The Daily Reckoning

The Jolt Felt 'Round the World

The Daily Reckoning - Weekend Edition
March 3-4, 2007
Baltimore, Maryland
by Kate "Short Fuse" Incontrera

VIEWS FROM THE FUSE: THE JOLT FELT 'ROUND THE WORLD

Finally. On Tuesday, something - albeit briefly - took the place of Anna
Nicole coverage on MSNBC and CNN...

The Dow fell more than 500 points at one time during the day, the biggest
drop since the markets reopened in the days following the 9/11 attacks.

As with most events in the market, there is no one clear-cut reason why
the tumble occurred - just a collection of speculations. After all, no one
ever said the markets act rationally.

You could look to the Far East for a clue: Tuesday saw the highest daily
slump to smack the Chinese stock markets in ten years...and the rest of
the global economy certainly felt the jolt.

China's People Daily Online reports: "If the Chinese markets catch a cold,
the major markets around the world will sneeze," Teng Yin, an analyst with
Everbright Securities, quipped.

"This is the first time that Chinese stock markets have affected global
markets significantly, but it won't be the last," Teng said. "The reason
is China's growing economic power."

Of course, this isn't the only reason U.S. stocks had their worst week in
four years. February's revised U.S. Consumer Sentiment fell to 91.3 from
the originally reported 93.9. Weak durable goods orders sent some
'worrisome' signals to the market. And, oh yes, Big Al dropped the big
"R": recession.

In "private" speeches on both Monday and Thursday, the former Fed chairman
flexed his economic muscles and showed that he still has the power to move
the markets simply by uttering the dreaded word.

"By the end of the year, there is a possibility, but not a probability, of
the U.S. moving into a recession," Mr. Greenspan was quoted as saying by
Bloomberg News, which based its report on interviews with people who
attended the CLSA Japan Forum in Tokyo, where Greenspan was speaking.

However, the New York Times points out: "To be clear: Mr. Greenspan did
not, as some analysts incorrectly inferred, predict that a recession was
imminent. In fact, he said few forecasters anticipated one. But he did
caution that the United States appears to be at the end of an expansion
and that such times usually bring with them the seeds of a recession."

Of course, Bernanke disagrees - and probably feels a little perturbed by
his predecessor's continuing power over the markets. He, along with St.
Louis Fedhead William Poole, asserts that there is NOT a recession in the
future, perhaps just a bit of economic "slowdown".

Most analysts don't predict that the sky is falling, and - surprise! -
neither do we here at The Daily Reckoning. After an eight month high for
stocks, a correction is not only unsurprising, but also inevitable.

And to further ease your fears, take this to heart: On Friday, whilst
eating lunch at our local favorite, Mick O'Shea's, Anna Nicole coverage
was back in full swing on all of the televisions in the bar. In fact, it
was the only thing CNN reported on during our meal.

So clearly, all is right with the world.

Short Fuse
The Daily Reckoning

P.S. The definitive reason for the market tumble will probably never be
revealed, but we do know this: this past week's events show the markets
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THIS WEEK in THE DAILY RECKONING: With stocks looking at its worst week in
four years, we had a lot to report on this week. And don't worry if you
missed some of our coverage - we have all five issues catalogued for you,
below...

Normal Markets 03/02/07
by Bill Bonner

"A 'normal market' is a lot like a 'normal tornado' - both can whip things
up and tip over the outhouse. Our only hope is that we're not in it when
it does. Bill Bonner explains..."
http://www.dailyreckoning.com/Issues/2007/DR030207.html

Japanica! 03/01/07
by Dan Denning

"Bennifer. Brangelina. TomKat. If the global asset boom were a celebrity
marriage, what would we call it? Chimerican? Americhinan? Or how
about...Japanica! Dan Denning looks at the events of the past week and
aims to answer the question: is the whole current global asset boom model
in jeopardy? Read on..."
http://www.dailyreckoning.com/Issues/2007/DR030107.html

