Inflation Fears Hit Chinese Shares

China's inflation rose in August to the highest level in more than a decade while the country's August trade surplus climbed to its second-highest level ever. The Mainland's CPI rose 6.5% year on year (the target at the beginning of the year was 3%).

Investors were cautious that the central bank will further tighten liquidity. The central bank had raised interest rates 4 times this year, and increased bank reserve ratios 7 times. Shanghai fell 4.5% and Shenzhen fell 4.4%. HK managed to stay fairly steady because the valuations had not risen at the same pace as the Mainland markets.

China announced it's foreign exchange reserves is now almost US$1.4 trillion in July 2007. Since the first Mainland enterprise (Tsingtao Beer) listed in HK in 1993, Mainland enterprises have now raised US$200 billion in the HK market one-seventh of the country's foreign reserves. Yes, HK benefited from Mainland enterprises listing here, but we also played a part in building the financial infrastrucutre.

The recently announced through train, QDII relaxations etc. are aimed at reducing inflationary pressures on the Mainland by trying to divert some of the liquidity slooshing around into investments in HK.

Market Indices
Hong Kong Hang Seng: 23952.24 - 0.20%
Japan Nikkei: 15877.67 + 0.71%
Shanghai Composite: 5113.96 - 4.51%
Singapore STI: 3494.57 + 1.53%
South Korea Composite: 1847.36 + 0.63%
Taiwan Weighted: 9003.12 + 0.73%

*Intraday trading

Where the US Goes ... A Tale of 2 Markets

The HK market fell in early trading because of worries that Friday's weak US job data and DJIA drop of 249 points would carry over.

However, by the end of trading, the market had recovered its nerve and closed up at 23,999,70.

Market Indices
Hong Kong Hang Seng 23999.70 +0.07%
Japan Nikkei 15764.97 -2.22%
Shanghai Composite 5355.29 +1.50%
Singapore STI 3441.87 -1.35%
South Korea Composite 1835.87 -2.60%
Taiwan Weighted 8937.58 -0.89%

*Intraday trading

HK Inc.

The HK Governement announced that it now owns 5.88% of the HK Exchange (#388)making it the single largest shareholder. This drew criticism of market intervention.

Of course, in Singapore, the Government is majority owner (through GIC and Temasek) of almost all mbig listed companies. Somehow, Singapore has escaped criticism. Of course, HK does not complain to being held to higher standards.

Some complain that tighter integration of the HK and Mainland markets would expose HK to the risk of "policy" driving the market (i.e. vis-a-vis China). Maybe they have forgotten to take a look at the make up of the HK market. Over 50% of the market capitalisation is from mainland stocks, over 60% of the daily turnover are in Mainland stocks, and over 90% of the funds raised are for Mainland enterprises. Like it or not, HK is a proxy market for the Mainland.

Foreign investors are not allowed to invest directly in the Mainland. They do it either through the Qualified Foreign Institutional Investors (QFII) scheme or through the HK market. The quota for QFII is US$10 billion shared among 50 institutions (less than 1 day's turnover on the HKEx). No wonder the HK market is so active.

The HK Government already appoints 6 of the 13 directors of the HKEx including the Chairman and the CEO who is an ex-offico member of the Board. Also, investors need to get the approval of the Financial Secretary to own more than 5% of the shares.

Market Indices
Hong Kong Hang Seng 23982.61 - 0.28%
Japan Nikkei 16122.16 - 0.83%
Shanghai Composite 5277.18 - 2.20%
Singapore STI 3488.97 + 0.66%
South Korea Composite 1884.90 - 0.21%
Taiwan Weighted 9018.08 + 0.01%

*Intraday trading

Tighter Bank Reserves in China

The People's Bank of China (PBOC) raised the cash reserves that banks are required to keep up from 12% to 12.5%. This 0.5% increase will take RMB 170 billion off the table. The Chinese economy has been growing at a breakneck speed of over 9% per annum since it was opened 30 years ago.

The "non stop through train" to invest in HK shares will likely be delayed until after the 17th Congress while technical details are being worked out. However, at the same time the minimum RMB 300,000 required for investment in Qualified Domestic Institutional Investors scheme has been reduced to RMB 100,000. Which coincidentally is the same level as originally proposed for the through train for individual investors. Rumours are that it will be be increased to RMB 300,000 --- go figure! Seems like the CSRC, the CBRC, PBOC and SAFE really have to start talking to each other.

