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Plunge Protection Team
Is It Real ... Does It Work?

by James A. Shepherd
of The Shepherd Investment Strategist,

a service of JASMTS, Inc.

There has been a lot of dialogue in recent times about the existence and purpose of the so called "Plunge Protection Team." Many have stated matter-of-factly that due to its existence, market collapses are a thing of the past. Since I have been asked about this issue many times in the last few months, I thought we should examine the facts and myths surrounding this matter.

First of all, in answer to the question of the existence of a facility to provide for orderly markets in the event of panic, the answer is yes, such a facility has been authorized by Executive order. This order was issued as a result of the findings surrounding the investigation of the causes of the crash of 1987. In the Federal Record, you will find the following Executive Order #12631. Its contents are rather self-explanatory, as you can see.

DATE: 03-18-88

31 -- Money and Finance
Working Group on Financial Markets

By virtue of the authority vested in me as President by the Constitution and laws of the United States of America, and in order to establish a Working Group on Financial Markets, it is hereby ordered as follows:

Section 1. Establishment.

(a) There is hereby established a Working Group on Financial Markets (Working Group). The Working Group shall be composed of:

(1) the Secretary of the Treasury, or his designee;

(2) the Chairman of the Board of Governors of the Federal Reserve System, or his designee;

(3) the Chairman of the Securities and Exchange Commission, or his designee; and

(4) the Chairman of the Commodity Futures Trading Commission, or her designee.

(b) The Secretary of the Treasury, or his designee, shall be the Chairman of the Working Group.

Sec. 2. Purposes and Functions. (a) Recognizing the goals of enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation"s financial markets and maintaining investor confidence, the Working Group shall identify and consider:

(1) the major issues raised by the numerous studies on the events in the financial markets surrounding October 19, 1987, and any of those recommendations that have the potential to achieve the goals noted above; and

(2) the actions, including governmental actions under existing laws and regulations (such as policy coordination and contingency planning), that are appropriate to carry out these recommendations.

(b) The Working Group shall consult, as appropriate, with representatives of the various exchanges, clearinghouses, self-regulatory bodies, and with major market participants to determine private sector solutions wherever possible.

(c) The Working Group shall report to the President initially within 60 days (and periodically thereafter) on its progress and, if appropriate, its views on any recommended legislative changes. Sec. 3. Administration. (a) The heads of Executive departments, agencies, and independent instrumentalities shall, to the extent permitted by law, provide the Working Group such information as it may require for the purpose of carrying out this Order.

(b) Members of the Working Group shall serve without additional compensation for their work on the Working Group.

(c) To the extent permitted by law and subject to the availability of funds therefore, the Department of the Treasury shall provide the Working Group with such administrative and support services as may be necessary for the performance of its functions.

The provisions of Executive Order 12631 of Mar. 18, 1988, appear at 53 FR 9421, 3 CFR, 1988 Comp., p. 559, unless otherwise noted.

The issue for us is not whether there exists the means and the desire to attempt to forestall a crash, the issue for us is whether or not it can be successful in every case since this would preclude our ability to profit from a stock market crash. There were three major selling events that culminated in a market turnaround in the two years following the market peak of 2000. In each of these events, it was rumored that the recovery that occurred as the market was plunging was sparked by massive buying in the S&P; 500 futures contract (allegedly by the PPT). Please observe the chart below of the DJIA with the three events identified.

NOTE: This chart is being shown as an example only and does not represent the frequent interventions that took place over the summer and fall of 2007; into the fall of 2008 and continuing in 2009.

As you can see, on Sept. 21, 2001 as the market was plunging after re-opening post-September 11, it managed a turnaround that marked the end of that selling event. We saw a fairly substantial rally thereafter, albeit one that we identified as not being the beginning of a new bull market as many had stated (our positions continued to present our best risk/reward). Volume that day, and this is very important, was just under 2 billion shares on the NYSE. As I have pointed out many times, on the day of the crash in 1987, volume nearly doubled from the previous record of just over 300 million shares to 604 million shares traded on the NYSE Oct. 19, 1987. That truly marked a selling climax.

On July 24, 2002, you can see that the DJIA made another turnaround after being substantially lower. Again this marked the beginning of another rally, though also one we said was not the beginning of a new bull market. Volume that day did set a record, at 2.8 billion shares, yet if this was truly a major event, occurring on record volume, why didn't the market keep going higher, as a new bull market was proclaimed by many? Why didn't this event mark an ultimate low? The answer is that we were and still are, in a primary bear market and this event was not the reversal of that environment. Furthermore, in my opinion, volume in the event of a true bottom in the stock market should be somewhere around 4 billion shares on the NYSE.

Now look at the most recent event,as depicted in the chart, Oct. 10, 2002. As is consistent with the previous two events, the market staged a recovery that day after being sharply lower initially. Volume on that day totaled just over 2 billion shares, far below the aforementioned record day of July 24, 2002. Again, this is not the activity you would want to see if you were looking for a real long-term bottom in the stock market.

But the question is, did some group buy heavily in the futures pits to stop the decline? Perhaps, but the main thing we have to remember is that, in my opinion, none of these events were truly of crash potential. Why? It was because we had not achieved critical mass readings, in the model at those times. So from my standpoint, we did not see a crash because the conditions were not right for a crash to occur. Only twice in the last 100 years have the conditions been right for a true crash, as measured by the model - in October 1929 and in October 1987. However, at present we are very close to such readings and it is my expectation that we will indeed get to critical mass sometime soon, though that is not guaranteed.

So yes, perhaps an organized effort did exist to stem the tide of selling in the periods we are looking at (and certainly took place in more recent times, especially in 2007 and 2008). But that does not mean the same efficacy will be seen when a true collapse begins. If we get to critical mass readings in the model, and true panic sets in, I do not believe it will be possible to stop the selling until the selling is exhausted in a normal fashion. Just remember that there are trillions of dollars in retirement and other types of funds that can be switched into cash equivalents at the click of a mouse or by a phone call. When that happens, as the average investor panics and decides to bail out of stocks, fund managers will have no choice but to sell more and more stocks in order to satisfy these redemptions or transfer requests. As that happens, stocks will cascade lower in the most massive collapse ever. The idea that the average investor will simply 'hold on' or 'stay the course' or 'look at the long term' is pure rubbish. The essence of human nature never changes and I am completely confident that when real selling gets started, investors will panic as they always have. We, having already established our plan of action, will be profiting from this inevitable outcome and will then be using our profits to buy up stocks at bargain basement prices when most others are convinced that stocks will never recover. This is the way the markets - whether stock or other types of markets - work. They always have and they always will work the same way because markets are controlled by people and people react at major turning points in the same manner. J.P. Morgan and others also tried to stop the collapse in 1929 with huge pools of money, to no avail. So too will any efforts be ineffectual when the selling really starts in the current timeframe.

Jim Shepherd
Jim Shepherd,
Founder and President

Combined household debt now totals a staggering $13 Trillion

The consumer now represents 70-80% of GDP (Personal Consumptions Expenditures), it doesn't take much reasoning to conclude that if debt has been expanded dramatically to allow for consumers to continue spend, when that ends (as it is now) it will mean trouble.

Jim Shepherd from a Newsletter in The Shepherd Investment Strategist
August 17, 2007