A lesson in trading discipline

The latest missive for paddypowertrader:

In my first blog I wrote that one key indicator of risk appetite would be a reversal of fortune for the yen. That’s exactly what’s happened last Wednesday. Take a look at the Euroyen cross – it jumped out of a key downward trendline. Short Euroyen is a deflationary trade – it’s a sign that risk appetite is on the decline and that Japanese investors are selling their assets held overseas and bringing their cash home; it’s also a sign that the carry trade is breaking down. A reversal is very significant, especially when combined with the other bullish indicators as the indices push up above their 50-day moving averages. So I bought some EUR/JPY at 11942 and by Thursday evening it was comfortably trading above 12200. Nice trade. So I thought to myself that I’d need to watch it carefully but if it holds above the 12000 level that’s a further sign that we could have seen a bottom in equities, for now.

So I went to bed on Thursday night smugly looking at a growing three figure profit on the euroyen cross, thinking about all the nice Christmas presents I could buy with the proceeds, which in turn would keep the high street humming and my retail longs winning. But then the Senate voted down the auto bailout and EUR/JPY plummeted an hour to two to 200 points below where I went in, taking out the position. I’d put a stop at 11972 above where I went in so I made just £30 on that trade. And because my position size was so small (just £1/pt) I couldn’t do what Mr FT usually does on the currencies and take some profits when the trade was firmly in the black, just leaving a small long running. It was all or nothing. In my case, I got next to nothing.

Now here’s the really daft part. I was almost speechless when I found my P/L figure so unexpectedly reduced on Friday morning, even though most of the loss was down to the loss of that single EUR/JPY trade. So at 8am set about selling off half of my winning equity trades, in a panic about potentially losing even more profit. My retailers and other equities had fallen back a bit, but a lot of them were well off my stops, and as the news filtered through that some sort of TARP-inspired rescue would transpire, the markets recovered sharply during the day. So I compounded my panic by cutting back the risk, even going short on FTSE and the Dow momentarily before the indices bounced back.

All this is a tricky call. It’s easy to add risk – building up positions - when the market is moving in the direction you’d like, and the profits just appear to multiply. But the more risk you take on, the more pain and shock you feel when the inevitable reversal happens. But that’s exactly what stops are for and the trick is to be disciplined – if you’ve built up a position over time you can trail some stops near high points but leave others with wide margins so that the whole trade isn’t chucked out by the volatility. It’s also a lesson in the risks involved in leaving trades running overnight – and a warning about being too smug about having called a move correctly.

And having been stung I didn’t have the guts to buy back in to the EUR/JPY – look how quickly it bounced back! A sign that there’s still some desire out there to buy equities, I think. I might have another go at it later in the week.

Trading Update

This week I’m still running that long gold position from $777, and I’ve added to it a bit with additional longs from $789 and $803, all protected with stops; I’ve moved the stop on the main gold trade to $790. As far as I can tell, it’s dollar weakness that is pushing up gold, together with a bit of a revival in other precious and industrial metal prices on the back of that theme about infrastructure and automobile production. I still have a basket of equities that I’m long of, although my long positions in Barclays and Man Group hit their stops (above the entry point) in Friday’s volatility and I’m disinclined to buy back in. I’m also looking to see if the long EUR/GBP trade is going to get squeezed, particularly if the various bits of eurozone data due out are weak (I expect they will be). So I’ve set a small sell order in EUR/GBP below the current trading range at 8930, with a tight-ish stop just 40 points away at 8970. And I’ve got a long FTSE position from 4266 and a long Dow position from 8430, both with stops set just above their entry point.

Splashing cash and watching rabbit ears

Flash's latest blog for paddypowertrader:

Splashing the cash and watching the rabbit ears

I’ve had a decent couple of trading days since the last blog. My risky retailers gamble paid off quicker and better than I expected; Darling’s VAT cut fuelled some speculative buying of beaten down shopkeepers, something I didn’t fully anticipate.

My thinking at the moment is that a combination of Christmas cheer, end of year relief, and Obama anticipation could be just enough to keep equities afloat into the New Year. So for the time being I’m happy to stay running with my equity longs, and I’ve been building them up a bit. In the retail sector, I have long positions in Kingfisher, Sainsburys, Marks and Spencer and Morrisons supermarkets, and at the start of Tuesday I added longs in Vedanta Resources, Game Group, Barclays and BT.

The Fed splashes out

Now that quantitative easing (a fancy term for printing money) has seriously taken hold, it’s led me to revise my opinion on gold. The Fed has been working the printing presses hard over the last few weeks. How do we know this? Well, they’re not issuing bonds as fast as they’re buying up assets, bailing out banks and underwriting bad debts. So rather than raising cash from the wider market they’re just pumping out dollars. An awful lot of dollars. This particular bailout is going to cost the US more than it cost them to do World War Two. One analyst says that it’s the biggest, most expensive programme of public spending in American history.

Going for gold

Set against the inflationary effect of printing money, credit remains tight and demand is muted, so this will have a restraining effect on prices. So I’m not expecting gold to go back to $1000 but there will continue to be some upward pressure if the dollar continues to weaken; and nervous investors are looking for somewhere, anywhere to put their money that might help it to retain its value. Commodity prices in general are likely to rise if the dollar weakens, which will also help gold.

So I’m staying long gold for now, with half my gains from my £2/pt long from $729 protected with a stop at $798, and I added to my position this morning by buying another £1 at $817, with a stop set at 798. This is because I’m anticipating a bit more downward slippage for the dollar, particularly against the yen and the euro, and because I think commodity prices in general are showing signs of firming up over the next few months.

Don’t believe the eurohype

I missed out on most of the currency moves; I was away from the screen for most of Friday and Monday, and so didn’t find a good point to get in. There were some great trading opportunities on offer in EUR/JPY and EUR/USD, but I just wasn’t there at a moment I felt confident to put the trade on. Despite the monster gains in the indices since last week, the dollar is continuing to weaken against the yen. My GBP/USD short was stopped out for a £500 gain at 1.53, and my EUR/GBP short is finished too – stopped out for around £50 of profit. But, looking ahead, I’m still inclined be bearish on the euro, even against sterling – bits of the eurozone are in such poor economic shape that even if France, Finland and bits of northern Europe only get ‘mild’ recession, other places – particularly eastern and southern Europe will have a seriously dragging effect. Unemployment, plummeting property prices and very weak demand will leave all currencies battered, but it’s hard to see how European Central Bank will be able to manage the very different needs of its constituent countries. These tensions are going to cause some structural problems for the eurozone, which might not be able to shake off recession as fast as the UK and the US. So I’m looking for an entry point to go short EUR/GBP again.

Is the dollar’s run done?

Does all this mean the dollar will weaken substantially? I’m not so sure. If credit wasn’t so tight, then we’d see huge capital flows into the economy, and soaraway inflation. But perhaps the money being printed is offsetting the money that has been blown up in the process of deleveraging. Trillions of dollars have drained away as share prices have collapsed, banks have written off assets and complex derivative bets have gone horribly wrong. There’s also the effect of ‘dollar repatriation’ where investors sell off risky assets overseas and stick their money back under the mattress at home. A lot of funds have been selling hard, because everyone wants their money back, partly to avoid defaulting on their debts. Everyone, Flash Rabbit included, is conserving as much cash as they can.

And a bit of inflation, in a period where demand is weak, could be a good thing. Inflation means that the value of debts go down quicker over time, relative to wider price rises; in times of inflation, basically debts ‘deflate’. Plus lower interest rates will work through. It’s going to get cheaper to borrow money, if you can find someone who’s willing to lend you some. Across the developed world, fiscal stimulus is temporarily putting a bit more cash in people’s pockets – much needed cash. As interest rates fall, households and businesses will find their debts easier to pay, with more disposable income trickling back into the economy.

Beware the ominous rabbit ears

But – just take a look at the long term chart on the S&P 500, which looks suspiciously like a classic ‘double top’ or pair of rabbit ears. We are back at the 800 levels of 2003 and 1997. Doesn’t look like it’s headed back up to 1500, does it? The best we can hope for is a sideways move or some sort of slow ‘slope of hope’. There’s some resistance at the 750 – 800 level but if we drop below this then we are a looking at 500, or much, much worse.



And yet – a lot of equities are still trading cheaply, even in relation to reduced future earnings. And governments are pumping out the policies and cranking the printing presses like there’s no tomorrow (because perhaps there isn’t).

By the end of January we could well see another 2000 point move on the Dow – and I’m not confident to say in which direction it’s likely to be. Remember the Dow was trading well above 10000 eight weeks ago! And it’s precisely the existence that ‘wall of worry’, that uncertainty and anxiety, that makes me think that this is a good opportunity to be cautiously bullish. If you can withstand the inevitable volatility, my view is that for a good number of large cap equities, the risk/reward ratio is to be found more to the upside than the downside, at least for the next couple of months.

Bargain basement or liquidation sale?

