From a near stall experienced at the end of 2008, Chinese growth has been improving with manufacturing surveys indicate expansion, residential property shows sign of stabilization, consumption has held up – stems from Beijing’s aggressive policy in response to the economic crisis.
Exports may have stabilized at a low level, but imports continue to be weak. Commodities have dominated Chinese imports, as China took advantage of cheaper prices. It may slow its purchases in 2H2009 as commodity prices now climbing and stockpiles filled. So far, commodity exporters have benefited most from the surge in Chinese commodity demand.
Thus far, government investment has driven growth acceleration while domestic private demand has weakened. So far, Chinese electrical demand has yet to match the surge in investment and industrial production.
In an effort to limit unemployment, the government has purchased excess output including metals, grains, and goods to refined fuels to processed metals. Chinese consumption has held up, but from a low base and the strong performance of retail and auto sales, prompted in part by incentives does illustrate the ability of the government to influence public and private consumption. It raises the possibility that China may have had a stronger underlying domestic demand dynamic than many credited.
Chinese bank lending has been particularly aggressive, reaching a value equivalent to 25% of China’s 2008 GDP. But this lending, whose pace reaccelerated in June 2009, might contribute to asset bubbles, especially in property and could increase non-performing loans in the future. Small and medium enterprises, however, still have challenges finding funds. Of late, officials have begun mopping up some of the liquidity through issuance of bills.
Given the still speculative nature of the Chinese markets and the influence of government policies, the equity market could be vulnerable for a correction. It is worth remembering that Chinese markets are buffered form foreign portfolio flows, given investment restrictions, and that the Chinese government is carefully restarting the IPO pipeline.
Thursday, July 30, 2009
Monday, July 27, 2009
RMB – A Managed Currency for Now
I am a bull for RMB as in the worst global recession since the Great Depression, China is the only large economy that is growing. It has over $2trillion in foreign exchange reserves, about 29% of all international reserve assets.
For now, China doesn’t want stronger RMB as it makes less competitive on a global stage for trade. It needs a relatively weak RMB to continue exporting its way to growth. That’s why the Bank of China manages the value of its currency. You see when dollar-based investments and revenues flow into China, converting these inflows to the RMB puts an upward pressure on the currency.
To offset the local demand to exchange US dollars to RMB, the Bank of China takes the other side of transactions – selling RMB and buying USD. This keeps the exchange rate stable and China builds vast amounts of dollar reserves.
For a decade, China maintained a fixed exchange rate policy – the RMB was pegged against the dollar at 8.27 RMB, and in 2005, China changed its currency policy. It abandoned the peg after political tensions rose between China and its key trading partners.
Under the ‘managed float’ policy, China agreed to let the RMB trade in a defined daily trading band while gradually allowing it to appreciate. This was China’s way of pacifying its trading partners while maintaining complete control over its currency. Over the next three years, the RMB climbed 17% against the USD and if the RMB was determined by market forces, it would trade around 5.80 to 6.00 level.
Since August 2007, RMB has been kept within tight trading band of around 6.80 level. Trading of RMB has been heavily restricted by the government – authorized only within mainland China and only through China’s agent banks.
Now for the first time, China is relaxing restrictions and allowing the RMB to trade off-shore with select Asian neighboring countries. This is the first step in China’s attempt to temper growth in its foreign currency reserves and to make the RMB a globally traded currency.
Despite China’s concern about the value of its large stock of US assets, reserve diversification will continue to be difficult, though the purchase of $50 billion in SDR-denominated bonds from the IMF will be only a small share of its $2 trillion in reserves. Investment in resource-rich countries will continue to be a major part of China’s asset allocation.
For now, China doesn’t want stronger RMB as it makes less competitive on a global stage for trade. It needs a relatively weak RMB to continue exporting its way to growth. That’s why the Bank of China manages the value of its currency. You see when dollar-based investments and revenues flow into China, converting these inflows to the RMB puts an upward pressure on the currency.
