Silver – Oversold Moments In Past 3 Years
May 16, 2012 Leave a comment
Anatomy Of An Overreaction
May 16, 2012 Leave a comment
JP Morgan announced that it lost $2 billion due to either a flawed hedging strategy or just bad trading.
Some reports cite that the loss is more like $1 billion when you account for the gains made on the other side of the hedge which the initial strategy was trying to protect or offset.
My question is to ponder whether JP Morgan’s stock price has overreacted.
The market capitalisation of JP Morgan prior to this news was approx. $161 billion.
It’s stock price has fallen near 14%, meaning it’s market cap has fallen $23 billion and now stands at $138 billion.
I’d like to compare it to BP’s 2010 Macondo oil rig disaster in the Gulf of Mexico.
Sadly, 17 men died as a result of this explosion and it crippled parts of the Gulf Coast economy, not to mention the environmental damage caused.
Prior to the rig explosion, BP stock was trading at $60 per share and its market cap was $190 billion.
2 months later, the stock had fallen to $27 and it market cap was $86 billion.
Today, BP’s stock price has risen 40% from that June 2010 low but more importantly, it’s stock price recovered the decline that it suffered following the sinking of the oil rig, within 4 months.
The financial settlement costs for this disaster is estimated to be near $8 billion.
Both companies; are making a net profit of approximately $25 billion per annum, have P/E estimates of between 6 & 7 for the next fiscal year and are trading just below their book value.
JP Morgan’s error doesn’t seem to be systemic, life-threatening nor open to punitive lawsuits.
Assuming that the JP Morgan loss will be $2 billion, the ratio of the financial loss compared to the fall in the company’s value matches the decline experienced by BP.
It looks like an overreaction.
Are German bonds all that?
May 11, 2012 Leave a comment
North Rhein Westphalia (NRW) goes to the polls this weekend.
The political tension surrounding the elections is about many seats Angela Merkel’s party may lose.
NRW is Germany’s most populous state and it’s GDP equals 22% of Germany’s total and if it were a country, it’s economy would be the world’s 14th largest. With a GDP estimated to be in the range of $550 billion and it carries a debt of approx. $230 billion, which is quite a debt for a state with a population of 18 million.
Actually, its Debt to GDP ratio is quite conservative when compared to the whole of Germany’s which runs at around 85%.
While Germany’s GDP to Debt ratio is below the 105%+ marks that Greece, Italy, Portugal, Ireland and the U.S. carry, it is worth exploring why German debt is more revered than France’s.
France’s Debt to GDP ratio is close to Germany’s, yet their 10 year bond has a yield of 2.80% while Germany’s commands a “safe haven” status of 1.52%.
Why do German 10 year bonds trade at 1.52% and why did investors recently accept a negative yield for their short-term deposits?
Is it because Germany’s debt obligations are perceived to be safer than France’s?
For some background, it’s important to note that European countries gave up their right to control their monetary base when they adopted the Euro. It is the European Central Bank that establishes interest rate and monetary policy.
Yet the Bundesbank has said that “it won’t allow inflation to rise”. Hmm, so if inflation rises in Germany (currently at 2% p.a) and the Bundesbank can’t set interest rate policy – how does it propose to control inflation? Perhaps it can influence it’s government to decrease government spending. I don’t think this would help it’s safe haven bond perception.
A German 10 year bond yield 1.52% seems to be close to the low end of its logical range. If inflation rises, German federal and leading state government debt rises and its GDP purchasing power weakens, I can see these bond yields tripling before they halve.
Big Declines in Coffee, Cocoa, Cotton & Sugar.
May 11, 2012 Leave a comment
Since their 2011 highs, Coffee & Sugar prices have fallen 43%, Cocoa has declined 37%, Orange Juice Concentrate is 48% lower and Cotton prices have retreated 62%.
Obviously it’s now cheaper to buy these commodities than it was last year and some are even hitting the same levels seen 10 years ago.
