Money Game

Foreigners Are Piling Into Japanese Stocks In A Way They Haven't Done In Years [CHART]

Joe Weisenthal — Fri, 24 May 2013 01:32:46 GMT

The gyrations of the last two days aside, here's a good representation of how the Japan trade is captivating the global investing class.

Michael McDonough of BloombergBriefs.com tweets this photo which really drives home how much money has come in this year vs. recent years.

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O'ROURKE: The Last Two Days Have Shown That Central Banks Have Gotten Ridiculous And Have Blown Their Credibility

Joe Weisenthal — Fri, 24 May 2013 00:25:37 GMT

Mike O'Rourke of JonesTrading wales on the various Fed Heads and the Bank of Japan for having created a ridiculous situation where the entire market is just obsessed with every utterance from central bank chiefs, sucking away the oxygen from the real issues that should actually be driving markets.

He writes in this evening's note that the events of the last two days are damning:

Losing Credibility.

Earlier this month we highlighted comments Chairman Bernanke made a decade ago ... “I worry about the effects on the long-run stability and efficiency of our financial system if the Fed attempts to substitute its judgments for those of the market. Such a regime would only increase the unhealthy tendency of investors to pay more attention to rumors about policymakers' attitudes than to the economic fundamentals that by rights should determine the allocation of capital.” The events of the past two days (both here and in Japan) confirm this is the environment we are in. The situation has become so ridiculous that San Francisco Fed President John Williams had to assure the market that the Fed could increase purchases if the economy has weakened once tapering commenced. This stems from the Bullard application of QE - using QE in the same manner as the Fed Funds rate. Although the FOMC has adopted it, the Fed Chairman has done an awful job of communicating it. In any event, it is pathetic if the Fed needs to promise the next round of additional easing before the current easing has even slowed. It gives the impression that markets would simply be happier with a centrally planned economy. The reason that none of the FOMC members can give any inkling of when tapering will start is because they can’t quantify the benefits of it. In other words, they don’t know the effects of what they are doing, they just know they need to keep doing it.

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Japan Is Now Soaring 3.3% After Yesterday's Huge Crash

Joe Weisenthal — Fri, 24 May 2013 00:15:00 GMT

After yesterday's stunning 7% crash, the Nikkei is rebounding. In initially the gain was just 1.7%, which is now huge.

But now it's up 3.3%, which means it's recouped a pretty decent chunk of the losses.

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Charles Schwab: Investors Will Benefit From A 'More Cyclical Stance'

Mamta Badkar — Thu, 23 May 2013 21:16:00 GMT

FA Insights is a daily newsletter from Business Insider that delivers the top news and commentary for financial advisors.

Tactical Investors Will Benefit From A 'More Cyclical Stance' (Charles Schwab)

Some people have spoken of a different Great Rotation – not from bonds to equities, but from defensive to cyclical sectors within the equity market. Now, Brad Sorensen at the Schwab Center for Financial Research says they are moving to a "more cyclical stance."

"We are moving our rating on the consumer discretionary sector to marketperform from underperform and moving industrials to outperform from marketperform. Conversely, we are dropping the ratings of both the utilities and consumer staples sectors to underperform from marketperform.

"…While defensive have surprisingly led much of the rally to this point, valuations appear stretched to us and the move seems to be getting a little long in the tooth. In fact, even in a potential overall market correction scenario, we believe it's quite possible that the traditional defensive groups get hit worse than the cyclical that would traditionally bare the brunt of the decline, due to the run seen in the former group. Therefore, we believe tactical investors would benefit from these moves in both a further market rally, which is what we think is more likely, and in a near-term pullback, which is certainly a possibility."

Investors Should Fear These Three Things More Than Fed Tapering (Yahoo Finance)

Fed "tapering" shouldn't be the biggest concern for investors, according to Michael Santoli at Yahoo Finance. He says there are three things that are more worrisome than the Fed:

1. "Another economic soft patch." 2. "A financial accident." Rates on high yield bonds are at record lows and demand for these has been strong. "This combination raises the prospect of bouts of volatility causing some unforeseen rupture in the capital markets." 3. "A sense of invincibility. …Should nothing come along soon to knock back investor expectations or cause the markets to correct lower, then the main thing to fear will be fearlessness itself."

"The Bond Sell-Off: It’s For Real" (Goldman Sachs)

In the past couple of weeks, U.S. Treasuries have seen a big sell-off. Goldman Sachs writes of this time, "The Bond Sell-Off: It's For Real." Francesco Garzarelli and Silvia Ardagna at Goldman say that investors have got too pessimistic on global growth, which has stunted the rise in yields, and that the bond market has been reacting more and more to economic data ever since the Fed said it would use certain economic data as a threshold to determine its interest rate policy.

"Our model estimates (and, consistently, our forecasts) show 10-year Treasuries reaching 2.5% in the second half of this year, with German Bunds trading at 1.75%."

Investors "Anchor" Their Market Performance Predictions And This Reflects Their Bias (Sovereign Man)

James Montier's Behavioral Investing draws on two recent findings by neuroscientists that applies to investors. 1. Humans think short-term, not long-term. 2. Humans also conform to herd mentality. Montier also argues that humans have a tendency to "anchor" their calls or expectations on market returns to recent events or trends, and that this reflects their bias.

Six Brokers From Morgan Stanley And Wells Fargo Join Merrill Lynch (The Wall Street Journal)

Six financial advisors have joined Merrill Lynch from Wells Fargo and Morgan Stanley. Together they manage over $600 million in client assets.

Michael Dolle joined Merrill Lynch in Winter Park, Florida, from Wells Fargo. Le Minsk joined Merrill's office in Short Hills, New Jersey, from Wells Fargo. Peter Benington, Steven Benington, and Steven Cross joined Merrill's East Lansing, Michigan office from Morgan Stanley's Wealth Management unit. Finally, Conrad Branson joined Merrill's Mill Valley, California office from Morgan Stanley.

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STOCKS STAGE REMARKABLE COMEBACK: Here's What You Need To Know

Matthew Boesler — Thu, 23 May 2013 20:00:00 GMT

Nikkei plunge versus good U.S. economic data puts markets in a tug of war.