To offset the local demand to exchange US dollars to RMB, the Bank of China takes the other side of transactions – selling RMB and buying USD. This keeps the exchange rate stable and China builds vast amounts of dollar reserves.
For a decade, China maintained a fixed exchange rate policy – the RMB was pegged against the dollar at 8.27 RMB, and in 2005, China changed its currency policy. It abandoned the peg after political tensions rose between China and its key trading partners.
Under the ‘managed float’ policy, China agreed to let the RMB trade in a defined daily trading band while gradually allowing it to appreciate. This was China’s way of pacifying its trading partners while maintaining complete control over its currency. Over the next three years, the RMB climbed 17% against the USD and if the RMB was determined by market forces, it would trade around 5.80 to 6.00 level.
Since August 2007, RMB has been kept within tight trading band of around 6.80 level. Trading of RMB has been heavily restricted by the government – authorized only within mainland China and only through China’s agent banks.
Now for the first time, China is relaxing restrictions and allowing the RMB to trade off-shore with select Asian neighboring countries. This is the first step in China’s attempt to temper growth in its foreign currency reserves and to make the RMB a globally traded currency.
Despite China’s concern about the value of its large stock of US assets, reserve diversification will continue to be difficult, though the purchase of $50 billion in SDR-denominated bonds from the IMF will be only a small share of its $2 trillion in reserves. Investment in resource-rich countries will continue to be a major part of China’s asset allocation.
Profit on an Accounting Mirage
More investment banks are reporting windfall profits for the second quarter. That’s helped fuel advances in US and global stocks. Having said that these decidedly positive developments don’t necessarily indicate better days have arrived for the US banking sector.
I say these profits are merely a mirage created by an obscure accounting rule that allows banks to transform ‘toxic debt’ on their balance sheets into income. Also, the benefits of less competition, and favourable interest rates. Indeed, the Financial Accounting Standards Board has made it possible for the biggest US banks to book profits on loans that have not been fully repaid.
Banks will book income on loans that have ‘reduced credit quality’ by recognizing the value of the bonds on their balance sheets and the cash flow those securities are expected to earn.
In JP Morgan’s case, the firm took on $118.2 billion in toxic debt when it acquired Washington Mutual Inc last year. As a receiver of that debt, JP Morgan was allowed to mark that debt down to ‘fair value’, but now the bank says that those same debts may appreciate by some $29 billion over the life of the loans. And as those loans are paid back, that money is booked as profit.
Of course, this distorts banks’ earnings and camouflages the deterioration in other banking segments. Consumer and business loan losses continued to rise. Retail earnings were down sharply. Home equity charge-offs jumped and banks are warning that mortgage losses will continue over the next several quarters. Credit cards losses are highly dependent on unemployment situation – now at 9.5% in June, its highest level in two decades. The banking industry as a whole is getting pounded by rising consumer loan delinquencies, rising mortgage delinquencies, rising commercial real estate losses and more.
If you look no further than the huge divergence between Goldman Sach and CIT Group, you would realize the government is creating a two-class system of banks. Goldman, which received a large shot of TARP money and other supports, has generated a record profit in 2Q thanks to big gains in commodity, interest rates and stock trading.
On the other hand, the large commercial lender CIT was left to twist in the wind. The government refused to allow it to sell backstopped debt via the Temporary Liquidity Guarantee Program. CIT almost tumbled into bankruptcy before a group of bondholders agreed to bail it out with a $3 billion infusion.
Goldman shares have surged 89% and CIT shares have plunged 78% this year. Now that is a divergence!
I say these profits are merely a mirage created by an obscure accounting rule that allows banks to transform ‘toxic debt’ on their balance sheets into income. Also, the benefits of less competition, and favourable interest rates. Indeed, the Financial Accounting Standards Board has made it possible for the biggest US banks to book profits on loans that have not been fully repaid.
Banks will book income on loans that have ‘reduced credit quality’ by recognizing the value of the bonds on their balance sheets and the cash flow those securities are expected to earn.
