George Orwell Revisited

We Are All Equal, But Some Are More Equal Than The Rest

sopskysalat said...
I just did a mental calculation. SIT, KLSE all done a 10% from top. HSI, DOW, N225 only did a 5% so far.

Depending on the markets, they will over-react more or less than others based on a number of factors. Let me point out a few:

1) High ratio of retail players. Weak holders generally. Self- explanatory. Not just China and Malaysia but just have a study on Indian markets for the past 12 months, the daily volatility there is quite horrendous.

2) Recent daily average volume compared to long term daily average volume. Or put in another way, the amount of fresh liquidity injected into the markets.

3) The nature and characteristics of fresh liquidity - speculative, opportunistic, short/long term, ... ??

4) Stretch ratio. The extent of gains over the most recent days or weeks. The higher the stretch ratio, the more vulnerable will be the markets as it also implies more people sitting on loads of gains, more prone to profit take. Malaysia was the BEST performing market so far in 2007 ytd (The Shanghai and Shenzen markets fell just as much because of the silly rumours, to them that was a localised event)

Numbers Don't Lie

Aside from sounding like Yusli, a sobering moment would be to have a look at the latest quarterly results of all listed companies, just pick from the bunch any listed firms and you can see the positive earnings growth. Be it finance, plantations, services or exports, most companies are registering significant improvement in revenue and margins. In line with being the best dividend yield paying market in Asia, its time for more stickability with foreign funds.

I see a big difference with this bull run and the one in 93-97, the latter has a lot of smoke and mirrors, a lot of hype, a lot of wishy-washy high-falutin dreams and superflous projections, but no hard numbers. The 93-97 period was a pure liquidity driven thing. There were mega-city projects, high-tech enclaves, even city on a river!!?? Currently, the most outrageous project currently is the South Johor thing, and its not that outrageous at all if you think about it.

The country spent 7 long suffering year trying to get rid of the excesses, now we can compete much better, and our ringgit is still a long way from the 2.6 to the USD back in the mid-90s. While we cannot and should not be over-exuberant, we must know how "pretty" we are so that when strangers call us fat and ugly, or bloated, or like now very sexy - we should know who we are and where we stand and not be swayed by sweet nothings.

Ozone Layer In Markets Broken

Times like these, we have to assess major pointers and plan strategy. What we know:

1) This is a yen carry trade reversal fear, not a China thing anymore

2) This is largely fear based, rather than actual unwinding of stocks and bonds to buy back yen

3) Is growth intact, is earnings intact, yes and yes

4) What about inflation, if anything the US is headed for a soft landing

5) Now that the dust has settled, look at the interest rate differentials btw yen and uds, yen and ringgit, yen and aud, yen and euro ... the differentials are still very attractive to continue with the yen carry trade

6) Would carry trade unwind? Not likely, the differentials are still there... Why then the correction? Its largely fear-based, China dropped on silly rumours, yen held steady, Nikkei lost a bit. Dow carried on the losses but the yen gained 2 yen in strength during US time ... fear sets in that this is the beginning of a tide, but more likely it is just a lot of forex traders taking positions favouring the yen in anticipation

7) A real yen trade reversal will be accompanied by dramatic weakness in hot currencies such as ringgit, oz dollar, even sing dollar and brazilian real ... that was not evident, so its still largely fear based

8) Why the panic then? Equity markets rising 9 out of 10 days, no bad news, all are waiting for some excuse for it to correct, though the quantum may be overdone

9) BOJ does not want a strong yen as it will curtail recovery plans, other central banks also do not want a strong yen as that will rock their financial markets. Can expect a joint statement from Fed and BOJ on a view supporting a flat yen to calm markets

10) Correction of 10% is termed as a correction, many markets have reached that level already

11) Don't expect back to normalcy in a jiffy, it will take more than a few days for markets to rebuild their bases before continuing the bull run

12) Hence bull run is not deflated but rather interrupted

View To A Kill

The Nikkei did not drop by much yesterday and the yen was largely unaffected. Shanghai dropped on rumours of a 20% stock capital gains tax. This has already been refuted by the authorities in this morning's paper. Dow Jones fell but what was more interesting was the yen's strength, no reason for the yen to strengthen but for reversal of carry trades.

1) Reversal of carry trades in yen need only be a whisper and it will trigger off fears and prompt more currency traders to buy the yen, reinforcing the fears of those who borrowed in yen to buy stocks and bonds in other currencies.

2) Does it matter whether the yen deserves to strengthen? No, it does not matter, reality rules. Will the BOJ step in, yes and the rest of the Asian central banks plus Fed will step in to assuage the weakness.

3) The big wigs do not want the yen to strengthen too much from here.

Continued fear driven selling this morning. Expect yen to stabilise and gain support from central banks later today. Calm to return. Buying on weakness yesterday was not warranted. Buying on weakness today is a better bet.

Ooooiii!!! Yus baby, where the f___ are you now?? Still buy aah??? - as heard in many broking halls this afternoon...

Drop Until Your Mother Also Cannot Recognise!

Well, everyone wanted the correction, but when it came, the severity was under-estimated. That's the problem when you are in a trend, everyone looks at the good stuff and brushes off the bad stuff. Well, all papers applauded the RM4bn turnover last week, nobody bothered with the potential selloff due to the build up in volume. The market would have needed to trade at RM3bn to RM4bn for three out of the next four days to alleviate the unusual overbought position .... but did any papers even highlight that fact, no its the RM4bn and better things to come, how not to die.

I still believe we are only in the second stage of a 4 stage bull run, and yes, it is still a super bull. Those caught on the wrong side, will have to accept their losses and try again, no point complaining. No more "I should have..." "I could have..." .... I absolutely hate people who say those phrases ... it just mean you cannot stand to lose, not willing to take a risk, unwilling to accept losses or mistakes, unwilling to move on, always needing to blame someone or something ... take it in your stride, don't be a petty person. Learn and move on.

Bursa The Confounding Stock

A regular reader wrote to me: "I was wondering whether you could share with your readers your thoughts on Bursa (the stock). I remember reading your blog some time back last year that it was one of your top 10 picks for 2006. The reason I am asking is that I am confused with the recent calls by analysts, a rare few say it's still a buy while most saying it is a sell due to high valuations vs. the region. How will you rate Bursa now? Still a buy vs the region, e.g SGX? .... Is our bourse really worth buying at 40x PER compared to SGX, Hang Seng or even ASX? What is the upside now? Recently, the news flow has been positive in the media with regards to our local bourse.. news such as higher volume is good for Bursa and that our market is slowly opening up with new products and ideas. e.g RSS. However, our bourse is and still is plagued by not-so-friendly policies which have seen some investors diversifying their assets overseas e.g in the case of PPB Oil and Genting. Meanwhile, new investors are looking more to list their companies abroad as they can fetch a better valuation and also avoid the bumiputera investor issue."

