Tag: Emerging Markets

February 12, 2016

February 5 – February 11, 2016

Negative yielding government bonds. Lending to Emerging Markets hits the brakes. Japanese 10-year bond crosses the zero bound.

Three key articles that stand out this week are 1) Elaine Moore, Robin Wigglesworth, and Leo Lewis’ “Government bond yields send recession signal” in the Financial Times, 2) Jonathan Wheatley’s “Lending to emerging markets comes to halt” in the Financial Times, and 3) Richard Barley’s “Japan and the Strange Case of the Negative Bond Yields” in The Wall Street Journal.

Other items that are worth a mention:

Blackstone is considering entering the public nontraded REIT (Real Estate Investment Trust) market. No surprise considering the increased volatility in the world, lack of yield in traditional investment products, that Blackstone is probably one of the best (if not the best) suited Alternative Asset Managers with the best pedigree, and that the largest player in the market (ARC) has been brought down by an accounting scandal (only the tip of the iceberg). Watch how quickly this product category grows for Blackstone.
Bank profit margins are hurting from the declining spread between 10-year and two-year U.S. Treasuries.

From a post that Nouriel Roubini did for Project Syndicate: “…financial markets haven’t reacted very much, at least so far, to growing geopolitical risks, including those stemming from the Middle East, Europe’s identity crisis, rising tensions in Asia, and the lingering risks of a more aggressive Russia. How long can this state of affairs – in which markets not only ignore the real economy, but also discount political risk – be sustained?”

On the plus side, Voluntary Job-Quitting is up. People are feeling more confident to leave their jobs.

Interesting graphics:

From The Wall Street Journal, the Baltic Dry Index continues to fall (side note for the Hawaii readers, Matson just had its earnings call and indicated that while they’re having difficulties in its other markets – understandably considering the dramatic fall in shipping prices – things are going just swell for them in Hawaii. Thank you Jones Act.)

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

Government bond yields send recession signal. Elaine Moore, Robin Wigglesworth, and Leo Lewis. Financial Times. 5 Feb. 2016.

“In Germany, the average yield on all government debt is now negative, while Japan is on course to become the first major bond market with a 10 year bond that yields nothing. In Europe and Japan, government bonds worth nearly $6tn now trade at such highs that buyers will make a loss if they hold the paper to maturity.”

So shortly thereafter, the Japanese 10 year bond did cross the zero threshold.

“At these levels the bond market is forecasting recession.” – Marcus Brookes, a fund manager at Schroders

“The Janet and John way to explain it is that for the next 10 years you have to think inflation will be much, much lower than 2% to want to buy these bonds. Otherwise you’d be locking in a loss.” – Brookes

“Investors face the difficult prospect of assessing whether low inflation has become ingrained thanks to the collapse in commodity prices. A greater concern: has central bank interference in the financial markets made pricing so opaque that investors are risking the sort of losses incurred last April, when a European Central Bank driven rally in bond markets suddenly expired?”

“The lifespan of the rally in government bonds will depend on how long investors keep faith in central banks, says Tad Rivelle, chief investment officer for fixed income at TCW, a Los Angeles based asset manager. Every economic cycle has a grand narrative that eventually unravels, he says. In the late 1990s it was the information revolution, in the 2000s it was housing prices.

‘This cycle the narrative has been that central banks have got the ball, know what they’re doing and can keep the game going as long as they want,’ he says. ‘But humans have not found a way to abolish cycles.'”

Lending to emerging markets comes to halt. Jonathan Wheatley. Financial Times. 5 Feb. 2016.

More good news.

“The surge in lending to emerging markets that helped fuel their own – and much of the world’s – growth over the past 15 years has come to a halt, and may now give way to a “vicious circle” of deleveraging, financial market turmoil and a global economic downturn, the Bank for International Settlements has warned.”

“That reversal has already taken place, according to BIS data released on Friday.

The total stock of dollar-denominated credit in bonds and bank loans to emerging markets – including that to governments, companies and households but excluding that to banks – was $3.33tn at the end of September 2015, down from $3.36tn at the end of June.

It marks the first decline in such lending since the first quarter of 2009, during the global financial crisis, according to the BIS.“

“The Institute of International Finance, an industry body, said last month that emerging markets has seen net capital outflows of an estimated $735bn during 2015, the first year of net outflows since 1988.“

Hyun Song Shin, head of research at the BIS, noted that “while some advanced economies had reduced leverage after the crisis, debt had continued to build up in many emerging economies. ‘Recent events are manifestations of maturing financial cycles in some emerging economies.'”

