How to think positively about a crashing stock market

Who cares if right now hedge fund investors want all their money back? Sooner or later, they'll change their minds.

By Andrew Leonard

Published November 21, 2008 5:53PM (EST)

I remarked to my 14-year-old daughter this morning that after the 10 percent decline in the Dow Jones Industrial Average over the last two days, stock prices have dropped back to around where they were when I started putting money into college funds for her and her younger brother back in 1997. She winced. As did I when I saw a story in the Financial Times this morning reporting that hedge fund investors had withdrawn $40 billion worth of their investments in October, and even bigger numbers were expected for November and December. Redemptions on such a scale force hedge fund managers to sell their holdings whether they want to or not, inevitably putting ever more downward pressure on stocks. Where will it end?

The question poses its own answer. It has to end at some point, doesn't it? There is only so much that can be redeemed. According to the FT, some hedge funds are now sitting on huge piles of cash. Naked Capitalism's Yves Smith sees this as a hopeful sign: "One bit of good news: enough funds are [so] heavily in cash in anticipation of these investor demands that observers believe that markets will suffer considerably less from forced selling."

If you think of hedge fund deleveraging as a huge sucking force dragging down the market, then you also have to imagine that at some point, that suction will come to an end. Once the wary and fearful have redeemed all their investments, there should be bargains galore. Long before the recession ends, the stock market will likely spring back.

In another rare outburst of optimism, Felix Salmon argues this morning that the current phase of the crisis is not a full-blown financial meltdown. He cites the relative stability in one key measurement of credit tightness -- the TED spread.

The TED spread today is 213bp -- more or less exactly where it's been for the past few weeks. Which says to me that for all that financial stocks are being crushed, this is no reprise of the financial crisis we saw in the wake of Lehman's collapse. Rather, it's an old-fashioned economic crisis, which severely erodes the equity of leveraged banks, but where money still flows and even the occasional IPO can get away if it's priced at a discount. Or, to put it another way: it's a bear market, not a financial meltdown. Which might be little solace to anybody whose stocks have been crushed of late, but which might help reassure policymakers at least a little.

You know times are tough when you are relieved to learn that we are only experiencing one of the worst bear markets since the Great Depression, and not an unthinkable meltdown certain to destroy civilization as we know it. Now that that's settled, I can go on to worry about other things, such as the fact that unemployment in California jumped a full half a point in October, up to 8.2 percent. That's the highest its been out here since 1994.

Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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