Market Musings 14/11/11

Concerns around the Eurozone show no signs of abating. Writing in last weekend’s FT, Merryn Somerset Webb perfectly captured the options policymakers are considering when she wrote: “Europe will get one of three things: a break-up leading to a systemic banking crisis and a global recession; or a commitment to an impossible level of austerity followed by recession and civil unrest; or a round of ECB-driven money creation and sovereign bond-buying that will make the UK’s extraordinary QE programme look like my children’s pocket money“.

 

Like Merryn, I suspect that the third option will be the one chosen by Europe’s political leadership. You only have to look at our main trading partners to see what will happen when the Eurozone’s monetary sluice is fully opened – as I note in the current issue of Business & Finance, inflation in both the US and UK stands at a three year high. This inflation tax will disproportionately affect people on lower incomes, and people need to move to protect themselves against it. My advice remains that you should increase your exposure to both gold and equities (at least, the ones with strong balance sheets) and reduce holdings of cash (whose value will be eroded by inflation) and government debt (given the state of public finances across much of the world).

 

Speaking of public finances, we recently got an overview of the Irish government’s medium-term fiscal strategy. Have a look at Table 3.2 (on page 28) in it – cutbacks in day-to-day spending between now and 2015 are expected to be mostly offset by ever-increasing debt service costs. This is the inevitable consequence of the dithering by the present government – and its predecessor – when it comes to right-sizing public spending.

 

Silvio Berlusconi stepped down as Italy’s Prime Minister, leaving behind a dismal track record. As this article notes, it’s easier to do business in Albania than in Italy.

 

I was not surprised to read that 2011 is likely to be the third highest year for S&P buybacks on record. We’ve seen a lot of share buybacks in Ireland too (e.g. Ryanair, Abbey, United Drug, Dragon Oil) this year, which partly reflects companies’ reluctance to invest capital in M&A and development at a time of such economic uncertainty.

 

(Disclaimer: I am a shareholder in Irish Continental Group plc) Turning to corporate newsflow, today brought trading updates from both Kingspan and ICG. Kingspan reported that it rate of increase in sales is slowing, but falling input cost pressures are giving a boost to margins. I am a long-term admirer of Kingspan for its structural growth qualities and excellent management (CEO Gene Murtagh is one of the most impressive executives I’ve met) but given the weak macro outlook it’s one that will struggle to reach the valuation it deserves in the near term. ICG released a trading update earlier this afternoon which revealed that 9 month EBITDA has declined by €5m yoy (from €45m to €40m) as fuel costs have increased by €8m over the same period. While, as ICG says, “the economic backdrop remains challenging”, I note that its strong balance sheet (net debt was only €13m at the end of Q3 – and the company paid a dividend of €8.2m during that quarter) gives ICG the staying power to consolidate its position while weaker competitors such as DFDS and Fastnet take capacity out of the market.

Market Musings 6/6/11

A few things have caught my eye since my last blog post. Firstly, the Lex column in the weekend edition of the Financial Times had a good piece on Greece’s creditors, a theme that Bloomberg picked up on this morning. According to an analysis by BarCap, a mere 30 institutions hold two-thirds of Greek government debt. The main creditors are: Domestic €90bn, ECB €40bn, Other Central Banks €35bn and German & French banks €34bn. BarCap estimates that the recovery rate for Greek bonds will be 25-28% of nominal value, which is no great surprise given where Greek bonds are trading.

I’ve seen some recent debates about Argentina’s default, with several people giving the impression that we’ve nothing really to worry about should Ireland walk away from its debts. That’s not quite the case. On my recent travels in Argentina many of the people I met spoke of how their savings were mostly wiped out after the default happened. This Irish Times piece gives a good picture of the impact that this had. Staying on this theme, another thing I noticed when I was in Buenos Aires and Mendoza was that even modest homes were “fortified” (bars/shutters on all the windows etc.). I asked the locals why this was the case, and they explained that after seeing how their savings were mostly wiped out many people simply convert their wages from pesos into US$ and keep it in cash at home. Of course, the consequence of people not putting their money into the banks is that  it is harder for firms to borrow which means less investment in the economy. So, alas, default is no panacea. As an aside, not all of the cash is kept in shoeboxes in peoples’ homes – when I was in Uruguay I noted that every second building seemed to be a bank, and this local press story explains how many Argentinians keep their savings in financial institutions located in their smaller neighbour, rather than invest in their own economy.

