Rational Advisor

Okay, for all you that think you are smarty pants try this

http://www.intelligence-test.net/part1/

Just to let you know my score was 16…

Rational

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http://people.ambrosiasw.com/~andrew/funny/piggy.swf

Rational

From the Oct 2, 2007 House Financial Services Comittee in the US

“Although the particulars are different, our reading of financial history suggests that the abuses and risks are all too similiar and enduring. When you strip them down to their essence, they are variations on a few hardy perrenials - excessive leveraging, misrepresentation, insider conflicts of interest, non-transparency, and the triumph of engineered euphoria over eidence”
- Robert Kuttner, Financial Commentator

17 Oct 2007 Financial Times of India
The government’s proposals, under which it wants to curb the use of offshore derivative instruments that allow foreign investors to trade anonymously in underlying Indian stocks, were packaged as a “discussion paper”. In reality, the document is infused with an urgency that suggests it could be implemented as early as next week.

“If the document is implemented as it is, it will be bad for the market. There will be more selling to come. But there is some feeling that there could be a bit of backtracking on the part of the authorities,” said Rajeev Malik, economist with JPMorgan.

Under the government’s proposals, foreign institutional investors would face tight restrictions on new issuance of the instruments, known as participatory notes or P-notes. In addition, a significant portion of those already in existence would be required to be wound up within 18 months

JPMorgan estimates the no­tional value of P-notes in the market at about $89.8bn (£44.1bn, €63.2bn) as of Au­gust this year, or nearly 52 per cent of assets controlled by foreign institutional in­vestors. This was more than 11 times greater than March 2004 levels.

The market for issuance is dominated by about 10 foreign investment banks and is believed to generate a total of about $200m-$300m for their bottom lines.

India’s market has risen 19.4 per cent since the US Fe­deral Reserve cut rates in mid-September, with much of the rise driven by an in­flux of money through P-notes.

Market participants said the move to wind down the P-note system was inevitable as India’s regulatory environment evolved to­wards global best practice.

“If we’re going to become a developed market, you need to know where all of these flows are coming from. Hot money flows are good for nobody,” said Tarun Kataria, managing director and head of corporate, investment banking and markets, India with HSBC in Mumbai.

Others say the government will need to improve procedures for registration for foreign investors to encourage them to come in the front door. The regulator only re­cently started allowing hedge funds to register and many remain reluctant to brave the red tape, which is time consuming and expensive.

There is also a widespread belief that many of the investors using P-notes are in fact the controlling shareholders of Indian companies who are playing their own stocks. (Rational - Insider trading, manipulation - why am I not surprised!!!)

Another group suspected of surreptitiously playing the market is Indian politicians, many of whom stash their wealth offshore. (Rational - again, why am I not surprised!! Corruption)

While exposing these scams will be good for governance, it might mean there will be less liquidity in the market in the near term. That could spell bad news for the great Indian bull-run over the next few months.

17 Oct 2007 07:17 BST From Financial Times: India’s financial markets plummeted at the start of trading on Wednesday after the stock exchange regulator moved to restrict foreign portfolio inflows of capital via offshore derivatives.

Trading in India was suspended for an hour three minutes after the open, following the breach of circuit triggers. Stocks are expected to fall further when markets reopen. The Nifty index plunged by 524.15 points, or 9.25 per cent, to 5143.90 while the BSE Sensex dropped by 1,507.71 points, or 7.91 per cent, to around 17,544.15 before trading was suspended.

The rupee fell to two-week lows, down 1.4 per cent to 39.88 against the dollar from Tuesday’s close. The market decline came after the Securities and Exchange Board of India on Tuesday night released a discussion paper proposing policy changes on offshore derivative instruments. Sebi’s proposed restrictions on the issuance of participatory notes to offshore investors would effectively plug an important source of equity inflows.

Thursday 18 Oct 2007 09:46 BST From Business Week online
Business Week reports: It was a shock for everyone playing the Indian stock market. On the evening of Oct. 16, the Securities and Exchange Board of India (SEBI) issued a statement on proposed policy changes. Worried about manipulation in a hot market, the regulator proposed to restrict the usage of offshore derivative instruments by foreign investors as a route to playing the Indian stock market. It gave investors till Oct. 20 to adapt to the new rules.

