Is it a slow motion train wreck? Do we just sell everything and go into cash because the litany of problems is too difficult to overcome?
I have countenanced going into cash four times in my career: October 15 of 1987, October 8 of 1998, March of 2000 and October of 2008. Three were dead right, one was dead wrong and I had to reverse course, literally intra-day.
These four moments are more instructive than anything I can write at this moment, because they explain what a real crash looks like versus a slow-motion train wreck, a high-speed collision and an ill-fated judgment so you can reason about which one or ones we might be facing.
First, the crash of 1987. Not many recall the era well, but the crucial point of this particular meltdown was that it was based on overvaluation first and then a breakdown of the stock market's economics second.
Going into the year, we had an acceleration in the economy coupled with an influx of reckless Japanese buying. The Japanese ruled the financial world back then and they had no qualms about purchasing stocks at literally any price. Japanese investors, not US investors, drove up valuations to, at their peak, 29x earnings -- an unsustainable level even for the robust economy that we had at the time.
The crash occurred in two parts. The first drove us down about 500 points from the 2700 level. At the time, that leg was widely attributed to multiple shrinkage. The second leg was a one-two punch of one of the worst weekly declines going into the actual 508-point train wreck, and then the next day, when the market lost another 300 points to a miasma of selling -- which bottomed at about 1100 -- a plummet of 1600 points over several weeks' time.
How did that come to pass? Again, it was two-fold. First, a group of now long-since-forgotten charlatans proselytized a product called portfolio insurance, which basically used futures to stop out any fund down 5%. Second, the S&P futures were relatively new and raw, as there had never been a true test of the interplay between Chicago and New York.
It was disastrous, like throwing gasoline on an already burning building. The result? The Black Monday crash.
Now here's what you need to know about that event: It was based on nothing more than valuation and failed interplay between Chicago and New York. Down 5%, the insurance kicked in, which led to a flood of sell orders and a wipe out of bids both on the Nasdaq and the New York Stock Exchange.
A year later, even if you had bought on the worst day that Friday before the crash, you would have been fine -- owing to the strength of the economy and the false tell of the market. We were in cash, because Karen Cramer did not like the action, and literally called for a crash the week before because of a lack of buyers no matter what. Good call -- and we finished up for the year.
The second call, my fabled wrong call, came after I started TheStreet. The market has been weak for much of September, as Long Term Capital, one fund, had an immense number of positions of incredible size. The people who ran the fund weren't charlatans. They were misguided, pre-algorithmic alleged geniuses who did not understand the power of their own positions.
Their fund was threatening to bring down many banks. But the Fed was oblivious to what was going on and then-Fed-chair Alan Greenspan, quite frankly, was oblivious to the entire -- and dire -- situation. I sensed a total collapse, perhaps because my own fund, suffering from an ill-timed opening, suffered from massive redemptions.
At the absolute low point of the decline -- check the timestamp -- I panicked and wrote a piece called "Get out Now" at around noon. At 2 p.m. Greenspan came to his senses and announced an emergency rate cut with all sorts of promises of liquidity provided. I ate crow and reversed course -- but, for readers, it was too late and I was awash with a waterfall of derision. The market took off and didn't looked back, with barely a few days of declines. I never forgot my mistake, which is an understatement of colossal proportions.
Unlike 1998, I nailed 2000 so well that I still can't believe it. We had a remarkable run in the Nasdaq from 1998 until the middle of March of 2000. I pressed my bet even as late as the first week of that month because, as a chart would show, that's where the move up accelerated and the best gains were to be had. Two and a half weeks later, I reversed course, told people to sell and went into cash for the most part, with some gigantic Nasdaq short positions.
How did I know? Pretty easy: The Street. I saw the Nasdaq roll over and witnessed the incredible decline of our own stock price and others, as secondary after secondary was launched by the smarter operators. No, we weren't able to get one done, which said pretty much all you needed. There were no bids for the Nasdaq-listed stocks.
The proceeding months wiped out more than a trillion dollars of capital and many investors never returned. But the overall impact to the economy was negligible. It was all about ridiculous overvaluation. The market failed to recover, mostly because the decimation was so great -- but a look back showed barely a ding to the S&P. It was a concentrated crash that had nothing to do with real earnings. Supply overwhelmed demand.
Finally there's the 2008 crash, which was systemic in nature, deeply-rooted in the economy and a Fed that pushed us over the brink with a tone def set of rate increases that kept on going to the point that the damage was irreversible. Had the Fed just clamped down on bad housing loans and issued leveraged tests to the financials, the Great Recession would not have occurred. But the data was strong -- indicating a robust economy without seeing the rot underneath. It was a terrible mistake; I blame reckless funds and a smug Fed that truly did know nothing.
Now we have our own train wreck coming -- and as much as I do not want to say this, it's combining a lot of the worst characteristics of several of the declines I just profiled.
The '87 crash had to do with the machines running roughshod over the buyers. This time, the algorithms are the machines, and the weapons of choice are scantily clad ETFs that can overwhelm the system as surely as portfolio insurance could. There are so many of them and they are the machine guns of an era, mowing down the brave soldiers trying to bargain hunt.
I will save the 1998 fiasco for last. The 2000 dotcom bomb went off because of reckless underwriting. The economy was robust. But the greed was astonishing and the comeuppance swift.
The 2008 call was spot on -- but hated. I was ridiculed for making the call, which was done on the Today Show of all places, and even though it saved you a fortune, the time I spent on the cross for making it was extraordinary and unforgettable. But I could see how weak the system was by virtue of my contacts, which were much better than the Fed's, and I got people out correctly. Subsequently, I have received many kudos for the call.
In 1998, I misjudged the resolve of the Fed. Just a few days before it made its emergency slashing, we had heard reassurance from Greenspan about the strength of the system. He was dead wrong, and reversed course, which was quite unexpected -- and it seared in my mind the idea that some Fed head's correct quickly.
Which brings me to today's situation. Right now, we have an incredibly fast deterioration on the horizon for anyone who listens to the market. That's like 2007-2008. We have a Fed that is, lamentably -- like 1998 -- unaware of the danger that could occur. But mercifully, we do not have 2008. The system is intact. It's a cyclical downturn linked with what was overvaluation that is now already brought down by the decline, like the first part of the 1987 debacle.
So here's where I come out. Right now, the Fed is making the same mistakes as in 2007 -- totally misjudging the rot underneath, first from autos, then housing and now construction. Soon, it will be layoffs and consumer spending declines. If the Fed doesn't reverse course as it did in 1998, then we should continue along a 1987 path, that's as obvious to me as was 2007-2008.
It's all on them and a fickle President, who has boxed them into a corner as if it were their own doing -- not his -- like 2007-2008. My conclusion? I would say "get out now" -- my ignominious call at the bottom of 1998 -- but I have been saying it's no good for some time.
But we will have a 2007-2008 lite if the Fed doesn't change from its foolish course and go back to data dependency with one eye on the stock market, as valuations sink to levels like part one of 1987. Hopefully, we don't get the worst of both worlds, a one-day crash coupled with no change of Fed policy.
It's all on the Fed. If it listens to the market, we are near the bottom. If not? The worst parts of 1987 and 1998 will occur -- although lower valuations preclude 2000 and the lack of leverage, mercifully, take the Great Recession off the table.
