Friday, March 22, 2013

Backpacking in South America and a Global Update

Investors,

   I spent January and February backpacking through Argentina, Chile, Peru, and Ecuador.  I wish I could write an analysis of the economies and societies as detailed as I did for China last year here, but I didn't gain comparable insight.  There are a few key themes worth briefly discussing, and a few specifics that I think you'll find interesting.  I'll then delve into a update on global markets.

South America: Most of South America is export driven with a focus on raw commodities.  China provides much of the marginal demand for commodities ranging from cattle to iron, so several South American countries are nearly a levered play on China.  Much of the continent faced intermittent civil war until just 35 years ago, so social institutions are weak and corruption is rampant.  
  Argentina is in the midst of a currency crisis, which will likely become a fiscal and political crisis in the next two years.  Wealthy Argentines are pulling their money out of the country as fast as they can circumvent the capital controls in place, and I wouldn't suggest fighting the smart herd.  One funny anecdote that highlights Argentine problems - the magazine ''The Economist'' publishes a ''Big Mac'' index, comparing the prices of McDonald's Big Mac across countries as a half-serious inflation index.  The government of Argentina ordered McDonald's to lower the price of its Big Mac in Argentina to make inflation appear lower.  McDonald's responded by lowering the price, but hiding the item from the menu.  If you walk into a McDonald's in Buenos Aires, you won't see the Big Mac advertised, but can request it and get a half-price meal.
  From a social perspective, Chile has a strong work ethic and social fabric, but is overly dependent on copper (42% of exports), and has a stifling bureaucracy; crossing the border from Mendoza into Santiago by bus required a 4 hour layover at border security where I had to stand in 3 separate lines to get various documents stamped.  Domestic service industries are nascent at best.  Peru and Ecuador lack the social institutions and infrastructure to support fast economic growth in the near future.  Of the four countries I visited, I'm most optimistic about Chile in the medium and long-term.
   Finally, one random point of interest about global real estate - I met an Argentine entrepreneur/investor named Jose who made the point that between 1965 and today, the population of the world doubled with plenty of population growth in the US, and even in Western Europe, so obviously there was strong demand for new homes and offices.  Today, the population of the western world is stagnant, and in many places shrinking.  Instead of a growing pie, we now have a shrinking pie in many areas.  For every new "hot spot" development, blocks of other homes must become abandoned.  Any time you see an underpopulated area that you think will prove a good investment, you need to ask yourself, where will the people come from to fill it and what other area must become underpopulated?  Real estate is fundamentally local, so there will certainly be areas of high growth and great returns to investment, but the secular trend is for stagnant demand.   Housing trends of the last century were supported by relatively consistent population growth that has now ended.  This argument even applies to much of the Eastern world.  China's population has stagnated and Japan is shrinking.  World population growth is coming almost entirely from India and Africa.  

Global Update: I recommended shorting the Yen in early 2012 and it's come down around 17%, with half that move coming in the last few months.  This is a big move for a currency and this trade has become a little crowded from a short-term technical perspective...but I still love the position and think it has a long ways to run.  I discussed the logic here; since then Japan has gained a new central bank head who was brought on specifically to print money and induce inflation.  This may end up looking like the best and most obvious trade of 2013 and 2014; I suggest selling on any pullbacks if you're not already in the trade.  
   Equities have continued their "stealth rally", a series of small winning days that have largely left the retail investor behind and many professionals too as people wait for significant but nonexistent dips to buy.  Retail investors stepped up their investments in mutual funds in the last three months, chasing recent moves as always, but more buying pressure has come as corporations buy back their own stock with cash on hand or newly issued debt.  It's perfectly sensible for companies to pursue these buybacks, but it has historically anticipated periods of poor equity returns for the market as a whole going forward.  
   The federal reserve is knee deep in the fourth round of quantitative easing with $85 billion in purchases of mortgage securities and treasury bonds each month.  I think they'll likely end the MBS purchases within the next 6 months since Fed officials have acknowledged they're ineffective; the MBS buying is just turned into profit for a handful of lenders and big banks and is having little effect on mortgage rates.  How long Fed bond purchases continue is anyone's guess.
   Finally, there's currently a bank run going on in Cyprus, which creates a risk that Cyprus could leave the Eurozone and set a bad precedent for the PIGS.  The problem is that the ECB/EU organizations are reluctant to simply write a blank check to solve the problem, and Cyprus' debt is so great relative to its GDP that the only way to cover it may be to seize individual deposits from banks.  Still, the total problem is just $13 billion, a trivial sum in the scheme of Eurozone problems; this will likely be easily resolved soon, but there's a small risk that it will be the straw that breaks the overburdened camel's back.  
 
Ending corruption:  I promised Jose that I would ask for the input of my brightest friends and colleagues on ending Argentine corruption and that of other South American countries.  Jose has done his own research and estimates that the Argentine government accepts about $3 billion in bribes annually to dole out state construction contracts and similar projects.  This creates massive dislocations and inefficiencies.  Jose is looking for ways to make a difference, and exploring ideas like creating a Wikileaks type site to expose the corruption of individual politicians.  Some other ideas include creating an agreement with global financial institutions (either imposed from above like the Basel accords or as a voluntary organization), to stop funneling dirty money out of Argentina.  If politicians had no way to get sums larger than $1 million out of the country without anyone noticing, bribe taking would be greatly reduced.  We're looking for creative and practical ideas.  

Cheers,
Ari

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