Market Musings 27/8/11

It’s been a busy 48 hours since I last scribbled down my thoughts on the wider market. I did write a focused piece on Anglo Irish Bank’s H1 results after I attended their presentation yesterday, but there have been plenty of other goings on such as Bernanke’s utterances at Jackson Hole and INM’s results that also caught my eye.

 

Turning firstly to the commodities space, this chart by Mike McDonough reflects something that I’ve been wondering about for some time - equity markets appear to be pricing in a deeper recession than the commodities markets. As Mike says, “one is wrong”. Regular readers of this blog know that I’ve become a lot more bullish on shares since the recent pull-back, so you can guess which one I believe to be overvalued. Hence, despite their recent performance I’m quite comfortable with my more oil-sensitive (on the cost side) positions Ryanair (oil made up 39% of its operating costs in FY11) and Irish Continental Group (oil made up 20% of operating costs in FY10). It should be noted that (i) ICG does not purchase forward its fuel requirements, unlike Ryanair; and (ii) Clearly, a significant retreat in the oil price will likely be allied to a worsening of the economic outlook, which would sap some customer demand for transport services. In terms of my long oil positions, BP and PetroNeft, both of them are so cheap that I wouldn’t have any sleepless nights over holding them even if the oil price dropped like a stone from here.

 

(Disclaimer: I’m a shareholder in Independent News & Media plc) Independent News & Media (INM), the biggest newspaper group in both Ireland and South Africa, issued its H1 results yesterday. Operating profits were broadly in-line at €34.5m, but net debt at €452.1m was higher than the €446.3m reported in May. In terms of the outlook, INM says: “advertising conditions remain tough and volatile”, and it sees no “uplift or normalisation in advertising conditions before the year-end”. My rationale for originally buying this stock was that I see real potential for an uplift to the shares as debt is paid down (net debt accounted for circa 75% of INM’s enterprise value at the time of writing). However, given the poor outlook, it’s going to be a while before we see the sort of recovery in advertising markets that would facilitate a meaningful acceleration in the debt pay-down (at the current rate it’s being paid down it will take INM nearly a decade to become debt-free). So for me it’s a hold for now.

 

A cautionary tale: A Greek retiree withdrew his savings from the bank, stashing the paper money in the wall of his home. Rats devoured it.

 

Bank of America-Merrill Lynch has an interesting piece on Eurobonds that’s worth a read.

 

Ben Bernanke’s Jackson Hole speech didn’t quite live up to some of the hype going into it. Pimco’s El-Erian has a good ‘interpretation’ of it here. The fact that the Fed has now decided to extend its September meeting to two days to “allow a fuller discussion” of its options means that attention switches both to that and President Obama’s speech after the September 5 Labor Day holiday to see what the next policy rabbit to be pulled out of the hat will be.

 

Finally, a good news story to end with. Shamrock Rovers this week became the first Irish team to qualify for the group stages of a European club football competition by prevailing over Partizan Belgrade in the Europa League, helped by this fantastic goal. Congratulations to them.

Market Musings 12/8/11

Markets rebounded a bit yesterday, but remain well below recent highs. Since my last update the main news has been the introduction of a short-selling ban in a number of EU member states, which I’ll look at in more detail below, while other things that have caught my eye include the price of gold, poor economic indicators in the UK and France, and also some corporate newsflow.

 

First up though, I was pleased to be “welcomed back” (!) by two readers who posed some really great questions to me about commodity prices and the short-selling ban yesterday. If there are any topics, within reason, that you’d like me to visit on this blog, feel free to get in touch and I’ll tackle it them here asap.

 

When the rumours about the introduction of a short-selling ban emerged yesterday afternoon, my initial response was to say that (i) this will does nothing to cure the problems in Europe’s banks; (ii) such measures have failed to work before; and (iii) bans are counter-productive because they increase the perceived riskiness of assets that are the subject of such bans, as market participants will no doubt become more wary about investments where governments and/or regulators intervene to significantly change the rules of the game.