This is Flash's latest blog over at paddypowertrader:

One of the equity sectors I’ve spent time trading profitably in and out of over the last few months is UK retail. UK retail, I hear you ask. Are you insane? Perhaps, but I’ve made a few bob on some long positions in big, unloved retailers over the last few months. Not by my usual ‘buy and hold’ strategy but by buying on dips and looking for peaks to sell.

Take DIY retailer Kingfisher, for instance. Since mid-June it’s been trading in a 96p – 140p range. By buying near the bottom of that range and selling when it gets up to the high 120s or 130s I’ve picked up £30 here, £40 there. Not too bad. Kingfisher is one of those unloved businesses that is likely to do well in a buoyant housing market and in a ‘Changing Rooms’ era when home improvement, paid for by borrowing and equity release is all the rage. Now that house prices are plummeting, just like companies that sell carpets and ‘big ticket’ furniture items like sofas, they’re not doing nearly so well, so the market has already priced in a considerable reduction in their profits.

Like half the rest of the spread betting community, I made a few bob shorting the likes of Topps Tiles, Land of Leather and DSG Group earlier this year. But Kingfisher is interesting because as well as mega-home improvement stuff, they also sell everyday stuff – tools, paint, plants, Christmas lights. The B&Q brand is solid and they’ve been offering some good deals recently to lure the punters in. And their shares have consistently bounced when they get down towards the bottom of the 96p range. So having sold my last lot of Kingfisher at about 110p, I bought some more this morning at 102p.

Another lot I’ve been watching are the supermarkets. When Morrisons got down towards their recent low of 225p I dived in and bought at £3 a point from 229p. In spite of all the carnage in the wider indices they’re still trading at around the 250p mark. Sainsbury’s is the same. Bought in mid-October about 250p, sitting at 270 to 280p. Now these aren’t big gains but so long as the price holds off the yearly lows there’s some money to be made. And if we do eventually see a bounce (which I have to say, I’m beginning to give up hope on), these are great levels to have got in at and bought some shares. And I’ve protected all these positions with stops so I can’t lose any money.

Retail stocks are a gamble at the best of times. There are so many factors that affect their price – fads and fashions, stocking levels, profit margins, whether they have the right buying policy (look at the mess that M&S made of food retail earlier this year); but there are also residual values, and there are dividends to be had. Retailers also have assets. And Marks and Spencer, according to some analysts, is trading at around the residual value of its property portfolio. Now if they can make some money by aggressively discounting (and judging by the number of M&S bags I saw on the train home this afternoon, they must be doing something right) to be buying into a massive blue chip global consumer brand at this level does begin to look like a bargain basement price.

And I’m watching Game Group (I’ll do another blog about why video games are worth keeping an eye on), Debenhams, and even that very unloved, almost unprofitable outfit French Connection. Mrs Rabbit says that their coats this season are exactly the right shape. In the US, I’m watching Wal*Mart and cheapo retailer Family Dollar.

Now, this is seriously contrarian. We know that the consumer is being hit hard by the downturn; unemployment is rising; disposable income contracting. But in a world in which commodity and energy prices could easily plummet another 25%, and in which ‘just in time’ delivery means that retailers don’t have to carry the same amount of stock that they used to, which means that overheads are rapidly falling, it would be a very poor retailer indeed who couldn’t still make some money in this period. And today’s retail sales figures, whilst a bit unbelievable (only a 0.1% decline in Oct?) might just suggest that there is more resilience in the high street than the consensus suggests.

So with a slightly churning feeling in the pit of my stomach, I went long of M&S today from 205p, and I’m considering buying a few hundred M&S shares for my ISA.

I have to say that it makes me feel anxious writing this, but if I was Warren Buffett (or even Philip Green) I’d be out with my cheque book buying up sackloads of high street brands in anticipation of better times in two or three years time. As it is, I’m just trickling in a few long positions (£1 here, £2 there) and seeing what happens. I’m not ready to bet anything on a rise in the wider indices though.

In wider trading, I’ve cut back. I’m still running a short EUR/GBP position, a short GBP/USD position, and that long gold trade from $129. I’ll keep you all posted about how I get on.

Meltup, and meltdown

Total nightmare. At least Flash had the sense to buy some gold this morning. And is Citibank safe?

Reuters has this:

NEWS
- G20 leaders head to U.S. for summit to address worst financial crisis in 80 years
- Euro zone data shows bloc went into recession in Q3, first time since common European currency formed
- U.S. retail sales suffer record decline in October
- Citigroup Inc to shed 10 pct of global workforce. Sun Microsystems Inc cutting 5,000 to 6,000 jobs
- GM's Opel seeks 1 billion euros in German state aid, Western Europe car sales plunge 15.5 percent in October
- Freddie Mac reports record $25 billion quarterly loss, draws on $100 billion Treasury Department lifeline
- U.S. Fed Chairman Bernanke says central banks worldwide ready to do more to support faltering growth - U.S. Senate to take up auto bailout bill, unemployment on Monday
- U.S. banking regulator unveils plan to prevent about 1.5 million foreclosures, breaks ranks with Bush administration
- Pakistan asks International Monetary Fund for $9 billion bailout
MARKETS
- U.S. stocks fall, Dow <.DJI> slides 337.94 points, or 3.82 percent. Dow slides 5 percent for the week
- European stocks close higher as oil shares storm ahead
- Stock markets up in Asia <.N225>, but pare sharp gains by half
- Oil drops 2 percent as Euro zone enters recession
- Interbank lending rates for dollars up for second day
- Dollar rises against a basket of major currencies, falls against the yen
- Gold futures up more than 5 percent in heavy buying ahead of G20 summit
QUOTES
"By working together, I'm confident that with time we can overcome this crisis and return our economies to the path of growth and vitality." - U.S. President Bush in his weekly radio address to air on Saturday.
"The funds and guarantees that may be required would be invested in product development and manufacturing sites in Germany and would by no means be spent outside of Europe." - Opel statement.
"You'd have to be a brave investor to be a bargain hunter now. There are bargains out there, but you'd have to be prepared to hold them for a considerable amount of time." - Peter Dixon, an economist at Commerzbank in London.
"People are going to wait on the sidelines and see what comes out of (the G20 meeting) before they start to take a view with respect to what's going on next week." - Robert Blake, senior currency strategist at State Street Global Markets in Boston.
"Frankly, we at Dow are looking at an '09 that looks like a pretty protracted global recession, probably going into 2010." - Andrew Liveris, chief executive of Dow Chemical Co , the largest U.S. chemical maker.
EVENTS
Saturday, Nov 15
WASHINGTON - President George W. Bush and French President Nicolas Sarkozy are expected to meet world leaders at an international financial summit of G20 nations to examine ways to overhaul the financial system (Compiled by World Desk, Washington, +1 202 898 8457) Keywords: FINANCIAL/SNAPSHOT

Nassim Nicholas Taleb - angry with economists

Rifkin on networks instead of markets

His manner of delivery is a bit irritating, but his ideas are right on the money.

Jeremy Rifkin on energy networks

Equities - quick update

(image from LOLFED)


A decidedly mixed bag of trades over the last week or so. The crucial call is whether we are seeing the death throes of a fake bull market, or a determined effort to bottom out the market ahead of some sort of recovery, with determined government intervention designed to boost confidence and avoid financial armageddon. Flash favours the latter view, but the evidence is mixed and he needs to guard against too much optimism.

A wave of Obama-inspired euphoria flushed over the market at the end of last week, bouying up equities, but it's not been enough to offset the bleak, bleak outlook for mega US stocks like GM and AIG. And Fannie Mae unveiled another crock of shite today, enough to sour the mood and force traders into swift profit taking. Unfortunately Flash was out so he missed the chance to join that party, sacrificing a chunk of cash to the twin gods of misplaced optimism and smug complacency.

Flash bought into a bit of clean energy bounce on the back of Obama, buying into the Powershares Wilderhill Clean Energy ETF towards the end of last week- that trade climbed into profit but it's now back underwater. Flash has a stop and knows how much he'll lose if it plummets. Flash also bought some Johnson Controls shares, which were looking pretty cool, but as they're a major supplier to GM the contagion from GM has spread to them today and he got chucked out of that trade for a hundred quid loss. What is looking more positive are some of the large cap stocks that Flash bought into - British Airways is up nearly 40% from where he bought them at 115; Kingfisher is holding up from where he went in at 103; Firstgroup has been fantastic - up to the upper 400s from a purchase point of 412; BHP Billiton up around 25% from where he bought them at 828; M and S in the mid '60s from an entry point of 220; Game Group is working well.

Another blog to come about the screen economy - video games, cinema, and which stocks Flash favours in this sector. He's taking a close look at Pinewood Shepperton at the moment - the stronger dollar means that it'll be at least 20% cheaper than 2007 for Hollywood to come and shoot in the UK over the next 12 months, and there's always a James Bond-influenced bounce to consider.

Flash has long index positions firmly entrenched from - 3699 (FTSE); 8356 (Dow); 870 (S&P). He's added bits and pieces to them on the journey up and down, but not been as nimble as he should have been in getting the cash out of these calls.

So he's reasonably happy, but it's not getting any easier. Perhaps it would just be better to go back short?

