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there is no global enormous liquidity


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#1 greenie

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Posted 21 January 2007 - 06:22 PM

As I mentioned many times, those preaching the presence of 'enormous liquidity' are misguided and not separating the forest from the trees. What we have is gigantic credit-based leverage. Following comments from professor Roubini's blog discusses what could be going on.


"Credit Derivatives, Hedge Funds and Leverage Ratios of 50: The Credit House of Cards
Nouriel Roubini | Jan 20, 2007

Gillian Tett, the sharp Financial Times editor who covers derivative instruments, structured finance and the explosion of credit in financial markets, reports on a senior banker telling her how leverage ratios of 50 or more are currently easily reached in financial markets:

"He then relates the case of a typical hedge fund, two times levered. That looks modest until you realise it is partly backed by fund of funds' money (which is three times levered) and investing in deeply subordinated tranches of collateralised debt obligations, which are nine times levered. "Thus every €1m of CDO bonds [acquired] is effectively supported by less than €20,000 of end investors' capital - a 2% price decline in the CDO paper wipes out the capital supporting it. "

Just to clarify this credit pyramid that looks like a Ponzi Game: you start with 20,000 euros invested by some investors into a hedge funds of funds; this is all equity. Then, this fund of funds borrows - at a leverage ratio of three - and invests the initial capital and the borrowed funds into an hedge fund. Then this hedge fund takes this fund of funds investment and borrows - at a leverage ratio of two - and invests the raised capital and the borrowed funds into a deeply subordinated tranches of a Collateralized Debt Obbligation (that is itself a highly levered instrument with a leverage ratio of nine). So the final investment of 1 million has behind it 20,000 of equity capital and 980,000 of debt. So, if the value/price of the final investment falls by only 2% the entire capital behind it is wiped out. This is a credit house of cards where a dollar of capital is turned into 49 dollars of additional debt to finance an investment of 50. The systemic dangers/risks of this fragile credit house of cards are complicated to assess as they depend on how much of this debt/credit accumulation is concentrated or spread among many financial intermediaries. But, at face value, this kind of leverage ratios looks scary."

http://www.rgemonito...m/blog/roubini/



As you know, if you go 10X leveraged instead of 2X in your trading account, the number of stocks you buy will go up (more liquidity), but also the risk. Good luck betting on this kind of liquidity.
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It's the illiquidity, stupid !

#2 Tor

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Posted 21 January 2007 - 06:31 PM

The correlation between liquidity and higher markets is spurious at best. I have recently found some research on this point.
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#3 CLK

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Posted 21 January 2007 - 06:49 PM

Greenie, Isn't it possible that the last six years of under performance in the stock market has already accurately discounted the future risk that you portend ? I thought that a couple hedge funds already blew up recently, not so much as a ripple in the market. I'm not saying we can't get a normal 10% correction, I don't see how it could be more than that though. What is your trading, investing objective or plan of action, based on your assessment of the market ?

#4 dcengr

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Posted 21 January 2007 - 06:50 PM

Apparently there's still enough collateral to keep the market from dropping and making it go higher.. What you're saying makes sense, but until the time they run out of money/credit to kep pushing it higher, it'll go higher. When the money/credit runs out, yes there may be big doo doo.. its trying to time when that occurs thats hard. If you look at my COT chart, the futures traders appear almost maxed out, at least on a historical basis. Maybe the time is close.. I don't know. At the moment, there's no price deterioration that "even a caveman can see it".
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#5 jawndissedi

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Posted 21 January 2007 - 08:36 PM

Roubini's piece borrows heavily from a much superior analysis posted by Doug Noland the day before and on several previous occasions.

Greenie: before you get too committed to the long end of the bond market, read Noland's 12 January 2007 comments under the sub-heading "Nominal GDP."
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#6 greenie

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Posted 21 January 2007 - 10:24 PM

Greenie: before you get too committed to the long end of the bond market, read Noland's 12 January 2007 comments under the sub-heading "Nominal GDP."



JD, I have not seen anything yet that changes the big picture - US government bonds will be highly sought, whereas company bonds, even the ones of highest quality could be risky. Two things are going to happen.
1. Perception of risk in the marketplace will increase and the spread between corporate and treasury bonds will widen.
2. US treasury bonds will be the vehicle of safety, increasing its demand and hence price (==lower interest rate).

One consequence will be that even though Fed drastically lowers interest rates, distressed homeowners will not be able to refinance because they will need to bring cash to the table. Some version of the same picture will play in the corporate space now going gaga over leveraged borrowing.

Is Noland's picture different?

Thanks, G.


CLK, I am a IT/LT player. In my picture, the amount of money coming to the market started to go down (but still remained positive) from the end of 2005. That showed up in a set of divergences - the leading sectors such as SOX, HGX topped out long back. Yield curve inverted. Also, money managers started to prefer value over growth (i.e. risk), as you can see in downtrend in NDX:SPX ratio and RUO:RLV ratio from early 2006.


The last rally from July was a bear killer rally, and it is over now (check NDX:SPX). I think now the money coming to the market is turning negative, and it will lead to rapid deterioration. In this stage bull market gain of two years can be wiped out in 3-4 months.

