more on top-down investing

the macro turn

Last week I wrote about a phenomenon I’ve been noticing lately–that stock reports published by analysts from first-rank brokerage houses seem to have little company- or industry-specific reasoning in them, but rather rely for their conclusions on general macroeconomic arguments. (Macroeconomics is the study of prospects for the total economy of a country, a region or the whole world; microeconomics looks at the decision-making behavior of individuals and firms.)

The Wall Street Journal’s“Heard on the Street” column from this Monday makes a similar observation, that “traders seek salvation from correlation.”  It reports on research from Credit Suisse showing the prices of stocks have recently been moving together (without regard to individual company differences) to an extent not seen even at the peak of the financial crisis of a few years ago.

possible reasons

As my friend Bob pointed out in a comment to my post, for brokers who regard research as a loss leader, it’s cheaper and easier to try to apply macroeconomic insights–generated either in-house or from third-party economists–to individual companies than it is to hire experienced microeconomic generalists, who know the characteristics of firm vs. firm and product vs. product competition, or veteran industry specialists to create original research.

In addition, my hunch is that many hedge funds are run by traders, whose strengths are in their willingness to take risk and their ability to sense the short-term (meaning from a few hours to a few days) direction of the stock market.  They find microeconomics and accounting much too time-consuming, and maybe too boring, to learn.  And doing so would make them look too much like conventional (read: low-fee) investors, as well.  So they’ve settled on the macro analysis that’s much easier to learn the rudiments of, but which is much more characteristic of bond markets, as a guide to their equity dealings.

The Wall Street Journal suspects that the increasing popularity of ETFs–mostly index products–as trading vehicles for individuals and institutions may be the root cause.

the key question

It’s possible that the current Wall Street fascination with macroeconomic-based investing will prove a short-term fad.  I suspect it will have a longer life than that.  In any event, I think the key question for investors, especially those who want to buy and sell stocks based on their micro analysis of individual firms, is whether this current macro trend is:

–a substitute for microeconomic knowledge the big players don’t have, or

–an alternative, a change in investor ideas of what makes a good stock, away from its individual traits to the way it reflects aspects of the overall economy.

In the first case, having economic or marketing insight into an individual company’s structure and products will be an advantage.  In the second, you risk being in the position of someone trying to use the rules of checkers to play a game that’s morphed into pachisi (Sorry!, to you Parker Brothers fans).

the TIF case

the negative analyst report

The Goldman report on TIF that I mentioned in my original post argued that the jeweler would report a blowout 2Q11, but would say that its worldwide business was going to be negatively affected in the second half by global economic slowdown.  Goldman suggested that the 2Q report would be a last hurrah for TIF before a period of sub-par results.

the quarter

The quarter was a blowout.  In a sense, the company did acknowledge the possibility of future earnings weakness as well, by upping its full-year guidance only by the amount its 2Q results had exceeded consensus expectations.  TIF also remarked that the current period held great uncertainty.

At the same time, TIF management made it clear that the company continues to see very strong results to date.  It’s also apparent from the numbers that business accelerated into 2Q, even though macroeconomic worries were rising (see my TIF post for more details.)

the stock response

The stock reacted to the earnings report by rising almost 10% on Friday.  To me, this suggests that the stock market still wanted to buy the individual profit characteristics of TIF and was using macroeconomic tools as the best (only?) means it had for figuring them out in advance.  If so, what we’re seeing in the overall market may just be imperfections in the research process and not a paradigm shift.  This argues that good individual stock research is still an advantage–perhaps a greater one than usual.


The other report I cited concerned the Macau gambling stocks, and was negative.  Hong Kong-traded gambling stocks sold off on the report’s publication and haven’t really recovered.  The Macau government will publish gambling industry data for August in the next couple of days.  This will also be an interesting event to observe.


growth in China: the (semi-) bearish case

hurricane aftermath

Another day without internet access or TV. We still have water, but it’s contaminated. And the pressure is dropping. At least there’s electricity—which makes us considerably better off than most of our friends and neighbors.

I managed to find a Panera with working internet yesterday. It was so packed with other information-seekers that I barely found a table. The connection was slower than dial-up (if I really can recall what that was like).

