Greek Tragedy?

Greek Tragedy?

Now what?

Photo: Ryan Maguire. Source: Gratisography

Yesterday Greek voters gave the Tsipras government a decisive victory when they rejected the terms of the latest bailout deal offered by creditors in June. Technically, the vote didn’t decide anything, since offer wasn’t really on the table anymore. But politically, it amounts to a vote of confidence in Tsipras’ hard line.

It seems likely that Greece will default on €7 billion in T-bill and loan payments coming due in July. They’ve already delayed payment on a €1.5 billion loan from the IMF, although the IMF says Greece is in “arrears”—not default. At this point most observers think the fallout from a Greek default will be limited, as most of its debt is held by the European Central Bank and other government—versus private—institutions.

But as we learned from Lehman’s bankruptcy in 2008, a default can have significant unexpected consequences. No one thought that Lehman’s default would cause a large money market fund to break the buck leading to a modern institutional bank run. At a minimum, a Greek default will upset markets, create uncertainty, and slow economic activity. But it’s now possible that Greece will leave the Euro altogether and go back to the Drachma. The Tsipras government says this is not their goal, but none of the other 18 Euro-zone nations are defaulting on their debt. An exit from the Euro by Greece (“Grexit”) would be painful, disruptive, and nasty.

European creditors could blink, and ease the terms they’re offering. But that’s doubtful. Public comments from officials since the referendum point to a hardening—not softening–of positions. Angela Merkel, the German Chancellor, seems unlikely to expend political capital on behalf of Greece. Despite the costs, a Grexit (and bank nationalization) seems the most likely outcome.

Amidst the chaos, two things are certain: 1). Any transition will involve a lot of economic pain for Greece; and 2). There will be lots of volatility.

Douglas Tengdin, CFA

Charter Trust Company

Yankee Doodle Investor

Are our markets fair?

“Spirit of ‘76” by A.M. Willard. Source: Wikipedia

There has been a good amount of discussion about the structure of the stock market. Some have looked at how stock market trades are executed and concluded that our markets are rigged—that powerful insiders use special access to inside information to game the system and profit at the expense of average investors.

It’s true that the stock exchanges are a lot different now than they were 20 years ago, largely in reaction to new technology and new SEC regulations. And some market-makers do try to “scalp” a penny or two off of big trades—buying 1,000 shares of IBM at 165, selling them at 165.01. Do this enough times and you can make some real money.

But there’s good evidence that investing in the market has gotten cheaper. It stands to reason that when market makers compete, consumers benefit. Investment giant Vanguard studied their transaction costs and found that they have declined 60 percent over the past 15 years.

For all their flaws, US markets remain the most open, transparent, and efficient in the world. Our commitment to free markets and free information sets a high standard. The more we can do to get more market information to more people, the better everyone will be. July 4th is about freedom and fairness. Our markets should try to be both.

Douglas Tengdin, CFA

Charter Trust Company

Greece on the Caribbean?

Are the lights going out in Puerto Rico?

Photo: Joao Pacheco. Source: Picjumbo

Today the Puerto Rico Electric Power Authority (PREPA) is scheduled to pay $400 million in principal and interest to bondholders. It’s unlikely that they have cash to do this. They drew down their reserve account a year ago, and haven’t built it back up. In fact, the bond’s trustee issued a notice a couple weeks ago, warning that they don’t have the funds to make the payment.

The default is likely to send shock-waves through the municipal bond market. Now, defaults are routine in financial markets. It’s why creditors get paid interest on loans—there’s always a chance you won’t get your principal back. And we have courts to sort out the claims when things go wrong. Municipal defaults are less common that corporate filings, but there’s still a settled bankruptcy regime. In 2013 Detroit filed Chapter 9, adjusted its debts, and moved on.

But Puerto Rico is a special case. It’s not a State, it’s a Territory. Its own Constitution guarantees the priority of their General Obligation debt, but you can’t pay back money you don’t have. And most of Puerto Rico’s $72 billion in debt was issued by special territorial corporations, not the Territory itself. So, as you might say on Facebook, it’s complicated.

At this point many analysts start going into mind-numbing detail about special purpose clauses and payment waterfalls that make me need to get up and move around. But the bottom line is this: Puerto Rico’s total debt is greater than 70% of its declining economy. The median US State debt to GDP ratio is less than 16%. And that doesn’t even consider PR’s pensions, which are less than 20% funded.

Puerto Rico Real GDP. Source: World Bank, Bloomberg

Up to now, the Territory has tried to borrow its way to prosperity, filling budget gaps with more obligations. But that doesn’t address the underlying issue. Their economy has been contracting every year since 2006, a date that coincidentally corresponds with the expiration of a clause the US tax code that favored US corporations with subsidiaries there. The IRS closed the loophole, PR’s economy declined over 15%, and Governor Padilla has said, “No mas.”