The suddenness of the decision took everyone by surprise, especially since billions in foreign money had entered India through these derivatives. When the market opened the next morning, Oct. 17, it fell almost immediately by 1,500 points or 9%—quite a switch from the day earlier when the Mumbai index closed at its all-time high of 19,000. The selling was so furious that trading had to be suspended shortly after the market opened. It was only after soothing statements by the regulator and the Indian finance minister, P. Chidambaram, that New Delhi did not mean the measures to be so harsh, and that they were awaiting market feedback on the changes, that trading could be resumed. The market climbed back up, to close at 18,633, down just 360 points in total.

From The Hindu Friday Oct 19
MUMBAI: The stock markets witnessed the biggest single day fall on Thursday as the Bombay Stock Exchange 30-share sensitive index (Sensex) lost 717.43 points at 17998.39. Metal, realty and bank stocks were the worst hit. On the National Stock Exchange (NSE) the 50-share Nifty also was down by 208.30 points at 5351.

The Participatory Notes (PNs) issued by the foreign institutional investors (FIIs) are still creating confusion in the stock market as the capital market regulator plans to impose a cap on the investments through this route, where the identity of the investor is unknown The heavy institutional selling took the indices to below the 18000-mark, which was achieved few days back.

Rationals thought - Although I don’t think this is the major drop, I do think we are close to it. Just think February, it was China, and now it’s India. These emerging markets volatilities are telling us something - Be careful.

By Standard & Poor’s reckoning, the bull market celebrated its fifth anniversary this week. The lowest point touched by the S&P 500 after the tech bubble blew up came on October 9, 2002. It has been on an up trend ever since.

The same applies to the Morgan Stanley Capital International World index, which covers the world’s developed markets, and which troughed on the same day.

It seems like nothing fazes the equity markets these days, not even October, the month that brought us the memorable crashes of 1929, 1987 and one or two others. They are quick to rally on the flimsiest of favourable news and eager to discount any signs of trouble.

It’s as if the August meltdown never happened, and the U.S. housing crisis, subprime mortgage disaster and continuing global credit crunch were just figments of borrowers’ overactive imaginations.

Could it be that investors are stirring happy pills into their morning coffee?

It’s no coincidence that the recent turnaround began right after the Fed slashed interest rates last month, just weeks after the Fed, the Bank of Canada and other central banks poured money into the financial system to fend off the credit crisis.

Just pour piles of money into the financial system, slash interest rates by half a percent and the bears are all trampled to death. All that money in a few hands is powerful and it doesn’t take much to power the markets higher through buy programs, futures, ETFs and other derivatives.

Both the MSCI World and Emerging Market equity indices struck lifetime peaks, while Wall Street also set new records

However, it was Asia that enjoyed the lion’s share of gains as investors remained convinced that strong growth in the region would offset any slowdown in the US.

Hong Kong has been one of the strongest performers it has been the chief beneficiary of funds from mainland Chinese investors following Beijing’s relaxation of investment rules. On August 20th, Beijing said that Chinese retail investors and other investors could purchase Chinese shares through Hong Kong.

This market almost seems to be gloating. You throw everything at us and we’re already back setting new highs.” But that’s what happens when central banks pour in liquidity and punters become convinced that the bailouts will keep coming if the financial system smashes into any more icebergs.

But volumes have been down so I know there is not a lot behind this.

That means it would not take much to send stocks spinning the other way and quickly drive out such non-economic players as the quantitative funds that base their bets on trading data and other technical factors.

Certainly profits are weakening. The credit crisis is still there, but has been pushed into the background. The housing market is a mess. The consumer is tapping his credit cards as a last defense.

Plenty of people have lost their shirts betting against the remarkably resilient U.S. consumer, whose continued free spending is all that stands between continued slow U.S. growth and an outright recession.

For instance, half of U.S. states report that sales tax revenues are falling short of expectations, a sure indicator that higher mortgage costs, falling house values and uncertain job prospects are restraining consumers.

There is also a range of rather less joyous anniversaries this month

On Friday, October 19, brings the 20th anniversary of Black Monday, the worst day in the history of the developed world’s stock markets. On that day alone, the Dow Jones Industrial Average fell 22.6 per cent, its worst single day.

Wait another week for an even more inauspicious anniversary. On Monday, October 28, 1929, the Dow fell 13.5 per cent. The next day it fell a further 11.7 per cent. This was the Wall Street Crash that would usher in the global Great Depression.

