Can this "rebound" in HSI last?

Hong Kong market is an open market that couples with China and US market. The so-called fundamentals in Hong Kong are comprised of property, banking and finance, and China concepts. None of these sectors are sound under the anticipated decline on economy. As eventually equity market will follow the economy and not the vice versa, the "rebound" in HSI in recent 2 days cannot last long.

An update on US credit crisis:

Risk Premium (according to figures posted on Bloomberg):

1-month LIBOR: 297 pts (dropped)

3-month LIBOR: 314 pts (dropped)

5-year AAA: 531 pts (risen!)

10-year AAA: 651 pts (risen!!!; now 8.01%!!!)

This is a notable phenomenon: LIBOR drops; AAA finance rate still rises. The bailout only benefits the bank yet the bank does not pass it out to grade AAA financial institutions. Without continuous support, selling of asset will continue. Companies that rely solely on banks may stop worsening on liquidity issue as bank will loan. But, companies that also include institutional investors will find their shares in the market at a low price - even not as bad as last week. Divestment still rolls on. We cannot expect much on the coming market.

An alternate explanation is that banks KNOW their AAA counterparts are in deep holes. These AAA counterparts do not have the muscles to climb out. Under a starving condition, why bother throw a pill of supplement while bank themselves cannot have their crave fulfilled? And afterall, this pill of supplement can only provide vitamins but not calores.

Actually, there can even be a third interpretation: AAA is anything; AAA is nothing. The rather arbitrary announcement of upgrading and downgrading, particularly AFTER corporate quarterly result announcement, inevitably raises our question: what are you guys, S&P, Moody, etc, doing? You do not warn ahead but after? And a grading from AAA to AA+ or even just AA can be changed in ONE NIGHT? This is a REAL CREDIT CRUNCH: not on figures but on TRUST.

Mortgage rates do not change. Yes, no rise; NO DROP.

If we look at the bond yield, they all rise. However, interestingly the prices for bond below 2-year also rose - the reverse of the trend of last Friday. While bond yield rise should mean an outflow of money from bond market to elsewhere, the short-term bond yield and price rise at the same time can also mean the market is still looking for shelter despite the rise of yield.

How about the currency market? USD is rising against EUR again, and JPY is rising against USD, also again. USD drops against GBP though (again according to bloomberg figures).

EUR:USD -> 1.3572

GBP:USD -> 1.7400

USD:JPY -> 101.77

The trend may mean a turn back for USD and JPY. GBP is still stable so far (yes, so far, but at least thank Gordon Brown). Integrating with the above phenomena: credit is tight on financial institutions; demand on bond is still substantial, and easy money like USD and JPY is still not accessible; US credit crisis is far from relaxing, not to mention resolving. If financial instiutions continue their divestment, then the stock market of US will continue to tumble. Meanwhile, property market is still tight judging by the high risk premium on mortgages. Both markets will hammer the derivatives and futures markets, and initiate further losses on and sucks liquidity from banks and financial institutions. Such tide-up will tighten the credit of banks again due to write-off on balance sheet and compliance to accounting principle. The cycle will continue.

So, can we expect a deep V? It can be a deep V, but for sure it is not LV (Long deep-V).

Or, actually I can think of a forth explanation on the rise of AAA rates amidst the fall of LIBOR: helicopter is there. Bernake and Paulson, like the Joker (Jack Nicolson) in Batman 1 (by Tim Burton), will throw as much money on the street as they like. If I were the bank, understanding that there would be a "competitor" with "unlimited" money supply and authority to loan at will (at any rates), why did I drop the rate and bear the risk myself? Particularly I know it cuts really deep?

Just pray that our Jokers will not be like Jack the Joker who spreaded poisonous gas at the same time. Don't forget about the national debt, and the flooding USD.

Rates Update

Up to now, the saving measures have a very limited effects:

Risk Premium:
1 month LIBOR: 309 pts
3 month LIBOR: 332 pts
5-yr AAA: 475 pts
10-yr AAA: 600pts (!)

