Sunday, August 15, 2010

Wall Street Journal’s Flawed Reasoning For Possible Crash

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The Wall Street Journal published an article entitled, “Is a Crash Coming? 10 Reason to Be Cautious” on Friday, August 13th. While a crash is certainly possible, the reasons given by the Journal have little to do with why one could occur.

The Journal did make it clear that it was not predicting a crash. The article’s author specifically stated, “I don’t make predictions. That’s a sucker’s game.” Indeed it is a sucker’s game for almost all mainstream financial journalists, just as professional basketball is for midgets – it’s just not an area of natural talent. That of course doesn’t mean that no one can do it, but the author nevertheless made this illogical leap and this nicely set the tone for the rest of his article.

Most of the reasons given in the article for a possible crash were actually arguments for a double-dip recession. These include (my comment follow in italics):

The Fed is getting nervous (more like catatonic).

Deflation is already here (if so, it will be the first time in history money printing created deflation).

People still owe way too much money.

The job picture is much worse than they’re telling you (one of the ‘they’ referred to is the Wall Street Journal itself by the way).

Housing remains a disaster.

We’re looking at gridlock in Washington (so don’t expect any more big spending programs that accomplish little and raise your taxes)

All sorts of other [economic] indicators are flashing amber (actually bright red).

This is an implied assumption in the article that market crashes are related to recessions, also an illogical leap not supported by the facts. The worse U.S. market crash of all-time took place in October 1987, five years after a recession had ended and almost three years before another one began. There were also mini-crashes in 1989 and 1997. The economy was not in recession during these crashes either, nor was it during the recent flash crash.

Economic downturns are more properly associated with bear markets – a long, slow decline in stock prices as opposed to the sudden, sharp drops that take place during crashes. They require very different trading approaches. Even bear markets can take place outside a recession however. The 1998 bear market due to the Russian debt default and the implosion of Long-Term Capital is a good example. Both crashes and bear markets can be caused by global liquidity events and as we saw recently during the Credit Crisis, global liquidity events can also lead to recessions. This did not happen in the U.S. in the 1980s and 1990s however.

Perhaps the Wall Street Journal should have entitled its article, “10 Reasons Why We Are Headed Into a Recession”. They would have to find three additional reasons of course and they would also have to be a bit shameless as well since I already wrote that article on July 8th and it was published on a number of blog sites that day. Well, at least the Wall Street Journal is making some efforts to try to keep up with the blogosphere, even though those efforts are confused and coming weeks later. Now, what can we predict from that?

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

1 comment:

Broken Bob said...

There's been way too much "money printing"? If so, it has been of a very special and historically unprecedented variety. Analogous to modern "smart bombs" in warfare, this "money printing" has been directed toward propping up "Emperor's New Clothes" bubble assets (housing, mortgage-backed securities, credit default swaps, AIG, GM, and pretty soon, California Bonds). Prices of those assets rose to irrational, dizzying heights over recent years (and in the case of housing, over recent decades). The recent "money printing" has not put cash into circulation where it can do inflationary damage; Rather, it has gone toward propping up the illusion of home equity value necessary for the borderline solvency of the middle class, and toward keeping the uber-rich from losing a significant portion of their paper profits. Neither of those parties are taking their propped up, irrationally priced assets and monetizing them at a faster pace than before. Neither of those parties are spending incremental, monetized cash in the marketplace. (In the case of the middle class homeowner, the rate at which they monetize their inflated asset has in fact declined.) So "Where's Waldo?" (inflation) in this picture? He's nowhere to be found. (BTW, I hope you welcome and encourage alternate points of view in this forum. If not, I'll stop posting.)