December 14, 2004
Forget the Fed, Bank Loans are Back. Buy Small Caps
The Fed raised the Fed funds rate one-quarter percent again today, which took the inflation worriers by surprise; pushing 10 year Treasury yields 19 basis points lower, and turned my screen completely green as stock prices responded. The real isue is business loans, and they are heading up.
This is one of those stories you can use over and over again. It seems like investors talk themselves into believing inflation is rising every six months. When they do, take their bet. This economy is driven by productivity growth, which means lower costs and prices and rising profits. Inflation is not a problem.
Most important point about monetary policy is not the Fed's rate move today. It is the fact that banks, which had shut their doors to business lenders from late 2000 til this May, have opened for business loans again. Loans were down $230 billion from December, 2000 to May, 2004, the sharpest decline since the Great Depression. Since then business loans have increased by about $30B, as you can see below.
It's small banks, not the big ones, that are lending as you can see in the chart below. That's very important for growth and hiring in small companies, which make up more than 50% of GDP and 75% of new jobs. This economy is going to grow by 4% or more next year.
The return of banks to business lending creates an interesting opportunity in the market. Large companies never borrow money from banks; small companies only borrow money from banks. This should make small cap stocks outperform large caps as small companies respond to the sharp implicit drop in their cost of capital as banks become more friendly. They have increased by nearly 20% since their August lows.
Collateral evidence in the middle market buyout business, where lenders are lining up for meetings and sending huge boxes of candy to private equity sponsors again (and it's about time; I was getting hungry.) Today's market, with small caps (IJR) up big relative to large caps (SPY), is an illustration. And you are going to hear a lot of we love small business talk this week from the White House meetings this week. I am staying long small cap stocks.
JR
Posted by John Rutledge at 4:16 PM
December 13, 2004
We Need a Telecom Network Ownership Society
This Wednesday and Thursday I will attend the White House Economic Summit where we will discuss the the President's Ownership Society agenda. Ironically, down the street, the FCC will meet Wednesday to discuss a draft of their long-awaited Tri-Ennial Review order (TRO) that has been circulating in WDC. Language in the draft could be a real setback for property rights in the sector by imposing (deep-discount) controlled prices on access to large buildings, even where it is already being provided at market terms. We need clear network ownership rules to generate the capital spending we need to compete in the global markets.
The DC Circuit Court decision six months ago plainly told the FCC to restore property rights in network assets. They have made progress doing so for broadband. But now the FCC is trying to give the CLEC's a boost by entertaining switching high capacity access from market prices to (discounted) controlled prices. And this in spite of the strong stock prices for the major CLECs since last summer, AT&T's recent positive earnings signal, last week's Sprint-Nextel merger announcement, and recent indications that landline capital spending in the sector is finally rising.
We don't need King Solomon. We need an FCC that follows the law and the direction of the courts.
CLECs already have access to the buildings--over 535,000 lit buildings through owned networks and commercial leased access agreements with other network owners. And CLECs own more than 300,000 miles of fiber today.
This isn't about access; it's about money. Forcing carriers off commercial agreements onto controlled TELRIC pricing would lower lease costs by more than 30% -- a huge corporate welfare payment to the CLECs. Ruling on competition levels building by building would be a legal and competitive nightmare.
The FCC granted the ILEC's flexible pricing for special access in 2001; since then prices have declined more than 10% per year.
The study of telecom reform the US Chamber of Commerce delivered in October, with me among the authors, estimated that well-defioned property rights and other reforms could trigger $58 billion of capital spending and over half a trillion dollars of GDP over 5 years, cut telecom per-minute charges by half, and permanently increase productivity by providing small businesses with the high-speed telecom services they need to compete with other companies in China, Korea, and India that already have it.
Time to get going on that agenda.
Posted by John Rutledge at 7:11 PM
December 10, 2004
John Snow's Re-Appointment Good News for Tax Rates
Today the White House announced the President had asked my good friend John Snow to remain as Treasury Secretary. That's great news for the economy and the stock market.
John is a real believer in the power of low tax rates to improve growth and stock market values. He was the point man two years ago in pushing the dividend tax cut through Congress. Since then equity values have increased by nearly 40%, some $3 trillion dollars.
He can help do it again in 2005.
This time the stakes are even bigger. Make the lower marginal rate permanent. Reduce the dividend tax rate to zero. And reform social security to allow people to own personal retirement accounts. Together these changes could give both the US economyu and the stock market a real lift next year.
Posted by John Rutledge at 12:13 AM
Iraq Update
Today I had lunch in New York with a senior retired military officer who has just returned from Iraq. His observations are not encouraging.
Although he believes, as I do, that Iraq will hold elections in January, the security situation is not improving. A sobering fact: 43% of US troops in Iraq are reservists or national guard, not regular military.
More sobering still: there are a number of dozen sites in Iran where Russian advisors are helping Iran'[s nuclear weapons program. Don't rule out a pre-emptive strike against these facilities in the next year.
Posted by John Rutledge at 12:00 AM
December 9, 2004
Asian Markets
Markets are selling Asian ETF's today; Korea (EWY), Pacific ex-Japan (EPP), Japan (EWJ) all down. It's a head fake.