Market Indices
Hong Kong Hang Seng 24050.40 - 0.08%
Japan Nikkei 16257.00 + 0.61%
Shanghai Composite 5393.66 + 1.56%
Singapore STI 3466.06 + 0.61%
South Korea Composite 1888.81 + 1.24%
Taiwan Weighted 9017.08 + 1.16%

*Intraday trading

Putting the Worries Behind Us

Market Indices
Hong Kong Hang Seng 24069.17 + 0.77%
Japan Nikkei 16158.45 - 1.60%
Shanghai Composite 5310.71 + 0.31%
Singapore STI* 3441.10 + 1.93%
South Korea Composite 2534.38 - 0.49%
Taiwan Weighted 8913.85 - 0.10%

*Intraday trading

Waiting for August

Hong Kong was dragged down by profit-taking and investors awaited the release of key U.S. economic data for August.

Market Indices
Hong Kong Hang Seng 23886.07 - 0.08%
Japan Nikkei 16420.47 - 0.63%
Shanghai Composite 5294.04 - 0.51%
Singapore STI 3376.06 - 0.30%
South Korea Composite 1874.74 - 0.38%
Taiwan Weighted 8922.98 - 0.63%

*Intraday trading

No follow through on Friday's Rise

Market Indices
Hong Kong Hang Seng 23904.09 - 0.33%
Japan Nikkei 16524.93 - 0.27%
Shanghai Composite 5321.05 + 1.96%
Singapore STI 3386.22 - 0.20%
South Korea Composite 1881.81 + 0.46%
Taiwan Weighted 8979.96 - 0.02%

Jackson Hole to the Rescue

The Hang Seng Index was up 499 to close at 23,984.14, yet another new high.

And to what do we owe this? Anticipation that, in his speech in Jackson Hole today, the Fed Chairman will tip his hand about the coming cut to the Fed Funds rate (most are expecting 0.25% and some are even looking for 0.5%) at the next meeting on 18 September 2007. As if that wasn't enough, the Washington Post has published leaks of the President's plan to rescue home owners who are unable to refinance their 0% down, no interest teaser loans. It's a wonder that the market did not finish up 1,000!!!

It seems that political expediency has taken precedence to financial responsibility. Mortgage brokers earned fat fees to help unqualified buyers buy over priced homes they could not afford. Now the US government is proposing to bail them out! And the Hong Kong government was accused of intervening in the HK stock market in 1998 by fighting off the hedge funds who were intent on bringing down our financial system like they did in the rest of Asia. "Let the market adjust to the correct level", they said.

Any way, I am real glad I am not a US taxpayer now being asked to finance some dumb borrower who got himself into trouble. Hmm, maybe they were not so dumb after all.

Locally, the Securities and Futures Commission "SFC" issued a restriction notice on Man Lung Hong Securities Ltd (broker numbers: 3490 and 3499) today (Friday 31 Aug 2007) under sections 204 and 205 of the Securities and Futures Ordinance.

The HKEx, has suspended Man Lung Hong's right to access the trading system, and declared Man Lung Hong a defaulter under Rule 3702 of the Rules of CCASS, the Central Clearing and Settlement System. HKEx will closeout the unsettled stock positions of Man Lung Hong Securities.

Last year 3 brokerages were put under restriction orders (2 subsequently folded and 1 was rescued) when the SFC found that they had mis-appropriated clients' assets. The current case is different in that apparently an employee misappropriated his clients' assets. The firm was put under a restriction order because apparently senior management had been aware of the mis-appropriation for some time and had allowed the employee to try to trade out of the position. Under the Securities and Futures Ordinance, the firm is required to notify the SFC as soon as practicable on discovering the problem.

Clients can seek compensation from the Investors Compensation Fund which would pay out a maximum of HK$150,000 per account. Many have questioned whether the sum reflects current market conditions as it was set during the collapse of CA Pacific (a brokerage) in 1998 and have not been adjusted since (the market have almost tripled in that time). The maximum payout was set at HK$150,000 as this was sufficient to pay off 80% of the clients in full. Clients with bigger balances were deemed to have been sufficiently sophisticated to assess the risk and did not need to be rescued.

The Fund has approximately HK$1.5 billion and was funded by a 0.002% levy on stock trading transactions. The levy was discontinued at the end of 2005 but can be re-instated should the balance fall below HK$1.0 billion.

Market Indices
Hong Kong Hang Seng: 23,984.14 +2.13%
Japan Nikkei: 16,569.09 +2.57%
Shanghai Composite: 5,218.82 +0.99%
Singapore STI*: 3,373.73 +1.58%
South Korea Composite: 1,873.24 +1.71%
Taiwan Weighted: 8982.16 +2.02%

*Intraday trading

Where the US Goes ... We Follow!

