Platinum Capital (listed Aussie hedge fund PMC.AX). Global market commentary from the:
December Quarterly Report
16-01 1755
CURRENCY
There have been no changes in Platinum's currency weightings. The
rise in the Euro relative to the US$ is working in our favour. We are
positioned for the A$ to continue to rise relative to the US$ in 2003
with a hedged position of 69%.
COMMENTARY
Late in 2002 we visited a broad cross section of high quality
companies in Japan and came back with a general impression of quiet
yet growing confidence. One could sense a rise in their self-belief
as the merits of pursuing their traditional patient and systematic
planning and execution has begun to bear fruit.
Constant themes were the raising of productivity and the reduction of
costs. This in Japan means finding ways to harness technology to
reduce weight and size and to improve manufacturability. We were
constantly reminded of the depth of know-how and the tremendous
specialisation by individuals and companies which through gradual
incremental embellishments has been building extraordinary
competence. Most of the companies visited have been increasing their
R&D spend, capex was typically below depreciation and where serious
money was being spent overseas it was in low cost countries. One of
the benefits of specialisation and a loyalty to staff is clearly seen
by the mutual trust and cohesion found in most Japanese companies.
There are inevitably costs to this approach in the short term but
there are also great advantages in avoiding over-aggressive hiring
and firing which tend to show up mainly in the longer term.
The big idea in Japan at present is the emergence of China as the
next great market. To some extent, company management is using the
threat of Chinese low production costs to drive through reforms on
the home front. There was not a single company visited that was not
expanding or enlarging its presence in China. Some of the figures
quoted for the difference in costs were astonishing with products
being landed in Japan at the value of their raw material at local
prices. Chinese made bicycles, for instance, admittedly of poor
quality, were selling at prices one tenth that of Japanese made
units. Most companies have already been operating in China for
several years and have very largely mastered the problems of local
sourcing and distribution. Competition from Korean and some Western
European and US companies is strong but the Japanese are in the
forefront in many areas.
The areas which on previous visits we found to be concerning
management, mainly incentive systems, forced lay-offs and board
restructuring, were largely dismissed this trip as having been
tackled. The main concern now is exogenous, the persistence of price
deflation. On the financial side the management of the better
companies have done what they can, eliminating debt from the balance
sheet and hoarding cash. At the operating level, however, the short
term problem of the automatic deflation of reported profits
continues. On the other hand, it can very plausibly be argued that
large long term benefits are accruing as a forced emphasis on
manufacturing efficiency and cost control does wonders for
international competitiveness.
After a decade of price decay, influenced by weak demand, new supply
channels and easier access to imports, domestic prices in Japan no
longer seem out of alignment with those of other developed countries.
At the current exchange rate this competitiveness is evident with the
country being able to run a trade surplus of around US$100 billion
per year. This attests to its producing what its trading partners
want and gives Japan an ability to project considerable economic
power abroad.
From our perspective, this last decade has not been entirely lost by
Japan and so long as savings are generated at home and locals own the
Government bonds, the country may be able to extricate itself from
the mire without resorting to excessive use of the printing press.
After all, interest rates are perhaps below the economy's medium term
growth rate. The outstanding stock of debt is unquestionably large so
it is likely to be a tight race. However, valuations in Japan reveal
a total lack of belief in the ability of firms to earn a sensible
return on assets employed (see chart below). For those who question
the absence of commentary about the Japanese banking system and the
rising bankruptcies, the answer lies in our ability to be highly
selective with the shares we hold and to take appropriate positions
regarding the currency.
One of the benefits of studying the fall-out from the collapse of the
Japanese bubble is to learn lessons for the US market. We often hear
that the US will prove much more responsive than Japan in getting to
grips with its problems. This may be so though we believe there are
obstructions to market-clearing such as Chapter 11 bankruptcy
protection, litigation hurdles, state subsidies and so on. Either
way, we would expect the US market to continue gradually to de-rate
just as we saw in Japan. New share leadership will emerge and it is
almost certain not to be in the information technology sector.
Companies heavily burdened by debt are likely to be ill-treated (the
slogan being debt and deflation don't mix). So-called, "quality of
earnings" is paramount in an environment of weak pricing power and a
mere sniff of accounts fiddling will set off a fury of selling.
Investors will pay above the odds for growth and certainty of
earnings.
Several of these factors can already be seen at work in Wall Street,
in the case of defensive stocks the trend has perhaps been taken too
far. This has given Platinum some useful short selling opportunities,
in particular as regards consumer non-durable companies like Anheuser
Busch, Procter & Gamble and Colgate. The market also seems to be over
optimistic in its expectations for the profit growth of several
financials. This false optimism is all part of what we describe as
using the "retrospectascope". By the time the bear market has
woven its web, investors will have given up on any fantasy about the
Fed or tax cuts as panaceas for the natural deflating of a massive
financial bubble. Quite the contrary, it is probable that questions
will be asked about the efficacy of the various forms of
intervention.
Will Europe share the same fate? There are some factors that suggest
Europe could have a similar outcome but debt is much lower on the
Continent and valuations are also considerably lower. The worst
performing market, and indeed the one with the worst outlook,
Germany, is now capitalised at Euro 380 billion, putting it in line
with Australia! Even making adjustments for what is not listed in
Germany, this is truly astonishing. Further we feel the accounting on
the Continent is less promotional although far less conservative than
say, ten years back. There is one serious cloud that needs to be
watched. Should the US dollar weaken further, one of the European
drivers, namely exports, would suffer.
A weak dollar would have other serious implications particularly on
US fixed interest securities and shares. Foreign ownership of US
assets is now over 70% of US GDP, having more than doubled since
1990, and of the US treasuries in issue, over one third are held by
foreigners, who also own some 23% of the corporate bond market and
over 12% of US equities. With a relatively poor choice of
alternatives, the mired Yen and the politically incohesive Euro, some
speculators seem to be seeking refuge in gold. Writing in a book just
released, "Tomorrow's Gold - Asia's Age of Discovery" (published by
CLSA Books), Mark Faber, a seasoned campaigner with good historic
insight, suggests that the international liquidity which has been
created will find itself expressed in higher prices of many
commodities including gold and silver. We share many of his views and
see the Company's 5% position in gold producers as protection against
likely currency instability.
We think currencies will be a major topic as 2003 unfolds. As noted
in our annual report of June 2002, on the basis of purchasing power
parity the Chinese economy is massively larger than the current
renminbi exchange rate would suggest. The growing trade surplus and
foreign direct investment, running at around US$120 billion per year,
would normally ensure a strong appreciation of the Chinese currency.
However, currency restrictions and other devices such as internal US$
accounts and now the opening up of an internal gold market all
conspire to keep the currency fixed to the US$.
CONCLUSION
Terrorism, war and high oil prices are all damaging to consumer
confidence and business investment in the short term. Longer term
there is reason for optimism. Valuations have come back to sensible
levels in Asian and European markets and quality companies will be
able to achieve modest earnings growth. The level of debt and general
uncertainty will promote volatility as short term events are
periodically given too much emphasis.
K Neilson
MANAGING DIRECTOR |
