Sunday, May 9, 2010

The next Step- Reality

The next Step- Reality

All the mirrors that were talked about in the past blogs are now taking form all over the world in ways that should cause major problems in the next 2-5 years but longer term will be deemed as a “best thing that ever happened” scenario. We don’t want to see the “pretend and extend” period last much longer. The protests in Greece will spread across Europe and eventually to the U.S. We see it now on the Arizona’s bill on immigration even though the AZ law is no different than the federal law. Arizonians see their state suffer from all the added costs associated with the free lunch that illegal’s get and want to enforce the federal law. Protests and lawlessness come from not only economic factors but also from social factors. As we have been stating in the past, “When your neighbor tells you he got a zero percent car loan, works 4 days weeks, got a home and student loan reduction as well as interest rate relief, a cost of living raise, free school lunches and health care that might send one over the edge”.

As for the market actions the past few weeks we have seen cracks starting to form. On April 14th the market dropped over 100 points then made a marginal high followed by a 200 drop April 27th. The following week volatility surged and the drop ensued. Then this past Thursday an earthquake in the financial markets sent the markets down over 950 points although the drop was NOT REAL. It was more like 550 points. There was a train wreck between computers and human actions.

There were a multiple set of events that contributed to the decline. First many traders had sell stops, second once certain technical levels were violated and selling intensified but the 3rd factor of program trading caused the air pocket. Most of the free fall were NYSE stocks that printed far below their previous trades on ECN’s that didn’t have any liquidity. NYSE specialists can hold their stocks for up to 90 seconds if they have a massive imbalance. Over 80% of NYSE stock’s volume traded on the NYSE exchange 10 years ago. Specialists would freeze a stock for up to 90 seconds then put a block up before resuming trading. If the specialists couldn't resume an orderly market they would halt the stock for 15 minutes. The problem is that the 80% market share has diminished to less than 30%. This left the other ECN’s to make markets but when they saw the NYSE hold some of their stocks, the other ECN’s either stopped making markets or dropped their bids. Program trades cancelled their NYSE orders and went to other ECN’s where there weren’t any bids near the previous trades. Over a 4 minute stretch the market moved down 500 DOW points thanks to some excessive stealing by some ECN’s. The biggest rip off was Accenture stock trading at a penny although that trade and many others were busted. The slower specialist system prevailed over computers gone wild.

The frenzy lasted only 4-5 minutes but the lawsuits will last for many years to come. It can happen again and will probably happen during the upcoming crash. Guess it proves that speed can hurt. Just as the 1998 Long Term Capital collapse caused markets all over the world to fall unless the current rules are changed the collapse of our stock market like 1987 where program trading was the main culprit will repeat itself. Long Term Capital thought they had all the correlations figured out and it worked for a while until it didn’t. And when it failed the professors were dumbfounded. They thought their system was infallible. Now we have more programs that not only work on speed but correlations that will work until they don’t.

There is a strong likelihood that the April highs will hold for the year and maybe many years to come. There are many stocks like the restaurant sector that have lost 20-30% in a matter of 2-3 weeks. Dow 10,250 level remains support even though it was broken because of bad “prints” this past Thursday followed by 10,183 then 9850. A crash will occur once 9850 is broken. After last weeks decline a bounce back to 10,750-10,823 is likely. If the DOW closes above 11,300 it would signal a move higher. With free money here and in Europe it could delay the crash from later this year to next year although this scenario is less likely as countries like China raise rates. China’s property values have risen ridiculously the past few years and their collapse could be the tsunami wave that hits the US. China has a glut of buildings and vacancies that make Dubai look good.

The market’s tide has changed from buy the dips to sell the rallies until the proof of closing above 11,300 occurs. The old saying of “sell in May and go away “should be valid this year especially in a second year of a president’s term. Technically the tremors have started and it’s only a matter of time before the bear train resumes. As we saw in the past week markets fall at a faster rate than they rise. Sectors leading the next wave down- restaurants, hotel, auto and auto parts, retail and housing along with banking and insurance sectors. The US consumer is done. Higher taxes and inflation are in Santa’s stocking. The bill is coming due and the manner which the government handles the payments will determine how far the shoe drops. DOW 5,000 in the next few years is not out of the question. Hopefully we stop the printing presses and save all the trees we need to pay our way out of debt. Currently it's difficult to see this scenario from becoming reality.