Dow Tumbles Admist Ebola Outbreak Scare
October 14, 2014 by David Stockman
The last time the stock market reached a fevered peak and began to wobble unexpectedly was August 2007. The proximate catalyst back then was the sudden recognition that the subprime mortgage problem was not contained at all, as Bernanke had proclaimed six months earlier. The evidence was the surprise announcement by the monster of the mortgage midway—–Countrywide Financial—-that it would be taking huge write-downs on its $200 billion balance sheet.
At the time, it had not quite invented the term “fortress balance sheet” per JPMorgan’s later hyperbole, but the market overwhelmingly believed that the orange man—–Angelo Mozillo—-ran a tight ship; that the proponderant share of its business was in “safe” Freddie/Fannie originations and guaranteed paper; and that any losses from the sketchier subprime mortgage business that it had recently entered would be covered by its loan loss reserves and the massive earnings on its GSE book of business. Only now do we know that Countrywide was a house of cards that has cost(so far) its reluctant suitor, Bank of America, upwards of $50 billion in write-offs, losses and settlements.
It is in the nature of bubble finance that markets do not recognize disasters lurking in plain sight. Prior to the August 2007 swoon, Countrywide still had a market cap of $15 billion. Indeed, at that point the combined market cap of Bear Stearns, Freddie Mac and Fannie Mae, Lehman Brothers, AIG and GM, just to name the obvious, was upwards of one quarter trillion dollars!
Markets were most definitely not in the classic “price discovery” business. That is, they were not discovering information about the speculative rot under housing prices or the dealer lots bulging with unsold cars or freshly minted subdivisions where subprime residents were delinquent on both their mortgage and car loans or the adjacent strip malls that had no tenants and no customers.
Instead, the stock market had discovered the “goldilocks economy”—–a pleasant place of subdued inflation, measured growth and perpetually rising stock and real estate prices. The most notable point was the belief that the Fed had delivered this salutary state of affairs owing to its enlightened management of the macro-economy, and that this condition could be sustained indefinitely.
Bernanke had somewhat immodestly called this the Great Moderation, and it was reflected in the stock market averages and the capitalization rates they allegedly embodied. Not incidentally, the market had risen nearly continuously for 55 months, and the “buy the dip” brigade of the dotcom era had come back from the dead. So dips got shallower and the setbacks less frequent.
That may sound like the recent past, and it was. The forward consensus of sell-side analysts was that S&P 500 earnings (ex-items) for 2008 would come in around $110 per share or at about 14X based on the July interim high of $1550 per share. Likewise, the NASDAQ had recovered from its thundering crash of 2000-2001 and had climbed by nearly 100% in the four and one-half years through early August 2007.
Needless to say, goldilocks turned out not to be all that. When the macro-economy buckled under the weight of crashing housing and real estate prices, a plunge in home and commercial real estate construction, a severe liquidation of auto and durable goods inventories and the evaporation of phony financial sector profits, the dips became a deathly plunge, and the “attractively valued” 14X market ended up something else altogether.
As it happened, S&P 500 earnings ex-items came in at about $55 per share for 2008, or half of Wall Street’s hockey-stick projections as of August 2007. And if honest accounting, as embodied in GAAP earnings reported to the SEC is considered, the outcome was only $15 per share.
Self-evidently, the stock market was no longer a discounting mechanism by the end of the second Greenspan Bubble in late 2007 when the Great Recession officially commenced. It had essentially become a casino where the hedge funds and day traders made short term bets in a rigged market. In effect, the Greenspan Put had become institutionalized by the liquidity flood that had accompanied the Fed’s slashing of interest rates from 6% to 1% during the 30 month period after the dotcom crash of 2000. There could no longer be any doubt, at least by the lights of Wall Street, that the central bank had a “put” under the market.
By now it seems indisputable that central banks “puts” are a magnificent elixir for stock market gamblers—so long as confidence is maintained and our monetary central planners have the tools and wits to short-circuit the “dips” before they become runaway crashes. In the section from the Great Deformation below, I described how the Fed reacted aggressively to thwart the correction that commenced in August 2007 when the subprime crisis began to manifest its ugly fangs.
As it turned out, the stock market rallied by another 10% before hitting a final peak in October 2007. Moreover, the Fed continued its campaign to put a floor under the market for another 11 months after the peak—even as the credit and stock market bubbles festered and the underlying macro-economy steadily deteriorated. During this interregnum, the Fed capitulated to Wall Street as symbolized by its panicked response to Jim Cramer’s famous rant described below.
