Traders and Spiderman

The way the global stock markets are behaving these days remind me of one of the most fascinating superheroes of our time—Spiderman. Why do I say that? Because, the only way traders can stay in this market and sleep at night is if they can emulate the agility of our web-weaving superhero.

By the way, those who idolize Warren Buffet and still subscribe to this agonizing “buy-and-hold” strategy, need to rethink; and, do so really quickly! I am a big fan of the Oracle of Omaha, but am also a realist. If you don’t have the kind of money Warren has, then forget this strategy. He can wait and wait for a long time; moreover, he can move a stock price just by buying it. Some years ago, when he purchased the convertible bonds of this much-hyped technology company, level 3 technology (NYSE:LVLT), the stock price shot up (yes, the fundamentals remained the same but Warren’s confidence in the company was enough for investors to jump in). Isn’t that a beauty? You buy these bonds at a low price and stir the market, get the prices to go up, and then  convert these bonds to stocks, and sell. Great! Once you are really successful, it doesn’t matter whether you make a wise or a dumb decision; you still make money and everything is hailed as a “touch down.” Nothing succeeds like success!

Enough written about Warren; let’s go back to our discussion on traders and Spiderman. Since the market hit the March 2009 lows, the major indices have rallied almost 60%-70%. Even though, the sovereign debt troubles were lurking in the background, thanks to the printing presses of central banks around the world, markets kept hitting new highs. This year, though, it has been a different story. Every day, with every new headline, the market has swung both ways. China’s steps to curb lax lending and Greece’s potential default issues (the bulging sovereign debt CDS spread has been well-documented by several bloggers and financial sites, ex: www.zerohedge.com) have scared the investors/traders to take cover. On the other hand, every dip in the market has been used as buying opportunities by some big investors—institutional and hedge funds—scaring-off the shorts who like to take the market further down. In the midst of all these up and down swings, there are serious claims by many Wall Street  insiders that some of the big financial institutions with proprietary trading disks have been happily manipulating the markets, with complete disregard for the fundamentals, and raking in huge profits. As a trader, I can see that possibility. Just when you think the market is downbeat, around 3:30 PM, the market takes a dramatic turn to the upside. This kind of manipulation is even seen in systematic pump-up of S&P futures before the market open. In my observation what I have found is, even when the news is fundamentally bad (I am talking about equities in general) and the global markets are reflecting that pessimism, US stock futures slowly rise, from their deep lows, as the pre-market hours progress toward market opening. I have never understood why?

So, since President Obama came out with his declaration of “Volcker Rule” in 3rd week of January, financial markets have whipsawed with every news headline and economic data. Traders have been forced to buy when the markets went higher and sell or short when the markets went lower. Traders have done well if they have kept their Spiderman instincts and acrobatic skills highly sharpened. Those who wait for the markets to go in one direction, up or down, have been left waiting, because at the end of the day, they have been left with nothing to show. The mantra has been, “take your profits when you have them, and cut your losses when things go in the other direction.”

This can be really stressful. Yet, traders can survive these market swings before a long-term trend is put in place. One has to be disciplined and show great agility to move with the markets and profits can be made in this market. Unfortunately, for those investors who keep dollar-cost-averaging (ex:401k) if the eventual secular long-term trend is bearish, then another “lost decade” could be devastating. Market and economic forecasts from some of the big names (likes of Nouriel Roubini, Harry Dent, Md El-Erian) in the industry have been nothing but lower normal to bleak. After 20 years of expansion and the excesses, some pundits believe that we will be reverting to an historic mean, which in plain speak, means lower markets, lower returns and lower living standards.

I hope long-term investors would still end up earning good returns; but a careful consideration of investment “time horizon” is a must. I know that for most people who are in the stock market, it is simply impossible to move with the market gyrations (it’s not just about the stress, people just don’t have the skill or the time or interest to follow the markets). But those who trade and religiously follow Mr. Market, may do well to learn from Spiderman.

Timing is everything. Good luck to all!

