Monday, July 13, 2009

5 Ways to Profit Fast if the Financials Beat Expectations?

Advice from a Global Markets Trader

Every major market move since the current economic crisis started, has originated with the earnings picture of the financial sector. With the banks the crisis began, with the banks the March rally began. Thus it's hard to imagine a better way to revive the rally than upside surprises in the financials

If they surprise either way, traders need to have a plan in place.

Logically, The Banks Shouldn't Be Profiting, Right?

What am I missing? Given their apparently deteriorating fundamentals, banks should not be showing Q2 profits.

Official unemployment is 9.5%, well beyond the worst case stress test 8.9% levels. Each decimal point means thousands to tens of thousands of additional bad mortgages and credit card debts. It means less spending and thus more bad commercial mortgages. It means more job losses, which means less spending, and so the vicious cycle goes.

Yet the New York Times recently ran an article predicting profits at Goldman Sachs. Noted economist and NYU Professor Nuriel Roubini has also acknowledged that due to changes in FASB accounting rules the banks may be able to show good results for another quarter or so. He doesn't go into detail about how this could be.

So one should at least be prepared for the possibility of positive bank earnings.

Yes, it's conceivable that with enough cooperation from regulators, enough bad debt can "revalued" or just plain moved off the balance sheet, all fully legal. Yes, it's also possible to create enough fake profits, as was done via AIG, to feed the major banks profits. Yes, in a worst case scenario, Washington can invoke "the greater good" and just plain print up some cash to give them.

These are possibilities, but I don't claim to understand how it's really going to be done

I've tried to follow some of it. There was a very good article: Exclusive: Big Banks' Recent Profitability Due to AIG Scam, though it got a bit too technical to fully follow.

What to Do if The Financials Surprise to the Upside?

While I may not understand how they'll do it, I do know how to respond in order to profit from the news.

Here are some of the obvious ideas from someone who follows global stock, commodity, and currency markets.

The Main Idea: Buy Assets that Feed "Risk Appetite"

The overall concept here is that because confidence in the stability of the US financial system has been at the heart of the current economic crisis and March rally, expect a burst of optimism to break out in the global markets for any asset that increases in value on improved growth prospects. Another term for these kinds of assets used in the currency and commodity trade is "risk assets, " assets that carry more risk but benefit more if conditions improve

These are assets that rise with optimism about growth. Even if the bank profits are as fraudulent as those in Q1, we might well see a rise in optimism, and those prone to short term trading for short term fast profits could score. Here are some of the obvious ideas from someone who follows global stock, commodity, and currency markets.


Short term traders should buy stocks and stock indexes, the more volatile the better, or related ETFs. Longer term investors seeking income should begin to take partial positions in their favorite stocks IF they're willing to watch them and put stop losses under them when the reality about the banks finally surfaces. If they can't watch these or won't put stop losses underneath these to minimize risk of loss, they should stay out of the market.


Get Crude: Most commodities rise with growth prospects. Industrial commodities like crude oil obviously find greater demand. Crude oil has been among the most volatile, fast to rise when the mood is good, fast to fall when fear takes over, almost ignoring actual supply/demand factors like inventory levels. Note: related commodities would also be likely to do well.

Gold: With prospects for rising growth comes the prospect for rising inflation. Given the explosion in new bills circulating in all major currency groups, the only thing holding inflation back is the deflationary pressure of recession. Once that is gone, it will be difficult for governments to control inflation given the unprecedented, massive expansion of money supply. When there is fear of inflation, gold rises. Fast. Note: Silver would also be expected to rise along with gold.



There are 2 kinds of currencies that do well in times of optimism.

One kind is commodity currencies, the AUD, the CAD, and to a lesser extent, the NZD. Economic expansion means increased demand for the commodities on which these economies are based, thus these do well.

The other kind are high yielding currencies that are bought for "carry trades". These include the AUD and NZD. "Carry trades are simply currency trades involving the sale of a low yielding currency in order to buy a higher yielding one and profit on the difference in interest between the two the longer you hold them, as long as the lower yielding currency that you sold doesn't rise in value relative to the higher yielding currency, one can earn the difference in interest.

Because currency trading is usually done with leverage, often 100:1 or more, even $5000 can control $500,000 in currency like the AUD. If you're earning 3% on AUD and paying almost nothing on the JPY you sold, so 3% of $500K is $15,000/year or portion thereof. Moreover, if risk appetite/optimism continues to rise, you profit on appreciation in the higher yielding currency against the lower yielding one you sold.

The same principle applies to other currency pair, I merely present a few of the most obvious ones.

What to Avoid

Safe-haven Assets: Most kinds of cash, especially low yielding, safe-haven ones like, JPY, USD, CHF, EUR and US Treasuries.

These have low yields, and will be dumped by currency traders. Moreover, currencies that have had major expansions of supply (almost all major ones, but especially the USD) will be vulnerable to inflation.

On the Other Hand, If Bank Earnings Disappoint

Quite simply, do the opposite, avoid or sell short stocks and commodities, hold JPY, USD, and CHF in that order. Sell the AUD/JPY, buy the JPY versus anything. Review my past articles, since this has been my belief.


The above is just a brief overview of where traders should look to trade long if banks surprise us once again and once again spark a rally in stocks, commodities, and higher yielding and commodity currencies.

Disclosure & Disclaimer: the author may have positions in the above instruments. The opinions expressed are not necessarily those of AVAFX

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