The parallel between market risk and Domino effect.

Domino theory

The domino theory was a theory during the 1950s to 1980s, promoted at times by the government of the United States, that speculated that if one state in a region came under the influence of communism, and then the surrounding countries would follow in a domino effect (Wikipedia).

What is Domino?
For the last seven years, with only one failure, a world record has been broken in the small city of Leeuwarden, Netherlands. On November 13, 2009, in an hour and a half, almost 4.5 million dominos toppled each other over in a variety of ways; including climbing stairs, uncovering hidden pictures, tripping domino “trap doors,” and creating a pyramid replica. The 4.5 million in fallen dominos broke the previous world record of 4.1 million set the previous year on what is now officially called Domino Day, occurring on the second Friday every November. The construction of the set took many days to complete as each stone (the official term for a domino) was carefully placed with tweezers to assure its position was perfectly situated. As remarkable as it was to set up and tip 4.5 million dominos, it is concern over the falling market “dominos” that has grabbed the majority of attention as of late. Ironically, just like the epicenter of the market‟s recent concerns, the falling domino world record took place in Europe, comprised of a team of 90 domino experts from 14 European countries.

The real question for the market remains whether the falling European dominos of Greece, Spain, Hungary, and others will be strong enough to knock over enough stones to topple the global economic recovery and emerging expansion.


My investments are not directly impacted by government debt. Market Domino While most people understand the current global debt crisis is a serious matter. 3. 4.The parallel between market risk and Domino effect. many investors and market pundits prescribe to the Domino Theory. These include the nearly 8 million workers who lost their jobs. many investors may still be thinking along these lines: 1. to the list of casualties caused by the most severe recession since the Great Depression. and Hungary — is not the first domino to fall. As a result of the many victims that have been hindered by the after effects of this recession. home losses. The thought is that the already fallen dominos. Companies are healthy right now. 2. hundreds of thousands of homeowners who lost their residences. Greece. we can add troubled countries. Now. such as unemployment. it is just the latest. While there is some truth to the statements above. it is vitally important for investors to   Remember The Domino Effects That Occurred In The Economy And Financial Markets During The Mortgage And Housing Crisis and To Have A Specific Risk Management Or “Stop Loss” Strategy In Place For All Their Investments Case Study on Europe: It is important to note that Greece — followed by Spain. have created a wave that will spread through the global economy to systematically knock over all dominos and send the world back into a double-dip recessionary episode. 2 . like Greece and others. and the too-many-to-count number of small businesses that had to close up shop. and others.5 million dominos that toppled in succession to break the previous world record. which states that one bad event tips over another issue that eventually causes everything to fall just like the 4. Italy. Dividend stocks do well in a bear market. The fact of the matter is that there have been many victims of the aftershocks of the severe recession we have just exited. Earnings are fine.

The parallel between market risk and Domino effect. 3 .

the bottom line is that not all dominos are the same size and thus have varying levels of impact from their falling. Assumption #1: Can a Small Domino Really Topple a Bigger One? Within the global economic landscape. 4 . in theory. That standing dominos can‟t push back. can smaller dominos actually topple bigger ones? Think of a regular sized domino that falls into another domino of the same size — both will fall. Hungary. and India. one has to assume that either: 1. can Greece really be the “trigger” of the falling global economic dominos? Interestingly enough. Domino theorists counter the small domino snag by arguing that if Greece falls. All dominos are the same size or that small dominos can topple big ones and 2. So the question is. which could keep growing as each country falls until the combination is big enough to topple Europe and eventually the global economy. While that is certainly exaggerated. the market is likely giving too much credibility to a serial-defaulting nation like Greece to be able to topple enough other dominos to derail global growth. The Problem with the Domino Theory While the Domino Theory certainly makes sense in the realm of little black stones with white dots on them positioned in an orderly pattern. In other words. While this could happen. Greece.” Domino builders strategically place “trigger” dominos to set off the next wave of toppling dominos. the most important “real” dominos in any world record attempt are in fact called “triggers.S. so does Spain.. Let‟s tackle each of these two assumptions. While workers create separate intricate designs with their dominos. there isn‟t one. and Spain are not on the same economic scale as the U. What is the effect? Most likely. it is obvious that not all dominos are the same size.The parallel between market risk and Domino effect. China. The combination of Greece and Spain results in a bigger domino. The bottom line is that in order for dominos to fall neatly in order. Now imagine a regular sized domino falling against a domino 10 times its size and weight. it is based on assumptions that frankly do not hold water in the complex world of global markets.

