Category: Current

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Current International

The USA elections and the reflection on the society

While the votes of the elections in the USA are still being counted, one thing is apparent. Donald Trump did surprisingly well. So well that he might even win the elections. No credible predictor or poll suggested that it might be a tight race. Trump was given an outside chance of between 3% and 15% of winning a second term. Now it looks like the odds are even, and the dream of a “blue wave” is shattered.

More worrying than a second term of a Trump presidency is what the election reflects on the society of America. One would have thought that a president who is accused of rape, who talked about groping girls, who paid less income taxes in the last 15 years than a primary school teacher and who blurs the lines of his own businesses and the state should have had a torrid time at the polls. There were so many books written about his chaotic style of management, his impulsive decision making and his love for dictators and kleptocrats, but hardly a word praising him.  He used teargas on innocent peaceful demonstrators for a photo opportunity and called true American heroes of his own party (like John McCain) cowards. Trump has lied too many times to count and seems to be a blatant racist. Instead of defending the ideals of the free world, America has become the laughingstock of the world.

Any president with that track record would have, in normal times, not had a chance to gain any support. Yet, because of the massively increased voter turnout, there are now probably more people who voted for Trump than in the last elections. That is astonishing and worrying. Do voters even care if their leaders have characters to look up to? Why do so many believe his blatant lies? Besides Trump, Majorie Taylor Greene won a seat in Congress. She is a believer and promoter of the QAnon conspiracies which are at best far-right wacky ideas which make the Nazi propaganda of the 1930’s look like a bad b-grade movie. Why do citizens believe in this non-sense and support leaders who clearly have lost the moral high ground? It is a dangerous slope when minorities are being singled out as delinquent, and the leaders viewed as “a messiah sent by God”.  Where is our society heading to?

But then should we be surprised when we live in a world where most do not read content that is longer than 280 characters, never mind a book. We adore stars not because of their acting talents, but because their willingness to expose their private live on TV. Life ambitions are not formed by your family and those you grow up with, but by complete strangers flooding you with posed pictures on Instagram. And your child makes more money in a year investing their pocket money in some arbitrary code called a cryptocurrency than you do working 5 days a week, 9 to 5.

It is a very turbulent world where we need leaders with a strong moral compass. Instead we are voting for clowns, Rambos, reality TV personalities and fools. It is a sad state of affairs.

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Current

Eskom – how to turn around a ratings-killer

South Africa’s electricity producers pre-audited financial results show that they are living on borrowed time. What should the government do to avoid being dragged down by it?

Eskom the South African state-owned electricity producer and distributor, which effectively has a monopoly, briefed the parliament on their financial situation recently. The picture that emerged was not pretty.

Their debt increased to R488bn. The interest costs were R39.5bn but the operating cash surplus was only R36.2bl. This means that Eskom must borrow more to pay the interest portion on their existing debt. One does not need more than grade 4 maths skills to realise that this is not sustainable. Because the debt burden is equivalent to 12.5% of South African governments total outstanding debt, it poses are very real risk to the South African Government. The Credit Rating Agencies have identified Eskom’s debt burden as the single most important risk.

As the Investors view the South African governments fiscal situation as more unstable (because of the potential Eskom liability), the servicing of the South African government debt will become more costly. A 1% rise in the interest demanded would result in a R38bn increase is debt servicing costs for the South African government. It is more than what the government currently spend on Agriculture & Rural development or what they currently spend on Infrastructure.

To most South Africans it feels like the sinking of the Titanic – previously thought impossible or at least unlikely. As we are about to hit the iceberg, the music is still playing for the intoxicated tenderpreneurs, celebrating themselves and admiring their Captain. Under deck in the cramped quarters, most of the poor are passing their time by dreaming about a better future on the other side, only to be awaken by the thundering roar cause by the crash. As everyone scrabbles to abandon ship, it is once again the poor that find themselves last in line.

What to do?

Eskom is a product of the apartheid system. Since self-reliance was the driving force of capital allocation. Most power stations were built in the late 1970’s and early 80’s. Although many are due to retire over the next 20 years, the date can surely be pushed out by appropriate maintenance, something currently in very short supply.

Most power stations should be sold to private investors, who generally have better incentives to get the best long-term performance out of the Assets.

At the same time, Eskom should offer new owners 10 year and 20 year off-take agreement, thereby giving the power producers certainty over future cash flows. It would also make it easier to fund the purchase of the power stations, because the off-take agreements should be bankable. This would also go a long way to attain the Governments stated goal of creating 400 black industrialists.

Eskom might retain a few power generators, primarily the diesel turbines and the pumped storage systems which only come in service when there is a peak demand, as well as Koeberg, the nuclear power station.

