Charting around Asia

Limit UP in Equities!

by John Needham, The Daniel Code Report | May 20, 2009

India

It’s Good News Week on the sub-continent where India finally finished a month long election for its National Government. The re-election of Sandra Ghandi’s Congress Party with a new mandate and importantly winning many more seats signalled hopefully, an end to the crippling constraints of coalition with the Communist Party and others of similar ilk.

The Congress Party made its best showing since 1991 in the April-May elections, winning 206 seats in its own right. With its allies, it has 262 seats in the 543-seat lower house of parliament. This time, the Congress-led alliance is without India's formerly influential communist parties, which won 24 seats in the general election, against 61 previously. The prospect of a business friendly government finally being able to effect market and economic reform without the shackles that coalition with often anti business parties has imposed, gave rise to an unprecedented 20% jump in the SENSEX and NIFTY 50 markets, India’s main Equity indices on Monday morning. Trading was suspended for the day by both the Mumbai bourses after the 20% move.

I cover this market and the USD-INR cross for our Indian clients and it has been obvious for a while that the Indian equities market was relatively stronger than US markets. In fact NIFTY has been leading international markets since the March lows. My friend Akshay, a senior broker at India’s oldest and most prestigious broking house, was sceptical of my comments and averred that Indian markets always take their lead from Wall Street. Well not on this occasion sport!

MUMBAI (Reuters) - Indian initial public offerings are expected to end a 15-month drought and make a comeback, led by state-run firms, after the ruling coalition scored a comfortable victory in national elections. The win has cheered the stock market as the strong mandate will free the alliance from the shackles of the left parties, which stalled stake sales including a planned $10 billion IPO of state telecoms giant Bharat Sanchar Nigam Ltd (BSNL).

The main stock index leapt more than 17 percent on Monday, its biggest one-day jump in almost two decades, in the euphoria after the election verdict, and traders expect the market to rise further over the near term. The spike follows a strong rebound since mid-March, driven by a revival in global risk appetite and hopes of a boost to slowing growth by increased government spending and opening up of the Indian economy. Buoyed by the recent market recovery, companies have already successfully raised more than $1 billion in the past two months from private placements of shares.
The benchmark stock index has risen 70 percent in the past two months, after falling 52.5 percent in 2008 in its worst year on record. Foreign funds have moved about $2.1 billion into Indian stocks so far this year, including $783 million for an almost 10 percent holding in developer DLF Ltd last week. That marks a sharp turnaround from 2008, when foreign funds dumped Indian stocks worth $13 billion.

On the cross rates, the Indian Rupee (INR) made the biggest one day bar in recent history to firm dramatically against the US Dollar.

Down Under

Australia and New Zealand have just enjoyed the dubious distinction of being ranked in Morningstar’s latest managed fund report as the worst of the 16 countries covered:

“NZ fund managers rank bottom of 16-country survey. NZ fund managers have been given a D- rank in a world best practice survey.

New Zealand ranked lowest in a study of managed funds in 16 countries carried out by investment researcher Morningstar. The study measured the experiences of managed fund investors, with the aim of identifying best practice in funds management from the countries in North America, Europe and Asia in which Morningstar operates. New Zealand was rated D-, while the United States topped the list with an A rating, followed by China with a B+. Australia was rated 11th with a C.

The report looked at transparency of these investments - what was disclosed about the people running the fund and the details of what it had invested in. In many countries fund managers named the people looking after the money, when they started work, if they had during the year. NZ funds were not good at disclosing their fees structures, allowing them to be easily compared with other funds.”

"Transparency in prospectuses and reports, investor protection, and taxation were the main areas where New Zealand did not rank well," Morningstar said. "On transparency, disclosure of portfolio holdings was cited as one of the most important areas needing improvement."

New Zealand and Australia were the only countries in the 16-country study which did not need full portfolio holdings disclosure on a regular basis. The study also argued the Securities Commission in this country was insufficiently resourced.”

This is the flip side of a lack of competition in fiscal services. Commentators and analysts in Australia have argued that the apparent health of the Australian and New Zealand Banks (the big 4 banks or “Four Pillars” are one and the same on both sides of the Tasman Sea) is due to the lack of competition imposed by government policy. Their argument runs along the lines that as they were not challenged by robust competition (try none), during the boom, they did not by necessity move out the risk profile, into more risky lending models and hence have not suffered from the losses gutting their more feral cousins in US, UK and Europe. And that’s a cute argument but probably not true.

