Wednesday, 27 November 2013

When someone robs you it can take a while to get back into things . . . .

It's taken me a week to get things back into shape since my home was burgled. During that time we've had the usual avalanche of verbal prognostications from Washington. Ben Bernanke once again managed to have the economic cognoscenti tripping over themselves trying to pick the next move of the Fed. Of course what we all know now is the Fed is quite simply on hold until early 2014. That leaves markets with little to do but to continue an upward move until told otherwise. We are now entering a very dangerous phase in the current bubble and it's worth looking at a few things.

This week's housing numbers from the US should help the Fed move on at the appropriate time from QE-infinity.  The S&P/Case-Shiller Home Price index showed a move up by 13.3% from a year earlier. Building permits in U.S. were up  6.2% in October to five-year high.

Housing, along with employment is central to the Fed starting to taper. Investors need to keep an eye on Case Schiller as it's my belief any weakness will be jumped on by the uber-doves at the Fed to backslide. 

On another matter investors need to note that volatility is extremely low. This blog remains of the view that we are currently seeing a a good short term buying opportunity in volatility indices. Take for example the Eurostoxx VIX and the S&P500 VIX:

Both of these indices remain at multi year lows due to the fact that the Fed and ECB basically limit their ability to move higher for extended periods by effectively selling a free put to the market via QE. Thus every time the markets try to move down a wall of money dampens the effect. If you believe that QE in the US gets scaled or tapered in (say) March one could expect the breadth of the markets moves to increase and with it volatility.

This blog likes to go back to basics when inflexion points, such as a Fed taper seem to be getting closer. Below is a chart of the S&P500 v. the Put/Call ratio on the CBOE. The thing to note is that although there was a blip up last week in the ratio indicating that there were investors in the market looking to buy protection for their portfolios. The converse is that said ratio remains reasonably low and indicates to me investors are almost "sleep-walking" their way to record highs. This of course spells danger; if not for the implicit "Bernanke Put" an move downward would be magnified. Investors should keep a close watch on this ratio, noting that the lower the ratio moves indicates the greater the complacency in the market in respect to the current market levels.

A friend called me earlier today to say he was looking at a retailing opportunity in the bicycle space. He's a pretty dry character when it comes to due diligence and therefore is far better qualified to look at the sector then someone like me who's passionate about the sport. I gave him my general views about shops and retailers I've dealt with. Both of us agreed that in terms of time v. cost there's something missing in the bike servicing area. As I said recently I've never felt like I've been over-charged by a bike shop for a service. It seems ludicrous to me that somewhere between $80 - 100 gets you a good service that usually gets you on the road without any problems, which I consider to be a bargain now days. Add to this the fact there's a shortage of bike mechanics and you wonder why the price point isn't under more upward pressure. It all reminds me of the growth in high end watches and the restricting factor that is the lack of watch makers. As an example Rolex actually started an academy system in the US where they helped graduates setup shops. They literally trained you and wrote you a cheque knowing that if they couldn't meet the servicing demand consumers would drift away to cheaper more easily maintained time pieces. Perhaps we'll see the major manufacturers of bikes do the same thing? Think about it this way; you hand over your $3000  for a mid-range carbon frames bike. The experience is great until you hear a click in the bottom bracket or have a derailleur that gets out tune. If the mechanic you take it to doesn't fix it you start to think this bicycling thing is nuts . . . the result is one expensive dust catcher in the garage.

My Cannondale has been making some odd noises. The most obvious adjustment has been the headset. Readers will know that I've always had the odd issue with headsets and find the lack of science involved with adjusting them to be somewhat puzzling, especially because carbon framed bikes are quite precise in terms of the distribution of forces within the components and frame. In my case I've tightened the headset cap in the usual manner; try an eighth of a turn, ride, test and adjust again. Here's video from GCN showing how to adjust the cockpit on a carbon framed bike:

The thing to note here is the way he tightens the various bolts a little at a time so as to not focus all the forces on one small area. You see most of these type of components work to spread the load across the frame etc. Also note the use of a proper torque wrench. I've said it before, but it's worth repeating . . . buy a torque wrench and don't try and skimp on the cost. A$200 wrench will save a $4000 frame etc. You have been warned.


Friday, 15 November 2013

It's only deflation if you don't have money to spend . . . fancy 138km's on a bike?

