I warn you… I’ll get hate mail for this. I am a bad person.
Perhaps, I spent too much time in European cities because Athens and Greece in particular always failed to impress me.
Ok, they have a lot of crumbly buildings. But so do every other country in the region. Ephesus is more impressive than the Panthenon. The Colosseum more impressive than the Valley of the Temples.
And then there’s the food. It’s terrible. Leaves or cheese, sometimes both, double soaked in oil pretty much sums it up.
If you’re not into crumbling buildings, they offer the islands, which are quite nice, laid back, and fun with those little hilltop villages you see in the postcards, riddled with cobbled streets and fat ladies with missing teeth, smiling at you.
Unfortunately, all this novelty wears thin after about 48 hours and so after some water sports, which you can only do for so long, you’re left exhausted by sex – because let’s face it, you’ve run out of anything else worth doing.
It’s easily the best thing about Greece and I highly recommend it for that reason. It’s cheap, sunny, warm, dysfunctional, and boring… which makes it the perfect place to go for a dirty weekend away.
I realise my tastes are unique, and plenty of people love Greece for all the reasons I don’t. In particular, the Chinese… which is really what this article is about.
Unless you’ve been living under a rock, you’ll have heard of China’s ambitious One Belt, One Road initiative. It is essentially the restoring of the historic Silk Road established by Genghis Kahn with his arrival in Europe and Alexander the Great who almost reached the Chinese province of Xinjiang.
There is a long history here with the Hellenic world and Eastern Europe having carved mathematics and Indo-European languages along the old Silk Road, and the Greek-Buddhist syncretism which influenced the development of both art and philosophy in China and India.
While Brussels farts around with Brexit and Draghi puzzles a catchy name for the next batshit crazy money printing initiative, China has been steadily and quietly using their massive FX reserves ($3 trillion) to lay the groundwork for future trade and their subsequent geopolitical power that will accompany it.
Take a look at where the money is flowing and why.
When it comes to maritime links, first stop once out of the Suez is Greece. It is for all purposes perfectly located as a gateway to the rest of Europe.
The Chinese, being fiendishly smart, realise this. It’s why they’re going to rule the world within a couple decades.
China’s COSCO Shipping, owner of the world’s fourth largest container fleet, took a 67% percent stake in Greece’s largest port last year.
As reported by the Nikkei Asian Review:
“The port’s container-handling volume surged more than fivefold in seven years, totaling 3.47 million twenty-foot equivalent units, or TEUs, in 2016.
When the terminal was still state-run, the Port of Piraeus did not even crack the global top 100 in terms of container volume. Today, it ranks among the world’s 50 biggest container ports.
According to Greek media reports, the port authority’s management team will soon announce new investment plans. The pillars are expected to be a new cruise ship terminal — aimed primarily at wealthy Chinese tourists — and a vessel repair center. One Cosco source said investment over the next five years will “exceed 600 million euros.”
In December, State Grid Corp., a Chinese power transmission company, agreed to acquire a 24% stake in a subsidiary of Greek state utility Public Power Corp.
And this from Reuters:
“Greek infrastructure development group Copelouzos has signed a deal with China’s Shenhua Group to cooperate in green energy projects and the upgrade of power plants in Greece and other countries, the Greek company said on Friday.
The deal will involve total investment of 3 billion euros ($3.28 billion), Copelouzos said in a statement, without providing further details.”
And last year, a deal was struck whereby (through the Fujian Shipbuilding company) China accesses European technology – in particular, financingnaval armament agreements valued at more than $3 billion, which, by the way, represents 7 percent of Greek GDP. Not small.
Greece likes it since it provides another 190,000 new jobs.
As reported by Bloomberg:
“Fosun International Ltd., the Chinese conglomerate that’s part of a venture to transform the former Athens airport site into one of the biggest real-estate projects in Europe, is now turning its attention to Greek tourism.”
And Reuters elaborates:
“China – which has already submitted a bid to buy a majority stake in Piraeus – is also eyeing the construction of an 800 million-euro airport in Crete and the main airport in Athens when the government puts it on sale later this year, Greek officials said. Development Minister Nikos Dendias said the two sides also discussed a high-speed rail project.
China attaches great importance to Greece’s unique geographic advantage of being a gateway to Europe and, in that light, is prepared to intensify its cooperation with Greece in basic infrastructure such as ports, roads, (and) railways.”
Now here’s what’s interesting…
I speak to a lot of money managers every week, and I can count on my hand just two who, like us, are acquiring Greek assets. This is one extremely uncrowded trade. It’s oh so lonely, which brings an additional level of comfort.
