Tag Archives: currency

the Italian election–investment significance

February 26, 2013 By in Current Market Thoughts, economics Tags: , , , , , , , , , , , , 1 Comment

I’ve always found the Italian stock market–yes, there is one–to be a waste of time for foreigners.  There aren’t very many interesting companies (I’ve only held Tod’s and Bulgari in my portfolios, other than when I’ve taken on turnarounds).  Also, to my mind the market there is run for the benefit of political and industrial insiders, not for the average Italian, and certainly not for investors from other parts of the world.  Even if I could have tapped into the underground flow of inside information, it’s not clear it would be usable without violating US securities laws.

Anyway, the current election issue isn’t about the viability of Italian stocks.  It’s about the viability of the euro.

setting the stage

Italy is the third-largest economy in Euroland, after Germany and France.

Italy has a very inflexible, high-cost, slow-growing economy.  Many of its industries are under competitive attack, not only from elsewhere in Europe but from emerging Asian giants like China, as well (think:  clothing, leather goods and furniture).  Rather than allow/force adjustment to the new reality, the Italian government has borrowed lavishly and spent with abandon to help keep an uncompetitive economy above water.  For a long time, although bond investors saw the government debt piling up–it’s now around 140% of GDP, they assumed that Euroland as a whole was guaranteeing repayment.

Then the Greek crisis erupted.   …and bondholders began to work out that:

(1) maybe Euroland wasn’t really guaranteeing Rome’s borrowings, and

(2) the debt was so big that maybe Euroland couldn’t make good even if it wanted to.

Seeing the credit markets closing their doors to Italy, the country ousted the prime minister, Silvio Berlusconi, who had overseen the creation of much of the mess, and replaced him with a “technocrat,” Mario Monti.  (“Technocrat” means combination hatchet man and fall guy–someone who would make necessary, but politically suicidal, reforms and then fade into the woodwork.)

Monti did heroic work.  He wasn’t able to address sky-high labor costs, but he did restore government spending to what’s called a primary surplus, meaning that government income is covering all expenses, ex interest on debt.  The country’s government bond mountain is no longer growing; it’s starting, very slowly, to shrink.  To put this in context, this is more than Washington has had the courage to do.

the election

Monti got nudged out and an election was called to form a replacement government.  It was held last Sunday/Monday.

Four main parties:

–the Democrats; labor-backed, reform-friendly;  led by Pier Luigi Bersani

–People of Freedom; roll back reforms, start spending again; Berlusconi (a figure sort of like a cross between Nixon and Rupert Murdoch, without the redeeming qualities)

–Civic Choice; pro-reform; Mario Monti (who decided not to fade into the woodwork)

–Five Star; get rid of the political establishment, default on government debt, leave the euro; Beppe Grillo (like Jon Stewart, only taken seriously).

pre-election polls 

Polls from fifteen days ago, the latest allowed by law, predicted the Democrats would get the most votes (45%?)  and would form a coalition with Civic Choice (15%?).  Grillo might get 15%.  With 25%, Berlusconi would be left out in the cold.

“instant” exit polls

In Italy these are done by phone.  They’re not reliable.  But they showed the expected outcome.

as it stands now

Later polls, and preliminary voting results, show a different picture.

The Democrats will win the lower house outright.

In the Senate, however, it looks like this, according to USA Today:

Bersani          32%

Berlusconi          30%

Brillo          24%

Monti          14%.

In other words, the two pro-reform parties, led by Bersani and Monti, would fall short of a majority in the the upper house, so the coalition they had been planning on forming would be useless.  Why?    …both Brillo and Berlusconi did a lot better than expected.

where to from here?

No one knows for sure.

None of the others want to link up with Berlusconi.  That leaves a possible Bersani-Brillo combination.  But it’s not clear they have enough in common to form a coalition.

