Dow – Next Stop 7,200!

The Dow collapse is gaining momentum. The next stop is 7,200. And if that level is broken, almost anything is possible!

The government is throwing everything at the credit and mortgage markets. It has taken over Fannie Mae and Freddic Mac and has pledged to take hundreds of billions of dollars in crummy assets from the nation’s major financial firms.

Outcome – the rate of the 30-year fixed mortgage, which is America’s bread and butter loan are not going down – they are going up. The average 30-year rate jumped to more than 6.4% and just shy of the August high of 6.58%, the highest in more than a year. This is because bond investors are dumping the heck out of bonds as they learned that the budget deficit soared to US$454.8 billion in fiscal 2008 – more than double the US$161.5 billion deficit in 2007 and the highest in history of the country.

Thus far, the carnage on Wall Street is linked to forced liquidations by hedge funds that had taken on far too much risk. Over the past decade, the greatest excesses were in housing and finance. Volatility in financial markets this week appears to have been sparked by the growing realization among investors that a global recession is imminent. It has overshadowing the good news on the declining LIBOR rate.

The recession that we may be facing is likely to be along the lines of the 1973/75 downturn. That recession was relatively long and deep. Real GDP from peak to trough and the downturn lasted for 18 months. By contrast, the past two recessions were relatively short and real GDP declined at most 1.3 percent and the downturn lasting for nine months each.

My view is that in this round of recession, the weakest period for the economy is likely to be the fourth quarter of this year and the early part of 2009. The unemployment rate will likely rise through the next year and peak at around 7-8% in early 2010. In this environment, consumer spending will be particularly weak and it would not be surprise to see declines for multiple quarters, marking the first declines in consumption since 1990-91. The National Association of Realtors (NAR) noted that 35 to 40 percent of sales were foreclosure-linked. Distressed sales are pushing activity higher.

In short, the leaks are now turning into a gusher. For a recessionary economy like US, Dow is still trading at a relatively high valuation with PE in excess of 20x. This compared to an average PE of 10x for Asian markets.

It's Global

In case you had thought that the current credit problem was only affecting the US and Europe, think again. It is affecting almost every major country on Earth. Reality struck like a lightning bolt. The easy money is gone. The financial alchemists have been run out of town on a rail.

I found a good summary of recent events from RGE Monitor as follow:

• Iceland – it has been at the foremost of the global credit crisis as its banks heavily relied on wholesale funding to finance the aggressive expansion abroad. With the rapid depreciation of local currency and the seize-up of credit markets, refinancing of debt is almost impossible and some analysts predict Iceland GDP could shrink by 5-10% after almost 5% growth in 2007.

• Hungary – While it's not suffering a banking crisis a la Iceland, the global credit crisis has exposed long-simmering vulnerabilities – high level of foreign currency lending, slow growth, twin deficits and heavy reliance on non-deposit foreign funding. Given its woes, eyes are focusing on rest of Eastern Europe for signs of trouble.

• Turkey - a number of analysts have cited Turkey in particular is vulnerable due to its large current account deficit.

• Ukraine – its high reliance on external finance leads it to seek financial assistance from the IMF. With persistent inflation and a widening trade deficit and domestic and regional political uncertainty have contributed to deposit outflows, tighter money market rates and exchange rate volatility. The Ukrainian currency, hryvnia, sank by 20% so far in October and the equity market fell over 70% this year.

• South Africa – worries that a global recession would depress export demand especially metals, and investment inflows needed to finance its current account deficit. So far, the Rand has fell to its lowest level since 2003 while President Thabo Mbeki's resignation ushered in a period of political and economic uncertainty.

• UAE – It starts to feel the pinch of reversal of speculative capital that flowed in early this year to bet on currency revaluation. Long term project finance costs already tightened throughout the GCC and the freezing of global credit markets exposed UAE banks, which financed rapid credit growth with foreign not local borrowing. Worries about Dubai's property market are looming. Kuwait 's Central Bank stepped in Sunday to prop up one of the country's biggest banks.

• Venezuala – the main problem is that its sovereign wealth fund, known as Funden, holds about US$300mn in debt instruments that Lehman had agreed to cash. With Lehman's bankruptcy, Venezuela will have a hard time selling the debt. Moreover, the fund has a significant amount US$2bn allocation allocated in structured notes.