It’s hard to get around here by car, since so many trees and power lines have fallen and blocked the roads. Our town says electricity won’t be restored to everyone before Friday. So we probably won’t be able to get back to our “normal” worries about the decline of the US, the dominance of China and the potential implosion of the EU until after the Labor Day holiday.

the bearish China case

Speaking of China, the same issue of Foreign Affairs (Sept.-Oct. 2011) that contains the bullish article I wrote about yesterday, also has a second. It’s “The Middling Kingdom: the Hype and the Reality of China’s Rise,” by Salvatore Babones, a Senior Lecturer at the University of Sydney, Australia. It argues the opposite. It says the world wildly overestimates China’s future power.

Here are Mr. Babones’ reasons:

  1. Like the US, the Chinese economy has benefited in the recent past from increased female participation in the labor force. But, but for both China and the US, this temporary boost to GDP from a large influx of new workers has passed its peak. For this reason alone, future GDP growth will be slower (for both countries).
  2. Increased longevity of parents plus the one-child policy will mean Chinese adults will be spending less time working and more and more time caring for the elder generation.
  3. Urbanization, a key aspect of China over the past two decades, has given a big boost to productivity as workers turn from subsistence farming to industrial work. But urbanization has gone about as far as it can go in China (why isn’t made clear). Like increased female participation, this second turbocharging factor won’t be firing up the Chinese GDP growth rate any more.
  4. Back to the Silver Generation for a moment. In addition to citizens working less, according to Mr. Babones, an increasing number of workers will be compelled to shift from high productivity, high value-added manufacturing work to low productivity service jobs taking care of the elderly. So China will no longer enjoy such a high-octane “mix” of new jobs as it does now.
  5. China’s growth to date has been highly destructive to the environment. It doesn’t have much environment left to destroy. Therefore, future growth cannot be as polluting as it has been in the past. Part of the future price of growth will be pollution control devices. Therefore, growth will be more expensive.
  6. China has reached the point where it is a highly efficient manufacturer. The next step for it would be to spawn a generation of creative pioneer entrepreneurs, like those behind Apple or Google, who will imagine and build highly innovative products. This is unlikely, however, given the tight control the Communist Party keeps over all aspects of the Chinese economy. Non-conformity isn’t a virtue in China.
  7. China’s population will begin to fall after 2020. Adding a shrinking workforce to shrinking productivity may be a recipe for 3%-4% real GDP growth, if that; it isn’t one for a 10% rate of advance.
  8. (not so much a reason, if you get down to it, as an observation) All of the academic predictions of future Chinese strength are based on computer models that take the facts of China’s recent past and extrapolate it far into the future. This is probably the best that econometric modeling can do, but that’s more a commentary about the limitations of computer models than assurance that the conclusions are correct. (In the late 1980s, for example, the predecessors of today’s computers were spewing out the same sorts of predictions about Japan. Look how that worked out.)
  9. The surge in the Chinese economy over the past twenty years has restored the country to the relative place in the world that it held in1870. Last time it got to this point, it regressed; why should this time be different?

Mr. Babones’ conclusion: “ If the international system comes to see China, and China comes to see itself, as an important but not all-powerful participant in the global system, irrational fears will diminish on all sides…”.


While it may turn out to be a correct, I’m not persuaded by #9. Maybe repeated invasions had something to do with China’s poor experience last time around?

#8 is Garbage In, Garbage Out said another way.

As to #1-#7, there’s no guarantee that China will stumble over any or all. Nevertheless, this is a useful checklist of early warning indicators to be monitored for signs that the China “story” is coming unraveled.

As/when Chinese economic growth begins a deceleration, I don’t think the country will come to a screeching halt. Nor do I think that signs of slowdown will be evident for at least the next several years. In fact, I think that if anything the developing world is still underestimating near-term prospects for both the Chinese consumer and the Chinese manufacturer.

But if we think of China as a growth stock—better than expected profits for longer than the consensus expects—the Babones article raises legitimate questions about the duration of growth. If/as his view gains acceptance, it will mark an end to one of the two types of “blue sky” open-endedness that characterizes a true growth phenomenon.

What would this mean? –that simply betting on Chinese growth won’t be enough. World markets will either focus on some other secular growth story or, more likely, will begin to focus more narrowly on Chinese industries or regions where growth still abounds.

What to do? For now, I’m going to cheerfully continue to bet the Chinese economy will keep on surprising to the upside. But I’ve got to begin to plan for the day when Chinese expansion eventually surprises computer modelers on the downside. Thanks to Mr. Babones, however, I’ve got plenty of time to ponder what I’ll do.

growth in China: the bullish case

Hurricane Irene has come and gone. Here at home we’ve got electric power, which makes us better off than most. There’s a local state of emergency in effect, during which driving isn’t permitted. You wouldn’t get far in any event, since many key streets are still flooded.

