Time To Pause?
Bend it Like Zuck
I remain an unreconstructed long term bull on the US stock market. Technology is accelerating and the economic recovery continues albeit at its admittedly slow pace. And what else are you going to buy when you sell your stocks? Do you really want to buy bonds? Or BRICs? But markets never go in a straight line. And near term there are troubling signs. Let’s start with some market “internals”. Margin debt has reached new heights, insiders are selling, valuations are no longer in the “cheap” category, the tech/biotech IPO parade has reached tsunami proportions and tech/biotech stocks have been soaring. (At least until a few days ago)
And then there is Facebook’s $19 billion purchase of WhatsApp, a firm with a grand total of 50 employees. A billion dollars obviously is not what it used to be. I watched the reaction on the financial news networks. One Silicon Valley guru after the other was trotted out. They were all green with envy (like me) but speechless. Nobody wanted to criticize the global genius of Mark Zuckerberg, nobody wanted to be called a curmudgeon, everyone was striving to “get it.” And no sense saying Facebook paid too much. After all, maybe Zuck in his next acquisition might throw a few billion their way. I have been one of those writing that the new high tech global economy is winner take all. Yes if a couple billion users sign up for WhatsApp for a dollar a year, that is a couple billion in revenues with peanuts in expenses. And as WhatsApp becomes the dominant global messaging service, the network effect kicks in in its favor. I get it. Let’s hope that some new genius does not come up with a better mousetrap. (Yikes! Zuck can spend billions faster than I can type. He just bought a firm called Oculus for $2 billion.)
Somehow this is all so year 2000. Remember how the tech darling but soon to be technologically obsolete AOL used its stock to take over a real company called Time Warner. Or how Yahoo paid billions for GeoCities and Broadcast.com, only to close them down just a few short years later. And how even solid companies like Amazon and Akamai lost 90 percent of their value after the year 2000 dot com peak. And how Global Crossing was going to wrap the world in glorious subsea fiber tunnels of light. Which it did and the world was grateful. But unfortunately the company went broke. Ditto for low earth satellite pioneers Globalstar and Iridium.
Starting from the days of the canals and the railroads, bubbles and tech investing are joined at the hip. Some economists have even argued that tech bubbles are good for the economy as a whole because needed infrastructure gets put in place even if entrepreneurs and investors go broke.
I am not saying that another year 2000 bubble is nigh. But a bump in the road maybe. I do not recommend specific stocks but one way to play this might be to park money in the “old” tech companies (like Microsoft and Apple and even Google?) which are loaded with cash and talent and low P/E multiples. The big global financial stocks, which are still cheap and voracious users of technology, may be another place to look. It is the users of technology who are the real winners in the acceleration of technology.
So much for the internals. Now for two major “external factors”. Note I am not even going to discuss Fed tapering which as I have discussed in prior blogs I consider a minor event. The government, which includes the Fed, is not changing its spending but only shifting the financing of that spending.
Will Putin the Terrible Sink the US Stock Market?
I do not have much to add on the geopolitical side of the Ukraine situation except to say that Crimea historically been part of Russia but that Putin did not have to act like a thug to achieve the retrieval of the lost province. He could have gotten what he wanted by just asking. From an investment point of view the best outcome is that Russia decides not to invade the rest of Ukraine and that Obama’s punishment for Russia is minimal. I think this is the most likely outcome although there is a risk that I am dead wrong. If I am right, the issue goes away as a negative for the US and Russian stock markets. Otherwise, this could get ugly.
Remember Russia with its energy exports is a major player in the global economy. Punishment for Russia means punishment for the global economy. Obama has been criticized for his Teddy Roosevelt in reverse “speak loudly and carry a small stick” foreign policy. But from an investor point of view at least in the case of Crimea this is the perfect policy. The bottom line is no major damage to the global economy, even if America looks like the fool.
In my book, Investing in the Age of Global Defaults, I spoke favorably about Russia as a possible alternative investment. My argument was that Russia is endowed with substantial human and natural resources and has learned its lesson from seventy years of Communism. Many disagree with this and classify Russia as the land of lawless kleptocrats, nuclear missiles and a declining and alcoholic population. And now Putin seems to want to restore the empire that was the old Soviet Union.
