Gravitas Spark CrowdFunding

Author: Gary McCarthy

  • Five Fintech Trends To Watch

    Sesame Street aired its first episode fifty years ago this week but it’s all change these days. Of course, Kermit and Big Bird are still around, Bert And Ernie are still good friends but this childhood staple is now a pay-TV item courtesy of HBO. In the politically correct minefield that is the US today whoodathunk that paying for Sesame Street would attract the least social debate from that summary update. One must get used to change. And if we are going to reference muppets and commerce then it’s not a huge stretch to visit the topic of banking.

    It is no secret the banking sector faces huge technology challenges. Some banks will fail. Some will thrive. The differentiating factor will be their success in ‘fintech’, or more explicitly, the application of technology in financial services. The planet has its first billion customer financial services franchise, Alipay, but this business was built on technology not a traditional bank branch network. The opportunities in fintech are enormous as the arms race continues between old-style banks and new tech-savvy financial platforms. It will be fascinating to see how this battle plays out but here are 5 trends we are keeping a close eye on.

    1. Global fintech funding activity: Funding activity in Q3 2019 reached $12.3 billion according to the latest FT Partners report. That is the most active quarter ever despite the global economy slowing down. This tells us that fintech spend is a structural trend irrespective of economic cycles.
    2. Bank vulnerability: Consultants McKinsey have published a report saying that a significant economic downturn would put 60% of banks in a weakened state which they may not survive. McKinsey have called for the banking sector to “urgently consider a suite of radical organic or inorganic moves before we hit a downturn”. Banks will be making plenty of announcements in the coming months. It won’t be just HSBC and Deutsche Bank.
    3. Mobile meets banking: The partnership between Goldman Sachs and Apple on a payment card has attracted plenty of criticism of its gender-biased credit algorithm. Not a cool start but the trend is set. Mobile ecosystems are perfect for financial services.
    4. Big Tech wants to bank: The aforementioned 1 billion customer financial platform, Alipay, in China has not escaped the attention of other big tech players. It is no surprise to see reports of Google plans to offer checking accounts to consumers in partnership with traditional banks. Amazon are already doing credit cards and business loans so the lines between tech and banking are becoming very fuzzy.
    5. The war on cash: Surveys of consumers’ last 10 purchases reveal that a whopping 60% of payments are now executed without cash. In some countries like Sweden, that percentage can be over 90%. The shift to audit-friendly digital payments is very attractive to governments and regulators so expect further moves in the currency/cash arena. Facebook will struggle for credibility with its Libra cryptocurrency but there will be other players who won’t have to admit they will happily bank profits to publish false information. Banks may not have a great reputation but Facebook appears determined to win the race to the credibility floor. Currencies need credibility. New currencies, crypto or other, have failed that test so far.

    The good news for consumers and businesses is that fintech should deliver better services at lower costs. Consumers and costs are only moving in one direction. On that basis, this writer would actually suggest the McKinsey report is too optimistic. Muppet leadership and poor economics don’t need a recession to kill off more than 60% of banks. The trends are irreversible and the unloved status of banking means there will be no HBOs to save the muppets.

     

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  • The Most Important Poll In Markets Today

    As impeachment hearings begin in Washington this week one can’t help wondering what Roger Ailes would do. Ailes, the creator of Fox News, is the subject of the latest US blockbuster mini-series, The Loudest Voice. It’s a scary reminder of how Fox News dramatically changed the US political landscape and used TV, not just to shape audience views but to deliver a vision of the world demanded by its viewers. Ailes himself once said, “Truth is whatever people will believe”. It is already clear Ailes’s legendary truth-shaping genius would be sorely tested on Capitol Hill right now. However, it might not even matter.

    There seems to be an air of resignation that Donald Trump’s base support of Fox viewers are unmoved by their President’s daily dose of awful. Porn star pay-offs, Greenland annexation, Kurdish betrayal, North Korean love letters, Twitter tantrums and Putin puppy dog fawning have failed to erode core voter support of circa 44% in current national polling. Critical to this robust base is the cult-like devotion of almost 90% of Republican voters. Thanks to the electoral college voting system in the US it’s entirely possible Trump could be re-elected in 2020 with a sub-50% support base. However, wall-to-wall TV coverage of impeachment hearings in Washington is possibly the last chance for this core support to shift.

    The live TV depositions of the first two witnesses from inside the US State Department, George Kent and Bill Taylor, paint a very stark reality that the Prime Minister of an ally, Ukraine, was the subject of a mobster style shake-down. The foreign policy version of wise-guy extortion was the blocking of much needed military aid to force a false investigation into election rival, Joe Biden. There are multiple other witnesses due to testify with similar tales and the only accounts missing are White House figures defying subpoenas to appear. It’s TV torture for Trump and his Twitter account is exhibiting heightened levels of agitation. However, there is only one poll that ultimately counts.

    We are only in the impeachment hearings phase. The vote to impeach is still to come in the House of Representatives and will likely pass. Then it’s on to the Senate for a trial. The hurdle in the Senate to actually convict Trump and remove him from office is a two-thirds majority guilty vote. This is where Republicans failed in impeaching Bill Clinton. Most observers correctly believe it is currently almost impossible to see how the required 20 Republican Senators cross the aisle to vote with Democrat Senators for removal of the President.

