Monday, October 31, 2016

Gary Shilling interview with Gurufocus - Part 1

You started your firm in 1978, about 38 years ago. Looking back, what would you have done differently?

I would probably start earlier. I always had the desire to start my own firm, and by nature I am not cut out to work for other people as I am too independent. I think this is the reason I have had the success I have had, because I can say what I think. But what I found difficult is that in the financial service industry, most people are paid to be bullish. As you know, I was fired twice by Don Regan, who was the CEO of Merrill Lynch, for forecasting recessions. I was Merrill Lynch's first chief economist and in 1968 I had forecast the 1969-70 recession that occurred, but it was not being bullish on America, which was the Merrill Lynch slogan of the day. So Don Regan fired me, and I took my entire staff with me to another firm, which was later bought back by Merrill Lynch so I got fired again. The story on Wall Street is that I am the only guy who was fired twice by Don Regan. The reality is that most people on Wall Street are paid to be bullish and I am not the only one who was fired for having different views. Being right or wrong is not important so long as you are bullish. Most economists have lived through a number of bear markets and recessions but they have never forecast one, at least they never talked about it. Again, if I were to do it all over again, I repeat that I should have started earlier.

Previously, you told me about your successful bet on the Australian dollar, can you tell us a little more about that thesis?

The Australian dollar was simply a way to play the decline in growth in China. China basically grew because of globalization, which I think is the most significant world economic event of the last three decades, the shifting of production, mainly manufacturing, from developed countries to China. It did not change the overall demand for manufacturing goods, but it concentrated their production in China. Of course, the story is that Australia is the main big supplier of coal to China as well as iron ore and other minerals, so China is basically difficult to short, as they control their currency, they control their stock market. The only way you can really short China is through stocks in Hong Kong, which is not quite the same. So the Australian dollar was simply a way to short China, nothing against the Aussies. They are digging up the island continent and basically sending their minerals to China. That was pretty much the whole rationale there.

What are the fundamental things you pay attention to when looking for opportunities in currencies?

I think the reality in currencies is all about global economic growth. Countries are always looking for ways to increase their production, and if this does not happen domestically, then their approach is to increase exports, and the way to accomplish this is to make them cheaper through currencies. So there exists a global desire to devalue against the U.S. dollar, something we see in the commodity currencies: Canadian, Australian and New Zealand dollars. Other commodity currencies are the Brazilian real and Mexican peso. Then you have the euro currency and the Japanese yen, with those central banks are deliberately trying to trash their currencies. Again, because they want to increase exports. Then you have the so-called "me-too economies”: South Korea, Taiwan, other Asian currencies and elsewhere, who want to join the parade; that includes China. China really wants to devalue and have a weaker currency. This is difficult for China to accomplish, and it started a year ago. With the collapse in stocks in China, there was a tremendous outflow of money and they tried to accommodate that by loosening their foreign currency reserve, which was decreased from $4 trillion to $2.2 trillion, basically to accommodate people wanting to move their money out of China. They traded U.S. dollars for Yuan's. They would like to devalue their currency but they are afraid that if they do, it will create an even greater outflow of money. One of the things China has done is to link their currency to a basket of currencies, so they can say they are flowing with the other currencies and going along with the crowd. They are very opaque about this, and one is not quite sure what they are doing versus the U.S. dollar. I think in terms of currencies, the U.S. dollar is the best bet. Virtually everybody else is trying to make their currencies cheaper relative to it.

When we are looking into currencies, should we look at exports?

In a theoretical economic sense you look at exports but I do not think exports, per se, are that important. Many countries are simply trying to increase their exports, in term of the export import balance. It is a big determinant of currencies these days but I am not sure it is as important as delivered government policies. In the case of the commodity currencies, yes, I think it is true of the Brazilian real, Russian rouble, Canadian, Australian and New Zealand dollar. The weak commodity prices are very weak there. Regarding the yen and the euro, they are driven by central bank policies.

Any authors or books you could recommend for developing a better understanding of currencies and their markets?

None that I can think of at the moment, as currency markets are now divorced from the normal determinant. For example, one of the things that has periodically received a lot of attention is purchasing power parity, the idea that a Big Mac costs about the same in the U.K., France, Canada, China or wherever. The idea is that ideally the currency should adjust to bring the prices into balance, but unfortunately this is not the case because currencies are so politically driven that I do not have any book I would recommend.

Starting from the beginning with currencies, it is all about global economic growth, and as long as growth is slow and we are now in the age of deleveraging, working off the excess of the 1980s and 1990s we will have a great desire to devalue. Of course, to the extent that everybody devalues, they can offset each other.

via Gurufocus

Monday, October 24, 2016

Central Banks and QE results

Central banks are finally realizing that their attempts to spur economic growth with low interest rates, then QE and most recently, negative rates, haven’t worked.

