THE NEXT CRISIS: A WAVE OF DEFAULTS IN THE PRIVATE SECTOR BONDS

The end of the year has arrived but the storm in the risky assets did not get any relief. The panics that started with the end of the QE asset buying took an end in the stock market with the statement of being patient with the rate hikes but the interest rates of the junk bond with under investment grade credit rating are soaring.

The panic regarding the Fed's interest rate hikes and the very serious decline in energy prices in the market where the US has a size in excess of 2 trillion USD and the size of the Emerging countries' stock estimated as being between 600 billion USD and 1.1 trillion USD, causes the threat of a serious bankruptcy and default. Even if there isn't any threat of default in some cases, it will become very expensive to issue new bonds in the coming months.

Following Yellen's warning in August regarding the over-valuation, the weather suddenly changed in the junk bonds that were the brightest asset class in 2014. The investors realized that the returns had dropped significantly and thus started to shun the new issues. At the end of November, the annual return on these assets had already become nil.

The drop in energy prices, a couple of minor default cases in the Chinese bond market and the rise in bond yields in the 2-year bonds in the US were also one of the straws that broke the backbone of the market. Currently, while the return in the energy companies' bonds have risen to double digits, the spreads in the others, that is the interest rate difference with the US government securities in peer-term, began to expand as the market indicated that the default risk was on the rise.

Widening of the spreads does not indicate the deterioration of the financial condition of the company; on the contrary, as the energy constitutes an input for all the companies, their costs are going to drop significantly. However, the liquidity is tight in the markets and the existing funds have started to move to the private sector bonds with high credit rating and to the US government securities.

Many companies had issued new securities under the assumption that the maturing bonds would be rolled-over. If they are forced to redeem them due to the rise of the interest rates, they may default. And the defaults could put into trouble the leveraged funds that hold them in their portfolio. This wave of defaults could well spread to the stock market.

The risks regarding the raising of the interest rates by the Fed by mid-2015 and the harsh decrease in the available foreign currency reserves in Russia's central bank could reach proportions that could ignite a panic in the financial markets. And the spark that could set the fire on may come from China. China is the number one issuer through Hong Kong in the Emerging Economies section of this asset group and is also the most risky country. In particular, the situation of companies operating in the housing sector is faltering. Currently, China's private bonds are standing tight based on the assumption that the Chinese government will not allow the bankruptcy of the debtor companies. In the event that Beijing changes its attitude, a real panic could start in the junk bond market and could spread to all risky assets...

BOOM BUST SEQUENCE IN OIL

During a market turmoil, any asset can drop severely and investors who are trying to catch the bottom of this free fall end up losing their money and sometimes their fortunes in the process. During such an environment, it is rather difficult to tell whether the drop in the price is heading for a crash or is only a correction, often a short-term one.

The recent drop in the oil prices reminds us about the dilemma faced by every investor or trader: is it a crash or a short-term correction? Oil prices dropped by more than 35% since early summer and more than 50% from its top of 147 USD a barrel which was reached in 2008. When you have such a severe drop, you start to ask to yourself whether it is time to buy it? A correction of 50% is enough for many investors and traders to start buying but what if it were to drop further to 60 USD a barrel? One should look for the possible catalysts that would permit a comeback of the oil...

A low price in oil stimulates the demand in many related sectors but diminishes the exploration and development thus reducing the oil supply with time. At one point, the demand starts to push the price of oil until a point is reached where the imbalance between supply and demand reverses the process and we have a severe drop if not a crash in the price of oil.

Currently, many oil producers (many of them being high-cost producers) have a break even price in the range of 60-70 USD and if the prices were to continue to drop, they will get into trouble: their budgets for capital expenditure will record a loss and a drop in the supply will follow; currently, there are deferrals and delays and their cost structure don't make that profitable at 70 USD a barrel. And the long-term outlook for the industry is moderate; in fact, the price of the barrel may remain flat around 70 USD for some time to come.

But there is also the production level of the conventional oil approaching the peak level. Despite the development of the unconventional oil production (oil sands, U.S. oil shale, biofuels and natural gas liquids), the drop in the price of oil will hurt their production as they are costly. Their production determines the growth in the production of oil in general and they depend too much on higher price levels. Further, the current levels of the oil prices will hamper the development of electric and /or hybrid cars as their operating costs are higher.

The oil producing countries in the Middle-East and Africa, as well as Russia need prices that are higher than 70 USD a barrel in order the break-even with their budgets (Russia has a break-even level of 85 USD a barrel) . Saudi Arabia has a strong financial position which will permit her to withstand for long years of low prices (thus allowing her to drive out competitors such as U.S. oil shale producers) but the other oil producing states do not have that luxury; if the low prices persist for some time, they will reach a limit and production cut will follow thus driving up the price of oil.

The energy stocks got hurt from this process and we can find many beaten stocks in the industry. This also leads us to believe that one should feel bullish as far as the pessimism is concerned. The depressed energy sector forces us to think that there are some value stocks present there but currently the investors look to the short-term. With no replacement of the fossil fuel in the near future, the long term outlook of the sector is still bright. The most important factor which affects the oil price is the growth in the world's economy and the current slow growth is affecting adversely the price of the oil. But a surge in the demand for oil from countries such as China and India will create a shortage in the supply of oil and the price will go up. And the current selloff witnessed in the energy sector is currently telling us that the worst being left behind; soon, a rebound will start but it will be a slow one. Nevertheless, the price of oil should fluctuate in an upward trend, reaching the target price of 180 USD a barrel in the long run.

THE JANISSARY'S SWORD: A METHOD TO THE STOCK TRADER

If there is a myriad of strategies that can be used for trading in the stock markets, there's only one good trading strategy...

It does not consist of trying to run after the small details of the galaxy of financial securities and/or markets for such a broad approach requires a lot of time and consequently carries with it frustration as well as unforeseen losses. What is required instead is specialization, especially if one does not trade full time. Expertise in a defined field is not required; the trader has to be excellent at something instead of smattering in everything regarding the financial market. This could be a certain industry or sector; but it could also be a specific or defined strategy...

In Turkey, many successful investors (or amateur traders) have followed the strategy of following one stock and made fortunes. This strategy is also used by the traders in major investment banks across the world and they are expert in a specific field such as currencies, stock, bonds or repurchase agreements without excluding futures, options and commodities.

But this approach borrows a lot from the trend following approach. The strategy requires holding a stock for a few weeks or months and being sufficiently expert enough in that particular stock in order to set a take profit level which indicates when to sell, i.e. when a major change in the trend occurs in the market. Essentially one buys until the trend reverses and then one switches the process.

When I traded in the ISE (Istanbul Stock Exchange), I was jumping on every stock but generally my position went to nowhere other then meeting barely the inflation rate. It wasn't until I specialized in a half a dozen large stocks that I started to make substantial amount of money. I was betting on the seasonal effects and using technical analysis to adjust my timing. I did not accumulate additional positions in any given stock but tried to buy it at a reasonable level, a level that was sure enough to avoid heading south.

It takes time to develop an expertise but once it is developed, one has an edge over the herd. The important thing is to set a take profit level where the position will be closed and to stick to it. Once the take profit level is reached, the position is closed.

When you concentrate on a defined industry, it allows you to control the market just once a day in order to check the prices. If there is no signal that triggers a buy or sell order, you control it the next day and so on. Focusing only in a certain industry permits you to avoid major decision mistakes and grow your capital rapidly. But the prerequisite for the success of this strategy is to  have a capital that you can afford to lose; it has it's financial as well as it's psychological reasons: if the money will be needed for something else, the trader will be afraid and thus will be unable to make the right decision.

