Ghost of Bubbles Past: Let's Play a Game

All things one has forgotten, scream for help in dreams.
Elias Canetti, Die Provinz der Menschen

Mr. Wall Street Says: Don't worry, the Fed's got your back!

Let's play a game.

This is the alternative to a 'crash' which is a two year grinding bear market. The classic example is 1973-74 but since we did not have good numerical data we decided to use the bear market most recent, 2000-2002, that everyone seems to overlook. The SP took a top to trough haircut of 47%!

Bear Market: And So It Begins....

Plus ça change, plus c'est la même chose.

After sorting out the limits and characteristics of their capital and cash flows, for any trader, any investor, the first and fundamental question should be: am I operating in a bull or a bear market, or one of indeterminate trend, a sideways drift?

For those who do it, the reason for this is obvious. Even a daytrader will notice the change in the complexion of the tape during a bull or bear market in a given stock, index, currency or commodity. Or should we say, any trader who remains in the game for any length of time.

The highest percentage way to make money is to be long in a sustained bull market, and to hold your positions, with minimal changes, adjusting only at periods of obvious relative strength and weakness. Thus do bull markets make geniuses of us all, and therein lies their greatest danger to the self.

In a bear market, short positions tend to 'work' for longer durations than usual, but the rallies are sharp and ferocious, and can wreak havoc on both your account and sympathetic nervous system. In a bull market, short positions work only during the corrections, which are short and sharp, with prolonged perids of generally upward drift. Short side trading is almost never easy, even during bear markets, when nothing really is easy. And when trying to buck the tiger's odds of playing options or the futures, life becomes a triple black diamond adrenaline ride. You might be surprised at how many traders get hooked on the rush of the occasional big profit in brief periods, from styles that are indeed harsh mistresses, both giving and taking small fortunes. We are no different, having done it, all.

So, are we in a bull or bear market, and has anything really changed? The fundamental question, and perhaps the one we so often forget to ask?

The Bonfire of the Vanities

When we speak of new highs and new lows in prices, or the value of most things in commerce, remember that we are speaking in terms of something else. In the case what we discuss here, it generally is the US dollar. And its not your grandfather's dollar, but one which is fully fiat, from the Latin, "let it be done, or it shall be because we say so." Perhaps its nature is better understood when used in the hopefully familiar phrase, fiat lucere, "let there be light."

"Lenin is said to have declared that the best way to destroy the Capitalistic System was to debauch the currency. . . Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million can diagnose." J. Maynard Keynes, Economic Consequences of the Peace, pg. 235

Given fiat money, they shall be as gods perhaps. Except in this case fiat is a vanity, and provides not light by which to see clearly, but rather clouds and distort the true value of things for those who would use it so.

"...wealth gotten by vanity shall be diminished, but wealth gathered by labor shall increase." Prov 13:11-12.

Keep these charts in your mind going forward, because we may see some unexpected twists and turns as we move into this endgame, which of course is nothing really new, at all.

"The real menace of our Republic is the invisible government which like a giant octopus sprawls its slimy legs over our cities, states and nation. At the head is a small group of banking houses... This little coterie...run our government for their own selfish ends. It operates under cover of a self-created screen...seizes...our executive officers...legislative bodies...schools...courts...newspapers and every agency created for the public protection.” John Francis Hylan, NYC Mayor, 1922

The January Stock Market Indicator

"As January goes, so goes the year."

The January Barometer basically says that as goes the S&P 500 in January, so goes the market for the year. “A down January means a down year” would seem to be the obvious reading for 2008. Credit Yale Hirsch, editor of the Stock Trader’s Almanac, for devising the January Barometer in 1972. According to the Hirsch research, January’s trend matches the trend for the year about nine times out of 10. If you toss out a few close calls, when the market was up or down less than 5 percent for the year, the January Barometer still works three out of four times, the Stock Trader’s Almanac reports. Since 1950, the S&P 500 has posted a gain for the year 91% of the time that the index experienced a positive January. For those "cautious" investors who desire an even larger sampling, since 1926, that percentage [a positive January foreshadowing a positive full year] falls to 80%, although that’s still a pretty telling predictor of future market activity.

Strictly market lore like other purely coincident indicators, like winning football teams, magazine covers, and women's hemlines? Not so, according to peer-reviewed statistical research.

"...We systematically examine the predictive power of January returns over the period 1940–2003 and find that January returns have predictive power for market returns over the next 11 months of the year. The effect persists after controlling for macroeconomic/business cycle variables that have been shown to predict stock returns, the Presidential Cycle in returns, and investor sentiment, and it persists among both large and small capitalization stocks and among both value and growth stocks. In addition, we find that January has predictive power for two of the three premiums in the Fama–French [1993. Journal of Financial Economics 33, 3–50] three-factor model of asset pricing."

