The
Burning Questions For 2015
John Mauldin
Dec 18, 2014
|
Louis
Gave is one of my favorite investment and economic thinkers, besides being a
good friend and an all-around fun guy. When he and his father Charles and the
well-known European journalist Anatole Kaletsky decided to form Gavekal some 15
years ago, Louis moved to Hong Kong, as they felt that Asia and especially
China would be a part of the world they would have to understand. Since then
Gavekal has expanded its research offices all over the world. The Gavekal
team’s various research arms produce an astounding amount of work on an
incredibly wide range of topics, but somehow Louis always seems to be on top of
all of it.
Longtime
readers know that I often republish a piece by someone in their firm (typically
Charles or Louis). I have to be somewhat judicious, as their research is
actually quite expensive, but they kindly give me permission to share it from
time to time.
This
week, for your Outside the Box
reading, I bring you one of the more thought-provoking pieces I’ve read from
Louis in some time. In Thoughts
from the Frontline I have been looking at world problems we need to
focus on as we enter 2015. Today, Louis also gives us a piece along these
lines, called “The Burning Questions for 2015,” in which he thinks about a
“Chinese Marshall Plan” (and what a stronger US dollar might do to China),
Abenomics as a “sideshow,” US capital misallocation, and whether or not we
should even care about Europe. I think you will find the piece well worth your
time.
Think
about this part of his conclusion as you read:
Most investors go about their job trying to
identify ‘winners’. But more often than not, investing is about avoiding
losers. Like successful gamblers at the racing track, an investor’s starting point should be to
eliminate the assets that do not stand a chance, and then spread the rest of
one’s capital amongst the remainder.
Wise
words indeed.
A
Yellow Card from Barry
What
you don’t often get to see is the lively debate that happens among my friends
about my writing, even as I comment on theirs. Barry Ritholtz of The Big
Picture pulled a yellow card on me over a piece of data he contended I had
cherry-picked from Zero Hedge. He has a point. I should have either not copied
that sentence (the rest of the quote was OK) or noted the issue date. Quoting
Barry:
Did you cherry pick this a little much?
“… because since December 2007, or roughly the
start of the global depression, shale oil states have added 1.36 million jobs
while non-shale states have lost 424,000 jobs.”
I must point out how intellectually
disingenuous this start date is, heading right into the crisis – why
not use December 2010? Or 5 or 10 years? This is misleading in other ways:
It is geared to start before the crisis &
recovery, so that it forces the 10 million jobs lost in the crisis to be
offset by the 10 million new jobs added since the recovery began.
That creates a very misleading picture of where growth comes from.
We have created 10 million new jobs since June
2009. Has Texas really created 4 million new jobs? The answer is no.
According to [the St. Louis Fed] FRED
[database]:
PAYEMS – or NFP – has gone from 130,944 to
140,045, a gain of 9,101 over that period.
TXNA – Total Nonfarm in Texas – has gone from 10,284 to 11,708, for a gain of 1,424.
TXNA – Total Nonfarm in Texas – has gone from 10,284 to 11,708, for a gain of 1,424.
That gain represents 15.6% of the 9.1MM total.
Well
yes, Barry, but because of oil and other things (like a business-friendly
climate), Texas did not lose as many jobs in the recession as the rest of the
nation did, which is where you can get skewed data, depending on when you start
the count and what you are trying to illustrate.
My
main point is that energy production has been a huge upside producer of jobs,
and that source of new jobs is going away. And yes, Josh, the net benefit for
at least the first six months until the job non-production shows up (if it
does) is a positive for the economy and the consumer. But I was trying to
highlight a potential problem that could hurt US growth. Oil is likely to go to
$40 before settling in the $50 range for a while. Will it eventually go back
up? Yes. But it’s anybody’s guess as to when.
By
the way, a former major hedge fund manager who closed his fund a number of
years ago casually mentioned at a party the other night that he hopes oil goes
to $35 and that we see a true shakeout in the oil patch. He grew up in a West
Texas oil family and truly understands the cycles in the industry, especially
for the smaller producers. From his point of view, a substantial shakeout
creates massive upside opportunities in lots of places. “Almost enough,” he
said, “to tempt me to open a new fund.”
It
is time to hit the send button. I trust you are having a good week. Now settle
in and grab a cup of coffee or some wine (depending on the time of day and your
mood), and let’s see what Louis has to say.
