Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 19-Oct-07
WSJ: "When crash means 'buy'"

Web Log - October, 2007

WSJ: "When crash means 'buy'"

How mainstream financial media are cheerleaders for the Principle of Maximum Ruin.

As we watch the current financial scene unfold, we see the following message in the financial media: There's really nothing to worry about, but maybe be a little cautious since there have been problems before.

No one wants to go out on a limb and say that there will never be another crash, but the larger message is always the same, that when the stock market dips a few percentage points, then that's a great buying opportunity to take advantage of the next all-time high (which, surely, will only be a couple of weeks away).

In order for a generational financial crisis (like 1929) to be as totally devastating as possible, it's necessary for as many people as possible to believe that a crisis could never happen and, once it's begun, that it will end quickly.

This is the basis for the principle that I've discussed several times on this web site, the Principle of Maximum Ruin: That a generational financial crisis will ruin the maximum number of people to the maximum extent possible.

The mainstream financial media are doing as much as they can to convince people that, while there might something to worry about some day "down the road," there's nothing to worry about now.

These articles are especially plentiful today, as investors commemorate the false panic of Monday, October 19, 1987.

An article in Friday's Wall Street Journal illustrates very well how this works:

"When Crash Means 'Buy' - After Black Monday, Advice to Invest on Dips"

The 1987 crash -- 20 years ago today -- had investors bracing for the worst. When the worst didn't come, those who quickly recognized that the economy and the stock market were far more resilient than they had thought looked smart.

A little more than a year later, the Dow Jones Industrial Average had made back all the ground it had lost, and anyone who bought in the aftermath of the crash could feel justifiably pleased.

"I put all of my 401(k) in the stock market at that time, and it turned out to be one of the few really smart things I've ever done," says ING Investment Management economic adviser James Griffin, who was then an economist for Aetna Life Insurance.

Even after declines this week, at 13888.96 yesterday, the Dow is up nearly eightfold from its close of 1738.74 on Black Monday, Oct. 19, 1987.

As the market has rebounded from every downturn in the 20 years since the crash, individual investors accepted the notion that they should continue to plow money into the stock market even when the picture looks bleak. "Buy on the dips" has become their creed, and standard-issue investment advice. Many saw this summer's credit-market turmoil, which sent stocks down sharply in August, as a buying opportunity. The Dow industrials have rebounded more than 8% since their recent low on Aug. 16 and hit two records just this month.

It is a testament to the dynamism of the economy and stock market, and how skillful policy makers have become when faced with a crisis. At the same time, there is a risk that investors have become too complacent, and that if the day comes that the economy can't bounce back, there will be big losses.

"Probably the largest lesson taken away from 1987 was a belief in the system and the ability of the system to avoid disaster," says John Bollinger, president of Bollinger Capital Management in Manhattan Beach, Calif. "In the long haul, that's probably a lousy lesson for the markets to have learned, because it ultimately sets up for problems down the road." ...

Mr. [James] Griffin, now at ING, says what made him bullish in 1987, when many of his colleagues were not, was the way the Fed, under its newly appointed chairman, Alan Greenspan, responded to the crash. Cutting interest rates stood in contrast to 1929, when the Fed kept rates high. The Fed lowered rates in 1995 after the Mexican peso crisis, in 1998 after the Russian debt crisis, in the aftermath of the Sept. 11, 2001, attacks and, most recently, in response to this summer's turmoil.

Donald Fine, a market analyst at Chase Manhattan Bank in 1987, recalls that after the crash "the recession talk began immediately." But when the economy shrugged off the crash "it said that the economy was considerably more resilient than people thought," says Mr. Fine.

The next recession didn't begin until 1990, making the economic expansion begun in 1982 the longest ever in the U.S. during peacetime. The expansion that followed, which didn't end until 2001, was the longest in history. It's all part of a damping of economic volatility over the past 25 years that some economists dub "The Great Moderation."

One consequence of the Great Moderation has been that companies no longer get rocked as hard by the forces of boom and bust as they did before. That, and policy makers' skill at guiding the economy through crises, has meant buying stocks after selloffs has generally been a good tactic. ...

The real risk, says Mr. Bollinger, is that someday the U.S. economy will run into trouble that defies the ability of the Fed to deal with or, to put it another way, that the success of economy's resilience over the past 25 years has more to do with luck than it does with policy makers' skill."

It isn't just WSJ that's cheerleading for the Principle of Maximum Ruin. Here's part of a Friday morning column on written by financial contributor Rev Shark:

"How You Could Have Managed the '87 Crash"

There is a lot of talk today about the stock market crash that took place 20 years ago. It certainly is important to understand that the market can act so dramatically. Although the 1987 crash was of an almost unimaginable magnitude, it does illustrate that the potential for surprises is always lurking.

However, it is important not to learn the wrong lessons from the crash as well. I would bet that much more has been lost worrying that another giant one-day crash might occur than was actually lost in the 1987 crash. Fear of a crash has caused a lot of people to be overly cautious without must justification. ...

If you used any sort of money management system at all and set stops at reasonable levels, the great likelihood is that you would have been out of almost all your positions before the market crashed 23% on Monday, Oct. 19, 1987.

The lesson here is obvious. Use a money management system, and when stocks are downtrending, don't be too quick to try to catch the turning point. If you keep that in mind, not only would a 1987 crash not cause you too much pain, but it would present a huge opportunity if you stayed patient.

Don't let fear of a crash make you overly cautious. Just make sure you develop a system for cutting losses and stick to it.

This is the typical cheerleading that you read today, along with this silly advice to "set stops at reasonable levels." He's wrong about this on multiple levels.

He's suggesting that you use "sell stop orders" to protect yourself. That means that you instruct your broker (or your online software) to sell your stock as quickly as possible after the price goes below the "stop price."

The first problem is a psychological one. People are told that if the stock market dips, then it's a buying opportunity. Using a sell stop order means you're going to SELL when the market dips. That makes no sense at all.

And second, sell stop orders would have done no good at all on Oct 19, 1987, because the stock exchange was overwhelmed with sell orders and couldn't keep up. A stop sell order would have done you no good.

On days of massive selling, computer systems all over the world will experience failures, because they haven't been designed to handle the huge number of transactions that occur.

Basically, you should assume that, once panic selling begins, it will be several hours, or perhaps an entire day, before you'll be able to execute any orders at all. Remember that everyone will be trying to sell, and you're going to be in line behind a lot of people, many of whom have contacts and a lot more clout than you have.

From the point of view of Generational Dynamics, we're able to see in "real time" how the Principle of Maximum Ruin unfolds. The fact is that few people believe that anything like the Great Depression could ever happen again; most people seem to believe that even a recession could be controlled by the Fed. This could be described as the generational equivalent of "Pride goeth before the fall."

It is 100% certain that we are headed for a major worldwide financial crisis. This will be a generational crisis and, unlike the False Panic of 1987, will continue for years. The stock market fell 40% in 1929, but it kept falling after that, and by 1933 it had fallen to 10% of its peak value. That's the kind of thing that's going to happen again. If you INSIST on adopting a "Buy on the dip" philosophy, then wait until the Dow Industrials dip below 1500, and then it will be time to buy again. (19-Oct-07) Permanent Link
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