Sunday, September 19, 2010

Please rethink your bond purchases ... please think ...

We just saw money flow out of domestic funds for 19 straight weeks…who is selling? Those who can’t imagine an improving economy, or better investor sentiment, or new and exciting innovations. Certainly there are hardship cases forcing people to cash in stocks to pay expenses, but with prices the same that tells us someone has accepted the risk that the sellers can no longer take.

Posting here

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Sunday, September 12, 2010

Inflation begins - food inflation is the start

When does serious inflation really start? Well, if you had to pick a point, it might be at a point when many pundits believe deflation is likely, as has been widely discussed this spring and summer by professional money managers.

Two to three years ago, many investment talking heads (myself included) spoke of the potential for emerging and developed countries stock markets to diverge in, at least, the strength of their upward market trend. The idea being that the developed country markets would move sideways, while emerging markets would continue to thrive.

The credit crisis which culminated in the stock market plunge of 2008/2009 of course showed how correlated these markets could be during times of panic. However, there is nothing wrong with the general divergence thesis during normal times, with many emerging markets getting close to re-testing their 2007/2008 price levels. Divergence is or will be here, and remains as real a prospect as ever.

However, there is one place where divergence currently exists: the "anticipation" of inflation/deflation. In developed nations, the worry is that future deflation will set these rich economies on a two-decade Japanese-style slump. In developing economies, the worry is the opposite and, rather than an intellectual debate about the future, the issue is immediate and proximate: inflation, which IS (t)here. Especially food inflation.

Large developing nations, such as India, China, and Russia, have all recently reported jumps in their inflation rates, headlined by significant jumps in food inflation (see here, here, and here). This has even resulted in an overall significant jump in global food inflation too (see here). This is the result of climate change generally, which of course plays out via specific "natural events", such as drought, flooding, and "rainfall dosing" (which is a term I am using to describe the phenomenon of growing season rainfall remaining relatively the same, but is concentrated in far fewer days [but does not consist of "flooding", per se]). This is in addition to the lower yields that are produced from heat-stressed plants. Climate-change induced food issues are here, and they are here to stay for some time.

The only reason that inflation remains off the radar screen of many professional investment types is that, in the western world at least, the food budget typically consists of a very low proportion of overall income. Whereas, however, the opposite is true in the developing world (or more so, even, in the undeveloped world), food budgets constitute a much higher proportion of the total income. So, food inflation has a much greater effect in those countries and feeds into the total inflation picture very quickly. In food, the principle of substitution (the idea that, during inflationary times particularly, folks substitute cheaper but roughly similar items for more expensive ones) has only limited applicability: after all, everyone needs to eat.

Food inflation also enters the general inflation cycle very quickly too (especially farther down the income ladder a country is) because, aside from an inflationary element of its own, the inflation knock-on effect is very pernicious, as the factory worker,, marches into the boss' office, and demands a raise to deal with his deteriorating ability to feed his family. This scene plays out exactly the same way, hundreds of millions times, in hundreds of thousands of bosses offices.

The dream that (some may have that) food inflation emanating in one part of the globe won't spill over somewhere else is likely to be met by the insistent ringing of the morning's alarm clock: free trade in food. As pricing for food rises - there and here - the knock-on effect will also be felt as like looking into a mirror - here and there.

Climate change, and its resultant outputs, will have effects ranging from the evisceration of the capital value of, particularly, long-dated low-yielding stripped bonds, to the more pragmatic, of the renewed popularity of the high-yielding home garden.

So, the weather issues of this summer's northern hemisphere's growing season provide a glimpse into the future: a future which is coming fast. For those who want to understand it better, there's no better place to point your binoculars than at the emerging market countries.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Saturday, September 11, 2010

Emerging Markets - Are you sufficiently exposed?

Pounding the point home, once again.

I have written a great many times (e.g. 1, 2, 3, 4 or all, 5) since this blog started over four years ago, about the need for any forward-looking, growth-oriented investor to have a very serious weighting in emerging markets. A recent article in the Financial Post, highlighting information from Goldman Sachs Global Economics Paper No. 204, makes the point worth repeating, once again.

They point out that the emerging markets now total some 31% of the global stock market capitalization, and suggest that this will expand to 55% by 2030. Is that shocking? Hardly. According to the OECD, a global club of rich countries, emerging markets already have 49% of the global GDP, on a purchasing power parity basis; and they appear slated to continue growing rapidly. Is it a surprise to think that their stock market valuations are slated to follow their growth?

What is shocking, is that against that, Goldman Sachs estimates that developed market investment funds hold just 6% in emerging market equities, out of their total equity allocation. They believe this will rise to 18%, by 2030. In other words, if you are a typical rich country investor, a peek behind the curtain of investments that YOUR investment advisor has gotten you into, would reveal that you are sitting at just 20% the emerging market exposure you should be at, assuming you simply want to mirror the world economic powers (e.g. 6% divided by 31% = 20% exposure). By 2030, the situation gets somewhat better, but your exposure would still be wildly low, compared either to world GDP then, or emerging market stock market capitalizations.

If you wanted to simply mirror global market returns going forward, then seriously underweighting one of the two most easily visible growth investment themes going forward sure isn't the way to do it. If you wanted outsized returns, then you'd likely seek even more participation in rapidly growing economies, assuming you have decent entry points, e.g. valuations not stretched. (Are they currently too high? Not in my book. They are trading at an average PE ratio of just 12, according to the Financial Times, which compares to a PE on the S&P 500 of 14.7).

The other thing to know here, is that the emerging markets are no longer the wild west. They have solid economic principles they are managing their economies on, and populations of great savers (oh, if only the western world were so lucky now!). This makes it pretty easy to suggest that their stock market volatility is going to continue to move down, especially compared to the overleveraged and overspent rich countries.