 

These counter-arguments were put to me:

 

Well it’s time for something radical

It’s better than doing nothing and have rampers profit from what is nothing short of criminal with no risk of prosecution

If Italy and Spain are happy with their fundamentals they will not suffer from a suspension of short selling

The Irish and US experiences with bans are poor examples to give

 

My quick response to those four arguments are: (i) I agree that radical policies are needed, but I don’t see how a short-selling ban will do anything to cure the patient; (ii) The short-sellers wouldn’t have been circling around the banking sector unless something was very rotten in the system; (iii) Italy and Spain’s “fundamentals” – sclerotic growth, substantial public debt, big deficits, dire demographics, structurally high unemployment – would make me nervous; and (iv) I think using a fellow peripheral European country and the country where this bank problem first really started to emerge is fair.

 

To the above I would add the following: Bloomberg’s Mike McDonough, who is a must-follow on Twitter, produced this great chart which shows the experience of a short-selling ban across five countries, adding the UK, Germany and the Netherlands to the two I provided as examples.  As I said above, the ban does nothing to address the fundamental reasons why the market has turned negative on financials, namely worries about the growth outlook, the increasingly likelihood of substantial write-downs on holdings of sovereign debt and political calls for a punitive tax on banks. These problems will not go away as a result of  a trading restriction which Galileo Global Advisors describes as “knee-jerk” in a FT article that’s well worth a read. In particular for this bit:

 

A 2005 Cornell University study looked at short selling rules in 111 countries and found no evidence that bans reduced the frequency of market crashes. More recently, the International Monetary Fund found that 2008 prohibitions “did relatively little to support the targeted institutions’ underlying stock prices, while liquidity dropped and volatility rose substantially”.

 

Elsewhere in the FT, the influential Lex column concludes with this point that mirrors part of the argument I made yesterday:

 

Market gravity pulled weak companies down, as investors recognised that the shorts were right. When pessimism is justified, bans will not stop the truth from emerging.

 

Turning to France, earlier today it announced that second quarter GDP growth came in at zero, below consensus of +0.3%. Clearly this is the last thing Sarkozy et al need after the recent concerns about its economy. Staying with macroeconomic news, a study by LSL and Acadametrics says that UK house prices have fallen to a 19 month low.

 

In the commodity space, gold futures hit $1,800 an ounce earlier this week but have fallen back a little on CME margin hikes and also the uptick in equity prices. Given how volatile markets are at this time, I wouldn’t be surprised to see the upward trend resume in the near term – Merrill Lynch reckons gold will hit $2,000 in the next 12 months, which looks easily attainable given the troubled backdrop and the possibility of another round of quantitative easing in the United States. The margin increase serves as a reminder that while the path of least resistance is up, it will be a rocky one. One of my readers has asked if I can provide…

 

An analysis of the equity and businesses surrounding gold extraction and trade

 

…which is something I aim to tackle over the weekend, along with the dividend yield report I promised yesterday!

 

Finally, one “grey market” name I’ve written about before is One51. It released its 2010 annual report yesterday, which revealed a solid underlying performance, with pre-tax profits (before exceptional items) rising to €24.5m from €19.5m in the previous year. Its NAV of €2.56 per share was well down on the €3.66 at the end of 2009, with most of this decline down to a non-cash impairment charge on the value of its listed and unlisted investments. The main worry I would have on this front would be the value of its NTR stake, which it includes in the books at €48.7m, or just under 40c a share. Even if you wrote this to zero (which would obviously be an aggressively cautious step to take), you still get a NAV of over €2 a share, versus a current share price of €1.00. While its illiquid grey market status and significant Irish exposure mean that a discount to NAV is warranted in my book, a 50%+ discount looks excessive to me. One way that it could help to address this discount is by transitioning to a listing on the Irish Stock Exchange, which would improve the marketability of its shares. One area that has attracted media attention is remuneration levels at the group. While it is easy to point at how much the top dog in any company is paid, overall employee costs should not be ignored. The total P&L charge on this front of €65.4m was -6% from the previous year, while average wages & salary costs of €38k per employee (a whopping 14% below 2009 levels) are hardly excessive.

