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Generational Dynamics Web Log for 1-Oct-2008
Pundits are all smiles, as they await a "panic crash" or "retail capitulation"

Web Log - October, 2008

Pundits are all smiles, as they await a "panic crash" or "retail capitulation"

Panic selling on Monday became panic buying on Tuesday, as Wall Street recovered about half of what it had lost on Monday.

I received the following from a web site reader today:

Market summary, 30-Sep-2008

Market summary, 30-Sep-2008

"So how are you doing? I am sitting here watching CNBC and the talk about fear in the markets, I do not see the real fear I have been waiting for, fear where the people exit the markets and the banks. The “follow the herd” has not happen yet, I don’t know if we will be able to see the tipping point or there will be a general panic from Main Street. There may be a couple of days over the next couple months but the downturn now has turned into severe downward spiral, I think October will be brutal. I have been checking your site and blog, the only comment I have is that the great depression will not happen again -- this time it will be the Greater Depression!"

You're absolutely right. The "generational panic and crash" has not yet happened, but it could happen any day now.

The people in Washington have no idea what's going on. They think that the market is going down for psychological reasons, and that all they have to do is "restore confidence."

But the evidence from 1929 refutes that. What is clear is that the 1929 crash was caused by forced selling -- people who had invested on margin had to sell everything to meet margin calls, and selling everything pushed prices down even farther. Investor psychology had absolutely nothing to do with it. It boggles my mind that Ben Bernanke, who is considered the world's greatest expert on the Great Depression, doesn't understand that, and has said some unbelievably dumb things over recent years.

I had previous written about Nouriel Roubini's blog, Michael ("Mish") Shedlock's blog, and the Calculated Risk blog (with Tanta), thinking that these people had begun to catch on to what's going on.

These and other blogs have turned into nattering jokes. Shedlock is on some weird crusade to stop the bailout, CalculatedRisk can't decide whether or not there'll be a recession, and Roubini, who's become an international television superstar, constantly flip-flops on whether such-and-such a detail in the bailout plan is will PREVENT systemic failure or CAUSE systemic failure. These people must be getting along on their good looks, because it's certainly not their brains.

What is it that makes these people, as well as Ben Bernanke and other so-called "experts," such airheads? It must be Generation-X perversion (even though they're not all Gen-Xers). All you have to do is look at a couple of the graphs in "How to compute the 'real value' of the stock market," and you can see it right off. This isn't rocket science; it's perfectly obvious to anyone who understands calculus. Don't any of these bloggers know calculus?

There are actually lots of signs that a lot of forced selling is already going on. The Lehman bankruptcy two weeks ago is apparently having major chain reaction effects, according to a Wall Street Journal analysis. Pundits have been saying that hedge funds are deleveraging like mad. And of course, banks have been falling like dominoes, here and in Europe.

Furthermore, the credit markets were worse on Tuesday than Monday, with interest rates at fresh historically high levels.

One day soon there will be a generational panic and crash because there MUST be.

Ironically -- and this is perhaps the craziest thing of all -- the pundits are smiling today, because they believe that the end is in sight. As incredible as it seems, they're all disappointed that we haven't seen a "panic crash" or "retail capitulation" yet.

No, there's no sign of real fear on CNBC. They're waiting gleefully for a "panic crash" and "retail capitulation."

That's where the markets sell off wildly, and then the bubble can start again. They're hoping for that, so that the champagne parties can come back.

Why would they ever think that? Why would they think that if a "panic crash" occurs, then it will mean that the markets had reached bottom and were going up again? Where did they ever get such an idea?

They got it because that's what happened in 1987. The market fell 23% on on one day, October 19, 1987. That's the pattern they've been studying and remembering, and that's the pattern that they expect to repeat.

There are several major reasons why the 1987 pattern doesn't apply today:

The senior financial managers in 1987 were from the Silent Generation that survived the Great Depression. These people where very cautious. It's true that they panicked in 1987, but they had lived through the 1929 crash, and they could tell pretty quickly that things were different in 1987. Today's senior managers are Boomers. They don't have any idea what's going on, since they were born after the Great Depression ended.

The stock market was actually underpriced in 1987 (see "How to compute the 'real value' of the stock market"). As of today, the market has been way overpriced for 13 years, and the Law of Mean Reversion applies today, where it didn't in 1987.

There is a huge real estate bubble, which wasn't the case in 1987, and its collapse today is accelerating. According to figures released on Tuesday, house prices declined in July at the fastest pace on record, signaling that the housing crash is nowhere close to ending.

But for some reason that totally escapes me, these pundits and bloggers are totally blind to what's going on.

It's really eerie to see what happened in 1929 being repeated, almost as if everyone were reading from a script.

I've quoted the following paragraph from John Kenneth Galbraith's 1954 book The Great Crash - 1929, many times before, but it's a like a mystical song that appears to be more and more meaningful, each time you hear it:

"A common feature of all these earlier troubles [previous panics] was that having happened they were over. The worst was reasonably recognizable as such. The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximize the suffering, and also to insure that as few as possible escaped the common misfortune.

The fortunate speculator who had funds to answer the first margin call presently got another and equally urgent one, and if he met that there would still be another. In the end all the money he had was extracted from him and lost. The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains. ... The bargains then suffered a ruinous fall. Even the man who waited out all of October and all of November, who saw the volume of trading return to normal and saw Wall Street become as placid as a produce market, and who then bought common stocks would see their value drop to a third or fourth of the purchase price in the next twenty-four months. ... The ruthlessness of [the stock market was] remarkable." (p. 108)

That's why the comparison of today to 1987 is the same mistake that investors in 1929 made, making a comparison to the panic of 1907. Investors are making exactly the same mistake today, totally oblivious to the generational changes that make everything different.

This is what leads to what I've been calling the "Principle of Maximum Ruin," where everyone gets back into the market, only to lose money again -- the maximum number of people are ruined to the maximum extent possible. In 1929, the markets fell for four years - to 10% of their peak value, by 1933.

So those hoping for a "panic crash" or "retail capitulation" are going to get their wish. As usual, be careful what you wish for.

I had lunch recently with my boss and his boss. They were discussing the stock market, and I said, "It's going to crash. Everyone will lose everything." They both laughed. I guess I was lucky they didn't call security.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (1-Oct-2008) Permanent Link
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Generational Dynamics Web Log for 1-Oct-2008 Pundits are all smiles, as they await a "panic crash" or "retail capitulation"

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Generational Dynamics Web Log for 1-Oct-2008
Pundits are all smiles, as they await a "panic crash" or "retail capitulation"