Author: Tom Yorke, Oceanic Capital
Covestor models: Global Diversified Conservative, Global Diversified Moderate, Global Diversified Aggressive
Lately we feel like we are stuck in a Seinfield episode – specifically, the one about the bizzarro world where everything is upside down, where good is bad and right is wrong.
It’s been said so many times – but still bears repeating – if it weren’t so sad it would be funny. That about sums up the War of Words coming from Europe and keeping us all on our respective toes, making the risk-on versus risk-off trade a dizzying daily trip on the Tilt-A-Whirl.
Euro Saga, Chapter 832
For one or two weightless moments last week, the show being performed in Europe felt like some responsible adults might be in charge and politics was going to take a back seat. Unfortunately, by week’s end it became clear that it had all been a head fake; we were in for more of the same and likely worse. The talk degenerated onto modifying treaties and making more suitable domestic unions, rather than putting out the fire burning so brightly right in front of their eyes. It is a game of liars’ poker, and the stakes are a deep and extended global recession at best, but more likely a depression. The best result from our eyes was the coining of the phrase “Merkozy” – a combination of German Chancellor Angela Merkel and French President Nicolas Sarkozy, intended to suggest that there was at least some agreement to be found among the key players.
Exactly what started this week’s collapse is debatable but the leading candidates were clearly the ongoing drop of Deutsche Bank’s commercial paper acceptance by U.S. money market funds. This is quite a large canary in a very small mine. Hellooo, does anyone remember what happened to Lehman Brothers when their CP lines weren’t rolled over?
These large European investment banks rely very heavily on access to the U.S. short term funding markets for their daily operations. A shut down of this access will surely prompt a scramble for US dollar funding elsewhere. If this can happen to Deutsche Bank, imagine what the French banks must look like. It’s been fairly widely reported now that these banks, following new mandates for increased capital, have been pitching any asset they could get a bid for, and certainly not the more beleaguered of assets on their books. This type of capital constriction is surely not going to help Europe “grow out” of its problems.
Having the over-levered European nations come to the aid of the European banks, either through direct loans of US dollars or allowing the various Central Banks to accept highly suspect collateral as “money good,” is not very inspiring. The problem gets worse given that these same banks have bought up the debt of these various sovereign entities and still carry them on their books at face value, when globally these assets can be purchased for 30-75 cents on the Dollar (Euro). This is some house of cards that is being ignored by the politicians … but not the markets.
It’s certainly not coincidental that John Corzine, from MF Global destruction fame, has been all over the news. The loss of $1.2 billion of client funds, previously believed to be in sacrosanct “segregated funds” accounts, has brought the hot white light on Wall Street again, just what we needed. As if the OWS crowd didn’t have enough on their plates. In any case, some global futures markets’ volumes are way down as thousands of previous “customers” have their funds so tied up in this bankruptcy they can’t even trade anymore. The service the speculators provide to us all, by giving “true” farmers and other tradesmen the ability to stabilize their income and lock profits by hedging in the futures markets, is immense and quite probably little understood. If these farmers and tradesmen decide their respective businesses are too financially treacherous and pack it in, good luck finding what you’re looking for in aisle seven of your local grocery store.
All this happening at year end, when liquidity is difficult at best, only serves to exaggerate the process and magnify any market move. The margin clerks are once again pressed into service, legitimately working to protect their firms (and their jobs) by liquidating any asset available to meet looming margin requirements. This traditionally leads to selling of gold and other similarly deep and liquid assets, as the game is not when or even what to sell, but to sell anything as soon as possible. This can cause assets to fall precipitously, break through longer term trend lines and other technical trading patterns and cause a pile-on effect. Anyone who was a bit later to the party – call them “late longs” – gets taken out, as they generally panic and sell, if the margin clerk hasn’t already. This frenzy is not pretty and is what has been driving gold recently. The fundamentals are out of the picture. The paper based, uncollateralized, hot off the printing press dollars seem to be all that matters during a frenzy like this.
Two headlines from Bloomberg’s “First Word” column on 12/15 are not much help:
– Merkel is being buffeted by domestic political turmoil, threatening to distract her efforts to follow through on last week’s EU summit agreement, with her general secretary and coalition partner, unexpectedly quitting yesterday.
– French leaders are girding for the loss of the nation’s top credit rating.
In or Out?
In November we had nine trading days in the first three weeks where owning stocks seemed like pure lunacy, where the markets dropped 7.75%. Then later in November we had the same markets gaining almost 8.5% in just six trading days (Google Finance). Think about that! Could anyone possibly even come close to being in or out of the stock market on the right days? Not so much! It’s a recipe for disaster and an invitation to day trading capital destruction, as well as extreme over use of your mental capital.
So what do we do?
-Stay the course. Don’t be distracted from our goals of being properly diversified across various asset classes, understand no one promised us a direct, trouble-free route from here to retirement or financial security.
– Do not panic, as that only adds to the confusion and duress.
– Look for opportunities within the stress and understand the machinations of the markets, e.g., margin calls and year end illiquidity, and their magnified affect on things.
– Keep in mind all previously “known” correlations between assets often vaporize during periods of extreme stress, as everything can and will be sold off at once, save the USD and US Treasuries (for now), and avoid making any long term decisions based upon the supposed new relationships too soon.
And remember some fast facts:
– A famous Brinson study determined asset allocation determined 93 % of a portfolio’s return.
– In 2006 a Psychological Science study found emotionally impaired patients made better investment decisions than healthy patients.
– Perhaps you heard that missing just the ten best “up days” over 10 years can cause you to sacrifice the great majority of your returns. The point is no one lives in a vacuum, and you will likely participate in some very significant down days during that same period as well, but at least through proper diversification you may minimize negative returns and enjoy the up days as well.
