The risks rebounded significant in European and US hours, continue to head north now. I cannot join the market here given a near-term unknown unknown in the market.
The known unknown, those recognized uncertainties like fiscal cliff, doesn't kill. somehow the market would price it in along the way until it really comes out.
What kills is the unknown unknown, which is not commonly seen by the majority, under-estimated by the market. We call it "lion in the grass" as it is how lions disguise themselves and prey on some other poor little animals .
In the coming weekend, we will have the chance to see one of these events. On the 25th Nov, Catalonia, an autonomous community of Spain, will have the parliamentary election, which is widely taken as an independence referendum.
Bear in mind that if Catalonia, one of the few positive contributors to the fiscal book of the Kingdom of Spain, leaves their motherland, all the assumptions/forecasts made before about Spain's debt-to-GDP ratio, debt sustainability will need to re-do. What would be the market reaction?
Here it comes to the question: How likely will Catalonia choose to leave? I really don't know. But whenever I watch FC Barcelona Vs Real Madrid, it seems the desire for independence is for real...
Watch out this Spanish lion in the grass this weekend...
Common sense is not so common
Le sens commun est fort rare
Monday, November 19, 2012
Wednesday, November 7, 2012
An update on the repeat theme of 2010 in 2012: A bearish view
In the article of 2012 is going to repeat 2010 dated Sep 14 2012, I set out the repeat theme for risks in the rest of the year.
Nearly two months on, the repeat theme has played out nicely with Hang Seng rising from there to the peak by around 10%. For those who made money out of this rise, it should be the time to re-evaluate whether or not it is still justified to hold on with the risks.
The election in the US yesterday was clear a bad sign with Democrats claiming the President and Senate while the Republicans got the lower house. This unchanged setting basically tells us that NO way we will have a full resolution in fiscal cliff on time. The best case is muddling through with some sorts of half year extension in tax cut.
I am turning bearish here with the fact that uncertainties in the market are growing. Today we have the national congress in China, but my real concern is still in Europe.
Now, having sold out all Hong Kong stocks , I would go long 2-month ATM call (costs around 2.2%) and sell 2-month future on Hang Seng Index. The long ATM call is basically a "down side protection" to my bearishness here. And my break-even point would be any 2.2% drop in the index.
The real risks to this short-biased view is that new Chinese leaders after today, namely Xi and Li, somehow feel the the urge to do something to boost the economy.
But the upside is that if there is no stimulus after the 18th National Congress, what the market has been expecting, building into the price in the past 2 months seems groundless and reversal is due to come.
Nearly two months on, the repeat theme has played out nicely with Hang Seng rising from there to the peak by around 10%. For those who made money out of this rise, it should be the time to re-evaluate whether or not it is still justified to hold on with the risks.
The election in the US yesterday was clear a bad sign with Democrats claiming the President and Senate while the Republicans got the lower house. This unchanged setting basically tells us that NO way we will have a full resolution in fiscal cliff on time. The best case is muddling through with some sorts of half year extension in tax cut.
I am turning bearish here with the fact that uncertainties in the market are growing. Today we have the national congress in China, but my real concern is still in Europe.
After the US presidential election on the 6th, the National Congress in China on the 8th (Today), the market will face the Eurozone finance ministers meeting on the 12th and the Catalonian parliamentary election in Spain on the 25th.
The Greek Prime Minister Antonis Samaras said that his government would run out of cash on the 16th of this month if the Eurozone finance ministers couldn’t make the decision to release another tranche of aid during their meeting. The case for Greece has always been a game of brinkmanship and it may actually turn out to be fine. However, the market will need to deal with another European country further down the road. Catalonia, the autonomous community of Spain which has been trying to gain independence, will have the regional parliamentary election. The victory of any anti-Spain party would cast doubt on the fourth largest economy of the Eurozone.
The updated chart from the repeat theme on Hang Seng hinting a peak in November looks scary too, doesn't it?![]() |
Source: Reuters, click to enlarge |
The real risks to this short-biased view is that new Chinese leaders after today, namely Xi and Li, somehow feel the the urge to do something to boost the economy.
But the upside is that if there is no stimulus after the 18th National Congress, what the market has been expecting, building into the price in the past 2 months seems groundless and reversal is due to come.
Sunday, September 16, 2012
When will the music stop?
Under QE3, it will take 44 months to create the same liquidity as QE1 did and 15 months as QE2...
What about the impact on asset prices? Pick the number you like....
What about the impact on asset prices? Pick the number you like....
