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I wasn't there in 1929 and students of 1929 all have very differing views. 1987
was VERY MUCH a derivative related event and accordingly was very short lived.
It also occurred just after an expiration and the rolling of hedges wasn't a
very common factor back then. In 1987 most of the "insurance' was underwritten
by individual investors with very low margin requirements and this resulted in a
market "in temporary distress" which again didn't last long.
The good news today is that risk management is better ...... this doesn't mean
a market can't go down ... but it does mean that a massive repricing may be
less likely. NDX trades over a 30% vol. which means daily moves of almost 2%
are to be expected and in fact should be commonplace ..... sometimes it trades
40 - 50 vol. which magnifies the issue.
The other big issue in the US marketplace is that, for domestic investors, there
are choices. I can trade Yahoo for Disney ... which happened in the last few
days. I can trade eBay for 10 year notes. If you buy the demographics argument
(Dent, etc.) ... great demographics exist until about 2007 or 2008. Look
around you ... everyone is working .. in my industry Wall Street can't fill
all the derivative jobs ... just look at the listing son Bloomberg.
Additionally the world economy... which was on the brink last year... has had a
pretty impressive comeback.
Things that would worry me .... obviously very large changes in interest rates.
A dramatic change is implied volatiltiy....but again I'm a derivatives person
and I think volatility tells 90% of the story. The economy drops dead ....
again probably not an overnight occurrence.
the big unforeseen news event.... even this would need to knock the economy out
of growth mode.
Gitanshu Buch wrote:
> Thank you, doctor, for the excellent Japan perspective, it brings out the
> core systemic differences between 1989 there and 1999 here.
>
> >From the institutional standpoint, one thought keeps striking me, courtesy
> the exisitence of the relatively smooth big-picture risk transfer mechanism
> here in the US...
>
> How much sudden damage (as in 1987, 1929) can be done in the US market
> anyway?
>
> Even in 1987, the market fell 15% from its peak over a 2 week period before
> Black Monday... that, for a market used to growing 15% per year must have
> set off alarms somewhere before the Monday happened.
>
> Since then, everybody macro level is presumably hedged, or can get hedged
> with lightning speed.
>
> Everybody that is not hedged, loses money and has their investment assets
> taken away.
>
> If everyone flows from protection to protection - the way the risk transfer
> mechanism works between the mechanism's intermediaries, seems to me it
> creates its own natural checks and balances re velocity of one way moves and
> the extent that they can impact the market adversely at a macro level.
>
> If anything changes the fundamental premise of a long term directional move,
> the whole institutional investing world recognizes it, and adapts.
>
> Like you say, money has to find a home somewhere.
>
> Conceptually, this tendency ot checks and balances would seem to explain the
> stairstep market we've been seeing for the past 4-5 years - where economics
> and demographics set aside, the risk transfer mechanism played a major role
> in containment.
>
> The fat tails of recent years came from individual trades gone wrong and
> herd mentality riding that entity's misfortune, not systemic problems as
> evidenced in Japan.
>
> 1994 was a mass exodus due to fixed income - but the party was over in a
> brief couple of months.
> 1996 was a mass exodus due to tech rotation - but that party was over in a
> month.
> 1997 was a piggy back on Mr Neiderhoffer, and that was over in 2 months.
> 1998 - ditto LTCM, again over in 3 months.
> 1999 - whatever the reason (I honestly forget) but it was a smooth down
> move, some cages rattled, and game over.
>
> The point of the above data - is that the velocity was contained, and the
> extent of damage was contained.
>
> Big-picture trends (eg investor preferences into Europe-Asia over USA, into
> tech out of fixed income, of demographic investment trends etc)
> notwithstanding - can 1987 happen??
>
> Sure, chinks develop in the system every now and then - where volatility
> goes north of 100% and the Specialist Function ceases to exist as a stopper
> in the velocity of one way moves or the occasional rogue trade gets done
> that has market-wide impact.
>
> Seems to me these sharp narrow "small time" 10%-20% "corrections" would get
> more prevalent, as opposed to any sustained bear market - since the system
> gets too expensive for anything more to happen, and the world leans on the
> wrong side too much, and we over-correct in the opposite direction, swiftly.
>
> Opinions, Doctor?
>
> Gitanshu
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