    This reluctance of Republicans to convict is not driven by any devotion to the country, the presidency or the constitution. It is entirely driven by survival instincts. Republican political careers without the support of the Trump base are toast. But that Trump approval rating within the Republican vote needs to stay at 70% or above. Below that and Senators will know the numbers with or without the MAGA Trump base won’t stack up to beat their Democrat rivals in 2020 elections. So, this internal approval rating within the Republican/Fox base is absolutely critical for Trump’s survival. It also will be watched closely by financial markets.

    A Trump presidency in real trouble will encourage the Chinese to stall on trade war negotiations. That, in turn, will continue to hurt global manufacturing activity levels. One should also consider the impact of a chaotic exit of Trump from the presidency. There will likely be an electoral backlash and fears of a new less business-friendly occupant of the White House. Wall Street is already ringing alarm bells about a potential Warren or Sanders presidency. One should also not overlook the impact on US consumer confidence.

    It will not be easy for a nation to digest the likely truth that the 2016 election was manipulated to install a Russian foreign policy asset. One should be mindful of the performance of markets the last time the US suffered a crushing embarrassment. Arguably, the Nixon resignation and the Vietnam retreat in 1973-1974 had multi-year consequences rather than the Middle-East oil crisis of 1973. The Watergate Hearings were first televised in May 1973 when the S&P 500 was trading at 615 points. By June 1982 the S&P had more than halved to the 290 level after a multi-year bear market. This makes for sober reading but one could argue we are in a better place than the 70s. Globally, investors are enjoying a good year despite geopolitics and slowing economic activity. It’s all very Goldilocks – cooler economics, warmer money-printing/rates.

    Sure, the S&P 500 chart makes for cheerful watching as it reaches all-time highs. Also, TV screens will provide some amusing moments from Capitol Hill in the coming weeks. But…voter polls have the potential to present an uncomfortable truth whether they change or not. The first possibility is that the truth, as most sentient beings understand the meaning of the word, will be ignored and the Trump support belief/truth remains unmoved. In that case, the longer-term implications of constitutional chaos, geopolitical instability and continued illegal actions from the White House will be significant.

    The alternative scenario of a significant shift in Republican polling will deliver more immediate negative market reaction but hopefully undo 25 years of Fox News reality shaping and abdication of broadcasting responsibility. No doubt there will be short term pain and embarrassment for many but a restoration of truth to US politics can only be a good thing. The loudest voices have enjoyed too much airtime.

     

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  • A Decade of Lessons for European Equities

    Well, here we are. Just 54 days until a new decade dawns. These milestones tend to prompt a little bit of reflection albeit I do try to avoid the mirror for illustrations of the ravages of time. On a more constructive note, time is typically an investor’s friend as the miracle of compounding over multi-year periods can deliver surprisingly strong returns.

    If we reflect on Europe’s financial decade there has been no shortage of millstones to weigh on performance. Take your pick from the recession, sclerotic growth, banking woes, sovereign debt crises, Greece or BBBBBrexit. Would you be surprised to know that European equities managed to carve out a total return of 92.7% since October 2009?

    Thanks to the analytics team at Albert Bridge Capital we were pleasantly surprised to find out that the annualised return for European equities(MSCI Europe Index) was a solid 6.9% per annum over the ten year period. That’s pretty much what any wealth advisor will assume over the long run as a return for perceived higher-risk equities. So all ok then? Not quite.

    Obviously, the starting point for measuring performance is somewhat helpful given markets had plummeted in 2008-2009 during the global credit crisis. However, like most things in finance, exploration of relative performance can generate a better understanding and potential insights. In the same Albert Bridge report, we learned that US markets have had a much better decade. Total returns for the S&P 500 since October 2009 were 233.8%. That equates to an annualized return of 13% per annum or almost double the annual rates of return achieved by investors in Europe.

    There might be some readers who feel the US typically has been the superior performing market due to business-friendly regulations/taxes, deeper capital markets plus a vibrant tech sector. That’s where things get quite interesting. If we look at the previous three decades from 1979 to 2009 the bull market delivered total returns of over 2500% or 11.5% per annum for US investors. Amazingly, returns for European investors were exactly the same! So the question is why has the relationship broken down in the past decade?

    My own personal focus in previous articles has been the stubborn stall speed of European equities for pretty much the last 5 years. European equities have gone precisely nowhere in performance terms since April 2015. The US market has accelerated in the same 5 year period by a further 50%. It is possibly a little early to definitively explain the divergence in performance and we have noted recently belated signs of life in European equities(mean reversion anybody?). However, the following observations are worth some consideration.

