Big Picture View - Equities Well Supported (Updated)

Updated:
Stocks gained on a fresh wave of M&A announcements, including a deal by Xerox to acquire Affiliated Computer Services for $6.4 billion.Abbott Laboratories gained after the company said it will buy the pharmaceutical business of Belgium's Solvay for as much as $7 billion in a deal that will expand its presence in emerging markets. Covidien will acquire brain-monitoring technology firm Aspect Medical Systems for $12 a share in cash, or a total of about $210 million, net of cash and short-term investments acquired. Johnson & Johnson says it's bought 18% of Crucell for 301.8 million euros ($440 million) -- a 30% premium to Friday's close -- and will pay development milestones and royalty payments if flu vaccines that the two firms will develop make it to the market. Among major economic news this week, the Case-Shiller housing price index and consumer confidence data are due out Tuesday morning, while GDP, ADP employment and crude inventories are slated for release on Wednesday. The above news indicate that corporations are more willing to tap the markets for the low rates. Expect more such M&A activity in the coming days. This links up nicely to the article posting below. Of course we have to bear in mind that the US$ weakness is also supporting US equity purchases.
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Every now and then, its important to reassess the big picture view. Getting the big picture correct will make for a more confident trading mindset, or reasons not to trade the market. It is clear that the developing economies are recovering more rapidly than developed nations. If you look at central banks at developed countries, they are still keen to keep rates low. This emphasised the fact that while there is some sort of recovery, it will be a long drag to becoming substantive.

By mid-2009, most central banks in advanced economies reached the trough in their rate cycles. Fed and Swiss National bank reduced the lower end of their target bands to 0%. Bank of Japan has been taking a "zero rate interest policy" 0.1% interest rate for sometime now. Sweden's reserve deposit rate is negative, and that's a useful indicator. A few central banks - Fed, BoJ, Sweden and Bank of Canada - have made explicit commitments to keep policy rates low for a long period. Australia should be the first to tighten among the G-10 central banks, as early as Q4 2009. Bank of England could be next, possibly by December/January.

Whether a central bank starts to tighten is a clear indication of how confident the central bankers are of the recovery in their country. The danger is that some could stay loose for too long, thus fomenting a bubble. That is exactly what is happening in HK, owing to its dollar peg, which resulted in very low rates, but that does not correspond with its real economy which is recovering quicker thanks to its ties to China - thus fueling its property boom.

• ECB held at 1% in June 2009 and may stay there depending on economic data.
• Federal Reserve held at 0-0.25% since December 2008 and will likely remain there all 2009 and 2010.
• Bank of Japan held at 0.1% since December 2008 and will likely remain there all 2009 and 2010.
  
• Bank of England held at 0.5% since March 2009, lowest rate since 1694.
• NZ held at 2.5% since April 2009 but may resume cutting to 1.5% later in 2009.
• RBA of Australia held at 3% in June 2009, lowest since 1960, and may hike in Q4 2009.
• Canada held at 0.25%, its lower bound, since June 2009 and may resort to quantitative easing.
• Swiss National Bank cut target range for 3mo Libor to 0-0.75% in March 2009 and may stay there until 2010.
• Norway cut 25bp to 1.25% in June 2009, its rate trough. Norway may hike in Q4 2009.
  
• Denmark cut 10bp to 1.55% in June 2009, maintaining a 55bp spread versus the ECB.
• Sweden cut repo rate 25bp to 0.25% in July 2009, committed to staying there until end-2010. In a break with the tradition of zero setting the lower bound, the deposit rate was set at -0.25%.

Economic indicators can be sluggish and yet stock prices can rally, there is nothing wrong with that. The equity markets collapsed a few months before the subprime implosion took over. The recent G20 meeting reinforced the view that they will plan to leave the emergency stimulus in place even though there are signs of some recovery. The G20 basically did not want to pull the brakes too soon. That can only mean one thing, higher equity prices. Yes, there will be bouts of minor correction, but these are just bumps. You have very low interest rates, some signs of recovery, an easy monetary policy, a much lower risk aversion attitude, where can you place your bets ... bonds??? ... of course its equities.

