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Liquidity is gone

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The #1 question


July 12, 2009

Liquidity - it means having an ample supply of ready buyers so that when you bring whatever it is you have to market, there are people with money who are ready, willing and able to buy what you have to sell.

When you invest in stocks, you are entirely dependent on liquidity. If liquidity dries up there is literally no one to buy your shares. Without buyers, prices plummet and only stop when they hit values so low they are "ridiculous."

The #1 stock market question is this: Is there real liquidity in the market? Or to put it more simply, are there real buyers ready, able and wiling to buy stocks?

Rising prices and big volumes alone is not enough information to provide an answer this question.

Here's a reality check

Are investors behind the current market bounce?

I don't think they can be.

Here's why:

1. Private and institutional investors are sitting on 30% to 50% stock losses which they first have to SELL to raise cash to buy more stock.

2. If they're getting cash from stock sales, they have 30 to 50% LESS money to play with then they had a year ago. That is not good for liquidity.

3. If they're bringing in new money, where is it coming from?

Up until very late in 2008, there was very little cash sitting on the sidelines. How then can there be MORE cash available for stock purchases NOW after so much wealth was destroyed in the last several months?

4. If the new money in the market isn't coming from stock sales or from cash reserves, it had to come from somewhere.

It's possible then that stock prices are not being pushed up by legitimate buying but are instead being pushed up by a handful of high volume players who were given mountains of cash by the US government to "keep the banking system from melting down."

5. We know a few things about the trillions of dollars the US gave away in the past year:

a) It went almost exclusively to a handful of banks that maintain very aggressive trading programs

b) A big chunk of it is "missing" - the Obama administration literally can't (or won't) account for it

c) This money sure hasn't shown up in increased credit availability to consumers and businesses. Bread and butter business credit services remain in the doldrums.

The big question

Is is really possible that the trillions given to "the banks" is what's being used to create the illusion of a liquid, rising stock market that's "bouncing back?"

Not only is this a possibility, it's a probability because it's the only scenario that makes sense if you accept the analysis above. They liquidity has to be coming from somewhere and logic says the most likely source are federal government funded financial institutions, not investors who are less willing and certainly less able to play the equity shell game.

The truth about the Crash

If you look at charts of how markets collapse, for example the stock prices of the Depression of the 30s, the fabled "Crash" of 1929 was actually a mild retracement compare to the real collapse that followed.

Don't take my word for it.

Look at the charts from that era and then compare them to the charts from the collapse of the Japanese stock market which started in 20 years ago and still is not even close to recovery.

The next shoe to drop

Who cares if stock market prices collapse? After all, the stock market isn't the whole economy, right?

Here's the big problem:

Stock prices dramatically effect the health of pension funds and pension funds are the biggest holder of private wealth in the US and one of the country's biggest social stabilizers.

If stock prices continue to fall, pension funds will find themselves unable to meet their commitments.

Pension failures will result in more credit card default, more foreclosures, and more personal bankruptcies as people who counted on payments stop receiving them or receive less than they expected. This will lead to ever lower real estate prices, lower demand for all kinds of goods and services, and more business bankruptcies.

This will result in a vicious cycle that will spiral downwards until a true bottom is reached.

When the true bottom is finally reached, history shows that there won't be a vigorous "bounce" from the bottom. Instead there will be a long, slow stabilization period during which the financially wounded recover and rebuild (those who are able to that is.)

The last time this happened, it took over 30 years for stock prices and the economy to recover.

In fact, you can say accurately that the recovery did not take place until those who were 40 years and older during the Crash of the 30s were carried off the playing field and a new group of people sat down at the table to play who didn't bear the scars of their parents.

A key point for understanding what's still possible

The original "Crash" of 1929 that historians moan and groan about was NOTHING compared to what followed in 1931 to 1932.

Again, don't take my word for it. Look at the charts from that era. You'll see that it's impossible to overstate the seriousness of the potential precipice we're standing on - all the worse because "rising stock prices" are lulling people into a sense of false security.

The fact that a professional trader - with access to and an interest in knowing who is actually providing the volume on the "buy side" of this market - says the buying is coming from just a handful of "momentum" players is a sign that we may be in for a much more severe crash in the near future than most people can imagine.

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