• China – Q3 marked the fifth consecutive slowing of Chinese real GDP growth, implies fewer commodity imports but government sponsored infrastructure projects may pick up some slack – clouding the outlook for countries like Brazil, Chile and Australia among others.

Now, we see the problem is global. As the US continues to sneeze, it's probably safer to say that the rest of the world gets walking pneumonia.

Until Next Time

Stop listening to the happy talk out of Washington and Kuala Lumpur!

The latest Mortgage Bankers Association figures on home loan applications, which tracks demand for home purchase and refinance loans, plunged 17% in the most recent week. The purchase application sub-index is now plumbing depths not seen since October 2001, a sign that housing demand remains anemic.

Some pundits have made a big deal about the recent improvement in certain domestic and developed market credit indicators. The gains stem from the Federal Reserve's and Treasury's largesse, as well as the banking bailouts being put into effect in continental Europe, the U.K. and Canada, among other places. But the improvements have been minor when compared to the hundreds of billions of dollars in aid that has been thrown at the markets. There are also disturbing signs that the aid isn't getting at the core of the problem — the housing market.

The credit virus is now spreading its sickness to the four corners of the world.

In Hungary, the currency has been plunging for weeks on end as global investors pare risk and withdraw funds from higher-risk emerging markets. The forint recently traded at 214 against the dollar, a huge decline from the 143 level back in July. Magyar Nemzeti Bank, Hungary's central bank jacked up the nation's benchmark rate to 11.5% — an increase of a full three percentage points — to defend the currency and stem the flight of capital.

in Argentina, the country said it plans to seize $29 billion of private pension funds. This caused bond yields in the country to surge. The Merval stock index plunged more than 55% on the year. The government last raided pension fund investments to service its debt in 2001. But it didn't help. Argentina then defaulted in a move that sent shockwaves throughout the global capital markets.

As for Iceland, the market has all but collapsed. The country's three biggest banks have been nationalized. Its currency has lost more than half its value in the past two years. It's being forced to pursue a multi-billion dollar bailout from its Scandinavian neighbors and the IMF.

The most shocking of all: Its benchmark stock market gauge, the OMX ICEX 15 index, has plunged 89% year to date! To put that in perspective, if the Dow did the same thing this year, it would be trading around 1,460.

India is running into trouble. Overseas funds dumped a record $12 billion of Indian shares so far this year. Foreign exchange reserves have dwindled by $42 billion as the Indian rupee has imploded. It recently slumped from 39.20 against the dollar to 49.50 — a record low.

In short, currencies aren't just declining. They're crashing. Stock markets aren't just falling. They're collapsing. Foreign investors aren't just walking for the exits. They're running and trampling anyone in their paths.

Summary of past recession and movements in KLCI

USD/JPY @ 90

The one that is likely to be the most shocking of all is the speed of change!

Speculative booms have already busted – in housing, commercial real estate, equities, commodities, emerging markets and above all, debts. There is a strong hope that the government comes in to repeal the law of gravity or prevent investors from selling. But it will be a blood transfusion with a falling heartbeat.

Nikkei plunged to a 26 year low and selling by investment managers, bracing for another wave of redemptions, also fed the declines. BUT the most interesting part is that as the financial crisis raised recession fears and it drives up the yen, piling the pressure on the country's exporters. One emerging cause of concern has been the rapid appreciation of the Japanese yen as investors who have in the past borrowed in Japan to invest in higher-risk economies are undoing those trades. This has caused a massive repatriation of funds into Japan, causing the yen to rise in value against other currencies.

Now, I see there is a strong case for FX intervention by MoF at USD/JPY 90, of which a break of that level could mean a quick move to 80 as market conditions may force a ‘line in the sand’ defense. I doubt that authority is running out of options.

Last week, it has triggered a stop loss orders below 95 Yen and it may test 90 Yen again, the lowest since 1995 when the USD/JPY fell to its historical low of 79.75 in April.

According to MoF, the yen below 95 has a strong adverse impact on Japanese exporters’ profitability, while the Nikkei at these levels will affect the whole economy, including banking sector capitalization. Last Friday, the authority has made verbal intervention in the special G7 statement on Yen’s recent excessive volatility. There are already large stop loss orders resting, taking the yen quickly to USD/JPY 90.87 and it would take a few trillions of foreign currency asset sales by Japanese retail investors to accelerate the Yen appreciation.

