Hong Kong asset market in state of siege

Like the GCC, Hong Kong is forced to raise interest rates at a time when its economic growth slows and its stock and property markets are under pressure. The economists call this “a suboptimal currency area” since the business cycle of the US and Hong Kong are no longer synchronized but the currency peg devastates the local stock and property markets. The Hang Seng index is highly correlated to the monetary liquidity in the Hong Kong interbank markets and inversely correlated to a spike in HIBOR. This linkage is even more pronounced for Hong Kong property stocks, notably Sun Hung Kai Properties and Henderson Land, whose shares can well fall 20% in 2016. The Dragon is wounded and its fire will gut the Hang Seng property index, just as China’s crackdown on corruption destroyed the value case in Macau shares.

I find it alarming that the three month Hong Kong Interbank Rate (HIBOR) has now risen above the three month LIBOR for the first time since the 2008 global financial crisis. The three month HIBOR rate has nearly doubled in the past month due to speculative attacks on the Hong Kong dollar peg and the exodus of Chinese flight capital as Shanghai shares fell 22% in January 2016 alone. The rates on the interbank market could rise by at least another 100 basis points in 2016. George Soros’s bearishness on China, awful PMI numbers and a crisis of confidence in the ability of Chinese policy makers to manage a securities markets, the lifeblood of a capitalist economy. China’s $28 trillion credit bubble, the biggest credit pyramid in human history, means a Japan style lost decade for the People’s Republic’s $10.4 trillion economy. This means the world faces a ten year bear market for Chinese equities, crude oil and the emerging markets, when the Morgan Stanley EM index could well fall another 25% to 540. As capital flows accelerate from China, I expect the People’s Bank to stun the world financial markets with a shock devaluation in the Year of the Monkey. This is the reason China H shares trade at six times earnings. This is the reason the Hang Seng index has fallen below 19000. This is the reason the Bank of China, founded by Chairman Mao, trades at three times earnings. This is a financial Great Leap Backwards for the Communist Party.

Lord Rothschild advised to buy when “blood runs on the street”. Asian Pacific shares now trade at valuation bottoms last seen during the 2002 (SARS) and 2008 (Lehman) bottoms. As in the GCC, panic selling by offshore funds has crated deep value bargains even though Asia is a growth warrant on the global economy. Asia is also the epicenter of the shock waves from China’s economic hard landing, FX and debt shocks. If the US economy slips into recession, all bets are off in Asia. The world faces history’s first “Made in China” global recession, as I argued so often in this column in the past year.

2016 is a US Presidential year that could well see Donald Trump move into the White House, the Chinese yuan devalue by 15% and Brent crude fall to $20 a barrel. A world in which the Saudi Tadawul, Shanghai A shares and Wall Street money center banks fall 20 – 24% in a month is a world begging the Federal Reserve to reconsider its planned four rate hikes in 2016. The world desperately needs a rate cut but the Yellen Fed is a central banking Nero, fiddling while Rome burns. In such a world, as Madonna’s Material Girl once observed, the guy with the cold hard cash is always Mr. Right!

In retrospect, my strategy idea last week to buy the Canadian dollar at 1.45 for a 1.38 target proved highly profitable. Janet Yellen’s dovish FOMC statement spooked Wall Street as it did not rule out a March rate hike but it also sapped the US dollar uptrend. The mere hint of a Russian-Saudi output deal led to the mother of all short covering rallies into Brent, up almost 20% from its January lows to $36 a barrel. Canada, as a classic petrocurrency, (oil and gas is 25% of exports) naturally benefited from spikes in Brent. The fall in the Chicago Volatility Index (VIX), a global bid in risk assets and a shock Bank of Japan rate cut helped the Canadian dollar soar from 1.45 to 1.3950 last week.

Financial distress in Alberta and Prairie home prices (Regina, Calgary, Saskatoon) do not allow me to be secular bullish on the loonie, as I doubt if Canada GDP growth in 2016 will top 1.2%. The Fed funds/Eurodollar futures markets on the Chicago Merc now price one rate hike in 2016, not the four implied by the FOMC dot plot. There is a $4.6 billion net short Canadian position in the Chicago futures markets that must be squared as the foreign exchange market dials back its prospects of US monetary tightening. Yet the grim realities of the oil glut, Texan shale technologies, post sanctions Iran, Saudi Arabia’s unwillingness to be OPEC’s “swing producer” and limit up storage capacity mean the secular bearish trend in oil and the Canadian dollar will resume. Take profits on the long Canada trade at 1.39 with a stellar six figure profit since the 1.45 trade entry level.

The Russian rouble’s epic collapse to 81 provided an opportunity to finally buy the worst performing major currency in emerging markets. I can envisage the buy/sell range on the Russian rouble at 81 to 72. Russia is in recession, with a 4% GDP decline.

The 60% fall in the Russian rouble after Putin’s Crimean Anschluss was the trade of the century (though I concede this is only 2016 and there are 84 long years to go in this century!). Sadly, family office investors in the Gulf were devastated by unhedged positions in Russian rouble denominated debt, notably in the notoriously volatile OFZ and rouble Eurobond markets. The long term economic prospects of Russian are awful as the oil/metals bear market takes its toll and capital flight rise to its highest level since the fall of the Soviet Union. I expect the Russian public, with bitter memories of the rouble free fall and banking dominoes in August 1998 and August 2008, will do the rational thing and switch out of rouble deposits into US dollars. This could force Russia to impose capital controls. Expect billions of Russky dollars to suntan in Panama, Cyprus and the lakeside money souks of the Swiss Alps.

