David Fuller and Eoin Treacy's Comment of the Day
Category - General

    Six Impossible Things Before Breakfast

    Thanks to a subscriber for this report by James Montier for GMO which may be of interest. Here is a section:

    It appears that asset markets are priced as if secular stagnation were a certainty. Certainty is a particularly dangerous assumption when it comes to investing. As Voltaire stated, “Doubt is not a pleasant condition, but certainty is absurd.”

    In order to believe that asset market pricing makes sense, I think you need to hold any number of “impossible” (by which I mean at best improbable, and at worst truly impossible) things to be true. This is certainly a different sort of experience from the bubble manias that Ben mentioned in the opening quotation, which are parsimoniously captured by Jeremy’s definition of bubbles – “excellent fundamentals, irrationally extrapolated.” This isn’t a mania in that sense. We aren’t seeing the insane behaviour that we saw during episodes like the Japanese land and equity bubble of the late 1980s, or the TMT bubble of the late 90s, at least not at the micro level. However, investors shouldn’t forget that the S&P 500 currently stands at a Shiller P/E of just over 28x – the third highest in history (see Exhibit 17).

    The only two times that level was surpassed occurred in 1929 and in the run-up to the TMT bubble. Strangely enough, we aren’t hearing many exhortations to buy equities because it is just like 1929 or 1999. Today’s “believers” are more “sophisticated” than the “simple-minded maniacs” who drove some of the other well-known bubbles of history. But it would be foolish to conflate sophistication with correctness. Current arguments as to why this time is different are cloaked in the economics of secular stagnation and standard finance work horses like the equity risk premium model. Whilst these may lend a veneer of respectability to those dangerous words, taking arguments at face value without considering the evidence seems to me, at least, to be a common link with previous bubbles.  


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    The next move after a weak March could be a useful rally

    Thanks to a subscriber for this report by Warwick Grigor for Far East Capital Limited focusing on Australia. Here is a section on the property market:

    Have you noticed how much debate there is over so many issues that we confront? It is usually a face-off between those who can see an issue clearly in one corner, and those with vested interests in the other. As an example, the global warming debate is one that has been ongoing for a long time largely due to the inability to achieve consensus amongst scientists and the complications of obtaining meaningful measurements. But something that should be less controversial is the state of the property market in Australia. Do we have a bubble or don't we?

    We do have an extraordinarily strong market that cannot go on forever. The bigger the cycle upturn the harder the fall on the other end. The collapse of the mining and resources boom was proof of that. After every party there is a hangover. We are seeing many initiatives being proposed, and some undertaken, that are designed to take the heat out of the market. Yet there will still be pain in due course especially for the inexperienced property investors who have been dragged into euphoria of booming property prices.

    In the meantime we see arguments for and against a bubble and an impending collapse. Perhaps we should be focusing on sensible measures rather than trying to do a King Canute. You don't have to wait for direction from the government or the regulators in order to think ahead. Start getting your finances in order now so you can weather the storm.


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    A startup says it can now produce enough for 4 million meatless burgers a month

    This article from Quartz may be of interest to subscribers. Here is a section:

    Brown and his team will have plenty of competition. In restaurants alone, more than 5 billion lb of ground beef are consumed every year. And then there’s the other meat-alternative companies that have charged into the space. Beyond Meat is another high-profile faux-beef company that’s looking to make inroads into the retail market, and Memphis Meats announced last week it created the world’s first meatless chicken tenders made from self-reproducing cells.

    Until now, Impossible Foods has slowly entered the market by popping up in high-profile restaurants in New York City and San Francisco. The goal, though, is to get in front of the most devout meat lovers. In fact, that’s part of Brown’s metric for success. Forget the people obsessed with vegetables.

    “Our definition of success is: we score zero points if a vegan or vegetarian buys our burger,” Brown says. “The more of a meat lover they are, the more they are our target customer.”

    The company’s market research has shown that even the most devoted American meat eaters will never stop wanting it—but they would be interested in a product that tastes just as good and is also made of plants, Brown says. In other words, a product that comes from an animal is not part of the intrinsic value of a burger. It’s more about how delicious, nutritious, and affordable that product is.


