"After reading this article, do any Chinese Banks or Russian energy companies come to mind?"
Introduction
The first thing I should mention is that I absolutely do not recommend purchasing stock in any of the companies he mentions in this article.
It’s actually kind of funny because Vivi (one of my younger sisters) said at dinner tonight that she needed stocks to buy for her mock stock market investment project. [Very] sarcastically, I stated “definitely invest all of your money in small Chinese Banks and Russian energy companies”. Very ironic that, apparently unsarcastically, this “Chief Economist” is recommending the same thing. It is very important to know that Russian energy companies (and banks), as well as Chinese Banks are trading at very low levels for a VERY good reason. First, let’s start with China:
Chinese Banks
Important fact #1 about China – there is no market – emerging or developed – that is more prone to bank runs than China. The Chinese government has an “implicit” guarantee that it will bail out banks if they are at risk of failure due to a bank run. By “implicit”, what they are actually saying is “I want to give your customers a certain level of assurance, but should there actually be a bank run so horrible that you are at risk of shutting down, we will sit down and decide if we want to screw you over or not”. There was a rural bank in China that had a 3-day run before the Central Bank stepped in and said “your deposits are protected”, and things calmed down. Did they actually do anything other than say “everything is going to be okay”? Nope. Would they have done something had the bank run continued? I guess we’ll never know, but my guess is they would have let it die.
Wealth Management Products (WMPs)
So why do bank runs have anything to do with valuations on a Chinese financial institution? Because they are related to this “super-safe” reserve requirement that the author refers to. The number, to be exact, is 20% (slightly higher for large banks, slightly lower for smaller banks). Basically, for every $1 the bank takes in, they can lend out $0.80. The rest must be kept either in the bank vault or on deposit at the central bank. The problem with this what the Chinese euphemistically refer to as “Wealth Management Products” or (WMPs). These WMPs have ballooned to approximately 10 trillion yuan (4Q2013) – more than double since the same time 2 years prior. WMPs are advertised by banks as high-yield accounts and work like this: The bank depositor wants a higher yield, so the bank recommends investing in riskier loans to generate higher yields. However, due to strict banking laws, most Chinese banks are not allowed to hold certain loans on their balance sheets below certain credit levels. To get around this, “trust companies” were invented to take these customer deposits. These trust companies pay a commission to the bank for advertising their services, then invest the money in junk-grade debt. How do they do this? The bank either originates “risky” loans and sells them to the highest-paying trust company to keep them off its balance sheet or the trust lends the funds directly to the company. The company (receiving the money) then deposits that money at a bank, invests it in their newest project, or (interestingly enough) reinvests them in a WMP to complete the process again for a different company.
When there is money from one place loaned to another place to be reinvested back in the same place again (and repeated over and over again) you have what we call a house of cards. As property values continue to increase in China (the author mentions that Beijing prices have quadrupled), property owners can continue to borrow against these increases. If this whole “sell subprime loans to investors because property values just continue to go up” thing sounds familiar – it’s because that’s exactly what happened in the years leading up to the 2007-2008 financial crisis. Apparently people are noticing the issue sooner this time and, in response, have sold their stock in Chinese banks to reduce their risks (thus driving down the P/E ratios referred to in the article).
Russian Energy Companies
As for Russian Energy companies, I just cannot get over the authors rationale for buying. He says, “As for the other value play, Russian energy companies, they trade at similar and in some cases, even more depressed prices, i.e., approximate average price-to-earnings ratios of 4, and price-to-book ratios of 0.60. Sure, there is a degree of corruption risk, but then that doesn’t seem to hold off investors buying Philippine or Indonesian stocks at about four times the price”.
The author summarized: Russian Energy companies are a good buy because they trade at low earnings and book ratios and the corruption in Russia is just as bad as some other countries. Solid.
My short-but-sweet two sense on Russian Energy (Gazprom in specific) is that Europe gets about 25% of their natural gas from Russia. Ukraine is currently in talks with Slovakia to provide natural gas to the country should Russia disrupt the supply. The United States is also more than capable of shipping LNG to supply the 25% shortfall in Europe should Russia continue to cause problems – the US Congress would just have to approve it. If our politicians are serious enough about cracking down on Russia, this outcome is a strong possibility. What’s the outcome of this? The Russian energy industry is screwed, and minimally higher natural gas prices for Americans (about $1 per thousand cubic feet based on my research earlier this semester).
Conclusion
I don’t think I’ve ever read an article that made less sense than what Mr. Martin Hennecke has just written. He rationalizes buying extremely risky stocks by saying they trade at “historically low ratios”. Keep in mind that this is right after he belittles investors for piling into funds due to their “past performance” (which obviously don’t guarantee future results). This is very frustrating for me – a solid investing plan should be based off of more than just a couple ratios. They are certainly an important part of the “big picture”, but nevertheless not the entire picture. Moral of the story is this guy is a joke. I don’t know anything about “The Henley Group Limited”, but I wouldn’t hire this guy as a middle-school finance club advisor let alone the “Chief Economist” of my company.
This is the catch-22 of financial news… the only people that I want to listen to are the ones who aren’t talking. The people who are smart enough to know what they’re talking about are making money in hedge funds, not running their mouths on air so that they can write “regular guest on CNBC and Bloomberg” on their article’s “about me” blurb. Ridiculous recommendations are what keep these guys on the air. After all, what’s so interesting about hearing “I think equities are going to remain flat for the year, and markets are fairly priced.”? These guys love it when hell breaks loose and they can make comments like “x company is going to zero” or “buy stock in the worst companies on earth.
