Why Is Eastman Kodak’s Bankruptcy Important?

The graph below represents the price of Eastman Kodak stock since January 3rd, 2012. The spike to over 80¢ per share occurred on news that the company might be filing for Chapter 11 bankruptcy. The bars indicate the volume of trading.

So why would the price of this stock double on the possibility of bankruptcy? Whatever the reasons, Eastman Kodak has filed for bankruptcy and pre-market trading is now 39¢ a share. There is an important lesson in this news: financial ignorance, greed and manipulation impact the price of stocks. If we apply the same principles to the entire stock market, add the low volume of trading, the hoarding of cash by investors and world economic news, then the stock market should be in a meltdown.

The except below from Zerohedge explains a “melt-up stock market”. If their analysis from January 16th is correct, it will not be a slow economic decline. Eastman Kodak and MF Global are showing us the future of the stock market.

David DeGerolamo

A Useful Fiction: Everybody Loves A Melt-Up Stock Market

A sudden sharp decline in stocks may not thrill retail investors, but it would be catnip for big trading desks that used the melt-up rally to get short.

One of the more useful Wall Street fictions is the naive notion that big players and small-fry equity owners alike love low-volatility “melt-up” markets that slowly creep higher on low volume. The less attractive reality is that big trading desks find low-volatility “melt-up” markets useful for one thing: to sucker retail buyers and less-adept fund managers into an increasingly vulnerable market.

Beyond that utility, low-volatility “melt-up” markets are of little value to big trading desks for the simple reason that there is no way to outperform in markets that lack volatility. The retail crowd may love a market that slowly gains 4% for the year, barely budging for months, but such a market is anathema to big traders.

It’s always useful to ask cui bono–to whose benefit? In this case, highly volatile markets don’t benefit clueless retail equities owners, as they are constantly whipsawed out of “sure-thing” positions.

From the big trading desk point of view, this whipsawing provides essential liquidity, as retail traders and inept fund managers trying to follow the wild swings up and down provide buyers.

I have a funny feeling the “smart money” has built up a nice short position here and as a result the market is about to “unexpectedly” decline sharply. The ideal scenario for big trading desks here is a sudden decline that panics complacent retail traders and managers into selling (or leaving their stops in to get hit).

Then, a few days later, as the carnage deepens, presto-magico, the big traders become buyers and the sudden decline ends.

Frankly, the market is looking like it’s ready for a “surprise” decline. Various sentiment indicators are suggesting massive, widespread complacency–not bullish euphoria, but bullish complacency that reflects the general belief that the European Central Bank and the Federal Reserve have “fixed” the European credit crisis, and they have the power and will to “backstop” any market decline.

The most telling evidence of this is the VIX volatility index has declined for months and reached a level that typically reflects strong bull markets and widespread confidence. Yet there is abundant evidence that the global economy has rapidly decelerated and is now contracting.

This is only one widening divergence that historic precedence suggests will be settled with violent increases in volatility and sharp “unexpected” declines.

As noted here many times in 2011, “the only trade that matters” is the DXY dollar index, as stocks have long been on a see-saw with the dollar: when the dollar rises, stocks decline, and vice versa. Yet for the past three weeks, stocks have risen along with the the dollar.

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