Category Archives: Foreign markets

thinking out loud about Euroland (II)

November 14, 2011 By in Constructing a Portfolio, Current Market Thoughts, Foreign markets, Portfolio management, Strategy Tags: , , , , , , , , , , , , , Leave a comment

Euroland is small

Yesterday, I tried to argue that in world economic terms the Eurozone is smaller than many investors believe and that, therefore, even a severe recession there next year will only have a mild negative impact on global growth prospects.

There are two additional economic factors to consider–trade and investor expectations.

trade

Ex oil, most trade among Eurozone members is with each other.  Sales to the EU from China–Europe’s largest external trading partner–amount to less than 3% of the economy of either.  The same is true for business between the US and the EU.

Trade usually rises and falls faster than a country’s overall economy, though.  So a 5% decline in Eurozone GDP next year might translate into a 10% decline in imports.  Certainly not a good thing, but not by itself a disaster, either.

investor uncertainty

To my mind, the bigger issue by far is investor uncertainty.  Such fears typically turn out to be wildly overstated.  That knowledge doesn’t help much, however, if it’s your portfolio that’s being swamped by waves of irrational selling.

Even though Americans have been investing in foreign stock markets in a serious way for almost thirty years, I think most people still don’t understand that there isn’t a one-to-one relationship between world economies and world stock markets.  The relationship works for bonds, which comprise a much larger class of securities, but not for equities.

There are two reasons for this:

–in most countries, large portions of the economy have no publicly listed companies.  In the US, for example, the real estate, housing and auto sectors, all of which are important for GDP growth, have very little stock market representation

–in many countries, the owner of a domestic enterprise can easily be a foreign company.   In this case, the owner’s main public listing is probably in a foreign country–if it is listed at all.  Again, it contributes to GDP but has no local stock market presence.   TIF, for instance, is a US company but earns money and adds to GDP in the EU, Japan and China.  Ikea is a global furniture company founded by a Swedish entrepreneur.  It’s incorporated in the Netherlands and not publicly traded anywhere.

world stock markets by size

In world stock market terms, the Eurozone is smaller than it is in a macroeconomic sense.

The world stock markets open to foreigners break out roughly as follows:

US          45%

Eurozone          11%

rest of Europe (mostly the UK, with a dash of Switzerland and Sweden)          13%

Japan          9%

Canada + Australia          8%

emerging markets          14%.

Slicing the Eurozone up a bit further, the area’s main components are Germany and France, which together make up more than half the total.   By far the biggest sector is financials.

Unfortunately, there’s no reliable information I’m aware of to sort out the relationship between where companies in continental Europe may be listed vs. the countries where they make their money.  I think we should assume that all financials are pan-European enterprises, no matter where they are listed.  For other sectors, the tendency has been for countries to declare that certain companies or industries are national treasures and can’t be acquired by foreigners.  My guess–and it really is a guess–is that ex financials, most multinational exposure is to non-Eurozone areas.  If so, this exposure would be an economic and stock market plus.

conclusions

In the parsing of world stock market above, which gets down to the level of markets that make up as little as 2% of the world’s stock markets, Greece, Italy, Portugal and Spain don’t show up at all. They’re that small.

In terms of investor concern that’s depressing overall European markets, then, the issue has got to be either the indirect effects on business in France and Germany of problems in smaller Eurozone economies and/or the negative effects on the very large banking sector.  My guess is that the negative signal European markets are giving is much more the latter than the former.

 

Tomorrow–how to structure an equity portfolio in light of European stock market weakness.

thinking out loud about Euroland (I)

November 13, 2011 By in Current Market Thoughts, economics, emerging markets, Foreign markets, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , , Leave a comment

recent trading

During this latest iteration of the Eurozone existential crisis, we’ve dropped from 1350 on the S&P 500.  We’ve visited 1074 and seen 1284, both within weeks of one another.  We now seem to be generally moving sideways, but bouncing between 1215 and 1270.

