[The first installment in an ongoing occasional news series that looks at the anticipated “aftershocks” of the global financial crisis, in some cases even exploring possible profit opportunities.]
By William Patalon III
Money Morning/The Money Map Report
It used to be that buying a stock was like buying a house. You’d find a house that looked super from the street – and inspect it carefully, before committing to a deal.
But what if you couldn’t get inside? Or even worse, what if the property changed after you carefully inspected it, so that you ended up buying a house with a trashed interior, or a crumbling foundation that made the house risky to live in, and virtually worthless to sell? Or what if a new regulation made the house you spent so much for – and had saved so long for – obsolete overnight, so that you were left with nothing to show for the years of saving and investing, possibly even forcing you and your spouse to forgo your long-dreamed-of retirement? Instead, you both have to keep working.
That’s a lot like what we’re seeing in the U.S. stock market right now.
If the “house” I referred to is an analogy for the stock market, we’re all having to watch as government regulations, elected lawmakers, credit providers, rating agencies and others all work to change the way business is conducted – in many cases, changing the game after consumers (investors) spend all their hard-earned savings for that house (major stock or mutual fund purchase).
If that’s truly the case, it’s understandable if most U.S. investors are left feeling burned – or even worse, helpless – to the point that they’ve decided it’s better to just sit on the sidelines. After all, why participate in a game in which there’s no way to win?
But what if you knew, ahead of time, what marketplace changes to expect? Then you’d be in the driver’s seat – right? You’d know what to anticipate, could craft a profit strategy to follow, and then could just sit back, watching and waiting for the events you’ve already positioned yourself to profit from.
Investment expert R. Shah Gilani – a retired hedge fund manager who’s been chronicling the credit crisis as a Money Morning contributing editor – thinks it’s possible to peer into the future and see the changes that are looming. Gilani, the editor of a new trading service called the Trigger Event Strategist, is predicting a series of so-called “aftershocks” from the financial crisis that investors need to watch for.
These “trigger events” are seismic occurrences that will cause major aftershocks. And the fallout from those aftershocks will bring about marketplace changes that, properly played, can be exploited for profit, Gilani says.
“It’s like having a meteor hit the earth,” Gilani says. “Because of the seismic-level events that will result from the aftershocks of this meteor strike, there will be all sorts of other trigger events” that will translate into profit opportunities, if properly played.
Some of these will involve going long – that is, actually buying the stock, option or security that’s likely to benefit the most from the trigger event. But this strategy can also involve short selling – identifying the company, stock, fund or security that’s going to be punished the most, and profiting on that decline.
In this story, we’re going to take a look at five key aftershocks investor can look for. These are by no means the only ones Gilani is predicting: But they are five of the most dramatic, and are among the most important ones investors need to be able to understand and interpret. They are:
- The collapse of the investment banks.
- New government regulations.
- The implosion of the commercial real estate sector.
- The transformation – and consolidation – of the insurance industry.
- And the overseas fallout that will force the International Monetary Fund (IMF) to intercede.
Let’s consider each “aftershock” in a little more detail.
- The collapse of the investment-banking sector: Lehman Brothers Holdings Inc. (LEHMQ) has filed for bankruptcy, Merrill Lynch & Co. Inc. (MER) will become part of Bank of American Corp. (BAC) – guaranteeing itself a dependable source of capital, via bank deposits, but also putting itself under much closer regulatory scrutiny. As a Money Morning investigative report showed, banks are using bailout money to buy other banks, or investment banks, creating some real behemoths.
Investment banks used short-term borrowings, and a lot of leverage, to operate what was an “extraordinarily profitable business,” whose services were needed, Gilani said. Indeed, the need remains and the model wasn’t completely bad – it was the extraordinary use of leverage, combined with some questionable “financial engineering,” that caused the sector to go off the tracks.
“Even now, if you could go back in time and buy Goldman Sachs (GS) at its IPO, would you do it? Of course you would. It’s an extraordinarily profitable business model,” he said. “Not long after this cycle returns, and the [investment banking] players come back onto the field, [you’ll be able to] invest in Citi (C), or you can invest in Wells Fargo (WFC) … but why don’t you come back and redo the old Goldman Sachs model? After all, you remember how profitable it was for such a long time.”
Gilani’s projection: Scrutiny and oversight will increase in the near term, and for some time to come. Look for private equity firms – and hedge funds – to step in as the new providers of the capital dealmakers need to provide needed investment banking services. And don’t be surprised – eventually – to see banks spin out their investment banking arms into standalone units that are better able to maneuver and capitalize on the available marketplace opportunities.
2. New government regulations: The United States must remake itself to once again become the kind of financial market where there’s the right mix of free-market capitalism and nurturing/limiting government regulation – for that’s what created a strong global confidence in the U.S. financial system. Right now, that confidence has been lost, meaning the all-important process of “capital formation” could go elsewhere – to Shanghai, Dubai or London. That would be devastating to any possible U.S. economic rebound, given that financial services is a crucial piece of the country’s $14 trillion economy, and the fact that the sector employs an estimated 6.6 million people.
