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Bad Moments In History Tend To Compound Significant Crises

by Dr Joe Duarte
January 27, 2014


What Lies Beyond The Perfect Storm?

Exclusive to Decision Point.com

Reality has a way of making the best narrative look bad, which is what may be happening to this stock market.

In this space on December 16, 2013, we noted "The year 2014 promises to be a pivotal year for the United States and the World as significant political, financial and demographic shifts look set to collide." We expanded the notion by discussing the yet unrealized effects of three distinct issues: 1) The Affordable Care Act. 2) The Fed and its Taper Dance, and 3) the increasing use of off the books trading by big institutions by using dark pools and what is now described and know as "Upstairs" and "Downstairs" trading.

The take home message was that there were a fair number of very big and very unpredictable issues which could rear their ugly heads at some point during the year. At that time, it was pretty much an open secret that China's off the books banking sector was a factor. But the mainstream media, and the talking heads that work for big banks stuck to the narrative which suggested that the Chinese government was going to paper over any losses from the shadowy practices of the insitutions involved in what is yet another off the books trading scheme, which unfortunately invoves $4.8 trillion dollars according to a Bloomberg report citing data from Moody's.

So, last week's tumble in global stocks, was blamed on emerging markets and the negative effect that the Fed's tapering is going to have on them. Fair enough, that makes sense. But, it's not all that's going on. Consider that financial crises are as much a function of any underlying imbalance in markets at any time, but that they are also dependent on the moment in history during which they happen. In other words, the state of the World and of the institutions, personalities, and interactions between countries and key players at the time of the crisis, is a major factor in how things play out. The latter factor, is even more important than the cause of the crises, because it is what dictates the response, and thus has a significant influence on the outcome of the crisis.

The Great Depression occurred because real money, that is money used by real people for real things, such as food, clothes and gasoline, was comingled with Wall Street funny money. So, the speculative crash took out not just Wall Street's money, but also real people's money. And so we had the Great Depression. That the world was not quite over the politics of WWI, and that Hitler and Japan were beginning to make their moves aimed at world dominance, just added more fuel to the fire. And that the Federal Reserve raised interest rates as the markets crashed also helped quite a bit.

Let's flash forward to 2014. In the 1990s, the U.S. government, behind President Clinton and Fed Chairman Alan Greenspan, repealed the Glass-Steagall Act. This was the law, established after the Great Depression, that kept Wall Street funny money away from real people's money. During the period of time that the Glass-Steagall Act was in play, recessions were painful, but not a single one devastated the finacial system as did the crash of 2007, which came as a result of the subprime mortgage crisis. The fact that Wall Street money and real money were comingled into bets made via credit default swaps on subprime mortgage CDOs just made things worse.

So the Fed printed money, which mostly went into the pockets of big banks while companies that got bailed out by the government decided that robots were a better bet than people in order to produce goods. So, no meaningful job creation for people came about in the last five years, although robots made out like bandits. To read more about this phenomenon, visit our series "The End of Work."

The world is not in a very good place at the moment. Economic recoveries have been uneven. There are signs of slowing and choppiness in places that have recovered, albeit modestly, since no one is hitting it out of the ballpark right now. There is a civil war in Syria. There are significant conflicts in Africa, and unrest in the Middle East. Russia's winter olympics are a big unknown when it comes to security. And Ukraine is on the verge of yet another violent uprising and possible civil war. The fact is that nobody is getting along. When people don't get along, there is no trust. When there is no trust, there is no peaceful solution. Problems don't get solved. Markets fall when there are no solutions.

The Glass-Steagall Act has not been resuscitated. And the Dodd-Frank laws, and the Volcker Rule are not even close to being implemented. That means that, for all intents and purposes, real money and funny money are still comingled. At the very least, this is a fuzzy issue. That's bad. That makes for confusion. This will cause problems. When you add the regulatory burden of Dodd-Frank, and the Affordable Care Act, it's not hard to see why businesses are once again starting to lay off workers and are putting their money into robots. This is a negative that adds plenty of weight to the difficulties that are going to become apparent down the road.

The Federal Reserve is tightening interest rates, despite the fact that they are calling it a taper. The fact is that the world became a free money junky and that it's starting to have the early signs of a big drug withdrawal syndrome, and that the fear of some kind of Chinese default on esoteric parterships and that a potential meltdown of the Chinese shadow banking system is a sudden possibility has gotten people's attention. If governments don't get along and economies are paralyzed, no solutions will come forth for a long time. Meanwhile, the pus will ooze from the festering wounds of shadow banking, dark pools, "upstairs" trading rooms and credit default swaps.

