• "Kee" Points with Jim Kee, Ph.D.


    • Tesla
    • Turkey
    • Midterms Elections


    Tesla

    I don’t usually talk about specific companies in Kee Points. But the fact that Elon Musk hinted at taking his electric car company private illustrates, I think, the key point from last week’s discussion of corporate governance. Publicly traded companies face a lot of pressure to perform – to generate positive cash flow and earn a positive return-on-investment. Tesla is not doing that, and Musk, the company’s founder and CEO, is feeling the pressure. Just markets at work.


    Turkey

    Turkey’s currency, the lira, has lost almost half of its value against the dollar this year. Part of this has been caused by economic sanctions imposed on Turkey by the US. Turkey is detaining a North Carolina pastor (Andrew Brunson) on terrorist charges, which has lead President Trump to double tariffs on steel and aluminum imports from Turkey. Part of the lira’s decline is also due to the markets’ growing loss of confidence in Turkish President Erdogan and his finance minister, son-in-law Berat Albayrak (Financial Times).


    Loss of confidence creates capital flight, and Turks and outside investors are moving their money outside of Turkey, ditching the lira (driving its value down) in favor of more stable currencies like the dollar. This hurts Turkish companies and banks that borrowed money overseas (i.e. in international currencies) because they now require more lira to pay back creditors. Again, just markets at work. The last time the lira collapsed was in 2001, and Turkey was bailed out with a loan from the International Monetary Fund. This time, Erdogan plans to go to China, Russia, and/or Iran (Asian Times). US stocks are selling off but I don’t see any big movements in global financial stress measures (e.g. the Federal Reserve’s various financial stress indices, Treasury-euro dollar spreads, etc.). But of course we are always monitoring these and will continue to do so.


    Midterm Elections

    The ongoing threat of a global trade war continues to worry markets, and it has proven to be the key policy issue for global markets in 2018. But I’d say Trump alone is driving this, not his own party (Republican) or the Democrats (or even his own advisors!). If you think about it, that means that the US mid-term elections are neither here nor there with respect to the trade angst that Trump has initiated. In other words, the midterm elections have no real bearing on the number one issue facing markets this year. That is something to keep in mind as we head into the fall election season here in the US.


  • "Kee" Points with Jim Kee, Ph.D.


    • Japan
    • Corporate GovernanceUS
    • Corporate GovernanceJapan
    • A Long-Awaited Change?
    • Why is This Important?

    There were several articles in the press last week that I thought deserved more emphasis than they got because of their broader applicability. This week I am going to focus on Japan.


    Japan

    When Japanese Prime Minister Shinzo Abe was (re)-elected in 2012, he proposed three areas of reform or stimulus to get the Japanese economy growing. Known as Abeconomics, these three “arrows,” as they continue to be called, are, (1) monetary stimulus, (2) fiscal or government spending stimulus, and (3) structural reform including corporate governance reform. Most of the policy emphasis since 2012 has been upon the first two, fiscal and monetary reform. At the time (2012), I wrote in Kee Points that these were unlikely to move the needle much on Japanese growth because, fundamentally, Japan’s problems weren’t monetary or fiscal. And indeed since then the Japanese economy has averaged just under 1.3% average annual real GDP growth (Japanese stocks did turn upward after a 15-year decline). That’s a little above its longer-term average growth rate of just under 1% growth, but not much. From an investment perspective, Japan’s problem is corporate governance.


    Corporate GovernanceUS

    Does a company use its resources efficiently and profitably? That depends upon the system of rules or processes by which a firm is managed and controlled, which is known as corporate governance. For example, in the US the emphasis – since the late 1980s – has been on profitability or Return-on-Investment (ROI). This is made manifest through management buyouts (MBOs), M&A activity (mergers and acquisitions), and private equity actions (formerly LBO’s or “leveraged buy outs”). These corporate governance actions fall under the rubric of “the market for corporate control.” They are aimed at replacing underperforming managements and selling off underperforming assets in an attempt to unlock hidden or potential value. In fact, in his Nobel Lecture, economist Merton Miller argued that the legacy of the 1980’s corporate buyout movement was that it forced all managements to behave as though they had been “LBO’d.” The result is that US companies have the highest ROIs in the world, averaging about 9.5% real or inflation-adjusted (Credit-Suisse HOLT). They also have the highest shareholder (investor) returns.

     

    Corporate GovernanceJapan

    Japan, on the other hand, has had a corporate governance problem for decades, which has resulted in companies there misallocating capital (i.e. not using it profitably) for decades. In fact, the whole ‘managing for shareholder value’ revolution described above that occurred in the US from the late 1980s to present has been absent in Japan over the same period. Japanese managements have not been compensated with stock, and Japanese people have not been encouraged to own stock. Company takeovers and buyouts have been discouraged or barred. As a result, Japanese companies have the lowest ROIs in the world, or about 4.5%. Thatis why US shareholders have gained tremendously over this period, while Japanese shareholders have not. It is one reason why the US is not the next Japan.


