Getting Better With Age? Woody Allen and the Graying of America

My wife and I went to see Woody Allen's new movie Midnight in Paris yesterday.

We thought it was terrific, and, judging from the packed theater that burst into applause at the end of the movie, most of the viewers enjoyed the movie as well.

Woody Allen is now 75 years old, and Midnight in Paris is his 41st movie.

While I am not a movie critic, I think it is fair to say that while the content of Mr. Allen's films have changed considerably from his earlier years, the quality remains of the highest caliber.

Mr. Allen's work ethic has not been slowed by his age, a trait he shares with a number of individuals in areas such as finance and law.

Americans, it seems, have become less eager to retire, and with advances in health care we are able to work longer than previous generations were either able or desired.

However, this trend is not without its controversial aspects, particularly in situations where older workers are not producing the same level of work as their younger counterparts.

The New York Times on Saturday carried an interesting article on this subject. Here's an excerpt:

As roughly 44 million baby boomers hit retirement age over the next decade, the problem of how and when to step aside is becoming a hot-button issue, said Robert J. Gordon, a professor of economics at Northwestern University. Many older workers have had to put off retirement because of stock market losses during the recent deep recession. And while unemployment among older workers is lower than the national average at 6.2 percent, it is up sharply from three years ago, when it stood at 2.9 percent.

http://www.nytimes.com/2011/05/28/business/economy/28worker.html?pagewanted=1&_r=1&sq=older%20workers&st=cse&scp=1

Writing in the Financial Times over the weekend, Gillian Tett observed that this desire to avoid retirement seems to be largely an American phenomena.

According to Ms. Tett, in Europe, retirement is something that is eagerly anticipated rather than dreaded - recall the large protests in France when President Sarkozy tried to raise the French retirement age from 60 to 62 years old.

Still, with nearly every industrial country facing huge fiscal shortfalls, and with birthrates still low in Europe and the United States, delaying retirement may become more the norm than the exception globally.

Japan's Fiscal Woes

Interesting piece in today's New York Times about Japan.

I wanted to post it because it presents a good counter-argument to my semi-bullish comments earlier this week about the Japanese stock market.

(Let it be noted that Random Glenings tries to look at all sides of an issue!)

While most of the talk in the United States naturally focuses on our fiscal debt woes, Japan's are in some way even worse.

Ever since the Japanese bubble burst in the late 1980's, successive Japanese governments have attempted to reinvigorate their economy through massive fiscal stimulus packages.

Unfortunately, these attempts have been largely unsuccessful, but the debt burden continues to grow.

You wouldn't know it from Japanese interest rates. The 10-year Japanese government bond yields around 1.1%. With Japan trapped in a deflationary spiral, any sort of positive return is attractive to investors.

In addition, Japan is a country of savers. Unlike the U.S. - where spending and credit are viewed as a birthright - the typical Japanese citizen reacts to a slower economy by saving more. 95% of the Japanese fiscal debt burden is held by Japanese citizens, which makes it less vulnerable to outside creditor pressures.

Today's article suggests that this might begin to change:

...the numbers are frightening, especially given Japan’s lack of political leadership around fiscal issues. Government debt stands at about 1,000 trillion yen ($12 trillion), with gross borrowings of around 200 percent of gross domestic product. The productive means to pay off those liabilities are shrinking as Japan’s average age creeps toward 50. Thanks to scant immigration, the country also loses one million people a year.

Could Japan’s Debt Lead to a Crisis? - NYTimes.com

The article goes on to describe a scenario where the Japanese might need to start relying on foreign capital to finance its debt. This in turn could force interest rates higher, and push the Japanese fiscal deficit even higher.

As the Times notes:

If non-Japanese creditors demanded higher yields to compensate for low growth, the country’s dependence on short-term borrowing would quickly lead to spiraling debt service costs. Even a 5 percent haircut on government debt would equate to $600 billion.

Few have pockets that deep. Europe’s resources are tapped out on its problems. America is struggling, and would be even more so if Japan dumped the almost $1 trillion in United States Treasuries that it holds. The only sizable pool of capital available would probably be Chinese.

Sobering thoughts.

Is the Market Due for A Correction?

Most of the research I'm reading these days has turned cautious on the stock market.

Many strategists cite the length of the current bull market - it has been more than 2 years since stocks bottomed early March 2009, which is longer than more cyclical bull markets have historically run.

There are also the concerns relating to weakness in areas like manufacturing and housing, where recent data would suggest the economy has been slowing.

Here, for example, is a paragraph from this morning's research piece from Mary Ann Bartels, Merrill Lynch's chief technical market strategist.

Note that Ms. Bartels views the consensus bearish view as mildly positive from a contrarian viewpoint:

AAII Bulls/Bears at lowest level since the Jul/Aug 2010 lows
Based on data from the American Association of Individual Investors (AAII), US investor bullish sentiment relative to US investor bearish sentiment is at the lowest level since the late August and early July 2010 lows. As an indicator of sentiment, the AAII Bulls/Bears ratio is at or near oversold or bullish contrarian levels and suggests that individual investors are the most bearish since last summer's bottom for the S&P 500 at 1040-1010. In our view, AAII Bulls/Bears is a potential positive for the US equity market. In yesterday's Chart Talk, we highlighted that Investors Intelligence % Correction suggests that too many investors expect a correction, which is also contrarian bullish for the US equity market. Our key support on the S&P 500 remains 1305-1294.

I went to hear Ed Clissold, Global Equity Strategist at Ned Davis Research (NDR) this morning.

I've written about NDR a number of times on Random Glenings. The firm does top-shelf research on the global equity and bond markets, based on their huge database of historic market data. The firm is not always right, but I find their research very thoughtful and useful in my investment work.

NDR is among those strategists looking for at least a pause in the market's bull phase. Ed noted that NDR would not be surprised to see a 5% or 10% decline in the markets over the next few months. However, given the positive backdrop of low interest rates and an accomodative Fed policy, NDR would also not be surprised to see stocks recover nicely by year-end.

In their opinion, NDR would suggest moving to more defensive stocks as a tactical asset decision. Specifically, they like the "SHUT" sectors: Staples; Healthcare; Utilities; and Telecom for investors who want to stay in the equity market.

However, NDR's overall asset allocation remains overweight equities, and underweight bonds. It is hard to get bulled up on bonds with rates so low, and while stocks are obviously more volatile they still offer better return potential than fixed income alternatives.

Goldman Sachs: "Japan equities set to rally back to pre-crisis highs"

Kathy Matsui of Goldman Sachs wrote a bullish piece on the Japanese stock market in yesterday's Financial Times.

Japan, of course, is currently mired in attempting to recover from the disastrous aftereffects of the earthquake and tsuanmi. First quarter GDP was -3%. Electricity remains in short supply, and many businesses have cut back production. The response of the government has been widely criticized, and Prime Minister Kan has been scrambling to contain the political damage.

And yet, as Ms. Matui writes:

Compared to the 1995 Kobe earthquake, when price to earnings multiples traded at 77 times, the full year p/e {for the Topix} stands at a more globally comparable 13 times.

For reconstruction, the government has approved a $50bn supplementary budget, and a second budget totalling $125bn is expected this summer. Since the earthquake, the Bank of Japan has conducted sizeable fund supply operations and expanded its asset purchase scheme by 14 per cent to $500bn. The BoJ has stated that, if necessary, it will take further steps to ease policy.

FT.com / Markets / Insight - Japan equities set to rally back to pre-crisis highs

The Nikkei is currently trading at a lower multiple, and offers a higher dividend yield, than the S&P 500, and yet the Japanese stock market has lagged most of the global stock markets.

I'm not totally convinced that this is the time to jump into the Japanese stock market - even the bullish Ms. Matsui doesn't think that the Nikkei will start to move until the fall - but I like the concept.

Japan is full of world-class companies, and its famous work ethic remains intact despite 20 years of economic malaise. With the government poised to throw massive resorts into rebuilding, I am confident that Japan will begin to show signs of recovery by this fall.

The question is: When do you start buying Japan?

Good News for Vertex

Last month I wrote a short note discussing my first encounter with Joshua Boger of Vertex Pharmaceuticals:

http://randomglenings.blogspot.com/2011/04/joshua-boger-of-vertex.html

After graduating from Wesleyan University in the 1970's, Dr. Boger earned a PhD in biochemistry from Harvard. His obvious talents lead to a job offer from drug giant Merck, and so he started in their research laboratory.

But Boger soon became dissatisfied with the way that Big Pharma attacked drug research, and wanted to go out on his own. So, despite having three small children, he left Merck to go off on his own.

Dr. Boger started Vertex in late 1980's. His goal for the company had been to develop new and innovative research techniques in the process of attacking some of the more difficult diseases. Given that he had been on track to be head of Merck's research laboratory, it was a pretty risky career step, but one that paid off handsomely.

If you want to read about the early years of Vertex, I highly recommend reading The Billion Dollar Molecule, written by Barry Werth. Although the book was published in 1994, it is a fascinating look into the high risk/high reward world of biochemistry research.

Dr. Boger still is on the board at Vertex, but has recently turned his attention to other endeavors in the last couple of years.

Vertex today has a market cap of over $11 billion, despite the fact that it has never made any money in its entire history.

This is about to change.

Yesterday Vertex received final approval for its drug called Incivek, which offers a cure for hepatitis C. Sales for Incivek are projected to be very strong, although it is also expected to receive strong competition from Merck's Victrelis, which also treats patients with hepatitis C.

Incivek treatments will not be cheap. Here's the lowdown from this morning's New York Times:

Vertex set the wholesale price of Incivek, also known as telaprevir, at $49,200 for the entire course of treatment. Merck’s Victrelis, also known as boceprevir, costs $26,400 to $48,400 depending on the duration of treatment. Both drugs would be used in addition to the standard therapy, which costs about $15,000 to $30,000 depending on duration.

Vertex executives defended the price, saying that cures can prevent the problems that can be caused by hepatitis C, like liver cirrhosis, liver cancer and the need for a liver transplant.

“Cure is rare in medicine and that makes the economics very compelling,” said Joshua Boger, who founded Vertex. He stepped down as chief executive two years ago, but is still a director.

http://www.nytimes.com/2011/05/24/business/24drug.html?_r=1&ref=business

When I mentioned the Vertex news last night to a group of clients, they asked:

"Why does it cost so much?"

Instead of giving a flip answer - Vertex is charging what they think the market will bear - I pointed out how long it took for the company to actually get to this point.

Testing on this drug actually started in 1993. Eventually the costs added up to nearly $4 billion, with no certainty of success. Thus, while it is true the gross margins for Incivek will be impressive for Vertex, you could also argue that in some ways they are trying to recoup some of their research costs.

But the issue still remains: who will pay for Incivek?

Emerging Market Investing

Paul Lim had a good column in yesterday's New York Times about investing in emerging markets stocks.

Mr. Lim pointed out that it seems almost universally accepted that investing in the emerging markets makes sense. However, the performance of this sector has been mixed so far this year, largely lagging the gains in the S&P 500.

Unlike the Federal Reserve and Bank of Japan, most central banks in the emerging economies have been struggling to rein in growth and inflation. The Bank of China, for example, has raised rates several times this year trying to slow growth, as has the Brazilian central bank.

The actions of the central banks, combined with attempts by governments to slow down the rate of inflows from overseas investors, have curtailed gains in emerging markets stocks relative to the U.S.

The article also notes that stocks in the emerging markets economies are more tied to commodity prices than might be generally perceived:

International stocks generally have higher correlations with commodities markets than do domestic equities. While energy and materials companies make up less than 16 percent of the S.& P. 500 index of domestic stocks, those two categories account for 27 percent of emerging-market stocks.

The Allure of Foreign Stocks Starts to Fade - NYTimes.com

Emerging markets bond funds have also seen large inflows, which has pushed yields in countries like Brazil and Mexico to levels lower than many European countries. As this morning's Financial Times reports:

The credit default swap index for 15 major emerging market countries has fallen by a third to 206, while the iTraxx SovX index for western European CDS has climbed to almost 190.

I agree that, longer term, the emerging markets offer an appealing combination of strong economic growth and powerful demographic tailwinds.

However, the ride forward will not be smooth, and the emerging markets probably carry more risk than investors are currently perceiving.

Meanwhile, high quality, dividend-paying US stocks continue to trade at attractive valuations, especially if current economic slowdown persists.

General Stanley McChrystal

It's not often that I get the chance to have a casual conversation with a four-star general, but it happened to me last night.

I have been attending the Global Transportation Conference here in Boston put together by Merrill Lynch's excellent transportation analyst Ken Hoexter for the last couple of days.

The conference featured presentations by a number of leading transportation (railroad, air freight, etc.) companies. It's a great way for me to get the chance to hear a number of leading companies in a fairly efficient fashion.

As part of the conference, Merrill hosted a dinner last night that featured General Stanley McChrystal as the after-dinner speaker.

You might remember General McChrystal: he was head of the U.S. Armed Forces in Afghanistan until about a year ago.

Then, last April, he made some ill-considered remarks about several senior people in the Obama administration in a magazine article. In the ensuing uproar, the General was recalled to Washington and then tendered his resignation.

It was a fairly inglorious end to a spectacular career in the military. General McChrystal played a lead role in numerous military conflicts over the past three decades, and also was an important part of the fight against terrorism. By all accounts, he is a very smart man.

Since he left the military he has been teaching a course at Yale. He also has started a consulting company featuring other retired military commanders which works with businesses large and small in addressing management issues.

He also is on the board of several corporations, including the airline jetBlue, which is why he was at the conference last night.

Now to my brush with fame.

Before the dinner started Merrill had a small cocktail hour for the participants at the conference. I really didn't know too many other people, so I was introducing myself to another attendee when I turned around and found myself face-to-face with General McChrystal.

Contrary to his reputation, the General could not have been nicer and more gracious. Since he had just arrived, I had the chance to talk to him for a few minutes.

(To say that others were envious would be an understatement.)

One of the most interesting comments he made concerned the types of meetings he had when he was head of US operations in Afghanistan.

Unlike what I imagined, the General said the meetings were very open, and no one felt constrained to offer their opinion even to the point of being argumentative.

Oh, really, I said? Even to a four-star General?

With a smile, General McChrystal said "Especially to a general!"

He went on to explain.

Today's US military is made of professional soldiers. Not only have they been involved in numerous deployments in the Middle East and Afghanistan, but they also have spent a good part of their adult lives learning and training about how to battle the enemy throughout the world.

Moreover, unlike in previous generations, most of our military are older, and many have families in the United States. It's one thing, the General explained, to order an 18 year-old recruit to execute an order to attack. It's another to tell a 38 year-old soldier who might have a family stateside to put themselves in harm's way just because an officer thinks it's good idea.

General McChrystal cited the recent incredible raid by Navy SEALS to finally execute Bin Laden.

"I'll bet you anything," the General said, "that every one of those SEALS helped plan that raid. It was too risky, and they're too highly trained, not to get those men involved. And given that the success of the mission depended on their execution, you have to know that they were involved almost from the beginning."

I came away from our discussion not only impressed with General McChrystal but also with a much greater awareness of how much changes in society have influenced virtually every part of American society, including the military.

As he noted, General Eisenhower could simply tell his subordinates to execute his orders, and get on with his day. Today's military commanders have to constantly work at communication, and in making sure that everyone in his command is "on board" with the decisions that are being made.

I should add that his after-dinner remarks were excellent, and well worth a listen.