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Thursday, 17 December 2009

Jamie Montier has been transmogrified. He now resides at GMO, where he works with Jeremy Grantham and Edward Chancellor. The latter is author of Devil Take The Hindmost, which is a rip roaring, roller coaster of a read, dare I say, a veritable financial thriller. You’d probably have to go all the way back to France’s Henry IV to find just as many Hugenots gathered together in the same room. Their clients should be thankful though because GMO brings home the bacon and produces a lot of thought provoking work too. 

The chart above comes in Montier’s most recent document, which lists the ten things that need to be learned from the financial crisis. The chart shows the futility of forecasting. Let’s face it, if forecasting worked we’d all be socialists by now. Montier’s chart reminds me of a story, which I think was told by Kenneth Arrow, who spent the Second World War working in the US Navy’s Metrological department. He was asked to give a forecast for the weather some weeks, or it might even have been months, ahead for the D Day landings. Arrow told his superior that it was impossible to make a forecast that far out. “ I don’t care, just give me a forecast, any forecast,” he was told. This chart should be kept in mind when reading our piece of Happy Accidents.

Sunday, 13 December 2009

The IPOD Generation (Indebted, Pressured, Over taxed, Depressed)

Paul Kedrosky has just written a widely cited piece on the subject of contrarianism. The inspiration, he says, came from an article in the New York  magazine, on the subject of counterintuitive thought. Writers, like Malcolm Gladwell, have become rich and famous popularising this style of thinking. 

In finance, we worship the counterintuitive and the contrarian. Think of John Paulson, George Soros, and the late Jimmy Goldsmith, each of whom became as rich as, well: Paulson, Soros and Goldsmith. They had the nerve to take huge contrarian bets while the rest of us scratched our heads and bottled it. 

Kedrosky’s believes that contrarianism is the new consensus, which is a shame because most of time it doesn’t work. Contrarians might make interesting dinner party guests and they certainly goose up dull investor conferences, but they are seldom right. At least, they are seldom right in a time frame that is useful. Contrarianism only works, he says, when you arrive at a turning point. He has stuck the drill into a nerve hasn’t he? We have just entered the forecasting season, when strategists and economists give their predictions for the coming year.  

Turning Points
Kedrosky is right, trends do stay in place for much longer than most realise. The great bull market of 1982 to 1999, being a case in point. I entered the stock market in 1986 and throughout my career there were always a number of very clever people predicting the demise of the US consumer. They were right, eventually, like after more than twenty years later.

Where, though, are we now? The main reason why so many of us are nervous must certainly have something to do with the increase pace of change we experience in our lives. The influence of technology is certainly one reason for this. There are around 1.7bn internet users to day and 4.3bn mobile phone users.  Within five years there will be more than 3bn internet users and most of those will connect to the network from a mobile device. Linked to this great cycle of connectivity is the burst we are experiencing in social networking. Facebook was only created in the first years of the current decade, yet it already has more than 300m subscribers.

Our global population is becoming more intimately linked and as result fear and ecstasy can zip around the globe in the click of a mouse. In parallel to what is happening in cyber space there is the breakneck pace of change of the real world. In 1960 the global population was 3bn. Today, forty years later, there are more than 6.5bn people alive. This may be the key. When you look at demographics it is extremely easy to believe that we have arrived at a turning point, a fork in the road after which some of those dire predictions, so loved of contra thinkers have more chance of coming true.

Prediction is a fiendishly difficult task to get right, in fact it is impossible to consistently get right. However, when you look at population the numbers are large and the pace of change is slow. We therefore have more chance of being right, or at the very least, being wrong, but in the right direction. 

Over the course of the last century we have experienced two over arching mega cycles. Demographic change and the steady and continuous march of technological innovation.
When it comes to demographics, as we have seen, population growth has been explosive. As a result of this growth millions of young people have joined the workforce and helped increase GDP growth. In addition, the workforce got a boost from the number of women entering employment. In the US, in 1970, 40% of woman were in some form of employment. By this decade that had risen to 70%. 

Population growth and an explosion in the rate of female employment are two of the main reasons that wealth increased in developed countries like the US. These are megatrends. Another megatrend, which boosted wealth, was an increase in the number of hours worked. On average, Americans today work two weeks longer than they did in 1970. 

