Category Archives: Brexit

Brexit, sterling and InterContinental Hotels Group (LN:IHG)

August 3, 2016 By in Brexit, currency effects, Lodging, Uncategorized Tags: , , , , , , , 1 Comment

Early indicators after the UK vote to “Leave” the EU are already showing the country is dipping into recession.  Nevertheless, large-cap stocks in the UK have held up surprisingly well.

This can clearly be seen in the results just announced yesterday by IHG.  The fear of markets before Brexit about hotels had been that the post-recession cyclical upsurge in vacationing had just about run its course–and that, as a result, hotel profits were just about to peak/had already peaked.  But the figures from IHG were good and the stock rose by about 3% on the news.

To see how this can be, it’s important to note    that the post-Brexit decline in the fortunes of the UK has been expressed almost entirely in a 10%+ decline in the British currency.  This is an unexpected boon for British-based multinationals.

As Richard Solomons, the CEO of IHG, put it in yesterday’s report to shareholders:

“Note that whilst the UK comprises around 5% of our group revenues,

approximately 50% of our gross central overhead and

40% of Europe regional overhead are in sterling.

At 30 June 2016 exchange rates, approximately 70% of our debt is denominated in sterling.”

All of these figures are now 10% less in purchasing power terms than they were pre-Brexit.  Without any price changes, revenues will be 0.5% lower in dollar terms than they would have been.  But overheads will be down by much more.  In addition, the dollar value of the company’s debt is sliced by about $128 million.

This situation has two positive effects in the minds of UK investors:

–profits will likely be higher than anticipated, making the stock more attractive, and

–to the extent that a company like IHG, which has the lion’s share of revenues outside the UK, is affected by Brexit, the influence is likely to be positive.  This means that it can act as a way for British residents to preserve the purchasing power of their savings.

 

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.

 

Brexit, sterling and the case for London stocks

July 6, 2016 By in Brexit, the UK, Uncategorized Tags: , , , , , Leave a comment

the UK stock market

I started to learn about the UK stock market in 1986, a scarily long time ago, when I took over management of a failing global fund.  I realized pretty quickly, though, that despite similarity with the US in language and accounting standards, London stocks trade on complex signals that are far different in kind from those I was familiar with in New York.  I ultimately decided that the large effort required to become proficient would pay too small a reward to justify making it.  So I remain more or less an innocent (read:  the dumb money) in that market to this day.

12% cheaper

Nevertheless, the large drop (about 12%) in the value of the pound against the dollar suggests to me that there will ultimately be a big post-Leave-vote equity investing opportunity in the UK.  If the government follows through on its plans to cut the corporate tax rate from the current 20% to 15% (something the EU would have opposed) and lowers interest rates as well, the potential would be substantially larger.

Two reasons:

Mexico

–Weak currencies most often mean strong stock markets.  The most striking example I can think of is Mexico in the 1980s.  Over that period, the peso lost 98% of its value against the US$.  Still, Mexican stocks were, in US$ terms, just about the best-performing in the world–outdoing the US stock market by a mile.

Three causes:  supportive economic policies by the Mexican government; currency decline gave Mexican exporters a powerful price advantage; and the currency collapse created substantial inflation, which prompted local investors to strongly prefer equities as a way of preserving the real value of their savings.

Yes, Mexico is an extreme, but stocks in the UK are now 12% cheaper in US dollars than they were a couple of weeks ago.  And the government appears to be preparing to implement significant economic stimulus.  So earnings prospects for many firms are substantially better.

currency markets lead the way

–currency fall typically comes in advance of stock market rise.  The lag may be months.  This is partly because the currency markets always seem to act far ahead of stocks and bonds.  It’s also because equity investors, particularly in Europe, want to see some evidence of earnings improvement–either actual results or management confirmation that the numbers are looking surprisingly good–before they are willing to act.

timing

The big question, I think, is not whether London stocks, especially multinationals or exporters, will do well.  It’s when the fallout from the Brexit vote will have fully played itself out in financial markets.  Given that European investors typically take the month of August off, and that the start of this annual vacation period is only a few weeks away, my guess is that this won’t be until close to Labor Day.

our neighbor’s house, banks and Grexit

June 29, 2016 By in Brexit, Uncategorized Tags: , , , Leave a comment

This post could also be titled, “Why bank stocks have never been my favorites.”

a mortgage loan story

There’s a house down the street from us that has been empty for the past seven or eight years.  It’s worth maybe $150,000.  The former owner stopped making mortgage and property tax payments in 2008(?), mailed the keys back to the bank that gave him the loan and left for another part of the country.

