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Turning point reached in market rally
I was planning to write a blog post last Friday to point out that both the DOW and S&P 500 have almost reached the 61.8% Fibonacci retracement level as shown the chart of the S&P500 above. Technical analysts believe that the Fibonacci retracement levels are potential turning points in markets as mentioned in my earlier blog post “Using Fibonacci to identify potential turning points“. Marketclub had just released a great video analysis on the DOW and S&P500 called “Can we go higher forever?” which warned of a potential reversal as both these indexes are approaching the 61.8% retracement level. I wanted to share that with readers of this blog but I was tied up with some other tasks so I never got around to doing the post and of course on Friday night, the US Securities and Exchange Commission (SEC) announced that it was charging Wall St mega bank Goldman Sachs with civil fraud. The US market fell heavily on this news so I guess it is a little late to be sending the warning on a possible market turn. Of course all Asian markets, include Australia are down a fair bit today.
Is this just a small problem to which the markets have overreacted to, or is it the beginning of something bigger? I like what John Mauldin said in his newsletter, “As we all know, there is never just one cockroach”. If you see one cockroach, there are bound to be many others nearby. Hedge fund Paulson & Co worked with Goldman Sachs to create a subprime Collateral Debt Obligation (CDO) product called Abacus 2007-AC1. As Paulson & Co had taken short positions on this product, it was in their interest to make sure it was full of the worst mortgages so this product would fail. This toxic investment product was then sold by Goldman Sachs to many of the bank’s unsuspecting CDO investors. John Mauldin pointed out that Magnetar, another hedge fund has been reported by Pro Publica to have worked together with at least nine other big name banks including Merrill Lynch, Citigroup, UBS and JPMorgan Chase on multiple subprime CDO products similar to Abacus. I suspect that once CDO investors realise that it may be more than just “bad luck” that caused their CDO investments to become worthless, this will not be the last law suit that we will see taken against Goldman Sachs, and they will not be the only bank who will be sued. Goldman Sachs has denied any wrong doing and have vowed to fight this law suit. Whether they eventually choose to settle quietly or go for a lengthy court battle against the SEC, it will cost them a lot of money and irreparable damage to their image. Goldman Sachs in Europe has already had a lot of negative publicity in recent months for their role in arranging swaps for Greece that may have masked the country’s budget deficits.
If the big banks get into financial trouble again, who will bail them out this time? The last time, the government bailed out those that were deemed “too big to fail” for fear that their collapse would cause a systemic risk to the whole global financial system. However, the bailouts and government mandated bank mergers only made those big banks even bigger. Without serious financial reforms to the banking system the systemic risk is now even bigger, as pointed out by Boston University professor Mark Williams, a former Fed bank examiner and author of Uncontrolled Risk: The Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System. He says “We still have structural problems with our banking system that need to be fixed. We have not solved the systemic risk, ‘too big to fail’ problem yet.” Below is a video interview with Mark Williams from Yahoo Tech Ticker.
While it is still too early to tell if this will turn out to be a one day stock market correction like the Dubai news in November in 2009, or a short 10% correction like the Greek debt crisis in January 2010, or another big leg down like the Lehman Brothers bankruptcy in October 2008, it is definitely a good idea to hedge your stock portfolios. The Shanghai index is down almost 5% as I write this. This could turn out to be THE turning point of this 13 month rally.
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