Foto: Maik Meid. Shhh... the Macroeconomist is About to Speak
The world is hanging on the macroeconomists’ every word. Their analyses of US economic indicators had become almost totally irrelevant for investors – but now times have changed.
Economists were ignored last year because movements in the financial markets did not revolve around the classical economic pillars of consumption growth, employment, export and investments. Instead, they were driven by what we could call ‘technicalities’ – the Fed’s impressive bond-buying program.
It was these monthly purchases of USD 85 billion worth of government bonds and mortgages that determined market sentiment. In the same way as a conductor decides how his orchestra will play, the US central bank determined the rhythm and timing in the financial markets. However, conductor Ben Bernanke has now indicated that he will be taking a less prominent place on the podium.
It is worth examining the statistics again
This means that the members of the orchestra will have to get to grips with the music themselves once again. How should all the pieces be interpreted – allegro or fortissimo? What is the real state of the US economy? What are the indicators actually saying about the US economy? If the last meeting of the US central bank made anything clear it’s that the Fed itself is being influenced more than ever by the statistics reflecting the health of the US economy. Those numbers are of crucial importance to the question as to whether the central bank should gradually taper its stimulus policy.
Excessive focus on consumers
So the macroeconomists’ narrative is once again gaining kudos among investment teams. However, it is striking that the macro analysis is in many cases now geared to the wrong part of the economy. The emphasis is on Joe Sixpack, the consumer side of the US economy, leading to fierce debate on the unemployment numbers. The question is, are these unemployment statistics an accurate reflection of labor supply? Have Americans perhaps become so somber about their chances of a job that they are giving up – the so-called discouraged workers? Important and interesting discussion though this is, it doesn’t get to the heart of the matter.
Business holds the key to recovery
Where things really matter right now in the US economy is on the corporate side. After all, Mr. Average US Consumer reverted to his old spending patterns pretty soon after the credit crisis broke. And the predicted dramatic increase in savings levels has not materialized. This means that the United States has now reached the point where higher economic growth will have to come from companies. Without businesses, economic growth will not manage to rise above the somewhat tepid 2% mark. Are businesses going to earmark funds for investment in machinery and other capital goods and to expand their workforce? What’s the state of play?
The corporate starting point is healthy
If you look at the current level of corporate investment as a percentage of national income, then this is rising but remains historically low. At the same time, the profitability of US corporates is quite frankly high.
Earnings are averaging some 12% of that same national income. Crucially, profitability has not been this strong in the last forty years. US companies are doing very well, thank you. With such a favorable starting point, the key is to focus on forward-looking indicators, including the monthly survey among purchasing managers of large corporates. They recently reported real growth in their order books. Combined with the fact that inventories are pretty low, that is good news.
But when will businesses dare to start taking risks again?
Every shred of new information on ‘corporate US’ potentially provides insight into the entrepreneurial ‘animal spirits’ that are so crucial to robust economic growth. And that’s why investors should once again be sitting on the edge of their chairs when the macroeconomy is being discussed.
Wikimedia CommonsFoto: Ricky Qi . Nuevo experimento en Shanghái
In an attempt to further liberalize China’s economy, central government officials have created an experimental new free trade zone, which officially opened for business this week. The zone combines four existing but smaller development areas within Shanghai that are already exempt from import and export tariffs. Although the entire zone spans only about 29 square kilometers, many people believe its creation is just as important as the special economic zone that first opened the door for foreign investors to China’s economy, created in Shenzhen about 30 years ago. Given the excitement, some companies headquartered in Shanghai, especially those listed on the domestic A-share market, have seen their stock prices soar on the news.
I had an opportunity to visit several Shanghai-based companies during my recent research trip there. While many people (myself included) remain unclear as to all the details of the plan, most are quite encouraged by the move. Through my conversations with local businessmen, it seemed clear that two things really set the Shanghai Free Trade Zone (FTZ) apart from recent economic experiments elsewhere in China, such as in Wenzhou and Shenzhen.
