Thirty Years


Thirty years ago tomorrow morning on Friday 16th October 1987 I slept in. The alarm clock hadn’t gone off. I was abruptly woken by a ringing telephone. It was my friend Chris, ‘There has been a storm, electricity is down, tubes aren’t running; how are you getting to work?’ ‘Buggered if I know,’ I thought to myself. I’d slept through the biggest storm in 100 years. The storm though, was just beginning. 

I jumped in the car and drove to the City. It was an eerie journey, much quieter than usual, driving around fallen trees around Shepherds Bush and avoiding advertising hoardings and signposts on the roads. I parked in Finsbury Square and jogged down to the office in the Stock Exchange building. Only a few of us made it in. As I remember, the Stock Exchange opened late at around 09:30hrs but there wasn’t much business around and the phones were largely quiet. I only did two bargains during the whole morning. Together, they cost my book £125k by 10:00am on Monday. The market closed early at around midday and we headed off for the weekend. At 1:30pm the monthly US trade figure was announced. It was larger than expected and elevated concerns that the Fed might raise rates after a low interest rate period that saw the Dow rally 44% in just 7 months of that year. That the Americans and Iranians were busy lobbing missiles at each other that week and the next did little to help confidence. Markets began to sell off, spurred by ‘triple witching,’ option expiration in the States and the Dow closed down 4.6% on the day. It was a nervy weekend for market operators.


The waterfall event on Monday, or Black Monday as it became known, took no prisoners. Everything got hosed. Our telephone dealer boards lit up like Christmas trees from the get-go and however wide we made our prices, we got stuffed with more and more inventory. The cascade selling accelerated with index arbitrage programs flooding the systems with more orders than could be processed creating a frantic and chaotic trading environment with stock exchange systems repeatedly failing and where everyone it seemed, was rushing for the same exit. When these events happen, investors sell what they can sell, not what they should be selling. Often, that means the big liquid blue chips get smacked first because liquidity vaporises in smaller names. The blue chips are of course, the names that have the biggest weighting on the indexes. The Dow finished the day down 22.6%, the FTSE -26%. 

Numb and exhausted, we got in the lift at the end of the day and repaired down to Jonathan's, the bar at the bottom of the Stock Exchange. It was full, but very, very subdued. Brokers and market-makers were hunched over their drinks mulling over the catastrophic events of the day and the impact on their lives. Some had lost fortunes; some their firms. 


Interesting then that this week saw the 10th anniversary of the 2007 market high. In fact, the market rally from August 2007 to October 2007 is remarkably similar to that which we now see from August this year. I’m not going to write a technical market note, for the moment anyway, but would remind the casual observer that the start of bear markets are characterised by sudden, violent and persistent one way price action that wipe out years of gains in days. The current bull market, which has been underpinned by Central Banks for so long, is way past it’s sell-by date. If you choose to look, there are stacks of experienced market practitioners and commentators warning that this mature market is over-heated. Don’t ever anyone then say, ‘no-one saw it coming.’ We did in ’07 but similarly, no-one was listening then.

Market Quants; Kill or Cure?

This brilliant VPRO documentary on Quants should be required viewing for all involved in markets.

The problem with heckling from the cheap seats is that the rest of the audience can get bored pretty quickly and stop listening. Then you get thrown out. It’s the old ‘cry wolf,’ thing. I kind of feel like that about shouting from my soapbox about quants and all they have spawned in markets from HFT’s, trading Algo’s, to derivative and structured product modelling. I’ve watched their growth from all the way back when index arb models lit the fire that turned into a market conflagration in 1987 to the subprime CDO models that did so much to destabalise the financial system in 08 through to the occasional flash crashes we see today.

The simple fact is that very few managers and certainly no boards have the first clue about what the quant ecosystem that plumbs their banks together is capable of. Nor do they understand the assumptions made in those models or how vulnerable the models are to human error or abuse, either internally or externally. The video clip above is very well worth watching. It is a very straight forward reality check; a reality check from the practitioners themselves; ‘it is clear that a major rethink is desperately required if the world is to avoid a mathematically led meltdown.’

Long Winter


I was lucky enough to be invited to the 18th birthday party of the daughter of a good friend on Saturday. I was pleased to be there because she has endured her own tough journey these past six years that have required digging deep into her own reserves of courage, tenacity and fortitude. Indeed, we all shared the joy of recovery, some though, more enthusiastically than did others. I thought the generous line up of mojito cocktails on the bar to kick things off might have been a tad naïve, but my friend, steady as a rock when the 18 year olds descended on the bar like a herd of wildebeest in a five year drought, said, “don’t worry David, I’ve had a word with the bar staff, half measures only.” Some hours later, as some of the said eighteen year olds were negotiating the dance floor as if they were on the foredeck of a small yacht in a big storm, I couldn’t help thinking that my friend may have underestimated the capacity eighteen year olds to glug half measures of cocktails rendering his cautionary “word to the staff,” somewhat redundant. As the odd 18 year old stumbled out to the bushes or found themselves kneeling over the white porcelain many happy memories of spinning bedrooms came flooding home but I couldn’t help thinking of the market party. Just a wee bit longer and some participants will be reeling around like those 18 year olds, disorientated and numbed to the reality of their predicament.   


