Best chart of the year

Jeff Immelt has decided to step aside after 16 years at the helm of GE. During the period he fundamentally changed the nature of the business, yet shareholders haven’t seen the rewards. The internet is full of Welch vs Immelt comparisons, so no need to explore that here.

Jack Welch was a bit before my time, but I’ve seen his mug on book covers when browsing through bookstores around the world. I’ve never opened one of his books, but I can only assume it covers earnings manipulation in great detail, after seeing the below chart courtesy of a 2012 Business Insider article

Source: Business Insider

GE took a $50m fine in the early 2000s for accounting shenanigans. Remember when that was a big number?

What would similar earnings manipulation be worth in 2017?

Property investors are killing it, sucks for everyone else


Our interactive guide to bricks and mortar across the world

Source: Daily chart: Global house prices | The Economist

People will claim it’s all about the fundamentals until it ends in tears.

Central banks and legislators need to assert control over retail banks. Start by preventing zero down-payment loans, and making all bank executives personally liable if their bank goes bust. Skin in the game, not fat bonuses until they cause a steep recession followed by a comfortable retirement.

Consequences or more pages?

Read William D Cohen’s piece on the mess which is Dodd-Frank. Surely severe consequences for criminal behaviour and true skin in the game (not outrageous options packages) would be more effective:

According to Davis Polk, the Wall Street law firm, the new regulations governing the banking system run to more than 22,000 pages of new rules, that’s on top of the 848 pages of the Dodd-Frank law—all of which is still in the process of being decoded, let alone understood, in the more than six years since the law was passed. Another 20 percent of the regulations mandated by Dodd-Frank still have not been written

Ignore the title of the article, it’s not a political piece.

If investment managers aren’t focused on driving down costs now, they soon will be

Good chart and discussion on the flow to passive funds at Abnormal Returns. Investors are decisively moving towards lower fee funds:

No matter how you slice the data the shift into lower cost funds is firmly in place. The chart below shows the nearly monotonic relationship between fees and fund flows over the past year.

On China, stay sceptical

I was in China a few months after Lehman Brothers collapsed. Guangdong, the manufacturing heartland bordering Hong Kong, was a mess. Factories were closing and previously buzzing night spots were shuttered. Yet the economy kept chugging along according to official statistics.  I assumed they were making them up.

The Chinese government response to the Global Financial Crisis, was to order a massive indiscriminate lending binge. They responded to a crisis caused by sub-prime lending, by accelerating their own sub-prime-lending. China undoubtedly cooks its GDP figures, but the lending binge did support the economy.

The below chart shows the Chinese miracle has involved an unprecedented acceleration in indebtedness.

Source: Blackrock

China’s private debt-to-gross domestic product (GDP) ratio has surged to more than 200%. Never has a big economy piled up so much debt so quickly…

…Thanks to its large domestic savings rate, it has little external debt—the original sin that has sparked many emerging market (EM) crises. Beijing is working on fixes for internal debt issues, such as turning short-term bank debt into long-term bonds and redirecting credit to the private sector and households. But ultimately, China needs to find more sustainable engines of growth beyond further debt accumulation by unproductive national and local SOEs, or accept slower growth.

High foreign debt prevents aggressive currency devaluations. By choosing not to borrow from foreigners, China has left open their ability to significantly devalue the currency to enable export fuelled growth. It will be interesting to see if China will risk a devaluation, with an US President more focused on protecting jobs than his predecessors. A currency devaluation won’t work if the response from the developed world is tariffs.

There are two other key unresolved questions when looking at China’s medium to long-term prospects. (1) How much longer can China keep piling on debt?; and (2) Will the political system be able to absorb lower growth?

On China, stay sceptical.

NB: If you want to see how your country I positioned on the above chart, go here.

Remember stock analysts are nearly always too bullish!

As the new year approaches, the financial press will be full of stories such as:

  • “Top 10 stock picks for 2017”
  • “Investment experts say 2017 will…”

Which brings to mind the McKinsey article from 2010 “Equity analysts: Still too bullish”. In essence they found that equity analysts nearly always over-estimate profit growth. However capital markets are more constrained in how they value companies. Actual P/E ratios are typically substantially lower than those implied by analysts forecasts. Here is an excerpt:

Moreover, analysts have been persistently overoptimistic for the past 25 years, with estimates ranging from 10 to 12 percent a year. Our analysis of the distribution of five-year earnings growth (as of March 2005) suggests that analysts forecast growth of more than 10 percent for 70 percent of S&P 500 companies. compared with actual earnings growth of 6 percent. Except 1998–2001, when the growth outlook became excessively optimistic. Over this time frame, actual earnings growth surpassed forecasts in only two instances, both during the earnings recovery following a recession. On average, analysts’ forecasts have been almost 100 percent too high….Capital markets, on the other hand, are notably less giddy in their predictions. Except during the market bubble of 1999–2001, actual price-to-earnings ratios have been 25 percent lower than implied P/E ratios based on analyst forecasts

The brief article and charts are available here



Do you know the sector composition of your index ETFs?

Good article highlighting the difference in performance between similar index ETFs by The Irrelevant Investor:

Small value stocks are up 25.5% YTD. Small value stocks are up 32.5% YTD. Nope, that’s not a typo. The first one represents Vanguard’s ETF, VBR. The second and better performing small-cap value ETF is IWN, from iShares.

As you can see from the chart below, they were neck and neck until the election, and then IWN kicked into high gear. The reason for this divergence is 29% of IWN is in financials, VBR is just 18%. Does this mean that iShares is the “better” option? Of course not, at least not due to twelve months performance. Over the last five years, IWN has returned 107%, while Vanguard’s offering is up 121% over the same time (also, does not mean Vanguard’s is superior).

Read the full article here

High exposure to financial services could increase the volatility of broad index funds during financial crises. It’s something to consider when choosing which index funds/ETFs to invest in.



Time to reassess the risk of investing in family businesses?


Family businesses are viewed as being less “corporate” than their listed peers. They are associated with poor governance, family disputes (especially over succession) and bad treatment of minority investors. However, Credit Suisse research indicates family businesses outperform:

Read the full article here (Nikkei Asian Review) and a more detailed breakdown of the analyses here, including performance by generation (Credit Suisse).

Similarly, a BCG study showed that family businesses in emerging markets grow faster than their peers, but achieve lower returns:

A Bain study indicates that returns to shareholders in companies where the founder is involved are 3x higher:

Time to rethink the bias against family businesses?


Investors appetite for risk remains below dotcom and pre-GFC peaks

Interesting piece from BlackRock on investors risk appetite versus historic levels:

So, will risk appetite rise? Our BlackRock Macro GPS suggests that economists remain too pessimistic on the growth outlook for major economies in the months ahead. It highlights that economic conditions may not be as downbeat as the consensus suggests. At some point, stronger confidence in the economic outlook may prompt money to shift into risk assets, providing some upside potential. We believe upgrades to growth forecasts and greater clarity on the policy agenda of U.S. President-elect Donald Trump could help stir more investor hunger for risk. We don’t expect renewed bouts of euphoria, but we see scope for investor optimism to lift equities and other risk assets, and see a mild rise in bond yields.

So, still more upside to the S&P 500’s P/E ratio of c. 25x?