Barracuda

Here’s the problem—while Vice Presidential hopeful Sarah “Barracuda” Palin spoke on Wednesday night, none of us knew that in fact, the speech was a red herring. The barracuda we should have been thinking about was the one in the 1977 Heart song:

You lying so low in the weedsI bet you gonna’ ambush meYou’d have me down, down, down, down on my kneesNow wouldn’t you, barracuda?

On Thursday, the barracuda had the market down on its knees. The Dow Jones Industrial Average plunged 344.65 points, or 3%, to 11,188.23, its lowest close since July 28. The Dow returned to bear-market territory, off 21% from its record close of 14,164.53 hit on October 9, 2007. The S&P 500 dropped for a fourth consecutive day, falling 3% to 1236.83 and the Nasdaq Composite Index tumbled 3.2% to 2259.04. All of this occurred on heavy volume, indicating that it was not some sort of “summer fluke”. There was no one piece of information that caused the slide in stocks. Rather, it was as if investors decided that selling stocks was the new black this season.

The worrying issues that triggered the selling included: the Labor Department reported new claims for unemployment benefits rose by 15,000 last week, capping a multi-week trend that could portend bad news later today when the government's monthly data on nonfarm payrolls are due for release. We also saw evidence that the “back-to-school” period was pretty dismal for retailers. All of this on top of the fear that hedge funds would be unable to meet September 30 redemption requests was too much for the market to bear. The barracuda was indeed dangerous and venomous.

The theme yesterday can be summed up as follows: “what if all H-E-double-hockey sticks breaks loose and the worst case scenario really does occur?” This view was voiced by none other than perma-Cassandra Bill Gross, managing director of Pacific Investment Management. Gross begged the government to "open up the balance sheet of the US Treasury" in order to prevent a continuing asset and debt liquidation of "near historic proportions." Gross noted that we are looking at a burgeoning ``financial tsunami,'' which demands immediate government action. Those kinds of comments underscored the fear that a worldwide recession was upon us and as a result, well, you know the numbers.

Here is how the “worst-case” economic scenario, that is, a full-fledged global recession, could unfold. It would likely start with the US consumer, who under a bit more inflationary pressure might fully capitulate and retrench, leading to a massive corporate profit margin squeeze and then stocks continue to fall, confidence is shattered and we are in a horrible negative feedback loop. I think that the “worst-case” is an outlier in the range of possibilities, but you would have to be nuts not to factor it in to your asset allocation. In other words, there’s a barracuda in our midst—we don’t know whether she will swim out to sea or attack again, so the best advice is to guard against her.