December 23, 2009

Banks and Market Manipulation

A simple look at any chart shows that even the government and big banks do not have superhuman powers, at least not unconditionally.

Unusual events are often the consequence of unusual actions. The 65 percent rally from the March lows is one of those unusual events that can be rationalized but not really explained.

The economic indicators that really matter for this cycle - unemployment rates and property prices - have been moving in the wrong direction for months contradicting the stock market's move to new recovery highs. Is it possible that banks are using government cash to artificially bid up prices?


Unfortunately, there are too many unknowns to conclusively answer this question, though I suppose the government would want it that way, that doesn't mean we can't reason on the matter. In fact, a look at the available information sheds some light on the manipulation theory while a look at history provides valuable clues as to its effect.


In 1988, in response to the 1987 Black Monday where stocks collapsed 22 percent, Ronald Reagan signed an executive order to establish a specific committee designed to prevent a major market collapse. As per this order, the Secretary of the Treasury, the chairman of the Federal Reserve, the chairman of the SEC and the chairman of the commodity futures trading commission make up the core of this team.

By extension, major financial institutions like JP Morgan Chase and Goldman Sachs are used to execute their orders. There is much more to this unique "financial powerhouse fraternity" designed to keep a lid on potential market meltdowns. (A detailed report about this secret team is available in the January issue of the ETF Profit Strategy Newsletter.)

How could this team buoy prices?


Supply and demand drives prices. Where the demand comes from does not matter.

In emergency situations, the Federal Reserve is said to lend money to major banks, which serve as surrogates who will take the money and buy markets, predominantly futures, through large unknown accounts.

The timing of those buys will be such that those shorting the market will be forced to buy back shares. In theory, this eliminates the most pessimistic investors and causes others to buy. Soon sideline money from mutual and hedge funds comes in, and the rally gathers a life of its own.


The notion that prices can be inflated artificially makes sense and sounds good in theory. Based on the evidence, this kind of maneuvering even seems to be more common than we think.

But a simple look at any chart shows that even the government and big banks do not have superhuman powers, at least not unconditionally.

In 2000, 2002, 2008 and 2009, the major indexes declined 30 percent or more. One of the flaws of artificial buying is that all the money used to buy stocks will eventually have to be taken out.

As we know, banks are not immune to greed and once prices start declining, banks are likely to be the first to cut their losses and flee the sinking ship.

In summary, we can conclude that there seems to be an organized committee with the job description of lifting markets. Quite likely, their efforts have contributed to the protracted rally in stock prices.

However, as we've seen, the market is too wild to be contained. Normal market forces still apply. One of those age-old forces is investor sentiment, possibly the best known and most accurate contrarian indicator around.

Extreme levels of pessimism tend to signal market bottoms while extreme levels of optimism tend to signal tops.

The ETF Profit Strategy Newsletter used this contrarian indicator as a foundation to issue the March 2nd Trend Change Alert which foretold a massive rally with a target range of Dow 9,000 - 10,000 a mere seven days before the March lows were reached. Now, once again, we see an extreme of investor sentiment - and this time it's optimism. According to the Investors Intelligence survey, this week saw the highest percentage of bulls since December 2007.


More importantly, the major indexes are butting up against levels of resistance that have been years, even decades in the making. Those different resistance levels converge in the Dow 10,100 - Dow 10,500 range, which is the very range the Dow has been stuck in for over three months.

The ETF Profit Strategy Newsletter includes an analysis of predominant, and probably formidable, levels of resistance along with a short, mid and long-term forecast, and a target range for the ultimate market bottom. If history is a guide, and it usually is, the market will do what it wants, regardless of the government's efforts.

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