The local sheriff has seized the house for non-payment of taxes, which total maybe $20,000, and has tried to auction it off a number of times.  The minimum bid, which no one has offered, is the taxes owed.

Why no bidders?

The bank still has a lien on the house for the $300,000 mortgage it granted almost a decade ago when all the loan craziness was going on.

why I don’t like bank stocks

The bank is apparently still unwilling to recognize the loss it made on this loan.  I presume this is because if its books were scrubbed of all the similar dud loans it is carrying, the bank’s financials would look pretty awful.  So it pretends the loans are still good.  To some degree, but not totally, investors can see through the pretense and the bank’s stock (I don’t know which bank) probably trades at a discount to book value.  But the reality is hard to see from the outside.   This is why bank stocks make me uncomfortable.

from Brexit to Grexit

What does this have to do with Grexit?

Bank stocks throughout the EU plunged when the “Leave” side won in the Brexit vote.  That has very little to do with the UK, in my opinion.  But if Britain can leave the EU, so too, can Greece, whose economy has been moribund for close to a decade.  Leaving would allow Greece to devalue its currency and thereby give its economy at least a temporary boost.  That would only work if the country defaulted on its sovereign debt at the same time.  So default is a probable consequence of Grexit.  That would be very damaging to the EU banks whose vaults are stuffed with Athens-issued bonds.

 

Brexit, Grexit and Lehman

June 28, 2016 By in Brexit, Uncategorized Tags: , , Leave a comment

Just about two weeks ago, Finnish finance minister Alexander Stubb called a British vote to exit the EU Europe’s “Lehman moment,” meaning it would signal the onset of an economic catastrophe similar to the one that shook the world when we found out that the US investment bank Lehman Brothers was bankrupt in 2008.

How apt is the comparison?

…not much at all.  In fact, I think it’s kind of crazy.

Lehman

US and EU banks spent the middle of the last decade creating increasingly exotic and risky derivatives based on packages of home mortgage loans.  When there were no mortgages left to grant that might have any prayer of being repaid, the banks manufactured even more preposterous securities based on mortgages that far exceeded the mortgagees ability to repay, and where the amount lent exceeded the value of the property by a lot.  When the music stopped in 2008, institutions like Bear Stearns or Lehman, whose audited financials showed them with billions of dollars in shareholders’ funds, were filled instead with worthless mortgage-backed securities and were actually bankrupt.

That wasn’t the bad part.

Commerce around the world is based on trust and on the financial soundness of banks.  Firms normally send goods to customers in advance of being paid.   They get a bank IOU on shipment, which they can cash in either on delivery or shortly after.  When companies realized that the middleman bank could possibly declare bankruptcy while goods were still in transit and they were holding trade IOUs–meaning they would be unsecured creditors in a bankruptcy proceeding, to be paid at best a small fraction of the IOU amount, and even that a long time in the future–they stopped sending any merchandise   …to anyone.  World trade came to a standstill.

Just as bad, enterprise control software systems showed managements right away how large the losses were that they were incurring by not being able to sell anything.  They responded with mass layoffs of employees.  That made the economic situation even worse.

In comparison, Brexit is a walk in the park.

Grexit

Of course, the rhetoric of Stubb and other pro-Remain politicians is one of the reasons for the panic that has seized financial markets once the “Leave” result was returned.

The only possible point of comparison I can see is that Brexit could lead to Grexit, Greece exiting the EU.  So far, the austerity regimen imposed by the IMF and the European Central Bank on Greece, when that country confessed to have falsified its national accounts for many years and to be unable to service its government debts, has created nothing but misery for Greece.  Leaving the EU and devaluing its currency would be an alternate solution to Greece’s financial woes.  Were it to do so, however, Greece would likely default on its sovereign debt.  That would hurt the EU banks who still hold large swathes of it.