An Epitome of A Full Scale Bear Market:: Russia

Russia's financial market seems to exhibit what we might call a full scale bear market.

chart courtesy of Danske Bank

We previously featured part of this in our previous post " A Government Cardinal Sin That Results To A Bear Market? War!"

Collapsing equity and currency markets, soaring interest rates as funds flee, and declining currency reserves hallmark a true bear market. Major contributing variables: Russia's recent military activities in Georgia, falling oil/energy/commodity prices, global deleveraging and rising risk aversion.

Fear Index Pointing To Tradeable Rally Ahead?

Markets are being whacked globally in the aftermath of the combined troubles plaguing the US financial industry, particularly Lehman bankruptcy, Bank of America’s buyout of Merrill Lynch, aside from the capital raising and credit rating of insurer AIG.

There seems to be so much fear in today’s market climate.

One of the popular measure of Fear is the VIX index as defined by Wikipedia, ``VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Referred to by some as the fear index, it represents one measure of the market's expectation of volatility over the next 30 day period.”

During the past year each time the VIX spiked beyond 30, the markets tend to temporarily bottom and usher in some short term “rebound” as shown below…

The blue vertical lines point to the historical “peaking” activities of the VIX index.

The temporary bottoms which it coincides with have been followed by rallies as shown by the trend lines of the S&P and the Phisix. But the important point is that the scale of past rallies have differed, of which is a very important determinant of the viability of the trade proposition.

Bottom Line: Further selling pressures could translate to “short term trading windows” for the Phisix. At the risk end, these may seem like "catching falling knives"; but given a longer term perspective, opportunities seem to present itself as buying at fire sale levels.

Today's Phisix Carnage (4% Drop): More AIG Than Lehman?

First of all I don’t think today’s 4% massacre of the Phisix which was a vicious blue chip selling was mostly about Lehman.

 

I suspect this to be more of AIG-driven.

 

Look at today’s news from CBS,

 

``Friday, the firm said it was reviewing its operations and that "everything was on the table," suggesting it might sell assets to raise capital and avoid a crippling downgrade. Standard & Poor's said it might cut its rating if AIG didn't take steps to shore up its business.

 

``Aside from potential asset sales, AIG is also seeking to raise more than $10 billion in capital, the Journal said. AIG has already raised about $20 billion in 2008.

 

``AIG shares slumped a record 31% Friday on concern the world's largest insurer may be downgraded by ratings agencies, triggering billions of dollars in new capital needs.

 

``Standard & Poor's put AIG's ratings on CreditWatch with negative implications, suggesting the agency may downgrade the insurer in the future.

 

``"Additional market value losses will place some strain on the company's resources," Standard & Poor's credit analyst Rodney Clark said in a statement. "AIG's potential access to the capital market may be more restricted in the short term."

 

One, compared to Lehman, AIG has direct exposure to the Philippines, which means any emergency fund raising from the mother unit would most likely involve directing its offshore treasury units to sell its most liquid holdings elsewhere (including the Philippines).

 

Second it’s all about timing. The news says AIG’s declaration to “sell assets to raise capital” was announced Friday. The amount of foreign selling today (Php 840 million) was almost to the same degree from last Friday (Php 749 million). But today’s action reflected more of the urgency to exit which almost falls squarely with sentiment reflected in the news report.

 

Of course this is just a suspicion.

Why Doomsday Forecasting And Bad News Sells: Learning From the Black Hole Machine Experience

``You gain strength, courage, and confidence by every experience in which you really stop to look fear in the face. You are able to say to yourself, 'I have lived through this horror. I can take the next thing that comes along.' You must do the thing you think you cannot do." -- Eleanor Roosevelt (1884-1962) former First Lady of the US

Bad news does sell! It had been a fortuitous event to have seen it happen first hand. And it was not just bad news, but a sci-fi version horror story as well.

It was not to my expectation that such an article would command tremendous response when I posted at my blog in the late afternoon of September 9^th, about the next day launching of the world’s largest ever scientific experiment called the Large Hardon Collider (LHC).

“Doomsday” was the battlecry of some the critics, see Will Tomorrow Be Doomsday? “Black Hole” Machine Switches On., who vehemently argued that any glitch encountered from such experiment could lead to an insurmountable growth of man made “black hole” that would eventually “consume” the world; our real time Armageddon.