Even when stocks rake in just 5% or 6% return, that is still powerful compared to the prevailing interest rates of 2%, and the differentials are substantive enough for people to put their money to work. Asset managers will have to reduce their cash holdings and put them to work in order not to under perform. The very low rates are not designed to prop up the stock markets per se... its really to boost corporate borrowing and corporate lending, which is a much bigger concern, all of the G20 are grappling with unemployment and needs the corporate side to borrow and spend more. The stock markets are just a bystander beneficiary to that objective. Good till year end.


p/s photo: Zhang Xin Yu

Central Banks & Their Gold Strategy

We all know that the biggest demand for gold comes from central banks. Just how has their buying or selling strategy been over the last 12 months? Is their strategy influenced by the amount of USD being printed into circulation? Are they afraid of the dollar not being able to uphold its long term value? Will they ever regard holding US Treasuries as an option only? Is any of them seriously hinting of reverting back to the gold standard? By holding more gold and less USD does that mean more flexibility to their monetary policy?

• Reduced central bank gold selling and increased investor buying may have been helping to underpin high prices in 2008 at a time of turmoil in financial markets. The renewal of the central bank gold selling agreement with a lower threshold suggests that gold sales by central banks will be lower in the next five years, a move the could support gold prices.
• Gold's share in global foreign exchange reserves is about 10%, the third largest asset by value despite being unevenly distributed across countries. The U.S. and European central banks account for the highest amounts both in absolute terms and as a share of reserve holdings (about 50%). Emerging market central banks have a much smaller share. Gold's share in global reserves declined sharply since the 1950s -1960s.
  

Regulation of Central Bank gold sales


• In August 2009, the central banks party to the central bank gold agreement (CBGA), who collectively have a gold share of just under 60% in their reserves, agreed to renew the treaty but with a lower maximum sales threshold. Analysts suggest that the marginally lower threshold could provide a "mild support" for gold.
• The annual sales by the central banks party to the treaty will be less than 400 tons. The previous agreement had a cap of 500 tons per years. The IMF's planned sales of 403 tons are included in the overall cap of 2000 tons from 2009-2014. With the Swiss National bank suggesting it will not sell, only the European central bank and the Banque de France are likely to take advantage to sell. The Italian and German central banks have been reluctant to sell their gold holdings.
• In H1 2009, estimated net sales by official holders of gold were 39 tonnes, 73% lower than in H1 2008. Net gold official gold sales are expected to be only 140 tons in 2009, the lowest since 1994.
  
• In 2008, European central banks sold the lowest levels of gold in about decade, reversing the practice of recent years whereby official sales helped depress gold prices. Banks bound by the central bank gold agreement (most of the European central banks) sold about 343 tons of gold , the lowest since the first agreement was signed in 1999, and well under the 500 ton annual limit.
• In the fall of 2008, central banks stopped lending out gold to banks as they were afraid they would not get it back. This reluctance contributed to an increase in bullion borrowing costs to 2.649% for one month, the highest since May 2001 and high above recent levels (5yr average 0.12%).
  
• An asset allocation assessment would suggest European central banks still have too much gold. EM central banks have low gold holdings in part because of the rising cost of gold and worries about an inability to sell when forex liquidity is required.
  

Gold holdings of Emerging Market Central banks

• GCC private investors have much higher stocks of gold than its central banks do. However, Qatar increased its gold reserves in 2007.
• China announced early in 2009, that it had increased its total gold holdings by 75%, likely from shifting non-monetary gold to the central bank. Although that increase now makes China one of the top 5 official gold holders, gold makes up less than 2% of China's $2.1 trillion in foreign exchange reserve by value. On the margins, China is likely to keep adding slowly to its holding but it is unlikely to make purchases on the open market given the potential for disrupting prices and reducing the value of USD holdings
• Aside from China with 1054 tons, the emerging market central banks with the largest gold holdings are Russia (540 tons), Taiwan (424 tons), India (358 tons) and Venezuela (356 tons) as of May 2009. Aside from Venezuela and Lebanon, the gold shares of which make up 37.5% and 27.5% respectively of total reserves, most of the other large holders have a gold share of only about 4% of reserves.
  

