Tag Archives: emerging markets

thinking about 2016: currencies

October 22, 2015 By in Basic Concepts, currency effects, Strategy Tags: , , , , , , , Leave a comment

There’s no overall theory of how world currencies interact with one another.  Rather, there’s  patchwork of general relationships.  I find two most useful:

—general creditworthiness, or would I lend money to these guys (WILMTTG)?.

Another way of asking the same question is whether a country can generate enough foreign exchange to pay for its imports and meet the minimum service requirements on its foreign borrowings.  A “No” answer means trouble.

Natural resources-oriented emerging countries, both in the Middle East and in Latin America, are going to flunk this test, suggesting that for them currency depreciation is in store.

—relative interest rates 

Generally speaking, countries where interest rates are rising will have stronger currencies than those where rates are stable or falling.

This rule suggests that the US$ will continue to rise against the euro, yen renminbi and emerging markets currencies–meaning just about everything.

 

As a practical matter, domestic stock markets seem to work best when a currency is stable or depreciating slightly.  A rising currency, because it lowers the domestic currency value of foreign earnings, acts as an earnings headwind.

 

I’ve found that the currency markets–read: traders in the big multinational commercial banks–are always three or four steps ahead of me in figuring out where currencies are going.  For equity investors, there may also be an issue of how the companies whose stocks they hold are acting internally to hedge their foreign currency exposure.

Typically, this second isn’t as big an issue as it might seem at first.  Stock markets most often understand that hedges now protecting profits will soon expire and, in consequence, pretty much ignore the earnings per share generated by hedging.

The question of what’s already baked in the currency trading cake is a more serious one.  It has me questioning whether any interest rate rises that may come in the US next year aren’t already factored into today’s currency rates.

my conclusions

The US$ will be flat to up vs. all other currencies next year.

The yen will be down, on my “No!” answer to the WILMTTG question.

Emerging market currencies will generally be weak.

The renminbi will be flattish, on weak relative rates but “Yes to WILMTTG.

Too soon to act on, but will the euro be stronger in the second half?

stock market implications

All other things being equal, companies with costs in weak currencies and revenues in strong currencies will have the best financial results.

Multinational companies based in the US with exposure to natural resources emerging markets may do poorly.

Those with EU exposure may show slim growth, if any, in their operations there in the first half.  Better news in the second?

As a general rule, when the domestic currency is rising, look for purely domestic companies and for importers.

 

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.

 

 

thinking about 2016

October 19, 2015 By in Current Market Thoughts, Long-term themes, Recent Market Action, Strategy Tags: , , , , , , , , Leave a comment

At present, world stock markets appear to me to be obsessively focused on the smallest details of the here and now.  This may be fine for short-term traders, but getting caught up in this mindset is the surest recipe for trouble for us as long-term investors.  Our biggest advantage against professional traders is taking a longer view.

So it makes sense that we should be shifting our focus toward the new year, even though (actually, because) I think the markets have yet to do so.

My thoughts (which will be presented in more detail in my yearly strategy posts in a few weeks):

interest rates

Rates will be somewhat higher a year from now than today.  The Fed, however, has made it clear that the journey back from emergency-low rates to normal–that is to say, from zero to perhaps 2% for overnight money–will take years.  In theory, higher rates make fixed income relatively more attractive to investors than stocks, mimplying that the stock market suffers price-earning multiple contraction.  I’ve written a number of times, and I still believe, that virtually all of this contraction has long since been factored into today’s stock prices.  Even if this is incorrect, next year’s rise is going to be quite small.  Absent a crazy panic, the potential headwind from PE contraction is likely to be extremely small.  

world economies

–the US will continue to be strong

–the EU has bottomed and will gradually strengthen, so next year will be better than this

–China ‘s transition from export-oriented growth to expansion led by domestic consumer spending is happening at a satisfactory pace.  While traditional economic indicators, which are generally speaking all focused on exports (the wrong place to look), continue to be ugly, overall economic growth next year will be at least as good as in 2015

–natural resource-producing emerging countries will continue to have troubles.  The main issue will not be lower commodity prices.  It will be dealing with excessive debt taken on when companies/governments believed in a perpetual commodities boom, and adjusting private/government spending downward to deal with lower levels of commodity income.

 

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.

vendor financing and Carly Fiorina

September 23, 2015 By in Uncategorized Tags: , , , , , , Leave a comment

prelude

The leaders in the race for the Republican presidential nomination are both deeply flawed business people.   Both are brilliant marketers.  Both are, paradoxically, running–successfully–on their “records” in business, something that alternately bemuses and appalls the financial community.

The Trump case is complex: excessive use of leverage that all but destroyed the family real estate business in the late 1980s, followed by a successful decades-long struggle to rebuild what was lost.

The Fiorina record is less so:  her tenure at Hewlett-Packard is best summed up by the fact Fortune magazine points out that HPQ stock gained almost $3 billion in market value the day she was fired.

As her poll numbers continue to rise, however, attention is beginning to shift to Fiorina’s tenure at Lucent, a spinoff from ATT that included Bell Labs and ATT’s telecom infrastructure business.  Lucent was a stock market darling in the late 1990s, but collapsed in the early 2000s under an accounting scandal surrounding vendor financing.  Fiorina, who became CEPO of HPQ in 1999, was long gone by then.  But the question is beginning to surface as to what role she played in promoting vendor finance at reckless levels before she left.

So I figured I’d write about what vendor financing is.

vendor financing

I’ve found that a good way of gauging competitive strength is by looking at how quickly a company gets paid for its goods or services.   On the positive end of the conceptual spectrum is the firm that gets paid in full before it makes or delivers stuff.  On the far negative side is the outfit that either gives its products/services away or pays you to take them.

Vendor financing falls much nearer to the negative pole.  It isn’t simply giving customers 180 days to pay.  Vendor financing is long-term loans given to customers by a firm to induce the purchase of that company’s very expensive capital equipment.  In Lucent’s case, vendor financing involved multi-billion dollar deals for telecom infrastructure equipment.

At first blush, there’s nothing wrong with this.

The company providing vendor financing may have a lower borrowing cost than a customer.  So one could argue that this is a relatively harmless way of providing a product discount.  In addition, the fact that a customer doesn’t have to line up bank financing makes it easier for a super salesman to close deals–and lock up clients–in a very short time.  In the land rush to stake out territory in the fast-growing mobile phone infrastructure, it became a staple of dong business in Europe and emerging markets in the 1990s.

Even in its most benign form, however, vendor financing has issues.

It makes company profits look better than they otherwise would be.  Let’s say, for example, my list price is 100, on which I earn an operating profit of 50.  If my customer asks for a discount of 10 to seal the deal, my sale would be 90 and my profit 40.  If I counter with 100 plus cheap long-term financing, then I still show sales of 100 and a profit of 50, even though I’m giving a discount.  The loan I provide simply sits on the balance sheet and has no effect on profits.  So I’ve hidden the discount and inflated my profits.

Like most financial things, vendor financing didn’t remain in its benign form for long.

Telecom vendors soon began offering financing to firms that wouldn’t be able to arrange commercial bank loans.  Then they began to offer loans that would be impossible for customers to repay  …and/or for more equipment than they could ever possibly use.

Lucent was eventually charged by the SEC with accounting fraud.

 

In an extremely carefully written article on the front page of the New York Times yesterday, Andrew Ross Sorkin reports that Fiorina was involved with a multi-billion dollar Lucent vendor loan to a company called PathNet that had less than $1.6 million in annual revenue (shades of Solyndra)–something that came up in her unsuccessful Senate run in California.