Brennaman’s Four Points for the Week

Brennaman’s Four Points for the Week

1.                   FED Watch – Quantitative Easing III (QE III) Ending in October – What is next?  The Fed will likely announce this week that they are going to continue tapering the bond buyback program to $25B in July (from $35B in June) down from the $85B at the start of QEIII in 2012.  Inflation is tame at 1.9%, running below the 2% target for well over 25 months; with unemployment at 6.1% and improving (albeit at a snail’s pace).  Anemic economic growth as measured by the GDP remains the point of interest this week as the preliminary numbers for the 2d quarter should be released Wednesday.  Nonetheless, barring a negative number (not expected) the FED will end QE III in October and the real issue becomes when do they begin raising short term rates.  Our best guess is still 2d quarter 2015 or later. 

 2.                   Ukraine Watch – Appeasement tin the Works? – I hate to delve into politics (not really) but the situation in Ukraine continues to be unsettling on many fronts.  Let’s face it, Putin has done a very good job of positioning Russia in terms of controlling the situation in Ukraine.  He (and Gazprom) supply 40% of the energy (natural gas) consumed by the economies in the European Union (European Commission news release May 2014) with some countries approaching 60%+.  So what can be done?  European Union Energy Commissioner Guenther Oettinger has hinted that restricting technology related to energy development may be in the offing but has stopped well short of saying there will be sanctions on Russian exports to the Continent.  Economic sanctions on Russian exports and imports to Russia are likely to hurt the EU more (and the average Russian citizen) in the short run than hinder the policy of Putin and his foreign policy in Ukraine.  Russia is a major partner with the EU and the loss of trading could well plunge them (EU) into a recession; and a cold winter.  Worst case is the core of the EU, France and Germany, seeks self-service over remedying the situation in Ukraine.  Shades of Europe in the 1930’s.  Likewise can Putin afford failure in Ukraine?

3.                   The Bull Market – Earnings Announcements Are Taking Some Wind Out of the Sails – Apple, Amazon, and Visa were among the many companies announcing 2d quarter earnings this past week.  Apple provided fuel for an upward broader market movement but Amazon disappointed with another quarter of losses even with strong top-line growth.  Visa as well as General Motors and Starbucks missed earnings.  Anecdotally, these results and others could indicate that that the consumer is still reticent to return to pre-recession spending levels as they continue to deleverage and restore savings/investment accounts.  The wealth effect expected after five years of good market returns has not emerged on Main Street.  Despite the disappointing earnings news, the markets were basically flat for the week; trading activity was low maintaining a low level of price volatility, while the yield on the U.S. Treasury 10-year bond remains at 2.47% where it began the week.  So the Bull Market? – The number of days since the last correction of 15% or more stands at 678.  The average since 1929 is 752 days.  Historical trivia at its best.

4.                   Bond Yields – Do They Indicate Lower Confidence in the Direction of the Equity Markets? – We are in 20^th quarter of the economic recovery (National Bureau of Economic Research - NBER) that started in 2010 and the average length of expansions since WW II is 20 quarters.  So, are the low bond yields telling us to beware of investing in the equity markets?  As usual I tell clients to be diversified across the board and to look for risk and be prepared.  But I do not think the bond yields are telling us to head for the exits away from the equity markets.  Yields are where they are for many factors not the smallest of which is that central banks in developed nations continue to feed liquidity into the markets to stimulate economic growth.  Geopolitical risks and strife have put pressure on yields as well as investors seeking safety with available cash (still high levels after the market decline and recession).  Finally, low inflation (domestically and abroad) coupled with anemic economic production (GDP) is also adding to lower yields in nearly all bond markets (Russia is at 8%).  Until the Federal Reserve (among other central banks) sees inflation as a threat and GDP growth is healthier than at present, yields here and abroad will be muted.

