Monthly Archives: July 2010

Malaysian stocks: I’m not enthusiastic

July 13, 2010 By in Asian economic development, emerging markets Tags: , , , , Leave a comment

the FT’s comments

Yesterday’s Lex column in the Financial Times points out a certain lack of enthusiasm by foreign investors about holding Malaysian stocks.  Lex suggests that this is because Malaysia has nothing really special going for it, in the way China or India do.

my recollections

That may well be part of the reason for this coolness, but I don’t think it’s anywhere near the whole story.  Here’s what I think:

1.  Let’s start with the observation that Malaysia is a very small stock market.  No foreign portfolio manager needs to own Malaysian stocks, unless he has an extremely restricted mandate, say, ASEAN or Malaysia itself.  Generally speaking, however, as more emerging countries have opened their markets to foreigners, investors have tended to look for investment vehicles with wider mandates, not narrower ones.

2.   As the Asian economic crisis spread to Malaysia from its origin in Thailand in 1997, the empires of highly financially margined but politically well-connected Malaysian magnates began to slowly collapse from the combination of a plummeting stock market, a declining currency and higher interest rates.  Not only would these prominent figures be ruined by a continuation of the situation, but decades of government effort under the New Economic Policy and the Industrial Coordination Act to shift more of the country’s wealth into the hands of the ethnic Malay majority (known as the “bumiputra” program) would have been reversed.  So in September 1998, Malaysia imposed capital controls.  (this is kind of like today’s Ireland story, only in this version the government rescues the real estate speculators by leaving the euro and declaring martial law.)

There has been vigorous academic debate since then as to whether this action had a positive or negative effect on the subsequent course of the economy.  From a foreign portfolio investor point of view, however, the decision was unambiguously horrible.  It meant that his investments were frozen in place.  He couldn’t sell his Malaysian stocks and repatriate the proceeds.

What a mess!  What an embarrassment!  For a corporate investor building a plant in the country, the asset freeze may have had no practical consequences.  Not so for an institutional equity investor.   He would have to disclose to clients that their Malaysian holdings were now illiquid.  Pricing would become a constant issue.  Suppose a client wanted his portfolio liquidated and turned into cash in his home currency.  The Malaysian portion would have to be paid in kind, not a welcome result.   Portfolio managers would have to explain at every meeting with existing or prospective clients how and why he had been so maladroit as to be caught out this way.

The damage to a professional reputation from being in this situation would far outweigh any possible gains that might have come from holding a small Malaysian equity position.  Managers, or at least their supervisors, have long memories.  I think anyone who witnessed the capital control imposition would have a hard time taking the risk of going back into Malaysia, or allowing any subordinate to do so.

3.  Malaysia was a much scarier place to be during the Asian crisis than I think many remember.  The anti-Semitic leanings of Dr. Mahathir, the prime minister, became known to the world as he blamed the economic trouble on a cabal of Jewish financiers led by George Soros.  Mahathir relieved his deputy in charge of economic policy, and his presumptive heir, Anwar Ibrahim (who apparently opposed capital controls), of his job.  Not only that, Anwar quickly found himself accused of corruption and then tried and imprisoned for allegedly forcing his limousine driver to have sex with him.

Foreigners in Malaysia, especially Americans, feared for their physical safety–whether they had real reason to or not.

In summary, I think Malaysia still suffers from the “fool me once, shame on you; fool me twice…” syndrome.  Just writing about it gives me the shivers.

At some point memories will fade.   But absent a something-special that, as Lex points out, Malaysia doesn’t seem to have, that won’t be for a long time.  probably not until everyone who lived through (and survived professionally) the capital controls episode–or, like me, was luckily watching from the sidelines–disappears from the investment management industry.

The IMF’s latest economic forecast

July 12, 2010 By in Current Market Thoughts, economics, Portfolio management, Strategy Tags: , , , , , , , , , Leave a comment

the July World Economic Outlook

On July 7th, the IMF released its latest adjustment to its World Economic Outlook initially published in April.  There are three main changes:

1.  The agency is raising its forecast for world growth in 2010, by .4% to 4.3%.  Two reasons for this:

Recovery in the advanced economies from the financial shock of 2008 is proceeding faster than the IMF anticipated, even just three months ago.  As a result, it is boosting its forecast for these countries by .3%.  The US is a relative laggard, but it still doing .2% better than the IMF thought.

