Who Would Have Thought It? - Betonmarkets

Author: cordieliea | Posted: 31-08-2007

Who would have thought it? A recent financial cartoon depicted two Wall Street traders on their way to work in conversation. The speech marks read "It turns out poor people with bad credit can't afford to buy a new home. Who knew?"

You can take this line as meaning that Wall Street failed to see the dangers, or more sarcastically; that it knew the dangers but ploughed on ahead because the returns were so great. Either way, it highlights the issues at the centre of the recent financial storms, says BetOnMarkets.com's Michael Wright.

There have been "sub prime loan time bomb" warnings, for a long term before the markets collapsed. However while stock markets kept on going up, such concerns were brushed aside. Equity markets around the world, with the exceptions of the sharp corrections in February and March, had marched consistently higher since the summer of 2006. The Dow Jones broke through its all time pre-internet bubble crash high, while other indices were also at, or near their record highs.

So what changed? It is difficult to pin point a single event that finally caused equity markets to plunge as they did in July and August. It is more akin to a scene in a cartoon when the character runs off a cliff, and keeps on running in mid air until they look down, and then they begin to fall. Whatever actually started the fall, it seems that this "contagion" has spread to many areas that were previously thought to be unconnected.

Mortgage companies have recently been hit with the double whammy, of falling house prices, and rising defaults. The Case-Schiller Home Price Index recently posted a record annual decline. For the first time in a long while, year on year house price changes, were negative in every one of the cities measured. Some major mortgage companies have filed for bankruptcy protection, while others had to draw on their emergency credit lines, as more and more customers have defaulted on their home loans. The industry is going into the 3rd stage of the boom to bust cycle, which is called 'lawsuits' with borrowers suing the lenders, and visa versa.

Recently we saw an unprecedented "flight to safety" as investors feared a run on the banks. The complicated way that debt has been parceled up means that nobody really knows exactly who is exposed to what. Investors fled with near panic to assets which have little or no perceived risk attached to them such as US Treasury Bills.

European banks have been particularly hard hit and Alexander Stuhlmann of Germany's Landesbank was recently quoted as saying that "The German banks' situation is not uncritical". The interbank lending rate shot up, as financial institutions eyed each other with suspicion. With lenders raising the margin requirements, some traders had to shore up their margins with either adding more cash, or liquidating their positions at discount prices. Lastly the earnings have been coming in a little weaker then predicted and some companies such as Wal Mart have lowered their outlook for the up and coming quarters.

The big question is whether the US Federal reserve will cut rates as many are predicting and hoping, or whether it will maintain is hawkish stance on inflation. Fed Futures point to the chances an FOMC rate cut as being likely. Assuming that this is indeed the case, more questions arise: If the Fed cut interest by a quarter percent, will it be enough to stem the flow of negative business and consumer sentiment? Will it be enough to power the US Indices back above their recent highs? Will it stop the US housing market slump? Will it stem the rising number of credit card defaults?

The answer to all of the above is possibly yes, but perhaps not in a hurry. The world's number one economy may indeed go on to recover from this scare, but there may now be too much fear for a broad based rally, as we saw in the months leading up to the recent drop.

Using Betonmarkets.com you can potentially profit from this bearish to neutral outlook. By placing something called a 'no touch' bet, you can win if the market continues to go down, stays flat or rises slowly. By placing this no touch level above the current price of the S&P 500 you can profit from further falls or an anemic bounce. A no touch bet on the S&P500 with a 30 day term with a trigger placed above the 52 week high or 120 points higher from where it is now returns around 10%.