Lessons from 1929

They say history repeats itself. Like a wave, it repeats itself again and again albeit with different characters. 1929 was well known for its crash, yet we saw crashes after crashes after that. Easy credit was one of the root cause that caused Wall St to soar to stratospheric heights, when eveyone from barber to shoe shines were talking about the market. Stock prices were moving like they have their own lives. And we saw that happened in KLSE '93. Soros well known for its speculative activities, in 1929 there were speculators too. So let's pause awhile and watch the video (http://video.google.com/videoplay?docid=7233622324068640582&hl=en)

Recession Blues

Technically, an economy is in recession if the GDP shrinks by 2 consecutive quarters. While this year’s celebration of CNY is muted and subdued in Kulim ( I believe it’s the same for the rest of Malaysia), I don’t see any strong evidence of a massive crash like the one we are seeing, reading or hearing everyday in US, UK and Europe. STAR reported 12,000 job cuts on Tuesday alone in US which affected all industries. It was 71,000 layoffs on Monday. All together 211,000 jobs have been lost in the month of January alone in US. What is peculiar is not only losing company are slashing jobs but profitable companies like Microsoft which announced $4 billion quarterly earnings are retrenching to the tune of 3,000 job cuts. This implies that the management is expecting a longer and deeper recession beyond 2010. At this moment US and UK economy is going for a free fall. Financial institutions are the most vulnerable. Unfortunately also, they are the heart and soul of the economy, not to mention employment and wealth creation. It is a vicious cycle. Remarkable news today is not only companies are falling like a pack of card but government as well, like in the case of Iceland. Indeed the Titanic has hit the iceberg.

Malaysian economy is expected to slow down drastically after CNY. You will be seeing a lot of hangover blues after Chap Goh Mei. In fact, many won’t have to wait that long as the HR ministry has reported officially 50,000 jobs will be lost. This has prompted Bank Negara to cut interest rates by 0.75% to 2.5% as a pre-emptive measure against economic slowdown. It also reported credit card NPL stood at 2.6% recently. I hope this is true figure. Time will tell.

Anyway, judging from today’s restaurant and food business in Kulim on the third day of CNY, I can say satisfactory. No doubt business has dropped by 30% but this decline is manageable. I believe the number could have been lower if business is willing to slash prices or reduce their profit margin. We have not reached the desperate level of US and UK. The financial institutions are still flush with liquidity. The Chinese have big reserves as they have saved during good times. At the same time, the civil servants are getting increment in pension. By today’s figure, the Malay would have formed nearly 85% of the civil services are they are prolific consumers unlike the kiasu and kiasi Chinese. So the Malays play a big role in generating consumption and investment. The role of government is of great important at this stage. Which is why at this stage, I am still using the word slowdown instead of recession in Malaysia. On a micro level, my estimation is we have a reserve of 18 months till July 2010 before feeling the devastating impact. So if we can stand for another 18 months with the hope that the first light of recovery in US seen by 3rd. quarter 2010, Malaysia will avoid recession. At this moment the odds are only 25% that we will have recession in 2009. Malaysia suffers not from credit crunch but from confidence to lend and borrow. This will be difference between slowdown and recession. I wish all Malaysian Chinese Gong Xi Fa Chai in the year of the OX.

Obama's Mission

Barrack Obama was inaugurated as the 44th. US President after a slip in oath taking ceremony. He will inherit from Bush administration an American economy in the most severe crisis since 1929-1932. He accepted the presidency, with a promise to remake America and claim world leadership. Obama would become the first African American president in history. To call his a black president might not be right as his mother is white. I thought that is only possible in movies. So that is an American Dream fulfilled. In Malaysia, after another crushing defeat in KT, incoming PM, Najib also promise to remake Malaysia. But this is the same filthy emperor in another piece of suit whereas in US it is a complete change in government.

The departure of Bush marks the end of a controversial and violent decade. His cohorts are long gone. Blair was forced out by his party members and Howard was defeated in the Australian general election. 2000 till 2009 is a chaotic time starting with 911, invasions of Iraq and Afghanistan, global terrorist attack, major disasters like the Tsunami and SARS and the current global financial crisis. You have a version of Armageddon.

