My Diary 393 --- The Worst Q1 in 16 Years

My Diary 393 --- The Fed Supercop and Japanese Play; The Worst Q1 in 16 Years; The Fiscal-Periods Ends of US Dollar

 

 

March 31, 2008

 

Today, Asian stocks failed to hold up on last week's positive momentum, sending the region's benchmark to its biggest Q1 decline in 16 years, on concerns of faltering US consumer spending will erode exports of cars, clothing and electronics. YTD, S&P500 decreased 10.43%, Euro area stocks slipped avg 11%, and MSCI AP also lost 12%. So far, about US$3tn in value has been erased from global stock markets t according to BBG.

Over the last weekend, US major retailer --- JC Penney said that its 1Q SSS will post a “high single-digit'' decline (from 75c/sh to 50c/sh) on a percentage basis. This is consistent with a flat Feb real consumption figure, putting 1Q08 on track for +0.7% yoy after 2.3% on 4Q07. A majority of analysts feel that 2Q08 will be a lot worse than Q1 (-ve) given recent collapse in consumer expectations. In addition, UBS may need to write down a further US$11bn, triggering concerns on banks' access to capital.

Elsewhere, 1MWTI declined to $104.86/bbl, moving up $3 during last week. US Dollar inched up 0.3% against YEN (99.51) and fell 2.4% against EUR (1.5782), which hit a new all-time high on last Wed at $1.585. The 3MUST yield is up nearly 80bp on the week to 1.37 after last week’s rally squeezed the yield to less than 60bp. UST yield curve is flattened somewhat with 2yr yield lost 3bp@1.646, and 10yr slid 9bp @3.438.

Well, well, as we are heading to the end of one of the worst quarters in the history, an new effort to deal with the current severe credit crisis is coming into birth by its promoter, President Bush and Treasury secretary Henry Paulson…

 

The Fed Supercop and Japanese Play

Today Wall Street is waiting for the biggest ever regulatory structure since the Great Depression to be announced by Treasury Secretary Henry Paulson. The so-called “Fed Supercop” plan maps out a course for broader oversight of US financial markets by consolidating power into the Federal Reserve. It will eliminate overlapping state and federal regulators and give the Central Bank an expanded role in looking at the books of investment banks and brokerages…Any interest to apply for a job with US Fed, it is time now … However, what remains unclear is exactly how much the Fed would be able to control Wall Street's freewheeling I-Banks, which have lost billions of dollars over the past 6 months from buying risky mortgage-backed securities. While the proposal will for the first time impose regulation of hedge funds and private equity firms … Does it mean the risk appetite will be suppressed going forward?

Having said thus far about the regulatory reform, the messy US financials now is more looking like a replay of many of the events that happened in Japan in 1990s as everyone is talking about a borrower rescue, not a lender rescue … While the biggest difference is Japan, until 1997, had funds to lend but nobody wanted to borrow, while US now is the reversal case ... Other perspectives look similar…The Japanese corporate sector was rebuilding its balance sheets and only until 1997, the average Japanese did not feel much pain. But after 1997, the combination of a weak YEN and a sagging stock market hit the banks as they realized that they were no longer meeting the 8% CAR and desperately needed to reduce lending. To make things worse, then-Prime Minister Hashimoto was trying to reduce the government fiscal deficit – at the most inopportune time -- by raising consumption tax and other tightening measures. As soon as such ideas hit the headline in Jan 1997, the stock market collapsed and everybody sold YEN…Banks got hurt further …Now we all know Japan had two capital injections in March of 1998 and 1999 to end the credit crunch…

This is what we have to see happen in the US, according to Nomura Research --- 1) there are 8,500 local banks in the US with no access to SWFs or other bailout money – if the big banks were ok, then they could help out --- But this is not the case. So the small banks have to reduce their lending, creating a major credit crunch in the US; 2) the Tokyo area housing bubble in the late 1980s is exactly the same magnitude as the US housing bubble today, but the commercial real estate problem in Japan was far bigger than the one facing the US today. Japan’s history showed that to return to normal will take at least two years and this is also suggested by the US housing inventory ratio; 3) the 300bps spread given by Alan Greenspan in the recession of the early 1990s is no longer there. This is because US corporates have low demand of loan due to their strong B/S and consumers are already too indebted to take more…What does it imply? The banks find no other ways out but Capital Injection ……

