Wikinvest Wire

A Game of Confidence

Tuesday, March 14, 2006

In The Stock Market's DaVinci Code by Jonathan Moreland, the topic of the Plunge Protection Team is once again discussed by a somewhat mainstream financial writer (this is presumed to be the same Jonathan Moreland that writes over at TheStreet.com, also
author of Profit from Legal Insider Trading: Invest Today on Tomorrow's News - if not it's still a good article).

The question of the Plunge Protection Team has been around since shortly after the 1987 crash when the Working Group for Financial Markets was formed under the Reagan administration.

The idea is similar to the famous offers made during the 1929 crash, when during the height of the panic, representatives were dispatched to the floor of the NYSE to loudly order thousands of shares of U.S. Steel and other companies to bolster support for a floundering market.

The stock market is, after all, very much a game of confidence.


Along with most every other modern financial market, including commodities markets where prices are determined by futures contracts and options rather than actual delivery of the commodity, the stock market is subject to the whims and emotions of those seeking capital gains.

Increasingly, it seems, investors believe that they will be protected from loss.

True believers — many on the Internet, as might be expected — point to public statements by no less than Alan Greenspan. During a speech given on Jan. 14, 1997, at a university in Leuven, Belgium, Greenspan said: “We have the responsibility to prevent major financial market disruptions through development and enforcement of prudent regulatory standards and, if necessary in rare circumstance, through direct intervention in market events.”
...
But a surprising number of investors think the government's invisible hand is active even in the absence of obvious threats, like the blow up of Long-Term Capital Management in 1998 and the horrific Sept. 11 attacks. Specifically, diehard PPT believers claim that in three months in 2002 (June, July and October) and March 2003, and again in March, April and October 2005, equity indices were challenging widely followed technical supports — but miraculously recovered.

The avoidance of a stock market meltdown has stumped the logic of many big-picture investors, too. The Economist magazine has been sounding an alarm for years about the U.S.'s current account deficit (now at a record 6 percent of GDP), the inevitable bursting of the worldwide real estate bubble and the overindebted U.S. consumer and government. More recently, rising interest rates and/or inflation, a declining rate of corporate earnings growth, soaring energy and commodity prices and enormously costly natural disasters have added to strains on stock prices. Despite all this, the market has rallied each time off its numerous, relatively recent technical fault lines. For market bears the market's resilience is literally unbelievable. So much so, that the only explanation is the existence of the Plunge Protection Team. (The PPT is also purported to be active in the gold markets, which has recently been setting record highs after being depressed for two decades. But that's a whole other story.)
...
So how did this team of crisis managers come to be viewed by some as a secretive fraternity of government and business interests, secretly manipulating stocks and gold and making a mockery of the concept of free markets? Brett Fromson, of the Washington Post, who went on to work for TheStreet.com and the Wall Street Journal, was the one who wrote the Washington Post story that came up with the PPT name. (He says a clever copy desk staffer came up with the name for a headline.) Fromson covered the Washington/Wall Street beat, which connected the ongoing relationship between the political and financial capitals. “I got the idea for the story after seeing that many of my sources were often in meetings together. I realized there was an enormous amount of planning going on.” He adds, “The story resulted from a lot of reporting and relied on the people I was talking with having a relationship of trust” with him. Fromson said noone called him after the piece was published telling him that he got it wrong — or that he was insane.

Perhaps the only certainty about the PPT conspiracy theory is that it is not going away any time soon. While every rebound by the indices in the face of damning economic fundamentals and market technicals deepens the conviction of PPT believers; not even a market crash will likely convince them otherwise. After all, the market's massive slide from 2000 through 2002 didn't even unwind the theory. Either way, someone should make it into a movie. It might be called Wall Street's Da Vinci Code.
The idea of "free markets" seems kind of silly when you think about it.

Interest rates are certainly not set by "the market" - governments now effectively set both short and long rates. And, currency trading has got to be the most manipulated market on the planet - when considering what Asian governments have done in recent years, even for supposedly "floating" currencies, it is hard to imagine what it would be like to try to make a living trading currencies.

