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On The Origin Of Crashes & Clustering Of Large Losses
Excerpted from John Hussman's Weekly Market Comment,
Abrupt market losses typically reflect compressed risk premiums that are then joined by a shift toward increased risk aversion by investors. In market cycles across history, we find that the distinction between an overvalued market that continues to become more overvalued, and an overvalued market is vulnerable to a crash, often comes down to a subtle but measurable shift in the preference or aversion of investors toward risk – a shift that we infer from the quality of market action across a wide range of internals. Valuations give us information about the expected long-term compensation that investors can expect in return for accepting market risk. But what creates an immediate danger of air-pockets, free-falls and crashes is a shift toward risk aversion in an environment where risk premiums are inadequate. One of the best measures of investor risk preferences, in our view, is the uniformity or dispersion of market action across a wide variety of stocks, industries, and security types.
Once market internals begin breaking down in the face of prior overvalued, overbought, overbullish conditions, abrupt and severe market losses have often followed in short order. That’s the narrative of the overvalued 1929, 1973, and 1987 market peaks and the plunges that followed; it’s a dynamic that we warned about in real-time in 2000 and 2007; and it’s one that has emerged in recent weeks (see Ingredients of A Market Crash). Until we observe an improvement in market internals, I suspect that the present instance may be resolved in a similar way. As I’ve frequently noted, the worst market return/risk profiles we identify are associated with an early deterioration in market internals following severely overvalued, overbought, overbullish conditions.
With respect to Federal Reserve policy, keep in mind the central distinction between 2000-2002 and 2007-2009 (when the stock market lost half of its value despite persistent and aggressive Federal Reserve easing), and the half-cycle since 2009 (when Fed easing relentlessly pushed overvalued, overbought, overbullish conditions to increasingly severe and uncorrected extremes): creating a mountain of low- or zero-interest rate base money is supportive of risky assets primarily when low- or zero-interest rate risk-free money is considered an inferior holding compared with risky assets. When the risk preference of investors shifts to risk aversion, Fed easing has provided little support for prices (see Following the Fed to 50% Flops), which is why we believe it is essential to read those preferences out of the quality of market action.
Our most important lessons in the half-cycle since 2009 are not that overvaluation and overextended syndromes can be safely ignored. Historically, we know that these conditions are associated with disappointing subsequent market returns, on average, across history. Rather, the most important lessons center on the criteria that distinguish when these concerns may be temporarily ignored by investors from points when they matter with a vengeance. In other words, our lessons center on criteria that partition a bucket of historical conditions that are negative on average into two parts: one subset that is fairly inoffensive, and another subset that is downright brutal. Central to those criteria are factors such as deterioration in the uniformity of market internals, widening credit spreads, and other measures of growing risk aversion. Once that shift occurs, market declines often bear little proportion to whatever news item investors might latch onto in order to explain the losses.
As Didier Sornette pointed out more than a decade ago in Why Stock Markets Crash, “the underlying cause of a crash will be found in the preceding months or years, in the progressively increasing build-up of market cooperativity, or effective interactions between investors, often translating into accelerating ascent of the market price (the bubble). According to this ‘critical’ point of view, the specific manner by which prices collapsed is not the most important problem: a crash occurs because the market has entered an unstable phase and any small disturbance or process may have triggered the instability. Think of a ruler held up vertically on your finger: this very unstable position will lead eventually to its collapse, as a result of a small (or an absence of adequate) motion of your hand or due to any tiny whiff of air. The collapse is fundamentally due to the unstable position; the instantaneous cause of the collapse is secondary. In the same vein, the growth of the sensitivity and the growing instability of the market close to such a critical point may explain why attempts to unravel the local origin of the crash have been so diverse. Essentially, anything would work once the system is ripe… exogenous, or external, shocks only serve as triggering factors. As a consequence, the origin of crashes is much more subtle than often thought, as it is constructed progressively by the market as a whole, as a self-organizing process. In this sense, the true cause of a crash could be termed a systemic instability.”
Keep in mind that even terribly hostile market environments do not resolve into uninterrupted declines. Even the 1929 and 1987 crashes began with initial losses of 10-12% that were then punctuated by hard advances that recovered about half of those losses before failing again. The period surrounding the 2000 bubble peak included a series of 10% declines and recoveries. The 2007 top began with a plunge as market internals deteriorated materially (see Market Internals Go Negative) followed by a recovery to a marginal new high in October that failed to restore those internals. One also tends to see increasing day-to-day volatility, and a tendency for large moves to occur in sequence.
An interesting feature of the recent air-pocket in stock prices is that many observers characterize the depth of the recent selloff as meaningful. What we’ve seen in recent weeks is very minor in a historical, full-cycle context. The market has not experienced even a single 3% down day in nearly 3 years. The chart below shows the cumulative number of 3% down-days in the Dow Jones Industrial Average over the prior 750 trading sessions, in data over the past century. It’s certainly not an indicator that we would use in isolation, but in given current valuations and the recent deterioration in market internals, we should not be surprised if this absence of large daily losses is short-lived.
