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CLSA’s Christopher Wood is underwhelmed by President Bush’s plan to freeze subprime home rates. US policymakers led by Hank “the Hunk” Paulson are clearly reacting to the political need to be seen to be doing something as the housing mess intensifies, he notes in the latest issue of his client newsletter Greed & Fear. The reported proposal to organise loan modifications for distressed borrowers sounds fine in theory. “But in practice, it will be devilishly hard to implement,” he says:

There is no easy panacea out of this mess for US policymakers unless Washington wants to outlaw foreclosures altogether. The quickest way is obviously to take the pain and the writeoffs now. That offers the best chance of a classic V-shaped bottom. But the more the policymakers delay the unwinding, the longer they will postpone the recovery. Any attempt to rewrite the contracts on securitised loans will also make would-be-investors even more skittish about investing new money in securitised mortgages.

Wood remains firmly bearish on US financials, but says he would be even more bearish now on European financials “where the downturn is going to hit later than in the US, and where the lack of transparency in terms of the problems in the credit markets remains much greater than in America”.

Greed & Fear’s advice to absolute-return investors remains to bet heavily on both Bank of England and ECB monetary easing next year. It may also pay to be short the euro and sterling against not only the Asian currencies, but also against the US dollar, notes Wood, adding that this is despite the fact he believes the Fed will also be cutting aggressively in 2008.

The British economy, meanwhile, “is a much more straightforward sell than the US economy”, because its growth profile is so heavily orientated to finance, housing and subprime-consumer financing. This is why the British economy could quite conceivably turn out to be the biggest loser from the so-called “subprime crisis”.

Overall, if the downturn is coming in Europe and America, the more traumatic the experience for borrowers, the more likely they are to be scared off from taking on new debt going forward. This risk-adverse phenomenon is what CLSA’s economics team has described as “boomophobia”, notes Wood. Clearly the Japanese approach to dragging out the country’s banking and property bust has led to a virulent case of boomophobia in that country. While in America it is not clear how loan modifications and the like will encourage new credit creation going forward. Such actions will certainly deter investors from buying new securitised credit. For now all the evidence is that the issuance of securitised debt continues to slow sharply. Thus, US adjustable-rate mortgage securitisation fell by a quarterly 52 per cent to US$88.37bn in the third quarter of this year, the slowest rate of securitisation since the same quarter in 2002.

The Middle East, however, where Wood has been in the UAE, “is in the midst of a boom which has further to run”.
As most of the countries in this region have, like Hong Kong, a dollar peg, and are likely to retain one, the recent trend of asset-price appreciation is only likely to accelerate as Fed easing accelerates.

Wood notes growing interest in Middle East stock markets among global emerging market investors. “These markets had a significant correction in early 2006 after a retail-led boom and they are now recovering. Valuations are reasonable, while the pegged currencies suggest accelerated asset appreciation.”

His advice to fund managers is to look at the Middle East markets and use any short-term correction to build positions:

All the evidence is that the Middle East markets will participate in the emerging bubble in emerging markets which will be the consequence of the current cycle of Fed easing. And the longer the currencies remain pegged, the bigger the potential bubble in Middle East asset prices.
As for China: “There has been renewed press hype about more aggressive tightening measures in China. In Greed & Fear’s view, this is once again likely to prove more bark than bite. With global growth clearly slowing, it is unlikely that Beijing wants to take the risk of tightening aggressively. Still Beijing is likely to allow a slightly more rapid rate of renminbi appreciation in 2008″.

Wood continues to advise relative-return investors to neutralise the MSCI China weighting. In that context the recent correction is a buying opportunity for those who have been underweight China, he notes. If Beijing sticks to its long standing policy of token tightening, the present bull market in China shares is “likely to climax in a monster asset bubble as large if not larger than what was seen in Japan and Taiwan in the late 1980s”.

Still, Wood seems to feel there’s comfort in knowing that, as in all bull markets, “a one-third correction is possible at any time”. That said, if the above view proves wrong and China tightens aggressively into a US slowdown, he adds, then China equities as an asset class should be shunned altogether in 2008.

But such behaviour would be wholly uncharacteristic of the current PRC leadership under President Hu Jintao and Premier Wen Jiabao, for whom incrementalism and gradualism are political obsessions. This is why investors should not believe in aggressive tightening until they see hard evidence of it. For now, there is no such evidence.