Attending to the Warning Signs of a Major Stock Market Correction

Many in the stock market are fairly ebullient - when the market soars - which is when it's not taking a dump on certain days or in response to specific events (e.g. Ebola infections, ISIS gains in Iraq etc).. Most have been beneficiaries of the Fed's infusion of "crack" in the form of "quantitative easing" and cheap money. (With another round on the horizon. Notice how the DOW stopped dropping once the buzz began about QE3, following QE1 and QE2 - which have together infused $4.3 TRILLION in bond purchases so far).

But at some point, the cheap money flow has to stop and even if it's done slowly Maul Street will respond hysterically, which is what has prompted discussion of how large a future correction will be ('How Bad Can It Get?', WSJ Sunday in Denver Post, Oct. 19). As the article observes, "corrections of 5% to 20% are a normal part of the stock market" and pointed out that even J.P. Morgan built corrections into his forecasts (often taking advantage of inside info while the little guys got toasted.)

Thus, those in the market now, whether in 401ks, IRAs or doing their own thing in day trades, need to be aware of the potential for loss, and large loss. In line with this, the article points out the "gloomiest" prognostication for a drop so far has been Scottish stock market historian and analyst Russel Napier. He suggests that Wall Street "might fall by 75 percent or more before the carnage is over."  This would put the DOW at about 4300 or where it was in 1980.

And it's not just a remote possibility. Arch-forecaster Nate Silver, in his book, The Signal and the Noise- Why So Many Predictions Fail But Some Don’t  warns (p. 347):

"Of the eight times in which the S&P 500 has increased at a rate much faster than its historical average over a 5-year period , five cases were followed by a severe and notorious crash, such as the Great Depression and the Black Monday crash of 1987”.


Interestingly, two of the largest stock market dives have followed two of the biggest bubbles: the first of 37.85 percent and on the heels of the bubble that formed from Jan. 14, 2000 to Oct. 9, 2002, and the second of 58.78 percent that formed (mainly due to the housing bubble) from Oct. 9, 2007 to March 9, 2009.

Are there warning signs to attend to? Of course! First among them is that IF  the economic future was truly rosy long term interests rates (a barometer of economic growth, i.e. since it indicates wages going up) would have been going up. But instead we observe them tumbling with the benchmark yield on 30-year Treasury bonds having now dipped below 3% and yields on the 10-year note at mid 2013 levels.

People should also be leery of the S&P increasing beyond the range Silver notes over a 5-year period, and the DOW is also a proxy of that - and red alarms ought to sound if it hits 17,000 and stays there any length of time.

A final warning sign which too few attend to is stock buybacks by the companies themselves. I mean, WHY should you have to buy back your own stock to create an artificial rise in share price if your company is genuinely doing well? It makes no sense. If you're going to use any extra money for anything it ought to be for paying dividends, not stock buybacks!

Columnist Jonathan Clements in his piece in the WSJ Section of the Post this past Sunday, observes:

"Many companies were big buyers of their own stock before the 2007-09 market decline, only to scuttle their buyback programs during the market crash. In recent years with share prices up sharply they have begun to voraciously buy back."

And why not, because they are then reaping the bounty of their own high share prices? Buy backs also make management's stock options more valuable - so what better way to compensate the Street's honchos?  Strangely, all this has selectively blinded investors to the lack of dividends. As Robert Arnott, quoted by Clements, stated:

"Dividends are reliable, You cut them at your own peril - but you can cut a buyback and hardly anyone notices."

Why? Why aren't the little guys more aware of how they're being shafted? Maybe for the same reason, as former trader Michael Lewis observed this morning on CBS' Early Show, they're not paying attention to how flash trading is ripping them off via "millisecond" advantage and thereby gaining pennies on the dollar with each trade made. They essentially gain those pennies (which add up to billions over time) by getting shares redeemed before you can via that slight micro-time advantage.

Why doesn't the SEC do anything to stop this baloney? According to Lewis, because once they leave the SEC they will be looking for jobs on the Street so don't want to alienate it with antagonistic regulations or judgments.  So don't look for the SEC honchos for any guidance or alerts to help you with navigating the swamps of Maul Street. You are literally on your own - with maybe this blog and a few others to try to provide some heads ups.

What you can do is what every sane investor ought to be doing: leaving any stock now that doesn't deliver dividends and is only doing buy backs. (With a little research you can find this out.)

You can also re-assess your risk tolerance. Can you really afford to lose 75 percent of your 401k  if the market came a crapper again? And don't take any online quizzes to asses your current risk tolerance! Psychologists will tell you when the market's going up, DOW headed toward 17,000 as it is now, people tend to over answer on the positive side.

