Friday, August 30, 2013

Time to Buy Emerging Market Stocks?

source:  Citicorp; Financial Times

The latest weekly piece from global strategist Michael Harnett at Merrill Lynch highlights the bullish sentiment surrounding European stocks.

According to his data, European equity funds have received inflows of $12 billion over the past two months, one of the highest levels on record.This is even more impressive when you consider that the investment surge is occurring at the end of August, traditionally one of the slowest times for investing during the year.

Meanwhile, sentiment around the emerging markets (EM) stocks remains decidedly bearish.  Nearly $4 billion flowed out from EM  funds last week, according to Merrill, which is the largest outflow over the past 9 weeks.

Investors are clearly worried that we are seeing a replay of the 1998 EM meltdown, even though many observers insist that "this time is different".

Paul Krugman in this morning's New York Times, for example, thinks that we should be more worried about the European peripheral countries like Greece instead of Indonesia.  While the fundamentals may suggest that the problems are containable, he thinks that government responses may make the situation considerably worse:

Consider, for example, the worst-case nation during each crisis: Indonesia then, Greece now. 

Indonesia’s slump, which saw the economy contract 13 percent in 1998, was a terrible thing. But a solid recovery was under way by 2000. By 2003, Indonesia’s economy had passed its precrisis peak; as of last year, it was 72 percent larger than it was in 1997. 

Now compare this with Greece, where output is down more than 20 percent since 2007 and is still falling fast. Nobody knows when recovery will begin, and my guess is that few observers expect to see the Greek economy recover to precrisis levels this decade. 

Why are things so much worse this time? One answer is that Indonesia had its own currency, and the slide in the rupiah was, eventually, a very good thing. Meanwhile, Greece is trapped in the euro. In addition, however, policy makers were more flexible in the ’90s than they are today. The International Monetary Fund initially demanded tough austerity policies in Asia, but it soon reversed course. This time, the demands placed on Greece and other debtors have been relentlessly harsh, and the more austerity fails, the more bloodletting is demanded.

Predictably, perhaps, Ambrose Evans-Pritchard of the London Telegraph thinks that the world's monetary authorities are underestimating the dangers of the current EM situation.

He notes that most have focused where Professor Krugman is; namely, the much healthier currency reserves, and less foreign debt exposure, of most of the EM countries.

However, as EM countries seek to mitigate some of impact of the reversal of the global capital flows it enjoyed over the past few years, the potential for serious policy misstep is high:

This has the makings of a grave policy error: a repeat of the dramatic events in the autumn of 1998 at best; a full-blown debacle and a slide into a second leg of the Long Slump at worst. 
Emerging markets are now big enough to drag down the global economy. As Indonesia, India, Ukraine, Brazil, Turkey, Venezuela, South Africa, Russia, Thailand and Kazakhstan try to shore up their currencies, the effect is ricocheting back into the advanced world in higher borrowing costs. Even China felt compelled to sell $20bn of US Treasuries in July. 
"They are running down reserves by selling US and European bonds, leading to a self-reinforcing feedback loop," said Simon Derrick from BNY Mellon.

The problem as I see it is best captured by the chart shown above, courtesy of strategists at Citigroup by way of the Financial Times.

The resources are available to China, Brazil, et. al. to contain the impact of market sentiment.  The problem is whether the local political sentiment is sufficient to ask its populace to face difficult economic times to appease the currency markets.

So are the EM stocks now a bargain?

Writing in this morning's Financial Times, here's what columnist James Mackintosh noted:

Emerging markets are not one of those screaming bargains...

EM equities have not even had a one-fifth fall from their peak this year.  In dollar terms they are off 16 per cent; in local currency terms they are down less than a tenth.

But in relative terms EM shares look like a steal. They have lagged behind developed market shares in the past three years in a way reminiscent of the aftermath of Lehman's collapse, the 1997 Asian crisis, or the reaction to the 1994 rate rises.

The valuation discount to developed markets has not been as big since 2005 (on a price-to-book value) or 2006 (for price to forward earnings.

I think Mackintosh has got the situation right:  EM stocks look cheap, but they could get even more attractive as the true impact of the Great Global Unwind become more evident.

Thursday, August 29, 2013

Stay on Vacation - You're Not Missing Anything

source: Zerohedge

 The last week of August has traditionally been quiet.  But this year has been unusually subdued.

