Tag Archives: investment

Business Investment is Falling

Thesis: Now is the time for companies to invest in themselves given the upcoming rise in treasury yields.

Many companies have slowed investing considerably this winter. This is not surprising given what has been occurring on a macro level. The value of the dollar is rising and the overall world economy is struggling. These things coupled with hurting US energy sector has most likely contributed to these figures. According to recent reports, the demand for investment in non-defense capital good excluding aircrafts fell 1.4% from January. This is after we saw flat growth for the first two months of the 2014.

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According to experts, “Weak business spending—along with other factors like a downbeat export picture—prompted some economists to downgrade their assessments of how much the economy expanded in the current quarter. Morgan Stanlety said it now thinks gross domestic product grew at a 0.9% annual rate in January through March instead of its prior estimate of 1.2%. Macroeconomics Advisers lowered its estimate a tenth of a percentage point to 1.4%. http://blogs.wsj.com/economics/2015/03/25/weak-demand-strong-dollar-u-s-businesses-arent-investing-much/.  This is why I believe now is the time for companies to engage in serious capital expenditures. The US economy has been performing well relative to the rest of the world. Interest rates are due to start increasing as we have seen with this graph provided by FRED.

fredgraph

 

The Fed has recently announced they will most likely being raising interest rates this year after many years of keeping them as low as possible to spur investment. This is why now is the time for companies to invest in themselves. In as soon as this year, the cost of borrowing could become a lot more expensive, leading to potentially lessened profits for companies. Federal Reserve vice chair Stanley Fisher said, “It will likely be appropriate for the Fed to raise rates this year, but said rate increases won’t followed a predictable or necessarily steady course once the Fed begins lift-off.” http://www.businessinsider.com/stanley-fischer-fed-speech-2015-3. This unpredictability is another reason why now is the time to invest. Capital expenditure is a key driver of revenue growth and can be the difference between sustained long term growth or stagnation. If companies are not able to invest in themselves and buy new plants, property and equipment (PP&E), then they can not grow and build revenue. While some companies may counter this by saying they can cut costs and improve the efficiency with how they operate, I say good luck. These kind of management strategies are good in the short term but are not sustainable. At some point, investment is necessary. While rates are expected to increase, this does not mean they will shoot up overnight. It is necessary for companies to begin building a plan and capex schedule for the next 10 years so they are able to prepare for this increase. Many companies have gotten comfortable with these low rates and may be dealt a major blow when this increase occurs. Hopefully companies are prepared and are able to adjust properly to whatever action the Fed takes. If not, it could mean trouble for GDP growth over the next few years.

 

Chinese Investment

Thesis: Investment by foreigners (notably China) damages the economy in many ways.

I was born and raised in metro Detroit, Michigan, and have been familiar with the economic situation of Detroit for many years. In 2013, the city of Detroit went through bankruptcy on the public front. However, in the private realm, there were (and still are) two major proponents for the city. Their names: Mike Ilitch and Danny Gilbert – two billionaires who have been pouring their money and resources into rebuilding Detroit. They have done everything from purchasing casinos, buying buildings, knocking down blighted homes, and creating jobs through their various entities. When one of these two billionaires acquire property in Detroit, they actively improve the buildings and surrounding area in an effort to help revitalize the city. But this is not the case for all investors. Many Chinese investors purchase real estate in Detroit simply due to the low cost, but then do nothing to improve the property. So while some activist investors are aiming to improve Detroit and revamp the local economy; other investors are simply buying and holding hoping others will do the work for them. In an article by Forbes titled, “China’s Newest City: We Call it ‘Detroit”” it discusses the attraction of Detroit properties to Chinese investors.

My first example was one that hit close to home and contained some economic impacts that are less robust than my next argument, but nonetheless prevalent. An article by Bloomberg titled, “China Wants to Buy Europe” discusses how aggressive Chinese investors are being in foreign markets. “Until 2011, China was mostly a receiver of European investment, but then the debt crisis drove down asset prices. Some governments became desperate to privatize, and venerable corporations got less picky about potential investors. Chinese buyers acquired Volvo in Sweden, a large stake in Peugeot Citroen and fashion house Sonya Rykiel in France, the Piraeus Port in Greece, Pizza Express restaurants and the upscale clothing maker Aquascutum in the U.K. Chinese investment increased exponentially” (Bloomberg). Essentially, before the financial crisis, companies were able to be picky about where they received credit. Once the credit markets dried up, they needed to look for outside investors where the Chinese were aggressively investing.

Chinese M&A activity

The preceding image taken from the Bloomberg article does an excellent job depicting Chinese investment. The large increase in investing in the EU is concerning, due to the current financial position of the EU. The increased investment by the Chinese will increase their net exports (thereby decreasing net exports of the EU) which will have a further compounding effect on the EU. So China’s increased investment in the EU is further crippling an area that is already struggling on many fronts as evince by the near parity of the U.S. dollar and the Euro. That being said, if the Eurozone does make it out of the crisis, it is quite possible that these Chinese investors bought at the bottom.

Why Proxy Access Is a Good Thing

Thesis: By forfeiting some governance to the shareholders, companies adopting proxy access will help not only themselves but also prospective investors.

The new year has brought in a new wave of large companies in favor of proxy access by investors.    This issue of proxy access found its origin three years ago when the SEC attempted to mandate a requirement for proxy access but was denied in federal court.  Since this case, shareholders have been forced to fight for proxy access on a company to company basis and their cause is finally gaining momentum.  Proxy access allows shareholders with a minimum, company-determined stake in the company to nominate directors to the corporate board.  This push towards a more democratic system will ultimately benefit both shareholders and the companies themselves.