Your
trying to catch up analyst,
John Mauldin, Editor
Outside the Box
The Burning Questions For 2015
By Louis-Vincent Gave, Gavekal / Dragonomics
With two reports a day, and often more, readers
sometimes complain that keeping tabs on the thoughts of the various Gavekal
analysts can be a challenge. So as the year draws to a close, it may be helpful
if we recap the main questions confronting investors and the themes we strongly
believe in, region by region.
1. A Chinese Marshall Plan?
When we have conversations with clients about
China – which typically we do between two and four times a day – the talk
invariably revolves around how much Chinese growth is slowing (a good bit, and
quite quickly); how undercapitalized Chinese banks are (a good bit, but fat net
interest margins and preferred share issues are solving the problem over time);
how much overcapacity there is in real estate (a good bit, but – like youth –
this is a problem that time will fix); how much overcapacity there is in steel,
shipping, university graduates and corrupt officials; how disruptive China’s
adoption of assembly line robots will be etc.
All of these questions are urgent, and the
problems that prompted them undeniably real, which means that China’s
policymakers certainly have their plates full. But this is where things get
interesting: in all our conversations with Western investors, their conclusion
seems to be that Beijing will have little choice but to print money
aggressively, devalue the renminbi, fiscally stimulate the economy, and
basically follow the path trail-blazed (with such success?) by Western
policymakers since 2008. However, we would argue that this conclusion
represents a failure both to think outside the Western box and to read Beijing’s
signal flags.
In numerous reports (and in Chapters 11 to 14 of
Too Different For Comfort) we have argued that
the internationalization of the renminbi has been one of the most significant
macro events of recent years. This internationalization is continuing apace:
from next to nothing in 2008, almost a quarter of Chinese trade will settle in renminbi
in 2014:
This is an important development which could
have a very positive impact on a number of emerging markets. Indeed, a typical,
non-oil exporting emerging market policymaker (whether in Turkey, the
Philippines, Vietnam, South Korea, Argentina or India) usually has to worry
about two things that are completely out of his control:
1) A spike in the US dollar. Whenever
the US currency shoots up, it presents a hurdle for growth in most emerging
markets. The first reason is that most trade takes place in US dollars, so a
stronger US dollar means companies having to set aside more money for working
capital needs. The second is that most emerging market investors tend to think
in two currencies: their own and the US dollar. Catch a cab in Bangkok, Cairo,
Cape Town or Jakarta and ask for that day’s US dollar exchange rate and chances
are that the driver will know it to within a decimal point. This sensitivity to
exchange rates is important because it means that when the US dollar rises,
local wealth tends to flow out of local currencies as investors sell domestic
assets and into US dollar assets, typically treasuries (when the US dollar
falls, the reverse is true).
2) A rapid rise in oil or food prices. Violent
spikes in oil and food prices can be highly destabilizing for developing
countries, where the median family spends so much more of their income on basic
necessities than the typical Western family. Sudden spikes in the price of food
or energy can quickly create social and political tensions. And that’s not all;
for oil-importing countries, a spike in oil prices can lead to a rapid
deterioration in trade balances. These tend to scare foreign investors away, so
pushing the local currency lower and domestic interest rates higher, which in
turn leads to weaker growth etc...
Looking at these two concerns, it is hard to
escape the conclusion that, as things stand, China is helping to mitigate both:
- China’s policy of renminbi
internationalization means that emerging markets are able gradually to
reduce their dependence on the US dollar. As they do, spikes in the value
of the US currency (such as we have seen in 2014) are becoming less
painful.
- The slowdown in Chinese oil
demand, as well as China’s ability to capitalize on Putin’s difficulties
to transform itself from a price-taker to a price-setter, means that the
impact of oil and commodities on trade balances is much more contained.
Beyond providing stability to emerging markets,
the gradual acceptance of the renminbi as a secondary trading and reserve
currency for emerging markets has further implications. The late French
economist Jacques Rueff showed convincingly how, when global trade moved from a
gold-based settlement system to a US dollar-based system, purchasing power was
duplicated. As the authors of a recent Wall Street Journal article citing
Reuff’s work explained: “If the Banque de France counts among its reserves
dollar claims (and not just gold and French francs) – for example a Banque de
France deposit in a New York bank – this increases the money supply in France
but without reducing the money supply of the US. So both countries can use
these dollar assets to grant credit.” Replace Banque de France with Bank
Indonesia, and US dollar with renminbi and the same causes will lead to the
same effects.
