My Diary 373 --- Eye on Fed, Eyes on Decoupling

My Diary 373 --- Eye on Fed, Eyes on Decoupling, Eyes on China, Eye on Valuation

January 30, 2008

Overnight, EU regional equities rose on average 1.6% while US major index remained flat. 2yr/10yr UST yields each moved up 10bps. The USD was flat on a trade-weighted basis, while the 1M WTI contract increased  to $92.05/bbl, its highest price in more than two weeks. All eyes will be on the Fed tomorrow with markets firmly priced in 50bp easing.

Bond markets are now pricing in a US recession, and with the global equity market sell-off in recent weeks, talk of a global recession has been on the rise (IMF just released World Economic Outlook with US/World growth downgrade from 2.5%/4.9%, to 1.5%/4.1%). Meanwhile. the sharp drop in equity markets in emerging markets indicates that those regions have not decoupled enough to be immune.

Globally, it seems that there is a lot to be resolved in 2008, inlcuing a presidential election plus a tax rebate program to be voted on, numerous corporate buyouts and bailout programs to be passed, GSE limit revisions, Olympics this summer (will China economy roll over immediately after), how low will the Fed cut interest rates, etc etc...... It is an interesting time and a lot of questions will be answered in a year.

Markets: Eyes on Fed

Yesterday, US durable goods orders(+5.2%),bounced in December, propelled by a surge in aircraft orders. The outcome looks odds with last months plunge in the ISM new orders index , which puts extra focus on the January ISM (due on Friday). Market is expecting another downbeat ISM print as firms are confronted with very subdued growth in final demand. Housing front, data remain in a steep slide with which recent downside surprises in single-family building permits and new home sales were followed by Case- Shiller prices contracted 2.1% MoM in Nov and 7.7% yoy.

Scary news today is that CNBC said the ratings agencies are set to downgrade AMBAC and MBIA as early as Wednesday, but hled back by the NY state. Many industry analysts bleive that the ratings agencies cannot wait whilst the banks argue about how / whether to bail the monolines out as the rating ageny is to independently rate bond so investors can rationally choose their risk profile. Minutes ago, a report by Oppenheimer says Merrill may face extra $10 bio in writedown.

Put all this together, I am expecting the Fedto cut a further 50bps. Assuming a 50bp rate cut is the case, global market sentiment may receive a further boost near term. While growth concerns persist, the continuing decline in the risk-free interest rate means that the incentive for PM to invest has increased substantially. An obvious question is what to pick? Ahead of this dramatic easing, EM equities have suffered because of reduced global liquidity and valuation considerations. EM local markets – a major source of alpha for non-dedicated fund managers – have also been hurt as such allocations have been reduced due to rising portfolio volatility. The decline in riskadjusted returns has encouraged fund managers to take a more defensive stance.

Asia: Eyes on Decoupling

Talking about EM market, foreign investors continue to focus on the Asian decoupling or not argument. Certainly, Asian  fundamentals has changed from the late 1990s, but I am quite doubtable to think it will remain immune from recession in the US.

This argument misses an important point, which is that the Asian domestic side may also be hit. It has been assumed that Asian external demand may weaken on US recession, but this will be offset by strong Asian domestic demand. That said, it is important to consider at least the risk that booming Asian money supply and credit growth, which have fuelled local asset market rallies, may slow materially going forward as global credit conditions have tightened. In the region, the basic transmission mechanism has been the following: booming portfolio inflows -> offset by central bank intervention (A small part been sterilized) -> soaring liquidity growth and asset inflation. Up until recently, Asian policymakers were focused on combating this through a combination of higher interest rates and stronger currencies. With the U.S. slowing sharply, a key question is whether domestically this liquidity injection has resulted in overcapacity and overleverage... it still nee some times to tell the consequence... Secondly, the decoupling supporters were used to talk of globalisation... but we only can pick one or the other but not both.

The good news from a macro perspective is that Asia continues to enjoy significant savings surpluses, which should serve as an important economic shock absorber. Moreover, Asian policymakers will no doubt move swiftly to support any shortfall in demand through easier monetary policy – including via weaker currencies.

Metals: Eyes on China

According to SCB, this outlook for base metals in 2008 is that overall prices should trend lower, with demand growth likely to soften while supplies accelerate. As a major producer and consumer of base metals, China’s trade position has a profound impact on the global metals markets. There are some key trends for 2008 and most significantly, China could become a net importer of primary aluminium. This will provide some support for a market that has underperformed the rest of the base metals complex to date, due to China’s rapid output growth.

Conversely, China’s decreasing reliance on imported copper will reinforce a bearish outlook for the metal as global supplies improve. For nickel, the key determinant is the pace of growth of domestic nickel production – local supplies rose by 56% in 2006 and 39% in 2007 as local processors utilised low grade nickel pig iron ores. With lower forecast nickel prices in 2008, output growth should be constrained to a more modest 22% and they expect China’s refined nickel imports to expand in line with growth in the stainless steel industry.

I beleive that people have heard about the Snow Storm In China... the impact is huge as a transportation analyst told me that it is the first time to hear that Chinese government  takes dry bulk vessels out from international market and back to domestic coastal coal transportation... the lack of coal seems very serious ... BDIY now stands @5615 pts,  broke the 5,700 level with market still expect to see 60%+ drop from peak of 11000.

AH Shares: Eyes on Valuation

From Bloomberg, HK economic growth will slow because of the US subprime crisis and slower growth in China, accoring to HKMA Chief Joseph Yam. Echoing his words, HSI has another big fall today (-584), sitting right above the 250dma.  Moreover, due to the recent market turbulence, 5 new IPOs this month have been cancelled  and it's the 1st time in 10 years that HK didn't have a IPO listing in Jan.

A share wise, the market also plunged (7.19% on Monday) on the growing recession fear in the US, further US subprime blowout & tough policy stance/tone on credit tightening due to mounting inflationary pressure & increasing political vigilance ahead of the NPC in this March. The A-share de-coupling as witnessed in past few weeks has failed to hold. Stocks were sold off while the Shanghai Composite Index has broken down below 4700 & closing to 4457 yesterday. There are a few reasons for cautious standing toward  A-share market in 08 --- 1)  the sustained supply pressures going forward from the lockup period expiry for institiutional tranche subscribers and strategic investors in large IPOs last year, among which RMB 1.1 trn will be on 1Q08 ( Tt =3.3 trn in FY08, 11% cupprent market cap); 2) NDRC recently expressed concerns about the 2008 corporate business environment; 3) Domestic demand is strengthened since retail growth reached 16.8% yoy, but GDP contribution of the service sector dropped another 0.3% with increasingly difficult to manage oil, coal and electricity prices, power shortage in 17 provinces; 4) Merrill Lynch has started the de-rating of Chinese Consumer, quoting safe haven premium under threat with stretched PE multiples.

Last valuation-seraching piece comes from Morgan Stanley’s HK Market View after they contacted over 200 clients. Overall, hedge funds are falling more on the absolute bet (HK/China will go up) and the relative bet (HK/China better than Asia/Global). Many long-only funds were sidelined because of volatility or already overweight HK/China and therefore reluctant to trade... so  it is not yet time to back up the truck, but it is a good idea to start picking up stocks with attractive valuations and strong fundamentals.

Good night, my dear friends!