The Global stock markets instead of responding favorably to news of the enactment of the Emergency Economic Stabilization Act of 2008 in the US have instead been declining. In addition, the credit crisis has now taken root in Europe as European nations scrambled to put into place their own bailout plans to save their own domestic banks. Forbis NV, the largest retail bank in Belgium, was recapitalised with an infusion of €11.2 billion orchestrated by a tripartite efforts of Belgium, Luxembourg and the Netherlands. Ireland in a unilateral move, declared that the Irish Government will guarantee all debts and deposits of its 6 largest banks. Although the move was initially denounced by fellow EU countries, fearing a flight of deposits to Ireland, the measure was later adopted by the Greeks. The latest EU nation to adopt such a measure was Germany which virtually acts as a guarantor for all its saving deposits in the retail banking sector worth €560 billion, a quarter of its GDP. This is in addition to the €50 billion rescue package for the Hypo Real Estate AG, one of Germany largest property lender.
Investors are currently still holding to a wait and see attitude as to the trickle down effect of the US $700 billion bail plan. US Treasury bonds yields have remain extremely low due to the flight to quality from the stock market. Investors are avoiding the corporate bonds market as they are wary of what could be a Warren Buffett’s “time bomb” hidden within those investments. The loss of confidence in the financial system has resulted in investors avoiding anything that is remotely deemed risky. Even though the bailout plan seeks to unlock the credit squeeze in the financial markets, banks are still unwilling to lend and if they do lend, the lending comes at a premium. The bailout plan protracted journey to become law has also resulted in the market having doubts about the effectiveness of the plan.
Many analysts agree that what was initially regarded as a domestic problem of the US has now mushroom into a global crisis affecting Europe and ultimately Asia as well. The situation now faced by the Europeans echo that of 1971 when the US abandoned the dollar’s link to the Gold standard. Currently all eyes are on the European Central Bank (ECB) to see if it will cut its interest rate. The reason is that with the establishment of the Economic Monetary Union (EMU), EU nations no longer have the powers to lower interest rates nor devalue their currencies. To give the ECB supranational control of monetary polices, all these powers were surrendered to the ECB.
Thus today individual EU nations, no longer having these powers, are resorting to protectionist methods to insulate themselves from the fallout. The irony of the whole situation is that, the EMU was established to enable the global economies move away from its dependencies on the US dollar. Instead of diversifying risks, globalisation has instead intensified risks even to seemingly immune areas. With the scale of interaction in the global economies, this has resulted increased interaction between Europe and US, making the European nations more exposed to any situation in the US.
Analysts are warning that as the contagion spreads across the globe, Australia could be in for a rougher ride than the Americans. This is because despite a boom in the commodities market, Australia has been running a budget deficit. Household debts are at 177 percent of GDP, one of the highest in the world. Since late last year, the shares prices on the Australian Stock Exchange (ASX) had declined by as much as one third. Mining shares have also been declining. If the slide in the commodities sector continues, Australia will indeed be facing a crisis worse than the US with no means to pay for its imports and no means to borrow in the current credit crunch.
Today, the economies of the world are intertwined together in ways that we cannot imagine. Globalisation has intensified risks in even in areas which we once thought were safe. The traditional model of investing used to be based on three main asset class; stocks, bonds and money market instruments each with its own level of risks and with the money market instruments being the most stable relatively from fluctuations and inflation. Today with a proliferation of exotic financial instruments like CDO’s and MBS rated triple “A” by rating agencies, nothing can be taken for granted at face value anymore. Investing in the financial market has become as dangerous as sticking one;s hand into a nest of cobras and hoping not to get bitten. Shares prices used to be based on the dividends that it pays out but today this has all changed. Movements in shares prices are dictated by its earnings potential and market sentiments instead which are subjected to manipulative creative accounting as in the Enron’s Scandal.
The one thing which has not changed with globalisation is the inefficiencies of the market. With computerisation, trading on the stock markets are done using computer programmed with algorithmic patterns designed to execute trading orders even before human traders are aware of the changes in market conditions. Combined with the use of statistical arbitrages, algorithmic trading has changed the landscape of the financial market dramatically. This is the main reason why hedge funds outperform the other funds on the financial market. Quantitative analysis like statistical arbitrages isolates the price inefficiencies of assets allowing removal of risks while algorithmic trading takes out the emotional aspects of trading removing what Alan Greenspan termed as “irrational exuberance”. The downward side to this investment strategy is that it requires volume trading and a lot of capital as the price differentials are calculated up to two decimal points.
However situation for arbitrages also exist in other markets and not just the financial markets. As former London City stockbroker Rajeev Shah pointed out, conditions for arbitrage can also be found in the world of Sports Arbitrage. Using computer programs like the ArbAlarm, one can capitalise on price differentials just like the financial markets. (To gain more insight, read “Sports Arbitrage–How to place riskless bets & create Tax free investments”).The main difference between this market and the financial market is the transparency which exist in the world of Sport Arbitrage. Mutual funds used to be the simplest and easiest way to invest in as an investment vehicle for retirement. The problem is that with globalisation and increased competitions, this no longer holds true. As demonstrated by the current financial crisis, many investors are caught with their pants down as they have no idea what they are investing in. What presumably was triple “A” class investments turns out to be nothing more than a proliferation of “toxic assets”. With the current economic climate, perhaps it is time to rethink outside the box and look beyond traditional models of investments for one’s retirement. An article published in the Financial Times called “Cherished myths have fallen victim to economic reality” explains why and how times are changing beyond our comprehension. Either way, it should be “Main Street” and not “Wall Street” who should reap the benefits. Instead today, “Main Street” is just bearing the losses of Wall Street’s greed and recklessness.