The Investor July 2018

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We launch ShareFinder 6 

By Richard Cluver

Business and social commitments mean that in recent years I have been increasingly on the move across this planet that we all call home, which is why in the first place I began development of the ShareFinder asset management system for my own personal use: to allow me the freedom not to worry about the security of my lifetime savings.

Happily then, I was able before my recent departure for five weeks in Greece, to announce the completion of the latest iteration of the ShareFinder series; a greatly enhanced ShareFinder Mobile which I am confident will soon become the gold standard of private investor tools.

We developed it for investors who only sleep easy if they can regularly but very hastily check to see that their investments are safe and growing satisfactorily in a world of frequently dramatic change. With myself in mind I originally foresaw a simple programme which I could access quickly on my cell phone wherever on my travels I had Wi Fi access in a coffee bar, airport or, today, on buses, trains and aircraft. Of course it is similarly usable on a laptop or tablet.

With the development of the SF6 version, we took the time to put out a beta version so that experienced ShareFinder users could bench test it and offer their own wish lists of features and methods of access. And the result is a product which is very affordable, quick and easy to use without any of the problems that plagued first generation market analysis software.

Thus, for example, all the workings are done in the cloud on ShareFinder International computers. Investors simply use a coded access to calculations of their own personal portfolios that have been done for them in advance. Thus, the only limitation users face is the speed of the connection they are able to access.

They can call up any one of ten different portfolios based upon any one of five different stock exchanges. Furthermore, with time, we will be adding all the world’s major stock exchanges to that list. But for now, there are the two major US exchanges; the New York Stock Exchange and the Nasdaq, The London Stock Exchange, the Australian Stock Exchange and the Johannesburg Stock Exchange.

The Mobile will guide you to create an Index-beating portfolio molded to your particular needs of growth versus security and growth of capital as opposed to growth of income. And once you have chosen your portfolio it will guide you to buying those securities at the most opportune time.

Finally, once you have built your portfolio, the Mobile will maintain a daily watch over it telling you immediately when any of the securities in it are underperforming the market average and, more importantly, offer you more desirable substitutes. When you open the programme your first action is to click on the Portfolio menu to choose which one you want to analyse. From the pull-down menu we have in this case selected one named “Top 30…”

The programme will then provide you with a series of standard analyses of the portfolio. Thus, for example, you can see how the portfolio has been performing relative to the ShareFinder Blue Chip Index of each of the markets in its database. In this instance we are seeing the aggregate performance of the portfolio traced in blue relative to ShareFinder’s selection of the JSE Blue Chip Index in red. You can select a graph display of performance since the inception of the portfolio or the year to days or three years, or one year, one month or just the last ten days.

 

Furthermore, there is a message displayed which details how the portfolio is performing in percentage terms relative to the Blue Chip Index.

There is also a tracking line which allows you to see the value of the Portfolio and the index value on any particular date and, the value that the portfolio is likely to grow to year by year over the decade if it continues growing at the same speed as it has averaged since inception. The picture on the right illustrates how this appears:














If you only have time for a quick look at how the market is performing as a whole and whether you need to spend a little more time with individual shares in your portfolio, you are next offered a general market analysis. If everything is in green on the left hand side then you have nothing to worry about.

In this case Developing Markets are underperforming compared to those of the Developed world so, if you have South African or Australian portfolios you should be prompted to make the time for a little work to protect them. However, on the right the Developing country shares are outperforming in the longer term so you should not have any worries if you are a long-term investor.

Next, we move on to see the programmes analysis of the likely performance of Blue Chip shares as a whole in any of the chosen markets. The High/Low Index plots the difference between the highest and the lowest values of the index each day in recognition that as investor uncertainty increases this difference increases and as confidence rises the gap narrows. In the illustration, uncertainty had been diminishing for several months and simultaneously the Blue Chip Index had been falling. However, note the red projection of the Blue Chip Index which suggests that until August 3 the Index is likely to rise. The red projection extends to the next 12 months.

