overnight: sharp drop in the yen, global stock market rally

what’s going on

A month or so ago–I don’t remember the exact timing–the Japanese central bank expressed concern that its weak yen policy was great for export-oriented companies but was hurting ordinary citizens, since food, fuel and other daily necessities are generally priced in dollars.  So these items cost a quarter or a third more today than they did before Abenomics kicked in.  The Bank of Japan intimated strongly that, because of the deterioration in citizens’ living standards, it was no longer interested in further yen weakness.

This morning in Tokyo the Bank reversed course and voted 5 – 4 to increase the amount of extra money it’s pumping into the economy, in what is now an all-out effort to create 2% inflation.

The yen has dropped by about 2.5% against the dollar, as I’m writing this just at the NY open.  The Japanese stock market rose by about 5% on the announcement.  Europe and US stock index futures are up as well.

my take

As I’ve written, probably too many times, I think Abenomics will end in tears.  Continuing currency weakness will just make the ultimate bad outcome worse.  That’s because I believe the root cause of Japan’s quarter-century economic malaise is that the country has chosen to defend its traditional way of life at the expense of economic progress.  One result has been to perpetuate a culture of covering up industrial/manufacturing mistakes.  Fukushima Daiichi is a terrible example; Takata airbags are the latest.  Impossible legal and cultural bars, many erected in the 1990s, still exist to removing from power people at the top of the pagoda, so to speak.

Continuing currency weakness will, in theory, buy more time for change to occur.  Admittedly, I’m no longer in close contact with the Japanese economy, but I don’t see any signs that effective change is happening.  Without it, the depreciation of the yen will mostly mean a massive loss of national wealth–and more time in power for incompetent industrialists.

(In my view, France and Italy have almost exactly the same issues.)

So, while the new tide of central bank money into the world will likely make markets move higher for a while, its main effect will probably be to smooth over economic bumps in the road for the US and China.  We should enjoy the ride.  But we’ve also got to think about how to defend ourselves from the ultimate negative consequences for Japan–and anyone who does business with/in the Land of Wa.




bye bye, QE

Yesterday the Fed made public its current assessment of the US economy, something it does on a regular basis.  It its press release, the agency said it had “decided to conclude its asset purchase program this month.”  In other words, the third round of quantitative easing (QE) by the Fed since the economy turned down in 2008 will end tomorrow.

what QE is

The Fed’s job is to foster maximum sustainable economic growth and employment, without creating inflation.  Its usual tool is short-term interest rates: it raises them when the economy is starting to overheat and lowers them during a slowdown.

The recession that began six years ago was so bad, however, that even lowering short rates to zero wasn’t enough to put the economy back on an even keel.  So the Fed also began to add extra stimulus,  pushing down long-term interest rates as well by buying Treasury bonds and government agency debt (especially mortgage-related).  QE is the long-term bond purchasing program.

The weird name apparently comes from a UK economist who lives near the shipyards where the Queen Elizabeth was built and likes the initials.

what its end means

The Fed thinks the economy is strong enough to be weaned off QE.  The labor market is improving; the economy is stronger; inflation is right around the Fed’s 2% target.

The next step, sometime next year (April?, June?), will be to start raising short-term interest rates back to normal.

The move up to normalcy is important for two reasons:

–at some point–not any time soon, but at some point–very strong money stimulus becomes bad for the economy.  It doesn’t boost output any more and starts to create runaway inflation.

–the Fed would like to be in a position to respond to a new emergency by lowering rates.  At present, other than more QE, whose effectiveness is a matter of debate, the Fed has no tools.

how high?  how fast?

Members of the Fed’s Open Market Committee periodically publish their views on, among other things, the course of short-term interest rates.  Their median projection for the Fed Funds rate is:

2014      0 – 1/4%

2015     1 1/4% – 1 1/2%

2016     2 3/4% – 3.0%

2017     3 5/8% – 3 7/8%.

FOMC members think that the end-2017 rate of around 3.75% is normal.

So: the process of normalization will take three years, and will have short rates rising by close to 400 basis points.

how right?

The current target normal Fed Funds rate of 3.75% is 50 basis points lower than when the Fed began publishing projections like this a while ago.

