Altus Insight - January, 2015

The Altus Insight
Market news, commentary and relevant topics for today’s alternative asset investor

Date: January 31, 2015
FR: Forrest Jinks
RE: Weeks when decades happen.

Before jumping into this month’s article I need to follow up on the December article (click here to read). The article had the most comments from readers of any article emailed out in a long time. Thank you to everyone who took the time to email or call. Additional information came to light regarding Warren Capital as was discussed in the article. As a point of clarification, it was Warren Equipment Leasing, not Warren Capital, which appears to be the source of the fraud. It also appears that none of the Warren Capital employees, including the executive team, was involved with Warren Equipment Leasing and the entirety of the equipment leasing/financing business was run only by the now deceased owner of both Warren Capital and Warren Equipment Leasing. It may seem like a small distinction for those of us looking at the situation from the outside but for the employees of Warren Capital who have seen their worlds turned upside down it is an important one.

 

Vladimir Lenin is well known for his efforts in overthrowing the czars in Russia, but he also is the source of many quotes that are still common today. One of them comes to mind when looking back over the past month, “There are decades where nothing happens; and there are weeks where decades happen.” I was not alive during some of the more…shall we save active...periods of US history but it still feels a little hyperbolic to put the few short weeks of January 2015 into the same classification that Lenin was probably referring to. And yet, January was quite the month;

  • Attack on Charlie Hebdo office in Paris kills 12 and results in a countrywide manhunt that leads to more deaths. This in turn becomes a massive march against terrorism in Paris bringing together world leaders from throughout the Western World (though none from the US). Meanwhile, similar marches and demonstrations are held in Muslim based countries against the newspaper.
  • Terrorist/Rebels Boko Haram sieged and gained control of Baga, Nigeria, the last major town to have resisted their advances. News reports claim the city has been burned to the ground and thousands of citizens massacred.
  • Tensions and attacks flare between Israel and Hezbollah (again) but contrary to many previous flare ups, and possibly a sign of progress between the parties, the situation is quickly resolved.
  • In Greece, SYRIZA, the Coalition of the Radical Left, obtains enough votes to become the country’s ruling party. While not overtly “euroskeptic” the party’s leader Alexis Tsipras has stated on many occasions that Greece is unlikely to fulfill its obligations to the bond market and the ECB. With a sizable amount of debt expiring in March look for the posturing between Greece and the rest of the Eurozone to begin in earnest later in February.
  • Rebels take over the Yemen capital of Sana’a. This leads to the resignation of the President. Watch this area for the possibility of an increased Al Qaeda presence as a result of the current power vacuum.
  • The king of Saudi Arabia, a longtime ally of the US, died. His half brother assumed the throne and promptly beheaded three people.
  • ISIS captured the beheading of two Japanese citizens on video, the first time non-westerners have been so brutalized.
  • For the first time in many decades Cuba and the US undertake formal diplomatic relations.
  • The ceasefire in Ukraine is shattered as fighting intensifies to its highest level in months, including dozens of civilian casualties.       
  • Only weeks after assuring investors that it planned to continue to peg its currency, the Franc, to the Euro, the National Swiss Bank removes the currency peg and the Franc appreciates 30% against the Euro in a single day.
  • The European Central Bank announced for the first time that it will launch a massive quantitative easing program due to ongoing weakness and the threat of deflation. Of course the stock market loves the news and goes up, despite all the accompanying bad economic news.
  • After several years of trending downward, and well into the current economic recovery, for the first time in the history of our country, more businesses died in 2014 than were started. While not news that the stock market would take the time to consider or news that would be prominent enough for most Americans to even read, this is an issue that has serious long term consequence for the US. More on this can be found below.
  • Oil prices continue their dive, with an almost daily loss of price only occasionally interrupted by a recovery bounced. This is also discussed in depth below.
  • Argentine Federal Prosecutor Alberto Nisman is found dead in his apartment the same day he was set to testify against the members of the current ruling government for their involvement in covering up Iran’s involvement in a terrorist attack on a Jewish community in 1994. The country, once a model of democracy and the seventh richest economy in the world continues its downward spiral.
  • Oil/gas services company Baker Hughes announces the layoffs of 7,000 people due to the collapse in oil prices. Several other companies, of varying sizes, follow suit.
  • Target announced plans to lay off 17,000 workers in Canada.
  • The Federal Reserve provides upbeat commentary on their opinion of the US economy despite economic difficulties in most other major economies and the increase in the value of the US dollar. Forward guidance on the plans to raise interest rates remains unchanged from the previous meeting. More on this below.

January was clearly a busy month. Was it an outlier or a harbinger of things to come?

