August 30, 2005
Why Europe Does Not Grow
In France they call it "Economic Patrioism."
In case anybody is wondering how France is faring on the global competition for capital to feed growth, here's an example from today's Daily Deal:
The French government, in a new policy that has already drawn fire from European Union regulators, plans to create a list of companies to be protected from foreign takeover and permit targeted French companies to adopt anti-takeover defenses allowed in the bidder's own country. French Prime Minister Dominique de Villepin, in fact, coined the term "economic patriotism" to describe the government's hostile response to rumors in July that U.S. rival PepsiCo Inc. would acquire French food giant Danone SA.
The French government then trumped themselves in the stupid policy department by requesting that pension funds, banks, and insurers direct their investments toward his list of "strategic" industries.
Sure wouldn't want all that yoghurt to fall into the wrong hands.
Thereby, they have cleverly insured that French workers will have neither a job nor a pension account to live on.
Sacre bleu!
JR
Posted by John Rutledge at 6:45 PM | Comments (4)
August 29, 2005
Fed Funds Mantra Does Not Explain Growing Economy
Fed Funds Mantra Does Not Explain Growing Economy
The news is full of economists wringing their hands over what the Fed is going to do with the Fed funds rate, whether they have tightened too much or too little, and just what level of the "real fed funds rate" would be neutral. Meanwhile the economy keeps growing. What gives?
Monetary policy is a lot more than the Fed funds rate. What matters is whether the network of bank and non-bank lenders to businesses that make up the country's credit markets are functioning or not. As the chart below shows, business loans are growing like crazy.
That's important because credit markets don't work like the textbooks and macro models would have you believe. In the textbooks, investors compare the interest rate with projected returns on projects. Raising rates causes them to trim marginal projects, investment spending falls and output contracts.
The real world is not like that. In 30 years of investing and owning companies, I have never seen an investment project accepted or turned down because Fed funds rates were 1% higher or lower. But I have seen plenty of projects cancelled and businesses shrunk because the credit markets imploded. It is the availability of loans, not the posted interest rate, that matters.
Monetary policy has its principal impacts on the economy not by moving the economy from one equilibrium point to the next, like in the textbooks, but by causing sudden, discontinuous changes, or "blackouts", in credit availability.
The credit market is a communications network, no different from an electricity grid. Normally, credit markets function well. But, from time to time, a policy disturbance causes the network to "black out." During these times, the credit market is far away from equilibrium and recorded prices (interest rates) are not a good metric for incremental borrowing costs.
Example: the period November, 2000 until May, 2004, during which business loans contracted from $1104 billion to $870 billion. During that period, Fed funds rates were pushed lower and lower, but total costs increased to borrowers, as evidenced by the land office business being done by mezzanine lenders during the period. This blackout was the principal reason the economy underperformed foreacsts during much of that period, which many referred to as the jobless recovery. Small businesses, which make up more than half the economy and nearly three quarters of hiring, have few alternatives to banks for working capital. When the credit market blacks out, they lay off their workers and output shrinks.
The credit blackout ended in May, 2004. Since then businesss loans have increased by $148 billion to $1018 billion (8/17). This gusher of credit has driven borrowing costs sharply lower for the average business borrower as banks, mutual funds, and hedge funds competed for business, even though Fed funds rates increased the entire time. That's why growth and profits keep surprising economists. this is particularly true for bank-loan dependent small companies. This is why small- and mid-cap stocks have outperformed their big brothers and will continue to do so.
Network theory tells us that networks characterized by super-connectors--a small number of actors that are connected to many others--are especially prone to failures. The fed and Treasury, sitting atop the credit system, are both superconnectors of the first order. The result is on-again, off-again, monetary policy. We would bhave a more stable economy with a distributed processing system that pushed policy making out into the network, rather than controlling it from the center, for the same reason our flexible labor market works better than the centrally controlled labor markets in Europe.
The great econonists of old knew this. That's why Wicksell, Keynes, and Irving Fisher wrote about credit collapses. It's worth reading them again.
JR
Posted by John Rutledge at 11:51 PM | Comments (7)
Gulf Stock Markets
Gulf Stock Markets
With all the talk of real estate bubbles in the US, investors should take a look around the world. Nine of the ten top performing stock markets in the world this year are in the oil producing countries in the Arabian Gulf.
It's important to keep track of these markets. They have a direct bearing on what some of the largest and most liquid investors in the world are thinking. And Gulf investors will ultimately finance the rebuilding of Iraq through direct investments in businesses and property.
