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.

Dylan Grice is leaving Societe Generale, but the respected analyst has some characteristically colourful parting advice. In his final Popular Delusions note, he recommends investors take cues from the lowly cockroach, which is praised for its “singularly simple and seemingly suboptimal mechanism: It moves in the opposite direction of gusts of wind that might signal an approaching predator.” Market timers, take note. Also in global macro, David Rosenberg lists ten near certainties to invest around, and Nomura analysts spot a possible link between rising house prices and falling fertility rates. At home, Australia's two-speed economy appears to have created an extreme two-speed market, and, following Woolworths' de-merger of Shopping Centres Australasia Property Group, Macquarie looks at the historical performances of “parent” and “child” stocks after spin-offs. Elsewhere, GMO gives up on bonds, Somali pirates know how to negotiate, and Kim Jong-un is named sexiest man alive. On video, Hugh Hendry declares, “God is dead, life is absurd and there are no rules.”

What makes a great success?...

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“Since there are few more accomplished species on earth than the lowly cockroach where better to start looking for an answer? … [Nowadays] everyone knows that only an idiot would want to own equities. It's true that bonds don’t offer much return with yields down here 'but at least you don’t lose your capital.' They’ve had 10% maximum real drawdown, after all. They're risk-free. Some economists even tell us that governments can’t go broke if they are in control of the printing press. That your only risk with bonds is inflation, but let’s face it deflation is the risk here. Look around, we’re deleveraging! Central banks couldn’t create inflation even if they wanted to!! We’ll be lucky to emulate Japan!!! according to Nobel Prize winning clever-clogs. I happen to think the clever-clogs wrong. But I don't really know. ... What I do know is that it’s all beyond the lowly cockroach. Of course, if you’d been clever (or lucky) you’d have owned equities in the 1990s and bonds in the 2000s. You’d have switched out at the top. But how many did? … For the overwhelming majority, timing these events is a mug’s game. Yet today everyone asks what the trigger will be for a bond rout. They need to know so they know when to get out of bonds. It's what they’re paid to do. … A cockroach would avoid playing the game in the first place. He’d accept that he wasn’t clever enough to know when to switch out of one asset class and into another. He’d probably do everything he could to avoid having to make such horrible decisions. He’d buy bonds and equities together, ensuring that each year he held them in equal proportion.” (Dylan Grice of Societe Generale, November 23)

Ten near certainties to invest around... 

1. “Fat-tail distribution curve: Need to be more diversified than normal across asset classes and currencies.
2. Near-6% output gap: Deflation themes trump inflation themes. Preservation not just of capital, but of cash flows.
3. Fed to keep rates near 0% through mid-2015: Interest rate volatility minimised; long-short fixed-income strategies in vogue.
4. $1.7 trillion in cash on corporate balance sheets: Corporate bonds remain a solid investment given prospective low default risks.
5. Fed to replace Operation Twist with outright bond buying: Treasury yields head even lower, making dividend yield in the equity market that much more alluring.
6. Real interest rates to remain negative: This is a very powerful positive thrust for the precious metals complex.
7. Stephen Harper around until 2015, Mark Carney around until January 2015; Barrack Obama around until November 2016, Ben Bernanke around until 2014: Very bullish for the Canadian dollar.
8. Geopolitical tensions -- Middle East, China transition, Greek default, US fiscal cliff, high and rising youth unemployment rates and Japan-China rift: Exposure to raw materials is a good hedge against these recurring flare-ups.
9. Looming political change in Japan: Bad for the yen, good for large cap exporters.
10. Malthusian population dynamics: That two more billion people to feed in the next 35 years means we need 70% more food; an agrarian revolution is in its infancy stages.”

(David Rosenberg of Gluskin Sheff, November 23)

Housing and fertility...

