Putting the spice back into investing.

An option by any other name ...

Wednesday, October 29, 2003
I was reading an article at BusinessWeek online today and I came across one of my pet hates. The article is about some unsavoury practices over at Putnam Investments. The author explains how the influx of fresh money overwhelmed Putnam to such an extent that the poor company wasn't able to cope. This in turn lead to some nefarious doings of the type that are creeping out of the woodwork at a number of firms. So no news there. The interesting part was the way that Putnam reviewed and paid for performance. Let me quote the article here:
"The fund managers were under the proverbial gun. If they didn't meet their benchmark every quarter, they'd get a visit from the performance police inside Putnam. This central group of monitors would rake over a portfolio to determine why it didn't meet goals and how to correct it for the next quarter. "But performance over any one period can be random, and having people swarm in to look for something wrong misses that point," says Steve Oristaglio, one of Putnam's current co-chief investment officers. "REALLY DEVASTATING." This "gotcha" culture and emphasis on short-term results fed a sense of paranoia, which encouraged fund managers to make big, risky bets so they could meet quarterly goals -- and also earn a big bonus."

The last sentence - the part after the dash - is what I found interesting about the article. All the managers were doing, was to optimize their expected payoff in the context of their pay package. Putnam had a harebrained incentive scheme in place which could IMHO only lead to something like what is mentioned in the article.

Let me explain: imagine for a minute, that the fund manager outperforms his benchmark by a large margin. This will then ensure that he gets a huge bonus. Now imagine that he does worse than his benchmark - this will lead to him "just" earning his basic salary. Now that looks like an option payoff to me. Now the fund manager knows that the value of his option will rise if the underlying (his performance) is more volatile. Presto! In come the big bets.

This is my beef with performance related fees - they only make sense if you have enough other factors (managers investment in the fund, high water mark, ...) to mitigate the "option-factor".

Khodorkovsky vs. Kremlin: Who'll blink first?

Monday, October 27, 2003
If you're cynical, you could say that "in the good old times" people used to be arrested in Moscow and then brought to Siberia. Nowadays, you get arrested in Siberia and whisked to Moscow. Russian oil magnate Mikhail Khodorkovsky was arrested in Siberia on Saturday, flown to Moscow and charged with seven crimes including forgery, tax evasion and embezzlement.

Khodorkovsky, the CEO of Yukos, is currently in Moscow's Matrosskaya Tishina (Sailor's Rest) jail. Yukos promptly nosedived today and closed 15.4% down for the session. The entire story led to massive speculating about the future of investing in Russia, a coming downgrade of sovereign debt (Russia was just upgraded) and the second coming of Joe Stalin (just kidding). I think that reality will turn out to be much less exciting.

Yukos and the Kremlin have been engaged in a major game of chicken for some months now. If you look at the domestic situation in Russia right now (Duma elections coming up), you could get the impression, that president Putin is engaged in some campaigning Russian-style. If you look at the polls, you'll see that the Kremlin-friendly United Russia party is running neck and neck with the communists. Putting a famous oligarch into jail might bolster the Kremlins standing with the average Ivan who thinks that privatisation was a big mistake. Reuters puts it like this:

"...it may even raise Putin's standing among the bulk of the electorate which views oligarchs largely as robbers of state assets who left them worse off than under the Soviet system. "I am a pensioner, so by default I can't be on Khodorkovsky's side. He...is a thief," said Zoya Andreyevna, in her early 70s. "I trust Putin. His eyes are so kind. He is a kind man, he understands us pensioners."

The arrest comes at a pretty stable anyway. Moody's has just upgraded Russia to investment grade which makes for a pretty stable backdrop. Most Russians will probably take a break from getting their money back onshore, but my opinion is that the repatriation of capital will continue apace - if the Kremlin doesn't do something stupid.

If Putin really wants to mess this up, he just has to take the fight to the other oligarchs right now. This would lead to a maximum of uncertainty and surely increase capital flight. Now, I'm not ruling out that the Russian president will at some time in the future (say one or two years further on) start to crack down on the other Yeltzin-era oligarchs, but I'm willing to bet that it won't be in the near term.

