Are the levees starting to break?
By Doug Wakefield with
Ben Hill
"I have often
stopped to ponder our human condition -
specifically, our uncanny ability to dismiss the
seriousness of an event beforehand and to lament
our lack of preparation after it has happened. How
many New Orleans residents stated, in some form or
fashion, that they never expected the storm to
break the levees? But, it’s easy to see the
rational behind their unresponsiveness. They had
been through countless storms since the levees
were first established and nothing that dire had
ever happened." So I wrote in September 2006 (The
Investor’s Mind: Too Costly to Bear).
By
late 2003, I knew that we were living in a
historic time. With
this
in mind, I began to write to warn investors about
the enormous risks in the financial markets and to
record my observations, so that future generations
could more fully comprehend this mania as they
look back on this period.
Since that time,
and the release in January 2006 of our research
paper on short selling, Riders on the Storm: Short
Selling in Contrary Winds, I have certainly had
plenty of material to write about. However, up
until July 2007, it appeared as though
understanding numbers, people, and events, outside
of the day-to-day noise of upward moving price
trends, was a complete waste of time. The markets
were climbing, and thus my comments appeared to
have little value.
Even today, many
investment and trading publications continue to
talk as though real-world events - like Wall
Street banks receiving billions from sovereign
wealth funds to cover similar losses of
investments backed by thousands of mortgages and
credit cards - tell us nothing about the next
major trend in worldwide capital markets. Yet, as
we ponder what has transpired over the last
several years, ask yourself, "Are most of the
things unfolding today really that unpredictable?
Could we really not see that unlimited amounts of
debt and dollars would eventually create enough
stress to have real world consequences?"
Now, some reading this article might be
thinking, "Hey, we’re about out of the woods," and
you certainly have a right to your opinion, but do
you really believe we can fix our current dilemma
by papering over all of our problems with more
short-term debt?
Prices move
fast The difference between most retail
investors and advisors versus professional traders
is that since traders realize they can destroy or
make their careers in short periods of time, many
of them respect, and watch for, rare events. In
our November 2007 article, A Gallery of Crowd
Behavior, we noted the price levels of various
assets that had hit multi-year extremes in either
bullish or bearish sentiment. Since that article,
the following price changes have taken place:
The Nasdaq 100 Index has dropped 14.4%,
the Philadelphia Bank Index 16.4%, the AmEx
Broker/Dealer Index 14.9%, the Hong Kong Hang Seng
Index 15.2%, Countrywide Financial shares 56.4%,
Citigroup 28.6%, the US Dollar Index 0.85%, and
gold has gained more than 11.7% (all as of January
15).
While my forecast - based primarily
on the speed of ascending and descending trends,
Elliott Wave patterns, and crowd sentiment
extremes revealed in bullish and bearish sentiment
- was largely accurate, I was wrong on gold.
If you’ve read some of my articles over
the last few years, you may have already been
convinced that prices could move lower. So, the
next question is, "Did your investment strategies
and managers profit from these changes, or have
your losses been mounting since the credit
contraction began last summer?" If you are losing
money, then you need to reread the opening
statement to this article and prepare now.
Fear and greed are
measurable Some professional traders use
bullish and bearish sentiment numbers, which are
based on the number of long versus short contracts
in particular investment markets, and volatility
measures to assess the markets.
For
example, when I made my gold forecast in November,
gold and silver showed daily sentiment readings of
94 and 96, respectively. With so many people on
the long side of this trade, it seemed a foolhardy
entry point. And, with current daily sentiment
readings on gold and silver at 94, I continue to
stand aside.
In February of 2007, I spoke
with Mike Arnold, of Pairnomics. With his
experience as a floor trader on the Chicago
Exchange - a job only a few individuals in the
world of money have ever held - I thought his
opinion would be beneficial to our subscribers.
One of the first things Mike spoke about was that
the volatility index, or the VIX, had hit a
17-year low.
In June 2006, when the equity
and commodity markets were hit, the VIX surged
then began to decline as these markets started
their ascent again. The VIX hit its 17-year low in
December of 2006.
Then, in May of 2007,
the banking index started moving down, and the VIX
rose. Even with the Fed rate cuts from August
through December of 2007, the VIX has not returned
to its May to July level. With the hammering that
equity markets have taken around the globe since
2008 opened, it seems many investors’ attitudes
have changed from complacency and greed to fear,
which is what the VIX was designed to measure.
