I got this e-mail which I thought was really interesting. I got it through a newsgroup I'm subscribed to. I'm reprinting it below and adding some comments in italics. They chose to title it "Blow-off Models", I'm not sure why, as it's about more than just blow-offs.

Speaking of blow-offs, does anyone else think that this finally it? Are we finally setting the stage for the big crash? Even EconDropout thinks it's time to bail. The A/D ratio can't get much worse, even the most ardent bulls are dumbfounded by the Nasdaq's absurd 1,000 point rise, and volume has exploded during the last month. Is this the blow-off top, or is there going to be one that's even bigger than this?

I can't imagine it getting any worse than this, but I've said that so many times that I don't even believe myself any more. Even with the whole November 9th Day of Reckoning thing, I was never convinced that a crash was likely before then, that date had a life of its own, and an arbitrary one at that. But now I really am becoming convinced that we're not just entering the final months of the bubble, but the final weeks. I'm thinking that the crash is going to occur any day now, but this time it's not theoretical, it's beginning to look like reality. More Rimpy crazy talk? We'll know before too long.

Rimpy

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1999, 1929 What is the same as then only more so:

Stock P/E (price to earnings) ratios of 40-60, or 1000, or even negative in cases like amazon.com. [I've read a few newspaper articles from 1929 where they talk about stocks trading with P/E's of 50, 75, or in a few "extreme cases", over 100. It's funny that they called a P/E ratio of over 100 "extreme" in 1929.] Historical averages are around 15, while a ratio of 20 used to be considered risky. [While it's clear that P/E's ratios much higher than their historical range, there really is no such thing as an "average" P/E ratio that stocks should trade around at any given time. The "natural" (notice the quotes) P/E ratio of a stock depends heavily on interest rates, or more generally, the return of competiting investment choices.] Record trading volumes and index highs (as with the final weeks before the 1929 crash). [And this happened in the final weeks of 1989 before the Nikkei finally fell back to Earth. I think the concept of a "blow-off top" is commonly accepted among bulls and bears alike.] A small and shrinking proportion of stocks propping up what is otherwise a bear market, with insane valuations, e.g. Microsoft has a market cap equal to 10% of US GDP. [How many countries have a GDP greater than MSFT's market cap? Maybe ten at most?] The broad indexes have been in decline for well over a year now, [while the indices continue to rocket up -- the same thing that happened in 1928/9 and 1971/2, both which preceded severe bear markets], a lot of very large companies have blown off 30% or more of their market cap, as was the case in 1928-9. The ratio of advances/declines (A/D) has been in negative territory for many months. [Like a blow-off top, a narrowing market is common at the end of manias, even during Tulipmania.] Massive and accelerating liquidity (a polite way of saying printing temporary money) injections by the central bank (the Fed). [I'm beginning to think that this absurd rally we're experience is due to the Fed injecting lots of money in our economy. I remember reading a while ago that the Fed was setting up a special plan whereby banks could borrow against their bonds at very low interest rates without selling them during a three-month window. Can somebody help me here? I don't remember the details.]

The percentage of middle-class Americans playing the market has two historic highs- 1929, and a new, much higher high in late 1999. [I don't know if this is true, I think the 1960's take second place.] A negative US savings rate. [Actually, it's not negative anymore thanks to some changes in the way the Personal Savings Rate is measured. I think the changes were justified, but it doesn't change the trend of the PSR, which has been declining for years.] This has not happened since the Great Depression. No shock absorbers here!

Skyrocketing real estate prices, c.f. Japan, 1989 (Japan has been in recession ever since). Total American stock market capitalization (the aggregate price of all the stocks traded) has surpassed 200% of US GDP. This ratio hit 120-160% just before the '29 crash (depending on whose figures). [I also heard that it was only 120% in Japan at the peak of their bubble, but a lot of their asset inflation was concentrated in the real estate markets. The problems with numbers such as these is that it's very difficult to get a precise measure of the overall value of the asset markets, and it's impossible to know how much they are "inflated" since their true value is unknown.]