Partly because of increased demand from the advanced economies, partly from the internal dynamism of China, India and Brazil,  developing economies are doing .5% better than expected.

2.  The aggregate 2011 growth forecast remains unchanged, but its composition shifts. The IMF now thinks the US expand by 2.9% in real terms next year, or .3% faster than it figured in April.  This gain is offset by a .2% reduction in the growth forecast for the EU, from a 1.6% gain to 1.4%.

Faster recovery this year in the advanced economies implies that inventory replenishment there will be completed earlier than expected.  The IMF figures that .1% of growth that it had penciled in for next year will occur in 2010 instead.

3. The IMF comments on possible financial fallout from the EU next year. Its observations are helpful in the sense that I think they offer a worst-case scenario.  The IMF base case is a “muddle through” scenario, with some loss of output in Europe both this year and next because of financial turbulence.  The alternative–the assumption by the IMF that EU governments allow the situation to spiral downward to the point that an EU financial crisis does the same amount of damage to the world as the US financial crisis of 2008–then, the IMF thinks, world growth next year will be reduced by 1.5% from the current forecast of 4.3%.

The IMF gives no reasons for why a second financial crisis should be as large as the first.  On the other hand, I don’t think the IMF analysis is intended to be a realistic assessment.  Instead, I think it’s supposed to be a first approximation of the order of magnitude of a second major financial shock.  My guess is that because the public already half-fears more financial troubles, the shock would be less than the first.  Government action would probably be more focussed, as well.  In any event, though, I think the interesting aspect of the IMF economic simulation is that, unlike the case in 2009–when world output contracted by .6%–2011 would still be a period of global economic expansion.

Let’s make another back-of-the-envelope calculation on the assumption that half the pain would be felt in the EU and the rest would be distributed equally around the rest of the world.  That would imply that European output would fall by about 2% in 2011, producing the second recessionary year there out of three.  The US would grow, but only by about 2.2%.  The developing world would slow down to a “mere” 5%+ growth rate.

Again, the interesting thing for an investor is that ex the EU most individual countries would still be expanding through the European pain.

my conclusion

I think this is another piece of evidence that world economies are in better shape than the consensus thinks.  And, as the IMF itself has commented elsewhere, the numbers point investors toward stock markets in developing countries.

US cellphone scoreboard

July 9, 2010 By in Industry Analysis, Stock ideas, Technology, Wireless Tags: , , , , , , Leave a comment

comScore, a marketing research firm focused on communications in the digital world, just released its latest report on cellphone usage in the US.

The results:

top OEMs

Samsung    22.4% of the market

LG     21.5%

Motorola     21.2%

RIM     8.7%

Nokia     8.1%

Domination of the US market didn’t do the Korean companies much good, since their share comes almost completely from the older, less profitable “feature phone” part of the market, not the smartphone segment.  Samsung, for example, recently guided investors to expect record profits in the second quarter.  But strong memory chip demand will likely be somewhat offset by falling mobile phone results.

smartphone market share

Overall smartphone market share has almost doubled in the past year to comprise about 21% of the market. Share has grown 2.3 points over the past three months.

The leading phone operating systems are:

RIM     41.7% of the market

Apple     24.4%  (not including iPhone 4)

Microsoft     13.2%

Google     13.0%

Palm     4.8%

During the three months since the previous comScore report, Google’s Android-based phones gained a total of 4.0 percentage points of the market, taking share from all others, especially from Microsoft.  (According to other reports, Android has already surpassed Microsoft.)

cellphone  feature usage

social networking or blog     20.8% of users, up 2.6 points over the past three months

browser     39.1%,     up 2.3 points

smartphone share growth      up 2.3 points

downloaded apps     30.0%,     up 2.1 points

text message     65.2%,     up 1.4 points

music     14.3%,     up 1.4 points

games    22.5%,      up 0.7 points

This is the most interesting set of figures.  If we look at the incremental changes in smartphone market share and feature usage, it appears that the main changes in behavior are that new smartphone buyers are browsing, blogging, networking and downloading apps with their phones.

