The Money Train - Will They Or Won't They?

I know its a silly sounding translation from Cantonese, the "direct train" or "straight through train", both referring to the program that was supposed to allow Chinese citizens to invest directly in HK shares. Let's look at the debate, the highs-lows, and the probability in the end.

a) The plan was first announced on August 20th that a pilot program will be started to allow nationals with a Bank of China account in Tianjin to buy HK listed shares. Since that day, the HSI has appreciated some 45% to reach 32,000 but has given back quite a bit over the last two weeks.

b) HSI suffered selling bouts after a Credit Suisse report on Nov 12th said the pilot program had been delayed till 2Q 2008. The report also said that the government may impose a US$30bn cap for the entire program.

c) It is however, more likely that the sell down was due to sentiment being affected by the authorities' clampdown on the illegal money transfers from Shenzhen to buy HK shares (please read blog below).

At the end of the day, China still has too much liquidity despite the recent sell down in China stocks. They already have the QDII program which could see some US$70bn going overseas. The sovereign fund CIC will be investing some US$200bn overseas as well. The "direct train" program is expected to draw out US$30bn into HK. All up, we are looking at taking US$300bn away - if you hook that up with a few more mega A-share listings next year, that will certainly keep a cap on the upside for China equity markets next year, or at least make it a lot harder and volatile. It should be a lot tougher to make money in Shanghai and Shenzhen next year.

On the matter of overseas investments, the bulk of it will go straight for HK listed shares, followed by Singapore and then South Korea. Talking about A-share listings, the current market conditions may have postponed the A-share plans for CNOOC, the next best thing after Petrochina. But it should proceed once the market is on a better footing, look for Jan/Feb 2008 listing. Following that, Zijin should be next, an excellent gold play / commodities play. Also in the news, China Railway Group, the world's third largest construction contractor & the largest in China, will be raising US$5.5bn from its HK and Shanghai IPO for a simultaneous A-share and H-share listing.

So, in conclusion, will the "direct train" become a reality? Chances are very high that it should occur because soaking up liquidity and presenting investors with more alternatives are major priorities to Beijing. On Monday, the Shanghai Stock Exchange announced that it will allow foreign MNCs to list on their exchanges - more alternatives and to soak up liquidity. The 3 companies cited to get the ball rolling were HSBC, Coca-Cola Amatil and Siemens. The HSBC homecoming listing will be an event of major proportions, mark my words.

HK Calling!

The HK and China markets have been the most robust and active over the last 4 weeks. The huge Petrochina and Alibaba.com listings have propelled momentum driven investors. Following the euphoria, the Shanghai and Shenzhen markets are going into a downtime. The markets there failed to maintain above the 150 day trendline despite trying a few times. That took some liquidity players away from the markets.

When markets experience a downshift in liquidity, people go looking for reason, and the CPI / inflationary pressures were convenint (and real) excuses. Investors were spooked when the same excuses were repeated day in day out. Those were excuses for the markets there to deflate. To me, the shift down in China markets is more a technical thing rather than a fundamental exorcism. They will need to find their feet before rebuilding, so no hurry to bottom fish in China markets as these momentum driven markets will need to build a bse first before relaunching themselves, it won't be a V-spike back up. Take your time to see the base building.

The HK market is probably the BEST long market globally for the next two quarters. The disconnect in the currency owing to its USD peg created a downward pressure on its domestic interest rates (being at a a much higher level than the prevailing rates in the US). The weaker USD automatically boosted competitiveness in HK, a sort of reverse "post Asian financial crisis". Following the 97 crisis, all Asian currencies lost between 30%-50% of their value against the USD. HK kept their peg, and hence huge structural unemployment was hitting HK the worst. Large chunk of industries which can no longer compete with the "expensive peg" were forced out. Many moved to Shenzhen if they could. Now, we are seeing the reverse - the pain before, now the pleasure. The HK market is now the BEST long market because it is a natural China play, without the frothy valuations. The HK market is also the most liquid Asian place to be. International investors have been converging there almost the same time the USD started to weaken dramatically. Funds have been redirecting capital to HK at the expense of smaller Asian markets - thats very clear over the last few weeks.

Many cited the China's "direct/through train" as the main thing which has driven the HSI up from 24,000 to 32,000. I don't think so at all. Now as China markets have corrected, the HSI has fallen in sympathy. Both are very much momentum driven markets with lots of liquidity. However, Shanghai and Shenzhen are victims of high-inflationary expectations. Not so much for HK.

