Few people would have disagreed at the beginning of the year that the nine-year-long bull market was reaching its end phase. That didn’t diminish the shock when it actually happened. Here is Breakingviews’ imagined account of how the good times came to an end in 2019.
Day 1 – The market opens on an unremarkable Monday. A mid-sized maker of car fan belts files for Chapter 11, blaming European tariffs levied in response to U.S. trade barriers. Three hours later, Facebook announces a data breach, which it attributes to alt-right Generation Z whiz-kids with possible links to Russia. Investors, jittery over the impact of trade war and tech-sector weakness, start to sell. The S&P 500 Index slumps 4 percent, financial and internet stocks bearing the brunt.
Day 2 – Tech stocks fall further and faster. That afternoon, President Donald Trump takes to Twitter to call Federal Reserve Chairman Jerome Powell an “ENEMY OF THE PEOPLE” for his reluctance to cut rates. Later at an event, Powell emphasizes that the Fed is not on a pre-set course, but stocks only slide further. Trump muses on replacing the Fed chief with wrestling promoter Vince McMahon. Despite confusion over whether such a thing is possible, the S&P slides 4 percent.
Day 3 – Two ratings agencies say they are downgrading a basket of BBB-rated bonds to junk status, expressing concern that a slowing economy will push up defaults. Spreads on high-yield bonds widen dramatically. Market-makers stop trading some exchange-traded funds exposed to corporate debt, and collateralized loan obligations, which buy and repackage junk-rated loans, start offloading assets. The S&P slips 3 percent.
Day 4 – Trump announces the formation of “Team America,” a group of U.S. plutocrats who pledge to invest their personal wealth in the U.S. stock market, including the chief executive of one of Wall Street’s biggest lenders and Treasury Secretary Steven Mnuchin. Within hours, Tesla chief Elon Musk, who had been named as one of the group, tweets that he is looking forward to taking America private “at 420.” Stocks dive a further 5 percent.
Day 5 – Warren Buffett, whose name did not appear on the Team America line-up, tells a CNBC interviewer that he sees no buying opportunities at current levels, and is minded to use his $100 billion cash pile buying back shares instead. Retail investors take fright. Stocks slump 3 percent. Facebook’s valuation has now fallen from $390 billion at the start of the year to just $200 billion.
Day 6 – Over the weekend, Chinese President Xi Jinping expresses concern that, as the holder of $1.2 trillion of U.S. debt, China’s feelings have been hurt by U.S. volatility. Starbucks branches immediately attract protests in second-tier Chinese cities, and rumors proliferate that the People’s Bank of China is preparing to sell Treasuries. Yields on 10-year debt hit 4 percent. The S&P has now fallen 20 percent in a week.
Day 7 – Talks over the acquisition of a large media company fall apart. The buyer blames uncertain markets, but reports emerge that the company’s bankers got cold feet, and withdrew a letter they had provided declaring themselves “highly confident” of arranging financing. Shares in dozens of putative takeover targets fall as much as 30 percent. Trump tells Fox News that Securities and Exchange Commission Chairman Jay Clayton could be doing more to help.
Day 8 – An open letter from Wall Street bank chief executives appears in the financial press, arguing that post-crisis banking reforms have made the meltdown worse. They argue that proprietary trading, which could have enabled banks to buy up stocks on their own account, would have stemmed losses, and call for a reconsideration of Basel 3 and Dodd-Frank Act rules. Financial stocks rise, but the S&P still ends the day down 2 percent.
Day 9 – Mnuchin announces he is standing down from the Treasury, but pledges his full support for the president. Trump says he will pick a replacement quickly, and declines to shut down reports that he is considering rapper Kanye West for the role. Stories emerge that the original selloff may have been triggered by hedge funds who had set up algorithms to trade automatically based on Trump’s tweets. Markets are flat.
Fed expected to hike interest rates, defying Trump
Day 10 – Facebook says Buffett is investing $10 billion as a vote of confidence, taking voting shares and generously priced warrants. The slide in stocks has stopped, as abruptly as it began. The market closes up slightly but has lost almost a quarter in two weeks. Congress begins to discuss curbs on algorithm-based trading. After markets close, the White House announces its new pick for the Treasury: first daughter Ivanka Trump. -Reuters
-John Foley and Neil Unmack
The Top 7 Investment Trends That Have Been Identified In 2019
Most people give up on their resolutions by mid-February. As we usher in the second quarter – a reminder that it’s never too late for investment goals.
The year is firmly underway and investors are searching high and low for new opportunities to grow their financial portfolios. Being abreast of these of investment trends gives some insight into how they are most likely to move.