My sense is that financial markets think the figure is still too high.  If we were to assume, for example, that inflation would run at 2% and a short-term lender should get a 1% real annual return for the use of his money, then short rates should be at 3%, not 3.75%.

what should an equity investor think?

We know for sure only that interest rates will be going up next year.  That can’t enhance short-term economic activity.

In the past, in periods of rising interest rates stocks have gone sideways and bonds have gone down.  Maybe things won’t play out the same way this time, but past experience suggests it will.

The period of greatest uncertainty about rates will likely come before the process begins.

Positive economic energy in the US can play out either through higher stock prices or currency appreciation, or some combination of the two.  We’ve already had recent substantial appreciation of the dollar vs. the euro.  If the dollar continues to rise, it will be important not to have exposure to euro earners.  Users of euro-denominated inputs will benefit, though.

Because a higher dollar acts somewhat like a rise in interest rates, continuing dollar strength seems to me to suggest slower Fed action.


More about this when I write about strategy for 2015.




overnight rally in Macau casino stocks




Why the rally?

Two reasons, I think:



what the WYNN report brings home


Two reasons for this favorable outcome:



what to do



peer-to-peer lending, the next big banking innovation

the demise of the department store

The story of the big commercial banks over the last forty years is sort of like that of the department stores, only in slow motion.  In the case of the latter, entrepreneurs targeted the most profitable “departments” of the cumbersome retailing giants and competed against them with freestanding specialty store chains offering a wider selection, trendier products and lower prices.  Toys, consumer electronics, jewelry, household goods, cosmetics, and, of course, various types of apparel were all targeted.

The financial world, for some bizarre reason known only to itself, calls this process “disintermediation.”  It has been underway for almost a half-century.

Consider what a bank does for a living:

in the simplest terms, it borrows money from some people, paying, say, 2% interest, and lends it to others at, say, 8%.  It uses the difference (the spread) to cover costs and make a profit.

money market funds

The first big disintermediation came in the 1970s, with money market funds.  These substitutes for bank checking or savings accounts take deposits from customer and make short-term (meaning a few months) loans to governments and corporations.  The entire spread, less expenses, goes to the money market shareholder.  So in normal times, money market funds pay considerably higher interest than banks.  The banks’ only advantage has been government deposit insurance.

The emergence of the money market fund produced a massive shift of customer deposits away from banks.

junk bonds

The second was  junk bond funds.  The first junk bonds were “fallen angels.”  That is, they were issued with low coupons by companies whose businesses subsequently deteriorated.  As a result, their bond prices had dropped sharply (and therefore the bonds’ yields had risen to high levels).  Careful credit analysis would turn up either companies that were on the cusp of a favorable turn in their fortunes or others where the market had considerably overestimated the chances of default.

As they become popular, junk bond funds soon faced a shortage of suitable bonds to buy. This led to the creation of an original-issue junk bond market–or junk bonds as we know them today.  These bonds were direct competitors to the corporate lending operations of banks.  However, junk bond issuers offered lower interest rates plus fewer restrictive covenants to borrowers and they delivered the entire spread, less expenses, to the fund shareholders.

Again, there was a massive shift of profitable business away from banks.

peer-to-peer lending

We’re in the early days of a third big disintermediation.  Peer-to-peer lending is, I think, will end up replacing banks as makers of small personal and commercial loans.

As things stand now, P2P lenders are simply internet-based intermediaries.  They do credit analysis to determine an interest rate for a given loan, put potential lenders and borrowers together and take a fee.  As I see them, they’re very much like the creators of money market funds or junk bond funds, only targeting a different “department” of the banks.  In the junk bond case, though, the “department” quickly morphed into something else.  That could easily happen with P2P, as well.

What’s most interesting about peer-to-peer to me is that the leading firms are preparing to go public by issuing common stock.

More when IPO dates are closer.


online shopping continues to evolve

Three studies reported in the press this year about the behavior of online merchants have caught my eye.  They all call into question what I think is the consensus belief that online shopping is not only faster and simpler than going to a bricks-and-mortar store, but that it’s cheaper as well.

–the first concluded that the price Staples showed to an online customer varied with that customer’s location.  More specifically, price depended on how close the physical stores of rival office supplies companies were.

