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Generational Dynamics Web Log for 3-Nov-07
MarketPsych investor fear index forecasts sharply increased market turbulence.

Web Log - November, 2007

MarketPsych investor fear index forecasts sharply increased market turbulence.

With investor anxiety increasing, the index forecasts a return to the "mini-panic" level of August.

Since I wrote about the Marketpsych "Fear Index" in September, I've been following it on a daily basis. Each day I watch CNBC and make my own judgment as to whether investors are anxious or sanguine, and then the next day I check to see if my judgment is matched by a change in this fear index, and it's been pretty accurate so far. It appears to be a very powerful tool for assessing the level of investor anxiety and panic.

Here's the graph of the index as of today, annotated with some of the major events that have triggered ups and downs in the index this year:

MarketPsych Fear Index -- 2-Nov-2006 to 2-Nov-2007 <font face=Arial size=-2>(Source: Marketpsych)</font>

MarketPsych Fear Index -- 2-Nov-2006 to 2-Nov-2007 (Source: Marketpsych)

From the point of view of Generational Dynamics, the ups and downs of the stock market are not as important as the changes in behaviors and attitudes of the masses of investors, as it's the latter that indicates major generational changes that trigger huge historical events.

If you examine this graph, then you'll see the following:

Although the index has had wide swings throughout the year, the general trend has been strongly upward since mid-January. This long-term trend is particularly significant for Generational Dynamics, because it appears to show a massive increase in the level of panic and anxiety among those in the Boomer generation and Generation-X.

In the past few days, the index has exhibited exactly the same pattern that it exhibited just prior to the February 27 and August 17 "mini-panics." This observation, combined with the long-term trend just described, indicates that we're getting much closer to the full-scale generational panic that Generational Dynamics predicts MUST occur, with 100% certainty.

In order to clarify the annotations on the above graph, I've prepared the following list of the events that I consider most likely to have triggered the major ups and downs in the index since mid-January. The actual data values are approximate, since I have no access to the data other than what I can read from the graph itself.

January 19, index=4 and rising. Financial Times publishes an article about hedge funds, indicating that hedge fund managers may be committing fraud. After all the political turmoil following the elections began to simmer down, the index was at 4, the lowest point of 2007.

February 20, index=6 and spiking up. Media reports start talking about the falling ABX index. More important, many media reports are saying that the Shanghai stock market bubble appears close to bursting.

February 27, index spikes from 12 to 22. A "mini-panic" occurs on Wall Street, and in Asian and European stock markets, after the Shanghai stock market index falls 8.8%.

February 27 - May 20, index falls to 11. Investors conclude that there was nothing to worry about, as the Shanghi bubble resumes.

May 20 - early June, index steady around 11.

June 6, index at 12 and rising. Morgan Stanley in Europe signals a "Full House" sell signal.
June 15-22, index rises from 12 to 15. Bear Stearns reveals that it's bailing out two hedge funds. This is the first major announcement of a CDO "writedown" -- securities that had previously been AAA rated were now becoming worthless. The index starts falling again down to 12.

July 18, index spikes up from 12 to 15. Bear Stearns announces that its hedge funds are almost worthless. This is the major inflection point of the "credit crunch" crisis of August, as financial managers realize that all kinds of hedge funds, commercial paper, and even some money market funds may contain worthless or near-worthless assets. On July 19, the market reached a historic high, Dow 14000.

July 26, index spikes again to 21. Worldwide markets plummeted 2% as credit crunch increases.

August 5, index around 21. CNBC's Jim Cramer becomes hysterical, blaming Ben Bernanke for letting the economy tank. The video is widely reported and viewed.

August 9, index spikes to 25. BNP Paribas announces that they would freeze three of their hedge funds that had invested in mortgage-backed securities. In response, US and European central banks inject billions in cash to stanch market meltdown. It was getting clear to me at this time that we were beginning to see real signs of a generational panic. The Fed continued to pour more money into Wall Street.

August 16, index at all-time high of 26. It was clear to me that investors were approaching full-scale panic, and I wrote that the nightmare is finally beginning.
August 17, index at all-time high of 26, spikes down to 18. The Fed makes an extraordinary announcement to lower the discount rate. Fed Chairman Ben Bernanke, who didn't believe in bubbles and thought that the 1930s Great Depression could have been avoided with a minor change in Fed policy, begins his Great Historic Experiment, trying to stay ahead of a stock market crash by injecting liquidity into the marketplace.

