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Friday, November 14, 2008

The Market's Three Competing Forces

Are you one of those that watches the market everyday and is first dismayed by the equity you are losing and second stunned by the enormous volatility? Do you wonder how it can be that the market can continue to rise and fall as much as ten percent daily? The reason that this market continues to show this much volatility is because it continues to be driven by three competing factors each vying for leadership in moving the market. On any given day, the market can be moved by one, two or all three of them. As such, not only does the market show incredible volatility but unpredictability.

1) The economic malaise

That we are in an economic malaise is neither a shock nor in and of itself a stimulus one way or another on the market. The real problem is that we live in a world overwhelmed with economic data. As such, with each passing day there is another economic number that tells us we are in the middle of an economic malaise. Today that number was October's retail sales. The problem is that there are all sorts of numbers. There are weekly numbers, monthly numbers, and quarterly numbers. You can count that nearly every single day there will be a new economic number, and you can count on that number being bad. It's sort of like having a big zit on your nose. You just can't get away from it. That's what it's like to have a really bad economy and an endless stream of economic data. Each and every number is bad and it's a constant reminder that our economy is on the brink of disaster.

2) Government action

While you can count on constant reminders of just how bad the economy is, you can also count on governments all over the world to step in for aggressive action. Sometimes its the Fed, or its equivalents in Europe and beyond, cutting rates. Other times it's the Treasury, or its equivalents, calling a massive stimulus package. Earlier in the week, it was the Chinese government that announced a stimulus package worth roughly $600 billion. It is hard to know if it is merely wishful thinking or confidence, but more times than not the markets respond positively to stimulus, bailouts, and rate cuts. Because there are lots of governments around the world, and even more departments within each government, you can also count on some government somewhere announcing something stimulating that would have a positive effect on the market.

3) Speculation

The main reason that there is so much volatility is because there is now all sorts of speculation in the market. No matter what sort of economic news or action there is in a given day, markets don't move ten percent daily naturally. When we see rapid movements on the level we normally have, that is driven almost entirely by speculators. Speculators come in several different forms. Often times, they are the big money behind things like hedge funds and private equity. Other times, they are simply individuals sitting in front of a computer screen in some bedroom somewhere around the world. The biggest problem with speculators is that they don't respond to any economic data or government action. Their movements are calculated entirely based on technical movements of equities and debts. This is the sort of sophisticated analysis of charts that attempts to predict short term momentum, and frankly, even those that practice in it don't fully understand it themselves. As such, their effect on the market is even more difficult to predict except to say that they will definitely continue to provide volatility. (which is another reason why I continue to back a volatility play)

So, there you have it. On any given day anyone of these three forces will be vying for a leadership role in moving the market. Which one will emerge is anyone's guess, but for the time being they have created quite the roller coaster ride.

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