James Hardie is an Australian building materials company that got into a lot of trouble locally due to asbestos content in some of their products. Now after many years of litigation and struggling against the tide of a slowing housing market globally the company yesterday surprised the ASX when it announced an operating profit of $US108.3 million ($115.9 million) for the six months to September 30, up from $US56.3 million a year earlier. This excludes asbestos, regulatory and liability adjustments, which would put its profit higher at $US194.1 million. It has upgraded its full-year earnings target to between $US180 million and $US195 million. Why do I mention this? Well, Hardie's is predominantly a US housing play now days and for a management team so bearish on the world in general it must be a huge signal that for the first time in many years they are investing in new capacity in the US. Investors know that this blog has for sometime been positive on America, but a data point such as this is good news all around.

Investors should now revisit stocks such as Toll Brothers the upmarket home builder if they wish to leverage this recovery to it's maximum:

"Six years of pent-up demand is just beginning to return to the market," Chief Executive Douglas Yearley said on a call with analysts to discuss the preliminary results.

Toll has underperformed the S&P500 year to date, but is starting to gain momentum. The company is expecting a 65 percent jump in revenue in its just-ended fourth quarter (taking it across the $1 billon threshold for the first time since 2007) and also reported a preliminary 6 percent rise in orders. David Crowe, chief economist at the National Association of Homebuilders, said 12 percent of houses sold in the United States this year to date cost $750,000 or more. Last year, the number was 9 percent. Toll Brothers said it expected its average selling price to have risen 21 percent to $703,000 in the three months to Oct. 31 meaning they are now in the sweet spot. 

If Toll brothers and Hardie is telling you demand exists in the worlds biggest economy, what then does the fact that Global gold demand fell to a four-year low in the third quarter tell us? Certainly it implies that inflationary expectations are low at the moment.

Gold demand was 869 tonnes between July and September, according to data published by the World Gold Council. There was a collapse in demand from India, traditionally the world’s largest consumer of gold (likely to now be overtaken by China) due to a series of government restrictions on gold imports. Said imports fell 32 per cent over the quarter to just 148 tonnes, the lowest since early 2009. Indians hold over 1trn in gold currently and it basically sits in banks and temples gathering dust. The problem is that the Indian currency has been under pressure, which forces up the prices of imports (especially energy), draining the governments reserves due to their subsidising of key fuels. The more gold they import, the more INR has to be sold to pay for it and the greater the pressure on the central government.

This is a problem for investors in all emerging markets. The gold restrictions demonstrate the ability of governments to legislate you out of returns. For example, being short INR is no longer an easy position to hold when the government takes this sort of action. Of course for India it may end up being a good thing. India is not in the same league in terms of exports as China, rather it's about demand and a low INR and middling growth is not going to help the world economy. If India could unleash a third of it's gold reserves this blog is of the view that Asia as a whole would benefit considerably. Investors should watch this situation closely.

As it's Friday and this is a short end of week blog I want to mention that a friend of mine has reminded me about the Orica-Greenedge Winery Ride on December 1st at Mitchelton Vineyard in norther Victoria. I looked up last years event on Strava and looks to be around 1500m of climbing in one big block. Other than that it's flat and should be fun.

I'd like to do it, but it's one long drive to get there and at this late stage it's a bit hard to get a partner. One thing I learnt about riding sportives in Australia when I went to the Wiggle Classic in the Hunter that the riders don't seem patient or organised enough to form mini pelotons and help each other as they do in Italy and Switzerland. People are friendly, but the mass ride thing is still reasonably new to the great majority of riders here, so I guess that will change over time.


Tuesday, 12 November 2013

Surprised and robbed . . .

Surprised . . . Last Friday the US non-farm payrolls surprised observers by coming in at at positive 204,000. Surprisingly, given recent history, markets rallied by 1% giving this blogger pause for thought. When did good news become good news again? It seems that for the past few years good news was bad, because any good news was treated as a possible trigger for the Fed to ease their $85bn a month in asset purchases. The conviction of this blog remains that tapering is unlikely to happen before December 17, which readers will know was a crucial date to get the US budget crisis back on track. If the Fed sees another stalemate in these talks they are unlikely to withdraw stimulus. Having said that, the market is now leaping forward and suggesting that the political polls are now so skewed against the recent political wars that the various arms of the US government have little or no room to restart the shenanigans of the past and therefore will rollover on much that was disputed.