The Dow Jones Industrial Average closed last night up 247 as investors re-evaluated the Fed's position. A letter to Sen. Charles Schumer from Federal Reserve Chairman Ben Bernanke pledging to "act as needed" to help the economy (read cutting Fed Funds Rate) should the problems in the credit market start to affect the wider economy.

The Hang Seng Index rose 463 to close at 23,483 with turnover of HK$95.87 billion. China Construction Bank was outstanding and rose to an all-time high of HK$6.30 before closing off the day's high. All in all, it appears that investors have got their nerve back and started bargain hunting.

Market Indices
Hong Kong Hang Seng: 23,484.54 +2.02%
Japan Nikkei: 16,153.82 +0.88%
Shanghai Composite: 5,167.88 +1.14%
Singapore STI*: 3,342.28 +0.23%
South Korea Composite: 1,841.70 +0.85%
Taiwan Weighted: 8,771.21 +1.48%
*Intraday trading

Where is the Fed Cavalry?

The US market was down 280, and the HK market followed suit. At one stage the market was down 700 but managed to close at 23,020 down 343. Turnover was HK$104.2 billion.

There was disappointment that the Fed is still targeting inflation as "public enemy no. 1". This is read as meaning that there will not be a cut in Fed Funds rate in the short term.

The Fed was in a bind. Clearly, what is happening on Wall Street is affecting Main Street. The housing slowdown is worrying as it will spill over into other areas e.g. household goods, etc. Consider that the acquisition price of Home depot was cut substantially to reflect not only the availability of funds, but also future prospects. However, just 2 weeks before the sub prime mess hit the fan, the Fed had been saying that inflation was still worrying. Perhaps it was naive to expect the Fed to admitting it was wrong so soon.

I expect that there will be a cut in the Fed Funds rate in the not too distant future as the economy starts to show signs of slowing down. The next FOMC meeting will be on 18 September 2007. At that time, the Fed will data from which to draw conclusions on the state of the economy.

Market Indices

• Bombay Sensex*: 14,977.96 + 0.39%
• Hong Kong Hang Seng: 23,020.60 -1.47%
• Japan Nikkei: 16,012.83 -1.69%
• Shanghai Composite: 5,109.42 -1.64%
• Singapore STI*: 3,304.99 -1.14%
• South Korea Composite: 1,826.19 -0.17%
• Taiwan Weighted: 8,643.32 -0.97%

*Intraday trading

A Much Needed Correction

Finally, a meaningful consolidation! The market was down today on profit taking, closing at 23,363 down 213.97 with turnover HK$122.94 billion (second only to yesterday's HK$126.35 billion record high). Most mainland shares were down on the open and closed off the day's highs. China Life continued to surge on good 1st half results. There was also buying in issues where the A-share were trading at a big premium to the H-share.

Of course, Shanghai continued its upwards trend oblivious to what is happening to the rest of the world.

Market Indices

• Hong Kong Hang Seng: 23,363.76 -0.91%
• Japan Nikkei: 16,287.49 -0.09%
• Shanghai Composite: 5,194.68 +0.87%
• Singapore STI: 3,343.00 -1.34%
• South Korea Composite: 1,829.31 +1.46%
• Taiwan Weighted: 8,727.55 +0.11%

HK Shares Rose on Expected Funds from Mainland

The Hang Seng Index rose sharply on the opening and continued strongly to close up 655 at 23,577.

Today is the first day that the Bank of China Tianjin Branch can officially open accounts for Mainland clients to invest directly in HK shares. Investors believe that valuations of H-shares (Mainland issues) will rise to close the gap with their A-share prices.

Construction Bank of China "CCB" (#939) performed strongly on good results and disclosure that it had only minor exposure to the sub prime mess. The Mainland's 3rd largest bank closed at $6.15, the highest level since listing in October 2005.

Shanghai hit its sixth consecutive record closing high. The Mainland market is now 60% more expensive than HK on average.

Market Indices

• Hong Kong Hang Seng: 23,577.73 +2.86%
• Japan Nikkei: 16,301.39 +0.32%
• Shanghai Composite: 5,150.11 +0.83%
• Singapore STI*: 3,388.44 +0.56%
• South Korea Composite: 1,803.03 +0.65%
• Taiwan Weighted: 8,718.31 +0.32%

*Intraday trading

A Correction!

A correction in HK, that is. The Mainland market continued on the upswing gaining 1.49% to yet another new high of 5,107 having just broken through 5,000 for the first time yesterday.

