Showing posts with label deleveraging. Show all posts
Showing posts with label deleveraging. Show all posts

Tuesday 18 May 2010

But the original problem - too much debt - hasn't gone away. It has just been transferred to government balance sheets.

Time to give up debt addiction

GREG HOFFMAN
May 17, 2010 - 2:12PM

The first week of May's panicked trading on world financial markets was eerily reminiscent of the post-Lehman chaos of September 2008. Equity markets plummeted, debt markets froze and inter-bank lending rates skyrocketed.

The question is not whether Greece can or cannot pay its debts (without dramatic cuts to government spending, it looks nigh on impossible), but which country is next.

With Spain, Portugal and Ireland in the firing line, it's no wonder banks are reluctant to lend to each other. It's also no surprise that the European Union (EU) and International Monetary Fund (IMF) have orchestrated a 750 billion euros ($1 trillion) rescue package.

The Europeans, being European, took their time. But, not surprisingly for students of human nature or politics, they've taken the easy option and kicked the can down the road. For now, another crisis has been avoided.

In hock

For more than a decade, Western consumers borrowed too much money, ably assisted by financial institutions creating financial products they themselves didn't understand. When the consumers couldn't pay and the banks were about to collapse, governments bailed them out. Remember the calls for a "global stimulus package"'?

Well, it worked in as far as we're not looking down the barrel of another Great Depression. Amongst the recent chaos, statisticians announced that the US economy generated an astonishing 290,000 jobs in April.

But the original problem - too much debt - hasn't gone away. It has just been transferred to government balance sheets. Now, one of those governments can't meet its obligations. So what do we do? We just transfer the problem onto bigger balance sheets. In this case, they're the ones owned by the EU and the IMF.

The buck, however, can't get passed any further. Europe and the US are not too big to fail, but they are too big to bail. It is going to hurt but eventually, eventually, the Western world needs to reduce the overall leverage in the system. And what form might that take?

How to deleverage

McKinsey and Co, a consulting company, recently produced an insightful analysis of 45 prior episodes of deleveraging, 32 of which followed financial crises. The authors conclude that there are four ways to deleverage an economy, and only two of those options are available to the West today.

The two options are inflation and "belt tightening". The latter has been the most common tonic to a bout of indebtedness (16 of the 32 post-crisis deleveraging episodes).

This means cutting back on government spending in order to bring spiralling foreign debt balances under control and the result, in all cases, was a substantial reduction in economic growth.

Inflation might seem like a far more palatable solution and, for creditors, there's no doubt it is. Perhaps best described as "default by stealth", inflation erodes the value of debts and, if you're the supposed recipient of those debts, the value of your assets.

Inflation also reduces the value of all other assets in an economy, creates substantial frictional costs and destroys a country's ability to borrow in its own currency again.

It might be the most palatable option for a leveraged electorate, but for the owners of capital, inflation is a disaster. And once the inflation genie is out of the bottle it can be very difficult to get it back in.

As investors, we should be preparing for one or both of these factors to have a substantial impact on our portfolios over the coming decade. In many ways, however, we should welcome it. It's in everyone's interests to unwind imbalances in global trade and fiscal budgets and so begin the process of Western deleveraging. Otherwise we run the risk of a crisis so big it might portend another Great Depression. From my perspective, the sooner the better.

This article contains general investment advice only (under AFSL 282288).

Greg Hoffman is research director of The Intelligent Investor

http://www.smh.com.au/business/time-to-give-up-debt-addiction-20100517-v84t.html


Financial success? Debt-free

Many Americans have redefined the meaning of financial success in the post recession era, to be debt-free.


Friday 7 May 2010

'Fat finger' trade forces US stocks dive

'Fat finger' trade forces US stocks dive
May 7, 2010 - 6:30AM

The biggest intraday point drop ever for the Dow Jones Industrial Average may have been caused by an erroneous trade entered by a person at a big Wall Street bank that in turn triggered widespread panic-selling.

At one stage, the Dow was down a whopping 998 points - or 9 per cent - before rebounding but it was still sharply lower for the session as continuing worries about Greece and the so-called sovereign debt contagion ate into investor confidence.

The so-called "fat finger" trade apparently involved an exchange-traded fund that holds shares of some of the biggest and most widely traded stocks, sources said. The trade apparently was put in on the Nasdaq Stock Market, sources said.

But US stocks still ended sharply lower, as continuing worries about the debt crisis in Greece ate into market confidence, prompting a wide-spread sell-off.

US stocks posted their largest percentage drop since April 2009, with all three major indexes ending down more than 3 per cent.

Indexes earlier in the afternoon had plunged even more steeply, before paring losses.

Observers questioned why Procter & Gamble’s stock tumbled precipitously - and some say that could have been behind the massive plunge.

Both Fox News and CNBC reported that a trading error involving P&G stock could have been responsible for part of a dip that dragged the Dow Jones Industrial Average within a hair’s breadth of a 1000-point drop.

The sudden sell-off saw investors desert stocks wholesale.

