Tips to survive the massacre

Dubai: The financial world's equivalent to the "Chainsaw Massacre" is clearly upon us. The indices below reflect total mayhem; the last guesstimate I heard: $30 trillion (Dh110.2 trillion) of asset values slashed. Real panic as the chainsaw works its ugly cuts.

Amidst massacre there will be opportunity. The shiny-cuff-linked financial adviser will tell you to "average in". I agree. With the one caveat: the more astute will be looking at the opportunity to balance averaging-in (regular buying) with great market timing. Here is today's question: how do you know when the market is turning?

Warren Buffett's exam answer might include comments such as: when people are fearful "I am greedy"; when people are greedy, "I'm fearful".

Chainsaw slashing is a buying opportunity for Buffet, but then he has lots of liquidity to play with. He might also conclude with "when the Robin sings spring is over".

The problem for the layman is in knowing the weather patterns. This week's space seeks to outline three key dashboard indicators that help. First up: the "fear index", or the VIX index (its ticker title). A good one this, and last week's scores show that the Chainsaw Man is still amongst us.

For Howard Smith (QIM Asset Management) "share price complacency" is at around 20. The higher the number the greater the fear. At 20 you can watch the film without the fear of spilling your choc-ice.

This year we have had it as low as 15 which is cartoon stuff.

The October high was at 80 with last week ending around the 60's. Apparently it dipped towards 40 with the Obama factor until the herd realised that leadership change is not sufficient for chainsaw blockage.

Massacre Man is still therefore amongst us: "it's almost impossible to make money too far above 20"says Smith. 60 is therefore really scary.

The VIX is the symbol for the Chicago Board Options Exchange Volatility Index. It relates to stock market volatility embedded in the near-term S&P 500 option prices and is said to reflect the market fears over the next 30 days. The fact that you have not been to Chicago is irrelevant in this globalised and very-coupled world.

For many fund managers, the Americans got us in, and the American (equity markets) will lead the way out. If this is true the VIX will become an extremely useful guide.

Second on our crisis dashboard is the 3-month Libor rate, and particularly its relationship with the Overnight Index Swaps (OIS rate). This environment provides insights into the amount of liquidity around and the willingness of banks to lend to each other.

Libor relates to the London Interbank Market; rates are a good reference for all of the worlds most liquid and interest-rate driven markets.

In dollar terms, the spread between Libor and the OIS represents the premium paid for inter-bank lending against dollar overnight swap rates which capture central bank interest rates.

Libor/OIS reached an all-time high at 2.94 per cent in October. Most of the year it had operated at below 0.1 per cent; the jump therefore reflecting massive loss of confidence in inter-bank lending. The higher the rate, the more disinclined banks are to lend to each other.

Whilst Libor rates and the Libor/OIS spreads are still abnormally high, they are down on October. The feeling is one of gradual, but only very gradual improvement. VIX might well need the Libor/OIS spread to settle down before it settles down.

Third on our dashboard is the TED Spread. This is the difference between 3-month US Treasury Bills and 3-month Eurodollar Bills. The resulting difference is an indicator of credit risk, and specifically, the fear of corporate default. The "fear" is measured on the basis that the US T-Bill is considered to be the "risk free rate" and the US has never defaulted on a debt. The Eurodollar rate is the rate given to corporate borrowers. A high spread would suggest greater fear of corporate default.

For most of the year, the spread has been between 1 and 2. October witnessed the spread at around 4. The suggestion is that the herd saw the risk of corporate defaults at around 100 per cent more likely.

Today's "averaging-in" remains a remarkable opportunity to enter the markets before the Robin starts singing.

Markets are way-off their recent past means. The "fear indices" demonstrate how far off. The big point though is: when the fear subsides, will you be in the position to have benefited from fear?

To re-quote Glyn Own at RMB, "crisis is when the scared hand wealth to the brave."

The writer is chairman of Mondial Financial Partners LLC

The VIX is the symbol for the Chicago Board Options Exchange Volatility Index. It relates to stock market volatility embedded in near-term S&P 500 option prices and is said to reflect the market fears over the next 30 days.