Last week saw another wild, roller-coaster ride on the American stock markets. At one point, the Dow-Jones Industrial average sank below 7500 - within hailing distance of the 7200 low point of July 2002, and nearly 50% below its high-water mark of 14,100, recorded in October 2007. Investors all over the country have seen their funds and portfolios shrink by nearly that same percentage. Americans who sold out have lost trillions in investment wealth during the last year, including a significant share of that just during recent months. For those who didn't sell, the paper losses look pretty scary.
No government action - no matter how costly - seems able to turn the markets around. Every week or so brings new market lows, along with new calls for government to "do something". The "urgent" $700 billion bank bailout of early October apparently did nothing except pour $700 billion into a black hole. Banks who got some of that money are not lending it, but are waiting to see which other banks they can buy up, at fire-sale prices. Experts assumed that the election would stabilize markets, but that has not occurred. Stocks just keep sinking, as though on a greased slide. Even solid companies (e.g., General Electric) are priced far below reasonable value, based upon their profitability and business prospects.
After a week of sickening decline, the Dow closed just over 8,000 - up nearly 500 points. A late rally on Friday, November 21, followed Timothy Geithner's selection as President-elect Obama's Secretary of the Treasury. Some pundits and commentators believe that Mr. Obama's choice of a middle-of-the-road Sec-Treas might have stabilized the stock markets.
Well, let's hope so. We'll see what happens. Like thousands of hard-pressed fund managers, pundits, talk-show hosts and reporters, this modest investor has no clue what markets will do in this new week and the weeks following. My best guess is that the Dow and other markets will go up a little more, then slide back down again; go up a little, then drift gradually down (like a deflated balloon), perhaps ending Thanksgiving week under 8,000 once again. But who knows? This is only a guess, based upon previous market behavior.
Whatever happens, market "explainers" will continue to grasp slender reeds on which to hang wide market swings. When stocks go up, good quarterly profits from this or that corporation are said to have encouraged investors. (Today the word is that Fed moves have "cheered" investors.) When stocks go down, analysts blame losses by GM, or poor holiday-sales prospects, or a depressed rickshaw market in China. Rarely does anyone blame political "uncertainty" as the cause of investors' jumpiness. This is the "elephant in the parlor" no one wants to mention.
Mr. Obama's cachet is so high that few commentators dare suggest that his election has made investors very, very nervous. I believe this is so, however. While his public persona is impeccable and reassuring, investors don't really know which Obama is going to show up. Will he govern pragmatically and sensibly, from the center, as hopeful commentators claim? Or will he move leftward - toward socialism, more government regulation, higher taxes, "green" economics, and the destruction of disfavored industries, like coal - as his roots (and some of his comments) indicate? At this point, no one knows. We have very little data.
Economic news this fall has been terrible, starting with the Freddie Mac and Fannie Mae failures. These were spurred by the ingestion of too many non-performing mortgages by banks and traders in securities. America's Big Three automakers - Ford, Chrysler and General Motors - are also teetering on the edge of bankruptcy. Their requests for billions in loans from the U. S. Congress - unsuccessful, so far - had a touch of burlesque last week, when all three Detroit CEOs flew to Washington in private jets to plead their case with Congress. (It's difficult to convince lawmakers that your company is going bust when you're flying around the country in a private jet.)
Both political uncertainty and the bad economic news from financial and manufacturing sectors have caused wild swings in the market since late September, to be sure. But markets are also an "inside game" of their own. Big investors and traders use market movements - both up and down - to make money. Because these guys are so big, they can "lead" market swings. We call them Bulls and Bears, as though they are distinct parties who bet on markets going either up or down, respectively. Often, however, they are the same parties who control enough resources to lead markets in either direction. (Call them the Bully-bears.) All are savvy enough to sense both the mood of the investing public and the political and economic winds that affect markets.
Entire libraries of books have been written about these things, so this minor article will not add much to the reservoir of knowledge. Yet one sees very little written about bull/bear dynamics. My purpose is to help readers see that there is more going on than necessarily meets the eye.
The Bully-bears tap into the public's prevailing mood to move markets in ways that bring them short-term profits. When some event makes the public mood optimistic, the bulls buy big, causing markets to go up. This movement encourages millions of smaller investors to buy, pushing markets up farther. The bulls have their finger on the pulse of the market, so they know when the rally is tapering off. At that point they sell, taking profits and pushing the market back down. Small investors follow, trying to sell out before they get burned. As more sell orders come in, market indices drop and we are in another downward slide. This is merely short-term profit-taking, but the "explainers" will say markets dropped on lower-than-expected profits from Microsoft, etc. Then the cycle repeats, as it has done for much of the last year. Only the steady net decline in market indices suggest fundamental concerns that are rarely mentioned.
The inverse tactic, exercised by market movers and shakers, is called "selling short". The big guys engage in it when a negative event occurs, or when they sense pessimism in the investing public. In such cases, major players start selling, even when they don't have anything to sell. To do this, they take future "buy" orders in the expectation that when they will need to sell on the promised date, they will be able to pick up that stock at a price lower than they will receive when they sell it. They expect to be able to do this because they anticipate prices being pushed downward, in part, by their own large-scale selling. This will lead myriad smaller investors to sell as well. In effect, they can create the market conditions that will let their tactic succeed.
