Global Stock Market BLOG - Mike Burnick

Here's an Option Play Your Can LEAP on Right Away

In yesterday's post (One Way to Profit in a Volatile Market: Options Trading 101), I described the leverage and big profit potential you can get from a simple strategy of buying call and put options.

Another options strategy I discussed on CNBC was using LEAPS options (or Long-Term Equity Anticipation Securities). I really like LEAPS because they give you similar leverage to standard options, but over a much longer time frame.

Most standard options have an expiration date that’s 30, 60, or 90 days away, and that time flies fast. But with LEAPS, you’ve got a year, 18-months, or even two-years to wait for a big market move to play out.

LEAPS Provide Extra Time for Your Strategy to Play Out

Right now, I'm following several LEAPS call options on a few emerging market ETFs that have performed well this year, but sold off in the recent correction. Some of these LEAPS look relatively cheap right now, and offer substantial upside once the market settles down. 

For instance the iShares FTSE/Xinhua China ETF (symbol: FXI) is a great case in point. This ETF offers terrific longer-term profit potential tracking China stocks, in fact it has already jumped more than 30% higher this year, even after the recent market correction.

Another way to play this potential, and at a much lower cost, is to buy LEAPS call options on FXI. For example, right now you can purchase a January 2009 LEAPS call option contract on this ETF for just over $2,000 plus brokerage commissions.

This option provides you with the “right” to the appreciation potential of 100 shares of FXI; plus you’ve got nearly a year and a half – 17 months to be exact – for this ETF to make its next big move, handing you profits on the trade.

Options Tie Up Less of Your Trading Capital

Alternatively, you could purchase 100 shares of FXI outright, but that would cost you about $15,000 – which is more than seven-times the cost of the option. Now, for many experienced investors that’s not a lot of money in the context of your total portfolio size, but it’s still fifteen grand of your capital that’s tied-up while you wait for this trade to play out.

By purchasing the FXI LEAPS instead, you’re only tying-up $2,000, and you’ve still participating in the upside potential for almost a year and a half – until January 2009.

Just to give you an idea of the upside potential that’s possible, the last time this China ETF made a big move in June and July, the near-term call options on FXI soared about 500% in just over 30 days, just take a look at the chart below!

Now, don’t expect every options trade to work out this well, because 500% is an exceptional gain, but it illustrates the point that just a handful of gains like this over the course of a year or two can provide a nice boost to your overall investment results.

One Way to Profit in a Volatile Market: Options Trading 101

I was invited to appear as a guest on CNBC yesterday afternoon for a segment on options trading strategies. The very first question from the host was, “What are some of the options strategies you are focused on right now?” 

I’ve personally used options trading strategies often in my nearly 20-year career in the investment industry. At times, I’ve used options to hedge my risk in existing positions, but I have mostly purchased both put and call options outright – making directional bets on individual stocks or market indexes.

In addition to the many options available on popular indexes today, there are also hundreds of exchange-traded funds that now offer listed options, giving traders more flexibility than ever before. While trading options is more speculative than purchasing mutual funds, ETFs, or stocks – it’s really not complicated at all – as long as you stick with a simple directional strategy of trading put and call options.

Options are Great for Playing Sudden Market Shocks

At the Sovereign Society we have an existing signature research and trading service that focuses on currency options, and a new service that we've actually just launched called Market Shock Trader.

I developed this new options service to give Sovereign Society members an easy to follow, no-nonsense way to focus on the big upside profit opportunities in index options and options on exchange-traded funds. In both of these services we recommend simple, directional plays that involve going long both puts and calls – nothing more complicated than that.
 
Perhaps the biggest advantage options have to offer is leverage, which can potentially boost your returns many times over. For instance, it's not uncommon to find attractive options trades where you have 10 to 1... 50 to 1... or even 100 to 1 leverage on the underlying security. This means that even SMALL moves in the underlying index or ETF can mean BIG potential gains from your options.

That said, options are more speculative than many investments, like mutual funds, but are perhaps less risky than futures, so they aren't for everyone. Here's a good rule of thumb when trading options; use only money you can afford to loose if you're wrong, because you will be wrong at times.

Discipline is the Key to Realizing Big Potential Gains in Options

However, if you follow a disciplined options trading strategy, you’ll often be able to position yourself for double- and even triple-digit gains; and these profit opportunities far exceed anything you’re likely to earn from investing in blue-chip stocks or mutual funds.

Let me give you a very recent example of the profit potential in options that simply can’t be matched by other investments.

Global currency markets have been red-hot lately, thanks to increased volatility from the ongoing credit crunch. As a result, we've seen a bit of a “carry-trade” unwind that's boosting the Japanese Yen’s value against most other major currencies.

Our currency options service has been taking full-advantage of this market volatility. In fact, my colleague Jack Crooks recently recommended December call options on the Yen that gained 139% for subscribers – and one of these trades was just a few weeks in the making.

Just to give you an idea about the leverage-advantage of options that I discussed above, the value of the Yen itself moved up less than 4% or so during this time, while the call option surged 139%! Jack also scored gains over 100% on Euro put options in recent weeks too.

This gives you an idea of the big profits that are possible using a relatively simple, straightforward call and put buying strategy.

Tune in to my blog again tomorrow when I'll show you where I'm finding option trades with the best upside profit potential right now.

Diamonds are a Girl’s Best Friend… Apparently in China Too!

In the midst of a multi-year bull market in natural resource companies, with mining stocks performing very well, apparently one group has been somewhat left behind.

“Diamond producers' shares have trailed mining companies since early 2006 as an abundance of gemstones weighed on prices” according to a recent article in Bloomberg. However the outlook for these firms going forward is glittering again, thanks to robust demand from… you guessed it: China!

Diamond supplies have dropped 75% since 2000, according to National Bank Financial Inc., of Canada; a direct result of too little new diamond production coming online. In fact, “no new diamond mines are scheduled to start production in the next three to five years.”

While Supplies Slump, Demand Soars

Set against this backdrop of falling stockpiles, demand for precious gems is surging from upwardly mobile emerging economies in China and India. These two rapidly growing nations are the fastest growing markets for diamonds right now, thanks to annual incomes that are rising “as mush as 18 percent” in China and India.