But it was ultimately for naught. The market suffered a devastating 55% collapse in the 18 months after the unavoidable correction of the Greenspan Housing Bubble commenced in August 2007. Stated differently, central bank bubbles can be fueled and coddled for an extended period, but ultimately reality sets in.
So here we are once again, and it is once again claimed that this time is different. The 65 month rise of the S&P 500 bears all the hallmarks of a central bank fueled casino—- even more completely than the 2003-2007 run. Also once again, the market is said to be “attractively valued” and that next years earnings(ex-items) at $125 per share represent only a 15X PE multiple. So after the “healthy correction” of the past week or so, it is purportedly time once again to buy the dip.
Except this time is indeed different, but not in a good way. When Bernanke & Co. stalled off the August 2007 correction for nearly a year, they still had plenty of dry powder. The federal funds rate was 6% and the Fed’s balance sheet was only $850 billion.
But now, however, we are on the far side of the great monetary experiment known as ZIRP and QE. The money market rate is at the zero bound and has been pinned there for 69 months running—a stretch never before experienced even during the Great Depression. Likewise, the Fed’s balance sheet has grown by 5X to nearly $4.5 trillion—again a previously unimaginable eruption.
These conditions undoubtedly explain the “buy the dips” joy ride pictured above. And they also probably explain why actual LTM GAAP earning at about $102 per share on the S&P 500 are exactly where they were in the fall of 2007—-at the tippy top of the historic range at 19X. But no one cared then— nor apparently do they now.
But what is profoundly different this time is that the Fed is out of dry powder. Its can’t slash the discount rate as Bernanke did in August 2007 or continuously reduce it federal funds target on a trip from 6% all the way down to zero. Nor can it resort to massive balance sheet expansion. That card has been played and a replay would only spook the market even more.
So this time is different. The gamblers are scampering around the casino fixing to buy the dip as soon as white smoke wafts from the Eccles Building. But none is coming. For the first time in 25- years, the Wall Street gamblers are home alone.
CHAPTER 23
THE RANT THAT SHOOK THE ECCLES BUILDING
How the Fed Got Cramer’d
After climbing steadily for four and a half years, the stock market weakened during August 2007 under the growing weight of the housing and mortgage debacle. Yet in response to what was an exceedingly mild initial sell-off, the Fed folded faster than a lawn chair in a desperate attempt to prop up the stock averages. The “Bernanke Put” was thus born with a bang.
The frenetic rate cutting cycle which ensued in the fall of 2007 was a vir- tual reenactment of the Fed’s easing panics of 2001, 1998, and 1987. As in those episodes, the stock market had again become drastically overvalued relative to the economic and profit fundamentals. But rather than permit a long overdue market correction, the monetary central planners began once more to use all the firepower at their disposal to block it.
The degree to which the Bernanke Fed had been taken hostage by Wall Street was evident in its response to Jim Cramer’s famous rant on CNBC on August 3, 2007, when he denounced the Fed as a den of fools: “They are nuts. They know nothing . . . the Fed is asleep. . . . My people have been in the game for 25 years . . . these firms are going out of business . . . open the darn [discount] window.”
In going postal, Cramer was not simply performing as a CNBC commen- tator, but functioning as the public avatar for legions of petulant day traders who had taken control of the stock market during the long years Greenspan coddled Wall Street. What the Fed utterly failed to realize was that these now-dominant Cramerites had nothing to do with free markets or price discovery among traded equities.
AUGUST 2007: WHEN THE FED CAPITULATED TO FINANCIAL HOODLUMS
The idea of price discovery in the stock market was now an ideological illusion. The market had been taken over by white-collar financial hoodlums who needed a trading fix every day. Through Cramer’s megaphone, these punters and speculators were asserting an entitlement to any and all gov- ernment policy actions which might be needed to keep the casino running at full tilt.
If that had not been clear before August 2007, the truth emerged on live TV. The nation’s central bank was in thrall to a hissy fit by day traders. In a post the next day, the astute fund manager Barry Ritholtz summarized the new reality perfectly: “I have two words for Jim: Moral Hazard. Contrary to everything we learned under Easy Alan Greenspan, it is not the Fed’s role to backstop speculators and guarantee a one way market.”
