Will HSBC's 'bull' eyeballs bleed?

HSBC has been the great bounding bull of the world stock market for the past 11 years. I have monitored it closely since then, firstly for personal reasons, and later because I welcomed it to Malta on the basis of my long work as a consultant to Mid-Med Bank in the early Nineties.

I felt Mid-Med sorely needed a privatisation process. When circumstances moved me close to HSBC, that bank had already been a success story for decades in Hong Kong with its shares commanding a premium rating.

I remember well that 11 years ago the prestigious American magazine Business Week called it a "money machine" and it also called the shares of STET, the present Telecom Italia, a "steal". Both shares skyrocketed subsequently. It was a happy day for analysts and investors.

HSBC has in the past few days been receiving a lot of unwelcome attention. Funny photographs of its chairman have been published. So what has gone wrong with the bank, which once looked down on the rest of British banks like the gods of Mount Olympus?

The scientifically researched answer for whoever has invested in HSBC international bank or in its Malta subsidiary is that, as often happens, some analysts are overreacting to the world economic slowdown - a minor planned slowdown in comparison with the great uncontrolled slowdowns that occurred in the not too distant past when the economic process was misunderstood.

That was a time when a statesman like Sir Winston Churchill, great in war but ignorant in economics, completely mistook the needs of the British economy. In 1925 he put Britain again on the gold standard after an economically exhausting World War I.

He thus helped to precipitate economic distress in his country and Europe. This finally led to Hitler, the Spanish and Abyssinian wars and the transformation of Mussolini into a Nazi puppet.

Churchill's economic mistakes in 1925 were those of ignorance and the usual overreaction of politicians to things they did not understand. Such events are not likely to recur.

Nor is there any evidence that US President George W. Bush and his man of economic destiny and high financial adventure - Federal Reserve (US central bank) chairman Ben Bernanke - have lost their successful leadership of world economic movements.

Benign environment

President Bush might be said to be the exact opposite of Churchill. The former is presiding over the world's most successful economy, which in turn is pulling up countries like China, with its 1.3 billion inhabitants, into hitherto undreamed of realms of prosperity and financial power, while as everybody knows useless killings go on in Baghdad, that cradle of civilisation.

The world in which HSBC operates today is far safer than the one that inevitably led to the ruinous clash of the world's mightiest nations in the late Thirties of the last century. This was when a world economic crisis was intensified by the actions politicians took to answer a now easily explainable economic downturn by introducing further economic contractionary measures.

Ignorance in economics, as in family life, can be much worse than thievery, which is however never lacking. The international economic environment in which HSBC is now operating is largely a benign one.

The first point the investor must understand is that there is absolutely no chance of HSBC being swept away by a Thirties-like depression, which had the effect of bankrupting half of America's banks and creating double digit unemployment in that country, or even worse if we use modern statistical standards.

If HSBC's 'bull' eyeballs are made to bleed, it will not be because its hard work in the past was wanting in any way. Eleven years ago it fully deserved the label "money machine", which it certainly does not deserve at present.

The biggest reason for its comparative decline is that it is a miserly paymaster to its staff, and because it employs a dividend payout policy that is a joke when compared to that of a far weaker bank like Lloyds TSB, which has stemmed its decline and boosted a weak share price by being generous to its investors. It is now enjoying much deserved success among local and international investors.

Bounding stocks

As I write this piece in the middle of last week, my Bloomberg screen shows every sign of extreme nervousness. These are unpleasant, frequent warnings displayed - much more frequently than usual - stating that Bloomberg is not responsible for the accuracy of the figures displayed, that investors buy and sell shares at their own risk, and that shares can go down as well as up.

My office breathed the anxiety of Wall Street. It is great fun to experience the first full blast of the communications revolution. For stocks on that day were bounding around with oil prices, and that they would continue to bound as long as the global oil supply and demand continued to be so uncertain.

Throughout the week there was an oil and base metals sell-off, keeping commodity prices on back foot. The oil price was on a jumpy downward trend. The world economy, including China (but not to the same extent), was slowing down.

The reason for fun and not anxiety was that this was a planned slowdown. The world economy has been made to slow down by the United States and for a very good reason. The US comprises about 25 per cent of global economic activity. It is the economy's flywheel, the big wheel that makes the small wheels spin.

America has decided that enough was enough as regards the rapid growth being witnessed in the world economy, for the time being. If the evil genie of world inflation were to be released from the bondage where statesmen like former British Prime Minister Margaret Thatcher put it, it would destroy that capitalism for which it stands.

Capitalism cannot do without a modicum of inflation. It must however be a modicum and nothing else. Capitalism needs a sound system of liquid money flows about which, however, as The Economist of January 6 pointed out, so little is known.

It stated (page 57): "Though there is no agreement on how to measure liquidity, using the global supply of dollars as a proxy, The Economist estimates that in the past four years it has risen by an annual average of 18 per cent, probably the fastest pace ever."

The fastest pace

Many will agree that the flow of dollars into the world economy, as described by The Economist, is turning into a cascade. This development is unacceptable even to the US. Many important economies are thus switching a substantial part of their monetary reserves into the euro, which is an expression of the European civilisation's depth of wisdom and not just of a handful of brilliant economic analysts.

If the American economy is the flywheel of the world economy, its housing market lies at its heart. Any bank manager will tell you that real estate activity makes up about 80 per cent of his bank's workload.

The housing market is the part of the economy that makes itself most vulnerable to movements in interest rates, and it employs a lot of copper. Other areas of economic activity like the production of armaments are less vulnerable to interest rate oscillations.