 

Two highly alarming stats to chew over – the percentage of Americans who don’t have $1,000 in savings to cover emergencies? 64%. The percentage of Americans who don’t have any savings whatsoever to cover emergencies? 24%.

 

And finally, seeing this gold-dispensing ATM was a highlight of my recent trip to Dubai.

Market Musings 25/5/11

I didn’t expect to have any time to blog on my travels through North and South America but with an hour to spare I thought I should scribble down a few observations.  From a broad markets perspective, I wasn’t surprised to see that most of the leading share indices have declined in line with the prediction given in my last update, but I have to admit that I would have thought that the declines would have been more pronounced than they have been. We’ve seen a good bit of volatility in currency markets too. The “flight to safety” theme is well and truly in the ascendancy here with the Swiss franc rising to an all-time high against the euro. Concerns about peripheral Europe remain to the fore, but the EU elite appear hell-bent on pursuing measures that will worsen and prolong the crisis instead of doing the sensible thing and imposing haircuts on the unsustainable debts that Ireland, Portugal and Greece have.

One of the worst offenders when it comes to advocating policies to address the peripheral countries’ problems that make absolutely no sense is the French government. My heart sank when I saw that Christine Lagarde is the leading candidate to take over the IMF. Christine believes that Ireland should be raising taxes on business (translation: jobs) at a time of deep recession, which of course will serve only to heap further pain onto the Irish economy. It was staggering to see several Irish politicians enthusiastically support her candidacy, given her views about our economy. Something to remember for the next time a canvasser calls to your door.

Speaking of bad policy decisions, I note Tullow Oil’s subtle dig at the UK government in its announcement accompanying its acquisition of Nuon in the Dutch part of the North Sea. At a time where concerns about energy security are elevated it makes no sense that George Osborne raised taxes on E&P operators in his last budget.

The US debt ceiling talks continue to drag on. The reality that both the Democrats and the Republicans need to face up to is that America’s debt and deficit positions are completely unsustainable. The fiscal jaws need to close sooner rather than later, and I was pleased to see that Grover Norquist, who I’d the pleasure of meeting at a free-market conference in Brussels some years ago, is applying pressure on politicians to do the right thing and cut spending, instead of raising taxes.

Turning to the banks, I see that Moody’s has placed 14 UK banks, including Bank of Ireland’s UK subsidiary, on notice for a possible downgrade. Not a big surprise, but I do think that the UK government is trying to wean them off its support a little too early. I note an interesting suggestion by economist Ronan Lyons for a maximum LTV to be applied to future mortgages by the regulators in Ireland. That’s a sensible suggestion which I endorse, but I would go a step further and say that total borrowings should be taken into account as well – we all know imprudent folk who have built up a “portfolio of debt” that encompasses personal loans, car loans, credit card debt and mortgages. While my more libertarian-minded friends would say that individuals should be allowed do with their finances as they wish, the problem with that logic, as we’ve seen in Ireland, is that the taxpayer usually has to pick up the tab for financial messes created by other people.

Did you know that shale gas formations have the potential to double the world’s gas reserves? Staying on energy, here are some interesting perspectives on US gasoline consumption, via the good people at Morgan Stanley:

1. Americans spend $500bn on gasoline a year (50% of total US oil demand).
2. US households spend twice as much on gasoline and motor oil as they do on education.
3. At $5/gallon (it’s at $3.85 now), assuming constant demand, US households would spend as much on gas & motor oil as they do on healthcare.

Finally,  a commodity price update – Starbucks is raising the price of bagged coffee sold at its US stores by 17%. I like coffee as long-term investment given that the commodity has robust structural drivers – the demand boost that the more than 1bn “emerging middle class” people in Asia will give this over the coming years is going to be staggering to watch.