Don’t believe me?
I present to you the Greek Stock market:
Here’s small caps:
Chinese travel to Greece has been surging since around 2013 but this entire party looks like it’s only just getting started.
You tell me what’s going to happen when 1.5 million Chinese tourists start showing up in Athens every year looking for crumbling buildings and fat, toothless, charming ladies selling oil soaked cheese and leaves?
“In a world of growing interdependency and challenges, no country can tackle the challenges, also the world’s problems, on its own.” — Xi Jinping
Further to the last item above, things are looking ever-tougher for the South African mining sector. As I’ve discussed in the past, the fall of South Africa over the last decade has been phenomenal. With the nation going from world’s top gold producer, to now barely breaking the top 10. Anecdotally, it’s well known that miners…
Maitre D’:“And finally, monsieur, a wafer-thin mint.”
Maitre D’:“Oh, sir! It’s only a tiny little thin one.”
Mr Creosote:“No. F**k off. I’m full…” [Belches]
Maitre D’:“Oh, sir… it’s only wafer thin.”
Mr Creosote:“Look – I couldn’t eat another thing. I’m absolutely stuffed. Bugger off.”
Maitre D’: “Oh, sir, just… just one…”
Mr Creosote:“Oh, all right. Just one.”
Maitre D’:“Just the one, sir… voila… bon appetit…”
[Mr Creosote somehow manages to stuff the wafer-thin mint into his mouth and then swallows. The Maitre D’ takes a flying leap and cowers behind some potted plants. There is an ominous splitting sound. Mr Creosote looks rather helpless and then he explodes, covering waiters, diners, and technicians in a truly horrendous mix of half digested food, entrails, and parts of his body. People start vomiting.]
Maitre D’: [returns to Mr Creosote’s table] Thank you, sir, and now the check.
The Monty Python skit depicted has a lot of truth in it.
Only idiots refuse to acknowledge excess. Society is littered with examples of the consequences. Eating too much results in indigestion and lethargy, and, if done, regularly obesity and an early grave.
We’d be forgiven for thinking that these simple truths don’t or won’t apply to the financial markets.
Indeed, the GFC was but one of the last examples of such excess, and Canada’s own Real estate market is now suffering what Mr Creosote suffered.
There are naturally other examples, many covered in my subscriber-only publication, but there is one elephant in the room worth looking at:
The above graph, which I nicked from Bloomberg, is actually only a few months old… and as such out of date.
How out of date can it actually be, you might ask? Heck, it’s less than a month old.
Well, that’s true but since these numbers are changing by the minute. When I sat down this afternoon to write this and I look at my Eikon terminal, the BOJ, for example, is already over 504.8 trillion yen.
These numbers should boggle the mind. They’re tough to get your head around.
Combined, these three central banks account for roughly 14 trillion dollars of balance sheets.
What I want to point out today, however, is that the BOJ is actually accelerating this trend… quintupling its size in under a decade.
Today, the BOJ is much like Mr Creosote – their balance sheet being larger… yes, larger than the entire country’s GDP. Now, isn’t that some achievement?
Of all the three musketeers the FED actually looks relatively benign. Crazy when you think about the numbers but true nonetheless.
This is what happens when even though you’re gorging yourself at the buffet your two mates are shovelling sausages down the hatch without even chewing them and thus ingesting more than you are. You’re all going to suffer massive indigestion and quite possibly death but they’re probably going to get them sooner.
In terms of numbers the ECB balance sheet is roughly 43% of the Eurozone’s GDP, though with Draghi’s ongoing asset purchase program this will blow out further.
The Fed, on the other hand, are sitting at just 25% of US GDP and now actively discussing reducing the balance sheet. Whether they can actually do this or not without all sorts of market disruptions remains to be seen, of course.
What we have, however, is a massive divergence in monetary policies going forward… something I’ve been beating the drum on here. There are a number of factors that will cause a fracturing of the unprecedented coordination between global central banks, which the world has come to accept as standard.
At the tail end of this insanity sits the BOJ who shortly will own the majority of the Japanese bond market as well as a healthy slice of the equity market. Unwinding those positions will bring true chaos.
The yen will slice through the last recent lows of 120, heading rapidly for 150 and there will be all sorts of fun to be had for those positioned.
The question to ask yourself is this: “How far can the Fed push this divergence between central bank policies without causing a disruption (in bonds) to the overall market?”
As you ponder this question, let me remind you of what that last wafer thin mint did to Mr Creosote.
