Weekly Z Turn Letter - 24/05/09

Quote of the week

For a nation that is afraid to let its people judge the truth and falsehood in an open market, is a nation that is afraid of its people. -- John F. Kennedy 

1. Hedge Fund ETF? See attached Chart 1_HFETF

 

QAI US Equity, is an ETF tracking the performance of IQ Hedge Multi-strategy Index, which is to replicate the return characteristics of the hedge fund universe. Looks all good cos apparently you do not have to pay the performance fee but only an administration fee to gain the access to the benchmark performance of a multi-strategy hedge fund.

The index that QAI is tracking, includes L/S Equity, Global Macro, Market Neutral, even-driven, fixed income arbitrage, emerging market and other strategies commonly used by hedge funds.

But to me, it is more like a Hedge Fund of Fund less than a Multi-strategy hedge fund because it gains its exposure to each of the strategy by having a position in various ETFs. And one of its weaknesses comes from the fact that it can not short anything directly, but instead by longing specific reverse ETFs to gain the short exposure, which creates tracking error compared with the actual hedge fund who can short outright in the market. Because of the characteristics those reverse ETFs are having (Intra-day perfect but overnight disaster), it might sometimes be a huge disaster to hold reverse ETFs as an investment.  

Never the less, still a good product innovation though.

 

2. Some more on SOEs in China

 

Last time here we presented a report from HKMA on the profit sustainability of SOE firms in China, from the perspective of the artificially low interest that they paid to access cheap loan funding from banks. Today, we look at a simple comparison between top 20 market cap SOE firms vs. the rest of the market, which is around 1500 companies. Basically it shows a huge concentration of profit coming from those top SOE firms. 

                 

                       NP in 2008    NP Growth YOY      NP in 1Q 2009    NP Growth YOY     PE 08     PE(Estimated)09  

Top 20 SOE         602.52 Bln        60.1%                  154.47 Bln          0.61%             14.59            14.3 

The rest             240.68 Bln       -44.83%                  59.14 Bln          -50.43%           45.94           26.9          

(NP in Billion RMB and figures from Hong Zhou Kang http://www.hongzhoukan.com/)

3. Call it "Chasing the diminishing marginal buyer" from Tyler Durden

Flagrant example of chasing the marginal buyer as others offload their shares. GS upgraded BOA right before its issuance but it ain't enough. MS came out, literally upgraded all the banks' target price in a BIG move, check out Chart 2_MS UG. Show time...

4. Early Sign of Dollar Debasement

One of the unintended but inevitable consequences for the government reflation policy is the depreciation of paper currency, especially when large amount of the budget deficit needs to be financed through monetization. Dollar debasement trade has been the talk for a long time but it seems that we were not at the point, one of the reasons is the dollar shortage in a deleveraging world. As Mr. Chris Wood of CLSA pointed out a depreciation of dollar would not be qualified as a debasement, without the companion of sell of, or dumping of the US treasury.

While it is still premature to say Sovereign players are going to sell their treasury inventory in the foreseeable future; but the real problem is the supply of treasury outweighs Fed's current will and the ability to absorb them all. It is interesting to note that, there are a few early sign in both smart money community as well as the open market to get well positioned into this, before it really starts.

a. John Pulson allocated 30%+ of its equity portfolio into one single position of Gold ETF and also at the same time bought several gold miners stocks to a substantial level, as well as the gold miners ETF.

b. David Einhorn's Greenlight was buying gold back to 4Q last year and it also added to its Gold position in 1Q 09 according to its filing with SEC. Interestingly Greenlight also entered some long-dated IRS betting the rise of rate.

c. And more importantly see Chart 3_2s10s, the spread of 2y and 10y has gone back to the level of 2003 contributed mostly by the rise of 10s.

One thing that i would like to point out is, a lot of people are simply referring this to terms like inflation or hypo-inflation, which makes me feel a bit uncomfortable with. Because the mess we're in now is an unprecedented and complexed one, which requires more specification and dedication rather than a game of terminology assignment as stupid as calling a market bottom. Dollar debasement can happen just because of one simple reason that people are losing their confidence in the dollar and the US, Breton Wood II, or the worst fiat money system regardless of where the inflation is going to be. So, putting the trades like those on now at least renders you two benefits, in terms of both current risk reward profile and the chance to run ahead of the herds.

Therefore, these sort of the early signs are indeed worth paying attention to; as Mr.Einhorn said, at least, just in case. 

2 important figures fyi, 1. According to GS, FY09 is going to see 3.25 trillion treasury issuance, which makes us wonder, even if China is not going to sell, is it there to take more at the sustainable pace? 2. Budget deficit is going to be 12.5% according to Secretary Tim.

5. In the end, fun for the weekend.

Mission One, a sleek, powerful electric motorcycle, shared by TED. 

Top Speed: 150+mph; Acceleration:0+100 in 5.9 seconds; 

Torque: 110 ft/lbs peak; Adjustable traction control and regenerative braking. 

http://www.ted.com/index.php/talks/lang/eng/yves_behar_s_supercharged_motorcycle_design.html

Have a great weekend.

Best Regards

Oliver

Interesting things over the weekend

1. Toyota Finance Co. China is going to issue debt in RMB to boost its sales through cheaper car loan.

Only 8% of the car sale in China in 2008 was done through financing while this number is more than 60% in developed countries. Typically, consumer can get car loan through either banks or the finance companies operated by the car makers, and the later one often charges a higher rate due to its funding constrain. This issuance, if successful, could help with Toyota to boost its car sales by offering lower rate to its clients and should expect more debts of this kind to come in the future, given China is loosening its restriction on consumer loans, especially car loans.

