Market crash: are we there yet ?

[sailingdog]

Rick-

Thanks for the update from an industry insider... I hope your company survives. Good luck.

[Sapperwhite]

Thanks Rick,

I know my posts are "doomsday", thats because it isn't outside of the realm of possibilities. I hope nothing that bad happens, but to say it can't happen is foolish.

I hate boiled shoe leather and turnips, but 55gal drum roasted rat doesn't sound that bad, in China they where serving rat as "mystical dragon meat" and people loved it until they found out it was rat, probably tastier than cardboard dumplings. Mmmmmm dragon meat.......

[SteveSouthwood]

The words, "Don't panic Mr Manwaring" come to mind.

Let's put a few things in perspective - well at least mine.

First thing to put in mind is the banking repo market. This is the underlying network of short term asset backed loans that banks make to each other on a daily basis to meet their capital adequacy requirements. To those of you who don't know what this is, here's how this was first explained to me. Imagine you're a garden shop. You have a bunch of lawnmowers but don't have enough cash until next Thursday. You don't need all your lawnmowers until then. Borrowing money without offering some form of security would be expensive as the lender would take on the risk of default and they would demand a premium for taking on this risk. If I offer up a bunch of my lawnmowers as security so that if I default, the lender keeps the lawnmowers, the lender is going to lower the rate on the loan as it is now less risky. Make sense? It worked for me.

So the banks are repoing their assets between each other every day. Not just mortgage backed securities - every freely traded asset is repo'd. A good chunck of the repo market is overnight. ie loans that have to be paid back the very next day. Of course, on a Friday, these are three day loans. not overnighters. It is normal. It works well.

So here's the problem. There's all these mortgage backed securities and the banking industry is discovering that not all of them are the low risk securities they thought they were. It turns out that some of them (understand this - just some of them - remember the tiny fraction of the loans that are actually at risk) are pieces of pooh. Problem is, noone knows (yet) which of them have pooh in and which ones don't.

As the uncertainty (perhaps I should say fear) built no surprise that noone wants to take an mortgage backed security as collateral as security for an overnight loan until it is fully understood what it's true value is.

So we get into a bit of a vicious circle. Conventional means for valuing a security is to look at it's market value - the value at which it is currently trading. Given the volume of the repo markets (remember, they are shifting daily) the repo markets provide a strong indicator of value. But the banks are afraid of playing pass the pooh and ending up with an undervalued asset so they're not buying or repoing from eachother. So the secondary market shuts down and the normal means to price the MBS securities evaporates.

So what I see are a few things happening :

Some of the higher risk (probably as a result of derivative bets) hedge funds in the US have tanked - ie Bear Stearns. Some funds have lost value - ie Goldman.

Over in Europe where uncertainty is higher they have no idea what they've got so the Paribas of this world are suspending activity in some funds until they know true value.

The banks still need liquidity. The central banks know that only a small portion of the MBS securities are pooh so they're propping up liquidity by offering to repo the securities. They will continue to do this until greater transparency occurs within the markets and true value can be expected.

The central banks will keep reloaning the same money overnight (remember this if you see more liquidity being pumped in on Monday - it will be the same money) while the industry frantically gets round valuing the loans inside each security. As greater transparency returns, the banks will resume repoing to eachother and the central banks will gradually reduce the amount they are providing in liquidity.

What's happening now is that fear is dominating the markets and creating a huge amount of volatility. I reckon that this will all settle down shortly. Those who ran to safe haven's will lose out and the calmer heads will either do fine by riding it out or make a killing by buying cheap.

After it settles things will be different. There will be less mortgage money available but not by much. You may see greater regulation to protect people from themselves. I certainly do not see a housing or market meltdown. I am not panicked.

It is of course interesting to see the somewhat predictable outpouring of comment from the "wish we were still on the gold standard" crowd and the resurrection of the "brink of collapse" arguments that are now over 20 years old.

These are my humble views. I will offer no advice to anyone as we all have to make up our own minds.

[sailaway21]

Good post, Steve.

Why I will hold, and maybe even buy, if the market drops further. If my investment was fundamentally sound last week, what's changed to make it less so this week? What other alternatives do I have to invest the money in? If two months ago I could have gotten the stock I am considering at it's current price, and I still feel it has good value, why would I consider selling when two months ago I'd have been tripping over myself to buy at this rate.

