Download - Falcon Cap Then Now
FALCON CAPITALPan Asia Multi StrategyLong Short
David Hamilton – Executive Director(61) 411 886 155(61) 3 9863 [email protected]
Simon Selimaj – Executive Director/Chief Investment Officer(61) 3 9863 - 8558(61) 417 880 [email protected]
Question No.1
Falcon’s calls then and now!
2
Falcon Research Reports
“Ominous Omens” Report July 4, 2007
“Rough Seas” Report Sept 7, 2007
“Hindenburg Omen” Report June 23, 2007
“Perfect Storm” Report July 7, 2008
ASX 200
3
Ominous Omens – published July 4, 2007
4
TH CA
Pan Asia Absolute Return Fund
We at Falcon Capital are cautious with respect to the US, Chinese & Australian equities and wish to suggest toinvestors that it is now prudent to reduce exposure to high risk and leveraged equity positions in these countries.We believe that inflationary pressures are looming & that rising bond yields are toxic for most equity markets.While Japan will not be immune from a major correction in the USA or China, the Japanese economy will emergeas a major beneficiary of inflation due to a recent history of falling asset prices (deflation).
Ominous Omens!
Source: Bloomberg, CLSA Asia-Pacific MarketsSource: US Bureau of Labour Statistics
Fig.2 US import prices of good from ChinaFig.1 US 10-year Treasury bond yield (log-scale)
1/ USA The US 10-year Treasury bond yield has now broken out of a 26-year trend line (see Fig 1) If the move issustained that will inevitability, be negative for US Equities as well as loan credit spreads. Inflation pressures arerising due to rising energy and food prices and this is now clearly being factored into the bond market with risingyields. The US import index grew 0.9% month on month in May 2007 which was one of the fastest monthly risesince 2003.
For many years the volume of Chinese exports have risen but the price of Chinese exports continued to fall. Eachyear the retail price of a Chinese TV or DVD player fell in price and we in the West scratched our heads andwondered how the Chinese could produce such products at such low prices. The net result was that for yearsChinese manufacturers were exporting deflation to the Western world. This is now no longer the case as the pricesof Chinese goods to the USA rose into positive territory for the first time on a year-on-year basis by 0.1% (see Fig2). From July 1 2007 the Chinese government will cut or eliminate export tax rebates for more than 2,800 exportitems. China is now exporting inflation!
5
The American housing downturn is still a problemand the latest foreclosure data shows that problemscontinue to build. Foreclosure tracker Realty Tracreported that foreclosure activity rose by 19% monthon month & 90% year on year in May 2007 to arecord 176,137 filings (see Figure 3).
Banks and other lenders have only just startedtightening standards. Tighter lending standards willrestrain housing demand and when combined withhigher bond yields will deepen the US housingdownturn.
With inflation becoming evident in other areas of theeconomy the US Federal reserve has less flexibilitythan it did in the past to lower interest rates tosupport the housing and equity markets should atumble occur.
Page 1
Ominous Omens – published July 4, 2007
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2/ China
A slowdown in the US will significantly affectChina’s export sector, which represents over1/3rd of the economy. It will also adversely affectcapital flows which will be negative for monetaryconditions in China. We also suspect that thereare serious problems with the profitability ofmany industries in China due to risingcommodity and wage pressures that have notyet been publicised.
The Chinese government’s inability to managethe economy has led to an excess of liquiditywhich has ultimately flowed into the Chinesestock market.
An overlay of the NASDAQ (tech bubble and bust) of the 1990’s and the Shanghai A shares (see fig 3) highlightsthe speculation in the Chinese equity market. Based on price-to-earnings multiples, Yuan- denominated shares inShanghai are three times more expensive now than they were two years ago! A short term “bust” is brewing.
Fig.3 Source: DataStream & CLSA
3/ AustraliaAustralia is highly dependant on exports to boththe USA & China and any crisis will have majorrepercussions on commodity producers.
