Why market pull back can cause crashes?
Cash reserve in percentages of stock holdings has been reduced, due to the good new economy, and stock prices moved up. Liquidity has been at an all time low, in terms of cash needed to settle all stock transactions. So any pull back creates a domino effect around the world.
U.S. mutual funds are run by young managers (age 25-45) who are brave but foolish. They know only how to pick stock but not how to work the companies they invested. A few exception being Chrysler, Campbell Soup, Sunbeam, and AMES. Most mergers and acquistions only improve by scale and did not change by refocus and re-engineering. Picking the wrong stock means buying and selling in large quantities, causing an inbalance in the market. Crashes of individual stocks are known daily.
So, how can market crash be avoided?
Liquidity is the most important factor. Some government such as Taiwan, has become a source of stock and cash pool for their stock market. Total cash involved has reached $4 billion NTP. Is it enough? A formula used by President Bush has been $1.5 billion for index of 2000. At Dow of 8000, the liquidity needed is $6 billion. So, Taiwan government is doing with $4 billion for an index of 7000. Not enough.
And the stock pool and cash pool will have to be adjusted periodically. Recently, Congress has approved for U.S.banks to invest in stocks. We can expect with some regulation that banks will eventually support the liquidity of U.S. stock market. To provide stock when there is demand and to have cash to buy stock when there is need for cash.
This is the time to put the banks to work. Buy at low prices then sell at higher prices when demand for stock comes back. The cash and profit resulted will be used for maintaining the liquidity in the market, both stocks and cash. |