First, the scoreboard:

Dow: 15,296.88, -10.29, (-0.07%)
S&P 500: 1,650.73, -4.62, (-0.28%)
Nasdaq: 3,459.34, -3.96, (-0.11%)

And now, the top stories:

The 7.3% plunge in the Japanese Nikkei 225 stock index overnight really set the tone for global markets this morning. Before New York markets opened, stock futures were down 1%. European PMI data were slightly better than expected, but still pointed to a deep recession in the eurozone. Of course, this comes as no surprise, but it certainly didn't do anything to help counter the effects of the Japan sell-off.
Initial jobless claims, out at 8:30 AM ET this morning, fell to 340,000 in the week ended May 18 after spiking to 360,000 the week before. The data release beat economists' predictions for a smaller drop in initial claims to 345,000.
Right at the opening bell at 9:30 AM, shares of American Electric Power and Nextera Energy – two major electricity utilities, experienced a flash crash, each plunging more than 50% over the course of just two seconds.
U.S. flash PMI (out at 8:58 AM) and the FHFA house price index (out at 9) both beat economists' consensus estimates as well. However, it wasn't until the release of April home sales data at 10 AM – which also beat estimates – that the market started heading higher.
An unexpected rise into positive territory for the Kansas City Fed's monthly manufacturing conditions index at 11 AM coincided with the beginning of another up-move in U.S. stocks.
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CHART OF THE DAY: The Japanese Nikkei's Historic Plunge In Context

Matthew Boesler — Thu, 23 May 2013 19:09:00 GMT

Overnight, the Japanese Nikkei 225 stock index plummeted 7.3%. It was the worst single-day loss on the index since the Fukushima nuclear disaster two years ago.

Even still, given how fast Japanese stocks have risen recently, that only takes the index back to the levels it was at on May 9.

The general sense is that traders rushing into the Nikkei recently have been doing so in a highly-levered fashion. (That's hedge fund manager Kyle Bass's take. Nomura currency strategist Jens Nordvig agrees, as does Société Générale strategist Sebastien Galy.)

"I would argue that the move is more about position squeeze than a broader macro concern," says Nordvig.

"More broadly the carry trade built up over the past few months is unwinding as VaR management systems kick in with higher volatility, expect rising margin calls and the likes," says Galy.

The bloodbath may be over for now – Nikkei futures are currently up 0.1% from the last close as of 2 PM ET.

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Why There Was An Insane Flash Crash In Utilities Stocks At The Opening Bell

Linette Lopez — Thu, 23 May 2013 19:09:00 GMT

When markets opening in New York City this morning, shares of American Electric Power and Nextera Energy, two big electric utilities trading on the NYSE, took a complete nosedive.

American Power briefly plunged 54%, and Nextera Energy plunged 62% — the question is why.

To figure out what caused this crash, Business Insider reached out to Eric Hunsader, founder of Nanex, a research firm that compiles and analyzes market data.

First thing's first, it's important to realize that this morning was the morning after a Fed announcement. Hunsader said that since utility stocks are impacted by moves in interest rates, it's likely that traders were repositioning themselves based on Bernanke's comments.

The problem is that as they were all rushing to sell, there weren't enough buyers.

"It just so happened that this morning there was no liquidity and that sector just got killed," said Hunsader.

Now the question, then, is why hasn't this happened before?

The explanation for that lies in regulation. The NYSE used to use a measure called the Liquidity Replenishment Point (LRP) to stop crashes like this. Basically, when an order goes in and removes a lot of liquidity in stock, the NYSE slows down trading so liquidity can trickle back in.

However, after the 2010 flash crash, regulators decided to make the NYSE dump LRPs and put them in line with the crash preventing measures other exchanges were using. NYSE objected, saying their way was better for investors, but they lost out on that one.

In place of LRP, and as a pilot for one year, NYSE adopted the Limit-Up Limit-Down (LULD) system last month.

With LULD, essentially, trading in a stock will halt for five minutes if the price of a stock suddenly moves up or down 5%-10% compared to the average price for the last five minutes. It's 5% for S&P and large cap stocks, 10% for small stocks.

Ideally, price bands should double at the open and the close, since volatility is more likely.

The problem is that, until August, LULD isn't going to be implemented for the first 15 minutes of the trading day, and the last 30 minutes of the trading day at all.

And that's just one thing according to Hunsader. The real problem, he said, is that creating price bands isn't enough. It's too confusing, and liquidity is gone faster than people think.

"It's not going to take care of 99% of what we [Nanex] see," he said.

And what Nanex sees are 2-3% drops in stocks all the time — mini flash crashes that pop stocks (even large cap stocks) up and down with little explanation.

Usually, the market just keeps on moving, but that may not always be the case. In this case, American Electric Power and Nextera Energy are huge companies witha combined market cap of $60 billion (thereabouts), so they (in turn) dragged down the entire utilities sector.

It wasn't during the Flash Crash — which is exactly the scenario that regulators are trying to prevent.

"It's going to be a nightmare when we have a big market move and a lot of stocks trip, because no one will know when to stop them," he continued. "We would like to know if the SEC tested this LULD regulation on Flash Crash data."

That would be a good thing to know indeed.

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NYSE Trader Explains How Indices Work And Why They Are So Important

Daniel Goodman — Thu, 23 May 2013 17:43:00 GMT

A stock index is a basket of stocks that helps investors keep track of the market, its fluctuations and its trends.

The S&P 500, Dow Jones Industrial Average (DJIA), and Russell 2000 are some of the popular indices financial experts are looking at to get a gauge of the markets.

Watch below NYSE floor trader Jonathan Corpina, a senior managing partner at Meridian Equity Partners, Inc., explain how indices work and what the key differences between major indices are:

Produced by Daniel Goodman

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Kyle Bass Helped Cost The University Of Texas Millions Of Dollars, And It's Hilarious That He's Attacking 'Macro Tourists'

Joe Weisenthal — Thu, 23 May 2013 16:53:00 GMT

Back in April 2011, hedge fund manager Kyle Bass advised the University of Texas (disclosure: my Alma Mater) on taking delivery of nearly $1 billion worth of gold bars.

Now that bet has gone sour.

WSJ's Gregory Zuckerman reports:

Gold's slump has saddled the second-largest U.S. college endowment with more than $300 million in paper losses. But the swoon hasn't shaken the faith of Bruce Zimmerman, who since 2007 has been chief executive of University of Texas Investment Management Co.

"We always prefer that our assets go up, rather than down, but we're not day traders," said Mr. Zimmerman, whose company invests $29.5 billion for the benefit of the University of Texas and Texas A&M systems. "Gold is a hedge, and it still fills that role."

Meanwhile, Kyle Bass continues to make his multi-year argument that Japan is going to blow up. And after last night's 7% decline he slammed "Macro Tourists" as being behind the selloff.

This is utterly hilarious.

"Macro Tourists" is a phrase that was coined by former policy economist and global macro trader Mark Dow to characterize investors who left their comfort zone to make big pronouncements about how macroeconomics really works.

Kyle Bass's expertise is in private credit, mortgages, and so forth. He recently unveiled an intriguing contrarian bet on a phone book company. This stuff is his wheelhouse. He's been famously incorrect on Japan blowing up, and his arguments about a "Keynesian endpoint" is a made-up phrase.

So in other words, the term Macro Tourist was originally coined to describe an investor like Bass going from private credit to global economics and sovereign debt. Now slamming other people about this? Hilarious.

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KYLE BASS: The 'Macro Tourists' Are Responsible For Last Night's Big Plunge In Japan

Matthew Boesler — Thu, 23 May 2013 16:11:03 GMT

At the beginning of April, Kyle Bass went on CNBC and slammed the "macro tourists" that were driving up Japanese stock prices.

