The Market Ticker
Commentary on The Capital Markets- Category [Market Musings]

No, this is not a crash call.

It is, however, a warning - that you should beware of the conditions that have preceded severe market dislocations before, be aware of them, pay attention to them, and contemplate whether it is worth being involved in the market at this particular time.

Market dislocations come from many causes but have one common precursor -- over-extension of credit (margin debt) that must be rapidly unwound.  The are seeded in an environment that is generally volatile in the negative direction, thus exposing a greater percentage of those positions to margin calls.  They are usually accompanied by or associated with an expiration of one or more instruments that provide alleged "protection" against such volatility, where the cost of their replacement is high.  

The precise trigger for the event itself is usually analyzed in the wreckage that follows with all sorts of books and papers, yet the fact is that none of those are more than a guess.  In 2000 a little dog-crap public firm (that incidentally still exists!) was, to the best of my ability, the triggering event -- they announced a restatement at an inauspicious time.  2008 was of course blamed on Lehman, but in fact Lehman was a symptom, not the problem itself.

Every night someone wakes up in a cold sweat and pushes the flatten button.  Someone else wakes up with delusions of grandeur in their eyes and mashes the buy it all button.  

The dislocation itself happens when a lot of the first group show up at once and few or none of the latter do, and then the phone starts to ring on the desk (or in the hand, nowdays) of all the people who didn't mash that flatten button -- and they've got a big fat margin loan out that has now driven their account into negative equity. 

Cascade selling comes from people who are told they must sell because the margin clerk is on line #1 and he's just advised you that if you do not deliver good funds to him within the next hour you will be forcibly liquidated and, if you still have a debit balance, they will next lien all your assets, including in most states your house.

I will note that despite all the crying and screaming in the last two of three days, and the elation during one of them post Fed minutes, the conditions are not ripe, at this particular moment, for that to happen.  It doesn't mean it can't, just that it's not all that likely that today is the day.  I can no more see into people's bedrooms at 3:00 AM than can you.

But -- and this is the point to consider -- the fact that such events come not from a market that is "topping" but one that has started to decline and where volatility is rising means that the time to contemplate saying "That wisp of smoke may mean the curtains are on fire" is not the day before the event, believe it or not.

If you wait until then you're probably 10, maybe 20% off where you should have sold and gotten out.  You gave that up simply based on hope and hype, and the difficulty of selling in that environment when you're that far down from where the pretty number on your screen said you were (all fake money, by the way, until you sell) is well-understood. 

It's hard to bail on a position that's 10 or 20% down from where it was.  It's even harder to bail on an entire portfolio that's down 10 or 20%.  The simple fact is that it is a near-certainty that if you wait until that happens you probably won't bail at all and thus you'll take the entire ride down or far worse, sell at the bottom in the depths of panic.

And that's the best argument for doing it before that pattern -- and the decline from that top occurs, especially if you've got positions that are up 20, 50, or even 100% or more over the last couple of years.

Pigs get slaughtered.

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