March 11, 2019 – Jobs, jobs jobs! Canada vs U.S. head-to-head analysis of February job gains.
China exports tumble. Who’s winning the trade war?
Facebook pivoting to privacy? Yeah right!
Barrick and Newmont pursuing joint venture. Was the hostile bid just a ploy?
Norwegian SWF dumping oil stocks. Does this present an opportunity?
WeWork or WePlay?
Bank of Canada holds rates steady, blaming recent economic slowdown.
Questions: What is your outlook on interest rates?
Link: Eugene Wei’s “Status as a Service (StaaS)”
Intro: Welcome investors to the absolute return podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.com.
We are talking about practice man. What are we talking about practice? We’re talking about practice man.
Julian: Welcome ladies and gentlemen to episode 4 of the absolute return podcast. Now we’re not talking about practice today, but what are we talking about? Rate cuts. That’s right we’re talking about rate cuts man. I am Julian Klymochko.
Mike: And I am Mike Kesslering.
Julian: So, in addition to rate cuts we’re also going to touch on the bank of Canada and their interest rate decision this week. The interesting story about we work and some of the related party and pet project investments, the Norwegian sovereign wealth fund is now dumping oil stocks. Of course, touching on this Barek and Newmont drama that seems to continue with different twists and turns each week. Facebook announcing a pivot to privacy, a massive tumble in Chinese exports and finally we look at the job reports in Canada and the us. Kicking it off with the jobs numbers this week we have quite the contrast between Canada and the U.S. So, Canada really having outstanding job numbers, fifty-five thousand nine hundred in February exceeded consensus estimates of effectively flat and this comes on the back of a very very strong report in January of sixty-six thousand eight hundred. The unemployment rate remains at five-point eight percent. So, we’re seeing really strong numbers at a Canada contrast that to the U.S., which announced only twenty thousand jobs in February which was substantially below the hundred and eighty thousand as expected by economists. The unemployment rate declining to three-point eight percent. But really interesting divergence in economic figures there, Mike what are your thoughts?
Mike: Yeah, I think this that this highlights the, one thing in Canada is it highlights the strength of the full-time jobs versus part-time jobs and it’s kind of a data point against the popular argument that we’re moving towards a more gig economy. In this past jobs data what you saw was that there were actually 67,000 full-time jobs created along with a loss of 11,000 part-time jobs.
Julian: I really want to stress that you can’t take these monthly job figures as gospel. They’re not carved in stone. They’re just very very rough estimates, I call them W.A.G., wild-ass guesses by the statisticians putting them together via polls. So, it’s more important to really look at the trend perhaps take a look at the three-month average. Putting the back-to-back numbers in Canada. It’s the strongest two months stretch of job growth since 2012. Which is pretty surprising and then looking at the us numbers, these 20,000 jobs gain which is very disappointing. It comes on the back of really really strong numbers in January and December. So, you’ve got a discount that take a look at the averages and it’s really important also to look at the inflection points. Because those inflection points rapid changes in unemployment jobs figures declining, I think is a really good coincident or perhaps even leading indicator on where the economy is heading.
Mike: So also, with your comments with regards to averages and following the trend, it sounds like you wouldn’t really recommend creating a short-term strategy that focuses on these specific numbers.
Julian: Well look predicting the economy is incredibly difficult if not impossible. But it’s really important to keep your finger on the pulse of things, keep track of where the numbers are coming in and each number on its own isn’t super meaningful in and of itself. However, helps kind of paint a mosaic on where we stand and where things are heading. Chinese exports coming the most in three years falling 20.7% in February. Which was dramatically lower than the average economists estimate of a four-point eight percent drop as a reaction to this news; Chinese stocks sank by over four percent on the day marking their worst trading day in five months. A number of reasons that these pretty bad economic numbers came out of China, economists are cautioning on taking too much out of it just blaming seasonal distortions around the Chinese New Year holiday saying that what was most of the surprise right there. But I mean it’s hard to argue that this trade war that the us has been waging on China isn’t having a pretty dramatic effect on the Chinese economy.
Mike: Absolutely and in terms of the Chinese New Year that is something that is completely expected and so I don’t I’m not really sure if I’m buying that in terms of what economists are giving as rationale. But what I would say is that this is a perhaps a leading indicator of a global recession in terms of Chinese exports falling and any weakness in china is never good for commodities.