What’s next? There’s never only one cockroach. PREPA’s default will be followed by problems among all the other special corporations. Even its general obligation debt may face challenges. The island is trying to work out a deal with the major bondholders, but negotiations are likely to be tough.

Get ready for a long, hot summer. If you want to know who’s next, just watch where the vultures are gathering.

Douglas Tengdin, CFA

Charter Trust Company

Ode on a Grecian Turn

“What men or gods are these? What maidens loth? What mad pursuit? What struggle to escape? What wild ecstasy?”

The Townly Vase. Source: British Museum

That’s what John Keats wrote almost 200 years ago while contemplating the bas-relief on a Greek vase. But the words could almost be applied to the political and financial situation in modern Greece.

Not much has changed since the last time we discussed Greece, except that the deadline for Greece to make its debt payments has gotten closer. Last weekend Prime Minister Tsipras called for a referendum on July 5th regarding the latest European bailout proposal. He also instituted capital controls and declared a bank holiday to avert a collapse in the Greek financial system.

Global markets have sold off almost 5% since negotiations hit an impasse last week. For Greece, the consequences are significant. Should they leave the Euro—and start printing and using Drachmas—they could lose access to imports. During Argentina’s financial crisis in 2001 and 2002 that economy collapsed. There were riots; people couldn’t get medications; diabetics died because insulin wasn’t available. Some foresee a similar humanitarian crisis if Greece leaves the Euro.

All-Cap World Index, 2014-15. Source: Bloomberg

But like Argentina 15 years ago, it’s hard to see significant contagion outside of Greece if they go back to the Drachma. Greek debt is mostly held by the ECB and IMF, and they aren’t about to become insolvent. A Greek default may be no more significant than the $40 billion bankruptcy of the electric utility Energy Futures last year. The lights didn’t go out in Texas back then.

Up to now, polls have shown that most Greeks want to stay in the Euro. They prefer having a stable currency and banking system to the chaos and manipulation of their pre-Euro economy. But they also want an end to the current austerity regime. That’s why they elected Tsipras and the Syriza party.

But uncertainty has increased, and along with it, volatility. Keats closed his famous poem with the lines, “Beauty is truth, truth beauty. That is all ye know on earth, and all ye need know.” Next week’s referendum may offer us truth. But as for beauty? We’ll have to see.

Douglas Tengdin, CFA

Charter Trust Company

High on Hope

Is the market full of hot air?

Photo: Davide. Source: Pixabay

Some portions may be. Some shares are so puffed up it doesn’t look like the companies can ever justify their valuations. As an example, take LinkedIn. The professional networking darling went public in 2011 and didn’t look back. The stock’s been on a tear, rising almost 5 times—a 45% annualized return.

But what’s next? The firm is priced at over 100 times this year’s expected earnings, and over 60 times next year’s. Even if they earned a placement fee on every hire in the country, they’d still be overvalued. The last time insiders bought shares—except for exercising options—was in 2011, when the stock was below 100. Lately, all they’ve done is sell.

Source: Bloomberg

Some have called these companies—LinkedIn, Netflix, Salesforce.com—“hopium” stocks. They trade based on the hopes and dreams of their retail investors, and give them a “rush” every time they go up. They generate lots of noise. And investors get the shakes every time their shares swoon. They should be part of an Exchange Traded Fund, with the ticker H-O-P-E.

Valuation matters. When shares are overpriced, the path of least resistance is down. The market may be fairly valued, but that doesn’t mean every value is fair. If you buy something without regard to value—just hoping to sell it later at a higher price—that’s the “Greater Fool Theory.” And if there’s no one left to buy it from you, you’re the greater fool.

Douglas Tengdin, CFA

Charter Trust Company

It Takes A Team …

What can we learn from this year’s NBA finals?

LeBron James. Source: Wikipedia

LeBron James is awesome. The 6’8” forward dominated the NBA finals this year, scoring an average of 36 points per game. By some measures, he had the best performance of any player in any finals ever—leading both squads in points, rebounds, and assists. But his team, the Cleveland Cavaliers, still came up short. They lost the series 4-2, giving the title to Oakland’s Golden State Warriors, the first team in 25 years to win an NBA championship without any Finals experience from any of the players on their roster.

How can someone so skilled fail to bring home the title trophy? The answer is teamwork. “King James” had a great series, but his team had only 16 assists per game—significantly less than Golden State’s average of 23. James put the ball up 33 times per game. There’s four other players on the court—one player can’t do it all.