These markets are hot, hot, hot! According to my friends at the Global Investment House in Kuwait, the Global Index of the top 100 companies in the Gulf increased 15.6% in August, 73.6% year to date, 109.8% over the past 12 months, and 469% since December, 1999. These 100 companies have a current market capitalization of $628 billion. Real estate markets, if anything, are even stronger.
JR
Posted by John Rutledge at 10:13 PM | Comments (2)
Progress & Freedom Foundation
I am happy to say that last week I joined the board of directors of The Progress & Freedom Foundation. You can read PFF's full press relese here.
PFF is a market-oriented think tank in Washington, DC that focuses on public policy issues in information technology, including the communications, intellectual property, e-commerce, energy, competition, and regulatory issues that I believe are so important for growth.
I have known the people at PFF for some time through my good friend Jeff Eisenach, one of PFF's founders in 1993. They do absolutely first class work.
I also serve on the Advisory Committee for PFF's Digital Age Communications Act Project (DACA).
PFF also hosts the annual Aspen Summit each August, where they bring together an extraordinary group of CEOs, thinkers, and policy makers to debate digital policy issues.
I will keep you posted on PFF activities as they occur.
JR
Posted by John Rutledge at 9:13 PM
August 24, 2005
China Competing for Capital
China Competing for Capital
The Standing committee of China's 10th National People's Congress is meeting in Beijing all week to consider new legislation. Here are a few of the items on their agenda.
1. Reducing the personal income tax by doubling the personal exemption, below which no tax is paid, from 800 Renminbi ($99) per month to 1500 RMB ($185) per month. In recent years personal income tax revenues have grown faster than all other taxes.
Why? Growth of 9 % per year. In 1993, when current exemption levels were set, only 1% of wage-earners made more than 800 yuan a month. Today, 52% of incomes exceed the limit. Per capita consumption by urban workers hit 1143 RMB per month ($138) last year.
2. A new law to protect minority shareholders, giving them the right to audit a company's accounts and the right to put their shares back to the company if the company makes profits but refuses to pay dividends to shareholders.
3. A law giving more power to the China Securities Regulatory Commission, their securities watchdog, to give them the ability to freeze bank accounts of companies violating securities laws.
4. A law to guarantee the assets of foreign central banks.
Sound familiar?
Every day, China is passing laws to improve the rule of law and reduce the risks a foreign investor must consider before investing in China. They know that the key constraint to growth today is a country's ability to compete for capital. It would serve us well to remember the same lesson when Congress comes back to town after their August recess.
JR
Posted by John Rutledge at 3:27 AM | Comments (1)
August 19, 2005
Forbes on Fox Saturday at 11AM EDT
I will be a guest on the Forbes on Fox show which airs tomorrow (Saturday, August 20) at 11 Eastern time on the Fox News Channel. Hope you can join David Asman, Rich Karlgaard, the Forbes editors, amd me for a lively discussion of the impact of oil prices on the economy and stock market.
JR
Posted by John Rutledge at 2:25 PM
August 16, 2005
Wake Up Call for US Education
I am on my way to Seattle tomorrow to address the NCSL (National Conference of State Legislators, 8000 state legislators from 50 states) annual meeting there on Thursday on taxes and state budgets.
I will also speak to the Republican Legislative Campaign Committee at lunch on Friday about how to promote growth in their states. I can summarize my talk in 2 words, technology, and education. We have to learn that in today's global economy, we are competing for capital, not jobs. Human capital tops the list.
Bill Gates spoke to the group today on the subject. Here's what he had to say:
When I compare our high schools to what I see when I’m traveling abroad, I am terrified for our workforce of tomorrow. … In 2001, India graduated almost a million more students from college than the United States did. China graduates twice as many students with bachelor’s degrees as the U.S., and they have six times as many graduates majoring in engineering. In the international competition to have the biggest and best supply of knowledge workers, America is falling behind.This is our wake up call, folks. we may not get a second chance.
JR
Posted by John Rutledge at 7:22 PM | Comments (9)
July Housing Starts -0.1%.
Starts were down a bit in July, but permits increased. Backlogs at home builders fell 1.6% to 230K homes but are still at the highest levels since 1979.
All the talk about whether this is a bubble or not is a waste of time. Prices went up a ton in the past 2 years for one reason; falling interest rates. Rates are not going down from here on. Game is over, not this month, not this quarter, but prices are not going to keep rising.