MONEY AND DEBT: THE CORNERING OF THE EMERGING COUNTRIES

If we were to look to this previous week in general, we would see that the emerging countries’ currencies have gained in value, the interest rates dropped and the stock markets rebounded. If the financial markets had been able to price everything, they could have said that the worse things are in the past now. But let’s leave these things aside and have a look on what’s going on in the World. If we were to look into the countries with whom there’s cooperation, we can see that uncertainty and fragility are on the rise thus the situation is getting worse. Either what is seen regarding the exterior is wrong or the emerging markets’ financial places are pricing some kind of a dream. Things don’t hold together; they do not confirm each other. As everybody says, the deflationary pressures in Europe are mounting.

What does deflation mean? The general price stability refers to the icon that everything goes well. It also means that trends are sustainable, there’s no serious problem or any kind of fragility thus there’s a price stability. But there are two types of major deviations in the price stability. First, there is the rise in the prices which we call inflation; once this begins, it creates serious problems and must be dealt with before getting worse. The other deviation that destabilizes the price is the situation where prices start to fall instead of rising. The environment where the prices start to fall can be said to be deflationary. So what happens in a deflationary environment? The demands weakens, the economy stagnates and moves towards a crisis, unemployment increases, the volume of non-performing loans climbs geometrically, thus the economy enters into an unsolvable crisis. You cannot solve the deflation through the fine tuning of the monetary policy by manipulating the markets. The situation of the emerging markets is as follows: deflation is a serious danger which requires a surgery and by taking a pain killer, you are deceiving yourself. We are taking this pain killer, the dose is getting a bit larger and thus we dive into a world of fantasy and we hope that we can keep our people calm. In the emerging countries, you can keep your people calm but you cannot calm down the foreign investors who came here. You can provide them with the opportunity to get out of the markets without loss or even with a profit but you will hurt your people and this will come to the surface with time.

Favourable indicators help the foreign investor to get out of the markets. Why are the markets so optimistic in their pricing? If they were to price the reality, the balance sheets would deteriorate, the exit would accelerate and thus they would lose the control. In order to delay this, they find the solution in clutching at straws, in the intake of drugs. But this will not provide the desired result. On the contrary, it will cause the unfavourable situation to endure more in the medium term, thus increasing the damage. During the 2008 global crisis, everyone was watching the USA. The investment banking was about to end. First, everybody talked about Bear Stearns, then Merill Lynch and Lehman Brothers; Lehman Brothers went down and Merill Lynch was rescued while the panic increased. Why? They had inflated severely the asset values. The role of the optimistic pricing of the market was important and following the crisis, everyone curses the capital markets as well as the investment bankers; they said “They are the ones who created this problem”. And now, the emerging markets’ finance people are doing the same thing. People should should not trust them; this optimistic pricing gives to the person who is carrying the risk the following message: “calm down, hold on onto what you have”. And to the one who has some money, they say “do you want to earn some money? Come!” Thus they encourage them to take risks. Its equivalent to the encouraging prostitution. The system currently looks for people that it can push in order to save itself.

IMF report does not expect a significant recovery in the world. The financial markets of the emerging countries read it but are not able to price it. If they were to price it, the following would happen. First; you are a country that has a saving gap. First of all, the interest rates have to increase and one has to accept the rise in the exchange rate too. Asset values, securities and real estate will decline because the credit volume will be rapidly shrinking; then it will become apparent that things don’t look like they should seem to be, everyone will flee from risk and suddenly the system will begin to collapse. They cannot find any other option than to cling to a lie in order to delay it. Does this lie find any support from abroad? Some parties seem to have some projects with the south-east of Turkey and are trying to delay the collapse until they reach their goal. In other words, not only the future of Turkey is put under a lien, but also a political support is provided to the losses related to the country’s territorial integrity.

The ECB is in a desperate situation. The central banks do not have the problem-solving ability; they just buy some time to the politicians. They provide painkillers; other than that, they do not have any other feature. They act like anesthesiologists. Currently, everybody hopes that the central banks will undertake quantitative easing in order that the pain will not be felt and people will go on sedated as usual. Even in the IMF’s report, it is mentioned how vital is the quantitative easing that Europe and Japan are going to make. There is a need for more painkillers because the pain is increasing. Draghi wants to provide plenty of money but there is the brake of Germany. The repo auction has received 81 billion of demands, roughly a quarter of what was expected; the purchases of bonds, especially covered bonds are not good at all with being 1.7 billion in the first week. Draghi is forcing to give the message of “we will provide you with money, stay calm, do not give up hope” but the problem is the following. Europe’s expertise area is the industrial production. They failed to create a new area of expertise. Europe is ageing and its load has increased a lot. Its service sector reached very abnormal levels; it moved to the post-industrial society but basically it has lost its competitiveness on the elements. The central banks’ policies will not bring a solution to the loss of competitiveness. The coming of the favourable days in the European market is not expected any time soon. But some parties are trying to take some advantage of Europe’s helplessness by saying “I will take advantage of this, I’ll take some painkillers and try to appease my people”. It is due to this that there are abnormal prices in the market.

As far as the USA is concerned; the chairman of the Fed had a statement. It will soon undertake non-conventional policies because the conventional policies do not work any more. We're talking about the traditional fiscal and monetary policies. This situation makes it difficult to see the results of the US moves. First; it has direct consequences in the USA. Second; it also has consequences in the world.  The results upon the world have a boomerang effect upon the USA. One is confused about the second impact for they do not know and the uncertainty is very high. When looking at the Fed officials, some of them say that the interest rates shouldn't be raised until the end of 2015, others say until 2018. It is obvious that the Fed is trying to look cute to the markets; it may be lobbying or it has something else in mind. The markets do not want to hear about the rise on the interest rates. Because they have inflated so much the asset values (and the biggest problem lays in the bonds), if the interest rates were to start to rise, the system currently in place in the world will collapse. Thus they are very uncomfortable with the interpretation of the rise of interest in this regard. US will no longer be making monetary expansion and the dollar will continue strengthening. The world needs something that will counter-balance this. There are attempts trying to handle this by softening the negative situation through the drop in the oil prices and quantitative easing which will be undertaken by the central banks of Europe and Japan. This is done continuously by broadcasting, there is continuous brainwashing activities. Are these things enough? No, they are not. You only temporarily relieve the pain with drugs, but you will fail to stop the worsening of the problems.

Emerging countries are countries that are overly dependent on outside sources. Monetary expansion in the USA is over. The monetary expansions of Europe and Japan are of no use for the emerging countries for the time being; how will the emerging countries finance their current account deficit? The ratio of short-term debt to the total debt is on the rise. The increase of the interest rates, the risk aversion and the contraction of capital flows is a nightmare for the emerging countries. One doesn't know how the need for external financing will be met and is never spoken; in order to avoid that this comes to the people’s mind and the markets price it, the statements related to the monetary expansion of Europe and Japan  are exaggerated. The financial markets of the emerging countries are trying to give the impression of “we are not afraid” but in reality, they are afraid to death. They don’t know what will happen two months later. In all the emerging economies, with China being a probable exception, there is a big fear. Some things are changing and they will not be the same as it was during the last 10 years. Money will not rain from the sky miraculously when they will get into trouble.  They know this but they don’t know what to do in order to avoid people’s panic. They just say whatever comes to their mind, the exaggerate everything that is optimistic and they ignore all the negative things. This also prevents the efficient use of scarce resources, activates bad pricing and worsens the problems.

The current state of the affairs aggravates the structural problems. IMF states that they should keep their promise regarding these structural problems. What do you want as IMF? Do you want to prevent the aggravation of the structural problems or are you giving free passage to the process that causes the aggravation of the structural problems? Which one do you want? In fact, they want to see people being sedated.