In JP Morgan’s case, the firm took on $118.2 billion in toxic debt when it acquired Washington Mutual Inc last year. As a receiver of that debt, JP Morgan was allowed to mark that debt down to ‘fair value’, but now the bank says that those same debts may appreciate by some $29 billion over the life of the loans. And as those loans are paid back, that money is booked as profit.
Of course, this distorts banks’ earnings and camouflages the deterioration in other banking segments. Consumer and business loan losses continued to rise. Retail earnings were down sharply. Home equity charge-offs jumped and banks are warning that mortgage losses will continue over the next several quarters. Credit cards losses are highly dependent on unemployment situation – now at 9.5% in June, its highest level in two decades. The banking industry as a whole is getting pounded by rising consumer loan delinquencies, rising mortgage delinquencies, rising commercial real estate losses and more.
If you look no further than the huge divergence between Goldman Sach and CIT Group, you would realize the government is creating a two-class system of banks. Goldman, which received a large shot of TARP money and other supports, has generated a record profit in 2Q thanks to big gains in commodity, interest rates and stock trading.
On the other hand, the large commercial lender CIT was left to twist in the wind. The government refused to allow it to sell backstopped debt via the Temporary Liquidity Guarantee Program. CIT almost tumbled into bankruptcy before a group of bondholders agreed to bail it out with a $3 billion infusion.
Goldman shares have surged 89% and CIT shares have plunged 78% this year. Now that is a divergence!
Thursday, July 23, 2009
Making Sense of 2Q Earnings
So far, markets have been cheering the news coming from US financial firms – sparked by news that Goldman Sachs handily beat analysts’ profit estimates. And the party continued as JP Morgan, Bank of America, Citigroup and other institutions posted similarly upbeat reports.
But, wait a minute!
Aren’t these the same firms that were receiving billions and billions of tax-payers money just to stay afloat a couple of months ago?
Sure, Goldman has already repaid the $10bn it borrowed directly from Uncle Sam. That’s probably so just so it can hand out huge bonuses again this year.
Investors don’t really seem to care about such trivialities. They’re just cheering the news and move the stocks higher.
Here are the financial earnings hoopla – that the profits are largely based on government handouts used for big trading profits during self-inflicted volatility. Consider the fact that CIT – a major small business lender – just barely cleared a deal to keep itself out of bankruptcy. Not all financial institutions are smelling like roses.
Of course, profits came from the trading units, but not all units are winners. Goldman is still wrestling with a losing commercial real estate loan portfolio and slow investment banking operations. Meanwhile, JP Morgan, BAC and Citigroup are seeing deteriorating conditions in their consumer loan portfolios.
And with new legislation on the horizon – including the credit card reforms, possible caps on executive compensation and other major initiatives – it is hard to picture how these institutions will have a smooth sailing from here on out.
Consumers are changing their behaviour. Credit is unavailable and companies that produce frivolities are going to suffer the consequences. Consumer retrenchment is happening here. It is going to dictate how quickly or slowly the economy turns around and it has major implications for all stocks in your portfolio.
But, wait a minute!
Aren’t these the same firms that were receiving billions and billions of tax-payers money just to stay afloat a couple of months ago?
Sure, Goldman has already repaid the $10bn it borrowed directly from Uncle Sam. That’s probably so just so it can hand out huge bonuses again this year.
Investors don’t really seem to care about such trivialities. They’re just cheering the news and move the stocks higher.
Here are the financial earnings hoopla – that the profits are largely based on government handouts used for big trading profits during self-inflicted volatility. Consider the fact that CIT – a major small business lender – just barely cleared a deal to keep itself out of bankruptcy. Not all financial institutions are smelling like roses.
Of course, profits came from the trading units, but not all units are winners. Goldman is still wrestling with a losing commercial real estate loan portfolio and slow investment banking operations. Meanwhile, JP Morgan, BAC and Citigroup are seeing deteriorating conditions in their consumer loan portfolios.
