My Diary 324 --- History Repeats Itself, A Spring Water Please,

My Diary 324 – History Repeats Itself, A Spring Water Please, Holdup China’s Red Flag and East vs West Scene


September 6, 2007

Overnight, equities were down ( S&P -1.2%/ Dow -1.1%) and treasuries rallied (10YR @ 4.47% and 2YR @ 4.02%). The yen was strengthening, suggestive of a pullback from carry trades. Separately, signs of money market woes continued, with 1M and 3M LIBOR (5.72%) still climbing in the US and the Euro area.

In economic front, the pending home sales index, a leading indicator of existing home sales, plunged 12.2% in July, the largest monthly drop in the history of this series which began in 2001. The ADP estimate for August private payroll growth was 38K vs estimate 80K. On data wise, focus today will be on Aug ISM non-manufacturing and the key release of the week remains Aug NFP. Market is now thinking that the Fed will likely cut the discount rate before any FFTR cut.

History Quietly Repeats Itself

Today is a quiet again as there are not much buyers in sight --- money mgrs have been quiet, hedge funds can't do anything with this level of financing and banks have been better sellers as their balance sheets swell from ABCP and LBOs. At the same time, the whole loan market is shut down and ARM issuance has dwindled to next to nothing.

I made a joke with our head of fixed income in Australia by saying that this is just a nother debt-fueled boom turning to bust, with the implosion of the subprime mortage market exposing all the weak links in the credit chain. On the back of my mind, this is no a joke and w e have seen the similar circumstance before in the past two decades. In early 1990s, the asset in questions were commercial real estate and junk bonds, while in the later of last century, it was technology stocks an related assets. Both times there was wide-spread skepticism on whether conventional reflationary policies would be able to prevent a substantial slump in the economy and in the prices of risky assets.

History quietly repeats itself. What we know is it did not take long for new booms to unfold, with a different set of assets becoming the objects of speculation. This time, I think there will have no difference as history always repeats itself, just in different appearance. The will be an ending point to this debt super cycle, but we are not there yet. Thus, volatility will likely persist for a while longer, but the authorities still have policy gun powers, and later a new round of reflation will kick start the system again…… So friends, we wait to see again.

A Spring Water Please

Most markets today remain extremely illiquid and most of major banks are now crying for “A Spring Water, Please!” The problems in the money markets are not going away, despite the Fed's best efforts. Following the tumble in the US rates market, the HKD 3M HIBOR was fixed at 4.972%, which breaks the record in the past 6 years. Now, there is a good chance for the 3M HIBOR to go over 5%.

In Europe, ECB said it will offer extra cash to banks to reduce the cost of credit, just hours before it is due to decide on interest rates. The overnight deposit rate for euros had risen to 4.68% yesterday, a six-year high and above the benchmark refinancing rate of 4%. The BOE joined the world's major central banks in easing lending between commercial banks, by offering to provide additional cash to reduce ``unusually high'' overnight interest rates…. Even the eagle Anglos join the team now.

Bad news is that the plague of subprime now spreads to Australia as NAB and its largest competitors threw a financial lifeline of more than A$10 billion ($8.2 billion) to several SIVs caught in the fallout from the U.S. subprime mortgage rout. These banks use conduits to keep some ST loans off their B/S. This decreases the amount of regulated capital they must retain, allowing them to lend more to customers… Another greedy stories, right!!

In IR future market, there shows a 72% chance for the FED lowering its 5.25% target rate to 4.75% on Sept. 18. Going forward I still think that the world’s largest CBs will do their best in proving liquidity to the global financial system. The problem is however that the money market is already flush with liquidity and this had not improved risk sentiment significantly. Abundant liquidity in the money market cannot solve the fundamental problems in the credit market as evident in the melt down in the amount of outstanding in the US CP market. Therefore we must pay extra attention to new signals from US fundamentals and the impact of credit related losses on key market players. … Bring a Telescope with you when you go to bed…..seriously!!

China’s Red Flag Helds Up Well

The HSI lost 0.1% and closed at 24050 on the back of increased concern a U.S. housing slump will trigger a recession in the world's biggest economy. HSI also dropped after the OECD lowered its forecasts for growth in the US and Europe The OECD cut its 2007 economic growth forecast for the U.S. to 1.9% from a May figure of 2.1% and for the euro region to 2.6% from 2.7%.

Today, China’s “red flag” is held up well (some of you may not know the Chinese meaning!!). In HK, HSCEI rose 1% to a record 14,423 while CSI300 heads up to 5412. Given no big news in the market, would this run be another round of money pushed bull because trading volume is +10% up and 70% of the stocks advanced. Banks add the most to index’s growth and steel is the strongest one. The recent trading pattern looks like that every major sector takes turn to advance and finally those ST also surge. LOOK OUT … it is a dangerous time….

Quick news from Davos Forum told that the government announced index future preparation is ready and will be promoted soon. This may lead to the appearance of index future within 2007 and may influence the one direction bull performance. Another rumor is that banks will raise mortgage loan down payment to 40-50% for 2nd property or high-end house, to curb investment/speculative demand, and decrease correlation between banks and property industry. As many Chinese analyst called, the policy can somehow slow down high-end property sales and curb crazy property price, but in mid-long term increasing supply will be the KEY!!!.....Does the government really know what the key is!!!

Another East vs West Scene

There was a significant differentiation in the impact of recent credit crunch between the eastern and western world. In the East, the financial market turmoil does not seem to be an issue and the economic growth continues to be strong across Asia.

China has stood out as a backbone of stability throughout the recent turmoil, with equity prices continuing to rise. India's GDP growth accelerated again this week, while equity markets have bounced back strongly since mid-August, with the likes of the HSI and other emerging market indices up over 20%. It appears that, if there are problems with liquidity in the East, it is because there is too much!!! Can we pipe some Liqudity from east to west.. it sould be a good business, I think.

Looking to the West, CBs are busy in taking actions. The Fed in particular has reacted quickly to the credit market turmoil. Market consensus now is for a 25bp cut at the next FOMC meeting to restore confidence and address the clear risk that 'Wall Street's' financial turmoil spills over into 'Main Street'. However, the current market distress is as much about psychology as anything and it is unclear if cuts in the target funds rate will solve the worries about transparency and counterparty risk.

Outside the US, both BoE and ECB look to be on hold for the next couple of quarters in response to the turbulence. The biggest problem in the west now is the lack of inter-bank

liquidity (beyond overnight lending), and despite all their efforts, that does not seem to have loosened at all... More to come and hopefully it is not overwhelming.

Good night, my dear friends