The Global Financial Picture and its Antecedents
In these tumultuous times, one looks at the stock market with dread. Titanic shifts in wealth occur on a daily basis as the players in this zero-sum game battle it out for the challenge of a lifetime. What is really sad is that many of the players do not ever understand that this is a zero-sum game; that the stock market is nothing more than a wealth-exchange system. That’s right. Wealth is not created by the stock market, but is exchanged among the players. To be in that market without realizing that very fundamental fact is, in my opinion, rather foolish.
Many have their life’s savings and their retirement tied up in the stock market, and it amuses me even more to hear all of the talking heads giving the exact wrong advice about what to do. They all say “stick it out”, “hang in there”, and “you don’t want to miss that uptick”, etc.
But many of these naieve players have been listening to this very wrong advice as they watched their portfolios cut in half or worse over the past year. Many are actually getting hit by margin calls and thus are seeing their holding sold by their brokers to cover themselves. This is part of the drive in the titantic moves being seen daily in the market right now.
I tell all my friends these days to *be in cash*, but they get so many mixed messages they don’t know if they should listen to me or listen to the idiot financial advisers. And I can fully appreciate the emotions involved. Moreover, many are in complicated financial instruments tied to the market carrying tax consequences and other hits for an early pullout. This is really sad, because it only complicates the picture even further for them.
I still stick to my mantra: BE IN CASH. You can always jump back in when the smoke clears. And so what if you miss the “initial uptick”. At least you would’ve limited your losses.
But where did all of this come from? Where did all of the bad advice on how to deal with the market generate? This is my take on it.
During the 20th century, we saw something incredible — the stock market always seemed to go up in the long run. The thinking of that times was to “be in it for the long haul”, without any thought or consideration as to how a zero-sum game can always keep going up indefinitely, and what was driving it. No one was interested since it seemed to be going up forever.
Now, I invite you to click the following link:
Big Charts of NYSE
Now set the time frame to “All Data”, and the frequency to “Yearly”. Yes, I am too lazy to past a picture of the chart into this blog, but I think it’s better if you play with these charts for yourself.
You will notice that the NYSE, a composite of all the stocks on the New York Stock Exchange, has shown a steady increase from 1970 till 2000 or so. Then you see a very sharp decline. Then you see it rise again from 2003 till now, where you see an even bigger decline knocking its levels back to where it was back in 2002. You will also note that since 1970 where the data starts, there has been no such titanic shocks before on that scale.
Now, look down beneath the price chart to see the volume chart. Look at how the volume increases corresponds with the rise of the NYSE, and look what took place from 2000 till now. This, my friends, tells the true story about the markets. Charts don’t lie, and what you see here is the real truth about the market. But how does one interpret this truth?
Think for a moment. The stock market is a zero-sum game. It does not create money; nor does it destroy it. Money simply shifts hands. Every dollar you make on the stock market *must* come out of someone else’s pocket, and every dollar you loose *must* going into the pockets of another. That is the inherent nature of a zero-sum game.
Now, look back again at the volume chart and you will start to understand what is really happening. Throughout the latter half of the 20th century, there was a big push to get more and more average people involved in the stock market — either directly, or through some derivative instrument, like mutual funds, 401Ks, IRAs, and the like.
My “Greater Fools” theory on the stock market: in order to make money on the stock market, you need greater fools to take the stocks off your hands at a greater price than you paid for it. Therefore, the only way the market can continue that growth curve in the 20th century is to have an ever increasing number of “Greater Fools” to keep flocking into the market, and this is marked by the steady volume increases you see from 1970 till 2000.
The problem is, of course, is that the supply of Greater Fools is limited. You eventually hit exhaustion. Then the prices stop rising. Then panic ensues and everyone starts selling off, generating even more panic which leads to ever more sell-offs. Those fools caught at the top of the market then give up their dollars to those whom they bought from. Yes, my friends. Those fools at the top of the market are left holding the bag for the wealth the rest of us have managed to extract from the market before the fall.
Fun stuff, huh?
What does this mean for the greater financial picture overall?
Implicit in many financial policies and financial instruments is the fallacy of “infinite growth” — that is, the markets will continue to grow forever without bound. Because of the fallacy of that assumption, anything based on that fallacy must fail eventually.
And now to introject some chaos into your understanding of the markets.
