Weekly Musings 42 10-31-11
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The Pattern of Rising Instability
The typical mainstream media reporting of the EU's "rescue plan" last week focused on the euphoric global stock market rally that resulted from the announcement of the "solution." Skeptics such as Zero Hedge suggested the euphoria might last 48 hours. That seems to have been a good estimate.
Few have commented on what I see as the primary feature of these wild swings of sentiment: they are evidence of rapidly rising instability.
The pattern of official announcements being followed by euphoric celebrations which then quickly degrade into renewed bouts of gloom seem to be following a wave form in which the amplitude of each swing up and down widens with each cycle, even as the time between each wave decreases.
As an analogy, it's like earthquakes (or wind-storms, etc.) are not just happening with greater frequency--each successive earthquake/storm is stronger than the previous one. Market observers have long noted that markets tend to gyrate wildly like this just before crashes: though each move up or down may appear erratic, the pattern of rising amplitude and compressed time between the next peak and valley is unmistakable.
This makes a kind of psychological sense: Bulls are selectively seeking evidence that their world--stable, growing, secure--is still intact, and over-react to any reassurance they find, while those who fear this world is crumbling are exiting with greater alacrity when doubts re-emerge from the statistical and emotional noise.
Another way to visualize the current destabilization of Europe (and consequently the global economy) is a spinning top that is rapidly losing momentum. The top begins wobbling erratically just before it falls over. (Thank you, Chad D., for the analogy.)
I don't see any force on the horizon which can add momentum to the wobbling top of global finance, I see only friction and chaotic instability increasing. I strongly suspect we get a "credit event" within the next 7 weeks that triggers a mini-crash in global stocks and commodities.
Caution is advised.
What Are The Odds of a Monster Rally in the U.S. Dollar?
As Musings readers know, I am tiresomely focused on the only trade that really matters in my view, the U.S. dollar vs. everything else.
Despite the recent dip in the dollar (DXY) resulting from the 48-hour euphoria of Europe's faux "rescue"--a dip that is already being reversed as I write--the potential remains for what one commentator calls "the greatest USD rally of all time."
Here is the long and short of it (wordplay intended): banks are short currency and long assets. As assets start declining in value, then banks will have to sell assets to cover their "shorts" in currency, mostly in dollars.
I know this may be confusing, but another way to think about it is this: if you borrow currency (money) to buy a house, then you're short currency and long real estate. If the house plummets in value and you want to remain solvent, then you have to sell what you're long--the house--to cover what you're short--currency.
On a global scale, that liquidation of long asset positions to cover short positions in the dollar could generate one of the greatest short-covering rally in history, as all assets other than the USD are now correlated (i.e. the same trade).
More Systemic Risks Appear Every Week
One of the characteristics of increasingly unstable systems is the sudden entry of destabilizing forces which had previously been muted, inconsequential or simply opaque. Here is one example coming out of Europe:
Small Eurozone banking empires are now at risk. It turns out big banks in Sweden, Austria and Greece have dominated the banking sectors of the smaller nations within their financial gravitational pull. Problems in these peripheral countries such as Romania, Latvia, et al. then spread to the mini-empire's host nation.
We can discern the Pareto Principle at work here: when 20% of the loans in a small country become distressed, that has an outsized impact on the mini-empire's own banking sector. The mini-empire represents 20% of a larger multinational banking sector, and its problems then "infect" (create outsized effects in) the larger sector.
The models of "contagion" and "dominoes falling" offer visual representations of this process of appearently modest problems spreading quickly to much larger systems, destabilizing them in ways which were not foreseeable when all was well with the financial world.
New OWS News Site Launching
A new site devoted to collating and distributing news from the Occupy Wall Street movement will launch in the next few days: http://owsnews.org I am honored to have been invited to be a direct contributor, i.e. one who doesn't need an editor's approval. I will make spare use of the privilege, as I will only post entries that relate directly to the OWS movement and its general goals.
Virus Alert: FWIW
FYI, received from a trustworthy source but not verified by me: "If you receive E-MAIL called: Invitation FACEBOOK, though sent by a friend, do not open it and delete it immediately. It is the worst virus as announced by CNN. A new virus has been discovered recently that has been classified by Microsoft as the most destructive virus ever. It is a Trojan Horse that asks you to install an adobe flash plug-in.
Once you install it, it's all over. And there is no repair yet for this kind of virus. This virus simply destroys the Zero Sector of the Hard Disc, where the vital information of their function is saved."
From Left Field
Thanks for reading--
Charles
