Economies and Investment Risk Management
By Mike Lauterborn
(for Sacred Heart University)
9/27/11
Fairfield, CT – The world has turned – and changed dramatically – since the global financial crisis of 2008. Investors are still licking their wounds and sitting on their funds, hesitant about getting burned again. What’s happening now with various economies, what’s down the road and how can an investor minimize risk while reaping solid returns?
That’s what a panel of leading experts stepped in to speak on at Sacred Heart University Thursday evening, Sept. 15, addressing a full house of students and business people in the Schine auditorium with a presentation titled “Recent Developments in Financial Risk”.
The informative talk was moderated by SHU’s own Dr. Lucian Orlowski, chair and professor of the John F. Welch College of Business’ (WCOB) Department of Economics and Finance, who expressed, “We need a major rewrite in finance to account for risk forecasting.”
Working toward that goal was first speaker Dr. Bluford Putnam, chief economist of the Chicago Mercantile Exchange Group, who boasts a rich background in finance and is the author of several related books. His focus was “Integrating Risk Management into Asset Allocation: Era of Great Divergence.”
“What did we learn from the financial panic of 2008?” Putnam asked the gathering. “The pieces of the puzzle didn’t go back together so well. The system hasn’t come back like people thought it would. When you come out of a financial panic, you take risk down. You want to be less in debt. The U.S. is currently tapped out. Companies are back but sitting on their cash. The Federal funds rate is near zero and consumer price inflation is rising toward 4%.”
In studying the world’s economies, Putnam observed great divergence occurring between the U.S. and certain mature markets versus emerging economies, which puts the U.S. in jeopardy. “China and the U.S. are aging fast -- China in particular because of its “one child” policy. “In 2020, China will have an older population than the U.S.,” he said. “And yet, China has a rural to urban migration, which makes it seem younger. At the same time, Russia, whose population is shrinking, can use energy to exploit its growth potential.”
Putnam continued, “Brazil and India have well-managed central banks, and there’s a lot of consistency,” Putnam continued. “Mature countries’ interest rates are at 0% while emerging are at 7% or 8%. Countries like Brazil and China have a lot of the United States’ debt and what they do with it will determine what happens here. Europe issues debt in Euros, which is a problem as no central bank controls it.”
In short, Putnam summarized, “Emerging markets are coming up and doing well, and there are big swings between ‘risk on’ and ‘risk off’ investments. We’re not going back to the period of 1950 to 2008. 2008 was like a big party and we all collapsed in a heap and didn’t get up again.”
Directing his comment to the student body, Putnam cautioned, “I hope you’ve got job opportunities in other countries as there will be none here.”
On Putnam’s heels, Dr. Kwamie Dunbar, an assistant professor in the WCOB’s Department of Economics and Finance, focused on “Recent Developments in Financial Risk: Credit Risk Dynamics in Response to Fed Changes.”
Dunbar said that in 2007-2008, investors reassessed their risk, making it difficult for a number of highly leveraged firms to raise operational capital. The Fed hasn’t made things easier: there have been times when investors expect the Fed, when they meet, to do something and they don’t. “Investing gets affected each time,” he suggested.
Following that thought, Dunbar’s department colleague, Dr. Abu Amin, said that studies show there is a high probability of change in the Fed funds target rate during a week when there is an FOMC (Federal Open Market Committee) meeting. “When the Fed unexpectedly lowers the target, counterparty risk responds more favorably,” he said. “During expansion periods, an unexpected increase in the Fed funds target rate is especially helpful to risky debt.”
Capping the presentations were Albert Cheng, Senior VP of Atlantic Asset Management and Sidney Hardee, Managing Partner of Hardee Brothers, LLC. The mission of their respective firms is to find ways of using interpretive data to guide investors.
“We look at opportunities and have to come up with risk metrics on a minute-by-minute basis,” said Cheng. “There’s a lot of volatility in the market. You can’t just look at quarter to quarter or month to month.”
Cheng said that ETF (Exchange Traded Funds) usage has changed investing. “Individuals can now access markets instead of going through brokers. More players creates more volatility,” he noted.
Hardee elaborated. “ETF handling has evolved from traders (hedges, speculators, arbitrageurs) to institutions (hedge funds, corporations, portfolio managers) to intermediaries (broker dealers, RIAs) and finally to individuals (retail). When I can sit in flip-flops and p.j.’s and trade gold, the market has changed.”
Hardee advised, “To be successful as a pro in the financial world, you need to develop framework to identify and manage risk. Then you have to categorize risk: mitigate one set and take advantage of the rest.”
Hardee’s market approach involves taking a variety of commodities and currencies – 60% U.S. equities, the rest global – synthesizing everything at the macro level then making buy-sell decisions. That strategy, he said, has yielded 7% to 8% performance with less volatility.
“You really have to take all you’ve heard tonight, boil it down and apply it to all markets,” Hardee suggested, receiving nods of appreciation from the gathering.
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