First is the ease of doing business. The Shanghai FTZ will introduce the concept of a “negative” or restricted list of business areas. Thus, companies, especially foreign companies, can choose to engage in a variety of business activities as long as they are not on the government-restricted list. Currently, companies can only do what the government explicitly allows them. The freedom to explore is one of the key elements needed for innovation in business, and the Chinese government itself may perhaps also learn how to adapt to a role with limited power in business through the zone. Second is financial liberalization. It is widely expected that banks operating in the new trade zone will have the freedom to set interest rates freely, and may not be subject to the current interest rate cap imposed by China’s central bank. In addition, there is also discussion over some degree of capital account convertibility of China’s currency, the renminbi.
Some critics have questioned whether the new trade zone is just another method for the local government to raise more land sale revenue. However, I see more positive signs this time. First of all, the decision to set up the zone comes directly from the central government, and is exempt from certain laws implemented everywhere else in China, giving more freedom to businesses. Even Asia’s richest man, billionaire Li Ka-Shing, recently commented that with the development of the free trade zone, Shanghai could pose serious competition to Hong Kong’s current status as the free business gateway to China.
Why might China’s government take this experiment so seriously this time? There are two compelling pressures. Internally, economically developed areas like Shanghai have faced significant growth bottlenecks in recent years, and seek further reform in order to liberalize the economy, especially the services sector. Internationally, Chinese officials in late May expressed China’s interest in joining Trans Pacific Partnership (TPP) negotiations. Being able to join the TPP means further opening its economy, especially financial services to international competition for China. Thus, the government needs a test case like the FTZ to access its readiness for greater competition in these sectors.
Shanghai’s talent base, legal system and administrative efficiency still need to catch up with international service centers in Asia like Hong Kong and Singapore. However, if Shanghai’s experiment is considered a success, liberalization policies may be rolled out to the rest of the country. This is how reform happens in China: taking thoughtful steps with measured risks. We saw how experiments in its special economic zones transformed China into the world’s factory decades ago. This time, the expectations seem equally high for Shanghai’s new experiment.
Sherwood Zhang, CFA Research Analyst at Matthews Asia
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Charlie Awdry. Foto cedida. ¿Están las políticas de Pekín influyendo en la economía real?
Chinese equities have recently rallied and the market is beginning to outperform parts of Asia and other emerging markets. This has come at a time when investor sentiment and expectations are very low. Just as economists cut their gross domestic product (GDP) forecasts, the Chinese economy is starting to show signs of a recovery that appears to be gathering pace.
Investors who have avoided China for a while may be wise to reconsider their positioning
While China still has many structural issues to address, the Chinese authorities’ rhetoric and policy has turned more supportive of reform and growth and this is now feeding through to more robust economic activity. Since the new Communist party leaders took office in November last year, we have been encouraged by their reform agenda including putting pressure on weak financial institutions, curbing the powers of large state-owned monopolies and getting serious about economic reform. It is refreshing that the new Party leaders are content to endure short-term economic growth pain for long-term sustainability gain. However, it appears over the Summer that they have begun to stress growth over reform.
Within our portfolio, companies that have benefited from this more positive backdrop include BMW’s joint venture partner Brilliance China
Encouragingly, the latest macroeconomic indicators suggest that these initiatives are having the desired effect. In analyzing China’s economic health, among the key data we closely monitor are purchasing managers’ index (PMI) manufacturing surveys, commodities demand and power consumption. HSBC’s flash China PMI for manufacturing rose from 50.1 to 51.2 in September, adding to signs of a rebound in its economy. Meanwhile, given an apparent pick-up in global economic activity and order outlooks, it’s not too surprising that China’s export growth edged up to 7.2% year-on-year, exceeding market expectations.
Recently, China’s power production increased to an all-time high as summer temperatures soared. According to data compiled by Bloomberg, electricity generation has climbed to its highest monthly figure on record. The official Xinhua News Agency estimates that China’s power use may rise by 5 to 6 percent in 2013. Already this year we have witnessed a strong pick up in China’s power generation growth – see chart.
Chart: A strong pick up in China’s power generation growth
The half-year corporate reporting season has also been reassuring. A notable number of companies have produced strong profit growth above expectations at a time when scepticism about China has been high. Within our portfolio, companies that have benefited from this more positive backdrop include BMW’s joint venture partner Brilliance China, China’s leading SUV brand Great Wall Motor, and offshore oil service provider China Oilfield Services. We are increasingly positive on China. Many companies appear to offer good value and profit growth potential, while current valuations are cheap compared to historical price-to-earnings and price-to-book measures.
