Forced Liquidation

By: Bob Hoye | Thu, Sep 22, 2011
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The following is part of Pivotal Events that waspublished for our subscribers September 15, 2011.



"CEOs to Obama: 'Get Out of the Way - For Job Creation!'"

~ CNBC, September 6, 2011

Some chief executive officers are showing some integrity and common sense.

"S&P Could Fall 20%, 2-Year Treasury Could Hit 0%"

- Bank of America analyst, September 12, 2011

"Fear is overpowering greed in the $7.6 trillion U.S. Corporate bond market, with investors pricing the biggest reversal in credit spreads in more than two decades."

- Bloomberg, September 7, 2011

The observation is based upon a method that compares action in spreads with the ratio of upgrades and downgrades.

This method by Deutsche Bank (DB) confirms our comments that the corporate market had reversed trend on schedule and had deteriorated severely - well before the dreaded fall crisis.

Does the above methodical statement on U.S. corporates suggest that the debacle we have been expecting has happened already?

The DB method is interesting but spread-widening, itself, is nowhere near the dislocations reached in the 2008 Crash.

Two thoughts: It ain't over until it's over, and how much debt-garbage is the Fed still carrying?

Bad stuff was bought in a moment of "irrational exuberance" about the Fed's own ability to throw credit at a credit contraction and make it go away.

We still think that one of the pre-requisites for a prospective central banker should be to spend a credit cycle as a margin clerk.


It is not just the credit markets that are coming apart, it's also the theories and boasts behind interventionist economics. If these guys were brokers they would have got out of the business years ago.

One example is Greg Mankiw, who in late 2007 boasted that because the Fed had a "Dream Team" of economists nothing could go wrong. Unaware that a classic financial bubble was collapsing, he believed that it was a prosperity that could be "managed".

Then only six quarters later as classical financial collapse had turned into a classical rebound, interventionists then boasted that without the "stimulus" the classical panic would not have ended.

This is a preposterous contrast in boasts that should suffer wide-spread condemnation.

Similar boasts from officials at the Bank of England after the post-bubble crash of 1825 are in the literature as are those by the Fed following the 1929 Crash.

Corporate spreads widened a little over the past week, commodities (CRB) weakened and the stock market continued volatile. We had thought that generally conditions would be positive out of the August problems into the first part of September.

Relief was recorded in an unusual number of 4-percent up-days that were offset by as many 4-percent down-days.

As fascinating as record volatility has been, the action remains on the path to to a "classical" fall period of forced liquidation.

It reminds of when Bob was white-water kayaking. To get to some choice rapids and drops, private logging roads were used. Drivers of the huge logging trucks were reasonable - they only used half of the road - the middle half.

But, seriously, one of the smaller roads crossed one of their main highways. In addition to a normal stop sign there was a big sign that warned:

"Our logging trucks take five seconds to go through this intersection - whether you are in it or not."

That nicely describes the formidable nature of the acute phases of a post-bubble contraction. No agency can stop them from happening and no agency can end heavy liquidation until it clears - on its own.

Timing Indicators

So far as we can tell, "Sell in May and go away" could be based upon the probability of credit spreads to reverse to widening in May. This seasonal tendency provides serious opportunity when it occurs near the end of a speculative surge.

The reversal started in April and has continued.

Another ancient tradition has been seasonal weakness in financial markets in October. Moreover, all of the great post-bubble crashes have occurred in the fall, with typically the greatest pressures suffered in October. After a test in November markets recorded a vigorous rebound.

This was the pattern with the bubbles that completed in 1720, 1772, 1873 and 1929. The one that completed in 1825 suffered severe liquidation into January, 1826. On the 2008 crash, initial severe liquidation did not conclude until March of the following year.

In the 1340s Northern Italy, which was the financial center of the world, suffered a severe contraction. The most serious phases occurred in the fall.

On the nearer term, we use the behaviour of the gold/silver ratio. When it goes down - as in the spring of 2009 - financial markets go up.

Then when it goes up it signals the end of a speculative party.

The extreme low was 31.1 at the end of April as the speculative surge topped out. The high was 47.7 as the Sovereign Debt crisis became intense.

As conditions eased (without leaving the headlines), the ratio declined to the 41 level in late August. As noted last week, rising through 47 would indicate a turn for the worse.

In the past week it has increased from 43 to the 45 level.

Another indicator is the real price of gold, which goes up during a post-bubble contraction. It turned up at 143 in May 2007, as the credit markets turned down. The high in the panic was 518 and when it turned down in February 2009 it anticipated the end of the panic by a couple of weeks.

The low with the first business cycle out of the crash was 303 earlier in the year. The uptrend was set in April and that signaled the end of the party.

The high was 486 set in the August troubles. When the uptrend was set in April we thought it would eventually reach the 2009 high, but this could be exceeded.


European and Asian stock markets set new lows in September. Generally, that was from key highs in the April-May window.

Western Hemisphere indexes (Brazil, Mexico, New York and Toronto) have been volatile, but firm relative to elsewhere.

The point is not to focus upon S&P earnings or Fed policy - that is for stock market intellectuals. The real financial world is in a fairly typical post-bubble contraction whereby the dominating feature is that too many governments, too many companies and too many individuals are having difficulties in servicing debt.

The feature of every new financial era has been the over-employment of debt. The results have been that the mania to borrow (and lend) expands debt beyond the ability to service it.

Editors at Barron's in 1932 understood it with:

"The Federal Reserve policy of cheapening credit through the purchase of government bonds has been unable to make a dent in the conservatism of borrower or bank lender, in short, every anti-deflationary effort has yet to provide positive results. The depression is sucking more and more bonds into its vortex."

And it is applicable now.

It seems that Bernanke, as a scholar on the fifth post-bubble contraction, has not read Barron's editorial.


In setting new lows, most stock exchanges in Europe and Asia are technically in bear markets. New York, London, Canada and Brazil are not there - yet.

The August low for the S&P was 1100 and that is the level that will formally decide the bear. Violation of the August lows will do the same for the other indexes.


Link to September 16, 2011 'Bob and Phil Show' on



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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