Dollar Source: Used with permission from Bloomberg L.P.. FIGURE 9.8 IBEX 35 Index Source: Used with permission from Bloomberg L.P... Dollar Source: Used with permission from Bloomberg L.
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FIGURE 9.7 Euro versus U.S Dollar
Source: Used with permission from Bloomberg L.P.
FIGURE 9.8 IBEX 35 Index
Source: Used with permission from Bloomberg L.P.
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FIGURE 9.9 Spain Generic 10-Year Bond
Source: Used with permission from Bloomberg L.P.
destructive in terms of buildings, and more disruptive in terms of shuttingthe stock exchanges There was also the shock of the 9/11 attacks as theywere the first major attacks by al-Qaeda on American soil At that point, theUnited States or the world hadn’t previously experienced such an event anddue to inexperience no one was sure how to react When 3/11 transpired, themarkets were able to contextualize the event and realize that this would notnecessarily mean that a major disruption would ensue The airspace wasnot shut down in Spain, nor was the train system The biggest disruptions inSpain occurred due to the protests that happened the following weekend.The biggest indication that this was not a disastrous event for the finan-cial system of Spain was the fact that the European Central Bank didn’tthink it was necessary to lower interest rates to counteract the potentialdownside effect
The interesting play would’ve been to buy those Spanish bonds whenthey hit 4.25 percent or so The bond market went sideways for a monthbefore rallying very strongly to drop yields below where they had beenbefore the event Once again, they reestablished the existing trend in themarket The euro against the U.S dollar had a very similar play as well Itwas rallying prior to 3/11, sold off with the event, and then resumed its trendafterward To a lesser extent, the IBEX was not necessarily rallying prior
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to the attack, did sell off, and then began a major rally that would see theindex end at the highs of the year
JULY 7, 2005: LONDON TRAIN
AND BUS BOMBINGS
On the day of the attack, here’s what I wrote:
The greenback is wildly fluctuating with the news of a terrorist bomb attack in London The U.S dollar index is down 38 at 90.00 Globally, bonds are higher across the board as a flight to safety is occurring with the U.S 10-year benchmark at 3.98 percent In turn, equities are substantially lower, with markets down between 2 to 3 percent Gold is sharply higher by $3.50 at $427.25 and oil is lower by $1.15
at $60.15 Oil at one point was down $2.60 on the news The markets are now in the process of reversing previous moves with the exception
of selling the British pound.
London was struck by a series of at least six separate and apparently coordinated explosions in its subways and buses dur- ing the morning rush hour this morning, according to the New York Times “The explosions ripped apart a double-decker bus and caused officials to close and evacuate the entire subway system.” Reuters is now reporting seven bomb blasts The casualties and death initially appear to be substantial, but it’s still too early to tell Prime Minister Tony Blair is leaving the G8 meeting to return to London.
Blair made a brief statement before leaving: “It is reasonably clear that there have been a series of terrorist attacks in London There are obviously casualties, both people who have died and people who are seriously injured, and our thoughts and prayers, of course, are with the victims and their families .
“Just as it is reasonably clear that this is a terrorist attack or a series of terrorist attacks, it is also reasonably clear that it is designed and aimed to coincide with the opening of the G8 There will be time
to talk later about this It is important, however, that those engaged
in terrorism realize that our determination to defend our values and our way of life is greater than their determination to cause death and destruction to innocent people in a desire impose extremism on the world Whatever they do, it is our determination that they will never succeed in destroying what we hold dear in this country and in other civilized nations throughout the world.”
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I was watching Fox News on Saturday and they had on an sane number of people (seven) to discuss the housing market on Neil Cavuto’s weekend show One of the “interesting” choices to discuss that market was comedian Ben Stein However, he was one of the few commentators to provide a cogent response to what would cause the housing market to decline Essentially, he said there needed to be an exogenous event to disrupt employment and cause a decline in home prices An exogenous event The rest of Europe is on a heightened state
in-of alert U.S Homeland Security has not raised the alert level here Yet Let’s hope that exogenous event doesn’t hit on our soil today Expect to hear stories that this is payback for participation in the war in Iraq Spain and now the UK have been hit Poland, Australia, and Japan will be discussed as future targets.