A better argument is that monopoly banking is so cosy that nobody from the big 4 at least, was out combing the bushes for the more entrepreneurial business in CDOs and the like, so other entities (Grange and Merrills and Lehmans) got that piece of business. As it happened the Down Under banks ducked that particular bullet but landed plenty of others. ANZ’s adventures in margin lending are worth reading (see Opus Prime).

Australian and New Zealand governments have reacted to the mildest correction in their economies as if the bats of hell were upon them. Both moved early to guarantee retail and wholesale deposits for both quality institutions and some not so worthy. Indeed finance companies that had already frozen investor redemptions due it is said to illiquidity but in many cases insolvency, were given another lease of life by these guarantees. As usual when governments get involved, we got unintended consequences (borrowers got a higher rate at the more risky models but with government guarantees who needs banks) which pushed up the cost of bank funds accordingly. Major bank’s overseas fund raising has also been guaranteed by national governments. How long banks will need government guarantees and how they will be withdrawn is just another question that must be addressed in time.

Momentum in the fragile property sector in Australia has been maintained by an ever inflated government grant to first home buyers and in a separate category, new home buyers. What started as a Federal grant of $7000 has now mushroomed with a mix of State and Federal grants to upwards of $32,000 depending on State variations. What true demand for housing really is, has been effectively masked by government incentives. The recent announcement that the grant would be withdrawn was of course reversed almost immediately, and like most addicts on the public teat, weaning is going to be long and wearisome! What we know with certainty is that there are large differences in demand at the “no deposit” level which is what has been going on despite promises to the contrary. Just wait for the Reserve Banks Down Under to say “We didn’t know”.

I have been uber bearish on Down Under real estate for over 18 months. In the peculiar hot house of Australian financial journalism where access to important figures is a function of favourable coverage, few are critical. The culture of parsing government statistics is small and to question government (and bank) figures just doesn’t happen. My belief has been that government programs and relationships between banks and government (there are only 4 big commercial banks in Australia and New Zealand), and the fact that their business model and super profits are wholly dependent on the “Four Pillars” policy which I have written about for you many times, which effectively entrenches their monopoly (actually oligarchy) position, has served to mask what is really happening in the housing market.

I have been puzzled for a good while as to how the Australian average wage can be $61,521, but the average house price in Sydney is near $553,000 and rising. Melbourne average house price is $463,500, up almost 25% in the year to mid 2007, and they are pretty stable at those levels.

For years we wondered, or I did at least, about how all those US and UK citizens could afford their McMansions. We know now that they could never afford them. It was all smoke and mirrors. For the Australian housing market, (and NZ is not far behind), the figures just don’t work. And for exactly the same reasons that they couldn’t be maintained in US and UK. I hadn’t been able to work out with certainty, how this particular trick was being done, but today Robert Gottliebsen of Business Spectator gives us the first insight. Robert is a kind man who never has a bad word to say about any, so you can take his mild story much more seriously than may be apparent.

As you read it keep saying “Sydney house prices average 9 times average earnings”. Let’s see how that works out!

From Business Spectator today:

How our banks went too far
Australia prides itself on the fact that we have four banks with AA credit ratings. Yet Citi analysts say we are in danger of losing those ratings because our banks, led by the Commonwealth, have over-expanded lending, particularly in housing.

We have all been around long enough to know that these analysts’ reports require elaboration and qualifications, but overnight it suddenly hit me that Australia was in danger of losing this treasured bank status because of our own version of sub-prime.

To understand this you have to go back to the American origins of sub-prime and then examine the parallels with what is happening today in Australia. The origins of both the US sub-prime crisis and the over-lending in Australia is related to well meaning interference by governments in the financing process.

Back around 1977, President Jimmy Carter signed into law an act which required banks to meet the credit needs of lower income people in districts where they were big depositors. It was a piece of total nonsense because at the time everyone in banking knew that if banks loaned to people who could not pay there would be huge bad debts. Surprisingly, the act lay dormant for over two decades until President Clinton told the big US banks in the late 1990s that if they wanted to expand their operations into more US states, consolidate branches or merge, they would need to lend to low income people in compliance with the Carter act.

