My Diary 321 --- Property Bubble, Hostaged Bernanke, I Believe I

 

My Diary 310 – Property Bubble, Hostaged Bernanke, I Believe I Can Fly and Shipping the Economy

 

 

September 3, 2007

 

 

Hello, friends: I am coming back to normal.

 

 

There Is A Bubble!

Bubble, there does exist a bubble in China’s Property market, at least in the high-end segment. This is what I said to my INVESCO colleagues in today’s weekly market review. In fact, from the sold but vacant Hangzhou villas and high-end residential apartments, from the recent 69K rmb/sqm land price in Shanghai (Bidder is SuNing, a retail chain-stores mgr!!!), from the 15K rmb/sqm price increase in Regents Park within 2 months, and from July’s Shenzhen (+19.4%) and Beijing’s (+10.4%) yoy home prices  moves (WOW, can beat the A-share markets), I think very hard on what has been going wrong in this market.

 

Two reasons, I think…1) supply and demand mismatch --- it is easy to see the massive demands for mid/low-end residential units (like Shanghai Canes). However, the fast appreciation of land cost due to limited supply and the growth and earning pressure have cornered many listed developers to concentrate their resources on rich margin, high-end products.  This not only results in higher market ASP, but also brings in speculators. 2) policy mismatch --- nearly every local developer told me that there is virtually secondary market as the government has been purposely raised the barriers to curb the market liquidity in order to kill speculators. This good policy intention turns out heading into another direction. A side-effect of no secondary market is that Chinese buyers are not able to monetarize their gains in the small primary home, while the desire of upgrading their living conditions has lead them take in the second home or simply pay the extra amount (equivalent to price hike). Now, with the fast rising housing price and mortgage rates, do you start smelling sth vied because it looks like there is an increasing amount of new home buyers will be caught in this seemed to be “ everybody-win” game.

 

For the companies I visited, my view is that the smaller-sized players such as CPG, Shanghai Zendai, SRE, and Lai Fung are more vulnerable to a liquidity squeeze given they have fewer projects and less diversified geographical location. Separately, ppl should watch out for Greentown and Neo-China which have aggressive expansion plans and could be exposed to higher funding risk for their committed land or project purchases.

 

Bernanke Is A Hostage!!!

In the other side of Pacific Ocean, housing issue is also a headache for the Fed Chairman (See the close-tie between China and US). An interesting piece of comment from last week’s WSJ I recall is that “Mr. Bernanke is in part a hostage to the legacy of the Alan Greenspan era, when the Fed seemed to ride to the rescue during every financial crisis.” This so-called legacy is the famous “Greenspan put”, but what looks irony to me is can you imagine today’s Fed Chairman is “a hostage” of former Fed chief’s policy?

 

The street is now trying its best to convince Mr. Bernanke to behave as what Alan had done before. But the Fed doesn't have the same flexibility this time because what Fed tries to wipe off is the credit excesses produced by its reckless policy in the early part of this decade. In last week’s Jackson Hole commentary, the “hostaged” Chairman expressed his concerns over subprime and growth risks and left the door open for a September rate cut IF (and this is critical) markets go downhill from here.  Certainly, equity investors embraced such a gesture ... but wait…...

 

In the same speech, Chairman Bernanke reiterates that it is NOT the central bank’s responsibility to bail out lenders/investors from the consequences of their decisions reinforces the deep reluctance to cut rates for Wall Street. This is consistent with one of the interpretations of the recent Fed's discount rate cut --- the Fed doesn’t want to cut the Fed Funds rate for fear of the “moral hazard” it creates. Remember, the Fed's first obligation isn't to reflate the bubble but is to protect the larger economy and especially price stability.

 

Will Asia Decouple US?

