When I boarded my plane in San Francisco on Thursday morning, May 6, the Dow was down an uncomfortable, but tolerable 150 points. When I arrived in New York that night I was greeted with headlines screaming “CRASH: DOW PLUNGES 1,000.” I was not surprised.
In a letter sent to my premium subscribers the day before I predicted a fall in the S&P 500 to 1,050 (click here for the call at http://www.madhedgefundtrader.com/May_7__2010.html ), although I thought it might take two months to get there. Instead, we got it in two hours! Since then, I have heard every possible explanation for the instant death spiral. A fat fingered trader accidently entered an order to sell not one million shares at market, but one billion. Al Qaida hacked into the NYSE mainframe. High frequency traders ganged up on a thin market to generate some windfall profits.
I heard every possible theory, except the one that was the true cause-- stocks are too expensive! The US economy is in the midst of an epochal transition from a long term GDP growth rate of the 3.9% rate we saw during the last decade, to maybe 2%-2.5% this decade. If you don’t believe me, look at the chart below showing a rapid deterioration of the leading economic indicators for most of the OECD. The “V” is rapidly turning into a “square root.” That does not support the PE multiple of 23 the market was sporting a few weeks ago. Maybe the lower growth rate supports a 16 multiple, but only on the best of days when buyers are feeling wonderful about themselves.
When the fall came, all risk assets moved south in unison, while Treasuries exploded through the roof on a flight to safety bid, along with the dollar. This was also as I expected (click here for that call at http://www.madhedgefundtrader.com/April_28__2010.html ).
Let me spell this out more clearly. When I say there is a massive risk reversal at hand, what I really mean is “Run, Forest, run!” (Forest Gump for international readers). It is not the time to be too clever by half by staying short the yen (YCS) or the 30 year Treasury bond through the (TBT) (click here for my pleading with you to heed the wake up call to tighten up your risk controls at http://www.madhedgefundtrader.com/April_20__2010.html ).
Those of you who took my advice to pile on the cheap downside protection while volatility languished at 16% (click here for that call at http://www.madhedgefundtrader.com/March_18__2010.html ), made an absolute killing as it raced to 42%. Suffice to say that as the euro breaks $1.24, the dust is still flying in great impenetrable clouds, and the sidelines seem more comforting by the minute. Remember, there is no law that says that you must always keep a position on, no matter how hard your broker argues to the contrary.
The “flash crash” is in effect the little boy who shouted out that the emperor has no clothes. It was a day that has been long in coming. The screaming great weakness in the global capital markets has long been that it is totally dependent on voluntary private capital. There is not a penny of government money anywhere to insure that IBM is $130 bid, $130.01 offered.
This was not a problem when I entered the business during the seventies, a small “old boy’s” club of specialists made markets for 100 share round lots, and the business was overwhelmingly retail. Ramp up the volume 100 fold, triple the volatility, and bring some Cray computers running top secret algorithms, and it is a different story completely. Just as British Petroleum (BP) punched outside the technology envelope, drilling on the Gulf floor at 5,000 feet, so have the hedge funds and high frequency traders done on the floor of the NYSE. Needless to say, this has all taken the public’s confidence in the markets and the securities industry to new all time lows.
In the aftermath of the life threatening losses seen in 2008-2009, market makers are now on a hair trigger to whip their capital right out of the market. At Morgan Stanley, they used to tell us to “stop answering the phones.” Liquidity vaporizes, creating a vacuum that leads to triple digit moves in the indexes and Dow stocks trading for pennies.
To combat this, exchange officials are now pushing for the kind of daily limit moves for single stocks that have long been in force in the futures markets and foreign stock markets. In Tokyo, for example, most shares are limited to daily moves of around 10%, which proved extremely useful when Barings went bankrupt in 1995, and when NASDAQ crashed in 2000. Here, that might mean stocks don’t trade for a week when there is a surprise hostile takeover or a big earnings miss as they get stepped up or down 10% a day with no trade. Expect the new rules to be implemented within three months. If you want a smooth ride, expect to pay through the nose for some high end shock absorbers. To we stock traders, that means having to share a single bed in a cheap motel with a gaggle of snoring regulators.
To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on the “Today’s Radio Show” menu tab on the left on my home page.