I’m always interested investigating how far the pendulum has swung when I see such price moves when compared to the changes in the supply and demand story. Although seasonal changes have great effect, I still remain bullish on the direction of prices of commodity prices, especially the soft and grain commodities. An old blog post that I wrote about Cotton may be interesting for readers to re-visit.
The FINVIZ website is also a wonderful resource where you can quickly check the prices and retrieve charts on various commodities.
Government & Corporate Unfunded Pensions
April 23, 2012 Leave a comment
In a recent interview with Charlie Rose, Chicago Mayor, Rahm Emanuel was asked to list the greatest challenge that lies ahead for his city, to which Emanuel replied, “addressing the pension deficit”.
U.S. city, municipal and state governments are massive employers and yet their workers don’t have pensions that are funded and ready for their retirement.
The theme surrounding the funding, reforming and creating pensions is currently one of my favourite topics of research.
In this post, I wanted to discuss some points that concern me about underfunded pensions.
Just to start, consider the social and financial effect that will involve millions of employees not having enough money to retire on. If cities continue to run high budget deficits and unfunded pension schemes, it will be difficult to recruit firefighters, police and health professionals.
Government can reduce their pension liabilities by increasing their revenues (higher property taxes, parking costs), cutting costs (less or infrequent services, fewer employees) or selling assets (infrastructure such as freeways, power stations or airports).
These pension deficits also exist amongst U.S. companies. But they are better at hiding it.
Over the past year, American corporations have bragged about the robustness of their balance sheets. They are quick to tell investors how they’ve restructured their affairs, sold off unwanted businesses, trimmed costs and grew their earnings.
Although, much of the earnings growth has been a function of cost cutting and not revenue growth, which is another story all together.
Amongst this self promotion, I noticed stories that proclaimed how certain companies have billions of dollars in “net cash” held on their balance sheet.
An example might look like something like, Company ‘A’ has a market capitalisation of $20 billion. It has total (long and short-term) debt of $2 billion whilst its cash or equivalent securities amounts to $4 billion, thus they have a “net cash” position of $2 billion. All of this looks OK until you discover they have an unfunded pension liability of $7 billion, which amounts to one-third of its market cap.
It is annoying that items such as goodwill and deferred tax benefits appear so clearly in a company’s list of assets (correctly, pension assets do not belong the company), but you need to dig deeper in order to find what their total obligations are.
The rising cost of capital
April 1, 2012 Leave a comment
I wanted to expand on a previous post from Jan 18, 2012 titled “What if interest rates double”. https://robzdravevski.com/2012/01/18/what-if-interest-rates-double/
What if the cost of capital doubles or triples within 10 years?
I don’t think this outcome is far-fetched and I do think it is worth considering or at least being prepared for.
In the U.S., the Prime rate is currently 3.25%, a 15 year fixed mortgage costs 3.4% per annum and the government 10 year bond is yielding 2.2%. Australians pay 6.5% for a 3 year fixed home loan while the Reserve Bank of Australia’s Cash Rate is presently 4.25%.
Whether it’s the mortgage, government or capital markets, rising rates in the coming decade shouldn’t be a surprise. After all, they are at the extreme low of their historical ranges.
Continued cheap credit isn’t something we should wish for. Take a look at Japan. Deflation is the larger evil.
Presently, central banks are trying to reflate economies and the result of the increasing monetary base should be inflation. How high it will rise will depend on the policy employed to curb it from becoming hyper-inflationary. One strategy that will be used will involve raising rates in order to slow a recovering and expanding economy.
We should remember that rate cuts are used to stimulate activity. Keeping rates low for a prolonged period tell us either how sick an economy is or how much of a “jump-start” the economy ultimately needs.
I think that rising rates should be (quietly) celebrated as they signal an expanding economy. The rising cost of credit is designed to temper the growth or least keep it at a measured pace.
Rates will rise noticeably in the next 10 years from the combined results involving policy, creditworthiness, lending criteria and the flow of money.
Although economies should improve, the inflationary effects of central bank “money printing” and the legacy of company and government bond defaults will be the greater influence towards the cost of credit rising.
