Saturday, July 19, 2008

Read between the lines in the NY Times

In today's

Private jet sales slow:

But manufacturers at the Farnborough International Airshow said this week that they were seeing signs that private jet sales in the American market were beginning to soften.

The economy has downshifted:

Even to many economists who recently thought the gloom was overblown, the situation looks grim.... Job losses will probably accelerate through this year and into 2009, and the job market will probably stay weak even longer. Home prices will probably keep falling, shrinking household wealth and eroding spending power.

Even the Hamptons charity circuit is hurting:

Along the East End of Long Island, fund-raising is down at benefits, and charities are worrying about their futures.

SO who wants to buy stocks? The bulls are cowered, but the bears overplayed their hand by excessive shorting. Thus, the Feds want to force them to cover with their new short selling rules.

And just like higher oil prices have caused the greatest transfer of wealth the world has ever seen, there is a level that these prices cause to much pain in the world's economies. And the backlash starts.

It's the same with stocks. The bears have extracted tremendous sums of money from the bulls. But now the collateral damage is becoming too great. 401K's now have a two handle. Pension costs are rising as actuarial assumptions aren't getting met. The banking system is in tatters. And the public's idea of a safe investment is turning out to be a mattress.

So why be bullish? Because this reminds me of all the Hong Kong stock and currency crisis in 1998. But let me get back to today's NY Times:

More than two years ago, Nouriel Roubini, an economist at the Stern School of Business at New York University, said that the housing bubble would give way to a financial crisis and a recession. He was widely dismissed as an attention-seeking Chicken Little. Now, Mr. Roubini says the worst is yet to come, because the account-squaring has so far been confined mostly to bad mortgages, leaving other areas remaining — credit cards, auto loans, corporate and municipal debt.

Mr. Roubini says the cost of the financial system’s losses could reach $2 trillion. Even if it’s closer to $1 trillion, he adds, “we’re not even a third of the way there.”

Roubini, and two others wrote a great paper on how hedge funds manipulative trading practices excaberated financial conditions in emerging markets, and specifically that role it played in the 95 Mexican Peso crisis, the Thai baht in 97, the Korean Won in 97, the Malaysian Ringgit in 98, the Hong Kong stock and currency crisis in 98, and the Russia and Brazil contagion later that year.

Here's a few excerpts:

Yet, market power stemming from size, reputation, and ability to leverage, may give large players a unique role in affecting market dynamics with destabilizing consequences...

most of the crisis episodes considered in this study unfolded against the backdrop of deteriorating macroeconomic fundamentals, policy uncertainties, and structural weaknesses..

fundamentals is positive but weak, the speculative firepower of a large investor may be sufficient to force a devaluation...

large players may not just lead to short-term, high-frequency excess volatility of exchange rates and other asset prices, but also to persistent and destabilizing deviations of asset prices from their equilibrium values, with negative effects on real economic activity.

presence infl­uences the equilibrium portfolio strategies in the market as a whole, especially when the large trader has more precise information. We may reasonably expect this in­fluence to increase further if the large trader is given the opportunity to let the market learn her positions and/or information.

Which is precisely what Bill Ackman wanted to happen when he was on CNBC last week. He had shorted Fannie and Freddie Mac common and debt, and then told viewers how he had "devised" a plan for the GSE's whereby shareholders would get nothing, and debt holders would take a price haircut. All in the "interest" of attempting to "solve" the housing crisis, while enriching himself.

Instead, by letting people know her portfolio position, she may increase the probability that her strategy be successful.

Through her in­fluence on the trigger strategies of small traders, the large investor induces some herding in the market: for a given distribution of private signals, her position affects the number of agents taking the same side of the market...

In this case, the strategy is to profit from the panic they have attempted to induce, and we had every daytrader in the world mimicking the "smart" money that was short the financials.

Instead, those short got crushed. Ackman's interview was at the low for the market's financials. His "tag team partner," Meredith Whitney slammed Wachovia, increasing market hysteria.

And we found a bottom in the banks.

The Dallas Fed has a nice little report about the Asian financial crisis, and how Hong Kong was able to get out of the Catch 22 situation that it had found itself in.

During the Asian financial crisis, speculators exploited this interest rate predictability. They took short positions in the Hong Kong stock and stock futures markets. At the same time, they sold borrowed Hong Kong dollars against the U.S. dollar. Under the currency board,the HKMA stood ready to buy back Hong Kong dollars. And herein lies the dilemma under the currency board. On the one hand, continued buyback shrank the monetary base and drove the short term interest rate up sharply, arresting the outflow of U.S. dollars in defending the currency board. On the other hand, overnight interest rate upsurges—300 percent at one point in October 1997— triggered precipitous drops in stock and stock futures prices, producing hefty profits for short-sellers. After every attack, market confidence plummeted.

Hong Kong intervened . They bought stock futures that popped the index 20% and imposed currency controls. The intellectuals warned us that this would be disastrous. It wasn't, and the crisis ended. The bears went away. And the Hong Kong government doubled their money in the stock futures in less than three years.

The Feds' instituted short sale restrictions on the stocks of the GSE's and the primary dealers, that promptly caused the greatest short squeeze in financial stocks that we have ever seen.

Already the complaining is starting--We are interfering with free markets. But are we? If the shortsellers were following the rules, would we of had such a huge rally?

A specific minority, wants bearish things to happen to help them benefit financially. But what's the greater good for all people? In retrospect, the HKMA's intervention was the greater good, as their market was being destroyed by shortsellers.

Here the same thing was happening. But instead of destroying penny stocks, they went after the banking system. Find a weakness, and exploit it. Do it on a massive scale. Tell people your strategy, and panic the marginal seller until even the most seasoned participant panicked.

These players in the financial system used all the techniques that Mr. Roubini wrote about in his working paper "The Role of Larger Players in a Currency Crisis" but instead of going after a country's currency, they went after our nation's banks.

We've had banks that made stupid loans, and hid their losses as Level 3 assets. They've paid themselves egregious salaries, and shown themselves to be just as infallible in judging risk as the poor credit sub-prime borrower. But that doesn't mean the banking system goes away, just like the tech stock crash didn't prevent Apple Computer from innovating.

So when the NY Times, quotes the most intellectual of the bears, Mr. Roubini, be aware that the same events are unfolding on what he had previously written about.

Now though, he can't recognize it, because he would have to change his bearish position.

And mindsets don't change; they only get proven wrong.


Anonymous said...

Bad Economic News + Absence of Short Covering = No More Rallies

See you at the bottom!

Anonymous said...

Oh, I remember. There are no economic problems in the US. We are just a nation of whiners.

palmoni said...

We have economic problems galore. I just think the market is going to overlook them, and that the stock market and the economy will diverge.

When Phil Gramm gets canned because of his statements, it means even Republicans can't be in denial. Wall Street was in denial also, until they converted eveyone to the "dark" side.

So now it rallies to shake the "dark" side's conviction.

It looks like it needs a ways to go!