Monthly Archives: December 2015

Shaping a Portfolio for 2016: petrodollars

December 10, 2015 By in oil and natural gas, shale oil, Shaping a Portfolio for 2016, Uncategorized Tags: , , , , , 1 Comment

Petrodollars is the term coined in the 1970s to describe the money flow from oil consuming nations to oil producers–meaning by and large OPEC–during a decade when the crude oil price skyrocketed from around $3 a barrel in 1970 to $25+ in 1979.

Some economists of the day feared that this massive increase in money paid for fuel would be, in effect, withdrawn from circulation in the global money supply, and that the resulting money supply contraction could cause a worldwide recession.  (I have no idea where this notion came from, but it was seriously discussed.  Another strange idea being floated then was of the “backward-bending demand curve,” i.e., that there was something magical about oil so that the higher the price went, the more demand increased.)

What happened instead was that these funds were quickly recycled into the world money supply through increased spending by OPEC and through gigantic purchases of financial and other assets, from Treasury bonds to real estate to large stakes in publicly listed companies in Europe and the US.

Economic growth in the OECD did slow markedly during the 1970s and inflation rose sharply in places like the US, as industry heavily reliant on ultra-cheap oil struggled to adjust.  One might also argue that the fact that money was going from the pockets of avid consumers to those of wealthy savers also retarded economic expansion.

What I’ve just written is only interesting, other than to me, because the reverse of that 1970s flow is now happening.  More money is remaining in the hands of consumers.  According to the Financial Times, during the September quarter alone, Middle Eastern sovereign wealth funds cashed in at least $19 billion of their investments to underpin current government spending. Since not all asset manager report withdrawals, the true figure could easily be twice that.

It’s clear that a large shift of wealth away from OPEC and to oil consumers is under way.  But, in addition, as OPEC liquidates financial investments to fund current spending–Saudi Arabia is actually talking about issuing international bonds to fund its budget deficit–it will provide another monetary (and consumption) tailwind for economic growth in 2016.

Shaping a Portfolio for 2016: currency and interest rates

December 9, 2015 By in currency effects, Shaping a Portfolio for 2016, Uncategorized Tags: , , , 1 Comment

currency

Japan and the EU have tried over the past several years to jumpstart their economies through massive currency  depreciation.  This has resulted in a gigantic loss of national wealth in both regions.  It has also depressed the local standard of living by making dollar-denominated commodities–energy, food, metals, textiles–more expensive.

But the move has also revived industry, at least in the EU, by making end products cheaper.

Therefore, Europe could see substantial export-based growth in 2016.  As usual, I’m thinking that Japan is a lost cause.

interest rates

The US is alone among major countries of the world to have recovered far enough from the 2008-09 recession to begin to raise interest rates from their current intensive care lows.

The Fed Funds rate will most likely be be boosted to +0.25% next week.  And the benchmark will doubtless be raised again in 2016.  Nevertheless, the initial increases will probably have little, if any, negative effect on economic activity.

My guess is that we’ll exit 2016 with the Fed Funds rate at 1%.

At first blush, it would seem that by increasing interest rate differentials between the US and the rest of the world, the Fed would induce international fixed income investors to reposition their portfolios. Selling foreign bonds and buying US Treasuries would give them both higher interest income and the chance at a currency gain–since the flow of foreign funds into the US would imply further strength in the US$.

However, the Fed move has been widely telegraphed for an extended period of time.  We’ve already seen considerable struength in the US$ in 2015.  My guess is that most of the potential asset shift has already taken place in 2015.

So, I’m thinking that the Fed’s interest rate moves will be a non-event in both domestic economic and currency terms.

Tomorrow:  petrodollars

Shaping a Portfolio for 2016: emerging markets

December 8, 2015 By in economic problems in emerging countries, emerging markets, Shaping a Portfolio for 2016, Uncategorized Tags: , 1 Comment

your father’s emerging markets…

I started working in emerging markets in 1984.  At that time, the most important were Hong Kong and Singapore.  If one were feeling adventurous, Thailand, Malaysia and even Indonesia (shudder!) beckoned.  Taiwan and Korea were also on the list, but not easily accessible to foreigners.

At that time, there was a certain equivocation in the “emerging markets” term.  Yes, the stock markets were relatively rudimentary and overlooked by investors in the US and the EU.  But the economies of the big ones, Hong Kong, Singapore, Taiwan and Korea, were all advanced, with living standards for the average resident somewhere between those in Europe and the US.

With the notable exception of Indonesia, the 1980s-style emerging markets were all oil importers (Malaysia and Thailand have large reserves of natural gas, and export LNG, but that’s a different thing).

Back in the day, investing in Hong Kong was all about the then-colony, now SAR, with exposure to the mainland limited to the successors to the nineteenth-century opium traders and a few small manufacturers with operations on the mainland.

Mexico was the notable emerging market not in the Pacific.

 

…and today’s

China is now, of course, the emerging markets behemoth.  Direct access to foreign portfolio investors isn’t seamless.  Nor, in my view, is it desirable.  However, the investment significance of Hong Kong has radically shifted, from a focus on the physical place to the access its China-related listings allows to the mainland.

Perhaps more important for today’s economic situation, however, the emerging markets arena has expanded to include much more of Latin America (think: Brazil or Venezuela)–and, after the fall of the Berlin Wall, Russia and Eastern Europe as well.  Some thrill-seeking investors have tiptoed into the Middle East as well.

Two strong net effects:

–the emerging markets category contains many more emerging economies, with less stable politics, and

–today’s emerging markets are heavily weighted toward exporters of natural resources, especially oil.

for 2016:

China is several years into a transition from being an export-oriented manufacturer to being a domestic demand-oriented service economy.  The way I look at it, China is doing better than the consensus thinks–and will continue to do so in 2016.

