Are We Heading Towards Another Long-Term Capital Management Crisis?

The Dow slid 226 points on Tuesday - is that all there is? Sorry, a 1.6% move up or down in the context of how far we've come since 1982 is almost a non-starter.

I can't act like a screaming girl, and declare that a buying opportunity has materialized because we had a "panic" today. Panic? That's girly man talk when we're talking 1.6% dip. Words mean something to me, and the use of "Panic" to describe Tuesday's less than 2% market downturn is just plain a shoddy.

I sure was wrong about the narrow range I discussed on Monday night as the market sliced down through 1530s on the S&P like a Ginsu knife through iron plate, and suddenly finds itself in the 1511 range. That would leave me to guess that the 1490 is the next level of support to be tested in a further decline, if not 1500 first as a round number.

You've got to admit that the contagion worry is taking on a life of its own and beginning to snowball. My guess that 1530s would hold was a failure on my part to properly anticipate that high-yield yields would grab investors' attention as much as it did. Pimco's Gross, no doubt public enemy number one to the stock market bulls, did make some good points about the 150, or so basis points rise in the high yield corporate market. Sorry, that's reality in the CDX world and it's a problem that can't be ignored.

The market also has every right to worry about how the Chrysler (DCX) deal will be priced. I'll fall off my chair if the rumors of 800 points above LIBOR come true, but hey - this is the world we live where there is an opaqueness to what's going on in the credit markets and how things spill from one area to another and who's most exposed and levered.

I had a good chat with Hugh Johnson of Johnson Illington advisors late Tuesday afternoon. Hugh reminded me that there will be important existing homes sales data for release today. If the data can show some stabilization, Hugh thinks that will ease some market fears. He feels the same way about new homes data later in the week. Hugh also told me that he sees the likelihood that Q2 GDP will come in at close to 3% annualized when the number is reported Friday, and that would also help the market.

Hugh has been around for a long time, and I reminded him that the banking sector of today is not what it was back in the S&L crisis days when we went home one Friday afternoon, and wondered whether Citibank would be shut by regulators over that weekend. Hugh did talk to me about a number of crises going back to Silver Thursday, and the Hunt Brothers, and reminded me that contrary to the gloomiest of predictions during the crisis times, the market and economy ultimately rebounded and did not go into total meltdown.

Hugh even talked about the 1998 Long-Term Capital Management crisis which happened during August, and resulted in a large market swoon which eventually abated and led to strong gains in the fall of that year. Hugh said it's useful to look back at those episodes of angst to gain some perspective, though he also reminded that bad times can and do happen on Wall Street, and that if we are at the cusp of another rough time the markets will muddle through as they always have.

I also caught up with Stanley Nabi over a Silver Capital Partners. He was completely unimpressed with the contagion fears, calling it a "side show." Stanley is a guy who helps manage $8 bln these days, and has been around for a long time as well. He told me that the market was trading more on psychological driven momentum than fundamentals. He's in the camp that believes housing's woes are not going to tank the economy.

Michael Metz at Oppenheimer is another fellow I talked to on Tuesday, and one of his biggest gripes with this market are the unknowns that are associated with the world of hedge funds, and their leverage. And he's not just worried about mortgage related problems. Michael told me that with the recent rebound in the yen, it's looking as if some carry trade unwind is also going on, noting that during the last serious bout of unwinding, world stock markets took it on the chin back in late February, and early March. Mike told me that the "carry trade has long be one of the most successful strategies and that it has become overcrowded." Again, he complained that the carry trade, and associated leverage are opaque issues.

So we're dealing with some interesting two-edge sword dynamics. The things the bulls have loved - hot real estate, big income from derivatives from securitizing mortgages, the carry trade and money to be made off the leverage in that arena - are issues the bears can easily exploit as well to the peril of the bulls.

Whether it results in a 1998 LTCM-like crack remains to be seen. Stay tuned.

Comments

[emily x]

Michael Metz brings out a good point (as always) -- "the unknowns that are associated with the world of hedge funds, and their leverage." Large amt's of leverage, margin, whatever, goeth before a fall. How much of a fall is the question. But when you don't know how much leverage there really is, b/c hedge funds are under no obligation to tell anyone, that makes one nervous. Thanks for bringing it to our attention. PS -- words mean something to me, too, and the use of "screaming girl" and "girly man" is gratuitously sexist. It doesn't seem worthy of the rest of your analysis.

[wixeywaxy]

Unusually interesting article for this site. The hedge funds are an indictment of the SEC who is supposed to protect the public from just such risk by assuring that there is transparency in at least among the institutions that could make a major impact on the economy. We may never have a meltdown of the hedge fund industry but that isn't the point. We should have a window into it that prevents us being blind sided by an event that could undermine the values of all financial assets. Vic

[bhakta]

the USA is a sinking ship. The companies that are INTERNATIONAL will do well, those dependent on the USD alone will sink to the bottom. THE USD is a dead currency in a world where other countries do not over spend, do not attack without provocation and use their resources for their countries, instead of exhibiting military prowess on every continent. Ten years ago a USD bought 55 Thai Baht, today it buy between 30 and 33 depending on where you are shopping, ditto for every currency in the world; yet the Sec. of the Treasury says they want a SRONG DOLLAR! Who can believe this pack of liars?