Well, we just had a very scary capitulation when both individuals and financial institutions join hands to seek liquidity around the world. Banks, bond insurers, hedge funds, other financial institutions need to sell stocks to raise cash for their survival, public needs to sell stocks to lock in any profits still left. This is a process of dumping all stocks to raise cash and liquidity for any price they can get, a capitulation. Good thing that market closed on Monday (1/21), otherwise it would have been an 1,000 drop in Dow, another Black Monday. Monday's close also gave Fed plenty of time to watch, think and react, resulting a 75 basis point cut.
This crash reminds many people about 1987. But I don't think this is 1987. 1987 crash is more due to the so-called program insurance or program trading mechanism going terribly wrong and caused by trading professionals, not individual investors. The initial drop of market caused computers and traders to sell more futures which invoked more computers and traders to sell even more futures (and cash index had to follow suit) and escalated out of control. It was futures leading the way. At the extreme, we saw a large deviation that futures was priced way below cash index. The crash was very fast, a free fall in a couple days. This is also why we saw market recovered in a relatively short time.
This time, it is different, it is fundamental, it is demographic, and it is an almost repeat of 1970s. Setting aside the banks and financial institutions, for the public, some baby boomers have probably not been comfortable with this market turmoil since last year, and want to lock in their nest eggs and cash out which has caused more baby boomers to cash out. They don't want to take the risk of sitting through this credit crisis and bear market, since no one knows how long it will last this time. Time is not on their side, not like the younger generations who have the luxury of time. How can we blame them? With fast falling residential real estate and no sight of its bottom, it is only natural for them to protect their remaining nest eggs.
The market action seems to support this assumption. Unlike 1987, the sale of stocks so far has been a more slow process than 1987. The selling has happened in real stock shares first, then futures had to follow suit. Actually last week (1/14-1/18), many mornings the futures were trying very hard to lift the market with a mini rally by opening higher, only to be crashed by real shares selling for cash by individuals and mutual funds acting on their behalf. The cash index has been leading futures market in this market meltdown, unlike 1987.
If this assumption about baby boomers is correct, they will never likely get back into the stock market again after cashing out, due to growing risk averse profile with their increasing age. All they concern is to protect their cash with consistent monthly income, this is why you see US 10 year and 30 year treasury bonds reaching so high these days, the so-called safe haven vehicles. Maybe stocks in the future are undervalued at 50% of book value, 70% of intrinsic value, P/E at 8, PEG less than 1, but who cares. Yes, maybe inflation is gradually eating their long bonds away, well, let us worry about that later when inflation reaches double digit.
This discussion about baby boomers is not new, since as early as 2001, Wharton professors of Andrew Abel and Jeremy Siegel have voiced concern about the herd behavior of baby boomer generation and their cashing out simultaneously will cause a stock market meltdown around 2010. We are not quite there yet, but close enough. At the same time, who wants to be the last one to cash out at the lowest price anyway? Does their prediction finally become reality now?
In order to get stock market back on track, we need sustainable long term liquidity support from the next two generations. However right now, they are more concerned about social security, healthcare, jobs, credit card debt, have neither interest, nor cash and liquidity to invest in stocks, at least not at the scale to match the whole generation of baby boomers cashing out at the same time. Fed has cut interest rate very aggressively by 75 basis points, more to come, and probably provided some good short term liquidity too. But it is ineffective in this kind of market environment. Flood of liquidity will provide a temporary rebound which will only give more people incentives to cash out. Lower rate doesn't help if no one lends to each other due to credit concern. These days, it seems that every bank, financial institution and individual have some kind of credit problems and concerns.
The worst case scenario is that it might take a whole generation's time to get next generations interested in stock market again, and their willingness to invest by providing sustainable money inflow. Hope it won't take that long. But just look at 1970s, Dow peaked in 1972 (some argue 1968), bottomed in 1982, a 10 year bear market, half a generation's time.
What might be the best defense strategy in this market environment? My strategy is and has always been sticking to gold, silver and precious miners. This kind of credit and equity market turmoil and people's distrust of all paper assets will only make gold more appealing and the reason to be held for long term protection of their nest eggs. Gold has been and will always be the last resort of all paper money in the world and provides the ultimate liquidity for all. Precious metal miners will get dumped from time to time due to equity market turmoil, but they will come back since their underlying assets are real physical assets of gold and silver, not black box computer modeled phantom mortgages or government printed paper money with falling value. Precious metals miners act as long term options on gold not only without time decay but also with increasing value through time.
As J. P. Morgan (the real person, not the phantom bank) always said "Gold is money, that is it". I think he also meant, Gold is liquidity.