![]() |
Source: The Federal Reserve, click to enlarge |
Friday, September 14, 2012
2012 is going to repeat 2010
![]() |
Source: Reuters, click to enlarge |
![]() |
Source: Reuters, click to enlarge |
![]() |
Source: Reuters, click to enlarge |
Let's enjoy the rally while it lasts. If 2012 turns out to repeat 2010, then 2013 is going to be a repeat of 2011, if not 2008...
I will illustrate further here the headwinds facing the market next year both in the US and Europe as we head toward the end of this rally.
Monday, September 10, 2012
The ECB’s bazooka/ Gold rising on misunderstood fundamentals
Basically all assets were buoyed by
the ECB’s bazooka, a plan to load up unlimited amount of troubled country’s
debt, since last Thursday. I have to admit that my assessment regarding “no
open-ended commitment from the ECB” (See rationale here) was wrong and hence I missed
the rally in the past few days.
With the one-sided rising
asset prices in the past few days, I spot some upward movements in certain
assets were unjustified, and gold (silver as well) is one of the assets that rose
on a misunderstood fundamental.
The ECB’s bazooka, a.k.a. Outright
Monetary Transactions (OMT), is a plan to remove certain “tail risks of Euro
breakup” with the details listed below:
1.
Purchases of sovereign bonds maturing in 1 – 3 years in the secondary
market
2.
No quantitative limits are set on OMT
3.
No subordination of private investors
4.
Full Sterilization
5.
Conditionality of OMT is attached to EFSF/ESM program
Indeed, OMT is enough to build a firewall to
safeguard the too-big-to-fails (Spain and Italy) as long as those countries
comply with austerity measures (Of course, austerity will mean a recession for
them). OMT, in my opinion, has several implications to the market:
l
Removing a Lehman-like re-denomination risks in Europe in the intermediate
term (until a blowup of the ECB)
l
Increasing recessionary risks for countries under OMT, just like the Greece
and Portugal which carried out austerity measures under the current Trioka plans
l
The total liquidity in the euro system will stay unchanged given the full
sterilization structure
I think the Operation Twist (OT) by the Fed which
was firstly launched in Sep 2011 and then extended in Jun 2012 was a good
example in explaining the term “sterilization” and its impact on asset prices.
As I covered here few months ago, sterilization is
hardly supportive to commodity prices (incl. precious metals). This is also the reason why gold peaked at US$ 1,900 last September and trended down to recent low at US$ 1520 in Q2 2012 despite the crisis in Europe kept worsening.
If OMT really means less crisis, no money
printing and higher chance of recession in Europe, I don’t see the reason why
the “safe-haven”, “money-printing-sensitive” gold could rise as much as, if not
more than, equities, Euro or others assets that benefit from the removal of
tail risks in Europe.
While some investors are arguing gold will
rise as the Fed will carry out QE 3 on 13th Sep FOMC meeting to match
what the ECB did last Thursday, I am holding my breath to see what will happen otherwise.
I am particularly interested in the movement
of gold in Euro (XAUEUR) if QE 3 doesn’t become reality this week. A dramatic
fall for this pair is likely to happen:
![]() |
Source: Reuters, click to enlarge |
Tuesday, September 4, 2012
If central banks only get a BB gun while the market expects a bazooka…
The article was firstly published on September4, 2012 on the Marketwise column of China Daily.
Since mid-June, risk assets across the board have been buoyant for various reasons. One of the most dominant reasons is that central banks globally started hinting for another round of accommodative momentary policies in the face of poor economic readings and worsening debt woes in Europe.
Since mid-June, risk assets across the board have been buoyant for various reasons. One of the most dominant reasons is that central banks globally started hinting for another round of accommodative momentary policies in the face of poor economic readings and worsening debt woes in Europe.
Mario
Draghi, the president of the European Central Bank (ECB) has made a strong statement
in an investment conference in London on 26th July, 2012 pledging to
do whatever it takes to save the Euro. Mr. Draghi further announced that the
ECB is considering some non-standard monetary policies after the Governing
Council Meeting on 2nd August, 2012.
After
Mr. Draghi’s speeches in the past two months, it is widely believed that the
ECB would set a target yield range for short-dated Spanish and Italian
government bonds and enforce this target yield range by purchasing enormous amount
of these bonds in the secondary market. However, given the plan’s structure and
timing, I remain skeptical as to whether or not this grand plan will come into
being on time while the market is expecting it in a matter of weeks.