In systems that grow beyond a certain “magical rate”, the growth become chaotic. It does not matter what the system is — it could be populations of bacteria or players in the financial world –, it’s almost a “law of the universe” from the standpoint of chaos. Click the next link:
Feigenbaum Logistic Map
You will note the simple recurrence equation for growth listed, and the map of what happens when growth rates are too high. The numbers bounce around chaotically. Why? Because you have growth that depends on finite resources. If you grow faster than your resources does, you hit a ceiling and — well — chaos ensues. No pun intended!
What we see going on in the marketplace is a similar story, though more complicated than this simple formula. Humans with a stake in the game will do whatever they can to keep the party going even when it’s quite evident that the party must end eventually. We see this in the sub-prime mortgage fiasco going on right now. Since the greater fools ran out of their normal market, they kept it going higher artificially by seeking out riskier and riskier investments, which themselves came to a head as we have seen. It merely delayed the inevitable. If you go back to that NYSE chart, you see after the big drop in 2003 the market go even higher, but without the matching concomitant increases in volume. The NYSE figures were pushed up artificially higher by something, and since the markets are so interconnected, my guess is that it was pushed up higher by all the bad loans that were made.
You see, I am as guilty as the next guy here, because not only did I benefit from the financial boom in the 90s, but I also — after the so-called “dot-com” crash — managed to re-fi my home twice without any real income!!! Now admittedly, it helped tremendously in keeping my home and thus a roof over the heads of my family in those times, but really and honestly I should not have received those two loans without a solid financial basis.
Well, these days I am on better financial footing, but many were not able to make that transition and had to default on their loans, and thus began the “shout in the mountains” that lead to the avalanche in the financial markets we see today. Yes, my friends, another aspect of Chaos Theory: Self-Organized Criticality:
SOC Link
The language in this link may be beyond some, but basically what it states is that dynamical systems have a tendency to organized themselves to a critical state that can then undergo a “phase transition” — a drastic change of state — almost spontaneously. Basically, a fancy way of stating that “what goes up, must come down”, at the risk of oversimplification.
I am basically stating that all the current efforts to blame the fall on the last administration, on the CEOs of AIG, Meryl Lynch, and Lehman Bros, etc. is all a wash. Once that critical state was hit, a little girl going “BOO” on Wall Street would’ve triggered the avalanche. And no, I am not kidding.
The Obama Win and what that means
What about the [ast election and the overwhelming win by Obama, who has now become the nation’s “Great Black Hope”? (There are reasons I use that phraseology, but I will go into that in a future blog.) I am not convinced that He nor his team he’s assembling has a clue on how to halt this avalanche. He seems to be picking everyone who is from the “old school” understanding of economics. No one has yet to mention the very plain fact that most of our financial infrastructure is predicated on a fallacy. I suppose to mention that fact would really cause the panic to amplify even more. You don’t want to spook the poor saps left holding the bag too much or they would all want to dump their bags at once driving everything to zero. And yet, the governments around the world pulling money out of thin air in their vain attempts to “shore up” the banks will only trigger a devaluation of currency that will send the market down even faster.
There is the spectre of deflation which would seem at odds with creating money out of thin air which should trigger inflation. Fun stuff huh? But I have come up with a modification to the self-organized criticality theories with special regards to the financial markets and how governments try to manipulate them:
The dynamical system so conditioned will see to organized itself to a critical state that will thwart any and all of the usual attempts to control said system. Basically, the dynamical system will evolve itself to the point of ignoring the usual control points. Basically, what I am saying is that “all the King’s horses and all the King’s men could not put the financial markets back together again!” Could there be hidden wisdom in a simple tale for kids? Hmmmm….
And yet we see that very thing taking place. Of all the coordinated efforts of many governments to inject money into the broken Humpty-Dumpty market, nothing has really worked. If that doesn’t scare the willy out of your pants, it should. I am basically saying that we are in for some “interesting times” the likes of which have never been seen before in the history of the world. I dearly hope my prognostication is dead wrong, but I see no reason to assert otherwise. I predicted this 2nd financial shock about 8 or 9 years ago; I just wasn’t sure when it would happen. It’s actually happening earlier than I had anticipated, and we’re just seeing the beginning, folks. Now GM is talking about needing a bailout, and perhaps a couple more US auto manufacturers will be sucked into that downdraft as well. And the cascading cacophony of failures will continue for years to come. No market will be immune. Attempts governments make to stop it will only either make the problem worse or delay the inevitable.