Citigroup shares continue to plunge to a low of $2.50. This comes after the plan to break the business into 2 core business. Within a space of one year Citigroup has turn from a financial supermarket to a 7-11 store. In the same week, all UK top banks were crushed to pieces. Royal Bank Scotland share price crashed to a low of 10 pence! Barclays massive loss in value resulted in 440 million pounds wipe off for the Abu Dhabi group which happens to be the owner of Manchester City. Immediately, the UK government through BOE launched a 100 billion pounds fund to bail out these trouble banks. The UK government has already acquired 70% stake in RBS and 45% in Lloyds at this moment.

Obama’s administration is mulling on setting a government bank specializing in buying bad assets from troubled major banks. It is similar to the Danaharta and Danamodal set up in 1998. The difference is the Danaharta mechanism was actually created to bail out Dr M’s cronies and Daim’s troubled assets. I suggest the US government buys the toxic asset at face value so that these banks can start lending again and stop the economy downturn. It will get the economy growing again and hence reduce the cost of write downs of bad loans in the future. At this moment, I can’t foresee anyway out as long as these toxic assets are still in the balance sheet and as the economy continues to deteriorate, future write-offs will increase with no change of recovery. The cost of bailing out these banks is less than not bailing out due to its wide systemic risk impact. The credit and capital market faces a severe credit crunch. Immediate action is required.

The breaking up of Citigroup

During the end of last weekend, Citigroup reported another quarter loss of around $8 billion. This brings the total to around $26 billion for 5 quarters since the start of sub prime mortgage crisis. $26 billion is enough to wipe up the whole of Maybank! The result seems to suggest that bottom is still far away. Citigroup is forced to split its business into 2 groups. Citicorp would house the stable and profitable banking business like commercial, investment banking and credit card. Citi would host bad business like loans. This event is significant as it herald the end of the bank holding group era with this development. It looks like Citigroup has to scale down its financial supermarket business to one that fits 7-11 store to survive. I have always maintained that except for the “toxic asset” they held in their balance sheet, its banking business has been profitable. In regards to toxic asset, the US government has agreed to guarantee 90% of the value while Citi will foot the rest. The US government is a major shareholder when it bought $45 billion worth of preference stocks at 10% fixed dividend with an option to convert. The downside is dividend is restricted to 1 cent every quarter for the next 3 years. The last closing price is $3.50 and it has gone down as low a dollar in 1990 during a mild recession. If it does again, I will make my move to swoop the undervalue stocks. Of course I know that Citigroup purchase is risky but I am reminded also on the day Alexender the Great, Napoleon and Hannibal snatched victory from the jaws of defeat at a critical decision decision. I believe now is the time. I am using Citigroup performance as a barometer for economic recovery.

On the political front, BN has lost again. It lost by more than 2000 votes despite spending $250 million for a month’s week campaign. It will badly reflect on Najib, who now has lost 2 consecutive defeats. According to MCA, the Chinese in KT has given solid support to BN with increase in votes. Had they switch, the margin of victory could have been bigger. This is the sentiment you got days before the polling day, as Chinese packed opposition dinner to hear speeches. It looks like it did not translate into votes because the Chinese are “kiasi” and being practical lot. I don’t think Hudud has got anything to do with it. Hudud is not an issue in this by election. The Chinese voted BN because of promises of handouts and threats. Let’s see whether BN will keep its promises. After all, 2012 is only three years from now. At this current sentiment, it is not advisable for BN to antagonize the rakyat again.

The Moon

For the past 4 days, it seems that the MOON or BULAN is big and bright at night. This is the time whereby a lot of mental patients in Hospital Bahagia will go even crazier. They will be in estasy. This can also be interpreted as a good omen for PAS in the KT by election this Saturday. RPK predicted a 5,000 majority vote for PAS candidate. Chinese papers reported that betting syndicate is giving the odd of 9-1 for the PAS candidate. That means at this moment (excluding cheating and vote tampering), BN is staring at a massacre. This will reflect badly on Najib who is poise to take over as PM in less than 3 months time.

