Thirty Years

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Thirty years ago tomorrow morning on Friday 16th October 1987 I slept in. The alarm clock hadn’t gone off. I was abruptly woken by a ringing telephone. It was my friend Chris, ‘There has been a storm, electricity is down, tubes aren’t running; how are you getting to work?’ ‘Buggered if I know,’ I thought to myself. I’d slept through the biggest storm in 100 years. The storm though, was just beginning. 

I jumped in the car and drove to the City. It was an eerie journey, much quieter than usual, driving around fallen trees around Shepherds Bush and avoiding advertising hoardings and signposts on the roads. I parked in Finsbury Square and jogged down to the office in the Stock Exchange building. Only a few of us made it in. As I remember, the Stock Exchange opened late at around 09:30hrs but there wasn’t much business around and the phones were largely quiet. I only did two bargains during the whole morning. Together, they cost my book £125k by 10:00am on Monday. The market closed early at around midday and we headed off for the weekend. At 1:30pm the monthly US trade figure was announced. It was larger than expected and elevated concerns that the Fed might raise rates after a low interest rate period that saw the Dow rally 44% in just 7 months of that year. That the Americans and Iranians were busy lobbing missiles at each other that week and the next did little to help confidence. Markets began to sell off, spurred by ‘triple witching,’ option expiration in the States and the Dow closed down 4.6% on the day. It was a nervy weekend for market operators.

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The waterfall event on Monday, or Black Monday as it became known, took no prisoners. Everything got hosed. Our telephone dealer boards lit up like Christmas trees from the get-go and however wide we made our prices, we got stuffed with more and more inventory. The cascade selling accelerated with index arbitrage programs flooding the systems with more orders than could be processed creating a frantic and chaotic trading environment with stock exchange systems repeatedly failing and where everyone it seemed, was rushing for the same exit. When these events happen, investors sell what they can sell, not what they should be selling. Often, that means the big liquid blue chips get smacked first because liquidity vaporises in smaller names. The blue chips are of course, the names that have the biggest weighting on the indexes. The Dow finished the day down 22.6%, the FTSE -26%. 

Numb and exhausted, we got in the lift at the end of the day and repaired down to Jonathan's, the bar at the bottom of the Stock Exchange. It was full, but very, very subdued. Brokers and market-makers were hunched over their drinks mulling over the catastrophic events of the day and the impact on their lives. Some had lost fortunes; some their firms. 

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Interesting then that this week saw the 10th anniversary of the 2007 market high. In fact, the market rally from August 2007 to October 2007 is remarkably similar to that which we now see from August this year. I’m not going to write a technical market note, for the moment anyway, but would remind the casual observer that the start of bear markets are characterised by sudden, violent and persistent one way price action that wipe out years of gains in days. The current bull market, which has been underpinned by Central Banks for so long, is way past it’s sell-by date. If you choose to look, there are stacks of experienced market practitioners and commentators warning that this mature market is over-heated. Don’t ever anyone then say, ‘no-one saw it coming.’ We did in ’07 but similarly, no-one was listening then.

Market Quants; Kill or Cure?

This brilliant VPRO documentary on Quants should be required viewing for all involved in markets.

The problem with heckling from the cheap seats is that the rest of the audience can get bored pretty quickly and stop listening. Then you get thrown out. It’s the old ‘cry wolf,’ thing. I kind of feel like that about shouting from my soapbox about quants and all they have spawned in markets from HFT’s, trading Algo’s, to derivative and structured product modelling. I’ve watched their growth from all the way back when index arb models lit the fire that turned into a market conflagration in 1987 to the subprime CDO models that did so much to destabalise the financial system in 08 through to the occasional flash crashes we see today.

The simple fact is that very few managers and certainly no boards have the first clue about what the quant ecosystem that plumbs their banks together is capable of. Nor do they understand the assumptions made in those models or how vulnerable the models are to human error or abuse, either internally or externally. The video clip above is very well worth watching. It is a very straight forward reality check; a reality check from the practitioners themselves; ‘it is clear that a major rethink is desperately required if the world is to avoid a mathematically led meltdown.’

Glencore; Meltdown or Death Spiral?

While the UK markets attention has been dominated by the Rate Debate and Volkswagen, we have a rather serious problem brewing on our own doorstep. Glencore is in meltdown and with its 5 year CDS trading on Friday either side of 600bps it is a wisp away from a death spiral. That’s the point when, ‘get me out I’m not having this in my portfolio when it goes down,’ PM’s jump ship and their numbers outweigh the bargain hunters. Investors who subscribed to the recent rights issue, and wouldn’t I love to see the crib sheet and FAQ sheet written for the salesmen by corporate finance for that one, will be feeling that maybe ‘cheap,’ wasn’t quite the right word to be banded around at 125p.

Whatever valuations analysts put on Glencore, equity investors may be about to be reminded that equity is at the bottom of the capital structure. Following the announcement earlier this month of the company’s $10bn recapitalisation plan through a rights issue, dividend suspension, asset sales, capex cut and production cut; Moody’s put the company on negative watch on its Baa2 rating, (just above junk). The market is beginning to question if the $10bn recap is sufficient to guarantee the survivability of the company and the whole asset structure is consequently having convulsions.

The problem becomes acute if Glencore is downgraded to junk. At that point we have a potential Lehman / AIG scenario in the commodity space. While Glencore is the biggest listed leveraged bet on the price of copper and the Chinese economy through its mining operations, it is also one of the world’s biggest commodity trading firms. A downgrade to junk could trigger forced selling from PM’s not able to hold junk paper, collateral liquidations and market counter parties slamming the doors shut. The complex daisy chain of OTC derivative contracts have an unquantifiable market risk. At the minimum, fear of a bad thing happening is enough in this fragile environment to unsettle the broader market. Risk managers and regulators must surely have Glencore front and centre on their radar this weekend.

Goldman have suggested in a recent note that it would take only a further 5% drop in commodity prices to tip Glencore over the edge. Bernstein meanwhile apparently think it is cheap.  Sure, the company will announce asset sales, like its agri business, and the shares may enjoy big % temporary spikes. My view however, is investors have no business touching this stock unless they have a near term blue sky view for copper and Chinese growth to which it has a high sensitivity. As neither are likely to be forthcoming investors should take a wide berth. Better to catch the turn in the commodity cycle when it comes with companies who are ahead of the game rather than behind it and examine Glencore only when it recovers its rating and financial health. Better to pay more for something with longevity than to bet at the roulette table in a casino on fire, which is exactly what an investment in the company is now.