Tuesday, February 24, 2015

Loadsa money...

A good research piece from one of the Swiss banks this week suggests that market consensus is probably underestimating the tidal-wave balance sheet effect of the more than $1tn in globally generated after-tax corporate earnings per year. 

Since the financial crisis, non-financial corporates have been de-leveraging balance sheets through an unprecedented accumulation of earnings, and a relatively conservative approach towards debt issuance. At the same time "cash outgoing" activities such as capex, M&A, buybacks and dividend pay-outs have failed to keep pace with the balance sheet cash build-up. 

Since 2009, while total global non-financial corporate debt has increased, leverage (defined here as net debt to equity) has declined consistently to historical lows around the globe. What this means is that although the dollar value of debt has gone up, the rate of increase in the asset base (as a result of increased cash retention) has gone up faster, so that corporate leverage has actually declined.

In addition, the global low-rate environment has encouraged CFOs to take advantage of low interest rates to extend their corporate debt terms much further out, with the result that corporates are now net providers of short-term funding to the market.

Investors should focus on the following potential consequences: 

1) market premiums will grow for an increased level of share buybacks and dividend pay-outs; 
2) there will be a re-assessment of benchmark cost of capital calculations and market multiples, as long-term leverage ratio expectations get reset as cost of capital goes down, the market risk premium should decline to, justifying higher valuations overall); 
3) even higher future premiums for corporates who have shown a disciplined approach towards value-accretive M&A and capital expenditure projects; 
4) a decline in corporate credit spreads if low-leverage capital structures become the new norm; and 
5) unused corporate funding or cash attracting a significant level of activism or governments looking to tax large pools of cash. Activist funds in the US have been particularly focused on this issue, with some success. 

Our view is that this has been a long-standing theme and one which will remain so for some time, even if US interest rates start rising in the second half of 2015 (if that happens, we don't believe that it will be much more than a couple of token adjustment just to show that the Fed can...).

There are a couple of ways of playing this theme through ETF's that focus on companies that are part of buyback or high dividend paying indices. We already own those. We're also looking for the same in Japan, where the build up of cash continues to support this concept in the context of Japan's steadily improving earnings environment (Nikkei index constituents have just registered the ninth consecutive quarter of higher than expected earnings).  

Steve & Justin
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Thursday, January 22, 2015

The only game in town...



The ECB QE package – a total of over €1.1tn - was much larger than initial market expectations of €500bn to €600bn. Mario Draghi also left the door open for the monthly bond purchases of €60bn to be continued beyond next September’s notional end-date.  This is, on the margin, positive for European equities and fixed income - notably the Eurozone's peripheral countries – whilst being negative for the Euro.

Yesterday’s price action confirms this with EUROSTOXX Index up 1.7%, Spanish 10Y bonds gaining 14bps and the Euro -1.9% against the USD. 

We’ve been pointedly underweight European markets for a while now, but there are 4 developing reasons – independent of yesterday’s ECB move - for being less underweight European equities:

1. ECB's accommodative monetary policy is starting to filter into the real economy via lower borrowing costs.

2. There are signs of a pick-up in the credit cycle, as a result of stronger household loan demand and a recovery in corporate lending, as well as reduced disparity in lending between countries.

3. The sharp fall in the Euro from the highs last year helps the EU's competiveness and is a tail-wind for EPS, especially when compared with the headwinds faced in the three years to ‘Q3 2014 created by a strong Euro. UBS thinks certainly thinks so, and suggests that Q1 EPS could be boosted by as much as 6% from the currency 'swing' YoY. The Germans will certainly be big beneficiaries, even if they are reluctant participants in the QE process.

4. Lower oil prices will boost real consumption decently. Markets have so far focused mainly on the negative implications of lower oil prices, but not on the positive aspects of this “global tax cut” equivalent.

Short-term, the EU economy will remain feeble, deflation fears will continue, EPS forecast revisions will remain the worst of any equity region and could eventually imply negative equity returns in '15. The political construct of the EU/Euro could also be tested by rising support for euro-sceptic parties in countries with elections this year (in Greece – this Sunday – Portugal and Spain), and in the UK as an important non-Eurozone member.
However, much of this could now be in the price, and as a consequence, European equities look like they could be a better 2015 story than was first thought – once you’ve hedged out the currency risk - provided that European politicians start following the ECB's lead and embark on long overdue reforms (something they've avoided doing). If they don't, there's not much more that the ECB can do.
However, although QE might have a limited effect in real terms, there’s no doubting that markets love it. It’s also worth noting that the ECB’s move comes in a week in which we've seen the PBOC inject around RMB400BN into China’s banking system (offsetting last week’s clumsy crackdown on margin lending by stockbrokerages), unexpected rate cuts by the Reserve Bank of India and the Canadian Central Bank and a shift in the consensus on potential Fed rate increases to 'lower for longer' (2016 anyone?). In Japan, the BOJ has also extended its QE from the original end-March end date and modestly boosted the 2 programmes it uses as part of its QE. This global wave of central bank created liquidity is equity and fixed income friendly.

Overall – the basic point is this.

If 2013 was a year of low yield for fixed income, 2014 a year of no yield, 2015 is shaping up to be a year of negative yields. By comparison, equities look like the only game worth playing.

Steve & Justin


e-mail: steve.davies@javelinwealth.com

contact: +65 65577186

Find us on Facebook: http://www.facebook.com/JavelinWealth


Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.