WSJ: Ignore the Stock Market (until February)

Down in the morning, up in the afternoon. Or is it the other way around? The topsy-turvy stock market is tough to read.

In the last year, the Dow Jones Industrial Average has briefly been over 13,000 and below 8,000. The past month has felt like the Cyclone roller coaster on Brooklyn's Coney Island -- lots of ups and downs, the whole rickety thing feeling like it's going to crash at any minute.

Great investors are taught to listen to the market. Each tick of the tape has something to say about expectations for growth, inflation, policy changes and looming recessions. The stock market is like a giant mass of pulsing plasma doing price discovery and a game of hot potato, getting stocks into the correct hands with the right risk profile. It's way too big for any one person to manipulate, let alone touch directly. Instead, millions of us provide input with our buying and selling decisions.

When it's at its most efficient, with buyers and sellers neatly matched up at the right price, it's a pretty good predictor. The Crash of 1929 announced a recession, and the wake-up call unheeded might have caused many of the bad policies leading to the Great Depression. The Crash of 1987? Not so much.

You see, the market is a great manipulator. In September, the Dow dropped 700 points intraday after the House of Representatives voted down the Treasury's TARP bank-rescue bill. Spooked, the House passed the bill the next week. Or how about this? The Dow was up 300 points on Election Day applauding an Obama victory and then down 1,600 points since.

The market can also be a bold-faced liar. On Jan. 22, the Fed announced an emergency 75-basis-point rate cut in response to huge drops in European markets. A few days later, it came out that a rogue trader at Société Générale lost them $7 billion and the bank was unwinding his positions. Oops.

So which is it now: an efficient mechanism or a manipulating liar? Should you listen to it warning of doom or anticipating renewal? I'd say stick wax in your ears and don't listen to the market until February.

Don't get me wrong. The freezing of the credit markets is wreaking havoc on the world economy. Corporate profits are dropping. Central banks are fighting off deflation and may not turn off the spigots fast enough -- which could ignite runaway inflation. But because of the credit mess, I am convinced the stock market is at its least efficient today. Don't read too much into any move. Here are the five biggest dislocations taking place:

- Tax-loss selling: Whenever you have a loss in a stock -- and who doesn't -- it's always tax smart to sell it, take a tax loss and either buy something similar or wait 30 days and buy the original one back. December can be an ugly month of indiscriminate selling. The December effect will be huge this year.

- Mutual-fund redemptions: Mutual funds are also dumped for tax losses. When the stock market is down in the morning, it's usually because of mutual-fund redemptions.

Fidelity's giant Magellan fund, down 56%, is one of many in the $6 trillion stock-fund business having an awful year. As investors call or click to get out of these funds, Fidelity and the others have to unload shares the next morning to raise cash. This forced-selling overwhelms the system. New York Stock Exchange specialists, who are supposed to maintain an orderly market, stop buying and back away. You get huge drops, which can unnerve even more investors and cause them to redeem.

- Mutual fund cap-gain distributions: To make matters worse, in December mutual funds do capital-gains distributions. In a down year like 2008, you would think there are no taxes to pay. Think again. Legg Mason's Value Trust, run by Bill Miller, outperformed the market for 15 years by buying many "unvalue" names like Amazon. If investors redeem, he may be forced to sell many of these stocks originally purchased at very low prices, triggering further capital gains (the fund did a big cap-gain distribution already in June) in a year his fund is down 62%. You can almost guarantee investors also will sell more of these underperforming funds to pay their unexpected tax bill.

- Hedge-fund redemptions: Instead of overnight selling like mutual funds, hedge funds typically require 45 days' notice for investors to get out of a fund. They've been furiously selling since September to raise cash to pay investors. This usually shows up as a set of stocks that just go down and down and down with no obvious explanation.

Rubbing salt in hedge-fund wounds is the fact that Lehman Brothers was a prime broker to many hedge funds, holding their shares. While Lehman's bankruptcy was not a problem in the U.S., in England the policy is to freeze accounts until the mess can be sorted out. There are billions in assets locked in this bankruptcy, and hedge funds are forced to sell positions in the U.S. and elsewhere to raise cash, exacerbating the downside here.

By the way, when hedge funds are down for the year, they work practically for free until they make up the loss. We'll see hedge funds close and stocks liquidated as -- no surprise -- hedge-fund managers like to get paid.

