Trump on trade: unintended consequences?

A straightforward analysis of what Mr. Trump is doing would be:

–tariffs slow overall growth and rearrange it to favor protected industries.  There’s no reason I can see to believe something different might happen in the US

–apart from the third world, protected industries tend to have domestic political clout but to be in economic trouble.  In my experience, these woes come more from bad management than from foreigners’ actions

–the go-it-alone approach is a weak one, since it provides ample scope for a target country to shop tariffed goods through an intermediary

–the apparently arbitrary way the administration is acting will cause both domestic and foreign corporations to reconsider future capital investment in the US.

 

There are, however, two other issues that I think have long-term implications but which aren’t discussed much.

–tariffs may cause industries that have moved abroad to retain labor-intensive work practices (and continue to use dated industrial machinery) in a lower labor-cost environment to return to the home country.  If such firms come back to the US, it won’t be with the old machinery.  New operations will be very highly mechanized. In other words, one likely response to the Trump tariffs will be to accelerate the replacement of humans with robots in the US.

–as I see it, China is at the key stage of economic development where, to grow, it must leave behind labor-intensive work and develop higher value-added industries.  This is very hard to do.  The owners of low value-added enterprises have become very wealthy and powerful.  They employ lots of people.  They have considerable political influence.   And they strongly favor the status quo.  The result is typically that the economy in question plateaus as labor-intensive industries block progress.  In the case of China, however, the threat that the US will effectively deny such firms access to a major market will kickstart progress and deflect blame from Beijing.

 

If I’m correct, the effect of trying to restore WWII-era industry in the US will, ironically, achieve the opposite.  It will accelerate domestic change in the nature of work away from manual labor.  And it will run interference against the status quo in China, allowing Beijing’s efforts to become a cutting-edge industrial power to gather speed.

 

 

the EU today: structural adjustment needed

Let’s assume that my description of the EU ex the UK is correct–that beneficiaries of the traditional order (the elites) are, and will continue to be, successful at thwarting structural change that would rock tradition but produce higher economic growth.

How should an equity investor proceed?

There are two schools of thought, not necessarily mutually incompatible:

–the first is that in an area where there is little growth, companies with strong fundamentals will stand out even more from the crowd.  This lucky few will therefore gain much of the local investor interest, plus the vast majority of foreign investor attention.  If so, in places like continental Europe or Japan one should look for fast-growing mid-cap companies with global sales potential for their products and services.  These will almost certainly outperform the market.

The more important question for an equity investor is whether they will do as well as similar companies domiciled and traded elsewhere.

–my personal observation is that the general malaise that affects stock markets in low-growth areas like Japan or the EU infects the fast growers as well.  The result is that they don’t do as well as similar companies elsewhere.  I haven’t tried to quantify the difference, but it’s what I’ve observed over the years.

It may be that the local market is offended by brash upstarts.  It may be that local portfolio managers deal only in book value and dividend yield as metrics.  It may simply be the fact that local laws prevent owners from eventually selling to the highest bidder, thereby damping down the ultimate upside for the stock.  One other effect of a situation like this is, of course, that entrepreneurs leave and set their companies up elsewhere.

 

The bottom line for a growth investor like me is that these areas become markets for the occasional special situation, not places where I want to be fully invested most of the time.  Because of this, and because of Brexit, the UK assumes greater importance for me.  So, too, Hong Kong, as an avenue into mainland China.  And to the degree I want to have direct international exposure–which means I want to avoid the US for whatever reason–emerging markets also come into play.

 

A final thought:  one could argue that the lack of investment appeal I perceive in Japan and continental Europe has nothing to do with political or cultural choices.  Both areas have relatively old populations.  If it’s simply demographics, signs of similar trouble should be appearing in the US within a decade.  I don’t think this is correct, but as investors we should all be attentive to possible signs.

 

Make in India?

I’m not sure exactly why I’m on a foreign markets/economies kick, but I think I’m pretty close to the end of it.

India and me

I’ve been fascinated/horrified by India economically for over twenty years.  On the one hand, the country has lots of potential, based on a huge internal market and a large, well-educated workforce.  On the other, economic success for India continues to rely on how favorable the monsoon season is.  The country’s leaders are clearly aware of, and dismayed by, the fact that nations they may regard at any given time as peers soon leave India behind in the dust.  But not that much has changed over the time I’ve been observing.