Flash hits paddypower

Flash has got a new guest spot on the paddypowertrader blogs, one of the sites that he stalks for information and ideas. You can read his first blog for them here.

A cautionary clip from 2006

Other than the sexist comments at the end, Flash thinks this is very, very instructive.

Back in the water

Well, Flash has been dipping his toes back into the market, and whilst he's not exactly striking off out to sea, he's waded in with some good calls over the last few days.

He was onto the turn in USD/JPY and followed it through with a couple of NZD/JPY longs today which have been delightful. He caught the big rally this evening in the Dow and S&P. He's shorted EUR/GBP and so far that's more than 100 pips on side. He thinks the euro ought to revert back down to the 0.70 mark against GBP and that's what he's gunning for. The weakness of the eurozone really hasn't hit home yet, whereas in the UK a lot of the doom is firmly out in the open.

Flash even bought some equities today. That might be a bit premature, but you never know. He's increased his long position in British Airways, and bought back into Morrisons Supermarkets, Game Group, BT and Cineworld. So far, except for BA, all up a bit. Perhaps a bit more in the morning. The logic (?) on BA is that they're now so cheap that they're vulnerable to an investor or two with deep pockets who wants to buy an airline swallowing them up. Iberia buys into BA, BA buys Iberia, AA ties up with BA, a kind of mating game for global domination. Look what happened on the Cathay Pacific rumour the other week. And they're now so cheap that he intends to hold them for a couple of years, even if they drop by a third. He's only got a few hundred shares - good for a 10% discount on flights which he'll make use of and make back his losses that way (someone said "It's like a discount travel card with unlimited upside"). In the long term Flash thinks the airline industry is pretty screwed, but there will still be winners and losers. And he thinks, perhaps irrationally, that BA is more likely to be a winner.

He even bought some BHP Billiton shares the other day - that's been a bit of a white knuckle ride, but they're in the black.

His reasoning on Billiton is that the resources stocks are oversold and sooner or later there will have to be some sort of reinflation. On the other hand the miners are very exposed to emerging markets which are going to be totally crunched. On balance though he thinks there's some long term value there. Particularly if the dollar devalues a bit. This is what is preoccupying him at the moment. He can see that EUR/USD could well be heading for parity, which he'd welcome, as he's short EUR/USD, and in which case cable would logically move down to the 1.40 - 1.50 mark. He thinks euro interest rates will have to come down pronto otherwise the gummed up markets will stay gummed up, and borrowers will be reaching for their suicide pills. A certain amount of dollar devaluation could actually be disinflationary for the rest of the planet - a bit of retracement could help balance things out - provided commodities don't go climbing mountains, which seems unlikely because there ain't much cash in corporate pockets left to buy stuff with, and what cash there is people are hoarding.

The consumer world outside of the USA hasn't completely felt the benefit of the collapse in commodity prices yet, because the dollar has simultaneously strengthened. A certain amount of weakening might be a good thing. Countries with high domestic inflation are going to get even more screwed as the dollar climbs, and their currency falls, and thus imported inflation kicks in. Look at Iceland. On the other hand, all of the big thematic trades, the carry trades, the long commodities bet, the Asian/Russian tiger bet, the emerging market infrastructure plays, have completely unravelled. And we're not allowed to short the financials any more, so they've taken even more of a hammering. So the dollar provides the flight to safety, and Flash thinks that's got further to go - plus people will be taking money out of more 'risky' emerging markets and putting their cash into the relative safety of US equities. And there could well be an Obama effect as the US digs itself out of its political pit which could boost equities some more. A more interventionist government will provide some fiscal stimulus and start spending on public infrastructure - schools, rail, roads, energy, that sort of thing. Once the spending tap gets turned on there will be some reinflation, particularly becuase the spending won't be financed by taxes, it'll be financed by borrowing. A New Deal of sorts, and the beginning of another reinflation bubble (and perhaps a journey southwards for the dollar?) So being long the Dow and S&P seems like the right call, although he's been trying to do this for months and has been totally caned. Caution is needed. Position sizes are small, stops are in place and he's watching carefully.

The big toxic call - and the next source of jarring volatility - will be what happens with emerging market currencies which are collapsing all over the place - Iceland, Hungary, Pakistan, Russia. One explanation for the vicious sell offs of the last few weeks is that anyone with assets has been selling them to raise cash - not just hedge funds, but insurance companies, pension funds, Russian oligarchs, retail investors, you name it. But particularly people with foreign currency debts - eastern european countries, but also the UK - as their currencies have plummeted have been forced to sell euro (and dollar) denominated assets to raise the cash to service these foreign currency debts, which have been getting more and more expensive by the day. So there's a self-reinforcing cycle of liquidation and deleveraging, made worse by the fact that the usual hedging strategies (the carry trade, shorting the dollar, buying commodities etc) have completely broken down. The easy pop, as usual, has been at hedge fund redemptions, and undoubtedly the hedgies will have had to get out of some painful trades which will have compounded the problem, but the real dealers here are the investment banks and the retail banks and their big corporate customers - they're locked into cycles of liquidation just to keep their cash flow afloat, especially when bad debts are on the rise and the cost of overnight borrowing is still pretty prohibitive. This might also partially account for the selloff in gold.

Most eastern european countries, with their swiss and euro denominated mortgages and loans are in the grip of utter panic now - this piece has a more lucid analysis than flash can manage at this time of night. That's why the Swedbanks etc exposed to another wave of sub-prime in eastern europe are looking at some big, big trouble - pointed out in this piece months back. So he's expecting the euro, but even more than the euro, the dollar to continue to appreciate against the emerging market currencies - difficult to see what can stop them, really. There's a self-reinforcing cycle there as EM countries have to sell their foreign exchange reserves in euros and dollars to prop up - buy back - their own currencies.

The gold short isn't working so well - whether this is a short term bounce or an indicator of some sort of inflationary pressure will no doubt reveal itself in the next couple of days. Flash thinks gold has further to go down but it hit his target of $720; but there's a lot of resistance to further falls in the $720 - 30 range; the dollar would need to make another move upwards for gold to resume its southwards drop, it seems. For now Flash is just running a small, lossmaking gold short from $744 and will watch and wait.

Marx and Spencer

"Modern bourgeois society, with its relations of production, of exchange and of property, a society that has conjured up such gigantic means of production and of exchange, is like the sorcerer who is no longer able to control the powers of the nether world whom he has called up by his spells. For many a decade past, the history of industry and commerce is but the history of the revolt of modern productive forces against modern conditions of production, against the property relations that are the conditions for the existence of the bourgeois and of its rule. It is enough to mention the commercial crises that, by their periodical return, put the existence of the entire bourgeois society on its trial, each time more threateningly. In these crises, a great part not only of the existing products, but also of the previously created productive forces, are periodically destroyed. In these crises, there breaks out an epidemic that, in all earlier epochs, would have seemed an absurdity -- the epidemic of over-production. Society suddenly finds itself put back into a state of momentary barbarism; it appears as if a famine, a universal war of devastation, had cut off the supply of every means of subsistence; industry and commerce seem to be destroyed. And why? Because there is too much civilization, too much means of subsistence, too much industry, too much commerce. The productive forces at the disposal of society no longer tend to further the development of the conditions of bourgeois property; on the contrary, they have become too powerful for these conditions, by which they are fettered, and so soon as they overcome these fetters, they bring disorder into the whole of bourgeois society, endanger the existence of bourgeois property. The conditions of bourgeois society are too narrow to comprise the wealth created by them. And how does the bourgeoisie get over these crises? On the one hand, by enforced destruction of a mass of productive forces; on the other, by the conquest of new markets, and by the more thorough exploitation of the old ones. That is to say, by paving the way for more extensive and more destructive crises, and by diminishing the means whereby crises are prevented."

Marx and Spencer
1848

In Business

Dow crashes....again. Gold up, unsurprisingly, but it'll come down...

Very useful BBC programme here on the prognosis for the next year, two years, five years. Flash almost completely totally agrees with John Kay.

Flash sells out...and buys in... yet again

Will he ever learn?

Very nasty trading indeed but Flash is dropping in a few long equity positions.

He bought some BA at 115, some Game Group at 150, some Firstgroup at 490, some Royal Bank of Scotland at 100, and some more Kingfisher at 130. He also picked up some BT at 142. All, with the exception of RBS, showing a bit of a profit.

And yesterday evening, and again this morning he sold some gold and reinstated a EUR/USD short from around the 1.37 mark.

So far so good. Not trading the indices yet - he wants to see a more sustained rally before he burns any more cash there.

And, pasted below - here are his current thoughts on gold and USD as posted to the paddypowertrader blog (with acknowledgements to people in the know who have helped him think this through).

"Long term, broadly speaking, I’m still very bullish on USD, for the reason that a lot of emerging market economies have expanded on the basis of buying up cheap USD-denominated assets and using cheap dollars as a source of funds to expand lending. Now that liquidity/credit is tightening, and growth is rapidly slowing, they are selling off dollar denominated assets and scambling to call in lending- USD foreign exchange reserves held by overseas governments are falling. PLus EM currencies are tumbling all over the shop - partly because commodity prices are falling, demand for exports is slowing, and so their economies can’t make so much cash in real terms, so the prospects look really dire for them.

