Master Rider Blog

Lessons Learnt

September 7th, 2007 NW Teong

1)       There is boom-bust cycle in economy, in business and in each sector of the economy. The current market turmoil in US is a classic example in the real estate and hence the debt market.

2)       Do not assume that the authorities will do nothing and hence let the system unravel by itself. If we look back into the history, we would know that the authorities would not hesitate to act in the event of a crisis. Some examples, US Fed took action to ease its policy during the following events: 1997 Asian Financial crisis, 1998 Russian debt default and collapse of LTCM, Y2K date change etc.

3)       A financial crisis may force an economy into a deflationary trap and no government in the world would want its economy to reach that stage. If you have witnessed what Japan economy has gone through in the 90s, you would understand this. It took 13 long years for Japan to come out from that deflationary trap. Obviously, we have also noted when the deflationary force has gathered momentum, even an extremely low interest rate environment (even negative interest rates0 could not help to ease the situation. Yes, deflation is an ‘economic monster’ that everyone would love to avoid! Avoid for all you can, that does not mean we would not fall into one.

4)       A slow and gradual unwinding of market excesses is fine, a sudden and rapid collapse of market is definitely a no-no. This will cause serious confidence issue which itself may cause a bigger collapse in the world market.

5)       US today is still the largest economy in the world, and a sudden melt down in its financial system would have serious implications on the world economy and stock markets. However, we also need to understand that while US has a domineering position, its position would gradually being eroded due to the emergence of other big economies such as China, India and other up and coming economies in Asia, and other parts of the world. At times, we may read news article talking about economy of other countries de-coupling from US’s economy. To me, this is a matter of degree. That is the influence on other countries from US would decrease over time but will not totally decouple from it. Not so for a long long time.

Just like the bull-bear cycle in stock markets, the boom-bust cycle is really a reflection of human nature which has not changed much since the day we human beings first invented “money” or “currency”. We have reasons to believe that Fed and the US government would not hesitate to act in the event of a crisis. In fact both have lots of ammunition and thus have the ability to prevent a financial crisis at the moment.

At this juncture, the biggest nightmare for US would be a serious capital flight by the foreign investors whom might be sparked by the market turmoil in US. This will only happen if foreigners (as well as American) lose confidence in the US financial system and hence decide to divest their US holdings and re-invest these funds in overseas markets. We all know that foreigners have a substantial holding in US assets such as US Treasurys, equities, real estates and others. While this is not likely to happen now, it is always a possibility that this might happen one day. Perhaps, this will be carried out at a very gradual speed.

All of us would not want to be in the middle of a stampede. The worst nightmare that one may have is that you wake up one morning and realizes that you are in the middle of a stampede. What will you do? The most rational thing to do is to secure a safe spot (if you can find one) and wait for the stampede to be over. Remember, the casualties due to a stampede were never caused by the original cause (For instance, there is a stampede due to a fire in a cinema and many people died not due to the fire but due to the stampede itself). A smart investor will never allow herself/himself to be in the stampede situation in the first place. How to avoid, you may ask? My answer is: Don’t follow the crowd!

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Entry Filed under: Macro, Personal, Stocks