Loosing Your Shirt
On Wednesday (October 17th 2000) the Dow Plunged more than 421 points in the first half hour of trade. The Big Board went into free fall from the opening bell, as CNBC reporters repeatedly stressed that small investors should not be panicked into selling in this market.
The vast majority of inexperienced investors time their market participation poorly. Record numbers of small investors have been tempted into borrowing to buy stocks at high and inflated prices, investors have been conditioned into riding out the waves.
Over the last few years investors have been conditioned into riding out the waves. They have been told to hold on as “the market will spring back and go on to new highs”, which admittedly to date it has done. People have been encouraged to buy on the dips as “these prices are a buying opportunity and will seem like bargains when the market comes back”.
This October’s fall on Wall Street was prompted by continuing earnings warnings, consistently high oil prices and higher than expected inflation figures in the US.
WAITING FOR THE MARGIN CALL
Margin Debt on stocks is now at record levels. Record numbers of small investors have been tempted into borrowing to buy stocks at high and inflated prices. As the price of the stock falls below the margin level, calls go out to the leveraged investor. Just as transpired in 1929, if the investor defaults, and cant make the margin payment, the shares are sold out from beneath him, creating further selling pressure. The more selling pressure, the lower the share price falls, in-turn leading to more margin calls, causing a debt induced selling spiral, which, in the past has been followed by investor panic.
Commentators of this recent sell off on Wall Street reminded us that we have seen this kind of market correction before; “remember 1998”, failing to tell their viewers the differences between 1998 and today. In 98 there was not the same number of big cap stocks in trouble. For example in 1998, IBM held up throughout the sell off. INTEL never lost anything like it did this time.
A collapse in an already over valued stock market was averted in 1998 by the lowering of interest rates by the Federal Reserve, further boosting money supply available to buy stocks. In the rising energy cost and inflationary environment of today, this option will not be available to the Fed.
THE SETTLEMENT PROCESS
Again CNBC stated the positive side of the day was the massive volumes of shares traded, signaling that a possible bottom had been reached.
In the Crash of 1987, the real crisis was not so much the evaporation of paper profits, but the inability of the financial system to settle all the trades because of the exceptionally large volumes involved. Many clearing houses and banks were unable to meet reserve requirements, leaving the entire financial system in potential gridlock.
LOSING YOUR SHIRT
As history clearly demonstrates, the vast majority of inexperienced investors time their market participation poorly, getting in at or near the top (in the midst of the mania), and then ride it all the way to the bottom before selling.
I first spoke to Franklin Sanders in 1997 while shooting the documentary Millennium Money. When we spoke about the dangers of this market phenomenon he said; ” We are talking about individuals here, not institutions. These people are not seasoned investors, and by seasoned investors I mean people that have lived through all the delusions of a bull market and gone all the way to the bottom. You can read about it but until you have experienced it, until you have seen your own self-delusion; you see the market top and all the technical evidence is there, but you keep holding on, you say; no I think its going to come back, its got to come back. The reason that happens is you start with this set of ideas in your mind and its very difficult to change those. It is even more difficult when all your self interest is wrapped up in this set of ideas; all your treasure is wrapped up in the stock market. How can you admit you have been wrong, and meanwhile the market just keeps going down and further down.
hat’s another reason this market is so dangerous now. Look at the social change we have been talking about, we are a people now that are motivated by greed. When people look at their IRA’s (pension funds) and they have gone down to half, or a third of what they were, they are going to be mad, and they are going to come out with fire in their eyes looking for a scapegoat.”
AGAINST THE CROWD
Historically precious metals have been contra-cyclic with Wall Street. The last big bear market in stocks was in 1973 – 1974. From the market high in early 1973 to the low of late 1974, the Dow and S&P 500 lost nearly half of their value, while the high tech “Nifty Fifties” tumbled more than 60%. Apart from a brief period in 1976, it took 10 years, up to 1983, for the Dow to reach its 1973 highs. In the same period, of early 1973 to late 1974, gold gained in excess of 150%, while, between early 1973 and the market high of 1980, the precious metal gained an amazing 1200%, a nice return for the few who had bought at the bottom and sold near the top.
Today we are living in fast changing and volatile times. Leaving aside the dramatic and disturbing social changes in the West in recent years, Middle East tensions are increasing, oil prices continue to soar, the inflation genie is again out of the bag and stocks are the most overvalued they have been in all of history. Meanwhile gold and silver are the cheapest they have been in twenty years.
by Philip Judge