Wednesday, August 1, 2007

Cool Headed Opportunism

"The selling was so aggressive on Tuesday because this was another reminder of the great unknown," said Vinny Catalano, chief global strategist at Blue Marble Research. "There appears to be no clear understanding of how deep the credit-derivative problem is and how long it will take to be resolved."
Wall Street Journal, Abreast of the Market, August 1, 2007

”Markets do not always trade in line with fundamentals. All asset classes show inefficiencies, and much money is made exploiting them. But this latest spasm raises questions about the vast and unruly market for credit derivatives. How does it operate, and how to gauge fundamental value?” John Authers, FT, July 31, 2007

Perhaps the most unnerving aspects of the present financial market meltdown is the magnitude of the hits taken and fear of the great unknown. For, every bad news story seems to involve not your garden-variety decline, say, 10 – 15%. Rather, the damage is in the mega category, >50%. Moreover, today’s news that investors who want out of the latest Bear Stearns debacle can’t get their money only adds to the concern. And, if recent history is any guide, when they can get their money, it will likely be in that mega loss category. Yet, it is the ignorance re just how deep the rabbit hole goes that remains the most dangerous part of the current financial market meltdown.

Frankly, none of what is occurring is news to the readers of this blog and my weekly reports. For well over a year, the risk factors pertaining to the black hole of knowledge re credit derivatives and hedge funds has been noted. So, as the rest of investment world finally acknowledges the risks that existed all along, the appropriate current investment strategy requires a little Joe cool (see image above - the pass that became "The Catch")*.

Investment Strategy Implications

With correlations so high (and even higher in market declines – see blog entry July 26, 2007), the potential for the brake to become the accelerator is possible but not highly probable. That’s another way of saying that the contagion the markets are experiencing is likely to fall somewhere between the systemic dangers prevalent during the LTCM crisis and the isolated Amaranth blow up. If so, then a buying opportunity is unfolding with leadership change underway. As noted in this week’s Weekly Report, the investment strategy course of action is to answer the three questions posed (see Monday’s, July 30th blog below).

*It seems only fitting to use the image above as a very small tribute to Bill Walsh, a true innovative genius.

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