–the second concluded that Amazon has been raising its prices  this year, to the point where for some things AMZN is now 10% more expensive than Wal-Mart and 5% more than Target.

–the third, covering 16 popular online merchants and noted last week in the Wall Street Journal, found that:

—–Travelocity charged users of Apple mobile devices to access its site $15 a night less for hotel rooms than everyone else

—–Home Depot showed cheaper items to shoppers using a desktop than those coming to its site via laptop, tablet or phone.  The difference averaged about $100.

—–Cheaptickets and Orbitz charged on average $12 less to customers who logged into their sites than those who didn’t, without alerting people to the savings.

—–some sites seemingly experimented with pricing by randomly offering customers higher or lower quotes.

my take

Some of this is a little weird–like why an iPhone user should get a discount (I would have thought the pricing would go in the other direction).  A lot parallels the traditional practices of bricks-and-mortar retailing.  Using a phone or tablet is apparently the equivalent of driving up to a sore in a limo and expecting a bargain.

The emergence of the same in online retailing signals a significant maturing of the medium.  We’ve left the early days where to make profits grow it’s enough just to get more traffic.  The game is now all about finding the highest price that will convert browsers to buyers, thereby maximizing the profit per transaction.

We all know some variable pricing happens, both in online and bricks-and-mortar retailing.  But as potential customers become more aware that it occurs a lot more online than they had thought, and as they learn the signals they need to send to get a lower price, the tricks merchants now employ will become less effective.

A so-so economy will accelerate this adjustment process, with negative implications for online-only retailers, I think.


oil at $80 a barrel–a Saudi plot?


Here’s why:




An example:









Tesco, Coke and IBM, three Buffett blowups

Warren Buffett of Berkshire Hathaway fame is perhaps the best-known equity investor in the United States.

What made his reputation is that Buffett was the first to understand the investment value of intangible assets like brand names, distribution networks, training that develops a distinctive corporate culture.

Take a soft drinks company (I’m thinking Coca-Cola (KO), but don’t want to dig the actual numbers out of past annual reports).  Such a company doubtless has a secret formula for making tasty drinks.  More important, it controls a wide distribution network that has agreements that allow it to deliver products directly to supermarkets and stacks them on shelves.  The company has also surely developed distinctive packaging and has spent, say, 10% of pretax income on advertising and other marketing in each of the past twenty (or more) years to make its name an icon.  (My quick Google search says KO spent $4 billion on worldwide marketing in 2010.  Think about twenty years of spending like that!!!)

Presumably if we wanted to compete with KO, we would have to spend on advertising and distribution, as well.  Maybe all the best warehouse locations are already taken.  Maybe the best distributors already have exclusive relationships with KO.  Maybe supermarkets won’t make shelf space available (why should they?).  And then there’s having to advertise enough to rise above the din KO is already creating.


What Buffett saw before his rivals of the 1960s was that none of this positive stuff appears as an asset on the balance sheet.  Advertising, training, distribution payments only appear on the financials as expenses, lowering current income, and, in consequence, the company’s net worth, even though they’re powerful competitive weapons and formidable barriers to entry into the industry by newcomers.

Because investors of his day were focused almost totally on book value–and because this spending depressed book value–they found these brand icons unattractive.  Buffett had the field to himself for a while, and made a mint.


This week two of Mr.Buffett’s biggest holdings, IBM and KO, have blown up.  They’re not the first.  Tesco, the UK supermarket operator, another firm right in the Buffett wheelhouse, also recently fell apart.

what I find interesting

Every professional investor makes lots of mistakes, and all of the time.  My first boss used to say that it takes three good stocks to make up for one mistake.  Therefore, she concluded, a portfolio manager has to spend the majority of his attention on finding potential blowups in his portfolio and getting rid of them before the worst news struck.  So mistakes are in themselves part of the territory.

Schadenfreude isn’t it, either.

Rather, I think

1.  Mr. Buffett’s recent bad luck illustrates that in an Internet world structural change is taking place at a much more rapid pace than even investing legends understand

2.  others have (long since, in my view) caught up with Mr. Buffett’s thinking.  Brand icons now trade at premium prices, not discounts, making them more vulnerable to bad news, and

3.  I sense a counterculture, Millennials vs. Baby Boom element in this relative performance, one that I believe is just in its infancy.