And I thought of sarcastically relating such theme to the financial world: Financial pundits promoting for a global meltdown/depression could have perhaps wrongly premised their theme-instead of selling for financial or economic reasons, selling should have been recommended as the best approach to monetize on everything we own to enjoy the last moments of our lives (that is if there would be any buyers at all).

Figure 1: sitemeter.com: BAD News/Horror Story Causes Readership Spike!

When I checked on my blog counter (sitemeter.com) on September 10^th, I was stunned by the number of hits (which had spiked by fourfold) registered mostly from the said article as shown in Figure 1.

It was enough proof that many people can be easily swayed by horror stories!

Why People Love Horror Stories or Bad News

Some scientific research shows that the attachment/addiction to horror movies are partially due biological reasons such as “anxiety disorders” which carries either a genetic component or influenced by the environment where the trauma from horror movies results to the “release of opiate enorphins” or the revving up “the body's sympathetic nervous system” (Swedish.org).

Others say that scary movies could represent our legacy of “tribal rite of passage.” Dr. Glenn Sparks of Perdue University quoted by medicine.net ``There's a motivation males have in our culture to master threatening situations," Sparks says. "It goes back to the initiation rites of our tribal ancestors, where the entrance to manhood was associated with hardship. We've lost that in modern society, and we may have found ways to replace it in our entertainment preferences". In other words, enduring hardships (from horror movies) implicitly signifies as kind of psychological “ego” booster.

For others, it’s all about our alternative emotional safety valve outlet or other means to ease our aggressive impulses. From MSN’s celebrated financial pundit Jim Jubak,

``Sigmund Freud, Carl Jung and Bruno Bettelheim all theorized that we read fairy tales about evil stepmothers, parental abandonment in dark woods and child-eating witches to help us express and then cope with our darkest fears.

``The psychological value of these tales, in this theory, lies in the formulaic, repeated return to archetypical fears in what the reader knows -- even a reader as young as my 6-year-old daughter -- is a fiction. It also helps that, unlike real-life horrors, these tales usually have happy endings.”

Or similarly, why does bad news sells?

It can be little bit of Schandefreude (finding delight on other’s misery) or the release or ease of one’s stress by knowing of the suffering of others or social sympathy (misery loves company?) or occasionally “bad news is better than no news” (sciencedirect.com).

Overall, bad news or horror stories easily connect to the base human emotions of fear or anxiety or insecurity. These psychological aspects represents as an easy way to sell information (or even TV programs -e.g. reality TV as Fear factor!).

What lessons can be learned?

Incidentally, my blog (inspired from kiddy blogs then) had been originally setup for archiving purposes (where I can retrieve or search back issues faster) and secondarily, for public consumption. Although I’ve got a relatively small readership base, I hardly thought of it as a business model until the ad sponsorships came (yes, now I am also open to write for company blogs who are in need of outsource writers). Furthermore, I am delighted to see a small but increasing trend of readerships.

Nonetheless, since we knew that bad news sells all along, and if I were to simply aim for more readership in order to expand on my business model, then I would have concentrated on drilling on the bad news theme. But again, since my primary goal is to be profitable in financial market space, I would commit to assiduously to work on to be as objective as possible.

Famed self improvement author Dale Carnegie once said, ``When dealing with people, remember you are not dealing with creatures of logic, but creatures of emotion." (highlight mine)

Emotions such as fear, insecurity and anxiety can be used as Core Buying Emotions (CBE) or from a marketing perspective, a purchase trigger mechanism that could move people into action.

For some, doomsday forecasting can be an attractive CBE platform to promote one’s business. Whether or not such theme could be real world applicable isn’t perhaps the main concern by such promoters, but the business or popularity that could be generated from adhering philosophically to such dire scenarios.

The Black Hole Machine Encounter and Possible Investment Themes

As for the LHC or the “black hole machine”, we are not science experts to agree to disagree with the argument of the risks of its operation. One thing we know is that if the dissenters are right there won’t be anyone left to argue against it since we’d all be gone.

