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Tuesday's
Market Plunge
by Michael A. Nystrom
BullNotBull.com
February 28, 2007
At it's worst level,
the Dow was down today over 540 points in a global selling spree that
started overnight in China. By the end of the day, it had recovered
somewhat, but still closed down over 400 points. The real story was the
volume: 2.3 million advancing shares advanced, versus 2.3
billion decliners in what could be the most lopsided
selling day in history! In other words, 99% of today's share volume
was down!
After hearing this news, many people's first instinct is to ask
"What caused it?" The next question people are concerned about
is, "Will it continue?" And finally, "What should I
do?" I'll do my best to answer those questions in this article.
What Caused It?
It's hard to say exactly what single event, if any, "caused"
today's market meltdown, but we do know that it was a global
selloff that began overnight in China. The Shanghai index fell a
whopping 9% the very day after it reached an all time high. Remember,
this market had risen over 130 percent last year, so this was obviously
a market driven by speculation, similar to the 1929 US market, and the
2000 Nasdaq market. The parabolic rise made
a correction inevitable, and jittery, speculation-driven markets
such as these can sell off on the slightest hint of rumor.
"Traders
said the slide did not appear to be triggered by concrete news,"
but instead was fed by various fears. The linked article goes on to
discuss a number of rumors that fluttered through the crowd. Westerners
are much more likely to ascribe the cause of the plunge to Greenspan's
speech to a business group in Hong Kong, in which he stated the US
economy was likely headed for a recession by the end of the year.
Greenspan is no longer head of the Federal Reserve, and holds no
official position, but his words and opinions obviously still have
considerable sway. Apparently he's still the Maestro.
This morning's bad news didn't end with the markets. Early risers also
learned that a
suicide bomber struck the main gate of the compound Dick Cheney was
visiting in Afghanistan, in an apparent attempt on the VP's life.
Later the Commerce Department reported that durable-goods
orders fell 7.8 percent in January, including the biggest slide in
business equipment demand in three years.
It was a morning of bad news. Markets are emotional and all the
pessimism took its toll. The fact that consumer
confidence was announced to have risen to a 5-1/2 year high did nothing
to help the morning sentiment. I'm not sure what drugs consumers are
smoking these days - or maybe it's the people doing the surveys -
because things sure don't look that great to me!
So to get back to what "caused" the plunge - conditions were
ripe, and there were a number of triggers. Before we go on, let's take a
look at some charts:
Dow down 3.29%, S&P 500 down 3.4%, Nadaq down 3.86%. This is not
crash territory by any stretch of the imagination, (though you woulndn't
know that from CNBC's
breathless reporting of the plunge). It just feels like it because
we haven't seen any substantial pullbacks over the past 5 years. These
were in fact the worst market drops since September 2001.
The technical situation with the Dow, S&P 500 & Nasdaq are
similar, so lets focus on the S&P 500. The eight-month uptrend on
the daily chart has clearly been broken. The trend line that served as
support for the past eight months now serves as overhead resistance.
Today's action also plunged prices below both the 50-day and 100-day
moving averages. Not a good sign for the bulls.
From a longer term perspective, however, the uptrend since the start of
the Iraq War in March 2003 is still intact, and not at all threatened by
today's drop. Weekly MACD is topping out, however. From the looks of
things, a short-term stock market top is in place.
It was a uniformly down day. The dollar continued its slide:
As did the precious metals. Silver fell about 5%, and gold was down
about 4%, backing off from its quest for $700 per oz.
The gold bugs index also fell about 7.5% - almost twice the amount of
either gold or the general market. Investors who think of holding gold
shares as insurance against a general market drop may want to reconsider
after today's performance.
Where did the money go? It fled to the safety of US treasury bonds. The
10-year yield continues to slide.
Will the stock slide continue?
Greenspan's remarks last night and the ensuing market slide calls to
mind his famous "irrational
exuberance" comments in 1996. Like this time, those comments
were made while the US market was closed, and led to an overnight global
market selloff. Hong Kong fell almost 3 percent; Japan - the biggest
Asian market at the time - fell 3.2%. Germany dropped 4%. The Dow fell
too, but recovered most of it by the end of the day. In the long run, US
markets went on to experience even more
irrational exuberance, continuing to this day. The events of December
1996 turned out to be just a minor blip in the roaring bull market of
the late 1990s. Greenspan made those original comments when the Dow was
hovering around 6,500; it has since nearly doubled.
