Bull: "Rumours Of My Death Have Been Greatly Exaggerated"

sopskysalat said...
Weak retail sales, econ data.. new info of late payment of subprime borrower... sent the US equities into a tail spin again.It is very tough. Weak data give the carry trade fear of US lowering interest rates and also weak econ.Not an easy task.. Strong data sounds bad, weak as well... moderate better.

Pricechart said...
Is the bull going to shit?

a) Slowing US demand, largely expected, will cause the Fed to lower rates soon, markets pricing in the possibility of this being a trend rather than a one-off decrease, which will narrow the differentials. Sectors which were sold down in Japan were those reliant on US demand such as auto makers and electronics, which is to say that the selling is properly fundamentals motivated rather than a herd based mentality.
b) Narrowing of differentials, well not quite yet. Even with the data a rate cut is not going to come in rapid succession. Labour data out last Friday still indicate a pretty firm labour markets there, so it is still hard to draw hard and fast conclusions.

c) Investors need to be aware that if there was a real reversal of yen carry trade, you would see the yen dollar rate rising to 105 at least. What we are seeing are markets pricing in risk at every turn, and reverses happening every now and then, not a deluge.
d) Lower Fed funds rate, good. Corporate profits, still good. Last I heard, these two factors would assure for a good market place.

e) I'd expect markets to start diverging from here on because the recent ups and downs have gathered all markets as one. There is no doubt that there is sufficient liquidity swishing in the system. I think we should be seeing funds moving in directions where the action should be, rather than do a blanket move on all markets. This is probable because good funds will always look for alpha outperformance.

Bottomline, I am not too concerned over the mini selloff. Like Yus-baby said, another buying opportunity.

Funds Flow & Asia

Getting In & Out

The correction in Asia in particular, and global markets in general, caused some panic buttons to be pushed. For a time it looked like the markets may be headed for the abyss should the yen continue to strengthen or US numbers indicate a hard landing scenario. Thankfully sanity prevailed, or in my other blog, the Plunge Protection Team came to the rescue to buy time for investors to rethink their positions and to take the fear element out of the market equation.

However, some damage has been done. It is inevitable that there will be some redemption of funds being invested in emerging markets everytime fear and risk rear their ugly heads. For the first 7 days of March, a check with the funds which are dedicated to investing in Asia (except Japan) showed a startling redemption of US$4 billion. The redemption affects investments by these funds into China, Korea, Malaysia, Singapore, India, HK, the Philippines, Thailand, Taiwan and Indonesia. To quote the Citigroup report: "China funds experienced the highest outflows among the 10 economies, with US$964.8 million withdrawn in the five trading days, followed by India funds, which lost US$740.9 million, and Singapore funds, which saw withdrawals of US$201.6 million."

However to just look at absolute numbers may be one-dimensional. We also have to look at withdrawals relative to market size, and the relative popularity of certain markets over the last 3 months in particular. Grouping those parameters, you will find that the impact is greatest for China, followed by Malaysia and then Singapore. In actual fact, Malaysia was the hottest market globally on a YTD basis, hence no surprise that Malaysia will lead in gains and correction quantums. What's significant was the US$4 billion redemption in a week is the largest ever weekly redemption, and more than 2.5x the next biggest redemption which was recorded in May 2006.

The fact that the all time biggest redemptions did not cause a major collapse in emerging markets indicate that there are a lot more investors at play, not just mutual funds. More players, better underlying quality and depth to the run.

Time to get nervous? Well, I would regard the above examples as indicators of a much stronger quality bull run. Having a redemption that is 2.5x bigger than the previous biggest amount, and still being able to withstand and see it turnaround, is a pretty big deal. The yen carry trade is big, but not everyone will act as one. They all entered at different times at differing currency levels and invests in different instruments. The absolute size may be growing and it cannot grow forever, but the recent scare would have prompted a significant amount to cover and unwind their positions - thus temporarily deflating the pent up risk-balloon.

If we were to look at global equities, the huge run-up in oil prices in 2005 and 2006 did not cause markets to collapse. In fact markets continued to defy the rising price of oil and gas. The jumps in fuel prices, to me, was even bigger in significance to the current yen carry trade fear. Rather than take all these as negatives, I see a much stronger base being built underneath the current bull run.

There is an additional factor now, the pricing in of risk. What that means is that when markets retest their all time highs (and they will this year), instead of thinking two or three times, investors will be thinking 5 or 6 times before plunging head first into the rally. Pricing in of risk will mean that at every significant level we will see more profit takers and doubters, it will mean a much more gradual climb and not the kind we have been seeing for the past few months.

