Stock Market: Chronicles of a Stock Crash

When individual investors jump in

Because as history makes clear, by the time individual investors are jumping in, that's the time the bull market is pretty much over. Individual investors are often the last hurrah, when most of the advance has already happened. (…) This is how sucker rallies draw people in. Once the most naive and least informed buy in, who else is left to drive prices higher?

Retail investors rush in. Uh oh., March 2006

When the money velocity is good, people order high-priced items

  • 2004-2005: Apple AAPL.O earnings grew at an increasing rate during a healthy economy, but the grow-rate declined later: check the EPS Growth(%) bars for AAPL online at
  • The actions of human beings spurred on by an increasingly ebullient social mood “create” rising earnings, and a bull market in stocks reflects the presence of such a mood. “This” direction of causality explains why the movements of aggregate stocks prices can almost always predict aggregate earnings. Rising earnings are the fruits of a bull market. When the fruit is ripe, the tree is already in its declining season. If you wait for the fruit to ripen in order to turn bullish on the trend of the tree, it is too late (Robert Prechter, A Call to Arms, 1994)

Credit expansion

  • 1990-1997: the Fed restarted the credit expansion process. They got a huge increase in consumer credit, they aided an enormous increase in speculation in credit markets and securities markets. They exported credit abroad, with U.S. banks becoming big lenders to emerging countries, and investors became convinced the growth rate in these countries was much better than it was in the United States. This credit expansion did not create inflation — unfortunately, because price inflation might have stopped the credit expansion (Terence Corcoran, January 1998)
  • 2006: Margin debt as a percentage of the S&P market cap has climbed to an all-time high. The previous peak? Early 2000, at the height of the Internet bubble (… and M)utual fund managers are holding about 3.38% less cash than they should be (Traders Narrative)

Disciplined investors accumulate cash

  • 2005: We are seeing a lot of managers, especially those for whom valuation is really important … build up cash stakes that are higher than historical averages … Many value-minded money managers have seen their cash levels rise over the last year amid a dearth of attractive investment opportunities. Even Warren Buffett's Berkshire Hathaway Inc. ended 2004 with $43 billion in cash equivalents. Having such a large cash stake is “not a happy position,” Buffett lamented in his annual letter to shareholders in March, but he'd “struck out” in attempts to find suitable investments (Meg Richards)

Risk is mis-priced

  • 2003-2007: as the economy and credit markets boomed, investors were clamouring for risk, taking on more and more for less in return. Optimism ruled. The most tangible result was that market interest rates dove to record lows relative to government bonds, with even risky products such as junk bonds earning investors a scant premium to “risk-free” debt such as Treasury bills (Boyd Erman and Derek DeCloet, February 2008)


  • In a bull market, professional money managers can add value relative to the benchmark, which is usually conservative (the short term lending rate, for instance). In a mania, no one can add value. Index funds win. (Robert Prechter, Bulls, Bears and Manias, 1997)

When the retail investors jump in,

  • stop all automatic dividend reinvestments: need to hoard cash for the next implosion in a few years
  • stop buying individual stocks — only buy indexes in a currency which is appreciating the most
  • stop making in-kind contributions to the RRSP

Must wait until the retail investors are gone, there is blood in the streets, war spoils are taken and everybody capitulates. This might take 1 to 3 years. Markets will have a nice ride now on and ETF indexes are the best way to enjoy the ride. Corporate earnings are growing more than usual.

Must wait…

RULE #1 is to never lose money

When retail investors are out

When retail investors are out, fear is investors’ default emotion. Regardless of the new piece of news or analysis that emerges, investors won’t fail to interpret it in the worst possible light—and will keep on selling. This is of course the mirror image of what happens during bull markets, when new news tends to be perceived as positive, and investors send stock prices to levels that, only in retrospect, turn out to be unsustainable high

Tom Browm, November 2007

Wait until the retail investors are out of the market

Retail investors are out

  • 2007: This phrase was said USA's 2007 Thanksgiving day at CNBC's Squawk Box
  • 2002-2003: The same was read in at the bottom of the Internet Bubble crash
  • We as individual investors are very afraid right now. Did you notice all the articles from us personal finance bloggers about the market throughout the year and the lack of them right now? (MoneyNing, November 2007)
  • The internet traffic directed to major electronic retail stock-brokers decreases (Babak, Barron's)

Bad news

  • Good news have limited effect on the markets. In previous months it was common a mix of bad and good news — no news is good news —, but by November 2007 all news look bad
  • When fear is the dominant emotion, often negative media stories and bearish analyst reports can have unusually large short-term downward impacts on stock prices — just like bullish stories and analyst comments have an inordinately positive impact during bull markets. The overreaction doesn’t become clear until time has passed. For example, a financial analyst's report (Meredith Whitney, CIBC World Market) caused Citigroup C.N to lose more than 7% of market capitalization in the first 30 minutes of trading in November 1, 2007
  • With the credit market crunch, a kind of gee whiz, delinquencies are higher sentiment comes in the media (JJ Hornblass, January 2008)