While it is certainly true that little black rectangles with white dots seem to be just standing there “waiting” to be toppled. one wonders. once everything is in place. which has sent oil prices from a year-to-date pre-crisis high of $87/barrel to the current $76/barrel as of June 17. these dominos are pushing back. 2010 — a 13% drop which doesn‟t even highlight the fact that oil got as low as $66/ 5 . For the market. the market is concerned about a country the geographic size of Alabama with an economic size smaller than that of the Dallas-Fort Worth metropolitan region. The U. Thus. While there has been much focus on the negative effects of the crisis in Greece and other European nations.The parallel between market risk and Domino effect. each section is not connected in fear that a mistake could bring down the entire array of dominos and ruin weeks of painstaking work. the “trigger” dominos are carefully positioned. The obvious concern over Greece is that it will eventually topple the world from growth back to recession. it seems that Greece has emerged as one of these “trigger” dominos. The assumption in dominos is that standing dominos cannot push back.S.. with the markets the assumption that the world is held hostage by the emerging difficulties in parts of Europe is just erroneous. how a domino the economic size of Dallas could actually derail the bigger dominos of the world‟s global economy? Assumption #2: What Happens When Dominos Push Back? The second assumption has the greatest importance for investing. often by tweezers. While not insignificant by any measure (who doesn‟t love Texas?). and other countries are not just sitting around waiting for Greece to topple the global economy. the same cannot be said about global markets. For whatever reason. On the contrary. commodity prices are pricing in a huge global slowdown. China. As a result. The interesting perspective that the market and many Domino Theory pundits are focusing on is the incorrect assumption that negative events do not foster a reaction. In Domino Theory. as the final pieces of the puzzle. the next domino in line just waits to get toppled. However. what the markets have not factored in is that positive events have also sprouted as a result of these issues. which are real concerns and real negative headwinds for the global economy.

S.. barrel. Thus. Copper prices. measured by the Barclays 10-Year Treasury Index).91/lb — a 20% reduction in costs. Treasury Notes and Bonds. 2010 price of $2. shouldn‟t it be optimistic that companies may now be more profitable since they can make products at 20% less costs than they could just 30 to 60 days before? But the “benefits” of the problems in Greece do not just apply to manufacturing. while the market is worried that Greece will slow down global growth. This means that mortgage rates for home buyers and refinancers have also moved lower given their near lockstep movements with Treasury yields. So. the U. 6 . a major input into industrial production of goods.0% to the current 3. 2010.S. China. As the fears over the problems in Europe have intensified. they also help consumers.The parallel between market risk and Domino effect. all of the manufacturing in Germany. and everywhere else around the world just saw a 13-20% reduction in input costs to make things. The demand for these bonds has driven up prices and thus sent their yields plummeting from 4.61/lb to the June 11. Brazil.2% levels (as of June 17. has fallen from a precrisis 2010 high of $3. investors have flocked to the safety of U.

In addition. 7 . In fact.26% before the problems in Greece to a new low of 4. the 30-year fixed mortgage rates have declined from 5.000 home almost $28. the costs needed to fuel up the car or heat the house have also declined meaningfully over the last several weeks due primarily to the concerns in Europe.000 in principal and interest costs over the length of the loan.The parallel between market risk and Domino effect.84% as of June 17. This means that the “benefit” from the recent market dislocation has saved a buyer of a $300.

as well as lower mortgage rates. Because of these strong recoveries.The parallel between market risk and Domino effect. while parts of Europe and Japan have seen recoveries that are more modest. to more restrictive policies by raising interest rates and placing curbs on growth. gas. Brazil. The reason this transition happens is that unabated growth can create inflation and therefore countries with stronger growth need to find balance between growth prospects and inflation concerns. The fact of the matter is that the global economy that has emerged from this latest recession has rewarded countries and regions quite unevenly. central banks in those faster growing countries have begun to shift from accommodative monetary policies. Australia. which were the catalyst to fuel the recent growth. the economy. But the biggest “benefit” of the problems emerging from the European fiscal crisis is far greater for investors. 8 . than just lower costs for commodity asset classes such as oil. Areas like China. and the United States have all seen powerful economic recoveries. Germany. and therefore the markets. India. and copper.