The East Is 'Red'

HK's Financial Markets' Future

The Shanghai Stock Exchange has a market cap of nearly HK$7,400 billion (US$950 billion). In comparison, China companies listed on HKSE comes to a total market cap of HK$2,000 billion, which means roughly 21% of China listed assets is in HK. If you were to check the same figures 3 years ago, 6 years ago and 10 years ago as a percentage of total HKSE market cap, suffice to say that China stocks may be instrumental in revving up interest in HK stocks for the last 5 - 8 years.

China stocks listed in HK are known as red chips (H shares). Most are also dually listed in Shanghai. One trades in HKD while the other is in yuan. Shares on Shanghai Exchange or Shenzhen Exchange are known as "A shares". Foreign investors can only buy the A shares provided they have QFII quota. As at the end of November last year, there were 85 red chips.

Companies under HK rules generally come under more stringent financial reporting rules. Red chips trades in HKD which has more convertability. The rule of law in HK makes for a significant reduction in risk premium in terms of accountabity, securing shareholders' rights, etc... Hence you would expect the red chips to trade at a premium to the A shares. Unfortunately the reverse is true.

Both H and A shares have the same shareholders' rights but the HK listed red chips are at a discount to their Shanghai counterparts. For example Bank of China in Shanghai trades at more than 30% premium to its HK share price, while China Life in Shanghai is at a quite ridiculous 60% premium. Whether a stock is at a premium or a discount, its all valuation. Who is to say the Shanghai price is more correct than the HK price? Maybe the smarter valuation is in HK and not Shanghai??

Looking at the China prices, the premium is not one which is based on strong factors. Rather, it is based on weak factors such as the LACK of good listed China companies in Shanghai and Shenzhen exchanges. While that will push up premium on good stocks, it is not something that will or can last.

One of the biggest danger making its round in HK is the fear that a few red chips may be making its way back to list solely on the Shanghai Exchange, owing to the better valuation there. Better valuation means cheaper access to funds. It will also allow for borrowing in yuan as the bulk of most red chips business is out of China anyway.

Among those touted as being the first movers back to Shanghai include China Telecom and CNOOC. What about the views from party leadership? I am sure they would want Shanghai Exchange to flourish, hence moving these stocks back would be the right thing to do. However, they will end up with a dire lack of visibility among international investors. The bulk of foreign investors wanting a slice of China action will have to go via China funds. The restrictive QFII quota also means it will have to be looser and broader in the near future.

I doubt WTO and Hank Paulson will look upon this development positively. They can bring back companies to Shanghai but also needs to loosen up the QFII immediately. If not, the current crop of those with QFII quota will see their funds trade at a big premium due to scarcity.

What companies would lose out on if they leave HK? Access to multi-currency fund raising options. Better and more stringent financial regulatory processes, which bodes well if the company intends to compete in international markets or be in jvs with international partners. Access to human capital and launchpad for market visibility. How many international news bureau or international business channels do you see in Beijing or Shanghai (or Singapore for that matter)??!!

At the end of the day, if more and more red chips convert their H shares back to A shares, the premium would dissipate anyway. Don't tell me then the companies would want to relist their H shares in HK again? It is also a question of Shanghai or HK for the party leadership .... but I thought Shanghai and HK belonged to the same party leadership??

Red chips moving back won't hurt HK's financial future much, it would have been very nice but the depth and breadth of the markets in HK means losing the listing is not material. It would hurt the actual companies more for them to move back because of the reasons cited above.

Idealogy Cannot Exists On Its Own

Plunge Protection Team

I came across a very well written article entitled, "The secret maneuverings of the Plunge Protection Team" By Mike Whitney of Information Clearing House. I have highlighted some parts for discussion.