The funny thing about manipulating markets is that when something other than paper or electronic signals have to actually be delivered, and there is a supply/demand imbalance, manipulation can no longer work its magic.

Oil is a good example - if the peak oil crowd is correct, no market manipulation can prevent the simple supply/demand fundamentals from driving oil prices skyward as adjustments to consumption are slowly made.

After all, market manipulation is merely a way to manage the supply and demand dynamic - once one of these becomes unmanageable, things seem to work themselves out in a disorderly manner.

There may be a similar scenario for gold and silver. Many conjecture that the gold ETFs are intended to forestall delivery shortages for these metals - time will tell. It seems natural that gold coins in hand, or stored in a vault somewhere away from New York would be superior to Wall Street offerings.

As for stocks, it seems that meaningful declines can be prevented for much longer than most bears would believe. Of course, some would say that this only worsens the "true" market correction that will eventually come.

Only time will tell how long the game of confidence can go on.

7 comments:

chubbyray said...

Tim,

I think your assessment here hits the mark. Further, market manipulation (central planning) is done to benefit statists, who 'earn' theirs by courting government favor. For the rest of us, perhaps there can be some solace in a well-placed bet on the right side of the eventual price dislocations.

The Ignorant Investor said...

What would expect the market to be corrected to? Trading at 30x earnings for an extended period would be irrational given historical multiples, but when the current multiple on the S&P is near historically average levels, why would we need to look for conspiracy theories to explain why its staying in the 9k-12k range?

Damian said...

The bigger issue I've seen with the description of the actions of the PPT is that it would require an enormous amount of money to make it happen across all these different investment vehicles.

I don't have a strong opinion on the theory either way, but it does seem to me as unlikely that the government would be able to inject that amount of capital from a dollar perspective and it also seems unlikely that they would be able to "cover their tracks" - someone would let the cat out of the bag.

dan said...

Market manipulation will always exist.

Manipulation is a fundamental game that we see in nature everyday. (venus fly trap, cameleon) on and on. Its a very important strategy in survival.

SBC didn't buy up 70% of the bells to let the "free market" determine future price of broadband.

Lowering their current DSL prices to dirt cheap levels, definately helped manipulate the market/public into approving of the mergers.

dlp said...

Those in charge will do everything in their power to prevent a significant decline in all inflated asset classes. It is in no one's interest to see the DOW back at 6 or 7 thousand or for U.S. home prices to revert to 2000 levels - the only winners would be short sellers and renters.

The tools are available to prevent this from happening, unlike in 1929, so as long as Asia complies and the currency debasement can be spread around, things will go on. The only reason Asia wouldn't comply would be if some major geopolitical shit hits the fan, and even then probably not until after the 2008 Olympics, as 2008 is China's emergence onto the world stage in a big way and they'll be happy to do whatever is necessary to preserve the status quo until then.

Lacking some significant catalyst, it seems more likely that all asset markets will be kept afloat for the next ten or fifteen years, kind of like equities in the seventies, and inflation will rage, but somehow the people will be told othewise as they get squeezed, and then squeezed some more, and the U.S. will slowly adjust to more moderate standards of living.

At least, that's the best case scenario.

Aaron Krowne said...

If anything has been artificially bolstering the market, it is the propping-up of consumer spending. I've heard that 75% of the domestic economy is based on consumer spending. This open trend must be orders of magnitude more influential than any deus ex machina "market agent" interventions.

The upshot is I don't think this pattern has a much longer lifespan. 1-2 years, I'd bet. There is too much conspiring against consumer spending; too much coming back down to earth.

chubbyray said...

The price of money, interest rate(s), is the most obvious example where central planning attempts to set a price different from a free market. Banking interests are the chief beneficiaries here. There are other examples. In time, the result is always an unsustainable imbalance that ends with a dislocation - currency crises in Mexico/Thailand/Argentina, collapse of Soviet Union, etc. The Chinese saw this coming and decided that a looser grip on something was better than a tight grip on nothing. The hand around here is firming.

Cor: Consider where the SP500 and house prices would be if interest rates were neutral with real inflation at, say, 8%-9%.

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