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There is a common belief that a “Plunge Protection Team” is sitting in a hidden room, somewhere deep within the bowels of our government, with its trigger on a Cramer-like BUY-BUY-BUY button every time the market plummets. Many people feel that this “team” will prevent our markets from acting in a disorderly manner. This, they claim, should cause, you, the investor, to “feel” more confident in our equity markets, since Uncle Sam is always at work protecting you. However, I am not one of those people with such misguided beliefs.
Let’s look at the history behind this mysteriously active Plunge Protection Team, and then let’s see if they have actually been able to “protect” us from plunges.
Creation of the Plunge Protection Team
The last two weeks of October 1987 saw the equity markets shed approximately 22% of their value. After this market crash of 1987, President Ronald Reagan created the President's Working Group on Financial Markets to recommend solutions for enhancing U.S. financial markets, preventing significant volatility, and maintaining investor confidence. The group consisted of the Secretary of the Treasury and the Chairmen’s of the Federal Reserve, the Securities and Exchange Commission and the Commodity Futures Trading Commission.
Thereafter, this “Working Group” became known as the Plunge Protection Team, and many believed that this “Team” would intervene at the appropriate moments to prevent significant volatility in the markets, which would, thereby, prevent market crashes in the future. As the myth has been perpetuated, it can supposedly do this by convincing banks to buy stock index futures, or by having the Federal Reserve do the buying. The goal was supposedly to allow markets to correct in an “orderly” fashion so as to “maintain investor confidence” in our equity markets.
Have You Felt Protected?
If there really is such a team hard at work, with their ever-present finger on the “buy” trigger, then we should not have had any stock market “plunges” since 1987. Rather, the stock market should have only experienced “orderly” declines since that time, and not plunges of 10%, and certainly not over 20%, within a period of a day to a couple of weeks in the same manner as that experienced in 1987. So, the question we now have to look at is if the facts within our markets actually support the existence of such a “Plunge Protection Team” actively at work in protecting us from significant stock market “plunges.”
Since 1987, I don’t think that anyone can fool themselves into believing that we have not experienced periods of significant volatility. In fact, the following instances are just some of the highlights of volatility since the supposed inception of the Plunge Protection Team:
  • February of 2001: Equity markets declined of 22% within seven weeks;
  • September of 2001: Equity markets declined 17% within three weeks;
  • July of 2002: Equity markets declined 22% within three weeks;
  • September of 2008: Equity markets declined 12% within one week;
  • October of 2008: Equity markets declined 30% within two weeks;
  • November of 2008: Equity markets declined 25% within three weeks;
  • February of 2008: Equity markets declined 23% within 3 weeks.
  • May of 2010: Equity markets experienced a “Flash Crash.” Specifically, the market started out the day down over 30 points in the S&P500 and proceeded to lose another 70 points within minutes. That is a loss of 9% in one day, but the market did manage to close down only 3.1% in one day!
Based upon these facts, you can even argue that significant stock market “plunges” have become more common events since the advent of the Plunge Protection Team, especially since we have experienced more significant “plunges” within the 20 years after the supposed creation of the “Team” than in the 20 year period before.
The Last 2 Weeks
In the last two weeks, our equity markets have experienced quite an eventful 16% loss in equity values, and more is probably still to follow. In fact, some of our technical readings have nearly jumped off the charts.
For example, our advance to decline ratio jumped to the level of 19 declining stocks for every 1 advancing stock. Another example is that our declining volume to advancing volume was 98.5 to 1. But that is not really the worst of it. In fact, we experienced such off the chart numbers not once, but for two days in a row.
In fact, our equity markets were more oversold over this period than they were in the Flash Crash of 2010 and the 2009 March low!
But, not to worry, as our ever-present Plunge Protection Team is on the job!!
Erosion of Confidence
I think everyone would agree that market movements are based upon whether confidence is pervasive or lacking within the investment community. In fact, when questioned about the Fed’s ability to control the market, Alan Greenspan shed some light on this matter for us rather succinctly when he stated that “the idea that the FED can prevent recessions is a puzzling notion . . . Rather, the stock market is driven by human psychology and waves of optimism and pessimism.”
In fact, I propose that the idea of a Plunge Protection Team has been goal of the creation of this “Working Group.” If the public simply thinks that there is a team that is going to protect them from losses, then they would have more confidence in placing their money at risk in the equity markets. After all, isn’t the main goal of this “team” to maintain investor confidence?
However, as market crashes continue to happen more and more frequently, it causes an erosion in the mystique of the Plunge Protection Team’s ability to prevent such market crashes. I believe such erosion of confidence is actually more damaging and important an issue than whether or not they are actually involved in supporting market prices. For as long as volatility is on the rise, and confidence erodes within our markets, our investment accounts will erode along with it, whether you believe that we have a real Plunge Protection Team or not.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in SPY over the next 72 hours.
Source: Plunge Protection Team: No Different Than Santa and the Tooth Fairy?