It may be that another election is on the cards.

investment significance

From the perspective of a global investor with no intention of buying Italian equities–Prada IPOed in Hong Kong, after all–it isn’t, strictly speaking, necessary for me to see Italy solve its structural problems.  All I need is for the country to limp along in its current state of denial, on the road to insignificance.  I might even be able to stomach a rollback of some of the Monti reforms.   That’s providing Italy doesn’t repudiate its debt, leave the euro, turn its primary surplus into a deficit or otherwise punch a big hole in the bottom of the euro boat.

At this moment, I consider the stuff on my “bad” list as highly unlikely to occur.  Nevertheless, absent a miracle solution to the Italian Senate partisan logjam, we’re going to go through a period of Euroland jitters until Italy has a new government.  My guess is that the shaking will mostly take the form of euro weakness.  Also, dedicated European equity investors will likely make their portfolios a bit more defensive, and will probably get the funds for doing so by aggressively trimming recent outperformers.

With little European exposure myself, I’m content to remain on the sidelines for now, with an eye out to possibly add shares of Europe-based multinationals that may come under selling pressure.

Note:  One minor conceptual worry–not one for today or tomorrow, though.  I’ve been channeling my inner Trotsky for a while now.  I’ve already consigned Japan and Europe to the dustbin of history–with a potential double dose of bin for Greece and Italy.  If I  keep on going like this, at some point there’s more dustbin than anything else.    That would be bad.

the latest Japanese election comes on Sunday

December 14, 2012 By in economics, Japanese development Tags: , , , , , , , , Leave a comment

getting scared straight

Cable network A&E is now into its third season of Beyond Scared Straight. This is the latest iteration in the Scared Straight genre, created in the 1970s, in which budding criminals visit prisons and are supposedly frightened back onto the straight and narrow by Ghost of Christmas Yet to Come-like interaction with the inmates.  I’ve never had enough interest to try to figure out how much is real and how much is staged.

There is a real-life Scared Straight, though, for economics and public policy.  It’s called Japan.  Maybe we should send our elected officials in Washington for a visit.

Japan

The Japanese economy has been in neutral for almost a quarter-century, during which the standard of living for average Japanese citizens has steadily eroded. The workforce is aging (it’s actually been shrinking for about a decade) but Tokyo doesn’t allow immigration.  Weak management is slowly (sometimes, not so slowly) killing even iconic companies, but foreign turnaround specialists aren’t allowed to take control.

Worse, the government borrows heavily to spend on pork barrel “stimulus” projects that yield no economic return.  As a result, national debt now exceeds 2x annual GDP. That’s a Greece-like number. Perversely, because Japan is almost devoid of good new investment opportunities (small “counterculture” companies run by younger managers are an exception), citizens continue to plow their savings back into government bonds, even though they yield next to nothing–creating a continuing cycle of misery. The Diet has not been overwhelmed by the interest expense of its reckless borrowing, nor has it had trouble, so far, in raising fresh funds to squander.

There’s an election on Sunday, in which the hapless Democratic Party of Japan is likely to be replaced by the Liberal Democrats, who have been the dominant force in modern Japanese politics.  The DPJ was voted in a few years ago to change the patronage culture, but almost immediately lost its way in a frenzy of intra-party bloodletting.

why the election is interesting–and maybe important

Shinzo Abe, who will become the Prime Minister if the LDP wins, is running on a platform that includes dismantling the independent central bank.  If Mr. Abe gets his way, the bank will be forced to print money as fast as the presses can turn, until this action creates at least 2% annual inflation.

Wow!

I guess the idea is to weaken the currency so that even arthritic export-oriented manufacturing companies will be able to make a profit.   There’s also the “advantage” that the currency markets, rather than the legislature, may take the blame for the immense loss of national wealth that would ensue.  At the same time, to the degree that the LDP is successful in creating inflation, it will also likely triple or quadruple the interest rate on new government debt–potentially making it impossible for Tokyo to service.  Scary.

