December 11 – December 17, 2015

The Fed did it! Diversify, diversify, diversify. Technology offers a chance at low hanging fruit. High Ground Looking over a Swamp, aka Cheniere.

The Fed finally raised interest rates!  Definitely one of the three themes from the week, which I’ll cover only briefly in Christopher Condon’s coverage in BloombergBusiness“Fed Ends Zero-Rate Era, Signals 4 Quarter-Point 2016 Increases,” simply because I’m sure you’ve already read about this.  The other two themes covered 1) “Beyond Property: Chinese Developers Look to Diversify” by Esther Fung in The Wall Street Journal and 2) “Digital advances uneven across US economy” by Sam Flemington in The Financial Times.  In addition, I think it’s worth noting the dismal of Cheniere’s founder and CEO, Charif Souki, this past week – see below.

*Note: bold emphasis is mine, italic sections are from the articles.

Fed Ends Zero-Rate Era, Signals 4 Quarter-Point 2016 Increases. Christopher Condon. Bloomberg. 16 Dec. 2015.

In a nutshell:

“The Federal Open Market Committee unanimously voted to set the new target range for the federal funds rate at 0.25% to 0.5%, up from zero to 0.25%.  Policy makers separately forecast an appropriate rate of 1.375% at the end of 2016, the same as September, implying four quarter-point increases in the target range next year, based on the median number from 17 officials.”

“Prior to 2008, the effective fed funds rate had never dropped below 0.63%, according to data compiled by the St. Louis Fed dating back to 1954.”

While the commentary is that the raising of rates will be gradual, I’m fairly certain that if rates make it to 1.375% by end of next year, it will be jarring.  Granted, hopefully the economy will be firing on all cylinders to justify that rate.  Already Wells Fargo and others have raised their Prime Rate by a quarter point to 3.50%.  The Bank of Mexico has increased rates for the first time since 2008 in order to prevent further weakening of the peso relative to the US dollar.  Hong Kong which has a currency peg to the US dollar is also raising rates. This is only part of the knock-on effects – clearly there is a lot at stake.

Beyond Property: Chinese Developers Look to Diversify. Esther Fung. The Wall Street Journal. 10 Dec. 2015.

For those that don’t know, real estate development in China got “a little” over its skis. As result, it’s been tough for real estate developers, especially those not in the first tier cities.

“… a growing number of developers who see no end to the pain in Chinese real estate and are looking to get out. Other developers are branching off into everything from banking to cosmetic surgery to women’s soccer.”

“Some even suggest a long-term de-emphasis on property as China’s birthrates slow and the population ages.”

“According to Moody’s Analytics, housing and its related industries contributed 18% of the country’s gross domestic product in 2014, down from 23% in 2013.”

“The property sector has turned from being China’s economic growth engine into its burden.” – Ma Guangyuan, a Beijing-based independent economist.

“While housing sales are up 7.9% by volume in the first 11 months this year from a year ago, construction starts have been declining at double-digit levels. Growth in investment in residential property slowed to 0.7% growth in the first 11 months of this year, down from 9.2% for last year.”

Consider the “ghost cities” and all of the empty building inventory that is meant to house the hundreds of millions of rural citizen when they migrate into the cities.  What happens if they don’t migrate?  Consider that the allure of higher wages and the “iron rice bowl” (China’s implicit understanding that companies will look after the welfare of their employees – at least the State-Owned-Enterprises) is fading.  See Mark Magnier’s “China’s Workers Are Fighting Back as Economic Dream Fades” in The Wall Street Journal.

It is no surprise that developers are diversifying.  Real estate development is a cyclical business (even if this cycle in China has been cranking for decades since Deng Xiaoping came to power).

“In May, real-estate firm Shanghai Duolon Industry changed its name to P2P Financial Information Service Co. to diversify into Internet finance and consultancy services, driving its shares sharply higher.”

“Evergrande Real Estate Group Ltd. (also one of the China’s largest developers), which recently spent $2.1 billion buying uncompleted property projects, has delved over the past two years into mineral water, dairy, grains and oil.”

Other examples include Dalian Wanda’s purchase of the Ironman triathlon group, its creation of a financial holding company and its crowdfunding project “Stable Earner No.1” (promising investors annualized returns of 12% – 6% from income and 6% from appreciation).

However, even if the developers themselves are not excited about their prospects, Chinese insurers feel differently. See Jacky Wong’s article in The Wall Street Journal “Why China’s Insurers Are Bidding Up Property Stocks” (it was also listed in last week’s “Other Interesting Articles.”)

Digital advances uneven across US economy. Sam Flemington. The Financial Times. 16 Dec. 2015.

“Research from the McKinsey Global Institute finds that digitization could add $2.2tn to US gross domestic product by 2025 as companies lift productivity by exploiting advanced technologies.