The two main reasons government often sites as why they should not privatise the power stations are senseless. The first one is that they will not be able to control stable power generation. It could hardly be worse than in the current situation. The private sector will be incentivized to supply as much and as consistent electricity as possible, because that’s where they generate their profit. If they don’t do it, somebody else will.

The second reason often cited for not privatizing is that the sales price is probably below what it had cost them, especially their two newly build monsters. That is probably true. Any project that has been overcapitalized will not be worth as much as all the inputs combined. That is the result of bad capital allocation and poor project management.

But getting anything to reduce the debt burden is surely much better than the never ending increasing of the debt burden.

Just look at what private sector companies have done when faced with unsustainable high debt burdens, like EOH, Aspen and Tongaat Hulett. The management sold anything that did not fit into their recovery strategy and used the proceeds to slash their debt.

Eskom would then make a margin on selling on the electricity through their grid. Since they retain the distribution network, the government can make sure that they fulfill their promise of connecting every household to the grid and providing electricity to every South African. Finally the poor would actually benefit from Government policies.

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Current International

The dark side of online shopping

During the Covid-19 induced lockdown, one industry has been doing particularly well. Online retail. Is this the new holy grail for shopping or are does it come with nasty side effects? Are the costs fully priced in?

Besides offering the convenience of shopping from home, online shopping has two big advantages. The first is that the selection offered is much bigger than a brick and mortar shop. Companies like Amazon have got a vast selection of items to spend cash on. The second advantage is that the products are often cheaper than those bought in a physical store. In times like these, cheaper is exactly what most consumers want. The increased demand of goods bought online during the lockdown was so enormous that the e-commerce giants had to hire thousands of new employees. But it was not only the dominant internet retailers that benefited from the shift to online purchases. Thanks to Shopify, building an e-commerce website was within the reach of almost anyone.

The advantages for companies selling their wares online are obvious. They no longer need to rent expensive shop floor space, but cheaper industrial warehouses are adequate. They also do not need to worry about changing their displays and using expensive shopfront props and designers to make their shops inviting. Now they only need to hire a few whippersnappers to create a few new graphics. The armies of bored sales agents and shop assistants are replaced by a handful of call centre agents, mostly outsourced to the cheapest bidder somewhere in the emerging world. And the stock control is much simpler because there is no need for an internal distribution system. The products go directly from the warehouse to the consumer. And best of all, the consumer saves money and time – in theory at least.

The effect on the business landscape has been dramatic. In the USA, 9 300 brick and mortar shops closed in 2019. That number would surely increase dramatically this year, partly thanks to Covid-19. Bloomberg, a financial data provider, estimates that number of shop closures in the USA will be about 25 000 in 2020. Worldwide we have seen a similar trend, although not as dramatic yet. But that will change. The world is evolving and so should businesses. The intense focus on price and efficiency may seem like an undisputed benefit to customers and therefore society, but is that so? Are we counting the full costs of the changes?

Although our capitalistic system has been the greatest driver of innovation, sometime the change did not incorporate all the costs though. Cheap coal fired power stations bring down the cost of electricity by ignoring the costs of the air pollution. Similarly, cheap flights are only possible by not including the costs of the harm of the exhaust fumes. The growing appetite for cheap red meat is partly to blame for the deforestation of the Amazon rain forest. The impact of the deforestation has not been included in the cost calculations because, like the examples above and so many other instances, the costs are external or social costs. It is difficult to allocate the cost to an individual. The cost might not even be borne by a specific country, but by the whole world society. It is not hard to determine who originated the costs, but it is hard to determine who the money should be paid to. So how does the shift to online retail fall within this category?

Simply put, there are few factors not currently considered that count against online retail. For one, it is not an even playing field. An online retailer reach is unconstrained by geography. They can operate across borders and even across different continents. As such, their headquarters can conveniently be located it in a Tax haven. The value of intangibles, such as their brand is also hard to quantify, and they would be able to structure their company in such a way that most of the profits are made in the most least taxed country. That is very hard to do with brick and mortar shops. They typically pay their Taxes where they operate, and as such contribute to the fiscus of their host government.

A second problem is that shopping centres normally have at least one, sometimes more anchor tenants. They might be a big grocery shop, pharmacy, hardware store or department store (although they are going our of fashion fast). The idea is that those well-known shops draw a lot of customers, who need to do their regular shopping there. The small shops surrounding the anchor tenant are line shops and might be anything from mom-and-pop shops to boutique fashion stores, bookstores, delis, food outlets or hobby shops. These are small businesses, owned by an individual, families or small companies. They rely on the foot traffic going past their shopfront. If the big anchor tenants close because they face unprecedented pressure from big online retailers, the small line shops would surely not survive. The evidence can be seen in the USA which is littered by abandoned shopping centres.