Consider British Columbia’s recently issued
AAA-rated two year renminbi dim sum bond. Yielding 2.85%, this bond was
actively subscribed to by foreign central banks, which ended up receiving more
than 50% of the initial allocation (ten times as much as in the first British
Columbia dim sum issue two years ago). After the issue British Columbia takes
the proceeds and deposits them in a Chinese bank, thereby capturing a nice
spread. In turn, the Chinese bank can multiply this money five times over (so goes
money creation in China). Meanwhile, the Indonesian, Korean or Kazakh central
banks that bought the bonds now have an asset on their balance sheet which they
can use to back an expansion of trade with China...
Of course, for trade to flourish, countries need
to be able to specialize in their respective comparative advantages, hence the
importance of the kind of free trade deals discussed at the recent APEC
meeting. But free trade deals are not enough; countries also need trade
infrastructure (ports, airports, telecoms, trade finance banks etc...). This
brings us to China’s ‘new silk road’ strategy and the recent announcement by
Beijing of a US$40bn fund to help finance road and rail infrastructure in the
various ‘stans’ on its western borders in a development that promises to cut
the travel time from China to Europe from the current 30 days by sea to ten
days or less overland.
Needless to say, such a dramatic reduction in
transportation time could help prompt some heavy industry to relocate from
Europe to Asia.
That’s not all. At July’s BRICS summit in
Brazil, leaders of the five member nations signed a treaty launching the
US$50bn New Development Bank, which Beijing hopes will be modeled on China
Development Bank, and is likely to compete with the World Bank. This will be
followed by the establishment of a China-dominated BRICS contingency fund
(challenging the International Monetary Fund). Also on the cards is an Asian
Infrastructure Investment Bank to rival the Asian Development Bank.
So what looks likely to take shape over the next
few years is a network of railroads and motorways linking China’s main
production centers to Bangkok, Singapore, Karachi, Almaty, Moscow, Yangon,
Kolkata. We will see pipelines, dams, and power plants built in Siberia, Central
Asia, Pakistan and Myanmar; as well as airports, hotels, business centers...
and all of this financed with China’s excess savings, and leverage. Given that
China today has excess production capacity in all of these sectors, one does
not need a fistful of university diplomas to figure out whose companies will
get the pick of the construction contracts.
But to finance all of this, and to transform
herself into a capital exporter, China needs stable capital markets and a
strong, convertible currency. This explains why, despite Hong Kong’s
pro-democracy demonstrations, Beijing is pressing ahead with the
internationalization of the renminbi using the former British colony as its
proving ground (witness the Shanghai-HK stock connect scheme and the removal of
renminbi restrictions on Hong Kong residents). And it is why renminbi bonds
have delivered better risk-adjusted returns over the past five years than
almost any other fixed income market.
Of course, China’s strategy of
internationalizing the renminbi, and integrating its neighbors into its own
economy might fall flat on its face. Some neighbors bitterly resent China’s
increasing assertiveness. Nonetheless, the big story in China today is not
‘ghost cities’ (how long has that one been around?) or undercapitalized banks.
The major story is China’s reluctance to continue funneling its excess savings
into US treasuries yielding less than 2%, and its willingness to use that
capital instead to integrate its neighbors’ economies with its own; using its
own currency and its low funding costs as an ‘appeal product’ (and having its
own companies pick up the contracts as a bonus). In essence, is this so
different from what the US did in Europe in the 1940s and 1950s with the
Marshall Plan?
2. Japan: Is Abenomics just a sideshow?
With Japan in the middle of a triple dip
recession, and Japanese households suffering a significant contraction in real
disposable income, it might seem that Prime Minister Shinzo Abe has chosen an
odd time to call a snap election. Three big factors explain his decision:
1) The Japanese opposition is in complete
disarray. So Abe’s decision may primarily have been
opportunistic.
2) We must
remember that Abe is the
most nationalist prime minister Japan has produced in a generation. The
expansion of China’s economic presence across Central and South East Asia will
have left him feeling at least as uncomfortable as anyone who witnessed his
Apec handshake with Xi Jinping three weeks ago. It is not hard to imagine that
Abe returned from Beijing convinced that he needs to step up Japan’s military
development; a policy that requires him to command a greater parliamentary
majority than he holds now.
