Tuesday, December 8, 2009


Hong Kong
A further melt up remains the most likely end to 2009. The equity markets’ resilience has been further demonstrated over the past week with the mini panic over Dubai. This is an amusing example of markets being rudderless when America is closed, given that the news broke over
the Thanksgiving Holiday.

The whole episode also serves as a further reminder of how investors are prone to panic when debts they presume are government guaranteed are in fact not so. There is certainly no reason to assume that Dubai World is government guaranteed. In this sense it is a similar situation to Fannie Mae and Freddie Mac. Hopefully, unlike what happened in Washington, Abu Dhabi will insist on a haircut imposing some much needed discipline. On the point of detail, Dubai World announced on 25 November a request for a six-month standstill in its debt repayments, while the Dubai government said earlier this week that it will not guarantee the debts of Dubai World. The state-owned holding company then said on Tuesday that it will restructure only US$26bn of its US$59bn debt.

In Hong Kong this week for meetings with investors, GREED & fear has noted a natural comfort with the Asian story but a worry that the asset bubble thesis has now become consensus. There is also a growing discussion as to whether the US economy could be gaining traction leading to rising hopes of a healthy recovery. This is natural given improving consumption data, such as the latest auto sales data. Thus, US light vehicle sales rose to a seasonally adjusted annualised rate of 10.93m in November, up from 10.46m in October (see Figure 2). There is also growing focus on the robust US corporate cash flows

GREED & fear cannot deny all of the above. And clearly if the credit multiplier does pick up in America, then the trade in Asia becomes to buy Asian exporters and in particular Japanese exporters given that a healthy US economy means a fundamentally stronger US dollar since the foreign exchange market will be quick to discount higher US interest rates.

Still GREED & fear’s base case remains to wait for hard evidence that releveraging is occurring before assuming it will happen and adjusting portfolios accordingly. There is certainly no sign of this as yet in the trend in bank lending. US commercial bank loans fell by 5.9% YoY in the week ended 18 November (see Figure 3). While securitisation activity remains lacklustre. US agency MBS issuance fell by 22% MoM to US$100bn in October, down from a recent high of US$235bn in June, while non-agency MBS and non-mortgage ABS fell by 53% MoM and 37% MoM to US$2.3bn and US$11.6bn in October (see Figure 4). Still both these areas will need to be watched closely for any revival in activity given that rising velocity of money circulation will only be confirmed in the macro data after a big lag by which time the financial markets will have already reacted.

Meanwhile, it is certainly wrong to assume that all of the upside has been discounted for Asia and emerging markets, however consensus has become the view that Asia and emerging markets are the best place to be. On that point it is worth noting that, even after the remarkable performance seen this year, most emerging markets remain well below their pre financial crisis highs. Thus, the MSCI Emerging Markets Index is still 27% below its all time high reached in October 2007 in US dollar terms (see Figure 5). This is despite the fact that most of the major emerging countries have demonstrated impressive macro resilience in the context of the recent US downturn.

GREED & fear should make it clear that the view here remains that emerging markets will surpass those pre-crisis dollar highs sooner or later. But the guess is that one big correction lies between then and now, and during that correction the US dollar will rally on the deleveraging trade and the oil-led commodity complex will correct.

GREED & fear also continues to believe that the best stress test for any potential Asian resilience remains a S&P500 correction, in terms of how Asia performs in any such correction. And for now the S&P500 has still not had a decent correction to allow for that stress test. Still the tricky short term issue is what exactly will trigger such a correction beyond the obvious point that stockmarkets have advanced a long way from the bottom reached in late October 2008 for Asia and in March for the S&P500. In terms of potential triggers for any correction, it remains much more likely in the short term that the S&P500 will correct because of monetary tightening concerns than because of concerns about a “liquidity trap”. This is because the US stock market continues to view a zero federal funds rate as a positive and not as a symptom of a problem. This is why a further spike in oil remains to GREED & fear the most plausible near term catalyst for a correction.

One market where investors now understand fully that zero interest rates are a symptom of a problem is Japan. The intensifying deflationary pressures have now finally triggered a reaction leading to this week’s emergency “unscheduled” Bank of Japan monetary policy meeting. Note that the BoJ does not make a habit of calling emergency meetings. But having called such a meeting, the BoJ again managed to disappoint expectations when the market probably wanted to see a big increase announced in quantitative easing. On this point, it is fair to note that the BoJ has never stopped quantitative easing. Indeed the central bank increased the size of its monthly outright purchase of JGBs from Y1.2tn to Y1.4tn per month in December 2008 and to Y1.8tn in March (see Figure 6). The BoJ decided on Tuesday to “further enhance easy monetary conditions” by providing up to Y10tn to the market at a fixed rate of 0.1% for three months. It is also the case that the BoJ has another regular meeting scheduled on 17 December at which more announcements may well be forthcoming.

To read the full report: GREED & FEAR