Product saturation: in 1929 there were 2000 automobile companies (according to Warren Buffet), now there are a plethora of redundant .coms, many with multibillion dollar market caps and essentially no earnings. [I always thought that a better example was railroads in 1840's England. There were a few success stories at the beginning, with very high returns on the first projects. Hundreds of other projects were started, with the expectation that returns on capital would match those early ones. But in a free market, high-return investments never last for very long, as lots of competitors crowd into the same market, making the return much lower. In the end, redundant railroads were built between the same two cities, as neither had a very high return as they had to cut prices to compete with the other. The speculators bid railroad stocks to the sky, expecting every project to have the same kind of returns as the first ones.] The total percentage of internet trade is still insignificant, except possibly in stocks. [Although the Internet isn't quite the CB of the 90's, I think it is a lot of hype and the predictions for e-commerce are ridiculous. I see it as being marginally more popular than catalogue shopping. Maybe that's just wishful thinking, because I really hope that we don't become a nation of people who live out our lives in front of a computer.] Cascading defaults, external recessions/depressions. Large areas of the Earth are already experiencing severe economic hardships [and the rest of the world has been held up by the US's insatiable appetite for imports], some countries such as Thailand and FSU are in what can only be called a depression. A ripple of bailouts from Mexico (actually to the American banks that underwrote the bad loans, btw) [I've read a few articles by credible people who trace this bubble's origins to the bailout of Mexico] to S. Korea to LTCM (this one apparently threatened to collapse the entire system).

Rising profits (in some sectors, notably not in internet, electronics) and productivity, but no rising standard of living. [Except for the very wealthy, again another characteristic of the 1920's, except that the gap between the have and have-not's was a lot more exagerrated back then.] Pyramid schemes: something of a footnote, this sign of the times has resurged in the past few months, having disappeared in the late '20s. Media cheerleaders. [And CEO's like Bezos who spend more time promoting their stock than managing their company.] Try to find a sour note out there among the spinmeisters. This will make any panic even worse. [I'm not sure why he adds this in -- maybe because of a higher level of enthusiasm driving the bubble?]

Most importantly of all is the (American) public attitude, that we are in a "New Era", of "New Economics" where the old rules no longer apply. [Hence the name of this board.] New technologies (airplane, radio, car) and high-flying tech companies are going to pilot us into a Long Boom of never ending prosperity. [Again, the Railroad Mania in 1840's England was a product of the public's infatuation with revolutionary technology. And you also have the promises of the New World driving the South Seas bubble and Mississippi Land Scheme. But why tulips? Enthusiasm for international trade? The tulip had been recently introduced to the Dutch economy, coming originally from Turkey, I believe.] Unfortunately, we are still propelled along by those old twin engines of human behavior- greed and fear.

What is new or different:

No gold standard, floating currency exchange rates. Historically, each and every time paper has been substituted for a precious metal the currency has been inflated into oblivion within a few years or at most a few decades. [This is what really scares the crap out of me, even more than a stock market crash. I think there are a lot of good reasons to worry about the stability of the dollar, namely whether or not our huge trade deficits are ever going to catch up to us.] The difference in the current "experiment" is that this time the entire world is running on paper or it's electronic equivalent, with the $US as a reserve currency, in amounts limited only by disk storage space (not by the amount of available lumber as in the past). [LMAO!]

Derivatives markets, bank exposures. There appears to be something on the order of $120-200 trillion (depending on whose figures you use) floating about the global marketplace. [I've heard figures closer to $50 trillion.] No one really knows what all is out there, how it all works, the amounts or the due dates, since these instruments are not regulated. US banks are exposed to the (official) tune of a cool $33+ trillion (Item: who gets to bail them out?). Bear in mind the US GDP is about $9 trillion, World GWP about $25 trillion. Much of this new paper was concocted by physicists cum Wall Street rocketeers; I wonder how many of them studied sigmoid curves, predator-prey equations and catastrophe theory? [What's going to happen to the derivatives market if a three-sigma event were to occur? Nobody is prepared for the extreme scenario, this was the topic of one of Easy Al's speeches a few months ago. If such an event were to happen, nobody is really sure how the derivatives market would react or whether it would be able to handle such an event.]