    1. The US technology sector has a vastly bigger weighting in the US market than that of tech in the equivalent European index. The big tech winners like Microsoft, Apple and Amazon have accounted for a large portion of overall market performance. It is worth recalling the famous statistic from Hendrick Bessembinder’s “Do Stocks Outperform Treasury Bills?”. Bessembinder found in his study of US equities markets that the best performing 4% of stocks were responsible for all the wealth created in the stock market from 1926 through to 2018! It could be the case that the US has had a small number of very significant tech winners in the past 10 years.
    2. If we look at the European market index one can’t help noticing that there is a very big weighting attached to the banks’ sector. This is one of the sectors most challenged by technology as well as unresolved bad debts. The Japanese experience will inform readers that this can be a performance killer for decades. There’s another interesting point to make about “losers” or underperforming stocks. By avoiding losers(difficult) overall portfolio performance can dramatically improve. The research team at OSAM found that if the bottom 25% of performers were excluded since 1994 one would have enjoyed annualized returns of 22% per annum over the subsequent 25 years to today. Think how Europe would have performed in the past 5 years without its banking sector.
    3. My own preferred focus is the unintended impact of the relative difference in interest rates between the US and Europe. With zero interest rates in Europe, zombie companies(and banks) have been able to survive and continue to consume capital which otherwise might have funded a new Amazon or Netflix. The blunt truth is that companies in the US fail more quickly as lenders and investors require higher returns. The absence of a genuine cost of capital has dogged Japan’s recovery too. High numbers of limping zombies or “losers” can seriously damage the efficiency of capitalism and overall market performance.

    For private investors perhaps the key message would be that Europe has plenty of world-class investment opportunities but is also carrying a lot of baggage. For equity crowdfunding investors bear in mind that little statistical nugget about how a relatively small number of winners deliver the majority of wealth creation. There is plenty of merit in a strategy to build a portfolio of start-up investments to boost one’s risk exposure. And remember, even in the big blue-chip markets there are lots of failure zombies too. The US markets have found a few winners in recent years but there’s no reason you can’t find a few too over the next decade.

     

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  • The Most Bullish Equity Chart This Week

    Whisper it quietly but Santa might deliver a nice surprise for equity investors by year-end. The source of our optimism stems from activity in a sector upon which we usually hesitate to lavish affection; the banks. The headline news that US equity markets are touching all-time highs is hardly revelatory fare for even the most casual reader of the business press. Indeed, we are often wary of Mr Market’s delight in generating such gushing headlines to attract the maximum number of enthusiastic investors back into stocks before delivering crushing pain.

    Our cautious optimism this time is the return of the US banking sector to 12-month performance highs as captured in the following chart:

    What is worth watching over the next few trading days is whether the chart pattern can “break out” and move above previous highs set at the beginning of 2018. It is true that the US earnings season for corporates has been reasonably positive but the market is still very dependent on the technology sector. To put that concern in context we were struck by a stunning recent data point; the combined $2.3 trillion (yes) market value of Apple and Microsoft now exceeds the total value of all publicly traded companies in… Germany. The Teutonic manufacturing monster is just the 3rd largest exporting nation in the world and 4th ranked economy globally.

    The other way of expressing this hope in financial market terms is that the “value” style of investing is due a comeback after years of underperforming “growth” stocks fueled by the technology sector. Typically periods of value outperformance are rather short and very significant so we should find out rather soon if the market driver baton is passed on to the laggard value sectors like energy, mining, banks, etc. Of course, the financial press will quickly create a macro/geopolitical narrative to “explain” the melt-up in equities markets. Take your pick from the following two early favourites:

    • Potential de-escalation of US-China trade tensions.
    • China turning on the credit spigot again and the Yuan stabilizing.

    Of course, these potential macro developments are helpful but let’s be very frank here. There is really only one financial datapoint that counts; how much money(at zero cost) or liquidity is being pumped into markets by the central banks, led by the Fed.

    As a quick reminder, in 2018 central banks tried to remove financial markets from the monetary methadone clinic by phasing out quantitative easing(QE) and actually raising rates. The result was a very large negative bag of performance coal from Santa at the end of 2018.

    Now check out the policy u-turn by central banks in 2019 with the Fed cutting interest rates for the third time in recent days. By some measures global liquidity provided by central banks has passed the $75 trillion mark and it doesn’t look likely to stop for some time. See in the following chart how the S&P 500 is moving in lock-step with central bank largesse in 2019. Note this in sharp contrast to the pattern in 2018 when liquidity was drained and interest rates were hiked by monetary authorities across the globe.

    The consequences of super-easy money in the longer term are for another article but, for now, let’s just say extra liquidity needs to find new investment homes; most likely they will be neglected laggard sectors showing ‘value’. Banks might be just the start…

     

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  • How Many Sequels For Nightmare on Downing Street?

    Halloween for horror enthusiasts has been a little disappointing so far. As another Brexit deadline passes one can’t help noticing the total absence of street riots, Boris’s corpse in a ditch or Mark Francois’s Territorial Army uniform exploding. Brexit must wait for the outcome of a General Election to be held on December 12th. Europe must wait too but is only giving the UK until 31st January 2020. More deadlines, more headlines and more economic damage. This self-mutilation of an entire country feels more “Saw” than Freddie Krueger if one were looking for Hollywood parallels. Now hold that Hollywood thought.

