I'm reprinting a message I wrote in April about why
that stock market crash happened. I plan on taking up
some of the comments and themes here in my series
about market crashes and economic cycles in the future.
Remeber I wrote this in April, so it is dated:
By background I'm trained to be a historian. I have a
Master Degree in history and was two years into a PHD
program at one of the top 10 public universities before I
left and pursued trading. The largest stock market
crashes in history have ended the same way and I expect
this one will do the same. Today people list Bill Gates as
the wealthiest man in the world, although I'm not sure
that is still true. He is not the most powerful. I don't
know who is, but I am sure it is not him. In 1900 the
most powerful man in the world was J.P. Morgan. He
was the baron of Wall Street and became the most
powerful international banker in the world during
World War I. He worked mostly behind the scenes,
never out in the open. One of his main advisors, was a
Colonel House, who also happened to be the main
advisor to President Woodrow Wilson. House had his
hands in the creation of the Federal Reserve Board and
the World War I peace treaty.
When the stock market collapsed in 1907 it was a
freefall. The selling didn't stop until J.P. Morgan
stepped up and personally pumped so much money into
the market that he was able to stabilize it. After seeing
what he was doing other Wall Street firms joined in the
buying and supported the market.
In 1929 stock market crash the public got massacred. It
was hard to find an uptick. It was called Black
Thursday John F. Kennedy's father was short and
made a fortune. So was Jesse Livermore. The Bank of
Morgan was already cashed out and was sitting on the
sidelines. Thomas Lamont, who took over the
operations of the bank after J.P. Morgan died, called up
a committee of men, made up of the heads of the nations
largest banks, and held a meeting. They left the meeting
a few hours later and walked on to the New York stock
exchange floor. Lamont walked up to the booth for U.S.
Steel and bid 205 for twenty thousand shares. $410,000
worth of stock. The other men went to other booths and
did the same. They spent a total of around $125 million
dollars. No small sum in 1929.
Traders on the floor took notice and began buying. The
market rallied into the afternoon and for several days.
But it wasn't enough. The next Tuesday the market
completely collapsed. In two days it fell another 25%.
The reputation of the Morgan Bank and Wall Street
was destroyed.
Once elected, the new President, Franklin Roosevelt
took steps - through the use of regulation - to limit the
power of the Bank of Morgan and reverse the policies
they - and other large banks - encouraged and the
Federal Reserve carried out in the 1920s which helped
to lead to the crash and depression. Chiefly being
adherence to the gold standard and higher interest rates
while the country was in a recession and the European
economies were in a depression caused by World War I
and war debts owed to the Morgan Bank and other
international banks. It was the end of a dynasty. As
Roosevelt said in his inaugural, he was going to "throw
the moneylenders out of the temple." Now someone will
talk about throwing the oracle out - Greenspan - if this
current mess doesn't stabilize..
There are two lessons to be learned from this:
1)This market downturn will most likely end when you
see large institutional firms begin to buy stock. Buying
by individual investors will not stop this crash.
Historically this is how crashes end. In fact there was
talk by a few floor traders on the NYSE that they were
just sitting on the sidelines and waiting for a "white
knight" to come in on CNBC Friday. That's what they
were talking about. You'll know it will happen when
you see large buy blocks go by in stocks and someone on
CNBC will say that "buy programs" are being executed.
I expect that the open Monday will be rough. I
currently have three short positions and will cover two
of them - PCLN and REGN - during this downturn. I
have obscene profits in them and don't want to be
covering these before the big boys do appear. I have
another position in KEYN, but I will move stops down.
If that downturn does not mark the bottom I still want
to be short something and KEYN has had a tendency to
not rally very much when the market does - a lot of
stocks will be left behind. This bottom and rally should
come Monday morning. If it doesn't than things will
really be ugly and I'd expect it to come on Tuesday. So
the market is now at the mercy of big money boys
sitting in their offices waiting to press the buy buttons.
2)The second lesson is that the next rally will have to
hold. If it falls back through the lows of this crash than
there will be another and much worse one. I doubt this
will happen. But you never know. I will probably buy a
few shares of a stock once the rally begins and short a
couple of stocks a few days later when its over, using
tight buy stops. But I don't plan on buying much of
anything until the market stabilizes and looks like it can
stay above the 150 day moving average. I don't care for
trying to guess the ultimate bottom. People who have
been doing this the past week have lost their ass. Why
take such an enormous risk to make an extra 5 or 10%?
You make money by not gambling, but by taking
conservative positions. One last thing. Things sure look
gloomy now. But the worst thing that could happen is
that we have a bear market. And that will eventually
become a great buying opportunity. Most bear markets
on average last 6-8 months. And the most profitable and
safe time to buy stocks is right when the bulls come
back. So even if things appear horrible for the next few
months there will be a day when I come out in this
newsletter excited about dozens of different companies
that will be incredible long term opportunities. The
bulls will come back, its only a matter of time. Lets hope
its sooner than later.
