Well almost everybody is going head over heels with Grexit. I have covered this aspect in my India focused blog http://niftyparadox.blogspot.in/2015/06/euro-zone-crisis-and-why-it-will-be.html
Overnight, there have been many articles in the blogosfear with classical economic theories explaining why it is gloom and doom for Euro. For all those so called pundits talking about gloom, I would like to remind them [and of course all the readers of this blog], let us rewind history a bit and look at major sovereign debt / currency issues over the last few years
Germany 1932 , Mexico 1982, Yugoslavia 1983, Russia 1998, Argentina 2001
Source: https://en.wikipedia.org/wiki/List_of_sovereign_debt_crises
In each instance, there was gloom, doom and Armageddon posted across the press [because the concept of blogs didn't exist then] Do these countries exist on the political map today? Yes of course
Does business thrive in these countries; Germany and Russia stand out distinctly right?
Specific to Germany, it was a result of World War 1 reparations that of course led to a hyper-inflationary period but what happened over a period of time? Germany got its act together, focused on its strengths of meticulous engineering and became one of the strongest manufacturing economies of the world. Look at where Germany is today [I won't go into the details of World War 2]
This list is missing the Brazilian default in 1986-87
Another Source: https://en.wikipedia.org/wiki/Sovereign_default
Then of course we had the Asian currency crisis and historical details of the same are covered here
https://en.wikipedia.org/wiki/1997_Asian_financial_crisis
The classical economist version for Grexit starts with the premise: Greeks [public + private] people put together do not have enough Euros for starters. And they rightly point out that in the event of default, credibility of Greek Sovereign will be very much in question.
My rebuttal to that is look at US, UK, Japan - all these economies are surviving by debt monetization. Yes I agree that there are no quick fix solutions and global markets will temporarily go into panic mode - but that will be extremely short-term. Let us say that Greece does go ahead and trigger a sovereign debt default as it does not want to reel under pressure from creditors with regards to modifications in government spending
It decides to return to drachmas [hyper-inflation will be the first and direct consequence of this] then the classical economist asks how will Greece grow without any Euros in hand first.
My Answer: They don't need it. Let us look at the most low hanging fruits
Tourism: They can create a Special Purpose Vehicle and form a consortium of Public-Private-Partnership. Rights and Warrants can be created for social and corporate tourism requirements. There will be bidding processes and the winning bids have to place money upfront. No matter how much the pressure from other Euro-zone members, the bids will go through eventually.
So much was written about the outsourcing challenges when businesses in US, UK and Central Europe started outsourcing jobs to emerging countries like India, Philippines in the IT/ITES space. There were protests, lobbying but the end result? Profit and economic gains over-ride all other concerns eventually and the same will happen to Greece
The very instance of privatization of airports and seaports can also be taken up by Greece [currently a suggestion by Troika for next bailout] Greece can default on its debt and still take up the privatization route.
For agriculture, it can tie up with commodity majors like Cargill or other major food companies
Last but not the least, if we look at the German default, Russian default, Greece is nothing in comparison today. All the short-term pain will be behind us in less than 5 years and Greece will be a thriving economy.
So that is it as far as Grexit is concerned - short-term pain followed by a prolonged phase of economic hustle and bustle.
Let us now shift attention to major indices
DJIA
Last 10 years
To put things in perspective, in a larger monthly / quarterly time frame, the swing low for DJIA has been about 11k on downside [2010-11] and swing high has been 18200 [2015]. Ignoring inflation effect and assuming that 18200 was indeed the top, 61.8% of the retracement is very logical.
Total Swing = 8200 points [61.8% = 5068] So even a sharp fall to 15k [Swing Low 11000 + 5068] or 14k [Swing High - 5068] is well within reasonable limits of market trading ranges.
Giving more credence to this is the fact that despite so many negatives that cropped up, in the last 5 years, no correction has exceeded 2k on DJIA in the last 5 years. So it may just be the time when the larger correction plays out.
The other argument is leaning towards the US Fed discontinuing Zero Interest Rate Policy [ZIRP] and look to raise interest rates later this year. If one goes through the fine print of policy details, that premise holds true only under normal business circumstances and Grexit is not normal business circumstance. Should there be a Euro-contagion, then forget about rising interest rates, one can expect a fresh round of QE all over again!!!