The market is buying back U.S dollars as news of a freight train
in Turkey that was derailed by a bomb hits the newswires Airline and travel stocks are getting skewered early in European markets Both the Bank of England and the European Central Bank left rates unchanged However, this doesn’t exclude action later should the sit- uation warrant it Obviously, the UK’s economy will suffer and had been softening anyway This will accelerate the process And perhaps, bring forward a rate cut by the BOE as well It would be smart for the ECB to do the same.
The coordinated attacks hit London during rush hour, blowing up threeLondon Underground trains and one double-decker bus The explosionskilled 52 passengers, and 700 were injured (four suicide bombers werekilled) It killed and injured more people than any single IRA attack and wasthe worst in Britain since the 1988 Pan Am Lockerbie attack, which killed
270 There were so many rumors flying after the attacks it was difficult tokeep track of them—from talk of new airplane attacks in the United States
to stories of UK sniper units following a dozen al-Qaeda suspects in Britain
On July 21, some of those rumors came true as another attack occurred,but the bombs failed to detonate
From an economic standpoint, the major impact of the July 7 attack was
a daylong disruption of London’s transportation and mobile cation infrastructure The European Central Bank’s Jean-Claude Trichet, theBank of England’s Mervyn King, and the Federal Reserve’s Alan Greenspanall agreed that “the attacks will not have significant impact” on economicgrowth The Bank of England didn’t cut interest rates due to the event, butdid cut rates a month later by 25 basis points from 4.75 percent to 4.50percent (Figure 9.10)
telecommuni-With that in mind, let’s look at how the financial markets reacted TheBritish pound had just had a significant drop in value against the U.S dollar
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FIGURE 9.10 Bank of England Rate
Source: Used with permission from Bloomberg L.P.
in July and was making new lows for the year (Figure 9.11) After the event,
it put in a new low, then rallied, then put in another new low, then rallied,and then finished the month above where it had closed on July 1 That’ssome confusion in a short period of three weeks The British pound ralliedfrom there until the beginning of September, when it renewed its sell-offand eventually closed the year below the lows established in July This issupportive of the patterns we have seen—that an event can interrupt thetrend, but doesn’t kill it The event can provide and usually does provideexcellent opportunities for quick countertrend trades or even better trendtrades from better levels than existed before the event The generic 10-year
UK bond’s action was similar to what happened to Spanish bonds, but notnearly as dramatic (Figure 9.12) The UK bond yield fell during the eventand then quickly rose in the weeks after the event The yield would gosideways for the remainder of the year, but end the year at the lows of 4.10percent
For equities, we’ll look at the FTSE 100 (Figure 9.13) This index had
an initial drop that day of close to 200 points before recapturing almost all
of its losses It would go sideways for most of the month before resumingits upward trend It finished the year at the highs for the year
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FIGURE 9.11 British Pound versus U.S Dollar
Source: Used with permission from Bloomberg L.P.
FIGURE 9.12 UK Generic 10-Year Government Bond
Source: Used with permission from Bloomberg L.P.
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FIGURE 9.13 FTSE 100
Source: Used with permission from Bloomberg L.P.