As is the case in so many other commodity markets right now, this growing supply/demand imbalance is leading to higher prices. Diamond prices surged 8.4% in the first-half of this year alone – that’s four-times faster than the same time a year ago.

Evy Hambro, who manages the world's No. 1 metals fund, the BlackRock World Mining Fund, is quoted as saying: “The supply and demand fundamentals are very supportive for prices.'' Hambro also notes that this should be a longer-term issue; “We see dwindling stocks and a shortage of new mine development.”

Diamond Prices Still Have Some Catching-Up to Do

As a result of this imbalance, prices are bound to keep moving higher. Anglo American Plc, which owns almost half of De Beers, the world’s largest diamond producer, expects demand for the precious stones to grow as much as 5% per year.

“Diamond stocks trailed other commodity shares even before the effects of the equity market rout triggered by a global credit crunch,” according to the article; but surging demand from emerging markets is causing diamond prices to catch up fast.  In fact, “China's diamond imports rose more than threefold in the first half,” and in India, diamond imports “increased 14 percent in the second quarter” alone.

Here’s another factor that should help keep diamond prices high: the industry enjoys a cartel-like status, since just a few major mining companies dominate global diamond production. Rio Tinto Group, Anglo American, BHP Billiton, and Russia's closely held ZAO Alrosa, together control 75% of diamond output worldwide.

Right now, that’s good company to be, whether you’re a “material girl” – or an investor looking for the next undervalued commodity play!

Back on The Closing Bell...Today!

I'll be back on The Closing Bell with Trish Regan this afternoon.  Tune in at 3:15pm EST or catch the video on demand.

End of Quarter Reckoning Awaits Wall Street

A decent bounce on Wall Street last week carried the S&P 500 to a spirited gain of 2.3%, while the tech-heavy Nasdaq jumped nearly 3%.

So the inevitable question that the talking heads on CNBC are asking today: is the worst of the selling behind us, and has the correction ended? I’m willing to wager that the answer is no, here’s why.

Several of Wall Street’s biggest investment banking firms – who have been caught at ground-zero of the sub-prime storm – are closing out their third fiscal quarter at the end of this week. Some of these firms including: Bear Stearns, Goldman Sachs and Lehman Brothers have either already reported losses related to leveraged bets on mortgage loans or derivatives tied to them.

But the complex web of derivatives that’s been built up over the years includes many securities that are difficult to accurately value in the best of environments, given the complexity of these securities and the infrequency of trading in them. Add in a credit market that has virtually ground to a halt in recent weeks and you’ve got a recipe for lots of “unknowns”.

The Credit Crunch Coming Out Party Fast Approaches

At quarter’s end, all public companies, including those mentioned above, must close their books and make every effort to account for all outstanding investments by “marking to market” the value of those holdings – including derivatives. By SEC rules those firms closing their books at the end of August have 45 days to file their full financial disclosure documents.

This tells me that starting in early September and running through mid-October – when the 45-day deadline passes – there will be the ever present potential for lots of little hand-grenades going off on the balance sheets and income statements of Wall Street firms.

Then, many of the nation’s biggest banks including Bank of America, Citigroup and JPMorgan Chase, who close their books at the end of September, will have till mid-November to fess up their own sub-prime sins.

It ought to make for an interesting Autumn on Wall Street – better stay on your toes this Fall!

On Wall Street: Much Weeping and Gnashing of Teeth, as Wall Street Bonuses are Jeopardized by the Credit Crunch Correction...

I read an article in Bloomberg this morning that says it all about the pain America is feeling from the sub-prime meltdown, and why the Fed MUST do something (like slash rates) quickly to relieve the stress: “Bonuses on Wall Street Threatened by Credit Crunch”!

Putting aside for a moment the estimated two-million U.S. Americans who are likely to have their homes foreclosed upon this year – the really tragic consequences are the Wall Street Investment bankers who may no longer be able to afford a summer house in the Hampton’s!

According to Bloomberg, Wall Street bonuses “ probably will decline as much as 5 percent from 2006, according to Options Group”, that’s after a dramatic buyout fueled increase of 20% last year – which still sounds like a whole lot better deal than the average American worker is getting – with wages stagnant in recent years.

Even the CEO of Goldman Sachs may have to take a pay-cut this year, from the $50 million bonus he earned last year in guiding one of the street’s top firms. In fact, “Last year, the five biggest U.S. securities firms paid about $36.5 billion in bonuses, up 32 percent from a year earlier,”according to the article. Also, total bonus compensation on Wall Street surged “19 percent in 2004, and 18 percent in 2005.” So, one would hope that some of these “Masters of the Universe” tucked some of that booty away for a rainy day!

Meanwhile on Main Street, the July jobs report showed fewer jobs added than economists forecast, while the unemployment rate rose.  Average hourly earnings rose six-cents – or three-tenths of a percent in July – a slight slowdown from increases of 0.4% in each of the last two months.

Oh, and the number of U.S. homes facing foreclosure nearly doubled last month – on the way to an estimated 2 million loan defaults. But hey, as long as beachfront properties in the Hampton’s hold their value, Wall Street should somehow muddle through.

Tune in to Squawk Box on CNBC.com

This morning, I was on the air at 7:00am EST on CNBC's Squawk Box.  Click here to watch the segement on-demand on CNBC.com.

From Bubble to Bubble with Plenty of Fed Puts in Between

In yesterday's post , I explained the origin of the famous "Greenspan Put" option: used to bailout Wall Street from its own speculative excess in 1998 after the collapse of hedge fund Long Term Capital.

That episdode set up the expectation that the Fed would always ride to the rescue of financial markets.

A few years later, after jacking up rates in 1999 and early 2000, which finally triggered the bursting of the internet bubble (a case of too much too late?) the Greenspan Fed once again issued put options in massive quantities from 2001 to 2003 to once again rescue Wall Street.

This time the free and easy money flowed into the housing bubble. And Wall Street was only too happy to supply the hot-air!

The banks and brokers outdid themselves in creativity this time with an alphabet soup of asset backed securities and derivatives.

These things are sliced and diced and packaged in such a way that few on Wall Street really understood or knew how to value them – and they were sold off to investors in the four corners of the investment world.

