Has the storm passed global markets?

It wouldnt be a surprise to think on these lines, as global financial markets especially Equities have settled in a range.Is this the lull after a storm or a lull before the onset of the next upheaval? I would argue its somewhere between the two. Financial markets seem to have priced in a lot of bad news already, which is a slightly comforting fact for investors. The not so comforting fact is, we could have the next storms beginning to take shape already.

I would equate the present climate in global markets to the US hurricane season of 2005, which was the most active hurricane season on record when 15 hurricanes were recorded. Where i draw a resemblance is, global markets have been hit by bad news at regular intervals. No sooner one crisis eases, another seems to creep up. First it was the subprime crisis, then it was the credit crisis. Even as the world still recuperates from these twin blows, even bigger problems could be in the pipeline.

The news of a $50 bn fraud by a hedge fund run by the former chairman of the Nasdaq Bernard L Madoff is a huge setback for investor confidence in hedge funds. The hedge fund industry has been on course to post the worst year on record, as they have been hit by redemption pressures as investors sought to reduce risk. This news could potentially become a huge problem, how it affects markets remains to be seen.

Another potential problem area is commercial real estate. An article on the Dow Jones Newswires said data from Standard & Poor's shows nine large banks hold about $121.1 bn in commercial real estate loans. These loans have to be marked to market. The three biggest holders are Citigroup, Merrill Lynch and Barclays, which each hold more than $ 20 bn of related investments. A next wave of write off could be around the corner.

Credit cards could be in line as well. Rising unemployment is bound to hamper the repayment capacity of borrowers and in turn create headaches for the lenders. An article in the Wall Street Journal quoting te Nilson report, a newsletter that follows the industry stated JP Morgan Chase, Bank of America and Citigroup had nearly 60% of the $ 724.44 bn in outstanding loans at the 10 biggest card issuers in the US as of June 30. One need not be a rocket scientist to do the arithmetic. Writeoffs on credit cards could be huge....thats not an understatement by any stretch of imagination.

Well, the markets seem hell bent on giving us analysts a tough time even in 2009. For now, i await the onset of a much needed break at the year end. I hope 2009 will not be as bad as 2008, but all i can do is hope, wait and watch.

A fightback from the Samurai?

If there has been a symbol which represents Japan, it is the medieval Samurai. I have cited the exmaple of a Samurai, as i believe the Japanese yen has the potential to stage a fightback against major currencies, most notably the US Dollar.

The Yen is a currency which has always been very attractive from the view of a carry trade i.e. borrowing money in Japan converting it to Dollars and investing it in the US. The trade is settled by reversing the sequence of transactions. The interest rate differentials between the two countries made this a very lucrative trade, as Japan is one of the few countries where real interest rates are negative. Interest rates in the US were much higher, which increased the lure of the "carry trade". Well things are changing now. The interest rate differential between the two countries is much narrower, as the US Federal Reserve has cut interest rates aggressively. Trades which were entered into earlier are no longer as attractive, in fact would'nt be wrong to say are a loss making proposition presently due to the shift in interest rates.

The imminent reversal of carry trades is likely to lead to a stronger Yen, which ironically isnt in Japan's interest as the country is an export oriented economy. Another important fall out is, Japan has been one of the favored destinations to borrow loans taking yen denominated loans will become more difficult. This will reduce the amount of capital flowing from Japan into global financial markets.

I believe we could witness a sharp rally in the Yen. Markets have a tendency to surprise, the rally in the US Dollar through most of 2008 being a prime example. Given the problems the US experiences in terms of its current account deficit and labor market, it is difficult to believe the rally in the US Dollar will sustain over the next 9-12 months. In the present markets getting the direction right is a herculean task by itself, getting the timing right would be impossible.

A rally in the Yen is potentially the surprise trade of 2009, I believe there is a possibility the rally might last longer than expected. My thoughts have already started to drift to 2009, as i await the end of what has been a tumultous, crazy and a very eventful year.