FYI | Aug 01 2007
The Aussie dollar at US85c. Macquarie Bank shares at $73. Paladin Resources at $6.54.
Strange things seem to be happening these days as the local stock market recorded its biggest one day loss (3.3%) in six years on Wednesday.
Forget all the news headlines on the internet, even if they have been written by journalists working for reputable media institutions such as Reuters. What we are experiencing is no longer confined to sub-prime homeloans in the US. It has become a much, much bigger problem now. This is cancer in the heart of the global financial system. And, of course, there never is a doctor around when you need one the most.
Soon a whole army of surgeons will do a detailed investigation and they will find bad cells at several places in the system. It is anyone’s guess how big the damage will be that emanates from these black spots. However, it is but logical to assume that even the healthy parts will suffer from the illnesses elsewhere.
Probably the best way to describe what is currently happening is through the term “risk reversal”. The world is learning, again, that risk is not merely an expression, it is a real and tangible factor that pops up to the surface at times. Unfortunately this is one of those times.
What revealed itself at first as a seemingly contained problem in part of the US housing loan market has now spread to debt markets in general. The risk reversal we are experiencing has become a matter of debt, credit, leverage but above all a matter of exposure to these three key elements. It is not difficult to see how this will affect financial assets across the globe. Exposure is everywhere.
For investors this is not a time for trying to be the smart one, or the brave. As I write this week’s editorial rumours are circling in the heart of Wall Street that some of the world’s most prestigious hedge funds and wealth managers are sweating over their assets. Bad news begets more bad news. Forced selling by one investor triggers margin calls elsewhere.
What should be genuinely discomforting is that nobody knows how exactly this risk reversal will develop and what the tangible consequences will be. What we do know is that investors are selling because they fear the worst while others are selling because they have no other option. Add the increased likelihood of more bad news hitting the street –whenever that will be- and it is not difficult to see that what we are experiencing now is only foreplay still.
Time to bring out the old familiar chestnut expressions: “Something is rotten in the state of Denmark”, “One cockroach is never on its own”, “The market can remain illogical far longer than you or I can remain solvent” and “When they raid the house of ill repute, even the good girls and the piano player go to jail”.
The most important thing to remember is that fundamentals carry very little value at this point in time. This is not about how well the global economy is traveling, or about China, or changes in energy consumption. This is all about leverage, liquidity and exposure and about a global financial system that has to get rid of its cancerous black spots in order to become healthier again.
This is by nature a process that comes with victims and with losses. And it won’t end until it is finished though nobody knows at this stage when that will be.
It is also fair to say that once the financial world has wrestled through this process the world will have changed, and possibly quite dramatically so. Risk appetite will remain at a much lower level for a much longer time. What seems like nearly impossible today may simply become reality throughout or after this “correction”.
One of the immediate questions that come to mind is: is this the start of a bear market for global equities?
So far the problem is one of the financial sector, albeit at the heart of it. The question whether we are experiencing the shift into a bear market (and some reputable technical chartists believe we are) will be answered by how quickly and how far this financial problem will spread into other parts of the global economy. If the cancer spreads far enough to cause considerable damage the answer will be affirmative.
That, unfortunately, will turn most of us into victims. However, that question has yet to be answered.
Till next week!
Your I wish I have a more upbeat story for you all next week editor,
Rudi Filapek-Vandyck
(as always supported by the Fab Three: Terry, Chris and Greg)