Yet that is exactly what it did. Within days of the rant which shook the Eccles Building, the Fed slashed its discount rate, abruptly ending its tepid campaign to normalize the money markets. By early November the funds rate had been reduced by 75 basis points, and by the end of January it was down another 150 basis points. As of early May 2008 a timorous central bank had redelivered the money market to the Wall Street Cramerites. Although the US economy was saturated with speculative excess, the Fed was once again shoveling out 2 percent money to put a floor under the stock market.
This stock-propping campaign was not only futile, but also an exercise in monetary cowardice; it only intensified Wall Street’s petulant bailout de- mands when the real crisis hit a few months later. Indeed, on the day of Cramer’s rant in early August 2007, the S&P 500 closed at 1,433. The broad market index thus stood only 7 percent below the all-time record high of 1,553, which had been reached just ten days earlier in late July.
Ten days of modest slippage from the tippy-top of the charts was hardly evidence of Wall Street distress. Even after it drifted slightly lower during the next two weeks, closing at 1,406 on August 15, the stock market was still comfortably above the trading levels which prevailed as recently as January 2007.
Still, the Fed threw in the towel the next day with a dramatic 50 basis point cut in the discount rate. Although no demonstration was really needed, the nation’s central bank had now confirmed, and abjectly so, that it was ready and willing to be bullied by Cramerite day traders and hedge fund speculators. The latter had suffered a “disappointing” four weeks at the casino; they wanted their juice and wanted it now.
Needless to say, the stock market cheered the Fed’s capitulation, with the Dow rising by 300 points at the open on August 17. The chief economist for Standard & Poor’s harbored no doubt that the Fed’s action was a deci- sive signal to Wall Street to resume the party: “It’s not just a symbolic ac- tion. The Fed is telling banks that the discount window is open. Take what you need.”
The banks did exactly that and so the party resumed for another few months. By the second week of October the market was up 10 percent, enabling the S&P 500 to reach its historic peak of 1,565, a level which has not been approached since then.
Pouring on the monetary juice and signaling to speculators that it once again had their backs, the Fed thus wasted its resources and authority for a silly and fleeting prize: it was able to pin the stock market index to the top rung of its historic charts for the grand duration of about six weeks in the fall of 2007. There was no more to it, and no possible excuse for its panic rate cutting.
HOW THE FED GOT CRAMER’D
The Fed’s abject surrender to the Cramerite tantrums in the fall of 2007 was rooted in ten years of Wall Street coddling. Mesmerized by its new “wealth effects” doctrine, the Fed viewed the stock market like the famous Las Vegas ad: it didn’t want to know what went on there, and was therefore oblivious to the deeply rooted deformations which had become institu- tionalized in the financial markets. The sections below are but a selective history of how the nation’s central bank finally reached the ignominy of being Cramer’d by financial TV’s number one clown.
The monetary central planners only cared that the broad stock averages kept rising so that the people, feeling wealthier, would borrow and spend more. It falsely assumed that what was going on inside the basket of 8,000 publicly traded stocks was just the comings and goings of the free market— and that this was a matter of tertiary concern, if any at all, to a mighty cen- tral bank in the business of managing prosperity and guiding the daily to-and-fro of a $14 trillion economy.
But what was actually going on in the interior of the stock market was nightmarish. All of the checks and balances which ordinarily discipline the free market in money instruments and capital securities were being evis- cerated by the Fed’s actions; that is, the Greenspan Put, the severe repres- sion of interest rates, and the recurrent dousing of the primary dealers with large dollops of fresh cash owing to its huge government bond purchases.
This kind of central bank action has pernicious consequences, however. By pegging money market rates, it fosters carry trades that are a significant contributor to unbalanced markets. Carry trades create an artificially en- larged bid for risk assets. So prices trend asymmetrically upward.
The Greenspan Put also compounded the one-way bias. For hedge fund speculators, it amounted to ultra-cheap insurance against downside risk in the broad market. This, too, attracted money flows and an inordinate rise in speculative long positions.
The Fed’s constant telegraphing of intentions regarding its administered money market rates also exacerbated the stock market imbalance. By peg- ging the federal funds rate, it eliminated the risk of surprise on the front end of the yield curve. Consequently, massive amounts of new credit were created in the wholesale money markets as traders hypothecated and re- hypothecated existing securities; that is, pledged the same collateral for multiple loans.
The Fed’s peg on short-term rates thus fostered robust expansion of the shadow banking system, which as indicated previously, had exploded from
$2 trillion to $21 trillion during Greenspan’s years at the helm. This vast multiplication of non-bank credit further fueled the “bid” for stocks and other risk assets.