But we lost internet access at about 1am Sunday morning. Comcast customer service, apparently unaware either of the hurricane or its propensity to lose service in even a light rain, says the company has no idea why service has been interrupted or when it will be restores–only that it won’t be soon. That last makes sense, given the large number of trees knocked over by high winds and the extensive flooding. Still, you don’t come away from the conversation with a feeling the company is on top of the situation. Welcome to Comcast.

Given that I’m not going to write on my phone, and I won;t have a tablet until m current Financial Times subscription runs out, I’m writing this on the back porch (using LibreOffice). At worst, I’ll post it from a Starbucks or a Panera tomorrow.

I spent part of the day reading the latest issue of Foreign Affairs (Sept.-Oct 2011). Two competing articles on the growth of the mainland Chinese economy caught my eye.

The bullish one. For China anyway, is “The Inevitable Superpower,” by Arvind Subramanian, a Senior Fellow at the Petersen Institute for International Economics.

Mr. Subramanian opines that China and the US are neck and neck today as superpowers. On the three key variables for assessing superpower-ness, US has the edge in size of GDP, but China is the clear winner in the strength of government finances and the global influence of its trade.

Long before the end of this decade, however, China’s economy will surpass that of the US. Even figuring that China’s growth rate drops by a third and the US picks up its pace a bit, by 2030 Mr. Subramanian figures China will account for 20% of world GDP, or a third more than the US’s share. The Middle Kingdom will also be as dominant a power as the US was in the decades right after WWII—when it was, economically speaking, the only game in town.

By that time, Mr. Subramanian concludes, the US will have to dance to any song the Chinese piper plays—like it or not. And the US may not like the tune that’s called at all.

As experienced portfolio managers all know, an analyst has enough trouble making precise predictions one year in advance, so actually changing your portfolio based on a possible outcome three decades hence would be folly, even if you were 100% convinced it would come to pass.

On the other hand, Wall Street strikes me as being unusually myopic at the moment. If we focus on the one area where the US leads China–economic size–and do some simple arithmetic, we can come up with an eye-catching result that I don’t think is on the radar screen of many investors.

If an economy grows at 10% per year, five years later it’s 60% larger than it started out. In contrast, if an economy expands at 2% per year for five years, it’s 10% bigger than before. Put a different way, before 2016 is out, the mainland economy could be larger, on a purchasing power parity basis, than the US. If we consider, as well, that the EU will doubtless be in the tortoise camp over that span while other emerging economies will come close to matching China’s growth rate, what we are calling emerging markets could together easily be 50% larger than the developed world—and be in much healthier financial shape.

Implications? Throughout my investing career, emerging markets have been viewed by investors from the developed world as high-beta plays on the developed-world business cycle. In the late 1980s, an economist friend from Japan pointed out to me the potential importance of intra-developing-world trade in creating the possibility of a self-sustaining business cycle in the developing world. The big question has always been when that might occur, and how that would affect the typically high cyclicality of emerging markets equities.

This is a more complex question than it appears on the surface, since developed world investors create this cyclicality by moving in and out of emerging equities as they try to time the US/EU business cycle.

At the very least, we’ll have an answer soon.

That’s it for today.

Tomorrow the bearish China case, “The Middling Kingdom: the Hype and the Reality of China’s Rise,” by Salvatore Babones of the University of Sydney.


Tiffany’s even more dazzling 2Q11

the results

TIF reported July quarter  results (like most retailers, the company’s fiscal year ends in January of the following calendar year) just prior to the opening bell on Wall Street last Friday.   The numbers were better than the stunningly good results of 1Q11.

Sales were up 30% year on year at $872.7 million.  Earnings per share, at $.69, were 33% higher than in 2Q10.  Remove non-recurring items–mostly the costs of moving the New York head office, however, and eps were up 58%, at $.86.  This compares with the brokerage house analyst consensus of $.70, with estimates ranging from $.64 to $.77.

TIF raised its full-year earnings guidance by $.20/share to $3.65-$3.75.  My interpretation of management’s (very brief) remarks about this lift is that, as the business looks now, TIF should easily surpass this figure.  The only possible sign of weakness comes from Europe, where comps were “only” up 12% on a constant exchange-rate basis.  But during a time of political and social turmoil, there’s no sense in their raising the guidance bar any further.

Makes sense to me.

stuff I think is worth noting

–TIF bought back 330,000 shares of stock during the quarter at an average price of $74.29.  Not necessarily the greatest trade ever, but it tells you management thinks the intrinsic value of the company is significantly higher than that.