And with new legislation on the horizon – including the credit card reforms, possible caps on executive compensation and other major initiatives – it is hard to picture how these institutions will have a smooth sailing from here on out.
Consumers are changing their behaviour. Credit is unavailable and companies that produce frivolities are going to suffer the consequences. Consumer retrenchment is happening here. It is going to dictate how quickly or slowly the economy turns around and it has major implications for all stocks in your portfolio.
Tuesday, July 21, 2009
The Next Hit
We have avoided Armageddon, at least for now and some have been loudly announcing the end of the recession. I am part of this and we are not out of the woods yet and there are a few more bumps in the road, and can be quite steep hills. As big as the sub-problem? Maybe.
When asked few weeks ago, what was my biggest concern – it would be European banks, which I have been highlighting many times the potential to create significant risk for the entire global system. This may be even dip us back into recession.
The insane lending policies in US mortgage banks has bring the world financial system to its knees, but one rarely knows the fact that Europe’s banks have been much aggressive in funding emerging markets expansion than US or Japanese banks. To compound the problem, the Europe’s banking system is in far worse shape than the US system. The losses may be bigger and their capital to meet those losses is certainly less.
Regulators in the UK allowed 20:1 leverage on a regular basis. It is now almost 40:1 and with tangible common equity (TCE), which includes preferred shares is around 55. This compared to US situation of which the average leverage of Tier 1 Capital of the five largest banks is in the range of 12:1 and is actually down from ten years ago. The assets of UK banks are about 5 times as large as UK GDP and by comparison, for the US, the ratio is barely 2:1.
And now turn to Eurozone. Leverage is now 35:1 and with TCE is almost 55. Now, this is the real issue and according to some Austrian-economist friends “Good, they should al be allowed to die” and this could potentially raise unemployment rate to something like 20%. This is a global risk, not just localized to Ireland or Spain or Austria.
I have some dealings with Swiss private bankers and they are known to be conservative. But somewhat, somewhere, some of them ran up a little leverage of nearly at nosebleed high 65%. According to a friend of mine, these banks are technically bankrupt.
Eurozone banks are already reeling from losses from US sub-prime related problems. Compounding this is Switzerland and Ireland’s bank assets are over 7 times, the UK is over 5 and the Eurozone on average of 4 times. Now, they have to face with even deeper losses from their own lending portfolios. Assuming that the losses were just optimistically 5% of the portfolio, it would be 20% of Eurozone GDP. The same goes for Portugal, Spain, Greece and Ireland. A 5% loan losses in Ireland would be 40% of GDP, the equivalent of US$5 trillion and I wonder where does Europe to find few trillion dollars?
After all, we are all connected, and what happens in Rome, no longer stays in Rome. Burn this into your mind!
When asked few weeks ago, what was my biggest concern – it would be European banks, which I have been highlighting many times the potential to create significant risk for the entire global system. This may be even dip us back into recession.
The insane lending policies in US mortgage banks has bring the world financial system to its knees, but one rarely knows the fact that Europe’s banks have been much aggressive in funding emerging markets expansion than US or Japanese banks. To compound the problem, the Europe’s banking system is in far worse shape than the US system. The losses may be bigger and their capital to meet those losses is certainly less.
Regulators in the UK allowed 20:1 leverage on a regular basis. It is now almost 40:1 and with tangible common equity (TCE), which includes preferred shares is around 55. This compared to US situation of which the average leverage of Tier 1 Capital of the five largest banks is in the range of 12:1 and is actually down from ten years ago. The assets of UK banks are about 5 times as large as UK GDP and by comparison, for the US, the ratio is barely 2:1.
And now turn to Eurozone. Leverage is now 35:1 and with TCE is almost 55. Now, this is the real issue and according to some Austrian-economist friends “Good, they should al be allowed to die” and this could potentially raise unemployment rate to something like 20%. This is a global risk, not just localized to Ireland or Spain or Austria.