The Black Monday

Asia sold off like crazy. Europe came apart at the seams and the US futures were lock-limit down before the open. That is precisely what happened in 21 years ago. On Friday October, 16 1987, stocks cratered. Then the following Monday, stock markets around the world absolutely cratered. In a single session, the Dow 22.7% — in a session — the single largest point decline in history.

The financial winds are blowing unfavourably. As money is being printed uncontrollably, inflation is the only option and fiat currencies are doomed. Global capital flow is shifting direction and composition. In other words, money is escaping risky assets and making a beeline to safer U.S.-dollar based assets and cash.

When the stock market bubble burst in Japan back in 1989, (the real estate bubble burst a couple of years later), the Bank of Japan pumped massive amounts of yen into the financial system and that pushed interest rates to zero. The key lesson is that when banks have a massive amount of bad debts, the liquidity fails to translate into lending. Furthermore, Japanese consumers, after being crushed by the stock market crash and watching real estate investments crumble, weren't interested in borrowing anything at any rate. And many had no collateral left to borrow even if they wanted to. Does any of this sound eerily familiar?

My long-standing forecast for this phase of the decline is 7,200 on the Dow. But do not assume that will be the final bottom.

In his testimony before Congress yesterday, former Fed Chairman Greenspan confessed that this financial crisis may be the worst in 100 years. If that's the case, then it's not beyond the realm of reason to anticipate a stock market decline that's also among the worst in 100 years.

We may get a sharp rally at any time, especially if the government intervenes. If so, use it as your opportunity to sell the balance. But crisis is also opportunity — for the country to heal itself and for you to build your wealth.

Trade well and follow the trend, not the so-called experts.

Are Banks Ready to Lend?

One common phrase in the newswires is that ‘Will the government programs get banks to start lending?’ This is a curious question and it is much appropriate to ask if the programs allow banks to fully restore credit loss and if confidence is fully returned with right credit appetite?

What I realized after the massive liquidity injection in the past months is the large increase in bank assets, estimated to be around US$120bn increase (+67%) in cash assets, including bank reserves held at the Fed, aimed to offset the strain in the funding markets. There was an US$64bn jump in residential mortgages and a US$14bn jump in commercial mortgages, which is the kind of assets growth that most observes are usually associated to when they ask if banks are going to lend.

With what have been done so far, I am sure that LIBOR will be strongly pulled towards the rates that money is available through government programs and possibly will also halt the credit contraction now taking place in the market, but it is unlikely to expand bank balance sheet until prices stabilize.

With huge multi-hundred point swings in the DJIA becoming the new norm, it reflects the extreme uncertainty felt by investors and businesses. Some even argue that the whole host of actions taken by Treasury and the Fed Reserve has the unintended consequence of contributing to the very fears those actions were intended to calm.

Housing and consumer spending were overdone during the past decade and it will take time to clear the excesses. Likewise, with the leveraging up of financial assets tied to housing and the consumer were also extremely overdone and this will take a considerable financial resources to work toward a resolution.

Even banks flush with cash, there is still far less tolerance for risk, particularly in parts of country where housing prices are falling rapidly. Banks are taking more seriously on 5-Cs i.e. Conditions, Credit, Collateral, Capacity to Repay and Character) in approving loans and tighter lending requirements mean credit will likely remain constrained for quite some time.

Over-extended consumers are well-aware they can no longer rely on rising home values and a ready line of credit to support their spending, evidently as housing starts continued to move lower, pushed by the sharpest decline in single-family activity since late 2006.

In short, I do not look for near-term improvement.

Najib – Getting It Right!

Markets expect Najib, the newly appointed Finance Minister to display solid economic stewardship than his predecessor. It goes without saying that the Kuala Lumpur stock exchange has lost almost one-fifth of its value this year to date. Ringgit Malaysia saw its biggest one-month loss since the end of the dollar peg in 2005 with GDP growth is now under threat. Job creation has reached record lows, as unemployment, particularly among young majority Malays, is high.

However, judging from his maiden policy yesterday, I think Najib still have a lot to learn and definitely he would be a good choice of apprentice if the coast looks calm. This is no time for complacency.

