Gold News

Now, About That October 2014 S&P Crash

Not quite the shake-out needed, but just the "correction" the Fed wanted...
JESSE Livermore is considered to be one of the greatest traders who ever lived, writes Gary Dorsch, editor of Global Money Trends newsletter.
Also known as the "Boy Plunger" and the "Great Bear of Wall Street", Livermore was famous for making and losing several multi-million Dollar fortunes and short-selling during the stock market crashes in 1907 and 1929.
Most notably, he reportedly pocketed $3 million during the Crash of 1907 and made a $100 million profit during the Crash of 1929. He subsequently lost both fortunes.
Livermore learned that the big money was not made by day trading on short-term price fluctuations, but instead, greater success comes from determining the direction of the overall market.
"Adopt a buy-and-hold strategy in a bull market and sell when it loses momentum. And always have an exit strategy in place."
Before his death, Livermore wrote a book titled, How to Trade in Stocks, in which he famously warned his readers that "the stock market is designed to fool most of the people, most of the time." Yet...
"All through time, people have basically acted and re-acted the same way in the market as a result of: greed, fear, ignorance, and hope – that is why the chart patterns recur on a constant basis."
And in regards to the latest "Bear Raid" operation on Wall Street – ie, the near 10% sell-off in the S&P500 index – we have all seen this movie before and it usually ends the same way.
In a typical Bear Raid, the US stock market begins to gradually lose its footing and then there is a sudden, sharp downturn that climaxes in a scene of panicked capitulation selling. Stop losses are hit below the 200-day moving average, and weak handed investors are flushed out at the bottom.
What follows next is a sudden quick rebound from the lows, followed by an eventual recovery of all the previous losses that were engineered by the Bear Raiders. Once investors begin to realize that they were hoodwinked, they begin to pile into stocks again at higher prices.
Long-term investors, that is to say, the Richest 10% of US households that own 82% of the listed shares, are happy the shakeout was brief and rather painless, and that the rally can continue, fueled by corporate buybacks.
Livermore had also seen this type of "Bearish Raid" during his days on Wall Street...
"The theory that most of the sudden declines or particular sharp breaks are the results of some plunger's operations probably was invented as an easy way of supplying reasons to those speculators who, being nothing but blind gamblers, will believe anything that is told them rather than do a little thinking. The raid excuse for losses that unfortunate speculators so often receive from brokers and financial gossipers is really an inverted tip. The difference lies in this: A bear tip is distinct, positive advice to sell short. But the inverted tip – that is, the explanation that does not explain – serves merely to keep you from wisely selling short. The natural tendency when a stock breaks badly is to sell it. There is a reason – an unknown reason but a good reason; therefore get out. But it is not wise to get out when the break is the result of a raid by an operator, because the moment he stops the price must rebound. Inverted tips!" – Jesse Livermore, Reminiscences of a Stock Operator
The long awaited downturn in the S&P500 index finally began on Sept 19th and ended on October 15th. The S&P500 index topped out at an all-time high of 2,015 and briefly fell to as low as 1,820 for a decline of 9.7%, or just shy of the 10% requirement to be regarded as a bona-fide correction.
Such shakeouts are part of the normal cyclical movements in the stock market, and they are regarded as a healthy exercise that shakes out the speculative froth from the market, and thus prevents the emergence of unsustainable bubbles that can burst into bear markets later on.
What was unusual this time however, was the extraordinary length of time that the S&P500 Oligarch index has avoided a correction of 10% or more. The Dow Jones Industrial index has gone 725 trading days without a correction, the fourth-longest streak since 1929. (In the 1990s the Dow went more than twice this long without falling 10%). However, a correction in the S&P500 index typically occurs about once every 18 months.
But it's been 38 months since the last bona-fide correction of more than 10%...
As Livermore famously warned: "The stock market is designed to fool most of the people, most of the time."
Prior to Sept 19th, 15 top strategists on Wall Street had raised their year-end targets for the S&P500 index. Goldman Sachs chief US equity strategist predicted the S&P500 index would reach 2,050 by year-end. Deutsche Bank raised its year-end projection to 2,050 and Stifel Nicolaus's went wild, forecasting a rally to 2,300. Wells Fargo raised its view to 2,100.
On Sept 3rd the chief US-market strategist at RBC Capital Markets told The Associated Press, "What usually stops bull markets? It's almost always a recession," adding he sees no indications of a downturn looming.
Following the S&P500's relentless rise to above the psychological 2,000-level, the percentage of newsletter writers that were bearish on the US stock market had dropped to 13% as of Sept 3rd, the lowest percentage since October of 1987, according to a survey of more than 100 writers, and taken by Investors Intelligence report.
In sharp contrast, the percentage of bullish writers was 56%, or about 4.5 times as many as the bears. Contrarians said the extreme readings might be an ominous sign, but the optimists were unbowed.
"A great many investors and analysts are wasting their time trying to prove that stocks have formed a new bubble, which they claim must soon pop," a newsletter writer told Investors Intelligence.
"I think they are right about the bubble, but wrong about which market is in danger of a crash. It is much easier to make the case that the Treasury bond market is the real bubble these days."
However, just the opposite scenario would unfold in the weeks ahead.
Shockingly, the yield on the 10-year US T-note briefly plunged from as high as 2.65% on Sept 19th as low as 1.87% on October 15th. Traders were buying Treasury notes as a temporary safe haven while fleeing from the stocks markets.
Contrary to widespread expectations, the S&P500 index fell nearly 10% from its all-time high, before hitting a panic bottom low at the 1,820-level. What was the cause of the unexpected downturn in the S&P500 index from Sept 19th through October 15th?
There are many moving parts that can move the markets at any given point in time. But in the view of Global Money Trends, top Federal Reserve officials and other G-7 central bankers wanted to see a shakeout in the stock markets.
Inter-market technical analysts can point to several factors that were rattling the S&P500 index during this 4-week period, in what could be described as a perfect storm. There was;
  1. a partial unwinding of the Yen Carry trade, with the US Dollar sliding from as high as ¥110 to as low as ¥105.25;
  2. the sharp slide of the German DAX-30 index to far below key support at the 9,000-level;
  3. the sharp slide in the S&P's Oil and Gas sector due to sharply lower oil prices; and
  4. continued weakness in the Russell-2,000 small cap index;
  5. the release of the Fed's newest tool – the "Dots Matrix" published on Sept 17th and telegraphed a series of baby-step Fed rate hikes, beginning around the middle of next year, to 1.375% by the end of 2015. The Fed also nudged its expected path of interest rate hikes to 2.875% by the end of 2016.
Hiking short term interest rates would require draining excess liquidity, which in turn, could puncture liquidity addicted markets. However, the "Dots Matrix,' is mostly a psychological weapon that is used by the Fed to influence expectations about the future, without actually doing anything to turn its rhetoric into a reality.
Thus, the Fed can talk about hiking interest rates, as a mechanism to influence currency exchange rates, for example, without actually draining liquidity that could undermine the value of the stock market. Eventually, however, empty rhetoric would lose its potency in the markets, if not backed up by complimentary actions. Failure to act would tarnish the Fed's reputation even more.

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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