Equities just had their worst week since May 2012. I don’t think it’s going to improve much. The Dow, Eurostoxx, FTSE, CAC and Dax are now at a loss for 2014. Aim is in are around bear market territory and the Russell 2000 is off 9.5% YTD. We have been following the multi-decade "Jaws of Death" (Megaphone Top) stock market pattern from way back in 2008-9, and warning that when it finishes, a significant bear market will follow. It is possible that we’re at that juncture now and the next bear market and economic collapse has begun. Most people don’t care to contemplate the J of D thing and some have asked me to stop writing about it. Sorry, it’s not going away.

This blog is not a specialist market blog although I do post the odd thing that may be of interest or of importance to a wider audience. Occasionally, I throw up the odd chart but its important to remember that we can play around with charts and often make them, by manipulating the amplitudes, time frames or by using dodgy correlations fit any particular argument. The way to dispell the noise is to look at longer term charts which eradicate distortion. The MACD, Moving Average Convergence Divergence, is a  trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the "signal line", is then plotted on top of the MACD, functioning as a trigger for buy and sell signals. Lets take a look at the MACD for some important equity indices then but on long term monthly charts

Monthly MACD on the S&P

Monthly MACD on the FTSE

Monthly MACD on the EuroStoxx

As you can see they are all in fact gently rolling over. The smart money has left the party and is leaving town.

Weekly S&P

There are a growing list of metrics that would usually indicate a short term bottom is at hand. Those include put/call ratios, elevated volatility, oversold momentum, extended relatives and so on. These metrics though work best in bull trends. In bear trends things do get overdone and extended; then they get more overdone and more extended. Remember, crashes mostly happen from oversold conditions, not overbought ones. 

Point of recognition

Many still view the current decline as a “healthy correction.” I may be wrong but I don’t think it is. The “healthy” view will change when the market experiences a point of collective recognition but we’re not there yet. Until then, this adolescent bear will cheerfully chew up bulls and bears alike until market psychology changes. Last week the Investors Intelligence survey registered bears at 14.1%. By the end of this week the other 85.9% will no doubt be considering their position.

In fact, when we witness the inevitable rally sometime this week being met with aggressive selling, as the bears grow in number, I think people may be shocked with the ferocity of moves. That will mostly because a growing wave of sellers will be met with market liquidity displaying the consistency of dried glue. Bulls need to recover the 1990 level in the S&P for the bears to raise the white flag and that looks like a very big ask. All bears need to establish is a lower high.

Crumble discusses the stock market Jaws of Death pattern

In summary then, in my view best case is a rally, perhaps after more weakness from later this month / early Nov  into the year end then the bear grips the investment complex.  Worst case is we skip the rally bit and plummet from here. Traders should look to short snap back rallies or just go on an extended break for 2 years. Long only investors should be in safety first, low beta defensive mode. The 19th of September, when we got out confirmed Jaws of death pattern, may prove to be a historic date for markets.

It’s going to be a long winter.

“Sell everything and run for your lives”

Headline of the week comes from who else but Albert Edwards at SocGen in his Global Strategy Weekly with his "‘Basket trade’ suggests “Sell everything and run for your lives”........... taken from a letter last weekend to the FT from a Mr Matt long who writes,

Sir: The next financial apocalypse is imminent. I know this to be true because the (FT Weekend) House and Home section is now assuming the epic proportions last seen before the great crash. Twenty four pages chock full of adverts for mansions and wicker tea trays for $1,000. You’re all mad.
Sell everything and run for your lives.
Matt Long, Seilh, France.

I rather like Mr Long's approach but fear that he is more accurate in his assessment than perhaps he knows and certainly than most of my colleagues in the City either appreciate or will admit to.

Scotsie 100

The Scottish independence debate has so far been characterised by a poverty of original clear thinking.  The paper below by Paul Marsh, Emeritus Professor of Finance at the London Business School and Scott Evans of Walbrook Economics, about the merits of Scottish independence from a stock market perspective, changes the tone somewhat. In it, they soberly de-construct how Scotland would have fared since 1955 with its own stock exchange and how it would fare as an independent country.

With the clock running down we urgently need more input of similar calibre. One could be forgiven for thinking that the actuality of the situation is that Salmond & Co are dreading the "Oh bugger, that wasn't supposed to happen, what now?" moment if they actually do win while one might be left to think that Cameron & his playmates, latterly supplemented with a squadron of clickty-clack heeled media friendly thirty-something women junior ministers, won't shed a tear because the embedded Labour majority at Westminster will be gone forever.


Jaws of Death

In a recent post, "When Help-To-Buy Will Become Just Help,"  I attempted to articulate why it is feckless to encourage young people to buy a property when interest rates are at 320 year lows in the UK. There are more problems though, ahead.

It is clear to many of us that there is a worrying negative divergence between QE fuelled asset prices across the risk spectrum and the reality of spluttering global GDP growth, or indeed it's complete absence. For many of us who have been through this in previous iterations, 1987, 2000 and 2007 for example, there is an elevated level of concern yet unsurprisingly, it has little resonance with investors given prices continue to climb and indeed, in some cases accelerate which is a sure and certain sign of a blow off top.

