risk free assets

Most governments' bond in developed countries were considered risk free assets. No more. Right now, only Germany, U.S. Canada, Aussie Japan and U.K's bond are considered risk free. However, you still face currency devaluation among these countries because of potential money printing. That's probably the most important reason why gold is up so much.

The dry out of funding to European countries ex Germany has made the financial market very volatile. The valuation matrix is confused because the risk-free rates are changing rapidly. If you can buy government Italy bond at over 7%, how much you will demand to own Italy corporation bonds? The required return on equity will be at least 12%. That's the challenge the market faces.

ECB and European debt solution

The market seems believing that there is a simple solution to the European debt problem and blaming that politicians for not acting. I question that wisdom. To me there is no valid solution short term but through long hard cuts on social warefare.

One easy solution which everyone from Obama to Sarkosy to Cameron and Putin (except Germans) believe is for ECB to be the lender of last resort. The problems with this solution are two folds. 1. First, fundamental fairness. Who is going to decide buy which country's debt. Why help Italy not Spain? At the end of day, buying debt is a subsidy to the country. Second, ECB buying will incentivize politician to increase deficits. It is much easier to get elected by promising more warefare and tax cuts than cutting spending and higher taxes.

China's impact on steel and Base metal

The debate whether there is a soft or hard landing in China is raging on. But one thing is clear, the investment led expansion is slowing down. The two major engines for investments led growth are high speed rail and real estate. Both of them slowed recently. Real estate sales in major cities are down from 30 to 50%. The safety issues and short of capital has slowed high speed railway construction. According to official figures, 70% of the projects have stooped. The impact on base metal are negative. The impact on steel is the biggest, which extends to iron ore and coking coals.

Apple again

On July 20th, I cautioned that Apple need new Blockbuster product every two or three years to maintain the growth rate. It is very unlikely. In long term I am not too keen on Apply. However, in short term, if the stock trades below 365, the stock should be bought for a trade.

I have been bullish on Intel over 2 years. The stock is approaching $25. I will either sell a covered call @25 or sell the stock.

The market is full of hope about Europe. I will be skeptical about it. If ECB can do what FED is doing (printing 2 trillion), all the problem will be gone in short term. But Germany is not going to allow this to happen and I applaud its decision.

Where is the money for EU bank bailout

The market is very excited about the prospect that EU will stabilize the banking system in Europe. Eventually they do not have a choice. However, the question is where the money would come from. Most European countries. credit rating have been downgraded, except Germany and France (plus a few Scandinavia countries). France is in no position to inject large sum of money without jeopardizing its own credit rating. So at the end of day, Germany is going to put up the money, whether it is a guarantee and leveraging. In order to satisfy its voters, Merkel will demand harsh conditions for the bailout. I won't be surprised to see some banks in Europe to lose big in their equity. Non-secure creditors may also have some risks. I have some doubts on orderly restructure of Greek debt.

The price for the german vote

Germany has voted overwhelmingly to support the expansion of ESFS. The market will soon realize that the promises that Merkel made to her coalition were not market friendly. ESFS will not be levered up easily as U.S envisioned. The market has further downside to go.

When to buy gold

Gold has been down for a few days and it has corrected about 15%. I would not be surprised that gold down another $200-400 to 1200-1400. The Fed is under pressure not to do QE3. Germany is fiercely oppose any QE for European Central Bank. All these have create downward pressure to gold prices. But overall, paper currency has lost trust around the world and gold will find a bottom soon.

The market is very volatile over last month and influenced by every rumor and news from Europe. My feeling is the volatility will die down a bit and overall, the market is still in a downward trend. QQQ is relative expensive and energy is over sold.

The likehood of QE3 and its potential impact

The Fed is inching closer to QE3 and I will put the probability higher than 50%. It may boost assets prices in short term but will have a longer term negative impact on U.S. economy. Commodity prices will soar and U.S. dollar will depreciate. The higher import price couple with high food and energy prices will offset any positives the QE may bring. It will also make emerging market policy makers life miserable. All emerging markets have to tighten again to combat inflation. If you want to take advantage to invest in stock market, keep you time horizon short. I will buy real estate as a hedging of inflation.

Googel did not overpay for MOT

Many analysts came out and complained that Google overpaid Motorola Mobile. Their logic is flawed. Some simple analyses.

Google is paying 12.5 billion dollars. Motorola has over 3 billion in cash with no debt. By the deal closing time, the cash will be around 3.5 billion. So Google is basically paying 9 billion. MOT is generating 450 million free cash flow a year. Given a 10 multiple, it is worth 4.5 billion. Notel's patent portfolio was sold for 4.5 billion. It is reasonable that Google pay 4.5 billion for MOT's patent portfolio. In addition, Google gets 5 billion dollar goodwill which can be write off gradually. The tax benefit over long term will be at least 1 billion.