30-yr Fixed Mortgage: 466 pts
15-yr Fixed Mortgage: 440 pts
5/1-yr ARM: 443 pts
1-yr ARM: 582 pts
30-yr Fixed JUMBO: 596 pts
15-year Fixed JUMBO: 533 pts
5/1-yr ARM JUMBO: 467 pts

NONE OF THEM HAS IMPROVED!

Will the BOE measures work?
The dilemma is :
if not save, the bank that does not use it can still subject to further pressures from the market. Only the biggest bank with good fame can take this burden. Even so, the risk of insolvency is high. The good side is: incompetent bank will no longer be in the market and further poison it. The risk is: panic, and despair.

if save, it means that the beneficary bank is really in trouble. For the moment a sharp drop may be ceased by the government action. Yet, its future is even more uncertain. Once the government invests, it locks in. Tales about inefficiency and political interference of SOEs are no news to the public. The handling of these acquired banks, after the turmoil, is another headache.

Maybe a combination of direct injection, nationalization, endorsement, acquistion, and exchange of problematic asset by government bonds may help out the current situation. However, it also means the huge accumulation of government debt as well as an influx of "money" into the black-holes. Governments use their own credits, at the risk that eventually even the government will bankrupt and its currency will greatly depreciate, meanwhile deflation is still happening inside that country (which is completely against conventional economic concept but can happen as its asset also loses price).

Dilemma (Con't).

If I were the investors of the bank, and with the information that the government will take over, what will I do?

The government invests on the banks to provide capital to polish the balance sheet. It also lowers the volume of available shares in the market (and hence drive the price up, or at least stop tanking of the stock price, and hence the book value of the equity). However, whichever bank accepts this investment gives the signal that it is in deep problem. The larger the amount, the bigger and deeper the black-hole. In case the black-hole is too large and deep to be saved, under the consideration of stopping panic, government may take-over the bank to continue its operation and prevent massive withdrawal. But, government will not simply just eat the rotten tomato, and there may not be just one rotten tomato. Merger and buyout, under government's guide, will happen when situation "stablizes", or on the contrary, may happen immediately to avoid further worsening. Restructuring, in the company and in the market, can be expected. Job cut by these banks may not happen immediately (or the panic will continue), but it will continue after the panic period, after restructuring takes place.

Go back to the question: if I were the investor, what will I do?

In case I look for long-term investment return, I will not dare to invest on them at all. In case I hold shares of them, even at a low price, divest them. Even though there may be a chance of its survival, and, after restructuring, its result will improve and hence its stock price may increase again. However, there are too many uncertainties. Particularly once government takes over the ownership, the transaction terms and deal will no longer be a purely commercial decisions. Chances are transferral at a premium (especially if transaction takes place among "natoinalized banks") and the acquirer will have to take a heavy burden for a few years before full recovery. During the same period, one may find other more transparent and market based companies to invest on. At worst, receiving interest through the shamed deposit rate is still better than exposing to another 10-20% downside risk. Opportunity is always there; just whether or not one grasp it when it is there.

Dilemma

If I were the US government, what would I do?

I would have nationalized everything: banks, thrifters, and even home owners (?!). I would be the major shareholder of banks and make them continue to lend money. I would be the major shareholder of thrifters to gurantee all CDOs. I would, well, finance the home owners directly so that they can continue to pay the thrifters and banks.

However, if that is the case, will the stock market will be out of troubles? What will the investors think?

Chain Reactions

Now with the credit crunch, various companies will face shortage of cash and may result in solvency issue. The possibilities of bankrupcy has increased. But this is not the end of it. Many of these firms had issued bonds and many buyers of these bonds also buy the CDS (credit default swap) from banks and financial institutions for hedging purpose. Now as banks and financial instituions are in deep dangers that trigger their clients' liquidity problems, it can cause the both the bankrupcy and the inability to honor all CDS which in turn trigger another wave of scare on the banking system. If they couple with the problems on Alt-A and credit card loans, a huge global recession can be expected.

Interesting Observation...

