If you think things are bad in the United States…

Posted by Jim O'Leary on 11/18/08 8:53 am

Over the past months, bashing the U.S. and George W. Bush has become a global pastime. It seems around the globe and at home, anything that George 41 looked at turned to stone, and if he kissed it, it would surely die. In general, even though the President does not have much impact on the economy, he is either praised or made fun of for where we are in the business cycle. In particular, the first year of a Presidency has virtually no impact on the economy, so this is the fate waiting for President-elect Obama. The recession will be his fault, and the critics will slam and make fun of his efforts as unemployment continues to rise.

What I find most amusing is that business people in the U.S. are much more optimistic than their competitors across the sea. In several company visits in Europe, I have heard management praising their investments in the U.S. and their long-run opportunities, while realizing that their own economies, at best, will be flat to 1% over the next three years. The higher dollar will translate into increased profits in their own currency.

I just returned from a trip to the United Kingdom, and in all of my visits to the U.K., I have not heard as many firms considering delisting in the U.K. and listing in the U.S. The only thing holding these companies back is that passive index funds will delete them from the FTSE index and sell their shares if the companies delist from U.K. exchanges. While it seems a pity to have capital misallocations lead to bad decisions, it is the reality.

What I found most surprising was the suggestion that the GBP and the U.S. dollar may be trading on a one-to-one parity by the end of 2009 (currently, the GBP trades at 1.5x the U.S. dollar). Gloom in their own country and greater growth opportunities, lower long-term energy prices, and potentially higher relative interest rates are cited as some of the reasons for the rise of the U.S. dollar. The unfortunate consequence of the continued rising of the U.S. dollar would be a slowdown in exports and tourists visiting the Big Apple and Disneyland. The upside would be inexpensive weekend visits to London.

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Brewing Up Senator O

Posted by Jim O'Leary on 11/14/08 10:32 am

It is Friday, the last day of my journey in Great Britain, and it seems fitting that the weather turned fair and sunny, and that I can end the week feeling some optimism after a week of gloom and doom. The gloom and doom was repeated all week by the media about not if there would be a downturn in the British economy, but rather if the severity of the downturn would be short, long, or shallow. 

However, it turns out there are bright spots not only in the U.K., where Scotland still shines, but also around the world. China is forecasted to have 9% growth in 2009, India 6%, and Japan .5%. But the biggest surprise is Africa. My final meeting was with the maker of Guinness beer who shed some light on Africa, which is the one area in the world that was totally spared by the housing crisis that has crippled Europe and the U.S. Without anyone noticing, Africa has forged regional pacts to promote trade and production. There are a few exceptions to the new peace and prosperity in Africa, but outside these areas, the rest of the continent is booming and buying beer.

Kenya was the home to President-elect Obama’s father and is also home to Senator Keg Lager. Senator Keg beer was introduced two years ago when Obama became a U.S. Senator. He became the country’s favorite U.S. Senator, and Senator Keg Lager was soon Kenya’s favorite beer. This pleased Kenya’s government as most alcohol consumed in the country is unregulated moonshine. Although it kills and maims some of its consumers (the beer is sometimes made with ethanol), the people who make the moonshine do not pay taxes, but the consumers of Senator Keg Lager do. Now that Senator Obama has been elected the next President of the United States, the beer is called just OBAMA. In other beer news, sale of Guinness may be flat in the U.K. and Ireland, but it is growing rapidly in Nigeria (along with sales of Scotch). Read more

Lastly, one of our top ten holdings, HSBC, was in the news today on the subject of two topics. (1) The company is the only major U.K. bank that has not been forced to take either governmental or Middle Eastern money to shore up its capital base. (2) HSBC may be forced to repossess its Canary Wharf headquarters now occupied by Metovacesa. HSBC holds an £810 million GBP loan on the building, and it appears it will once again take ownership of the building. HSBC will be able to write off the £810 million GBP loan and pocket approximately £200 million GBP in cash that Metovacesa paid up front for the building. I guess this goes back to yesterday’s conclusion that it is only a recession/depression if you lose your job.

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Feeding the Dragon

Posted by Jim O'Leary on 11/14/08 9:46 am

The ‘dragon’ doesn’t eat Chinese food; it eats money! The recent $586 billion stimulus cash fed into the Chinese economy stands as both a surprise move and an aggressive move. The sizeable population of China warrants this kind of influx of cash if it is going to have any reasonable chance of working. The stimulus is designed to cut business taxes, fuel infrastructure and manufacturing growth, and ease the housing crisis, among other things. The plan is scheduled to run through the end of 2010.

