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Monday, March 27, 2006


oil contagion?

the front of wsj's c section today gives a treatment of the disastrous collapse of capital markets in dubai, saudi arabia and kuwait in the last two months. the previous year has seen a combination of rising oil prices and repatriation of capital by nervous oil sheiks concerned about the safety of their holdings in an increasingly vitriolic anti-muslim west fuel an immense boom -- driving home markets to dizzying gains -- tripling in the space of 36 months, doubling in the last 12. all this is but a continuation of steady gains dating back some years, coincident to the rise of the price of oil out of the teens per barrel.

recent weeks, however, have seen the bubble burst, with the saudi market -- the region's largest -- losing a third of its capitalization.

Analysts say the selloff in the Gulf shows few signs of spilling over broadly to other developing countries -- as happened in 1997 when a currency crisis in Thailand sparked broad losses throughout Asia, or when Russia's debt default the following year roiled global markets -- because few investors outside the Gulf own its stocks.

... A few of the top-performing, but more volatile, emerging markets, such as Turkey or Brazil, are seeing signs that global investors are lightening up on their holdings. Their benchmark indexes have fallen by more than 5% this month. "It's a warning sign that people are worried about risk," said Arjun Divecha, a fund manager with GMO Emerging Markets in Berkeley, California.
with emerging market debt spreads near rock bottom, an expansion of risk premiums could emerge with lightning speed. it matters that the mideast markets are thinly traded by westerners -- but it also matters that some of the largest private investors in the west are middle easterners rich with oil revenues. even if these parties are not brought to margin calls and forced liquidations by virtue of wide diversification, the experience is likely to make them more risk averse in coming months and potentially liquidate some global positions to raise defenses.

there's also the prospect of social unrest in the mideast, where small investors are a new phenomena that accompanied the market bubble and a booming local oil-based economy. literally millions have been hurt, and many leveraged parties wiped out entirely by the vicissitude of capital markets. large protests by devastated household investors have already taken place in kuwait, and the government has intervened in the market there.

watch in coming weeks for signs of retrenchment in emerging markets. contagion is a tricky thing, and markets certainly autocorrelate in times of rising volatility. after years of expansion and easy money, the widespread complacency of global investors could quickly and perilously be undone.


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