Just after receiving their MBAs, Wall Street analysts must be required to attend special internal training classes: the “What Me Worry School of Security Analysis.” The first lesson is that there’s really no need to worry after all about this alphabet soup of arcane derivatives blowing-up, because if it did… why the Fed would simply issue more put options!

The New PPT Swings Into Action

The Greenspan Fed started jacking up rates a few years ago (again too late) and the fresh faces at the Bernanke Fed decided to toe-the-line, keeping rates high even as the housing sector's foundations began to crumble.

Now, in full reactionary mode, the Fed last week cut the discount rate (a different kind of put). And it appears to be just a matter of time before more Fed issued puts (vintage Bernanke) come flowing into the hallowed halls of Wall Street!

The new Plunge Protection Team under Helicopter-Ben’s leadership may have to put in some serious overtime to reign in the current subprime mortgage mess. With losses initially estimated at between $150 and $300 billion – and these early estimates always get revised higher – the financial system my face a whole series of ongoing market shocks that will make the LTCM bailout look like a tea-party.

The Subprime Crisis Isn't Over Yet; be Prepared for the Next Market Shock

Mortgage industry bailouts and the related collateral damage in derivatives – many of which can’t even be accurately valued in this credit crunch environment – could easily exceed the inflation adjusted expense of the U.S. Savings & Loan bailout twenty years ago.

That episode of irrational exuberance led to the bankruptcy of thousands of S&Ls, with the Resolution Trust Corp. liquidating assets for just pennies on the dollar, and costing taxpayers nearly a half-trillion dollars adjusted for inflation!

With Federal Budget deficits deeply in the red already, it simply may not be possible to fund such a massive bailout without triggering significant and lasting after-shocks in global financial markets.

These tremors will be felt far and wide, but should create many opportunities for attentive investors to profit.

Now here’s the $64 trillion question: When Wall Street cashes-in the next round of put options courtesy of the Fed… I wonder what speculative bubble they’ll think of inflating next?

Have No Fear… the PPT is Here; But Beware of Ongoing Market Shocks!

I had a good healthy chuckle the other day while reading a blog post from my colleague Jack Crooks who conjured up fond memories by mentioning that the Plunge Protection Team (PPT) was back on the job on Wall Street!

To refresh your memory, the Plunge Protection Team was the affectionate term given to the Fed back in the good-old “irrational exuberance” days of the late1990’s. During this halcyon period, the Alan Greenspan-led Fed repeatedly rode to the rescue of global financial markets.

This gave rise to another charming phrase that’s been back in vogue in recent days: the “Greenspan Put”, which refers to the fact that the former Maestro of the Federal Reserve always stood ready to backstop troubled financial markets anytime Wall Street got in over its head with speculative excess.

Today, we’re in a new era – with Ben Bernanke conducting the Fed’s rag-time band. Well, you can change the Chairman, but it seems like the Fed is still playing the same old tune.

A Brief History of the “Greenspan Put”

Way back in 1996 – four years before the technology/internet bubble imploded – Alan Greenspan warned in a very public speech about “irrational exuberance” and the role it played in “escalated asset values.” But the Maestro didn’t put his money where his mouth was at the time, continuing an easy money policy that had persisted since late 1994.

A year later came the Asian financial crisis, followed the next year by the Russian debt default and devaluation of the ruble. This series of events led to the collapse of giant hedge fund Long Term Capital Management (LTCM) in late 1998.

Greenspan responded by rounding up Wall Street banks to bailout the insolvent hedge fund and stem a credit crunch. And in return, the Greenspan Fed aggressively cut lending rates in order to pull Wall Street’s fat out of the proverbial fire – quid pro quo!

How to Buy Fed Issued Put Options…

Thus was born the era of the “Greenspan Put”. This refers to a popular trading strategy of purchasing protective put options as an insurance policy (or hedge) against unexpected market risk. If the market or index falls in value, your put options should soar in price so that some – if not all of your losses in the market are offset with option profits.

If you were well informed enough to buy put options on the Standard & Poor’s financial sector index, or the S&P homebuilder’s index – prior to the recent credit crunch correction – then you probably suffered no pain (or at least reduced pain) as global markets sold off. And if you owned enough put option contracts on select indexes or ETFs, you probably even profited from the sell off.

But oh those Greenspan Puts… they have magical powers indeed, but can’t be purchased on the major listed options exchanges. No, these put options are issued only by the Fed and are made available to a select club of Wall Street insiders; we’ll call them the “irrational exuberators!”

The Power of the Greenspan Put at Work

In 1998, when the Fed rode to Wall Street’s rescue by cutting rates swiftly during the LTCM crisis, Greenspan was essentially giving big banks and brokerage firms a free put option as insurance against their “irrational speculative exuberance.”

Wall Street soon realized that “greed (excess speculation) is good”, and if anything bad were to happened, the Maestro would just ride to the rescue all over again issuing more Fed put options as he rode on into the sunset.

In fact, the Greenspan Put issuance of ’98 handed Wall Street lots of cheap and easy money with which they could speculate, apparently without risk, thanks to the existence of these special Fed put options.

And Wall Street saw that it was good… and promptly speculated some more – in the internet sector. This easy money led directly to the most speculative phase of irrational exuberance in the tech-bubble market, which not coincidently took place from 1998 to March 2000. During this period the tech-heavy Nasdaq 100 Index doubled in 1999 alone!

The Greenspan Put saved financial markets from gridlock in 1998, but led to even more recless speculation by Wall Street in the years that followed leading to the tech/internet bubble.

Tune in to my blog tomorrow when I explain how the Greenspan Put was soon used again -- this time inflated the housing bubble -- and why new Fed Chief Ben Bernanke is about to call out the PPT now.

PS You can read this entire article, and receive daily updates from all the Sovereign Society experts delivered six-days per week by signing up for the FREE Sovereign Society Offshore A-Letter.

The Gnomes of Zurich Weigh-in on Wall Street Woes

The debate raged all day on CNBC, and you could scarcely read an article on the newswires yesterday, without being subjected to a point/counter-point debate over whether the Fed’s emergency half-point cut in the discount rate will be enough to calm jittery markets.

After the Fed signaled Friday that it’s “prepared to act as needed ” to rescue Wall Street and its hedge fund customers from the growing credit crunch – speculation has grown about whether a cut in the key Fed funds rate will soon follow; either at the Fed’s next meeting September 18, or perhaps even before.

