The Crash of 2008 (is not over yet)

I've been getting questions from friends today about the failure of the bailout and the stock market's reaction, so here goes. I think today was a historic day that will be remembered for years to come as the day that American democracy prevailed against the power and greed of Wall Street (Paulson, Buffet, Gross, Diamond and co). During lunch today I was watching the market during the $700B "Emergency Economic Stabilization Act of 2008" debate with some traders (email me if you'd like to join our chat), everyone was on edge as the representatives made their final arguments for and against the bill (think in the bunker with helmets on). The 15 min vote began and most (including myself) were certain that the stock market sell off (wall street's way of threatening congress), Bernanke (Great Depression specialist) and Paulson (Treasury God) had spooked the House of Representatives into voting for something of which they clearly did not understand. It was a massive bill which had been drafted in a rush and would only serve to postpone the inevitable downturn. And in doing so, they would transfer taxpayer credit to the same assholes who got us into this mess in the first place. I say taxpayer credit because the taxpayer is already hurting, look at their home prices! There's something to be said about allowing the free market work its self out, but there's also something to be said for congressmen (and women) representing the people that elected them. Good for congress for doing the right thing today and voting no on that bill. The stock market decline sucks for alot of people, but this bear market has been long over due (dow is only down 25% from the all time highs). If the stock market needs $700B to keep from crashing, then stocks are overvalued!! Ok, so do I think that Paulson and co will just give up, no, no way! There will be another bill and eventually they will get something passed that saves the bankers from all loosing their jobs. This might even happen soon, and we will certainly get a rate cut from Bernanke. In other words, this is far from over, but today I felt a hint of faith in democracy and free market capitalism. That's a feeling I haven't felt for a long time.



From a purely technical standpoint the damage was staggering. The Dow Jones lost 777 points (7%), the Nasdaq puked 200 (9%) and the S&P hemorrhaged 107 (9%) after Paulson's bailout got shut down by congress. The Dow and the S&P losses were the largest ever in magnitude and the largest in % since the crash of 1987 (black Monday) when the Dow dropped 23% on a single day. There are some parallels between today's crash and the one back in Oct. 1987 , but not many, at least so far. Here's what happened to the Dow in '87:


There are some interesting qualities to the 1987 chart (click it for a closer look), clearly it would have been an easier call back then. I especially want to point out that the Dow dropped 41% from high to low in that down cycle and the RSI made a low of about 10. Compare that with the Dow dropping only 25% from 14,000 so far and an RSI at almost 40.
I guess what I'm trying to say is, the Dow could (and should) potentially fall much further, don't underestimate the potential for the market to decline more than you expect. A simple measured rule gives 9,750 as a target from today's close below 10,750, but there's also the target of 9,200 for the massive head and shoulders top and finally a 41% from from all time highs (same as 1987) would leave the Dow at 8,300. How far will it actually drop and how long will it takes? Who knows. The sooner it gets there, the sooner we can pull ourselves out of this mess which is partially why I like the House decision today. If Paulson put a gun to my head and asked me how low we were going I would say the lower 9,000s some time this year, but the timing really depends on market psychology and what the next rabbit Paulson and Bernanke can pull out of their hat. I wouldn't be surprised to see it happen tomorrow, but the indicators aren't extremely convincing Note the VIX at all time highs:


I think the VIX is a little misleading because of the short selling ban which drove more investors to use puts to short stocks (since option MMs can short anything naked). If the market does figure out how to rally, a ideal area to short would be near 10,700 on the Dow and lower 30's on the VIX. But if the market crashes down to the lower 9ks tomorrow then you can forget about this bear market imho. Any thoughts? So how well is the short selling ban working out?