Tightness in interbank money market rates is among the risks that we are monitoring, although the likelihood of an imminent liquidity crisis appears to be minimal as the People’s Bank of China (PBoC) is unlikely to allow this to happen: one concern is that house prices are rising strongly again and the authorities may want to cool this trend. We also continue to look for any signs that the reform process is slowing. Overall, we expect the Chinese economy will experience moderate expansion this year – an ideal scenario for stock pickers like us. Investors who have avoided China for a while may be wise to reconsider their positioning.
Opinion column by Charles Awdry, investment manager of the Chinese Opportunities Fund at Henderson Global Investors
Although my last name might give me away as a Latino, I grew up in Washington, DC; thus conducting business in the Latin American has been as foreign to me as to anyone else from outside the region.
After four years of working and traveling across the southern cone, I have developed a set of guidelines to follow when conducting business around the region, and here are my top five reasons TO BE conducting business in Latin America.
1. Be There.
One of the most important aspects of generating business in Latin America is the “Confianza,” or confidence. You have to gain the trust of future clients, investors and business partners and the only way to do it is by showing commitment and presence. You can surely try the angle of impressing them by calling from your New York or London office, which I myself tried back in 2009, but being present with boots on the ground opens up more doors than any phone call could.
2. Be Connected.
Connections and references are everything in the region. It is always good to have a reference from a friend, client or business partner when conducting business in Latin America. Remember this is a region that sees companies and people coming all the time, and they want to be sure any investment or business they are conducting with you is long term. I came to Argentina with very few contacts and references, and it took me and my business partners almost 9 months to land our first serious client. Till this day, my references are my top way of landing meetings and closing deals with new clients.
3. Be Local.
Anytime I have started doing business in any country, one of my biggest fears is to be perceived as a “Business Tourist”. The main mistake I have seen peers (or competitors in my favor!) make is to assume business stereotypes in the region and assume processes are conducted in the same way it is in the US or Europe. Being local in business means more than learning Spanish or Portuguese; it means learning about the local rules and regulations of the businesses we are offering. This means truly understanding both the competition and the specific regional needs. I offer the same services in Latam to local clients that I do to my US-based clients, but the delivery, execution, and personalization is always different. It might be as simple as the client only needing half of your offerings, or as complicated as adhering to extremely specific local regulations. Whatever the case may be, you must know it first instead of your clients informing you.
4. Be the Expert.
Being the foreign businessman might just be the best selling point and attribute you can use as part of your business development. Being prepared in any meeting and showing you can add value to clients might not be enough in Latin America. Be one step above, and show your expertise in your field of business. After all, any client you are prospecting is also receiving a telephone calls from someone in London, Luxembourg, and another firm just like your’s in the US telling them they can get the job done from afar. I prepare for my meetings by researching who my future client is currently doing business with, the reasons why they have chosen their current business partners and how I add value to relationship. Hint: Letting them know you came to them locally instead of calling them from far away sometimes wins half the meeting, hence my first point.
5. Be Happy.
Chances are your company is looking to expand businesses with clients and investors in Latin America. These countries are becoming extremely wealthy, savvy and welcoming, and I can hardly think of a better time than now to enter the region. If your company is appointing you as the next business developer for the market, make sure you want to be conducting business here, as there are challenges and it is not for everyone. If it is for you, try the make the most of it and have fun! You will be working, but remember that this is the region where it’s ok to be 15 minutes late, wherelunch meetings last 3 hours and where your future clients will open up their doors of their homes for you in the weekends.
So get ready, get involved, and get your boots on the ground. Currently no other region possesses the opportunities and energy that Latin America lends to both the international business and investor. There will surely be a stumbling block or two along the way, but with the appropriate market knowledge it will be more than worth it and will pay off quickly.
Photo: Flickr, Masato Ohta from Tokyo, Japan. Celebrate with Tokyo
Many in Tokyo erupted with delight and excitement following the recent news of the city’s selection as host to the 2020 Summer Olympic Games. Following a failed bid in 2016, Tokyo edged out rivals Istanbul and Madrid on its way to becoming the first Asian city to host the Games for a second time.
