Macau and ATM machines

During its days as a Portuguese colony, Macau was reputed to be a key center used by the mainland underworld to launder its ill-gotten gains.  The main laundromat, as it were, was allegedly the  collection of casinos run under a monopoly granted to the Ho family.

After the return of Macau to Chinese rule, the government moved quickly to break the monopoly and to guide the casino industry toward the Las Vegas model through technology transfer by granting casino licenses mainly to prominent US Las gambling operators with a Disney-esque approach to business.

A second political problem threatening the legitimacy of the Chinese Communist Party began to arise during the last decade as fabulously wealthy political insiders began to flaunt their riches through elaborate, ostentatious gambling jaunts to Macau.  A crackdown ensued, which also served the long-term interests of Macau by strongly redirecting the emphasis of the Macau gambling industry away from high-roller VIPs toward middle class and upper middle class patrons.  This, by the way, follows the development of the gambling market in the US.

During US trading hours yesterday, media reports from Hong Kong surfaced suggesting Beijing was beginning to crack down on middle class gamblers as well as VIPs.  The stories said the daily limit that mainland residents vacationing in Macau are allowed to withdraw from their (renminbi-denominated) bank accounts through a local ATM would be cut in half from–MOP 10,000 ($1300) to MOP 5,000, effective tomorrow.

Given Beijing’s plans for Macau’s economic development, this report made little sense–although, realistically speaking, who knows what Beijing’s day-to-day thoughts are.

The US-traded Macau names immediately dropped by around a tenth in a flattish market.  In today’s Hong Kong trading, Macau gambling stocks fell by 7% or so (expressing about half the negative sentiment in NY)–with the strongest (relative) performance by Ho-controlled SJM.

After the close of Hong Kong trading, mainland authorities “clarified” the initial report, saying that, yes, the per transaction limit on ATM withdrawals by mainlanders in Macau was being cut in half, but that the total daily limit would remain unchanged.  No reason why the clarification took 12 hours to be made.

In early US trading today, Macau-related stocks have made up about a third of their losses from yesterday.

As a holder of Wynn Resorts, Wynn Macau and Galaxy Entertainment, I’m going to sit on my hands.  If I held nothing, I’d be inclined to buy a bit.  My preference would be for the Hong Kong names, however, for two reasons:  the US market is being driven now by dreams of a domestic industrial revival, so foreign casinos aren’t at the top of institutions’ wish lists; and investors who dumped out their Macau holdings in a panic yesterday will be loathe to buy them back at a higher price, at least for a while.

stocks in a 4% T-bond world

There are two questions here:

–what happens to stocks as interest rates rise? and

–what should the PE on the S&P 500 be if the main investment alternative for US investors, Treasury bonds, yield something around 4%?

On the first, over my 38+ year investment career stocks have gone mostly sideways when the Fed is raising short-term interest rates.  The standard explanation for this, which I think is correct, is that while stocks can show rising earnings to counter the effect of better yields on newly-issued bonds, existing bonds have no defense.

Put a different way, the market’s PE multiple should contract as rates rise, but rising earnings counter at least part of that effect.

The second question, which is not about how we get there but what it looks like when we arrive, is the subject of this post.

in a 4% world

The arithmetic solution to the question is straightforward.  Imagining that stocks are quasi-bonds, in the way traditional finance academics do, the equivalent of a bond coupon payment is the earnings yield. It’s the portion of a company’s profits that each share has a claim on ÷ the share price.  For example, if a stock is trading at $50 a share and eps are $2, the earnings yield is $2/$50 = 4%.  This is also 1/PE.

A complication:  Ex dividends, corporate profits don’t get deposited into our bank accounts; they remain with management.  So they’re somewhat different from an interest payment.  If management is a skillful user of capital, that’s good.  Otherwise…

If we take this proposed equivalence at face value, a 4% earnings yield and 4% T-bond annual interest payment should be more or less the same thing.  In the ivory tower universe, stocks should trade at 25x earnings if T-bonds are yielding 4%.  That’s almost exactly where the S&P 500 is trading now, based on trailing 12-months “as reported” earnings (meaning not factoring out one-time gains/losses).  Why this measure?   It’s the easiest to obtain.

More tomorrow.

 

Saudi Arabia’s about-face

About a week ago, Saudi Arabia brokered an agreement among oil producing countries to cap their aggregate output of crude at 32.5 million barrels daily.  This will require daily liftings to be reduced by 1.2 million barrels.  Of that 1.2 million barrels in cuts, the Saudis themselves will account for 486,000, or just over 40%.

