There's always a suggestion that banks' reluctance to lend has been a factor in lackluster GDP growth. Domestically, leading middle market lenders like Wells Fargo have said that their better tier clients are flush with cash and don't need access to credit. The issues for bank customers are risk aversion and a lack of confidence. Wells Fargo said that middle market commercial lenders would generally like to grow their asset bases.
Now comes an interesting study of export behavior in Peru, based on an analysis of real-world customs data from that country. Professors Paravasini, Rappoport, and Wolfenzon of the Columbia Business School write:
"Out of the total decline in exports from Peru, only 15 percent was driven by credit shortages. The other 85 percent was due to a drop in consumer demand. “Our 15 percent figure is a lower bound as it refers only to the decline in exports due to lack of finance to exporters. Finance can have a bigger impact as it surely also affects importers at the other end,” Wolfenzon says.
While trade is clearly based on supply and demand, it’s important to understand the relative importance of these both forces. To this end, Wolfenzon suggests a general takeaway. “The Peruvian government could not have done much to improve the country’s export performance,” he says. “The problem was a lack of demand from importing countries.”
Weak demand from developed countries in the United States and Europe is and will continue to be the issue for the resuscitation of the global economy. On the domestic side, whether for the production of goods for domestic consumption or for exportables, the issue continues to be weak demand and a lack of business confidence. Lack of access to credit doesn't seem to be the big issue.
Tuesday, January 31, 2012
Monday, January 30, 2012
Jeffries Sees Little Inflation Risk
Ward McCarthy's group at Jeffries, commenting on the latest FOMC communications, noted the following:
"Also, by setting a long-term target for unemployment of 5% to 6%, the FOMC is also acknowledging that labor market conditions are not likely to improve enough to allow inflation to take hold for years. YoY average hourly earnings have held to a range of roughly 2% to 4% for the past thirty years. Historically average hourly earnings have not moved toward the upper end of that range until the unemployment rate is below 6%. With the unemployment rate at 8.5% and average
hourly earnings growth at 1.9%, there is a long way to go before labor market conditions will support a persistent rise in inflation."
Good news for holders of financial assets, particularly bonds, but not good news for middle class workers and for new entrants into the workforce. Ironically, just when the risk-reward profiles for most corporate investments are also getting a boost, CEO's continue to be reluctant to invest in new product development and market expansion, according to McKinsey.
Capital investment against this kind of labor market backdrop would have the potential to raise labor productivity, which would be good for both earnings of the corporation and its workers. If productivity picked up, then a rise in earnings would itself not have to be inflationary. The difference between projected GDP and potential GDP levels is considerable. There seeems to be little potential for energy or commodity driven inflation either. So the difference between nominal and real returns will also be small. There's little room for a rise in inflationary psychology either.
Going into the cycle, executive compensation schemes probably induced too much risk taking, especially in financial services. One wonders whether we've flipped psychology on its ear. By cutting expenses, standing still and using excess cash to buy back shares while not having a long term vision for creating value, perhaps some of those same CEO's are being too risk averse here.
Sunday, January 29, 2012
A Sanguine Consensus From Investment Experts
The Minnesota Chapter of the Association for Corporate Growth co-hosted its annual forecasting dinner with the CFA Society of Minnesota, and it was a full boat with about 450 people in the audience.
The investment recommendations too were things I have heard before from Merrill Lynch's CIO list to many others. The Fed's recent pronouncements may have taken the edge off investors skepticism. The recent uptick in 4th quarter GDP, which brings output about equal to pre-recession levels seems also to be making investors less glum.
Fourth quarter earnings season has been mixed, so far. GE's announcement about its core industrial businesses was disquieting. Other industrial companies have fared better, especially on the top line. I wonder if some of this wasn't timing of orders.
Dean Junkins, the Chief Investment Officer of Wells Fargo Private Bank noted some interesting facts about the strength of corporate balance sheets. A consensus equity recommendation is that investors hold a large stake in dividend paying stocks, either with a high dividend growth rate or with a high yield and a sustained record of increases. Even with the strength of dividend increases in 2011, Junkins noted that the overall payout ratio for SP500 companies is at its lowest levels in 140 years!
On the fixed income side, another consensus recommendation is to include high quality corporate debt, and indeed there are several funds which have been in this strategy for two years already, enjoying substantial gains. Higher quality High Yield (an oxymoron?) also got the nod from participants as a quasi-equity play and as a source of additional income for a portfolio.
According to one panelist, in 2007 there were $20 trillion in high quality credits worldwide which would be considered qualified investments for large institutional accounts. Today, the panelist said, the number is now about $12 trillion in high quality credits.