The second complain is the combination will impede the growth of Android. It is pure nonsense. If Android is the best platform out there, then HTC, Samsung and others will continue to use it.

buy list

The market is down sharply and I would get ready a buy list to gradually get into the market.
The following is my first list

In U.S.
MSFT (buy around 24.7)
INTC (19.5)
AAPL (360)
IGR (6.5)

In Canada
SU (31)
TCK.B (39)
BPO (15)
RY (47)

Is the market correction over?

The market is down over 4% today and 9% in a week. I have expected the market to correct for some time. The correction creates some positives for the economy. First, the lower oil and other commodity prices which will be good for inflation. The high inflation around the world is the major culprit cause the slowdown. Second, Europe has been pushed to the corner so a solution will finally come in a form to require more sacrifices from Germany but more power to Germany as well. Third, if the economy can recover, it will be on its own without the help of fiscal and monetary easing which is much more healthy than artificial pop up by QE.

The worst thing can happen is The Fed will come in again and do a QE3 which will inflate everything. If that happens, be afraid.

potential debt ceiling deal

The potential deal looks like 4 trillion dollar cuts in 10 years, which means average 400 billion out of the economy every year (2-3% of GDP). Of course, the debt deal may bring some certainty to the market and induce some corporate investments (one trillion? at most). It definitely will slow GDP by at least 1% a year. I do not see the positive for stock market.

Apple

The earning and cash flow is incredible at Apple and given its growth rate, the stock is very reasonable priced. Most analysts have a 450 or higher price target on APPL. The only thing I will be cautious is new product line. Over last five years, APPL has brought two new products (Iphone and Ipad) to the market and generate 100% growth every year. If Apple does not have new blockbuster product come on line, the growth will slow and competition will intensify.

The worst option

Benarke testified that the Fed is ready for extra stimulus. This is the worst possible option. The mere mention of possible QE3 has get market excited but it also pushed the oil up by 2 dollars and Gold another 20 dollars. The speculation in raw materia will push them mush higher and the inflation will not moderate as expected by the Fed. That's enough to get the Fed out of any further stimulus. So it will be high inflation and no QE3 at the end.

europe debt problem and QE3?

The Europe debt problem is getting worse but the market is rallying on the hint that Fed may start QE3. My take is that QE3 is not going to happen. The cost is too high. The market reacts to push oil up 2 dollars and gold 20 dollars. The inflation will outweigh all the benefits QE3 may bring. Buy protection when it is cheap

unintended consequences of lower oil price

The IEA released 60 million crude oil and the crude price dropped 5%. It may backfire. The supply in crude is tight and the high price is keeping a lid on demand. When the high price lasts longer, it can change people's behaviour, such as buying electronic car. If the prices turn lower quickly then people will go out buy those SUV again and demand will shut up. The longer the crude price is kept low, the bigger the supply problem will be. I hope the IEA release is one-time only. if not, we will see crude price shut up to 150 in the summer of 2012.

lsx increase bid for TSX

Just as I expected, London stock exchange increased the bid for TSX by 4 dollars. In response, Maple group increased its bid by $2 to $50. There are still regulatory hurdles to overcome. I will sell the share around 46.

RIMM

Research in Motion dropped 20% today. Just as I predicted in Nov. 2009, smart phone would become a commodity and competition would intensify and margin would drop. Sure it all happened in 18 months. How should we value RIMM right now. From income point view, a p/e of 5.5 does not give you much for a negative growth company. Instead, I would turn to the balance sheet. RIMM has 3 billion dollar cash and very little debt. 3 billion cash transfer to $5.5/share. The ongoing business is selling about 13 billion dollar. The real estate and equipments probably are worth 3-4 billion dollar and Patents are worth 1 billion dollar. Given that the company is still profitable and make 2-3 billion dollar a year, I do not see the share go lower than 20 dollars (around 12 billion Enterprise value). I would buy it below 25 dollar.

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toronto stock exchange

The battle for control of TSX has intensified but the stockholders are more confused than ever. The stock drooped one dollar today and the vote is June 30th. My guess is that London Stock Exchange will increase its offer closer to 48 and give little time for Maple to react. If London Stock Exchange keep the current offering price, there is less likely it will get the vote. I will buy X @around 43.30 in Toronto today and get our around 47

supply disruption vs. demand surge

The high commodity prices have caused inflation around the world. The slowing demand induced by high interest rate in China and other emerging market have somewhat the muted impact on overall commodity prices. The reason is simply, we have supply disruptions. First, OPEC refused to increase output yesterday (you have to question if they have the ability to increase the supply), Second, the weather has played a major role to disrupt agriculture products. Third, the political and military difficulty in Africa and middle east have made investments in mining in those countries less desirable. All these increase the prices of commodities. I am afraid we are in a high inflation and low growth period and The Fed can do little about it.

