yesterday’s OPEC meeting: no production cuts = oil below $70 a barrel

Yesterday’s OPEC meeting ended without an agreement to withdraw output from the market in an attempt to halt the recent sharp crude oil price decline.  This should have come as no surprise   …but it did, at least in the sense that oil prices–and oil-related stock quotes–fell further on the announcement.

In its earliest days, OPEC was badly understood by large oil-consuming countries.  It had greater solidarity than the garden-variety economic cartel because it was at heart a political–not an economic–entity.  It’s main goal was to end exploitation of producing countries by the big international oils, which made gigantic profits while paying the producers a pittance for their crude.

But even in those heady days for OPEC, there were significant divisions within the group.  Members who had small reserves and pressing government fiscal problems wanted the highest possible current prices.  In contrast, others, like Saudi Arabia, with long-lived reserves and better government finances, wanted to keep prices low so consumers wouldn’t start to seek out petroleum substitutes.  Often the result of these divisions was leaky agreements violated by smaller countries and made to work chiefly through greater-than-promised cutbacks by Saudi Arabia.

Today, there are many more non-OPEC oil producers, like Russia, Brazil or the US.  It’s also a generation since OPEC broke the dominating power of the big oils–plenty of time for institutional memory of past oppression to fade.  In addition, Saudi Arabia must know that the burden of enforcing any agreement would fall disproportionately on it.

Letting prices fall to the point where high-cost producers are forced out of the market is the only way any commodity prices stabilize, in my view.  In the case of oil, as far as I can see we’re nowhere near that point.

What I find odd is the negative commodities and stock market reaction.

(By the way, duinr the oil shocks of the 1970s, the US was the only developed country to fail to increase taxes on oil in order to discourage profligate consumption.  We chose instead to continue to protect a dysfunctional auto manufacturing industry.  If I’m correct about lower prices, we’ll have a chance to correct that error  Let’s hope we take it.)

 

Chinese port company stocks beginning to rise

I’ve been interested in the Hong Kong-listed port operators for a long time.  Ten or fifteen years ago, it was a truism that world trade had a direct, and high-beta, relationship with world GDP growth and that port operators in China were direct beneficiaries.  Yes, there are substantial differences from one name to another within the group, but if economies are expanding, they were the clear place to be.

Today, the situation a lot more nuanced.  Beijing clearly understands that its future is not in low-end export-oriented manufacturing.  The complete collapse of the global trade finance system in late 2008 made customers, particularly in the United States, realize that their supply chains were too extended (dysfunction in the operation of the California ports helped this thought process along, as well).  The result has been a reorientation toward suppliers closer to home.

This move has, in a sense, reversed the causality in port stock watching.  It used to be that rising GDP meant the Chinese port stocks would go up.  Now, I think, the right line of reasoning is that if the Chinese port stocks are going up, then there must be significantly rising economic activity somewhere (China and the EU would be the default guesses)–whether we can see it clearly or not.

Anyway, the Chinese port stocks are just breaking out of the trading they’ve been in for that past half-year.  They’ve only been acting better for a few days.  But if the move continues, this could be an indicator that 2015 will be a better year for world commerce than the consensus now thinks.

 

Ackman, Actavis, Allergan and Valeant

This is a situation I didn’t pay much attention to while it was going on but which I think has interesting implications for merger and acquisition activity in the future.  It doesn’t seem to me, however, that investors in general understand exactly what went on.

The bare bones:  Bill Ackman, of Pershing Square fame (and J C Penney infamy) bought just under 10% of Allergan, the maker of botox, and urged the company to put itself up for sale.  Ackman then allied himself with serial pharma acquirer Valeant to make a joint hostile (meaning against the wishes of the target) bid for Allergan.  Actavis, a third pharma company, emerged as a “white knight” to rescue Allergan from Valeant’s clutches with a bid that topped Valeant’s offer by about 15%.  Valeant conceded defeat.

 

This is the latest enactment of one of the oldest dramas on Wall Street.  A “black knight” makes a hostile bid for a vulnerable company.  The target firm, realizing that it is now in play, understands that at the end of the day it will most likely be acquired.  The only choice that remains to the target is to choose who the acquirer will be.  Invariably, it determines to join with anyone but the black knight that has caused all this trouble.  That’s why hostile bids fail as often as not.

