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10.10.08 Nightly Market Thoughts

(two days late)

I was looking for Friday to be capitulation day (at least for the short term). I am putting it at better than even odds that it was such a day. Just when I couldn't imagine fear becoming much worse, it did exactly that. At about 3 PM, just before the snapback rally, my subjectively appraised nadir of sentiment occurred on various internet forums I visit. Perhaps the quote "It's darkest before dawn" carries some truth. Then again, it's also darkest before the world comes to an end.

Some quotes from message boards I read:

  • "One of my neighbors dumped ALL of his stock yesterday... "
  • "I did [the same] early this week"
  • "Just sold all my TDAmeritrade positions... I can't take anymore of this... Lost 40% on my portfolio. There is still way to much uncertainty in the market and there is no telling where the bottom is. I'm keeping all my 401k stuff as is since I dollar cost average all of that. But this is just getting ridiculous. The problem in the market still hasn't been fixed and won't get better for another two years as I see it. I'll put my money back in once the market gets confidence back in it."

The quotes sound like classic J6P capitulators: selling at bottom, waiting till the market goes way up ("gets confidence back") before buying back.

The snapback rally in the last hour was breathtaking (as was the volatility in the beginning of the day). The DJIA went from just over 8000 to nearly 8900 in about 40 minutes. That's over 11% in 40 minutes (as in index!). I've never seen anything like it. To put this in perspective, that's a year's average historical return in 40 minutes of trading. When we finally have our exhaustion rally, it will be similarly powerful.

I'm pretty much all-in as of the close on Friday. If the market keeps going down, I'll have to raise more cash somehow.

A few people on the finance forums I visit are calling for a crash tomorrow. That could be the very skepticism that fuels a rally. When the rally comes, few will believe in it. The market will climb the wall of worry. When enough people finally believe it, these lows will be tested again.

I'm just a penny on the train track
Waitin' for my judgement day
Come on baby girl let me see those legs
Before I get flattened away...


I don't wish to spread alarm on the line people but the big issue confronting the market is I'm afraid the health and sustainability of Morgan Stanley and Goldman Sachs. It is unimaginable that they can be allowed to go, I suspect that they will be nationalized at some point today or over the weekend.

-- Hugh Hendry, Partner and CIO at Eclectica, on CNBC

Roubini's blog thoughts

Talk about scary:

The US and advanced economies’ financial system is now headed towards a near-term systemic financial meltdown as day after day stock markets are in free fall, money markets have shut down while their spreads are skyrocketing, and credit spreads are surging through the roof. There is now the beginning of a generalized run on the banking system of these economies; a collapse of the shadow banking system, i.e. those non-banks (broker dealers, non-bank mortgage lenders, SIV and conduits, hedge funds, money market funds, private equity firms) that, like banks, borrow short and liquid, are highly leveraged and lend and invest long and illiquid and are thus at risk of a run on their short-term liabilities; and now a roll-off of the short term liabilities of the corporate sectors that may lead to widespread bankruptcies of solvent but illiquid financial and non-financial firms.

His solution?

At this point severe damage is done and one cannot rule out a systemic collapse and a global depression. It will take a significant change in leadership of economic policy and very radical, coordinated policy actions among all advanced and emerging market economies to avoid this economic and financial disaster. Urgent and immediate necessary actions that need to be done globally (with some variants across countries depending on the severity of the problem and the overall resources available to the sovereigns) include:

- another rapid round of policy rate cuts of the order of at least 150 basis points on average globally;

- a temporary blanket guarantee of all deposits while a triage between insolvent financial institutions that need to be shut down and distressed but solvent institutions that need to be partially nationalized with injections of public capital is made;

- a rapid reduction of the debt burden of insolvent households preceded by a temporary freeze on all foreclosures;

- massive and unlimited provision of liquidity to solvent financial institutions;

- public provision of credit to the solvent parts of the corporate sector to avoid a short-term debt refinancing crisis for solvent but illiquid corporations and small businesses;

- a massive direct government fiscal stimulus packages that includes public works, infrastructure spending, unemployment benefits, tax rebates to lower income households and provision of grants to strapped and crunched state and local government;

- a rapid resolution of the banking problems via triage, public recapitalization of financial institutions and reduction of the debt burden of distressed households and borrowers;

- an agreement between lender and creditor countries running current account surpluses and borrowing and debtor countries running current account deficits to maintain an orderly financing of deficits and a recycling of the surpluses of creditors to avoid a disorderly adjustment of such imbalances.

