Inside the Market Meltdown, Beneficiaries of the Plunge, An Oil Spill Opportunity and More!

by Addison Wiggin & Ian Mathias

  • An epidemic of “tickeritis” becomes a plague… The 5 makes sense of yesterday’s nonsensical market action

  • Beyond the nutty trades: Reasons the bull market is due for a rest

  • The dual beneficiaries of the plunge

  • “Asymmetrical warfare” — how the Coast Guard is approaching the big oil spill, and an opportunity to profit

  • Readers see conspiracy in yesterday’s market action… Our response, below


  Looking back, we recognize some interesting words showed up in yesterday’s issue, characterizing the market as of late:


“Gyroscopic action”


A “crazy market”

Little did we expect that moments after the issue arrived in your inbox, the market would take these terms to an entirely new level.

Down 1,000 points at its worst, the Dow recovered to a 350-point loss on the day.

And all because “M” is just a hair too close to “B” on a standard American keyboard, we’re told.

The story goes that a trader at a major firm perhaps mistyped a trade as “billions” rather than “millions.” Word is the trader works (worked?) for Citi, which Citi promptly denied.

But on what stock did the fatal trade occur? Because there was more than one crazy drop:

  • The accounting firm Accenture plunged briefly from $40 to $0.01

  • IWD, an ETF tracking the Russell 1000, fell off a cliff from $61 to $0.09

  • Procter & Gamble didn’t take nearly as big a fall — dropping to 37%, to $39 — but it’s a component of the Dow Jones industrials.

That was enough to trigger a wave of automated sell orders, pushing the Dow below 10,000. And once the 10,000 line was crossed, then a wave of automated buys kicked in.

Fun times, eh? Hope your retirement plans survived intact. Jeebus.

  Remember our update on the volatility index yesterday? It was already up to 25, from a two-year low of 16 less than a month ago. Then the dog day hit:

Get a load of this…

“And you thought stock prices were determined by buyers and sellers with live brains deciding the discounted current value of future earnings,” quips Dan Denning from his post at The Daily Reckoning Australia.

“To us, the big take-away from yesterday's U.S. episode is how, in the rush to digest and reprice news and information constantly, the market now appears susceptible to runaway feedback loops that swing prices and trigger buy and sell decisions automatically.

“This does not seem like an improvement in efficiency. It seems like a systemic vulnerability that could be exploited in the future deliberately to cause mass panic and wealth destruction.”

  Bear in mind this isn’t the same sort of program trading that contributed to the 1987 crash. The intervening 23 years have brought the practice to whole new levels of mathematical sophistication, with hubris to match.

“Yesterday’s roller-coaster market,” explains our stock market vigilante Dan Amoss, “made it even more apparent that ‘quant,’ or computerized, high-frequency trading exacerbates swings in the market.

“Rather than supply cash to the market during panics, and supply stock inventory to the market during melt-ups, it appears that these funds do the opposite. Quant trading relies on the same garbage-in-garbage-out models that created such wonders as ‘AAA’-rated CDOs.

“The physics and mathematics Ph.D.s that create and modify these models should do something more productive, like apply this math where it’s actually appropriate and predictive: in engineering problems, rather than markets that are heavily influenced by emotion.”

For the record, we take rating agencies to task in the next beta issue of Apogee. If you’re not yet in the program, enroll here. The first three issues — including the recommendations — are free.

  Oh, and, the SEC is promising to investigate. That is, as soon as its employees can tear themselves away from their usual practice of porn surfing.

  Of course, it’s easy to overlook what would have happened had the day been glitch-free. The Dow still would have likely shed 200 or 300 points as the Greek crisis came back into view.

Credit default swaps on European banks reached record levels yesterday — even higher than right after the Lehman collapse. The specter of a credit-market freeze is stalking the globe once again, if only in the shadows. The Richebacher Letter’s Rob Parenteau explains in an interview with Canada’s BNN you can see here.

  Too, the bull market was simply getting tired. “The market was overbought, ahead of itself and due for a correction,” Marc Faber told Bloomberg. He suggests taking advantage of any rebound to reduce your positions. With the Dow down 600 points in the last five trading days, “maybe we’ve made a major high in the latter part of April this year and that we will, from here on, have a more meaningful decline.”

