My Diary 360 --- The Paulson Truth, Turkey Smell Not-right, Coup

 

My Diary 360 --- The Paulson Truth, Turkey Smell Not-right, Coupled Stock Markets, Metals Are Heavy, Yen and Deflationary Oils

 

November 23, 2007

 

With Oil running to $100/bbl, subprime rumors hanging around, swap spreads pushing wider, and equities having a shocker, obviously fear and bear have taken over the battle field in the markets.

I am kind of thinking how those Wall Street bankers were looking at the “Turkey” on the table, while the panic snaps back in the markets and the Fed minutes indicate there is not a lot can central bankers do, as even law makers can't force people to trade or trust each other again.

The problem now is not so much liquidity but of markets failing…… Well, maybe I worried too much … anyway, life has to continue and “Happy Thanksgiving”.

The Paulson Truth 

It was another ugly week as the panicked trading worsened. Tuesday’s hopes of an emergency Fed meeting were dashed while conflicting signals from the Oct 31 FOMC meeting minutes further disappointed the market. Regional equity and credit markets also responded negatively to Henry Paulson’s shifting view on US mortgages and Freddie Mac’s wider than expected US$2 billion loss.  As cited by WSJ, the Former GS CEO, Paulson expressed his concerns on US housing market as the number of potential US home-loan defaults "will be significantly bigger" in 2008…… Well, at least, there is someone from Goldman tells the “ugly” truth and my new friend Richard said Goldman does not live in Mar, a place has no CDOs and Sub-primes…

Cross checking the minutes of the Fed's October 30-31 meeting, FOMC actually downgraded GDP forecasts for 2008. Now, the members have proven what Alan Greenspan said --- recent signs of a collapse in credit tied to subprime-mortgage lending were ending --- is wrong…Well no more blame on a retired Fed Chairman, he hasn’t closely looked at the data recently…

There is more bad news from US Housing numbers as housing starts showed that the slide in single-family construction has intensified. The number of units authorized for construction with single-family permits has plunged 21% in the past 3 months, including an 8% decline in October. The lack of stability in the permits data, which provide a slight lead on their more volatile starts counterpart, suggests that starts have yet to bottom. So does the large overhang of housing inventory. Beyond that, the level of US initial jobless claims edged down to 330K last week. The bad—but hardly surprising—news is that claims have made a convincing move higher. The good news is that the move so far has been limited…. Remember employment and consumers spending are the last resorts to ring fence a housing-led recession….

That doesn't smell like turkey

"No buyers of risk" is what I keep hearing and it characterizes the markets well over the past few weeks, and fear and leverage unwind rule the markets right now. Of course, I am not suggesting this is the end of the world, but I do feel that we’re getting close to having the Fed to suit up and save the day – at least in the credit markets. Without the provision of much needed liquidity, the drying up of capital markets and bank lending will soon start to hit the economy at large. In fact, it is all about liquidity and the on-going deleveraging trade that is happening in a disorderly manner as reflected in this past weeks’ equity and credit market performance. What is worrying is that the minutes from the October FOMC meeting indicated that the latest rate cut was a close call. The markets remain fixated on the Fed cutting Fed fund rates in December (90% prob.) – but the Fed has remained steadfast in giving little away.

Reflecting the drying up of liquidity has been the sharp increase in swap spreads, which has also inverted and creeping up of LIBOR rates. The moves in swap spreads are almost unprecedented in recent times, with the 5yr swinging from 96bp to 110bp before closing at 102bp... Within 24 hours !!!.... The last time swap spreads were this wide was in November 2000. The current widening comes at a time when US financials are not only facing significant write-offs in their structured portfolio exposure, but structured investments vehicles are coming back onto their balance sheets and delinquencies are now starting to rise. Against this backdrop, equity market volatility over the past week has not been helped by further reductions in 4Q consensus earnings estimates, clearly with a meaningful concentration on those in the financial sector..... that does not smell like turkey, but dead ducks, fair to say!

