Oct

29

Notes, from Steve Leslie

October 29, 2008 |

I know to many this is very basic commentary but it may prove helpful to some here: This explains in one paragraph why things go down a lot faster than they go up. Hedgefunds, mutual funds and pension funds must sell on the way down. They have no choice. They must meet margin requirements and other technical requirements. This forced liquidation scenario is the most wicked of wickeds that the unfortunate fundamental investor faces in their education.

Remember near the end of the movie Trading Places where the Duke brothers (Ralph Bellamy and Don Ameche) are approached by the exchange with their margin calls. Their comment was “we don’t have that kind of money!” Same thing there as here. This is the cataclysm when people trade with OPM (other people's money). They are universally more cavalier and reckless than if they have their own capital at risk. LTCM in 1998 suffered the same fate when they had a famous decoupling of their spreads. Their models, suddenly and evidently without warning, [stopped working; the firm faced margin calls and] had to liquidate. Then, the Investment Banks and Commercial banks came to the rescue because they saw ultimate value in the spreads. Otherwise they would have not gotten involved and the Fed would have had to step in and take over the company. At the time, they controlled over a trillion dollars of assets on their books. Whereas with an intangible to go up in price it takes many months to build up a position and to trade ahead of the fundamental estimates.

This scenario is very well described by Dr. Hersh Shefrin in his book Beyond Greed and Fear: Understanding Behavioral Finance. He eloquently describes how it takes a fundamental analyst approximately nine months for their estimates to catch up with a stock price. What we see today especially with the stock market is pure technical trading. It has everything to do with liquidity needs in an environment where credit is non-existent. Until this picture becomes clearer when Investment Banks and Commercial Banks will give up their new found capital and help companies thaw out from this very arctic deep freeze credit crisis, we shall continue to trade in a black hole of confusion. I actually heard a “professional” comment, “It has been three weeks since the Federal Reserve and the Treasury put forth their solutions. How long do you think it will take for these things to start to work?” Summary: It took years for us to get into this mess, we are not going to get out of this one overnight.


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