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Selling the U.S. by the Dollar
The most obvious investments seen in the United States from foreign sources are the sovereign wealth funds, which have been injecting capital into Citibank, Morgan Stanley, and Merrill Lynch since the subprime rot hit home. Setting these aside for a moment, I want to investigate how much other foreign investment there has been in the U.S. in the last year. The Treasury and equity investment, as shown in the Treasury International Capital (TIC) flow data issued on a monthly basis, allows one to see foreign investment. Another area is foreign investment in U.S. real estate; in addition, the acquisition of U.S. companies by foreign-based companies and lastly foreign companies setting up manufacturing units in the U.S. Our unit labor costs are looking very attractive to the more union-controlled countries in Europe and the UK and with transportation costs going through the roof due to high oil costs, building it where you sell it makes a lot of sense.
Back to the TIC data, which had its highest reading last May with $135.752 billion coming into the U.S., in August the number fell to its lowest reading of -$70.484 billion. The volatility in this data is not normal and compels us to use the average, over time, to see if there is any trend in the amount of international investment as measured by the data. Taking the average over the last year (including the June and August data), the monthly average was $58.06 billion. The previous year's average was $77.81 billion. Foreign investment fell almost $20 billion per month. This is very important data as the macroeconomic argument has long been that the Net Long Term TIC flows are the offset to the Trade Deficit. If the investment flows don't cover the Trade Deficit, we are in a cash flow negative situation. This is one of the reasons why the dollar has lost value over this time period. We have more money going out than we have coming in.
Looking at the same time periods for the Trade data over the last year, the monthly average was $59.113 billion; the previous year was a higher $62.560 billion. The conclusion is that we ran about a $1 billion per month cash flow negative balance over the last year and the dollar declined. The previous year we ran a $7+ billion per month surplus and the dollar fell (but only 9.8 percent) compared to 12.6 percent last year, as measured by the dollar index basket of currencies.
The average price of oil from 2006 to 2007 was $65.60 per barrel, while from 2007 to 2008 it averaged $76.81 per barrel. It's easy to point the finger at oil as the culprit. However, during the higher deficit period oil prices were lower and in the last year oil prices were higher, tending to disprove oil as the culprit. The reason: exports have been growing and imports besides oil (in dollar terms) have been decreasing. During this time study, there seems to be a correlation that foreign investment declines in tandem with a decline in the U.S. buying of foreign goods.
Vacation home investments from overseas have increased as the dollar has weakened. In a survey by the National Realtors Association, 13 percent of foreign buyers were from Mexico, 12 percent from the UK, and 11 percent from Canada. Of these buyers, 22 percent were looking at these purchases as investments and 47 percent primarily considered them vacation properties. Obviously, some were a mixture of both. It will be interesting to see if the next data (due out in July) shows a pick up as the dollar is so much weaker.
When do we get to the point that the attractive prices of U.S. assets actually put a lid on the dollar's devaluation? Well, let's look at the amount of demand offsetting the imbalance in the Trade versus the TIC data piece of the puzzle. The amount involved in real estate is not enough to have that impact, but the continued establishment of manufacturing in the U.S. by foreign entities (motor vehicles being the most obvious) continues and becomes more attractive due to the dollar's weakness. Labor costs are less, as well as the amount of capital needed in foreign currency terms to set up a new Toyota Truck plant in San Antonio, for example. Foreign companies are continuing to acquire U.S. companies. The question is when we will reach the point of equilibrium as far as the dollar is concerned between an investment turnaround that stops the dollar's devaluation: a recovery in the economy and a decline in the international cash flow imbalance. The recovery is first. A shift back to a more positive position is next as the real estate bottoms and the dollar strengthens, hopefully followed by the longer term possibility of the U.S. being able to buy back some of the assets sold during the slow down. If this is not achieved, then, ultimately, we may end up as wage earners working for foreign asset managers.
Hopefully, the cash flow direction will change before we get to that position as the next economic cycle comes to our rescue! The current declining dollar trend started in June 2001, so we are six years and nine months into the cycle. The last run-up in the value of the dollar lasted eight years and 10 months, so we should be getting near the end of the down cycle. But it appears we may still have some time to go before the dollar bottoms out.
