Blast from Financial Armageddon's Past

OK, so it's three years old, but after yesterday's market plunge, the commentary I posted in March 2007, "Rise of the Selling Machines," suddenly seems as fresh as ever:

In the popular 1984 film, The Terminator, current California governor and former actor Arnold Schwarzenegger plays a cyborg sent back in time to eliminate the mother of future leader John Connor before he could be born. Single-minded and highly developed, the robotic killer relentlessly pursues his intended prey throughout the movie, despite strong resistance from the hero’s supporters, although the good guys eventually win out in the end.

While the story is pure fantasy, some may not realize that in the stock market there are the equivalent of dangerous man-made automatons lurking in every corner. Often technology-based, they are powerful, sophisticated, and difficult to keep under complete control. Yet they are exerting a growing and pervasive influence on prices. Unfortunately, these potential share-price assassins, if they were to be suddenly unleashed all at once, represent a Terminator-like threat to financial markets, especially if conditions are just right.

Like they are now, when the economy is rolling over and share prices have already begun to correct from historically overvalued and overbought extremes.

First among the potentially destructive creations are exchange-traded funds, or ETFs, which have become a significant feature of the modern investment landscape. Far too significant, some would say.

Recent research from Prudential Equity, for instance, suggests that buying and selling in three small cap ETFs is having a sizeable impact on certain stocks in the Russell 2000 index. By their reckoning, activity in Barclays Global Investors’ iShares Russell 2000, iShares Russell 2000 Value, and iShares Russell 2000 Growth index funds accounts for 20% to 40% of turnover in some smaller issues, according to the Wall Street Journal.

Like index-related arbitrage and other forms of basket-type trading, such activity is not driven by fundamentals in the traditional, Graham-and-Dodd sense, but instead reflects the rapidly expanding role of various technical, arbitrage, thematic, and macro-type investing strategies.

The problem is that while some of this “price insensitive” trading—not based, in other words, on stock-specific information or insight—has been a boon for equity markets in recent years amid gushing liquidity and a mad dash for incremental returns, the negative consequences for prices as credit, economic, and investment cycles turn for the worse could be considerable.

Under the circumstances, index-related selling, for example, could transform markets in thinly-traded securities that have been unusually liquid and serene into boggy swamps of illiquidity. This would spur widespread fear and even a sense of panic, along with a substantial increase in volatility, as hordes of investors scramble nervously towards the exits.

The broad use of chart-based, trend-following, and momentum-driven trading and investing strategies is also likely to exacerbate the market’s woes in the face of a sustained downturn. With fear a more powerful motivating force than greed, the herding behavior that such methods naturally encourage will likely create a snowball effect that will be hard for anyone—either those diving in or those bailing out—to resist.

Other modern risk-management methods and tactics will also fan the bearish flames once former long-term bull markets start coming apart at the seams. These include the widespread use of high-powered statistical and computerized models that measure and help manage risk exposure using data derived from recent market behavior. When trading conditions are serene, firms can take on more risk; if prices start swinging wildly, they must cut back on their exposure, which often means selling into a falling market.

In the past, corrections and full-fledged bear markets have been accompanied by significant price gyrations and converging correlations between different products, sectors, and markets. When that happens in an environment like we have now, where there are numerous large institutions with complex and highly-leveraged bets in myriad markets, it creates the potential for a seemingly relentless death spiral where selling leads to increased volatility, begetting further selling.

There is also the unsettling and potentially destabilizing fallout from the growing use of portfolio-based margining and risk management strategies. Aside from the sudden and unwelcome appearance of gaps between expected and actual risk of loss, rising illiquidity in some markets will force many participants to try and sell positions or hedge themselves in others that remain accessible, causing additional markets to quickly buckle under the pressure.

Another potential source of destructive energy will likely stem from capital flows linked to gyrations in foreign exchange markets, a far-reaching reassessment of trade policies in the face of slowing growth around the world, and the unwinding of global financial imbalances that are already at unsustainable extremes.

Moreover, during uncertain times, history suggests that investors tend to favor repatriating funds that are invested overseas, regardless of whether the decision makes sense in the long term. 

Finally, a dramatic increase in outstanding derivatives exposure, especially in recent years, suggests that violent crosswinds associated with speculation, hedging, and unwinding will wrack the underlying assets. Formerly deep out-of-the-money and structural long-term derivatives positions that were once thought to require little oversight will suddenly demand active risk management, as will exposure taken on in more recent times.