The New Normal

One of my favorite market commentators is PIMCO’s CEO Mohamed El-Erian. He has this remarkable gift of making pithy statements about the prevailing market conditions that really make sense. Without delving into his market credentials, let me simply state that the man is too good in taking a measure of the macro fundamentals and policy effects and explaining it to his audience.

El-Erian has been very vocal about the massive changes in the way the markets would evolve in the aftermath of the financial crisis. In his words, we will be living in a world defined by a “new normal.” I have been thinking about this new normal. While it may sound too alarming to some, I would like to ask this question: “Is this (new normal) what Karl Marx famously wrote about in his 1880 magnum opus, ‘Das Kapital’?” Marx predicted the end of capitalism and the rise of communism. While I am confident that such a dramatic shift in our economic system is too far fetched, it is probably worth our time to understand what Marx was thinking. Robert Heilbroner, in “The Worldy Philosophers” writes this about Marxian predictions:

"Why did it (capitalism) breakdown? Partly because it developed the instability Marx said it would. A succession of worsening crises, compounded by a plague of wars, destroyed the faith of the lower and middle classes in the system."

“The Marxist prediction of decay was founded on a conception of capitalism in which it was politically impossible for a government to set the system’s wrongs aright; ideologically, even emotionally impossible. The cure for capitalism’s failings would require that a government would have to rise above the interests of one class alone—and that was to assume that men could free themselves from the shackles of their immediate economic self-interest. Marx’s analysis made
that doubtful.”

And here we are, plagued by two wars with no end in sight and an economic crisis with a devastating impact on the middle class. This economy continues to lose jobs when it should be creating 150,000 jobs per month, just to keep the new entrants into the job market, employed. Although, Case-Shiller Index is showing some stability in home prices, it could be just a temporary calm before another huge dip. This is very much a possibility, if the middle class continues to get squeezed with no relief in the job market. On top of it, soaring deficits and national debt is not making it easy for those who are constantly worried about the future. Debt may not be a problem, provided we have the capacity to grow. But that notion of sustained economic growth and productivity increase are things of the past. If history is any indication, the debt level and the flood of fiat currency, thanks to the Fed, will eventually lead to inflation and higher interest rates. There are counterarguments to that notion, especially, with forecast of tepid consumer demand and contained labor cost due to prolonged high unemployment, that instead of inflation we may see Japan-like prolonged deflation. But, if demand for the US debt tapers for obvious reasons, especially among foreigners, the yields on the long-term bonds will rise thereby increasing the prospects of higher cost of capital. That will certainly dampen the recovery of housing sector and strangle business investment. How do we grow then? Lack of sustainable growth (not the growth that creates excesses) means that the country has to embrace new austerities, otherwise face a daunting possibility of nation’s inability to service the sovereign debt!

In the midst of all these economic upheavals, those who rely on jobs to sustain their living and building a nest egg will find things really difficult. Global competition in the labor market will ensure slow income growth while fight for resources among the nations will certainly impact the commodity and energy prices. And, the continued military expenses will distract the US from diverting all the precious capital on education, healthcare, economic growth and the funding of social security and Medicare. Is that the Marxian breaking point? I am sure, the American willpower and the ability to fight against all odds may save the day, but that does not change the prospects of a new paradigm of living for ordinary Americans.

This new normal, is, in a way good for this young nation. In the long run, new austerities and focus away from material excesses will be beneficial for this country. As long as people believe in the system and its fairness in most occasions, they are ready to ignore some of the imbalances and the acts of few corrupt people while striving to adjust to the new realities. In the short term, the process of adjustment to these new realities will engender pain and anger. That can be managed if our leadership forgoes the partisan politics and starts governing with a promise of better future.

The more I think about the aftereffects of the current crisis, more I am convinced that this extreme notion of “growth at any cost” will lead to highly asymmetrical societies, which essentially, what the Marxian ideologues wish to see. Although, asymmetry is a fact of capitalist society, as those who are able and somewhat lucky, hardworking and opportunistic, can quickly climb the economic ladder while the rest would have to be content with what’s left in the middle and the bottom. Economic inequality is an unavoidable fact of the system we live in. Yet, so far, this system has proven to be just, creating opportunities for all and instilling a belief that if one is ready to work hard, one can reap the fruits of that hard work.

