Aiks...so this is what a Golden Period looks like!
.Last week was a time when investors wondered what they have gotten themselves into. They thought they were invested in good sound businesses not casino chips (you every wonder why DBS bank is called a "blue chip" company?) but the recent wild fluctuation on the market makes a rollercoaster ride at Magic Mountain look like a walk in the park.
Strangely just when investors thought the stock market was about to collapse on Tuesday, it staged a sharp rebound after the Fed decided to cut rates by 0.75%. Markets panic, Federal Reserve panic....oh my is the global economy as we know it coming to an end.
It was explained in the media that the recent turmoil is due to investors' worry about a US recession. However, if you have been reading the financial news you will know that the US recession is one of the most talked about recession - there was talk about a US slowdown since the end-2006 and in early 2007 Greenspan warned of a recession...and so on. Also, my own monitoring of US fund managers have been doing show they have been preparing for a consumer slowdown by moving to defensive stocks such consumer staples and away from discretionaries. Home builders and banks whose earnings are expected to fall have been sold down. Why would markets panic about an event that is well anticipated?
The market might be higher or lower by the end of the year depending on the length and depth of the US slowdown/recession and its effect on the global economy. The jury is still out and the markets are suppose to adjust as more economic data comes out. My belief is the instability in the market is actually built-in - there were several such sharp selloffs in the past when the economic outlook was alot better - end 2006, Feb/March 2007, Aug 2007 ...and the market recovered from each of them with or without intervention from the Fed.
What is the source of inherent instability in the market?
1. Derivatives. Futures, options, etc. These were supposed to be used for hedging your equity positions but only a small % of the contracts are used for this purpose. These products allow hot (and fast) money to make big bets on the direction of the markets. The notional amount that is traded in derivatives is U$510 trillion. This is the equivalent of millions of dollars betting on the earnings of a lemonade stall. One example of how the derivatives market can add to volatility of the underlying assets goes like this : issuers of Hang Seng put warrants were forced to short the futures contract after the Hang Seng took a sharp plunge to limited their losses - that cause the Hang Seng to fall further. On the rebound, call warrant issuers are forced to limit their losses by buying HSI futures causing the HSI to rise further.
2, Leverage. An important source of liquidity that fuel the rise in almost all markets - commodities, oil, gold, stocks ...etc is the Yen. The Yen can be borrowed cheaply and used to speculate on the markets. Whenever the Yen rises, it forces the speculators to selloff assets to pay back their Yen denominated loans. The other form of leverage is margin trading which is now more widespread than before due to aggressive promotion by brokerages. When the underlying assets fall, traders are forced to sell to meet margin calls...On Tuesday the Bombay stock exchange shut down after plunging 10% at the open because brokerages were dumping stocks due to margin calls, in Australia margin calls reached a record high on Tuesday....in other words, there is a whole lot of selling that has nothing to do with the US recession, traders were selling because they were forced to do it.
The recent market panic caused the Fed to panic and cut rates by a huge 0.75%. The market is again "threatening convulsion" if the Fed does not cut by 0.5% in its coming meeting. The problem with these "emergency" rate cuts to calm the market is they will add to instability later on. The Fed is suppose to act on the best evidence about the economy is now forced to react to the market. Too many rate cuts and we might get another bubble, more instability and so on. We are definitely in for more volatility, more hair raising rides...so who is in charge of this place?...I'm afraid nobody...