Big Picture Brock

MP: Woody Brock earns a living, I presume a good one, thinking about the world and it’s economy and travelling around selling those opinions. What I was wondering is where in that picture does Australia come in?

WB: Well Australia is unique in the world picture in that it is positioned between Asia, the United States and to a lesser extent, Europe. In addition Asia came of age at an accelerating rate with the end of the Iron Curtain and communism, with the rise of China so now Australia sits here with the ability to export minerals and commodities which we don’t have. That being true, with a great climate, with tourism as well as this, Australia is very well positioned I think for the next 20 years to benefit from being an Anglo-Saxon country in the other end of the world and also being a purveyor of tourist services and commodities to Asia.

MP: So you’d be overweight Australia?

WB: Yes, I would be overweight Australia because your price earnings ratio, your valuations while they’re robust, they’re not excessive.

MP: This sort of discussion presumes there is a global market. Capital is always running around the world looking for the best trick. Is there a local market or just a series of regional ones?

WB: You have to be careful in what you’re asking because on the one hand there are lots of people around the world who are looking for opportunities who for the first time in history are able to put their money all over the world. This is globalisation of the markets. It’s very important. These days many people think that because of this there’ll be a kind of global market with one interest rate, stock markets all in sync. The reverse is in fact the truth. It’s not an easy point to make but you can show mathematically that the more globalised the world is, in fact in a funny way the less correlated the pieces are. Let me give you an example. Here we are in a global world, correct? If this is true could you explain the following? In the last four years, how has the Indian stock market done? Very well. Now you know the word Chindia - it’s often used to describe the Indian Chinese revolution. How is the Chinese stock market done in the same time?

MP: Terribly.

WB: Terribly '” you’ve got it. Reverse correlation. Let’s shift to the biggest stock markets on earth. Japan and America. How have they moved? In sync. or anti-sync in the past 5, 10 or 15 years?

MP: Out of sync. Were there any reasons for that?

WB: Yes, but they are very much out of sync. Not for a couple of minutes, for a long time. Russia. Japan. Europe. America. Australia. Brazil. China - they’re pretty independent of one another. This is so different from my parent’s world. The stock market. America. Australia. England. Germany. France. They are pretty much in tandem with one another, so today you really do want to be asking what do I get into that’s pretty cheap and what shall I get out of where I’ve made some money.

MP: Do you mean economies, or do you mean geographical areas?

WB: As an investor the question I have to ask is what stock market can I put my money into? You try to buy cheap and sell high. That’s nothing new. It goes back thousands of years. The Carthaginians wrote about it. The difference today is there’s always going to be a stock market that’s cheap when something else is high. The cycles aren’t correlated so I can ride one up for five or 10 years, yes, make some money there and find something cheap.

MP: That begs two questions.

WB: Yes.

MP: A general one first. Sometimes there are good reasons for things being cheap.

WB: There are indeed, but if you look at the history of bear markets, the fundamental reason that they happen is that because of a 15 year growing disenchantment with the market when you have a bubble like we had in 2000 and then look at the Dow today. It’s 10,500. Correct? The Dow Jones three years ago was 10,500. Yet earnings have been terrific for three years. What that says is despite the best possible news about fundamentals people are getting out of stocks. The price earnings ratio has dropped from $US35 to $US20. It’s a way of saying we don’t want you so much anymore. Let’s try some real estate because people have been burnt.

MP: But you’re also saying that five years ago people were totally stupid. That it was never worth the multiple that it was trading at.

WB: That is a very different point. It’s correct in its own right but the fact is you will always have bubbles and you will always have bear markets. All I’m saying is look for these, try to buy when things are pretty low. You never get the turning point but you know when the oxygen’s thin and you know when things are too high and you know when they’re [cheap]. But you never get it right.