Fear of capital loss, fear of surprise, fear of insufficient liquidity—these are the natural “shorts” on the free market. The paternalistic Dr. Green- span, trying to help the cause of prosperity, thus took away the market’s natural short. In so doing, he brought central banking full circle. William McChesney Martin said the opposite; that is, he counseled taking away the punch bowl, thereby adding to the short. Now the punch bowl was over- flowing and the short was gone.
Speculators were emboldened to bid, leverage their bid, and then to bid again for assets in what were increasingly one-way markets. As time passed, more and more speculations and manipulations emerged to capi- talize on these imbalances.
“Growth stocks” were always a favored venue because they could be bid- up on short-term company news, quarterly performance, and rumors of performance (i.e., “channel checks”). During these ramp jobs, which ordinarily spanned only weeks, months, or quarters, traders could be highly confident that the Fed had interest rates pegged and the broad market propped.
Financial engineering plays such as M&A and buybacks came to be es- pecially favored venues because these trades tended to be event triggered. Upon rumors and announcements, these trades could generate rapid replication and money flows. Again, speculators were confident that the Fed had their back, while leveraged punters were pleased that it had seconded to them its wallet in the form of cheap wholesale funding.
At length, the stock market was transformed into a place to gamble and chase, not an institution in which to save and invest. Since this gambling hall had been fostered by the central bank rather than the free market, it was not on the level. That means that most of the time most of the players won and, as shown below, the big hedge funds which traded on Wall Street’s inside track with its inside information won especially big and un- usually often.
Needless to say, frequent wins and hefty windfalls created expectations for more and more, and still more winning hands. As the Greenspan bub- bles steadily inflated—both in 1997–2000 and 2003–2007—these expecta- tions morphed into virtual Wall Street demands that the Fed keep the party going. Wall Street demands for a permanent party, at length, congealed into the presumption of an entitlement to an ever rising market, or at least one the Fed would never let falter or slump.
Finally, this entitlement-minded stock market became a blooming, buzzing madhouse of petulance, impatience, and greed. Cramer embodied it and spoke for it. By the time of his rant, the Fed had become captive of the monster it had created. Now, fearing to say no, it became indentured to juicing the beast. After August 17, 2007, there was no longer even the pretense of reasoning or deliberation about policy options in the Eccles Building. The only options were the ones that had gotten it there: print, peg, and prop.
One of the great ironies of the Greenspan bubbles was that the free market convictions of the maestro enabled the Fed to drift steadily and irreversibly into its eventual submission to the Cramerite intimidation. It did so by turning a blind eye to lunatic speculations in the stock market, dismissing them, apparently, as the exuberances of capitalist boys and girls playing too hard. By the final years of the first Greenspan bubble, however, there were plenty of warning signals that there was more than exuberance going on. Hit-and-run momentum trading and vast money flows into the stocks of serial M&A operations were signs that normal market disciplines were not working. Indeed, the M&A mania was a powerful indictment of the Fed’s prosperity management model.
These hyperactive deal companies with booming share prices were be- ing afflicted ever more frequently with sudden stock price implosions that couldn’t have been merely random failures on the free market. Yet, as in the case of the subprime mania, the central planners undoubtedly read the headlines about these recurring corporate blowups and never bothered to connect the dots.
http://davidstockmanscontracorner.com/this-time-is-different-the-fed-is-out-of-bullets/
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Fear Goes Viral on Wall Street
October 15, 2014 By Yuval Rosenberg,
The Fiscal Times
So much for the stock market being too complacent. The Dow Jones Industrial Average tumbled more than 450 points by midday Wednesday before erasing most of those losses in seesaw action that might have left traders with whiplash. Stocks plunged more than 2 percent at the open, recouped some losses and then dropped to fresh lows that erased the S&P 500 index’s gains for the year and left the Dow off by more than 4 percent for 2014. By late afternoon, the losses had been pared back to just over 1 percent for the Dow and 0.81 percent for the S&P 500.
In case it wasn’t clear before: Fear and volatility are back.
Reinforcing that point, the CBOE Volatility Index (the VIX) spiked more than 24 percent to a level above 28, the highest it’s been since late 2011, when the Eurozone debt crisis gripped investor attention. It wasn’t all that long ago that the market’s so-called fear gauge was hovering closer to 10, well below its long-term average of around 20. But renewed fears about the European and Chinese economies, some surprising signs of weakness in the U.S., falling oil prices and even headlines about Ebola have shaken investors’ out of their calm.