From now on, there is a risk of another short covering rally before year-end, but I would use that as a chance to get out of some problem positions and I suspect that other real money accounts will do likewise.  Too many people got burned in Sept/Oct and don't want to repeat that. Fundamentally, I think that the bad news that isn't priced in relates to increasing consumer delinquencies in credit card and auto loan debt.  Additionally, with reports being published predicting further CDO write downs north of $100 billion, there is just too much uncertainty to call a bottom.

Bottom-line: Stay tight until we can see the picture more clear.....

Stock markets are coupled

Most stock markets have fallen this month, with S&P 500 down 8.6%, on pace for its worst month since September 2002.The declines reflect expectations that investment losses created by the biggest slump in housing since 1991 are curbing growth in the world's largest economy. Elsewhere is the same.... MSCI World Index of developed-country is down 7.9% from a record on Oct. 31, and the MSCI Emerging Markets Index has fallen 11% from its high on Oct. 29.

I think the latest losses in global equities and the accompanying plunge in government yields (UST 2yr =2.99) once again characterizes the process of risk reduction and, perhaps, outright liquidations currently taking place. The “decoupling” emerging markets are also correcting. This (again) shows that regardless of your view on the likelihood of economic decoupling, markets remain highly correlated. The HSI is down 18.6% from its end-October high. Panic selling also pushed SHCOMP below 5000 level for the first time since Aug. ..... How many Chinese bull still survive now......

Worse place is Japan. The country became the first of the world's 10 biggest stock markets to enter a bear market when the Topix index declined 20% from its 2007 peak. The performance looks bad but should not be a surprise as record crude oil price (a problem for all manufacturing-based economies) is a particular disadvantage in Japan, which imports almost all of the oil it needs. Crude oil futures touched a record $99.29 a barrel this week, and are up 62% in the past year. As a consequence, BOJ on Oct. 31 cut its growth estimate for the year ending in March to 1.8% from 2.1%......

Metals are still heavy

The recent decline in metal market is becoming more serious. In US$ terms the base metal prices have down 20% from its May peak. In terms of other currencies, such as Euro and CAD, the decline is even more pronounced. However, I would expect 30% more to fall in next year; the basket’s prices are still 50% above last cycle’s peak.

To a large extent, I think the financial speculators are responsible for the skyrocketed commodity prices to shoot beyond what could justified by supply-demand fundamentals. and problem is that these speculative monies also imply that commodity prices maybe more correlated with risk appetite than it was historically, suggesting that the current setback may reflect the volatility in the markets.  However, we also have to remember that over a longer-term period, metal demands are driven by the economic cycle and the global industrial production growth still explains much of the variation in metal prices through recent cycles. On that basis, the softening in prices may be a warning that growth is cooling…… that would be another negative signal to 2008 outlook…as a result; the bigger-picture is that the growth risks seem heavily pointed to the downside next year. Even if Asia keeps growing, there are question marks over growth in the US, Japan and Europe…. See the metals are not feathers, they are still heavy…..

 

Yen and Deflationary Oils

Another expression of risk appetite is the JPY, which has obviously enjoyed another round of X-board gains. USD/JPY has broken below the May 2006 low of 108.95. That presumably opens scope for even more significant declines if risk appetite keeps deteriorating. In carry trades, investors sell currencies in countries with low borrowing costs and buy higher-yielding assets elsewhere, profiting from the difference. The risk is exchange-rate fluctuations erase those profits. 

In addition, oil climbed to records this month as the sliding dollar and falling equity prices prompted investors’ interest on physical assets including gold. As I described in my past diary, the markets seems not to worry about the risks of higher oil prices as long as core inflation remains low and various subsidies and price control in Asian countries keep a lid on energy cost increases.

ut this may not be the case to Asia over long-term as our Asia appears more exposed to oil risks, given not only its high energy intensity, but also its economic growth relies on net exports. Thus, the risks of oil is not just that it drives up headline inflation, but that it will ultimately dampen the heady economic growth rates currently enjoyed across the region … remember rising energy/fuel costs act like a tax,  lowering the purchasing power of consumers thus depressing household spending. And energy-intensive investments become more costly, thus holding back a big chunk of expenditure in the economy. Moreover, rising energy prices tend prompt a tighten policy…… then what can you look through is a “deflation’ story ….

 B

Good night, my dear friends!