However, the flipside will be further dislocation in the jobs market. Automation could displace between 10-15% of middle-skilled occupations such as clerical, sales and production roles over the period from 2015-25, equivalent to 8m-12m jobs, the report predicts.

That would be nearly twice the displacement rate of recent decades. The report finds that 60% of occupations could have 30% or more of their activities automated.”

The room for improvement in production efficiencies is a case for optimism, but the prospects of job rationalization is cause for concern.  Consider that US median wage has been flat for 45 years (GMO third quarter newsletter) largely due to advances in technology, globalization, and policies that have favored capital over labor (as Ice-T said, “don’t hate the player, hate the game.”)

“Looking at just three big areas of potential – online talent platforms, big data analytics and the internet of things – we estimate that digitization could add up to $2.2tn to annual GDP by 2025, although the possibilities are much wider.”

But digitization is happening “unevenly” with “the US only reaching 18% of its digital potential.”

Industries that have a lot of catching up to do: agriculture, construction, and hospitality.

“After the IT sector itself, the most digitally advanced companies are in media, professional services, finance and insurance, and wholesale trade, the report says.”

Cheniere Energy

The reason I bring this up is because it wasn’t long ago that Bloomberg Businessweek had a feature on Cheniere and Charif Souki, “America’s Most Unlikely Energy Project Is Rising From a Louisiana Bayou” (9/2/15), profiling Souki’s rise and decent and rise again – and now post script decent.

From that article:

“Cheniere Energy, based in Houston, has spent more than a decade, and upwards of $20 billion, turning 1,000 acres of swamp into the first LNG export terminal in the continental U.S.”

Still yet to make any money (the terminal is about to be activated).

To get a sense of the scale of the operation, “Sabine Pass makes its own power. Cheniere paid General Electric $1 billion for 24 gas-fired turbines that were initially designed as jet engines. By the time the terminal is fully operational, they’ll generate about 450 megawatts of electricity, enough to power a city of almost 300,000 homes.”

FYI, America’s natural gas pipeline network leads right to the facility.

A little on Souki, Charif Souki after a stint in investment banking used own/run Mezzaluna in Aspen and LA along with two other restaurants in LA . In 1996 he became and oil and gas executive by purchasing a defunct public company.  The article is really worth the read. Oh and,

“In 2013 his total compensation was $142 million, good enough to make him the highest-paid CEO of a U.S. public company. About $130 million of that came in the form of company stock.”

As Howard Marks, of Oaktree Capital, says “To succeed in the markets you need 1. Aggressiveness, 2. Timing, and 3. Skill.  If you are Aggressive enough and Time it right, you don’t need skill.  Only when the market declines or the timing is bad do you see who had/has skill.”

I’m not implying that Souki doesn’t have skill.  He clearly has grit (aggressiveness).  His timing has been good and bad, but ultimately the commodity slump has been too much and too long leading to Carl Icahn and the board of directors to can him.

Other Cheniere and Souki related articles:


Other Interesting Articles

Bloomberg Businessweek

The Economist


BloombergBusiness: Blackstone Seeking to Raise $4 Billion for Real Estate Debt Fund 12/10
FT: Wells Fargo warns of ‘stresses’ in its energy portfolio 12/14

FT: Yields on junkiest US bonds breach 18% 12/15

FT: Any end in sight for the big oil slide? 12/15

FT: Celebrate the rise of flawed, febrile China 12/16

FT: Banks raise prime rates after Fed move 12/17

FT: Fed rise – Hong Kong caught between US tightening and China slowdown 12/17

FT: Second rating agency cuts Brazil to junk 12/17 Interest Rates, Cap Rates Don’t Move in Lockstep 12/15

National Real Estate Investor: Net Lease Buyers Develop Bigger Appetite for Medical Properties 12/14

National Real Estate Investor: Private Equity Real Estate Fundraising Surges in 2015 12/16

NYT: China’s Coastal Cities, Underwater 12/11

NYT: Why Very Low Interest Rates May Stick Around 12/14
NYT: Battered, Apologetic and Still Pitching Their Hedge Funds 12/15

WSJ: Private Equity’s ‘Hidden’ Fees Totaled $20 Billion 12/13

WSJ: China’s Workers Are Fighting Back as Economic Dream Fades 12/14

WSJ: The Government’s Financial Watchdog Just Warned Us That Another Third Avenue-Style Bond Fund Run Is Likely 12/15

WSJ: Even as Oil Plummets, China Keeps Prices High 12/16

WSJ: Rent Your Place on Airbnb? The Landlord Wants a Cut 12/16

WSJ: Fed Rate Increase to Cool Hong Kong Property Prices 12/16

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