I noted in a recent article published by Bestinver that they place importance on comparing the market cap of the company relative to the cash and cash equivalent assets of the company a number of years in the future (2012 in this example).
We like this approach.
If we take a companies net assets and modify their value to current valuations (conservatively), and then add the free cash flow we feel can be achieved over the next 5 years, we can compare this sum to the market cap at the moment.
For example a company that achieves a 20% return on equity consistently that has a conservatively valued balance sheet and can be bought for x2 book would be good value under this approach. If they held hidden assets on their balance sheet it could be an exceptional investment.
Saturday 17 September 2011
Meeting with Carmignac
This week I met with members of the respected investment house Carmignac.
They divided the conversation into three geographic regions: the USA, Europe and Emerging Markets.
Felt the US had little real GDP growth prospects for a number of years
The consumer will continue to de leverage
The US government is reaching a debt ceiling and hence likely to offer less support to GDP growth in the future
Corporations continue to prefer investing abroad than in developed markets in general
Even when country was downgraded their cost of borrowed trended downwards. Their equity took a hit as GDP growth likely to suffer if government will invest less in its economy as can borrow less due to approaching its ceiling
However, still has advantage of the reserve ccy hence many people around the world hold USD and would lend to the government, hence their low rates
Is market suggesting government should take a more aggressive role in supporting its economy by offering the country lower rates
In Europe there was an agreement that only three viable solutions exist: money printing (a temporary solution), fiscal unity or debt restructuring
They are very underweight European equities in general, especially their banks, and are not keen on holding the Euro
Felt Europe was in a similar situation to Japan in the 1990s. There consumer de leveraged but the export machine started working
Now many developed countries need to export so more tension with currencies and trade (not an isolated case anymore)
Euro was more stable than USD because of advantageous interest rate differential
Inflation fears reducing, likely to take Euro down
Europe very dependent on banks for financing (like Japan), whilst USA less so (opposite 75/25 split in bank to capital market funding)
This means whilst banks are unable to lend as they have to re capitalize themselves from poor investing in the past and new regulation, Europe is unlikely to find much new capital in this arena for growth. We may see European companies looking for more capital in the capital markets if they decide to open up, or they will be static
Problem of Japan was it took so long to admit the problem of its banks and start to re capitalize them
Euribor is increasing more than Libor in the US as European banks are not trusting each other as much so cost of borrowing is increasing
Very positive on EM as they become more consumption based and less export based economies. They feel inflation will decrease. Since EM equities now are at a 30% discount to DM equities when compare MS indices, they could be the sweet spot for EM equities: growth, low inflation and cheap initial position. I don’t think I agree as strongly as they do. They are using a relative cheap indictor, when it should be absolute! I don’t think inflation will be easy to control with wages increasing 20% per annum. There will be a benfit from commodity prices decreasing if we see less capital injections from DM central banks and recession in DM, but internal inflation is still a problem resulting from the growth they have which is very high. Interest rates seem to be stabilizing in the EM world – but lets see how the economy reacts.
There portfolio core is on companies helping to make EM consumers have a better quality of life. This is primarily consumer companies, infrastructure and financials
The satellite portion is in more growth opportunities such as technology and raw materials
They like gold miners as feel they are out of synch of the gold price. I note that gold miners sell gold at a certain pre determined price or unhedged. Hence their earnings over the next 10 years will depend on the gold price over that time period rather than just at this moment when there is a lot of fear and when gold attracts the most attention as an investment!
They feel at this moment have to guess what will be the safe havens, i.e. where capital will flow
Worried about EM currencies as they may see lots of capital outflows if DM recession occurs, hence may be an opportunity to buy them soon
EM consumers hard for them to buy foreign basic consumer goods as more expensive (remember their currency is quite weak and costs are higher abroad). For the growing rich they may be attracted to the high quality DM consumer goods, hence the strong business environment for BMW and Louis Vuitton in sales and profits.
EM consumers are therefore buying more local brands and consumer goods, and here there is the potential for many opportunities
Note that many international corporations have lower margins in EM countries, hence their P/S ratio will be lower if all sales where based in these countries
They divided the conversation into three geographic regions: the USA, Europe and Emerging Markets.