The most updated key rates spread are as follows:

1-month libor: 301pts

3-month libor: 325pts

5-yr AAA: 468pts

10-yr AAA: 593pts

30-yr fixed mortgage: 447pts

15-yr fixed mortgage: 423pts

1-year ARM: 570pts

30-yr fixed JUMBO: 582pts

15-yr fixed JUMBO: 523pts

Two horrible observations:

1. 1-month libor now is higher than the prime rate, even though just by 1 basis point. It means that bank lends money to another bank is even "riskier", from the bank's point of view, then bank lends money to an individual.
2. 10-year AAA banking and finace rate is even higher than 1-year ARM (and no need to mention about 15 and 30 year fixed rate) by 23 basis point. Bank is even not trusted by their colleagues than the trust on an individual who may just have nothing but a social insurance number to purchase a flat.

Another observation that may tell more stories:

M2 Money supply by Fed:

June 1st wk: -10.8b, June 2nd wk: -6.8b, June 3rd wk: 2.4b, June 4th wk: -23.6b

July 1st wk: 24.5b, July 2nd wk: 0.3b, July 3rd wk: 48.7b, July 4th wk: -14.2b

Aug 1st wk: -8.8b, Aug 2nd wk: 7.0b, Aug 3rd wk: -10.5b, Aug 4th wk: 3.9b

Sept 1st wk: -5.5b, Sept 2nd wk: -1.9b, Sept 3rd wk: 20.6b, Sept 4th wk: 165.5b

Oct 1st wk: -4.0b

From June to August only 12.1b USD was supplied to the market by FED, unlike the beginning of the year (almost 20-30b every week). This may partly explain why actually the capital market loses fuel to continue the rebound. Of course, once trust is lost; the money borrowed will not go to the market but back to bank's balance sheet. Nevertheless, the situation at the beginning of the year is less worse than the middle. Particularly when more banks find themselves eventually will face their judgement days, they will become more conservative and are willing to hold risk-free asset (for a low yield) and hence money flows back to US treasury and FED.

Same trend continues on September at a more extreme scale. Only by the last week (when special credit event happened) FED supplied a real substantial amount at 165.5b at once. But then on the last week, FED "received" money again ("-4.0b"). It is rather obvious that to keep the business running, banks and financial institutions have to feed money to the black-hole like balance sheet. And these money can only go nowhere but back to almost risk-free asset, i.e. government bonds, certificate of deposits, or plain cash.

Unappealing enough, there are something also notable:

USD->JPY: 98.66

EUR->USD: 1.3548

GBP->USD: 1.6966

USD->CAD: 0.861

USD->AUD: 0.6618

USD->RMB: 6.8318

Just a day JPY keeps climbing while other OECD currencies keep tanking. So is RMB. In a sense USD is "climbing" against other OECD currencies except JPY. But again, if USD flows back to US for balance sheet, the expansion of credit by FED indirectly to the market does nothing good at all. On the other hand, comparing with countries with sufficient reserve or with foreign currency control (Japan and China respectively), USD keeps dropping: it is an unwanted currency or has no channel to leave the country. Combining together, USD is contracting all the way back to its country at a big discount (as OECD countries' asset has lost value by 60-70%) and is not welcomed (or blocked). It means the losing influence of USD on the world.

Once such a trend/attitude is formed, soon enough the demand and supplies of USD will form a "super-conducting loop": USD from FED to bank and then back to FED and to bank, with little multiplier effects due to high distrust on market and low level of investment.

What does it mean? It means liquidity trap: see what Japan has been.