Discount-brokerage stock prices are very low

  • Ameritrade AMTD.O and E*Trade ETFC.O under-perform the indexes SPY.N and XLF.N when the individual investors are getting out
  • E*Trade ETFC.O: <$5 in 2002-2003 and again in 2007

Increased volatility. Retail investors eventually decrease volatility

  • Variability is more flat when there are more retail investors
  • Volatility increases as the retail investors get off and good and bad economic information hit the news in the Fall

Heavy selling volume

  • 1987: In October 1987, the price movements during the previous two trading days eliminated at-the-money options as stock options expired on the 3rd Friday. Investors could not easily roll their positions into new contracts for hedging purposes. This pushed more investors into the futures markets, where they sold future contracts as a hedge of falling stocks. Increased sales of futures contracts created a price discrepancy between the value of the stock index in the futures market and the value of stocks in NYSE. Index arbitrage traders took advantage of this price discrepancy to buy futures and sell stocks, which transmitted the downward pressures to the NYSE. There was a considerable imbalance of sell-orders relative to buy-orders (Mark Carlson)

Margin calls

  • A margin call is a like a snowball rolling down hill. Once a call is triggered it takes a disproportionate contribution to shore up the loan because for every dollar of collateral that is liquidated to pay down the loan there is one dollar less to securitize the rest. For example, suppose a lender holds $5 worth of stock as collateral for an $11 loan requiring 50% collateral - $.050 less than he holds. He calls in the margin and sells $1 in stock, reducing the loan to $10 but cutting the collateral to $4, only enough to support an $8 loan. It is indeed a slippery slope (Mortgage News Daily, March 2008)
  • 2007-2008: Banks are reducing exposure anywhere they can and the shortest way to do that is to cut leverage … The losses started in mid-2007, when prices of subprime loans, those to homeowners with bad credit histories, started tumbling because of a surge in delinquencies. The contagion spread to other credit markets, including bonds backed by student loans and credit cards and now mortgages backed by federal agencies, which have an implied guarantee from the U.S. government. Prices keep falling, with yields on mortgage-backed debt issued by agencies such as Fannie Mae rising last week to the highest level relative to U.S. Treasuries since 1986. Costs to protect corporate bonds from default are close to a record high … For AAA rated residential mortgage backed securities, banks have raised haircuts 10-fold in the past year to 20% (Bloomberg, March 2008)

Bond yields drop


The 3 month Treasury Bill rate is an important fixed income security because it is a remarkably accurate gauge of panic in the equities markets

  • Must wait until the day when the 3 month T-Bill yields are close to zero — it was 0.3% on September 2008, falling +50% in a single day —, negative when accounted for inflation, because everybody takes the money out of money market funds
  • Bond yields continue to drop as investors pile into safe government securities from the riskier stock markets, the fear of lower prices for shares is palatable, an indication that there may now be some capitulation in these markets. Capitulation is an indicator that the smart money is ready to move back in and buy under valued stocks, a driver that might see the higher move into the end of the year (Michael L. Levy, World Market Update, November 27, 2007)
  • The last 24 hours have been the most challenging for financial markets since World War Two. As equity markets tumble and volatility soars beyond tradable levels, the immense volume of safety buying has pushed short term US treasury yields to their lowest level since 1941. This has played havoc from interest rate spreads and forward points to commodity markets. The strain on the financial system has virtually stalled lending, as banks are so fearful of default, that lending to each other has ceased (Tobias Davis, World Market Update, September 18, 2008)
  • While government treasury bonds have increased in price as flight to safety has once again taken hold and the prospect of further rate cuts drives yields down, the same is not true for other debt instruments. (…) Muni bond issuances are being pulled (…) Private equity and their leveraged deals are now long dead. Problems at money market funds are once again making headlines. And banks are once again reticent to lend to each other, and for good reason, as evidenced by the rising spreads on interbank lending rates. LIBOR is once again soaring to distress-signalling levels, and the US two-year swap spread is the highest its been since 1989 (Sprott Asset Management, November 2007)

Once the retail investors are gone, the best time to go shopping in the stock market is between the 3rd Friday of November (OptEx) and before the U.S. Thanksgiving (4rd Thursday of November)

