Asset Management: Asset Manager Insights

Frothy markets and the posh buyers’ club

man with bicycle standing against red clouds in the sky

This month’s news focused on the return of “alternative” markets, political instability (for different reasons) in Germany & Zimbabwe, and Tesla’s continued production troubles.

Merkel’s diminishing reign

The inability of Angela Merkel to form a coalition in Germany is causing consternation throughout Europe. The region’s most stable (and solvent) power is suddenly not quite so stable. Ms. Merkel’s authority has been diminished at a time when strong leadership is needed. At the time of writing the outcome of the ongoing talks is unknown although odds appear to favor a “grand coalition” with the Social Democrats (SPD) – déjà vu.

Crocodile in sheep’s clothing?

In Zimbabwe the long-standing nonagenarian leader, Robert Mugabe, announced his resignation shortly before impeachment proceedings were initiated. He has been replaced by 75 year old Emmerson Mnangagwa, colorfully nicknamed “The Crocodile”.

Mugabe’s 37-year authoritarian rule started promisingly but became increasingly erratic, repressive and corrupt. The economy of a beautiful country was slowly driven into the ground. In the meantime Mugabe, has, allegedly, salted away more money than he is ever likely to need.

Mnangagwa’s ascendency to the leadership was greeted gleefully on the streets of the capital Harare but given what is known about “The Crocodile” we wonder if celebrations are a little premature.

Frothy markets and the posh buyers’ club

In the past, one of the indications of a build-up of excessive froth in financial markets has been the boost in prices (and turnover) in “alternative” markets – classic (and not so classic) automobiles, works of art, rare coins – or rare anything. To that list we could now add bitcoins and other “crypto” currencies. Liquidity is abundant, interest rates are low and investors are clutching for yield and return in what will continue to be a low-growth world.

In this context it is worth noting that in mid-November Leonardo da Vinci’s Salvator Mundi painting sold for a record $450.3 million (including buyer’s premium) at a Christie’s New York auction. This surpassed Picasso’s Women of Algiers which sold for a mere $179.4 million in 2015. The de Vinci painting was rediscovered in 2005 and an impressive marketing campaign overwhelmed doubts about its authenticity and concerns over its condition.

What price a 500 year-old painting? What price a bitcoin? What price a Ferrari 250 GTO? There is no right answer as fundamentals play no role in these decisions. We wonder how many “investors” in bitcoins really understand what they are buying. We suspect very few. They are buying because it has risen astronomically in price and they want a piece of the action before it rises further. They probably feel very sophisticated buying something that they struggle to understand and of course believe themselves to be super-smart if they happen to make money. We’ve met some of these “smart” people. No doubt many of you have as well. And no doubt many of our readers will own some “cryptos”.

We are not for a minute denigrating blockchain technology – the impressive computer science behind secure, fast, anonymous and inexpensive peer-to-peer transactions. This has many potential applications in the “real” world and if it helps to make payments systems more secure than the existing flawed practices then it can only be for the good. But are the majority of bitcoin investors even aware of the blockchain science underpinning their transaction? So we say again, what price a bitcoin? We have no idea – but then nor does anyone else.

Getting in sync with the global upswing

Europe must take over the lead in world growth
As part of our 2018 Global Investment Forum: Five-Year Outlook, Europe must move from laggard to leader in the global growth race if our base case scenario is to be achieved.
 
Read more in our 2018 Five-Year Outlook.

At the beginning of November the Bank of England raised its benchmark rate to 0.5%, from 0.25% – the first increase in a decade. The Bank’s governor, Mark Carney, was quoted as saying: “The global economy is firing on most cylinders. It’s doing very well…it’s not surprising that the stance of policy is changing.” In the next breath he said: “The UK is participating a little less in this global upswing. We are going through a relatively unusual period of underperformance.” Many observers were puzzled by the increase given the continuing Brexit turmoil and speculation about the political future of the Prime Minister, Theresa May.

We, on the other hand, support the increase. Rates have been too low for too long. Capital is misallocated in a low (no) rate environment – towards speculation and away from capital investment. This is a global phenomenon – hence very poor rates of productivity growth. In the U.S. it now seems likely that the Federal Reserve will raise rates again in December – one of Janet Yellen’s last moves before she vacates her post in February next year. We will also be supportive of this move.

So gradually we creep towards “normalization” – Canada, the UK and U.S. have increased rates while the ECB has announced it is halving its level of monthly bond purchases. Of the majors only Japan is holding out although we have detected some sensible noises in recent months. The world is a long way from actually regaining “normal” but it is of some comfort that the road-map has changed.

A costly and expensive bottleneck

Tesla continues to frustrate its long line of waiting and deposit-paying customers (believed to number over 500,000 globally) by announcing further delays to its Model 3. It was hoping to build 5000 Model 3’s a week by December but that has now been pushed back three months. In the third quarter it made just 260 Model 3’s due to “production bottlenecks.”

In the meantime the company has announced its biggest-ever quarterly loss of $619 million – about 30% worse than anticipated. The stock price fell only marginally at the time of the announcement although the price of the company’s debt did not fare quite so well.

Tesla is a market “darling” despite continuing to fall short of its promises. Its market cap is second only to GM’s amongst U.S. auto manufacturers. This is a remarkable state of affairs considering it is some distance away from profitability. Some analysts suggest it will always be “some distance away.” We like the luxury vehicles it has produced and don’t doubt that the Model 3 will be a fine motor vehicle but this is a tough industry that burns cash and reputations and any call about where the next few years will take Tesla is beyond the remit of our crystal ball.

Market watch – positives and negatives

Stock markets provided a mixed bag of performance in November. At the time of writing (data to November 28) and utilizing MSCI local currency price performance we find EAFE down by 0.5%; the EU down by 1.6%; and the Eurozone down by 2.1%. By contrast, the Far East is up 0.9%; Pacific 1.0% and North America 1.9%.

Turning to selected country stock market performance for November (again MSCI local currency price returns to Nov 28) Hong Kong is up 4.3%, Singapore 2.5%, the U.S. 2.1%, Australia 1.1%, Switzerland 0.7%, Japan 0.4% and Canada 0.1%. The negatives are clustered in Europe: Denmark down by 4.6%, Belgium 4.1%, Spain 3.5%, Sweden 3.0%, Ireland 3.0%, Italy 2.3%, Netherlands 2.3%, France 1.9%, Germany 1.0% and the UK 0.5%.

Benchmark government bond yields (10-year) drifted close to levels that they have maintained for much of the past year. On average, they fell slightly over the month while at the very short end yields rose marginally – in other words, the yield curve flattened. This is not unexpected given the ongoing firm trend in global economic performance and the gradual rise in key central bank rates. A further flattening seems likely.

Pyrford is registered as an investment adviser with the Securities and Exchange Commission and is a wholly-owned subsidiary of BMO Financial Group.

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