“Nature gave us pain as a messaging device to tell us that we are approaching, or that we have exceeded, our limits in some way.” — Ray Dalio
The banking sector is beset with challenges from disruptive FinTech companies. We are now seeing increasing levels of collaboration between FinTech enterprises and big banks. Since FinTech organizations are largely decentralized, they are not subject to the same constraints as regular banks and financial institutions. Thanks to the innovative technology that FinTech brings to the table, conventional banking is dead as we know it.
FinTech has revolutionized the way money is transferred, stored, transported, and processed. FinTech companies utilize sophisticated encryption technology, and banks are now having to play catch-up. To even the playing fields, they are feverishly working with FinTech organizations to create systems for the digital age.
FinTech Evolution: From Back-Office to Front-Office
FinTech has advanced to such a degree that blockchain technology is now the way of the future. This technology is used as a public ledger for all BTC transactions. As new blocks of information are added to the ledger, additional recordings are made available. This is done in a chronological fashion. Now, regulatory authorities are having to create oversight systems and strategies to monitor blockchain technology.
Since FinTech is decentralized, it will naturally be difficult to regulate. Various authorities will be hard-pressed to implement constraints, checks and balances in a peer to peer-based network. The evolution of FinTech is remarkable. What began as a behind the scenes operation is now front and center for clients, offering them direct access to financial markets.
The main areas for FinTech operations are found in:
Domestic and international money transfers.
Personal loans – by comparing interest rates.
One of the most notable changes in international financing comes in the form of crowdfunding. With this option, businesses and individuals can quickly and easily raise money in an unconventional way. There is no need for clients to go through the standard banking channels, replete with all the obstacles to qualify for loans. Cryptocurrency, in the form of Dogecoin, Litecoin and Bitcoin makes it possible to expedite money transfers to eligible clients. It is possible to qualify for financing by quickly gauging a client’s tax returns, personal and/or business bank statements, credit scores and pay slips. While banks may require time to process this type of information, FinTech companies routinely beat them to the punch.
$23 Billion + Investment in FinTech in 2016
Access to credit lines is a particular niche sector that FinTech has cornered and dominated. This is particularly true of small and medium enterprises which need access to lines of credit. While banks have been increasing the amount of loans offered to clients, there are significant barriers to entry and prerequisites that need to be met. The FinTech sector is certainly more lenient, efficient and geared towards servicing market requirements.
Banks find it difficult to conduct pricing on loans, and typically avoid certain types of nontraditional loans. There is talk of rapid growth in SME lending opportunities, valued at over $280 billion with a double-digit annual growth rate for the next several years. This certainly lends credence to fueling the rapidly growing FinTech sector which reported investments of over $23 billion last year.
Dramatic Innovation in Banking
Banks have adopted a mixed response to the disruptive technology presented by FinTech companies. They are not sure how much they should invest in this new technology, and this also hinders the level of integration that banks have with FinTech. Sometimes, banks consult with FinTech organizations, at other times they buy them out and incorporate their services completely.
This speaks volumes about the low integration and high integration strategic approaches adopted by big banks like Bank of America, Wells Fargo & Company, Citibank and Morgan Stanley. What is clear is that banks are reluctant to go it alone and develop their own FinTech systems. Banks are also fully liable for the activities of FinTech companies that they partner with, making them reluctant to sign them on. BTC (Bitcoin) remains the most successful decentralized technology yet, and there is no intervention by central banks, regulatory agencies or governments.
The challenge now is what to do about FinTech: regulate it or let it operate free from constraints?
DETROIT — A 20-year-old Detroit man is being charged with murder and armed robbery after the two separate meetings he arranged to purchase Air Jordans on Tuesday turned violent. The incidents, the second of which ended in a fatality, occurred just hours and blocks apart in Detroit’s west side. The victim, Corey Harris-Thomas, 17, of Grosse…
This article was featured in John Mauldin’s Outside the Box newsletter.
Last week in Outside the Box, Jim Mellon shared some good advice on picking stocks in the Age of the Index Fund. Jim said,
[C]ommitted investors should make a list of companies that they really like, know about, and want to own – at the right price. If the shares of those firms are too high, put in limits, possibly 20-30% below current levels, and wait. Don’t let cash burn a hole in your pocket – let the stocks come to you, and don’t chase.
Within a day of publishing Jim’s piece, my friend Vitaliy Katsenelson’s quarterly letter to clients landed in my inbox, and I thought it would make a good follow-up to Jim’s article. Vitaliy is one of today’s most outstanding value investors – he’s the author of Active Value Investing and The Little Book of Sideways Markets; he’s a regular speaker at events around the annual Berkshire Hathaway meeting in Omaha; and he stages his own excellent VALUEx Vail event every summer.