And the 10th anniversary of the worst day of the 1997 Asia Crisis, which finally hit the US and Europe on October 27, 1997, is also almost upon us. That day, the New York Stock Exchange was forced to close early by the weight of selling, although it soon recovered.

The biggest dive in terms of points on the Toronto Stock Excvhange came on Wednesday, Oct. 25, 2000, when the index fell 840.26 points in a day as the tech bubble burst, while the Toronto market fell more than 10 per cent on Oct. 19, 1987.

Four of the 10 biggest single-day point drops for the Toronto index came in October, none in September. And the mother of all bad days on the markets, Black Tuesday, came on Oct. 28, 1929, when the Dow fell 12.8 per cent.

The results of such dramatic declines can vary. After the crash of 1929, the Federal Reserve responded by tightening monetary policy. The result was an economic disaster.

But in 1987, and again in the late 1990s, the Fed reacted by easing monetary policy, and the markets went on to new heights.

Also, true turning points can be difficult to spot. Black Monday changed investor psychology, but it did not blow the economy off course. Meanwhile, there was no single dramatic day in March 2000 to signal that the tech bubble had at last burst. That realization dawned over a matter of months.
There was also little ballyhoo in October 2002 when, it now turns out, the new bull market took life.

In combination with the realization that the current “up” or bull cycle has now lasted 60 months, while the average for the 12 post-war bull markets as measured by S&P is only 56 months, the raft of nostalgia for big market crashes can only help to unnerve investors.

It is hard to find too many similarities with the horrors of the worst Octobers past, but world markets do show some disquieting tendencies.

Interest is focusing on particular sectors and stocks that are showing positive momentum. That suggests investors are herding into stocks that are already moving forward.

This is a dangerous business and can lead to sudden falls as soon as investors decide it is time to jump off. Market advances are becoming narrower, with fewer big stocks leading the forward motion. Advancers are increasingly outnumbered by decliners in the major indices.

In the options market, investors are showing an abnormally strong preference for “put” options - which confer the right to sell at a given price and hence act as insurance against a market crash - rather than “call” options, which allow you to buy at a certain price.

But the most worrisome examples are in the Asia-Pacific region, particularly Hong Kong. Whatever the case for the underlying economies in the region, the growth in their stock markets in recent weeks is unnaturally fast and plainly driven by flows of money. Most alarmingly, Hong Kong’s Hang Seng has
gained 46 per cent in less than two months, since Chinese authorities cleared the way for domestic retail investors to invest there.

A comparison of the Shanghai Composite over the last 16 months with the NASDAQ Composite in the 16 months leading up to the bursting of the tech bubble in March 2000, is cause for alarm. The two charts are similar, except that Shanghai has accelerated even more.

The odds of a meltdown probably are low, but they’re not so remote that investors shouldn’t be maintaining liquidity. Giddy markets should inspire caution. And the markets — as they were in 1987 — are giddy now.

We believe that the disconnect between stock prices and fundamentals will self-correct over time.

While the markets have rebounded from earlier lows, it’s important to understand that volatility is a normal part of investing. Long-term investors go through many ups and downs over the years. The successful ones are those that filter out the day-to-day fluctuations and focus on the things they can control, including their emotions.

Rational

The leading candidate is a major geopolitical shock. A U.S. attack on Iran, for instance, could drive oil prices past $100 a barrel, lead to wholesale liquidation of dollar assets by Middle Eastern investors and destabilize the region by drawing powers like Russia into the conflict. That, in turn, could set off a financial crisis by prompting wholesale liquidation of stocks by leveraged hedge funds and other investors, while putting enormous stress on the leveraged balance sheets of major banks and securities firms. Such a catastrophe could be worsened by the trillions of dollars of derivatives that Berkshire Hathaway CEO Warren Buffett has called “financial weapons of mass destruction.”

Meanwhile, top executives at Goldman Sachs and elsewhere have referred to August’s market setback as a 100-year flood or a 20-standard-deviations event - a fancy way of implying that it was a statistical fluke unlikely to recur. Dislocations in the mortgage and leveraged-finance markets emerged, hammering stocks by nearly 10% over a few weeks and battering a group of big quantitative equity funds that suffered declines of as much as 30%.

What happened in August, however, was no extreme event. The setback in the junk-bond market was mild compared with what happened in 2002. If a geopolitical shock erupted in a period of market instability, the Street would have to deal with some real financial trouble.