The third point is more philosophical. We, the human race are social creatures. We crave human interaction. Solitude leads to destitute. While it is easier to order your groceries from the comfort of your own home, it takes away one more crucial point of human interaction. We also forgo the subtle knowledge we get from talking to our local butcher about the best cuts, or from the advice we get at our local DIY store. We would not act on the recommendations of the in-store beautician, but rather on computer or AI generated suggestions.

Not only do brick and mortar shop employ more people from our community, spend more Taxes in our community but they serve as meeting points, places where we exchange ideas and do what we need to do most – interact with other people. Those are big costs not included in online purchases.

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Current International

This time it is different

As the impact of the Covid-19 disaster unfolds, the politicians and central bankers did not want to be caught napping. They unleashed a stimulus package that makes the 2008 Global Financial Crisis look like a b-rated warm-up act. But will there be unintended consequences?

Historically, Central Banks used the adjustment of interest rates as the main lever to stimulate the economy. As the economy grows too fast, and fears of inflation were emerging, central banks put the brakes on by increasing interest rates. And when the economy falters, they released the brakes again by reducing interest rates. That worked to some degree. Lower interest rates encourages companies to borrow money and invest it, while higher interest rates did the opposite. Central banks are not the only ones able to stimulate the economies, politicians can do it too. However, politicians generally have a noticeably shorter time horizon. Central bankers could afford to act independent and look at the long term.

Policies before the 2008 financial crisis were primarily focused on keeping inflation low. Inflation destroyed a recovering Germany in the early 1920’s and wreaked havoc across the world in the 1970’s. From the 1980’s onward most developed countries and more and more emerging countries began to control inflation by a combined effort of fiscal prudence and monetary restraint.

The war on inflation was seemingly a fading memory by the time the 2008 global financial crisis hit. But since the political response to the crisis was underwhelming, it was up to Central Bankers to come to the rescue. They lowered the interest rate to almost 0%, and where then seemingly running out of ammunition. That’s when the Fed Chairman Ben Benencke announced that the Fed will use their balance sheet, which in US Dollar terms is essentially unlimited, to buy US government bonds across the yield curve.

This would help in two ways. Firstly, the interest rate would stay low and the government can borrow as much as they want at low rates. Secondly, since they would buy bonds on the secondary markets ie from investors like banks and insurance companies, they would inject a lot of cash into the system. The cash could be used to invest in other projects.

Some investors with good memories were wary. Surely the increase in money supply would cause inflation? Not so. Since 2008, most developed markets were struggling to avoid deflation. Inflation is like red wine. You would want a glass a day, but a bottle is detrimental to your health. Economies do well when inflation is at about 2%, poorly when it is when it is below 0% and even worse if it is above 10%. It is the fastest way to lose the value of money, just ask any Zimbabwean.

Inflation has been the least of most economist concerns for years. During the early 2000 the rise of China because of their low cost of production has been a counterweight to stagnant wages in America and rising living expenses across much of the developed world. After the financial crisis, the excess spare available production capacity coupled with the efficiencies gained by better use of the internet and an ever better integration of high tech in normal production (like using robots in car assembly and drones to detect crops that need more attention for a higher yield) has kept a lid on inflation.

In effect of the Covid-19 crisis was truly unprecedented. In the last week of March, the weekly jobless claim was 6.8 million. Previously the weekly jobless claims in the USA reached about 600 000 during times of crisis. The US Federal Reserve Banks response has been equally dramatic. They started buying bonds again at an extraordinary pace. The effect on their balance sheet has been 3 times larger than during the global financial crisis of 2008. This has been met with the responses of the European Central Bank, the Japanese Central Bank and even some emerging market central banks. The politicians have also been much quicker to respond. Altogether, the response to the crisis has been more than 9 trillion US Dollars.

The difference to the financial crisis though is that this enormous injection of cash has not been met with a corresponding destruction in capital. During the global financial crisis of 2008, home prices collapsed and many property developments across the globe were abandoned because the developers went bankrupt. The glut of homes on the market meant that prices stayed low for long and investment bank in the USA had to raise about U$ 300bl to fill the holes one their balance sheets.

This time it is a crisis in the lack of income, because so many economies were shut down. It has (not yet) led to a destruction of capital. Even though we probably won’t see the same record profits generated this year, the global total wealth (capital and income) has increased by the stimulus packages and therefore we could see a consistent upward pressure on inflation, maybe not now but probably in 3 years’ time.

While it is right to focus on retaining the livelihoods of everyone affected by the epidemic, it is prudent to keep an eye out for potential unintended consequences, especially when one of those is inflation.

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Current International

Let’s hope we got this right

This post was originally published in early May

To fight the Covid-19 epidemic though, decisions had to be made. Now, a few months in, the cost of the measures become clear. It is devastating, but according to the politicians and scientists this is the only way to prevent more deaths. Let us hope they are right.

