I like this hypothesis in economics that state that markets are efficient especially stock markets. If you buy something on the stock market, it is correctly priced and your return is depends on the risk you're taking. Economists believe that stock prices follow a random walk with an upside bias and investors cannot predict the movement of stock prices. The hypothesis states that stock movement today is independent of its movement yesterday. The stock market prices are supposed to reflect all known information and only new information will move markets.......
Given the market turmoil of the past 2 weeks, I think most investors will ask the economists to "go fly a kite" with that hypothesis. It is very clear to them that markets are more likely to move down than up. The risk of inflation, subprime mortgages and a rising possibility US recession continuously pressure stocks to move down. It is crazy not to get out of such a market because "the sky is falling". Market commentators believe the stock market have more downside and "the worst is yet to come". As I type this, the US market looks set for an awful start today and futures indicate that it has a triple digit loss....the US$ looks weak, tomorrow Asian stock markets will sell off and that leads to more selling in US markets etc.....looks very predictable to me. So how does one reconcile the Efficient Market Hypothesis (EMH) with the behavior of our markets in recent times?....are the economists wrong?
[....I've to go out now. I'll be back to write what I think is going on in the markets. Please if you have any views on the recent market turmoil or the EMH, please leave a comment... ]
Went to sleep, woke up to check the DOW and saw it has plunge 211 pts. Now if that is not going to cause a panic tomorrow, I'll be surprised. Then there will be selloffs in Nikkei, STI, Hang Seng and so on. ...its like a pattern. Last week's selloff I believe is due in part to the unwinding of the Yen carry trade more than fears of a US slowdown. As the Yen strengthens, hedge funds that borrowed the Yen heavily to purchase higher yielding assets around the world are forced out of their position. You can tell how much unwinding takes place by the "across the board selling" that takes place - you see commodities, stocks, Aussie$, NZ$ etc selling off at the same time. In the past 2 days, while stock markets around the world fell, oil and commodities rose and emerging market currencies fell - the unwinding has abated what is happening now is hedge funds are pulling out their money from risky emerging markets. Remember these hedge funds were responsible to our index rising from 2800 to 3800. The selling has been indiscriminate - it doesn't matter if the stock had good earnings and growth potential, they are just sold off with everything else. It is the falling stock prices that induce alot of fear in investors not the deterioration of the economic fundamentals....
"The stock market anticipated 7 of the last 4 recessions", George Soros (I think).
Stock markets fell ahead of every recession and sometimes fell in anticipation of recessions that don't come. In George Soros' book he explained the idea of reflexity - selloffs in stock markets can actually trigger the recession it is anticipating - a form of sell-fulfilling prophesy. ...and George Soros probably triggered the collapsed of the Pound by shorting it heavily together with the speculators preying on counrties undergoing economic weakness. The Asian Crisis was precipitated by hedge funds attacking asian currencies and shorting the stock markets. This caused long term foreign investors who are normally resilient to lose confidence and pull out en masse causing the collapse of Asian economies. Shortly after the Asian Crisis, the US formed a committee to look at the emergence of hedge funds and to develop a govt response to these funds. There are persistent rumors that Hank Paulson is part of a mysterious Plunge Protection Team, whose job is to work with bankers in secret to stabilise the markets in the event of a hedge fund attack (I will come to this later and explain how it is related to the frequent mysterious selldowns we see on the US equities market in the last hour and how it is related to the discount rate cut in Aug 2007). Hedge funds today control several trillion $ and there is little doubt they can move markets.
Last week there was an article in The Edge explaining how the Indian govt can actually buy oil fields and extract oil at less than $50 per barrel and the Saudis complained about the persistent demand for them to pump more oil while they already have no more storage space and have to put them supertankers sailing around without a place to unload. So is there a real shortage of oil? You look at the moves in the oil market, it can go up (or down) by US$3 per barrel in a day, what does that say about real demand and supply? Why is oil rising if the US economy is suppose to be slowing down and US the biggest consumer of oil?
