Wednesday, November 4, 2009

Dollar-Equity Correlation: Roubini’s Wrong Again

From the Asia Times' Inner Workings blog:

Readers of this blog have been following the dollar equity correlation since Aug. 21 when I first write about it (and to my knowledge, I was the first analyst to publish about it — if you know of others please let me know).

Now the dollar-equity correlation issue is top of the financial blogs, for example this summary of views at FT’s Alphaville blog:

On Monday, none other than Nouriel Roubini, aka Dr. Doom, was making much the same argument in an FT opinion piece. Roubini, though, had dubbed it ‘the mother of all carry trades’ saying:

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius — even if they are just riding a huge bubble financed by a large negative cost of borrowing — as the total returns have been in the 50-70 per cent range since March.

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade — you short the dollar to buy any global risky assets.

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe — for now — for the mother of all carry trades and mother of all highly leveraged global asset bubbles.

So will it all end in tears?>>>MORE