    On so many levels Brexit is the gift that keeps on giving for the media, and the Conservative party is definitely the Scream Queen of the franchise. The Conservatives’ occupancy of 10 Downing Street in recent years has delivered two general elections, two leadership elections, two referenda and two Brexit extensions. In keeping with Brexit bizarreness, the bookmakers still see the Conservatives as the best bet to win most seats in the December 12th election and continue as the key protagonist in the Brexit nightmare. This may turn out to be the case but readers might want to consider some new characters and plots which have a very good chance of hitting our screens.

      • UK Business:

    Apple and Facebook may have delivered excellent results on Wall Street this week but the news from UK bellwethers is more mixed. The UK’s benchmark index of blue-chip stocks, the FTSE 100, is light on technology but weighted heavily towards financial, energy and mining giants. Let’s just say the updates from Lloyds and Royal Dutch Shell this week have been less than stellar. Domestic UK business is already grappling with Brexit paralysis so a global slow down(Hong Kong recession confirmed) will only squeeze margins and investment plans further. Property and business confidence are strongly linked in the UK economy so a RICS survey which found 62% of respondents confirming a downturn in commercial property is not helpful.

      • UK Currency:

    The removal of a hard Brexit outcome, for now, has stabilised Sterling (GBP). The UK currency reflects the short term views of the financial markets but those relatively benign views can violently shift. Think about how many villainous comebacks occur in a popular horror franchise. Brexit has that same potential to re-introduce Mr. Market as the villain only a decade after the credit crisis.

      • Trade Talks:

    In the week that saw the publication of The Globalist, a biography of the late great Peter Sutherland, one can only wonder what he would think of Brexiteer trade delusions. As the father of the World Trade Organisation framework and the incredible complexities of trade talks, he could paint a rather scary picture of the post-Brexit free trade discussions. Lots of red lines, lots of blood and lots of time. It will be long and it will be ugly irrespective of Brexit actually happening.

      • UK Politics:

    Brexit means Brexit. Taking back control. The people’s will. What will be the post-election slogan of the new government? The current narrative is that parliament is broken and an election is needed to clear a path to deliver the wishes expressed in the referendum. A more incendiary line is that the body politic is frustrating the wishes of the people and is the real villain in the Brexit story. On that basis, the chances of a non-conclusive election and a hung parliament could become the ultimate gore-fest. The probabilities of a hung parliament are more than significant in what is effectively a 4 party election voted on a first-past-the-post basis. Those are the classic ingredients for a very volatile vote and outcome. The nightmare scenario of political paralysis, clocks ticking towards EU deadlines, businesses cutting jobs and civil unrest is a combination of events which even a villain like Jigsaw would appreciate.

    Back in the real world, we can only hope the least worst results of Brexit materialise and then reflect on a horrible hindsight truth. Hallowe’en began as the Celtic festival of Samhain. How the world must wish David Cameron and his Attorney General had paid more attention to Celtic matters when framing the Brexit referendum question. The Good Friday Agreement eighteen years earlier placed into international law the UK’s commitment to keeping at least one of its borders in the EU. The sad irony of Brexit is that the Conservative and Unionist Party of the United Kingdom has committed to sawing off one of its own limbs. The horror of that, and possibly another Celtic sequel to follow. Bloody tragic.

     

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  • Time Waits For No Business

    Time has been on my mind this week. As a weekend of clock-manipulation beckons, I have a growing feeling that time is, in a business sense, accelerating dramatically. I accept that the acceleration of time makes no scientific sense but bear with me. Google’s engineers have just used quantum computing power to solve a problem in 200 seconds which current supercomputers would take 10,000 years to solve. Armed with that mind-boggling evidence of machine efficiency, perhaps a more accurate statement of my feelings is that the world is speeding up rapidly. Not unlike our climate, the normal life cycle of a business is undergoing a profound change.

    First, let’s remind ourselves of a normal business cycle. Molex Inc was founded in 1938 and started out business life making plastic flower pots. It quickly moved on to making plastic power connectors for General Electric and was instrumental in the development of the first car radio, the first mobile phone and the first Hi-Definition TV. Plastic power connectors are now almost a commodity (despite what Apple charges you for their notoriously delicate Mac chargers) and Ireland is not the place to be in the business of manufacturing a commodity type product. Little things can destroy profits in these types of businesses. Thanks to the Trump Trade war with China, profits at Molex are hurting and sadly its Shannon plant is to close with the loss of 500 jobs and its base in Ireland since 1971.

    There will be further employment hits from trade wars and Brexit lunacy but do not be fooled into thinking we are experiencing once-off events or a normal business cycle. Nokia started life making toilet tissue and rubber boots. Then they conquered the world of mobile phones owning 40% of the mobile market and 50% of the smartphone segment by 2007. Unfortunately, Nokia didn’t focus on the development of the smartphone. Apple and Samsung did. Nokia’s phone business was sold to Microsoft in 2014 after a market share implosion to just 3%. So for the last five years, Nokia has reinvented itself as a mobile networks player. Until yesterday. Or, more precisely, until 5G. The life cycle of each generation of networks continues to shorten and the upcoming rollout of 5G is presenting profit challenges for Nokia and its share price; just the 23% collapse yesterday, the biggest share price fall since 2000.