Vitaliy leads off with a statement that many of you will resonate with: “We are having a hard time finding high-quality companies at attractive valuations.” He then lays out the case that “the average stock is overvalued somewhere between tremendously and enormously.”
So what will make this market finally tank or plunge us into the next recession? Vitaliy doesn’t know, and he’s not afraid to say so:
We spend little time trying to predict the next recession, and we don’t try to figure out what prick will cause this market to roll over. Our ability to forecast is very poor and is thus not worth the effort.
What he does know is a lot about value investing in trying times – I mean, wouldn’t you say the past two decades have been trying times for value investors, all things considered? Vitaliy’s is just one of the wise perspectives I’ll be sharing with you, along with my own, as we all gird up for the Great Reset in our future.
– John Mauldin
By Vitaliy Katsenelson, CFA
We are having a hard time finding high-quality companies at attractive valuations.
For us, this is not an academic frustration. We are constantly looking for new stocks by running stock screens, endlessly reading (blogs, research, magazines, newspapers), looking at holdings of investors we respect, talking to our large network of professional investors, attending conferences, scouring through ideas published on value investor networks, and finally, looking with frustration at our large (and growing) watch list of companies we’d like to buy at a significant margin of safety. The median stock on our watch list has to decline by about 35-40% to be an attractive buy.
But maybe we’re too subjective. Instead of just asking you to take our word for it, in this letter we’ll show you a few charts that not only demonstrate our point but also show the magnitude of the stock market’s overvaluation and, more importantly, put it into historical context.
Each chart examines stock market valuation from a slightly differently perspective, but each arrives at the same conclusion: the average stock is overvalued somewhere between tremendously and enormously. If you don’t know whether “enormously” is greater than “tremendously” or vice versa, don’t worry, we don’t know either. But this is our point exactly: When an asset class is significantly overvalued and continues to get overvalued, quantifying its overvaluation brings little value.
Let’s demonstrate this point by looking at a few charts.
The first chart shows price-to-earnings of the S&P 500 in relation to its historical average. The average stock today is trading at 73% above its historical average valuation. There are only two other times in history that stocks were more expensive than they are today: just before the Great Depression hit and in the1999 run-up to the dotcom bubble burst.
We know how the history played in both cases – consequently stocks declined, a lot. Based on over a century of history, we are fairly sure that, this time too, stock valuations will at some point mean revert and stock markets will decline. After all, price-to-earnings behaves like a pendulum that swings around the mean, and today that pendulum has swung far above the mean.
What we don’t know is how this journey will look in the interim. Before the inevitable decline, will price-to-earnings revisit the pre-Great Depression level of 95% above average, or will it maybe say hello to the pre-dotcom crash level of 164% above average? Or will another injection of QE steroids send stocks valuations to new, never-before-seen highs? Nobody knows.
One chart is not enough. Let’s take a look at another one, called the Buffett Indicator. Apparently, Warren Buffett likes to use it to take the temperature of market valuations. Think of this chart as a price-to-sales ratio for the whole economy, that is, the market value of all equities divided by GDP. The higher the price-to-sales ratio, the more expensive stocks are.
This chart tells a similar story to the first one. Though neither Mike nor Vitaliy were around in 1929, we can imagine there were a lot of bulls celebrating and cheerleading every day as the market marched higher in 1927, 1928, and the first eleven months of 1929. The cheerleaders probably made a lot of intelligent, well-reasoned arguments, which could be put into two buckets: first, “This time is different” (it never is), and second, “Yes, stocks are overvalued, but we are still in the bull market.” (And they were right about this until they lost their shirts.)
Both Mike and Vitaliy were investing during the 1999 bubble. (Mike has lived through a lot of more bubbles, but a gentleman never tells). We both vividly remember the “This time is different” argument of 1999. It was the new vs. the old economy; the internet was supposed to change or at least modify the rules of economic gravity – the economy was now supposed to grow at a new, much faster rate. But economic growth over the last twenty years has not been any different than in the previous twenty years – no, let us take this back: it has actually been lower. From 1980 to 2000 real economic growth was about 3% a year, while from 2000 to today it has been about 2% a year.