The collapse in the Russian rouble will unhinge inflation expectations (CPI is now 12%) and threaten Putin’s pensioner/fixed income constituency that lives outside Moscow and St. Petersburg. This could have a geopolitical impact if the Kremlin agrees to a negotiated end to the Syrian civil war in Vienna. This could, in turn, set the stage for a Russian-Saudi Arabian diplomatic rapprochement and oil output deal. This would ignite a bull market in Russian OFZ bonds as the central bank in Moscow cuts its 11% money market rate.

Sterling was last a petrocurrency during the North Sea oil bonanza of the early 1980’s. Yet I am shocked to see sterling plummet from 1.70 two years ago to below 1.42 on cable now. Planet Forex has concluded that the sceptered isle will leave the European Union (the Brexit scenario). Sterling’s 7% fall in the past three months is hugely correlated to the collapse in money center banking shares, thanks to the City of London’s role as a global finance hub. UK credit default swaps have also risen in 2016. I remember cable trading at 1.58 only last year and the gnomes of Bishopsgate brace for an Old Lady base rate hike. Mark Carney has done nothing to boost the sterling and the UK current account deficit is its Achilles heel at 4.5%. I remember cable was a buy on the eve of the Scottish referendum and the general election. Is June Cameron’s D-Day on the EU? Will wage inflation finally force Carney to act? Is 1.40 cable a historic level to, as in 2009, buy sterling? Finally buy sterling?

I can barely believe the green phosphorescent flicker of the Bloomberg screen. Citigroup trades at 39.7 as I write this column, down 24% for 2016, even though 2016 is all of one month old. So what has spooked Wall Street? Energy loan losses? A Lehmanesque contagion event in China during the Lunar New Year? A US housing collapse? (Get real!) Emerging market horror stories? I concede Citigroup is the eye of the storm in every global macro angst on Wall Street. Yet America’s ultimate global money center bank has a net tangible book value at $60. The Federal Reserve raised rates at the December FOMC but the ten year US Treasury note yield has fallen to 2.04%, a flattening of the yield curve that compresses net interest margins. Yet Citigroup is priced as if the US is heading into a deflationary, Japan style lost decade. This is nuts. As usual at a time when the jobless rate is 5%, gasoline prices have “tanked” and the Case Schiller index shows a robust US housing market. Bank loan growth, credit cards debt and US mortgage credit are all accelerating.

Citigroup now trades at 0.68 times tangible book value, a metric that is unreal for a $1.9 trillion asset too big to fail bank with a footprint in 160 countries that generated $17.2 billion in net income in 2015. Wall Street has priced in a very significant deterioration in earnings that is simply not credible to me. Of course, the memories of 2008 (and even 1991) should haunt any investor in Citigroup, when Uncle Sam was the white knight after Chuck Prince’s toxic mortgage debt team in New York accumulated $50 billion losses and wiped out shareholder capital until the government TARP bailout. The Citi tagline read “Citigroup never sleeps” and neither did its depositors and shareholders. So is 2016 a rerun of 2008, banking déjà vu? Absolutely not.

Citigroup is one of the world’s best capitalized banks, with $147 billion in capital and a Basel Tier One ratio of 12%. Citi Holdings, “bad bank”, 20% of assets or $500 billion in 2009, now has a mere $100 billion in assets, mainly North American credits that are profitable. Citi has $12.6 billion in loan loss reserves. The plunge in oil prices hits energy lending but is a ballast for the Global Consumer Bank. Citigroup’s leverage ratio was slashed under both Pandit and Corbat to its current 7%.

True, as Banamex demonstrated in Mexico, emerging markets banking is black swan prone, yet Citi’s clientele in the Third World is primarily multinational corporations, not debt laden local corporates or sovereigns. Capital markets revenue will be tough in 2016 but the rise in volatility is positive for the bank’s vast rates, currencies and OTC derivatives businesses. Now that Citigroup shares have fallen 32% from their most recent peak, I believe the bank trades at 6.8 times earnings. This is not just inexpensive. It is absurd, as long as Wall Street is not pricing another a systemic risk spasm in international, another Lehman/LTCM/Continental Illinois/ Creditanstalt scale debacle. The credit default swaps, the US Treasury yield curve and the Treasury Eurodollar (TED) spread simply do not reflect the systemic angst of bank equity investors on the NYSE. This is the reason I buy Citigroup above 39 for at least a 46 target.

I had recommended shorts in the Singapore dollar since late 2014 when it was obvious that trade/capital flows would contract in Southeast Asia. This happened with a vengeance in 2015. The Singapore dollar has since depreciated from 1.34 to 1.43 against the US dollar. While I agree that the Singapore dollar is a managed currency (MAS uses the exchange rate as a primary tool of monetary policy) it remains a classic proxy for a China hard landing, regional trade and political woes, despite the Republic of Singapore’s AAA credit rating. Singapore is afflicted with an imminent property crash, its Big Three banks will be forced to write off China loans. Commodities and the reexport business to the Middle Kingdom face a Black Death. The Singapore Inc. business model is dependent on Big Daddy in Beijing and Big Daddy is in deep macro doo doo now. I remember the Singapore dollar as a safe haven in 1997 and in 2008, a Southeast Swissie since it outperformed the ghastly falls in the won, rupiah, ringgit and baht. In fact, Sing/rupiah spiked 50% in the fateful summer of 1998 when Indonesia’s banking system went bellyup, anti-Chinese riots swept Java and the Suharto regime was overthrown. My call? Sing 1.52 by June.