Julian: It’s worthwhile keeping your finger on the pulse on this one as well. I really saying how the Chinese economy shapes up this year. They reduced, they recently reduced their economic growth target this year to six and a half percent on the year which is a 29-year low. So, China has been blazingly fast growing on the economic side over the past three decades. But things certainly starting to slow, the trade war definitely having a pretty material impact here and I think in my opinion trump really is winning and you can tell by the economic numbers, you can tell by each nation stock market. In my opinion it’s pretty clear that trump has the upper hand. Implications here is that china I think will come to the table and get a deal done with the us on the trade front.
Mike: And what sort of timing are you thinking for a free trade deal?
Julian: Well Trump indicated that they would be meeting at the end of march. So, I guess we’ll keep our eye open for that and see what happens. But as for now you look at how the market really recovered over the past two three months since the Christmas eve low and the market is really pricing in a trade deal at this point. So, if nothing is forthcoming watch out below. Big news out of Facebook this week with CEO Mark Zuckerberg announcing that Facebook would be a pivoting to privacy. So, Zuckerberg indicated that Facebook users would be able to communicate privately using secure and encrypted messaging and ephemeral stories. He stated quote it will become a privacy focused communications platform. But I think the market and critics are skeptical on this one. What are your thoughts?
Mike: Yeah so, I actually looked at this through the lens of Eugene Wei’s recent blog post status as a service. We’ll post that link in our show notes as well. But this long post I will admit has two main principles. The first being that people are status seeking. Second being that they will seek out the most efficient path to maximizing their social capital. Now he praised the networks like Facebook twitter and Instagram, because of their scale and breadth of viewership. Which allows users one of the more efficient ways to maximize their social capital without limits. By definition a private network or direct messaging platform puts a cap on the amount of social capital that can be earned. Making it suboptimal relative to an open one now a more open at public network will be a little more popular than a private one, because of this paradigm. Basically, what Facebook is saying here is that they think that the paradigm has shifted throughout the years and so they’re pursuing more of a private platform. Facebook mostly exists to sell ads in an efficient way. So, I don’t know how seriously this strategy shift can be taken in whole.
Julian: Yeah, I’m skeptical, the markets skeptical and critics are very skeptical. Facebook became one of the largest companies in the world by harvesting user’s private information and effectively selling it to the highest bidder and some people are thinking that this is just a ploy to get their attention away from the various scandals that Facebook has suffered over the past 12 months. It’s constantly in the news, you had the whole you know Russian influence on the election and selling data to third-party apps. Letting them access a whole host of private information and then getting into a lot of trouble with the regulators. So, I think everyone’s pretty skeptical and some even going so far as this is just another ploy to entrench Facebook as the dominant platform out there.
Mike: Absolutely and it seems kind of like a shiny object similar to on December 20th I believe it was when they announced their new stable coin that would be offered through WhatsApp.
Julian: Yeah it will be a nice thing to see what they do on the crypto front. But with respect to privacy Zuck we don’t believe you.
The drama between Barrick gold and Newmont mining continues to play out with pretty dramatic swings being taken that throughout this scenario. Now what we’re seeing currently is that Barick and Newmont are talking about a joint venture. Which to me it’s kind of unveils barks’ hostile bid, which I have always been quite bearish on and thought it had a very low chance of success. This is kind of being revealed as just a ploy to get Newmont to come to the table to discuss potential joint venture on their Nevada assets and so you can take that and think that this was Barrick’s goal all along, saying Newmont was susceptible to being taken advantage of there comes along sees that Newmont is trying to buy Goldcorp, bare wants to throw sand in the gears of the deal just to advance their own strategic interests in getting a joint venture on their Nevada assets in which they share with Newmont and the main goal here is that the companies realize that they could recognize $750 million in annual synergies or a cost savings which would effectively just flow straight to the company’s bottom line.
Mike: Yeah in terms of the synergies, those are things in terms of a joint venture. You don’t need to merge, you can just have a joint venture for the properties that contain the bulk of the synergies and in terms of the negotiating tactic by Barrick, what it’s really doing is trying to close the gap between ownership of that joint venture. So what Newmont is proposing is a 55 percent majority interest for Barrick whereas Barrick thinks that they should have 63 percent. So, it really just seems like they’re trying to close that gap.
