Monthly Archives: March 2015

a dollar shortage?

March 17, 2015 By in currency effects, currency markets, securities markets Tags: , , , , , , Leave a comment

response to a reader’s question

A reader asked me to comment on this post on the Zero Hedge website about a potential US$ funding shortage.  The post was sparked by (is a rehash of) this recent commentary by JP Morgan’s currency strategist.

Let’s be clear that this is not my area of expertise.

Nevertheless, here goes:

the blogger

The Zero Hedge post, following the JP Morgan piece, observes that it has become unusually expensive to buy large amounts of US dollars.  The last time this happened was just as Lehman was failing, signalling serious problems with the world financial system.

The post author concludes that because dollars are again pricy we’re warming up for another round of severe banking problems.

JP Morgan

I don’t think the blogger is correct.  It seems to me he’s mixing up cause and effect.  Also, this is not what JP Morgan is saying.

history

Back in 2008-09, the main issue  was counterparty risk.

Bear Stearns, whose financial statements showed assets–mainly bonds, loan participations…worth about $80 ended up bankrupt, with those “assets” really worth close to nothing.  Lehman’s value was coming under similar questioning.

The conclusion the financial markets drew was that maybe all the banks’ financials were similarly not worth the paper they were written on–and that therefore anyone you lent money to, even for a few days or weeks, might go under before you were repaid.  So the wisest–and only–course was to lend to no one.   The world financial system froze up.

An important leading indicator of this mess was the increasing cost of borrowing dollars to finance trade.

today

Today’s situation is very different.  Two factors are involved in the current high cost of finding dollars:

–it’s cheaper to borrow in euros, hedge currency exposure and convert the loan proceeds into dollars than it is to borrow directly in dollars. (Similarly, in recent years it’s been cheaper for a Mets fan to fly to San Francisco to see the Mets play there than buy a premium seat at Citi Field.) Enough American corporations are doing so to dramaically up the cost of obtaining dollars.  They will presumably continue to do so until do so until this arbitrage makes no sense.

–today’s carry trade is sell euros (or just about any other currency)/buy dollars.

my conclusion

Today’s situation, unusual as it is in post-WWII history, doesn’t signal the onset of a new banking crisis.  Rather, it’s a function of differences in central bank monetary policy between the US and EU caused by differences in the relative economic health of  the two areas.

an aside

JP Morgan mentions one thing for which it has no hard information but that may prove important.

The corporate borrowing situation described a few lines above makes no net impact (in theory, anyway) on the fx value of the euro.  The currency hedging contract exactly offsets the effect of the purchase of dollars.

Suppose, though, US companies aren’t hedging.    After all, multinationals have tons of money in overseas banks and lots of physical assets in foreign countries.  Currency losses on both are currently ripping gaping holes in firms’ income statements.  Companies might consider that having, say, euro-denominated liabilities would neutralize some of the damage (I feel confident that the JPM strategist has either made, sat in on, or at least heard about, financing pitches arguing US companies should do precisely this).

If so, their dollar-buying isn’t  being offest by hedging contracts and  is putting upward pressure on the US$.

equity implications

If so, once converting euros into dollars becomes expensive enough, US companies will presumably stop doing it.  This could cause a significant bounce in the euro.  This would likely switch European stock market preferences away from dollar earners toward (beaten down) domestic issues.

 

 

want index underperformance …try an actively managed bond fund

March 16, 2015 By in Bond Environment, bond market, Investment firms, junk bonds, junk bonds, Portfolio management, securities markets Tags: , , , , , , 1 Comment

Indexology

‘For a while I’ve been following the Indexology blog written by S&P.

As the name and source suggest, the blog extolls the virtues of indexing–after all, S&P makes them and sells information about them.  I find the posts to be generally interesting.  My only quibble is that the Indexology people seem to be true believers in a strong version of the efficient markets hypothesis.  They’ve all drunk the Kool-aid and don’t stop to question how it can be that basically every professional active manager underperforms   …nor do they try to imagine what circumstances could create even a temporary burst of outperformance.

I’m well aware of all the figures about equity manager underperformance.  However, I’d never thought much about bond funds, the subject of the Indexology post of March 12th.

