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The deleveraging cycle has now well and truly commenced, and Asian and other emerging asset markets will be big beneficiaries, says CLSA’s Christopher Wood in the latest issue of his client newsletter, Greed & Fear.

“If the catalyst was subprime mortgages, the end game is likely to be intensifying focus on the solvency or otherwise of certain financial institutions”, he says.
In the past week, (since Wood’s last G&F missive, warning of the middle market, Alt-A mortgage problem) mortgage and corporate bond spreads have further blown out, he notes, “while S&P has admitted that Alt-A is subprime by another name”.. But with market focus continuing on the still unanswered question of who owns all the garbage “tranches” of securitised debt, and with tens of billions of dollars of bonds and bridge loans funding LBOs still unsold, the market focus is switching to the risks embedded in the financial intermediaries.

And that is what the surging spreads on Wall Street investment banking credit default swaps are pointing to, he notes. “It is no longer enough to wait in hope that the rating agency will not downgrade the CDOs. Rather the desire is to sell the paper, no matter what the discount, rather than be found out owning it and running the risk of seeing it go to zero.”

From an investment point of view, the mess in US-originated structured finance represents for the Asian equity asset class, in the longer term, “a gigantic buying opportunity”, says Wood. For just as, first, US tech stocks and then US housing finance were the bubble beneficiaries of Fed easing post -LTCM and post-Nasdaq collapse, “so Asia and emerging asset markets will be the likely bubble beneficiaries of the coming Fed easing”.

“If this is the longer-term story, in the short term there is likely to be more collateral damage, which is why investors would be best placed now if they had hedged the credit spreads. For those who have not done so by now, it is clearly rather scary to short credit after the recent violent moves in CDO and CLO related debt,” Wood advises.

In Greed & Fear’s view, “it is still not too late to short the debt and equity of financial institutions that are most exposed to securitisation and structured finance, for that is where the unwinding of the credit bubble will climax.”

Financial panics “generate a lot of noise in financial markets”, says Wood, “but such a primarily US-focused financial panic will do nothing to unwind the secular asset reflation story in Asia”.

Indeed, he concludes, “it may accelerate it by fast-forwarding Fed easing, as the likelihood of Fed easing has certainly increased after the 10-year Treasury’s 54bp fall since 12 June.