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This Isn't a Bottom, It's a Disturbance in The Force

by: Kevin Price October 10, 2008 | about stocks: DIA / QQQQ / SPY    

Kevin S. Price

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Think of the moment in the original Star Wars when the bad guys destroy Princess Leia's home planet of Alderaan with a single blast from the Death Star. Just then, back on Tatooine, Obi-Wan Kenobi shudders and says "I felt a great disturbance in the Force, as if millions of voices suddenly cried out in terror and were suddenly silenced. I fear something terrible has happened."

We've had a similar sensation here over the last few days as the latest data on mutual fund outflows reveal a time-honored pattern: When individual investors (and, yes, their panicky advisors) simply can't take the pain any longer, they dump stocks very late in the game.* Now, we want to be very clear here. These data alone don't imply a bottom any more than any other single indicator can. Especially when forced selling seems dominant and the credit markets remain broken.

But with the VIX setting daily records, put-call ratios pushing higher, and other measures of bearishness breaking out all over the place (this magazine cover is a classic contrarian item, but daunting and a little scary nonetheless), we could be reaching a point where the rubber band is stretched too tight--at least for the short term.

This morning's (for now very short-lived) hoot-and-holler reversal** off of the first half-hour's plunging lows notwithstanding, this market remains deeply damaged. Whatever current technical-psychological extremes might do to the broad averages in the short run, we continue to be concerned about the prospects for corporate earnings. Now, a loss of 40% or more in market capitalization certainly does imply an adjustment for expected weakness in earnings. But here's the thought experiment: What if the next few quarter's results are flat-out ugly? Is a steady drip of corporate weakness (and thus retrenched spending and hiring) adequately "priced in"?

