June FOMC statement came this afternoon and the report took away all the sizzle that was being expected by the market. One interesting thing in this report is Fed has come to an understanding that it has and will be deploying all the tools to keep economy from falling into a depression.
Fed has mentioned that growth rate fall has slowed down a bit. It has taken some comfort from how its monetary policy is helping the economy. Fed is still on it target to make its purchases related quantitative easing. Also fed has come to clear conclusion that lower fed fund rates will be there for a long period.
These things have clearly confirmed the hikes that are being priced by the market are incorrect.
so what next in terms of trading with in rates space. Expect a clear range bound market with falling volatilities in the front end. Long term rates have some room to rise but they will fall in the medium term.
tomorrow i will post some trades. BTW, i have been playing with IBM condor and so far this trade has done well (as of today it has made 1000 dollars profit).
Good Night
Chandra Khandrika
Wednesday, June 24, 2009
Sunday, June 21, 2009
Economic thoughts
Public mood towards economic thought prevailing today is that economists, central bankers and regulators failed to see the crisis coming. Majority group started questioning the theories propounded and practiced in diagnosing the problems. Among economists we see people talking down Keynes and his followers who have prescribed government has to save the sick economy by providing adequate antibiotics of stimulus. On contrary they claim that irrationally predictable human behavior is cause of these problems and new set of tools and theories needs to be developed. In my perspective, neither Keynes is wrong nor was his predecessors wrong. There is an old proverb everyone is right from their own point. Each economic thought has two messages. First message belongs to the time when this theory was developed and second message gives a timeless message that is applicable to all time periods.
To understand modern day economic thought it is imperative that we understand how various people have left their long lasting impressions on this field. People like, Adam Smith, David Ricardo, Joseph Schrumpter, Alfred Marshall, Jeremy Bentham, Keynes, Milton friedman, efficient market theorists and behavioural finance economists. Although this list is not exhaustive but it would be apt to say that these folks have contributed towards the development of economic thought that we are witnessing today.
Smith came up with invisible hand theory in 1776 with the publication of Wealth of nations and became to be known as father of Capitalism. But Capitalism existed since the dawn of human civilization. Capitalism is not an object that needs to be discovered. Smith when started observing how people from various trades cooperate seamlessly to produce goods for mutual economic prosperity. This idea serves under all times and eras. But crooked human behavior can mercilessly subject some humans to appalling working conditions of production of goods for making profits. This makes people like Karl Marx to propound radical thoughts and make capitalism as an evil. We should not forget, in the long run only two regimes, democracy and capitalism prevails on the surviving living beings on the planet earth. David Ricardo came up with his theory of comparative advantage trade theory for mutual prosperity. As times have changed, global trade increased, industrialization has matured in western countries we have witnessed prosperity only to be punctuated by great depression of 1929. Economists have observed this crisis and its consequences and Keynes prescribed that government should bend over knees to support the economy by providing stimulus and central bank should become ultimate liquidity provider. Later on Milton friedman came up with his theory of monetarism stating that due to political nature. In late 70’s economic thought already loaded with shades of smith, Keynes, friedman evolved into a new direction in the hands of efficient market theorists. This has lead to development of fascinating derivative structures as chief risk transferring tools. Global trade machine has seen a gush of liquidity and wheels started moving at full speed. This machine came to a grinding halt when subprime crisis took hold. Behavioral economists have sensed now it is their time to rise to the occasion and prescribe solutions. This group says irrational exuberance displayed by people towards the appreciation of housing prices has caused the problems that we are seeing. To support their claim Shiller and akerlof came with their book animal spirits. Are they right? There is no one answer. Current crisis has clearly showed that we have not learnt enough in understanding the functional mechanism of capitalism. We have a long way to go and theories to date have failed and behavioural finance is trying to take a role onto itself to explain the problem. Will they succeed? Next crisis will tell that
To understand modern day economic thought it is imperative that we understand how various people have left their long lasting impressions on this field. People like, Adam Smith, David Ricardo, Joseph Schrumpter, Alfred Marshall, Jeremy Bentham, Keynes, Milton friedman, efficient market theorists and behavioural finance economists. Although this list is not exhaustive but it would be apt to say that these folks have contributed towards the development of economic thought that we are witnessing today.
