Tag Archives: business

the Chinese currency and the Chinese stock market

August 12, 2015 By in Asian economic development, Balance of Payments, China, currency markets, Current Market Thoughts, economic problems in emerging countries, economics Tags: , , , , , , , , , Leave a comment

Throughout my financial career I’ve found that in sizing up currency markets traders from the big banks have always been ten steps ahead of me.

I’ve hopefully learned to live with this–meaning that because I’m never going to outthink them I believe my best currency strategy should have two parts:

–to avoid making future currency movements a major element in constructing my portfolio, and

–to be a “fast follower” if I can–that is, to figure out from a trend change what the banks must be thinking and to consider getting on board if I think the trend is going to have legs.

 

China has moved the price at which it will buy and sell renminbi down by 1.9% yesterday and by another 1.6% today.  Informed market speculation seems to be that another couple of downward moves of the same magnitude are in the offing.

From a domestic policy perspective, China would prefer a strong currency to a weaker one.  As I mentioned yesterday, the country has run out of cheap labor and must, therefore, transition away from the highly polluting, cheap labor employing, export-oriented basic manufacturing that is the initial staple of any developing country.  This kind of business has been the bread and butter of many Chinese companies, some of them state-owned, for decades.  Many are resisting Beijing’s call to change.  The strong currency is a club Beijing can use to beat them into submission.  In this sense, the fact that the renminbi has appreciated by 10%+ against other developing countries’ currencies over the past year, and by around the same amount against the euro, China’s largest trading partner, is a good thing.

On the other hand, the developed world has made it clear to China that if it wants to be included in the club that sets world financial policy, and in particular if it wants the renminbi to be a world reserve currency, the renminbi cannot be rigidly controlled by Beijing.  It must float, meaning trade more or less freely against other world currencies.  So China has a long-term interest in doing what it has started to do yesterday–to allow the currency to move as market forces drive it.

Why now, though?

World stock markets seem to be thinking that a severe erosion of China’s GDP growth is behind the move toward a currency float–that it’s backsliding from a committment to structural reform.

I’m not so sure.

I think what currency traders have concluded is that Beijing has enough money to prop up its stock market and enough to keep its currency at the present overvalued level–but not both.  So they’re borrowing renminbi  and selling it in the government-controlled market in the hope of pushing down the currency and buying back at a lower price.  Understanding what’s going on, and realizing the risks in defending a too-high currency level, Beijing is bending in the wind.  Doing so limits the amount of money that can be made this way, effectively short-circuiting the strategy.

Offshore renminbi, which can’t be repatriated into China, trade about 5% cheaper that domestic renminbi.  That’s where we should get the next indication of how far renminbi selling will go.

As far as my personal stock investing goes, my strong inclination is to bet that renminbi-related fears are way overblown.  I’ like to see markets calm down a bit before I stick a toe in the water, though.

 

 

 

 

 

the Chinese renminbi “devaluation”

August 11, 2015 By in Asian economic development, Balance of Payments, China, economic problems in emerging countries, economics, Purchasing power parity (PPP) Tags: , , , , , , , , Leave a comment

devaluation?

Every day the Chinese government sets a mid-point for trading of its currency prior to opening.  The renminbi is then allowed to trade within a 2% band on either side of the setting.  At this morning’s setting, Beijing put the mid-point 1.9% lower than it was yesterday.  This is an unusually large amount and can be (is being) read as an effective devaluation of the currency.

What does this really mean?

background

In the late 1970s, when China made its turn away from Mao and toward western economics, it chose the tried-and-true road toward prosperity trod by every other successful post-WWII nation.  It tied its currency to the dollar and offered access to cheap local labor in return for technology transfer.

Late in the last decade, the country ran out of cheap labor.  So it was forced to begin to transform its economy from export-oriented, labor-intensive manufacturing to higher value-added more capital-intensive output and toward domestic rather than foreign demand.  The orthodox, and almost always not so successful, method of kicking off this transition is to encourage a large appreciation of the currency.  That causes low-end production to leave for cheaper labor countries like Vietnam or Afghanistan.