Where are we now then? Well there has to be a suggestion that markets are anticipating the coming normalcy in monetary policy and are reverting to a time when good news was indeed good news. The dollar should be investors flashlight in a dark tunnel. The recent rate cut by the ECB (also a surprise) will weaken the EURUSD and add to a strengthening trend. For stocks, we may have to rethink allocation in that if good news becomes "good news" again it is likely that the cyclicals will start to revalue in investors portfolios which are currently dominated by the financials and defensive dividend yield stocks.

Robbed . . .

On Saturday I took off for my usual early morning ride aboard the Evo and returned to a house that had been broken into. My car was missing and so were the keys. The thieves had gotten into the house and stolen my wife's bag. We found the car dumped not far away with the sunroof open and the glove box contents tipped out in the front seat. It would seem that the thieves had second thoughts about the car and instead were happy with 300 bucks in cash and some smaller items. Oh, they scratched the drivers side doors and kept the keys meaning we have to have the car locks all changed etc. The police were good about the whole thing and even dusted the house and car for finger prints. Thankfully my wife who was in the house at the time was untouched . . . and that's the most important thing. They could have taken a stack of other stuff for all I could care so long as they didn't hurt her. 

Surprised II . . . 

At the end of calendar year Q1 this blog posed the question: Is the Commonwealth Bank of Australia the best bank in the world? Last week CBA was the last of the Australian major banks to report and it once again surprised the market with its' result. The bank earned AUD2.1bn in the quarter,, which is up 14%. That's a massive number in such an economy as Australia's where there's very little to distinguish between the majors. The only thing that worries me is that loan loss charges for the quarter were significantly lower, down 22% to $228 million. Now the bulls suggest this is because much of the provisioning that went on in the 2008 - 10 period is now being written back via reclassification. That may or may not be valid. Rumours are flying that the banks of late have reduced their standards for new credit applicants. Given the heat in the Australian property market at the moment I hope that this remains just a rumour. I have no concrete numbers that backs this up except for the expansion in the banks loan books. 

The continuing reliance of the Australian economy on China is the biggest problem that the local banks face in ensuring their latest foray into the market for home loans doesn't go array. There must have been some nervousness in Aussie boardrooms when it started to leak that China will cut its growth target to 7% next year. The clearest sign that the government there means business came on Monday (as reported in the FT), when it was revealed that banks issued Rmb506bn ($83bn) in new loans in October, down from September’s Rmb787bn. New credit issuance, including China’s "shadow banks", was also much lower in October, falling to Rmb856bn from September’s Rmb1.4tn.
If this keeps up then China will indeed have to lower growth targets to 7% or even less. Then what will happen in Australia. Once again Investors need to watch the iron ore price.

Iron ore was trading at $136 a ton in China on Monday. Singapore based trading House Noble group expects that to fall to just under $100 a ton. If that happens the effect on the Aussie Dollar should be to push it down towards USD0.85, which has been my target since the start of the year. 

Putting all this together investors in Australian mining stocks as part of a broader cyclical switch will be hoping that US strength in the coming year will stabilise China and with it cushion any falls in commodities. Of course the one thing this blog knows for certain about commodities is that they over-shoot on both the upside and the downside, so expecting a non-non-volitile goldilocks scenario might be a little too much.


Monday, 4 November 2013

Conferencing . . .

Firstly apologies for not blogging last week. I was lucky enough to attend a conference dealing with the family office (FO) sector here in Australia. Normally I find conferences a bit dry as people tend to be pushing a very specific idea and often a very specific set of products off the back of it. In the case of last weeks gathering I was happily surprised by the fact that the conference stayed away from specific  investment structures and rather just took the view that financial, legal and accounting professionals needed a bit of education in respect of FO's and how they expect to be dealt with.

The one word I came away from with respect to these institutions (and the size and age of these offices really does mean that they are institutions) was patience. If you expect a family office to react to your first suggestion or idea you'll probably be disappointed. I was speaking to one senior advisor about my frustrations in respect of my push to get some investors together to do the due diligence on the Commerzbank London / SE UK property portfolio sale earlier this year. In my usual fashion I went through my investment case, not as a pitch, but rather in an effort to work out what I'd done wrong. The truth was I hadn't done anything wrong, I just didn't have a deep enough relationship to be given the benefit of the doubt. The idea was solid and the numbers made sense, but probably needed to be part of my own personal portfolio for a longer period. Perhaps I could track a couple of buildings within the group and show how things progressed? You see it's a long term thing and without a track record in this specific field my ability to action the advice would be limited. You live and learn.

