News Highlights - Week of 18 - 22 July 2011
Consumer price inflation in Malaysia accelerated to 3.5% year-on-year (y-o-y) in June, the highest level in 27 months, on the back of rising food and transportation prices. On a month-on-month (m-o-m) basis, consumer price inflation stood at 0.3% in June. In Hong Kong, China, the composite consumer price index rose 5.6% y-o-y in June, after climbing 5.2% in May, primarily driven by increasing food and housing rental prices.
* The Bank of Korea has restricted foreign exchange agencies' investments in foreign-currency-denominated bonds issued domestically by local enterprises for the purpose of Korean won financing, effective 25 July.
* Last week, Korea Housing Finance Corporation priced a USD500 million 5.5-year covered bond at a coupon rate of 3.50% and Samsung Securities issued a KRW300 billion 3-year bond at a coupon rate of 4.33%. In the Philippines, power conglomerate First Gen Corporation offered PHP10 billion worth of perpetual preferred shares last week with a dividend rate of 8% per annum. In Thailand, real estate developer Sansiri issued a THB1 billion 5-year bond carrying a coupon rate of 5.4%.
* In Singapore last week, water treatment company Hyflux issued a SGD100 million 5-year bond carrying a coupon rate of 3.5%; real estate developer Joynote issued a SGD180 million 5-year bond and a SGD320 million 7-year bond at coupon rates of 2.585% and 3.408%, respectively; and Singapore's Housing Development Board sold a SGD600 million 10-year bond at a coupon rate of 2.815%.
* The Export–Import Bank of China plans to issue CNY24 billion worth of bonds in two tranches. The China Three Gorges Project plans to issue a 3-year CNY5 billion medium-term note. In Indonesia, Medco Energi Internasional plans to auction USD50 million–USD100 million worth of bonds, while Permodalan Nasional Madani and Nippon Indosari Corpindo plan to sell IDR300 billion and IDR500 billion worth of bonds, respectively. Meanwhile, the Treasury Department of Thailand announced its plan to issue a THB3 billion securitized bond to finance property development projects.
* Japan recorded a trade surplus of JPY70.7 billion in June after posting a deficit of JPY855.8 billion in May. Singapore's non-oil domestic export growth eased to 1.1% y-o-y in June from 7.6% in May, due to lower shipments of electronic goods and declining sales of pharmaceutical products. The Philippines' balance of payments surplus soared to USD5 billion in 1H11 on the back of strong portfolio inflows and overseas Filipino remittances.
* Indonesia's car sales fell 0.3% y-o-y in June, while domestic motorcycle sales rose 0.8% y-o-y. In Thailand, total car sales decreased 0.4% y-o-y in June, following a 10.2% fall in May. In Japan, department store sales rose 0.3% y-o-y in June after registering a 2.4% decline in May.
* Government bond yields fell last week for most tenors in Indonesia, the Philippines and Thailand, while yields rose for all tenors in the People's Republic of China (PRC), the Republic of Korea, and Viet Nam and for most tenors in Malaysia. Yield movements were mixed in Hong Kong, China; and Singapore. Yield spreads between 2- and 10- year maturities widened in Hong Kong, China; Indonesia; Malaysia; Singapore; and Thailand, while spreads narrowed in most other emerging East Asian markets.
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Abstract:
Here are the ingredients in the plot: A problem everyone's aware of. If it isn't resolved, a shutdown with unspecified but possibly disastrous consequences. A deadline which seems indispensable, since in its absence it appears nothing would be done. And despite the presence of the oncoming freight train, movement toward a solution is deterred by highly entrenched positions. It's truly white-knuckle time, and if the progress toward a solution continues to lag, the things that must happen won't.
I'm not talking about the nearly concluded drama at the National Football League, where failure to reach a labor settlement for just a few more days would have caused significant changes in the schedule for the coming year, upsetting the flow of wealth to owners and players and depriving fans of the game they love. I'm talking about the down-to-the-wire battle over the U.S. debt ceiling. I've decided to devote a memo to the debt issue and its significance. I especially hope it'll be helpful to our non-U.S. clients, for whom the lack of progress to date must be absolutely incomprehensible.