3) The final
factor explaining Abe’s decision to call an election may be that in Japan the government’s performance in
opinion polls seems to mirror the performance of the local stock market (wouldn’t
Barack Obama like to see such a correlation in the US?). With the Nikkei
breaking out to new highs, Abe may feel that now is the best time to try and
cement his party’s dominant position in the Diet.
As he gets ready to face the voters, how should
Abe attempt to portray himself? In our view, he could do worse than present
himself as Japan Inc’s biggest salesman.
Since the start of his second mandate,
Abe has visited 49 countries in 21 months, and taken hundreds of different
Japanese CEOs along with him for the ride. The message these CEOs have been
spreading is simple: Japan is a very different place from 20 years ago.
Companies are doing different things, and investment patterns have changed.
Many companies have morphed into completely different animals, and are
delivering handsome returns as a result. The relative year to date
outperformances of Toyo Tire (+117%), Minebea (+95%), Mabuchi (+57%), Renesas
(+43%), Fuji Film (+33%), NGK Insulators (+33%) and Nachi-Fujikoshi (+19%) have
been enormous. Or take Panasonic as an example: the old television maker has
transformed itself into a car parts firm, piggy-backing on the growth of
Tesla’s model S.
Yet even as these changes have occurred, most
foreign investors have stopped visiting Japan, and most sell-side firms have
stopped funding genuine and original research. For the alert investor this is
good news. As the number of Japanese firms at the heart of the disruptions
reshaping our global economy – robotics, electric and self-driving cars,
alternative energy, healthcare, care for the elderly – continues to expand, and
as the number of investors looking at these same firms continues to shrink,
those investors willing to sift the gravel of corporate Japan should be able to
find real gems.
Which brings us to the real question confronting
investors today: the ‘Kuroda put’ has placed Japanese equities back on
investor’s maps. But is this just a short term phenomenon? After all, no nation
has ever prospered by devaluing its currency. If Japan is set to attract, and
retain, foreign investor flows, it will have to come up with a more compelling
story than ‘we print money faster than anyone else’.
In our recent research, we have argued that this
is exactly what is happening. In fact, we believe so much in the opportunity
that we have launched a dedicated Japan corporate research service (GK Plus
Alpha) whose principals (Alicia Walker and Neil Newman) are burning shoe
leather to identify the disruptive companies that will trigger Japan’s next
wave of growth.
3. Should we worry about capital misallocation in the US?
The US has now ‘enjoyed’ a free cost of money
for some six years. The logic behind the zero-interest rate policy was simple
enough: after the trauma of 2008, the animal spirits of entrepreneurs needed to
be prodded back to life. Unfortunately, the last few years have reminded
everyone that the average entrepreneur or investor typically borrows for one of
two reasons:
- Capital spending: Business is expanding, so our entrepreneur borrows to
open a new plant, or hire more people, etc.
- Financial engineering: The entrepreneur or investor borrows in order to
purchase an existing cash flow, or stream of income. In this case, our
borrower calculates the present value of a given income stream, and if
this present value is higher than the cost of the debt required to own it,
then the transaction makes sense.
Unfortunately, the second type of borrowing does
not lead to an increase in the stock of capital. It simply leads to a change in
the ownership of capital at higher and higher prices, with the ownership of an
asset often moving away from entrepreneurs and towards financial middlemen or
institutions. So instead of an increase in an economy’s capital stock (as we
would get with increased borrowing for capital spending), with financial
engineering all we see is a net increase in the total amount of debt and a
greater concentration of asset ownership. And the higher the debt levels and
ownership concentration, the greater the system’s fragility and its inability
to weather shocks.
We are not arguing that financial engineering
has reached its natural limits in the US. Who knows where those limits stand in
a zero interest rate world? However, we would highlight that the recent new
highs in US equities have not been accompanied by new lows in corporate
spreads. Instead, the spread between 5-year BBB bonds and 5-year US treasuries
has widened by more than 30 basis points since this summer.
Behind these wider spreads lies a simple
reality: corporate bonds issued by energy sector companies have lately been
taken to the woodshed. In fact, the spread between the bonds of energy
companies, and those of other US corporates are back at highs not seen since
the recession of 2001-2002, when the oil price was at US$30 a barrel.