Implosion isn’t imminent.  Mr. Abe hasn’t won yet.  Maybe he’ll change his tune after he’s in office.  Maybe the Bank of Japan won’t simply roll over and do what he says.  But, to mix metaphors a bit, that’s kind of like saying that the fuse to the dynamite that’s being lit is very long.  Japan could be an Asian version of Greece if a few years.

the really scary part for the US

In a nutshell, Japan’s basic problem is that since the early 1990s it has chosen to prop up the status quo, in the face of a changing world, no matter what the cost.  What’s really scary for an American is that Washington seems to be taking a turn down the same road.

foreigners now own more Japanese government bonds than any time over the past thirty years…Why?

September 24, 2012 By in Bond Environment, Current Market Thoughts, inflation vs deflation, Investment firms, Japanese development, Strategy Tags: , , , , , , , Leave a comment

foreign JGB ownership continues to rise

The Bank of Japan announced last week that foreign ownership of its government bonds has now reached  the highest level since 1979.

The foreign investors piling in aren’t individuals like you and me.  They’re mostly professional bond investors who manage mutual funds and institutional pension accounts and, to a lesser extent, non-Japanese central banks.

What’s the attraction?

To the layman’s eye, there would seem to be none.  The Japanese economy hasn’t grown much for over two decades.  The Tokyo government continues to borrow heavily to run its operations, so the stock of JGBs continues to expand.  And interest rates are extremely low.

There are, however, two positives.

90% or more of Japan’s government bonds are held by Japanese citizens and institutions.  They regard JGBs as the ultimate safe investment.  They also see themselves as having little other choice (without taking unacceptably high amounts of risk) than to continue to hold.  They roll their money over into new bonds when their current bonds are redeemed, too.  So–unlike the case with, say, US Treasuries, where foreigners own about half the outstanding bonds–there’s little chance of the JGB market being roiled by panicky foreigners repatriating funds to the their home markets.

Also, the Japanese economic situation is well-known.  It has been for all practical purposes unchanged for over two decades.  Chances of any change appear to be slim.  To boot, in the deflation-prone Japanese economy, low yields look somewhat better in inflation-adjusted terms.

In other words, although you won’t make much money–other than a possible currency gain–the chances of a loss appear to be very small.  That’s what makes Japan so attractive to global bond professionals.

not so in the rest of the world

The sub-prime mortgage crisis in the US and the Greece/Italy/Spain government debt crisis in the EU have driven bond yields for Treasuries and for German governments to within striking distance of JGB yields.  In fact, short-term German government notes trade at negative yields.

Inflation-adjusted, Treasury yields are already negative, as well.  It’s possible that economic recovery now under way will eventually cause inflation to rise further, worsening this situation–and causing the Fed to raise rates.

In Germany’s case, if the Eurozone is to survive it looks like Germany will have to accept more inflation than it traditionally has been willing to do.  It will also bear a large amount of the cost of bailing out profligate Spain and Italy.  (Greece?  It’s too small to matter; my personal bet is that Athens will be eventually expelled from the EU.)

in short

Marketers of bond funds continue to tell us that bonds are a good place to have our money.  If we look at what those managers are doing with any funds we give them, however, we see the best low-risk option they’re able to find is Japan, whose virtue is that losses will probably be minimal.

Another case of:  watch what they do, not what they say.

watch the currencies!–what they’re saying now

September 13, 2012 By in currency effects, Current Market Thoughts, Dividends, economics, Keeping Score, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , , Leave a comment

three key pieces of data for investors

Over the last several weeks, two pieces of information have emerged that have potentially great importance for equity investors.  A third may develop from the US Federal Reserve today.

They are:

1.  the Case-Schiller index, which is very influential in the US, despite being a lagging (also called confirming) indicator of the state of the housing market, has finally signalled that overall residential prices have bottomed and are on the mend.  The five-year slump is over.