It may be the case that the current 55 month cyclical bull market in shares runs for considerably longer. Deep into 2014 would not be out of the question, at least from a technical perspective. There are unfortunately, some long term patterns in markets that are maturing and are signalling "caution!" 

Let's take a quick look 

 This is not a short term or even intermediate forecast. It is a long term, heavy duty predictive pattern which historically has a high degree of accuracy and is ominous in the extreme. 

The pattern in textbooks is known as a “megaphone pattern.” A technical analyst called Dr McHugh coined the “Jaws of Death,” phrase to describe it and is probably the messiah of this structure. It appears both at tops and bottoms and is seen when the trend heading into it is going to reverse. The series of higher highs and lower lows that create the pattern are telling us that investors are becoming increasingly uncertain about the correct valuation for the stock market. In effect, it’s doping nothing more than mapping investor emotion and indecision which itself reflects changing investment metrics.

The current pattern is 23 years in the making which is telling us a very severe sell off will eventually occur. 

According to previous research, (Encyclopedia of Chart Patterns by Thomas N Bulkowski), the statistical probability of a failure in this pattern is 4%. Obviously then, the probability of a reversal is 96%. It is a five point reversal pattern and as you may note above, we are coming to the end of the fifth point. When the reversal kicks in the downside target is the lowest point in the pattern which in this case is point D which was the 2009 low at 6,547 which would also probably lead the S&P down to the level it reached in 2009 which was around 676. However, shares can easily extend below those “lowest point,” targets and given the sheer size of this pattern they will probably do so. Eight previous patterns in the last 100 years did exactly that.

The Dow has perhaps 5-10% of upside to complete the pattern although touching the trend line is not a requirement and not doing so would not invalidate the pattern. It may truncate and reverse earlier but from where we are, the odds currently favour more upside.

If this pattern follows through, the impact such a seismic move will have on economies is simply calamitous. It will make the reversals of the last twenty five years look like gentle dress rehearsals and the prevailing child like belief in the ability of central banks and governments to protect investors will turn to dust. Most market people would accept that the current environment works only if everyone sticks together and collectively perpetuates a number of economic myths. The moment people start to question why markets aren’t matching their daily reality then things unravel rather quickly. I am convinced the mortgage guarantee scheme in the UK for example, is a pernicious political scheme to lift the housing market and distract consumers from the growing cost of living and taxation burden. Political cowardice got us to where we are and political cowardice will drive us over the edge. The “Jaws of Death,” is then, warning that all is not well economically.

Let’s take a look at some historical precedents. 

The pattern in 1929 formed over 3 months before the Dow almost halved in the following 2 months.

1957 saw the pattern form over 3 months . The 20% fall in the Dow kicked off a recession that eventually saw JFK being elected.

1965-66 took a year to form and although less imperfect it still had the required 2 x pivot points to make the pattern valid.

The 1972-73 pattern preceded the oil crisis, the 1973 Arab/Israeli War and Nixon’s resignation. The pattern is imperfect yet the two required pivot points are there. A 26.5% fall was followed by a 21.9% fall over the subsequent 4 months.

1987 - It took 3 months to form but the 2 month 41% drop wiped many firms and individuals out. Anyone who tells you it wasn’t scary has forgotten what it was like. The creation of multiple market intervention tools and successive rounds of money printing which led to a vast transfer of wealth to a small number of banks all stem from this event.

1998-99 was a perfect pattern and again reminded us that the severity of correction is usually correlated to the time taken to form the pattern. In this case, a 20% fall was followed by continuous withering declines over 2 years, recession and war.

2008 had a 4 year gestation period and the severity of what followed was and continues to be, self evident.

The common characteristics that mark the aftermath of this pattern in the last 100 years are in fact, plunge – recession – political change – war. Pondering over these charts though, you can now perhaps begin to see why the implications of a 21 year formation period for the “Jaws of Death,” that is of current concern, is quite as ominous as it is. Does that mean we could see stock market falls of more than 50% and what exactly would that mean not just for valuations but for example geopolitically, economically, socially and so on? In the short term however, we can expect the Dow to top out perhaps between 17,000-18,000 into 2014, (perhaps even 2015), with the chance of a mild overshoot. If the market were to go parabolic and hit the potential highs much sooner then risk would correspondingly be elevated.

A drop, when it comes, could be sudden and precipitous. I suspect though, our long term tools will provide some warnings; they usually do and this is the first of those.

Dr McHugh's recently published book, "The Coming Economic Ice Age," should be avoided by readers of a nervous disposition. Anyone else concerned with capital preservation and longevity of hard earned wealth, such as it might be, should consider buying it immediately. 

Am I being sensationalist? Not really, there is nothing new in these cycles. Markets always ebb and flow and occasionally do so dramatically. The difference this time is that they have been artificially elevated by central banks and that will make the fall out much more severe than otherwise might have been the case. In fact, the subsequent economic nuclear winter will be very rough, especially on the people who least deserve it to be so and that is criminal.