Shin “noted that the indebtedness of companies in emerging markets as a percentage of GDP had overtaken that of those in developed markets in 2013, just as the profitability of EM companies had fallen below that of DM ones for the first time.”

“Now that the dollar is strengthening, we have turned into a deleveraging cycle in Ems. So there is a sudden surge in measurable risk; all the weaknesses are suddenly being uncovered.“

Japan and the Strange Case of the Negative Bond Yields. Richard Barley. The Wall Street Journal. 9 Feb. 2016.

“Japanese 10-year government bond yields turned negative for the first time ever Tuesday, and now stand at minus 0.03%. The feat has already been recorded elsewhere – the Swiss 10-year bond yields minus 0.4% – but this is the first time a member of the Group of Seven economies has seen such a development.”

“The JGB (Japanese Government Bond) market has for many over the years looked like an accident waiting to happen. The country’s debt stands at a staggering 2.4 times gross domestic product, a level far above its peers, and still rising. The International Monetary Fund thinks the ratio could reach 2.9 times by 2030. Japan lost its triple-A rating from Moody’s as long ago as 1998; it currently stands at A1.”

“Across global fixed-income markets, there are now $8.7 trillion of bonds sporting a negative yield, or 21.1% of the total outstanding, according to Bank of America Merrill Lynch data.”

And yet the Yen keeps getting stronger…. To help understand Why the Yen Just Keeps Getting Stronger, see Alex Frangos’ article in The Wall Street Journal.

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bello: The endgame in Venezuela

Bloomberg – More Wall Street Strategists Are Cutting Their S&P 500 Estimates 2/6

Business Journals – Small businesses have the blues this winter 2/9

Forbes – China: Land of the Setting Sun (Gary Shilling) 2/8

FT – Why it would be wise to prepare for the next recession 2/4

FT – Hedge funds target a weaker renminbi 2/8

FT – Google passes significant barrier in its plan for driverless cars 2/9

FT – Outflows from China top $110bn in January 2/9

FT – Riksbank cuts rates deeper into negative territory 2/11

FT – BNP Paribas to curb lending to US energy sector 2/11

Investment News – Blackstone considering getting into nontraded REIT market 2/4

NYT – If There Is a Recession in 2016, This Is How It Will Happen 2/4

NYT – Stung by Low Oil Prices, Companies Face a Reckoning on Debts 2/9

Project Syndicate – The Global Economy’s New Abnormal (Nouriel Roubini) 2/4

WSJ – Corporate Credit: Less Than Angelic 2/8

WSJ – Tech Stocks: Why the Selloff Could Get Worse 2/8

WSJ – Bank-Stock Carnage: This Number Is Killing Them 2/8

WSJ – Global Recession? What This Key Indicator Says About It 2/9

WSJ – Voluntary Job-Quitting Hits Highest Level in Nine Years 2/9

WSJ – This Chinese City’s (Shenzhen) Property Market Is Out of Control 2/10

WSJ – As Economy Suffers, Economic Theory Flourishes 2/10

WSJ – Why the Yen Just Keeps Getting Stronger 2/11

Special Reports

NYT – Traveling Through Venezuela, a Country Teetering on the Brink 2/9

January 8, 2016

December 25, 2015 – January 7, 2016

Sovereign-backed corporate debt. Chinese Real Estate Developers in America. Hanergy shares unloaded at a 95% discount. RCAP files for Chapter 11 bankruptcy.

The S&P 500 is down nearly 5% through Thursday, the circuit breakers in China have been triggered twice this week (market is closed for the day after a fall of 7% – the rule was just implemented at the start of 2016 and China is already suspending it), one gigabit/second WiFi kiosks are being rolled out in New York City, North Korea has detonated a nuclear bomb as a test (apparently not a hydrogen bomb, doesn’t make me feel all that better), Crude Oil dropped below $33 a barrel (good for consumers, bad for producers) Venezuela is quickly heading to hyperflation (monthly inflation greater than 50%), Sunni – Shia tensions have spiked in the middle east after Saudi Arabia executed a high profile Shia cleric… basically welcome to 2016. Hope you had a restful holiday.

I recognize that these topics are getting a lot play in the press, so I won’t go into detail. For those who haven’t been following: for more on the Chinese stock market and the knock on effect to the rest of world markets see “Why China Is Rattling the World” by Karl Russell and K.K. Rebecca Lai in the New York Times. Note that China’s foreign exchange reserves fell $108bn in December to $3.33tn according to central bank figures (see graphic below from “China’s Shortest Day Will Prolong the Pain” in The Wall Street Journal).

