Category Archives: currency effects

Are individuals coming back to the US stock market?

November 2, 2010 By in Constructing a Portfolio, currency effects, Current Market Thoughts, inflation vs deflation, Portfolio management, Shaping a portfolio for 2011, Strategy Tags: , , , , , , , , Leave a comment

some preliminaries…

A little more than a week ago, I wrote a post I called “Thinking about 2011,” in which I discussed the economic and stock market forecast of Jim Paulsen of Wells Fargo.  My understanding of his position is that the US economy is much farther along the road to recovery than one would imagine from the doomsayers of the “new normal.”  In fact, judging by the experience of the past twenty-five years, this recovery is ahead of schedule, not behind.  More than that, things are about to pick up all by themselves.

If so, the soon-to-be-launched quantitative easing by the Fed is not only unnecessary, but it has the potential for creating a lot of inflation–fast.

I said I thought Mr. Paulsen’s analysis was far from consensus.  My friend Bart, a canny veteran still working on Wall Street, wrote a comment to my post saying that Paulsen is a lot closer to the thinking of institutional investors than I realize.  Although confident that Bert is correct, I replied that I didn’t see this consensus being acted on yet in stock or bond prices.

…bringing us to yesterday morning

Monday’s Financial Times contains an article with a London byline titled “Investors increase exposure to equities.”  The story references two data providers:  the Investment Company Institute, the trade association of the mutual fund industry in the US; and EPFR, a Cambridge, Massachusetts-based data aggregator that I’m not familiar with.

According to the FT, EPFR says funds that invest in US equities have had inflows of $13.3 billion since the beginning of September.  Funds focussed on Europe have taken in $1.2 billion over the same time span.  Last week alone, the inflows were $2.7 billion and $840 million, respectively.

The ICI maintains the official figures for mutual funds based in the US (which may be a slightly different universe than EPFR’s).  These data don’t clearly support the EPFR statements.  What they do show, however, is that in mid-October, redemptions of US-oriented equity funds suddenly slowed from a flood to a trickle.  At the same time, inflows to international funds began to accelerate.

I tried to contact EPFR this morning, without success.  By the way, I’ve been pleasantly surprised to find how uniformly cooperative the information sources I contact as an equity market blogger are.  I expect I’ll eventually hear from EPFR as well.  Whether I do or not, though, the point is still that we may have seen an inflection point in investor behavior.

What does this mean?

The change in money flow may mean nothing.  Or it could reverse itself in short order.  After all, at least according to the ICI data, bond fund inflows haven’t diminished a bit.

On the other hand, government bonds have been weak recently, as have bond-like domestic US stocks.

My hunch is that world stock markets may be in the process of changing their character in a meaningful way and that I don’t have the two months for leisurely thought that I thought I had, if I want to keep positioned in stocks with a good chance of outperforming.

The first thing to consider is what kinds of stocks might be vulnerable if:

–economic growth is picking up steam,

–interest rates are rising, and

–inflation may be a problem, meaning the Fed has got to see to it that rates rise some more.

At this point, I still need to be convinced that any of this stuff is really going to happen.  And I don’t want to launch into an overhaul of my positions without thinking about it carefully first.  All I want to do is to identify potential underperformers and figure what I would need to do to get from overweight to a more neutral position.

I’ve also been thinking that many of the same stocks that have done well over the past eighteen months also stand to be outperformers in a higher-growth, more inflationary world.  But I want to make sure of that, too.

More on this topic over the next few days.

 


China: the US is dumping its chicken feet in our market!

September 28, 2010 By in Asian economic development, Balance of Payments, China, currency effects, Current Market Thoughts, economics, emerging markets, Strategy Tags: , , , , , , , , , 2 Comments

background

what dumping is

Dumping involves selling products in an export market.  Two conditions have to hold for sales to be dumping:

1.  the selling price must be below some concept of “fair value.”

Typically, this means the selling price abroad is lower than the selling price in the home market.  Alternatively, the country where the products are sold may claim the selling price there is below the manufacturer’s (average) cost of production–even though it may be the same as, or higher, than the selling price in the home market.  The “cost” is usually figured by the export country’s regulators.  That may be a lot higher than what’s shown on the financials of the manufacturer.  Historically, the US has been regarded as a master at ending up with a high number.