This doesn't mean prices will collapse. It doesn't mean you have to sell your house. Just don't get carried away with yourself and bet on further price increases.
Why interest rates? I know it doesn't sound romantic, but you can think of the value of a house the same way you think about the value of a bond. One pays a future stream of cash--the coupons on the bond. The other pays a future stream of payments too--the value of the rent you do not have to pay (or could collect) on the house. Falling rates increases home prices in exactly the same way it works for bonds or, for that matter, stocks.
How much? houses last for a long time and future rents increase at something like the inflation rate. And rates are very low today. All 3 factors contribute to a back-loaded income stream--bond guys would call this a high duration. I use 25 years as an estimate. That means a 1% drop in the mortgage rate would push home values up by about 25%, and a 1% increase in mortgage rates would reduce values by the same amount. (This is not quite true. The relationship is nonlinear, therefore asymmetric. But close enough for government work.) If rates hang around current levels, prices will simply level off.
What about the other arguments you are hearing from people claiming prices will rise forever? Mostly crap. In particular, the idea that prices will rise because mortgage interest is deductible makes no sense at all; it was also true 2 and 3 years ago when prices were 50% lower. Same goes for aging baby boomers, new family formations, and the best of all, "we are running out of land." Only new information can move prices. That means stronger than expected growth can matter to some degree, as could new information on building moratoriums. But the average age of baby boomers is one of the more predictable variables in economics.
Be very careful with your exposure to the housing sector, especially REITs, home builders, and building materials companies,in the next few months.
JR
Posted by John Rutledge at 11:33 AM
Tech Sector Industrial Production
What's my favorite whine? We need more capital spending on information technology! The chart below shows why.
Semiconductors doing fine, thanks to growing global demand and the cell phone sticking out of every teenager's ear. Computers not quite so good--capacity moving to Asia. But communications equipment sucks big time.
There are two reasons why the communications equipment production is still in the toilet. First, telecom regulations in the US killed capital spending for the past 5 years. As I have written recently, there is a good chance Congress may give us a new telecom law this year that fixes a lot of the problems. That could trigger huge capital spending in high-speed telecom networks, something people in the US know they need to compete in global markets.
The other reason is that Asian countries have had a huge increase in capital spending on communications equipment. The gap between US and Asian orders has been so big that many companies have moved production and R&D facilities to Asia. That portion of lost production will not come back.
This may be the single most important growth issue for the US economy. Our communications network is the central nervous system of the entire economy. We are not competing for jobs; we are competing for capital.
That's why it is troubling to hear news reports today about ongoing negotiations between US and Chinese officials over panties and tank-tops. They should be talking about capital equipment--high-tech capital equipment--the key to our future productivity.
JR
Posted by John Rutledge at 10:52 AM
July Industrial Production +0.1%
Today's July Industrial Production numbers (+0.1% in July, +0.8% in June, +3.0% last 12 months (LTM)) are not as weak as people think. Manufacturing output was up just +0.1% percent in July; but +0.4% excluding autos (remember the employee cost sales gimmick).
Business equipment +1.3% in July, +6.7% LTM. Capital spending increases are still intact. Manufacturing capacity utilization in July was 78.3%, same as last month and far below Wall Street expectations. This is good for bond yields because it will let some air out of inflation worries.
JR
Posted by John Rutledge at 10:22 AM | Comments (1)
July CPI +0.5%, But It's All Oil Prices
The July CPI, out this morning, increased +0.5% over June, and 3.2% over a year ago. It was all oil prices; energy was up +3.8% for the month, +14.2% over year ago! The CPI ex food and energy was only +0.1% in July, +2.1% over July a year ago.
So which one really matters? Depends on why you are asking the question.
If you want to know how many dollars are going to be leaking out of your pocket next month pay attention to the overall (bigger) number. Unless you have made a deal with your local gas station owner to only charge you based on the "core" CPI. Good luck.
If you want to know what it means for interest rates, however, pay attention to the smaller number, which attempts to strip out commodity price increases/decreases. Why? Because the increases in oil prices that drove prices up is a big one-time increase, rather than an increase in the long-term growth rate, of prices.
The reason we are interested in secular inflation, rather than one-time bumps, when thinking about interest rates is because the expected annual rate of price gains is one component in thinking through the expected total return on goods, which are alternatives to securities in investor portfolios.
