Category Archives: EU financial crisis

the shrinking euro (and yen)

January 5, 2015 By in currency effects, EU financial crisis, Strategy Tags: , , , , , , , , , Leave a comment

the shrinking euro

This time a year ago, it cost $1.36 to buy a euro.  It was $1.39 by March.   The euro then moved sideways vs. the greenback until early summer–when it began an almost continual descent that has the EU currency now trading at just above $1.19.  That figure is down 14% from the 2014 high, and off 12.5% from the year-ago level.

reasons?  

The surprising revelation last summer that the overall EU economy was slowing, not accelerating as most observers, myself included, had expected is the most important, I think.  Sanctions against Russia and recent worries that a new Greek government might repudiate its sovereign debt have just added to the funk.

The Japanese yen has tracked more or less the same course vs. the dollar as the euro–meaning that neither Japan nor the EU has gained/lost competitiveness vs. its main global manufacturing rival.

Looking at the situation from a more conceptual level, both Japan and the EU have relatively old populations and both give much higher priority to preserving their traditional social order than to achieving economic progress.  Neither characteristic argues for long-term economic/currency strength.

consequences

economic

In the short run, currency declines stimulate overall economic activity.  They also rearrange growth to favor exporters, import-competing industries and service industries like tourism.  This means that local currency profits for firms that have their costs in euros and revenues in harder currencies will likely be higher than generally anticipated.

The huge fall in oil prices will still be stimulative, but the edge will be taken off the benefit a bit by the currency decline.

Euro-oriented holders of dollar-denominated assets benefit; dollar-oriented holders of euro assets are hurt.

financial markets

I expect European bond managers will continue to boost their holdings of US Treasuries, figuring they’ll get both yield pickup and an anticipated currency gain.  This flow will keep long-term interest rates in the US a bit lower than they would be otherwise.

Equity managers will shift European holdings more toward multinational firms with dollar-denominated assets and earnings.  Some of this has happened already.  Many times, though, PMs will wait until they see the weak currency stabilize before reallocating.  Personally, I don’t think waiting makes any sense, but that’s what people seem to do.

US firms with European assets and earnings will face the double negative of slow growth in the EU and the diminished value of EU profits in dollars.   I think US-based manufacturers of consumer staples are particularly at risk.

hedging

While the extent of the decline of the euro may be a surprise, the fact that it’s a weak currency shouldn’t be.  This means many US companies that have euro exposure will have hedged away part of this risk.

I have conflicting thoughts on this issue.  Almost universally, investors ignore profits gained by hedging.  The idea, which I agree with, is that in short order the favorable hedges will run out, exposing the weaker unerlying profit stream.  There’s no sense in paying for profits that will be gone in a quarter or two.  On the other hand, while firms always reveal hedges that have gone wrong (and argue that investors should ignore these losses), they don’t always highlight hedging that has worked.  I guess I’m saying that I’d be leery of companies with EU exposure even if reported profits don’t show any unfavorable impact.

 

 

 

Shaping a portfolio for 2015 (vi): the rest of the world

December 11, 2014 By in Asian economic development, bond market, China, emerging markets, EU financial crisis, frontier markets, Hong Kong, Japanese development, Portfolio management, Shaping a portfolio for 2015, stock market Tags: , , , , , , Leave a comment

world GDP

A recent World Bank study ranks the largest countries in the world by 2013 GDP.  The biggest are:

1.   USA         $16.8 trillion

2.  China         $9.2 trillion

3.  Japan          $4.9 trillion

4.  Germany          $3.6 trillion.

The EU countries taken together are about equal in size to the US.

stock markets

From a stock market investor’s point of view, we can divide the world outside the US into four parts:  Europe, greater China, Japan and emerging markets.

Japan

In the 1990s, Japan choked off incipient economic recovery twice by tightening economic policy too soon–once by raising interest rates, once by increasing its tax on consumer goods.  It appears to have done the same thing again this year when it upped consumption tax in April.

More important, Tokyo appears to me to have made no substantive progress on eliminating structural industrial and bureaucratic impediments to growth.  As a result, and unfortunately for citizens of Japan, the current decade can easily turn out to be the third consecutive ten-year period of economic stagnation.

In US$ terms, Japan’s 2014 GDP will have shrunk considerably, due to yen depreciation.

If Abenomics is somehow ultimately successful, a surge in Japanese growth might be a pleasant surprise next year.  Realistically, though, Japan is now so small a factor in world terms that, absent a catastrophe, it no longer affects world economic prospects very much.

China

In the post-WWII era, successful emerging economies have by and large followed the Japanese model of keeping labor cheap and encouraging export-oriented manufacturing.  Eventually, however, everyone reaches a point where this formula no longer works.  How so?    …some combination of running out of workers, unacceptable levels of environmental damage or pressure from trading partners.  The growth path then becomes shifting to higher value-added manufacturing and a reorientation toward the domestic economy.  This is where China is now.

