The Daily Reckoning January 31st
Markets never stand still. So observes Daily Reckoning favorite, Chris Mayer, in his essay “Ireland On Sale”.
But why is this so? Why are markets always in such a hurry to go somewhere…and to where is it they are so briskly headed? That’s what investors want to know. Well, most of them, anyway.
At this very moment in time, the US stock market, as measured by the broad S&P 500 index, sits at multi-year highs. On the very crest of the wave. Not since the cowabunga days of late 2007 were stocks this expensive. The melt-up has been tremendous, no doubt about it. Indeed, provided the wheels don’t fall off today, you’d have to go back to the late 1980s to find a better performing January for Standard & Poor’s favorite 500 stocks. That’s pretty impressive stuff…even to an enthusiastically ambivalent newsletter editor.
Of course, nobody wants to know about the past. To the average man on the street, it’s the future that holds the real opportunities…the good decisions…his hopes and dreams…and the big money that comes with “getting it right.” The past has come and gone, he reasons. “Full steam ahead!”
Plenty are the folk who see redemption in the morrow. The future brings with it a chance to atone for the folly of yesterday, correct for the mistakes of the past, regain the losses of last quarter, last year…last decade and more. People don’t want to rehash old trifles, to resurrect sore memories. Time marches in one direction only and, as they say, time is money.
But there are no clues to be found examining the future. It is empty space. Vacant. Unoccupied. And it is untraveled. We can make predictions and forecasts, talk about “future earnings” and “projected profits,” we can extrapolate trends out to infinity and beyond. Still, nothing is confirmed until the rent is paid and the profits are earned…until the future becomes the present and the present has faded into the days of old.
And so it is on the past, that ramshackle literary concoction of rumor, hearsay and conjecture, that we are left to concentrate our efforts.
“Every saint has a past,” quipped that great Irish wit, Oscar Wilde, “just as every sinner has a future.”
Unfortunately for us, yesterdays can be almost as difficult (virtually impossible) to navigate as tomorrows (totally impossible). History is a vast expanse, offering the casual tourist plenty of chances to get lost. Moreover, we humans are prone to all kinds of quirky biases. How can we be sure, for example, that we’re not gathering up the wrong information? (Selection bias.) Or that we’re not just seeing what we wish to see? (Confirmation bias.) Or that we haven’t mixed up causal relationships, mistakenly attributing some occurrence or another to a cause other than its own. (Epiphenomenalism.)
We have to take history with a grain of salt. Nobody sees it coming.
One helpful thing we can notice about the past, however, is that it contains things that won’t be — and cannot be — in the future. At least not in the same way. Twenty-one year old Joel Bowman will not be composing tomorrow’s Daily Reckoning — a good thing for you, perhaps…not so good for us. That youthful editor resides in the (fast-escaping) past.
Another example, this time to do with economics: Let’s say that you bought a watch last week. You cannot go to the store tomorrow and buy the exact same watch. You can buy another just like it…but not the same one…and not with the same money. The cash was spent. Transaction recorded. Units logged. So too have the hours of workmanship that went into making the watch been used up. The energy was expended. And now it’s gone. Provided you bought a watch of reasonable durability, you won’t be buying a new one, a replacement, for some time. (Until it breaks…or you lose it.)
Now let’s say you bought that watch on credit. You’ve borrowed from the future in order to “wear the time” on your wrist today. Instead of using that money tomorrow, you’ve brought it forward. The economic activity has been used up. Even if you could look into the future, it would be nowhere to be seen.
Fellow Reckoners can sense where we’re going with this already (even if they can’t quite see into the future).
For the past half a century or more, governments and private citizens around the world, particularly those in the West, spent an enormous amount of tomorrow’s earnings. They borrowed from the future in order to enjoy today what they might otherwise have enjoyed tomorrow. Mostly, they borrowed from the economic output of the emerging markets, countries like China and India.
Looking into the West’s recent past, we find a sixty year credit expansion. In its future, somewhere, is a corresponding gap.
Follow Joel on Twitter, right here: https://twitter
It is easy to forget just how much of a whopper Ireland’s bubble was. But my focus is on the post-crisis investment opportunities created in Ireland as a result. In short, I’m bullish on the Emerald Isle, and I have a way for you to invest there.
First, I want to give you some memorable snapshots of how crazy things got at the heights of 2006…and also in the depths of November 2010.
