Why would it? Remember, up is down, war is peace, black is white, bad news is good news.well US didn't seem too bothered about Asian developments
Mispricing Risk / Conflict of Interest
from Mish's Global Economic Trend Analysis by Michael Shedlock
There were two very interesting posts on May 17th by John Succo on Minyanville about risk. The first is called Don't Confuse Risk Taking With Value.
I haven’t had much to say lately. Just more of the same. With money growth my firm estimates at an egregious 14% (compared to a falling GDP now quoted in the 1-2% range, we can safely say that the money is becoming more and more anemic in producing growth), no wonder speculation in stocks and other assets is unabashedly high, along with risk. But I don’t confuse risk taking with value and I hope you don’t either.
I have suspected for a long time that government “intervention” or “participation” (or whatever you want to call it) in private asset markets is as high as it has ever been. The markets are just not acting “naturally” to me. They seem orchestrated in many ways. Why? With the levels of debt in the system (we have no historical reference), central banks must keep asset prices rising so that the debt doesn’t look so bad on balance sheets. To keep the public and corporate sectors borrowing, they have to have rising collateral. Governments are becoming a larger part of the real economy with their debt creation. Free money means lower returns for everyone.
One piece of evidence is something strange going on in option pricing. If governments are buying risky assets like stocks, they wouldn’t buy individual stocks, they would buy indexes. Any rally in stock markets would be led by index buying, not from the bottom up where investors buy individual stocks because they see fundamentals improving. Option prices are saying that is exactly what is happening.
.... Normally correlations fall as stocks rise because healthy rallies are created from the bottom up; normally correlations rise as stocks fall because corrections are caused more by macro events like recessions that affect all stocks.
.... Recently we are seeing correlations creep up as the market grinds higher. This is quite unusual.
.... The reason correlations are creeping up is that the rally is not being led by investors buying individual stocks, it is being led by index buying. I see a large and unnatural buyer (the buyer wants to pay the highest price possible) in indexes every day. I suspect it is the Bank of China buying U.S. stocks with sterilized trade dollars.
Stocks that want to go down because investors deem the fundamentals deteriorating are eventually dragged up with the rest of the market because of the index buying. Index buying infers that participants just want exposure to stocks regardless of fundamentals.
This increases risk. When trade slows down (as it is), there will be less trade dollars to recycle. When debt gets too high there will be less sterilization and lending to buy stocks.
Conflict of Interest
The second article from Professor Succo was called I Knew It Was Bad, But….
I asked a large broker firm to send over its smartest math person on Collateralized Debt Obligations (CDO) structuring. I wanted to know what I am missing: why is the market so sanguine in the face of deteriorating collateral values in the mortgage market? One of my firm's theses has been that, as the mortgage market deteriorates, investors holding CDO as an investment would realize losses and this would feed into other risky asset classes. Why aren’t losses being seen when the market is clearly deteriorating?
The team that came over was headed by a very smart gentleman. He was very good at math and very straightforward. Working for a broker I was prepared for some sugar coating. I didn’t get any.
The answer is simple and scary: conflict of interest.
He explained that due to the many layers of today's complicated credit products, the assumptions used to dictate the pricing and outcome of CDO are extremely subjective. The process is so subjective in fact that in order to make the market work an “impartial” pricing mechanism must exist that the entire market relies upon. Enter the credit agencies. They use their models, which are not sensitive to current or expected economic activity, but are based almost entirely on past and current default rates and cash flow to price the risk. This of course raises two issues.
First, it is questionable whether "recent" experienced losses over the last few years really represent the worst of the credit market (conservative). But even more importantly, it raises a huge conflict of interest: the credit agency's customers are the very issuers of the tranches they rate. The credit agencies, therefore, need to compete for business based at least in part on the ratings they are willing to give these tranches. As a result, they will only downgrade when forced to by experienced losses; not rising default rates, not a worsening economy, but only actual, experienced losses. Even more disturbing, they will be most reluctant to downgrade the riskiest tranches (the equity tranches) since those continue to be owned by the issuers even after the deal is sold.