Julian: I got a quote here from Barrick’s CEO Mark Bristow saying quote “We’ll consider dropping the hostile bid when we get a workable JV.” so they’re both at the table currently undergoing discussions, I don’t believe either them necessarily want this hostile bid to go through. Newmont certainly doesn’t want that. Certain large shareholders one of which is vaneck which holds approximately 6% of both companies. They definitely want to see them pursue this joint venture as opposed to the hostile takeover. A lot of shareholders in the gold space are really trying to stress the focus on shareholder returns and not just growth to be the biggest, not just production growth. But they’re looking for a solid return on capital. As for history between Barrick and Newmont, I mean they’ve really been going back and forth on this idea of either combining or having a joint venture for two decades and but there’s a long history of hostility between the management teams. We’ve seen that in the past and who knows where things will go. Perhaps they are able to settle it. Another really stunning U-turn in this whole drama is, it was unveiled that Bristow the Barrick’s CEO when he was a head of Rangold prior to its merger with Barrick, he actually proposed a deal with Goldcorp. Stating that they had world-class assets I believe he said and now contrast that to him just disparaging Goldcorp in his criticism of Newmont’s deals. So, you can tell egos are involved and it’s a war of words. But I mean it’s kind of tough just to believe anything of what these guys say in the press meaning you know and behind the scenes, what they previously said is completely the opposite.
Mike: Absolutely and in terms of a war of words and shareholder value one of the things that was pointed out that since john Thornton became president at Barrick that their underperformance has been in dollar terms about twelve billion dollars while he has taken home about 65 million dollars in compensation. Which is something as an executive definitely looks negative as well something that was pointed out. Although there may not be valued to shareholders in a merger between the two companies, there’s certainly have a lot of value for investment bankers. It’s estimated that the fees would be around seventy million dollars on one side, which is pretty crazy.
Julian: Yeah really fun situation to watch. We’ll see how things proceed. But my call is that a hostile bid definitely won’t happen. I think it’ll be unsuccessful, Barrick will continue to push for a JV. I think that’s the most likely scenario and then we’ll see if it happens over the next month or two.
Norway’s one-billion-dollar sovereign wealth fund is ditching oil stocks. That’s right they just announced that they would be phasing out their investments in oil and gas producers. However, they will continue to invest in companies oil companies that are developing renewable energy businesses. So, the reason that they’re making this pretty dramatic move and I say dramatic because Norway’s sovereign wealth fund effectively got all of its money from oil production of which they produce a lot offshore. So, they indicated that they would quote reduce the vulnerability of our common wealth to a permanent oil price decline. I mean you got to take that with a grain of salt they indicated that climate change is an important risk factor. They did phase-out coal stocks and 2015. Certainly, I think this has an ESG bent to it. But I really wanted to note two things. Number one is when you see a move like this which in my opinion rings the alarm bell of forced selling where a wholesale decision to sell investments irrespective of price or valuation I think that could present an interesting opportunity to other investors willing to buy those assets on the cheap. So, when you have for selling where they frankly don’t care about price, they just kind of sell for whatever they can get. I think opportunistic investors should definitely take a look in that scenario. The other thing that I wanted to mention is that in the announcement they indicated that they will no longer invest in firms that are classified by index provider FTSE as being in the energy exploration and production sector. That really goes to show you the tremendous power that index providers have. Where a massive billion-dollar fund will just scratch an entire sector, sell everything that an index provider classifies into that sector. So, I think that was pretty exceptional there.
Mike: Absolutely and in terms of the E&P; divesting of E&P’s they are still investing in integrated companies. So there still is an E&P aspect to their investments which is a little bit interesting. The other aspect is that last month they actually made a move to bring their ESG investing in house in order to save costs. Now they’ve decided not to cut this mandate despite the fact that the allocation has been underperforming the broader market by about 3% annualized over the last eight years. So, I guess my question to you Julian is so for a fund like Norway sovereign wealth fund, are social concerns more important to them than investment returns?
Julian: I think that’s the trend that we’re going to see much more of coming into the future. The citizens ultimately control sovereign wealth funds and so if the people want to see a more environmentally friendly asset allocation, then they’re going to have to sacrifice returns to get that. I believe the more investments that you eliminate ultimately that will end up with lower investment returns. So, it’s a conscious choice that they’re making, and it appears that that is the direction that they’re moving. In terms of size of this divestment, oil companies currently account for 1.2 percent of the fund. Which is $7.5 billion that they’re going to pivot out of in the near-term medium term. So, look forward to that and see if you can pick up any oil companies on the cheap.