"The Working Group on Financial Markets, also known as the Plunge Protection Team, was created by Ronald Reagan to prevent a repeat of the Wall Street meltdown of October 1987. Its members include the Secretary of the Treasury, the Chairman of the Federal Reserve, the Chairman of the SEC and the Chairman of the Commodity Futures Trading Commission. Recently, the team has been on high-alert given the increased volatility of the markets and, what Hank Paulson calls, "the systemic risk posed by hedge funds and derivatives.” Last Tuesday’s 416 point drop in the stock market has sent tremors through global system. An 8% freefall on the Chinese stock exchange triggered a massive equities sell-off which continued sporadically throughout the week. The sudden shift in sentiment, from Bull to Bear, has drawn more attention to deeply rooted “systemic” problems in the US economy. US manufacturing is already in recession, the dollar continues to weaken, consumer spending is flat, and the sub-prime market in real estate has begun to nosedive. These have all contributed to the markets’ erratic behavior and created the likelihood that the Plunge Protection Team may be stealthily intervening behind the scenes. According to John Crudele of the New York Post, the Plunge Protection Team’s (PPT) modus operandi was revealed by a former member of the Federal Reserve Board, Robert Heller. Heller said that disasters could be mitigated by “buying market averages in the futures market, thus stabilizing the market as a whole.” This appears to be the strategy that has been used. Former-Clinton advisor, George Stephanopoulos, verified the existence of The Plunge Protection Team (as well as its methods) in an appearance on Good Morning America on Sept 17, 2000. Stephanopoulos said: “Well, what I wanted to talk about for a few minutes is the various efforts that are going on in public and behind the scenes by the Fed and other government officials to guard against a free-fall in the markets….perhaps the most important the Fed in 1989 created what is called the Plunge Protection Team, which is the Federal Reserve, big major banks, representatives of the New York Stock Exchange and the other exchanges and they have been meeting informally so far, and they have a kind of an informal agreement among major banks to come in and start to buy stock if there appears to be a problem. They have in the past acted more formally… I don’t know if you remember but in 1998, there was a crisis called the Long term Capital Crisis. It was a major currency trader and there was a global currency crisis. And they, with the guidance of the Fed, all of the banks got together when it started to collapse and propped up the currency markets. And, they have plans in place to consider that if the markets start to fall.” Stephanopoulos’ comments have never been officially denied ... Robert McHugh, Ph.D. has provided a description of how it works which seems consistent with the comments of Robert Heller. McHugh lays it out like this: “The PPT decides markets need intervention, a decline needs to be stopped, or the risks associated with political events that could be perceived by markets as highly negative and cause a decline; need to be prevented by a rally already in flight. To get that rally, the PPT’s key component — the Fed — lends money to surrogates who will take that fresh electronically printed cash and buy markets through some large unknown buyer’s account. That buying comes out of the blue at a time when short interest is high. ... If a secret team is interfering in the stock market, it presents serious practical and moral issues. For one thing, it disrupts natural “corrections” which are a normal part of the business cycle and which help to maintain a healthy and competitive slate of equities. More importantly, outside intervention punishes the people who see the weaknesses in the stock market and have invested accordingly. Clearly, these people are being ripped off by the PPT’s back-channel manipulations. They deserve to be fairly compensated for the risks they have taken. Moreover, artificially propping up the market only encourages over-leveraged speculators and smiley-face Pollyanna’s who continue to believe that the grossly-inflated market will continue to rise. Rewarding foolishness only stimulates greater speculation. The tinkering of the PPT is sure to erode confidence in the unimpeded activity of capital markets. It’s astonishing to think that, after years of singing the praises of the “free market” as the ultimate expression of God’s divine plan; these same conservative ideologues and “market purists” favor a strategy for direct intrusion. The actions of the Plunge Protection Team prove that it’s all baloney. The “free market” is merely a public relations myth with no basis in reality. Saving the system will always take precedent over ideology; just as the “invisible hand” will always be overpowered by the manicured and mettlesome fingers of banking elites and Wall Street big wigs. ... Trust in the Free Market is wavering. Whatever happened to the idea of completing the “market cycle” and allowing markets to self-correct whether that meant belt-tightening or not? And, what about the ethical question of whether government manipulation should be allowed in a “free market”? Also, by what authority do the government and the privately-owned banks interfere in the futures’ markets and shift momentum from the prevailing trend? Is this a free market or a command economy?..."

My Take - The argument is based on the fact that free markets should be allowed to exist. Why? Why is that necessary? Different times in history and financial markets have different roles to play. 50 years ago a financial collapse is likely to be a localised event, not now. Localisation has now gone on to be globalisation. Localised event is now a domino-effect thingee around the world.

As a politician, bureaucrat and/or steward of good governance, nobody in those positions would want a total collapse of financial markets, as the rebuilding process may take decades. Maybe there is too much leveraged instruments out there. It is easy to be critical, to call for total free market movement when there are so many inherent faults within the financial system is irresponsible. Maybe there is too much leverage now and to allow for unmanaged falls could lead to catastrophies that many economies may not be able to recover from. We have to acknowledge that there is a herd mentality among certain fund managers and hedge funds even, and collectively they can take huge advantage over the rest of the markets by playing the trends together - who is to say that they are not acting in cahoots sometimes??!! Hence we do need a power player, to bring sanity back, and not allow any big domination or excessive manipulation by the one group of funds. The existence of PPT also signals as a threat to diminish any potential plans to corner or misguide the markets with criminal intent.

Countries with jobs usually do not have much war, starvation or violence. Countries with few jobs usually have lots of those, we don't want more chaos than what we have now.

