History Repeat or Rhythm

Finally, I finished reading the book, "The Big Short" by Michael Lewis.

I have to say it is one the better books I have read for a long time. 

Reliving the story before the housing crisis, it is filled with drama, emotions of fear and greed showing the stupidity of human reactions dealing with it.

There are plenty of lessons to be learned. The events of 2008 crisis will stay clearly in the minds of many for years to come.

I can draw some parallels to events that is happening currently.

In reality, we have not solved the fundamental problems of the crisis. Reckless speculation still persists.

Banks are still too big to fail.  The solutions given to resolve the crisis was to bail out the big banks through QE1, QE 2 and QE 3 ( or infinity ). 

QE1 — drove the Dow Jones Industrial Average up 2,377 points over a span of about 16 months.

QE2 was good for just 1,199 points and only about 8 months of rally. The interesting thing there is, all of that went up in smoke within a couple of weeks, thanks to the debt ceiling debacle!

Then, just a couple of months ago, Bernanke really thought he was firing the biggest bazooka of all by launching QE-Infinity — saying he was going to print money forever. The rally lasted 1 day!

Until proven otherwise by price actions Q E 3 is not working and there will be QE 4 which will probably be announced tomorrow after the FOMC meeting.

During 2007-8 - just before the crisis, the big banks continue to raise their stake on CDO. These resulted in one of the biggest corporate bankruptcies of financial institutions. Over a short period, we saw the evaporation of some of the biggest names - Lehman Brother, Merrill Lynch, New Century, Watchovia and Northern Rock ( UK ) and the big bailouts for BAC, AIG, GE and Goldman Sachs.   The people who perpetuated the mistakes got out with millions of dollars and went unpunished till today.

I am seeing the same kind of gamble made today. Just only recently, we saw the trading failure of London Whale of JP Morgan. Initial loss were estimated to be only 2 billion but it is slowly exploding the the estimated $8b. It was said to be a hedge but the truth was someone got greedy.

In the book, there was the account of Wing Chau who prided himself as manager of CDOs and Howie Hubler, considered to be a star hedge fund manager at Merrill Lynch, lost huge amount of money. Both got out rich and unpunished. Howie had the notoriety of incurring the biggest loss ever in any trading house.

On the other hand, there were Michael Burry who was right on his bet on CDS against the sub prime but it took longer than he wanted for the events to unfold and that he had to go into hiding to avoid calls from customers and potential lawsuits. Eventually, he made lot of money for all his customers.

I could see similar situation today in the bond and precious metals market. Just take one example. Look a the recent report by Alasdair  Macleod.  http://www.goldmoney.com/gold-research/alasdair-macleod/gold-futures-market-heading-for-crisis.html?gmrefcode=dollarc

The banks are again taking huge speculative positions against the fundamentals. If things break up, they will trigger another crisis and get away free. Tax payers will have to bail them out again. 

How to make money from such market conditions?

First, recognize that fundamentals can lag price actions for a while. It happened in the dot.com bubble, the 2008 crisis, Enron, Worldcom and it will happen today. Sometimes, it can go against you for 2-3 years! Market can be irrational longer than you are solvent.

There are those who are fully convicted and continue to stack on their positions like what Michael Burry was doing. This is a stressful position. Burry almost gone into a depression because of the delay of fundamentals catching up with the price. He was right on the facts but the timing was early.

The key is to continue to research to ensure that your beliefs are fundamentally sound. There is a risk of reinforcing a self directional bias. It takes logical, balance and clear thinking to make sure you are on the right track.

As a trader, I will not trade against the trend. I will trade side way with a directional bias on my fundamental beliefs. You may still lose some money but at least it will be limited. A lot of time you still make some money.

Once the trend is there, jump onto the wagon. The market has a way to ensure that you are totally discouraged before it turns. You may be wrong a couple of times before you get it right. Once you get it right, it could mean a substantial profit that sustains you for the next few years.

I have written a lot on how I trade. Exercise discipline in following your trading plan.

The Big Short - by Michael Lewis

I am half way through Michael Lewis "The Big Short" after finishing "Liar's Poker",  a hilarious account of the time he was in Salomon Brother.

The book gives details about the time before the big housing crash and credit bubble in 2008. It is like reliving that period in a trading environment. Very interesting and a lot of lessons can be related to  the current situation. There are a lot of parallels to be drawn.  For me, the situation mirrors the situation now where the bond market has gone stratospheric with central bankers trying to evade the financial crisis - lots of manipulation to blindside the real direction. It is a great read.

There are few lessons to be learned.

o Fundamentals are key to the market long term.  Often it is not seen until it is a little late. This is the big money maker. I can make money from trading volatility, side way directions but the big bucks is from getting the long term trend right. The best way is to bet on the long term trend. But the market can always go against you short term creating apprehension and fear. Just before the crash housing price continued to go up despite extremely poor fundamentals. Thus, the ability to hedge and following trends are very important skills.

o Market will always go to extremes.Manias engulfes greedy investor and fear cripples the weak. This is where money is made by betting on the right directions.

o There is a problem of personal direction bias - unable to see the true direction of the market because of personal conviction. There are blind spots. Wonder how many smart people failed to see the dot.com bubble or the housing collapse? How could regulators failed to see failing lending standards and rapidly deteriorating fundamentals ? Similar situation to bond market, gold and silver valuations? Can the world continue to thrive with unsound finance, ,massive currency printing and intensified currency wars? To solve the problem, always reexamine your bias in the light of new evidence and at the same time hedge your positions until you get the direction right. The fundamentals can lag the price actions by a few years!

o It depicts rampant greed, manipulation and corruption in the political system and financial world -  companies like JPM, Citibank, Goldman Sach and our previously, Morgan Stanley, Salomon Brother, Lehman Brother etc. Never trust these guys!

Interestingly, I read a bad review on Niall Ferguson "The Ascent of Money".  But I like the book. It gives a wonderful historic account. I am not scholarly enough to debate the good Harvard professor on his account of the history of money. But I am seeing that history is showing much rhyme in current events now. For those who do not read, you can view a 4 hours BBC documentary on the book at  http://www.youtube.com/watch?v=4Xx_5PuLIzc.