Friday, August 8, 2008

Greenie: More analysis about possible hedge funds margin calls today....

think greenie, think calmly and look for suckers to fade no more.

these series of trades are what hedgefunds were doing because their logical appeals:

1. short financials
2. long cmdtys
3. short $ vs. euro
4. short high P/E nasdaq stocks

The problem with long-short trade is just that you can be right fundamentally about 3 out of the 4 trades.

But just one of them could be wrong and as you cover, you also cover the existing position and this clearly triggers a feedback loop.

The one that is wrong was the idea that USA will print like Zimb, and thus long commodities indiscriminately. These would prove disastrous as they force unwind the otherwise "correct" trades.

So far from my trades I anticipated #1 - 3 correctly (deffering financials short while continuing to sell cmdtys).

I underestimated the extent to which the hedgefunds do #4 though, and as a result took a bit of a hit although not much as I just scaled in 2 days ago.

From Amaranth's experience, once the margin call is over prices quickly adjust to where they were and in this case I am just salivating over the potentials in financials.

By the way, the CRE lack of participation in this rally is perfectly explained by the LACK of shorting in that sector as opposed to financials. There's no immediate comparison of ABK/MBI/FRE in CRE space, ... well maybe GGP who seems to have a refinance schedule every other weeks.

As a final reminder, in a margin call, the lender's goal is not to maximize profit but to minimize losses and thus prices could be unpredictable as the need to cover quickly outweighs EVERY other consideration. Thus the strong incentive for everyone to stay away from this runaway trainwreck just purely from technical reason. One week is about as good as historically true in the unwindings of such event, but the larger the trade typically it takes longer periods to clear. Think back on how crazy people were in the past 3 months on commodities and decoupling theories to help quantify that last statement.

PS: Greenie observed astutely by saying:
""There were correlations between completely unrelated sectors (like the above one, or QID - gold shown yesterday)"


Now we know the disease, the winner is the one who guesses correctly the end of the episode AND identify the most mispriced stock.

Let the game begins.


Wisdom-Seeker said...

Excellent commentary. The emergence of novel correlations has to be throwing many of the stat-arb funds into a panic as well.

How far do you think the Euro/Dollar unwind will run? Seems as though that would set the limit on the current "Wave C" runup in U.S. equities. And we all wanna know when the next downleg is gonna start!

Also, just wanted to drop in and say Hi!

MTGSPY said...

i'm just working from memory here, but wasnt 1.3x was a "stable" level of euro before it started moving up relentlessly? Thx for stopping by.