Tag Archives: emerging markets

Shaping a portfolio for 2015: elaboratng on yesterday’s post

December 16, 2014 By in characteristics of their financial markets, emerging markets, Shaping a portfolio for 2015, Strategy Tags: , , , , Leave a comment

A reader had two questions about yesterday’s post, which I figured it would be easier to answer here than simply in a comment.

emerging markets

The big attractions of emerging economies to an equity investor are the possibility of very rapid economic growth for the country and of finding future titans of world industry as infants.  The two standard paths of gaining exposure to these markets are: to invest directly or to buy a developed-world multinational with significant presence in the economy in question.

Some emerging markets aren’t open to foreigners.  For those that are, the most important thing to realize, I think, is that there is typically little local support for stocks.  There are usually no pension funds or other local institutional investors (because there are no pensions and residents aren’t wealthy enough to afford financial products like insurance).  Local citizens don’t have enough money to be able to own stocks.  As a result, emerging market performance ends up being heavily dependent on foreign inflows and outflows.

Foreign flows can be very cyclical.  When developed market investors are feeling confident, inflows to emerging markets are typically very large.  When they’re scared, outflows are the order of the day.  Because there’s little local buying power, these outflows invariably cause sharp price declines.

Right now, oil-exporting emerging markets are being hurt very badly by the declining price of crude.  investors are also worried that emerging markets-based companies may have borrowed excessively, in US$, during the past few years of easy credit.  Such debts were a big factor in the crisis in emerging Asian markets that started in 1997.  In fact, today’s developments in Russia sound a lot like what happened in Malaysia in the late 1990s.

Yes, emerging market will eventually settle out.  I don’t think we’re anywhere close to that point, though.

rent vs. buy

Take Adobe.   Say you’re a web designer who wants to start a business on your own and that you want to use Adobe tools.

Buying a Creative Suite package to get started used to cost $2,500 – $3,000.  That’s a lot.

Many people would do one of two things:

–bite the bullet and buy, but never, ever upgrade; or

–find a bootleg copy on Craigslist for $200 or so.  Yes, it would probably stop working after six months, but it was cheaper than getting an “official” copy.

How many people took the second route?   I don’t know  …but probably a lot. I once heard Bill Gates estimate that 40% of the small business users of Office in the US were using counterfeit copies

Adobe has now gone over to a rental model.  $50 a month gets you access to the Creative Cloud version of all the Adobe tools.  The same sort of thing for photographers–$10 a month for Photoshop + Lightroom, vs. $600 to buy  (Amazon is selling the last disk version of Photoshop for $1500).

The plusses:

–the move from buy to rent changes a big one-time capital expenditure by a small business customer into an affordable monthly operating expense.  If users stay subscribers for at least five years, Adobe gets more money from rental than from a sale.

–Just as important, matching the tool expense more closely with customer cash flows is bringing a whole bunch of former illegals into the fold

–the company may also be attracting casual photography users who would never before have contemplated using Photoshop, but for whom $10 a month isn’t a big deal

–subscriber growth has continually exceeded consensus expectations.

The rental model isn’t exactly new.  It has been used for all sorts of equipment for years, from copiers to burglar alarms to colonoscopes.

What surprises me is that Wall Street has been so slow to figure out that the rental model works for software, too.  Yes, in the early days, the accounting looks ugly.  In fact, the faster the transition to rental goes, the uglier the income statement looks.  Development expenses remain the same, but instead of chunky sales revenue, the company only shows subscription payments for that month.  But professional analysts should be able to see past that.  My guess is that they miss completely the bootleg copy phenomenon.

 

 

 

 

 

Shaping a portfolio for 2015 (vi): the rest of the world

December 11, 2014 By in Asian economic development, bond market, China, emerging markets, EU financial crisis, frontier markets, Hong Kong, Japanese development, Portfolio management, Shaping a portfolio for 2015, stock market Tags: , , , , , , Leave a comment

world GDP

A recent World Bank study ranks the largest countries in the world by 2013 GDP.  The biggest are:

1.   USA         $16.8 trillion

2.  China         $9.2 trillion

3.  Japan          $4.9 trillion

4.  Germany          $3.6 trillion.

The EU countries taken together are about equal in size to the US.

stock markets

From a stock market investor’s point of view, we can divide the world outside the US into four parts:  Europe, greater China, Japan and emerging markets.