I have some dealings with Swiss private bankers and they are known to be conservative. But somewhat, somewhere, some of them ran up a little leverage of nearly at nosebleed high 65%. According to a friend of mine, these banks are technically bankrupt.
Eurozone banks are already reeling from losses from US sub-prime related problems. Compounding this is Switzerland and Ireland’s bank assets are over 7 times, the UK is over 5 and the Eurozone on average of 4 times. Now, they have to face with even deeper losses from their own lending portfolios. Assuming that the losses were just optimistically 5% of the portfolio, it would be 20% of Eurozone GDP. The same goes for Portugal, Spain, Greece and Ireland. A 5% loan losses in Ireland would be 40% of GDP, the equivalent of US$5 trillion and I wonder where does Europe to find few trillion dollars?
After all, we are all connected, and what happens in Rome, no longer stays in Rome. Burn this into your mind!
Monday, July 20, 2009
Top 3 Forecasts
I love cycles and spend considerable time to understand it. I was exposed to this work when I had a chance of working with Geoffrey Moore, a leading guru in this field at the early part of my professional career. I heavily indebted to him, and thus far, his works have done pretty well for me.
As part of my half-yearly secular review, I put forward my Top 3 forecasts for those, who believe!
The first big move in gold in the late 1970s and now we are in the second big move. However, I see possible correction here in 2009, then I see gold moving higher in 2010 and still higher in 2011. The most recent peak, we saw in gold was in 2008 and already central banks around the world are fighting this economic crisis tooth and nail, printing money like there is no tomorrow, hence driving hundreds of billions, perhaps, trillions of dollars worth of frightened money into gold, silver, platinum, oil and other assets. So for short term traders, I think this is an opportunity to make money on the downside and for longer term investors, I think it is going to be an opportunity to add to the core holdings.
And in the case of US dollar, I have been the bear for as long as memory serves. Cycles suggest an 11-year decline of US dollar that does not end until 2012. Right now, in parallel with a gold correction, I see the likelihood of a dollar rally. In this regards, I would keep at least some portion of my money out of the dollar, putting it into stronger currencies like the AUD, NZD or the Swiss franc. The intermediate swings are too big and too regular to ignore.
I expect interest rates to move higher, especially those of high-grade paper but a new decline later this year and ending in 2012. Of course, low grade paper would probably move closely the pattern in the stock market in terms of price. In relation to the equity, I would take a very cautious, balanced, long-term to play the big sweeping negative trend in the stock market over the next several years.
What we are witnessing today – right now – is merely the calm before the big hurricanes hit. The combination of the 20-year economic cycles and the 500-year geopolitical cycle – a major power shift from East to West and or West to East, which is now the case, both crushing down on the economy in one singular time frame.
I see this as one time in the lifetime when we can build a great fortune like a handful of smart investors did in the great bear market of the 1930s, and then build still another fortune in the great bull market that follows.
As part of my half-yearly secular review, I put forward my Top 3 forecasts for those, who believe!
The first big move in gold in the late 1970s and now we are in the second big move. However, I see possible correction here in 2009, then I see gold moving higher in 2010 and still higher in 2011. The most recent peak, we saw in gold was in 2008 and already central banks around the world are fighting this economic crisis tooth and nail, printing money like there is no tomorrow, hence driving hundreds of billions, perhaps, trillions of dollars worth of frightened money into gold, silver, platinum, oil and other assets. So for short term traders, I think this is an opportunity to make money on the downside and for longer term investors, I think it is going to be an opportunity to add to the core holdings.
And in the case of US dollar, I have been the bear for as long as memory serves. Cycles suggest an 11-year decline of US dollar that does not end until 2012. Right now, in parallel with a gold correction, I see the likelihood of a dollar rally. In this regards, I would keep at least some portion of my money out of the dollar, putting it into stronger currencies like the AUD, NZD or the Swiss franc. The intermediate swings are too big and too regular to ignore.
