Among the posts this past week were entries about stock market crashes and the Fed's Beige Book.
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Putting Crashes Into Perspective
Originally published on Friday, Oct. 18 at 5:58 p.m. EDT.
One retest of the opening lows one hour into the day, and that was about all the threat bears could muster. I still get the feeling that too many people operate with a bomb-shelter mentality -- the fear of getting hit by a "crash." Could it happen? Absolutely, but in my trading, the "flash crash" was as close as I'm come to experiencing a crash.
It is interesting though to look at the single worst days in the history of the Dow Jones, courtesy of The Wall Street Journal. Since the crash of 1987, in which the Dow dropped more than 22% in a single day, there has not been a single-day drop exceeding 8%. In fact, there have been five down days of 7%-8% since 2000, which means there is about a 0.15% chance it will happen. Since 1987, a drop of 7% or more has occurred seven times, or about a 0.10% it will happen.
Well, that's about once every 3.5 years, so I should stay vigilant, right? Well, that's the kicker -- these drops appear in clusters. Furthermore, when you factor in three up moves since 2008 of 6.84%, 10.88% and 11.08%, along with a double-digit move in October 1987, you find that the big up moves often shadow the big down moves. The big move in 1987 offset one of the big drops the same month. Two of the big moves in 2009 offset two of the big drops in 2009. In other words, the big moves up happened within a week of the big moves down.
In the end, when we factor out the big moves higher against the big moves lower, we really only find about three times since 1987 a substantial single day move lower is the kind of move keeping some folks out of the markets in any manner. We are talking about a .045% probability. And the move down in 1987 was last seen 58 years earlier.
All this means is that if you are avoiding the market or staying short looking for the big 10% or 20% drop, then the odds are stacked against you. In fact, if a big drop is coming, it is more likely to happen over a matter of days and weeks, giving folks time to hedge, adjust positions, exit longs or get shorts in order to play the move. Furthermore, many of the big initial drops were met with big snapbacks, which also provide the aforementioned opportunities of adjusting portfolios.
The simple fact is you can't live in fear of 1929 or 1987, regardless of what charts someone posts in their similarities. Even if you hate this market, stay flexible to taking some short-term long-side plays while waiting for the bearish catalyst to finally show some teeth and find some footing.
Parsing the Beige Book
Originally published on Wednesday, Oct. 16 at 2:29 p.m. EDT.
In the Fed's Beige Book, the economy was described as expanding "at a modest to moderate pace," which covered the period of September through early October, thus capturing a few weeks of the partial government shutdown.
Here are some relevant comments from the release:
- Consumer spending continued to increase and activity in the travel and tourism sector expanded in most Districts.
- Business spending grew modestly in most districts.
- Employment growth remained modest in September. Several Districts reported that contacts were cautious to expand payrolls, citing uncertainty surrounding the implementation of the Affordable Care Act (Obama care) and fiscal policy more generally.
- Demand for nonfinancial services rose and manufacturing activity also expanded modestly.
- Residential construction continued to increase at a moderate pace. By comparison, non-residential construction again expanded at a slower rate.
- Residential and CRE activity varied across districts, but largely continued to improve.
- Financial conditions were little changed on balance, with lending activity remaining modest in most Districts.
- Price and wage pressures were again limited.
The bottom line is that the U.S. economy is growing, but at a still lackluster rate of about +2%. It's becoming more likely that the Fed will wait until January when Federal Reserve Chairman Janet Yellen has full rein to decide what's next with its policy. Assuming this is the case, the Fed will have a $4 trillion balance sheet by then -- up from $3 trillion at the end of 2012 -- with no change in the average rate of job gains and what is still a +2% growth rate.
The Fed members' econometric models will say "keep on going," which they probably will. But practical common sense should call for some "look in the mirror" introspection so they can see that what they are doing isn't working. Not to mention it will likely cause a mess when it's time to reverse (as we saw over the summer with just the mention of it).
In response bond yields are dropping -- ProShares UltraShort 20+ Year Treasury
At the time of original publication, Kass had no positions in the investments mentioned.
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