The ‘feel-good’ effect with the RM5bn capital injection into ValueCap will be exhausted much sooner than anyone dreamed possible and we will face an economic crisis that makes the recent experience seem mild by comparison.

Hey Dude – it is not the stock markets that ail the economy, but consumer and business confidences that are affected by global slowdown. The liberalization policy for services sector, efforts to improve foreign direct investment etc are not, if all intangible and structural and that important changes will not be an immediate gain.

At this volatile stage, we should pretense of influencing the course of events, and neither should you. Instead, we need to focus on what you must do now to protect yourself and your family from the financial firestorm that rages around us.

The more he says about ‘No Need to Panic’, I think the opposite will prevail. In my previous posting, I shared the experience of President Hoover in managing the Crash of 1959. Thus far, I cannot find single little part of his maiden policy that show clear statutory authority nor the mandate to attempt to anticipate and prevent risks across our entire economic system.

His tools are too blunt, in that exercising it would likely spur greater concern and too narrow, in that he assumes that stock market is the only one group of participants in today’s broad financial markets.

Signs of Optimism?

source:www.zmelifetips.com

Warrren Buffett is buying American stocks, commodity prices are crushing, latest leading indicators are pointing north and massive liquidity is pumped into the system. Governments attempts to unclog the credit markets.

Despite all efforts on asset markets, recessionary conditions have arrived on the real economy side of the equation. September retail sales numbers suggest that consumption is declining rapidly and falling consumer confidence is likely to further delay housing recovery. Combining with a large scale reduction in capital spending plans, it would not be surprise to see a substantial recession lasting into at least 1Q2009 with sharp rises in unemployment extending past mid year.

The Japanese economy stagnated for a decade or so, following the collapse of its asset price bubbles in the early 1990s. Question now is that will the US economy experience a ‘lost decade’ in the wake of its own burst asset price bubbles?

The only difference between then and now is the responsiveness of policymakers. Unlike the case in Japan, which was quite slow to support the Japanese financial system via monetary easing and direct assistance to financial institutions, US policymakers have responded very aggressively. The Treasury Department is about to embark on a program to recapitalize financial institutions, hence it will help to reduce the risk of a downward spiral of bank lending and economic activity.

Having said that, Japan’s experience during the 1990s shows that the US economy could experience a few years of sub-par economic growth due to corporate deleveraging, in turn investment spending.

Over the past few months, the press has been filled with stories claiming that current dislocations in credit markets are the most severe financial crisis since the Great Depression. The 20% decline in the Case-Shiller 20 metro market housing price index since 2006 is prima facie evidence that residential real estate was overvalued and there are indications that further declines in house prices lie ahead.

What is apparently lacking is the policy stimuli to support traditional Keynesian type of aggregate demand boosting. This in my view will constitute the final component in turning around the current dilemma. Otherwise, equity market will be subjected to torrid weeks, perhaps months ahead as concerns over recessionary economic conditions returned to the fore. Of more concerns, I see the current deterioration in the labour markets as only the start of a process that is likely to see unemployment rise further by end of next year.

The challenge to policymakers and for market to watch for is the minimization of pass-through of what transpired in Wall Street to Main Street! Otherwise, it would be highly impossible to guess how much economic activity will be lost with the timing and pace of repair in credit market conditions. Likewise, the guess part for the psychological impact of the financial crisis on highly interdependent consumer and business behaviour.

Backfire When Governments Give a Pep Talk

Let me relate a story to you that after the Crash of 1959, President Hoover called together a group of the nation’s business leaders for a special meeting in Washington, and his message went something like this:

“When you go back home tonight, you’re going to do the right thing for our country. You’re not going to lay off employees. You’re not going to stop hiring. You’re going to do everything in your power to keep the economy going”

Outcome:- they did precisely the opposite, taking major steps to cut jobs and the rest is history.

Since the credit crisis burst approximately 14 months ago, I note that each new government countermeasure seems to have backfired. Investors are shifting some assets back to weaker hands while banks’ balance sheet continuing to deteriorate. It creates greater divide between price and reality and as soon as symptoms of the true risk levels resurfaced, there will be sudden and explosive market adjustments. Either, one rushing to dump high risk assets, which the line gets blurred by days and other category of investors, who otherwise might have not been unduly impacted by this, also suffered parallel losses and surging anxiety.