Targeting the Americans for having PPT is very silly. The US has military and global economic leadership, I would expect them to have some sort of PPT. Capitalism yes, but free markets has to be redefined according to the times. The buggers who call for total free markets need to broaden the bigger picture. Its idealogical, but not practical. Just like most things in life, who practices pure Communism or pure planned economy anymore? Capitalism, free markets, planned economy are all models based on theories, not absolutes based on religious fervour.

Not many people know that Malaysia has one of the highest GDP percentage being listed, its in the high 80s. Other developed countries ranges from 50%-70%. What that means is that many countries' economic performance have a moderate to very high correlation to financial markets. If we have totally free markets and let's go bacl to the LTCM 98 debacle, nobody step in, KLSE was already in the 500-700 range after the implolsion, now you get another round of financial free markets correction, it would decimate demand and assets globally.The KLSE might even have gone to 200 not by its own fault in any way. So we need to think of repercussions, because unguarded corrections could kill off more than we could rebuild.

Yes, the shorts might be dealt a bad deal but its a "lesser evil" kind of scenario here. Its not just in saving major correctional phases, the PPT could also come it to deflate excessive liquidity by exhorting various central banks to tighten policies or soak liquidity. What we want is to lessen the pendulum swings on both extremes.

Sometimes things are not as bad as they seem. Chill man!!

He Ain't Heavy, He's My Big Brother!

As reported by AFP today: " ... Temasek said it will continue to monitor developments in Thailand before making future decisions regarding its controlling stake in telecom giant Shin Corp, formerly owned by ousted Thai premier Thaksin Shinawatra. In a letter to the Straits Times, managing director for corporate affairs Myrna Thomas said Temasek makes investments like any other company based on commercial considerations and after factoring in potential risks (#1). “Our investment in Shin Corp in Thailand was no different. We had a positive assessment of the outlook for Thailand and completed the investment in accordance with market norms and best practices in international mergers and acquisitions,” Thomas said. “We continue to monitor the political situation and business environment in Thailand and will take the appropriate decisions as an investment firm.” She noted that Temasek has maintained its “triple A” credit ratings from agencies Standard and Poor's and Moody's. The letter was in response to a reader who had written to the newspaper that Temasek's Thai investment was a national concern as Shin Corp has now lost 45% of its value since the deal was concluded last year. Singapore's ties with Thailand were strained after the Thaksin family sold a 49% stake in Shin Corp to Temasek in a tax-free deal which angered the Thai public ... Relations further deteriorated when Thaksin had a private meeting in the city-state with Singapore Deputy Prime Minister S. Jayakumar in January (#2). "

When you are wrong, just admit it and move on. Not good to keep grasping at straws and kicking sand when you are down. Temasek has done very well in most of its investments, but its silly to defend a pretty gaping investment thought process which went awry. Not by chance, but more due to arrogance and not doing sufficient homework on the Thai deal.

On point #1, This time that Temasek managers have made mistakes that in-depth due diligence and a modicum of investment-banking knowledge seemingly could have avoided. Temasek's decision to buy a majority stake in Thailand's Shin Corp from members of Prime Minister Thaksin Shinawatra's family unleashed a political firestorm that eventually contributed to Thaksin's decision to step down from power temporarily before being ousted later. The US$1.9 billion deal was widely criticized in Bangkok not only for the tax-free nature of the transaction but, more significant to Temasek, for the sale of strategic telecommunications concerns to a Singaporean government-linked entity. Political protesters cast Temasek's purchase as "economic imperialism", and a consumer boycott of Shin's mobile-telephone arm has dented revenues and profits in recent months. Temasek officials at the time explained that it is not a government-directed policy agency, and that Temasek makes investment decisions on strictly commercial grounds. Until then Singapore Inc had been able to skirt nationalistic criticism in Thailand, despite making substantial positions in many formerly Thai-owned banks in the aftermath of the 1997-98 Asian financial crisis.

More significant were the apparent legal blind spots in the Shin Corp deal, which some analysts now contend would have been less controversial if it had been broken up in two or three phases. Temasek was forced hurriedly to divest Shin's stake in budget airline Thai AirAsia because of Thai laws restricting foreign ownership that they apparently overlooked. What kind of due diligence and investment deal structuring or thought process that goes on when you can miss out on these glaring landmines?! There are still lingering legal questions about the waivers Temasek received to avoid making a mandatory tender offer for two Shin subsidiaries, and whether foreign concerns are allowed to own a majority stake in telecommunications concerns that operate under government concession.