    Long-Awaited Change?

    But it appears that corporate governance reform in Japan may be at hand, a key aspect of Abe’s Third Arrow. Last week, the Wall Street Journal had an article titled, “Japan Inc. Is Decluttering – and Foreign Investors Love the Look.” The article pointed to the growing pressure to improve returns (ROIs) and corporate governance, citing the Abe Government’s push for a “greater focus on shareholder returns – not traditionally a high priority for Japanese executives.” My intention here is not to make a case for or against investing in Japanese companies. It is to draw a broader insight.


    Why is This Important?

    Looking at the world broadly, US corporate governance rules favor shareholders the most, while in other regions like Europe, shareholders share the focus with workers (and/or environmental concerns), and in Japan shareholders have been pretty much neglected until recently. That explains a lot of the shareholder (i.e. stock market) returns in these countries, and it is important. Most discussions about international investing focus on two things, country growth rates and market valuation levels. Those are important, but incomplete. What is missing is corporate governance, which varies substantially from country to country. Accounting for differences in corporate governance, and the consequent differences in ROIs, does a much better job at explaining long-term investor returns in different countries.


  • "Kee" Points with Jim Kee, Ph.D.


    • US Economy
    • Trade Restrictions
    • Stocks and Elections

    US Economy

    As expected, second quarter GDP growth (annualized) came in fairly strong at 4.1%, and first quarter GDP growth (on average the lowest) was revised upward from 2% to 2.2%. As a reminder, one quarter’s GDP number has almost no predictive power as to what the next quarter’s GDP number will be. However, most economists expect growth to remain strong over the next few quarters, barring any real ratcheting up of trade tensions, which is possible. The other item of concern out there is the midterm elections, where betting odds are already giving a slight edge to the Democrats to win the House, and the Republicans to retain the Senate (HCWE & Co.). Here are a few “smart points” (I hope!) on each:


    Trade Restrictions

    Consumer surveys like the University of Michigan’s Survey of Consumers show growing concern over tariffs. About 15% of survey respondents mentioned concerns about trade in May, and that has risen to 35% in July (Knowledge@Wharton). Right now, the US is engaged in three simultaneous trade “feuds.” The first is with China, the second is with Canada and Mexico through the proposed rewritings of NAFTA, and the third is with the European Union (e.g. the US has imposed tariffs on steel and aluminum exports). In general, tariffs protect domestic producers at the expense of domestic consumers, who pay higher prices for imported goods. In practice, the market itself - meaning supply and demand responsiveness or “elasticities” - determines how much of a tariff is passed on to consumers in the form of higher prices, and how much is absorbed by producers by paying less to suppliers, workers, shareholders, etc.


    And it just gets more muddled from there. Currently, many countries subsidize their exports by giving exporting companies access to cheap or government-provided capital, whereas in more market-oriented economies, companies have to compete for and pay more for capital. And different countries have different levels of labor and environmental regulations, which leads to different cost structures for companies from different countries. Immigrants and refugees, typically thought of as two different groups, are also causing some global confusion with respect to immigration policy. Finally, the decision-making of global firms maximizing profits does not necessarily take into account national security issues, so there is some potential conflict there. For example, it might be profitable for a company to share sensitive technology with a country in order to have access to its customers. There are probably a few circumstances where such decisions could lead to higher shareholder value, while at the same time compromising US security (Asian Times).


    As an economist, I still hope for a “bullish outcome,” one where on balance trade restrictions are reduced rather than increased. That seems to be what the world would like to see. The differences today are that the US (i.e. Trump), to quote Jeanie Wyatt, is the trade bully while the rest-of-the-world is arguing against restrictions. That’s different from the past, where the “Washington Consensus” promoted trade liberalization, and the rest of the world often fought it.


    US Stocks and Elections

    If history is any guide, the market will probably be range-bound (i.e. up and down) until the election, with a decent bounce in November and December. That’s the historical pattern for US stocks during midterm election years: The market starts off strong and then sells off and bounces around without a strong trend until after the election, at which time it finishes strong, resulting in positive but below average returns for the year. So far that’s what we’ve seen during this midterm election year as well.


  • "Kee" Points with Jim Kee, Ph.D.


    • Yield Curve Again?
    • Trump and the Fed
    • Three Forces and The Dollar
    • Dollar and Currency Wars
    • That Goes for Oil Too

      

    Yield Curve Again?

    I know I have talked a lot about the yield curve in Kee Points lately, so I know the topic is getting tiring. However, I did want to share with you a few insights from a recent Credit Suisse report titled, “U.S. Equity Strategy: Yield Curve Inversion Won’t Signal Doom.” Over the past 50 years in which inverted yield curves have preceded recessions, the lead time has been very inconsistent, with recessions following anywhere from 14 months later to 34 months later. Equities (stocks) rose an average of 15%-16% in the 18-month period following an inverted yield curve, with a range of between -11% and +30% (Credit Suisse). The note asserted that historical flattenings have anticipated slowing growth, while today’s flattenings are due to divergent global economics as longer-term treasury yields are “tethered” to other sovereign (government) bonds, while short rates reflect stronger U.S. growth (and concomitant Fed policy).


