Let's review the action: The stock market had been cruising along nicely, steadily making new high after new high. Suddenly background nervousness unexpectedly burst to the forefront. The market dropped sharply. After a weak recovery, the Dow fell to new lows, scaring the bejeezus out of nearly everyone and turning even the most steadfast bulls into vicious, gnarling, howling grizzlies. But before long, a powerful erection of prices -- fueled by a sudden, renewed sense of investor optimism and relief -- lifted hope once again. Can new highs be far behind?
Lets take a look at the price action on the Dow chart:
Hey! What the ---
Observant readers will notice immediately that the above is not the story and chart of recent price action, but rather a chronicle of the Dow's activity nearly ten years ago, in reaction -- we can now confidently say, overreaction -- to the "Asian Contagion." Shortly after those fear-filled days, the Dow went on to recapture 8,000 and beyond. One year later, it was a thousand points higher. Speaking of which, after capturing the 9,000 level, the Dow had a similar fit of panic and displayed a nearly identical chart pattern in reaction to the '98 Russian bond crisis: A new high, a reaction, lower low and then recovery to new highs. After the scare had passed, Dow 10K was not far behind:
Both cases were brought on by extreme nervousness over external events that seemed powerful enough to bring the economic expansion to an end. While it is easy to laugh those events off now as "overreactions," it is wise to remember the real terror they generated at the time. I recall quite clearly the fear and uncertainty, and it is not all dissimilar to the current concern over the 'sub-prime bust.' Then as now, there was a focused, media frenzy with everyone imagining worst-case scenarios.
In 1997, while some remained confident that the Asian contagion would not spread, others argued there was no possible way such an event could be contained. It would spread like a cancer through the global economy and spell the end of economic growth. Sound familiar? Having not occurred, others were convinced one year later that the Russian debt default would result in a cascading daisy-chain of defaults across the globe. In both cases, the bears were wrong and investors who stayed long or went long while everyone else panicked did quite well for themselves.
To me, the market events of late are developing a similar feeling to the events of a decade ago. After years of complacency, suddenly everyone is in a panic. This time, rather than international events, the worry is over the domestic housing market - its slow motion bust and the impact that millions of foreclosures, defaults and the tightening of credit will have on the US, and by extension, global economy. Could this be the final nail in the coffin for the bull market, the expansion, the US economy?
Up until yesterday's sharp rally, it sure did look like it. But with the market's strong show of confidence, suddenly things don't look so bad after all. Today's chart bears a striking resemblance to Dow '97 and Dow '98, which went on to "happy endings."
But what brought about this sudden surge of optimism? It was traders' conviction - real or imagined - that the Fed is inching ever closer to lowering rates. In other words, traders believe that the Greenspan put that has been in effect since the '87 crash has been successfully rolled into the new Bernanke put. Whether this was Bernanke's intention or not remains to be seen.
But if traders are correct - that Fireman Ben is standing at the ready with his magic liquidity hose - then by all means now is the time to buy. Buy - hand over fist, because true to his promise, Printing Press Ben is lighting up the print shop, and more money means more inflation and asset prices will be going up - let the dollar be damned. Mortgage meltdown? That will go down in the annals of market history along side the Asian Contagion and the Russian Default as fears that never came to pass.
Caveat Emptor
But remember, the market has misinterpreted Bernanke's statements before - something you may remember that he tried clumsily to correct with private statements later to the "Money Honey." Could it be that the markets misinterpreting him again? This time perhaps purposely - forcing him to either call their bluff or just back down silently. Interestingly, while the market was strong in its reaction, analysts remain divided about the true meaning of the Fed's statement.
So far, nothing has been able to stop this bull market, but that is not to say that nothing will. A resemblance of charts present with charts past is certainly nothing to base your entire decision on. However, the reason they look the same is because the underlying psychology is similar, and the reason I post them is to remind you of what the fear was like. If you were in the market 10 years ago, you certainly remember the terror and the uncertainty -- in August '98 the Dow fell 512 points in one day -- that ultimately came to naught. But somehow, at this bleeding edge of history, it is much more difficult to be confident about a future yet unwritten.
If Bernanke is serious about lower rates, the bulls may yet have a chance. Not a guarantee, but a chance. If Bernanke somehow tries to "clarify" his position in the coming days - forget it. But remember, the stock market's rise or fall takes place within a larger context, and that larger context remains bloated with monetary imbalances and peppered with risks - economic and otherwise. If a correction is avoided now by the reckless printing of money - the ultimate crash is not prevented, only delayed.
So, is this correction over, or is this just a dead cat bounce?
We should know soon enough.
As always, comments on this story are welcome here: http://www.bullnotbull.com/blog/?p=110