Marc is back by popular demand for this year’s Agora Financial Investment Symposium in Vancouver. And today’s the final day to snag your early-bird registration discount.

  “This is what happens when a market with no investment merit at current valuations runs out of speculative fuel,” says Dan Amoss, expanding on Faber’s point.

“When governments and central banks manufacture the illusion of an economic recovery driven by deficit spending and money printing, the faith in the sustainability of that recovery is — not surprisingly — weak.

“Now, after two market crashes in the space of a decade, the list of greater fools is shorter. Mom and pop investors have largely chosen to sit out this cyclical bull market, making it very narrow and jittery, rather than broad and sustainable.

“After yesterday's drama, I think we can forget about the widely anticipated surge in mutual fund inflows.”

Dan can always spot a good short opportunity. Now he has a lot more to choose from. Stake your claim in this correction with a $1 trial of Strategic Short Report.

   Of course, if you’ve had your eye on a stock that looked a little pricey last month, we may well be near the time to jump in.

Ten days ago, Patrick Cox told his Breakthrough Technology Alert readers, “I’m strongly recommending that you get ready today for the next panic. Decide which companies you wish you’d bought when they were cheaper. Make a ‘rainy day list’ and be ready to act on it. Keep your powder dry and be ready to buy grossly undervalued stocks for the long run.

You can learn about Patrick’s list right here.

(As long as we’re talking about nailing this correction, yours truly was quoted in Futures two months ago: “The rally we’ve seen is one of the longest recession rallies in history and it’s not going to last, and when it starts falling, it’s going to fall pretty hard.” Patrick, Dan Amoss and I will all be in Vancouver this summer to share our strategies about where we go from here. Check out the full guest lineup.)

  So who are the beneficiaries when stocks perform the sort of high-diving act they did yesterday? Just what you’d expect…

Remember all that talk about the 10-year Treasury yield breaching 4%? That was so last month. This morning, the benchmark note sports a yield of 3.43%. A 30-year fixed mortgage can be had for almost 5% again.

The dollar index, for its part, is just a breath away from 85, near Panic of ’08 highs.

  Gold sits smartly at $1,200. Once again, the dollar and gold are moving up in tandem — a new twist to the “safety trade” that’s come into play only in the last three months or so.

A reminder: If you haven’t yet signed up for our next gold coin webcast, time’s a-wastin’. It goes live next Tuesday at 1 p.m. In addition to our friend Nick Bruyer at First Federal Coin, we’re getting input from experts at the two major coin-grading firms. You don’t want to miss this one. The event is free. Sign up here.

  U.S. stocks gyrated some more on the open this morning — down, then up, then down again. Clearly, the adrenaline from yesterday hasn’t worn off, else we’d be way up on this news…

  The first positive, if dubious, print on employment in 2½ years came in from the Bureau of Labor Statistics (BLS) this morning. The highlights…

  • 290,000 jobs added last month — 231,000 of them in the private sector

  • U-3 unemployment rose from 9.7% to 9.9%

  • The U-6 figure, including the underemployed, rose from 16.9% to 17.1%

  • The average workweek grew from 34.0 hours to 34.1

So why the rise in the unemployment rate?

The Labor Department games that number to exclude “discouraged workers” who’ve given up looking for work. Even U-6 excludes discouraged workers who gave up more than a year ago. As some of those people regain confidence and begin looking for work again, the labor pool gets deeper.

Oh, irony… the quants’ statistical sleight of hand is coming back to bite them, yet again.

Still, there are a number of positive take-aways…

  • Census hiring accounts for only one in five of the new jobs added last month

  • Even accounting for the Census, we’ve added substantially more jobs than the 100,000 needed just to keep pace with population growth. That hasn’t happened since November 2007

Of course, that’s assuming the numbers haven’t been gamed in other ways. Heh. We’ll find out next month when the revision gets filed away in some dusty backroom of 2 Massachusetts Ave. NE in Washington.