Temasek's lack of transparency and its general aversion to press interviews have only added fuel to the fire of the nationalistic backlash its aggressive investment strategies are starting to cause across the region. Citing the above examples, some investment analysts contend that during Temasek's drive to acquire big stakes in regional strategic industries, particularly in banks and telecommunications, the investment company is not effectively gauging through its due-diligence procedures the possible political and even social ramifications of its investments. And that in turn raises important new questions about the quality of Temasek's previously highly regarded management team.

On point #2, a failure to appreciate neighbourly sensitivities. Thaksin has been ousted, and the Thai government is suing him from every angle. Yet you have a high ranking Singapore politician meeting him in Singapore. Foreign Minsiter Nitya Pibulsonggram had already said before the meeting took place that he had personally warned his Singporean counterpart that there would be "reactions" from Thailand if ousted prime minister was received by Singapore Deputy Prime Minister S Jayakumar. Nitya said after having been informed of deposed prime minister Thaksin Shinawatra's pending visit to Singapore, the Thai Foreign Ministry notified Singapore "at least three times" that the treatment to be accorded Thaksin was "unacceptable" to the Thai Government.

A lack of awareness of regional cultural and political sensitivities is a big shortcoming in Temasek. The trouble is they are too proud to probably admit it. When egos, pride, nationalism, excessive feelings of superiority and lotsa cash gets mixed up, its hard to be humble man!!! Mark my words, they will end up selling Shin Corp back at a huge loss.

Takes My Breath Away...

Quotable Quotes By Yus-Baby

As reported in The Star today:

Yusli said retail investors might have been “caught” in the recent fall in the market, but the correction represented a good buying opportunity.

(eerrr Encik..., if you have X amount of funds and you bought shares with it ... X minus X = 0, very hard to buy with zero funds ...

Plus what about those who followed your advice buying at 1,250 ... which was also a "buying opportunity" then, ... at 1,110 nobody dared to come out to say anything??? ... now near 1,200 another "buying opportunity" !!???...

Once and for all, Yus-Baby, give us all your "buying opportunities" for the year so that we will know what to do with our funds, ... if you say there will be 10 buying opportunities in 2007, then we will use our funds this way X/10 ...okay??!!).

Coast Clear???

Or Skeletons In The Closet Still???

So, you want to hear good glowing stuff or things in the closet? No point just looking at bullish things, let's look at potential traps for the markets.

US Hard Landing - The whole thing was started by Greenspan saying that there was a 30% chance of the US economy getting a hard landing in 2007. When very old people speak, people get scared. The 30% scenario is scary because in a lot of economic models (which predicts soft/hard landing and economic cycles based on almost every single available economic indicator), the chance for a hard landing is ten percent to ZERO. Hence for Greenspan to come out and say 30% is a big deal, maybe he knows more than the rest, maybe he's getting senile, maybe he has forgottent to take his medicine - but in a true economist way, his opinion cannot be wrong, can it??!! If you get a hard landing, aha, he was right after all. If you get a soft landing, he is not wrong either (he said 30%, not 60%!!). That's how an economist always get to keep his job. That's how you keep being called superman! The hard landing scenario had more weight when the release of recent data stated that demand for US made manufactured goods dropped 5.6% last month, its steepest decline since July 2000. Consensus wise, economists were expecting only a 4.5% decline. In a separate report, the Labor Department said productivity went up an annualised 1.6% in Q4, revised from 3%, while the cost of labor soared 6.6%, well beyond the previous 1.7% estimate. There is concern that the implied upward pressure on wages could feed inflation. So you have a scenario for raising rates in one and dropping of rates in another. At the end of the day, I would see job security as a major indicator. You have jobs, you will spend, .... drop in manufacturing orders is more likely an adjustment in inventory cycles ... you have jobs, you will have houses, you can ride out subprime debacles ... you have jobs, you can ride out inflationary pressures... I would view employment data very closely, there's one this Friday (read below)!!!

Interest Rate Differentials & Carry Trade - Well, I have almost talked this one to death. But this will be the determinant to whether we have a massive reversal of yen/swiss franc carry trade or not. Today, the European Central Bank will meet and is more than likely to raise interest rates a quarter percentage point to 3.75%. The Bank of England will also meet, but is anticipated to keep rates steady this time around. But just how big is the yen carry trade? A report by JP Morgan's Tokyo office said the amount is around US$340bn, much the same as the figure I obtained from other sources in an earlier blog. However, JP Morgan said that about 3/4 of these carry trades invest in foreign bonds (and not primarily in foreign hot equity markets as many were led to believe). Hence, the fears over carry trade might be a tad overdone. That is to be expected because of the microscopic focus of the media on all issues - you give them ONE TOPIC and they will analyse it from all angles, promote it before each commercial to stay tuned to hear further opinions on the SAME bloody topic. The over-exposure of the same one topic led everyone to believe that its REAL, A PRIORITY and IMPORTANT. It must be important cos they mention the bloody thing every other minute on CNBC or Bloomberg channel... right??! Lack of information causes uncertainty, excessive information causes irrational fears to multiply (good things become very good, bad things become very bad).