At some point, when investors have shed their fear in favor of indifference, we'll have reached a real, lasting bottom, one that will have created some truly spectacular investment opportunities. As we've been arguing for months now, the name of the game is still risk management. Capital preservation is a virtue, as those who lives to fight another day will benefit enormously from the wreckage on Wall Street.

~~~~~~~~~~~~~~~~

* The bigger question is when those who have just bailed out of stocks will have the wherewithal to return. If they wait too long, they will have perfected the disastrous sell-low, buy-high sequence that impairs the results of so many individual investors. What people need here is discipline. If you go to cash now, start buying back in whether the market go higher or lower. If it goes lower, great...you'll pick up the merchandise at even better prices. If it bottoms at or near these levels and heads higher (even if slowly and unevenly), you won't wait too long to participate. We could be more specific about this, and maybe next week we will be.

** Which brought back memories of a time when CNBC's Maria Bartiromo actually squealed--there's no other word for it--her approval of the day's trading action. In keeping with the Star Wars theme, and given that stocks were trading roughly 40% higher then than they are now...that moment feels like it took place long ago, in a galaxy far, far away.

Source

Jennifer Ablan, "Flight to quality as money funds rise, stocks dive," Reuters, October 10, 2008

Jeff Kearns, "VIX Options Index Advances to Record Above 60 on Credit Freeze," Bloomberg, October 9, 2008

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This article has 73 comments:

  •  
    Oct 10 04:22 PM
    Oh yes, your article is right on target! Just because everything is tanking (the government is bailed out banks, auto manufactures, etc.). It must be time to invest money in their stocks. Maybe I was born yesterday, but not that early.
    Reply
  •  
    Oct 10 04:31 PM
    Wait a minute ... This whole thing is a metaphor, right?

    Death Star ... Federal Reserve

    Tattooine ... Lehman Bros.

    Obi-Wan ... Alan Greenspan

    I see it clearly now. Darth Paulson will use the FORCE to unclog the credit system. Meanwhile R2Bernanke2 will stop the elevator's descent and turn it around to move upward again while Princess Bartiromo struggles to free herself from Jim Cramer the Hutt.

    YES. It all makes sense.
    Reply
  •  
    Oct 10 04:52 PM
    That Obi-wan quote pretty much sums it up.
    Reply
  •  
    Oct 10 04:56 PM
    @sheople: he didn't say throw *all* your cash back in now. those who bail out in panic right now...and wait too long to come back in...only serve to be the out side of the trade for those who don't panic and are willing to get in there first. you don't go all-in right away...but at these valuations, dipping the toes back in is a must.
    Reply
  •  
    Oct 10 04:58 PM
    I vote for Tony Blair as C-3PO.
    Reply
  •  
    Oct 10 05:02 PM
    "Did you feel a great disturbance in the Force, as if millions of voices suddenly cried out in terror and were suddenly silenced?"

    Obi-wan, "No --- just some gas." from "Hardware Wars"
    Reply
  •  
    Oct 10 05:05 PM
    Smarty_Pants I about pissed my drawers reading your comment

    "R2Bernanke2"... ha ha ha!
    Reply
  •  
    Oct 10 05:08 PM
    Obi-Wan was on the Millennium Falcon on the way to Alderan when he felt the disturbance, not on Tatooine. I like Bernanke as the Emperor and Paulson as Darth Vader…
    Reply
  •  
    Oct 10 05:09 PM
    Dang, Smarty, how come you ain't President?
    Reply
  •  
    Oct 10 05:36 PM
    The thought of Maria squealing is certainly delightful, except of course I was short when she was squealing long, so I hated it. Now I'm naked long. Let the squealing commence till DOW 10000 where I will be short again.
    Reply
  •  
    Oct 10 05:45 PM
    Anybody know the exact date the world is going to end? Will it hurt? Should I wait till then or kill myself now?

    Also, sheople, I think the phrase you meant to come up with is, "I was born at night, but not last night".
    Reply
  •  
    Oct 10 06:01 PM
    "Should I wait till then or kill myself now?"

    No, don't kill your self. Hang in there and UNDER NO CIRCUMSTANCES accept the mark of the beast (666). It might cost you your head but you will gain your soul forever.
    I kid you not.
    Reply
  •  
    Oct 10 06:20 PM
    Once 3-month libor comes down when banks gain confidense, there will be so much liquidity worldwide that nobody will know what to do with it all! Look at OIL?? Wasn't that the main consumer & business squeeze, and responsible for all of this inflation.. Once all of the mutual fund / hedged fund forced selling is done, we're going to see the biggest rally in history.. With overnight LIBOR coming down, hopefully it feeds into longer term paper and will feed into the economy... Plus the VIX saw a sell off, so we're starting to see crowded shorts change their minds and possibly sellers getting back in.. Also the technicals are at tech bubble lows & post '87 crash 25 yr trend line..My 2 cents, we'll see what happens!!!!
    -distressedvolatility
    Reply
  •  
    Oct 10 07:19 PM
    The Writer made a huge mistake in this piece, by neglecting to mention the Wash Sale Rule. You take your big fat loss...then you buy back the same stock or ETF or Mutual Fund within 30 days and guess what. You don't get to count your big fat loss as a loss anymore. The IRS requires you to write Wash Sale on the line on your Schedule D, that would have shown your loss. The exception to the Wash Sale Rule is only for those who officially make their Mark To Market and declare themselves Professional Traders to the IRS. I'm truly amazed at how many investors and traders I've spoken to who don't have a clue about the Wash Sale Rule. The IRS will bust em eventually if they violate the rule.