Still, that’s a lot better than simply buy and hold and ride the up cycles and down cycles because the problem with that, my father did that with his money. Yes he made money when the stock market went way up. And then before he died in 1981 he lost everything in the worst stock market in 100 years. So buying and holding unfortunately in a world of cycles can be very costly.

MP: The second obvious question is what do you see is cheap at the moment and what do you see is expensive?

WB: I’m not in the market picking business so I hesitate. I’m more of the economic side and the macro side so I really would rather pass on that. Certainly you can make some assumptions about the improvement of the Chinese banking system and there’s evidence that it will improve. The Chinese economy has done marvellously. Probably with some good news about infrastructure whatever, the Chinese market ought to be catching up with the economy the way it already happened in India. I’m not going to buy India am I? China makes me a little nervous because it’s such a weird system but I would go for something quite cheap.

THE US AND CHINA

MP: OK, let’s take the stock market out of it. What economies do you think are under-rated at the moment? China is well rated.

WB: China’s economy is misunderstood because of the fact it’s unfortunately adopted text book strategies for achieving its 9 plus percent growth rate. They peg their currency. The Chinese currency would, in a free market have tripled in value. The Chinese cheated. They pegged their currency so Wal Mart can just make everything in China. We call that an excess outflow of jobs because it wouldn’t have happened had the currency done what it should have been doing all along so China will do anything to get jobs in the short run. Peg its currency, non convertability of the currency. All kinds of banking problems. This is basically a violation of the requirements of the World Trade Organisation Charter which China signed.

Time’s running out for China.The world is fed up. Vietnam is fed up. Turkey is fed up. The new textile initiatives of China have irritated everybody everywhere and unfortunately you’re going to see protectionism. So while I admire the Chinese economy particularly the people with their high savings rate and willingness to work 80 hours a week, never confuse the people which are the great assets of China with the Government which is frankly been a mess for 60 years.They’re different. We have to hope that the Government catches up with the quality of the people. And so China is a very tricky story.

MP: Most of the world could say that about the United States at the moment as well.

WB: Well the United States of course has the problem of a trading deficit that’s very large and widely considered unsustainable, that’s the problem. You’ve got to remember Australia in fact also has a large trade deficit and has had one a long time. As has New Zealand, Spain and Holland for that matter. But we’re the reserve currency nation, we’re very flexible, we’re very big, we have the highest productivity supposedly.

It's so strange for a country like the United States to be running this one way trade deficit to hell which we have been doing, so we wrote a big piece about this a year ago, and it’s very interesting. The United States never had a trade deficit. Between 1918 and 1983 we ran basically trade surpluses. But notice, our trading partners grew faster than we did. Japan and Europe grew every bit as fast if not faster than we did after the War. We didn’t have to rebuild.

It’s probably the biggest story that people missed but the death of growth in Japan and Europe is a shocker. For five, ten, twenty years it’s a catastrophe. particularly when Europe and Japan have the biggest problem of aging populations. They’re really getting old fast. To pay for old people you need 4 per cent growth.

So what’s happened in the past 15 years is the rise of China with its practises and the death of growth in Europe and Japan have combined to give us a huge trade deficit we otherwise wouldn’t have had. That’s not to say our own practises don’t contribute to the trade deficit but we found they were about 15% of the problem. The real problem was the death of growth of our allies in the practices of China which have seen the Chinese trade deficit with America grow from US$20 bn to about US$200 bn. That’s a shocker.

MP: What about the fundamental problems of the United States?

WB: Some problems, some opportunities. Remember just like with China. Fortunately, it’s your people and the system that’s the asset. Australia, Ireland, America are growing fast. They have optimistic happy people. They believe in the future. They can move and live where they want. You can hire and fire people. That is the great asset. Not these temporary problems. The great assets are your people and their dreams. Been to Germany recently?

MP: No

WB: The Germans have fabulous education. It’s one of the greatest cultures in the world but they’re making Daimler for 40% less in Slovakia than in Stuttgart. Bye bye.