The next megatrend that boosted GDP has been the increased availability of credit and rising property prices. Consumers have been able to use the rising value of their homes to raise money.

The last megatrend, as we suggested above, has been technology. According to George Magnus, in a recently published book called, The Age of Aging, the only one of the megatrends that can continue is technology. We have arrived at the mother of all turning points. 

The iPod Generation
Many of you will have come across Magnus in his role as UBS’s senior economist. I worked with him briefly, in the mid 1980s, when he was the chain smoking economist at Chase Manhattan, where he was teamed with Gavin Davies, who then went on to fame and fortune at Goldman Sachs. 

Magnus’s focus in his book is the Boomerangst generation, which is the generation who will have to clear up the mess made by the Baby Boomers. A subset of the Boomerangsters is the cohort that was born during the 1980s and 1990s, which Magnus calls the iPod generation. That is iPod as in: Insecure, Pressured, Over Taxed and Debt ridden. I so wish I had thought of that.

The iPod generation has a lot to worry about. In the UK, according to a study carried out by Credit Action, 7.5 million, or 40% of parents had to help their children pay off their debts. Another survey, by the Nationwide gives a clue as to why: in 1997 the average cost of a house for a first time buyer represented 2.5 times their salary. Today that number has risen to 5.23 times. 

In the US two thirds of 20 year-olds have debts. The average debt for the group aged between 22yrs to 29yrs was $16,120 as of August 2006. The fastest growing volume of debt was for those who had borrowed more than $20,000.

Overindulged and over nurtured the iPod generation are not well equipped for the new reality: 15% of 18 to 24 year-olds think an ISA is an add-on for an iPod. Weep? Now cry, 10% of them think it’s an energy drink. 

Global View
One Magnus’s key points is the aging and the shrinking of the workforce. This, together with increases in life span, will affect the dependency ratio. The dependency ratio measures those in the working age group, between 15 and 64, and compared to those who are dependent upon them for support. Dependents are children and the old. In the West the declining birth rate has resulted in a drop in in the proportion of young dependents. However, the increase in life span has resulted in an increase in older dependents.

According to data that Magnus quotes from Ronald Lee, the total dependency ratio hasn’t changed much in over 300 years. But, as Magnus explains, that overall number hides a very important change. The reason the overall number is not expected to change much in future years  is,  as we have seen, child dependency is falling. By contrast, the number of old dependents is rising rapidly. It is forecast to increase from 23% to 45%. Just examine what this will do to health care costs. More than half the total amount spent on a person’s healthcare occurs in the last five years of life.

Taken globally, the proportion of the population that is over 65 will rise from 7% today, to 16% by 2050. However, when you look at individual countries the change is more stark, more worrying. Japan is at the forefront. Today, there are 3.4 people of working age to support each person over the age of 65. By 2050 that number drops to an astonishing 1.3. Two things will have to happen to counter this. Either Japan allows more immigrants in, or the right investor will find the right robotics company and make out like King Midas.

The changes in European dependency rates are also sobering,  particularly for Italy, Spain, France and Germany. For America, because of the high levels of immigration, the change is more benign. In China today, there are 9.5 workers to support each of the over 65 group. Another encouraging sign for China is that the work force will continue to rise over the coming ten years. However, after that it starts to go pear shaped rapidly. The dependency rate will drop to 2.5 by 2050.  

We appear to have arrived at a demographic turning point. Maybe that's why so many contrarians are starting to voice concern.

The complete version of this post, together with charts, was published by Cykepartners

Thursday, 3 December 2009

At a turning point

How many of the world’s biggest businesses are in disarray Finance and banking, advertising, newspapers and music, television or fixed line telecoms and soon, if we are right, mobile telecoms. The pharmaceutical industry has stopped innovating and has to buy it in.

The forces of creative destruction are on the rise. Consider then the following: today nearly a billion people use social networking sites. Within the next five years there will be 3 billion internet users, most of whom will also use social networking sites. Over that period the volume of internet traffic is expected to increase by 66 times and download speeds, over both mobile and fixed line, will have increased many fold. The distinction between TV and the internet will disappear and we will always be surrounded by rich digital content. Social networks will have a greater grip on the economy.