Felt the US had little real GDP growth prospects for a number of years
The consumer will continue to de leverage
The US government is reaching a debt ceiling and hence likely to offer less support to GDP growth in the future
Corporations continue to prefer investing abroad than in developed markets in general
Even when country was downgraded their cost of borrowed trended downwards. Their equity took a hit as GDP growth likely to suffer if government will invest less in its economy as can borrow less due to approaching its ceiling
However, still has advantage of the reserve ccy hence many people around the world hold USD and would lend to the government, hence their low rates
Is market suggesting government should take a more aggressive role in supporting its economy by offering the country lower rates
In Europe there was an agreement that only three viable solutions exist: money printing (a temporary solution), fiscal unity or debt restructuring
They are very underweight European equities in general, especially their banks, and are not keen on holding the Euro
Felt Europe was in a similar situation to Japan in the 1990s. There consumer de leveraged but the export machine started working
Now many developed countries need to export so more tension with currencies and trade (not an isolated case anymore)
Euro was more stable than USD because of advantageous interest rate differential
Inflation fears reducing, likely to take Euro down
Europe very dependent on banks for financing (like Japan), whilst USA less so (opposite 75/25 split in bank to capital market funding)
This means whilst banks are unable to lend as they have to re capitalize themselves from poor investing in the past and new regulation, Europe is unlikely to find much new capital in this arena for growth. We may see European companies looking for more capital in the capital markets if they decide to open up, or they will be static
Problem of Japan was it took so long to admit the problem of its banks and start to re capitalize them
Euribor is increasing more than Libor in the US as European banks are not trusting each other as much so cost of borrowing is increasing
Very positive on EM as they become more consumption based and less export based economies. They feel inflation will decrease. Since EM equities now are at a 30% discount to DM equities when compare MS indices, they could be the sweet spot for EM equities: growth, low inflation and cheap initial position. I don’t think I agree as strongly as they do. They are using a relative cheap indictor, when it should be absolute! I don’t think inflation will be easy to control with wages increasing 20% per annum. There will be a benfit from commodity prices decreasing if we see less capital injections from DM central banks and recession in DM, but internal inflation is still a problem resulting from the growth they have which is very high. Interest rates seem to be stabilizing in the EM world – but lets see how the economy reacts.
There portfolio core is on companies helping to make EM consumers have a better quality of life. This is primarily consumer companies, infrastructure and financials
The satellite portion is in more growth opportunities such as technology and raw materials
They like gold miners as feel they are out of synch of the gold price. I note that gold miners sell gold at a certain pre determined price or unhedged. Hence their earnings over the next 10 years will depend on the gold price over that time period rather than just at this moment when there is a lot of fear and when gold attracts the most attention as an investment!
They feel at this moment have to guess what will be the safe havens, i.e. where capital will flow
Worried about EM currencies as they may see lots of capital outflows if DM recession occurs, hence may be an opportunity to buy them soon
EM consumers hard for them to buy foreign basic consumer goods as more expensive (remember their currency is quite weak and costs are higher abroad). For the growing rich they may be attracted to the high quality DM consumer goods, hence the strong business environment for BMW and Louis Vuitton in sales and profits.
EM consumers are therefore buying more local brands and consumer goods, and here there is the potential for many opportunities
Note that many international corporations have lower margins in EM countries, hence their P/S ratio will be lower if all sales where based in these countries
Wednesday 14 September 2011
Structural and cyclical trends we observe
When we suggest we are in a structural change as opposed to a cyclical one, we often quote the muted role of interest rates currently observed in DM.
Interest rates are often the dominant variable that determines economic activity in a normal business cycle. However, at one point the debt load becomes so large the DEBT itself becomes the dominant variable that affects economic growth! History suggests this occurs on average every 30 years.
It is not an accident this debt was accumulated by primarily households and governments in DM. The former were borrowing to maintain their quality of life whilst real wages were not increasing due to the birth of a globalised labour force.
Governments were forced to borrow as trade and budget deficits were allowed to continue under the illusion they would eventually sort themselves out.
Eventually the market decided to take action as the politicians were not doing much.
Real GDP growth is not likely until the issue of the debt is resolved. History suggests restructuring is usually required to resolve this problem.
We note the continuous pressure on real wages and the growing % of GDP of profits relative to wages do not seem to be cyclical trends, but fueled by globalisation. This force is so powerful we only see this reduced by protectionism - which of course will create a whole set of new problems with less advantages.
A cyclical trend we have observed over the last decade has been the declining price/earning ratio of DM equities. This occurs every 15 - 20 years on average and is often triggered by a shift in capital to real assets from financial assets. It is therefore no surprise when p/e ratios started to decline in around the year 2000, commodities started to rise and the USD started to decline. We expect this to change over the next 5 years (we feel differently about the USD as we think its role in the future will be different to its role in the past. Another financial asset (ccy) will take more advantage of capital flowing to financial assets as confidence returns to the financial system). This would be extremely positive for equities, especially if they are able to maintain their high level of profitability from being the most flexible participant in the economy, hence the one that can most take advantage of globalisation.
