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The Blowoff Phase

(March 5, 2000) - 5 days before the NASDAQ Top

Please note that since the following article was written on March 5, 2000, some of the information or links contained herein may be outdated.  Also, I didn't realize I made a mistake re: Jesse Livermore's trading right before the 1929 crash until at a later point in time.  I did most of my research using the New York Times when I initially wrote this article, and it turned out that the Times erred when they mentioned that Livermore was on the long side of the market.  Jesse Livermore was actually short (he started shorting various industry groups that have topped out back in the summer) before the crash and during the crash.  By the time the United States was heading towards the Great Depression, Jesse Livermore had amassed a fortune of over $100 million.

The paragraph below is taken from the first chapter of "The Great Crash," the most famous book written about the Crash of 1929 by John Kenneth Galbraith, the immortalized ninety year-old Paul M. Warburg Professor of Economics Emeritus at Harvard University.

"Vision and Boundless Hope and Optimism"

On December 4, 1928 President Coolidge sent his last message on the State of the Union to the reconvening Congress.  Even the most melancholy congressman must have found reassurance in his words.  "No Congress of the United States has met with a more pleasing prospect than that which appears at the present time.  In the domestic field there is tranquility and contentment ... and the highest record of years of prosperity.  In the foreign field there is peace, the goodwill which comes from mutual understanding ... "

And we all know what happened in 1929.

Like what I outlined in my previous email, today's economic situation in the U.S. is no different.  Advances in computer processing power, the internet, fiber optics, and telecommunications technologies have enabled us to achieve greater efficiencies.  Increased productivity, higher corporate profits and a higher standard of living are now upon us.  What the automobile and the radio have done for the 1920's the PC, internet and the telecommunications companies have done for the 1990's.

Unfortunately, the mainstream media and the investing public severely overhyped these technological innovations and took the stock prices of these companies to their historical extremes.  Coupled with the loose monetary policy that the Federal Reserve started adopting in 1994, and I can safely say that we have had a stock market bubble as early as 1995.  For years people have predicted a great crash.  Yet it never came.  We had two close calls--one triggered by the Asia Crisis in 1997 and another by the failure of Long Term Capital Management and the Russia Crisis during in 1998.  On both occasions, Greenspan bailed us out.  This created a severe moral hazard problem.  By doing this, Greenspan has created a prevailing psychology in investors' mind.  They have learned to profit by "buying on the dips."  And while a 20 to 30% correction may ruined an investor on margin, as long as one is not on margin, he or she will be fine.  After all, the market would bounce right back up.  There can be no secular bear market which people experienced during the 1930's and as late as the 1970's.  Moreover, Greenspan would save all of us in the event of a crash.  As a result, more people bought stocks, thinking it's as safe as bonds during the "long-run."

Even the Last Bear is "in"

Bears who have long predicted the capitulation of the market are now ignored.  All the others are ostracized.  The last bear on the London Stock Exchange is now out of the door ( They have proved to be incorrect on many occasions, so why would they be ever correct?  Well, just because a crash hasn't happened yet, it doesn't mean it won't ever happen.  As long as more buyers flood the market with new money (and as long as Greenspan adopts a loose monetary policy) overvalued growth stocks such as internet stocks and telecommunications stocks become even more overvalued.  In the short-term, that's all it matters--demand and supply and the amount of money we get to play with.  As late as last November, I was urging my friends to buy technology stocks.  Recent economic and social trends, however, have indicated to me that this orgy of speculation is about to come to an abrupt halt.

How many of your friends bought stocks in 1996?  How about in 1997 or 1998?  Early 1999?  I did not personally start buying stocks until January 1998.  Since then, this number has exponentially multiplied.  And why not?  Greenspan PROVED the market could ONLY go up in the long-term.  The Nasdaq returned approximately 50% in 1998.  Last year, it returned 83%.  From late October of last year to today, the index shot up from 3,000 to 4,900--a return of more than 60%.  If anyone is not buying, then they're missing out big time!