Note: The term "macro tourist" refers to someone who is not a traditional macro expert stepping out of one's comfort zone to make big bets based on one's own (often flawed) notion of economics.

Today, Bass blames the macro tourists for the historic 7.3% plunge in the Nikkei 225 last night.

Here's what he had to say on CNBC just now:

When you look at Japan, it looks to me like their industry has been hollowed out over the last 15 years, analogous to the U.S. manufacturing business getting hollowed out in the late 70s and 80s.

They've been exporting jobs overseas because of the strengthening yen. So, I think the weakening yen – if you look at the balance of trade data from the Ministry of Finance, you see exports moving up about 5% year over year, but imports moving up about 3-3.5% – they still have a balance of payments deficit even after the yen has [weakened] materially from its [highs].

I don't think that it's the panacea that equity investors think it is.

I think that the people that have bought into the Nikkei – I refer to them as macro tourists – I think they are renting the stocks. They're not really owning them. And that's why you see movements like you see today.

As we noted earlier, given how highly leveraged the Japan trade has been, some have been waiting for a big unwind.

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Dow Erases 120 Point Loss, Turns Green For A Second

Sam Ro — Thu, 23 May 2013 15:55:00 GMT

It's been a wild day in the markets.

After trading down by 120 points earlier this morning, the Dow has rallied and even turned green briefly.

Unfortunately, the same couldn't be said about Europe, which closed at its lows of the day.

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Europe Had A Horrific Day

Sam Ro — Thu, 23 May 2013 15:35:00 GMT

European markets just closed after experiencing a brutal sell-off.

England's FTSE fell 1.9%.

France's CAC 40 fell 2.1%

Germany's DAX tumbled 2.1%

Spain's IBEX fell 1.7%

Italy's FTSE MIB tanked 2.6%.

A string of Flash PMI reports across Europe improved, but still came in below the 50-level. This suggests that Europe's manufacturing and services industries are still contracting.

On Wednesday, Federal Reserve Chairman Ben Bernanke told the Joint Economic Committee of Congress that the Fed could start tapering its quantitative easing (QE) program during one of its next few FOMC meetings depending on economic data. QE is one of the Fed's economic stimulus programs, which is intended to lower interest rates through bond purchases.

"Markets fear musical chairs may have started," said UBS's Art Cashin. "Bernanke must bring back some sense of certainty or… If bulls can regain momentum, they may claim invincibility."

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GOLDMAN: 'The Bond Sell-Off: It’s For Real'

Matthew Boesler — Thu, 23 May 2013 15:30:00 GMT

U.S. Treasury yields bottomed out in July 2012 after three decades of a steady grind lower.

Since then, they have had their ups and downs, but eventually, the yield on the 10-year U.S. Treasury hit a high of 2.06% on March 11, right before the financial crisis in Cyprus blew up and the consensus began to shift its focus to fears over an emerging slowdown in global growth.

That backdrop set the stage for a big rally in Treasuries as investors piled back into them, sending yields all the way down to 1.63% on May 2.

In the last three weeks, however, yields have reversed violently as investors have sold bonds and are once again testing the post-low highs set in early March.

And this time, Goldman Sachs says the bond market sell-off is for real (in a note to clients titled "The Bond Sell-Off: It’s For Real").

"Our bond valuation models (Sudoku and GS Curve) and a separate study of the determinants of US Treasury yields which explicitly accounts for the impact of QE, policy ‘guidance’, uncertainty and the European crisis indicate that intermediate yields should be trading in the upper half of this range, given the decline in systemic risks and the brightening US economic outlook," write Goldman's Francesco Garzarelli and Silvia Ardagna in the note. "Our model estimates (and, consistently, our forecasts) show 10-year Treasuries reaching 2.5% in the second half of this year, with German Bunds trading at 1.75%."

Garzarelli and Ardagna make two assertions central to their case that this time is for real: (1) investors just turned too pessimistic on global growth, halting the previous rise in yields, and (2) the bond market has become more responsive to economic data since the Federal Reserve tied its interest rate policy to specific economic data thresholds in late 2012.

Here is their argument:

We relate the recent sell-off in yields to a shift in expectations that had turned too pessimistic. As we argued in the April issue of our Fixed Income Monthly, 10-year government bond valuations in the major markets had departed from their macro underpinnings in a statistically meaningful way, and the likelihood of a sharp correction had therefore increased. A stronger-than-expected payrolls report acted as a catalyst, compensating for a string of moderately underwhelming economic data (our US MAP score, which compares realizations to economists’ forecasts, improved in May).

More broadly, we find evidence that the US bond market returned to being more responsive to incoming economic information in comparison to the case in the second half of last year (to illustrate, the chart below plots the regression line between the US Map scores and changes in Treasury yields around the data releases). We ascribe this movement to a shift in the Fed’s reaction function. In the second half of 2012, the Fed’s forward guidance on the future path of the policy rate was linked to a specific calendar date. The introduction of ‘macroeconomic thresholds’ in the Fed’s policy guidance last December led investors to focus again on data developments. In this context, we note that market forecasts for 2013 US growth have now clustered around 2%, and that the downside risks have been revised down materially (see chart below).

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US Markets Are Making A Stunning Comeback

Sam Ro — Thu, 23 May 2013 15:19:00 GMT

Markets around the world are in the red today.

U.S. markets were down over 0.9% earlier today, but have since recovered some of those losses in the wake of a string of good economic news.

The S&P is now down just 0.3%.

However, Europe is still near its lows of the day.

England's FTSE is down 2.1%.

France's CAC 40 is down 2.5%.

Germany's DAX is down 2.7%.

Spain's IBEX is down 1.9%.

Italy's FTSE MIB is down 2.8%.

This follows sell-offs across Asia. Japan's Nikkei fell by a stunning 7.3%.

Over in China, the Flash Manufacturing PMI unexpectedly plunged to 49.6 from 50.4 a month ago. A reading below 50 represents contraction, and this is the first sub-50 reading in seven months.

Eurozone, German, and French Flash PMI numbers all showed improvement in May, however, all of the numbers continued to be under 50.

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BLANKFEIN: Don't Worry, Goldman Isn't Giving Up On China Yet

Linette Lopez — Thu, 23 May 2013 15:14:00 GMT

Last night's bad PMI number seems to have been the tipping point in a recent build up of bad Chinese data that came in last month. This morning, the Nikkei fell by 7.3%, and markets around Europe are down as well.

News from Goldman Sachs earlier this week probably didn't help either. The bank exited the massive investment it made in the Industrial and Commercial Bank of China back in 2006. It was made even before ICBC became the 2nd biggest IPO in history. The stock, though volatile to say the least, is up 57.1% since that year.

So, even though Goldman has sold off pieces of its stake in ICBC five times since it 2010, with all this bad news coming out about China, it's hard not to ask — why now? Does Goldman buy the China bear argument that the increasing cost of credit in the country will cripple growth?

