Elephant? What Elephant?

May 1, 2000

The previous installment in the Bubble series ended with a view hints of how one could about using the long and strong psychological lever offered by the Dow Jones if one happened to be assigned the task of engineering a soft and controlled landing for the equity markets.

Comments on the suggestion implicit in Bubbles 6 and 7 that there is in fact some kind of intervention in the market using the approach described there, and through any additional leverage that can be obtained from the futures markets, revealed that a good many people think the idea outrageous and highly unlikely. As if Governments would never consider doing such a dastardly deed! Unthinkable!

Elephant in the suburbs
Perhaps these people should be aware of the following little fable. One morning this man woke up to find large round and deep footprints in his garden. He also noticed that some branches had been broken off from the trees in his garden, a few even from quite high up. When he showed this to his wife, she said, "Must be an elephant. Can only be an elephant – they leave tracks like that and make a meal of branches."

He of course replied, "Silly you! Where would an elephant come from here in suburbia."

The next morning was the same. Deep round tracks and even more trees damaged. Again the wife said, "Elephant", and again the husband laughed. But it wasn't as hearty a laugh as before; it sounded just a little bit doubtful.

The third morning the laugh had a touch of hysteria to it.

The fable has three possible endings. You, the reader, can decide which one you like best. But think long and quite hard before you make your selection.

  1. That evening the guy decided to sit in ambush in the garden. The next morning his wife found him trampled to death.
     
  2. He called the zoos and circuses in the vicinity and soon discovered that an elephant was indeed missing and that he could earn a reward if they recaptured it.
     
  3. He sat in ambush during the night only to discover it was a group of neighbourhood pranksters who were playing a practical joke on him.
     

So, did you think long and hard? Did you get the drift of the fable and that it relates to the matter of market manipulation? Did it strike you that there is really no difference between the three endings?

The key to the fable – and to the matter of market manipulation – is not the endings; it is the fact that for at least three nights running there were uncontested and unequivocal evidence of an elephant feeding in the garden.

Oh, if pranksters are responsible then there was no elephant? That will be good news for the husband and wife. No elephant at all. Excellent. So they do not have to worry about anything; they can sleep peacefully at night. The observable fact that their garden is being progressively ruined is just a joke. Ha! Ha! Ha!! It isn't really an elephant. Sigh of relief!

Just something else that behaves exactly like an elephant would. To do the same damage.

From the perspective of the owner – and of the garden! – is there really a difference?

Looking for elephant tracks
The fable shows that the cause of the tracks and damage is less important than the fact that tracks are left and that damage is being sustained. So the question is whether any tracks are being left in the equity market that would indicate some kind of intervention?

As a start to exploring this question, consider three scenarios:

Scenario A: All early indications are that Wall Street will be relatively stable to bullish.

Scenario B: Early indications are that the market will have a down day, with Nasdaq and the tech stocks due to be the hardest hit right from the opening bell.

Scenario C: This is going to be one of the rare, quite extreme days; the market should open down with near panic conditions and there is potential for a mini-crash at least.

How can the elephant be expected to behave under these three different conditions and where would one look for its tracks?

Previously, the suggestion was that the 30 stocks in the Dow Jones index offer the easiest and most cost effective way of influencing market behaviour on Wall Street. If one were to accept this as fact, how could intervention according to this assumption be detected?

What kind of tracks?
One clue lies in the fact that over time and under normal conditions the Dow Jones and the S&P500 index tend to remain in step. The ratio of 1 point on the S&P500 index being the equivalent of about 8 points on the Dow Jones is quite widely accepted and used by analysts. Of course, the ratio is not exact and does not remain constant from day to day, but there is a relationship.

Intervention that begins with the Dow Jones and only after some time interval spills over into the broader market, would appear as major distortions in the relative movement of the two indices over some time interval. What does help in this respect is that as a rule intra-day trends in the indices follow the typical S-curve – except right after the open, when sharp and steep changes can occur in response to pre-market expectations.

The S-curve says that a new trend begins rather slowly, picks up speed as the trend becomes established and accepted, and then gradually slows down again as the market reaches a level where either support or resistance become evident. The slow down in the trend near extremes provide a kind of built in delay that generally enables the broader market to catch up with the more rapid movement of the Dow Jones, before the market either settles down in a sideways move, starts to extend the recent trend again, or reverses the trend – with new trend again starting slowly before speeding up.

This means that there might be slight distortions in the expected ratio between the S&P and the Dow, with the latter leading and the S&P following, but that these should not be extreme and should average out in due course.

Deviations from these expected patterns of behaviour are the tracks that would suggest some kind of intervention has taken place.

Identifying the tracks
In order to identify signs of intervention, one should begin by speculating what form the intervention will take – if and when there is intervention. Consider this question in relation to the three Scenarios mentioned earlier.

Scenario A: With the market expected to open stable to firm, there is no need for intervention. The Dow and the S&P500 should behave quite in line with the 8-1 ratio, with of course minor leads and lags as the market trends and settles down again.