There is a huge uncertainty on the shopping season

When there is blood in the streets

Buy when there's blood in the streets and sell to the sound of trumpets

Baron von Rothschild

Bull Market Bashes End With October Crashes

Wait until there is blood in the streets

Bank failures: borrowers line up to withdraw their cash

  • 2008: IndyMac fails, the seventh bank to fail since the credit crisis began last summer 2007, and the second-largest bank to fail in the Federal Deposit Insurance Corp.'s 75-year history. At this time, stocks in nearly all the nation's banks were clobbered Monday July 14, 2008, as the market bet that there will be more failures. (AP, July 14, 2008) Government officials closed down IndyMac on Saturday July 12, 2008, citing a massive run on deposits by worried customers. All 33 branches of the Pasadena-based bank closed three hours early, locking out hundreds of jittery investors hoping to withdraw their savings before it went under (…) IndyMac, known ironically as a “thrift” bank, becomes the second-largest savings firm in US history to go under, after the Continental Illinois National Bank and Trust Company, which collapsed in 1984. The latest failure was caused by massive losses in the so-called “foreclosure crisis”, which has seen huge numbers of property owners defaulting on mortgages taken out at the height of the property bubble (NZ Herald, July 14, 2008) IndyMac is the fifth U.S. banking company to fail this year, and the largest since the 1980s savings-and-loan crisis (Reuters, July 2008) IndyMac announced one week before that that needed to slash its workforce by 53% after regulators said the company is no longer “well capitalized” and the quarterly loss widened. “We don't expect to be able to raise capital until there is more stability and less uncertainty in the housing and mortgage markets,” Chief Executive Officer Michael Perry said in the statement (Bloomberg, July 7, 2008)
  • 2008: Stocks plummet; Massive bank failures; Banks in deep trouble; 300 banks could fail within the next three years: heard on TV on July 14-15, 2008: ABC's Good Morning America and CBS's Early Show (Kelly Brown, July 15, 2008) Comparing economic conditions to the Great Depression is a common theme for the media: the Business & Media Institute's The Great Media Depression found networks made the comparison more than 40 times in early 2008 (Kelly Brown, July 14, 2008)
  • 2007: On Sept 13, 2007, Northern Rock PLC, the fifth largest mortgage lender in the UK, requested from the Bank of England (BoE) emergency funding after facing a liquidity crunch. It was reportedly a temporary financial hiccup — Northern Rock was still solvent. This case is unique in that despite being quite healthy, depositors still rushed to withdraw their deposits from their savings at Northern Rock, creating a bank run that captured headlines around the world. Long queues were seen outside Northern Rock branches as depositors lined up to take out their savings. People did not seem to register that Northern Rock, despite being solvent and having capital above the regulatory requirement, was facing a liquidity problem because of its poor business model — it was overly reliant on wholesale markets for funding (Jean Pierre Sabourin)
  • 1984: According to the FDIC, Continental Illinois grew its business loans 180% between 1976 and 1981. It grew fast without regard to risk. In so doing, it took a big portion of risky oil and gas loans originated by Oklahoma-based Penn Square — that was heavily exposed to the energy sector when it imploded in 1982. Continental Illinois' $1 billion exposure to bad Penn Square loans caused investors to lose confidence — taking Continental Illinois down with it. A great book about the failure of its business partner, Penn Square Bank, Belly Up, reveals the important role of syndication — originating a loan and then selling it to someone else — in the failure of financial institutions. The lesson is that in finance, rapid growth, without regard to risk, often leads to even more rapid collapse (Peter Cohan, July 11, 2008)
  • “Failed banks are a lagging indicator, not a leading indicator,” said William Isaac, who was chairman of the F.D.I.C. in the early 1980s (…) ‘`So you will see more troubled, more failed banks this year’ (NY Times, July 2008)
  • Texas Ratio. Gerard Cassidy and his colleagues at RBC Capital Markets have developed an early-warning system for spotting future trouble at banks called the Texas Ratio. The ratio is calculated by dividing a bank's non-performing loans, including those 90 days delinquent, by the company's tangible equity capital plus money set aside for future loan losses. The number basically measures credit problems as a percentage of the capital a lender has available to deal with them. Cassidy came up with the idea after covering Texas banks in the 1980s. Until the recession hit that decade, many banks in the state were considered some of the best in the country. But as problem assets climbed, that view was cruelly challenged, Cassidy recalls. The analyst noticed that when problem assets grew to more than 100% of capital, most of the Texas banks in that precarious position ended up going under. A similar pattern occurred in the New England banking sector during the recession of the early 1990s, Cassidy said (Alistair Barr, May 2008)

Large-cap CEOs are fired

When the capitalist system fails, capitalists don't look for system failures. They look for human devils who have mucked up a perfect system

  • 2007: Merrill Lynch MER.N ousted the CEO after announcing massive write-downs for the sub-prime mortgages, asset-backed bonds and loans, equivalent to 13% of the market value, exceeded Merrill’s net earnings for all of 2006 and equated 42% of gross revenue in the first nine months of 2007.
  • 2007: Swiss-based UBS AG, Citigroup C.N and H&R Block CEOs were also fired. Wall Street firms dismissed top executives as overdue payments on sub-prime mortgages rose and foreclosures set a record
  • 2008: Wachovia Corp. WB.N ousted CEO Kennedy Thompson of the fourth-largest U.S. bank after the board blamed him for losses that cost the lender more than half its market value in the past year (Bloomberg, June 2, 2008)
  • 2008: List of CEOs deposed during the credit crisis: Merrill Lynch & Co.'s Stanley O'Neal, Citigroup Inc.'s Charles Prince, Marsh & McLennan's Michael Cherkasky, Bear Stearns Cos.' James Cayne, Ambac Financial Group Inc.'s Robert Genader, MBIA Inc.'s Gary Dunton, Wachovia Corp.'s Ken Thompson. Must add: AIG's Martin Sullivan (CBC)
  • 1987: Bank America BAC.N fired its CEO as it dealt huge losses by the placement of a series of bad loans in the Third World, particularly in Latin America

