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Tuesday's Market Plunge

by Michael Nystrom
February 27, 2007

At it's worst level, the Dow was down today over 540 points in a global selling spree that started overnight in China. By the end of the day, it had recovered somewhat, but still closed down over 400 points. The real story was the volume: 2.3 million advancing shares advanced, versus 2.3 billion decliners in what could be the most lopsided selling day in history! In other words, 99% of today's share volume was down!

After hearing this news, many people's first instinct is to ask "What caused it?" The next question people are concerned about is, "Will it continue?" And finally, "What should I do?" I'll do my best to answer those questions in this article.

What Caused It?

It's hard to say exactly what single event, if any, "caused" today's market meltdown, but we do know that it was a global selloff that began overnight in China. The Shanghai index fell a whopping 9% the very day after it reached an all time high. Remember, this market had risen over 130 percent last year, so this was obviously a market driven by speculation, similar to the 1929 US market, and the 2000 Nasdaq market. The parabolic rise made a correction inevitable, and jittery, speculation-driven markets such as these can sell off on the slightest hint of rumor.

"Traders said the slide did not appear to be triggered by concrete news," but instead was fed by various fears. The linked article goes on to discuss a number of rumors that fluttered through the crowd. Westerners are much more likely to ascribe the cause of the plunge to Greenspan's speech to a business group in Hong Kong, in which he stated the US economy was likely headed for a recession by the end of the year. Greenspan is no longer head of the Federal Reserve, and holds no official position, but his words and opinions obviously still have considerable sway. Apparently he's still the Maestro.

This morning's bad news didn't end with the markets. Early risers also learned that a suicide bomber struck the main gate of the compound Dick Cheney was visiting in Afghanistan, in an apparent attempt on the VP's life. Later the Commerce Department reported that durable-goods orders fell 7.8 percent in January, including the biggest slide in business equipment demand in three years.

It was a morning of bad news. Markets are emotional and all the pessimism took its toll. The fact that consumer confidence was announced to have risen to a 5-1/2 year high did nothing to help the morning sentiment. I'm not sure what drugs consumers are smoking these days - or maybe it's the people doing the surveys - because things sure don't look that great to me!

So to get back to what "caused" the plunge - conditions were ripe, and there were a number of triggers. Before we go on, let's take a look at some charts:

Dow down 3.29%, S&P 500 down 3.4%, Nadaq down 3.86%. This is not crash territory by any stretch of the imagination, (though you woulndn't know that from CNBC's breathless reporting of the plunge). It just feels like it because we haven't seen any substantial pullbacks over the past 5 years. These were in fact the worst market drops since September 2001.

The technical situation with the Dow, S&P 500 & Nasdaq are similar, so lets focus on the S&P 500. The eight-month uptrend on the daily chart has clearly been broken. The trend line that served as support for the past eight months now serves as overhead resistance. Today's action also plunged prices below both the 50-day and 100-day moving averages. Not a good sign for the bulls.

Stock Market Crash 2007

From a longer term perspective, however, the uptrend since the start of the Iraq War in March 2003 is still intact, and not at all threatened by today's drop. Weekly MACD is topping out, however. From the looks of things, a short-term stock market top is in place.

Stock Market Crash 2007

It was a uniformly down day. The dollar continued its slide:

Stock Market Crash 2007

As did the precious metals. Silver fell about 5%, and gold was down about 4%, backing off from its quest for $700 per oz.



The gold bugs index also fell about 7.5% - almost twice the amount of either gold or the general market. Investors who think of holding gold shares as insurance against a general market drop may want to reconsider after today's performance.



Where did the money go? It fled to the safety of US treasury bonds. The 10-year yield continues to slide.

Stock Market Crash 2007

Will the stock slide continue?

Greenspan's remarks last night and the ensuing market slide calls to mind his famous "irrational exuberance" comments in 1996. Like this time, those comments were made while the US market was closed, and led to an overnight global market selloff. Hong Kong fell almost 3 percent; Japan - the biggest Asian market at the time - fell 3.2%. Germany dropped 4%. The Dow fell too, but recovered most of it by the end of the day. In the long run, US markets went on to experience even more irrational exuberance, continuing to this day. The events of December 1996 turned out to be just a minor blip in the roaring bull market of the late 1990s. Greenspan made those original comments when the Dow was hovering around 6,500; it has since nearly doubled.

Will this time be the same -- another tremendous buying opportunity for those willing to buy the dip? Doubtfully.