The continuous delay and tighter rules proposed for Chinese mainland investors before they can buy HK shares was given as the main reason dragging the HSI lower. I don't think that's true at all. The reasons why HK markets shot up were due to reasons explained in paragraphs above. One thing though, the HK markets have been extremely volatile over the last two weeks. The day to day market swing can be between 2% to 4%. That clearly indicates to me that the underlying liquidity and bullishness. But the fact that it has failed to main above the 150 and 200 day trendlines, despite the feroucious buying would confirm that the markets there have to go lower first.

There was a 20%-30% drop in China's property transaction volume over the "golden week" in early October. A slowdown in China property and equity markets could be a potential trigger for a correction in Hong Kong, or so they say. Recent property launches in HK have seen more than 50% of these new properties being snapped up by China nationals from the mainland. The reverse reflation back to HK economy is a significant development. HK's economy continued to grow in the third quarter with its GDP rising 6.2% in real terms over the same period last year. The result marked the 16th consecutive quarter that GDP growth exceeded the average trend growth. HK's economy should be able to attain 6% growth for 2007 as a whole, with GDP growth of 6.1% in the first three quarters and given the prevailing strength in domestic demand. Now, you would have to add the impact a much much weaker USD from 4Q onwards, and that should cause some surprises in growth figures on the upside in the coming quarters.

Merchandise exports grew 6.4% in real terms, with exports to Chinese mainland and many other emerging markets growing well. Services exports grew 12.3%, reflecting strong inbound tourism, vibrant financial market activities and a continued surge in offshore trade. Domestic demand played a key role in driving the economy forward. Private consumption spending grew 9.7%, supported by the improving job market and rising household income and wealth.

So on balance, the HSI has a lot more going for it than Shanghai or Shenzhen. However, some of wind may have been knocked from the sails of HSI may be due to Chinese authorities clamping down on cash withdrawals from southern banks to try and stem the flood of illegal money boosting HK's bullish stock market run. The daily withdrawal limit from banks in Shenzhen, just across the border, has been capped at 30,000 yuan (US$4,000), and some banks have limited or stopped cash withdrawals from ATMs even. The proximity of Shenzhen to HK was the cause of such liquidity outflow, and lots of mainlanders have opened up accounts to invest in HK stock through underground money exchanges.

Apparently about five percent of HK's stock market's daily turnover comes from mainland individuals. Some estimated that half of the entire cash withdrawals from the mainland, 195.6 billion yuan in the first nine months, took place at Shenzhen banks.

Should HK be worried? Nah, the fundamentals driving HK markets are a lot stronger than patches of liquidity issues. The reflationary aspect due to the peg, coupled with a high propensity for domestic rates to go lower, should see the fundamentals winning out soon. Did I mention that a more dormant Shanghai and Shenzhen should see more funds finding its way to buy HK properties instead. That is an important development because Hk basically runs on 5 things - tourism, shipping, services, stock market and properties. Investors going through these 5 would be ticking each one positively going forward. Hence the HK markets should still be the best LONG market once it has settled down. I see a 25,000-26,000 as a good area for base building.

A Disconnect In Equity Markets

Even my aunt has been selling her share holdings!!!

Of late there has been a disconnect in global equity markets. Its like all were at a party dancing and talking, and somebody switched off the electricity. Everyone is mumbling among themselves that they are having such a fine and dandy time, maybe they should continue dancing and partying in the dark and without air-conditioning. Some decided to leave for home and rest cause they know it will take some time before electricity is restored.

Important Market Strategy Pointers

a) The only "safe" equity markets seem to be the US and Japan. Both for differing reasons. The US because of the devalued dollar, if the dollar decline over the last 4 weeks did not happen, the Dow Jones index probably will be trading at 11,000 now. The Nikkei is caught in a quandry with a stronger yen, but its probably the ONLY economy not having to deal with inflationary pressures - hence Japan is not in danger, in fact it may be the best performer for the remainder of 4Q2007.

b) The HK and China markets have been the most robust and active over the last 4 weeks. The huge Petrochina and Alibaba.com listings have propelled momentum driven investors. Following the euphoria, the Shanghai and Shenzhen markets are going into a downtime. The markets there failed to maintain above the 150 day trendline despite trying a few times. That took some liquidity players away from the markets. When markets experience a downshift in liquidity, people go looking for reason, and the CPI / inflationary pressures were convenint (and real) excuses. Investors were spooked when the same excuses were repeated day in day out. Those were excuses for the markets there to deflate. To me, the shift down in China markets is more a technical thing rather than a fundamental exorcism. They will need to find their feet before rebuilding, so no hurry to bottom fish in China markets as these momentum driven markets will need to build a bse first before relaunching themselves, it won't be a V-spike back up. Take your time to see the base building.

c) The HK market is probably the BEST long market globally for the next two quarters. The disconnect in the currency owing to its USD peg created a downward pressure on its domestic interest rates (being at a a much higher level than the prevailing rates in the US). The weaker USD automatically boosted competitiveness in HK, a sort of reverse "post Asian financial crisis". Following the 97 crisis, all Asian currencies lost between 30%-50% of their value against the USD. HK kept their peg, and hence huge structural unemployment was hitting HK the worst. Large chunk of industries which can no longer compete with the "expensive peg" were forced out. Many moved to Shenzhen if they could. Now, we are seeing the reverse - the pain before, now the pleasure.