SUM IT UP AND MOVE ON
Terrorist attacks are like heart attacks for the financial markets They ate tremendous initial uncertainty and discomfort as everyone attempts toassess damage and future risk, all within hours of the event There will be ru-mors of additional attacks, there will be misunderstandings of who was res-ponsible, there will be denials by some groups and other groups claimingresponsibility, and there will be extremely volatile markets
gener-In this environment of uncertainty, there are plentiful opportunities forthe coolheaded and well-prepared investor You don’t have to have tick-by-tick access to the markets to take advantage of the situations and pricemovements However, you do have to be prepared with an understanding
of where things have been from a trend standpoint and what the policy ofthe U.S Federal Reserve has been In this chapter, I have purposely left outreferences to the wars that followed from 9/11, but these will be covered
in a later chapter There were many repercussions from 9/11, 3/11, and 7/7that will be written about for generations My viewpoint is one of writing arough draft of the financial history that ensued from the perspective of only
a few years after the events The longer-term social impact will be felt fordecades
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C H A P T E R 10
Government Change
The world of politics provides rich ground for event trading and
analy-sis In fact, it is so fertile that I’m devoting two chapters to this area.This chapter is devoted to change in the party in power, and how thatimpacts the financial markets Like all of economics, this is an imperfect sci-ence and there are many qualifications of the event’s impact on the markets.Some political change is sudden, turbulent, and easy to see like Argentina’s
in 2001 Other change is more subtle with longer time horizons such as the
1994 shift in the U.S House of Representatives As in all the chapters, ourgoal here is not to develop a specific model that fits all types, but rather ageneral paradigm that we can use to analyze most of the changes in govern-ment that occur and how to make money from them
The three events we examine span a broad spectrum of change We look
at these chronologically as I believe each event would have been studied
by political parties around the world and learned from so as to not repeatexactly the same mistakes We look at the 1994 U.S midterm elections, the
2001 Argentina presidential elections, and the 2005 German federal tions The U.S midterm elections had the Democratic Party lose control
elec-of the U.S House elec-of Representatives for the first time in 40 years and put
in place the cast of characters who would see a U.S president impeached.The 2001 Argentine political and economic crisis would see the head of gov-ernment change three times in less than two weeks and cause the country
to massively devalue its currency Finally, the 2005 German elections werefascinating in that all of the fun and positive mojo by the victorious partywould be squandered before it actually took office
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1994 U.S MIDTERM ELECTIONS:
THE RISE AND FALL OF GINGRICH
The U.S 1994 elections for the House of Representatives and the Senatewere a watershed event for numerous reasons First and foremost, the out-come marked a change of the party in power in the House for the first timesince 1954 Next, the outcome marked the first time in 40 years that Repub-licans controlled both houses of Congress Last, it marked the first time that
a sitting Speaker of the House (Tom Foley) would lose his seat during anelection since the U.S Civil War in 1865 The Republicans gained 54 seatsand took control of the House of Representatives In the Senate they gained
8 seats and defended all 13 of their seats that were up for election TheRepublicans also gained 12 more governor seats in the states around thecountry This is why it is so important to review that year and understandthe changes that occurred and how those changes continue to impact U.S.politics to this day
The outcome was the culmination of tremendous change in the lican political leadership and ushered in a dramatic change in Congress.Congress had been a bastion of power for committees and the chairmen ofthose committees reigned supreme up until about the mid-1970s Then via aseries of scandals and new blood demanding change, these chairmanshipswere eroded until more power could be distributed to those who utilized akey new instrument in the legislative process: television The advent of C-SPAN and the broadcasting of congressional speeches dramatically changedthe way that members of Congress could get their messages or opinionsout to the public No one understood that better than Republican NewtGingrich
Repub-Scandal, Then a Contract