The 1990's bull market was driven by three powerful fundamental factors: technology, disinflation and demographics. We had the twin internet and telecom booms, which fueled demand for computer and telecommunications hardware, software, programming and related services. The increasing trend of outsourcing to Asia yielded the dual dividend of falling prices for consumers and increasing profits (made in taiwan) for corporations. The booming economy created many high paying jobs, and workers were increasingly participating in automatic stock investment plans through their 401(k)'s. The world was at peace. The mood of the country was expansive and optimistic.

The post-bubble economy did not experience a collapse - as was widely expected - due to the massive flood of cheap money provided by the Federal Reserve. This money helped stave off bankruptcies - both personal and corporate, although we did see the three largest corporate bankruptcies in history in 2001-02: Worldcom, Enron, and Conseco. Easy money also led to the housing industry boom, but for many, it was a muddle-through economy without the excitement or the optimism of the 90's boom.

The question at hand today is: what can drive the economy forward now? The housing industry is on the skids. American manufacturing is a thing of the past. The US auto industry is in big trouble. There is no technology "silver bullet" like the internet or mobile phones that we saw in the mid-1990's which can carry the economy forward. Microsoft Vista was released to a chorus of yawns. The current expansion looks tired. The only thing bullish is the outlook for war. And going forward, the demographic outlook for stocks is not favorable. Even Harry Dent, who is still predicting Dow at 20,000 by late 2009 (interesting report for free download) is bearish long term and speaks of something like a second great depression to follow.

The first wave of baby boomers is expected to begin retiring soon. Many of those boomers who dream of an early retirement check their 401(k) balances and do their calculations - in their head or on fancy spreadsheets - as to how many more years of working and savings growing at x% per year until they can retire. But the smart ones are already quietly heading for the exits. The first boomers start retiring in the next few years, and in order to maintain their standard of living, they need to sell their stocks. The problem with this is that as boomers begin to sell, without additional buyers the stock market will go down. This is bad for those who are still trying to use the market as a savings device, and may lead to a premature rush to the exits.

The stock market has provided many with paper wealth, but that paper wealth must eventually be converted into cash. Therefore, as individual boomers retire, it is in their interest to maximize their own return by cashing in and selling their stocks (and/or other assets such as real estate) as quickly as possible - before others have a chance to. This is a defensive mindset - the complete opposite of that which prevailed during the expansive 90's.

To sum up, the economy is slowing and the nature and composition of the economy is changing. Furthermore, a social mood change is in the air. There are no technological breakthroughs to drive the economy forward and baby boomers - with one eye on retirement - are beginning to shift their attention away from stock accumulation and towards stock distribution. After all, if the short-term market top is in, and retirement is just one or two years away, what is the point of holding stocks?

What should I do?

Inevitably, the question comes back to "What should I do?"

Unfortunately, there are no easy answers to this question, since everyone's situation is unique. The best advice that I can give is to learn to understand the dynamics of the economy and stock market, and to learn to think for yourself. Listen to experts, take in as many opinions as you can, but critically evaluate what they are telling you. Just six years ago at the Nasdaq market peak, the deafening mantra from Wall Street was "Buy and Hold!" This was excellent marketing material, but terrible investing advice. The world is always changing, so you must keep up with the changing events and understand how they will affect your life and your portfolio.

Two excellent, brand new bearish books have crossed my desk in the past few weeks from publishers, and I will have reviews of them on my website later this week. The books are Financial Armageddon, by Michael Panzner, and Crash Proof by Peter Schiff. They're both excellent books, have good advice and I recommend them both. If you'd like to be notified when these reviews are up, as well as when other articles such as this one are published, please sign up to my low volume email announcement list.. What's going to happen tomorrow? Stay tuned.

As always, comments on this story are welcome here.

Thank you and best regards,
Michael Nystrom

Also of interest:
Bullish on War, Part II
CNBC Video from Today's Plunge
Ron Paul: Hypocrisy in the Middle East
Alan Greenspan 1967: Gold and Economic Freedom
How the Fed Lost Control of the Money Supply
Must See/Listen Video: Dr. Bill Veith with Alex Jones on the Fiat Money System
McNosis, Retiring Boomers and the Silent Crash
Tough Times Ahead for Elder Boomers?
A New American Dark Age
Wheat Shortage? The Emerging Bull Market in Wheat


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Turn off the TV and think!





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