Beneficiares of the market meltdown

So we have a once in a lifetime meltdown caused by a bunch of Wall street banks thought to be infallible, going down bankruptcy lane or going to the government with a begging bowl to save their skin. Made me think, is there anyone out there who benefits from the change in environment.

Well, we finally have a strong push for changes in the regulatory environment that makes Wall Street banks, especially ones that are pure play investment banks, come under the ambit of regulations set by the federal reserve. One of the changes proposed could substantially change the face of the OTC (over the counter) market. Currently, the entire forwards market trades over the counter. It is estimated the interest rate swaps that use LIBOR as a benchmark is close to $345 trillion. Yes, that’s trillion. In addition, the credit default swap market, another OTC market was at its peak, a $61 trillion market. These markets were essentially operated by large wall street banks which were considered to be infallible and therefore counterparty risk was never an issue.

The fall of Lehman however changed the dynamics forever. The repurcussions of the fall of the relatively small Wall Street bank were felt worldwide resulting a terrible October month that was felt even by the common man on the street. A large part of this pain was felt due to counterparty risk.

Exchanges are meant precisely to take care of counterparty risk. New regulations to standardize trading over exchanges mean a bonanza for these firms. Imagine what can happen if an additional $400 trillion worth of trading happens over exchanges instead of the OTC market. The fees that they could generate over trading could be staggering. This represents a huge growth are for these firms. We therefore have firms like the Chicago Mercantile Exchange, InterContinental Exchange and NYSE Euronext racing to create trading platforms for these forwards and credit default swaps.

So how about these as investment opportunities? These firms trade in U.S markets under the tickers, CME, ICE and NYX and are trading at extremely low historical valuations. This is so not just because the market meltdown but also due to lower trading volumes that lead to lower fees and therefore, lower revenues.

The future for these exchanges is bright though. Growth opportunities are significant and valuations, extremely compelling. Smells like a good opportunity, doesn’t it?

On Auto bailout and IIP numbers

So we have a day when the auto bailout doesnt go through, asian and European markets sink, U.S market futures are down 3% and then, lo and behold, markets are up convincingly in the green. The resistance markets are showing is phenomenal. Neither a terrible unemployment report with 533000 jobs lost, the most since the 70's when expectations were at 340000 and a failed auto bailout that puts at risk 5 million jobs can hold back markets. These are sureshot signs that markets have bottomed out. Markets, however went up on some comments from the White House that the auto bailout would be funded from the TARP, which does not required congressional permission. I'm willing to bet that the big 3 will get the money they require one wayMind you, this does not mean the the mess in the U.S is over. Credit card defaults and auto defaults are next in line. Home prices are expected to decline in 2009 too and this could mean further liquidity contractions and writedowns. However, what this tells me is that markets are more or less convinced that policymakers are willing to do whatever it takes to get the economy back on track. The concern with doing whatever it takes, essentially flooding the economy with money, since reducing interest rates have not really worked, is that the dollar has to start depreciating at some point of time. This process has already started except against the Yen, which is more a result of the Yen carry trade i think. However, an unwinding of the Yen carry trade which leads to the appreciation of the Yen against the dollar happens when markets fall. This is not the case though. So not exactly sure whats happening on this front. Hedge fund deleveraging is more or less over I believe, or if it is happening, then it is more orderly.

About the Indian markets, we see the same resilience. Growth for 2009-10 has been pruned to sub 6%. IIP numbers came out -ve, the first time in 13 years and stunned everyone. Markets which were about 3% down at the time of the announcement stayed flat started moving up and ended up on a positive note. This -ve number is a positive for banks since it signals that RBI would have to be more aggressive when it comes to cutting interest rates. FII's have started buying in this market. I guess the reasoning is that India has above average rates of growth and should therefore attract FII money. However, the current rally is purely technical and I expect, it will go back down soon. However, I dont think it will go below 8500 anytime soon. In my opinion, this is a fantastic buying opportunity if you have a 1 year horizon. Oil is a great sector to invest in since I believe the worst is over for it. Banks and infrastructure will be good sectors to invest in.
These are interesting times and a great investment opportunity. If there is a time to make money, it is now..

market view

A couple of quick comments. I believe oil has bottomed out and is likely to reverse back to $50 levels. I say this because oil has gone up in spite of bad news about a decline in China's exports and drastic reductions in India and China's economic growth forecast by various firms and agencies like the World bank and the IMF. This would be a good time to take an exposure in stocks that are linked to oil. In the Indian markets, we have Aban offshore, Cairn Energy and RPL. I would look at buying them in dips. I see similar reactions to stocks that trade in the U.S markets. Stocks like Schlumberger, Transocean, Valero, Exxon all are up over the last few days. The dollar is starting to decline which would give impetus to oil, gold and emerging markets.
About the direction of the markets, I believe they should could touch 10500 levels and then it will most likely reverse. This i say based on technicals and also that the government is coming out with another stimulus package next week that is expected to be bigger than the first one.