Below that, as you can see in the illustration immediately above, the current performance of each share in the portfolio is analysed. And then, in greater detail we have displayed the Underperforming shares in the portfolio. You are offered a list of the current performance of each company in the portfolio in terms of price and dividend growth over five and ten year averages compared with the Blue Chip share average with the figures appearing in red where they are below average and green if they are above. You are also provided with the best price you are likely to expect if you sell them and an estimation of when that sale is likely to happen.

Then, in turn, you are offered a series of suggested replacements for the shares you want to sell together with their relative performances again highlighted in green if they are above average and red if below:

Next, there is a long list of the shares in every market which are underperforming the Blue Chip averages so, if you have the time, you might like to page through the list to see if there are any listed that you might have a passing interest in!

Finally, if you still have time to catch up on the news, then right at the bottom of the display there is, on the left, a listing of the latest business and investment news and, on the right, the general news headlines. You can click on any of these paragraphs in order to receive the news story in full:

What to do with a million Rands

By Richard Cluver

A reader will shortly receive a million rands from a maturing investment and has been considering his options. One would be to settle his home loan, another to proportionally increase his holdings in his share portfolio or to invest abroad, perhaps in one of the Russel funds. Here the problem is which one?

He adds; “My overall feeling is that I need to keep my powder dry but would like to start thinking about my strategy. As such do you have any plans to launch an International Prospects Portfolio, or maybe another Prospects Portfolio in South Africa?

Currently I am not able to analyse the relative values of offshore unit trusts and, I have to confess that being able to do so is low on my priority list since long observation has shown that they are poor performers.

By way of illustration, the compound average growth rate of all unit trusts operation in South Africa since their inception has been 5.58 percent whereas the JSE Overall Index has grown on average at 12.9 percent. My graph below details the performance of the JSE Overall Index since 1985 with the red trend line representing the market mean. The purple line depicts just how badly the unit trusts have lagged behind.

And, of course, you can do a whole lot better if you use the techniques we employ within the ShareFinder software. To illustrate this, consider my graph of the Prospects Portfolio which we launched in January 2011:

As you can see, that portfolio has gained in value at a steady 21.4 percent compound since its inception. That’s 380 percent better than the average unit trust.

Investing in your own home mortgage bond is always a good option because you effectively get one of the highest possible interest rates and, of course, it is effectively tax-free. However, without getting too dramatic, I, like many, have become very concerned about the current stance of the ANC. I know it is a vote-catching ploy but amending the Constitution to grab personal property would very unlikely extend only to land. There are already precedents of governments taking a chunk of citizen’s assets because they cannot balance their budgets.


Accordingly I am in favour of building up overseas assets though you need do so with great caution because, for example, if you own a share portfolio in Britain, you would need to employ a British attorney to wind up your estate if anything happened to you; and you would be subject to British death duties and further to Capital Gains Taxes in South Africa.


So, whatever you decide, I would caution you to seek the help of a tax lawyer/accountant before you go ahead. I have recently heard of some horrific stories of widows receiving only a fraction of the money their husbands invested overseas for them!


That said, the new ShareFinder Mobile which has been going out on a first-come first-serve basis to current SF5 users, enables one to tailor portfolios to your individual needs with shares selected on the British, US and Australian stock exchanges as well as on the JSE. Furthermore, it maintains a daily watch over each portfolio so that you can immediately identify all underperformers and replace them with better-performers.


We have been giving a lot of thought to the package we will offer subscribers to the SF6 Mobile and have virtually decided that in future such users would receive Prospects and my weekly column for free. In the process we were surprised to discover how many users of the software were resident outside of South Africa where all the initial development was done so many years ago. Should we be continue doing a SA-orientated Prospects or should we offer portfolios in each country in which we offer market analysis? This is complicated by the fact that our plan is to continue adding new markets to the Mobile so that eventually we cover all 52 countries in which there are currently share markets operating. It would make Prospects very unwieldy if we tried to offer portfolios covering each of the 52.
However, the Mobile does portfolio-building automatically for users and so I have begun to question whether Prospects itself is not becoming superfluous. Here the only issue is to decide on a price that is fair to residents of different countries where buying power differs enormously.

