My Diary 369 --- Monolines situation is worrying, Chinese shoes

 

My Diary 369 --- Monolines situation is worrying, Chinese shoes are shaking, The EUR bull is ending

January 22, 2008

“God Bless Us” is the final remark of a late afternoon market notes sent by Citi’s regional sales head, quoting huge redemption from long funds and hedge funds, margin call for retail accounts, structural product hedging and pessimistic sentiment. Echoing his comments,  Asian equities have collapsed for a second day on unrelenting fears that the US is heading into recession. The losses followed on from Europe's declines, and a fall in New York futures. India halted -7% today (20% ytd), HangSeng -8% today (-21.7% ytd). The Nikkei broke into 12K territory for the first time since September 2005, down 4.7%.

Meanwhile, intra-day BBG news quoted the long-time-no-see investor’s, George Soros, bearish views on the global economy, saying the situation is much more serious than any other financial crisis since the end of WW2.  …Now, I see another market rumor saying that FED will have urgent meeting tonight and to cut 75bps…But where is Ben? Does anybody have his phone number… give him a call then ……I will put some inks about monolines first…

Monolines situation is worrying

After S&P and Moody's had placed the ratings of Ambac Financial Group and subsidiaries on review for downgrade, Fitch Ratings has now taken the once inconceivable step of downgrading a major US financial guarantor, Ambac to AA and its senior debt rating to A, leaving both on Watch Negative.  The deciding factor was clearly ABK's decision to shelve its equity offering plan given market conditions along with pressure from a large shareholder to consider a less dilutive option of run-off that may be more beneficial to shareholders.

This is a big deal. Monolines insurers have created US$2.5 trillion "wrapped" securities of which US$260bn relate directly to subprime. As the rating agencies adjust their models and start to downgrade the monolines based on a paucity of capital to pay out on defaults, the knock-on impact could spiral…Why? Because the number of forced sellers (AAA accounts that can't hold bonds rated below that) and the investment banks with hedges that need to be written down will lead to further financial system stress. In the case of the UK banks, direct exposures are estimated as about GBP200mn at Barclays and GBP100mn at RBS (CSFB estimates). In itself, these are manageable numbers, but the increasing counterparty risk is leading to pressures across their books.

Equity markets are currently trying to price this in, with RBS at GBP3.50, 50% of last summers high at a level not seen since July 2000…Hey, is this another Y2K bug… This looks like overdone, but clearly all the leverage is not out of the system yet.

Chinese shoes are shaking

China markets got the same deadly hit as the rest of the region. Today HSI dropped 8.7% to 21,757 while H-shares slid near 12%. SHCOMP also sagged 7.21% as the widening reach of the US subprime woes has increased investors' worries toward Chinese banks and triggered a panic sell- off… in particular, BOC A-share suspended in this morning and likely to last until the bank issues a statement in response to the amount of provision related to its subprime MBS exposure of US$8bn in its 4Q results. Fundamentally,  to the Chinese banking sector, the country’s tightening policies will eat up part of their earnings, while the worsening of US and global economies is just adding salt to their wounds……underweighting the sector…

Talking about A-shares, this market is essentially operated in a closed environment & subject to the local news flow & sentiment. I think it’s now due for some consolidation, hence the risk-adjusted return may not look that favorable in the short-term as mounting inflationary concerns may continue to overhang the market. Policy wise, Chinese government has rang in the New Year with a clear tightening bias, as evidenced by 50 bps RRR hike effective from 25 January 2008 and a significant acceleration of RMB appreciation in the past several weeks. The authorities have reportedly set a new bank loan growth target of 13% for 2008, down sharply from the current loan growth rate of 17%. Last week, the central bank pledged more actions to cool the economy and contain inflation with NDRC surprised the market announcing ‘temporary’ freeze on retail prices on basic foodstuff. It has triggered concerns amongst some investors whether the motive behind such measures is that the food inflationary pressure has been more severe than expected. The most updated CPI forecasts for 2008 now are 5.0-5.5%.

In general, three rationales behind the current tightening campaign --- 1) structurally, it is part of the government’s growth “re-balancing” strategy to reduce the economy’s overdependence on capital spending and the export sector while boosting private consumption; 2) cyclically, it reflects the authorities’ heightened concerns of liquidity overflows in the economic system, and consequently rampant speculation in asset markets; 3) recently, officials have become increasingly worried about overall price stability caused by surging food costs. In this environment, I will continue to suggest "defense" in portfolio construction and recommend overweighting sectors, including toll roads, IPPs, gas distributors, consumer staples, telecom particularly Mobile, Sinopec, while avoiding cyclical sectors, e.g. property, steel, cement, bank, nonferrous, shipping, ship building, construction, etc.

The EUR bull is ending

The Yen rose against the Dollar (106.55) and the Euro (154.63) after the Fed and ECB said economic growth is slowing. As the US is heading for hard times, the bigger question is what happens to the rest of the world, including currency and commodities?

Judging from the current prints, the downward momentum for European growth is picking up pace as hard data (German retail sales and IP) and business sentiment surveys demonstrate.  The ECB are right to worry about wage deals and the rise in inflation expectations, but at some point lower growth outlook will see these concerns subside.  Europe cannot insulate itself from the US to such an extent that a recession is priced into the US and no cuts are priced into Europe.  Oil is the key for the European inflation and it has moved lower (87$/bbl) and further economic data weakness, that looks likely, will encourage this thinking. These are very significant changes and could signal the end of the EUR bull move. The decoupling theory is really coming under pressure and the extreme pricing off treasuries should mean the almost the worst is priced into the US Dollar and the EUR needs to play catch up.… The world is recoupling ……

A US recession poses a bigger threat to the global economy& Commodities than a slowdown in China, according to Princeton University economics professor Burton Malkiel.  And in NYME, 1M WTI is trading at USD87.6/bbl, dropped by more than 10% from a record high of USD100.09/bbl hit on 03Jan 2008. Looking forward, geopolitical and weather factors that drove oil prices higher in 2007 are still operating as we enter 2008, suggesting upside pressures.  Base metal complex prices also fell as anxiety spread that a fiscal stimulus would not be enough to prevent a recession. Copper ($6,800 a metric ton) dropped by more than 3.5% on continuing worries that demand will decline and estimates that copper prices will average 7% lower this year than they averaged in 2007. Historically, Copper slid in each of the past three U.S. recessions…… the metal looks attractive for the spot price now …But I want to be patient for a while… 

Good night, my dear friends!