I think I set a target of RM9-10 when I put Bursa as one of the top picks, the stock was trading at RM6 I think. I think there were 5 sell reports out at that time, and only two research houses had it as a buy with a target of RM8.50, I think it was Deutsche and Nomura, kudos. It is very very hard to value Bursa or any exchange for that matter. Still, if you force analysts to come out with rpeorts, they will be racking their heads to pick the type of valuation that can justify the stock as a buy but will not be able to find it, hence the myriad of sells. Ask any analysts about Bursa share price and they will shake their heads.

The safest way is to do peer to peer comparisons, even then it has serious flaws. If you were to compare HKSE and SGX with Bursa, its apples and durians. Both are trading at 38x and 33x 2007 earnings respectively. While Bursa is at 40x. The other more established bourses such as LSE, ASE, Euronext and Deutsche Boerse trade in the 20s. Well, the action is a lot hotter in Asia in 2006 and probably 2007, hence the higher valuations for Asian exchanges. Bursa is higher than SGX and HKSE despite the fact that volumes and the derivatives are a lot bigger in Singapore and HK. It is also part of the "inefficiency" of Bursa that makes it to deserve a higher PE - it means there are more efficiencies and improvements to margins for Bursa in the future. Hence 40x or even higher is justifiable ... somewhat.

But a lot depends on the liquidity driven rally in Asia, if the bull run is a shortlived one, Bursa could fall quite fast. Bursa is and will always be a high beta to the index performance. High beta means higher than normal correlation to the index, i.e. when index gains 10%, Bursa could gain 25%, and the reverse will be true as well. So in that sense, Bursa is a VERY HIGH RISK stock, not one that you can lock up for your kids' education.

A much better yardstick would be the market cap for each exchange because to me an exchange IS a monopoly. Its a gatekeeper, a toll gate that collects from one and all when you want to buy shares in that country. How do you price a monopoly? How do you price OPEC if it was a company? Or better still, its like putting a price on UEFA if its corporatised and list as a money making venture.

HKSE's market cap is around US12bn, SGX is at US5bn and Bursa is at US1.7bn. Of course these two are financial centers and HK has a lot of advantages which also trumps Singapore such as the huge China listings and a huge derivatives market. SGX has made a lot of inroads with respect to derivatives but its China listings are more the smaller companies. One China listing in HK could equal 10-20 China listings in Singapore. If we look at SGX's valuation, it will never get close to HKSE because of the China factor. Hence the SGX is a better yardstick for Bursa's valuation. The call warrants is making good inroads and soon we will get at least 2-3 new CWs a week, then we stand a better chance to close the gap. Btw, Bursa, why no put warrants??? Pretty silly if you ask me.

As for RSS, my opinion is quite clear.... yuks! Bursa also lags terribly in futures. For example, tell me how accessible is accessing futures prices for the average investor?? How to keep track of index futures or palm oil futures when people have to pay/subscribe and even then find it hard to track the movements, its not visible enough. Why?? Because Bursa wants to make money at every juncture, want futures prices, pay first la. If not you can log onto Bursa website, which will crash everytime volume surge past RM2bn a day, and its delayed (you didn't pay wat..). The blinkered strategy is naive and short sighted. Only when people can monitor, will people trade, don't charge at every level.

To long term funds, there is only one Bursa. Though a few major stocks have decided to list in SGX instead of Bursa, Bursa is still the place where you can find stocks unique to Malaysia and its up to Bursa to keep it that way. As a long term investor you either have a stake or you don't. For exchanges such as LSE or Nasdaq, buying 5% or 10% of Bursa cannot hurt. For that, the Bursa will find a new support level for the stock even in the event of a collapse in bull run. I don't think you will find a lack of long term fund buyers of Bursa below RM9.00 owing to the respective market caps of various exchanges.

Hence even though I am pretty fed up with Bursa's management, I do think we are only in second stage of a major bull run. I have hence set a year's high price for Bursa at US2bn, which is a decent relative valuation to SGX bearing in mind the oncoming deluge of CWs amidst a bull market, which makes the target at RM13.50.

Execution Wheels In Motion for South Johor

The HK Factor

An advisory committee which include 5 BSDs, some more so than others, has been put together to look into the development of the Iskandar Development Region (IDR) in Johor. The main objective is to figure out ways to lure foreign investments and turn the growth corridor into an attractive investment centre. Badawi apparently handpicked the five, thanks goodness KJ was not picked. The interesting thing is that all 5 areJohoreans and have agreed to be on the committee. The munificent 5 are: Tan Sri Samsudin Osman, Tan Sri Kishu Tirathai, Andrew Sheng, Tun Musa Hitam and Robert Kuok.

I am pleasantly surprised with the inclusion of heavyweights such as Andrew Sheng and Robert Kuok. There is a deliberate weighting to people who have successfully delivered outside of Malaysia, in particular HK, and with a solid reputation in Asia-Pacific. Andrew Sheng was the chairman of the Hong Kong Securities and Futures Commission, a post he has held since October 1998. He was the deputy chief executive of the Hong Kong Monetary Authority from 1993 to 1998. Between 1989 and 1993, Dr. Sheng worked with the Financial Sector Development Department of The World Bank in Washington, DC. From 1976 to 1989, he held various positions at Bank Negara Malaysia, the Central Bank of Malaysia, including chief economist and assistant governor in charge of bank and insurance regulation. Dr. Sheng is the recipient of Hong Kong's Silver Bauhinia Star. He is a a chartered accountant, and holds a first class Honours degree in economics and doctor of law degree from the University of Bristol, United Kingdom. Presently he is on the advisory committee of CIMB as well.

Robert Kuok has formed many strategic alliances with various parties. With governments, he formed joint ventures to establish shipping businesses, and hotels, office buildings and convention centres. Thus, through business acumen, creativity and his valuable political connections, he has diversified into many important sectors of the economy. Apart from a multitude of enterprises in Malaysia, his companies have investments in many countries, including Singapore, Thailand, China, Fiji and Australia. Kuok controls the Shangri-La Hotels chain, Kerry Group, Perlis Plantations Bhd, South China Morning Post and many more companies.

In the NST: "It has been reported that the area has the potential to attract investments of up to RM47 billion with an initial investment amount of RM15 billion. ... Their experience, links, reputation and input is expected to help establish a zone that is on par, if not better than similar projects in the United Arab Emirates, India and China ... Musa, the former deputy prime minister, has held various posts at the international level. Samsudin is the former chief secretary to the government and is the chairman of the Employees Provident Fund Board and Investment Panel, while Kishu is best known for his textile business (Globe Silk Store). The 2,200 sq km IDR is dubbed the "project for all investors" and has been identified as the next growth area in Malaysia with potential investments in tourism, a financial centre, housing, medical facilities and education. It is estimated that within the next 20 years, the entire project has the potential of creating 800,000 jobs and the capacity to double the annual per capita income of the people to RM31,000 from RM15,000"

Why do I say the execution wheels are in motion? The presence of Andrew and Robert alone is the best move Badawi can make. The make or break for the IDR depends largely on foreign investors into the region. There are 3 groups of investors in the order of importance: HK, Singapore and Middle East. Many might be surprised why I would rank HK ahead of Singapore. Its the Macau factor!