The HK market is now the BEST long market because it is a natural China play, without the frothy valuations. The HK market is also the most liquid Asian place to be. International investors have been converging there almost the same time the USD started to weaken dramatically. Funds have been redirecting capital to HK at the expense of smaller Asian markets - thats very clear over the last few weeks.

d) Smaller Asian bourses will be ignored. Following from the above pointer, smaller Asian bourses will be ignored. Coupled with the fact that there is a global inflationary problem rearing its head now from Argentina to Malaysia to China and Australia. While HK lso has that problem, the interest rate & currency shifts still favour HK equities.



e) Of all Asian bourses, Malaysia seems to be hardest hit over the last 2 months. Though the ringgit is at 3.35-3.39 against the USD. The ringgit actually gained the LEAST against USD when compared to all Asian currencies, including the NZD, AUD, pound and Euro. So, basically after a stellar currency strengthening in 2H2006 and 1Q2007, since then the ringgit has been a huge underperformer. I mean, the ringgit also underperformed the Thai baht over the last 12 months. What gives?

The government and Bank Negara are not saying anything but its a clear reflection on the highish valuations above 1,400 level and a gradual exit of foreign funds to HK. Foreign funds had a good run on the ringgit and the KLCI, and above 1,400 seems a touch iffy going forward. Recent political developments did not help matters. More crucially, foreign investors are a bit fed up with Malaysia's brilliant "power point presentations" on the various "corridors and big concept plans ... and the stigma on subpar execution and lack of transparency. The Port Klang thing probably scared off many real Gulf states big investors. Why does it take so long to push things from concept to reality?? We all know the answers, get the professionals, reward performers, punish the insiders trying to take care of themselves. No follow up on offenders, troublesome issues left on its own with authorities hoping the media and public will eventually forget them, or cause them to focus on some other diversion.

Corporate wise, the DIGI-Time deal left a very sour taste in the bigger picture players. Yes, DIGI climbed but its due to the removal of the uncertainty and that Telenor is still in control. But its so obvious that a company with the track record and success of DIGI cannot get the GGGGGG license on its own, but will only get it after "bailing out" another wasteful and mismanaged company - guys, if we mismanaged less companies, we won't have to rely on these "ingenious" corporate manouveres - and we should have learnt that over the last 15 years..., yes/no???

f) Research houses citing the upcoming elections as a big kicker for the KLCI have a bigger chance to be wrong in light of the above factors cited. Just look at the wonderful active volume in PN17 companies and third rate companies dominating the volume charts over the last few weeks - ah, yes, these are the "election counters" ... really? If those are election counters, its a wonderful reflection on the real economy.

The World According To Goldman Sachs

The stars are all aligned and the planets all converge to make Goldman Sachs and its alumni the most powerful "club" in the financial world. Merrill Lynch has just announced that it will appoint John Thain (the current head of NYSE Euronext) to be its CEO. Yes, Thain was a former mortgage bond trader at Goldman Sachs before rising to the top as president &COO of the esteemed firm.

Possibly the last piece of the puzzle will be whether Robert Rubin (ex-Goldman Sachs CEO as well) will be appointed to replace Chuck Prince at Citigroup. It looks likely and this "club of insiders" will almost control the global financial world. They already have Henry Paulson (another top alumni from GS, former chairman & CEO of GS) as the Treasury Secretary.

The thing is that is only the surface, Goldman Sachs' alumni is a headhunter's paradise for the very top financial and political jobs in the US and most of Europe. Here are a few examples:

a) GS will not be leaving its mark at NYSE Euronext following Thain's exit as Thain's successor will be Duncan Niederauer, an ex-MD & co-head of GS equities execution services.
b) The Treasury Undersecretary in the US for domestic finance is Robert Steel (former GS vice chairman). One of his important role is to direct bailout vehicle for banks with the huge Structured Investment Vehicles (SIVs), the cumbersome off balance sheet items of major banks and brokers.
c) One of the very top hedge funds manager globally, Edward Lampert (who currently is the chairman of Sears after having bought into the company) is from GS risk arbitrage unit.
d) Robert Kaplan, the current head of the highly influential Harvard Management Company, was an ex-vice chairman and head of GS investment banking unit. He replaces the highly successful but underpaid El-Erian. The endowment fund is around US$35bn.
e) The current governor of the Bank of Italy (central bank), Mario Draghi, is a an ex-MD at GS.
f) The current governor of Bank of Canada (central bank), Mark Carney, is also an alumni.
g) At the Federal Reserve Board, just a notch below Bernanke, sits William Dudley, another alumni, an ex-MD and ex-chief economist of GS. He oversees domestic open market in the US and forex trading operations and the provision of account services to foreign central banks.
h) The upcoming chairman of the Federal Reserve Board of New York will be Stephen Friedman, another GS alumni.
i) Robert Zoellick the new top guy at the World Bank was an ex-MD & chairman of Goldman's International Advisors unit.

p/s my bet for the next CEO for Citigroup will be the brilliant Jamie Dimon, the current CEO of JP Morgan Chase. He was the wonderboy under Sanford Weill at Citigroup but left Citigroup after losing a power struggle with Deryck Maughn in 1998. Jamie has since showed his mettle by building up Bank One speedily before merging it with JP Morgan Chase. Homecoming queen in the making. The position at Citigroup will be highly attractive to Jamie as it will prove he is "the man" in the end.

HK's Horse Of The Year (Not)

The Sopranos In HK Racing

Horse racing in HK is certainly one of the best managed. High payout ratios, great liquid pools, the best trainers and jockeys all converged to HK as the race prizemoney is very decent. Fixed races are probably among the lowest in the world. While there is still some hanky-panky (going-not going), HK horse racing easily ranks as the top in my books.

The committee awarded Horse of The Year award a few months back to Vengeance of Rain, trained by D Ferraris. They handed the coveted award to Vengeance Of Rain in honour of his triumph in the world's equal-richest turf race, the Dubai Sheema Classic, and conveniently forgot Viva Pataca had thrashed him mercilessly twice at home afterwards in the Audemars Piguet Queen Elizabeth II Cup, then again in Champions & Chater Cup.

The judges - three from the Jockey Club and three journalists from leading Chinese-language newspapers - clearly and simply got it wrong. The voters mostly cited the Dubai win as the deciding factor. If that was the case, then in 2004, the Horse of The Year award should have gone to Cape of Good Hope who won not one but two international Group 1 races - that year the award justly went to Silent Witness, who thrashed Cape of Good Hope a couple of times at home in HK, and one of the races was the Group 1 HK Sprint. So, following that logic, Viva Pataca should have won the award back in July 2007, hands down!!!

Here's where The Sopranos get into the picture. While racing in HK is always a showcase for those rich enough to be horse owners - there is still "good rich" and "not so clean rich". Viva Pataca is owned by Stanley Ho, the Macau casino king of yesteryears. Sometimes money can only buy you so many things in life, it can never buy real respect. Safe to say that Stanley Ho's riches may be regarded quietly by many as not-as-worthy as the fortunes of other tycoons. Secondly, he is from Macau, not HK. Though discrimination of any kind is almost non-existent between the two ex-colonies - Macau is still not HK. Macau has been known to be notorious feeding ground for gangsterism - purveyors of prostitution, illegal loan sharking and toll-gating businesses. Same old, same old, you cannot survive or prosper in Macau for such an extended period without being linked with the gangs in Macau.

It did not help matters that the trainer was John Moore, once a top jockey in HK and Macau who made the switch to horse training successfully. Well, John Moore's reputation is not exactly "clean". Back in the 70s, HK and Macau racing were as dirty as in Malaysia and Singapore. Horses were pulled frequent and race fixing was rampant. Anybody in racing then, whether a trainer or a jockey during that period has to be a bit "dirty" to survive. John Moore naturally did not come out of that period unscathed. Even when John Moore won the trainer's championship, the stigma never really left him. Hence till today, John Moore is still being regarded as a good trainer who bets. Someone who will bring home the favourites but makes hay with his longshots which escapes everybody's attention.

1 + 1 = 0. Hence you put the two together, plus when given a real alternative in Vengeance of Rain, it is natural for the judges to vote accordingly. But seriously, reputations aside, Viva Pataca should have been the winner regardless who owns it. John Moore for his history, should be judged by each horse he trains - he got Viva Pataca to win the really important races, and that's all that's important in this award. The horse is innocent. The HKJC and judges will have more tart on their faces when Viva Pataca wins the Group 1 Invitational race next month in HK.

Beware Google-CW

At the closing price of US$660.5 yesterday for Google, the newly listed warrant now trades at more than 40% premium with its CW price at above 25 sen. Even at 20 sen its very expensive, 15 sen is OK. The issuer will be throwing papers at you at anything above 20 sen.

