It's Still Hitting the Fan in Subprime
According to the ABX indices at markit.com, the “subprime contagion” (which has now spread to products that had virtually nothing to do with subprime) is still gashing collateralized debt obligations left and right. Much as it did approximately three weeks ago, the business media has prematurely heralded the end of the subprime blowup.
The famous BBB and BBB- CDOs haven't gotten any better, according to the ABX. Admittedly yesterday's news, but things aren't exactly "contained"
(bbb and bbb-)
What about the "A"-grade CDOs?
Not so good, either:
That said, I have never shared the same degree of pessimism as Barry Ritholtz, Yves Smith, and other uber-bears on this issue. Everybody read about the spectacular self-immolation of the Amaranth fund, but nobody read about how most of Amaranth's money flowed to Centaur, the Houston-based energy fund that bet against Amaranth which won a multibillion-dollar pot when Amaranth folded. Similar dynamics apply here; the flagship investment banks are in the process of forking out billions to hedge funds which bet against them. That is healthy, buccaneering capitalism. Considering the old joke that economists correctly forecast nine of the last two recessions, the subprime-Armageddon crowd will soon accomplish the heretofore impossible feat of making economists' track record an enviable one.
Puzzlingly, last week's super-rally and Friday letdown were accompanied by a fall in interest rates. The 10-year bond is now at 4.95%, a miraculous turn of events for the likes of the Blackstone Group, whose equity holding company (BX) lost 30 percent of its value in the week following its IPO. The newsletter does not expect the conjoined equities and bonds rallies to continue.
China Effect, RIP
Another point of interest was a joint Chinese-Singapore 19% stake in Barclays' bid for ABN Amro, accelerating a Beijing trend of investing its foreign exchange reserves into Western financial institutions. (China and Singapore will own a combined 11.5% of the planned Barclays-ABN juggernaut; this was after China purchased approximately 10 percent of the Blackstone Group.) Why would the Chinese government be so keen on effectively pumping up certain capstone financial institutions of the West?
I read yesterday that the wages of Chinese coastal cities have gone up approximately 50 percent over the past two years. The "China effect," in which cheap Chinese labor held down global wages, is officially over.
A logical consequence of a controlled currency is contained domestic inflation, but ultimately the government must counteract it through either monetary tightening (not palatable), or exporting that inflation to the outside world. While it was predictable that China would choose the latter, their manner is more puzzling: they are essentially buying stakes in huge piles of bonds (Blackstone, Barclays, and other credit-derivative alchemists) even as they are removing money from US Treasurys. This will stabilize debt markets in the short term, but it will amplify inflation in the medium term, whether or not the Fed comes to its senses and alters its archaic “inflation ex food and energy” (incidentally the two areas in which inflation is skyrocketing). Wasn't inflation ex food and energy the brainchild of Arthur Burns, possibly the worst – and most inflationary – Fed chairman of the last half-century?
Commodities
We rejected the idea of going long on oil last week. Oil prices have gyrated quite a bit since then, but they are at about the same place. We still see the oil risk premium as too high, and we disagree with the options markets' apparent assessment that oil will reach $100/barrel in the next two years. Besides the fact that China's oil demand must decelerate in the medium-long term, oil still has an inordinately high risk premium associated with it, which has nowhere to go but down even if demand rises slightly above consensus forecasts.
Accordingly, we advise that investors remain short oil and commodities currencies, and we recommend remaining long the dollar.
In our inaugural newsletter, we recommended buying French equities on Sarkozy's election. Sarkozy seems much more inclined to the “high road” of “consensus politics,” that fatal poison to free-market principles everywhere. Sarkozy's planned reform package has already been somewhat diluted, its effects have been priced in, and Sarkozy does not seem particularly inclined to go beyond that. Unload the French equities.
Summary
This week we are mildly bullish on the dollar, both for technical reasons and a new apparent willingness of the Chinese government to bribe invest in American financial institutions. That will be highly inflationary in the medium term, but good for the dollar and good for most asset classes in the short term. We are somewhat bullish on the euro (and do not see that changing for a while), neutral on the pound, and bearish on the yen (still). And, of coure, we remain very bearish with regards to Japanese and Chinese equities.
--Alex Forshaw
http://www.bestwaytoinvest.com
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