Today's Stock Market Action Looks A Lot Like August 1998

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.

Something is seriously bothering the stock market and the news that's out there isn't enough to justify what is going on. Such was the case in August 1998 as well. What caused the sudden bear market to appear out of nowhere in 1998 became fully evident only after the fact. The same could be the case in August 2011.

Perhaps the flash crash in October 1997 was a warning of things to come, just as the flash crash in May 2010 may have been a prelude to today's stock market drop. In the second half of July of 1998, stocks began to nosedive suddenly, just as they did in 2011. Some stabilization took place in the market toward the middle of August in 1998 and then a new deeper plunge began. Today, the Dow Jones industrials were suddenly down over 500 points this morning on what could only be considered minor bad news.

There were actually two problems causing the market debacle in 1998. Everyone knew about one of them - the Russian debt default and devaluation of the rubble, which took place on August 17th (less than half of the eventual market decline took place before this date).  Only Wall Street insiders knew about the second one - problems at Long-Term Capital Management (LTCM) - that almost brought down the financial system. 

Trouble in Russia was evident as early as October 1997 and it resulted from the fallout from the Asian financial crisis, which in turn started as a currency crisis in Thailand in July of that year. Today, Europe is undergoing a crisis with the euro that began in Greece in 2010. By August 1998, the Russian central bank had spent a great deal of its dollar reserves defending the ruble and decided to give up. The default had a number of ripple effects, but the most important one on LTCM wouldn't be known by the public until late September, only days before the market finally hit bottom.

After the Russian debt default, stocks plunged until the beginning of September. The market was close to its ultimate low at that point, but only because of the subsequent successful rescue of LTCM.  Stocks then rallied for approximately three weeks. A bailout of LTCM was arranged by the Federal Reserve on September 23rd. The market then sold off until early October hitting a new low and then the decline  was over.

In the rally that followed the stock market experienced huge gains led by a bubble in tech stocks. This was a consequence of the Fed lowering interest rates and pumping too much money into the financial system. The Fed had a lot of leeway to do both in 1998 and still there were serious negative results between 2000 and 2002 when the tech bubble collapsed. Inflation wasn't a concern back then because commodity prices had been declining for almost two decades and were around their lows. It should be assumed that a failure to have successfully rescued LTCM would have caused a much bigger drop in stocks (as happened when the Fed didn't bail out Lehman Brothers in September 2008).

The Fed has a lot less ability to maneuver in August 2011. Fed funds rates have been at zero since December 2008. The Fed has already expanded its balance sheet by approximately $2 trillion since the Credit Crisis began. Commodities are closer to their all-time highs now, not their lows. Another bailout like the one in 1998 (which was minor compared to what occurred during the Credit Crisis) could send inflation assets into a bubble. Gold is already trading over $1800 today and seems to be leading the way.  

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

Is It 1998 All Over Again?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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In some ways the market reminds me of 1998. Energy prices had hit a low in the spring and rebounded, but then dropped off again in the summer. Stocks were deteriorating into the summer, but rallied strongly in July for no really good reason. Low prices caused energy production to be curtailed and this eventually led to higher prices for the next 10 years. That scenario is quite likely to repeat itself. Whether or not the stock market collapses in August as it did in 1998 remains to be seen. Is there a contemporary version of Long-Term Capital out there?

The future of oil and natural gas prices is clearly laid out in Schlumberger's earnings report today. Like Halliburton earlier this week, Schlumberger said a sharp drop in natural-gas drilling in North America caused an earnings decline. Drilling in the U.S. and Canada reached a five-year low in recent months and no rebound is likely to take place in the foreseeable future. The reduction in drilling activity has also effected oil and has done so globally. While energy companies have scaled back oilfield activities worldwide, the number of rigs operating in the U.S. oil patch is off roughly 55 percent from last summer. If you also consider that a number of large-scale multi-year projects to increase productivity from declining fields (many of the world's biggest producers) were cancelled when oil prices were at lows in the winter, the future becomes easy to predict. There will be shortages of oil in a year or two. The U.S. is particularly vulnerable to these shortages because our energy production is dropping precipitously. The authorities will be surprised when this happens and they will blame greedy speculators and scheming by foreign producers for causing energy prices to skyrocket when these shortages appear.

As for the stock market, it has been going up no matter what. There has been a 10-day rally as of yesterday - a long time for an uninterupted rally. There was a big move up yesterday on fairly heavy volume. The Nasdaq has also just closed a gap on the weekly charts made last September. On the daily charts the RSI is about to hit the max. According to the mainstream media all of this is taking place because of good earnings. Even a cursory analysis of the earnings reports indicates that earnings are actually in very bad shape however. The earnings news out last night was uniformly bearish, but the European markets still rallied and U.S. stock futures were up this morning. So, it looks like the market goes up no matter what. This only happens when large amounts of liquidity are being poured into the financial system by the authorities. Why are they doing this now is a good question.

Reports have started to appear about how the Credit Crisis is over and the U.S. housing market is recovering. The worst of the Credit Crisis is indeed over, but this however doesn't mean recovery is taking place, nor that the economy is getting better - it isn't. As for housing recovering, this really strains credulity. Once a bubble collapses, it needs to have a long and severe drop to correct the excesses and housing has not gotten anywhere near that point yet. British GDP statistics were out overnight and the economy there shrank 5.6 percent year over year, the biggest drop since quarterly records began. Yeah, things are getting better all right.

NEXT:

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


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.

Oil Enters Buy Zone

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

At the extremes of sentiment, there is nothing more bullish than a bearish commodity. When oil got to around $12.50 a barrel in 1998, surveys showed that only 3% of traders had a positive price outlook . Within days it was trading over $17 a barrel. The turnaround was sudden and explosive. The few contrarians who saw the opportunity made a lot of money in a short period of time. It turned out that $12.50 wasn't the low however, that was in the $10 range and it took a few more months to reach it. Similar behaviour is possible this time around.

Nymex oil fell as low as $33.44 in overnight trading. This represented a sharp drop in 24 hours after more than five long months of steep selling. It is common for markets to have six month sell offs. It is also common for the selling to end with a big drop at the end. Keeping that in mind, I started buying OIL today, even though I do not think oil has hit its low just yet. I suspect that this will be somewhere between $22 and $28. The set up for a good short term trade or the beginning of accumulating a position seems to exist though.

As I have said many times, the bottom price of oil will be determined by the cost of production. This is much higher than it was in 1998 because there is less easy to get to oil available. Much of the oil that has come on line in the last few years is oil that is expensive to produce, such as tar sand oil from Canada. This supply will start disappearing with oil selling in the 30s and the loss of supply will become extreme in the 20s. While you can find any number of news articles about how the demand for oil is going down because of the economy, you will see little about the supply also decreasing, which is the bullish side of the equation. Economic arguments that deal with the demand picture without mentioning supply are meaningless and should always be discounted.

Oil is one of the four pillars of inflationary investing (along with gold, silver, and food commodities). Keep in mind that it is priced in U.S. dollars and the Fed basically said this week that it intends on printing any amount of currency necessary to get the U.S. out of its current depression (my word not theirs). Just last night the BOJ in Japan lowered interest rates to 0.1%. England will likely institute ZIRP sometime in 2009. With the world's central banks engaging in hyperinflationary policies, it is only a matter of time before the price of inflation-linked commodities skyrocket. You just need to time your entry and wait for that to happen.

NEXT: Bailouts: It's Not Just Banks, It's not Just the U.S.

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.