Forced selling

  • The credit cycle denial phase is reflected in the willingness of a bank to issue highly dilutive equity and investors’ willingness to buy it at a significant discount. In contrast, however, at the bottom of credit cycles the willingness of a bank to issue extremely dilutive equity is met with investors’ unwillingness to buy bank equity at any price. (…) But should the economy continue to deteriorate (…), the banking system will once again require further capital and the “denial” that once joined bank issuers and investors together will be transformed to fear. And with that capital will be raised not through equity issuance, but through sales of non-credit assets at fire sale prices. Those able to throw good assets overboard will survive. Many will not be so lucky and will end up in the arms of the regulators (Minyan Peter)
  • In a liquidity crisis, there is a market shock that forces investors who are highly leveraged to liquidate. Their liquidation drops prices further –- remember the market already had some sort of a shock, so it doesn’t take much to move prices down more -– and this causes even more forced selling. You end up with a downward spiral in prices. This is helped along because some of the people who might be natural buyers run for the sidelines. The end result of this cycle is that prices are determined by liquidity issues, not by value (Rick Bookstaber)
  • 2007-2008: The Gulf Arab emirate of Abu Dhabi bought 4.9% of Citigroup C.N for $7.5B (NYT, November 2007). Citigroup C.N also received $12.5B from the Government of Singapore Investment Corporation, Capital Research Global Investors, Capital World Investors, the Kuwait Investment Authority, the New Jersey Division of Investment, shareholder Prince Alwaleed bin Talal of Saudi Arabia and former chief executive Sanford Weill and his family foundation (AP, January 2008)
  • 2007: Abu Dhabi bought 7.5% of Carlyle Group for $1.35B, at a 10% discount (FT, September 2007)
  • 2007: E*Trade was forced to sell a portfolio of asset-backed securities consisting mainly of prime mortgages at 27 cents on the dollar (FT, November 2007)
  • 2007: Ping An Insurance (Group) Co 2318.HK, China's 2nd life insurer, bought a 4.2% stake in Dutch-Belgian financial services firm Fortis FOR.AS (Reuters, November 2007)
  • 2008: Lehman Brothers LEH.N sold $4B of debt (Reuters, January 2008)
  • 2007-2008: Merrill Lynch MER.N received $6.2B from Singapore's Temasek Holdings and Davis Selected Advisors for newly issued common stock (RTTNews, December 2007). It also got $6.6B in exchange for a 14% stake, from the Kuwait Investment Authority, the Korean Investment Corporation, and a unit of Japanese bank Mizuho Financial Group Inc; they received preferred shares worth $52.40 each, with a maturity of 2.75 years and an annual dividend of 9% (ABC, January 2008)
  • 2007-2008: Bears Sterns BSC.N and China's CITIC Securities Co 600030.SS exchanged stakes for $1 B (Reuters, October 2007) — this was later cancelled (Reuters, March 2008)
  • 2008: Lenders to Carlyle Capital Corp. Ltd. CCC.AS liquidated securities held in its US$21.7-billion portfolio since it was unable to meet margin calls from four banks. Carlyle Capital leverages its US$670-million equity 32 times to finance a $21.7-billion portfolio of AAA-rated residential mortgage-backed securities (MBS) issued by U.S. housing agencies Freddie Mac and Fannie Mae (AOL, March 2008). It eventually collapsed: Carlyle shareholders were left with nothing (Peter Cohan, March 2008). Carlyle Capital's share price plunged 58% in just one day in light trade to $0.30. The initial public offer price 10 months before was $20 (Reuters, March 2008)
  • 2008: Peloton Partners, a $3bn (£1.5bn) hedge fund run by former Goldman Sachs star traders, was forced to liquidate its two investment funds when it became apparent that they could no longer meet margin calls from investment banks. Focus Capital, an award-winning US-based hedge fund, has liquidated some of its biggest positions, raising fears of another implosion in the high-rolling sector. After taking a series of significant writedowns over last couple of weeks, the Bank of Montreal BMO.T is facing still another $500 million in write-downs after failing to meet margin calls on two of its trusts. Thornburg Mortgage TMA.N was forced to pay $300 million in new margin calls (Mike "Mish" Shedlock, March 2008)