–Comps (comparable store sales) were stronger in 2Q than in 1Q for all regions of the world except Europe.  High-end jewelry sold especially well.  Chinese customers outdid themselves.

–3Q-to-date is just as strong as 2Q.

–Dollar weakness played a role in boosting earnings from Japan and Europe.  There’s no easy way to figure out the exact number, but my back of the envelope guess is that eps would have been around $.08 less without a rise in the ¥ and the €.  I think the $ will be a secular weak currency and that’s part of the icing on the cake of the TIF story.  But I don’t think we’ll see a gain this big again soon.  We might even see some giveback in 3Q11.

–Capital spending plans remain unchanged at around $250 million, but TIF will open 17 new stores this year–one fewer in the US than previously planned, one in Europe.  Eight remain penciled in for Asia-Pacific.

–Thursday-Friday trading in TIF wasn’t what I would have expected.  Before the open on Thursday, jeweler SIG (every kiss begins with Kay; he went to Jared) reported stellar US results for 2Q11.  US comps were up about 12%.  Despite this hint that TIF’s results would be unusually good, TIF shares faded after an initial rise to close down about 1% for the day.  On Friday, post results, TIF was up by 9.3%.

Isn’t Wall Street supposed to discount information in advance?



US sales (51% of the business in 2Q) were up 25% year on year at $438.2 million.  Half that gain came from purchases by foreign tourists, led by Chinese visitors.  Comps in the Fifth Avenue flagship store, a mecca for foreigners, were up 41% vs 2Q10.

The biggest factor was higher price.  Statement jewelry at prices of at $20,00-$50,000 and $50,000+ were notably good sellers.  However, units were up for all categories selling for at least $250.  Only silver jewelry, at the lowest price points, didn’t come to the party.


Sales were $173.2 million (20% of sales), up 55% year on year during 2Q in this region.  Comps were up 51%.  China and Korea were the strongest areas.

What can I say.  I thought the 31% growth in comps for 1Q were great.


Sales were up 21% to $142.5 million (17%).  Comps were +8%; the rest was currency.  Sales momentum was good throughout the island nation, and built as the quarter progressed.  Purchases by Japanese tourists in Hawaii and Guam, counted in US results, were also good.


For the first time, TIF is mentioning foreign tourists–China and Russia–as a factor in its fledgling European operations, although most purchases are still by locals.  At $101.3 million, sales were up by 32%.  Comps were up 11%; the rest was currency.  Unit volume increases were the biggest factor in growth.  The UK was good; the continent was better.


TIF has an “other” business, which consists of wholesale sales to emerging markets where TIF has no stores plus trade in rough diamonds.  The total for 2Q11 was $17.4 million.  I haven’t included it in my percent-of-sales calculations.  It’s not big enough to move the needle.

the stock

Same idea as three months ago  …except my numbers have changed a little.

I think TIF can earn $4 a share in fiscal 2011.  My base case for fiscal 2011 is $4.75.  If we apply a 20x multiple to those figures, we get an $80 target based on this year’s results and $95 based on fiscal 2012.  In an uptrending market, the multiple would easily be 25x, implying a correspondingly higher stock price.

In contrast, in a bad market/economy, next year’s earnings might be flat at $4, or even down a bit.  Applying a 12x multiple gives you a price of $48 (at the absolute bottom in 2008-09, TIF traded at under 9x depressed earnings of $2).

At Friday’s close, then, the $25 of upside I think possible is almost exactly counterbalanced by $20 of downside if the economy goes mildly south.

As it turns out, even though I told myself (repeatedly) that I was going to let the force of the downtrend of the past month or so play out without my buying anything, I found myself replacing the TIF I sold at $76.50 earlier in the year at around $63.50 on the day the market hit 1106.  That tells you something about me; it also says I think the more bullish outcome is more likely.

To my mind, the key variable is not China, which I think will go from strength to strength, or the overall US economy, which I think will be a story of the differing fortunes of haves  have-nots (think Europe in the 1980s) that will aggregate into only modest progress.  The big issue I see is that US comps generated by US citizens have got to lose steam at some point.  As long as they don’t drop to zero, I think the stock will be ok.