An interesting exercise is to write down in detail the factors that add up to the total after-tax return on goods on one hand, and the factors that make up the total after-tax return on bonds, on the other hand. Then examine your list for what has to be true to make total returns equal. That is the right way to understand the relation between inflation (one of the components of the return on goods) and interest rates (one of the components of the total return on bonds).
Of course, the CPI is not a very good measure of expected gains in holding real goods either. More than half of the CPI is services, and you can't store haircuts. A better indicator would be the expected annual increases in rental prices on the stock or real estate. That number, adjusted for various transaction cost, maintenance, and tax considerations, would give you a total return on real assets to compare with the total return on securities (the interest rate) in making asset allocation decisions.
Bottom line, this CPI report is a low inflation report, and argues for lower, not higher, bond yields (4.23% on 10 year today).
What about the Fed? The Fed understands that higher oil prices are a contractionary pressure on the economy. Today's report will not put pressure on the Fed to raise rates; it will put pressure on them to lower rates. The higher oil prices go, the more likely it is that the Fed decides rates are actually too high to keep the economy growing.
JR
Posted by John Rutledge at 9:15 AM
August 12, 2005
Oil Prices, Inflation, Interest Rates
Oil Prices, Inflation, Interest Rates
Lots of folks today saying oil prices could hit $75 in next few weeks. Truth is, over short periods, oil prices could do almost anything; they may be right.
You will be hearing people say this is the end of the world, that it will throw the US into recession, that it will increase inflation and push rates higher. Not so.
Over longer periods people adapt to oil prices. that's why we use about half as much oil per dollar of GDP than we did when oil was cheap. And all the growth of the US economy is in the service sector where the only think you need oil for is the dressing on your ceasar salad dressing. Not saying oil doesn't matter (Double negative? No it's not.) Just saying we need to take a deep breath before biting down on our cyanide capsules. Loose credit markets dominate high oil prices for growth.
Regarding inflation, a spike in oil prices causes a spike in prices, not an increase in sustainable inflation. It pushes output down, not up. They know this at the Fed too. High oil prices are more likely to cause the Fed to back away from raising the Fed funds rate target than to push it higher. And bond yields (10 year Treasury is 4.26% today) will ignore the whole thing.
JR
Posted by John Rutledge at 1:04 PM | Comments (2)
US Growth OK, Don't Sell Out
Today's numbers disappointed some people. June trade deficit +6.1% at $58.8 billion, about 5.7% of GDP. The bitg bulge in the number is rising imports since the US recovery picked up steam, although oil imports are a factor too. I worry more about exporting capital, especially technology capital, as the US share of global communications equipment has fallen by half, from 40% to 20% over the past 5 years.
Other numbers: July Import prices +1.1% (oil prices), August Michigan consumer confidence index down, and yesterday's advance retail sales report (0.3% ex autos) was a little weaker than people wanted to see.
Bunk. Growth is very strong. Use this passing cloud of worries to buy other people's stock at better prices.
JR
Posted by John Rutledge at 12:26 PM | Comments (2)
China Cuts Taxes, Spurs Growth.
Big number from China today. July retail sales there +12.7%, after 12.9% in June. Restaurant sales +17.5%, according to a Bloomberg report, with clothing +16%, appliances +13.9%, furniture +16.9%, cosmetics +16.9%, telecom and mobile phones +21.4%.
What's going on? The government cut taxes for 400 million farmers and raised the exemption level before paying income taxes. Sound familiar?
Big winners? Dell, Adidas, GM, and Wumart (that's right, Wumart Stores).
American's who think of China as a backward, Communist nation, need to take a closer look. The growing Chinese middle class and expanding technology sector are the real stories there.
I like to invest in China by placing chips on China's principal vendors, including energy, technology, and money. That leads me to own EPP (Australia, New Zealand, Singapore, Hong Kong), and EWY (Korea).
JR
Posted by John Rutledge at 12:11 PM | Comments (4)
Japan Growth Strong
Japan's real GDP grew 1.1% in the second quarter. Q1 revised up to +5.4%. Spending was driven by capital spending, government spending fell. Supports my view that Japan turnaround is sustainable. My nameless advisor there, who I refer to as Fibonacci, agrees. Koizumi has called an election for September 11 (coincidence?). I like Japanesse stocks and own EWJ.