Employment Data - Three very important data bits will come on Friday. February nonfarm payrolls are expected to grow by 95,000 jobs, while unemployment is anticipated to match the 4.6% rate seen in January. Average hourly earnings are expected to show a rise of 0.3% from January. What we don't want to see is a massive drop in jobs' growth or a dramatic rise in unemployment. What is massive? Well, if nonfarm payrolls grew by less than 60,000 or unemployment breaches 5.0%, then be VERY WORRIED. The scenario for a hard landing would increase dramatically. Plus this would signal the start of an "easing trend" for Fed funds rate, which would then NARROW the interest rate differentials = reversal of yen carry trade!

Liquidity Driving Markets - No one is denying that excess liquidity is driving most markets. The good thing is we are seeing some action being taken to soak up some of the liquidity. You cannot have excess liquidity as the major driving force as that would always lead to over-valuation and market excessive behaviours. The recent scare on yen carry trade reversal may have eliminated a portion of the liquidity from the system. This would have brought better sanity and clarity for the markets. Not just the BOJ, in fact, other central banks have been trying to rein in liquidity as well. Over the last few weeks, the People’s Bank of China raised reserve ratios on financial institutions to 10%, the fifth hike since mid-2006. The Reserve Bank of India raised reserve ratios by 50 basis points to 6.0%, the second since December 2006. We can expect China to continue with this form of tightening as a better way to reduce liquidity. The China Economic Review says analysts expect reserve ratios in China to go as high as 11.5% in 2007. And analysts expect more hikes in India given domestic inflation of 6.5% and forecasted GDP growth of 9.2% (highest rate in 18 years). What this could mean is a bumpy uptrend ride for the rest of the year, so you will have to work harder to earn money in 2007. Have to look for curveballs, winding roads, traffic danger signs, ... and not over-gear.

Could The Yen Be Undervalued? - While we yak on about yen carry trade. There are two main reason for investors to indulge in them, one is the interest rate differentials, and two, that the fundamentals actually point to a weaker yen! But there is a growing voice that says that the yen is in fact undervalued and not the flip side as most would be led to believe!!! The yen hit an all-time low against the Euro last month, and its trade-weighted value was at its lowest since 1970. According to the Economist's Big Mac Index, the yen is undervalued by approximately 28%. At some point, this imbalance must be corrected and the yen has to rise. Then we have the recent raise in interest rates, what this could mean is that MONEY is no longer FREE or CHEAP in Japan. Though it will probably be in 4Q 2007 before we see BOJ raising rates again, it could be the start of a long term trend. As almost everyone expects the BOJ to raise rates very slowly, the BIGGEST potential market correction will come should BOJ decided to raise rates again anytime in 2Q or even 3Q 2007, as that would set off panic buttons. Watch the old foggies in Japan closely. This has happened before. When hedge funds reversed their yen carry trade positions after Russia defaulted on its debt in 1998, the yen appreciated by 20% in two months. Just imagine, a 10% appreciation now would have spelt catastrophe even! Then at another instance, the Japanese government announced a plan to recapitalise its crippled banks, the yen jumped 13% within three days. Yen carry trade catastrophies are not new, nor are they rare. The BOJ has been holding onto the near 0% interest rate policy for more than 10 years, and yen carry trades have been around for as long as that. To me, its the gap and trend of interest rate differentials that will dictate matters in the end. So, watch things that will narrow or widen that gap to get a better read on markets for the rest of the year.

Oh... do I believe the yen is undervalued? Yes actually but only slightly, I do see Japanese corporates competing very well already at 120-125, I think they will be able to compete even at 110 or even 105. So, if I was running a hedge fund, I would still borrow in yen to invest, but I would hedge the position so that I lock in yen rate but maximise on the low interest rates.

Hindsight Harry

Easy to explain the past, hard to predict the future. Fundamentals... good. External risks have been mentioned before, but the gravity of the correction caught most, including myself, by the balls... and being yanked at the same time! Looking back now, every commentator would be a genius, so instead let's try and make more sense of it. The exaggerated selloff was based on the following factors:

1) No meaningful correction for all equity markets since late 4Q2006 (9/10)

2) Problems in the US subprime mortgage market (4/10)

3) Reversal of yen carry trade (6/10)

4) Large imbalances in Central and Eastern Europe (2/10)

5) Geo-political risk due to the concerns about Iran nuclear program (2/10)

6) Pricing in of risk into equities (9/10)

7) Hard landing for US economy (5/10)

8) China sneezes (2/10)

The ratings given are my view on their role in the current correction phase for equities. When markets rise, no one really bothered searching for reasons of the hows and whys. But when they fall, my god, we all need reasons? In scrambling for the nearest, most plausible reason, we lump one and all into our theory to explain away our fears and disappointment. However, not all reasons are created equal, some are more hype and tripe.

