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Market Mayhem Forthcoming

August 19, 2001

On May 22, 2001 the Nasdaq reached an intraday high of 2328, the Dow 11,350, and the S&P 500 1315.  Since then the markets have been held inside of an extraneous trading range with April's lows marking the 'bottom'.  Although this range looks secure in the near term (meaning the next few hours/days of trading), fear not patient bears, because the summer is almost over…

The markets typically trade in a comatose fashion during the months of July, and August.  That said, during the last four months of the year (Sept-Dec) trade regularly becomes more intense.  Those expecting this year to be any different than the norm may be naïve, as it is almost a certainty that the markets will either cruise higher (scratching May's highs as the economy rebounds), or crash lower (busting April's lows for any number of reasons).  All that is needed to turn yesterdays lows into a reality is the pervasive mind state from investors that 'I won't begin buying until the market 're-bottoms'.  Likewise, all that is needed for the markets to pierce their upper trading limits would be for investors to ignore all that is ugly with the economy, and corporate earnings, and simply buy.  Given the currently weak economic circumstances the former seems more probable.

Is It Soon Time For A 1929 Type Crash?
Seasonal market volatility trends help harden a point: that being that market bulls do not like volatility.  Through out history extreme periods of market volatility arrive most often when severe bear markets are present, and/or when significant bull markets have just ended.  The reason why is because of a decrease in the bullish herd mentality in the marketplace.

The question to be asked now is how much has this market changed from the market of the last decade, and how greatly will the face of markets continue to change in the foreseeable future. By 'change' I am referring to the methodology investors choose to invest by, not the actual economic/stock market relationship per se. 

To be sure, pundits, and steadfast bulls still apply 'new paradigm' answers to 'old paradigm' questions.  For instance, it is still popular to sidestep equity valuation concerns with highly speculative notions such as 'sidelined capital will most surely soon enter the markets', 'the consumer will save the economy from recession', and 'Greenspan will cut rates again next week!'  By comparison, the investing environment was much different back in the 1920s; fund flow information didn't exist (investment trusts were the rave), popularized consumer confidence readings didn't exist, and you would have been lucky to find an average investor who knew who the Fed boss was, much less hanged on his every word, or action. With this in mind, isn't it wonderful that analysts today can surmise that tomorrow's investor will pull money out of money markets, and throw it into stocks?  Isn't it fabulous that a monthy uptick in consumer confidence (conference board, Mich) can propel stocks higher for a brief moment?  Lastly, is it not amazing that a single man apparently understands the economic malaise so incredibly that he alone can stave off recession, and put profits into your pocket?

The point of the above ramble is that a great deal of what is considered to be wonderful in today's market has been created, and it is not essential to the markets intrinsic value. Rather, branches of discussion that enable seemingly logical bullish analysis have flourished in recent years, leaving the average bear in the cold (bears tend to like readings such as corporate debt/default rates, manufacturing, consumer debt/savings, and employment).  As such, even though many people like to compare the 1920s to the 1990s using statistical extrapolations, this may not be an applicable pursuit. Why?  Because many of the 'important' statistics, or events that investors now focus on didn't exist back then. As well, some economic statistics that did exist back in 1929 (GDP for instance) are currently being ignored.  How do we begin to compare GDP trends, the negative savings rate, and corporate debt loads between the two periods in question if few investors are looking at these events?   In sum, new bullish investment ideologies can, and have extended investor hopes, thus changing the way the markets function.

What changed after the crash of 1929 was that economic, and stock market activity united: this is a less than dramatic way of saying that those bullish ideologies that had persisted in the 1920s slowly died after the crash, and a more fundamentally contained market eventually emerged.  Why this collapse of investor optimism occurred has been rationalized on many levels.  Suffice it to say, feverous demand for stocks in the 1920s did not continue into the 1930s. This could be the case with today's market.  For instance, at the beginning of this year who could have predicted the Fed would be cutting interest rates for the seventh time next week and stocks would be struggling?  Has investor optimism already begun to collapse?

Perhaps the volatility uptick set to arrive later this year will not spawn a repeat of the crash of 1929.  Surely the statistical comparisons between today and October 1929 are persent, but everything today's investor is looking at is merely salad dressing to the underlying economic situation.  As such, how important is record corporate defaults in the first half of 2001 if this news does not impact trade?  The tepid answer is that corporate defaults are not important at all if the investor does not care about them.  However, what the corporate default picture does, like so many other things, is have a trickle down effect.   Higher corporate defaults can mean that poorly run businesses will encounter higher borrowing costs, and the banks, after losing money off the defaults, will implement tighter lending policies.  As such, record corporate defaults can mean absolutely nothing for the markets, but its occurrence comments on a larger schematic that 'eventually' can alter how investors choose to price the markets.  

The word 'eventually' is applicable when looking at the U.S. dollar. How crucial is the relationship between the current account deficit and the price of U.S. dollar?  For many years the current account deficit has been expanding - the dollar rising (CA has gone from 1.5% of GDP in 1996 to currently 4.5% of GDP).  However, only now has the 'unsustainable' current account deficit told investors that the dollar may be poised for a drop.  The lesson here is that looming negatives can strike at any given moment.  For instance, just as a few people prophesized a stock market collapse back in the mid-late 1920s, there are those that have been calling for a drop in the dollar for the last few years.  However, the actual collapse date(s) are not stricken to a statistical calendar.  Rather, the stats act as the scenery for the markets (or the stage), and be it 1929, or 2001 it is the sole discretion of investors as to whether tomorrow the markets are dancing in the clouds, or stalking though hell. 

* By what methodology will people choose to invest by tomorrow? 

Getting back to volatility.  A good comparison to the last two years is 1999: or a year when a bullish herd mentality swept the markets. As you can see volatility, at least by the Dow/Nas measure, did not exist.  

Lastly, for those of you wondering, Robert A Young was running the Federal Reserve Board when the markets crashed in 1929.  I would venture to say that many average investors did not know this.  Question is, how many investors will remember the name 'Greenspan' 70 years from now?  1929 and 2001: two very unique periods in market history; periods with different themes, and different investor perceptions.  Perhaps the only similarity being that most investors thought the worst was over until the summer doldrums ended….

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