Research Watch

PORTFOLIO POINT: This is a sampling of this week’s best research notes. In a world of too much information, we hope our selection helps you spot the market’s key signals.

As commodity prices continue to tumble and warnings about the domestic economy grow louder, a boutique US investment firm is noticing worrying similarities between Australia and Europe’s crisis-hit periphery. It warns the Australian dollar will likely fall sharply, alongside the property market and our banking sector, which is expected to call on the Reserve Bank for help. Luckily, governor Glenn Stevens has just been named one of the top central bankers of the year. The US Federal Reserve is also in focus ahead of Ben Bernanke’s Jackson Hole address – two bond titans disagree about the likelihood of a new round of quantitative easing – and as Republicans push for a new gold standard, one analyst thinks that could be a model for Europe while another argues it will only make things worse. Meanwhile, Deutsche Bank sums up earnings season in a single chart, as research suggests investors should pay closer attention to post-result analyst calls. A Hamptons handyman spills his hedge fund secrets, a millionaire trader is accepting entries for Miss Penny Stock 2012, and, on video, walnuts offer some of the best returns in China.

Is Australia the next Europe?...

“The Australian banking system is highly reliant on external funding and will likely become dependent on the RBA for liquidity in the near future. Our view is that the RBA will have to become much more activist in supporting its major banks as the structural slowdown in China and the housing market continues. We believe the RBA will ultimately be forced to take similar action to developed market central banks either by aggressively cutting interest rates or propping up banks through domestic open market operations akin to the liquidity injections seen by the ECB. Quantitative easing is also a possibility if the RBA is forced to buy bank debt to try to stave off a financial crisis. Under such a scenario, the AUD would fall considerably. The crisis-stricken economies along the eurozone periphery share one key characteristic: their external debt is too high and their net international investment position (NIIP) – measuring the difference in stock value between assets held abroad and asset held domestically by foreigners – is deeply negative. Yet, a closer look and you will find Australia and its neighbour New Zealand in the same company, with negative NIIP well above countries such as Turkey and Brazil.” (Variant Perception, August 2012)

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Luckily, Glenn Stevens is in charge...

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“Global Finance magazine has named the heads of the Central Banks of six countries as the World’s Best Central Bankers over the past year. The ‘Central Banker Report Card’ feature, published annually by Global Finance since 1994, grades Central Bank Governors of 50 key countries (and the ECB) on an ‘A’ to ‘F’ scale for success in areas such as inflation control, economic growth goals, currency stability and interest rate management... [as well as] the determination of central bankers to stand up to political interference, and their efforts at influencing their governments on such issues as spending and economic openness to foreign investment and financial services.” (Global Finance, August 23)

To ease, or not to ease...

“Two of the world’s leading bond fund managers, Bill Gross and Jeffrey Gundlach, have taken opposite stances on whether Federal Reserve chairman Ben Bernanke will hint at extending the US central bank’s bond-buying program during his speech in Jackson Hole, Wyoming this Friday. Gross, founder and co-chief investment officer of bond giant PIMCO, told CNBC on Wednesday that the announcement could come at the closely watched Jackson Hole annual global central banking conference, led by the Fed, which begins Friday. ‘I think either at Jackson Hole or two weeks later, at the next Fed meeting, that we’re going to see policies where checks will be written and Fed balance sheets expanded,’ Gross said. For his part, Gundlach, chief investment officer and chief executive officer of DoubleLine Capital, took the opposite stance and told Reuters he does not expect another round of major stimulus soon from the Fed. ‘An actual massive bond buying program could take the 10-year down to pretty much as low as the Fed wants it. I don’t see that in the near term, however,’ Gundlach said on Tuesday.” (Reuters, August 29)

That’s earnings season...

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(Deutsche Bank, August 27)

Next time, pay attention to analysts...

“Research from Jordan Schoenfeld, a PhD candidate at the University of Michigan’s Ross School of Business, suggests analysts’ tone isn’t merely reflective of how analysts view a company’s results. It can be predictive of where the firm is heading. Mr. Schoenfeld pulled analyst quotes from a collection of over 25,000 quarterly transcripts held from the beginning of 2001 through April 2008. Using lists of negative and positive financial words developed by Notre Dame professors, he constructed a measure of analyst tone–the more positive words (like ‘opportunity’) than negative ones (‘setback’), the more positive he judged the tone to be. He found that when analysts’ tone is more upbeat than usual, a company is likely to see more analyst upgrades than downgrades, and even then to match or clear estimates when it next reports results. Most importantly, its share price tends to outperform in the days and months that follow. The upshot: Collectively, analysts may actually be quicker than investors to sense when something has shifted.” (Wall Street Journal, August 28)

Confessions of a hedge fund handyman...