Our biggest fears are increasing tax burdens from debt laden governments, and our obsession with the mean reversion property of profit margins we have observed throughout the last 100 years, which are currently at record highs. Is globalisation allowing this to continue?
Interest rates are often the dominant variable that determines economic activity in a normal business cycle. However, at one point the debt load becomes so large the DEBT itself becomes the dominant variable that affects economic growth! History suggests this occurs on average every 30 years.
It is not an accident this debt was accumulated by primarily households and governments in DM. The former were borrowing to maintain their quality of life whilst real wages were not increasing due to the birth of a globalised labour force.
Governments were forced to borrow as trade and budget deficits were allowed to continue under the illusion they would eventually sort themselves out.
Eventually the market decided to take action as the politicians were not doing much.
Real GDP growth is not likely until the issue of the debt is resolved. History suggests restructuring is usually required to resolve this problem.
We note the continuous pressure on real wages and the growing % of GDP of profits relative to wages do not seem to be cyclical trends, but fueled by globalisation. This force is so powerful we only see this reduced by protectionism - which of course will create a whole set of new problems with less advantages.
A cyclical trend we have observed over the last decade has been the declining price/earning ratio of DM equities. This occurs every 15 - 20 years on average and is often triggered by a shift in capital to real assets from financial assets. It is therefore no surprise when p/e ratios started to decline in around the year 2000, commodities started to rise and the USD started to decline. We expect this to change over the next 5 years (we feel differently about the USD as we think its role in the future will be different to its role in the past. Another financial asset (ccy) will take more advantage of capital flowing to financial assets as confidence returns to the financial system). This would be extremely positive for equities, especially if they are able to maintain their high level of profitability from being the most flexible participant in the economy, hence the one that can most take advantage of globalisation.
Our biggest fears are increasing tax burdens from debt laden governments, and our obsession with the mean reversion property of profit margins we have observed throughout the last 100 years, which are currently at record highs. Is globalisation allowing this to continue?
What determines GDP
If we were to be simple and crude, my simple understanding of basic economics would suggest that Nominal GDP growth is based on three main drivers:-
1 Population growth and the ratio of young to old workers (i.e. 25 to 50 year olds)
2 Productivity (generally means increasing capital intensity or more innovation from a better educated and better motivated workforce)
3 Inflation: Here we refer to the growth of credit (more savings in an economy more firepower to unleash credit later) and money printing
Hence an economy with large savings, strong productivity increases potential (i..e starting from a relativey low capital intensity and low penetration of highly educated workers) and a steadily growing population with a large proportion of young workers is the ideal combination
We add here a short note on austerity measures. For economies where confidence still remains but has been weakened, austerity can help raise confidence and hence provide access to new capital which can allow new growth to be created. However, generally, in the medium term likely to be problematic, especially if the return of the capital invested is weak.
Austerity in general reduces future deficits, hence reduces the debt level for the future, but does not rsolve the issue of the large debt you currently hold which required the austerity measure to be started.
Large debt burdens are only finally killed by growth, which comes from receiving new capital. Countries where confidence remains need a good plan to attract capital. Those that have no confidence for the market, must eventually restructure debt to attract new capital by offering the potential of large margins (how capitalism works)
1 Population growth and the ratio of young to old workers (i.e. 25 to 50 year olds)
2 Productivity (generally means increasing capital intensity or more innovation from a better educated and better motivated workforce)
3 Inflation: Here we refer to the growth of credit (more savings in an economy more firepower to unleash credit later) and money printing
Hence an economy with large savings, strong productivity increases potential (i..e starting from a relativey low capital intensity and low penetration of highly educated workers) and a steadily growing population with a large proportion of young workers is the ideal combination
We add here a short note on austerity measures. For economies where confidence still remains but has been weakened, austerity can help raise confidence and hence provide access to new capital which can allow new growth to be created. However, generally, in the medium term likely to be problematic, especially if the return of the capital invested is weak.
Austerity in general reduces future deficits, hence reduces the debt level for the future, but does not rsolve the issue of the large debt you currently hold which required the austerity measure to be started.
Large debt burdens are only finally killed by growth, which comes from receiving new capital. Countries where confidence remains need a good plan to attract capital. Those that have no confidence for the market, must eventually restructure debt to attract new capital by offering the potential of large margins (how capitalism works)
The modern value investor needs to be more concerned with Macro issues
Sometimes it does not surprise me that most respected value investors of the last 50 years have been based in the USA.
