Wednesday, December 02, 2009

What Goes Around Comes Around

Macro Man recently had an unfortunate experience with one of his brokers. Dialling a 24-hour line, he left an order at about 8 pm London time with the New York desk to execute a couple of trades in the Asian time zone. Waking up the next day, Macro Man searched his Bloomberg messages for the confos....but alas, none were forthcoming. When he got to the office, he rang the broker, and found to his horror that the orders (buying some Asian equities on a day when they rallied strongly) were never executed.

After a flurry of discussion, it was agreed that the broker would execute the orders at current pricing (or, in one case, when the market re-opened), calculate Macro Man's opportunity cost, and compensate him for the loss. Fortunately, the trades weren't very big at all, so the opportunity cost was not particularly large for him. However, in a "fill 'em and bill 'em" industry, that money can only be replaced by volume...something like 140,000 lots. Given that the broker was prepared to make him good on the whole amount, Macro Man decided to split the difference on the "opportunity cost"....the cost to him was neglibible, and the broker sounded very relieved indeed.

This little story illustrates an interesting principle: namely, what goes around comes around. While Macro Man likes to joke and take the piss out of his brokers with some regularity, he believes in treating his counterparts fairly. This, in his view, is generally the best way to ensure that he gets treated fairly and looked after in the long run. If, on the other hand, you beat people up every day, it has a funny way of catching up with you in the end.

In any event, this maxim- what comes around goes around- seems particularly apt in light of a couple of recent market phenomena. While Dubai has fallen away as a "prime mover" of financial markets, it is still burbling away in the background, with no resolution yet in sight.

Macro Man wonders if the Dubai sovereign (and Abu Dhabi behind them) would have been quite so prepared to cast Dubai World adrift (credit wise, that is) if one of its subsidiaries owned a crown jewel in a major Western economy. Say, like, what if Dubai Ports owned the operating rights to six major seaports in the US? We'll never know, of course, but Macro Man cannot help but wonder if DW would have been cut adrift so easily if Congress hadn't blocked the Dubai Ports deal in 2006.

Similarly, Japan's Financial Services Minister, the maverick Shizuka Kamei, has been on the tapes this morning callign for joint intervention to weaken the yen. OK fine...but from whom? The Europeans are moaning about a strong euro already, so they're hardly going to be first in line to intervene for someone else's benefit. And what about the US? Let's see: U6 at 17.5%, GM in bankruptcy, and the Democrats' approval ratings are sliding fast. Where's the attraction for helping out the Japanese?

Of course, Japan would have a much easier time persuading other G7 nations to take the other side of the trend and weaken the yen had they themselves been willing to step in over the summer of 2007 and take the other side of the yen carry trade. But they didn't, as then-MOF currency surpremo Watanabe thought it inappropriate to stand in the way of private sector capital flow. (little did we know that it was his wife pushing the buttons!)

Well, Japanese repatriation has been the primary driver of yen strength recently. And while the governments are different on both sides of the Pacific, it would be hard to justify stepping in now, at 87, when the MOF failed to "take profits" by selling USD/JPY >120 in 2007. What goes around comes around.
In any case, there is (as Macro Man has ovserved before) no divine right to a trade surplus. And despite the yen's strength over the past couple of years, Japan's trade surplus is starting to widen again...even as the American deficit also widens.
Now, Macro Man has some sympathy for the view that the yen will weaken moving forwards, and confidently expects short JPY to feature prominently in the GS Top 10 trades today. But he's not holding his breath waiting to get bailed out by the G7...he suspects that he'll have to make his money the old-fashioned way on this one.


Mike Tyson said...

Shanghai continues to zig whilst the western banks and homebuilders continue to zag.

Steve said...

I have been puzzling over how trade surpluses can increase along with currency strength for the past few weeks, still don't get it.

I wonder in this case if it's Cash for Crunkers? Just about every country has had a program in one form or another. China, costs be damned, we have an infrastructure to build?

Gregor Samsa said...

Part of Japanese exports is imported from China, and pegged to the $.
Oil is a lot cheaper this year, even more so if you're not paying with dollars.
On the whole, popular opinion overstates the effect of currency rates on the trade balance.