Finally, let’s look at a Tobin’s Q chart. Don’t let the name intimidate you – this chart simply shows the market value of equities in relation to their replacement cost. If you are a dentist, and dental practices are sold for a million dollars while the cost of opening a new practice (phone system, chairs, drills, x-ray equipment, etc.) is $500,000, then Tobin’s Q is 2. The higher the ratio the more expensive stocks are. Again, this one tells the same story as the other two charts: Stocks are very expensive and were more expensive only twice in the last hundred-plus years.
What will make the market roll over? It’s hard to say, though we promise you the answer will be obvious in hindsight. Expensive markets collapse by their own weight, pricked by an exogenous event. What made the dotcom bubble burst in 1999? Valuations got too high; P/Es stopped expanding. As stock prices started their decline, dotcoms that were losing money couldn’t finance their losses by issuing new stock. Did the stock market decline cause the recession, or did the recession cause the stock market decline? We are not sure of the answer, and in the practical sense the answer is not that important, because we cannot predict either a recession or a stock market decline.
In December 2007 Vitaliy was one of the speakers at the Colorado CFA Society Forecast Dinner. A large event, with a few hundred attendees. One of the questions posed was “When are we going into a recession?” Vitaliy gave his usual, unimpressive “I don’t know” answer. The rest of the panel, who were well-respected, seasoned investment professionals with impressive pedigrees, offered their well-reasoned views that foresaw a recession in anywhere from six months to eighteen months. Ironically, as we discovered a year later through revised economic data, at the time of our discussion the US economy was already in a recession.
We spend little time trying to predict the next recession, and we don’t try to figure out what prick will cause this market to roll over. Our ability to forecast is very poor and is thus not worth the effort.
An argument can be made that stocks, even at high valuations, are not expensive in context of the current incredibly low interest rates. This argument sounds so true and logical, but – and this is a huge “but” – there is a crucial embedded assumption that interest rates will stay at these levels for a decade or two.
Hopefully by this point you are convinced of our ignorance, at least when it comes to predicting the future. As you can imagine, we don’t know when interest rates will go up or by how much (nobody does). When interest rates rise, then stocks’ appearance of cheapness will dissipate as mist on the breeze.
And there is another twist: If interest rates remain where they are today, or even decline, this will be a sign that the economy has big, deflationary (Japan-like) problems. A zero interest rate did not protect the valuations of Japanese stocks from the horrors of deflation – Japanese P/Es contracted despite the decline in rates. America maybe an exceptional nation, but the laws of economic gravity work here just as effectively as in any other country.
Finally, buying overvalued stocks because bonds are even more overvalued has the feel of choosing a less painful poison. How about being patient and not taking the poison at all?
You may ask, how do we invest in an environment when the stock market is very expensive? The key word is invest. Merely buying expensive stocks hoping that they’ll go even higher is not investing, it’s gambling. We don’t do that and won’t do that.
Not to get too dramatic here, but here’s how we look at it: Our goal is to win a war, and to do that we may need to lose a few battles in the interim.
Yes, we want to make money, but it is even more important not to lose it. If the market continues to mount even higher, we will likely lag behind. The stocks we own will become fully valued, and we’ll sell them. If our cash balances continue to rise, then they will. We are not going to sacrifice our standards and thus let our portfolio be a byproduct of forced or irrational decisions.
We are willing to lose a few battles, but those losses will be necessary to win the war. Timing the market is an impossible endeavor. We don’t know anyone who has done it successfully on a consistent and repeated basis. In the short run, stock market movements are completely random – as random as your trying to guess the next card at the blackjack table.
However, valuing companies is not random. In the long run stocks revert to their fair value. If we assemble a portfolio of high-quality companies that are significantly undervalued, then we should do well in the long run. However, in the short run we have very little control over how the market will price our stocks.
Our focus in 2016 was to improve the overall quality of the portfolio – and we did. We will stubbornly continue to build a portfolio of high-quality companies that are undervalued.
The market doesn’t need to collapse for us to buy new stocks. The market falls in love and out of love with specific sectors and stocks all the time. In 2014 and 2015 healthcare stocks were in vogue, but in 2016 that love was replaced by a raging hatred. We bought a lot of healthcare stocks in 2016. In the first quarter, REITs as a group were decimated and we bought Medical Properties Trust (MPW) at less than 10 times earnings and a near 8% dividend yield – more on that later. We also spend a lot of time looking for stocks outside the US, in countries that have a free market system and the rule of law.
The point we want to stress is this: We don’t own the market. Though the market may be overvalued, our portfolio is not.
For a more extensive version of our thoughts on investing in today’s environment, see “How Investors Should Deal With The Overwhelming Problem Of Understanding The World Economy.”