Here is an economy where they have enjoyed a (1) stable political system and (2) currency with (3) continuous access to capital markets for funding. Hence the bet on a cyclical recovery always worked! Buying value therefore generally always paid off!
However, today we are seeing structural changes occur which will change the economic structure and the role of different economic participants in a drastic manner. Here the cyclical bet is more likely to go wrong we feel - as countries are competing with each other as well as companies within a country and outside the country.
This means currency management needs to become a more important part of the valuation equation, forcing the current value investor to be more concerned about MACRO issues.
Here is an economy where they have enjoyed a (1) stable political system and (2) currency with (3) continuous access to capital markets for funding. Hence the bet on a cyclical recovery always worked! Buying value therefore generally always paid off!
However, today we are seeing structural changes occur which will change the economic structure and the role of different economic participants in a drastic manner. Here the cyclical bet is more likely to go wrong we feel - as countries are competing with each other as well as companies within a country and outside the country.
This means currency management needs to become a more important part of the valuation equation, forcing the current value investor to be more concerned about MACRO issues.
Monday 12 September 2011
Currency management coming to the fore
We are seeing the market react as if a default in Greece is likely to happen this week. We always felt this was always going to be the necessary solution to remove the excessive debt load. The market talked about it, but we may see how it really reacts this week.
This would be difficult for the market. It would immediately fear that other European economies could be next, putting great pressure on the EURO and European equities and debt markets as money flows out of the European Union into supposedly safer hands.
It seems the USD has taken this role, no doubt EM debt will also enjoy decreasing spreads.
In our portfolios equities are within 40 - 50%. High quality is approx, twice the amount of cyclicals. We do not want to change this ratio at this stage of developments.
Value investors must be careful as we cannot think of this as a standard business cycle where liquidity is the main issue and a bit more time will help us. We are dealing with structural changes that affect solvency of economies - they are not only liquidity issues. Hence we are looking for companies that can survive and are cheap. Structural changes take time to be resolved. Hence the large cash load in portfolios.
Currency management is becoming more of an issue as large cash holdings must be kept in currencies where its purchasing power can increase. This is likely to be in EM, or countries whose GDP is correlated to these economies. This can include Canada.
We will be studying three different categories of economies to understand their currencies. The first 2 DM, and the third EM.
This would be difficult for the market. It would immediately fear that other European economies could be next, putting great pressure on the EURO and European equities and debt markets as money flows out of the European Union into supposedly safer hands.
It seems the USD has taken this role, no doubt EM debt will also enjoy decreasing spreads.
In our portfolios equities are within 40 - 50%. High quality is approx, twice the amount of cyclicals. We do not want to change this ratio at this stage of developments.
Value investors must be careful as we cannot think of this as a standard business cycle where liquidity is the main issue and a bit more time will help us. We are dealing with structural changes that affect solvency of economies - they are not only liquidity issues. Hence we are looking for companies that can survive and are cheap. Structural changes take time to be resolved. Hence the large cash load in portfolios.
Currency management is becoming more of an issue as large cash holdings must be kept in currencies where its purchasing power can increase. This is likely to be in EM, or countries whose GDP is correlated to these economies. This can include Canada.
We will be studying three different categories of economies to understand their currencies. The first 2 DM, and the third EM.
Important portfolio issues
We have tried to mitigate our exposure to continued weak growth in advanced economies by:-
Buying being very sensitive to price, i.e. not paying for growth
Buying high quality companies whose business is not cyclical and who have strong balance sheets
Diversifying in currencies and not just holding the currency of where we are (which is the EURO)
Buying companies that have revenues that are geographically diversified
As prices become cheaper gaining exposure to cheap physical real assets (often cyclical companies). This strategy helps mitigate risks from excessive money printing by the authorities
We have been keen to gain exposure to emerging economies but are concerned on how to achieve this without increasing the risk/reward ratio. We have attempted to do this via:-
Buying advanced economy companies that have a repectable and growing revenue base in emerging economies
Buying companies that are involved in businesses that deal with real assets. We favour oil and timber. We note the latter commodity is not as easily transportable as the former, hence prices are more locally determined
We have stayed clear of buying foreign currencies such as the AUD, SGD etc as we are not currently comfortable with how to value such variables.
We have also stayed clear from buying industrial or precious metals. Our foray into agriculture ended poorly as we bought an EM company whose corporate governance proved to be most untransparent and anti shareholders.
As a result we are advancing our macro approach to consider new avenues to implement exposure to EM when the prices are more attractive. Our decision to maintain a low exposure has proven to be good so far. We feel it is better to be earning a wage and seeing that increase in those regions, then being a foreign investor in their stock market.