Interestingly, the immediate debt crisis is somewhat artificial. It is occasioned now only because of our debt ceiling, which currently limits the net debt of the United States to $14.29 trillion. Such ceilings are far from the norm worldwide. Many other nations seem to function no worse without them.
But the U.S. has the historical accident of a ceiling, and we must deal with it. Because the limitation is set in terms of absolute dollars and not indexed for inflation or growth,we would run into it every few years even if our debt only grew apace with the economy. "In fact, it's been raised nearly 100 times over the
decades." (Financial Times, July 16) But thanks to the especially rapid growth of our debt relative to GDP in recent years –exacerbated by the Afghan and Iraq wars and the financial crisis – the ceiling has the potential to provide some real excitement every once in a while.
For much of the last century, as public equity markets have grown, the choice for owners of private businesses that had growth potential was a simple one. Stay private, with limited access to equity capital or go public? In making the decision, the owner weighed the pluses and minuses of a public offering. On the plus side, liquidity increases and you have access to far more capital, generally at a lower cost, since the investors buying your equity tend to be more diversified (and thus willing to overlook a portion of the risk in your company). On the minus side, you risk loss of control (if not right away, but at some point in time in the future; remember the cautionary tale of Steve Jobs and Steve Wozniak being forced out of Apple in the 1980s) and you also have far more stringent corporate governance rules (think Sarbanes-Oxley) and information disclosure requirements. The venture capital market eased the transition, by allowing small firms that were not ready to go public to raise equity from private investors, albeit at a higher cost than they would pay in public markets
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That giant whooshing, and humming, sound you hear are all the printers at the basement of Marriner Eccles getting refills and start the warm up process. Because according to the Fed Charles Plosser the Federal Reserve is actively preparing for the possibility that the United States could default. Which can only mean one thing: an immediate paradrop of millions of $100 bricks to every man woman and child in the US since as we all know by know Tim Geithner has repeatedly confirmed the Treasury has absolutely no default plans. None.
Per Reuters:
Philadelphia Federal Reserve Bank President Charles Plosser said the Fed has for the past few months been working closely with Treasury, ironing out what to do if the world's biggest economy runs out of cash on August 2.
"We are in contingency planning mode," Plosser told Reuters in an interview at the regional central bank's headquarters in Philadelphia. "We are all engaged … It's a very active process."
Plosser said his "gut feeling" was that President Barack Obama and Congress will come to an agreement to increase the Treasury's borrowing authority in time to avert a default on government obligations.
And in addition to the warming up, the Fed is also engaging in the following:
The Fed effectively acts as the Treasury's bank — it clears the government's checks to everyone from social security recipients to government workers.
"We are developing processes and procedures by which the Treasury communicates to us what we are going to do," Plosser said, adding that the task was manageable. "How the Fed is going to go about clearing government checks. Which ones are going to be good? Which ones are not going to be good?"
"There are a lot of people working on what we would do and how we would do it," he said.
Plosser added that there are difficult questions that the Fed itself had to grapple with.
The Fed lends to banks at the discount window against good collateral. But what happens if U.S. Treasuries no longer fit that bill?
"Do we treat them as if they didn't default, in which case we would be saying we are pretending it never happened? Or do we treat them as if they defaulted and don't lend against them?" Plosser said. "Those are more policy questions."s at the basement of Marriner Eccles getting refills and start the warm up process.
We urge the secretary of tax evasion to take a hint or two from his "Treasury Bank" brethren and start contemplating a Plan B since we now stand less than 48 hours away from D-Hour and there is still no consensus.
