12/3/2009

The major U.S. indices closed the previous trading week with a somewhat stagnant movement in the wake of the widespread recognition of the debt crisis in Dubai. The DJIA made an insignificant move backwards losing only .0001% (-10.21 points) while the S&P lost just slightly more with a .07% decline. The more volatile NASDAQ had the most noteworthy turn downwards losing ground by -1.46%.

It appears the markets may have been awaiting the remedy for the forefront of current financial news. This resolution, whether a temporary fix or a longstanding one, deals with the city-state of Dubai's dilemma of repayment for the massive amount of debt it has incurred. The amount of funds owed approximates $60 billion for which Dubai is seeking a six month deferral on payments coming due shortly. This debt was incurred largely through the extravagant real estate development for the city-state through its government owned enterprise Dubai World.

Dubai is part of the UAE (United Arab Emirates) which consists of a total of seven emirates. The UAE operates akin to the United States in the approach that all the emirates unite under the same political, economic, legal, and military structure. An individual emirate also retains the sole ability to construe some functions of its operational undertakings such as the governance of its home facilities and the local law enforcement and provisions just as a state in the U.S. has the authority to do.

The UAE, however, has attributes within it that causes it to act unlike the federal government of the U.S. or other nations that operate in a similar federal framework. The most pertinent difference relating to the implications are not only for the markets of the UAE, but for indices worldwide. This disparity is that there is no obligation for a fellow emirate to come to the aide of another emirate in the event of a financial meltdown.

The mentioned option to help associate emirates has been the case for Dubai at the present moment. The investment world has been watching closely to see if its oil rich brother emirate, Abu Dhabi, would come forth and assist Dubai with its surmounting liabilities. If Abu Dhabi does not provide aide to Dubai, other measures would be forced such as a restructuring of the borrowed funds by Dubai or simply pure defaults on its obligatory instruments.


What Does the Debt Crisis in Dubai Mean for the Markets? 

Excessive borrowing without a sound means for repayment is what caused the financial markets within the United States to implode and, thus, caused a ripple effect throughout the world that sent markets across the globe to bottoms that have not been tested in decades. Should there be a fear that Dubai could do this to the world once again causing a second global financial crisis within less than a two year period? There are two strong factual notions that support the concept that the debt of Dubai will not cause a second international monetary crisis. These two realities are the following:

1) Many economic and investment authorities, such as myself, would affirm a second final crisis coming from the Dubai situation is a very unlikely scenario as the debt owed by the city-state is inconsequential to the lack of funds attributed to the highly leveraged credit crisis that unraveled in the latter part of 2008 in the United States. The International Monetary Fund estimates banks in the U.S and Europe will incur losses of $2.8 trillion between 2007 and 2010 as a repercussion of the current credit crisis which thwarts the $60 billion in debt not repayable - at least on-time -- by Dubai World. For the record, there is roughly another $20 billion in obligations owed by other businesses within Dubai that have been largely ignored by the media. Still, $80 million in total liabilities is minute in the grand scheme of things for international banking.

2) The calamity in Dubai holds a far stronger relationship to the collapse of the automobile industry of the U.S. than the American financial crisis that was engulfed within our economy for two reasons. These rationales are for the fact that it spirals from 1) an entity and 2) a single state. Dubai's situation is limited largely to itself and not the other emirates as well as only to the conglomerate Dubai World. The same type of relationship holds true for the U.S. auto industry where the catastrophe was rooted primarily in Detroit, Michigan through the formerly known Big Three automakers.

Ironically, Dubai's entity, Dubai World, is a singular business owned by Dubai, yet it is not backed by Dubai's government. The opposite is true with the auto industry in the United States. Originally, the automakers were not owned by the U.S., but what was saved from the Big Three during the auto crisis was backed by our government as the our federal structure took ownership of the remaining auto presence for the aide it gave to it. The psychological ramifications of Dubai not being able to repay its obligations when they come due, however, could likely cause a negative business perspective on the UAE as a whole. This is the reason that the world is watching to see if Dubai's wealthy counterpart, Abu Dhabi, would help in financing Dubai's problem as it is estimated to have liquid assets nearing $800 billion.