In other words, the largest globally coordinated reflation in human history.

10.9.08: Nightly Random Market Thoughts

More carnage. Unbelievable. The last hour was like a knife through butter. I'm recording my thoughts every night because I don't think something like this will happen again in my lifetime.

The NASDAQ bottomed at 1100 in 2002. Today, it closed at 1645. Another couple of days like today, and we'll match those lows. Same with the DJIA: 7200 vs 8579.

Back when I first started learning about the stock market back in 1997, I came across the idea that the long bull market of the 90s was fueled by easy money policies of the Fed and the bubble would eventually pop, followed by economic devastation. The NASDAQ suffered the brunt of the blow when the bubble popped, but it wasn't nearly as swift as this recent fall, and the recession was mild. I was surprised at how well the US economy fared. Economic devastation never came. I wonder if the reason is that the economy remained distorted via other sectors such as real estate, and we're only now seeing the consequences of excess credit. The real estate bubble only really grew after the stock market bubble popped. Perhaps the consequences of the easy money policies predicted by that cabal in the late 90s are finally coming home to roost.

All sentiment indicators are off the charts. There is going to be a massive short/medium term bounce Any Day Now, though there's no telling how much lower the market will go beforehand. My strategy is to:

1) Accumulate long term positions as the market keeps going lower.
2) Play for extreme risk, short term positions (for that bounce) that could result in 10-20 baggers when people are running for the hills. Small bets, potentially large payoffs.

General Motors' market capitalization today dropped below its value at the 1929 peak. It was a great company back then, at the height of the 20s market bubble. It is a shit company today.

Iceland's government took over its three largest banks and suspended trading on its stock market for two days. Almost every talking head on CNBC after today's market close wanted the government to "do something". If war is the health of the state, so are economic crises.

Kulicke and Soffa:
Market cap: 170.51 M
Total cash: 172.76 M
(I haven't looked closely at the balance sheet, so don't make anything more of it than "heh".)

The 1 year chart for crude looks suspiciously like the state of Virginia.

All part of the New World Order.

More Random Market Thoughts: Gold

An interesting phenomenon has occured during the recent market downturn. The XAU-to-Gold spot price ratio has reached historical lows*. As an example calculation, today XAU closed at 121.53. The gold spot price is right around $900. The XAU/Gold ratio is 121.53/900 = 0.135. A couple of days ago, when the XAU reached the low of 96.61, the ratio was even lower.

What does this ratio being so low mean? That depends on what the numerator and denominator represent to investors.

Gold itself (the shiny stuff) is rarely a good investment. Perhaps once or twice in a lifetime it reaches such levels. Rather than being a good investment, it acts as a great store of value--empircally the greatest store of value civilization has known. Being a great store of value, it would be very useful if and when society collapses. It would retain its value when the rule of law disappears and gangs roam the streets. I see physical gold as a survivalist tool. Everyone should have a shelter to hide out in, just in case, with at least a week's supply of water, ready-to-eat meals, guns, ammo, duct tape, WD-40, and toilet paper, and everyone should have some bullion. Just in case.

Gold mining companies are a proxy for the price of gold, and usually are highly leveraged to it, so that potential returns are much higher**. Thus, gold mining companies can be much better investments than gold itself. If civilization collapses, nobody will honor any shares, and there may not even be a stock market left. But if the meltdown is figurative, rather than literal, gold mining shares will do well. As long as civilization doesn't collapse, gold mining shares are the way to play a rise in the price of gold.

