Plunge Protection Team Won't Prevent A Bear Market
by Comstock Partners, Inc.
Thursday, September 15, 2005
Although we believe that the market is set for a serious decline, some readers believe that government manipulation will hold up the market and prevent anything more than a minor dip. In our view the trading range in effect since last December will turn out to be a distribution top that precedes a resumption of the secular bear market that began in early 2000. Stocks remain significantly overvalued, while sentiment remains unusually high at a time when the Fed has been tightening, yield spreads have been narrowing and energy prices have been soaring. In addition there is abundant evidence that the economy was slowing even prior to Katrina, which can well be the outside event that tips the economy over. If the Fed does not hike the funds rate at next week’s meeting, it will only be due to their acknowledgment that the economy is at risk for a major slowdown—and that has not been discounted by the market.
In addition the chances for a financial crisis at this time cannot be ignored. In today’s Wall Street Journal alone, there were three separate articles outlining the potential for some major problems. First, Greenspan warned that Wall Street firms could become incapable of hedging all the risks posed by Fannie and Freddie. Second, the New York Fed is meeting with a number of Wall Street firms to discuss credit derivatives risks. Third, the Treasury is worried about an acute shortage of ten-year Treasury bonds eligible to fulfill a September futures contract. All of this would not be happening unless the authorities were seriously concerned about threats to the financial system.
Despite the prevalence of conditions that usually precede major bear markets, some observers believe that government manipulation of the market through its so-called “plunge protection team” won’t let a serious decline occur. The existence of the plunge protection team has actually been known for some time, and we first wrote about it in a comment dated May 10, 2002 (see archives). To quote from that comment: “Following the 1987 market crash, the Federal government became concerned about the potential disastrous effects of another market unraveling, and began to seek ways of averting a financial collapse resulting from a stock market meltdown. As a result President Reagan issued Executive Order 12631, dated March 18, 1988, establishing a Working Group on Financial Markets (Working Group). The group was to consist of the Secretary of the Treasury and the Chairmen of the Federal Reserve Board, the SEC and the Commodity Futures Trading Commission. The purpose of the group was to prepare options to deal with a serious stock market collapse that could seriously impact major financial institutions and the economy.
“Since that time the group has met regularly, and each agency has prepared a plan to deal with a potential crisis. Significantly, the Executive Order specifically stated that the group should consult with ‘representatives of the various exchanges, clearinghouses, self-regulatory bodies, and with major market participants to determine private sector solutions wherever possible.’ We also know that Chairman Greenspan has previously stated that the financial authorities would intervene under certain circumstance to prevent a meltdown. In a speech given on January 14, 1997, he said, ‘We have the responsibility to prevent major financial market disruptions through development and enforcement of prudent regulatory standards and, if necessary in rare circumstance, through direct intervention in market events’.
“The above is what we know; the rest is conjecture. A number of market observers, aware of some violent upside moves seemingly coming out of nowhere, believe that either the Fed or a group of private firms have intervened on numerous occasions to prevent the market from falling. This would be easy enough to do at reasonable cost through timely purchases of index futures.” While we have no specific knowledge of any interventions, a recent detailed report by Sprott Asset Management presents a well- reasoned circumstantial case that such interventions to prop up the market have occurred on a number of occasions.
The key question, however, is whether government manipulation of the market can stop the unfolding of a serious decline. To this question, we believe the answer is “no”. None of the major institutions in Japan, acting individually or in concert, were able to prevent an 80% collapse in their market following 1989, and we all know how hard they tried. In the U.S., intervention did not stop declines of 50% in the S&P 500, 79% in Nasdaq, and 83% in the Nasdaq 100 from early 2000 to 2002. The great trader, Jesse Livermore, an expert market manipulator himself, once said that no amount of manipulation can stop the overwhelming force of a major trend. In our view, that trend is on the verge of turning down once more, and we doubt that governments can stop it through manipulation any more than they can prevent destruction from an earthquake, a tsunami or a major hurricane.
© 2005 Comstock Partners, Inc.
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