Norwegian and Global Equity Markets: Heating Up
Last Wednesday I gave a presentation to Norway Business Club (Norway BC) in Oslo. I have been meaning to put it up, but I've been busy with various things (like going to see Norwegian demonstrations). Open BC is basically an online business networking service, which began in Germany but now encompasses a large group of entrepreneurs, venture capitalists, academics and consultants all over the world. This was the first meeting ever of the Norwegian Business Club, and it was my priviledge to be presenting at this prestigious event.
Here is a summary of my presentation, titled "Norwegian and Global Equity Markets: Heating Up", with some additional commentary presented under each slide.
First of all a brief re-cap. Remember the year 2003? OK, so there was some momentum behind the equity markets, but no one was claiming then that this was a growth market. Equities were pretty depressed still, at the expense of bonds as institutions were still very wary about risk assumption. Back then the attitude was very much that if you were going to venture out and take on some risk, make sure it's minimal and well balanced by a healthy weighting in secure bonds. Real estate in the U.K. and the U.S. was pretty much a hold with a slow upward trend at this point in time for most speculators, as investors were waiting to see how things panned out in, in particular, the equity markets.
It was three years ago, in 2003, that the real catalyst came into play for equities, and that's why I chose to look at this year in particular to begin this presentation. 2003 was "the tipping point", principally because, as Brian Wesbury from the blog at Real Clear Politics notes, in the United States in this year "tax rates on long-term capital gains and qualified dividends were dialed back to 15% ... which turned on the entrepreneurial spirit almost instantaneously". What most people don't realise is that it was this action that was in large part responsible too for the heating up of Chinese equity markets: the initial instiutional investment from the U.S. was crucial to garnering enough liquidity (trading depth) to get these markets going.
How about commodities? Commodities were for the most part beginning to pick up on the back of a weak U.S. dollar, but again, in relative historic terms then still pretty much moving sideways. Notice again the involvement of the U.S. (dollar) here: I hope this is illustrating how powerful and influential the United States is in the world economy. The reason I labour this point is that there's a lot of talk about how the U.S. is playing second fiddle to China/how the U.S. is losing its superpower status etc. These dramatic rumours are usually put about by the media; unfortunately, most journalists do not understand the economy. Anyone who has the remotest understanding of economics would never even suggest the U.S. is losing any kind of global power status - in fact, the reverse is true: the U.S. has never been economically more powerful. Not only is she responsible in large part for the movements of commodity prices and emerging market currencies linked to he dollar, the Chinese growth everyone is hyped about right now was driven into action by United States investment, and is cushioned by none other than United States government bonds, where China's reserves are stored.
Three years later and the scene looks completely different. Commodities have been driven to universal all-time highs, and equities are beginning to follow suit as investment appetite for risk increases. For the same reason, yields on bonds are hitting accross-the-board highs, starting at the long-term end and moving in towards even the shorter term T-Bills, pushing prices lower. Real estate in the United States lost some $200 billion in 2005 as, once again, speculators began looking fo faster, higher gains.
This recent issue of "dollar denominated certificates linked to gold" by Beijing is essentially one more acknowledgement from China that its economy is overheating. Basically the agreement is that you give China gold, and she gives you dollars. China, loaded with dollars right now it wants to have ready to prop up its economy if necessary, has two options: either issue a certificate like this or print more Yuan and convert the Yuan for the dollars she holds, except she can't do this because it will encourage inflation she doesn't need in, you guessed it, an overheated economy. Pay no attention to the certificates as an investment, but bear in mind the implications of such investments.
The peculiar paradox between high commodity prices and rising equity prices is explained later on, but suffice it to say that it's an overlap as investors look for high returns. Much of this is created by hedge funds, which manage about $1 trillion of the world's money. Hedge funds have in many respects changed the investment landscape, since they work to compete not only against indexes but also against each other, and hedge fund managers are rewarded on winnings derived from profitable investments over a certain benchamark. The giant growth in the number of hedge funds certainly helps in part to explain why recovery has set in much quicker than say, after the market crash of 1929.
In the short term, it's been 12 months of solid growth for the UK, the US and Norway. Look at the gains in the chart of the Oslo Bors (All Share). There are a couple of reasons for this.
