December 14, 2012

By Derek On December 14, 2012 Under December

When you are lying on your deathbed, you aren’t going to look up and say, ‘Gee, I wish I had spent more time in the office.’”Dr. Meyer Friedman

On the weekend, Xi Jinping made a highly symbolic visit to Shenzhen – his first official visit as new Communist Party chief. Xi was paying homage to Deng Xiaoping’s 1992 “southern tour” which kicked off China’s rocket ride to market reform. To force the message home he laid a wreath on a Deng Xiaoping statue and met with four former officials who were with Deng 30 years ago on that trip.

Interestingly, few if any roads were closed in Shenzhen during his visit and Xi Jinping tooled around in a regular bus without tinted windows. The minimal police presence was noted in blogs across China, reinforcing Mr. Xi’s recent stance on burning the red carpet and drowning the pigeons on official visits. Let’s hope Mr. Xi ate well, anyway.

By visiting Shenzhen should we conclude the General Secretary of the Communist Party wants to push the doors to reform open wider still? We will have to wait and see but that is a tall order and we have had no clues that is his intention. Before getting excited, it is useful to remember Mr. Xi was hand-picked by vested interests to maintain the Party’s primacy in all affairs economic as well as political.

With export growth dribbling in at 2.9% for November, vs. the expected 9% increase and imports also quiet at just 2% growth, recent economic stats out of China show external demand is lifeless, to say the least. Yet, industrial output manfully climbed higher-than-expected to 10.1% and electricity output leaped almost 8% – the brightest showing in 11 months. The all-important FAI number averaged 20.7% growth ytd, with railway and subway investment accelerating. All this points to China’s Q4 economic rebound being mostly driven by domestic investment.


I Dream of Gini

The results of a survey released on Sunday of 8,438 households and almost 30,000 individuals conducted jointly by the PBoC and Southwestern University make interesting reading. Not only is China’s real urban unemployment rate, at 8.05% almost double the official level (in part because this survey counts migrant workers and the official one doesn’t) but the country’s Gini coefficient is soaring. A Gini coefficient of “0” represents perfect equality of income across the population, while “1” means Warren Buffet owns everything. The official Gini coefficient for China is 0.41 but according to this survey it is now 0.61. (For comparison, the global average is 0.44 and the US is 0.45). This is a massive and politically sensitive jump in difference between the well-connected “yous” and the forgotten “mei-yous.”

Beijing will take notice, whether they acknowledge it or not. The economy is in serious need of restructuring and the Gini coefficient is a good thermometer of rising heat in society which will find destructive ways of release. The time to tackle hard issues like unbalanced growth and the resultant chasm in wealth gap is during a crisis. We had the grand-daddy of all crises three years ago and China instinctively reverted to active central planning to save itself. Now we have a mini-crisis and Beijing has again made no moves toward shifting the economy’s focus away from ever greater investment to sustain ever less growth. Despite ostensibly low-budget tours to Guangdong on important anniversaries, I don’t see any signs of real change on the ground.

But the Shanghai equity market is cheap and any growth, even low quality growth, will be rewarded. Those with a longer-term view will probably do well to accumulate equities at these depressed levels.

For those with young children:

The 3 Stages of Life

1) You believe in Santa Claus!
2) You don’t believe in Santa Claus!
3) You are Santa Claus!


Hong Kong Lifts the Drawbridge Higher

Last week in EMI we looked at the strong possibility of US-listed Chinese companies being forced to delist due to the impasse between regulators regarding audit inspections. Many believe these companies will “just move to Hong Kong.” The rules in HK regarding unequal voting structures will be one reason that will not happen, I have argued.

Now there is another: HK is making its listing rules stricter under the leadership of Ashley Alder, who took the helm of the Securities and Futures Commission a year ago. A securities lawyer in Hong Kong for more than 20 years, Mr. Alder has seen first-hand the problems with current lax regulations regarding listings and he has commented publicly his concerns over “deficiencies in some sponsor work over the past few years.”