 

The Worst Q1 in 16 Years

The 1Q08 stock markets looks very different from what markets had expected at the start of this year……So far S&P500 lost 10% -- the worst start to a year since 2001, while Europe DJ Stoxx 600 Index fell 18.55% and Nikkei Index retreated 18.18% ... Simply looking at the YTD performance, I don’t think these figures support the argument of Asian ”decoupling'' as China ( HIS -17.85%, CSI300 -28.99%) and India ( SENSEX -22.35%) markets are among the 10 worst-performing equity benchmarks globally.

The question is why the large and faster-growing economies like China and India is not able to shield investors from the credit-related financial crisis in the US?  What is going wrong …..Well several things went wrong here…1) the desperate hedge funds sold stocks that were the easiest to sell, spooked by volatility and gripped by pessimism.  Over the week, according to the US$115bn Asian regional funds tracked by EPFR, the continuous redemptions force Asian funds to maintain high level of cash - rose 110bps MoM to 2.7%. This is the biggest since Oct 04 and is higher than its ex-crisis average of 2.5%. YTD outflows from all Asian regional and country funds total US$12bN - This is equivalent to 6% of their AUM vs. 8% in 2001. If history rhythms, an additional US$5bn may be redeemed, a level which will completely wipe out the net inflows that entered Asian markets in 2007…2) with energy, food and metal prices holding high in an environment of declining real US interest rates, Asian markets paid a price for rising inflationary expectations, which have forced them to tighten monetary conditions. That has been particularly a problem for economies such as China and India where domestic demand for investments is strong… 3) Local factors in China, say the release of large blocks of currently non-tradable shares held by the government and strategic investors, have dampened the investors’ sentiment as the stock glut is amounted to US$428bn.

Thus, we still have not seen any sustained long-term buy interest and stocks may repeat that pattern and fall to the lowest levels of the year amid forecasts for 4 straight Qs of declining profits and worsening bank credit losses … According to Bloomberg, while S&P500 is trading at the lowest valuation (14X FWPE) in almost 20 years, S&P500 members may report a 9.9% decrease in Q1 profit and 3.1% in Q2. I think the market will have more downside risks skewed as the falling of earnings beside the financial sectors have not been fully anticipated and priced in yet……Talking about valuation and earning growth, MSCI China is now trading at 13.7X PE08 and 27.1%EPSG; MSCI HK at 16.5X PE08 and 3.1% EPSG, vs. MSCI AxJ at 13.5X PE08 and 14.2% EPSG. In addition, the H-shares premium contracted significantly last week from 101% to 64% with trading volumes continued to slide down and realized volatility climbed most for HSCEI (82.7%)…

 

The Fiscal-Period Ends of US Dollar

It is interesting to compare the two central Banks across Atlantic Ocean…In short, the combination of aggressive US rate cuts, unorthodox Fed policy measures, and a signal that all US investment banks are "too big to fail" may have bought the ECB some time. But in many ways, credit markets have been even more dysfunctional in the EU area than in the US, with Euro CDS, money market and high-quality spreads still very elevated…Another issues is headline inflation is currently well above the ECB's target. The latest ECB Staff projections call for inflation to remain above 2% in 2009, although growth expectations were trimmed.

In fact, the US is "exporting" its economic weakness through a falling USD, which will make it increasingly difficult for the ECB to stand pat as the US housing bust unfolds. But throughout the credit crisis, there have been windows of relief, such as the Fed's TSLF auction, designed to provide cheaper funding to strapped securities firms and to help restore confidence to USD. Certainly, the market fully expects more bad news going forward and more stresses in the financial system to develop. And as those events develop, it will most likely threaten the USD.  But in the near-term, as month-end, and quarter-end in the Europe and fiscal year-end in Japan is typically associated with repatriation (Sell USD /BUY JPY &EUR) by corporates seem to have more than outweighed USD buying from US corporates who are also repatriating foreign receipts.

 

Good night, my dear friends!