Ubiquity, Government and Business
In last month’s Capital Comment News we talked about businesses needing capital to expand and how investors can fill that role through Active Participation. Feedback from that newsletter got me thinking again as to where “business” now stands, where its future is, and what opportunities that brings.
Is this the real life?
Is this just fantasy?
Caught in a landslide,
No escape from reality
Queen - Bohemian Rhapsody. See them live at Wembley here.
In last month’s Capital Comment News we talked about businesses needing capital to expand and how investors can fill that role through Active Participation. Feedback from that newsletter got me thinking again as to where “business” now stands, where its future is, and what opportunities that brings.
Long time readers of my newsletters will know I’m a fan of John Maudlin’s “Thoughts from the Front Line” and “Outside the Box”. Well recent issues entitled “How Change Happens” and “Financial Markets, Politics and the New Reality” provided the stimulus I needed to delve deeper into this subject.
How Change Happens
It’s not the first time John Maudlin has discussed the interrelation of seemingly random events in his newsletters – in fact he says “this is an encore appearance of the letter that is clearly the most popular one I have ever written”.
But what drew me again to this issue was the paragraph “Today we will look at what complexity theory tells us about the reasons for phenomena as apparently diverse as earthquakes and the movement of markets. Then we’ll look at how New Zealand, Fed policy, gold, oil, and that lone investor in St Louis are all tied together in a critical state”.
It’s quite a long article, with headings “Ubiquity, Complexity Theory, and Sandpiles”, “The Critical State”, “Fingers of Instability”, ”We are Managing Uncertainty”, and “A Stable Disequilibrium”. But it’s well worth reading and you don’t have to be a Maths major to understand it. In essence it puts forward the notion that when things are unstable it’s not the last grain of sand that causes the landslide, it’s the underlying instability of the system itself.
What’s relevant to this period in history is it wasn’t the sub-prime mortgage, or the collapse of Lehman Bros that triggered (this) Global Financial Crisis it was the fundamentally unstable system as consumers worldwide borrowed money for all sorts of things because times were good. House prices always went up, house loans were cheap, you could borrow 100%, the banks were chasing people to borrow money, and you didn’t need to prove income with low-doc loans. Greed (or rather reward with no input) took over and who knows what sub-prime loan was the final grain of sand that started the landslide.
As John says “The world financial system allowed too much risk to be taken on, then spread that risk far and wide through fancy new financial engineering and securitisation. Many investors and pension funds thought that by buying a lot of different types of securities they were diversifying their risk, when in fact the same connected risk ran through almost everything”.
The fact is while in Australia and New Zealand we may have missed the worst of the GFC we will be affected as the U.S. and Europe recover from the debt burden. And according to John Maudlin – and many other economists – that’s going to take some time.
Financial Markets, Politics and the New Reality
George Friedman, the well known geopolitical analyst and author of “The Next 100 Years” is often quoted by John Maudlin. George’s view is that politics and the markets always interact and it has only been the prosperity of the markets in the recent generation that has allowed the structure to remain unchanged. After 2008 that stability was no longer possible. “The investors’ problem is they mistake the period between 1991 and 2008 as the norm and keep waiting for it to return. I saw it as a freakish period that could survive only until the next major financial crisis – and there always is one”.
His article examines the European Union and the Euro currency. He makes the point that they were created for political reasons – namely to stop the wars that had torn Europe apart for the first half of the 20th Century and economic considerations were a means to an end.
He says “The world is not unpredictable, and neither is Europe nor Germany. The matter at hand is neither what politicians say they want to do nor what they secretly wish to do. Indeed, it is not in understanding what they will do. Rather, the key to predicting the political process is understanding constraints – the things they can't do.
“Investors' view that markets are made unpredictable by politics misses two points. First, there has not been a market independent of politics since the corporation was invented. Second, politics and economics are both human endeavours, and both therefore have a degree of predictability”.
His conclusion is we have entered an era in which political factors will dominate economic decisions, and traders who wait for the old era to return will be disappointed. To read it all click here.
Low Interest Rates and Deflation
There are numerous articles out of the U.S. and Europe predicting an extended period of low interest rates and a deflationary environment, largely from government intervention as a result of the GFC. A good example is the Hoisington Quarterly Review and Outlook, again courtesy of John Maudlin, which amongst other things, shows “Excessive Debt leads to Extended Episodes of Low Interest Rates”.
Here in New Zealand firms participating in the Reserve Bank's quarterly survey have pared back their expectations for rising consumer prices over the next two years after inflation dribbled to its slowest pace in 13 years in the second quarter.
Bearing in mind the interconnectivity of the world, and government intervention, we would expect an extended period of low interest rates and low inflation in New Zealand. In such circumstances the “investment capital gains” to be made lie more with increasing the revenues and profits of a business than simply waiting for inflation to increase the value of a passive asset like a house. Indeed it could be said that the trouble the world is in now is due to leveraged speculative investment in which the participant added no real value at all.
Business is Looking Good
We know there is a strong demand for good businesses but supply is down. It seems - with SMEs especially - owners are holding on to their business as alternative investments show such low returns.
For example, term bank deposits typically return between 2% and 5.5% depending on the term. Non-banks such as building societies and finance companies do offer higher rates say up to 9% for 5 years. See interest.co.nz chart here. Meanwhile business owners are achieving returns on investment of between 20% and 40%. They also see the value of their business growing with the demand for goods and services increasing as the economy returns to normal after the downturn caused by the GFC.
I was delighted to read economist Rodney Dickens’ Ravings of a month or so ago giving “An Optimistic Perspective on NZ’s Economic Growth Prospects”. In the introduction he says “New Zealand has a small domestic market and it is a long way from consumers in Asia, the US and Europe, both of which create challenges for local firms looking to grow. But burgeoning technology, including more than just information technology (IT) has created opportunities for innovative Kiwis. New Zealand’s longer-term economic growth prospects don’t rely on the sorts of things economic forecasters focus on (i.e. consumer spending, residential building and export prices). And in general it doesn’t rely on the current large companies. It will depend largely on the ‘new economy’ companies that will drive employment and even export growth in the future”.
His article reviews the fascinating range of “new economy” companies that have popped up all over New Zealand in the last few years. He says “Some have come out of university-related and other incubators, but many reflect the innovative ideas, perseverance and hard work of Kiwi inventors”.
Most of the examples quoted are export oriented. You can read the article and the examples quoted here. And if you’re looking for a way to participate in NZ start up companies you can do so via the Global From Day One Fund. By the way this Fund closes on 31 August - the end of next week – so if you’re interested get back to me now..
From the enquiries our sister company Tabak Business Sales are receiving it seems people are already thinking now is a good time to buy a business. Banks are back lending, new financiers are entering the market, the baby boomers are looking for alternative investments, and on today’s market where fair value is based on past EBIT, there’s plenty of room for the “investment capital gains”. So if you’re looking to buy or sell a business they’ll be more than willing to help.
If you subscribe to our Capital Comment Opportunities you will have seen some of the business investment opportunities we currently have on offer. I’m updating this in the next few days so if you’re not on the subscription list and you’d like to get that newsletter, simply reply to this email with Subscribe Opportunities in the subject line.
In the meantime if you’re looking for finance to buy a business - or to expand an existing one – we’d be happy to assist. We specialise in arranging loans for business and all forms of property and have access to all bank and non-bank lenders and private equity.
Cheers
JP
John Paine
TBK Capital Limited
Level 15, BDO Building
120 Albert Street
Auckland 1010, New Zealand
Phone +64 9 307 3257
Fax +64 9 309 4519
Mobile +64 21 902 901
Email john.paine@tbkcapital.co.nz