Tag Archives: economy

thinking about 2016: commodities

October 20, 2015 By in Current Market Thoughts, Portfolio management, Recent Market Action, stock market, Strategy Tags: , , , , , , , , , , 4 Comments

commodities

In the broadest sense, commodities are undifferentiated products or services.  Producers are price takers–that is, they are forced to accept whatever price the market offers.

Commodity products are often marked by boom and bust cycles, that is, periods where supply exceeds demand, in which case prices can plummet, followed by ones where supplies fall short and prices soar.

 

For agricultural commodities, the cycle can be very short.  For crops, the move from boom to bust and back may be as little at one planting season, or three-six months.  For farm animals, like pigs, chickens or cows, it may be two years.

 

For minerals, which right now is probably the most important commodity category for stock market investors, cycles can be much longer.  Base and precious metals have recently entered a period of overcapacity.  The previous one lasted around 15 years.  One might argue that prices for many metals have already bottomed.  I’m not sure.  But I think it’s highly unlikely that they will rise significantly for an extended period of time.

 

Oil is a special case among mined commodities.  Lots of reasons

–the market is huge, dwarfing all the metals other than iron/steel.

–there’s a significant mismatch between countries where oil is produced and where it’s consumed.

–there’s one gigantic user, the US.

–for many years, there was an effective cartel, OPEC, that regulated prices.

To my mind, the most important characteristic of oil for investors at present is the wide disparity in out-of-pocket production costs between Saudi crude ($2 a barrel) on the one hand, and Canadian tar sands ($70? a barrel) on the other.  US fracked oil ($40? a barrel) is somewhere in the middle.  The lower-cost producers have gigantic capacity, and the potential to ramp output up if they choose.  This wide variation in costs makes it very difficult to figure out at what price enough capacity is forced off the market that the price will stabilize.  For example, Goldman, which has an extensive commodities expertise, has argued that under certain conditions crude might have to fall to $20 a barrel before it bottoms.

 

The oil and metals situation is important for any assessment of 2016, because:

–about 25% of the earnings of the S&P come from commerce with emerging markets, many of which depend heavily on exports of metals and/or oil for their GDP growth

–the earnings for about 10% of the S&P 500–the Energy, Materials and Industrials sectors–are positively correlated withe the price of metals and oil.

–a low oil price is a significant economic stimulus for most developed countries, meaning margins expand for companies that use oil as an input  and consumers spending less on oil will have more money left to spend elsewhere.

As a result, one of the biggest variables in figuring out earnings fo the S&P next year will be one’s assumptions about mining commodities prices, especially oil.

 

More tomorrow.

 

 

the Fed’s rate rise dilemma

October 15, 2015 By in Current Market Thoughts, economics, emerging markets, Federal Reserve Tags: , , , , , , Leave a comment

It’s looking more and more to me as if the Fed is being paralyzed into inaction by worries about two possible negative effects of beginning to raise rates now.  The dilemma is that the current zero interest rate policy is playing a large role in making each situation worse.

 

The IMF is arguing that economies in the emerging world are too fragile at present to withstand even a small rate rise in the US.  The agency points out that many emerging economies are very dependent on dollar-denominated natural resources, and therefore are being hurt badly by the current slump in demand for minerals.  In addition, many have borrowed heavily in US dollars to finance industrial (read: natural resources) capacity expansion.  Even a small rise in US interest rates, the IMF says, could spark a sharp upward spike in the value of the dollar against other currencies.  This would further dampen demand for natural resources.  At the same time it would make the local currency cost of dollar-denominated loans skyrocket, possibly into impossible-to-repay territory.  In other words, the Fed could trigger an emerging market crisis similar to the one in smaller Asian countries in the late 1990s.

Of course, what made natural resources firms so foolish as to create wild overcapacity?   …one big reason has been the availability of cheap (by historical standards) dollar-denominated loans.   What has prompted (and continues to prompt) US investors (among many others) to take the risk of lending crazy-large amounts of money for projects in places they know nothing about and for projects they didn’t understand   …years and years of low interest rates on Treasury securities and other safe alternative caused by the Fed’s intensive-care low rates.

 

The Fed has carefully studied the failure of Japan in the early 1990s to reignite economic growth after its economic meltdown in late 1989.  The key factor there, in the Fed’s view (mine, too, for what that’s worth) was that the country tried to remove policy stimulus too soon.  The Fed knows that it has already used up all its economy-healing power, so the country would be reliant on Washington for fiscal stimulus to rescue us in the event it makes a similar mistake.  But we all know that Congress has a poor track record for corrective action in crisis and is particularly dysfunctional now.  So the price to the economy of acting too soon could be very high.