Congressman and then Speaker of the House Gingrich began laying thegroundwork for taking over power in the late 1980s and early 1990s Gingrichand the Republicans constantly attacked the Democrats and kept them onthe defensive, whether it was Jim Wright’s book deal or Dan Rostenkowski’sfelony indictment for abuse of House stamps or President Bill Clinton’sinvestment in Whitewater More important, the Republicans hung togetherand stayed united behind defeating President Bill Clinton and First LadyHillary Clinton’s health care proposal that both Clintons had staked as akey piece of legislation for the Democrats It never even got to a vote inCongress The Republicans did an amazing job of blocking all the attempts
by the Democrats to bring any important legislation to a vote during theelection year To some extent, this continues in Congress to this day during
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election years This is why all important bills must be brought up in thepreceding year and why you can honestly say that members of Congresswork for only half of their time in D.C
Late in the 1994 campaign, Gingrich and 300 Republican leaders peared on the steps of the Capitol to announce their “Contract with America”
ap-in which they pledged to carry out a 10-poap-int platform to reform Congressand pass major pieces of conservative legislation in the first 100 days oftheir rule I remember watching the event in the trading room as all themajor news outlets covered the story It was a coup for the Republicans andfueled their victory
After the elections, a state of political gridlock ensued as the licans controlled both houses of Congress (legislative) and the Democratsheld the presidency (executive) This has implications for the markets From
Repub-a common sense stRepub-andpoint, Repub-a gridlocked government meRepub-ans in generRepub-al one
of two scenarios can exist In scenario one, the two sides work together andcompromise over what the priorities for new legislation and for spendingwill be This means that neither side gets to do exactly what they want orspend exactly what they want Therefore, government expenditures gen-erally are contained, because no strong agenda gets favored, like healthcare In scenario two, the sides don’t work together, they don’t compro-mise, and no one gets anything close to what they want At best, this meansthat budget bills get passed and ongoing spending is at the same levels andsame priorities as the year before At worst, this means that the battlesthat flare up can escalate to a point where Congress refuses to pass budg-ets and debt ceilings for spending so that the government is effectivelyshut down
This latter scenario is precisely the path that the Republican Congresswent down with Democrat Bill Clinton The acrimonious relationship be-tween the Democrats and the Republicans led to partisan fighting and verylittle compromise This meant that very little legislation got done without
it being dragged on via extended debate This included spending bills andmeant that Congress would not overspend or increase dramatically theamount of money dedicated to new initiatives Keep in mind, this was allhappening after the fall of the Berlin Wall and the need to increase defensespending had dropped as well
Market Reaction
Let’s get to what was going on in the markets As always, let’s look at what theU.S Federal Reserve was doing at the time Throughout 1994, the Fed andAlan Greenspan were aggressively raising rates—they took federal fundsrate from 3.00 percent at the start of the year to 5.50 percent at the end ofthe year (Figure 10.1) They would raise rates to a peak of 6.00 percent in
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FIGURE 10.1 U.S Federal Funds Rate
Source: Used with permission from Bloomberg L.P.
February Look at what the generic U.S 10-year government note was doing(Figure 10.2); it comes as no surprise that the yield was rising along withthe Federal Reserve raising rates
This set the stage for a massive rally in 1995 when the Fed began tocut rates and we had a gridlocked government Note that the Fed cut ratesonly 50 basis points in 1995, but the yield on the 10-year note dropped fromalmost 250 basis points, from 8.00 percent to 5.50 percent Putting it anotherway, the yield on the 10-year was back down to the level it had started from
in 1994, but the fed funds rate at the end of 1995 was a whopping 250 basispoints above where it had been at the beginning of 1994
For stocks, clearly 1994 was not a good year, as the market was gesting the beginning of a monetary tightening cycle and uncertainty overthe change in the government In Figure 10.3, the Dow Industrials startedthe year at the peak and immediately went south upon the Federal Reserveraising rates Once the Fed policy makers changed their cycle to an easingone and the gridlocked government was in place, the Dow boomed and hadone of the best years on record Interestingly enough, large-capitalizationstocks outperformed the small-cap stocks in this rally, which could be in-terpreted to mean that no Republican Congressman could get the goodies
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FIGURE 10.2 U.S Generic 10-Year Government Bond
Source: Used with permission from Bloomberg L.P.
FIGURE 10.3 Dow Jones Industrial Average
Source: Used with permission from Bloomberg L.P.