No more. The new rules mean that companies must file their prospectus with full financial information when they apply to the stock exchange for permission to list – not just when the begin selling shares, as the current rules stand now. More importantly, banks “could be held criminally liable” if they bring shoddy companies to market which have fraudulent statements in their shoddy financials.

That will give the unctuous corporate financiers a cause for pause (never a bad thing) and they are already whining a more transparent listing process might preclude them from sponsoring risky high-growth Chinese companies. My view: Good news for investors everywhere – the soon to be adopted law is already having its intended and beneficial impact.

On the Bookshelf:


Korea + Laos

Last month we looked at newest WTO member Laos as an investment destination. While it is very early days and the country only has two stocks trading on its exchange, Mirae salesman Tony Chung has found a listed Korean company that derives all its earnings from Laos: Kolao Holdings (900140 KS). With a market cap of $700 mn (similar to Laotian f/x reserves, I might add), this microcap has been a stellar performer: up almost 300% this year.

Listed two exactly two years ago, Kolao is the largest private company in Laos and reportedly responsible for 4.5% of GDP. They are the dominant automobile producer and distributor of new and used cars and motorcycles. The company imports Hyundai and Kia cars and operates the only automobile assembler (KD kits) in the country. The company also imports motorcycle parts and assembles them under the “Kolao” brand. Kolao has about a 40% market share in both cars and bikes. With less than 15% of roads paved and lots of rain, the business for motorcycles and car parts has a bright future in Laos.

The Laotian automobile and motorcycle market is growing at an average 16% per annum, doubling every four years. Kolao gets 60% of revenues from the new car business and 25% from used cars so this is really an auto dealership with an expanding branch network in a very poor country with bad roads. Average gross margins for the business are 22%.

In the first half of this year, Kolao saw sales jump 58% y-y to $120 mn and net profit soared 78% to $17 mn. The big plan is for the company to establish a firm beachhead in Laos and then export into Cambodia, Thailand, Vietnam and Burma. Let your trusted Mirae salesperson know if you would like a meeting or conference call with the company.

China’s Top 50

The results of this year’s “Top 50 Most Valuable Chinese Brands” survey was just released (here) by Millward Brown, which compiles these statistics using a proprietary “Brandz” formula. MB is part of Kantar Group, the world’s second largest market research organization after Nielsen Company. The company analyzes brands around the world and, not surprisingly, named Apple the world’s most valuable brand this year and last.

Although the road through the report is strewn with horse apples and road kill, courtesy of touchy-feely management consultant lingo such as, “thought leadership,” and “Brands will need to be more relevant,” it does echo what our analysts have been saying about consumption in China. The Chinese consumer is becoming more discriminating and they are beginning to look to brands more than just looking at price. Much of this has to do with the “erosion of trust” caused by the daily food scandals average Chinese need to avoid if they wish to live normal life spans.

As can be seen from the table on the left, it is quite a mixed performance. At first glance, one would assume stock market performance explains Tencent’s 60% jump in brand value as the stock is up 60% this year. Yet Baidu saw its brand value jump 40% while the stock is down 20% ytd. Market share is one of the metrics that can explain both results. Near monopolies are valuable things, something my Seattle neighbor Bill Gates and former Hungarian refugee Andy Grove would both agree with.

If brands need to be “more relevant” to the consumer, how “relevant” is this survey to real hard measurable stock market performance?

Take a look at this chart:

Millward Brown claim their China Top 50 Portfolio has outperformed MSCI China significantly – especially the Top 10 basket. The China Top 10 Portfolio is up 29%, the China Top 50 Portfolio is up 5.8%, while MSCI China has fallen 5.6% over the time period chosen. They date this rather confusingly from July 10th last year until September 12th this year, which may explain some of the disparity in the chart they are trying to highlight. However, if one played around with the dates and stripped out Tencent, how would the performance of these baskets of stocks compare to the benchmark? Would using the top-ranked brands in China, according to Millward Brown, as a starting point for a real portfolio show “thought leadership”? I think this deserves further investigation.


