Events Searching For Reasons

The global market woke up to the first day of December with markets plunging 3%-7%. I watched CNBC for a couple of hours as talking heads try to make sense of the massive drop following 5 straight days of substantive gains. Suddenly in a couple of days the markets are worried about global economic recession? Suddenly we are surprised with weak oil prices? Suddenly we are worried about Obama? We knew all that a couple of days back, didn't we? We go looking for reasons to explain events all the time. It was staring in our faces all the time:

Thursday, November 13, 2008

Why Things Will Get Worse First - November 30

Let me say that we are about 75% through the correction phase. Is it too early to go long on equities again, I would think so. There appears to be a few more shoes waiting to drop. We have the auto sector. There could a few more big corporate failures which could dent sentiment, e.g. GE Capital and a few big hedge funds, and some private equity companies as well. AIG is still in ICU and the bloody wound is not clotting properly, its still bleeding and the doctors are very tired.

The biggest shoe among the many shoes to drop will be the hedge funds. Yes, many hedge funds have sold down their positions as early as 2Q 2008. In fact, for Malaysia hedge funds and normal institutional investors have sold down Malaysia earlier than the rest of Asia due to our big political uncertainty, and the flip-flop policies on IPPs and CPO. The entire process of selling has seen its fury over the last two months in particular when funds of all kind had to de-leverage. Good stocks and almost all asset classes were sold down mercilessly. Stocks and bonds as well, even bonds of companies which are in no real danger of going bankrupt are now selling at distressed levels (e.g. 70-75 cents to the dollar).

Naturally there has been an oversold situation, but nobody is willing to come in to bat for these oversold situations yet. Thats largely because fund redemptions are still high and many are still expecting more redemptions. While up to 15%-20% of all hedge funds might have closed shop or is in the process of winding down, the actual number needing to close down by middle of next year could reach double that figure.

While many hedge funds and mutual funds have been selling down everything, there are still a huge number of hedge funds who have frozen redemptions temporarily. You can only freeze redemptions for so long. Unlike mutual funds which are traded daily, hedge funds clients can only request their money back on certain dates, usually once a month or quarter. Many have suspended the monthly dates, but they are unlikely to be able to hold out on the quarterly dates for redemptions requests. Guess the FINAL DATE for this year for most hedge funds investors to file to redeem their stakes. Yes, its November 30th.

Many traders are already shorting some stocks that are likely to to be affected. If you are close to Goldman Sachs, they have a list/index that tracks the top stocks held by hedge funds. Request the index stocks there from them. To get some insight on how hedge funds have been de-leveraging, the 3 weeks ending October 10th saw that GS index falling by a massive 34%, while over the same period S&P 500 fell only 28%. The lock up period is only a temporary haven, it might make for another round of selling. Only, this time it could be a lot worse as volume and bargain hunters may have used up some of their cash already over the last few weeks bargain hunting. 7,600 for the Dow looks more likely than 9,000 for now.

But like I said on the first line, its about 75% over, best to do nothing, best to give up the first 10%-20% in a bottoming rally rather than trading into a volatile market with a strong downside bias. Keep at least 70% cash.

p/s photos: Vivian Chow Wai Mun

Blow By Blow Commentary (Pun Intended)

Important Posting -
Want to go on holidays also so difficult. Now in Tokyo and quite reluctant to spend my yen as it has risen more than 5%...sigh. My last trip was more than 10 years ago, and I immediately knew that I was back in Japan when I saw a small fruit stall selling durians for 3,500 yen per fruit. It was displayed on a small pedestal as well. Thats close to RM120 for one ordinary looking durian and its not even the good ones, its probably from Thailand cause there is little pungent smell being emitted.

a) Whats up with Iceland banks? Who even knew they needed to have so many banks? The banks got into trouble apparently by being big in "internet banking", a delayed dot-com bust apparently.

b) Though I have featured Nouriel Roubini a number of times, I have to say that he called it brilliantly and has mapped out the step by step destruction even before it happened. He is way better than the always doom and gloom Marc Faber, or even the successful investor but poor macro commentator in Jim Rogers. Though I agreed with most of his writings, I was not as bearish as he was, he was much more convinced. He expected the massive bailouts, and he even predicted that there will still be bank runs despite the bailouts. What we are seeing now are akin to bank runs except that the central bankers are trying to pre-empt that. Roubini's prescription is for each major country affected to come out and say that they will guarantee ALL DEPOSITS just like Ireland has done ahead of everyone else. I expect the Fed and Treasury to come up with a similar announcement in the US, and even by HKMA and Australia. But it may not happen in EU because the ECB would be loathed to do that as the union is made up of varying "quality of banks".

c) Is this a confidence thing, we all thought that the bailout fund would have assuaged that!!! What Happened?? What is happening is that the bailouts in US and UK and parts of Europe have confirmed investors' fears that things are really bad. Even with the bailout packages, banks are still NOT WILLING to deal or lend with one another as your counterparty risks are too high. That freezes credit. People with good credit cannot even get a car loan in the US.

d) What we are seeing is not completely a crisis of confidence. It is also a unique situation which has brought about certain unanticipated events (thus delaying the recovery and calm): USD went up after the bailout, not because the USD is strong, how can it be strong when the Fed is now ladened with toxic assets backing the issuance of new dollars? The USD went up NOT because its a reserve currency, which was what I thought initially as well, but rather there is a shortage of USD as institutions and companies sought USD to pay down their debt in USD. People just did not want big outstanding loans. So, we are seeing companies and institutions trying to be careful and cautious, not that they want USD but to pay off their loans which are mostly denominated in USD. The unexpected spike in USD caused a panic among latent demand for USD which exacerbated the USD's unworthy strength.

e) The yen gained even more over the past week as hedge funds all unwound their yen carry trade, i.e. sell OZ bonds and buy back yen. Hedge funds are crippling the recovery despite the bailout because September was the worst single month for most hedge funds. They had to sell everything, even good assets such as commodities in anticipation of the massive outflow and redemption of funds by hedge funds investors.

f) So I do expect calm and confidence to return very quickly. Its just that the bailouts and concerted efforts to lower rates came at such rapid succession that it cause hedge funds and investors to do many other things seemingly to increase volatility of markets. I believe investors are OK with the measures enacted so far, guaranteeing deposits would be the final kicker. Its just that investors and hedge funds went and did other stuff as well, which destabilised markets hence prompting the broader media to conclude that investors ARE NOT HAPPY with the bailouts and rate cuts - wrong reasoning you all, pretty pathetic.

g) Finally, why I am getting more comfy with the global situation.... is that Jim Cramer asked all to SELL SELL and sees 7,700 for the Dow. If ever there was a consistent financial idiot, it would be Cramer. If you look up the dictionary under "idiot" you'd probably find his picture there. I am so glad he panicked and call for a sell. I am so so relieved. I rarely call anyone a financial idiot, but apparently the phrase "financial idiot" was invented strictly for him. (Even if the index does get to 7,700 he is still a financial idiot... randomness alone can get you 2/5 correct)

p/s photos: Li Bing Bing