If you look around the region over the last 3 years, the most exciting ventures were the highly successful redevelopment plans for Macau and the two IRs in Singapore. For Macau, the success of making the place into a gaming and entertainment center has exceeded the wildest of expectations. The IRs in Singapore has led to a strong uptick in high end property and new developments over the last 2 years in particular. When you are in the top 20 developers in Asia-Pacific, it will be very silly not to give the IDR a second look, after having witnessed the remarkable successes in Macau and Singapore. I will find it very shocking if Capitaland, Cheung Kong, Lippo, SHK, Keppel Land, Allgreen, etc... not making a footprint in IDR. Play the cards right, they rather be wrong than miss out. To top it all off, we have a much more outward looking and progressive Khazanah dealing the cards. Now execute well... please!

South Johor has a few things going for it:

a) very low cost of land

b) market differentiation away from Macau and Singapore's IRs

c) access to competitive labour

d) proximity to Singapore and a flow-through of visitors from the IRs

e) Air Asia's excellent coverage for air transportation intra-region

f) almost a blank canvas to start with

g) great potential for long term gradual development into 30-40 year plan

Despite the misgivings over the torrential floods in the southern region, the fact is the bulk of infrastructure is still not there, which give rise to planning to overcome the known obstacles. Lack of infra has been cited as a stumbling block but that is not that big an obstacle, in fact it will help that they can start with pcokets of development together with top international names as jv partners.

Dreams? Well, the appearance of Andrew and Robert will definitely open doors easily and ignite interest from top developers and investors from China and HK. Singapore being Singapore will try and jump ahead of the HKers.... queue man, queue... Already recent transactions by SP Setia indicate a significant jump in prices (yes, the land was in an already built up area, but still bears watching). UEM World has not revalue its land bank. What if Li Ka Shing buys 10 acres to develop a few hotels and condos? What if Disney decided to come in because Robert Kuok and Li Ka Shing are also coming in? A lot of IFs but it just takes one to start the ball rolling.

South Johor-Singapore can be big or can be bland. It could turn out to be positive like Kowloon-HK, or even Shenzhen-HK ... proximity yields a lot of benefits if handled properly. I think the Singapore government knows as well that it is to their advantage as well if South Johor prospers. One of the first thing Andrew and Robert will probably suggest to Badawi is "fast-track all FDIs applications to IDR", instead of a 3 or 6 month process, the process could be decentralised to a one-stop shop with nothing over 1 month.

How to play the South Johor situation? You now have a market that is very liquid. You need catalysts to move them. Research reports or the setting up of this influential committee are catalysts ... look for more land signings, joint ventures, FDIs into the region. You probably have to BUY & HOLD to get full value. As we are in the midst of liquidity driven rally, holding these shares might not be a bad idea anyway if you are bullish on the markets.

Current property players in South Johor - Asiatic has 6,000 acreage next to Senai airport. IOI Properties has a similar sized land bank also next to Senai airport. Johor Land has 1,500 acre along North-South highway. Crescendo Corp with 1,400 acre in Kota Tinggi distric (hmmm Kota Tinggi, not that good huh...). The others worth mentioning are KSL with 700 acre along Senai-Desaru highway and UM Land with 500 acre also next to Senai airport.

Of course thats not where the big fishes are located. They are the ones with excellent land bank within a 10km radius from the causeway. UEM World with 15,300 acre; Danga Bay Sdn Bhd with 1,400 acre; Gamuda with 1,200 acre; Tebrau with 1,012 acre; and Mulpha with 800 acre. I think if the execution wheels continue to turn, UEM World could be the best performing stock in 2007. Target? What if I say RM15!!!! But of course, a few more wheels need to turn for that to happen. But I would not be shocked at all if the stock reached that level this year.

Super Bull - Dejavu 1993?

While I have maintained my bullishness on global equities in general, the bullishness of the Malaysian markets have caught many by surprise, including myself. Having been through the 87 October crash (although to me I remembered it as the yen rally as I was working in Tokyo at that time) and the quite silly 93-94 super bull run in Malaysia/Asia, it makes for good comparison.

The 93 run was brought on by easy money from foreign investors seeking better returns. Call them hedge funds or cowboy funds or even astute international funds, but the 93-94 run was brought on by liquidity. Let's take the Malaysian example then. When you have good liquidity and the currency is looking strong, nothing seems to be able to go wrong. But the market was very maverick-driven, character-driven ... stocks associated with people will go very far and high. Plus it was very much retail driven. there were many days when we used to boast that our volume exceeded even the US markets. Looking back, thats when everyone should know its a false bull, and it will only take a prick to burst the bubble (pun intended).

The current run has its similarities, strong currency and deluge of foreign funds. However there are some remarkable differences - no more false volume, back then anyone could be buying or holding RM200,000 to RM500,000 of stock on contra with almost zilch in asset backing. The very shoddy risk management of the majority of broking houses allowed that to happen. I had 8 analysts under me then and every one of them was earning less than RM4,000 per month but were holding stocks on contra that had a market value of RM200,000 or more. That kind of scene was repeated at almost every level of society, magnified. So those days, markets were much more volatile owing to the 7-day itch and forced-selling and contango trades going wrong. You don't have that today, which adds quality to the rally, and also less volatility on the downside.

The 93 market went on a rampage sometime in March/April 93 and basically did not stop till January 94. Even then, the market was just waiting for a prick to come along to get itself out of its over-inflated misery. So, actually, not entirely right to blame the pricker but rather the timing was more than ripe, any kind of prick will do the job.

Were there some fundamentals back in 93, well yes kinda. Much like the present day. There is still a feeling of detachment from what is played out on our stock screens and what we can see and feel in daily biz life. Most will feel the real economy is actually not that hot, is it? But we have to remember also that the detachment is there because the stock market is a forward discounting tool and not an anal thermometer. Technically, we are supposed to get better days ahead.

The current rally is not character/maverick driven (thank god)... those old enough will remember the names of Teh Soon Seng (Shanghai calling), Sam (Africa did not like me), Repco Lau (still around), Tajuddin (retired hurt), Halim S (not all there but not out of it yet), etc... just the mention of a counter linked to them will send it limit up. There were many days when there were at least 3-4 counters going limit up, and the players take it all nonchalantly. Syndicate play has never been so easy. There are still syndicate plays in the current run but it is not as severe or arrogant. The other good thing is its driven more by fundamentals and research, rather than rumours and whispers. Glad to see many stocks recommended by research houses performing much better than generally expected. Its a good sign to have research higher up the ladder of priority and recognition. If not, we will stay in cowboy land for a much longer time.

Hence, if there were 4 stages to a super bull run, we are probably entering the early second stage only. Beware of corrections as there will be corrections in super bulls. Surprisingly, it is much better to stick close to technicals and study the support lines in correction phases of a super bull as many will be looking at the same thing, thus it generally will come true.

The biggest blessing I think about this time around is that players will find it very hard to be over-leveraged, at least most will be able to keep the bulk of their profits this time around. Used to be, it was easy to get 5x to 10x your net worth to play the stock markets. Now, you'd be lucky to get 1x, maybe some aggressive places you can get 2x. When you start to hear of places which will offer you 4x or 5x, you know its time to reduce your positions.