Smith came up with invisible hand theory in 1776 with the publication of Wealth of nations and became to be known as father of Capitalism. But Capitalism existed since the dawn of human civilization. Capitalism is not an object that needs to be discovered. Smith when started observing how people from various trades cooperate seamlessly to produce goods for mutual economic prosperity. This idea serves under all times and eras. But crooked human behavior can mercilessly subject some humans to appalling working conditions of production of goods for making profits. This makes people like Karl Marx to propound radical thoughts and make capitalism as an evil. We should not forget, in the long run only two regimes, democracy and capitalism prevails on the surviving living beings on the planet earth. David Ricardo came up with his theory of comparative advantage trade theory for mutual prosperity. As times have changed, global trade increased, industrialization has matured in western countries we have witnessed prosperity only to be punctuated by great depression of 1929. Economists have observed this crisis and its consequences and Keynes prescribed that government should bend over knees to support the economy by providing stimulus and central bank should become ultimate liquidity provider. Later on Milton friedman came up with his theory of monetarism stating that due to political nature. In late 70’s economic thought already loaded with shades of smith, Keynes, friedman evolved into a new direction in the hands of efficient market theorists. This has lead to development of fascinating derivative structures as chief risk transferring tools. Global trade machine has seen a gush of liquidity and wheels started moving at full speed. This machine came to a grinding halt when subprime crisis took hold. Behavioral economists have sensed now it is their time to rise to the occasion and prescribe solutions. This group says irrational exuberance displayed by people towards the appreciation of housing prices has caused the problems that we are seeing. To support their claim Shiller and akerlof came with their book animal spirits. Are they right? There is no one answer. Current crisis has clearly showed that we have not learnt enough in understanding the functional mechanism of capitalism. We have a long way to go and theories to date have failed and behavioural finance is trying to take a role onto itself to explain the problem. Will they succeed? Next crisis will tell that
Sunday, June 7, 2009
Interest rates Update -10 yr futures
10y rates have seen a rise after seeing their historical lows. Since the housing markets went into correction, credit markets have started adjusting for new realities and consequently markets had seizure and Federal reserve had to become the ultimate buyer of the risk to bring markets to their normal levels. These actions have dragged 10yr rates to historical lows. But since then after some apparently known as green shoots, positive economic news and profits from financial sector has helped equity markets to recover globally. this sowed the seeds of recovery in investors minds and everybody started getting into the market. We have also witnessed during last two months housing sector has improved due to incentives like $8000 tax credit to first time buyers and very low mortgage rates. Improved consumer sentiment, lower job losses and finally the bankruptcy of GM and chrysler brought equity markets to new state. All these factors and rising treasury supply helped treasury rates to go up. From here where ....
Fundamentally speaking, treasury rates have further room to rise. Unless, some fed speaker insinuates about their support to low mortgage rates.
Technical analysis confirms the same mood. The candle chart shows a bearish trend formation. Due to some random cause there might be a chance for markets to rise (yieds fall) but atlease for this week treasuries are on the slide to fall
Better to initiate
short in 116 calls at 1-09 ticks. excluding comm and fees.
Managing Risk-Option Greeks
Option GreeksOptions are subjected to risks from, option underlying changes, option volatility and passage time. These three forces act together but not in unison to impact on the price changes in everyday trading. Individual forces can be viewed per se to analyse the dynamics. To do so, we have 4 sensitivities, namely Delta, Gamma, Vega and theta respectively.Delta: Change in Option price for an infinitesimal change (1 bp or 1/100 bp) in the underlying (futures price or swap rate or Libor rate)Gamma: Change in the Delta of the option for a shift in the underlying.Vega: Change in the option price for an infinitesimal change in the volatility of the underlying.Theta: Change in the option price due to passage of time.Vega skew: Change in the Volatility due to change in the underlying.Main sources of change in the option price can be attributed toa) Change in underlying (Yield Curve)b) Change in volatility (Implied Volatility)c) Change in option Moneyness (expiring in the money or out of the money)d) Passage of time (carrying value)