Historically, this transition is extremely difficult.  Resistance from those who have made fortunes the old way is invariably extremely high.  I read the current “anti-corruption” campaign as Beijing acting to remove this opposition.

I find the Chinese political situation very opaque.  Nevertheless, a few things stand out.  To my mind, China is not likely to go back to being the mammoth consumer of natural resources it was through most of the last decade.  My guess is that GDP growth in 2015 will come in at about the same +7%or so China will achieve this year.  In other words, China won’t provide either positive or negative surprises.

For most foreigners, the main way of getting exposure to the Chinese economy is through Hong Kong.  Personally, I own China Merchants and several of the Macau casinos.  The latter group looks very cheap to me but will likely only begin to perform when the Hong Kong market is convinced the anti-corruption campaign is nearing an end.

EU

In many ways, the EU resembles the Japan of, say, 20 years ago.  It, too, has an aging population, low growth and significant structural rigidity.  The major Continental countries also have, like Japan, strong cultural resistance to change.  These are long-term issues well-known to most investors.

For 2015, the EU stands to benefit economically from a 10% depreciation of the euro vs. the US$.  As well, it is a major beneficiary of the decline in crude oil prices.  My guess is that growth will be surprisingly good for the EU next year.  I think the main focus for equity investors should be EU multinationals with large exposure to the US.

emerging markets

I’m content to invest in China through Hong Kong.  I worry about other emerging Asian markets, as well as Latin America (ex Mexico) and Africa.  Foreigners from the developed world provide most of the liquidity in this “other” class.  If an improving economy in the US and higher yields on US fixed income cause a shift in investor preferences, foreigners will likely try to extract funds from many emerging market in order to reposition them.  That will probably prove surprisingly difficult.  Prices will have a very hard time not falling in such a situation.

 

Pandora (CPH: PNDORA) and the dollar

November 12, 2014 By in currency effects, Current Market Thoughts, EU financial crisis, Stock ideas, stock market, Strategy Tags: , , , , , , , , Leave a comment

This is one case where it’s easier to write the name than the symbol, which includes its principal trading market, Copenhagen.

Pandora is the jewelry company that burst on the scene early in the decade with an innovative line of charm bracelets.  It IPOed to much fanfare in Copenhagen in 20111   …and almost immediately collapsed as its product began to be knocked off by established jewelry chains.

The company has since rebuilt itself.  The stock is now about 10x the price at its nadir almost exactly three years ago.  I’m still learnings the story–and this is not a stock I feel comfortable enough with to recommend that anyone else buy it.  But the turnaround seems to have been accomplished with better management, stronger control of inventories and the introduction of a line of rings, which are harder to knock off.

There are more pluses to the story, like development of the company’s own retail channel and increasing e-commerce presence, which is boosting purchases by men.  But the knockoff issue still exists:  here in the US, for example, Signet Jewelers’ Jared sells Pandora; its lower-end but much larger sibling, Kay, sells its own knockoff line.

 

Two ideas attracted me to Pandora a few months ago:  the rings, and the possibility that continuing economic weakness in the EU would force people to trade down further–meaning that a company like Pandora might increasingly be in the sweet spot for jewelry.  My main worry is that I’m very late to the party, as the stock chart illustrates.

 

The main reason I’m writing about Pandora, though, is not to highlight the company but to point out a fact about the dollar.  In Danish kroner, I’m up by 11% since buying the stock in August.  In US$, however, I’m up a tad less 3%.  Yes, I’ve wildly outperformed European stock indices but I’ve given almost all of it back in losses on the currency.

My point:  that’s what’s been happening to every US company that has a presence in Europe (or in Japan, for that matter) since May.  Of course, not all of them have sales that are way above average for Europe, so they generally have US$ losses on operations.  On the other hand, the biggest of them will have hedging operations that temper the near-term effects of currency fluctuations.

Given that about a quarter of the earnings of the S&P 500 come from Europe, it seems to me that the combination of weak economic performance there plus weak currencies represents the biggest threat to earnings growth facing the S&P 500 today.

I don’t think this issue is a reason to sell US stocks across the board.  It’s more a reason to reposition away from firms with European exposure.  Upcoming earnings reports from companies like Tiffany will give us more information.

Conversely, European currency weakness is setting up another opportunity to buy Europe-based multinationals with significant dollar exposure, just as we had several years ago.  Typically, the negative effects of currency depreciation are factored into stock prices first, and the positive effect on earnings only with a lag.

 

PS.  On December 3, 2014, in kroner I’m up about 22%, in US$ about 12%.