If you go back to Soros' book The Alchemy of Finance, there a few interesting diagrams inside explaining how markets are inter-related and intertwined with the economy. You can mount an attack by creating a vicious cycle. If you examine the attack on the Hong Kong US$ peg during the Asian crisis it goes like this short the HK dollar, this will result in the HKMA defending the peg by raising interest rates, higher interest rates cause the HK stock market to fall, investors fearful of further downside pulled their money out putting more downside pressure on the HK dollar ...and so on. The cycle was broken only when Donald Tsang as Finance Minister decided one day to use the reserves to buy up blue chips on the HK exchange. ...the move caused the market to have its largest one day gain in history and burnt speculators bad enough so they remember not to mess with the HK markets for a long time.
In the book Crisis of Capitalism, George Soros explained that the US economy is likely to face a crisis because of mounting debt. Not only are they running a huge deficit with the rest of the world, the US consumer has chalked up a record level of debt, the housing market is buried by bad debts and so on...all these problems can be traced back to the time the gold standard was abandoned and countries adopted a fiat money system.....since then it has been one crisis after another all related to currency - Mexican peso crisis, Asian crisis ....and the current crisis that is unfolding remember we started with a subprime problem (not a weak problem US$) but now it is transformed into a weak US$ problem.
Now what is happening is the creation of a vicious cycle centered around America's economic problems:
1. Pushing up of oil & commodity prices to manufacture inflation fears.
2. Shorting of US$ and US/global equities since rising oil prices
hurt consumer demand.
3. The weakening US$ can be used to argue for higher oil
....in the meantime the Nikkei gets bashed because the Yen keeps rising. While the US has a real serious subprime problem it is trying to handle and prevent a contagion, the weak US$ & falling US stocks add to its problems. A recession will worsen the subprime problem and vice versa so this can really get nasty. History tells us that if markets are operate at this point without intervention we will see a shock or massive dislocation in the markets soon i.e. the worst is yet to come.
But do governments intervene in the markets? ....and does a Plunge Protection Team exist? ...and why does US market selldown in the last half hour?
.....Go back to 17 Aug 2007, the critical day is the meltdown 3 months ago. I was awake that night to watch the US market trade as fireworks was expected, it was options expiry day and market was very volatile...it (DOW) suddenly broke and went into a free fall -100, -200, -300, -400....just when everyone was about to throw in the towel, the US market made a miraculous recovery to close +ve territory. That night the Fed announced a discount rate cut and the situation was diffused. If you go back to the trading of the past 2 weeks, the market will trade "normally" throughout the day and then a flood of sell orders would come at the last 20 minutes causing the market to close at the low of the day. ...strange why would sellers wait until the final 20 minutes to get out and at very bad prices when they have the whole day to do so. ....a last minute selloff gives no chance for the buyers to step for a better close. Whatever it is, confidence in the US markets is lost and that adds to the downward pressure on the US$ in Asian trade....
Nobody knows when the markets will turnaround. I usually buy when there is alot of fear but I've been selling to raise cash in anticipation of better opportunities to buy. Already I see the dividend yields reaching double digits with some of the REITs having DPUs of 12-15% or more ....a quick check on the various REITs show they are lock on to average leases of 5 years or more even in a deep recession, they should be able to pay at least half the dividends. I'm not a big fan of REITs but if the yield get high enough, I find it hard to resist. ....I'm not biting yet as better opportunities might arise.
When will the market turnaround? There seems to be no end in sight. If markets operate efficiently it should have discounted the subprime problem and US economic slowdown already, but there are probably other forces at work. My take is the currency markets probably hold the answer...at some point the Japanese central bank will have to intervene prop up the US$ as they have done so many times in the past ....... they are now on the verge of recession as their exporters are strained. One verbal warning was given last week by BOJ and typically they will act when the speculators least expect.
Up or down the markets are always very interesting as long as you are cautious and don't get burnt by the volatility. Within the volatile moves are opportunities that will be handed to you as investors throw the baby out with the bath water.