So what does the low XAU-Gold ratio mean? It's predicting, if my views above are correct, the apocalypse itself, a breakdown of society, not just economic hardship. That scenario seems very unlikely to me. Many people will lose their jobs and life savings, but it won't be Mad Max. The ratio is discounting a highly improbably scenario.

One more variable is noteworthy. As I said below, politicians and economists fear deflation with a passion that I don't understand. I'd rather have my money worth more rather than less after whatever is coming, recession or depression. But my views don't matter (and rightly so), so the next few months will see the greatest coordinated global reflation effort in human history. As the supply of money increases, the value of money will decrease, and the value of gold will rise.

For the ratio to normalize to historical levels, either the XAU has to rise significantly, or the price of gold will have to drop significantly. I see the latter as very unlikely. Thus, the most undervalued sector in the stock market is the gold miners. As I said recently, this is the time to accumulate. A diverse basket of gold mining stocks is an excellent way to begin taking advantage of this once-in-a-lifetime buying opportunity. Large profits await those who are brave.

* HUI - Goldbugs index. It only has gold stocks that do not hedge their positions. Relatively new.

XAU - Another older index of gold-related stocks. It contains companies that hedge their positions.

Here, I use the XAU instead of the HUI, even though the HUI would be a more accurate indicator of relationship to the gold spot price, because I can't find data on the HUI before 1996.

** As a simplified example, if a company can "make" gold for $250, and the price of gold is $300, it's profits are $50. If the price of gold rises to $350, profits have doubled to $100. On the other hand, if the price of gold falls to $245, the company is losing money and can potentially go bankrupt. It is unlikely that physical gold will ever be worthless. Leverage: higher returns, higher risk.

*** As always, if you take my advice, you deserve whatever life throws at you.

Random Market Thoughts: When does the downward spiral stop?

There's a lot of fear out there that we're going into a depression, or that we're going to suffer deflation, which seems to be everyone's worst nightmare. I'm not an economist and don't really understand why deflation is such a Horrible Thing or why inflation is somehow less worse. I read somewhere recently that deflation represents an "inverse bubble" in which people keep hoarding cash and don't buy goods or make investments even at attractive prices. I don't see how this vicious circle (positive feedback) is necessarily what's to be expected. Instead, I expect a usual stock cycle (negative feedback) in which stock prices decreases till they reach a floor and then rebound as economic growth resumes. So what factors will create a floor under stock prices at their bottoms?

Right now, those with little cash:

financial companies

Those with more cash:

many non-financial companies

Those with a lot of cash:

few non-financial companies, either with cash saved up, or with strong, regular, predictable cash flow

As stock prices continue to slide, those non-financial institutions with lots of cash will see value in non-financial institutions with less cash. Consolidation will be the name of the game. Many public companies will be bought by private owners. Expectation of being bought can provide a floor for stock prices.

As stock prices continue to slide, dividends will continue to rise. Right now, GE has a yield of 6.1%. Merck's is almost 8%. These are approaching very compelling valuations. As they continue to rise, investors will choose to own stock rather than buy fixed-income investments or Treasury securities which pay a lower yield and don't have the potential to provide additional returns from price increases like stocks.

As stock prices continue to slide, PEs will continue to shrink. Right now, AMAT has a price/sales ratio of 2. As I've told Brandon in the past, I've been waiting to buy AMAT for over a decade. My standard for "great value" is when AMAT's P/S ratio is 1. Unfortunately, I missed the 1995 massive capital expenditure chip cyle, so I've been waiting for the last decade. The industry has matured and is no longer cyclical, but if and when AMAT's P/S ratio becomes 1, I will buy far out of the money 2011 LEAPS. More generally, when prices go low enough, there will be people who will realize that stock XYZ hasn't been this poorly valued in the last 5 years, 10 years, 20 years, etc and will step in to buy.