    Personally I think we saw the bottom today. I'll give you two thoughts on the subject...maybe three.

    1. When Hank Paulson starts buying up those pesky Mortgage Backed Securities, the Credit Default Swaps designed to insure them will be voided, and nobody will have to pay the premiums any more.

    2. Hank Paulson has the option of using the 700 Billion to buy Preferred Shares. Let's say he does that...the banks can now lend out 10 times that amount, ie 7 Trillion. But of course they first have to borrow the 6.3 Trillion from somewhere...maybe China?

    3. Hank could do a hybrid of 1 & 2, buying the pesky securities for say... 15 cents on the dollar and then match it with a preferred shares purchase of an equal amount. This might sweeten the deal enough to get lots of bankers on board, and get us a bigger bang for our 700 Billion bucks.

    Maybe I should call Hank.......
    Reply
  •  
    Oct 10 07:29 PM
    Distressed Volatility is right (and is probably in line somewhat with maybe even Peter Schiff, but he's much better at speaking for himself than I am). Helicopter Ben has been creating money out of thin air and pumping into the system. It's not moving because of the constipation in the banking system, but eventually all those dollars will need to find a home, and it won't be under mattresses. Deflation for now and maybe a year or two, but after that, look out. Massive bubbles everywhere. Commodities, equities, etc. The Dow will probably reach 20,000 (in debased dollar terms), but none of us will feel wealthier because milk will be $20.00 gallon.
    Reply
  •  
    Oct 10 07:29 PM
    What you don't know is that the galactic stock market (GSM) was on Alderan- the planet that was destroyed. Needless to say, it never recovered.
    Reply
  •  
    Oct 10 07:50 PM
    Socialism, sorry I didn't make my point more clear. Dip your toes, but don't fall in. There is no bottom. Manufacturing is gone. Financial appreciation took it's place. Now there is no appreciation or manufacturing. Jobs are going to continue to be lost. Businesses, banks, etc. are going out of business. Until something is done about the manufacturing, nothing is being done. Something of a metaphor, but true. We are in for big trouble. More trouble than getting a cold toe.
    Reply
  •  
    Oct 10 08:08 PM
    Looks like America was playing daft all along, suckering more countries into their black hole so they could then, you guessed it, lend even more, about 10 trillion dollars I bet. America needs to give into the natural trend, have the dollar crash, hand the baton to Asia and be done with it. Not let all the world suffer for possibly years till a radical unforseen set of solutions is found to keep them in power, this isn't a war but I feel its seen this way.
    Reply
  •  
    Oct 10 08:11 PM
    Well, we cannot have a bottom without plenty of people saying we aren't there yet and others saying that it is all going to zero or some such nonsensical number.

    Just as the call for $250 oil was a good time to sell, the calls of the coming apocalypse are a good time to buy. Sure no need to go all in if you want. Me, I plan to go down swinging. No sense sitting out the last fight, if that's what it is.

    When things hit P:E of 1 (as some have) or a .25 price to sales ratio as others have, I think it is ok to start buying some things.
    Reply
  •  
    Oct 10 08:22 PM
    I got a feeling the G7 will conspire to let the market bottom out a little more before releasing their super plan, so it has the intended impact. Bet you my $5 nothing is actually done on Monday, probably not till the following Monday. I would bet more, but that's all I have left after trusting the president, "we are not going into recession" were his confident and precise words, what a monkey.
    Reply
  •  
    Oct 10 08:29 PM
    "we are not going into recession" were his confident and precise words, what a monkey. "

    Do you expect him to tell the truth when our economic system is based on FALSE confidence? "Yes, we lent out 90% of your checking account, but don't worry, you can have all of your money at any time."
    Reply
  •  
    Oct 10 09:22 PM
    Smarty Pants:
    Best. Post. Ever.
    Reply
  •  
    Oct 10 10:51 PM
    A market bottom has formed. Vix touched 70, put call equity ratio blew up over the roof and valuations are RIDICULOUSLY low. Governments are a cm short of guaranteeing every penny that goes through the financial system (actually they are by pledging putting the necessary capital into them). So, as soon as credit markets start rolling over again, which i expect to happen on tuesday after the governments pledge (normality is not needed, just a sign that it will start to run again), a huge rally will get underway. The market is in an extremely oversold condition and cash is piled up in the sidelines. Investors are SURE that the market is extremley cheap, but they don´t want to get burn´t in this downward spiral, but as soon as the market gets more stable buyers will pile up.

    One important thing to consider is that losses in the financial market are only nominal losses. Productive real assets are still there. People that demand products are still there.
    Reply
  •  
    Oct 10 11:09 PM