When Tokyo hosted the Olympic Games in 1964, the event was instrumental to Japan’s economic development and reconstruction. It also served as a platform for Japan to re-introduce itself on the global stage (Its new bullet train debuted the week before the event, showcasing its technological capabilities). Almost 50 years later, the “Shinkansen” train continues to operate at the world’s highest levels of safety and reliability.
Tokyo’s success comes as Japan’s economy is showing signs that “Abenomics” is starting to work. On the day after the Olympic committee announcement, second quarter GDP growth was revised up to 3.8%, from 2.6%—with better-than-expected domestic capital expenditure as the driver of the revision. Other statistics show that deflation is easing while wages are improving.
Tokyo’s Olympic bid was characterized by its mostly low budget appeal, with plans to refurbish existing facilities rather than to build completely new ones. Infrastructure for transportation and accommodations are already well-established in the city. Therefore, though there may be a positive impact on sentiment, the direct economic impact from the Olympics appears likely to be limited. Tokyo’s own assessment is for an economic boost of roughly US$30 billion, which is only 0.5% of GDP. However, I believe the long-term impact the Games may leave on Japanese tourism should not be ignored.
Last year, overseas tourists to Japan totaled roughly 8.4 million people. Though that number is one of the highest in history, it’s a far cry from the 58 million visitors to China or 67 million visitors to the U.S. Tourism’s contribution to GDP for Japan was only 2.1% in 2012, while France and Italy boasted a contribution of 3.8% and 4.1% respectively. Despite having rich tourism resources, Japan’s inbound tourism has been hampered by a lack of effective promotional strategies and the perception that it is an expensive place to visit. In reality, Japan’s prolonged deflation and, more recently, the weakened yen, have brought Japan travel costs down to levels comparable to vacation destinations like Hong Kong and Singapore.
As middle class incomes in Asia rise, the region’s tourism industry seems likely to experience long-term growth. The media attention that the Games will attract could serve as the catalyst to elevate Tokyo and Japan in the mix of potential holiday destinations. Given the already established infrastructure and relatively low base, a tourism boost could have a profound impact on Japan’s economy. Tokyo already reigns as the world’s gastronomy capital as defined by its world-leading total of 323 Michelin Stars. All it needs is more people to come eat.
Opinion column by Kenichi Amaki, Portfolio Manager at Matthews Asia
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
¿Qué esperar tras la decisión de la SEC de levantar las trabas a la publicidad de los hedge funds?. ¿Qué esperar tras la decisión de la SEC de levantar las trabas a la publicidad de los hedge funds?
Hedge and private equity funds have traditionally been low-profile investment vehicles catering to sophisticated investors. The posture has not been out of choice, but attributable to an 80 year SEC rule prohibiting the general solicitation and general advertising of funds, particularly offerings conducted under Rule 506 of Regulation D. However, the SEC’s recent decision to lift the marketing ban as part of the 2012 Jumpstart Our Business Startups (JOBS) Act is reverberating throughout the industry as firms unaccustomed to promoting their products now face the prospect of competing for investment capital in a new, marketing driven frontier.
The SEC lifted that rule in an attempt to offer more consumers with more investment choices and better information. Hedge and private equity funds can now broadly solicit and promote their products in a manner similar to mutual funds, creating the need for sophisticated marketing and communication strategies.
But that isn’t as easy as it sounds.
Traditionally, funds have been conditioned to maintain a very low profile and more recently, a defensive and reactive posture in the face of negative publicity. Facing these restrictions, funds have limited marketing departments and are ill prepared to compete in a new promotion driven marketplace.
The change couldn’t come at a more challenging and promising time to reach out to the global US$25 Trillion UHNW market. High quality funds can gain a competitive advantage by leveraging their performance with effective financial marketing and promotion to build credibility, trust and relationships with highly targeted audiences. This opportunity is juxtaposed with the post-2008 credit crisis investor mindset that is increasingly reluctant to invest capital into “black box” vehicles that do not communicate their strategies, methodologies and track records in a transparent manner.
The best marketing and communication professionals expertly harness their clients’ expertise, philosophy and track record to develop compelling content that informs and educates their audiences using a mix of thought leadership, marketing collateral, media positioning and events to build awareness of the product, trust in the firm and credibility for its value proposition.