Goldman Sachs CEO Lloyd Blankfein was on Bloomberg TV this morning giving a firm answer amidst all the chaos.

Here's what he told anchor Erik Schatzker:

"Well, first of all, catch the wave when it comes-- I don't know if you've been watching but there has been a wave and it's been going on for quite some time. It may be interrupted. ICBC, again, is not the key to our interest in China or the big reflection of it. ICBC was an investment we made at a time when China was taking its banking system public and was looking for partners-- really, kind of quasi-strategic partner-- to help-- not only provide investment capital but also expertise. And so they wanted firms like ourselves. And there were other financial institutions that partnered with other banks. And so we ended up holding that investment for a while. But through that investment we became very close with important people in the banking system. And we maintain that relationship today. We're investing in China because China-- I was going to say it's the future-- but it's a big part of the present as well."

Blankfein went on to say that Goldman would be happy to make an ICBC sized investment again, but the time would have to be right.

Does that calm anyone's nerves?

Watch the full interview below:

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Weimaresque Hyperinflation Is Ravaging One Of The World's Most Popular Video Games

Peter C. Earle — Thu, 23 May 2013 15:09:00 GMT

As virtual fantasy worlds go, Blizzard Entertainment’s Diablo 3 is particularly foreboding.

In this multiplayer online game played by millions, witch doctors, demon hunters, and other character types duke it out in a war between angels and demons in a dark world called Sanctuary.

The world is reminiscent of Judeo-Christian notions of hell: fire and brimstone, with the added fantasy elements of supernatural combat waged with magic and divine weaponry. And within a fairly straightforward gaming framework, virtual “gold” is used as currency for purchasing weapons and repairing battle damage. Over time, virtual gold can be used to purchase ever-more resources for confronting ever-more dangerous foes.

But in the last few months, various outposts in that world — Silver City and New Tristram, to name two — have borne more in common with real world places like Harare, Zimbabwe in 2007 or Berlin in 1923 than with Dante’s Inferno. A culmination of a series of unanticipated circumstances — and, finally, a most unfortunate programming bug — has over the last few weeks produced a new and unforeseen dimension of hellishness within Diablo 3: hyperinflation.

Austrian Economics and Inflation

In casual use, the term “inflation” is used in conjunction with price increases. From the perspective of the Austrian School of economics, though, that phenomenon is a secondary effect of increases in the money supply. As Henry Hazlitt wrote,

When the supply of money increase[s], people have more money to offer for goods. … Each individual dollar becomes less valuable because there are more dollars. Therefore more of them will be offered against, say, a pair of shoes or a hundred bushels of wheat than before. A “price” is an exchange ratio between a dollar and a unit of goods. When people have more dollars … [goods] rise in price, not because [they] are scarcer than before, but because dollars are more abundant. [1]

Furthermore, inflation is not simply an increase in the supply of money within an economy; it is the increase in that portion (if any) not backed by a commensurate increase in specie: most common in history, market commodities like gold or silver. Thus fiat currencies are, unless tightly controlled as to the amounts being created versus being destroyed (with the latter typically only occurring due to wear), notably susceptible to inflation.

As virtual currencies are digitally-created and not commodity-backed — therefore, not particularly dissimilar from real world currencies in this day and age — those such as Diablo 3’s gold are de factofiat currencies.

Sinks, Faucets, and Inflation

In virtual economies, the primary instruments used to control the money supply are “faucets” and “sinks.” Faucets are ways through which game currency is injected into the game. This generally involve players receiving currency from the game system itself, as opposed to other players. In such situations, the received currency is created anew. Sinks are ways through which game currency is removed from the game. This generally involve players paying currency into the game system itself, as opposed to other players. In such situations, the paid currency is destroyed. [2]

Examples of faucets and sinks in Diablo 3 are included below:

Faucets

Drops — When a player defeats a foe, they often receive a reward of virtual gold or a good saleable into virtual gold;
Rewards — The game involves the player undertaking “Acts,” and within each act are a number of “quests.” For completing these, players are typically awarded virtual gold;
Buyers — Players can sell items to “in-game” (computerized, non-human) buyers, receiving virtual gold.

Sinks

Repairs — Over time, a player’s equipment will become damaged in combat and suffers wear-and-tear, requiring periodic restoration from an in-game craftsman in exchange for virtual gold;
Forging — Players pay virtual gold to an in-game blacksmith for weapons;
Rakes — Using the gold auction house costs players both a listing fee and a transaction fee, removing virtual gold from the economy;
Consumables — Players can purchase potions, scrolls, and other items from vendors for virtual gold.

Diablo 3 was rolled out in May 2012, and there seem to have been early concerns among players that gold sinks within the game were insufficient. One site noted,

[M]ost of us (probably including Blizzard) assumed that the Blacksmith would be widely used — he was, after all, the only major gold sink in the game … but dropped items alone selling in the [auction house] have been enough to satiate the appetite [of players] and crafting is … a waste of [gold] when one could easily buy an optimal item from the [auction house] rather than pumping 50 to 170K of gold into [a Blacksmith-crafted weapon.] [3]

The establishment by Blizzard of a real money auction house (“RMAH”) alongside a virtual gold auction house in the game provided players with an incentive to both farm the game for real world profits and to pursue arbitrage opportunities. The RMAH was also created, at least in part, to disincentivize players from patronizing third party markets outside the game. Nevertheless, bots — automated game participants whose sole purpose is to farm the game world for items to sell — quickly emerged.

Although its anonymity may make it subject to skepticism, several weeks after the game’s debut a source claimed that there were at least 1,000 bots active 24/7 in the Diablo 3 game world, allegedly “harvesting” (producing) 4 million virtual gold per hour. [4]

Most of the gold generated by the ruthlessly productive, rapidly adapting bots found its way to third party vendors in a black market which undercut the prices in the sanctioned, in-game auction houses.

The combined effect of heavy bot activity and insufficient sinks immediately impacted the gold markets, and inflationary pressures were soon apparent. An exasperated player complained in August 2012:

I purchased most of my gear for around 5 mil [gold] early on. I’ve been farming for awhile [and] have saved around 30 million gold [but now] I can’t upgrade the gear I have ... Where is all this money coming from? Why is everything so expensive? [5]

And as in real world economies, the price effects of money inflation often arise unevenly. With gold prices falling, prices began spiking in certain goods. Another player noted with curiosity

[Y]esterday Fiery Brimstone was 150K, now almost 300K. Each time I hit refresh it seems to be going up a bit[.] [6]

Gold Floors vs. Black Markets

The RMAH had minimum and maximum dollar amounts for in-game gold transactions: $0.25 minimum, $250 maximum. Market participants were also limited to dealing in increments of a certain size, called a “stack.” The “stack” was initially set to 100K gold. But as gold prices fell owing to rapidly building supply, the stack size was changed in August 2012 to 1 million. This practice, known as redenomination, is a fairly standard (if cosmetic) method of addressing inflation, but was viewed by some players as tacit devaluation. [7]

If you’re changing the [price] of gold from 0.25 per 100,000 to .25 per 1,000,000 I would like to cancel my gold auctions before you do that. You’re completely shifting the market in less than a day, and those of us that have auctions listed that will be affected by this change cannot cancel them until after the patch hits, which is potentially too late. [8]

To be clear, at the time at which the redenomination was introduced, gold was still trading above the floor rate. But being artificial, caps and floors not only prevent markets from clearing, but give black markets a target to undercut, to say nothing of offering players an opportunity to avoid the 15 percent fee — another intended gold sink — levied upon transactions within the auction house.