I Left My Yen In Shinjuku

Rohan_888 said...
http://www.rgemonitor.com/blog/roubini/5/5/
"Then, the yen starts to appreciate again – by a sharp 9% in one month - when a small emerging market economy defaults (Ecuador soon?) and a large hedge fund goes belly up (another Amaranth?). Then, suddenly one piece of good news comes out of Japan (a growth pickup?) and in a matter of 72 hours the yen appreciates by 12%. Then a major global macro hedge fund loses $2 billion dollars in 48 hours on the yen unraveling and decides to close shop; another one loses billions too and decides to restructure its operations. Carry trades unravel rapidly, margin calls are triggered, levered positions go belly up and the entire financial system goes into a seizure. Then the Fed is forced to cut the Fed Funds rate in between meetings by 75bps (in spite of still good US GDP growth) in order to avoid a financial meltdown, a collapse of US financial markets and a global recession.

Readers of this blog (Roubini) may think that the first paragraph above describes very precisely the current situation of the yen and of the global financial system in the last year. Indeed, news reports have been endlessly talking about the yen carry trades driven by low Japanese interest rates. Readers of this blog may also think that the second paragraph above is a typical Roubini "doom & gloom" fear mongering and describing a scenario that is totally unlikely to occur in 2007. But what I was describing in the first two paragraphs above is not 2006 and a fear mongering scenario for 2007 but rather what actually and exactly happened in August-October 1998."

My guess is that the current situation is worse than in 1998. Another worry seems to be realized at the moment, that the subprime lenders in the US are in much worse shape than most thought: http://mortgageimplode.com/
During 2007 more than 1 trillion ARM's will be reset, we only have just started.Economists from the Austrian school (Marc Faber, Richebacher, etc) expect a bloodbath in the US caused by overspending by consumers, rising debt on all levels and no "real" investments that cause growth, the only thing they have been good in lately is "asset shuffling" (hedge fund managers and companies like Goldman & Sachs) as Faber calls it. Almost all American economists however think that all will be well, because the US is so clever, surely they will find a way out. To me the Austrian camp looks a lot more convincing.

sopskysalat said...
One thing which you did not highlight Dali, that is, why not borrow yen and buy into nikkei directly instead of going for ADR in Nasdaq and Dow? I guess a lot of carry trades are going to other instruments than japan-linked. Nevertheless, today nikkei hit a new record. HSI and STI are taking a break.

Salvatore_Dali said...
Sops,
To borrow in yen and then invest in equities is naturally a lot safer. The nature why the carry trade is so huge is that many prefer the double-whammy effect, but want to lock in the returns as well. So, to go short on yen, and going long on another currency maybe the only risk they want to take. To further boost returns, it could be an Aussie bond or Singapore REIT, ones with a fixed return somewhat plus currency gains.

To borrow in yen and go long in Nikkei is just a MARGIN STOCK ACCOUNT la... As usual the retail players are not that aggressive in Japan. As for institutions, that is akin to just being very leveraged, hard to explain to board of trustees.

sopskysalat said...
sal,
Alas, I phrased message wrongly. Sorry! I wanted to say borrow yen and buying into local Japanese stocks intead of going for ADRs. But you may have explained that to go for double whammy, one gain on FX and other stable cum high yield instrument. Perhaps, if the Japan equities are more attractive, then money will not be going elsewhere but Japan.

Salvatore_Dali said...
sops,
you are correct, if the investor was a Japanese investor, borrowing in yen to invest in Nikkei would be akin to Margin Financing, no big deal, happens all the time. For foreign investors, borrowing in yen and buying Nikkei stocks would actually be a very astute move (if they are as bullish as we are on Japanese stocks this year). Guess, some of them are not that bullish on Japanese stocks.

Of course the MAIN reason why they would not do that is that THEY EXPECT THE YEN TO WEAKEN, hence to invest in Japanese stocks on the Nikkei may see any gains being wiped out by yen's weakness - hence for a foreign investor, it is a difficult decision to go long on Japanese stocks in Tokyo. That is why I suggested Japanese ADRs as possibly the best instrument/investment this year.

Thai-Tanic Or Thai-Wok

Well, the new government in bangkok is either headed for a Thai-tanic implosion or if you understand Cantonese its the latter, same thing. It seems the new people at the helm are slow in learning the ropes. The recent debacle over stopping foreign funds speculating in stocks and the baht was so ill-conceived and handled that a dramatic u-turn was necessary, at least they reacted fast and well. Even then, damage has been done, the SET index has failed to breach the 700 level since, making it the "cheapest" and most lagging equity market in Asia on a 6 and 12 month to date ranking.

There are basically 3 things which troubles investors about Thailand:

a) Don't try to fix something which you are ill equipped to. The rules concerning foreign capital inflows and outflows was a good example. Do it via other less intrusive ways. Are the new leaders satisfied after bactracking... apparently not, lose face I guess, so they keep coming up with new rules and regulations which pisses off everyone. The latest is the military-controlled government's plans to expand the definition of a foreign company!!!??? If I was a foreign investor, I'd be pretty pissed off, I won't even wait for more developments, obviously they are on a witch hunt to please someone or hurt someone. This has caused some countries to protest that the moves would violate Bangkok's WTO committments. The EU has sent a letter protesting and Japan and the Us are expected to voice similar discontent.

Enough already, you don't have to show you are freshly in power, hence you have to act like a new broom, sweeping all dirt of the past as fast as you can. You already got the culprit/snake out of power. Tackle changes slowly. Consolidate the government first, have the people elect a proper government first, already people are getting less comfortable the longer the military holds onto power in Bangkok.

b) Stop the witch hunting. In a strategy to kill off Thaksin, even the son and daughter have been questioned, now you even want to drag in the wife. Sure, you may not like what he did, maybe he did siphoned funds, mis-priced assets for personal gains, did not pay taxes ... but too much too soon creates instability. Just freeze all assets and cash related to Mr. T, deal with it slowly, do not release assets till he shows up to defend the charges. Don't create things every other day, you know he won't show up in the present climate. Creates too much gossip, uncertainty and distractions from the real things that needed to be addressed.

The current massive PR ploy to discredit Mr. T only works to irk more people about Thailand's pettiness. The recent silly misunderstanding with Singapore politicians further puts the pettiness of Thai officials to the forefront, grow up already!

c) The southern Thailand problem. You have to involve Malaysia to solve the problems. Independence for southern Thailand is out of the question and not really what they are asking for. I think Malaysian PR status to be issued to all Muslim Thais in southern Thailand could be a start. No conversion to Malaysian citizenship necessary or encouraged, they keep Thai citizenship. They can travel and work freely in Malaysia or remain in Thailand. Although some Malaysians will not agree with that proposal, its a pragmatic solution. It does not serve Malaysia well if the southern Thailand region crisis is not solved.

Create a Southern Thailand Consultative Body with the ringleaders and insurgents as members. At the end of the day, its an economic problem and not really a religious one - give them a decent southern economy with good learning institutions and proper investing strategy to attract good companies to relocate there. No jobs, idle hands, vicious minds.