At the end of the day, the most important ingredients for a successful fund will remain a winning strategy and track record. However, what has changed is how funds will increasingly compete to attract investors in what will become a much noisier marketplace where the loudest voices may not necessarily be the best investments.
In this new marketing environment, hedge and private equity funds, even highly successful ones, will need to effectively communicate their value proposition to attract investment capital. Moving forward, the positioning and promotion of an investment product in the right way with the right audiences will become an increasingly important component of its success.
Opinion column by Ray Ruga, Co-Founder of CVOX Group
. Twitter, la siguiente OPV tecnológica, cambia las reglas del juego
Headlines over the past weeks have been buzzing with talk of Twitter- as it is set to be the largest tech IPO since Facebook. Twitter is shaping new ways for users, content providers and advertisers to interact. It’s became a “global town square” – a forum where Presidents, NBA superstars, economists, and journalists can be found sharing their thoughts, research or updates in real-time format. It provides a filter through the endless amounts of content, showing users only the main message. This pure social media play has established itself in our culture with its very own verb, “tweeting.” This is not an opinion on whether to participate in the IPO of Twitter or not- instead we aim to examine how Twitter has positioned itself to become a game changer in media.
A “global town square”
Throughout history there has been a town square where everyone from politicians, musicians, and story tellers went to share their views and talents. Lively discussions, sharing of information, trading of ideas- all of this happened in a live format. Twitter is trying to promote this same exchange by providing a digital platform for users to get real-time content on any topic they desire. Users can follow sports commentators, key thought leaders, and media outlets – and have a custom feed of information tailored to follow these content providers or also trends/topics they are interested in.
“Second screen”: providing a filter for endless content
In today’s digital information age, we are facing a constant barrage of information. Users are constantly scanning through lengthy articles just to find the bottom line- which is exactly what Twitter looks to provide. Tweets are limited to 140 characters- a purposefully chosen number, keeping messages brief and to the point. In a society where our attention span is short and time is limited, this strategy keeps users engaged. Think of Twitter as a filter, providing a “second screen” of longer form information.
“Pure” social media play
Twitter is the only company solely focused on social media and promotes the most interaction and engagement with its users, given the focus on it’s real-time format. This benefits Twitter in their potential to create powerful advertising relationships, as demonstrated in a recent partnership with Nielson TV ratings. Nielson will utilize Twitter to track real-time emotional reactions of users to TV content, giving advertisers and producers powerful information of what engages audiences.
Twitter has been able to brand “tweeting” as a verb
In the 1960s as Xerox made the first office copy makers, to make a copy become known as “xeroxing,” and in the early 2000s as Google become popular, performing a web search became known as “googling.” Twitter has branded “tweeting”- the verb for creating messages on Twitter. This is significant as it shows that the company is a pioneer; a new word is needed to describe its use. Secondly, it shows the company has been well established in our culture, as the verb is well recognized. Both of these factors indicate that the company is creating an important place in its industry, and from the success in Xerox’s early days and the continued success of Google, bodes well for Twitter’s potential future.
Foto: Ruhrfisch. El impacto geopolítico y económico de la revolución del gas de esquisto
You have to go back to the early 1970s to find the last time that oil production increased in the US. However, at that time demand was also increasing at a much faster rate than production and thus the positive impact of rising oil output was more than offset by growing imports. By contrast, and as a result of changing demographics and improving efficiency, demand is currently declining and this trend is likely to continue.
The technological advances that enable oil and gas to be extracted from shale, and Washington’s support for the exploration and production industry are the key factors behind the significant growth in energy output, a trend that will continue for several years. As a consequence, the US is now materially less dependent on oil imports from outside of North America – it imported 40% of its oil requirements in 2012, down from 60% in 2005. This decline in dependence on foreign oil has major implications for the global economy and geopolitics.
The production of natural gas from shale formations has rejuvenated the natural gas industry in the US. The US is singlehandedly relieving the pressure on OPEC and helping oil prices to recede from levels that have rationed demand for over two years. Consequently, one of the essential preconditions to improved global growth, namely adequate and preferably abundant supplies of reasonably-priced, oil-based energy, is now in place.
North America will add a further 0.8 – 1.0 million barrels per day (mbd) of production by the end of 2013 (to put this in context, the US consumes around 18 mbd), and at current crude oil prices this trend will continue. Meanwhile, tougher fuel standards, driving the development of more efficient trucks and cars, will likely keep oil imports on a downward trend.
