February 7th, 2010
Everyone seems to be looking at historical precedents for gauging the severity of this correction. When the Great Depression was on everyone’s mind last spring, many used the1933-35 recovery to benchmark this Financial Crises Crash recovery (see “Two Market Consolidation Models” of Sept 30, 2009). As we crossed the neckline of the inverted head-and-shoulder bottom, I looked to the 2004 nine-month correction from the dot-com Bubble Crash as the model of what this correction might look like. A fairly compelling case could have been made for either.
However, since this correction has been so severe and so fast (in 12 trading days already reached the extent of the 2004 correction, down 7.4%), I continued combing the long-term S&P 500 chart and discovered something I’d completely overlooked before:
The market twice before had 20+% short, severe moves over the past 12 years, both times down from around 1150-75 to 950 in a matter of weeks:
- 1998 Russian Financial Crises and LTCM Collapse
- 9/11/2001 World Trade Center Terrorist Attack
We remember the 9/11 tragedy in the midst of the dot-com Crash; it can’t be called a correction. But the 1998 crash is another matter. The Ruble financial crisis hit Russia on 17 August 1998 was triggered by the Asian financial crisis, which started in July 1997 [in Thailand]. During the ensuing decline in world commodity prices, countries heavily dependent on the export of raw materials were among those most severely hit. Petroleum, natural gas, metals, and timber accounted for more than 80% of Russian exports, leaving the country vulnerable to swings in world prices.
Russia’s default on their bonds triggered a major crises in the US with the collapse of Long-term Capital Management (LTCM):
“…..in 1998, Russia defaulted on its bonds- many of which Long-Term owned. This default stirred up the world’s financial markets in a way that caused many additional losing trades for Long-Term. By the spring of 1998, LTCM was losing several hundred million dollars per day. What did LTCM’s brilliant financial models say about all of this? The models recommended waiting out the storm. By August 1998, LTCM had burned through almost all of its $4 billion in capital. At this point LTCM tried to exit its trades, but found it impossible, as traders all over the world were trying to exit as well. With $1.2 trillion dollars at risk, the economy could have been devastated if LTCM’s losses continued to run its course. After much discussion, the Federal Reserve and Wall Street’s largest investment banks decided to rescue Long-Term. The banks ended up losing several hundred million dollars each.” [from “When Genius Failed“]
And what did the S&P 500 chart for 1998 look like?
The great bull market of the late ’90’s came to a severe bump in the road in the fallout of Thailand and Russian monetary crises. It would be ironic if the current market recovery similarly paused due to the Euro crises from Greece, Austria, Spain, Hungary, et al. Market top then around 1150 – same as recent top on January 19. Bottom at 950 four months later – same as neckline of inverted H+S bottom in June.
History may not repeat itself but it surely has echoes. One thing that’s certain, at least to me, is that Friday’s bounce was encouraging but totally unconvincing. I’m betting on a bottom again around that 950 neckline.