In this environment, and especially with a shrinking US trade deficit, my reading is that the dollar becomes stronger - remember that US weakness is RELATIVE to weakness everywhere else, and in my view, the weakness pretty well everywhere else (partly as a result of sub-prime etc in the US) is set to get worse. In the US however, taxpayer bailouts notwithstanding (and interestingly, everywhere else is now going down this road, so we;re all in the brown stuff) there are the beginnings in place for some sort of recovery, especially as inflation is going to go almost to zero in the next 12 months, because of recession/demand destruction/contraction in output.

So that then leads to gold. It’s hard to see how gold can go up, other than with short term panic bursts of trading like we’ve seen over the last week, when the rest of the commodity environment is so disinflationary. PLus if the dollar strengthens I agree that gold will become more expensive here relative to the dollar (and I expect sterling and euro to tank even more in the next few months as recession really bites), but that doesn’t mean that the PRICE of gold, denominated in USD will go up. In fact I’m expecting it to fall. A lot. So my view remains resolutely long USD, short gold, and then trickling in a bit of long equity over the next few weeks and months.

But of course I could be wrong…….

THe opposing view says that the bailouts are deeply inflationary. I’m not quite sure I buy that argument - I think the rate cuts signal a shift away from a single-track focus on inflation towards looking at the downside risks of outright recession. And I think that the downshift in house prices, commodity prices and even - likely real terms wages as the labour market becomes tighter and more competititve- should stave off some of the inflationary pressure. Demand is more than muted, it’s almost utterly destroyed. Of course the flipside of currency devauation against USD for EUR, GBP, and even more worrying places like Iceland and Russia will be deeply inflationary - but that in a way will just strengthen demand for ‘hard’ currency like the dollar. Hence dollars retain their value. And remember, if we take a historical view, gold is still trading near its recent mega highs and the dollar is not that far off some of its lows. I’m still gunning for EUR/USD parity, especially if the slowdown in Europe (especially southern and eastern europe) turns into something even nastier, which seems entirely possible to me.

And I can see that in an environment of outright bust gold would have an appeal - but I expect a slow, painful bottoming out rather than outright bust.

So this morning I sold some gold and reinstated a EUR/USD short. I wonder if I’ll be able to hold it through the volatility…"

The lights go out in New York City

Well not literally, but if things carry on like this for another week or two the lights will be going out all over the world, at least in the trading rooms, and by extension in workplaces, factories, farms, schools and hospitals as the globalised version of the economy judders to a complete halt.

We are now looking at the S&P 500 heading down to 900, the dow heading down below 9000, and the FTSE headed below 4000. This an event building towards the scale of 1929 - which could lead to a medieval scale depression and bloodbath, followed by very unpleasant global conflicts over resources, particularly water, gas, food and oil. Taxes will have to rise to pay for the orgy of borrowing; there will be enormous demand destruction - it's essentially the end of the rampant consumer society that began in the 1960s and accellerated through the age of reagan, thatcher, the bushes, clinton and blair. Not such a bad thing perhaps. It points to an entirely different social and economic order - the banking system at least partially owned and guaranteed by the state, self-help and local community aid/mutualism will be essential - and one in which the economic assumptions that have prevailed over the last thirty years are completely unravelling. So Flash needs to do some more careful thinking. He actually thinks some of this could be quite a good thing. A monumental adjustment, or a monument to the massive expansion in credit and borrowing begun by Thatcher and Reagan. But one thing is sure, flash parties for the masses are over and we're heading into a more austere few years. For example, Heathrow Terminal 5, a monument to the millennium, is terminated. Flash was hanging around there on Saturday night and observed that the only people buying anything were in the pub that sold cheap beer. Austerity...

In pure capital destruction terms, this is carnage. It's beyond insane. Flash is out for the moment. He just can't risk any more cash in this crazy market. On the other hand he thinks that he ought to be buying equities aggressively but the volatility is so extreme that it's just impossible. He may make a couple of strategic equity purchases in the next couple of days - BA at 128p looks pretty darn cheap, BT at 154 likewise, similarly with some of the utilities and even the real estate stocks.

All the gold shorts stopped out, unsurprisingly; the dollar longs are what has kept him in the game over the last couple of days but in the wild swinging back and forth they too got stopped out. He made a pile of cash shorting EUR/JPY too. Flash thinks that going long gold for the next few days may actually be the right call now as the currency markets are just so messed up too - no liquidity - spreads widening - the whole international financial system going through its death agonies. It's likely that investors will continue to pile into gold. But Flash thinks that the outcome of this is likely to send gold tumbling as deflation accelerates, fuelled by dollar strength. In the final analysis, gold has to trade in line with the rest of the commodity complex.

In Flash's view, the dollar will continue to appreciate against all other currencies, particularly any emerging market ones which have been the beneficiaries of the cheap dollar over the last few years. A lot of emerging markets have pumped up their economies by buying cheap US assets denominated in dollars - and this trade is now unravelling (and thanks to a fried who runs a proper hedge fund for this insight. The US trade deficit will shrink. The Euro is toast. It could easily go back to parity with the dollar. Sterling will also get at least mildly toasted, as we could have just as big a mortgage meltdown here - especially if property prices halve in value, which looks entirely possible. People who are thinking that their 80% mortgage is comfortable will get nasty shocks if property prices drop another 15 - 20%, The banks aren't lending anyone anything, and most households are way over-extended, and unemployment/layoffs will kick in, making the gloom even worse. Wage inflation has been modest, and is likely to remain modest if the labour market contracts, as competition for jobs will push down what people can ask for.

States and whole countries are now going bankrupt. California is on the brink, Iceland is over the edge, and Indonesia looks badly messed up. China is going to have some severe challenges as demand for manufactured goods collapses. Its labour market will contract and the flow of cheap dollars is going to stop.

Governments are going to be under intense pressure. Tax revenues will be severely reduced; this will lead to pressure on public services; there will be pressure to control imported inflation but also to stimulate investment. Probably one of the only viable solutions is for government to keep up its investment in the public sector, and to borrow more to fund it. If government doesn't take a Keynesian turn then the prospects for those people that are not able to insulate themselves in highly skilled occupations are really bleak. Education, reskilling, retraining and keeping public services going will be crucial, otherwise we risk turning the country into a divided rathole like NYC in the 1970s.



Borrowing will push sterling down, and this may stoke inflation, but it'll make exports more competitive, not that there's much left to export as far as UK manufacturing is concerned. And the UK economy, built on services, is in a particularly vulnerable position. Flash thinks that the value plays, if and when the dust settles, would be infrastructure, engineering, manufacturing, educational services, utilities, and some value-based retailers. If he didn't thoroughly disapprove, he'd also be investing in security services, prisons and defence. But he won't do that. He's also still bullish on the potential of small scale creative industries, but they'll have real trouble accessing capital. So he expects a newly politicised, DIY ethos to take hold, fuelled by web, accessible media technologies and small scale platforms of all kinds, digital and physical. The web will be crucial but the big mass media institutions could well get absolutely stuffed. Major tech companies like Google and Apple could well continue to be winners, so this could be a great time to buy them; on the other hand their prices might fall another 30 - 40% from here given the action of the last few weeks.

Even with a global recession, the pace of technological change is unlikely to slow. Flash thinks that its ingenuity and innovation that is the only thing that will stop UK plc from going down fast. And in some ways he thinks it's pretty good for some of the smugger business grandees to get caned. But he also knows that the people who really get caned are those at the bottom of the pile. And that worries him a lot.

It's like a riot in which the traders are just smashing up everything in the city. Not unlike when the lights went out and the looters went on the rampage in New York in 1977. And it's very hard to see what will calm anything in this market. People that were outright short will be coining it; as readers of this blog will know, Flash has been in naive optimist mode, trying to call a bottom, for the last three months. He was wrong.

However, it's precisely because of this bleakness that Flash is looking for a bounce.

But Flash thinks he needs to see the dow up another 900 points and holding there, the S and P back to 1080 or 1090 before he trades again. Perhaps this is the grandmother of all corrections and stocks are just going to trade cheaper. After all, not that many folk are going to have much cash left once this riot unravels and a damage assessment can be done.

Appetite for risk

Well, flash has been toying with the idea of some full tilt trading in the face of some extreme nervousness and volatility (VIX at multi-year highs, routine 3 -4% drops in the indices).

What gives him this view?

Well, the bailout looks like 80% a done deal. So there is likely to be some sort of relief rally. Data on how deep the piles of dodgy loans the banks are buried in is out there. We know a recession is coming, or is here - but how bad are things, really? Commodities are coming off fast (he made a packet shorting gold in the last couple of days), oil is coming down, and Flash thinks it could hit $75 a barrel within weeks. Flash has also made a good bit being long USD, and nothing has changed this view. All of these major transitional events - a reworking of the easy assumptions of the previous macro environment - (ie long commods, short USD, long inflation, short airlines, short financials, short consumer stocks). This changes the game for equities, despite some really nasty payroll data today, and more contraction to come. What Flash was surprised by was that the reaction to the data was much less violent than on previous payroll days - this reinforces his view that recession and unemployment is largely priced in. Earnings will be hit - of course - but how cheap can equities get? Answer - very cheap indeed, but Flash is working with small stakes and very large margins as a way of dampening off some of the volatility. And he's stlll, despite all the nastiness, way up on the year.