Another player predicted,

[T]his [change] will likely have 2 effects … [it] could kill the private 3rd party market for gold and hopefully discourage botting … [but] because the real money price of gold is decreasing on the RMAH … [g]old will become cheaper as botters flood the market in an attempt to unload their massive surplus of gold before it becomes absolutely worthless. … This decision will further destabilize the economy [as in the gold auction house] prices shoot from 100,000 gold to 1,000,000 gold … [or] 10,000,000 gold to 100,000,000 gold. … The same would happen if the [Federal Reserve] decided to suddenly release a flood of currency into the U.S. economy[.] [9]

By early 2013, the gold price had fallen to the exchange floor set by the game managers — $0.25/million — and players began to show signs of concern. One asked,

[Are] there any plans of lowering the floor of gold[?] … It has been at .25 for about 2 weeks now … should I sell my gold now before it gets lowered? [10]

A Delirium of Stacks

Hyperinflation is the economist’s equivalent of an astrophysicist’s quasar cluster or a marine biologist’s dolphin “stampede”: a rare exhibition of a unique set of circumstances which arise infrequently and are closely studied when they materialize. Such events are exotic enough that they become legendary: many individuals knowing little about monetary policy are aware of the recent outbreak in Zimbabwe, or familiar with the defining instance in the post-WWI Weimar Republic.

Economically, the tipping point in the transformation of inflation into hyperinflation is characterized by a profound drop in the outstanding demand for money: when holders of money expect the supply of money to increase — particularly without any sense of timing, bounds, or other guidance — monetary demand in the present drops in favor of surrendering money for vendibles.

The focus of possessors of money, therefore, devolves into an effort to capture known, present purchasing power against the likelihood of its decline in the near future. Saving, in any event, delaying consumption, is chastened; and if a cycle of declining purchasing power and rapidly rising prices ensues, ultimately the propensity to hold money declines precipitously and may fundamentally disappear.

This was demonstrated when, in a message board entry prefaced by stating “Sell Equipment before Patch 1.0.5 Hits!” (a patch is a piece of software added to an operational program or application as bugs are found, changes desired, or ways of improving performance discovered), a player warned that,

Blizzard just announced that the drop rates for [certain] items are going to be doubled … if you haven’t already, you should consider converting your current gear to cash … since real $ [are] the best hedge against gold devaluation[.] [11]

If historical cases of hyperinflation — real, and now virtual — have one thing in common, it is the instinct among its victims to blame the symptoms rather than the disease. The Austrian economist Hans Sennholz noted that during the German hyperinflation, “intrigue and artifice” were believed to be at work. [12] Similarly, a handful of Diablo 3 players, frustrated about the decimation of their purchasing power, expressed increasing suspicion of manipulation and conspiracy theories.

[W]hy [are] certain items priced [s]o astronomically high? Many of them are not even that good yet cost 100’s of millions of gold. … I have about 45,000,000 gold saved up [and] check every few days to see if I can get any upgrades that are worth the gold, but … everything is vastly overpriced … clearly controlled by the gold sellers. [13]

And, predictably, any number of baleful remedies were proposed. [14]

While RMAH prices for virtual gold rallied occasionally, the prevailing direction of black market prices for virtual gold was inexorably lower as third party sellers undercut the in-game gold floor. In February 2013, Patch 1.0.7 was rolled out, introducing a range of new gold sinks intended to sop up ever-increasing virtual gold; they included new weapons and items not eligible for sale on the RMAH. One month later, with gold prices continuing to decline, a player made the following diagnosis:

[A]dditional gold sinks [are] unfortunately comparable to spitting on a fire ... [they] do nothing to limit the core issue which is that players are earning gold faster than they [want] to spend it. Repairing is not a … good gold sink as it works best [for] players who are [dying]. … Crafting is the same, works well on players who can get the items to craft with … but leaves players with limited gold supply out of the picture. … The amount of gold that drops … needs to be nerfed, and not softly. [15]

The effort appears to have been futile, as the growth of the virtual gold supply continued to grow.

Several competing definitions for hyperinflation exist, with the strictest — an increase of 50 percent in one month — defined by economist Philip Cagan in his 1956 book The Monetary Dynamics of Hyperinflation. [16] By his definition, the Diablo 3 economy appears to have entered hyperinflation between February and March of 2013, when the black market price of gold fell from $0.20/million to $0.05/million — a decline of over 75 percent in a few weeks. [17]

At around that time, a player commented that he was

watching the markets collapse and gold become worthless. … So you feel rich that you have a billion or two in gold[?] … [W]ell guess what, you aren’t … there is nothing you can invest in to hold value. The only thing worth anything has become $$$. [18]

With a sardonic irony that markets sometimes display, real world currencies had assumed the role of commodity gold, and virtual gold had gone the way of all flesh and fiat currencies.

This, however, was still only the penultimate stage. On May 7th 8th, 2013, Blizzard rolled out Patch 1.0.8, which contained the seeds of the last, hyperbolic surge of gold superabundance. One change was the altering of the gold stack size from 1 million to 10 million per $0.25: a simultaneous redenomination and 90 percent devaluation (sitting, as the price was, at the RMAH floor) of virtual gold, targeting black market rates of roughly 4 cents per 10 million. In addition, a bug within the patch allowed users to cancel transactions in the auction house before completion, essentially allowing them to double their gold on demand. [19]

In just a few hours, the already gold-swamped economy saw trillions more created: a mammoth deluge of, by then, worthless virtual gold chasing finite goods, driving prices upward in leaps and bounds. It was, at last, the hyperbolic blow-off characteristic of real world hyperinflationary episodes. Some of the price increases (in Diablo 3 gold) are shown below:

	2013 avg price	1-6 May avg price	7-8 May price
radiant star amethyst	17.4M	41.2M	85.8M
radiant square ruby	187K	260K	337K
flawless square topaz	491	5,170	8,700
star emerald	764K	1.1M	1.6M
tome of jewelcrafting	694	3,400	3,100

And in a noteworthy departure from real world hyperinflation, rather than resorting to barter (which frequently takes the form of food for skilled labor), as runaway inflation became hyperinflation, many chat channels — through which some measure of trade was consummated — seem to have fallen empty: without a need to eat or clothe oneself in the virtual world, some players simply appear to have turned away. [20]

Aftermath

Blizzard quickly closed the in-game auction houses and audited transactions which took place during the blowout, banning players who took advantage of the bug and donating the proceeds of certain sales to charity. The gold stack size was also moved back from 10M to 1M. One week later, on May 15th, the above-cited items were quoted at the following, approximate virtual gold prices: radiant star amethyst, 26.1M; radiant square ruby, 375K; flawless square topaz, 8,600; star emerald, 797K; tome of jewelcrafting, 1,350.