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    Thanks to a subscriber for this report from Deutsche Bank which may be of interest. Here is a section: 

    Investors should be particularly sensitive to indicators that are associated with being in a misaligned world. This analysis can be applied both to sunk capital and new investment. For companies with low growth capex, margins on existing production will clearly be more important than incremental value creation or destruction on new investment. For high growth companies, returns relative to the cost of capital on new investment will be more critical. 

    Investors should be wary of high-carbon companies where decarbonisation is likely to be demand driven (for example coal generators facing lower production as subsidised renewable production is built). However there may be value opportunities where decarbonisation is supply driven (for example restrictions on coal production, or forced coal closures could increase margins on remaining capacity even while overall volumes drop). 

    Investors should look for low carbon companies in sectors where supply constraints are likely to be more significant than demand constraints as volumes grow. They should be wary of sectors where the mechanisms for growth are likely to drive down returns (for example long asset lives with technological progress and short-term market pricing). 

    By understanding the positioning of companies in the matrix of volume and value, investors can make an informed judgment. Market valuations can be set against current opportunities and future expectations. Shareholder engagement can help ensure the right corporate strategy

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    Growing International Opportunity for Drug Development

    Thanks a subscriber for this report from Oppenheimer which may be of interest. Here is a section:

    We believe estimated prevalence is the best measure of the overall cancer market’s size. We have estimated future prevalence for 2014-2018 (Tables 3, 6, 9). To arrive at these estimates, we used the 2012 or 2013 estimate and added estimated incidence (Tables 1, 4, 7) and subtracted estimated deaths (Tables 2, 5, 8) for each year. Exceptions included cancers that did not have prevalence data for 2012 or 2013. In cases where 2013 prevalence was not available for US patients, we used the 2009 prevalence estimate for 2013 or the incidence estimate. For these same exceptions outside the United States, we estimated 2012 or 2013 prevalence as a ratio to incidence that was consistent with US data.

    Based on prevalence, we estimate the overall market for cancer therapies in the United States is slightly over 14 million patients growing at 7% per year. In Europe, we estimate the overall market is composed of 8 million patients and is growing at 16% per year. In Japan, we estimate the market is nearly 2 million patients and is growing 13% per year. We believe incidence is the best measure of front-line (newly treated) cancer market’s size (Tables 1, 4, 7). Therefore, we conclude the market for front-line therapies in the US is currently 2 million patients and is decreasing at 8% per year. In Europe, we estimate the market for front-line therapies is approximately 3.1 million patients and is growing at 4.5% per year. In Japan, we estimate the market for front-line therapies is currently 680,000 patients and is growing at 2% per year.

    We believe the best measure of the market size for second-line and greater (relapsed/refractory) therapies is prevalence less incidence, which should account for all living patients who are not newly diagnosed. Therefore, we conclude the market for relapsed therapies in the US is currently 15 million patients and is growing at 10% per year. In Europe, we estimate the market for relapsed therapies is approximately 10.8 million patients and is growing at 11% per year. In Japan, we estimate the market for relapsed therapies is currently 2.1 million patients and is growing at 8% per year. 

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    Citigroup Canary in the Coal Mine

    Thanks to a subscriber for this article by Christopher Whalen for theinstitutionalriskanalyst.com which may be of interest. Here is a section:

    Citi’s equally large credit card book – in nominal terms the most profitable part of the business – has a gross spread of almost 1,100bp, but also reported over 300bp in defaults in 2016.  Still, with a 800bp net margin before SG&A, credit cards are Citi’s best business.  Indeed, Citi’s payment processing and credit card business are the crown jewels of the franchise.  If there were some way to sell the rest of the Citi operations, the payments processing and credit card business could be worth a multiple of Citi’s current equity market valuation. 

    The trouble with Citi and many other US banks is that their business are dominated by consumer credit and real estate exposures, with little in the way of pure C&I loans.  When you look at most US banks, the vast majority of the exposures are related to real estate, directly or indirectly.  Thus when the Fed manipulates asset prices in a desperate effort to fuel economic growth, they create future credit problems for banks.  As our friend Alex Pollock of R Street Institute wrote in American Banker last year:

    “[T]he biggest banking change during the last 60 years is… the dramatic shift to real estate finance and thus real estate risk, as the dominant factor in the balance sheet of the entire banking system. It is the evolution of the banking system from being principally business banks to being principally real estate banks.”