Fears on interest rates, inflation and depreciating currencies
We hold cash versus equities, having little room for bonds at the moment
We hold cash with the aim of deploying in equities when the price is attractive for us
We hold more equities than cash due to the opportunity cost (negative real rate) and fears of continuous money printing eventually increasing inflation in EM and this will be exported to DM, reducing the purchasing power of cash
We fear increasing inflation in EM will lead rates to increase there reducing global growth. We think this will be positive for the USD and lead risk assets to decline. We therefore still hold a substantial holding in cash ready to be deployed when we see more interesting price levels
If the USD does increase, we would be looking to short the currency. Hence LONG US equities and SHORT USD would be a long term trade we would like to continue for a number of years
There are always at least two parties recipient to change. Since I cannot go long EM currencies I can go SHORT the USD. The question is relative to what? We can do a basket of currencies
Whilst alternative currencies are not available to the USD in the transition into a multi polar world, gold is likely to coninue to receive positive capital flows
Balance sheet issues?
Consumers in DM are de leveraging and consumers in EM still can't leverage up to take up the slack. Hence WEAKER GLOBAL AGGREGATE DEMAND IN CONSUMER SPENDING. This is bad for global growth
Currencies increasing in EM will help give consumers in EM a stronger purchasing power. It is also less politically damaging to help reduce inflation then increasing interest rates
Governments in DM are leveraged. De leverage via money printing to reduce the burden of their debt, reduce spending to reduce the deficit (but this reduces future debt but doesn't reolve the problem of past debt - that is often solved by growth which comes from receiving new capital to invest!)
New capital can be attracted by initiatives whilst there is confidence in an economy or debt restructuring when that confidence is gone, or bankruptcies to reduce the number of competitors and hence increase margins
Capital is attracted when their is an opportunity to make a profit!
A global initiative would help develop a plan on how each makor economy should play a certain role to help dilute the large global imbalances that have been developed over the last decade
A single country cannot resove this problem. Whilst capital has become global, labour has not, and neither has politics. This has created a tension on who does what
Corporates are the economic participant that can best maneovre in a globalised world. They are flexible to deploy capital where they want, not fixed like governments or stubborn like households. hence they can optimise their return and better adapt to a changing environment. We see this as corporate profits are increasing as a share of GDP whilst wages and tax returns are decreasing
Growth differential between EM and DM implies that cyclicals should be a better investment in EM and high quality in DM
Commodities have been driven up highly in recent years. Focus on supply constrained commodities such as OIL, PLATINUM and other commodities that are taken from only a few sources that are being restricted or where demand is increasing (but not a cyclical demand)
US needs to change the balance sheet and structure of its economy and be more competitive (via wages and currency and benefits)
Europe needs to have debt sustainability either via writedowns, fiscal transfers or money printing (not a long term solution)
EM need to help the consumer either via increasing currency valuation or easier access to credit or more support so save less
Buying being very sensitive to price, i.e. not paying for growth
Buying high quality companies whose business is not cyclical and who have strong balance sheets
Diversifying in currencies and not just holding the currency of where we are (which is the EURO)
Buying companies that have revenues that are geographically diversified
As prices become cheaper gaining exposure to cheap physical real assets (often cyclical companies). This strategy helps mitigate risks from excessive money printing by the authorities
We have been keen to gain exposure to emerging economies but are concerned on how to achieve this without increasing the risk/reward ratio. We have attempted to do this via:-
Buying advanced economy companies that have a repectable and growing revenue base in emerging economies
Buying companies that are involved in businesses that deal with real assets. We favour oil and timber. We note the latter commodity is not as easily transportable as the former, hence prices are more locally determined
We have stayed clear of buying foreign currencies such as the AUD, SGD etc as we are not currently comfortable with how to value such variables.
We have also stayed clear from buying industrial or precious metals. Our foray into agriculture ended poorly as we bought an EM company whose corporate governance proved to be most untransparent and anti shareholders.
As a result we are advancing our macro approach to consider new avenues to implement exposure to EM when the prices are more attractive. Our decision to maintain a low exposure has proven to be good so far. We feel it is better to be earning a wage and seeing that increase in those regions, then being a foreign investor in their stock market.