It's surprising how the outlooks all seem to converging around the same central tendencies. That's usually a cause for concern. The argument for high yield debt was made from the point of view of spreads and of default rates. Europe was something to be monitored, but no panelist felt that a Euro nation bankruptcy was in the cards. Investors are piling out of commodities, which suggests a benign inflation outlook. Pretty sanguine again.
Volatility and correlation among asset classes will likely remain high. This, coupled with an almost zero cost of funds, suggests that high turnover, risk-based strategies should be where the really money is made. Some commentators mention that corporate cash and the low cost of debt will help fuel mergers and acquisitions in the first six to nine months of the year.
The old saw goes, "the market climbs a wall of worry." If that's true, I didn't hear any worries from this panel.
The investment recommendations too were things I have heard before from Merrill Lynch's CIO list to many others. The Fed's recent pronouncements may have taken the edge off investors skepticism. The recent uptick in 4th quarter GDP, which brings output about equal to pre-recession levels seems also to be making investors less glum.
Fourth quarter earnings season has been mixed, so far. GE's announcement about its core industrial businesses was disquieting. Other industrial companies have fared better, especially on the top line. I wonder if some of this wasn't timing of orders.
Dean Junkins, the Chief Investment Officer of Wells Fargo Private Bank noted some interesting facts about the strength of corporate balance sheets. A consensus equity recommendation is that investors hold a large stake in dividend paying stocks, either with a high dividend growth rate or with a high yield and a sustained record of increases. Even with the strength of dividend increases in 2011, Junkins noted that the overall payout ratio for SP500 companies is at its lowest levels in 140 years!
On the fixed income side, another consensus recommendation is to include high quality corporate debt, and indeed there are several funds which have been in this strategy for two years already, enjoying substantial gains. Higher quality High Yield (an oxymoron?) also got the nod from participants as a quasi-equity play and as a source of additional income for a portfolio.
According to one panelist, in 2007 there were $20 trillion in high quality credits worldwide which would be considered qualified investments for large institutional accounts. Today, the panelist said, the number is now about $12 trillion in high quality credits.
It's surprising how the outlooks all seem to converging around the same central tendencies. That's usually a cause for concern. The argument for high yield debt was made from the point of view of spreads and of default rates. Europe was something to be monitored, but no panelist felt that a Euro nation bankruptcy was in the cards. Investors are piling out of commodities, which suggests a benign inflation outlook. Pretty sanguine again.
Volatility and correlation among asset classes will likely remain high. This, coupled with an almost zero cost of funds, suggests that high turnover, risk-based strategies should be where the really money is made. Some commentators mention that corporate cash and the low cost of debt will help fuel mergers and acquisitions in the first six to nine months of the year.
The old saw goes, "the market climbs a wall of worry." If that's true, I didn't hear any worries from this panel.
Schools Can't Force Better Choices on Students
Schools have been enlisted into the vanguard of society's fight against obesity, by revamping their cafeteria lunches. Cafeteria managers are being told to eliminate "fast food options" and to substitute healthy alternatives, whatever that means. The first problem has been that the customers don't like the changes. Newspapers report of students rebelling against their tofu wraps with Swiss chard. They taste "yukky," and students don't eat the stuff. Those with cars head out to Subway and smuggle in contraband. The costs for the new menus are, of course, higher, since the food service companies have developed their lowest cost options around the traditional fare, which has been in place since I went to school. A chicken nugget is a chicken nugget. Pizza continues to be a "go to" alternative, because it is the number item in "food away from home," even though we all know it has too much fat, too much salt, and too many carbs for a balanced diet.
Now comes the worst news from social science research: exposure to nasty foods like sugar-sweetened colas, candies and snacks during middle school has a statistically weak and insignificant relationship to weight gain among these populations, regardless of ethnicity, gender or income, in a longitudinal study.
Students are already taught in a variety of courses--nutrition, health science, biology, conservation--about the costs of our food system and about the perils of too many calories from sugar, fat and meat. Regulating their food over the relatively small number of food interactions the students have over a calendar year apparently doesn't have a discernible effect. Let's stick to the academic route, improve the alternatives without putting off the customer, and hope that the current generation starts to make better choices when they are out of school.
Now comes the worst news from social science research: exposure to nasty foods like sugar-sweetened colas, candies and snacks during middle school has a statistically weak and insignificant relationship to weight gain among these populations, regardless of ethnicity, gender or income, in a longitudinal study.
Students are already taught in a variety of courses--nutrition, health science, biology, conservation--about the costs of our food system and about the perils of too many calories from sugar, fat and meat. Regulating their food over the relatively small number of food interactions the students have over a calendar year apparently doesn't have a discernible effect. Let's stick to the academic route, improve the alternatives without putting off the customer, and hope that the current generation starts to make better choices when they are out of school.
