Why the Market Swoon May Become “Disorderly”

You’d think Wall Street analysts had other things to worry about these days. But no. A hype battle is brewing among them as to whether Apple or Google will be the first with a market capitalization of $1 trillion. In early 2000, the candidate was Cisco, before the very notion was obviated by events.

With the S&P 500 down only 6% from its September high, these analysts are not worried that Apple or Google would lose their footing like Cisco did in 2000. But beneath the surface, the bloodletting has been brutal. I received this note from an investor with decades of experience:

Subject: Holy Crap

In the past 5 days, I’ve hit 15 of my trailing stops. I just placed another batch of sell orders. All I have left is mostly cash, precious metals, and bonds. I had a lot of energy MLPs in my taxable account and they have been massacred – oil, gas, coal, midstream – everything. Buy-write funds ditto [funds that use a covered-call options strategy]. I have a few stocks left, but it’s pretty skimpy.

But one thing I’ve learned to never ignore: trailing stops despite fear of a whipsaw. I have always regretted waiting.

It wasn’t like this a week ago. On October 8, when the S&P 500 was just a good day below the magic level of 2000, UBS’s Intellectual Capital Blog explained it to the worried minions this way:

We’ve all read it somewhere (or maybe thought it): The recent dramatic small-cap underperformance must be some sort of signal. At a minimum, this must mean that: 1) it is time to abandon our long-standing small-cap overweight that we initiated in August 2012 or 2) the stock market is treading on thin ice, right? Well, as tempting as it is to believe that the market “must be telling us something,” the historical record is pretty clear and leads to the exact opposite conclusion.

In fact, a vicious rout in small caps – that’s what these folks mean by underperformance – “is actually fairly bullish for both smalls-caps and the overall market.”

I won’t even try to get this straight.

Not a minute passes by when someone doesn’t explain to us incredulous souls that something bad, some kind of rout or wholesale destruction or a sneeze from China, is actually bullish, that in fact everything is bullish, no matter what, for a myriad reasons, including that the Fed will do another round of QE and save us all.

So on Monday, after a whiplash-inducing intraday just-buy-the-frigging-dip rally that collapsed spectacularly, the S&P 500 skidded through its 200-day moving average. That’s a crucial line for chart decipherers and trend prophesiers. The Dow and the Nasdaq have done so last week. The Dow had five triple-digit days in a row, four down, and one rip-roaring Fed-induced rally that lasted less than a day. Long live volatility. It’s back.

But it hasn’t registered yet, apparently. Axel Merk of Merk Investments dryly tweeted: “Judging from few emails brokers have received about market volatility, odds are we haven’t seen anything yet.”

The last time the S&P 500 dropped below its 200-day moving average was in 2012, twice, but recovered quickly. It taught everyone that dips of this nature were nothing but a “buying opportunity.” Just buy the frigging dip became the rallying cry. It worked better than anything else, and the dips became shorter and shallower as dip-buying set in more and more quickly.

Other times, falling below the 200-day moving average has turned into a broadly observed sell signal. And that’s the problem with technical analysis: it generates momentum and self-fulfilling prophesies, on the way up, and on the way down. But then there’s the direction of the line, currently still going up. So far, so good. If the indices stay below the line long enough, they’ll push the line into a southerly direction. And that would be a sign for all to see that the chemistry of the market has changed. By that time, the “holy crap” investor above will have been resting on his cash laurels for a while.

But beneath the skin, it looks much worse than the benign 200-day moving average: 80% of the stocks in the Russell 3000 are 10% or more below their highs, according to Bloomberg. Many of them have gotten demolished. Some have gone bankrupt as the appetite for high-risk debt at these low yields is drying up [read… Credit Bubble Begins to Exact its Pound of Flesh: GT Advanced Tech Soars, Crashes, and Burns]. That’s the bloodletting in small caps that UBS said was “actually fairly bullish.”

Cali Money Man, a seasoned wealth manager who sat at various desks during the last three crashes and hasn’t forgotten the lessons, observed that a large-scale decline in stock prices may become “disorderly on a scale we’ve not seen since the crash of 1987.”