Sonja Saunderson, Chief Investment Officer at Momentum Investments, speaks to us about seven cyclical trends and longer structural investment trends they see dominating 2019 and what they mean for investors.
1.Better valuation in growth-orientated asset classes
Valuations are more attractive in equity and property assets in emerging and developed markets – with the United States (US) being the laggard. This is largely due to market corrections in 2018.
2. Moderating global growth
This trend has been in the headlines with 2019s growth forecasts being revised down. There is potential for a recession in the US in 2020, although there is some debate as to whether this would only be a further slowdown.
One of the biggest ticket items this year is the US-China trade war and its direction – whether it will escalate or moderate. Regional trade integration is coming to the fore more prominently.
In South Africa, Eskom and the elections are two big geopolitical issues this year. General elections take place on May 8 and the results are eagerly anticipated, as is the action thereafter.
Eskom, South Africa’s power utility that is struggling with a debt of $30 billion and power supply problems, poses a systemic risk and could affect economic growth and the country’s sovereign credit rating.
Investor take out: We are expecting a year of volatility, which gives active investment managers opportunities and strengthens the case for investing in alternative asset classes such as private equity.
Longer structural trends:
A lower return from asset classes is expected, in part due to the significant overhang of debt. Extreme volatility will mask this at times, but we expect lower returns in the medium to longer term.
2.Hunt for returns
The expectation of lower returns means the hunt for yields is on. This will lead to continuing innovation in listed and unlisted markets such as smart-beta investing, and the growth of alternative asset classes where higher returns can still be found. Although, these investments are more complex and restrictive.
3.Pressure on fees
The pressure on asset management models will continue with the focus on lower fees. Surviving models will either be a scale approach where the volume of assets can pay for the costs of asset management, or the boutique model where smaller teams can justify higher costs on a smaller asset base.
The long-term investment trend is not just about delivering a return against a benchmark, it is meeting clients’ needs and goals. This is the focus of outcome-based investing which simplifies the investment process by helping investors remain focused on what matters – staying invested.
Investor take out: Having a trusted adviser will be key to ensuring investors can develop sensible financial plans. Regular engagement with advisers will help navigate the bumps in the road and stay the course, which has proven to be the best investment strategy. Along with this, investors need to have a diversified investment portfolio.
– As told to Melitta Ngalonkulu
How To Better Support Business Innovators
We business schools pride ourselves on our commitment to the promotion of best practices, as well as our rigorous research and ability to produce tomorrow’s leaders today.
Globally, 81% of corporate recruiters interviewed by the Graduate Management Admission Council said they planned to hire MBAs.
The cost of an MBA – including living fees while studying – is recouped in about three and a half years thanks to the salary increase it commands.
A nice, celebratory pat on the back all round, then? Not quite.
Business schools, the centers of innovative thinking and excellence, could offer so much more to the wider economy in South Africa. We need to extend our services to many more people than we currently do.
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If what we do is good, then shouldn’t more people get hold of it? We just need to step into the sunlight out of our ivory towers for a second, and look at what we could be doing to better support those business innovators who don’t have access to funding and educational opportunities right now.
In its 2018 Entrepreneurial Ecosystem Snapshot for Gauteng, the Aspen Network of Development Entrepreneurs identified 255 organizations offering support services to entrepreneurs and small businesses.
Only one of the programs listed is offered by a formal business school, which suggests that either we are not doing anything, or, if we are, what we do might be irrelevant in the wider entrepreneurial ecosystem.
Small businesses are the past, present and future of South Africa’s economy. Today, the Small Business Institute (SBI) reckons 98.5% of all companies in the country are SMEs, the vast majority of which (around two thirds) are micro-enterprises employing fewer than 10 people.
These are not the select few entrepreneurs lucky enough to have the qualifications, capital or funding to enter our program.
They’re not the high-growth startups who’ll be looking for venture capital investment at some stage in their career. But they need our help all the same.
According to the National Development Plan, small businesses are expected to provide 90% of jobs by 2030. Today, however, SBI’s figures suggest they account for less than a quarter of formal employment – well below international standards and what might be expected given their proliferation.
The most popular reason for the collapse of a small business which has been through one of the current business development programs in South Africa is that the entrepreneur was offered another job – which suggests that current programs are good at teaching entrepreneurs skills valued by business, but not the value and reward of building a business themselves.
The second most common reason is the business idea wasn’t successful, which means we could be helping them understand how to address problems earlier, understand the root issues and learn more about how to pivot before it’s too late. And teach them to build better business ideas.
