Monthly Archives: May 2014

catching a falling knife

May 30, 2014 By in Constructing a Portfolio, Current Market Thoughts Tags: , , , , , , 1 Comment

what they say

American stock market sayings tend to be earthy and fatalistic, like “what goes around…”, or to refer to ursine gustatory “sometimes you eat the bear…” or waste evacuation practices.  Colorful, maybe, and consoling, but otherwise not very practical.

British financial clichès, on the other hand, are somewhat more high-tone but equally useless in practice–think:  “jam tomorrow,” or “horses for courses.”  One exception:   trying to catch a falling knife.  It’s a gruesome and appropriate image.

catching a falling knife

Catching a falling knife means buying a stock that’s going down in flames, while the downward spiral is still in progress.  It’s never a good idea.

On the other hand, however, if the stock in question has any intrinsic merit, there must come a time when it’s right to buy it.  And, in my view, that certainly shouldn’t be only after it has recovered, say, half of a 30% decline.  So there should be–remember, I’m an aggressive investor–a time when it’s right to behave in a way that looks a lot like grabbing for a blade in freefall.

To my mind, there are two aspects to any substantial stock/sector/market decline.  One is valuation, the other emotion.

valuation

This is the realm of fundamental analysis and is the more straightforward of the two.   Many times, stock declines begin when valuation is stretched and end when valuations are more reasonable.  This is what market corrections are all about–to provide some financial incentive–say, the possibility of a 10% gain over the coming year–for new buyers to act.

But valuation isn’t enough.

At the very beginning of my Wall Street career, I talked with everyone I could find who had experienced the market collapse of 1973-74 first-hand.  One of the portfolio managers I worked for in the late 1970s told me of buying stocks in mid-1974 for less than the net cash on the balance sheet, only to see them continue to fall, by another 10%-20%, over the ensuing six months.

Look at price charts of just about any stock today to get a more current example.  Look at their prices at the market low in March 2009.  Many were changing hands then at under 10% of the current quote.  How so?  People were scared out of their wits–something that always happens at market lows–and unable to function objectively.

emotion

This is all about technical analysis, gauging the level of investor fear/greed.

For me personally, a stock has to be trading at an attractive price on fundamentals before I’m willing to start the very subjective, voodoo-ish process of trying to figure out whether negative emotion surrounding a stock/sector/the market is mostly exhausted.

I look at:

—time, since fear always takes longer to abate than I’d expect

—trading volume, since sometimes downdrafts end with a final high-volume rush to sell

–the extent of the decline

–hints that the stock is finding a level below which it doesn’t want to go (this is risky, since the stock may only be two or three steps down a flight of stairs).

why write about this now?

I think the selling of “concept” stocks that we’ve seen over the past couple of months is over, and it’s time to sift through these names carefully in a more than nibbling kind of way.

 

 

Piketty on inequality

May 29, 2014 By in Books, Current Market Thoughts, economics Tags: , , , , , , 2 Comments

Capital in the 21st Century

Last year,  Le Capital au 21e Siècle, authored by Thomas Piketty, a researcher on economic inequality who teaches at the Paris School of Economics and who has been publishing academic articles for the past 15 years, came out in France.   Virtually no one (me included) read it.  But then it was picked up and translated into English.  It has become a runaway bestseller in the two months since then for that most unlikely of places, the Harvard University Press. Last weekend I even saw Capital in the 21st Century displayed prominently in the Bestseller rack of the only book kiosk in the San Francisco airport.

To be clear, I haven’t read C21C,  and I have no present intention of doing so.

But I have seen it and I thought about buying it.  That’s the next best thing to having it on my bookshelf  …which is pretty close to having turned the pages   ….which is the next best thing to having understood the arguments.   That’s why I don’t feel so bad about writing about Prof. Piketty’s work this morning.

The book is almost 698 pages long in English, close to 1,000 in French–and probably a zillion as an e-book.  It also has a technical annex available online that contains all the supporting data used (whose validity has been questioned in a front page, above-the-fold article in the Financial Times–no response from M. Piketty yet).  The detailed annex is thought to be the book’s best feature.

