Tag Archives: EU

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.

 

looking for patterns

October 21, 2014 By in Constructing a Portfolio, Current Market Thoughts, economics, Portfolio management, Recent Market Action, Stock ideas Tags: , , , , , , , , , 2 Comments

Yesterday I wrote that the recovery that follows a sharp stock market decline is an important time to look for changes in the kinds of stocks that investors are eager to buy and the ones they’re happy to dump overboard.  I’m not sure why take place at these market inflection points, but the very often do.

Step one in trying to detect new patterns is for each of us to examine our own holding to see what’s happening with them.  We’re not just looking for under performance/outperformance during the downdraft.  We’re basically looking for two kinds of outliers:  stocks that underperformed on the downside and are continuing to underperform (bad!); and for stocks that outperformed on the way down and that are continuing to outperfrom now (very good!).

Step two is to widen our search to try to get a feel for what the overall market is thinking.  The way of doing this that I find most useful is to try to imagine the general economic situation the world is in and what kinds of stocks should be winners/losers if my picture is right.  Then I look at the stocks themselves to see whether their price movements confirm my thoughts or not.  Then I adjust if needed and repeat.

The most difficult situation is one where I’m 100% convinced I’m right but the stocks say otherwise.  This is rarely the case, in my experience.  At least someone has already picked up on a major investment theme before me.  But that’s okay.  A trend may last for years.  If I’ve missed the first three months it’s not a big deal.  Besides, being the only one in the restaurant has a kind of eerie feel to it.  If I’m thoroughly convinced I’m right, I’ll probably take a small position and prepare myself to add more quickly as other diners come through the door.

what I’m looking for now

The world is still in a slow recovery from the Great Recession.  The US is doing fine, given dysfunction in Washington.  China has structural change issues that have it growing at a “mere” 6% – 7% or so.  On the other hand, the warts in Abenomics in Japan are showing themselves and the EU is starting to look a lot like Japan of the 1990s.

Four big macro changes over the past, say, six months:

–China has been much more persistent than I had thought possible in trying to steer its economy away from low value-added export-oriented manufacturing toward higher-end businesses aimed at a domestic audience.  This changes the composition of growth, but is good, in my opinion.

–The EU is flirting with recession again.  The biggest culprit is France.  This is bad.

–Energy prices are falling–a lot.  This is bad for energy producers, great for everyone else.

–I had expected world growth developments to express themselves mostly (exclusively?) through changes in stock prices, with the US going up and the rest going sideways.  Instead, the principal expression has been through changes in currency values. This makes a difference.  A higher dollar slows economic gains in the US in much the way an increase in interest rates would; the fall in the euro acts as a (desperately needed) stimulus for the EU.

So, I expect…

1.  Slow GDP growth means secular growth stocks will do well, cyclical value stocks (much) less so.  Long Millennial/short Baby Boom ideas may be the best.

2.  Companies with costs in euros or yen but revenues in dollars stand to be big winners from recent currency moves.  So too companies with assets in the US.  Assets or earnings in the EU or Japan are now worth less in dollars than they were earlier in the year.

3.  The energy situation has a lot of moving parts (more tomorrow).  The clear winners are energy users.  The clear losers are the oil-producing countries where the deposits are controlled by national oil companies (think: Latin America, Africa).

Once I publish this, I’m going back to see if the markets are running with these ideas or not.

 

 

 

Scotland votes to stay in UK

September 19, 2014 By in economics, EU financial crisis, Scotland independence referendum Tags: , , , , , Leave a comment

Early this morning New Y0rk time the results of the Scottish independence referendum were announced.  The main features:

1.  “No,” meaning stay in the UK, votes made up 55% of the total; “Yes” votes were 45%.  

Yeses were much weaker than late polls had predicted.  Part of this is the nature of polling.  Part is also that sixteen-year-olds have the vote in Scotland and political pollsters have a difficult time getting accurate teen opinions.  I think the greatest part, though, is that No voters felt their views would be frowned on and were reluctant to share them.

2.  Almost 85% of eligible voters cast a ballot.  This is an immense number and indicates that citizens regarded the vote as crucially important.

3.  The result averts potentially destabilizing ripple effects throughout the EU.  Had Yes carried the day, separatists in, for example, Spain or Italy would have had a concrete example of success to spur on their own efforts.

4.  Scotland will become more autonomous.  This is partly the result of promises the UK made to tip the voting toward No, partly pragmatic politics to ensure an independence vote won’t recur.  Presumably similar, though likely smaller, efforts to assuage unhappy regions will take place elsewhere in the EU.

 

The response of stock markets has been positive, but small.  This is understandable, since the near-term effect of a No vote is preservation of the status quo.  Interestingly, though, the recent decline in sterling, which had been attributed to Scottish independence fears, hasn’t reversed itself–implying that other factors are behind the weakness.

will EU stock strength continue?