I mention large down-days for a reason. A market crash comprises of a series of one-day losses that may be large, but are not particularly extraordinary in and of themselves. The problem is that they tend to occur in sequence rather than independently. In the chart above, you’ll notice that the cumulative total of 3%+ down days often spikes nearly vertically from zero, meaning that large down days tend to cluster. We may wish to believe that a 25-30% market plunge has zero probability since we know that the probability of a one-day loss of several percent is quite low, making a whole series of them seemingly impossible. But that view overlooks the tendency of large losses to occur in succession. It also overlooks the tendency for monetary easing to support stocks only when low- or zero-interest risk-free assets are considered inferior holdings in comparison to risky ones.
In Didier Sornette’s words, analyzing a crash in terms of individual daily returns “is like a mammoth that has been dissected in pieces without memory of the connection between the parts… Independence between successive returns is remarkably well verified most of the time. However, it may be that large drops may not be independent. In other words, there may be ‘bursts of dependence’ … leading to possibly extraordinarily large cumulative losses.”
In short, recent weeks have seen a strenuously overbought record high in the S&P 500 featuring the most lopsided bullish sentiment (Investor’s Intelligence) since 1987, coupled with increasing divergence and deterioration across a wide range of market internals, including small-capitalization stocks, junk debt, market breadth, and other measures. With compressed risk premiums now joined by indications of increasing risk aversion, we remain concerned that risk premiums will normalize not gradually but in spikes, as is their historical tendency.
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"Nobody could have seen it coming!"
-Cable News Anchor, Not-too-distant future
OT: This Story needs to be told...
...Unf*cking believable...More news out...
U.S. is Responsible for the Ebola Outbreak in West Africa: Liberian Scientist
It's about gaining control of West African resources over the Chinese...
http://www.globalresearch.ca/a-liberian-scientist-claims-the-u-s-is-resp...
Too many people still think that the Gov is their friend!
Hey what's wrong with a little taxtion and a little free medical?
A lot more taxation, and to be used as a medical guinea pig !
But dont worry the gov has everything under control!!
Long on beer and popcorn.
my neighbor's half-sister makes $63 /hour on the internet . She has been out of work for 10 months but last month her pay was $16551 just working on the internet for a few hours. More Info... www.job-reports.com
But....QE4-5eva?
Umm. But won't the historical tendency will be subverted by a new FED reality?
Hussman with chart on 3% drops
i prefer chart with # of wall streeters jumping out windows
300+ foot drops for banksters.....I wanna see the chart on that.
1. Origin of a crash usually starts with over bought equities with high margined capital that has been leveraged countless times ( see rehypothecation ) and endless stock repurchases by foolish corporations. (See IBM, Apple etc.)
2. The end result of banksters and Wall Street crooks hitting the pavement and or sidewalk after jumping from a great height. (See jump fuckers.)
Damage has already been done, crash a certainty. Only question is which snowflake will "unexpectedly" start the avalanche and when. Gird your loins.
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Old Bankster Proverb
IBM down 7% and missed big on the top line, yet the S&P is up 7 points. When a bellweather totally misses estimates and the broader market ignores the results, then nobody can conclude that the market is functioning.
I live on my 401K.....It crashed years ago.....Shit storm ahead....I'm glad I had a good time when I was young
You've already had a perfectly good crash. What did you manage to do with it?
Expect a grinding bear market instead.
The market will screw you.....at some point you just need food and water....I own my house....now I just have taxes and SKS and F-you
Not you....I mean the Man....time is short....We of like minds need too help each-other
Not you....I mean the Man....time is short....We of like minds need too help each-other
Didier Sornette's "market cooperativity."
I prefer the term "herding," but then cooperativity is probably more mechanical and thus descriptive in the sense that most asset gathering participants and computer trading algos are watching prices and not each other.
Of course individual investors - ever the fanboys of momentum favorite cocktail party stocks - do in fact 'herd" in the sense that they look to the opinions of other retail investors and the market letters and advisors who feed off of individual retail investors for reinforcement of their belief in the stocks that "everyone" owns.
The problem we have now are computers in large part doing the trading. They distort the market because they do as they are programmed to do. When they finally fall outside their boundary variables things will happen very fast and likely to cause a cascade failure and will take everybody by surprise.
And it will happen so fast....Just keep pounding that sell button
In sub-millisecond increments...
Be funny as hell if those computers just decided to take over.
If some 'singularity' were to occur, the whole system could be taken over within a day. All the infrastructure is in place...even our nuclear missiles are computerized.
Maybe the computers will keep us around as pets or something...IF we're cute enough.
Get cute, people! Learn some interesting tricks, amusing antics to please your new overlords...
I was watching that Death of The Dollar video
With the old Chinese professor. I like the part about PMs
The Day the Dollar Died - YouTubeThe dollar isn't dead yet... most global debt is denominated in dollars. As the markets crash and liquidity dries up there will be a scramble for dollars both to save and to pay down debt. The dollar will rocket upward as a result. When the markets have finally bottomed and most of the debt has been destroyed, then all bets are off as to the fate of the dollar. But the dollar will remain quite strong, increasingly strong for seberal years to come.
http://www.globaldeflationnews.com/u-s-dollar-indexelliott-wave-update-f...
