Hedging Options

Just google "Buffett on derivatives" to see the latest on the subject from the Sage of Omaha. In theory, derivatives are financial means to manage risk by syndicalizing it. In practice, nobody knows how well they work when large scale panic selling and/or contagion hit the financial markets.

The recent worries about subprime lending in the house market, preceded by the Chinese sell off, has one ponder as whether or not these might be the signs for financial trouble that not only Buffett, but also Greenspan as of late, has been talking about.

If one considers the slowing of the house market together with the drop in durable goods orders (i.e. what goes with/into a new house), one may get a picture that's so much uglier than what one is normally told through the 'official' channels. To get an idea as how far and wide the subprime lending has gotten, consider the range of companies whose executives are called to testify in front of the US Congress: HSBCPlc (HSBA.L), New Century Mortgage Corporation (NEWC.PK), Countrywide Financial Corp. (CFC.N), General Electric Co's (GE.N) WMC Mortgage unit and First Franklin Mortgage (FFHS.O). Subprime lending has made for many a record high bonus on the Wall Street of the 2006's end.

The options for the US government are few and limited. It can raise or lower interest rates. If it lowers them, one side effect could be that houses keep appreciating--one source said that all the subprime lending problem would disappear if house prices went up by 10%. The cost of so doing is increased inflation, which has already been at work. Another casualty could be the mighty dollar itself, including its position for some treasury departments in the developing and oil exporting worlds. Raising rates is a an even less likely option for the current thinking goes that it would send the whole economy down, so it would be considered only if inflation was acknowledged as the bigger problem than the risk of recession. A third option would be to raise taxes. If the Democrats were in power, that would have been the way out of this situation. The Republican executive may decide though to creatively tax the US by going into Iran. Not counting the political evidence supporting a war with Iran, the economic rationale is there. The dollar would improve its safe haven status, the oil would keep transacting mostly in dollars, and a lot of the financial troubles that have been accumulating since Greenspan would be shouldered by us all in the form of war debt, or something along the lines of the war budget (deficit) for Iraq.

Consequently, some options for the individual investor become: defense companies, Swiss Francs, and US Treasuries. Before I forget, let's mention Red 22 in Las Vegas.

Global consumer trends

Following is an excerpt from a McKinsey Quarterly survey about various changes over the next decade. However pertinent and intuitively valid, these projections are silent on two dimensions. Nothing is said about the future of digital products and the middle class from the developed nations, respectively. The digital goods' likely evolution will marked by defiance of intellectual property rights until the developing countries become themselves generators of digital goods. If what goes on in the US consumer market is an indication for the future, the middle class consumer in the developed nations and the consumers in developing nations will likely be increasingly alike. And, considering their prediction, this might have been the working assumption of the McKinsey consultants. However, the European consumer, given the protectionism in the EU market, looks differently.

A changing consumer landscape

Economic growth in the developing world will usher nearly a billion new consumers into the global market-place over the next decade, as household incomes reach the level (around $5,000) associated with discretionary spending. Although these consumers will have less spending power than do their counterparts in the developed world, they will have similar demands as well as access to global brands. Many industries therefore face polarized markets where premium and no-frills offerings are squeezing middle-of-the-road ones.

This polarization will become a fact of life throughout the materials sector as well. Consider the automotive industry, which is largely concentrated around two kinds of vehicles: high-volume, low-cost models and premium luxury ones. Materials providers will benefit if they can offer auto-makers differentiated products—say, for lighter bodies with improved fuel efficiency. Likewise, specialty providers of high-strength steel and aluminum are harnessing technology to create captive markets among luxury carmakers. Similarly, paper manufacturers have profitable niche opportunities to design innovative packaging for makers of consumer products such as ice cream or potato chips.

In fact, premium niches represent important opportunities for producers of aluminum, paper, and steel as they find themselves squeezed by high input prices, the substitution of materials when customers attempt to slash costs, excess capacity, and tough competition. Winners will increasingly need to play the role of productivity-improvement partner to their customers—by offering services, for example, or helping in areas such as product design.

"Global trends" by Ivo J. H. Bozon, Warren J. Campbell, and Mats Lindstrand

Some thoughts before the opening bell

Nobody knows the extent to which the recent stock-markets "correction," which began with the Chinese bourses, was due to anyone from the so many objective factors, such as Chinese overheating, American economical slowdown, or global excess liquidity.

Of significant relevance I find a subjective potential factor and an anecdote. Just before the Chinese sell-off, Greenspan said via satellite link to a business conference in Hong Kong the following: "When you get this far away from a recession, invariably forces build up for the next recession, and indeed we are beginning to see that sign. For example, in the US, profit margins have begun to stabilize, which is an early sign we are in the later stages of a cycle." The, otherwise widely circulated, anecdote has it that a certain Li Ruichang, a 63-year-old Chinese engineer and speculator, stated the day after the fall of the Chinese bourses that: “Things like that happen. But I’m not worried about a crash. After a five-year-long bear market, the bull market shouldn’t end that fast.” I should add that Mr. Li's statement came a day after the sell-off, as the Asian and European bourses were still falling while some in China regained some of the losses. Before the sell-off, the Chinese major indexes were twice as high as 12 months before. In any case, for some, the strength of the Chinese stock market consists of its number and determination (not to lose) of investors.