A boost in consumer demand and spending is desperately needed for China’s economy to continue its previous growth, which has been about 10% annually since the mid 1970’s. That’s when the government took on a form of free-market socialism. It has worked well since then, but clearly no major economy has been able to escape the global meltdown.

The driving force behind China’s growth is, ultimately, its massive population. When the people were constrained for nearly a century under the rigid Mao’s form of communism, they were a drag on the economy. When market liberalization reformed government leadership came about, the people became consumers and entrepreneurs.

Today about two-thirds of China’s businesses are in the private sector. The government owns the remaining third. With the greater apportionment of the economy residing in the private sector, the stimulus should more effectively flow into and through it. The increased private ownership of businesses should result in greater chances for success from the stimulus.

The effects at home most likely would not be felt with any great impact immediately. The government has been cautious in its expectation of quick results. The two-year plan of disbursement is designed to create the correct, timely flow of funds into the system.

Domestic spending should increase. While the plan will boost jobs, production, and consumer spending – as well as reduce the housing and credit problems – some skepticism remains. Boosting the economy at home is part of the picture, but China’s interdependency in a broader, global economy cannot be overlooked.

China depends heavily on its exports, and Europe is its biggest customer. Although economies continue to slump there, and markets remain tenuous, news of the stimulus was received favorably abroad. The news caused a blip in the U.S. markets, while European exchanges had jumps slightly higher. Asian exchanges showed the greatest reactions. Tokyo’s Nikkei rose 5.8% at the news. The Hong Kong Hang Seng Index was up 3.5%, and the Shanghai Index had the greatest increase at 7.3%.

A general consensus among analysts and other experts seems to indicate optimism toward the success of the large stimulus plan. China should feel positive results in the shorter term, but globally positive results will occur over time, at least well into next year.

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Short Sharp Shock

Posted by Jim O'Leary on 11/13/08 10:47 am

This Thursday morning, the headline of The Independent read “Short Sharp Shock.” Finance Chancellor Alistair Darling stated to the newspaper that “We are going into a recession. I remain confident that we will get through it.”

Unemployment rose in the United Kingdom to 1.82 million and is projected to climb to two million in 2009 and peak at three million in 2010. Welfare recipients increased by 36,500 over the past month to 980,900 and the number is forecasted to continue increasing over the next year. In addition, it is believed the housing market will continue to degrade into the recession.

Despite all of the bad news, Chancellor Darling did have some good news. He forecasted that inflation will drop to 2% in 2009 and 1% in 2010, the price of oil and other commodities will continue to fall over the next two years, and interest rates will continue to fall below 1%. Furthermore, the government will go into a deficit spending mode and begin new infrastructure projects to create jobs. John Maynard Keynes, a well-known U.K. liberal economist and the father of Keynesian Economics, taught that countries should make sure they help the economy in difficult times while living within its means.

In relation to the individual, those who are able to keep their jobs should see a rise in their standard of living as their cost of living goes down and their incomes remain the same. (Scotland is still seeing employment growth.) As the saying goes, the only difference between a recession and a depression is one’s circumstances. If one loses his or her job, it is a depression, and if one holds onto his or her job it is only a recession, with benefits. So on this rainy day in London, it may not be as bleak as it appears.

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A Strong Long-term Strategic Plan Can Pay Benefits

Posted by Jim O'Leary on 11/12/08 10:33 am

One of the lead business stories in this morning’s London Daily Mirror touted the headline, “HSBC’s still raking it in.” (HSBC is a top ten holding in Navellier’s International Growth Portfolio.) The news story revealed that the bank has boasted profits over the past quarter despite a £3 billon GBP write-down in its investment portfolio. The profits were a result of fat margins produced from growth in the Far East. 

Several years ago, on one of my visits to HSBC in London, a senior executive reviewed both Chinese and HSBC’s (Hong Kong Shanghai Bank Corporation) history.  China, over the past 1000 years, has been a dominant country both militarily and economically. It was only in the near-term that it was reduced to an impoverished state. HSBC’s presence in Hong Kong and participation in the revitalization of China uniquely positioned it to reap profits from China’s ascent to the title “manufacturer to the world.”