1) Self-explanatory.

2) Take the US subprime market, yes there are problems. Honkers & Shankers must be given loads of credit for being almost the first big bank to highlight the problem. Merrill Lynch calls for a sell on HSBC but I think its a very good buying indicator for HSBC. A bank that does not hide and manages risk astutely, makes early calls and cuts losses before gangrene sets in, deserves kudos and premium points. While there are problems in the subprime market, it is but a very small portion of the overall lending market. It is called subprime for a reason, it is not prime! Things not prime having problems is normal. But when markets fall and you go around looking for culprits, its a convenient fodder to stoke the embers of fears.

3) Its not just the yen carry trade thats creating potential problems but als swiss carry trades. Liquidity levels continue to be enormously accommodative, driven by high borrowing due to low interest rates. The Euro M3 money supply is growing at a 9.8% annual clip, its fastest in 17-years! Two of the biggest suppliers of easy money are BOJ and the Swiss National Bank. Whe you set lending rates so low, what do you expect investors to do? You know the story about the girl who climb trees and do not wear panties ... An estimated US$330 billion of carry trades in yen and Swiss francs are swirling around the global markets. BOJ lends at 0.5% while the Swiss lends at 2%, but I am still largely unconvinced that there is substantive unwinding as the differentials are still intact. In fact next week the ECB may even hike its interest rate further, thus reinforcing the differentials even more. In fact once things stabilise, I would expect even more to join in the yen and swiss carry trade now that players will get an even better buffer on the stronger yen.

4) & 5) Serious political journalists trying to put their 5-pence worth into the fray ... fergedaboudit already!

6) Strategists at 12 of the biggest Wall Street firms predicted in December that S&P 500 stocks would rally an average 7.8% this year. The unanimous bullish outlook on Wall Street last happened in 2001, when the S&P 500 dropped 13 percent. Too much of a good thing means no one is looking at risk side. Now we are trying to price in risk.

7) The “soft landing” scenario for the U.S. economy was jolted on February 16th with news that housing starts plunged 14.3% in January to a 1.41 million annual rate, the lowest level since 1997. The Fed’s 2-year rate hike campaign has toppled the U.S. home building industry into a severe recession, and now a meltdown in the sub-prime U.S. home loan market threatens the stock market.
In other signs of severe distress in the all important U.S. housing sector, sales of new U.S. homes plunged 16.6% in January to an annualized rate of 937,000 units, the sharpest monthly decline in 13 years. This hard landing scenario bears watching as a worsening of conditions in the US could pull the rug off a lot of bulls' feet.

8) China will be volatile as 60% of players are retail, but the 9% selldown was pure rumours and baseless. Even without austerity measures, the markets there are doing some self-correcting.

In conclusion, my views:

a) been overly bullish

b) still believe we are in a bull market

c) even though external risks have been mentioned, the gravity of correction has been overdone

d) equity markets in oversold territory now but will take a stabler yen to move it back to normalcy, another few days

e) when we look back a week or two down the road, we would all be amazed at the excessive bearishness now

f) the present low point stands a very high chance of being the lowest point for all equity markets this year

Today's Images Prequel!

Equity Sales/Dealers




Recent Research Reports







Buying On Weakness





Checking Your Portfolio

Bursa's Stock Options Scheme

People With Margin Accounts





Chartists

Today's Images Part Deux


Analysts & Strategists





The Only Thing Still Up & Erect In Asia






New office attire for hedge funds execs





Only thing still up & beautiful in Japan

Asia fund managers waking up this morning

Today's Images

Retail Investors In Asia

The Guy Who Asked Retail Investors To Join In Recently

Bursa's Senior Mgmt

The Guy In The Previous Posting Below Who Was Not Scared Of The Reversal Of Yen Carry Trade

A Remisier In Malaysia

What's It All About... Yen-nie?

The reversal of the yen carry trade has been cited as the major trigger for the current correction phase. Yes, and we have debated the yen carry trade for the last few weeks a number of times already. So is the reversal genuine? Yes and no, I would say there were some reversal but based largely on fear rather than on a sustained belief that the yen would strengthen even more significantly over the next few months. There is also some confusion as to where do the yen carry trade invest in? Some will cite the Asian hot stock markets as a possible destination. Just have a look at the size of the yen carry trade each month and map that to the inflows, there is some connection but not by much. Investors must be aware that the yen carry trade is not a recent phenomenon but rather one that has been on-going for the past 15 months. Then we can see a better dis-connect between certain markets and the carry trade.