2. More pain to feel on office rent in Shang Hai.

Have been visiting Shang Hai quite a few times in 2008, though not this year. One of the feelings that I had so strongly is the supply of office space in Pu Dong area. At that time IFC Shang Hai was still under construction and we had already got the then highest building in Asia just completed on the other side of the road. In 2009, more data is out to confirm that vacancy rate has been steadily up for a few months while rent of the top class office in 1Q is down around 15% yoy according to the local statistic.

3. McDonald in US vs. Café De Coral in HK

One of the evidences that people started to adjust their consumption habit during a cyclical recession in an indebtedness-de-leveraging world, is the restaurant they dine at. McDonald sees its Feb sales number up 6.8% while the number of newly opened restaurant in NYC dropped for the first time in 2008, to 119 from 163 in 2008. If you think one step further as to where is our Uncle M in HK, it won’t be hard for you to think of Café De Coral, even though it is not cheap around 20 P/E multiple and Dvd Yield around 3.4%, but just can not help pointing that out for you after I had a dinner there recently, paying 51 HKD but getting a set of food, more delicious than most 200+ that I had. Go to have a trial if you are in HK if you have not yet, to see how efficient and cost-saving they are.

4. Another 4 trillion package?

There has been quite a number of media reports over the weekend stating that it is possible that Chinese Government is going to launch another 4 trillion stimulus plan, as early as next Wednesday. While the first 4 trillion has been focusing on the infrastructure and FAI side, this 2nd round will, on the other hand, be concentrating more on the consumption side. Whether or not it is true, I don't have the answer for you. But what is worth noting is how the market is going to act on it, next week when it starts to talk about it. We shall see.

Super Deflation vs Inflation --Weekly Z Turn

Super Deflation vs Inflation --Weekly Z Turn  (28/02/2009)

1.      The best way to view this crisis.

The best perspective to view the current crisis that we are in was provided by my highly respected strategist on the street, Mr. Christopher Wood. He had it this way on few of his weekly write up, Greed & Fear saying we are now in a crisis, for the western developed economies, having both structural problems accompanied by the synchronized cyclical downturn in the real underlying economy.

So, given that as the real way to look into this problem, we should definitely try to get the solution accordingly rather than either mixing them two together or dealing one without caring the other.

Most of the traditional policies, both monetary and fiscal ones, were to a large extent targeting the cyclical downturn since we, in reality, did not have many examples of a structural crisis, especially one of this type and this severity, in our history. Therefore, when policy makers woke up and started to jump right into the mess to try to look for the best weapons out of their toolkit, they unavoidably re-got together at the end of a same tunnel called Keynes and Mr. Greenspan, albeit for some stubborn teammates like ECB, who is still way behind the club and is still wondering whether or not to get a catch up. Yes, unfortunately and sadly, still…

Therefore, my argument is, no matter what kind of the efforts that they are trying to make. Until the moment that they could correctly identify the origins of this mess and focus on each aspect of the cube accordingly, it would be difficult for us, and for them as well to see the light at the end of the tunnel. While we can never rule out the worst-case scenario, in which we prolonged the crisis by not giving the patient the right medicine. 

How can you make a prescription to cure one without at first, properly identify one?

2. China in a possibility of super deflation

One of the saddest things that our human being have to be faced is that, a coin is always going to have 2 sides. While enjoy all the goods on one side, you have to admit that, more and less, earlier or later, you are going to pay for the price of it. The Great Globalization, is also the case.

Before this global party, for a country that is in a economy downturn to stimulate its economy, one of the methods that is usually helpful and quite effective according to the statistic is currency depreciation, in a way of which to make its exporting goods and service relatively cheaper to attract purchase abroad, to compensate its weak domestic demand. However since we were enjoying the best cake out of the moon for the past few years, when Chinese acted as a vendor financing party and producer for people in the States to borrowed at a cheap rate to consume, the world has been linked together in a way that we had never experienced before. As a result of that, when we walked into this crisis, it can probably be safe to assume that, since this mess is going to be a synchronized and simultaneous one, it will not be easily solved by simply a depreciation in the currency since the point now is not the relative price between different countries but the real retrench in the final demand, that has been artificially high for the past few years. 

That being said, we can also safely assume that in the emerging Asia we are definitely facing a less concerning structural difficulty in the balance sheet of both private and public sectors compared with our western counterparts; However, it would probably be ambitious for us to claim that we could have less impact, slightly bigger in my humble opinion, because of the collateral damage from the west. In a word, it is such a self-deception to call for the idea of "De-couple". Simply put, for the consumption side to stop spending and to start saving, it would be as easy as a click; While for the producing side to adjust it business scale, the process would be both painful and long. Take mining sector to be an easy example, for a mining company to adjust it production, even for a normal business cycle, it would probably take 7 years to start from none to make its supply fast enough to catch up on the uptrend of the economy (Number from BHP). 

With that being said, i am calling China, even for the long term to be more deflationary rather than inflationary as many believe, given the size of its infrastructure investment and other related stimulus investment package. Personally speaking, they would contribute more to the deflation side, simply because the more you're spending on those now, the more the over-capacity it will become if the transition from exporting oriented business model to a domestic consumption driven does not succeed. And as always, I am super bearish on the probability of how domestic consumption driven economy that we can become in the foreseeable future without a change in the constitution of China.

In one word, we are now apparently trying to stimulate our economy in the short run; but in reality, I am afraid we are just building an economy of more capacity in the long run...