Gilani’s projection: As this unfolds, there will be opportunities for profit via something he calls “regulatory arbitrage.” But it’s still very early in the game here. Look for a separate Money Morning report on this “aftershock” within the next week.
3. The implosion of the commercial real estate market: Citigroup is cutting 50,000 jobs, Lehman Brothers is in bankruptcy, and consolidations in the financial-services sector are escalating. The bottom line is that these are all possible trigger events leading into the collapse of the commercial real estate sector. This will be “much more problematic than the implosion of the housing sector, as commercial real estate is much harder to move,” Gilani says. “And some of the most expensive real estate anywhere is in the financial-services sector.” Job losses will translate into still more trouble in the commercial slice of the residential real estate market – as expensive apartment buildings and condominiums remain vacant, and unrented. Consumer confidence is shaky, so consumers aren’t spending. That means that retailing is also suffering badly, some chains are closing locations, and some – such as Circuit City Stores Inc. (CCTYQ) –- are even turning to bankruptcy. That’ll leave open spaces in untold numbers of malls and shopping centers
Gilani’s projection: “We’ll hear a very loud ‘thump’ when this other [credit crisis] shoe falls,” and it won’t be good for the overall economy’s health, he said. But even a seemingly negative aftershock such as this one provides potential profit opportunities.
4. The consolidation of the insurance sector: The collapse of American International Group Inc. (AIG) was just the start of this story, not the end, as many investors believe. Some companies will be swallowed up by others, and some of those successful suitors may actually thrive, making them enticing profit plays. Indeed, with this aftershock, there will be profits to be made on the way down, and more when the rebound comes.
Gilani’s projection: The government can seize banks, allowing the weak ones to fail so long as it guarantees depositors’ money. But it’s a whole different story with an insurance carrier. “If your bank goes out of business, and your money is safe, all it means is that you might have to go elsewhere for a loan. And with fewer competitors, that loan might cost more,” Gilani says. “But if an insurance company goes under, and you don’t have the health insurance, disability insurance, or annuity that you’ve been paying on and counting on, well, that’s devastating.” So devastating, in fact, that the government can’t allow that to happen.
5. The mobilization of the International Monetary Fund (IMF): If there’s one decision that U.S. Treasury Secretary Henry M. Paulson Jr. wishes he could have back, it is the decision to allow Lehman to fail. It was a “line-in-the-sand, get-tough decision, and it was a huge mistake,” Gilani believes. With the inherent instability in today’s world – and the potential for terrorist regimes to gain power – the IMF won’t risk drawing a line in the sand with an at-risk country, he said. Instead, the IMF will employ a “good neighbor” strategy, and help all those it can. And that help will come in the form of major capital infusions – $100 million or more. This will stop any possible “contagion,” like the one that emanated from Asia in the late 1990s. And it will prevent some alluring profit plays, Gilani says.
Gilani’s projection: Some recipients will resent the get-tough policies that the IMF requires countries to put in place. But those policies are good, and actually make the country strong in the long run. Some of the countries he expects will be receiving this capital will make for excellent investments. Again, stay tuned.
Final thoughts: By watching for these “aftershocks,” Gilani says “the bottom line is that, as these events unfold, you’ll understand the ramifications – and you’ll have the chance to trade them ahead of the curve, often for significant gains.”
[Editor’s Note: Contributing Editor R. Shah Gilani has toiled in the trading pits in Chicago, run trading desks in New York, operated as a broker/dealer and managed everything from hedge funds to currency accounts. In his recent journalistic investigation of the U.S. credit crisis, Gilani was able to provide insider insights that no other financial writer or commentator could hope to match. He drew upon the experiences and network of contacts that he developed through the years to provide Money Morning readers with the "real story" of the credit crisis – and to propose an alternate plan of action. It’s a perspective on the near-financial meltdown that more than a quarter-million readers have read in Money Morning alone – not to mention the 2 million estimated to have read his unique insights on Web sites worldwide.
How can you protect yourself from these daunting aftershocks? Well, with the U.S. financial markets in such disarray, Gilani has launched the Trigger Event Strategist, a specialized trading service that looks to profit from the predicted aftershocks. In a new report, Gilani details the aftershocks, the “trigger events” expected to emanate from them, and his plan to play these powerful global trends for profit.
In the meantime, continue to watch for Gilani’s thought-provoking columns in Money Morning – including his just-published U.S. economic outlook that’s part of our new “Outlook 2009” New Year forecast series.]
News and Related Story Links:
- Money Morning News:
Citigroup Whacks Another 50,000 Jobs; Cuts Expenses by 20%.
- Money Morning Credit Crisis Investigative Series:
The Inside Story of the Collapse of AIG.
- Money Morning 2009 Economic Forecasting Series (Part II):
For the U.S. Economy in the New Year, the Pain Will Precede the Promise.
Asian Financial Crisis.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.