US Macro: Q4 2004 GDP

Friday, January 28, 2005 | | 0 comments »

At 3.1% lower than the expected 3.5%. In itself a chunky negative surprise for the US markets which are down (for now at least) on the back of the announcement.

But within the 3.1% the government component is sitting at 0.9% up less than expected from Q3's 0.7%. The Q1 and Q2 numbers were 2.5% and 2.2%.

This is noteworthy: the current economic recovery was kick-started by fiscal stimuli - most notably tax cuts and deficit-spending. With those being scaled back (well, theoretically deficit reduction is the order of the day in Washington) the hope all round must be that the economy is now self-sustaining.

On that count the signs are mixed. But the likely budget-busting $80 billion supplementary for Iraq being prepared by the Bush Administration indicates that the crutches of fiscal stimuli haven't been kicked away quite yet.

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Buy the company on its accounting fundamentals? On the basis of its stock chart? Or something in between?

These are really questions about whether or not investors should be concerned with trying to time the market. And, unless their investment horizons (and finances) are of heroic proportions, they probably should be, starting first at the macro-economic level.

The chart above shows annual US GDP growth (blue line, right scale) set against the annual S&P return. The GDP point for 2005 is an estimate from the Federal Reserve Bank of Philadelphia's quarterly survey forecast. Equity markets being forward looking, the S&P data is offset a year (1985 set against 1986 GDP and so on).

The correlation between the two sets is 53%. In other words, the movement in one explains more than half the movement in the other. On that basis it's a pretty small small step to conclude that the S&P500 is being wagged to a degree by GDP forecasts.

With UK data the same exercise shows a correlation of only 23%. In fact, FTSE100 data correlates more closely with US GDP data than with that of the UK. And over the same period the returns of the FTSE100 and the S&P500 show an 88% correlation. It appears, then, that for investors in both the US and the UK markets valuable guidance for portfolio direction is to be had from simply watching the US GDP actuals and forecasts.

This is intuitive and fairly obvious. But still some will wonder why bother - just play the solid company fundamentals. The same chart above shows that from 1986 to 2004 S&P500 returns ranged between -26% and +34%. With a 60 point range like that the non-heroic amongst us should conclude that the bother is profitable. No need even to hit the nail on the head with the timing.

Sources: S&P500 and FTSE100 data from; US GDP data from US Dept of Commerce, Bureau of Economic Analysis website; UK GDP data from the World Bank website.

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"You won't lose much money and you won't make much either."
Sir Ron Brierley on diversification

Guinness Peat Group plc (GPG), the investment holding vehicle ("corporate raider" to its detractors, "industry rationalisers" to supporters) chaired by New Zealander Sir Ron Brierley is a curious thing. Market cap around £700 million and holding ecletic investments in quoted-equity or subsidiary form across New Zealand, Australia, the US and the UK. It's one of those companies so closely identified with its chairman that share-holders concerned with succession-planning tend to worry.

Guinness Peat is one of the top-picks for 2005 amongst New Zealand brokers. Normally this would be enough to run the other way. But the company accounts are satisfactory on the criteria used by Capital Chronicle and one part of the portfolio looks especially promising.

In 2003 Guinness acquired control of Coats, plc and has since become sole owner. Coats is a 250 year-old UK thread-maker with near £1000m turnover and 22% of the world market. That makes them world number one. Coats also represents over 30% of Guinness' assets, a heavy gearing indicative of the board's confidence.

But why become excited about a thread-maker?

Can you say "Multi Fibre Agreement"? The MFA expired on 1 January 2005 after three decades of quota enforcement aimed at protecting the US and other developed world textile producers from lower cost competitors. China and India are expected to benefit the most from the demise of the MFA and the implied increase in volumes sold to the developed world - especially China which boasts seriously modern capacity on a scale lacking in India. Coats is present in both these key markets, particularly China.

There are WTO provisions to limit Chinese imports of textiles to the US to year-over-year increases of 7.5%. But these are China-specific, and may possibly not even be invoked. In any case, Coats geographic spread is such that it can supply whoever is ramping-up production to meet the expected increase in textile demand.

Coats also shows company specific signs of encouragement, particularly in converting debtors and stocks to cash. As the bedding-down of the company progresses this squeezing of the pips ought to improve working capital further.

Want a second opinion? Here's what Accrual - our UK scribe, sounding board, perennial cynic and accountant - thinks:

"Guinness Peat....

Well, the market has perhaps got wind of their success too, they are trading at a 52 week high. Rewards will never be as great as you or I might wish as the company is a vehicle for Brierley and pals. But they do invest for the long term. They have cash and I think they got a bargain with Coats. Expecting profits to rebound.

Coats had seen the light prior to their enforced demise and were moving stuff offshore, have proprietary technology, are well represented in mature and emerging markets (from a marketing and manufacturing perspective) - have cash in their property portfolio and, astonishingly, a well funded pension fund - which should have got better still (with luck). Dep'n policy is sound (motors 5 years, IT 4 years etc, plant can't remember but Ok). Note US pensions in pay't never increase. Oh to be a US pensioner.

