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Thursday 4 June 2009
Signs of recovery driven by liquidity, not return to normality
In other words, we are nowhere near back to normality, whatever the headlines might indicate, and the current bull market in stocks looks vulnerable to a correction should anything happen to knock a hole in investors’ sentiment.
Signs of recovery driven by liquidity, not return to normality
Tom Holland 3 June 2009
Take a selective look at the headlines, and you can see signs of normality breaking out all over the place.
But despite the appearances, financial conditions are far from normal.
Sure, there are encouraging signals that the immediate crisis is over.
Most importantly, the money and credit markets are no longer entirely locked up. Banks are no longer too scared to lend to each other, and credit spreads have narrowed from the sky-high levels of a few months ago.
At the same time, investors have rediscovered their appetite for risk, pulling money out of safe havens like US Treasury debt and pushing it back into stock markets, especially in Asia. As a result, Hong Kong’s Hang Seng Index has climbed an impressive 62 per cent in just three months.
Improving conditions in the financial markets have been matched by some signals that real economies are stabilising. Leading indicators in the developed world are no longer deteriorating as quickly as they were. China’s purchasing managers’ indices have returned to positive territory. And commodity prices are rising strongly, with crude oil now trading at double the price of its December low, raising hopes that energy demand is recovering.
But investors should proceed with caution. The current rally in asset prices is being driven almost entirely by a wave of liquidity, rather than by any clear recovery of demand in the real economy.
If you doubt that, take a look at the first chart, which shows the Hang Seng Index plotted alongside the Australian dollar’s exchange rate against the US dollar.
As you can see, the correlation between the two is remarkably tight. Yet there is little fundamental economic reason why Hong Kong’s stock market should march in lockstep with Australia’s currency.
What the two do have in common, however, is that they are both perceived as risk assets.
As developed world central banks led by the US Federal Reserve have embarked on a policy of quantitative easing, they have released a wave of liquidity into financial markets that is pushing up prices of some riskier - and potentially more rewarding - assets.
With short-term interest rates of 3 per cent compared with rates close to zero elsewhere, the Australian dollar has recently found renewed favour with carry traders.
Meanwhile, Hong Kong stocks have been widely bought by international investors as a play on early stimulus-driven recovery in China. In addition, the Hong Kong market has also been pushed higher by the tide of liquidity released by higher bank lending on the mainland, as hot money leaks out to arbitrage the price differential between domestically listed A shares and Hong Kong-listed H shares.
Yet whether the extent of the liquidity-driven rally is justified by the improvement in underlying economic conditions is highly doubtful.
Any recovery in the US economy will be faint at best, as consumers rebuild their savings. Meanwhile, the upturn on the mainland has been powered by an unsustainable rate of bank lending rather than by a rebound in external demand. With bank lending set to slow in the second half of the year, growth is likely to soften.
Meanwhile, despite the recent surge in asset prices and the wealth effect that should encourage, Hong Kong’s economy remains a long way from a sustainable recovery. Unemployment is rising, and although the local purchasing managers’ index - historically a good guide to future growth - is slowly inching higher, it remains in contractionary territory (see the second chart).
In other words, we are nowhere near back to normality, whatever the headlines might indicate, and the current bull market in stocks looks vulnerable to a correction should anything happen to knock a hole in investors’ sentiment.
By Lina Saigol, Kate Burgess and William Macnamara June 4 2009
Chinalco is set to walk away from a $19.5bn deal with Rio Tinto following weeks of wrangling over the terms of the transaction, in a dramatic U-turn that sent shares in the Anglo-Australian miner sharply lower.
The Chinese state-owned group could not reach agreement about a $7.2bn convertible bond that was a key part of the proposed deal, which would have been the biggest overseas investment to date by a Chinese company.
The terms of the convertible were pitched at a significant premium to Rio’s share price in February when the deal has announced. That premium has now shrunk.
Rio is now exploring a number of alternatives, including a $12bn rights issue and creating a joint venture with rival BHP Billiton which would include stakes in eight assets that Rio had originally proposed to sell to Chinalco.
The joint venture would combine Rio’s and BHP’s prized iron ore assets in the Pilbara region of Western Australia.
Chinalco’s eleventh-hour departure follows intense anger from Rio shareholders over the original terms of the deal, which would have seen their stakes significantly diluted after the Chinese group converted its bond to equity.
Rio still needs to pay back almost $20bn in debt over the next two years.
Shares in Rio were 205p or 7 per cent lower at £27.07 in afternoon London trading, while BHP fell 3.3 per cent to £14.44.
Rio said a statement on Thursday that it was “pursuing a range of options, some of which are at an advanced stage, for maximising shareholder value and improving the group’s capital structure.” It said it would make a further statement in due course.
Chinalco and BHP declined to comment.
As well as being unpopular with some Rio shareholders, the proposed Chinalco deal had aroused considerable opposition in Australia, amid concerns that a foreign state-backed enterprise would own a strategic stake in the country’s biggest natural resource assets.