China, armed with a cadre of young, creative economists with PhDs from the best universities in the West, decided to do things slightly  differently–to hold the currency relatively stable and to boost domestic wages by a lot to achieve the same end of making export-oriented manufacturing uneconomic.  The idea is that this doesn’t bring the economy to screeching halt in the way currency appreciation does.  So far this approach seems to be working–although the shift does involve slower growth and a lot of domestic disruption.

At the same time, forewarned by the immense damage done to Asian economies by speculative activity by the currency desks of the major international banks during the 1997-98 Asian economic crisis, China elected not to let its currency trade freely.

what’s changed?

For some years, China has been upset about the fact that despite being the biggest global manufacturing power, and by Purchasing Power Parity measure the largest economy on earth, it has virtually no say in world financial or trade regulatory bodies.  Those are dominated by the US and EU.  The main reason for China’s limited influence is that its financial system isn’t open.  (The other, of course, is that fearing China organizations like the new US-led Pacific trade alliance pointed excludes the Middle Kingdom.)

So China has been gradually lessening state control over the banks, the financial markets and the currency, in hopes of being admitted into the inner sanctums of bodies like the IMF.

In one sense, this is why China is becoming less rigid in its control of renminbi trading.

why now?

There’s no “good” time to let a currency float.  China doesn’t want to cede control over currency movements at a time when the renminbi might appreciate a lot, since that would be a severe contractionary force.  On the other hand, it doesn’t want the currency to fall through the floor either, since that would result in new export plants sprouting up all over the place.

China is growing more slowly than normal and is experiencing currency outflows as a result of that.  Letting the currency slide a bit relieves some of the pressure–although it may simultaneously attract speculators to try to push the renminbi lower.  So, yes, it is a sign of economic weakness.  At the same time, the loosening comes shortly before the IMF will decide on admitting the renminbi as one of its reserve currencies.  And it follows by a few months Beijing allowing banks to issue certificates of deposit at market rates, rather than at yields set by central planners.  So it’s also a step toward a healthier, more economically advanced, future.

my take

I think worries about the stability of the Chinese economy are overblown.  I also think that traders are using the Beijing move as an excuse for selling that they’ve been wanting to do anyway.  Beijing may have been the trigger for this, but it isn’t the cause.

 

 

 

 

results from Disney (DIS): a lesson in how the market works nowadays

August 6, 2015 By in Cable, Constructing a Portfolio, Current Market Thoughts, Discounting, Entertainment, Industry Analysis Tags: , , , , , , , , , Leave a comment

DIS and ESPN

A relative in the movie business called my attention to Marvel Entertainment a few years ago.  When it was acquired by DIS in late 2009, I held onto the stock I got and added more in the mid-$20 range Marvel, of course, has been pure gold for DIS, even though DIS initially went down on fears that DIS had overpaid.  Naturally I sold the stock way too early, in the mid-$60s–acting more like a value investor than a growth stock fan.

My first thought on reading the DIS 10-K, as I acquainted myself with the company,was that the company really should have been named ESPN, since at that time the cable sports network accounted for 2/3 of DIS’s overall operating profit and virtually all of its earnings growth.

red flags about ESPN

Over the past several years, a number of key warning signs have popped up about ESPN, however:

–ESPN decided to expand into the UK, signalling to me that it considered its US franchise on the cusp of maturity

–but ESPN was outbid for soccer rights by locals and effectively terminated its international expansion ideas–not good, either

–DIS began to shift cash flow away from ESPN and toward the movie and theme park business, which I took to be a sign of corporate worries about ESPN’s growth potential, rather than simply diversification for diversification’s sake

–serious discussion has begun over the past year about the demise of cable system bundled pricing, which likely benefits ESPN substantially (I suspect we’ll find out how substantially sooner rather than later)

–since ESPN.com’s recent format change, I find myself almost exclusively using Time Warner’s Bleacher Report for sports information

–personally, although this isn’t the most crucial part of my analysis, I think the progressive dumbing-down of ESPN coverage, in imitation of sports talk radio, to gain a wider audience will backfire.

To sum up,, there has been an increasing collection of evidence that ESPN probably won’t be the same growth engine for DIS that it has been in the past.

