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You're at a fruit market. But, instead of just being able to buy apples at this fruit market, you can also sell fruit.
You're not a farmer, so you come to the market to buy some apples and you see two fruit stands. Fruit Stand A on the left
is buying and selling apples at 50 cents apiece. However, Fruit Stand B on the right is buying and selling apples at 53 cents
apiece. People are buying and selling apples at these two stands all the time, and the price at a stand could change at any
moment. But, while you're there, apples are 50 cents and 53 cents, respectively.
You're a smart person, and you quickly
realize that you can buy apples from Stand A and then sell them across the street to Stand B and make a 3-cent profit. But
you have to do it now; you can't wait. So you buy all the apples at Stand A and then run to sell them all to Stand B.
Congratulations.
You've committed fruit-stand arbitrage.
Arbitrage is exactly that: the selling of the same item between two different
markets to make a profit off the mathematical differences in price. However, it's not apples that are traded--the goods in
question are usually stocks, currencies and other securities. Arbitrage happens when you get a stock, usually a common one
like General Electric that's traded on multiple markets (Japan, Hong Kong, U.S., etc¿). The stock is usually worth within
fractions of a penny the same on each of those markets. However, there are often some minor variations.
People who
participate in arbitrage take advantage of these variations--and make a ton of money doing it. As seen in the fruit stand
example, you can make a "riskless profit" from buying and selling apples between different markets.
There are some
big hedge funds that make almost all their money off arbitrage. But, despite this simple example, arbitrage is mathematically
complex--and involves a good portion of risk if you don't know what you're doing. You probably won't be able to participate
in arbitrage directly, but you can always invest in a mutual fund that does.
Home / Markets / Industries / Finance
Wednesday, May 14, 2008
Merrill Lynch Fund Manager Survey Finds Inflation Overtakes Growth as Number One Stagflation Fear
Comtex
NEW YORK & LONDON, May 14, 2008 (BUSINESS WIRE) ----Stagflation fears are gripping investors, but inflation concerns are fast overtaking worries about economic growth, according to Merrill Lynch's Survey of Fund Managers for May.
Fund managers were slightly less negative in their expectations for economic growth and corporate earnings. Particularly striking was that fewer panellists believe the world has already entered recession - 18 percent took that view in May, down from 24 percent in April. The number expecting recession within a year fell to 29 percent from 40 percent. Instead, investors are focusing on inflation. A quarter of respondents expect global core inflation to rise in the coming 12 months, compared with just 7 percent in April. This is prompting predictions of higher bonds yields, with 80 percent of investors expecting long-term rates to be higher a year from now. In contrast, fewer respondents are predicting higher short-term rates.
"Evidence is pointing to a possible sell off in bonds as inflation worries mount," said David Bowers, independent consultant to Merrill Lynch. "A sharp rise in bond yields could help convert this financial crisis into an economic crisis."
Investors unconvinced by earnings forecasts
Despite expressing a lower risk of recession, the panel still worries that earnings estimates are detached from reality. More than three quarters of investors (77 percent) said, in response to a new question, that consensus estimates for global corporate earnings are too high.
Moreover, fewer investors see value in equities. The number of investors who believe that equities are undervalued fell to a net 15 percent in May, which is down from a net 26 percent in April. Fears of overvaluation are also apparent in commodities. In response to new questions, a net 52 percent of asset allocators said that they thought oil is overvalued, and a net 29 percent of asset allocators thought gold to be trading above fundamentals.
Scarcity of earnings re-ignites the commodities trade
Fuelled by growing inflation fears, Eurozone investors have rediscovered their enthusiasm for the commodity trade. Oil & Gas, seen as inflation-proof, has extended its position as Europe's favourite sector with 41 percent of investors overweight, compared with 29 percent in April. A net 11 percent of investors expect inflation to rise in the coming year (2 percent in April). Oil & Gas and Basic Resources benefit from one of the few clear growth stories.
"In a slowdown, earnings momentum drives out-performance - not value. The relentless need for food and infrastructure in developing markets means that commodities, and not labour, are the scarce resources in this cycle, and this scarcity means pricing power," said Karen Olney, chief European equities strategist at Merrill Lynch. "Banks, on the contrary, are being penalised for earnings decay. While still unloved, this month they are no longer seen as cheap as they move from value-trap, implying upside, to trap status."
One month ago nearly a quarter of Eurozone and U.K. investors said banks were undervalued, and that number has now fallen to zero.
The threat of stagflation is also bad news for company pension plans. Indexation means a rising cash-call at a time when profits are moderating for many. Developments in the U.K. are being watched closely.
"Investors might not appreciate that the U.K. Pensions Regulator has the power to ensure pension contributions rank ahead of dividends. As of 14 April, these powers have been strengthened," said Karen Olney.
Liability Driven Investment (LDI) can hedge pension plans
Investors should be paying close attention to the unfolding story of the extent to which higher inflation translates to higher pension fund payments for corporates. They should monitor the investment strategy that plan sponsors are using. The gap in performance between those corporate pension plan sponsors using and not using LDI could increase markedly as stagflation takes hold.
"Plan sponsors using LDI have the advantage of a hedge against higher inflation and sharp changes in interest rates," said Gordon Latter, Pensions and Endowments Strategist at Merrill Lynch. "Those pension plans that remain unhedged leave themselves at the whim of the market."
NOTES TO EDITORS
A total of 191 fund managers participated in the global survey from 2 May to 8 May, managing a total of U.S.$615 billion. A total of 179 managers participated in the regional surveys, managing U.S.$413 billion. The survey was conducted with the help of market research company Taylor Nelson Sofres (TNS). Through its international network in more than 50 countries, Taylor Nelson Sofres provides market information services in over 80 countries to national and multi-national organizations. It is ranked as the fourth-largest market information group in the world. Survey results were analysed by David Bowers, who is joint managing director of Absolute Strategy Research Ltd, a financial services consultancy.
Merrill Lynch Global Research has consistently achieved high rankings for its equity and fixed income research in numerous regional and global investor surveys, such as Institutional Investor, The Wall Street Journal, LatinFinance, Asiamoney, Euromoney, Extel and Reuters.
Merrill Lynch is one of the world's leading wealth management, capital markets and advisory companies, with offices in 40 countries and territories and total client assets of approximately $1.6 trillion. As an investment bank, it is a leading global trader and underwriter of securities and derivatives across a broad range of asset classes and serves as a strategic advisor to corporations, governments, institutions and individuals worldwide. Merrill Lynch owns approximately half of BlackRock, one of the world's largest publicly traded investment management companies, with more than $1 trillion in assets under management. For more information on Merrill Lynch, please visit www.ml.com.
SOURCE: Merrill Lynch
Merrill Lynch New York Susan McCabe Walley, +1-212-449-0389 susan_mccabe@ml.com or London Tomos Rhys Edwards, +44 (0)20 7995 2763 tomos_edwards@ml.com
Copyright Business Wire 2008
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