JR
Posted by John Rutledge at 11:53 AM
India Growth Accelerates
India Growth Accelerates
Number out this morning that India's Industrial Production +11.7% in June, the biggest number since geometry was invented there before the time of Euclid (he got it from them.) May revised up to +10.9%. Consumer goods +23.7%. Ay Chihuahua.
This number implies India's GDP this year will be 8% or more this year. Their Central bank has decided to NOT increse interest rates to encourage investment . Federal Reserve, please take note of this.
Last month Prime Minister Manmohan Singh made a very impressive pitch to US investors during his talk to the joing session of Congress on his visit here. Singh understands that in today's global economy, we are not competing for jobs; we are competing for capital.
I own a position in IIF. Down about one percent today; think I will buy some more.
JR
Posted by John Rutledge at 11:42 AM
August 10, 2005
India Profits Screaming
The headline story in today's (actually tomorrow's; you know, the time zone thing) Economic Times published by the India Times is incredible. 118 companies in the India stock market have earned more profits in the past three months (the first quarter of the fiscal year) than they did in the entire previous year.
I own IIF, the Morgan Stanley exchange traded fund for India, to capture some of this growth. Like China, India is driving world growth.
Be a little careful though. A separate story yesterday warned there are rumors the Prime Minister is thinking of resigning out of frustration over lack of success in selling state-owned companies.
And, by the way, The Economic Times, along with the Shanghai Daily (where today's headline reveals the currencies in the central bank's new currency basket, but not their weights in the basket) make pretty good breakfast reading. I have both with my oatmeal every morning.
JR
Posted by John Rutledge at 11:35 PM | Comments (1)
National Video Franchises Are Going to Happen
National Video Franchises Are Going to Happen
In the last year, people all across America have figured out that we need world class high-speed communications networks to compete with companies and workers in Asia. The resulting pressure on politicians to do whatever is necessary to trigger the investments to build those networks is starting to produce results.
A week ago Senator Ensign, of Nevada, introduced a new telecom bill that would largely return telecom to market forces. The market value of US telecom equipment makers, who make the boxes, switches, and fiber that would build new networks, increased by $12 billion in two days, and telecom company shares increased by another $10 billion, for a total of $22 billion. That's 10% more than the market capitalization of GM or ford, and 25% more than the market cap of AT&T. In 2 days.
Last Friday the FCC put their oar in the deregulatory water by removing regs from DSL services. That's good too.
One of the hot issues is video. In order to earn a return on the $1500 or so it will cost to run fiber to a home the telecom companies plan to offer consumers video services that will compete with current cable services. In the end customers will be able to buy every communications service--home phone, cell phone, internet, movies, TV, vopice mail, and whatever else they dream up--from several competing sellers. Great for consumers--more choices and certainly lower prices.
But current regulations would require the companies cut separate deals with thousands of local governments, each of which has the incentive to hold up the train. That would slow down fiber investments by years. Not good.
Today the Texas legislature took the matter into its own hands by passing a law that would remove that power from local governments. Now a company will be able to apply for one statewide franchise. I am not surprised by this, having testified there on the subject 2 weeks ago. But I am surprised by their speed and resolve, which indicate this is a front-burner issue with voters.
In a talk to the National Governors Association in Des Moines 2 weeks ago I recommended they all do the same before Congress gets tired of waiting and settles the issue for them.
You can read more about the video franchise issue in my good friend Randy May's blog on the subject today, as well as in an op-ed in today's WSJ.
Senator Ensign's bill would handle the issue by moving franchising to the national level. The stock market clearly thinks the Ensign bill, or something similar, has a real chance of becoming law later this year.
No one has ever accused the White House of beiong politically naive. They need to get in front of this issue and drive it across the goal line if they want to keep that reputation. Today, the President signed the 1000 page, $286.4 billion transportation bill into law--in a Caterpillar plant in Montgomery, Illinois. I am sure he received a standing ovation. The 6000 projects Congress loaded into the bill will certainly sell a few bulldozers. At the signing, he told the group "If we want people working in America, we've got to make sure our highways and roads are modern."
But it's information technology, not bulldozers, that can help American companies compete globally. Aggressive leadership fromthe President could dramatically speed the passage of a new telecom law and unleash massive investment in information technology. With or without the White House, however, I think Congress is going to solve this problem this year. I suggest they jump on this issue before the train leaves the station.
