The End of Yen-carry Trades?

With the recent meltdown and volatility of global financial markets, there has been signs of significant withdrawal of Yen carry trades around the world's financial markets. Yen carry trades had been the biggest contributor to global flush of liquidity, aided by the low interest rates in Japan and therefore investors resorting to investing in high yielding assets globally by borrowing cheap Yen, which implies low cost of funding. Due to the fear of financial credit crunch as a result of US subprime financial woes, investors have become risk averse (due to rising currency, i.e, Yen) on high yield and risky assets, such as equity related securities, which therefore sparked the selling off of such assets globally. The rise of Yen could become a double-edged sword, in the sense that the cost of borrowing increases, and at the same time the exchange rate for the currency of domain investment destinations weakens against Yen.

Moreover, with the expected upcoming improvement in Japanese economy, it is harder to expect interest rates in Japan would be kept at such low level. In fact, it is likely that Bank of Japan may raise interest rates further sometime this year.

All this could be a signal that Yen-carry trades will continue to be liquidated going forward. The bad news is volatility in global financial markets may continue to persist from time to time until the amount of Yen carry trades become less significant. How long? I am afraid this will be a journey, not an event!

How Subprime Mortgages Can End Up In Your Investments

I came across this article in a local business magazine which sums up nicely how knowingly or unknowingly subprime mortgages can end up in one's investments. I believe you are aware that the current subprime woes have massive sell-down on global financial markets, due to major concern on potential tightening on global liquidity, significant losses on global funds with exposure to subprime and ultimately impact on global economy. The following is the money trail of subprime:

Cycle 1
- Buyers with weak credit background secured housing loan from (subprime) lenders and typically pay annual mortgage rates that are at least 2% points higher than average bank lending rates

Cycle 2
- Mortgage brokers, mostly based in California, collaborate and form partnerships with the once profitable subprime lenders and Wall Street;

Cycle 3
- Subprime lenders attracts people with exotic mortgages without documentation-free loans, which do not require evidence of income or savings.

Cycle 4
- Large Banks / wholesalers buy the subprime loans. They then bundle the debt and sell it to Wall Street firms.

Cycle 5
- Wall Street banks package subprime loans into mortgage-backed securities and collaterised debt obligations (CDO). Sales of CDOs reached USD2.4trillion in 2006!

Cycle 6
- When a bank creates a CDO, it meets with credit raters to discuss the quality of the contents, including subprime debt. They then divide the CDO into portions in to get the desired rating for each portion.

Cycle 7
- CDOs include a mix of bonds and securities backed by mortgages and home equity loans. In 2006, an estimated USD100billion worth of subprime debt went into USD375billionin CDOs sold in the US.

Cycle 8
- Investors invest in CDOs because they offer higher returns than bonds given the same rating. Banks, insurance companies and pension funds take on more risks in pursuit of higher yields.

At the end, when housing property in US collapses, this led to many subprime borrowers defaulting their loans, thus causing a chain of reactions across the entire financial market!

The above event is a true classic result of human greed, as demonstrated by all parties who decided to be part of this high risk lending scheme, all with the hope of making huge returns.

As always, some degree of prudence is desirable in any investment decisions.

Why Hedging Is Important

If you ask most retail investors, most will tell you that they only know how to make money one way, that is, take profit when the asset price rises. What happens when one's prediction goes opposite way? One simply loses money. During stock market downturn, it is not difficult to find that many investors sell on panic mode, either to minimize or to cut losses. In truth, no matter how good you think you are in picking the best stocks, chances are your prediction may turn out the other way due to various factors such as false information, poor market sentiment or other external factors driven by politics, change of governmental policies or regulations, etc.

It is important therefore to hedge against your investments, or simply put, to reduce your exposure risk in any particular investment instrument. Remember the game of blackjack in a casino? A card player may opt to purchase an "insurance"against banker's cards having a blackjack and therefore stand to minimize losses if banker's cards do turn out to be such. The same applies to investment trading. An investor can hedge against its investments by separately entering into a hedging instrument such as options and futures, so that he protects his investments against unforseeable losses in the event the market movement goes the opposite direction. This is commonly practiced by institutional investors of money market instruments and corporations who have significant exposure to foreign currency and commodity such as crude oil and other raw materials. For example, if one expects crude oil prices to rise above USD70 per barrel when current price is USD50, an airline company may decide to enter into a options contract at say USD60 to hedge its position on crude oil to prevent further cost escalation. If actual price exceeds USD60, one stands to gain due to cost savings. However, if price falls below USD60, one stands to lose as he now is required to pay a higher price for the commodity.

In stocks, one may also use derivative instruments such as options or futures to hedge against one's investment portfolio. Technically, to hedge one would invest in two securities with negative correlations. The idea of hedging is therefore not to make more money but essentially to reduce one's exposure risk or to reduce losses, in the event of adverse market movement. Bear in mind that if the investment one is hedging against makes money, one will have typically reduced the profit that you could have made, and if the investment loses money, one's hedge, if successful, will reduce that loss.

In an adverse market condition such as the current stock market turbulence caused by US subprime and credit woes, an investor who has had a proper hedging technique would have safeguard his or her investments by reducing the amount of potential losses.