You may remember Michael Lewis’ story on Ireland, “When Irish Eyes Are Crying,” in Vanity Fair in March 2011. As he noted, by 2006, a fifth of the Irish workforce was building houses. The construction industry alone grew to become a quarter of the whole economy — compared with 10% for a “normal” economy.
Ireland was building half as many houses as the UK, which had 15 times more people. And the price of an average house in Dublin soared 500% from 1994 to 2006. “In parts of the city,” Lewis wrote, “rents had fallen to less than 1% of the purchase price. That is, you could rent a million-dollar home for less than $833 per month.” That’s a price-earnings ratio of 100 times on Irish homes!
When it all went bad, the rottenness was equally stunning. Anglo Irish Bank — older than Ireland itself — lost nearly half of the money it lent out, most of it to Irish property developers. In total, Anglo lent the equivalent of all its depositors’ money to Irish developers. “By 2007,” Lewis writes, “Irish banks were lending 40% more to property developers and speculators than they had to the entire Irish population seven years earlier.”
Oh, but how things change. Markets never stand still. Here is Wilbur Ross, the shrewd old investor who loves to invest in broken things on the theory that they will mend: “Ireland is a high-tech economy with noncyclical exports, good infrastructure [and] a young workforce.”
There is much to like about Ireland. And investors have swooped in to pick up bargains. Irish commercial property prices, for instance, have fallen 65% since their peak in 2007. Dublin office space now yields a relatively plump 7%, and retail space pays 6%.
The preferred way into this market is to buy bank debt from Ireland’s distressed banks. For a time, Irish banks were reluctant to shed Irish property at discounts. Instead, they sold off non-Irish property loans first. But now, they are selling Irish property aggressively. In October, Lone Star, a private equity group, picked up $600 million in loans at a 60% discount off the face value of the notes.
The biggest investor in Irish assets this year? Let the Financial Times tell it:
Kennedy Wilson, which so far is the biggest private equity investor in Irish assets, is one of several groups that invested $1.44 billion to rescue the Bank of Ireland from state control in mid-2011. It also bought the bank’s real estate investment management business, as part of a rapid expansion of its European operations.
“These deals enabled Kennedy Wilson to get under the bonnet at the bank and helped it to cherry-pick some of the best assets,” says one Dublin banker, who did not want to be named.
It is gratifying to read these stories because this is exactly what I hoped might happen when I recommended the shares of Kennedy Wilson (NYSE:KW) one year ago to the subscribers of Capital & Crisis.
The most interesting part of any cycle is the post-crisis cleanup. And that is KW’s métier in real estate. On the third-quarter call, CEO Bill McMorrow (the largest shareholder in KW), talked quite a bit about KW’s activities in Ireland. Of the $1.5 billion the company (along with KW’s equity partners) invested in the first nine months of the year, about a third of that was in Ireland.
The chart below shows the discounts some investors are getting. (KW does not usually disclose the discount it pays because, presumably, it does not want to rub it in the bankers’ faces. Discretion is part of what helps KW get in a position to cherry-pick.)
McMorrow is bullish on Ireland’s real estate market. “Even though it can get masked in this whole euro situation,” McMorrow said, “there is actually corporate growth going on in Dublin… You’ve got growing populations in confined, high barrier-to-entry markets with high-quality markets. So you are going to get rent growth.”
McMorrow points out that half of Ireland’s population is under the age of 35. And 500 US companies have their European headquarters in Ireland. “It is the only EU country, I think, that has had positive population growth in the last 10 years,” McMorrow continued. “So you are going to start seeing vacancy rates in central Dublin decline, in my opinion.”
The first office building KW bought, Brooklawn House, had a yield of a little over 14% — and that was with no debt on the property. “And to give you a frame of reference,” McMorrow added, “that Brooklawn office building sold, rightly or wrongly, to investors in 2006 for $61.5 million. We bought it for $20 million. It is all playing out, I think, just as we felt it would when Matt [Windisch, EVP of Kennedy Wilson] and I made that first trip to Dublin two years ago,” McMorrow concluded.
McMorrow has great instincts for this kind of thing. He snapped up distressed real estate in the midst of Japan’s bust…and then repeated the performance during the US bust of 2008 and 2009. I would cite his 2011 annual letter, in which he tells how he bought Kennedy Wilson in 1988 when it had 11 employees, one office in Santa Monica and a book value of $50,000. Today, KW has 23 offices and its book value is $510 million. That’s an annual growth rate of about 50%. (Keep in mind KW went public only in 2009 by acquiring a public shell.) I don’t think he’ll keep up that blistering pace of growth, but if he does even one third as well, shareholders should enjoy enviable returns.