“History doesn't repeat itself, but it does rhyme.”   Mark Twain

“Those who cannot remember the past are condemned to repeat it.”  George Santayana

Brennaman's Four Points For The Week May 12, 2014

Brennaman’s Four Points for the Week

 

1.       Russia and the Ukraine (continued) - The sanctions the West has imposed on Russia (Vladimir Putin) are questionable in their effectiveness and leads me to believe they are symbolic in the short run.  Over the weekend the deepening crisis in the Ukraine punctuated by the elections in eastern Ukraine for independent sovereignty (surprise – they voted 90%+ for independence) has pushed world oil prices back above $108 per barrel on fears that the supply to the EU would be disrupted.  This will have little effect on U.S. oil in the short run but if the supply is disrupted there or in the Middle East then we will see a spike in price in all things petroleum.  Some good news is that we are seeing natural gas inventories increasing at a faster rate than we have seen in the past and we should not have a shortage come the next heating season.  Natural gas prices continue to fall which helps to offset the effects somewhat of the rising crude prices.

2.       GDP Growth – Will it Go South? - The Gross Domestic Product (GDP) growth rate number is already being whispered as having contracted in the first quarter.  As you recall the number we expected was in the 2%+ range but we observed a number of .1%; with economists blaming the ill effects of a brutal winter across much of the United States.  Some economists are now saying the economy actually contracted by as much as ½% or more.  Definitely bears watching as the month progresses and we await the revised numbers.

3.       Shifting Our View to Southeast Asia. - China and her neighbors are still trying to get along in terms of fishing, oil exploration and in general freedom of the seas.  Again I pose the question – “Why do we care?”  It is clear and simple that free movement on the seas anywhere on earth is vital to economic growth and of course our national self-interest and national security.  As you recall, China has essentially claimed the entire South China Sea as their sovereign waters.  This action has been met with condemnation from nearly all the countries in the region since this action by China closes off access to deep sea commercial fishing and navigation routes if unilaterally enforced by the Chinese.  The growing Chinese naval presence in the region threatens to thwart free commerce and create an air of tension that could push the area into deeper conflict.  Any conflict would shut off the free movement of goods to and from China.  Not to mention the impact on Taiwan.  A disruption would impact our economy in a negative way.

4.       Existing Home Sales - The sale of existing homes is increasing in some markets, mostly in homes appealing to affluent buyers (dare we say “sellers’ market”?).  The areas are not located in any one area but seem to be in high growth states that are seeing lower unemployment and population growth.  Historically low mortgage rates are adding to the picture, especially in the price ranges not associated with “starter homes” (varies from “Location to Location to Location”).  Perhaps we are seeing a slow beginning to a better housing market as the spring and summer selling seasons go into full swing. 

Next week I will discuss investment themes we seeing emerge (or sustained) for the next 12-36 months. 

 

Have a good week.

Brennaman’s Four Points for the Week

I started writing these for my friends and clients.  I thought I would share these items each week with a wider audience.  Please let me know what you think.

Brennaman’s Four Points for the Week 

1.       The Gross Domestic Product (GDP) numbers that we observed last week were at first glance quite disappointing.  With the numbers approaching 0 at .1% growth for the 1^st qtr. of the year, many prognosticators were blaming the weather, the crisis in Ukraine and a general malaise that is generally associated with our slow recovery.  I agree that all three are evident in the low numbers but the drop from 2.6 in the 4^th qtr. of 2013 conveys a certain reluctance on businesses to stretch for growth when the overall environment is uncertain as to taxes, market growth both domestically and foreign, and the U.S. consumer still unwilling or unable to resume outsized spending while still deleveraging from high levels of debt.  Perhaps the revised GDP numbers at the end of this month will shed additional light.

2.       As a contrast to the dismal GDP growth rate, we witnessed a dramatic increase in new job creation for the month of April, driving the unemployment rate down to 6.3 from 6.7%.  This is a good directional movement and much a needed boost to consumer sentiment.  The fly in the ointment if you will is that nearly as many people (mostly older, long term unemployed) continue to leave the job market (actively searching for work or take lower paying jobs to fill the breach).  The pie in the sky numbers that we are adding new jobs at a rate not seen since the peak in  2008 (pre-recession) belies the fact that wage levels are still significantly lower than 5 years ago and the labor participation rates continue to decline.  This last is driven in part by the long-term unemployed dropping form the workforce but also by the fact there are not enough new jobs for recent high school and college graduates.  The number of new jobs that need to be created to fill this gap is closer to a number of 425K each month.  The Federal open Market Committee (FOMC) still sees the need for quantitative easing and remains committed to keeping interest rates low through the end of 2015.  We shall see.  Inflation is lurking.

3.       There appears to be an increase in corporate governance emerging.  Berkshire, General Motors and Pfizer are among the companies with shareholders and boards questioning the leadership actions taken by CEO’s in the conduct of their companies’ business.  Surprisingly enough there is still not a widespread discussion of the salaries these individuals are making even though their operational results are faltering.

4.       Ponder now the question as to when we should buy bonds versus staying with dividend paying stocks?  I am still in the camp that we are still waiting for the rising interest rate cycle to begin (“Waiting for Godot?”).  For the client with a time horizon of 5-7 years the S&P dividend yield is 2.06 versus the yield on the 5 year U.S. Treasury bond of 1.68%, stock dividends can be compelling.  The decision is a question of the level of risk the investor is willing to take not just how much yield she/he is getting for the move.  I think it is a discussion worth having with my clients.

 

Why Should We Care About The Ukraine?

Last week a client asked me why shoudl we care what happens in Ukraine. Aside from teh fact that we are a worl leader and should care what happens elsewhere in teh world, I decided to give a brief answer to him so we cold move on to other issues. Mainly eyh performance oif hjis portfolio over teh last 2 years.

Here is my response.

Why do we care? Forget Russian hegemony and imperialist desires of Putin we need to visit what really happens if things go south in a big way.

1. The European Union (EU) economy is and has been fragile for decades. Their ever growing dependency on natural gas from Russia and satellite countries highlights a weak point that Putin is sure to exploit if he has to do so. If the flow of natural gas is disrupted or stopped altogether the economies of the EU could grind to a halt. The EU as a whole is a huge trading partner for the United States and the repercussions would surely be felt in our own economy.

2. Russia is the number 3 (behind the Philippines and Indonesia) producer of nickel a key component in the making of modern steel. The U.S. does not even crack the top 15 in the world since we have limited deposits. The current world supply is constrained because of events in Indonesia (another article) so Russia has the goods that the world needs, at least the EU. See comments about the economy in number 1. Russia also has other deposits of minerals that are needed with the same possible effect.

3. A dominant Russia can have adverse effects ranging far beyond the Ukraine. The former Soviet bloc nations are unsure as to whether they are next in line if Ukraine is “reabsorbed”. These uncertainties restrict development of new markets for U.S. and EU goods. Our economy depends on the free flow of goods all over the world and adding areas of instability is another road block to future growth.

4. Finally, we see Russia as a competitor in the world market and if they are willing (and able) to subvert the government and free will of Ukraine, can we trust them in the market place to be a stable business partner? That is the real question

Have a good week and I look forward to hearing from you.

Steve

One of Life's Transitions

I had a conversation recently about my transition from military to civilian life.  The discussion covered not only the differences I had to adjust to, but also how I was able to use key lessons from my military experience as a leader and adapt and apply them productively to benefit my career and the civilian businesses I’ve worked for.  Since these lessons have broader applications, I am giving you a condensed account of them here.

 When I left the military, where I had been a commander and leader for over twenty years, I found myself in a very different world.  Everyone did not share the same expectations, discipline and work style and I was no longer responsible for other people.  A lot was expected of me but the only things I was responsible for were my desk and me.  It was a big change.  Having a friend who had been in the military as my supervisor and a few former military service people on my team helped ease the transition.  At first, I liked the freedom but after a few years, I began to crave the responsibility and leadership I had found in the military.  As it turned out, the same skills and abilities I had developed in the military contributed both to my ability to adapt to civilian life and to resume a position of leadership within a few years.