If PAS wins, then it is not strange (assuming free and fair election) but what is really strange is by Najib's statement last Friday, re-affirming his confidence that Malaysia will not slip into recession. It seems that Malaysia will buck the trend. Obama had told Americans to expect recession to last for years. BOE has cut interest rate to its lowest level since 1694 because of massive contraction in economy. Singapore PM has told his citizens to brace for the worst. I think in everywhere the sentiment is the same except this great country. At this moment, to be fair, I think there is only 50-50 change we will follow the gang if the recession last one year. If it is more than one year, all bets are off. I can't see why we can be exempted since oil and palm oil prices are falling like nobody business. Not to mention about corruption which is endemic in Malaysia. After CNY, Penang and Kulim will be hit with a violent first wave Tsunami. The latest news I heard from my cousin is Intel will cut 15% of their workforce after CNY. However, it is not known whether it is global or confine to Malaysia only. If it is confined to Malaysia, that would be real bad. In 2007, when Intel starts to offer VSS, everyone was looking forward. Today, the word R is a dreaded word. After all, if you are sacked from the manufacturing sector, there is little possiblity you can get employment in other firms. Unless you go to education which will take this opportunity to squeeze you high and dry. Well at least in WOU, things are not so bad. The VC has guaranteed employment till 2013, provided you perform. It even paid one bonus for 2008. I don't think you can expect one this year. But on the relative terms, consider yourself lucky. It's better than retrenchment or shorter working hour or pay cuts. But because I am a fundamentalist value investor, a deep crisis present good opportunities to buy good business at a deep discount.

BOE Interest Rate Cut

BOE cut interest rates to 1.5%, the lowest since 1694. This underscores the vulnerability of the UK economy which is expected to be officially in recession end of this month. With this rate cut, I expect sterling to depreciate further. I forecast the UK rate will track closely the US rate at 1%. I am expecting another deep cut in 3 months time when global recession hits its peak. I think the rate cut is unavoidable as I have mention that mortgage market in UK is sensitive to interest rate movement. This is to stem the drastic fall in property prices which would pose a systemic threat to the UK financial system. BOE reported fast deteriorating situation of the British economy.

Today, the bears maul the bulls. Looks like the rally is unsustainable with the fall in CPO and oil prices. The current rally is due to the Middle East tension last week. Once situation calms down, the world would be facing a global recession and weak growth in the next 12 months. Penang and Kulim manufacturing sector is bracing for a massive retrenchment, pay cuts and shorter working hour after CNY. So all of us must enjoy our CNY. We must yam yam yam seng because we might not have an opportunity after this for a long time. The winter has set in.

Globetronics announce consolidation of their par value from 10 cent to 50 cent in its bid to reduce speculation and create long term value. I support this decision. It is long over due. But such exercise will not create value in the short term. No cash transaction will take place. Just divide your shares by 5.

Today is the examination board meeting for SBA at WOU. It was a long meeting to discuss the results of 14 courses. The meeting was held up by one course which has a low passing rate. After much deliberation, 10 marks were awarded across the board. This is done after report manipulation and pressure from management to reduce the high failure rate. I did not say a word but I feel the trend in education today is being dominated by consumer power of dollar and cent rather than quality. A high failure rate is blamed on the poor lecturer, difficult content and harder questions. Nobody blamed the students poor quality. Being in this industry of higher learning for 6 years, I think quality of students are dropping by the year. Last Friday, I opened an account with Citibank. Guess what? I was told later that the officer gave me a wrong number! Quality of new bank officers have dropped drastically. They are no longer capable to give good advice, let alone do a good job. Communication skills are poor and knowledge non existence among the new generation of bankers. And this are degree holders with good CGPA. Bah!