Recent economic and social trends are now essentially indicating to me that "everyone is in."  Just as 1932 and 1982 were the best time to buy stocks 'coz no one bought them, it is now time for us to leave the equity arena and leave the inmates alone to run their own asylum.  The entire world and all segments of each of their respective societies are now literally engaged in this orgy of speculation.  In the past six months, Finland, The Netherlands, Denmark, France, Germany, China, Hong Kong, Australia, Japan, Brazil, Mexico and Canada... all of them have seen their stock market indices and their companies' P/E ratios elevated to extreme proportions.  News Corp, the biggest company in Australia, is now worth 16% of Australia's GDP (read:  To put this into perspective: If News Corp was Microsoft and Australia was the U.S., then Microsoft would need to appreciate another 200% to reach the value of  News Corp.  That would put the market cap of Microsoft at an astounding $1.5 trillion!  The recent IPO of the internet portal that caters to China "" was oversubscribed two thousand times in Hong Kong.  Massive lines stretching to more than three blocks long were seen outside the banks that accepted subscription forms.  Here in the U.S., real estate prices have soared because of "the boom."  In London, housing prices soared nearly 200% in the last few years.  The Nikkei surpassed 20,000 on Thursday, a level not seen since the Asia Crisis and before that, the speculative bubble of the late 1980's.  This is all happening while the country is technically still in a recession.

The Fed is now tightening monetary policy (ie. less money to play with).  Some fund managers (the remaining ones who aren't allowed to hold cash are now forced to buy shit in order to chase unachievable returns) and other "smart money" are now leaving the market en masse.  Historically, mutual fund inflows start slowing in April.  All of Europe, Asia, and the Americas are now in the game--a game of musical chairs with no chairs.  The final stage is set.  The whole world is now literally crowded in the top deck of the Titanic and the iceberg is dead ahead.  People are partying in such a drunken state that they are oblivious to what is happening around them.  Most aren't wearing life jackets.  Some even have steel balls chained around their ankles (if anyone is currently on margin, then they're essentially doing this to themselves).  Greenspan's been serving the drinks but now he's about to stop.  When everyone wakes up, they'll realize the drastic situation they're in, but by then, it would be too late.  Very few would escape.  Most would drown.

When this happens, most people could forget about getting out of the market in time, especially if all one has is an online brokerage account.  Websites will be down, phone calls would be placed on hold for hours (in the crash of 1987, even calls after hours to Fidelity were placed on hold for hours, and today, phone calls to Charles Schwab after 10 pm would be placed on hold for nearly an hour as well), and even if you managed to get through, your individual orders would be placed behind those of the brokerages and fund managers.  In such a state, they would be the ones to get out first--not the individual investor.  For people with stop loss orders who think they're "safe": In a crash, if anyone thinks they can get out at their stop loss price in a volatile stock, then they're seriously kidding themselves. Ask anyone who bought Onsale (ONSL--which merged with, or EGGS) the day before Thanksgiving weekend in 1998 and he or she will tell you what happened.

The stock jumped from under 20 to nearly 100 (in fact, the peak was at 9915/16--pity to those who had limit orders set at 100) in a matter of two weeks and the half-day trading day we had prior to the Thanksgiving weekend again proved profitable. If I recall correctly, the price jumped from about 60 and peaked at 99 15/16 during that day and settled somewhat lower. The Monday after, we had Black Monday and ONSL actually traded in a range of something like 60 to 90. People who placed stop orders at 80 were screaming "Bloody murder!" on the ONSL message board at Yahoo!. Seems like most of them got stopped out in the low 60's. If we ever have a crash, then I suspect some people out there who bought volatile growth stocks will get stopped at a much lower price.

Bears and "Doomsayers" are Not the Ones Responsible

I talked to a close friend of mine in Australia the other day and he remarked that it was "pessimistic people" like me who will be responsible for the market crashing.  I don't concur.  Like I said earlier, I was still buying stocks in November and was still holding some and optimistic about them until late January.  Lately, all I have articulated is rational dissent.  By getting greedy and thinking that they deserved to get rich without working (or thinking they can get at least a 20% return every year), people have elevated their favorite stocks to historical extremes and fragile bubble prices.  By not doing their research and due diligence, people's thinking are held hostage to the mainstream media and propaganda (coincidentally, CNBC comes to mind).  By Greenspan thinking he can play economic god, people are thinking they're protected and thus buy more stocks (ironically, the Federal Reserve was established with a the goal of ending business cycles--a job that they have not done so well).  By acting in a herd mentality and by taking out second mortgages and home equity financing, borrowing on credit card and pawning their jewelry to buy overinflated growth stocks (and even on margin), people are sealing their own fates.  When this all ends, you can blame these crazies who effectively ruined the 21st century economy.  Not the bears.  So we start the 21st century with a worldwide recession or even a depression.  Great.  Just what I needed.  Another close friend of mine remarked to me last night that a friend of his is essentially arguing that higher interest rates won't affect the "new economy stocks" since they have higher growth rates, etc.  If you have watched CNBC, CNNfn, or CBS lately, you would've heard these arguments--and they're pretty plausible too.  It's funny, however, that these "rationale" hasn't come up until very recently, when the performance of the Dow and the Nasdaq started to diverge.  Interest rates are a killer for growth stocks!  To grow, these companies need to borrow, and one can only do so many secondary offerings (and venture capital only makes up a small amount of borrowing, and they won't be involved after the company is public anyway).  For example,'s interest payments on their current debts would increase significantly (their latest debt offering was done in Europe, since no one in their right mind would buy their debt over here--they're classifed as Caa3 by Moody's, by the way).  Same with JDSU and GBLX.  Or how about the latest biotech craze?  One extreme example is TCLN.  I wonder how long the company can remain solvent if interest rates rise substantially (look at the very first paragraph is the latest SEC filing--and the fact that it has risen nearly 4000% from its recent low is another thing for concern)?  Or how about fuel cell stocks (PLUG)?  Maybe superconductors stocks (check out: CDTS, ISCO.OB, and SCON)?  These companies don't even have any meaningful revenues.

