FYI | Jan 19 2008
By Rudi Filapek-Vandyck
Imagine this: you are about to cross the street, you look to your right, then to your left and to your right again and make your first step off the footpath when all of a sudden the sound of a fast moving vehicle coming around the corner of the street catches your attention. What do you do?
a.) you try to gauge whether the vehicle’s speed will still allow you to get to the other side without being run over?
b.) you continue crossing the street, heart thumping in your chest, trusting the driver will use his brakes in time?
c.) you step back onto the footpath, wait for the car to pass by and then try to cross the street again?
Most people wouldn’t have much difficulty in answering this question. If anything, our inner instincts would probably force our legs to take those steps back before our minds would fully realise what the question is. Yet, if the same question and response occur in global financial markets, traders and stockbrokers respond with dismay and disbelief that investors decide to step back onto the footpath where they can safely reasses the situation again.
The team at FNArena has been equally surprised by the ferocity and the speed at which global equity markets have retreated in the first weeks of the new year, but we are not surprised by the retreat itself. To use the analogy above: while retreating back onto the footpath investors all of a sudden realised it wasn’t just a small car that came flying around the corner, it looked more like a big truck with a few heavy load vehicles attached to it. Hey, your instincts must have told you, better safe than sorry and retreat a little further. We don’t want any jumping rocks or falling shrapnel to hit us either.
The main difference between our real life analogy and with what has happened in equity markets over the past three weeks is the duration of the process, not the reflex that caused it. That and the fact that in real life you will lose time, and time only, while investors in the markets have seen the value of their assets decline in rapid tempo. Even though they haven’t been hit by the truck, it still hurts.
There’s another important similarity: if a few pedestrians are crossing the street and one retreats it is likely the other ones will do so too, even though your standard academic will later explain to you that the more pedestrians are in the process of crossing the street, the higher the chances the driver will spot you all in time and step on his brakes – but then again, it’s a heavy loaded truck not a Mini that is heading towards you.
In financial markets selling by some investors often leads to selling by others, especially at times like these when margin calls are being made and safety levels are being breached. All it takes is for one hedge fund, or one insurer, or one bank, to be made a forced seller and before you know it the impact of this on the share market pulls in another institution as a forced seller. And further down it goes…
This also explains why at times like these many things often don’t seem to be making sense. Like, if Australia’s economy is in a much better shape than most of the rest of the world, and expected to remain in a much better shape, while benefiting from strong growing Asian economies, how come Australian shares have been punished equally as hard as their US peers? Why are stocks of companies with local operations being sold off together with those that operate internationally? Market leaders together with marginal players?
There is a lot of “illogic” behind the indiscriminate selling that has occurred over the past ten trading days and the smartest and savviest ones in the market are without any doubt doing their calculations and assessments to benefit (later) from these aberrations. What investors have to keep in mind though is that trying to pick the bottom in markets like these remains a high risk exercise, also because the US reporting season is still only in its early stages while economic data are likely to provide some additional shockers.
Here at FNArena, we are no financial advisors, but if we were standing on the footpath looking at the truck passing us by, we would simply wait and be patient. We can live with the fact that some of the other pedestrians around us will reach the other side of the street sooner than we will. But hey, we’d just want to make sure there’s no bus coming behind that truck.
Patience is one of the true virtues when making investment decisions. We think this especially applies within the current global framework.
US shares closed again lower on Friday. Do you really want to know why? Put simply: bad news. It’s all over the place these days and there doesn’t seem to be any relief around. The optimists in the market will probably see this as proof that the bottom is near, and they could be right, but even they don’t know what’s behind that big dustcloud that’s following our passing truck.
Currently, US bond markets are putting a 72% chance on the fact that US official interest rates will be cut by 75 basis points between now and the end of January (there’s speculation the Fed might act before the meeting and then again at the meeting) but the big question for Bernanke and Co is whether such a message would help their cause in stabilising the markets or achieve exactly the opposite.
Governments will start moving into the picture soon. Not only to provide further stimulus to US consumers, and to reduce inflation fears elsewhere, but possibly also to help their deep troubled financial institutions. As pointed out by Anatole Kaletsky (from GaveKal) in a newspaper column recently, the cash injections by sovereign funds are clearly not enough to stabilise the global financial system, and time is ticking.
The sooner all this is over, the better. But that’s the core of the current problems, isn’t it?
For those investors willing to bank on the fact that share markets might be staging a relief rally anytime soon now, we hereby repeat a cautionary note from Friday’s Gartman Letter in which Dennis Gartman points out that January options expired yesterday in the US, and thus also the “protection taken by many via January puts”.
Says Gartman: “It appears from the open interest figures on the CBOE that much of that protection bought through today has not been rolled over into February, leaving portfolios vulnerable next week. If so, panic might develop Monday and Tuesday, and we’ll be short into that possible panic. We are short of equities, hedged with our long position in gold. Quite honestly, we are happy with that position, for the market is telling us that we are right.”
Maybe the best new year’s resolution to make this year is to be a good hunter. All good hunters share one key characteristic: they know the value of being patient.