The inclusion of ethanol highlights the fact that as a result of the implementation of the Renewable Fuels Standard in 2005, the US effectively linked grains and oilseeds to crude oil. As the world’s largest exporter of agricultural products, it has been able to command much higher prices for farm products, boosting another industry and the entire Midwest economy. This augments the economic advantage accruing from the shale energy revolution and reinforces North America as the engine of improving global economic growth.
The changing relationship between the dollar and commodity prices will be the most disruptive feature, because this relationship has prevailed for 40 years. Essentially, fewer dollars will be spent outside of North America to support the US’s 18mbpd (and declining) level of oil consumption. Combined with the flow of investment money into the US, which is supporting increasing energy production, as well as related industries such as chemicals and engineering, and the general recovering economy, the dollar will likely enjoy a period of sustained strength. Given that this development will take place amid strengthening global growth, which will tighten commodity markets, we anticipate that this will result in a period of strong commodity prices together with a robust dollar.
In addition to the macroeconomic impact described above, it is reasonable to extrapolate that US foreign policy, especially as it applies to the Middle East, may be influenced by the rapidly declining dependence of America on OPEC production. A study by Germany’s foreign intelligence agency, the BND, for example, concluded that Washington’s discretionary power in foreign and security policy will increase substantially as a result of the country’s new energy wealth, and that the potential threat from oil producers such as Iran will decline. Moreover, the development of energy resources in the US is taking place at a time when several Middle East countries are undergoing seismic political changes. This background only reinforces the US as the preferred target for investment and increases the likelihood that oil prices will remain elevated into the foreseeable future.
Opinion column by David Donora, Head of Commodities at Threadneedle
. A Turn Towards Domestic Consumption and National Players
The UK and Europe have been late in joining the party to celebrate economic recovery, but signs of this happening are now getting stronger. In the UK, we still see pretty strong headwinds, but the loose monetary policy appears to be working, and the government’s initiatives to boost the housing market are also taking effect. Initially, the recovery appeared to be very consumption-biased, but now appears more broadly based. Recent manufacturing surveys have been strong, and the upward revision to second- quarter GDP was due to better-than-estimated exports and business investment. Meanwhile, PPI claims of around £10bn have certainly helped encourage consumers to spend. Additional support should come from the likely return of around £50bn in cash and shares to Vodafone shareholders, as a result of the sale of the company’s stake in Verizon Wireless. Similarly, the Eurozone remains burdened by a very weak trajectory for government debt and continued bank deleveraging. Manufacturing surveys have strengthened, however, pointing to useful growth, and news from the periphery has improved, assisted by some pushback against austerity.
In the US, where growth has been established for longer, the news has been a little more mixed. The healthy recovery in the housing market may now find the going heavier because of rising mortgage rates, following the rise in government bond yields. In addition, the expected pick-up in capital expenditure by companies is proving more elusive than expected, despite strong balance sheets and aged equipment.
In Japan, Abenomics has certainly had an effect in kick-starting activity. Shinzo Abe has promised a “three arrow” policy, the first two being monetary and fiscal injections. Arrow three consists of a number of specific policies to support growth. This is the part of the package that has yet to materialize in a meaningful way. Markets are looking for activity in this respect, in order to avoid disappointment.
In emerging economies, regions have been moving in different directions. Outflows of capital, following talk of tapering in quantitative easing by the US Federal Reserve, have led to currency weakness, particularly in regions with weak trade and budget positions. This has prompted the authorities to tighten monetary policy to defend currencies, which is impeding growth. In contrast, reports from the all- important Chinese economy have improved a little, with retail sales, trade and manufacturing data above the levels anticipated.
In light of the generally improved outlook for growth in developed economies, we have looked favorably towards companies with domestic exposure in economically-sensitive areas. In Europe, in particular, we have had pretty defensively-positioned portfolios, but have recently added to domestic players, largely through banks, autos and cable companies. In the UK, we had substantial positions in housing-related areas. These stocks have enjoyed strong performance, however, and are already discounting a good recovery. We have therefore looked at adding to defensive growth stocks, which have been overlooked in recent months. In the US, we also favor stocks driven by domestic consumption; again, though, housing-related stocks appear to be reasonably fully valued.
