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Everything is Still Connected
Last week on CNBC Asia, I had an interesting discussion with hedge fund whiz Ken Fisher. We discussed the relationship between the Japanese Yen and the equity markets, and Mr. Fisher said his statistics show an extremely high correlation between the two. This concept was discussed in detail in the August 18 newsletter, titled "Everything Is Connected". Well, everything is still connected, and that "fear trade" – buying the Japanese Yen whenever subprime rears its ugly head – is alive and well. Last week, when it became apparent that Citigroup was the latest casualty in this ever-worsening saga, the Euro – Japanese Yen currency pair (EUR/JPY) promptly took a 200-pip swan dive before recovering (see figure 1).
Figure 1: EUR/JPY dives as Citigroup announces as $20 billion loss. Source: Saxo Bank
Marked To Market vs. Marked To Model
Will we see more of this type of action in the currency markets? You can bet on it. The size of the write-downs projected by big banks and brokerages is liable to grow, since the losses are "marked to model", rather than "marked to market". What does that mean? Well, we all know the stock price of Google, because it trades every day on the Nasdaq. Every day, buyers and sellers agree on an appropriate price for Google, and we accept that price as correct. We say the price of Google is "marked to market", meaning that the market has determined the value of the shares. But what about instruments that don't trade at all, how do we value them? There is no way to mark these trading instruments to market, so they are "marked to model" – meaning that there is a model that is used to determine the worth of the investment. In a way, you could say that the value of this investment is a matter of opinion, because different models would yield various results.
Here's a hypothetical example; let's suppose that a company's model indicates that an investment is now worth 50% of the original price paid. If the company paid $10 billion, the value is now $5 billion, yielding a loss of $5 billion from the original price. The company announces a $5 billion write-down, and the stock tumbles down.
But what if the investment really isn't worth $5 billion? What if it isn't worth anything at all? The company would later be forced to admit that the losses were worse than previously reported, and that they lost $10 billion instead of $5 billion. This is why the subprime issue generates so much fear; because these instruments do not trade on the open market, there is no objective way to estimate the extent of the losses. Nobody knows for certain how bad subprime really is, or how deep it goes.
Merrill Lynch as Fred Astaire
Faced with such a dire situation, firms are scrambling to keep these losses under wraps for as long as possible. Merrill Lynch faces a likely SEC investigation, as they have now been accused of colluding with hedge funds to sweep these losses under the rug. Here's how the alleged deals worked: Merrill would sell the subprime-tainted mortgage instruments to a hedge fund, with the understanding that the hedge fund could sell them back to Merrill in the future – at a guaranteed profit. This would create the impression that Merrill was less exposed to subprime than it really was. These ugly allegations were made by the Wall Street Journal, and when the opening bell rang, Merrill's shares tanked accordingly.
Later during the same session, we saw the U.S. stock markets recover as heavily sold Merrill Lynch shares popped sharply higher, regaining some of the earlier loss. What was the reason behind this move? The company had released a statement, which said in part: "We have no reason to believe that any such inappropriate transactions occurred." Note that Merrill didn't actually deny that any inappropriate transactions occurred; they only stated that they had "no reason to believe" that they occurred. For concocting that crafty statement, Merrill's spokesperson should be given a permanent slot on "Dancing with the Stars".
Trading in Singapore
Singapore is an Asian country with a Western feel; nearly everyone speaks English and the people are extremely friendly. One of the great things about this tiny equatorial republic is that they "get it" when it comes to trading. Singapore offers extremely favorable tax treatment for traders; it is a small but powerful country that understands the benefits of attracting the financial community. What are those benefits? The next time you're in New York City, just ask the real estate agents in the Battery Park area, or the diamond merchants on Jeweler's Row on 47th Street at bonus time, or the restaurateurs in Little Italy and Chinatown. Traders bring high income and wealth to an area, and generate a tremendous amount of high-end business in leisure, entertainment, and luxury items.
This tiny but powerful republic goes all out to attract the best and brightest not only in finance, but in science and technology as well. With the Singapore economy at virtual full employment, defined as an unemployment rate below 2%, companies are having difficulty filling the projected record number of jobs - estimated at 235,000 – that will be created this year. When you consider that jobs figure, please keep in mind that the population of Singapore is estimated at just over 4.5 million. As a result, wages are skyrocketing, with starting salaries for many positions rising 15% above last year's levels as employers scramble to find workers.
The Sing Dollar, as the locals call it, does not float freely; instead it is traded against a basket of currencies of the city-state's major trading partners, within an undisclosed trading band known as the nominal effective exchange rate (NEER). Details of the trading band are kept secret to prevent speculation on the currency. The fear is that the current strong economic growth and resultant higher wages will lead to inflation. To combat inflation, most countries raise interest rates, but the Monetary Authority of Singapore (MAS) takes a different approach. Instead of raising rates, the MAS attempts to control inflation by managing the exchange rate. To defend against inflation, the MAS recently allowed the currency to reach new highs vs. the U.S. Dollar (see figure 2).
Figure 2: The USD falls to new 10-year low vs. the Singapore Dollar. Source: Saxo Bank
There have been numerous stories in the press, both here and in New York, speculating that Jim Rogers, the brilliant commodities trader, will relocate from Manhattan to Singapore as soon as the sale of his Riverside Drive townhouse is complete. Rogers believes that China's currency will triple or quadruple in the next few years, and is greatly decreasing his exposure to the U.S. Dollar, which he feels will fall dramatically. How does one decrease exposure to the greenback? Well, selling your $15 million townhouse and leaving the country is certainly one way to do it.
Singapore boasts one of Asia's wealthiest economies, and this seems likely to continue as third quarter growth clocked in at an astounding 9.4% clip. It was announced last week that the first night race in the history of Formula One Racing would be held here next year, in September of 2008. Last week also saw the first flight of the Airbus A380, courtesy of Singapore Airlines; at seven stories high, it stands as the largest passenger aircraft ever built. Singapore isn't perfect, and its pursuit of order and cleanliness does give this place a slightly antiseptic feel, but it seems that there is always something new and exciting happening here. If you don't mind a bit of humidity, Singapore can be a wonderful place to visit, and a fine place to trade.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through