News Highlights - Week of 4 - 8 July 2011
The People's Republic of China (PRC) raised its policy rates to curb inflation for the third time this year—by 25 basis points (bps) each—to 3.5% for the 1-year deposit rate and 6.56% for the 1-year lending rate, effective 7 July. Meanwhile, Bank Negara Malaysia kept its policy rate at 3.0% but hiked its statutory reserve requirement ratio by 100 bps to 4.0%, effective 16 July. Viet Nam slashed its repurchase rate by 100 bps to 14.0% effective 4 July, after a series of rate hikes earlier this year.
* PRC's consumer price inflation accelerated to 6.4% year-on-year (y-o-y) in June – the highest recorded – on the back of rising food prices. Consumer price inflation in the Philippines surged to 4.6% y-o-y in June, the highest level in 26 months, driven by price increases in water, electricity, gas and oil, food products, and education fees. In the Republic of Korea, growth in producer price inflation was constant at 6.2% y-o-y in both May and June.
* Net foreign investments in the Republic of Korea's local currency (LCY) bonds stood at KRW2.2 trillion in June, as net bond purchases for the month widened to KRW8.5 trillion, which eclipsed maturity redemptions of KRW6.4 trillion. However, net foreign investment in Korean LCY bonds was down in June from KRW2.6 trillion in May.
* Thailand's Public Debt Management Office has approved five foreign banks to issue THB-denominated bonds up until 31 December. First Gulf Joint Stock Company plans to issue its debut bond worth THB6 billion, while Credit Agricole Corporate and Investment Bank, ING Bank, and Export–Import Bank of Korea were granted permission to issue THB10 billion each. Meanwhile, Lloyds TSB Bank was given approval to issue bonds up to a total of THB6 billion.
* The PRC's exports grew 17.9% y-o-y in June, from 19.4% in May while import growth slowed to 19.3% y-o-y in June, from 28.4% in May. Trade surplus grew to a 7-month high in June at USD22.3 billion. Malaysia's export growth eased to 5.4% y-o-y and imports rose 5.6 % in May. In the first 5 months of the year, total exports increased 6.2% y-o-y to MYR279.2 billion and total imports rose 10.3% to MYR228.0 billion. As a result, Malaysia's trade surplus in January–May stood at MYR51.3 billion.
* Last week, Shanghai International Port issued CNH3 billion of 5-year callable bonds to yield 5.05%. Indonesia's Bank Sumut sold IDR600 billion of 5-year bonds with a coupon of 10.125% and IDR400 billion of 7-year subordinated bonds with a coupon of 11.35%. Korea Hydro and Nuclear Power Co. sold USD500 million of 10-year bonds. Korea Gas priced a JPY30 billon samurai bond. Korea Land & Housing Corp. issued KRW250 billion of 3.5-year bonds at a coupon of 4.27%. Hyundai Merchant Marine raised KRW240 billion from the sale of 5-year bonds at a 5.8% coupon. Thailand issued THB40 billion of 10-year inflation-linked bonds at a coupon of 1.2%. Asian Property Development issued THB1.5 billion of 3.5-year senior notes that carry a step-up coupon of 4.5% in the third year and 5.8% in the fourth year.
* Government bond yields fell last week for all tenors in Indonesia and for most tenors in the PRC, the Philippines, Singapore and Viet Nam. Yields rose for all tenors in Hong Kong, China and for most tenors in the Republic of Korea, Malaysia and Thailand. Yield spreads between 2- and 10- maturities widened in the PRC; Hong Kong, China; the Philippines; Thailand; and Viet Nam, while spreads narrowed in the rest of East Asian markets.
In recent times, many companies have resorted to inflating their numbers in keeping with their reputations or to meet investor expectations. What started as a trickle is now a full-fledged practice. Fortunately, equity analysts have been quick to sift through annual reports and flag instances of creative accounting. Here are some of the more common fudges in corporate India's accounting standards.