Why? “Too many poorly understood structural changes have created unstable markets. It’s been unstable rising, which we’ve enjoyed. Now comes the dismount”:

Low liquidity in a rising market (liquidity evaporates with prices).

Phenomenally low trading volume, largely covered up by enormous volumes of high-frequency trades and ETF arbitrage.

Massive hedge fund speculators only lightly restrained by regulations on leverage, but unrestrained on selling into down markets.

Low confidence in the economy by retail and professional holders (esp. Boomers who cannot take another large drop, their 3rd in 15 years).

Record high use of technical analysis systems, which will give near-simultaneous, widely followed sell signals.

The effect of the massive switch to fee-based accounts during the past 6 years. We’re now fiduciaries (no matter what the fine print says). Collecting fees on the way up then watching it all evaporate will not look good. Yes, we tell ourselves that we’re now long-term strategic asset-allocators, hand-holding financial planners, and wealth advisors. But we forgot to tell our clients. They still think we’re investment managers. Either we’re going to sell on the way down; or get sued if the market goes down big but does not bounce back like it did last time. My guess is that we’ll sell.

And if this occurs with rising rates – so both stocks and bonds drop – it will get ugly fast.

None of these reasons have anything to do with sky-high valuations and the sheer distance that asset prices can plunge from their perch; or with corporate and economic fundamentals, a slowing world economy, or the implosion of China’s property bubble. These real-world reasons come on top of Cali Money Man’s structural reasons why the decline could become “disorderly.”

For chart decipherers and trend prophesiers, however, nothing is ever quite this unidirectional. Short term, the market is at the highest level this year of “oversold,” having skidded so much in such a short time, according to Bespoke Investment Group’s Overbought vs. Oversold chart. Nothing goes to heck in a straight line. A bounce would surprise no one at this point. And if enough chart decipherers and trend prophesiers believe that, they’ll produce another self-fulfilling prophesy.

Bank regulators are now fretting about the subprime auto-loan bubble, caused by reckless lending. They’re worried it will damage the banks. But when this doozie pops, it will hit sales, manufacturing, production, services, railroads…. It won’t go away quietly. Read… Debris from Subprime Auto Loans to Ricochet across Main Street

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  15 comments for “Why the Market Swoon May Become “Disorderly”

  1. HD says:

    Subject: “Holy Crap”. I like that one, short and sweet. Wonder what kind of headlines we’ll be reading in the MSM when control will finally be lost. If (I won’t say “when”, because there’s no harm in hoping all will still end reasonably well) the implosion would turn systemic – involving banks and their wonderful derivatives game – I wonder if they have a plan B. Any thoughts on that, besides martial law and Fema camps?

    Wolf, I would be much obliged if you could delete my first comment, since I posted it unfinished by mistake. Which reminds me: is an “edit” button out of the question? Sure would be helpful in cases like these.

    • Wolf Richter says:

      No problem. Done.

      An edit button, as much as we would like one, is not part of this program. Someday, when I have some time (LOL), I need to look at other options.

  2. I can see Janet Yellen pacing in her office, wringing her hands with the TV on in the background …

    “What … ” she asks of nobody in particular, “what if bond-buying doesn’t work this time?”

    “Out, damned spot! Out, I say!—One, two. Why, then, ’tis time to do ’t. Hell is murky!—Fie, my lord, fie! A soldier, and afeard? What need we fear who knows it, when none can call our power to account?”

  3. jeffries says:

    If there are only a few human traders left and all the rest is done with computers then wouldn’t this negate fear trading? I am not that savvy when it comes to all this but am doing my best to figure it all out. What a complex game the financial industry has concocted- does anyone understand the big picture or are the experts in each financial division separated? I am tired- there does not seem to be much concern about real people who don’t want to make a killing- we just want to make sure we are not a burden on our families as we age. After experiencing the three downturns mentioned I am out and will never return.

    • Petunia says:

      On the tech side of HFT there is no one who understands the whole picture because it is a collage. Some are trying to exploit the market as a whole, others just a segment/industry, and still others a particular trading situation.

  4. economicminor says:

    Ah a bounce… and then the BTFD team will be happy… until they find out it was just a bounce.