To summarize, under normal business circumstances, a correction on Dow upto 16k is very much likely and then catch up with Nikkei to 21k levels. Under special business circumstances, a correction upto 14k on Dow is highly likely only to surge higher from there. Also note that even at 14k levels, the DJIA level will be almost double that of the swing low experienced in 2008-09
FTSE: FTSE rallied from 5250 levels in 2010-2011 to 7k levels in 2015. So a Fibonacci correction to 5950-6080 levels is very much warranted
DAX: It started its rally from a swing low of 5700 and nearly tripled from there. Even in case of a severe correction, it is unlikely to go below 7700. DAX will be a bit tricky because should a Euro-contagion take place, all PIIGS countries will be far more cost competitive and can throw German businesses temporarily out of gear. On the positive side, German government and corporates can still spring positive surprises. Eurozone breakup will bring hyper-inflationary and currency crisis for peripheral Europe but what happens to DMs and Bunds? They will sky-rocket in purchasing power - don't be surprised to see large scale mergers and acquisitions by German companies on the back of a strong DM thus ensuring that a large part of loss in Germany is offset by the stakes in businesses acquired ;)
Empirical Evidence suggests that once central banks hit the ZIRP zone, there is no looking back from there. Of course, this cannot be a general conclusion as the only data point we have is Japan. Japan started the concept of ZIRP but has never ever managed to raise interests after that for some reason or the other. Any major crisis and ZIRP by FED, ECB, BoE and BoJ will continue at an aggressive rate.
BOTTOM-LINE: ANY MAJOR CORRECTION OUT OF A CONTAGION NOW IS A BIG BIG OPPORTUNITY. Ignoring short-term blips, the structural bull market is very much intact.
Markets rarely move in the direction that masses are expecting. If you ask me where is the next major shock going to come from? The next major shock will come from the Silicon Valley IMHO.
Crazy valuations in billions of dollars when firms are not even listed and private equity funded ventures are posting losses big time to gain traction; this is the space that has a massive asset bubble, similar to the dot-com mania in 1999-2000. The music at some point will start here and there will be a lot of plugs pulled out.
Gold / Silver: Both of these have had phenomenal bull runs from 2001 to 2013 followed by a corrective phase. In terms of price, silver has seen over 50% shaved off from its swing high and gold has seen almost 40% shaved off from its swing high. In terms of time correction, a 13 year rally is very much a prime candidate for a time correction of 2-3 years. It is very difficult for gold to go below $1000 per ounce and for Silver to go below $12 per ounce. These are high probable profit trades on the long side as we are in the last phase of both price and time correction. Forget what academicians and economists say about Gold / Silver, they will continue to generate 10% gains compounded annually from current prices over the next 5 years.
Any major credit crisis will basically take out speculative and leveraged long positions from the system without really impacting the physical demand for gold / silver. Countries like China and India have an insatiable appetite for physical gold and prices will eventually regain all lost ground and go on to surpass old highs to create new highs
Nymex Crude: This too, has witnessed over 50% correction from last 2 years' highs. Technically as well as fundamentally, prices need to hover around the $70 / Barrel mark. That is where crude will eventually stabilize even if it goes to $30 / Barrel [rare and low probability event]
To wrap up, ignore all the noise with regards to Armageddon. A correction is very much likely globally and corrections are healthy for the markets. They weed out complacency and keep the structural bull market intact. In current circumstances, the extent of correction is perhaps underplayed. The carnage may not end at 61.8% of rise but will be a major buying opportunity nevertheless.
My Big Alpha Trade Recommendation for 2015-2016
Short NetFlix [CMP 657]
Expected Price over 18 months: 250
Worst Case Scenario: Price 250 in October 2016
Investment Outlay
August 2015 Expiry 475 Put = 2 Dollars
December 2015 Expiry 475 Put = 10 Dollars
January 2017 Expiry 470 Put = 45 Dollars
Total Outlay = 57 Dollars
Assuming that the pay-off does come through by January 2017 and that the Put being deep in the money will have no time premium, Even then, the value of the Put will be about 225 netting about 170 dollars in the bargain. The earlier this happens, greater will be the pay-off.
