Friday, November 29, 2013

Stock Market Status

One characteristic of a bubble is that as it approaches its zenith, it ACCELERATES, because market participants no longer perceive ANY risk! They begin to think it's a "sure deal" and that they "can't lose". This phenom can been seen in this chart and in data that shows that stocks have been higher eight weeks in a row. No one even cares about the macroeconomic data any more!

Another sign of a bubble is that market participants are so sure that the market will continue to rise that they BORROW more and more money to pile in. Margin debt is now in record territory.

Still another bubble characteristic is that central bankers remain in denial throughout the ordeal! Just last week, Alan Greenspan wrote an article in which he still denies any responsibility or influence that was a causational factor in the housing bubble.

Still another characteristic of a bubble is that the media become cheerleaders for it! They have no desire to see reality return to the market, so instead they beat the drums for it to go even higher.

In fact, media people often ATTACK anyone who raises alarm bells. It may even become a death knell for the careers of people who wave the red flag. They are viciously attacked as "perma-bears" and treated with opprobrium.

Perhaps one of the best descriptions I've heard lately was from an analyst on Wall St that admitted that the stock market is now a "game of musical chairs". Everyone on Wall St is playing, just hoping that when the music stops and the bubble pops, THEY will individually survive the panic when it ensues. But unlike the real game of musical chairs, in the financial markets, there are only HALF as many chairs as market participants. That's because for every person wanting to SELL in a panic, there must also be a willing BUYER of those same stock shares or futures contracts.

What makes it even worse is that there is also something called "counter-party risk" or "third party risk". That's the risk that even if you CAN find a willing (but foolish) buyer in a collapsing market, that buyer might not be able to complete the purchase if they are losing money. Even if you sell at a profit, the counter-party to that transaction might not be able to complete it! This is one reason why derivatives are so risky. They escalate the counter-party risk geometrically. It even causes risks to other people that had nothing to do with the transaction at all.

In THIS game of musical chairs, when the alarm sounds and EVERYONE is running for the chairs, there is NO ONE willing to BUY during the panic. That means that chairs become mighty scarce when that moment comes. Then the risk increases geometrically like a tidal wave through the financial markets.