Help with choosing a portfolio

By Richard Cluver

Mr N has been selling off shares for three years and now sits with a third in cash. He writes, “In the light of your latest Predicts should I not start accumulating stock now and in this case what would you suggest?

I asked ShareFinder to create a portfolio for someone who is comfortably retired and wants his capital to grow as rapidly as possible. This is what the programme offered:

I would be cautious about choosing EOH because that company is in a state of transition, but all the rest would be suitable for Mr. N.

Is pessimism overdone?

by Brian Kantor

The SA economy: will it gain relief from a stronger rand and less inflation?

The SA economy (no surprise here) continues to move mostly sideways. Growth in economic activity is perhaps still slightly positive but remains subdued. Two hard numbers are now available for the June 2018 month end: for new vehicle sales and the real supply of cash – the notes in issue adjusted for prices that we combine to form our Hard Number Index (HNI) of economic activity. Because it is up to date, the HNI can be regarded as a leading indicator of economic activity that is still to be reported upon.

Its progress to date is shown below. It shows a falling off in activity in 2016 and a more recent stability at lower levels. It is compared to the Reserve Bank’s business cycle indicator based on a larger number of time series that continued to move higher in 2016-17 but has also levelled off in recent months. The problem with the Reserve Bank series is that it is only available up to the March month end for which GDP data is also available.

https://archive.investec.co.za/content/dam/investec/investec.co.za/Images/Daily-View/2018%20images/march%202018/hard%201%2011072018.PNG

 

We show the growth in the HNI and the Reserve Bank cycle below with an extrapolation 12 months ahead. The HNI cycle suggests growth of about 1% in 2019 while the Reserve Bank cycle is pointing lower.

 

https://archive.investec.co.za/content/dam/investec/investec.co.za/Images/Daily-View/2018%20images/march%202018/hard%202%2011072018.PNG

 

It is striking how well the real cash cycle (included in the HNI) can help predict the cycle of real retail sales. Retail sales volumes gathered momentum in late 2017 stimulated it would seem by an increasing supply of real cash. This momentum has however slowed more recently as inflation turned higher in the face of a weaker rand. Retail sales have been reported only to April 2018.

https://archive.investec.co.za/content/dam/investec/investec.co.za/Images/Daily-View/2018%20images/march%202018/hard%203%2011072018.PNG

The key to any revival in domestic spending will be less SA inflation. And inflation will, as always, take much of its momentum from the exchange rate. The recent weakness in the rand has been a body blow for the SA consumer. It has little to do with events in SA and much to do with slower growth expected in emerging market economies, especially China. Where the dollar goes, driven higher by relatively stronger growth and higher interest rate prospects in the US, emerging market currencies, including the rand, move in the opposite direction.

The best hope for the rand and for the SA consumer is that the pessimism about emerging market growth has been overdone. If so some recovery in EM exchange rates can be expected – and that the rand will appreciate in line with capital flowing in rather than out of emerging markets. Some of these forces have been at work this week, helping the rand recover some of its losses and improving the outlook for inflation in SA. It may also if sustained even lead to lower interest rates in SA – essential if any cyclical recovery is to be had.

The importance of inflation for the business cycle is captured in this correlation table of key growth rates in SA. Inflation may be seen to be negatively correlated (and significantly so) with the growth in retail volumes and new vehicle sales. It is even more correlated (0.85) with the growth in the supply of real cash – that is in turn highly correlated with the growth in retail activity. And as may be seen, the growth in retail activity is also strongly correlated with growth the Reserve Bank’s cyclical indicator (Resbank) (0.80 correlated):

https://archive.investec.co.za/content/dam/investec/investec.co.za/Images/Daily-View/2018%20images/march%202018/hard%204%2011072018.PNG

The problem for South Africa and the Reserve Bank that targets inflation, is that so little of the inflation experienced in SA is under its control. The exchange rate takes its own course – driven by global sentiment – so pushing prices higher or lower, that in turn drives spending lower or higher. Interest rates that may rise with more inflation and then fall with less inflation make monetary policy pro-cyclical rather than counter cyclical. 11 July 2018

A fast-approaching Train Wreck

By John Mauldin

Three years ago, the McKinsey Global Institute released a massive research report called Debt and (not much) Deleveraging. It reviewed the global debt situation and where it might be taking us. The answers were not pleasant. I wrote about it at the time in Living in a Free-Lunch World.