Will when this avalanche stop? I do not know. Will the stock market ever “fully recover?” I don’t think so. I cannot see beyond the current mess because the picture has become chaotic that there is simply no way to know what will emerge “on the other side”.
But I will say this: We are in for one helluva ride!
So what does poor “Joe the Plumber” do?
Well, actually, if you are in the plumbing business, I wouldnt’ worry too much. For starters, your job can’t be outsourced. And as long as people continue to use pipes for their water supply and flush toilets to get rid of their shit, there will be a demand for you. They may pay you a bit less, but you’ll get by.
If you are “Joe the Hedge Fund Manager”, it was nice knowing you. Time to start thinking about a serious career change and possibly relocation. You really don’t want to be in an area with 10s of thousands of out of work people in your field all competing for the same scant handful of alternative jobs available. Do your research well and get the hell out of New York NOW.
If you are “Joe the Software Geek” working in IT, especially on a hot money producing website, stay exactly where you are. If you are thinking about hopping jobs,think carefully about whether or not the company you hop to can weather the impending financial firebomb headed our way. Even think that about the company you are with currently, and make the necessary adjustment in your short-term career goals.
If you are “Joe the Nurse”, stay put. Or better yet, consider relocating to Florida or California, or any place where wealthy seniors like to flock to. There’s still a shortage in the nursing field, so mop it up.
If you are “Joe the Entrepreneur”, think creatively yet realistically about your plans and goals. There may be hidden opportunities to capitalize on the firestorm to come. Drink in information from many sources about the global and local marketplaces, and try to understand how one relates to the other. Then POUNCE.
If you are “Joe about ready to divorce Jane”, this may be a wonderful time to file if you can kick Jane out of the house first. Especially if your mortgage is below water due to no fault of your own. You may be able to get rid of Jane and keep the house too. But be sure you keep the kids as well, because if Jane leave with them you are still screwed.
If you are “Joe the Homeless Beggar”, expect to get a lot of competition in the upcoming years. Expect also your begging clientele to become increasingly tight-waded as this burn-down progresses. You might actually consider this a golden opportunity to do something more meaningful with your life. Hop to it.
If you are “Joe the Civil Servant”, stay where you are. Rest assured that the government you work for will find newer and more creative ways to rip the rest of us off in order to maintain their power-base, of which you are a part.
If you are “Joe the Student”, you’ve got some real issues to think about. You have to do the hard thing of thinking about where the world will be when you graduate and whether or not a market will exist for your hard-won skills. Never-mind whether or not you’ll be able to afford it or not. Coming out with your sheepskin and a $100K debt just to take up a career of taxi driving is worse than skipping the whole affair and just jumping to taxi driving. Or consider the career of being a beach bum. Or leech off your parents for as long as they will let you. Forget joining up with the Armed Forces unless you have a death wish. Talk to some old vets first — especially from the Viet Nam War era — to get a good picture of what to expect before you do something foolish. Trust me; it’s better to be a beach bum or a continual headache for the old man.
The Upshot of all this?
Unless you pay attention to what is REALLY going on (as opposed to what all the talking heads are babbling) and plan according to your own personal situation, you will be screwed. Plain and simple. It’s going to be tough enough even with the best laid plans of Mice, but really you don’t want to leave your future to “Fate”. Now is NOT the time to be believing in all that “God” hogwash. Now is the time to consider No. 1 your primary importance. Understanding instead of “Faith” is what will save your ass. Let the fools do as they will. Let them burn in their own self-created hells. YOU, on the other hand, must look and think in ways that are extremely non-traditional if you are going to come out of this alive. Don’t take my advice; don’t take anybody’s advice. Understand the situation for yourself and TAKE ACTION. Do this and there’s a good chance you will emerge victorious. Listen to the idiots on CNN, Bloomberg, and your Nice Friendly Government to your own peril. Understand why they say what they do, and what’s in it for them vs. what’s in it for you.
It took me another 3 or 4 years to return to my place of intellect. I had to re-examine all my beliefs, and later I would come to question the very nature of belief itself. I did not leave any stone unturned. I questioned everything and sought answers.