In turn, the authorities may actually have exacerbated the very panic that they initially want to avoid. I believe this is because the US debt crisis is far larger than previously believed. As of 1Q08, 1,479 banks and 158 thrifts at risk with US$3.2 trillion in assets, or 41 times the bank assets estimated at risk by FDIC.

Today, at one hand, the authorities finding panacea for current financial illness, on the other hand, the authorities are risking their balance sheet and perhaps too soon for the debt markets. In the Fiscal Year 2009 mid-session review, the Office of Management and Budget projected the 2009 US federal deficit will rise to US$482 billion – hence a major burden on US and other debt markets (That commitment is made before the recent bailout commitments were known). If that amount is included into the equation, it can easily exceeded US$1 trillion mark and certainly this can be confidence damaging and if the situation is serious enough, it could be a global paralysis for short-term credit markets.

The end results can be very corrosive and could be a cause for more losses and pains, if many people are exiting the banking system.

What is Certain is Uncertainty

Global central banks are joining in (or properly to be said – concerted efforts) to basically give away money, but if stock market is a good judge, then the outcome is akin to spending us into the poor house!

It is natural for investors to think that the worst is over. May be so… but that will need us to be really luck…

Oil prices – a good market indicator of market’s willingness to take risk – lost steam and credit market conditions are also appear to be easing somewhat – but is this just a blip or are we at the turning point?

What I am really certain now is that we are facing greater uncertainty ahead.

The process of de-leveraging is still going on, and the speed is faster by days and on the real side of the economy, talk is shifted from simply a recessionary possibility to the severity and length of this downturn. US home prices yet to find a floor with US private consumption to show negative growth for the first time since Q4 1991 and unemployment is high and rising.

Measures so far are pretty much designed to keep banks afloat and it still very much lacking the traditional Keynesian in boosting aggregate demand. If this plan is not materialized in the next 3 to 6 months, it would not be shocking if the financial conditions of financial institutions will take another beating again in March 2009.

Rescue plans that have been put up so far will be severely undermined, which will result in a severe and sharper recession. An idiot will tell you that his first priority now is to have a good paying job now, otherwise it would be a bad dream if aim is to reduce the debt overhang of distressed household.

So far, the DJIA has given up more than 2,000 points from the last day of September 2008 and the S&P’s 500 index has lost 38% this year. More than US$8 trillion of stock market wealth has evaporated since January 2008.

The lending system is in bad shape and barely functioning at all. According to recent article in Wall Street Journal “secular bear markets can last for 14 years or longer, like the one from 1968 to 1982. Typically, such bear markets are accompanied by repeated economic disappointments, as excesses that developed during long periods of growth are unwound”.

Let us hope they’re wrong! God Bless!

Unfortunately, They R Rite!

Six out of ten American people are now worried that a full-fledged depression is more than just ‘possible’ – CNN poll, Oct 6 2008

In last depression – the life savings of millions wiped out, banks a smoking ruin..thousand of companies bankrupt, 25% unemployment rate and more were struggling day to day just to survive.

We have every reason and right to be worried.

Warren Buffett’s word in recent days …’In my adult lifetime, I don’t think I’ve ever seen people so fearful economically as they are now’

Of course, this sounds alarming and I have been accused to be melodramatic, but the truth is nothing but the truth.

My mother asked whether she should move her retirement account to another institution, and over the past three weeks, I was questioned on the markets by nearly everyone I encountered.

That likely to mean more downside for stocks in the short term. The average bear market in the S&P 500 has seen an average loss of 34.1% over 20 months and so far the index down 20.5% from its high made on October 9, 2007. The last bear market, which lasted from March 2000 to October 2002, it took the entire index down 49.1% over about 30 months. The fiercest bear occurred back in 1937 to 1942, with the index losing 60% of its value over 62 months.

All these numbers show to us that there could be plenty more pain ahead. Of course, there also reasons to be greedy at this point of time. During the average bull market, we are talking a whopping 164% return over 57 months.

Gold – My Forever Love!

Washington doesn’t have the US$700bn and now the US government is even more broke and alternative would be a lot more painful and perhaps may take years to recover from. We are likely to see substantial devaluation of the US dollar, of course, as part of the trick, the government will inflation it away, through more smoke and mirrors, but eventually the end results still the same.

