Markets brace for the best
14 October 2013
The American stock market went up on the weekend, which is perhaps an indication of how investors think the US gridlock will play out. It really is an astonishing exercise in political control by the right wing of American politics: well funded sectional interests. Republican credibility is plummeting (which is not to say Democrat credibility is rising). Some kind of extreme brinkmanship seems inevitable, which is just the time when bargains can be picked up by investors.
The AFR is reporting that fund managers are bracing for a volatile week on the local bourse as the United States risks a default on its debt without a resolution from Congress to extend the debt ceiling. This is something of an understatement. But for SMSF investors it may represent an opportunity.
Robert Gottliebsen in today;s Business Spectator identifies the main reason why the US absurdities are dangerous: uncertainty in the derivatives market:
"The reason the Lehman failure was so catastrophic was its effect on the derivatives market – the $200 trillion unregulated market that connects the world’s banks. In the case of Lehman an immediate consequence was the freezing of the repurchase agreement, or ‘repo’, market.
"If any US debt default extended longer than a short period (no one is certain whether a ‘short period’ should be defined as a few hours or a few days), exactly the same thing will happen only on a much bigger scale.
"Banks and investment houses use the ‘repo’ market for secured, short-term borrowing. Between $2.5 trillion and $3 trillion worth of US Treasury bonds are used as collateral for ‘repo’ loans. When Lehman banks and investment houses found that the collateral they believed was backing their loans was no longer there, the market froze and the ramifications spread through the global banking system via derivatives. A huge credit squeeze with much higher interest rates followed."
The architecture of the global capital markets is as fragile as ever, and vulnerable to the political nonsense. But, for an investor, this may not be all bad. America will have to get a solution eventually, and harm is likely to be temporary. Asset prices will return, if they fall. In particular, with the Australian dollar high, a sharp correction in the American stock market may be an opportunity to buy overseas.