QE3, nokia and msft

The economic data are very downbeat and the market is speculating that Fed is going to do a QE3. My take is QE3 won't happen. The cost is much higher than benefit for another round of QE. The inflation would fly higher and average American will suffer. Emerging market will have to tight more and Fed's reputation will suffer greatly.

There is rumor that MSFT will buy Nokia's wireless business. It would be good for MSFT if it happens. Nokia still has the biggest market share in emerging market. If window platform can takeoff, then the merge will be good for both companies.

Market misconception

The market collectively believes
1. The Fed will be there again when economy slows. QE can be done indefinitely. This is not true. The cost (higher inflation) will be much higher than benefits for more QE.
2. Chinese RMB is way undervalued. In fact, on PPP basis, the undervaluation is small. A big Mac meal cost about $3.8 (25 RMB) n China. Most clothing are more expensive in China. If RMB float freely, a 5-10% appreciation is more likely than 20-30% as market expected.
3. Inflation will be contained because of wage constrain. Over last 20 years, the global trade is the most important factor to slow inflation . But it is changing rapidly because of cost in China and other EM market are rising rapidly and cost of shipping is rising as well. The imported inflation Will be felt by average consumer whether t s represented by CPI or not.
4. The higher corporate profits are due to good management. This is far from true. a big part of the profits are coming from lower dollar, higher commodity price and lower financing costs.

Will Greece restructure its debt?

The Greece debt problem is getting all the attention again. The argument for restructuring is getting louder. There are both positives and negatives on restructure. The negatives are obvious. They will hit financial market hard and it may spread to other PIIGS countries. The positive is that
Greek people will get some relief and introduce some risks to bond holders (they are having free lunch for too long).

The reality is EU will delay this decision as much as it could. Do not expect any new bailout package or restructure any time soon. My guess is some decisions will be forced upon at the end of this year.

The market is ahead of itself right now.

peak earning

The PE ration looks very reasonable on S&P 500 but the problem is that the earning is probably at or close to peak. Given the fact that PPI is much higher than CPI, profit margins are getting squeezed. Federal Reserve is being cornered as well. High inflation and slow growth will be here to stay. Government's stimulus and bailouts around world are near end because of voters anger. I expect the market to go down around 7%.

The market is going lower

The Canadian market has held up really well and given the troubles we are facing, I would expect it will go down 5% quickly. The problems the market is facing are
1. High inflation will limit the options of central banks. Emerging market will slow down to limit the inflation
2. Uncertainty in Japan on the nuclear issue is a short term concern, my sense is the worst case is not likely.
3. Middle East troubles are getting worse and no good solution is on sight. It will keep oil price high.
4. No stimulus from U.S. government and the Fed can not do a QE3 given the high inflation
5. The profit margin is being squeezed given the high PPI and relative flat CPI.

tsunami and earthquake in Japan

The earthquake and tsunami in Japan has caused confusion in the market. The rebuilding will boost short term economic activities in Japan but the fiscal situation in Japan is terrible. It may cause the rating of Japanese bond to drop.

Microsoft

Microsoft is trading less than 10 P/E multiples and it has net cash about 35 billion. The company has a 75% gross profit margin and grow around 10%. The Nokia deal should provide some positive earning boost in 2012. Microsoft never had any success in mobile and Nokia has about 40% of mobile market share. Even if Nokia's market share drop to 20%, that's still a big plus for Microsoft. Microsoft should trade around 32. I would buy it around 27.

Higher food inflation

One of the unintended consequences for printing money is higher food prices across the globe. It is especially tough on emerging market and poor countries. The uprising in Egypt and other parts of the Arab world is a warning for China and India. I suspect fighting inflation will be the priority for Chinese and Indian Government. The tightening of credits and interest rate will be more than market expected. It will finally break the uptrend for commodities this year (as long as Federal Reserve is not doing QE 3). The out-performance of Canadian and Aussie market will not be repeated this year.

Egypt situation

The market seems happy with the situation in Egypt. It assumes the end of Mubarak is near and it will be peaceful. The disruption will be insignificant. I do not agree with this assessment.
First, there will clashes between protesters and pro-government forces. There are many interested groups benefited from the current government and they will no go quietly.
Second, even a power change at the top is not going to cure the inflation, poverty and corruptions. Just look at Pakistan, the change of government did not do much good for its people.
Third, the oppositions are not well organized and the fighting for power will be ugly as soon as they lose their common enemy.

I will be very cautious right now. The market is due for a correction.

back from China

I was away in China for a couple of weeks. Some of my observations>

1. Inflation is running high and people are anxious
2. No one believe the prices of real estate will ever drop which gives me some doubts
3. The construction of high speed rail is enormous in terms of both the mileage and speed.
4. urbanization is fast. Plenty of jobs in the cities.
5. Wage is on the rise for low skill workers.