Scenario B: If the tech stocks are due to be hit in a big way, the Dow will be reasonably protected at the open. If the Dow is then ramped and kept in positive territory, the example it sets will sooner or later bring the slide in the rest of the market to a halt and perhaps bring in the "buy the dips" crowd to reverse the down trend. If successful and the broader market recovers to break even or even turn positive, the Dow can be allowed to slide a little again to prevent over-exuberance from setting off a new bull trend.

Scenario C: Facing a massive sell-off right from the start of trading, it would be foolish to waste resources by trying to hold back the fall. It has to be assumed that the elephant is quite intelligent and aware of this fact. It would then be better to wait for the sell-off to reach a point where it begins to show signs of settling down – probably not too early in the day, but, say, as lunch time approaches and trading becomes less intense and volatile. Then intervention would have the best effect and most chances of success.

Given these scenarios for when to expect the tracks made by intervention, what exactly should they look like?

Large and round and deep
The nature of the intervention, when it occurs, will be designed to attract attention. No agency can realistically expect to dominate the market by brute force. Subtlety is needed. Luckily, there already exists an experienced and quite large force in the market that can be harnessed to achieve the kind of success that must avoid any single player.

American investors have been conditioned during the long bull market and even more so during the very volatile period of the last few months that it is profitable to "buy the dips". All that needs to be done is provide a clear signal that "It is now time to buy".

The more visible the signal, the better – it will help to get everyone out of the starting blocks at about the same time and thus have the most effect on the market. The ideal signal is a strong, steep and sustained rising trend in the Dow Jones – probably the most widely and closely followed indicator in the world and, because it contains a mere 30 stocks on an un-weighted basis, probably the easiest of them all to manipulate.

Consider this: On Friday, 28th April, the Dow Jones closed at 10734 points. The total of the closing prices of the 30 Dow stocks is about $2160. The average closing price is thus $70.20, which is very far removed from the Dow value of 10734. This implies that the value of the 30 Dow stocks have to be multiplied by about 5 to get the (approximate) Dow point value (10800 against 10734, but close enough).

Now the interesting part. This means that if the price of one stock increases by $1 while the prices of the other 29 stocks remain unchanged, the value of the Dow will jump by 5 points. If all 30 stocks increase by $1, the value of the Dow will jump by 5 x 30 or 150 points. Similarly, if the prices should fall.

The Dow is the long lever Archimedes would have loved; he would have been even more enthralled by the real heavyweights among the 30 Dow stocks – not heavyweights in terms of market cap, but just in price: General Electric ($157); American Express ($149), Hewlett Packard ($135); JP Morgan ($128); Intel ($126); IBM ($111) – all as of Friday's close in round dollars – for a total of about $806 or almost 40% of the Dow. A 3% jump in the price of these 6 stocks would equal a combined increase of over 24 x 5 = 120 points on the Dow.

Using these facts, how would one really make any large and round and deep tracks?
Actually its very easy. Just wait for a moment in time when offers to sell are relatively thin and quite spread out. Then issue a buy order to you broker that would take out all the offers for some distance above the latest price in say 2-4 of these 6 stocks, or any other good candidates among the rest. It would of course improve deception to select those stocks that are firstly price heavyweights and also have some good market news to justify investor interest.

When the Dow Jones suddenly begins to jump 10 and 15 points on just about every tick, gaining as much as a 100+ points in a matter of just minutes, the dipsters' cannot contain themselves any longer and they are there in force, boots and all, buying up everything in sight – a proper feeding frenzy that would put the Great Whites to shame.

Within a few more minutes the S&P500 and the Nasdaq are also up to speed and from now on it is all plain sailing – to confuse the metaphors even more. The good news, of course, is that the early purchases to get the whole frenzy going can be sold a little later at a handsome profit to add that little bit extra to the war chest for a future rainy day.

The final clue to intervention therefore is a very sudden, abrupt, steep and sustained rise in the Dow Jones Industrial Index that leaves the S&P500 lagging way, way behind. Such an action typically can be expected to commence at an opportune moment when offers are relatively thin and spread out. This should be either at the open, while many potential sellers are still on the sidelines to see what will happen. Alternatively, after a steep and sustained fall in the market, when there are relatively few desperate sellers close to the latest trade, with a long tail of left-over offers stretching up behind the current action.

Under those conditions and given the "buy the dip" mentality so prevalent in the market, doing as described above is perhaps as close to a sure bet as an investor could make in any market.

Should there be an elephant in the market and should the elephant use optimal methods to achieve his objectives, the kind of tracks that are left behind, as described above, ought to be not too difficult to identify. The greater the sudden and steep divergence between the Dow and the S&P 500, the deeper and larger the tracks.

And the more frequent these tracks, the greater the probability that there really is an elephant loose out there. Or, alternatively, that there is a good number of pranksters out there who are leaving elephant sign all over the place.

Can there really be an elephant out there?
Evidence from the way Wall Street has behaved over the past few months instill a strong suspicion that there are lots of elephant sign around.