But P&G’s stock, which had been trading at $US62, suddenly began to crash, falling around 20 per cent at one point for no apparent reason.

The Dow Jones industrial average ended down 347.80 points, or 3.2 per cent, at 10,520.32. The Standard & Poor's 500 Index was off 37.75 points, or 3.24 per cent, at 1128.15. The Nasdaq Composite Index was down 82.65 points, or 3.44 per cent, at 2319.64.

Several sources said the speculation is that the trade was entered by someone at Citigroup. A Citigroup spokesman said it was investigating the rumour but that the bank currently had no evidence that an erroneous trade had been made.

http://www.smh.com.au/business/markets/fat-finger-trade-forces-us-stocks-dive-20100507-uh91.html

Saturday 20 December 2008

Dollar roars back as global debts are called in

Dollar roars back as global debts are called in
For six years the world has been borrowing dollars to bet on property, oil, metals, emerging markets, and every bubble in every corner of the globe.

By Ambrose Evans-Pritchard Last Updated: 3:48PM BST 23 Oct 2008

The strong rebound in the dollar has surprised some analysts
This has been the dollar "carry trade", conducted on a huge scale with high leverage. Now the process has reversed abruptly as debt deflation - or "deleveraging" - engulfs world markets. The dollars must be repaid.
Hence a wild scramble for Greenbacks which has shaken the global currency system and shattered assumptions about the way the world works. The unwinding drama reached a crescendo yesterday as the euro fell to $1.28, down from $1.61 in July. The slide in the Brazilian real, the South African rand, the Indian rupee, and the Korean won, among others, has been stunning.
Stephen Jen, currency chief at Morgan Stanley, said US mutual funds, pension funds, and life insurers invested a big chunk of their $22 trillion (£13.5 trillion) of assets overseas to earn a higher yield during the boom. They are now in hot retreat as the emerging market story unravels. "There is a complete rethink going on. People are bringing their money back home," he said.
Hedge funds are 75pc dollar-based, regardless of where they come from. Many are now having to repatriate their dollars as margin calls, client withdrawls, and the need to slash risk forces them to cut leverage. The hedge fund industry had assets of $1.9 trillion at the peak of the bubble.
Data collected by the Bank for International Settlements shows that European and UK banks have five times as much exposure to emerging markets as US and Japans banks, with surprisingly big bets in Latin America and emerging Asia - where they rely on dollar funding rather than euros.
The fear is that deflating booms in these frontier economies will have an 'asymettric' effect on the currency markets, setting off another round of frantic dollar buying. "It is not impossible that the euro could collapse completely against the dollar, going back to 2001 levels," said Mr Jen.
He said the "composite" dollar-zone including China, the Gulf oil states, and other countries locked into the US currency system, will together have a current account surplus next year. The de-facto euro bloc of the core euro-zone and Eastern Europe is moving into substantial deficit. This creates a subtle bias in support of the dollar.
Of course, much of the currency shift this year is a natural swing as the crisis rotates from the US to Europe and beyond. The dollar was pummelled in the early phase of the crunch when economists still thought Europe, Japan, China and the rest of the world would decouple, powering ahead under their own steam. The Federal Reserve's dramatic rate cuts were seen then as a reason to dump the dollar.
The decoupling myth has now died. The euro-zone and Japan appear to have fallen into recession before the US itself, led by a precipitous fall in German manufacturing.
The ultra-hawkish stance of the European Central Bank - which raised rates in July - is now viewed as a weakness. Foreign exchange markets are no longer chasing the highest interest yield: they are instead punishing those where the authorities are slowest to respond to the downturn.
A hard-hitting report by Citigroup this week said the ECB had unwisely ignored screaming signals from the bond markets earlier this year for a rate cut. "The ECB did not listen. Not only did they no reduce rates as they should have but they increased them in one of the biggest policy mistakes of 2008," it said.
The spectacular dollar rebound has geostrategic implications. Heady talk earlier this year that dollar hegemeny was coming to an end - or indeed that the US was losing its status as a financial superpower - now seems very wide of the mark.

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3242927/Dollar-roars-back-as-global-debts-are-called-in.html

Sunday 7 December 2008

Mutual Funds: Saner Markets Ahead

Industry Insights

Mutual Funds: Saner Markets Ahead

Michael Maiello 12.05.08, 6:00 AM ET

In the December issue of Dan Wiener's newsletter, "The Independent Adviser for Vanguard Investors," Wiener interviews James Barrow, lead manager for $31 billion Vanguard Windsor II, and learns that the venerated value manager believes that hedge fund liquidations should cease by the end of the year, taking a good deal of volatility and downward pressure out of the markets.

Barrow told Wiener that: "All of that money the banks loaned the hedge funds is getting called in. They are selling these guys out. Not only are these guys getting redeemed by their investors, they're getting redeemed by their lenders. I don't know how long this has to go on--it'll obviously be over by the end of the year, but it could be pretty bloody between now and then."