Our stock market is currently facing a troublingsituation due to: slowing earnings growth fromapprox 20% to circa 9.5%. However, the danger isthat the pace of earnings upgrades is now startingto ease … resources are driving earnings growthwhile industrials are deteriorating. The strongreturns in Australia have been almost entirelydriven by P/E expansion against moderate growth.The result is a very stretched market in terms ofvaluation… not seen since 2000.
All Industrials (ex NWS)
1 yr forward rolling PER
2
4
6
8
10
12
14
16
18
Apr-61 Feb-65 Dec-68 Oct-72 Aug-76 Jun-80 Apr-84 Feb-88 Dec-91 Oct-95 Aug-99 Jun-03 Apr-072
4
6
8
10
12
14
16
18
X
Average over whole period (10.6x)
Average since 1990 (14.4x)
X
Source: IBES, Macquarie Research, May 2007
Ominous Omens – published July 4, 2007
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4/ JapanThere is one place that rising bond yields should prove rather more bullish for equities, both from a relative return andan absolute-return basis. Firstly, the yen would rise as domestic Japanese actors cease to seek yield elsewhereand as interest rate differentials narrow making the carry trade less attractive. The main impact would be anunwinding of the carry trade. Arguably, the yen carry trade is one of the largest sources of excess capital in the globalsystem today. It has been instrumental in supplying leveraged funds for bets on high yield currencies, commodities,emerging market debt and fashionable stock markets. All of these asset classes would be losers.Secondly, Japanese asset prices would rise. This is counterintuitive in that interest rate increases are normallyassociated with falling asset prices. But Japanese households are net savers and rising interest rates translate tohigher returns on domestic yielding assets such as term deposits. Rising interest rates also signal the death ofdeflation in the economy!Japan will emerge as an out performer while China and the US lick their wounds.
4th July 2007
© Falcon Capital Group 2006. All rights reserved. This publication is intended to provide general information only and has been prepared by Falcon Capital Pty Ltd (ACN 119 204 554) (AFS License No. 302538), the issuer of the Fund, without taking into account any particular person's objectives, financial situation or needs. Investors should before acting on this information, consider the appropriateness of this information having regard to their personal objectives, financial situation or needs.
Offers of interests in the Fund are contained in the Falcon Capital Information Memorandum (IM). A copy of the IM is available from our website: www.falconcap.net or contact Client Services on (03)9863 8559 or 0411886155 or email [email protected] You should consider that IM and seek professional advice before making any decision about whether to acquire or continue to hold an investment in the Fund.
Ominous Omens – published July 4, 2007
Page 2.
Hindenburg Omen – Monday, 9th July 2007
From: david hamilton [[email protected]]Sent: Monday, July 09, 2007 2:03 PMSubject: FW: Ominous Omens
This occurred on 23 June 2007
Dave
Hindenburg OmenThe Hindenburg Omen is a technical analysis signal that attempts to predict a forthcoming stock market crash. It is named after the Hindenburg disaster, the crash of the German zeppelin of the same name in May 1937. The Hindenburg Omen is the alignment of several technical factors that measure the underlying condition of the stock market - specifically the NYSE - such that the probability that a stock market crash occurs is higher than normal, and the probability of a severe decline is quite high. The rationale behind the indicator is that, under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows - but not both. When both new highs and new lows are large, it indicates the stock market is undergoing a period of extreme divergence. Such divergence is not usually conducive to future rising prices. A healthy market requires some degree of internal uniformity, whether the direction of that uniformity is up or down.
ConclusionsThe probability of a move greater than 5% to the downside after a confirmed Hindenburg Omen within the next 41 days after its occurrence is 77%, the probability of a panic sellout is 41% and the probability of a real big stock market crash is 25%. The occurrence of a confirmed Hindenburg Omen does not necessarily mean that the stock market will go down. On the other hand there has never been a significant stock market decline in history, that was not preceded by a confirmed Hindenburg Omen.