In my view, the most likely outcome is that the oligarchs will reach an informal agreement with the Kremlin to play fair in the coming months. This will then lead to Khodorkovsky accepting the Kremlin as a power he won't be able to fight and the Kremlin then striking a deal with him. This should lead to markets calming over the course of the next few months. One thing is certain - we're probably going to see some wild swings in the next couple of weeks because every piece of news coming out of Russia is going to be examined with a microscope.

In brief: I don't expect this turbulence to worsen much going forward. I would stay away from Russian equity in the short term - the moment that Exxon and Chevron start talking to Yukos again about buying a stake is the time I'll look at the market again. Flexible investors might want to pick up some sovereign bonds if yields rise again but should always keep in mind that "emerging markets are called emerging markets because they are difficult to emerge from in an emergency".

Berserk buyers bid billions? I'm Googled!

Sunday, October 26, 2003
Everyone's favorite search engine seems to have found its way to the market. The FT and the Wall Street Journal both reported on Google's planned IPO. You can read about it here. This is real good news for very many people, especially those investment banks on the shortlist and the present owners of the company.

Speaking of which: Sequoia Capital and Kleiner Perkins are the only VCs in the game. They led Google's only financing round back in 1999 and their funds own around 5% of Google's equity. Other soon to be richer people include Andy Bechtolsheim (Sun Micro) and Ram Shriram (former VP of Business Development at Amazon). Most people seem to think that Google is worth around $15bn - $25bn - this translates into a gain of (at least) $700m for the VC funds. As Sequioa and Kleiner Perkins recieve around 30% of their funds capital gains, the individual partners of both firms stand to make around $7m each on the floatation. Not bad at all! A quick look the numbers published by the University of California show, that the aforementioned funds have delivered very nice returns for investors as well.

The question most investors are probably asking themselves is: "Should I try to get into the Google float?". I obviously can't answer this question but I'll try to provide my thoughts based on the facts that we have. The problem is that we have almost no hard data to go by. So what we'll do instead is take a look at the proposed IPO process. The FT writes that:

Google is considering holding a massive online auction of shares early next year in an initial public offering that investment bankers predict could value the internet search-engine company at more than $15bn.

This auction process sure sounds fair to those people still smarting from the nefarious goings on ("spinning", ...) surrounding past hot IPOs. The only problem is that the happy owners of Google shares bought at auction will probably have paid to much. The reason for this is the - by now infamous - winner's curse. The name dates back to a paper by three oil engineers from 1971 [Capen, Clapp, Campbell, "Competetive Bidding in High-Risk Situations" Journal of Petroleum Technology]. They looked at auctions for drilling rights and the results that the winning company went on to achieve. The starting scenario is pretty simple - every company has their geologists estimate how much oil is under every plot in the auction. If we assume that there are enough companies (with competent geologists) then we can expect, that the average estimate will be close to the actual amount of oil.

The estimates will then form the basis for the respective bids. It stands to reason that the company with the most optimistic geologist will bid the highest. If this happens, then the company will probably lose money (or make less than they expected). The same thing hold true for an auction in stocks. Every investor has to make up his or her mind about the value of - in this case - Google. The offering prospectus is available to all investors, but they will still have to make assumptions about the future growth, profitability and so on and so forth. These assumptions form the basis for the individual bids as in the previous case. The result should be the same - the winners in the auction will probably turn out to be disappointed in the long run. This is the essence of the winner's curse.

Hello? Hello?

Saturday, October 25, 2003
One sector which has been left out of the recovery until now are telecoms. The market that we've seen i the past couple of months has been very conducive to to higher beta gearing. The easy way to go was to buy any cheap cyclical stock and then just hang on. The fact of the matter is that you'll be pretty hard pressed to find any more resonably priced cyclicals right now. If you factor in the fact that the upswing might not continue past the middle of next year, the case for cyclicals turns out to be somewhat shakey.

Telecoms could be an alternative going forward. If you separate Telcos into wireless and wireline, you get two different investment stories. Wireline operators offer a very nice income play. Balance sheets are looking better and most companies are continuing to restructure and optimize their business. This in turn leads to efficiency gains and higher free cash flow which can be used for dividends. Wireline companies are not investing anymore - and it probably is the right strategy. Users are defecting to wireless operators in large amounts and business is shrinking (slowly). So we should look for companies that are valued like their close cousins, the utilities, and which offer similar long term dividend potential.