Yet…

…DIS shares were down by about 10% in Wednesday trading (in an up market) on the first signs in the earnings report of the factors I’ve just listed.

discounting?

Where was the market’s discounting mechanism, which in the past has been continuously evaluating corporate strategy and factoring worries like the long list I’ve mentioned above into the stock price?

…only on the earnings report, not before

To my mind, DIS trading yesterday is another indicator that information isn’t flowing on Wall Street as fast as it once did.  That’s neither good nor bad;  it’s just the way the game is being played in today’s world.  What we as investors have got to figure out is how to adjust our own behavior to fit altered circumstances.

My initial thought is that it may be riskier than it has been to dabble in down-and-out industries like mining or oil until the final bad news has hit income statements.

 

bracing for higher interest rates

August 5, 2015 By in bond market, Constructing a Portfolio, Current Market Thoughts, Portfolio management, securities markets, stock market, Strategy Tags: , , , , , , , Leave a comment

Long-time readers may remember that in an embarrassingly premature fashion, I began writing about the upward path away from non-crisis interest rates toward normal several years ago.  It looks like liftoff day has finally come, however.

The consensus expectation, informed by judicious leaks by the Fed, is now that the Fed Funds rate will rise by .25% next month, and by another .25% before yearend–meaning short rates will exit 2015 at .50%.  A highly stylized view of the Fed’s intentions is that it will continue to raise rates at the same 1/4% clip at every second Fed meeting next year–meaning another 1.0% increase during 2016.  The goal of rate normalization is an endpoint for Fed Funds of around 3% (but probably lower).

This is a potentially important change of direction for two reasons:  rates have been at emergency lows for an extraordinarily long time, and the thirty-five year war against inflation has been long since won.  The secular trend of ever lower nominal interest rates–for many financial market participants, the only trend they have ever seen in their working lives–is over.  Barring another world financial disaster, nominal rates may be higher in the future, but there’s no chance they’ll ever be lower.  So the thought habits of a lifetime are about to be shaken up.

What does this mean for stocks?

Past tightening cycles have been bad for bonds, but stocks have been flat to up.  The generally accepted explanation for the latter phenomenon is that the negative effect of higher rates is offset by robust profit growth.  Said another way, positive earnings surprises (more than) offset the negative effect of price earnings multiple contraction.

Personally, I think this explanation is the right one.

Critics of the applicability of the idea to the present situation point out that this time rates will be rising long after the business cycle has turned.  Therefore, they argue, the chances of a surprisingly large corporate profit surge are slim.  In consequence, the “normal” protection for stocks against Fed tightening is absent.

Four thoughts:

–the reason rates are still at 0% is that the “normal” cyclical profit surge hasn’t happened yet.  Maybe surge isn’t the right word for today’s situation, but world economies certainly aren’t firing on all cylinders yet.

–profit rises and Fed tightening aren’t independent events.  The Fed has made it clear that it intends to tighten only to the extent that economic strength allows.  The agency has often referred to the repeated disastrous mistakes Japan has made over the past quarter-century by tightening too soon.  If profit growth doesn’t permit, tightening will go more slowly than many expect.

–for the S&P 500, half the index’s profits come from abroad.  The EU (25% of profits) will likely be stronger next year than this; China may be, too.

–where else will money go?  Certainly not into bonds.  Cash is the only safe haven.  It’s possible there will be a large outflow of money from stocks into cash.  I don’t think so.  That’s partly (mostly?) because I like stocks.  More substantively, institutional investors may shade their portfolios a bit toward cash, but their large size means they can’t maneuver quickly, so the risk to them of betting against stocks in a major way and being wrong is enormous.  In addition, my sense is that a defining feature of the bull market that began in 2009 is the lack of retail participation.  If so, retail has already bet heavily–and incorrectly–against stocks.

A final point:

–yielding 0%, cash isn’t an attractive alternative to me at.  However, given that the period of zero interest rates is coming to an end, I’ve got to ask myself at what level would it be?

If we assume that inflation will be steady at 2%, I would find 3% cash and a 4%+ long bond very attractive.  That may be evidence that we’ll never get there.