Conclusion - Failure to address the 3 areas would mean the SET will go to 550 very fast from the current 690 level. Further missing out on the global equity bull run. I'd be a strong buyer though at 550 this year, good chance of getting there. Failing to address the 3 areas of concern will not just lead to Thai-Wok but rather Thai-Lun-Wok!

A Yen For Your Thoughts

sopskysalat said...
Thinking aloud, can the recovery of nikkei be contributed by yen-carrying trade, borrowing yen to buy equities? Then, the weakness in yen can also be explained that yen were sold to reinvest into overseas "safe" instrument such as reits and bonds like you said earlier. I wouldn't think I will borrow yen and invest them into high risk instrument such as stocks in TSE. My opinion, learning to explain situation outside.

Actually, there is too much emphasis on the yen movement. The relatively big yen carry trade naturally creates a weak scenario for the yen going forward. You are correct in that they borrow in yen, convert (sell yen) and invest in other foreign currency assets (stocks, REITs, bonds or just currency deposits). Naturally this exacerbate the yen's weakness. Bank of Japan is at a quandry really. The economy has been improving and they would like to raise rates somewhat, but they also want the yen to be flat or weakish to keep the economic recovery to be sustained.

Is there a time bomb here in the making? The thing could get blown apart if the yen appreciates very fast over a short period causing many to cover their yen carry trades in haste, this could propel the yen's appreciation even further. Of course, this is a big IF.

Would a couple of BOJ rate hikes cause the yen to reverese course? Probably not yet cause we are talking of below 1% at the moment, even a couple of rate hikes will not be sufficient to narrow the interest rate differentials between the dollar/euro/aud and the yen. Moreover, what is driving the carry trade is the players know that the G7 would want the Japanese economy to recover more from here on, and that the BOJ would commit sepukku first than let the yen appreciate. The G7 of course would not want excessive weakness in the yen which would price their Euro products out of being competitive.

The yen carry trade is estimated to be totalling more than US$33bn now and rising. I would think this to be an excellent ye carry trade:
Borrow in yen and pay 1% or less, sell the yen to dollars, and buy Japanese ADRs or Nikkei ADRs in Nasdaq.

Part of the reason why the Nikkei has not been rising as much as expected is that the bulk of yen carry trades is into foreign currency investments. However, if you believe in the weaker yen story, the Nikkei's gotta rise alongside. The Euro is in a more precarious situation than the dollar as the yen seem to have weaken a lot more against the Euro. Even though there was no official statements from the recent G7 meeting, I am sure the G7 would have been concerned over yen's weakness. However, the G7 would have also realised that the EU economies have generally performed much better than the Japanese economy over the last 4 years, and they may be swayed to suffer slightly to allow the Japanese economy to recover more (i.e. allow yen to be weakish).

The ECB recently voted to maintain its key interest rate for its 13-member countries at 3.5%. However, ECB President Jean-Claude Trichet is expected to hint at a March rate hike, saying the ECB is watching monetary developments with "vigilance" or "strong vigilance." The current inflation rate is less than the ECB's goal of "just below 2%" despite German economic strength. Also, money supply is said to be growing twice as fast as the ECB's comfort level. One issue possibly keeping the ECB from hiking in the near-term is political pressure in regard to the weak Japanese yen. This will stop ECB from hiking too aggressively as that will only promote a weaker yen and a stronger Euro. While I do not think yen will be very weak this year, in fact it may stay firm as I believe the BOJ, Federal Reserve and ECB would be wanting to make sure that the yen carry trade does not get out of hand. They may actually get BOJ to start raising rates soon. The Japanese economy has been recovering well for the last 2 years, and a slightly stronger yen in 2007 would not hurt much. That is the "mis-calculation" by most of the yen carry trade investors. I do see the yen being allowed firm up slightly this year, partly to dissuade the carry trade. Then the Nikkei can carry on its march towards 20,000 this year without the yen carry trade distraction.

Possibly The Best China/Asia Play With Possibly The Best Mgmt In Asia

Readers of this blog will know that I have been an ardent admirer of Li & Fung from HK. It is possibly the "best China/Asia play" with possibly the best management in Asia. Trading company Li & Fung (0494) has entered into an agreement with Tommy Hilfiger to acquire the designer's global sourcing operations for HK$ 1.9 billion. Turnover of the sourcing operations for the year ended March was approximately HK$5.48 billion, while unaudited attributable adjusted earnings amounted to around HK$242 million, Li & Fung said Sunday. The deal is to be completed before March 28, with financing coming from internal cash resources. In September, the company raised around US$314.9 million (HK$2.46 billion), mainly for M&A activity and opportunity such as this. Tommy Hilfiger's buying offices in Hong Kong, Taiwan, India, Bangladesh and Sri Lanka will be integrated into Li & Fung, which buys consumer goods and manages supply chains for retailers and brands worldwide through its 70 offices in 40 countries and territories.

But why Li & Fung ... Li & Fung, one of Hong Kong's largest export trading company, has been an innovator in supply chain management. Its basic philosophy behind supply chain management is to reduce costs and lead times, allowing its customers to buy "closer to the market." Li & Fung has been a pioneer in "dispersed manufacturing." It performs the higher-value-added tasks such as design and quality control in Hong Kong, and outsources the lower-value-added tasks to the best possible locations around the world. The result is something new: a truly global product. To produce a garment, for example, the company might purchase yarn from Korea that will be woven and dyed in Taiwan, then shipped to Thailand for final assembly, where it will be matched with zippers from a Japanese company. For every order, the goal is to customize the value chain to meet the customer's specific needs. Companies like Li & Fung, narrowly focused and professionally managed, could be the trend for the next decade. Its edge:

1) Its integrated, one stop shop, squeezing out the savings due to economies of scale and leverage in purchasing due to its size
2) Its integrated, allowing clients to be involved or make alterations anytime along the supply chain line. This also allows for very speedy in-out from design phase to final product. The speed to market is a huge advantage.
3) The bulk of operations are in China, which has basically the most cost-effective labour production center in the world. Add that to a sophisticated tech driven supply chain at every level, it is hard to top.
4) Li & Fung is actually very high up on the supply chain due to the value-add they provide to clients.
5) Enjoys excellent margins due to unique business model. Clients will find it very sticky to be with Li & Fung once they have dealt with them. Margins in the region of 25%, well cushioned from external risks.
6) Excellent management. Clear vision, grand startegy witgh key performance indicators at every stage. Been ticking off these flags one by one with great execution. Extra point for Western mgmt philosophies coupled with very strong Asian roots and sensibilities.

It is clear the company has broken through their limited mindset from the 90s. In the 90s, the company was good but struggled to surge past the US1bn turnover mark. By improving and adding value all along the supply chain, they have become almost invaluable to more clients. In 2004 the company reached US6bn in turnover and last year, its hovering near the US10bn mark, and all that on excellent margins.

Its obvious due to the size of the company now, it cannot rely on organic growth anymore. Hence the recent acquisition of KarstadtQuelle International Sourcing for EUR60m and the purchase of Hilfiger's sourcing operations.