The Other January Effect, Journal of Financial Economics, Volume 82, Issue 2, November 2006, Pages 315-341

Do Central Bankers Dream of Endogenous Sheeple?

While your blogger is mending from a rather bad cold compliments of his brood of young dependents, they being the reason for working and worrying as hard as we sometimes do, we are pleased to present an extended excerpt from a favorite publication targeted at the Central Banking crowd, appropriately named Central Bank News.

Central bankers seem to be an affable group of fellows. Clubbable, as the British might say. A bit on the reserved side, their cocktail parties must seem like Economic Department soirées, without the occasional pleasant-on-the-eyes graduate assistant. Efficient, bureaucratic types such as T. S. Eliot must surely have had in mind when writing The Lovesong of J. Alfred Prufrock.

"...I am not Prince Hamlet, nor was meant to be;
Am an attendant lord, one that will do
To swell a progress, start a scene or two,
Advise the prince; no doubt, an easy tool,
Deferential, glad to be of use,
Politic, cautious, and meticulous;
Full of high sentence, but a bit obtuse;
At times, indeed, almost ridiculous--
Almost, at times, the Fool."

The stuff of good bureaucrats and effective military staff, with a touch of the common mailman. Excepting embellishment that indolent recuperation has allowed, this is verbatim, as those-who-know have written it. You can't, and really do not need to, make this stuff up.

Central Banking Publications
29 January 2008

"We are not panicking, are we?" ask the central bankers. (They don't KNOW yet? - Jesse)

Ben Bernanke has come in for a lot of stick for allegedly panicking in the face of stock market collapses but other central bankers are not acquitting themselves very well either.

Many of them were on duty – but off the record – at Davos last week. Messrs Trichet of the ECB, Geithner of the New York Fed, Carney of the Bank of Canada, Knight of the BIS and a gaggle of others. All stressed the extreme gravity of the situation. But they seemed completely at a loss when it came to policy responses. (Let's see, shall we prevaricate and cut rates, or jawbone and cut rates? - Jesse)

It must be better to cut rates decisively now, said one, even if we have to raise them again later. The costs of precipitating a banking collapse are so horrendous they far outweigh the risks of a little increase in moral hazard and the risk of stimulating inflation. Others nodded sagely. (Collapse? OMG, the Wall Street bonus money was at risk! - Jesse)

The old system that they thought they understood and to a degree managed has gone, said another. “Everything is on the table”; “the extent of this crisis is very far-reaching”. They welcomed initially the repricing of risk but this has gone far beyond that with the losses of the monoline insurers put at up to $150bn. (Everything? - Jesse)

Faced with what threatens to become not just a credit crunch but the biggest banking crisis in a generation, all they have are their poor little interest rate tools. They are all one-club golfers, after all. No wonder there is a new mood of humility about. (Bet me - Jesse)

Bernanke under fire

When at its emergency video conference convened by Ben Bernanke at 6 pm on Monday 21 January, the Federal Open Market Committee decided to lower rates by 75 basis points to 3.5%, the biggest single cut since 1982, it took the decision “in view of a weakening of the economic outlook and increasing downside risks to growth.”

Ed Yardeni, a well-known Fed watcher, says the FOMC statement should have read: “The Fed chairman panicked on Monday… He convinced all of us to vote for the rate cut except cranky old Bill Poole.”

Accusations of panic came from George Soros, the FT, The Economist and many other quarters. And far from cheering markets, only a few days later the Fed came under pressure to cut again by at least another 50 basis points at its regular meeting. What is going on? (Neo-Keynesians are such rate cut sluts - Jesse)

The first big cut came at the end of a day which saw shares in Asia and Europe plunge as investors dismissed President Bush’s plans for a fiscal boost, unveiled on Friday, 18 January, as largely irrelevant. After the overnight losses on Asian exchanges, European bourses followed suit. On January 21, The FTSE 100 lost 5.5% to 5,578, its biggest drop since the World Trade Centre attacks. the DAX was down 7.2% to 6,790 whilet the CAC 40 tumbled by 6.83% to 4,744.