The numbers are stunning.

bond fund (under)performance vs. benchmarks

Here they are:

–in 2014, 97% of the government bond funds underperformed, as did 98% of the investment-grade corporate bond funds

–in both categories, over 95% underperformed over the past five- and ten-year periods

—73% of the junk bond fund managers underperformed in 2014; over the past five years, 88% underperformed; over the past ten, the number is 92%.

Bright spots?:

–among actively managed senior loan funds (which don’t contain bonds;  they hold pieces of syndicated bank loans to non-investment grade corporate borrowers), 70% outperformed last year.  Over the past decade, though, underperformers and outperformers are just about equal in number.

–61% of municipal bond managers outperformed in 2014.  55% did so over the past fie years.  However, over the past ten, 70% underperformed.

reasons for this woeful showing?

Indexology offers none.  Personally, I have no firm ideas.

Looking only casually at the results of Bill Gross over his years at Pimco left me with two impressions of the former Bond King:

— he continually bet very aggressively (and correctly) that interest rates would fall–sort of like an intelligent version of Jon Corzine, and

–a large chunk of his outperformance disappeared through the high fees Pimco charged for his services.

Indexology doesn’t talk about fees, which can’t have improved the situation for bond managers generally–and I presume the Indexoogy numbers are after them.

The better areas for relative performance are smaller and contain less liquid securities.  I wonder what role pricing–which I presume is not based on daily trading but on the theoretical models of third-party experts–plays?

 

downward revision of 1Q15 revenue by Intel (INTC)

March 13, 2015 By in earnings conference calls, economics, EU financial crisis, Portfolio management, Recent Market Action, Stock ideas Tags: , , , , , , , , Leave a comment

Yesterday INTC issued a press release revising downward the 1Q15 guidance it gave when announcing 4Q14 results on January 15th.

The company now expects 1Q15 revenue to be $12.8 billion vs $13.7 billion previously–a drop of about 6%.

What does this mean?

–My impression is that, like most publicly traded companies, INTC provides guidance that gives itself a margin of safety against having a negative surprise.  That is, the guidance is a reasonable figure, given the data at hand, but a little on the low side.  So the downward revision means INTC has used up all its wiggle room and then some.

–The reporting convention is to list the factors behind the revision in the order of their importance, with the most significant first.  For INTC, these factors are:

—–weaker demand for business desktops, and

—–a resulting runoff in the number of INTC chips that wholesalers’ are willing to keep in inventory.  This is magnifying the effect of the retail shortfall on INTC’s sales. (Think:  instead of selling 10 chips and reordering 10, the wholesaler has sold, say, 9 and reordered 8.)

 

–The reasons behind weaker sales–again, most important first–are:

—-slowdown in the rate at which small and medium-sized businesses are replacing their outmoded Windows XP machines

—-economic weakness, especially in Europe

—-currency weakness, especially in Europe.

Operating margins remain unaffected, despite the revenue drop.  That’s because higher selling prices are offsetting the negative effect of lower unit volumes (which would seem to imply that unit volumes are off by 6%).

my take

My guess would be that sales to end users are off by 4% vs. forecast and the other 2% is from reduction in wholesale inventories.  I suspect that these are sales deferred rather than lost, so I’m not too concerned.  This probably does signal, however, that the vast majority of the current corporate upgrade cycle is over.

I’m more interested in currency/volume effects in the EU.  It’s less to figure out what’s happening with INTC than to to get advance warning about how other firms with European exposure may fare as they report results.

I’m guessing, based on their order in the INTC press release, that businesses clinging to XP are 60% of INTC’s problem, 40% is Europe.

If so, Europe accounts for a 2.5% falloff in sales.  Let’s assume that the decline of the euro accounts for half of this, or 1.25% of $13.7 billion, which equals $170 million.  The euro has fallen by 8% since January 15th.  $170 billion/.08 = $2.1 billion, implying that European end users now make up only about 15% of INTC’s sales.

This strikes me as low, although in a quick look through the company’s 2013 10-K (the 2014 one isn’t out yet) the geographical breakout  of operations that I found listed the location of INTC’s computer-building customers, not where the end users are.