External dependence is growing and the emerging countries are in the debt spiral. First; they said that emerging countries’ economies have serious structural problems. Second; what will happen to the banks if sources do not come from abroad? Would the banks’ situation worsen? Would the cash flow in the economy get damaged? In the future, if credits do not come from abroad to the banks, there will be serious issues due to the structural problems. Why? Because they have become too dependent to outside. They say that there’s no problem; it’s a big lie! The emerging countries want to grow at the rates of minimum 5% or 7% in order to avoid the increase in unemployment. When they try to grow, the current account deficit grows dramatically. This means that the emerging countries’ growth is very problematic.  Then what needs to be done? The emerging countries need to grow but while doing it, they must not have a current account deficit. In order to achieve such a goal, one needs to undertake major structural changes. Major reforms have to be undertaken in all areas but do the global conditions allow this? No.

If there was a problem in only one emerging country, the domestic demand would be reduced through price adjustments, the competitiveness of the exports would be increased, the structural changes that would make this possible could be undertaken if the global conditions were normal. However, if we have the same problem in all emerging countries and they all try to apply the same recipe, none have a chance of success. Because they have to narrow the domestic market and return to the exports and all will be doing the same. The stated structural reforms will not work in the present circumstances and shall ensure the sedation of the masses. And when the structural reforms are undertaken, the bill will be paid by the masses. When the purchasing power of the large segment of the population decrease and its debt is growing, the domestic market is being slaughtered. And without the domestic market, one cannot do anything in the foreign markets.

Then where does come the definition and the proposal of these structural reforms? The definition of the structural reforms has been spoken in the latest IMF summit. One needs to give some confidence in order to have the foreign capital coming into the emerging country. And in order to provide such a confidence, every requested thing is done. And the bill regarding the demands of the foreign capital is put before the masses. Meanwhile there is a conflict of interest that is growing and one cannot correct the economic structure by deteriorating the public’s situation. The places will turn into a quagmire, the pool in its bottom will grow and will never get filled; no one will invest in such a place nor live in it…

Since 1980, there is a need for a new world order. What did the USA want? She wanted to be the sole superpower and to define this new world order according to her interests. After the Russian crisis of 1998, the situation changed. There is no consensus about the new world order because the USA is no longer the only superpower. The world is becoming multipolar and it is not possible for everyone to protect its own interest. Some of them will be sacrificed; Russia and China are not coming to terms. China has become a great centre of attraction and this has become apparent in the APEC summit. USA is not a country that can content itself with remains and the tension is escalating. Even if they come into terms among themselves, the bill will be put before the emerging countries. Emerging countries do not have friends, they have to take their power from their own people but instead they are putting the bill before their people while money comes from abroad.

To save the day by finding debt from abroad is a recipe for running to a disaster. One has to avoid this incorrect understanding. First, one has to prevent the growth of the lien placed upon the future of the people. If this situation requires a serious economic recession, it also needs to be prepared for digest. But if one does not give up the gains, it will mean doing what the foreigners want and the problems will be exacerbated. This is what the governments, bankers and the markets say. The people of these emerging countries pay the taxes and the government should not jeopardize their future. But if the control is given to the foreign capital, everything will go in reverse…

GOLD: THE OUTLOOK FOR THE MINING COMPANIES.

GOLD: 

THE OUTLOOK FOR THE MINING COMPANIES.

The gold had dropped significantly to its four-year low on 05112014; it caused a fear among the producers for they have lost their room for action due to the long but painful drop in precious metal prices. The latest drop in gold has augmented the fears that it could drop further to 1.000 USD, a price which is below the break-even point of many gold producers around the world.

This severe drop in gold prices came as the major gold mining companies had started to report grim results for the third quarter, presaging worse results for the last quarter. These results came despite the efforts from the same companies to reduce their costs.

The investors who lost money in this process are facing a tougher picture: the gold price may drop to 1.000 USD. And this probability scared the investors and consequently, they sold the whole industry.

When the gold dropped significantly, the major producers undertook to reduce their costs, augment their production efficiency and put into shape their financial statements. But as the gold prices are in a severe downtrend, the investor has the fear that there isn't much room left for additional cost cutting without reducing the production itself.

The severe drops seen in the share prices of major gold producers is a sign that the investor is leaving the gold and acquiring interest-bearing assets, despite the fact that some of these companies had posted good results that had beaten analysts' expectations.

The main cost cutting program for the major gold producers can be summed up as: reducing expenses, recording write-downs, stopping the work in some projects and selling some of their deposits. Such moves should bring the cost of producing 1 ounce of gold to less than 1.000 USD; even some of these major companies could force 900 USD.

Once the price reaches the bottom (if it ever happens), a limited rebound should take place where the gold price would reach 1.150-1.200 figure after which the price should stabilize for while in a narrow band of 1.250 - 1.400 USD; the gold mining stocks should follow suite. In the short run, the EUR/USD which trades at around 1.2500 may drift lower to below the 1.2000 figure thus forcing the gold to drop further towards 1.000 USD due to the inverse relationship between the two. But this should not last long and we should see a rebound towards 1.3000 or more which should have a positive impact upon the price of the gold.

When gold is rising, mining companies deliver to investors superior operating  leverage for their profits rise quickly. When they add an extra leverage such as debt, the mining stocks offer very good returns when the gold rises.  But when gold trades between 1.100 - 1.200 USD, the mining companies stop growth spending, continue cost reductions and dividends cuts. Once the gold drops below 1.100 USD per ounce, the equity value starts to diminish significantly.

When the gold mining company carries a lot of debt, it makes it less appealing if gold prices are stagnant or falling. But gold mining companies that have a better debt profile are generating more demand. And the lower the debt level, the better it is in terms of low cost production. Thus such a company is best positioned to withstand a gold price downturn.

Currently, the average cost of producing 1 ounce of gold is about 1.150 USD and the producers made plans in which they forecast 1.300 USD. Most of the producers have a production cost that is around or slightly above this figure and a prolonged lower figures in the gold price will force many gold producers to leave the industry (the bloodbath) and subsequently form the basis of a rise in the gold price due to the imbalance between supply and demand and of course, trigger another bull market for the gold mining stocks. But this will take some time and is tightly linked to the course of the USD in the future as well as the level of the interest rates and inflation. The demand for gold should be stable for some time but a pick-up is likely as early as 2016. In a strong rally occurring in such an environment, one may see the gold price hitting the 2.000 USD figure...

WORLD STOCK EXCHANGES: THE "GREAT CORRECTION" HAS STARTED

WORLD STOCK EXCHANGES: THE "GREAT CORRECTION" HAS STARTED

How long will last the panic attack? After Lehman, is the giant bull market over? The bull market in world stock markets did not finish yet, but a large correction lasting in October is quite possible. As far as the terminology is concerned, when the stock market loses more than 20% from its peak, it indicates that it's a bear market whereas a 10-20% loss of value is a "correction".

On Friday, the leading world stock markets continued with their bloodbath. S&P 500 and MSCI World Stock Index had lost value this week by 3.1% and 2.7%, respectively.  World stock markets saw a fortune of $ 3.5 trillion melt. According to data from research firm EPFR, all the investors fled from riskier assets to the Money Market Funds by placing $ 47 billion. The VIX index which is considered a risk indicator for the world stock markets, jumped by 13% on Friday to attain 21.24 by not only reaching the summit of the year but also went above of the long-term average of 20.

The wave of selling was initiated by the dark prognostics of the IMF. The Fund revised down its growth forecast for 2014 and 2015, while the Eurozone (EB) recession and inflation risk were found to be 40%. The President Lagarde has deepened the fears by anticipating lower growth in the coming years. The decline in the oil prices, China's gradual slowdown and the confusion in respect to the steps to be taken by the Fed and the ECB on the matter of the monetary policies have contributed to the wave of selling.

Let's start from the Fed. FOMC minutes and Labour Market Demand Index, published twice a month came low and most probably in the meeting which will take place in the end of this month, the sentence of "low interest rates for a long time," will remain in the text for a long time. But there isn't much support to the FOMC's view regarding the strong dollar and the slowdown in the world economy will force the economy to stop. On the contrary, the declining loan rates and accelerating employment could quite possibly permit the economy to grow by 3% or be stabilized in a faster pace. On the other hand, it is also possible that a strong dollar would cause a collapse in the commodity markets by combining with inflationary pressures. The investors do not know how the Fed will behave in the midst of opposing winds, the contradictory statements coming from the governor raises uncertainty.