Li & Fung will be well protected even in an economic downturn as that would cause more companies to outsource more. Li & Fung is the classic company that jumps a few rungs of ladder every 3 years, and its hard to ride along with it as you cannot imagine any further growth for the company. So, at around HK25 currently, it should have no problems scaling above HK30 this year and beyond. Though its market cap is already US11bn, the company is on a good thing and their excellent management which tries to improve at every level with zero complacency bodes well for its future.

Company is helmed by Victor Fung. Victor holds Bachelor and Master Degrees in Electrical Engineering from the Massachusetts Institute of Technology, and a Doctorate in Business Economics from Harvard University. Victor holds a number of civic and professional appointments. He is a member of Chinese People’s Political Consultative Conference and the Hong Kong Government Judicial Officers Recommendation Committee. From 1991 to 2000, Victor Fung was Chairman of the Hong Kong Trade Development Council and from 1996 to 2003, he was the Hong Kong representative on the APEC Business Advisory Council. In 2003, the Government awarded Dr. Fung the Gold Bauhinia Star for distinguished service to the community. His brother, William Fung is Group Managing Director. WilliamFung graduated from Princeton University with a Bachelor of Science degree in Engineering and holds an MBA degree from the Harvard Graduate School of Business. He was conferred the degree of Doctor of Business Administration, honors causa, by the Hong Kong University of Science & Technology. He currently serves as a member of the Economic and Employment Council of the Hong Kong Special Administrative Region.

So, What's Really Driving The Markets?
Getting To The Core

You have equity markets gaining every single day for more than 10 days in a row. The record for US markets was, I believe a 10 day gaining streak back in January 1989. Since then, almost 18 years later do we see a similar phenomenon. Readers of this blog will be aware that I have been bullish since beginning of 2006, and even stressed that back then, all equity markets are going into, or even already in the midst of a bull market without most people realising it.

This bull run was cemented a few years back, the believers were few, which is why the level of participation rarely got to a prolonged euphoric state. This is clearly one of the quieter bull runs. But why are we in this bull run? Why are markets all so bullish?

If you cite earnings, lowering of interest rates ... it would be yes, and a maybe respectively. There must be some underlying reason for the hooplah. I think I must have touched on this before, but its worth mentioning again:

a) bull run part of rise in "commodity prices" - prices as in most commodities, what we have for the last 4 years was a stupendous jump in commodities, when they jump and its due to demand jumps, then it will be inflationary, ... but this time around, the demand was largely due to corresponding larger jumps in productivity (e.g. outsourcing in China), thus inflationary domino effects was muted ...

b) China - the impact of China alone in the global economy has been understated. More than 60% of listed US companies have some sort of outsourced operations, directly or indirectly, in China. What that means is by doing so, it raises productivity and results in a better allocation of resources. Hence you find many US companies finding it easier to maintain or even grow margins over the last 4 years, thus translating into a happy Wall Street and stock prices. And this is not a one to three year thing, I think the outsourcing resulting in growing margins can still be pushed for at least another 3-4 years before differentials narrow to the point of negligibility.

c) private equity - the pooling of funds into private equity over the last 3 years have been outrageous. PE firms have been able to register better returns than most equity indices thus the flow of funds are continuing. The rise of PE is partly due to the brilliance of many PE managers but largely to the existence of too many staid, large but undervalued listed companies. By taking them private and recharging the batteries, many PE firms have been able to improve margins and refocus these undervalued companies, and then relist them at higher premiums. They are doing something good, but they are basically just bringing up these companies to par valuation, nothing terribly fantastic. But PE activity will cause the valuation of sectors of interest to rise, even the mere whisper of a takeover will raise valuations of similar stocks in the same industry. The effect is higher prices for all, and the number of undervalued companies will see a gradual reduction in numbers, and even the quantum of difference in undervaluation will reduce ... = higher equity prices.

d) REITs - it frees up a lot of capital, an awful lot of capital, most of which went into good hedge funds or private equity. Who buys REITs, retail yes but more so are insurance companies who now have a better way to manage risk and returns better than just bonds. So, its not a zero sum game, effectively more bondholders are switching to REITs, and sellers of REITs have been raising cash like crazy, and sometimes you don't even have to lose control of the asset. A big contributor to liquidity in the system.

e) China again - the rise and rise of China have opened up a huge market place for a lot of US and European companies. Fees, commissions, joint ventures, projects have sprung up like nobody's business - just ask the top 10 American investment banks in China, and the IPO fees they are getting. To any big corporation, previously you have a 5% market share of a 100 billion dollar industry, now you have 5% of a 130 billion dollar industry with the emergence of China as a consumer. The more successful China integrates with the international market forces, the better off will the Chinese be, and the bigger the consumption demand for global goods and services. Looking at the per capita in China, even if per capita income rises by 10% each year, there is still enough excitement to last for 10 years at least before the vicious cycle gets ugly.

f) Asia recovery from financial implosion - enough said, it took many countries at least 5 years since 1997 to get rid of the excesses, now most are just trying to get back to parity. If you remember correctly, the ringgit used to be 2.5 to the dollar in the 90s. Considering that we have gotten rid of excesses, improve productivity, reduce corruption, improve transparency... and US deficit is at even higher levels now, getting back to 2.5 is a no-brainer. But we don't want to get there too fast, we need exporters to feel comfortable. Hence Zeti has been smart enough to keep ringgit's rise in line with China's yuan. Getting to 3.3 or even 3.2 this year is a cinch for the ringgit. Export industries should relook into their margins and productivity seriously before screaming at eroded earnings - the ringgit has been helping you buggers for far too long. If you cannot operate at 3.0 to the dollar in 12 months time, you better just fold your business cause you cannot compete in the global markets. To rely on a weak ringgit to compete means you have a very weak business model and not much competitive edge. A country will depress its currency to gain export dollars to recover from a crisis/weakened state, its over now. We have to move up the ladder.

In conclusion, the recent gains may seem frothy but its not all hot air. Plus the fact that markets tend to be very bullish anyway in the FIRST QUARTER, I do believe the second and third quarters will be more volatile with sharp downside bias before perking up in FOURTH QUARTER again. Its really difficult to see the market correcting 10% even from here, any pullbacks will be in the region of 2-3% tops. On valuations, prices are high but not excessive levels yet to warrant a sharp correction.

In fact, the risks to all equity markets are largely EXTERNAL rather than within the markets itself. I see EXTERNAL factors being the largest risk poser, for example: a collapse of a small brokerage in China triggering a huge loss in some regional bank; unexpected austerity measures in China's property market (e.g. 50% deposit for purchases) triggering a sharp sector correction and mood change; Republican and Democrat parties elevate their differences and stalling on issues/laws progression; pockets of violence boils over globally requiring international attention; H5N1 outbreaks or new strains of the virus in parts of Asia (again); US dollar collapsing by 5% in a couple of days triggering massive capital flow changes (if that happens, the ringgit could go from 3.5 to 3.1 overnight, and that may trigger a collapse in KLSE as people perceive no more upside for ringgit and would want to lock in gains and leave) ... So, even when you can see no risk, there are still risks.

