Contagion

Definition: In economics and finance, a contagion can be explained as a situation where a shock in a particular economy or region spreads out and affects others.

Stocks held up early, consolidating Thursday’s move when a report circulated that hedge funds have begun cutting ties with Deutsche Bank. Meanwhile, the bank continues to voice its confidence that it will weather the latest storm without the need for government intervention. However, we’ve heard this before back in 2007 when none of the Wall Street giants needed help-until they did.

The Street had put on a brave face with respect to a possible contagion should the German bank giant go through a deep crisis. Yesterday’s knee-jerk reaction proves that beneath the calm surface; memories of Lehman Brothers, Bear Stearns, and our own banking collapse loom large.  With Deutsche Bank hitting another all-time low, it’s becoming harder to see how the bank pays a fine now equal to its market cap.

Deutsche Bank

I don’t think risks today mirror those of 2008, but I will say that we shouldn’t whistle past the graveyard either.

Pharaohs of Wall Street Fading Glory

Central to worries about the systemic risk are hedge funds involved in derivatives trading.  It’s a very complicated and sophisticated area of investing that always seems like a gold-plated time bomb. Of course, one of the reasons those Pharaohs of Wall Street like depravities is because they aren’t making any money in the stock market.

Hedge funds have underperformed for seven years; most recently, they posted results that look like old CD returns at community banks.

Hedge funds typically charge a 2% administrative fee and demand 20% of profits for their expertise, but individual investors and institutions are beginning to have second thoughts. Last year, 979 hedge funds closed their doors, the most since 2009. 

This year, investors aren’t waiting for managers to pull down shingles and to return funds they’ve already moving money into what’s known as passive funds. Through July, $211 billion was pulled from active hedge funds while $163 billion poured into passive funds.

As for the exposure of large U.S. banks there is no doubt that the industry is better positioned through stronger capital ratios (and dumping toxic debt on the Fed) to withstand a tidal wave of bank failures out of Europe.

U.S. Capital Ratio

Even though the stock market tumbled into the close, I’m not panicked. I loved the action in Caterpillar (CAT), and the potential takeover of NXP Semiconductors (NXPI), a favorite of mine that underscores the potential in technology.