oil is down 13%. That means that the Fed is expected to maintain its accommodative monetary policy stance geared towards driving economic growth. where is the inflation? This is especially true when copper is down 20%. and the list goes on. beef is down 8%. Brazil. the U. corn is down 10%. The concerns for global growth caused by a country the size of Alabama with the economic impact of Dallas have essentially taken global inflation out of the picture and have allowed the central banks of China. there are slightly better odds for an interest rate cut than an increase. mortgage rates are down 9%.The parallel between market risk and Domino effect. gas is down 19%. But the problems in Greece have changed all of this. 9 . the market predicts that at the September 21. After all.. and others the ability to not have to shift from the gas pedal (accommodative monetary policies) to the brake (restrictive monetary policies). The same story plays out for the December 2010 and January 2011 FOMC meetings. As the nearby table illustrates. This potential policy shift is best shown by looking at the implied probabilities of future Federal Reserve (the Fed) interest rate moves based on the daily trading of Fed fund futures.S. the most likely scenario is that interest rates will be unchanged and remarkably. 2010 Federal Open Market Committee (FOMC) meeting.

The problem is that this is only part of the equation and frankly. and employment has posted job growth to the tune of 1. And the recent market pullback is not a reason to run for cover in fear of toppling dominos. attractive place than where we were 60 days ago. the market gets to pick up stocks at 10-20% lower prices than just 60 days ago. And as I mentioned. Not Worrying About It The bottom line is that the market is focusing solely on the worst case scenario the impact of Greece (and other European countries) will have on the prospects for global growth. I believe that now is an attractive time to consider adding risk. In my opinion.The parallel between market risk and Domino effect. No doubt. and perhaps last. that were briefly slowing down global growth by shifting from accommodative to restrictive monetary policies. the smallest part. bull market run for the markets in 2010. China.1 million net new jobs (not including census workers) in six of the last seven months. lower gas prices. valuations are now set at attractive levels. increasing commodity allocations. the real story is not the concern that the 1% consensus growth rates of Europe will slow. Businesses have lower input costs that improve margins. parts of Europe are worse. This pullback has been overdone. not less. when you have larger dominos actually pushing back against smaller dominos. But consumers have lower mortgage rates. and fundamentals of the market continue to trend towards the transition to sustainable growth. And. and Brazil.S. As a result. We Should Be Thanking Greece. the result may be positive. The real story is that where the market sits right now is a more. the grand finale — global central banks in economic powerhouse countries like the U.. not negative. Rather it serves as an opportunity to try and take advantage of attractive valuations created by misaligned economic fears to position portfolios to help take advantage of what I believe will be the next. and shifting to a more aggressive bond 10 . once again have a reprieve from inflation concerns and have their foot back on the economic growth accelerator. While the market is focusing on the fact that Greece and a few other European countries may fall back into recession. Investment themes such as adding to stock exposure.

If so. the market would have shattered the record.5 million dominos set on Domino Day 2009. may be good opportunities to help take advantage of this market dislocation.The parallel between market risk and Domino effect. fear creates opportunity and there is an abundance of fear out there. In a world where not all dominos are the same size and some dominos actually push back. as the recent pullback has toppled more than $440 billion in stock market value (market dominos). with poor sentiment. It is easy for the market to paint a picture where global growth falls like that world record of 4. While we expect an upward trending market. That said. it could just be the positive side of the recent crisis that the market focuses its attention on next. volatility will likely remain very elevated. 11 . This market remains in a fragile state. exposure with greater use of high-yield bonds. But do not be surprised if the market eventually realizes that normal rules of dominos don‟t apply to a “game” as complex as the global economy. But do not expect a straight up rally from here.