    This rapid evolution of technology is not just a challenge for technology companies. Be under no illusions that the integration of new technology into all types of businesses is now critical to compete and ultimately survive. Frankly, if businesses are not using data to connect with their customers and then understand what their customers want there will be disruptors more than happy to come up with the next smartphone, product or service. Disruptors can move quickly and don’t need the traditional fixed asset tools of business. Look at Uber – a taxi company that doesn’t own its taxis. New York taxi medallions/licenses as recently as 2014 were changing hands for $1.2 million. You might get $150k today for the same iconic yellow medallions.

    Visit a McDonalds recently? A bank? Robo-servers and robo-advisors reign. Automation is happening now, and not just narrow task-based robotics. Artificial Intelligence(AI) is too often perceived as a replacement for repetitive human tasks. Think again because the machines will think, soon. The most powerful applications of AI will be the combination of experienced humans and deep learning; collaboration rather than substitution. Consider medicine and Atomwise which uses AI deep learning algorithms to massively speed up drug discovery/research with hit rates improving by 10,000x. The largest pharmaceutical companies have been under pressure for a number of years now and share prices have gone nowhere. Glaxo and Novartis share prices have barely moved in five years on market disappointment with the pipeline and delivery of new blockbuster drugs. The blockbuster model is dead so managements are searching for new strategies. Cost-cutting is one, as Cork discovered this week with the loss of 320 Novartis jobs.

    These job losses are very sad for employees, their families and communities but the news is not all bad. Before the fall of the Iron Curtain and the entry of China into the global market place, Ireland Inc got it right, positioning itself as the world’s best high-end manufacturer and service provider. The consciousness of time and fast technology in this article is that Ireland needs to move again and avoid Nokia-type complacency. At a recent excellent Accenture presentation on AI, there was a fascinating factoid that Paisley in Scotland was at one point in the early 1900s host to the third-largest company in the world. Coats Group, the textile manufacturer was ranked globally behind US Steel and Standard Oil. Coats Group plc still loiters in the FTSE 250 index of medium-sized UK companies but the last thread mills in Paisley closed in 1993.

    It is worth reminding ourselves of the political pressures to keep the Ford plant in Cork open in the mid-1980s. It didn’t happen for Ford’s unfortunate workers but Cork did get Apple in the same ‘80s period and its 4,500 employees today. Today Apple is a trillion-dollar company and Ford’s market value is below that of Tesla, its relatively tiny electric vehicle competitor!

    A final thought on cycles. As Mario Draghi retires from the ECB without a single interest rate hike to his name, be prepared for Japanification of the business cycle. Ultra-low interest rates and low growth can keep zombie companies alive for long periods but ultimately they will wither and die. Financial markets may well be close to all-time highs but it disguises massive shifts in value and growth expectations across sectors; see retail, banking, auto, telecoms, energy and media sector performances as Mr. (pick your pronoun) Market’s concerns for the future.

    The markets are already discounting a world of corporate zombies, super quick technology cycles and constant competition from new companies who can access capital cheaply and require no fixed assets.
    Constant competition and low growth require business managers to be super-focused on customers, market trends and costs. There’s nothing particularly artificial or intelligent about acknowledging that reality. So, bank that extra hour of sleep at the weekend.

    Then think time and technology.

     

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  • Ship Ahoy, A Lesson in Risk……

    The giddy financial headlines of the past decade have been dominated by massive profits for investors in technology stocks, social media influencers and opportunistic purchasers of distressed property portfolios. However, the stories in the world of shipping have been less cheerful. Years of over-supply of freight capacity killed pricing in a global fleet of over 10,000 ships which doubled in size from the early 2000’s. The dry bulk sector has possibly been worst hit with benchmark shipping rates falling by up to 98% from previous highs in 2015-2016. Needless to say investors in publicly traded dry bulk shipping stocks have experienced share price implosions of 95-99%.

    As China’s economy and global manufacturing slows with an increasingly fraught geopolitical environment one could be forgiven for thinking the chances of a shipping recovery would be certainly dead and buried. Welcome to the risk of certainty and the explosive results of almost everyone being caught out at the same time with the same wrong view.

    Events in recent weeks in the crude oil carrier sector have been mind-blowing. And, we are not talking about the Donald’s latest attempt to blow up the Middle East with his Syrian gift to Turkey’s Erdogan. Yes, the Saudi refinery bombings and general US-Iran tensions have contributed to a squeeze on the pricing of rates for very-large-crude-carriers (VLCCs) but crude oil prices have subsequently settled back to pre-bombing levels. Not so VLCC shipping rates. What if we told you VLCCs are currently on daily charging rates of $300,000?  For context, as recently as mid-August daily rates were as low as $25,000.