Where is McMorrow pointing KW’s bow next? Toward Spain.
“We’ve just opened an office in Madrid that is primarily focused on the auction business,” McMorrow said. “The Spanish government has just set up an institution similar to what was set up in Ireland. It’s a liquidation entity that the government is moving banking assets into. So that may present some investment opportunities, and the Spanish banks have big exposure outside of Spain to the real estate business.”
Stay tuned to the KW story. I think it is a good one.
In 1881, Dakota Territory had never sold a bushel of wheat to anybody outside of Dakota. Six years later, it sold 62 million bushels.
I recently read Garet Garrett’s The American Story, which came out in 1955. It is a well-written history of America, unusual because of its emphasis on the powerful economics that drove the country to great heights. Garrett tells the Dakota story in this book, which is a useful reminder about how economies grow and prosper.
What happened in Dakota was that farmers invested in machinery. The riding plow, the reaper and the combine harvester made the farms far more productive than they had been. Suddenly, the labors of one man could produce 5,000 bushels of wheat. A single miller could turn that wheat into 1,000 pounds of flour.
But that was not all. New railroads connected the farmer to the mill and the mill with markets and ports in the East. The energies released were enormous. Garrett writes:
“So the labor of four men — one a farmer in Dakota, one a miller in Minneapolis and two on the railroad — plus a very low rate for ocean carriage — could put into Europe enough flour to feed 1,000 people for a year.”
Let’s look at another example: steel. In 1870, there was nothing anyone would call a steel industry in the U.S. Americans bought their steel from Europe. Yet 30 years later, Americans would produce more steel than Germany, France and England put together.
Again, the investment in machines and rail and roads unleashed a torrent of once frozen economic potential.
Those forces worked wonders as a free people tinkered, invented and created. “In sheds and attics and little machine shops everywhere,” Garrett writes, “with sticks and strings and glue and bits of metal, eccentric minds were making models of things that might work, either to save labor or to save time — two thoughts with the same meaning.”
Steam drills. Sewing machines. Electric lamps. Rotary printing presses. Cranes and elevators. Steam engines. Steel ships. Air brakes. Plumbing. Refrigeration. All of these things came in the years that followed.
Millionaires sprouted up like mushrooms. “Most of these new millionaires had come from the ground — from the mines and steel mills and oil wells and packing houses — and smelled of their work,” Garrett writes.
Wall Street financed great undertakings that would be beyond the power of five or six rich men. Huge sums of capital went toward growing the new industries. Many of the larger enterprises now had public stockholders.
The first billion-dollar company in America was United States Steel, stitched together by J.P. Morgan. It owned not only steel plants, but coal mines, limestone quarries, ships, railroads and whatever else touched on steel.
Wall Street sold it to the public for $40 per share. Then it fell to $9. But a few years later, Wall Street was buying it back from the public at $100 per share. And soon it topped $200. It was a heady, risky time. If you bought five stocks, odds were that two might go to zero. But the three, held long enough, produced fortunes.
This is the work of a free people. Testing things. Trying them out. Succeeding and failing. It is a rough laboratory from which winners and losers emerge through trial and error. It is what builds great wealth, great economies and great countries.
It is the American story of two centuries past.
While there are no virgin places for a new American story to take root, no empty continents where a people might go to try to build something from scratch, there are new versions of the American story unfolding in places likely to produce astounding wealth in similar ways.
In places like Mongolia or Myanmar, for example, you find today’s Dakota Territory. Not that Mongolians are as free as those American pioneers, but there is so much frozen potential to unlock by applying technology and know-how and capital to their situations. It’s these mind-bending changes — and the lure of profiting by them — that attract me to explore the world beyond the developed West.
Original article posted on Laissez-Faire Today
The greenback is starting to walk the plank this morning.
Now it’s only a matter of time before it breaks down and moves sharply lower. When it does, it will complete the final part of a downside move that’s been forming for the better part of the past six months…
The U.S. dollar index didn’t even come close to its July highs during its fall rally. Instead, it’s feeling out its next move lower. The breakdown zone is right near 79 — a mark that’s getting closer every day. When we do see a meaningful move below 79, the reaction is set to be a swift drop that will eventually drag the dollar down toward 2011 lows.