Rate cuts in europe, the UK and the US now look more likely than not. Credit markets are gummed up and liquidity is awful.

So Flash thinks the uniform short equity trade is overdone. Some of the financials look like they could be worth more in a year or two than now. Some of the more solid retail propositions will see their overheads coming down over the next few months. Flash observes that whilst the mood on the street is muted and nervous, it doesn't feel like a full on depressionary recessionary gloom like the early 1980s (although this could yet come...) And the defensive plays - utilities, infrastructure stocks look pretty attractively priced. However the resources stocks deserve more of a hammering and they've been what's been pulling down the indices more than anything else.

However, a relief rally could be a good point to get some longer-term long equity positions in place.

So for this reason, holding on to his hat and bracing himself for a kick up the arse, Flash has staked a bit on a couple of long Dow and S and P positions. He'll get stops underneath them if there is a relief rally, but really wants to try to hold them for a bit longer than a few hours. A high risk strategy, but at a time when all the retail investors seem to want to buy gold and put their cash in the safest place, Flash thinks the market could reward him for taking a risk.

And he has cumulatively added to his small long positions open in the following stocks over the last week or so: Scottish and Southern Energy, Firstgroup, Kingfisher, Marks and Spencer, Workspace Group, E*Trade, Morrisons Supermarkets, Cineworld Group, Game Group, Barclays. Plus he's holding on to his shares in Tribal Group, BA, HBOS and IG Group, despite them being underwater right now.

Stupid? Perhaps. But the rewards will be good if this view works. And the amount he's made shorting gold has covered some of the other indiscretions and recklessness. He stands by his forecast that gold will be back to $720 or below before too long.

Diverse, inclusive, innovative, ambitious

How wonderful. Flash wishes he'd got a job there. It looks like such a great place to work, so well managed.

Flash wishes all the former Lehman employees well but can't help the word hubris coming into his head.

I am the hedgeman...

Another horrible morning dawns. However as Flash is long USD he's not too bothered. He was wondering when the people that put their faith in the euro were going to get a nasty surprise. Today's latest round of bank collapses and nationalisations seems to be it.


Anyway - Macro Man has more - and puts it better than Flash; and this, via FT Alphaville is pretty good too.



As the financial crisis deepens, jobs go and bailouts expand, the humour just seems to get more intense and - well, lyrical. In what we hope will be an occasional series, here’s today’s offering, from a Tokyo-based Beatles admirer known only as Mori (yes, a “hedgeman”…):

I am the Hedgeman
I screwed up as you screwed up as he screwed up
We’re in this mess together
see how they run from a money market fund
see how they fly
I’m crying
Sitting on some futures
Waiting for the bounce to come
Short duration T-bond, stupid bloody Dick Fuld man
You’ve been a naughty boy
You let the bank go down
I am the hedgeman (woo)
We are the hedgemen (woo)
I am the Paulson
Goo goo gajoob
Mr City Banker
Sitting pretty little bankers in a row
See the TED-spread fly, like Lehman in the sky
See how they run
I’m crying
I’m crying, I’m crying
CDO-squared custard
Dripping from a dead trader’s eye
Cram-a-lotta crap in
Pornographic lev’rage
Boy, you’ve been a naughty girl
You let your risk control down
I am the hedgeman (woo)
We are the hedgemen (woo)
I am the Paulson
Goo goo gajoob
Sitting in an English building society
waiting for that run
If the run don’t come you get a loss
When they nationalise the English way
I am the hedgeman (woo)
We are the hedgemen (woo)
I am the Paulson
Goo goo gajoob
Expert, texpert coked-up brokers
Don’t you think the credit analysts laugh at you (hee hee hee, ha ha ha)
See the bond guys smile like pigs in a sty
See the S&P slide
I’m crying
Securitised pilchard
Climbing up to triple A
Elementary screw-up, trillion dollar bail-out
Man, you should have seen them shorting
Those investment banks
I am the hedgeman
They are the hedgemen
I am the Paulson
Goo goo gajoob
G’goo goo gajoob
Goo goo gajoob
G’goo goo gajoob
G’goo

Paulson, the dollar and a bewildered rabbit (or, greed is bad)

Flash is hardly trading at all - in part because most of his long positions have been wiped out, in part because he's busy with other stuff, and most importantly because he doesn't have the time to watch the screen - and when the intraday moves in the S&P 500 have been over 3% practically every day for the last week there's a lot of screen watching to do.

There seem to be two possible views about where the market has got to right now.

The orthodox view at the moment seems to be roughly as follows:

A central bank bailout of the toxic debts held by the banks radically weakens the dollar. On the back of this, sentiment has moved sharply against the dollar, gold went stratospheric (that's a move Flash would have liked to have got some quick and dirty profits from, but half the rest of the world got on that bandwagon), and commodity prices have pushed back up. The only reason for this that Flash can spot is that the dollar's weakness means prices need to increase, plus a sentimental flight to 'safety' of gold. But gold isn't worth anything if no-one has the cash to buy it. Nothing has changed on the commodity demand front. If anything, demand will be weakening. To some extent the inflationary pressure of oil heading back up for everywhere other than the US will have been somewhat dampened by the currency move. So all the signs point to more contraction and a drop in commodity prices.

OK - so what has driven the collapse in the dollar's value? The orthodox view says that a bailout increases the US national debt enormously. And Flash understands perfectly why politicians and citizens are furious about having to buy a ton of currently worthless junk debts off the greedy bankers. But there are some wider considerations.

If the entire wholesale credit market collapses then the entire US economy collapses. A lot of domestic value is held in property and if half the country goes into negative equity then the consequences for the banking system are severe. Perhaps this pain is a necessary adjustment - it's a pretty bleak thing for people who need to eat, sleep, live and look after each other - but for those people that like capitalism, deeply ironically it requires one of the the biggest state subsidies the world has ever seen. It would be interesting to know what the ultra free market libertarians make of this: Flash is guessing that the ones that bet big the banks would collapse are shouting 'bring it on', but ultimately no-one will gain if we're into a 21st century great depression.

Regardless of what happens there will be a continued contraction in available credit as the banks rebuild their battered balance sheets. And discretionary, risky lending has already reduced, but borrowing is just going to get more and more expensive in real terms; credit in emerging markets who have been dependent on a one trick cash cow - resources - is going to get even tighter.

And the cost to taxpayers of doing nothing needs to be considered too - mass unemployment, crime rate goes through the roof, millions made homeless, businesses failing. And remember that companies are taxpayers too - and perhaps taxes will have to rise to cover some of this, but in Flash's book that's not such a bad thing, and isn't the end of the world as we know it. The alternative probably is.

Now if the US goes for a bank bailout plus a fiscal stimulus package - new deal mark II, with some protection for homeowners - some sort of government trust which backs distressed equity, then the outlook looks rather more positive.

If the US goes for a rate cut then although it might weaken the dollar it might also accelerate growth - hence strengthening the US economy against the negative growth of the rest of the planet. Similarly in europe and in the antipodean world - rate cuts may help boost liquidity and that is sorely needed.

Now a second question is - how inflationary is this?

Common sense would suggest that injecting this much cash, and cutting rates would have an inflationary effect. But wait a minute. Is cash actually being injected into the system? Well, quite a bit went in last week, but not just in the US - it was a co-ordinated action across the globe. So it's more like an emergency blood transfusion than a flooding of the arteries.

Buying these bad debts is not necessarily a complete disaster for the USA – what would be a complete disaster is if nothing is done – mass unemployment, complete collapse of wholesale credit market, and thus business/consumer credit market. And the position of these toxic MBS only weakens if the housing market doesn't improve.

But perhaps there's a line to be drawn between the inflationary pressure of rate cuts and stimulus, and the drag on demand caused by the fact that most people have completely run out of money. No-one's buying anything much right now. And ultimately if the US recovers more quickly then that's good for the dollar. And it will take another year for any kind of confidence to return to the housing market. So this could be a great time to buy property if you're cash rich.

So, the second, perhaps counterintuitive view is as follows:

How sustainable is the rally in GBP, EUR, AUD, NZD etc against the dollar when arguably these economies, and thus currencies are even more vulnerable? Flash suspects that other governments will also have to commit funds to back up some of the toxic debts in their system too. Actually Flash thinks the UK might not come out of this as badly as others expect - the UK economy is more flexible than most, and Keynesian public sector investment is providing some ballast, despite the crazy property boom. Hence he is still long GBP/EUR, a trade that's actually worked over the last two months.

So it comes down to two views (and many thanks to some more intelligent economic commentators who have helped Flash build up enough of a picture in his thick head to write this).

