Structured equity products, more than hedge funds, 

     behind crash

By Brendan Brown

October 08:- Most market participants believe that hedge fund liquidation and short covering were a major factor in the extraordinary slump,the subsequent rally on Monday and Tuesday and then the further plunge on Wednesday October 15. From October 7through October 10, the S&P500 index plunged 22.5% from 1065 to 832 intraday and then soared by 28% to 1063 at its intradaypeak on October 14. By the close on Wednesday the market was down by 12% again. Similarly, Japan's Nikkei index.dropped 26% at the end of last week and then surged 31% before tanking again. There were thus huge losses and gains as well as frustration and then relief for those who missed out in these 24 hour violent "bear" and "bull" markets.

Issuers of structured equity products dump stocks

At a dealer meeting that I attended, during the crash, the theme was structured equity products. Our conclusion was that there was huge downward pressure from the forced sellers. These may well have included some hedge funds. But quantitatively, more important, were the insurers of the vast array of structured equity products. These products offer their holders guarantees of principal repayment in full (in exchange for caps and limits to upward potential when equity markets are rising). The issuers took panic action to cut losses.

In that respect, the series of crashes were more similar to the October 1987 collapse than that of October 1929 when the margins of individual investors were wiped out.

The potential for a technical recovery stems from the wall of money from investors who now have a low exposure to equities. Hedge fund shorts have also been covering. Against this potential buying are the continual reports of negative earnings, causing individual stocks to fall and indices to follow suit. There is also an overhang of structured equity products and stocks held by distressed hedge funds, asset managers and stale bulls. Illustrating the uncertainty, on Monday, the trend was mainly upwards, but on Tuesday and Wednesday further sales from issuers of structured equity products and whipsawed hedge and mutual funds saw the S&P 500 index tumble from a Monday intraday high of 1063 (28% above Friday's intraday low), down to 900 points.

Where do we go from here?

Despite present gyrations the US market could proceed on a flat but volatilie trend until the Spring 2009. The bottom last Friday was probably the bottom, but S&P could oscillate mainly between around 900 and 1100, averaging just south of 1000. Plus side factors would include optimism on Obama program of fiscal reflation and a calmer financial system. Dips could include very likely deeply negative news about the European economy (including an East European emerging market crisis) and geo-politics. On the assumption that US recession could bottom out in the Summer 2009 and a growth cycle upturn starts around three quarters later (Spring 2010), a sustained stock market recovery (still volatile ) could get under way fromSpring 2009. Morover with risk-free rates on short term government securities having by then fallen to virtually zero everywhere, therewill be an appetite for potentially higher returns. This will apply especially to cash over-loaded investors.

European markets will follow the US lead but very weakly. The reason is that Europe is entering a lost decade ( i.e. lagged falls in real estate, overtight monetary policy, lengthy overvalued exchange rates and non-transparency of losses in the financial system). Japan and other East Asian markets will follow the US.

Brendan Brown is London-based chief economist at Mitsubishi UFJ Securities International and a financial markets historian.


Copyright © All Rights Reserved.

Content on the site is copyright of and its writers. Reproduction of this publication's copyright material is not permitted in web, electronic, printed or any other form without the written consent of the publisher. See Dangers of Flouting International Copyright Law For syndication rights please email This site is for information purposes only. The publication neither recommends nor advises on the investment and trade in currencies, bonds, stocks, commodities, futures, options, other derivatives, funds or any other financial or investment product or instrument. All information has been obtained from sources believed to be reliable, but accuracy cannot be guaranteed. Readers are solely responsible for the use of this information. They should not rely on it and should regard it as only one of their sources. They should seek advice elsewhere. The publisher of, panellists, other forecasters and contributors disclaim liability for any loss, damage, injury or expense that might arise from the use of the information and services contained herein. For further details on Marketpredict's code of conduct, disclaimers and dangers of flouting international copyright law, please examine Who We Are.

no registration needed

Research & Consultancy
services from Market Predict

Research & Consultancy

Asset allocation
Base Metals
Precious Metals
Softs & Grains
Hedge Funds
Endowments & Pensions
Environment & Recycling

  Lateral Scenarios
Market Psyche
  Code of Conduct
Who we are
Useful sites
Website Design
© 2006 Command Media