However from the benefit side, the Large Hadron Collider is suppose to uncover the underlying structure of the universe; the Higgs boson “elementary particles cause matter to have mass”, validity of the Grand Unification Theory (are electromagnetism, strong nuclear force and weak nuclear force a single manifestation?), existence of the superstring theory (quantum gravity) and dark matter and dark energy [Yes I am glad to learn that if scientific observation is accurate, the latter two forces dominate the Universe, from the BBC, ``The latest astronomical observations suggest ordinary matter - such as the galaxies, gas, stars and planets - makes up just 4% of the Universe. The rest is dark matter (23%) and dark energy (73%)].

Not only that, the LHC project will allow us to “accelerate computing cycles” (sciam.com) for “safely storing and then processing huge amounts of data” (guardian) which should revolutionize the way we utilize the internet and vastly enhance the research capabilities in the world of science.

In short, from an investment perspective, the LHC could be the nexus or the springboard for the next generation technology BOOM and a great enhancer of the lives of our children and hopefully including us, if scientific discoveries arrive on time and at affordable costs.

Fannie And Freddie Bailout Designed To Save The US Dollar Standard System

``Over the past few years, the Agencies were central to the process that brought the emerging world’s savings to the US housing market. And governments were involved every step of the way. When the world’s central banks (and other big bond investors) decided that the implicit US government backing for the Agencies wasn’t enough, the US government had to make the backing explicit.”-Brad Setser, Council of Foreign Relations, So true …

 

It was a highly volatile market out there this week.

 

The initial salvo was wild cheering from global equity markets on the recent action by the US Treasury to take its Government Sponsored Enterprise (GSE)-Fannie Mae and Freddie Mac- into “convervatorship” (quasi-nationalization). However, the festiveness quickly dissipated when the realities of “a weakening global economy”, the ramifications from the credit event of the F&F takeover on the Credit Default Swap Market and concerns over the persistent deterioration of US financial conditions as manifested by the lackluster capital raising quandary by Lehman Bros, which until recently, was the 4^th largest investment bank in the US, sunk into the consciousness of global investors which resulted to a retreat from most of the earlier gains.

 

The conservatorship program includes the taking over of management control of Fannie and Freddie (F&F) by its regulator the Federal Housing Finance Agency (FHFA), where common and preferred stock would be diluted and not eliminated. The takeover now alters the corporate objective of the GSEs to “improving mortgage financing conditions” from “maximizing common shareholder returns”.

 

The program also includes capital injection into the GSEs by US Treasury and FHFA to maintain the positive net worth of these agencies in order to fulfill its financial obligations, where in exchange the US Treasury receives “senior” preferred equity shares and warrants aimed at securing solvency.

 

Aside, a new credit facility designed to secure liquidity concerns will be introduced to backstop F&F and Federal Home Loan Banks, and which is set to expire on December 2009. Lastly, a temporary program will also be put in place to acquire GSE Mortgages in order to secure market liquidity of mortgage securities also slated to expire on December of 2009.

 

For starters, Agency securities are one of the world’s most widely held securities by both private and the public sectors (Sovereign Wealth Funds and Central banks).

 

Morgan Stanley’s Stephen Jen has a great breakdown on these (highlight mine),

 

`` Total foreign holdings of long-term USD securities increased from US$7.8 trillion in 2006 to US$9.8 trillion in 2007, with US$1.3 trillion of this annual increase from increased foreign holdings of US long-term debt securities, including US Treasuries, agencies, agency ABS and corporate bonds.  Foreigners are dominant in some of these markets.  For example, some 57% of the marketable Treasury securities are held by foreign investors. 

 

``Foreign investors’ appetite for US agencies – both straight agency debt and agency-backed ABS (also called agency pass-throughs) – has risen sharply.  (Fannie Mae and Freddie Mac (F&F) are government-sponsored enterprises (GSEs) with two main activities.  First, they securitise mortgages by converting conforming mortgage loans into tradable mortgage-backed securities (MBS).  Second, they have an ‘investment portfolio’ business, whereby they issue AAA rated agency debt to finance the holding of MBS or other assets.  The latter is a ‘carry trade’, capitalising on the then-implicit government guarantee.  One key part of the policy discussion regarding F&F is whether their second activity is justified.)   Of close to US$7.5 trillion in outstanding US agency debt and agency-backed ABS, some US$1.54 trillion (according to Fed flow of funds data, June 2008) is held outside the US, with China, Japan and AXJ being the largest holders of these securities, with US$985 billion of this latter figure held by foreign central banks. (The share of total US long-term securities held by foreign investors has more than doubled since 1994 (from 7.9% of the US$16 trillion in securities back then to 18.8% of the US$49 trillion outstanding as of 2007).” 

