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Tag: market cycles

Jon Stewart, one of the most astute and insightful commentators of our time, explains the May 6th 2010 Flash Crash in this video from the Daily Show: A Nightmare on Wall Street

The Daily Show With Jon Stewart Mon – Thurs 11p / 10c
A Nightmare on Wall Street
www.thedailyshow.com
Daily Show Full Episodes Political Humor Tea Party

If you are a day, swing, or momentum trader, how would you trade in this market? Did trading on May 6th blow through all the sell stops on the order books?

Well, I have one friend who is an accomplished trader and he related his strategy regarding this issue. He refrains from trading if the market moves too violently or if there isn’t a clear reason for the market movement (e.g. a war, terrorist attack, major corporate bankruptcy, etc.)

One supposed benefit of an electronic marketplace and program trading by black box algorithms (algos) is market liquidity that would prevent just this type of collapse. The October 19th 1987 Black Monday crash was supposedly caused by computer program trading. It happened again this time — did we learn anything?

Or, as the saying goes:

History is the same events happening to new people who experience it for the first time as though it never happened before.

See the 13-page report below for my predictions for 2010 and more:

  • Stock Market
  • Real Estate Market: The next wave of ARM defaults? Is it time to buy yet?
  • Interest Rates: Stay low or heading higher?
  • Currency
  • Precious Metals
  • Commodities
  • Political: Will real reform be passed?
  • The Blame Game
  • Wild Cards
  • What’s the real problem and what are the potential solutions?
  • What would really shock me?

David’s 2010 Predictions

Related Post: 2009 Year in Review

Can good economic times last forever? Is it impossible to have “stable” economic growth?

This is the argument presented in Barry Ritholtz’s post: Galbraith: Financial Stability Creates Instability

Here are the essential points of the article.

  • When the economy is good for a long time, people then think the good times will continue indefinitely so they take extra risk (e.g. debt).
  • This additional risk eventually sows the seeds of the end of the economic expansionary period.

For example, during the 2000 real estate bubble, housing prices were thought to only go up, therefore the logical conclusion was for everyone to buy as much real estate as possible (by using financial leverage or debt) since this was an easy road to wealth.

Of course this speculation led to massive over construction of residential and commercial real estate. The resulting overcapacity caused falling prices which, as we now know, completely destroyed our financial system and the economy.

Interestingly, classically accepted econimics says that the economy can remain in a steady state – yet it never does, does it?  Ritholtz’s article explains what really happens.

Key Quotes

McCulley was referring to economist Hyman Minsky’s concept that long periods of stability cause people to take on ever more debt and ever more risk, leading to a gigantic meltdown.

Systemically-speaking, the Ponzi phase is one of risky behavior crowding out prudent behavior in a world free of regulatory controls. If risky behavior is temporarily rewarded with profit and this temporary period is long enough, then risky behavior wins and drives out good behavior.

Think we’ll remember this during the next bubble?

Related Posts

One of the most obvious signs of the market cycle being at its peak is when new people enter the market with no experience and DO WELL.

During the stock market bubble ending in 2007/2008, Lenny Dykstra, a baseball player known for tough play but limited intelligence had become a respected financial anaylst and investment guru (even endoursed by Jim Cramer).

Naturually there was no substance to Dykstra’s investment genius, just the tail wind of a massive credit bubble and rising stock prices.

Watch these 2 segments of the Daily Show below about Dykstra’s rise and fall as an “investment guru”.

 

Note the spots in the video where Dykstra says that he doesn’t read books because they hurt his head and where Cramer calls him “brilliant.”

It should come as little surprise that Dykstra has now filed for bankruptcy, is multiple millions of dollars in debt, and has dozens of lawsuits filed against him.

As a side note, Lenny Dykstra was endorsed and promoted by Jim Cramer who said Dykstra is “one of the great ones in this business.” That should have been a clue that there was probably no substance. Watch Cramer on video tape admitting to manipulating stock prices: Jim Cramer on The Daily Show.

Calculated Risk also posted about this story in this post – Daily Show: Financial Guru?

What do you think? Comment below and let me know.

Probably the biggest fundamental truth to any market is that markets rarely remain in perfect equilibrium Instead, markets (such as the real estate market from 1998 through 2009 or the stock market from 1996 through 2003) move through different stages of asset price levels, participant psyche, and fundamental value.

The following are what I observe to be the 6 changing stages of any market.

Stage #1: Pricing Supported by Fundamentals

  • Asset prices are in-line with historic norms.

Stage #2: Speculation Starts

  • Market participants identify the current trend and project that it will continue indefinitely — speculation starts.

Stage #3: “New” Pricing Justified

  • Asset prices are so distant from historic norms that they are justified by new economic theories.
  • For example, during the 1990’s tech bubble, higher price-earning ratios were justified and main stream media proclaimed that we were in a “new economy”.

Stage #4: Mania

  • When more and more buyers / speculators want to get in on the action, asset prices go through the roof.
  • Consequently, even “junk” sells as easily as quality assets as unsophisticated buyers are taken advantage of by deal promoters in sometimes fraudulent schemes.
  • Transaction volume and pricing reach levels that cannot be explained rationally.
  • For example, during the tech bubble many internet companies with no real revenue and/or profit went public with ridiculously high valuation (and failed quickly).  During the 2006 peak of the real estate market, “liar loans” and “flipping” were rampant.

Stage #5: Crash and Burn

  • There are few new buyers and no more “greater fools” so buying demand drops and asset prices fall rapidly and dramatically.

Stage #6: Never Again

  • Lessons are learned and new regulations are proposed or implemented to curb the abuses that “caused” the market crash.
  • Assset prices may be below long term economic value of the underlying asset.

However…

Despite many visible and memorable booms and busts, the odds are that we will NOT remember that market cycles exist; instead, most market participants will get caught up and participate in the next bubble.

“There is NO doubt that sometime in the future, we are going to have this conversation again.  It will not be for quite a period of time, but it will occur because the flaws in human nature are such that we can not change that.  It doesn’t work.”

– Alan Greenspan speaking in reference to the simultaneous collapse in the credit, stock and real estate markets in 2008.

Start over at Stage #1 and repeat the cycle.

What do you think?

Do you agree with the 6 stages I’ve identified?  What stage do you think we are in the real estate, stock or other markets you know of?  What are some market cycles you have observed in your lifetime?

Please comment and share your opinion.