January 13, 2014 By in China, Current Market Thoughts, economics, EU financial crisis, Portfolio management, Stock ideas, Strategy Tags: , , , , , , Leave a comment

EU outperformance

Since the middle of last July, the S&P 500 is up by 8.7%.  Over the same time span, large-cap EU stocks have risen by almost 14% in € terms–and the € has risen by almost 5% against the $–meaning close to a 20% return for dollar-oriented investors.

Will this relative strength continue?

I think so.

Here’s why:

favorable circumstances

–the EU has finally put the worst of the Great Recession behind it and is beginning to recover

–the US continues to expand, but its alleleration will be lower than the EU’s

–the new Chinese administration is undertaking two necessary economic reforms, both of which will slow near-term economic growth and (I think) create uncertainty.  (The two: wresting control of banks from local/regional governments, and shifting away from low value-added export-oriented manufacturing.)  /so Pacific Basin growth will likely be less dynamic this year than usual, as well

either/or

So far, good news about the EU has expressed itself in both currency appreciation and in a rise in local currency stock prices.  My guess is that the € won’t weaken, but that most of the currency gain has already happened.  I expect the strongest areas of the EU market will continue to be early business cycle domestic-oriented areas, however.  The extent of underperformance by multinationals listed in the EU will probably be a function of the strength of the €.

a cyclical phenomenon

Eurosclerosis is the word coined to characterize the pre-EU European economy.  It meant sub-scale firms, excessive regulation, intra-European protective barriers, rigid labor, high unemployment and an aging population.

The launch of the € has resulted in transparent (and lower) pricing throughout the EU, M&A to create world-scale firms, and the elimination of intra-EU customs/tariff barriers.

But the union is still stuck with rigid labor, an aging population and vigorous defenders of their national economies in France and Italy, two of the three largest countries in the EU.  So eurosclerosis isn’t behind us.  We’ve got eurosclerosis 2.0 instead.

In other words, playing the EU is a business cycle idea, made more interesting by lack of oomph in North America and in the Pacific.  But we can’t forget to sell–probably some time late this year.

 

 

the EU and negative nominal interest rates

November 18, 2013 By in economics, Strategy Tags: , , , , , , , Leave a comment

Over the past year or two, the European Central Bank has periodically talked about the possibility of engineering negative nominal interest rates in the EU.  What it is talking about?

There are two possibilities:

1.  In overly simple terms, money policy is stimulative if the real (that is, after subtracting inflation) interest rate is less than zero.  For example, if inflation is 3% and the nominal interest rate is 1%, the real interest rate is -2%.  So cash is a loser, giving a sharp economic incentive to individuals and corporations a sharp incentive to borrow money and to invest their cash balances in projects that will cause economic growth.

Suppose there’s no inflation, though, or that prices are falling by, say, 2% per year.  If the best that money policy can do is bring nominal interest rates down to zero, the real interest rate is still +2% from holding cash.  So cash is a big winner.

In this deflationary scenario, the only way to achieve a positive real interest rate is to get nominal interest rates down to, say, -4%.  How to do so?  …tax bank deposits.

That’s not enough, though.   …and here’s where things get a little wacky.

If I’m going to lose 4% a year by keeping my cash in the bank, I’m going to buy a safe, withdraw my money and keep bills and coins in my house.  Scrooge McDuck writ small!!

Government can’t accept this.  So it puts “use by” dates on currency, so money expires at the rate of 4% a year if it isn’t spent (I said this wad going to be wacky).

But wait…  Citizens won’t accept this move, either.  They run to currency dealers (or gold merchants) and convert their money into non-imploding stuff.

Government responds by imposing controls on purchases of metals, foreign currency and maybe other commodities, too.

…and so on.

Anyway, this recipe for political and economic chaos can’t be what the ECB is talking about.

2.  As evidence has been mounting that the EU economy has passed its cyclical bottom and has begun to perk up a bit, the euro has been strengthening.  From early July until late last month, for instance, the currency had risen by about 8% against the US$.  A bit of that is fallout from the government shutdown in the US, but most is because investors are beginning to reallocate funds away from other parts of the world and toward the EU, where they sense surprising positive economic momentun.  Trade is starting to increase, as well.  Both developments increase demand for the €.

Once an uptrend like this starts, it also attracts speculative inflows of cash from large banks, hedge funds–sometimes gigantic inflows–who want to bet that the uptrend will continue.

What’s wrong with this?

It’s that a rise in a currency acts very much like a rise in interest rates–it slows down economic growth.  Not exactly what the ECB wants.

So it’s jawboning.  It’s threatening to tax large inflows of speculative cash, most likely by at least enough to offset any anticipated currency gain.  It’s hoping to fend off speculators by announcing the actions it will take to drive them away.

So far, the ECB has been successful.  It wouldn’t be entirely out of the realm of possibility, however, to see taxes placed on large bank deposits (after all, big speculators are going to deal in electronic money, not bills and coins) at some point to drive speculators away.   The main point to remember is that this won’t be some loony scheme to create overall negative nominal interest rates, just losses for currency speculators.

The main effect on investors will be to lessen the attractiveness of pure domestic EU plays and to retain some allure for EU-based multinationals.