Analysis of DeltaDelta of an option connotes,· Probability that option will expire in the money or out of the money· Hedge ratio (underlying, to be bought or sold to make position Delta neutral)Delta Range: -1 to +1 for call and puts respectivelyDelta ITM ATM OTMLong Call +0.5 to +1 +0.5 0 to +0.5Long Put -0.5 to -1 -0.5 0 to -0.5Governing forces for the Deltaa) Delta dynamics with passage of timeb) Delta dynamics with yield curve changesc) Delta dynamics with volatility changesDelta dynamics with passage of time: Delta determines probability that option might settle ITM or OTM. As we approach expiration, there will be less chance for the underlying to move around. This will cause an OTM option to expire OTM by changing its current delta (probability) less than 0.5 to zero. Similarly, an ITM option will attain delta (probability) of 1. Tricky element will manifest through an ATM option. This option will have delta of 0.5 until before expiry and on the day of expiry this option delta will move from 0.5 to 1 and expire in the money or move to 0 and settle unexercised. This kind of radical movement causes option gamma to manifest wide swings causing huge PL movements.Option type Moneyness Before Expiry on ExpiryLong Call ITM between 0.5 to 1 1Long call ATM 0.5 1 or 0Long Call OTM between 0 and 0.5 0Delta Dynamics with Yield curve changes: Yield curve (underlying) changes will impact on the option by changing the moneyness. Rising yield curve may cause the moneyness of a payer to increase or decrease for a receiver swaptions.Option type Moneyness Rates Rise ChangeLong Call ITM Delta moves towards 1 from above 0.5 Delta increasesLong Call ATM Delta moves towards 1 from 0.5 Delta increasesLong Call OTM Delta moves towards 0 from below 0.5 Delta decreasesOption type Moneyness Rates Fall ChangeLong Put ITM Delta moves towards -1 from above -0.5 Delta increasesLong Put ATM Delta moves towards -1 from 0.5 Delta increasesLong Put OTM Delta moves towards 0 from below -0.5 Delta decreasesDelta Dynamics with Volatility Changes: Volatility impacts, delta by increasing the uncertainty with in the deltas. So higher volatility should suggest, an ITM option can move to ATM or OTM and OTM can move into ITM and so on. Therefore, Volatility’s impact is viewed as causing the ITM delta to go down; TM delta to increase and ATM delta remains same.Option type Moneyness Volatility Rises ChangeLong Call ITM Delta moves towards 0.5 from near 1 Delta decreasesLong Call ATM Delta remains at 0.5 Delta increasesLong Call OTM Delta moves towards 0 from below -0.5 Delta decreasesPL Impact: PL impact from the delta can be estimated by applying market change to the delta.PL = Delta* Market ChangeConventions for swaptions· Purchase payer equal to long call in terms of rates· Purchase of receiver is equal to long put in terms of rates· Sell a payer is equal to short call in terms of Rates· Sell a receiver is equal to short put in terms of ratesDelta can be measured in terms of yield rather than in terms of price. In a sell off positive delta position (short market) will gain and in a rally negative Delta position (Long Market) will make loss.Delta Direction for SwaptionsSwaption Type Delta Market positionPurchase Payer Positive Short the MarketPurchase Receiver Negative Long the marketSell Payer Negative Long the MarketSell Receiver Positive Short the MarketAnalysis of GammaGamma risk predicts how delta changes with respect to larger underlying changes. Due to large movements in the underlying, option delta changes and this will cause significant PL impact. For instance, an ATM option before expiry if settles ITM or OTM (crossing the strike) on the day of expiration then delta changes from 0.5 to 0 or 1. This sharp change in delta causes gamma to increase significantly.How Gamma works: For a long ATM payer swaption (long Call) position is long gamma. Whenever market rallies (yields fall), this position will loose delta and becomes less short. In other words, option will move from ATM to OTM. In this transition, Long gamma acts as cushion by adding PL. Similarly, when market yields rise due to a sell off, the position will become, ITM and gamma makes the position shorter.a) Gamma Dynamics for Yield curve changesb) Gamma dynamics for the volatility changesc) Gamma dynamics for the passage of time.Gamma Dynamics for the yield curve changes: Options most common and direct and largest source of risk comes from the underlying changes. Underlying movement can make an OTM option into an ITM option and vice versa or leave both ITM and OTM options on the edge at ATM. This kind of change has major impact from gamma to the option.Option Type Gamma Rates Rise changeLong Call ITM moves towards 1 from above 0.5 (Gamma decreases)Long Call ATM moves towards 1 from 0.5 (Gamma decreases)Long Call OTM moves towards 0 from below 0.5 (Gamma decreases)Gamma dynamics with Volatility Changes: Volatility being indication of uncertainty, it drives Gamma for ATM option down because, rising volatility suggests that market is going to move from current point to somewhere. This will make ATM delta to move from 0.5 to higher or lower. So, Gamma decreases. Whereas, for OTM and ITM options rise in volatility means no more status quo and rates will move to somewhere and they will be getting new money ness, which would be obviously ATM. This would cause, their Gamma