Huge loses on paper

  • 2007-2008: The following is a list of banks' write-downs of sub-prime mortgage loans, leveraged loan commitments, and other assets since September 2007 up to January 15, 2008. Major banks have forecast or announced more than $75 billion of write-downs and losses (Ed Leefeldt), (BBC), (BBC):
Date Bank Write-down credit loss Type of loss
Merrill Lynch $22.1 B
UBS $13.5B
Bear Stearns $3.2 B
JP Morgan Chase $3.2 B
Jan 15, 2008 Citigroup $18.1 B subprime mortgages
Jan 15, 2008 Citigroup $4.1 B consumer loans
Dec 20, 2007 Bear Stearns $1.9 B subprime mortgages
Dec 19, 2007 Morgan Stanley $9.4 B mortgages and assets
Dec 13, 2007 Lehman Brothers $830 M real estate, asset-backed securities
Dec 12, 2007 Bank of America $3.3 B collateralized debt obligations
Dec 12, 2007 Wachovia $1.1 B subprime mortgages
Dec 10, 2007 UBS AG $10 B subprime mortgages
Dec 6, 2007 Royal Bank Scotland $2.5 B investment banking
Nov 20, 2007 Freddie Mac $2 B bad loans and loss
Nov 15, 2007 Barclays $2.6 B subprime mortgages
Nov 14, 2007 HSBC $3.4 B bad loans
Nov 13, 2007 Bank of America $3 B
Nov 13, 2007 Scotiabank C$135 M asset-backed commercial paper and structured credit
Nov 13, 2007 Royal Bank Canada C$160 M subprime mortgages
Nov 8, 2007 BNP Paribas $197 M
Nov 6, 2007 Capital One $4.9-$5.5 B credit losses
Nov 1, 2007 Credit Suisse $1 B bad debts
Oct 31, 2007 Deutsche Bank $3.2
Oct 30, 2007 Merrill Lynch $7.9 B
Oct 15, 2007 Citigroup $5.9 B subprime mortgages
Oct 5, 2007 Merrill Lynch $5.6 B
Oct 1, 2007 Citgroup $310 M subprime
Oct 1, 2007 UBS AG $3.4 B fixed income and rates division
Sep 4, 2007 Bank of China $9 B subprime loses
Sep 3, 2007 German regional lender IKB $2.6 B exposure to the US sub-prime market

Dividend cuts

  • Banks with lower Tier-1 capital ratios will cut dividends first. Must check their FDIC scores before to decide which one to buy
  • Average dividends are historically around 4%: when price drops too much, dividend yield becomes too high and will revert to the mean
  • 2007: Citigroup C.N cut dividends from 7.37% to 4.37%: $0.54/q to $0.32/q (January 2008); the first time since 1990
  • 2007: National City Corporation NCC.N cut its dividend 49%: $0.41 to $0.21 per quarter (WAVE3, December 2007) It later slashed the dividend to $0.01/q and agreed to sell a $7 billion stake to investors led by Corsair Capital LLC at a 40% discount (Bloomberg, April 2008)
  • 2007: Washington Mutual WM.N cut dividends from 7.14% to 4.59%: $0.56/q to $0.15/q (December 2007); they decreased the dividend also in 1992 and 2001, but not more then 40%
  • 2008: UBS AG cut its dividend by a third (Zurich, April 2008)
  • 2008: Wachovia Corp. cuts its dividend by 41% to $0.375 per share from $0.64 cents, to save $2 billion annually in order ``to build capital ratios and provide more operational flexibility". It is also raising $7 billion in a share sale after reporting a surprise first-quarter loss of $393 million (Charlotte, April 2008)

Quarterly profits drop 30-60% on highest quality names; more on others

Name Symbol Profit/Earnings Fall (less is better) Notes Source Date
American Express AXP.N 10% Reuters January 2008
Banco Santander STD.N 6% Spain's largest bank AP February 2008
Bank of America BAC.N 95% Barron's January 2008
Bank of New York Mellon Corp BK.N 72% Reuters January 2008
BB&T Corp BBT.N 6% RTT January 2008
Commerce Bancorp CBH.N 47% South Florida Business Journal January 2008
Natixis SA CNAT.PN 50% France's fourth-largest bank Bloomberg February 2008
Deutsche Bank AG DB.N 48% Germany's largest bank Frankurt February 2008
Fifth Third Bancorp FITB.O 42% 53 January 2008
JPMorgan Chase JPM.N 34% Reuters January 2008
M&T Banc Corp MTB.N 70% BW January 2008
PNC Financial Services Group Inc. PNC.N 53% ROB January 2008
UBS USBN 79% first quarterly loss in nine years Swissinfo February 2008
US Bancorp USB.N 21% AP January 2008
Wachovia WB.N 98% WSJ January 2008
Wells Fargo & Co. WFC.N 38% the lowest profit in six years AP January 2008