The downside of hedging is that often it is a more complex tool and it is never easy to achieve a perfect hedge. Do not rule out the possibility that things could still go wrong even with hedging. Just bear in mind that the objective of hedging is to reduce losses over one's exposure, not to make more money.

On the flip side, one could also use the above derivative instruments to make a speculative profit rather than hedging. I shall look at speculation vs hedging on another day.

A Real Threat on Liquidity Crunch?

Global markets have truly suffered a highly turbulent moments since last week, contributed by the extreme volatility in Wall Street as a result of its worsening subprime woes and impact on credit crunch. More and more subprime lenders and even investment bankers around the world were either issuing warnings, reported major losses and some investment funds were even being stopped from further withdrawals. This has a serious impact on credit and tightens liquidity in the global market, which had been previously high in abundance and provided huge appetite for high yielding investments and as a result, led to a major uprise in all major assets classes.

Now, liquidity is under a serious threat as last Friday, the European Central Bank, the Bank of Japan and US Federal Reserve together pumped USD162.5 billion into the world financial systems to head off a major crisis of confidence. The last time US Federal Reserve did this was after the 911 event. This was an act of reassurance, which suggest that Governments around the world are ready to supply credit in order to restore the confidence and avoiding panic around the globe.

In Asia (ex Japan), the scenario was somewhat different. Although central banks of Singapore, Indonesia and South Korea were also quoted to be on standby mode to supply funds to the market, it never happened or at the most, it was only a token of intervention. This suggest the risk of subprime exposure in Asia is far less significant. This could be due the fact that Asia led by China and India has seen tremendous and sustainable growth for the past few years and thus increased intra-Asia trade and reduced dependency on US. The continued economic growth of these two countries will likely spearhead support of such trend.

Unlike the previous crash in February, the current volatility in Wall Street may prolonged for the next one to two months as the subprime woes may not have bottomed out. So it may take a tad longer time this time for the dust to settle and for global investors to restore confidence.

However, in any deep lying problems there lies potential opportunities, particularly for the Asia stock markets. As the Asia growth stories continue to unfold, it is a matter of time investors confidence will be restored, particularly the fact that US economy is still at a healthy growth despite the subprime problems. In fact, the subprime mortgage factor should not overly impair US economy as the pain is confined to the subsegment of the property market and financial institutions. After all, the total subprime loans only made up 4% of the total loans in US.

Malaysia's New Northern Economic Region

First we had the Southern Economic Region, named Iskandar Development Region (IDR), reminiscent of the special economic region of China's Shenzhen, which closely link with its counterpart Hong Kong. In IDR's case, it's an open economy that targets foreign investors focusing on service related sectors, tourism and properties with close collaboration with neighbour Singapore.

Over the past 2o years, Malaysia's economic growth and competitiveness has been built around the manufacturing industries, particularly the Electronic and Electrical industry. With the emergence of China, India and now Vietnam, Malaysia's competitiveness has suffered serious threat as its cost escalates and competitive edge deteriorates. Agricultural sector has also remained stagnant over the years. In realization of the need to continue boosting Malaysia's economic growth going forward and bringing these sectors that had served Malaysia well in the past to a higher level, here comes the realisation of a new economic region that serves to propel the country to the next frontier. The investment amount potentially total 177billion Malaysian Ringgit (USD51.2 billion) in mostly private funding over 18 years to turn its mainly agricultural and manufacturing north into a logistics, food-processing and tourism hub by 2025.

There are about 4.3 million people living in this region, in which ethnic Malays forms the majority of the population, other than Penang state. About two-thirds of them are in the region's rice-growing areas. The average annual income of around 2,477 Malaysian ringgit (USD717) per household, is the lowest among the six regions in the country except for the east coast (Kelantan and Terengganu). With the NCER, the Government aims to increase annual income by three fold and boost GDP four fold by 2025. In addition, it is expected to create 500,000 jobs by 2012, doubling to a million by 2018.

The biggest beneficiary is expected to be the state of Penang, where currently high tech electronic and electrical manufacturing dominates both in the island and main land. For the past decade, the state's economy had stagnated or deteriorated due to a number of manufacturing companies moving their base to other more attractive low-cost base countries such as China. Also, it's competitiveness has suffered due to its failure to move manufacturing up the value chain. Real invention from Research and Development remains weak. So, one of the main objective is to move up the value chain such as enhancing output from research and development. But there lies other more ambitious plan. Malaysia intends to convert Penang into a major transportation and logistics hub, by building centralized and integrated infrastructure and transportation links, including highways, bridges, railway and monorail services, expansion of air links and airport to cater for budget airlines.

Other key targets include:
- enhance tourism and tourism spending;
- become a modern food zone, helping the country to increase its efficiency in food production

A grand plan indeed, but will it be successful or is this another potential mega project flop in the making? The Government do mean business, as the formation of a central implementation agency appears to suggest so. The central agency will be a government body under a council to be chaired by Malaysia's Prime Minister and comprising the deputy PM, the chief ministers of Penang, Perlis, Kedah and Perak, as well as some cabinet ministers. It will be responsible for implementing the detailed planning and will launch a one-stop centre.

Later, I shall look into where are the potential opportunities it could bring to investors.