JR
Posted by John Rutledge at 10:27 PM
August 9, 2005
Fed Announcement Today: Put down your Dictionaries and Back Away Slowly
Fed Announcement Today: Put down your Dictionaries and Back Away Slowly
Fed watchers are gathering silently on the lawn of the Federal Reserve Board today awaiting the big announcement. At 2:15PM the Federal Open Market Committee is going to issue a memo announcing that they have decided to increase their Fed funds target by one-quarter of one percentage point, from 3.25% to 3.5%, which everyone, and I mean everyone, has known for weeks.
Yesterday, my neighbor's gardener waved me down as I drove past and asked me if I thought there was any chance the Fed would do a half today instead of a quarter. Told him no. He didn't think so either.
They the Fed watchers will carefully examine the memo, checking its wording, its spelling, its punctuation, and the rag content of the paper it is printed on.
My personal position is 3.5%, exactly the same words, 2 spelling errors, a comma changed to a semi-colon in the second to last line (Is this significant?), and 25% rag content. I am neutral on the ink color.
Last time the Fed watchers got pretty excited about what looked like a change in wording, but it turned out to be drool from one of the older members who fell asleep while signing the memo. False alarm.
The FOMC members, of course, have been watching out the windows all day, wondering how the Fed watchers will interpret their words. The psychology so thick you can cut it with a chain saw.
More on this later in the day. I have to get geared up for the 2:15PM announcement.
JR
PS: This viewpoint is going to anger approximately 1500 PhD's at the Fed and lots more Fed watchers than that. Can't be helped.
Posted by John Rutledge at 1:41 PM | Comments (3)
August 4, 2005
I Lost Money Today in the Stock Market
I Lost Money Today nthe Stock Market
Sometimes I write about investments that have gone up, so I thought it would be a good idea to confess that almost every stock I own went down today when the stock market went down. Bummer.
What happened to cause today's declines? Absolutely nothing. The fundamental factors that make me believe stocks are very good investments today--low inflation, low interest rates, rising productivity, rising profits, and the storm watch themes like dividends and telecom reform that you see on our website--are just as true tonight as they were before the market opened this morning.
Reminds me of the joke I remember from long ago about there being two kinds of life insurance you can buy in Beirut, minutely and hourly.
Sometimes I think we would be much better off if we only got to see stock prices once a year on our birthday. Equities are for making money over years, not days.
In response to today's declines I sold exactly zero shares of stock. Hope it goes down again tomorrow so I can buy some more good stuff cheap.
The S&P 500 is up 13% over the past year. The Dow closed at 10,610 today; it was 7500 a little more than 2 years ago. Hang in there investors. It's going to be fine.
JR
Posted by John Rutledge at 10:12 PM | Comments (2)
CNN In the Money this Saturday
CNN's In the Money show this Saturday
I will join Jack Cafferty and his roundtable colleagues this Saturday at 1PM Eastern time to talk about interest rates and home prices. The show airs again at 3PM Sunday. Hope you have a chance to see the show.
JR
Posted by John Rutledge at 10:04 PM | Comments (1)
Forbes on Fox this Saturday
Forbes on Fox this Saturday
I will be a guest on Forbes on Fox this Saturday at 11AM Eastern time on the Fox News Channel, joining David Asman, Steve Forbes, Jim Michaels and the Forbes editors to talk about foreign policy, old vs. new economy investing , and looking at specific stocks. Hope you have a chance to catch the show.
JR
Posted by John Rutledge at 9:58 PM
August 2, 2005
Whoops! Japan ETF ticker is EWJ. My bad.
Whoops! Japan ETF ticker is EWJ. My bad.
A loyal subscriber who reads a lot more carefully than I type has poined out that I referred to the Japan Exchange Traded Fund as the ticker EWY. I was wrong, of course, it is EWJ. My response below.
Thanks for finding the error. You are right of course, EWJ is the Japan ETF.
It was a Freudian mistake; Korea (EWY) has been so good to me (up about 50%) that my fingers just typed the letters. I own both stocks, but for different reasons. Korea is the best way to place a bet on China technology growth. Japan is a great turnaround and dividend story.
Thanks
John
Posted by John Rutledge at 11:48 AM
Surge in Tokyo Land Prices
Tuesday's Japan Times reports new data showing Tokyo's first surge in land prices in 13 years. The average land price along select major streets in Tokyo grew 0.4 percent from a year before. (We'll have to excuse their referring to 0.4% as a surge; it has been a long time for them.)
Prime downtown tracts did better. Tokyo's ritzy Ginza district was 9.9 percent higher than a year ago, but still 60 percent lower than its peak in 1992.
