Punditry Aside, Market Crash Is Continued Liquidity Panic

By Aaron Krowne
Founder, ML-IMPLODE.com

In this brief post we remind the reader of the power of the “liquidity panic”, i.e. market crash, in the spirit of the fall 2008 crash. We feel this post is necessary because of the incessant din of punditry in the past few weeks attempting to explain the market action as the result of one dramatic event or the other, or one “market viewpoint” or another (e.g., “the US won’t default”, “the US is a poor credit and may default”, “Europe is screwed”, “Europe is saved”, etc.).

Obviously, many such viewpoints swirling around are actually contradictory to each other, and no one can truly say which is correct, so it should quickly be apparent by logic alone that such “sentiments” could not possibly be the source of such a uni-directional move — that being a 15% crash in the equities markets.

Here is a snapshot of the overall market action (in the Dow); note the distinct downtrend started on July 21st:

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Here’s an annotated version, with a more technical “candlesticks” view:

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I could have included more events in this chart, but these were the biggest ones. Note that it doesn’t seem to matter much whether these major, “earth-shaking” events are good or bad; the effect on the overall market trend is nil or extremely brief (less than a day). And here is that trend painted out explicitly:

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Now, I am no “market technician”, but when I saw this pattern, even a week ago, it was apparent to me the market was on a parabolic downtrend, and it was going to keep going down, barring a major change in the underlying liquidity mechanics of the market. (None of the news events labeled above qualify, mind you.) Some people were fooled by the intra-day reversals of August 1st, 3rd, or 5th; I (and those who correctly identified the parabolic trend) were not.

What I am prattling on about is that this isn’t a “normal” trading market; it isn’t responding to the “big news” events in a common-sense way (much beloved by omnipresent j-school financial writers), if at all. It is only responding to what is happening with liquidity. And that is clearly draining out. The Fed has dialed back its QE intervention greatly, if not totally exited from the market. The Treasury is going back to market to borrow in a big way, a dynamic which vacuums the liquidity out of stocks (Lee Adler at the Wall Street Examiner is the world’s top expert on this dynamic).

I’m not saying the normal state of the stock market should be dependent on mass liquidity injections from the Fed, but that is what the “Bernankestein’s monster” of a market we have today now requires to stay alive.

Of course, we saw this movie before; witness the fall 2008 crash:

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Will we get the same remedy of continued, unprecedented mass liquidity injections (money-printing)? Probably. Unless Bernanke wants stock armageddon.

As you can see from this chart I swiped from Doug Short, the stock market has essentially become little more than what the Fed is doing to prop it up. You can see that all of the uptrend in equities since the fall of 2008 coincides with quantitative easing phases.

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Ironically, it is during these same intervals that 10 year Treasury yields actually endsup higher, showing that the Fed doesn’t really give a toss about the superficial goal of lowering interest rates — they just want to see stocks goosed. Looked at another way, essentially the market makers are using QE to dump Treasuries onto the Fed, and then run out and buy stocks for speculative purposes.

As the chart above shows, we got a twofer, in response to the 2008 panic and spring 2010 “mini-panic”; so I expect a “threefer” now.

That, of course, is probably what gold and silver are responding to. In 2008, one could naively assume that extreme QE would not be implemented, so gold and silver tanked along with everything else, in the scramble for liquidity. Today the reaction is the opposite, thanks (or no thanks) to the Fed. The debt ceiling silliness has little to do with it.