Thursday, October 30, 2008

Standing on the Sidelines or Sprinting for the Exits

The stock market traditionally hits bottom after most investors are, in Wall Street terms, standing on the sidelines, waiting for prices to stabilize so they can start buying again. Every week since at least the end of July, including this week, at least one analyst has announced a bottom in the stock market. Most of these calls have met with disappointment as the market did not turn upward. I think there is an explanation for the excessive optimism we have been seeing about the stock market. Most of the analysts on Wall Street have not, in their lifetimes, seen the financial underpinnings of the market get so bad that many of the participants are not standing on the sidelines, but are instead sprinting for the exits. If you forget to ask how much of the money is standing on the sidelines and how much is sprinting for the exits, the market seems to be in a better place than it is.

Of course, I am not suggesting that everyone is sprinting for the exits. When I look at pension funds, for example, they seem to be staying put. It is hard to imagine where else they could go. But there are plenty of signs of market participants sprinting for the exits — grabbing what money they can and getting out of town, sometimes literally:

  • Why did Treasury Secretary Henry Paulson drop his original Wall Street Bailout plan, after going to so much trouble to get it railroaded through Congress, and replace it, at least for now, with a bank capitalization plan? One reason was that he did not want the money to get caught up in the rush for the exits. If he had gone through with his original plan, much of the bailout money would have left the country by now.
  • AP reported recently on Wall Street workers leaving the New York metro area, sometimes even leaving the industry or leaving the country. When some of the top financial talent in New York are selling their homes at a loss just so they can get out of town quickly, you know some of the money that is leaving with them is not coming back anytime soon.
  • Hedge fund liquidations continue at an alarming rate that is not fully explained by institutional or market forces. Rather, it appears that many hedge fund holders are being forced to liquidate to cover losses elsewhere. That is to say, trillions of dollars in paper assets are simply vanishing in thin air. These investors won’t have the money to put back into the markets when the markets hit bottom. One current sign of forced liquidations is the 15 percent decline in safe-haven assets in categories such as gold, utilities, and health care.
  • An unprecedented number of U.S. investors are nearing retirement. In many cases, the most rational action for them is to take all the money they know they have and live on it for the rest of their lives. Not all of them will take that rational course of action, of course, but many will. As one journalist recently put it, “That money shouldn’t have been in the stock market in the first place!” and it won’t be coming back to the stock market, at least not much of it, during the lifetimes of its owners.
  • When the major brokerage houses converted to bank holding companies, CNBC called it the end of an era. What I think they meant, but couldn’t quite say, was that it was the end of Wall Street as we know it.
  • The recent record levels of volatility in the stock market suggest that some of the billion-dollar players who previously smoothed out market fluctuations have now run out of money.

With so much more de-leveraging and liquidating to come, it is hard for me to imagine that the stock market can stay consistently at this month’s levels. But I also don’t think the market bottom will be a dramatic event that will be obvious at the time. It could easily be just a momentary dip, and it may be a year later before we can look back and say, those 15 minutes were the lowest the market went.