    I would agree that if you are going to sell to not stay out of the market for a long period of time. There are going to be companies, outside the financials, that have low debt and lots of cash that will prevail. Look for them and don't worry if you don't get the bottom price. These are historic times, but the U.S. is not going to sell out to the likes of China, Russia, and Europe. They have worse problems than we do in some cases. We have the infrastructure and resilience to weather this downturn and financial crisis. It is just going to take some time for the implementation of cash to work through the system. We still aren't done heading down in the overall market.
    Reply
  •  
    Oct 10 11:31 PM
    Not sure if I understand what this article is all about. Is this some movie review for the Star Wars trilogy?

    I accepted long ago that I don't know and will never know where the stock market bottom is. Instead of spending my time trying to buy stocks at the bottom, I find it much more productvie to figure out which great companies I can buy at attractive valuation.

    And let's not forget that buying a stock is only half of the equation, the other half, and probably the harder half, is to figure out when to sell.
    Reply
  •  
    Oct 10 11:55 PM
    Maria is the most annoying tv head,ever. That screeching voice comes to me in dreams..
    Reply
  •  
    Oct 11 12:34 AM
    Stagflation, stagflation, stagflation.
    Hyperinflation, inflation, inflation.
    So sad for our nation, our nation.

    For the bankers:
    just spam and bad rations.
    Reply
  •  
    Oct 11 12:50 AM
    concerning modern poets and fractional reserve bankers

    I loath them, loath them, loath them.
    I loath them hi and low.
    I loath them with a loath I loath.
    I loath those so and so's.

    I loath them in the morning.
    I loath them in the night.
    I'll loath them till I loath to loath,
    yet loath them more I might.
    Reply
  •  
    Oct 11 12:58 AM
    Smarty pants:

    that really was your best work yet! I read the post before checking the name...

    I knew it was you or curbs...

    I got my work cut out for me!

    moonbat, do it then!

    I'll have ya'll know, you keep me entertained I watch Karl Marx ride his horse into the white house...

    I can't wait to see our posts about those policies...

    Question: will the 'fairness doctrine' apply to blog posts?
    Reply
  •  
    Oct 11 01:19 AM
    Moonbat those are some nice rhymes
    Reply
  •  
    Oct 11 06:28 AM
    "Do you expect him to tell the truth when our economic system is based on FALSE confidence?"

    No, but there's no need to lie in such a convincing way, fooled the same people that he was trying to help.
    Reply
  •  
    Oct 11 09:18 AM
    Hey Beenaround,

    I have that date for you it's 12/21/12 per the Aztec calendar
    Reply
  •  
    Oct 11 11:56 AM
    So Moonbat, if you believe hyperinflation is coming, certainly you are not sitting on a pile of cash! How ironic it would be to see all that safe "cash" chewed to death by grinding inflation.
    Reply
  •  
    Oct 11 12:55 PM
    No Free Cake,

    Since I know government interference in the market place is only destructive and since I know they will continue to inflate, it is a no-brainer (convenient for me!) to guess we will eventually have hyperinflation or at least stagflation. No, I don't trust the USD. Eventually, the foreigners will get wise too.
    Reply
  •  
    Oct 11 12:57 PM
    Buy SSO and UYG right now. If it goes to $6, big deal. In six months it will $20. That's all that matters. No one ever got poor buying close to the bottom. The American economy will recover. That's why the dollar is strong. Because everyone on earth trusts the American economy.
    Reply
  •  
    Oct 11 01:06 PM
    "Because everyone on earth trusts the American economy. "

    Sounds like the "greater fool" theory.

    China, "fractional reserve central banking" is the "poison pill" of capitalism. Please move to 100% reserves or at least shoot bankers who go insolvent.
    Reply
  •  
    Oct 11 02:16 PM
    To capitulate, or not to capitulate: that is the question:
    Whether 'tis nobler in the mind to suffer
    The slings and arrows of outrageous losses,
    Or to take arms against a sea of sellers,
    And by opposing end them? To go bust: to lose more;
    No more; and by going bust I say we end
    The heart-ache and the thousand natural shocks
    That my brokerage account is heir to, 'tis a consummation
    Devoutly to be wish'd. To go bust, to lose more;
    To buy: perchance to reocver: ay, there's the rub;
    Reply
  •  
    Oct 11 02:21 PM
    Walleke, fantastic.

    Prepare another one for later. If you think the sell/don't sell is hard ... if you sell wait until you are faced with the decision whether to buy back in ... now, later, now, later, argh!
    Reply
  •  
    Oct 11 02:36 PM
    walleke,
    Brilliant!

    "... now, later, now, later, argh! "

    Ain't an unstable financial system great? But that is what people get when they accept a dishonest banking system.

    A "nation of stockjobbers" indeed! (Paraphrase or quote from T. Jefferson.)
    Reply
  •  
    Oct 11 05:12 PM
    "help us obe ben bernanke, you're our only hope". The traitor Sir Alan Greenspan is actually the sith lord.
    Reply
  •  
    Oct 11 07:24 PM
    Geez this the most literary thread on any finance board I've ever seen! pfffsssttt {Ray passes some gas}. Keep up the good work! Good night and good fight! Here in the Balkans where I'm posting from there was a bank run today (Saturday). Since foreigners usually are contrary indicators, that might be a good thing, though it also could mean the start of a European contagion... As for Star Wars, which frankly I've only seen the first one on TV years ago, I think Greenspan is Yoda ( the song by Weird Al comes to mind).
    Reply
  •  
    Oct 12 12:23 AM
    moonbat