Category
Martin Hutchinson
-
It's Time to Brace for a Repeat of 2008
If you think the global economy is out of the woods now that the European Union (EU) has expanded its effort to solve the sovereign debt crisis, then I'm afraid you're sorely mistaken.
No doubt, the European crisis is far from being solved – but that's hardly the only potential economic catastrophe looming on the horizon.
Indeed, two successive articles in the Financial Times last week warned of a new disaster approaching: They forecast 25% declines in financing volume for both commodities finance and aircraft purchases in 2012.
Now that would be truly bad news.
You see, the most job-destroying feature of the 2008-09 recession was a 17% decline in world trade that was caused by the financial crash and the disruption to the world's banks. That decline intensified recessionary conditions and caused millions of job losses worldwide. Some 700,000 jobs were being lost each month in the United States alone for a period in early 2009. That's more than double the previous worst monthly losses since World War II.
And now we could be in for a repeat.
In fact, it's hard to see how one can be avoided.
In today's distorted world financial system, a combination of over-loose monetary policy, intractable budget deficits, and tightening regulation seems to have made a credit crunch more or less inevitable.
So if you're smart, you'll take a moment to examine exactly why, and then figure out who the winners and losers are going to be.
Here's how.
A Disruptive Disconnect
When you look at bank lending, it's clear that the link between the huge amount of world money growth and the meager supply of lending to productive enterprise is broken.
U.S. Federal Reserve Chairman Ben S. Bernanke and his international colleagues can hand as much money as they like out to banks, but if the banks don't lend it, that money will be wasted. And right now the banks aren't lending to trade and private businesses for three reasons:
-
The BRICs Will Be Dead Weight in 2012 – Invest in These Five Emerging Markets Instead
Don't let the headlines fool you, there's lots of money to be made in global investing in 2012.
You're just going to have to be careful – more so than in years past – because right now the line drawn between successful markets and markets that are in danger of collapse is treacherously thin.
Take the fashionable growth markets, the BRICs – Brazil, Russia, India and China – for example.
Dead Weight
It's been 10 years since Chairman of Goldman Sachs Group Inc. (NYSE: GS) Asset Management Jim O'Neill coined the BRIC acronym. His recommendation was certainly effective – one of the best of all time, even. But today, all four BRIC countries face problems, and their troubles illustrate the dangers of following investment fashions.
Just take a look:
- China appears the least troubled of the four BRICs. However, it looks to be facing a recession, inflation is approaching double digits and there is a massive bad debt problem in the banking system. Too much money has been invested in uneconomic rubbish – "malinvestment" as the Austrian school of economics calls it. My own guess is that China will do fine long-term but you probably don't want to invest until the size and shape of its problems is clear.
- India has a government that can't stop spending, inflation over 10% and huge corruption. Furthermore, its stock market is still pretty inflated. I wouldn't put much money there until the government changes. Contrary to what you read in the media, almost all the real liberalization progress came under the Vajpayee government of 1998-2004, which the Indian electorate then ungratefully threw out. I'd want an Indian government without the corrupt socialist Congress Party before I'd invest; only then could I be sure that Indian gains would not be poured down a rat hole.
- Brazil has been run by big-spending socialists since 2002 and has been immensely lucky to benefit from the commodities boom. Now the boom has topped out (probably temporarily) but its government is still overspending and has begun to harass foreign investors. Brazil is in big trouble if commodities prices fall.
- In Russia, Vladimir Putin will become President again next March. Need I say more? Like Brazil, Russia has benefited immensely from the commodities boom (in its case, primarily the run-up in oil prices). However, it treats foreign investors even worse than Brazil does, it is even more corrupt and it appears to be running out of money.
If the BRIC's prospects are bad, those of much of Europe are even worse.The Eurozone's debt problem could have been solved early on by throwing Greece out of the euro (a much deserved punishment). However European authorities have now thrown so much money about in such unproductive ways that it's doubtful whether the euro is even salvageable anymore.
A recession in 2012 seems unavoidable, although Germany may benefit from the problems of its trading partners (if it is not forced to bail them out). Well-run European Union (EU) members that are not part of the Eurozone, such as Poland, may also benefit from the chaos, although Poland's current foreign minister Radek Sikorski doesn't seem to think so.