— Laurence Hayward, Senior Advisor, Silicon Valley Bank's Global Financial Services
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Cautious Optimism in Job Data
U.S. technology companies increased hiring for the third consecutive year in 2007, although the pace of job growth slowed, reported the AeA trade association. About 5.86 million people worked in the nation's tech sector last year, a gain of 91,400 from the prior year. Despite the positive statistics, the industry group warned that the U.S. risks "an impending slide" in global competitiveness unless the government addresses specific problems, including investment in research, improving the education system, and reforming immigration policies to allow talented workers to enter the United States. Nationally, technology workers earned an average of $79,500 in 2006, while in California's the average tech wage was $101,200. (San Francisco Chronicle)
Happy Coexistence
In the discussion about how WiMax and Long-Term Evolution will coexist, the major infrastructure suppliers believe LTE will be the dominant wireless standard, although the technologies could be complementary. WiMax supporters tout its faster deployment and potential in the emerging markets, while LTE advocates cite the wider adoption by the major carriers in developed markets. WiMax is launching in a matter of months and LTE is expected to debut in 2010 at the earliest. Experts stress that designing simpler networks is crucial to future upgrades. (VentureWire)
Bigger Isn't Always Better
Under today's tough market conditions, Big Pharma is under increasing pressure to develop blockbuster drugs while at the same time control costs, fend off generic competition and create shareholder value. Borje Eckholm, CEO of Investor AB and one of AstraZeneca's biggest shareholders, thinks the vertically integrated pharma model can't effectively meet all those demands." You have to ask yourself: "Do you have economies of scale in R&D?" He asks if big is better and suggests that Big Pharma would be better off outsourcing projects to smaller developers who have the entrepreneurial spirit needed to discover groundbreaking drugs. He said that better returns were potentially available and also emphasized the growing pressures of helping to run publicly listed companies. (The London Times)
No Exit
Venture-backed fell significantly in Q1 2008, pummeled by a drop off in the public markets and uncertainty in the private equity markets. There were 80 M&A deals valued at $7.78 billion, a steep decline from 110 deals valued at $15.69 billion in the previous quarter and 105 deals at $10.2 billion in the first quarter of 2007, reports VentureSource. IPOs came to a virtual halt, with only six venture-backed companies raising $391.9 million in their public offerings, down from $1.20 billion in 13 offerings in the first quarter of 2007. The amount of time to liquidity via M&A edged up to 6.97 (versus 6.24 in Q1 2007) and the median amount raised for companies exiting in an M&A raised to $24.75 million (versus $17.35 million in Q1 2007).(VentureWire)
Biotech Bonanza in Israel
Israel's biotechnology sector is poised to attract 12 percent more investment this year from venture capital funds, according to Israel Venture Capital (IVC). "If we do feel the effects [of an economic downturn] it will only be seen in two quarters' time," says Eyal Solomon of human resources firm Ethosia. The report concludes that there is still ample opportunity to make money by addressing unresolved medical problems, or to make existing procedures safer, cheaper and more effective. The major development in biotechnology is the field of cleantech, as governments around the world are committing significant sums toward cleaner air, ground, and water. (The Jerusalem Post)
Best Buy Ventures Out
Online job postings indicate that Best Buy Co. is launching a venture capital arm to invest in emerging technologies. The postings say Best Buy Capital will operate two investment vehicles: a fund for existing business units and a fund to make direct investments in early-stage companies developing emerging technologies or inventions considered disruptive to the marketplace. This is not Best Buy's first foray into tech investment. In 2002, the company acquired Geek Squad to offer a tech support service through Best Buy stores and in 2007 the company invested in video hosting company Mydeo Ltd. and acquired broadband provider Speakeasy Inc. for $97 million. (VentureWire)
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April 7, 2008
A Feckless Fed?
The now legendary credit fiasco in the banking and brokerages industries has Washington in high dudgeon over a vast new array of regulations. The timing could not be more perfect. You have an industry full of highly compensated executives that will be subject to intense congressional scrutiny in the next few months and it's an election year. If federal regulations and the tax code are the stock-in-trade of our esteemed representatives, we can think of one aspect of the U.S. economy that will remain robust in 2008 — campaign contributions. Although it's unlikely that anything will actually be accomplished this year, the speeches and hearings with all the attendant falderal will be quite a spectacle. The fun will be in figuring out which agencies will win and which will lose. Call it a D.C. observer's equivalent of "March Madness."
