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The Market Is Nutz



August 17, 2011 – Comments (0)

I did a blog a couple of years ago in the midst of the financial meltdown of 2009 with the same title. Well, it’s deja vu all over again.

There are some interesting parallels, and an important difference. In 2009, the market crash was understandable, but the following volatility was never explained. Today, mucho volatility, ditto we do not know why, but the sum total of all the 3 digit up and down in DIA, was down, but a mere 1% or 2% or so. Not exactly a market crash. I have collected here some of the theories being put forth, but to skip to the ending, I am not convinced of any of them.


Merkel and Sarkozy have called for a Stalin-era Soviet Union style of governance for all Europe. This strikes me as desperation heralding something really, really bad about to happen. Perhaps rearranging deck chairs on the Titanic? A week or two ago, it was rumors of the weakness of French banks. Now, it is the German economy stalling out. Will Italians eating Tuscan bread or Greeks fishing for octopus, accept dictates from the German Bundestag? Somehow, I doubt it. Still, what does this have to do with the US? OK, rise in the dollar against the Euro, or collapse of European bonds; but triple digit moves in DIA? It does not make sense that one would cause the latter.


I have read articles claiming that computer trading, buying and selling in microseconds, as a culprit. Supposedly, these are computers ‘playing tag’. They take normal market movements and magnify them by orders of magnitude. Well, sounds logical, but this theory does not hold water. This type of trading has gone on for a few years. Why would it rear its ugly head only in the past couple of weeks? Why did it not cause such volatility constantly in the past couple of years?


S&P downgraded Treasury paper, Fitch reaffirmed AAA and a stable outlook. Agreed, very confusing. These actions are a reasonable excuse for hippy-dippy behavior in fixed income securities. However: it is not clear to me why a downgrade by S&P would cause reaction in equities, since they are not related to fixed income investments directly, but only indirectly, and sloppily at that.


This is one factor that I will concede. I do not invest on margin, and therefore have no idea how margin investors act or react. Margins have been increased, causing margin calls. Investors who have bought on margin getting one of these have to either liquidate other positions, raise cash, and cover, or permit their margin buys to be liquidated. This as the cause of volatility sounds plausible. However: is this enough of a power to cause DIA to go up and down 400 pts on consecutive days? I have my uninformed doubts.


This is another case where I will give a bit of credit, but only because I do not know what exactly they have done the past couple of weeks, or know how to find out. There are many media stories of famous (infamous?) managers getting into, out of, or holding significant positions in this or that. They control $billions, so what they do surely will influence the market. But does it explain all the movements? Somehow, I doubt it.


Investors dog-piling into Treasuries should herald market stability. They wish to find a safe haven for their money, so Treasury paper. This should cause a steady exit from stocks and into bonds, and therefore a steady but sure decline in DIA. This does not explain market volatility, in fact, it should herald the exact opposite. Decreasing yields generally mean an expectation of recession, sure, but up and down 3 digits for 2 weeks straight? I do not think so.


I read a Fool article saying that most of the DIA collapse had to do with BAC. See, DIA is weighted, and a significant move in one stock can lead to a huge movement. It was postulated that BAC was the main culprit. Perhaps. On this idea, I bought BAC, and my investment is up around 15% in just a few trading days, so this theory might be true. Do not know exactly how this works, but if BAC goes from 7.00 to 7.75, how does this influence DIA? Do not know, but if you have the formula, do share? BAC sells at 0.33 price/book, so, in theory, you get a big bargain. But: Countrywide, $billions in lawsuits, plus an opaque balance sheet. Still, a primary cause? Somehow I doubt one stock can cause this level of volatility.


I suggest that you make no trades for a couple of weeks until the market settles down. Maybe, by then, we will know what is really up with the market. In the mean time, enjoy Mr. Toad’s Wild Ride.


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