    The purpose of this article is not to explore the exact combination of factors contributing to a ten-fold increase in freight pricing and an 80% increase in the value of certain shipping stocks in a matter of weeks. We’d rather use this event as a cursory reminder that a relatively minor combination of events can, in certain circumstances, create a violent reversal in market behaviour and views. More specifically, be very wary of an asset class displaying symptoms(pricing) of an extremely certain view. Think of crude shipping and a strong consensus view that the sector was nowhere close to recovery. Now think of a much larger asset class…

    How about the sovereign bond market where $16 trillion of debt currently carries negative yields? In lay person’s terms that is an overwhelmingly benign view of inflation over the coming years, ie bond yields would have to rise significantly(and bond prices fall at the same time) to counter the destructive effects of inflation on capital currently delivering no compensatory income. In contrast to the shipping sector, the cheery consensus view on bonds feels a little too one-sided and allows for very few surprises. A world without surprises just doesn’t feel like the right call in the current bizarre geopolitical environment.

    Finally, to complete our shipping journey it is worth highlighting it is only the VLCC sector(fleet size of 800 ships) which is experiencing stratospheric rate inflation. The larger dry bulk sector remains incredibly depressed in terms of asset values – barely 2 x annual cash flows – but has a couple of interesting drivers over the next few years. Firstly, there is no bank lending appetite and stricter regulatory rules which ensure excess capacity is being whittled down rapidly. Second, recall our mantra that every investment should now consider climate change. The shipping industry is in clean-up mode with global regulations now requiring costly installation of ballast water treatments plus engine re-calibrations for lower-sulphur content fuels by 2020. That means there will be further temporary capacity hits next year.

    Now, also consider shipping as a sector typically non-correlated with other financial assets which are currently trading across the board at close to all-time highs. In fact, shipping is considered a ‘geopolitical hedge” – shipping rates benefit from wars, conflict, canal closures and the odd lunatic leader. The world is currently well supplied on the “leader” front  so don’t be afraid to ship in some protection from madness.

    Of course, the Greeks have been the ultimate shipping nation which has hit hard times. Up until recently, it was assumed Greece would never be able to access bond markets for a decade. Now they are borrowing at cheaper rates than the Land of the Donald. Whoodathunk!

    Certainty, in transport terms, can be laden with risk and emotional biases. Aristotle Onassis put it quite well…

    “I made a big mistake. I never believed in the world that we live in, emotions can overcome every logic in business” 

     

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  • Debt Works Until It Doesn’t

    WeWork was the IPO that didn’t happen. Now we are about to find out how the combination of excessive debt and a loss of market confidence can obliterate equity valuations. WeWork’s largest shareholder, Softbank, is going to bail out its own original investment of $10.5 billion with an injection of up to $5 billion in new capital.

    The zinger for readers and Softbank’s investors is that the latest ‘survival’ valuation of WeWork will be circa $8 billion; yes, that’s half what Softbank will have invested in total. Wowzers. Was it just a month ago we were told by WeWork’s bankers that the equity was worth $47 billion? Indeed it was. It turns out there was a little flaw in the IPO plans. WeWork had built up liabilities(leases) or long-term debts which amounted to another $47 billion number. Debt or “other people’s money” is perfectly fine to employ in building a business and funding growth but when it’s a very large amount of money then the confidence of those other people is everything.

    Unfortunately, WeWork’s IPO filing documents highlighted a business that was not only losing billions of dollars but was extremely light on detail as to how those losses could be stemmed in expansion mode. Once the IPO failed to happen and raise additional capital, events turned ugly as landlords, banks, service providers etc began to take steps to protect their exposures on concerns about a potential cash crunch just months away. There is a temptation to view the WeWork implosion as an extreme case study in excessive leverage meeting funding realities. The more sobering truth is that WeWork may not be such an extreme example. You see, this debt thing can be quite popular when interest rates are unnaturally low; arguably, capital is almost free until it isn’t. Just ask the IMF.

    In recent days the IMF has been sounding the alarm on the huge rise of debt issuance in an ultra-low interest rate environment. Their concerns were focused on the corporate sector rather than governments who are enjoying negative rates on $15 trillion of debt. The IMF analysis stated that up to 40% of the $19 trillion(!) of debt owed by companies is now at risk of default if there is a global economic downturn. The world’s most powerful banker, JP Morgan’s Jamie Dimon, says there is a recession ahead but not now. This writer does not feel comforted by this stay on calamity and is rather struck by a number of developments which suggest that “confidence” is slipping.

      • Fund Management Liquidity:

    The high profile blow up of Woodford Investments is keeping fund administrators very busy in Dublin, London and Luxembourg as people who should know now realize they haven’t a clue whether investments in funds really are liquid ie the end of day prices reported by these fund administrators are actually achievable. Investors in funds at Woodford, H20, Lime Asset and GAM have found out too late. Other investors are vulnerable too.

      • Bond Fund Liquidity:

    The IMF examined a sample of 1,760 bond funds or 60% of the $10.6 trillion invested globally in these type of assets. They used the worst monthly redemption flows experienced since 2000 to stress test the funds. Alarmingly, the IMF reckons almost one-sixth of these funds would struggle to repay investors at month-end ie liquidity constraints would require more time to sell/realise funds.