For this reason, one of the bigger problems in the m&a game is that no one really wants to be the black knight.  Once the villain has appeared, however, there’s usually no trouble in finding someone willing to ride to the rescue.  In most cases there’s at least one potential acquirer hoping against hope that someone else will make the first move.

 

The Ackman innovation: in February, when he and Valeant became co-bidders for Allergan, he agreed to pay Valeant 15% of his Allergan profits if a third-party ended up acquiring Allergan.  This created a win-win situation for Valeant, which would either come away with Allergan or with several hundred million dollars for having played the black knight role.

Issues:

–what was the Allergan price at which Valeant shifted from hoping to acquire the company to wanting to collect a fee from Ackman?;

– did Valeant ever really expect to own Allergan?;

–most important, will this maneuver work again?

I don’t know  …but the answer to question #3 depends a lot, I think, on the answer to #2.

 

economy performance vs. stock market performance

Th financial media often talk about the prospects for the stocks market as closely liked to the prospects for the overall economy.   Is this right?

in a general way, yes

The most important investors in developed markets tend to be citizens, or at least residents, of the country in question.  This is partly because doemstic securities are the ones individual investors feel most comfortable with and can easily get the most information about.  It’s also partly because institutional investors like pension funds or insurance companies both want to match their domestic liabilities with domestic assets, and because they are most often legally required to do so.

When a country is booming, employment is high and wages are rising, money tends to flow into stocks.  When times are bad, not so much.  In particular, it’s been my experience as a global investor that stocks in high GDP growth countries tend to do better than very similar stocks headquartered in low GDP growth nations.

looking a little more closely, no

This is the easiest to see in Europe.  Switzerland has annual GDP of about $650 billion.  Germany’s is six times that.  Yet, the two countries have stock markets of just about the same size.  How so?

Two reasons:

–the Swiss market is dominated by international pharma and financial companies.  Only a tiny amount of their business is done in Switzerland.

–large chunks of Germany’s very important export-oriented industrial sector are unlisted.  The German stock market leaders are banks, public utilities and the autos.

In neither case–tiny country with enormous multinationals, or big countriy without many domestice companies listed on the stock exchange-os there a strong relationship between economy and stock market.

the US

–The US is the country where, thanks to the SEC, the most information about the geographical breakout of earnings is available.  Slightly over half of the companies in the S&P 500 provide geogrpahical earnings data.  If we assume that the structure of the rest of the index mirrors that of the reporting companies (a whopper of a leap, but I’m not sure what else we can do), then the earnings of the S&P break out about as follows:

US      50% of reported earnings

Europe  25%

Rest of the world    25%.

–Large parts of the US economy, like construction/property and autos have minimal representation in the S&P 500.  In the former sector, lots of companies remain private.  In the latter, a lot of the activity is by foreign companies.

significance?

If we just look at likely GDP growth for the US in 2015, we’d probably be predicting a pretty good year for stocks.  GDP may be up by 3% real, 5% nominal.  Money will likely flow into stocks.  The Fed will probably be careful not to rock the boat by raising interest rates too quickly.

However, we have two other issues to factor in:

–economic activity in the EU, Japan and emerging markets may not be so great and the dollar has been strong vs. foreign currencies.  This may mean that US-domiciled multinationals may not look so good, especially after their foreign results are translated back into dollars.

–In addition, we have to consider how we can find publicly traded stocks that are tied to potential hotspots for 2015 growth.

 

the ever-expanding Black Friday

For at least the past couple of weeks the Promotions tab of my email inbox has been stuffed with a gazillion Black Friday promotions.  In the bricks and mortar world, Wal-Mart (WMT) has announced that this year its Black Friday period will last for 10 days (today is day one).  [The term “Black Friday,” by the way, originated in Philadelphia, according to the Visual Thesaurus, as a police description of the extra work they had to do on the Friday and Saturday after Thanksgiving.]

In the years immediately after the Great Recession, retailers, led by Wal-Mart, began to try to push the traditional start to the holiday shopping season forward from Friday to Thanksgiving Day itself.  The theory hat lent urgency to this endeavor was that times were bad and consumers had little desire or ability to do extensive shopping.  Therefore, the first merchant to make a sale would do well; retailers who held back would find consumers’ wallets already empty.

