A few weeks ago, I was as per normal drinking at a watering hole near my office and a very unfortunate incident involving some red wine and a white shirt forced me to end the night early and make my way home. While I was walking to take a cab home, I bumped to an investment banker who was also making his way back. When he saw me, he quickly took the opportunity to get into a discussion on the USD with me. Apparently, he was caught in a dilemma on what to do with his USD. Now let me just say, I have been shocked by the number of people who are holding onto their USD with the hopes of a meaningful rebound. Someone once told me, "the trend is your friend", and the trend is down for the USD. So I think anyone reading this out there, do consider moving out of the USD and put it into something else.
Ok back to my conversation with the investment banker on the USD. One of the ideas I posed to his was to put it into HKD. What! Isn't the HKD pegged to the USD since 1983? So why would that make a difference. Here is how I see it. For a USD holder, there is no downside risk because the value of HKD will never fall against the USD if it remains pegged. However, if they do what I believe they will do, USD holders will get to enjoy at least a 10% one off gain as the HKD gets revalued.
Here is why I think it will happen. Currently, the Hong Kong dollar is tied to the US dollar and trades in a small band between HK$7.75 and HK$7.85. Recently, the Hong Kong currency has been trading at the upper end of that band, which has an impact on those who deal in large sums.
Take for example the Kuwait Investment Authority was committed to buy a HK$7.8bn stake in the listing last month of AIA, the Asian arm of US insurance group AIG. When the time came for the sovereign fund to write a cheque in Hong Kong dollars, it found that the amount of US dollars it had to pay had risen substantially from its original estimate.
The way the Hong Kong dollar has been trading at the top of its band as an indication of the pressure the currency is under to rise, and I really expect the peg to be dropped within the next 3 years.
Analysts say it is usually problematic when a strong economy has a weak currency. Thanks to the peg, Hong Kong is importing its monetary policy from the US. But the American policy of zero interest rates to stimulate a listless economy is hardly appropriate for an economy that is growing at a rate of more than 6 per cent a year, say analysts. And while the US is desperately attempting to boost asset prices, Hong Kong’s property prices are already high and rising. With their largest trading partner being China, importing RMB goods with a weakening HKD is just going to be inflationary for Hong Kong.
If the peg were to disappear tomorrow, many analysts forecast that the Hong Kong dollar would appreciate by a minimum of 10-15 per cent.
Hong Kong is well on its way to becoming a de facto dual currency centre as China continues to take steps to internationalise the renminbi. The increase in Chinese renminbi circulation would give rise to a dual currency system in Hong Kong and over time this could pave the way for an eventual HKD/RMB peg.
In conclusion, there is still hope for USD reference currency holders.
Ok back to the events of the week. Everything went according to plan this week, with the Republicans retaking the house and the Obama going through a humiliating defeat in the midterm elections. The QE2 package was more than expected and for a longer period of time. The market cheered and we had a strong rally which many observers believe the market will continue to rally. The last QE move was 1.6 trillion and the global markets rallied 75% from their lows. So the 15% returns over the past 2 months since the Fed signalled QE2 looks to be a preview of more to come.
Non-farm payrolls came in better than expected with 151k new jobs created. This was very much better than expected and the first positive month of jobs growth since May 2010. Although it is good news, the market did not take it that well because positive economic data means the Fed may choose to do less QE than was declared. One funny point which I feel compelled to state in this post was Bernanke's speech pointing out stock prices were low. We always knew that Greenspan always supported strong stock prices with the "Greenspan Put" but to have a Fed chief state that he wanted stock prices higher, isn't that comforting? Hahaha.
The last time there was so much cheap money, it was the Japanese that led the way, with tons of cheap money through their zero interest rate policy. But compared to the US, the Japanese has been more held back than the US. The difference between the two is the culture. The Japanese corporations have a more prudent attitude towards investing compared to the US corporates. Why? Because they have learnt from their lessons in the past when corporate Japan was busy buying up corporate America. With the introduction of cheap money in Japan came the arbitrage vultures profiting from "carry trades" on the yen. That went on for many many years. With the US getting into this trouble, the yen carry trade has been unwounded (that is on of the key reasons why the yen has been appreciating so quickly). Now the USD carry trade has started and never has the world see so much money flooding the market. It is just scary to think about it. Asset price inflation is all but a sure thing.
Right after the Fed announced their decision, Coca Cola went out and issued 3 year notes to 4.5 billion over 3 years at less than 1 percent. Expect to see more large corporations to go out and raise money at such a cheap rate. This is going to be a trend and what is going to happen is more merger and acquisition action. To me, that is going to be the key driver for the stock market going forward. We will see more market leaders looking to acquire their smaller competitors because it is very easy and cheap for them to raise money due to their size. With interest rates going at less than 1%, almost every acquisition is going to be yield accretive. Also the valuations offered in takeovers can be higher because it is not difficult to attain higher returns over the low cost they have to pay for financing.
What this means is valuations will be richer and many industries may see price earnings re rating over the next few quarters. Although I do not think it is sustainable, but with so much money sloshing around we really do not know when the party will end. So with this outlook, I am going to reiterate my call for an overweight in equities with little downside risks in over the next 6 months and to steer away from bonds. The party has just begun for us and lets enjoy it while it lasts.
Best,
SVI
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