But What do I Know? said...

I wonder if Smith Barney is still making money the old-fashioned way now that it belongs to Morgan Stanley. . .

Anonymous said...

As Bernanke's support in Congress appears to be on the decline, could his appearance in front of the Senate Banking Committee tomorrow be the next catalyst for the risk-off trade?

Anonymous said...

Speaking of Bernanke, Blackswan's Taleb says goodbye.

Anonymous said...

To the tune of "Macho Man":

Macro macro man,
I want to be, a macro man.

Have got this stuck in my head since I started reading your blog.

I-Man said...

Love the karma allegory with your dealings with the nyc broker-

Grandma I always told me to be kind.

I seem to recall a similar story from a young PTJ in Market Wizards perhaps?

Where he could have totally wrecked a broker on a trade error, and put him out of business, but he agreed to do the halfsy thing.

Came back around with big dividends I'd say.

You treat heads the way you'd want to be treated yourself, and its surprising the chips that may fall your way.

And as per the yen, as you know, I am still on JV and playing ETFs, but I cant help but see any pullback on FXY back to the 112-110area as a nice re-load entry.

Great risk/reward there the way the I sees it with a stop at 108... Love monthly charts with no barrier to the upside.

Anonymous said...

Maybe this was a sign in Sept

shifting assets and staff from its troubled property developer Nakheel to its portfolio management arm Istithmar World

I-Man said...

Is the absence of chatter here a sentiment indicator?

Gregor Samsa said...

I suppose everyone has already placed his bets. There's nothing to do until something happens one way or the other.

Steve said...

The market has us speechless I-Man.

I have a question for the equity guys (I'm an old bond horse): Why, according to BBG, does the S&P trade at 2.25x book, the Dax at 1.5x book, and the Topix at 1.05x book? Is this sort of disparity "normal"?

Anonymous said...

I would take the opposite view. Given the large disconnect between fundamentals and market valuations I would assume that traders are on the sidelines waiting for the disconnect to converge. The next big opportunity in my view would be a large decline in risky assets and an all across spike in implied vols. Whether this takes place today or next month remains the main question...but at this point one can rest assured that it is not a matter of "if" but "when".

Our Man in NYC said...

Steve: I don't know the answer, but most people tend to ignore the Balance Sheet (almost entirely) and instead on their projected CFs and discount rates.

Or to quote a sell-side mate over lunch (on AMZN's BV, amongst other numerous issues): wtf do you care about that? The only things you need to know is they're a machine, you'll buy everything through them in a couple of years. Will double revenues in 3-4yrs and treble EPS, so get on board!

*Sorry for the rant*

Ian said...

Steve: Its because US corps tend to generate higher ROEs, which means that even if P/E ratios were similar, P/B would be higher. In Japan, for example, your typical 1x book metal basher is lucky to generate an 8% ROE, while in the US a similar company might do 15%.

Now as an explanation for higher ROEs, we could credit US managerial skill, more favorable regulatory regime, book cooking, etc....

Gary said...

Steve - all book value is not created equal around the globe

Different countries have different rules on how to depreciate assets (straight line, accelerated, etc) and over what "lifetime" the asset gets depreciated.

Factory equipment (remember that?) in the US gets depreciated over 25 years. never mind if it becomes obsolete in 5 years (like a semiconductor plant) or if it is still viable after 50 years (like some tool manufacturing facilities).

Depending on the country, you also get more / less assets leased, instead of owned.

Some countries allow for tax loss carry forwards to be considered assets, others not.

And (ahem), some countries require assets to be marked to market, while others mark to acquisition cost.

The list of accounting caveats is very long, even if (as Our Man in NYC points out) most sell side analysts don't know and don't care. Its not their money they are betting with

Then you also have to consider balance sheet makeup (beyond accounting).

If a country does lots of manufacturing, it is a very capital intensive. Germany, Asia, etc.

If a country's economy is more service oriented, the most important assets of most firms walk out the door each night. These assets obviously don't end up on the balance sheet or in book value.

And if a country has made the shift to "knowledge based industry" (to use Peter Drucker's framework) ... many of the assets of a firm are actually business processes, which again don't appear on any balance sheet. Think Google or Amazon and maybe UPS/FedEx.