Aside from the annual, “How much do I owe the taxman?” another timeless and vexing question is: how best to predict stock returns? Everyone has particular metrics that they pay attention to, such as PE ratios, dividend yield, forecast earnings growth, GDP growth and how many Pisces are on the board, just to name a few, but does this have any grounding in reality; do any of them have predictive value at all?

In “Forecasting stock returns: What signals matter, and what do they say now?” Vanguard Research has published (here) an interesting paper that looks at the historical relevance of a dozen popular predictive metrics and how they have fared since Winnie the Pooh was first published (1926).
Among the list of potential predictors, the metrics tested were:

- P/E 1, (trailing 1-year earnings)
- P/E 10, (10-year earnings, or Shiller’s CAPE)
- Trailing 1-year dividend yield
- Trend of US GDP growth
- Fed Model, or the spread between earnings yield and bond yields

And just for the heck of it, they tested “Trailing 10-year average US rainfall.” (Really). Below is the proportion of variance of future real stock returns explained by various metrics, 1926-2011:

The bars in the above chart represent the R-squared of the predictability of regressions. The PE metrics were easily the strongest of the indicators tested, yet even the 10-year cyclically adjusted trailing PE only “explained” 43% of returns. That leaves almost 60% of those returns, like the popularity of Justin Bieber, “unexplained.”

Some popular metrics, such as trend earnings growth, 10-year Treasury yield, and even corporate profit margins showed LESS stock return predictability than using average rainfall levels….

Obviously, using such metrics in regression analysis to predict future performance for emerging markets is close to impossible due in part to the much shorter time series (history) available. What such research as this shows is predictive ability improves over longer periods of time. As Vanguard concludes: stock returns “should not be forecast over short horizons.”

Vanguard themselves, using their proprietary model (which we would hope incorporates some of this study) estimate there is a greater than 50% likelihood that we will enjoy “at least a 5% annualized real return” for the US stock market over the next 10 years. This is close to the historical average return of 6.8% observed since 1926. What are the probabilities of “another lost decade” of negative average real US stock returns where things absolutely suck and we all lose our jobs? 20%. And their final unique conclusion? “The future is difficult to predict.”

Because we cannot know the future with any degree of reliable accuracy (and some would say the past as well), it is necessary to have discipline when investing. Speaking from painful experience, every time I ignore this I lose money. Closing out some positions at year-end makes me realize what an ass I have been. While feeling sorry for myself and looking for someone else to blame I came across this gem:

Bunting’s 12 Laws of Investing

Dan Bunting was a money manager in London for 40 years and recently passed away. Below are his thoughts from four decades of investing experience.

1) Sell stocks of companies that announce huge acquisitions, that over diversify, or that spend a fortune on lavish new headquarters.
2) Avoid stocks where management picks fights with analysts or hedge funds.
3) Watch out when executives start selling a lot of stock.
4) “Run a mile” from all stocks in an industry going through a huge investment boom. This always leads to massive over capacity and a collapse.
5) Steer clear of investing in manufacturing companies. Those industries are plagued with extreme cycles of boom and bust.
6) Pay little attention to economists or market “gurus.” (But keep reading EMI just in case…).
7) Mistrust all mathematical trading formulas as well. They fail just when you most need them to work.
8) Look for companies where the insiders are buying lots of stock.

9) Look for companies generating a lot of cash, as that is almost always the start of sustained outperformance.
10) Look for companies which have monopolies, or near monopolies, and those which manage to take out their main competitors.
11) “Class shows.” Pay attention to the quality of management – you are buying a business, not a stock.
12) Look for companies in the consumer sectors. The closer you are to the consumer, the more money you will make. The ultimate guarantee of profit is to possess the trust of the consumer.

