By John Reizner |
Is the recent decline in the S&P 500 from the December 5, 2014 recent high of 2079.47 a significant top that potentially may be followed by continued selling waves similar to the sharp sell-off ending in the autumn of 2011 or even during the stock market debacle during the 2007-2009 financial crisis?
Or may “buying the dip” at this juncture be the right move for investors? I think that either is possible as there are many similarities between the stock markets of 2007 and now.
On December 10, in my blog post here, I suggested that a SPY put hedge might offset a potential decline in the S&P 500, which closed for that day at 2026.14. That decline has been unfolding though with great volatility in both directions. Should I detect a potential bottom to this market, I will alert readers in my blog which accompanies my articles on this website. That may happen at any time.
In the U.S., October margin debt declined from the preceding month as the reversal in the markets has been met by investors' margin selling and reductions in margin balances. A decline in margin debt after such a long upswing in such debt balances as is the case now has marked market tops in the past. Continued trends in the margin debt figure bear close watching.
The catalyst for a potential Black Swan reversal: a reversal in the paradigm of a rising U.S. stock market may (i) be further economic trouble in Europe and the slowing growth of global economies ex-U.S., (ii) actual price deflation in major economies, (iii) the sharp oil price decline and upheaval in the oil-dependent Russian economy as well as (iv) volatility and violent action in Chinese stock markets. A crisis of confidence in the Fed’s ability to manage a recovery in the U.S. economy or in their ability to manage an exit from monetary ease (if they do indeed attempt to exit the policy) may also stand as a Black Swan event.
Are there similarities between the sharp stock market break on February 2007 that preceded the market crisis in 2007 and commenced in October of that year and current downside action in the U.S. equities markets? Or is this holiday time downturn just a garden variety decline where one may "buy the dip" with impunity and continue to profit through a resumption of rising stock prices.
I wrote in an article on April 10, 2007 entitled "Are Stocks Still Worthwhile Investments: A Reconsideration - The Odds of a Panic," that there was "an unsupported speculative fever" in the 2007 stock market that was being mirrored in the Hong Kong stock market. At the time the Hang Seng Index was also ratcheting in violent trading action as moves in that market have in the past preceded similar action in our market acting as a canary in the coal mine.
I wrote in 2007:
The thing that troubles me about the February 27, 2007 market break is not only the high volume, terrible breadth and sharpness of the fall, but also the sharpness of the snap-back rally in its aftermath. it was reported that some market participants were hoping for a continuation, a washout of the speculation in recent stock prices after February 27 - a further decline. it is known that our market break followed an abrupt fall in the Shanghai market, which has also snapped back in the near term.
I believe in our case as likely in the Shanghai market, the snap-back may indicate an unsupported speculative fever underlying the markets. In the month or so before Black Thursday in 1929, the market fell but the speculators kept pushing the market. When market selling took over, it was relentless. It may be a bit of a stab to say the two periods bear a resemblance, but the form of the speculative fever can be compared.
But I will say that in my view the odds of a stock market panic have increased due to the widespread participation of the public in equities, as happened in prior speculations. Also, hedge funds, for example, have created a culture among money managers and some investors, of short term and ultra short-term time horizons. together, these conditions may contribibute to high market volatility."
Currently the American and Shanghai market have showed signs of alternating waves of speculative buying and sharp corrections. Volatility on U.S. exchanges has risen as we experience the second sharp decline in three months.
Margin buying has increased in Shanghai and foreigners have been snapping up Shanghai “A” shares through the Hang Seng while believing that those shares are undervalued and that the party in Chinese equities may continue for some time. These factors have helped the recent reawakening in Chinese stock prices gain traction as well as increasing the volatility. Shanghai stocks swooned by 5% on December 9 amid recent action by Chinese authorities to restrict certain types of collateral for borrowing cash that finds its way into speculation, dampening money flows to their equities market.
The party in China may continue for a while until when the party is over…May a potential upset in Hong Kong and Shanghai stock markets affect the outlook for U.S. equity markets? It is likely best to keep an eye on Chinese stock markets as they have acted as a leading indicator for U.S. stocks in the past.
The flash factory activity in China contracted in December as a sign their economy may be slowing down, but the leaders in that country may be expected to counter the slowing economy and a reduction of inflation by loosening credit. The leaders of that country must ensure prosperity as a means of maintaining social order outside of brute force.
The Chinese economy is now greater in size than the U.S. economy and movements in the Chinese economy wield great influence in the world as American hegemony and economic dominance worldwide recede.
An argument that we may not have a serious decline in U.S. markets from this point emanates from the idea that interest rates may remain low for 2015: that there is plenty of low interest rate ammunition for a continued stock market rally even if the Fed has slowed the pace of bond buying.
Typically, a rising stock market requires a long series of interest rate increases to bring it to bear. This has happened before virtually every bear market. An inverted yield curve (when short term rates are above long term rates) are not only a precursor to occasional recessions but many stock market downturns as well.
But the times we live in are not typical – at least according to the series of bouts of QE and the ZIRP policy the Fed has undertaken. I think that there is more speculation within the offices of the Federal Reserve than by market participants on Wall Street. But there been great financial experiments by central banks and governments in the past.
Roosevelt’s New Deal was a social experiment enacted when he came to power after the 1929 Crash and the evidence shows that it may not have been the cause of economic growth at that dark time in our history; the World War II’s economy resurgence of demand for goods and services and changing the gears of factories’ production over to warfare equipment likely stemmed the tide of economic depression.
In 1937, eight years after Black Thursday, the stock market collapsed once again and economic conditions in America deteriorated once more even after a nascent fits of recovery after the depths of 1932.
Ben Bernanke, a student of the economic conditions of the Great Depression, realized that Fed authorities tightening credit prior to 1937 likely was the culprit causing that downturn and second stock market debacle of that era. He vowed that he would never preside over a repetition of the mistakes of the 1930’s central bank. Thus he presided over the massive and continued central bank easing after the financial crisis of 2008-2009.
A tribute to the resiliency of America: the American economy and stock market recovered in time after the Depression and even in light of the Great Recession. I think that deflation is winning the inflation/deflation argument in the American economy at least for now – the growth of America’s businesses is spotty given the absence of a more certain political and regulatory environment. Growth is minimal among many of our trading partners, with Europe and Japan still facing deflationary pressures.
There is a battle against debt and deflation being waged by the world’s central bankers using financial weapons of cascading levels of more debt and money creation. The potential risk is that the action of central bankers morphs into an economic MAD – “mutually assured destruction.”
We are not immune to a repeat of the 2007 – 2009 stock market experience if you believe that we are in a similar financial and economic paradigm as then. As we know, every bubble that forms has somewhat different characteristics than the preceding ones. We appear to be in the mid-later stages of a money printing bubble that has spilled over to financial assets. The grand financial experiment of the world’s major central bankers continues.
The late John Templeton, perhaps the greatest investor of his time, said that by the turn of the next century – the Dow Jones Industrial Average could reach 100,000, though I suspect the journey would be highly eventful in that eventuality. John Templeton was a rare seer born of his study, experience and vision: he was rarely wrong about the markets during his investing life.
What do you think?