August U.S. equity trading volumes are at 16 year low, while corporate debt issuance has declined to levels not seen in five years.   Even viewership of financial news programs such as Fast Money and Mad Money has plunged to record lows:

CNBC Nielsen August_1
source: Zerohedge

Whether all of this activity - or lack thereof - is of any significance is hard to say.

But it does suggest that we shouldn't read too much in any market activity when volumes and interest are so light.

Wednesday, August 28, 2013

A Look At Microsoft Over the Ballmer Years

In the aftermath of Steve Ballmer's announcement that he will be retiring as CEO from Microsoft, it has been hard to find an article that judges his performance favorably.

Here, for example, is an excerpt from a short piece from the Harvard Business Review:

The business media lit up over the weekend with the news that Steve Ballmer, the college friend who worked alongside Bill Gates to build Microsoft and was heir to the CEO job, will step down within a year. Ballmer, whose skills were in many ways complementary to Gates', took the helm of an already massive organization as it entered an era of relentless disruptive innovation by competitors. He managed to hold the stock price on a pretty even keel, but no better than that....

It's worth taking a step back to look at what all the chatter is about.

The debate has focused almost entirely on the leadership of innovation.... There's a pattern in them. They argue over whether Bing was a respectable competitive response to Google or not; they give Xbox its due, while tending to cordon it off as a special case; they accuse Microsoft of being oblivious to the threat posed by Web and mobile apps, or point to evidence that it was responding. Ballmer is being damned or defended wholly on the string of innovative (or not) products released on his watch.

It is easy, I think, to criticize Ballmer for missing some of the changes in technology, but I wonder what many of his critics would have done in a similar situation?

Steve Jobs at Apple could afford to take a "bet the company" strategy when he returned to the helm because he really had no other option.  Before the iPod was introduced, most analysts believed the best days of the company were long gone.

The Windows franchise is dominant in the personal computing world, despite numerous efforts of other companies to unseat it.  Just try to send someone an email attachment from Apple's Numbers program, or Google documents, and see what the reaction will be.

Microsoft remains the third most valuable company in the S&P 500.   Yes, a number of Microsoft's products have landed with a thud on Ballmer's watch, but compare its performance to other tech companies in 1999.

When Ballmer took over, the bubble was in full swing.  Multiples on tech stocks were trading at nose-bleed levels. MSFT in 1999 was trading at a P/E of 80x, but this was actually a discount to the 200x Nasdaq multiple.

Consider the fate of other tech high-fliers from the start of 2000: AOL, Dell, Lucent, Sun, Hewlett-Packard, Motorola.  All have either crashed to earth, or gone out of business.

Here's an excerpt from today's New York Times:
Among Mr. Ballmer’s generation of tech executives, his post-2000 stock performance is hardly the worst. Shares of Cisco Systems, the biggest maker of computer networking equipment, have dropped 54 percent. Shares of Oracle, one of the biggest business software companies in the world, have fallen 30 percent. 

Dell, which is now trying to go private as part of a turnaround, is off about 70 percent. Sun Microsystems, once one of the most influential tech companies, was purchased by Oracle in 2010 for $5.6 billion, 88 percent below its value in 2000. 

Today MSFT trades at 12x, essentially in-line with Apple trades (12.5x), EMC (12x),  and Oracle (11x). Only Google (19x) has price/earnings multiple that is at a premium to the S&P. The bloom is clearly off the tech sector, at least as far as investors are concerned.

Put another way: if MSFT had the same earnings multiple as when Ballmer took over from Bill Gates, the stock would be at $240 a share versus $33.

So in order to judge Ballmer's performance, it seems to me, analysts should focus on Warren Buffett's favorite metric:  book value per share.

Under Ballmer's watch, the book value of Microsoft shares has risen from just under $4 per share to about $9.50 per share, or a compound growth rate of slightly less than 7% per annum.  Nothing special, perhaps, but better than many other large companies like General Electric (+6% per annum) or IBM (+2.5%).

The real problem Ballmer faced, and his successor will in future years, is nicely summed up by this quote from last weekend's New York Times:

Microsoft’s seeming strength, according to George F. Colony, the chief executive of Forrester Research, has proved a weakness. 

“I would argue Microsoft does have a financial problem, and it’s been the fear of losing those massive profits from Windows and Office,” Mr. Colony says. “By doing everything it can to try to protect those profits, Microsoft has taken a defensive position for more than a decade. And in technology, if you play defense you’re going to lose.” 