It’s like that in any significant endeavor. We can do more together than we can individually. We’re social creatures. Whether it’s sports or investing or school or family, none of us is as good as all of us.

There’s no doubt that James is one of the best basketball players ever. This was his fifth consecutive NBA Finals appearance—something that hasn’t happened since the ‘60s. But success is a lousy teacher. It makes you think you can’t lose. Life is a team sport. As Magic Johnson, another great basketball player once said, “Ask not what your teammates can do for you, ask what you can do for your teammates.”

Douglas Tengdin, CFA

Charter Trust Company

Investments, Finance, and Robo-Advisers

What’s the best investment plan?

Photo: Andreas Praefcke. Source: Wikipedia

Lots of people ask for investment advice. They need help managing their money. They talk about the stock market or bank rates. But what they really need is financial guidance.

Classically, finance has three major reports: income, assets, and cash flow. Each of these areas has inflows and outflows—positive and negative entries. An income statement covers income and expenses; a balance sheet shows assets and liabilities; with cash flow there are inflows and outflows. Investment advice just addresses the asset side of the balance sheet—a small part of our total financial profile.

For most of us, our planning needs are pretty simple. When we’re young, we need to manage our income and expenses to save as much as we can and invest that. Ten to fifteen years from retirement, we need to get serious about asset allocation. But for most of our lives, our human capital is worth a lot more than our financial capital.

But simple isn’t easy. It’s one thing to talk about saving—it’s another thing to do it. Saving requires us to invest in ourselves when you’re young and avoid frivolous purchases and expensive credit card debt. Sticking to a budget is critical. As we grow older, it’s more important to manage risk—time is no longer on our side. The last ten years of saving are the most important, because that’s when the magic of compound interest kicks in. For example, if we are able to save $6000 per year starting at age 30 and earn 7% per year, our assets will double from $1 to $2 million in the last 10 years. But the world doesn’t travel in smooth curves. By the end of our accumulation period, we can’t afford to ride through a significant downturn.

Source: Douglas Tengdin

That’s why robo-advising may work for young people, but it’s not so good for people approaching retirement. Because it’s not just about what we make. It’s also about what we can keep.

Douglas Tengdin, CFA

Charter Trust Company

Clearing the Air?

What’s holding back China’s economy?

Photo: John D. Liu. Source: World Bank

One possibility is pollution. China’s economy has grown dramatically over the past two decades, as market-based incentives and expanding global trade have encouraged them to produce more and capitalize on their natural advantages. Over the past two decades, the size of their economy has grown ten-fold, from $1 trillion to almost $10 trillion dollars.

But such growth comes at a cost. While China’s economic miracle has lifted hundreds of millions out of abject poverty, it imposes costs on the environment. After all, you need a lot of power to fuel this growth. Energy production has almost doubled during this time.

Source: World Bank

Lately, Chinese growth has slowed, downshifting from over 10% per year a decade ago to only 7% now. That’s still a lot, but the transition has many people wondering why this is happening.

Pollution is a real problem. Air pollution can be particularly dramatic. Smog and soot slows food production and creates health issues. In Beijing, smog has been reported at 20 times the safe levels. This has grounded flights, closed highways, and kept workers home. Water pollution also makes people sick and contributes to a water shortage. Pollution may be costing the Chinese economy as much as 5% of its economy, or $500 billion per year.

This is reminiscent of the pollution problems western countries had as they industrialized. London’s “pea-soup” smog was immortalized in the verse of T.S. Eliot—“the yellow fog that rubs its back upon the window panes.” All countries have to address environmental issues as they grow.

Ultimately, China will have to manage its environment along with its economy. Otherwise, its future will be shrouded.

Douglas Tengdin, CFA

Charter Trust Company

Our Culture, Our Selves

Does corporate culture matter?

Bust of Socrates by Lysippos at the Louvre. Source: Wikipedia

The short answer is yes. A culture centered on client service and financial accountability will produce higher financial returns; by contrast, a culture with outsized rewards for managers who treat the firm like a personal piggy bank will generate lower returns. But how do we measure corporate culture? One way is by reading the company’s annual report, especially the CEO’s letter to shareholders. This document is an unstructured, free-flowing description of what the chief thinks is important. There’s no SEC-mandated boilerplate or caveats. By examining what is said—and not said—we get a chance to look inside his or her head.

Continue reading Our Culture, Our Selves

Nuclear Humility

Can we learn humility from physics?

Castle Bravo Blast. Source: Wikipedia

70 years ago Harry Truman asked the leaders of the Manhattan Project to recommend how atomic power should be used. World War II was wrapping up. Germany had fallen. Japan was on its knees but still defiant. Millions of servicemen were preparing to be redeployed from Europe to the Pacific.

Continue reading Nuclear Humility

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