Category Archives: Industry Analysis

the trouble(s) with the luxury goods industry

September 14, 2016 By in Luxury goods, Retail, Uncategorized Tags: , , , , , 5 Comments

For most of the past quarter-century, the publicly traded luxury goods industry, both companies based in the EU and in the US, has been a source of almost continual outperformance.

the old pattern

Its appeal rested (and I do mean the past tense) on two major trends:

–the gradual aging of the working population in the US and EU.  A twenty- or thirty-something in either area typically aspires to own a work wardrobe, a car and a house.  A forty- or fifty-something, in contrast, wants to own jewelry and a vacation house, and to go on a cruise.

So the rising affluence of older workers in the US and Europe has meant increasing demand for luxury goods.

–growth in Japan and the development of capitalism in China, beginning with Deng’s turn away from Mao in the late 1970s.  Again, increasing affluence has sparked higher demand for globally recognized luxury goods.  In addition, in China “gifts” (read: bribes) of luxury goods have long greased the wheels of bureaucratic approval of new projects–until the ongoing anti-corruption crackdown there began a few years ago, that is.

What has been less well understood is that the unit profits from selling a given luxury good in either China or Japan has been much, much higher than elsewhere (double would be my first approximation).  This means that if Japan/China accounted for 25% of a company’s sales (and a sales figure would typically be all a luxury goods firm would announce), they would represent half the company’s profits.

the new

–the rise of Millennials (the suit, car, house people) in the US and EU and the gradual retirement–and loss of income–of Boomers are putting a crimp in demand for luxury goods in these areas.

–luxury goods sales in Japan have hit a brick wall in recent years.  This is partly demographics, partly the immense loss in purchasing power that the Abenomics-induced depreciation of the yen has caused.

–the China case is a little more complicated.  The main reason for the falloff in Western luxury goods sales there is, of course, the anti-corruption campaign.  But even before this, there was a clear trend of high-end consumers in China away from foreign luxury brands and toward domestic ones.   It also seems to me that years of economic stagnation in the EU have further undermined the image of European brands as cultural symbols of power and influence.  So my guess is that even as/when the anti-corruption campaign runs its course, the bounceback of traditional European luxury goods sales will be muted.

my bottom line

Studying stock performance patterns of the past twenty or thirty years suggests that major selloffs of luxury goods stocks are always buying opportunities.  I don’t think this will be the case any longer.   This is not to say the stocks won’t go up in market rallies.  They likely will.  Bur they won’t be leaders.   And the best-known names will lag firms that primarily serve Millennials, as well as companies that tap into growing consumption in China.

real estate, a new S&P sector

August 31, 2016 By in real estate, Uncategorized Tags: , , , , Leave a comment

To any professional investor from abroad, one of the oddities of the S&P 500 and other domestic indices is the relative absence of real estate and construction from them–despite the vast expanse of land in the US and the importance of the sector to the domestic economy.

This situation may be partially one of choice–that large real estate entities in the US have no trouble obtaining bank finance and, because of this, elect to remain private.  It’s also one of the myopia of index makers like S&P, however, which did not allow real estate investment trusts (REITs), the main corporate form of publicly traded real estate in the US, into its flagship S&P 500, until not much more than a decade ago.   Starting in 2001, REITs and other real estate companies have been included, but have been buried in the Financials sector.

a new sector

In the middle of next month, real estate will become truly visible in the S&P 500 for the first time, as the S&P creates an 11th sector to house them separately.

The new categorization would seem at first blush to be little more than paper shuffling, or an opportunity for the S&P to sell new index information.  I think it will have more than symbolic significance, though, both for property companies and for the residual Financials sector (mostly banks and brokers).  For the first time, investment professionals in the US will be forced to explicitly consider in the analysis of their investment performance the effect of their decisions about property and about banks/brokers as separate issues.

In other words, property will be hard to ignore.

I think the change will ultimately raise the level of knowledge about, and interest in, property stocks by American professionals to the level that’s common in the rest of the world.  If I’m correct, it will provide an extra cushion of support for REITs, which until now have been mostly supported by individual investors.  And–who knows?–it may mean that large family-controlled real estate companies will begin to consider public listing, raising the profile of the new sector further.

hedge funds and uncorrelated returns

August 24, 2016 By in financial planning, Getting financial advice, mutual fund holders and financial advisors, Uncategorized Tags: , , , , , , , , 1 Comment

beta     

One of the initial topics in my first investment course in graduate school was beta, a measure of the relationship ( generated from a regression analysis) between the price changes of an individual stock and those of the market.  A stock with a beta of 1.1, for example, tends to move in the same direction as the market but 10% more strongly.  One with a beta of 0.9 tends to move in the same direction as the market but 10% less strongly.  The beta of a stock portfolio is the weighted average of the betas of its constituents.

the beta of gold stocks

At the end of the class, the teacher posed a question that would be the first item for discussion the following week.  Gold stocks have a beta of 0.  What does that mean?

The mechanical, but wrong answer, is that gold stocks lower the beta, and therefore the riskiness, of the entire portfolio.  If I have two tech stocks, their combined beta may be 1.2.  For two utility stocks, the beta might be 0.8.  For all four in equal amounts, then, the beta is 1.0, the beta of the market.  Take two tech stocks and add two gold stocks and the beta for the group is 0.6. But this doesn’t mean the result is a super-defensive portfolio.

