Domino Day Is Less than Two Months Away

By: Brady Willett | Wed, Sep 20, 2006
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The world record for most dominoes toppled in a chain reaction is 4,002,136. This number would have been even larger if it were not for a bird flying into the arena and accidentally knocking over thousands of dominos before the show began.

While toppling dominos is entertaining, the financial market equivalent goes by the frightening word 'contagion'. The last time the financial markets had to deal with a serious bout of 'contagion' was in 1997. And although the odds of another Asian crisis are not currently high, recent market events are threatening to spark a financial crisis. If a financial crisis grows large enough, the threat of contagion follows.

Fear is in the air

Thailand's currency, the baht, posted its biggest loss in four years yesterday following a military coup. Coup Leader, Army Chief Boonyarataklin, declared martial law and closed the markets today for a holiday. Tomorrow the Thailand stock exchange could open for business and with it another run out of the baht....

Over the last three weeks Amaranth Advisors has lost more than $4 billion in funds under management. The bulk of this loss is, reportedly, tied to a bad natural gas bet. The firm is currently trying to sell its energy portfolio to stay alive, and investors in the fund are scrambling to sell. No one saw the demise of Amaranth coming and - thanks to the funds secretive bets - no on can be exactly sure what tomorrow will bring.

But Don't Despair -- Yet

It is unlikely that a military coup in Thailand marks the birth of another Asian crisis. Leading into 1997 many investors/speculators started to pull money out of Asia, and as currencies and financial markets weakened the rush to get out quickly mushroomed. Today investor confidence in Asia is blooming, regardless of one bloodless coup.

It is also unlikely that Amaranth marks the birth of another LTCM. That Amaranth has lost billions, while alarming to some, really doesn't mean much so long as leverage is not in play and/or copious amounts of forced selling does not disrupt the markets. From what we know, Maounis's fund made some wrong way bets on natural gas. End of story.

Timing of the next toppling

The conclusion that another Asian crisis has not arrived should be of little comfort. Instead what should be remembered is that the Asian crisis only came to be regarded as such through the gift of hindsight. When the baht was devalued on July 2, 1997 the global financial markets barely noticed - the Dow closed up by 1% on the day. It wasn't until after other Asian currencies and financial markets were being toppled that the markets finally awoke to the crisis at hand: on October 27, 1997 the Dow dropped by what was then a record 554 points.

As for Amaranth, just because the fund is probably not another LTCM doesn't mean that the market theme of boom/bust is not about to rhyme. Rather, loose monetary policies following the 2000 stock market bust have helped set up an unprecedented amount of dominos that could be toppled, and the birds are circling: the US is more dependent on foreign investment than ever before, the US consumer is deadly dependent on US interest rates remaining low/asset prices remaining high, and US housing prices are starting to weaken. With much of the world overly dependent on slowing US demand and investors pricing in goldilocks, it doesn't take a great deal of imagination to envision a domino being flicked...

This year Domino Day is on November 14. By November 14 two more Fed meetings will be in the bag, the ominous month of October will be in the rear view mirror, and the US midterm elections will be over. In other words, by November 14 we will have a clearer understanding of whether the Thailand coup and Amaranth collapse were important events for the financial markets, or hiccups akin to the krona's slide early this year and demise of funds like MotherRock.

Needless to say, Bernanke and company will meet later today to remind us that there are forces at work to keep the first financial domino from ever being toppled. Endangered or not, the bird that knocked those dominos over was promptly shot and killed.

 


 

Brady Willett

Author: Brady Willett

Brady Willett
FallStreet.com

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