I also realise now that many investment banks and even private banks have not really worked out how to best service family offices. The main problem with IB's and PB's is that they drive their efficiencies through an economy of scale. That's very good when dealing with institutions used to combing the markets for opportunities and disparities in valuations etc.. FO's don't have desks of traders or even teams of investment bankers with the time or the inclination to look at every prospectus that they get in their email daily. They rely on a true bespoke service, not a fake one. Some of the most up-market mens retailers offer a bespoke tailoring service, but it's not bespoke in the sense that you might get from establishment that measures you for a suit and has you back 4 or 5 times before finalising your suit. Most of the fashion houses now have their staff decide a base size and then provide the variation to the computer cutting pattern. It's like the banker who has one presentation and merely changes the name of the client on the title page; it's superficial and if it's not updated and recast enough the client starts to work out that they are at the other end of a long chain. Well thats what you can't do with FO's. The cost of dealing with FO's isn't the value of the due diligence put into valuing and packaging an asset, it's in the time taken to understand that things need to be built up over many months and years.

Talking with the various professionals at the conference also told me that hard assets were still the main focus of the very wealthy. It seems that the FO's suffered along with the rest of the financial sector during the economic crisis of 08-09. Securitized structures obviously had cost many time, money and stress. Real estate seems to remain in play with many I spoke to happy to put funds into direct ownership or even slightly subordinated mortgages. This later point surprised me, though 2nd mortgages are better in terms of recoverability than some MBS type paper by virtue of being more nimble to action. A yield pick-up of a couple of hundred basis points probably makes sense where the FO knows the market in question. And that's another good example for an advisor to consider. I now know that offering a Melbourne based FO the chance to invest in second mortgages in (say) Chicago probably won't win me any kudos, whereas a direct investment by way of a property easily valued and financeable is, while still not easy, at least palatable the basis for a broader conversation on asset purchases.

Since 2008 anyone seeking finance for their ideas has had a tough time sourcing funds through the old channels of banks and finance companies. Now without a risk taking mentality at the various traditional sources the valuation gap between buyers and sellers has grown ever wider. This enables the cash rich non-traditional financiers and investors to involve themselves where formerly they would have had to participate further down the capital structure. At the moment the mining and resource sector is out of favour because of the perceived risks in the economies of the main users (i.e China). According to E&Y Consultants a total of 165 deals worth only $8bn were completed in the three months to September, down from 236 deals worth $20bn in the same period a year ago. So where does that leave investors? The gap cannot continue to stay open and I suspect that the usual suspects of private equity and FO's will step in to take up the difference. That's especially truee given the hurdle rate for returns is low and likely to stay low for some time, in fact even if the hurdle rate (ie. government interest rates) starts to tick up investors in these economically sensitive industries are likely to generate considerable positive alpha.

This blog remains of the view that equities will continue to outperform cash for one very bad reason: money is cheaper than return on equity. In my last posting I pointed out that the corporate profit season in the US had seen profits in the S&P500 up only 4.9% year on year (ex-JPM litigation charge), but of course when compared to short-end cash returns this seems like a good risk. The most likely inflexion point now seems to be in March once we've negotiated yet another series of US debt ceiling and budgetary talks.

As many readers would appreciate I have little outright love for the valuations of Australian banks. The risk of buying something on around 1.8x tangible book v. an Australian Dollar dividend yield of 200or so bps over the applicable government debt is perhaps not enough at this stage in the cycle. I will be looking at a full review of the Australian banks at the end of this week. I am still suggesting to local investors to diversify into European banks to best leverage the recovery there.

As far as cycling goes I've pretty much been taking a low key approach since the Hunter Valley expedition a couple of weeks back. Since the Cannondale has been out of service I've been relying on my old friend the Pinarello Dogma 60.1. To spice things up I've been changing around wheels at fairly short intervals. It's interesting to do this as you definitely start to get a greater sense of the strengths and weaknesses of your frame. Trey getting some different wheels and see what I mean.

I'm strictly a road cyclist these days, but occasionally I see something that amazes me from across the divide in the mountain biking world:

I'm not saying I want to start riding around Chile on a mountain bike, but after seeing this it certainly seems like a lot more fun than some of the streets around Sydney.