A beta of 0 doesn’t mean the stock is riskless.  It means that the stock returns are uncorrelated with those of the stock market.  So adding one of these doesn’t lower the risk of the portfolio.  Instead, it introduces a new dimension of risk, one that may be hard to assess.

a painful lesson   

Portfolio managers who embraced beta in its infancy didn’t get this. They assumed uncorrelated= riskless, learned the hard way that this isn’t true when their supposedly defensive portfolios imploded due to sharply underperforming gold issues.

uncorrelated redux      

I’ve been looking at marketing materials for financial planning firms recently.  Allocations to hedge funds are being touted with the idea that their returns are uncorrelated to those of stocks or bonds. This is substantially different from the original claims for this investment form. Over the past fifteen years or so, the hedge fund pitch has gone from being one of higher-than-market returns, to low-but-always-positive returns, to the present uncorrelated.

The reason is that in the aggregate hedge fund returns have consistently been lower than those for index funds for many years and that they do have years where their returns are negative.  What’s left?   …uncorrelated, just like zero-beta gold stocks.  I guess it has been revived because the last “uncorrelated” investment disaster is so far in the past that few remember it.

why hedge funds?

Why have hedge funds at all in a managed portfolio?  They must have some marketing appeal, sort of like tax shelter partnerships or huge fins on the back of a car, that are aimed at the ego–not the wallet–of the client.  A darker reason is that the sponsoring organization may also run the funds, and would miss the huge fees they generate for their managers.

 

 

 

 

 

 

Intel (INTC) and ARM Holdings (ARMH)

August 17, 2016 By in semiconductor manufacturing, Uncategorized Tags: , , , , , 1 Comment

At its Developer Forum yesterday, INTC announced that it is opening its cutting-edge fabs to manufacture chips that employ ARMH designs created by third parties.  So, as at least part of its business, INTC intends to become a foundry like TSMC.

(An aside: despite its glitzy style, it’s much harder to find information about the move on INTC’s website than on ARMH’s.  I don’t know whether this has any significance, but it’s the sort of odd fact that rattles around in a security analyst’s head until an answer can be found.  Is it me?  Is INTC more interested in sizzle than steak?  Is INTC’s IR effort still mired in the mindset of the former regime?…)

I’m not sure what the total significance of this move is, but at the very least:

–TSMC, the premier foundry, a Taiwanese company, trades at about a 17x price earnings multiple.  INTC now trades at about the same PE, although it has typically traded at a lower rating than TSMC in the past.  In contrast, ARMH trades at about 70x, a PE that I think must be unsustainably high, even though ARMH has managed to do so for years.

For my money, INTC’s fabs are better than TSMC’s.  Making loads of ARM chips for others will likely not lower INTC’s pe ratio.  Arguably, as the foundry business expands, INTC’s pe will rise.

–in every generation, the size of chips shrinks while the cost of a next generation fab rises. As a result, the amount of output that a fab must have to be able to operate profitably increases, while the penalty for having too little output goes up as well.

The ARMH partnership signals, I think, that INTC believes that to maintain its manufacturing edge, it must accept manufacturing orders from outside parties.

 

More tomorrow.

 

 

 

 

thinking about Big Oil

August 16, 2016 By in oil and natural gas, shale oil, Uncategorized Tags: , , , , , , 2 Comments

I’m starting to feel I should be interested in oil stocks again.  That’s mostly because I think that we’ve already seen the lows for the oil price earlier in this year, when quotes were flirting with $25 a barrel.  I continue to think that crude will trade in a range between $40 and $60.

Under normal circumstances, I’d figure that the big multinational integrated oils would be the safest bet and that one could add some oilfield services shares to provide speculative upside potential.

For today, however, I don’t think the traditional formula is right.  Instead, I think the main thing to come to grips with is the technological change that hydraulic fracturing has brought to the industry.  I think this is similar to what happened in the steel industry when mini-mills began to compete with blast furnaces  …or to semiconductor manufacturing when third-party fabrication plants opened in Taiwan, enabling the separation of thought-intensive design from capital-intensive plant ownership  …or to the computer industry when the minicomputer and the PC replaced the mainframe.

If I’m right about this, then anything that has to do with the older order is out.  This means multi-year mega projects in remote or hostile environments (physically or politically) are substantially more risky than they have been.  It also means that the builders of giant offshore drilling equipment to find, lift or transport this kind of output aren’t coming back any time soon.  Nor are the service companies that own this sort of equipment and specialize in this kind of drilling.

The Big Oil majors, who have been the leading proponents of exotic mega projects, must also come into question, as well.   How quickly can/will they mentally adjust to a new era of abundant oil rather than perpetual shortage?  What will they do about projects that are now under way?

What other industries undergoing radical transformation have shown in the past is that the incumbents take a surprisingly long time to adjust to the new circumstances.  If that proves true again, then the best way to make money will be to undertake the tedious task of examining smaller fracking-related drillers and service companies to see how they will benefit.