For example, sensing something in the wind, Ace Investing might offer millions of shares of Widget, Inc. - currently selling at 100 - at a price of 80, perhaps a month from now. Ace doesn't really have those shares, but some investors grab the offers because they look like a good price. Ace's large offering suggests that there might be a problem with Widget - or perhaps there is a known problem - so they begin to sell, too. Millions of Widget shares flood the market, perhaps collapsing the share-price to 50. Ace buys (at 50) the shares they need to fill their sell-orders, and sells those shares at 80. Ace pockets millions in short-selling profits.
In reality, profit margins are usually much smaller than in the example. When the dynamic extends across the entire market, it becomes a true Bear market. "Shorting" becomes SOP, as the declining market creates more of the conditions that enable the tactic to succeed.
Shorting is defeated when most investors refuse to be stampeded into selling out. When investors are optimistic, they buy up whatever is offered, leaving would-be short-sellers no low-priced shares with which to fill their sell-offerings, as they come due. If Widget is still selling at 90, for instance, when Ace is committed to sell millions of shares at 80, Ace will take a big hit. The tactic cannot work unless investors' general mood is pessimistic.
These dynamics apply to commodities, too. A closely watched one, during the last year, has been oil. It is instructive because it has gone through both a bull and bear cycle during that period. By July, traders had bid oil-futures up to the rarified (and patently absurd) price of $147 a barrel. Prognosticators assured us that oil would certainly hit $200 a barrel, although even Middle East oil sheiks knew the price should not be above $70. Congressmen declaimed, denounced, and viewed with alarm, but nothing seemed to arrest the inexorable climb of oil (and gasoline) prices.
Commodity traders, however, knew which signs would presage a reversal in oil's bull market. One warning shot was fired in July, when President Bush signed an Executive Order undoing previous orders signed by Presidents George H. W. Bush and Bill Clinton. The new order lifted a ban on offshore oil drilling. When Mr. Bush signed it, the price of oil futures dropped by $6 a barrel on the first day. A long slide - which turned into an outright crash - commenced (as I had predicted in "When Good News is No News"  on July 22).
Oil futures are now trading under $50 a barrel - nearly $100 below the July peak, and gasoline is selling under $2.00 a gallon. The crash was materially spurred by Congress's failure to extend its own offshore drilling ban, which has been included in the Department of the Interior's funding bill for 20+ years. Fierce political pressure from environmental groups could not get the ban extended. Coastal areas were thus opened to new drilling. Seeing the handwriting on the wall, oil traders - who were buying everything in sight six months ago - are now selling short. The mood of the oil market has been changed by current events and the promise of future events.
On a larger scale, and in a longer time frame, something like this has happened to our economy and our securities markets. First, there was optimism and ebullience. In late 2007, the Dow industrials average reached its highest level in history. The future seemed unlimited.
Then, the presidential campaign began, accompanied by a steady drumbeat of economic doom. Media reports began to say we were in a "recession", although the factual indicators denied it. Congressional Democrats did everything possible to prevent development of domestic oil resources, and the price of oil soared. Investors began to pull back, perhaps thinking that someone knew something they didn't. The long market slide began.
As Democratic candidates Hillary Clinton and Barak Obama squared off during their six-month primary, they fashioned programmatic proposals to address the economic situations of various states. One of these was Ohio, where many workers believe that the North American Free Trade Agreement (NAFTA) has hurt industries in which they work.
Pandering to this economic fear, Barak Obama "promised" that he would "re-negotiate" the NAFTA treaty. Although he later flip-flopped on this, investors internalized his apparent threat to undo one of the very tools that has helped the economy grow since President Clinton signed it. Mr. Obama hammered the Bush economy, claiming that things were in a terrible mess and that he would bring big "change", if elected. Markets waxed and waned, but gradually sank lower and lower.
Finally, serious events pushed the economy onto the slippery slope. Banks that had let too many mortgages to questionable borrowers, and financial institutions that had bought too many of those non-performing mortgages as securities, began to sag under the weight of those troubled instruments. Endangerment of the country's financial system brought full-scale panic to the stock markets. Wall Street bears made a killing selling short, as prices dropped in some cases to levels not seen since the 1950s. There seemed to be no bottom to the market, as both small and big investors sold out and took trillions in real losses.
This is where we are now. Hold-fast investors (like yours truly) are hanging on by their fingernails, wondering if the companies whose paper they hold will stay afloat or go bust. Anything construction-oriented is worthless. (e.g., shares of Hovnanian Builders' preferred stock - whose par value was originally $25 a share - are now selling for 40¢.) Century-old giants, like GM, are on the ropes. There is wild talk of salving "capitalism's demise" with massive government controls and irrevocable moves toward socialism. People who have worked all their lives to own a home and build a decent retirement wonder if they will have anything left. (I wonder the same.)
Mr. Obama now has the ball, and he has started naming his cabinet and his closest advisors. Knowledgeable insiders say his people are "centrists" who will steer sensible recovery policies. Critics say they are Keynesians who advocate massive "stimulus packages" (but not tax cuts) to bring the economy back.
The guy on Main Street doesn't know what to think or expect. He's just waiting to see which way the fish flops, hoping it's not rotten and won't stink up the joint.