Fed fund futures trading indicates a strong likelihood of at least a quarter-point cut in Fed funds to 5% when the Fed next meets. And there’s a growing probability that a half-point cut may be in the offing.

But is this much ado about nothing? According to a recent article in the Financial Times, there’s scant evidence so far that credit difficulties in the financial world are having much of an impact on the real world economy.

Wall Street May be Leveraged to the Hilt, but Mainstream Businesses Aren’t

Corporate debt levels in the world’s major economies have been steadily falling for years. In the U.S. debt makes up only 32% of total financial assets, the lowest level since 2001. In Europe and Japan, corporate borrowing is less than 25% of assets – these are historically low and very manageable levels – especially considering corporate profit margins are near record highs.

As the Financial Times article reported, “the cost of borrowing for companies with stronger finances, and even for those with junk bond ratings, has generally been flat or even falling over the past month, irrespective of the turmoil.” In fact, corporate bond yields for triple-A rated firms are hovering at a fairly low 5.5% now, down from 5.75% a few months ago.

But is the financial day of reckoning in the business world only being delayed?

Over the weekend, the Gnomes of Zurich – guardians of the global monetary system – weighed in on the subject. On Sunday, Swiss central bank president Jean-Pierre Roth said, “We hope that volatility stays higher."

Reality Strikes Back

“What we had was not normal, namely, practically no volatility,” Roth went on to say that, “Markets cannot be a one-way street, or you will get excess.” Say, for example, mortgage lending practices that were way too easy for far too long.

On the subject of subprime Roth said, “something unbelievable happened. People who had neither income nor capital got credit with very attractive conditions. Now reality is striking back.” You don’t say!

Never underestimate Wall Street's ability to overindulge in too much of a good thing! Zurich’s chief gnome also reiterated that, “the aim of central banks should not be to eliminate volatility.” Take that Ben Bernanke!

One might suspect the Swiss central bank holds put options contracts on the U.S. financial sector index. However, Roth is simply echoing what several Fed officials have themselves alluded to in recent days, that no significant change in monetary policy is necessary – or should be carried out - unless the financial system is seriously threatened.

Perhaps the Fed took a closer look and sees more threats to the financial system on the horizon.

The Rebound Continues... in Asia and Europe

Wall Street’s rebound last week seems to be carrying over, at least so far, in Asian and European markets today, but troubles for the U.S. housing sector may be far from over.

Taking a cue from New York’s Fed induced rally on Friday markets in Asia closed sharply higher overnight. Japanese stocks gained 3% overnight, as the yen continued to decline against the dollar. Hong Kong’s Hang Seng jumped almost 6% overnight, while the China Enterprises index, which includes 41 mainland China firms listed in HK surged nearly 9%. Elsewhere, Indonesia gained almost 7%, while South Korea rebounded 5.7%.

Since many of these markets have been battered even worse than Wall Street during the past few weeks of the credit crunch correction, the rebound is welcome for global investors. In Europe, shares are also rebounding in early trade.

How Much Will Credit Crunch Affect the Real-World Economy?

Bloomberg reports that Fed Vice Chairman Donald Kohn, attending a conference in Australia, said the effect of the subprime-mortgage crisis on U.S. consumer spending will likely be ``modest''.

However, Mark Zandi, chief economist of Economy.com warned in a recent New York Times article that continued deterioration in housing may be a significant drag on growth.

Many more sub-prime and low interest “teaser rate” loans sold in 2005 and 2006 will have their interest rates reset much higher this year and next. According to the article, about 1.7 million households will lose their homes to foreclosure this year and next – that’s nearly double the number of the last two years.

With loan delinquencies and default rates on the rise, Zandi of Economy.com says the outlook is “very dark,” largely because of the current “self-reinforcing downward cycle” of falling house prices, loan defaults and credit tightening that pushes house prices down further.

The debate over just how much of the stress seen recently in the financial world is likely to spill over into the real-world economy is likely just getting started.

Upsetting the “Delicate Balance Between Fear and Greed”

In yesterday’s blog post I asked: “who’s ready for a bounce.”

Apparently beleaguered stock markets in Europe and America were more than ready, and the bounce we got on Friday was a good one. European bourses were already showing respectable gains, and U.S. exchanges had yet to open, when the Federal Reserve announced a surprise half-point cut in the discount rate.

The Fed’s move in cutting the rate at which it lends directly to major banks, while not as significant as a reduction in the more closely watched Fed funds rate, nevertheless gave a very important psychological boost to the market.

The Fed told investors that it’s willing and able to do whatever’s necessary to keep the financial system well-stocked with liquidity (i.e. cheap and available money) to help it function normally.

The Crisis of Confidence in Global Markets

And at times like this, psychology plays a dominant role in financial markets; it’s perhaps THE most important factor right now. An article in the Financial Times from last week says it best: “Financial markets are driven by a delicate balance of fear and greed.

Now, however the dial is swinging violently towards fear.” In further explaining the credit crunch correction we’ve been witnessing the article goes on to say that “parts of the financial world have suffered a collective crisis of confidence.”

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A delicate balance of fear and greed upset… a crisis of confidence in markets… I think that sums up the situation perfectly. According to Bloomberg, in less than four weeks starting July 20, global equity markets dumped about US$3.4 trillion in value. The Morgan Stanley Capital International World Index sold off more than 10% since reaching a record high on July 19.

A Selling Climax?

Last Thursday, the selling in global markets reached panic-like proportions. Markets in Indonesia and the Philippines dropped 6%, Korea sold off 7%, Taiwan and Hong Kong each fell over 3%. 

The selling continued in Europe with major EU markets losing 3% to 4% while emerging European bourses lost 6% to 7%. Finally, panic selling hit the Americas with Brazil off just under 3%, while Argentina and Chile both plunged over 4%.

On Wall Street, the Dow initially fell almost 400 points, and it looked like a full-blown route was on, but then Wall Street bounced and closed down just fractionally on the day (the S&P 500 actually posted a gain), erasing most of the big loss.

The recent carnage prompted well known global fund manager Mark Mobius of Templeton Asset Management to comment to Bloomberg: “It's a selling panic. It's gotten out of hand with a lot of hedge funds and we're seeing a lot of negative news with very few positives.”

