Unfazed by the turmoil

Serious investors are still basically optimistic despite the global volatility.

Summary: Serious investors I know in the US suggest there has been an over-reaction to China’s softening and China will be successful in avoiding a hard landing. US companies are able to borrow at attractive rates, and although demand is soft, there is no recession in sight, the serious investors say. They say Europe will keep Greece afloat and that technological advances over the next 30 years will be more dramatic than those of the last 30.

Key take-out: The serious investors are still basically optimistic. If there were something negative brewing, I wonder if they would be able to anticipate it.

Key beneficiaries: General investors. Category: Economy.

For the past several decades I have organised a series of lunches on summer Fridays for serious investors who spend their weekends in eastern Long Island.

In the past I have tried to cover a broad range of investment topics at each lunch. I varied the format this year, asking attendees who were experts in certain areas (energy, Greece, technology, cybersecurity, etc) to talk about their views and then have others comment on what was said. The goal was to drill deeper into fewer subjects at each lunch but cover most issues over the four sessions.

Those in the group who were close to operating companies said that the problems in China had not yet had an impact on their business. They offered that investors were over-reacting to China’s softening. Only 1 per cent of US corporate earnings came from China out of 38 per cent from all foreign sources, one participant pointed out. 

Lower oil and commodity prices were a positive, and US companies were able to borrow at attractive interest rates. Most economic indicators, such as durable goods orders, supported the view that the US economy was still okay.

Some complained that overall demand was soft and it was hard to increase revenues. This explained the vigorous merger and acquisition activity undertaken by chief executives desperate to increase earnings and making strategic acquisitions to do so. By combining marketing and administrative functions, a new company could improve profits with even modest revenue increases. 

Bear markets usually precede recessions, and almost everyone believed there was no recession in sight. 

One pointed out that no recession had ever occurred without at least one instance of Federal Reserve tightening. Perhaps the widespread discussion of when the Fed would raise rates is a substitute for the reality of the actual move, but most observed that the United States was basically a consumer economy, exports represent only 13 per cent of GDP, the unemployment rate had come down and those with jobs were still spending. 

The concern is that the debt accumulated during the easy money period may be difficult to pay back. This is particularly true in the energy sector where there is a lot of high-yield paper outstanding and some of the weakest companies were heavy borrowers. The decline in equities may also be reflecting the problems in credit.

There was good news and bad news on the technology front. A senior executive at one of the major internet companies attended one of the lunches. I asked him my favourite question: “Will developments in the next 30 years match those of the last 30?” I just cannot conceive of the next thirty years producing anything comparable to the internet and the smartphone. He answered without hesitation. The advances of the next 30 years will be more dramatic.  

I also invited a person knowledgeable on the Greek financial situation to one of the lunches. He acknowledged that the economic prospects for the country were bleak, but he thought Europe would keep the country afloat. 

As for China, the group seems to have been sceptical all along. Almost nobody thought real growth there was 7 per cent, so the slowdown was not unexpected. Some believed the situation was much worse than in 2008. Attendees were also suspicious of the stock market, questioning valuations and accounting.

The group believed China has enough resources to avoid a hard landing now and that it will be successful in doing so. What may come out of this turmoil is a more cautious Chinese leadership. They may move slowly on their rebalancing efforts, and they are almost surely going to pull back on any territorial expansionist efforts to concentrate on keeping the economy growing.

China's authoritarian government depends on strong central leadership. An escalation of civil unrest would challenge that and they will do everything possible to avoid it. The consensus of the group is they will be able to maintain stability.

A chief executive of a major oil company participated in one of the sessions. He said the drop in the price of crude had really hurt smaller exploration and production companies around the world. Many companies have suspended their efforts to find new deposits, and energy capital expenditures are down substantially. In spite of the drop in price, companies have stepped up production from existing wells. The result is that there is plenty of supply on the market now, depressing the current price, but several years from now there may be a shortage of crude. 

Overall, my sense of this year’s lunches is that the participants were still basically optimistic, as they generally are. I wonder if there were something big and negative brewing out there, whether the group would be able to anticipate it.

Byron Wien is vice chairman of Blackstone Advisory Partners LP, where he acts as a senior advisor to both Blackstone and its clients in analysing economic, social and political trends. This is an edited version of his latest commentary. 

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