Monthly Archives: September 2011

five reasons we may be in a trading-oriented market for a while yet

September 19, 2011 By in Constructing a Portfolio, Current Market Thoughts, day trading, market timing, Portfolio management, Recent Market Action, Strategy, Trading Tags: , , , , , , , , , Leave a comment

By a trading-oriented market, I mean one where:

–the indices generally move sideways within a narrowly defined range, and

–individual stock price movements are strongly influenced by traders who have short-term holding periods–a day, a week, even a few hours–and who buy and sell very rapidly.  As a result, both individual stocks and the markets can exhibit sharp up-one-day, down-the-next patterns.

Why should a market like this persist? 

Five reasons:

1.  The economies of the developed world have slowed a lot and are no longer providing clear up or down signals.  And, at the moment, the EU’s continuing bungling of the situation in Greece is producing alternately hopeful and despairing news headlines that short-term traders are using to help them ply their trade.

2.  Pension plan sponsors continue to shift money from traditional investors to “alternatives” like hedge funds, many of which are run by traders and employ a short-term trading style.  This shift continues despite the fact that alternative managers are more expensive and in the aggregate have produced inferior returns pretty continuously for almost a decade.  Don’t ask me why.

3.  Fundamental information about individual companies has become harder to get.  Over my thirty years in the business, brokerage houses have become progressively more dominated by traders.  During the 2007-2009 market downturn, they gutted their research departments as a way to cut overheads.

Also, the shift by individual investors from mutual funds to ETFs and by institutions to alternatives means the research budgets of traditional long-only institutions are not what they once were, either.

4.  Discount brokers offer mostly trading tools and technical analysis to their clients.  Why?  They make most of their money from customer transactions, not from clients outperforming the market.  Also, setting up a research department is complicated and expensive, and it potentially exposes the firm to lawsuits if investment recommendations go awry.

5.  Many mutual funds still have big accumulated losses–both recognized and unrecognized.  In large part, these losses come from individuals buying mutual fund shares at high prices in 2006-07 and then redeemed them at much lower levels in 2009.

As counterintuitive as it sounds, these losses are a big asset to current shareholders.  They allow a manager to change the structure of his portfolio without generating net taxable gains.  This fact also permits–and, in my opinion, should encourage–mutual fund managers to take a more aggressive trading stance to use the losses more quickly.  This maximizes their value to shareholders.  And some newer funds may have years and years worth of losses to avail themselves of.

The result of this is that even the most buy-and-hold-oriented taxable investors may be trading much more than usual.

investment implications

One of the first pieces of Asian investing lore I encountered years ago (and one of the few I’ve found useful) is that the daily market action is like a rapidly turning wheel.  You can stay away from the wheel and not be hurt.  You can jump on the wheel and not be hurt.  They only way you can be severely injured is to try to jump on and off.  In other words, if you dabble in trading and don’t devote your life to it  you’ll get your fingers badly burned.

For the vast majority of us, as individual investors, the best approach is to take a longer investment horizon than the market does–to endure short-term volatility rather than try to profit from it.

Barney Frank’s idea of “reforming” the Fed

September 18, 2011 By in economics, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , 2 Comments

the Fed’s Open Market Committee

The Fed’s Open Market Committee, which determines the Fed’s interest rate policy, consists of 12 members.  Seven are appointed by the president, five are taken on a rotating basis from among the heads of the 12 regional Federal Reserve banks.  The regional bank heads are selected by the boards of directors of their respective banks–typically prominent local businesspeople–and approved by the Fed’s board of governors.  The Huffington Post has the best synopsis I’ve seen.

the Frank proposal

Barney Frank, the senior Democrat on the House banking committee, is trying to change that.  According to Bloomberg, Mr. Frank wants the five regional banker votes eliminated.  They would be replaced by four appointees chosen by the president.

Why the change?  In Mr. Frank’s opinion, the current procedure isn’t “democratic” enough, because the regional Fed chiefs aren’t vetted by publicly-elected officials.     …and, oh, by the way, Mr. Frank also disapproves of the way the regional Fed chiefs vote.  They’re too worried about inflation (that is, about sound money).  Looser money policy than they’re willing to tolerate might help spur job growth, he thinks.  Presumably political appointees would vote as they’re told to by their political bosses.

Basically, then, Mr. Frank’s goal is to induce a significant level of inflation in hopes of creating jobs.

This is a bad idea.

The one sure effect of a higher level of inflation would be to weaken the dollar.  That would doubtless frighten the foreigners who own huge amounts of Treasury bonds, causing them to demand higher coupon rates before they roll over their holdings as existing bonds come due.  In fact, the last time the US was in this situation, during the Carter administration, foreigners flat out refused to buy dollar-denominated bonds from the US.  They not only demanded higher rates; they demanded to be repaid in harder currency, like the D-mark, before they would lend Washington money.