The Final Bits

What we are seeing are the remnants of the blowout by the subprime mess. While the US economy will continue to be weak over the next 2 quarters, the stock markets could be finding its feet now. Darkest before dawn, they say... then its true for E*Trade.

Everyone knows that E*Trade is primarily in online investing, and a successful one at that despite strong competition from TD Ameritrade and Charles Schwab. However, they found that their margin financing business is so good for stock trades that they went and bought a "phone-based bank" that makes and buys mortgage loans, and invests in securities backed by mortgages as well. Since beginning of this year till June the stock held firm just above US$20-US$22 level. The initial subprime surprise in July and August sent the shares down to US$13 and there were days it went close to US$10. Well, that's the good news, cause last night the shares fell another 59%!

There were reports flaming rumours that investors could withdraw funds and ask questions later which will put E*Trade at a real bankruptcy risk situation. The company said its US$3bn portfolio of asset-backed securities includes about US$450 million in so-called collateralized debt obligations. E*Trade is sitting on US$12.4 billion in home-equity lines of credit, in which people borrow against the value of their homes. Of that, US$404 million was delinquent at the end of September. While the lion's share of the home-equity loans was made to borrowers with strong credit, 60% didn't require "full documentation" and at least 25% of the loans were extended to people in California or Florida.

They had their run cause the bank purchase allowed the company to register record revenue from 2003 to 2006, so much so that trading commissions made up only 20% of revenue last year. Well, someone will need to step in and offer about US$500m-US$1bn as capital infusion and take control of the plane with engine failure.

China & Its Private Equity Strategy

Inflow - Foreign PE firms sealed 129 deals in China last year, with a total investment of US$12.9 billion. In the first quarter of this year, the investment soared to US$7.56 billion, a year-on-year jump of 329%. The Chinese government has been actively trying to "control" foreign PE firms from being overly-aggressive in their buyouts. US buyout firm Carlyle Group's high-profile bid to take 85 percent of China's biggest construction equipment maker Xugong Group Construction Machinery in 2005 was a trouble spot for Beijing. Carlyle has since scaled down its original 85% bid to 45%, but the deal is still pending approval.

China issued Provisions on Acquisition of Domestic Enterprises by Foreign Investors last year in a bid to regulate foreign M&A activities in the country. In August, the Anti-Monopoly Law was enacted and will take effect next August. The new rules require any major foreign M&A deal to be examined and supervised for national economic and industrial security reasons by relevant government bodies. But the tightening regulatory environment will not deter or scale back foreign M&A activities. The interest among foreign investors is still overwhelming despite their concerns about regulatory uncertainties.

The number of M&A deals involving foreign capital decreased slightly to 296 in the first half of this year, down from 316 in the first half of 2006. The slump was mainly due to the bull stock market, which has pushed up share prices and transaction costs, and the uncertainty about regulatory approval procedures. The situation is likely to continue in the second half of this year until valuation expectations subside, and financial investors are likely to remain focused on minority positions in larger transactions until they sense a change in the regulatory landscape.

Outflow - This is more tricky for China as they have been rebuffed and chased away like a pack of wild dogs by some countries' protectionist policies on certain big deals - remember CNOOC; the failure to buy Unocal and Maytag!

Owing to nature of these big Chinese companies, they are defacto arms and legs of Beijing anyway - even when they do not have "state enterprise" printed on their front door. Hence diversifying away from USD and reinvesting the forex reserves smartly, can be done via various vehicles.

On October 25, ICBC announced a bid for 20% of South Africa's Standard Bank for US$5.6bn. This ties in very well with Beijing pronounced strategy to secure better ties with the African nations. Beijing is now more willing to accommodate minority stakes in order not to attract negative press. It is considered as a better long term strategy to accumulate strategic stakes without ruffling feathers. Another example, recently China Development Bank bought 3.1% of Barclays. Citic's recent purchase of a convertible note (convertible into a 6% stake) into Bear Stearns is another example. Bear Stearns will get 2% Citic in return.

However, sometimes you will have to get your hands dirty because you just have to get involved. BHP's audacious bid for Rio Tinto cannot be allowed to happen just like that, in the eyes of Beijing. Word has it that China Development Bank has been buying Rio Tinto shares by the bucketloads even as I write. That's because a BHP-Rio Tinto company amounts to a near monopoly in many areas of commodities supply chain. However, a bid by China development Bank for Rio Tinto looks unlikely in light of last week's comments by China's Vice Minister of Finance, Li Yong, who effectively barred CIC from taking control of "strategic" global assets. He said one-third of fund capital had been earmarked to buy banking assets that the state already owned and another third would recapitalise the Agricultural Bank of China and China Development Bank. Only about $US67bn would be left to invest in global financial markets, he said. Li said the fund would invest gradually and cautiously and it would steer clear of industries such as airlines, telecommunications and oil. Well, Rio Tinto does not fall under those categories, so still game on.