      • Corporate Bankruptcies:

    Despite super-low interest rates there has been a marked increase in corporate casualties as banks possibly try to move before Jamie Dimon’s recession prediction materialises. Thomas Cook might be the high profile name of recent weeks but watch out for a more serious situation in the energy sector. Not unlike WeWork’s aborted IPO signaling some pain to come in the real estate sector, the failure of Saudi Arabia’s oil monster IPO, Aramco, to attract sufficient market interest highlights some real stresses in the energy sector. By August this year, there have been 26 bankruptcies in the US oil and gas sector. Expect that number to grow significantly as a massive $240 billion of debt is due to mature in the US oil sector by 2023 according to ratings agency Moodys.

      • Winners and Losers:

    The market is beginning to differentiate its treatment of debt across sectors. Take an example closer to home. Irish franchises built on junk bonds, Ardagh and Digicel, are perceived very differently by global institutions. It is incredible to think that Ardagh in the packaging sector is one of those fortunate companies in Europe which is enjoying negative yields on its debt while Digicel’s bonds in the struggling telco sector are yielding double-digit percentages. Suffice to say double digits is not a good look but can also be a good guide as to the market’s perception of a company or a sector’s prospects of refinancing highly leveraged balance sheets. As mentioned earlier, confidence is everything. Watch the energy sector closely.

      • Macro is Key:

    It is interesting to see what are the key macro drivers for equity markets at the moment. Note these markets are close to all-time highs. If you thought it was fundamentals driving markets you’d be wrong. London macro analytics gurus, Quant Insight, are seeing all the major benchmark indices driven by macro regimes/factors. Dig a little deeper with their analytics and there’s another interesting nugget. The most significant macro factor for developed markets in Europe and the US is corporate credit(bonds) but in emerging markets, the story is more nuanced. Emerging markets are very correlated with central bank support(QE) and inflation. This could suggest leverage is a bigger problem in emerging markets where corporate debt has tripled in 10 years to $2.78 trillion. The repayment profile for emerging market corporates is also a worry; 80% of the debt is due for repayment within five years.

    WeWork didn’t work for many investors in the end. Debt works for lots of businesses as they grow but high levels of debt require high confidence from ‘other people’.  Little things can become quite significant triggers on market confidence. The problem for investors and fund administrators is that a confidence shock can and will generate rapid risk shifts that can destroy equity, wealth and even entire franchises. Current debt levels are too high to ignore and the bond markets will inevitably ‘earn’ respect if not interest.  We write regularly about “other people’s money” for good reason and we always liked the words of former Clinton advisor, James Carville:

    “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

     

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  • 5 Surprising Stats from the Financial World this Week

    President Trump just wished everyone a happy Columbus Day. As the Kurds in Syria reap the murderous whirlwind of another Trump foreign policy screw up, it is a disconcerting experience to see an icon of ignorance celebrating an icon of discovery. However, in the spirit of discovery we thought it appropriate on a Nobel prize-giving day to highlight a few developments in finance which might resonate with the curious.

    Let’s start with Brexit (where else…) and then flag four other statistics which caught our eye on Columbus Day:

      1. Brexit negotiations enter a crunch week. The latest research from the institutional research team at Alliance Bernstein now puts the odds of an extension to the 31st October deadline at 80%. Possibly more interesting is that, if the general election is inconclusive and a referendum ensues, the chances of a win for the Remain vote are put at 70%. Clearly, the general election is now key to how Brexit plays out, with the chances of a no-deal Brexit hovering around 50%. That elevated level of risk is definitely not priced into European share prices.

    There still appears to be a significant amount of hope that Brexit will end with a deal. A deal is possible in a pragmatic informed world. One is less hopeful in a world of populist politics, ignorance of facts and a casual approach to the truth. Furthermore, beware the politicians overly dependent on hope. Perhaps Alfred Nobel himself said it best.

    “Hope is nature’s veil for hiding truth’s nakedness.”

    1. Up until this week there had been only one female winner of the Nobel Prize for the Economic Sciences in the past 50 years. Esther Duflo became the second female winner this week and is also the youngest ever winner at 46 years of age. Her prize-winning work with two colleagues (Banerjee and Kramer) used empirical research to explore the causes of poverty and the policies which actually work. Unsurprisingly, education and gender equality hurdles feature strongly in their research but it could be argued the field of economics also shares similar challenges…
    2. The trials and tribulations experienced by the banking sector are well known to long-suffering shareholders. What is possibly less well known is how quickly some banks are transforming their business models to survive. It might surprise those with pre-conceptions of banking inertia to read that RBS has already closed 56% of its branches in the UK.
    3. We have written quite frequently on the benefits of long term investing and the powerful trifecta of time, volatility and compounding. A YouGov study in the UK found that over 52% of women have never owned an investment. The number for men was 37%. Clearly, those RBS branches missed an education opportunity!
    4. Trade war Twitter headlines continue to drive financial markets. As the Hong Kong protests continue to simmer there is still the possibility of an additional headwind; Capital wars. China, when it isn’t bullying the NBA or Apple, could choose to weaken its currency(Yuan) and exacerbate trade tensions with the US. This will clearly have negative implications for the world’s largest trading bloc, Europe, and its companies. So which companies would be worst affected? Nowadays, thanks to super powerful processing power and modern data crunching techniques, there are analytics available to answer that specific macro question. Surprisingly, it’s not your classic German industrial which is most exposed. The UK macro analytics firm, Quant Insight, see AIB as the most exposed large cap European company to a negative move in the Chinese Yuan(CNH) versus the USD. If ever you wanted confirmation Ireland is very much a barometer of global trade this is it.