 The McKinsey team created this fascinating graphic summing up the world debt situation as of mid-2014.https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_2_20180608_TFTF.jpg

Source: McKinsey Global Institute

From the Great Recession’s beginning through Q2 2014, global debt grew $57 trillion to $199T. (From here on, I will use capital T to denote trillions, since we must use the word distressingly often). That includes household, corporate, government, and financial debt. It does not include unfunded liabilities.

Dr. Woody Brock wrote:

CBO projections show that within 18 years, entitlements spending will absorb all US federal tax revenues—leaving no revenues even for interest expense on the debt and for the military. In Germany, which proudly pays annually for its expenditures without incurring debt, Deutsche Bank has estimated that by 2045, income tax rates of 80% (total, not marginal rates) would be needed for its PAYGO system. The entire workforce of the nation would be in bondage to the elderly. Other nations face even worse prospects.

I should note that the CBO projections assume no recessions and an optimistic compound 3% growth rate. I think most of my readers would assume that neither will end up being the case.

But even $199T back in 2014 was a lot of money. We should also note that, through the magic of double-entry accounting, each dollar of debt liability appears on someone else’s balance sheet as a $1 asset. Debt is wealth, if you are the lender. Most of you reading this probably are, in some fashion.

(If we could somehow make this debt magically disappear, we would also make wealth disappear, but we may have to do exactly that. This is a serious problem we will address later in this series. For now, just note that I am aware of it.)

McKinsey calculated that from 2007–2014, world debt levels grew at a 5.3% compound annual growth rate. That was slower than the previous seven years but still considerably faster than the world economy grew. Hence, debt as a share of world GDP rose to 286%.

Not all the debt categories grew equally. Government debt grew far faster than household, corporate, or financial debt. Household debt growth fell to a relative crawl, from 8.5% annual growth in 2000–2007 to only 2.8% in 2007–2014. Which makes sense because families had little choice but to deleverage, often via bankruptcy.

Government and corporate borrowers faced no such pressure. Their debt kept growing at a slightly higher pace after the recession. Yes, some corporations hunkered down and rebuilt their balance sheets. Most did not. They kept borrowing and lenders kept lending, encouraged by central bank-generated liquidity.

This is an important point I’ll return to in future letters. We talk a lot about profligate governments running up debt, and rightly so, but they are not alone. Businesses are equally and sometimes more addicted to debt. That would be fine and even positive if it were funding innovation and new production. But much of this new corporate debt paid instead for share buybacks that reduce equity, leaving the corporation more leveraged. That seems to be what shareholders want. They should beware what they wish for.

Rapid Maturity

As far as I know, McKinsey has not updated that 2015 report, but we can get similar data from the Institute for International Finance’s Global Debt Monitor.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_3_20180608_TFTF.jpg

The totals aren’t the same as McKinsey showed for those years, so I suspect they have different data sources. They’re close enough for our purposes, though.

Adding together the same-coloured bars, we get these global debt totals:

  • 1997:   $74T
  • 2007:   $167T
  • 2016:   $216T
  • 2017:   $238T

If those are accurate and my math is right, global debt grew at an 8.5% compound rate from 1997 to 2007. Then it slowed to 3.6% from 2007 through 2017. That’s good. We went on a worldwide debt diet.

But last year, we appear to have binged because debt grew 10.2% from 2016 to 2017. Breaking it down by sector, non-financial corporate debt grew 11.1%, government debt grew 6.7%, household debt grew 12.5%, and financial sector debt grew 11.3%, all in calendar 2017.

