Market's dive is just the start

By Bill Fleckenstein

For a change, this week I'm going to delve into stock-market machinations (both on the surface and behind the scenes) because I think they suggest we have reached a critical stage in the credit-unwinding process. My focus will be on Thursday's action.

Black cat crosses bulls' path

Before the open, stock-index futures were down about 1%-plus. Why was that important? Because in the last year or so, when we have seen an ugly session (like the one Tuesday), it's typically prompted an immediate rally -- if not the following day, then the day after that.

However, Wednesday's rally was pretty punk. Which is why I (and the bulls) thought there'd be another attempt the next day. The fact that the futures fell out of bed pre-opening was thus an indication that something was potentially very different.

As I checked all of my contacts in credit land, it quickly became clear to me that this was the source of the problem. One friend who watches the high-yield market said: "Credit is an unmitigated disaster this morning. Bonds down 2% to 3% across the board." In addition, the "Lord of the Dark Matter" confirmed that structured credit was really getting thumped, ditto all the leveraged indexes and the ABX credit stack. To quote him: "Mate, there is a massive margin call in structured credit and there are no marginal buyers for it."

40 lashes for leverage

All of the above matters, because (as I have noted repeatedly) the abuses that have been rampant in the structured-credit arena have kept the game going for longer than one could have expected.

With the credit market in shambles, I do not believe any new leveraged buyouts will be announced. And terms are being changed on those deals that are not locked down. At some point, I expect to see some deals canceled. But even if by some miracle the approximately $250 billion of deals in the pipeline get done, I would say that the concept of the LBO put -- which has powered the stock market for some time -- is toast.

In addition, if these money-center banks and brokers are unable to wriggle off the hook of some of the deals done at absurd terms, or if they're unable to syndicate the bonds (as we saw last week, vis-à-vis the KKR/Alliance Boots deal), you can be sure that the banks will scramble to reduce risk elsewhere, further exacerbating the credit-tightening process. Meanwhile, the brokers can only be considered at more risk now than they have been previously; in fact, the credit-default swap on brokers was widening early Thursday, which added to the pre-opening angst.

Thus, virtually every problem I've been discussing in the credit arena -- whether that be consumer credit, structured credit or junk debt -- is getting worse, and at a faster rate. That is not bullish for anything. However, at the very same time that's occurring (which the market is now beginning to recognize -- witness the action in financials of all flavors), there has been an absurd party happening in big-cap tech. That, as the OPM (other people's money) crowd assumes that if it's big, liquid and a tech stock, they can speculate there and make money while financial system implodes. (This activity makes those who bet on an inside-straight look smart.)

Ripening fruit on the tech vine

I'm keeping my eye on this activity for two reasons: (1) There's going to be a tremendous opportunity to short absurdly priced tech companies (which are largely run by managements that seem more focused on playing beat the number

and fiddling option programs than on conducting their businesses); and (2) When the stocks of those companies start sinking, I think it will be a sign that the market is ready to accelerate to the downside. Perhaps tech will be strong up until the day before the market dislocates. I don't know the timing, but as I have said repeatedly, the only thing of which I am 100% certain is that we will have a crash/dislocation.