HSBC’s profits derived from this long-term strategic plan along with early actions at its U.S. based subsidiaries helped it maintain its strong capitalization basis. HSBC is one of the two major British banks that did not need to take part in the £37 billion GBP banking bailout. Not only are they not subject to new rules and government nudging to lower interest rates they charge to U.K. based clients, they are also profiting from their connection to China.

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Will China’s Plan Be Enough?

Posted by Traci Sinclair on 11/12/08 10:02 am

Many economists found China’s announcement Sunday of its sweeping domestic stimulus plan encouraging. As the global economy stumbled, then staggered, and now limps under the weight of a global credit crisis, economists explored scenarios that would shore up the global markets. Many economists suggested that China, with a sovereign wealth fund of some $200 billion, according to a Forbes article published in February 2008, and as of November 11, 2008, a further $1.8 trillion in its foreign exchange reserve according the People’s Bank of China, could provide enough economic capital to get the global economy moving again.

However, China’s economy is not as strong as it once was. And, these same economists who looked to China to step in and help the global economy forget the fundamental axiom that governs the global market: everything is connected. China could not hope to isolate itself from the global recession.

At first glance, China’s economy performs admirably and would be the envy of many countries under a favorable global economy, to say nothing of during a global financial crisis. China’s projected GDP for Q4 2008 stands at around 5.8%. This projection dwarfs America’s GDP in Q3 2008, which the Bureau of Economic Affairs reports fell to –.03%. However, if the projection for China’s economy holds, it will reflect a growth rate nearly 6.1% below 2007’s growth rate of 11.9%.

Faced with a potential national economic crisis of their own, the Chinese government instituted a public works plan to invigorate its flagging economy. Devoting some $586 billion, or roughly 15% of its economy to a massive public works program, China has decided to reinforce its own domestic economy and thereby to ultimately strengthen the global economy.

Although it is difficult to think of an investment of $586 billion as particularly conservative, China’s decision to employ its vast resources to guarantee its economy is nonetheless a predictable response to a declining economy according to Jim Jubak of MSN Money. Current projections suggest that the Chinese economy may be off by as much as 30%.

China’s decision is not only driven by a slowing economy. Forecasts predict that by 2015, one-half of China’s population will live in urban areas, and by 2035, approximately 70% of China’s population will have left the rural areas and moved into the cities. Such a significant change carries with it necessary changes to the labor market, most specifically the creation of new jobs for the one-time rural population.

But although China is not directly investing in the international marketplace, its building projects will help shore up the global economy. Rich in people, China is relatively poor in natural resources. In order to build the infrastructure improvements, China will have to import great quantities of reinforced steel, concrete, wood, oil, gas, and natural gas. These imports will ultimately benefit the global economy even if they don’t provide the sort of direct infusion of capital to the global market for which many held out hope. Simon Johnson, onetime chief economist for the International Monetary Fund and senior Fellow at the Peterson Institute for International Economics, argues that the massive resources required for China’s infrastructure project will stabilize if not raise the prices of commodities. Jubak agrees, saying that the demand for construction staples like iron ore may help shore up markets projected to fall by 10-20% if demand and production remain at current levels.

China’s stimulus plan hinges on the conventional wisdom that the global market influences every sort of economic project, even the most domestic like infrastructure development. In the article “An old Chinese myth,” published January 3, 2008 in the Economist, Jonathan Anderson, an economist at UBS, argued that China’s economy is far more dependent on investment, which accounts for 40% of its GDP, than it is on exports, which he estimates account for roughly 10%. Yet even if exports are not the primary force in the Chinese economy, exports still exercise a significant influence on the health of the country’s economy. Anderson notes that Dragonomics forecasts of China’s economy in 2008 estimates that net exports will fall by one-half. This fall will translate to a net loss of about 1.5% of China’s GDP. As Anderson notes, such a loss is hardly catastrophic, but it is significant.

The significance of the modest loss to China’s GDP resides not in the absolute dollar value of such a loss but rather in how even such a relatively small loss threatens to undermine China’s economic strategy. Much of China’s wealth rests on manufacturing. But rather than capitalizing on its enormous pool of available labor to drive its manufacturing, China has invested heavily in plants and equipment to make its factories as efficient as possible. In February 2008, Alan Wheatley of the International Herald Tribune argued that China would find it increasingly difficult to sustain its capital-intensive growth model if the global economy continued to weaken. He reports that in 2006 investment was already at 45% of China’s GDP and argued that sustaining this growth model might require as much as 60% of China’s GDP. Even under the best of times, such prodigious investment would be difficult to sustain, and given the current vitality of the credit markets and the falling export markets, the possibility of China financing its growth model seems more unlikely still.