There was only one way for Mr Bernanke to stem this flow of liquidity that was threatening to become the cancer of the very economy he was trying to doctor. His method is to raise interest rates. This he did for the 16th consecutive time.

He was obviously doing his best to dampen the housing market and, as a by product of his activity, he dampened HSBC's world share price. If anyone wants to understand the HSBC we have on our doorstep, he should do more than question our politicians.

Household's systems

Mr Bernanke's deflationary policies brought worldwide trouble, though not serious trouble, at an HSBC that seemed to be powering ahead. Ponder the fact that the world's somewhat clumsily self-styled "local bank" displayed in its last interim results figures that would have been the source of envy in many a great bank in the European Union.

Its pre-tax profits jumped 18 per cent to a record of $12 billion. These unmistakably stellar profits were, however, obfuscated by the dramatic trouble that surfaced in HSBC's American adventure.

Household International was bought by HSBC in 2003 for $14.8 billion. This purchase apparently has had far less luck than its brilliant Mid-Med Bank purchase, which is being rewarded by an 18 per cent return on equity (ROE), and a healthy though not spectacular share price, as demonstrated last week.

Household handed out loans that proved to be dubious and that no bank in Malta would ever have dreamt even to consider. Its banking systems were no match for those of our banks in Valletta. There were low-income, trailer park customers who caused trouble. In spite of all this, Household generated $9 billion net profits - a decent 17% on capital invested.

It seems that the real trouble is that HSBC deserved to be teased by the financial press, not censured. It deserved to be hailed by future historians as the great beacon of Western financial endeavour in China and a great factor of the awakening of the mighty and long suffering Chinese people to its proper place in the world financial community.

China gave the so-called Arabic numbers to the world. It made medieval Italian banking and consequently modern banking possible. China is moving forward with the often bungling colossus of the Industrial and Commercial Bank of China (ICBC).

Let HSBC expect no gratitude for its China leadership and everything will be safe. HSBC can stand on its own feet. ICBC should be allowed to come forward, and HSBC should stop giving funny forecasts about ICBC share price behaviour.

ICBC is a most probable success story as it has the substantial backing of Goldman Sachs. As regards HSBC's bleeding bull 'eyeballs', the UK quality financial press has failed to notice the stiff competition ICBC is offering to HSBC. This peaked appropriately on Christmas Day itself when ICBC climbed 10 per cent.

On that day most HSBC analysts were enjoying their Christmas Day celebration. I do not regard the share price movement of ICBC on Christmas Day as a coincidence. I would liken it to the Egyptian attack on Israeli lines in 1973 on the Jewish New Year's day of Yom Kippur.

The Western financial press should stop giving undue importance to the present HSBC share price trouble, attributing it to the Household nonsense, when HSBC is earning so much on Household and neglecting the ruthless competition from ICBC.

Unexpected developments

The eyeballs of the charging HSBC bull will probably not bleed since there is a great need for its international banking mission all over the world; and not least in Malta, where all bank ratios improved within a few months of its arrival.

The HSBC Malta operation has been probably performing better than its international one. ICBC might try to displace it as the world's record-breaking bank. HSBC now occupies fourth place with honour. A new dividend and employee bonus policy can get it a long way towards its former glory, but most important of all it is badly needed in China, where as any psychologist can tell you, the Chinese will not stoop, playing the old bad debts game despite the fear of Communist anti-corruption firing squads or worse.

The habits of a nation cannot be changed in a decade or in a few months. In Malta we have experience of how HSBC have made all too well known banking improvements. Mid-Med Bank, as was to be expected, had some oriental characteristics.

Goldman Sachs is behind ICBC, of whose shares it promises to hold five per cent for eight years, but it has not got the experience of HSBC in leading the Chinese. HSBC has a worldwide banking vocation that ICBC is already trying to imitate.

ICBC cannot do all too easily when one remembers the events of recent years that led to its recapitalisation.

In Hong Kong there was probably some unloading of HSBC shares and a startling movement of its shareholders to ICBC. It would be impossible to explain the surprising success of the ICBC initial purchase offer (IPO), which fooled all analysts. It was more than double expectations.

Capital flows have a raison d'etre behind them. The Chinese economic situation can certainly absorb both great banks, and one of them can be a model for others. The reader can guess which bank I am referring to. HSBC is not, however, above being noticed worldwide in an unwelcome way.

This happened last week because of some funny appointment to its board in Mexico. The roof of the Chinese economy is to some extent determined by the availability of that country's labour supply. It has some way to go before its limits are reached.

The biggest chance that the HSBC bull's eyeballs will bleed is when the Chinese people will become restless as capitalism pours out its benefits. Trouble comes not when a people is economically crushed but when it comes to taste the rewards created by hard work.

In China there can be unexpected developments, and not only for HSBC, but these developments augur not famine as in the days of Mao Tse Tung but unbounded banker wealth paying for swirling folk dancers, such as we saw in Valletta a few days ago at Christmas.

HSBC helped create Chinese prosperity. Let it not lose its momentum and let us not talk nonsense about "bleeding eyeballs". What is in doubt is the rate of successful advance and not the advance itself. S&P has affirmed its AA- long term and A-1+ short term counterparty credit ratings.

This article is not intended as investment advice, but aims to help produce an investment culture. John Azzopardi Vella has promoted the Malta Development fund and advised S&P. He is currently research economist of DBR Investments Ltd, which is licensed by the MFSA. E-mail: johnazzopardivella@hotmail.com