Although I think the revival of the housing market gives a second wind to the domestic economic expansion, in the counter-intuitive way Wall Street works, it also has a darker side.  Other than Washington suddenly starting to do its fiscal policy job, which would be a huge positive surprise, it’s hard for me to see what new positive market-moving economic development could happen in the US over the coming months.

2.  The European Central Bank has announced a broad support plan for the bond markets of the weaker members of the Eurozone.  Yesterday, the German high court rejected litigants’ assertions that the German government was barred by that country’s constitution from participating in the plan.  Germany is slated to provide over 25% of the financing of the Eurozone rescue plan, so this decision was crucial.

The implication is that EU economies will be stronger over the coming year or so rather than weaker.

3.  The Fed may announce further unconventional measures today to support the US economy.  The Fed has repeatedly said that fiscal policy would be a much more effective engine to spur growth, but apparently sees about the same chance as I do of that happening.

Two measures are possible.  One is additional bond buying, intended to flatten the yield curve.  The second is a commitment to hold short-term interest rates at today’s emergency low levels for the next three years.  Yikes!  Three more years of nearly no income from CDs and money market funds?

I think the second would  have the more significant effect for Wall Street.  It would give two contrary signals:  it would say that there’s no need to flee the bond market anytime soon; and it would imply that the only liquid investment that will provide significant income for savers any time soon is the stock market.

three places to see their effects 

1.  the performance of general stock markets in their local currencies.

The S&P 500 is up 9% over the past three months.  I think the recovery of house prices, which is the major source of wealth for most Americans, is the main reason.  EU growth should also have a positive rub-off effect on US firms involved in foreign trade, as well as the many S&P firms with substantial operations in Europe.

The Eurostoxx 50 is up 19% over the same span.  Broader indices are up in the mid-teens.  Most of the outperformance of the S&P has come in the past month, when Eurozone rescue plans have been publicized. Dollar-based returns on the EU indices are much larger.

2.  You can also changes in the lists of sectoral winners and losers, as I’ve written about on the Keeping Score page on PSI.   Generally, the US investor has shifted away from defensive sectors toward IT and Consumer Discretionary, two moderately bullish areas, while not to sectors like Materials that would benefit from a strong general economic upsurge.

3.  Most US investors generally ignore the third area–currency movements.  I think it’s certainly true this time.  But from mid-July until now, the € has risen from a value of $1.20 each to $1.29, or 7%.  True, the ¥ has been rising since March, when holder had to pay 84 to get $1.  But it has also recently risen above the 78 level that the Tokyo government had been trying to defend.

To my mind, the Japanese economy still has nothing much going for it.  Seeing that currency rise at all–which normally happens only in a healthy country–really says something.

the message?

If we add a currency gain of 7% to, say, a 14% rise in European stocks, the total return to an American investor in the past month is more than 20%.  If we have indeed made a major turn in the EU, the party is far from over, in my judgment.

Many European stocks still have strikingly high dividend yields–certainly a temptation to income-oriented investors but also a warning of potential risk.

I’ve been advocating having a severe underweight in the EU, with exposure only to companies listed there but with significant operations elsewhere.  I haven’t made any changes yet, but I’ve got to at least reconsider my position.

Conversely, US-listed companies with large businesses in the EU may not be having great local currency sales at the moment, but they’re enjoying a big boost in dollar terms.

The rise in the ¥ tells me that at least a part of what is happening is not foreign currency strength.  It’s dollar weakness.  That may be because of continuing fiscal policy failure here, or just the perception that all the potential good news is already out.

The much greater € strength suggests that real economic improvement is expected in the EU.  I’m still mostly convinced that Greece will be forced out of the Eurozone (and the EU).  But markets may not be willing to wait for this final shoe to drop.

To sum up:  we may be in the early stages of a significant shift in the attitude of global equity portfolio managers about where they want to place their clients’ money.  If so, I think the clearest sign is coming from the currency markets–it’s mildly against the US, strongly for the EU.