Japan has done so badly for so long that it may be impossible to revive. If public debt were still at the level of a decade ago, Japanese shares would be a screaming buy, as the market is at a quarter of its 1990 peak. However, with debt around 220% of gross domestic product (GDP) and no sign of the country's budget problems being solved, it may be nearing the point of no return and eventual debt default. On the whole, it's best avoided.
Apart from the United States, that leaves one obvious rich-country market, [To continue reading, please click here...]
-
Master Limited Partnerships: A Simple Way to Put More Cash in Your Pocket
These days, high-yielding investments are a must-have for investors.
It's nonnegotiable. This market is simply too volatile to be taking long shots. You have to be prepared for the next potential market dip, and that means having a steady stream of "bonus" cash coming in on a regular basis.
Unfortunately, interest rates right now are absurdly low, junk bonds are too risky, and high-yielding stocks are few and far in between.
That leaves just one place to look for serious income: Master Limited Partnerships (MLPs).
MLPs, for those not familiar, are tax-advantaged limited partnerships whose units are traded on exchanges just like common shares of stock.
However, a key difference between MLPs and stocks is that MLPs pay very high yields – typically 5% to 12%. This is because U.S. law mandates that they pass most of their income on to unit holders.
Still, being limited partnerships, their ordinary shareholders do not suffer unlimited liability (as they would in a regular partnership) and so can treat their investment as if it was in an ordinary company.
However, because their income is not taxed at the partnership level, the government limits the kinds of businesses that can use the MLP structure. It's restricted primarily to operations engaged in the extraction, storage, and transportation of energy commodities, which are deemed essential to the U.S. economy and national security.
As a result, MLPs derive 90% of their income from natural resources – primarily oil, natural gas, and coal production and transportation.
Two especially attractive businesses for the MLP structure are pipelines and ownership of existing oil resources. Pipelines generally charge a fixed fee per unit of product carried, so they earn a steady return that can safely be paid out to investors. Existing oil and gas fields incur no exploration costs and only limited production costs. Meanwhile, their exposure to oil and gas prices can be hedged in the futures market, so they, too, can safely pay a fixed dividend to investors.
MLPs economically bear more resemblance to fixed income investments than to regular shares. However, the drawback is generally very little upside potential, except through variation in oil and gas prices.
Additionally, if the MLP is invested in a finite pool of oil or gas, there is a finite lifetime to it, and the income to investors may be accompanied by a gradual loss of principal. Fortunately, MLP tax treatment accounts for this, and so a large portion of each year's dividends is considered a return of principal. That may have advantages to some investors holding MLPs in taxable accounts.
MLPs are generally not very risky, and bear a strong resemblance to each other, so even though there are two exchange-traded funds (ETFs) that invest in MLPs – the Alerian MLP ETF (NYAE: AMLP) and JP Morgan Alerian MLP Index ETN (NYSE: AMJ) – there does not seem to be much advantage.
Instead, you're better off investing in one of the following three high-yielding MLPs:
-
Euro Meltdown: This One European Country Can Bring Down The Entire EU… And The Rest Of The Global Economy With It
-
These Two Emerging Markets Just Got A Lot More Enticing
With U.S. economic growth on the wane and the European Union (EU) on the brink of collapse, there's never been a better time to increase your exposure to emerging markets.
And two fast-growing developing economies just became a lot more enticing.
I'm talking about Colombia and South Korea – both of which just signed free trade agreements (FTAs) with the United States.
Both treaties date back to the last days of the Bush administration – when bilateral trade deals were fashionable – but had gotten hung up in Congress.
To some extent, free trade agreements merely deflect trade from other paths. However, since the EU has signed a trade deal with South Korea and is negotiating one with Colombia, there are both defensive and trade-building reasons for these deals.
South Korea is a trillion-dollar economy and one of the United States' most important trading partners, with two-way trade totaling $74 billion in 2008. And Colombia's potential as a trading partner is enhanced by its geographical position – close to both the East and West Coast U.S. markets.
