Thursday, June 7, 2007

Technical Thursdays: Risky Business

If there is a fault line to the market that has the potential of turning what has passed for a market correction thus far into the real deal (>10%), today’s excellent Wall Street Journal article ("The Sure Bet Turns Bad") on hedge funds, investment banks, and sub prime derivatives may be it. As the chart to your left shows, the price action of the big investment banks appear to reflect a concern that may be more widespread than simply “rates are rising, stocks go down”.

As you can see, only Goldman (blue) is beating the market thus far this year, with Bear Stearns (maroon), the focus of the Wall Street Journal article, marooned at the bottom of the performance list. Coincidence or an indication of heightened risk?

Investment Strategy Implications

Investment banks are at the epicenter of the financial innovation universe. And, as has been noted on this blog and in my reports, financial innovation is pushing the envelope in ways no one, literally no one, has a real firm grip on. Since gaining insight into the consequences of financial innovation and engineering is, at best, a work in progress, perhaps the markets can help.

Granted, there are many other aspects as to why the common stocks of complex financial institutions rise and fall. After all, they are levered to the market and economy. But it is hard to ignore the potential connection between financial innovation and risk.

Perhaps the price action of the major US investment banks is trying to tell us something.

Note: A worthwhile visit to International Swaps and Derivatives Association is in order.

And, to gain a sense of one measure of the growth in derivatives, visit

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