My Diary 357 --- CCB Saved BOA, Minsky Moment & FIH, 3 Month Sur

 

My Diary 357 --- CCB Saved BOA, Minsky Moment & FIH, 3 Month Survivor Test, Yen Back to Life

November 14, 2007

After struggling in the mud of sub-prime-related headlines, the market came back with better-than-expected results from Wal-Mart, rumors on Buffet's reinsurance to the embattled mono-lines and the Goldman’s CEO clarification on their level-3 assets…

Now, good news continues to pop up as on the BBG screen, news shows that HSBC 3Q profit rises… will the market cheers for HSBC, one of the largest US subprime lenders, or should we put a question mark to it?  I belong to the last camp…

Let me start with Wal-Mart and Bank of America, and then move forward to tear my doubt on the “liar” headline numbers….

 

CCB Saved BOA

Overnight, Wal-Mart reported slightly better than expected 3Q07 net income of $2.86bn, underpinned by top-line and earning growth. However, if we dig into depth, we can see that the 15% growth in EPS is largely due to its share repurchase activity, and that while revenue increased 9% to $91 bn, it fell short of consensus ($91.4 bn). Moreover, WM stated customer traffic was lower and ended the quarter with $5bn in cash vs $5.9 bn in the prior year quarter… So, I have to say that the overall picture isn’t so great, given a sluggish domestic growth and a more aggressive use of free cash flows.

In addition, the market also saw Bank of America announced last night that they expect total charges to exceed $3.5 bn in Q4, notably higher than street research estimated losses around $1.4 bn. However, to the market’s surprise is that the Bank’s announcements of significant investment gains on the backburner.  BOA's $3 bn investment in CCB made 2yrs ago is worth about $19 billion as of last week, and management announced they will recognize the $16 billion mark-to-market gain under "Other Comprehensive Income" (not P&L) in the 4th quarter.  They also have an option to increase their ownership stake in CCB from 8.5% to 19.9%, which on paper brings their total potential gain on CCB in excess of $30 bn… What a splendid investment in their book … Am I fair enough to interpret that as --- “Chinese Bank Saved US Bank in the Sub-prime Storm”…I think that headline should have no problem to make the front page at WSJ.

Talking about sub-prime woes, today, the former hedge fund manager and current Dallas Fed Chief, Richard Fisher, said that investors ”are not out of the woods quite yet, and they have miles to go before they, and we as central bankers, sleep.''  In fact, traders today see an 82% chance of 25bp reduction at the Dec. 11 meeting, FFF contracts show.

To my own point of view, I think there is clearly more pain to come in the credit markets as the AAA and A series of the ABX (07-2) indices plunged to 69 and 27 cents on the dollar respectively. At the meantime, downgrades from ratings agencies could lead to a vicious circle of fire-sales and falling asset prices. As a result, the US mortgage woes will be with us through next year and yet the press headlines continue to repeat the same press about rising foreclosures and delinquencies…such a spiral-downward process actually has a “sexy name” --- Minsky Moment.

 

Minsky Moment & FIH

As one of the most famous post-Keynesian economists, Minsky has a theory of Financial Instability Hypothesis (FIH)…Here are my Quote … According to the theory, the financial structure of a capitalist economy becomes more and more fragile over a period of prosperity. During the buildup, enterprises in highly profitable areas of the economy are rewarded handsomely for taking on increasing amounts of debt, and their success encourages similar behavior by others in the same sector (because nobody wants to be left behind due to underinvestment). Increased profits also fuel the tendency toward greater indebtedness and financial innovation, by easing lenders' worries that new loans might go unpaid…then the whole direction is heading to so-called "Ponzi" Scheme.