The rest of the emerging markets arena is a mess.  Economically, that’s mostly because so many countries depend on mineral exports.  From a stock market point of view, it’s that plus the high weighting of natural resource issues (including banks that finance them) in the local indices.

My guesstimate is that Greater China will show 6% real GDP growth in 2016.  As a group, the rest will be in the minus column.  I have no idea what the net result will be.  I’m planning on it being mildly positive.

Until the oil price begins to recover–mid-year at the earliest, I think–I don’t see this as a time to hold an emerging markets index.  Individual stocks or a China fund/ETF is the way to go.  Other than China, developed markets, rather than emerging markets, are the place to be.

 

 

 

 

 

 

 

 

Shaping a Portfolio for 2016: the EU

December 7, 2015 By in Shaping a Portfolio for 2016, Uncategorized Tags: , , , , Leave a comment

the secular situation isn’t great

On average, the population of the EU is older than that of the US and younger than Japan’s.  It faces the same problem as the two other traditional economic powers of waning trend GDP growth, based on minimal expansion of the workforce.  If the workforce in the US is growing by 1%+ per year and Japan’s shrinking by -0.5%, the EU’s is  somewhere in the middle, rising by, say, 0.5%-.

It, too, is caught by anti-change forces bolstered by claims of “exceptionalism,” but of a complex sort.  France, Italy, Germany, the UK…each claim that it is exceptional–and that the others are not.  This hinders productivity growth.

All in all, not a pretty sight for investors.

cyclically, though…

…the EU has several positive factors going for it at the moment:

–the value of the € against the dollar has fallen from $1.40 in mid-2014 to $1.08 now.  That’s almost a 25% drop.  Yes, the devaluation has caused a massive decrease in €-area wealth.  But that’s the past.  The currency decline is also acting as a significant boost to economic activity, in the same way a sharp drop in interest rates would.  This positive effect is most pronounced for export-oriented or import-competing activities.

–after several years of GDP-growth pummeling austerity measures, the EU has belatedly adopted the same quantitative easing the US successfully used to restore economic growth.  As a result, the EU is in a sense like the US with a three-year lag–meaning growth can have a monetary tailwind aiding it for the next few years.

–the EU gets most of its hydrocarbon energy from abroad.  Russia, for example, is a mammoth supplier of natural gas to the union–all priced on a heating value equivalent with oil (translation:  it’s very expensive).  As a result, the EU is a prime beneficiary of the drop in the oil price over the past year or so.  The decline in the € has offset that a bit, but oil still costs 40% less today in euros than in early 2014.

–the Grexit crisis is over.

–emigration from the Middle East, especially Syria, is a big plus.  An influx of millions of young, motivated, reasonably trained workers is precisely what a sclerotic EU workforce needs to underpin GDP growth.  Chauvinistic politicians will doubtless dampen the effect somewhat, but this is still a significant long-term positive.

 

All in all, I think the EU has the potential for surprisingly strong economic performance in 2016.

 

 

 

Shaping a Portfolio for 2016: the US

December 4, 2015 By in Shaping a Portfolio for 2016, Uncategorized Tags: , , , , 1 Comment

The US is the most straightforward of the investment regions of the world.

We’ve arguably made the best recovery from the deep recession caused by the financial meltdown of 2007-08 (China is the other possible candidate).  Real GDP in 2016 will be close to 15% higher than the previous pre-recession peak.  We’re also unique among major nations in the world in being about to make the first baby steps to bring interest rates up from their present emergency-room lows.

That’s the good news.

GDP growth

The other side of the coin is that the trend growth rate for the US economy is now much lower, at about +2% per year, than it was at the end of the last century.  That’s mostly a function of the aging of the population, something the Fed had begun to talk about, but few had noticed, in the 1990s.

We’ve now entered year seven from the economic low point in late 2009.  So I think it’s hard to make the argument that there’s lots of recession-induced pent up demand still waiting to be unleashed.  As a result, it’s also difficult to make the case that overall economic growth in the US in 2016 will be higher than 2% real, meaning maybe 4% nominal.

S&P 500 earnings growth

Publicly traded companies tend to be the best and brightest of those operating in the US.  Their profit growth should be somewhat higher than the norm, say, +7%.

Two factors suggest that the overall tally won’t be higher than that:

–the S&P 500 provides little exposure to autos or construction, two of the faster growing components of the economy, and

–it’s hard to figure what will happen in the energy sector, which, despite its recent poor performance, still accounts for 7.1% of the S&P 500 index.

in a perfect world, growth could be higher, but…

Growth could be substantially higher than that, were the two major political parties not so economically dysfunctional.  Partisan bickering an patronage politics probably subtract 1% from the country’s growth potential.   Arguably, Washington has always been like this and it’s just more noticeable today because of the aging of the population and the fact that inflation is near zero.

look for beneficiaries of structural change

Underneath this relatively calm surface, however, there’s lots of structural change taking place.

–Millennials have replaced Baby Boomers as the largest segment of the population.

–The internet is continuing to create new businesses and disrupt old ones.

–Both Boomers and Millennials are migrating in large numbers–the former toward warmth and away from high taxes, the latter toward large urban areas.

It seems to me that these are the kinds of areas where outperformance will be found next year.  That would imply another year of growth stocks outdoing their value counterparts.

interest rates

The effect of higher interest rates?

The most important point, I think, is that rising rates are unlikely to affect the patterns of out- and underperformance by much (personally, I don’t think there’ll be any effect).

The facts that the pace of rising rates is likely to be glacial and that the advent of the process has been as well-advertised as Star Wars …and over a longer period…suggest than any negative effect on stocks is likely to be mild.