To just look at the US$200bn under the newly established China Investment Corp (CIC) would be a blinkered move as that will not fully reflect the firepower and arsenal within Beijing's grasp and overall strategy. CIC's swift purchase of a minority stake in Blackstone (one of the world's leading private equity house) is more than just an investment. it serves two main purposes. One, CIC will get shown a lot more important deals under the purview of Blackstone - hence CIC will get access to invests together on significant deals should CIC so chooses. Two, by dancing with Blackstone, CIC will not be seen as the main aggressor when acquiring stakes of important and sizable companies around the world, even in sensitive sectors CIC will be able to hide under the professional guise of Blackstone.

Word has it that CIC will take up similar minority stakes in some other big private equity firms as well for the same purposes. Apparently 3 big PE firms have been approached, including KKR, Texas Pacific and Carlyle. I would expect a deal with Carlyle to be tabled soon as that group understands the political landscape better, and would better appreciate the synergies beyond just capital involvement. Beijing just doesn't want more backlash on the movement of China's capital juggernaut.

Remember The Yen Carry Trade?

The yen carry trade caused some anxious moments a few months back when the fear of players unwinding their trades took centrestage. That died down and investors continued to borrow in yen to invest in other higher yielding currencies, stocks or bonds. Just like Britney Spears, oops, I did it again... the sustained but managed weakness in USD has basically unraveled the yen carry trades. The current equity weakness globally is merely a result of yen carry trades unwinding. The stronger the yen, the worse off will be the investors who borrowed in yen to buy Aussie bonds, Singapore REITs, US stocks, Malaysian plantations, HK-H shares, etc...

While we were sleeping, the USD has breached the 110 yen level. The yen's strength is not the only one. The euro has also moved from strength to strength against the greenback hitting record highs after expectations of a further interest rate cut at the next Federal Reserve policy meeting. Further euro support came in the form of comments from a senior Chinese political figure, who said that China should diversify its US$1.43tn foreign exchange reserves by buying more strong currencies like the euro.

Ben Bernanke told US lawmakers that the Fed expects economic growth to slow in the fourth quarter of 2007 and the first half of 2008. Further dollar depressing news came in the form of US consumer sentiment data, which fell to 75.0 in November, hitting its lowest level in two years. On the other hand, the European Commission said eurozone economic growth this year will be slightly better than expected, however, financial market turbulence is seen slowing growth in 2008 and 2009. Markets largely ignored comments from US Treasury Secretary Henry Paulson, who defended the dollar’s status as the world’s reserve currency.

The yen has appreciated against a basket of currencies and not just the USD, but the effect was more pronounced with the greenback. The yen also found support from comments by Bank of Japan Governor Toshihiko Fukui, who underlined the need to increase interest rates in a timely manner. The greenback made some small recovery against the yen on news that the US trade deficit unexpectedly narrowed in September on strong export growth. However this was short lived as the yen soon hit a 1 ½ year high against the dollar on the back of fears of wider credit related losses in US financial firms which resulted in speculators unwinding carry trades.

Now it looks likely that high yielding currencies such as the AUD, Canadian loonie, NZD and Thai baht should see an exodus of hot money due to carry trades, and weaken a bit from here.

Shanghai Au Revior? Sayonara USD??

Following the listing of Petrochina-A share, the markets in China just continued to tumble. The People's Bank of China announced Thursday it might use a variety of measures, including bank and treasury bond issues and reserve requirement ratios, to control the country's "severe" liquidity problem.

A PBOC report gave no details about the extent of the measures or when or how they would be implemented, but it stressed that absorbing liquidity in banks and strengthening credit control could not fundamentally tackle the constant and rapid accumulation of liquidity and other structural problems. Recent talks about stock market risks by senior economists have also intensified worries about further government measures. China's economic growth is expected to exceed 11 percent for 2007 and growth in the consumer price index (CPI), the main measure for inflation, will be around 4.5 percent year-on-year, though some foreign analysts put the inflation figure to be at 6.0% at least. The latest figures and report by PBOC hints at at least one or maybe two more rate hikes before the year is over. Hence the rate hikes will definitely occur, and that is what's spooking China markets. The effort to maintain the dollar-renminbi exchange rate at a level approved by China’s State Council has already led to an enormous increase in the Chinese economy’s financial liquidity. The consequences of this are now manifested in property and stock market inflation, but not yet in rampant and uncontrolled consumer price inflation – at least for now. But if China does not accelerate the renminbi’s revaluation, the world might see a large burst of consumer inflation in China in the next 12 months. If so, the consequences will be a choice between the destructive runaway inflation and stagflation. The fall-out from this scenario, however, would be largely confined to Asia.