Israel's invasion of Gaza

Israel invaded Gaza and the whole world erupted in anger over the decision. They have forgotten that it was Hamas rockets that provoked the Israeli government to take such a drastic military action. Israel was asked to end the campaign and go for a ceasefire. That would be sheer stupidity on Tel Aviv side without getting a firm commitment that rocket attacks will stop. In Sun Tzu Art of War, when you are on the winning side you must keep the pressure on the enemy. The pressure must be relentless until your enemy is subdued. A ceasefire will just allow Hamas fighters and bombers to regroup. Unfortunately, the Middle East tension has caused oil prices to rise again. Now it is going to breach $50 mark. This has caused oil and gas company like KMN to rise and a rally for IOI Corp. Today it is traded at a high of $4.40. Imagine how much it has risen since October ($2.45). Or the fact that it was hovering around $3.5 since the December till last week. But I doubt it can be sustained. Perhaps this is CNY January effect rally? After all, the full impact of an economic slowdown is expected after CNY. The mood in Penang is Malaysia will face a recession. I am more optimistic as I think we can barely avoid a recession due to our strong financial system. The slowdown is due to US recession. Unless I see any deterioration in economic figures, I maintain that we should see the first light of recovery by 2nd quarter 2010.

I have been with WOU for 3 months and today another senior lecturer has resigned. This is the second resignation for the School of Science since I joined in October. Looks like the turnover rate is very high for a university. On my way back, my Proton Iswara car was hit at the back by a lady driver. I felt a loud bang. Penang road is congested during peak hours and if you are not alert you will accidentally bank into people's backside. Bad karma ripen!

Uchi Tech: A Quarterly Review

Based on the last quarter result ending 30th. September, Uchi Tech's revenue declined by 33% quarter to quarter comparison. As a result, its EPS has dropped by 32%. This is expected due to its heavy reliance on US and European markets. Nevertheless, its products target high end customers, who are recession proof unless a prolonged economic recession sets in. However, the good news is this company carries no bank borrowings in its balance sheet. Uchi has a cash of $121 million. In addition its inventories dropped by 18% while retained earnings rose from $72 million to $83 million. Its healthy balance sheet is enough to last 2 years of deep recession. Bear in mind also Uchi's product commands high (about 50%) profit margin.

In regards to institutional shareholding structure the list has not change, implying its long term sustainability:-

(a) Lembaga Tabung Haji 6.6%. They have been actively acquiring shares since November.
(b) ASB 5.5%
(c) ASW 2020 3.15%
(d) ValueCap 3%
(e) EPF 1.45%
(f) GIC of Singapore 0.9%

Notice the presence of ValueCap, ASB and GIC of Singapore. Assuming a drop of dividend to 15 cent this year, Uchi will still yield an astonishing 15.7% at a price of 95 cent! The sustainability of the dividend is almost certain due to its zero gearing and cash rich position. In addition, its major shareholders are also top managers of the company. This ensures that the interest of the shareholder is aligned to that of the manager. This is a classic principal agency theory and good corporate governance practices.

The Fall of Sterling: Propects and Potentials

One important lesson that can be learnt from the current global financial crisis is that no institution, country is immune from its impact. The bigger you are, the harder you fall. One good example is the mighty pound sterling fall from grace. Pound sterling decline substantially compare to the euro. By today, euro has reached parity with the sterling. The impact has even affected EPL clubs as weakness of sterling means less euros to buy or pay the wages of Continental European footballers.

UK economy and financial institutions are the second hardest hit after their American brothers. You can say it is like an Anglo-American crisis. The flight of safety to US Treasury securities add to the woes of pound sterling. But I believe the big decline is unjustified in the long term. Firstly, London's role as the world premier financial centre remains unchallenged even with the introduction of the euro. Secondly, the UK government has set up 50 billion pound sterling fund to bail out Big 8 financial institutions in UK. So far none has utilized the fund. This has avoided serious bank runs and systemic failure in the UK financial system. Thirdly, based on 35 years history, pound sterling has bounced back strongly each time it has declined to a bottom. The last bottom was in 1992 after the sterling was attacked by George Soros. The sterling is just like a high beta stock. The RM 5.2 rate against the sterling is the lowest since 1998. Average rate during this decade is RM 6.