Looking-forward, one important question for the market is how much the housing recession will affect US consumer spending and thus the overall economy. Beyond that, a key expectation is whether the global economy will exit this volatile period with a reasonable shape. This is actually a tough question about the macro environment in such a difficult time as we now only know the global decoupling story exists in some economies but not every corner. What has changed is that the US is no longer the only engine of the global economy, but what hasn’t changed is that US markets still price the global cost of capital.

 

Asian economies today face both ST liquidity issues and LT inflation risk. Our economic growth is creating inflation down the road, which suggests CBs will look to raise interest rates over the medium term - but we have ST liquidity woes. China is a good example of this dilemma. In fact, recent statistics are revealing that the region’s export dependency has grown since 1998.  Although it may be true that a growing % of the region’s exports go to China and intra-regional trade is 40% of total exports, 70% of intraregional trade is dependent on final demand from outside the region. The result is that the cross-country production network leaves the region vulnerable to “ripple-down” effects from assemblers to suppliers in the case of a sharp global economic slowdown. And the effects could be even greater on the region if U.S. growth slows to 1%. China could be even more vulnerable.

 

I Believe I Can Fly

Let us leave the housing headaches to central bankers (this is their job!). We take a break in the “flying” equity world.

 

Today, Shanghai Composite advanced 98ppt  to  5317. The overall A-share market seems in a crazy mood with trading volume expanding 15% higher than last Friday and 85% of the stocks advanced this morning. Sector wise, aviation is the best sector due to improved operating data and the industry M&A news is leading investors becoming enthusiastic. Air China, CSA and CEA all reached 10% limit. After 3-months suspension on up-coming strategic alliance with SIA & Temasek, CEA is leading the sector singing the 1996 song by R&B singer R. Kelly. In the near term, I think the A-share market is a bit hot, but it doesn’t implies the market will have any big problems. According to 1H07 reports of listed companies, the earnings results in 3Q07 will also be very attractive. Thus, the further advancing of the stock still will have strong back support from their fundamentals. 

The H-share market was very quiet ahead of the US holiday. There was news coming out last Friday, saying that the retail QDII will be postponed. I also heard rumors in the market that some ppl were going to sell HSIF aggressively. HSIF opened lower by 400pts, however, there were solid buying interests after the market opened and the stock market stabilized.

An interesting observation is that following the policy announcement of “HKStock Express”, the dual-listed A-&H shares have risen 38% in just two weeks and MSCI China 30%, although not a penny of Chinese retail investors’ money has hit the Hong Kong stock market yet. MSCI China is now trading at 18.4X 2008PE vs 30X for the A-share market and 20X for the B-share market . Now MSCI has also learned how to sing “I Believe I Can Fly”...:)

 

Shipping the Economy?

Somebody may ask, what else is flying? Good call and it is iron ore. Globally, iron ore prices are still raising as solid demand from steel makers is outpacing limited supply growth. The drivers are 1) exports of iron ore from Australia and Brazil have been particularly disappointing; 2) Chinese spot prices hit a high of $106/ton in July, according to CRU* data, a 45% increase yoy. Prices in Australia and Brazil also trended higher to reach $70/t and $97/t respectively in the same month. Chinese imports of iron ore remain particularly strong and reached 33.6Mt in July and in the first seven months of 2007, reached 221Mt, a 19% yoy increase. Another factor behind this jump in prices is higher freight rates, which are pushing up transportation costs.

As a result, shipping companies are actually sailing through this month's turmoil in financial markets and shareholders are poised for annual returns above 20%. Shipping rates as measured by the Baltic Dry Index climbed 9.6% since world stock markets started a decline on July 17. Record prices for hauling coal and bulk commodities are benefiting everybody. According to Bloomberg, orders for bulk carriers are close to their highest ever, A total of 1,364 bulk carriers are on order (almost 3X the level of a year ago), and sales of raw materials to China will climb 25 percent this year. Although the rising cost of credit threatens to stall financing of new vessels, who dare to make a bet with me that the shipping companies won’t carry the economy further?

Good night, my dear friends