The J-curve: sort of useful What it implies for US stocks

What the J-curve is

In economics, the J-curve theory is a (very, overly: take your pick) simple attempt to explain or describe what happens to trade between two countries when the currency of one trading partner declines vs. the other’s.  The theory takes its name from the shape of a graph of the balance of trade, assuming the explanation is correct.  The graph initially bulges in one direction before moving gently and gradually in the other; that is, it looks like a “J” lying on its side.

Like most academic stuff, it rises or falls on the simplifying assumptions the theorist makes.  In the basic form of the theory, they are:

1.  there are only two countries trading.  Let’s call them A and US.

2.  all exports are priced in the currency of the country where they are produced.   Let’s say the currencies are ¥ and $.

3.  prices change immediately, but the quantities imported only gradually respond to the new prices.

An example Continue reading

The trouble with luxury goods

Luxury goods stocks have been good performers this year…

The stocks of luxury goods companies have been stellar performers during 2009, despite the fact that the companies are showing unusually sharp declines in revenues and profits.   This apparent disconnect is not peculiar to luxury goods, but instead is a characteristic of stocks in general, where buyers are doubtless anticipating a sharp bounceback in corporate earnings in a more normal economy in 2010.

…but will expectations be fulfilled?

There are several reasons, however, to think the expected surge in revenues and earnings may not occur for luxury goods in the way it has in the past. Continue reading

Pricing illiquid assets

The New York Times had a recent article on the sharp decline that university endowments have suffered over the twelve months ending in June.  The worst of the results reported, those from Harvard and Yale, are roughly the same loss as the S&P 500 suffered over that period.

One question jumps out at me that this article, and other similar recent articles chronicling college endowment woes, doesn’t address:  How do they know?

The hallmark of university endowment investing strategy for more than ten years has been deep involvement in illiquid “alternative” assets.  Yale and Harvard have been leaders in this movement.  In the case of the S&P 500, Standard and Poors furnishes the index numbers, which are supported by billions of daily transactions in the S&P 500 constituents.  The main feature of illiquid assets, on the other hand, is just that.  They’re illiquid–they seldom, if ever, trade. So where do the prices that the holders use come from? Continue reading

Update on Sinopharm; prospects for Wynn Macau

Sinopharm (ticker: 1099), the largest drug distributor in China, stated trading yesterday in Hong Kong.  It spiked up to a 25% gain early in the morning, but faded in the afternoon session (yes, the market does close for lunch) in a declining market to end the day up “only” 16%.  This is apparently better than the average IPO first day trading experience this year in Hong Kong, but to my mind a bit disappointing.

The stock fared better in trading today.  Volume was half the 360+ million of its debut, but Sinopharm was up sharply, again in a down market and with a failed IPO debut of a construction company, to boot.  Sinopharm closed at HK$19.98 (vs the HK$16 offering price) and restoring my confidence in the state of the bull market in Hong Kong.

Still looks good for Wynn Macau.

New Japanese government says: no currency intervention

Mr. Fujii speaks

Shortly after their dramatic election win, the finance minister appointed by the Democratic Party of Japan gave an interview in which he said that under normal circumstances (which today’s are) the new government had no intention of intervening in the currency markets to influence the value of the yen.

At first glance, this seems like a statement of the obvious.  This biggest reason that governments have stopped intervening in the currency markets in recent years is that they have learned that even with multi-national coordination their resources are dwarfed by those of the big global commercial banks.  In other words, national governments no longer have the power to make their currencies move as they might like.

Two messages

I don’t think that this is the point, though.  I see this statement as containing two messages, one internal and one external.

1. The internal message is to the Japan Business Federation (Keidanren).  Throughout the Liberal Democratic Party rule, the Japanese government was committed to the export-oriented manufacturing model of economic development.  As late as 2004, Tokyo was intervening in the currency markets in an attempt to lessen the volatility of the yen, and, implicitly, the profits of Japan Inc.  The message is that the cozy old relationship is gone.

2.  The fact that Japan was defeated by the US in WWII had a profound effect on the attitude of an earlier generation of Japanese leaders toward the US.  The burden of having lost the war compelled them to accede to American government requests that were not in the Japanese national interest.  Limiting for the first half of the Eighties the number of automobiles it would export to the US to levels way below what American consumers wanted to buy, because Washington requested it, is a prominent example.  Participating in coordinated currency intervention in support of the dollar has been another.

This is an attitude that was already gradually fading as politicians who experienced WWII left public life.  It is also one that former prime minister Koizumi took great pains to try to change.  The DPJ message is simply–No more.

Investment conclusions

Why is this of any investment interest at all?

For one thing, Japan has been one of the staunchest economic allies of the US over the past fifty years.  Its changing relationship with the US is emblematic of attitudes in the rest of the world.

The Democrats seem also to be thinking that a currency crisis involving the dollar is not so far-fetched and is saying in advance that it will not be part of a dollar rescue.