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Monthly Report
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Economic Outlook
U.S.A: We expect the US economy to be in recession before the end of this year (negative growth in Q3 and Q4), but the scale of the unwind in the credit markets has been greater than we expected and has caused us to move the anticipated timing of recovery into 2009.
Oil price rises together with a weak base mean that CPI inflation will finish this year around 4.5% well above what most central banks would deem acceptable. The Fed will not have to wait long for inflation to fall back however as GDP growth weakens. We expect CPI inflation to average 1.5% in 2008.
Irrespective of near-term inflation pressures the deflation in credit markets means that rate cuts should be expected at each of the three FOMC meetings this year. We expect the funds rate to be 4.5% on 31 December. Aggressive cuts will continue through 2008. This year’s moves are discounted, even so flight from the credit markets will push 10-year government yields to 4% by end-2007 and through this level in 2008.
Rough Seas Report Sept 2007
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TH CA
We at Falcon Capital highlighted the problems of the US housing sector in our Ominous Omens Report dated 4th
July 2007. Less than a month later this provided the trigger for a large sell off in world stockmarkets. Ben Bernanke and the Fed came to the rescue with an immediate 0.50% cut in rates and the world stockmarkets rebounded. Don’t be seduced by the recent rally as the structural flaws in the subordinated debt market are so profound that it is almost a certainty that the US growth will slow dramatically.
For historical reasons that we will highlight below the months of September and October 2007 are particularly vulnerable. Use the current “reflex rally” to sell into the market and lighten position that were not lightened prior to the credit crunch. Call this a second chance!
Rough Seas Ahead!
We are here
7th September 2007
Falcon CapitalPan Asia Absolute Return Fund
Adelaide Presentation Nov 2007
While Treasury yields have fallen asset-backed commercial paper yields have soared.
Banks have tightened credit controls and are less inclined to lend.
A contraction in credit due to the sub-prime lending crisis will in all probability lead to a dramaticslowdown in the real economy.
The U.S consumer is exhausted. Falling home prices not seen since the 1930’s will affectconsumption.
July 06 Sep 06 Nov 06 Jan 07 Mar 07 May 07 Jul 07 Sep 07
6.6
6.4
6.2
6.0
5.8
5.6
5.4
5.2
5.0
US asset-backed commercial paper yield, Jul 06 – 13 Sep 07
Source: Bloomberg
%
A1/P1 1-day yieldA1/P1 15-day yield
U.S Cracks Emerging
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YEN - Carry trade nearing end
The yen carry trade is one of the largest sources of excess capital in the global system today. Ithas been instrumental in supplying leveraged funds for bets on high yield currencies, commodities,emerging market debt and fashionable stock markets.
Adelaide Presentation Nov 2007
Yen Carry Trade is Over
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Falcon - December 2007 Monthly report
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The 2008 Investment Outlook:The Year of the Rat will be a challenging one for Global equities. Entering 2008, we see the key themes for Asian equities as: i) a US-led G7 downturn; ii) Earnings downgrades; iii/ resilient domestic Asia; & iv) structural fund inflows into Asia.
Theme 1: The US Downturn…The US economy is rapidly decelerating. Some measures (such as housing) suggest the US may already be in recession. This will lead to a significant slowdown in Europe and Japan. Industrial World growth is expected to slow from 2.4% in 2007 to 1.4% in 2008.
Theme 2: Earnings cuts… Top-down macro matters at inflection pointsThe defining event of early 2008 will be the massive cuts to earnings estimates. Since mid 2007 we have emphasized the disturbing scenario that was unfolding due to the sub prime crisis. However, the Street was emphasizing that earnings were still strong and would continue to be. Indeed, for the past four years top-down strategists have been too cautious in their profit forecasts and bottom-up indicators were more accurate. But top-down strategy shines at economic inflection points when investors need perspective. A disconnect now exists between bottom-up corporate profit forecasts of 14% in 2008 and 11% in 2009 and many top-down EPS forecasts of -3% in 2008 and 5% in 2009. We expect analysts to cut EPS estimates sharply during 1H.