So that's my answer as to why a usual negative feedback stock price cycle will happen rather than a positive feedback vicious circle: consolidation and expectations of consolidation, dividend increases, and attractive valuation.

Blood in the Streets

Fear has reached epic proportions. I follow market sentiment closely and have for the past 11 years, and I've done historical research for the data available before that. This is the greatest acute panic in the market since 1987, certainly far above what I've ever seen personally. Edit: It greatly exceeds the fear present during the bear market bottom of 2002, 9/11, the LTCM bailout of 1998, and the "Asian flu" of 1997.

Anecdotally, nobody wants to touch stocks. On various message boards I frequent, there are innumerable warnings to wait till the market "stabilizes" before buying, and nobody is recommending buying now. Jim Cramer recommended pulling out all money you might need over the next five years on the Today show this morning. 6 in 10 Americans think a depression is likely.

Many people do what's called "dollar cost averaging": dumping money into stocks at regular intervals. If we label these "dumb buys" because they do not take economic analysis or market conditions into account, buying now would certainly be a "smart buy". There is far, far greater probability of higher than market returns if one buys today than from any prior dumb buy, or when the market was at all time highs less than a year ago.

There's blood in the streets. It's time to accumulate. Far-above historical returns await the brave.

Figure this one out

A few days ago, bailout failed, market tanked 400 points. We were perplexed. Today, bailout passes, market drops 450 points. Explain that, bitches.

My tentative conjecture subject to future revision should more data arise: we're all fucked!

Pork Chop Sandwiches!

Whenever things seem dire, I turn to GI Joe. You might remember the PSAs at the end of the show when a GI Joe would remind kids not to stick their tongues in electrical outlets or eat nails. Here are a couple more (NSFW - language):


Bailout sentiment

I first noticed it at the end of last week: most of the "average joes" on various message boards I visit were against the bailout. A WSJ article from today confirms what I found anecdotally.

The defeat in Congress of a proposed $700 billion economic-rescue package followed an intense outpouring of voter anger, fanned by politicians, interest groups and media on the left and right, that overwhelmed calls from the president and top lawmakers to pass the deal.

Amen and Hallelujah

Jeffrey Miron:

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

Snapshots of Russian Financial Crisis

One common argument I've heard recently about the banking difficulties is that if the economy is damaged, there's a point beyond which the damage is so severe that a depression will set in. In another words, a little bit of damage is bad, a lot of damage is worse, but after a certain point, too much damage causes the entire economy to unravel and dogs to sleep with cats.

One data point against this view might be the Russian financial collapse of 1998. I don't fully know the details of what happened, but I do know how the Russian Trading System (the stock market) reacted. You can see that the market lost most of its value from mid-1997 to mid-1998.


By my calculations, the RTS lost about 92% of its value. To get a sense of the magnitude of the loss, that would be a DJIA reading of under 1200 down from its high of just over 14000 back in 2007.

What happened next?

The precipitous drop from the first chart is a mere undulation on the left side of the second chart. After the bottom hit, the stock market began to rise immediately, and fast. Less than five years after the bottom, the RTS regained everything it had lost. Four years after that, it had quadrupled its previous all time high (from just under 600 to just over 2400). In other words, in nine years, it multiplied its value about 50 times that at the bottom. That's an annual return of about 55% from the bottom.

To further emphasize, that's an annual return of about 15% from the top of the previous bubble. (As a benchmark for comparision, the DJIA has historically grown 10-11% per year on average during its history.) An hypothetical omniscient being knowing what was coming in late 1997 and early 1998 would have given the advice, "Yes, there will be pain in the short term, but in the slightly longer term, things will be fine."

From what I know about the crisis, which is admittedly, very little, there was little intervention by the Russian government, and what intervention was done had little effect. Certainly, nothing was done that compares to the various bailouts enacted and proposed over the last several months in the US.