 

We featured a chart on the composition of foreign holdings of the F&F in Inflation: Myths And Beneficiaries. Nonetheless, private ownership of Agency backed papers appears to have stagnated since 2005 while foreign public ownership has steadily increased as shown in Figure 2.

Figure 2: Northern Trust: Foreign Public-Private Exposure On F&F

 

In perspective, aside from foreign holdings GSE debt securities are likewise owned by US households and institutions or financial entities as commercial banks, savings banks, credit unions, pension funds, life insurance companies mutual funds, brokers, ABS issuers and REITs.

 

However, as % of total outstanding debt, in 2007 ownership of GSE debt in pecking order: foreigners comprise 19.92%, followed by commercial banks 13.87%, households 12.06%, mutual funds 7.67% and ABS 5.13% (Northern Trust).

 

So when US Secretary Paulson was asked of the US government’s takeover of F&F, his reply as quoted by the Washington Post,

 

``"The U.S. government had no choice," he said.

 

``Mr. Paulson, in an interview with CNBC on Monday, said foreign pressure was not the "major driver" of the takeover, but acknowledged that "there's no doubt that there's fragility in the capital markets."

 

``"These companies are so big, and they are owned by investors all around the world. You are obviously going to get concerns," Mr. Paulson said. "It was definitely concerning overseas, but there was concern in this country. I tell you, my phone is ringing the most from investors here." 

 

This means the US financial system have reached a near calamity. 

 

However many had been quick to lash at the “conservatorship” program as virtually a bailout of foreign owners of agency securities.

 

While this perception seems partly correct, I think most of these critics ignore the fact that these actions basically signify a remedial patchwork to the emerging cracks at the Fiat Paper Money “US Dollar” standard system. The massive current account imbalances a common feature in today’s world tends to amplify on the systemic flaws especially amidst today’s heightened volatility.

 

At present, countries with current account surpluses at one side of the ledger need to be offset by countries with current account deficits at the opposite side. As an example, deficits of the US have been more than sufficiently covered for by capital flows from mostly emerging markets paving way for the unorthodox pattern of “Poor countries Financing The Rich”.

 

Yes, while various politicians and experts from around the world have boisterously decried about “social inequality”, unknowing to most is that such inflationary “inequality” mechanism appears to be the imbedded on the US dollar standard platform. Think of it, while profits are privatized, losses are socialized! Wall Street’s politically connected gets rescued, while the masses pay for the mess created by the former. The failed F&F model was demonstrative of the Keynesian brand of capitalism and not of the laissez faire genre. (Please don’t associate the fiat paper money standard as epitomizing laissez faire or free markets too. Same with currency markets, interest rate markets or even oil markets! These markets are controlled heavily by governments notably on the supply side. As an aside, the “anarchy” in the Shadow Banking System wasn’t symptomatic of a free market mess, but one of going around banking regulations or taking advantage of “regulatory loopholes” in order to take on added leverage by assuming more risk to magnify returns by the establishment of off-balance sheet Structured Investment Vehicles (SIV). Going around loopholes do not signify free market paradigms).

 

Going back to the unorthodox pattern of “Poor countries Financing The Rich”, during the gold standard, current account imbalances had effectively been curtailed by the shifts in the gold reserves by nation states engaged in trade. This essentially accounted for as an automatic adjustment mechanism, which is absent today under the digitalized and unlimited printing capabilities of central banks to churn out money “from thin air”.

 

And as we noted above, current account imbalances today need to be offset. During the recent past, the nations with current account surpluses signified as subsidies to domestic export-oriented industries but came at the expense of domestic consumers, i.e. China, Asia and other emerging markets. On the other hand, current account deficit nations run subsidies on domestic consumers via expanding domestic debt (financed by current account surplus countries) at the expense of domestic production. From which the transmission mechanism had been mainly via currency pegs or dollar links.

 

The foreign buying of agency papers or US debts were meant to sustain mercantilists’ policies by frontloading currency and interest rate risks in order to keep the exchange rate undervalued and thus promote domestic export oriented industries in order to expand employment. Hence, the currency manipulation policies that led to the current account imbalances had primarily been meant as a tool to manage domestic political risks.