The main theses of C21C are:

–over the past fifty years there has been a steady rise in the percentage of a given country’s wealth being captured by the already rich.   This can be seen everywhere there are records of wealth available.  The rich continue to get richer, the poor, poorer

–this phenomenon is just the way it is in the capitalist system

–the best (only?) way to remedy this bad situation (for 99% of us) is for government to tax the rich heavily and redistribute the money it collects to everyone else.

significance?

What grabs my attention is the uproar that C21C has created in the English-speaking world. I think this shows that inequality is a much bigger hot-button issue than I had realized.

I can understand why C21C is popular.  Prof. Piketty presents a simple, universal framework for understanding the complex problem of how to provide equal opportunity for all citizens.  More than that, no one is at fault for the way things are now.  Inequality isn’t due to bad schools or discrimination, to the failure of corporate boards to rein in CEO pay, or to regulators’ failure to thwart the perfidy of crooked traders at commercial banks.  It’s just the way capitalism works (just as churning out 700-1000 pages to present a few simple ideas is the way academia works).

There’s also a simple, politically popular solution–redistribution.

It may well be that C21C will prove a flash in the pan, and that the book will take its place on bookshelves alongside other unread (I typed “undead” initially–must be my unconscious in overdrive) tomes like Alan Greenspan’s The Age of Turbulence or the Steve Jobs biography.

On the other hand, it may stimulate a useful public policy debate on inequality in the US.  The only worrisome outcome, to my mind, would be that its conclusions might be taken uncritically as a justification for policies that don’t seem to have done a whole lot of good so far for France.  Great for the US, though, if all the French techies who have decamped to Silicon Valley are any good.

 

financial inversions are proliferating

May 28, 2014 By in Current Market Thoughts, financial inversion, Stock ideas, Strategy Tags: , , , , , , , Leave a comment

A while ago, I wrote about the financial or tax, “inversions” that have been sweeping the US pharmaceuticals industry.  Basically, a US company that pays a full 35% Federal corporate tax bill can reincorporate in a low-tax foreign jurisdiction–purely on paper–by taking over a foreign firm already set up there.  This is financial engineering at its finest/worst.  No one has to move; offices and plants remain untouched.  Certain conditions do have to be met, however.  The US acquirer must fold itself into the foreign acquiree so that the foreign entity is the survivor.  And foreigners must own 20% of the shares of the merged company.  Otherwise, it’s pure financial gravy.

Consider a US company that has $1,000,000,000 in pre-tax income.  After Federal tax, that’s $650,000,000.  If the firm can “invert” itself and end up with a 20% tax rate on that income, the after-Federal-tax number becomes $800,000,00.  That’s an annual savings of $150,000,000–a 23% jump in the funds that can be used for capital investment or paying dividends.

IHG

It’s no longer just drug companies, though.  Last weekend, media reports that Intercontinental Hotels Group, PLC (IHG) had been approached by a US hotelier, speculated to be Starwood (HOT), about a combination of this type.  IHG supposedly rejected a $10 billion takeover offer.  (IHG’s stock price indicates we may not have heard the last chapter of this story, since the quote rose to just about the reputed offer price after the news came out.

investment implications

1.  Back in the Stone Age (the late 1970s), when I entered the investment business, investors were very sensitive to the rate at which a company’s profits were taxed.  At that time, the prevailing view has that the higher the tax rate, the better quality the earnings were.  The rationale was that in order to be used for dividend payments, cash generated in low-tax jurisdictions would need to be repatriated and local corporate tax paid.  Therefore, the apparent profits generated in low tax areas were illusory and not to be trusted.

Now, that view seems very Austin Power-ish.  As I see it, for good or ill, over the past decade or more investors have been indifferent to the rate at which profits are tax.  It’s solely profit growth that counts.  Whether it’s achieved through selling more products or by astute tax planning doesn’t matter.

But the “modern” view has to be changing again, I think, as inversions become more popular.  It’s now a distinct investment plus to be a foreign company in a low-tax jurisdiction.  This means that, sooner or later, a US firm in the same industry will make a takeover bid.