ASX 200 Breaking down 15 February 2008
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Falcon - April 2008 Monthly report
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Conclusion: Rather than seeing signs that the worst is behind us, we think the clouds are intensifying again. The markets across Asia and Australia are seeing; 1/ disturbing technical patterns such as very narrow breadth i.e. only a handful of stocks driving the indices, 2/ the valuation tailwind is fading quickly – on our metrics, the market is back out of cheap territory. Overall fundamentals are deteriorating, and whilst still our market timing indicators are in neutral territory, markets are not far away from heading back towards sell levels. The euphoria surrounding the relief rally is fading, and we are now approaching the danger zone of bear market rallies – i.e. when they typically finish. Finally, there is caution in the US, Europe and China.
Our call on Commodities 3 June 2008
From: David Hamilton [mailto:[email protected]] Sent: Friday, 6 June 2008 3:06 PMSubject: FW: commodities to tumble
SUMMARYA near perfect storm of a rolling commodity market, hoarding suppliers, slowing demand, and rapacious US regulators with a slew of proposed regulation who will stop at nothing to end the commodity “speculation”which has stopped traditional hedgers in those commodities from being able to hedge their positions. In formal chart terms, the global commodity complex bubble officially popped last week. This bubble had been steadily inflating since 2002 (since the last peak in the USD) and finally popped from Tuesday to Friday with oil (CL1) attempting a last run at 132 on Thursday evening and then coming off to close at 127. This is a monumental WATERSHED occurrence and marks a major shift in market mentality from inflationary/stagflationary to a period of disinflation at the margin for the foreseeable future.
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Our call on the Aussie Dollar – 11 June 2008From: [email protected] [mailto:[email protected]] Sent: Wednesday, 11 June 2008 3:17 PMTo: [email protected]: A$
Aussie dollar dilemmaThe Aussie economy continues to outperform, 1Q GDP growth was twice what economists expected. However the external accounts are looking more and more stretched. This Triple-A gives our take on the forces that have shaped this Australian economic cycle. The currency is now in the end game of a commodity driven bull run that has caused the current account deficit to explode over the last five years.
All deficits are sustainable for as long as someone is willing to finance them. And until now there has been no shortage of people looking to put money into A$ fixed deposits or lend money to Australian banks. But a firm currency is crucial to these flows as the yield pickups over US$, yen or S$ rates that look so attractive while the currency is firm offer no compensation if the Aussie starts to weaken.
The problem is that the combination of rising domestic rates, rising commodity prices and low yields overseas that have sustained money flows into Australia looks to be running out. And with the current account deficit 6.7% of GDP any cessation of money inflows is likely to see the currency fall sharply. Given this policymakers face a dilemma. Interest rate hikes, needed for inflation, risk making the end game for the Aussie tougher by allowing an even stronger currency and an even bigger current account deficit in the short term. Tax increases would cut the deficit but should have been done years ago. All in all a soft landing for the Aussie looks unlikely. And a sharp fall in the currency will make the stresses in the economy and financial system that much worse. 17
Aussie & Yen prediction 8th July 2008
a b
c x
a b
c
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Perfect Storm – published 7th July 2008
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Falcon CapitalPan Asia Fund
The Perfect Storm is brewing!The bear market that began around nine months ago is still to play itself out. We are on the verge of a pending“Perfect Storm”, where the following issues will start to impact investor sentiment:
Deleveraging of Australian mortgages, corporate & consumer debt will impact credit growth and asset qualityfor the banks
As the Australian economy hits the brakes the Global Commodity Cycle is also slowing.
The Australian dollar will experience significant turbulence at the same time as Japanese investors repatriatetheir Australian high yield investment funds back to Japan into Yen denominated accounts and equities.