Money Matters That Matter to Money 02/28/07
by Bill Bonner

"As yesterday's events show, money is like a perpetual child. It needs to
be cared for and worried about; otherwise it can get out of control. This
week, Bill Bonner reminds us of a time when people still worried about
things like trade deficits and money supplies, and how a current carefree
attitude toward these things might lead to our downfall. Read on..."
http://www.dailyreckoning.com/Issues/2007/DR022807.html

A Bad Hand for Bernanke 02/27/07
by Adrian Ash

"It's clear Bernanke's been dealt a bad hand by the Maestro. But will the
gold market fold, raise, or call his bluff...? Our U.K correspondent,
Adrian Ash, explores..."
http://www.dailyreckoning.com/Issues/2007/DR022707.html

Gold's Eternal Truth 02/26/07
by The Mogambo Guru

"This week, the Mighty Mogambo tries to convince his gathered audience
that owning gold is the only way to save yourself from bubbles and a
falling dollar. Well, gold and the Mogambo Time-Sharing Investment Scam
(MTSIS). Read on..."
http://www.dailyreckoning.com/Issues/2007/DR022607.html

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---------------------

FLOTSAM AND JETSAM: Shanghai down 8.8%, London down 2.3%, the Dow down
3.3%. And so far, the ASX down by 3.5%. Is this the crash for which we've
been flying a flag for weeks now? According to The Daily Reckoning
Australia's Dan Denning, the answer is a resounding no. Read on...

A Crash - Or Just a Collision?
by Dan Denning

The events of this past week is what you get when global markets go up for
nearly eight months without a significant pull-back. It's more of a
collision than a crash, the kind of thing that happens when you go over a
speed bump too quickly. You bang your bumper into the asphalt. It's not so
much that there were a lot of sellers this past Tuesday, but that there
were a lot fewer buyers.

Not that we'd ever want to be accused of being bullish, but let's keep
things in perspective. The same Shanghai 300 Index that fell 9% had been
up 23%, year to date. In the context of its rise the last three years,
Tuesday's collision was tiny. A real crash would be more like what
happened to American sub-prime lender Novastar (NYSE: NFI). The company
fell by 50% over three days when it reported rising defaults from its
sub-prime borrowers. It also added, ominously (a ridiculous
understatement) that it did not think it would make money any time in the
next five years. Gulp.

Yet what is so different about paying too much money for a stock like
Novastar and paying too much money for stocks as an asset class? In both
cases the faulty assumption was the same: abundant liquidity would drive
earnings and prices higher. With Novastar, it was higher interest rates
that burst the bubble. With global stock markets, it was something else.

This brings us to the key vulnerability of the Goldilocks Paradigm: money
supply, or liquidity. It takes a constantly increasing amount of money to
drive stocks up. The same amount won't do. Bubbles require more buying
power, always more. That's why liquidity theory is a better explanation of
global stock price movements these days than valuation. Stocks long ago
ceased to be correlated to real measures of value. With superannuation,
private equity, and institutional buying, the ready supply of liquidity
has been pretty smooth into all stocks-emerging markets and the Dow
alike.

But not this past week. So just what happened? And where to from here?
Probably more selling this week to shave another 5% off index values,
followed-and we're only guessing here-by a fresh run toward record highs
in the North American spring. If we're wrong, the crash to end all crashes
will be this month. And though we think that day is coming, we don't think
it's arrived just yet. Why?

Did you know that on any given day, just over 30% of the volume on the New
York Stock Exchange comes from automatic, computer-generated buy and sell
programs? The NYSE makes the data public on its website. We'll quote some
of it in a minute. But it's important for a simple reason: the direction
of global markets is determined a lot less by human beings and a lot more
through program trading by computer programs, models, and algorithms.

The upside of this is that automated buying power pushes stocks higher.
The downside is the Dow falls 200 points in two minutes as sell orders are
automatically generated and executed. There's not even time for some good
old fashioned hand-wringing and sweaty brows. Computers don't sweat. And
they don't panic. They just execute. "Sell."