For context on the history between Sunni and Shia Muslims see “Sunni and Shia: explaining the divide” by Heba Saleh in the Financial Times.

And it’s worth showing the following graphic that was in the Financial Times that highlights the company valuations of the FANGs (Facebook, Amazon, Netflix, and Google Alphabet). Irrational exuberance for some (note the PE multiples)…

Sorry, I digress. Since it has been two weeks since the last post, there are many articles in the “Other Interesting Articles” category worth reading, but I’m only going to focus on 1) Elaine Moore and Jonathan Wheatley’s “Fears mount over rise of sovereign-backed corporate debt” in the Financial Times, 2) Eliot Brown and Esther Fung’s “Chinese Developers Build In America, but Look for Buyers at Home” in The Wall Street Journal, 3) Ben Bland’s “Hanergy Thin Film founder sells 6% stake” in the Financial Times, and 4) just because RCAP filed for bankruptcy this week, I’ll cover a little of the rise and fall of this once star of public non-traded REITs.

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

Fears mount over rise of sovereign-backed corporate debt. Elaine Moore and Jonathan Wheatley. Financial Times. 5 Jan. 2016.

One way for a sovereign country to keep its debt levels down is to hide it in companies that are effectively (either explicitly or implicitly, but preferably implicitly) controlled by the government.

“More than $800bn of emerging market sovereign debt is being camouflaged by the growing use of bonds that offer implicit state backing without always appearing on government balance sheets, according to new research.”

Why not, especially considering the buyers of this debt have been willing to oblige.

“The growing use of such bonds suggests developing countries are increasingly transferring debt obligations to third parties that have taken advantage of historically low interest rates to load up with cheap debt.”

“Although official debt-to-GDP levels of countries such as India, Russia and China remain low by global standards, the growth of less visible debt which they might still have to guarantee in a crisis underlines the potential scale of their liabilities.”

“New figures from JPMorgan and Bond Radar show that issuance of quasi-sovereign bonds outpaced that of sovereign bonds in emerging markets last year, raising the stock of such debt from $710bn in 2014 to a record $839bn by the end of 2015.

By comparison, the stock of all external emerging market sovereign debt stood at $750bn at the end of last year, according to JPMorgan.”

For example,

“Quasi-sovereign borrowers include 100% state-owned entities such as Mexico’s Pemex, local governments in countries such as China and entities in which the government owns more than 50% of the equity or has more than 50% of the voting rights – a description that encompasses Brazil’s Petrobas.

However, the treatment of such debt is not uniform. Bonds issued by Pemex are included in debt-to-GDP calculations for Mexico, but this is unusual and only 19 of the 181 quasi-sovereign bonds tracked by JPMorgan carry an explicit sovereign gurantee.”

Therefore, it is of no surprise that the big ratings agencies have been down grading the sovereign debt of countries with large amounts of corporate debt tied up in semi-sovereign companies.

“What can really break the dam is the quasi-sovereign element in EM external debt,” says Gary Kleiman of Kleiman International, an emerging market investment consultant. “People have always assumed there is an implicit backing, but that capacity has not been called into question explicitly.”

“Analysts say the problem extends beyond that of dollar-denominated debt. Emerging market companies have issued an estimated $23.7tn including dollar and local currency debt, up from about $5tn a decade earlier. Many such issuers are quasi-sovereigns. About $16.7tn had been issued by companies in China, according to the BIS, almost all of which carry an implicit or explicit state backing.”

Chinese Developers Build in America, but Look for Buyers at Home. Eliot Brown and Esther Fung. The Wall Street Journal. 29 Dec 2015.

As real estate developing opportunities are becoming scarce (or more financially risky) in China, the large Chinese developers are expanding into various unrelated business lines and more naturally, have expanded into new markets abroad. Interestingly, they tend to bring their buyers with them.

“Big Chinese development companies, including Greenland, Dalian Wanda Group and Oceanwide Holdings, are collectively planning billions of dollars of U.S. development, including Chicago’s third-tallest tower and a $5 billion apartment project in Brooklyn. Most of the large developers have ambitions one day to collect as much as 20% of their income from international markets such as the U.S. and England.”

“Buyers out of China thus far account for about 40% of Greenland’s Los Angeles project… Wanda is expecting foreign buyers – the bulk of which are Chinese – to buy about 30% of its 94-story, 406-unit condo and hotel project in Chicago.”