    Trump and the Fed

    Speaking of Fed policy, I am sure you saw in the press that President Trump was “not thrilled” about the Fed’s recent rate hikes and its stated intentions to continue with more hikes going forward. The President feels that the Fed’s actions could derail the nascent economic recovery, and his comments caused a small media frenzy over whether or not he was threatening central bank independence. To be honest I think the media was just trying to spice up a non-event. But as an economist I can tell you that central bank independence is important! Most economic textbooks display the relationship between central bank independence and economic growth across different countries and time periods. Without a doubt, countries with central banks that operate independently of whichever political group happens to be in power at the time grow much faster (i.e. enjoy more opulence) than those who’s central banks are controlled by the current ruling party. Central bank independence is measured by things like price stability (particularly in developed countries) and central bank leadership turnover (particularly in developing countries). Perhaps no central bank is truly or purely independent, but a high degree of independence is definitely preferable to a low degree of independence.


    Three Forces and The Dollar

    The value of the dollar relative to other currencies (i.e. exchange rates) is driven by (at least) three somewhat independent forces today. The first force is a “safe haven” effect, as global money flows into dollars and drives up the dollar’s value whenever there is some large global concern. The second force is differential central bank policies, as the central bank of the United States (the Federal Reserve) is moving rates higher and has ended asset purchases, while central banks in the rest of the world (Europe, Japan, China) are still targeting low rates. This makes income-yielding investments in the US more attractive than those in other parts of the world, and investors bid up the price of dollars to purchase them. Finally, differential growth rates between countries (even if central bank policies were identical) tend to lead to differential rates-of-return. When growth is higher in the US than in the rest of the developedworld at least, it can lead to capital inflow and a demand for dollars.


    Unfortunately, many analysts focus on just one of these three forces, which leads to confusion or partial understanding. For example, you often hear analysts say, “strong economy, strong dollar.” That reflects the last force, or differential growth rates. But in fact, you can have a strong economy and a weaker dollar, if the economies in the rest of the world are growing even faster. It is growth relative to the rest-of-the world that best describes the relationship.


    Or you can have a situation like last week, when President Trump attributed the dollar’s strength to the second force, or central bank policy. Trump suggested that the Fed’s actions of raising rates, when the rest of the world’s central banks are not, is making the dollar too strong and hurting US exporters.


    Finally, you can have a situation like the global financial crisis in 2007-2009, or the Standard & Poor’s downgrade of US debt in 2011. The dollar spiked (rose) dramatically in those periods, and that was because of the first force, the safe-haven effect. My point is that all of these factors―the safe haven effect, differential central bank policies, and differential growth rates―affect the dollar to varying degrees in different time periods. Don’t fall into the error of always ascribing the dollar’s movements to just one force while ignoring the others.


    The Dollar and Currency Wars

    China started pegging its currency to the dollar back in 1994, and it acquired instant monetary credibility by doing so. But when you tie your currency to that of another country, and your growth accelerates dramatically relative to that other country, then there is pressure for your currency to appreciate. That was China in the 2000s after it joined the World Trade Organization in 2002. Many in the US at the time charged China with keeping its currency artificially low by not allowing it to float and appreciate relative to the dollar. But others advised China that if it cut its currency’s link to the dollar and let it float, it might just lead to capital flight and a currency collapse, because it was not known whether or not the world was interested in holding a freely floating fiat (not backed by anything) currency from a communist country. China chose to incrementally loosen the band around which it pegged its currency to the dollar, allowing it to appreciate a little while being called a currency manipulator at the same time. Today, with China’s growth slowing, the forces on China’s currency are the reverse, or for it to weaken.China is again loosening the peg a little and allowing the currency to depreciate, and again it is being labeled a currency manipulator. I think these kinds of situations reflect the lack of any real kind of global monetary framework or coordination in the world at present. This was hinted at in a Wall Street Journal editorial on Monday, which is perhaps a topic for another Kee Points.


    That Goes for Oil Too

    Last week I mentioned devoting a Kee Points to the topic of oil, but this is not that Kee Points! However, I did want to point out that the error mentioned above, of always seeing a market in terms of just one force working upon it while neglecting or being ignorant of other forces, often occurs in oil market discussions. Oil is influenced by global demand, global supply, and by the value of the dollar. The dollar influences oil prices because globally oil is priced in dollars (If the dollar is weak, it takes more of them to buy a barrel of oil, and the price of oil in dollars rises. If the dollar is strong, then it takes fewer dollars to buy a barrel of oil, and the price of oil in dollars falls.) Like the dollar, all of these forces are typically influencing oil to varying degrees depending upon the period, but I am surprised by how often I see some analysts always talk about oil primarily in terms of the dollar, or of global demand, or of global supply conditions. You should always start by recognizing all three.


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