Buying When There’s “Blood in the Street”

That proved to be a prescient observation. In fact, in recent days you could comb through pages of the Wall Street Journal, the Financial Times, or just watch five minutes of CNBC, and see many references to the world “panic”, which is often the stuff that market bottoms are made of – or at least market bounces.

Stocks typically bottom with a flurry of bad news, panic selling, and one-sided market psychology (the sky is falling). Isn’t there a very old saying about buying when there’s blood in the streets…

The following quote is from a Bloomberg story last week “‘Blood is hitting the streets, everyone seems to be panicking, and there's reason to panic,’ said Patrick Chang, who helps manage $4.5 billion at CIMB-Principal Asset Management Bhd. in Kuala Lumpur.”

It sounds as if a healthy bounce is way overdue, and it looks like it began on Wall Street with Thursday’s turnaround, followed by Friday’s gains. Stay tuned!

Who’s Ready for a Market Bounce?

In yesterday’s blog post (Is it Time to Panic Yet?) I asked: “Is the selling almost over? Well, maybe.”

Here’s the way I size up the markets right now...

Typically, panic corrections are – just as the name implies – sharp but relatively short declines that often (but certainly not always) occur in three fairly distinct waves of selling.

Why three? I have no idea. Maybe it’s because good things always come in threes – but it’s something I have observed over the years.

Anyway, below is a chart of the MSCI EAFE Index of international stocks from 2006, and you can clearly see what I mean...

The sell off began in May 2006 and the first down leg (marked in red) took a quick 8.5% off the index, almost before anyone knew what happened... sound familiar?

Then we saw a small bounce, followed just a few weeks later (beginning in June) by a second leg down that left the EAFE index down about 15% total in about one month’s time.

Last year’s correction effectively ended in early August when the index traded above the peak reached during the second bounce, and by Thanksgiving Day, the EAFE Index was hitting new highs again!

This pattern so far looks remarkably similar to what we are witnessing right now in the market indexes. Let’s go back to the charts; showing the EAFE index on a year-to-date basis...

This time around of course the markets began their decline in mid-July, shaving a quick 7% off the index, while nearly every talking head on CNBC said: “great buying opportunity!”

Then we got a bounce for a few weeks, followed by the second (and current) leg down that has left the EAFE index down about 12% from its July high... at least so far.

If you go back and look at a historic chart showing the 1998-Long Term Capital-induced sell off in global markets, you’ll see a very similar pattern to this.

The Next Leg Down? Perhaps After a Healthy Bounce

Should the markets continue to follow this pattern, confirmed by the market sentiment signals I also watch closely, then I would expect stocks to bounce soon – perhaps followed by a third (and hopefully final) leg down for this correction.

Notice from the first chart, that the index did indeed have a third leg down in mid-July 2006, but this stopped short of making a new low. Still, it signified three distinct waves of “panic” selling pressure, culminating in a climax double-bottom “type” formation.

It wasn’t a true double-bottom, since the third leg down did not reach or exceed the lows of the second leg, but it was close enough. You have to be somewhat flexible with these technical interpretations. Sometimes, as was the case in 1998, the third leg will carry even lower and mark the absolute low of the correction.

It Looks Good on Paper Anyway

A word of caution; moves in the markets very rarely unfold exactly the same way twice – so this is only a rough guideline or template I’m using to see what comes next.

If a bounce does develop sometime soon, the “character” of that bounce/rally should provide more information about what’s coming next.

Tune in again tomorrow, when I’ll discuss some of the sentiment indicators I’m following, and what they’re saying about the market right now.

In the meantime, for more about the credit crunch correction check out what all of our experts have to say on the Sovereign Society home page!

Is it Time to Panic Yet?

As the Wall Street induced credit crunch continues to unfold, with new victims popping up nearly every day and announced losses already running in the tens of billions – it’s really no wonder that international markets are feeling the credit pinch too.

So far, about $4.5 trillion has been shaved off the value of global stocks since record highs were notched just three weeks ago... yes, you read that correctly.

It was only on July 19 that global markets last hit a new high. Since then, the Morgan Stanley Capital International (MSCI) World Index is down close to 10% in less than one month. Emerging markets predictably, are falling even faster with the MSCI EM index nearly 15% off its high, also less than one month ago.

Investors were miffed last week when the U.S. Federal Reserve didn’t ride to the rescue with a rate cut. Wall Street seems desperate for the days of cheap money again, so as to save what’s left of their bacon.

But global central banks are doing their part, by flooding the financial system with money, the most since the September 11 attacks. Central banks in Japan, Europe and the U.S. have pumped more than $350 billion into the global financial system in the past five trading days alone.

However financial markets continue to fall, in what can only be called a selling climax at this point (can anyone say panic?) and perhaps, therein lays the potential good news!

So, is the Selling Almost Over? Well, Maybe...

This is the debate that rages on CNBC and in the pages of the Wall Street Journal: is this a correction, or the return of the bear? And isn't it about time for a bounce?

Calling on my own experience of nearly two-decades in financial markets, it seems to me more like a classic “credit crunch” induced selling panic, at least so far. In this type of correction markets fall fast and hard, but often they bounce back quickly too.

The pattern thus far looks a lot more like the 1997 Asian Contagion, or perhaps even more similar to the 1998 financial crisis that sunk Long Term Capital. The current carnage also bears a similarity to last year’s growth panic in May 2006, when investors had a panic-attack about the Fed keeping rates too high for too long and threatening global growth... remember that episode?

Correction Was Overdue, and Bull Market is Mature

It was just 14 months ago, and the last time global markets suffered a correction anywhere close to 10% -- which used to be considered normal back in the good old days. To say that we were overdue for a sharp correction is a vast understatement.

Of course you could also argue that we’re overdue for the next bear market too, going by historic standards of average bull-market longevity – but let’s save that discussion for another post.

Today, we were headed for yet another triple-digit loss when out of nowhere, and for no particular reason, the Dow staged a 300-plus point turn around. Stay tuned!

PS Tune in tomorrow and I'll show you exactly where the markets stand right now on a technical basis, and where I believe we may be headed next!

Keeping an Eye on the Tiki-Bar Ticker

Yesterday, as Wall Street began yet another sickening decent toward more losses, I was thankfully unaware as I strolled back from the dock after a morning of fishing in the Florida Keys.