If you are a growth investor, go wake up your investment advisor, and demand he or she explain exactly why your emerging market exposure is so darn limited.

Disclosure: Participant in the emerging markets theme via DEM, DGS.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Thursday, September 09, 2010

And this is how inflation starts ... climate related food price increases

The Russians have recently decided to continue the ban on wheat exports, until late 2011, as the Russian heat wave and associated drought have reduced this year's harvest to what is currently estimated to be about two-thirds a normal harvest (of course, once they actually harvest and weigh the harvest, I suspect they'll likely find that the actual harvest is less than that; just as happened in America following the 2009 harvest).

In a climate-changed world, this is just what will be one of many stories about inflation arising from food issues. Current estimates are for Russian inflation to increase to 7% from the current 5.5%, due primarily to a "price shock" associated with the reduced harvest. 

A very broad view of a long-term climate-change investment strategy, would be to go long on soft commodities - however, expect lots of volatility, sometimes wild volatility, as part of this equation.

Reuters story here

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Tuesday, September 07, 2010

Dividend Oriented Portfolio Poised to Outperform?

I've recently written about the relatively high dividend yields available from some of the major S&P 500 companies in comparison to the terrible yields in things like US government bonds (10 years at 2.5%) and municipal bonds.

In my opinion, the bull market in bonds is due to come sliding - possibly crashing - down, just as other inflated investments have in the recent past, eg NASDAQ, peak years 2000-2001, US housing market years 2006-2007. Tears are inevitable.

On the other hand, with the idea in mind that you can construct a reasonably safe dividend-oriented, relatively diversified stock portfolio going forward, which provides a yield well above that, AND with decent potential for dividend growth, I screened the S&P 500 for stocks yielding above 3%, in market-leading names I recognize, and with decent (more than 10%) returns on invested capital (ROIC).

Here's the list I came up with, that I think will outperform the S&P500 significantly in total return over the next two years:

The only name that doesn't strictly meet that criteria is General Electric, which has a relatively low return on invested capital, given the capital intensive nature of its business and its past actions as, effectively, a bank.

The dividends all appear reasonably safe with these companies, as they have either relatively moderate payout ratios, or have recently lifted their dividend payments.

The last thing to consider is the potential impact of climate change on these companies over the short to medium term. In my view, none of them have the potential for short-to-medium term implosion, like I detailed for Compass Minerals.

However, some have a bit of climate-change short-to-medium-term risk as I see it, as discussed below:

Altria is a cigarette manufacturer/retailer. It is possible that climate change could affect their business in two ways:

Firstly, smokers tend to be in the lower economic strata; these are the folks who will be most effected  by potential food inflation. If they are spending more for food, then less is available for things like cigarettes which, despite their addictive qualities, are still a discretionary purchase. Some smokers may choose to quit if their budgets become more squeezed, accelerating the already evident trend of sales degradation, or they may trade down to lower margin brands.

Secondly, its possible that there could be some tobacco crop failures going forward (drought or too much precipitation/at wrong time), resulting in higher input costs. This would put Altria in the unenviable position of a margin squeeze, or having to hike prices (resulting in sales loss), or consumers trading down to cheaper brands.

On balance, I would rate their short-to-medium-term climate risk issues as moderate.

Heinz is a food manufacturer who could also be affected moderately over the short-term in a manner fairly similar to Altria. While consumers are unlikely to quit Heinz's type of product (they still need to eat), they may well trade down to cheaper brands with lower margins. Secondly, crop failures could also have a similar impact as described to Altria, above.

Sysco has moderate short-term climate risk, since they are a food distributor who supplies many restaurants. If food inflation picks up, then the general consumer will spend less on restaurant meals, meaning that many of Sysco clients could reduce volumes/orders (lowered revenue for Sysco) and suffer some financial distress (meaning Sysco's accounts receivables could also balloon).

Procter and Gamble is the final one which I believe also has some short-to-medium term climate risk. If food inflation occurs, and leaves fewer dollars on the table of their customers, then their customers may very well trade down from the PG family of premium products, to more economically priced ones.

On balance, I would say that this portfolio probably has average climate-change risk on a go-forward basis.

Disclosure: No positions.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Sunday, September 05, 2010

End of the Equity Cult? Maybe - but don't buy bonds!

Citigroup says that it's the end of the equity cult ...

It has taken 10 years, and two 50% bear markets, to reverse this cult. European and Japanese equities are already trading on dividend yields above government bond yields. US equities are almost there as well. An immediate reincarnation of the equity cult seems unlikely. Global corporates, especially the mega-caps, rushed to exploit cheap financing as the equity cult inflated. They have been slow to redeem equity now that the cult has deflated. Equity oversupply remains a drag on share prices."


The investing buying public is now pouring into bonds, with tragically low yields, at a fraction of the purchase volumes for equities, a ratio signalling a top for bond prices, unless long-term deflation really is coming.

My question is ... how can deflation truly be on the long-term horizon, in the face of obvious and growing disparities between food production, and consumption? Food inflation, always and inevitably, leads to all other kinds of inflation. Long term deflation like Japan - not a chance! (Post-script addition: this food inflation will be caused by, mainly, climate change as the primary driver).

So what piling into bonds will get you, over the medium to longer term (5-10 years), is a yield unlikely to keep pace with inflation, or a price which virtually ensures that you suffer a capital loss if you sell early.

Instead, you can take a dividend yield for a great many S&P 500 stocks which are well above the 10 year US government bond rate, something that hasn't happened for a very long time.

Bonds or stocks? Well, at the yields offered, bonds are now very risky.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.