Investment event might be influential

By DAVID MOON, Moon Capital Management, LLC
November 28, 2010

In 1987, Michael Douglas and Charlie Sheen starred in the movie Wall Street, a story highlighting insider trading and coinciding with both a rash of real insider trading scandals and a crash in stock prices that year.

Douglas and Sheen reprised their role two months ago in Wall Street: Money Never Sleeps. Weeks later, the FBI and a host of other government agencies came public with an insider probe that reaches all across the financial industry.

The more things change…

While this most recent insider trading case was a big story in the financial press, it was a minor footnote almost everywhere else. It was buried in the second section of an AP wire story printed in this newspaper last week.

It has, in my opinion, the potential to be a much more important and influential event than might first appear. The most important investment events are usually understated at first, and they are almost never expected.

This insider trading case is both.

On Monday, FBI agents simultaneously raided hedge fund offices in New York, Connecticut and Massachusetts. The Wall Street Journal reported that insider trading charges will likely extend beyond these hedge funds, to include mutual fund traders, consultants, investment bankers and analysts. It is the kind of story that could drag on and grow for months, destroying fragile investor confidence at each step.

It is the first time that I can remember that a massive insider-trading scandal might include some pretty well-known mutual fund companies.

Fox Business Network’s Charlie Gasparino speculates that this case – or series of connected cases – will have very little impact on “little investors.” I hope he is right. Ten years ago, however, the Department of Justice began questioning Microsoft’s legal right to bundle its software – an attack that had little impact on the company’s operations, but precipitated the technology stock sell-off of 2000 – 2002, along with a 60 percent decline in Microsoft shares.

Sometimes the most apparently benign of events can have monstrous unintended consequences.

Predicting those possible events is hard. However, there are some common criteria to look for.

These events are unexpected. If something is on television every day, it probably isn’t a threat. (This is the primary – and about only reasonable – argument against higher interest rates.) The market reacts to surprises.

These events don’t usually seem like a big deal at first.

The relationship between the market event and its eventual impact on stock prices and values isn’t always obvious.

The event is not necessarily related to earnings or interest rates, although those are eventually affected. Elections aren’t real risks, but larger geopolitical events can be.

The bursting of a financial bubble is always a macro financial threat. Always. The trouble is that we usually don’t know that they’ve burst until well after the fact.

Perhaps this insider trading scandal is little more than legal theater – a post script to the Michael Douglas sequel. I hope so. But investors should always be leery about the next surprise. If not insider trading, then perhaps missiles flying around northeast Asia.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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