Category Archives: Basic Concepts

internal and external economic adjustment

July 12, 2016 By in Balance of Payments, currency effects, currency markets, economics, Uncategorized Tags: , , , , , Leave a comment

This is ultimately about the euro and the EU.  Today’s post is about creating a framework for thinking about this issue.

It’s a condensed version of a longer post I wrote six years ago on Balance of Payments (actually, a series, for anyone who’s interested).   Although a big simplification of what is actually going on in the world, it highlights what I believe is a central structural issue facing the EU and Japan today   …and potentially the US, at some point.

 

imports and exports

The residents of any given country typically don’t consume only items made in that country.  They buy imported goods as well.  In fact, the marginal propensity to consume imports is normally higher than the marginal propensity to consume, meaning that as spending increases imports rise at a faster rate.

paying for imports

The country as a whole gets the money to pay for imports in one of a number of ways:  it can make things to sell to foreigners, it can use accumulated savings, it can sell assets to foreigners or it can borrow.

imbalances

In an ideal world, every country would make and sell exactly enough goods and services through export to pay for the imports it purchases.  That’s seldom the case, however.

chronic deficit

Consider a country that, year after year, buys more from foreigners than it can pay for with the proceeds from what it sells.  To continue consuming foreign goods at the same rate, such a country has to either sell assets, like land or companies, or borrow from foreigners.  At some point, however, it will reach the limits either of what it has that others want to buy or the amount foreigners will lend.

This situation sets the stage for a potential foreign currency/trade/economic growth crisis.

internal/external adjustment

Here’s where we get to internal/external adjustment.

There are two ways of dealing with this issue:

internal

–the government can slow down overall consumption (essentially, create a recession) by raising interest rates/taxes by enough to decrease consumption of foreign goods and services

–domestic industries can voluntarily restructure themselves, with/without government help, to improve quality and lower prices so they make more things foreigners will want (unlikely to happen on a large scale)

–the government can erect tariff or regulatory barriers to imports, to try to redirect consumption to domestic goods (almost always a bad idea:  look at the US auto industry since the mid-Seventies)

None of these actions are likely to win unanimous applause from voters.  And if legislative action produces negative results, it will be completely clear who is to blame.  So politicians everywhere, and particularly in badly-run countries, tend to not to want to choose any one of them.  Instead, they most often opt for the external adjustment route.

external

–This means to encourage or embrace a decline in the local currency versus that of trading partners.  That simultaneously makes foreign goods more expensive for locals and local goods cheaper for foreigners.  Devaluation will encourage exports and inhibit imports, achieving the same end as rising interest rates, but without the sticky legislative fingerprints attached.  It’s those horrible foreign exchange markets instead.

 

More tomorrow.

 

 

 

 

 

 

mutual funds/ETFs in time of stress

July 11, 2016 By in ETFs Vs. Mutual Funds, stock market, Uncategorized Tags: , , , , Leave a comment

As I mentioned last week, since the Brexit vote some property-based mutual funds trading in the UK have had to suspend redemptions while they attempt to raise the needed cash through asset sales.  This raises the question about how US mutual funds and ETFs might fare in a similar time of stress.

We have, of course, the large downturn of 2008-09 as a recent example.  The US survived that period of significant stress with scarcely any issues.  T

he worst experience of my working career, in terms of redemptions was in the aftermath of Black Monday in 1987, when the US stock market lost almost a quarter of its value in one day.  In the load fund I was running at the time, which also had a strong record, I lost about 5% of my assets under management over a few weeks.  Colleagues running no-load funds at other firms lost up to a third of theirs.  Again no very serious issues that would have required suspending redemptions.

The entire US stock market was closed for several days following 9/11.  But that was because US trade-clearing banks had their recordkeeping computers, including backups, all located in or around the World Trade Center; it took them several days to get back on their feet.  The banks have since established backup systems at more remote locations, so that presumably won’t be problem again.

It may be, then, that our potential worry is only about specialized funds that hold highly illiquid assets like property.

One significant source of regulatory worry has been the rapid growth since 2009 of passive products–ETFs and index mutual funds, which don’t have large staffs of portfolio managers and traders used to making lots of transactions.

Experience with ETFs has been, to my mind, surprisingly positive from a redemption point of view.  That’s because the theoretical idea that the brokerage houses that trade ETFs would move their bids to such a low price that all desire to panic-trade would evaporate, has so far worked every well in practice.

The only thing we as investors should note is that during several “flash crashes,”  the brokerage bid price for affected ETFs that I’ve seen has been as much as 15% below net asset value.  That’s a clear warning not to use market orders for these vehicles in bad times–or not to sell them at all.

To my mind, the one unanswered question is how liquid index funds might be in a future crisis.  The worst that happens, I think, is that big indexers do the same thing as the UK property funds and suspend redemptions for a time.  On the other hand, my entire working experience is that it’s institutions, not individuals, who panic during crises.  And these tend to cash in actively-managed products in times of stress, not index funds.  So maybe they’re not a big worry after all.

Something to think about and plan for, though.

redemption halts in UK-based property funds

July 7, 2016 By in Brexit, ETFs Vs. Mutual Funds, Property/housing, the UK, Uncategorized Tags: , , 1 Comment

Over the past week or so, the boards of a number of UK property mutual funds have exercised the ability their charters give them to suspend shareholder redemptions.