This Saudi decision flies in the face of the kingdom’s previous policy and its experience in the 1980s, when it repeatedly reduced production in a vain attempt to stabilize prices.  What happened back then?   …other OPEC countries, with more pressing needs for cash and with relatively short-lived reserve bases (so playing a long game made little sense, just as today), failed to make the output reductions they agreed to.  More than that, they boosted their liftings instead in amounts that more than offset the Saudi cutbacks.  So prices continued to fall, and for years afterward Saudi Arabia lost access to long-time customers.

Over the past two years, because of the bitter experience of the 1980s, Saudi Arabia has refused to reduce its output despite pleas from other OPEC members.  It  has even increased production a bit.

…until now.

What should we make of this about-face?

The superficial arithmetic for Riyadh is clear–reduce output by 5%; the price per barrel rises by 10% as a result; total revenue rises by 5%.  That’s assuming no cheating by other parties.  But in the case of every economically-driven commodities cartel, cheating always happens.  And the Saudis know that OPEC proved itself no different from other cartels 35 years ago.

 

What’s interesting about this case is that for us as investors situations like these, where we have imperfect information, arise more often than we would like to believe.  Rather than obsessing about what we don’t know in these cases, it’s important to see what conclusions we can draw from what we do know.

In particular:

–Saudi Arabia simply can’t have forgotten about its experience in the first half of the 1980s.  It must believe that eventually some parties will fail adhere to their production quotas.  But it must have some reason to believe that this won’t happen immediately

–it’s possible the kingdom thinks that with supply and demand are almost evenly matched, output reductions will cause the crude oil price to rise substantially.  The price rise will ward off cheating

–the Saudis must also think that what they’re doing now is a better strategy for them than that of pumping full-out and keeping prices low.  Why should this be?  My first thought is that Riyadh’s finances are not in strong enough shape to continue to endure $40 a barrel oil

–the Saudis must realize as well that $50+ a barrel will reinvigorate the shale oil industry in the US, capping any possible price rise.  On the other hand, keeping prices at, say, $40 a barrel won’t make shale oil go away.  The industry will simply lie dormant for a while, ready to spring to life again when prices are higher.  On the other hand, they may no longer believe that they can destroy the shale oil business forever by keeping prices low.  they may even fear that technological advances and cost-cutting will make shale viable at $40 if they are allowed to take place.  So, counterintuitively, the best strategy for combating the threat of shale may be to discourage the development of such new techniques by keeping prices higher

my take

Buy shale oil and monitor OPEC closely.

 

 

 

 

 

is 4% real GDP growth possible in the US?

the 3% – 4% growth promise

One of Donald Trump’s campaign promises is to create 3% – 4% GDP growth in the US.  Is this possible?

The first thing to note is that this is real GDP growth, meaning after inflation has been subtracted out.  I’m not sure Mr. Trump has ever clarified this–or that he wouldn’t be nonplussed by the question–but his appointees to head the Treasury and Commerce departments have said real is what they mean.  Also, 4% nominal (that is, including inflation) growth is about what the US has been churning out in recent years.  So promising 4% nominal growth would be like P T Barnum putting up his “This way to the egress” sign.

where does growth come from?

Simple models are usually the best (as in this case, feeling embarrassed when calling them “models” is a good indicator of simplicity).  Growth can come either by having more people working or by having workers be more productive, meaning churning out more output per hour.

more workers

Having more people working is a function of demographics.

Each year, the population of the US rises by about 0.8%.  Half of that comes from children being born to people already residing in the US; half comes from immigration.  If we take increases in the population as a proxy for increases in the workforce, then demographics can generate a bit less than 1% trend growth in GDP.

This also means that if Mr. Trump carries through on his threat to deport 3% of the workforce and restrict entry of immigrants, not only will the social consequences be shameful, he will make it that much harder to achieve his GDP objective.

productivity

Given that demographics will likely either not change, or will change in a negative way, getting to the low end of the 3% – 4% range will only be possible if worker productivity rises.   Let’s make the optimistic assumptions that the Republicans’ white supremacy rhetoric doesn’t discourage any potential immigrants and that there’s no increase in deportations.  If so, productivity gains would have to be at least +2.2% per year to achieve the low end of the GDP growth goal.

If +4% growth isn’t simply “marketing” in the worst sense of that word, the Trump camp must believe that productivity can be boosted to +3.2% per year.

