13th December 2011: Managing Investments In A Tail-risk Minefield

 

Quote of the Day:

We are increasingly concerned by the combination of high and increasing leverage in China, coupled with an impending peak in China’s working-age population ratio and its level, combined with a rapid ascent in property prices there. Our preliminary work shows this has been a potentially dangerous combination in the past 40 years when and where it has occurred, highly likely followed by a credit and property bust, either brief or prolonged.

Ajay Kapur – DB Asian Equity Strategist

Macro Overview

Making Tail Risk Work For You

• Months after I wrote a comment extensively about “Tail Risk” (specifically in Asia – and more recently here), it seems everybody has a word on it. In fact this article, published after mine in The Times of India – reads awfully like mine! Today ZeroHedge publish an extensive report about tails to keep a look out for under the title: Six Tails That Deutsche Bank Are Watching For Next Year. Right at the top of the list is China’s potential growth slump with persistent inflation – which could unleash the dragon’s fat tail… just like I alluded to in my article: The Looming Growth Recession in China.
• Today highly respected economist at UBS, George Magnus, said (about 7 mins into the video) that Chinese growth, because it is only reported on YoY basis, may be as low as 6% QoQ. That’s a really good environment for tail risks to propagate in a country which is used to a real growth – inflation spread of 8%+. Couple this withIndia’s horrific Industrial Production number it seems quite likely that China will ease monetary (and potentially fiscal policy, says Magnus) imminently.
• Remember, tail risks do not necessarily mean that asset prices go down… it just means the chance of your entire portfolio blowing up spectacularly rises significantly, which, of course, is not the same thing.
• On the same day, coincidentally Sino-forest announced that it would indeed default on its convertible bond securities (see FT article) … mind your eye… plenty more where that came from. What recovery rate would I put on these convertible bonds to investors? Errm… pretty darn close to ZERO – you might as well write the entire investment off as one monumental tail-risk swipe.
• Hugh Hendry is a controversial figure. He set up a short China investment portfolio and chose to short in liquid, low risk companies outside China which remained exposed to China in a big way. Many people thought he was incredibly fool hardy to short the World’s fastest growing economy … looks like his fund may report being up over 50% this year.
• Hendry takes a clever approach which sought to exploit tail-risk concerns without necessarily exposing the portfolio to much tail-risk of its own – purchasing extremely low-level Japanese CDS in companies heavily linked to Chinese growth). If anything it just goes to show, it’s not just the idea that counts, it’s how you implement it that matters…. having said that, having the right idea helps!

Market Overview

Europe Still Soggy

• Just to give you an idea of how serious this European crisis has become, S&P seem to be weighing up a downgrade of France AAA rating. And Chart of the Day is Greek CDS… man that is one scary chart!
• So much for Black Friday euphoria… sales were rubbish (see this Forbes article) – just ask Best Buy shareholders – stock got mullered today.

Chart of the Day

Greek CDS (Source: Bloomberg)

Events

Macro Events:

Update:

• Nothing Significant

Alerts:

• AustraliaInflation
• India Inflation
• Japan Tankan Survey
• Spain Inflation
• UK Inflation

 

Corporate Events:

Results:

• Nothing Significant

Dividends:

• Nothing Significant

Reading, Links:

Nothing Significant