Never before have so many US citizens filed jobless claims so quickly. At the beginning of February the US unemployment rate was near a historic low, but by the end of March, the weekly jobless claims figures were 10 times higher than the peak during the world financial crisis of 2008. Some countries, especially those in emerging markets have performed worse.  Being jobless is devastating. Unemployed become despaired, depressed and suicides go up. Those who managed to keep their jobs are often forced to take a pay cut or unpaid leave. Small business owners must make very tough decisions if they want to survive. Many of their corporate clients have not paid their invoices, at least not in full, in order to preserve their own cash. During the second half of March the Federal Reserve Bank had to quickly step in and provide extra liquidity as many medium to large companies drew all their credit lines available to them. The US Dollar strengthened while emerging currencies collapsed, making it much more expensive for the needy to import medical equipment and supplies. Closer to home, many industries were brought down to their knees. The whole film industry is standing idle, affecting thousands of freelance artists and artisans. Restaurants were ordered to close, many will never re-open. The tourism sector is decimated and is unlikely to recover until travellers have got the confidence that they will not get infected. The side effects of the fight against the Covid-19 virus are brutal, but all policies had one goal in mind, to save lives.

The Covid-19 coronavirus was spreading fast and is killing people.

Experts reminded us of two previous Corona Virus epidemies, the Middle East Respiratory Syndrome (MERS) and the Bird Flu, both of which had remarkably high fatality rates. It was estimated that at least 2 million would die in the USA, and worldwide the figure would be in the tens of millions. Here in South Africa, it was estimated on the 23rd of March that up to 1 million lives would be at risk within the following 40 days. As the fatality models were updated with more accurate data, the mortality came down significantly. It is not clear how accurate the models would be, because the most important measure to epidemiologists, the percentage of the population that has been infected, has not been determined. Instead everybody relied on tests confirming if a patient currently has the virus. That might be useful to doctors (even though there is no medicine for the disease), but not for epidemiologist. Very few ever questioned the models used, as no one wanted to be responsible for thousands of deaths. Let’s hope we used the right models to predict the development of the epidemic.

When the Covid-19 epidemy started in China, the response from the Chinese government was remarkable and quick. The city of Wuhan was locked down, extra hospitals were built in a week, school kids were sent home and the whole economy was shut down. These stories made us wary of this deadly disease. And our suspicions were confirmed when it spread quickly to the northern parts of Italy, where hospitals resembled war zones. Politicians were scrambling for ways to stop the spread of the virus. Even though personal hygiene, including frequent washing of hands and not touching the face has been the gold standard to prevent respiratory virus infections, governments decided to go further. Their response was modelled on the same draconian measures that China took. Schools were closed, factories were shut down, Mines were ordered to stop mining and businesses asked their employees to work from home. Disturbingly though, no extra special measures were put in place to protect those who were clearly the most at risk of dying – those in the old age homes. All the measures helped to flatten the curve of infection.

As the countries are opening their economies up again, it is a good time to reflect. Not to appoint blame, but to determine if the measures taken have the desired impact? A repeat of the hospital scenes of Italy were seen at the Elmhurst hospital in New York. Completely overrun and stretched on all kinds of resources the health workers did a remarkable job with the tools they had. The NHS in the UK was also getting busy, as did some of the hospitals in Spain. But non were as overrun as those in northern Italy or New York, not even those in the southern parts of Italy. We have not heard of shortages of beds in Germany, Netherlands or Australia. Even the developing world did not show any of those chaotic scenes. Here in South Africa, the Life Healthcare Group reported that their hospitals have an average occupancy of 40%, and that their losses amount to a few hundred million already.

 As virus tracers in the Netherlands and Iceland have not found a single transmission from child to parent, we must ask if it is the right policy to keep the schools closed as log as possible. They are facing an ever-daunting task in trying to catch up on the lost schooldays, or more likely redo the whole school year, since anything learned at the beginning of the year will be forgotten by now. Children from richer families would possibly have had some lessons on-line, via Zoom or Microsoft Teams, but it is once again the children from the poor communities that will suffer more. Let us hope the closing of the schools brought more relief than it will cause pain.

Now, 40 days on from when president Ramaphosa was advised that up to 1 million citizens could be at risk, we have only had 6 336 confirmed cases and 123 deaths. The strict lockdown surely had something to do with it, but such a huge variance could also indicate that the models used were wrong. And a flat curve does not matter to the starving and hungry, who cue for kilometres in the hope of getting a food parcel. It also does not matter to the immigrants around the world who are at best ignored and in many cases excluded from any relief efforts. For the people in need this crisis is just about survival, about living or dying. After all, flattening the curve does not mean that people do not get it. The same amount of people get the virus, just over a longer time period, giving the hospitals a chance to cope. Are we better off because of the lockdown? Perhaps, but at an increasing social cost.

