#1 Investment Weekly – Interference

There has been a lot of talk about how Government intervention has helped prop up economic activity recently. Stimulus packages may be the devil incarnate according to History buff, Niall Ferguson, with dire, long-term, consequences for budget deficits, but short term traders are not interested. Paul Krugman believes stimulus is a necessary evil if we are to get the world’s economies moving again. The mandarins in Beijing agree with the latter view, but only on the premise that once in a while, horns need to be reined in – just as they are doing so now.

The problem with the Ferguson/Krugman argument is that both live in that iron-rice bowl known as tenure and in the great big goldfish bowl of academia. Neither have any credibility – but its been fun to watch this Trans-Atlantic brain tussle. While both are right that piling on debt is only going to lead to trouble in the long term and the market should decide, while stimulus packages/rescues were necessary and big government is important right now, China’s leaders are probably looking on wondering what all the fuss is about. Beijing started the stimulus well before anyone else, allowing the Shanghai Composite to rally from its low well before the rest of the world officially called the end of the bear market. So, it is appropriate that China, who can now lay claim to being the foremost authority on such matters, is the first to tweak the faucet.

I am sure that Beijing is watching the medium term uptrends of both Hong Kong and Shanghai very carefully, making sure that neither index falls below their trend lines. They are not want to undo all their good work turning around confidence in equities. So, I see buying opportunities in Shanghai (if you can get hold of A shares), while Hong Kong has more downside, but the buck must stop at 19,000 to avoid some sharp technical selling. To ensure that this does not happen, I’m sure that Beijing’s mandarins have had a quick peek at some of the first half earnings numbers and are betting that they should be sufficiently encouraging to keep the bulls happy, and give those nasties that were piling on the puts last week back in their rightful place. While that scenario plays out, the index is likely to swing around in a narrow band.

I’m sure, as well, that the authorities are aware that the shortest bull market’s in Hong Kong’s recent history both lasted 11 months and that a halt to the recent recovery now would set a major precedent. In fact, just to match a normal bull market return, the index has to reach about 30,000 by May next year (I’m assuming that we don’t have a 911 type market because it’s impossible to predict such events).
HS Index bull-bear phases

In other words, there is still another 50% before we reach a normalized return. Finally, everyone knows that Hong Kong bull market cycles always end with a PE multiple of +20x. Therefore, the conditions are not ripe for an end to the current bull cycle, and the upcoming results season, plus the occasional piece of Government-inspired good news should keep both markets afloat.

The earnings season in Hong Kong has just begun with those China-focused bankers at Bank of East Asia, as always, laying themselves open to scrutiny first. The HK$384 million or 48% increase in first half net profit looked impressive. However, there was a positive HK$1.4 billion swing in investment profits which meant there was HK$1 billion which didn’t show up on the bottom line. The breakdown of the disappearing profits was evenly split between: lower net interest income, higher operating expenses and higher provisions. Interestingly, there was no change in impairments to China customers, but a 47% jump in Hong Kong customer delinquency. The real killer was a 300% surge in overseas delinquencies (is this why it sold its Canadian banking business to ICBC?) We shall never know. The stock has underperformed the HS Index by 10% since the beginning of June, and these results are not likely to manipulate that trend much.

You’ll be glad to hear that Hong Kong’s stock market regulator is finally putting those end-of-day auction-manipulators out on the streets. They aren’t being thrown in jail, but rather the SFC has suspended their prison sentences or their licences. Bank of China’s shares seemed to be a common target for the two known cases (a private investor and a broker from Corporate Brokers) which both took place a year ago. Fortunately, the suspensions should put an end to any prospects of re-introducing day-end auctions. We can’t have amateurs illegally manipulating equity prices, when we have a Keynesian behemoth up north doing it Krugman-style for us.

#1 Investment Weekly – What recession/bear market

The whole financial world has gone mad. Apparently, while I was away on my usual summer holidays, a big part of the European economy pulled out of recession and China’s stock market entered a bear market. Although the first statement could be technically correct, the audience has no idea what it means, while the other technicality is pure poppycock, which well-informed China watchers have summarily dismissed.