Hey Friend, Don't Talk Cock-Lah!
Anchor & Adjust Away

If there was one thing I learnt from this subject I took called Decision Making & Statistics, was Anchor & Adjust as a common form of decision making. Readers of this blog will be familiar with the concept as I use it all the time to bash the so called expert opinions.

A&A can hide incompetence and mask sub-par analysis. All you do is anchor to the most recent point of reference and adjust up or down according to available data. While that is not wrong, it is a chicken-shit way of analysis or offering an opinion. A bit like "after the horse has bolted", and all the expert is saying is "well, I think he went that way, and should continue doing so".

So it is certainly not surprising that many local and foreign research houses have come out with chest-pounding press releases in recent times. For someone to come out this week and saying "Bursa Malaysia is expected to surpass the Kuala Lumpur Composite Index’s (KLCI) all-time high of 1,332.04 in Januray 1994 based on the current rally, underpinned by the increased liberalisation of economy, accommodative fiscal and monetary policies and improving corporate returns on equity (ROE)" ... is pretty much talking cock-lah. Where was the prediction when the index was at 1,000 a couple of month's back (just a couple of months back)? These so called experts will A&A their predictions and think of new reasons to justify their existence and the desired levels, but will not stray from the pack, cause it is safe.

Part of the reason why there is so much talking cocks and b.s. is also due to the very average journalistic ability and integrity exhibited in most Asian papers. To parrot opinions without "sifiting out the chaff from the wheat" give rise to empty headlines and little-value-add information in an era of information overload. Besides just reporting news (biz news in particular), to move from being mere reporters to journalists requires investigative journalism, thought-provoking commentary and hard line questioning. Need to move up the ladder, y'all.

Show me one person to predict 1,300 for KLCI in 2007 anytime in their analysis last year. ???? Where are the so called experts... hmmm... go fly kite lah with so much hot air around! I can safely say when index reaches 1,300 ... some other a-hole will come out and say there is a good chance for the index to reach 1,380 within the next 6 months ... OMG of course la ... don't say things which makes people KNOW how average and pathetic your mind is.

Seriously, a good analyst will be able to come up with a decent thesis for the KLCI to be at 900 or 1,200 or 1,500 ... all within 15 minutes. Give me a level and I will tell you a story, usually its called b.s. but if I do it persuasively well, you will nod along in agreement. Hence to sift out the really good opinions from mere stuff that smells of ammonia is to seek out:

a) consistency of argument and logic
b) ability to defend stance taken
c) correct short term views should be taken with a ladle of salt
d) correct long term views with solid big picture arguments should be given more weight
e) the ablity to locate market catalysts 6, 12, 18 months down the road
f) must be persuasive

People Say I Am Pretty!
Are You Prepared For Re-entry?

Many investors may be shaking their heads at the rise and rise of blue chips in most Asian markets. The trouble is once you have taken your profits, it feels silly to reenter at higher prices. For once in a very long time, foreign funds and research analysts think Malaysia (and Asia) is beautiful. Not just pretty but looking pretty even when compared to other Asian beauties!

Do we need people to say we are pretty? Ladies should know better, when someone says you are pretty, they usually want something from you (yes, they want to f___ and f___ over you). Before you get all hyped up, they stand for flatter and fawn.

When did Malaysia get to be so pretty? Are we really pretty? The truth is, we are what we are, country themes are just like fashion fads, they come and go. When you are hot, do not fight it, just join in the trend but gotta be careful when the party is over. Once the pretty one has been partied on too long, and the guests all have left, you are left intoxicated, feeling like a barf-bag, and wondering why no one calls you pretty anymore.

Why Malaysia is pretty now:
Currency - Everyone thinks it will have a good chance of reaching 3.3 this year. Even now, Bank Negara is having to buy dollar to keep it above 3.5 .
Plantations - Good outlook still.
GLCs - Many following KPIs and turning more professional and better managed.
Dividend yield - 12 months back, Malaysian stocks offered the best dividend yield but nobody bothered. Now, we still offerred the best dividend yield and that is touted as a strong point. Whether you are pretty or ugly, I can always think of reasons to support the opposing views (kudos to analysts).
M&A - Synergy Drive is more than just a trend setter. The size and ambition have made people notice that GLCs are jumping onto global best practices, and taking advantage of leverage and economies of scales.
Trend - Don't fight the trend. When the research houses have to find new "country themes", they seem to be running out of options. HK and Singapore while still good, looks a bit frothy. More are putting Malaysia as the new prom queen for 2007 - a lot like HK's music awards, its basically your turn, not that you deserved the award!

The most important factor to me is TIMING - foreign investors and analysts are not stupid, history have shown that the year leading to elections will have a strong positive bias on markets and projects.

There will be a pullback as the index has not even paused for any consolidation. Hence investors who have taken cash from the table should ready themselves on what to buy for re-entry. For re-entry purposes, I have highlighted good covered warrants to aim for. I believe there will be a healthy pullback soon to 1,190 to 1,200.

Hit List

Astro-CB 8/2007: Single digit premiums, stock has not really moved much. Indonesia no longer a story but a good potential, same as India. In-house production good long term strategy, becoming a content player as well. Buy when covered warrant nears 0.40 or thereabouts.

KL Kepong-CA 11/2007: Best exposure in oil palm as the IOI covered will be expiring soon. Story for CPO still solid. Covered warrant can be bought around 1.00 even now, with or without pullbacks.

Maybank-CA & CB 1/2008 & 11/2007: Rotational play will pick up on Maybank as it has lagged the rest. Look for Maybank-CA around 2.80 and CB around 2.00 .

Tenaga-CB 10/2007: Probably the best covered warrant around. Low premium, great upside for the stock in 2007. Buy now or later, its great if you can get them below 2.00 .

TM-CA 11/2007: The sceond best covered I guess. Tenaga, TM and Maybank are likely leaders to push the index higher over the next few weeks and months. Very low premium. Great if you can get them below 1.60 .

Wanted: Investment Expert, Must Have Humility
As Reported In Bloomberg

If you are Mark Cahart, you almost have it all your way for most of your life. Mark Carhart looks out over the packed New York conference and tells investors that Warren Buffett has it all wrong. Carhart, 40, co-head of the quantitative strategies group at Goldman Sachs Group Inc., uses his July speech to poke fun at Warren's penchant for investing in market-leading brands like Coca-Cola and Gillette. He cites study after study showing that big-name companies with high price-earning multiples or rapid growth rates make poor bets. Traditional stock pickers like Buffett, a fabled raconteur, do have one redeeming quality, Carhart jokes: ``They tell great stories.'' (Lesson - Don't fuck around with people who have done better and longer than you)

Carhart is one of the world's most successful money managers, a mastermind behind Global Alpha, a US$10 billion hedge fund for wealthy clients and employees of Goldman Sachs. In 2005, Carhart and co-manager Raymond Iwanowski, 40, notched a 51 percent gross return at Global Alpha. Posting that kind of gain requires taking risks -- and last year, Alpha lost 6 percent, its first deficit since 1999. Carhart, a former assistant professor of finance at the University of Southern California, helps oversee other hedge funds, four mutual funds and scores of separate accounts. In all, he and Iwanowski have US$101.5 billion at their command. Carhart and Iwanowski use math-heavy trading tactics that fund consultant Sol Waksman likens to counting cards in a casino. The two lead a corps of computer-loving traders, statisticians and finance and economics Ph.D.s. (Lesson - If you have the scores of Phds, math wizards and other brilliant minds at your disposal, you should generate superior returns... NOT! Be humble with financial markets, once you think you have mastered it, you are fucked. If you approach with the attitude that the more you know, the less you know of it, you stand a better chance of not have egg on your face, and live to fight again.)