What is the market saying?  This trading pattern says to me that the market is highly emotional but no one has a clue to figuring out what’s going on in the Eurozone.

thoughts on Euroland

As a first step toward developing a (hopefully) intelligent stance to take toward the Eurozone in building an equity portfolio, I thought I’d try to list the points I feel confident about.  That may be enough for me to use;  at the very least, I may be able to highlight what other information I really need to know.

Here goes:

1.  Matters would be worse on Wall Street if the US economy weren’t recovering.  While not thrillingly optimistic, the view of Jim Paulsen, Wells Fargo’s chief investment strategist, is an interesting–and, to me, a completely plausible one.  He terms the current sluggish recovery as normal for the US in today’s world.  It only looks bad when we compare it with recoveries from thirty or forty years ago, when economic circumstances were very different.

2.  The Eurozone won’t be generating much economic strength for years, I think.  If so, as investors we should regard Europe as a special situations market and be very choosy about what stock we own.  If we take it as given that we don’t want much exposure, our biggest concern has to be that the economy there gets bad enough that it punches a hole in the bottom of the world’s economic boat.

Why do I think European prospects are dim?

–Japan hid the banking problems that resulted from its late-1908s speculative bubble for a decade.  Its economy stagnated during that time.

–The US fixed the worst damage to its banks almost immediately and the economy began to perk up 18 months later.

–Euroland?  So far, it has followed the Japanese example.  The result has been little growth and creation of the only negotiating chip places like Greece and Italy have.  Even if the EU recapitalized its banks tomorrow, we wouldn’t see the positive economic effects until 2013, at the earliest.

3.  Euroland’s investment importance comes from the accumulated wealth its citizens hold, not its size or growth prospects. 

How so?

Look at the Eurozone’s (small) size.

Using Purchasing Power Parity calculations from the World Bank (I got them on Wikipedia), global economies break out as follows:

Brazil, Russia, India, China         25% of the world

US, Canada, Mexico          23%

Eurozone          15%

rest of EU          5%

Japan          6%

everybody else          26%.

I draw two conclusions from this list:

–Euroland isn’t that big in world terms any more.  The fate of the “other” 85% is hugely more important than what happens in Europe.

–One possible outcome for the Eurozone is that it fades into insignificance in the way that Japan has during the past two decades.  I’m not sure this is the most likely outcome, but it’s a good possibility.  After all, the EU has many of the same cultural rigidities that have helped to sink Japan, and it hasn’t fixed its banking system.  Japan’s economic collapse didn’t stop the 1990s from being a very profitable decade for investors elsewhere.

4.  The worry isn’t a deep recession in Europe–it’s uncertainty about unanticipated consequences.  At least, I don’t think it should be about Eurozone recession.  According to the Conference Board, a US-based economic consultant, the world is likely to grow by about 3% in real terms (that is, after subtracting inflation) in 2012.  The agency thinks  the EU is most likely to grow by 1%;  its “pessimistic” scenario has the area little better than flat for the next half-decade.

What does Europe mean for overall world economic expansion, in the Conference Board’s view?  Realistically, nothing.  In the base scenario, the EU chips in .15% to world growth–more or less a rounding error.

Let’s assume that somehow the bottom falls out of Europe next year and the Eurozone has a horrible recession where output shrinks by 5% in real terms.  That would subtract .75% from world expansion.  The globe would still grow, but by 2%+ instead of 3%.

 

That’s it for today.  More on this topic tomorrow.

investing in stocks outside your own country: the Vale example

March 28, 2011 By in Basic Concepts, Current Market Thoughts, economics, emerging markets, Foreign markets, Portfolio management Tags: , , , , , , , , , Leave a comment

Still at spring training. So far, the Mets have beaten the Braves (five Atlanta errors) and lost to the Cardinals.