Bank of England interest rates have fallen from a peak of around 5% to only 2% due to the sub prime mortgage crisis and the economic recession. At the same time RM deposit rate remains around 3% as opposed to sterling deposit rate of 1.75%. This has turned the negative interest rate differential to postive. I expect the sterling to fall below RM 5 mark if BOE continues to cut rates. It will depend again on the next quarterly result of the British economy. In UK, the mortgage market is sensitive to interest rates movement. I don't expect a recovery of the UK economy for another 3 more quarters. Thus, I believe more rate cuts are in store in the next 2 quarters. I speculate a cut to 1%, slightly above 0.75% by the US Fed. All things remain constant; sterling is expected to slide below RM 5. That would definitely make the sterling an attractive currency to speculate or invest in. Sterling bear will dominate 2009 but be prepared for a turning point end of this year.

US Dollar & the Equities Market

It is essential for investors and speculators to understand the linkages between the US dollar and global equities market as part of their financial risk assessment. Uncle Sam’s greenback is a much sought after currency during financial crisis and uncertain times. The simple reason is the US is the only superpower left in this world. Superpower in terms of political, military, cultural and of course economic might. No doubt, US faced twin deficits, namely budget and trade deficit. But the underlying strength of US lies in its value of Gross Domestic Product worth trillions of dollars, innovation, creativity and political stability. China might hold $1 trillion of US dollar as its reserves, but it still lacks the factors mentioned above. So Uncle Sam is not bankrupt or about to go bust. The irony is the greenback has been appreciating since October 2008. Compare that with July 2008. What a stark difference. During that time, US government has been printing US dollar bills at a feverish pace and yet its value appreciates. It didn’t go the way of the banana currency.

As global equities market collapse in panic (especially in 8 days of madness in the first 2 weeks in October), investors, speculators, fund managers and sovereign governments shifted funds toward US Treasury securities. Demand for US IOU bills push up its prices to record high while the yield reaches near zero. That means, thanks to the financial crisis, Uncle Sam is borrowing your money for free! The collapse of global equities market led to the price bubble of US Treasury securities. That explains why US dollar gains strength rapidly. Recently, the US Fed cut interest rate to 0.75% and this has contributed to the weakness of the US dollar. But that is due to interest rate factor rather than the lowering of risk aversion among investors. When investors are risk averse, funds will be parked in safe heavens like the US Treasury. Hence, one should expect the fall of the dollar again after calmness has returned to the global equities market. Investors would be more willing to take more risk by selling the dollar and switching into high yield currency asset. At this moment, I think investors are still risk averse. Another indicator one should look is the weakening of the yen. Due to low cost of borrowing, the yen remains a favorite carry trade strategy. In this strategy, speculators and investors will borrow in yen and convert into high yield currency asset.

At this moment there is a serious misalignment of prices in the financial and commodities market. The weakness of the US dollar is one of the chief factor of the stratospheric oil price last July ($147/barrel). Today, it is priced slightly above the $45/barrel. While the price has dropped 70%, has the US dollar appreciated by 70% against the basked major world currencies? As such, this misalignment cannot carry on for long. It is either the oil price will have to rise again or the US dollar will have to appreciate further. The facts are OPEC has cut production and new oil fields exploration has stopped due to low oil price. Once the economy stabilizes, the full impact of the fiscal measures by the Chinese government will be seen. With the severe shortage of oil supplies, prices will roll up again. Palm oil will follow suit. Its current price of $1700 is simply not sustainable. La Nina is expected in May which brings in heavy rainfall. We are already seeing the impact of global warming. Low harvest against high future demand will push prices up again. Thus, the morale of the story is in this complex and interrelated financial markets, one cannot function independently on its own. Now, you understand why La Nina can affect the prices of your butter and margarine.

Enter the Dragon: 2009

Firstly, I would like to wish all global citizens a safe, healthy and prosperous 2009. For the first time in many years, you do not see motorists rushing to petrol station to fill up their petrol tanks. You might wonder why I have not posted the year end 2008 review. The simple reason is after a horrendous year we all have encountered, this is the last thing I want to recall. I am more interested in what can be expected in 2009. It's better to look at present rather than the past. Enough said, looks like it's a wet New Year's eve and day. Rather than drenched in cold and wet rain, I prefer the comfort of hot meal 4 course dinner of steam fish and crabs and chicken bean sprout (better known as “Nga Choe Kai”) with my parents and relatives. It is to celebrate the old man's 65th. birthday recently. Besides that, being out with those hooligans on the street in Gurney Drive is a risk not worth taking. Times have changed. Situation is no longer as secured and comfortable as it used to be.

