TBTF October 4, 2010 - My little China girl

Too Big to Flail

October 4, 2010

“My little China girl, You shouldn’t mess with me, ill ruin everything you are, I’ll give you television, I’ll give you eyes of blue, I’ll give you men who want to rule the world” (David Bowie – 1977)

It seems as if history has caught up with this song, for the aforementioned china girl does no longer have to feel she will be ruled by western society. It seems the Chinese are the ones doing the ruling these days.

Over the weekend there were a couple of Chinese-led news stories that were really noteworthy.

First of all Chinese premier Wen Jiabao, on his tour of European capital cities,  told Greek lawmakers that China will keep on buying Greek bonds when Greece returns to the capital markets next year. Nor will China cut their holdings of European bonds, underlining its strengthening ties with the European Union. As a token of the Chinese  belief in the Greek resurrection, China is setting up a $5 bln fund with which the Greek can buy Chinese vessels.

Secondly a report surfaced in the Financial Times that China and France held secret talks over “heightened co-ordination of exchange rates” which might mean they are looking for a new reserve currency now that the $US is losing some of its appeal. France was quick to deny the FT report but still one has to wonder if the US, with their congressional move to label China a currency manipulator, might have pushed China a little too hard for their own good.

It is starting to feel as if China is doing a trial run on how to act when they replace the US as the new lender of last resort.  Granted, it will take a while, if ever, before that happens, but it seems the Chinese are out to gain financial world dominance, just as the Japanese tried to do back in the 80’s and early 90’s. We all know how that ended up, so don’t trade in your English dictionary for a Chinese one just yet. But the US and the Europeans are  giving them an awful lot of room to play with.

In the US the financial story of the weekend was the final SEC report on the flash-crash on may 6^th this year. The conclusion of the report was that a firm called Waddell & Reed Financial Inc apparently sold 75.000 S&P-mini futures to hedge a portion of it’s risk in its $75 billion investment portfolio. Triggering the major selloff which saw the Dow plunge close to 1.000 points in less than 30 minutes. The question is of course how a mere 75.000 mini futures can cause such a landslide and better yet, are we close to a ban on hedging our investment portfolios for the risk of a market meltdown is too great?

The CME, where the mini-futures are traded, published an answer to the SEC report, refuting much of their findings:

´Futures and options markets are hedging and risk transfer markets.  The report references a series of bona fide hedging transactions, totaling 75,000 contracts, entered into by an institutional asset manager to hedge a portion of the risk in its $75 billion investment portfolio in response to global economic events and the fundamentally deteriorating market conditions that day. The 75,000 contracts represented 1.3% of the total E-Mini volume of 5.7 million contracts on May 6 and less than 9% of the volume during the time period in which the orders were executed.  The prevailing market sentiment was evident well before these orders were placed, and the orders, as well as the manner in which they were entered, were both legitimate and consistent with market practices.  These hedging orders were entered in relatively small quantities and in a manner designed to dynamically adapt to market liquidity by participating in a target percentage of 9% of the volume executed in the market.

As a result of the significant volumes traded in the market, the hedge was completed in approximately twenty minutes, with more than half of the participant's volume executed as the market rallied – not as the market declined.  Additionally, the aggregate size of this participant's orders was not known to other market participants.

Additionally, the most precipitous period of market decline in the E-Mini S&P 500 futures on May 6 occurred during the 3½ minute period immediately preceding the market bottom that was established at 13:45:28. During that period, the participant hedging its portfolio represented less than 5% of the total volume of sales in the market.’

Will be continued, no doubt.

The economic data coming from the US Friday was a bit better than expected overall. Consumer Confidence and Construction spending were a bit better, while ISM came in broadly inline. The market reacted as it has done all week: NOT at all

Dow + 0.39% S&P +0.44% Nasdaq +0.09% EuroUSD 1.375 Oil $81.50 Gold $1.319

Within the S&P Basic Materials and Oil & Gas were the main winner (+1.3%), probably on the SinoPec investment in the Brazilian operations of Repsol, which some skeptics say overvalues the Brazilian oil. But then again, if you are China you can never have enough oil I guess.

Just as investors bid up oil related stocks after the aforementioned Chinese ‘intervention’ I suspect they will bid up European stocks come this morning, as China voiced their support for Greece (backed up with dollars of course). Will it be enough to break out above the DAX resistance? I doubt it, but I will probably will be long as we try.

Happy Hunting & Let’s be Careful out there !!!