“It was another summer in paradise. My guys and I did just about everything. Beyond the leaky roofs, broken pool heaters, and $50,000 tree installations (for one tree, singular), we also built a backyard dirt bike track for a kid’s 13th birthday party and fixed a photo booth in a rich guy’s basement in the middle of the night. We drained an entire pool for fear of contamination by a dead raccoon, and we drove dogs (plural) to acupuncture appointments. We even jump-started $100,000 electric Teslas. For three different people. … The schism and anger between the Über-rich and the not-so-Über, not-so-rich, continues to expand... My guys at the airport see a lot more hedgies in big rim hats, hunched over, staring at the pavement when they board their helicopters on Sundays, and a lot more household staff are now being given confidentiality agreements to sign. The rich want to go underground. At least the smart rich do. … Possibly in an effort to order to avoid PUAAR (pent-up anger against the rich), lots of folks are now trying (unsuccessfully) to adopt competitively distressed lifestyles: musty Montauk beach cabanas, over-restored vintage SUVs, and outfits that are stylised to look trashed and dirty, but actually cost more than a decent wardrobe... I even taught two members of Team 212 how to farm using their vintage Farmall Cub tractors.” (Joe Schwenk, a Hamptons contractor, via New York Magazine, August 22)

A gold-plated European solution...

“The final link between gold and money was severed 41 years ago this month, when President Richard Nixon ended the Bretton Woods systems that fixed the price of gold in dollars, and fixed other currencies to the American one. …  As a rough rule of thumb, currency systems last around 40 years. The classic pre-World War I gold standard lasted that long. The Bretton Woods system lasted 27 years. On that reckoning, the existing system of floating central bank currencies, with the dollar as the global reserve currency, is already living on borrowed time. The strains are showing. The dollar is in long-term decline as the US shrinks in relative importance. Central banks are frantically printing more paper money but having little impact on the real economy. Asset markets are getting ever more unhinged. It is hardly surprising that people look at the mess and start to ask hard questions about whether the monetary system is really working. … Don’t rule out gold playing a role in the final stages of the euro crisis. One fix for the beleaguered single currency might be to switch to a metal-based monetary system. After all, in the 19th century Europe operated a gold standard fairly successfully, and that was effectively a single currency. Alternatively, if the euro falls apart, or one or two members leave, there might be a good case for backing new currencies with gold. Italy, for example, has some of the highest gold reserves in the world. … Back [a new lira] with gold and suddenly it would look like something investors could take seriously.” (Matthew Lynn via MarketWatch, August 29)

Or not...

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“[The Gold Standard] did not lead to better growth or even to stable prices. The peak to trough oscillations in prices (inflation to deflation) were arguably greater. As you can see from these two charts from the St Louis Fed ... there were more recessions under the Gold Standard. Relapses were more common. … The charts use a different scale for the inflation index (which is how FRED does the data) so you have to look closely. What you see is that there were two nasty bouts of post-war inflation: the late 1940s and early 1950s (a crafty move to devalue the post-war debt); and the 1970s Phillips Curve blow-off (the High Keynesian heyday). Other than that, the fiat-era price record has not been so bad. There have been no destructive plunges into deep deflation, which is when real trouble often starts. By contrast, the Gold Standard saw multiple episodes of deflation, five between minus 10% and minus 20%.” (Ambrose Evans-Pritchard via The Telegraph, August 29)

Searching for Miss Penny Stock...

“Timothy Sykes, millionaire trader and investment teacher, has created a beauty pageant, Miss Penny Stock, to ‘inspire students’ (or perhaps an excuse to peruse attractive women). ‘It’s going to be a classy competition,’ Sykes insists. ‘It’s not going to be some ditzy girl who wants to get by on her looks, it’s going to be a girl who wants to learn stocks.’ At the casting event, beauties will model ‘bikini and cocktail’ (presumably dresses, not drinks) and be asked questions like, ‘Do you know about stocks?’ He says more than 100 women have already applied. ‘She’ll be a pretty face to show what I can do with my teaching,’ he continued. ‘I want to teach everybody, so why not models?’” (New York Post, August 26)

Video of the Week: Invest in Chinese walnuts...

With more traditional investments like stocks and property offering only small, or sometimes negative, returns over the last few years, a market in so-called ‘cultural playthings’ has sprouted up, sending prices for large walnuts into the tens of thousands of dollars.

(Reuters, August 27)