My Diary 332 --- Mr. Market Comes Back, a “Too-Big-To-Fail” rule

 

My Diary 332 --- Mr. Market Comes Back, a “Too-Big-To-Fail” rule, Make Money Out of Tide, China remains as your lover, Copper and Crude Picks

 

September 20, 2007

 

Don't fight against the Fed!!! This is the first thing Dr. Alexander taught me in his CLSA training lecture of “Teach yourself to become a better trader”. Indeed, he is right at least over the past 48 hours after so-named” Bernanke-Greenspan Put”.

Overnight, the Treasury market opened lower as global equities celebrated a generous gift -- 50 bps easing.  Beyond that, I saw the risk/credit assets were better bid which further pressured USTs today as money were obviously on the move after being parked in risk free/liquidity mode for a while. Even though I am a fundamentalist, technical now is a pretty good guide post …Let me kick-off my dairy today but this piece will be the last piece before I return from China for the Moon Festival.  I do miss my family and my mom’s homemade dishes.

 

Mr. Market comes back!

Looking at all the asset classes in the past two days, I believe any trader, who wants to secure the last big portion of his or her bonus, will still sit tight. (Really, who and give me the phone number and I will call). On the back of an upsized Fed rate cut which fueled further downside momentum, the markets saw a sharp & confident return to risky assets. One big takeaway is the economy needs easier money more than price stability right now. Fair enough so far…

Unfortunately, bonds aren't really buying it as price action suggests the benefits that accrue to bonds via a weak economy have been trumped by fears of inflation, particularly after that Fed decision. The 2-10 yield has pushed out to 56.4 bps and the longer-end gets sold, hard. Bond prices in the EU & Japan were hit on the rush to risk. Other assets replicate the same “return-to-risk” trade…The USD remains weighed off by rates and the yen & most of the majors. Gold is ticking up again with spot at 728.75, exceeding the recent high. Crude is bubbling along above 82 at 82.12.

 

 

There is a “Too-Big-To-Fail” rule?

Given that Core CPI YoY was 2.1%, edging closer to the 2% upper bound of the FED's target range and Actual PPI was -1.4% vs. consensus -0.3%, I do not fully understand why cut rates? In particular, why the rate cut was more aggressive than expected? (I can also flip the “rate cut” and “cut rates” now)… In the statement, the Fed gave no indication that inflation was a dead issue, although we know the core inflation has improved modestly YTD and the Fed said that ``some inflation risks remain.''

I still recalled  Mr. Bernanke himself said at the Kansas City, Fed's Jackson Hole Conference last month --- “It is not the responsibility of the Federal Reserve, nor would it be appropriate, to protect lenders and investors from the consequences of their financial decisions.'’ So why did he fire two bullets in one shot? Perhaps the Fed chief was "sick of those late night calls at home" from Wall Street asking for rate relief. But now more talks will heat up over the "Greenspan Bernanke put" (or bailout) with my colleague noting "next new highs in stocks...more carry trades for everybody”... you see why Mr. Market is coming back!!

 

Some Fed defenders said today that unlike the ECB, the Fed has a dual mandate to foster maximum sustainable growth and stable prices. It also acts as a lender of last resort. Thus, in the short run, the Fed can't do all three…”They have to insure the growth side. They'll get back to inflation later.'' But I would like to put it another way, in what I called a doctrine of “too big to fail.” If you're going to screw up, make sure you screw up big, so that it creates systemic risk --the scariest word in a central banker's vocabulary – and engenders a policy response.  If you don’t get what I said and I will give you another clue --- the Bush administration reversed its policy, allowing Fannie Mae and Freddie Mac, the two largest sources of money for U.S. home loans, to expand their investments in an effort to make mortgages easier to get… Aha, Daddy is always there, keep playing fires, son!

 

Make some money out of the Tide!

 

Overall, the cut in the discount rate is a immediate, good news for financial markets. The reason is that the discount rate essentially acts as a cap on short-term LIBOR rates, and so the 50bp cut should help lower interest rate charges for those homeowners with ARM that will reset in the near future. The cut in the FFTR is a more and less a boost to confidence, but in terms of actual economic impact, will work with a much longer lag.

In fact, bonds today are getting a bit dragged on by the ongoing rally in equities, and concern over potential inflation pressures. Data was not a huge contributor to market action, even as the housing reports missed, that debacle has become generally accepted as the way of the future. The current smack-down may have some staying power, but with all the uncertainty still on the markets' back, a quick reversal would be entirely feasible on a headline of any magnitude that could be read as a tape-bomb.