Wireless offers a growth story. Average revenue per user (ARPU) is on the rise and the number of wireless users is still rising. It looks like this will be the years that we'll see more wireless users than wireline. These to factors could see us looking at very nice revenue growth in the wireless sector going forward. I'm looking forward to Deutsche Telekom floating T-Mobile - this should offer us another pureplay wireless investment - Vodafone is pretty expensive already.

The Yellow Menace

You can hardly read anything on the world economy without encountering some article on the evils that China seems to be spreading around the globe. This China bashing seems to be very much en vogue these days. An article in the print version of the economist takes a hard look at the allegations leveled at China and comes up with a mixed bag of results. I'll try to sum up the gist of the article for those of you without access to the Economist.

The $120 billion trade surplus with the US is not the whole picture - China runs deficits with other countries. The entire current account surplus is only 1% of GDP. The simple fact is that China is importing like crazy. This demand should be welcomed by industrialised countries because it accounts for most of the growth in exports that these countries have seen in the past year. Stephen Roach of Morgan Stanley has pointed out, that two-thirds of China's export growth has come via subsidiaries of foreign companies in China.

One other thing to keep in mind is that most US homebuyers and recipients of tax refunds probably have the chinese to thank. If you take a look who is financing the US deficit, you'll see that the biggest holders of treasuries and agencies are not Fred and Wilma Rubble from Boise. Most US debt is in the hands of Asian central banks. This is of course (at least partly) because of the countries attempts to keep the dollar strong - but it is also a fact that someone has to finance the deficit. US holdholds sure seem to be incapable of saving at all.

Sure, the yuan is undervalued - but China is not the bogeyman everyone makes it out to be. The aforementioned article from the Economist ends with a very nice paragraph, which I just have to quote:

The heart of rich countries complaint's is an unwillingness to accept responsibility for their own economic faults. It is easier to point the finger at China. But the real cause of America's trade deficit is its low savings rate, the result of surgung household borrowing and a big budget deficit. Similarly, Japan and Europe should not be tempted to use the cheap yuan as an excuse to postpone much-needed reforms. The proper cure lies at home.

My sentiments exactly.


Wednesday, October 22, 2003
Just a short note to tell you that I'll post something substantial tomorrow. Client visits took up all of yesterday and today - so time to write anything meaningful.

Bond markets Snowed under?

Monday, October 20, 2003
Thank you, Secretary Snow, for telling us that everything is just fine. In an interview with the Times, the Treasury Secretary enlightens us to the fact, that the booming economy will create two million new jobs in the coming year. The Times interviewer comments thus:

"With a US election approaching, the figures he mentioned were significant in political as well as economic terms. Two million is the number of jobs the Bush Administration is accused of ?destroying? since it took over the White House and the rule of thumb among US economists is that 200,000 new jobs a month are needed for the unemployment rate to show a sustained decline."

Aha. Well I'm not holding my breath (look at previous entry) until I see all this economic growth feeding through into employment. What GDP growth will lead to, is rising rates. The May 04 Fed Fund Future currently implies a rate of around 1,4% - this looks like people looking for some tightening to me. The effects of an upcoming rate hike could be something that the doctor didn't prescribe. Just imagine what would happen, if (consumer) debt started getting really expensive. Goodbye disposable income for one thing.

On related news: the Secretary "never meant to talk down the dollar" (cough, sputter) and the President reached an agreement with Hu Jintao to create a group of experts from both countries to discuss the implications of floating the chinese yuan. Sounds like a very face-saving measure for both sides! I'm sure that any panel will dither, blather, stall and do nothing up until the point that China decides to float.