I don't know if any of this applies to the current situation in the US. Things may be very different here. But this is one example of a market washout that did not lead to a depression, but rather, was followed by robust growth. There's an oft-heard viewpoint from proponents of the market that when bad investments pile up in the economy, the best thing to do is to let them fail. It puts the economy on sounder footing which is required for growth to resume. The Russian financial collapse of 1998 might be one example confirming this view.

You might have noticed the precipitous drop in the RTS in the last year. Nearly all of the world's financial markets have done the same. I don't know how meaningful the drop is in foreign markets, so I did not include it in my calculations, though even if I had, the numbers would be less robust but still impressive.


In the midst of a panic, there's a profit to be made. The best buys are the hardest to make. Acting crazy is tough.

I'm predicting today was a good day to buy.

Edit: Another prediction, this one I'm not very confident about but think has a decent chance of happening, say 10%. There will be a 1000 point up day on the DJIA very soon.

I'll be in my bunk

Olivia Wilde is so sexy she makes me want to strangle a mountain ox with my bare hands.

--Megan Fox

Yes, the US is, in essence, a free country

Yeah, I realize that taxes are high, non-violent people are locked up in the Drug War, consenting adults can't do nasty things to each other, etc. But the thread at Austro-Athenian Empire that Micha linked below makes me shout, "Let's have some perspective!" Lost in the giant thread was this insightful comment by Stephan Kinsella:

Mises had it right when he said that you could tell if a country is basically capitalist (in the good sense) or not: whether it had a functioning stock market. We do, and I am quite sure Mises would never agree with such a ridiculous claim that there is “no distinction” between the state and the Fortune 500 companies. Of course they are essentially private. The market is hampered, but it is not the state. If it were the state, it could not produce as much as it does (see Mises’s socialist calculation argument).

“The nominally “private” sector large corporation is part of an interlocking directorate with the regulatory state.”

Saying it’s “part of” is arguing by squishy semantics. Anyway, it’s where we would differ. I appreciate your criticisms of vulgar capitalism or libertarianism, but it is not vulgar to recognize that companies are hampered (and yes they support the state too, as do most people) and distinct from the state.

It's batshit insane to believe that corporations ARE the state. If that makes me a "vulgar libertarian", then vulgar libertarians of the world unite, hoist the black flag, and smash ... something! A stock market is a humanistic, democratic, dare I say, egalitarian institution.

We not only have a stock market, but we all kinds of derivatives markets.

(Quick definition: A derivative is something that derives its value from something else. Examples: options (from stocks), futures (from commodities), etc)

This gives anyone the freedom to pretty much bet on anything.

If you're worried that the market might go down, you can sell your stocks, or short stocks, or keep your stocks but buy put options as a hedge.

If you believe that oil prices are going to kill the economy, you can buy oil futures or companies that produce oil or companies that drill for oil. Sure the economy might suffer, but you'll make money.

If you beleve Cheney's gonna screw us all by using the war as a means of profiting his buddies, you can become of those buddies by buying shares of Halliburton.

If you believe that the Fed is debasing the currency, you can buy gold or gold futures or shares of gold mining companies.

If you think VT is going to beat UNC, you can bet against UNC.

If you think people are underestimating McCain's chances, you can bet on Intrade that he's going to win.

If you think Israel and the US are going to bomb Iran, you can bet that on Intrade and make money.

We're close to the point of being able to bet whether or not it will rain tomorrow.

For almost any future possibilities, you can adjust your investments to fit them.

It's good to live in a country where almost any bet is possible. We're not helpless in the face of a changing economy. It would really suck if we were forced to keep our retirement money in a vehicle that we couldn't change, that we couldn't modify, and it would really really suck if that vehicle was on unsound financial footing. That would be like.... Social Security.

There's a lot of wackjob blathering about how the "entrenched political class" screws over the helpless little guy. Bullshit! The little guy, for as low as $8 a trade, can profit off of anything pretty much anyone in this country does.

Now, if someone claimed that Social Security IS the state, I'd agree. See the difference?