The Daily/Weekly Hundred-Year Flood

It's said that there are “hundred-year floods." In Wall Street speak, this means we have tail events, which rarely occur. In my 28-year career, I should've seen just one or so of these.

In the first 20 years of my career, I saw a handful of tail events: the Crash of 1987, the S&L/ RTC crisis, LTCM, 9/11, the breaking of the Internet bubble… You get the picture. Since then, we seem to have hundred-year floods and tail events so often (weekly bailouts, crashes, anomalies, bank failures, nationalizations, and the like), that they've become mundane.

Let’s look at the list of the messes I've noted above. In normal markets, we should expect just one of these every decade or so. To have them all occurring simultaneously is deeply disturbing. Let’s face it: People are afraid. Afraid of losing their nest eggs, afraid of not being able to retire, afraid of losing their jobs, afraid of losing their homes - the list goes on. 

To be sure, this is no joking matter. In fact, it may not reverse itself for decades to come. The social tol of all this leverage and predatory lending gone bad has yet to be fully felt. And the ridiculous government programs which will likely only extend the pain are shameful.

And imagine what happens if half of your money disappears a few years before retirement, and your investment advisor tells you to “buy and hold.” Do they give any consideration to how much money you must earn to get back to square one - let alone to attain your goals? This is why I continue to believe that more pain lies ahead.

What Lies Ahead for the Markets?

In a word - pain. I have often written about the “pain trade,” or what will hurt the most people the most. Markets have a way of finding where the crowd is wrong-sided, and inflicting as much pain as possible until those weak-handed participants are eviscerated.

This leads me to what the pain trade is for equities both here and abroad: A sharp, swift, sudden move down. Clearly, tens of trillions of dollars have evaporated during this crisis. The only thing more sickening to watch is people stubbornly expecting to break even. In the first place, waiting to break even is a painful position to be in, since the world usually could care less what your entry point is. In fact, professionals will usually shoot against those naively trying to break even.

To be frank, I think the pain trade may have already begun, despite those optimists telling you to “stay the course” and “hold for the long term” while they wait for things to work themselves out.

I would like to share a few charts on markets that I feel may reveal what the future may bring. Please note that I am not short the markets - instead, I continue to avoid risk with no equity exposure, no credit exposure and an eye toward picking up assets on the cheap when the odds are in my favor.

I remain with our high-coupon US government-agency MBSs and cash. I favor highly liquid assets, so that I can easily exit my positions to pounce on emergent risk opportunities - once the pain has been handed out in large doses.

All Eyes on the Dow Jones Transportation Index


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I've chosen the Dow Jones Transportation Average as the best example of what to expect. After all, if the consumer is toast, and spending and credit have dried up. What better place to look than those who move goods from Point A to Point B?

Dow Jones Industrial Average at a Weekly Closing Low

One of the earliest “trading commandments” I learned (yep, learned the hard way, by losing) is that markets can resolve themselves from an overbought or oversold condition in one of 2 ways - price or time.

In this case, the market has been oversold for months - and yet, the best Mr. Market could muster was a consolidation at the bottom end of the trading range. This is otherwise known as churning at support, which is the worst possible scenario for an oversold market: It shows us that there isn't enough demand to induce the security to rise in price. Rather, it sucks in more people at a support that eventually becomes resistance - or yet more supply as the next down leg ensues.

This is, in fact, what's currently happening to the Dow Jones Industrial Average, which appears ready for a fresh down leg to new lows. This move, as best I can tell,is one few are prepared for.


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S&P 500 Index

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The chart above is anything but healthy. The longer a market churns, the larger the move that follows. That move can come in either direction and, given my macroeconomic viewpoint, I fully expect the move to be downwards.

While I doubt that's the way things will play out, it's always a possibility. The longer term picture, however, is bleak, and a move to S&P 450-550 shouldn't be ruled out. After all, I expect earnings for the S& P 500 to be no greater than $35-40 per share in 2009, and given a P/E of 10-15, yields a target in the 500 area.

Longer term S&P 500 Chart

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In conclusion, the evidence points toward lower asset prices, possibly quite soon. I'm positioned for such an event - but, as always, if I'm wrong, all I'll have lost is opportunity, not precious capital. Part of me hopes I'm correct - but I also hope I'm wrong.

I'd hate to see so much pain inflicted on so many.