to rise.Gamma Dynamics for the passage of Time: Gamma grows, as time to expiry gets closer. This will create even unthinkable gammas. Passage of time is worst enemy of ATM option writer. As we get close to maturity, gamma rises so high that it becomes impossible to hedge the option. Whereas, OTM and ITM options together enjoy the luxury of gamma decreasing to zero.PL ImpactGamma = ((Delta (new) – Delta (old)) /2)*( Market Change)^2New Delta = old Delta + Gamma*(Market Change)Swaption Type Gamma position Market positionPurchase Payer Long Gamma Short MarketPurchase Receiver Long Gamma Long MarketSell Payer Short Gamma Long MarketSell Receiver Short Gamma Short MarketLong Gamma position will contribute towards more delta in rising markets and less delta in falling markets. This kind of situation can be paraphrased as Gamma Trading.Analysis of VegaVega risk predicts the change in the option price due to the volatility change in the market.A) Vega dynamics due to yield curve changesB) Vega dynamics due to passage of timeC) Vega dynamics due to change in VolatilityVega Dynamics due to passage of time: Vega of an ATM option is highest and ITM and OTM options have lower Vega. Vega of and option decreases with expiry date getting closer. In other words, we will see the certainty in the option getting expired ITM or OTM. This shows, Vega decreases for options of all moneyness to zero.Vega dynamics due to change in Volatility: Vega rises with increase in implied volatility. ATM Vega will change slightly but OTM and ITM Vega rises. Significantly.Vega Dynamics due to Yield Curve changes: Yield curve changes alter the moneyness of the option. This will cause and option to move from being ITM to OTM and so on. Accordingly, Vega will change due to these yield curve movements. This change is referred as Vega skewAnalysis of ThetaTheta risk predicts everyday cost of carrying the option. There is no imaginable hedge for this kind of risk. As we are all certain time passes by. But, still it warrants, to get grips with the dynamics of the theta.Theta Dynamics due to yield curve changesTheta dynamics due to Volatility changesTheta dynamics due to yield curve changes: Yield curve changes alter the moneyness of the options. This will alter the theta profiles. For an ATM option carry will be highest and lower for ITM and OTM options. Theta for options that are close to expiry and ATM will be highest and for deep ITM and OTM options close to zero.Theta dynamics due to volatility changes: Theta for options increase with rise in volatility.
Analysis of DeltaDelta of an option connotes,· Probability that option will expire in the money or out of the money· Hedge ratio (underlying, to be bought or sold to make position Delta neutral)Delta Range: -1 to +1 for call and puts respectivelyDelta ITM ATM OTMLong Call +0.5 to +1 +0.5 0 to +0.5Long Put -0.5 to -1 -0.5 0 to -0.5Governing forces for the Deltaa) Delta dynamics with passage of timeb) Delta dynamics with yield curve changesc) Delta dynamics with volatility changesDelta dynamics with passage of time: Delta determines probability that option might settle ITM or OTM. As we approach expiration, there will be less chance for the underlying to move around. This will cause an OTM option to expire OTM by changing its current delta (probability) less than 0.5 to zero. Similarly, an ITM option will attain delta (probability) of 1. Tricky element will manifest through an ATM option. This option will have delta of 0.5 until before expiry and on the day of expiry this option delta will move from 0.5 to 1 and expire in the money or move to 0 and settle unexercised. This kind of radical movement causes option gamma to manifest wide swings causing huge PL movements.Option type Moneyness Before Expiry on ExpiryLong Call ITM between 0.5 to 1 1Long call ATM 0.5 1 or 0Long Call OTM between 0 and 0.5 0Delta Dynamics with Yield curve changes: Yield curve (underlying) changes will impact on the option by changing the moneyness. Rising yield curve may cause the moneyness of a payer to increase or decrease for a receiver swaptions.Option type Moneyness Rates Rise ChangeLong Call ITM Delta moves towards 1 from above 0.5 Delta increasesLong Call ATM Delta moves towards 1 from 0.5 Delta increasesLong Call OTM Delta moves towards 0 from below 0.5 Delta decreasesOption type Moneyness Rates Fall ChangeLong Put ITM Delta moves towards -1 from above -0.5 Delta increasesLong Put ATM Delta moves towards -1 from 0.5 Delta increasesLong Put OTM Delta moves towards 0 from below -0.5 Delta decreasesDelta Dynamics with Volatility Changes: Volatility impacts, delta by increasing the uncertainty with in the deltas. So higher volatility should suggest, an ITM option can move to ATM or OTM and OTM can move into ITM and so on. Therefore, Volatility’s impact is viewed as causing the ITM delta to go down; TM delta to increase and ATM delta remains same.Option type Moneyness Volatility Rises ChangeLong Call ITM Delta moves towards 0.5 from near 1 Delta decreasesLong Call ATM Delta remains at 0.5 Delta increasesLong Call OTM Delta moves towards 0 from below -0.5 Delta decreasesPL Impact: PL impact from the delta can be estimated by applying market change to the delta.PL = Delta* Market