The first thing I should mention is that I absolutely do not recommend purchasing stock in any of the companies he mentions in this article.
It’s actually kind of funny because Vivi (one of my younger sisters) said at dinner tonight that she needed stocks to buy for her mock stock market investment project. [Very] sarcastically, I stated “definitely invest all of your money in small Chinese Banks and Russian energy companies”. Very ironic that, apparently unsarcastically, this “Chief Economist” is recommending the same thing. It is very important to know that Russian energy companies (and banks), as well as Chinese Banks are trading at very low levels for a VERY good reason. First, let’s start with China:
Chinese Banks
Important fact #1 about China – there is no market – emerging or developed – that is more prone to bank runs than China. The Chinese government has an “implicit” guarantee that it will bail out banks if they are at risk of failure due to a bank run. By “implicit”, what they are actually saying is “I want to give your customers a certain level of assurance, but should there actually be a bank run so horrible that you are at risk of shutting down, we will sit down and decide if we want to screw you over or not”. There was a rural bank in China that had a 3-day run before the Central Bank stepped in and said “your deposits are protected”, and things calmed down. Did they actually do anything other than say “everything is going to be okay”? Nope. Would they have done something had the bank run continued? I guess we’ll never know, but my guess is they would have let it die.
Wealth Management Products (WMPs)
So why do bank runs have anything to do with valuations on a Chinese financial institution? Because they are related to this “super-safe” reserve requirement that the author refers to. The number, to be exact, is 20% (slightly higher for large banks, slightly lower for smaller banks). Basically, for every $1 the bank takes in, they can lend out $0.80. The rest must be kept either in the bank vault or on deposit at the central bank. The problem with this what the Chinese euphemistically refer to as “Wealth Management Products” or (WMPs). These WMPs have ballooned to approximately 10 trillion yuan (4Q2013) – more than double since the same time 2 years prior. WMPs are advertised by banks as high-yield accounts and work like this: The bank depositor wants a higher yield, so the bank recommends investing in riskier loans to generate higher yields. However, due to strict banking laws, most Chinese banks are not allowed to hold certain loans on their balance sheets below certain credit levels. To get around this, “trust companies” were invented to take these customer deposits. These trust companies pay a commission to the bank for advertising their services, then invest the money in junk-grade debt. How do they do this? The bank either originates “risky” loans and sells them to the highest-paying trust company to keep them off its balance sheet or the trust lends the funds directly to the company. The company (receiving the money) then deposits that money at a bank, invests it in their newest project, or (interestingly enough) reinvests them in a WMP to complete the process again for a different company.
When there is money from one place loaned to another place to be reinvested back in the same place again (and repeated over and over again) you have what we call a house of cards. As property values continue to increase in China (the author mentions that Beijing prices have quadrupled), property owners can continue to borrow against these increases. If this whole “sell subprime loans to investors because property values just continue to go up” thing sounds familiar – it’s because that’s exactly what happened in the years leading up to the 2007-2008 financial crisis. Apparently people are noticing the issue sooner this time and, in response, have sold their stock in Chinese banks to reduce their risks (thus driving down the P/E ratios referred to in the article).
Russian Energy Companies
As for Russian Energy companies, I just cannot get over the authors rationale for buying. He says, “As for the other value play, Russian energy companies, they trade at similar and in some cases, even more depressed prices, i.e., approximate average price-to-earnings ratios of 4, and price-to-book ratios of 0.60. Sure, there is a degree of corruption risk, but then that doesn’t seem to hold off investors buying Philippine or Indonesian stocks at about four times the price”.
The author summarized: Russian Energy companies are a good buy because they trade at low earnings and book ratios and the corruption in Russia is just as bad as some other countries. Solid.
My short-but-sweet two sense on Russian Energy (Gazprom in specific) is that Europe gets about 25% of their natural gas from Russia. Ukraine is currently in talks with Slovakia to provide natural gas to the country should Russia disrupt the supply. The United States is also more than capable of shipping LNG to supply the 25% shortfall in Europe should Russia continue to cause problems – the US Congress would just have to approve it. If our politicians are serious enough about cracking down on Russia, this outcome is a strong possibility. What’s the outcome of this? The Russian energy industry is screwed, and minimally higher natural gas prices for Americans (about $1 per thousand cubic feet based on my research earlier this semester).
Conclusion
I don’t think I’ve ever read an article that made less sense than what Mr. Martin Hennecke has just written. He rationalizes buying extremely risky stocks by saying they trade at “historically low ratios”. Keep in mind that this is right after he belittles investors for piling into funds due to their “past performance” (which obviously don’t guarantee future results). This is very frustrating for me – a solid investing plan should be based off of more than just a couple ratios. They are certainly an important part of the “big picture”, but nevertheless not the entire picture. Moral of the story is this guy is a joke. I don’t know anything about “The Henley Group Limited”, but I wouldn’t hire this guy as a middle-school finance club advisor let alone the “Chief Economist” of my company.
This is the catch-22 of financial news… the only people that I want to listen to are the ones who aren’t talking. The people who are smart enough to know what they’re talking about are making money in hedge funds, not running their mouths on air so that they can write “regular guest on CNBC and Bloomberg” on their article’s “about me” blurb. Ridiculous recommendations are what keep these guys on the air. After all, what’s so interesting about hearing “I think equities are going to remain flat for the year, and markets are fairly priced.”? These guys love it when hell breaks loose and they can make comments like “x company is going to zero” or “buy stock in the worst companies on earth.
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