It's only when the tide goes out that you learn who's been swimming naked

Warren Buffett

When war spoils are distributed


It's not risky to buy securities at a fraction of what they're worth

Warren Buffett

After the war, the stronger survivors take possession of war spoils

  • 2008: Let’s reflect on this week just for one moment. Lehman’s – GONE. Merrill’s – SOLD, AIG - NATIONALIZED, Washington Mutual – IN TALKS, Morgan Stanley – IN TALKS, HBOS – BEING BOUGHT. If you would have said that these sorts of collapses / mergers would happen in 1 week, along with global central banks pumping $US250 billion into the financial system I would have laughed. The world works in funny ways, and we have witnessed a 1 in 100 year event this week (Tobias Davis, 19-SEP-2008)
  • 2007-2008: Bank of America BAC.N purchased Countrywide Financial CFC.N for $4B in an all-stock deal to rescue the biggest mortgage lender in USA (25% market share) from bankruptcy (Herb Greenberg, January 2008) with help from the government (J. Richard Finlay). Countrywide shares were valued at 52-week low $7.16 a piece, a huge discount from 52-week high of $45.26 (Reuters, January 2008): customers and assets are transferred from losers to winners and losing share-owners paid the party
  • 2008: JPMorgan Chase JPM.N acquires Bear Stearns BSC.N for $2 a share in an all-stock deal — 99% below its all-time high of $167 a share in February, 2008. This is only about 25% the value of the Bear Stearns building in New York: JP Morgan got 75% of the building and Bear Stearns' entire business effectively for free. Book value = $80/share. The Fed is financing $30B of Bear Stearns' less liquid assets, so that JPMorgan will not be infected and be hit be a liquidity run as well. Founded in 1923, Bear Stearns was the nations' 5th-largest investment bank. A week before, Bear executives were talking about how the firm was poised to report a profitable first quarter, after the firm posted its first quarterly loss in its 83-year history in Q4 2007 (BW, AP, WSJ, March 2008). “Dude. $2 a share” represents a nominal price paid to Bear's shareholders in the absence of any alternative — beggars can't be choosers (Felix Salomon). Unfortunately there is no alternative — Bear goes bankrupt tomorrow if someone doesn’t “back” them, and he Fed forced this: if Bear goes bankrupt every counter-party freezes and consequently the market (Bye Bye Bear). The US investment bankers are all tied to each other through positions on each other’s books. If one (like Bear Stearns) goes down, they could all go down. The Fed has little choice but to step in and provide support to the healthier banks so the damage to the financial system can be contained. The Fed did the same thing in 1998 when it protected the banks from the collapse of Long Term Capital Management, the hedge fund that lost $4.6 billion in just a few months (Paul Lennox, World Market Update - North America, 17-March-2008) (More Rumors) — In the other side, there is severe overcapacity in the fixed income and investment banking businesses as volumes have decreased significantly. In addition, their expertise in mortgage-related fixed income could take many years to recover. They don’t have the time for the markets to recover. They are also facing severe credit and market price issues that could overwhelm the operating earnings issues. Banks are slowly starting to restrict their business lines with them. Therefore, their credit lines are shrinking and financing costs are rising. Revenues will decrease because fewer counter-parties are dealing with them and the markets and economy are slowing. Expense reductions can’t keep up so operating margins are squeezed on the top and bottom line. Staff are demoralized because of the stock dropping. Investors like Joe Lewis and CITIC have been burnt severely. The track record doesn’t justify new additional capital (Hammer)
  • 2007: JPMorgan Chase JPM.N was rumored to acquire Washington Mutual WM.N, Suntrust Banks STI.N or PNC Financial Services PNC.N by year-end (Charlie Gasparino, January 2008). Washington Mutual WM.N previously slashed its dividend payout 73% to $0.15 a share (Reuters, December 2007)

Banks cannot enter into bankruptcy. Critically under-capitalized banks are placed either into conservatorship or receivership. Significantly under-capitalized banks (the next level up from critical) are required to raise more capital or are required to accept offers to be sold

Insiders buy Banks and Financials

  • There are many reasons to sell, but there's really only one reason to open your wallet and buy stock… you think it's dirt-cheap and likely headed much higher in price. (…) Stock buying by insiders at banks, consumer lenders and insurers in the S&P 500 index jumped recently to the highest level in 12 years. That's the strongest “buy signal” I've seen for banks since the aftermath of the Savings & Loan crisis. This aggressive buying has occurred even as bank shares slide into a black-hole of mounting subprime mortgage losses. Insiders are in the best position to know how well their businesses are performing (Mike Burnik, March 2008)

Eventually, the risk appetite starts to normalize but nobody notices it

  • 2008: The London Interbank Offered Rate (LIBOR), the rate at which banks loan funds to each other has climbed to a record high this morning blowing out a full 431 basis points to 6.88%, a far cry above the Fed's target of 2.0%. Euribor, the Euro rate for one month rates rose to the highest on record as well highlighting the funding constraints in the market (Tyson Wright, 30-SEP-2008)
  • 2008: US 3-month T-Bills yielded 3.25% in early 2008, so the LIBOR/T-Bill spread was 139 basis points (1.39 = 4.64 - 3.25%). The spread was over 220 basis points at its widest last fall in 2007: that premium finally appears to be narrowing (Paul Lennox, World Market Update - North America, 03-JAN-2008)
  • The LIBOR/T-Bill spread is a good indicator of the money market risk premium, and that premium finally starts to narrow. The LIBOR rate is the rate banks generally borrow from each other at and it is also the base rate for many corporate loans and debt structures. It’s one thing for the Federal Reserve to be lowering the Fed funds rate and for T-Bill rates to fall, as this is the rate the government borrows at and is considered the market’s “risk-free rate”. LIBOR is an indicator of where the real market rates are for banks and corporations and it is important that that rate is starting to follow the Fed Funds rate and the T-Bill rate lower