Wanted to highlight an article this week in the wall street journal about wework, the office space company that now apparently does a lot more than just leasing office space. Wework was last valued at $47 billion. So certainly, a unicorn highly valued in the private market. It has raised more than nine billion dollars from investors including Softbank’s massive Vision Fund and in a clear indication that they’ve raised way too much money, the wall street journal revealed that they’ve been investing in all sorts of different disparate companies that really have nothing to do with office leasing or what weworks’ going to do. I mean they bought a private jet for the CEO, they’ve been investing in pet projects of his, wave surfing, surfboard company. I think and even some health food companies. They did a school when they couldn’t find a school good enough for their kids. So, him and his wife took company funds and invested in the school I believe and they’re doing all sorts of kind of weird acquisitions. They bought an SEO and marketing company conductor for 126 million and they also bought the website Meetup for a hundred seventeen million. So certainly, a case of I don’t even know if you’d be considering at a start-up when they’re valued 47 billion dollars. But a start-up raising probably too much money that they know what to do. It’s certainly more and then they need to invest in their core competency, their core business and so it’ll be an interesting training day if this company was public. Perhaps becoming public soon and short sellers could be salivating at the revelation that the corporate governance is not looking to get here. Mike what are your thoughts?
Mike: Yeah you have so in terms of corporate governance you mentioned the VC investments. But also, they came under scrutiny a couple months ago when their CEO is actually selling his private stock of we work to purchase office buildings that were then leased back to we work and earning millions in the process really and in terms of the actual amount of stock that he was selling, the wall street journal quoted it to be in the millions as well. Perhaps even the hundreds of millions. So, this is just kind of the shady corporate governance that we’re seeing and it’s not something you typically see when there’s large institutional investors invested in a company like this. But Masayoshi Son has famously invested in Alibaba after only one meeting.
Julian: Yeah, I mean some major red flags here from a corporate governance standpoint they’re doing some crazy stuff, where they’re investing their cash, and, in my opinion, they really have a very little competitive advantage. I see competitors cropping up all over the place. I mean get some office space and lease it out to startups. People think that they’re highly exposed to a cyclical downturn. They think that wework will be the first to go. So, we’ll see if wework goes public shortly. I mean they’ve discussed JPO plans and I think with these red flags popping up all over the place that short sellers should be salivating at the prospect of wework coming public soon.
Mike: Yeah really, they are a start-up. But it’s an old-world business. It’s really just subleasing office space with really great marketing and as well in terms of the vs. investments, you know perhaps Softbank just thinks that wework can invest better in startups than they can.
Julian: Yeah who knows.
Bank of Canada out this week with an interest rate decision unsurprisingly keeping the benchmark rate steady at one point seven five percent. No one was really expecting for a hike or a cut. So, Bank of Canada acknowledging that it was surprised by how abruptly the economy is decelerating and the last podcast we talked about a myriad of issues in Q4 that really caused the Canadian economy to slow to a crawl. I believe it was 0.4 percent annualized growth in December you know the people are talking about the r-word recession. That’s a very close to negative growth and certainly has the bank of Canada nervous on a number of fronts. So, we talked about reasons on why the economy slowing so much and so the bank noted such factors as high borrowing costs. Which we are talking about last time, they noted the wealth effect on cooling housing prices. People can’t treat their home equity line of credit as piggy bank anymore. Because their home isn’t going up in value anymore. So, they can’t get additional purchasing and spending power out of their home equity and lastly, they also indicated that Canadians are becoming more cautious on their spending and as we previously discussed the rate hikes the bank of Canada ultimately took the benchmark rate from 0.5 percent to 1.75 percent over a couple years and it doesn’t seem like much. But it seems to be ultimately having a pretty dramatic effect on the Canadian consumer here. What are your thoughts?
Mike: Yeah something that we discussed earlier in the podcast was the strong jobs number. Now perhaps the expectation is that consumer spending will grow in the second half of the year once this jobs data gets baked into consumer spending and what I really think it’s coming down to is flexibility in terms of policy for the bank of Canada and one area that they can maintain flexibility is in lowering the neutral interest rate. Which is currently at 2.5 to 3.5 percent. So, credibility is always a major concern for central banks and just weeks ago the head of the set of the bank of Canada was discussing increasing rates. Where lowering the neutral rate will actually allow them perhaps maybe to just do one more rate raise and leave it at that as opposed to a couple more raises.