Investing in a foreign country

In my experience, one of the most difficult (and expensive) things to learn about investing outside your home country is that what you consider to be self-evidently and commonsensically true about the characteristics of good investments there isn’t necessarily so in someone else’s market. Instead, the rules that govern each market are the product of that nation’s legal framework, its shared social norms and the risk preferences of the dominant investors there (be they local or foreign), as well as the objective characteristics of the companies that are publicly listed.

The situation is made more difficult because we’re all, at least initially, not consciously aware of our deepest presuppositions about our own market. We don’t think to ask anyone in a new market what the rules of the game are, either, because we assume they’re the same as ours. And the people in the new market that we might ask are, like ourselves, probably not consciously aware of the assumptions they share with their fellow local investors.

Take the US and UK markets, for example. Superficially, the two are very similar. They have the same general language, same general legal system, same general accounting conventions. One is the former colony of the other. They are political allies. Everyone talks about Anglo-American capitalism as being different from the Japanese or continental European varieties.

Yet the two markets are quite different.

For example:

–Americans “know” that debt is a cheaper form of capital than equity; British investors “know” the reverse.

–The letter of the law is paramount in the US. In the UK the spirit of the law is more important. If some one can figure out a way to exploit imprecise wording in a contract to achieve an advantage, he’s likely lionized in the US. In the UK, he’s vilified.

–UK investors prefer to own the stocks of mature companies that generate free cash flow, pay rising dividends and have low price-earnings multiples. US investors are pretty evenly split between such value investors and growth advocates, who prefer younger, faster-growing firms that are cash flow users, not generators, and pay no dividends. US individual investors are prepared to pay very high PEs for stocks in the latter class.

How does one learn these rules? Mostly through experience—and through being aware that it’s important to be on the lookout for them speeds up the process immensely.

At the present time, there’s an interesting instance of “local ground rules” in progress, one that will go a long way toward fleshing out the rules of investing in Brazil, a potentially important emerging market. Here it is:

Vale, a large, publicly listed company in Brazil, is one of the world’s most important miners and exporters of iron ore. Iron ore is the main raw material used to create blast-furnace steel, the type of steel used to make automobiles. Vale’s most important customer is the steel industry in China.

Although Vale is happy to remain a miner/exporter, the current Brazilian government isn’t content with the current state of affairs. According to a recent Financial Times article, it wants Vale to integrate forward by investing in steel mills in Brazil and so it can produce steel for export in its home country. Vale is refusing.

The government’s response? …to force the current Vale CEO out of office, in the hope of replacing him with someone willing to adhere to the government’s wishes. As I see it, the government’s reasoning for its action is not that becoming a producer of steel, in direct competition with its largest iron ore customer, will be good for Vale or its shareholders. The rationale is that it will be good for Brazil.

It isn’t clear yet whether the government will get its wish.  I suspect that if I knew more (read: anything) about the Brazilian legal system, I’d have found tha there’s a deep-seated belief that natural resources really belong to the citizenry as a whole, that private companies don’t own natural resource deposits in the same way they do other assets.  And that idea is the basis for the government’s request.  If so, this might imply other industries might be immune from these tactics.

But every country has investment issues like this.  In Korea, for example, if a company is seen to be making “too much” money, it has been asked to make a “voluntary” contribution to some government-sponsored research project.  In Japan, the banks were never intended to make money; they were intended to gather national savings to make cheap loans to export-oriented companies.  Recently, we’ve learned that yoghurt-production is a key b in France, and thus not subject to foreign takeover.  For a decade or so, US oil companies were legally barred from charging market prices for the oil they brought to the surface.  And the US has massively protected/subsidized the domestic auto industry for as long as I’ve been a professional investor.

My private belief is that these quirks end up being bad for the capital markets anyplace they’re enforced.  They result in inefficient allocation of capital.  And that results in lowe price earnings multiples for stocks in the affected industries.

In a practical sense, however, there’s nothing any single investor can do about the local house rules  …other than to be aware they exist, lurking under the surface, everywhere–and take appropriate protective measures.