 

oil? ebola? the dollar?–why stock prices have been falling

October 14, 2014 By in Consumer Staples, Current Market Thoughts, economics, emerging markets, Energy, EU financial crisis, Industry Analysis, Mining, oil and natural gas, Securities regulation, shale oil and gas Tags: , , , , , , , , , 4 Comments

In many ways, stock market commentators have an unenviable task.  At any given moment they have to come up with new and interesting reasons why stocks are rising or falling.   The media gurus’ difficulties are compounded by the fact that most are story presenters who have little understanding of investing and are therefore reliant on sources whose statements are many times influenced by their own private agendas.

After peaking in mid-September, US stocks have fallen by about 7% through yesterday/  This has erased most of their year-to-date price gains, although with dividends factored in the S&P is still up about 4% since New Year’s Day.

Among the current “explanations’ for the fall are:

–a falling oil price.  I don’t think this makes sense.  It would be one thing if world GDP were turning negative and demand were sagging as a result.  The current issue, however, is oversupply, being caused by the rise of shale oil/gas production in the US.

Yes, 10% of the S&P 500 consists of oil-related stocks, many of which are hurt by lower prices.  But, to simplify a bit, the other 90% of the index is a beneficiary.  Lower prices are bad for oil-producing nations in the Middle East, for Russia and for the rest of OPEC.  But they’re great for consumers.

Another point:  today’s production contracts with national oil companies provide that virtually all revenue from oil price increases above a certain level goes to the host country, not to the international oil firm that is developing the petroleum deposits.  Although this has been true for decades, my sense is that many investors still don’t get this.  The dynamic is much more consumers gain/emerging countries lose than the consensus thinks.

–ebola.  More about this tomorrow.  Ebola is scary.  The only model we have for what happens to stocks once investors become aware of pandemic possibilities is SARS.  On the other hand, Doctors Without Borders has been handling ebola patients for many years without a single infection of their own.  In my view, stocks would be way lower than they are today if investors viewed ebola a real threat.

–the dollar.  This is an issue, although almost no one is talking about it. The US dollar has risen against the euro by almost 10% since early May.  In back-of-the-envelope terms, 25% of the earnings of the S&P 500 is sourced in euro.  A 10% fall in the dollar value of the euro means that overall S&P earnings–without factoring in current Euroland economic weakness–will be 2.5% lower than previously thought.  Discounting this outcome would explain about half the recent market decline.

my take:

–technicals.  At the peak a few weeks ago, stocks had already discounted all the S&P earnings growth that’s likely for 2014.  In addition, the market had already also factored into prices, let’s say, a third of the expected earnings growth for the index next year. This is normal market behavior, granted, though, that we haven’t seen “normal” for the better part of a decade.

By September, potential short-term buyers couldn’t justify paying higher prices for stocks.  In addition, euro weakness + a lot of other miscellaneous stuff had put 2015 profits under threat.

We’re now in the process of determining how low prices have to go to bring buyers back.

Looking at past levels where lots of buying and selling has taken place ends up being a surprisingly effective tool for figuring out where buying will emerge again.  Don’t ask me why.  If this rule of thumb holds true, as I read the charts the key levels are 1840-80 (i.e., where we are as I’m writing this) and 1800.

Scotland votes to stay in UK

September 19, 2014 By in economics, EU financial crisis, Scotland independence referendum Tags: , , , , , Leave a comment

Early this morning New Y0rk time the results of the Scottish independence referendum were announced.  The main features:

1.  “No,” meaning stay in the UK, votes made up 55% of the total; “Yes” votes were 45%.  

Yeses were much weaker than late polls had predicted.  Part of this is the nature of polling.  Part is also that sixteen-year-olds have the vote in Scotland and political pollsters have a difficult time getting accurate teen opinions.  I think the greatest part, though, is that No voters felt their views would be frowned on and were reluctant to share them.

2.  Almost 85% of eligible voters cast a ballot.  This is an immense number and indicates that citizens regarded the vote as crucially important.

3.  The result averts potentially destabilizing ripple effects throughout the EU.  Had Yes carried the day, separatists in, for example, Spain or Italy would have had a concrete example of success to spur on their own efforts.

4.  Scotland will become more autonomous.  This is partly the result of promises the UK made to tip the voting toward No, partly pragmatic politics to ensure an independence vote won’t recur.  Presumably similar, though likely smaller, efforts to assuage unhappy regions will take place elsewhere in the EU.

 

The response of stock markets has been positive, but small.  This is understandable, since the near-term effect of a No vote is preservation of the status quo.  Interestingly, though, the recent decline in sterling, which had been attributed to Scottish independence fears, hasn’t reversed itself–implying that other factors are behind the weakness.