Service

One of the key lessons I brought home from my military experience was a commitment to service.  This was a very important element in my ability to lead, inspire and mobilize others.  A sixth generation member of the military, my commitment to service was strengthened and honed by military experience, both through serving my country and helping those I commanded develop professionally and personally through the programs I instituted and direct personal action to resolve problems.

Leading service men and women, sometimes 350 of them, I was inescapably involved with all aspects of their lives.  When I was a platoon leader in Germany, I used to make a habit of dropping in on members of my team at home unexpectedly to make sure things were all right with them.  I remember dropping in on one soldier, who had his whole family with him and whose low pay made it hard to make ends meet.  When I arrived, I heard a baby cry-from hunger.  We resolved the situation through getting them the assistance they needed and helping them plan.

After that, we made it a habit to regularly round up unit families on the base and take them to the mess hall to eat, even when this was not standard procedure.  Similarly, I instituted programs to deal with alcoholism and gave service members one chance to straighten out that problem, rather than just kicking them out with a dishonorable discharge.  What I brought back from this was an ability and desire to lead and inspire a team to a high level of excellence by developing their ability as individuals and as members of a team, to overcome whatever challenges they faced.

When I returned from the military, my commitment to service continued.  It is my conviction that a major part of leadership is mentoring and helping others develop.  For that reason, I was on the leadership development committee at BB&T, have mentored junior colleagues informally throughout my career, have been a Boy Scout leader and belong to the Rotary Club.

Strategic Planning

A second skill I brought back from the military was the ability to teach others how to plan strategically to achieve goals by following eight essential steps starting from the definition of the goal, through evaluating competing strategic approaches and ending with taking the steps to achieve those goals within the desired time frame.  The first person outside of the military I taught this approach to was my eleven year old son, who went on to earn the Eagle Scout rank by applying these principles in developing and executing a plan to pave a driveway perfectly within the time he’d calculated.  He was justifiably proud of the accomplishment, as I was of him.  Of course, I went on to share this skill with others in the teams and businesses I led, which contributed significantly to our successes.  However, his success is the one I enjoyed the most.

Stamina, Discipline and Focus

As a leader, responsible for soldiers’ lives, I learned how to work 20 hours a day dealing with everything from training to logistics to the development and nurturing of members of my team, to include their families when appropriate.  I developed a discipline and focus in resolving complex problems and dealing with the unexpected that have served me extremely well in civilian life.  To cite just one example, I only have to go back to the 9/11 event.

This event will be a seminal event for my generation as well as my son’s generation (Millennial).  My team was managing nearly $2 Billion in assets at American Express and clearly we were affected by the closure of the stock market for a week not to mention the turmoil that followed after they (the markets) were opened a week later on 9/17.  We spent the five or so days following 9/11 studying history, consumer sentiment, and market behavior in an attempt to prepare ourselves for the tumult that we were sure was going to occur on the opening day.  Many of those around us took a short vacation seeing as how they had nothing to do since the markets were closed.  We stayed the course, exercising discipline and focus. 

Stamina was also important because the enormity of the events in New York, Washington and Pennsylvania creeped in whenever you let your guard down.  When the markets finally opened, we were not immune to the downdraft but were well prepared to take advantage of the markets' violent swings over the coming weeks.  So much so, we had very good investment performance for the 4th quarter and actually for the year.  Our clients were happy and we were profitable despite the horror and national pain.  Clear thinking, planning, and having clear-cut goals and objectives combined with stamina, discipline and focus carried the day.

Loyalty

Loyalty to your group and above all to your mission is an ingrained part of being in the military.  I translated that into loyalty to the organization I work for and its mission when I moved to the civilian sector.  This has been the keystone of everything I do and perhaps the most important element of my success.

Flexibility

Perhaps surprisingly for some readers, I also learned the importance of flexibility and being able to work from the bottom up through my military experience.  Part of this came from the military’s habit of alternating periods when you are in command with periods when you are a staff member-which develops the ability to look at challenges from different points of view.  Another part came from skills I developed when working with streetwise supervisors, who put me in situations where I had to develop personal relationships with people in charge of different parts of an operation in order to succeed.  Those assignments taught me how to solve problems by getting to know people across units and divisions, in order to work to support their goals and needs to accomplish the larger mission.