Elsewhere, the International Air Transport Association cut its 2011 global airline-industry profit forecast by 54% because of higher oil prices, political protests in the Middle East and North Africa, and Japan’s earthquake. No great surprise there I would have thought.

I was really surprised that the Slovenian electorate rejected plans to raise the minimum retirement age to 65 from the current levels of 58 for men and 57 for women. Considering that life expectancy in that country is now 79 (having increased 10.5 years since 1960), it is inevitable that the country will reach a stage where the demographics cannot sustain such a set-up. Better for countries to reform systems to take into account longer life expectancies now before the demographic time bomb detonates.

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 25/4/11

Blogging has been quiet with the Easter break. However, there’s been a good bit of action around the market, with commodities and sovereign concerns again to the fore. So, let’s recap what’s been going on.

As I noted in a recent article in Business & Finance, this year will see a marked increase in M&A activity both here in Ireland and abroad. Divestments – actual and expected – are particularly newsworthy these days between the banks (Bank of Ireland sold its 50% stake in a fund-of-funds business) and the State, where there is ongong speculation about what assets the government will offload in an effort to repair Ireland Inc’s balance sheet. One of the points I made in my B&F article was that State assets would need to be reformed ahead of their disposal, and an obvious target here is their cost structure. The Sunday Independent had a good analysis comparing pay at the highest levels of public enterprises here versus other countries which threw up some eye-popping results, including the revelation that the head of An Post enjoys a level of remuneration that is nearly three times that of the head of the Royal Mail.

In the US, concerns about the country’s $14.3trn national debt show no signs of abating.  Legendary investor Jim Rogers is the latest to warn about the lack of buyers of US Treasurys once quantitative easing ends in June. This is a theme I touch on in the upcoming May edition of Business & Finance in a piece which examines whether or not investors should, as the saying goes, “Sell in May and go away“. One thing which I’m not inclined to buy is the US dollar, which I see weakening further against the euro over the rest of the year. Here’s something which added to my general bearish sentiment towards the dollar.

The national debt in the UK also concerns me. In March the Exchequer racked up a deficit of £18.6bn. Over the last 12 months the total fiscal deficit in the UK has been £141.1bn (circa 10% of GDP). Britain’s deficit relative to its GDP is at a similar level to the US, and indeed ourselves. So the Anglosphere “delinquents” collectively need to get their houses in order.

Speaking of countries that need to sort out their debts, Greece was again in the spotlight, with its 30 year debt trading at 50c in the euro late last week, which to me shows that the market is convinced that a restructuring of its debts is inevitable. I expect Interpol to come knocking on my door shortly (!), because Greece isn’t best pleased with anyone who says that sort of thing. Of course, Greece blaming Citigroup for its latest woes reminds me of Anglo Irish accusing UK brokers of spreading ‘baseless rumours’ before its demise. But what shape might Greece’s debt restructuring take? This Citi note offers a few ideas. Ideas that may well apply closer to home too.

Further afield, China continues to deteriorate. The Financial Times reported over the weekend that it has ordered its banks to conduct stress tests modelling for a drop of up to 50% in house prices. Regular readers of this blog will be familiar with the video showing that China has 64m empty apartments, which makes me think that the fall out from a crash in China will be horrendous. I wouldn’t be keen on buying anything with a material exposure to China at this point.