During the same period, companies stopped investing in new plant and equipment.  Rising inflation made it too hard to figure out whether these investments made any economic sense.  Then there was the mammoth recession of 1981-82, when interest rates rose above 20% as Paul Volcker set about putting the inflation genie back in the bottle.  At the time, it was conventional wisdom that this process caused so much economic hardship for the country that no one would advocate reintroducing inflation into the economy ever again in our lifetimes.

So more inflation = high interest rates + weak currency + economic slump = higher unemployment + personal bankruptcies + business failures.

Would anyone want that?

But here’s Mr. Frank, who lived through the pain once–and who should know better, eager to take the risk of this happening again.

Why, Barney?

It may be that Mr. Frank, as a Democrat in a legislative chamber controlled by the Republicans, figures he can make a political statement without any risk, because no bill of his will ever pass the House.

Even so, the pro-labor/anti-business tone of his proposal invokes memories of an era of class struggle in the US that ended half a century ago.  It may resonate with voters in their seventies or eighties; anyone younger will likely just regard the Frank bill as I do–irresponsible and dangerous.

investment implications

Higher inflation means lower bond prices and lower price-earnings multiples for stocks.  Any threat to the independence of the central bank will create big problems financing government debt.  It may not be foreigners who balk at buying Treasuries, either.  Historically, domestic bond investors have been the first to react when government policy threatens the value of their investments.

My guess is that the Frank bill is DOA.  Given that far-right Republicans also want to lessen the independence of the Fed, however, I think the situation warrants continuing monitoring.

Bill Ackman: buy the Hong Kong dollar for revaluation potential. Does this make sense?

September 16, 2011 By in Asian economic development, China, economics, emerging markets, Hong Kong Tags: , , , , , Leave a comment

the Ackman investment idea

Bill Ackman, the hedge fund manager behind Pershing Square Capital, delivered a keynote address at a CNBC investment conference on Wednesday, September 14th.  In his remarks, he suggested that investors buy the Hong Kong dollar.  He expects that currency, which has been pegged to the USD for the past 28 years, will soon be revalued upward.  One possible revaluation target is the Chinese renminbi (Hong Kong is, after all, basically a province of China; another would be a basket of currencies representing Hong Kong’s trade flows (which is what many smaller countries move to when they unpeg from the greenback).

Pershing Square has already acted on this idea.

his reasoning

I didn’t hear his talk, but I did see his subsequent appearance on CNBC to explain his thinking.  He has two points:

lots of potential upside, no downside

–by buying one-year options on the HKD you can get 25x leverage.  If you used .5% of your capital to buy options and the HKD were repegged against the USD at a level 30% higher, you’d make a profit of more than 10% of your capital.  Against this huge gain, the downside is tiny:  you lose  the .5%.

the peg isn’t economically justified

–when a small country pegs its currency to another nation’s, it has to keep its short-term interest rates in line with the other country’s.  US interest rates are at zero,  as we heal from the massive damage done by the financial crisis.  For Hong Kong, which is growing strongly, a zero interest rate policy is massively over-stimulative and the source of destructively high levels of inflation.  Therefore, a move to a more appropriate exchange rate is likely.

is that it?

Pretty much.  Mr. Ackman also says he’s studied the history of Hong Kong carefully and that in”similar circumstances” Hong Kong has changed its peg.  It’s hard to believe he’s serious about that, though.  I don’t see how any decision a colonial governor might have made several decades ago in support of the interests of the UK would cast any light on the decision Beijing might make today in support of its own national interest.

Mr. Ackman’s reasons aside,

what could go wrong?

Pegs are usually motivated by economics.  Not in this case.  The Honk Kong peg is all about politics.

1.  The current peg was introduced to stem massive outflows of money from Hong Kong when Beijing and London announced in 1983 that Hong Kong would be returned to the mainland in 1997.  Given that many Hong Kong citizens had fled from China after WWII, losing all their possessions doing so, something had to be done to lessen the fear of a repeat.

Hong Kong citizens have long since come to understand that hitching their star to Beijing was the luckiest thing that ever happened to them.  So avoiding panic selling of the HKD is no longer a reason for having the peg.

2.  The inflationary buildup caused by the peg, almost from its onset, forced traditional Hong Kong industries like textiles, garments and electronic assembly out of the colony and into the mainland–initially into the nearby Special Economic Zone of Shenzhen.  In other words, it expedited the technology transfer that Beijing desired to hasten the mainland’s industrial development.