What’s this all about?

The central issue is, of course, the “Leave” result of the Brexit vote.  This has two negative consequences for UK property.  The first is that property is a domestic sector, where holders whose base currency is the US$ or the € have felt the full brunt of the subsequent fall in sterling against those currencies.  The second is that although suddenly 12% cheaper to foreigners, it’s questionable whether offices or other commercial properties will retain their allure once the UK is on the outside of the EU.  Also, the central bank is predicting the vote will cause a mild recession, always a bad thing for property.  So bargain hunters haven’t yet appeared as buyers.

On balance,  a lot of people want to cash their shares in.

The second problem is endemic to property.  It’s not a particularly liquid sector.  Not only would you get a horrible price in a forced quick sale, it’s probably impossible to get the paperwork processed and a check in hand inside, say, a month.  Property funds–in fact, all mutual funds–try to safeguard against being overwhelmed by redemptions by keeping a percentage of assets (maybe 2% or 3%) in cash.  Funds also have credit lines they can draw against if need be.  But for property funds if holders of 10% of the outstanding shares all want to redeem at once that won’t be enough.

Initial redemptions can also create a self-reinforcing cycle.  Shareholders who initially had no intention to redeem may join the queue simply because they fear continuing withdrawal pressure will depress net asset value further.

The result is that the funds in question have been unable to meet the redemptions they’re experiencing.  They’ve been forced to suspend redemptions while they raise cash in a orderly way.

I don’t think the redemption window will be opening any time soon, although I’d imagine enterprising brokers have already set up a market to transact in these suspended shares, at a substantial discount to NAV, no doubt.

 

Lessons for the US?  More tomorrow.

 

SolarCity (SCTY)

June 23, 2016 By in mergers and acquisitions, Uncategorized Tags: Leave a comment

SCTY

I’ve been surprised by the poor quality of the press coverage of the acquisition of SCTY proposed by Tesla (TSLA), the lead dog in the Elon Musk empire, of which SCTY is also a member.

Two points:

–it shouldn’t come as a shock, as it apparently has to some writers, that Elon Musk controls both firms.  This dual ownership presents potential conflicts of interest, although the existence of a separate quote for SCTY allows that firm to link stock-based compensation of the employees of SCTY directly with the performance of SCTY shares, rather than those of a bigger entity.  That’s not necessarily bad.  (Years ago, when Fox went public, the fact that Fox executives held options on the parent, News Corp, and not Fox, told me where the advantage would lie in parent/subsidiary negotiations.)

TSLA/SCTY’s is a common relationship, especially outside the US, with plusses and minuses that are well-documented and well-known, with, apparently, the exception of US financial writers.

–equally common is the behavior of stocks involved in an all-stock acquisition.  Most often, there’s downward pressure on both stocks as a result of the arbitrage I talked about in yesterday’s post.  Wouldn’t know that from the financial press, though.

 

I don’t have a strong opinion about whether the combination will be good or bad.  But at least I know what the issues are.  The sad state of reporting on TSLA/SCTY shows how far the financial press has been hollowed out.

 

Tesla (TSLA) is bidding for SolarCity (SCTY)

June 22, 2016 By in Autos, mergers and acquisitions, Uncategorized Tags: , , , , , , , , Leave a comment

The offer is an all-stock deal, with TSLA willing to exchange 0.122 – 0.131 of its shares for each outstanding share of SCTY.  The exact figure will depend on a closer examination of SCTY’s books.  The proposal was announced after yesterday’s close.

My thoughts:

–in today’s pre-market trading, SCTY shares are up by about 14% and TSLA’s stock is down by around 12%.  This has little to do with the merits of the deal.  It’s all about arbitrage.  To the degree the market regards the acquisition as a done deal, it ceases to look at SCTY as an independent entity.  SCTY becomes instead equivalent to a deferred issue of TSLA stock.  Because the bid is at a premium to the pre-offer price of SCTY, SCTY is a relatively cheap way to own TSLA.  So arbitrageurs sell short the “expensive” form of Tesla, i.e. TSLA, and use the money they receive to buy the “cheap” form of Tesla, i.e., SCTY.  So SCTY goes up and TSLA goes down.

–my guess is that there’s no other bidder.  Elon Musk, who owns 20%- of TSLA also owns 20%+ of SCTY.  As is often the case with family-owned empires, one firm ( TSLA) is the heart of the enterprise.  Other companies are arrayed as satellites around the central hub.  Those tend to be more highly specialized, sometimes riskier–and invariably dependent on the main core for essential goods/services.  In this case, the Gigafactory being built by TSLA is going to the be the source of the batteries that SCTY will be distributing to customers.  Who else needs one of these?

–price is the main motive, I think.  SCTY is less than a tenth of the market cap of TSLA, so acquisition won’t make a radical difference in the latter’s fundamentals.  In most cases I’ve seen, the hub-satellite relation persists for decades, with third-party shareholders content with their stepchild status as an adequate tradeoff for the satellite’s narrower focus and faster earnings growth in specific circumstances.

–arguably, this is a good chance for adventurous to buy TSLA shares toward the lower end of its recent trading range.  I’m going to sit on my hands for a while, though, to try to gauge how severe selling pressure on TSLA may turn out to be.