Australian Equity analysts are yet to downgrade their 2009 earnings estimates.
New Zealand Banks first & with Australian Banks to follow
Last week there was a freeze of redemptions in New Zealand property funds, which locked up NZ$1.34bn ofinvestors’ money. The panic over the open-ended property funds shows concerns hitting more mainstreamrespected financial service franchises, at a time when the New Zealand domestic economy looks to be entering asignificant decline and in particularly the highly leveraged property market.
The New Zealand situation is deteriorating at a pace that could precipitate depositor concerns about the health ofthe New Zealand banks. A financial crisis in New Zealand will directly ricochet into Australia since major Australianbanks have 15-25% of their lending in New Zealand. Banks in both New Zealand and Australia have very highloan-deposit ratios, resulting in massive dependence on wholesale funding.
20
1993 1995 1997 1999 2001 2003 2005 2007 2009
21
18
15
12
9
6
3
0
-3
% YoY
New Zealand median house price growth
For these reasons we recommend a zero weighting in Australian banks. For like New Zealand, there has been aconsumer debt-driven bubble of massive excesses in Australia further fuelled by the following wind from thecommodity boom.
The domestic economy is now unwinding just as the oil led commodity index is showing growing evidence ofcracking.
Macro investors should bet aggressively on falling interest rates and a weakening currency in Australia. But bothtrends will not be bullish for Australian banks which absolute-return investors should remain short. As for relative-return investors in Asia Pacific the increasing likelihood of significant Australian dollar weakness over the next 12months or more is another reason to run a massive underweight in Australia. This should be funded by anoverweight in Japanese domestic stocks, including Japanese Banks.
The financial excesses of the credit bubble were not just confined to America. Rather this is a global phenomenonwhere the greatest excesses have been where the Western free market model has been most vigorously practised.The model has been fatally compromised by the only too evident view of the relevant financial service sectors thatthe relevant governments and central banks will always bail them out of a problem.Investment flows into Aussie and Kiwi dollar instruments from the Japanese have already begun to slow (seebelow).
Source: Jones Lang LaSalle, Reis, CB Richard Ellis Oct 2006
Perfect Storm – published 7th July 2008
21
The Japanese withdrawal from exposure to Australian & NZ high yielding currencies is slowly gatheringmomentum . The Japanese enthusiasm for the high yield on offer in Australia & New Zealand and the willingnessto ignore the obvious currency risks have been well documented. The Japanese investment trust industry hasinvested Y2.9tn (AUD$30 billion) in Australian bonds and another Y511bn in New Zealand bonds as at the end ofJune 2008 (see below)
USA5.6
Australia2.9
Germany1.6
France1.4
Italy1.2
UK1.2
Norway0.8
New Zealand0.5
Denmark0.4
Others3.4
Source: CLSA Asia-Pacific Markets, The Investment Trusts Association of Japan 2008
At present there has yet to be a panicky withdrawal of funds by the Japanese , but the stampede for the exit willinevitably come.
10
9
8
7
6
5
4
3
2
1
0
% Australia’s Non Performing Loans NPL’s
1990 1992 1994 1996 1998 2000 2002 2004 2006 1H08
Perfect Storm – published 7th July 2008
22
The long-term problem for Australian Banks will be rising Non Performing Loans. (NPL’s) These have barelybegun rising. The NPL ratio for Australian banks is now only 0.4%, compared with a peak of 9.1 in 1992. (Seeabove)
The issue for banks in both New Zealand and Australia is that the rapidly weakening economies means that theywill be forced to lower lending rates as both the Australia and New Zealand central banks start cutting ratesaggressively in coming months. But the problem will be that deposit rates will not come down nearly as quickly.One reason why is that the Australian and New Zealand currency bubbles have finally begun to bust. The NewZealand central bank has already cut once but a lot more rate cuts are coming since short term rates are still8%. As for Australia, the central bank faces a problem of a two tier economy, in the sense of the strongcommodity driven economy in the West and the weakening housing market in the East of the country.