The first is obvious: it's an oil-heavy market, and oil has been producing spectacular gains for anyone in the business. But a far too often overlooked point is also that it's a very young market, only just established in 2001, and typically, valueable state assets such as Telenor and DnB (telecoms and banking) have been floated onto the Bors in order to bring value to the market, and value it has certainly brought. Norway is full of great, asset-rich, profitable companies, with a long overdue equity platform. In many cases it's more a perception than a reality that the Oslo Bors is oil-tied: although supported by companies benefiting off the high oil price, there are still lots of other great companies there which will continue to grow now they have a public equity listing, even after the price of oil slips.
I love these two slides, taken from a presentation given by Justin Urquhart-Stewart in that magic year, 2003. What it illustrates more than anything is the need to stay invested no matter what or you end up missing all the gains. This is prescient advice right now in Norway, for when the oil price begins to come off, there's sure to be a correction to the market that in my view is probably not needed, but will come about anyway as investors lose faith in the growth of the bors over the long term. Stay invested however, and there are enough great companies there for the long term to provide substantial capital gains.
If you've been an equity salesman on Wall Street or in London for the past two years, your favourite words are probably "asset backed". You know that you can sell anything as long as it's backed by "real assets". But the term assets is flexible, and becomes more so as attitudes to risk strengthen.
Here's an illustration I made to show the process of capital investment and divestment as attitudes to risk change. Essentially it charts the period referred to above, 2003 - 2006, but it can be applied to pretty much any time in the last century, and it offers a good example of where capital may well be headed.
Real estate is placed on it's own above all the others since it works slightly differently: arguably it's not represented properly since a boom in equities generally re-precipitates a real estate boom as real estate investment companies have more capital to speculate with and as the knock-on effects of the equity boom create a demand for high priced real estate, particularly in the corporate arena.
The last two boxes, "Asset-backed securities" and "Intellectual property" represent equity, the other boxes are their own suigeneric investment catagories. The red arrows represent large-scale and sudden capital departure, wheras the blue arrows represent a timely and more rational movement of capital. Post-2003, the departure of speculative capital in real estate to the equity markets has been a capital transfer that is in part responsible for the growth in the charts above. The most serious stage in the capital markets in terms of capital departure however is represented in the smaller red arrow, where speculative investors leave commodity speculation in order to pursue higher returns in the equity markets. For some time, as the illustration shows, speculators have been toying with commodity speculation supported by a "safety net" of bond-weighted (usually government and AAA) investments.
This is where hedge funds have so dramatically changed the investment platform. Because they are inextricably and comparitively performance-based, once one hedge fund leaps into the equity markets and shows gains, the rest tend to follow. But why pursue equities rather than commodities? Simply because once speculators have realised gains on a base commodity, the next obvious investment is in companies which are benefiting from the rise in these commodity prices. In investing in these companies, they are assuming more risk, naturally, but there's also a higher potential upside: just look at the comparison of the increase in the price of oil and the increases in the prices of oil companies. While oil has showed around 100% rise in price, many oil companies have shown returns of four or five, or in some cases, as much as fifteen times that.
The reason technology is so popular for venture capitalists is that returns are high relative to risk. Technology is certainly risky, but it's not a volatile business with absolutely unpredictable returns, and the market rewards the sector with generally high valuations as a result. From this model, there is certainly an indication that technology is returning slowly to the forefront of the investment world, and that at some point there will be a significant influx of investment towards the sector.
The price of oil, of course, is not just dependent on speculators' capital, however. It's also based on genuine demand. The current oil price high is supported by both: a fear of oil shortage due to middle eastern tension, and genuine demand from Chinese consumption. However, fear only lasts so long, and it's only a matter of time before middle eastern fears begin to get factored out of the oil price. Funnily enough, the same is true for Chinese consumption. China cannot forseeably keep growing at the pace she has over the last five or six years, and there are signs, as demonstrated above, that some of that eonomic growth is already starting to slip off. The recent interest rate hike should sound real warning signals here, although that's paradoxical again, because interest rate hikes are not always such a bad thing for an economy.