Ever had the feeling we are at some kind of a turning point? Ever felt swamped by the digital deluge of data? Do those bright, sparky teenagers, who will be entering the job market in five years, seem different and completely at home in the world I have just described? Now think how many of the companies you invest in, whether in China or Chingford, have thought about what social networking means for them? To gain access to the complete article go to

A review of Stephen Roach's new book on China

In the first nine months of this year $126 bn of speculative money flowed into China, inflating the stock market and other asset prices. This sum is the excess in the nation’s reserves, after you deduct $327 bn in trade surplus and $64 bn in direct foreign investment. The market is voting with its wallet, it might like China’s economy but it loves the prospects of its currency even more.

The market’s view of the dollar and the renminbi gets to the heart of the issue, China and America are mirror images of each other. One saves while the other spends, one likes to invest in the future whereas the other doesn’t. The manner in which both countries’ are trying to stimulate their two economies in the wake of the financial crisis is a case in point. In the US, 15% of the funds are being spent developing carbon neutral technologies, whereas in China the figure is 85%. China is having a good financial crisis, as its stock market suggests. By contrast underperformance has become a long term trend in America. Despite the current rise, American stocks have had a miserable decade.

Tragedies always end in a death while comedies end in a marriage. When reading Stephen Roach’s recently published collection of essays, The Next Asia, there is a suspicion that one is witnessing that uniquely modern amalgam of the two, a tragicomedy in which China and America are the co-leads.

The most disturbing essay in the book relates to Roach’s appearance before the House of Representatives. In his written testimony, Morgan Stanley’s chief economist, and now the chairman of its Asian operations, attempts to explain why protectionism would be a disaster for America’s interests. Cheap goods from China and assertions that the currency is undervalued are not the key to the problem, Roach tells Congress. Placing tariffs on imports from China would be like squeezing a balloon, the problem would simply manifest itself somewhere else. Furthermore, in the wake of the financial crisis America is even more dependent on China’s investment in American bonds, so why antagonize your banker?

In his introduction Roach mentions the three mega-trends that animate our world: globalization, the IT revolution and the fact that an ageing population will require pensions. The last of these is a problem that the first two ought to have helped solve. Both globalization and the IT revolution have led to disinflation and increases in productivity. However, both these prizes have been squandered.

For twenty five years, US consumption represented 67% of GDP but, come this decade, that number surged to 72% at the peak. This rise in consumption had little to do with increasing salaries and as we now know, more to do with rising stock and house prices. Roach estimates that over the course of the last expansion, which lasted 69 months, private sector compensation, which he describes as the broadest measure of earned labor income in the US, increased by just 17% in inflation adjusted terms. This meant that it fell $480bn short of the 28% increase that occurred over the previous four business cycles. The US Bureau of Labor statistics estimates that median, inflation adjusted wages, have risen by a cumulative total of 0.9% over the seven years ending in 2007. As Roach points out, this meagre rise seems at odds with economic theory. With rather less hyperbole than John Ralston Saul, in The Collapse of Globalism, Roach has come to the same conclusion: the world’s largest submerging economy, America, is becoming just as polarized as emerging economies like China. Globalization is not working for the average American.

The imbalance will be magnified if America reverts to tariffs - the American consumer, that $10 trillion locomotive that has always pulled the World out of previous slumps, will be derailed if the protectionists on Capitol Hill have their way.

No one could be that stupid though, could they? They can in a tragicomedy. In an essay written in 2007 he estimated that the probability of America becoming more formally protectionist was 60%. He then warned that there was a disconnect between the financial markets, which seem oblivious to the risks and the direction of debate both in the Senate and Congress.

Yet while Roach is critical of his own country he hasn’t been dazzled by China. The hot money might be flowing into Shanghai property, or the Chinese stock market, but Roach fears he might be watching another slow motion train wreck. Tallyrand said of Napoleon that it was the qualities that made him great that finally caused of his downfall, you suspect the same might be true of China. The country’s response to the financial crisis is to do what it always does - invest in infrastructure. China loves fixed assets and exports, they represent more than 80% of GDP. About half the exports go to the developed countries, where consumption is fragile and the returns on fixed asset investment are falling.Between 2000 and 2008 $1.50 of credit resulted in a $1 gain in GDP, but by the first half of this year $7 of credit was required to add $1 to GDP. As China’s Premier, Wen Jiabao said in 2007, China’s economy was increasingly: “unbalanced, unstable, uncoordinated and unsustainable.” China needs less bricks and more credit cards, it needs soft infrastructure.

