Is the fiscal situation in Greece a global threat?

In reality the fiscal situation in Greece is not a global economic threat. Greece is only going through a debt crisis.

To evaluate the matter, it is important to differentiate between the stock of debt and the flow of new debt.

We should not be complacent about the stock of debt: it is high and probably unsustainable at 180% of GDP. Even with higher growth of economy this level of debt would be a challenge. Greece's growth is very low, demographics are unsupportive, productivity is very week. However, we should not forget that Greek debt has already been significantly restructured in such a way that it is manageable in the short-term. Altogether, current high level of Greek debt is a threat to Greece. It will probably impact its creditors as well.

On the other hand, Greek debt flows fundamentals have exceptionally improved, and have been strong. What Greeks did is almost unprecedented. Within five years, they turned their government primary balance to a surplus. Similarly, their current account, over the same period, went from a deficit of 115 to a surplus of over 1%.

So, we have a country that runs a primary budget surplus and a current account surplus, but where, partly because of austerity, there is no growth possible. Hence, the stock of debt crisis only. It can add to market volatility. If poorly handled by Eurozone powers, it can result in Euro weakness. This will hardly result in global economic threat.

Asset allocation of endowments

Endowments and sovereign wealth funds are expected to invest with the longest time horizon and view.

The chart sums up latest disclosures of investment holdings by endowments and Corporate Pension Funds.

The first observable fact: low level of lack of fixed income in endowment portfolios, 9.00%.

Second, 53.7% of endowment holdings are in "alternative" classes: hedge funds, private equity, and real estate.

Equities are only 27.00% of endowment portfolios.

Alternatives investments, offering lower liquidity and lower volatility, are not so "alternative" for endowments, who are assuming that returns will be better from hedge funds, private equity, and real estate.

As a result, almost 99% of endowments expect better than 7% annualized returns over the long run, while only 66% of pension funds expect the same.

Source: Market Insights. 1Q 2015. JP Morgan Asset Management.

The Magic in selling a business interest.

Recently the partners of Redmount Capital were at a luncheon with Earvin Magic Johnson delivering a keynote speech.

We were hoping for some insight from Magic, in our mind the most successful pro-athlete entrepreneur, turning his athletic power into business empire. He built best-in-kind connections to propel his business juggernaut. His business visions are not only contrary to the consensus but also ahead of times.

Right away we were made aware that Magic is a genuinely fun person. He is charming yet highly opinionated.  We knew he was competitive but as he spoke we also learned how fond he is of a good competition. It seems he is not only in it to win it but also to get better. All along he was affectionate to the listeners, truly appreciating their interest and presence.

"So should I sell Lakers?"

As he spoke we kept looking for details in his entrepreneurial ways. He let us as he brought up the

sale of his ownership in LA Lakers. Magic acquired interest in to the team in 1994. In 2010 the news

of his LA Lakers sale took many by surprise, Most people thought that he was making a mistake and that he will come to regret it. 

At the luncheon Magic explained why he decided on the sale. LA Lakers were doing as good as they have ever done...or could have ever done. Kobe was getting older. Magic had another plan in the works. He was just looking for the right offer. 

What was his plan? His purchase, in partnership with Guggenheim, of LA Dodgers.

Magic knew Dodgers presented a similar opportunity as Lakers in 1994, only larger. He realized that he needed capital. which he could obtain, if he sold something. He also knew that he needed his focused attention on Dodgers.

Several well-known billionaire investors were ready to partner with him in the Dodgers deal. Choosing the right one seemed easy but he wanted himself to be a large investor in the deal. He wanted to call the shots and make good money.

Prior to that, several offers were received by Magic to consider selling Lakers, but he was looking for the "right offer". He did not elaborate what he thought the "right offer" was. We suspect he knew what it would look like - at a right price and timed to let him get the Dodgers' deal done.

"So should I sell Lakers?" Magic asked us all in the room, extending the microphone towards us. "You guys are smart enough, you have clients like me". "Yes", spoke the group. Magic nodded in satisfaction, with his smile getting brighter.

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In 2010 Earvin Magic Johnson effectively exchanged his ownership in LA Lakers for the one in LA Dodgers. A classic replacement of a business interest in a stage of diminishing returns for a one with remaining opportunities. Another plus, the business was bigger with higher RIE (Return on Invested Effort). 

This may just be the Magic approach to selling a business interest.

Photo by Curtis E. Hollowell, Redmount Capital Partners.

Lower oil prices: good news or bad?

The past months have been marked by weaker oil prices, with the WTI breaking below $44/barrel, and now sitting below a record 5-year low. With the lack of agreement among OPEC members to cut output, and subdued demand in a low potential growth environment, investors should probably factor in durably lower oil prices than they have been used to over the past 3 years. Is this good news or bad news?

Let’s consider the largest consumer in the world: the US economy. Although lower oil prices have historically been generally positive, not all periods of falling oil prices have led to an accelerating economy. Indeed, while lower prices coming from rising supply with resilient demand are good, declining demand is worrying. So, which is it today? Despite a small seasonal down-tick in world demand in October, rising supply has clearly been the prevailing factor driving prices down over the past few months. As long as this is the case, lower oil prices are positive for energy consumers. As to the U.S. industrial sectors exposed to capital equipment, a slowdown may be on the way since oil companies will inevitably reduce capital expenditures.

What about the rest of the world? Who are the winners, who are the losers? Net oil exporters will obviously suffer, while net oil importers will benefit.Not surprisingly, the Middle East will be the largest loser, although the region is immunized by its large fiscal surpluses. The situation in Russia is far more problematic, and the collapse in oil prices will certainly accelerate the country’s fall into recession. That said, the majority of the world economies are net oil importers/consumers and will therefore benefit from the slump in oil prices. As such, a further step towards discerning the prime winners is to look at the share of energy in their consumer price indices: the larger, the better. Turkey should also welcome lower oil prices as a means to reduce its large current account deficit and to better control inflationary pressures. Finally, Eastern Europe (Poland, Hungary, Czech Republic) as well as some core European countries (Spain, Germany) will get a nice boost from cheaper oil.

So, all considered, lower oil prices are a net positive for the global World economy. What opportunities on the investment side? Lower energy prices support consumers’ purchasing power. In the US, periods of negative oil returns have historically been associated with periods of out-performance of the MSCI Consumer Discretionary and Staples equity indices over the MSCI US equity index. An exposure to the US Consumer therefore appears to be a direct way to benefit from lower oil prices in USD.

Markets at a Glance, January 2015

With U.S. consumer confidence reaching 11-year high in January the consensus is pointing to an estimated 3% GDP growth in the US, with a possibility that for the 1st time in many years US economy will contribute more to global growth than China.

We believe more volatility should be expected in 2015 as the Fed begins to normalize rates. This has several ramifications for capital markets and investment portfolios. Low oil prices and higher rates may impact industrial and energy sector capex.

Many commentators blame current market turbulence on the plunging oil price. We believe it is more about lingering geopolitical issues and a pending Federal Reserve (Fed) rate hike. 

First, we expect volatility to be elevated compared to the levels witnessed from 2012 to 2014. 

Second, we continue endorsing tactical stand within fixed income. Two- to five-year bonds are likely to prove the most vulnerable to higher rates. 

Although volatile, equity markets are expected to perform, although marginally, positive, benefited by the stronger dollar and growing US economy. 

Since we are cautious about downside risks in the equity markets we endorse measured and disciplined execution of equity strategies within portfolios.