Monday, January 19, 2009

U.S. Treasuries: The Real Economic Pearl Harbor


"Misery is when you heard on the radio that the neighborhood you live in is a slum but you always thought it was home".

Langston Hughes, 1969 "Black Misery"

Falling interest rates globally will have a pervasive influence on asset allocation among fixed income, equities and alternative assets. The tipping point will be whether Asian investors continue to buy or sell U.S. Treasury securities. This, and not the more generalized climate of negative sentiment mentioned by Warren Buffett will be the "Economic Pearl Harbor" of 2009 and beyond.

And initial indications are not encouraging.It is a well known fact that Asian investors dominate holdings of U.S. Treasury securities.

According to U.S. Treasury data, foreign holdings of U.S. Treasuries increased 29% to roughly US$3.1 trillion from Jan to Nov 2008. This was also a rise of 32% Y-o-Y. It indicates that in a global flight to quality trade, U.S. Treasuries continued to be the asset of choice among global investors.

Combined Asian investor holdings of U.S. Treasuries comprised 46% or US$1.4 trillion. This was 6% down from the Nov 2007 level. Of particular note was the massive jump in Chinese holdings by 49% to US$682 billion, with the Taiwan and Tahiland also increasing their holdings by 16% and 25% respectively (albeit from a lower absolute numbers). This is in stark contrast to other Asian investors (Japan, Singapore, Korea and India) whose holdings actually declined.

What does this mean? It means that a special buying program by the Chinese is still intact (for now). It also means that non-Asian central banks and institutional investors have stepped up their holdings too (e.g. U.K. and Caribbean central banks).

It also means that those investors who appear to be tiring of U.S. Treasuries (Japan and Korea) are now probably ripe for alternatives to low-yielding Treasuries. Back in 2003 and 2004 this "opened the door" for massive structured product sales in Asia including sub-prime based CDOs and bonds. The problem now is that a combination of: poor fund of fund returns; the pressure of Basel II regulations; and Madoff-inspired fears of product transparency and liquidity means that many traditional buyers are going to be sitting "paralyzed" by a sense of risk aversion.

In theory "untainted" FoHF brand names should be the winners in the next hedge fund buying cycle. The problem is that many of these product providers have failed their investors with average HFoF performance returning minus 19% in calendar year 2008 and the marketing pitch of diversification also proving a sham.

So which strategies will be the winners in 2009? It certainly looks like Korea and Japan should be prime geographical targets for education programs to help end investors get firmer footholds into managed futures, global macro and certain long-only exposures that might be cost effective. There is little this author sees in terms of HFoF getting signficant market share unless they try to sell managed account HFoF products that might see some favorable traction over the medium term. Mahalo.

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Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.