Tradesense (a.k.a.Horse Sense)

This Blog was launched on 9th October 2008 just after the beginning of the worst financial crises the world is witnessing and fear seems to be reaching its peak.

Sixthsense investing appears to be the need of the time!! The intention is tickle it every week.


Monday, February 23, 2009

Decoupling – have the seeds been sown?

The decoupling theory – Asia and Asian markets (sans Japan) decoupling from the rest of the world – keeps surfacing from time to time – specially when the markets in Asia tend to perform better than those of US and Europe. It happened in the first two weeks of February when the Chinese and Indian markets seem to have started outperforming the US and European markets. However as the US market indices have started to challenge the November 08 lows the perception seems to be altering again. So is decoupling a possibility at all?

Prima facie it appears to be a difficult proposition. The reasoning is very sound:

“Basically, there are two stories to tell here about the sudden downturn in the global economy.

The easiest to understand is the collapse of industrial production in East Asia, where the supply chain starts in places like Taiwan and Vietnam and moves through places like China and Japan before cars, shoes, computers and flat-panel TVs arrive at stores in the United States, Western Europe and everywhere else.


… the 40 percent decline in Taiwan's industrial production at the end of last year was the "canary in the coal mine" of Team Asia's formidable export machine. At about the same time, Japan's exports fell 35 percent, Korea's 17 percent, and China's fourth-quarter gross domestic product was essentially flat -- no economic growth at all.

… never seen declines this fast and this steep, even during the Asian economic crisis ... It all reflects not only the sharp pullback in discretionary consumer spending around the world but also an equally sharp pullback in the flow of foreign investment that was used to build factories and shopping centers and has been an important driver of growth in the region.

Demand for Asian exports will pick up again before too long, but it will be a long time before they reach the levels attained at the height of the bubble economy. And it will be longer still before foreigners will be eager to invest in expanding capacity again.

Ideally, Asians would respond to this challenge by reducing their heavy reliance on exports and foreign investment and reorienting their economy more toward domestic consumption. But … that's not as simple as it sounds.

For starters, the things Asians might want to consume aren't necessarily the things they produce to export, so production would need to be reoriented and workers retrained and redeployed. And to replace the foreign investment, these economies would need to develop financial institutions that can raise and invest risk capital, which right now they don't really have. Most significantly, Asian governments would have to create safety-net programs like Social Security so people don't save so much and spend so little.

In short, the Asian downturn is probably manageable, particularly now that the Chinese government has responded with a massive stimulus package. But it will take time for the region to make the necessary adjustments to get the region humming again.”

As I see the lessons learnt/being learnt during this severe downturn will have a lasting impact as these Asian countries now re-orient there industrial and fiscal policies to ensure that over dependence on exports is reduced in the years to come. Also trade within the region will now be a much greater focus as two of the most populous countries in the region ‘Chindia’ look to push their growth with policies that are much more domestic investment and consumption oriented. India always was domestic consumption story (save the IT and IT enabled services and Generic Pharmaceutical industry) and now can be regarded as a great advantage.

As the quote above points out - the reorientation will be challenging and will take time – a decade or so. But as the US and European consumption story sees its twilight in years to come it is the Asian and some of the resource rich countries such as Brazil that will need to fill-in. And as this re-orientation sees initial success foreign capital (US and European savings) will start seeking these countries and the capital required to sustain a reasonable growth rate will find its way. The seeds for this shift – possibly a power shift too - appears to have been sown.

Disclosure - No Positions


Copyright © 2008-09 Tradesense

Monday, February 16, 2009

Warning Signal

Last week’s market reaction is attributed to the lack of details in Giethner proposal. The basic issue revolves around the valuation of the bad /toxic assets. A low price while taking the asset of the bank balance sheet will also cause further charges to be taken and may require further capital. Bloomberg quoted an expert saying that … “Through this whole process, it seems as if the government needs to take a course in marketing.” It is unclear if he will come out with the details.

Thursday’s movement of US stock prices will tell us a lot about it! Just when one thought that the supports were to give way the market rebounded and bulls took-off.

And there appears to be some tactical work behind this. As one writer put it –

“I figured out why Geithner was so vague in his speech Tuesday... now each time the market is weak and about to fall off a cliff they can release another piece of "salvation" - this methodology could last for months. Why shoot your load all at once?? Genius! I tell you there must be an army of technical analysts employed somewhere in the bowels of government. Their timing is beyond impeccable; below S&P 800 and the panic would have begun.”