Gold Sales by the IMF

• The IMF, the third-largest official holder of gold, intends to sell 403 tons (12%) of its 3217 tons of gold, pending approval from 85% of its members which will likely be given in the fall. Any sales are likely be gradual though and may be sold to central banks.
• IMF gold sales are unlikely to be disruptive for the gold market and could be positive if the gold is purchased by other official investors (like central banks).
  
• The IMF is likely to start selling in 2010, selling about 200 tons a year.

p/s photos: Aya Nakata

European Union Financial System Might Be Even Worse Off

The media tend to focus on the credit crisis too much on just the US and maybe the UK. Even the secondary focus was largely on how China would figure in being a catalyst for recovery. There are pockets of the world that are facing the crisis with more devastation, and urgency for help. In a sense for them, its should be called a debt crisis rather than a credit crisis. We are talking of Eastern Europe, Western Europe, Russia and Ukraine... hey, basically the EU. Most of what's written below was taken from The Telegraph, UK.

In much of Western Europe, things are nearing boiling point. Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP.

"A failure rate of 10pc would lead to the collapse of the Austrian financial sector," reported Der Standard in Vienna. Unfortunately, that is about to happen.

The European Bank for Reconstruction and Development (EBRD) says bad debts will top 10pc and may reach 20pc. The Vienna press said Bank Austria and its Italian owner Unicredit face a "monetary Stalingrad" in the East. Mr Pröll tried to drum up support for his rescue package from EU finance ministers in Brussels last week. The idea was scotched by Germany's Peer Steinbrück. Not our problem, he said. We'll see about that.

Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. It must repay – or roll over – $400bn this year, equal to a third of the region's GDP. Good luck. The credit window has slammed shut.

Not even Russia can easily cover the $500bn dollar debts of its oligarchs while oil remains near $33 a barrel. The budget is based on Urals crude at $95. Russia has bled 36pc of its foreign reserves since August defending the rouble.

In Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America's sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not.

Almost all Eastern bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets. They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).

Spain is up to its neck in Latin America, which has belatedly joined the slump (Mexico's car output fell 51pc in January, and Brazil lost 650,000 jobs in one month). Britain and Switzerland are up to their necks in Asia.

Whether it takes months, or just weeks, the world is going to discover that Europe's financial system is sunk, and that there is no EU Federal Reserve yet ready to act as a lender of last resort or to flood the markets with emergency stimulus. The European Central Bank already needs to cut rates to zero and then purchase bonds and Pfandbriefe on a huge scale. It is constrained by geopolitics – a German-Dutch veto – and the Maastricht Treaty.

It is East Europe that is blowing up right now. Erik Berglof, EBRD's chief economist, said that the region may need €400bn in help to cover loans and prop up the credit system. Europe's governments are making matters worse. Some are pressuring their banks to pull back, undercutting subsidiaries in East Europe. Athens has ordered Greek banks to pull out of the Balkans.

The sums needed are beyond the limits of the IMF, which has already bailed out Hungary, Ukraine, Latvia, Belarus, Iceland, and Pakistan – and Turkey next – and is fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where the IMF may have to print money for the world, using arcane powers to issue Special Drawing Rights. Its $16bn rescue of Ukraine has unravelled. The country – facing a 12pc contraction in GDP after the collapse of steel prices – is hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch. Pakistan wants another $7.6bn. Latvia's central bank governor has declared his economy "clinically dead" after it shrank 10.5pc in the fourth quarter. Protesters have smashed the treasury and stormed parliament.

In almost every way, this is much worse than the Asian financial crisis in the late 1990s, as indicated by the table below. There are accidents waiting to happen across the region, but the EU institutions don't have any framework for dealing with this. The day they decide not to save one of these one countries will be the trigger for a massive crisis with contagion spreading into the EU. The governments and ECB cannot risk NOT saving any one country or banking institution, but that strategy is drawing almost all the reserves and ammunition these institutions have.

