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Dave Forest

Dave Forest

Dave is Managing Geologist of the Pierce Points Daily E-Letter.

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The Gravitational Pull of Financial Disaster

There are two views on the economy and stock markets.

The first (and most widely-held) is that these are "responsive systems". Prices for homes, stocks and labour react to events around the world. News of positive GDP growth in the U.S. sends prices higher. This week's news about Greece's grave economic situation drives them down.

The less-discussed alternative is that economies and stocks are "intrinsically organizing". (A term borrowed from ecosystem theory, to describe systems that behave more according to their own, inner rules rather than responding to external stimuli.)

Under such theory, events (good or bad) are merely the excuses for markets going up or down. In actuality, the market has already "decided" that it is ready to go higher or lower. The people involved then simply look around the world for events that justify this position. Manias and disasters thus have an almost gravitational pull.

Proponents of this theory would say that Greece was this week's "closest at hand" story, the easiest for already-bearish investors to latch onto. If there hadn't been bad news about Greece, investors would have looked for something else. There's always a disaster somewhere.

The theory does have some weight. Prior to this week's Greece scare, a number of indicators had turned decidedly negative. As I mentioned a few weeks back, yields on U.S. commercial paper started mysteriously rising late in March. Signally investor flight from these investments.

US Commerical paper rates

There wasn't any particular bad news associated with the change. But it was as if the markets were signaling they were ready to start look for reasons to get negative. And they found a plausible-sounding one this week.

The real explanation is probably somewhere between the responsive and intrinsic end-members. Our system of information transmission is not perfect or instantaneous. There is always an "inner circle" of people who know about important events before anyone else does.

There was likely a small group privy to the problems in Greece. They could see this was not going to end well.

Those groups would start selling off investments that might be hit by wider recognition of the Greek problem. Causing small, but noticeable fluctuations in some markets. Not enough to cause panic, but enough to suggest (at least to the people paying attention) that something is afoot.

This "insider selling" creates a generally negative financial environment. Investments in several sectors are besieged by selling pressure. Other investors pick up on the "negative vibe", even if they don't know the exact explanation.

Negative sentiment makes investors fearful. Now the markets are primed for a drop. It's simply a matter of some scary-sounding news emerging and giving people the green light to start dumping.

This news could be the thing that originally spooked the insiders. Or it could be something completely different that comes along in the meantime.

Just a theory. But it does seem to fit the details of the last month. Interestingly, the aforementioned commercial paper yields continue to rise. Yields on 90-day asset-backed paper are up 20% since I last wrote.

90 Day US Commercial Paper Rates

Is the market seeing something else on the horizon? Or is it simply time that something else emerged?

By. Dave Forest of Notela Resources




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