2.  the sales have to be shown to be doing damage to local industry participants in the export country.

special China-only ” safeguard” provisions

As one of the conditions for its joining the World Trade Organization, China had to agree that an increase in sales volume over stated limits would count as dumping during a number of transition years, even if conditions 1 and 2 above weren’t satisfied.  The rationale was to allow local industry participants time to adjust to a world with competition.

tires and chicken feet, a year ago…

As I outlined in a post when it happened a little over a year ago, President Obama invoked the “safeguard” provision regarding low-end auto tires produced in China and sold in the US.  There was no economic I can see for doing this.  It was purely back-room politics, a favor for the United Steelworkers union.

China responded by taking the first step in the WTO dispute resolution process.   It placed tariffs with equal revenue impact on imports of chicken feet (and to a lesser extent, wings) from the US.  At the same time, it opened an anti-dumping investigation of American chicken parts.

…and now

Over last weekend, Beijing released the findings of its chicken feet inquiry.  Yes, dumping has occurred (no surprise here–you can’t give away domestically all the chicken feet the US producers.)  Duties of between 50% and 105%, depending on the breeder, will be imposed for five years.

While presumably technically correct, the decision appears to be as economically self-wounding as the Obama decision a year ago.  Why?

Americans like white chicken meat.  To meet demand, US poultry companies breed chickens with gigantic breasts.  The chickens also have to have enormous feet and legs so they don’t topple over.  America doesn’t want all the feet breeders grow;  they’re more or less a waste product.  But they’re a delicacy in China, whose importers will reportedly pay up to 20x what the feet would fetch domestically.  (I’ve eaten chicken feet once or twice in Hong Kong and New York.  For what it’s worth, I don’t get the appeal.)

The result of the tariffs:  food costs go up in China; Chinese eat more of their skinny domestic chicken feet; American poultry producers, who should be allies of China in Washington, make less money; and the treasury in Beijing has more income–just what it needs.

there’s a deeper game afoot (as it were)


In other times, this situation would be pure comedy.  But, although I think the chances of truly damaging trade actions are slim, I don;t feel they can be completely ignored, as one would have done in the past.


From the US side, both parties in Washington appear desperate to find someone–anyone–other than themselves to blame for their poor stewardship of the US economy.  Moderation also seems to be in very short supply.  In addition, companies that sell Chinese products in the US–meaning just about everyone– are less vociferous inside the Beltway in their support for China, given recently announced limits on their ability to expand their operations in the Chinese market.


For its part, C

hina has been slow to recognize how big a burden it is putting on a country with a quarter of its population through the peg between the renminbi and the US dollar.  It has no reservoir of good feeling or obligation to the US, based on WWII and its aftermath, either.  Quite the opposite.  It is acutely aware of the Opium Wars and other abuses of the “Great Powers” of the nineteenth century–in which group it includes the US.  And it believes it is a major victim of the US financial crisis.


It’s not clear, to me anyway, that either side really understands the other’s position.  In the case of the US, I’m confident Congress is completely in the dark.


As a result, I worry that there’s some small chance that one side or the other will accidentally move the politics of trade beyond the only marginally relevant into areas where real economic damage can be done.  I don’t think this is likely, at this point, or even that this possibility should be factored into portfolio composition for anyone.  But for the first time in at least a decade, I think this is a situation to be thought about–in terms of what action to take if events take a turn for the worse–and monitored.

world trade is booming again: two pieces of evidence

June 20, 2010 By in currency effects, Current Market Thoughts, Industry Analysis, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , , , , Leave a comment

container shipping

According to the Financial Times, major container shipping lines are finding that their business is growing much faster than they had anticipated or planned for.  Deliveries from Asia to Europe are a particular sore spot.  They are advancing at a 23% year on year pace, well more than double the rate anyone thought six months ago. 

Combine this with the fact that ships are travelling more slowly than usual to save on fuel costs, and the result is that the shipping lines are running short of containers to put their customers’ wares in.

We’re not at the same point of high demand that we were a few years ago, when the bottleneck was the ability of the departure and destination ports to load and unload shipments.  Still, it’s possible that some customers will be turned away during the runup to the yearend holiday season.