Mainland investors feel insulated against the problems of the sub prime debacle in the US.

Market Indices

• Hong Kong Hang Seng: 22,921.89 -0.20%
• Japan Nikkei: 16,248.97 -0.41%
• Shanghai Composite: 5,107.66 +1.49%
• Singapore STI*: 3,362.94 -0.24%
• South Korea Composite: 1,791.33 -0.47%
• Taiwan Weighted: 8,690.09 -0.49%

*Intraday trading

The Shanghai Shuffle

It looks likely that the Tianjin pilot project to allow Mainland individaul investors to invest directly in HK shares will be extended to Shanghai which will team up with ICBC. Although many had expected Shanghai to object to the Tianjin scheme, Shanghai apparently decided to "get with the programme" and cut themselves in.

It is also interesting that they have chosen to go with ICBC one of the 3 Mainland banks listed in HK. China Construction bank "CCB" is the only one left without a partner. I would assume that one of the other major cities, such as Chongqing, may be next. The Chinese way is to share the goodies.

HK is becoming more and more a Mainland market with over 50% of the market capitalisation, 60% of the dialy trading, and 90% of IPO's being Mainland companies. As we become more integrated with the Mainland, we will become more like the mainland market i.e. "policy" driven.

The Shanghai market set a new high today above 5,000 points on the index, and we went along for the ride closing up 620 to 22,966 on the HSI. Another day like today and we will be hitting new highs. Personally, I won't be betting against it.

Market Indices

• Hong Kong Hang Seng: 22,966.97 +2.77%
• Japan Nikkei: 16,316.32 +2.61%
• Shanghai Composite: 5,032.49 +1.05%
• Singapore STI*: 3,380.05 +1.76%
• South Korea Composite: 1,799.72 +2.29%
• Taiwan Weighted: 8,732.84 +2.82%

Day 3

The third day of trading after the announcement allowing individaul Mainland citizens to trade HK stocks saw the HSI close up 617 at 22,346 with turnover of HK$80.07 billion. Buying was concentrated in H-shares i.e. shares of companies incorporated in the Mainlnad as these are expected to be the main beneficiaries of the relaxation.

There was some question as to the role of QDII now that individuals will be allowed to trade HK shares. QDII is aimed at the institutional market players with upwards of RMB 300,000 while individuals will be required to open accounts with at least RMB 100,000.

Effective today, interest rates on loans will rise by 0.18 percentage point (one-year) to 7.02% from 6.84%. Interest on deposits will go up 0.27 percentage point to 3.60% from 3.33%. The interest rate increase announced yesterday after market close by the Mainland authorities appears to have had little or no effect.

With the expiry of futures and options next week, there will be some interesting trading situations. Buy on weakness and sell into strength.

Note: As a matter of interest (pun strictly intended) interest rates and corresponding changes are divisible by 9. Mainland banks work on 360 days basis and using this makes it easier to calculate the interest.

Market Indices

• Hong Kong Hang Seng: 22,346.88 +2.84%
• Japan Nikkei: 15,900.64 -0.00%
• Shanghai Composite: 4,980.07 +0.50%
• Singapore STI*: 3,301.75 +2.26%
• South Korea Composite: 1,759.50 +1.34%
• Taiwan Weighted: 8,493.46 +0.17%

*Intraday trading

Up 1,020 then Pullback

As expected the market opened up, about 600, then it gapped up by 1,020 points on short covering. However, the momentumwas not sustainable and we finally closed up 200. Rather disappointing given the good news from the Mainland.

Actually, it is only natural that some investors will sell into rallies. I will be more worried if the market was up 1,020 today on top of yesterday. We finally closed up 133 at 21,729.

Consensus is that the Fed will cut Fed Funds rate soon. I believe that this will be the beginning of a string of cuts, and that eventually the turmoil will quieten down. At that time, the HK market will be driven by internal factors.

The Tianjin Factor

Yesterday, the Mainland Chinese State Administration of Foreign Exchange "SAFE" announced a pilot scheme that allows Mainland individual investors to invest directly in the HK market through the Tianjin special zone. This is the result of lobbying by the former Governor of the Central Bank Dia Xianglong who is now the mayor of Tianjin.

See http://www.gov.cn/english/2005-10/09/content_75318.htm

The scheme will allow Mainland investors to open foreign currency accounts with the Tianjin branch of Bank of China (or, any branch of BOC acting as agent for BOC for the Tianjin branch) and trade HK stocks. This was met with enthusiasm by Mainland investors who see HK as a more rational and "cheaper" market compared to Shanghai and Shenzhen. SAFE announced earlier this year that individual Mainland citizens may exchange up to US$50,000 per annumin foreign currencies. The Mainland has over US$1.33 trillion in foreign currency reserves.