I had taken the family on a short mini-vacation to Islamorada for some much needed R&R prior to the start of the school year, and before Hurricane season turns really nasty.

So I wander in to the thatched-roof tiki bar at my hotel, as I have been around this time each of the past few days, take a seat on a rough wooden bar stool in the shade and order a refreshing beverage.

I scanned the tiki bar scene, expecting to see some colorful parrot-head characters straight out of a Jimmy Buffett song – but instead my focus locked onto Warren Buffett instead!

Fishing for Stock Tips

No, the “Oracle of Omaha” wasn’t sitting at the other end of the bar sipping a Rum Runner – it was his picture I saw displayed on one of the TV screens in the corner of the tiki bar. I was even more shocked, and disturbed to find the channel tuned to CNBC, which was at the time running a story about Buffett’s latest stock buys – apparently he’s scooping up more health care shares.

Here in Islamorada, I thought that I could get away from it all at least for a few days… miles away from the every day, as the beer commercial says. But here I was in my shorts, flip-flops, and t-shirt watching the ongoing saga of the stock market sell-off in a very surreal setting. Waitress, I need two more boat drinks!

While the kids splashed away in the swimming pool nearby, I kept watching the drama unfold on the little flat-screen TV in the tiki bar – I just couldn’t help myself.

From Parrot-Heads to Talking-Heads

It is humorous watching the endless parade of talking heads on the tube talking their “book.” (yes, I have likewise been part of this rouges gallery… guilty as charged!) Today, most of the talk was about how the worst of the credit crunch was behind us now, and that this should present a good buying opportunity – fins to the left, fins to the right…

This logic reminds me of the old axiom that goes: corrections are good buying opportunities, IF you fully understand the reason for the selling, and are convinced that it’s gone too far to an irrational extreme.

Then again, as John Maynard Keynes once famously said: markets can remain irrational longer than you can remain solvent.

Right now however, investors are still trying to get their arms around the murky details of the subprime mess and surrounding credit crunch that has triggered this latest round of fear and loathing on Wall Street.

New revelations about growing losses keep leaking out, like a boat with a bad bilge pump. So it may be a bit early just yet to certify this a great buying opportunity, but at least Buffett is buying (Warren not Jimmy)!

Perhaps “come Monday it’ll be alright” again on Wall Street, but better hold tight.

Global Central Banks Open the Floodgates of Liquidity

I have been taking a short break away from the office, on vacation in the Florida Keys since Friday for some much needed R&R. But try as I might to focus on catching snapper on the offshore reefs here, my thoughts can’t help but return to the credit crunch saga on Wall Street.

Trading appears to have fallen into a typical pattern – an early week bounce followed by a Thursday-Friday sell off in financial markets. Institutional fund managers don’t want to get caught with the wrong holdings in their portfolios over the weekend, with the ever-present potential for market moving news.

In a new twist to the unfolding saga, Central Banks around the world flooded financial markets with liquidity in an attempt to ease the credit crunch.

“Central banks in South Korea, the Philippines, Singapore, Indonesia, India, and Malaysia have said they were prepared to add cash into their financial systems. The Bank of Japan injected 600 billion yen ($5.1 billion) into its system today after adding 1 trillion yen on Aug. 10.

“Central banks in the U.S., Europe, Japan, Australia and Canada added about $136 billion to the banking system last week, aimed at preventing overnight interest rates from surging and ensuring banks have access to funding ,” according to an article in Bloomberg.

More easy money readily available for borrowing by banks seems to be the typical solution to this problem – only time will tell how effective this tactic will be.

Russia’s Neighbors Catching On...

In a post yesterday (Russia’s Newest Oil Grab: the Great White North?), I discussed how Russia’s thirst for control of energy resources has reached new heights... or more literally depths... as the Kremlin seeks to press it’s claims for potential oil reserves thousands of feet beneath the Arctic Ocean.

I have written extensively about Russia’s bare-knuckle tactics when it comes to “negotiating” with western oil companies over energy deals within its own borders; but now Russia’s neighbors are following the Kremlin’s play-book too!

According to the Financial Times, “Kazakhstan has warned a foreign consortium led by Eni, the Italian oil company, that it will demand better terms at the giant Kashagan oilfield in the Caspian Sea.”

It seems that Eni, which owns an 18.5% stake in the project, has under-estimated the cost of developing the Kashagan deposits – to the tune of only $80 billion or so! This apparent cost overrun gave Kazakhstan more than enough of a pretext to propose reopening “negotiations with the companies about this project.”

Other western oil companies being summoned again to the bargaining table include: France’s Total (TOT), Shell (RDSB), Exxon Mobile (XOM) and Conoco Phillips (COP), among others.

Of course their greatest fear (which will likely be realized) is that “Kazakhstan might follow the example set by Russia, which last year forced a Shell-led group to surrender a majority share in the Sakhalin II liquefied natural gas project to Gazprom after development costs almost doubled.”

Kazakhstan’s grand energy plan is to triple its total oil production to 3 million barrels a day by 2015. This increased supply will be much needed by growing global economies, where demand is surging, against a backdrop of uncertain supplies.

No matter the outcome of Kazakhstan’s “renegotiations” with western oil firms about this project, the ultimate result will almost certainly be much longer delays in bringing this extra oil to market; and perhaps less investment dollars spent on new exploration endeavors in this uncertain part of the world.

It’s all just another brick in the wall... of higher oil prices.

Jim Rogers: "Anybody who thinks the Fed should cut interest rates is nuts!"

In an update to my earlier post about Cramer's recent antics on CNBC; calling for the Fed to cut interest rates to save Wall Street's bacon -- CNBC interviewed global investor Jim Rogers recently, asking him the same questions.

Rogers said: "Anybody who thinks that the Fed should cut rates is nuts!" Rogers countinued, "It would be terrible if the Fed did cut interest rates", which would only trigger a worse fall in the dollar, and make inflation in the U.S. that much worse, in Rogers' view.

Says Rogers: "The Federal Reserve was not instituted to bail out Wall Street, Lehman Brothers, Bear Stearns, and a few people like that. The Federal Reserve was established to keep a sound currency, let's hope they do it."

Are you listening Cramer?

You can view a video clip of the CNBC interview with Jim Rogers by clicking here!