US Data Flow - Economy quo vadis

If you look at BLS Stats you can see, that the main driver of the corporate profits that we're seeing during earnings season has been the increase in productivity (up 6,8% Q2 and 4,1% last year) coupled with a fall in unit labor costs (down 2.8% in Q2 and 1.2% last year). This is unusual - productivity growth is above trend and has not yet fed through to higher labor costs. Productivity tends to pick up after a recession because companies find out that they can pressure workers into longer hours and less pay (which leads to less workers). After a while unit labor costs start to rise and layoffs come to a stop. Hiring then starts again and productivity comes back to trend level.

This is something we're not seeing right now. Layoffs are continuing, so we can't expect a substantial reduction in the number of people out of work in the near term. In a situation such as this one, one could expect people to sharply reduce spending and start repairing their household balance sheets - i.e. pay down debt. The reason that this hasn't happened, is because of the tax cuts which have boosted personal income. While salaries have grown only marginally, disposable income has risen as a result of tax effects.

The tax effects could also be one of the contributing factors in corporate investment. Spending on new equipment before the year's end leads to a special, 50% depreciation deduction. This comes on top of higher margins (via productivity) and thus leads companies to restart investing. This investment seems to be concentrated in high tech stuff (which was the first thing spending was cut on) and this fact has contributed to the bounce in some of our old friends on the NASDAQ. The big question is, whether consumer demand will stay stable in light of the petering out of tax advantages. The same thing applies to capital investment. The jury will probably stay out on this question for a while - meaningful data is sparse this week - we're all waiting for next week and some intensive data flow.

Greenspan short, gold long?

Saturday, October 18, 2003
I finally got back from a gruelling two day junket yesterday night and am about to leave for a weekend getaway. As I was catching up on news I was especially interested in the goings on over at the APEC Summit. You probably don't have to be a prophet to figure out what will be on the agenda. The only problem with the agenda, is that everyone has the same goal. Japan wants a weaker Yen to avoid strangling its nascent economic recovery - Europe wants a weaker Euro to weasel out of taking tough (and therefore unpopular) steps towards labor market and social security reforms. On the flipside: the foreign holders of 1,7 trillion dollars worth of US Bonds (someone has to finance the current account deficit - and it ain't being done by people in the US) very obviously do not want the dollar to fall.

This scenario is very nicely expounded on over at The Economist. If everyone wants to devalue, then it won't work. It is simply impossible for every currency to fall vs. every other currency. The point that Buttonwood makes in the aforementioned article, is that there is something that these currencies can fall against. Gold.

The reason being, that investors have lost confidence in central bankers and are looking for a safe haven investment. Chris Wood form Credit Lyonnais Asia is cited as saying:
“Gold will rise as confidence in the ludicrous powers still attributed to central bankers wanes”

He goes on to set 3.400 USD per ounce as a possible price target. This should be good news for gold investors - but doesn't answer the questions some of us have re future currency trends.

Note 1: Is it just me or does anyone else get the impression that forecasting extremely large price increases is a recurring habit of metals analysts?

Note 2: Coming up on Monday we'll examine the latest US economic data and I'll finally get around to posting something concerning the equity risk premium.

No update today

Thursday, October 16, 2003
I'm on the road and can't summon up enough energy to write anything today. Spent the whole day listening to speakers talking about central european real estate markets. So in case anyone wants to know anything about office space in Hungary -> don't hesitate to mail :-)

I'll try to post something substantial tomorrow (reading a good paper on the equity risk premium).

A Different Take on the 2004 Presidential Race

Wednesday, October 15, 2003
I was reading about the US electoral system over at USS Clueless the other day and was quite taken with the very concise description of the process. You can imagine that I was pretty happy when I saw a paper on the Journal of Finance web site with the promising title: "The Presidential Puzzle: Political Cycles and the Stock Market" (Pedro Santa-Clara and Rossen Valkanov, forthcoming in the October issue).

I couldn't wait to read it and apply some of my newfound knowledge of the US political system. The nice thing about academic papers is that almost all the salient findings are condensed in the abstract. I quoted the abstract for you - but before we get there, I'd like to ask you to go into audience participation mode. Just fill in the blank space with the political party of your choice so that the sentence is correct (no need to speak aloud if you are someplace where people might wonder about your random utterances): A _________ president is better for the stock market.