 

In other words, the US dollar standard system paved way for political imperatives over economic goals, see figure 3.

Figure 3: Asianbondsonline.com: China-US yield curve

 

What sense would it make for a current account surplus country as China to buy or load up on assets of a depreciating currency, thereby suffer from currency loss? What sense too for current account country as China to buy assets whose yield is less than what is offered domestically, thereby suffer from opportunity cost of low interest rate spreads (assuming holding bonds until maturity)? And this has been going on for years!

 

The same for deficit countries, domestic consumers had been financed to go into a debt driven asset buying binge which resulted to overleveraged driven massive speculation, again for political goal of sustaining finance driven economic booms, where the demand from domestic consumption boom has greased the industries of current account surplus countries as China and emerging countries.

 

The US dollar, functioning as the world’s de facto currency reserve currency, has fundamentally been used by the US government to freely load up on debt, given its special privilege to underwrite from its own currency, by selling almost unlimited financial claims to international investors to finance such speculative unsustainable booms.

 

And as the US real estate and financial boom has basically unraveled, all these seem to be in a transition.

 

Recently there had been some signs of reluctance of nations with current account surpluses to stack up into agency papers. Of course, the recent actions by the US Treasury may seem to have assuaged the concerns of repayment by buying more into US treasuries instead of agency papers.

 

So what can we see from all these?

 

One, current account surpluses nations or foreign central banks seem to have the tolerance bandwidth, given their accrued currency reserves, to suffer from the risks of currency and interest rate losses provided they get repaid for holding these securities until maturity. I guess the actions by the US treasury may have answered such “repayment” concerns.

 

Two, foreigners which have been formerly financing the US real estate securitization boom appears to be bailing out, if not help tacitly ‘nationalize’ the structurally beleaguered industries by buying into agency papers until recently.

 

It also reveals of the extent of overdependence or vulnerability of the US on relying on foreign financing. The risk seems such that if foreign central banks or state owned Sovereign Wealth Funds or affiliated institutions would deem to have accumulated more US dollar reserves than what they might think is required, and change their priorities by reducing finance exposure to the US, which can even lead to more volatility in the US. Political factors can also hold sway to the appetite of foreign financing of US deficits.

 

In addition, understanding its present predicament and limitations, the “capital short” US government seems to be working feverishly to attract or to intermediate for foreign capital participation into buying out its besieged financial institutions. Example, a syndicate led by UK’s 3^rd largest bank, Barclay’s along with a “club rescue” team of “Temasek of Singapore and China Development Bank, was reportedly have shown willingness to back a deal that would put Barclays in the top tier of financial institutions.” (timesonline.co.uk)

 

Three, it’s all about the increasing integration of geopolitics or the decreasing hegemony of the US, as seen in the “Poor financing the Rich” aside from “Autocratic and non-democratic states financing democratic countries”!

 

Some Poor but Autocratic/non democratic nations that have been a beneficiary to the ongoing wealth transfer appear to have accumulated enough political clout as to weigh on the internal political policymaking of the US. 

 

Remember this quote from Yu Yongding, a former adviser to China's central bank quoted last in our Will King Dollar Reign Amidst Global Deflation? ``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic, if it is not the end of the world, it is the end of the current international financial system.” The recent political actions employed by the US government appeared to underscore such circumstances and Mr. Yu’s prayers seems to have been answered.

 

Or how about Russia’s recent military offensive against Georgia (as discussed in Toynbee’s Generational War Cycle: In Mindanao or In Georgia/South Ossetia?) which has practically left the US as a political nonparticipant to a besieged ally?

 

This only goes to show how the US looks to be losing its imperial edge over the global geopolitical economy and how the US dollar standard system appears to be in greater jeopardy. 