From an option buyer perspective, the maximum loss on this trade is the premium paid i.e. 57 dollars
Risk-Reward Ratio almost 1:3
No Iron Condor, Straddle, Butterfly or any such synthetic combination. Simply Long Puts as mentioned above. Probability of Success: 90% plus according to my estimate
Overnight, there have been many articles in the blogosfear with classical economic theories explaining why it is gloom and doom for Euro. For all those so called pundits talking about gloom, I would like to remind them [and of course all the readers of this blog], let us rewind history a bit and look at major sovereign debt / currency issues over the last few years
Germany 1932 , Mexico 1982, Yugoslavia 1983, Russia 1998, Argentina 2001
Source: https://en.wikipedia.org/wiki/List_of_sovereign_debt_crises
In each instance, there was gloom, doom and Armageddon posted across the press [because the concept of blogs didn't exist then] Do these countries exist on the political map today? Yes of course
Does business thrive in these countries; Germany and Russia stand out distinctly right?
Specific to Germany, it was a result of World War 1 reparations that of course led to a hyper-inflationary period but what happened over a period of time? Germany got its act together, focused on its strengths of meticulous engineering and became one of the strongest manufacturing economies of the world. Look at where Germany is today [I won't go into the details of World War 2]
This list is missing the Brazilian default in 1986-87
Another Source: https://en.wikipedia.org/wiki/Sovereign_default
Then of course we had the Asian currency crisis and historical details of the same are covered here
https://en.wikipedia.org/wiki/1997_Asian_financial_crisis
The classical economist version for Grexit starts with the premise: Greeks [public + private] people put together do not have enough Euros for starters. And they rightly point out that in the event of default, credibility of Greek Sovereign will be very much in question.
My rebuttal to that is look at US, UK, Japan - all these economies are surviving by debt monetization. Yes I agree that there are no quick fix solutions and global markets will temporarily go into panic mode - but that will be extremely short-term. Let us say that Greece does go ahead and trigger a sovereign debt default as it does not want to reel under pressure from creditors with regards to modifications in government spending
It decides to return to drachmas [hyper-inflation will be the first and direct consequence of this] then the classical economist asks how will Greece grow without any Euros in hand first.
My Answer: They don't need it. Let us look at the most low hanging fruits
Tourism: They can create a Special Purpose Vehicle and form a consortium of Public-Private-Partnership. Rights and Warrants can be created for social and corporate tourism requirements. There will be bidding processes and the winning bids have to place money upfront. No matter how much the pressure from other Euro-zone members, the bids will go through eventually.
So much was written about the outsourcing challenges when businesses in US, UK and Central Europe started outsourcing jobs to emerging countries like India, Philippines in the IT/ITES space. There were protests, lobbying but the end result? Profit and economic gains over-ride all other concerns eventually and the same will happen to Greece
The very instance of privatization of airports and seaports can also be taken up by Greece [currently a suggestion by Troika for next bailout] Greece can default on its debt and still take up the privatization route.
For agriculture, it can tie up with commodity majors like Cargill or other major food companies
Last but not the least, if we look at the German default, Russian default, Greece is nothing in comparison today. All the short-term pain will be behind us in less than 5 years and Greece will be a thriving economy.
So that is it as far as Grexit is concerned - short-term pain followed by a prolonged phase of economic hustle and bustle.
Let us now shift attention to major indices
DJIA
Last 10 years
Total Swing = 8200 points [61.8% = 5068] So even a sharp fall to 15k [Swing Low 11000 + 5068] or 14k [Swing High - 5068] is well within reasonable limits of market trading ranges.
Giving more credence to this is the fact that despite so many negatives that cropped up, in the last 5 years, no correction has exceeded 2k on DJIA in the last 5 years. So it may just be the time when the larger correction plays out.
The other argument is leaning towards the US Fed discontinuing Zero Interest Rate Policy [ZIRP] and look to raise interest rates later this year. If one goes through the fine print of policy details, that premise holds true only under normal business circumstances and Grexit is not normal business circumstance. Should there be a Euro-contagion, then forget about rising interest rates, one can expect a fresh round of QE all over again!!!
