1. » And we got increased volatility The Politics of Debt: Speak Up! Economic and Financial News for the Rest of Us October 3, 2007 @ 2:02 pm

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Expect increased volatility

Finance, Politics Comments (7)

On August 20th, when the concern on the media was the liquidity crisis and the falling market I wrote to a good friend of mine “The move on the DIA since the bottom of 2002 looks parabolic. If we break the previous high we will be “on the other side of the curve” when things get really high very fast. I don’t think this is a fundamentally inspired move, rather speculative (i.e., bubble) perhaps based on increased liquidity injected by Central Banks, or perhaps based on the new rules for pricing options based on risk.”

Remember that on August 31 Bernanke said that there was not going to be a bailout for lenders or investors. Yet, statistical indicators seemed to point to a parabolic ascend of the Dow Jones if there was a breakout of the previous high. When I see an oddity like that in my mathematical model, I try to figure out what may produce it. One simple answer is “the oddity will not materialize”. Now, my model is just a statistical model and can only tell me as much (in other words, I have been wrong before).

What I do expect as we approach the previous high is increased volatility. Also increased press noise. I call press noise to the incessant buzz you hear at crucial junctures in the market.

They way it works in general, is the following. The market operators who are betting for a breakout based on their own models will feed the press with gloom and doom ideas. Since their goal is to acquire as much stock at the lowest possible price, whenever asked they will mention only the negative aspects of their scenario. Eager journalists, and bloggers, take this news and, if they fit their own mental economic model, publish it as a revealed truth (after all, we all love a scoop). After all, at a juncture, you have only a 50% chance to be wrong.

On the other hand, the market operators who are betting the market will correct, will feed the media with the opposite view, a rosy picture where everything is going to be perfect forever. Of course, their goal, based on their model, is to sell as high as possible before and during the correction. So, get ready to read predictions of nasty crashes and wonderful new economies.

In other words, during those periods of increased buzz, political and market operators start using the media to manipulate the markets and the small investors. The tools are old as the markets itself, the reason basic as human biology (namely, greed and fear).

Where are we now

Gold broke new highs, as I expected, so did oil, and in my model it is logical that the DJ and SP500 break out, followed later by the NASDAQ revisiting the 2000 highs. I do not think this move has anything to do with an improved economy, and if you read my previous articles, you will know why.

The next month should be interesting to watch, as October is an infamous month on the stock market and most market analysis seem to focus on some “mysterious” forces nobody can understand. The scenarios I see with more probability are:

  1. Double top in October, nasty correction, Fed bailout, break out in November
  2. Double top in October, nasty correction, more bad news in Black Wednesday, Fed lets the correction run its course and bails out in January
  3. Realization by the market that there may be a recession going on, bear market that can’t be stop by the Fed
  4. Break out in October happy sailing

As I mentioned before, I think the Fed will do everything in its power to provide liquidity to the markets. I do not think they are going to wait for a recession in order to inject liquidity because continuing the war effort would be very difficult during a recession. However, any excess liquidity the Fed injects into the markets will seed a hyperinflationary crisis down the road. This is model they seem to be following is not original, is the model the Soviet Union followed to support the War in Afghanistan and ultimately destroyed the Soviet economy.

The only reason I do not think that scenario 3 has more probabilities (although I think it is more realistic), is that the crash of 2000 is still fresh in the minds of the market participants. For the next big correction to start it is necessary the existence of a social conviction that the laws of thermodynamics, as they apply to the markets, are something of the past (most people get convinced that there is a “new economy”, a “new paradigm”, or that “it’s proven that things this time are different”).

Remember that these articles are not pieces of financial advice, only political-economic opinion.


Franklin @ October 1, 2007

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