One might argue that they already have enough regulatory power. A couple stories are instructive. First, in the late 1980s, when the leveraged buyout business was rolling, Congress was concerned about lay-offs from LBO restructurings destroying jobs in their districts and the Fed was worried about credit losses. For their part, the Fed defined something called a "highly levered transaction," or HLT, and they asked banks to track and report on them. There were no limitations imposed, just, "Tell us what you are doing." HLT lending came to a screeching halt and that LBO era died. Second, at one time I worked for a foreign bank that was 100 percent funded in the commercial paper market: no deposits needed, no FDIC insurance and, maybe, no banking license. So we went to the Fed to ask if we gave up our banking license would we escape regulation by the Fed and the Comptroller of the Currency. Their response: you can give up your license but we will regulate you anyway. The point of these stories is that, even with the limitations placed on it by Congress, the Fed has vast power to influence, control and alter activities in the financial markets if it so chooses. One question today is why didn't they use the powers already at their disposal to stop the credit train wreck?
Chief among the targets for the new regulation will be investment banks and hedge funds. The current situation harkens back to the rescue and orderly liquidation of Long Term Capital Management in 1998. In that event, the New York Fed used its powers of "persuasion" to convince 16 banks and investment banks that it was in their economic best interest to prop up and unwind LTCM. Three days later, the congressional hearings focused on discovering why a government agency decided to save this firm at this time. The answers by Alan Greenspan could have been taken almost verbatim from last week's testimony by Ben Bernanke about the Bear Stearns rescue. Ten years ago LTCM seemed like an isolated incident and the Fed and Congress missed the real lesson. Large risky pools of capital, however they are formed, can destabilize the financial markets. This is simply a function of their interaction in the markets and the evolution of counterparty risk. Greenspan often worried aloud about the systemic risk posed by Freddie Mac and Fannie Mae, but he never uttered a word of consternation about hedge funds.
It's important to note that this systemic risk to the financial markets is not generated by all large pools of capital. If a venture firm makes a series of foolish bets and loses all its money (as some have), the markets are not unduly affected. If a private equity firm's LBO performs poorly and falls into bankruptcy, other than the losses to lenders and bond holders, no one needs worry. Hedge funds are different because their principal source of return generation is high leverage and rapid trading in the financial markets. If those bets go wrong, the ripple effect can become a tsunami. Consider, for example, that hedge funds are the counterparties in fully 30 percent of the $45 trillion global credit derivative market. That notional exposure is equal to the entire GDP of the United States.
Our sense is that the times are changing. Recall that a key objective of the securities laws we live with today was curbing the insider investment pools that were used to manipulate the NYSE prior to the crash of 1929. It's impossible to differentiate the operation of those funds 80 years ago from the hedge funds today, except for the speed with which they trade and the amount of leverage they use. To the extent hedge funds have been successful, it may not be because of any particular investment acumen, but rather, because they have operated in an environment where regulators have conferred upon them a particular competitive advantage. As Laurence Fink, CEO of investment management firm, BlackRock Inc., put it in an interview in Barron's, "Why aren't all large pools of capital regulated, including private equity and hedge funds?" Why indeed.
Beginning Belief
The first indication that Bernanke's Fed has regained some credibility turned up last week as the yield on four-week bills jumped to 1.49 percent. Perhaps his multiple jousting matches with Capitol Hill had something to do with it. Despite alluding to the "economic event that cannot be named," he somehow conveyed the sense that our central bankers understood the depths of the problem and would be able to stem the tide of credit panic. In any case, the stock market rallied a refreshing 3.2 percent and the Fed Funds futures seem to be bottoming out at 2 percent or so. All of this good activity occurred in the face of more massive subprime write-offs by UBS and a jobs report that was plainly awful. Maybe there is light at the end of this tunnel.
The economic foolishness on the campaign trail and elsewhere continued apace. Clinton's campaign strategist, Mark Penn, was booed off the field for representing Columbia in a free trade lobbying effort that conflicted with the anti-free trade stance of the campaign. Barack Obama seemed wonderfully unfamiliar with basic tax rate economics as he stumped for much higher capital gains taxes, arguing it would actually add dollars to government coffers. In Washington, a potpourri bill to fix the housing market was cobbled together. One element is a tax loss carryback for home builders that are losing their shirts. We're okay with that so long as they don't use the money to build more houses. The rest of the bill involved $300 to 400 billion to buy up mortgage paper and loosen credit standards for FHA loans. Shifting that risk from the mortgage market lenders and borrowers to the long-suffering taxpayers would be a useful topic for presidential debates. Finally, Sir Alan (see above) endorsed John McCain. It looks to be a long summer.
— Jim Anderson, Editor
Investment Strategy Outlook is published each week to highlight issues we hope you find relevant and topical. The views expressed in this newsletter are solely those of its authors and do not reflect the views of SVB Asset Management, Silicon Valley Bank, or any of its affiliates.
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Foreign Buyers Find U.S. Assets Cheap, Loyalty Expensive
As foreign buyers descend upon the United States, capturing widening swaths of the industrial landscape and putting millions of Americans to work for new owners, many remain uneasy about being on the selling end of the global economy. For many communities, the consequences include new jobs at decent pay, fresh capital to finance expansion and links to markets around the globe. However, many others are suffering from being branded redundant by huge enterprises with factories around the world. Foreign capital is putting more American businesses in the control of major enterprises based in Europe or Asia. (International Herald Tribune)
Fed President Sees Dark Days Ahead
Federal Reserve Bank of San Francisco President Janet Yellen said the U.S. economy faces "significant" risks, and policy makers must be ready to respond "in a timely manner." The economy "has all but stalled" and may contract through June, Yellen said in a last week at Stanford University. "The economy is still likely to turn in a sluggish performance for the year as a whole." The rate-setting Federal Open Market Committee must "be prepared to act in a timely manner," she said. (Bloomberg)
The Fed's New Job Description
The plan of Treasury Secretary Henry Paulson to overhaul the financial system includes a proposal to officially transform the Federal Reserve into a "market stability regulator" rather than merely a banker's bank. The Fed has been taking an expansive view of its own powers recently, for the most part with considerable public approval. Witness its decision to give a $29 billion line of credit to JPMorgan for the rescue of Bear Stearns. There was very little criticism of this move because so many people rightly feared the systemic effects on financial institutions if the Fed did not act. (New York Times)
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PIMCO'S Says Treasuries Are Overvalues
U.S. government bonds are "the most overvalued asset in the world, bar none" and it is tough to justify them as an investment said the manager of the world's biggest bond fund on Friday. Bill Gross, chief investment officer of PIMCO, said he was starting to take on a little more risk and had bought some bank and investment bank bonds. He added that it was too early to consider high-yield bonds since recession tends to produce defaults. However, he said it was not time to consider Treasuries, especially in light of Inflation risks. (Reuters)
Bond Market Sees Light Ahead
For the first time since December, the bond market is closing the credibility gap with Ben Bernanke and signaling that it finally agrees with the Fed chairman that an economic collapse has been averted and that interest rates are bottoming. Treasury yields rose a 0.33 percentage point on average through April 4 from this year's low of 2.49 percent on March 17, according to Merrill Lynch indexes. The increase is the first since December, when the Fed cut its target rate for overnight loans between banks and said lower borrowing costs "should help promote moderate growth." (Bloomberg)
Auction Collapse Quadruples Fee for Bond Alternatives
U.S. state and local borrowers, battered by rising interest costs from the collapse of the auction-rate bond market, now face higher fees to replace the debt. Denver found only five banks willing to provide backing for new variable debt to replace $208 million of auction bonds, down from 30 five months ago, said Margaret Danuser, the city's debt administrator. The cost to line up a buyer of last resort in case variable-rate demand obligations, VRDOs go unsold when yields are reset jumped as much as fourfold to $400,000 on $100 million of securities a year, borrowers say. (Bloomberg)
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