As fas as the ECB is concerned, Draghi is fearing as much as does IMF about the scourge of recession-deflation. The President wants to start an excellent QE by buying asset backed securities together with government securities but Berlin is opposed to this. The concerns regarding ECB doesn't have enough ammunition against the deepening of the recession have brought heavy losses in the stock markets of the Eurozone this week.

Now let's look to the future. In the past, this kind panic attacks were very short-lived because of the perception that central banks will engage rapidly would cause purchases first in the F/X market and the credit market, then in the stock market. This time, there is the perception that the Fed and the ECB will not rush to the aid, even if they rush, printing money will no longer support the economies which in turn suggest that the sales will continue for some time.

The world economy is not as bad as IMF described; on monthly basis,  the JP Morgan Global and HSBC Emerging Markets (GOI) PMI which measure the strength of the economic activity, have reported that during summer the activity remained flat at a moderate pace. The Chinese government repeated that it would take selective budget measures against the economic slowdown on Thursday. It is also possible that the Bank of Japan may soon undertake an additional monetary expansion.

On the negative side, other than the United States, there aren't any nice stories that could attract investors to take risks. All over the world, corporate profits have slowed down; the geopolitical risks in many developing countries and internal political conflicts are disturbing. Finally, the increase in volatility and the IMF's warning about the bubble forming in the private sector bond market have led to the loss of appetite in the leveraged positions.

In order to have the elimination of the pessimism, in the meeting to be held before the end of the month the Fed must take steps to eliminate uncertainty in its monetary policy, then one would need to see the recovery in the data from the world economy or certain main countries. In the end, the P/E ratios other than S&P 500 are quite low; if the sales prevail, the long-term fund looking for bargain issues will start to buy. It is quite possible that this correction will continue until the MSCI World Stock Index drops 5% more. The losses in risky markets such as Turkey can be a little bit more.

THE OUTLOOK OF THE WORLD ECONOMY

THE OUTLOOK OF THE WORLD ECONOMY

We observe that there is an overall adverse weather. During the last months, the increasing geopolitical risks have definitely an effect on it. The world economy may enter into a long-term slow growth period and one can predict the new normal growth as to be an inadequate one. If people expect that the future growth potential is going to be slow, then they will reduce today on investment and consumption. This situation may seriously impede the developed countries that are struggling with high unemployment and low inflation.

U.S. and European economies:

U.S. economy seems to be the most favorable in the global economy and has been the driving force of the global economic recovery. The evidence of this can be found in the incoming data. In the U.S. employment date announced on October 3, the unemployment rate has hit the lowest level in the last six years with 5.9%. Also, by growing 4.6% in the 2^nd quarter, the U.S. economy has reached the highest growth rate since 2006. Things seems to go well in the U.S. but because this positive trend will accelerate the Federal Reserve’s (Fed) move to raise the interest rates, this poses a vital risk especially for the emerging economies.

In contrast to the U.S.A., things are not good in the European economy. The 0% growth in September has confirmed it. Germany continued to grow, albeit small, while France and Italy’s economies shrank. It is also clear that the Ukraine crisis which affected the relations with Russia has a share in the economic downturn. European Central Bank President Draghi prepares to push the button of the program for an expansion similar to that of the USA (ABS) but it is important to note that it carries dangers for its sustainability and long-term risks.

Asian economies:

China's economy is showing signs of a slowdown on all fronts. While the economy is expected to grow around 7.4% in 2014, growth is expected to be around 7% in 2015. All figures below the level of 7% growth for China and the world economy means red alert. The growth in China is realized through export and savings. In order to compensate for that, China wants to stimulate the domestic demand, in other words, she wants to direct the citizens to consumption. The other main actor of the Asian economies, Japan, has shrank by 7.1% on annual basis by realizing the toughest shrink since 2009 by shrinking in the 2^nd quarter of the year. Although a growth of 4% is anticipated in the 3^rd quarter, the general economic outlook is not good.

Emerging markets:

The emerging countries which provided some breadth to the markets during the economic slowness period, may experience serious problems when the U.S. economy’s recovery becomes apparent. With the end of the quantitative easing and the increase in the interest rates, the experiencing of fluctuations in the capital inflow towards the emerging economies will be inevitable.

The countries called the Fragile Quintet and which is composed of Brazil, India, Indonesia, Turkey and South Africa who have a current account deficit, high inflation and a slowing growth are regarded as certain to lose speed in this process. According to the latest analysis of Financial Times, India was able to reduce its current account deficit by reducing its import of gold and by raising its interest rates. Indonesia also showed significant improvement in this direction.

But Brazil, Turkey and South Africa were not able to reduce the current account deficit despite raising the interest rates and falling growth rates. While in the Medium Term Plan, Turkey’s current account deficit which was projected to be 6.1% in 2014 will decline to 5.7% by the end of the year and the expectation for 2015 and 2016 have been reduced to 5.4%. If the growth performance is realized as 5% as claimed, this current account deficit may be a little more sustainable but if the growth of 2015 and 2016 is in the band of 2-4% but the current account deficit will continue to pose big risks.

In brief, the dangerous dependence on foreign sources continues at full speed. Also the Fragile Quintet and other developing countries’ currencies suffered a significant loss of value since September. Countries with strong export capacity can benefit from this situation, but due to Turkey's geopolitical position as well as its export quality, it cannot be said of her to be advantageous here. In this process, the investors who are financing the short-term financial needs of these countries may be expected to move to other countries such as the Philippines, Malaysia and South Korea when difficulties arise. 

THE COMING CRISIS AND THE FINANCIAL INSTITUTIONS

The minutes of the Fed has been issued. How should we look at them? When we go back to the 90s, we can see that the minutes of the Fed are not issued quite often. So, what happened and why are these minutes issued following the global financial crisis? As the transparency decreases and the problems get worse, some persons have started to issue different minutes. What is the purpose of it? The situation is critical; the interventions need to be diversified, the verbal intervention alternatives need to be enriched, one must also see it in this context. Something is happening and the markets are going to exaggerate them. Consequently, the expectations are being managed. But what are the most worthwhile things present in the minutes?

There is no mention of a modification in the calendar of the monetary expansion reduction. Instead, they are complaining about the market’s optimism and are very disturbed. They are trying to say that we did not learn our lesson. Obviously they imply that the message has not been delivered clearly, that the expected behaviors did not materialize, there’s an abnormal effort to deliver optimism due to the low volatility and this makes it difficult for the monetary authority to perform its duties. In the resulting summary, the central banks are as optimistic as the markets are. We should determine what is optimistic; you could say that we are pessimistic if we are outside the normal. If you draw an optimistic picture which is outside the normal, it is called optimistic. And this has its categories. But what you call the reality, must be accepted as the normal. Currently, the world has lost so much its direction that they the normal as pessimistic, they accept as normal a certain dose of optimism; what they call currently the optimism is to live in a world of dreams. One should define the Fed’s minutes in this context.

