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Vince Foster: Welcome to Sarajevo -- History's Greatest Black Swan Event and Today's Aftershocks


Tracing the bullet that launched the First World War through history -- to 9/11, the fiscal crisis, and, most likely, the market's next big shock.

The front page of the Saturday edition of the Wall Street Journal ran three headlines that can be juxtaposed to provide an interesting perspective to what frames today's geopolitical and market environment: "Broad Gaines Power Historic Rally: Stock, Bond, Commodity Indexes Rise in Unison for First Time Since 1993: Some See Clouds Forming"; "U Role Deepens in Syria and Iraq"; and "Two Shots Fired 100 Years Ago Today Swept the World Toward War."

On June 28, 1914 in Sarajevo, Bosnian Serb nationalist Gavrilo Princip assassinated Austrian Archduke Franz Ferdinand. If there was ever a black swan event, this was it. As ICAP rates trader and history aficionado William Naphin put it in one of his periodic historical commemorations:
100 years ago tomorrow modern history commenced: 

World War 1 would begin a little over a month after the assassination, with a host of consequences that still echo today:

  • the end of monarchical Europe as they knew it
  • Russian revolution of 1917
  • trench warfare and the ascendance of machinery (tanks; air power) in war 
  • the eventual end of the gold standard
  • hyper-inflation
  • Keynesian theory and government as aggregate demand of last resort
  • the Great Depression
  • America as the arsenal of democracy
The list goes on.

I would add the rise of Hitler and fascism, World War II, the Cold War, the Balkan Wars, chaos in the Middle East, 9/11, and, of course, our involvement in Iraq and Syria.

The Dow (INDEXDJX:.DJI) closed June 1914 at a level of 80.66 -- basically unchanged on the year, yet panic was right around the corner. William Silber wrote the following in The Great Financial Crisis of 1914:

Foreigners owned more than $4 billion US railroad stocks and bonds at the outbreak of the Great War, with $3 billion of that in British hands. These securities were liquid assets and could be sold quickly on the NYSE. Under the gold standard, foreign investors could then use their cash proceeds to acquire the precious metal from the American banking system.

The crisis began on July 27, 1914. The sale of dollars for pounds sterling in the foreign exchange market, and the increase in the exchange rate to $4.92 per pound, four cents above the gold export point, provoked gold shipments. On July 31, 1914, after the price of sterling failed to decline in response to record gold exports, Treasury Secretary McAdoo asked the NYSE to close. If foreigners could not sell their US stocks, they could not raise dollars and demand gold in exchange. McAdoo had rejected the direct approach, suspending the gold standard, as too costly to American credibility.

The NYSE would remain closed until December 15 when it opened at 56.76, down 30% from the level at the end of June. By the time the Treaty of Versailles was signed five years to the day Ferdinand was shot, June 28, 1919, the Dow had rallied 88% to 106.66. In the peacetime roaring 1920s, the Dow would go on to experience one of the greatest bull markets in history. On the other side of the Atlantic, however, the German war reparations levied by the Treaty of Versailles were crushing the German economy, eventually leading to hyperinflation and the rise of the Nazis.

The assassination of Ferdinand and subsequent Treaty of Versailles would continue to haunt geopolitics for decades to come in both Europe and the Middle East. These historical black swans came together for me personally on September 11, 2001 in downtown Sarajevo.

My wife is a Bosnian Croat from Sarajevo who escaped the war, left her family, and immigrated to the United States as an exchange student in 1992. The Balkan Wars broke out upon the dissolution of Yugoslavia and were inspired by the same reasons that incited the assassination of Ferdinand. The war was one of the most brutal since World War II, and the siege of Sarajevo was the longest of a major city in modern history. The stories told to me by my wife and her family are truly horrific.

We were to be married in Dubrovnik, Croatia, on September 15, 2001 but first flew into Sarajevo days earlier. The destruction from that war was still very visible. I had never been in a war zone, and to see the remnants from shelling and snipers was truly eye-opening. My wife's family's house was covered in spots where plaster covered shrapnel.

Sarajevo has been the frontline of Western civilization. It's one of the only cities in the world, besides Jerusalem, where you will find a Roman Catholic church, an Eastern Orthodox church, a synagogue, and a mosque all in the downtown area. When Constantine divided the church between Roman Catholic and Eastern Orthodox, the line went right through Sarajevo. Today it is the Ottoman influence that is mostly felt in Sarajevo as the city is predominantly Muslim.