“Chinese purchases of commercial property grew to about $5 billion through the third quarter of 2015, already a record that is up from $2.5 billion in all of 2014 and $1 billion in 2010, according to real-estate services firm JLL.”

“Nowhere has the interest been more concentrated than in Los Angeles, where at least 10 Chinese developers have purchased large development sites, all within the last two years, according to JLL.”

Of course, savvy to Chinese demand for real estate in the U.S., several domestic developers of higher priced condo projects in the U.S. have set up sales offices in or agreements with listing agents in China as well.

Hanergy Thin Film founder sells 6% stake. Ben Bland. Financial Times. 29 Dec. 2015.

“Li Hejun offloaded the shares at a 95% discount to their last traded price in May, before they were suspended from the Hong Kong exchange after plunging 47% in one day.”

“This week’s share sale values HTF at $1.16bn, far below the $21bn market capitalization recorded in May.”

So here’s the skinny. Hanergy Thin Film Power, once one of the most highly valued solar companies in the world utilized shell companies and accounting methods in an investment environment that was desperately looking for renewable-high tech investments particularly with a China tie. The company’s leader, Li Hejun, in the process briefly became China’s richest person.

There is a good amount of coverage on the subject, but two articles that will help you get your head around it pretty quickly are Abheek Bhattacharya’s “Hanergy’s High Demands for Rehabilitation” in The Wall Street Journal (8/17) and Miles Johnson and Lucy Hornby’s “FT Investigation: The strange tale of ticker ‘566’” in The Financial Times (7/20).

Basically, Hanergy maintained the highest profit margins (near 50%) in the industry (despite continual sales price pressure in the industry) by selling almost all of its product to its unlisted parent company at above market pricing. But no worry, the parent company didn’t actually pay for most of the product. Rather Accounts Payable and Accounts Receivables increased on both ends. The “listed Hanergy racked up receivables equal to 101% of annual revenue.” Still, to the investment community, the stock looked to be a winner and as a result several high profile emerging market funds added the stock and helped push the valuation to about 80 times trailing earnings. Then of course the façade began to fade (particularly after the China stock market collapse in the summer). The stock was suspended and now several months later…

“The founder and chairman of Hanergy Thin Film (Li Hejun), who was once briefly crowned China’s richest man, has sold a 6% stake in his solar power group for just US$70m – valuing the company at 1/40th of the $40bn it was worth at its peak.”

RCAP files for bankruptcy; Cetera to emerge as independent company. Bruce Kelly. Investment News – Crain Communications Inc. 4 Jan. 2016.

RSC Capital Corp (RCAP) said on Monday, January 4, that it is planning on filing for Chapter 11 bankruptcy protection by the end of the month. The debt holders (Fortress Investment Group, Carlyle Investment Management, and others) will infuse $150 million of new capital and take Cetera Financial Group from the carcass and the equity holders will be wiped out. At its peak RCAP reached $39.50 a share on April 1, 2014 (assuming the current number of shares outstanding that would have implied a market cap over $3.5bn). As of January 7 the shares are trading in the OTC market at $0.0335 a share for a $3m market cap.

For a great synopsis on the rise and fall of RCAP and particularly its founder, Nick Schorsch, Bruce Kelly’s “How Nick Schorsch lost his mojo” in Investment News is a great read. In a matter of two years, Schorsch’s American Realty Capital Properties’ (ARCP) real estate portfolio went from $100 million to $21 billion (largely assisted by the related financing vehicle of RCAP). Imagine the effort of buying that much property that quickly and the prices that would have to be paid to “win” that many properties. Of course, the timing was perfect (with bottomed out pricing after the 2009 crash which subsequently rebounded meaningfully) until it wasn’t.

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Manhattan Luxury-Home Prices in a Slide, Defying Broader Market 12/24

Bloomberg – The Return of the Affordable Starter Home 12/29

Bloomberg – Landlords Face Slowing Price Gains After U.S. Records Shattered 12/30

Bloomberg – U.S. Real Estate to Draw More Foreigners in 2016, Survey Says 1/3

Contra Corner – The Next Big Short: Jeff Bezos’ Brobdingnagian Bubble 12/31/15

FT – China orders SOEs to hire former soldiers 12/28

FT – Sydney property: pride or a fall 12/28

FT – Tokyo property: bargain basement 12/28

FT – Oil’s prologue likely to be a harbinger of worse things to come 1/3

FT – China’s currency remains on path to more downside 1/3

FT – Equities: And then there were nine 1/3

FT – Venezuela central bank curbs fuel fears over hyperinflation 1/5

FT – First WiFi kiosks set to land on New York’s streets 1/5

FT – Why global economic disaster is an unlikely event 1/5

FT – China to extend temporary share-sale ban to calm markets 1/6

Investment News – RCAP files for bankruptcy; Cetera to emerge as independent company 1/4