Thursday, January 26, 2012
Two Faces on Private Equity
source: yahoo.com/movies. Batman Forever
Warren Buffet's terse characterizations of private equity investors in his shareholder letters were on point: he portrayed bad PE actors who destroyed companies by drowning in them in debt while sucking blood out in management fees and special dividends. Today's Star Tribune trots out the case of Buffet's Inc., which was beset by a predatory private equity group which also sucked blood out of a turnip and put the company into bankruptcy for the second time. So, as part of the Presidential re-election propaganda machine's aiming at Bain-alumnus Romney, voters can conclude that all private equity firms are vultures, no investments ever add jobs, and all just feather the nests of billionaires. It's certainly a great mantra for election time.
Now, however, go to the interesting case of Calpers, the monster public employee retirement fund of California, which is an institutional gorilla that can command preferences in the market place, but which is also deeply caring and crusading against all forms of corporate opacity, fraud, social insensitivity, environmental degradation, inappropriate political speech, and so on. Calpers is just like Tommie Lee Jones' character "Two-Face" when he was a crusading district attorney.
Ironically, many public pension funds are now plowing into alternative investments, principally private equity, chasing the performance enjoyed by Calpers in 2010 when private equity was their best performing asset class, returning 21.5% and bringing AUM to $226 billion. On the Calpers site, it appears that in their measurement system, all vintages of private equity investments have returned positive IRRs since their inception. So, as investors(left side of Two-Face), Calpers is happy to take the outsize returns, but as crusaders for truth and justice, they are his right side and madder than Hades.
So, which is it? Private equity investments do create value and sustainable employment. They do no always employ slash and burn strategies in their portfolios. Some firms, as we know, are bad actors. Public employees, fresh from their Occupy Wall Street and other protests, can enjoy their enhanced returns from private equity. It is amazing that Candidate Romney, who above all can speak knowledgeably from experience, about private equity, chooses not to educate the electorate with an informed and balanced view of private equity's role in corporate development.
How to get justice for private equity? How about flipping a coin?
Monday, January 23, 2012
Euro Sovereign Bond Investors Get a Raw Deal
IMF Managing Director Christine Lagarde, speaking in Berlin, said, "It (stepping up to a bigger bailout fund) is about avoiding a 1930s moment, in which inaction, insularity, and rigid ideology combine to cause a collapse in global demand."
These profound insights are said by the Wall Street Journal to constitute a "dire" warning. We've been talking "dire" since last summer. I must say that before watching the behavior of sovereign bond investors, I had always thought of bond investors as being more the "green eye shade" types than manic-depressive equity investors. Now, I'm not sure at all.
European sovereign bond investors, particularly Greek bond investors, include many European banks. They are apparently willing to accept interest rates on new Greek bonds of 3% max, with a fifty percent haircut on the principal value of their old bonds, plus some unspecified higher rates in future years if the Greek economy does better than a baseline number. The IMF and the ECB have drawn a Maginot Line at 3%.
My question is the following: why on earth would any rational investor take a 20-30 year risk for 3% from a country that will not realistically ever be able to repay? The investors must not have any realistic mechanism for pursuing a default, but it's probably more rational to bite the bullet now, take the write downs, file perfunctory lawsuits, and wait and see what the ECB would do. The banks would be short regulatory capital, but it's hard to see the IMF, ECB and other alphabet soup regulators pushing the banks over the edge; that would be bad for everybody. Someone has to lend Greece money, but surely a 3% rate is irrational. Who's going to win this game of chicken?
The longstanding low interest rate environment which central banks have institutionalized globally has completely distorted capital prices, forcing investors to take more and more risk in search of returns. For example, stories abound about hedge funds that leveraged their Japanese sovereign bond purchases at three-to-one yielding them an annual return of 12.5% per year; the lenders who gave the money to the hedge funds didn't earn very much for taking this risk.
C. Fred Bergsten, formerly of the Brooking Institution and late of the Peterson Institute for International Economics ("PIIE") predicts that European leaders will dither until the last minute, pull a rabbit out of the hat, end the euro/Greek/European periphery crisis and Europe will emerge from the crisis "much stronger." I've followed his work since I was a graduate student, and he has thirty years of professional and emotional investment in the euro currency experiment. If the bondholders are irrational and give in, nothing fundamental will have changed: the weak players in Europe will still be weak, will be further eroded by ongoing recession and debilitated by internal political crises.
When MD Lagarde talks about rigid ideology and a collapse in global demand, that is very disingenuous. The growth in demand was driven by artificially low rates and the ability of EU periphery countries to borrow with impunity while running fiscal deficits in violation of their treaties. Now, the absurd suggestion is put forward that Germany should run fiscal deficits in order to purchase goods and services from Spain, Ireland and Greece. Not agreeing to do so would be "rigid ideology," according to the IMF.