What you really need to do is doff the rose-tinted glasses and pink Pollyanna hat and put on your black, negative thinking cap. Ask yourself how you would feel if you had $300,000 salted away  in 401ks and IRAs and after a major crash or "correction" had $75,000 left.  Would you be able to suck it up and move on? Would you be able to stick to the Street mantra of "Buy and hold!"  If not, you had better rethink your positions and portfolio.

The Bernie Madoff Victims - Or, Were They Caught in a 'Monkey Trap'?

"You don't need to belong to a country club, or drive an expensive car or buy expensive jewelry. You certainly don't have to own three separate dwelling places. It's all pretty obvious." = Joanne Meerow, one of Bernie Madoff's victims, in The New York Times (Madoff Victims, Five Years Wiser, Dec. 8)

In the Caribbean, in places such as Barbados, there is what is called a "monkey trap". It's needed now more than ever as the monkey population on the island has exploded and the varmints invade properties to steal fruit, especially paw paw, figs, and even breadfruit and mangoes. They are also wasteful - in that they often just take one bite and amscray.

There are different monkey traps but one commonly favored is to use a hollowed out breadfruit with a small hole in it - just wide enough for the monkey to insert his paw- and place a small, sweet fig (like a small banana) inside it.  To egg the monkey on, a tiny piece of banana or mango may also be placed just outside the gourd opening. If the monkey were to just heist the tiny morsel he'd be okay  - but it's not in their nature. The monkey wants more....more, more, more, and like too many humans ....it goes for the gusto. But once it grabs hold of the prize inside, he finds that the hole is now too small to withdraw it.

The monkey is trapped. For the proud human trap springer, there will be monkey meat to eat - a real dividend considering how food prices on the island are soaring through the stratosphere.  The monkey trap works because the monkey is unable to properly process the cost of grabbing his interior fig. It's not that he's stupid, only that he's programmed by evolution to snatch first and ask questions later. He must then, as we say, "repent at leisure".


Now, let's switch to the "monkey trap" sprung by Bernie Madoff on thousands of humans who - like the monkey - allowed their own greed and desire for more to trap them when the cost was intolerable financial pain, and loss.

How is it that so many of Bernie Madoff's victims had more $$$  than they needed already, and yet grasped for the fake promise of even more riches?  Answers given in a December New York Times piece may hold many clues, especially coming from one couple, the Meerows. As seen from Mrs. Meerow's quote above, they certainly didn't have to expand their wealth more than it was - they had quite enough to have a very comfortable retirement - more than 99% of Americans.

Other comments made - especially by Mrs. Meerow- shed even more light. For example, she cites a recent visit to their "old country club"  for a wedding, and observes that all its trappings on display "underscored that its society were all about things and jewelry and all that silly stuff." 

Adding: "That's not who we are anymore. Besides, if I had never walked into that club I would never have heard the name Bernie Madoff."

She was saying a mouthful there. An upper one percenter enclave, where baubles and money likely mattered more than anything else. A perfect place to play on members' innate greed to grab even more.  "Hey, you know, there's this guy Bernie Madoff who could really make you a lot more money!"

Another victim, author Geneen Roth, perhaps spelled out the core of what snookered so many Madoff victims into a "monkey trap" partly of Madoff's making, and partly of their own greed. As she put it:

"You can feel stuffed and full after binging on food, but there seems to be no amount of money for which people feel full"

She added:

"Anorexics who think they are fat are no different from those who have all money for all their basic needs but still worry they don't have enough."

And therein lies the trap. The yen for more! The inability or unwillingness to be more conscious of what it was they were getting into and above all, ignoring the old saw "if it sounds too good to be true it probably is".

I too had seen offers come in for high yielding CDs, other vehicles in the 9-12% range nearly a decade ago, but in the low interest rate environment on offer I ignored them. I didn't try for more because I felt we had enough to at least be comfortable. I wasn't afflicted by the American disease of "not enough money" insecurity - driving people to take inordinate risks. For the same reason, I've been out of the stock market since 1996. I have merely observed while it's gone on its roller coaster rides - alternatively wiping the suckers out before the next batch comes in - while I stick with my low earning money markets.  None of Bernanke's games with quantitative easing will get me to jump into this fool's market based on cheap money and financial hucksterism.

In this sense, it's hard to sympathize with Madoff's victims. They let their yen for more obscure their thinking. Even those who weren't necessarily wealthy, still wanted more than what the existing environment offered and thereby laid their own monkey trap.

In the memorable words of Geneen Roth:

"I do feel that my part in this was my own lack of consciousness about money. ....Would I like to get that money back? Yes!  But do I feel that what I've gotten since losing it has given me more wealth in a way, than anything I had before? Yes."

And another thing she's gotten is the ability to see clearly through any future monkey traps!

For the rest of us it means consistently being able to put our long term interest over any short term gains. Can we do it?

To learn more about monkey traps and avoiding them check out this link:

http://www.godlessinamerica.com/monkeytrap.html