Any major move by the market on the down side is likely to be manipulated with timed releases/leaks it appears. Well the market will turn out to be savvier. If it reads the emerging situation is not to its liking and decides to go down – it will! Experience tells me it can find its way if that is what is right in its perception. It will probably consolidate downwards instead of making a big move.

There was a feeling that the markets were stabilizing and credit in some measure was beginning to flow. Some liquidity it appeared had started flowing towards to the equity markets as players booked profit in treasuries - treasury yields improved. But last week’s market behavior probably indicates that some more turbulence is likely. This Bloomberg report brings out the point:

“Ten-year note yields fell the most in two months as investors, disappointed at the lack of details in Treasury Secretary Timothy Geithner’s bank-bailout plan and doubtful a stimulus package will spur growth, sought the safety of government debt. Stocks tumbled. The government, meanwhile, sold a record $67 billion in notes and bonds.

The benchmark
10-year note’s yield dropped 10 basis points, or 0.10 percentage point, the most since the five days ended Dec. 19, to 2.89 percent, ... Yields on the two-year note fell three basis points, the most since the week ended Jan. 9, to 0.96 percent. Thirty-year bond yields slipped two basis points to 3.67 percent.

The 10-year note yield touched 2.04 percent, the lowest according to data going back to 1953, on Dec. 18, the same day the 30-year bond yield fell to a record 2.51 percent. The declines came two days after the Federal Reserve cut its target overnight rate to a range of zero to 0.25 percent and said it was considering buying “longer-term” Treasuries to lower consumer borrowing costs and stimulate the economy.

On Feb. 9, as the government readied the week’s auctions, the yield on the 10-year note reached 3.05 percent and the yield on the so-called long bond touched 3.76 percent. The yields were the highest since November.

The sale of 10-year notes on Feb. 11 drew a yield of 2.82 percent, while the yield at the 30-year bond auction on Feb. 12 was 3.54 percent. The sale of three-year notes on Feb. 10 drew a yield of 1.42 percent.

The Fed’s custodial holdings of Treasuries for foreign institutions including central banks rose 0.5 percent to a record $1.743 trillion, central bank data show. The holdings had slipped the week before to $1.735 trillion, the first decrease in 24 weeks.

Custodial holdings of
agency securities dropped for the first time in two weeks, decreasing 0.3 percent to $817.9 billion.”

The liquidity moving to treasury securities and gold’s current behavior is definitely a warning signal.


Disclosure: No Positions


Copyright © 2008 -09 Tradesense

Saturday, February 7, 2009

The currency conundrum – is it another leg up for gold?

The logic in the currency markets usually has been: sell lower interest rate currency and buy higher/stronger rates. The strategy seems to have reversed now – low/zero yield seems to positive. Sample this:

“… when in Prague the Czech central bank slashed its interest rates to an all-time low, the Czech Koruna actually bounced vs. the Euro...

… 100-basis point cut to South African rates worked to stem the slide in the Rand - now trading one-third below its US-Dollar value of last February despite paying fully 1,050 basis points more...

… in London, the Bank of England took its base rate further into record-low territory at 1.0%...yet currency traders pushed the Pound Sterling to a two-week high above $1.4650...

… when the Reserve Bank of Australia cut its interest rate to a 45-year low, the Aussie Dollar bounced from near-6 year lows in response...

… after the central bank of Norway cut its target interest rate by 50 basis points to 2.50%, the Norwegian Krone turned higher after losing one-third of its value vs. the Dollar since July last year...

… when the world's No.2 behind the Fed, the European Central Bank (ECB), opted to keep its rates flat - the Euro lost 2¢ from this week's high…...despite paying returns to cash fully 200 basis points above the Dollar.”

The phenomenon was first witnessed with USD and JPY as the respective central banks raced to cut the rates to near zero. This clearly is a deflation biased view which it appears is looking to punish debtors.

Euro is likely to suffer in this sense till it announces a rate cut in March. If it also joins the zero interest band-wagon then one may wonder what’s left for the currency markets to play with? Is this is a precursor to a crisis brewing here? Does gold get a further leg up – it’s anyway a zero yield currency!

Look forward to readers views.

Disclosure: No Positions

Copyright © 2008 - 2009 Tradesense

Sunday, February 1, 2009

‘Good Bank -Bad Bank’ – Is there any other way out?