And finally, a quote from Mr. Bunting worth remembering, “You always make the biggest profits on the worst stocks.” Well, that one didn’t work for me!

“Very superstitious, writings on the wall,
Very superstitious, ladders bout’ to fall,
Thirteen month old baby, broke the lookin’ glass
Seven years of bad luck, the good things in your past
When you believe in things that you don’t understand,
Then you suffer, Superstition ain’t the way” – Steve Wonder

If the future is “difficult to predict,” how confident are you the world is ending next week on Friday, December 21st? According to mindless misinformed mainstream media, that is what the Maya have been predicting. These claims raise a few questions, most importantly: how good were the Maya at predicting things and should one just blow all their money on “boats and hoes” right now?
New Age followers and other chronically unemployable people around the world have taken to the internet by storm to promulgate the crazy idea that the Mayan calendar has long predicted the world would end next week – what? According to the public outreach website of the US space agency NASA, “Ask an Astrobiologist” (here), the administration has received over 5,000 questions from the public on this subject since 2007. Aside from seeking answers from a respected authority about the validity of the “End of Days,” some people’s questions even go as far as asking whether they should kill themselves (yes, please), their children (arrest them now) or their pets (fine by me).

An aside: NASA does other things than advise idiots on whether to top themselves. Late last year NASA launched the polar orbiting environmental satellite, Suomi-NPP. Using new technology, called the visible infrared imaging radiometer suite (VIIRS), after 312 orbits and 2.5 terabytes of imagery Suomi-NPP mapped the entire globe – at night. The result is a very cool video just released a couple of days ago (here) capturing what the earth really looks like at lower altitude as it rotates silently during the night. Note the literal black and white difference between North and South Korea too.

A World Gone Mad

Earlier this year, an Ipsos poll of 16,000 adults in 21 countries concerning this “cryin’Mayan” prophecy found that 8% of respondents were worried about the world ending next week with the nervous Nellies numbering as high as 20% of those polled in China, 13% in Russia, Turkey, Japan and Korea. In the US, 12% of people are concerned about the hoax and sales of private underground blast shelters, guns and canned food apparently are doing well. Some swept up in the global panic are melting their credit cards on shopping sprees figuring, I guess, that with the end of the world coming they won’t have to pay it back….! Could this explain recent strong consumption numbers in the US? More intriguingly, does it explain the weakness in the China equity market?

Below is an email I received from a friend in China who goes by the nom de guerre, “Broken Arrow:”

A novel explanation for China stock weakness:

I know a girl in Dongguan who is in the service industry (to put a positive spin on her vocation). She told me that although she usually just goes to her home town for Chinese New Year, she had just bought a ticket to go home on the 18th of this month (December). I asked her why and she said that her family was all preparing for the end of the world on December 21st (or 22nd, can’t remember). Furthermore, her family had been stocking up on candles and food supplies because (if the world didn’t come to an end, i assume) there would be at least three days of complete darkness with the sun blocked out and no water or electricity. Also, it wasn’t just her family, but the whole town or district in which she lives. The girl is from Qiqihaer in Heilongjiang, which seems like a pretty remote location to be worrying about the Mayan calendar. Although she was drop dead serious, so i just wonder how many of the 1.3 billion are thinking the same thing. But it certainly makes sense that people would be cashing out on stocks if the world is coming to an end in less than three weeks. I mean candles cost money!

In case she is right, it was nice knowing you, head for your boat if the sun doesn’t come out one morning soon!

It isn’t just China, either. Russia, a country that maintains only a nodding acquaintance with modernity, seems to be going bonkers. According to the New York Times, towns across the land are seeing hoarding and panic buying of emergency supplies. “There are no candles in all of Omutninsk,” we are told with great seriousness. Lawmakers in Moscow have even sent letters to the three main television stations telling them to stop commentary on the matter. Top officials from the Russian Orthodox Church have also been holding press conferences with the message from on high: “Everyone! Calm the flock down!….”

