As it turned out, in my personal opinion forum which I put out twice a month I decided to revisit the panic of 1907. As you know there are parallels between the financial disaster at the start of the 20th century and the 21st century. Both were severe liquidity crises which came roughly 100 years apart. But when you look deeper, there is a suddenly more disturbing reason to be concerned.
When I was at the Expo, I picked up a great book called the “Panic of 1907 Lessons Learned from the Market’s Perfect Storm,” by Robert Bruner and Sean Carr. According to the authors, the seeds of the panic were sown by the San Francisco Earthquake of 1906. We won’t get into the details here but you know the city of San Francisco burned down. It was the financial hub of the Western US in those days. Immediately, insurance and rail stocks were hit hard. The problem got serious when most of the insurance companies delayed paying claims as most sought to discount. The bill that came due was estimated to be anywhere from $350-500 million or upwards of 1.7% of US GNP. One firm, Fireman’s Fund had liabilities of $11.5 million with assets of only $4.5 million. At the end of the day, only 6 insurance companies fully honored their claims. But most of the insurance liabilities lay in foreign hands, mostly British. Insurance firms had to liquidate assets and after the quake $30 million in gold was transferred from London to the US. This turn of events created a liquidity crisis for the Bank of England and by 1907 the Bank of England placed restriction on US finance bills. These were instruments used by US banks to refinance their holdings in gold. In the summer of 1907 the volume of finance bills decreased from $400 million to $30 million in the space of 3 months! What this meant was that US debtors could not refinance their obligations with London and gold reserves in this country dropped by 10% in those short months. Just think back to spreads just 3 years ago and you can begin to appreciate the magnitude of their problem.
Keep in mind that the US at that time was considered an emerging market in the midst of the Industrial Revolution. This liquidity crisis stopped a blistering 7.3% expansion dead in its tracks. The origin of the problem was the earthquake. I’m sure you know where I’m going with all of this. Just because there was a disaster in Japan does it mean there will be another financial panic. But as we sit and watch the potential of the nuclear reactors to melt down we truly don’t know the extent of the damage nor do we really know to what extent the insurance companies will be able to cover the bill. This is the kind of world changing event that could have a very long term butterfly effect.
My take since the summer of 2009 has been the recovery should be able to continue as long as there wasn’t a major natural disaster or a terrorist attack. The parallel to the Great Depression was the dust bowl conditions which made the situation much worse. Now, world economies are so connected that an event such as Friday’s catastrophe in Asia will be felt around the world for years to come. Keep in mind that Japan at roughly $860 billion is the second largest foreign holder of US Treasuries according to a Washington Times story in 2010.
Turning to the current situation, our complex situation in the markets were aggravated by the fact the Chinese SSE stalled at a moderately important range and time relationship. I know they blamed it on their trade deficit but after a low of 2661 prices hit a high and backed off roughly 26 trading days into the pattern. There’s lots of support at the 2900 level so there’s no imminent danger of a breakdown but there is reason to be concerned. In early trading on Monday these levels were holding despite the action in Japan. You know by now the Nikkei took a big hit in Monday trading. It would already qualify as a mini crash.
Last week we compared the SOX to the BKX and were more concerned about banking than chip stocks. Its true, chip stocks were in a better position coming into last week than their banking counterparts but the selling came more from tech than the banks. With the information we have now, coming into the new week, prices have been selling off but the banks are not the leaders to the downside. That fact by itself could mitigate this sell off.
Another factor is the fact that traders bought the news of the earthquake, they did not sell it. But I don’t see where we have enough calculations at the low to suggest this correction pattern should be over. The gap down on Thursday created some technical damage to the charts for the first time since the President’s Day tumble and it may not be so easily repaired. For instance, the NDX had the biggest violation of the mid line in its median channel since a pullback in October. This one is already larger in scope. This is also the biggest violation of the channel in the SPX since the pullback in November and don’t forget it’s been wrestling with the long term bear channel at 1325 since it first broke down on February 22. There’s a ridge of support down to roughly 1275 and if that breaks we can get a rip down to a range of 1200-1225. A break of these levels would confirm at least an intermediate term top.
I know a lot of you have heard the main reason for the correction is the inverse relationship with the oil market. I’m sorry, I’m not buying it. I’ve been watching the bond market very closely and last week when the long bond rallied up to its 6 week consolidation high the equity markets were threatening to break down in a bigger way. When the bond market backed off, equities recovered. The bond market stayed up late last week when equities sold again. It was only on Friday where they backed off resistance did buyers come back into stocks. The problem going forward is the fact the bond market has violated out of the bear channel since October which suggested an intermediate low is in. I think the stock market is mortified by higher bond prices. I don’t see the bond market collapsing right now so we could end up in a big trading range in bonds which would lead to a continuation of the complex pattern we’ve seen in the stock market the past 3 weeks.
Consider the events of Friday. Civilization most certainly must and will do whatever they can to help our friends in Japan. However, that doesn’t change the fact it could choke off the weak recovery for the time being. Remember, the panic of 1907 came after a period of blistering growth due to the Industrial Revolution. We had no such blistering growth prior to the meltdown in 2007. This period of prosperity was smoke and mirrors. It will be interesting to see what happens if and when the bond market breaks through resistance.
I’d like to invite you to a free webinar I’m doing at the Traders Coach web site this Wednesday evening at 8:30 pm EST.
This is the link you need to register. We’ll be discussing how you can harness the power of Andrews, Fibonacci and Gann to catch important turns in the markets.
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Jeff Greenblatt is the author of Breakthrough Strategies For Predicting Any Market, editor of the Fibonacci Forecaster, director of Lucas Wave International, LLC. and a private trader for the past eight years.
Lucas Wave International (https://www.lucaswaveinternational.com) provides forecasts of financial markets via the Fibonacci Forecaster and other reports. The company provides coaching/seminars to teach traders around the world about this cutting edge methodology.