And oh, don't forget the discount of earnings model that analysts like to use so much nowadays.  You know, models that project earnings 20 to 30 years from now.  After all, these biotech and superconductors stocks probably won't have any earnings until that time.  If interest rates rise, then using the discount of earnings model, aren't stock prices supposed to decrease based on their present value?  The last I heard, they do.  The point is that the mainstream media is now thinking of everything to get people to buy these overinflated growth stocks.  In school, I learned that stock prices reflected the discount of dividends. When I started buying stocks, it was earnings. The way to value a company has gotten more extreme as time passes by, and the sad part is the public actually buys it.

In the first phase, people justified Yahoo!'s and Amazon's valuation based on a discount of earnings five to ten years from now. As Amazon's losses mounted and profits seem to be nowhere in sight, the spin doctors come out once again with an even fancier story. The public buys it once again. And now, it's the biotechnology and superconductor companies--most of which don't even have any meaningful revenues. But then, the public has been too well-rewarded by taking such risks, so they buy into them once again. Now, the spin doctors are coming out with models that discount "earnings" twenty to thirty years from now. This is truly amazing.

Ever wondered why people in 1929 was so reckless?  Or how about the tulipmania in Holland in the 1630's, when people sold their houses and all their belongings to speculate on tulip bulbs?  Or how ordinary men can commit atrocities in times of war?  When you read about this in history books and newspapers, you think to yourself: how can ordinary people be so blind and mad?  What can cause them to be so reckless?  Well, you're witnessing such a situation first-hand.  Look at all the people around you.  People are essentially throwing money away at worthless crap.  At  the end of the day, you can't eat your stock certificates (and I don't get one from my online broker anyway).  This is greed and herd mentality in the purest form, egged on by the mainstream media which exploits that greed and the public's immense gullibility.  When your grandkids ask you about this speculative mania in the late 1990's years from now, they'll wonder the same thing.  They'll ask: "Were people really valuing Yahoo!  (assuming it still exists) at 1,500 times earnings?  Or twice the market cap of General Motors?  Why?"  And you'll reply: "Yes, dear.  They were.  Well, people bought in the anticipation of future earnings at that time (which probably will never come as people have anticipated), and because their neighbors were buying and making huge amounts of money on it."  Then they'll ask: "But what about  Wasn't the company making a bigger loss every quarter?  How could people think they'll ever make money?"  With that you'll answer: "Well, the CEO Jeff Bezos came out and said they could, and plus, Amazon was the first e-tailer... people thought they were too big to fail.  And of course, you then have websites like the Motley Fool making recommendations on every week."  Your grandkids will remarked: "That's crazy..."  Hopefully, you can then tell your grandkids that you weren't one of the people who held those stocks when they crashed--and hopefully, you can teach them a lesson so your grandkids will recognize such a mania WHEN one pops up again (and I guarantee you that it will).