3. but when interest rates rise. 2. was the focus of risk management. exchange rates. stock prices. changes in the market liquidity of. which causes Orange co there have been significant losses of us $ 1.The parallel between market risk and Domino effect. The County Treasurer “Orange co portfolio” investing heavily in the so-called “structural bond” and “inverse floating rate products” and other derivative securities. dividends and margin risks. United States Orange Co (ORANGE COUNTRY) „s bankruptcy highlighted market risks arising from hazards. Procter (Procter&Gamble) has been involved in with Germany and the United States linked to interest rates interest rate derivative transactions. volatility in commodity prices and the prices of other financial products. MARKET RISK: Market risk (Market Risk) refers to securities companies due to market fluctuations to a position or portfolio loss possibilities. Subject to equities. changes in other market factors. the benefits of financial derivative products and decline in market value of these securities. interest rates. exchange rates and the negative impact of commodity price fluctuations. Procter lost 157 million dollars. interest rates. these companies leveraged derivatives become required to bear the burden.7 billion investment portfolio. 4. a market risk also includes the cost risk associated risks. After the offset these contract. 12 . these fluctuations in the market include: 1. when the two countries when interest rates rise higher than the rate of contract (requires Procter interest rate payments in accordance with the basic point higher than the commercial paper rate 1412). Examples abound of market risk bring losses to the Corporation. changes in the yield curve. Market risk is most often face a risk of securities company.

13 .The parallel between market risk and Domino effect.

3 98.:80/-.7- 9.9.7  200938 %.7089-099074//8147.9. 41 98  1907 .07.:99.9.8198-089843-443.908  -0 :3..39.38 9.8.08  %8549039.749.-908411:9:70 0/07.08-.0738147 4-.0 70897.4342..7/8 /7.- 9070.709 4229900    20093  90 2489 0 8..908.90.  90& $ 7.9434:941905.908  90 2.7.40/90.339070897.9900.30/.3/4907890.0 24309.89. 97:0 03 ...-994349.2089475.990250/574-.943 %8 8 0850.9900/ 8050..31.4738/43  .9:70.024309.-..9 .  070 8 90 31.@ ½ff   °¯f ¾f° ¯° €€ n         :9 90 574-028 3 700.00.90/942.4224/.80  %08.9.4:397908041.84:9147900.45507 8 /43   4 8 /43   .. 503 .3.709 570/.3/908940843 %0.33.3/.749     .034-.9024.0 .-0 :897.3/702.98 9.3/.0 .30/ .38413.754. .80/4390/.70.754.2.754..0 088039..03.02-07  .54.70/43 .4342.941./3410/1:3/1:9:708 8 90 30.08 9490- .74 8 8 /43   -001 8 /43 2479.094819 174290.#0807..0 900/ 39070897.4224/.0 24309..850/..30.70/94.9 3907089 7.-.9 90 $05902-07      0/07.3..3:.

08  .0738.907090 2.0 1742 31.98 147 4-..4  4 /4:-9  5.70.3/ 13.30/0.089 5..83 ..8947834990. 749 - 8193 1742 .7088.0.0 43 90 574850.3  90 82.9902.03 24398 :8308808.//3 94 894.749.38982.9.0 ...:/3 .854890/4-749 9490 9:30 41   243 309 30 4-8 349 3.79  3 2 45343  034:.438/07.02.9 98 8 43 5..39./..@ ½ff   °¯f ¾f° ¯° €€ n    0$4:/0%..0 5.4224/9 .43.  .4.990.0 24309.0 ..3/ 4907 :7450..3/507..38943948:89.38 3 0.9700.3 455479:39 94 97 .:.//378 %85:-.438038:87497.709098945. 54074:80 .3/ 7.0392.908 41:7450 84 %070.9438.3 .3/.3.-0749 3.438:2078.9:.4224/.. .8 ..7098987934 8.79 41 90 06:.70983    0902.39470.0 94 70897.104907:7450./.70.0739.907 9 807.8  2039430/  90 3/9070.08 .-0 5489.09.908 407. -.48989.741 94553 /42348  #.0.749025.9.9-00.:8384043904789.947   8.92574.03.8 41 90 2.7/89097.4:39708 2.9..0.8.0 494773-4:99  %0-499423089.943.3/ 8193 94 ..70570.997.89 -:2.3 :89   /.3 .70.8 .3/02542039.738 3/ 902.943 .90/-28.9438 ..007.4  3/ .9.9 41 700. 43900.709814.07/42348 90708:92..4:39708   .3.  9.3/ 17.9.0907 1449-.843947:3147..038:8 47078  3 8 41 90 .708:9 -00.89 80.0 34930.08843 9070.709814.9438  .9 070 -701 843 /43 4-.9    407 57.43.8 -003 4.2039.857.0.4..0  4-.:5 894..709 .707/42348..3/ .4393:0949703/94.9348.70 34 809 .0 41 . 8947 89.5:83-..99.. 2470 . .0 0.0.4:39708 0 90 & $  3.08 ..997.:8343901.8 .8 ..70 4780  :9 ..08 43.:..10.-.4342.0 9.9.0-090309 .0 -43/   .092094.3/ 9..0397..39..7097:3147902.4342.58..9 .808.8349.997.07/430  .78945489435479144894059.4342. 749  %0 574-02 8 9.040735:9.041 .08 9.07310.33700. 2470  349 088  .7095:-.1.997.798 41 :7450 ...04072479.3/ 1:3/.3 070 0 070   /.754.07.0892039902088:.0 . 0548:70  3.