IT’S WORRISOME THAT THE BEST and brightest on Wall Street consistently underestimate the odds of market-jarring events because this suggests that the financial community isn’t well-prepared for a true 100-year flood.

Why is it every year or two, we seem to experience 100-year events? When people talk about a 100-year flood, it’s another way of saying that something bad happened and they didn’t expect it.

As the markets get more complex, leveraged and interconnected, they become more crisis-prones. Advances in engineering have made the physical world a safer place, but financial engineering has increased dangers for investors.

Then and Now for instance, the leverage used by hedge funds and financial institutions can create the potential for a cascading decline, because price drops can lead to forced selling. The selling then can feed on itself and infect unrelated markets. That’s just what happened when the Long-Term Capital Management hedge fund collapsed in 1998. And despite the often-heard theory that the major stock markets are decoupling, there seems to be a growing correlation among them when prices drop. The growing influence of hedge funds and other leveraged investors may account for that.

Wall Street firms like to talk about their tolerance for risk and their willingness to provide liquidity. But these financial behemoths are highly leveraged, sometimes having just one dollar in equity capital backing every $30 of assets. Their holdings include tens of billions of dollars of illiquid securities. In reality, if disaster strikes, the financial giants might be sellers of assets and seekers of liquidity.

A BIG PROBLEM WITH LEVERAGE is that it can force investors to sell just when markets are most depressed and opportunities are greatest. The U.S. mortgage market arguably is as attractive as it has been in several years, but a leveraged investor like Thornburg Mortgage can’t take advantage of it. It was a forced seller of mortgages in August because lenders wanted their money back.

GEOPOLITICAL RISK, ESPECIALLY the danger posed by Iran, has been discussed

Given the hawkish view toward Iran by some officials in the Bush administration and the unpredictability of the Iranian regime, the odds of a U.S.-Iran conflict aren’t trivial — although the ability to wage war against Iran is questionable, given the U.S. armed forces’ deep involvement in Iraq. Iran has long been an irritant to America. In fact, one factor in the 1987 crash was the uncertainty caused by a U.S. attack on Iranian oil platforms that Washington said had been used to attack an American tanker.

The repercussions of a U.S.-Iran conflict could cause a repeat of what happened after the onset of World War I – an extended shutdown of major equity markets. The World War I situation shows just how fragile liquidity can be. Financial markets were blind to the coming of war in 1914 until it had virtually begun. The markets now might be ignoring the growing danger in the Middle East.

Another obvious risk is a Chinese economic slowdown or financial crisis. It’s notable that the biggest decline in the Dow this year — 416 points on Feb. 27 — was a direct response to a sharp sell off in the Shanghai market. While China still probably isn’t big enough in the world economy to prompt a market crash, it certainly could contribute to one.

There are several parallels between the economic and financial backdrop in 1987 and now, including a weakening dollar, rising oil and commodity prices, inflation fears, a long-standing economic expansion, an elevated stock market, a relatively new Fed chairman, rising protectionist sentiment and a lengthy span since the last 10% market correction.

Perhaps the most alarming similarity bears on the dollar, which has been under pressure against the euro, pound and Canadian dollar.

Prices of key commodities have surged this year, with gold hitting $750 an ounce, its highest level since 1980. U.S. financial authorities aren’t publicly talking down the dollar, as Treasury Secretary James Baker did to harmful effect just before the 1987 crash. Henry Paulson, the current
Treasury secretary, keeps reiterating that a strong dollar is in the national interest, but few in the currency markets think he means what he’s saying. Instead, they see Washington tolerating a weak greenback because it stimulates exports and should help trim America’s record trade deficit.

THE U.S. MAY BE PLAYING a dangerous game, because the depreciating currency might be taxing the patience of world central banks that are seeing the value of their huge dollar-denominated holdings erode. While a run on the buck — and a sharp market setback — are possible, it doesn’t appear to be in the interest of big dollar-holders like China, Russia or the Middle East nations to precipitate a collapse in the currency.

This has been the most volatile year in the bond market in ages as the outlook for rate changes has switched several times. Since the beginning of the year, the yield on the 10 year Government of Canada bond ran from 4% all the way to 4.8% and then back down to 4.4%.

As explained in his October edition of Basic Points — titled The Ghosts of Octobers Past — BMO Financial Group global portfolio strategist Donald Coxe laments the fact the U.S. federal reserve caved to Wall Street in its recent 50 beeps cut in interest rates.

