activist investors, austerity, Bundesbank, catalyst, CNBC, distressed assets, Edward Gibbon, emerging markets, EUR/USD, Europe, Event Driven, Fed, frontier markets, idiots, Japan, Japanese debt crisis, NAV discount, private equity funds, Red Bull, student debt, US
OK, I confess, this isn’t really about the EUR/USD FX rate. I was beginning another article, and my despair over the developed markets & their prospects just kept interfering..! But let’s try keep this somewhat brief – maybe I’ll return again after reading my Gibbon – and hopefully it will prove a good lead-in for my other article.
Despite the dismal performance in the US & Europe (why even talk about Japan..?) over the past decade, I just can’t get too hopeful from here. I sighed, and resolved again to just ignore the news, when I heard the growing swell of anti-austerity political dissent in Europe (and even fresh mutterings about EUR exit, and devaluation).
Like US consumers, who’ve long reached their predictable ‘frugality fatigue‘, no politician can stick to austerity talk (let alone implement it) for very long… Then again, I must give a little hat tip to European politicians – at least they’ve made a stab at austerity! The idea of austerity looks like sheer fantasy for politicians in the US (at least at the national level). Then again, as some folks have highlighted recently, even austerity talk in Europe seems pretty much an illusion – did you know it apparently means to ‘generally increase government spending at a slightly slower pace‘..!?
No matter how you look at it, the fiscal, debt and entitlement headwinds that the developed markets face in the medium/long term are pretty relentless. And just as they were caused, these issues will be inevitably be compounded by continued political irresponsibility. This will be a pervasive and crushing weight brought to bear on future growth & sentiment prospects in these markets. Sure, monetary policy – less politely known as printing money - has, and probably will, produce some (false) illusion of growth. But you have to wonder if that will be offset by higher inflation, currency debasement and/or other unintended consequences? Since we’re probably all sick of hearing about Europe every day, let’s talk a little more about the US:
Everything I see suggests (some sections) of the US economy/government are very/permanently broken, and the US dollar will suffer severely in the end. In contrast, I’m completely bemused at the arrogance and schadenfreude of the US financial media (CNBC’s the poster child here, as usual), who’ve called for a EUR crash against the dollar pretty much every single day for the past year or two. Which has been dead wrong! But so what, it’s not like they perform any sophisticated analysis or practice any type of accountability anyway… Their very reporting appears to be simply based on the notion that the US is in a superior place to Europe.
But take a look at each country: The vast swathes of uncompetitive industry, the high levels of personal and public debt, the abysmal fiscal/debt situations at the state level (I mean the US as much as Europe), the aging populations and their looming entitlements and, of course, their idiot politicians… Wake up – Europe is America, and America is Europe…and they’re both turning Japanese!
God, I dread to think of the consequences if we wake up some day and Japanese bond yields are doubling or tripling… That really does strike fear into my heart. Judging by the US response to Europe to date, however, a Japanese debt crisis is (ironically) perhaps the only possible event I can conceive of that might steer the US away from the brink in the end. Ugh, let’s not even imagine that… Meanwhile, trying to choose between the US & Europe, particularly in terms of currency, is like trying to choose your favourite leper…
Then again, who in their right mind would prefer to bet on the Fed, rather than the Bundesbank (albeit a diluted Buba), long term for currency stability?!
But the US media may be right eventually (like a stopped clock), but only briefly… We may be entering a (short) period (or perhaps we’re already there) where US growth, however anemic, looks far superior to European growth (or contraction?). But this is no particular indication of fundamental superiority or brilliance – simply a matter of timing and circumstance. The financial crisis originated in the US, and its impact eventually spread globally. Government bailouts and stimulus packages, and large scale quantitative easing, first occurred in the US also. Finally, the bankruptcy & restructuring culture in the US is far quicker and more advanced (yes, a fundamental superiority!) than what we have in Europe.