There also seems to be a network effect of two types.  First, the larger number of smartphones appears to be boosting the usage of older cellphone possibilities, like texting and playing games–though at a much slower rate than new smartphone adoption. New users also seem to be prodding existing smartphone owners to actually use their phones’ features.  Note particularly that social networking use is almost equal to smartphone ownership, and is growing faster.

investment implications

AAPL is the obvious beneficiary of smartphone trends.  The only issue I have with it is price.

I can’t work up any enthusiasm for Nokia, which has understood the smartphone phenomenon for many years but been unable to execute.  Phones are irrelevant for MSFT, other than to underscore its chronic inability to capitalize on its brand name and the dominant position it has had with consumers and businesses in the PC arena for twenty years.  RIMM’s strong business franchise is a plus for it, but the company is still a question mark in its ability to keep pace with AAPL.

Another investment avenue is the network operators.  The best is VZN, I think, but to get its share of the wireless joint venture with Vodafone you have to accept a piece of its fixed-line and cable/internet arm.  No thank you.

Absent pure social networking stocks on Wall Street, the last approach is through component manufacturers.  The strongest of these is Samsung Electronics, in my opinion.  The company is a superb manufacturer, so it’s also possible it will be able to follow HTC of Taiwan in producing attractive smartphones.  Both Samsung and HTC trade in quirky markets that are not for the faint of heart, however.  So this may be one case where the best investment is just to buy a smartphone (I own an Android) and enjoy it.


concept vs. valuation: the newest version of a traditional conflict

July 8, 2010 By in Current Market Thoughts, Recent Market Action, Strategy Tags: , , , , , , , Leave a comment

valuation vs. concept

For the 30 years + that I’ve been watching the stock market, there’s always been a conflict between concept and valuation among equity investors.

The opposition has often been regarded as one between growth investors as aggressive advocates of “concept” and value investors as the conservative custodians of “valuation.”  To some degree that’s correct, although it’s only a first approximation.  Value investors readily concede that there are value “traps,” stocks that look cheap, but have little chance of going up.  Companies in dying industries or ones where change of control isn’t possible might be examples.  Similarly, growth investors (most of us, at least) recognize that not all high expectation, high valuation stocks will justify their current prices, much less appreciate even more.

Another way of framing the issue is to contrast a “big picture” thematic macroeconomic investment stance of the “concept” investor with the “nose to the grindstone” approach of the “valuation” investor who looks for cheap securities without regard to in what industry or country they may lie.

Both approaches, taken as the primary—or even the only–security selection tool, have their potential pitfalls.  The investor who uses his overall conceptual framework to guide the search for individual securities risks overlooking evidence that contradicts his theory that an analysis of company operations might turn up.  The balance sheet-income statement only investor risks not seeing the forest for the trees.

examples:  valuation usually trumps concept in the stock market

the Nifty Fifty

This early Seventies period is one of my favorites–because it was so bizarre–even though it precedes my own professional involvement with stocks by four or five years.  The “concept’ was that a small number of fast-growing companies, like National Lead (car batteries) or Xerox (big office copiers), deserved to trade at p/es approaching 100x current earnings–which was 9x or 10x the multiple of the average stock .  How so?–projecting, say, 20% earnings growth each year for the following twenty and discounting that flow of future profits back to the present at even a high discount rate would product a value astronomically higher than the current stock price.

At that time, people also thought GDP growth could only be driven by manufacturing, not services, and concluded from this that base metals had to be a growth industry.  In addition, most Americans had never heard of Canon or Ricoh or fax machines, which were just about to wreak havoc on the domestic copier industry.

The subsequent price collapse was horrific and took a decade to reach completion (so much for efficient markets).

the road to the airport (Narita)

This was one of the last waves of the property mania that engulfed Japan during the second half of the Eighties.  The “concept” here was that continuing strong economic growth in Japan (The UK is like a man of 60, the US is like a man of 50, Japan is like a man of thirty.  Which would you rather be?–was a typical late-Eighties comment in the Tokyo market) would make even industrial land in the Tokyo suburbs immensely more valuable than the market realized.  As a result, investors reasoned, the warehouse operators, cement companies and the like who owned such land should trade at 10x the p/e multiples their “normal” operations would warrant.

Then the Bank of Japan raised interest rates.

Most of these companies are nowhere near their 1989 highs more than twenty years later.

the Internet bubble

Where is AOL today?–publicly traded, yes, but a mere shadow of its 1999 self.

today’s novel situation

Past major conflicts between concept and valuation have had the former side arguing for higher stock prices and the latter for lower ones.  Not so today.  The opposite is true.  A recent Bloomberg article is a good illustration.

Previous cases have been primarily about the stock market, and only secondarily about other asset classes.  This one is principally about bonds, with the stock market more or less suffering collateral damage from the negative sentiment the concept engenders.

Valuation:  the S&P 500 is trading at about 13x 2010 earnings and yielding about 2%, with profits being revised up by the most in the past six years.

If we assume the world will continue to expand, possibly at a rather slow rate, in 2011, corporate profits will be higher and the market multiple based on next year’s earnings (the market typically begins to discount the following year’s profit prospects during the summer) correspondingly lower.

Equating the stock market price earnings multiple with the long government bond yield would produce a long bond of 7%+ if bonds did all the adjusting or a stock market p/e of 25+ if stocks did.

Concept: It’s the “new normal,” a picture espoused primarily (solely?) by bond managers.  The general idea is that world economies have been so badly damaged by the financial crisis that global economic growth will be minimal for many years to come.  Governments will inhibit rather than help recovery.

This is, perhaps not by coincidence, the only scenario I can envision where it makes sense to invest in bonds at today’s ultra-low interest rates.  That is, it’s the only scenario where bonds don’t lose money

This concept has a corollary, that the apparent attractiveness of world stock markets–the main alternative asset category to bonds–is chimerical.  As far as I can see, this corollary is simply an assertion, without any attempt to provide a reason, other than the general picture that economic malaise will spread like a virus and infect previously healthy sectors and regions.

I also suspect that the bond manager analysis of stocks is comes from a rookie’s misunderstanding of the relationship between the economy of a country and its stock market.  In the case of bonds, the relationship is very close.  In the case of stocks, however, the relationship depends heavily on what sectors of the economy are publicly listed and what international exposure listed companies have.  There’s no general rule.  In the US, for example, commercial real estate, housing and autos have almost no direct market presence.

my thoughts

I think this is the most important issue facing the stock market in the US–in the world, for that matter–today.

It’s more an issue about sentiment than anything else.  The fact that the negative side is being put forward by people who have no practical knowledge of stocks is irrelevant.  They may be ugly, too, but that doesn’t mean they’re wrong in what they say.  Their being right would be an accident, but they’d be right nonetheless.

Earnings are likely to come through as well as predicted, if not better.  Looking at matters very simply, the US economy has gone from having 95% of the workforce employed to having 90%.  That extra 5% is likely to remain unemployed for a long time, creating a severe social problem.  Nevertheless, that 5% was in the aggregate probably not the most productive part of the workforce.  So it likely contributed 2%-3% of the output in US GDP, and perhaps the same amount (at most) to the domestic profits of publicly listed companies.

In the aggregate, domestic profits are about half of the total for the S&P.  This would imply–negative sentiment aside–the newly unemployed would create a one-time, 1%-2% reduction in the level of S&P 500 earnings.  So I find it hard to believe that corporate profits won’t come through in a way that justifies higher stock prices, especially since companies are starting to restore wage and benefit cuts instituted during the recession.  Raises and promotions are beginning to occur as well, in addition to very limited new hiring.

If the S&P falters, then, it will more likely be due to concept than valuation.

It will be interesting to see how the stock and bond markets develop from here.  In the past, in my experience, concept has always overreached by extrapolating the status quo too far into the future.   It has always lost out to valuation.

On the other hand, this is the first time in my experience where valuation has argued plainly for higher prices and concept for lower ones.

In the past, you might observe, the camp militating for higher prices has always lost out  At first blush, this would seem to be a worry for stocks.  But my take is that the overreachers are the bond guys, who are arguing for stable or higher bond prices.  They’ll be the ones undone by valuation.