Mauldin Economics: Cubicle Hell Warning Signs Scream “Recession” 1/5/16

NYT – When a Unicorn Start-Up Stumbles, Its Employees Get Hurt 12/23

NYT – Private Capital Fund-Raising Goal Rises to a Record $946 Billion 1/6

WSJ – After a Down 2015, Real-Estate Stocks Hope for Savior in Indexes 12/29

WSJ – Fannie and Freddie Give Birth to New Mortgage Bond 12/29

WSJ – What Happens When Japan’s Central Bank Runs Out of Bonds to Buy? 12/30

WSJ – China’s Stock-Market Interventions Postpone Grim Reality 1/5

WSJ – Apple Scales Back Orders for Its iPhones 1/5

WSJ – Why Odds Are Long for Macau Recovery 1/6

WSJ – China’s Shortest Day Will Prolong the Pain 1/7

WSJ – Norway’s Oil Fund Is Finding it Hard to Spend $6 Billion 1/7

Special Reports

December 11, 2015December 11, 2015

December 4 – December 10, 2015

Negative corporate outlooks in light of commodity woes, debt downgrades, and declining global GDP. Oil and gas shake down. It seems that the natural cycle of things is that the new/upcoming global hegemon exploit its former developing nation peers.

Before I focus on what I perceive to be the main themes from the week, I want to draw special attention to a few of the “Other Interesting Articles” at the bottom of the post.

Several large Chinese insurance companies are buying large and controlling stakes in public Chinese real estate development companies (WSJ: Why China’s Insurers Are Bidding Up Property Stocks 12/9) – prior to 2010 they were not allowed to own property assets. Unlike many insurers in Western markets that take debt positions or will buy properties outright due to their risk-averse nature, these insurers are buying direct stakes in speculative developers at heightened stock market valuations (largely due to the bidding among insurers) at time when there is an oversupply of product in the market.
Thought your home interest rate was low, imagine being paid to borrow. That’s the situation that many Dutch are finding themselves in (those with floating rate mortgages – very common in Europe). WSJ: Less Than Zero – Living With Negative Interest Rates 12/8.
If you’re in real estate, check out this article (The Real Deal: Can Blackstone’s real estate business keep growing? 8/26) from August that I just came across. Note the comment about the lack of margins in the net lease business, especially with interest rates likely to increase (really these investments are macro positions on the direction of cap rates considering you have very minimal control over the income). Related to this, see a post in ValueWalk about Kyle Bass accusing United Development Funding (a public non-traded mortgage REIT) as a Ponzi scheme, and comments in general about the public non-traded REIT sector.
As a compliment to one of the themes from this week, The Economist put out “Pipelines in America – Running on empty” highlighting that the mid-stream model is not as secure as many believe, which of course led to Kinder Morgan (one of the leaders in the pipeline business) to cut its dividend by 75% this week (see the Lex Column in The Financial Times “Kinder Morgan – plus ça change”).

On to the three overarching themes that will pull in a number of articles. First a continued decline in corporate growth prospects has now led to two venerable companies (DuPont and Dow Chemical) merging, see Dennis Berman’s “Dow-DuPont Merger – Better Living Through Layoffs” in The Wall Street Journal. Further continued corporate debt downgrades have resulted in there being only three US companies with a AAA credit rating, see Eric Platt’s “Corporate debt downgrades hit $1tn worth of issues” in The Financial Times, which of course due to the commodities slump (see Clifford Krauss and Ian Austen’s “If It Owns a Well or a Mine, It’s Probably in Trouble” in The New York Times) has one of the three – ExxonMobil – being reviewed for a possible downgrade. Second just how bad is it in the oil and gas business…Asjylyn Loder’s “Billions of Barrels of Oil Vanish in a Puff of Accounting Smoke” in BloombergBusiness points to the coming reckoning in how oil companies recognize reserves on their books. Third is an article (“In Nigeria, Chinese Investment Comes With a Downside”) by Keith Bradsher and Adam Nossiter in The International New York Times that points to the double edge sword that is globalization.

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

Dow-DuPont Merger – Better Living Through Layoffs. Dennis Berman. The Wall Street Journal. 9 Dec. 2015.