So Why Did this Happen? The media has been seizing
on events of the last week to explain the stock market
crash - the MSFT ruling, Abby Cohen's statements
about the risk in tech stocks, statements that tech stocks
have always been overvalued, and finally the CPI
numbers Friday. Truth is none of these events caused
this market selloff. The NASDAQ had entered a
precarious situation in the last weeks of March. The
charts tell you this. Probably the way to find the answer
is not to ask why did the market crash, but why did it
form a bubble. In hindsight its clear that is what it was.
[ Take a look at this chart of the money supply it tells
the story: ]
Well I think you have to go back to October of 1998.
That's when the Asian and Latin American economies
collapsed on a currency run. What happened was that
they had billion dollar loans owed to international
bankers which they could never pay off. Currency
traders feared that they would inflate their currency
and currency values plummeted. It was feared that their
economies would collapse and the world would be
thrown into some sort of depression. I remember
reading an article about an International Monetary
Fund meeting at the time in which a reporter talked to
some of the attendees at a party afterwards. Some of
them said things to the effect that its all over.
Everything is going to collapse. We'll have our last
party and take as much money as we can and that's it.
The US market tumbled and Alan Greenspan came to
the rescue. He lowered interest rates and increased the
money supply. But his goal wasn't to make the stock
market go up or rescue it. He was trying to patch
together the world economy. The idea was to stimulate
demand and economic growth in the United States so
that foreign countries could export as many goods as
possible here. That way maybe this could act as a
stimulus to recover their economies. That's why every
single quarter since October 1998 the US has recorded a
record trade deficit.
But most of these countries still have never recovered
fully. Japan is still in a recession and will never recover
until its central bank accepts the fact that it must create
inflation in order to force people to start spending. The
Third World is still debt ridden and some Third World
nations are even deeper in trouble because of the IMF
and World Bank prescriptions of higher interest rates,
higher taxes, and lower government spending. All
designed with the goal to prioritize paying off debts first
and making economic growth a second priority.
But things seemed to work. The world economy did not
collapse. Our economy took off thanks to interest rate
cuts and the increase in the money supply. Few noticed
though that a lot of this growth was due to rising asset
prices. Greenspan argues that 1% of GNP growth is due
simply to the stock market. That's unprecedented.
Its all a delicate balance and if this stock market crash
and interest rate hiking doesn't stabilize it could trigger
a financial crisis. If the US goes into a recession it will
ruin the rest of the world which depends on the US for
demand. Greenspan screwed up and has made a big
mess. Then in the fall of last year Greenspan increased
the money supply again in fear that there would a run
on banks if there were any problems with the so called
Y2K bug - which almost all experts agreed was more
fiction than reality. That's what made the stock market
take off and form a bubble. The NASDAQ went up a
ridiculous and unsustainable pace. Then once the New
Year turned he began to withdraw all of this money
from the banking system and raised interest rates
further. He was on pace to decrease the money supply
by over 30% during the year.
I knew about the actions he was taking with the money
supply and it made me a little concerned. I sold my
mutual fund holdings and long term holdings in
January. I didn't base this decision on the charts and
sold these positions too soon - the market continued to
take off.
At the end March it became clear to me that something
was amiss with the NASDAQ. Should have seen it a
week earlier than I did. First stocks which would
previously jump 10-30% after breaking out would
breakout and than flop. Secondly the final rally in
March was on very weak volume and the advance
decline line ration was in total decline throughout the
month. I also noticed that in a couple of NASDAQ
stocks which I was following closely insiders and
institutions were dumping shares like mad. Take a look
at Priceline.Com(PCLN) for example if you have the
time. Even William Shatter sold a large portion of his
holdings. I suspect that this was going on in most of the
other technology stocks throughout March. But it'd
take some research to confirm that. Then came the
Tuesday selloff and recovery from the other week. If
that wasn't a clear warning than you were way to
optimistic. I shorted a couple of stocks which didn't
rally with the rest of the NASDAQ once the rally
stopped a few days later. I figured that the NASDAQ
would at least drop back below 4000 and if it went
below 3700 there was a large chance that it would crash.
On Weds I noticed that large size sell orders were going
off in several NASDAQ stocks I was tracking. The most
notable was Keynote. I saw several 250k sell blocks go
off and it looked like institutions or insiders dumped
about 1 million shares that day, in a stock which traded
less than 600k everyday. I looked at the charts that
evening and things looked pretty grim to me. I thought
there was a good chance we were going to crash and
sent out the email stating that. Now we'll find out what
will happen and the end of this crash is dependent upon
when these institutions step in and buy. I don't know
when that will be. But the real question is what will
Alan Greenspan due. That all depends on what he fears.
Does he fear seeing a 1/2 to 2% increase in consumer
prices this year or does he fear risking a financial
collapse - which is now unlikely but will become a risk if
he raises interest rates anymore? I have no idea. He's
already proven that he is an incompetent
micro-manager of the economy. At the next Fed meeting
he'll show us if he is a complete nut or not. |