     

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  • Culture and Commercials Collide over China

    Culture and Commercials Collide over China

    The West’s Faustian pact with autocratic China is entering a very challenging phase and the timing is not without historical irony. Exactly fifty years ago Chairman Mao officially ended the disastrous Cultural Revolution initiated in 1966. That negative assessment is not just an outsider’s view; the Communist Party of China in 1981 stated that the Cultural Revolution was “responsible for the most severe setback and the heaviest losses suffered by the Party, the country, and the people since the founding of the People’s Republic”. The human cost was less explicit but is estimated at up to 2 million deaths. Fast forward to today and we are beginning to see headlines about “culture wars” involving China but this time the costs are more likely to be massive commercial damage. And not just for China.

    By now readers are familiar with the ongoing trade war between the US and China which is entering its latest round of negotiations this week. By all accounts it’s not going very well, a not unfamiliar experience for the cult followers of the Orange Toddler and “The Art of The Deal”. However, Trump’s take on the US relationship with China is one of the few policy areas where there is unanimous support across the domestic political spectrum for his view that China’s increasing commercial power and influence is negatively impacting US interests. Of course, Trump only sees the impact in dollar and balance of trade terms but US corporations are suddenly having to deal with a much more thorny issue; compromising their corporate values in order to protect commercial interests in Chinese markets. That was never in the Western capitalist play book.

    The consensus view among corporate capitalists was that the opening up of Chinese markets would deliver two big wins. Firstly, vast profits would be made from a billion plus population re-entering the global consumer market for the first time since 1949. Second, the assumption that, over time, Western values would be adopted by China and dilute the less palatable aspects of an authoritarian police state. Events of recent weeks would suggest the second assumption was very wrong which now threatens the correct commercial predictions. Just ask the National Basketball Association (NBA).

    Basketball, an American sporting staple, is now massive in China with an estimated 800 million fans or more than twice the entire US population. The commercial impact of that following is enormous in the context of TV rights and sports merchandise but now there’s a culture cost. The NBA has a reasonably well earned reputation for more progressive values compared to other US sports franchises like NFL(anthem kneeling) and MLB(political silence) but this week that reputation suffered badly.

    A tweet by Houston Rockets’ manager Daryl Morey in support of Hong Kong protestors triggered a firestorm from Chinese partners threatening lucrative TV and merchandise deals. The NBA responded with a craven apology for “hurt” caused to Chinese fans which rightly earned criticism in the US. Then there was a further communication making clear that there would not be an apology for the actual communication by Morey citing the NBA’s values of “equality, respect and freedom of expression”. The situation is still in flux and it’s possible the strength of the NBA franchise and lack of domestic alternatives will allow emotions to take a back seat eventually.

    However, the genie is out of the bottle as indicated by the following corporate examples:

    1. Apple has had to remove the Quartz news app in China because of its negative Hong Kong protests coverage. Hong Kong is not the only cultural touch paper. Apple has also removed the Taiwan flag emoji from its iOS operating systems in China.
    2. Marriott, the hotel chain, is also in trouble for listing Tibet as a separate country in a guest questionnaire.
    3. Luxury players, Versace and Swarovski, have both had to apologise to China for giving Hong Kong “country” status. Clearly, they didn’t get the “one country, two systems” memo. Nor have nearly every news channel on the planet currently observing events in Hong Kong.

    Information is power. Control of information is critical for authoritarian regimes and probably price insensitive as a survival tool. Therefore, it is possible the greatest commercial impact of the culture clash with China will be in the largest US commercial sector of them all, information technology. China is determined to maintain its “Great Firewall of China” which forced Google to give up its operations in the country as far back as 2010. Not for the first time, Google may have moved strategically earlier than most. The information strangle exported by China right now on corporates is merely the beginning of a major clash of values.

    At a more technological level the potential exile of China IT champion, Huawei, from the global IT eco-system could be the precursor to a “Digital Iron Curtain” being pulled across the Asian continent. Chinese companies like Huawei may have to develop their own internet protocols/platforms in a 5G world. This can only be commercially damaging for all companies and countries and might not stop at technology. Companies in the consumer space which have made huge profits in China will be torn between brand values and China profits. Both have a monetary value so a compromise will entail significant franchise valuation impact.

    One fears that developments in Hong Kong are poised to quantify that damage quite soon as corporates discover they traded their values for profits when Deng Xiaoping opened the door in 1978. Reversing that trade will be painful for companies, but probably triggered by far worse human suffering in Hong Kong.