Finuked: Where Are the Bunkers?

The markets were nuked - finuked, to be precise - by the FWMD (Financial Weapons of Mass Destruction, a.k.a derivatives) this week, and the brunt was borne by the Asian and European markets, which fell by 7 to 12% on Friday.

The emerging (or, as I heard someone say, submerging) markets were hit the hardest, with global investors running to the safety of 30 year US Treasury Bonds (which saw an yield as low as 3.7% on Friday) driving down the value of all emerging market currencies… Pound, Euro, Rupee, Real, Zloty, Peso, Forint…you name it. The Yen, however, stood out, moving to a 13 year high against USD, as the carry trade reversed full steam. This led to the Nikkei plunging 9.3%, given its export oriented economy. The plunge was aided by profit warnings and layoffs.

News of the UK’s GDP shrinking more than expected added fuel to the fire, as bourses across Europe were seen under tremendous selling pressure. The US futures (S&P500, Dow & NASDAQ) were limited down before the US exchanges opened and tje worst was feared. However, as usually happens, when such extreme expectations build up, the markets behave totally differently and most times exactly the opposite way. Thus, while the US markets were down, it was not catastrophic. This many players apparently did not like as they wanted the capitulation to happen. Most should know it never happens when you expect it.

IMF got active with its bailout product as a queue built up with Belarus, Pakistan, Hungary, Ukraine, Serbia etc. after Iceland agreed to an USD2 billion package. The fund, as I understand, has USD225 billion in assets and can help, but the pace with which the SOS is coming the fund will have its hands full soon. It is now expected that the submerging markets are going to take the baton from the developed world. Analyst fear that East Europe is the next place to watch, given the exposure Western European banks have and not forgetting Russia, Turkey, Argentina and South Korea which have their own problems. The emerging bond yields are on a five year high. And given that emerged markets are also submerged/submerging, it is not clear who will help whom!

There are no safe havens or hedges any more. Gold saw a plunge before recovering somewhat, as did oil despite a 1.5 million barrel per day cut announced by OPEC. Many hedge fund investors and large pension/life insurance funds seem to have run out of patience and are calling their money back. It’s a race out there as prices are plunging and everybody wants to beat the other to it.

The move from the denial to the acceptance mode has been swift and dramatic. It is estimated that the hedge fund industry has lost USD200 billion this year. The slight tightening of the money markets, as reflected by Libor, helped. Anyway, the transaction ticket size, as I understand, is so small (given the mistrust, uncertainty and the consequent risk aversion) that availability of such liquidity may not be material given the size of redemptions/margin calls.

Reflecting this confused state was CBOE VIX, which hit an all-time high of 89.5 but improved to about 79. Now talk of many insurance companies requesting to be included in the bail out is going to add more uncertainty. AIG’s (AIG) dollar burn rate has been higher than expected and it is reported that more funds may be required than what has been provided for. Questions are being raised about the sufficiency of bail out funds for banks as the imminent deep recession might cause default in the core loan assets (as against treasury holdings). The assets and inventory against which such lending was done would also have fallen in value dramatically, and more importantly so swiftly that the banks may not have had the time to assess the level of margin calls to be made on these. This explains the aversion to lend further as the banks need to evaluate the present asset cover to lend further. With demand destruction and falling inventory value the companies may not be easily able to find the cash need to roll on.

So what does an investor do? Streetwise is talking about (after analysis of) dividend yields, book values, cash on book, replacement costs etc. and above all the high fear factor as a good reason to buy. These values in today’s environment are as uncertain as the predicting wind direction a year or two ahead. The market today, as I mentioned in a previous post, is like a cancer patient in the ICU (unlike with the flu, diabetes etc., where known remedies/treatments are available) being treated by world renowned specialists (governments/central banks). It is easy to start treatment for such a critical patient, but ending it is never easy. While the main disease itself can spread, as the treatment progress lots of collateral damages happen and then these need to be addressed while progressing with the core treatment. This is tough and the results are not certain. It would be better first to see the patient out of the ICU and then take a view as to how far and how quickly he can progress. So much for market mortality!

Right now there are no bunkers to this attack. If you are exposed, you can do very little. If you did shelter yourself with some foresight (by being in cash), stay there and do not come out. You will require it to ride it out. If you have excess cash – say, which can see through a generation – then maybe you can take the risk of some exposure – the Warren Buffett way. If things do work out in the next 3 to 5 years in your favor, you may be able to see another two generations through! For others, it is caveat emptor.

Comments

[anarchist:]

What!, no "this is the bottom" articles at S-A this weekend, hmmm, maybe this is the bottom?

2008 Oct 26 12:42 PM

[Al-USA:]

Very informative article. A good read.

2008 Oct 26 02:03 PM

[BxCapricorn:]

Thank goodness none of this is actually happening. If it was, this would be the end of:
- overseas investments
- the global economy
- emerging markets
- immigration
- acceptance of free-market capitalism and democracy by the rest of the world.
- cable, boutique coffee, space exploration, most restaurant chains, infrastructure build-outs, charitable contributions, and on and on it goes.

While it would also signify the start of:
- protectionism
- re-emergence of unions
- global socialism
- local interests over all others, and on and on....

This is a seminal moment in World History.

2008 Oct 26 02:34 PM

[copperpenny:]

The operation was a success but the patient died.

2008 Oct 26 03:32 PM

[Moon Kil Woong:]

Blood Pressure 320/180, Pulse 70 and dropping, temperature 120, symptoms massive weight loss, cold chills, and schizophrenia with the patient screaming for food but can not eat. Bloated stomach that is unable to send nutrients to the rest of the body. Lack of neural activity either caused by a lack of a brain or one that has been lobotomized too many times.

Recommendation: Clear out the hall and start sanitation. It appears to be a new contagious plague. It makes the Fed into bald socialist megalomaniacs and the President is unable answer any questions.

2008 Oct 26 11:08 PM

[vbierschwale:]

Didnt Warren Buffett a few years back said that he had great concerns about derivatives because there was no telling how much they would effect everything ?

Virgil
www.KeepAmericaAtWork....

2008 Oct 27 08:27 AM

[notsosmart:]

the anal opening for lending is blocked.invest in prunes

2008 Oct 27 11:33 AM