How Lehman’s Anniversary Could Shake Markets in 2018

It was ten years ago when Lehman Brothers went bankrupt. That was also in the midst of a bear market and that bear market was to become significantly worse. Lost among some of the headlines is the fact that stocks were already in a bear market when the Lehman crisis unfolded.

  • Special: The Only 8 Stocks You Need for 2020
  • That makes comparisons between now and then less significant. Now, Lehman was a Wall Street institution and the bankruptcy of important firms has always rattled investors.

    History Has Lessons for Today

    History shows that 2008 was not unprecedented. There were also problems with Wall Street firms in the past. According to historians, during the presidential administration of Ulysses S. Grant,

    “disaster came in September 1873 when Wall Street financial institutions like the New York Warehouse & Security Co. and Jay Cooke & Co. “began to fall like dominoes,” according to [Grant’s biographer].

    Railroad companies shut their doors, investors went bankrupt, and laborers lost jobs. These events marked the beginning of the Panic of 1873.”

    That panic was precipitated by a monetary crisis. Grant faced the challenge of restoring the nation’s finances after the Civil War. The government had used paper money to fund the war, rather than gold which had financed operations of the government before the war.

  • Special: O'Reilly's Most Controversial Project: Mint New Millionaires. Details Here.
  • After the war, there was a debate of whether to return to a gold standard or use a bimetallic gold and silver standard. That debate led up to the Panic of 1873 which came as Wall Street firms collapsed. But, again, the crisis was building before the Panic.

    That Panic was significant and “led to a prolonged depression that lasted until 1879, but the nation’s taxes and national debt were reduced by $300 million and $435 million, respectively, during Grant’s tenure in office.” In effect, Grant used austerity rather than stimulus to fight the panic.

    Mood Sets the Tone for Crisis

    In both 2008 and 1873, there were signs problems were building, The national mood in 1873 was somber with the memory of the Civil War and Reconstruction challenging the very existence of the country. Nothing that dramatic existed in 2008 or now.

    But, in 2008, there were signs of a credit crisis. A recent presentation by Ben Bernanke, Chairman of the Federal Reserve at that time, highlighted that problems were building before the crisis. The chart below shows that the cost of credit backed securities shows the problems in advance.

    In hindsight, the panic was already causing spikes in the derivatives markets. The blue line shows the yield on credit card backed securities and that spike showed a crisis was building before Lehman.

    Bernanke concluded, “The panic of 2008 differed from the Great Depression of the 1930s in that the runs on the financial system during the recent episode were on wholesale funding, and occurred electronically, while in the 1930s retail depositors lined up in the streets.

    But the overall effect was the same:  A loss of confidence in credit providers caused the supply of credit to plummet, the external finance premium to spike, and the real economy to contract rapidly.”

    Notice that panics occur when problems get out of control. That is a simplification, but that reality highlights the importance of sentiment indicators.

    Negative Sentiment Could Foreshadow the Next Crisis

    Sentiment indicators are designed to help us spot times when bulls or bears are at extremes.

    One group of sentiment indicators are based on surveys. Every week the American Association of Individual Investors (AAII) asks members, “do you feel the direction of the market over the next six months will be up (bullish), no change (neutral) or down (bearish)?”

    The weekly data and historical results are then made available for free.

    The chart below shows the most recent data.

    Only extremes in the data provide useful information. As of this week, the latest AAII data from September 12 is not offering a buy signal. But, it is worth watching.

    According to AAII, “Optimism among individual investors about the short-term direction of the stock market fell to its lowest level in six weeks. The latest AAII Sentiment Survey also shows a strong rise in pessimism and a rebound in neutral sentiment.”

    The analysis continues that, “At current levels, all three indicators are well within their typical historical ranges.

    Tariffs and the possibility of an escalating trade war remain front and center on the minds of many individual investors. Also influencing sentiment are Washington politics (including President Trump), economic growth, interest rates (including monetary policy), valuations and corporate profits.”

    This indicator, and other sentiment indicators, could be worth watching right now. A shift to pessimism could signal that the long bull market that started in March 2009 is nearing an end. As in the past, it is likely that sentiment will be negative before the bear market accelerates.

    Sentiment may be the piece that is the trigger for severe sell offs. That has been true since the nineteenth century and history has shown that pessimism is high when the bear market begins.

    That could mean that sentiment drives price trends but some may argue that fundamentals drive trends. Fundamentals are certainly important but the public mood simply should not be ignored by investors.

    A bull market could shrug off bad news when optimism is high but can sell off when investors have negative feelings. Sentiment surveys like the one from AAII could help investors know when the probability of a sell off is high.

    Of course, following technical indicators like sentiment and identifying trade signals based on the indicators will take some time to do.  If you are uncertain about your ability to dedicate the required time to trading, there is a trading service, Triple-Digit Returnswhich uses a very specific system for choosing the right stocks to trade.

    Triple-Digit Returns looks for companies that are misunderstood and potentially undervalued, lost darlings, mergers or spinoffs that could benefit share holders, or companies that show signs of strong interest by insiders who know the company best and see value.

    This service provides a recommendation once a week. It could be used for trading or learning how to analyze stocks since each recommendation includes a detailed explanation of the company. To learn more, you can click here.

  • Special: The Only 8 Stocks You Need for 2020