As if encouraged by the second day gains in the Chinese and US stock-markets, officials put out several soothing messages. The Chinese regulators gave up on plans to curb speculation and were ready to consider opening their stock markets to foreign investors--it would be interesting to see if foreign speculators get any special treatment. In the US, Ben Bernake, chairman of the Federal Reserve, said that one could reasonably hope for a stronger economy by mid-year IF housing stabilized, and IF manufacturing improved. So far, his twice-conditional message has been taken as support for the rally.

But then again, what's a stock market if not a conspiracy of hopefuls? One would only have to distinguish among the types and motives of hope, and then check for alignment between their own and the economic realities.

On a final note, it's ironic how globalization has been considered to transcend stock-market rules, just as increased productivity driven by technology had been until (twice in) 2000.

Market failure vs. Regulatory failure

The long journey of the New York Stock Exchange (NYSE) from demutualization to a reverse-merger IPO, and on to the merger with Euronext, and to the alliance with Tokyo Stock Exchange (TSE), will make for a fascinating subject of many a business history book. Deutsche Börse and London Stock Exchange (LSE) will make for interesting collateral damage and props, respectively. It should be noted that NYSE has had a regulatory role in addition to its being a market for securities.

Equally interesting is the trajectory of the big i-banks relative to NYSE. Exemplar is Goldman Sachs (GS), which has placed its people and made money on ALL sides of the NYSE-related transactions, ALL the time from demutualization until last Friday when one of its analysts, by downgrading NYSE, sent its stock price (NYX) down. To return to the i-banks, they are forming what seems to be an exchange, separate from NYSE, to make sure they get the best service at the lowest cost. Thus, a question arises: Do we face a failure of the market, or a regulatory one?

Indeed, while the banks had been the NYSE patrons, the Exchange could do no wrong. Then the banks got out of NYSE, making lots of money, so that NYSE could do its job better--faster and cheaper trades. However, since the banks want to set up a separate exchange, inscrutable to you and I, is it that they don't trust either the open markets or the regulation that comes with open markets?

21st Century

Our communication - Wireless
Our dress - Topless
Our telephone - Cordless
Our cooking - Fireless
Our youth - Jobless
Our food - Tasteless
Our labor - Effortless
Our conduct - Worthless
Our relation - Loveless
Our attitude - Careless
Our feelings - Heartless
Our politics - Shameless
Our education - Valueless
Our follies - Countless
Our arguments - Baseless
Our boss - Brainless
Our Job - Thankless
Our Salary - Very less
Our Future - Hopeless!

Have a good day, with LESS problems!

Opportunity Cost of War vs.Military Keynesianism

Click on the image to expand
Source: What $1.2 Trillion Can Buy (NYTimes)

There has come the time for people to ponder war and its opportunity costs. For a comprehensive view on the cost of another war of sorts, check out this title: The Fifty-Year Wound: How America's Cold War Victory Has Shaped Our World

Change of ownership, change of fortunes

Who can tell the extent to which private/hedge funds owe their popularity to Sarbanes-Oaxley? Their coming into being could be attributed to urges similar to those that once made Enron popular, while the success of many may well lie with Sarbanes-Oaxley, the very act meant to prevent another Enron. This is to say that private/hedge funds can do what your regular financial institution could not even dream of after Sarbanes-Oaxley. Indeed, who doesn't know that what is not allowed for some becomes source of profit for others?

Signs of the popularity of the funds abound. For one, it is the sheer size of the funds phenomenon, there are about 9000 of them, with total assets of more than $1.2 trillion. Then there are the seasoned managers and deal makers leaving established businesses and financial organizations to join the funds. The investor public is also an increasing part of this, directly or not, knowingly or not, via either direct investments or the very pension funds they send money to every month, respectively. And, as if to take their popularity to the bank, some funds began offering themselves to the largest investor public there is, the public markets of capital.

Despite their popularity, when the amount of assets of the funds is considered in conjunction with leverage, or the absence of oversight, one can only rely on metaphors to describe their risk for anybody ranging from the individual investor to the whole economy. For a very interesting and multi-faceted conversation about funds, have a look at the comments following Hedge Funds Go Public, Culturally and Literally , in the DealBook section of NYTimes.

Market Realist goes as far as drawing an analogy between the conditions surrounding today's hedge funds and those that generated the 1929 crash, chief amongst being leverage. The second comment down, G. Gekko's, is a sensible and insightful analysis, followed by your own' s truly. My point is that by their going public, some of the best performing funds may signal the end of the party.

One can only hope we won't (be in a position to) know the risks associated with hedge funds before some form of oversight becomes the norm.

Due Credit

Much of the credit for winning the Cold War has gone to the late U.S. president Ronald Reagan. And deservedly so. Too little consideration and credit are accorded anymore to the last Soviet president, Mikhail Gorbachev. Had the world, and Mr. Reagan for that matter, had the misfortune of a leader like Brezhnev at Kremlin, we would have lived in a much less desirable world since 1985 onward. Indeed, our chance was that Mr. Gorbachev was both visionary and skilled politician. Visionary in the sense that he aimed for a better world, and skilled for his maneuvering change at so many levels in USSR, despite having so few allies and many adversaries.

Visionariness and skillfulness are not the notions usually associated with Gorbachev. Instead, most point to his quixotically trying to reform the CPSU from inside the party or to the apparent failure to hold the Soviet Union together. While I don't think he could have survived his adversaries, until august 1991 that is, from outside the CPSU, the dissolution of the USSR was the best outcome for all in final analysis.

Before we can learn more from the historians, it's worth having a look at a recent article from Der Spiegel based on Politburo minutes taken by a Gorbachev aide. The Politburo minutes are revelatory for Gorbachev the visionary and the skilled.