Any good business model must pass the ‘story test’ and the ‘maths test’. It’s the story test that’s hardest – visualizing how all the components fit together to reinforce themselves to build a viable, feasible, value-creating business.
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Likewise, current programs focus almost exclusively on the person leading the business as the business itself. As a result, many struggle once an organization gets too large for one person to effectively manage.
The process of capacity-building in second tiers of management is simply not taught in entrepreneur programs today.
However, there’s a twist here. In the big picture, maybe our measure of ‘success’ is too short-sighted. To become a successful business owner, learning through trial-and-error is critical, so failing fast forwards and brings rapid growth of skills into the economy as a whole.
All the big enterprises came from small ones. Oligopolies and oppressive wealth stifle the energy of creative destruction and the renewal so needed to freshen our economies and allow great new improvements and the seeds of great new companies to thrive.
Our business schools need to paint a picture of success through experimentation, rapid marginal improvements –not through a grand, elegant masterplan and the fiction of predictable implementation in complex situations.
On business ethics too, there’s much we can share. Many small businesses, for example, go through specific enterprise development (ED) programs developing products and services for corporates and government agencies.
If we’re really going to build the people who build the businesses who build Africa, we have to make our collective wisdom accessible to more of the people who count and fast-track their skills growth.
– Jonathan Foster-Pedley, The writer is Dean and Director of Henley Business School Africa.
Three Big Ideas In Warren Buffett’s 2018 Letter To Berkshire Investors
Investors expecting big changes in tone, or radical shifts in strategy from Warren Buffett and Charlie Munger in Berkshire Hathaway’s 2018 shareholder letter were once again disappointed. Berkshire didn’t unveil a dividend, both believe the whole of the conglomerate is worth more than the sum of its component parts, and they didn’t brag that hunting for acquisitions in today’s market was easy.
But there were a few important developments of note. For years, investors have studied succession plans at Berkshire for Buffett, 88, and Munger, 95, and this year’s letter gave further evidence of what they will be.
In 2018, Berkshire named Ajit Jain head of its sprawling insurance activities, led by GEICO, National Indemnity and its reinsurance operations, and Greg Abel as head of of its non-insurance operations. Those businesses span utilities, railroads, energy, chemicals, aviation, paints and housing and athletic wear, among others.
A year in, Buffett and Munger seem pleased with the performance of both, who are also now vice chairmen. “Berkshire is now far better managed than when I alone was supervising operations. Ajit and Greg have rare talents, and Berkshire blood flows through their veins,” the letter said. “These moves were overdue.”
In 2018, Berkshire’s insurance businesses returned to profitability and ended the year with a record $122 billion in float. Its railroad, utilities and energy business saw operating profits rise 30% to $7.8 billion and the bevy of other businesses that Abel was tasked with overseeing generated a further $9.3 billion in operating earnings, up 29%.
“Buffett threw a bone to those wanting more on succession by formalizing and endorsing the Ajit Jain and Greg Abel organization structure,” said Drew Wilson, a portfolio manager at Fenimore Asset Management, which has owned Berkshire shares with little turnover since around the time of the 1987 market rout.
However, this year Buffett and Munger didn’t mention their investing lieutenants Ted Weschler and Todd Combs by name in the shareholder letter. “I’m guessing we’ll get a lot of questions wanting more detail at the annual meeting,” added Wilson, who co-manages the $1.1 billion in assets FAM Value Fund.
Another wrinkle was Buffett’s decision to downplay Berkshire’s book value, an accounting metric that has headlined the company’s annual results for decades. “Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice,” said Buffett.
According to him, book value has lost relevance because Berkshire’s gargantuan $173 billion investment portfolio is a fraction of the firm’s overall assets, which are now weighted to operating businesses, led by insurance. New accounting rules, he argued, undervalue these operating businesses. Most important, Berkshire expects to repurchase a ton of stock, likely at prices well above book value.
“The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality,” Buffett said.
An unsurprising point, Buffett reiterated his belief that the easy buys of the post-recession market are gone. Thus Berkshire didn’t make major acquisitions in 2018, but bought $43 billion in public securities, primarily Apple. There were three finer points of Berkshires earnings and shareholder letter worth dwelling on.
Seeing The Forest From The Trees
No one wants to lose $25 billion in the span of 90-days, especially Buffett. But that’s exactly what Berkshire reported as it marked its books for a quarter in which U.S. stock markets slumped in October, and then plunged through December. Berkshire’s investment portfolio was marked down by $27 billion and it recorded a $3 billion impairment related to its share of Kraft Heinz’s recent $15.4 billion write down, where it’s a large holder.