In this article Berman aptly describes this merger and the many that have preceded it this year as “An America playing not to lose.” For three main reasons:

“The economy at large isn’t producing enough growth to keep stockholders content. For the largest companies – who are more or less indexed directly to U.S. and global growth – there is little they can do but keep cutting costs. Eventually, this takes the form of mergers, and 2015 has produced over $4 trillion of transactions. The vast majority of them are ‘in industry,’ which is banker-ese for cost cutting exercises.”
Activist investors… they have forced boards into an intellectual sameness, and certainly a fear of reproach.”
American companies are concerned by the likes of Huawei, Haier, Xiaomi, and others.

“And then perhaps the final, creeping fear: If the likes of Pfizer Inc., Anheuser-Busch, DuPont, UnitedHealth Group Inc. and American Airlines Group Inc. have lost faith in the future, why should we feel any different?”

Corporate debt downgrades hit $1tn worth of issues. Eric Platt. The Financial Times. 4 Dec. 2015.

“More than $1tn in US corporate debt has been downgraded this year as defaults climb to post-crisis highs, underlining investor fears that the credit cycle has entered its final innings.”

“S&P has cut its ratings on US bonds worth $1.04tn in the first 11 months of the year, a 72% jump from the entirety of 2014. In contrast, upgrades have fallen to less than $500bn, more than a third below last year’s total.” S&P has more than 300 US companies on review for downgrade.

Basically, “The Fed’s quantitative easing program helped to defer a default cycle and with the Fed poised to increase rates, that may be about to change.” – Bonnie Baha, head of global developed credit at DoubleLine Capital.

“Some 102 companies have defaulted since the year’s start, including 63 in the US. Only three companies in the country have retained a coveted triple A rating: ExxonMobil, Johnson & Johnson, and Microsoft, with the oil major on review for a possible downgrade.“ Keep in mind that in 2010 there were over 20, over 40 in 2009, and close to 80 in 2000.

Then of course the Third Avenue Focused Credit Fund has just blocked the remainder of its investors from redeeming their money. As David Reilly of The Wall Street Journal aptly put it “canary in the high-yield coal mine or an isolated blowup?”

If It Owns a Well or a Mine, It’s Probably in Trouble. Clifford Krauss and Ian Austen. The New York Times. 8 Dec. 2015.

“Nearly 1,200 oil rigs, or two-thirds of the American total, have been decommissioned since late last year. More than 250,000 workers in the oil and gas industry worldwide have been laid off, with more than a third coming in the United States.”

International mining company Anglo American is cutting its workforce by 60%. “In July, the company outlined plans to cut 53,000 jobs after reporting a loss of $3 billion for the first half of the year. Now, Anglo American plans to reduce its current work force of 135,000 to 50,000 employees.”

“Even with prices falling rapidly, American oil production has only declined to 9.2 million barrels a day, from a record high of 9.6 million barrels a day in June.”

“Many international oil projects have been canceled and production should fall more rapidly next year. But it probably won’t be quickly enough to stabilize prices. That is because companies are getting more production out of their investments as efficiency has improved. And some need to keep producing to keep up with their debt payments.”

Billions of Barrels of Oil Vanish in a Puff of Accounting Smoke. Asjylyn Loder. BloombergBusiness. 9 Dec. 2015.

“In an instant, Chesapeake Energy Corp. will erase the equivalent of 1.1 billion barrels of oil from its books.”

“Companies such as Chesapeake, founded by fracking pioneer Aubrey McClendon, pushed the Securities and Exchange Commission for an accounting change in 2009 that made it easier to claim reserves from wells that wouldn’t be drilled for years. Inventories almost doubled and investors poured money into the shale boom, enticed by near-bottomless prospects.

But the rule has a catch. It requires that the undrilled wells be profitable at a price determined by an SEC formula, and they must be drilled within five years.“

“The reckoning is coming in the next few months, when the companies report 2015 figures.”

“There was too much optimism built into their forecasts,” said David Hughes, a fellow at the Post Carbon Institute and formerly a scientist with the Geological Survey of Canada. “It was a great game while it lasted.”

The rule change will cut Chesapeake’s inventory by 45%. Denver-based Bill Barrett Corp. will lose as much as 40%. Houston-based Oasis Petroleum Inc. will lose as much as 33%.

“Drillers met the rule’s profitability provision last year due to a quirk in the SEC’s pricing formula. The agency’s yardstick is an average of the prices on the first day of each month during the calendar year. The price came to $95 a barrel at the end of 2014, even though oil was trading below $50 by the time the companies reported reserves in February and March. The 2015 average, including the Dec. 1 price, comes out to $51 a barrel.”