Beijing’s renminbi experiment

April 13, 2011 By in Asian economic development, China, economics, Hong Kong, Japanese development, Strategy Tags: , , , , , , , , Leave a comment

emerging market development

The standard road to economic development for emerging economies in the post-WWII era has been to emulate Japan …that is to say, to provide cheap labor and a supportive working environment to foreign firms in return for technology transfer.  To ensure the emerging country keeps its labor cost advantage, it typically pegs its currency to that of its largest target market (read: the US) or to a basket of currencies representing the bulk of potential customers.

As I’ve commented in more detail in other posts, the crucial testing point for this strategy comes when the emerging nation runs out of cheap productive resources.  Usually, the factor is labor–although it could equally be water or something else.  At this point, labor-intensive firms can no longer expand operations by turning farmhands into assembly workers.  They can only grow by poaching workers from each other, causing wages to rise and an inflationary spiral to begin.

letting the local currency rise

The orthodox solution to the problem is to dissolve the peg and allow the local currency to rise.  Doing so lessens or eliminates the labor cost advantage that has helped the emerging nation develop.  In theory, it also forces industry to evolve toward higher value-added production, and requires the labor force to learn new skills.  In practice, allowing the currency to rise is strongly opposed by industrialists who have become wealthy and politically powerful under the existing regime.

The rising currency solution has other characteristics, as well:

–overall growth slows, at least for a time,

–development reorients itself away from export-oriented manufacturing and toward the domestic economy,

–the real earning power of workers rises, but nominal wages do not necessarily change, and

–the real value of asset holdings increases for all.

This last characteristic is especially important.  In a rising currency environment, the wealthy make out like bandits.  Ordinary people get a boost to their earning power, but since they may not hold property or have a large amount of accumulated savings, they probably lose economic ground to the wealthy.

a different route

Of course, currency appreciation is not the only way to raise real wages.  Why not take the direct route and raise nominal wages?  Two considerations:  1) the mechanics of getting this done could be difficult, and 2) whoever mandates higher wages is clearly responsible for the consequences–there’s no possibility of blaming evil currency speculators for any negative effects.

Singapore

I can think of only one instance where an emerging nation tried this route.  Decades ago, when Singapore was primarily a textile manufacturer, the government there raised the cost of labor–through an increase in mandatory employer contributions to the government-run pension plan.  Singapore wanted to encourage higher value-added manufacturing.  What it got instead was textile firms fleeing and a recession–which lasted until the government rescinded the pension payment increases.

Hong Kong

Hong Kong might be seen as another case in point, although the currency peg there was instituted as a political measure–to lessen flight capital in advance of the handover of the former British colony back to Beijing–not an economic one.

The Hong Kong experience, created more by necessity than economic planning, had several important characteristics:

–economic/mobility increased significantly; power shifted quickly from the existing, mostly British, elites to new, mostly ethnic Chinese, players ,

–Hong Kong was forced to become a cauldron of entrepreneurial development, just to deal with the pressure of rising wages,

–nearby Guangdong province benefited greatly from the shift of more labor-intensive manufacturing there.

China

The large across-the-board wage increases for ordinary workers recently mandated by Beijing seem to me to be the clearest signal that China has decided to try to duplicate the beneficial effects of the Hong Kong currency peg.  The eastern seaboard will play the role of Hong Kong, western China that of Guangdong, and the “princelings,” the sons and daughters of former Communist Party leaders, that of the British.

The development of the offshore renminbi market may be a new twist in the plot, but I think that otherwise the story remains the same.  If this is correct, calls for Beijing to allow the renminbi to rise against the US dollar will continue to fall on deaf ears.  From a stock market point of view, the interesting consequence might well be surprisingly strong spending by middle- or lower-end consumers.  The big question is whether to play this through already prosperous retailers or to look for the emergence of new concepts tailored specifically to this audience.  The latter route promises much bigger payoffs; the big problem is identifying the correct stock/stocks to buy.