Australian PM Julia Gillard has even made a spoof video (here) that begins,

“My dear remaining fellow Australians. The end of the world is coming. It wasn’t Y2K, it wasn’t even the carbon price. It turns out that the Mayan calendar is true….”

After translating the feral accent into English, I realized she also blames K-Pop as a contributor to our demise. Go Korea!

The Daily Mail UK dourly referred to the video as, “Another unfunny Australian prank.”

Where Are Those Mayans Now?

We tend to think of the Mayans as an ancient civilization, wise and in tune with the cosmos. They built amazing cities with limestone pyramids arising out of the flat steamy jungle and then one day, they just disappeared. Having travelled extensively in areas the Mayans dominated; Chiapas, Guatemala, Belize and Honduras, I can tell you the Mayans never left. They are still there today, living in poverty, occupying the bottom rung of the socio- economic ladder and trying to literally scratch out a subsistence living on their tiny maize plots scattered throughout the countryside.

The Real Mayan Calendar

The date, December 21, 2012 corresponds to a change in cycle in the Mayan Long Calendar. This calendar isn’t their own but was adopted and expanded upon by the early Maya sometime after 500 BC. The Mayan calendar divided time up into as many as 20 different segments. What concerns us is the “baktun” or roughly 394-year cycle. The end of the 13th baktun cycle happens to be 12/21/12, yes, but for the Maya this would have been a significant date and one of riotous celebration, sort of a super duper New Year’s Eve party.

The Mayans loved big numbers and in fact, 20 baktuns make a “piktun;” a unit of time greater than 7,000 years which they apparently found useful. The most recent archaeological find in Xultun, Guatemala has just unearthed the latest Mayan calendar – which has cycles continuing another 7,000 years into the future. The Mayans never believed “the world would end;” we are just clocking the time odometer over to begin another cycle and we have a lot of baktuns and at least a piktun more to go.

The Mayan Long Calendar started counting time from August 11, 3114 BC and carbon dating implies early Mayan settlements were founded around 2,600 BC. This long Mayan history was not without drama. The Maya civilization collapsed twice. The first time was around 100 AD and marked the end of the “Preclassic Period.” The second time was around 900 AD and marked the end of the “Classic Period.” Classically, they didn’t predict either. The Spanish arrived in the 16th century, or 600 years after the latest collapse and began a 170-year long period of conquest of all Mayan territory. Well, they didn’t see that one coming either.

We are now coming to the end of baktun-13. Nowhere in Mayan hieroglyphics, all of which have been deciphered, do the Mayans predict anything like the end of the world. As history amply demonstrates, forecasting the future really wasn’t their thing.

What Will Happen on December 21st?

Aside from the winter solstice in the northern hemisphere, which falls on the same day, real astronomists cannot point to any special alignment, planetary or galactic that is unique that day in any way. I can say with some measure of confidence on that date I will be in New York having dinner with a friend where I will raise a glass and wish you all a prosperous baktun-14, and a Happy 2013!

Emerging Markets Illustrated will be back after the holidays.

The Last Page

Pope John Paul III visited Denver for International Youth Week some years ago. But when it came

time to go, he told his chauffeur that he wanted to drive the Pope-Mobile back to the airport. What could

the chauffeur say but yes? It turns out the Pope has a lead foot and got pulled over for speeding.

The cop, realizing he had just stopped the Pope, didn’t know what to do. So he called in to his

commanding officer.

Cop: “We got a big one here.”
Sergeant: “Who, the mayor?”
Cop: “Nope, bigger.”
Sergeant: “The Governor?”
Cop: “Nope.”
Sergeant: “The President?”
Cop: “Nope, even bigger!”
Sergeant, exasperated: “Well, who then?”
Cop: “I don’t know, but he’s got the Pope driving for him!”

Derek Hillen, CAIA
Mirae Asset Securities

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