Now take a deep breath and just read the following:
"The excess return in the stock market is higher under Democratic than Republican presidencies: nine percent for the value-weighted and 16 percent for the equal-weighted portfolio. The difference comes from higher real stock returns and lower real interest rates, is statistically significant, and is robust in subsamples. The difference in returns is not explained by business-cycle variables related to expected returns, and is not concentrated around election dates. There is no difference in the riskiness of the stock market across presidencies that could justify a risk premium. The difference in returns through the political cycle is therefore a puzzle."

I wonder how many of you came to the same conclusion. The authors are exceedingly self critical with regard to the possibility that this might be a spurious connection. IMHO it probably is. We all know that correlation is not causation and the authors themselves ask: "A fundamental question that we leave open is: Do political variables cause fluctuations in stock returns, or is it the other way around?". The entire thing could be a self referencing loop and lead to the old chicken and egg problem.

I wonder if this changes the election outcome :-)

Just butter me up!

Tuesday, October 14, 2003
Leinweber searched through a United Nations database and discovered that, historically, the single best predictor of the Standard & Poor’s 500-stock index was butter production in Bangladesh.

Leinweber, David J., 1997, Stupid data mining tricks: overfitting the S&P 500, Working Paper, First Quadrant.

Lifted from The Presidential Puzzle: Political Cycles and the Stock Market, JoF October 2003, PEDRO SANTA-CLARA and ROSSEN VALKANOV

More on this fascinating paper tomorow. Lots of interesting papers out - will have to spend some time catching up. Good thing I'm travelling on Thursday and Friday - bad thing that my itinerary starts @ 06.25 on Thursday. Will probably collapse over my airline coffee and spill acidic java over everything I was planning on reading.
[Listening to: DollyWoodDub - Ultra396 - (03:30)]

Thursday coming up - the week's hardest decision!

Looking at a Reuters screen all day has some side effects (I won't mention the side effects induced by our new printers which sound like 747's taking off). One of them is that you can't seem to get away from market related stuff at all.

Other offices run football, soccer, baseball or lotto pools. We run a stock pool. Rules: everyone picks 4 stocks on thursday (15.00 CET). The stocks are equally weighted. Whoever has the best performance by next thursday wins. Taking part costs 2 Euros per week [high rollers we are not!]. Our portfolio managers had to demonstrate, that they know their stuff -> the result is that we now have a realtime league table, sharpe ratios, risk return diagram and so on to show and analyse the results every which way (ahh, the wonders of technology).

My Portfolio this week: Credit Suisse, NTT DoCoMo, Saint Gobain, mg Technologies. Anyone have any thoughts on what to buy this thursday?

The Bear Facts

The Angry Bear was nice enough to comment on the "Cat caught in a Bubble" Post. He makes the point, that large percentage increases in earnings could be possible because earnings are at such a low level in relation to historical levels. Even a small increase in absolute earnings would then lead to a large reduction in P/E (ceteris paribus).

I'll look for data re trend earnings (Update: I looked see below). The important thing to keep in mind (IMHO) is that an increase _is_ an increase (in earnings) - that alone is a leap of faith. All that a Graham & Dodd P/E does, is give you frame of reference to examine your assumptions under. It could well be that earnings will rise - the thing that is bugging me, is that the investing public is assuming that returns will be high going forward as well. Buying into the market at this level then entails two basic convictions:

(1) Earnings will rise
(2) Earnings will continue to rise

I'm pretty sure that we'll see higher earnings going forward - we are already seeing them in some sectors. The thing to keep in mind is that earnings are going to have to rise pretty high pretty quickly to get to the point that we'll see valuations coming down to a more moderate level - and this assumes that (stock) prices will stay put.

If you have a 50% earnings increase during this year you'll reduce your P/E from 30 to 20 if stocks don't move. Factor in an expected rise of - say - 8% in stock prices and you'll be looking at a P/E of around 22. But again, this makes the assumption, that we will get meaningful and sustainable earnings increases. If you ask me, I'm pretty sure that we'll see rising earnings (see (1) above). I'm not so sure that we'll see much strength going forward (see (2) above).

