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Keep Calm And Carry On

Bob Hoye
Institutional Advisors
May 11, 2010

This was the big title on the route book for a tour of older sports cars on the May 1 week end. Over three days we covered 700 miles of mountain roads in Southern British Columbia. Sixty cars participated and the weather varied from sunny and warm to Sunday's drive over the Duffy Lake pass at 34 F and light snow.

The advice to "Keep Calm And Carry On" also applies to the markets. The reversal to distress is appropriate and the violence is impressive.

"The White House doesn't rule out sabotage in Thursday's wild Wall Street plunge"The Hill, May 7, 2010

The size of the decline was not caused by one trader making a mistake, it was another of the "One- Market" moves with the dollar strengthening as the hot games got trashed. Action in the latter became measurably overdone in momentum and bullishness and ran into "Sudden Deceleration".

Too many desks with the same trading programs exaggerated a natural decline into a computerdriven rout that compares to the "Portfolio Insurance" crash of 1987. The difference is that that break was within a strongly advancing business cycle. This one marks the end of the financial rebound out of the initial post-bubble crash. The problem in the sovereign debt market is not illiquidity, but insolvency. "Half-barbarous" countries borrowed too much money.

Other sectors recorded some outstanding moves. Long-dated treasuries soared to 124 and set the highest daily RSI since the bond blow off at the end of 2008. The "flight-to-quality" rush to the long end is now at risk.

Another event stands in the way of the notion that a trading error in the stock markets caused the collapse. Corporate bond spreads over treasuries widened. On the week, Baa jumped from 22 bps to 57 bps and junk soared from 631 bps to 750 bps. Eight weeks of narrowing was reversed in only one week.

In two weeks base metal prices in London plunged 18 percent as part of the rout and the gold/silver ratio jumped from 62.9 to 68.3 in only three days.

It was a very interesting week in the markets and the administration's notion about "sabotage" reminds of Russia in the 1930s when carefully contrived central planning inevitably failed and scapegoats were required.

Wrap: This is an important and timely break in the financial markets that is beginning to take apart all the "stimulus" and the intellectual confections behind it. In the meantime, we will remain calm and will carry on with our regular publications.

The gold/silver ratio provided the sell signal as it rose through 65 on Tuesday. The reversal from the high at 69.5 at 3 pm NY time on Thursday indicated the panic was ending. This phase of the panic may be over, but the results of the panic are not over.


May 10, 2010
Institutional Advisors

Hoye Archives

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