However, the kind of economic asymmetry that helps create conditions, which could potentially throw us back to the days of feudalism, is at the heart of this discussion. At this point in our history, we can recognize that egalitarian society is a utopian concept; however, if the growth mechanisms we put in place create conditions that enable the common man to make progress, provided he is making the right choices, then the system will do well and sustain itself. That system, undoubtedly will be under threat, if those conditions enable only the rich and the powerful to stretch its fabric, to such an extent, in an effort to amass filthy riches, that the general well being of the common man is completely disregarded.

Here I want to digress a bit. Being an active market participant, I watch lot of financial news. And, what has bothered me in the recent years is the presence of plenty of reckless enablers who in the name of “free market capitalism” glorify excessive risky behavior. I call them “enablers” because they are precisely the kind of people who refuse to talk about “inclusive” capitalism. They do not understand the true dharma of capitalism. They are the ideologues on the other end of the spectrum who drum up the rhetoric of “growth is good” even when the growth is built on unsustainable leverage in the system; these are the same people who are unapologetic in their quest for resources of this planet and instant use of these resources lest their miracle growth could escape them in their lifetime. They don’t even spare a thought for the future generations or the long-term sustainability of mankind. They are ubiquitous in times of asset bubbles. Unfortunately, their voice is heard and they somehow find success in reducing the masses into “intellectual parasites”, as they go about attacking those who publicly criticize their crony capitalist ethos. The good news is, as the system reverts to a more meaningful mean, these folks will find it hard to survive.

Coming back to my new normal theme, I think it is apt to remind the readers about the economic philosophy of the great Indian leader, Mahatma Gandhi. He rightly rejected the welfare state as an assault on the dignity of individuals’s ability to be responsible for themselves. He wanted an economic system that required people to be self-reliant. Yet, he was also against “rapid” industrialization. He felt that the ideal of endless economic growth could be inhuman and destructive. That is not a stance against capitalism or the idea of economic growth that brings prosperity to most. Nonetheless, his economic philosophy cautions the policy makers to approach growth without losing sight of long-term societal harmony.

I don’t think, we capitalists, rue the possibility of an economic bust after a significant period of healthy growth. We are accustomed to the cyclical nature of business. No business lasts forever and no industry enjoys infinite growth. Joseph Schumpeter, an Austrian economist, described these cycles of innovation, obsolescence and the emergence of new industries as “gales of creative destruction.” That’s how nature works; transformational cycles exist in every aspect of our universe. The fact that we have seen such prosperity in this part of the world for so many years while billions of people have languished in relative poverty is probably a sign that a transformation in economic balance around the globe is in order. The excesses in the financial world and the flow of capital away from real economies (where it could have improved the lives of millions) into esoteric financial instruments and the subsequent destruction of wealth are harbingers of this transformation. This is the phase where those who have lost some of their riches due to their own excessive behavior need to introspect and rebuild the system with much lower expectations while those who were deprived for long use the new opportunities to improve their lives. New normal is being established everywhere.

Here in the US and in the developed world in general, the standard of living will be affected because of all that has happened in the past two decades. I think the days of 20% return on investments are few, as policy makers rethink the growth strategies and focus more on fruits of economic growth impacting all sections of society. That is critical to keep the system from becoming unstable again. New financial regulatory framework will curb excessive speculation and risk-taking. If there are financial instruments that are meant for hedging purposes, the new changes will make sure that they are used for only those purposes and not for speculative trades. New tax policy and higher transaction costs will further discourage people from taking massive risks. I don’t think people will be able to use their homes as piggy banks. That would put an end to home equity being used for funding all kinds of spending programs and what will ensue is a more meaningful allocation of capital to meet the most important needs. World is changing fast and the emergence of new economies will redistribute capital in a way we have never seen before. New normal in our economy will need us to do more with less. In the final analysis, that’s not bad at all.