The NYSE keeps data on a weekly basis, so we can't see quite what happened
yesterday, at least not officially. But here's what it said about last
week, "During Feb. 12-16, program trading amounted to 32.1% percent of
NYSE average daily volume of 2,962 million shares, or 952 million program
shares traded per day... Program trading encompasses a wide range of
portfolio-trading strategies involving the purchase or sale of a basket of
at least 15 stocks with a total value of $1 million or more."

For the week, just 15 separate firms trade over 4 billion shares using
program trading. The NYSE classifies about 7% of these trades as "index
arbitrage," and the rest as "all other strategies." So just what are those
strategies? We don't know, of course. But our guess is that some of them
involve liquidating a position if the Dow falls, say 100, points.

You can see how the process of program-driven selling becomes
self-fulfilling, each order triggering more selling, which triggers
further orders. There are computer programs designed to prevent this,
called "trading collars," which apparently failed yesterday. At some
point-probably later this week-other "buy programs" will kick in, and may
in turn, trigger other "buy programs."

Our point in all of this is that all rational discretion about what a
business is really worth is thrown out the window. The index is driven by
the programs, which then influences fund and ETF buying, none of which has
anything to do with what a particular stock is worth. Buying and selling
become reflexive, rather than reflective.

This is what we call speculation driven by liquidity. And ironically, it's
why recent history shows major one-day slides in financial markets seem to
have little or no impact in the real economy. And it's not just one-day
slides either. Remember the tech-wreck? The Russian bond-default? LTCM?
All of these mini financial panics took place in the stock market without,
apparently, causing so much as a ripple in the real economy.

What happens in markets does matter, of course, and not least because it
affects the net worth of consumers, who spend and earn money in the real
economy. And in that sense, the stock market is a psychological leading
indicator of the real economy. If investors are getting skittish-or become
skittish because program trading causes a series of steep one-day
declines-it can carry over into real world behavior.

God forbid most Western investors look at the real world. Then they'd
really get scared, seeing millions of consumers in debt, with stagnant
wages and large mortgage liabilities. Fully price that into the market and
you'd start to see some real selling, as investor flee stocks into, of all
things, short-term bonds with stable yields.

Hmm. Here's a conspiratorial thought. Maybe all of this is an elaborate
plot orchestrated by the GoldmanSachs/White House plunge protection team
to drive global saving back into the U.S. bond market, just as the
government needs to refinance its deficit and pay for its wars. Hmmn. Show
of hands? Yea? Nay?

While you work that one out, we'll make one additional observation that we
made in the March issue of Outstanding Investments about gold stocks. In a
collision/correction/liquidation, gold stocks will behave like stocks and
not like the metal.

In a long-term bull market, the best entry points for the equity side of
gold are after these corrections.

Your risk is that the metal itself outperforms the shares over the
duration of the bull market. But if, as we believe, the big third leg up
in gold is coming, the post-correction rubble will be the best time this
year-and maybe for the next few years-to load up on gold senior and
juniors. Ironically, the juniors may hold up under a correction better
because there are fewer institutional owners (fewer weak hands with
twitchy sell fingers to shake out.)

Dan Denning
The Daily Reckoning Australia

P.S. To read the latest issue of Outstanding Investments, and to find out
how you can profit from zero-downside gold, see here:

Golden Opportunities
http://www1.youreletters.com/t/855566/12296005/785954/270/

To get The Daily Reckoning Australia, click here:

The DR Down Undah
http://www.dailyreckoning.com.au/subscribe-dr/

Editor's Note: Dan Denning is the editor of The Daily Reckoning Australia.
He's also the author of 2005's best-selling The Bull Hunter (John Wiley &
Sons), and spent five years as editor of Strategic Investment, one of the
most respected "big-picture" investment newsletters on the market. A
former specialist in small-cap stocks, Dan draws on his network of global
contacts from his new base in Melbourne, Australia.

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The Daily Reckoning's Weekend Edition: The Jolt Felt 'Round the World