Two conclusions, then:

more currency losses than expected for multinationals with European exposure in 1Q15, and

weaker than expected (I think) economic performance in Europe, as well.  Not a disaster, but worse than companies thought two months ago.

 

 

 

 

dealing with a rising currency

March 12, 2015 By in economics, growth vs value, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , Leave a comment

As far as the stock market is concerned, there are two main strategies for dealing with a rising currency:

1.  try to make currency work to your advantage

Profit growth will be highest for a company in a changing currency environment if it has its costs in weak currencies and its revenues in strong ones. In today’s world, this means having costs in, say, yen or euros and sales in the US.

The “good” stocks in weak currency countries gain in two ways:   from stronger profit gains and from domestic portfolio managers rotating their holdings toward the “good” industries.

The obvious candidates are export-oriented firms with high labor content in weak currency countries.  In these areas, firms with high strong-currency import content that sell finished products into the domestic market are the worst ones to hold.

 

In strong currency countries, in contrast, purely domestic stocks are the best bet.  They benefit only from portfolio manager rotation, though.  But they avoid currency induced weakness.

 

2. ignore currency and look for secular growth names whose expansion prospects outweigh possible currency losses 

As a growth investor, this is my preferred strategy.  Historically, the majority of such stocks have been in the US.  In today’s world, however, the ideal investment would be in a hot EU tech company with exposure to the US.

Any ideas?

the US dollar and commodities

March 11, 2015 By in Current Market Thoughts, economics, EU financial crisis, oil and natural gas, Strategy Tags: , , , , , Leave a comment

dollar strength is unusual

Over my working career, the US government has maintained a policy of encouraging gentle US dollar weakness, while keeping up a rhetoric (for domestic consumption) of wanting dollar strength.

From a practical point of view, what’s important for investors is that the current situation of considerable actual dollar strength is unusual.

$ ↑ means S&P earnings ↓

I’ve already written about the negative effects of the greenback’s strength against the euro on reported earnings for the S&P 500.  The EU currency has lost about a quarter of its value against the dollar over the past nine months or so.  Put another way, the 25% of S&P profits derived from the EU are worth 25% less in dollars than a year ago.  In back-of-the-envelope terms, this means overall S&P profits are now running about 6% lower than  they would be were the exchange rate back at €1 = US$1.38.

effects in weak currancy countries

Today’s post is a look at the other side of the coin–the effects of the dollar rise on sales of dollar-denominated products.

These fall into two classes:

—products made in the US.  Here the situation is easy to understand.  The higher local currency price of US products decreases demand for them in weak currency areas like the EU, and increases demand for locally produced substitutes.

—global commodities, which–from metals to energy to agricultural products–are priced in dollars in international trade.

commodities

the first round

For a producer in a weak currency country, the dollar rise initially means a jump in local currency profits.

For a weak currency consumer, the dollar increase means an immediate rise in local currency costs.

responses

The consumer responds to higher prices either by:

–consuming less, finding substitutes (like an extra blanket, or switching from coffee to tea, or riding the bus instead of driving) or

–cutting back on other things.

The producer waits to see the consumer response.  If there’s a dramatic falloff in demand, he can counter this by lowering prices.

the net effect…

…is a loss of purchasing power for the weak currency earner–and a consequent weakening of overall GDP growth.  The main question is how well substitution can cushion the blow.

a saving grace…

The collapse in the oil price, which began at about the same time as the dollar rise, has offset much of the currency damage to GDP in oil consuming countries.

…for most

The currency gains that oil producing countries may have made from lower  costs have been far outweighed by the plunge in unit revenues they’ve suffered.

the bottom line

The US is not a particularly export oriented country. And it’s a large net oil importer.

For most, the rise in the dollar has had  no negative effects–plus the mild positive of lower cost of  imported goods.

On the other hand, for citizens of, say, Japan, which imports large amounts of food and fuel, the fall of the dollar has been a disaster for ordinary consumers–mitigated only by the plunge in the oil price.  Europe is somewhere in the middle, consumers squeezed by a rise in the cost of commodities but buoyed by the large decline in the price of imported oil and gas.