When everybody capitulates

CAPITULATION = everybody selling

An ugly day for the markets: exchanges around the world fell 5%-10% the same day (every week)

  • 2007: The worst recession in 10-25 years: said on TV, BNN, January 21, 2008
  • 2007: Selling across the board: said on TV, CNBC, January 21, 2008
  • 2007: An ugly start to the week on a global level, with several world indexes dropping 4-5% overnight (Opening Bell, January 21, 2008). Stocks lost value in 42 of the 43 nations with widely followed markets; the only exception was Sri Lanka (The Record, January 22, 2008). The selling began in Sydney (Sean-Paul Kelley, January 21, 2008). Asia-Pacific: Australia's S&P/ASX 200 was down 2.9%, marking an 11-day losing streak that is Sydney's worst since January 1982. Hong Kong's Hang Seng index plummeted 5.5%, its biggest percentage drop since the September 11, 2001, terror attacks. Mainland China's Shanghai Composite index plunged 5.1%. After margin calls were triggered, people are offloading, or are being forced to offload, long positions. The loss was likely triggered by U.S.- and Europe-based funds retreating from Asia's deepest and most liquid markets. In Tokyo, the Nikkei Stock Average dropped 3.9%. We have already lost so many points, it's as if we have no more hair to lose and no more blood to bleed. India's Sensex (BSE-30) dropped nearly 11% before rebounding to close down 7.4%, the second-worst single-day tumble in its history. Markets in South Korea, Taiwan the Philippines also fell. Singapore's FTSE Straits Times index was down 3.5%. Indonesia's benchmark index fell 4.8%. So far this year, Japan's Nikkei-225 has dropped 13%, Hong Kong's Hang Seng is down 19%, Singapore's FTSE Straits Times index is down 18.9%, and China's Shanghai has slipped 6.6% and nearly 20% from its all-time closing high on last October 16. Russia: Russia's Micex declined 7.5%, the biggest drop since June 2006. Europe: London's FTSE-100 index plunged 5.5%, the Paris CAC-40 lost 6.8%, Frankfurt's DAX-30 shed 7.2%, Madrid fell 7.54% and the Swiss SMI gave up 5.26%. Middle East: The Dubai index fell 8.5%. America: Canada's S&P/TSX composite index fell 4.8%, the biggest one-day percentage loss since February 2001. Brazil's Sao Paulo Bovespa market closed 6.6% down. Argentina's Merval fell 6.3%. Mexico's IPC plummeted 4.77%. USA markets were closed on Martin Luther King Jr. Day, but DOW-30 futures dropped 4.5%, S&P-500 futures were down 4.7% and Nasdaq-100 futures slid 4.2% (AP, BBC, Bloomberg, CBC, CNBC, IHT, SBS, UPI, WSJ, January 21-22, 2008)

Not only financials

  • 2007: The MSCI World Index slipped 2.4%, extending its decline from an October 31 record to 17%. The MSCI Emerging Markets Index sank 5.4%, extending its retreat from an October record to 19.7%. The MSCI Asia Pacific Index lost 3.7% (Bloomberg, January 21, 2008)
  • 2007: The slump has made stocks cheap by historical standards. Europe's Stoxx 600 is valued at 11.1 times its companies' profits, the lowest since at least 2002. The 1,953-member MSCI World has a price-earnings ratio of 14.3, the cheapest since at least 1998 (Bloomberg, January 21, 2008)

Volatility climbs

  • 2007: The VDAX-New Index, a benchmark gauge of European stock-market volatility, surged 39%, the most since 2001. The measure of expected price swings for stocks is derived from prices paid for options on Germany's DAX (Bloomberg, January 21, 2008)
  • 2008: The CBOE Volatility Index ^VIX spikes above 40. These are the top VIX readings since 1990, the first year for which the CBOE has calculated ^VIX historical data:
Rank Date Intraday High Event Trigger
1 Oct 1988 49.53 Long-Term Capital Management fallout
2 Sep 2001 49.35 9/11 World Trace Center attacks
3 Oct 1997 48.64 Asian Financial Crisis
4 July 2002 48.46 WorldComp bankruptcy
5 Sep 1988 48.06 Russian Financial crisis
6 Sep 2008 46.72 USA Housing crisis
  • 2008: The volatility in the markets is really unprecedented as indicated by the VIX index, which hit a record high of 81.27% yesterday. In normal markets the VIX is typically in the mid to high teens but it has been pushing consistently higher the past couple of weeks (Paul Lennox, 17-OCT-2008)

Increased lot value

  • Lot values were huge, since that institutional investors are selling. Each trade involves millions of dollars/euros/etc. Lot value = lot size x share price

Stock market on the front page

  • 2007: Stock markets plunge: The Record's top front page, a local newspaper, January 22, 2008
  • 2008: Everyone is talking about the market now. Family. Coworkers. Talk radio shows. Radio shows about gardening. Everyone. Everywhere. (…) Somebody called in a radio show around 10am PDT saying that he sold everything this morning and went to cash. Oopsie. Missed that end of day scorcher to the upside (muckdog, September 18, 2008)