An aside:  My first stock market boss was a vintage 19th-century capitalist.  He believed that increasing worker productivity meant boosting the workload–and making employees work longer hours for the same pay.  (No, there was no company store where we were forced to buy meals; yes, we had to basically provide our own office supplies.)

That’s not correct, though.  Productivity improvement comes through better employee education/training and by employers investing in labor-enhancing machines (back then, it would have been computer workstations, or in my firm’s case, pencils).

productivity today

Productivity today has been stuck at around +1% per year growth for about a decade.  During the housing bubble, when the US was furiously churning out many more new dwellings than the country could afford and banks were making crazy no-documentation mortgage loans (websites were also sprouting up to show low-income renters how to buy a house and scam the system for a year of “free rent” before foreclosure), we got to maybe +2.8% for a number of years.  But the last time the US rose above 3% was in the 1950s, when industry in Europe and Japan had been destroyed by war.

my take

I hope Wilbur Ross can do what he says.

I think +4% growth is simply hype–and that Mr. Ross, if not Mr. Trump, knows the situation.

The trend in manufacturing is to replace humans with robots. That’s the most straightforward way to achieve productivity gains. Output climbs steadily; output per worker goes up faster.  However, the number of employees shrinks drastically.   For many displaced workers supporting Mr. Trump, this may be a case of being careful about what you wish for.

 

 

 

 

 

interest rates: how high?

the speed of interest rate rises

The best indicator of how fast the Fed will raise the Fed Funds rate will likely be the pace of wage gains and new job creation, as shown in the monthly Employment Situation report issued by the Bureau of Labor Statistics.  Infrastructure investment legislation that may be passed by the new Congress next year may also factor into the Fed’s thinking.  On the other hand, the continuing example of Japan, whose quarter-century of no economic growth is due in part to premature tightening of economic policy is also likely to play a part in decision making.

Much of that will be hard to be certain about in advance.  Current Wall Street thinking, for what it’s worth, is that the pace will be north of glacial but not fast at all–maybe a move of +0.50% next year, after a boost of +0.25% later this month.

The endpoint of policy, however, may be somewhat easier to forecast.

the final policy goal

 

Fed policy is aimed at holding inflation at +2.0% per year.  Its main problem recently is that it can’t get inflation that high, in spite of having flooded the economy with money for the past eight years.  So let’s say we’ll have inflation at 2%, but not higher, some time in the future.

cash

If so, and if the return on cash-like investments during normal times continues to provide protection against inflation and little else, then the final target for the Fed Funds rate is 2%.

bonds

If we consider the 30-year bond and say that the normal annual return should be inflation protection + 2% per year, then the target yield for it would be 4%–vs slightly over 3% today.

The 10-year?  subtract 50 basis points from the 30-year annual yield.  That would mean 3.5% as the target yield.

If this is correct, the important thing about the domestic bond market since the US election is the substantial steepening of the yield curve.  While cash has another 150 bp to rise to get to 2%, the long bond is within 100bp of where I think it will eventually settle in.

In other words, a substantial amount of readjustment has already occurred.

 

 

 

 

 

 

The Employment Situation, November 2016

The Bureau of Labor Statistics of the Labor Department released its monthly Employment  Situation report at 8:30 est this morning, as usual.

The results were good.  178,000 net new positions were filled during the month, which is right at the average monthly gain so far this year.  Net revisions were slightly negative, subtracting -2000 positions from prior months’ employment estimates.  The BLS also said wages made no upward progress during November, after having jumped a lot the month before.

The only out-of-the-ordinary figure was the unemployment rate, which fell to 4.6% from 4.9% in October.  We’ll likely find next month that the November figure comes from transitory statistical strangeness that will have already disappeared.

What to make of this ES?

Nothing, really.  In fact, I think that as stock market investors, we should no longer be monitoring the ES for signs of potential labor market weakness.  Instead, we should be on the lookout for indications of surprising strength, possibly in the number of new hires, but more likely in the rate of wage gains.

That’s because I think we’re well past the point where we’ve got to guard against economic weakness.  Instead, we’ve got to be alert for signs of the more likely threat–that the pace of interest rate rises will accelerate from the currently anticipated once-in-a-long-while pace..

The first step in adopting this new mindset, I think, is to consider what the endpoint for increases in the Fed Funds rate–and the resulting terminal interest rate point for 10-year Treasuries, which is the closer substitute for stocks in long-term investors’ portfolios–will be.

More on this topic on Monday.