The very sudden, steep and sustained increases in the Dow Jones – at times as much as 200 points or more in about 10 minutes or so – are very suspicious. It smacks just too much of the kind of 'take out all offers' behaviour described earlier; behaviour that seems designed to attract the attention of the dipsters and thus to mobilise support for the rally.

Surely, if someone wanted to buy a great number of some of the Dow stocks it would be more prudent and far more profitable to sit at an appropriate low level and simply wait for sellers to descend to where he is bidding. Even if that market player happened to be using other people's money for this exercise it still appears to be a little reckless to take out all the offers in practically one go – which is the only real explanation for that rapid a jump off a new deep low, or right from the open on a day when all the early signs from the futures markets warned of a very weak open. There have been occasions when the Dow Jones has rallied from more than 100 down to well over 100 points in positive territory within a very short while, to leave the S&P500 still 40 or 50 points in the red and catching up only gradually. But, so far, succeeding all too well after a while. Nasdaq too generally responds to a sharply rising Dow Jones to wipe out early losses completely or at least to a substantial degree.

When this happens it is difficult to interpret this as uncoordinated natural market action and not evidence of some kind of planned intervention with the specific purpose to end the steep fall in the price, or to prevent a sell-off from really taking hold at all.

Some light on the question of whether there really is an elephant out there is cast by the following excerpt from Executive Order EO12631, signed into effect on 18 March 1988 – not too long after the panic of October 1987 – and establishing the entity known as the Working group on Financial Markets with some very, very high powered members. The section below describes the purpose and function of this Working Group, aka the PPT, according to John Crudele of the NY Post.

Sec. 2. Purposes and Functions. (a) Recognizing the goals of enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets and maintaining investor confidence, the Working Group shall identify and consider:

(1) the major issues raised by the numerous studies on the events in the financial markets surrounding October 19, 1987, and any of those recommendations that have the potential to achieve the goals noted above; and

(2) the actions, including governmental actions under existing laws and regulations (such as policy coordination and contingency planning), that are appropriate to carry out these recommendations.

(b) The Working Group shall consult, as appropriate, with representatives of the various exchanges, clearinghouses, self-regulatory bodies, and with major market participants to determine private sector solutions wherever possible.

The author is not very clued up about the use of the burocratese that are used in official documents – sometimes because that is the way some people think and speak and at other times to make it difficult to understand what people thought and wrote.

The reference in Section 2 a) to what might just be interpreted as a wide-ranging mandate to ensure orderly markets and the maintenance of investor confidence, among other things, makes one wonder whether this EO did not perhaps establish something that is very large and grey, with thick legs and large round feet and a long trunk up front, with which to break branches from trees. Something that conceivably could leave behind the kind of sign our inhabitant of the fable saw on three consecutive mornings.

And what about the way the last two paragraphs are phrased. For example, remove the phrase "including governmental actions under existing laws and regulations (such as policy coordination and contingency planning)" and what remains sounds pretty much of a carte blanche, provided the actions are not taken by the government. In this respect it would be nice to know exactly where the line between government and non-government is drawn with respect to this EO.

The ending of the very last sentence, "to determine private sector solutions wherever possible", also sounds as if some kind of provision was being made for other than private sector solutions if these should no longer prove successful.

Readers can draw their own conclusions, but I would not be too surprised to hear a bit of trumpeting on nights when the markets have been showing signs of increasing turmoil. The only question is in which garden the tracks will lie tomorrow. It could be in the garden of a neighbour, or a few blocks over or even in a different suburb.

And if the tracks are actually in your garden they could still be caused by the pranksters who love to imitate an elephant – particularly if this proves to be very profitable.

Does it matter who leaves the tracks?
Of course not. The fact of the matter, as interpreted from what one can observe in the market, is that over recent months there often appeared a sudden, steep and sustained rise in the Dow Jones that, at first, is not reflected in the S&P500 or, on occasion, the Nasdaq. The rapidity and steepness of the rebound suggests someone – or something? – is taking out the offers on probably a number of the major Dow stocks as a near continuous action.

This does not appear congruent with normal market behaviour from someone motivated by the desire to buy cheap and sell high. It seems much closer to a deliberate attempt to rescue the market by mobilising the mass of people who have learnt over the past few years that buying the dips are profitable and who are waiting for a signal that it is time to do so again.

So far it is working and the effects on the market and the economy are laudable. And if success continues indefinitely until the markets are more stable and the risk of a sudden and catastrophic collapse has been averted, it will not only be Americans with their savings in the equity market who will give a standing applause and donate funds towards a statue of a large tusker in the city square – the whole world will be grateful and perpetuate the ban on trade in ivory.

The problem of course is that if these efforts at any time and for whatever reason prove futile, what happens then probably will be far worse and last much longer than if there had been no intervention at all.

If that should come to pass, it will be open season on anything that has a pair of tusks.

China has only 2% of its Total Foreign Reserves in gold.