Will the Next Bear Market be a Planned Event or a Failure of Central Planning?   (January 1, 2013)

Ironically, the very success of stock market manipulation only thins the market of legitimate participants and thus increases the probability that risk that has been suppressed for years will erupt uncontrollably.

Longtime correspondent B.C. recently shared some provocative thoughts on the nature of the next Bear Market. Bear markets are often defined as a decline of 20% or more from recent highs.

Alternatively, others look at long periods of subnormal returns as secular Bear Markets. For example, if officially measured inflation has reduced purchasing power by 35% since 2000, and total stock market returns (dividends plus appreciation) are 15%, then the real return of "buy and hold" is a negative 20%--a Bear Market by any reasonable metric.

That the stock market is manipulated is no longer in question. One explicit goal in the Fed's zero-interest rate policy (ZIRP) is to drive capital into risk assets such as stocks. That is a first-order, transparent policy of manipulation, i.e. a centrally managed policy aimed at managing markets to meet a key central-planning goal: creating an illusion of prosperity via an elevated stock market and the resultant "wealth effect" for the 10% who own enough stocks to matter.

Indirect manipulation is hidden from public view lest the rigging of the market taint the perception that a rising market is "proof" that Federal Reserve and Administration policies are "succeeding." Indirect manipulation is achieved via Federal Reserve quantitative easing operations, unlimited liquidity and lines of credit to fund bank speculations and masked buying of market futures.

This multilevel manipulation creates a Boolean either/or for any Bear market: either it is a planned "panic" that profits the banks or a systemic failure of the orchestrated campaign of market manipulation.

Here is B.C.'s commentary:

Consider the possibility that the banksters now effectively control the stock market in ways never before possible, using the NY Fed acting in concert with the dark pools, offshore shell companies and pass-through entities, PTFs, and high-frequency trading (HFT) via the for-profit exchanges.

How much would it "cost" the primary dealers to manage the markets using leveraged derivatives, assuming a complicit counterparty or counterparties?

Hypothetically, if the banks wanted to keep the SPX to no lower than, say, 3% to 7% of the 200 dynamic moving average (DMA) indefinitely, thereby keeping the 200 DMA in a steady uptrend, what would it cost? A few tens of billions at the margin?

If one or more parties could leverage 10:1 futures and then 10:1 again with options, it would cost a small fraction of banks' ~$13 trillion in assets and $1.7 trillion in cash assets.

One can at least envision the possibility of banks continually leveraging of futures and options on futures, rolling the positions forward while keeping sufficient amount of incremental liquidity to further lever long as required.

We can infer that if Wall Street banks wants the market to go down because it's the best opportunity for them to make money given the alternatives, a bear market will occur; but it will be blamed not on cyclical factors, overvaluation, etc., but on some other perceived "exogenous" factor, such as the "fiscal cliff", war, "policy mistakes", etc.

Yet with the banksters having directed Bernanke to explicitly talk up the stock market for more than three years, even specifically referring to the Russell 2000 (small-cap stocks) as a benchmark, to expect that a bear market will occur is by definition to assume that (1) the banksters will act in some manner to allow, or cause, a bear market; or (2) their efforts will fail to prevent one, risking their credibility and legitimacy. Given the hyper-interventionism and expectations management, one is left to assume that the banksters have the capability to prevent a bear market until proven otherwise.

But without a bear market, valuations will not improve enough to permit a future return that warrants the 35-50% cyclical drawdown risk in the meantime.

How does one trade, speculate, or allocate assets in an environment where one is like a conspicuous, slow-moving target in a shooting gallery for the HFT and PTF sharpshooters, or one's assets are hardly more than part of a slush fund for fee scalpers who add no value to the economy or society?

Thank you, B.C. for explicating the conundrum facing the manipulators: if they never let the market decline, the resultant modest appreciation and low yield does not provide an attractive risk/return given the possibility, however remote, that the market could escape the control of the Fed and banks and plummet by a third or a half.

The loss of credibility and legitimacy any serious decline would trigger could launch a positive feedback loop where buyers who have been trained by four long years of manipulation to "buy the dip" would lose faith if their buying was rewarded with sustained losses.

This means the manipulative Powers That Be must tread a precarious path between a Bear market sell-off that creates buying opportunities for themselves and a decline that escapes their grasp as a loss of faith in the manipulators' control triggers an avalanche of selling.

We can surmise that a manipulated sell-off will have a V-shape: a steep decline that triggers widespread stops and margin calls, followed by a sharp recovery as the manipulators buy the dip they enabled. Ideally, the sell-off would fail to reward buy-the-dip buyers, causing traders to sell to waiting hands. Perhaps the November sell-off was just such an orchestrated decline and recovery.

A sell-off that gets away from the manipulators would likely be characterized by failed rallies and high-volume selling as money managers bail on risk and the perception that the manipulators are not God-like in their powers.

If the markets are well and truly captured by the banks and officially sanctioned manipulation, then any sell-off will be limited. Ironically, the very success of the manipulation only thins the market of legitimate participants and thus increases the probability that risk that has been suppressed for years will erupt uncontrollably.

The after-effect of a Bear that escapes the Fed/bank Zoo is a market that has lost the legitimacy of a truly free market and the credibility of a centrally managed market. It will truly be a dead-zone market, abandoned by all but the bank/central planning manipulators and day-traders.

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