Not really sure about their other investments...Staveley probably sound. Young's sound, they'll never get in there unless the family has a stupid falling out - but I expect the divis are Ok. Dawson International may be a problem [Editor: Dawson 100% written down, thus possible upside barring capital infusions] - just dropped out of the FTSE...They are heavily geared to success with Coats which should come.

Anyway as the man says "I liked it so much I bought the co" Well, 2000 this morning"

Finally, for readers wanting to get an idea of Brierley the Investor, here's an interview from 1999.

NB: The writer bought shares in Guinness Peat Group plc (GPG) shortly after this article was published. GPG is listed in N Zealand, Australia and the United Kingdom.

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MD writes...

An Addendum: Goodbyes
An addendum to the last addition of 2004. In "Goodbyes" I forgot to mention the demise of Shell Transport and Trading plc, due to be subsumed in a nil-premium takeover by Royal Dutch with not a peep from the genii in the City or our esteemed Government!

Well, you heard it here first: the bloodbath has started.

Woolworth's have announced disappointing trading for the Christmas period as have Next. In a masterful stroke of PR-speak Woollie's said that actually they couldn't flog the stuff no one wanted first time around even when heavily discounted. Miss and Ms shopper are obviously beginning to see that the wardrobe is full enough!

Laura Ashley are so pleased with their Xmas trading that they have sacked yet another boss (with a fat payoff, no doubt). The list of disappointments goes on: Marks & Spencer; Burberry; J. Sainsbury; Morrison's; and so on.

In addition, a number of low-end retailers have already gone to the wall. Interestingly, no mention from Philip Green about how his empire is doing - could it be that not all is so rosy? Certainly, to visit the BHS store near me is to enter a Space Devoid of People. Even the mighty (sic) Wal-Mart is now described in the press as "beleaguered".

So what next? Well, take it from me - more of the same only in spades (at least for some). The party is most definitely over - vacancy rates are increasing with prime sites becoming available up and down the land. Expect progressively worsening results from electricals, fashion and so on and more failures. Time to sell those property shares.

London Stock Exchange
Ardent watchers of this column will note that the writer often despairs that everything in UK plc is for sale. The New Year brings further examples of which the LSE is one (actually it started last year). It is undergoing a rather public and painful auction. But, interestingly, a number of heads are now suggesting that just maybe it’s not such a good idea for the LSE to be under the control of either Euronext or Deutsche Borse. I doubt if they will be heard by the quick buck merchants, nor by HMG.

As we all know, these are often not always good for the acquirer or acquiree. Bank of Ireland is mulling over whether to close their last remaining Bristol & West branches; and such a move would be hugely embarrassing but probably largely ignored since the error (to purchase) was made so long ago.

Aggregate Industries is the latest UK plc to fall to foreign control with Holcim snapping them up. Admittedly, there is a while to go but no one seems to be fighting their corner. Come on, Hanson - how about it?

MmO2 - or O2 as it will soon be known - remains a takeover candidate according to the City. Depressingly, weekend comment suggested that the shares were a hold in anticipation of a take over by some deep-pocketed foreign Telco. No mention however, of their taking over anyone – the City doesn’t like such deals as a sale is so much easier. Still, if and when the offer finally comes you can expect an early capitulation as share options now mean that management is unworried about losing their position. The takeover invariably means instant riches beyond their wildest dreams.

Next week (January 24, 2005) sees the EGM of this once proud firm. Shareholders are expected to rubberstamp a takeover by JP Morgan (first a joint venture and then 5 years later a full-takeover). Quite why the take-over is necessary has never been properly explained. Other than as a quick way for shareholders to cash in.

Now where have we seen that before?

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Not long ago Capital Chronicle was cited on another website as being Asia-ignorant. There's truth in that statement, but we've been trying to educate ourselves. A part of our study is in the exhibit below:

Exhibit A: Real GDP growth rates in selected Asian countries, 1986-2003

The table sketches a risk profile of the mean-average GDP growth rate. The variance to the mean measure of standard deviation is widely known: skew and kurtosis complement this by describing distribution and probability of the data. How might these measures be interpreted in Exhibit A?

Israeli psychologists' Kahneman and Tversky experiments have become a standard part of behavioural finance teaching. The link above provides background, the third paragraph being all that's needed to follow this article. Consider the choices yourselves to get the idea.

The implication of that third paragraph is that we are risk-averse when it comes to financial gains, but risk-takers when it comes to losses. This latter point suggests the degree of emotional distress suffered does not increase that much more for a big loss versus a smaller one: knowing a loss will happen reduces (up to a point) sensitivity to its magnitude.

If that's the case (and it's contested), investments concentrating more returns above their long term mean are highly appealing. Such a distribution of returns is negatively skewed (a picture example is represented at Exhibit B), or below the perfect "zero" a normal distribution has. That makes the growth patterns of Korea, Indonesia and Malaysia stand out.

Exhibit B: negatively skewed distribution
The downside of these negatively-skewed distributions is that the sub-mean performance, when it comes, is bigger than the more frequent gains. But hey, a loss is a loss - remember?

