My Diary 315 --- Pig, Subprime, A/H Premium Fed Statement and US

My Diary 304 --- Pig, Subprime, A/H Premium Fed Statement and US Hole

A quick wrap-up of what happened over last week: liquidity evaporation has spread beyond sub prime-related markets, starting from hedge funds, then banks, HY bond issuance and ABCP for high-quality investors. It is when even high quality borrowers lose access to capital markets that alarm bells ring for central bankers.

 

Pig vs. Subprime

There is a basic looking-back question about why the recent financial market turmoil is triggered by sub-prime instead of other leverages assets like commodities? Personally, I think this rooted during 2H04 and 2006, when Fed started to raising funding cost from 1% to current 5.25% while the economic growth has helped keep investors confidence and low market volatility. For yield-hungry investors, they either extended the duration or traced down the rating category. Now we know that the overlapped area of long duration and low rating assets are subprime mortgages and its related derivatives.  Certainly, the financial innovated world + substantially leverage investors are two of other catalysts.

 

Interestingly, the real brew process is complex and hard to understand, just like no one can really imagine that the current 5.6% Chinese CPI was caused by PIG shock due to so called blue-ear diseases and low meat prices in the past few years. But the current turmoil in global credit and equity markets is possibly the largest financial shock of the past decade.

 

Fed Cut vs. Downside Risks

Last Friday, US Fed reduced the primary credit rate by 50 BP to 5.75%, so it is now 50bp above FFTR and issued a statement acknowledging deteriorating financial market conditions and tighter credit conditions and saying: “the downside risks to growth have increased appreciably. They also liberalized the mechanics of use of the discount rate window somewhat. One of the interesting message is Friday’s statement is greatly different from the post-meeting statement – no mentioning “inflation” anymore.

 

However, since the Fed will be providing liquidity to banks and not to other intermediaries such as hedge funds or banks’ SPVs or conduits, it is hard to see this small move liquefying such a broad range of asset markets. Thus we should expect further Fed actions in the near future. In particular, as the economy weakens in response to the credit freeze, the Fed will almost certainly be obliged to cut the Fed funds rate. Such a reduction would be far more significant than today’s move. 

 

China A/H Shares

On last Friday, The Hengseng AH premium index has widened 50bps from early July. Many red/blue chips stocks in the HSCEI and HSCCI Indices rebounded strongly, led by Property, Materials, Energy and transportation stocks listed below. It seemed to me that these sectors and stock are still the market darlings with every dips meaning a buying opportunities.  My favorite COLI boosted  ~15% so far.

 

HSCEI		px last	1d%
2600 HK Equity	Aluminum Corp of China Ltd	12.46	15.58
694 HK Equity	Beijing Capital International Airport Co	11.04	12.77
2883 HK Equity	China Oilfield Services Ltd	9.66	12.33
2777 HK Equity	Guangzhou R&F Properties Co Ltd	26.2	11.97
2328 HK Equity	PICC Property & Casualty Co Ltd	8.84	11.76
1088 HK Equity	China Shenhua Energy Co Ltd	27.55	10.64
1898 HK Equity	China Coal Energy Co	12.68	10.07
1919 HK Equity	China COSCO Holdings Co Ltd	11.46	9.98
1138 HK Equity	China Shipping Development Co Ltd	17.66	9.91
HSCCI
688 HK Equity	China Overseas Land & Investment Ltd	14.8	14.91
836 HK Equity	China Resources Power Holdings Co	16.72	10.29
828 HK Equity	Dynasty Fine Wines Group Ltd	2.76	10.40
291 HK Equity	China Resources Enterprise	27.4	10.71
152 HK Equity	Shenzhen International Holdings	0.79	9.72

 

 

But I beleive the greatest news is SAFE today announced the full liberation for Mainland Chinese to invest overseas without quota limitation. Wow... a big big move and let us review the A/H arbitrage trades again, given the new record high A shares. One of my colleagues said: China always loves us. Yes, for cheaper PE and less liquidity pressure.

 

What Worries Me

Overall, I hold the view that market conditions have deteriorated sharply, given Fed’s announcement, “tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward”. In fact, a series of economic data releases and corporate news questioned the strength of the consumer. The decline in the Philadelphia Fed’s measure of manufacturing yesterday and the decline in the University of Michigan’s consumer confidence index (August = 83.3 vs consensus = 88.0 and 90.4 in July) may be a foretaste of that broader weakening. The main data day will be Friday, when new home sales and durable goods orders will be reported.

Bottom line: If US really slow down, who can fill the hole?