Europe is already in deeper trouble than the ECB or EU leaders ever expected. Germany contracted at an annual rate of 8.4pc in the fourth quarter. Germany will have shrunk by nearly 9pc before the end of this year. This is the sort of level that stokes popular revolt. The implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece and Portugal as the collapse of their credit bubbles leads to rising defaults, or rescue Italy by accepting plans for EU "union bonds" should the debt markets take fright at the rocketing trajectory of Italy's public debt (hitting 112pc of GDP next year, just revised up from 101pc – big change), or rescue Austria from its Habsburg adventurism.

Hungary’s forint fell to an all-time low in recent days, and Poland’s zloty slumped to the lowest in five years on plunging industrial output. Half of all loans to the private sector in Poland are in foreign currencies so borrowers face a severe debt shock after the 40pc fall of the zloty against the euro since August.

There are contagion worries for Western banks that have lent $1.74 trillion (£1.22bn) to the ex-Soviet bloc -- split between $1 trillion in foreign loans and $700bn in local currency debt through subsidiaries. Austria’s banks are the most exposed with the share of risk-weighted assets tied to the region reaching 54pc for Raffeisen and 38pc for Erste Bank. The exposure of Germany’s Bayern Bank is 48pc, Italy’s UniCredit is 45pc, and Swedbank is 29pc.

The region needs to roll over $400bn in foreign debts this year, equivalent to a third of total GDP, raising concerns that it may need a massive rescue programme from the International Monetary Fund and the European institutions.

p/s photos: Elva Hsiao

Biz Snippets & Exorcism

HK / BLR - The Hong Kong Monetary Authority cut its benchmark interest rate to help boost bank lending as the city's economy slows amid a global credit squeeze. The base rate for banks will drop to 2.5 percent from 3.5 percent Thursday, based on the level of the US benchmark target rate plus 50 basis points, down from 150 basis points, chief executive Joseph Yam said. The HKMA tracks the Fed Funds rate, which is now at 2 percent, because Hong Kong's currency is pegged to the dollar. Australia cut its benchmark interest rate on Tuesday by one percentage point, the most since a recession in 1992, sparking speculation that other countries will follow to unlock credit markets.

China / Steel - Four big Chinese steelmakers have agreed to cut production until steel prices stabilise, which could mean the rest of this year, said Zou Jian, chairman of the China Metallurgical Mines Association. "The steel price declined a lot, so the steel companies decided to cut production until steel prices are stable,'' he told Reuters. He said Shougang Group, Hebei Iron & Steel Group, Anyang Iron & Steel and Shandong Iron & Steel agreed earlier this week to cut output by between 10 percent and 20 percent. He said the agreement involved steelmakers in Hebei province, which encircles Beijing, but other firms were also affected by the low prices.

US / Budget Deficit - The US government's budget deficit ballooned in fiscal 2008 to US$438 billion (HK$3.41 trillion), or 3.1 percent of GDP, as the economic downturn began to bite, the Congressional Budget Office said. The estimate compares to the US$162 billion shortfall that represented 1.2 percent of GDP in fiscal 2007, said the CBO, which monitors federal spending on behalf of the Senate and House of Representatives. "That is about US$31 billion higher than the US$407 billion deficit CBO projected this summer, primarily due to lower-than-projected revenues and higher-than-expected spending for defense and deposit insurance,'' it said. In its Monthly Budget Review, the CBO said corporate income taxes fell by around US$65 billion during fiscal 2008, which ended September 30.

US / Consumer Debt - U.S. consumers reduced their debt load by a record amount in August, the Federal Reserve reported Tuesday. Total seasonally adjusted consumer debt dropped by US$7.9 billion, or a 3.7% annual rate, in August to US$2.58 trillion. This was the first decline since January 1998. Consumer credit rose 2.4% in July. Non-revolving credit - such as auto loans, personal loans and student loans - dropped sharply by US$7.3 billion, or 5.4%, to US$1.61 trillion, after rising 0.9% in July. Credit-card debt dropped by US$612 million, or 0.8%, in August to US$969 billion.

