I heard a great explanation of the current market turmoil a few days ago – “You can’t explain stupid.” For a moment, let’s set aside the personal loss and devastation of a hurricane and think about it purely from an oil pricing perspective. About 25% of the US oil and 20% of natural gas production comes from the Gulf of Mexico. When a hurricane enters the gulf, off-shore oil platforms must be shut down and the workers evacuated to safety on land.
Although hurricane Gustav’s bark was bigger than its bite, I understand that it will be November before production is back to 95% pre-hurricane levels. Basic economics states that a decrease in supply results in an increase in price. Oil pricing was falling before the hurricane, but shouldn’t a hurricane at least slow the decline? Prices continued to fall when a second hurricane, Ike, barreled into the Gulf a few weeks later.
In March, the government bailed out Bear Stearns (NYSE:BSC). Just last week it bailed out Fannie Mae (FNM) and Freddie Mac (FRE). Lehman Brothers (LEH) is on the verge of being wiped-out this weekend without some assistance. The automakers have their hands out and without a doubt the airlines will be asking for some government candy too.
Bailouts add to the national debt. That sounds like a problem, but the consequences aren’t apparent to most Americans. However, just like in personal finances, the country pays a price for too accumulating much debt. Since “we the people” are the country, that means we will pay the price for the country taking on too much debt. Instead of our politicians, in BOTH parties, running around saying that change is a coming; it might be a more truthful to say higher interest rates and higher taxes are a coming. In spite of growing debt, the market continues to rally after each of these bailouts.
So what does this mean to traders? A difficult lesson that I continue to re-learn is that you must trade what you see not what you think. Trade the charts and manage your risk through stops. This has never been truer than this year. This market is beyond reason - “You can’t explain stupid.”