- Margin calls: Whenever stocks go down sharply, you quickly find who owns them with debt. We have seen spectacular margin calls, a requirement for more capital to cover share losses. Chesapeake Energy CEO Aubrey McClendon unloaded 33 million shares to cover losses. Viacom CEO Sumner Redstone had a forced sale of $400 million in Viacom and CBS shares because of a margin call on other stocks. You can bet many not-so-public margin calls are behind many huge price drops. These usually take place in the last 30 minutes of trading.

So won't January be alright once these dislocations weighing on the market are lifted? The January effect is supposed to be positive.

Well, often money managers are fired at the end of disastrous years. A new manager comes in, looks at the existing positions and dumps them all and remakes the portfolio with new stocks that he likes, thus generating more selling. My favorite Wall Street adage suggests that the stock market trades to inflict the maximum amount of pain. Remember, you can only ignore the stock market for so long. Once everyone thinks it can only go down . . . it might go up.

Friday, November 21, 2008

http://cosmos.bcst.yahoo.com/up/player/popup/?rn=289004&cl=10776017&src=finance&ch=4043681

Comments

[Adam Smith]

Interest Rates [Credit] are the Cause and Consequence of the Explosion of Income/Wealth Disparities and, Hence, of the Inherent Instability of This Economy:

Chart of Long-Term interest Rates
http://www.17-76.net/opening.html#interest

The Ominous Keynes' Liquidity Trap
Origin of the Chaotic Black Thursday 29 October 1929

The Obvious Solution is to Abolish Credit

Our Short Run Solution
The Credible New World Economic Order:

A Credit Free, Free Market Economy

What Else?... What Is Exactly the Other Option?

What Have You Been Proposed Except to Wait and Suffer Till The Crisis is Over?

We Know That When People Will Be Left With no Other Option
They Will Join Massively Once The Stock Market Crash.

We Will Jump Start our Economy After

The Market Crash

AND

When 100,000,000 People Have Join.

Although the Number of Adopters Will Grow in a Chaotic Manner,
at the Image of the Crash Which Will Render it Necessary,
In Order to Minimize the Time we Will be Left Without an Economy,
It Is in Our Best Common Interest To Give a Wide Audience to Our System.

The Age of Turbulence: Adventures in a New World Economic Order.

A Credit Free, Free Market Economy
http://www.17-76.net/

✔ Introduction

✔ The New World Economic Order

✔ Numbered Account

✔ A Credit Free Currency

✔ Assets Transfer

✔ A Specific Practice of Employment, Interest and Money

1776 - Annuit Cœptis: http://www.17-76.net/

Consider your environment, print and give a wide audience to that document.

Should you need to contact 1776 - Annuit Cœptis please write to [email protected]

[Kurt Hinz jr]

Hi there.

Well put, that's why I stick to good old VIX/VXO/VXN volatility indices...
They're so insanely high right now, I never saw anything like it before.

Well, Mr. Market currently punishes the folks who thought the sky is the limit and the bottom-fishers since then. Sooner or later the bears'll get their Waterloo. February? Makes sense to me.

http://finance.yahoo.com/q?s=^VIX
http://bigcharts.marketwatch.com/advchart/frames/frames.asp?symb=VIX
http://stockcharts.com/h-sc/ui?s=$VIX

Best wishes, my 2c, kurt.

[A market learner]

Mr. Kessler, Thank you very much for your great insight. I wonder if you knew this coming and coming so violently.

[Jonathan]

Well-written and informative article! I'm 25, just getting into the market and this clears up a lot. Thank you!

[RichL]

Most of the comments are correct, but I doubt that there will be a great deal of retail tax-loss selling. Few investors have gains this year, and they don't need to offset the non-existent gains with tax loss sales. Not to worry, the other reasons are more than enough to cause discomfort!

[On Margin]

Interesting piece. Significant amount of noise out their for investors wade through. The link below is a compilation of articles/ interviews from prominent bears or value investors that readers might be interested in...

http://consequencesunintended.blogspot.com/2008/12/endless-bottom-picking_09.html

[On Margin]

Interesting piece. Significant amount of noise out their for investors wade through. The link below is a compilation of articles/ interviews from prominent bears or value investors that readers might be interested in...

http://consequencesunintended.blogspot.com/2008/12/endless-bottom-picking_09.html

[Margaret]

"Ignore the Stock Market Until February" was well thought out and appreciated.

I look forward to an update.

Thanks!

[ed]

February 27, 2009 and the S&P is at a 12 year low...

[Tom Smith]

They're so insanely high right now, I never saw anything like it before.