Velocity of money. Today, $trillions are shuttled around the globe on a daily basis, computers and the internet have taken the place of the old electromechanical ticker tapes. [Many people think that a crash can't occur now because there is so much more transparency in the financial markets and a rapid dissemination of information. The markets are now a lot more efficient and no longer susceptible to a panic, they say. However, my opinion is that the rapid dissemination of information will make the panic even more severe. During the mania of the 1920's, National City (a very big bank at the time) opened over a thousand local offices. At the time, this was considered to be promoting the "democratization" of the market, which is the same line that the online brokerage firms tout today. The numerous local offices of National City helped spread the panic of 1929, as word spread very quickly of the events happening in NYC. Can you imagine the Yahoo boards on the day of the crash?] This has been a boon for IPOs, a new record of a nearly 1000% gain was recently posted in a few hours by a .com. The flip side (and I haven't seen this mentioned anywhere) is the potential speed and violence of a crash when greed is eclipsed by panic, circuit breakers and shock absorbers not withstanding. A busy signal might come to engender the kind of reaction in ex-daytraders that airplane engines did to victims of the London bombing. [Okay, maybe a busy signal isn't comparable to the London bombing, but I think a lot of people underestimate the difficulty they will have trying to sell when the panic does occur, especially through online brokers. It wouldn't surprise me to see the Internet suffer some of the most severe outages in its history on the day of the panic.]

The US was a net creditor in 1929, today it is a net debtor. [This is true. It won't make a damn bit of difference to the stock market in the short-run (the months after the crash), but it will have long-term consequences to the economy (the decade after the crash).] This trend has been accelerating- today foreigners hold around 2/3 of US T-bills [I've heard 40% foreign ownership of US treasuries and 8% foreign ownership of US equities] and other instruments. If (when) the stock market crashes, it may cause a devaluation in the dollar (this might take a few months or even a few years), making the holders of outstanding debt anxious to convert it into something else. [Although the media often talk about the siginificance of the Yen-Dollar exchange rate with respect to Japanese corporate profits and their nascent recovery, I think the bigger issue is what the Japanese are going to do with all their US treasury holdings if the exchange rate moves against them.] This would create a positive feedback loop, driving the dollar (and perhaps all the fiat currencies) into hyperinflation.

So this presents an interesting problem, which I have not seen addressed at all: how to manage the unwinding of this multiplicity of exposed positions insuch a way as to minimize the damage to the world economy? Presumably the Fed, the ECB, BOJ, etc. have some sort of war games rooms where they do such scenario planning, but they haven't been talking about it, besides, their objectives may be different.

Some say we face a deflationary era, as with Japan, others say the above will lead to (hyper)inflation as the US attempts to bail everybody out, including themselves. [It's funny that people talk about deflation or hyperinfation as being equally probable events, even though they are completely opposite, and very rare, events. I used to be in the deflation camp, but now I'm shifting to the hyperinflation camp. I still haven't made up my mind. On one hand, I think that too much capacity has been built into the economy, which would cause deflation. On the other hand, I expect all the dollars that foreigners have been holding will be dumped into the currency markets at some point in the future, which would cause hyperinflation. I'm still trying to sort that out in my mind.] Many trillions of dollars have been created at the stroke of a mouse in the past few years (5-10 trillion?) by the Fed, these are currently circling overhead in the stratospheric reaches of the stock, derivatives and real estate markets. How and when these get turned into goods and services (aka wealth) will have an effect on the inflation rate. This seems a natural starting point for the model, as an American bear market is the imminent event and potential primer for all the rest. [One thing is for sure -- the business cycle is not dead. We haven't had a severe recession in so long that nobody factors one in any more. Judging by their lending habits, banks aren't prepared for a recession. Judging by their spending and borrowing habits, consumers aren't prepared for one. Judging by their capital spending, corporations aren't prepared for one. And judging by stock prices, investors aren't prepared for one.]

A few references:

US Stock Market Crash Index:
http://wwfn.com/crashupdate.html
This mechanical index went on Crash Alert (-10) status Dec 19.

Pictures of a Stock Market Mania:
http://www.cross-currents.net/charts.htm

William Fleckenstein, The Contrarian:
http://www.siliconinvestor.com/features/contrarian/rap/

http://www.gold-eagle.com/editorials.html
Interesting articles, grain of salt required.

http://www.intelligentwealth.com/
Interesting links.

Extraordinary Popular Delusions And The Madness Of Crowds
By Charles MacKay:
http://www.litrix.com/madraven/madne001.htm
The entire text of this 1841 classic is online.

[And can I add in "Devil Take the Hindmost" by Edward Chancellor? That is by far the most exhaustive and up-to-date history of bubbles and manias that I have ever read.]

--
Forrest Bishop
Manager,
Interworld Productions, LLC
Chairman,
Institute of Atomic-Scale Engineering
http://www.speakeasy.org/~forrestb