InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
MAY 3 , 2017
Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.
Tonight, in IntelDigest, we continue a review of the economic landscape and investment opportunities this year. Please refer to the April 26 issue for the beginning of this review and our exposition on three areas of investment which have high growth potential going forward.
Because people and the markets are losing confidence in the ability of the Trump Administration and Congress to adopt stimulus measures for the U.S. Economy, we are entering a holding pattern in the markets. We believe that the broader market advance is stalling, and will not advance significantly until a Tax Reform law becomes a reality. As we do not expect that to happen until this Fall, at the earliest, we are focusing on specific sectors which have real growth potential despite the vagaries of American politics.
Thesis: Japanese Equities
The leadership of Japan … including Prime Minister Shinzo Abe and
central bank head Haruhiko Kuroda, Governor of the Bank of Japan … are concerned about the Japanese economy slipping back into deflation, after 25 years of virtually-nonexistent growth. They are prepared to use extreme measures to spur the economy.
The Japanese government is actively buying Japanese stocks, having already bought government and corporate bonds worth Billions of Dollars. The leadership is willing to do a good deal more money printing, as well as investing Billions in the equities of the country’s biggest businesses.
The inevitable result will be a falling Yen, and rising stock prices.
We are invested in a fund which grows with the increases in Japanese equities, but is not seriously impacted by a lower Yen.
Thesis: Virtual (Online) Banks
Online banking organizations are the same as traditional banks, except they operate without brick-and-mortar branches. These banks make their profit like traditional banks … borrowing money at low interest rates and lending it out at higher rates. But they can do so with greater profit margins because they don’t carry Millions of Dollars in brick-and-mortar overhead.
Successful virtual banks concentrate on real estate investments, using leverage (borrowed money) to amplify gains on the cash invested in properties. In fact, real estate investments are handled pretty much the same by online banks, by the biggest traditional banking corporations, and by you and me. In each case, the buyer’s equity in a real estate purchase consists of a small percentage of the actual purchase price, with a mortgage loan accounting for the lion’s share of the money in the deal.
As an example: a property is purchased for $500,000, with a 10% downpayment of $50,000. The buyer’s equity in the property is 10% of the value. The buyer is leveraged 10-to-1. If the value of the property increases by $50,000, this is a 10% increase in the property value. But, for the buyer, it is a 100% increase in the buyer’s equity!
This illustrates the power of leverage; it is also a simplified, but fairly accurate, description of the operations of most of the country’s big banking companies, such as JPMorganChase.
The typical Virtual (Online) Bank accomplishes similar returns on equity with MUCH LESS LEVERAGE than traditional banks. And, the Virtual Banks where we have invested are paying dividends of 10-11%.
Thesis: “Short” Shopping Malls
The Online Shopping Trend … popularized by Amazon.com, but expanding rapidly every year with retailers of all stripes … is draining the life out of shopping malls. Big-box stores, high-end anchor stores, and the smaller businesses which fill in the rest of the space in the shopping malls, are all contracting or downsizing or simply putting up “Going Out of Business” signs.
This is very bad news for those real estate companies which own and/or operate mall properties. It’s bad enough when anchor stores such as Macy’s and J.C.Penney’s announce closing dozens of stores. But, the smaller stores … referred to as “inline tenants” … are also struggling. This may hurt mall owners more, because inline tenants pay higher rents per square foot than anchors do.
Selling-Short certain real estate companies which own retail malls is a rational investment strategy for at least the next few years.
Thesis: “Short” Automobile Lending
Serious problems in the Automobile Lending industry center on subprime auto debt. Auto sales have been booming over the last few years (since the Financial Crisis), but much of the increase in sales came from cheap credit extended to subprime borrowers.
Statistics show that auto loan delinquencies and defaults were up in 2016, and these trends are accelerating in the early part of this year. Used-car prices are down; New-car sales are down. Delinquencies and defaults are rising to levels not seen since the Financial Crisis.
Warnings about automobile sales trends and/or subprime auto debt have been issued lately by Morgan Stanley, Bank of America, the Federal Reserve, and other regulators and debt-rating agencies.
With ever-rising delinquencies in the $1.16 Trillion auto loan market, the Federal Reserve Bank of New York has expressed its “serious concerns” for the industry.
Auto lenders will be hurt as more and more less-than-credit-worthy-borrowers default on their loans; lenders typically have to write off part of the loans on repossessed vehicles. More defaults also translates to oversupply of used cars and lower used-car prices. This is bad for both auto sales and for the lenders. For lenders, cars are the collateral for their loans. As used-car prices fall, lenders are more exposed to larger credit losses
Our thesis is Selling-Short certain auto lenders.
Thesis: Growth of Emerging Markets
Emerging Markets, especially in Asia, have high economic growth rates, typically twice the growth of the developed world in recent years. For example, in 2016, emerging market GDP grew at a 4.1% rate compared to 1.6% in advanced economies.
However, the higher volatility and perceived risk of emerging markets have kept the majority of investors from taking a chance on such investment.
Our thesis is that an investment fund which can control volatility by investing in the most stable companies in the world’s fastest-growing regions is worth consideration.