F&F Mix Results: Narrowing F&F Spreads But Defaults from F&F Credit Default Swaps

``In traditional finance, borrowers borrow and lenders lend. The only firms exposed to, say, home mortgages, are the banks that issue them. Thanks to derivatives, a firm with exposure can pass it off, and a firm with no exposure can assume it. Markets thus have less information about where risk lies. This results in periodic market shocks. Put differently, derivatives, which allow individual firms to manage risk, may accentuate risk for the group. Markets were stunned to discover that Long-Term Capital owned outsized portions of obscure derivatives. They dealt with that shock in typical fashion: they panicked.” - Roger Lowenstein, Long-Term Capital: It’s a Short-Term Memory

 

With the US government’s recent action to preserve the global monetary system, we find that aside from the undefined cost to taxpayers, the US treasury has now assumed the responsibility for the $5.3 trillion of mortgage securities aside from its outstanding $5.3 trillion of treasury securities as of March 2008.

 

So far, the US Treasury’s action has partially eased the yield spread of the F&F papers from its risk-free counterparts as shown in Figure 4.

Figure 4: Danske Bank: Before and After Spread of F&F vis-à-vis Fed Rate and 10 year Treasury

 

 

Even as the Federal rates had been lowered rates by 325 basis points as shown in the left panel in figure 4, the F&F rates have not equally responded. However, after the action taken by the US Treasury, the F&F rates dropped steeply as displayed in the right panel.

 

By lowering of the mortgage rates, the US government hopes to ease the burdens of homeowners smacked by a perfect storm of lack of access to credit, falling asset prices (real estate and stocks), rising unemployment, slowing economy and still high but fast declining energy/ fuel prices. 

 

And by narrowing the spreads from US treasuries, the US government hopes to provide cushion to the fast deteriorating financial and economic conditions by allowing investors access to cheap money which could feed into the mortgage market and buy F&F papers and thus restoring liquidity and confidence, aside from the credit ratings of the F&F papers.

 

But this doesn’t take away the fundamental problem of having too many houses for sale at prices buyers can’t seem to afford.

 

Moreover, the spreading of the mortgage woes to the level above the subprime market seems to be the next wave of credit concerns. The Alt-A mortgages covering about 3 million US household borrowers totaling some $1 trillion in mortgage papers with about $400 billion issued during the height of the boom in 2006 where an estimated 70% of borrowers were said to have exaggerated income (Bloomberg).

 

Aside the recent actions by the US government appear to have triggered a “credit event” in the CDS market of the F&F papers. A Credit Default Swap (CDS) is a credit derivative functioning as an insurance contract that pays if a company or “counterparty” defaults on its liabilities.

 

However unlike an insurance contract, the CDS market is many times more than size of the actual bonds referenced. The unregulated CDS market is estimated to be at around $62 trillion. The problem of which is if an outsized default occurs a contagion of non-collection from losses may lead to a systemic loss.

 

The recent “conservatorship” of F&F by the US Treasury has triggered defaults on some CDS contracts referencing to the F&F securities. The contracts affected were estimated at $250-$500 billion which should to result to some $10 to $25 billion in additional losses (Financial Times).

 

And perhaps some of these losses had been accounted for the recent volatility in the global markets.

Fannie & Freddie’s Conservatorship’s Possible Implications To Asia

``The US doesn’t just need US government money to support the US housing market: It needs money from foreign governments as well. And no one more than China. China’s central bank borrows RMB from the state banks (whether by selling sterilization bills or by hiking the reserve requirement) and then uses those funds to buy large quantities of Agencies. The flow of Chinese savings into the US housing market is entirely a government flow.”-Brad Setser, Council of Foreign Relations. So true … 

It’s nothing new from what we have been saying all along or from what we have been saying earlier.

The problem of the US deleveraging isn’t likely the same problem of Asia. Although much of the world’s tightened financial and economic linkages has unduly put to a strain on Asia’s financial markets. Aside from the slowdown in most of the OECD economies, which has likewise added to some pressures on the economic front.

Asia’s exposure to toxic papers remains modest as shown in figure 5.

Figure 5: IMF: Asia’s Exposure To Toxic Papers and External Debt

Next to the low exposure of Asian banks (as measured in % of equity) to toxic papers, the structure of external debt has been mostly long term except for Hong Kong, Singapore and Taiwan, which means financing woes have not been much of a significant concern.

 

Although we recently featured Korea as one of the apparent victims of the Fannie and Freddie’s where a foreign broker claimed the return of a currency crisis and a potential meltdown of Asia in Sequel To Asian Financial Crisis?, Costly Bailouts and Bernanke Buys Time, Figure 6 seem to dispel such concern.