The market’s behavior raises the question
whether the energy industry has been the black hole of capital misallocation in
the era of quantitative easing. As our friend Josh Ayers of Paradarch Advisors
(Josh publishes a weekly entitled The
Right Tale, which is a fount of interesting ideas. He can be
reached at josh@paradarchadvisors.com)
put it in a recent note: “After surviving the resource nadir of the late 1980s
and 1990s, oil and gas firms started pumping up capex as the new millennium
began. However, it wasn’t until the purported end of the global financial
crisis in 2009 that capital expenditure in the oil patch went into hyperdrive,
at which point capex from the S&P 500’s oil and gas subcomponents jumped
from roughly 7% of total US fixed investment to over 10% today.”
“It’s no secret that a decade’s worth of higher
global oil prices justified much of the early ramp-up in capex, but a more
thoughtful look at the underlying data suggests we’re now deep in the
malinvestment phase of the oil and gas business cycle. The second chart (above)
displays both the total annual capex and the return on that capex (net
income/capex) for the ten largest holdings in the Energy Select Sector SPDR
(XLE). The most troublesome aspect of this chart is that, since 2010, returns
have been declining as capex outlays are increasing. Furthermore, this
divergence is occurring despite WTI crude prices averaging nearly $96 per
barrel during that period,” Josh noted.
The energy sector may not be the only place
where capital has been misallocated on a grand scale. The other industry with a
fairly large target on its back is the financial sector. For a start,
policymakers around the world have basically decided that, for all intents and
purposes, whenever a ‘decision maker’ in the financial industry makes a
decision, someone else should be looking over the decision maker’s shoulder to
ensure that the decision is appropriate. Take HSBC’s latest results: HSBC added
1400 compliance staff in one quarter, and plans to add another 1000 over the
next quarter. From this, we can draw one of two conclusions:
1) The financial
firms that will win are the large firms, as they can afford the compliance
costs.
2) The winners
will be the firms that say: “Fine, let’s get rid of the decision maker. Then we
won’t need to hire the compliance guy either”.
This brings us to a theme first explored by our
friend Paul Jeffery, who back in September wrote: “In 1994 Bill Gates observed:
‘Banking is necessary, banks are not’. The primary function of a bank is to
bring savers and users of capital together in order to facilitate an exchange.
In return for their role as [trusted] intermediaries banks charge a generous
net spread. To date, this hefty added cost has been accepted by the public due
to the lack of a credible alternative, as well as the general oligopolistic
structure of the banking industry. What Lending Club and other P2P lenders do
is provide an online market-place that connects borrowers and lenders directly;
think the eBay of loans and you have the right conceptual grasp. Moreover, the
business model of online market-place lending breaks with a banking tradition,
dating back to 14th century Florence, of operating on a “fractional reserve”
basis. In the case of P2P intermediation, l ending can be thought of as being
“fully reserved” and entails no balance sheet risk on the part of the service
facilitator. Instead, the intermediary receives a fee- based revenue stream
rather than a spread-based income.”
There is another way we can look at it: finance
today is an abnormal industry in two important ways:
1) The more the
sector spends on information and communications technology, the bigger a
proportion of the economic pie the industry captures. This is a complete
anomaly. In all other industries (retail, energy, telecoms...), spending on ICT
has delivered savings for the consumers. In finance, investment in ICT (think
shaving seconds of trading times in order to front run customer orders legally)
has not delivered savings for consumers, nor even bigger dividends for
shareholders, but fatter bonuses and profits for bankers.
2) The
second way finance is an abnormal industry (perhaps unsurprisingly given the
first factor) lies in the banks’ inability to pass on anything of value to
their customers, at least as far as customer’s perceptions are concerned.
Indeed, in ‘brand surveys’ and ‘consumer satisfaction reports’, banks regularly
bring up the rear. Who today loves their bank in a way that some people ‘love’
Walmart, Costco, IKEA, Amazon, Apple, Google, Uber, etc?
Most importantly, and as Paul highlights above,
if the whole point of the internet is to:
a) measure more
efficiently what each individual needs, and
b) eliminate unnecessary
intermediaries,
then we should expect a lot of the financial
industry’s safe and steady margins to come under heavy pressure. This has
already started in the broking and in the money management industries (where
mediocre money managers and other closet indexers are being replaced by ETFs).