Foreign exchange gains/losses
You can have a long-term debt in a foreign denominated currency, or on the asset side of the balance sheet, you can have an overseas investment exposure. Both situations can lead to notional gains or losses. Until recently, there was no uniform standard for recognising profits and losses in various situations in the profit-and-loss account.
Besides, the corporates that routinely use forex hedges (forwards and derivatives) to manage forex risks pose an additional problem of how to recognise the realised and unrealised gains and losses on these exposures. While some strict (and welcome) changes have been made in terms of accounting standards, there are still fears on hidden/undeclared forex losses of many listed companies.
FCCBs: Interest and redemption premium
For many years now, companies have raised money in foreign currencies via convertible bonds. Typically, these bonds carry a very low coupon rate such as 0% or 1% and are redeemable at a huge premium, so that the yield-to-maturity value for the bond holder works out to 6-7%. The company hopes that the redemption premium will never be incurred by it since the bond holder will opt for conversion to shares.
Meanwhile, in the stock market, conversion is often not sought since the conversion price is lower than the prevailing CMP (current market price). In such cases, the redemption premium paid is routed 'below the line' (by charging it to share premium account, instead of reporting it in the profit-and-loss account ).
While this is the prescribed practice, it's unfair that such a charge on borrowed funds should not be reported in the profit-and-loss account uniformly across the life of the bonds. Even if the bond conversion to shares takes place, the discount to CMP implies that such issuances should be expensed like stock options.
Advances and investments
One of the most important determinants of shareholder value creation is capital allocation, that is, how a company reinvests the cash it generates. Redeployment in productive assets, such as plant and machinery, especially if the incremental business can be executed at a similar or better profitability, can quickly lead to multi-bagger stock performance as profits compound. Obviously, such opportunities are not uniformly available across all businesses. Many companies routinely divert the cash surplus from a profitable business to a cash guzzler, only to kill their own shareholder value.
Typically, such (mis)allocations of capital can be found by scanning the investment schedule in their balance sheets. Since investors have figured this out, the more creative companies often resort to making unjustifiable advances to group entities, which show up in the loans and advances schedule under the broader category of 'current assets'. There is nothing remotely current about such assets, since they are invariably share capital advance money or apparently short-term loans given to (often undeserving) parties, who enjoy the benefits of such funds for extended periods of time.
Acceptances
A simple word like this in the current liabilities schedule can send shivers down the spine of investors, especially if a bloating is visible. Acceptances are short-term liabilities that the company accepts and promises to pay such claimants in the future. The danger is that these liabilities might extend beyond the normal scope of trade payables incurred in the normal course of business.
For example, a short-term loan availed of to retire long-term debt can theoretically fall under acceptances. This helps the balance sheet in many ways. Firstly, long-term debt is understated as a result of diverting the liability to the current liabilities head rather than the debt head. Hence, the total capital employed (net worth plus debt) in the balance sheet effectively falls and artificially improves return ratios such as RoCE or RoA.
Secondly, the increase in current liabilities reduces the net working capital (CA-CL), which improves the apparent cash flow from operations. Again, this is artificial, since in a few days after the balance sheet date, the company will probably resort to switching the acceptances with proper long-term debt.
Thirdly, under-reporting of debt has the effect of boosting fair market capitalisation, and hence, fair value per share, wherever analysts attempt to estimate fair EV (market cap plus debt) as a multiple of EBIDTA. All other factors remaining constant, the effect of under-reported debt will be to boost fair market cap. Hence, the target price of the stock (calculated by a less-than-diligent analyst) would rise with no sane rationale.
As the Indian accounting standards are set to approach global standards of checking fraudulent practices, especially with the IFRS (International Financial Reporting Standards) convergence, some of these malpractices will hopefully end. Moreover, Sebi needs to lay down strict laws to combat this menace.
Even the Indian accountants and analysts will have to continue to set the bar high for accounting standards in such a way that corporates find it increasingly difficult to get away with a less-than-fair disclosures of numbers to investors.
