The Stock Market Sell Off Has Arrived

“It’s pretty much all out war,” said the chief financial economist at a large Japanese bank.

Yesterday, the battle was hot and heavy. By 8 PM last evening the financial media was in a panic. An attack of stock market panics was rolling over the world. Japan was down 5%. India was down 4%. In Russia, they stopped trading twice. In Iceland, they stopped trading in financial shares all together.

By the time the battle reached Manhattan, the London press expected the whole island to be pulverized. And for a while, it did look as though US stocks would be hammered to dust. The Dow fell 600 points at one point.

But by the end of the day, stocks were down...but not out. The Dow lost 363 points, to below 10,000. And this morning, there are signs of new life coming from Asia. One investor thought he saw a dove with a green twig in its beak.

What is going on?

The long-awaited sell off seems to be here... Suppressed, denied, and delayed – Mr. Market is finally having his say. And he’s speaking so loudly, even the clowns are listening. This from Jim Cramer:

“Whatever money you may need for the next five years, please take it out of the stock market right now, this week. I do not believe that you should risk those assets in the stock market right now.”

“I don’t care where stocks have been, I care where they’re going, and I don’t want people to get hurt in the market... I’m worried about unemployment, I’m worried about purchases that you may need. I can’t have you at risk in the stock market.”

“I think what you have to do, if you can withstand it, is just ride it out.”

It could be a long ride. By our reckoning, the bear market began in January 2000. Then it was held off by a huge barrage of cash and credit – which sent property prices soaring....and caused stock prices to rally. The Dow surpassed its January 2000 high – but only in nominal terms. Adjusted for inflation, stocks were still going down.

You remember our Trade of the Decade? Sell stocks on rallies; buy gold on dips. The second half of that trade has done very well. Gold rose from under $300 to over $900. Yesterday, it went up $25 – to $858.

But the first half of the trade has never looked very good. We kept our “Crash Alert” flag on the mast and wondered -- when will stocks fall?

It looks like they are falling now. Half the stocks on the NYSE hit new lows yesterday. Worldwide, stocks lost $2.2 trillion in value. The Russian stock market lost 22% in the last 5 days. Here in London, yesterday brought the biggest drop in FTSE history. And if this is the continuation of the major bear market that began in January 2000, it still has a long way to go. Typically, bear markets run for many years. After stocks peaked out in ’66, for example, it wasn’t until ’82 – 16 years later – that they finally hit bottom.

They have a long way to go in terms of price too. At major bottoms, stocks sell for 5-10 times earnings. This implies a Dow of less than half today’s level. Dow 5,000 – remember, you heard it here first!

But the war goes on. The forces of inflation (led by field marshals Hank Paulson and Ben Bernanke) are clearly on the defensive – desperately pumping cash and credit into the market to offset Mr. Market’s campaign of value destruction. The Treasury is blasting Wall Street’s bad debts – at a cost of about $700 billion. And the Fed itself seems to be firing all its ammunition at once. Bernanke told Barney Frank a couple of weeks ago that he had $800 billion to fight the war. And yet, here’s today’s headline from Bloomberg:

“Fed boosts cash auctions to $900 billion.”

The Financial Times adds that the Fed is planning, for the first time, to make unsecured loans. Bloomberg goes on to note that the Fed’s balance sheet swelled more in the last week than ever before – to a record $1.498 trillion of ‘assets.’ What are these ‘assets?’ They used to be US Treasury bonds. But the Fed is selling that relatively good paper to buy up the kind of paper that caused Bear Stearns and Lehman Bros. to go broke. It is bad enough – from a banking point of view – to be selling Treasuries in order to buy trashy credits and make loans against them. But now the Fed is going even further, making loans with no collateral at all. If the Fed were a publicly traded bank, we would rate it a sell. It isn’t public. But its money is. Be wary of it.

More thoughts...

*** “Shoppers cut spending,” says the New York Times. Analysts think we will see the first quarterly drop in consumer spending in nearly 2 decades.

“Crisis hits home,” adds the Boston Globe.

Elsewhere in the financial news is collaborating evidence.

“Big discounts fail to lure shoppers,” reports the Wall Street Journal. Restaurants are empty. Shopping malls are not even attracting strollers and gawkers – let alone people with money to spend. Auto lots are so quiet the salesmen take turns pretending to be customers – just to keep their skills at-the-ready. Even the private jet business is in a tailspin.

But don’t worry, dear reader. It’s not the end of the world. That’s just the way the world works.

Economist Irving Fisher described the process in 1933. When people get too far in debt, there typically comes a moment of panic when they rush to sell assets in order to pay it down. They know debt is a killer – especially when there is a danger they may lose their source of revenue. Then, as more and more people – and here we may as well be talking about big financial institutions – dump assets, prices collapse. This causes even more dumping. There’s a “stampede to liquidity,” said Fisher, as people try to raise cash and get rid of dodgy ‘assets.’

In other words, what is happening is just what you’d expect to happen. After a bubble, comes the crash. After a credit expansion comes a credit contraction. After life comes death.

So relax. It’s all a part of the plan...a part of the way things are supposed to work.

And of course, the authorities are supposed to do foolish and counterproductive things too. Misters Smoot and Hawley are always on call – ready, willing, and eager to make a bigger mess. Mr. Hoover is always in office too...with Mr. Roosevelt right behind him. They’re all more than happy to let the ‘up’ phase of a free economy take place. Heck, they’ll even claim credit for it. But come the ‘down’ phase – and they swing into gear trying to prevent it from happening.

*** Hedge funds are back in the news. Years ago, we explained how they were a “heads I win; tails you lose” business. The managers take big bets, because they are rewarded with a large part of the gains – typically 20% -- if they win the bets. And if they lose, it’s not their money!

Sooner or later, the fund is bound to take a loss...and the customer is bound to pay for it. Sooner or later seems to be here now. Tontine Partners have lost 66% of their money so far this year. Copper River is down 55%. Maverick Levered is 35% in the hole. Tremblant is off 28%.

Hedge fund investors are going to regret giving all that money to the managers; they’re going to need it.

P.S. If you enjoyed this article you can find out more about our free email, The Right Side by clicking here.

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The Stock Market Sell Off Has Arrived

The Big Sell Off Has Arrived