Market Musings 28/4/11

A case of “as you were” in the markets since my last update. Commodities remain at dizzying heights, sovereign concerns continue to loom large and equity markets continue to defy gravity.

Eurostat released its debt and deficit updates for 2010 on Tuesday, which reaffirmed what we already knew about the woeful state of the balance sheets and profit & loss accounts of many EU’s countries. Greece’s deficit hit 10.5% of GDP, above the 9.6% forecast. It was exceeded only by ourselves – at 32.4% – while other states in the deficit dog house include the UK (10.4%), Spain (9.2%) and Portugal (9.1%). I cannot understand why so many British commentators criticise the austerity measures being implemented by Chancellor Osborne – were it not for these steps the UK’s 10 year bond yield, currently at 3.48%, would be a lot closer to Greece’s 15.39%.

Ireland’s debt/GDP ratio ballooned from 65.6% in 2009 to 96.2% at the end of last year. Only Greece (142.8%), Italy (119.0%) and Belgium (96.8%) have a higher ratio than ourselves. Given the state of the Exchequer Returns posted since the start of the year, I assume that we’ve eclipsed Belgium by now. The words of Thomas Jefferson come to mind: “To preserve our independence, we must not let our rulers load us with perpetual debt”.

The bond markets continue to suggest that debt restructuring is inevitable in the PIG countries. The 2 year bond yields for Greece, Portugal and Ireland as I type stand at 23.4%, 11.4% and 11.1% respectively. Those of you who don’t obsess about markets as much as I do (!) may wonder why I’ve narrowed it down from the “PIIGS” acronym that used to do the rounds. Simple fact is that the market seemingly isn’t as bothered about Italy (2 year yield is only 3.0%) and Spain (2 year: 3.3%). You’d have to be a brave person to say the market has it wrong, but I am extremely nervous about Spain, and wouldn’t be surprised to see it moving back into the bears’ cross-hairs later in the year.

Turning to the US, here is some interesting housing stuff for you - More than 1 in every 5 Phoenix-area mortgage holders would need their homes to double in value just to break even. Elsewhere, there were few surprises from the Federal Reserve after its meeting this week. I do note, however, that the Fed has downgraded its growth expectations for the US, despite its massive stimulus efforts. By The Ben Bernank’s own admission: “It is a relatively slow recovery“. For a good primer on the folly that is quantitative easing, watch this video. Congressman Paul, one of my favourite politicians, talks a lot of sense about the Fed here.

Economics geeks will treasure this video.

Jeremy Grantham, who is the G in GMO, has written an outstanding investor letter which you can download here. While I wouldn’t agree with 100% of it, it is peppered with thought-provoking analysis and interesting stats. One thing that particularly caught my eye was the table that revealed China’s share of world commodity consumption:

• Cement 53.2%
• Iron Ore 47.7%
• Coal 46.9%
• Pigs 46.4%
• Steel 45.4%
• Lead 44.6%
• Zinc 41.3%
• Aluminum 40.6%
• Copper 38.9%
• Eggs 37.2%
• Nickel 36.3%
• Rice 28.1%
• Soybeans 24.6%
• Wheat 16.6%
• Chickens 15.6%
• PPP GDP 13.6%
• Oil 10.3%
• Cattle 9.5%
• GDP 9.4%

When the Chinese economy rolls over, as I expect it will in the not-too-distant-future (see previous blog entries about China’s property bubble and other pressures), that table will be particularly useful when it comes to predicting what commodities and shares will be the most affected.

Market Musings 12/04/11

Since my last installment we’ve seen further concerning news about the health of the UK economy, coupled with wobbles in the commodity market and further evidence that M&A activity is on the way back – in the more defensive sectors at least.