 

Along with more investors’ willingness to assume credit risk in the short run, I still hold the view that a heavy supply pipeline may result in a difficult environment for secondary market spreads to tighten substantially. Beyond that, I remind myself that I shouldn’t forget the underlying current of the economy and housing market remain troublesome.   Having said all that, I believe it is likely we can construct a ST trade that provides excess return, but selectivity will be the key and sector calls are meaningful in my opinion… So go and make some profit out of the tide.

 

 

China remains as your lover!

There was news coming out this morning, saying that the Chinese authority is considering including the corporate QDII program. Maybe inspired by my spill-over liquidity, HIS index was up 146 ppts to 25701 while HSCEI climbed 1.95% to 15552.

Interestingly a HSBC empirical research showed that in contrast to the past five rate-cut cycles from 1987 to 2001, the HIS had on an average dropped over 10% during the month before the first rate-cut, laying ground for better performance later, it seemed investors already priced in the 50 bps rate cut… See investors of H shares are smarter than else where…Hmm... On a sector basis, the finance and properties sub-indices of HSI tends to out-perform the commerce &industrials and utilities sub-indices during the past three US Fed rate-cut cycles in 1995, 1998 and 2001, up on average 10-25% in the following three months… and these findings are not applied today anymore … what a useless research report!!!

 

Look at China … guess what …Oh yes, index hit new record again! Today, SHCOMP added 74 ppts to 5470 as some blue chips suddenly become strong in the afternoon. Sector wise, transportation is strong as a whole, including the air lines and the railway stocks with Air China (+10%) and Daqin Railway (+9.98%)…The National Day golden weeks is seemed a power catalyst for these out-performers. Oh, gizz... one of my friends in China told me that the debut of Bank of Beijing created approximate 5,000 millionaires in one day because of employee’s holdings… Looking at the speed of millionaires producing in Chinese stock market… no wonder the property price hitting the roof!!!

 

 

Rising Gold & Dying Dollar

Gold rose together with Asian’s sun, nearing a 16-month high (Dec gold=$730.80 an ounce), as the USD traded within record low against the EUR @1.4043, boosting the appeal of the precious metal as an alternative investment.

The Euro looks to be the primary beneficiary of a weaker USD and rising risk appetite.  EURJPY is a carry favorite now and, with the Fed supportive with the 50 bps cut, increased market confidence should see further carry strength.  The JPY is once again a funding currency with rates still struggling to rise and market volatility subsiding…Going forward, whether we will get more news flow and/or the credit markets settle down is the big question though for now the Fed has stocked the fire…

 

Indeed, I was surprised that the Dollar fell so dramatically in the wake of such significant gains in US equities. But given US and global investors could well find non-US markets more attractive than US markets, this perhaps explains a portion of the USD underperformance. Certainly, if those sentiments persist, it would represent a medium-term problem for the Dollar. But a more basic issue for the dollar now is relative interest rates. However, further out, I think that aggressive and pro-active Fed policy to boost US economic prospects should result in significant capital coming back to the US. This in turn should boost the USD and allow for a recovery in the greenback, particularly against the majors.

 

Copper and Crude, you pick one!

Crude oil traded near a record close in NY on concern storms and declining imports may reduce US supplies before demand peaks in the Q4. Oil jumped to $82.09/bbl today after a US Energy Dep. report showed the nation's crude oil inventories fell 3.87 million barrels last week, almost twice the decline forecast by analysts. In addition, overall US refineries operated at 89.6% of capacity last week, down 1% from the week before as US refiners often shut units for maintenance in September and October.

Copper is catching up today in Shanghai on speculation demand for the metal will rise because this week's interest rate cut by the U.S. Federal Reserve will help contain a housing slump in the world's largest economy. Copper for December delivery on the SHFE rose 1% to 67,730RMB per ton. And Jiangxi Copper, China's largest publicly traded producer of the metal, climbed 6.9% to HK$20.35.

 

I think there is sth to be thinking about for the commodity markets as there is still no sign of either the housing market or the residential construction industry hitting bottom and starting to stabilize in the US.  Builders in the U. broke ground on 1.331 million homes at an annual rate, the Commerce Department said in Washington yesterday, the fewest in 12 years.  Maybe, at the back of people's minds, the credit and housing problems in the US are far from over, but the larger-than-expected rate cut offers investors some psychological assurance, which is giving a boost to metal prices… again, don’t fight against the Fed.

 

Good night, my dear friends