October 23rd, 2014
Published Daily

Chasing Stocks As Rome Burns

by Rick Ackerman on February 19, 2008 9:21 am GMT

U.S. markets were closed Monday, but global action in some of the E-Mini futures contracts suggests that a significant number of traders may have spent the holiday weekend sniffing glue. How else to explain the 17-point rally that seized the E-Mini S&P (see chart below) in off-hours trading Sunday night and early Monday morning? That’s equivalent to about 130 Dow points, and Tuesday’s opening could pump even more hot air into the buying binge if the short-squeeze driving electronic markets takes hold of the NYSE and Nasdaq.

This egregious disconnect from reality is bound to seem even crazier to anyone who caught up on Wall Street Journals over the weekend. I spent the holiday skiing in Vail with a friend from New Jersey and his daughter, but I also imbibed the contents of a pile of newspapers that had accumulated to a disconcerting height, as newspapers often do. Two stories in particular left me feeling less than ebullient about the stock market. One concerned what Ahead of the Tape columnist Scott Patterson referred to as the housing sector’s ‘negative equity problem.’ Patterson’s belated epiphany is a good six months behind unmistakable manifestations of the problem itself, but his analysis at least puts the Journal on record as understanding the crux of the problem: ‘Amid the hand-wringing about complicated credit turmoil lately,’ he wrote, ‘the economy’s fate still hangs largely on something simple and understandable: the value of your home’

Alas, No Panic

Just so. But how long will it take now for the Journal’s editors to glimpse the speeding locomotive at the end of the tunnel? Will it be another six months before they acknowledge on the op-ed page that the mere easing of administered interest rates has not transformed the most dismal housing market since the Great Depression into the widely hoped-for buying panic?

The other Journal story that might, but for lack of enough readers, have tempered Sunday night’s brainless buying spree ran under the headline ‘Where Will the Crunch Hit Next?’ According to Heard on the Street columnists Liam Plevens and James R Hagerty, the mortgage insurers will be the next to get slammed. But this is old news, really, and these guys, like Patterson, are months behind the curve. For, the big crunch is coming not in mortgage insurance, but in the $45 trillion market for credit default swaps. Mish Shedlock has written insightfully on this gathering tsunami, and I have linked a recent article by him in the Intraday Notes section of Rick’s Picks.

Just Chicken Little?

Meanwhile, even as signs of financial collapse continue to mount by the day, some otherwise astute observers seem to think Chicken Little has merely raised the shrillness of his warnings. Closely capturing the current nuance of such skepticism is the most recent exchange between me and my pen-pal Fred Hapgood, who ought to know better, He writes as follows:

‘You have to understand that you have a very serious wolf problem here. I have been being lectured about the imminent collapse of the economy for the better part of fifty years, often by smart people who had woven together what seemed like a pretty convincing argument from the materials of the time. This experience has left its imprint: statistically speaking, it is undeniable that when a smart person tells you the economy is about to collapse, even when he can offer a very convincing piece of reasoning to back up his prediction, the chance that anything like that will actually happen is close enough to zero as makes no difference.’

My reply:

‘Your own, straightforward observations should have convinced you by now that the global financial system is indeed at risk. And I am hardly speculating to say so, since the day’s headlines are in fact increasingly concerned with the unmistakable events of an actual and ongoing financial collapse.

‘All along, you have been dismissive of my arguments merely because economic doomsdayers have been ‘wrong’ for so long. At this point, though, to protect yourself from the consequences of a potentially very severe economic dislocation, mightn’t it be more useful to consider the evidence, and to give the doomsayers their due, than to obsess over such niggling details as might falsify their arguments?

‘Concerning the black hole-like, $45 trillion credit-swap market, if you have reasons for optimism, I’d like to hear them. Perhaps you are in the too-big-to-fail camp? But that argument has lost all credibility with the knowledge that the mortgage exposure alone of quite a few banking giants greatly exceeds their capitalization. (Incidentally, B of A is a not very surprising newcomer to the list of problem banks. It had somehow dodged the bullet on mortgage exposure, but if you read the story I linked earlier, you’ll know that its credit-swap risk is enormous.)’

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