OLD 7: 2008-10-8

Dear friends and investors,

The credit crunch is nowhere close to an end. Take a look on this (please remember, FED has reduced the target rate from 5.00% to 1.50% during the period):

Risk Premium from Risk free rate (FED):
1 Month LIBOR: 37 pts (1 year prior) -> 49 pts (1 month prior) -> 279 pts (current)

3 Month LIBOR: 50 pts (1 year prior) -> 82 pts (1 month prior) -> 302 pts (current)

5 Year AAA Finance and Banking Rate: 36 pts (1 year prior) -> 286 pts (1 month prior) -> 464 pts (current)

10 Year AAA Finance and Banking Rate: 91 pts (1 year prior) -> 379 pts (1 month prior) -> 582 pts (current)


Property Market is still horrible:

Risk Premium from Risk free rate (FED):
30 Year Fixed: 132 pts (1 year prior) -> 408 pts (1 month prior) -> 432 pts (current)

15 Year Fixed: 95 pts (1 year prior) -> 362 pts (1 month prior) -> 402 pts (current)

1 Year ARM: 97 pts (1 year prior) -> 394 pts (1 month prior) -> 560 pts (current)

30 Year Fixed JUMBO: 207 pts (1 year prior) -> 523 pts (1 month prior) -> 573 pts (current)

15 Year Fixed JUMBO: 180 pts (1 year prior) -> 447 pts (1 month prior) -> 506 pts (current)

5/1-Year ARM JUMBO: 168 pts (1 year prior) -> 428 pts (1 month prior) -> 461 pts (current)

Even for the conforming long maturity fixed rate mortgage on which most stable home owners are applying, the risk premium has gone up by 3.3 times (while the target rate has been cutting). One can imagine how mad the bank is on CASH. Nothing but cash cash cash. Needless to mention about ARM on which most "aggressive" home owners are borrowing. Another worthy to note phenomenon is that the JUMBO rate, i.e. for non-conforming mortgage (mainly for luxurious homes or in a sense for speculators who operate an leverage), which has already been necessarily higher than conforming mortgage rate, has also increased by 2-3 folds. People, with more asset living at or speculating on luxurious houses, or with ordinary lives at ordinary homes, or with nothing but a driver licence or social insurance number, are all evaluated by banks as RISKY. This is a really worthy phenomenon to observe.

Meanwhile, we can also take a look on the currency rate (spot):
USD - JPY: 100.4
EUR - USD: 1.3652
GBP - USD: 1.7221
USD - CAD: 1.1244
USD - AUD: 1.4457
USD - RMB: 6.8233

What are the same rates at 1 year ago?
USD - JPY: 117.3
EUR - USD: 1.4206
GBP - USD: 2.0394
USD - CAD: 0.9837
USD - AUD: 1.1127
USD - RMB: 7.5149

USD seems "rebound" (I don't agree with this term). But it more actually goes up against other equally or more seriously screw-up currencies like EUR and GBP (both are hit hard by financial turmoil) and CAD and AUD (both are hit by anticipation on lower consumption and hence lower demand on raw materials). JPY, despite its suck economy, has sufficient savings and reserves and hence somehow are "liked" by investors (at least its financial sector had screwed up way before other OECD countries, and by the never-hitting-same-tree-twice theory, it is safe, for now...). RMB is more interesting one. While its value is still stable due to its "isolation" from the world economy, it also subjects to a potential foreign investment withdrawal to cover their own asses.

Following the same logic, since most investment institutions and investors are holding their hands and withdraw their investments, and that cash is more preferred, gold price may not rocket as insufficient money for speculation and basic demand. But on the other hand, a collapse of gold price may not be seen in short-term, as there are investors using gold as a capital preserve tool, at least against inflating USD, EUR, GBP, etc (though evaporation rate may be higher).

Ok, enough pessimistic. Lets go for another way: what are the industries that may be able to survive?

As we can forsee a lack of easy credits and contraction on expenditure in the coming year, I think companies:

1. with substantial cash and null liabilities as well as tight cost control will find various opportunities for M&A,
2. related to daily consumptions, like fastfood chains, wal-mart like retail (cheap), cheap transportations, public utilities (electricity, gas, phone, internet), and cheap trading platforms (e-platforms),
3. in the government regulated business like also public utilities, public transportation, any green products required to comply with environmental regulations,
4. and professional firms that can help enhance company performance and provide restructuring, re-engineering, coperate governence, hiring and recruitment, change managment, etc solutions (like consulting firms, Big 4, law firms, HR, etc)

will have opportunities to survive.

(to be continued...)

David