7/9703/32.0.0 8/0 41 90 70..709945.20 80 .39.3:5.    1 84  90 2.8147902..47/070349.894550/24709.9.4:/ :89 -0 90 5489.0700./ 10.70 90 8.9:..4250.47/ 41   243 /42348 809 43 4234 . 5:8 -.039:.709.0.@ ½ff   °¯f ¾f° ¯° €€ n   0548:70970.9.908455479:39.4342 3.  9 .947/70./.:80898..3.7 4:99070   980.9:700704-..039.7889.70914.90 9544780392039 00050./42348.897..089.3.709 .39.907:8041 0/-43/8 2.20 .90/ %.99070/ 90 70..9902.943 :9/4349050.99 0702.709702.709 4:/ .7:0841/42348 /43 9.93472.8.3/90708.4.-044/455479:390894059.47/ . .0 8.3 -433894.70.8904-.809.89070.709 /42348 :9/4349-08:75780/1902.17..-:3/.0395:-.9:57.5.3..0 41982.1742070 %82.709/84.3/ 8420 /42348 .04110.98.7090. .:0 2.5594.990394343309      .

.425..709 1.3083902.0 574/:.7093.9 94 06:908  3907089 7.02039  .9:7.420706:70/94-0.90739070897. 2.709 78 .45479144 3.8.30 .3 .8 -003 3.489 78 . 57.....908 30/9439070897..0 1:.709 #8  701078 94 80.7096:/941  .425.:/08 90 .943  &390/ $9.4224/9 57.3/ 90 &390/ $9.9.30 3 2.90   9080 .3/ 3.-43/  788  /..4224/9 57.0/ 897:.3.9:.37:59.:0 41 9080 80..:7908 .2-0  .98 .4 9070 .884.308 /:0 94 2. 5439 07 9..709 ..908 .39 48808 41 :8    -43 3.90/07.908  0.9041.3083900/..98 .90574/:./03/8 .5489434754791444885488-908 90801:.9 41 ..9438  .097.90839070897.790-:7/03 1907904118099080..0 . /07.709 78 8 2489 41903 1.:8 41 78 2.908  894.3/ /0.:7908  .08930. 5.:7908 -:90339070897.2508 .9.0 .9478  $:-0.907 .907 !74.709 1:.38.905.9 706:708!74.30 7.709 78 .709 78 -73 48808 94 90 47547.304 # &%#  8-.8 90 14.3.99 3 ..908780 079..47/.308 0.-4:3/ 41 2.3.4397.:/0   3907089 7.0/ 3 9 072.7/8  7.078014.:7908 .4:39708033907089 7..@ ½ff   °¯f ¾f° ¯° €€ n    #%#$  .0 -003 831.3  .07.3/4907/07.90/  .9438 039094.908  0..08  ..4397.42207.78       .9:.90/2.39084 ..8:707 .4..3 90 ..080.73 788  %04:39%70.0 9 90 -. 78 41 80.9.709788.908780  90 -030198 41 13.425..4..943894.9 !74.08 .20398 3.0/ /07.0 25.937.9.9.574/:..3/ 2.507 7.0892039 5479144   !74.7831742.9:.94383902.3/ 90 30..30 7.30.:7.3/ 90 57.08 41 490713.908 7.308 3 4907 2.08-0.98 .3. .907489 243/4.3907.84 3...:808 7.

@ ½ff   °¯f ¾f° ¯° €€ n           .

Sign up to vote on this title
UsefulNot useful