The markets are so plunged to live in a dream that they are unable to escape from it. Some institutions are trying to wake them up but they insist in not waking up. Normally there various activities in the economy and one can also have casinos in the economy. But not a single state would not want its citizens to gamble carelessly because it will reduce its future income and thus create social problems. But today, due to the needs, the world has become the greatest casino in history and the central banks are at the point of being a part of it. The central banks are trying to escape from it and issuing some messages but the markets are not listening to them. As fa as the expectations are concerned, the verbal intervention is important but they cannot collide nor can they find the right solution. Those who are in the top decision-making status are aware of everything but are very helpless in the events before them. Other speakers in the lower echelon are not in the position of making a decision; their mission is to believe in what is said and to market it. And there is a question mark on how much they are aware of this despair. And they insist in continuing to gamble…

The one subject that has been persisted upon very often is the wish for the data to come out very poor from the West. That is, in order to have the interest rates to remain low for a long time and to have high liquidity, one has hoped that the figures coming from the developed countries would always be poor. This way, the money would continue to come and thus permitting this Ponzi scheme to continue. Despite the occasional poor data coming in, the attitude of the United States is clear: she doesn't to see the bubble to get bigger and, consequently, doesn't want the damage to be greater in the future. Currently they are not at the point of thinking about the functionality of the global functioning of the world. They are obliged to think for themselves first in which case, the emerging countries come after. The emerging countries are forced to fend for themselves. But to lure them into this position will leave helpless the foreign funds that are coming into these countries, their governments and their banking systems. But this is not just a problem of the emerging countries; this is a global problem. A loss of performance in the emerging countries can shake the world financial system, and this in turn will affect adversely everyone, developed countries included. The preservation of today’s standards in the emerging countries may not be possible in the developed countries too. 

The emerging countries were expecting that the monetary expansion would not be curtailed, the balance sheet downsizing would be constantly postponed, and the period of the rise in the interest rates would be set further in time and would not function as an impairing factor upon the short-term expectations. The only thing that they wanted to see here was that the economic data of the United States would not show any sign of recovery or would remain well below the expectations and thus the Fed would not undertake the aforementioned things and thus the money would continue to flow into their economy and the corruption and saving the day would carry on for some time. This wish stems from the fear of going under in case the developed countries were to stop the monetary expansion. Of course, there is a group that has taken excessive risks; the rulers of the country, large groups, in short the system who have constituted this economic equilibrium based upon excessive risk-taking is very desperate.

We all have seen what the ECB has done; it undertook repo auctions and monetary expansion, and provided huge liquidity in order to avoid the further deterioration of the banking system. Compared to the previous year, we can see that the government bonds of Italy and Spain that fell to the status of junk bond have seen a process of appreciation unseen in history; even Portugal and Greece have profited from this. If these banks (Spain and Portugal) are unable to pay the bonds despite this favorable environment, then the situation is very critical. And if these bonds were in the valuation of the previous year, what would have happened? In this case, the EU joint banking regulations would have created a bid, serious and very costly distrust. For instance, if the banks in Spain and Portugal were to face such a situation, then larger sums of money would be lost in Eastern Europe, mainly in Hungary. This would put the Western banking system into a more difficult position due to the chain reaction. The situation is much worse the current one and its costs is substantial. Would Germany want to assume this cost? Would it be possible to preserve the EU? When wants to scratch the surface of the affair, the story starts to take different directions.

How will this affect the emerging countries? If there is a tendency of a reduction in the risk-taking towards the emerging countries, the possible consequences of such an action would be the rise in the exchange rate and the interest rates, the depreciation of the assets and the beginning of the wearing of the balance sheets. This is a state of uncertainty and it feeds automatically the risk aversion. In this case, everyone will exhibit conditioned reflexes and the price volatility in the market will increase. Since the beginning of this year, there is a decrease in the capital inflow to emerging countries and this feeds the risk aversion. We shall start to see this in the coming fall…

THE BOND COMPONENT IN A PORTFOLIO: THE IMPORTANCE TO HAVE A RESERVE AND HOW TO USE IT

THE BOND COMPONENT IN A PORTFOLIO: THE IMPORTANCE TO HAVE A RESERVE AND HOW TO USE IT

Every portfolio has a bond component which permits to balance the risk involved in any investment. Depending on the size of the portfolio and the risk level of the investor, the bond component may vary from 0% for very aggressive investors to 50% for very conservative investors. This may also vary according to the market expectations where one will be hold less bonds when the market level is low and more bonds when it is high.

But what is of interest is how to use this bond component effectively if we want to boost our portfolio's return. The starting point of this is to see the bond component of the portfolio as a reserve which could be committed at any time to buy stocks when the conditions are favorable or are dictating such a move.

A reserve in a portfolio is the bond component which is not initially committed to the investment in a stock or a group of stocks by the portfolio manager. Thus it is available to address unexpected situations or exploit the investment opportunities that develop suddenly. The portfolio manager can hold it back in order to deal with an adverse situation or to commit it in an investment operation when such an opportunity arises.

It is often better to have some uncommitted liquid money or almost liquid asset (bond) to deal with adverse situations or favorable opportunities. It is sometimes very difficult to liquidate a position in order to meet an unexpected situation whether favorable or unfavorable. This can cause a disrupt in the portfolio's structure which in turn may affect adversely its return. By using this uncommitted reserve, the portfolio manager could preserve the current investment positions and quickly move to stabilize a weak exposure or to exploit a favorable investment opportunity.

The portfolio manager's decision as to when, where and how to employ the reserve is extremely important. Usually the portfolio manager should use a portion of the reserve at the given moment and time since it will be sufficient to fulfill the objective. But committing the reserve in its entirety at once can only be considered in extreme cases. In the event that the portfolio manager wants to exploit an investment opportunity by committing the reserve, a portion of it should be held back in order to exploit unforeseen events. In case that the reserve is substantial, it can be used all together to deal with new strategic situations or investing in a suddenly depressed blue chip.

Here is an example:

In the first quarter of 2009, the ISE had dropped to 20000 from its peak of 60000 (November 2007) and the consulting company I was working for saw the stock component of its investment portfolio drop more than the market itself. But the bond portfolio was unharmed and represented, at the time, 75% of the portfolio. As the market had hit rock bottom, I proposed to the management the following investment plan:

In the first phase, the stock component would be restructured by selling all the stocks except two of them. Then the proceed would be kept in the repo until an opportunity arises.

In the second phase, with the upcoming of the opportunity, the money stationed in the repo and the bond component would be merged to form a general reserve which would be used to invest in stocks.

In the third phase,  the general reserve would be invested in 10 stocks in total but TL equal weighted once the risk level of the market becomes meaningless.

The opportunity came on 23032009 and the portfolio was invested altogether into 10 stocks and the former 2 stocks that were present in the portfolio were first sold and the proceed was passed to the general reserve. The overall performance of the portfolio until November 2010 was 280% whereas the stock market's return was 200% (when the investment had been undertaken, the market stood at 23000 and when the portfolio was sold, it stood at 70000)...

THE NEXT STOCK MARKET CRASH

THE NEXT STOCK MARKET CRASH

The U.S. had printed too much money during the 2008-2009 financial crisis and while the property market was going through a major crisis due to the sub-prime mortgage scheme, the financial institutions' crisis forced the Fed to bail out a number of them. Then, the Fed has tried to encourage investment and spending by lowering the interest rates by force (historically low short-term policy rates, repeated reassurances that interest rates are going to stay low for some time and quantitative easing). The bubble that emerged ever since in the stock market has been characterized by the investment into the blue chip stocks that could be bought and held forever with confidence. The mutual funds have been presented as the safest and the fastest way to get rich for the common man. As the bubble expands, investment managers use aggressive investment techniques in order to generate huge increases in the value of their mutual funds shares. As mutual-fund asset values goes up, new money pours in. Thus, we have a self-reinforcing process which gives the false illusion of a money-making machine for everyone. But as the value of the assets has reached its intrinsic value, the thin spread between price and value forces the investment managers to take on more and more risks in order to generate adequate returns.

We can say that the next financial crisis will be due to the mutual funds as the decline in prices will inevitably be followed by a drop in the value of their assets. This will be triggered by the expectation that the Fed is about to end its quantitative easing program later this year (expected in October) which in turn should result in a rise in bond yields. Institutional investors  are in search of avoiding risk and will start soon to switch from the overvalued equities to the bonds which seem to be overvalued. The current bet in the market is on the extended period of low yields and are willing to invest for longer terms i.e. 30 years but these long term bonds do not offer adequate protection against any future rise in the interest rates.

