Category Archives: emerging markets

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.

recalling Tiananmen Square

October 3, 2014 By in Asian economic development, China, emerging markets, Hong Kong, Tiananmen Square Tags: , , , , , , , 1 Comment

I was fast asleep at home in the US in early June 1989 when a Hong Kong broker woke me up to tell me troops had opened fire on the crowds that had been occupying Tiananmen Square in Beijing.  That should let you know that I observed what was going on fback then from afar–as well as through the lens of a stock market investor.

Although I think there’s always the possibility of a mistaken escalation of the student demonstrations now under way in Hong Kong into Tiananmen-like violence, I see a number of important differences between the two situations.  Among them:

–Tiananmen Square took place in the heart of China’s capital, not in a politically marginal SAR

–1989 was a time of considerable political/economic unrest in China, with the economy unable to create jobs and, in consequence, hundreds of thousands of unemployed workers roaming around the countryside looking for work.  This was very scary for Communist Party leaders.

–during the months it took the Tiananmen situation to come to a head, many of the students who had originally occupied the square left, and were replaced by older unemployed workers, whose motives were less political and more economic.

–local units of the Peoples Liberation Army (PLA) were ordered to use violence on demonstrators to remove them from the square.  They refused–and were replaced by units from distant areas that had few cultural and ethnic ties with the demonstrators

–the careers of the soldiers–especially the commanders–who obeyed the orders to fire on the crowd were ruined

–world outrage at Tiananmen resulted in significant diplomatic and economic sanctions against China.  Private companies reallocated their capital away from China; highly skilled foreign workers, a key source of potential technology transfer, rethought their plans as well.

 

In sum:  I think media suggestions that the current student pro-democracy demonstrations in Hong Kong are the new Tiananmen are way off base.

I can see potential worries, though.  Clearly, Tiananmen taught the authorities not to use violence against demonstrators.  However, teenage student leaders may genuinely not realize where they live–that, just as there’s no crying in baseball, there’s no democracy in China.  It may also be that opponents of the current administration in Beijing would regard a political incident in Hong Kong as a way of derailing its anti-corruption campaign.  So there is a non-zero chance of a tragic accident.

What I’m doing:  I’ve found myself buying odds and ends on the Hong Kong stock market over the past few days, since the Hang Seng is down almost 10% from its pre-demonstration high.  I may nibble a bit more.  Ultimately, though, while I believe the current situation is very un-Tiananmen-like, I’m not going to bet the farm on my (limited) ability to analyze political events.  So I’m going to make up a shopping list, but wait for clear signs that the situation is being defused before doing much more.

 

 

Chinese economic growth: the big picture

September 23, 2014 By in Asian economic development, China, economics, emerging markets Tags: , , , Leave a comment

the problem Deng faced

In the late 1970s, Beijing came to realize that central planning would no longer work (assuming it ever did).  The economy had become too big and too complex.  So China had to adopt at least some Western free market principles.

The country had two main, related, economic objectives:

–to expand quickly enough to maintain employment and absorb the large numbers of young people looking for a job for the first time, and

–to reduce the importance/power of highly inefficient money-losing state-owned enterprises, which during the early Deng days represented over three-quarters of the country’s GDP.

China had to accomplish these goals without a modern central bank able to temper economic cycles, and without a lot of control over the day-to-day actions of the regional governments being ordered to create economic growth.

 

The result was an overall Chinese economy that grew very rapidly, using the time-honored developing country strategy of favoring export-oriented manufacturing.  Because Beijing lacked better controls, the economy tended to lurch between periods of speculative excess and of near-recession.

The SOEs were never supposed to fail–that would have created the kind of high unemployment that led to Tiananmen Square.  Rather, they were either to modernize or slowly fade away and be replaced by private enterprise.  Foreign investors quickly realized that the SOEs were an excellent economic policy timing tool.  When the SOEs were prospering, policy tightening by Beijing could not be far behind.  When they were approaching death’s door, Beijing would ride to the rescue.

what’s changed

Not any more, however.

China has reached the point where additional low-wage, sub-scale, highly polluting export-oriented materials or manufacturing operations provide absolutely no economic or political benefit.  So Beijing is not going to provide stimulus that would rescue some of the existing capacity and spawn more.  Waiting for stimulus to happen is a mistake.  Equating no stimulus with economic doom is one as well.

I find it encouraging not only that Beijing is trying to transition toward becoming a domestic demand-oriented economy, but also that it appears to feel comfortable that it can do so without negative political repercussions.  Yes, growth may be slower, but it will be more solidly based.

The investment conclusion I come to is to look for mid-sized domestic-oriented Chinese companies whose stocks have been punished during the current period of global investor disenchantment.

 

the June Fed meeting and “normal” interest rates

June 19, 2014 By in Constructing a Portfolio, Current Market Thoughts, economics, emerging markets, Stock ideas, Strategy Tags: , , , , , , , , Leave a comment

The other day, I wrote that the SEC is considering allowing mutual fund companies to place (presumably, large) exit fees on corporate bond funds, in hopes of stemming redemptions when interest rates begin to rise.

the Fed’s plans

This raises anew the issue of when the Fed will start to move the price of overnight money above the current zero, how fast will it move, and what level of rates it perceives its endpoint will be.

Wall Street perception…

What makes this important is that financial markets have come full circle over the past half-decade.  Initially, they didn’t understand the severity of the economic damage that occurred in 2008-09 and lambasted the Fed for lowering rates in a way they asserted would quickly lead to runaway inflation.  Hard to believe   …but that’s what pundits, especially hedge fund managers, were bellowing back then.

