The old adage of Victorian surgeons has been a guiding principle of my global equities strategy as the credit crunch of 2008 morphed into a credit Godzilla last month: when in doubt, cut it out. To paraphrase Wadsworth , bliss it was that dawn to be alive but to be a global macro trader was, well an exercise in financial masochism.

Still, ours is not to question why, ours is but to trade and die because Hank the Tank, Helicopter Ben and Wall Street’s defanged Masters of the Universe have blundered big time as the global markets galloped across the valley of death to their inevitable meltdown last week. Surprise? Hardly. Remember my KT column published on January 1, 2007, titled the coming global financial crash? I quote “The bull is old, tired and vulnerable. There is a debt pyramid that makes credit contraction and a liquidity shock inevitable.”

It is time to seek opportunity from the carnage in the financial markets, to gaze at the crystal ball for 2009 in quest of money making ideas or compelling risk-reward calculus trades? Absolutely. I still argue that Asian equities are in the danger zone as long as valuation metrics do not reach book value, the historic bottom in 1998 or at least the bear market trough in 2004 at 1.4 times book, 30 per cent below current levels. However, those bottoms were marked by compressed earnings while we are basically still in the pre-downgrade peak EPS silly season, despite the gutted indices. Bull markets are born when earnings and ROE collapse and then turn higher while consensus EPS expectations are down in the dumps.

As of now, I simply cannot envisage Asian equities flying on the upside, though individual consumer, bank and infrastructure shares will double. The catalyst for a new Asian El Torro will have to emanate from China, where I believe the Peoples Bank is no longer an inflation hawk and will aggressively trigger a monetary policy U-turn to prevent a contraction of bank lending at a time when exports/current account surplus are in free fall. This is the reason crude oil, the Baltic Dry Freight Index sulpher, steel, iron ore, copper and nickel are all in deep, vicious bear markets that will continue. Moreover, China cannot pop without a monetary policy trigger in Beijing and a compression of Wall Street market stress. I seek capitulation (panic redemptions, failure of Shanghai broker, bank runs in Hong Kong ) as my ideal entry point, possibly below 12000 on the Hang Seng and 7000 on the HK China Enterprises Index.

Meanwhile, the trade de jour is to take advantage of juicy volatility (the Chicago VIX is 45!) to sell out of the money strangles on global equities index where the risk-reward calculus is compelling. Oil is a compelling short because US, Europe, China , India demand for gasoline (car dealerships will go the wave of Brontosaurus by the tens of thousands worldwide) is getting crushed at the same time as Saudi oil production has ramped up. The result? An oil glut. My call? In a global recession, $20 a barrel in next twelve months. Super-cycle? Ha Ha.

I am convinced that we will see the SP500 bottom at below 1000 once money centre banks writedown/provisions peake and Paulson’s bailout plan has passed both the Senate and the Congress. The US economy has tanked as the ISM, auto sales, jobless rate, capex data proves. This could be the steepest recession since World War II for housing, capex and the consumer.

The real catalyst for a SP500 pop will be the perception that earnings will bottom and the end of the Great Unwind as hedge funds slash leverage while the buy side raises cash.

This is the time to be Ben Graham and Warren Buffett, not George Soros or Lord Rothschild (buy when there is blood on the street. Not relevant at this point in the global cycle, not even for the Islamabad and Baghdad stock exchanges!). My base case scenario is a SP500 trading range, making me a volatility seller via out of the money strangles once again.

Ironically, I am far more bullish on European equities, where conventional wisdom dictates the iceberg has still to hit the Titanic. We are at 25 year lows on forward earnings yields relative to the 10 year bellwether German Bund and free cash flow yields are above 6.5 per cent, higher than the 2002 bottom.

The European metrics extrapolate a 30 per cent fall in corporate profits in 2009, which is far too draconian. European companies have benefited enormously from offshoring, globalisation and the emergence of BRIC export markets (Think Siemens, Deutsche bank, Nokia, Credit Suisse) These trends make the profit recession of 2008 milder than 2002 or 1998, especially now that the Irish, Belgian and Dutch banking systems have been de facto nationalised. Still, bank lending and credit market seizures militates against a sustainable bull run as valuations never goose the animal spirits of the bourses without the ballast of easy money and rising EPS, particularly since European banks are still Basle Tier One capital challenged, when loan loss provisions rise.

Europe is a classic long/short arena and retail, autos, construction and shipping (from Oslo to Pireans) stocks are the ideal shorting vehicles now that it is verboten to whack the banks.

It is impossible to become bullish on Japan even if Aso-san is a bit more charismatic (he speaks English and does not offend China/gaijins by promising to trek to Yasukuni shrine to pray for the souls of Tojo and Yamamoto’s fallen samurais).

The economy is slipping into recession, the Nikkei Dow and TOPIX are still in the dumps, profit growth is still falling.

MATEIN KHALID
STRATEGIST, CAPITAL MARKETS & RESEARCH