Fears on interest rates, inflation and depreciating currencies
We hold cash versus equities, having little room for bonds at the moment
We hold cash with the aim of deploying in equities when the price is attractive for us
We hold more equities than cash due to the opportunity cost (negative real rate) and fears of continuous money printing eventually increasing inflation in EM and this will be exported to DM, reducing the purchasing power of cash
We fear increasing inflation in EM will lead rates to increase there reducing global growth. We think this will be positive for the USD and lead risk assets to decline. We therefore still hold a substantial holding in cash ready to be deployed when we see more interesting price levels
If the USD does increase, we would be looking to short the currency. Hence LONG US equities and SHORT USD would be a long term trade we would like to continue for a number of years
There are always at least two parties recipient to change. Since I cannot go long EM currencies I can go SHORT the USD. The question is relative to what? We can do a basket of currencies
Whilst alternative currencies are not available to the USD in the transition into a multi polar world, gold is likely to coninue to receive positive capital flows
Balance sheet issues?
Consumers in DM are de leveraging and consumers in EM still can't leverage up to take up the slack. Hence WEAKER GLOBAL AGGREGATE DEMAND IN CONSUMER SPENDING. This is bad for global growth
Currencies increasing in EM will help give consumers in EM a stronger purchasing power. It is also less politically damaging to help reduce inflation then increasing interest rates
Governments in DM are leveraged. De leverage via money printing to reduce the burden of their debt, reduce spending to reduce the deficit (but this reduces future debt but doesn't reolve the problem of past debt - that is often solved by growth which comes from receiving new capital to invest!)
New capital can be attracted by initiatives whilst there is confidence in an economy or debt restructuring when that confidence is gone, or bankruptcies to reduce the number of competitors and hence increase margins
Capital is attracted when their is an opportunity to make a profit!
A global initiative would help develop a plan on how each makor economy should play a certain role to help dilute the large global imbalances that have been developed over the last decade
A single country cannot resove this problem. Whilst capital has become global, labour has not, and neither has politics. This has created a tension on who does what
Corporates are the economic participant that can best maneovre in a globalised world. They are flexible to deploy capital where they want, not fixed like governments or stubborn like households. hence they can optimise their return and better adapt to a changing environment. We see this as corporate profits are increasing as a share of GDP whilst wages and tax returns are decreasing
Growth differential between EM and DM implies that cyclicals should be a better investment in EM and high quality in DM
Commodities have been driven up highly in recent years. Focus on supply constrained commodities such as OIL, PLATINUM and other commodities that are taken from only a few sources that are being restricted or where demand is increasing (but not a cyclical demand)
US needs to change the balance sheet and structure of its economy and be more competitive (via wages and currency and benefits)
Europe needs to have debt sustainability either via writedowns, fiscal transfers or money printing (not a long term solution)
EM need to help the consumer either via increasing currency valuation or easier access to credit or more support so save less
Sunday 11 September 2011
Investment strategies
1 Understand the economy the business is based
Interest rates, inflation, balance of payments, GDP structure
2 Law and government and regulation in the country
3 Market Structure of the industry locally, nationally, internationally
4 Dynamics of the company
Sunday 4 September 2011
Weekend Summary
Though I, and the average reader of this blog, is winding down a pleasant weekend of meeting friends, eating good food, complaining about the weather and the occasional discussion about how banks and politicians ruined the country, the reality is many today are suffering in a way our system has installed in peoples mind is not meant to occur. Too sophisticated is our society to allow suffering to have the basic needs of life– the problem is that with time this list got longer, rather than more necessary.
We shall now stop walking down this well trodden avenue before we enter into an anti consumerism tone and give a well detailed (though skewed) opinion on who is to blame (the answer is of course everybody, though some parties merit a higher coefficient of contribution).
We shall instead focus on our weekly review of movements in the business and financial world:-
Markets continue to rise and fall with large volatility and strong sensitivity to macro news items. Most recently, disappointing unemployment figures made markets drop 2% in the US. This highlights the uncertainty present in many investors’ minds.
Uncertainty is a big problem for many investors as old models/trends/systems are simply not working.
It is not a surprise; past numbers are no guide to the future!
To understand the future, you need to understand the drivers of the current state of affairs. When the economy is in a steady state or in a simple business cycle where interest rates determine economic activity in a dominant manner, than past numbers can be a good guide for the future.
However, one variable they should be looking out for is the debt load of almost all market participants in developed economies. This is simply not another statistic – it is reality! When leverage reaches a certain level it becomes THE statistic, not a statistic. It is the dominant variable that will ascertain the future of many economies. The longer this is ignored, the longer the problem lingers, like an unwanted smell that will not go away. Without the debt load in a country reaches a certain limit that a standard increase in interest rates leads to a large deficit to be continuously maintained to meet the debt load, at one point demand will decrease drastically. This will lead to rates increasing enhancing further the debt problem. Once in this situation there is only one way out – debt forgiveness to reduce the debt load and hence increase the potential return of capital in that country so new capital is attracted into the economy.