In the face of such uncertainty, China’s decision to invest so heavily in its infrastructure represents a bold economic strategy, a strategy that may well provide the boost its slowing economy requires. But if such changes are to be permanent, the global market will have to at the very least stabilize. Whether or not the best way to bring about this stability is to invest in local markets or to pour more money into the international markets is uncertain.

But the boldness of China’s plan may be its strongest asset. So long as China’s decision calms its market and inspires confidence, it will mark an important first step towards the nation’s and the globe’s economic recovery. It only remains to be seen if even such a bold strategy as China’s, which Time and other publications are already comparing to FDR’s New Deal, can inspire optimism.

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11th Hour of the 11th Day of the 11th Month: 1918

Posted by Jim O'Leary on 11/11/08 12:02 pm

Today in London, I sat in the middle of a strategy management meeting with one of the companies in our International Growth Portfolio when came two minutes for remembering those who fought in the Great War, the war to end all wars, that ended 90 years ago today.  In the eleventh hour of the eleventh day of the eleventh month, London, and all of England, paused on this Remembrance Day. While only a few living participants remain, we all hope that differences can be settled without war and that terrorist activities will halt. Unfortunately, such activities will probably not stop in the near future, which was the subject of today’s meeting.

When I first worked for the Boeing Company in 1975, jet pilots generally received only one stream of outside data, radar. Radar was used to determine aircraft location, altitude, and the location of other aircraft. Today, pilots of both U.S. and British fighter jets are fed over 60 streams of data, each coming from a different source. Needless to say, at the height of battle or while just flying a jet, a pilot would not be able to process 60 streams of data. The solution becomes the algorithms, which are used to find anomalies and provide information on what actions the pilot should initiate to respond to the predicted actions of the anomaly. 

The same algorithms pilots use to track and attack invaders into NATO and U.K. airspace are also applied to tracking and discerning terrorist’s activities. After the 9/11/2001 attacks on New York and Washington D.C., the United States formed the Office of Homeland Security. While some believe it is a bloated addition to the nation’s bureaucracy, it has provided one centralized location within the government to coordinate activities to secure the safety of the nation. Other nations have copied the concept, and as a result, an entire industry has evolved to support the internal security of the United States and a host of other countries.

London is hosting the 2012 Olympics, and the security challenge is great. To meet the challenge, it takes more than the 12,000 cameras and 500 full-time watchers (per shift) to root out possible terrorist activities before they occur. This is the job of defense intelligence contractors and the algorithms that were developed for jet fighters. These same algorithms that find anomalies using multiple data sources are being used to protect our borders and the 2012 Olympics. Additionally, as I found out today, the contracts that are being awarded to implement these algorithms are very profitable for the companies that provide them.

Have a happy Remembrance Day.

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Banks Defy Brown Over New Rate Cut

Posted by Jim O'Leary on 11/10/08 11:47 am

I am back in London staying at the Chancery Court where the Merrill Lynch Asian Pacific conference is being held. When I awoke Sunday morning, The Sunday Times lead story read “Banks defy Brown over the new rate cut.” Prime Minister Brown and Finance Chancellor Alistair Darling are upset that major banks are not passing on the rate cuts that the Bank of England enacted, nor are they planning to pass on proposed additional rate cuts.

The Bank of England slashed interest rates last Thursday by 1.5 percentage points to a 54-year low of 3%. Unfortunately for major U.K. banks, with interest rates so low, margins are “desperately low.” While most of the nation’s banks responded to the government’s actions, two banks, Barclays and HSBC, both of which did not take assistance from the government, have not responded as hoped and did not lower their rates.

Alistair Darling has indicated that the three partially nationalized banks, RBS, Lloyds TSB, and HBOS, “Would be put under greater pressure to pass on any cuts.”

One piece of bright news is that interest rates in the U.K. are expected to fall to 2%, with the additional cut coming just before Christmas.