The Fed top brass – people like Don Kohn and Tim Geithner – knew full well that they would be accused of a knee-jerk reaction to the markets, validating the growing view that Bernanke was following Greenspan in holding monetary policy in thrall to a Wall Street standard. But they were driven to act by fear of a cumulative and rapid collapse. ("Uh, can we have a heads-up for the next imminent collapse? - Jesse)

Yet it later transpired that the global stock market rout of 21 January may well have been triggered, not by fears of a US downturn as by the actions of one bank – Société Générale of France – as it frantically sold shares to unwind positions entered into by its rogue trader Jerome Kerviel in the course of accumulating losses initially put at €4.8bn ($7bn). (Le cover story? - Jesse)

Informed of this belatedly by the Banque de France, the Fed somewhat lamely insisted that they would have done the same if they had known at the time. (Yeah, and next time we'll tell mom. - Jesse)

What price central bank cooperation?

Central bankers were just breathing a collective sigh of relief that over Christmas and the New Year the collective action to relieve market tensions announced on 12 December had actually succeeded. Then they were hit by a new phase of the crisis – the sudden deterioration in the economic outlook for the United States, the stock market collapse, the SocGen affair, the monoline insurance crisis and widening losses at leading banks. ((But meanwhile the Fed was telling US 'all is well?' - Jesse)

Christian Noyer, the governor of the Banque de France, might say he is “not at all worried” about Société Générale, despite it falling victim to the biggest fraud in banking history. (Its only money. Yours! - Jesse)

But when the French central bank admitted that it had known about the fraud since the weekend (19-20 January), there were raised eyebrows in other central banks. Why weren’t we told?

Noyer’s late call to the Fed – and to how own government

On Monday 28 January Christian Noyer admitted that he was informed of the crisis on Sunday 20 January but delayed informing his government until the following Wednesday because he wanted to avoid the danger of leaks as the bank sold the position on the market. (Cherchez le Goldman Sachs. - Jesse)

Moreover, he insisted that SocGen’s actions in selling its positions had no influence on the Federal Reserve’s decision: “I consider that this affair has nothing to do with the monetary policy of the Fed,” he said. “It was a striking action but one that they took based on their judgment of the economic situation in the United States and so has nothing to do with European markets.” (Psych! - Jesse)

“The Fed does not decide its monetary policy actions, particularly not its exceptional ones, because of the situation on European markets in one day. That’s nonsense.” Thus central banks have started the year on the back foot, increasing moral hazard and giving a public demonstration of how not to cooperate. (Life imitates high school. - Jesse)

Sarkozy/Lagrande to lead calls for tighter regulation

When in doubt, call for more regulation. Inevitably, continental central bankers and politicians have seized on the banking crisis to call for more regulation. Noyer has already highlighted three areas in which the regulation of rating agencies needs to improve in the wake of the credit crunch: the degree of transparency in rating methods and the overall role of rating agencies in the securitisation process; whether to change the metric used for rating bonds and structured products and introducing a specific rating for liquidity risk. (Non-competitive! We risk losing important financial business to better organized crime - Jesse)

But regulation of ratings agencies and hedge funds are seen as yesterday’s agenda. Newsmakers expects France to use its presidency of the EU in the second half of this year to press hard for much greater harmonisation of financial regulation in the EU, including London…” (les renegade roast-boeufs, les vaches folles. LOL - Jesse)

Sovereign wealth funds hit back

Heads of the top sovereign wealth funds from the Gulf states, Russia and other emerging markets were in fighting mood in Davos.

Leading the calls for tighter regulation and codes of conduct was Larry Summers, the former US treasury secretary. What would happen in a 1992-type situation, he asked, if SWFs were involved in speculating against a currency as George Soros speculated successfully against the pound? It would create intolerable diplomatic tensions. We need ex ante assurance that this type of situation will not happen. That is why we need a code of conduct. (The IMF and World Bank have exclusive franchises for that - Jesse)

Not so, retorted the funds. We have always been and remain responsible investors. We do not need any of your codes of conduct imposed on us.

On the contrary, it is up to you in the heartland of your famous capitalist system to get your act together. You have lectured us for decades on the need for tighter bank regulation, anti-money-laundering rules and so on and now you are in a bigger mess than we ever got ourselves into. It is your banks who are coming cap in hand to us because they made such a mess of their business under your much-touted regulatory regimes. Get your own houses in order…. (After all we have stolen from you, and this is the thanks we get? - Jesse)

It is the revenge of the emerging markets."

Daily coverage of general central banking developments is available to subscribers through our website: Central Bank News

In Luke 16:19-31, when the beggar Lazarus dies he went to Heaven, while the rich man, Dives, went to Hell. Dives wanted to warn his brothers and asked Abraham if Lazarus could be sent back to tell them. Abraham refused. "If they hear not Moses and the prophets, neither will they be persuaded, though one rose from the dead."

What more can we say? Sleep well.