As the Covid-19 death toll in the USA surpass that of the 2017-2018 death toll of the seasonal influenza (when 61 000 died according to the CDC), it is obvious that Covid-19 is a very deadly disease. But possibly not as bad as was first expected. Recent antibody tests (which determine if a person has had Covid-19) in the USA suggest that the estimated infected population is between 50 and 80 times higher than first assumed. It might thus be that we are experiencing the tail end of the outbreak, and the only reasons we find increased cases is because every nation is increasing their testing ability. The more you test, the more you will find. These are theories which still must be proven. As with much else about Covid-19, much is uncertain. The economic suffering though is not uncertain. Numbers out this week will show the damage done.

UNICEF has warned that because of the intense focus on Covid-19, 4 million children will miss out getting vaccinated against polio, measles, diphtheria and hepatitis. The World Health Organisation has cautioned that the estimated deaths of Malaria will go up by 300 000 to reach 700 000. Let hope we have the right Covid-19 strategy, knowing that every one of those extra Malaria deaths is because it saved millions from dying from Covid-19. Let us hope we have got this right.

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Current International

How bad is the Covid19 epidemic?

The true severity of the crisis is only unfolding as I am writing this. Currently there are 1.7 million confirmed cases, 108 862 deaths and 404 236 patients have recovered. This equates to a death rate of about 6.4%. The figure though is misleading.

The problem with this strain of the corona virus is that it is transmitted incredibly quickly, and that many patients experience just mild symptoms, some none at all. And since the symptoms are very similar to the seasonal flue, many would have mistaken the signs for those of the flu, thereby did not bother to go to the doctors to get tested.

To get a better understanding of the severity of the epidemic, we would need 100% of a population (or the statistical representation thereof) to get tested for two things: 1) if they currently have the corona virus and 2) if they have had previously had been infected by the covid19 virus. While the first test would only paint the picture of a snapshot in time, the latter test (called an antibody or serological test) would reflect how much of the population has already been affected. Since most public health facilities are currently under severe strain, the antibody test has not yet been rolled out.

Most countries started testing for present Covid19 infections, but because of the relative cumbersome test, most have only tested 0.8% of their population. Outperformers like Germany have manged to test 1.5%. One country stands out though. Iceland has tested almost 10% of their population. Their results paint a more complete picture.

4.87% of the Icelandic population sample tested positive, but alarmingly half of those infected showed no symptoms at all, thus were asymptomatic. 0.65% of the infections turned out to be serious and the Icelandic death rate is 0.47%. But even those figures could be misleading because we don’t know how many were infected by the virus. It could have been that at that population has already gotten to the magical 70% infection rates, where the heard immunisation cause a natural slowdown to further infections as the virus can’t find enough new hosts to spread to. If Iceland is at that point the death rate would fall to 0.003% well below that of the seasonal flue at about 0.1%.

Similar statistics are available from the cruise ship the Diamond Princess where after the outbreak was not being contained, everybody was tested. Of those who tested positive, just more than half showed no symptoms and about 18% would go on to never show any symptoms at all. All this would substantiate that the epidemic has spread much quicker and much further than anybody assumed. This is confirmed by a case of the tragic death of a 15-year-old boy from one of the remote tribes in northern Brazil. They practically have no contact with anybody else, but the virus has announced itself in the most remote regions of the world.  This death also questioned another feature which was established in China.

Practically no Chinese children suffered from the infections of the Covid19 virus. This held true for most parts, but besides the death of the 15-year-old Brazilian, complications of Corona virus infection of the youth are increasingly reported in the UK and the USA. I see a strong correlation between the countries where Tuberculosis (TB) vaccination is mandatory and those were it is not. China tried to introduce the vaccination program in the 1940’s but they were too expensive for most Chinese. After the Communist Party came to power though, they eventually rolled the program out nationwide, and since somewhere in the 1960’s it was mandatory. Some countries used to have a mandatory TB vaccination programs, some don’t have them anymore. Others, mostly African, East Asian and South American still have a mandatory TB vaccination program. The infection levels seem to be very low in those countries. Interestingly, the countries who have not had a TB vaccination program for long, if ever include Italy, Spain, UK and the USA.

Given the wide range of possible scenarios it is right for the governments to proceed meticulous and cautiously, even if the economic impact is very severe. But because of the risk of losing livelihoods, it is important to paint a full picture of the severity of the epidemic, something that can only be done with the antibody tests.

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Current International

The case against share buy-back schemes

Shareholders invest their savings in companies to gain some return on their investment. The norm used to be in the form of dividends, but over time companies have rather been buying back their own shares and assumed that this would increase the value of each share. They reasoned that it is Tax efficiency. It should be discouraged.

