The Coming Market Crash And The "Trigger"

Includes: DIA, QQQ, SPY
by: Doc's Trading

My former article “Are We Crying Wolf Again" predicted a minimum 5-10% correction. This shallow prognostication was due to the fact that I saw no “trigger” that, as in 1929, 1987, and 2008, could cause forced selling (regardless of price). That was then and this is now. A serious crash is now probable and the bubble of margin debt will be the trigger and the cause.

What causes forced selling at any price? How will it happen now?

Here are a several nagging problems:

1. Circumvention of 50% Regulation T margins

2. Continued deterioration of the advance decline line

3. Sentiment

4. Possible China bank insolvencies

5. Nasdaq double top

6. Corporate buybacks

7. Bond yields at bottoms and basing

8. Junk bond yields

9. ETF exacerbation potential

10. European stock weakness

11. Volume patterns

12. Transports

13. IPO premiums and MA’s

14. Record margin debt and major margin percent below 25% with maintenance as low as 10%, a la 1929.(I think brokerage clearing houses should immediately increase minimum maintenance and margin requirements currently circumventing Regulation T.)

My July 1st – 7th prediction of a minimum 5-10% correction hit the Russell 2000 correctly to the top day and the S&P500 index at 1986.00 on July 3rd. My 1929 chart comparison was used to show the similarity of the technical patterns then and now. I showed just how vulnerable the immediate future was for this market.

As a result of serious investigations in search of that elusive “trigger”, I am sorry to report that my efforts to locate such a trigger have produced frightening results. The “trigger” as defined here is an underlying fundamental weakness that will cause our current stock market to accelerate a decline due to forced selling at any price, much as in 1929, 1987, 2000, and 2008.

In 1929 the “trigger” that caused forced selling at any price was the then 10% minimum margin requirement and maintenance. The unanswered margin calls set off selling by brokerage houses. 10% margin was also the cause of the 6-fold and uninterrupted rise from 1924 to the Dow high of 381. The lack of Federal controls and the unseemly 10% margin indeed proved to be insane. The decline set off a chain reaction resulting in the October, 29 six hour late tape.

As an interesting anecdote: A runner on the NYSE floor entered an order on the specialist book to buy Singer Sewing at $1.00. (the stock was selling for 54 at the time, down from over 100). He was filled.

In 1987 the trigger was the use of SPY futures by hedge funds as insurance to protect against a decline by selling them as substitutes for their stock holdings. Everyone ran for the exit at the same time resulting in a close one late October Monday (almost the same day as in 1929) that saw the Dow down 500 points — bear in mind, the averages were one ninth today’s prices then.

In 2000, a Barron's article pointing out a list of over 200 companies (all losing money) with recent IPO’s that had all leaped skyward at their opening price served as a warning of just how many days of cash remained in those companies’ coffers. Ultimately, they ran out of money, causing the beginning of a two-year (luckily not two day) unwinding of the ridiculous speculation known as the “dot com bubble”.

2008 needs no explanation — it’s still fresh in our memories. But suffice it to say, a near collapse or meltdown of the world’s financial structure and systems required a trillion dollar bailout.

Today’s trigger is almost too simple to believe. The fact that a circumvention of Regulation T’s 50% margin requirement has been allowed (sometimes called “portfolio margin”) especially in accounts over $100,000, has resulted in a high percentage of today’s accounts having bought at 25% and lower margins. This is today’s potential lightening bolt.

Many houses and clearing firms are allowing 155 and lower maintenance. Hello 1929. One reason there have been no loud voices objecting to this is because all first hand participants of 1929 are dead. Want to trade futures and have $10,000 to play with? Great, there are brokers lined up to loan you a million dollars at 1% interest — yes one million.

1% interest rates and 25% margin have enticed quite a few accounts believing the Fed will control interest rates and the printing presses to support any rise in market values. We’ve come full circle in 85 years.

Here are some other contributing factors that may add force to any decline:

1. Continued deterioration of the overall and sector advance decline lines as well as the number of new highs and lows and their ratios to each other.

2. Sentiment remains complacent in the belief that all declines are buying opportunities.

4. China has built “ghost cities” and sold the real estate to the Chinese populace who are forbidden to invest abroad. Their stock market is a rollercoaster causing the average Chinese citizen to invest decades of ancestral and family savings into real estate being built up into large cities with sky scrapers visible for miles, but that are literally empty. “Build it and they will come” — only they are not coming. Billions have been borrowed from Chinese banks by construction companies. These loans will never be paid back.

5. Nasdaq at 4500 is close to a double top.

6. Corporate buybacks are causing an increase in earnings, but this is artificial without an increase in revenues. This should be called “trick accounting”. Companies are borrowing at very low interest rates to buy back shares so CEO’s can get giant bonuses. What happens when the loans begin to drag on earnings due to rising interest rates?

7. Bond and note yields have bottomed out. Even a decline in the market will not be accompanied by lower yields.

8. Junk bond yields have been chased to ridiculous levels never before seen.

9. ETF’s could exacerbate any downturn if redemptions climb. They behaved in 08-09 but are now three times the size and quantity. A new downturn could easily lead to strong negative consequences, smashing many of the existing strategies out there today. The decline could metastasize to other financial sectors. As an example: The “flash crash” of 2010 where the market fell 10% in 30 minutes caused many ETF’s to decline 50%. 70% of all trades broken (cancelled) that afternoon were ETFs.

10. Recent European bourses’ weakness reflects the sluggish EU recovery — this could be exacerbated by recent Russian sanctions.

11. The technical volume patterns exhibited recently are negative. Increasing volume on declines and lighter volume on nearly nonexistent rallies.

12. The transports are getting toppy.

13. IPOs wild first day advances are shades of 2000. MA’s are also the latest rage since companies can buy other companies with inflated stock, or monies that are borrowed at cheap interest rates.

14. Allowance of sales on down ticks. The old “uptick to short” law cannot be enforced any longer due to too many ways around it with options and Nasdaq electronics.

15. Other bubbles now exist, blown from an inequality of wealth not seen in 90 years. For example, classic cars ($24 million for a 63 Ferrari); paintings ($100 million for a Max Earnest, $79 million for a Norman Rockwell); $37 million for a small house in the Hamptons or a condo in San Francisco or London. How about a $57 million apartment in NYC?

As a final note, investors may want to consider lobbying the appropriate legislators in an effort to persuade them into outlawing the recent circumvention of Regulation T (50% margin )and substituting former 50% margin and 25% maintenance. 50% margin has kept declines in check since the early 1960’s and unless re-implemented, may not be around to stem the next decline. The greed of brokers and clearing houses together with the availability of cheap money has fueled the unprecedented purchase of all types of assets. The promise of profits due to available leverage not seen in 85 years supports the same pie-in-the-sky beliefs that we witnessed in 1929 — it’s an endless summer with a “greater fool” always ready to bail you out.

I’m afraid “the die has been cast”.