View one (indefinite armageddon)

- because of the weakening dollar, commodity prices rise:
- gold, because of it’s ‘safe haven’ status carries on rising - but only as a hedge, and we all know what happened last time everyone tried to hedge their equity losses by going long commodities
- oil rises on the back of a weakening dollar

If inflationary pressures mount, then central banks can’t act to cut rates

- essentially stagflation/recession/late 1970s
- no stimulus
- massive bust
- house prices halve
- borrowing collapses
- liquidity and lending between banks collapses

...and then some sort of rescue plan is put in place, or else we all go back to barter/self-sufficiency/feudalism - aspects of which might not be a bad thing. So Flash is looking for companies that understand this new world - trouble is, not many of them seem to. And technological innovation/flexibility/responsiveness will still be important. But it means a total depression in the price of stocks. A total write off. Massive destruction of value. And even cash loses its value because inflation is totally out of control. But it would be a good time to be in venture capital. Funding start-ups which understand this new world. And perhaps buying companies involved in public services, prisons, policing/security, healthcare, water, rail, energy efficiency, transport. Or pawnbrokers?

View 2 (some sort of bottoming out)

A ‘new deal’ stimulus, particularly under a democratic administration could give the US a huge rebound over an 18 - 24 month period:

- The US trade deficit shrinks because import demand is dropping so fast in the US. US labour costs and wage growth falls because competition for jobs is more fierce.
- Dollars become more scarce, hence more expensive because there are fewer of them around...perhaps?
- The rest of the world goes into an even steeper downturn than the US
- US leads a recovery - not rapid but not slow either. By spring next year there are signs of recovery in the housing market, by which time it will be a bit late to buy into the housebuilders.
- Inflation poses even bigger a threat to emerging economy growth than the developed world and if demand for all the goods the developed world produces falls off, then those economies go into steep decline too.
- On the other hand, petrodollars are plentiful but if prices rise then demand falls off even more – so Flash is looking for a bigger correction – oil down to $75, even if production slows
- China is in trouble because it's fuelled by demand for manufactured goods and cheap overheads - but demand is falling off and overheads have massively increased. Hence food riots, higher infrastructure development costs, falling property values and a creeping problem of growing unemployment, linked to political discontent and the collapse of the consumerist dream.
- Emerging market banks and BRICs sell off foreign reserves to stay liquid, and credit growth in emerging markets collapses, emerging market growth therefore slows.
- Demand destruction pushes down commodity prices
- Self-sufficiency and energy efficiency become even more important and we probably see an increase in protectionism. The end of breathless millennial Free Trade. The break up of the WTO. But commodity prices fall because demand drops off rapidly.

For this reason, Flash is looking to be bullish on some US-consumer facing equities, particularly those which have been heavily sold – housebuilders, some of the financials, large cap retailers, infrastructure – rail, water, roads, some technology stocks – he just bought back into Apple.

Flash will sell down some of the resource stocks if a rescue plan is agreed.

Flash is looking for an entry point to go long USD, short gold, short oil. He sold EUR/USD on the manufacturing PMI figures out yesterday. Other economies also likely to need to do bank bailouts – the contagion isn’t limited to the US.

He does have one dow long running from 10687 but came within a hairbreadth of closing it out yesterday to recover some of his losses on some of the other long equity positions he'd been trying to hold.

But this is just a view. Trying to piece it together. For now, he's very, very cautious and just wishes some of those index shorts had been left alone.

In these markets you seem to get caned whatever you try to do.

Meltdown

Not much to say really, except that HBOS proved to be a dog of a buy, 90% of Flash's stops have been triggered, at least 50% for losses, and he's left holding a handful of anaemic looking equities showing some anaemic profits. And what's really shocking is that one of the UK's largest banks can say one day "our funding position is adequate' and the next agree to be bought up for virtually any price because they can't raise enough cash to keep the UK's biggest mortgage and retail deposit book afloat. This really is a monster of a disaster. And the leverage maniacs that brought us to this position ought to be held to account - perhaps it is indeed all of us, but some people have more responsibilities than others.

Lybos indeed. And who is going to want to write mortgages when the property market could slump another 10 - 15%? And cash doesn't cut it either. It's a total unravelling. And if the solution is for central banks to print money for bailouts then the inflation monster will be back with a vengeance.

All the long USD currency positions have been closed down and Flash just wishes he'd left some of the many index shorts he'd established to run their course properly. One little sideline might be to short some eastern european currencies - demo-trading buying GBPvsHUF has been pretty spectacular. Shame he didn't do it in reality.

Gold going from 777 to a high of 893 in 24 hours is pretty unbelievable too. Flight to safety? Capital flight out of the market, full stop. And most of Flash's trades in the last 3 days have been in the wrong direction.

Time for a breather and some reflection on the next move.

For light relief, this morning's FT Alphaville live blog was a cracker (especially some of the comments).

What a carve up

Well, the clock sits at two minutes to midnight on Lehman and Flash is frankly bewildered about how to trade this one.

Perhaps it would be better not to trade it at all. Trouble is, Flash has some decent long Dow and S and P positions sitting comfortably in three figure profits. But if the wider market decides to take this as a signal to go into full blown panic, then Flash will have to just cut them.

On balance he thinks he will cut the Dow long position in half when the futures indices open at 10.30pm tonight (if it's not cut in half for him) and put some hedging short equity positions on pronto.

Flash still stands by his view though that perhaps this isn't quite armageddon because so much is known - what may well not be known is the extent of all the other banks' exposure to Lehman (or ToxInc as FT Alphaville coined their 'bad bank' on Friday) - and that could have serious repercussions. So if there's even so much of a flicker on the price, as inevitably there will, the HBOS and Barclays long positions will go first thing tomorrow - and the same will probably be true for plenty of other much bigger fish. It's hard to see how most of the financials couldn't be heavily exposed to Lehman, unless they'd already got some damn good hedging in place ahead of this. (The hedging in all probability consists of heavy-duty short positions in their competitor institutions). Hence a mega selloff of bank shares?

Nouriel Roubini has this scary paragraph:

It is now clear that we are again – as we were in mid- March at the time of the Bear Stearns collapse – an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.

So tomorrow will not be a good day for the banks, unless some unctuous calming anti-panic lotion is administered by Uncle Ben or his acolytes before midnight. Not good at all. The end of tomorrow might be good day to do some financial bottom fishing if you've got a long line (of credit??). Nasty, nasty.

It also depends if Lehman's liquidation is orderly or disorderly. Perhaps at the very least an orderly liquidation might enable some sense of rationality to prevail. It would be in all the banks' interest for this to happen, and Flash expects an unctuous statement to this effect before the night is out.

If a deal - or at least a clear 'road map' to dissolution - isn't forthcoming then it won't be much fun out there at all. Or perhaps this is just the final shakeout, the Big Capitulation. Or perhaps (for the reasons outlined in the last blog, not). Flash is watching and waiting, and pleased that he's reduced his risk and has a fair chunk of the fund sitting in cash right now.

Piecing it together

Around lunchtime today Flash started to get an interesting feeling in the pit of his stomach. He spent some of the morning trying to get the measure of the market - it was lurching around and heading down towards new lows, and Flash was beginning to think that going short bigtime was the only way he was going to keep his P/L in the positive zone.

But then he stopped and had a think.

Why was it that his large cap stocks weren't caving in as fast as the financials? Unilever, Scottish and Southern, Firstgroup and BA were all holding it together fairly well. HBOS and Kingfisher were coming off really fast on the back of nasty figures from Home Retail Group and Merv's grim comments on the UK economic outlook, but the whole market didn't look like it was going into a catatonic bust, even though it's not been far off yearly lows. Plus his small caps were actually outperforming the market - Cineworld and Workspace were actually up a bit today. If it was a total bust we were looking at (and Flash had been worrying that it was, especially when around 40% of his gains have been wiped out in the first 3 days of this week), then how come some of his positions were actually doing alright?

Why was it that USD was still rallying against EUR and GBP; why was it that EUR was in rapid decline against JPY and GBP, and gold and oil were still coming down - making the deflationary call even more obvious. And with deflation comes a whole new economic picture - input prices lower, overheads lower, less pressure on household spending, increased margins and a whole new picture on interest rates/currencies which actually could enable an economy to come back into growth quite fast. And some gossip about the Fed cutting rates - well, OK, but Flash thinks that rate cuts will come faster in the UK and in Europe if the disinflationary trend holds.

Lehman had tanked down to $4 a share. So everyone now knows they are bust - either they find a buyer or what? They'll find a buyer, even if they sell at 50c a share. It's the end of the line and the market knows all of this. And if they find a buyer then the market rallies in relief.

And then some interesting figures came out of the US. Import price inflation had tanked; the trade deficit had narrowed; mortage rates were down, and initial unemployment claims were marginally lower. This combined with mortgage applications being up doesn't say that the US has turned the corner, but it does say that the decline isn't as rapid as it has been for the last few months. It also says that things may not be quite so bad as everyone says. And as Flash has been saying for months, it may be bad in the US but it's way worse in parts of Europe, particularly eastern and southern Europe. That's one of the reasons for the strength of the dollar. And there may well need to be eurozone interest rate cuts pretty rapidly. And everyone (except perhaps those with petrodollars) is running out of cash, because it's all been burned servicing debts and buying goods at overinflated prices.