You Can’t Always Get What You Want!

U.S. stock markets appeared somewhat miffed yesterday when the Federal Reserve failed to ride to the rescue and either cut interest rates, which was NOT expected, or at least indicate that they were prepared to do so in the near future, to help ease the Wall Street credit-crunch.

To provide some background; in the aftermath of the unfolding subprime mess, that has in effect “frozen” parts of the U.S. credit markets in recent weeks, a growing chorus on Wall Street has been calling for action by the Fed; or at least soothing words.

In fact, in a very well-publicized rant (perhaps overexposed by now) on CNBC last week, Jim Cramer, TV’s “Mad Money Man” pretty much made a fool of himself saying the Fed had “no idea how bad it is” for his Wall Street buddies that are suffering big hedge fund losses.

Of course his predictable prescription to ease Wall Street’s pain was for the Fed to cut interest rates; to be fair, he also indicated this would help millions of Main Street Americans save their homes from foreclosure.

Never mind the fact that the Fed’s easy money policies for so many years are largely responsible for the subprime mess in the first place, more cheap money is always the easy answer -- resurrect the "Greenspan put" says Cramer... booyah!

But Cramer and Wall Street did not exactly get what they wanted yesterday. The Fed maintained its target overnight lending rate at 5.25%, saying that inflation (not credit problems on Wall Street) was still their primary concern. The Fed however did toss a bone to the Mad Men of Wall Street, in at least acknowledging the credit crunch.

The Fed’s official statement read in part: “Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace.”

It sounds to me like the Fed – unlike certain manic-depressive CNBC market commentators – is not hitting the panic button... at least not yet.

The market itself did react in manic-depressive fashion, with the Dow working through a 200-plus point swing between 2:30 and 3:30, before finally ending with a modest gain.

It’s not unusual after a Fed meeting for the markets to take awhile digesting the news, before finding its true direction, which can often take a few days... stay tuned!

Russia’s Newest Oil Grab: the Great White North?

No it’s not Canada… at least not yet anyway…

As the price of oil skyrocketed to new record highs near $80 a barrel last week (before a steep reversal in price), I was quite amused to read in the Financial Times that the Russian Bear is up to its old tricks; trying to gobble-up more energy resources, in a new location this time… north of the Arctic Circle.

It seems the area in dispute is a geological formation called the Lomonosov Ridge – located just 4,000 or so meters beneath the surface of the polar ice-cap. But thanks to global warming, the oil and gas reserves in this region may be accessible after all, although still not easily – or cost-effectively.

But that hasn’t stopped intrepid Russian polar explorers from attempting to stake their claim to the North Pole.

In fact, while investors watched oil and stock prices gyrate wildly last week – the Akademik Fyodorov research vessel, accompanied by Russian ice-breakers arrived on station at the Pole, from its home port of Murmansk.

The plan is for this expedition to gather evidence – any evidence – that helps back up Russian claims that the disputed undersea mountain range is somehow connected to Russian territory, giving them a perfect right to drill for oil there.

Never mind the fact that Greenland is hundreds of miles closer to the disputed area than Russia, or that the UN rejected a Russian claim to this area already, back in 2002.

And the Kremlin most be discounting the fact that established international treaties clearly limit a nation’s sovereignty to a 200-mile wide “economic zone” around its coastline – while the nearest landmass is more than 400 miles away from this patch of ocean floor – the Russian oil expedition presses on.

According to the article, “BP has formed an alliance with Rosneft, Russia’s state oil company, to bid jointly for Arctic exploration acreage.” 

Won’t they ever learn?

P.S. For more on Russia's growing influence on the global energy sector, please visit my blog again tomorrow!

It's Different This Time

Since the credit-crunch induced global market correction in stocks began in mid-July, pretty much all regions and countries around the world have suffered some sort of correction – with the exception of mainland China markets – which have consistently hit new highs.

Where there is more reward, there is typically more risk also. That’s an investment rule-of-thumb that has stood the test of time. In May, 2006 for example, the last time we had an equity market correction of any real substance, the S&P 500 Index fell about 7.5% in little more than a month.

By contrast, the MSCI EAFE Index of international shares, and the MSCI Emerging Market Index, which in recent years have certainly provided more upside to investors, also corrected more. The EAFE index fell about 15% during the May ’06 market correction, while the Emerging Market index plunged a nerve-wracking 26% in just a month.

However this time around the pattern looks a bit different. While most markets are following a similar pattern during this correction, there are a few noteworthy exceptions.

Since July 19, 2007, when the S&P 500 hit its last peak, the Emerging Market ETF (EEM) has indeed performed worse, but not by a lot. The S&P 500 ETF (SPY) has corrected 7.2% since July 19, while emerging markets are off 9.3%.

And the EAFE ETF (EFA) of developed international markets is only down 6.5% – so far outperforming the S&P 500.

Looking at individual markets, the data is even more striking in its contrasts. For instance, you might expect the leading BRIC countries to be getting hit hard, perhaps even more than emerging markets as a whole. In Brazil’s case that’s true, since the Brazil ETF (EWZ) is down almost 12% since July 19, but Russia (RSX) is down just 7.6%, less than the emerging market index as a whole, and on par with the S&P.

Perhaps most stunning of all is the continuous record highs being ticked off by Chinese mainland stocks. In fact, the Shanghai Composite Index of mainland shares has gained nearly 17% since global stock markets began to correct on July 19.

These figures just go to show that today’s global investor should not be satisfied investing in a short list of broad market indexes or ETFs.

As international and emerging markets grow and mature, there are growing differences between the way individual markets and regions perform, and it pays to be allocated in the right ones at the right time.

Maria is a Terrific Host... and Perceptive Too

I left the office early on Friday, racing up I-95 to the NBC affiliate studios in West Palm Beach for an interview on CNBCs closing bell with Maria Bartiromo – an excellent host and very knowledgeable too. No wonder she gets paid the big bucks!

Unfortunately, due to my early departure, I didn’t get to fully observe  the late-day meltdown in the markets, resulting in another triple-digit loss in the Dow – just a shade less than 300 points this time, except for what I saw while I was on the air.

The renewed sell off in markets was kinda predictable, considering the as-yet unknown dimensions of the credit crunch (i.e. just how much money has been lost anyway) – and the fact that this was a Friday after all – anything can happen (and usually does) over the weekend!