Yen carry trade tend to stay largely in pure currencies or bonds as that would be the prudent play. You don't really want to be subjected to the vagaries and additional risk scenario from equities. Hence high yielding currencies such as NZ dollar and OZ dollar are the usual suspects. Next in line would be certain commodities such as gold. Other steadier investments such as REITs in good base currency would be highly welcomed, such as HKD and SGD.

Prior to the correction the yen was at 121-122 to the dollar. The yen is expected to be weaker in 2007, much as in 2006. Generally carry trade wants the yen to stay in the 120-125 zone this year and they would be happy to lock in the profits on invetsment. While the outlook on the yen is weak on fundamentals, most carry trade players are not looking at a much weaker yen to dabble to the carry trade. The main attraction is the 0.5% interest rate and the weighted risk to invest in higher yielding currencies, bonds and even equities. All they want is for the yen to be stable.

There is also a lumping of players involved in carry trade. Hedge funds always get the brunt but actually a lot of Japanese companies are involved in the carry trade as well and a number of high net worth individuals.

Now the yen has reached the 117-118 level. Let's look at the corresponding cross rates of various currencies, then you will get a better assessment of the actual quantum of reversal. There is some, but not much. Because if you look at the situation at 117 or 116, the interest rate is still at 0.5%, it is not going to cause panic but rather encourage even more yen carry trades. Because everyone knows if the yen goes up further, we can say goodbye to Japanese exporters, a scenario most central bankers would not want to see. G7 meetings have discussed the need for the Japanese economy to take back leadership in Asia, to take away some of the burden of motoring the global economy from the US, EU and China/India.

At the end of the day, its the interest rate differentials that will exert the most influence. BOJ while scaring people like there is no tomorrow, will not be raising rates anytime soon till at least 4Q2007. Figures coming in from the US sees some inflationary embers, so no rate easing there. Differentials stay, not narrowing. This round of carry trades started when the yen was around 112 in early 2006, so we are not taliign of a massive yen weakness movement since then.

Yes, we should worry when the yen carry trade actually starts unwinding on genuine concerns, as a trickle will turn into a stampede if its based on significant changes in fundamentals. Now is not the time, not yet anyway. Genuine unwinding will occur when players see the trend ending for a weaker yen - narrowing of interest rate differentials is the likely culprit. Either BOJ raises rate aggressively, or the EU/Fed lowers rate aggressively. While both are not likely in the next 2 quarters, if anyone were to make a move, its likely to be the EU/Fed, so watch their every move.

Am I Still Pretty?

Something Out Of Nothing

Now sit yourself down, the whole correction thingee over the last 3 days was brought on by the China markets which fell 9% of rumours of a 20% capital gains tax on stocks, which did not materialise and was denied by the authorities via the front pages of dailies. So, it was nothing! What happened next in other markets was a fear-based reaction, everything was fine and dandy with no big risks in the horizon. I have mentioned the external risks to the bull run but even then the external risks did not actually eventuate. Yes, I said "austerity measures" from China could rock the boat, but this was not even an actual move but just rumours. Yes, I did say the unwinding of yen carry trade, but first yen has to appreciate a lot more to bring about the problems. Does the yen have any reason to gain ground? BOJ raising rates to 0.5%??!! Hmmm, where are the Fed Funds rate, what's the rate in Australia or Malaysia, that's still a pretty good differential.

Now you have the core inflation data in the US at 2.3%, slightly above the comfort zone of the Fed, which mean any imminent reduction of Fed Funds rate would be diminished, thus reinforcing the interest rate differentials. If the yen rise more, I tell you, this would not spell the reversing of yen carry trade, but rather prompt more to do the yen carry trade.

Is this a correction or a major bloodbath. Major long term bear markets are prompted by something significant happening. 1987 (interest rate/yen/dollar); 1990 banking crisis; 1995 banking default by Mexico; 1997 Asian financial implosion; 1998 Long Term Capital Mgmt's hedge bets gone wrong; 2001 internet bubble demise; the September 11 factor; ... and now we have ... rumours of something which did not happen in China... and the fear of yen carry trade reversal which looks to be a scare rather than real. So, what I am trying to get at is a genuine blowout stems from something significant, what happened over the last 3 days is a load of smoke n' mirrors.

p/s of course the beautiful picture is a sequel to an earlier posting entitled "People Say I Am Pretty", but its mainly a silly excuse to load the two wonderful pictures up