Wall Street Downed by Profit-Taking

by John M. Curtis
(310) 204-8700

Copyright August 4, 2011
All Rights Reserved.                                         

             Today’s 513-point or 4.3% plunge in the Dow Jones Industrials was the worst since the financial crisis of 2008, signaling that the nation’s biggest hedge and private equity funds have turned to short selling, taking profits on long-term investments.  Panic swept Wall Street as the short sellers caused a big sucking sound for major stock indexes.  After the debt-ceiling-deal was completed, traders expected a bounce yet got the exact opposite.  “The conventional wisdom on Wall Street was that the economy was growing—that the worst was behind us,” said Perter Schiff, president of Euro Pacific Capital and former U.S. Senate candidate in Connecticut.  Schiff urges his investors to liquidate U.S. holdings and invest in Pacific Rim or Asian stocks.  “Now what people are realizing is the stimulus didn’t work, and we may be headed back to recession,” reaching the worst possible conclusion.

          Schiff’s analysis is based on the U.S. incurring more debt after Congress approved a $2.4 trillion increase to the nation’s debt ceiling.  Schiff couldn’t account for why the U.S. dollar rallied against the euro and British Pound Sterling, and why gold, silver and petroleum sold off.  Conventional wisdom holds an inverse relationship between stocks and commodities, namey, where one goes up, the other goes down.  Schiff’s analysis oversimplifies the U.S. stock market, where unregulated hedge and private equity funds make a killing on market downturns or profit-taking.  While there’s little doubt that the U.S. economy is weak, saying the stimulus didn’t work misses the point.  As former Fed Chief Alan Greenspan said, the U.S. economy sustained a once-in-a-hundred years meltdown in 2008, hampering President Barack Obama’s attempts at economic recovery.

            Schiff knows that without the stimulus many U.S. banks and financial institutions would be bankrupt now.  He also knows that many state governments and school districts would also be belly up.  It’s easy to blame the White House but investors must keep in mind cyclical profit-taking after long bull markets.  When Obama took office Jan. 20, 2009, the Dow stood at around 8,000.  With today’s plunge, the Dow stands at 11,383, over 48% higher than Barack’s Inauguration Day.  Market corrections often go to 20% or taking the Dow to 10,240, before turning upward.  Regardless of today’s profit-taking, most economists haven’t predicted a double-dip recession.  If the White House really wants to get to the bottom of the latest market drop, they need to deal with short selling by unregulated hedge and private equity funds.  When the market bottoms out and turns upward, Wall Street focuses on good news.

            No one likes the pain and fear on peoples’ faces during extreme profit-taking sessions.  While today’s unemployment report precipitated the sell-off, it could have easily been a drop in the price of tea in China.  Today’s sell-off was also blamed on Swiss and Japanese central bankers attempting to halt the run-up in currency prices.  Profit-taking and short selling caused today’s nosedive, not Wall Street’s convenient excuses.  Whatever happens with Japanese and Swiss currencies, it has little effect on the U.S. stock market.  Today’s report actually showed a decrease in jobless claims, hinting that tomorrow’s job report could show a significant improvement from June’s disappointing 18,000.  Wall Street’s unregulated hedge and private equity funds accelerate market downturns by short selling, a strategy that helps funds win during extreme profit-taking.

            If you listen to Wall Street’s perennial bears like New York University  Stern School Economics Professor Nouriel Roubini, you’d think you should keep stuffing your cash into your mattress.  Roubini frequently predicts market downturns even when they consistently rise over long periods of time.  When the government’s unemployment rate comes out Friday, it’s expected to hold at 9.2%.  Nervous markets find any reason to continue selling off, especially when unregulated hedge and private equity funds continue short selling.  Short selling accelerates market downturns by giving funds a reason to keep dumping stocks.  White House and Congressional leaders have done almost nothing to rein-in short selling by hedge and private equity funds.  Obama’s July 21, 2010 financial reform legislation did nothing to control short selling or derivative trading by banks and financial institutions.

            Today’s big swoon was nothing more than cyclical profit-taking, accelerated by short selling hedge and private equity funds.  While the economy’s still sick, Fed Chairman Ben S. Bernanke will no doubt begin more quantitative easing, AKA QE3, or repurchasing U.S. treasuries.  When equities have oversold, the major funds will swoop back in to purchase the same shares at bargain prices, triggering a furious market rally.  Whether the current “correction” takes the market down a full 20% to 10,240 is anyone’s guess.  Long-term investors should be reminded that profit-taking and market corrections are predictable parts of the stock market.  While the plunge occurs, the market focuses on only bad news.  When bargain hunters eventually swoop in, the bad news disappears and turns positive.  Some reassurance from the president and Fed chairman would go a long way in reassuring markets.

John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com.and author of Dodging the Bullet and Operation Charisma.

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