The correlation of Dubai and Dubai World to the UAE holds true also for the United States in relation to the automobile industry. If the U.S. government would have let one of longest known strongholds for the American economy completely collapse, not only would it have had a devastating effect on the economy, but on the American ability to repay the debt that has been instilled within the major American corporations through both U.S. and foreign investors alike. Although the relation of the U.S. government to the auto industry is much stronger than that of the UAE to Dubai World, the same psychological principle is still involved for both investors and firms looking to partake in future ventures within each federal system.

The American indices, for the stated reasons, should not experience a long-term negative impact should the news from Dubai be unfavorable regarding its current obligatory situation. Negative information relating to their debt crisis will likely only affect the U.S. equities in a less-than-positive manner in the short-term. This is a common investing pathology that occurs when there is a disturbance in any economic environment. In regards to the indices, this scenario plays out where the investing community makes a flight for safety into havens such as currencies or the bonds of large governments as individuals seek to avoid the undue risk associated with being in the equity marketplace.

This notion has further merit by the fact that only one U.S. bank, Citigroup, has any outstanding loans to Dubai. Countries that have banking systems with far more exposure to the extreme and luxurious growth of Dubai are those based in Great Britain. Barclays, HSBC, and RBS (Royal Bank of Scotland) are British banks that experts have approximated have the largest monetary lending to the troubled Dubai. To give a portrayal of the loans made to the emirates as a whole by the major countries, the following is from the article British Banks May Feel the Most Pain if Dubai Defaults (1):

(According) to the Bank of International Settlements and analysts reports, the U.A.E.'s biggest bank creditors as of last year were the British banks, which are owed $50 billion of the more than $123 billion. Following them are banks in France, Germany and the United States, which claim about $11 billion each.

The figures above provide a basis for the risks the British banks are facing resulting from Dubai's debt repayment predicament as the British have loaned nearly five times the monetary amount to the UAE as other leading nations.

The biggest lesson learned from the debt bomb in Dubai is that there may be other ones out there that are yet to be uncovered. If there are, the magnitude to which they are would have to be far larger than what is occurring in Dubai to create a second credit crisis. This would inevitably have to be the result of a larger nation incurring a debt repayment dilemma. As supported in my first rationale above, the ratio of outstanding debt of a nation, city-state or the like would have to be more than a diminutive amount, such as the financial obligations of Dubai, in relation to the debt created by the credit crisis. There are many nations out there, but few would have the creditworthiness to accrue the amount of liabilities to do this and, thus, ravage the marketplaces of countries across the globe as the United States did with its financial crisis.

Source: 1) Sanati, Cyrus. British Banks May Feel Most Pain if Dubai Defaults. DealBook. 30 November 2009. NYTimes.com. Web 30 November 2009. http://dealbook.blogs.nytimes.com/2009/11/30/british-banks-may-feel-most-pain-if-dubai-defaults/

Fundamentals 

The economic calendar below is for the first complete trading week in December 2009 which commences on the anniversary of Pearl Harbor. It delineates the days and times for important economic figures and individual addresses that, for the most part, should move the indices upon their releases.       

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Sentiment

The Volume and Open Interest report from the CME for November 30th’s final close states there are 19,696 puts open compared to the 11,979 calls for the December E-mini. The outstanding puts and calls from this report offer a put/call ratio of 1.64. This sentiment indicator is up by 40% since my last report. In my past two writings, the number has hovered between 1.18 (November 25th) and 1.19 (November 18th) after making rapid declines in the analysis of it done prior to these two previous figures.

From the point of a contrarian, this sharp upward move in the ratio indicates that there is much more bearishness entering the markets once again since my two preceding reports. This investing standpoint advocates not following the crowd and doing the opposite, hence, signifying a bullish signal for equities. The marketplace should make at least a nice minimal move upward before any type of decline in the indices would occur according to the contrarian school of thought for trading and investing.