In fact, the latest financial fireworks that helped precipitate today’s drop was a mid-afternoon report by none other than… Cramer.

He implied that there could be more trouble ahead, revealing that Bear Stearns (BSC)sounded a bit… less-than-perfectly-confident on a conference call today, as they tried explaining to investors that their profitability has been "solid" over the past two months; even as investors lost $1.5 billion in two of its hedge funds.

In recent days we've heard that the casualties of the credit crunch are spread far and wide. Hedge funds in Boston and Australia are in trouble, and a lender in Germany had to be bailed out by the government.

In one of the more interesting tales, one of AXA Fund Management's money market funds fell 20% in value over the past month, with too much sub-prime paper dragging it down, even though the "average" credit quality of the fund's holdings was "A" rated.

Against this backdrop, investors are rightfully concerned about potential losses that may not have surfaced yet among top banks and brokerage firms. American Home Mortgage (AHM) basically went bust as a result of sub-prime lending woes. And other leading stocks in the sector including; Wells Fargo (WFC), Wachovia (WB), Washington Mutual (WM), Bank of America (BAC), and even Citicgroup (C) have seen their share prices pummeled as a result.

Back to Maria...

The CNBC interview mostly focused on the state of the sub-prime market, and the resulting credit crunch and its impact on private equity firms. Of course, private equity has been a leading role in the record $539 billion worth of leveraged buy out deals so far this year, which has certainly helped boost the market.

Most of these deals have been financed with high-yield loans packaged and sold in CLO (collateralized loan obligations, not to be confused with their now X-rated cousins -- CMO’s or collateralized mortgage obligations) to investors who are now backing away from the market in response to the depening credit crunch on Wall Street.

But Maria asked a very perceptive, man-in-the-street question that’s been largely lost in the ongoing debate about credit derivatives and leveraged buy-outs. Maria asked: “What does this mean for the economy as a whole?” In other words; forget about Wall Street, what’s the impact on Main Street?

That’s really the $64,000 question, isn't it? Unfortunately for both Wall Street and Main Street alike; there’s just no clear answer.

Perhaps the best answer to this difficult question has already been provided by Steven Rattner, a managing principal in Quadrangle Group a leading private equity firm. 

Writing presciently in the Wall Street Journal about the, then just beginning sub-prime debacle in mid-June, Rattner said: “The bigger – and harder – question is whether the correction will trigger the economic equivalent of a multi-car crash, in which the initial losses incur large enough damages to sufficiently slow spending enough to bring on a recession, much like what happened during the telecom meltdown a half-dozen years ago.”

Great question Steve. Please let me know when you have the answer!

On a brighter and more positive note; at least one high-profile private equity deal was consummated this week. Banks lead by JP Morgan (JPM) were forced to take a small loss, but completed the Chrysler buyout deal (by Cerberus Capital), placing $8 billion in loans with investors.

The loans were sold at a discounted 95 cents on the dollar to attract buyers, but after the sale, the loans traded as high as 98 cents in the secondary market!

At least this demonstrates that, If the price is right, there’s still a willing buyer in this market!

P.S. If you’d like to see my interview with Maria today on CNBC, where I discuss the ongoing credit crunch on Wall Street – and how this could impact the private equity fueled buy-out boom – click here!

Video: My Interview With Maria Bartiromo

“U.S. and European Investment banks are saddled with nearly $500 billion in leveraged loans that they can’t peddle to investors…”

To catch my CNBC chat with Maria Bartiromo, click here.

Chart of the Week: The Credit Crunch in Pictures!

U.S. and European investment banks are reportedly saddled with nearly $500 billion in leveraged loans that they are unable to peddle to investors, due to the credit market crunch that appears to be going global.

The trouble is, these investment banks had already committed capital to leveraged buyouts and other deals, when credit markets began to seize up, and investors quickly stepped away from the market to reduce risk.

While U.S. Treasury bonds have rallied, pushing the yield on the 10-year note down to
4.7%, yields on lower-rated junk bonds began to surge higher last week. In fact, the “spread” between these two very different types of bonds has jump to above 4% from around 3% about a week ago.

It’s worth noting however, that this spread is still at very low by historical standards, as can be seen in the chart above. In fact, throughout most of the 1990’s the high-yield spread was at current levels or even higher most of the time, and financial markets performed pretty well.

Bottom line: global financial markets continue to enjoy an environment of strong economic expansion, slowing but still robust profit growth, and low default rates among high-yield borrowers. This suggests that, absent any more credit-market "incidents", the contagion may soon be contained.

The Global Market Roller-Coaster Ride Continues, but with Stronger Growth Ahead

The roller coaster ride continues in global financial markets, with the Dow Jones Industrials gaining 150 points yesterday – all of it in the final half-hour prior to the closing bell. Asian markets followed that lead overnight, and so far European markets are also following suit to the upside.

While it’s certainly too soon to say if the credit-contagion has run its course, this is a good time to take stock of the bullish fundamentals that should eventually help support global markets.

On this note, the International Monetary Fund (IMF) recently issued an update to its World Economic Outlook, boosting its forecast for even more robust economic expansion.

According to the IMF’s new calculus, global GDP growth should advance 5.2% in 2007, and they expect the same above-trend growth rate to continue in 2008 as well. You can probably guess that the main “swing-factor” in this upgrade is China: which recently announced that 2nd quarter GDP surged nearly 12%!

According to the IMF’s statement, “Emerging market countries have continued to expand robustly, led by rapid growth in China, India, and Russia.”

Sticking out like a sore-thumb in the IMF data, and standing in sharp contrast to emerging markets; the IMF reduced its expectations for U.S. growth, forecasting an expansion of just 2% in GDP this year for our economy.

According to analysis from Henderson Global Investors, “Strong growth in emerging economies is boosting global growth to a 35-year high.” It's too bad the U.S. isn't more fully taking part.

So even though we are in the midst of a global risk-aversion sell-off in financial markets, there is still a silver lining in these storm clouds, at least for investors in international markets.

I just provided an update to subscribers of my Global Market Investor service, telling them which markets around the world offer the best long-term profit potential right now. If you would like to see which markets should be on your short-list for potential investment, click here!