While the Australian central bank refrained from cutting rates in July 08, the situation, presents an idealopportunity for macro investors to bet aggressively on falling interest rates and a weakening currency.
CommoditiesThe break of oil below US$120/barrel surely signifies the commencement of a medium term correction in oil andthe related commodity index. We would not be surprised to see oil now drift toward US$100 per barrel or lowerduring this medium term correction, a period during which commodity and other cyclical related stocks should beexpected to underperform. This will occur in the context of a continuing recognition by investors that growth iscontinuing to slow.The oil correction is occurring as expected in the context of a strengthening USdollar. We expect the US dollar to rally more because US consumption is slowing sharply and the US currentaccount deficit is about to decline even more sharply than it already has done. Such a dollar rally will gainmomentum if the American currency breaks 75 on the US dollar index.
The break down in the oil-led commodity complex will curb the inflation scare in both the West and Asia that hasgenerated so much noise this year.
As for Asia, with the inflation scare about to disappear, the asset allocation recommended for dedicated equityinvestors remains to get out of commodity and cyclical related stocks and into interest rate sensitive stockswhich will be viewed as beneficiaries of a weaker oil price. The obvious structural underweight in Asia Pacificremains Australia.
07 July 2008© Falcon Capital Group 2008. All rights reserved. This publication is intended to provide general information only and has been prepared byFalcon Capital Pty Ltd (ACN 119 204 554) (AFS License No. 302538), the issuer of the Fund, without taking into account any particular person'sobjectives, financial situation or needs. Investors should before acting on this information, consider the appropriateness of this information havingregard to their personal objectives, financial situation or needs.
Offers of interests in the Fund are contained in the Falcon Capital Information Memorandum (IM). A copy of the IM is available from our website:www.falconcap.net or contact Client Services on 0411886155 or email [email protected] You should consider that IM and seekprofessional advice before making any decision about whether to acquire or continue to hold an investment in the Fund.
Perfect Storm – published 7th July 2008
Aussie/US$ prediction – 30 July 2008
23
Falcon Presentation – Roadmap June 2008
24
ASX 200 Roadmap – Oct 2008
ASX 200
AnxietyDenial
Capitulation
Fear …FUDD
Financial woes/deterioration Economic deterioration → stagflation
Panic
Despondency
Desperation
•Earnings decline•Margins compression•Market continues to de-rate•Trust and confidence continue to fade
Euphoria
Macro Inflexion point
•Credit cycle deteriorates rapidly which impacts growth
Growth, Momentum, Buyout, Earnings revisionsStyle rewarded: Macro, Value, Contrarian Technical, Risk (Debt, cash flow)
Investors talking bearish but trading with a long bias.
Lynchpin: trust is failing.
Bear market will continue until ~mid 2009. Markets (as opposed to earnings growth) will bottom first, while sectors (as opposed to country allocation) are the key to create alpha in a bear market… focus on sector rotation.
Top-down strategy shines at economic inflection points when investors need perspective – discrepancy lies between top-down estimates and bottom-up estimates – do not rely on analysts... especially at major inflexion points and also at the C wave decline (or economic deterioration phase).
a
b
c x
25
ASX 200 Australia Roadmap – July 2008
ab
cx
ab
cEarnings certainty is now critical...
Valuations are misleading... EPS down grades to continue FY09 sticky and just starting...
Domestically growth rolling over under the weight of de-leveraging. Expect asset deflation and product inflation risks to become apparent.
Rolling over phase of the business cycle: Rising inflation & domestic economic slowing down. Capacity constraints remain.
The effect of the EARNINGS BUBBLE & the inflection point of the earnings cycle remains the key risk for equity market FY09 EPSg...
Substantial earnings downgrades follow over 2 years with slowing economic growth and then rising inflation...
Higher B&DD drive Bank downgrades but FY09 EPSg still at risk...