In this regard as well, I think the peg has long since outlived its usefulness.  Cost differences are still a motivation for having as much as possible of the management and administrative structure of a firm on the mainland, though.  And  that has forced faster infrastructure development in the major eastern urban areas.

However, I think there’s still a reason that Beijing would like to keep the HKD/USD peg.

3.  Beijing has made it clear that it wants the renminbi to become an important international currency, perhaps one day an alternative to the USD as a reserve currency for the world.  China has put a tremendous amount of effort into furthering this goal over the past couple of years in, for example, the way it has structured bilateral trade agreements and in the way it is fostering Hong Kong as a center of offshore renminbi finance.

Making the HKD a more attractive substitute for the renminbi doesn’t advance this effort.  It sets it back.  That’s why my guess is that a revaluation of the HKD dollar won’t happen.  If Beijing had its way (and it probably eventually will) the HKD will be supplanted by the renminbi, even in Hong Kong, and just fade away.

A much safer way of playing possible revaluation would be to buy Hong Kong stocks that have revenues linked to the renminbi and costs linked to the HKD.  But you’d stand to make a 20%-30% gain on revaluation, not the 2500% jackpot Mr. Ackman is hoping for.

WYNN/Wynn Macau (HK:1128)’s new Cotai casino gets government okay: implications

September 15, 2011 By in Casinos, China, Current Market Thoughts, emerging markets, Entertainment, Hong Kong, Industry Analysis, Lodging, Stock ideas Tags: , , , , , , , Leave a comment

the WYNN Cotai project

Last Monday in Hong Kong, Wynn Macau announced that it had received a 25-year concession from the government of the SAR to develop a new casino in Cotai.  The concession consists of 51 acres of land.  1128 will pay a land premium of US$193.4 million and annual rent of US$771,738.

The planned casino, which WYNN has been talking about for the past six months, will likely cost US$3.0-$3.5 billion and will probably debut in 2014 (the concession requires the casino to be in operation within five years).  Given that 1128 already has about US$ 1 billion in cash on the balance sheet and will probably earn another US$2 billion from its existing Macau casino operations before the new venue opens, financing the project will not be a problem.

market implications

I think there are four:

1.  Macau, which I think has done an excellent job of developing the casino industry in the SAR, has been very careful in recent years grant new casino concessions slowly enough that supply doesn’t outpace demand.  The WYNN concession indicates that it believes strong demand from the mainland will continue for at least the next several years.

2.  There had been speculation in Hong Kong that Beijing was upset at the relatively greater success of US casino groups in Macau vs. the incumbent Ho family.  The WYNN concession shows me that this isn’t the case.  All along I’ve believed that the SAR has actually been eager to have US casino operators (why else give an initial concession to WYNN?), for two reasons:  to get the convention/resort expertise of Las Vegas, and to break the power of the triads in the market.

3.  The Hong Kong stock market has apparently begun to worry about what happens to the casino industry in Macau after the concessions granted to current operators end in 2022.  I think these worries are silly–as if Macau would set onerous new terms that would compel operators either to leave or to run their casinos to extract capital rather than expand.  That would turn the SAR from the Las Vegas of China into its Atlantic City–an outcome that would be disastrous both for the casino operators and for Macau.

For those who think that pieces of paper are more important than common sense in these matters, the WYNN Cotai concession agreement requires the company to remain in Macau and run a casino for the next twenty-five years.

4.  There have also been market worries that, because current concessions end in about ten years, western banks won’t finance casino expansion.  For the incumbent operators, this is not a big issue.  For one thing, casinos are so cash generative that a company like 1128 won’t need financing.  For another, mainland Chinese banks are likely the preferred lenders to the casinos.

thoughts on WYNN and 1128

Both WYNN and Wynn Macau have been spectacular performers, year to date.  I don’t think anything is “wrong” with either stock.

WYNN hasn’t participated in the market rebound of the past few days, mostly, I think, because it resisted the preceding downdraft.  1128 is suffering from (misplaced, in my opinion) jitters in the Hong Kong market about the possible rapid deceleration of growth of the Macau gambling market.

For the moment, the US market is, understandably, concentrating on stocks that have been severely beaten down in the market’s fall.  I expect investor interest will return to WYNN soon enough (although I have written October $170 calls on a small part of my holding).

1128, which I also hold, is a more difficult situation to assess.  To US eyes, it’s a fabulous stock.  It’s trading on well under 20x forward earnings, with easily 25-30% earnings growth is prospect–much more if the Macau gambling market remains as strong as I think it will. And there’s the capacity expansion in a couple of years, as well.  Yet Hong Kong investors, who will make or break the market in the stock, appear unwilling so far to differentiate 1128 from its much weaker competition.  And they’re clearly worried about a possible downturn in Macau gambling.  More patience may be required here.