In May of 2012, the price of virtual gold was approximately $30/100,000 or $0.0003/gold. [21] As this article was completed — and bearing in mind that these prices may be erroneous, stale, or merely indications of interest — one site showed Diablo 3 gold being offered by four third party sellers at an average price of $1.09/20M, or $0.0000000545/gold: one ten-thousandth its market price one year earlier. [22] In the RMAH, virtual gold was priced at $0.39/1M.

Remembering that game economies are private and players are voluntary members, there’s no explicit mandate to ensure rigid inflation control as one often sees (however rarely pursued) in public economies. That said, knowing that gaming experiences can be upended by economic missteps, there is a clear business interest for gaming firms in keeping virtual currencies and the greater economies as a whole stable.

Frequently, hyperinflationary episodes have ended by substituting a currency outside the political and central banking control of a nation for the sovereign currency. During the early 1990s, during Serbia’s hyperinflation,

[t]he authorities could not print enough cash to keep up. On Jan 6th, 1994, the dinar officially collapsed. The government declared the German mark legal tender … [which] end[ed] the hyperinflation. [23]

Two obvious solutions for managers of virtual economies include more vigilant bot restrictions and close — indeed, real-time — monitoring of faucet output, sink absorption, prices, and user behaviors. More critically, though, whether structured as auctions or exchanges, markets must be allowed to operate freely, without caps, floors, or other artificialities. Unrestricted (real) cash auctions would for the most part preempt and obviate black markets. [24]

One also surmises, considering the level of planning that goes into designing and maintaining virtual gaming environments, that some measure of statistical monitoring and/or econometric modeling must have been applied toDiablo 3’s game world. The Austrian School has long warned of the arrogance and naïveté intrinsic to applying rigid, quantitative measures to the deductive study of human actions. Indeed; if a small, straightforward economy generating detailed, timely economic data for its managers can careen so completely aslant in a matter of months, should anyone be surprised when the performance of central banks consistently breeds results which are either ineffective or destabilizing?

By no means does this analysis intend to equate the actions of virtual gaming firms with the policies of governments or central banks, or to malign their indisputably talented managers, designers, and programmers. While their actions may ultimately generate similar outcomes, central planners seek and wield power whereas the actions of commercial gaming interests are undertaken to compete with other online entertainment providers by delicately balancing opportunities for newer players with the need to continually challenge experienced players.

By all accounts Diablo 3 is a great game; one hopes that with this episode passed, it will reacquire its former glory. But while decision-makers at online gaming firms can and should be forgiven for not anticipating the perilous and unpredictable torsions of rapidly expanding money supplies, the events of the last week provide a stark reminder of the power and inescapability of the laws of economics.

[Editor's Note: What would be the best multiplayer video game monetary system? Should there be a fixed amount of in-game money? Should the only source of new money be “mining,” à la Bitcoin? Should there be no designated in-game money at all, so as to allow a market-selected money to arise via the barter of in-game commodities? Sound off in the comments!]

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KANSAS CITY FED MANUFACTURING UNEXPECTEDLY TURNS POSITIVE

Matthew Boesler — Thu, 23 May 2013 15:00:00 GMT

UPDATE: The Kansas City Fed's latest report on regional manufacturing conditions is out.

The headline index unexpectedly turned positive, climbing to +2 from -5 last month.

Economists predicted a slighter rise to -4.

Any reading above 0 on the index indicates expansionary conditions, so this is good news.

Below is the full text from the release:

Tenth District manufacturing activity improved somewhat, rising above zero for the first time in seven months, and producers’ expectations for future activity also increased. Most price indexes recorded little changes from the previous month. The month-over-month composite index was 2 in May, up from -5 in both April and March (Tables 1 & 2, Chart).

The composite index is an average of the production, new orders, employment, supplier delivery time, and raw materials inventory indexes. The rise in production came from both durable and non-durable goods-producing plants, with the biggest increase coming from machinery and metals manufacturing. Other month-over-month indexes were mixed. The production index edged up from 1 to 5, and the shipments, new orders, and new orders for export indexes also rose. In contrast, the employment index fell from -3 to -7, while the order backlog index was unchanged. The raw materials inventory index rebounded from -17 to 0, and the finished goods inventory index moved slightly higher.

The majority of year-over-year factory indexes improved somewhat in May. The composite year-over-year index increased from -6 to 0, and the production,shipments, and new orders indexes also rose. The capital expenditures index rebounded from 7 to 11 after falling last month, while the order backlog and employment indexes were basically unchanged. The new orders for exports index climbed higher after reaching its lowest level in nearly four years last month. Both inventory indexes improved modestly.

Most future factory indexes rebounded after falling last month. The future composite index increased from 4 to 11, and the future production, shipments, and new order indexesimproved markedly after posting four-year lowslast month. The future order backlog index edged up, and the future capital expenditure index posted considerable gains. In contrast, the future employment index was unchanged, while the future new orders for exports indexes eased slightly. The raw materials inventory index rose from -7 to 1, and the finished goods inventory index also moved higher.

Most price indexes remained stable from the previous month. The month-over-month raw materials price index was unchanged at 7, while the finished goods price index edged down to its lowest level since July 2010. The year-overyear raw materials and finished goods price indexes moved slightly lower. The future raw materials price index inched higher from 38 to 41, while the future finished goods price index eased somewhat, indicating fewer firms plan to pass recent cost increases through to customers.

Here is what the survey respondents are saying:

“We are attempting price increases, although the market does not support them. Fuel cost is of increasing concern to recovery.”
“We are working at leveraging available technologies to improve efficiencies to keep our expenses under control.”
“We are not managing any differently than in the past. We do not expect large price increases in the coming year as there is still a lot of unused capacity in the economy. We do eventually expect significant inflation as capacity utilization increases, but this looks to be a year or two away given current growth trends.”
“Reductions in force have taken place over the past several months to lower cost of production in response to increases in cost of raw materials and lower selling prices.”
“Trying to pass on material cost increases to customers with significant push-back from them. We are planning more low cost automation in production.”
“We are implementing further business excellence programs and further empowering the shop floor to increase our competitive edge.”
“Customers comment upon the uncertainty of future health care costs and federal taxes. Both issues are creating too much uncertainty for many companies to spend discretionary dollars.”
“We had a better month last month, but it was still very much lower than we should be this time of the year.”
“We have initiated price increases that will take effect July 1. We are finding alternative products to offer to our customers that will replace what they are using now.”