Technical, Risk (Debt, cash flow)Macro, Value, ContrarianGrowth, Momentum, Buyout, Earnings revisionsStyle rewarded:
Anticipation
Confirmation
26
MSCI Asia ex Japan Roadmap
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
Crisis has now moved to the next, more damaging
phase.
This phase is about real economic
slowdown & losses in regular banking
business.
Risk aversion continually risesCredit contraction intensifies
Cost of capital increases – investments shelved
Lack of confidence curtails spending & discretionary spending power failsFinancial
sector problems will
rumble on.
Chinese buying spree stokes inflation, but is mismatched with productive capacity of eco
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09
Weak earnings intensifies, especially for manufactured exports
Central Banks tighten policy and then orchestrate loosening
Confidence falters and recession hits
Export order cancellations increase
Commodity prices crash as Asian demand collapses
Bad debts in banking system rise
Chinese mal investment exposed
ab
c x
a
b
c
Deflation theme becomes prominent then Inflation… watch US30 yr GB
C wave: phase wherethe real economy is being impacted negatively… expect ongoing earnings deterioration.
27
Japan Roadmap – Oct 2008Nikkei 225
Anxiety Denial
Capitulation
Fear …FUDD
Financial woes/deterioration Economic deterioration → Deflation → Inflation
Panic
Despondency
Desperation
Euphoria
Macro Inflexion point
•Credit cycle deteriorates rapidly which impacts growth
Growth, Momentum, Buyout, Earnings revisionsStyle rewarded: Macro, Value, Contrarian Technical, Risk (Debt, cash flow)
Lynchpin: trust is failing.
Top-down strategy shines at economic inflection points when investors need perspective –discrepancy lies between top-down estimates and bottom-up estimates – do not rely on analysts... especially at major inflexion points and also at the C wave decline (or economic deterioration phase).
Mean Reversion, Value (P/B)
Complacency
Contempt
Caution
Confidence
Conviction
Optimism
Excitement
WORST OF BEAR MARKETWash out - Prices decline relentlessly.Selling breadth, nowhere to hide.Volatility high.Fundamentals ultimately collapse in response.White candles in sequence signal reflex rally is due.
BOTTOM OR POINT OF OPPORTUNITYLarge degrees: financial crisis, question of existence, survival.Intermediate degrees: recession, “panic” and FUDD.Minor degrees: accompanied by “bad news” and market immune.
ab
cx
ab
C Bear truncation
ReliefHope
"C" waves — Declining "C" waves are usually devastating in their destruction. They are third waves and have most of the properties of third waves. It is during this decline that there is virtually no place to hide except cash. The illusions held throughout waves A and B tend to evaporate and fear takes over. "C" waves are persistent and broad.
New leadership emerges
•Earnings decline•Margin compression•Market continues to de-rate•Trust/confidence fade
ELLIOTT WAVE COUNT: Instead of a b c x a b c and then wave 1 with a wave 2 correction could turn out to be a major A B and now mature C.
Contempt
Acute phase shifting to chronic phase
Anticipation shifting to confirmation…
28
DOW JONES INDUSTRIALSFailure by the US to distinguish between a liquidity versus solvency issue and once more deal with the problem by throwing money at it risks pushing up
commodity prices up further in the short term. For Asia inflation risks remain on the high side. It also means
monetary policy will remain tight and tighten further in some countries, to the detriment of domestic demand.
The world economy is in for a protracted downturn.
1) The worst housing recession in US history. House prices decline 20-30% from their peak.Prices already down 15% and falling.
2) Downgrading of the monoline insurers.Rating agencies cut AMBAC & MBNA AAA ratings.
3) Bankruptcy of a large regional or national bank. …. Bear Sterns, Indymac, Fannie Mae, Freddy Mac
4) Liquidity drying up in a range of financial mkts: incl. interbank & money mkts.ACHIEVED LIBOR rose after Fed cut rates on 18 March.