“Make in India’

“Make in India” is the marketing slogan the Narendra Modi administration has chosen to promote foreign direct investment, a time-honored tool for simulating economic progress through technology transfer.  Think:  Japan, Korea, Thailand, Malaysia, China…  The road map is clear.  The only question is whether a country has the political will to make the journey.

rules for success

I thought I’d try to list in this post, loosely in order of importance, what’s needed to attract foreign firms to create a business in a developing country.  They are:

–a large pool of trained, or trainable, workers

–roads and ports, to get output from the manufacturing site to market

–sources of electric power, clean water and telecommunications

–a stable legal system, so the rules of the game are clear at the outset and the goalposts don’t get moved after a firm has committed capital

–protection for intellectual property.  A generation ago, multinationals dealt with this crucial issue by sending to the Third World only the tools to make machines that were already obsolete in the First.  By and large, that’s no longer a viable option.   Because in today’s world technology transfer means not only how to organize and run a business but also current trade secrets, protection of intellectual property is more crucial than ever.

–it’s always nice to have a large internal market, so that the success of a factory doesn’t depend solely on export orders

–it’s also nice to have an eco-system of available suppliers and support industries grouped nearby.

How does India stack up?

It has a large internal market and a big pool of potentially available workers.

The physical infrastructure has never been great, in my experience   …and India has never seemed to me to have effectively in made infrastructure development a high government priority.

India has always struck me as distinctly unwelcoming to newcomers, and to foreign enterprises in particular.

Mr. Modi says he wants to change that.  Whether he will be able to is another question.  So, too, is whether he really means what he says.

 

 

 

Shaping a Portfolio for 2016: emerging markets

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.

 

 

 

 

 

 

 

 

the Chinese currency and the Chinese stock market

Throughout my financial career I’ve found that in sizing up currency markets traders from the big banks have always been ten steps ahead of me.

I’ve hopefully learned to live with this–meaning that because I’m never going to outthink them I believe my best currency strategy should have two parts:

–to avoid making future currency movements a major element in constructing my portfolio, and

–to be a “fast follower” if I can–that is, to figure out from a trend change what the banks must be thinking and to consider getting on board if I think the trend is going to have legs.

 

China has moved the price at which it will buy and sell renminbi down by 1.9% yesterday and by another 1.6% today.  Informed market speculation seems to be that another couple of downward moves of the same magnitude are in the offing.

From a domestic policy perspective, China would prefer a strong currency to a weaker one.  As I mentioned yesterday, the country has run out of cheap labor and must, therefore, transition away from the highly polluting, cheap labor employing, export-oriented basic manufacturing that is the initial staple of any developing country.  This kind of business has been the bread and butter of many Chinese companies, some of them state-owned, for decades.  Many are resisting Beijing’s call to change.  The strong currency is a club Beijing can use to beat them into submission.  In this sense, the fact that the renminbi has appreciated by 10%+ against other developing countries’ currencies over the past year, and by around the same amount against the euro, China’s largest trading partner, is a good thing.

On the other hand, the developed world has made it clear to China that if it wants to be included in the club that sets world financial policy, and in particular if it wants the renminbi to be a world reserve currency, the renminbi cannot be rigidly controlled by Beijing.  It must float, meaning trade more or less freely against other world currencies.  So China has a long-term interest in doing what it has started to do yesterday–to allow the currency to move as market forces drive it.

Why now, though?

World stock markets seem to be thinking that a severe erosion of China’s GDP growth is behind the move toward a currency float–that it’s backsliding from a committment to structural reform.

I’m not so sure.

I think what currency traders have concluded is that Beijing has enough money to prop up its stock market and enough to keep its currency at the present overvalued level–but not both.  So they’re borrowing renminbi  and selling it in the government-controlled market in the hope of pushing down the currency and buying back at a lower price.  Understanding what’s going on, and realizing the risks in defending a too-high currency level, Beijing is bending in the wind.  Doing so limits the amount of money that can be made this way, effectively short-circuiting the strategy.

Offshore renminbi, which can’t be repatriated into China, trade about 5% cheaper that domestic renminbi.  That’s where we should get the next indication of how far renminbi selling will go.

As far as my personal stock investing goes, my strong inclination is to bet that renminbi-related fears are way overblown.  I’ like to see markets calm down a bit before I stick a toe in the water, though.

 

 

 

 

 

the Chinese renminbi “devaluation”

devaluation?

Every day the Chinese government sets a mid-point for trading of its currency prior to opening.  The renminbi is then allowed to trade within a 2% band on either side of the setting.  At this morning’s setting, Beijing put the mid-point 1.9% lower than it was yesterday.  This is an unusually large amount and can be (is being) read as an effective devaluation of the currency.

What does this really mean?

background

In the late 1970s, when China made its turn away from Mao and toward western economics, it chose the tried-and-true road toward prosperity trod by every other successful post-WWII nation.  It tied its currency to the dollar and offered access to cheap local labor in return for technology transfer.

Late in the last decade, the country ran out of cheap labor.  So it was forced to begin to transform its economy from export-oriented, labor-intensive manufacturing to higher value-added more capital-intensive output and toward domestic rather than foreign demand.  The orthodox, and almost always not so successful, method of kicking off this transition is to encourage a large appreciation of the currency.  That causes low-end production to leave for cheaper labor countries like Vietnam or Afghanistan.