So even though the mortgage market has deteriorated substantially, mark-to-market losses by those holding the CDO paper have generally not been realized simply because the rating agencies have not changed their ratings for all the above reasons. Accounting rules only require holders of the paper to mark prices according to the accepted model, not actual prices.
Actual prices where traders can really buy and sell is substantially lower than where investors are marking their positions. The levels at which investors are carrying the paper is not reflecting underlying reality as the holders simply hold their collective breath and the rating agencies ignore a worsening environment.
I asked them what would force the rating agencies to change their ratings and the response was “it's just a matter of time if the market continues to deteriorate, for the agencies at some point will be forced by the cumulative losses to acquiesce." Because these losses have been compressed, any re-adjusting of ratings by these agencies are likely to result in a massive repricing of risk.
Previously I talked about rating agencies in Cozy Relationships & Improprieties and Moody's in Wonderland. These two posts from Professor Succo lend more evidence to the idea that all is not what it seems.
Although we can see what is happening, there is no one alive that can say exactly when this will matter. However, we can say three things for sure.
1. Massive losses in CDOs (and conflicts of interest) can not be hidden forever.
2. The current trends in leverage, risk, and consumer debt are all unsustainable.
3. The longer things continue on the current path, the worse the eventual outcome.
Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/
Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com/ to learn more about wealth management for investors seeking strong performance with low volatility.
Why would it? Remember, up is down, war is peace, black is white, bad news is good news.
Interesting piece from Mick Shedlock:
The levels at which investors are carrying the paper is not reflecting underlying reality as the holders simply hold their collective breath and the rating agencies ignore a worsening environment.
2. The current trends in leverage, risk, and consumer debt are all unsustainable.
3. The longer things continue on the current path, the worse the eventual outcome.
this could give the markets another boost...
"China's new state investment firm on Sunday said it plans to make a $US3 billion investment in the Blackstone Group, one of the most prominent and powerful US private equity firms. China's soon-to-be-established foreign exchange investment company would make the investment in the form of nonvoting common units of Blackstone, a firm that has been at the forefront of a global boom in mergers and acquisitions. China announced in March it was setting up a vehicle to help diversify part of its $US1.202 trillion of foreign exchange reserves, the world's largest, to improve returns and diversify risk. State media have said the new agency could manage up to $US200 billion, although some Chinese economists have called for twice that amount to be at its disposal.
"This is a very, very significant move and it symbolizes that China believes in America," said Frank Holmes, chief executive of US Global Investors Inc.
"We are talking about a very sophisticated country. This is an excellent strategy for them to bring their dollars back into America."
from another bb..... sorry not really 'trading' related at all, but interesting fundamental info nonetheless
The Chinese now have 50% of Fannie and Freddie's mortgages, which account for 70% of the US mortgage market. So they have 35% so far. I wonder if it's common knowledge in the US that the Chinese own 35% of all US homes that have mortgages on them?
Now apparently they are starting a $200 billion fund to buy up US Firms/Stocks.
The Chinese have US$1.2trillion to spend.
I have been waiting for this diversification since early last year.
I think its all over for USD.
I wish i had some connects there so i could get them to put a few mil into each of my stocks LOL
(including a takeover bid for BLZ at 50cps!)
from another bb..... sorry not really 'trading' related at all, but interesting fundamental info nonetheless
The Chinese now have 50% of Fannie and Freddie's mortgages, which account for 70% of the US mortgage market. So they have 35% so far. I wonder if it's common knowledge in the US that the Chinese own 35% of all US homes that have mortgages on them?
Now apparently they are starting a $200 billion fund to buy up US Firms/Stocks.
Edwood, where did out find this info?
A quantum shift in power afoot?
Seems so.
My old man always told me to learn Chinese. I thought he was bonkers... but I never thought the west would hand economic power to the Chinese on a silver platter either.
a long-haired dictionary might've helped:
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