My verdict? Well, I guess that we'll see (are seeing) a good earnings season which will bring the valuations down. I don't see much room for further gains in the market. Unemployment/job creation worries me, worsening monetary conditions worry me, the failure of households and firms to repair their balance sheets worries me (should I go on?)...

Update: Earnings
If you look at earnings trends you'll see, that we're pretty much on the trend line - the market bubble led to an anomaly with earnings rising disproportionally (especially if you look at pro forma earnings with double fudge and a cherry on top). We are not - as one might think - in an earnings depression. Look for yourself: either in Dr. Ed's Strategy Handbook or at the ever popular Department of Commerce.
10:07 AM :: Karsten :: permalink ::

Cat caught in a Bubble

Monday, October 13, 2003
Michael Kantor over at the Calico Cat examines the notion that we might be looking at a bubble again - read his post here. I'll try to drag some frothy facts out of the closet in support of the bubble theory.

Just an aside: I recommend reading this especially if you are of the bullish persuasion - looking at facts which don't dovetail with your personal convictions is a great way to avoid confirmatory bias.

One classic measure of valuation is the Price/Earnings ratio. You can calculate it by dividing the index value by index earnings. You'll usually see people calculating the P/E ratio by using forward (i.e. expected) earnings. It's obvious, that this entails a pretty large helping of forecast error. The old fashioned way to calculate P/E is on the basis of past earnings - this eliminates the risk, that your forecast is way off (short discussion here). Now if we look at the S&P 500 P/E (trailing earnings) we get a value of around 30x. This is not cheap! Now I could be wrong - earnings could rise and everything would be fine if the index value stayed the same. But this isn't actually what investors want (or expect).

If you take a look at the UBS Index of Investor Optimism you'll see (on page 28) that almost a quarter of those surveyed expect a return > 10% in the coming 12 months (mean expected return 7.9%). This would mean ever rising multiples or a massive rise in future earnings to reduce the P/E to something a little more reasonable. The alternative is that the expected returns are not going to materialise.

But investors disregard the P/E and keep jumping into the market. The problem is, that they are buying on margin. Now this really looks like "getevenitis" to me.

In short: I would be very careful about buying stocks just now. I could - of course - point to quite a few positive market metrics but it has been my experience, that you ignore the basics (such as P/E) at your peril.
11:50 AM :: Karsten :: permalink ::

Coffee, Coworkers and Koizumi - yes, it's monday

The usual monday morning ritual of coworkers, coffee and confusion is almost past. Time to catch up with overnight news:

Japan: Kyodo News poll sees PM Koizumi returning to power at next month's general election.

I'm not all that sure that this is news - are there any serious opponents that Koizumi should be afraid of? It seems to me that he has all his challengers close to home in the LDP anyway. Holiday in Japan (Health & Sports Day!) so no equity trading to talk about today - btw no trading in the US Bond market either (Columbus Day today). The Yen is looking pretty strong vs. the Euro this morning (which is good news for me).

Not much in the way of economic data out today either - looks like a slow start to the week. EUR/USD is correcting lower - as there is no hard data out there at the moment we'll have to focus on corporate news as a proxy for the state of the US economy till mid-week.

It's survey time again - the regional US Fed surveys are expected to show further strength in the US manufacturing sector. The University of Michigan consumer sentiment is seen to rise slightly. US retail sales may decline and could foreshadow a slowdown in spending in Q4.

My gut feeling is slightly bearish for the US equity markets this week - I'm looking for further consolidation before I even start to think about buying into the market again.

Note: Don't you love market commentary? The signal to noise ratio is immense - just look at this comment from Hugh Johnson, chief investment officer at First Albany Corp:

"It's very hard to predict what is going to happen, It's clearly the big week. The outcome for the stock market will depend on what those CEOs say about prospects."

OK. Now everyone who could also have said that, please stand up. Great. Now call yourself chief investment strategist. I mean really, this is non news. I always love how people parade in front of the camera and say inane things about irrelevant market moves. More crystal ball gazing here.

10:48 AM :: Karsten :: permalink ::

Trade like an idiot - you'll be in great company...