How is it, though, that Congress has been able to ignore its economic responsibilities for so long?  …it’s at least partly due to the fact that the Fed continues to cover for lack of legislative action by running a super-easy monetary policy.  The Fed is an enabler.

 

my thoughts

Neither threat to policy normalization–the potential effect on emerging markets and the lack of an economic backup–is going to go away.  Arguably, the situation will deteriorate the longer the Fed waits.  I think the Fed should start the normalization process now.

3G acquiring Heinz, Kraft, Anheuser Busch, SAB Miller: the common denominator

October 14, 2015 By in Consumer Staples, Current Market Thoughts Tags: , , , , , Leave a comment

What attracts Brazilian takeover specialist 3G to mature companies in low/no growth industries?

Three features are right out of a finance or marketing textbook:

–the target firms are priced at modest multiples of earnings in the stock market, that reflect the consensus assumption that earnings growth will be hard to come by.  So there’s money to be made if 3G knows that assumption is too pessimistic.

–in an industry that has two giant competitors with, say, 25% of the total market each, and then a bunch of firms with no more than 5% each, the two leaders will continually knock heads with one another.  Both have large absolute market shares but no relative market share advantage against one another.  If 3G already owns one (as is the case with Kraft and SAB Miller) and the two combine, even if they are forced to divest assets to avoid antitrust objections , the post-merger industry structure will be something like one 40% giant and a (possibly larger) bunch of 5% midgets.  The one giant will have 8x the market share of its nearest rival–a huge competitive advantage.

–in mergers like Kraft/Heinz and AB InBev/SABMiller, there’s lots of duplication in SG&A that can be eliminated

 

There’s a fourth reason that doesn’t get talked about much, but which I think is much more important than the other three–

–at the end of WWII, victorious troops returned to the US and began fashioning the “modern” American corporation, the structure that most mature publicly traded enterprises still maintain.  A basic building block was the idea of span of control, or the maximum number of people who any manager could effectively supervise directly.  That number was seven.  So if a firm had 7,000 workers performing essential company tasks, they would need 1,000 first-line supervisors.  Those would, in turn, require 70 second-line supervisors, who would be controlled by 10 third-line managers…

Of course, that was in combat.  And that was before copiers, fax machines, television, cheap landlines, personal computers, cellphones or the internet   …and when most workers had far less training/education than today.

In addition, in the army, a lieutenant would be in charge of 30 people, a captain 150, a lieutenant colonel a thousand.  So it was an easy conceptual step to associate importance in the company hierarchy with the number of people under a manager’s purview.  But this means that if a manager opts to run a department more efficiently with fewer people he risks losing status in the firm.  So no one does this.  Instead, managers want to have more subordinates, even if they’re underutilized.

So these companies tend to be bloated with non-productive labor.

 

To address again the question of what 3G does…

…it looks for companies that still cling to a seventy five-year old business model that internal bureaucracy keeps in place, and modernizes it.  It looks for the 15% – 20% extra people the target firm employs and lays them off.  It also sells the corporate art collection or the polo club a former chairman persuaded the board to allow him to buy.  It installs zero-based budgeting, meaning managers are required to justify all expenses each year, not just new ones.  By this time, it doubtless has a good idea going in of where to look for fat.

To my mind, the surprising thing is that this pre-technology corporate structure has lasted so long past its sell-by date.  3G is willing to be a catalyst for change because it sees the immense profits that can be made by doing so.

 

should corporate stock buybacks be banned?

August 19, 2015 By in stock buybacks, Tobin's q Tags: , , , , , , Leave a comment

This is becoming an election issue.

Elizabeth Warren, deeply suspicious of anything to do with finance, regards them as a form of stock manipulation.

Many more mainstream observers note that $7 trillion (according to the New York Times) spent on buybacks by S&P 500 companies has consumed a large chunk of their cash flow at a time when both wage growth and new investment in physical plant and equipment in the US have been paltry.  They argue, without further elaboration that might have the argument make some sense, that the latter are being caused by the former.  Therefore, they think, if only stock buybacks were eliminated, employment and wages would rise and the US would reemerge as a global manufacturing power.  I imagine the same people are saving their old calendars in case 1959 should come back.

There are instances where, in my view, stock buybacks are clearly the right thing to do.  Imagine a publicly traded company that has a profitable business that generates free cash flow, and that has no liabilities plus $1 billion in cash on the balance sheet.  Let’s say the firm’s total market capitalization is $500 million.  In this situation, which actually happened for a lot of companies in 1973, stock buybacks would accommodate shareholders who wanted to liquidate their holdings and create $2+ in value for remaining shareholders for every $1 spent.  I can’t see any reason to outlaw this.