Reaction to soft Q3 growth stories in Japan, failure of Korean central bank to lower rates to restore weakening growth. Also a striking op-ed in the Japan Times today about the string of recent peasant and worker violence in China. Exception is Hong Kong, where real estate is firming. There is reason to worry about China. Our government is leaning on them to revalue the RMB, which would further tighten credit. NOBODY knows how to estimate what would happen. I believe the Japan growth story is very solid. "
Posted by John Rutledge at 6:38 PM
December 7, 2004
Gulf Market Press Summary Source
I got a lot of emails from people asking me where they can track news on the Gulf markets I mentioned in my RealMoney article (posted to blog last night.)
There is a website you can access which will send you an email with links to the financial press in all the Arab newspapers. You can see it at . It's a great way for US investors to see the Iraq, oil, and other news stories from a different perspective.
Posted by John Rutledge at 6:42 PM
December 6, 2004
Brewing Chinese Peasant Revolt?
An op-ed in today's Japan Times describes a number of recent incidents of Chinese peasants and workers taking to the streets to express their growing anger against government officials in violent ways.
As you read the article it is worth remembering that China has experienced peasant revolts about every fifty years for the past 6000 years. They are 7 years overdue.
The Beijing government understands they must deliver rising living standards to keep this situation from boiling over. That means importing massive amounts of capital from the US, Japan, and Europe. They have accomplished this by systematically sweetening the terms for foreign investors. They will continue to do so.
Attempts by the US government to force the Chinese government to revalue the renminbi worsen the problem. To do so the government would sell dollars from their reserves, which would shrink Chinese bank reserves, reduce credit supplies, and slow the Chinese economy. There are 200 million itinerant construction workers in China today. Not good.
This also explains why it is imperative to preserve political stability in the Arabian Gulf. It is going to take $750 billion to develop the additional capacity to meet rising Chinese oil needs over the next decade. It won't happen unless the Gulf is safe enough for investors to take the risk.
Below are some excerpts from the article:
In the industrial city of Chongqing in Sichuan province, 50,000 rioters laid siege to a municipal building in protest against bureaucratic abuses.
In Henan province, an ethnic clash erupted between members of the majority Han group and the Islamic minority group, causing heavy casualties.
In Shanxi province, scores of people were wounded, some fatally, in a bloody demonstration against an economic development project that would force hundreds of farmers to evacuate.
In Sichuan province, 100,000 farmers rallied against a dam construction project, inviting military intervention.
In Fujian province, peasants marched on City Hall in opposition to expressway construction.
In the city of Shenzhen workers staged street sit-ins to demand wage increases.
It appears that Beijing has a time bomb ticking in its midst: a surge of popular dissatisfaction.
Posted by John Rutledge at 8:22 PM
Look for Job Growth to Accelerate
Look for an acceleration of new jobs in the coming months fueled by the return of banks to business lending again.
After falling $230 billion between November, 2000 and May this year, business loans have now increased by $25 billion. Big boost to small companies with no alternative source of working capital.
Posted by John Rutledge at 7:30 PM
Invest in a Chinese Airline? I don't think so.
Any investor contemplating investing in a Chinese company needs to read this article in today's WSJ.
Air China, which is trying to raise as much as $1.1 billion through an initial public offering of shares in the Hong Kong market, is telling investors that it plans to upstream as much as $1 billion with a finance company controlled by its parent, China National Aviation Holdings Co. Investors will get to ride in the back seat.
You are going to see a lot more of these. Chinese leaders have decided that the only way to deliver the rising living standards their people expect is to import massive amounts of capital. That means enticing foreign direct investors and selling securities of domestic Chinese companies in foreign markets.
Warren Buffett once described investing in an airline as temporary insanity.
Investing in an airline in the Hong Kong market owned by a Chinese parent is permanent insanity.
Posted by John Rutledge at 6:57 PM
Measuring Progress in Iraq
If you want to know what the outlook is for Iraq you need to ask the guys who know--the investors who set the prices in the Gulf stock markets.
My friends at Global Investment House in Kuwait--in my judgment the most astute observers of Gulf capital markets--tell me that local investors like what they see. Their overall index of the Kuwaiti stock market is up 14.2% year to date (YTD), and 18.7% last 12 months (LTM). That's about double the year to date performance of our S&P 500 (7.1%), and NASDAQ (7.2%). The Dow Industrials are up only 1.3% YTD.
Real estate stocks in Kuwait are up 15.4% YTD and 19.5% LTM. Stocks in Gulf countries other than Kuwait are up 37.2% YTD, 41.0% LTM. Islamic stocks (companies that run their businesses in compliance with Islamic principles) are up 25.8% YTD, 35.1% LTM.
These prices are meaningful because they represent the present value of the free cash flow that listed companies will generate within the period governed by current regimes, current law, and current property rights. Investors will seriously discount the expected cash flow of a company located in a country with an unstable government because that cash flow stream would be abrogated by any change of government. Increased stability, therefore, translates into a longer expected cash flow stream and higher stock prices.
This is especially so for real estate investments, which are completely immobile and, therefore, a perfect barometer of local investor expectations of the likely duration of their current government. This is one case where an increase in the duration of a security means less risk, not more risk.
My current bet is that Iraqi elections will be held on schedule in January
Posted by John Rutledge at 4:00 PM