In the Great Depression, the dollar saga ended only after Roosevelt devalued the currency in January 1934 by raising its exchange rate with gold from $20.67 to $35.00 and that was a de facto 69% devaluation of the US dollar.

The same thing is going to happen this time around, even without the confirmation of any President or anyone in Congress or the Fed as the market will do it for us. The US dollar is toast and no ifs, ands or buts about it.

Issue at hand is that what can you do to protect your wealth?

First, get away from illiquid investments, especially real estate and long term government and corporate bonds. Forget about the yield and the most important thing right now is making sure you get back your money. Forget about increasing your net worth.

Second, hedge the value of money. Seek out tangible assets that thrive when the US dollar is sinking and inflation is rising. You bet – GOLD!

I was told recently that the US Mint is temporarily halted sales of its American Buffalo 24-carat gold one-ounce bullion coin as it simply ran out of inventory. Demand for physical gold and silver has been so strong that many coin and bullion dealers and wholesalers have had difficulty having any merchandise in stock or immediate delivery. Not only that we are seeing shortage in American Buffalo, also the South African Krugerrand and Mexican 50-peso. Premiums are up sharply.

I was told that global spending for the exploration of nonferrous metal, including gold, silver and other non-iron metals hit US$10.9bn last year, up from just US$5.2bn in 1997 and US$1.9bn in 2002. Many new deposits are smaller and lower grade and it can take seven to ten years to bring a new mine on line.

While it is true that the US dollar is rallied in recent months due to risk aversion, but eventually all countries that saddled with debts will come due. There will be a point that the Chinese and Saudis will get sick of underwriting Uncle Sam’s lifestyle. China has less than 1% of its reserves in gold and that is pretty low by international standards and likewise with the six oil-rich members of the Middle East.

Voting by Footing

House passage of the EESA was greeted with much skepticism as stocks headed lower. Asian and European stock markets plunged, led by banking and commodities stocks. Across Asia, all markets were also in the red. Tokyo's Nikkei 225 index fell to its lowest level in 4 1/2 years, sinking 4.25 percent to 10,473.09 and Indonesia's key index plummeted 10 percent, it's biggest one-day drop ever. The outlook for the U.S. economy darkened after figures released Friday showed that 159,000 jobs in the U.S. were lost last month, the fastest pace in more than five years. Over $1 trillion in wealth has been wiped out in just five days of stock and bond market declines.

Greed has been replaced by fear; euphoria, by panic; trust, by suspicion and we are already see devastating losses for investors in almost every asset class.

The government's bailout plan is designed to help clean up debts that have gone bad so far. But what about debts that turn sour from this point forward? And how about the US$182 trillion maze of best known as derivatives? Even before these bailouts, the Office of Management and Budget (OMB) projected the 2009 federal deficit would rise to $482 billion.

Besides the great bailout plan was signed by the US President on Friday, the day after, the previously agreed-to bailout of Germany's second biggest property lender, Hypo, fell apart at the seams, sending government officials scurrying to come up with an alternative deal. But the amounts needed are huge: 20 billion euros by the end of next week, 50 billion euros by the end of the year, and as much as 100 billion euros by the end of 2009. UniCredit — the biggest bank in Italy, whose shares have been plunging lately — is trying to raise $9 billion in capital to stay afloat and even the country of Iceland is shopping for bail out.

Recent economic reports point to intensifying recessionary conditions. Employment contracted at a faster pace in September and together with tightening of underwriting standards, it will lead to more defaults. As a result, credit markets are spiraling into a deep freeze, threatening to destabilize the US dollar.

What A Messed Up World!

To say growth in most countries has slowed this year is too generously commented. Dislocation in credit markets, tightening financial conditions in major economies, generalized inflation fears, risk of further nationalization in the name of survival etc are among typical dark humor for default socialism that one cannot deny the gravity of the situation.

The CBO crisis has lifted the Fed deficit estimates above US$400bn and we are still yet to find footing to the root of the problem and really it is not beyond a simple trick of buying time through short term funding otherwise before it becomes a moot point. The top 10 bail-outs in the last 30 years have cost countries more than 10% of the income.