Consequently, as the investors will get worried by this decline, they will start to cash in their mutual fund shares which in turn will force the investment managers to sell more assets thus starting a downward spiral. This may result in a severe drop in the stock market (say between 30% - 50% range) within a period of two years. But the blow will hit harder the stock markets of the emerging countries where drops in the 70% - 80% area would not be uncommon.

When the market will hit the bottom, a new area will open and we will see the rebirth of the value investment. Following the bottom out of all the main stock indexes, in all cases the recovery may be a slow process. Although some of these markets will recover faster than the others by returning to the original level within a couple of years, in real terms, this will take longer than expected with the inevitable surge in the inflation coupled with the rise of the interest rates. 

THE COMPLACENCY SYNDROME IN THE CAPITAL MARKETS

The brokerage firms such as Merrill Lynch have conducted a survey among the global fund managers and all have reached a common conclusion: the investors are afraid the most about "Geo-political" crises. The Geo-political crises are namely the shooting down of the Malaysian passenger aircraft over the Ukraine, Israel's actions in Gaza which could create reactions in the Muslim world. While all these have been realized, the spot market has reacted weakly to them. In the derivative markets which provide an insurance against such risks, a complete insensitivity is raging. This insensitivity is called complacency syndrome and the actual mental state  has become the threat number one to the capital markets. Complacency is a windfall for the states such as Turkey which are following nonsense economic policies. Bubbles will soon begin to take shape in the world capital markets. Then what could end this complacency and when will it occur?


 The world is crawling. ISID's victories in Iraq and Syria are causing thousands of mujaheddin to come to the region and the actions of Israel in Gaza is causing a reaction in the Muslim world with an increasing pace. In such an environment, if a 9/11 type terrorist attacks repeat, one should not be surprised. Also, the ISID which has repulsed the Iraqi army should be expected to undertake an offensive towards Baghdad and Kirkuk in which case, it will create a panic in the Brent oil market.

According to the Western states,  the Malaysian passenger aircraft was shot down by the East Ukrainian separatists with the missiles and tactics provided by Russia. Accordingly, we may see the announcements of new sanctions against Russia which will target the energy and financial sectors. Putin will not stand empty-handed; the world is drifting towards a new Cold War.

But the reaction given by the financial markets to the shocks that could potentially change the history of the world is very weak and transient. When the crises abrupt, the markets sell a day or two, and then continue their journey to the peaks of 2014. This apathy is understandable in the spot market. Even if the large funds understand the medium-term risks, they cannot explain them to the customers to whom they are making sales without the reflection upon the economic parameters. Because the "Geo-political" issues are raising uncertainty about the future, one would expect the investors to purchase insurance  in the futures and options markets.  Perhaps what is happening in the Middle East and Ukraine did not change my expectations of a positive return on shares  but I can say that the uncertainty as to my expected return has increased. I would protect my portfolio by buying puts and by shorting the index futures. Furthermore, the premium to be paid for such insurances is historically low. But the investment funds are not tempted by these insurances, and if they did, we would have seen jumps in the volatility indices, mainly in VIX.

That's what we call behaving as if there were no imminent and obvious risks. There are several reasons for such complacency. First, there is the common perception that the Fed and ECB will preserve the the financial system in case of an occurrence of adverse shocks. Second, financial asset prices other than "junk bonds" are not very expensive.Third, the world economy has an accelerating momentum and the investors think that the Geo-political crises will not suffice to curb this momentum.

It is very easy to predict the consequences of complacency. For a few weeks, the S&P 500 and other global stock exchanges will test new highs with the coming of strong sales and profit figures compared to the past. Then re-acceleration of the world economy will be priced in the marketplace. When October is reached, this complacency will turn into a bubble i.e. speculative pricing in the critical financial markets. In October, with the official start of the Fed's exit from QE and/or the heavily indebted Euro-zone states are such a bad shape that not even ECB will be able to save them is understood, a disturbance will begin. As the prices are too high, panic sales will follow in case of a bad news or a slight shock. 

Of course, the markets will anticipate this, thus the panic sales may start in September but may be delayed until the end of the year. But one thing is for sure: the result of any complacency has always been a bubble and a financial crisis and in the process, we are now very close to point of no return.

ARGENTINA'S FOREIGN DEBT: THE TANGO WITH DEATH

ARGENTINA'S FOREIGN DEBT: THE TANGO WITH DEATH.

We see statement ads appearing in the American newspapers. One days the Argentine Government publishes a statement with the following heading: "A handful of vultures is rendering Argentina insolvent and thus threatens the world economy." The following day, you can see a statement coming from the investors who are accused of being vultures as follows: "We are not vultures. This is our investment and there is a court resolution regarding it. We want to have our rights on it; because the Argentina's Government does not accept us as interlocutors, they are risking the world system."

Then what is the problem? Argentina could not pay the bonds maturing in 2001 and became somehow insolvent. Then in 2005, a debt restructuring agreement was made with the bond holders​​. A further restructuring of the debt had been made in 2010. It was a bond stock worth about 100 billion dollars. And the interest rate was too high. With the first restructuring, an agreement had been reached with 76% of the bond holders in 2005. They took their new bonds and retreated. Then in 2010, the number of investors with whom an agreement had been reached attained 93%. But the remaining investors refused to enter into agreement. These bonds had been accumulated by some vulture funds. Recently, the U.S. Supreme Court announced that the Argentina's Government had to reach an agreement by paying an interest for the period without agreement too as well as for these bond holders. When Argentina saw the bill put before her by the court, she said "that's too much!". And that is precisely when the war of ads begun.

Why did it happen? For a very simple reason. The payments to the bond holders were being done through Mellon Bank of New York in New York. Because the transaction was taking place in the United States, the American courts could come into play quite easily. Because the U.S. dollar was a reserve currency, the American law was valid everywhere.

But another news came forward. The French Finance Minister Michel Sapin gave a statement where he stated in a romantic fashion that the reserve currency characteristic of the U.S. dollar should be brought to an end. The French Minister was quite unhappy about the 9 billion dollar fine given by the American courts towards BNP Parisbas. BNP Parisbas had performed transactions with Soudan and Cuba without respecting the sanction decisions taken by the American Congress. Transactions effectuated against the sanction decisions brought 9 billion dollars fine. BNP Paribas accepted this fine. There was nothing left to Michel Sapin other then complaining. The big French bank blatantly did not respect the American sanction. That was the first mistake. More importantly, the French Government did not determine even on its own the transactions that were contrary to the sanction. And that was the second mistake and it was a severe embarrassment.

The sanction comes out from the American Congress. The American Courts rule for fines to the ones who do not comply to it. And the French bank said "yes" to it. And the only thing that the French Minister can do is to complain about it. As a matter of fact, there is nothing that he can do. Why not? Because the world keeps on working with the U.S. dollar. The world has about 10 trillion U.S. dollar of reserve currency. 60% of it is constituted of U.S. dollars. The remaining is acting like a dwarf: their trading volume do not beyond billions of dollars. China's money is kept in the depositories of the United States. Why is everybody investing in China where there no law? Because its money is kept in the United States. If a problem arises, you open a lawsuit, obtain a freezing of the assets and then make the necessary collection. BNP Paribas is paying its fine. Argentina will try to reach a compromise with the bond holders with whom she did not reach to an agreement. The resolutions of the American courts are going to be applied and Argentina will be forced to comply to them one way or the other...

If successful, all these things could make us think that one should expect a similar development regarding the other populist Latin American countries such as Chile, Venezuela etc. The aim would be nothing more than the destitution of the populist governments and their replacement with liberal governments. Let's see what's going to happen...

ECONOMIC PREDICITIONS UNTIL THE END OF 2014

ECONOMIC PREDICITIONS UNTIL THE END OF 2014

Following the declaration of Bernanke in previous May stating "I think we may exit QE", the emerging markets faced two small crises. Since the middle of March, the risky assets, i.e. stocks, emerging markets' F/X, and the bonds across the world have witnessed a strong rally. What will happen for the remaining of this year? Will the emerging markets face a major crisis or will they continue to see a rally?