Click here for the full release >

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Tesla Repays Its Government Loan 9 Years Early

Ben Klayman — Thu, 23 May 2013 14:59:00 GMT

DETROIT (Reuters) - Electric carmaker Tesla Motors Inc. on Wednesday paid off its U.S. Department of Energy loan nine years earlier than required, using money raised last week in a stock and debt offering.

The automaker said on Wednesday that it wired $451.8 million to repay the full loan with interest.

"I would like to thank the Department of Energy and the members of Congress and their staffs that worked hard to create the (Advanced Technology Vehicle Manufacturing) program, and particularly the American taxpayer from whom these funds originate," Tesla Chief Executive Elon Musk said in a statement. "I hope we did you proud."

Republicans have criticized the Obama administration's support of new-technology companies, including struggling automaker Fisker Automotive Inc, as well as electric battery maker A123 Systems and solar panel maker Solyndra. Both A123 and Solyndra filed for bankruptcy.

DOE officials heralded the Tesla payoff in a press release.

"When you're talking about cutting-edge clean energy technologies, not every investment will succeed - but today's repayment is the latest indication that the Energy Department's portfolio of more than 30 loans is delivering big results for the American economy while costing far less than anticipated," U.S. Energy Secretary Ernest Monizsaid.

Moniz said more than 90 percent of the loan loss reserve Congress established remains intact, while losses represent about 2 percent of the overall $34 billion portfolio.

DOE first offered loans to Tesla and other automakers in June 2009, when the companies could not arrange financing through public markets during the recession.

The DOE's $465 million loan, received in 2010, allowed Tesla to open its plant in Fremont, California, and build the Model S electric car, which recently received a near-perfect score from Consumer Reports magazine and starts at $70,000 before a federal tax credit.

The payoff was more good news for a company that reported its first quarterly profit earlier this month.

Musk, a billionaire who owns 27.5 percent of Tesla, said on Monday that the company would repay the loan.

Tesla was funded privately through its first seven years after its 2003 founding, and it received the DOE loan as part of the advanced technology vehicle manufacturing program.

After making payments last year and the first quarter of this year, Tesla said it repaid the balance of its loan using a portion of the almost $1 billion raised last week in stock and notes offerings.

(Editing by Dan Grebler and Matthew Lewis)

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ART CASHIN: 'Markets Fear Musical Chairs May Have Started'

Sam Ro — Thu, 23 May 2013 14:58:00 GMT

The U.S. stock markets are open, and they are in the red.

Europe is doing even worse. Asia, which has been closed for a few hours, saw Japan's Nikkei plunged a horrific 7.3%.

This comes after a disappointing Chinese PMI report, which suggested manufacturing activity was actually contracting.

Europe and Asia are also catching up with Fed Chairman Ben Bernanke, who told us yesterday that they could start tightening monetary policy within the next few months.

Bernanke has some people worried that changes made by the Fed could cause money rotate out of the stock and bond markets.

Perhaps, this is what's going on today.

Here' UBS's Art Cashin:

Overnight Volatility – What happened in the U.S. looked to have a somewhat muted impact in Tokyo. Japanese stocks opened higher and then fell through their own trapdoor.

China's Purchasing Managers Index fell to 49.6. Not only was that the first full drop in seven months, it moved the number into recessionary territory (China? Recession?). The Nikkei plunged 9% (1400 Dow points) from the high to down 7.3% (1100 Dow points). The yield on the JGB ten year shot above 1% (that's nearly 200% since the BOJ went aggressive).

The plunge in Japan, right on the back of the sharp U.S. reversal, has a sea of red ink flowing around the globe. Bond pits are especially nervous.

Consensus – A big surprise in claims could shake things up. Markets fear musical chairs may have started. Bernanke must bring back some sense of certainty or….. If bulls can regain momentum, they may claim invincibility. May you live in interesting times. Stay very, very nimble and have a great Memorial Day Weekend!

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Here's The Main Reason People Think The Chinese Economy Is Screwed

Mamta Badkar — Thu, 23 May 2013 14:35:25 GMT

Bearish sentiment on China has returned. Recent economic data has disappointed markets and last night's HSBC Flash PMI showed that manufacturing contracted for the first time in seven months.

Remember, while China has been trying to rebalance its economy towards domestic consumption, it is still largely driven by investment and exports.

But "the main bear story for China," according to CLSA's Christopher Wood is that it "is taking more and more credit growth in China to deliver less economic growth."

Wood says that this argument only grew legs with the release of the latest total social financing (TSF) data. TSF includes trust loans, entrusted loans, FX loans, bankers’ acceptance bills, corporate bonds, and non-financial stock sales. This was up a whopping 81% on the year to 1.75 trillion yuan, but down from 2.54 trillion yuan the previous month.

In the first four months of the year, TSF was up 63% on the year to 7.91 trillion yuan. From Wood:

"The increase in social financing data relates to the increase in the volume of such activity. The annualized growth in terms of the overall aggregate is harder to calculate since the PBOC has only issued social financing data since 2002. Still an estimate would suggest that in aggregate terms social financing outstanding is growing at an annualized rate of around 22%. This is clearly still well above nominal GDP growth of 9.6% YoY."

"This raises another issue. That is that growth rates of China credit have been bordering on the scary since the massive 2009 infrastructure stimulus prompted by the Lehman bust and the related collapse in Chinese export growth. Thus, aggregate social financing outstanding, which remember includes bank lending, has soared from an estimated 121% of GDP in 2008 to 192% of GDP in April. Another way of looking at this, as highlighted to GREED & fear by one contact, is that the Rmb64.4tn surge in social financing since 2009 is equivalent to 14% of 2012 world nominal GDP."

Deutsche Bank's John Horner also shared the sentiment. He recently wrote that more weak data out of China showed that "heighten concerns of a 'broken' Chinese growth dynamic that is no longer responding to rapid credit expansion."

So the two concerns stemming from this are 1. The Chinese central bank is running out of ways to help bolster growth. 2. The Chinese economy is "long addicted to debt-financed investment-driven growth," according to Wood and needs to rebalance.

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The Two Big Winners Today Are Gold And Apple

Joe Weisenthal — Thu, 23 May 2013 14:27:43 GMT

Markets are falling (although the US is not as bad as it was earlier).

The big winners so far: Gold and Apple.

We've explained a lot in the past about why gold and Apple move together, but the basic gist is that both represent asset classes in their own right that are uncorrelated with overall market moves.

Anyway, here's a chart showing how GLD and Apple are outperforming stocks.

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Utility Stocks Flash Crash At The Opening Bell (AEP, NEE)

Matthew Boesler — Thu, 23 May 2013 14:11:00 GMT

This morning, when New York markets opened at 9:30 AM, shares of American Electric Power and Nextera Energy, two big electric utilities, briefly plunged 54% and 62% respectively.

Both companies are in the S&P 500, and the flash crash brought the utilities sub-sector of the index down nearly 8% overall.

The massive moves resulted in a trading halt in shares of both companies.

Now, AEP is only down 1.5%, and NEE is down 1.8%.