The expected increase in investments and turnover will boost the HK market, and will act as an effective arbitrage mechanism for the Mainland and HK markets and close the gap in valuations of dual listed companies. The next step is to allow HK investors to trade in the Mainland markets through another "pilot" scheme?

The Bernanke Rally

The Federal Reserve cut the discount rate from 6.25% to 5.75% and encouraged banks to borrow at the discount window. The effect was stunning!

The HK market opend up 700 points and closed the day up 1,208 with turnover HK$105.3 Billion. The question is "Is this the end of the correction, or a dead cat bounce"?

The Fed has shown that it is ready to step in to correct market imbalances by providing much needed liquidity. Borrowings at the discount window can now be repaid after 3o days instead of the more usual 1 day. There is no question that the Fed will continue to inject liquidity until the storm blows over. That does not mean that it will rescue players from their own folly. By not cutting the Fed Funds rate at this time the Fed is treating this as a liquidity crunch only.

The worry is that this will spill over into the larger economy impacting the man in the street. It will certainly make it more difficult for unqualified buyers to get a mortgage which may not be such a bad thing. However, the homes market drives an increasingly large part of the economy, and a slowdown there will have an effect. This will affect US consumers and ultimately US imports of goods and services.

Right now, the Mainland is insulated from the worst of the battering. In fact, the correction comes at an opportune time for Mainland funds to start acquiring quality assets in HK at much lower valuations than 2 weeks ago. The market basically took off on the announcement of QDII relaxations even before Mainland funds were able to put in their applications to invest overseas.

The current problems in the US is also good news for the HK stock market because Mainland investors will prefer t5o stay closer to home and to invest in companies that they are more familiar with rather than exotic instruments. When QDII was first conceived, it was supposed to invest only in fixed income products on the assumption that they are "safer" than stocks. How time changes!

A "perfect storm"? How about 1,300 points down?

The market opened weak and was down 200-300 points. Tokyo was down over 900 in the morning and in the afternoon the Hang Seng Index followed Tokyo's lead and was down almost 1,300 points to under 20,000. It recovered with short covering and was down some 280 points at the close.

On Thursday, the trading pattern was very similar and there were rumours that futres brokers were receiving margin calls in mid trading as market volatility was outside expected norms, "a perfect storm". We saw many quant funds taking huge hits because the volatility was outside their parameters. When will we learn? This happened in 1997 with the Asian Financial crisis, the LTCM debacle, and the Russian meltdown. It's always the tail end of the bell curve that gets you.

Just as in the LTCM debacle, and the Russian meltdown fiasco (and in South America before that) we can expect the US Cavalry to ride to the recus. By that, I mean the US Federal Reserve. And right on cue, the Fed cuts the Fed Funds rate by 50 basis points. The "Greenspan put" is again in effect. There is really not much choice. Either you save US financial institutions from their own follies, or you watch the market implode from lack of liquidity and credit concerns. Unfortunately what happens on Wall Street will after Main Street. George Bush and the Republicans have enough to worry about in the Middle East. With an election year coming up, the last thing they need is is an economy that tanks.

So where does that leave us? Rumours have been flying around that Chinese money is poised to come in. The market got ahead of itself on the announcement of QDII and went straight up to almost 24,000. We are now back at the pre-QDII announcement levels at the beginning of the year. QDII applications are being approved. The current levels will let QDII money buy in a favourable levels now that hedge funds speculators have been shaken out.

HK Shares End Roller Coaster

Yesterday, HK shares ended almost flat after 5 days of volatile trading. The Hang Seng Index closed down 12 points at 22,443.

Last Thursday saw the HS Index down over 200 followed by down over 400 on Friday. When the US market closed down on Friday, everyone expected Monday to be a bloodbath. Monday was up over 200 followed by over 400 up on Tuesday on the back of good results from HSBC and Hang Seng Bank (which against all expectations reported net profits up lover 50%).

But this was not to last. Wednesday followed with over 700 points down giving back the gains over the last 2 days.

The worries were of course related to the sub prime loan fiasco in the US. Major concerns were that hedge funds will need to liquidate in order to meet margin calls in the US, or at least taking profits. Since, most major funds are also exposed to hedge funds, this can turn into a snowball.

Over the longer term, with the liquidity in Chiona, HK will weather this through as more funds are diverted our way via the QDII. But over the shorter term, we should expect to see more volatility.