The rally may continue until the end of September in the risky markets. In order to have a change in the guidance of the Fed which fuels the risk appetite in the markets, one needs a rise of 3% in the wages which in turn cannot materialize in the short term. The ECB may perform an additional QE during the period of September-October. Thus, we have a substantial liquidity present in the markets.  The world economy has left behind the state of hibernation and the overall recovery has spread. 3Q profits from companies are expected to exhibit good performance. Valuations are expensive, but the "fury" or "bubble" stage is not present for the time being. There is still a large amount of cash present in the global funds. Volatility indices are in the bottom of the latest 5- to 7 years and with the exception of geo-political crises, there are no reasons for its rise for the time being. The momentum is very important in the financial markets: the momentum of the rally of 2Q is expected to continue in 3Q.

What is going to happen in the last quarter of the year?

Risks will increase geometrically as the end of the year nears. In October,  asset purchases of QE of the Fed will stop. Markets will inevitably ask the questions as to the increase in interest rates once again as well as the time of the dose and how long it will last. While market players will be searching for the answers for a while, a profit taking is quite possible. How much inflation will cause the global growth? With  the looming rise in food and oil prices while the output gap is closing around the world, central banks constituting the reserve currencies may be forced to withdraw the previous optimistic discourses. At the end of Q3, the financial assets will see a bubble in their prices and even in a small shock wave will set the stage for a hard sell.

The most fortunate of financial assets:

The Japanese and the emerging markets' shares are among those highly recommended. Both have historically low P / E averages.

What are the most hated assets?

U.S. and Euro-Zone (EU) "neighboring countries" (Greece, Portugal, Italy, Ireland and Spain) government securities premiums are excessive. The very low returns cannot be explained by economic or political developments. These assets are kept afloat with the generosity of the central bank and the carry-trade.

Euro, gold, and oil prices will trade how?

No one will earn any money in 3Q. It is likely that the EUR/USD will decline in the short term. But there are formidable barriers to the rise of the Euro; ECB does not want it. Thus, the EUR/USD will trade in the band of 1.35-1.40 during 3Q. This situation will provide a partial support to the gold and oil. The retreat of the gold till 1.000 USD/ounce has become a sort of a dream now. The gold is expecting the inflation to surface in the United States after which it will make its major move. The biggest support for the gold stems from the fact that the United States' real interest rates will remain very low for years to come. The reasonable goals for the gold in 3Q would be a trading zone of 1.350-1.400 and a year end target of 1.450. The decline in the oil prices is caused by the supply dynamics; for example, the United States has risen to the position of number one producer of oil after Saudi Arabia within two years. The world economy will never reach its previous power which sent the Brent barrel's price to 140 USD. The Brent oil may trade 100-110 USD but one has to consider the geo-political risks. The scary scenarios would be the failure to achieve a peace agreement between Iran and P5+1 and ISID's jihad in Iraq inspires terror and sabotage in the oil-producing centers of the Arab world.

Sales in the emerging markets will begin in October:

The Presidential election in Turkey do not cause a threat but the economic policy that Erdogan is going to apply in this position will look more like a time bomb. Professionals such as Babacan and Simsek will not be present in the new cabinet. The government will undertake a rapid economic growth campaign by forcing the Turkish Central Bank. We shall see a renewal in the rise of the current account deficit and inflation. With the Fed going out from the QE which will ignite the escape of the speculative funds, the Turkish Central Bank will be forced to raise its interest rates again. Turkey's dream will end by the end of this year and the nightmare will begin.

What are the greatest dangers facing the world?

Clear risks are no longer seen on the economic front. Dangers such as the failure to improve the economic growth and the transition to the deflation in the EU are present but they will evolve very slowly and the investors will adjust their positions by anticipation. But the political arena is a brewing pot. The war in Iraq may soon become a battle ground encompassing the whole Middle-East. Does Russia have another objective after the defeat in Ukraine? Will Argentina and Venezuela, which are the problematic countries of Latin America, have a balance of payments crisis which in turn will shake to the ground all the emerging countries? Will the dispute between China and the other regional countries over the continental shelf turn into an armed conflict? And the most important question: will the fundamentalist Islamic terror that took roots again in Afghanistan and Iraq, undertake a new tragedy of 9/11?
 

EQUITY TRADER: THE DECK OF CARDS

Any equity trader could improve its portfolio's growth by considering two decks of cards which have in total only 108 cards. The normal procedure will be to consider 52 cards to represent all the investments done in one single company at a time during the lifetime of the portfolio. For example, if the trader opened a position for a single company by betting the ranch, he will put away one card from the deck of cards. And he will repeat this process for the remaining investments. The red ones will represent the investments which resulted in a loss while the black ones will represent the investments which resulted in a gain.

Once the deck of cards is out cards, the equity trader can not make any more investments at all. Under those rules, he will be forced to think carefully about what he is going to do and thus, in the long run, he will do much better.

One will ask himself why such an approach? Quite often, the traders overemphasize the concept of portfolio diversification while their initial capital is low. Then, they have a tendency to think of placing their limited capital here and there, and then wait for the results while hoping for the best. Instead, they should concentrate upon one company at a time and set to themselves a take-profit level; once reached, they will transfer the grown capital into another company and this will continue until a satisfactory level is reached. Thus, with the use of a deck of cards, this will simplify the matters and put some discipline into the affairs.

This approach is very simple and is very efficient in changing the life of the trader. It will help him quite a lot in beating the market by a wide margin over a long period of time.

THE EQUITY TRADER: FIGHTING THE BATTLES AND NOT THE WAR.

When I operate in the stock market, I prefer to use technical analysis instead of fundamental analysis because I am, basically, a visual person. I always question the validity of the fundamentals as the news pour in regarding a particular stock. As an individual trader, I have to make some decisions as to whether to buy, to sell or to stay by the sidelines. Thus, I do not rely upon the fundamentals as much as others do, especially when they have under their command. a group of analyst who do the research and present the reports. Technical analysis is a tool that permits me to make investment decisions for myself. That does not mean that technical analysis is superior to fundamental analysis; it merely helps me in taking my investment decisions such as going long or short in certain positions or to do nothing at all. Of course, the main focus is the money management aspect of the trading which permits me to be profitable. In my investment decisions, the fundamental analysis represent only 5%-10% in terms of weight whereas the remaining is technical analysis. When there is a big news that is going to come out, I just stay away from it and I avoid trading it. And if I have positions that are going through while the big announcement is made, I have clear cut rules as to what to do which are based upon the importance of the news that is coming out.

Fundamentals are always important in the equity markets but I prefer to use technical analysis. Certainly, every trader is supposed to know very well the markets he will operate and I have preferred to concentrate on equity markets rather than F/X markets, despite I have an eye on it. And I concentrate on two major stock groups: S&P 500 and S&P/TSX Composite. I keep abreast about what they are doing and the interrelations between them. If I were to follow the fundamentals alone, I would not be able to keep up with all of the stocks. As far as the fundamentals are concerned, they are simply to know when the news are going to come out, to know what are going to be the interest decisions which are going to affect all the markets and to look at the technical picture in order to time my entry.

I use a limited number of screens in order to follow the markets. When I did my military service, I was taught to use several screens at the same time in order to have a snapshot about the events, to understand what was going on and then to shape them in my mind in order to arrive to a conclusion which in turn would set the base of my decision. The vast majority of the traders are facing too many screens and the information that is being pumped in is far too much. And this leads to excessive analysis which in turn becomes analysis paralysis. The trader gets confused and starts to mash up keys as he is overloaded with data and becomes an impulsive trader.

Basically, I prefer to use a single laptop with a few pages open and I don't need any fancy recent high tech features which I believe as to be useless. If you are not able to trade on your laptop, then having a dozen screens will definitely not improve your trading.