    So shall we have a one day bounce or a real bounce of a week or so?

    How high? How long? Shall the eventual be strung out or shall the fear just start now.. The VIX says later.. VIX during the 2008/9 crash reached almost 50. It is still in the 20’s.

    My lines in the sand are a high around 1935 which is the bottom of the old channel and a low of 1860 which is the top of the old channel (both are time sensitive as they are upward channels). It is when we break decisively below 1860 that things get dicey. The bottom of the old channel, established from the 2009 bottom today would be around 1615..

    Below that? The old low of 2009 is a target IMO.

    • economicminor says:

      Yeah edit would be nice… 1935 is the bottom of the newer channel which started around Jan 2013

  5. NotSoSure says:

    But there’s a bounce today although USD/JPY doesn’t seem to be the driver. Will we see red again by the end of today? It’s POMO day though.

  6. Vespa P200E says:

    IMHO – QE3 will be extended indefinitely or new round of QE4 call it mother of all QE will be unleashed in Q1 2015 if the market goes berserk to the downside beyond say cyclical swoon to ugly global downturn which just may make Great Recession of 2008 look like child’s play.

    CBs of the world including China and US and even EU (Sorry Mario – no more OMT per bosses in Germany) went on liquidity binges AKA QE orgy for the last 6 years and every attempt to re-float the QE is having less of oomph and perhaps bigger hangover kicked down the road 1 too many times.

    Nasty downturn in global economy will result in common folks protest and the politicians will resort to more money printing in race to devalue to boost export leading to trade wars and real war to shift the focus from street protests.

    We indeed live in the interesting times…

    • economicminor says:


      What IF they continued QE Infinity and because it hasn’t really caused the desired results, that the market just pukes anyway?

      Because looking under the hood we see that the only real growth has been again fueled by subprime auto sales which you know as well as I do, this isn’t even a patch job but just out and out stupid fraud or con. Is it real growth when financials borrow money at the FED window at ZIRP and then buy US Treasuries with it and thus show a profit? Is it real growth when large corporations sell bonds to these same TBTF institutions who borrowed the money at ZIRP and repurchase their own shares? Where is the income growth to repay all this? So you buy something that goes down in value, Oh, you don’t have to use that lowered valuation on your balance sheet, just put that pig in Level 3 holding company so that it can grow into its future potential in maybe 2056.. after all, losses are only real when declared. Otherwise they are? Fake? Fraud? Shim Sham Flam?

      This may not be the time but there is going to be a time when the curtain is pulled back and the old man pulling the leavers is revealed. There was no Wizard and the gold street was just shiny paint over just red bricks.

  7. LG says:

    I would like to take the liberty and sum up all your comments.

    You can not print jobs or profits!
    You can however artificially inflate asset values by expending credit and the money supply.

    • economicminor says:


      For a while but not forever. At least not so far in history has that been done. Maybe this time it will be different but I’m not betting on that.

      This is a business cycle that has been artificially push way beyond any previous limits ever noted… I posted a piece on bubbles the other day. Here is a different perspective on cycles. https://cyclesman.com/audio-commentary/ed101214

  8. Orlando says:

    This article is very interesting, the comments are excellent! I think with a balance sheet at 30% of GDP, we are approaching the level of most banana republic central banks. If the market is crashing in order to goad the central bank into a new round of QE, this is going to be very risky. If the FED plays into this, it could be serious lights out for the entire world. Unlike the EU and Japan (and China!), the demographics of America are pretty good in terms of economic productivity (robots aside, of course). I think the FED will try to talk this through, but realistically they can not do anything as big as QE3.

  9. Vespa P200E says:

    Well, I checked out the CNBC app today and the these moronic quxotic chimp touts’ headlines read:

    1. The top 10 signs for when the selling is over
    2. Why the stock market sell-off may be nearing an end
    3. “Buy the dip” seems done: Sterne Agee technician (exhorting the buy the dip mantra)

    I’d say expect next leg down as fear – what fear?

  10. The Universe says:

    It is no coincidence that the second peak in US oil production occurred just before all this began.

Comments are closed.