I would not be at all surprised to see some good buying opportunities arise if the mood expressed here by some is shared by many.

[hellosailor]

Sailaway-
"why would I consider selling when two months ago I'd have been tripping over myself to buy at this rate."
The big why, is that the stock market is a speculative game which by all rights and means should be located in Las Vegas and treated as gambling, plain and simple.
Remember the crash around 1988? It took FIVE YEARS before money market funds were able to recover their values after that one. So, every player out there has to decide now: Will the market drop to 13000? 12500? or even 11900? Before it comes back how much, how fast? Buying in at 13,200 versus the 14,000 it was two weeks ago sounds great--unless you think it will drop to 12,500 and if you wait for two more weeks of plummeting, you can double or triple your profit.

It is a sad but true statement that 94% of all the players on the stock market LOSE in order for the remaining 6% to make great profits. The only folks who make a profit every time, time after time, and the brokers. And they should be forced to work on their feet, in cheap tuxes, just like the dealers at any other casino. For an hourly wage.

The market is a game where the rich, with full time to play the game, and inside information to play it well, steal from the wanna-be-rich who haven't quite caught on that the house always wins. Indeed, even in a crash, the house WILL WIN, and it is the little rubes who go belly-up.

[wind_magic]

Originally Posted by sailaway21

If my investment was fundamentally sound last week, what's changed to make it less so this week?

If it's a bubble then it wasn't a sound investment to begin with.

Originally Posted by sailaway21

What other alternatives do I have to invest the money in?

If it's a bubble then the best investment is cash. A market crash is nothing but everyone wanting to invest their over priced homes, their stock certificates, bonds, everything they have to buy one asset ... CASH. Sometimes cash is king, because sometimes people will trip over themselves and do anything to convince you to give it to them, even fire sale all of their derivatives. And you might think cash is always a bad investment since $us has dropped in value so much over the past 2 years, but when debt starts eating itself and money starts being destroyed and trillions turns into billions, cash money becomes a whole lot more valuable.

That's all a market crash is ... everyone, at once, wanting to buy cash.

And treasuries are nice too.

Originally Posted by sailaway21

If two months ago I could have gotten the stock I am considering at it's current price, and I still feel it has good value, why would I consider selling when two months ago I'd have been tripping over myself to buy at this rate.

I would not be at all surprised to see some good buying opportunities arise if the mood expressed here by some is shared by many.

Obviously the real question is if it's a bubble or not.

[chris_gee]

A couple of points. The market doesn't go up 10% pa longterm, I think the studies show 1-2% pa in real terms. Most if not all the rising US stock market of the last four years is due to the declining dollar, in terms of other currencies it may well have fallen.
When you look at the market action in the last hour or even half hour of recent days you see sudden major reversals. Most market trading is speculative within 1 day. Some hedge funds are reported as having made major losses. However each trade has two sides and the winners equal the losers. The catch is that some major players, think the big brokinghouses, have the ability to manipulate the market by size applied at the right time, often knowing their clients positions, and squeeze them out into losses, while picking up a nice gain themselves. Much like a casino with rigged tables. The nett effect is money transfer from poor to rich. I doubt that Cramer is really concerned about the lil guy, in calling for rate cuts rather keeping the game going for those who profit from it.
Going back to the original point, not many businesses can consistently return 10% on their capital which would be an excellent result. Therefore one can't expect to invest in the market ie all businesses as a whole and get that. However you can create an illusion for a time by printing money.

[bestfriend]

If you take it from the sky is falling viewpoint, I am in a very bad spot. Well, we all are, but just for example. I have 12 years to retire. And if the market is indeed going to be unstable or crash, there will not be time for my money to recover. Our 457 gives us two basic choices, varying degrees of aggressive and conservative accounts, and bonds. Am I safe putting it into bonds and taking the lower more stable percentage? Whats the smart thing to do? Financial advice on a sailing forum, how crazy is that?

[Rickm505]

Buy Treasuries

[bestfriend]

Thanks Rick.
Whats the biggest industrial economy in the US, is it the auto industry? Well it has to be one of the largest. Look at how long and how many people they have been laying off. Look at how long and what kind of incentives they offer for the consumer to buy. Prices have not gone up in a long time, 0% interest for 5 years has been on the table for a year now. My Pop always said that the auto industry was the leading indicator of a good or bad economy in the US. (Americans can't live without their cars.) I don't know if that is true or not anymore, but just thought it was interesting.