Hong Kong's Hang Seng Index rose 2,332 points (10.7%) to close at 24,090. The HSI had declined more than 10,000 points from the peak in October 2007 and was in danger of breaching the 21,400 support level, closing 21,757 on 22 January 2008. Since October 2007, the HSI had given up almost all the gains in 2007 which began the year at just over 20,000.
The catalyst was the Fed cutting Fed Funds rate by 0.75% from 4.25% to 3.50%. The Fed Discount rate was cut by the same percentage from 4.75% to 4.00%. The last time the Fed made such a large cut was in August 1982.
The expectation is that the Fed will continue to cut rates aggressively at the meeting next week, perhaps by as much as 0.50%. The Fed is expected to cut rates down to 2.75% by April, and 2.0% by September. How low can it go? The lwest was 1.0% on 25 June 2003.
Will cutting interest rates help? Almost certainly. The problems with providing liquidity to banks through the discount facility is that the banks do not want to borrow. They have sufficient cash. The problem is that they need capital injection because of the book losses they have taken from revaluing the "sub prime loans". By cutting interest rates, the Fed makes it easier for borrowers to keep up their payments. Taken together with the US Government's efforts to negotiate a moratorium on interest vrates re-setting, this will reduce the expected default rate, and allow the banks to start valuing the sub prime based securities at closer to their real value rather than the current "fire sale" levels.
Why didn't the Fed cut by 0.50% in December 2007 instead of the miserly 0.25%? The reason given was that there were still inflation worries, and the Fed wanted to try injecting liquidity directly to banks through the discount facility. That did not really address the problem of pending defaults on sub prime mortgage loans. Only a moratorium on restting interest rates, and a reduction of the rates will achieve the aim of stabilising the market.
The HK market reacted positively to the rate cut. However, we still expect the market to be volatile over the next 6 weeks until the rate cuts take effect. In the short term, we are looking for 27,000 for the near term and up to 34,000 sometime during 2008.
Wednesday, January 23, 2008
Thursday, January 17, 2008
Will Sub Prime Choke Growth in China
The HK stock market fell over 3,000 points over the past 5 days. Yesterday, 16 January 2008, it fell 1,300 points. The HKEx shares fell from a high of HK$268 to HK$170.
There are 2 main factors at work: concerns over the impact of the sub prime crisis in the US, and tightening of monetary measures by the PRC authorities.
Sub Prime Crisis
The sub prime crisis will take some time to work its’ way through. There is a real problem in that the underlying assets may not be as good as it should be because mortgage originators have been cutting corners and lending to unqualified borrowers. However, the extent of the problems in the financial market is magnified by the fact that there is no market for the CDO’s securitized by mortgages regardless of the quality of the underlying assets.
So far, we have seen financial institutions writing off tens of billions of US$. There have been delinquencies in mortgage payments but not to the extent suggested by the financial markets which have over reacted as usual. Just because Merrill Lynch (US$15 billion) and Citigroup (US$18 billion) have had to write off tens of billions of US$, the market is expecting every bank to have to do the same.
JP Morgan has just announced write-offs of less than US$1.3 billion much less than Merrill or Citigroup.
Tightening in China
The Chinese government announced that the banks reserve ratio will be further tighten to 15% in an attempt to rein in inflation. In a mature economy where the deposit base is stable, increasing the reserve ratio will mean less money can be lent out. But in China where the deposit base is growing at double digits, increasing the reserve ratio will very little impact on banks’ ability to lend.
The current impact is temporary and mostly emotive. When banks in China start announcing their results we will see that they continue to expand their lending.
Impact on Exports to the US.
Some people are concerned that exports to the US will fall because the US economy may go into a recession. In looking at exports, we must remember that only a small component of that is value added in China. The rest are raw material and energy costs. Therefore, we cannot compare the entire value of exports to GDP (which measures value added) as some have done.
Using only value added in China, exports are not a large component of GDP. In fact with the Chinese economy expanding at double digits, any shortfall in exports may be made up for by increased domestic consumption.
Conclusion
The present correction represents an opportunity to buy into the market at attractive levels. I particularly like the Chinese financials, and the HKEx.
There are 2 main factors at work: concerns over the impact of the sub prime crisis in the US, and tightening of monetary measures by the PRC authorities.
Sub Prime Crisis
The sub prime crisis will take some time to work its’ way through. There is a real problem in that the underlying assets may not be as good as it should be because mortgage originators have been cutting corners and lending to unqualified borrowers. However, the extent of the problems in the financial market is magnified by the fact that there is no market for the CDO’s securitized by mortgages regardless of the quality of the underlying assets.
So far, we have seen financial institutions writing off tens of billions of US$. There have been delinquencies in mortgage payments but not to the extent suggested by the financial markets which have over reacted as usual. Just because Merrill Lynch (US$15 billion) and Citigroup (US$18 billion) have had to write off tens of billions of US$, the market is expecting every bank to have to do the same.
JP Morgan has just announced write-offs of less than US$1.3 billion much less than Merrill or Citigroup.
Tightening in China
The Chinese government announced that the banks reserve ratio will be further tighten to 15% in an attempt to rein in inflation. In a mature economy where the deposit base is stable, increasing the reserve ratio will mean less money can be lent out. But in China where the deposit base is growing at double digits, increasing the reserve ratio will very little impact on banks’ ability to lend.
The current impact is temporary and mostly emotive. When banks in China start announcing their results we will see that they continue to expand their lending.
Impact on Exports to the US.
Some people are concerned that exports to the US will fall because the US economy may go into a recession. In looking at exports, we must remember that only a small component of that is value added in China. The rest are raw material and energy costs. Therefore, we cannot compare the entire value of exports to GDP (which measures value added) as some have done.
Using only value added in China, exports are not a large component of GDP. In fact with the Chinese economy expanding at double digits, any shortfall in exports may be made up for by increased domestic consumption.
Conclusion
The present correction represents an opportunity to buy into the market at attractive levels. I particularly like the Chinese financials, and the HKEx.
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