Michael Mauboussin, the Chief Investment Strategist for the well known fund manager Legg Mason, provides some interesting insights into the reasons why most investors perform poorly over time, and what are the key skills to develop for successful investing. He has written several books and is an adjunct professor of finance at Columbia University. He was interviewed recently by WealthTrack and I have summarised below the key points:
-While more hard work leads to better results in most spheres of life – it doesn't necessarily do so in the investment world where investors do too much and typically end up buying high and selling low. Often, sitting tight and not doing anything is the best course of action.
-Surveys of a variety of investor groups (including institutions) have shown that they typically hire managers who have recently outperformed and fire managers who have underperformed – and that they would have been better off over the following two year period if they had stayed with the underperforming managers.
-Investors suffer from a "recency bias" and their returns have lagged returns on mutual funds as they chase the hot funds of the day. The key is to find an asset which is unloved and cheap and then hold it (which is different from just buy and hold).
-Most activities in life lie somewhere along the continuum of pure skill, no luck and pure skill, no luck. Investing falls more towards the luck end of the spectrum, and that is why it is so hard to beat the market as everyone is working really hard at it and their skills sort of cancel out.
-It is therefore important to have longer time periods to assess managers (and strategies) as it is only then that their skills will be apparent. In the short term it tends to be noisy and luck plays a key role.
-Really good performances (or outcomes in other aspects of life) are usually a result of skills with lots of good luck – and luck tends to be transitory and mean reverting.
-There are three important skills to develop as an investor: 1) an analytical edge – which, firstly, requires the ability to analyse the difference between the price of an asset and its fundamentals, and, secondly, to position a portfolio appropriately by provide higher weightings to the good ideas , 2) behavioural - to avoid the traps and biases we are all prone to – i.e. over confidence and be overly swayed by market sentiments which tempts us to buy high and sell low, 3) institutional barriers – to avoid being with the pack.
-The well known value investor Seth Klarman of Baupost Group said it best: "Value investing is at its core the marriage of a contrarian streak with a calculator" implying that when everyone loves or dislikes something, take out your calculator and try to spot the discrepancy between the price and its fundamentals.
-The capital accumulation rate of a stock, which is determined by its price, is what matters to an investor. Dividend paying strategies only work if you assume that the dividends are fully reinvested with no taxes. For example, a sock worth $100 which pays a dividend of $3 is then worth $97 , and will be worth $100 only if you reinvest the full dividend.
-The market is currently attractively valued with the S&P500 estimated p/e for 2012 at around 12 versus a historical average of 15/16 – implying a yield of 8.3% which provides an excess return over treasuries of about 5%.
-US corporate balance sheets are healthy, and in particular the large multinationals are trading at attractive valuations and provide an attractive investment opportunity.
Thought provoking insights from Mauboussin and while we would all like to attribute our success to a superior set of skills – it is more often likely to be a result of luck! This is also the point made of Nassim Taleb in his book "Fooled by Randomness". Does this mean we give up working on our skill s? – of course not! – as he notes, luck is mean reverting, so developing your skill set and being prepared to take advantage of a favourable change in fortune would be an appropriate strategy. His observation on dividends is also instructive – dividend paying stocks have done well over long periods because the have also exhibited solid earnings growth, but the assumption underlying this thesis is that the dividends are reinvested and not spent! And on his final (and in my view) most important point, "be a contrarian with a calculator" – Greece and Tepco bonds anyone?!
With the abysmal job growth number released this Friday, the debate between austerity and further fiscal spending is likely to intensify in the weeks and months ahead. Talks of starting an infrastructure bank are an opening salvo from Obama – expect an acrimonious debate and more market volatility ahead. For those who continue to believe in the merits of fiscal austerity I would suggest listening to this 50 minutes lecture by Professor Paul Krugman delivered recently at Cambridge University to celebrate the 75th anniversary of the General Theory. To borrow an apt Sanskrit prayer from the Vedas: "tamaso maa jyotirgamaya" – "lead us from darkness to light"!