Their team makes -- and sometimes loses -- millions of dollars a day. At the heart of their empire is Global Alpha, which generated about US$700 million in fees for Goldman Sachs in fiscal 2006. This money machine hums mostly behind the scenes. Carhart and Iwanowski, friends since their days at the University of Chicago Graduate School of Business, oversee about 10 other Goldman hedge funds, too. Together, they trade everything from Japanese stocks to U.S. soybeans, to Israeli shekels. Global Alpha is part of the richest hedge fund empire the world has ever seen. Last year, Goldman Sachs eclipsed D.E. Shaw & Co. and Bridgewater Associates Inc. to become the largest hedge fund manager, with US$29.5 billion in assets as of Dec. 31, 2006. That figure excludes Goldman's proprietary-trading funds and its funds of hedge funds.

Carhart and Iwanowski hunt for market variables called risk factors that often lead to excess investment returns, or premiums, according to people familiar with the fund. Some, such as a measure called the value premium -- the difference between the return of a group of stocks with high book values relative to their prices and that of a group with low book value-to-price ratios -- have been used by other money managers for years. Goldman Sachs has identified more than 20 new risk factors, which it doesn't disclose, even to its own investors. Carhart never reveals the secrets. Old friends and people who've invested in the fund say they're not really sure how it works. (Lesson - Once you think you have found the key, it will evaporate right in front of you.)

On any given day, Carhart's team of 50-60 investment professionals uses Global Alpha's factors to deploy 20 trading strategies in markets the world over, according to an investor in the fund and Global Alpha documents. During 2006, the fund's picks ranged from Japanese and Dutch stocks to bets on and against the Polish zloty. At the center of the Global Alpha story are Carhart and Iwanowski, devotees of quantitative analysis, or quants, who came to Goldman Sachs from opposite ends of the financial world.

Carhart first turned heads in money circles as a doctoral candidate at the University of Chicago and later as an assistant finance professor at the University of Southern California's Gordon S. Marshall School of Business. Iwanowski, by contrast, has spent his entire career on Wall Street. What unites them is that they're quants, who put their faith in data, rather than human judgment, when deciding what to buy or sell. To money managers like them, what you think about a company's management or products doesn't matter much. ( Lesson - Quants take the human element, the human judgment out of the equation.... well, you can't and shouldn't.)

Jokes aside, Carhart would do well to heed two Buffett rules. No. 1: Never lose money. No. 2: Don't forget rule No. 1. In 2006, Global Alpha went wrong when just about everything else at Goldman Sachs went right. After a roller-coaster ride that included a 10 percent August plunge, Global Alpha ended the year down 6 percent, according to an investor in the fund. The loss, the first since 1999, came in a year when Goldman earned US$9.54 billion, the most in Wall Street history. The investment bank made headlines by earmarking US$16.5 billion for salaries and bonuses, including a record US$53.4 million bonus for Chief Executive Officer Lloyd Blankfein. Carhart and Iwanowski declined to comment for this story, as did other Goldman Sachs executives. It was a rare misstep for Global Alpha. The fund skated through the 2000-02 U.S. bear stock market without a down year and posted an annualized return of 19.75 percent, after fees, from Dec. 4, 2001, to Dec. 31, 2005, according to Global Alpha's 2005 annual report. The average hedge fund returned an annualized 9.1 percent from Dec. 1, 2001, to Dec. 31, 2005, according to Hedge Fund Research. Shares of Buffett's Berkshire Hathaway rose a mere 5.9 percent during the period.

Only now, Carhart and Iwanowski are in a hole. Like most hedge funds, Global Alpha charges an annual management fee of 1.5 percent or 2 percent and takes a 20 percent cut of any profit. Before the fund can take its 20 percent in 2007 -- assuming it makes money -- its quants must first make up the 2006 loss.

One of the most-surprising things about Carhart is that for a guy in an industry known for big money and bigger egos, it's hard to find anyone who'll say a bad word about him. Former colleagues, classmates and teachers remember him as one of the smartest people they've known. After graduation, Carhart headed for Yale University, where he majored in economics and served as managing editor of the Yale Economics & Business Review. He also began dabbling in the markets as a director of the Yale College Student Investment Group. After Yale, Carhart set to work on a doctorate in finance at Chicago. He studied under finance professor Eugene Fama, best known for his work on the efficient-market hypothesis, which holds that prices reflect all there is to know about stocks or other securities.

Global Alpha doesn't merely bet on the direction of stock or bond prices. It bets on differences between those prices. Global Alpha employs seven strategies in the bond markets alone, according to Goldman Sachs Global Alpha Fund Plc's June 30 semiannual report. The simplest of them is to buy government bonds of one country while shorting those of another. In the U.S. stock market, Global Alpha might buy oil and insurance stocks and simultaneously bet against semiconductor shares. The fund also allocates part of its US$10 billion to something called ``global event anomalies,'' according to a November 2001 prospectus. With this strategy, the fund attempts to make money from corporate stock buybacks and divestitures and from changes in how market indexes like the S&P 500 are calculated. Carhart and Iwanowski also employ a commodities strategy and an asset-allocation strategy that bets on various mixes of investments: stocks, bonds, currencies and beyond.

Global Alpha quants have designed their fund so that if things go wrong, the probability is low that the 20 strategies will lose a lot money at the same time. That, anyway, is the idea. In the 2005 report filed with the Irish exchange, Global Alpha reported a gross return of 51 percent for the year. The report says only two strategies -- global anomalies and the country bond selection -- suffered losses of more than 1 percent. During the first quarter of 2006, Global Alpha rose a net 9.5 percent. The next quarter, a bunch of the fund's strategies soured. Global Alpha lost 3.5 percent during the period. Its ``developed equity country selection'' fell 2.5 percent, hurt by bad bets on Japanese and Dutch stocks. Its developed country currencies strategy sank 1.9 percent, whacked by a wrong-way wager on the dollar and another against the pound. Emerging market currencies strategy sank 1.7 percent, nipped by short positions in the shekel and zloty.

Piecing together the second half of 2006 is harder. A Global Alpha investor who asked not to be identified says the fund's roughly 10 percent slide last August mostly reflected bad bond market investments. Global Alpha also bet that stocks in Japan would rise while those in the rest of Asia would fall -- wrong; that U.S. stocks would stumble -- wrong; and that the dollar would rise -- wrong again. Global Alpha finished November down 11.6 percent in 2006.

Trees don't grow to the sky. Neither do hedge fund returns. Superman exists only in comics.