Is It Over?
...confidence is still fragile and the position of the market is weak as it enters a seasonally dangerous period.
It was twenty years ago today that marked the pre-crash peak in 1987. It was 78 years ago on September 3 that marked the pre-crash peak in 1929. The number 78 is an harmonic of the orthodox high this year in the first week of June.
The technical pattern of both periods are remarkably, eerily similar: both markets crashed on the 55th Fibonacci day from the high. Both markets epitomized periods that showed how dangerous it was to join the crowd, to join the band when everyone piles onto the same side of the investment bandwagon.
Currently, there seems to be a prevailing sentiment that the market is washed out and that the Federal Reserve has saved the day. There seems to be great expectations about the prospects for a cut in the Fed Funds rate. There appears to be an almost universality of opinion that if such a cut were to occur that the markets would be out of the woods.
This year, unlike 1987, has seen a credit crunch exacerbated by funds relying on quantitative computer models. From where I sit there are more unknowns and more reasons to be risk adverse now than there were in 1987.
These so-called "market-neutral" hedge funds had attracted enormous sums of money over the last few years. So, what we had was a sea of money being surfed by like-minded models. Like-minded models because they were created by like-minded people using like- minded leverage.
A lot of surfers were trying to catch the same wave that turned out to be a tsunami, perhaps a tsunami in slow motion as opposed to one playing out in just a few days.
A lot of market participants were/are once again on the same side of a financial band wagon. Only this time they were algorithm-driven. In the same way program-driven portfolio insurance failed to protect money managers in 1987 and instead actually exacerbated the decline, likewise, over recent weeks stat hedge funds found themselves un-hedged and decidedly market un-neutral.
From where I sit, I think much of the popularity of these quant funds stemmed from the aftermath of the technology bubble of the late 1990's. The disparity between the excesses of many new-paradigm internet and technology names versus many old economy stocks bred models to capitalize on these kind of deviations in value. But, the vampire of value is in the eye of the beholder. Sooner or later the notion that value is subjective, that value is an art and not a science, is driven like a stake into the heart of quant.
Ironically, some of the appeal of the mountains of money seeking the soulless decision-making process of machines was likely a response to the hot air that rushed out of the turn of the century's exuberance and a belief that a lack of emotionality would provide superior returns in an arena that requires a psychological prism because it is ruled by human beings.
These quant models are built to discover deviations in "normal" price relationships, executing longs on "undervalued" stocks and shorts on "overvalued" stocks. Ironically, the more overpriced some stocks became and the more underpriced some stocks became, diverging from historical norms, the more attractive the opportunities to capitalize on the divergences appear/appeared in the minds of the models.
Light the fuse of like-minded models with a match of derivatives and douse with leverage. The result: we saw some dislocation in many segments of the market: up spikes in the go to glamorous and waterfalls in undervalued names.
Structural fragmentation in the equity market collided with dislocation in the credit market.
So, is it over? Now that the Wall Street financiers and speculators have been bailed out by Sgt. Boom Boom, now that the Street has received a little help from its friends, has the long awaited 10% correction come and gone and it's "up, up and away" again? The market is entering the anniversary of many significant highs and secondary peaks (such as 1937 and 2000). Moreover, confidence is still fragile and the position of the market is weak as it enters a seasonally dangerous period. September is the weakest month of the year.
Additionally, is the S&P in a position to breakout without a test of the lows? V bottoms are rare.
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Will Bernanke's baptism by fire prove less of a conflagration than his predecessor's when he was green on the job in 1987? Or, is the bailout just in the first inning? Bill Gross of Pimco is calling for a Fed bailout of the housing market. Is housing to big to fail or too big to bail?
The 1987 crash followed a three to four month blowoff high into August 25, which culminated a five year advance. The high this summer followed a three to four month blowoff high, which culminated a five year advance.
If the S&P declines below its Quarterly Swing Pivot of 1416 (which roughly coincides with the midpoint of the range from the August 16 low to Wednesday's high) the recent rally will have proved to be another retracement rally to the 20 day moving average. Then, the Street may be introduced to the act they've forgotten about for all these years.
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