Hyperinflation has always been the final outcome. People are wishy washy and think the last tick matters. They change their minds based on momentum and think they are making a proper analysis. The only thing that matters is the math. There is no math that has the USD retaining purchasing power. I don't care what nonsense they put on the screen, or how many bogus commodity contracts they flood into the market. I certainly don't care what a moronic 22 year old banker thinks or how much money he throws at a trade. There is no outcome from this situation where the dollar does not continue to hyperinflate and prices do not reflect hyperinflation.
I just explained why the math works in favor of a stronger dollar for several years to come. Choosing to ignore it is an emotional decision which will not serve you well. Hyperinflation may very be the eventual outcome once the deflationary depression has bottomed, but in the mean time, the dollar gets stronger as the world's huge debt bubble implodes.
http://www.globaldeflationnews.com/anatomy-of-a-bubble-how-the-federal-r...
A stronger dollar equals declining prices...I know that hyperinflation COULD be an outcome, but I don't see how it happens in this economy.
In the past periods, there has been someplace to 'grow' into. But we're tapped-out for growth these days. The industrialized countries are seeing declining incomes, they can't hyperinflate anything. And the third world never saw any of the income growth needed to support rabid consumption.
The only way we get to hyperinflation is if we start to see rapid increases in wages. As long as TPTB are successful in keeping them down, deflation is the only realistic outcome.
And, because of the weakness of the underlying situation, I think that the deflation could become unstoppable, despite all their efforts to inflate the bubble.
Either way, all the toxic, unsustainable debt WILL be purged from the system. By inflating the debt away, or by deflating the asset values and the massive defaults that will follow. That's it...there is no 'door number three'.
You are 100 % correct.
Hyperinflation is, always has been and always will be the final solution.
What most people forget is that just like th bond and stock markets the currency market is exactly the same.
They just cannot equate the same driving forces to a currency like the dollar. But it is there.
You cannot unprint dollars .
Once printed its too late, they are in the system.
The mechanism is little understood.
Deflation and the dollar going higher is certainly the first stage, that is very true, but there comes a point where it cannot be sustained.
Wages fall, incomes and profits at SME's collapse ever lower, tax bases start to collapse, People retrench putting all faith in the one asset class left, cash.When bonds and stocks are driven to insane highs there comes a time when the normal rotation stops.
But there is now a desperation and an unwillingness to see that the greatest threat of all is that in fact its the currency itself that is now a bubble, a bubble that can become so gigantic it makes even stock and bond bubbles look tame.
So as you rotate out of high prices stocks in a bubble into a high priced bond market in a bubble you just drive that bubble higher, and it goes faster and faster and then a rotation back in ever shortening cycles and deflation gets worse and the dollar goes ever higher.
But then it changes, strikes, wage claims, unionization gets stronger, and the government relents, first in the Public sector and then it spreads, the private sector gets moving, and the economy goes down again as mass discontent spreads.
So the fed prints ever more, and to keep check on wage rises attempts to raise interest rates, but that fails as the govt cant afford that without more printing., so more printing comes along and wage demands are met in the PS the the private sector and more and more printing ensues,
As inflation starts to bite that is when sentiment changes, faith in the dollar evaporates, as people now see inflation starting to rip and wage claims get ever more crazy and higher.
So the fed prints more .
and more and more and morand morand more again.
Hyperinflation is the outcome.
There is no where else to go.
No filthy ponzi scam voucher masquerading as a currency like the euro trash will be entertained, the Yen, don't make me laugh, the GBP,, with its Wiemar busting debt levels,
Where else can it go, Gold, Yes, some but not all,
Minor currencies will first get flooded, especially those with decent central banks and low debt ratios, but they will soon be overwhelmed.
Where do you go.
You know the dollar will be worth less tomorrow so want more today.
and next day and the next day and the demand will continue and the fed can do fuck all.
Why, because it cannot raise rates even 0.005% with bankrupting itself.
so it will forever print.
Currencies last an average of about 40 years or so.
The dollar is in late stage terminal decline.
Its just waiting for the market to see it that's all. Just like what happens in the stock markets just a longer time frame.
You can build a house of cards, but you can't live in one. The paper ponzi economic facade cannot withstand a light breeze much less a real shock.
Market crashes :
"Only the last breath is sudden"
As Sornette showed , even extreme events can be sliced up in smaller increments .
This leads to Ultra-extreme events , the Dragon-Kings .
Or , the Alien under (or in) the bed .
See
http://andreswhy.blogspot.com/2013/11/dragon-kings.html
http://andreswhy.blogspot.com/2013/12/finding-aliens.html
As long as prices are falling/disinflating there will always be a buyer of "paper promises." How the bodies are actually removed will be a challenge though.
Why are we talking about all this unimportant stuff? Don't you know iGadgets, Inc. reports earnings soon??
I am the Alpha & the Omega. All crashes have 1 cause (911's notwithstanding). The rate-of-change in monetary flows (our means-of-payment money times its transactions rate-of-turnover), drops suddenly and predominately within 1 month, e.g., the May 6th flash crash, etc.