Overall, there are myriad signs that the economic winds are shifting and a bearish darkness is settling over the investment landscape. It’s worth remembering, of course, that when the share-price Terminator shows up, he won’t just be a character in a movie.

Comments

[roger]

What seems like a good idea to day,could become
a very bad one in the future.
Humankind is forever saddled with limited knowledge,
blinded by desires for instant gratification.

[ykw]

The Terminator: Main Street & Wall Street Inverse Correlation

Ok, so now you see how the market works. Employ a little relativity, and expand that 35 minutes to 35 years. When a fat, ignorant investor jumps into the tank, the sharks pounce immediately. When skinny, ignorant investors jump in the tank, the sharks continue eating the fat ones and leave the skinny ones to fatten up. The vast majority has no business being in the market, seeking something for nothing, through passive investment.

Most individuals would serve their own purpose better by investing in themselves. A good rule of thumb for a job is that you should be learning practical skills 50% of the time, on average, paid by the employer. Otherwise, work half-time, just to get enough cash flow to meet minimal expenses, until self-investment returns the required skills to demand the necessary pay, or to start a small business.

The pension plans are now fat, ignorant investors. Agency works for agency, not you. It’s not bad or good; it is. If you managed your own money, you would be thinking about it at night. A money manager has thousands of clients, each with different needs. Even if we ignore management fees, it is not possible for them to manage your life / wealth. The pensions are toast.

As a rule of thumb, roughly, for a small business, in a symbiotic world, you can pull out a profit generally equal to working capital, 10-20%. Let’s use 10% for a start-up. In equilibrium, over time, labor is going to cost 50% (51%), one way or the other, which means that if you want to make as much as the average employee, you need to have 5 employees. If you want to make more (not recommended – go the corporate route), you need to have more employees (you are all in the same boat).

You need to be the best, so, over time, you cannot both do the work and manage the business. When everything cancels out across the economy, the only thing left is unique talent. Your unique talent is the foundation of your business. A collected portfolio of unique talents among your employees builds out your business to fill your niche. If you balance the fulcrum, the laws of physics ensure increased voltage, in quantum jumps.

Once you have run a business effectively, or worked in several effective businesses, what the multi-nationals are doing in the markets becomes crystal clear. At that point, you are in a position to actively invest and beat the market.

How you let agency out of the corner is up to you, but be realistic. What kind of world do you want to live in, given the practical development time required to overcome existing limitations? Real change happens across generations. It took 35 years of 7/24 effort to corner the empire. Don’t waste the opportunity. How do you want to raise your children?

Agency – public, private, & non-profit, is the net sum of responsibility not taken by individuals over time. Virtually group with others that accept their share of responsibility, and leave the rest to the arbitrary management of multi-national corporations, to balance the fulcrum. The very best you can do is be a solid example to children, because you will be dependent on the smarter ones in your old age, regardless of what numbers are entered into the computer.

Communities cannot be extensions of the state, which are extensions of the nation, which are extensions of the cartels. They have to exist on the other side of the fulcrum, with a looking glass for virtual separation, between themselves and the cartels, which has all kinds of implications. For example, as a small business owner, you do not want to engage the global corporate information system, which guarantees your ultimate liquidation, to decide who you are going to hire or rent to.

Look around. The planet developed humans. Humans developed markets. Markets are designed to draw people, who want something for nothing, with a ponzi scheme, into a nice warm pool. Now, the planet is increasing variability. Hello. Trying to outsmart the planet as a learning exercise is one thing; expecting to actually do so is another.

Wealth is a function of profit, from tapping the universe, to grow the universe, and we have not begun to tap our potential. The universe is like a giant pool table, with trillions of balls colliding, over time, and we have a few snapshots, of a few balls, over a very short time period, in a quantum system. Knowing the unified field equation does not tell you what is going to happen tomorrow. For that, you need a computer, the size of the universe. You can only control a shrinking piece, for a shrinking period of time. Resistance to change is a parameter of gravity, and gravity recognizes gravity – the black hole. Gravity is the shark.

The game is still afoot in the market, and the multi-nationals obviously have no financial trump. Where do you suppose all the trump counter-balancing their power is?

[This is unbelievable]

We need audits.

Rep. Alan Grayson: You Own the Red Roof Inn, Thanks to the Fed; Why the Fed Does Not Want an Audit; America is Wall Street's Sucker

http://tinyurl.com/2ftuxaq

[Truth Seekers - CLICK HERE!]

go and watch this video on the market crash.... http://www.youtube.com/watch?v=O0ROwi7aQLk