Desperate rate cuts

  • 2007: In separate moves, the Bank of Canada trimmed its key overnight rate by 0.25%, less than an hour after the U.S. Federal Reserve, acting a week before its scheduled announcement date, axed its target rate by 0.75%. After the morning's actions, the key policy interest rates for the two countries have been shaved to 4% in Canada and 3.5% in the U.S. (The Star, January 22, 2008)

Politicians intervention on the financial institutions

  • 2008: The US Treasury is investing $250 million in shares of nine major US banks including Bank of America, Wells Fargo, Citigroup, JP Morgan Chase, Goldman Sachs, Morgan Stanley,Bank of New York Mellon, State Street and Merrill Lynch. Governments in Europe have pledged one trillion euros for European banks and the Japanese are set to announce a rescue plan of their own tomorrow (Paul Lennox, 14-OCT-2008)
  • 2008: Regulators and central banks the world over scramble to protect their domestic banking sectors. The global banking sector fell into a virtual panic overnight, with regulators and central banks scrambling to cobble together bailout packages and liquidity injections all aimed at saving an ailing global banking sector. German authorities, in a surprise move, guaranteed all bank deposits within their borders, following Ireland which did so last week in an effort to stave off a run on its domestic banks. South Korea has called for an emergency meeting amongst its neighbours to coordinate market intervention while Spain appears to be mulling over the nationalization of nearly the entire Spanish banking sector. In Iceland, officials are struggling to piece together a plan to save the economy from ruin as the Krona has effectively lost half of its purchasing power since the start of this year and 20% in the last week with a banking sector in chaos (Paul Lennox, 6-OCT-2008)

High cash levels in Mutual Funds

  • Check the cash levels in Mutual Funds — they stay on the side lines
  • Mutual funds and Hedge funds suffer massive redemptions
  • 2008: Mutual funds are selling stocks and hoarding cash just as trading surges to a record and prices grow more volatile than at any time since the Great Depression … (M)anagers moved more money into cash than their funds stipulated … Their cash relative to total assets also rose to a five-year high as managers found fewer stocks to purchase and anticipated redemptions … Mutual fund managers who invest for pension accounts, insurance companies and individuals raised the cash they held to 4.9% of client assets this month, according to Merrill. The last time the level was higher was in March 2003, after the S&P 500 had lost almost half of its value from its 2000 peak (Eric Martin)

Insiders buying more than selling

Evidence in the call/puts ratio

The Dow Jones Industrials index gets under 8,000

  • From Oct. 8 through Oct. 14, 2008, the Dow Jones Industrials had just fallen below 10,000 points to later sank as low as 7,883 (Triangle Business Journal). The fall accelerated when the DIA touched 9,000, but slows down when it arrives close to 8,200, where it fluctuates around for weeks

The USD dollar appreciates fast

  • The world panics and buys T-Bills denominated in USD$ with negative returns, just to maintain principal, after years of a steady decline in the US dollar value
  • 2008: Money continues to flee from any and everything considered the least bit risky. And the benefactors of that flight to safety continue to be the US dollar and Japanese yen. I know we should be used to it by now, but some of the currency moves today are just unbelievable. The Australian dollar, for instance, is down almost six cents (about 8%) and is now trading under 62 cents. Remember, it was at 98 cents about three months ago. And the British pound is having its worst day since 1992. The pound has bounced back from a ten-cent slide but is still more than six cents lower on the day. The euro has given up another three cents today and, at 1.27, it is down 21% from its mid-July 1.60 high. And no one knows where to trade emerging market currencies today (Paul Lennox, 24-OCT-2008)
  • The Oil drops from $145 to below $60 in just a few weeks, due to demand destruction since that speculators are forced out of the marked (margin calls)
  • The CAD$ lost 25% in a few weeks. The CAD/USD dropped from 1.10 to 0.80 in less than one year (December 2007 —> October 2008), since that the Oil price drops

Markets will make a new high in 6-12 months, 85% of the time

Other definitions of Capitulation

  • Capitulation is when you give up hope of the big payoff and just focus on protecting what you've got. We won't see it until more people believe that 1) they're better off in bonds, and 2) that the market will be much lower in six months or a year than it is now. It can come fast, in a panic, or slow, like a balloon deflating (Estragon)
  • Back in 1987, if you had bought on the 20th after “capitulation,” Mr. Market would have summarily handed you your head over the next two weeks. And in 2000-2002, I can't count the number of capitulations" on my fingers and toes. It is true that the 2000-2002 bear market ended in a whimper, and that the bottom in 1987 was relatively uneventful. My point is that we need to see more than a 5% loss on the S&P before capitulation'' even enters our vocabularies, and that capitulation is a relative term that would have lost you a hell of a lot of money trading off of over the years (BDG123)
  • For me bars/candlesticks with volume overlays are a more useful chart when examining “capitulations”. The huge hammers with massive volume spike combined with 90/10 and 10/90 days are what I would call capitulation points. It's the same thing, just seems a little clearer graphically in bars rather than a line (Tr22)


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