The U.S., the world's leading power is clearly in flux. The president is being seen as ineffective and has threatened to bypas Congress, a la Hugo Chavez, to pass his own laws, raising questions of constitutional breaches. Peggy Noonan recently described a stark potential scene during the upcoming State of the Union address, noting: "I imagine Barack Obama's State of the Union, I see a handsome, dignified man standing at the podium and behind him Joe Biden, sleeping. And next to him John Boehner, snoring. And arrayed before the president the members, napping." She then went further: "No one's really listening to the president now. He has been for five years a nonstop windup talk machine. Most of it has been facile, bland, the same rounded words and rounded sentiments, the same soft accusations and excuses," and "Looking back on this presidency, it has from the beginning been a 17,000 word New Yorker piece in which, calmly, sonorously, with his lovely intelligent voice, the president says nothing, or little that is helpful, insightful or believable." An ineffective president can't bully his opposition into doing anything, much less the right thing, assuming that this group could even come up with the right thing. This is another negative.

Think about this. Politically bankrupt and frozen institutions, a handcuffed Federal Reserve, an embattled president, trillions of dollars in shadowy banking and trading enterprises, and big players with big bucks sunk into credit default swaps are seemingly coming to a head at once. No one knows what those credit default swap bets are, or how much money is involved. But Friday's action suggests that someone lost and that they got that dreaded "dude, you owe me," phone call. More ominous is that the carnage started in the currency markets. That's never a good thing. Remember 1997 and 1998? That's when the Thai Bhat and the Russian Ruble crises hit. Big declines followed.

Did they bet on China? Did they bet on the Super Bowl? Did they bet on the Fed? Maybe they bet on the weather. Who knows? It doesn't matter. Friday's action was pretty scary and things could get worse over the next few days, if enough of those off the books, "Upstairs" trades generate those dreaded "dude you owe me" phone calls. Because that's when the losers have to sell liquid things such as stocks in order to pay their bets. And that's when chain reactions are kicked off because the big banks sell the bets to as many people as they can. And the big banks don't lose. That means, that as many of them did during the subprime mortgage days, they might have taken the other side, just to be safe.

What's our point? It's a bad moment. An over regulated economy can't recover enough to create jobs. Threats of more bad policy coming from a president in retreat with a subprime support cast, aren't likely to save anyone if the stuff hits the fan. And a Federal Reserve which has already brought down interest rates to zero and has printed zillions of dollars doesn't have much left in its bag of tricks, especially when it's trying to pull out of the easing cycle. So what lies ahead? Maybe nothing. Or maybe everything. And maybe we are now at the cusp of falling from Chaos into Disorder at a new order of magnitude. To quote Mel Brooks, we maybe moving into something awful at the rate of "ludicrous speed."

If the sellers decide to increase their stampede, this could be another legendary week ahead. Bad moments, unfortunately, tend to make bad things worse.

We hope we are wrong. But, we are also thankful that there are plenty of ways to short this market.

The Markets



Chart Courtesy of StockCharts.com


We'd like to first focus on one significan chart, that of the S & P 500 (SPX, above) and its relationship to the Bollinger Bands and the 200-day moving average. ended the year at a new all time high. Technically, though, the rally looks as if it can continue, at least in the short to intermediate term.

The dotted line at the bottom is the 200-day moving average. The solid line at the top of the chart is the upper Bollinger Band, which is two standard deviations above the 200-day moving average. Thus, this is a look at the long term trend of the market.

Think of the Bollinger Bands as indications of how far the market can rise above the 200-day moving average and stay in what is considered a normal trend. When the market rises above this upper band, it's usually gone too far. If you extrapolate this concept to the long term trend, as we are doing here, then you can get a good idea as to when a market is significantly overbought, and thus vulnerable to a correction.

The rally that started after Thanksgiving, in November 2013, took prices along the upper band. After a slight pullback, prices rose, and moved outside of the band. That was the warning moment. Normal market behavior dictates that prices move back inside the line.


Chart Courtesy of StockCharts.com


In other words, what we are seeing now, is a return to normal market behavior. Prices have to correct. Friday's action (see above) also took prices below the 50-day moving average. That means, that barring a major reversal, the intermediate term trend, that which measures weeks to months, has also been reversed. Higher volume, and weak readings of the MACD and RSI oscillators also confirm the overall weakness in stocks.


Chart Courtesy of StockCharts.com


The small stocks in Russell 2000 index (RUT) managed to stay above their 50-day moving average. But they also took a beating and are no place to be in the short term.


Chart Courtesy of StockCharts.com


The Nasdaq Advance Decline line (NAAD) also had a difficult day on Friday.

Conclusion

Friday's action in the stock market was significant. It looks as if the long term trend for stocks has reversed and that a significant correction has just begun. Prices may fall as far as the 200-day moving average on the S & P 500 before things calm down.

It's a bad moment in history. The Federal Reserve is in a tough spot. The U.S. government is in major gridlock and ideology rules the day, not common sense. Major conflicts are raging everywhere. And there are no signs that anyone is going to sit around the campfire and take a deep breath any time soon. Little of any positive significance can come from this kind of situation at this point.

Bottom line? Keep your eyes open. Protect positions. Make a shopping list. But don't get impatient. This could go on for some time.



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email: support@joe-duarte.com



 
   
   
   
 

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