What investment significance–if any–does the move of Black Friday from the week of Thanksgiving to the week before the  holiday have?

My take:

–I don’t think this is a sign of overall economic fragility, as it was several years ago.

–I do think, though, that spending on big-ticket items like housing and autos has left consumers with less cash for other items.  This is a normal pattern worldwide, including the US prior to the crazy bank lending spree that led to the financial crisis.

–WMT’s customer base is skewed toward the less affluent.  The company is facing increasing competition from dollar stores, as well as, I think, a rejuvenated Target.

–I suspect that there’s a Millennials/Baby Boom element to the promotional environment, with physical stores positioned to serve the latter–so that those retailers are competing in a no-growth arena.  One interesting (to me, anyway) aspect of the WMT promotion is that Black Friday prices are available today, but only in the stores, not online.

–My inbox bloat may just reflect my online shopping habits and have no further significance.  Still, any online merchant has the ability to avoid using the blunt instrument of price reduction and use couponing or customer-specific pricing to drive sales instead.  The idea is at least as old as dynamic pricing for airline tickets.  The practice is likely much more widespread than I care to believe.

My conclusions:

Most important, I don’t think signs of an increasingly promotional holiday season are a red flag either for overall US consumer spending or for the stock market.

Personally, I’m looking more for Consumer Discretionary names that are online or Millennials-oriented rather than physical store/Boomer plays.  No surprise there  …in the eternal struggle between Concept (growth) and Valuation (value), I’m normally going to be in the growth camp.  There will be times when valuation trumps potential.  I don’t think now is one of them, although I have noticed that for the first time in years WMT has begun to outperform.  If anything, this suggests to me that the holiday shopping season may be better for everyone than I’ve been thinking.

 

 

linking the Hong Kong and Shanghai stock markets

restricting foreigners

Every country has restrictions on ownership of assets by foreigners.  Some of this is unofficial, like when France said yogurt maker Danone was a crown jewel that Pepsi couldn’t buy, or when New York blocked Mitsubishi Estate from buying a decrepit Rockefeller Center.  Other limits–notably restrictions on non-citizens owning media or transportation assets–are set down in law.

why?

It’s common that emerging countries restrict foreign ownership of all publicly traded locally owned corporations.  The same thing happened in Europe as it was rebuilding after WWII.  Two reasons:

–countries don’t want rich foreigners (translation:  Americans) to be able to scoop up valuable national assets for a song, thereby disenfranchising the country’s citizens and making locals into sort of tenant farmers, and

–they don’t want the potential disruption to economic activity (the currency and the money supply) caused by mad rushes in and out of local stocks by foreign portfolio investors.

two classes of stock

The most common method of controlling foreign ownership is for a country to establish two classes of stock, one to be held by locals, the other by foreigners.  The details vary widely country by country.  What makes China unusual is that, generally speaking, locals and foreigners trade shares in different venues–the letter in Hong Kong, the former on the mainland.

problems with the system

Whenever there are two different markets, and two different prices, for the same security, the party that gets the lower price is going to be unhappy.  Given that the supply of foreign portfolio capital is large and the number of foreign-designated shares is typically small, it’s almost always the local citizen who feels disadvantaged.

In addition, raising new equity capital can be awkward.  Foreigners may balk at having to pay, say, twice what a local does to buy a new share.

Invariably there’s unofficial arbitrage between the two classes.

In China’s case, it’s possible that Beijing wants inefficient state-owned enterprises to be more subject to the goad that can be provided by professional portfolio managers.

Shanghai/Hong Kong trading opened this week

This week, China opened limited foreign trading in Shanghai-listed stocks (not Shenzhen stocks, however, which make up about 40% of China’s market cap).  It is also permitting limited trading by mainland citizens in Hong Kong.  The control mechanism being used is daily limits on the cross-border flow of money in and out of both markets.

ho-hum, so far

The plan was announced a while ago–the result being that stocks identified as possible targets for fresh money in both Shanghai and Hong Kong were bid up in anticipation in recent weeks.  However, the volume of cross-border trading has been low and highly touted beneficiaries have been selling off.

For China, this initial indifference is probably the best possible outcome.  Still, this is another step in opening Chinese financial markets to the world.  And one day the ability for us to buy mainland stocks may be important.  It’s just not today.

 

 

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