High Likelihood of a Market Crash
by: ContraHour posted on: June 22, 2008 | about stocks:
The
whole setup reminds me a bit of Elaine Garzarelli in 1987. Garzarelli was
a relatively unknown quant analyst and money manager at Shearson Lehman in
1987. In the weeks before October 19th, she made brief appear on FNN, the
precursor to CNBC, saying there was a high likelihood that the market could
crash. That sealed her place in history. A
lot of other warning signs indicate that the Bank of Scotland isn't that crazy
in predicting the unpredictable. First,
the past month generated an Hindenburg Omen.
The Omen is a measure of internal divergences in the market and is signaled on
June 6th. While the Omen doesn't necessarily mean the market will
crash, no crash has ever occurred without a signal in the prior 40
days. For instance, an Hindenburg Omen signal occurred on September
19th, 1987 about one month before the market collapsed. click to enlarge images The
market is suffering extreme internal divergences, similar to the NASDAQ and Dow
in 2000. During the final run higher, basically the only stocks going
higher were technology and Internet related. Similarly, right now, the
only stocks hitting new highs are commodity and agriculture related. The
banks and financial in particular are showing an unsustainable downside
divergence. The financial stocks have, in fact, already crashed.
While the financials typically move in line with the broader market, they have
been leading it lower in the past twelve months. The
market has worked off its oversold conditions from March and January and has
built up energy to move lower. The stochastics have just started
rolling over, as have the internal breadth indicators. Neither is yet at
an oversold extreme. In addition, the Summation Index never made it past
the 500 level on the rebound from January and March lows - that indicates the
rebound lacked breadth and depth. Of
course, the trade deficit continued to increase and the dollar plunged
anew. That caused a crisis of confidence in the market and contributed to
the crash in 1987. Combined with reckless comments from Secretary of
State James Baker, the market was nudged over a cliff. Similar
comments from Ben Bernanke's two weeks ago about raising interest rates
to stem the decline in the dollar could cause a similar panic if he
follows through with his threats. So
while it's difficult to predict a crash (a crash by definition are a
4 standard deviation event and therefore, unpredictable), I think all the elements
are in place for one to occur. 
Finally, the Fed and
politicians always have some hand in causing market panics. In 1987,
Greenhorn Central Banker Allen Greenspan caused problems when he indicated that
the dollar's decline would come to an end because the fundamentals were
improving. Shortly after taking leadership post, Greenspan hiked rates
partially to stem the greenback's decline.