To summarize, under normal business circumstances, a correction on Dow upto 16k is very much likely and then catch up with Nikkei to 21k levels. Under special business circumstances, a correction upto 14k on Dow is highly likely only to surge higher from there. Also note that even at 14k levels, the DJIA level will be almost double that of the swing low experienced in 2008-09
FTSE: FTSE rallied from 5250 levels in 2010-2011 to 7k levels in 2015. So a Fibonacci correction to 5950-6080 levels is very much warranted
DAX: It started its rally from a swing low of 5700 and nearly tripled from there. Even in case of a severe correction, it is unlikely to go below 7700. DAX will be a bit tricky because should a Euro-contagion take place, all PIIGS countries will be far more cost competitive and can throw German businesses temporarily out of gear. On the positive side, German government and corporates can still spring positive surprises. Eurozone breakup will bring hyper-inflationary and currency crisis for peripheral Europe but what happens to DMs and Bunds? They will sky-rocket in purchasing power - don't be surprised to see large scale mergers and acquisitions by German companies on the back of a strong DM thus ensuring that a large part of loss in Germany is offset by the stakes in businesses acquired ;)
Empirical Evidence suggests that once central banks hit the ZIRP zone, there is no looking back from there. Of course, this cannot be a general conclusion as the only data point we have is Japan. Japan started the concept of ZIRP but has never ever managed to raise interests after that for some reason or the other. Any major crisis and ZIRP by FED, ECB, BoE and BoJ will continue at an aggressive rate.
BOTTOM-LINE: ANY MAJOR CORRECTION OUT OF A CONTAGION NOW IS A BIG BIG OPPORTUNITY. Ignoring short-term blips, the structural bull market is very much intact.
Markets rarely move in the direction that masses are expecting. If you ask me where is the next major shock going to come from? The next major shock will come from the Silicon Valley IMHO.
Crazy valuations in billions of dollars when firms are not even listed and private equity funded ventures are posting losses big time to gain traction; this is the space that has a massive asset bubble, similar to the dot-com mania in 1999-2000. The music at some point will start here and there will be a lot of plugs pulled out.
Gold / Silver: Both of these have had phenomenal bull runs from 2001 to 2013 followed by a corrective phase. In terms of price, silver has seen over 50% shaved off from its swing high and gold has seen almost 40% shaved off from its swing high. In terms of time correction, a 13 year rally is very much a prime candidate for a time correction of 2-3 years. It is very difficult for gold to go below $1000 per ounce and for Silver to go below $12 per ounce. These are high probable profit trades on the long side as we are in the last phase of both price and time correction. Forget what academicians and economists say about Gold / Silver, they will continue to generate 10% gains compounded annually from current prices over the next 5 years.
Any major credit crisis will basically take out speculative and leveraged long positions from the system without really impacting the physical demand for gold / silver. Countries like China and India have an insatiable appetite for physical gold and prices will eventually regain all lost ground and go on to surpass old highs to create new highs
Nymex Crude: This too, has witnessed over 50% correction from last 2 years' highs. Technically as well as fundamentally, prices need to hover around the $70 / Barrel mark. That is where crude will eventually stabilize even if it goes to $30 / Barrel [rare and low probability event]
To wrap up, ignore all the noise with regards to Armageddon. A correction is very much likely globally and corrections are healthy for the markets. They weed out complacency and keep the structural bull market intact. In current circumstances, the extent of correction is perhaps underplayed. The carnage may not end at 61.8% of rise but will be a major buying opportunity nevertheless.
My Big Alpha Trade Recommendation for 2015-2016
Short NetFlix [CMP 657]
Expected Price over 18 months: 250
Worst Case Scenario: Price 250 in October 2016
Investment Outlay
August 2015 Expiry 475 Put = 2 Dollars
December 2015 Expiry 475 Put = 10 Dollars
January 2017 Expiry 470 Put = 45 Dollars
Total Outlay = 57 Dollars
Assuming that the pay-off does come through by January 2017 and that the Put being deep in the money will have no time premium, Even then, the value of the Put will be about 225 netting about 170 dollars in the bargain. The earlier this happens, greater will be the pay-off.
From an option buyer perspective, the maximum loss on this trade is the premium paid i.e. 57 dollars
Risk-Reward Ratio almost 1:3
No Iron Condor, Straddle, Butterfly or any such synthetic combination. Simply Long Puts as mentioned above. Probability of Success: 90% plus according to my estimate