That is the picture based on which I am taking the trades. Right now I am partly short NDX, and on any confirmation of the above picture, I will continue to increase short positions on every pop. If anything does not match the overall picture, I will reduce short exposure. The trade will last 6-9 months (or when NASI gets to -1200), after which I will think of covering all. Let us see how it goes.

Few doubts I have to the perfect picture are about some of the international markets not topping out yet.
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It's the illiquidity, stupid !

#7 CLK

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Posted 21 January 2007 - 11:19 PM

Greenie: before you get too committed to the long end of the bond market, read Noland's 12 January 2007 comments under the sub-heading "Nominal GDP."



JD, I have not seen anything yet that changes the big picture - US government bonds will be highly sought, whereas company bonds, even the ones of highest quality could be risky. Two things are going to happen.
1. Perception of risk in the marketplace will increase and the spread between corporate and treasury bonds will widen.
2. US treasury bonds will be the vehicle of safety, increasing its demand and hence price (==lower interest rate).

One consequence will be that even though Fed drastically lowers interest rates, distressed homeowners will not be able to refinance because they will need to bring cash to the table. Some version of the same picture will play in the corporate space now going gaga over leveraged borrowing.

Is Noland's picture different?

Thanks, G.


CLK, I am a IT/LT player. In my picture, the amount of money coming to the market started to go down (but still remained positive) from the end of 2005. That showed up in a set of divergences - the leading sectors such as SOX, HGX topped out long back. Yield curve inverted. Also, money managers started to prefer value over growth (i.e. risk), as you can see in downtrend in NDX:SPX ratio and RUO:RLV ratio from early 2006.


The last rally from July was a bear killer rally, and it is over now (check NDX:SPX). I think now the money coming to the market is turning negative, and it will lead to rapid deterioration. In this stage bull market gain of two years can be wiped out in 3-4 months.

That is the picture based on which I am taking the trades. Right now I am partly short NDX, and on any confirmation of the above picture, I will continue to increase short positions on every pop. If anything does not match the overall picture, I will reduce short exposure. The trade will last 6-9 months (or when NASI gets to -1200), after which I will think of covering all. Let us see how it goes.

Few doubts I have to the perfect picture are about some of the international markets not topping out yet.





Ok...thanks.


As Trend Signals posted earlier the Armstrong cycle map, the head of each peak
was a crash type top as in 98 for instance, the shoulders were garden variety
mild corrections.

We will be getting one of those end of Feb. so I suppose a 25% crash and rebound is
not out of the question. However, those events don't normally happen with the VIX
this low and this move looks alot like 1995, but did have a 10% correction then.

I would like to see a bull flag over the next few weeks then one quick burst to new highs,
that would be a great spot to load up short.

In the meantime I'm trading the st moves, but am aware I need to be nimble going long.

#8 greenie

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Posted 22 January 2007 - 12:15 AM

Time to go max short, based on NDX:SPX ratio ? Comparison with March 2000.


Now:

http://stockcharts.com/c-sc/sc?s=$NDX&p=DAILY&b=5&g=0&i=0&r=2384&.png


http://stockcharts.com/c-sc/sc?s=$NDX:$SPX&p=D&b=5&g=0&i=0&r=3148&.png


Then:

http://stockcharts.com/c-sc/sc?s=$NDX&p=D&st=2000-01-22&en=2000-05-12&i=t54872121486&r=9923&.png


http://stockcharts.com/c-sc/sc?s=$NDX:$SPX&p=D&st=2000-01-22&en=2000-05-12&i=t54872121486&r=9923&.png
It is not the doing that is difficult, but the knowing


It's the illiquidity, stupid !

#9 pdx5

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Posted 22 January 2007 - 12:45 AM

I concurr with Greenie's POV that what we have is balooning credit rather than balooning liquidity. For example when I deposit $1000 into my savings account, assuming the bank reserve requirements are 10% (I am guessing this number but there really is something called minimum reserve) then the bank can loan out $10,000. Voila...$1000 in bank turned into $10,000 for someone to spend or invest. That is what is happenning. This is fine and dandy so long as the borrowers are making profits on the borrowed capital such as buying an appreciating home or a profitable business. The problems will start when the borrowers can no longer make profit on their borrowed capital. Higher the loan to equity ratio, higher the risk of a default, and faster will be the effect felt in the economy.

Edited by pdx5, 22 January 2007 - 12:47 AM.

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#10 OEXCHAOS

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Posted 22 January 2007 - 09:00 AM

What is the practical difference between availability of credit and the availability of cold hard cash in a fiat currency or fractional reserve system? On thing to remember is that we're talking about global economies here. Businesses and people don't just stop at some point as if someone halts the music during musical chairs. Folks are constantly adjusting and readjusting their positions, creating wealth and making other folks better off. Additionally, the vast majority of folks who own an asset of any sort, won't be affected in a meaninful sense if it declines in value by 20%. The average Joe isn't trading his house on margin. He only gets a forced liquidation if he doesn't pay the mortgage, and even then he often can work something out. It's very dangerous to think in a linear fashion about this stuff. The street is littered with the broken accounts of "doomsday" Bears, and "debaclegaengers" who were convinced of a scenario that they could see so clearly. The hint is, if you can see it so clearly, it's not likely to occur in a fashion that you'd expect. Translation: You ain't Cassandra. Prepare for THAT. Just a tip. Mark

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