This is expected to be a difficult year. It happens to be the 80th. anniversary of the Great Depression of 1929-1932. Keynes went on to introduce his famous classical aggregate demand theory. Benjamin Graham went on to write his classical value investment philosophy titled “Security Analysis”, after nearly went bankrupt due to the Wall Street crash in 1929. 2009 provides the best opportunity to test the validity of Graham's and Buffet's value investment philosophy. I have not lost faith in value investment despite big paper loss in 2008. How can one be wrong if you are right in assessing its intrinsic value? In fact, market reaction should be ignored as “noise”. One must buy according to the value of the business. Let me quote Buffet's famous advice “When people are greedy, you should be fearful and when people are fearful, you should be greedy". I believe one should be greedy in 2009. How often do we come across such rare opportunity? The last major crisis was in 1998. An opportunity every 10 or 12 years is worth taking in terms of risk.

Malaysia should brace for the worst after CNY. In Penang and Kulim, manufacturing sector is sliding into a major slowdown. Retrenchment, pay cuts and shorter working time are no longer new news. Everyone is bracing for the worst after CNY when CEOs and Chinaman towkays are expected to announce another round of bad news. Nevertheless, I do not think the global economy will reach the scale of 1929-1932. I am betting on it based on the following factors.

Firstly, major central banks around the world led by the US Fed are proactive in injecting liquidity into the financial system to the extent of nationalizing financial institutions in US and UK. In addition, interest rates have been slashed to near zero. Bailouts have been approved to purchase “toxic asset” like sub prime mortgage instruments. The bail outs have been extended to the automaker as well.

Secondly, it's the financial institutions that have lost money as money remain circulated somewhere. If the bank has lost money, the money must be in the hands of an individual or organization. Thus, no money has disappeared. In fact the supply of money has increased as central banks inject more liquidity into the financial institutions. For example, the US government has injected $700 billion through its bailout plan since October 2008. As such, I expect the “mother of all super bulls” once stability is regained due to awesome liquidity.

Thirdly, don't discount the large savings rate and trade surplus of China. The Chinese government has started to pump prime its economy. The Chinese government cannot afford a prolong recession or the mandate from heaven to rule for the Communist party will expire.

Finally, the regulatory standards of financial institutions are much more sophisticated than in 1929. Prior to 1929, there is no international initiative as Basle II or bank deposit insurance scheme. Now, not only we have deposit insurance, all governments including US are providing blanket guarantee on deposit till 2010 to prevent bank runs. The US government is now a major stakeholder in Citigroup, AIG, Fannie Mae and Freddie Mac to prevent systemic crisis in the international financial system. The same happen in UK when BOE bought stakes in major banks to prevent systemic failure. With all these aggressive measures, how can we fail? The risk of failure is remote. It is like you are given the examination questions together with the answers. You have to be a real big idiot to fail the exam.

All is not that bad in Malaysia. Malaysian banks do not lack liquidity but only confidence to lend. As such, I am retaining the list of my Dream Team Portfolio for Malaysia and US. I might add some good value companies this year as valuation is getting cheaper by the days. Recovery is certain but I have no idea when. Buddhist principle emphasizes the concept of impermanence. Since, the market has been on the decline for quite some time, the next step is up. The bulls are hibernating waiting for the right time to crush the bears. So enjoy your beer, get soaked under the rain but don't forget the back seat belt on your way back. The police will have bionic eyes to spot offenders. Don't start the first day of the year $300 poorer.

PS: I have decided not to continue Empire Strikes Back sequel. The outcome has been determined. Najib will take over as PM and Anwar has lost. For a change, the bad guy wins in the end. That is more realistic in Malaysia.