Julian: Yeah, I wanted to clarify what the neutral interest rate is. They believe that the rate at which the benchmark rate would make the economy balanced and so they showed that this neutral interest rate would kind of be the peak of a rate hiking cycle. Previously they indicated that the current range of this neutral rate is 2.5 to 3.5 percent and the benchmark rate is at 1.75 percent. So that implies at least 3 more rate hikes until the bank of Canada views interest rates as being neutral. But many economists are now thinking perhaps the Bank of Canada needs to lower that neutral interest rate, the implications being if they lowered it from 2.5 to 3.5 to say two to two-and-a-half that implies that there would be perhaps just one more interest rate hike and if they do in fact lower the neutral interest rate to sub two, perhaps this whole rate hike cycle is totally done and next up we’ll see rate cuts.
Mike: And one other aspect is that usually the Bank of Canada doesn’t like to diverge too much from the fed in the U.S. So, the optics of doing rate hikes well the fed is staying put is something that typically the Bank of Canada refrains from.
Julian: Yeah it also depends on where the loonie’s at, the Canadian dollar. If Bank of Canada is hiking while the fed is not, then will see the loonie appreciate in value and that’s not good for many Canadian companies. So, I think the Bank of Canada really likes managing currency rates. So, in terms of them hiking while the fed is not, I mean forget about it it’s just not going to happen. Now getting to listener questions mike what do we have on bat here?
Mike: So, our question is what is your thoughts on interest rates.
Julian: So now we’re going to be talking about rate cuts and as you heard at the start of the podcast shout-out to one of the best basketball players ever, Allen Iverson talking about practice. Well we’re not talking about practice. We’re talking about rate cuts man. So, I’m pretty exciting to get into it. We’re just talking about the Bank of Canada rate decision. I wanted to note a quote from the central bank here they indicated that, quote, “The outlook continues to warrant a policy interest rate that it was below the neutral range.” So they’re pretty much saying they are done raising rates for the time being. I like looking at what the market is pricing and so there’s a futures market that assigns probabilities to future rate hikes and rate cuts. I have the data from both Canada and the U.S. and talking about Canada later this year the market seeing is 0% rate hike probability and they’re actually saying 11 1/2 percent chance of a rate cut by this summer in Canada. Which would be pretty significant. I mean a rate cut would imply that cycle is over and probably more rate cuts following that. Now if we go to the U.S. looking out all the way to the end of 2019, the markets pricing in a 0% chance of a rate hike and over a 20% chance of a cut years. I mean the fed really did a U-turn ever since the market tanked in q4. They really had their eyes on the stock market, they are concerned about you know financial tightening, tightening of financial conditions, the fed chair. Really walking back his previous comments that they would be mechanical in raising rates. They’re raising rates you know 0.25 percent all the way from they started near the bottom at 0.25 percent a number of years ago and they’re all the way up to what two and a quarter and so they are perhaps done there right hiking cycle as well.
Let’s talk about implications. Well if you have a variable rate mortgage, if you have a line of credit or perhaps even some auto loans they’re all priced off of variable rates prime rates, which are priced off the benchmark rate. So, if you have any sort of floating rate debt just you can expect that to not be going up in rate any time soon at least 2019, I believe that’s firmly off the table. We won’t see any rate hikes for the rest of the year, if not this entire cycle.
Mike: From an investment standpoint what are some ways to play that in terms of that thesis?
Julian: I mean if you look at where rates are, you know short term rates around 2% and the 10 year is still some three percent and so if you believe that those are going to stick around for the long term, then I mean stocks are cheap here. What’s the S&P at 16 times earnings, forward looking earnings, so that’s pretty decent earnings yield and if you compare that to long-term bond yields, I mean it’s kind of the best shirt out of the dirty laundry, right? You got to invest in something. I think stocks are much more attractive than long-term bonds here. Especially if you think rates might be going up, but even if they’re not then I think stocks are the way to go. You just got to kind of take the pain of additional volatility. But if you’re a long-term investor, then I think you should be fine here.
That does it for episode 4 ladies and gents. We’re talking about rate cuts. We’re talking about rate cuts man. So that’s just a shout out to one of the greatest basketball players of all time, Allen Iverson and he’s talking about a practice. So, if you enjoyed the podcast feel free to leave us a review on apple iTunes. Subscribe, of course we love getting your questions so reach out on twitter or flip us an email. Let us know any questions what you want us to talk about on the podcast and we’ll see you next week for episode 5, cheers.
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