Sunday, October 12, 2003
This little piece of news might be helpful for all those of you who are thinking about what to do in the market next week: J. Doyne Farmer of the Santa Fe Institute has used a novel approach to model traders behavior in financial markets. Instead of assuming that traders attempt to maximize utility, Farmer just lets them trade in a random fashion. Farmer et. al. differentiate between two kinds of traders - those that want to buy/sell at any price and those that trade via price limits. The interesting thing about the simulation is the fact, that the results tend to correspond quite well to historical data (LSE). To be fair: this probably says more about the influence of market constraints and the ground rules of the game vs. the intelligence (or lack of intelligence) on the traders side. Read the full paper here.
Update: I found the link to Nature I was looking for. The high point is this little gem:
This suggests that share prices are set by limit orders altering supply and demand - not by the reasoning behind those orders. Ormerod thinks that this apparent randomness comes from the imperfect ability of market agents to process the complex and often incomplete information at their disposal. The best strategy is virtually impossible to find, so everyone reaches different conclusions.

So it diesn't matter why you do something (reasoning) - the important thing is what you actually do (limit orders altering supply and demand). Now why didn't I think of that :-)

Ex orient lux? A special look at Asia.

Saturday, October 11, 2003
Some things never seem to change - investment managers (and their clients) have a neverending love affair with the Asian (ex Japan) market. In my opinion, Asia is one of those places where everyone just knows that fantastic returns are just around the corner. Sadly, I've almost never seen anyone actually make money off of that specific market. Anecdotal evidence? Sure, but I have a definite aversion towards investing in Asia.

An article in this week's Economist (print edition) makes a pretty strong demographic case for Asia. A little searching turned up this Asian Times article, which expounds on the issues presented in the Economist. In a nutshell: the younger population in Asia is saving less and spending more. If these Asian Baby Boomers follow the US/Western European consumption pattern in the years to come, we should be looking at some fantastic increases in retail spending. Even if personal incomes don't rise as quickly as some people seem to believe, we should keep in mind that the sheer number of potential consumers is staggering - there are around 1.2 billion Asians aged between 30 - 59 at the moment.

This Baby Boomer led expansion could serve as forceful catalyst for economic growth (and stock market returns?). The only thing I'm still pretty unsure about, is what actually to buy. From the macro perspective: horrid corporate governance, political risk and volatile currencies don't really make for a fantastic investment climate. The micro view is even worse - I wager, that it is almost impossible to predict, which local companies will be able to profit from the "Asian Baby Boom". Most of the listed companies tend to be former state owned conglomerates and not young, innovative consumer-oriented companies of the kind, that will profit from a future boom in private consumption. It could also transpire that western companies reap the rewards of retail spending - the development of home grown champions has usually been a second step in market development.

I'll keep looking for some facts to help firm up a final opinion but at the moment I'm still not convinced that I have to invest in the pacific rim. I'll keep you posted.

Oil Factoid

Although everyone refers to the basic measurement unit in the oil trade as "barrel" (not that anyone actually uses them these days) almost nobody seems to know why the barrel contains 42 gallons. When oil first started bubbling out of the ground in the 1860 people used any available container to store oil in. After a while one standard size emerged - a 42 gallon barrel.

This has been a standard barrel size in England since 1482 - King Edward IV established that size as the standard barrel for North Sea herring. The King had to standardize because the herring trade was "beset by skulduggery and divers deceits". It seems that fishing was pretty fishy back then. The oil producers in Pennsylvania adopted the herring barrel (as opposed to the 32 gallon ale, or the 36 gallon beer barrel) and it has stayed with us ever since.

Relaunch in Progress

Friday, October 10, 2003
It seems that markets are not the only things that are volatile - this blog will relaunch as a pure market and investing blog over the next couple of hours and days. Thanks go out to Michael of the Gold and Silver Blog for giving me some feedback which led to this decision. Be sure to visit him in case you're interested in any news on those attractive metals.

This article from the Economist might be of interest for those of you that follow the commodities markets. The gist of it is, that the price performance of commodities does tend to look somewhat less strong if you don't look through US-Dollar tinted glasses. Quote from the aforementioned article:

"Gold bugs have been triumphant as the yellow metal has brushed almost $400 an ounce, a price not seen since the mid-1990s. Traditionally, gold has been thought to be a hedge against inflation. With inflationary risks low, this scarcely explains its recent popularity. More likely, the rise in the gold price says more about the dollar than about gold. In euro terms, for example, gold prices have barely budged."

