- Money Morning Australia

Can You Beat Goldman Sachs?

Written on 14 October 2011 by Kris Sayce

Can You Beat Goldman Sachs?

Publisher’s note: Brand new Slipstream Trader market update video – just uploaded and free to watch on YouTube

In this week’s overview Murray Dawes looks at a few different scenarios that could arise out of a momentary impasse in the US S&P500. He points out where there’s resistance in the chart… and highlights where there could be “some great sell signals” coming up. He also gives his view on what the coming European rescue package could mean for buyers and opportunists… To get Murray’s insight ahead of the crowd – for free – just go here


Stock market volatility has been a regular theme in Money Morning recently.

It’s a theme we’ll continue today. And if we’re honest, it’s a theme we’ll have to follow for many more years. More on that below.


“The volatility of the US share market in 2011 is a little above average but it is well within historic norms and nothing like that experienced by our forefathers during the 1930s.” – Simon Marais, managing director, Orbis Investment Management

He’s not wrong. Look at the following chart:

stock market chart
Click here to enlarge
Source: Yahoo! Finance [Note: Log scale]

Between the end of 1929 and mid-1930, the Dow Jones Industrial Average dropped 89.5%.

By comparison, from the peak in 2007 to the low in 2009, the Dow fell “just” 54.9%.

What does that tell you? The 2008 financial meltdown wasn’t as bad as we all thought? There wasn’t – and won’t be – a second Great Depression…?

Or… the worst is yet to come?

Unravelling the Boom

On Tuesday, Slipstream Trader, Murray Dawes wrote:

“The irrational fear of prices falling has politicians scared to death. They are willing to throw unlimited amounts of other people’s money at the problem to stave off the markets attempt to return to equilibrium. The unravelling of 30 years of credit creation can’t be swept under the carpet.”

And don’t forget, the sweeping under the carpet hasn’t just happened since 2008. The market bubble actually burst in 2000. That was when the credit bubble reached a peak… reflected in the crazy investments made during the dot-com boom.

But rather than allowing the bubble to completely burst, the U.S. Federal Reserve applied a makeshift patch. So instead of the market falling… and investors learning the lessons of what was then a 20-year credit boom, the market recovered and the bubble re-inflated.

You can see on the following chart the big rate cuts starting in 2000 as the Fed took the benchmark interest rate from 6.5% down to 1%:

Federal Funds Target Rate
Click here to enlarge


It’s no surprise that as interest rates headed lower asset prices stopped falling… and eventually headed higher.

With money so cheap and fixed interest earnings so low, investors had to take bigger risks. So the damage was done by the time the Fed started jacking up rates in 2004.

And things would only get worse…

Decoding Greenspan


You may recall this was the period when Alan Greenspan ran the Fed. Fed statements were full of semi-cryptic language. But as with any cryptic message, the more it’s used, the easier it is to decode it.

That was the case with the Fed statements. For instance, the following sentences appeared in every Fed statement between June 2004 and November 2005:

“With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.”

At each meeting the sentences appeared, the Fed raised the Fed Funds Rate by 0.25%. The Fed changed the language for the December 2005 statement to a new phrase it used for the next three meetings… also increasing rates 0.25% each time.

So it didn’t take a genius to figure that as long as this statement remained, interest rates would keep going up.

And they did.

What did that mean for the markets?

Front-Running the Fed

Well, it meant the Fed was showing its hand. And the market took full advantage of it. Smart traders at the investment banks could make the pretty sure bet that rates would go up.

It allowed them to safely hedge their interest rate exposure.

Simply put, by giving the game away on its intentions, the goal of raising rates to slow down investment failed. In fact, it arguably increased risk taking. Because in order to maximise profits on hedged position, the sooner traders made bets on rising interest rates, the bigger the profits.

After all, if you’re pretty certain rates will go up in 0.25% increments for the foreseeable future, why wait? You wouldn’t. You’d leverage up as soon as possible to get the biggest bang for your buck.

In short, banks and traders were front-running the Fed… something the banks were quick to pick-up on from 2009 through to this year. And in both cases the big investment banks racked up big profits.

But with front-running opportunities fading away, so is the easy money. This week Bloomberg News reports:

“Goldman Sachs Group Inc. (GS), whose shares have fallen 43 percent this year, may report its lowest quarterly profit since the 2008 financial crisis…

“Goldman Sachs… said in July that it will cut about 1,000 jobs after its second-quarter drop in trading revenue was bigger than analysts estimated.”

All this makes us wonder what will happen next. Central bankers have shown they won’t allow banks to fail. Yet with easy money opportunities gone and interest rates close to zero the banks only have one choice if they want to make money…

And that means taking bigger risks.

Beat GS

The bad news is it won’t mean the same kind of credit boom you saw from the 1980s to 2000, and again from 2003 to 2007. Today the consumer and businesses are already maxed out on credit…

And besides, what’s left for the market to front-run the Fed on?

As someone who writes a monthly newsletter giving stock market tips, we’d love to tell you the market is heading for another dream run. Trouble is we just don’t believe it.

Our bet is we’ve seen the best days of the latest stock market boom (from 2009). And that the next few years – at best – are more likely to mirror the period from the mid-1960s to late 1970s… lots of volatility but not much in the way of long-term buy-and-hold profits.

That sounds like a nightmare for investors.

Well, it doesn’t have to be…

Providing you have a conservative long-term investment portfolio (cash and dividend paying shares) and a riskier short-term portfolio (small-caps and blue-chip growth trading) you can shield your investments against some of the worst volatility…

And if you get it right with your active portfolio you could achieve what Goldman Sachs can’t – a profit.



Related Articles

Why Chinese Monetary Planning Means More Volatility for You

Australia: The World’s Investing Casino

Why China’s Hidden Debt is Bad News for Aussie Stocks

The Great Indian Coal Rush

The Other Side of Short Selling

From the Archives…

What Debt Crisis?
2011-10-07 – Greg Canavan

Enjoy the Rally, It Won’t Last for Long
2011-10-06 – Greg Canavan

Why the Fed’s Actions Make Perfect Sense
2011-10-05 – Murray Dawes

Too Big to Bail
2011-10-04 – Murray Dawes

What Can We Expect Next From Commodities?
2011-10-03 – Dr. Alex Cowie

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Kris Sayce
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays. Read more about Publisher and Investment Director Kris Sayce.

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1 Comments For This Post

  1. SV Says:

    In a market without clear direction, it is difficult to achieve a profit with a portfolio of companies that somebody else picks for you, the companies whose dynamics you don’t intimately understand yourself. Too much money following too few companies.

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