 

A series of updates from UK consumer oriented firms continued to support my caution around that market. Recruiter Michael Page said that market conditions “remain tough”, with public sector hiring demand “difficult”, while plant hire group Speedy Hire said that it remains cautious about the prospects for a short-term recovery. The BRC said that UK retail sales plunged by the most on record in March,

 

As I recently discussed in an article in Business & Finance magazine, one area that continues to benefit from positive commodity trends is agriculture. On this front, Carr’s Milling, a peer of Ireland’s Origin Enterprises, released an update which has a bullish read-across for Origin. Elsewhere, cocoa prices plunged after French special forces seized Laurent Gbagbo in the Ivory Coast, which should hopefully lead to a new chapter in that State’s troubled history. Hard commodities such as oil wobbled today after Goldmans cooled its view on them.

 

(Disclaimer: I am a shareholder in AIB plc). AIB released 2010 results earlier this morning, that showed the bank lost €10.2bn last year. The group says that: “business and market conditions remain challenging and the environment for operating income generation remains difficult”. While deposit outflows had been flagged last year, I still raised an eyebrow at the confirmation that customer deposits decreased by €22 billion in 2010 to €52 billion. The deposit outflow was most acute in capital markets (corporate deposits), where deposits were -65% vs -10% in AIB ROI & -24% in AIB UK. AIB’s LDR widened to 165% at end-2010 vs 123% at end-2009. In terms of the quality of the loan book, AIB’s “criticised loans” are now at 30.2% of total loans, while impaired loans are at 13.4% of total loans. On funding, at end-2010, AIB had ECB drawings of €25.2bn & another €11.4bn from Ireland’s central bank, a combined €36.6bn or 25% of the balance sheet. However, the Polish disposal and Anglo deposit acquisition will have cut that somewhat since the start of the year. All in all things look very grave for the bank, which is effectively on life support from the State for now.

 

On the M&A front, we had denials from both BHP Billiton and Woodside that they were in discussions over a $49bn deal, while Schneider Electric was rumoured to be planning a deal for Tyco (market cap $23bn) . There has been a lot of speculation about BP’s intentions for its troublesome TNK-BP operation, and I was interested in this article about it. In terms of deals that are going ahead, post AT&T/T-Mobile USA & Vivendi/SFR I had wondered if more telco M&A would come. Then Level 3 paid $3bn for Global Crossing. Elsewhere, Flowers Foods paid $165m for Tasty Baking, which continues the narrative of consolidation in the North American bakery market, a process which Ireland’s Aryzta has been very active in.

 

There was a bit of military newsflow that caught my eye this week. Firstly, data was released that show global military spending continues to rise, with the world’s biggest spender, the US, having raised its expenditure by 81% since 2001. The US Navy conducted its first test of a laser weapon at sea. Speaking of weapons, watch this video.

 

I do hope that I’m ultimately proven wrong, but the government here looks to be dithering every bit as much as its predecessor when it comes to pushing through reforms and fiscal consolidation. And reform is urgently needed. One example of this came in the shape of a recent Irish Times article which revealed that despite the failings in governance in many areas of the public sector in recent years, a mere 1 of the 300 external candidates for senior civil service positions in the past 3-and-a-half years was successful. Opening recruitment in the public sector to further outside competition can only be a positive in terms of incentivising better delivery of services. On the spending front, the government announced yet another “review” which simply wastes more time and thus will result in even more debt being loaded onto our battered economy. Speaking of our battered economy, Bank of Ireland became the latest forecaster to cut its estimates for GDP growth.

 

I’m rather sceptical on the BRIC economies at the moment, for reasons that deserve a blog all of its own. A couple of pieces of news caught my eye in this space which reinforced my suspicions. Firstly, George Soros said that inflation in China is “somewhat out of control“. This chart by Bloomberg economist Michael McDonough also tells a lot about the inflationary issues affecting these emerging markets. Finally, one of the biggest holders of US Treasurys is of course the People’s Bank of China, and I was interested in reading that a former PBOC official has described the US Treasury market as “a giant Ponzi scheme“. Elsewhere, Australian housing data looks to be turning negative – this is a trend worth keeping an eye on.