September 15th, 2008

Unwinding Continues; Crash Begins

I’m not going to add to the what others can discuss more authoritatively than I concerning the financial turmoil today. For readers of this blog, today’s 4.71% decline in the S&P 500 shouldn’t have come as a surprise … the only thing we couldn’t foresee were the causes and explanations given by the talking heads.

The market acted perfectly according to script. Over the past several months, I’ve shown charts of the Index, the neckline, the evolving head-and-shoulder top formation that began in 2005, the right shoulder since the July 15 low nearly completed and described what consequences we could expect if the Index convincingly broke through that neckline. Here’s where we are as of today’s close:

Flash: As I write this I’m watching CNBC and just heard that AIG got a downgrade from S&P, an act, because of AIG is the world’s largest insurance provider and does business with countless organizations of all sorts, has resulted in another major sell-off on Asian markets (which were closed today). US futures already point to another sell-off tomorrow; as of now S&P 500 futures are at 1181. Who knows where it will be the closer we get to the open tomorrow morning.

I’ve been writing about a Bear Market Crash since February when the market was about 1400, or 19% higher. At the time, I was looking for a move to 1150. And then on August 25, I extended the bottom to the 900 area, or 20 below the neckline. Looks like we may be on the way to that level very quickly.

So far, the talking heads with their usual blinders on are focusing almost exclusively on the financial industry. The realization soon to set in is that consumer confidence is eroding almost as quickly as the price of LEH. As consumers see the value of their houses dropping, as continued talk of a financial meltdown, as they see neighbors starting to lose their jobs. This has to permeate through the rest of the economy. Rather than gaping at financial stocks lying flat on their backs, we need to start focusing on employment statistics, retail sales and retail stocks.

Another question is “Can anyone explain the surprising reaction of the $US in exchange markets and the action of gold and silver?” One explanation is that all these hedge funds and financial institutions were speculating heavily in the commodity and currency markets and the declines represent major unwinding of those positions in order to generate cash to shore up their liquidity.

Another reasonable explanation I’ve heard is that the market is evenly split between those who think that this economy is facing an inflationary surge a result of the financial system bailouts and pump priming (advantageous to help liquidate the debt in overseas hands) and a deflationary period resulting of the need and panic to unload assets as the financial system, businesses, governments and consumers deleverage and rebuild liquidity.

We are all familiar with inflation but few of us any have ever thought of deflation. Two major earlier deflationary periods were during the 1930’s Depression and the late 1890’s, that centuries financial crises. For a wonderful and very informative description of those deflations check out “The World Turned Upside Down: An End to Inflation?” an Minnesota Public Radio broadcast of March 18, 1998 (since it’s an old “podcast” you’ll have to download and install a free RealPlayer to play the RAM format file …..but it’s worth it).

The US credit crises is quickly spreading worldwide. For an analogy, look to the Great Depression.

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