No government wants to deliberately kill it's growth, so a rise in interest rates can sometimes just be the sign of a healthy growing economy. Certainly traders completely overreact to them. The reason the recent Chinese hike in interest rates looks so prescient is that they have been aggressively promoting foreign investment for some time, making speculation as easy as possible. With the introduction of the new JDR's (Japanese Depositary Receipts), the opening of Chinese derivatives exchanges and continued acclamations of "we're open for business" in the East, it's not difficult to see that the organic growth of 8% per year that the economy has been enjoying is not at least somewhat dependent on continued foreign investment. I made this point and outlined the perils recently here.
In a similar double-edge, the above chart, extracted from Wired magazine in December last year, shows how with the increase in the oil price new, cleaner fuel innovations become tenable as governments and entrepreneurs are increasingly incentivised to throw money towards these kinds of projects. Right now we're at about the "Biodielsel" stage, with the introduction of a new EU directive this year stipulating that 2% of all diesel fuel sold in Europe has to be biodiesel, and 6% of that has to be biodiesel by 2008. Biodiesel, incidentally, is an expensive combination of natural plants which mixed with diesel fuel makes it cleaner and more environmentally friendly.
Incidentaly, that was what was so peculiar about Enron: forget the accounting, the very fact that this was an energy company operating at a time of relatively low and stable gas prices and claiming to innovate in the industry should have put up huge warning signs to potential investors. There's a general rule: unless something is a problem today, be wary of companies which claim to be investing in solving it, because we usually only deal with problems - particularly ones that require hundreds of millions of dollars thrown at them - as and when they come around.
As I said earlier, unlike many, the Oslo stock exchange is a healthy market with a lot of solid companies with strong earnings and growth potential. What is more, Norway is an economically sound environment, and applying the "timing in the market" rule above, there are more gains to come out of the Bors over the long term.
The challenge right now for the Oslo stock exchange is to move away from being perceived as so oil-dependent, and get some recognition for a more diversified investment platform. Technology might well be the answer, and probably is: don't forget that technology is what's going to be the major factor in cleaner and cheaper fuels in the future.
Again, here is another model I designed that in retrospect should have a dotted line down the middle, because on the right hand side, the two boxes represent technology equity (predominantly) and on the left hand side the boxes represent multi-sector equity. Notice the significance of profits for investors works backwards: where speculators are looking for intellectual property, for example, they are less concerned about profitable cash-flow than in the stage of investment evolution where they are looking for real-estate backed investments.
This slide is really just an extension of "Capital Chanels" (above), but it does enhance where the present opportunity lies in the technology arena. In the 1990's there was a significant emphasis on investment in intellectual property, but little on the hardware that was responsible for storage, logistics etc. The result is that we are left with a world that is long on technological innovation but still largely underfunded when it comes to the way its configured. As an example, there's a lot of talk about virtual operating systems and when they are next going to be developed/whose going to develop them but little about how they are going to be backed up/stored. There's always talk about the potentials of Java and Solaris and Linux but little about configuring these applications. Hardware, logically enough, is the only means we have to provide for all the intellectual technology we have surrounded ourselves with, and that will soon be reflected in valuations of not only hadrware but logistics organisations. Indeed, traditional hardware firms are probably a concept of the past when it comes to technology: expect fully integrated third and fourth party logistics integrators providing everything from storage to customers' vital supply chain services. Because of the massive integrators these logistics/hardware hybrids will be able to make themselves to their customers, it is highly likely one will become the Microsoft of the future. Energy, power, healthcare and financial services will all become more complex in the software applications they draw upon in the future and one single compatible providor will hold huge industry power.
This slide illustrates some commonly overlooked considerations for growth. they are particularly useful when entering analysis of a market you don't understand, as they tend to be pretty universal. one point of paradox, however: there are examples of successful companies that go against these mantras, but when they do so, they tend to in bulk. If you're going to break all the rules, make sure you do it with style, I suppose!
An important consideration is when companies which have previously grown very successfully and very quickly in an organic fashion annouunce a series of large scale acquisitions or a large scale merger to enhance growth potential. Tom Peters is particularly against such measures: I'm personally not as against them as I think at the right time, in the right circumstance, M&A makes sense, but it's certainly something to watch out for.
Here are 7 checks for pump and dump (the process whereby a securities tout paid is paid in equity to promote shares of a company so that existing shareholder can realise the investment - which is going nowhere - at a capital gain), courtesy of Barry Ritholtz at thestreet.com. I like this - it's simple, but all too often overlooked. The most important two measures are probably "Check the Volume" and "Does the stock get analytical coverage?" If the answer is "low" and "no", be extra-weary. As the article points out, analytical coverage generally means institutional business: that's not to say no analytical coverage means no institutional business, but it certainly means no big institutional business, just so you know.
Here's a good example of a P&D stock which arrived in my e-mail only a few days ago.
This "stock tip" for Pingchuan Pharmaceuticals arrived in my inbox unsolicited last week, courtesy of a Gwendolyn Waters. A quick look at the chart of the stock gives a great illustration of Ritholtz's P&D check.
| PINGCHUAN PHARMACEUT (OTC BB) |  |
| ||||||||||||||||
|
|
0.10 (15.38%)
First of all, predictably enough, there's no analytical coverage at all on the stock, and it trades a total average of around $200,000 a day. Buy $20,000 of Pingchuan Pharma and you may move the stock's price! Notice there is no fundamental information on the company whatsoever, because this is a "bulletin board" stock: there is no regular market for it and it trades "over the counter". That means in order for you to sell $20,000 of Pingchuan Pharma the market maker will most likely have to go out and find a buyer for you. Hence the need for a "stock tout" such as Gwendolyn to push this via e-mail: current investors most probably cannot even find a market for the security!
Look at the chart and notice too that although the price of Pingchuan Pharma has gone up before, the volume on the stock has only moved as the price has come down: this implies that upward price movements were artificial, probably created as a result of the market maker for the stock moving the price up on the back of some news announcement generated by the company (that's just a guess). The point is, as soon as this stock moved upwards in price, sellers rushed for the door, and you can be sure that that is exactly where your $20,000 is going if you choose to take Gwendolyn's advice.
OK, some stock picks. No presentation about equity markets is complete without picks, since, right or wrong, they are the only really effective way to gauge the presenter's credibility. These are the companies I personally like - I'm not selling them - for the following reasons:
- TIVO fits the generic brand concept from slide 12, and is a strong concept with great brand recognition and a great technology. If only it can translate some of it's brand presence into market share in a really valuable unique provision business like broadband/television streaming, this is a company that would be worth billions, not millions. I see this happening.
- SUNW fits the logisics integration system I have talked about above. HP is abvious competitor, but there's too much product-cycle baggage with company and wih Sun's new One Touch system, it's primed to serve the new new economy in way no one ever previously thought possible.
- ORKLA is a Norwegian company and one which contradicts practically every "factor for consideration" above: it really breaks the rules in style. It's a consumer goods manufacturer but behaves nothing like one at all. I went to see the management recently who were very impressive: their mantra was "we try and do at least one deal every two years". This is a company that does big deals, and knows how to add value to mid-level brands - what's more, it's got nothing to do with oil!
- FAST is another norwegian company. I was hesitant about adding it. When I went to see CEO John Lervik speak recently - and very unimpressively - at a conference at the Oslo Business Summit at the end of January, this is the chart he put up to explain what exactly Fast were going to do in the future and where they were going to be, relatively positioned to their competition:
Excuse my naivite here, but would someone tell me what the hell that means? One thing is for sure - if this is the type of pitch Lervik gives his shareholders and prospective shareholders during the good times, I don't want to see what's going to happen in the not-so-good times! BUT, that said, the signs point to technology having a very big year over the next 12 months, and Fast is an obvious first point of call on the Norwegian Bors. It has good brand awareness, Fast guys and girls seem to be at all the parties you go to in Oslo despite having a team of only about 200, and they are all super-smart. This kind of thing may not be long-term strategic assurity, but short term it makes a big difference to a growth stock at the right time. It's not something I want to own for 10 years right now, but it's something I'd like to have in my portfolio for 1 year.
- VICORP is a company I worked with in London. It manufactures speech recognition software, and despite its tiny size, has a great blue-chip client base. I like the management, and it's a personal pick because I've worked closely with them and I trust them. Often that's the best reason you have to pick an investment.
Comments