Thoughts at the Edge of a Perfect Storm

Can the financial models of hedge funds and investment banks adequately account for what will happen when everyone makes their decisions from similar models?

I'm not sure American investors recognize how jammed the exits became when Mumbai's Sensex recorded its worst-ever point decline.

Or when investors took $8-9 bln USD out of Turkey's market--almost as much as they had attracted in capital last year.

Russia's stocks lost a quarter of their value in nine days.

In all, the recent losses in emerging markets were the greatest since 1998.

It's relevant to American investors, because daily changes in the emerging markets correlate about .74 with daily changes in the S&P 500 Index.

Banks are key to the contagion of financial crises.

Which is why the health of emerging market banks is of great concern in the face of growth problems.

Though South Africa was also caught in the downdraft, it remains confident that growth in China and India will continue to prop up its own and world economies.

There is hope that this is merely a correction brought on by rising U.S. interest rates and that the emerging market story has not come to an end.

No, the decline has not caused any aversion to investing in Asia.

Just witness the stampede for China's bank IPOs, which have attracted the participation of one in every five or six Hong Kong adults.

These are banks with untested risk management systems and a history of corruption.

And they propose to ramp up their loan issuance, even as China raises downpayments required for real estate transactions in an effort to dampen the explosion of (bad) loans.

For now, though, we're told there's no need for alarm in the Philippines and other Asian markets.

But, if I recall correctly, it was after the storm--and a sigh of relief--that the levees broke in New Orleans, in the face of multiple danger signs.

When everyone is drawing upon similar models, is it just a matter of time before they all head for the exits and create a Category 5 storm?

Note: More intermarket perspectives will be posted to the Trading Psychology Weblog later tonight.