And then Flash thought some more. If the consensus view is to be utterly bearish on equities, what is there to be bullish on? if the long commodities/short financials trade is over there will be a lot of big money geezers feeling quite a bit of pain. They'll have felt plenty of pain from the rally over the weekend and will have wanted to sell that off pretty fast; they'll have been looking for a reversal in USD's fortunes because they've been invested in short USD for the last 3 years, and got caned on that trade over the last 6 weeks; they'll have had not just their fingers but their arms burnt off trying to buy back into gold and the other commods only to see their positions turned to toast within hours of putting them on; they've pumped their cash into oil and commodities and other exotic debt based securities, and absolutely hammered equities and the financials partly as a response to covering some of the losses of the last few months. So the ride down in equities has been as desperate and testosterone fuelled as the ride up was in commodities.

But this is a big adjustment. And if it's a big adjustment then there will be some fast and furious short covering happening. In all the talk about the Fed printing money and taking on all the housing debt of the country, a couple of things have been overlooked. They may be nationalising Fannie and Freddie but they're also putting a backstop on the housing market. There's a big guarantee there. Sure, if the housing market tanks they will be taking on trillions of debt, but if it recovers, it becomes an asset not a total liability. And if everyone gets a bit more cautious about lending money, that's probably a pretty solid adjustment. And everyone is so invested in the short financials trade, the question is - how much shorter can we all be on financials? Isn't this actually the perfect time to be buying some banks? Not necessarily all of them, but there's no way all of them can go bust, can they?

So Flash went long. If he'd had more capital (having burned an awful lot of it in the last three days), he'd have gone heavily long. But he went as long as he could afford on the Dow and the SandP, and then went long on FTSE as well when it hit 5325. And he bought even more HBOS, even more Scottish and Southern, more British Airways and more Kingfisher. He even bought some Morrisons - deeply discounted at 250p - their results actually really weren't that bad, he thinks.

Then he left the screen alone for a few hours, and logged back in at 8pm to find an absolute monster of a 350 pt rally in progress.

There may be some chatter this evening about Bank of America hoovering up Lehman which has helped a rally; there may well have been some boosterist buying, and it may well come off a bit tomorrow, but Flash is as confident about this call as he has been on any other of his big winning trades this year. He's got stops locked in on all the core positions; he may not make as much as he'd like but he won't be losing so much in the next few days as he has in the last few, that's for sure.

Rethinking risk

After the agonising drawdowns of the last couple of days, Flash is stepping back and reassessing his view.

A few problems.

The disinflationary call has worked out perfectly - gold plummeting, dollar strengthening, and it's only really these trades that have kept his P/L afloat. Flash has been short EUR since way back when and reintroduced short EUR/JPY back to his fund late yesterday - now showing a nice profit, and EUR/USD broke through the 1.40 mark and now is headed down - Flash is looking for 1.25/1.30 as the next call (unless the Fed decides that an emergency rate cut is needed to stop the markets from tanking). Gold likewise - $720 an intermediate target but Flash thinks $600, with oil at about $85, would signal a real depression/recession.

But the second part of the call - that this should lead to a rally in equities, specifically some of the banks and large cap consumer stocks has eluded him. Shocking results today from Home Retail Group (and more to come, no doubt) have hammered Kingfisher, one of the stars of his portfolio since he got in there at 96p, and HBOS has taken a beating in the last couple of days. Stops are there to lock in some measly profits, but it ain't looking great for any of the financials or the retailers, or most of the other FTSE 100 stocks that Flash impulsively picked up on Friday afternoon - Unilever, Pearson, Scottish and Southern Energy and Marks and Spencer. Way too much trading, way too little assessment of the potential downside.

The Lehman raffle ticket got stopped out for a derisory gain of £2 - enough for a packet of chips which is probably all the bank may be worth. Flash was tempted to buy back in but he thought the better of it - he did however buy some more AMbac which again may prove to be a costly mistake.

Being impulsive and naive, Flash closed out his Dow short from 11500 when the market looked like bouncing early yesterday afternoon - for a while he thought he'd done exactly the right thing but this morning he's wishing he'd left it alone. Nothing now on the dow chart really to stop it retesting the 10900 level, or going for an almighty bust below 10000.

And yet - and yet - being bearish on equities has become such a consensus trade that Flash can't help wondering if there's some value in doing some buying. But in this market you need major confidence or deep pockets - and Flash's confidence has been ebbing away over the last 48 hours, along with a sizeable chunk of the cash in his pockets. On balance he is still more bullish than bearish about the USA - the UK he's becoming more circumspect about by the day. Very, very difficult markets to call, but it ain't looking good for the FTSE 100. Not at all.

Flash has quite a bit of his fund in small caps too - and there's been no spectacular action in these; on the other hand, the small caps he's invested in have largely flatlined in a really volatile market which gives him some hope that they were the right call - Tribal Group has held it's own all the way through the volatility of the last six months, and Workspace Group, in spite of its threatened relegation, has really done rather well - up to 140ish from where he bought them at 118. Cineworld holding up well too, Axeon crashed through his stop at 40p yesterday and he took a serious writedown - 5% of the fund - on that one. So much for energy efficiency and innovation. (What the hell were you doing putting 5% of the fund in an obscure small cap, I hear you say? Well, 5% of the fund were just the accumulated losses on what started out as a smallish position when he bought them at 80p. Another crap trade).

It's a dangerous market - and for this reason Flash has reintroduced that FTSE short and will look for a Dow short entry point this morning as a hedge against all his longs. It's only gold and the currencies that are keeping him in the money, but the fund has blown up badly in the last couple of days - too much risk, not enough margin - gave up a lot of his gains from the bounce over the weekend.

Less is more - so he's paring back his positions, putting on his tin hat, and holding off from trading. Like most of the rest of the world, unless they're selling. Which means that some serious downside could still be in front of us.

Careful with that margin, Eugene

The last 24 hours of trading have been a perfect lesson to Flash Rabbit in how NOT to apply the principles of 'less is more'. It hasn't been an unmitigated disaster, by any means, but to set it in context, by the end of Monday Flash's fund was 400% up from the February start and by the end of today it was back to under 300%. A 28% drawdown in less than 24 hours. Ouch.

Surely a sign that

a) the fund is overleveraged and
b) Flash is overtrading.
c) in these markets, it doesn't pay to take anything for granted.

A few examples.

Flash caught the upward rally in the dollar mid-morning on Monday perfectly but didn't have the confidence to run the position in EUR/USD, GBP/USD, and sacrificed around £400 of potential profit. No loss, but not nearly the gain that could have been. He did get AUD/USD on the nail and picked up a nice £350 from that trade.

Flash had Dow, S and P and FTSE longs in place from excellent levels (put in late afternoon on Friday) and caught pretty well all of the spectacular bounce in equities. However, instead of leaving them alone, and take some profits, Flash greedily decided to leverage up his position by moving some of the stops and trading on margin, adding new S and P longs at 1240, 1250 and even (arrogant idiot!) 1270. Well, that's great when the market appears to be going up (and Flash was out for most of Monday, so he didn't really experience the seasick yo-yo signals which are a sure sign of some nasty action to follow), but when the market decides to tumble hard, as it did today, and you're way overleveraged, it just eats up your capital even faster. And Flash, being flash, decided he knew better until he started to feel sick, and took some of the initial dip this afternoon as a buying opportunity for UK equities, which will probably leave his P/L even more painfully reduced when the UK 'adjusts' to the US' action tomorrow.

Flash had an excellent long position in AMBAC from around the 550 mark. Again, instead of just leaving it alone, he nicked some of the margin from this successful trade and leveraged it up. So when AMBAC tumbled from its highs around 880 to around 750 (which in theory should still give plenty of room for maneouvre on a 550 long), Flash was caught with his trousers down - the two extra positions he'd added at 780 and 800 were stopped out fractionally above break-even (ie zero gain) and the tasty AMBAC long turned to toast as AMBAC hit the stop at 720. OK so he had another couple of hundred quid to add to his trading capital but the greedy rabbit had already spent that opening up new longs in his ragtag bag of equities, which in the light of today's events are pretty appalingly judged. Of course, the financials could be in for even more blood letting, in which case it'll be great he got out of Ambac when he did, but Flash's big picture macro call is that we have to see some sort of proper recovery for at least some of the financials or otherwise we are heading into 1929.

Lehman went to pieces too. Flash hadn't leveraged that one so at least he just put it in his pocket - a quick £60 gain as the stock crashed through his stop at $14.00. He's opened up another blind Lehman punt just before close of trade today for a tiny 30p a point from around 770 - no prob if it goes to slash and burn, but nice bonus if some sort of rescue operation is mounted.

