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 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 21-Jan-08
WSJ talks about stock market "panic" as earnings plummet again

Web Log - January, 2008

WSJ talks about stock market "panic" as earnings plummet again

Will there be a "volatility explosion" on Tuesday?

According to an article in Saturday's Wall Street Journal, "Students of [economics history] will recognize where we now are in the current credit crisis: the panic stage."

The article provides an explanation for how we got here: "the U.S. economy built up an enormous credit bubble that has now popped." It blames this on the Federal Reserve, and gives a series of airhead reasons that don't even make sense since, at the very least, they don't account for the dot-com bubble. It continues:

"Enter the panic stage. The desire for debt has turned into a stampede to quality, especially Treasury bills. The same folks who never predicted the economy would recover in 2003 are now cheerleading recession. Any bank writedown or deal to raise capital -- no matter that it is part of the healing process -- is taken as a sign that there is more bad news to come.

Meanwhile, the politicians plot to "stimulate" the economy by dropping dollars from the Capitol dome. We are also told the Fed funds rate must chase the 90-day T-bill rate down to the levels it reached when we had negative real interest rates -- never mind the anemic dollar and soaring commodity prices. The danger now is that this panic becomes a self-fulfilling prophesy and talks us into a crash.

There are two ways in which a crash could happen. The first is insolvency of one or more financial institutions that triggers a systemic failure. The second is a loss of global confidence in U.S. financial management and the dollar. Neither has to happen.

His solution: "So what to do? Pass a tax cut that is immediate, marginal and permanent." I can't for the life of me figure out how this could possibly keep the credit bubble from continuing to burst, but that's what you get in these airhead WSJ articles.

From the point of view of Generational Dynamics, what's most interesting about this article is that the level of anxiety and panic among investors is getting so great that even the Wall Street Journal is talking about panic.

I would add that CNBC anchors apparently feel the same way. Normally they're bright, perky and cheery, but towards the end of last week they could barely crack a smile. Maria Bartiromo said she was exhausted, and Bob Pisani looked like he hadn't slept in a week.

This indicates that the high level of anxiety that began to increase early last year and really accelerated with the August "credit crunch" could well be near a critical stage.

There's very good reason for this. Not only have corporate earnings continued to fall, the rate of fall is accelerating.

Here's the summary from Friday from CNBC Earnings Central:

"As of Friday, January 18th:

63 companies in the S&P 500 have reported earnings for Q4, 49.21% have beaten estimates, 15.87% were in-line, and 34.92% have missed. (Data provided by Reuters Estimates)The blended earnings growth rate for the S&P 500 in fourth-quarter 2007, combining actual numbers for companies that have reported, and estimates for companies yet to report, fell to -19% down from -11.3% the previous week, attributed in part to both Citigroup and Merrill Lynch reporting earnings below estimates.

At the start of the quarter, the growth rate for Q4 was 11.5%. (Data provided by Thomson Financial)

Note that only 63 companies have reported 4Q earnings so far. There'll be hundreds of earnings figures coming in next week, so we'll get a better idea of whether the estimates are high or low.

We can now update the table of the changes in fourth-quarter earnings estimates since the beginning of the fourth quarter, as follows:

  Date    4Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct  1:             +11.5%
  Dec  7:              -1.3%
  Dec 14:              -3.8%
  Dec 31:              -6.1%
  Jan  4:              -9.5%
  Jan 11:             -11.3%
  Jan 18:             -19.0%

It's hard to believe, but these estimates are not only falling significantly again, but the rate of fall is accelerating faster and faster.

A few months ago, there were still people calling me crazy for predicting that we were close to a generational stock market panic and crash (like 1929), but I honestly doubt that there are too many regular readers of this web site who still think so.

Ever since January 1, the stock market has generally followed the 1929 pattern that just preceded the crash, and everyone reading this web site has to at least consider the possibility that the dam is going to break next week, or soon after that.

Interestingly enough, there's one thing that happened in 1929 just before the crash that I haven't seen yet: If you look at my Dow Jones historical page, you'll see that on Monday, October 7, 1929 (1929-10-07), the market went up 6.32% on that one day alone. This must have created an enormous amount of euphoria, and may have been an important psychological component leading up to the crash two weeks later.

So, there may yet be a big upward spike in the market just preceding any crash that occurs. What I don't know is whether that HAS to happen. I suspect not, because there have already been several euphoria/anxiety cycles in the last three months, and there may be no further need for a euphoria trigger.

So look, if you're a regular reader of this web site, then I strongly suggest that you get out of the stock market, get out of any kind of funds except cash and US Treasuries. If you get a CD in a bank, make sure that it's FDIC insured. I suggest that you do it on Tuesday morning; don't even wait until the afternoon.

I have one more piece of information.

According to one CNBC analyst, there's going to be a "volatility explosion" on Tuesday. Here's what Pete Najarian, co-founder of, said late Friday afternoon:

"January was what we call a "leap option." That means it's been around for a very, very long time. It expired today. We're no longer there. Those options have monster open interest. That's where the protection was. The puts on the down side, whether you're looking at the S&P, the quad Q -- go across the board -- there was monstrous protection in place. That no longer exists, starting now. They did not come in and buy it today, not enough, so the protection's not there. That's why we are set up for the perfect storm of any negative news -- I'm not saying it's gonna happen on Tuesday. But - the setup is there because there is not protection in place. When people have to scramble, they wanna protect a position, they're gonna have to run, and that's gonna send things down even faster and sharper. Volatility should scream on that."

I'm not entirely certain what all this means, but here's what I understand:

A LEAP (Long-term Equity Anticipation) option is an option to buy or sell stock at a fixed price prior to the expiration date. What makes LEAP options different from ordinary options is that the expiration date is far in the future, say 2-3 years.

The phrase "open interest" refers to the number of open options and futures contracts.

Now, I think what Najarian is saying is that a number of LEAP options expired on Friday. They would have been protected by investors hedging with short-term options and futures contracts, and there were a lot of those. These provided "protection," because the large numbers of these served to buffer falling stock prices.

On Tuesday, all of that protection will be gone, and if there's any bad news, then the market may fall sharply without that protection.

I don't know Najarian well enough, nor do I understand what he's saying well enough, to form an opinion about whether he's right about a "volatility explosion" on Tuesday. However, the other panelists agreed with him, for what it's worth.

However, whether he's right or not, the markets have been trending sharply down since January 1, and with the extraordinary collapse of corporate earnings, there's at least reason to be very, very cautious. (21-Jan-08) Permanent Link
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