While the current boom is much better than it’s opposite, it may not be an unadulterated positive for the shippers.  They are having to take ships out of mothballs in Europe simply to have them steam back to Asia full of empty containers.  It’s also possible that they’ll have to send some ships half-full to Europe, while Asian warehouses are bulging with merchandise waiting for shipment.  If that proves to be the case, added costs will take some of the sheen away from potential profit gains.

FedEx

FedEx is in a similar situation.  As I mentioned in an earlier post, the company went out of its way in its latest earnings conference call to sy it thought investors were much too gloomy about global economic prospects–because they didn’t understand how strong the recovery in world trade is proving to be.

The company cited the fast growth in air shipment of small, high-value technology goods from Asia to both the US and Europe as a bright spot for it.  Volumes were up 23% year on year in the May quarter, with prices rising 6% in addition. Bbusiness is so good that FedEx is accelerating its capital expenditure program and incurring additional expense to remove freight planes from storage and get them ready for work again.  Such expenditures, plus added personnel costs–raises reinstated, higher medical costs, larger pension expense–will prevent this strength from dropping down to the bottom line for the next six months or so.  The fact that these expenses are temporary has escaped the notice of TV commentators–implying it has also been missed by the analysts feeding them the information. 

what to make of this?

In both cases, the consensus–and the companies–have not been optimistic enough.    Interestingly enough, in both cases increased revenues may be temporarily overwhelmed by higher costs, although this situation will certainly reverse itself as the firms adjust to the higher revenue inflow.  I think the first point to be made is that there’s no reason not to be optimistic about the cyclical upturn in the global economy.

Thre’s also an important distinction to be made between air transport and sea transport.  The latter services deal with general merchandise, where speed is not of the essence, where items may be bulky–and therefore not suitable for air transport, and where shipping costs are paramount.  I think the fact that sea traffic to Europe is up so much implies that the general EU economies are faring better than investors now think.  There’s no evidence from these reports that the same is happening in the US.  This doesn’t mean that the US isn’t faring at least as well as Europe.  Strictly speaking, we know nothing, but the fact that the optimistic shipping report doesn’t mention the US might tilt me a bit toward thinking the US isn’t enjoying the same sort of uplift as Europe is.  This is not a thought to bet the farm on, but it’s a reason to pay attention more closely to precisely what companies say about the US in the upcoming weeks.

Air transport is for lightweight, high value-added items–meaning IT, smartphones, laptops and components in particular.  This would imply that positive earnings surprises could be coming from companies linked with these devices–industry in general and sellers of IT products in particular, as well as younger and more affluent consumers (who tend to be disproportionately large users of tech gear.

Of all of this, the most important to me is the suggestion that financial woes in Europe and the plunge of the euro have not damaged the region to the extent the consensus believes.

BIS: a currency collapse is a good sign, not a bad one

June 14, 2010 By in Basic Concepts, currency effects, Current Market Thoughts, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , , , , , , , , 1 Comment

In its latest quarterly review, published this morning, the Bank for International Settlements (the organization that comes up with international bank capital adequacy rules) presents results of research into currency collapses that is of particular importance to stock market investors.

the bottom line

The research studies a large number (79) of past currency collapses, mostly in developing countries.  There’s a complicated definition of what constitutes a collapse, but it’s basically meant a drop of 22% or more in the value of a country’s currency in a short period of time.

Collapses are associated with a permanent loss in real GDP of 6%–not a good thing.  –also something you’d expect to see.

What’s interesting about the study, though, is that it finds the output loss begins three years before the currency drop.  Therefore, although the currency decline is correlated with the output loss, the currency movement doesn’t cause it.

In fact, quite the opposite.  The currency collapse appears to mark the beginning of a period of accelerating economic growth that would likely not have occurred in the absence of the currency decline.  The better economic performance continues for several years, and ends up offsetting about two-thirds of the economic loss.

In other words, the currency decline, although frightening, is the first sign of economic healing, not the harbinger of further economic doom.  (Note, again, there’s no claim to have established causation.  The only assertion is that the better economic performance comes after the currency debacle.)

think:  the euro

The fall in the euro vs. the US dollar has been 21%+ over the past half year or so.  For my money, this counts as a currency collapse.