The Blowoff Phase

Definition: The last phase of a great bull market.  When all bad news and rational dissent is set aside, when the public starts "panic buying," and when there's absolutely no respect for the inherent risks of the stock market, such that the prices of stocks increase exponentially or even vertically.  This is the most deceptive phase, when everyone is at their most optimistic and when bulls are reluctant to leave and when even perpetual bears are tempted to enter because of the recent astronomical runup in stock prices in such a short time.  Figures such as Joe Kennedy Sr. and Bernard Baruch seriously doubted in late 1929 whether they made the correct decision upon exiting the market in February of 1929.  Towards the grand finale in 1929, even Jesse Livermore, one of the most famous figures who shorted stocks during most of his Wall Street career, went long on the public's favorite stocks.  This is the phase which entices small-time investors to jump in.  A phase when people liquidate their fixed-income funds, CD's, and savings accounts to buy stocks.  A phase when everyone is already "in."  A phase when the greatest risk is to not get into the stock market--to which I reply: "No. The greatest risk for not getting into the market was back in 1982. Not 2000."  A phase which makes the current price of the Nasdaq to be FOUR STANDARD DEVIATIONS above its 200-day moving average for the last six weeks.  Statistically speaking, if you're long, you have a probability of 99.9999% of losing your money at any time.  The current price of the Nasdaq is definitely an outliner, and when it corrects, it's going to correct in a big way.  All of the money out there is sucked into the market in this final blowoff phase, and with Greenspan tightening monetary policy, there is nowhere to go but DOWN.

Rubin's appearance on CNNfn:

Quote: "But I do think it is enormously important that people who focus on investing decisions, and all decisions in business life, maintain their discipline with respect to projections, with respect to taking into account risks, with respect to valuation."

My comments with a bit of sarcasm: Sorry Bob, I don't think anyone is listening to you right now. Even though it's difficult for analysts to project earnings in as little as a quarter from now, they're now projecting rosy earnings 20 to 30 years from now in order to entice more "investors" to fork up the money to buy stocks. And even though the Nasdaq is probably at its most riskiest in history, people have no respect for it. As for valuation? People were told to ignore valuation five years ago and they've been extremely well-rewarded for it. It is unlikely they will listen to you know. It's amazing that you actually received a spot on CNNfn.

And I wonder why he resigned his position as Secretary of the Treasury?  Hmmm....

And the fact that people ignored Greenspan's unusually hawkish speech a couple of weeks ago and the fundamental shift into speculative biotechnology stocks (these stocks make stocks such as Yahoo! look like blue chips) is a sign that the market is no longer rational.  This is a market led by speculators and traders along with a public that, as a whole, probably has less than an average of two years of "investing" experience.  Historically, whenever Wall Street meets Main Street, it has become a tragedy.  I do not anticipate this to turn out any differently.  If you currently want to make money buying and holding stocks, I suggest you go to Vegas instead.  You have much better odds there.

Will Greenspan Save the Day?

I figured he will try to--especially since this is an election year.  The CPT (the Crash Protection Team or as other people call it, the Plunge Prevention Team) will start buying S&P futures when the market starts tumbling.  They will run up its premium.  Arbitragers will cease the opportunity.  They will short the futures and go long on the stocks, thus slowing the market's fall.  Some of the public will start buying on the dips (if we have anyone with any buying power left and who is willing to risk it big-time), and we'll get a stable market.  It may even rally.  That being said, I believe Greenspan would let the market fall further than he did in 1997 or 1998 before he and his minions would intervene (which is actually illegal, I believe--but then, who'll complain?).  He cannot let this problem of moral hazard run any further.  He needs the public to feel the sting of a market fall to stop them from irrationally speculating.  I believe we'll have a crash which would be similar to 1987.  This is my most optimistic scenario for the LONGS.  I am only talking about the Dow, though.  We have no historically precedent for the Nasdaq, and I wouldn't be surprised if Greenspan cannot prevent an all-out fall of the Nasdaq.  After all, Lawrence Summers botched his relations with Wall Street with that disastrous inverted yield curve (banks lost billions on their derivatives positions), and respected Wall Street houses wouldn't buy stocks that trade at over 100 times earnings in a market fall.

Most probably, Greenspan can prevent a wipeout until elections are over.  But this will only be temporary.  Most likely, Wall Street would have to endure a secular bear market that could last as long as three to four years.  Like I said before, the major market indices would decline every year.  I have said 75% and 85% for the Dow and the Nasdaq, respectively when they bottom, but I wouldn't rule out much further declines.  Historically, whenever a market corrects after it has been at an extreme, it'll correct in the opposite extreme.  If we only confine this to the U.S., I could definitely place this in the top five if not the top three in terms of speculative bubbles in western recorded history, along with the tulipmania in Holland in the 1630's and the Mississippi/South Seas Bubble in the 1720's.  Forget 1929, 1962, the late 1960's, and 1987.  They are not even worth a blip on the radar screen.  Compound that with the fact that the whole industrialized world is in a speculative orgy, then I believe we probably could break all existing records in terms of financial bubbles.

Henry To

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