One of the great characteristics of a free and vibrant capitalistic economy is that there are many companies who are listed on the various stock exchanges and anybody has the ability to purchase shares in those companies and thereby get their share of the fortunes generated by the companies they invested in. This is non-discriminate allows anybody, no matter what their background is, to participate in corporations’ fortunes by investing in them. Everyone can be part owners without the need of actually establishing a business oneself, something that is much more difficult, stressful and often disappointing than it seems in theory. As a return the companies us the profits twofold. They use part of the profit to invest in future projects that should enhance the future of the company. The rest of the profit is returned to their shareholders in the form of dividends. That has changed over time, and recently many companies preferred to return most of the money due to shareholders by buying back the companies own shares. The reasoning given is that it is a more Tax efficient way of returning money to shareholders, because it would not attract withholding tax but only the much lower capital gains tax, if any at all. There are three reasons why this should be illegal.

Firstly, it muddles the true performance of the company. Management use the capital, that could have been returned to shareholders in form of dividends to pay for shares, and thereby increase the earnings per share (EPS), without increasing the revenue line at all. It suits them, as most of their performance is measured by the EPS, but it shifts more risk onto the shareholder because they now need to time the sale of their shares to realise their value of the apparent increased profitability. But, as it is obvious in the current Covid19 crises, even shares with increased EPS fall in a crash. But is also makes the live of an investment analyst much harder. The timing and the pricing of the bought back shares plays a crucial part of the valuation and the determination of the return on shareholders capital.

Secondly, managers of companies have a very poor record of determining what a fair value is. Anglo American bought billions of their own shares back at the hight of the 2008 commodity bubble. Back then, the share price was approaching R550, which was never to be seen again. The most laymen equity Investor could not have done a worse job themselves. Managers often struggle to unlock value by buying companies, just think of the massive write downs at Woolworths after their disastrous decision to spend half their market capitalisation on a department store in Australia, while there is a worldwide trend away from department stores. Or look at EOH, where the previous management had a never-ending appetite for acquisitions. That worked well when the share price raced to R150, but now at R3.40 their market capitalisation is much smaller than many of their acquisitions. If they have such trouble allocating capital efficiently in their own field of expertise, how would you expect them to judge their own share price realistically and unbiased?

The third reason is the most important though. If the companies always pay out a share of the profits in the form of dividends, it gives the investor the ability to decide themselves what to do with the cash inflow. If they feel that the company is undervalued, they might just buy more shares themselves. But they also can spend the income on anything else they might desire, not necessarily in the investment world. They might use the money to pay towards their next car or might use it pay for their next holiday. Clearly this has got a much wider and a more positive impact on the economy.

In a world where we are once again talking about Taxpayers bailing out big companies, it is important to understand that should the companies just resort to buying back their own shares when they return to profitability, thanks to Taxpayers money, the wider economic impact will be very limited. The main beneficiaries are the managers, followed by the shareholders. The wider society, who are the sole reason for their survival will have limited benefits. Paying out dividends in cash will broaden the impact substantially.

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Current

The illusion of Quantitative Easing

As quantitative easing morphs into a wide-ranging asset buying programs, it is masking the health of the real economy.

The South African Reserve Bank (SARB) has been the latest central bank to dig deep into its toolbox and pull out the unconventional Quantitative Easing magic wand. In the depth of the Corona crisis, over the last few weeks the debt market was marred by very unusual intraday spikes in yields. The liquidity suddenly seemed to vanish, something very rare in such a liquid market. The SARB decided to buy unspecified amounts of bonds to provide the liquidity and normalise the yields, thereby starting their very own Quantitative Easing program.

In 2008, faced by unprecedented financial liquidity constraints, Ben Bernanke, the Fed chairman at the time, unleashed an economic stimulus bazooka called Quantitative Easing (QE). Essentially, the Reserve Bank would print new money to buy Government Bonds, so that anyone holding bonds (like Banks, Insurance companies and Investment Funds) could sell them to get access to cash, without causing a rise in the yield (and therefore a loss of capital). This proved popular because in theory, a Reserve Bank, operating in a free-floating currency market, has got an unlimited balance sheet capacity. QE was adopted by a few big Central Banks in the developed world, who were facing liquidity crunches and were desperate to keep the yield low.

A low yield has got a very wide impact on the economy. Firstly, it means that the Government can borrow more capital without paying more in interest. Therefore, the Governments, on paper at least, were able to stimulate the economies with borrowed money. But countries like Germany and the UK steered their way to fiscal prudence instead of stimulating the economy. The USA in contrast spent billions on foreign wars instead of revitalising their creaking infrastructure.