There are also cases—IBM comes to mind–where continual buybacks make investors think that this is all the firm has left in the tank.  So though buybacks keep on generating increases in earnings per share, by shrinking the number of shares outstanding, they no longer support the stock price.  The generate selling pressure instead.  In theory, and provided management understands it can’t play with the big boys any more, the firm should liquidate and return funds to shareholders rather than to continue to destroy value.  Like that’s ever going to happen.  But investors will vote with their feet.  While maybe management conduct should be different, I can’t see how that could be legislated.

My big beef with stock buybacks is that the main purpose they serve is to disguise the gradual transfer in ownership for a company from shareholders to employees that happens in every growth company (more about this tomorrow).  This could be/ should be made clearer.

I also think managements should show more backbone when “forced” into buybacks to satisfy activist investors, in what is the 21st century equivalent of greenmail.

But the idea that barring stock buybacks will cause corporations to make massive capital investments in advanced manufacturing in a country that has a sky-high 35% corporate tax rate, a shortage of skilled labor and rules that bar a firm from bringing in needed technical and management employees from outside is loony.  It isn’t clear to me that removing legislative impediments to investment will be enough to roll back the clock and make the US a manufacturing power.  It isn’t clear, either, that we should want to return to an earlier stage of economic development.  But outlawing buybacks won’t achieve that goal.

Georgetown: Good Jobs Are Back

August 18, 2015 By in economics, employment, Employment Situation report, median incomes, wage gains Tags: , , , , , , , Leave a comment

Georgetown University’s Center on Education and the Workforce published an interesting analysis on the growth of employment during recovery from the recent recession.

The report counters what it describes as media portrayals of the recovery as being built on the creation of low-playing, low-skilled, benefitless, no-advancement positions as, say, baristas, Uber drivers and hamburger flippers.  Georgetown points to both the New York Times and the Wall Street Journal as among the culprits, citing articles written from 2012-15.  While this characterization may have been true in 2008-2009, the opposite has been the case during the five years since.

Over the past half-decade, job growth has been driven by “good jobs,”  which Georgetown defines as being in the upper third of their occupations by median wages.  Such positions pay $53,000/ year, or 26% more than the median for all full-time workers.  86% of “good jobs” are full-time, 68% offer health care benefits and 61% an employer-sponsored retirement plan.  Such benefits are typically add 30% in ecnomic value in addition to wages.

How can the media have been so wrong?

It’s because reporters have examined employment data by industry–looking at the types of products and services provided–rather than by the position being filled.  In other words, the reporters ended up counting a software engineer, an accountant or a marketing executive hired by Starbucks as a barista.

Looking at positions instead of industries, paints a different picture.

“Good jobs” have accelerated sharply since 2010.  Comprising 2.9 million out of 6.6 million total new jobs, they are dominating the recovery.  There are more “good jobs,” and more low-paying ones, today than there were in 2008.  Middle-wage jobs, however, are still 900,000 below their pre-recession levels (no explanation given by Georgetown for this).

 

The Georgetown report also shows that from 2010 on, workforce participants without at least some college have actually lost jobs across all wage categories–high, average and low–even though employment was expanding rapidly.  There are 39,000 fewer workers in “good jobs” who have high school diplomas or less (during a period when 3.1 million net new employees were hired), 280,000 fewer in average-paying jobs (2.1 million hired), and 159,000 fewer in low-paying ones (1.9 million hired).  It’s unclear how much of this replacement is due to employees upgrading their credentials, how much to changes in the labor pool, how much to changes in hiring practices…  In addition, college graduates made up 97% of the “good job” hires, 62% of the average-job hires and 39% of the low-paying hires.

 

I’m mostly interested in the economic implications of the Georgetown study.  But I find the report’s comments (p. 6) on the implausibility of the media articles to be interesting, and a little disturbing, as well:

“We find these media stories to be counterintuitive because they disagree with the well-established cyclical patterns of economic behavior. The consensus among economic researchers is that the economy has seen a strong shift toward college-educated workers since the early 1980s. The long-term shift in hiring, the increased economic value added, and the wage premium of college workers have persisted and strengthened for more than 30 years in periods of both recession and recovery. If the reports that the economic recovery was only producing low-wage, low-skill college jobs were true, they would suggest a profound reversal of structural trends in technology and globalization in place for decades. This seems unlikely given the weight of continued evidence to the contrary.”

I read this paragraph as addressing the issue of whether reporters just wrote pieces off the top of their heads or whether they may have simply been repeating the results of interviews with informed sources in the world of economics or government.  Georgetown seems to be saying pretty strongly that no credible person could possibly have told them anything remotely like they were printing.