That being the case, the Shanghai and Shenzhen markets will find little incentive to buck the trend. Why bid prices higher when you higher prices will mean pushing PBOC to raise rates even more aggressively or worse, come up with penalising fiscal measures. Hence the China indices is in for a welcome breather. In actual fact, PBOC is not so concerned over higher stock prices as long as its a managed run up. They are more concerned over things like inflation and renminbi. It looks very likely that the yuan will be allowed to rise significantly over the next 2 weeks, it has to happen already - looking at how the USD is weakening, and how the Euro is headed for 1.5 against the USD, and the likelihood of the AUD reaching parity with the USD. Controlling inflationary pressures is utmost in the priority of PBOC, no two ways about it. Raising rates are not having the desired effect (they have done that 5x already this year).

As for the USD, we are seeing a realignment ala 1987, though in a more controlled manner. The Fed seems to be in agreement to have a weaker USD. Bernanke commented on the upside risks to inflation but focused more on the downside risks to growth. The Fed Chairman expects growth to slow noticeably in the fourth quarter, which confirms his dovishness. If he had done the opposite and focused more on inflation like his counterparts in the Eurozone and Australia, the dollar could have rallied. However he chose to spend his time expressing concern that higher energy prices, tighter credit and continued weakness in the US housing market would lead to softer consumer spending. This coincides with the survey results from 10 of the nation’s largest retailers, 7 of which including Wal-Mart and Macy’s reported sales below forecasts. For dollar bears still looking for a recession, the Fed’s acknowledgement that consumer spending could be at risk indicate that they haven’t completely ruled out another rate cut. Although extremely volatile, Fed funds future are now pricing in a 90 percent chance for an interest rate cut next month. Recent trade fairs in Asia mostly showed a 10%-20% drop year on year in order from the US on the credit squeeze in the US, and slowing US consumption due to that. This real evidence should translate to a genuine weakness across the board eventually, thus a flattish to lower fed funds rate will dominate the capital flows over the next 3-6 months, thus prolonging a weaker USD. The weaker USD will sustain interest in the US equity markets but will cap any rise in other equity markets. Another 5% drop from here will ensure that the business and trade dynamics change substantially. The outlook for emerging markets won't be as rosy as it was a year ago. Trade surpluses will start to narrow, and FDIs will slow as well.

Hence the China markets will be forced to find its feet first and consolidate, and we will have to see how much more will the USD be "allowed" to go weaker (I suspect another 5%).

More Upside For IJM Plantations?

Even at RM3.50, there should be more upside for the stock. Those who followed at RM3.00 will do well to hold till then or near that level. Just to recap the reasons for the rerating:

a) the company did not sell forward the bulk of their current production, unlike many companies

b) Hap Seng Plantations listing on November 16 should see the share trade at RM3.40-3.50, and all things being equal, IJM Plantations should trade at a premium to Hap Seng Plantations (please re-read previous post on both companies)

c) the expansion into Kalimantan is proceeding better than expected

d) a narrowing of discount from over 30% to maybe 20% as IJM Plantations is getting bigger and better managed (better yields comparatively to the average in the industry)

e) expansion plans aggressive and well managed, has acquired 3 parcels in East Kalimantan (11,000ha, 10,200ha and 11,000ha)

f) the managed landbank expansion puts IJM plantations from being a smallish player to mid-size and well on the way to narrowing the gap to the big boys - the planned expansion will see a CAGR of at least 6% over the next 5 years

g) hence, just like Petrochina-A listing, good to hold till Hap Seng Plantations listing as IJM Plantations is superior in almost every way even though both trade on the same EPS for 2007 and 2008

I Know What You Did Last Summer

Being in finance and investments, you have to keep learning new jargon. Six months ago many probably don't even know what CDOs were, many kept hearing it over the last 2 months and had a vague idea of what that is, but probably would find it hard to remember the actual definition in totality - man, where's our c-drive, no retention power, somebody defrag me... or just close all windows in my house and reboot!

Just when you thought it was safe to no longer mention "subprime"... hey all suddenly screamed "I know what you bloody banks did last summer!!!" You got me on HSBC, then Bear Stearns, the UBS joined the fray, jumped across to Northern Rock, now Merrill Lynch and the bigdawg Citigroup.