Still, thanks to the success of its mainstay businesses, Microsoft has been able to afford multibillion-dollar investments in newer fields like Internet search, digital media players, smartphone software and, recently, tablets. 

The problem for Microsoft has been that it has often been forced to make those investments while playing catch-up. In the search and smartphone markets, all the snowballing effects of leadership, brand recognition and consumer habits that helped Microsoft in the PC market are working against it as it tries to catch Google and Apple. 

Tuesday, August 27, 2013

My Favorite Steve Ballmer Story

A great deal has been written about Microsoft CEO Steve Ballmer in the wake of his retirement announcement last week.

Lost in these articles is the crucial role that Ballmer played in creating Microsoft. When Gates, Allen, Ballmer, started the company, they shared a single dream of a world connected by personal computers (PC) that would be easily accessed by anyone, even those lacking in technology skills.

While you can argue that some of its products are not particularly user-friendly, Microsoft changed the world, and not too many companies can make that claim.

The story of Microsoft, and other tech giants, is beautifully told in a book titled Accidental Empires: How the Boys of Silicon Valley Make Their Millions, Battle Foreign Competition, and Still Can't Get A Date.  Written by Robert Cringely, the book later became the basis for a television series on PBS called "Triumph of the Nerds".

Even though the book is fairly dated (it was first published in the early 1990's), I still think it is one of the best in its genre in capturing the spirit of the tech industry in Silicon Valley.

Which brings me to my favorite Steve Ballmer story.

Here's the excerpt from Cringely's book:

The Age of Microsoft dates, I believe, from a moment in 1989 when executive vice-president Steve Ballmer borrowed some money. Prior to that moment, Microsoft had all the elements necessary for global digital dominance except the will to make it happen. Ballmer's mortgage signified that there was finally a will to go with the way.

Ballmer's was Bill Gates's Harvard buddy, and Microsoft's twentieth employee.When Ballmer joined Microsoft in those early days, he didn't even have an office, but was granted space at one end of the sofa near Bill's desk.  Ballmer, a former brand manager at Procter & Gamble, represented Microsoft's new business orientation, an orientation that surged after 1989. By that year, just as Bill had, he came to the blinding realization that IBM no longer controlled the PC business - Microsoft did....

So Ballmer took a chance.  He borrowed everything he could against his Microsoft stock, stock options, and his every other possession.  In all, Ballmer was able to borrow $50 million and he used every cent to buy more Microsoft shares....Ballmer was betting his entire fortune on Microsoft. This is the only instance I can recall of such behavior.

There's something about betting every penny you have in the world that helps with focus, and Microsoft has been very focused during the 1990s. As a result, Steve Ballmer is now Microsoft's third billionaire, joining Bill Gates and Paul Allen.

A different side of Steve Ballmer, perhaps, than you have heard about recently.

Monday, August 26, 2013


My post last Friday voicing my concerns about the emerging markets (EM) was not well-received by some of my colleagues.

They noted that the stock markets in the EM had already suffered considerable carnage over the past few years, lagging the U.S. markets by a wide margin.

In addition, valuation levels in markets like China and Brazil already are trading at historically low levels, setting them up for the possibility of a fall rebound.


On the other hand, it is also possible that U.S. investors are underestimating the popular anger that many EM countries are witnessing.  One of the most extreme cases is in Egypt.

I am far from an expert on the Middle East.  However, it seems to me that much of the turmoil in the region over the past few years has centered around religion:  Sunni vs. Shia, Jewish vs. Muslim, etc. Egypt's problems, however, are focused on economic conditions.

Quartz had a very interesting piece over the weekend discussing the reasons that so many Egyptians have taken to the streets, risking their lives in protests against the government.

When oil production started to decline in 1996, the article notes, the Egyptian government struggled to maintain decent living standards for its citizens.  It didn't help, of course, that its politicians were largely corrupt and despotic.

The government turned to the credit markets to try to keep its standard of living intact, and now faces a crushing debt burden, much of it owed to foreign creditors.

The Egyptian population has grown by +21% since 2000, but living conditions have steadily declined.  Here's an excerpt from the piece:

Rapid population growth and continued economic mismanagement has meant that youth represent about 25% of the population—but more than half of them suffer from poverty and unemployment. Economic mismanagement, much of which was quietly championed by the IMF and the World Bank (though they have now belatedly noticed that much of the policies they previously encouraged are now deeply problematic), has caused a widening of overall poverty while enriching mostly Egyptian elites.
With some 40% of the population living on $2 a day or less, and rates of illiteracy and unemployment hovering around a third of the population, it was only a matter of time before economic grievances translated into political outrage. The trigger factor, though, was food—on which a quarter of Egyptians spend more than half their incomes 

If you have time, you should read the entire piece - it does a good job of illustrating how difficult the whole situation has become.

I also believe that other EM governments will look at the Egypt as an object lesson of the dangers of trying to meet the demands of foreign creditors at the expense of providing basic necessities.

Put another way:  while the EM countries have the resources to meet it obligations, they may decide instead to brave the anger of foreigners if it means maintaining their positions.

Friday, August 23, 2013

Should Stock Investors Worry About the Emerging Markets Turmoil?

Many of my recent posts on the emerging markets (EM) have focused on the opportunities.

Stocks in countries like China, Korea and Brazil are all trading at price/earnings ratios below 10x, despite earnings expectations that are much higher than U.S. companies.  In addition, dividend yields on EM stocks are surprisingly robust; Chinese stocks offer a 3.3% yield, for example.

Yet in recent days I am getting the gnawing feeling that perhaps the current situation has the potential to become more serious.

The Financial Times this morning has several articles on the turmoil in the EM.

On the front page, for example, in a article titled "Developing world central banks lose $81 bn in reserves since May", they note that the reserves of some of the EM countries have taken a noticeable hit:

Some countries have suffered more precipitous drops.  Indonesia has lost 13.6 per cent of its central bank reserves from the end of April until the end of July.  Turkey has spent 12.7 per cent and Ukraine has burnt through almost 10 per cent. India, another country that has seen its currency pummeled in recent month, has shed almost 5.5 per cent of its reserves.

The FT goes on to note, however, that other EM countries like China and Russia have seen almost no impact from currency withdrawals.

One of Random Glenings favorite columnists Ambrose Evans-Pritchard was sounding the alarm yesterday in the London Telegraph.  He makes some comparisons to the EM meltdown in the late 1990's that ring true:

It was Fed tightening and a rising dollar that set off Latin America’s crisis in the early 1980s and East Asia’s crisis in the mid-1990s. Both episodes were contained, though not easily. 

Emerging markets have stronger shock absorbers today and largely borrow in their own currencies, making them less vulnerable to a dollar squeeze. However, they now make up half the world economy and are big enough to set off a crisis in the West...

Hans Redeker from Morgan Stanley said a “negative feedback loop” is taking hold as emerging markets are forced to impose austerity and sell reserves to shore up their currencies, the exact opposite of what happened over the past decade as they built up a vast war chest of US and European bonds. 

The effect of the reserve build-up by China and others was to compress global bond yields, leading to property bubbles and equity booms in the West. The reversal of this process could be painful.

However, Paul Krugman in this morning's New York Times remains cautiously optimistic that we are not about to see a repeat of earlier crisises:

 Does this reversal of fortune pose a major threat to the world economy? I don’t think so (he said with his fingers crossed behind his back). It’s true that investor loss of confidence and the resulting currency plunges caused severe economic crises in much of Asia back in 1997-98. But the crucial point back then was that, in the crisis countries, many businesses had large debts in dollars, so that falling currencies effectively caused their debts to soar, creating widespread financial distress. That problem isn’t completely absent this time around, but it looks much less serious.

Still, Krugman does not dismiss the worry that all of this could turn into something more serious:

In fact, count me among those who believe that the biggest threat right now is that policy in emerging markets will overreact — that their central banks will raise interest rates sharply in an attempt to prop up their currencies, which isn’t what they or the rest of the world need right now. 

Historically September is the weakest month for U.S. stocks, according to the Stock Traders Almanac.  Negative news flow combined with an historically difficult month for stocks could add fuel to a bearish fire:

Since 1950, September is the worst performing month of the year for DJIA, S&P 500, NASDAQ (since 1971) and Russell 1000. A 3.1% advance last September lifted Russell 2000 to second worst (since 1979). September was creamed four years straight from 1999-2002 after four solid years from 1995-1998 during the bubble madness. Although September’s overall rank improves modestly in post-election years going back to 1953 (third or fourth worst month depending on index), average losses widen to 0.9% for DJIA, SP 500 and NASDAQ and to 1.6% for Russell 2000. Although September 2001 does influence the average declines, the fact remains DJIA and S&P 500 have declined in 9 of the last 15 post-election year Septembers.