4th Quarter 2010
We are bottom-up investors and focus our research on companies and industries. We make no point forecasts with regard to interest rates, currencies, economic growth or major stock market indexes. We search for companies that we believe are undervalued relative to their normal earnings and have the ability to drive their return on invested capital higher. That said, we do pay attention to what is happening in the world and, at the risk of straying too far from our circle of competence, we will comment here each quarter on things we see in the marketplace that we believe are important.
By our count, QE2 is at least the fifth such effort by the post-Volcker Federal Reserve to aggressively provide liquidity to stressed capital markets. Previous episodes were after the 1987 crash; in 1998/99 in the wake of the collapse of Long Term Capital and in anticipation of the Y2K transition; as a reaction to the collapse in the internet bubble in the early 2000s; and in response to the 2008 financial meltdown. But there is an important difference with QE2: the Fed has this time explicitly stated that its goal is to raise asset prices with the expectation that this will engender confidence among consumers, investors and businesspeople, spurring them to borrow and spend again, increasing economic activity and employment.
But, rather than driving economic growth, QE2 appears to be fueling a new round of speculative fervor. This should come as no surprise: Chairman Greenspan’s aggressive monetary stimulus in the late ‘90s led to the internet bubble, while his low interest rate policies in the early 2000s helped inflate the housing bubble. And now after QE2, the reports we share below make us believe the speculative juices are beginning to flow again:
- The New York Times recently chronicled how real estate speculators like Harry Macklowe and Tishman Speyer, both burned on high profile deals the last few years, are back in the game and able to raise capital. Commercial real estate is moving again and several premier office buildings in New York and Boston recently transacted at capitalization rates of 4% to 5%, rivaling prices paid at the 2007 peak. And the capital markets are opening: Wall Street banks are preparing to sell $4 billion of Commercial Mortgage Backed Securities (CMBS) over the next month, exceeding the total sold since the credit markets seized in 2009. It looks likes its game-on for this asset class that needs large doses of leverage to generate acceptable returns for the equity holders.
- Goldman Sachs’ $1.5 billion stock distribution plan for Facebook is noteworthy, a trade that does its best to merge the scary parts of the internet bubble and the real estate bubble. This “deal” combines financial engineering (securitization), circumvention (or outright flouting) of securities law, the appeal of being “on the inside,” illiquidity and financial opacity along with the unbridled optimism for a nascent internet company. The deal is reportedly (and unsurprisingly) oversubscribed, evidencing no shortage of wealthy investors who are willing to jump at the opportunity to pay a fee of 4%, forgo 5% of all profits to invest a minimum of $2 million in a “special purpose entity” that holds shares in a company valued at 25 times revenues, and to hold this position until at least 2013.
- And In a recent report from Bloomberg News: “Surging demand in Asia for Chateau Lafite and other prestige French wines may be causing a bubble, dealers said.” The article quotes David Elswood, Christie’s International head of wine as saying, “Over the last year we’ve seen the emergence of the Chinese speculator.” Art and wine seem to skyrocket when people have money to burn.
It would seem speculative activity is on an upswing. Federal Reserve Chairman Bernanke can provide the fuel in terms of QE2 but once the fire is started he can’t be sure where the flames will spread or how fast the fire will burn. Nor can we. Sadly it seems financial memories are short and history does seem to repeat itself.
As newly liquid investors/traders stretch to find new areas of profit, we believe they are underestimating the negative impact of the loss of credit by a substantial but unquantifiable portion of the economy. Easy credit is what drove a large portion of demand and economic growth through the middle years of the last decade, and now that is gone. So unless credit becomes available to that segment of the economy (that probably shouldn’t have been borrowing to begin with), aggregate levels of demand are likely to remain substantially lower over the next few years. Sustaining asset inflation in a period of sub-par growth will be a tough assignment.
We believe it is a time of severe crosscurrents. Speculation and financial reality are likely to combine with an unpredictable outcome.
The material provided herein has been provided by Linde Hansen & Co. and is for informational purposes only. Linde Hansen & Co. serves as investment adviser to one or more mutual funds distributed through Northern Lights Distributors, LLC member FINRA. Northern Lights Distributors, LLC and Linde Hansen & Co. are not affiliated entities. 0358-NLD-3/9/2012This entry was posted in Contrarian Thoughts. Bookmark the permalink.