ChangeConventions for swaptions· Purchase payer equal to long call in terms of rates· Purchase of receiver is equal to long put in terms of rates· Sell a payer is equal to short call in terms of Rates· Sell a receiver is equal to short put in terms of ratesDelta can be measured in terms of yield rather than in terms of price. In a sell off positive delta position (short market) will gain and in a rally negative Delta position (Long Market) will make loss.Delta Direction for SwaptionsSwaption Type Delta Market positionPurchase Payer Positive Short the MarketPurchase Receiver Negative Long the marketSell Payer Negative Long the MarketSell Receiver Positive Short the MarketAnalysis of GammaGamma risk predicts how delta changes with respect to larger underlying changes. Due to large movements in the underlying, option delta changes and this will cause significant PL impact. For instance, an ATM option before expiry if settles ITM or OTM (crossing the strike) on the day of expiration then delta changes from 0.5 to 0 or 1. This sharp change in delta causes gamma to increase significantly.How Gamma works: For a long ATM payer swaption (long Call) position is long gamma. Whenever market rallies (yields fall), this position will loose delta and becomes less short. In other words, option will move from ATM to OTM. In this transition, Long gamma acts as cushion by adding PL. Similarly, when market yields rise due to a sell off, the position will become, ITM and gamma makes the position shorter.a) Gamma Dynamics for Yield curve changesb) Gamma dynamics for the volatility changesc) Gamma dynamics for the passage of time.Gamma Dynamics for the yield curve changes: Options most common and direct and largest source of risk comes from the underlying changes. Underlying movement can make an OTM option into an ITM option and vice versa or leave both ITM and OTM options on the edge at ATM. This kind of change has major impact from gamma to the option.Option Type Gamma Rates Rise changeLong Call ITM moves towards 1 from above 0.5 (Gamma decreases)Long Call ATM moves towards 1 from 0.5 (Gamma decreases)Long Call OTM moves towards 0 from below 0.5 (Gamma decreases)Gamma dynamics with Volatility Changes: Volatility being indication of uncertainty, it drives Gamma for ATM option down because, rising volatility suggests that market is going to move from current point to somewhere. This will make ATM delta to move from 0.5 to higher or lower. So, Gamma decreases. Whereas, for OTM and ITM options rise in volatility means no more status quo and rates will move to somewhere and they will be getting new money ness, which would be obviously ATM. This would cause, their Gamma to rise.Gamma Dynamics for the passage of Time: Gamma grows, as time to expiry gets closer. This will create even unthinkable gammas. Passage of time is worst enemy of ATM option writer. As we get close to maturity, gamma rises so high that it becomes impossible to hedge the option. Whereas, OTM and ITM options together enjoy the luxury of gamma decreasing to zero.PL ImpactGamma = ((Delta (new) – Delta (old)) /2)*( Market Change)^2New Delta = old Delta + Gamma*(Market Change)Swaption Type Gamma position Market positionPurchase Payer Long Gamma Short MarketPurchase Receiver Long Gamma Long MarketSell Payer Short Gamma Long MarketSell Receiver Short Gamma Short MarketLong Gamma position will contribute towards more delta in rising markets and less delta in falling markets. This kind of situation can be paraphrased as Gamma Trading.Analysis of VegaVega risk predicts the change in the option price due to the volatility change in the market.A) Vega dynamics due to yield curve changesB) Vega dynamics due to passage of timeC) Vega dynamics due to change in VolatilityVega Dynamics due to passage of time: Vega of an ATM option is highest and ITM and OTM options have lower Vega. Vega of and option decreases with expiry date getting closer. In other words, we will see the certainty in the option getting expired ITM or OTM. This shows, Vega decreases for options of all moneyness to zero.Vega dynamics due to change in Volatility: Vega rises with increase in implied volatility. ATM Vega will change slightly but OTM and ITM Vega rises. Significantly.Vega Dynamics due to Yield Curve changes: Yield curve changes alter the moneyness of the option. This will cause and option to move from being ITM to OTM and so on. Accordingly, Vega will change due to these yield curve movements. This change is referred as Vega skewAnalysis of ThetaTheta risk predicts everyday cost of carrying the option. There is no imaginable hedge for this kind of risk. As we are all certain time passes by. But, still it warrants, to get grips with the dynamics of the theta.Theta Dynamics due to yield curve changesTheta dynamics due to Volatility changesTheta dynamics due to yield curve changes: Yield curve changes alter the moneyness of the options. This will alter the theta profiles. For an ATM option carry will be highest and lower for ITM and OTM options. Theta for options that are close to expiry and ATM will be highest and for deep ITM and OTM options close to zero.Theta dynamics due to volatility changes: Theta for options increase with rise in volatility.