I am sticking to my long term positive view. First of all, Russia’s oil and gas resources are substantial and cannot be ignored. Robert Hardy writes a regular geopolitical essay Geostrat Worldview and the recent piece is extremely enlightening in this regard. Hardy makes the point that Russia has enormous opportunities to export oil and gas to China. Putin isn’t beholden to the US and Western Europe.
Secondly, there are Russia’s still significant human resources. Actually, this is a curious situation. A recent book by Loren Graham, entitled Lonely Ideas, Can Russia Compete, is very interesting. As Graham points out, Russia boasts a brilliant intellectual tradition in art, music, literature, science and technology. But in terms of putting inventions and ideas into practice and building technologically based companies, the Russian record is pathetic. Russia has been brilliant in developing technical ideas and abysmal in benefiting from them. Go into an electronics store and you might find products that in part owe their existence to some earlier Russian breakthrough. But you will never find a product made by a Russian company. In Graham’s words:
Russians have been creative world leaders only in some areas of intellectual activity, not in all. Music, literature, mathematics, and some branches of basic science are largely creations of the mind, able to prosper as long as their practitioners are given good educations and the financial support necessary for them to work in their fields. Russians usually do well in such areas. Technology, however, is a totally different subject; it is where the rubber meets the road, where intellectual creativity engages with society at large in a necessary and complex way, and where society can determine the success of technological projects, perhaps even unintentionally. The success of technology, which usually means profitability in a competitive international market, occurs outside the research laboratory, in the social and economic environment of the society as a whole. Russians have not done well in such activity. Where is the Russian Thomas Edison, Bill Gates, or Steve Jobs?
The institutional framework of property rights, law and respect for markets was absent under the Tsars and certainly under the Communists. Will Putin be more of the same or will the Russian intellectual genius finally be allowed to create dynamic companies?
Curiously, what Graham’s book does not mention is Russian anti-Semitism. Little Israel today is second only to Silicon Valley as a tech hub. Hundreds of thousands of émigré Soviet Jews are behind Israel’s success. (See George Gilder, The Israel Test) And of course we should mention Sergey Brin, cofounder of Google and the 19 billion dollar man, Jan Koum, founder of WhatsApp. The Russian Edisons, Gates and Jobs, it turns out do exist but they live in Israel and the US.
As an aside, there are some excellent Russian tech companies outside the resource sector. Yandex, the Russian Google is one. But so far the numbers are few. Russian stocks and the rouble have dropped dramatically since the onset of the Ukrainian problem but if I am right and the crisis fades away these declines will reverse.
China – Will the Middle Kingdom Sink the World Economy?
The news from China is slowdown. Exports, retail sales, purchasing managers indexes, all suggest China is slowing down. And for the first time in years, the renminbi is weakening against the dollar. The China bears are all saying “I told you so” but they have been saying this since 2010. Let me review what I see as the main underlying factors with the Chinese economy.
1. China’s Communist Party directed economic system has misdirected substantial resources into suboptimal investments such as real estate and commodities. Capital output ratios have worsened as it takes more investment to produce the same yuan of output.
2. The financial system, largely state controlled through state owned banks, is facing substantial problems as many borrowers cannot repay their loans. The shadow private banking system is exhibiting problems as well. A government bailout will be inevitable. To call this China’s “Minsky Moment” is not quite correct. The government will be bailing out itself. The borrowers who will be defaulting are local government entities and state owned firms. Minsky wrote about lending bubbles on assets owned by private borrowers. The Chinese system is a state directed resource system masquerading as a banking system. I don’t have good data on this but I do not have the impression that masses of Chinese private mortgagors are way over their heads as in the US in 2008.
3. The country is choking in pollution and environmental degradation.
4. Carrying this suboptimal economic system on their backs and making it work in spite of itself are the Chinese people – relatively well educated, obedient, hardworking and materialistic.
5. The best Chinese companies, largely in the technology area, trade in the US, albeit with convoluted ownership structures. Moreover, ordinary Chinese citizens legally cannot purchase shares in the best Chinese companies. The coming Alibaba IPO in the US will be closely watched. Will it be the $150 billion number that the bulls are hoping for?
6. The Chinese language is one which foreigners as a group cannot speak or read. Add to this the substantial Chinese restrictions on information flow. Knowledge about what is really happening in China will always be imperfect.
My own view is that unless China’s slowdown turns out to be of the extreme variety – say a negative GDP growth rate – China will not derail the US stock market. But China’s slowdown is not a plus and it puts a damper on other emerging markets which are resource oriented like Brazil or South Africa.