Japan

In the 1990s, Japan choked off incipient economic recovery twice by tightening economic policy too soon–once by raising interest rates, once by increasing its tax on consumer goods.  It appears to have done the same thing again this year when it upped consumption tax in April.

More important, Tokyo appears to me to have made no substantive progress on eliminating structural industrial and bureaucratic impediments to growth.  As a result, and unfortunately for citizens of Japan, the current decade can easily turn out to be the third consecutive ten-year period of economic stagnation.

In US$ terms, Japan’s 2014 GDP will have shrunk considerably, due to yen depreciation.

If Abenomics is somehow ultimately successful, a surge in Japanese growth might be a pleasant surprise next year.  Realistically, though, Japan is now so small a factor in world terms that, absent a catastrophe, it no longer affects world economic prospects very much.

China

In the post-WWII era, successful emerging economies have by and large followed the Japanese model of keeping labor cheap and encouraging export-oriented manufacturing.  Eventually, however, everyone reaches a point where this formula no longer works.  How so?    …some combination of running out of workers, unacceptable levels of environmental damage or pressure from trading partners.  The growth path then becomes shifting to higher value-added manufacturing and a reorientation toward the domestic economy.  This is where China is now.

Historically, this transition is extremely difficult.  Resistance from those who have made fortunes the old way is invariably extremely high.  I read the current “anti-corruption” campaign as Beijing acting to remove this opposition.

I find the Chinese political situation very opaque.  Nevertheless, a few things stand out.  To my mind, China is not likely to go back to being the mammoth consumer of natural resources it was through most of the last decade.  My guess is that GDP growth in 2015 will come in at about the same +7%or so China will achieve this year.  In other words, China won’t provide either positive or negative surprises.

For most foreigners, the main way of getting exposure to the Chinese economy is through Hong Kong.  Personally, I own China Merchants and several of the Macau casinos.  The latter group looks very cheap to me but will likely only begin to perform when the Hong Kong market is convinced the anti-corruption campaign is nearing an end.

EU

In many ways, the EU resembles the Japan of, say, 20 years ago.  It, too, has an aging population, low growth and significant structural rigidity.  The major Continental countries also have, like Japan, strong cultural resistance to change.  These are long-term issues well-known to most investors.

For 2015, the EU stands to benefit economically from a 10% depreciation of the euro vs. the US$.  As well, it is a major beneficiary of the decline in crude oil prices.  My guess is that growth will be surprisingly good for the EU next year.  I think the main focus for equity investors should be EU multinationals with large exposure to the US.

emerging markets

I’m content to invest in China through Hong Kong.  I worry about other emerging Asian markets, as well as Latin America (ex Mexico) and Africa.  Foreigners from the developed world provide most of the liquidity in this “other” class.  If an improving economy in the US and higher yields on US fixed income cause a shift in investor preferences, foreigners will likely try to extract funds from many emerging market in order to reposition them.  That will probably prove surprisingly difficult.  Prices will have a very hard time not falling in such a situation.

 

why the oil price will continue to be weak

October 22, 2014 By in Energy, Industry Analysis, Mining, oil and natural gas, Recent Market Action, shale oil and gas, Strategy Tags: , , , , , Leave a comment

supply and demand

In the short term (read:  for now and for some vague time into the future), demand for oil is pretty constant, no matter what the price (i.e., demand is inelastic).   People need to fuel their cars and heat their homes.  Industry needs to generate electric power and keep factories humming.

The supply of oil is similarly inelastic, for two reasons:

–major oilfields are mammoth, expensive, multi-year capital projects.  Engineers get underground oil flowing toward wells at what they calculate to be the optimal rate to drain the entire deposit.  Changing that rate once the oil is moving can mess things up so that lots of oil gets left behind–meaning having to do expensive and time-consuming extra drilling to recover it.