There is another way. And that is what is happening in Greece. The market structure is being aggressively changed by large market players been consolidated to ensure companies survive. These companies are becoming quasi monopolies. European competition authority is allowing this to ensure large service based companies survive and it will attract foreign investment because these companies will have stronger attributes to survive. Consolidation will mean job losses – but this will have to be achieved to reduce costs, increase margins and therefore attract new capital. Already in telecom and banking sector. Effectively the competition authority is being bypassed for the benefit of the survival of the economy. Ownership of assets being changed – restructuring of the economy is occurring. Waste will be removed – this means the middle and working class worker will pay as well as the previous owner of the company. Previous stakeholders lose capital or income to attract new capital – this is how it works. But here it is not the debt holder, it is equity capital and employees – the debt holder is being spared, no doubt because they want to tap further funds from the credit market.
With pasta models not working, investors will have to realize that uncertainty always exists! It is an uncomfortable thought, but it is reality. It is not removed by vast swarms of past data or even a deep understanding of history, though both can help interpret the present to assess what is likely to occur.
However, what is happening now does not happen in your average business cycle. Banks do not loss 90% of their market cap every business cycle, or the central bank prints such large amounts of currency every business cycle, or the housing market loss value for a number of consecutive years. We are in the midst of a large global transition initiated by globalization, and fueled by several components which were unsustainable. Politicians were unable to alter the courses of economies that were expanding in an unsustainable way, so the nature of markets will do the job for them…..
With past models not working, it is no surprise that markets react violently to new news. However, through a simple understanding of the main parameters that will change, one may not know the exact nature of the journey, but will have a good understanding of where we are going. Certain past trends that were strong components of recent economic history, which will not be to the same extent in the future are”-
Developed market middle class living beyond their means through increasing credit and asset prices. This will reduce consumer spending in these economies and lead to an increase in the saving rate
China will not invest so specifically in fixed investments for exports.
The international role of the USD as a reserve currency is likely to decrease over time
Greater political and fiscal union in Europe, or the return of individual currencies
Less welfare support for developed markets, higher retirement ages
Just these few changes, where there is little guess they will occur (only when), will make our future very different from our recent past. These are changes now being forced by the capital markets because politicians were unable to bring them to fruition. If you follow through the natural consequences of these changes, one can have an idea of what our future may look like, and then start asking who would benefit in this environment.
Though we have all heard of these stories, few are accepting them as the new reality. Instead, investors are caught in an “uncertain” world, frightened by the fact that old models don’t work, when it is really quite clear where we are going; only we don’t know how we will get there. One must be willing to forgive the details of the future to appreciate the bigger picture, which has such a powerful force leading it to this destination, that it is hard to think of an obstacle that can stop it.
A point on China not being able to continue with fixed investments to export. Look at the damage they have done on the margins of manufacturing photo voltaic modules. Prices have gone down so strongly that a number of US solar cell companies are going bankrupt every week. The Chinese companies are hardly making profit as they have developed such an overcapacity it would take years to allow demand to meet the supply – typical Chinese investment strategy that leads to a flooding of the market. If they finally end up as the only participants in the market it may be seen as a worthwhile strategy, but instead, it encourages protectionism. This is not clever. It also encourages more innovation in the USA to find new technology to generate solar energy, such as thin films (less labour intensive hence viable in higher cost locations).
We see Repsol and major shareholders getting concerned about Pemex and sacyr partnership. Always be aware of the shareholders of the company and what financial position they are in. Sacyr may want to sell, or get a larger dividend or force Repsol to sell assets so they get an extraordinary dividend as they own business is very weak at the moment. Pemex may want to buy those assets! Caixa worried. Especially as they hold assets like Fenosa where repsol is a large shareholder and they may be forced to sell that position!
We shall now stop walking down this well trodden avenue before we enter into an anti consumerism tone and give a well detailed (though skewed) opinion on who is to blame (the answer is of course everybody, though some parties merit a higher coefficient of contribution).
We shall instead focus on our weekly review of movements in the business and financial world:-
Markets continue to rise and fall with large volatility and strong sensitivity to macro news items. Most recently, disappointing unemployment figures made markets drop 2% in the US. This highlights the uncertainty present in many investors’ minds.
Uncertainty is a big problem for many investors as old models/trends/systems are simply not working.
It is not a surprise; past numbers are no guide to the future!