The second big beneficiary of low yields are banks. They can borrow at the Reserve Bank cheaply. The assumption is that they would pass on the low interest rates to their clients. It is doubtful how successful this was, since the banks had to grapple with ever increasing reserve requirements and snowballing compliance, thus were shy to lend their money out again. In-fact, a popular trade was a carry trade, i.e. using their cheap borrowing to invest in investment grade bonds thereby earning the small differential in interest – almost risk-free.

The third beneficiary of low yields were big companies who had the ability to issue their own bonds and sell them to investors. Since the alternative, the low yielding government bonds did not pay much, investors were happy to snap up any investment grade corporate debt yielding just slightly more. Companies like Apple found it more efficient to borrow money to pay dividends than to use their vast cash reserves. Second Tier companies also benefitted from the low yields, because even though their debt is sub-investment grade, they only had to pay yields slightly higher than their class-one peers. The result was a debt binge, with too many companies taking on too much debt. Now the Fed and the European Central Bank have announced that they will not be restricted by sovereign debt, but also buy corporate debt.

Big and listed companies benefit from low interest rates in another way. Since the sovereign debt is issued in the countries currency it is essentially the safest investment, and all other investment valuations take that as a yard stick. If the US 10 year debt yields 0.5%, then all other investments would need to return more than that, and the quantum is determined by the risk that the investment poses, ie the risk premium. Financial Research Analysts value shares of companies as a more attractive investment opportunity if their projected return would be higher than the risk free rate (10 government bonds) plus the assumed risk premium of the company. Thus, big dominant company with plenty of cash on their balance sheet could issue shares which would be prized much higher because of the low demanded return. Because of that, the internal rate of returns only needed to be relatively low. The effect has been a lot of money is being spent on projects that otherwise would have never passed the investment grade hurdle and will fail to enhance shareholders value. Another effect was that countless companies borrowed money to buy back their own shares. Earnings per share would grow, even if there was no actual top line growth, i.e. growth in turnover.

All this masks the health of the “real” economy. The trickle-down economic assumptions did not reach the masses. Most employees in the USA, as an example, are employed in the small or medium size enterprises (SME). It is much harder for these companies to benefit from the low interest rate environment. They are not able to issue bonds, and if they do, their quantity is so low that no institutional investor would bother looking at them. For most small businesses and start-ups it is very hard to borrow any money from banks, and if they do, the conditions are very onerous and combined with personal sureties. Therefor their “hurdle rate” is much higher. They have not been able to grow their businesses at the same pace as big companies have. This thirst for growth by the big created massive price increases for scarce resources. Specialized labour became very expensive (and they in turn increased the price for limited resources such as property beyond most affordability levels). These distortions are not reflected in inflation figures, because as long as the productivity gains equal or exceed the cost escalations, the cost per unit stays the same or falls. The main beneficiaries were big companies and e-commerce companies, not the small construction companies or the neighbourhood shops.

This has led to big distortions. California has just experienced the longest period of growth, but they have also had a massive increase in the homeless population. A recent survey found that 1 in 10 households across the USA would not be able to handle an unexpected $400 bill. These are not the typical signs of boom years, rather a worrying sign of policies not working. Much of the stimulus plans just passed by the American government to counter the effects of the Corona Virus relies on the type of trickle-down economics that has failed over the last 10 years. At some point the politicians need to step up and take the responsibility of building stronger more diversified economies rather than relying on Central Bankers to increase the economic activity, because they are always only able to target the big companies and hope for the stimulus to trickle down to everybody else.

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The right medicine

A few remedies the government should pursue.               

No country is spared from the worldwide Corona covid-19 virus outbreak. The incredible infectious disease spreads like wildfire and leaves in its wake thousands dead and economies on its knees. Never has it been this important to have strong political leadership. On the surface it looks like Namibia is relatively unaffected, with only two reported cases and three suspected cases. But is it, and is it sensible shutting down most of the economy for such a minor outbreak?

Luckily, we have many countries to learn from. The low number of reported cases is probably due to the lack of testing (it doesn’t help that the biggest health insurance companies said that they will only cover the cost for tests that come back positive).  South Korea tested 10 000 citizens for every 1 million to gain a detailed understanding of how far the virus had spread and which areas were more affected. In comparison, the USA thought that they were mostly unaffected bar a few outbreaks in Washington state. But since they started properly testing a week ago, their numbers have suddenly risen to more than 120 000, increasing hourly. Namibia needs a massive test roll-out. People who show any symptoms should be visited by mobile test units, not to clog up the already strained hospitals. Just as you can’t fight an enemy if you can’t locate them, is it impossible to target a containment if you don’t know how widespread the disease is.