Analysis of Deals-Players-risk -Interest Rate Derivatives
Most of the swaptions, libor Caps and floors and CMS floors that I have seen are from the following players1) Inter Dealer market2) Customersa. Hedge funds b. Mortgage banksc. Agenciesd. Hedgers and speculatorse. Insurance companiesMentioned below an array of players with varied interests at different points on the volatility surface. These players judge the market and their own unique needs and buy or sell options.Interdealer brokers· JP Morgan Chase Bank NA-New York Branch· Goldman Sachs Capital Markets LP· Deutsche Bank AG-New York Branch· Lehman Brothers Special Financing Incorporated-New York Branch· Merrill Lynch Capital Markets Bank Limited-London Branch· Bank of America NA· Credit Suisse International-London Branch· Citibank NA· Bear Stearns Bank PLCHedge Funds· PFG Relative Value Opportunity Master Fund LP· Element Capital Master Fund Limited· Elliott International LP· Parkcentral Global Hub Limited· Caxton International Limited· Citi Vega Select Limited· DE Shaw Dihedral Portfolios LLC· FrontPoint Fixed Income Opportunities Fund LPMortgage Banks· Washington Mutual Bank· Wells Fargo Bank NAAgencies· Federal Home Loan Bank of Atlanta· Federal Home Loan Bank of New York· Federal Home Loan Mortgage CorporationInsurance Companies· MetLife and other insurance companiesInter Dealer market main function is to provide, liquidity to the market. So they are generally market facilitators. Hedge funds take a view on the market and execute strategies. Deals done by these clients can be analyzed and reengineer the strategy behind the flow. Agencies are main creators of the volatility through callable debt and mortgage backed securities. This group has special interest to hedge the assets on their books. Hedgers and speculators have very unique need to protect their assets so they enter into options market.Player Main Role Needs ProductsInter dealer Facilitate the market Bid Ask spread all productsMortgage banks Holders of mortgages hedge monthly cash flows Amortizing Caps/Swaptions Agencies issuers of callable debt Hedge optionality Long dated swaptionsIssuers of MBSInsurances seller of GIC, Annuities Hedge long term liabilities CMS Caps/FloorsOthers CRA hedge using digitals Digitals
Wednesday, June 3, 2009
IBM Condor option
IBM is trading in the around 105. The price action of IBM is very stable and range bound. Implied volatility of IBM is at 27.84%. Not really high level of volatility but at this level the condor looks very attractive.
10 July 95/100/110/115 condor at a net credit of 3000 and commissions of 59.80. This trade has a risk of 2000.
Breakeven points on up side and down side are 113 and 102. If IBM stays below 113 and 102 this trade makes sufficient money.
Close the calls if ibm trends in upward direction.
Monday, June 1, 2009
S&P 500's rally is unsustainable
S&P 500 closed at 942. Looking at this graph below shows similar kind of drop and retracement after the technology bust. This retracement in the S&P is due to benign low interest rate regime that kick started. The question is will this rally sustain?
Let us examine few things that have lifted in 2002. At that time long term interest rates were at 5% levels. Govt and individual balance sheets were not leveraged. Globally, China and India started showing leadership in manufacturing and service sectors. This has lead to capping the price levels for various products. In this kind of world a busted economy needed fuel of low interest rates and markets have rallied to their heights. Fast forward to today. We are already in low interest rate regimes. Fed fund rates is at 0-0.25% range. Consumer balance sheets are deeply leveraged and resilient consumer is in the process of deleveraging. Government has taken the role of lifting the economy by creating enormous deficits. China and India are displaying signs of growth in response to government programs.
This gives a clear indication that any kind of monetary or fiscal medicine at this point of time is sheer wastage of resources. What needs to happen is deleveraging to reach equilibrium point. Till then we have two things that will play. One is uncertainity and second is dead cat bounces.
By end of June S&p 500 should stay around 900 or trend lower.
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