Will this time be the same -- another tremendous buying opportunity for
those willing to buy the dip? Doubtfully.
The 1990's bull market was driven by three powerful fundamental factors:
technology, disinflation and demographics. We had the twin internet and
telecom booms, which fueled demand for computer and telecommunications
hardware, software, programming and related services. The increasing
trend of outsourcing to Asia yielded the dual dividend of falling prices
for consumers and increasing profits (made
in taiwan) for corporations. The booming economy created many high
paying jobs, and workers were increasingly participating in automatic
stock investment plans through their 401(k)'s. The world was at peace.
The mood of the country was expansive and optimistic.
The post-bubble economy did not experience a collapse - as was widely
expected - due to the massive flood of cheap money provided by the
Federal Reserve. This money helped stave off bankruptcies - both
personal and corporate, although we did see the three largest
corporate bankruptcies in history in 2001-02: Worldcom, Enron, and
Conseco. Easy money also led to the housing industry boom, but for many,
it was a muddle-through economy without the excitement or the optimism
of the 90's boom.
The question at hand today is: what can drive the economy forward now?
The housing industry is on the skids. American manufacturing is a thing
of the past. The US auto industry is in big trouble. There is no
technology "silver bullet" like the internet or mobile phones
that we saw in the mid-1990's which can carry the economy forward.
Microsoft Vista was released to a chorus of yawns. The current expansion
looks tired. The
only thing bullish is the outlook for war. And going forward, the
demographic outlook for stocks is not favorable. Even Harry Dent, who is
still predicting Dow at 20,000 by late 2009 (interesting
report for free download) is bearish long term and speaks of
something like a second great
depression to follow.
The first wave of baby boomers is expected to begin retiring soon. Many
of those boomers who dream of an early retirement check their 401(k)
balances and do their calculations - in their head or on fancy
spreadsheets - as to how many more years of working and savings growing
at x% per year until they can retire. But the smart ones are already
quietly heading for the exits. The first boomers start retiring in the
next few years, and in order to maintain their standard of living, they
need to sell their stocks. The problem with this is that as boomers
begin to sell, without additional buyers the stock market will go down.
This is bad for those who are still trying to use the market as a
savings device, and may lead to a premature rush to the exits.
The stock market has provided many with paper wealth, but that paper
wealth must eventually be converted into cash. Therefore, as individual
boomers retire, it is in their interest to maximize their own return by
cashing in and selling their stocks (and/or other assets such as real
estate) as quickly as possible - before others have a chance to. This is
a defensive mindset - the complete opposite of that which prevailed
during the expansive 90's.
To sum up, the economy is slowing and the nature and composition of the
economy is changing. Furthermore, a
social mood change is in the air. There are no technological
breakthroughs to drive the economy forward and baby boomers - with one
eye on retirement - are beginning to shift their attention away from
stock accumulation and towards stock distribution. After all, if the
short-term market top is in, and retirement is just one or two years
away, what is the point of holding stocks?
What should I do?
Inevitably, the question comes back to "What should I do?"
Unfortunately, there are no easy answers to this question, since
everyone's situation is unique. The best advice that I can give is to
learn to understand the dynamics of the economy and stock market, and to
learn to think for yourself. Listen to experts, take in as many opinions
as you can, but critically evaluate what they are telling you. Just six
years ago at the Nasdaq market peak, the deafening mantra from Wall
Street was "Buy and Hold!" This was excellent marketing
material, but terrible investing advice. The world is always changing,
so you must keep up with the changing events and understand how they
will affect your life and your portfolio.
Two excellent, brand new bearish books have crossed my desk in the past
few weeks from publishers, and I will have reviews of them on my website
later this week. The books are Financial
Armageddon, by Michael Panzner, and Crash
Proof by Peter Schiff. They're both excellent books, have good
advice and I recommend them both. If you'd like to be notified when
these reviews are up, as well as when other articles such as this one
are published, please
sign up to my low volume email announcement list.. What's going to
happen tomorrow? Stay
tuned.
As always, comments on
this story are welcome here.
Thank you and best regards,
Michael Nystrom
© 2007
Michael A. Nystrom
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Michael A. Nystrom
Cambridge, MA
www.bullnotbull.com
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