Of course, it doesn’t hurt that the Fed’s aggressive easing policies continue to escort the dollar lower. Just yesterday, the Fed announced it will continue its $85 billion bond-buying stimulus plan in an effort to achieve lower unemployment. Meanwhile, the dollar drops to a 13-month low against the euro, according to Bloomberg.
There are numerous technical and fundamental factors stacking up against the dollar right now. It’s time to watch these levels closely and prepare for a dollar dump…
During the current commodity supercycle, there have been occasions—too many to count—when investor psyche has been damaged by reports about slowing U.S. growth, a hard landing in China or a debt crisis in Europe. Yet just behind the gloom, significant and positive trends are taking hold, causing the storms to start dissipating.
I often say that government policies are precursors to change, which is why we follow the monetary and fiscal actions closely as they can have a significant impact on asset prices. You have to go back about 16 months when Brazil kicked off the latest global easing cycle by cutting interest rates by 50 basis points. Since then many developing countries such as the Philippines, China and Colombia, as well as developed nations of Japan, the European Central Bank, the U.S. and the U.K. have joined forces in a world-wide synchronized stimulation of the economy.
Last summer, Mario Draghi indicated that the ECB would do “whatever it takes” to save the euro. In the fall, the Federal Reserve agreed to buy $85 billion a month in Treasuries and mortgages, amounting to $1 trillion a year. And just recently, Japan announced that, in addition to pumping $1.1 trillion into the markets through 2013, the central bank will keep an open-ended approach to buying assets through 2014.
Historically, central banks’ policy actions occur after there’s been some economic deterioration. Several months later, the stimulative measures work their way through the global economy.
This has been the case with China, which has been showing remarkable improvement in its export-oriented HSBC Purchasing Managers Index. The PMI is a measure of health of companies in China, as it includes output, new orders, employment and prices across numerous sectors.
This month, the Flash PMI came in at 51.9, beating market consensus, which was at 51.7. The PMI stands at a two-year high, as you can see in the chart below.
A few months ago, when China’s improving PMI was just beginning to attract attention, I talked with Peter Gibson and Randy Cass from Canada’s Business News Network, who were skeptical of the data because of the slowdown in Europe, China’s largest trading partner. I indicated that although Europe’s deceleration negatively affected China, there were other underlying positive factors taking place. In addition to the continuous stimulus program happening in the countries, China’s new leadership had been solidified. I believed that these dynamics would help PMI accelerate and exports to pick up.
PMIs are leading indicators for global resources stocks, which have lagged over the past year. In 2012, the Morgan Stanley Commodity Related Index only increased 1.4 percent. However, this year, the index is off to an incredible start, rising 6 percent in only four weeks.
Stocks across a number of cyclical areas of the market have benefited from this global improvement, including industrial companies such as trucking, rail and airlines. Take a look below at a classic cyclical measure of the market, the Dow Jones Transportation Average, or Dow Jones Transports. The index, an average of 20 transportation companies in the U.S., reached an all-time high last week.
In addition to the synchronized stimulus driving resources, we are entering the time of year that has historically been good for energy equities. Looking at two decades of seasonal patterns of companies in the S&P 500 Energy Index, the next six months have historically been the best of the year. While energy stocks typically decline in January, they have seen positive results in February, March, April and May. July has historically been the best month for energy stocks, climbing more than 3 percent on a median return basis.
It seems clear that there are a number of investors who have gained confidence in the global economy and are seeking to capture the growth opportunities taking place around the world. With the European crisis comfortably in the rear view mirror and global central banks taking the position that they will continue their easing policies, investors have taken their foot off the brake and have begun to accelerate.
As we’ve been consistently communicating in presentations lately, we see more sunshine and less stormy weather ahead. Take advantage of these momentous and seasonal shifts and make sure you have an appropriate allocation to equities poised to benefit, such as global natural resources stocks. As a benchmark weighting for investors, the energy and materials sectors make up 15 percent of the S&P 500 Index.
A caveat to these sunnier days is the U.S. debt ceiling issue. In managing expectations going forward, we likely will see volatility not unlike the ups and downs of the last four years.
However, every dip has historically been a buying opportunity. With many investors now considering equities today, future dips are likely to be opportunities to buy as well.
Original article posted on Daily Resource Hunter
Resource Investors: Why You Can Expect Sunnier Days Ahead! appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.