China, armed with a cadre of young, creative economists with PhDs from the best universities in the West, decided to do things slightly  differently–to hold the currency relatively stable and to boost domestic wages by a lot to achieve the same end of making export-oriented manufacturing uneconomic.  The idea is that this doesn’t bring the economy to screeching halt in the way currency appreciation does.  So far this approach seems to be working–although the shift does involve slower growth and a lot of domestic disruption.

At the same time, forewarned by the immense damage done to Asian economies by speculative activity by the currency desks of the major international banks during the 1997-98 Asian economic crisis, China elected not to let its currency trade freely.

what’s changed?

For some years, China has been upset about the fact that despite being the biggest global manufacturing power, and by Purchasing Power Parity measure the largest economy on earth, it has virtually no say in world financial or trade regulatory bodies.  Those are dominated by the US and EU.  The main reason for China’s limited influence is that its financial system isn’t open.  (The other, of course, is that fearing China organizations like the new US-led Pacific trade alliance pointed excludes the Middle Kingdom.)

So China has been gradually lessening state control over the banks, the financial markets and the currency, in hopes of being admitted into the inner sanctums of bodies like the IMF.

In one sense, this is why China is becoming less rigid in its control of renminbi trading.

why now?

There’s no “good” time to let a currency float.  China doesn’t want to cede control over currency movements at a time when the renminbi might appreciate a lot, since that would be a severe contractionary force.  On the other hand, it doesn’t want the currency to fall through the floor either, since that would result in new export plants sprouting up all over the place.

China is growing more slowly than normal and is experiencing currency outflows as a result of that.  Letting the currency slide a bit relieves some of the pressure–although it may simultaneously attract speculators to try to push the renminbi lower.  So, yes, it is a sign of economic weakness.  At the same time, the loosening comes shortly before the IMF will decide on admitting the renminbi as one of its reserve currencies.  And it follows by a few months Beijing allowing banks to issue certificates of deposit at market rates, rather than at yields set by central planners.  So it’s also a step toward a healthier, more economically advanced, future.

my take

I think worries about the stability of the Chinese economy are overblown.  I also think that traders are using the Beijing move as an excuse for selling that they’ve been wanting to do anyway.  Beijing may have been the trigger for this, but it isn’t the cause.

 

 

 

 

negotiating: Casio, China and Greece

requesting an investment banking client meeting

Years ago, so long ago in fact that Tokyo was by a wide measure the largest stock market in the world, I received a call from a broker asking whether I wanted to meet with the top management of electronics maker Casio in my office in Manhattan the next day.

I knew the company a bit.  I’d visited it in Japan.  It wasn’t a particularly well-run firm.  And it was an exporter, a weak yen beneficiary, at a time when the yen was soaring and only domestic-oriented companies went up.  So I had little interest.

But I said yes anyway.

The broker was in a bind.  He was supposed to be showing Casio the power of his firm’s client list in New York and some manager had cancelled at the last minute, creating a potential loss of face for both the broker and Casio.  I had only a small pool of money under management and my acceptance would obligate the broker to provide me a return service that my commission volume alone couldn’t buy.

Apparently, the CEO of Casio felt under the same sort of obligation.  The meeting was interesting and informative, although it gave me no reason to want to buy the stock.

negotiations with China

The main topic was the company’s negotiations at that time to increase manufacturing capacity in China.

Casio met with Chinese government officials over several sessions and came to a preliminary agreement.  When the two sides met again, ostensibly to cross the ts and dot the is, the Chinese side reopened the negotiations, demanding substantial new concessions.   What Casio expected to be the end point turned out to be the new starting point for further haggling.  It went along because it figured the costs of starting again elsewhere from scratch were too high.

This happened several more times.

Then a contract signing was scheduled.  At that meeting, the Chinese side accused Casio of complicity in the rape of Nanking and demanded still more concessions as a form of reparation.  Casio did so, even though the last contract changes removed all chance of profit from the new plant.

With some distance, the CEO’s main conclusion from this experience was that the long-term relationship of mutual respect and trust that he hoped to find in China was simply not there.  He’d already decided to cut his losses and do no more expansion in China.

Greece today

I was already quite familiar with this negotiating style, which might be described as death (of the other guy) by a thousand cuts.  I’d seen a former boss to the same thing to Lehman.  In that case, however, Lehman eventually picked up and left in disgust.

In its negotiations with the rest of the EU, Greece has been following the same playbook Casio described to me decades ago, down to the accusation of wartime atrocities.  The main casualty in this approach is the loss of trust between the parties, once the Casio-side party realizes the other has no interest in a solution that brings mutual benefit.

It seems clear to me that we’ve passed that point in the Greece-EU discussions.  We’ll find out over the weekend whether this precludes any agreement from being reached.