PIIE authors Boone and Johnson take a more normal economic approach to the crisis, suggesting that it has to deepen unless ongoing fiscal issues and bank insolvencies are addressed.
If the bondholders are irrational enough to go along with this charade, then I might just go and rip up all my teaching materials about the Capital Asset Pricing Model and Efficient Market Theory. This stage is not filled with economic actors, for sure.
These profound insights are said by the Wall Street Journal to constitute a "dire" warning. We've been talking "dire" since last summer. I must say that before watching the behavior of sovereign bond investors, I had always thought of bond investors as being more the "green eye shade" types than manic-depressive equity investors. Now, I'm not sure at all.
European sovereign bond investors, particularly Greek bond investors, include many European banks. They are apparently willing to accept interest rates on new Greek bonds of 3% max, with a fifty percent haircut on the principal value of their old bonds, plus some unspecified higher rates in future years if the Greek economy does better than a baseline number. The IMF and the ECB have drawn a Maginot Line at 3%.
My question is the following: why on earth would any rational investor take a 20-30 year risk for 3% from a country that will not realistically ever be able to repay? The investors must not have any realistic mechanism for pursuing a default, but it's probably more rational to bite the bullet now, take the write downs, file perfunctory lawsuits, and wait and see what the ECB would do. The banks would be short regulatory capital, but it's hard to see the IMF, ECB and other alphabet soup regulators pushing the banks over the edge; that would be bad for everybody. Someone has to lend Greece money, but surely a 3% rate is irrational. Who's going to win this game of chicken?
The longstanding low interest rate environment which central banks have institutionalized globally has completely distorted capital prices, forcing investors to take more and more risk in search of returns. For example, stories abound about hedge funds that leveraged their Japanese sovereign bond purchases at three-to-one yielding them an annual return of 12.5% per year; the lenders who gave the money to the hedge funds didn't earn very much for taking this risk.
C. Fred Bergsten, formerly of the Brooking Institution and late of the Peterson Institute for International Economics ("PIIE") predicts that European leaders will dither until the last minute, pull a rabbit out of the hat, end the euro/Greek/European periphery crisis and Europe will emerge from the crisis "much stronger." I've followed his work since I was a graduate student, and he has thirty years of professional and emotional investment in the euro currency experiment. If the bondholders are irrational and give in, nothing fundamental will have changed: the weak players in Europe will still be weak, will be further eroded by ongoing recession and debilitated by internal political crises.
When MD Lagarde talks about rigid ideology and a collapse in global demand, that is very disingenuous. The growth in demand was driven by artificially low rates and the ability of EU periphery countries to borrow with impunity while running fiscal deficits in violation of their treaties. Now, the absurd suggestion is put forward that Germany should run fiscal deficits in order to purchase goods and services from Spain, Ireland and Greece. Not agreeing to do so would be "rigid ideology," according to the IMF.
PIIE authors Boone and Johnson take a more normal economic approach to the crisis, suggesting that it has to deepen unless ongoing fiscal issues and bank insolvencies are addressed.
If the bondholders are irrational enough to go along with this charade, then I might just go and rip up all my teaching materials about the Capital Asset Pricing Model and Efficient Market Theory. This stage is not filled with economic actors, for sure.
Saturday, January 21, 2012
Shiny Pennies in Microsoft's Quarter
We wrote in July 2011 about how Microsoft shouldn't give up its foray into search with Bing! Looking at the most recent quarter, the WSJ notes a few items from the corporate earnings release:
We also wrote recently on our perceptions about Windows 8, which if successful should begin a meaningful cycle of laptop replacement for machines that can optimize the new operating system.
The stock has had a terrific run off the financial crisis low of $16 or so, but it continues to bear watching.
- Revenue for the company's servers and tools products, which form the backbone of enterprise networks and private clouds, jumped 11%, as the unit's income improved 17%.
- At the business division, which earns most of its sales from Microsoft Office, sales rose 2.8% as profit climbed 1.6%.
- Sales at the entertainment-and-devices business, which houses the top-selling Xbox video game console--advanced 15%.
- In online services, revenue climbed 10%. Microsoft has invested heavily in the unit, launching a splashy advertising blitz last year to promote Bing, which is the second-most-popular search engine in the U.S. behind Google, according to comScore Inc.
We also wrote recently on our perceptions about Windows 8, which if successful should begin a meaningful cycle of laptop replacement for machines that can optimize the new operating system.
The stock has had a terrific run off the financial crisis low of $16 or so, but it continues to bear watching.
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