To understand the future, you need to understand the drivers of the current state of affairs. When the economy is in a steady state or in a simple business cycle where interest rates determine economic activity in a dominant manner, than past numbers can be a good guide for the future.
However, one variable they should be looking out for is the debt load of almost all market participants in developed economies. This is simply not another statistic – it is reality! When leverage reaches a certain level it becomes THE statistic, not a statistic. It is the dominant variable that will ascertain the future of many economies. The longer this is ignored, the longer the problem lingers, like an unwanted smell that will not go away. Without the debt load in a country reaches a certain limit that a standard increase in interest rates leads to a large deficit to be continuously maintained to meet the debt load, at one point demand will decrease drastically. This will lead to rates increasing enhancing further the debt problem. Once in this situation there is only one way out – debt forgiveness to reduce the debt load and hence increase the potential return of capital in that country so new capital is attracted into the economy.
There is another way. And that is what is happening in Greece. The market structure is being aggressively changed by large market players been consolidated to ensure companies survive. These companies are becoming quasi monopolies. European competition authority is allowing this to ensure large service based companies survive and it will attract foreign investment because these companies will have stronger attributes to survive. Consolidation will mean job losses – but this will have to be achieved to reduce costs, increase margins and therefore attract new capital. Already in telecom and banking sector. Effectively the competition authority is being bypassed for the benefit of the survival of the economy. Ownership of assets being changed – restructuring of the economy is occurring. Waste will be removed – this means the middle and working class worker will pay as well as the previous owner of the company. Previous stakeholders lose capital or income to attract new capital – this is how it works. But here it is not the debt holder, it is equity capital and employees – the debt holder is being spared, no doubt because they want to tap further funds from the credit market.
With pasta models not working, investors will have to realize that uncertainty always exists! It is an uncomfortable thought, but it is reality. It is not removed by vast swarms of past data or even a deep understanding of history, though both can help interpret the present to assess what is likely to occur.
However, what is happening now does not happen in your average business cycle. Banks do not loss 90% of their market cap every business cycle, or the central bank prints such large amounts of currency every business cycle, or the housing market loss value for a number of consecutive years. We are in the midst of a large global transition initiated by globalization, and fueled by several components which were unsustainable. Politicians were unable to alter the courses of economies that were expanding in an unsustainable way, so the nature of markets will do the job for them…..
With past models not working, it is no surprise that markets react violently to new news. However, through a simple understanding of the main parameters that will change, one may not know the exact nature of the journey, but will have a good understanding of where we are going. Certain past trends that were strong components of recent economic history, which will not be to the same extent in the future are”-
Developed market middle class living beyond their means through increasing credit and asset prices. This will reduce consumer spending in these economies and lead to an increase in the saving rate
China will not invest so specifically in fixed investments for exports.
The international role of the USD as a reserve currency is likely to decrease over time
Greater political and fiscal union in Europe, or the return of individual currencies
Less welfare support for developed markets, higher retirement ages
Just these few changes, where there is little guess they will occur (only when), will make our future very different from our recent past. These are changes now being forced by the capital markets because politicians were unable to bring them to fruition. If you follow through the natural consequences of these changes, one can have an idea of what our future may look like, and then start asking who would benefit in this environment.
Though we have all heard of these stories, few are accepting them as the new reality. Instead, investors are caught in an “uncertain” world, frightened by the fact that old models don’t work, when it is really quite clear where we are going; only we don’t know how we will get there. One must be willing to forgive the details of the future to appreciate the bigger picture, which has such a powerful force leading it to this destination, that it is hard to think of an obstacle that can stop it.
A point on China not being able to continue with fixed investments to export. Look at the damage they have done on the margins of manufacturing photo voltaic modules. Prices have gone down so strongly that a number of US solar cell companies are going bankrupt every week. The Chinese companies are hardly making profit as they have developed such an overcapacity it would take years to allow demand to meet the supply – typical Chinese investment strategy that leads to a flooding of the market. If they finally end up as the only participants in the market it may be seen as a worthwhile strategy, but instead, it encourages protectionism. This is not clever. It also encourages more innovation in the USA to find new technology to generate solar energy, such as thin films (less labour intensive hence viable in higher cost locations).
We see Repsol and major shareholders getting concerned about Pemex and sacyr partnership. Always be aware of the shareholders of the company and what financial position they are in. Sacyr may want to sell, or get a larger dividend or force Repsol to sell assets so they get an extraordinary dividend as they own business is very weak at the moment. Pemex may want to buy those assets! Caixa worried. Especially as they hold assets like Fenosa where repsol is a large shareholder and they may be forced to sell that position!
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