Plunge Protection

Here is an extract from commentary that was posted at www.speculative-investor.com on 30th June 2002. 

It has become fashionable to point the finger at something called the Plunge Protection Team (PPT) whenever the stock market suddenly reverses higher or fails to collapse in response to bad news. The PPT, which does actually exist although its proper name is the Working Group on Financial Markets, is headed by the Secretary of the Treasury and counts the Fed chairman as one of its members. The theory is that the PPT acts to prevent large declines in the stock market by buying S&P500 futures at critical times.

Manipulation happens in the stock market on a daily basis. Mutual funds, specialists, hedge funds, Wall St firms and large speculators are often deliberately trying to move prices in one direction or another. This manipulation does not alter the trend, but it can affect the path the market takes to get from point A to point B. Furthermore, we know that the US Government intervenes in the currency and bond markets and we can be pretty sure that it meddles in the gold market, so it is not much of a stretch to conclude that the Fed and the Treasury are also directly involved in stock market manipulation. This is particularly so since it was revealed earlier this year that the Fed contemplated "unconventional measures" to stabilise markets.

Further to the above, it is not difficult for us to believe that the PPT would intervene in the stock market. However, we have seen absolutely no evidence that such intervention has occurred. In our view, those who are pointing fingers at the PPT are misreading the market.

Trading would be very simple if we could make money by just buying in response to good news and selling in response to bad news. Unfortunately, markets don't work that way. All of the financial markets will regularly do the opposite of what you expect if your expectation is shaped by the 'news of the day'. 

During the devastating stock bear market of 1974 the market would often rally in the wake of bad news. In fact, the news at that time was generally MUCH worse than any of the recent news while the upward reversals following the bad news tended to be more pronounced than the upward reversals we have seen over the past few months. There was no PPT in existence in the 1970s and, as such, no 'they' to blame for the rallies that occurred in the face of the deteriorating fundamentals.

As is the case now, the major stock indices were immersed in powerful downtrends during 1974 and each upward reversal was followed by a decline to new lows until the final capitulation occurred. In 1974 the final decline began when the Watergate scandal forced President Nixon to resign. This was the news from which there was no recovery and the market fell in almost a straight line until a major bottom was reached about 2 months later.

The PPT has enormous power and if it chose to make full use of that power it could certainly push the stock indices considerably higher. The Fed, a member of the PPT, has an unlimited ability to create dollars, so if it really wanted to the Fed could print enough currency tomorrow to buy the entire stock market. (There is, of course, a practical limitation to the Fed's currency-creating ability in that the more dollars it prints the weaker the US$ would become.) From what we've observed the PPT has not, to date, chosen to make direct use of its immense power as far as stock market support is concerned. For example, when the stock exchanges opened for business last year following the September terrorist attacks the market plunged for 5 straight days. The decline didn't end until a) the market had become more oversold than it had been at any time over the past 40 years, b) the small traders had capitulated and the commercial traders had covered a substantial part of their short position, and c) the S&P500 had dropped to within 10 points of major support as defined by the 1998 low. From such a position it would have been amazing if the market had not been able to mount a sizeable rally. 

If ever there was a time that the PPT could have justified an intervention the period of September 17-21 last year was it, but it looks as though the market was allowed to fall until a massive oversold recoil became inevitable. There was, of course, indirect intervention in the form of interest rate cuts and money-supply expansion, an effect of which, as we noted at the time, would be higher gold and commodity prices in the months and years to follow.

As far as last week's action is concerned, there seems to be widespread surprise that the market was able to recover in the wake of the Worldcom news. However, was the market's performance following this news really so difficult to comprehend that unnatural forces become the most probable cause of this performance? 

Prior to the reporting of the $3.6B 'mistake' in Worldcom's books the WCOM stock price had already fallen by more than 98% from its all-time high. In fact, WCOM's market cap, just prior to last week's news, made no sense if the results that had previously been reported by the company represented its true financial situation. The stock was way too cheap. Clearly, the specifics of Worldcom's creative bookkeeping came as a surprise but the market already knew, prior to the news, that something was horribly wrong at that company. It just didn't know the details.

The market (the S&P500 Index) is trending down and we expect this trend to persist until the majority of stocks have become fundamentally under-valued. However, within this downtrend there will be counter-trend rallies and there will be many occasions on which the market reverses higher following bad news. This is normal and is what the market must do if it is to maintain some semblance of hope (hope is what bear markets feed on). The final bottom could come quickly as a result of mutual fund investors giving-up en masse (perhaps in response to some devastating and truly unexpected news), or it could come slowly following a drawn-out slide (a death by a thousand cuts).

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