Chinese to Buy Euro Debt, plus

• Chinese Exports
  
• A Signal of an Expected Turn in the US Economy?
  
• Investment Implications of “Warehousing”
  
• Observing George Washington’s Birthday
  

Not an act of charity

The recent headlines that the Chinese government will support the euro by purchasing bonds of various European entities brought cheers to European markets as well as to those in the US. The cheers, however, missed the point. The Chinese government was not conducting an act of charity for the “old world.”

European banks have been the largest single international source of loans to Asian countries and companies, particularly those that have been labeled “emerging market” borrowers. Many of these loans are coming up to repayment dates. Rolling over loans is a normal part of banking when times are normal. Loans are not rolled over when banks are contracting their loan books. In 2011, approximately 40% of loans globally were for refinancing existing debt, and I expect that it may be a higher percentage in the surging emerging markets world. The Asian stock markets declined recently not because their sales and earnings were in the same sort of decline as was occurring in Europe, but because of the fear that in their need for capital, the European banks will retreat from lending to the region. If these loans were not rolled over, a number of Asian economies and companies would have to markedly retrench. An economic contraction elsewhere in Asia can undermine Chinese exports to the region. Already China is suffering from the contraction in the largest market for its exports, Europe.

Thus, the Chinese government is not practicing a form of charity, but following its own self-interest. The move is somewhat like the US government’s foreign and military aid loans. Each of them carries requirements that the credits so extended must be utilized in purchasing various goods and services from the US. These purchases have been an important source of revenue to our defense industries and our farm communities.

Problems in Asia?

The need on the part of the Chinese government to take these actions should first be seen as a flashing yellow light as to potential economic problems in Asia, the geographical center for growth for the rest of the world. Because of its current and future potential growth, I have been an advocate of North American, European, and Latin American investors upping their exposure to Asian securities to levels that approximate the Asian share of the growth of global GDP. Nevertheless, I view these statements of support for the euro as smart by the Chinese, but also as a warning that they see that their own growth can be curtailed by Europe’s problems. Thus, while Asian exposures in many portfolios should be enhanced, those investors who are now trying to play catch-up ball should move in a more measured pace.

Do the stock prices of consumer discretionary companies going up confirm an expected turn in the US economy?

Many believe that the US economy will become more robust in the near-term future and investors in consumer discretionary stocks will be richly rewarded. I do not think that is the only, or even a correct, interpretation of the rising prices for consumer discretionary stocks. The stocks that were rising in January were those with large market-capitalizations. However, in January, my old firm now known as Lipper, Inc., estimated that there was $8.4 billion net withdrawals from Large-cap Core and Large-cap Value funds. (I believe most of these net redemptions were in effect, completions of investment programs for long-term investors shifting their capital base due to voluntary or involuntary retirements.) In the same period, combining the flows into Small and Mid-cap Value and Core funds, produced net redemptions below $1 billion. In contrast to these trends, for ETFs in January there was a net inflow into Large Value and Core funds of $ 1.4 billion, and $ 2.2 billion in the Small and Mid-cap range of ETFs. The buyers of ETFs tend to have more of a trading orientation than the longer-term investment orientation of most mutual fund investors. To the ETF traders, liquidity is of greater importance. Both hedge funds and others that are hedging portfolios find the momentary liquidity of ETFs particularly inviting.

Investment implications of “warehousing”

What I really think is happening in many consumer discretionary stocks is that the buyers are less interested in the long-term investment value in these stocks than the ability to put sizeable amounts of money into them. In effect, they are warehousing their money that will get some market returns, while they are waiting to make more aggressive investments. We have seen similar techniques over the decades by somewhat cautious, or if you will, “chicken investors.”

The investment implication of an increase in “warehousing’ is that there is more capital available for aggressive investing than meets the eye. In some of these warehouse stocks there is risk if too many of these “chicken investors” move out at once, even when the companies are reporting good results.

Observing George Washington’s birthday

Saturday night, Ruth and I attended a wonderful dinner celebrating the 280th birthday of our first, and for many of us our greatest President, George Washington. The dinner was held at his privately restored estate, Mount Vernon. An exhibit devoted to Martha Washington's renowned cooking skills was located in the Visitors' Center. In terms of demanding attention to detail, one gets the sense that she was as formidable as her husband. Mrs. Washington’s attention to detail triggers my thinking about getting investment insight out of news headlines.


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