Flash has been eyeing Scottish and Southern Energy for months now - he's seduced by windmills and hydro, and because he's made a pretty big pile of cash, by his standards, he pumped a bit in to Scottish and Southern this morning from 1390ish, only to to see the dam break and the reservoir empty as the price plummeted to 1365. Something to do with Darling not ruling out the windfall tax for the comrades at the TUC, coupled with tumbling wholesale energy prices? He's set a stop at 1310 (roughly where resistance is on the chart) and will try to hold this one for the long term.

On the positive side, gold behaved exactly as Flash expected today - he's been watching it hovering around the 800 mark for some days and as oil slid, gold went south - great stuff - shorts running towards a four figure profit on gold now (for the second time this year), and Flash is targeting a crash down now for gold to around the $720 mark or even lower. He can't see any reason why it needs to be any higher - unless that is we have the mother of all market meltdowns in which case it might represent some sort of flight to safety - but see this piece which has persuaded him that the gold bulls are wrong. The disinflationary trend is just too well established now, plus so much cash has been burned going long on commods as they've tumbled, that Flash thinks gold can only go lower. On the evidence of the last 3 days worth of trades, where he has been cautious where he should have been confident, and confident where he should have been much more cautious, he'll probably be overconfident and wrong on this call too.

Flash had the foresight to at least bang on a quick Dow short around the 15000 mark and that has offset a fraction of the pain and damage caused to his long view by the nervousness

So, from the outright long call of the weekend, we are now back into hedging/check and balance/risk reduction territory. Stops moved on 3/4 of the HBOS position up to 290. Can't lose but may not be onto such a winner as he thought.

If things carry on like this, Flash will be forced to become much less flash and much more cautious. Even though his Templeton antennae are saying buy, buy, buy. Fine if you're a billon dollar hedge leaping thoroughbred, but the problem for micro macro rabbit market jockeys is that if you don't have the margin to ride the volatility, you just get chucked off the horse. Right now quite a bit of his margin is being used to prop up some badly judged FTSE long positions around the 5450 and 5500 mark. And another chunk of it was eaten by the market gods as a sacrifice to overconfidence and overleveraging on the S&P 500.

Perhaps the action today was just everyone getting out before the whole thing goes to pieces. In which case a short in gold and a short Dow position won't shelter Flash's fund and he'll give up another 10% before he can hit the 'sell' button tomorrow morning.

So can gold save the day? If deflation goes faster and deeper than everyone thinks, then what are the implications for equities? Flash thinks a massive rally for large cap consumer stocks. Or perhaps it's not so much deflation, it's just a total liquidity crisis - everyone, including the banks and the Fed, run out of cash, so no-one can buy anything, so all the prices drop like a stone? Answers please!

PS Apparently Lehman is revealing its skeletons tomorrow. That will be a relief, whatever the outcome, but we can expect a nasty, nervous market early doors. As a precaution Flash is considering taking the loss on all but one of the FTSE longs and opening up a short position in FTSE before he hits the sack tonight.

Going long, bigtime

After talking to some much wiser market players than him, Flash Rabbit has decided that the Fannie/Freddie bailout is unequivocally good news for the markets, because it removes so much uncertainty around the mortgage market and the debt guarantees market, and will restore a good measure of confidence to the financials - in the sense that they will not have to unload even more CDOs and that there will at least be the stability of the US Treasury bonds etc underpinning the US housing market rather than the crazy and schizoid world of the current 'free' market. Not great news for USD, putting it mildly so there will be a bit of a spike down, but Flash still thinks that the global macro picture is in USD's favour. Overall he thinks it's likely that the US trade deficit will continue to narrow and that the US economy is probably better placed to recover than most of the rest of the world. No serious long term player would want to buy Euros at this level - still pretty close to some of the historic highs against USD - even sterling looks more attractive than the euro, in Flash's opinion. Hence putting a short EUR/GBP position on when it hit its historic highs above the 0.81 mark earlier in the week.

Another interesting observation is that the rumours on Fannie and Freddie didn't particularly hammer the dollar, gold or oil on Friday afternoon - which again would suggest that the major, serious money will probably get back into the equities market. Where else is it going to go? Not into commodities, to get burned once again in the bonfire of demand destruction, unlikely to be seriously in currencies given that we've had such seismic shifts over the last 6 weeks, bonds are already overbought. So where else will it go? What looks the best value - i.e. where is the best risk/reward ratio at the moment? Equities, even if earnings weaken as expected. Particularly financials, large cap consumer stocks, infrastructure plays, big name retailers and certain niche small caps, particularly those operating in public sector services and in fast growing sectors e.g. creative industries.

For all of these reasons Flash is delighted that he's hung on to most of his long financials - particularly Lehman, AMBAC and HBOS. As the market got a sniff of the news on Friday afternoon there was a pretty strong rally out of the doldrums. Flash used this as an opportunity to restore a bunch of Dow, S & P and FTSE long positions, all of which are showing a profit, and he expects a pretty strong open overnight and tomorrow morning.If we do get a monster rally he'll shift the stops so he can't lose any money, but he'd love to have some Dow longs that he can run for the serious long term - 3 to 6 months. It's a pity that his long position in housebuilder DR Horton got stopped out in all the panic and volatility last week - he'll probably buy some more tomorrow if he gets a chance.

Most of the success of the last week's trading came in the currencies - clearly the long index positions got taken out one by one but judicious use of stops meant that Flash didn't lose much capital. Short EUR/JPY was a total monster and he's closed that one out now - probably has adjusted to a saner level and will trade in a new range now. Short AUD/USD, EUR/USD and GBP/USD also netted some excellent profits. He did get some of his short gold positions caned in the volatility, and missed out on the obvious opportunity to get some shorts in on the eurobanks during Trichet's press conference on Thursday - those old chestnuts Erstebank and Swedbank, very exposed to eastern european basket case economies, got hammered - Flash is keeping an eye on these and he thinks that Erstebank could have considerably further to fall, taking his cue from this prescient piece penned by a friend earlier in the year. But he's expecting all the financials to have something of a bounce up on the Fannie and Freddie news.

So, orders in place to buy more HBOS, and stops widened on the long dollar positions - he's trying to hold these for the long haul and may well treat a strengthening of EUR/USD as a further selling opportunity.

Plus on Friday he bought more UK equities - small long positions in Pearson and Scottish and Southern Energy to add to his existing long positions (list elsewhere in this blog, but some of his best performers have been British Airways, Tribal Group, Cineworld, Barclays, FirstGroup, Woolworths and Workspace Group).

All set for another torrid week! Bring it on!

Margins, errors and unknowns

Trading plan for this week - try to stay cool calm and collected even as the hurricane batters the Gulf of Mexico and oil perhaps spikes though the roof. On the evidence of a late Sunday night, the currency markets seem to be shrugging off the oil spike and USD/GBP, EUR/USD and EUR/JPY are behaving perfectly, from Flash's point of view, i.e. euro down, sterling down, dollar up, yen up. And if the hurricane isn't quite as bad as expected Flash is perfectly poised to take advantage of any bounce of relief when normal trading resumes on Tuesday.

Flash has Dow longs in place from 11180, 11365, 11378 and 11428 and he is hoping to hold onto them through thick and thin this week - if not there are stops in place which will ensure he doesn't lose any money. Everything in his fund is broadly unchanged except that he's bought even more HBOS and Barclays, and has dipped a toe in the housebuilding market with a purchase of a long position in distressed US housebuilder DR Horton. He might also buy some Taylor Wimpey tomorrow. On Friday he bought more Ambac, BT and Lehman as well...He's hoping that there is enough margin in most of his positions to ride out the volatility. The accuracy of the currency bets is offsetting the dampening of profit on the long indices - but flash remains long on FTSE, S&P and the Dow, and is hoping to stay long for at least a couple of weeks.

One anxiety is that his fund is totally underexposed to the opposite view - that the banks and housebuilders are fucked and that the dollar is as much of a basket case as any other currency, that demand exceeds supply in commodities - energy especially - and that the price of oil and gas could be headed back into the stratosphere again if supply gets seriously disrupted either by acts of natural or political/diplomatic violence. Of course, if energy prices do rise further and inflationary pressure builds back again it's hard to see how any of the world's economies will have anything other than a serious crash landing. Flash thinks that if oil goes sky high again then demand will be choked off even more, meaning that it will correct back downward because everywhere will be plunged into deep, deep recession. So the disinflationary call from a macro perspective remains valid, whether the disinflation takes 3 months or a year or more to work through. The other bit of Flash's view is that everyone KNOWS that the banks and housebuilders are fucked and therefore they are a total bargain at the prices they are trading at. Most of his long financial positions have sufficient profit and stops to make sure that he can't lose on them, so the risk/reward of taking his view seems pretty solid.

And even if we have even grimmer data/terrible results to come, it's the overbought commodity and resources stocks, and the other traditionally defensive plays that are likely to come down harder. Well, that's what Flash is betting on anyway, and he has stops and margins in place in case a major rethink proves necessary.

PS As a hedge against some of this inflationary uncertainty Flash has broken the habit of the last couple of months and taken out a small long position on the Gold Dec future from 838. It's purely a hedge - if the rest of his view falls into place then he will take a small loss, but given that oil is likely to be nasty this week, Flash is willing to take this risk.