Adding kurtosis to the mix changes everything. Kurtosis is a measure of the return to be expected above or below what a normal distribution would give. In other words, it's the likelihood of surprise results.

A kurtosis higher than the "3" of a normal distribution means more results around the mean and the tails, with less in between. Lower, and there are more results between the two tails and the mean with less outside these zones. Graphically, low and high kurtosis look like Exhibit C.

Exhibit C: Examples of low and high kurtosis
In the case of Korea, Indonesia and, to a lesser extent, Malaysia this suggests the effects of a negatively skewed distribution will be turbocharged.

That's terrific if the behavioural finance explanation convinces - just hang on for the occasional supermodel-like mood swings.

But find time in the portfolio too for the low kurtosis, kiss-your-sister attractions of lower growth, negatively-skewed but a whole lot less variant patterns of economies such as the UK and the USA.

* China GDP data from the Asia-Pacific Research Center at Stanford's Institute for International Studies (APARC Dispatches, October 2004)
* Kahneman & Tversky information from Peter Bernstein's book Against The Gods
* World Bank data via
* Asian Development Bank data via their Key Indicators 2004 publication (

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Message to subscribers

Wednesday, January 12, 2005 | 0 comments »

To Capital Chronicle subscribers who have not been getting the email alerts, the subscription service is now fully functioning again.

Many thanks for your perseverance.

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Tsunami Children

Tuesday, January 11, 2005 | 0 comments »

This scribe's first salaried job was in Her Majesty's Treasury, the UK's ministry of Finance and Economics. He worked in a unit overseeing the spending of the Overseas Development Administration, as it was then known.

You may read differently elsewhere, but aid can help. And emergency relief is priceless.

This is a link to UNICEF specifically to help children affected by the disaster.

It's a different kind of investment. Help, if you can.

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Standard Chartered Bank plc (STAN.l) bought today, subject to various approvals, 100% of Korea First Bank (KFB) for £1.8 / $3.4 billion, cash. The deal means KFB will represent 16% of Standard Chartered's revenues and 22% of its assets. Further details here from Bloomberg.

Boiled down, this deal is ultimately a big, bold, company-transforming bet on Korea. Is the country worth it?

It would be fair to describe the actual Korean economy as not hot. Consumer confidence is at a four-year low; the export economy is under threat from a weakening $US; domestic demand is languishing on the back of a burst consumer credit-card bubble 2 years ago; house prices are falling creating problems of negative equity; and the yield curve at the short end (1 year) is inverted, not encouraging a revival of limpid corporate investment.

On the other hand, exports are still strong; there have been fiscal surpluses since 2000; the country is a net creditor; the main credit-raters (S&P, Moody's & Fitch) regard the nation as investment grade - even with that problem neighbour; the complete yield curve is positive; and the banking sector has undergone beneficial restructural reforms since the Asian Crisis of 1997. The Korean Composite Stock Price Index (KOSPI) reflected these data, and their future promise, with a 10.5% rise in 2004.

But emerging economies are about more than numbers. Their political and social structures carry a weight in investment decisions that has long-since been shed by more mature and stable industrialised democracies.

Korea is democratic - vigourously so. And many of the social and political gains that marked other nations' emergence from industrialisation have been equally hard-won there. Moody's have been quoted as citing social welfare costs as a potential "drag" on gross domestic product growth. Maybe, but this ongoing societal investment is part of what makes Korea one of the most compelling of the emerging economies: political and social gains have investment value too.

Bottom line? Korea is a seriously appealing investment - geopolitical and near-term economic warts and all. In that light, Standard Chartered's gamble looks a great one.

RJH has no shares in Standard Chartered Bank plc, but has admired them for some time, in spite of their current creditor exposure to the wounded CAO .

Main research sources: website;Yahoo finance; DJ newswire

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Canadian contact Tattva returns for the New Year

A New Year brings with it many new desires. But since Alzahr will censor any such talk I will stick to financial matters.

My own area of expertise is Canadian real estate and the mortgage / loan markets. In fact, Tattva is licensed to arrange loans as well as thrill (I would link to some of my more titillating postings but let's stay on topic).

To keep Alzahr happy and help get the Financial House of Tattva on a good footing for future success I will be devoting more time to financial writings rather than my more comic misadventures. Given this and Accrual's thrusting start to the year, this blog may appear at times to be more of the Accrual and Tattva show. In which case we will both be looking for a piece of the action (Accrual), and a piece of financial rewards from any future syndication (Tattva).

The draft of this article went on and on eventually starting discussion of the topics listed below (I thought I would mention that to Alzahr). However, due to me becoming nearly as long winded as Alzahr I will end by detailing some of the future discussion topics:

1) Personal view on stock investment versus pay down of debt;

2) Tracking Canadian interest rate movements, and whether now is the time to go for a long-term fixed mortgage as opposed to the increasingly popular variable option;

3) General prospects for Canadian (really Toronto and GTA) housing markets and whether now is the time to consider rental investment options;

4) What these rental investment options are;

5) My adventures in the Mortgage Agent business; and

6) Finally, any thing Canadian the readers may wish to ask.

Until next time.

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