Why can't the mkt break, orderly or otherwise, for several years? A major re-pricing. Where all the Cash will go is a mystery, but can we see a substantial move lower and what can be done about it?
1) cash disappears
2) the fed can't print cash, and if they were to give cash to the major financial institutions, and other businessmen (like they did in Iraq, they took a pallet of money and simply threw it out the back of pickup trucks) as part of the Presidents Working Group on the financial markets they might end up in jail. The mantle of National Security has limits.
3) the fed can again step in and prop up the markets, by adding t bonds to the balance sheet of the big institutions, who then run the market against the shorts, and return the loaned assets to the Fed. okay so far, but if the sellers return in earnest, or Goldman decides to use its collateral to run with the market, (down) or simply to hedge their pension funds investors, by going short, then you have pandemonium. the Feds balance sheet will go into freefall. Goldman will be very rich, relatively speaking.
3a) then comes the end of the Fed, and King Goldman rules. The President puts a lock on the Goldman assets, but GS probably moves most of them offshore, and the pension funds live to fight another day, their constituents would rather play ball with Goldman, than with the political puppet who never did anything for them anyway. the Goldman candidates all win their elections (Whitman in Calfornia for instance).
3b) Goldman uses its squid tentacles to extract payment from the third world, (everyone but us, or the US). Voters are upset but as long as the money keeps coming in they can live reasonably comfortably, while the Greeks practise cannibalism.
4) a stock can only go to zero, but that's a big move relatively speaking, when one dollar is now worth what 100 dollars was yesterday.
5) If you see margin requirements tighten, then you know the end is near. Without the loose margin rules this economy will be at ground zero in ten minutes. And Goldman will lead the way. Goldman stock 20, Citi 3 bucks, but that spread will be huge relatively speaking.
6) the shock to the political class will include disinternment of the those who already had taken Goldmans money, and who were part of the crisis, and the Goldman annointed, who understand the new power shift. It may seem like splitting hairs, but the new Goldman candidates will hit the ground running. they may even coin a third party, the Bank Restoration Party or something.
7) now Goldman goes populist.
http://www.youtube.com/watch?v=F0lAIf78WIo&feature=PlayList&p=C1B06538A32767DF&playnext_from=PL&index=168
Thanks to the original poster of this Video...
Your whole it was not a run on the market, a planned run!?
Any way, you are a Great writter and I am sure you are all the more happy thinking that multiples of traders lack the wherewithall to crash the market place... But that is a LIE!
Type your ass off, LIE! to make yourslef feel better... but save the bullshit for the sheep you send you ignorant fucking letters too.
The Industry Must Educate the Public and Lawmakers About the Markets Without a true understanding of how the markets work, each time something out of the ordinary happens on Wall Street, the industry will be called down to Washington to testify in front of senators who know nothing of what they speak.
http://wallstreetandtech.com/trading-compliance/showArticle.jhtml?articleID=224800044&cid=nl_wallstreettech_daily
Reasons why orderly long-term declines probably won't happen include the extreme leverage at banks and trading institutions along with the advent of HFT. The game has moved from being fun and generally long-term profitable to scary and extremely dangerous.
appreciate that, good point.
to reflect the new reality of the "money supply" (post-mass-vaporization), asset prices will need to return to pre 1980 levels.
they had to destroy the economy to prevent the markets from seriously testing energy supply constraints. oil was headed from 147 to 500. not anymore. year over year economic contraction - for the next 3 decades - will bring the price of oil back down to $40. the unfortunate consequence (for some) is much lower asset prices across the board.
It amazes me sometimes when everyone is not stupid.
madhedgie... is this your original quote?
The “V” is rapidly turning into a “square root.”
And, I like it, because it's a clever one.
When talking GDP, the Obama Posse were saying real "variance" is coming, but all we are stuck with is a "standard deviation!"
On May 6, the market suffers a flash crash. On May 7, you write a letter to your clients calling for a fall to 1050S&P… Huh?
Don’t you have to say something before it happens for it to be a “prediction”?
Likewise, calling a downward trend isn’t all that prophetic these days… …and then taking credit when an “anomaly” hits (or comes close to your mark) is hardly a call either. In my book, you get credit if you call the anomaly!
Anyhow, the point I’d like to address rather then point out these factoids, is that your title suggests you know “The Real Cause of The Flash Crash”…
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