As I have said recently, the big banks waited for Paulson/Fed to come up with a US$100bn Superfund to help bail them out. That did not arrive, hence the revelation (just as scary as the one in the Good Book). Let's look at why so many investors are caught unawares on these shitty stuff. HSBC did the right thing, first to acknowledge that there is a problem, admit & write down the assets and control the exposure - that's why HSBC always trade at a premium in the eyes of Asian investors. The rest dragged their feet and evaded until it the cows actually rang the doorbell.

Many banks created Structured Investment Vehicles to carry a lot of these CDOs, and they did not show up on the balance sheets. Citigroup had the biggest OBS (off balance sheet) assets at US$222bn and their biggest SIV exposure was US$80bn, hence it would not be too far off to estimate that Citigroup may have to write off 50% of that in total or US$40bn. Bank of America staffers are probably the happiest as their banks have ZERO in SIVs and the OBS assets amount o only US$97bn. JP Morgan has US$128bn in OBS and has an exposure of over US$40bn to private equity firms. In total, Citigroup may have to write down US$21bn. That compares with potential losses of US$5.4 billion for Bank of America, the second-biggest U.S. bank, and US$4.1 billion for JPMorgan Chase. I think Bank of America is quietly sniggering that this debacle will close the gap between #1 and #2.

Merrill Lynch last month reported US$8.4 billion of writedowns in the third quarter and may be on the hook for another US$9.4 billion. However, the potential losses related to CDOs at the three major banks in absolute terms dwarf those of the largest brokers. Lehman Brothers, Bear Stearns, Goldman Sachs and Morgan Stanley, all stand to lose as much as a quarter of their equity. The announcement of Citigroup's potential losses and the exit of its CEO prompted Fitch Ratings to cut its rating to AA, three levels below the top, and say it may reduce the rating again. Standard & Poor's said it may lower its AA grade.

As bad as it sounds, the bad news seem to be a sigh of relief for the markets as more of the actual risks are now known. When you do not know the numbers, you worry more, now that you do - you can start to work off those numbers accordingly.

Reasons & Excuses

Business journalists, analysts, business presenters, fund managers, strategists ... all need to have reasons to explain market movements. The reasons had to be somewhat sensible and printable, and coming from the mouths of experts, it sounds more believable.

We sometimes go searching for reasons and excuses when there is really none. We are all brought up to pull out one of maybe twenty or thirty reasons from the basket everytime the market goes up or down excessively. Its like an objective test. The basket could include reasons such as:

a) the Fed is willing/ not willing to loossen

b) the BOJ is staying firm / raising rates

c) the market is overbought

d) the market has discounted the US$90 oil

e) the market is discounting the Turkish situation

etc...

Are we really picking the right reasons? We can only pick what is most plausible. Its a hindsight harry situation - you ask the "experts" after the event, not before the event, hence the "experts" will go through his/her usual bag of tricks (sometimes updated) and pull one or two reasons out of the basket. Chances are, markets sometimes goes up and down just because there are buyers and sellers, no big underlying reason.

Sometimes, markets go up and down based on the most unimportant news or excuses. How about more sellers than buyers? HK and China are down because I read everywhere the "direct train" (allowing Chinese to invest directly into HK shares may be delayed)... Please-lah... the HK market went up because of the disconnect with US monetary policy and USD peg. The China markets all having difficult days probably due to the huge amount of funds being tied up in Petrochina or those wanting to buy Petrochina-A shares in the secondary market, .. and/or huge amount of funds tied up in Alibaba.com IPO in HK.

Isn't that the main reason why Beijing wanted more A-share listings? To soak up liquidity and to offer more choices to mainland investors. Naturally index will go down a few percentage points just to accommodate such a popular and mega listing. Everyone wants to own a piece of Petrochina, its not cheap, the funds has to come from somewhere ...

Sometimes the reason for a swing is not as academic or ingenious. In fact, most of the time, the reasons are simpler. I get tired when the papers, the Bloombergs, the "experts" all tout the same diatribe of reasons ... because they have all been schooled the same way. Stick to people who can really add value, people who can be honest enough to say "I don't know, man"... instead of churning out the same old, same old without much thought or logical argument in their heads.

Beware of "experts" commentary, 99% of them come from the same bag of tricks, the reasons are all the same ... after a while they all learn to deliver each line of reason with much gusto convincingly. The more often you hear the same reasons, the more you believe its probably true, that's propaganda, the convenient truth, but usually not the truth because these group of people are too lazy to think properly or are just not market-savvy enough to understand the nuances of the markets.

People who read markets better are generally: willing to stick their necks out on a prediction; give well argued and well thought out points; not wishy-washy; and the reasons are persuasive and engaging.