Coxe writes that there is “no doubt” the Fed’s cut “has vastly benefited a collection of hedge fund managers and investment bankers whose collective wealth was already in the hundreds of billions of dollars.”

The next Coxe paragraph is worth framing: “The subprime and private equity excesses which created this global liquidity crisis originated in the misbehaviour of immoral and unconscionable people, many of whom happened to be very, very rich — and were determined to regain whatever wealth market forces had drained from them when their overleveraging, reliance on models rather than markets, misrepresentations and — in some cases — fraud were revealed.”

Coxe hits the nail on the head when he observes that the justification of “protecting poor homeowners” constitutes “mendacity on majestic scale.”

UBS is reassessing a “pure cyclical exposure” by cutting basic materials and energy to “neutral” from “overweight,” making technology its largest
“overweight” sector and moving telecoms to a modest “overweight” from “neutral.”

Speculating on the future

Last year, two U.S. senators published a report on the energy futures markets called “The Role of Market Speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat.”

As the title implies, the senators wanted to make hay by looking at what those shady hedge funds were doing to oil prices. It turns out that the report was pretty much ignored until recently, but its findings were interesting and it could lead to changes that would make it harder to
speculate. If speculators are a big factor in crude prices, and if the report’s recommendations gain traction, we’ll soon find out how big.

At the time, the benchmark oil price was about $70 (U.S.) a barrel, even though U.S. inventories were the highest they’d been since 1998 - not too far from the situation today. Although the report said it’s difficult to quantify the extent to which speculators affect the market, it found, not surprisingly, that speculation did move prices.

Who would disagree with that today? Last month, the Organization of Petroleum Exporting Countries announced an increase in production and the price of oil rose instead of fell. US Fund company Pimco’s commodity fund has grown from nothing to $12-billion in five years. Enbridge estimates that 25% to 35% of its crude oil storage is leased by financial firms playing the difference between spot and future prices. Big global banks have big energy-trading operations.

There are other signs of speculation in energy markets, too. Open interest - the volume of contracts agreed to - on the New York Mercantile Exchange has tripled in the past three years. While it’s true that higher prices can bring on more contracts, it’s hard to say speculative money isn’t a big thrust under oil prices, given the rash of new commodity funds and the cash they’ve raised. The Pimco fund is just one example; most pension funds around the world have some cash devoted to oil futures.

Nymex used to be pretty much the only place for trading energy futures in the United States. Not any more. The over-the-counter market, according to the Bank for International Settlements, now does 20 times the volume. During the oil price crashes of the eighties and the nineties, the OTC market was negligible.

The natural state of affairs in the futures market is for a producer of oil to agree to sell a barrel of oil in, say, three months for an agreed-upon price. The buyer will be a refiner, which uses oil, or an airline, which wouldn’t use the oil directly but rather as a hedge.

Now there are legions of other buyers - we don’t know exactly how much buying they do - who are simply gambling on a thesis: that oil is headed higher. It’s not a bad thesis - oil is finite, producers have underinvested for a long time and are in no huge hurry to crank it up, and Third World demand seems strong. But does it justify $80+ oil?

Probably not. Oil analysts vary widely on this subject, but a sample of respected ones says the speculative premium in crude adds between $20 and $35 a barrel.

What if these investment funds - and they’re not all hedge funds – decide they want to short the market? Since they tend to move in a herd fashion, that would mean a big drop in oil prices.

As things stand, it doesn’t look as if there are many reasons for the fund to go short, given the rise in oil prices. But the statistics aren’t that reassuring. High prices always lead to a drop in demand. The U.S. consumes about a quarter of the world’s oil, and demand there is starting to fall.

And there might be an even better reason. The Senate report says that changes to the U.S. Commodity Exchange Act, which Enron lobbied for and got in 2000, make it difficult to track speculative positions in the future market. Basically, big traders can use the OTC and London based markets to anonymously trade and, perhaps, manipulate prices as Enron did in energy. The senators want to put a stop to that, and the Commodity Futures Trading Commission does too: This summer, it said it wanted to tighten its oversight of the OTC market, which comprises 75% of U.S. energy trading. Lawmakers are in favour, so new rules are likely on the way.

Observers figure these proposals would curb a lot of speculation in the energy markets, which might just trigger a change in the herd mentality. In the words of an energy trade quoted in the report, “When those entities decide to start liquidating their futures positions, look out below.”

Rational