“I suppose we have to factor into our investment strategy this new ‘Fear Factor,’” Ed Yardeni of Yardeni Research wrote to clients this morning about the Ebola concerns. “The stock market is now driven by emotion rather than fundamentals. The former rapidly switches from greed to fear on Ebola news. At the same time, the latter remain supportive in the US, but less so overseas given the slowdown in global economic growth.”
What Yardeni calls emotion others refer to as investor psychology, noting that fear can lead to more fear and selling begets more selling. “In research done following the 1987 stock market crash, Robert Shiller asked investors what factors they cited for the market crash; their response was the sharp declines the week before the crash,” David Blitzer, chairman of the index committee at S&P Dow Jones Indices, wrote this week. “Crowd psychology plays a part.”
In that environment, Ebola is far from the most pressing fear, or the one that’s most relevant to investors. “Over recent weeks the outlook for many asset classes has become more uncertain as the toxic combination of multiple geopolitical risks mix with the latest downgrades to the global growth outlook,” Credit Suisse said in inviting clients to dial into a conference call on The Return of Volatility. “Indeed, following the dramatic moves in market prices over recent days, market participants are now openly questioning whether the outlook in many markets has fundamentally changed.”
If it has changed, investors using an outdated playbook could get burned. As Tim Edwards, director of index investment strategy at S&P Dow Jones Indices, noted in a blog post, the VIX has collapsed every time recently that it has jumped above 20. “Yet volatility levels are not guaranteed to fall,” Edwards wrote. “If the U.S. Federal Reserve’s largess was indeed the primary cause of the suppressed levels of volatility seen in the first three quarters of this year, the seat-belts are off.” Edwards notes that VIX short-sellers risk getting caught in a squeeze. “Hypothetically, such a short squeeze would trigger large purchases in volatility futures just as it is already shooting up,” he suggests. “A jump from 25 to 35 in such circumstances is not entirely unfeasible.”
Even so, the latest spike is still much milder than those of past scares; the VIX reached an all-time high above 80 in November 2008, after Lehman Brothers collapsed into bankruptcy. So while fear is on the rise and the S&P 500 is nearing correction territory (10 percent off its high), let’s keep the current jitters in broader perspective.
As Ashvin Chhabra, the CIO at Merrill Lynch Wealth Management, pointed out in a recent note, the S&P 500 has soared more than 200 percent since 2009, and this is just the fourth pullback of 5 percent or more in two years. Those kinds of pullbacks more typically happen a few times a year.
The smartest strategy, then, may still be to keep in mind Warren Buffett’s well-known advice — words that are easy to say and much harder to act on intelligently: “’Be fearful when others are greedy and greedy when others are fearful.”
http://www.thefiscaltimes.com/2014/10/15/Fear-Goes-Viral-Wall-Street
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Dow Tumbles Admist Ebola Outbreak Scare
Ebola figures into stock worries
October 15, 2014 by Kurt Nimmo
The U.S. stock market is beginning to realize a serious decline.
A tumble of more than 170 points on Wednesday was attributed to dismal retail sales data, Europe’s inability to realize an economic recovery and worries on Ebola.
“Ebola is in the background,” said Peter Boockvar, chief market analyst at The Lindsey Group. “It feeds generally into global growth concerns.”
Analysts are attempting to put a good face on the loss, saying a correction is not official until the market drops 10% or more. 20% over a two month period would indicate a bear market.
“My take is that absent a geopolitical shock, we’re experiencing what’s likely to be a painful correction,” the Nasdaq webpage reported today.
“We’re probably going to follow the Europe” markets,” said Peter Cardillo, chief market economist at Rockwell Global Capital.
“The stock market has had a nightmare roller coaster ride during the past 2 weeks,” Nadeem Walayat wrote for Market Oracle prior to the largest dip.
Walayat said the bear market is now officially dead.
“Waves of bearishness have been washing over the mainstream media that predominately at least 80% of the time remains obsessed by BAD news, for FEAR SELLS! be it Islamic State,” he writes, or “China with its Hong Kong crisis. Or what will turn out to be the real threat of 2014 – EBOLA !… So its no wonder that many market participants are running scared.”
Analysts also believe the latest dismal news will force the Federal Reserve to cancel its proposed interest rate hike following months of QE monetary infusion.
http://www.infowars.com/dow-tumbles-350-points/
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