Thursday, March 20, 2008

This Wild Market Explained

Wild Markets

I keep commenting on the stock market because it is on one heck of a ride and makes for pretty interesting drama. You could make a lot of money if you just bet on the volatility of the market.

A casual observer would wonder what the heck is going on. It looks like for every up day there will be a down day. Anybody who has watched the market for any length of time knows that these fluctuations are not normal. So what the heck is going on? Here is my explanation.

These problems all start with the Fed,technology, and globalization. In the early part of the decade, money was very easy to come by. To stave off a recession, the Fed pumped money into the market by lowering rates to ridiculously low levels. Added to this were new financial instruments which made it easy to slice and dice debt in ways neverthought of before. You sell these in a global market hungry for returns and safe investments and you have a situation where money is easy to come by and nobody knows who really owns what.

Now imagine you are a consumer who can get credit cards very easily. If you are like most Americans you are going to get as many as you can get and start spending. Well that's what happened here. Now imagine you have a scenario where not only can you get cards easily but chances are if you run up debt, the bank might not be able to figure out you actually owe them money. What do you think is going to happen?

Now you are seeing it play out on a trillion dollar scale. People are starting to wonder who is going to pay the bills. Companies who have these loans on their books know this but are stuck. They need to have cash in hand for either margin calls or to run operations but they don't have much assets to sell other than what could be worthless loans. They could try to sell the loans but they would have to take pennies on the dollar. So they sell other assets. Assets which are much more liquid. This causes the market to drop quickly. Of course whenever this happens, the Fed, for god knows what reason, steps in to save the day giving access to easy money yet again making the panic subside. Since markets go up when money is cheap, the market rebounds.

It still doesn't fix the inevitable problem, there are a lot of bad loans out there and someone is going to have to pay for them. This is why I'm still so bearish on the market.

For all the bluster about how bad housing is, prices are still pretty high. I look around at the houses for sale in California, and for all the doom and gloom most are still for sale at or above 2005 prices. That's nuts. What is going on is that sellers are refusing to believe they can't get the ridiculously high prices, so they just hold on, praying for the best. That's why the housing market hasn't bottomed yet. But eventually it will have to, because there are enough people who eventually have to sell because they have to move or they can't afford the payments anymore. The same thing will happen to this market. Companies are praying a miracle will happen that will make these loans worth something. That miracle isn't going to happen, and eventually they will have to write them down. When that day comes, then we will really be in a bear market, and only then will it be time to go all in.


  1. Good summary. I agree that the housing and bad loan situation has not fully materialized. Another three years (max) and I'm sure we'll get to that bleak reality. My only advice: while the stock market is bottoming out, don't get emotional. Hang tight.

  2. I think the day of reckoning is closer to a year than three, but I agree, it isn't too far off.