Both countries are growing quite fast. In fact, Colombia is expected to clock growth of more than 5% in 2011 and 2012.
The Biggest Beneficiaries
The South Korean deal offers the most potential to U.S. exporters, as the deal is expected to add about $10 billion to U.S. exports and gross domestic product (GDP).
U.S. exporters of agricultural products, which are projected to double from their current $2.8 billion, will be the primary beneficiaries. However, U.S. auto manufacturers and banks will also have a chance to break into the market.
On the other side, Korean exporters of cars, trucks and computer equipment will benefit from better access to the U.S. market.
Colombia has a thriving agricultural sector, but U.S. meat exports should jump significantly. Pork exports, for example, are forecast to grow 72%. IT companies and chemicals producers also will gain improved access to the Colombian market. But the greatest potential will be unlocked in the heavy equipment sector, as Colombia races to develop its mineral resources.
Reduced sanitary inspection barriers will improve the trade flow both ways. That will increase demand for Colombian coffee and flowers. But the big breakthrough will be in Colombia's energy sector, as the country's oil is an increasingly important export to the United States.
Now let's take a look at some of the specific companies that will cash in on these deals.
-
The One Country That Could Take Down the Eurozone – And It's Not Greece
It's been a rough few weeks for the Eurozone.
Portugal is still in trouble, Spain will be back on the coals after its Nov. 20 election, and if I were a bond trader, I would be shorting Belgium, which has serious deficit and debt problems, runs for months at a time without a government and is in some danger of splitting apart into its French and Flemish bits.
A bailout package for Greece has been agreed to, but the Greeks are struggling to form a government to implement it. And yields on Italian bonds are moving ominously higher, rising above the 7% that some think marks a point of no return.
So does this mean that a euro breakup and a Eurozone economic collapse are inevitable?
Not really.
In fact, of all the European nations in crisis, only Italy has the potential to take down either the euro or the global economy.
Just take a look for yourself.
Getting Rid of Greece
At this point, Greece obviously is a goner as far as the Eurozone is concerned.
Really, it should have been pushed out 18 months ago, when it was first revealed that the country falsified its figures to gain acceptance into the Eurozone in the first place. Its government deficit at the time was 12% of gross domestic product (GDP) – not the 6% it claimed, let alone the 3% it had agreed to abide to on its entry.
French President Nicolas Sarkozy already has admitted it was a mistake to let Greece into the Eurozone, because the gap between its economy and the well-managed polities of Northern Europe was much larger than the area's other members.
Former communist countries like Slovenia and Slovakia have integrated quite smoothly into the Eurozone, because their governments and people had already acquired the discipline necessary for membership. But since its entry into the European Union (EU) in 1981, Greece has lived on handouts, and raised its living standards artificially to a level two- or three-times the market value of its output. Exit from the euro is inevitable; Greece's problem cannot be solved in any other way.
In fact, the sooner Greece exits the euro, the better. As it stands now, it's rapidly becoming impossible for Greece to get its debt down to a manageable level, since the country's official debt has been deemed untouchable.
Once the EU leaders acknowledge the need to remove Greece from the Eurozone, the country's exit will be neither difficult nor damaging. The process of recreating the drachma will be similar to that followed in Slovenia, Croatia, and other ex-Yugoslav republics which abandoned the Yugoslav dinar in the 1990s.
Inevitably, Greece will have to default on much of its debt, but it's already doing that now.
So if it's handled correctly, Greece should not be a problem for the Eurozone or the world economy.
The PIIG Pen
The other smaller Eurozone weaklings aren't major problems, either.
-
Obama's Housing Plan: Subsidizing the Terminally Stupid
President Obama on Oct. 24 announced yet another housing bailout.
This time, borrowers who are underwater by more than 25%, are on time with their payments, and have Fannie Mae/Freddie Mac mortgages dating before March 2009 will be allowed to refinance their home mortgages at cheaper rates.
That looks to me like subsidizing the terminally stupid.
Housing loans are non-recourse in most states. So if you're underwater on your home loan by more than 25% and you're paying an above market interest rate of say 6% on your loan, you're paying around 10% of the value of your house to the bank every year (including principal) while being unable to move. Since rental yields are in the 4% to 6% range, you'd be much better off walking away from the house, taking the hit to your credit rating, and renting for a few years.