“Writedowns, which are reported on a quarterly basis, point to sizable revisions. The 61 companies in the Bloomberg North American Independent Explorers and Producers index have announced impairments of $143.8 billion in the past year.”

“Some of the wells may never be drilled, while others may return to inventories if prices rise.”

“The question is, how are these reserves going to come back?” said Subash Chandra, an energy analyst with Guggenheim Securities in New York. “Because if you have to spend within cash flow, those reserves aren’t coming back. Not unless we get a spike in prices, or we return to levered growth.”

In Nigeria, Chinese Investment Comes With a Downside. Keith Bradsher & Adam Nossiter. The International New York Times. 5 Dec. 2015.

Don’t misunderstand, China is not unique in seeking to capitalize on the natural resources of developing countries while also creating new markets for its national companies to sell their wares and to build infrastructure – in effect sending its capital infusions back home. Great Britain and the United States are old hands at this game as are many others. What’s interesting is how aggressively China has stepped into the void when others have pulled back.

“President Xi Jinping of China, who was in Africa this week emphasizing economic diplomacy, just committed $60bn in development assistance to the Continent.”

However, Africa is not a place for the faint of heart.

“Nigeria endured coups and a civil war in the 1960s, then effectively nationalized many foreign-owned companies in the 1970s. Nigeria developed a reputation for breaking or renegotiating contracts, antagonizing many foreign partners.

The risks have prompted Western companies to demand very fat profits before putting money into the country – returns on the order of 25 to 40% a year. Their Chinese counterparts have been willing to accept 10% or less.”

Doesn’t mean the risk has gone away – rather it is more likely that they have increased.

“Mostly state-owned Chinese construction companies have started $24.6bn worth of projects since 2005, the highest of anywhere in the world, according to American Enterprise Institute.”

“A little-known Chinese government agency, Sinosure, has guaranteed the loans. Sinosure insured $427bn worth of Chinese exports and overseas construction projects around the world in 2013, the most recent year available. The Export-Import Bank of the United States, by comparison, issued just $5bn worth of credit in each of the last two years.”

Yes, the Export-Import Bank lost its funding briefly in 2015 (which has since been restored), but the magnitude in contribution differences in meaningful. Further, China has to be wary of Africa’s bite.

In Nigeria (the largest economy in the continent) “Government revenue has dropped by more than half since the fall in world oil prices, so the country may not have the money to make good on the Chinese deals.”

Other Interesting Articles

The Economist

A Wealth of Common Sense: What Happens When There Are Fewer Suckers at the Poker Table? 12/3

BloombergBusiness: Manhattan Apartment Vacancies Rise to the Highest in Nine Years 12/9

BloombergBusiness: Here’s How Much the U.S. Middle Class has Changed in 45 Years 12/10

FT: The fall and rise of technology juggernauts 12/3

FT: Losses mount in China’s overcrowded steel sector 12/4

FT: Sovereign wealth funds withdraw $19bn from asset managers 12/6

FT: China working age population ‘to fall 10% by 2040’ 12/9

FT: Kinder Morgan – plus ça change 12/9

GlobeSt.: REITs Prefer Asset Sales to Stock Issues 12/8

NYT: Beijing, With Red Alert for Smog in Full Force, Closes Schools and Limits Traffic 12/8

NYT: Chinese Glacier’s Retreat Signals Trouble for Asian Water Supply 12/8

NYT: High-Yield Fund Blocks Investor Withdrawals 12/10

The Real Deal: Can Blackstone’s real estate business keep growing? 8/26

WSJ: Surprise – Your Life-Insurance Rates Are Going Up 12/4

WSJ: China’s Reserves: Blink and Miss It 12/7

WSJ: Where Rich Chinese Are Stashing Their Cash – America’s Hotels and Strip Malls 12/8

WSJ: Less Than Zero – Living With Negative Interest Rates 12/8

WSJ: Chanel Pays Record Price for Retail Space 12/8

WSJ: World’s Biggest Wealth Fund Given Property Push 12/8

WSJ: China Economy – Easing Cycle Keeps on Spinning 12/9

WSJ: Why China’s Insurers Are Bidding Up Property Stocks 12/9

WSJ: Junkyard Dog: How Oil-Fueled Debt Caught Up With Chesapeake 12/10

November 27, 2015

November 20 – November 26, 2015

Time to load up on Emerging Market equities? Are you aware of the global demographic trends…

Happy Thanksgiving! This week I’m only going to cover two articles. First was an article discussing whether or not now is the time to get back into emerging market equities by Steve Johnson in The Financial Times “Emerging market equity valuations slide to record low,” and second and of more importance was ““How Demographics Rule the Global Economy”” by Greg Ip in The Wall Street Journal as part of its multimedia 2050 Demographic Destiny collection of articles this week.