This all puts the US well ahead of Europe now – but it’s like having a Red Bull to help you bounce back on a Friday morning! It’s a sugar rush – there’s nothing to suggest a sustainable difference or advantage in the US vs. Europe. It boggles my mind to see the (US) media babble excitedly about the European debt crisis, while doing their level best to ignore the current or looming fiscal/debt disaster at the US federal & state level, another looming trillion dollar student debt problem (sure to be a key plank of Obama’s new election…sorry, stimulus plan!), and the 10,000 US baby boomers who are retiring every day and expecting their oh so rich public & private entitlements.
Oh, this is a little too depressing…let’s skip ahead. Bearing in mind the debt and growth outlook for the developed markets, on a broad brush basis I see two major investing opportunities for investors:
i) Emerging Markets: This is the obvious opportunity! Emerging (and frontier) markets offer much higher inherent growth potential, mostly under-valued currencies, much younger populations and (generally) excellent fiscal/debt situations. They also ideally offer better diversification and lower correlations for your portfolio. Their emphasis to date on export growth (to the developed markets) is bound to cause some more bumps in the road along the way, but you’ll now see an increasing focus on domestic/consumer-led growth and intra-emerging markets commerce as a counteracting force. China’s already leading the way in this new direction.
Look at the average investor and it boggles my mind the majority of their portfolio is still allocated to the developed markets, with emerging/frontier markets a v small runner-up… And they really think this is bloody safe..?! A little extreme perhaps, but maybe the portfolio allocation should actually be the exact reverse? This might even prove a nice (wealth) ‘hedge‘ for the average US/European citizen as they ultimately face higher taxes, lower entitlements and far more precarious employment prospects.
ii) Developed Markets: Market bulls point to cheap valuations in the developed markets. Of course this depends on which measures and ratios you focus on… And who cares? First, I’d dispute that valuations are cheap. Looking back historically, and considering the current rather shaky growth outlook (particularly in Europe), I’d describe valuations as merely average. Second, bond yields are crazy low – but supportive of higher equity valuations..? Really? What do you think those yields are telling you, and do you really want to build your house on that kind of sand? And third, look at Japan – stock market valuations can get cheaper and stay cheaper, and the economy remain dead in the water for years… This should also serve as a reminder that mean reversion often means enduring a painful overshoot, instead of a nice smooth glide path towards a happy average.
Sure, if I find a unique (economically insensitive) growth stock story, I’d be tempted to grab it… But as some readers have pointed out, my own stock picks have definitely been biased towards discounted asset/special situations. This was somewhat unintentional at first, but believe me, this is very deliberate on my part these days – it’s not just ‘value investing‘. Every stock (and management) can pitch their special growth story, but the sad reality for the vast majority of stocks is they need a good/healthy economy to rack up any kind of decent growth. They also need a boost to market & investor sentiment (that good economic growth provides) to expand their market multiple. That could really prove to be a tall order…and I’m not even thinking about the further damage that sub-standard/negative growth could wreak.
In terms of less risk AND better reward, the only logical opportunity I therefore see in developed markets is to invest in these asset based/special situations. The general premise is that you’re buying at a discount to asset value, and targeting value that can be unlocked with some kind of activism, consolidation and/or restructuring. The beauty is the discount price reduces your risk, while the path to value is often pretty independent of the economic climate. I’ve already written at length about investing in situations with a compelling catalyst (yes, dear reader, I owe a couple more in that series – I will, but I promise they’re hairier & far less certain!). I also highlighted plenty of listed activist vehicles if you’d prefer to delegate the task. More broadly, however, this opportunity can be best accessed through private equity, event driven and distressed debt strategies.
[Perhaps I should add iii) Absolute Return: The logical extension of ii) above is to go the full hog and also embrace low volatility/correlation absolute return opportunities. These will generally be accessed via managers and funds, rather than individual stocks. They include strategies like risk arbitrage, event driven (as above), long/short, life settlements, trading/CTAs, relative value, some forms of distressed debt etc.]