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Warning on the Stock Market

In the last day the VIX in the US has solidily broken out of a decending triangle, I personally think there is a high probability for a dramatic move to the downside over the next month or two.

If you have funds in the Stock Market you might want to remember that cash is a position.

Henry Lui who manages a hedge fund in NY and writes for the asia times explains it this way.

"The theory is that winnings are balanced by losses so the overall system will alway be in equilibtium. That is true unless some of the losers cannot pay because they lose not only all their money but their credit rating with it. In this case there will be a squeeze that quickly turns contageous to the winners as well. In the past, the Fed could step in because the creditors could all be fitted into one room. But today, the counterparties are in the thousands all over the world and there is no way to work out a hair cut deal within the time frame to stall a meltdown to provide an orderly unwounding of the contracts. Even the Fed cannot inject money into the banks fast enough because the banks would not know whom to lend to. While the overall picture is fairly clear and understandable, the actual details of the webs of derivative trades are unknown to any living soul. You cannot pluck a leaking balloon if you don't know where the leaks are. The banks will face a liquidity trap while liquidity dries up in the system. This is why the Fed and many other central banks are beginning to focus on regulations. But it is too little and too late and most of the effort is designed to cover the political asses of central bankers rather than curbing systemic risk. Nobody knows when this will happen and how it would happen but happen it will. It could be triggered by non-financial events. Derivative traders now use models and real time market data from the likes of Reuters which supply real time data to feed trading models that include all kind of factors, from weather, to geopolitics to market movements.

These guys use data that make the government statistics look like stale bread.

Traders cannot stop trading in anticipation of what might happen because they can't afford the opportunity cost fo not trading to the last minute. Everyday that a melt down has not happened means the likelihood of it happening has increased, but enough days going by without a melt down neutralizes fear and caution and that is when it will happen. It will always be a surprise.

This is a completely different problem than a cyclical recession which will surface sometime in 2007, mostl likely by Q2."

I can't tell you that the market will decline 20% before year end. All I can tell you is that if it does and you ask me why I didn't tip you off, I will direct your attention to this email and tell you I gave you the clearest warning I could.

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