The problem with all these federal schemes to assist underwater homeowners is that they prevent the market from clearing. That leaves an overhang of properties with owners who either cannot pay the mortgage or have a mortgage hugely larger than the value of their home.
In a free market, a tsunami of foreclosures would have occurred by now, and buyers could be sure that a price bottom had been reached. But in today's market, even though the S&P/Case-Shiller 20-city home price index has shown signs of bottoming out, buyers know there is a lot of artificial support being applied and have no assurance that the market won't lurch downwards again after they have bought.
Yet, economically, conditions are right for the housing market to bottom out.
Third-quarter gross domestic product (GDP) was up at a 2.5% rate, and, more importantly, private sector output rose at a 3% rate. That isn't a raging boom, but it shows that there is no immediate prospect of the economy sliding back into recession.
Interest rates are close to record lows. House prices, having returned on average to about 2002 levels, are now as affordable as they were at the bottom of the last downturn in the early 1990s.
The rental market also is showing considerable signs of strength. Economic recovery and an uncertain housing market are driving people into renting and pushed rents up. That, together with the overhang of pre-foreclosure homes, is now the principal obstacle to further housing recovery.
Of course, in the more economically vibrant areas of the country, such as the Mountain states and Texas, where unemployment is low, both home purchase and buy-to-rent deals are very attractive for those who can obtain mortgage finance.
To continue reading, please click here… -
Three Lessons From the Collapse of MF Global
In today's politically charged atmosphere, it's nice to occasionally find a situation in which everybody wins. And that's exactly what we have with the collapse of MF Global.
Politically, this failure unites both liberals and conservatives.
Liberals can rejoice, rightly, that Wall Street's pushback against the "Volcker Rule" – the provision in the Dodd-Frank act that said banks should not engage in proprietary trading – has been exposed as completely spurious.
And conservatives can rejoice in the come-uppance of a man who represented the worst of modern Wall Street's obsession with trading and flirtation with left-of-center politics.
Indeed, Jon Corzine turned Goldman Sachs Group Inc. (NYSE: GS) from a respectable corporate finance house into a dodgy trading-dominated casino. And, as if that weren't bad enough, he pushed New Jersey to the edge of bankruptcy. What a career!
Of course, apart from enjoyable schadenfreude on both sides, there are lessons to be learned. But before we get to exactly what those lessons are, we must first perform an autopsy on MF Global to see exactly what went wrong.
How to Kill a Company in 19 Months
MF Global started as a medium-sized derivatives broker before taking over Refco – a major name in commodities brokerage – after that group's 2005 collapse. And while it may be hard to believe now, MF Global at one time was extremely well connected, effectively managed, and had a solidly established business.
Of course, that all changed when Jon Corzine took over in March 2010.
Fresh from his term as governor of New Jersey and flush with cash from his lengthy stint at Goldman Sachs, where he was chairman and CEO from 1994 to 1999, Corzine was determined to make MF Global a major investment bank.
To accomplish this goal, Corzine essentially bet on the same equation he had used in his transformation of Goldman – that brokerage plus hedge fund equals investment bank.
To that end, he took risks with its own capital and maintained an advantage over Goldman and Morgan Stanley (NYSE: MS) by having no banking license. The absence of a license meant MF Global was free from onerous banking rules on leverage and (potentially) on proprietary trading. And under Corzine's direction, MF Global made the disastrous decision of betting too heavily on European sovereign debt.
Corzine believed that bailouts would continue ad infinitum, and that investors would not be made to suffer losses on their investments in such debt. Naturally, under "mark-to-market accounting," the write-down in MF's positions gave the firm enormous losses.
MF Global filed for Chapter 11 bankruptcy Monday after credit downgrades led to margin calls on some of the $6.3 billion in Eurozone sovereign debt the bank held. The position was five-times MF Global's equity.
And so MF Global failed just 19 months after Corzine took over.
As I said earlier, we can take some time to bask in the schadenfreude of all this, or we can take the opportunity to relearn some important lessons – three to be exact.
Those lessons are:
