April 14, 2003
Markets May Defy Logic a Little While Longer
“The images you are seeing on television you are seeing over, and over, and over, and it's the same picture of some person walking out of some building with a vase, and you see it 20 times, and you think, 'My goodness, were there that many vases? Is it possible that there were that many vases in the whole country?”
Defense Secretary Donald Rumsfeld
Clearly Mr. Rumsfeld’s ramblings during his ‘Meet the Press’ interview on Sunday were intended to downplay the widespread looting that has taken place in Iraq. To be sure, with the help of the internet it is not difficult to find pictures of liberated Iraqis stealing carpets, electronics, generators, museum artifacts, bobcats, forklifts, every type of furniture imaginable, and even a horse. In fact, the only thing missing from the images of looting is an Iraqi carrying a single vase. And although this is a pointless point to make, everyone knows that most vases can be carried with one hand or arm…Mr. Rumsfeld must not have seen what the lone Iraqi looter had in his or her other hand.
Looting and lawlessness aside, the Iraq ‘war’ unofficially ended last Wednesday when Saddam’s statue was demolished. And while some conspirators have suggested that the toppling of Saddam’s likeness was nothing more than a staged media event, the fact that allied troops are embedded inside Baghdad and Saddam’s regime has been unable to hold any semblance of power effectively means the liberation process has begun. Incidentally, if the U.S. is unable to orchestrate a smooth transition of power the word ‘liberation’ dims into the word ‘occupation’. As far as the financial markets are concerned either word is acceptable, so long as Iraqi oil soon begins to flow and no domestic terrorism emergencies emerge.
Is another geopolitical flashpoint opening up?
In the last week nearly every notable U.S. official – including Perle, Wolfowitz, Rumsfeld, Powell, and Bush (on Sunday) – has offered a tough warning to Syria for providing safe haven to members or Saddam’s regime, sponsoring terrorism, and possessing chemical weapons (although long suspected, this is the first time the U.S. has come right out and said Syria possesses chemical weapons). Judging by the U.S.’s tough rhetoric, it would not take much for the U.S. to give Syria an ultimatum. And while such an ultimatum – ‘disarm or you will be disarmed’ - may be months or even years away, if gaining Israeli support for a Palestinian peace process boils down to destroying Syrian support of the Hizbollah the U.S. appears willing to act. Moreover, without the U.N. inspections delaying things, an attack on Syria could be closer than most people thing.
-- That said, before any other Nation is attacked finding WMD in Iraq appears to be top priority. Franks has stated that the U.S. will need roughly 1-year to search all the sites they have mapped out…
Does the PPT Exist?
In this weeks Contrarian Chronicles Fleck follows Mauldin’s train of thought and states, “In the 15 years since its inception, one would think that if the President's Working Group on Financial Markets were engaged in plunge protection, somebody would know about it.”
It is easy to agree with Fleck and Mauldin (and Art Cashin): that since there is ‘paper trail’ and numerous people would have to be involved in a PPT conspiracy that no such secret order exists. However, to argue that a there is a paper trail for every financial transaction in the U.S. financial markets would be naive -- who bought all those put options before 9/11?
Beyond the ‘paper trail’ points, the crux of Mauldin’s argument is that since large sums of money are required to manipulate the markets there is no way to manipulate prices without someone knowing. After all, if someone starts buying huge S&P blocks and many billions are won or lost someone must surely know who is doing the buying. This argument is even more baseless than the paper trail argument:
Back when LTCM’s was the King hedge fund it controlled a significant portion of the derivatives market (i.e. LTCM had huge derivative bets against equity volatility leading into Asian crisis). When Merrill and others found out (some argue stole) about LTCM’s positions they immediately made huge bets against LTCM. The logic being that since LTCM was losing money and at risk of going under, taking the opposite position would be extremely profitable when LTCM was forced to liquidate its trades.
What the LTCM example shows is that hidden forces – not recognizable to anyone except insiders and criminals (Merrill has never admitted to stealing LTCM’s records) – can have a dramatic impact in the financial markets. As LTCM moved closer to bankruptcy it had to open its books to potential buyers…not surprisingly, more firms began to bet against LTCM’s positions and a bailout had to be orchestrated with the Fed’s approval to save the day. For the average paper chaser or trade watcher the entire LTCM episode would have completely secret -- in fact, the media picked up on the story only once the Fed got involed.
Point being, the entire reason why the PPT can influence trade with small, timely purchases is because people know (believe) that the PPT exists. The PPT acts contrary to an LTCM, because when firms know or think the PPT is in the market (perhaps buying a handful S&P futures using a nameless account through an unsuspecting house), they follow the trades (unlike LTCM Merrill and others are not going to bet against supposed Fed actions).
As for the statement that the PPT must be “the most incompetent team in the world because the markets have indeed plunged.”
* Have the markets really ‘plunged’ during the last 3-years? Or has the drop largely been orderly? My opinion is that the decline in U.S. equities has been extremely orderly -- even with a recession, 9/11, and Brazil default fears there has not been a single session that can be accurately defined as ‘panic’.
In short, the job of the PPT is not to rig the markets so that prices never fall. Moreover, the job of the PPT is not to make mammoth bets that prices will rally when Greenspan thinks prices have bottomed. Rather, the job of the PPT is to ensure the markets remain liquid and panic selling never takes place.
The Week Ahead
This week promises to be as unpredictable as last week. However, with many on Wall Street calling for an extended rally – including Ralph - there is increased near term focus on previous ‘bottoms’. Should earnings severely disappoint and/or no leading indicators for April come in better than expected, the markets could well retest their March bottoms.
That said, I have my doubts about the markets immediately retesting their lows due to the fact that earnings are not great and/or because the economic stats are extremely weak. You could say, like most, I am on the fence.
However, if prices hold steady or rally it will not be because of fewer vase thefts in Iraq, or because the Fed is manipulating prices. Rather, it will be because one or two economic reports – however meaningless they might be – show slight improvement, and this allows investors to hold on and/or shift some money into stocks. Despite a brutal 1Q03, we are in still in the season of equity inflows; we are still in a period when the markets can defy all logic and rally (even hold steady) when by all fundamental accounts weakness is warranted...we are in this period of unpredictability until at least May.
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