Friday, September 25, 2009

Asset Markets Rallies - A game of transferring wealth

All over the world, especially in emerging economies, asset markets are rallying hot. I did not foresee this and I think it is too late to join the party. Yes, you can still make money but the risk reward now is bad, the margin of safety too small.

Simply put, these are liquidity fueled rallies because cash is returning zero. The best risk/reward is when you got in near the ground floor. Liquidity led rallies have a nasty habit of reversing suddenly, so when it happen, and you had failed to get out earlier, you are square since you entered at the bottom. Everyone else net of those who bought and profit from you has will be staring at losses. May be we will have another round of financially ruined people committing suicide.

A liquidity fueled bull run is nothing but a Ponzi scheme. Wealth is not made as there are no fundamentals, i.e., earnings and cash flows to support higher asset prices. Those who bought low and sold high, must be matched by those who bought high and sold low.

The end of the liquidity binge is almost impossible to forecast, but there are only two causes: natural or unnatural. The natural cause will take the markets higher than the unnatural one. In this instance, the unnatural cause comes from governments draining liquidity, which requires political courage of the first order (not likely). The natural cause is when assets got so over valued, greed eventually gave way to fear against a tower of unreal values. Like a sand pile, it is impossible to forecast when it will collapse, only that it will.

Unfortunately for the prudent, the natural collapse of prices might not happen for a very long time. The wait might be years. Since politicians and central bankers mostly have no guts, this is the more likely outcome.

If you want to make money, on a risk/reward basis, find assets that give you cash flows. Capital gains in this cycle is a fool's game.

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