Is The Market About To Top Out?

Never invest with the herd. More often than not, it is disastrous for your investments. No one can predict what the market will do; but one of the best indicators of a market top is when a so called perma-bear becomes a bull.

Is a tiger changing his stripes a sign of a market top?

It is certainly one of them. When a famously bearish analyst joins the chorus of bulls, it's time to be a little careful. One of the loudest contrarian voices, James Grant recently jumped ship.

James Grant is the editor of Grant's Interest Rate Observer. Among his books is "The Trouble with Prosperity." He is often referred to as a “perma-bear.” Reporters ring him up when there is a downturn in the markets. A glass half empty kind of guy. His recent article in The Wall Street Journal and newly bullish stance has caused a buzz in the US markets.

The Market Does What It Wants To Do

Sharp rallies are the rule in a bear market, not the exception. It is common for the market to rocket upward in an overall downtrend. Take a look at the following chart of the Dow Jones from 1929 – 1932.

During that time, there were seven major declines and six major rallies. The rallies ranged from 19% to as high as 101%. And in every case, investors probably thought the worst was over and a new bull market had dawned.

This rally has not been built on the foundation of improving fundamentals. There is still too much wrong with the economy to hope that a new bull market is beginning just yet.

What To Do?

Don't sell and exit the market. This rally could run much higher regardless of the fundamentals. Book 50% of your profits, set trailing stop losses and let the rest of your profits ride.

1 Year After The Demise Of Lehman

One year ago on the 15th of September 2008 Brothers filed for bankruptcy. Reuters has created a great multimedia recap of the financial crisis 1 year after the collapse of Lehman Brothers.

Read more here

Financial Crisis? No, Capitalism As Usual

The August 5 edition of the Economic Times had an excellent article by Swaminathan S Anklesaria Aiyar titled "Financial Crisis? No, Capitalism As Usual"

In this article he makes the case that proclaiming the death of capitalism is premature and booms and busts are integral to Capitalism's 'Creative Destruction' process.

Read more here

Don’t Count Your Recoveries Before They’re Hatched

Ben Bernanke, the Federal Reserve chairman, sees “green shoots.” President Obama sees “glimmers of hope.” And the stock market has been on a tear. Are we out of the woods? Is the recession about to end? The recent news is certainly better but there are many reasons to be cautious about the economic outlook.

The International Monetary Fund (IMF) has just issued its gloomiest forecast ever. It says world GDP, which has never shrunk since the Great Depression, will shrink 1.3% in 2009, and then inch up to 1.9% in 2010. Growth of less than 2% indicates a global recession. So, serious recovery will not come before 2011.

The IMF sees world growth being strangled by what it calls negative feedback loops. The financial crisis first reduces cash flow to producing sectors. This causes a recession, with producing sectors slashing production and employment. But the recession then makes the financial crisis worse — more corporations and individuals default on bank loans. The banks respond by cutting credit further, and this hits production and employment further. This is the negative feedback loop.

The current global recession is likely to be unusually long and severe and the recovery sluggish because it sprang from a financial crisis. New IMF analysis shows recessions tied to a financial crisis, like the current one that has its roots in reckless lending for the U.S. housing market, are more difficult to shake because they are often held back by weak demand. Worse still is that today's recession combines a financial crisis at the heart of the United States, the world's
largest economy, with a broader global downturn making it unique.

The 2001 recession officially lasted only eight months, ending in November of that year. But unemployment kept rising for another year and a half. The same thing happened after the 1990-91 recession. And there’s every reason to believe that it will happen this time too. Don’t be surprised if unemployment keeps rising right through 2010.

Why? “V-shaped” recoveries, in which employment comes roaring back, take place only when there’s a lot of pent-up demand. That’s not what’s going on this time: today, the economy is depressed, loosely speaking, because we ran up too much debt and built too many shopping malls, and nobody is in the mood for a new burst of spending.

Capital Flows And The Financial Crisis

The latest issue of the The Economist has a great article on how America's huge current-account deficit and China's huge Current account surplus together created enormous global imbalances. A growing number of policymakers and academics believe that these lay at the root of the financial crisis.

To read more click here

The Demise Of The "Yen Carry-Trade"

The Japanese Yen surged as much as 10 percent against the dollar last week. In the last month, it has gained an astounding 34 percent against the euro. I am sure you might be wondering "So what? How does that affect me?" Let me try and explain.

The Yen's rise suggests that the pace of "financial de-leveraging" is accelerating. The global financial crisis seems to have brought a sudden end of one of the world’s biggest easy-money schemes, the so-called yen-carry trade.

The Japanese economy never really recovered after the collapse 20 years ago. To stimulate the economy the Bank Of Japan lowered interest to the point that effectively interest rate in Japan went to zero. Also, the Japanese are a frugal lot, amassing savings to the tune of trillions of dollars.

For much of this decade, Japanese and foreigners alike borrowed money in Japan and invested that money in higher yielding assets across the world, from home loans in America to equities in Mumbai. This turned Japan, with its $15 trillion in personal savings built into a provider of low-cost capital for the rest of the world.

No one knows for sure how large this outflow was. Much of the yen-carry trade took place beyond public scrutiny, in the form of currency options or other types of derivatives trading. Its size is believed to have been to the tune of hundreds of billions of dollars per year. Some of the biggest players in the carry trade were American and European hedge funds and banks. But Japanese individuals also fed the outflow of yen by pouring their savings into overseas investments, like emerging markets funds, in search of higher returns.

A simple example of the yen-carry trade is:

1. Borrow Japanese Yen at the rate of say 1%pa and convert the money into US Dollar.
   
2. Invest that money in a fund operated by a Singapore/ Hong-Kong based FII(Foreign Institutional Investor) who is allowed to buy/sell shares in India. The FII converts the dollars to rupees and buys shares of companies listed on the Bombay Stock Exchange. Assume that in 1 years time, the shares have increased in value by 20%.
3. Sell the shares, convert the rupees to dollars and the dollars to Yen. Repay the borrowed money with interest. Pocket the difference of 19%.
   

Main risks involved that the investor has to face are the stock market risk and the currency risk. This works perfectly when the markets are rising, but when the market turns, the gains turn into losses. This leads to a stampede for the exit causing a further fall in the market. The process feeds on itself, a sort of positive feedback loop. The results are visible on the screen. Huge falls in stock prices all over the world, massive sell-offs in the commodities market(oil, base metals, agricultural commodities etc), collapse of currencies(Indian Rupee, Korean Won etc).

I don't know how/when the crisis will be resolved. However one thing is clear: Huge currency speculation of the kind that made the currency carry trade a cornerstone of global finance in recent years is highly destabilizing. When this crisis is over, the authorities should aim to reduce it.