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Financial Markets: Bulges vs. Bubbles


Is the run-up into the expected QE2 announcement in November going to produce a financial bulge with a Mount St. Helens ending?

For hundreds of years, the financial markets have been subject to "bubbles." From Dutch tulips to dot-coms and subprime, people will always believe that it's different this time. There will be more bubbles in the future and they will pop.

But in reality, bubbles don't pop overnight. They're more like overinflated tires that picked up a nail driving down the interstate and began emitting a hissing sound. Those few investors that didn't have the sound system cranked too high during the subprime glory days could hear the hissing and profited enormously, while the vast majority kept dancing to the music (see Chuck Prince, Citibank (C)) until it was way too late.

I can add no incremental value to the discussion of financial bubbles, but let me add a potentially new concept: a "financial bulge." Let's think about a bubble on steroids. No hiss, just a big bang. To explain the bulge concept, the best example in the real world was the Mount Saint Helens explosion in May 1980. Mount Saint Helens is one of group of high peaks in the Cascade volcano chain ranging from British Columbia to northern California.

After a 100-year dormancy, Mount Saint Helens reawakened in March 1980 and started to bulge on its north side in April. For the next six weeks the bulge grew an average of five feet a day, finally reaching more than 300 feet. In early May, US Geological Survey scientists found it increasingly difficult to convince the public that the bulge was dangerous since there were no volcanic eruptions. On May 17:

"In response to pressure from property owners and with the Governor's consent, law enforcement officials escorted about 50 carloads of property owners into the Red Zone to retrieve possessions. Those who entered were required to sign liability waivers at the roadblocks and to leave by nightfall. Authorities agreed to allow another caravan of property owners in at 10:00 a.m. the following morning."

That caravan never occurred because at 8:32 a.m. on May 18, the bulge collapsed. The before and after pictures below depict the damage that happened in less than a minute. This was no slow, hissing leak.

It's time to translate a geologic bulge into a financial bulge. The answer is fairly simple. A financial bulge is a crowded trade on steroids. Is the run-up into the expected quantitative easing II (QE II) announcement on November 3 going to produce a financial bulge with a Mount St. Helens ending? Let's look at some charts. Below are 4-week charts of the euro, gold, crude oil, and 10-year Treasuries.

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Front-running the Fed is so easy and so profitable. It's like a simple little hike along the Iraq-Iran border. What could possibly go wrong? Like the geologists, several Minyanville professors are pointing at the QE II financial bulge and saying this really doesn't look too healthy.

There are still four more weeks for the bulge to grow. If this super-crowded trade blows up, where can financial assets go to hide? Equities? I can't see that. The only thing that makes any sense is cash in US dollars. Enjoy your zero return, but at least you'll still have your principal.

In the mean time, fear the bulge.

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No positions in stocks mentioned.

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