Systemic Risk Still Possible
By Paul Lamont
July 31, 2009
“It is noticeable in panic times that a period arrives when nearly everyone thinks that stocks are low enough, yet prices continue downward to a still lower level. The result is that many investors, after thinking that they have ‘loaded up’ near the bottom, find that it is a false bottom, and are finally forced to throw over their holdings on a further decline.” – G. C. Seldon. Psychology of the Stock Market, 1912.
The Recession is Over –7 Years Earlier
During the last few months, we suspect you have heard quite a few economists, politicians, and U.S. Federal Reserve Chairman Ben Bernanke describe the ‘green shoots’ of recovery. We found it remarkably similar to the outlook that Alan Greenspan gave seven years earlier. Sir Alan’s forecast followed two weeks when “shaky American stock markets have shrugged off fears that some of their biggest players are made of sand.” After Mr. Greenspan’s optimistic prognostication for the economy in March of 2002, the S&P 500 plunged roughly 35% to a new bear market low.
“It should be written down as an axiom that you always invest against the central banks.”– Jim Rogers. Market Wizards, 1989.
Municipal Bond Trouble
When the investment herd rushes into municipal bonds (actually, any investment) at an “unprecedented rate” according to Bond Buyer, we take notice. Especially when states and municipalities are having an increasingly tough time making ends meet. Unpaid property taxes are increasing. In Arizona, they are discussing selling the state legislature.
“Never, ever follow conventional wisdom in the market. You have to learn to go counter to the markets. You have to learn to think for yourself; to be able to see that the emperor has no clothes. Most people can’t do it. Most people want to follow a trend….Maybe that is valid for a few minutes in Chicago, but for the most part, following what everyone else is doing is rarely a way to get rich. You may make money that way for a while, but keeping it is very hard.” – Jim Rogers. Market Wizards, 1989.
Anything is Possible
Last month, we compared the current bounce to the 1930 bear market rally. We would like to clarify that we were referring to the pattern of the rally generally; not a specific price level or duration. These two latter characteristics (so far exactly similar: 47% rally in 147 days, though we don’t expect that coincidence to last) were recently noted by CNBC’s bullish commentator Jim Cramer. More important to us, is the outright dismissal of our comparison by Mr. Cramer (and other bulls) based on the assumption that “systemic risk has been taken off the table.” We clearly disagree. We understand that the Federal Reserve can lend to anyone under the sun. But after the Fed lent money to bailout Bear Stearns, the run on the bank continued. As Paul Friedman, COO of Fixed Income at Bear Stearns, told William Cohan in House of Cards;
“By early afternoon, Bear Stearns could see that the Fed’s rescue plan was not going to work. ‘By midday, the money is gone,’ Friedman explained. ‘The customers are gone. The customer credits are to the point where the wire room shut down. They couldn’t process them fast enough.’”
Three days before, on March 11th, Mr. Cramer had stated: “No! No! No! Bear Stearns is fine. Do not take your money out!” In Mr. Cramer’s defense, Bear Stearns at the time did have $18 Billion in cash reserves. And they were eventually taken over. But as Sam Molinaro, CFO of Bear Stearns, relates:
“It happened so quick and the market reacted so badly. We had a substantial run on the bank on Friday. Not only was the stock under pressure, but customers were trying to pull their money out at increasing levels. Prime brokerage clients, they didn’t want to do business with us. Stock lenders didn’t want to lend us securities. It was chaos.” House of Cards by William Cohan, 2009.
Our point is this: Do not underestimate a fearful market. Paul Friedman warns: “in terms of how quickly did it happen, and could it possibly happen that quickly, it really did. It really went from Wednesday morning to Thursday afternoon, twenty-four hours from solvent to dead. It seems inconceivable.” And since Cramer admits: “almost no one believes the system is still in jeopardy,” that has us worried.
With his assumptions also serving as his evidence, Mr. Cramer concludes: “Forget look-alike charts [and] focus on the fundamentals, because they tell you what the future will hold. And based on the fundamentals, the future seems downright bright to me right now.” A look at the ‘fundamentals’ is below, even if it is in chart form.
An Outgunned Army of One
Wall Street is in the marketing business. Making wise investments in financial markets is an entirely separate enterprise. As long as markets rise, the difference is not apparent. But it becomes painfully clear once a downturn takes hold.
After the down market of 2002, 43% of “individual investors described ‘personal research’ as the primary source for their investment advice.” So it is no surprise that after the recent sell-off investors are dumping their Wall Street broker or ‘easy money’ adviser. May we humbly suggest to investors that have already lost big but are determined to go it alone, invest in short-term U.S. Treasury Bills until you have studied the craft. Especially with corporate insiders selling stocks at the fastest rate since we mentioned it in 2007.
“In due course of time, if they bought on margin, they went to ‘the Cleaners,’ that mythical establishment to which their brother speculators had repaired some time earlier. ‘The Cleaners’ was not one of those exclusive clubs; by 1932 everybody who had ever tried speculation had been admitted to membership. - Fred Schwed, Jr. Where Are the Customers’ Yachts or A Good Hard Look at Wall Street, 1920-1938. 1969.
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