That mark-to-market loss more than wiped out $5 billion plus in operating profits, driving a $25 billion quarterly loss. For 2018, Berkshire lost $17 billion on marks to its investment portfolio, though virtually all of those were on paper, thus overall net income was just $4 billion for the year, a 90% drop.
The loss, however, may go a long way in proving an important point in the shareholder letter. Buffett insisted investors look at the totality of Berkshire’s assets and the advantaged way in the way they’re housed. Said Buffett: “Investors who evaluate Berkshire sometimes obsess on the details of our many and diverse businesses – our economic “trees,” so to speak.
Analysis of that type can be mind-numbing, given that we own a vast array of specimens, ranging from twigs to redwoods. A few of our trees are diseased and unlikely to be around a decade from now.
Many others, though, are destined to grow in size and beauty… Fortunately, it’s not necessary to evaluate each tree individually to make a rough estimate of Berkshire’s intrinsic business value. That’s because our forest contains five “groves” of major importance, each of which can be appraised, with reasonable accuracy, in its entirety.”
The mark-to-market loss may prove the point. There are few, if any, entities on the planet that could bear such marks. In fact, Berkshire still saw its overall cash and book value grow for the year. Those stuck looking at trees might obsess over the daily or quarterly marks of Berkshire’s growing investment portfolio, or have doubts when specific stocks like Apple falter, but the bigger picture is that its portfolio is housed in a structure that can bear the market’s inherent volatility. It is one of the biggest advantages Buffett’s enjoyed in beating the market over many decades.
Stock Buybacks And Retained Earnings
There are many examples of companies who should be criticized for buying back their stock at overvalued prices thus wasting money, or simply spending cash they don’t have. The tens of billions of dollars that banks like Lehman, Bear , Goldman, Merrill, Morgan, Citigroup and BofA spent collectively to buy back their shares in 2007 and 2008 as the housing market began cratering is one of the unforgivable sins of the crisis. They didn’t have the money for buybacks, but used them to delay a reckoning. When each imploded, or had to dilute their stock in government rescues, the folly of Wall Street’s biggest financiers was astounding.
For companies that do have the money, however, buybacks can still be effective.
Buffett did a good job showing this, using Berkshire’s holdings in American Express. Berkshire hasn’t traded Amex in the past eight years, because the company bought tens of billions in stock Berkshire’s holding has gone from 12.6% of Amex’s shares outstanding to 17.9%. As a result, Berkshire’s portion of the $6.9 billion Amex earned was about $1.2 billion, in theory. “When earnings increase and shares outstanding decrease, owners – over time – usually do well,” said Buffett.
What was unique in this explanation is Buffett didn’t dwell on stock prices. Berkshire’s $1.2 billion theoretical claim on Amex’s 2018 profits is about equal to the $1.3 billion cost it paid for its shares.
The price at which buybacks occur does matter, but the most important element in this explanation is whether investors’ holdings are increasing in a sustainably profitable business. In the case of Amex, it is the company’s fundamentals over time that have likely proven more important to Berkshire’s gains than the exact price of buybacks. Failed buybacks come at bad prices, but mostly because the business is bad.
When Berkshire Invests It Isn’t Just Stocks And Elephant-Sized Deals
A theme that deserves more study at Berkshire is how it invests cash into its operating businesses. These divisions are becoming more sizable, so it should be no surprise the size of investments are growing. Last year, Berkshire recorded nearly $10 billion in depreciation and amortization on the assets of its operating businesses and invested a record $14.5 billion in plant, equipment and other fixed assets.
As Buffett notes, “Berkshire’s $8.4 billion depreciation charge understates our true economic cost. In fact, we need to spend more than this sum annually to simply remain competitive in our many operations. Beyond those “maintenance” capital expenditures, we spend large sums in pursuit of growth. Overall, Berkshire invested a record $14.5 billion last year in plant, equipment and other fixed assets, with 89% of that spent in America.”
This spending may well be among the conglomerate’s most important and highest return in coming years. As profitable as Berkshire’s operating businesses were last year, Buffett, Munger, Jain and Abel decided in favor of growth investment, over billions in added profits they could have recorded to impress shareholders.
What will be the outcome of growth capex at BNSF versus spending cuts by many of its rail peers, or at Berkshire Hathaway Energy for that matter? Don’t sleep on Jain and Abel as investors, Berkshire’s owned businesses generated $37.4 billion in operating cash flow last year.
-Antoine Gara; Forbes Staff
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