–a macroeconomic look at OPEC’s oil-producing countries, especially in the Middle East, is a real eye-opener.  These nations typically have large young populations and more or less no economic activity other than oil.  In my cartoon-like view, they have tons of high school graduates entering the workforce each year and nothing to offer them but make-work “jobs” funded by oil money.  Keeping the political status quo ultimately requires that the oil keep flowing.  According to the Wall Street Journal, the budget breakeven oil price for Iran, for instance, is $140 a barrel and Saudi Arabia’s is $93.  (This isn’t an immediate do-or-die thing, though.  Countries can use savings, borrow or sell assets to bridge a budget gap for a while.)

recent history

Over the past decade or more, supply and demand have been close to being in balance, with China’s strong economic growth giving prices an upward bias.

China is now trying to halt the proliferation of low value-added, energy-wasting industry, so this source of extra demand is fading.  More important, the advent of oil extraction from shale in the US has raised world oil supplies by about 6%, or 5 million barrels a day over the past five years.

Given that demand is relatively constant, the only way to get buyers for this extra oil is to cut prices.  This is what’s happening now.

revisiting the 1980s

There’s lots of ugly history of colonial exploitation of Middle Eastern oil producers in the 1970s and before.  Let’s skip over that, in this post at least.

During the 1970s, OPEC pushed the price of a barrel of oil from under $2 to around $25.  By the start of the 1980s, the association was clearly divided in to two camps.  One wanted to maintain the highest possible current price (which had risen to around $35 for the easiest oil to refine).  The other, led by Saudi Arabia, the largest OPEC producer, feared users would find substitutes for oil, diminishing the long-term value of their vast untapped reserves.  It wanted prices at, say, $15 – $20 a barrel.

Saudi Arabia decided to force its will on the other camp by unilaterally raising production to stabilize prices.  However, a long and deep global recession soon began (partly caused by higher oil prices, mostly by the Fed’s decision to raise interest rates sharply to choke off runaway inflation in the US).

Saudi Arabia then reversed course and began to cut production, again to defend its preferred price level.  Other OPEC nations agreed to reduce production as well, but by and large never did.  Prices eventually bottomed at about $8 a barrel.

The point, though, is that the Saudi attempt to act as the “swing” producer by raising and lowering its output in order to stabilize prices, didn’t work out.  All that happened was that Saudis absorbed a huge amount of the pain of the price decline, allowing its OPEC rivals to prosper, in a relative sense at least.

today

I think Saudi Arabia learned from its experience in the early 1980s that unilaterally reducing production doesn’t work.  Besides, unlike in the early 1980s, it needs its current coil income to balance its budget.

Shale oil production will continue to grow, if nothing else simply from projects begun a few years ago.

As a result, I think the oil price will drift lower, either until a healthier world economy increases demand, or until lower prices force high-cost oil producers to shut down.  We’re a long way from the latter happening.

Bad for oil producers–in fact, energy producers of any stripe, great for everyone else.

oil? ebola? the dollar?–why stock prices have been falling

October 14, 2014 By in Consumer Staples, Current Market Thoughts, economics, emerging markets, Energy, EU financial crisis, Industry Analysis, Mining, oil and natural gas, Securities regulation, shale oil and gas Tags: , , , , , , , , , 4 Comments

In many ways, stock market commentators have an unenviable task.  At any given moment they have to come up with new and interesting reasons why stocks are rising or falling.   The media gurus’ difficulties are compounded by the fact that most are story presenters who have little understanding of investing and are therefore reliant on sources whose statements are many times influenced by their own private agendas.

After peaking in mid-September, US stocks have fallen by about 7% through yesterday/  This has erased most of their year-to-date price gains, although with dividends factored in the S&P is still up about 4% since New Year’s Day.

Among the current “explanations’ for the fall are:

–a falling oil price.  I don’t think this makes sense.  It would be one thing if world GDP were turning negative and demand were sagging as a result.  The current issue, however, is oversupply, being caused by the rise of shale oil/gas production in the US.