Reflecting on all of this now, I see there were was a definite period of adaption when I returned to civilian life, with some bumpy moments.  However, it is clear to me that my military service is both an inextricable part of who I am as a man and has contributed greatly to who I am as a business leader and a conceptual and strategic thinker.

 

 

Ethics and Trustworthiness - Semantics?

I had a friend ask me the other day as we were talking about one of the papers I had written in which I had mentioned core character traits that were important to me.  My friend thought these were so closely related as to be redundant or at best unclear in the sense of being different.  These core traits were being ethical (in behavior and thought) and being trustworthy.  Not wanting to get into a discussion of what Webster defines these I attempted to explain how I view them and I invite my readers to sound off as well.

Simply put, you cannot have one without the other.  You also need to include integrity.

The differences between being ethical and trustworthy are not just semantics.  Ethical behavior in my mind is doing the right thing in a moral and cultural context with morality having the upper hand.  Trustworthy on the on the other hand is linked to ethics in that an individual can be relied upon to do what he/she says they are going to do and that the actions fit in with the moral guidelines of society and culture.  Of course, an individual can be trusted to do bad things but he is not “trustworthy.”  Trustworthy in my opinion is a trait that an individual exhibits when he/she will safeguard my confidences, protect communal and personal property and put the interests of others before his/her own interests.

This can get deep into philosophy, which I have done on many occasions.  This also reminds me of a quote from an early mentor (Dan Rivera, 1979):  “The true measure of a man’s character is defined by what he will do when he knows he will not be held accountable for his actions.”  This quote, which I have lived with for over thirty years and more embodies ethics, trust, and integrity.  You cannot have one without the other two.

Chinese Bank to Buy Stake in U.S. Arm of Bank of East Asia

Does this bother you and why has not the mainstream media picked up this?  Okay.  I am not xenophobic but I am a patriot and a diehard capitalist.  Having established that (for those of you who do not know me very well) I must confess I am a bit perplexed about the Federal Reserve’s recent decision to allow The Industrial and Commercial Bank of China to purchase 80% of the Bank of East Asia.  The only press I have seen to date has been from the NY Times and the Wall Street Journal.  I will keep looking.

This is a watershed moment as it is the first time a Chinese institution would have a controlling stake in a United States financial institution (as reported today in the NY Times and the Wall Street Journal).  I mean, I am fan of the Fed on the general principle that someone needs to manage the money supply and supervise the banking system.  But when they are overseeing the domestic banks there are a multitude of regulatory guidelines and laws that actually make the domestic banks pay attention (okay – the 2008 Crisis still happened, but..).  However, how is the Fed going to get the Chinese banks to heel to their will.  After this transaction, the playground gets a little muddled and I am afraid no one is paying attention.

The Chinese government owns 65% of The Industrial and Commercial Bank of China.  Let that number sink in.  Who is going to have the most influence over the bank: the Fed or the People’s Republic of China?  If the question is too difficult for you then you need to brush up on comparative politics (Hint: The Communist government controls the actions of the bank when it comes to a pinch).  This will be a problem.  What is next – sale of one of our major shipyards to the Chinese?

Our banking system still has not recovered from the 2008-09 crises with earnings well below where they need to be for every bank to be healthy and growth anemic at the majority of the banks (JPM and GS notwithstanding).  The additional competition from the Chinese banks will apply more pressure (not at first according to the WSJ) overtime and the action will be fierce as the Chinese government will want a decent return on their investment (don’t we all?).  The FED can be satisfied that concerns about capitalization are non-existent since the Chinese treasury is awash with U.S. Dollars.  It must be appealing to the FED to have additional liquidity strength in our market but what if the Chinese decide, say in 10 or 5 years they do not want to play by the FED’s rules.  What does the FED (We) do?  Control of our own currency may be in the hands of the socialist (there I said it) Chinese government.

Let me know what you think.