Looking only at 2017, government debt seems to be the least of our problems. The biggest debt growth was everywhere else. But why did it suddenly accelerate last year? In part, because the world economy grew enough to let global debt-to-GDP ratios fall slightly.

 Here’s another IIF chart showing global debt as a percentage of GDP for both “mature” (what they call developed countries) and emerging markets:https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_5_20180608_TFTF.jpg

The developed world is far more leveraged than the EM world, but EM countries are no pikers at 210%. They often lack the stabilizing resources developed countries possess, too. IIF points to Argentina, Nigeria, Turkey, and China for the largest debt ratio increases last year. But many emerging market businesses and financial companies borrowed money in dollars, as the dollar was relatively weak and US interest rates ridiculously low. Further, our yield-hungry investors, both as individuals and its institutions, were more than willing to lend to them to get something more than 1–2% that they could from sovereign bonds.

This level of emerging market debt is unsustainable because, among other reasons, debt matures and must be either repaid or refinanced. Here’s emerging market debt by maturity:

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_4_20180608_TFTF.jpg Some $4.8T in emerging market debt matures from this year through 2020, much of which will need to be rolled over at generally higher rates and, if USD strength continues, in a disadvantageous currency environment. Will that be possible? I don’t know, but we’re going to find out—possibly the hard way.

But that’s a relatively minor concern. We have a much bigger one back home.

Leverage Plus Leverage

The IIF report includes this note about US corporate debt:

US non-financial corporate debt hit a post-crisis high of 72% of GDP: At around $14.5 trillion in 2017, non-financial corporate sector debt was $810 billion higher than it was a year ago, with 60% of the rise stemming from new bank loan creation. At present, bond financing accounts for 43% of outstanding debt with an average maturity of 15 years vs. the average maturity of 2.1 years for US business loans. This implies roughly around $3.8 trillion of loan repayment per year. Against this backdrop, rising interest rates will add pressure on corporates with large refinancing needs.

I see at least three alarming points in this paragraph.

First, corporate debt is now 72% of GDP. That’s in addition to the government debt that is approaching (or has passed depending on how you count debt) 100% of GDP and household debt at 77% of GDP. Add in 81% financial sector debt, and the US combined debt-to-GDP ratio is near 330%.

Second, 60% of new corporate debt is coming not from bond sales but new bank loans—and those bank loans have much shorter maturity, averaging 2.1 years. That means refinancing time is coming for much of it, and rates are not going lower.

Third, IIF infers about $3.8T in corporate loan repayments each year—just in the US. That’s a lot of cash companies need to find and I’m not sure all can do it. Aside from higher interest rates, the companies that need credit (as opposed to high-rated ones that borrow only because they can do it cheaply) tend to be riskier.

From a recent Moody’s report, we see that 37% of US nonfinancial corporate debt is below investment grade. That’s about $2.4T.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_6_20180608_TFTF.jpg  Source: Moody’s Investors Services

The proportion is similar globally. Furthermore, all corporations, both investment grade and speculative, added significantly more leverage since the Great Recession.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_7_20180608_TFTF.jpg Again, not all leverage is the same. Some companies borrowed to fund share buybacks but have vast cash flow and reserves. They can easily deleverage if necessary. Smaller, riskier companies have no such choice. I think they present the greatest systemic risk.

That said, it’s still a bit mind-boggling that, even after the Great Recession, just a decade later the average non-financial business went from 3.4x leverage to 4.1x. They are now roughly 20% more leveraged than they were the last time all hell broke loose. CEOs and boards seem to have learned little from the experience—or maybe learned too much. If you believe the Fed has your back, then leveraging to the moon makes sense.

