Finuked…Where are the bunkers??

The markets have been nuked…Finuked to be precise by the FWMD (Financial Weapons of Mass destruction a.k.a derivatives) this week and the brunt were borne by the Asian and European markets which fell by 7 to 12% on Friday. The emerging (or as I heard someone say submerging) markets were hit the hardest with global investors running to the safety of 30 year US Treasury Bonds (which saw an yield as low as 3.7% on Friday) driving down the value of all emerging market currencies… Pound, Euro, Rupee, Real, Zloty, Peso, Forint…you name it. Yen however stood out, moving to a 13 year high against USD, as the carry trade reversed full steam. This led to Nikkei plunging 9.3% given its export oriented economy. The plunge was aided by profit warnings and layoffs. News of UK’s GDP shrinking more than expected, added fuel to the fire as bourses across Europe were seen under tremendous selling pressure. The US futures (S&P500, Dow & NASDAQ) were limit down before the US exchanges opened and worst was feared. However as usually happens, when such extreme expectations build up, the markets behave totally differently and most times exactly the opposite way. Thus while the US markets were down, it was not catastrophic. This many players apparently did not like as they wanted the capitulation to happen. Most should know it never happens when you expect it.

IMF got active with its bailout product as a queue built up with Belarus, Pakistan, Hungary, Ukraine, Serbia etc. after Iceland agreed to an USD2bn. package. The fund as I understand has USD225bn. in assets and can help, but the pace with which the SOS is coming the fund will have its hands full soon. It is now expected that the submerging markets are going to take the baton from the developed world. Analyst fear East Europe is the next place to watch; given the exposure Western European banks have, not forgetting Russia, Turkey, Argentina and South Korea which have their own problems. The emerging bond yields are on a five year high. And given the emerged markets are also submerged/submerging; it is not clear who will help whom!

There are no safe havens or hedges any more. Gold saw a plunge before recovering some what, so did oil despite a 1.5mn. barrel per day cut announced by OPEC. Many hedge fund investors and large pension/life insurance funds seem to have run out of patience and are calling their money back. It’s a race out there as prices are plunging and everybody wants to beat the other to it. The move from the denial to the acceptance mode has been swift and dramatic. It is estimated that the hedge fund industry has lost USD200bn. this year. The slight tightening of the money markets as reflected by Libor helped. Anyway the transaction ticket size as I understand is so small (given the mistrust, uncertainty and the consequent risk aversion) that availability of such liquidity may not be material given the size of redemptions/margin calls.

Reflecting this confused state was CBOE VIX which hit an all-time high of 89.5 but improved to about 79. Now talk of many insurance companies requesting to be included in the bail out is going to add more uncertainty. AIG’s dollar burn rate has been higher than expected and it is reported that more funds may be required than what has been provided for. Questions are being raised about the sufficiency of bail out funds for banks as the imminent deep recession might cause default in the core loan assets (as against treasury holdings). The assets and inventory against which such lending was done would also have fallen in value dramatically and more importantly so swiftly that the banks may not have had the time to assess the level of margin calls to be made on these. This explains the aversion to lend further as the banks need to evaluate the present asset cover to lend further. With demand destruction and falling inventory value the companies may not be easily able to find the cash need to roll on.

So what does an investor do? Streetwise are talking about (after analysis of) dividend yields, book values, cash on book, replacement costs etc. and above all the high fear factor as a good reason to buy. These values in today’s environment are as uncertain as the predicting wind direction a year or two ahead. The market today, as I mentioned in my previous post, is like a cancer patient in ICU (unlike flu, diabetes etc. where known remedies/treatments are available) being treated by world re-known specialists (governments/central banks). It is easy to start treatment for such a critical patient, but ending it never easy. While the main disease itself can spread, as the treatment progress lots of collateral damages happen and then these need to be addressed while progressing with the core treatment. This is tough and the results are not certain. It would be better first to see the patient out of the ICU and then take a view as to how far and how quickly he can progress. So much for market mortality!!

Right now there are no bunkers to this attack. If you are exposed you can do very little. If you did shelter yourself with some foresight (by being in cash), stay there and do not come out. You will require it to ride it out. If you have excess cash – say which can see through a generation – then may be you can take the risk of some exposure – The Warren Buffet Way. If things do workout in the next 3 to 5 years in your favor, you may be able to see another two generations through! For others it is caveat emptor.