The trading error scenario spooks me. If a trader's error can move the Dow 700 points, then that same trader can manipulate the market 700 points. Saying that a single, unidentifiable trader can manipulate the entire stock market 700 points changes my world view.
I do not believe in conspiracy or market manipulation theories because economic incentives and the power of imitation are powerful enough to explain virtually all patterns. Conspiracies exist at times, but they cannot explain most real world phenomena. Add to that the psychological bias known as fundamental attribution error, the tendency for people to see situations as due to human causes. For example, for most of human history people believed that Zeus or similar anthropomorphic gods caused thunder and lightening. Conspiracy theories are Zeus-like explanations.
If you had asked me last week whether a single individual could cause a ten percent fall in the Dow by manipulating price, I would have answered absolutely not. But everyone else, every major financial news source, says I'd have been wrong. There are enough players who can do this that (1) a simple mistake caused Thursday's 7% intra-day dip and (2) no one can figure out who it was, which means that there are enough such players to make it hard to figure out. Short term market fluctuations are even less meaningful than I would have thought.
The VIX, a measure of stock market volatility, had mushroomed in recent days (see Yahoo! chart here) but it fell sharply today, 30% as of 10 AM, following the announcement of a European rescue plan for Greece. Nevertheless, it is still high. High volatility is associated with stock market bottoms, at least in the intermediate term.
Let's say the sharp dip on Thursday and the sharp increase today are due to the Greek crisis. It seems to me that the Greek cure will work for several years but not forever. In order to solve their problems, Europeans will need to curtail spending, which would seem to have a detrimental effect on demand, hence profits, hence the markets. Sounds like the US as well. Without monetary expansion the world economy is burnt toast. The real quality of life has been falling for decades as Federal Reserve Bank monetary expansion has subsidized government, hedge funds and Wall Street at the expense of productive Americans.
One analyst on Kitco is predicting hyper-inflation as the US and Europe continue to subsidize real estate and stock markets through monetary expansion. Bloomberg reports today that Ben Bernanke and the Fed have redefined what they mean by "tightening." Undergrad economics students learn that the Fed tightens by selling treasury bonds to big money-center banks. The cash received for the bond sales is taken out of circulation, reducing the money supply. In turn, that pushes interest rates up. But here is what Bloomberg says the Fed now means by "tightening", according to Mitch Stapley of Fifth Third Asset Management:
"Altering a pledge to keep short-term borrowing costs low or articulating plans to begin selling the $1.1 trillion in mortgage-backed securities it now holds will amount to a tightening of monetary policy because the announcements will send bond yields higher, raising borrowing costs, said Mitch Stapley, chief fixed-income officer at Fifth Third Asset Management in Grand Rapids, Michigan."
In other words, the Fed will tighten by saying it will tighten, not by actually tightening. That sounds a lot like my diet plan, except saying I'm going to diet doesn't have any real long term effect.
The central banks are painted into a corner. If they raise rates then the world markets will fall. If they continue to keep them at extraordinarily low levels (money market funds are essentially paying zero now) then there will be escalating inflation. When inflation starts, there will be few ways to stop it. One option might be to let the inflation ride. The Kitco analyst is thus predicting a 50,000 Dow, up five-fold from today.
A 50,000 Dow would mean that a dollar today would be worth a small fraction of its current value. I don't subscribe to that prediction (who knows?) but it does need to be considered. The other alternative, responsible tightening, would lead to falls in employment and an economic slow down. Given that unemployment increased recently to 9.9%, according to the Bureau of Labor Statistics, I suspect that Bernanke, et al. aren't in a hurry to raise rates.*
The response to the rising unemployment will likely be additional infusions of money into an already bloated monetary base (recall that Mr. Bernanke and the Fed tripled the monetary base in 2008, and that money is still ready for banks' use).
I happen to have "A" credit (I'm insane, I should have bought a McMansion and gotten the Fed to pay off the mortgage) and have started to get those invitations for credit card checks like I used to get a few years ago. Might inflation be right around the corner?
The one factor that has offset the inflationary bias in the economy is China. But China is likely to be thinking about expanding its home market rather than continuing to work for ever lower wages selling exports bought in a depreciating US dollar. If China starts pulling out of the dollar, then stock market increases will be over-matched by commodity increases as the dollar dwindles into the dust heap.
*The BlS writes:
"Nonfarm payroll employment rose by 290,000 in April,
the unemployment rate edged up to 9.9 percent, and
the labor force increased sharply, the U.S. Bureau of Labor Statistics reported today.
Job gains occurred in manufacturing, professional
and business services, health care, and leisure
and hospitality. Federal government employment
also rose, reflecting continued hiring of temporary workers for Census 2010."
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