But why shouldn’t we start to see banks’ high return consumer loan, SME loan
and credit card loan businesses replaced, at a faster and faster pace, by
peer-to-peer lending? Why should consumers continue to pay high fees for bank
transfers, or credit cards when increasingly such services are offered at much
lower costs by firms such as TransferWise, services like Alipay and Apple Pay,
or simply by new currencies such as Bitcoin? On this point, we should note that
in the 17 days that followed the launch of Apple Pay on the iPhone 6, almost 1%
of Wholefoods’ transactions were processed using the new payment system. The
likes of Apple, Google, Facebook and Amazon have grown int o behemoths by
upending the media, advertising retail and entertainment industries. Such a
rapid take- up rate for Apple Pay is a powerful indicator which sector is
likely to be next in line. How else can these tech giants keep growing and
avoid the fate that befell Sony, Microsoft and Nokia? On their past record, the
technology companies will find margins, and growth, in upending our countries’
financial infrastructure. As they do, a lot of capital (both human and
monetary) deployed in the current infrastructure will find itself obsolete.
This possibility raises a number of questions –
not least for Gavekal’s own investment process, which relies heavily on changes
in the velocity of money and in the willingness and ability of commercial banks
to multiply money, to judge whether it makes sense to increase portfolio risk.
What happens to a world that moves ‘ex-bank’ and where most new loans are
extended peer-to-peer? In such a world, the banking multiplier disappears along
with fractional reserve banking (and consequently the need for regulators? Dare
to dream...). As bankers stop lending their clients umbrellas when it is sunny,
and taking them away when it rains, will our economic cycles become much tamer?
As central banks everywhere print money aggressively, could the market be in
the process of creating currencies no longer based on the borders of nation
states, but instead on the cross-border networks of large corporations (Alipay,
Apple Pay...), or even on voluntary communi ties (Bitcoin). Does this mean we
are approaching the Austrian dream of a world with many, non
government-supported, currencies?
4. Should we care about Europe?
In our September Quarterly Strategy Chartbook,
we debated whether the eurozone was set for a revival (the point expounded by
François) or a continued period stuck in the doldrums (Charles’s view), or
whether we should even care (my point). At the crux of this divergence in views
is the question whether euroland is broadly following the Japanese deflationary
bust path. Pointing to this possibility are the facts that 11 out of 15
eurozone countries are now registering annual year-on-year declines in CPI,
that policy responses have so far been late, unclear and haphazard (as they
were in Japan), and that the solutions mooted (e.g. European Commission
president Jean-Claude Juncker’s €315bn infrastructure spending plan) recall the
solutions adopted in Japan (remember all those bridges to nowhere?). And that’s
before going into the structural parallels: ageing populations; dysfunctional,
undercapitalized and overcrowded banking systems; influe ntial segments of the
population eager to maintain the status quo etc...
With the same causes at work, should we expect the
same consequences? Does the continued underperformance of eurozone stocks
simply reflect that managing companies in a deflationary environment is a very
challenging task? If euroland has really entered a Japanese-style deflationary
bust likely to extend years into the future, the conclusion almost draws
itself.
The main lesson investors have learned from the
Japanese experience of 1990-2013 is that the only time to buy stocks in an
economy undergoing a deflationary bust is:
a) when stocks
are massively undervalued relative both to their peers and to their own
history, and
b) when a
significant policy change is on the way.
This was the situation in Japan in 1999 (the
first round of QE under PM Keizo Obuchi), 2005 (PM Junichiro Koizumi’s bank
recapitalization program) and of course in 2013-14 (Abenomics). Otherwise, in a
deflationary environment with no or low growth, there is no real reason to pile
into equities. One does much better in debt. So, if the Japan-Europe parallel
runs true, it only makes sense to look at eurozone equities when they are both
massively undervalued relative to their own histories and there are
expectations of a big policy change. This was the case in the spring of 2012
when valuations were at extremes, and Mario Draghi replaced Jean-Claude Trichet
as ECB president. In the absence of these two conditions, the marginal dollar
looking for equity risk will head for sunnier climes.
With this in mind, there are two possible
arguments for an exposure to eurozone equities:
1) The analogy
of Japan is misleading as euroland will not experience a deflationary bust (or
will soon emerge from deflation).
2) We are
reaching the point when our two conditions – attractive valuations, combined
with policy shock and awe – are about to be met. Thus we could be reaching the
point when euroland equities start to deliver outsized returns.
Proponents of the first argument will want to
overweight euroland equities now, as this scenario should lead to a rebound in
both the euro and European equities (so anyone underweight in their portfolios
would struggle). However, it has to be said that the odds against this first
outcome appear to get longer with almost every data release!
