'When markets collide' (continue)

The book starts with Introduction which I actually explained in my last post. In his introduction the author explains some of the reasons of present turmoil and emphasizes that ‘the present turmoil is neither the beginning nor the end of the transformation phase.’ He shares his experience with us and explains a big importance of market noise.


ABERRATIONS, CONUNDRUMS AND PUZZLES

He starts chapter first with explaining that when political and economical problems and issues are risen and haven’t concrete explanation they come to be called aberrations, conundrums or puzzles. And many of them were dismissed in market as a just noise while they needed to be solved and predicted. As the author says for him the strangest puzzle was that financial system has always been able and willing to overconsume and overproduce risky products ‘in the context of such large systemic uncertainty’. Now many investors instead of waiting for proper explanation and exact forecast rushed into trades with a big risk and high leverage. The consequence of this is that few months later the world economy ‘found itself in grip of significant market turmoil’. Good example of it is again US market turmoil. This country shows us a ‘stable disequilibrium’ –payment imbalance. Now dominant industrial countries are being challenged by developing competitors and some countries meet the situation when they have to ask for a help from countries which are don’t play a big role in the world economy. It is just because now developing countries have very high potential and ability to return credits and they ‘shift from operating in debtor regimes to creditor regimes’.
And it is still not clear what caused such a consequence in US market. One of the reasons is an interest rate conundrum. That recently long-term interest rates tended to be lower that they used to be and also ‘the U.S. equity markets were experiencing a period of robust price appreciation consistent with a period of strong economic growth that was forecast to continue.’ And again all these things are because people are missing market noise. And what recently was a noise for policy makers and economist became a big signal of reconsidering all the global financial system

HOW TRADITIONAL RESOURCES FAILED US

Second chapter is talking about different Institutions which have a great influence in global economic life, which are available to identify noises and even predict them. But even these institutions might fail us. The International Monetary Fund has considered to be the most influentional institution and as Rodrigo de Rato, managing director of IMF, said: “the Fund is fully prepared to meet the great macroeconomic challenges that lie ahead”. But IMF has to deal with global problems and questions and interact in traditional economic issues and innovations. And the IMF is not such trusted and knowledgeable “trusted advisor”. It faces different budget problems and its income is falling now. Changes which are being now in the world are so powerful that have a huge effect on an institution which is center of the international monetary system.
Another problem is declining market volatility which we can see the VIX. As more and more investors now are willing to assume risk, it is one of the reason of declining the VIX. But the VIX is not ‘only variable that behaved in this way’. The same has happened in measures of volatility for the fixed income and foreign exchange market. And the main reason, as the author emphasize is changing in investors’ behavior.
El-Erian says that we came to the time when ‘you have to worry about the return of your capital and not return on your capital’

SEPARATING WHAT MATTERS FROM WHAT DOESN’T

In third chapter it was written that it takes time to understand the transformations that are ongoing now. As time is going things changes and we can observe it by reading history. Most people feel themselves comfortable and in peace ‘with predictability and repetition’ and we tend to escape from difficulties and noises. In the chapter author gives some points which will help us to ‘identify and think about signals within the noise’ and which will give as an opportunity to manage consequences in appropriate way. But we shouldn’t forget that the noise will always accompany this complex world and unless we start to predict it and think about the consequences we can’t get a balance in the world economy.
So to learn the hardest step – identifying the source of the noise we should have practice and discipline and develop an ability to immediately interpret the signal when there is a big amount of data is being released by market. It is also important to understand if the anomaly related to ‘steady state’ or to the process of getting to the ‘steady state’ and the last step that you should to is underline the factors that caused a rise in anomalies.
Another important point in this chapter is an explanation of different market imperfections and one of the most useful is ‘market for lemons’ –MFL. The meaning of it is that there are a lot of goods and services which have hidden defect and people can’t know about these defects and have not sufficient information. This market illustrates ‘the impact of information and signaling asymmetries and breakdowns’. The term ‘blindness to Black Swan’ implies that people’s bias about dismissing large major developments even if they will have great consequences. Human beings don’t want to believe in Black Swan because they used to see the world structured and understandable and don’t see many important things. There is a tendency to simplify all events and interpret data as they want to understand it.

'When markets collide'

Mohamed El-Erian is a managing director and member of PIMCO's Portfolio Management and Investment Strategy Group. He also has other businesses and plays very important role in PIMCO’s work. In may 2008 his book ‘When markets collide’ was published and he won the Financial Times Goldman Sachs Business Book of the Year for it. So what this book is about?

In the book author shares with his thoughts about present and future economical situation and shows analysis of the reasons why some serious global economists make such a strange mistakes sometimes and can’t say right subsequences of economic decisions. Mohamed El-Erian wrote this book for individual investors, economists and policy makers, “It provides readers with insights on how best to exploit new opportunities and minimize exposure to changing patterns of risks.”

As there are always a lot of transformations in global economy, market and policy infrastructures can’t always cope with all the problems and a good example of it is a series of collapses in US mortgage market and present turmoil in all over the world which affected almost all social communities. And all these inconsistencies show us that present economy is changed and now we can see that some countries start dominating while previously they didn’t have any influence on the global economy. Also El-Erian attaches significance to such thing as a market noise. People in market tend to miss noise and react only to different transformations while noise plays very important role in economy; they believe there is little point in thinking about the longer-term implications for investment strategies, business models, or national and multilateral policies. The author shares with us with his experience about studying and importance of this noise and says that now people started to notice noise and think about all the consequences beforehand.

Mohamed has investigated the present market and its future and says that now policy makers became data-dependent and still mostly react to transformations. Also the author explains present economical situation and shows that in future “due to the difficulties in being able to rapidly identify and adapt to multiple structural changes” some firms may fail, some investors may become relevant instead of popular now.

The author gives us appropriate ways of behavior in present economic situation, shows the a new big influence of SWF, risks which we can have now, ways of protecting our own portfolio and advices not think only about present transformations but also listen to the noise in markets.