In terms of great trading profits that can be made in trading great trends, the vast majority of the markets have a well defined trend only 30% of the time and the remaining 70% of the time, the markets spend their time in the range bound environment by moving between the support and resistance levels. If one follows trend following method and the market is in the range bound environment, he will get chopped into pieces. When a market is moving in a very nice and smooth trend, one may take profits too soon. For example, if the trader had a period of losing trades and sees some profit on the table, he immediately takes it and sees afterwards the market going up. Consequently, the traders have to find a simple way to determine that there is trend, then join and stay with that trend in order to acquire the good results.

There are for M's of trading: Markets, Method, Money and Myself.

Markets:
There are several thousands of different instruments that one can trade and which are offered by various brokers across the globe and they are grouped under the following headings: equities, commodities, F/X and bond markets. Within these groups, one has thousands of instruments that can be traded. Thus, it is very important to know in what type of market and instruments you are going to trade based on your risk profile, your lifestyle, your character, your size of trading capital, your goals and outcome. In short, you have to know the right market that you are going to trade. The other thing that the trader has to know is whether the market is in trending or is in band consolidation. The trend markets go up or down in a consistent fashion with very small pullbacks. The other type of market is the range bound where the price is bouncing between the support and the resistance levels. The vast majority of the traders love trading in a trend environment but in the vast majority of the case, it is the range bound consolidation that prevails. One has to know which type of market he faces in order to decide what to do.

Method:
Every investor loves to hear about strategy and they surf the internet for it and talk to other traders/investors on the matter. One can find a lot of these strategies on the internet alone but the reality is that it is far less important than one thinks it is. What is important is when to exit a position. The trader has to know whether his method works better in a trend environment or in a range bound consolidation. Basically. if the trader's method is following the trend but the market is operating between a given support and resistance level, the chances of making money are slim. Alternatively, if the trader is using the range bound strategy and the market starts to trend, the trader has to struggle a lot. Consequently, the trader has to trade the right method in the context of the right market environment.

Money:
It involves money management and risk management. All new traders have to focus on this area first before looking to other areas. The trader should ask himself whether he is well capitalized for the market, for his method and also for his trading goals and outcomes. For instance, to aim to grow 1.000 USD into 1.000.000 USD in three months has very little probability of realization despite the fact that in the markets, everything is possible. So, the trader has to ask himself whether he is capitalized rightly and adequately for the thing he wants to do. Once this is solved, the trader has to work on his risk profile. The risk profile ranges from extremely conservative to extremely risky. This, in turn, will determine how much the trader is going to bet in one individual trade and how he is going to bet it. For this, the trader must never trade without a stop loss and must trade only a fraction of his capital for when he faces a loss, he will be able to come back.

Myself:
Many traders often forget that managing myself is the fundamental key to the managing of the remaining 3 Ms. When talking about the Myself segment of the trading, I mean the physical health and to be in a good position to handle the stress. It also means understanding the emotional health. When engaged into a trading, one faces risking his financial capital as well as his emotional capital, especially in day trading activities. If the trader is trading in order to pay down debt or meet its monthly expenses, he is already in a bad position. There is also the mental health where the trader looks at himself, how he sees himself as a trader, what kind of an image he has about himself. A negative mental health will impact negatively upon the trades. The trader has also to build a support structure around him for he is also a social human being. When sitting alone at home as a trader is frustrating and the trader has to go out and meet other traders. The trader should share his trading adventures with other traders and this will help him to manage better himself.

Back testing:
Back testing forms an important part of the trading strategy but sometimes people take it too far. I have developed some very good ideas just by looking at the charts, noticing how the market or the stock has moved. Most of the time, I have back-tested the chart configurations manually in order to assess whether the idea is valid enough in order for me to start to test it with real money in the market. What I have discovered was that one gets rapidly to the area of curve fitting. The markets change all the time and I have tried to forward-testing my ideas with real money and that when I started to see really was whether it worked or not based on a sample size of trading. If it works, then I start to consider the size of the betting. It's a part of a process and just by simply basing real money trading upon the back-testing is dangerous.

Growth or Income?
You must determine whether you are a growth trader or an income trader. Unfortunately, most of the traders' accounts are not big enough to generate income and thus they become growth traders. Realistically, they can only be growth traders until their account become substantial at which point they can become income traders. Another option would be to have two separate accounts in which one would serve the income aspect and the other would serve the growth aspect. But the trader must have a clear mind when doing this. The trader should not consider seriously his money on the account but instead should concentrate upon his trading. If he starts to consider his money on the account, then his mind will be blurred and his trading activity will be adversely affected. The money is just the outcome of the trading activity and as the trading are all recorded, a mere study of them will be sufficient to evaluate one's trading approach as a whole.

Trading exit strategy:
After I have done the technical analysis of the stock, I determine the stop loss level in case the position goes wrong thus cutting my losses in order to live another day. But when the stock behaves as expected, I have to devise an exit strategy. If you want to be a successful trader, you have to develop your own analysis style. Part of the routine to get into the game is to analyze the chart, to put the relevant support and resistance levels as well as the trend, to determine the probable course of the stock and to place on paper the possible stop loss levels as well as take profit levels. I set the entry point slightly above the support level and the exit point slightly below the resistance level; whereas I set the stop loss level slightly below the support level of the stock price. As far as the trend based trading is concerned, I use the trailing stop in order to catch the bulk of the movement. Basically I don't listen to the news and I just focus on doing my own analysis, planning my own trade, trading my plan and manage my own risk. This approach makes me a better trader for I am taking responsibility on how the trade fared. If the trade fails, the responsibility is mine and I don't blame anyone on this matter.

What to do when successive trades went wrong?
When I recognize that I am in a losing game, I stop trading. Then I go out for a walk or take some days off. After that, I study my losing trades, organise my thoughts and then proceed again. I review my basic points and keep a good diary of all my trades whether they are losing or winning trades which serve me as a compass for my future trades.  Together, they will constitute the basis of a successful trader. When a trader has a slump, by going back to his notes and the point formulated above, he can recover quickly. For example, if a trader finds out from his notes that 50% of his losses were generated in the trading performed on Mondays and Fridays, then when he stops trading on these days, his results will improve dramatically. The traders always ask themselves whether it is possible to recover from catastrophic trades? I suggest yes because I have seen individuals achieve that. It has to do with context. If you have lost a sizable fund, it will have a catastrophic blow upon your emotional as well as your physical health. The crucial question will be how they respond to that? For some people, it will be too much for them. Other may get into a spiral of revenge trading in order to get that money back but that seldom works and actually they compound their losses. Some others take a few days off in order to assess what happened, what went wrong and then work upon a plan that will permit them to turn around the situation. It may take a year to recover the loss taken in a foolish day; it can be done but it has to be done in a right way. To recognize is a part of the trader's journey.

Trading badly or being unlucky?
As soon as I see someone who is managing badly his risk, not keeping good records, diverting from his method or strategy, not preparing for the trading day, I can surely say that this person is trading badly. It definitely tells me that there something that is going wrong with that person; it could be his life or his health. The best thing to do is to redefine what success means. If I plan my trade and manage my risk, then that trade is a successful trade, regardless of its outcome. Planning the trade and managing the risk are the only ones that I can control. And this provides me to take away the pressure I feel in the trades. By focusing on what I can control,  my performance got better thus having a better confidence on myself, a better belief in what I was doing as a trader. This does not happen overnight; it's a long process with a turning point. Plan your trade, trade your plan and manage your risk; that's all you can do. You may have an excellent chart of a particular stock; you plan your trade and place your bet. Then suddenly, an unexpected news hits the trading floor and your stock heads south and takes you out from your stop loss level. Anything can happen in the market and the best thing to do is to plan the trade and implement it; that's all that a trader can do. Once the bet is placed, the only thing that the trader can do is to watch things happen.