What We Have Now is Fear

“The oldest and strongest emotion of mankind is fear.”
— H.P. Lovecraft

The question is why do we have fear today? Why aren’t people buying the stock market? Fear of the unknown, and known. It’s trading on raw emotion.
AMEX SPIDER Options Chart

AMEX SPIDER Options Chart by YCharts

It can be summed up in one word: Failure.

This isn’t market failure. It’s a failure of leadership. We have a huge dichotomy in the market right now. Corporate balance sheets look pretty good. Companies have deleveraged. They have trimmed expenses. Borrowing costs are cheap (for now). Big companies with stable business have an easy time getting credit.

But, today and over the past eight days we have seen destruction in asset values. The market can’t hold a bid, and isn’t trading on any fundamentals at all.

Sometimes the best way to conquer fear is to identify it. What are investors afraid of? Europe, the US fiscal situation, and simmering below the surface, the proposed China bubble.

What are some of the salves that we applied for those fears? In Europe, they have tried to restructure debt and throw money at the problem. It hasn’t worked and spreads between PIIGS and the Bund continue to expand. Will the Euro really hold together? Hard to believe it can.

There is no answer to the China bubble. Transparency isn’t one of the hallmarks of the Chinese economy. It’s been a tough short, ask Jimmy Chanos.

The US fiscal situation though according to pundits should have been resolved yesterday with the President signing a bill to increase the debt ceiling, right?

The market is telling you not so fast. There is a lot of unresolved stuff on the table. First, the market doesn’t believe the cuts in the debt deal. No politician has truly cut the budget before, why should we believe them now? Second, there are three gigantic overhangs on rallies. The uncertainties caused by the fill in the blank laws of Obamacare and Dodd-Frank make the forward looking market very uneasy. As regulators propose and write regulations, they have far reaching economic reverberations through deep parts of our economy. Third, the tax system in the US is going to change. It’s hard to know exactly how it will shake out. We are only guaranteed to have the present system through early 2013. Repeal of Obamacare and Dodd-Frank can’t happen until 2013. There will be an election in November of 2012 that could give a good clue how that gets sorted out. Currently, it’s flip a coin.

That’s uncertainty.

Robert Lucas won a Nobel Prize “for having developed and applied the hypothesis of rational expectations, and thereby having transformed macroeconomic analysis and deepened our understanding of economic policy”.

People’s rational expectations of the future right now are not good. Based on the last two years, why should they be? Based on the current data they have to look at, why should they be? That gives you a sniff as to why the market is selling off. The only thing they are certain about is Obama has been a total fail as a leader.

Sure, he inherited a rough economic environment. But every solution he has proposed has failed. Why will the next year and a half be any different?

Here is another certainty, this President’s proposals have been a total failure of Keynesian prime the pump, shovel ready projects. Yet yesterday, there was Harry Reid and Obama pushing for more infrastructure investment, more government spending as the answer. Insane.

Every market melt down that I have witnessed in my career as a trader has been different. 1987 was the craziest one I ever saw. The week before the big drop, the market was down every day and Black Monday was the day everyone threw in the towel. 1998’s LCTM massacre was just an unfamiliarity with the derivatives market. Once understood, the market recovered. 2008’s drop really manifested itself in August of 2007. There was a year of indigestion before the market really got scared.

This drop isn’t caused by anything except really poor leadership, and governments failing to get their finances in line. The budget battle over the last few weeks taught us something. Democrats were willing to criticize and respond. They offered no meaningful solutions to the problems on the ground except higher taxes and more spending. Every American knows higher taxes cause slower growth. Hence, they offered no solution.

The solution lies in putting forth policy that will incent growth, and cutting spending. If I were a Congressman right now from either party, I wouldn’t wait until November to propose cuts in spending. I’d find small mutually agreeable cuts today and begin the arduous march toward reducing the size and scope of government.

We have known for centuries that hope doesn’t work.

“What we fear comes to pass more speedily than what we hope.”
—- Publilius Syrus – Moral Sayings (1st C B.C.)

tip of the hat to Josh Brown at Reformed Broker for the link.