The trade weighted value of US dollar fell nearly 40% since Feb 2002 and along with the sharp rise in the US current account deficit has translated into poorer prospects to those economies depending on the fate of the US economy. The United Kingdom has slipped into recession and no one is immune from this shock. The Euro and Japan are skating dangerously close to recession, if not already in the recession.

Some central banks have tightened policy a bit further, but some are already on loosening path. The Reserve Bank of Australia, PBOC etc has already cut rates and the incipient of recession likely to resume easing sooner than expected, but I am still not too sure if it is going to be enough or reactive fast before the snowballing takes place.

External vulnerabilities are feeding into domestic demand. Discretionary spending by consumer is ebbing and portfolio flows have not been more volatile than in recent months.

The baton for FX whipping boy has passed more decisively from the US dollar to somewhere else. The currency stampede looks more perplexing and seriously misplaced, especially in recent months with the rebound US dollar. My view is that complacency will be shaken hard and I repeat a major health warning here that we are already in big mess!

We are no different position than that those excited, yet weird-looking scientists warming up the latest plaything – Large Hadron Collider to re-enact the conditions of the ‘Big Bang’ by smashing the components of atoms together. Lucky us that this black hole yet to push our luck too far otherwise we left with a massive explosion 14 billion years ago that created the universe.

World Going for ‘U’ Recovery

I expect the de-leveraging in the core of the financial system to be continually on its intrinsically disorderly and destabilizing path. The order of economy downturn associated with credit crunches tends to be more ‘U’ shaped than ‘V’ shaped in character and it is unlikely that world is heading for a sustained satisfactory performance until the 3Q09 at the earliest.

Already I heard some troubles brewing in Asia with latest Bank of East Asia (BEA) is facing the challenges after thousands of customers queued to withdraw their savings. It is said that this bank has quite a significant exposure to US bankrupt bank Lehman Brothers and US insurer AIG. Last week, the bank revealed a trading loss of HK$93 million.

There are already symptoms of cash hoarding at banks and businesses, in turn will lower willingness to extend credit. Credit growth especially to household is slowing, despite the Herculean efforts of central banks. These are classic responses due to financial stability concerns. Private consumption – which the centre of growth of US economy – is likely to move at a new slower pace.

The housing adjustment is far from over even though there are tentative signs that it is easing at a much softer pace. From a simple sub-prime mortgages, risk lies now with prime & jumbo mortgages, Alt-A mortgages and home equity loans and home equity line of credit with a total combined exposure of more than US$4 trillion. Risk is that this confidence crisis, which started at residential property may be spread to its cousin at commercial property. Commercial construction could possibly weaken sharply next year. According to the Federal Reserve, around US$811 billion of commercial mortgages were issued since 2005 and we could see around US$35 billion loss from commercial real estate loans, if the severity rate were to reach 2003 peak (45%) and that defaults were to rise to 10% respectively.

Investors are rushing to buy Treasuries in a classic ‘flight to quality’. The 30 year T-Bond gained more than five points and 2 year T-Yields dropped by more than 50bps. Many analysts and traders are now expecting the Fed Reserve to begin cutting rates again.

Public capitalized intermediary will become a key component of the policy cocktail to deal with problems of the hour. Consistently, in bank after bank, the losses suffered from the mortgage and credit crisis have exceeded the amount of new capital they could raise. The pile up of derivatives greatly exceeds the total assets of the firm. For example, Merrill Lynch has US$4.2 trillion and Morgan Stantley has US$7.1 trillion worth of derivatives in their respective books. The empowerment given to these intermediaries and valuation uncertainties will make private financing difficult to arrange, in turn put risk to true belief of capitalism. I leave the eulogies to others!

Month of October

October is the month that bought us the Crash of 1929 and the Crash of 1987!

Warren Buffett invested US$5bn in Goldman Sachs, Congress is throwing its weight and it is still not clear if that what is needed to solve current predicament. One thing that I am sure is that each American’s share of public debt will rise to US$37,000.

Topix is trading at around 1.2x book – at a 20-year low – cheap but not attractive enough, even though is supported by share buy-backs, near 2% dividend yield and generating a ROE of just below 10%.

Central banks are injecting liquidity through various of measures. Emerging markets were already trying to stem the decline of the currencies and equity markets.