    So whether a bank calls the exposure C&I or commercial real estate, at the end of the day most of the loans on the books of US banks have a large degree of correlation to the US real estate market.  And thanks to Janet Yellen and the folks at the FOMC, the US market is now poised for a substantial credit correction as inflated prices for commercial real estate and related C&I exposures come back into alignment with the underlying economics of the properties.  Net charge offs for the $1.9 trillion in C&I loans held by all US banks reached 0.5% at the end of 2016, the highest rate since 2012.


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    Time for Trump to Learn From Reagan

    It’s crunch time in America. The financial markets surged on Donald Trump’s election, on the assumption that his economic policies would, on balance, be pro-growth. Yes, Wall Street rightly loathes protectionism and the tech industry in particular is opposed to proposed restrictions on immigration – but business as a whole hopes that the President’s policies on tax, healthcare, spending, banking, regulation, energy, infrastructure and, maybe even in time, monetary policy would be neo-Reaganite.

    It’s still too soon to tell how all of this will pan out, but time is running out for the Trump administration on the economic front. It needs to get a lot more done a lot more quickly. There is, of course, healthcare reform. But the first real, tangible piece of good news has come from a very different area: there has now been some genuine movement on energy, with the Keystone pipeline authorisation. That is good news: the US needs to embrace all kinds of domestic energy production, and other countries should follow suit. The shale revolution 
has already transformed the US economy, which would be in a far weaker place without it.

    But while Trump has delivered on energy, he will need to turbocharge the rest of his agenda if he wants to keep on side those in business and Wall Street who thought that, despite his many downsides, the new president would end up improving the US economy overall.

    Reagan ought to be the Republican role model: a true believer in free market economics, he was a brilliant, lucid and powerful advocate for individual liberty. He cut marginal tax rates and simplified the tax system, while slashing the number of pages in the Federal Register from 70,000 in 1980 to 45,000 in 1986, as a note by Adam Slater from Oxford Economics reminds us.

    He did what very few politicians manage: he genuinely took an axe to red tape, deregulated extensively and simplified what rules remained. By contrast, the regulatory burden rocketed under Barack Obama. The Fraser Institute’s index of economic freedom confirms that America became a more free-market and economically liberal economy during the 1980s; in recent years, it has fallen back drastically.

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    AP Analysis: Trump Young Presidency Perilously Adrift

    Here is the opening of this assessment by The Associated Press:

    WASHINGTON — Just two months in, Donald Trump's presidency is perilously adrift.

    His first major foray into legislating imploded Friday when House Republicans abandoned a White House-backed health care bill, resisting days of cajoling and arm-twisting from Trump himself. Aides who had confidently touted Trump as the deal's "closer" were left bemoaning the limits of the presidency.

    "At the end of the day, you can't force somebody to do something," White House spokesman Sean Spicer said.

    On its own, the health care bill's collapse was a stunning rejection of a new president by his own party. And for Trump, the defeat comes with an especially strong sting. The president who campaigned by promising "so much winning," has so far been beset by a steady parade of the opposite. With each setback and sidetrack, comes more concern about whether Trump, the outsider turned president, is capable of governing.

    "You can't just come in and steamroll everybody," said Bruce Miroff, a professor of American politics and the presidency at the State University of New York at Albany. "Most people have a modest understanding of how complicated the presidency is. They think leadership is giving orders and being bold. But the federal government is much more complicated, above all because the Constitution set it up that way."

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    Moodys Warns Scotland Exit Could Leave Country Facing Junk Rating

    Here is a brief section of this story from Investment Week:

    Commenting on the potential for Scotland to become independent, Colin Ellis, chief credit officer for EMEA at Moody's, has warned the country would face "downward pressure" on its finances in the event of independence, according to The Times.

    The warning comes as lower oil price, currently sitting at around $55 a barrel, have left Scotland facing a large budget deficit and worse off financially than before the previous referendum in September 2014. 

    Back in 2014, when the oil price was above $100, an independent Scotland could have received a rating between A and Baa, placing it within the investment grade bracket.

    However, Moody's Ellis said current circumstances could see Scotland's rating drop to Ba, a junk status (also known as sub-investment grade), which would place it on a par with Azerbaijan and Guatemala.

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