This served as the topic of this week's mutual fund discussion between Dan Wiener, Adam Bold of The Mutual Fund Store and Richard Gates of TFS Capital. The consensus was that 2009 will bring smoother markets and it's time for investors to prepare for a market, if not an economic recovery.

The Forbes.com mutual fund panelists are:
Daniel P. Wiener, editor of Independent Adviser for Vanguard Investors and CEO of Adviser Investments.
Adam Bold, founder and chief investment officer of the Mutual Fund Store.
Richard Gates, portfolio manager for TFS Capital.

Hedge Funds, Mutual Funds and Volatility

Wiener: Barrow has been around the block many times, and his contacts within the financial community are quite broad, so when he says he thinks the hedge fund selling is about complete I have to think he's on to something. In addition, I have at least one source within one of the big clearing banks that thinks the worst is behind us.

With the last two big recessions (73 to 75, and 81 to 82) having lasted 16 months each, and the current recession now having been date-stamped as starting December 2007, there is some historical precedent for assuming we are at worst midway through the economic crisis. And since we know that markets are discounting mechanisms and will begin to discount the recovery before it arrives, it's probably safe to assume that we'll see the markets move higher sometime in 2009.

The X factor right now is employment and of course Friday's report will almost certainly set a negative tone. But remember that unemployment rises, and continues rising after recessions end. Unemployment peaked at 8.6% two months after the end of the 75 recession and peaked at 6.8% 15 months after the 91 recession. The last recession, from Mar '01 to Nov '01 saw unemployment continue to rise to a high of 5.7% for 19 months after the official end.

Gates: I agree the recent market dynamics are primarily caused by a massive de-leveraging process. Hedge funds, firms formerly known as investment banks, and other big institutional investors have been fighting for their lives trying to stay solvent. During this process, fundamentals and valuations have been thrown out the window and spectacular volatility has been thrust onto the market. This makes this market relatively unique from anything we have seen since the 1930s. It is very scary for many investors.

Mr. Barrow could be right that the de-leveraging process may be near its end. In fact, TFS has seen many of our long-short equity and other hedge fund trading strategies normalize a bit recently after months of unprecedented volatility. Of course, though, nobody really knows when the forced selling will stop. For instance, year-end hedge fund liquidations may come in larger than anticipated and may force managers to raise additional cash. But the important thing that investors need to realize is that sooner or later it will pass.

On a positive note, the indiscriminate selling and short covering has produced wonderful opportunities in the markets. Look at the short squeeze that recently occurred in Volkswagen! Owners of that stock had a once in a lifetime opportunity to sell at hugely inflated prices. Also, many closed-end mutual funds owned by retail investors are trading at steep discounts not seen in decades. Investors have the opportunity to buy many of these funds for 70 cents or less on the dollar.

If Mr. Barrow believes that the de-leveraging is about to end, I am surprised that he is not more active in taking advantage of the dislocations that are clearly prevalent in the market. For instance, he could be selling stocks that have been artificially buoyed by short-covering and using the proceeds to buy stocks that have been grossly oversold. These dislocations will go away once the forced trading ends.

Bold: We're not hearing any predictions in our conversations with fund managers. No one we've spoken to is comfortable making any predictions at this point. As prices would indicate, most managers have strong levels of optimism toward future prospects but can't say when things will turn in a positive direction. History tells us the market will advance well in advance of the recession's end, and with Monday's declaration by the NBER that our economy has been in recession since last December, I'm hopeful we're closer to its end than its beginning.

Most managers we're talking to are hopeful that the current projections being made by many economists that the recession will end late in the second quarter next year or sometime mid-year are accurate. Of course, those projections are made with the knowledge that no one knows for certain, and can't possibly take into account any events that are unforeseen. Just [Monday], Bernanke was discussing the impact of the financial crisis on this recession and how it will continue to be intertwined in the recovery as that unfolds.

Gates: In 2009, I think the markets will be less volatile than what we have seen in recent months and that some semblance of rationality will be regained. The reason for this is that I think the highly levered investors have been wiped out already. Plus, the government has had time to put in some backstops to shore up the financial industry.

To capitalize on this belief, we have been gradually increasing our exposure to various trading strategies. In addition, we are actively trading our portfolios to attempt to sell positions that we think our overvalued and to buy positions that we believe are undervalued.

Wiener: Consider that the Dow has seen 27 days this year when the swing from low to high was 5% or more of the prior day's close. Over the past dozen years there were a total of 14 such days. We've had 122 days of 1% moves or greater in the Dow this year. This comes close to the 128 days we saw in 2002, which as you know was the final year of that bear market.

Gates: For undervalued names, I will mention closed-end funds. The median discounts of these securities were 18% as of [Tuesday's] close. In other words, you could spend 82 cents to get something worth $1. Prior to this last summer, we got really excited when the discounts got close to 10%.

For overvalued names, I would look at positions that had large short interest positions over the summer and have outperformed the market since that time. The outperformance could be primarily attributed to short covering.


http://www.forbes.com/intelligentinvesting/2008/12/04/industry-insights-mutual-fund-panelDec5.html