Europeans (the British in particular) have no idea about what drives their economies because they are poorly informed. Business is hardly mentioned in the broadsheets, except when the politically-correct bank-bonus bashing begins again (Tax payers to underwrite final payments to failed bankers etc). Television newscasters seem to have very little idea what they are talking about when it comes to report on financial markets, and air time is limited to five minutes of fumbling. Compare this to the hours of time spent discussing financial markets in Hong Kong where news channels are dedicated to only discussing the stock market, and where even the main evening news has a special half an hour discussion. Newspapers also have full, separate sections on all aspects of the world’s financial markets. When you tell a European that you are a stock market specialist, their eyes glaze over, and series of apologies about their ignorance follows. This is a very worrying trait, because as Europe’s economies continue to have their manufacturing industries hollowed out by the cheaper powerhouses in the East, financial markets will grow in stature to such an extent that it will overpower everything else in terms of importance to their GDP. This is already very obvious on the ground.

While there is no doubt that unemployment has risen in the UK/Europe, the so called recession, that the newspapers and economists continue to pound on about, seemed very muted. The streets were still crowded with shoppers, and getting served at a shop was particularly difficult, because, while head office may have cut back on staffing levels at the shop floor level because of the losses at their treasury departments, traffic in shops seemed just as high as they were the last time I was in the UK, in the summer of 2006. I have to admit that Oxford is not typical of the whole of the country, but my travels to London and (briefly) Bristol, did not seem to be too much different. Streets were packed of consumers. A visit to Blenheim Palace (cost: 10 pounds a head) on a weekday was typical, with the car park extended to another field to accommodate the number of visitors. Paris was packed as usual, although numbers were supposed to be down 16%. However, this is compared with what? I got the impression that, while there has been a decline in economic activity from the heady, 2 standard deviation days of 2007, if one draws a long term trend line, I would suggest that the line is still pointing upwards, and that activity has simply returned back down to the line. Perhaps then, Europeans’ naivety about financial markets and economics is probably a good thing, because what is happening on the ground cannot be translated into a series of numbers that make sense to the masses. The Labour-backing Daily Express’ headline, “UK recession is over”, of August 13th, was a nice piece of propaganda. The rest of the UK press was busy shoveling out the usual titillation that the masses seemed to need on a regular basis. The Express made it look like the headline was official, but in fact it was only the opinions of a couple of economists.
HS Index and Shanghai Composite

In the meantime, back in Shanghai, the talk of bubbles that has been brewing for weeks, finally spilled over into a sharp pull-back in the Shanghai Composite. It moved from the top of its medium term trend line to the bottom, in quick time. Hong Kong sort of followed, with some very erratic trading in thinning volume. As I predicted on July 20th Investment Weekly – Just what the DR ordered, the A-H Premium Index crashed to an intra-day low of 121 on August 19th. As far as I can tell, the selling in Shanghai was driven by momentum on the downside, from an inflated position. There are no signs that Shanghai has just completed the shortest bull market in history.

As I’m quite convinced that China has not just pulled off the worst bull market in history, I’ve decided to double up on the model portfolio’s investment in China Wind Power. It is not a usual tactic of the portfolio to buy a stock at a price higher than the original entry point, but China is likely to announce more measures to boost its green industries ahead of President Obama’s visit to China in November. The addition will barely add to the risk/reward balance of the portfolio, as the beta has risen to 1.49 since April’s 1.45.

This week’s action, whether in Hong Kong or Shanghai, will be determined early in the week when important moving averages need to be tackled. For the HS index, the 20-day average is a tantalizing 300 points away. A gain of about that amount would lift the index above its parabolic and allow it to test the top of the Bollinger Band of 21,100. However, a move to the top of the band will bring out more profit-taking, allowing the current consolidation phase in the bull market to continue, and thus allowing the bears to continue their attempts to test the resolve of buyers.