Everyone knows where they were on 9/11, modern history's equivalent to the assignation of Ferdinand. I was in downtown Sarajevo, a city still recovering from a vicious war that had ended only six years prior and not far from where Ferdinand was shot in 1914. In a cruel irony, all these events from history -- the assignation of Ferdinand, the Treaty of Versailles, the Balkan Wars, and the Middle East Crisis -- were coming together at a single moment in time. You talk about a black swan.

The events of 9/11 remain engrained in the American psyche. After the 2008 financial crisis, a direct result of the monetary policy response to 9/11, I think the attacks led to a permanent paranoia in financial markets. There is a constant fear of black swans. Everyone is looking for the next crash. Up until recently, the rally out of the 2009 hole has to be the least owned and most hated in history. But successful investors remove their bias and emotion. To them, fear provides buying opportunities.

The mini crash of 2011 invoked fears of financial crisis 2.0. The smart money was heavily short and the fear mongers were pounding their chests, yet this proved to be one of the best buying opportunities in a decade. From a technical perspective, both the 2011 high and low are showing up in today's prices and could provide a compass for months to come.

Click to enlarge

Using Elliot Wave theory to "map" the market I do not count 2011 as the end of an impulsive rally. I think the top of the first leg from the 2009 low was the 2010 top. This is an important distinction when trying to understand where we sit today, and is an unorthodox but completely "legal" way of counting the market.

The 2011 high was a Fibonacci 0.618 extension of the first leg down off the 2010 high. This "b wave" extension is rare, but the nature of that rally was not impulsive. Impulse waves have to be 5s and but the market rallied in 3s. Recognizing this move as a b wave allowed one to understand the subsequent mini crash was not the beginning of a correction that should be sold, but rather the end of one that should be bought.

Using the 2011 low as a "c wave" that completed the rare but legal "abc running flat" provided the confidence to buy that crash instead of selling it like the smart money and perma-bears. A running flat is a very bullish corrective move and the ensuing rally has not disappointed. Using that low as the beginning off the next leg higher has also provided guidance for potential areas of resistance, and last week a major level was hit.

As can be seen on my "working count" chart, the Fibonacci projections from the 2011 low have been clearly recognized by the market. The 2012 high was into the .618 extension and the subsequent pullback was into the .382. The ensuing leg higher clearly recognized and vibrated the 100% level. As the market moved through the 100% extension it stopped at both the 1.382, and 1.50 marks, and Monday it hit the major 1.618 extension.

The 1.618 extension is one of the most prevalent Fibonacci levels and is often the target of a C wave or a 3. The following is my half of an email conversation with a fellow trader upon showing him my chart after the S&P tagged the 1.618 extension:

No one is counting 2010-2011 as ABC "running flat" which is key

IF we are finishing C could be going all the way to 1200.. if finishing 3 we probably trade sideways for a long time in a big chop to match the 2010-2011 wave 2

IF 1969 doesn't turn us back probably going a lot higher

The way I look at it is this...  it 'should' recognize the number if its real 

And it did..   soooooo...  if it doesn't stop there, then market doesn't care and its on to the next level... kinda like, yeah I see you 1.618, but I've got other things in mind

On Twitter I said, "1969 cash should get recognized." 
Because this is such a huge level with cyclical consequences I will allow it to wiggle on both sides before drawing any conclusions. The previous 618 extension in 2011 essentially vibrated for six months before turning the market lower. This is a larger degree wave and thus could be in place much longer. I will not concern myself with whether it is ending a 3 or C because the market will tell you by the nature of the pullback.

The market has been on a mission and Fibonacci has made his presence known. Is the 1.618 extension a stopping point? I don't know, but this is a natural place to stop and I would say the market is vulnerable to shock. The market often makes the news, and if it wants to make this level resistance then it may find the black swan to fulfill its objective.

The black swan event of a century ago continues to see black swan aftershocks to this day. Whether it's Ukraine, Syria, or Iraq, the next black swan event will likely trace its roots to Sarajevo 1914, when modern history began.
Twitter: @exantefactor
No positions in stocks mentioned.
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