Figure 6 IMF: Credit and Money Growth in Indonesia (left) and South Korea (right)

 

In short, much of the credit crunch in the OECD economies could have translated to a meaningful slowdown of liquidity growth in Asia, but this isn’t happening yet.

 

Broad money growth remains robust in South Korea (red) as shown in the right pane amidst a negative real interest rate (blue). In fact, money supply gained 13.2% last July (eastday.com). Yes, following the F&F takeover, Korea’s Kospi recovered by 5.24% while the won bounced from the streak of losses up 1.6%.

 

Meanwhile despite the 10% plunge in Indonesia’s JKSE index last week which had been linked to a sharp downturn in commodity prices. Credit growth seems to remain robust (left pane) courtesy of the IMF.

 

Funny how many of experts dug deep into the investing public’s psyche peddling the myth of how high “inflation” have caused the recent market rout. In terms of Indonesia, now that falling oil and commodity prices should equate to lower “inflation”, the rally in its market which should have happened seemed to have vanished altogether opposite the justifications by mainstream analysts.

 

Considering the dearth or selectivity of global liquidity much of the risk dynamics becomes more of micro than macro.

 

In the same way, these experts created the impression that the cutting of interest rates by the Bernanke’s Federal Reserves would lead to a rally global markets late 2007. It never happened.

 

In the same plane, local experts bruited about how remittances drove the Peso stronger. Where remittances remain at record levels, yet Peso has gone bust.

 

True, we can’t be wildly bullish on Asia because of the prevailing climate of uncertainty across the pond, but we should view this slack as an opportunity to accumulate than as an opportunity to run!

 

We believe that most of the selling that had accrued in Asia had been due to the ongoing deleveraging process (which includes unwinding of pair trades of the US dollar-commodity, momentum driven, aside from covert government support on the US dollar) which has importantly been the key link to most of the infirmities in Asian markets as shown in Figure 7.

Figure 7: US Global Investors: Declining Trend of Foreign Outflows

 

It is funny too how analysts screaming for us to run for the hills would use different data time frame references to prove or support their views. This cognitive bias is called “framing”.

 

Last August, we pointed out in Phisix: Knocking At The Exit Gates of the Bear Market! that 80% of the money which came into Asia in 2007 had been redeemed. Last week’s panic stricken analyst alluded to the size of foreign inflows from 2001 as a measure to portray a potential stampede amidst the gloomy outlook.

 

Well good enough, a chart provided by US Global Investors gives us a balance perspective. It reveals of almost the same pattern as we had been seeing in the Phisix: declining trend of foreign outflows!

 

According to US Global Investors, ``Net foreign selling in the emerging Asian markets since mid-2007 has exceeded more than half of the investment inflows seen in the 2003-2007 bull market. Capitulation among investors in the region might signal a rebound in stocks ahead.” (highlight mine)

 

Moreover, the recent actuation from the US government appears to give some light to Asian equities. This from the New York Times,

 

``But the takeover of the companies also reinforced concerns about troubles of the American economy and highlighted its significant reliance on foreign investors, particularly in Asia.”

 

If US policy actions had indeed been directed at Asia as caviled by some, then it is a blatant admission of dependence on Asian capital for the survival of the US dollar standard system.

 

Moreover, it also shows how much political capital Asia has generated enough exert influence on US policymaking to favorably act on its interests as in the case of F&F.

 

With the writing on the wall, how could one be bearish on Asia unless for short sighted reasons?

 

Finally I’d like to share this quote from Director of Research Robert J. Horrocks, PhD of Matthews International Capital (emphasis mine),

 

``The recent moves by the Treasury may help the process by which Asia reflates relative to the U.S., and this environment may be helpful for Asian financial stocks. They have been seen for too long as carrying the same kinds of credit risks as the Western banks, and Asian financial stocks suffered as their counterparts in the U.S. fell. Moves to reduce risk in the U.S. and global financial systems seem likely to favor Asian banks, which have clean balance sheets and strong underlying economies. Reducing risk in the U.S. debt market may also take pressure off regional currencies as investors worried that much of the official foreign exchange reserves were held in Fannie and Freddie debt.”

 

Now with the “inflation” scare and the “Fannie and Freddie” woes off the hook, would Asia find its legs and commence on a gradual recovery?

 

We’ll soon find out.