Speaking of materials, silver looks like it is about to break the $50/ounce level, not long after gold crossed the $1,500/ounce mark. For what it’s worth, I remain positive on gold, despite its dramatic rise in the past year or so, as it’s not a bad place to hide from any trouble – and we’ve a lot of that going on at the moment. Also, I note that gold surged after the withdrawal of QE1 last year, so will we see a similar move when QE2 is withdrawn? One point of note though – the gold/silver price ratio of circa 30:1 is well below the 20th century average of 47:1, so I wonder if silver has had its move for now. Watch this space!

Market Musings 15/04/11

It’s been a case of “as you were” since my last blog earlier this week, with the same narrative running through to today. Despite the narrative being a bearish one, I view this as positive, as it’s reassuring to see the market play out just as you expect it to. We’ve seen more wobbles on the commodity side as Goldman Sachs continue to reiterate their negative call on commodity prices. We’ve also seen further concerning data from the BRICs which strengthens my conviction that those are not markets to play for now. I have taken some money off the table, selling one of my “core holdings”, but I don’t see a compelling reason to top up any of my “trading positions” just yet.

(Disclaimer: I am a shareholder in Ryanair) The sector that will benefit the most from a sliding oil price is of course the airline sector. West Texas Crude fell 4.1% between the start of the week and last night’s close, and this has had a corresponding benefit on the likes of Aer Lingus (+8.8% in the same period) and Ryanair (+2.1%). The negative noises around the oil price and the world economy give me confidence that Ireland’s two listed airlines will outperform over the coming months.

Anyone who reads the papers knows that the US economy is very sick. Forecasters are downgrading their expectations for the US economy, which in turn will lead to downgrades for earnings estimates for stocks. These downgrades could well see global markets retrench over the quiet summer months. In my last Business & Finance article I asked if this is going to be a year where the old adage – “Sell in May and go away” applies. I suspect it will be. The US budget deal was heralded by those lacking in intellectual curiosity as a “historic agreement”.  But that’s just garbage. The amount of money the deal aims to save is $38.5bn. The US deficit over the past 12 months was $1.4trn. Complete drop in the ocean stuff. Citigroup takes up this narrative, warning on the prospects for the US dollar.

There was similar economic madness from the Irish authorities. The Minister for Public Expenditure and Reform, Brendan Howlin, said that the “stimulus” package his government is planning may be funded through higher taxes. In reality, the only thing that higher taxes will stimulate is higher unemployment.

The BRIC economies continue to cause concern for me. Especially China. I’ve previously banged the drum about the 64m empty apartments in the country, which makes Ireland’s property bubble look like “a modest overhang”. You can now add collapsing car sales and soaring inflation to the mix of things that make me bearish on China. Oh, and I almost forgot – to add to my narrative on the Chinese property market, Moody’s lowered its outlook for China’s property sector from “stable” to “negative”, saying that sales could fall as much as 30%.

Europe is still seeing severe problems, especially on the periphery. During the week the Greek 10 year bond yield went above 13% for the first time, with its spread over bunds at a Euro-era record. In an effort to address this lack of confidence, Greece plans to sell assets and cut spending, but will not restructure its debts.

The ratings agencies get little by way of enthusiasm here given their form for “closing the stable door after the horse has bolted”. However, Fitch’s decision to downgrade its ratings on Libya by three levels amused me given that Libya has no sovereign debt.

Bank of Ireland released full-year results, and while the absence of any detail on its capital raising means that many investors will wait on the sidelines until this is clarified, I was struck by the different trends it’s seeing relative to AIB. Firstly, BKIR’s deposits have been stable since November (AIB is still seeing outflows). Secondly, BKIR’s “challenged loans” were down sequentially in H2 2010, while AIB’s “criticised loans” were up sequentially in the same period. Thirdly, BKIR’s “impaired loans” stand at 9.2% (from 7.1% in H1), versus AIB’s, which are rising at a much faster rate – to 12.9% in H2 2010 (from 8.4% in H1).

Overall, very troubling macro developments. I suspect we’re in for a choppy few months in the markets.