Proponents of the second scenario, however, can
afford to sit back and wait, because it is likely any outperformance in
eurozone equities would be accompanied by euro currency weakness. Hence, as a
percentage of a total benchmark, European equities would not surge, because the
rise in equities would be offset by the falling euro.
Alternatively, investors who are skeptical about
either of these two propositions can – like us – continue to use euroland as a
source of, rather than as a destination for, capital. And they can afford
safely to ignore events unfolding in euroland as they seek rewarding investment
opportunities in the US or Asia. In short, over the coming years investors may
adopt the same view towards the eurozone that they took towards Japan for the
last decade: ‘Neither loved, nor hated... simply ignored’.
Conclusion:
Most investors go about their job trying to
identify ‘winners’. But more often than not, investing is about avoiding
losers. Like successful gamblers at the racing track, an investor’s starting point should be to
eliminate the assets that do not stand a chance, and then spread the rest of
one’s capital amongst the remainder.
For example, if in 1981 an investor had decided
to forego investing in commodities and simply to diversify his holdings across
other asset classes, his decision would have been enough to earn himself a
decade at the beach. If our investor had then returned to the office in 1990,
and again made just one decision – to own nothing in Japan – he could once
again have gone back to sipping margaritas for the next ten years. In 2000, the
decision had to be not to own overvalued technology stocks. By 2006, our
investor needed to start selling his holdings in financials around the world.
And by 2008, the money-saving decision would have been to forego investing in
euroland.
Of course hindsight is twenty-twenty, and any
investor who managed to avoid all these potholes would have done extremely
well. Nevertheless, the big question confronting investors today is how to
avoid the potholes of tomorrow. To succeed, we believe that investors need to
answer the following questions:
- Will Japan engineer a revival
through its lead in exciting new technologies (robotics, hi-tech help for
the elderly, electric and driverless cars etc...), or will Abenomics prove
to be the last hurrah of a society unable to adjust to the 21st century?
Our research is following these questions closely through our new GK Plus Alpha venture.
- Will China slowly sink under
the weight of the past decade’s malinvestment and the accompanying rise in
debt (the consensus view) or will it successfully establish itself as
Asia’s new hegemon? Our Beijing based research team is very much on top of
these questions, especially Tom Miller, who by next Christmas should have
a book out charting the geopolitical impact of China’s rise.
- Will Indian prime minister
Narendra Modi succeed in plucking the low-hanging fruit so visible in
India, building new infrastructure, deregulating services, cutting
protectionism, etc? If so, will India start to pull its weight in the
global economy and financial markets?
- How will the world deal with a
US economy that may no longer run current account deficits, and may no
longer be keen to finance large armies? Does such a combination not almost
guarantee the success of China’s strategy?
- If the US dollar is entering a
long term structural bull market, who are the winners and losers? The
knee-jerk reaction has been to say ‘emerging markets will be the losers’ (simply because
they were in the past. But the reality is that most emerging markets have
large US dollar reserves and can withstand a strong US currency. Instead,
will the big losers from the US dollar be the commodity producers?
- Have we reached ‘peak demand’
for oil? If so, does this mean that we have years ahead of us in which
markets and investors will have to digest the past five years of capital
misallocation into commodities?
- Talking of capital
misallocation, does the continued trend of share buybacks render our
financial system more fragile (through higher gearing) and so more likely
to crack in the face of exogenous shocks? If it does, one key problem may
be that although we may have made our banks safer through increased
regulations (since banks are not allowed to take risks anymore), we may
well have made our financial markets more volatile (since banks are no
longer allowed to trade their balance sheets to benefit from spikes in
volatility). This much appeared obvious from the behavior of US fixed
income markets in the days following Bill Gross’s departure from PIMCO. In
turn, if banks are not allowed to take risks at volatile times, then
central banks will always be called upon to act, which guarantees more
capital misallocation, share buybacks and further fragilization of the
system (expect more debates along this theme between Charles, and Anatole).
- Will the financial sector be
next to undergo disintermediation by the internet (after advertising and
the media). If so, what will the macro- consequences be? (Hint: not good
for the pound or London property.)
- Is euroland following the
Japanese deflationary-bust roadmap?
The answers to these questions will drive performance for
years to come. In the meantime, we continue to believe that a portfolio which
avoids a) euroland, b) banks, and c) commodities, will do well – perhaps well
enough to continue funding Mediterranean beach holidays – especially as these
are likely to go on getting cheaper for anyone not earning euros!
0 comments:
Publicar un comentario