The evolutionary tendencies toward Ponzi behavior and the financial sector’s drive to innovation are easily connected to the recent situation in the US home loan industry, which has seen a rash of mortgage innovations and a thrust toward more fragile financing by households, lending institutions, and purchasers of mortgage-backed securities. This is the “Minsky Moment” and the consequence is if without intervention in the form of collective action, usually by the central bank, then the Minsky Moment can engender a meltdown, involving asset values that plummet from forced selling and credit that dries up to the point where investment and output fall and unemployment rises sharply. This is why Minsky called his FIH --- A theory of the impact of debt on system behavior and A model of a capitalist economy that does not rely upon exogenous shocks to generate business cycles…… Now, we should better remember this word and use it during the “bullshit” debate of whether it is the end of Sub-prime bla bla….

 

3 Month Survivor Test

Witnessed the 2.9% climb in S&P500 yesterday, one should not have too much surprise that today HK stocks rose the most in more than 2 months. HSI Index climbed 1362 or 4.9%, to 29,166 and HSCEI rose 6.8% to 17,837. Both gauges posted their biggest advances since Aug. 20.

A-share market bounced back following the buoyant environment in the external markets. SHCOMP Index moved up to 5412, or +4.94%, leading by blue-chip stocks including Chalco (+10%), Air China (+9.52%), Shenhua Energy (+9.94%) and China Life (+8.21%). In the near term, I remain cautious on A-shares market momentum, given that China’s headline inflation ticked back up to 6.5% yoy in October, putting added pressure on the PBOC, which hiked banks’ RRR to 13.5% on last Saturday. Besides CPI, the other key indicator to watch for from China this week is fixed asset investment (due Friday). An upside surprise would strengthen the case for the PBOC to hike interest rates…. I think PBOC is now the toughest central bank in the planet ….:)

There is an interesting piece of research today, comparing Aug 17 with Nov 12. On Aug 17, the last round of subprime concern was kicked off by BNP stopped redemption of 1 of its hedge funds. But the “good” thing is subsequent announcement of similar incidents were ignored by the market. This time, the correction was kicked off by sub-primes in ML, Citigroup and Morgan. And when it is HSBC's turn, the market should also choose to ignore… (I definitely have to check on this call!) . As a result, the analyst call is that --- “Exactly like after Aug 17, whoever didn't get stretched off in this correction will survive till the next subprime concern - 3 months later.”

But I think the key difference is that this time we may not have the domestic liquidity headlines (referred to Premier Wen), however, we may still have Fed Cut. Thus, things may be not too bad, but don’t expect too much as well… Having something on hand is always better than nothing, my grandfather’s words again…

 

Yen Back to Life

The yen fell another day against the USD and EUR as a rally in global stocks gave traders confidence to buy higher-yielding assets funded with loans from Japan. The yen touched 110.88 per Dollar now (19:50pm. Nov16), the strongest since May 2006. It may fall to 112.20, said by a BBG analyst.  On the other side, Bank of America cut its forecast for the US Dollar on concern subprime losses and a slowing economy will reduce the appeal of U.S. assets. It predicts the dollar will trade at $1.48 per euro by year-end, compared with a previous forecast of $1.44, quoting “concern over the U.S. financial sector cannot be cast aside any time soon” ... certainly, the BOA and its analst now have more insightful iformation regading the manitude of damage of sub-prime BOMB.... see people do learn from the market and their own failures....

Talking about Dollar, I will follow up with a note of Commodities. Over the next 3- 6 months, the main focus will be whether the Fed heads off a deflation scare and credit crunch. While a little economic weakness and softer credit demand emanating from the US is good for commodities because it caps global real interest rates, we should overweight liquidity-sensitive assets, such as precious metals, and underweight  growth-sensitive assets, such as base metals. The reasoning is that the benefit of falling US interest rates and a weak dollar more than offset reduced imports, consumption and commodity demand emanating from the US. Risk is that the US consumer faces hard-to-gauge negatives (US housing keeps getting worse and the mortgage credit crunch is deepening), exacerbated by the Fed’s unwillingness to err on the side of ease. Moreover, consumer confidence is vulnerable to looming new highs in gasoline prices...

Bottomline: You should pick gold.... haha... an “obvious” answer ....

Good night, my dear friends!