Firstly,
if a target yield range is set, it literally means that the ECB will enter into
an open-ended commitment to buy unlimited amounts of Spanish and Italian
government bonds whenever the interest rate rises above the target range. Nonetheless,
an open-ended commitment has been a taboo for the ECB since such a commitment would
give rise to debt monetization and mutualization among member states in the currency
bloc according to their stakes in the ECB.
![]() |
Source: Reuters, click to enlarge |
Unlike
the Federal Reserve in the US which only serves one single federal government.
The ECB is held accountable to the 17 fiscally independent member states which
are not supposed to share liability with each other. While the Eurozone is
still at an early stage toward fiscal union, it is hard to believe that Eurozone
leaders would agree on re-distributing liability from debtor states like Spain
and Italy to creditor states like Finland and Germany in an unfair manner at
this point in time.
Secondly,
I would argue that if the ECB and other policy makers have the sense of urgency
to take this bold step when the capital market in Europe seems like it is returning
to normality after Draghi’s speeches in the past two months. The Euro has rebounded
from a multi-year low of $1.20 to the recent high close to $1.26 while the two-year
Spanish yield dropped to below 4% from nearly 7% just a month ago (See chart). These
market movements demonstrate not only improving signs of the debt crisis in
Europe but also a high expectation of investors regarding upcoming policy
responses.
Draghi’s
speeches have indeed succeeded in kicking the can down the road and calming the
jittery market. If buying more time is ultimately what policy makers in Europe want
to achieve, this goal is considered done. I expect the ECB
meeting on 6th September, 2012 is more likely to surprise to the
downside, especially when investors have such a high expectation on it.
If
the market is expecting a bazooka while the ECB can only provide a BB gun,
disappointment among investors will be a sufficient reason to sink risk assets.
Wednesday, May 23, 2012
Three magic tricks by the Fed in the past four years
The article was firstly published on May 23, 2012 on the Marketwise column of China Daily.
The Federal Reserve carried out three major unconventional monetary policies since late 2008, namely the two rounds of Quantitative Easing (QE1 and QE2) and Operation Twist (OT).
Instead of marking the Fed’s official announcement as the starting date of stimulating the national economy, I looked at the Fed’s asset size (i.e. reserve balance) to define the real start of the easing. For QE1, the Fed started the easing process when it bought billions of assets since September 2008, way before the official announcement in November 2008 and the program’s expansion in March 2009.
For QE2, Ben Bernanke, the Fed chairman, hinted at another round of easing in August 2010 at a conference in Jackson Hole (that was when the market expectation of QE2 materialized) and announced it officially in October 2010. For both QE1 and QE2, we saw a soaring reserve balance of the Fed (more liquidity provided to the market) during the term of QE.
For OT, which the Fed announced and launched it in September 2011, the overall reserve balance stayed flat as the Fed sterilized the additional purchases of long-term Treasuries at the expense of short-term bills and notes.
The first two QEs are different from OT in nature and hence had a different impact on asset prices. For QE1 and QE2, the Fed did throw billions of dollars to the market to inflate its own balance sheet and loaded up with securities. The overall capital injected to the market by the Fed can be observed by the increase in the reserve balance during the term of the two QEs. As a result, all risk assets including commodity and equity were buoyant with the increased liquidity. The effect on assets can be said as “too much money chasing too few goods.”
However, OT hasn’t expanded the Fed’s balance sheet as a result. Since OT is meant to increase the Fed’s holding in long-term Treasuries at the expense of the short-term ones, the overall liquidity in the market remained unchanged. With the extra purchases of long-term Treasuries, the Fed managed to keep long-term interest rates ultra-low.
Since the aggregate liquidity in the market has not increased, the impact of OT on asset prices is not because of “too much money chasing too few goods.” Instead, the magic trick that the Fed did in the past six months was to keep the risk-free rate, which is widely used to discount future cash flow in all equity valuation models, very low and in turn lifted the equity prices.
![]() |
Source: Reuters, click to enlarge |
The Achilles’ heel of QE1 and QE2 was the effect of “too much money chasing too few goods”, which drove up not only equity prices but also commodity prices. The side effect of rising commodity prices passed through the supply chain of all businesses and caused margin compression for corporates, which at the end dragged down the equity valuations and prices. However, since OT doesn’t cause an increase in market liquidity, it has NO effect on commodity prices. This is the reason why we saw a strong equity rally (i.e. MSCI World Index) but a sideways commodity market (i.e. CRB index) in the past six months.
As OT will come to an end in June, I will go through the possible effects on the market next time.
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