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Archive for August, 2009

The Economist has an interesting commentary about the relationship between countries with high GDP growth and the returns for shareholders. Since corporate profitability is a central driver for economic growth in the first place, one would expect that high GDP growth should be a prerequisite in determining the viability of an investment.

This was not the case when considering 2 testing strategies for 17 countries:

  1. There was a negative correlation between investment returns and growth in GDP per capita
  2. In sorting the economies by growth rate into quintiles (highest to lowest), the fastest growing countries yielded an average 6% return, while the slowest yielded 12%.

The obvious problem with these statistics lie in the year of the study (2005) since the US was still achieving 4-5% GDP growth, and would be considered apart of the “slowest growing quintile”. Perhaps Thailand and North Korea were in the top quintile, but for obvious reasons (political instability, risky currencies) they weren’t great investments.

I do agree with this logic, however:

Why might this be? One likely explanation is that growth countries are like growth stocks; their potential is recognised and the price of their equities is bid up to stratospheric levels. The second is that a stockmarket does not precisely represent a country’s economy – it excludes unquoted companies and includes the foreign subsidiaries of domestic businesses.

Yes; the first is an issue of valuation (when is it unsustainable for China to have a higher P/E multiple than the US?) while the second is an issue of internal vs. external business growth; would we rather own a US run company with 30% of its exports to emerging markets, or a foreign company with 100% of its sales to consumers in its own country?

IBM, for example, is an American run multinational company which contributes to the GDP growth of many countries overseas – however the tangible returns are realized by the shareholders (who are probably from the US), which explains why the “slowest growing” GDP statistic isn’t very relevant for investing, since the geographical scope of most businesses is very wide.

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I hadn’t been paying enough attention to the markets this summer to write anything meaningful until last week – it figures that as soon as I start writing, the markets begin to tank…

The Good:

My first move is to add “Credit Writedowns” to my blogroll. I can’t believe I’ve missed this for so long, since its probably one of the best sites I’ve ever seen. There’s more categorization and sub-articles (including a credit crisis timeline, which includes an archive of every major event in the past 3 years) than I’d ever care to read through, but that goes hand in hand with the extensive nature of the website.

The Bad:

Secondly, I’d say that The Big Picture is hanging on by a thread in the class of venerable blogs. The content has been lacking over the past 3 months – mostly since the author has been promoting his book at every turn – and his pursuits of investigative journalism have been mostly overridden by efforts to stir controversy. That said, Barry Ritholtz has been adding value with his “link fests” (which must be taking viewers away from the guy at Abnormal Returns).

The Ugly:

Thirdly, I think that this article from Reuters paints a very clear picture about the remaining problems concerning real-estate loans: Many of them haven’t been marked down from values at origination.

Emergency bailout facilities allow banks that otherwise would have failed under the weight of bad loans to hold those loans to maturity — pretending the bad ones will be paid off in full over time.

In reality, many loans will default and banks will bleed capital for years. Take commercial real estate. As the Congressional Oversight Panel has reported, few CRE loans that were originated at the peak will qualify for refinancing when they mature. Banks can pretend they will, carrying the loans at values far above what will ever be paid back. (emphasis added)

Then there’s this table — originated from SEC filings — which shows losses based on a loans marked at Fair Market Value (not the carrying value) as a percentage of Tangible Common Equity (TCE):

what-loans-are-worth

This suggests that if property values stay depressed at these levels through the lives of these loans, the losses will be understated at maturity. In other words, if the mortgages in JP Morgan’s loan portfolio had expired in June, the losses would wipe out about 17% of their equity (which is remarkable, since the difference between the Fair Model assumptions and the actual carrying value is only 3%).

More on this to come…

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