Nationwide, the average land price fell 3.4 percent, its 13th straight decline. Still, the margin of decline was the smallest since 1993, when the 13-year slide began.
Japan's National Tax Agency assesses land values at 410,000 locations across Japan every year to determine the "roadside land price," which is used to calculate inheritance and gift taxes each year.
The end of falling land prices matches the things I have learned from my confidential advisor in Japan, who I will refer to as Fibonaci. Fibonaci told me some months ago that real estate markets were starting to clear and the fire sale was over. Fibonaci also tells me Japanese companies are beginning to gush cash flow which will show up as rising dividends. Dividends? In Japan? I would not bet against Fibonaci.
The reason this is such a big deal for Japan is that economists do not understand real interest rates. Most economists calculate the real rate by subtracting a CPI inflation rate from short term borrowing costs. This would produce a number for Japan of 2-3% for the past 13 years, which does not appear burdensome.
The right way to calculate real rates, as Keynes understood in his brilliant Chapter 17 on "Own Rates" of his General theory, is to calculate the carrying cost of a balance sheet. Most companies hold tangible, fixed, assets and have financial liabilities. The cost of carrying their balance sheet is their borrowing cost less the weighted average inflation (including depreciation) of their assets, primarily land and equipment. This calculation for Japan shows a real rate of about 1000 basis points over the past 13 years, the reason Japan was mired in recession. You will find papers n this subject in the archives on our website www.rutledgecapital.com.
A company in Japan or elsewhere cannot begin to make a profit from selling their products uintil they have paid the rent on their balance sheet. The end of property deflation Japan represents a massive decline in real interest rates, good for Japanese growth, profits, and yes Fibonaci, even dividends.
I own a position in EWJ, the Japan ETF.
JR
Posted by John Rutledge at 3:45 AM | Comments (8)
August 1, 2005
Bonds and Real Estate Prices
For those of you who are worried about home prices, I don't like what I am seeing in the bond market.
The ten year bond yield has increased by almost half a percent in the past 2 weeks, from 3.88% to 4.32% today. That's worth 12-15% on home prices.
We saw this movie on the way up; now we may see a little on the way down. Home prices have increased by more than 50% over the past 3 years, driven primarily by lower mortgage rates. Mortgage are bundled and sold by the container load in the bond market, where they price off Treasuries.
The right way to think about home prices is like a bond, as the securitized value, or present value, of the stream of housing services they will provide in the future. Buyers in the commercial property market go through this analysis explicitly, using estimates of future rents to determine expected cet cash flow each year in the future. A proxy for residential housing is expected rental yields.
Worth noting. More construction and completions means more houses relative to people and incomes. It lowers expected rental yields, therefore depresses the value of existing properties.
Bond guys do this work all the time. Stock analysts don't do it but should do it. Home buyers should do it too.
The duration of the S&P 500 at today's interest rate levels is 26 years. that means it will take 26 years for the owner of the S&P 500 to "earn" half the present value of the index if he collected all the free cash flow. That means a 100 basis point rise in the after-tax cost of capital for the index would reduce its value by 25%.
The duration of the housing stock is not far off. It is shorter to the degree that rental values grow more slowly than cash flow, and longer to the extent that the cost of capital for housing is somewhat lower than for equities due to the yummy tax breaks on housing. On net, I would use roughly the same number.
That's why a half percent move in the bond yield worries me. It equals about 13% on home prices.
Don't get crazy and sell your house. But don't stand in line to buy one either. This housing boom is just about over.
JR
Posted by John Rutledge at 2:49 PM | Comments (3)
Coal is the New Oil
Coal is the New Oil
Peabody Energy (BTU) definitely has the coolest ticker on the stock exchange; it also has the hottest stock. People have figured out that they own tons (really) of coal, that the stock price undervalues their coal reserves in the US, and that rising oil prices caused by Asia's growth have made coal the new oil.
My good friend Jacques Berghmanns in Brussels told me he likes the company. Last week we saw why. BTU increased iought its dividend by 27% and announced a share buyback program. Looks to me like a 10-12% grower for a long time. My only concern is price. (I bought some 3 weeks ago; it's up 22.5% since then. Up 3.7% just today! Too fast for my tastes.) Still, it is just 16 times next year's (2006) earnings. Be nice if it would drop some so I could buy more.
JR
Posted by John Rutledge at 2:01 PM | Comments (1)