I just bought a replacement part for an old Jeep I keep around for winter driving. I got it at a local salvage yard ... most of their assets are valued at zero (maybe negative, because someone has to haul it away). The value of a salvage yard is the knowledge / skill of the greasy guy running it ... he knows where all the good parts are, what he can sell versus what is worth more as recycle material.

Most accounting systems in use today were designed for strict brick and mortar factory type companies... they don't capture the underlying business for any firm that differs -- whether a law firm, a Google, or a salvage yard

And how the local accountants / tax man in each country handles those gimmie factors effects fundamental equity ratios a lot.

Most sell side analysts don't bother, and to be fair to them, most portfolio managers don't ask too many questions during big bull markets. Too much low hanging fruit to be had

leftback said...

The question is: do US companies generate higher RoE in the business or by "creative accounting"?

Gary, agreed that there is always low hanging fruit to be plucked in a genuine bull market. But if the bull turns out to be a pantomime bull, then instead of the plucking you might hear a big sucking sound..

Gary said...

ROE differences are mostly a function of leverage, which in turn is (largely) a function of tax code and capital structure.

In many western economies, debt interest paid is tax deductible, whereas dividends are not. Hence, a greater reliance on debt, and lesser reliance on equity (all else equal).

Also, many erstwhile "industrial" companies are really just banks with a little side venture: GM is just GMAC/DiTech with a loser car factory on the side. Everyone thinks General Electric (GE) in the United States is an industrial conglomerate -- but 60% of their earnings still come from GE Capital. The medical machines and windmills and what not are all still a side show.

So comparing GE against Siemens or NEC is absurd. They aren't comparable companies even before you consider international accounting differences.

I suspect the banks in Europe/UK are employing at least as much "creative accounting" as their US counterparts.

The truly creative accounting, bordering on complete bullsh!t, is what passes for government accounting.

There, it would seem that Greece and the UK will probably have to admit they are in cash flow / debt trouble a few years before the US or Japan ...

pirate of seven seas said...

as the Chinese are holding yens everytime the BOJ plays his M expansions yen put options or short the currency looks a risky bet. Is a FX war ongoing there, so your timing is key.

hear today guanno tommorrow said...

well said, gary.

so how does one feel about buyimg equity in companies of nations that are bust?

Jock Welsh said...

"60% of their earnings still come from GE Capital"

Where the "earnings" may in fact be negative, hence the scramble to offload NBC Universal and other assets before the giant edifice of accounting crumbles completely under the weight of its own debt and bloated management structure.

leftback said...

Another discussion of "flation" and related issues, this rehashes several issues that Gary and LB have collectively hashed in recent weeks. This one is a little different from the Hendry view but still focuses on the apparent lack of money velocity. Note the general widespread amazement with the recent move in gold. It's good to know that others are feeling basically clueless about the market !

Welsh on Inflation, Bonds and Gold

Robert in Chicago said...

I cannot believe that, after reading your blog daily for over a year, and previously posting deep macro comments on other blogs for over a year, that this is what gets me to post here. But here goes: why in the world is this the top "related video" on the YouTube Smith Barney ad video that you linked to???

Anonymous said...

Goodbye Dubai...

Hello Venezuela

Anonymous said...

Who other than RBS would be dumb enough to lend money to Chavez's Venezuela?

Our Man in NYC said...

Agrees with Gary, on everything, though would add that if you're a 'Net Assets' approach kinda guy....then it's amazing how many of these pseudo financial entities show up by looking at how much of the ROE differences come from the Spread (Operating ROA - Borrowing Cost).

Nemo Incognito said...

Book values are kind of BS for leveraged cos (call option on TEV) and are especially bullshit for financials . Generally better to look at those ratios for non-financials, they tend to be a little less screwy between countries.

Oh, and to be filed under notable absences, all things Asia did not make the GS top 10 trades list for 2010. Curious.

Steve said...

Thank you to all (Gary, LB, Ian, Man in NY, Jock) for posting on my remedial question, very clear and all makes sense.

MM sorry for hijacking the comments.