We know in theory that currency decline has three effects:

–it acts like a drop in interest rates as a stimulus to economic growth,

–it redistributes economic energy toward exporters and import-competing industries.  It channels growth away from importers and foreign manufacturers.  And,

–it increases the value to locals of foreign hard-currency assets.

Said a different way, a stock market investor should look for companies that have hard-currency revenues and weak-currency costs.

My experience with European stocks has been that recognition of the new currency facts of life lag the actual currency movements by a couple of months.

What does the BIS study add to these theoretical musings?  The fact that in 79 past instances, this is the way things have turned out.

the euro decline: how will it affect US stocks? does hedging help?

June 2, 2010 By in Accounting, currency effects, Current Market Thoughts, Recent Market Action, Stock ideas Tags: , , , , , , , , , , , , , 2 Comments

the euro decline

Since early January, the euro has dropped against the dollar by about 15%, from 1€=$1.45 to 1€=$1.22. How will this affect the earnings, and consequently the price performance, of US multinationals that have substantial operations in Europe, like pharmaceuticals, or food, beverage and personal products companies?

negative effects?

My answer is:

–it depends;

–the effect is negative, but it will vary in importance by industry–meaning by how much of a firm’s European costs are denominated in dollars, what discounting it can get from its suppliers and whether it can substitute euro-denominated cost items;

–in my experience, investors tend to make a relatively large positive response to earnings gains that seem to come from being in a rising-currency country and to more or less shrug off losses that come from being in a declining-currency country.   The only exception I can think of to this “rule” is  Japanese electronics companies.  The market in Tokyo seems to regard these firms as commodity producers with indifferent management, therefore a relatively pure play on currency movements.

the much BIGGER story

My conclusion from all of this is that the big investing story–which I think is already beginning to unfold in price movements–is the attractiveness to European investors (and thus for everyone else in the world) of multinationals based there that have dollar exposure.

a footnote

There are two types of currency effects that appear in the financials of multinationals.

–One is the operational positive (negative) of having hard-currency revenues (costs) and weak-currency costs (revenues).

–The other is translation effects.   In my experience, investors everywhere ignore these.  (In simple terms, they come principally from converting foreign-currency balance sheets into the home currency at the end of an accounting period.  A US company, for example, would show a translation gain in the present circumstances from the loss in dollar value of its euro-denominated debt, offset by translation losses in the value of its euro-denominated assets.)

what about hedging?

Most larger companies hedge a least a portion of their anticipated foreign currency exposure.  In the case of exporters with long gaps between the time when they take/price an order and when they make delivery/collect their money– especially if the price is denominated in a foreign currency, —hedging can be crucial.

The purpose of hedging is to increase the probability of obtaining a satisfactory profit from operations.  It’s not to secure the highest possible profit.  So it’s reasonable to assume that hedging operations temper the size of any gains due to currency movements on the way up, as well as cushion any losses on the way down.

If a company faces a permanent depreciation of the currency in one of its export markets, I think that the fact it may have hedged against this for the next six months is irrelevant to the stock’s price.  Investors will understand that, although the company has done a good thing, it has only postponed the depreciation-induced hit to earnings–not eliminated it.  The stock will trade on anticipated post-depreciation results.

Porsche was an interesting case along these lines about seven or eight years ago.  The company, which produced its luxury cars exclusively in Europe, hedged three years’ worth of anticipated sales in dollar markets to offset what it (correctly) viewed would be   a prolonged period of euro strength.  Let’s say the appreciation in value of its hedging contracts made up a third of the company’s earnings over this period.  How do you value this portion of company profits.  My view, and that of virtually all American investors, is that hedging profits should be awarded a much lower multiple than the manufacturing operations’ results.  Europeans–and they were the dominant force in their home market–by and large thought the opposite.  Crazy, but true.

Another issue in dealing with hedging income is that most companies seem to me only to talk about the topic when things have gone badly wrong.   The cynic in me thinks that companies understand that hedging earnings aren’t highly valued, so they remain mum.  Among American companies, MCD is unusual in having said that it has hedged its anticipated profits from Euroland for all of 2010 at a rate of $1.41.

So:  1. investors, especially in the US, don’t care much about hedging, and 2. even if they did, many firms don’t disclose enough data to make the task worthwhile.

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