This idea of proxy access has become more accepted as more and more companies agree to the idea.  An article detailing General Electric’s adoption of proxy access gives some numbers to show the increasing acceptance of this policy:

The 17 such measures that reached a vote during annual meetings last year were approved by an average of 33.9% of shares cast, according to ISS.

By contrast, the 13 proxy-access proposals voted on during 2013 garnered an average of 32.5% support—with three getting majority endorsement, ISS added. Shareholders have submitted 93 such resolutions for 2015 annual meetings.

To summarize, in just three short years, the number of proxy access resolutions being voted on has increased from 13 to 93.  Some other companies that have adopted this new policy include Citigroup, Prudential Financial,  and Boston Properties Inc.

The first article hyper linked in this post best summarizes the overarching effects of such a policy when it states:

The shift could give pension funds, unions and other investors greater influence over the strategic and financial choices of U.S. companies by enabling individual or groups of shareholders to install their own directors.

I believe this new system is in the best interest of shareholders and companies alike.  Companies with proxy access will become more appealing to investors for they will feel a greater sense of ownership and control over the stock they own.  From the company’s standpoint, they stand to receive greater investment because investors are more likely to invest in a company in which they can have direct representation.  If a stock turns in a direction in which an investor is unhappy, that investor can create active change by nominating a director.

The numbers speak for themselves.  According to the article, Avrohom J. Kess, a consultant for companies considering proxy access, has predicted that 70 companies will have hopped on board by year’s end.  This new system reflects the current democracy we are governed by.  The ability to choose a director gives an investor more confidence in his decision to buy stock and will ultimately lead to increased investment in companies that adopt this proxy access.

New Proposed Oversight Regulation Could Lead to Less Regulated Markets

A new law in the European Union is in the early stages of being implemented that will require, as Margot Patrick and Juliet Samuel write in their Wall Street Journal article, New Rules Reshape Research Sector, “investment managers, such as those at hedge funds, to pay specifically for any analyst research or services they receive.” Some people are claiming that this law will be good by fixing an old outdated system where as Matt Levine writes in his article, Valuing Analysts and Hedging Death, “High finance operates on basically a gift economy, in which many goods and services — sports tickets, strategic advice, jobs for relatives, investment banking research — are given away to create goodwill in the recipient. The recipient is then supposed to reward the donor with lucrative merger mandates or trading commissions, but not in a straightforward transactional way. That would be crass. This is about relationships, not a mechanical balancing of accounts.” While I agree that this system is outdated, I am going to argue that this new law is going to lead to less regulated markets in two distinct unintended ways that create a system worse off than before.

 

The first unintended consequence of this law will be that some people and organizations will get information before others. Whoever pays the most will have first access to research and therefore be able to act on this research before others. This will create an even greater imbalance in the stock market towards large institutional investors (such as hedge funds) over individuals. The large hedge funds will be able to pay the most for this research and act upon it before others may even receive this research. This will lead to a market where firms pay extra to have these research reports before their competitors. You could have already purchased a report, but not received it because your competitor paid twice as much to receive it before you. This will create an imbalance and a largely unregulated market of firms having access to more resources and research than their competitors, not leveling the playing field in the slightest.

 

The second consequence of this law will be that it “could be most damaging for small brokers, particularly those specializing in less-traded stocks from smaller companies. Those brokers could end up out of business, if money managers use less research and fewer providers, industry officials said.” This will not only be devastating for smaller brokers, but will create a relatively large sector of smaller companies whose stocks don’t trade as frequently largely unregulated. This will leave certain companies without any research done on them, which could potentially leave companies susceptible to being part of a bubble because of lack of research on them. At the very least this lack of research will reduce the amount of transparency in this part of the market, the opposite effect of this new law.

How to evaluate investors in the era of government intervention

It’s becoming increasingly normal that government intervenes financial markets. On the last Thursday, the ECB finally joined the “QE club” and this announcement led higher stock price, lower interest rates and lower Euro, which is probably what the European policymakers wanted. While it’s tempting to just focus on macroeconomic impact of these intervention policy, one should not forget about an impact on investors’ behavior. In the ECB example, most of the discussions are about how QE policy works to get European countries out of economic stagnation, and only a few people seem interested in how the policy affects investors’ incentive.

Let’s say government intervenes particular market and the price of intervened asset keeps raising. While many investors think it’s might be a bubble, it’s not always the case that they sell that asset expecting their investment decision will be finally paid off when a bubble bursts. Why isn’t? One reason might be the fact that many investors are evaluated based on “excess return (alpha)”, not absolute return. In other words, they have to earn more than their benchmark (e.g. market indices of the asset class they invest) earns. This means that as long as the asset price keep raising, investors who go against the market keep making “loss” relative to their benchmark. And since their performance is often evaluated in short period of time, their best strategy to maximize their clients’ benefit could be just following the bull market, even if they know it’s a bubble.

There are two important implications drown by the example above. First, since some governments intentionally create market distortion based on their belief on how intervention can help to achieve their policy goal, we cannot just say “bubble is bad” in this era of government intervention. Second, when asset boom is going on, either buyer or seller of that asset is betting on their investment strategy, purely to maximize their profit just as they usually do. This also means that the investment strategy should be evaluated based on the investment performance, not from the “social welfare perspective”. Based on those arguments, I would disagree with the idea of “Betting against subprime mortgage loan was a good thing” in the recent blog post by Dean Baker.

As the recent episode of the Great Recession and aggressive policy response by the Fed and other US policymakers clearly depict, government intervention policy can help to achieve policy goals. However, it’s policymakers’ job to prevent excessive asset bubble driven by their policy. And we should evaluate investors by how much they earn, not by what they do for the society.