As far as Asian market is concerned, we are just 6% shy of the valuation in the 1997/98 Asian financial crisis. Historical PE dropped to 10.3x and is comparable to lows of 10.3x in the 1991 global recession, 11.1x in 1998 and 12.6x during the 2001 global recession.

Under current environment, cash is king. The KLCI has dropped 34% from its Jan08 peak and this could mean another 8-10% drop in the KLCI, if history repeats itself. Meeting with friends across Europe, US and Asia recently has given me a sense that investors are favouring maximum cash levels and very defensively in stock selection. It is also clear that most are very biased towards defensive domestic equities with highly visible cash-flows and holding as much cash as mandates allow.

Observing a Crisis

The incredible volatility in the financial markets has eclipsed virtually everything else, including the US presidential race, the start of Major League Baseball playoffs to the underlying economy.

So far, study by The Boston Consulting Group (BCG) shows that the banking industry globally has lost more than a fifth of its value in the first half of 2008. Following on the declines in value in the second half of 2007, nearly all gains in market capitalization since 2005 have been wiped out.

In the first half of 2008, 13 out of 14 industry sectors worldwide experienced double digit falls in total shareholder return (TSR). According to BCG, in four industries – telecommunications, chemical, engineering and electricity – average TSR plunged by more than 40 percentage points in the first half of the year.

Consumer loan is general and credit card loans in particular, are now subject to much close scrutiny. It is clear that tightening lending standards are no longer a phenomenon exclusively linked to property loans.

It is the interaction of falling asset prices, a weakening capital base amongst financial institutions and high inflation that is putting not just the United States, but the entire world in dealing with a near perfect storm that it is also here that we will find the answers to our questions.

• As it started with housing, it will end with housing. House prices in the US, UK and some EU countries are still well above their long-term average relative to disposable income, I think there are considerable rooms for it to fall for quite some time, until prices are adjusted below their long term equilibrium values and the current overhang must be dramatically reduced. It may take at least two years, not months.

• Central banks – a pain killer, not a problem solver. It is important to have confidence in central banking, but they are not GOD. They make policy mistakes too, and likely to be repeated. A number of US banks have capitulated over the past year, and more institutions, including non-banking financial institutions are in pretty serious trouble at the moment. What do the central banks do is basically spending tax-payers’ money to fix something which is unfixable, not at all dissimilar to the policy mistakes made in Japan 10-15 years ago.

• The de-leveraging just began. While I am a commodity bull, there is no way that fundamental factors alone can explain the rise in oil prices that we have experienced in 2007 and early part of 2008. It seems that commodity prices may have to adjust little downward from current level before the fundamental equilibrium price is reached.

The bad news is that the end of the crisis looks further away as policy makers are still behind the curve as well as the limitations for the authorities to cut rates aggressively, as the real short term interest rates are currently still negative in 20 of the 36 countries in Morgan Stantley’s research universe.

The good news is the first stage of the credit crunch is now over. Forced liquidations are no longer a daily occurrence, hence some sort of normality is likely to return to global markets, but it remains uncertain the extent of damages that have been inflicted on the real economy.

Confession of a FX Trader

I have been studying economic cycles more than a decade already. Over that time, I have held key positions in brokerages, research firms and banks and traded almost everything from equities to currencies.

Of all possible assets that I have my hand into, let me tell you that there is only ONE place – currency markets – that offers you opportunity to consistently creating wealth. Liquidity is high, huge and it dwarfs stock and bond markets combined.

This market is not complicated as many of us tend to believe. It is simply the act of trading one currency for another, governing by a set of economic principles.

Unlike other markets, like commodities, equities, real estates etc, there is always a bull market in currencies. You trade by buying and selling one currency against another. Like a see-saw, when one is going down, the other one has to be going up.

Given the size of FX market and so many participants, it is almost impossible for any one to corner the market. It is a level playing field for everyone and there is no issue about insider trading. Unlike stocks, one exposes to possibility of insider trading, cooked books and other corporate shenanigans.

FX market is always running 24 hours, no force shut downs. Stocks and futures can be shut down temporarily. No matter what happens, it was the only market in the world that wasn’t affected after the 911 attacks that closed stocks, bonds and commodities market across the globe.

This market is purely market driven – interaction of demand and supply and that is how prices are determined.