  “That makes it asymmetrical, anomalous and one of the most complex things we've ever dealt with,” says the commandant of the U.S. Coast Guard about the blowout and oil spill in the Gulf of Mexico.

The disaster has cast a cloud over the Offshore Technology Conference this week in Houston, where Byron King is in attendance.


“We are dealing in a battle space with no human access,” Adm. Thad Allen continues. “In fact, I call it ‘inner space.’ It’s more like Apollo 13 than the Exxon Valdez because we’re seeing everything with remotely operated vehicles.”


“It’s clear from Adm. Allen’s language,” adds Byron, “that he’s viewing the Deepwater Horizon disaster, and the following deepwater blowout, as the energy-equivalent of fourth-generation warfare.” If you’re not a military buff, that just means instead of conventional masses of troops lined up against each other, it’s a nasty guerrilla conflict.

“The Coast Guard boss has a mandate that includes protecting the U.S. coast and port facilities from acts of terrorism in an age of the same, so fourth-generation warfare is part of his worldview.


“Adm. Allen’s view includes his focuses on the robots, as well. If you’ve seen the movie The Hurt Locker, then you have a bit of a taste for how like the ordnance disposal guys in Iraq and Afghanistan, the energy players at the front lines of the Macondo well blowout perform tasks equivalent to ‘disarming’ bombs — or, in this case, the gushing oil well. Except they’re using remote operated vehicles that operate under 5,000 ft of water.”

Byron recently recommended one of the top ROV companies on the market. You can see his full write-up here.

  The deathblow has been dealt to meaningful audits of the Federal Reserve. Yesterday, its Senate sponsor, Vermont Independent Bernie Sanders, agreed to neuter his proposal to a one-time audit covering only the $2 trillion in “emergency assistance” since December 2007.

“His ‘compromise’ is what the administration and banking interests want,” our friend Rep. Ron Paul posted last night on Facebook. “They’ll allow the TARP and TALF to be audited, but no transparency of the FOMC, discount window operations or agreement with foreign central banks.”

And so it goes.


  “So in a computer-generated wave of selling,” a reader writes “the market goes into free fall and promptly drops 1,000 points! Then, miraculously, a tsunami of ‘buy’ orders bring it back 650 points. Volume numbers suddenly become unavailable? Are investors being played like a fiddle? The government's plunge protection team (Bernanke and Geithner) at work?

“Is the stock market being manipulated by the government the same way the housing and auto markets are? Are current stock valuations as phony as bank balance sheets and income statements?


“No, our government would never do that.”

The 5: You’re not the only reader who wrote in to suggest the Plunge Protection Team was working overtime yesterday. But in this case, the official story — incomplete as it is — is dreadful enough.

“I suspect after this weekend,” says our friend Barry Ritholtz, author of The Big Picture blog, “we will learn whether this was a high-frequency trading (HFT) error, or a futures/e mini error or some other factor.

“The fact is the big guys are often the dumbest investors in the room,” Chris Mayer reminded his readers this morning, “They’re the first to panic in a market decline and the first to buy back at any price during market rallies.

“As we know, price and value often swing wildly apart. And it is our theory — shared by many great investors — that price and value eventually come together. The best way to invest in the market is to buy value… and let price catch up.”

Enjoy your weekend,

Addison Wiggin

The 5 Min. Forecast

P.S. Lost in the shuffle of yesterday’s news was this item: Our friend David Walker, the former comptroller general, testified on Capitol Hill that by the year 2022, “the single largest line item in the federal government's budget will be interest on the federal debt."

And that’s assuming interest rates don’t rise.

If they do, “based on historical revenue levels,” the only thing the government could pay by 2040 is interest on the debt.

From this issue of The 5: Walker, Faber, Ritholtz, Mayer, King, Amoss, Cox, yours truly, Mathias and Gonigam will all be live in person at the Agora Financial Investment Symposium, July 20-23. The early-bird discount ends tonight at midnight.

Check out the theme, speaker list and topics to be discussed here. Sign up here. We’re filling up rapidly, so if you’re planning to attend, we suggest you take advantage of the early-bird registration before it expires. See you in Vancouver.


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