We have long been cautious of core government bonds. We retain that position, but are starting to see better value after a significant rise in yields. The short end of curves appears to offer the best value, discounting official rates rising at a faster pace than we anticipate. The 30-year end of the US treasury market also offers reasonable value. Around the 10-year level, however, we see some further upside in yields against the background of a tapering of quantitative easing and strengthening global growth.
Equities remain our preferred asset class. Valuations are no longer cheap but are still reasonable. Tapering is clearly a potential headwind, but economic recovery is a useful support. Furthermore, the M&A market has recently come to life with some very substantial deals in the telecom, IT and media sectors.
Opinion column by Mark Burgess, Chief Investment Officer at Threadneedle
As the global recession and financial crisis move further back in the rearview mirror, companies have been more proactive about using their balance sheets in ways that enhance shareholder value. But we think they can do a lot more.
As the market tumbled and liquidity dried up post-2008, companies became very conservative in weathering the storm, hunkering down and building up massive cash reserves on their balance sheets. By mid-2013, US companies were sitting on cash that was equivalent to about 11% of their total assets (see Display), a more than three-decade high, earning almost nothing. What’s more, a long decline in interest rates has made borrowing much cheaper.
When corporations don’t put their healthy balance sheets to work in productive ways, shareholders get restless.
Thankfully, that trend has changed. With borrowing costs still very low and business conditions stable to improved, management teams have been more receptive to using debt to buy back shares, increase dividends and make acquisitions.
Each of these actions can boost shareholder value. Share buybacks shrink the total number of shares outstanding, providing a shot in the arm for earnings per share by helping them grow more rapidly in the years ahead, all things being equal. Dividend payments provide attractive income to investors, and acquisitions—if done thoughtfully—can create new avenues for business growth.
But there’s more to do. It’s getting somewhat harder to find companies that seem content to ignore low interest rates and high cash balances, but we still see some firms doing exactly that—even good companies that already represent attractive investments.
They can do better for their shareholders.
Let’s use QUALCOMM as an example. The telecom giant is a well-run business, but the company management’s strategy for returning capital to shareholders has been pretty underwhelming. The firm sits quietly in San Diego with a net cash balance equivalent to about $18 per share, and $6 of that isn’t held offshore—making it more accessible. Without borrowing a cent or repatriating any offshore cash, QUALCOMM could buy back 9% of its shares outstanding. By issuing relatively cheap debt, it could leave more cash on hand and accomplish the same goal.
We believe that buying back shares would benefit both the stock and shareholder value. The company did report $1.5 billion in share repurchases for the second quarter. But since these purchases were used to offset the exercise of company stock options, the average number of shares outstanding actually rose compared with the same quarter in 2012 and, for that matter, the first quarter of 2013.
So, from the perspective of outside shareholders, no shares were repurchased. Even as Qualcomm’s corporate earnings have exploded in recent years, its stock price has languished. In fact, it’s trading at a discount to the S&P 500 Index in terms of P/E ratio—despite strong growth forecasts relative to the S&P 500.
Apple took a different route—but only after a lot of convincing. It was a longtime holdout from buybacks, offering similar justifications to those we’ve heard from Qualcomm and other companies. These include the need for sufficient cash reserves to make operational investments and acquisitions in a rapidly evolving industry. We acknowledge the need for some liquidity, but it’s telling to us that Apple eventually relented and borrowed against its cash reserve to buy back a substantial number of shares.
Other companies still resist share repurchasing, even when their stocks are undervalued and they have more than enough cash on hand to shrink bloated share bases. Qualcomm’s management has raised its dividend in recent years, a modest positive. But it doesn’t shrink the share base—and it certainly doesn’t help the company take advantage of its stock’s low P/E ratio.
In our view, truly shrinking a company’s share base by buying back outstanding shares is likely to lead to higher earnings per share later on. And since corporate cash is earning less than the dividend yield on the stock, it could actually save money. Whether a company uses cash, relatively cheap debt issuance or a combination of both to increase shareholder value, we think investors would welcome the news.
Kurt Feuerman is Chief Investment Officer of Select US Equity Portfolios at AllianceBernstein.