MP: Do you turn optimistic just because there are problems in Europe though?

WB: Well what’s unsustainable won’t go on. Already the old system is cracking in Germany. The famous Union IG Metal is admitting that it can no longer do for its workers what it used to..they can’t compete. They [must] lose their jobs to the Chindians or to the Slovakians.

My opinion about Europe is however that they went so far down the road towards the welfare state, towards unpayable levels of benefits that when you are going that far down the road, it’s very difficult for Government to take back what it gave you gave. The US didn’t go that far down the road. You didn’t go that far down the road. I think Australia incidentally with its pension system is a model for all of us. You’ve really done a good job in dealing with the retirement issue. We’ve just stuck to the old social security programme. We have not done a good job. Europe has done a terrible job. You’re a leader in that field.

MP: Yet European stockmarkets perform quite well?

WB: That’s another issue. What’s the best cosmetics company in the world? L’Oréal, based in Paris. What’s the worst. Revlon. Based in Madison Avenue, New York. Companies can be very good everywhere. Even in Vietnam. Never confuse companies with the macro statistics of a country. Don’t confuse companies with countries.

THE OIL PRICE

MP: You’re obviously pretty chuffed with the success of your oil forecasts. At what stage does the oil price rise enough to damage economies and slow demand?

WB: As Wal Mart reported a few days ago, their lower income people are suffering badly from heating bills and all these things. So, it’s happening. When people ask this question what they’re really saying is gee, oil went up last year but US GNP stayed at 4%. Oil was no problem. Wrong. Oil was already hurting. It’s just the impact of oil was masked over by the GNP boost from everyone borrowing more than ever against their houses and spending it. So that artificial stimulus from taking money out of your house which is at the greatest rate in history, masked the fact that under the surface the trade deficit was getting worse which is bad for GNP mathematically.

The price of oil was hurting. And.. on the other hand, there’s no question that a fixed increase in the price of oil let’s say 40%, 35 years ago, had twice the impact of the same percentage increase today because the economy utilised two times more oil per unit of GNP than it does today. And in your great grandchildren's time it will probably utilise one eighth as much as today and you will have hydrogen and we will all get 1000 miles a gallon. Not in my lifetime.

Big Oil went to sleep for 15 years between 1985 and 2000. In the previous 15 years they boomed and everybody put too much money into energy, the price collapsed in the middle of the 80s from $US35 to $US10.

If you’re a business person you’re not going to invest the required 6 trillion dollars if the price of what you make is going down and the political risk is going up and the volatility is going up, you’re going to say bye bye just to a stock repurchase which is what they all did. So Big Oil (larger oil companies) went to sleep. The oil fields peaked and bingo, if that’s not bad enough, India and China rise up with the largest potential increase in demand for energy in the history of the world times many times over. Put that together and you have an unpleasant next 20 years. So we believe oil is going to be a big story and a big investment opportunity. But not only with oil, it will be energy. It will be tar sands, hydrogen, wind. Everything’s going to be called up now, because the hydrocarbons aren’t there. They’re just not finding them.

MP: How big is the American xenophobia about China?

WB: Not much. It’s the wrong country about which to ask that. What’s the one country where no one minds immigrants. What country doesn’t fear immigrants will take my jobs. Well I can tell you, Australia may be second, we’re first. We’re not xenophobic. Most Americans don’t know much about China but they’re beginning to see this bellicose behaviour and find it very strange.

MP: Will America end up taking protection against China?

WB: I think global trade is so important to the world today, to our children’s living standards that we all have to try our best we can to play fair and square. My view is that China with all of the success that she has had is going to continue the game she’s playing. She must basically be retaliated against strongly. My fear of course as an economist is we don’t want the world of protectionism. If a country really egregiously violates the axioms of comparative advantage like China then targeted protectionism against anybody who aggressively cheats is part of what’s going to be needed to bring about a world where nobody cheats too much.

END