My Diary 318 --- “Nos” to Buy Call & Diversification, “Yes” to C

My Diary 318 --- “Nos” to Buy Call & Diversification, “Yes” to CBs and China

Market strengthened across the board this morning post the news that BOA are providing equity into Countrywide. Some people are now calling a bottom to the market and short covering. But the market-wide better run for risk assets is based on expectation of are least a Fed cut on Sep. 18^th is not before or more.

I don’t buy the Call

However, I don’t buy into the recovery as signs of liquidity crisis continue to pop up in the headlines, ARM resets will continue to punish the consumer, Fed is playing with discount rates and not Fed Funds, Conduits are still huge long financing risks with limited buyers and lastly the crp & financial supply pipeline is growing by the day.

Remember that sub-primes did not disappear overnight and we can read from the newspaper that HSBC and Leman brother is closing part of their US sub-prime related operations. One statistics quoted from the US consulting firm, Challenger, Gray & Christmas that in Indiana State, the total YTD lay-offs in the financial sector has reached 87,962, 75% higher than FY2006. Moreover, 19,670 local construction workers lost their job so far.

Diversification not work?

One of the most interesting observations I had over the past few weeks is that by looking back all the asset classes’ performance, the Modern Portfolio Theory doesn’t seem to work well on this globalized markets. Essentially, what I said is that the world is so crowded not because of China and India’s growing population, but more because of internet or economic relations.

Let me be more clear, as the sub-prime concerns hit the market, you see Yen and US dollars strengthening, while other high yield currencies like Kiwi and Aussie weakened. At the mean time, Treasury yields fall and equity indices drops, so do commodities. Today, you can watch the opposite side of the story. UST2Y@ 4.275, UST10Y@4.68, JPY@115, HSI +620pt, 2.77%.

Does this imply that the correlations across asset classes have risen under a tighter bonded world? Part of the yes is from the wide-spread failure in the Quants fund, which use historical data base and black-box model to arbitrage these “profitable” opportunities. Maybe the only light-bubble is China A share market in the mid-term.

Eyeball Focusing on Central Banks

Globally, the recent disruption in financial markets means extraordinary uncertainty further changes in policy and market outlook. A key factor is lack of knowledge about equilibrium value of mortgage securities and about distribution of related risks. As a result, the Fed is likely to cut rate no later than Sept 18 FOMC meeting and could cut the rate two more times in 4Q to 4.5%. We no longer expect any rate hike by ECB, and BoE this year. BoJ actually holds at 0.5% today.

Macro-front, Citigroup today cuts GDP forecasts for G3 with US growth at 2.0% for 07 but maintains 2.5% forecast for 08. The restraint from widening in credit spreads and higher borrowing costs will probably be greater in the US and the Euro Area than in Asia (including Japan). FX carry trade could unwind further, with the yen/dollar forecast strengthening to 105 in 4Q from current 115. Commodity currencies are likely to become softer in the near term.

Welcome to China

This is not an Olympic slogan. A-shares market was still the focus this morning. In the key psychology level, 5000 witnessed a lot of profit taking. Who benefits out of the volatility --- Ha, brokers. Citic, Haitong and Hongyuan are up +7.45%, +2.93% and +4.93%, respectively. Unofficial news said about 10,000 people has already pre-registered for the QDII accounts. Actually, this number looks low to me, but not at a surprise.

In fact, A-shares market has been one of the world's best performing markets over the past 12 months. Average PEs are + 50X historical earnings, with a number of firms with PER of +1000X. Risk aversion? There is no easy Mandarin translation as my Chinese fellows are building historical highs on an almost daily basis.

There is a paragraph from FT today talking about the Spill-over impact of Chinese wealth to the rest od world…” the truth is more complicated.Massive wealth has been accumulated in China over the past two decades and it is currently locked up in mainland equities, real estate and bank deposits. In less than five years that wealth is going to flood out of the country, causing huge tremors in overseas asset markets. I was told that many mainland's high-net worth investors are active in the H-share market in Hong Kong already.

We are all familiar with one of the effects of a globalising China: the relative price of labour falls, meaning cheaper "stuff". The second-round effect will be very different. As China's wealth globalises, the relative price of assets bought by private China is going to rise. Shares of offshore-listed Chinese companies, residential land in Hong Kong and Vancouver, farmland in Africa and natural resources in Asia will bear the first brunt of these outflows. The second wave could be companies with big and successful operations in China itself, where local consumers are witnessing the successful growth of many global companies themselves. The third wave will be harder to call.”

Hey, Welcome to China now as one day in the future, you will become part of CHINA if you got a broker call….:)

Good evening, My Dear Friends