I expect interest rates to move higher, especially those of high-grade paper but a new decline later this year and ending in 2012. Of course, low grade paper would probably move closely the pattern in the stock market in terms of price. In relation to the equity, I would take a very cautious, balanced, long-term to play the big sweeping negative trend in the stock market over the next several years.
What we are witnessing today – right now – is merely the calm before the big hurricanes hit. The combination of the 20-year economic cycles and the 500-year geopolitical cycle – a major power shift from East to West and or West to East, which is now the case, both crushing down on the economy in one singular time frame.
I see this as one time in the lifetime when we can build a great fortune like a handful of smart investors did in the great bear market of the 1930s, and then build still another fortune in the great bull market that follows.
Friday, July 17, 2009
Mark for Recession – Unemployment Rate
In my opinion, if there is one indicator to demarcate a recession from a depression, it will be unemployment rate. It will be too shallow a thinking that after the stock market rallied off its March 2009 low, the media and many pundits seem to be fixated on the financial markets to determine the severity of the crisis and to call its end.
The crash of 1929 proved to be the only prelude to further heavy losses in 1930-32. After the initial crash from 381 to 199, a huge rally emerged – prices rose all the way back to 294 for a 48% bear market rally. Initial losses were roughly cut in half. As we all know now, this optimism proved to be, well, premature as it turned out just a bear market rally, soon the market started to tank again. Stocks tumbled back to the crash lows, market cascaded lower for another two years and from the high during the summer of 1929, the losses amounted to a staggering 89%.
Fast forward to the bear market rally of 2009 – the rising sentiment does not forecast a betterment of the economy. Instead, a rising stock market foregoes rising optimism. I think that the next few weeks and months will not only be very interesting, but also very important because hardly anybody that I talked-to seems to think about the possibility of a new stock market low.
If we look at unemployment rate of the 1930s, the official US unemployment rate rose from the cycle low of 3.2% in 1929 to 15.9% in 1931 before it peaked at 24.9% in 1933 and hovered around 20% plus over the next two years after that. Contrast with the current timing, the rate rose from the low of 3.4% in 2007 to a recent high of 9.5% as of June 2009. If we look at civilian employment to population ratio, the downtrend in job market had already started in 2000, then the stock market burst. This was just the first act in a much longer drama.
These statistics clearly show that the severity of the current situation. Here you can see why this rally is not a garden variety post World War II recession, but something very different. The current plunge is secular, not cyclical and the world economy has a lot of rebalancing to do and this process will last much, much longer than the ‘green shoots’ crowd deems possible.
The crash of 1929 proved to be the only prelude to further heavy losses in 1930-32. After the initial crash from 381 to 199, a huge rally emerged – prices rose all the way back to 294 for a 48% bear market rally. Initial losses were roughly cut in half. As we all know now, this optimism proved to be, well, premature as it turned out just a bear market rally, soon the market started to tank again. Stocks tumbled back to the crash lows, market cascaded lower for another two years and from the high during the summer of 1929, the losses amounted to a staggering 89%.
Fast forward to the bear market rally of 2009 – the rising sentiment does not forecast a betterment of the economy. Instead, a rising stock market foregoes rising optimism. I think that the next few weeks and months will not only be very interesting, but also very important because hardly anybody that I talked-to seems to think about the possibility of a new stock market low.
If we look at unemployment rate of the 1930s, the official US unemployment rate rose from the cycle low of 3.2% in 1929 to 15.9% in 1931 before it peaked at 24.9% in 1933 and hovered around 20% plus over the next two years after that. Contrast with the current timing, the rate rose from the low of 3.4% in 2007 to a recent high of 9.5% as of June 2009. If we look at civilian employment to population ratio, the downtrend in job market had already started in 2000, then the stock market burst. This was just the first act in a much longer drama.
These statistics clearly show that the severity of the current situation. Here you can see why this rally is not a garden variety post World War II recession, but something very different. The current plunge is secular, not cyclical and the world economy has a lot of rebalancing to do and this process will last much, much longer than the ‘green shoots’ crowd deems possible.
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