…has turned 180º

Today, however, the markets are clearly, though more quietly, expressing their disbelief in the economic and interest rate projections that the Fed had been publishing before yesterday.

before yesterday’s announcements

Before the just-completed Fed meeting and announcements, the agency’s official stance was that the normal or neutral rate for Fed Funds was 4.0%.  It also had been saying it thought the central tendency for US annual growth in real GDP to be close to 2.5%.  And it expected trend inflation to be 2%.  Add another 100bp in yield to overnight money to get the 10-year yield, and that comes in at 5%, or about double the current level.

Why the skepticism?  The main reason is that so far the US has struggled to produce a strong economic pulse, even after five years in intensive care.  Part of this is the extent of the damage done in the financial meltdown, but part is also demographics and past is that there’s little chance that Washington will make things any easier.  So, Wall Street argues, there’s no reason for interest rates to be so high.

There’s more.  Bond yields in the EU are much lower, for comparable quality, than in the US, because of the miserable shape Europe is in.  No relief in sight, as well.   As a result, European investors will find “high” US yields attractive.  This buying should temper the domestic urge to have yields rise.

In addition, China continues to generate trade surpluses with the rest of the world.  Those funds ultimately find their way into US or EU bond markets, keeping yields lower than they otherwise would be.

…and after

The Fed issues new projections yesterday.  The changes that caught my eye are:

–neutral Fed Funds rate at 3.75%, and

–trend growth in the US closer to 2.0% than 2.5%.

The Fed is edging closer to the view being expressed by the markets.  One exception:  the Fed is now signalling that the initial move up in the Fed Funds rate next year could be a bit more rapid than it had previously been planning.

significance?

Historically, the Fed’s post-emergency moves to raise rates back to normal have been bad for bonds and neutral for stocks (yes, higher rates are a negative for stocks, ass well as bonds, but rising corporate profits act as an offset).  The biggest worry about the current situation is that the required rate rise may be much larger than normal.  I suspect this may not be the Fed’s final ratcheting down of the size of its projected upward rate move.  If so, I think we can be more confident that past experience is applicable.

A lower trend growth rate for the US economy implies that growth will be harder to come by.  If so, companies that can grow their earnings quickly should acquire a scarcity premium; their stocks may well trade at higher than normal multiples.  I see strong growth coming in four areas:

–emerging markets

–companies with unique products/services

–firms serving needs of Millennials, and

–firms in mature fields building market share through acquisition.

 

 

 

The financial crisis and the renminbi

June 16, 2014 By in Asian economic development, China, economics, emerging markets, reserve currency, securities markets, Stock ideas Tags: , , , , , , , , Leave a comment

As I apparently never tire of writing, the financial crisis that came to a head five years ago has resulted in an extended period of emergency ultra-low interest rates.  The tried-and-true idea behind this is to give economic activity a boost by making loans carrying negative real interest rates readily available.  “Free” money should make anyone with a pulse willing to borrow and spend.

In the past, these low-interest periods engineered by the Fed lasted at most a year.  We’re now into year six of the current episode.

One result of this extremely long emergency period is that fixed income investors are currently lapping up low-coupon Italian, Greek…even Iraqi..sovereign debt.  And crazy (in my view) fixed income products like contingent convertibles, no-covenant junk bonds and pik (payment in kind) junk bonds, where interest is paid in new bonds, not cash, are all finding eager buyers, as well.

Another is that savers living on interest payments (increasingly Baby Boomers), who are in effect subsidizing the financial rescue, are suffering.  In fact, Millennials have just surpassed Boomers as the most important single demographic force in the US economy.

All of this is well-known.

Another development, though, which may turn out to be the most important in the long run, has escaped notice so far.  It’s the increasing acceptance of the Chinese renminbi in world trade and in investment.

Fifteen, or even ten, years ago, China was content with the fact that all of its trade was effectively done in dollars.  Beijing let Treasury bonds pile up in its coffers, to the point where it rivaled–and the surpassed–Japan as the largest creditor of the US.  It had become uneasy about this situation even before the financial crisis.  Stunned by the meltdown of 2008-09, China decided to offer its currency as a substitute for the dollar.

Until the past year or so, the renminbi has drawn pretty close to zero interest.   This is partly because at first it wasn’t easy for either foreigners or Chinese parties to use the renminbi in trade.  Also, foreigners can’t spend “offshore” renminbi in China itself.

Yes, the renminbi is easier to use today.  But I think a big reason the renminbi is suddenly extremely popular now is the very low-interest rate environment we’re in.  Multinationals with Chinese operations can save 3% – 5% by settling Chinese trade transactions in renminbi.  In other circumstances, this might not be worth the hassle.  But if your cash balances are earning effectively zero and if you have to buy a pik bond or Iraqi debt to get a 5%+ yield, then switching from dollar to renminbi trade settlement is a relative bonanza.

This movement seems to be feeding on itself.  It’s causing very rapid growth in renminbi use, admittedly from a low base.  I don’t think this development has any important immediate investment consequences.  But it could end up making a profound (negative) impact on the dollar and the euro if it continues–as I expect it will.  The ultimate result would be to make renminbi earners much more attractive as investments than they currently are.

The big investment question is when the inflection point will come, when the renminbi will begin to be regarded as a viable alternative to the dollar as the world’s reserve currency.  Perception will likely precede reality by a long stretch   …although I don’t think the tipping point will come this year or next.  I view this as something important to keep in mind, however, so we can recognize what’s happening if this trend develops faster than I now think it will.