UK / Banks - The U.K. government said Wednesday that it will pump as much as 50 billion pounds (US$87 billion) of capital into the country's main banks as part of a rescue package designed to shore up the struggling sector. The cash injection, which will be exchanged for a stake in the banks, is part of a package that also includes plans to provide short-term liquidity and ensure the sector has enough funds to maintain lending. Combined, these institutions have agreed to increase their total Tier 1 capital by 25 billion pounds before the end of the year. The government said it will make the money available to be drawn on, if desired, as preference share capital or permanent interest-bearing shares and is also willing to assist in the raising of ordinary equity. It's also ready to provide an incremental minimum of 25 billion pounds of further support for all eligible firms. Details of how much will be provided to each bank are still to be hammered out. But the cash is likely to come with a string of conditions. Treasury said it will take into account dividend policies and executive pay packages and will also require that banks continue to support lending to small businesses and home buyers. Other U.K. banks, and the U.K. subsidiaries of foreign institutions, can also apply for inclusion. Shares in the sector were mixed in early trading, with RBS jumping 13%, Lloyds up 8.7% and HBOS rising around 28%.

Meanwhile Barclays fell 3.5% and HSBC dropped 3.1%.

ECB / Liquidity & USD - The European Central Bank pumped US$50 billion into money markets today and said it will double to 50 billion euros the amount of the single European currency it would lend for six months as it tried to ease a tightening credit crunch. In a separate statement, the ECB said it would also lend another US$20 billion to banks for almost three months in an operation that generated demand for more than four times that amount. On a day when currency injection announcements followed each other at a breakneck pace, the ECB, US Federal Reserve and other central banks appeared determined to reassure stressed financial markets that money was no object. The European Central Bank pumped US$50 billion into money markets today and said it will double to 50 billion euros the amount of the single European currency it would lend for six months as it tried to ease a tightening credit crunch. In a separate statement, the ECB said it would also lend another US$20 billion to banks for almost three months in an operation that generated demand for more than four times that amount.

The European Central Bank has announced a schedule for new coordinated action it will take with other central banks to expand the provision of US dollars to cash-strapped commercial banks. "In response to continued strains in short-term funding markets, central banks recently announced coordinated actions to expand the provision of US dollar liquidity,'' an ECB statement said. "Today, the central banks are announcing schedules for term and forward auctions of US dollar liquidity during the fourth quarter of this year.''

China / Yuan - The yuan rose the most in seven months, erasing a record loss posted in the run-up to last week's break in trading, after the central bank said it wants a stable currency. The People's Bank of China will focus on "maintaining the stability of the currency when applying macro-economic controls to the financial sector and formulating monetary policy,'' said central bank governor Zhou Xiaochuan. The currency rose 0.38 percent to 6.8169 a dollar as of 5:30 pm in Shanghai, according to the China Foreign Exchange Trade System. A 0.08 percent gain yesterday followed a 0.46 percent slide on September 26, the biggest drop since a dollar peg ended in July 2005. China's financial markets were closed last week for a public holiday.

Russia / Banks - Russia's government should lend the country's biggest banks 950 billion rubles (US$36bn) for at least five years to help unfreeze credit markets, President Dmitry Medvedev said. State-run OAO Sberbank and VTB Group, should get 500 billion rubles and 200 billion rubles respectively, Medvedev said at a meeting with senior finance officials in the Kremlin. "What we can decide on today is, first of all, giving subordinated loans to banks of as much as 950 billion rubles for no less than five years,'' Medvedev said.

Comments: The move to restore liquidity and confidence is well underway. Volatility will be high and the central banks will not stop until they get a proper hold of the markets. Its like a group of priests trying to calm down a child being exorcised, the reckless-financial-child's head is turning around and around and spewing green stuff (thought to be mashed up greenbacks) ... the exorcism continues...

p/s photos: Ayumi Lee