Now, I know some readers will take comfort in the fact that 63% of the corporate debt is rated investment grade. But as they say in Texas, hold on, cowboy, don’t ride away so fast. A lot of that debt is rated BBB, the lowest investment grade rating. For the glass half-empty crowd, that means they are just one step above junk. The chart below from my friend Rosie (David Rosenberg) shows that the number of BBB-rated companies is up 50% since 2009.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_8_20180608_TFTF.jpg Source: David Rosenberg

The problem, as I described in High Yield Train Wreck, is that bondholders and lenders won’t wait for the rescuers. When funds and ETFs, which hold BBB debt, start getting redemptions, investors won’t hang around to see which domino falls next. Institutions have rules that will make them start selling troubled bonds early. Liquidity probably won’t be there. Clearing the market will require sharply lower prices, which will create more selling pressure and eventually recession.

To further exacerbate the problem, the rating agencies that didn’t react quick enough in 2008 may be a little bit more trigger-happy this time. This will cause heartburn for CEOs with BBB paper outstanding.

To be sure, regulators and Congress took measures to avoid a similar crisis repeating. The banks aren’t the problem. The “shadow banking system” is the source for much of the shaky debt. The same investors stretching for yield in emerging markets have loaded up on private debt, too.

Steve Wasserman’s last weekly commentary is a good capstone here:

Moody’s has issued a statement that CMBS loans are now almost as risky as in 2007 because 75% of them are interest only, and the interest only period is now 6 years, up from 2.2 years just a few years ago. In addition, they are becoming much more covenant light, and are at higher leverage. All of this is a red flag since these things create much more risk of serious problems when the recession hits. There is also a bigger concentration of single tenant properties, which, as we have seen in retail, can be deadly in a recession. Asset and sponsor quality is also deteriorating. There is now so much competition to put out loans by so many non-bank sources, that borrowers can get lenders to compete, which always means lower quality underwriting. Far too much capital chasing too few good deals.

Underwriting is not nearly as bad as in 2006–2007 yet, but it appears the trend is what it always has been, when the economy is strong and there is too much capital, underwriting standards fall down, and then the stage is set for a bad outcome when the economy goes bad. It is typically 10–12 years between collapse of the last crash and then credit quality deterioration and the next credit collapse. We are at 10 years. Dodd Frank had rules to try to avoid a replay of 2008 in CMBS, but a lot of loans now are made by private equity funds that are not subject to these regulations.

One thing that is immutable is that as each generation comes into Wall Street, they think they know better how to do it, and they eventually do the same dumb loans in pursuit of profits and bonuses. It has never been different. We are not about to have a major crash again, but CMBS loan quality is deteriorating now, and one day in the next 2–3 years, it will be a bad problem. When they start doing a lot of CDOs and virtual CMBS pools with derivatives, then that is a sure sign the end is near.

I think Steve pretty much has it right. We’re ok for now, but we will have a problem when recession strikes. The next crisis, which I think will be yet another debt crisis, won’t look like the last one, but it will rhyme.

Circling Vultures

As in nature, carnage for some is opportunity for others. Investment bankers who specialize in corporate liquidations and restructuring see good times coming. Here’s a haunting quote from last month:

“I do think we’re all feeling like we were back in 2007,” Bill Derrough, the co-head of recapitalization and restructuring at Moelis & Co., told Business Insider. “There was sort of a smell in the air; there were some crazy deals getting done. You just knew it was a matter of time.”

A matter of time, indeed. Moelis and others are confident enough to start staffing up before the business appears, despite the tight labour market. Think about how unusual this is. Most companies are in a just-in-time, fully-optimized production mode. You succeed by precisely matching production capacity with current sales… unless you are a restructuring specialist. In that case, you hire the best people you can find and let them twiddle their thumbs until opportunities appear. And you think they will, soon.

Others will have opportunity as well—even you, if you are holding cash and in position to buy some of the valuable assets that will get “restructured” in the next few years. Doing it successfully will take extensive research and iron discipline. Many will try, few will do it well. Start preparing now and you may be one of the few. Remember, in 2009, it was easy to find great companies paying 4% to 6% dividends with single digit P/E ratios. You didn’t have to be an accredited investor to pick up juicy returns. You will get another chance not too many years from now. Patience, grasshopper.

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