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

Emerging market equity valuations slide to record low. Steve Johnson. The Financial Times. 19 Nov. 2015.

So the saying goes, when there is blood in the street buy real estate… essentially, the simple (yet emotionally challenging) formula of buy low and sell high. Therefore, now that emerging markets (EMs) have taken a beating, is it time to load up?

“Emerging market equities have delivered a total return of minus 2.1% since the start of 2010, compared with the 69.1% return of developed markets.”

“The latest leg of correction leaves emerging markets as the unambiguously cheap segment of global equity on a fundamental basis [but], with the exception of Russia, valuations simply haven’t become cheap enough,” says George Iwanicki, emerging market macro strategist at JPMorgan AM.”

“The MSCI Emerging Markets Index fell to a valuation of just 12.8 times 10-year average earnings at the end of September, according to calculations by JPMorgan AM, taking it below the previous nadir of 13.5 times during the 1997-1998 Asian financial crisis.”

“The cyclically adjusted price-to-earnings multiple is now barely half its long-term average of 25 times average 10-year earnings.”

“In contrast, the US S&P 500 index is trading at 23.4 times cyclically adjusted earnings, within a whisker of its long-term average of 23.6. The MSCI Europe Index is at 15.1, against an average of 20.6.”

However, “…emerging market earnings have been elevated for much of the current millennium by high commodity prices and rapid growth in both China and global trade.”

Seemingly it would be a good time to jump in, but…

“The asset class is currently trading on a multiple of 1.43 times book value… While this is below the long-run average of 1.8 times, it is above both the cyclical low of 1.28, recorded in late August, and the all-time low of 0.94 in August 1998.”

Basically, give it a little more time and no matter what, make sure you have the stomach for it.

How Demographics Rule the Global Economy. Greg Ip. The Wall Street Journal. 22 Nov. 2015.

One of the most powerful immutable forces in our world is demographics, importantly demographics shape trends…

“Next year, the world’s advanced economies will reach a critical milestone. For the first time since 1950, their combined working-age population will decline, according to United Nations projections, and by 2050 it will shrink 5%. The ranks of workers will also fall in key emerging markets, such as China and Russia. At the same time the share of these countries’ population over 65 will skyrocket.”

“Previous generations fretted about the world having too many people. Today’s problem is too few.”

“This reflects two long-established trends: lengthening lifespans and declining fertility. Yet many of the economic consequences are only now apparent. Simply put, companies are running out of workers, customers or both. In either case, economic growth suffers. As a population ages, what people buy also changes, shifting more demand toward services such as health care and away from durable goods such as cars.”

“Demographic forces are assumed to be slow-moving and predictable. By historical standards, though, these aren’t, says Amlan Roy, a demographic expert at Credit Suisse. They are ‘dramatic and unprecedented,” he says, noting it took 80 years for the U.S. median age to rise seven years, to 30, by 1980, and just 34 more to climb another eight, to 38.“

“By 2050, the world’s population will have grown 32%, but the working-age population (15 to 64 years old) will expand just 26%.

Among advanced countries, the working-age population will shrink 26% in South Korea, 28% in Japan, and 23% in both Germany and Italy, according to the U.N. For middle-income countries it will rise 23%, led by India at 33%. But Brazil’s will edge up just 3% while Russia’s and China’s will contract 21%.”

This will only compound pension and social security obligations…

“Among rich countries, the U.S. remains demographically fortunate: Its working-age population should grow 10% by 2050. But it will still shrink as a share of total population from 66% to 60%. The demographic drag on growth, in other words, will last decades.”

“In 2008, the same year Lehman Brothers failed, the first baby boomers qualified for Social Security, and since then, the number of beneficiaries has ballooned, from 41.4 million to 49 million.”

We are going to have to become a whole lot more productive to achieve GDP growth.

Lastly, while I’m not going to go into this article in detail, Ezra Fieser’s “The Town Viagra Built Tries to Move On” in Bloomberg Businessweek provides an example of whether it is better to have a short-term infusion of success/cash – that should theoretically leave you better off – or to never have had it at all…

Other Interesting Articles

Bloomberg Businessweek