2.  As the US corporate tax base begins to erode through financial inversions, there should be a response from Washington.  The rational one, in my view, would be to simplify the tax code and lower the levy on corporations to what’s normal in the rest of the world.

But no.  So far the only movement in Congress is to retroactively make inversions illegal.  This is the kind of thing that has helped give India its current reputation as a high risk area to do business in.

Still, reform of corporate taxes would potentially create a whole raft of winners and losers.  So it’s something to keep an eye out for.

 

crunch time for Abenomics in Japan

May 27, 2014 By in Asian economic development, economics, Japanese development Tags: , , , , , , , 2 Comments

The economic program of Prime Minister Shinzo Abe to revitalize a Japanese economy that has been dormant for a quarter century has three main points, or “arrows”:

–increased deficit spending by a national government already very deeply in debt,

–loose money policy to weaken the currency, making Japanese industry more competitive while supporting the dismantling of a raft of protective practices that have debilitated a once-powerful industrial base, and

–the corporate overhaul itself–the elimination of a nexus of laws and policies that have perpetuated now-outmoded industrial practices from the 1960s-1980s, and which have  also made it virtually impossible to replace the incompetent top managements that have run many Japanese companies into the ground.

Arrows #1 and #2 have been fired successfully.

To my mind, however, Abenomics has always been about the government’s ability to fire arrow #3.

That’s not going so well.  More than that, almost thirty years of watching the Japanese economy and Japanese politics have made me skeptical that meaningful structural change is possible.  The forces of the status quo are just too strong.  That’s also despite the will of Japanese citizens that such reform take place.  (In many ways, too, I see Japan today as like the Ghost of Christmas Future for the US.)

the Kuroda message

Late last week, an interesting thing happened in Tokyo.  In an interview with the Wall Street Journal, Haruhiko Kuroda, a career politician who is currently the head of the Bank of Japan (the equivalent of the Fed in the US), urged Mr. Abe to get going on structural reform.  “Implementation is key,” he’s quoted by the WSJ as saying, “and implementation should be swift…The major work to be done is by the government and the private sector.”  Bad things will happen to the economy otherwise.

Mr. Kuroda’s bluntness contrasts sharply with the wishy-washy statements en Bernanke has made before the US Congress about the need for supportive fiscal policy–none of which has been forthcoming–to aid the recovery in the US.

Of course, the stakes are much higher in Japan, where currency depreciation has caused a loss so far of about a quarter of the nation’s wealth, and a corresponding reduction in living standards for average citizens.  This enormous cost can only be justified if it results in structural reform.  But so far just about nothing has happened.

what needs to be done

Yes, Mr. Abe pointed out to the Journal in a response to Mr. Kuroda that electricity prices have come down and that protection of domestic rice farmers has been reduced a bit.

On the other hand, all the legislation enacted in the 1990s to prevent foreign companies from having any influence in the running of Japanese firms (takeovers of any size are virtually impossible) is still on the books.  Shareholder activists, foreign or domestic, are as unwelcome as ever.  Major Japanese investment institutions, presumably with government “guidance,” continue to take a hands-off attitude toward the companies whose stock they hold.  And companies themselves, other than perhaps the autos, seem to be in no rush to modernize the industrial practices that have caused so much economic hardship since the 1990s.

And, as Mr. Kuroda observes, time is running out for Japan.  The kind of positive jolt that deficit spending/currency devaluation/uslta-loose money give to an economy only lasts for a few years.  Without other changes, an economy gradually settles back into its former lower-growth state, only with higher inflation.  In other words, the economy in question is worse off than it was before.

For the sake of Japanese citizens, I hope Mr. Abe starts working on arrow #3 before it’s too late.  Unfortunately, almost thirty years of watching Japan tells me he’ll end up posturing a lot but doing nothing.  The only chance I see for a better outcome is if other politicians follow Mr. Kuroda’s lead and begin to speak out.  Unless/until this happens, I think the Tokyo market will continue to be an unpleasant place to be.