The second major challenge is how to support an already fragile economy. What to do. Firstly, all Namibians who have contracted the virus should automatically qualify for a N$10 000 payment. It might not be much for some, but for most Namibians it will go a long way to support them during the 2 weeks of isolation. Secondly, businesses should be encouraged to keep all their workers on their payroll during an eventual shut-down. To help, the government could offer to pay for 50% of the wages and salaries of all employees who work for a company with a turnover of less than N$10 million, 30% for companies with turnovers of between N$10 and N$20 million and 10% for the rest. To prevent the start of another Gravy Train, the government should use last years Tax returns. Businesses that honestly contribute to the fiscus should also be first in line to receive a handout.

Thirdly, the government should seriously consider a shutdown. Namibia has more to lose than most other countries when it comes to tourism. The tourist sector not only employs vast amount of people but is also a relatively big sector of the economy. But tourist simply won’t come back if they perceive Namibia not to be clear of the Corona Covid-19 Virus. It is the perception that counts. just as the tourists stayed away from Tunisia after the terrorist attack, would they stay away from Namibia if it is not perceived to be on top of the outbreak. Just as the tourists stayed away from Tunisia after the terrorist attack, they would stay away from Namibia if it is not perceived to be on top of the outbreak.

Decisive action by the government now shows the seriousness that they treat the problem and gives credibility. And credibility is what’s needed.

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The outsider President

The impeachment trial of Donald J Trump was a showcase of a pretentious and dysfunctional American political system.

If one would have asked the average American citizen 10 years ago what the chances would have been of electing Donald Trump as the president of the USA, it would have been in the low single digits, most probably close to zero. There were good reasons for this. For one, his character is flawed. A few of his companies have declared bankruptcies, causing pain and suffering to all those who worked there. Lenders had to take losses but somehow, he emerged with a majority stake. Within the financial system he was treated with suspect, and most lenders would not give him new lines of credit. His Tax returns are never released, and it is speculated that he used obscure laws to avoid paying any Tax. He was recorded bragging about groping females, a crime in itself, which he just dismissed as “locker-room talk”. He spreads rumors and falsehoods, makes up facts with no evidence at all.

Yet, in 2016 he won the elections against Hillary Clinton, a hard-working seasoned politician who had a track record of working across the party lines to make progress. But the voters were yearning for an “outsider”, someone who is not seen as being part of the Washington elite. And so, they voted for Donald Trump.

During his tenure as president, Donald Trump did and said many things that were not statesman’s like. He ridicules the press, especially those who are critical of him. He mocks opponents and lampoons public servants who put up any resistance to his impulsive policies. Hi antics remind of cheap reality TV shows, not the president of the USA. While they were obnoxious, they were not law breaking.  But then he crossed the line. The president asked his counterpart in the Ukraine to start an investigation on his most likely opponent in the upcoming elections, hoping to dig up some dirt on Joe Biden. Mr. Trump coerced them into doing it, by withholding military aid to the Ukraine, even though they are an ally at war. Using the president’s office powers to coerce a foreign government to essentially interfere in local elections to gain personal favor is against the law. When this was leaked to the press, the presidency did their best to cover everything up. Nevertheless, the House of Representatives decided to investigate. In the process of gathering evidence, the White House refused to provide any documentation that could be used as evidence and reprimanded officials from testifying. But there was enough circumstantial evidence for the House of Representatives to impeach the president.

As such a trail was set in the upper house, the Senate. The Senate is essentially the third leg of the American democracy, a counterbalance to the abuse of power in the White House, because they have the power to impeach a president who has gone rouge. Each Senator swears an oath to uphold the Constitution, and to govern in the spirit of the founding fathers. They are meant to be independently minded, to rise above the party lines and to ensure that the US citizens needs and desires are addressed fairly by the US government, and that their individual liberties are not adversely impacted. As such it was, even if predictable, astonishing to see that only 1 of the 100 senators decided to vote with his own consciousness, proving at least partial independence. Mitt Romney of the Republicans was later chastised by Donald Trump and vilified by the right-leaning media. Yet he did exactly what was asked of him, apply his independent mind to the question at hand.

Clearly, there might  be numerous Democrats who would have truly believed that the president should be impeached on both counts, just as well as there might have been numerous Republicans how did not think so. But that there is no other Senator willing to cross the party line to show their independence indications that it was more important for the senators to vote with their party, than it is to display their independent mind. It thus questions the need to have a Senate in the first place.

But this would have not come as a surprise to those of us who followed the whole proceedings. From the outset, without hearing any argument or evidence, the majority leader of the House, Mitch McConnell said that he would support the president and work closely with the White House. That is like a judge saying that they would work closely with the burglar who was accused of breaking in and stealing to ensure his innocence. The Republicans then proceeded to not call any witnesses who might have shed more light, and who were barred by the White House to testify in the lower house. Clearly this was not the making of a fair trial, but a rushed through procedure where the outcome was never in question.

It seems that the voters who wanted to vote for an outsider, someone not associated with the Washington elite, someone who would clear up the system of cronyism have voted for one that is a master at the above, Donald Trump.