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Losing Interest: European Banks Cut Key Interest Rates

Posted by Jim O'Leary on 11/7/08 12:53 pm

Is cheap money the solution to curbing the continuing losses of the international markets? Thursday, several prominent European banks slashed key interest rates in an attempt to pull the flagging European economy out of the recession that many leading economies forecast or fear they have fallen into. Jean-Claude Trichet, president of the European Central Bank, presented the decision to lower his bank’s key interest rate by 0.5 percentage point. The Bank of England also reduced its key interest rate to 3%. This cut of 1.5 percentage points represents the largest decrease in 27 years. The decision “gives a positive signal to financial markets” according to Gerhard Hemer director of economic fiscal policy of the European Craft and Employers’ Organization. He argues that evidence of the falling short-term commercial lending rates reveals that the decision was a good one, though perhaps not leading to as rapid an improvement as some hoped.

But a few questions about the prudence of the decision remain. Some economists worry that if done at the wrong time, cutting the key interest rate will decrease the real cost of borrowing money and drive inflation higher. However, drops in oil prices mitigate these concerns significantly. Selling Thursday for close to $60 a barrel, oil has fallen to less than half of the mid-July high of $147.27 per barrel.  As a consequence, most sectors of the global economy are experiencing some relief. Yet any inflation will likely lead to significant hardships throughout Europe. If the latest economic forecasts are accurate, England may be the hardest hit of all. The European Commission forecasted its economy will grow by negative 1%.

Nevertheless, most European economists agree that freeing up credit is one important step in returning investor’s confidence in the now flagging international economy. But as long as the problem is a lack of confidence in the market, any effective solution will have to alter how investors feel about the market. Unfortunately, such feelings can be notoriously difficult to alter.

What might spark the necessary change remains in question. Sound, deliberate changes in the lending policies of large banks are an important first step. But they may not be enough. As Ian Kernohan, Royal London Assets Management economist has pointed out, “Small cuts are not appropriate when the economy is slowing so fast and the MPC was right to be bold.”

Bold moves, unfortunately, are risky. The question becomes just how bold can we afford to be in a global economy that may already be in a recession – especially given the old proverb that markets fall more rapidly than they rise.

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China - “Not Done Yet”: Part 2

Posted by Jim O'Leary on 11/6/08 7:20 am

Decades, even centuries, saw the Asian giant seemingly plodding along into nowhere, moving from its heyday era of dynasties into an overpopulated mass of poverty. With a population of 1.3 billion and growing, continued poverty is unacceptable. Since the mid 1970’s, a new economic China has risen up. A massive financial reversal such as what occurred in 2008 as part of a global phenomenon will not stop this giant from moving forward. 

Part of the forward, and upward, movement is China’s progressively increasing middle class. Fifty percent of China’s population will live in cities in 2010. Urbanization and middle classes go hand-in-hand. Upwardly mobile middle classes live better in all ways, and the pursuit of better lifestyles drives economic growth.

The ‘Rice Bowl’ status has progressively given way to a population that consumes more of the things that it wants – not just what it needs. The Chinese diet has moved beyond mere staples to increased consumption of meat and dairy, markings of more prosperous societies and cultures. Beyond staples, the demand has risen for more and better homes, furniture, clothing, travel, technology—in business and in gadgetry, and sundry other things characterizing developed nations.

On the other side of the picture is the increase in goods and services accruing to health and medical needs. These run along a parallel track in any culture that has either a lot, or too much. Rising living standards in China have brought a focus in addressing the country’s health needs. The government poured money into improving Beijing’s environmental standards in preparation for the Olympics. Wastewater treatment, for example, was improved to a rate of nearly 90%, up from 42% in 2001.

With its huge population, China continues to face important environmental problems. Pollution controls are a challenge in all of the country’s major cities. Government mandated and financed measures were implemented in preparation for the Olymipics in Bejing, and the same steps are being taken in advance of the 2010 World Expo. The deficient wastewater problem in Shanghai is being actively addressed already. The Shanghai Environmental Protection Bureau recently spent $5.8 billion toward this end.

Shanghai is China’s largest city, with a population of more than 14 million (20 million metro), and Bejing is second with more than 12 million. The bookend global events of the 2008 summer Olympics and the 2010 World Expo constitute impacting financial and social events with lasting importance. They will set an example of twenty-first century urban modernity that leads the way for the rest of the country. The optimism for growth in China is a matter of looking beyond momentary crises and seeing the enormous potential that is there. Global stock markets rise and fall with the times. As the world financial community straightens out its problems, a healthy global economic picture will resume. Some countries will fare better than others in the end. China looks to be the continued leader in emerging markets

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