Warnings like these do not seem to impress investors much, which brings us to the most poignant lesson in Roach’s book. Economics does a decent job identifying the problems, where it fails miserably, is in the timing of the outcome. This tragicomedy, therefore, probably has a good more time to run.

Too Big To Fail

You might feel that you have maxed out on
the credit crunch, that you know it all. You
donʼt. But you have a chance to enter the
circle of trust and see the inner secretes by
picking up a copy of Too Big To Fail, by
Andrew Ross Sorkin.

Maybe Sorkin has access to a swarm of
nanobots, or maybe he has the personal
brain scans of all involved because the level
of detail in this book is astonishing. We are
talking deeply private stuff here and some of
it is explosive. We all have suspected that Goldman's runs
Street and that its tentacles have spread throughout
government. Read Sorkin's book and you will see your
suspicions confirmed.

One of the criticisms of this book, which I am not sure that
Sorkin can be blamed for, is that so many of the characters
have the same personality type. This becomes wearing after
a while. There is only so much testosterone you can take before
feeling as so you have been hammered over the head by the
fist of an alpha male.

For me, the key to the book was the passage where
Fuld attends a black tie do and encounters Hank Paulson.
 Paulson and Fuld were in regular contact at the time. Paulson
had repeatedly suggested to Fuld that he needed to find a buyer
for Lehman. It was an open secret that Lehman was on the ropes
and would be the next firm, after Bear Stearns to fail.

Fuld heard Paulson out. On his way home he sent an email from
 his Blackberry to members of his management team. He ran through
the list of things that were worrying Paulson. But he failed to mention
that Paulson's biggest concern was Lehman itself. That's the problem
with alpha males, they don't listen. The tragedy of the credit crisis was
that it was always someone else's problem. No one took ownership,
took responsibility.


S&M and Apple's smartphone future

In the late 1970s Herman Kahn, the polymath who is widely believed to have been the model for Stanley Kubrick’s Dr No, wrote an influential book called, The Emerging Japanese Superstate. Kahn was a master in the art of intellectual S&M, he both titillated and aroused American fears and dreams of Asian submission and domination. The script was simple and effective, Japan was on the way up and by implication, America was on the way down. In the early 1980s, with the dollar in a slump, Kahn’s interpretation was widely believed by a nation in self hate mode.

One of the few areas that America was doing well was in tech but even that was under threat. Japanese giants like Toshiba and NEC were beginning to give the US chip industry a good lashing. Then, when Japan threw its weight behind a new operating system called MSX, it looked like sayonara Silicon Valley, the PC industry would now fall. It never happened, the PC industry is still dominated by American names.

The reason that all this is now interesting is that the same script is being reprised today. Clients phone me up to say they have seen the future and the future is Chinese made smartphones selling for less than a hundred dollars. Apple is toast, and so is Samsung, Nokia and LG. Chinese white box handset makers, armed with Mediatek chips are on the march. Continued

What is Finnish for Good Night Vienna?

Nokia’s top management are in rutting reindeer mode at the firm’s annual capital markets day today and tomorrow. As I write this the stock is up 1.6%, grab the gain while its lasts because the long boat is sinking.

Just as we predicted in last week’s Mash (No 47, 25th November 2009), Nokia is bellowing that it is “The World’s biggest platform for mobile.”

Outside of Helsinki, does anyone care? In terms of profits, both RIM and Apple earn close to 70% of what is available in the smartphones sector. But let’s talk about the future, not today, not the past. The omens for Nokia aren’t great, in fact they are awful.

The first piece of bad news comes from India, where the authorities recently blocked Chinese phones. Check out the link, it will take you to a fascinating piece on an Indian website called Techtree. The ban related to those same white box Chinese phones we talked about in last week’s piece on Mediatek. More than 25m of them have already been sold and Indian mobile operators succeeded in having them blocked in their county. However, for 199 rupees (£3), the Chinese handsets can now be unblocked. Nokia was circling the wagons and planning to make its last stand in both India and China, the world’s most populous mobile markets. As Apple, RIM and Android devices took the developed markets Nokia at least had the emerging world. To Continue go to the Cykepartners website.