Saturday, May 19, 2012

Next leg of the crisis

It's instrumental to learn the financial history. Technologies advance, companies come and go, but human psychology doesn't change. While the boom and bust cycles don't unfold in the same way each time, studying the past gives us two important insights:
  • a sense of the time scales
  • the severity and magntiude of the events
The next leg

One thing that I learned is a financial crisis unfolds over more years, at different pace in different countries and can have many many legs downwards.

It looks like we are now entering the next leg of GFC originated in 2007.

At the moment, France and Greece are throwing tantrums. On one hand we have France threatening to disintegrate the Euro core when its new president Fran├žois Hollande, rightly so, wants to reset the fiscal and monetary agendas of the Euro zone. On the other hand, we have Greece on the brink of leaving Euro.

I wrote in February this year in my private blog:
...I just can't help thinking the financial world now has some kind of "Euro zone fatigue", sick of hearing bad news from the region and has basically switched off, not to pay any attention anymore for a while. I still reckon there is a good chance Greece will default [disorderly] this year. On the top of that, we have also the possibility Isarel may attack Iran and the mess in Syria. Not to mention the China bubble is looming behind the scene. We know from high school math, to calculate the probability of "at least one bad thing will happen" is to add the probabilities up. (And this hasn't taken into account this kind of stuff is not mutually independent.)
Greece did default but in an orderly fashion. Since then, the market sentiment has been calm until 2 weeks ago. Now we have another real possibility that Greece will "default again" and send another shockwave throughout our financial systems.

What is it for value investors?

What does this mean for value investors?

How bad the situation will get? When will be the market bottom? No one knows. The key is not to time the market. The key is to price individual companies.

At a minimum, we should all be prepared. The volatility is on the rise. When Mr Market presents us with opportunities, we need to act swiftly and decisively, deploying meaningful amount of money to buy mispriced companies -- companies with wonderful prospects for the next 15 years but priced only for the outlook of the next quarter.

Learning the history

Back to the issue of studying the financial history.

There are classic like Devil Take the Hindmost, Manias, Panics, and Crashes and  Extraordinary Popular Delusions and The Madness of Crowds.

However, these two are my favourites:
  •  In an Uncertain World - This is Robert Rubin's memoir of his life as the Secretary of the Treasury in the Clinton era. You will see how the Asian Crisis, the Mexican Crisis andthe Russian Crisis unfolded through the eyes of a policy maker. Besides, this also touches on Rubin's probabilistic thinking style, which is vital for decision making under uncertainty. (Isn't that what investing is all about?!) This is quite a page turner. I've actually read it twice. This book is particularly relevant in the context of the current Euro crisis.
  • Anatomy of the Bear - Russell Napier documented four greatest bear periods in this book. This book is relatively dry and the analyses get a bit repetitive. However, it gives you a lot of charts, statistics and newspaper vignettes, showing you how different asset classes performed, what the central banks were doing and the how market sentiments turned around those four market bottoms. It uses Tobin's Q-ratio has a barometer of the market valuation and it draws the conclusion that the return of price stability of commodities is a key indictator of the bottom of the market. They are interesting perspectives. But being a bottom-up investor, I personally won't use these indicators to time the market. To me, the real value of this book is in the historical facts Russell has compiled.
Hedge fund manager Hugh Hendry reckons "we are single-digit years away from the most profound market clearing moment". Will the final leg in the next couple of years be a China fallout or a Japan collapse or something else? There is no way of knowing. But we better be prepared.

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