Wednesday, 31 March 2010

Macro-Level Trends – Global Liquidity Movement – Looking Beyond the Surface of Ratios & Differentials

After the western stock rally of 2009/10, driven perhaps in large part by more speculative parties, caution has eased amongst the world's biggest funds slowly releasing historic levels of previously frozen liquidity. They seek as best as possible alternative safe haven homes given the paucity of western sovereign debt yields, and indeed the renewed concerns regarding sovereign default.

Perhaps the greatest of these actors are the major institutionals, often state run pensions firms and increasingly Asian, with ever increasing future legacy levels accruing as their national demographics age with increasingly inverted pyramids and ever increasing retirement expectations given the standards of living enjoyed having been through relatively recent industrial revolutions. Caught between future maturation demands and present poor returns across what were good RoI classes, they have started to employ cash by increasing exposure with their historically favourite asset-class - long-term, hard-physical asset-bases, typically 'future-proofed' & 'future-forward' infrastructure.

South Korea's National Pension Service move to purchase 12% of Gatwick Airport in the UK from US PE firm GIP is a good examplar of late.

[NB investment-auto-motives suspects that NPS took on the deal to align its future directly with that of the S. Korean economy. As a leading proponent in the creation of intelligent national infrastructure, emanating from Seoul, and as a designer and manufacturer of supporting electronics, S. Korea may well be hoping to be the world's leading force in delivering high-value intelligent infrastructure solutions as both West and East apply their massive infrastructure stimulus spending. To this end, Gatwick Airport could act as an a showcase for S.Korean systems tech, given that an airport must operate as efficiently as possible both 'air-side' and 'land-side'].

But it is not simply the 'Expectant East', others such as the high profile California's CALPERS scheme have gone as far as confronting Standard & Poors regards the integrity of the 'AAA' classification ratingg given in CDOs and ABSs. Given California's growing burden

So pressure builds the world over to find avenues of opportunities that offer both decent levels of return with the mitigation of risk. That is of course the investor's ideal, something which in today's still tumultuous western markets, is rarely apparent, as the ideal balance of risk-reward offered by healthy economies has been overtaken by general risk-adversity in low yield high-grade bonds, or for some relatively heavy 'risk-on' in junk territory, even if defaults have dropped from 14% to 5%.

Managers of large funds with a remit for a bias to safety will in reality have a broad portfolio of diverse asset classes over global geographies to review and allocate. However, an overtly simplistic yet useful tool is the comparison of Stock Market Ratios across the world, to gain a broad indication of both local economic well-being, the central pillar(s) of wealth generation, and importantly an estimation regards the level of 'investor fill' each market has experienced so indicating its place in the cycle.

Of course, each market has its own unique characteristics and whilst they can be generally grouped depending upon the similar underlying qualities that help drive the economy, the notion that they can be all laid out bare for direct cross-comparison is an anathema, even if the market data simplistically laid out as Average Yield & Average Price/Earnings, seems to beg immediate cross-border, inter-regional and continental comparison.

However, though overtly simplistic, the two data sets do provide a 'snap-shot' – albeit a very averaged out - view of specific national markets : as was illustrated as an influence in the previous post's Sterling Currency overview.

To expand this national & regional specific investment measure, the following highlights individual nation's Yield, P/E and the differential 'spread'. This latter figure, though not officially recognised as constituent part of the basic ratio analysis, can provide a useful indicator since notionally: the smaller the differential between Yield and P/E figures the greater the potential for profit-maximisation – though of course local inflationary factors and local 'currency capture' (in non & limited FX-trade environments) must be taken into consideration.

Thus the following, taken from the FT data pages on 29.03.2010, provides a basic overview :

Country/Region Yield vs p/e Spread

UK 3.0% vs 12.4 9.4

Austria 2.9% vs 22.6 19.7
Belgium 3.8% vs 17.6 13.8
Bulgaria 5.0% vs 7.9 2.9
(S.)Cyprus 5.0% vs 4.1 (0.9)
Czech Republic 5.8% vs 12.4 6.6
Denmark 1.1 vs 27.1 26.0
Finland 3.4% vs 21.1 17.7
France 3.4% vs 20.4 17.0
Germany 2.7% vs 18.7 16.0
DAX-30 3.1 vs 15.4 12.3
Greece 2.6% vs 12.0 9.4
Hungary 1.7% vs 15.7 14.0
Ireland 1.4% vs 21.4 20.0
Italy 3.1% vs 17.6 14.5
Luxembourg 2.4% vs 19.5 17.1
Malta 4.3% vs 5.0 0.7
Netherlands 3.1% vs 20.0 16.9
AEX 2.9% vs ??? ???
Norway 2.2% vs 17.2 15.0
Poland 2.5% vs 54.4 51.9
Portugal 3.6% vs 14.7 11.1
Romania 1.9% vs 12.6 10.7
Slovenia 1.5% vs 19.3 17.8
Spain 4.6% vs 11.2 6.6
Ibex 35 4.9% vs 10.3 5.4
Sweden 2.8% vs 14.0 11.2
Switzerland 2.6% vs 16.8 14.2

North America
Canada 2.6% vs 21.4 18.8
S&P/TSX 3.0% vs 19.9 16.9
USA 1.8% vs 20.6 18.8
Dow Jones 2.6% vs 16.4 13.8
S&P 500 2.3% vs 17.5 14.2

Central & South America
Argentina 6.2% vs 13.1 6.9
Brazil 3.1% vs 17.1 14.0
Chile 3.7% vs 19.7 16.0
Colombia 3.0% vs 22.6 19.6
Mexico 1.6% vs 17.3 15.7
Peru 3.2% vs 37.2 34.0
Venezuela 17.8% vs 0.4 14.4

Australia 3.6% vs 17.3 13.7
Hong Kong 2.7% vs 16.4 13.7
HangSeng 2.9% vs 15.8 12.9
Indonesia 2.0% vs 19.4 17.4
Malaysia 2.6% vs 17.4 14.8
New Zealand 4.9% vs 20.6 15.7
Philippines 2.4% vs 16.3 13.9
Singapore 2.7% vs 18.4 15.7
South Korea 1.3% vs 19.5 18.2
Sri Lanka 2.0% vs 19.9 17.9
Taiwan 2.6% vs 25.1 22.5
Thailand 3.3% vs 13.9 10.6

Japan 1.8% vs 31.4 29.6
Topix 1.7% vs 17.6 15.9
China 2.6% vs 15.6 13.0

India 1.0% vs 20.7 19.7
Pakistan 5.1% vs 10.1 5.0

Israel 2.7% vs 16.8 14.1
South Africa 2.4% vs 16.7 14.3

Russia 1.4% vs 13.3 11.9
Turkey 1.5% vs 12.4 10.9

A very brief overview highlights the best yields originating from: Argentina (6.2%), the Czech Republic (5.8%), Pakistan (5.1%), Bulgaria (5.0%), Cyprus (5.0%), New Zealand (4.9%), Spain's IBEX 35 (4.9%) and startling out in front Venezuela (17.8%). These best performers are largely either surging EM nations or arguably over-leveraged AM nations, the data but a snap-shot in time typically driven by past economic prowess and not discounting against what look to be rockier times ahead.

Venezuela's economy is typical of the region's yesteryear boom & bust cycles. It has been rocketed by the centrally governed industrial strengthening & diversification policy enabled by the petro-dollar income from state controlled oil assets. With the announced re-organisation of the PdVSA, the creation of Fonden – the National Development Fund - stabalisation of the national currency, and typically a 51% maintained stake in any JV enterprises the state is trying to create a self-sustaining economy and simultaneously move the populace inland to equalise resources, maintaining spending programmes under the 'Bolivarian Revolution' umbrella to do so. Thus private investment is riding – often in a PPP guise – the economic wave the government is trying to engender with the beneficiaries seen as heavy-hitter supporters of the Chavez administration. So here, although the data looks fabulous, as ever, the transparency, investment access and political dimensions are quite opaque.

As for other 'best performers'....

Argentina is a typically more stable nation compared to its northern counterpart, but it too seeks to diversify and strengthen away from its agricultural base, and seemingly following Venezuela's lead in oil extraction and export, has muted the fractious possibilities of drilling in the waters of The Malvenas / Falkland Islands – with the obvious irritation to UK international relations. This may be a vote-winning propaganda message at a time when the economy is in danger of slowing due to global contraction, but it does not add confidence for FDI; something Argentina may feel is in natural retrenchment anyway, hence its oil stance.

New Zealand stands in a similar spot given its heavy reliance on exported agricultural goods, but will undoubtedly simply continue to focus on Asian demand of meats etc. The Czech Republic has suffered less than other CEE countries given its proximity and relationship with Germany and the re-cycling of monies earned from outside the region and repatriated with returning EU workers, buoying residential property, retail and other sectors. As with Poland, the German relationship will be key as the Czech Republic maintains its localised role as lower-cost producer for German consumption. Cyprus & Bulgaria look in a weaker position given their respective reliance upon Greece and Turkey, neighbours which although diametrically opposed in terms of economic strength appear to be far more inward looking over the coming years given collapse of W.EU demand and importantly for Greece & Bulgaria the credit markets and its effect on public employment.

Looking at stock market valuations via the price/earnings measure, Poland, Peru, Japan, Denmark & Taiwan hold the greatest valuations at present with 54.4, 37.2, 31.1, 27.1 & 25.1 respectively. By established, conventional standards these are indeed high, when norms run between multiples of 10 – 20 x future earnings. However, as we saw with China's capital markets during their heyday in the run-up to the Olympics (reaching 30+ x), these valuations tend to be the result of non-conventional (by historical standards at least) factor(s). Typically the primary cause is inflation driven increased liquidity, the price spiraling effects of which can be exacerbated from circulation around/within a (near) captive currency market. This seems the case for Poland where returning migrants with wealth along with FDI have created a cross-the-board asset inflation, perhaps most noticeable in equities. Peru's boost from the commodity bull market, though a little dampened is still running with exports to Brazil & China the income of which in Peruvian Nuevo Sol has supercharged domestic capital markets, possibly also as a result of government interaction to buoy Peru's economy and international standing. Japan's high valuation is a result of the individual, corporate and institutional savings glut, essentially re-cycled Yen that provides personal and national feelings of security,
and a weather against externally created future systemic shocks The Denmark case appears similar is as much that the Euro-pegged Krone may have been domestically used to buoy capital markets during a period of immense western market volatility, instead of flowing-outward, so as to help stabilise the strength of the national economy; it's performance also assisted by the 'Flexicurity' labour market policy which enables companies to quickly adapt to changed conditions.

As stated, when seeking profit maximisation possibilities, one looks to the differential (or 'spread') between these two ratios. It is an inverse measure, so that theoretically the closer the figures are indicates a greater yield and lesser stock price/cost.

Here the immediately obvious best performers are (Southern) Cyprus (-0.9) & Malta (0.7). It is apparent that these figures, whilst attractive, relate to very small Southern European Island local economies which tend to a subordinate role in their related larger national economies – ie Greece & Spain – and undoubtedly benefit from protected and positive trade flows as a result of national policy toward agriculture, resource extraction and low-value secondary industries. Thus these star performers cannot be realistically compared to far deeper, broader and importantly transparent capital markets elsewhere, instead typically volatile relative to the level of government interaction and the level of domestic (possibly self-regarding) investor activity. Of the Bulgaria follows with a score of 2.9, it sits as a philosophical 'half-way house' situated between the characters of a small local entity (as described) and an increasingly maturing market structure given its EU membership ambitions. The 'spread' figure thus reflects this typical dynamic of a mechanism that operates in this transient territory, with A & B sections to Official & Unofficial markets, constituent players primarily related to oil/gas, mining, agriculture and machine parts – and thus highly correlated to the swings of W.EU & CEE macro-demand. With a 'spread' of 5.0 comes Pakistan, much like Bulgaria regards its original economic-base activities, but perhaps a further evolved Service sector, with the steadying influence of the US since 2004 (given Pakistan's Non-NATO Ally status) including US FDI and the sizable commercial trade interests with neighbouring India and China. That spread also perhaps indicates a cautious optimism as Pakistan rapidly moves beyond its 2008 economic crisis with the monetary and advisory support of the IMF, the 2010 onward growth rate expected at 4%+. Spain and the Czech Republic appear together at 6.6, yet it is expected that these two nations are travelling in opposing directions of economic fortune. Spain's sovereign indebtedness puts it amongst the harshly acronymed 'PIGS' group, a section that faces harsh, ongoing and possibly long, economic re-structuring which needs to both settle its over-leveraged and still over-valued property base whilst simultaneously creating new industrial/service foundations that must ultimately be globally competitive – this will not be an easy task. As the biggest player Spain has perhaps the hardest task, but positively (along with Portugal) it has the best cultural links to largely buoyant S.America; thus the possibilities of greater melding of cross-Atlantic interests – especially via banking (eg Santander etc) will need to be a major element of its future planning. For the short and medium term however, Spain looks to be effectively shrinking as its property-base valuation all too slowly diminishes so undermining the re-sparking of the economic engine. The Czech Republic, on the same 6.6 'spread' standing however, appears a better proposition given its rapid level of economic maturation and importantly being a beneficiary of Germany's overtly strong economic base; with in certain ways the country almost acting as an implicit economic annex.

To summarise, we can see that often beneath what appear outstanding Yield, P/E and 'Spread' figures many micro and macro factors come into play for the institutional investor. Critically at such still relatively fragile times is the question of market integrity, whether underpinned by true and proper, and critically exercised, regulation. As such doubts are trying to be eased even in the most advanced markets via the likes of the UK's FSA and US's SEC, it puts a greater onus on these typically developing capital markets to do the same, with the ambition to equalise confidence.

Importantly, such shifting times for these (and indeed all) countries and their capital markets, begs the question of national economic policy and the regional and global role that a country can credibly play. Given the ever pressing demand for personal and commercial mobility, still very high on the industrial agenda is the ambition for adoption, creation or re-invention of the local automotive sector, to something beyond the sales, service and repair of imported motor vehicles.

Part of the Czech Republic's success and Spain's downfall has been the differing approaches taken toward their indigenous auto-sectors. Of course given 1980s/90s history of FDI and Japanese & German 'transplants', and re-invention of SEAT cars under VW, Spain enjoyed the earlier economic injection which went on to propel standards of living and so the house-price bubble. From an Automotive standpoint the Czech Republic is simply latterly re-playing that model, but its innate geographic position leaves it in a less precarious position looking forward. The capital market masters of Spain must develop new realms for its auto-sector, perhaps better aligning SEAT with the high profile efforts in Spanish eco-tech so re-creating SEAT as a value-adding R&D hub, not simply the money-absorbing 'runt' of the VW brand stable it has seemingly becomes, even after much effort to re-invent it time and time again.

This is but a simple observational case for what ultimately should be a pertinent point of national economic modelling looking into the future. These ground-works should be being created today.

Ultimately, investors – institutionals especially – will look well past the surface-level data as presented in the FT, WSJ and increasingly elsewhere on the web. Capital Markets' 'Ratios and Differentials' provide an entry point of analysis and evaluation, but ultimately both Western & Eastern pension funds, insurance companies and similar conservatively driven asset-managers need to see national economic structures which make sense relative to national competence set against regional and global B2C and B2B demands. Even as the sociologically good ideology of an increase in public transport services takes grip amongst international politicians and green-activists, the reality is that the perilous state of many (esp Western) national budgets cannot possibly support the dream. So as transport systems become privatised or re-structured under privatisation – which in turn has a knock-on effect to its support-services base as we see with Jarvis plc's demise – so the question of personal and commercial mobility arises once again – a question that requires suitable solutions generated via private capital sources; which are at last being re-built in the West via personal and corporate balance sheets.