Still, what I’m trying to get at is that there will come a point in the tightening cycle where even an equity fan like me will have to reallocate toward fixed income.  We’re nowhere near that now, in my opinion.  But I think this, not the start of tightening, will be the real showstopper for stocks.  This is not an idea to act on, but it is one I think we should keep in the back of our minds.

big day for Amazon (AMZN)–why?

July 24, 2015 By in Amazon, cloud services, Current Market Thoughts, Industry Analysis, internet, operating leverage, Recent Market Action, software, Stock ideas, Technology Tags: , , , , , , Leave a comment

AMZN reported 2Q15 results after the close last night.  They were very good.

Sales were up 20% year-on-year; expenses rose by 17%, three percentage points less.  As a result, the company reported an operating profit of $464 million vs. a loss in the second period of 2014.

More than that, AMZN’s cloud services division, AWS, had revenue growth of 81% yoy and a quintupling of segment profits (basically operating profits less stock option expense) to $391 million.  AWS, broken out as a separate segment for the first time after 1Q15, remained a bit more than a third of the AMZN total.

 

AMZN posted an overall profit of $.19 a share for the quarter, vs. analysts’ expectations of a loss of $.13 a share and a deficit of $.27 per share in the year-ago quarter.

On the announcement, the stock immediately rose by 15% in aftermarket trading.

AMZN opened up by 20% this morning, before drifting down steadily during the day to close +9.8% in a market that was down just more than 1%.

 

Why the strong advance?

I have no good explanation, although I do have some ideas.

1. The obvious factor that changed overnight was the earnings announcement.

It contained a significant positive earnings surprise, one that makes it more likely that the company will earn, say, $1- a share in the current year. It makes the analyst consensus of $2.78 a share for 2016 more believable.   On the other hand, the stock was trading at $482 before the earnings report, or 173x the 2016 consensus.  Looking at the stock price another way, let’s say that at maturity for its businesses (whenever that may be), AMZN shares will be trading at 20x earnings.  To sustain the pre-earnings report price, that would imply a burst of rapid growth that shoots earnings up to around $24 a share.  That would be something like a doubling of earnings each year for the next five or six.

That’s already baked in the cake.  A buyer of the stock at this level must believe that $24 a share in eventual earnings is way too low.

I find it hard to believe that a $.32  per share earnings surprise during one quarter–when expectations were already sky-high=-would be enough to add 20%, or even 10%, to AMZN’s perceived market value.

2.  A second hypothesis…

What if investors are beginning to separate AMZN into two parts, AWS and everything else, and are doing a sum-of-the-parts evaluation.  To me, this sounds a little more plausible.  What would the numbers look like?

Let’s say that in 2016 AWS will comprise half of AMZN’s earnings and AMZN Retail the remainder.  To make the figures easier, let’s say each half earns $1.50 a share next year.

Let’s assume AMZN retail can grow in earnings at 20% a year for a long time, and that we’d be willing to pay 50x current results–a big number for a retail stock–for that future profit stream.  If so, AMZN Retail is worth $75.  To reach a sum-of-the-parts value of $482, AWS must therefore be worth about $400, or close to 270x its 2016 eps.  Ok, while I personally wouldn’t be willing to pay that much for AWS, I can see how someone else might.  However, I still don’t understand why confirmation that a holder at 270x earnings isn’t insane would cause the multiple to expand.  (Also, before I’d be comfortable valuing AWS as a separate company, I’d want to know more about how AMZN apportions revenues and costs among segments to ensure the published numbers don’t flatter AWS.  I’d also think long and hard about the possible effect of stock options.)

3.  The explanation for AMZN’s rocket ship ride that I’m leaning toward, however, is more technical.  Two factors may be involved.  At what Google Finance reports as 21+ million shares, today’s trading volume in AMZN was 7x normal.  The sharp opening spike suggests to me that algorithmic trading computers were at work reacting to the earnings report, not humans.  Humans, I think (?!?), would have a better sense of valuation.  I also suspect that the report and immediate upward move triggered a lot of short covering.

I’m partial to #3 because I think the whole reaction is a little  crazy.

Why is any of this important?  AMZN is a high-profile, large-cap stock with almost two decades of operating history.  There’s got to be a way to make money from the possibility that something like AMZN’s big move will occur with other similar names.