The banks got the message and sub-prime was born. Of course, I must emphasise that although the politicians started sub-prime, they can’t be blamed for what happened next.

Here in Australia our version of the Carter low-income lending act was the expanded first home buyers' grant. But if the government’s expanded first home buyers' grant was going to work as the politicians intended, the banks had to come in behind it and lend to low income people who had little or no deposit except the grant. Officially banks have asked for at least a 3 per cent deposit, but in practice that is not how it worked, particularly in new homes.

The banks got the message and loaned very large sums with little or no deposit required. Not only was this bad banking but, as we can see, the lending was so great that it threatens their AA rating.

Sub-prime was a terrific boost to the US economy until someone pulled the plug and stopped lending. In Australia our home starts, particularly in South Australia and Victoria, have been a huge boost to the economy at a time of global financial crisis. However, I have learned from lengthy discussions with real estate agents that in the past few weeks our banks have pulled the plug on 'no deposit' lending and now are requiring deposits – exactly what they should have done from day one.

I emphasise that this is not a sub-prime crisis or anything like it because the Australian first home borrowers do have reasonable levels of income. But because the change in lending rules comes as the grant is being reduced, it will mean that the prices of houses in the lower brackets may fall back to where they were prior to 'no deposit' lending. A lot of first home owners who bought at the inflated peaks will have negative equity. As long as the families hold together and employment is maintained that will not be a problem. But if Treasury is right about unemployment there is a clear danger.

The politicians are right to blame bad capitalism for the US crisis. However, what they must also recognise is that the bad capitalism in the US stemmed from a toxic combination of social engineering by US governments and bank lending to back it.

In Australia the first home buyers' grant was not a bad thing on its own. What made it dangerous was its combination with no deposit lending. Like the US it’s the combination that is potentially toxic.

This is the Australian SPI 200 index or Share Price Index, which went parabolic into 2007, challenging Shanghai for the title of the most over loved and over valued index in the world. It found support at the Danielcode black line, the last point of support for the 2003-2007 swing and has now retraced to the DC 29.7% mark. Fast markets retrace 29.7% then 37.5% so the dear old SPI has a lot of work to do to find sanctuary from the danger zone. The next leg down will be fun!

China

China is still posing as the strong man of Asia, and with the massive stimulus moving through its economy there is every chance that it will be the engine for its own deliverance as the model moves more to domestic consumption. On the Asia scene, China is switching from being entirely a consumer of raw materials to a vertically integrated producer/consumer by strategic acquisitions of important ore producers. Chinalco’s assays into Rio and Fortescue are indicative:

From China Stakes:

“With the rebound on the mining market, Rio Tinto’s share price is once again rising, and Chinalco’s bid to buy into Rio Tinto for $19.5 billion is beginning to look a bit deficient. Chinalco Deputy General Manager Lu Youqing claimed again recently that the two sides were not about to revise the terms of the deal and that despite some new wrinkles in the market, Chinalco would stick to the original plan.

Cockburn Range Kimberley, Western Australia, Australia Photographic Print by John Hay It has been reported by foreign media that Chinalco might revise terms about convertible bonds in the contract with Rio Tinto to make it more likely of approval by shareholders and Australian regulators. “This is merely guessing by outsiders. The two sides are working to finish the original plan,” Lu Youqing explained.

Rumours about the change in the deal come also from a report by Swiss bank UBS. UBS says that BHP Billiton may help Rio to raise money as an alternative to the proposed $19.5 billion scheme with Chinalco. According to UBS, BHP may buy up much of Rio’s additional offering, in return for which it may offer to set up a iron ore joint venture in Pilbara. BHP may move after Australia’s regulators make their judgment on Rio’s deal with Chinalco.
On May 5, Rio Tinto’s share prices in both Australia and the UK topped $45, the exercise price of the first batch of convertible bonds bought by Chinalco, and more and more market analysts now expect the agreement between Chinalco and Rio Tinto to be revised. This is the first time Rio’s share price has exceeded the exercise price.