The charts below, via Nanex, show how the two stocks completely melted down over the course of only two seconds.

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Where In The World Is Bitcoin Creator Satoshi Nakamoto? [CHART]

Joe Weisenthal — Thu, 23 May 2013 14:06:00 GMT

Last weekend, internet pioneer Ted Nelson speculated that the creator of Bitcoin (who goes by the pseudonym Satoshi Nakamoto) was actually Japanese math professor Shinichi Mochizuki.

This was the latest theory in an extremely long hunt by various researchers and journalists trying to identify Nakamoto.

Hilary Sargent at Chartgirl has put together a monster chart detailing all of the endeavors to find Nakomoto, and the various conjecturs that have been put forth about them.

Click the chart to see a full, large version in all its detail and splendor. Note that some points on the chart are satirical.

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BEAT: New Home Sales Rise 2.3% (ITB, XHB)

Mamta Badkar — Thu, 23 May 2013 14:02:00 GMT

New home sales climbed 2.3% month-over-month (MoM) to 454,000.

This beat expectations for a 1.9% rise to 425,000.

March figures were revised up to show a 3.5% rise to 444,000, from 1.5% to 417,000.

The median sales price was $271,600, and the average sales price was $330,800.

Supply of homes continued to stay tight with new homes for sale at the end of April totaling 156,000 or 4.1 months supply at the current sales pace.

Economists watch the new home sales number to get an insight into housing supply, because tight supply helps support home prices. It also reflects the health of the American consumer.

Yesterday, we saw existing home sales rise 0.6%, missing expectations. But the silver lining in the report was that distressed sales accounted for a smaller portion of overall sales.

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It's Time To Have An Adult Conversation About What's Going On In The Market Right Now

Joshua Brown — Thu, 23 May 2013 14:00:00 GMT

Welcome to the rest of 2013.

I certainly hope you've made some money in the first five months of the year (which was not hard to have done), because the environment seems to be changing.

Before I continue, I want to remind you that this is a forecast-free blog, we only discuss what is happening and our thoughts on possibilities for the future. If you want a man to predict the future and tell you what to do, you'll find no shortage of that sort of thing elsewhere.

Okay, just us adults here now...

Here's where we stand - heading into yesterday the S&P 500, Dow Jones and Russell 2000 had been in a three-way race to outdo each other in the record highs department. All three had been relentlessly ripping to greater heights throughout the spring and just about every sector and sub-sector had joined the rally by early April.

When we didn't get the traditional Sell in May pullback that so many had been ~~positioned~~ praying for, things just went parabolic for a week or so. Large cap pharmas like Bristol and Lilly began putting up dotcom-esque gains, highly speculative solar stocks began populating the most active lists and hedge funds took their short-squeezing, options-chasing activities into overdrive.

And then before you knew it, everyone was on the same side of the boat again.

What had begun as a gentle, if relentless rally up the side of a Wall of Worry had gotten too easy and the latecomers began making up for lost time. When one shows up to a party after everyone's already been there for two hours, a few quick shots of tequila are just the thing to "get on everyone's level". Goldman Sachs had joined a host of other Wall Street firms in raising their price targets for the S&P after playing catch-up for months - this week they went to 2100 for 2015, which could well have marked the highs for the year.

While we had not quite been at euphoria yet as I've discussed, we were probably headed there - multiples were expanding and people began talking reckless. Jeremy Siegel ripped his shirt off and beat his chest on Squawk the other morning while the permabears had mostly flipped bullish. Stocks were missing earnings and rallying on increased dividend and buyback announcements and a feeling of invincibility began to descend. A week ago I had wondered if this was as good as it gets.

And at just this moment - right as we thought we might escape the summer swoons of the past three years - Fear rang the doorbell.

Jon Hilsenrath's Fed hints of last week had the effect of strengthening the dollar and pushing bonds around a bit but stocks had been unaffected. That is, until Bernanke's testimony yesterday in front of a joint session of Congress while the minutes from late April hit the wire. Then we printed yesterday's "red candle" day, an enormous outside reversal - the likes of which we hadn't seen since February. And this was not just any reversal, but a reversal from a new intraday high on the S&P.

The very frightening statistic that's been making the rounds overnight is that the last two times the S&P 500 touched a record intraday high and then closed down more than 1% from that high were October 11, 2007 and March 24, 2000, the last two major tops for the market, both of which occurred before historic crashes.

Compounding this reintroduction of fear into the US market is the Asian sell-off that's unfolding as we speak. Having rallied 70% since November, the Nikkei is currently in the midst of its 11th worst day since 1950, down over 5% overnight as JGB yields unexpectedly spike. One of the side effects of the finance minister being hellbent on creating inflation is that, well, bonds are not going to sell quite as well at auction once it's agreed that they'll be money-losers. A lousy bond auction combined with the contractionary Chinese manufacturing PMI was all the region needed to be thrown into an uproar.

Turning back to the US, Dow futures are currently off 140 points as I write. Now what?

On average, going back as far as we have stock market data, history suggests that we get an average of three 5% pullbacks each year, one 10% correction each year and a 20% sell-off every three-and-a-half years. The fact that we haven't had so much as three or more down days linked together since December of 2012 and nary a 2% decline year-to-date, I suppose the optimal thing would be to go lower and get that out of the way. The predominant bear case of late has been the absence of a correction and the overbought readings of every sector.

A quick trip down to 1600 on the S&P (formerly resistance, now support) would remove that very valid complaint and set up a new leg higher without the current exhaustion.

A rally back and then failure today will strengthen the idea that a short-term top is in and we'll spend the summer playing guessing games about the Fed's next move while stocks correct or tread water. I don't see a problem with that provided it doesn't get out of hand. Given the underlying strength in housing, the improving employment trends (that matter more than anything) and the continuing problem of T.I.N.A., it's hard to see equities going bidless for very long.

In my view, a resumption of the rally from here led by a thinning herd of advancers would actually be the worst thing that could happen. I'd much prefer the cool-off.

And then, heaven forbid, the US economic data actually improves to the point where the Fed can actually take its foot off the gas - well, why would anyone be unhappy about that if it happened later this year?

There was one thing Jon Hilsenrath did say in my interview with him on TV last night that I think is very important and clears up a big misconception. He explained that Bernanke himself will not be using the term "taper" that everyone else is bandying about. The reason why is that the Fed does not want to create the impression that one policy move will necessarily be attached to three or four others. In other words, suppose the Fed were to drop its rate of monthly asset purchases from $85 billion to some less number in one of the next meetings. This could be a one-off action with nothing else behind it, designed to temper the market's expectations and gauge the effects.

I'd remind you that what Bernanke, as a self-styled "student of the Depression" fears the most, is a premature tightening a la FDR in 1937-1938, just as the nation was finally on the mend. If think that this central bank, which has just spent the last six years patiently reflating the economy, is about to yank the rug out from under it at the last moment, then you haven't been paying attention.

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