Add the fact that the quest for absolute returns has driven quite a few punters into metals and you get something which looks pretty frothy to me. I'll keep watching copper - as we all know "the only metal with a PhD" - and try to ignore the fact that I sold gold much to early :-)

The Echo Bubble

Dresdner Kleinwort Wasserstein strategist James Montier makes a persusaive case that the (US) Market is headed for some nasty surprises. According to an article in the german daily Handelsblatt, irrational exuberance seems to be back again.

Nasdaq buying on margin is at record levels and the weird thing about it is that everyone seems to be buying stocks that were the flavor of the month just a while back. It seems that the 20 best performing stocks from 1999 are up by around 75% on average YTD. This leads to the term "Echo Bubble". It even seems, that echo bubbles are a pretty normal thing - Montier says:

"The literature on bubbles in the laboratory may offer some extra insight. Vernon Smith (joint winner of this year's Nobel prize) is the major authority within this sphere. His work has shown that inexperienced traders take time to learn the errors of their ways - helping to explain the echo bubble pattern observed in so many data series. In his recent summary Smith writes "once a group experiences a bubble and crash over two experiments, and then returns for a third experiment, trading departs little from
fundamental value."

(Caginalp, Porter and Smith (2000) Overreaction, momentum, liquidity and price bubbles in laboratory and field asset markets, Journal of Psychology and Financial Markets).

I guess the old adage "once bitten, twice shy" doesn't relate to the stock market.

Add in the fact, that insider selling seems to be at record highs and you start to have images of big furry animals with large teeth stomping on the market in the near future.

Go Home Productions: "Sly Beyoncé Walks Like a Nerd": Pitchfork Review

Go Home Productions Track "Sly Beyoncé Walks Like a Nerd" was reviewed by Pitchfork's Ryan Schreiber. The full Review can be found here. Read it - it really sums up why I like bootlegs - just read this little excerpt:

"It's tag-team pop: Beyoncé backed by The Bangles' vapid "whey-oh-whey-oh's" gives way to a pitchshifted Susanna Hoffs throwing back more to '75 than '85 with Sly Stone's insistent crooning pulling up from the murky depths, and the track finally skidding to a stop for Pharrell Williams' longing tenor."

If you want the track - hurry up and visit GHP at his website.

Efficient Frontier Fall 2003

The Fall edition of the Efficient Frontier ist out. William Bernstein weighs in on Keyne's Paradox of Thrift and discusses Zvi Bodie's new Book Worry Free Investing and it's focus on investing in TIPS. Will have to peruse the article carefully as TIPS are not an asset class that we see much of in Europe.

There is also a nice reality-check article on future equity returns which really exemplifies Bernstein's attitude towards long term investment.

A new Book is in the offing from Bernstein as well - a teaser can be found here.

The somewhat misleadingly called "Link of the Month" (it is actually a link of the quarter) is a great read - just do what Bernstein suggests and concentrate on the last quarter of the Paper by Luigi Zingales and Raghuram Rajan. An IMHO very nice overview of (recent) economic history. Get the paper here.
12:34 PM :: Karsten :: permalink ::

Elections in Japan coming up...

Japanese PM Koizumi has scheduled an election on Nov. 9th. This comes just after him asserting himself in an internal LDP leadership struggle. The election will probably be another test of Japan's nascent economic recovery. Some signs of hope are emerging - Buttonwood has this semi-optimistic piece on Japan's struggle with the bad debt problem.

This comes just after overnight news of a further Bank of Japan easing. Remember: George Bush is in Tokyo next week - this leads many people to suspect that the BOJ will slow it's efforts to stop the appreciation of the Yen vs. the Dollar during next week. We'll wait and see.
10:38 AM :: Karsten :: permalink ::

Thursday, October 09, 2003
The incredible master of glitch pop has his birthday today and gives us a present. Get it while its hot:

After dallying with the idea of blogging, I finally took the plunge and started one. I wonder if I manage to keep this thing going ...