The proposal to take the toxic/lousy assets of the US banking system into a ‘bad bank’ and leaving the performing/good assets with the existing banks had initially received a positive response from the street wise it appears has run into a block – how to value these assets?

As one expert explains:

“Say a bank has a security it wants to sell to the bad bank. The face value is $100. The bank holds it at a value of $85. The market thinks it’s worth $65.

Banks will want the government to purchase assets for as high a price as possible, or at least to find some middle ground above depressed market values.

Buying the security at, or close to, $100 means the government would recapitalize the bank while transferring losses from shareholders to taxpayers.

Well, future taxpayers. They will be the ones who pay down the debt the government hopes to sell to fund this transfer, and make good on any losses. That debt, meanwhile, could prove stifling to the economy, and the losses pushed onto taxpayers could further undermine government finances.

‘Postpone the Pain’

“Creative pricing of toxic assets will only postpone the pain, extend the duration of the crisis, and present a bigger bill,”...

If the government purchases the security at $85, the future losses and bill to the public purse would be less. The problem is that this price could cause banks to recognize as permanent their losses on other securities. Right now, they claim those losses are temporary.

Such a move would cripple banks’ regulatory capital ratios. Plenty of banks could still fail. In that case, banks and taxpayers both get hit.

Buying the security at the market price of $65 means banks and the financial system immediately face a day of reckoning. While bank balance sheets would get unclogged, many wouldn’t be able to, or willing to, face the losses.

Nationalizing Banks

“If the government elects to pay fair market value, the bank will likely not elect to participate as capital hits would be too dear,” …

That could force the government to nationalize banks or seize them as part of the process of buying up assets. Either way, shareholders would get wiped out.”


So what we have is a ‘Damn if you! Damn if you don’t!’ situation.

According to various reports:
  • It is estimated that the falling US and British financial institutions have received $1trn. from the government (taxpayers), sovereign wealth funds and other investors.
  • Bank losses from the write-offs of bad loans and busted derivatives tally up to $1.5 trillion so far. In addition, $5 trillion to $10 trillion worth of off-balance-sheet businesses such as structured investment vehicles -- leveraged lending vehicles used by big banks to fatten their profits in boom times -- are being forced back to banks' balance sheets by regulators. Rules require banks to keep a base of real shareholder capital amounting to 10% of those funds. So banks need to find up to $1 trillion within the next year to meet that objective.
  • Add the $1.5 trillion in losses to $1 trillion in needed new reserves, and you can see that banks need as much as $2.5 trillion in new capital to remain solvent under current rules. Consider that the entire world banking system had only $2 trillion in shareholder capital in 2007, before everything blew up.
  • When you add the $500 billion from sovereign wealth funds to the $500 billion from the first tranche of the Troubled Assets Relief Program, it's only $1 trillion. That's already been provided. So that leaves a gap of $500 billion to $1.5 trillion.

And the feeling one gets is that nobody still has an idea on the depth of toxic assets in the system as a whole while individual institutions may have an idea about their position but may not want to disclose it fully.

The complication that has been brought in to the bailout approach is truly mind-boggling and it is becoming very clear that everyone is clueless.

Is there a simpler approach?

Now that it is very apparent that the taxpayers and public (present and future) at large are the suckers in this game and are going to foot the bill (which anyway is going to run into a few trillions of dollars), why not take a simpler approach.

The primary cause has been mortgages – and at the root are the ‘sub – prime’ mortgages. If the bad loans have been identified as they should have been by now, the government can take over these loans into its books and tell the banks that it will pay the monthly installments as per the original agreement with the borrower. If the average tenure/maturity is about 15 years say the government gets reasonable time to raise these trillions over a much longer period. As regards the banks these become performing assets and as the government instead of doling out only to the banks can also dole out to the mortgagees by giving them the actual ownership of their homes. While this would be akin to a grant and some may raise moral hazard issues, but what morality is left in the present plans? Further taxpayers and citizens will feel better knowing that they have helped fellow citizens than the unscrupulous financial institutions. Politically too it might find favor as relevant constituencies are addressed.

Given that the mortgage repayments are now to come from the government the derivatives based on the mortgages will also stabilize and the banks can reckon these mortgages in their books at face value thereby avoiding any major need for recapitalization because of loan loss provisions. The derivative products, given the government backing may turn liquid and find its value too.

Am I missing something? Look forward to your comments and response.




Disclosure: No Positions




Copyright © 2008 - 09 Tradesense