In tacit admission of the impotency of money policy, central bankers are intensifying their calls for fiscal stimuli. 

via Thinkadvisor

Monday, October 17, 2016

irrational exuberance in REITS ?

Last month, the overseers of the S&P 500 index split real-estate companies from financial stocks, creating an 11th equity category in response to the growing size and outperformance of the sector in recent years. Investors, though, should ask themselves if this is the property market’s equivalent of shoe-shine boys giving stock tips. 

Against a background of record-low interest rates, $62 billion flowed into U.S. real-estate funds from 2001 through 2015, with more than 120 Real Estate Investment Trusts going public and raising more than $38 billion. There are now 240 REITs listed on the NYSE and Nasdaq exchanges, with the real estate sector accounting for 3 percent of the S&P 500’s market capitalization.

Yields on REITs have traditionally exceeded those of the broader S&P 500 index, and leaped as house prices collapsed in the housing crisis a decade ago. The spread between the two yields then was fairly constant for about four years, but in the past two years, the difference has widened in favor of REITs. Investors have warmed to REITs for their ability to generate hard cash here and now, rather than waiting for capital appreciation from the (expensive) wider stock market. The combination of healthy dividends and price recovery means total returns for REITS have surged after bottoming in 2009.

Earlier in the recovery, single-family housing was subdued as many potential new homeowners lacked the credit scores, down payment money and job security to buy. They were also chastened in the aftermath of the price collapse; home ownership plunged as those who did form new households moved into rental apartments instead.

That drove rental vacancy rates down and multi-family housing starts up. About two-thirds of multi-family units are rentals, and building has recovered to reach 420,000 per annum, surpassing the earlier annual norm of about 300,000 starts. But single-family housing starts -- even after rebounding to a 720,000 annual rate from a low of about 400,000 -- are still far below the pre-housing bubble average of more than 1 million.

Even as house prices have recovered, they’ve been outpaced by rising rents. As a share of median income, rents have jumped while mortgage costs have fallen. Consequently, the National Association of Realtors’ Housing Affordability Index, even though it’s down from its March 2012 peak, is still well above its January 2007 nadir.

This index assumes that a household with median income buys a median-priced house with a 30-year fixed-rate mortgage at the prevailing interest rate. So its ups and downs are driven by family incomes, house prices and interest rates.

I broke the index down into its component parts, comparing the January 2007 to March 2012 increase, the March 2012 to June 2016 decline, and the entire lifespan. The earlier rise was fueled equally by declining mortgage rates and falling house prices. The ensuing decline in affordability was due to the leap in house prices, with small offsets from declining mortgage rates and rising income.

Since the start of 2007, the primary driver of the net 46 percent rise in affordability is the decline in mortgage rates. The net rise in house prices subtracted about 19 percent from the index while the small overall decline in incomes reduced affordability by 3 percent.

I also simulated the effect of a one percentage-point increase in mortgage rates to 4.9 percent from the current level of 3.9 percent, assuming home prices and incomes remain steady. Higher borrowing costs would reduce affordability by more than 11 percent. A 1 percent rise in house prices reduces affordability by a bit less than 1 percent, while a 1 percent increase in income adds the same amount. This confirms that housing, a very leveraged investment, is primarily driven by financing costs.

With conditions moving in favor of home ownership and away from rentals, I anticipate a similar shift in housing demand, although residential construction is not likely to grow appreciably. So far this year, investors seem to agree, with a 0.2 percent decline in the apartment REIT sub-index for apartments while the residential single-family component rose 3.5 percent.

There’s market evidence to reinforce this view. In the third quarter, apartment rents fell in San Francisco, New York, Houston and San Jose, the first drops after six years of boom. Nationwide, rent increases slowed for the fourth consecutive quarter, rising 3 percent in the third quarter compared with 5.2 percent in the year-earlier period.

Single-family housing will no doubt attract ample funds from REITs and other sources, now that the bulge of mortgage foreclosures has been eliminated. Also, with fewer households owing more than their homes are worth, more homeowners are able to refinance or purchase new abodes, and fewer will abandon their mortgage commitments.

Despite the bright outlook for REITs and other lenders that concentrate on single-family housing, it’s important to remember that investor zeal for yield has driven money into real estate of all stripes as well as other higher-yielding vehicles such as utility and consumer staple equities, preferred stocks, emerging-market securities and junk-rated bonds.

Many of these investment flows appear overblown, perhaps to the point of irrational exuberance. And note that the guardians of the S&P 500 are not immune to such enthusiasms; recall that in 2001, just after the bursting of the dot com bubble that had exploded the Nasdaq index, they added Information Technology as a subsector.