What's Causing This Slow-Motion Market Crash?

We have experienced a market crash.  It did not occur in one day, as in 1987.  Instead, it took a few weeks.  We would call it a slow-motion crash, but it seemed to happen quickly and relentlessly.  Analysis is needed.

The Proffered Reasons

Yesterday  we were treated to two explanations about why the market had another big decline.

Bernanke

In his speech, Bernanke was not strong enough in indicating that a rate cut was coming.  This statement would seem to have some truth, since the market declined during the Bernanke speech and questions.  Some thought that he indicated that cuts were coming.  Others were bothered that he even mentioned inflation, proving that he does not "get it."

Our comment? Get real.   Greenspan was much more obscure in his speeches.  Did traders expect Bernanke to announce a rate cut in a public speech?  So he mentioned inflation, which he clearly indicated was abating.  Big deal.  If a little Bernanke-speak causes a 500 point decline in the Dow, something is awry.

Rescue Plan Critics

Last night's Kudlow featured an aggressive commentary from Don Luskin [no link yet].  He felt that Treasury Secretary Paulson should have started buying distressed paper the moment that Bush signed the bill.  He then went on to criticize various features of the plan.

Our comment?  A totally unrealistic expectation.  Paulson is putting together a team and a plan.  It appears that the first intervention will be within ten days to two weeks.  By normal government standards this is WARP Speed, Captain!  The Treasury does not have all of the right people on staff.  Putting something together would normally take months.  Give it a chance.  The market will be watching the first intervention, so Paulson should get it right.

These highly negative comments feed into the popular perception, since the average citizen never really understood the basis for the plan.

The investment media, with a "death watch" on stocks every night, are featuring dire warnings.  The investment blogosphere and our trusted gatekeepers also are featuring  doom and gloom.

To take just one example, we wrote an important article, strictly factual.  The big-time media that have trumpeted the other side for years have not even picked up the story, either from the original source or from us.  It was also not mentioned by the important gatekeepers.  This is a symptom of a flaw in the media and the blogosphere, where business models seem to intrude on dispassionate analysis.

Briefly put, the market is not looking at data.  There is a general feeling that no data sources are accurate.  This leaves everyone free to offer his own forecasts for earnings and the economy.

The Real Reasons

The actual reasons for selling are pretty simple:

• Some hedge funds that had big leverage have been forced to sell at any price;
• Money is flowing out of natural buyers, the long-only mutual funds;
• There is no sign of relief in the credit markets.  That is not going to happen until we address the issue of counter-party risk.  It could happen quickly, through the suspension of FAS 157 rules, or more slowly, through the Treasury auctions.  It will eventually be addressed, but too late for many.
• Typical technical triggers, like a high VIX, have not worked in calling a bottom.
• No one with "long bullets" will buy aggressively until the prior conditions are addressed.

Individual Investors?

For those of us who manage long-only programs this has been a once-in-a-lifetime disaster.  It is not like 1987, which we experienced.  The starting point was not a wildly over-valued market.

Many of us who analyze market fundamentals for individual stocks are simply amazed by the current prices.  It is as if the market has priced in a Great Depression even before we have a significantly negative quarter of GDP.  We plan to revisit this topic on some individual stocks that we favor.

Most of those with money to deploy are just standing back -- a "buyer's strike."  The Fed action to intervene in commercial paper is an important move, but no one seems to understand the significance.

Our official posture has been bearish for weeks, so we are not yet deploying newly invested funds in our programs, but we have an exciting list of opportunities.  We also have some specific triggers that we are monitoring.

Comments

[whidbey:]

Your analysis is interesting but too long winded. The P/E on the S&P is still elevated, when it reaches compelling levels, under 15, there will be buying, but first buyers will want to know the Fed plans. One they don't want to hear is that the FF rate is cut to 1.5 or 1% leaving the Fed denuded in the future. If the CP market stabilized tomorrow there would still be the major banks issues. BAC and others are still flirting with failure because we don't have bankers who can/will stay off the high wire and just run a bank for customers. The overseas markets in general are saying that they have no life without the major western markets and they will drag much lower before returning. For now waiting for the air to clear in US markets is about all anyone can do. Unwinding is never fun, but it is necessary.

2008 Oct 08 03:35 AM

[fxtrader07:]

the author is right: credit markets and especially the interbank lending market are key. unless they get these fixed, the economy will come to a halt and stocks fall even further.. If they can't fix it for another year then todays stock prices will be fair to expensive (depending what sector you look at). If they can fix it over the next 3 months then many stocks are absolute steals here.

@Whidbey: true, the overall s&P p/e doesn't look that cheap. BUT: it already includes now the disastrous earnings of banks and insurers. And while these won't recover to 2006-2007 levels anytime soon, recover somewhat they will - bringing the S&P's p/e down again.
second, there are now tons of stocks trading for their cash in the bank, business for free. msft could buy itself at current stock prices with cash and free cash flow - and still have some money left. oil companies, oil servicers with strong order books and backlogs, fixed contracts for a couple years out trade at p/Es of 3-8, natgas companies at less than half of what their natgas is worth (and that's assuming todays low natgas prices to stay). mlps and royalty trusts trading with yields of 15-20%.
there is indiscriminate selling. make no mistake. either oil breaks down to $40-$50 for an extended period of time or these stocks are once in a lifetime bargains (and many are hedged anyway to quite an extent)

2008 Oct 08 04:01 AM

[investing57:]

The market is behaving in a manner consistent with hedge fund liquidations and mutual fund cash outs. There is no money coming in seeking value, partly due to the high demand for cash, and high fear levels.
Though we may go lower, the risk/rewards factors are tilting heavily to the buy side. It seems the market has discounted almost everything but a mega depression.

2008 Oct 08 11:07 AM

[carey_jim:]

It's possible to reason that America has lived off its "collapse of communism" dividends for the last 20 years and that we've finally spent them.

The DOW stood at 2000 in 1987, just before the fall of communism.

The Russians are reigniting the cold war for obvious reasons.
We are in deep debt to the Chinese communists.
We are in an interminable war over oil resources in the Middle East.
We save virtually no money for future investments.
We spend more money on "defense" from imaginary enemies(?) than we do on education.
We even spend more money on, cigarettes, gas guzzling cars, Viagra, cocaine (and trying to prevent the sale of cocaine), advertising, lobbying, gambling, etc., etc. than we do on cancer research, finding alternate energy solutions, crime prevention, repairing our infrastructure, laying fiber optic cables, basic scientific research, etc., etc.

Maybe the DOW is still WAY overvalued even at 9,000?

(How much are World Series tickets these days and how much does a hot dog and beer cost at a World Series game?)

2008 Oct 08 12:56 PM

[surgcare:]

It amazes me how the analysis of the market can be so esoteric and no where near the truth . The fundamental problem , which is simple , is that the consumer has shut down . There is too much debt in america , so people have stop spending . WHY IS THIS SO HARD FOR PEOPLE TO UNDERSTAND . The consumer is tapped out . Soooo all these high falluten maneuvers by poloticians and gov isn't going to correct the problem .

2008 Oct 08 07:28 PM