Yes, 10% of the S&P 500 consists of oil-related stocks, many of which are hurt by lower prices.  But, to simplify a bit, the other 90% of the index is a beneficiary.  Lower prices are bad for oil-producing nations in the Middle East, for Russia and for the rest of OPEC.  But they’re great for consumers.

Another point:  today’s production contracts with national oil companies provide that virtually all revenue from oil price increases above a certain level goes to the host country, not to the international oil firm that is developing the petroleum deposits.  Although this has been true for decades, my sense is that many investors still don’t get this.  The dynamic is much more consumers gain/emerging countries lose than the consensus thinks.

–ebola.  More about this tomorrow.  Ebola is scary.  The only model we have for what happens to stocks once investors become aware of pandemic possibilities is SARS.  On the other hand, Doctors Without Borders has been handling ebola patients for many years without a single infection of their own.  In my view, stocks would be way lower than they are today if investors viewed ebola a real threat.

–the dollar.  This is an issue, although almost no one is talking about it. The US dollar has risen against the euro by almost 10% since early May.  In back-of-the-envelope terms, 25% of the earnings of the S&P 500 is sourced in euro.  A 10% fall in the dollar value of the euro means that overall S&P earnings–without factoring in current Euroland economic weakness–will be 2.5% lower than previously thought.  Discounting this outcome would explain about half the recent market decline.

my take:

–technicals.  At the peak a few weeks ago, stocks had already discounted all the S&P earnings growth that’s likely for 2014.  In addition, the market had already also factored into prices, let’s say, a third of the expected earnings growth for the index next year. This is normal market behavior, granted, though, that we haven’t seen “normal” for the better part of a decade.

By September, potential short-term buyers couldn’t justify paying higher prices for stocks.  In addition, euro weakness + a lot of other miscellaneous stuff had put 2015 profits under threat.

We’re now in the process of determining how low prices have to go to bring buyers back.

Looking at past levels where lots of buying and selling has taken place ends up being a surprisingly effective tool for figuring out where buying will emerge again.  Don’t ask me why.  If this rule of thumb holds true, as I read the charts the key levels are 1840-80 (i.e., where we are as I’m writing this) and 1800.

Hilton selling the Waldorf Astoria for $1.95 billion

October 8, 2014 By in Asian economic development, China, economics, Industry Analysis, Lodging Tags: , , , , , Leave a comment

The day before yesterday, Hilton (HLT) announced it had agreed with Anbang Insurance Group of China to sell the Waldorf, the flagship of the Hilton chain, to the five-year-old mainland financial conglomerate for $1.95 billion.  Hilton will retain an unusually long 100-year management contract to run the hotel (terms not disclosed).  The Hilton will also undergo a substantial facelift “to restore the property to its historic grandeur”  (no details on how much or who’s paying).

When I began following the US hotel industry as an analyst in the early 1980s, US hotel firms were just beginning to transform themselves from owners of hotel properties into managers of hotels owned by others.

Why do so?

–Historically, ownership of hotels has been a low-return enterprise that ties up immense amounts of capital.

–In my experience, hotel management contracts involve the manager taking large slices of the property’s revenues, cash flow and profits–leaving the owner with tax benefits (e.g., depreciation) and the possibility that the property will increase in value.

As I see it, hotel owners fall into one of several categories:

–local businessmen who want the prestige of saying they own the town’s name-brand hotel/motel, and who prize potential tax writeoffs highly

–billionaires who want the same thing, only with iconic properties

–flight capital, where the owner’s interest is less with potential return than with the presumed safety of having “just in case,” non-portable assets located abroad

–national champions, that is, institutions that either officially or semi-officially represent their home governments and who are signalling their country’s rising status.

 

I see Anbang as falling into the last of these categories.  Its justification to itself likely also includes geographical diversification and its perception that real estate investment opportunities on the mainland are not as attractive as the Waldorf.  IN its defense, Anbang can arguably also make more imaginative use of a city block in a prime section of Park Avenue than Hilton has been able to.

All in all, though, recent Chinese deals for Manhattan real estate mostly call to mind the top-of-the-market foray of Japanese firms into Manhattan in 1989 (think:  Rockefeller Center, which turned out pretty badly for Mitsubishi Estate).