12 STEPS TO CAPITULATION
5) Meltdown of the commercial property market.Commercial property from NY to London are seeing declines in capital values.
6) Further collapse in stock prices.S&P500 now in bear market territory.
7) Further losses, beyond the USD250–300b now estimated, for subprime mtgs.US write down & credit losses now USD296b.
8) Big losses on unsecured consumer debt: credit cards, auto loans and student loans
9) Big losses on reckless leveraged buy-outs by private equity firms.
10) Meltdown in the “shadow financial system” hedge funds & special invest. vehicles
11) Wave of corporate defaults.12) A vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales
of assets at below fundamental prices.
ROUND 1 - The 12 points apply to US asset markets. As the US is the source of the global contagion impacting emerging markets it can be used to asses the position in the stock mark cycle of most markets. Subjective analysis indicates that seven of the 10 signals have been confirmed. The signal from this road map confirms the view that the bear market is not over, we are in the early part of the second half of the cycle.... which is the long drawn out segment of a credit unwind (develeraging cycle)...
ROUND 2 - Next phase … Actual contraction in GDP … neither tax rebates nor lower interest rates nor massive liquidity injection will forestall a severe retrenchment in consumer spending, stem sub prime losses or revive
risk appetite.
2 steps to financial meltdown …Potential time to buy stocks 29
Style and thematics – Oct 2008 Style Rewarded Style
Punished
Macro – Top down
Technical
Risk (CAPM, Strong Balance sheet and Cash flow)
Soon shifting to:
Mean reversion
Value (P/B)
(NB to justify high P/B need high ROE).
Growth
Momentum
Contrarian
Earnings Surprise +
Micro – bottom up
Buyout
Value –(now a trap)
P = f (V, I, X)
Themes Rewarded
Themes Punished
Aging Lifestyle – Drug/FoodAging Lifestyle – Healthcare/
Services/OtherAgribusiness Carbon FibreChina – domestic relatedClean Air / WaterCommodities (Volatile but intact)DefenseEnergyEnvironmental BusinessFinancials in emerging marketsGoldGovernment Selling StockHighly liquid issues… in burstsInflation (Food and non-Food)Islamic BankingJapan – Depressed ValueJapan FinancialsLED lightingMachine Tools (Robotics)Nuclear PowerWind
Agi
AircCasConConFinde-HanIndiInfrMBShipShipSolaTec
ng Lifestyle – Medical IT/ Imaging
raft & Travelino / Gamingstruction Machinerysumer Finance
ancials –(in developed economies leveraging will take years).d & Other Toolsa Related – (positive long term)astructure
O Candidatesbuilderspersr Powerhnology
Risk aversion: all small, mid and large caps are vulnerable… magnitude is more so with the smalls.
These thematics are yet to be confirmed by relative strength…need to wait for the dust to settle… 30
31
Alphabet Economics – Dec 2008
Outlook
Speedy Recovery
Depression
Mild RecessionLong drawn out recovery
Severe RecessionLong drawn out recession
Upturn
V-Shaped2001
U-Shaped1990
W-Shaped1981
L-Shaped1929
Comment
After slipping into recession in the third quarter of 2008,G3 growth resumes in 2009 Q2. This would be in line with an average duration of every recession in the postwar period.Probability: 5%
Aggressive central bank easing and a quick resolution to G3 banking sector leads to a recovery taking hold in the second half of 2009.Probability: 15%
Banking sector problems lead to a collapse in consumer and business confidence. Economic output contracts for the next 18 months and a recovery only starts to emerge mid 2010 as the process of de-leveraging runs its course. Probability: 45%
Banking failures spread around the G7 nations. Equity markets & house prices collapse further. Unemployment rises rapidly & deflation takes hold. World economic activity contracts for the next four years. Probability: 35%
Whichever way the economic path transcends … the likely outcome will be one of muted growth for many years to come.
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… and eventually a new long-term inflation cycle
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