Tuesday, October 28, 2008
Friday, October 24, 2008
Today was a difficult day to try to understand in the markets. Before the bell the S&P 500 futures contract was locked limit down. This hasn't happened in my memory since 1998. I don't think they even locked limit down post 9-11. Then the market rallied off that limit after the open and performed remarkably better than all the other markets in the world. Which is not to say it performed well, it was still down 3.5%. That's a lot, but not by recent standards.
First, by way of explanation the S&P 500 stock index future is a financial product that trades on the Chicago Mercantile Exchange and on the CME's 24 hour trading system Globex. This means that you can check where the S&P is trading with a 20 minute lag 24 hours a day all week at the Merc's website. This allows you to see how the market is responding to events overseas.
The futures contracts at the Merc are subject to limits on how far they can move overnight and during the day. They can at most move 60 points overnight and during the day there are trading halts as the market goes down 10%, 20% 30%. These were instituted after the 1987 stock market crash to try and slow such an event were it to occur again. So overnight in the rest of the world, stockmarkets got crushed. Japan was down 9%, Korea was down 10%, and before the US open European markets were down a similar amount. Therefore people trading the S&P expected a similar thing to happen in the US and so they locked the S&P limit down.
But then something surprising happened. The market rallied in the first few minutes of the day, bounced around during the day but never got back below the down 60 limit for the rest of the day and closing only down 3.5%. Far better than anywhere else in the world. It's hard to know why this is.
One reason might be that US existing home sales were stronger than expected because house prices have been falling faster than expected. This is seen as a good sign because the economy cannot recover until the real estate markets recover. It could also be seen as a bad sign because it means that the values of real estate and real estate debt held by banks are probably going to continue to decline.
So its hard to know what it means that he US was so much stronger than the rest of the world. It probably means that absent more dire news about the real economy markets in the rest of the world will probably rally on Monday. There will probably be a lot of spike rallies as different people, Warren Buffet, Barton Biggs call the bottom. But until the financial world is no longer asking what shoe will drop next, we probably have not seen the end of this.
Thursday, October 23, 2008
A very interesting day in the stock market today. The morning began with some grim news from the economy. Jobless claims came out at 478,000 a huge number but only 8,000 worse than expected. Also some data came out about foreclosures which was also grim as they are 17% worse than this time last year though only 3% worse than last quarter so things are getting worse but more slowly.
The interesting thing about this is what the market did: nothing. The market traded sideways and actually climbed in the morning before doing another dive for the deck routine in the middle of the day before recovering in the last hour to close up a percent or so.
So why is this happening? I think there are two things at work here, the first is that now that no one doubts the resolve of the government to do something about the financial crisis the market is looking to data about how the real economy has been effected by the crisis. Todays data and recent earnings have been bad, but not far worse than expected and apparently not worse than the market is pricing. So actually, in a way, even bad data is good for the market in the sense that it allows people to confront reality about the economy rather than their fears about it. This is why I think the market traded up in the early part of the day.
So why the dive for the deck and then rebound? I think the reason for that is more subtle. To explain it, I have to go back to my favorite quote from Donald Rumsfeld:
"There are known knowns. There are things we know that we know. There are known unknowns. That is to say, there are things that we now know we don’t know. But there are also unknown unknowns. There are things we do not know we don’t know."
Regardless of your opinion of Mr. Rumsfeld this is a useful insight into the current markets. Remember that no one currently working in finance has ever seen anything like this. Many things that three months ago people thought would never happen have happened, and then happened over and over again all over the world. People are now forced to admit that not only are there things they are aware are risks, they also have to worry about things which may be risks to the system but have not yet occured to them and won't until its too late.
Essentially people are afraid of the things they know are risks: a slowing real economy and declining corporate earnings. But now they also have to be afraid of things they don't know might happen. What happens if a major hedge fund faces redemptions and is forced into liquidation? What if the loans to AIG are not enough? What if the government takes a forceful action which it poorly thought through and makes worse what it is trying to improve?
Addressing risks people are aware of is simple. Over time we will know how the denial of credit to the real economy has affected it and the earning power of companies within it. Addressing the fears of people who are not sure what they are afraid of is a whole other thing and far far harder.
Luckily, it is easy to predict the behavior of people who are afraid of things they imagine and of things they cannot imagine: they sell.
Wednesday, October 22, 2008
In this piece I discuss whether one should follow the advice of Warren Buffet's NYT op-ed on Friday. When trying to decide the answer to that the first question you have to ask yourself is what kind of person are you.
Before you can answer that I can answer at least part of it for you: you are not Warren Buffet. By saying you are not Warren Buffet I am not saying that you are not a billionaire, you probably aren't, but that isn't the important part. Warren Buffet has a lifetime of experience in the markets and total confidence in his own judgement in matters financial. He also has proven time and again that he can successfully execute the buy and hold strategy, even through difficult times. For most people this is not the case.
Mr. Buffet points out that he is not a market timer and there may be more storms ahead, indeed the market has dropped 5% since he made his call. For Warren, however, a 5% or 10% or 25% or 50% decline will probably not shake his 10 year view that this too shall pass. That is probably not true for many investors. Many ordinary people when confronted with loss begin to behave non-rationally either through panic or denial.
This makes it likely that many ordinary investors would be shaken out at some point if the market declines, and therefore would not be around for the rebound. They would execute only half of the buy and hold strategy with likely negative results. So instead of buying now and resiging yourself to the possiblity that the market may continue to go down, it might make sense to resign yourself to the fact that you will miss the first 30% of the rebound and not buy until you are totally sure this is over.
Odds are the market will not recover as quickly as it had fallen.
Monday, October 20, 2008
In this video I talk about the non-responsiblity of Credit Default Swaps for the financial crisis. The AG for NY and the US Attorney for the Southern District today announced an investigation into the CDS market as they think it is the root cause of the financial crisis. This is like blaming your TV for the bad news you see on it. While its true that if you did not have a TV you could not see the news, but that doesn't mean the news didn't happen. It just means you didn't know it. And certainly the TV didn't cause the news, it reports the news. And so it is with CDS. Lehman went bust because the value of its assets declined below the value of its liabilities and its equity because its management thought conditions would improve and so did not liquidate troubled assets at fire sale prices as Merril and others did. In the event conditions did not improve and so the value of Lehman's assets declined to a point where in liquidation the bondholders got $0.08 on the $1 and the stockholders got nothing. The rumors of the weakness of the assets of Lehman were true, but were not made true by people betting on their truth.