Finally, they may be saying that the old “convoy” system, where the strongest members of an industry slowed themselves down while they and the government propped up the weakest–resulting, of course, in plenty of very weak firms in each industry, is also out.  If so, that would be a very good thing for the best Japanese firms, like Toyota, Honda or MEI, who will no longer be held back by the clunkers in their industries.

Update on the WYNN Macau IPO in Hong Kong

WYNN (I own the stock) has just filed an 8-k and amendments to its Hong Kong information package.

The company is now going to float 25% of its Macau operations, up from 20%, and expects to receive proceeds of up to US$1.6 billion rather than the US$1 billion it has previously forecast.

The top end of the pricing range is just over HK$10.   A first-day close of HK$13 or so would mean a market value for Wynn Macau of about US$8 billion, or just about the entire current market capitalization of the parent, WYNN.

Maybe American investors think that Hong Kong valuations of Macau are wildly overoptimistic.  Maybe they think the right price for Wynn operations in Las Vegas is zero (yes, the company may be flirting with breakeven in Nevada, but you’d think there will be a pickup in 2010 or 2011).  It could also be they just haven’t connected the dots yet–and maybe they never will.

It will be interesting to see how events play out.  For what it’s worth, I don’t think the first of these possibilities will turn out to be right.  Our next clue will come when Sinopharm starts trading.

It’s where stocks are going that counts…(ll) an illustration

Monsanto–up 650% from 2004-2007


In 2004, I was managing a number of growth stock portfolios when a broker called me and my co-manager to say one of his firm’s better analysts was beginning to recommend Monsanto (MON).

The story was simple, but powerful.  The “old” Monsanto, a chemicals conglomerate, had broken itself up into three parts:  pharmaceuticals, agricultural chemicals and basic chemicals.  The agricultural chemicals business retained the Monsanto name.

The attraction of the “new” MON was its dominant position in genetically engineered seeds.  This business looked as if it could grow in a number of different directions–new products, new variants of existing products, new geographical areas–at a very rapid rate (20%+ annually) for, say, ten years.  The stock was not well-known.  Its virtues had been obscured while it was part of the bigger entity.  It was also cheap.  And growth investors like us were just beginning to find out about it.  In other words, this was a classic, open-ended, growth stock situation.

MON did have some warts.  The conglomerate’s top management, which went with the pharma business, attempted to insulate itself from potential environmental cleanup claims in the basic chemicals business by structuring the breakup so liability would fall on MON before them.  Also, MON’s main moneymaker, Roundup (glyphosate), had gone off patent and was being attacked by generics.

My colleague and I researched the stock for a couple of weeks–really learning the company would take a year or more of steady work, though–and bought the stock at about $19 a share (I’ve adjusted the price for a subsequent 2/1 split).

MON quickly rose to $22, as more growth stock investors established positions.   At this point, my co-manager, a value investor at heart, decided that we should sell.  Her reasoning was that we had a 16% profit, that the stock was now overvalued, and that we could consider repurchasing it when it fell to $20–as it surely would.

I was strongly opposed to selling, given that I thought the stock could double or triple, so we did nothing.

(By the way, this kind of short-term trading maneuver, which depends on the other guy being the “dumb money” who will allow you to repurchase at a lower price, invariably backfires with growth stocks.  The seller ends up either having to repurchase at a much higher price, or misses out altogether on the bulk of the stock move.

There’s a matter of prioritizing, as well.  All of us, professional or not, only have a limited amount of high-quality thinking time that we can devote to finding and monitoring investments.  I think we should focus that time on what we hope will be big long-term winners, not on trying to exploit short-term market volatility.)

The stock did drop to $21 but then immediately reversed course and rose to $30.  At that point, my co-manager and I had a more emphatic version of the $22 discussion, but we did nothing.

Some months later, MON had risen to $52-$53, as the company announced a steady stream of good operating news.  I had just about convinced myself that as a stock MON had achieved almost all the outperformance it was going to, when I was visited by a health care analyst who was relatively new to our firm.

He was beginning to look into MON, which he considered to be substantially undervalued (remember, the stock had almost tripled in less than two years).  By this time, MON was talking about seeds that would produce plants that would not only resist insects or drought, but would also contain extra amounts of healthy substances, like omega-3 fatty acids.  Relative to drug stocks–other companies with important patents and earnings that don’t ebb and flow with the overall business cycle–MON’s earnings looked really good to him. And, again relative to other health care-related issues, the stock didn’t look expensive.

The new analyst thought MON could reach $70.  I wasn’t convinced, even though I knew the analyst was a careful researcher and had good judgment.  Maybe I was also looking in the rear-view mirror at the profit MON had made for my clients.  In any event, I sold the stock.

If you’re looking at a chart of MON, you know what happened next.  The stock went to $70.  Then, in a market worried about the business cycle–and therefore more favorably disposed to earnings not dependent on it–Congress passed biofuel legislation encouraging farmers to grow more corn.  That’s MON’s main crop.  The stock doubled again, to $140.

Lessons for a growth stock investor Continue reading