August 17 to September 8, index remains around 18. The investment community awaits the FOMC meeting, hoping for interest rate reductions.

September 17, index spikes up a little. Investors are suddenly nervous that the Fed won't cut interest rates.

September 18, index spikes down to 13. The Fed shocks financial community by announcing a full ˝% interest rate decrease, when only Ľ% had been expected. Investors turn giddy with delight and push markets up 2.5%. By October 9, the Dow Industrials had reached a new historic high: 14164.

October 15, index at 12 begins spike up to 21. This was the date of the mind-boggling "M-LEC" announcement. The Master-Liquidity Enhancement Conduit or "Super-SIV" (Structured investment vehicle) had, as its purpose, to allow Citibank and other banks to sell worthless securities (CDOs and other credit derivatives) to each other at artificially inflated prices, so that the artificial prices become "market prices." This would permit these worthless securities to be "marked to market" at the artificial prices. I wrote that this was out and out fraud, supported by the US Government in the form of the Treasury Secretary and, much to my surprise, the financial community apparently agrees with me, as the index has been increasing fairly steadily since then.
In addition, it was becoming apparent that third quarter earnings growth was much lower than in previous quarters.

October 19, index around 18. Investors commemorate the 20-year anniversary of the Panic of 1987.

October 31, index around 18, spikes up to 23. The Fed lowered the interest rate by another Ľ%, but investors had been hopin' and prayin' for a ˝% cut. Investors became sober, and bad news was no longer good news.

The index value for a particular day is subject to revision for a couple of days thereafter, and so the last couple of index values may change. But it's been pretty clear that something pretty dramatic changed after the Fed announcement on Wednesday, and investors are exhibiting genuine fear.

Let's review the big picture, what's really going on here. If you go back through history, there are of course many small or regional recessions. But since the 1600s there have been only five major international financial crises: the 1637 Tulipomania bubble, the South Sea bubble of the 1710s-20s, the bankruptcy of the French monarchy in the 1789, the Panic of 1857, and the 1929 Wall Street crash.

When comparing these international financial crises, the details are always different, but they're all remarkably similar in the following ways, as described in "The bubble that broke the world": A debauched and perverted use of credit, occurring at exactly the time that the survivors of the previous financial crisis have all died or retired; a huge asset bubble; the securitization of credit; and an upsurge in corruption. All of those elements are enormously present today.

From the point of view of Generational Dynamics, we're waiting until a "generational panic" triggers the inevitable collapse. The asset bubble MUST collapse; the credit securities (CDOs) WILL become worthless; the corruption MUST be punished.

The working hypothesis is that the "MarketPsych Fear Index" is a tool that tells us when this panic is likely to come. We've shown above that the index is showing a pattern that's similar to the last two "mini-panics" of 2007, and that the long-term trend of the index is up. We hypothesize that, therefore, there will be a new sharp spike up in investor anxiety and panic. Further, we hypothesize that if the current spike up in anxiety doesn't lead to a full-scale generational panic, then there will be further repeated similar cycles, until one of them DOES trigger a full-scale generational panic and crash.

Fed Chairman Ben Bernanke "cured" the August mini-panic by means of a dramatic and unexpected injection of liquidity into the financial system. It's possible that the Fed has enough firepower left to "cure" the coming mini-panic, possibly by shocking everyone by dropping the Fed Funds rate another 1% to 3˝%. However, he may not have the ability to do that, since it would weaken the dollar so substantially on world markets that the same international financial crisis may be triggered anyway, by a different route.

At any rate, this is a time of great danger to investors. If you're one of those giddy investors who believe that a new stock market crash is impossible, you might at least consider pulling out of the market until the next mini-panic is over. (3-Nov-07) Permanent Link
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Generational Dynamics Web Log for 3-Nov-07 MarketPsych investor fear index forecasts sharply increased market turbulence.

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Generational Dynamics Web Log for 3-Nov-07
MarketPsych investor fear index forecasts sharply increased market turbulence.