According to original plan, $7.2 billion of Chinalco’s investment is go into Rio Tinto’s convertible bonds. These convertible bonds are divided into parts A and B. Part A is to be converted into common shares in Rio Tinto’s listed sectors in Australia and the UK at $45 per share, and part B is to be converted into common shares in Rio Tinto’s listed sectors in Australia and the UK at $60 per share. Part A totals $3.1 billion, and part B $4.1 billion.
Some Rio Tinto shareholders said they would urge Rio’s Doug Ritchie, head of global strategy, to choose other solutions, such as additional offerings on the open market. As the market is rebounding, a certain amount of financing is opening up. Citigroup said recently that due to the wave of additional offerings in recent weeks, the market’s interest in additional offerings, and the fact that Rio’s current share price had exceeded the exercise price, calls for additional offerings from Rio would grow stronger.

Rio Tinto has said that it did not know any detailed reasons for the fluctuation in its share price. “The company is still working to reach strategic cooperation, and is continuing to consult shareholders, and the deal will be conducted according to the original plan.” Wang Wenfu, president of Chinalco Overseas Holdings, added, “We’re against any revision of the agreement or additional conditions.” According to the plan, Chinalco will pay $12.3 billion to buy a minor equity stake in other Rio Tinto assets. “Many shareholders are not considering this $12.3 billion investment.”

Currently, Chinalco’s bid continues to gain support from Rio Tinto’s management. Doug Ritchie said on May 7 that Australia should reinforce ties with China to gain “cheap capital” which will boost Australia’s share in the global resource market. He said Chinalco’s capital injection in Rio would not give Chinalco the ability to affect commodity prices. Ritchie also denied the rumour that the two sides were revising the $19.5 billion plan. “The current plan is reasonable.”

China’s Shanghai Composite index is clawing its way upwards and is flirting with the 50% retracement of the minor swing from 05/30/2008.

Japan

From ABC News, Australia:
“Japan's economy shrank by 4 per cent in the first three months of the year - an annualised fall of 15.2 per cent. It is a record fall and confirms Japan is in its worst recession since World War II.
Japanese consumer confidence hit a 10 month high in April, exports rose in March compared to February and factory production had its first monthly increase since September.

Share investors in Japan also believe the worst has passed, with the Nikkei 225 index rising 32 per cent from a 26-year low set on March 10. Austrade's chief economist, believes that the major east Asian economies are displaying "bamboo shoots" of recovery, just as many observers have described 'green shoots' in the US. "Industrial production in China, Japan and Korea is turning around a bit, the last Japanese manufacturing data was reasonable, so perhaps this is another sign of moving from the great recession to the great recovery, albeit slowly."

Japan's ongoing problem is that it will be recovering from what is now a very low base and, even at a rapid pace of growth, will take years to recover what has been lost in the last year. BNP Paribas economists told Reuters that the downturn in exports was only now hitting Japanese domestic consumers. "Weaker than expected figures for capex (capital expenditure) and private consumption suggest the negative impact from the export plunge is spreading to domestic demand. As such, the Japanese economy may return to growth temporarily, but it could suffer a contraction again afterwards." Japan's Government is trying to prevent this with a $200 billion stimulus package. Most of Japan's major exporters are not forecasting a rapid recovery, with most predicting stabilising sales and continued losses throughout this year.

The chart below is Japan’s Nikkei 225 index. I have used the quarterly chart here to show what happens when price discovery of tarnished assets is suppressed and zombie banks are kept walking by endless bailouts and highly opaque balance sheets. And that’s as kindly as I can describe it.

The outcomes of Japan’s failure to let the cards fall where they may in the aftermath of a record property and lending binge is still reverberating in this chart 20 years later. This is the fear for Western Central Bankers. Will major US and European markets rhyme with the Nikkei. Some certainly will.

CAUTION-The Daniel numbers on these charts are from historic sequences that may not be current at the time of publication. They are appended for historic interest only. Do NOT use these numbers to trade markets. Current Daniel sequence numbers for most currency crosses are available to subscribers at the Danielcode website.

John Needham is a Sydney Lawyer and Financial Consultant. He publishes The Danielcode Report and writes occasionally on other markets. He lives with his family in Australia and New Zealand.

�The fox knows many things, but the hedgehog knows one big thing. A Hedgehog Concept is not a goal, intention or strategy to be the best. It is an understanding of what you can be best at. The distinction is absolutely crucial�. ~ Isaiah Berlin, The Hedgehog and the Fox

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