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)...