) also traced out such a series of steep plunges and rallies as the bubble kept inflating thanks to a compliant Fed and the abandonment of the last trace of the gold standard. Employment was down, but animal spirits were still running high with the computing boom, the advent of securitization, and new innovations in consumer credit.

Though I saw this rally coming a mile away, I have traded it very poorly. First, I put too much emphasis on picking the absolute bottom for a buy-in.  Back in Feb and March I got out of most of my shorts by the time we were under 700, and I entered a bunch of limit orders to put over 1/2 of my net worth in SPY on the long side. Unfortunately, those orders started at 620, and we bottomed at 666. So I missed the bounce, and not only that, starting in April I began to short the junk stocks that were flying the highest and have been the real driver of this market. That was way too soon, and they kept on going, to the surprise of many a long-short fund as well. The outperformance of junk was a surprise, but the overall bounce has not been. When you have mood as compressed as it was back in March and you reach an exhaustion point after 18 months of a strong bear trend, you get a big reversal, which can then generate the extremes of optimism needed to set up the next plunge.

I’ve been buying long-term puts on the S&P and Nasdaq again since late March (way too soon, considering that I expected the rally to continue). I bought a bunch more yesterday, by the way. I view it as extremely unlikely that this market doesn’t decline to the point where solid value offers support — that would be a sub-10 PE and dividend yield of over 5% on dividends that have to fall by 50% or more from here to around $12 for the S&P. That would be the 240 level, but it should take at least a couple more years to get there (or below), if not four or five.

What has always worried me as a short in this market is not a 5-8 month rally, but a 12-18 month affair  like some of those that Japan has experienced in its long bear market since 1989:

Source: Yahoo! finance

That said, Japan’s financial sector was deflating while exports were improving, families had savings and the rest of the world was growing. Today’s situation is much, much more severe of course, and we can only find a parallel in the Great Depression for so many of the economic trends we are seeing. The longest bounce in that bear market was 5 months, and it was of similar magnitude (48% from Nov. ’29 to April ’30; we’re up 47% in the 4.5 months since March 6).

This is the Dow from 1928 to 1931:

Source: Yahoo! finance

And here’s how that bounce looked from 1933:

Source: Yahoo! finance

The S&P500 is now the most overvalued in history by PE (infinite as of this quarter’s running 12 month total, or a dot-com-esque 32 times current annualized earnings levels, about $7.50 per quarter). The dividend yield is about 2.5%, but dividends are nearly as high as earnings right now, which is completely unsustainable (they should be less than half of earnings). On a sustainable basis, the yield is 1.0 – 1.25%.

Here is the S&P PE ratio (TTM data through 12.31.08) going back to 1936. (the dates read right to left, since I can’t figure out how to reverse them in Excel). Data through 6.30.09 would be off the chart:

Real (U-6) unemployment is approaching 17% and climbing, and that is if you exclude the likely 6 million illegal immigrants who are out of work now (who used to take home $100 per day as construction cleanup boys or dishwashers). Throw them in, as we would have in the 1930s, and you get a solidly depressionary 20%.


Credit is still being withdrawn everywhere you look, whether in home equity, credit cards or small business loans. There has been a bounce in the corporate bond market, but that is due to the same technical forces that are driving the stock market, and the big bankruptcies are just beginning. Only the very weakest have gone under so far, like the car companies.

So with this backdrop, I don’t expect this summer’s good feelings to last into the holidays. The markets should start to roll over again soon, since the big-money value investors needed for a sustained advance can find no reason to buy in, and the little guy has been burned too many times to chase this market very far. Volume is very thin, and an unusually large fraction of trading is taking place between automated programs.

When the data to back up the green shoots theory fails to show up after another few weeks or months, and even official unemployment is solidly into the double digits and climbing, while another huge wave of mortgage resets hits the middle class, there will be no hope at all left to support this market, and it will slide to levels not seen since George Bush Sr. was in office.

It will then still not be a safe long-term buy. For that, considering all of the obstacles that the government has created to profit-making, we need to get back to Reagan-era levels, somewhere under the bottom of the 1987 crash.

S&P500:

Source: Google finance

Prudent Bear’s David Tice sees S&P hitting 400 within the year.

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Bloomberg has the interview.

Tice has prepared for this bust his whole career and has been cool as a cucumber since it started. He’s an E-waver and thinks we’re on the verge of the big C-wave that destroys all hope.

It is worth noting that the S&P500 Daily Sentiment Index reached 85% recently, and this more than any other signal says to me that we have topped for now. The question now is what happens if and when we drop 50-100 S&P points: do we bounce up to a new high, bounce around a range for several weeks, or keep on going right through 666?

One could probably do worse than taking a position in BEARX right now or scaling in over the next few months.

Not the bottom

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Most non-traders probably missed it, but the S&P 500 futures contracts tanked right after the close yesterday and touched 681 for a moment. We are bouncing a tad right now (futures trade around the clock during the week), but this is just another head fake. Lower lows await this month. However, I have now closed substantially all of my long-term short positions. I am not going to press my luck. If we make a nice washout low, I will even go long for a trade, but only from much lower levels than this.

Here is what we need before we can call a bottom:

1) The Russell 2000, Nasdaq, Nikkei and various stocks like Walmart, Home Depot, Apple, Amazon and Exxon Mobil need to make new 52 week lows.

2) The volatility index (VIX) needs to break AT LEAST 60 again, preferably 70. Look at how tame it still is:

3) Investors need to buy more puts and fewer calls. Everyone is gloomy, yes, but they are not worried enough about a major decline from here. When they give up on trying to time the bottom with calls and desperately try to short or protect themselves with puts, that will be the bottom.