Along came a bear and his name wasn't Boo. And when Mr. Stearns disclosed the pimple in his portfolio, it changed the broader market complexion.
Time to sit back and unwind
(DJ Jazzy Jeff & The Fresh Prince)
Good morning and welcome to the longest day of the year. Every day seems that way of late but alas, it's now official.
We welcome the new season with one eye on the tape and the other on the clock. Indeed, while skins are tan and bodies are taught, traders are anxiously edging towards the end of the second quarter.
Last week at this time, all seemed well in the world. The benchmark indices were eyeing double-digit gains, the market was operating efficiently and market prognosticators bantered about just how far this rally can run.
Along came a bear and his name wasn't Boo. And when Mr. Stearns disclosed the pimple in his portfolio, it changed the broader market complexion. It wasn't entirely unexpected- we spoke about it last week-but the situation has seemingly picked up steam.
Without getting into the nuts and guts of this particular trade, it's important to note two reasons why this might continue to matter.
First, if the damaged goods-collateralized debt obligations, or CDO's- are sold to the Street, it'll provide a benchmark price that will force holders of similar securities to "mark to market." Similar securities, in this instance, exceed $1 trillion and are the fastest growing segment of the bond market.
What's mark-to-market? In a nutshell, it's subjective pricing. When a dealer takes down a position that is either rarely traded or "off board," they assign a value to it. Often times, despite market fluctuations, they won't "show" the P&L as there's little or no pricing context.
This is nothing new-it's been going on for as long as I've been in the business and is, in many ways, industry practice. But if this particular package gets re-priced, it may ripple through the Street and cause waves of billion dollar losses.
Second, perhaps less likely but more dangerous, is the interwoven financial fabric that connects the market machination. $370 trillion worth of derivatives are floating around and they remain in play, cumulatively compressing risk. While ever-present, they need a catalyst, a pebble in the pond if you will.
That's called contagion and while it's a "tail event" (read: unlikely), there is precedence. Long-Term Capital Management, Thai Baht, Orange County, Russian Rubble. You get the picture. It doesn't happen often but when it does, it inflicts serious damage.
So, those are the dominoes. Bear Stearns, hedge funds, the brokers, large banks, firms with finance-based operations, the S&P (the financials are over 20% of the weighting), asset-class rebalancing and finally, global ramifications.
Alotta things have to happen for this to unfold and again, from a pure probability standpoint, it's unlikely. The onus is on us, however, to respect the risk and understand why SEC Chairman Christopher Cox said yesterday that they're closely monitoring the situation.
If his concerns are for "a potential systematic fallout," as he put it, they prolly should be on our radar as well.
Good luck today.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at email@example.com.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter