Thursday, 4 October 2012

Macro Level Trends – Triangulation to Square the Economic Circle – Corporates as the Global Economic Cornerstone.

Present investor cautiousness inside the Eurozone and even North America is only to be expected today given the strong traction and impressive rallies across certain sectors, banking the most notable, on the back of Mario Draghi’s promise to undertake whatever actions are deemed necessary. The fervency has diminished last week as profit taking by those who rode the wave; with general conjecture that investors will ‘rotate’ their holdings away from ‘defensives’ toward ‘cyclicals’ – better news for recently stock battered car-makers.

Caution Abounds -

Adding to that sense of caution has been the fact that a kind of impasse still exists between Spain and the ECB before the EU court approved monies can be injected, all dependent upon Spain’s official request for aid, which could in itself re-generate capital market fears. So the Eurozone appears to be in yet another ‘push-me, pull-me’ hiatus.

Adding to the sense of gloom is the reiterated press coverage regards the 40% drop of the Chinese stock market over the last year, the accompanying concerns of a possible Sino-Japanese military clash over the East China Sea islands, and the resultant continued constraint of Chinese consumer and industrial goods demand. Obvious is the parallel impact upon Germany’s export economy ranging from premium cars to specialist equipment, seen in manufacturing indicators, so affecting its ability and willingness to “lead” (in Soros-speak) the Eurozone's additional liquidity programme.

[A radical Sino-German corroborated agreement to improve the Eurozone situation would certainly be a revival short-cut, but would also deny the very necessary deleveraging actions required by the ECB and IMF via ESM & OMT, and possibly herald EU stagflation].

Indication from PRC leaders that new national stimulus measures worth $35bn would be forthcoming, so affecting the global picture, helped raise oil and metals prices.

So, the general macro-economic picture then could be said to have seen darkened clouds, interspersed with bright spots; investor reaction and prime stock markets, as ever reacting to the news-stream and indeed itself in a self-fulfilling manner.

The Oft Described Present Paradigm -

Yet, in what has become a very correlated investment world – confounding the historical orthodoxy of inverse asset class relationships – clear investment signals must be heeded, especially regards equities. An all-important true big picture perspective should to a far greater degree include much more ‘bottom-up’ recognition, interpretation and influence.

More than ever investors seek both a level of medium security and medium return. Yet western government bonds have massively diverged so as to be either a) over-subscribed and safe but with negative real interest yield, versus b) overtly volatile relative to Eurozone 'real-politik'. Commodities have suffered as part of the worldwide downturn so seeing heavy reduction in CapEx and sector restructuring. Property has likewise diverged as money has been directed out of EU periphery and various EM regions, so as to create a new and probably sustainable 'hyper-pricing' in select inner-city districts, and new hiked price-floors in the most pleasant suburbs. Equities are still trading on macro, fiscal-policy induced sentiment rather than in many cases underlying fundamentals. Noted in automotive have been the overt price swings - even amongst some of the best positioned (BMW & Daimler) - which are inconsistent with the company revenues : perhaps the most basic but prime indicator at present Reduced earnings guidance and goodwill write-downs seemingly having disproportionate effect on already historically depressed price/earning ratios. A beneficial era for those seeking to trade on interspersed peaks and troughs, but adding little to much needed confidence building throughout the West.

The Exponential Return of Confidence Invariably Slows Animal Spirits -

The present zig-zag effect along what appears a relatively narrow floor to ceiling band has been described by academics as the tail-end of the 'exponential effect'. The steep to shallow shaped curve created on a stock index after the previous mass exodus which tracks investors' initial 'rush for value' purchasing behaviour, so providing the massive uplift seen during the 2008 financial crisis, and to a lesser extent more recently over the summer as concerns about sovereign debt abated. The propensity for investors to snap-up what are viewed as bargain stock prices undoubtedly wanes as time passes. More participants enter the frey, and the near-term 'under-valuation gap' recedes. So the 'exponential curve', with its flattening tail, is the natural outcome, seen many times before and hardly a revelation.

The question is what happens next?

A collapse of confidence and so mass exit? Ongoing zig-zagging within a bounded range? Or the beginning of a new growth era?

Undoubtedly the short and mid term speculative investors will seek to monetise their gains, and seek new opportunities in other under-values capital markets – the MSCI EM index highlighting rebound possibilities after the man-made and natural disaster woes of Japan and Thailand, a settling of the Arab Spring, South Africa's diffused tensions, Brazil's internal rebound and China's present predicaments.

So western buoyancy, having seen a good run, may be for a time deflated.

But just as normal 'corrections' (ie pause for investor thought) is seen in typical stock growth spikes, so the exponential curve's 'flat-tail' premises time for renewed macro and micro consideration. This does not necessarily mean a partial collapse of confidence, but likely a new growth curve based upon firmer fundamentals rather than speculative re-bound stock buying.

Here, investment-auto-motives believes that any sharp retraction of confidence here and now would only contravene the logic of the broader picture, a picture that sees good reasons for mid and long-term confidence, created by :

a) China's willingness to top-up previous QE measures (presently $35bn)

b) Spain's assertion of continued austerity action to quell fears, 50% pass rate banking sector stress tests, official aid request.

c) France's shift toward 'socialism bounded within global reality'

d) Germany's low unemployment rates, increased pay awards assisting domestic consumption and decision to constrain high frequency trading so stabilise capitalise markets volatility.

e) An improving EU outlook, possibly averting extensive use of ESFS-ESFM / OMT

f) UK's much re-strengthened banking sector, improved growth prospects, still sound credit rating & room for additional QE moves as required.

g) US's ongoing bond-buying ($40bn per month) and retained 0% rate until 2015 with regulated responsible credit easing so assisting consumer spending across SMEs and blue-chip firms, highlights capital markets support..

If western markets are indeed rational, these relatively few but powerful macro indicators point to a more upbeat picture than that being presently painted.

A picture which overly concentrates upon the reduced Q3 & Q4 earnings guidance of many Euro-centric and multi-national companies, perhaps without recognition of the ongoing productivity balancing now inherent as part of new era operations. As witnessed by Volvo Truck, far leaner and more flexible operational stances have been demanded, especially in the areas of labour and supplier relations, which will allow for better commercial rebound than was the case in 2008 and 2010/11.

The Shape of Things Today -

This slow and admittedly painful commercial re-invigoration process, necessary as part of the broader 'structural turnaround' requirement across much of the west has and continues to be the central over-arching theme. Whilst the two fiscal crises brought about undoubted hardships, any contrived continuance of the former period of credit-fuelled 'good living' for governments, companies and consumers, would have simply widened an increasingly untenable cost-base gap between the notionally advanced and EM regions. By international standards, the EU was in danger of operating with increasing over-valuation of its competitive abilities, and the economic region in danger of having to become increasingly isolated to maintain what was essentially cost-driven currency inflation. Thus, many advanced nations, though especially the EU periphery, would have become wholly disconnected from the global stage, creating very real conditions of far greater public distress and possibilities for far right or far left political outcomes.

Instead, the west continues its hard but required 'economic diet', this period setting the tone for re-assessment of not just the usual econometrics of monetary and fiscal policies, but given the size of macro re-shaping required, questions about the basic very socio-economic template of the west. As EM nations are able to replay the west's 20th century industrialisation & commercialisation play-book, so the very high costs of 'saving' America and Europe – undertaken via 'QE' – must deliver a desired strategic social outcomes across (developed) skills and (higher value) employment, on a pan regional basis, so that America and Europe may seek to retain their positions as value-creators, in the face of what have become very capable EM nations.

That EM capability has obviously been derived from industrial and commercial learning absorbed directly or indirectly from the Triad regions (North America, Europe and Japan) and latterly S.Korea, Directly via multi-national companies seeking to expand their global footprints and gain promising new markets (BRICS especially so), and indirectly from a new generation of globe-trotting, constantly technologically & culturally absorbing, nationals. The obvious intent to replicate what is learned from the advanced nations so as to replay.

[NB It could be argued that much of that learning has already taken place throughout the last decade, so putting EM regions on a far more advantageous footing versus US-Euro-Japan-Korea].

The true beneficiary is of course the multi-national corporation, whether western in origin or increasingly so, with much improved financial and cultural 'fire-power', BRIC & CIVETS 'new multi-nationals'.

Many within this latter group will be unknown to average westerner, and often have limited insight amongst western investor groups, broadly followed but at a shallow level by analysts. Yet they have ever growing influence. That lack of general knowledge and deeper insight exists almost by default, as besides being beyond 'western geographies' such companies tend to populate the lower levels of the industrial pyramid. Greater exposure to the lower visibility 'primary' extraction/agricultural activities on a worldwide operating basis, medium exposure to 'secondary' processing/manufacturing activities typically on a LatAm, CIS or Asian regional basis, and though some inhabit the tertiary service sectors (ie telecoms) and have become dominant 'market saturation' players, do so typically on a regional intra-national basis (but have possibly the greatest world expansion ambitions given business model structure and access to retained and geared liquidity).

Though they may be listed on international bourses, and ranging in size from conglomerate to sector-contained, names like CNOOC Oil, BreadTalk and America Movil are still 'off the radar' and so foreign to westerners.

[NB This itself the natural consequence of historic western capitalism].

The Need for Western Advance -

There is increasingly realisation that much of the west is becoming 'left behind' as the gaze of heavyweight investor groups continues to look eastwards and southwards, calculating the investment promise from western multi-nationals' involvement in EM states, and vice versa, the ability of 'emerging multi-nationals' to:

1. improve performance in domestic markets as general population wealth grows

2. collect “unpolished” western assets for business turnaround (typically in premium && luxury domains, eg TATA - JLR)

3. expound the possibility to align domestic EM product & service offerings to the increasingly cost-driven needs of the 'austerity west'.

This much altered contextual backdrop, a reversal of the historical norm, then sets very real challenge for western national industrial policy setting, the strategy & operations of domestically orientated SMEs and blue-chips, and the overall population's skills-base those notionally 'advanced' regions.

'Advanced' a misnomer for notionally 'post-industrial' countries, which today after the credit-boom, are more than ever reliant upon a selection of medium-value and high-value industries for economic health, but must also contend with large sections of the 16 - 65 population who do not have the requisite formally taught or self-educated skills-set themselves to become proactive in those buoyant hi-tech, financial and cultural sectors which are in global demand, but are not geographically evenly spread over a nation.

Whilst certain level of unskilled and semi-skilled is invariably required to service basic service and industrial needs, and a return of 'off-shoring' is occurring thanks to rising EM wage levels, there appears to be very real and relatively urgent need for transformation of western labour-force capabilities. This very much the case because the international capabilities and competition gap within the private sector that has formed over preceding years (1995-2008) – in favour of the much improved EMs – was greatly masked by the west's maintained GDP and GNP growth levels, themselves under-pinned thanks to record (unsustainable, credit-fuelled) government spending to maintain national growth.

The necessary on-going contraction of central and local government funding and so downsizing of governmental responsibility – a central theme of the 'new normal' – means that any repetition of previous government funded job creation schemes in old industrial, economically depressed, areas such as is wholly untenable.

That unfortunate economic void can only be filled by the private sector and public-private partnership projects.

The former has a responsibility to invest wisely for the long-term, undertake ever greater due diligence and likely rebuff only temporary investment incentives. The latter is under new pressure to attract private participation, especially in infrastructure, when it has been noted that commerce dislikes the bounding regulations and terms that accompanying PPP's/PFI's; especially so at a time when governments have less financial and so philosophical and thus operational flexibility, and is more likely to enforce terms to reduce its own exposure.

This then indicates that western nations' future economic fortunes increasingly rely upon the private sector, a sector whose own commercial landscape has altered massively over the last 30 years, the last 5 years of which have been a major watershed.

As a consequence of the very personality of capitalism, seeking to grown general wealth and have such monies re-cycled into the capital markets via various avenues, the strength and role of the private industry – specifically the corporation – has grown and grown. That process, with its pros and cons, has seen organic decay of middle and small sized enterprise, unless otherwise supported as in the German mittelstand, as the power of economies of scale and access to capital for market expansion decides not only the fate of stock-holders, bond-holders and employees, but of local economies; and now in a few select cases, as with Apple Inc, even impact the health indicators of national economies.

The Shape of Things to Come -

However, the 21st century's rise of corporatisation has a distinctly different flavour to that of the 18th & 19th century versions, even arguably that of the 20th century model. Increasingly corporations, with the shop-widow of their prime and sub brands have become increasingly socio-centric, as the products and services of specific brands become ever more entwined into people's lives, consciousness and sub-consciousness; and so an increasing tribal arrangement ensues, promoted by the “socio-corporatisation” effect of web-based presentation and social networking

So whilst product and brand loyalty has always been an explicit part of consumerisation, best seen by the tribal rivalries of Chevy vs Ford pick-up truck owners in the American mid-west, or BMW vs Audi owners in affluent cities and suburbs, today because of the ability for brands to become present “24/7” through personal communications devices, the tribalisation effect of various sectors with especially close relations to its users in reality and hyper-reality (ie meshed reality) means that the corporate ability to mould people's self-identities at an all time high.

Through a wide spectrum of direct 'brokering' personal enablement and indirect cultural 'lifestyle' association, brands such as Apple Inc and RedBull have become far more powerful and socially entwined than product and service providers of the past, even compared to such socially impactful commercial leaps as gas-provision, electricity provision, previous white and browns goods provision, personal transport provision Utility service branding only really coming into effect in recent times when service bundling was introduced, but then only to a small degree as consumers price-hopped.

The commercial beauty of creating socially powerful brands is that – as seen with the model series of improved iPhones' – the elasticity of conventionally rational and so flexible pricing structures is overtaken by the ability to pre-set product life-cycle pricing structures, to control the supply-side provision to constantly be under demand-side levels, so maintaining sector and markets busting profit margins.

There is now arguably more allegiance to socially powerful brands than to the 'old' relationships with socio-groupings such as national identity, community identity, familial identity etc...the breakdown of the “grande narrative” to re-quote post-modernist commentators. Download of an iPhone application at a moment of dire need may create closer personal relationships between (wo)man and machine, and so ultimately more emotional support and so connectivity, than that of fair-weather friends or agenda driven associates.

Each time a desperate informational or physical need is met by a product or service there is in the consumer a reactionary joy akin to a worrisome broken-down motorist stood on a cold, dark road, then seeing the lights of the recovery service truck. At a basic, powerful level, a satisfied need equals advantage and happiness, an unsatisfied need equals disadvantage and unhappiness. The ability to produce the former should be a prime modus operandi for all consumer facing companies.

This possibly an unrecognised process of societal transformation which has uncomfortable overtones.

However, the upside – if it may be called such - is that new social groupings have and are being formed, centred around a 'like-me' perspective; that identity being of course brand(s) centric, fashion centric, and massively influenced of course by cultural / media promotion which merges the once independent interests of the teenager, twenty-something, thirty-something, with that of a mirrored corporate cultural and product offering.

During a period when society as was across western Europe is undoubtedly fragmented with strains upon many inter-relationships, when the 'grande narratives' of family, state and religion fail to unify, the aforementioned metaphor lays the contextual foundations for a world of far greater corporate orientated personal reliance. With it, a sense that corporations will have to take on greater corporate social responsibility, themselves through affiliated agencies, to create a form of responsible capitalism.

Melded Ideologies & Expanded Corporatisation -

The late 19th and 20th centuries saw ructions of socio-economic and thus political ideologies, the forces essentially creating triangularity of ideological choice between Conservatism, Liberalism/Socialism and Communism, the democratic model that emerged reflecting each to varying degrees, but obviously ultimately after 1945 seeing a split between the mixed market economy of democratic Western Europe and a centrally planned CCCP led Eastern Europe.

The 1989 collapse of the Communist ideal demonstrated the power of western democratic capitalism as the most effective force for social progress, the edicts of Adam Smith et al highlighting how it law-bound competition better serves the human instinct for progress and betterment. But of course the 2008 financial crisis – like its 1929 predecessor - with subsequent collapse of living standards for millions ((if not billions) across western Europe, has naturally called into question the disadvantages of the capitalist least in its most voracious form. The 'equal and opposite force' has been a call to far greater socialist, and in some quarters, communist values.

In reaction to this public call, political representation of the left (as in France) and right (as in UK) has had to steer a new course of centralism (as seen in Germany for many years) to both quell public anger and to also critically avoid the rise of true national socio-fascism or indeed a revived communism. When President Hollande backs necessary budget cuts and understands the long-term need for raised short-term unemployment, and Prime Minister Cameron talks of a 'Big Society' it is evident that there is no alternative to new centralist ideals and actions.

However, given the fact that western governments are increasingly financially strained through those necessary austerity measures, and the fact that western consumers are themselves deleveraging it is obvious to investment-auto-motives that the new economic power and thus social power lies in the hands of large corporations...and thus the socio-economic remedy of 'supply-side' economics, ideally assisted by a 'Reaganomic' political regime.

The trend towards the 'corporatisation' of western society has in effect been under-way for some time, with commerce initially seeing to increasingly immerse itself into cultural phenomena through social event sponsorship, and its decision to become far more proactive in humanitarian ideals, most notably through corporate philanthropy.

As such, in an overtly simplistic 'readable' manner, investment-auto-motives has named the process: “Triangulation to Square the Economic Circle”.

The three primary aspects being:

1) Historical economic ideologies of 'left' and 'right' largely debunked, over-taken by socio-economic commercial and policy pragmatism

2) Recognition of a much reduced role of the state, its sprawling divisions, agencies and quangoes, given the untenable cost burden to western society

3) Rise of principles based 'corporatisation', with a closer coupling of banking and industry to create new value from 'under-managed' firms and new firms; and greater autonomy for companies which demonstrate the three pillars of self-sufficiency, the profit motive and 'extended' CSR (viewed in steady long-term climb of share price)

The accompanying diagram – viewed top-right corner (for the length of this web-log) – simplistically demonstrates how this shift of traditional macro-economic perspectives may occur.

The 'Triangulation Effect' within politics seeks to demonstrate that the renowned tri-partite model bounded by the 3 primary ideologues of: Conservatism/Republicanism (pro-Hayak) vs Liberalism/Socialism (pro-Keynes) vs Communism (pro-Marx), has been effectively forever 'condensed' by the events of 2008. Those extreme points of view replaced by a necessarily narrower, less complex 'middle road' system which requires both greater 'input vs output' (ie value creation) accountability for all productive activities.

The 'Circularity Effect', which displays the relationships of the the people, government and commerce, highlights a near-term re-centring and mid-term rightward shift of economic bias, as western government states shrink – so as to only focus resources on the truly needy (elderly and disabled) – and a new powerful and greater economic dialogue grows directly between the corporate world (as a supply-side economic actor) and the consumer world (as a demand-side economic actor).

This then leads to the 'Squaring' (of that Circle) by viewing the re-vitalised closer relationships between a re-invigorated, far healthier, retail and investment banking system (the present ring-fencing expected to diminish as financing needs arise) and newly buoyant industry and commerce; itself growing closer still to the consumer across all levels from utility to luxury purchases (via the previous explanation of 'branded tribalism').

[NB the fact that Facebook is now 'experimenting' with ways to monetise its users personal data demonstrates just one of the methods being used to grow the 'brand tribes' model].

The Inevitable Case for Equities -

By historical norms, many corporate equities are indeed, “down in the dumps” even after the mighty rises from previous disfavour, seen across 2009-11, consumer cyclicals perhaps especially so, and perhaps best represented by under-appreciation of the auto-sector, rebounding markedly in the US as it has, and still affecting even the best positioned European players like Volkswagen, presently trading on a P/E of only 3.45.

Unlike certain government notes, high-yield corporate bonds though presently low on defaults and much sought in recent times are still exposed to the much mentioned 2015 financing wall. Thus mid-yield corporate bonds with a good risk-reward ratio have been massively oversubscribed.

So there is a very strong case to be made that the price of buying equity stakes in what are both continually strong and value generative companies as well as cyclically affected firms – various auto players reflecting both - has never been so attractive.

Constant and compelling news-feed regards the ever seismically shifting macro has arguably over-shadowed the level of required attention towards the micro of balance sheets, profit & loss statements and cash-books. And critically where done so regards the positions of more fragile entities – such as previously described Peugeot SA – such focus has distracted from the true and immediate value of the strong: possibly across all industrial and commercial sectors.

Cash is certainly ‘out there’ – the liquidity holdings of the more readily visible such as: Morgan Stanley, Goldman Sachs, Swiss Life Holding, Credit Agricole, Credit Suisse, Standard Life, Legal & General and even Italy’s ‘Generali’ ably demonstrate the fact. Even under the necessary regulatory intervention that separates retail & investment divisions, investment-auto-motives believes that the banking sector is fundamentally stronger than is generally believed, and will get stronger yet as present cash cushions built-up from central bank funds, external clients and incoming stock investors are added to by growing retail holdings. The internal leverage levels will be much reduced from the ridiculous levels seen pre-crisis, but cash levels will be at record levels and will need to be directed to grow national and western economies.

Though it may appear presently distasteful, to do so, many banks will need to deploy such monies via proprietary trading over the mid-term – even if partially selling-off certain geographic units recently – with also a new push towards fixed-income agreements with secure, wealthy parties (ie the “global elite”) so that they may undertake share trading, M&A and devise share accrual strategies that mesh both internal and external client interests.

Yet there is obviously a vitally important need to ensure attractive purchases, which means an unavoidable process of liquidity drip-feeding into what are and will be the most fit and able companies; many of which – arguably like PSA – are having to undergo a slimming process to regain competitiveness.

Add-in the sovereign debt turmoil of Europe, the growth volatility of the US, the structural re-orientation of China, Brazil and to a lesser extent India, and the reason for that slow drip-feed of cautious capital into good purchase opportunities, as and when they appear, becomes self-evident.

Conclusion -

The consequences of what has been unprecedented global economic disruption are still being witnessed, so the slow and steady approach by what is now a much (forced) changed financial community is unavoidable. Real world conditions altered the typical 'animal spirits' behaviour of once over-exuberant financiers, far, far more so than public humiliation or regulatory precedence.

But, much like the required 'Triangulation to Square the Economic Circle' it would be churlish – indeed foolish – to maintain an unaltered philosophical financial stance as real-world economic and financing conditions gradually improve in time.

Ultimately, if any person that lives in the western world is inevitably a de facto beneficiary of capitalism; whether of Soros or Gates billionaire ilk, a captain of industry, middle-manager, member of staff, high or low ranking bureaucrat, high or low spending consumer, or indeed most obviously but conversely a newbie financier or old aged pensioner.

But more obvious is the irrefutable fact that more and more, many or possible all westerners will rely upon pension schemes that directly draw income from investments in companies that are emerging market orientated and thus draw of the talents and productiveness of emerging market peoples and workers.

Thus, leading to a condition wherein the people's of western society of whatever ideological persuasion have become both the consumers of global goods and unwittingly become the beneficiaries (and so 'capitalist bosses') of emergent market workers.

Fact is that that western governments will need to follow the Scandinavian and EM lead by creating new and stronger sovereign wealth funds (SWF's) to alleviate the future stresses upon internal and external budgets, so that the PIIGS crisis – and the suffering of populations – may rarely happen again. Thus even governments well-being will increasingly need to buy into global capitalism via worldwide, regional and national firms.

Like it or not, no matter what your social standing “we are all capitalists now”, and even more so into the future.

That is not something to be confused about, instead we should be 'Confucian' about how such generated wealth can be best deployed. And to always remember that the most important things in life should never be ascribed a monetary valuation.