Scarcity of capital will be the second wave of upward pressure on interest rates. Banks will be required to hold greater liquidity and their lending criteria will remain tough but more importantly I believe money will flow increasingly from the developed world towards emerging markets, where the return on the capital invested will be a more attractive proposition to lenders.
This exodus of capital will cause interest rates in the developed world to move higher. It’s quite possible that the rise will be amplified by erroneous central bank policy because they deem higher rates are justified in order to stifle the inflationary result from their actions earlier in the decade.
These higher rates will also be used (and justified) in order to court capital back to safer investing jurisdictions.
The ramifications of this scenario would have far-reaching effects on their portfolios and I feel it is an important theme in which investors will need to prepare and position for.
In an upcoming post, I will apply this theme to how I think it will affect commodity prices and mining companies.
Cash is expensive
January 25, 2012 Leave a comment
Whether it’s property, equities, bonds, jewellery, art or even rare coins – there is often an opinion forthcoming whether it’s consider to be cheap, fairly valued or expensive..
Cash seems to miss out on falling into these categories. Cash is referred to as “king” in times of worry and “lazy” when everything is booming. You’re can be either “cash rich”, “cash poor”, “cashed-up”, “strapped for cash” or it can be “burning a hole in your pocket”.
The cost of money can be cheap or expensive when you are borrowing it but why can’t cash be expensive or cheap when valuing it as an investment?
Today, I think cash is expensive!
Notwithstanding the ebbs and flows of investment markets in the near-term, when compared to other asset classes, it’s probably very expensive.
The Earnings Yield
When scanning for what I refer to as a “Fertile Investing Habitat”, I take the Earnings Yield of an equity index (which is the inverse of the Price/Earnings Ratio) and compare it to the government 10 year bond yield and the interest earned on bank cash deposits in that particular country when trying to initially determine whether that “habitat” is potentially cheap.
For example, the P/E ratio estimate for the current fiscal year of the ASX 200 Index is 12, the inverse of this figure and thus its earnings yield is 8.3%. The yield for the Australian government 10 year bond is 4% and a generous at-call bank deposit would earn 5%.
From this I may deduce that the ASX 200 equity index might offer a better return proposition over nest few years versus the return prospects of cash?
To figure out if my investment in cash is actually expensive, simply invert the 5% bank deposit interest and your conclusion is a Price/Earnings (P/E) Ratio of 25. This is twice as expensive as the ASX 200 equity index!
What about the United States?
The S&P 500 has a P/E of 12.5 which equals an earnings yield of 8%. The 10 year govn’t bond’s yield to maturity is 2.1% (P/E of 47) and the Fed Fund rate is 0.25%, giving you a P/E of 400.
What if interest rates double?
January 18, 2012 Leave a comment
Over the past few months I have been asked whether the Reserve Bank of Australia (RBA) will lower interest rates by 25 basis points in the coming months.
My answer: Who cares?
With a RBA cash rate so low, does it matter that much if we see a rate cut of 25 basis points? Oh sorry, it might save borrowers $25 more per month. If your hoping for such a rate cut to save you $300 per year, perhaps you are too leveraged in the first place and didn’t do anything about it over the past three years?
The real damage will be done if rates were to double or triple over the next 8-12 years, of which I am placing a greater probability towards occurring.
The Australian inflation rate was last reported as 3.5% and the RBA’s “Cash Rate” is 4.25%, which equals a real interest rate of 0.75%.
Investors in Australia, today, need to re-educate themselves about the differences between a nominal interest rate and a real interest rate.
Earning 4.8% at-call in the bank, isn’t REALLY maintaining your purchasing power when you include the inflation rate, let alone adjusting for taxes!
What if……due to various global capital forces, the real interest rate rose 1.5%, which would be closer a 30 year average and when combining my view of prolonged energy and food inflation AND the economic effect of expanded money circulation, inflation rates could themselves rise a further 2%.
Hey presto! You would then have an inflation rate of 5.5% plus a real rate of 2.25% for a nominal rate total of 7.75%.
Add the spread that a lending bank would charge and you are suddenly borrowing money at 10.2%!!!
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