Federal Reserve, European QE, and Interest Rates: By economic identity (as opposed to a theory), an increase in the supply of something will result in a decrease in the market price of that something unless there is a corresponding increase in demand. This is on full display as the Euro continues to plummet in value compared to other currencies, especially after the announcement of the QE (an increase in supply). Additionally, in a vacuum, a decrease in the value of the currency leads to an increase in interest rates while an increase in the value of a currency leads to a decrease in interest rates. As mentioned above, the Swiss Franc appreciated an almost unbelievable 30% against the Euro, IN A SINGLE DAY. Switzerland is also fiscally disciplined and keeps its governmental debt to a minimum. With those things in mind, and understanding the economic volatility around the world, a person can understand how the rate for 10 year Swiss bonds can be negative.  Yes, you read that correctly, investors have to pay to give Switzerland the use of their money for 10 years.

But how do we reconcile that economic basket case France had lower interest rates than the US while several other EU countries, including Italy and recently defaulted Ireland, have comparable interest rates to the US? For the past couple meetings the Federal Reserve has indicated it will start raising interest rates sometime this summer. However, it doesn’t seem that the market is listening since borrowing costs, even on the long end of the yield curve, have dropped since the initial announcement of the plan to raise rates. The dollar is strengthening and the US economy appears to be much stronger than large economies around the world. Taken in conjunction with the existing extremely low yields on government debt in the Eurozone as discussed above, that more and more money will flow into purchases of T-bills. Going back to the same economic identity of supply and demand, if demand increases while supply stays the same the price of the subject good will increase. Since the yields (interest rates) on debt/bonds moves inversely to the price, an increase in demand for T-bills should result in a decrease in interest rates. How certain am I of this? This day and age my crystal ball looks pretty opaque, but as we take investment positions we (being Altus) are open to accepting short term interest rate risk while we reposition properties for resale and/or refinance. Long term I still believe interest rates will rise and as such still strive to put long term debt on stabilized assets. Or maybe I just hope interest rates will rise. If they don’t it means we are in a similar situation as to what Japan has experienced over the past several years, which is an economic situation that we certainly don’t want to have to deal with.

Small Business Creation Withering: As mentioned above, 2014 was the year that the trend lines finally crossed and more business died than were born. That this would occur while the US population continues to increase brings more gravity to the situation. Most new businesses are small businesses and studies show that small business startups (within the first 5 years of initiation) provide over 50% of all new jobs within the economy. New businesses are also a source of innovation and market disruption. The slowing in the rate of small business startups has a direct correlation to a reduction in job creation and innovation. Why is this occurring? Demographics is certainly part of it. As people age they are generally less apt to take risks, but demographics isn’t enough to be the only factor. The ever increasing web of (over) regulation continues to frustrate and discourage would be entrepreneurs while increasing loads of student debt provides a certain level of indentured servitude that makes it harder for younger, would be entrepreneurs to walk away from consistent paychecks. There are surely plenty of other reasons and certainly no one clear solution, but in a global economy where the US’s only true competitive advantage is its entrepreneurship and innovation, the loss of that advantage bears watching. Especially for investors as we make decisions on where to place our limited investment capital.  

Oil Prices Continue to Struggle: Oil prices have been discussed in multiple Altus Insights, as well they should be. Oil used to be far and away the US’s largest import, has been of great geopolitical relevance, and since the recovery has been far and away the largest driver of job growth in the economy. That jobs are lost due to the drop in the price of oil is not a surprise, that it is happening so quickly and to such a large extent is more of surprise. Granted, some companies may be using the drop in prices as an excuse to trim “the fat” that has accumulated during the rapid growth of the past several years but ancillary data tells a similar story. Ninety four drill rigs were taken off line in the past week alone. In a single week. This follows forty three rigs being taken off line last week. Together that is just under a 10% reduction in the amount of active rigs in the last two weeks alone. There is no escaping that this sort of drop in business activity will have a real and negative impact on employment. However, there is also no denying that the reduction in the price of gasoline should result in better consumer confidence numbers and increased consumer spending on non-fuel items. The Federal Reserve knows this and I believe this is why their recent notes release is so upbeat. Consumer confidence is an extremely powerful economic force and if the Fed can help stoke that fire consumer confidence alone may help keep the economic recovery going. It worked for George Bush in the early 2000s when he gave everyone a check from the US government, and with luck, it may work now.

There is no denying that certain parts of the country will be more adversely affected by the decrease in oil prices than other parts. We have discussed our avoidance of certain markets in Texas in past Altus Insights. However, we have remained bullish on some other markets that still have a fair amount of oil influence. We are now watching those markets very carefully to make sure any negative impact on oil jobs can be offset by growth in other parts of the local economy. We are also starting to look for markets that may be disproportionately negatively impacted by the fall in oil prices as those markets may produce some outstanding opportunities as oil prices stabilize.             

 

Happy investing.

 

Forrest Jinks

Altus Equity Group, LP

off: 707/932-5887

fax: 707/544-2972

www.altusequity.com