Retail investors or sovereign wealth
funds Whether we’re advisors with hundreds of
millions under management or investors with a few
million in our portfolios, when it comes to
overall size in the financial markets or sovereign
wealth funds (SWFs), we are specks.
Wikipedia defines a SWF as "a fund owned
by a state composed of financial assets such as
stocks, bonds, property or other financial
instruments. Most of the savings of SWFs originate
in accumulated foreign currency reserves."
Wikipedia also notes that SWFs have, "become
increasingly popular as the spending power of
global officialdom rockets upwards". So basically,
on their way to competitive currency devaluations,
some countries decided to buy other assets with
their huge and growing supplies of fiat.
The following indicates the scale of the
sums involved. In July last year, inflows amounted
to US$10.7 billion, in September $7.5 billion, in
October $11.2 billion, with outflows in August and
November of $12 billion and $10.8 billion, giving
a net inflow over the five months of $6.6 billion.
The past few months have shown that the
American retail investor, as reflected by the
numbers above from the Investment Company
Institute indicated the sum total of all investors
into or out of stock mutual funds, are no match
for sovereign wealth funds. Compare the numbers
above with those below, and you see why little
investors are losing any amount of influence they
once had.
China Investment Corp, made a $5
billion investment in Morgan Stanley on December
19, 2007.
Kuwait Investment Authority,
Mizuho Corporate Bank, Korean Investment
Corporation, Government of Singapore Investment
Corporation (Temasek) and Davis Selected Advisors
(US) made a $12.8 billion investment in Merrill
Lynch on December 24, 2007 and January 15 this
year.
Temasek, the Kuwait Investment
Authority, Prince Alweed bin Talal (Saudi Arabia),
and Sandy Weill (former CEO of Citicorp) made a
$20 billion investment in Citicorp on November 27,
2007 and January 15 this year.
As you can
see, the total net inflow from all investors into
US stock mutual funds from July through November
2007 was only $6.6 billion, while in less than two
months a handful of big investors placed a total
of $37.8 billion in three global, financial
powerhouses.
To help us grapple with these
numbers, we note that from 2000 to 2007, February
of 2000 saw the highest net inflows, at $53
billion, and July 2002 saw the highest net
outflows, at $52 billion. And I think we all still
remember what was happening in early 2000 versus
the summer of 2002.
Think, act, think
some more Most investors think they are paying
for advice about the future, but select
investments based mostly on past returns. And,
most managers and advisors get caught up in
pleasing their investors.
As market
volatility picks up, the world’s capital market
begins to look less like investing and more like a
casino. If you want to survive the markets ahead,
I strongly encourage you to seek those sources
that have a keen grasp of history, math, and crowd
and individual psychology. Then, make sure that
they have experience trading the short side of
markets and can give you very well thought out
plans about how they are going to deal with the
real world that is unfolding in front of us.
In closing, we include the following
statement, made in the UK Telegraph just days
before the opening of 2008, regarding the
shrinking number of new issues being placed in the
low and high grade corporate bond markets in
Europe.
"Glance at the more or less
healthy stock markets in New York, London, and
Frankfurt, and you might never know that this
debate is raging. Hopes that Middle Eastern and
Asian wealth funds will plug every hole lift
spirits. Glance at the debt markets and you hear a
different tale. Not a single junk bond has been
issued in Europe since August. Every attempt
failed. Europe's corporate bond issuance fell 66%
in the third quarter to $396 billion (BIS data).
Emerging market bonds plummeted 75%. 'The kind of
upheaval observed in the international money
markets over the past few months has never been
witnessed in history,' says Thomas Jordan, a Swiss
central bank governor."
2008 is likely to
be a historic year. We best get out our thinking
hats and ask those we are depending on for our
long-term financial success a lot of questions.
Since July 2007, the market environment has
changed. As the credit contraction intensifies and
market prices continue to adjust to the downside,
investors and advisors will have to move from an
investing to a trading mentality. Since most
investors and advisors have little to no
experience with that mindset, they should seek the
most liquid place to avoid the destruction of
their investment portfolios and find trading
professionals who have years of experience through
various market cycles.
Doug
Wakefield is the president of Best Minds
Inc, a registered investment advisor. He can be
reached at doug@bestmindsinc.com
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
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