The Chinalco deal would have required the backing of Australia’s Foreign Investment Review Board, which was in the final stages of completing an assessment before a final ruling from Canberra.
3 comments:
Signs of recovery driven by liquidity, not return to normality
Tom Holland
3 June 2009
Take a selective look at the headlines, and you can see signs of normality breaking out all over the place.
But despite the appearances, financial conditions are far from normal.
Sure, there are encouraging signals that the immediate crisis is over.
Most importantly, the money and credit markets are no longer entirely locked up. Banks are no longer too scared to lend to each other, and credit spreads have narrowed from the sky-high levels of a few months ago.
At the same time, investors have rediscovered their appetite for risk, pulling money out of safe havens like US Treasury debt and pushing it back into stock markets, especially in Asia. As a result, Hong Kong’s Hang Seng Index has climbed an impressive 62 per cent in just three months.
Improving conditions in the financial markets have been matched by some signals that real economies are stabilising. Leading indicators in the developed world are no longer deteriorating as quickly as they were. China’s purchasing managers’ indices have returned to positive territory. And commodity prices are rising strongly, with crude oil now trading at double the price of its December low, raising hopes that energy demand is recovering.
But investors should proceed with caution. The current rally in asset prices is being driven almost entirely by a wave of liquidity, rather than by any clear recovery of demand in the real economy.
If you doubt that, take a look at the first chart, which shows the Hang Seng Index plotted alongside the Australian dollar’s exchange rate against the US dollar.
As you can see, the correlation between the two is remarkably tight. Yet there is little fundamental economic reason why Hong Kong’s stock market should march in lockstep with Australia’s currency.
What the two do have in common, however, is that they are both perceived as risk assets.
As developed world central banks led by the US Federal Reserve have embarked on a policy of quantitative easing, they have released a wave of liquidity into financial markets that is pushing up prices of some riskier - and potentially more rewarding - assets.
With short-term interest rates of 3 per cent compared with rates close to zero elsewhere, the Australian dollar has recently found renewed favour with carry traders.
Meanwhile, Hong Kong stocks have been widely bought by international investors as a play on early stimulus-driven recovery in China. In addition, the Hong Kong market has also been pushed higher by the tide of liquidity released by higher bank lending on the mainland, as hot money leaks out to arbitrage the price differential between domestically listed A shares and Hong Kong-listed H shares.
Yet whether the extent of the liquidity-driven rally is justified by the improvement in underlying economic conditions is highly doubtful.
Any recovery in the US economy will be faint at best, as consumers rebuild their savings. Meanwhile, the upturn on the mainland has been powered by an unsustainable rate of bank lending rather than by a rebound in external demand. With bank lending set to slow in the second half of the year, growth is likely to soften.
Meanwhile, despite the recent surge in asset prices and the wealth effect that should encourage, Hong Kong’s economy remains a long way from a sustainable recovery. Unemployment is rising, and although the local purchasing managers’ index - historically a good guide to future growth - is slowly inching higher, it remains in contractionary territory (see the second chart).
In other words, we are nowhere near back to normality, whatever the headlines might indicate, and the current bull market in stocks looks vulnerable to a correction should anything happen to knock a hole in investors’ sentiment.
Chinalco set to quit $19.5bn Rio deal
By Lina Saigol, Kate Burgess and William Macnamara
June 4 2009
Chinalco is set to walk away from a $19.5bn deal with Rio Tinto following weeks of wrangling over the terms of the transaction, in a dramatic U-turn that sent shares in the Anglo-Australian miner sharply lower.
The Chinese state-owned group could not reach agreement about a $7.2bn convertible bond that was a key part of the proposed deal, which would have been the biggest overseas investment to date by a Chinese company.
The terms of the convertible were pitched at a significant premium to Rio’s share price in February when the deal has announced. That premium has now shrunk.
Rio is now exploring a number of alternatives, including a $12bn rights issue and creating a joint venture with rival BHP Billiton which would include stakes in eight assets that Rio had originally proposed to sell to Chinalco.
The joint venture would combine Rio’s and BHP’s prized iron ore assets in the Pilbara region of Western Australia.
Chinalco’s eleventh-hour departure follows intense anger from Rio shareholders over the original terms of the deal, which would have seen their stakes significantly diluted after the Chinese group converted its bond to equity.
Rio still needs to pay back almost $20bn in debt over the next two years.
Shares in Rio were 205p or 7 per cent lower at £27.07 in afternoon London trading, while BHP fell 3.3 per cent to £14.44.
Rio said a statement on Thursday that it was “pursuing a range of options, some of which are at an advanced stage, for maximising shareholder value and improving the group’s capital structure.” It said it would make a further statement in due course.
Chinalco and BHP declined to comment.
As well as being unpopular with some Rio shareholders, the proposed Chinalco deal had aroused considerable opposition in Australia, amid concerns that a foreign state-backed enterprise would own a strategic stake in the country’s biggest natural resource assets.
The Chinalco deal would have required the backing of Australia’s Foreign Investment Review Board, which was in the final stages of completing an assessment before a final ruling from Canberra.
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