The fact that TIF was a $58- stock just a handful of days ago suggests a certain level of anxiety on Wall Street’s part about retail names.  To me, this means that there may be a chance to add to the stock at lower prices than Friday’s.

bottom-up investing in a world turning top-down

the old days


I started looking seriously at non-North American stock markets in 1984, after six years researching a number of sectors in the US market.  At that time, UK and continental European investors used almost exclusively a top-down style.  That is, they used macroeconomic analysis to select the countries they were interested in.  They then either bought banks, on the idea that the loan portfolios mirrored the economic structure of the countries; or they ventured into other sectors based on their economists’ view on what would be the areas of greatest economic strength.

…vs. the US

This process stood in stark contrast to what American investors did–which was to select individual stocks, mostly based on firm-specific factors, but with a little industry or sector guesswork also thrown in.  In fact, Peter Lynch of Fidelity Magellan, the most successful investor of that generation, wrote in his first book that he really didn’t pay much attention to macroeconomics.  He just picked good companies.

continental Europe?

When I began to manage a global portfolio at a small firm in 1986, I was faced with the problem of continental Europe.  I had limited resources.  There were lots of countries, all with different customs, different politics and different attitudes toward investing.  But together they only made up 10% or so of my benchmark index.   I’d spend all my time looking at just them if I adopted the European approach.  So I decided to do what Americans do, just pick stocks, on a pan-European basis and hope I didn’t get hurt too badly.

Ten years of European integration–and stellar portfolio performance along the way–later, my “accidental” approach had become the new norm.  It has stayed that way since.

…or so I thought.

macro-driven analysis

I’ve been surprised over the past couple of weeks to be seeing reports that harken back to an earlier day when analysts drew conclusions about individual stocks from general economic analysis, and nothing much else.

Two stick out.

1.  According to press reports, Goldman cut its price target on TIF a few days ago by 13%, from $77 to $67.  2013 eps were clipped by 4%, from $4.60 to $4.40.  Why?  Slowdown in the overall US economy.  That’s it.  Macroeconomic weakness will translate into lower jewelry purchases.

We’ll get some new evidence when TIF reports a little later this morning.   But judging from last night’s results from more down-market jewelry company SIG (which you’d expect to be hurt more severely than TIF if consumers were pulling in their horns),  however, there’s no sign of slowdown yet.  SIG said same store sales in the US were up 12% year on year in each month of the July quarter, and up 12% as well for the first three weeks of August.

I’m not saying GS is particularly insightful about TIF, nor that what I’ve read (I haven’t seen the actual report) is internally consistent.  What strikes me is the methodology–that there’s no apparent attempt to find a metric more subtle than that GDP growth is slowing.

2.  Deutsche Bank recently declared that the growth days for the casino gambling market in Macau are over.  Why?  Imports of German luxury cars into China, which had been growing at close to a 50% annual clip in the first half of 2011, slowed to +22% in July.  Deutsche believes this means wealthy Chinese citizens are seeing their income squeezed by global slowdown and are cutting back on spending (again, I haven’t seen the actual report, but it has been widely covered by the Asian press).

But July was a blowout month for the Macau gaming market.

According to Deutsche, that doesn’t matter.  We’re already seeing now is a reduction in high-roller participation in the market, but it’s being disguised for now by a boost in visits by less affluent Chinese gamblers.  By yearend, Deutsche thinks the Macau market will only be growing by 20%.  Growth of a mere 10% is possible for next year.  Evidence for any of this??

That’s an awful lot of inference from a one-month dropoff in sales of imported automobiles.   Who knows?  …maybe this year’s models are ugly.  …or customers have run out of garage space and will pick up the spending pace when their new garage additions are finished.

This report really struck a nerve in Hong Kong, however.  The entire gambling sector fell, with some stocks off as much as 10%.  It hasn’t recovered to date.

premises and conclusions

It’s always possible that your conclusions end up being correct even though your reasons are crazy–or non-existent. I happen to think that both reports will end up being too negative.  But that’s not my point.

In my experience, good analysts visit stores, interview/survey customers, talk with suppliers and with competitors to build a bottom-up model of a company or an industry.  They have detailed factual knowledge of a set of companies that they then integrate into an industry view.  Then maybe they knock on the door of their firm’s economist to give empirical feedback about the house macroeconomic view.

In these cases, the flow seems to have been reversed.  An economist who deals at the highest level of abstraction seems to be dictating what analysts are “supposed” to be seeing.  There’s a risk that the house macroeconomic view acts as a set of blinders that certainly make the analyst’s job easier, but makes the results less valuable at the same time.  I hope this isn’t the start of a trend.

We’ll know more about TIF later on today.  And Macau gambling numbers for August will be out in a week or so.