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“We are not seeing the usual boom in Dragon babies [in Hong Kong]. In the first eight months of 2012, there were only 60,103 births in Hong Kong. Compared to the same period in 2011, this is down 5.2% y-y. In the past two Years of the Dragon (2000 and 1988), the number of births rose by 6% and 4% even as the marriage numbers declined by 1% and 7%. Thus, the current condition of a 5% drop in births while marriages are up by 5% is highly unusual. Considering that this is the Year of the Dragon and private hospitals’ zero quota on mainland babies does not come into effect until 1 January 2013, the decline in the birth rate may suggest that Hong Kong may have become so unaffordable that local fundamental demand is now being curtailed.” (Paul Louie of Nomura, November 25)

Pirate economics...

“Seizures of ships by pirates off the coast of Somalia may be down in recent months, but... because the place has been so stateless for so long, it provides a testing ground for theories about how people behave in the absence of meddlesome government. Economists have been interested in the free-market ways of pirates for a while. Last year a team of three published a paper drawing on data from more than 10,000 negotiations that took place from 1575 to 1739 between North African pirates on one side and monks acting for Spanish families on the other. They found that the Spanish managed to pay lower ransoms by dragging talks out. … The authors of a new paper gathered data from pirate negotiators. They found that Somali pirates pretend to be more sophisticated than they are, whereas shipowners pretend to be poorer. Nowadays both sides have an interest in a speedy resolution, since a prolonged negotiation incurs costs. For the shipowner, the cargo spoils and the ship goes unused. For the pirates, the captured crew must be fed and the ship guarded. And pirates cannot last long without a resupply of qat, which is to them as rum is to Captain Jack Sparrow. Settle too quickly, though, and one side or other is likely to get a poor deal. Government intervention can create perverse incentives. Spain paid a ransom of $1.2m for a fishing boat, the Playa del Bakio, in 2008—more than twice the amount previously paid for a vessel of that type, setting a new floor price. Indeed, although the number of ships taken is down, the pirates have adjusted by charging more per release.” (The Economist, November 24)

Australia's extreme valuation gap...

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“This extreme divergence appears unique to Australia. The same calculation across Asia reveals a smaller divergence. This is one demonstration of the power of the structural headwinds facing many industries in Australia, and how much greater an impact they are having in Australia compared with other countries.” (Tim Rocks of Nomura, November 26)

Stay on the right side of a spin-off...

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(John Conomos of Macquarie, November 26)

GMO has given up on bonds...

“GMO, the Boston-based asset manager, says it has 'given up' on the bond market, deciding to ditch long-dated sovereign debt as investors continue to pour billions into government bonds, including US Treasuries. Ben Inker, co-head of asset allocation for the $104bn group, told the Financial Times it is holding large, high-quality companies in the US but that its main bet is to keep money on the sidelines while it waits for better times. … 'We’ve largely given up on traditional fixed income,' says Mr Inker in an interview. He sold what was the last refuge of reasonably priced long-dated debt – Australian and New Zealand bonds – near the start of the year. … Mr Inker says that he is waiting for better times; forty per cent of a benchmark free asset allocation hedge fund he oversees is in 'dry powder'. The only time it has held more cash was in late 2007, ahead of the financial crisis, he says. A tenth of the portfolio is in emerging market and asset-backed paper and the rest is in stocks for want of anywhere safer. 'There are places where stocks look ostensibly cheap, say Europe, Japan, emerging markets,' says Mr Inker. 'But all of that is predicated on today’s profit margins being sustainable and we don’t think that they’re sustainable anywhere.'” (Financial Times, November 26)

Greece's equities outperform... vs China:

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Kim Jong-un: Sexiest man alive...

“The online version of China's Communist party newspaper has hailed a report by The Onion naming North Korean dictator Kim Jong-un as the sexiest man alive – not realising it is satire. The People's Daily ran a 55-page photo spread on its website in a tribute to the leader, under the headline 'North Korea's top leader named The Onion's Sexiest Man Alive for 2012'. Quoting the Onion's spoof report, the Chinese newspaper wrote: 'With his devastatingly handsome, round face, his boyish charm and his strong, sturdy frame, this Pyongyang-bred heartthrob is every woman's dream come true.'” (The Guardian, November 27)

Video of the Week:

God is dead, and there are no rules... Hugh Hendry offers plenty of thoughtful investment advice in this in-depth interview with The Economist.

(The Economist, November 21)