FMC (FMC) has two big problems. It’s agriculture solutions business is too exposed to Latin America in general and Brazil in particular, and the stock is not cheap enough given the dismal near- and mid-term forecast for Brazil. In 2014 52% of revenue from the company’s agriculture solutions unit came from Latin America.
How bad is business in this region? Take a look at Brazil, the biggest economy in the region and the biggest basket case.
Brazil’s economy shrank in the first and second quarters of 2015 with annualized growth in the second quarter contracting at a 2.6% rate. Analysts and economists are projecting that the country will finish all of 2015 in the red with the economy contracting by 2.5%. Things do get better in 2016 but not quickly and not by whole lot. Forecasts for 2016 have recently moved from a modest 0.3% expectation for growth to a call for a further 0.3% contraction. With inflation running at 9.56% year over year as of July—well above the government’s target of 6.5%– and with the Banco Central do Brasil determined to raise interest rates to fight inflation, another year of pain seems all too reasonable. At 14.25% in September, the bank’s benchmark interest rate was already the highest in nine years. Consumer interest rates in Brazil can go as high as 85%, according to the central bank. As you might imagine interest rates like that have put a big crimp in domestic demand.
Including in the agricultural sector where farmers use credit to buy the agricultural chemicals that FMC sells. Inventory for those chemicals in Brazil now stand at as much as a season’s worth of supply according to Credit Suisse. In that supply/demand environment pricing pressures—all in the downward direction—are severe. A plummeting real, which makes everything more expensive for Brazilian farmers in dollar terms, adds to the problem.
And the result for FMC? For example, on September 23 Credit Suisse cut its target price for FMC to $42 from $66 on weakness in the Brazilian market.
As an individual company, I like what FMC is doing to restructure and upgrade the company by selling lower margin—and non-core–businesses and using the proceeds (and debt) to buy faster growing and core businesses (such as Cheminova) that increase exposure to under-represented markets (such as Europe) and allow FMC to lower costs. I think this is a value stock headed for a turnaround. Company officers apparently think so too. Recently the CEO bought 48,909 shares. Other senior executives added 24,000 shares. Directors purchased 38,000 shares.
All things being equal I would continue to hold this stock in my Jubak’s Picks portfolio.
But all things aren’t equal.
There’s the dismal forecast for Brazil—which could get even dismal-er as the government of President Dilma Rousseff sinks under scandal. The president had an 8% approval rating with a 71% disapproval rating this summer—not exactly conducive to the clout a politician needs to get things done. That means a recovery in the Brazilian part of FMC’s business could be far away indeed—and that the timing of any recovery is just about total speculation. (My guess would be that a recovery is likely to coincide with the end of Dilma’s term in office. But she only began her second four-year term in January 2015.)
And there’s the relatively high price of FMC’s shares. I know it may seem odd to talk about a stock that’s down 40.84% for 2015 through September 30 as expensive. (The shares are down 56.3% since I added them to my Jubak’s Picks portfolio on June 12, 2014.) But they are on what I’d call an adjusted potential-recovery-basis. Think of FMC shares as an option on a recovery in Brazil and the other emerging economies that buy a lot of agricultural chemicals. At the September 30 close at $33.67, this is pricey option given the way that this stock is likely to lag such top of the mind Brazil and/or emerging market plays such as iron miner Vale (VALE) or Brazilian and Latin American banking sector leader Itau Unibanco (ITUB.) As options both are much cheaper than FMC—at $4.20 and $6.62 a share, respectively—and on past track records, they’re more likely to move up strong and fast on any recovery.
If that’s too much higgly-piggly thinking for you, then think of it this way, I’m selling FMC today because after this huge sell-off in emerging market and commodity stocks, I think there are better places to put my money for an eventual recovery.
Whenever it might be.
What’s ahead, sell off or panic?
After today’s action I think we can take “buy on the dip” off the list of alternatives.
Everything is down today—with the surprising exception of the Shanghai Composite index, which closed up 0.6% overnight.
At 3 p.m. New York time, the Standard & Poor’s 500 index was down 1.56% and the Dow Jones Industrial Average was off 1.55%. Mexico was 1.31% lower and Brazilian stocks were down 1.1% in Sao Paulo. In Europe the German DAX had tumbled 2.48% by the close of that market; in Milan Italian stocks were down 2.30%; and in Spain the IBEX 35 index was lower by 3.64%.
In Asia Hong Kong’s Hang Seng closed down 1.35% and Japan’s Nikkei 225 was off by 1.94%
Among other emerging markets Turkey’s BIST 30 index was lower by 1.74% and South Africa had dropped by 1.36%.
What’s going on? Read more
Do you know the facts of life of the global currency market right now?
Is the U.S. dollar headed up or down over the next few weeks? How about the Japanese yen? Is the Indian rupee and the Turkish lira and the South African rand headed into a crisis? How about the Brazilian real?
I’m asking because right now global cash flows—into some developed markets and out of most emerging markets—are driving the prices of global stocks and bonds. The effects of those cash flows are being expressed in the prices of currencies such as the dollar and the real. The movements of those currencies are both the expression of those cash flows—the way that they’re being turned into rallies and corrections in the financial markets—and, increasingly, the fundamental driver for price movements in those markets as the ups and downs of currencies cause changes in monetary policies in countries such as Brazil and India. And finally, if you’re trying to figure out where the bottom is for Asia’s emerging markets—which entered official bear market territory this past week when the iShares MSCI South East Asia Index fell to a 21% drop from the peak on May 8—I think understanding the likely currency moves over the next quarter or two is a key. (That index tracks the markets in Singapore, Thailand, Malaysia, the Philippines, and Indonesia.
So here’s my take on what you need to know about global currencies in 10 easy trends.
- In the short run the U.S. dollar is likely to get stronger against most global currencies. That’s because the gradual end of the Federal Reserve’s program to purchase $85 billion a month in Treasuries and mortgage-backed assets—possibly as early as the Federal Open Market Committee’s September 18 meeting–will push U.S interest rates at least slightly higher. With the rest of the developed world’s central banks still in stimulus mode (Japan) or in do-nothing mode (Europe), that means traders and investors looking for higher yields will turn to buying dollar denominated assets.
- We really don’t know how long the “short run” might be. It’s clear that Japan isn’t about to reverse its weak yen policy any time soon and the European Central Bank has revised its historic tendency to privilege low inflation above economic growth to the extent of keeping interest rates at historic lows for a long period of time as the EuroZone struggles to escape recession or near recession. But a sufficiently chaotic U.S. political season—one that saw a budget impasse and a credible threat of default resulting from a failure to raise the debt ceiling–could make the dollar seem decidedly less attractive as early as October.
- A strong dollar is a negative for commodities priced in dollars—such as oil—and for precious metals. Extreme fear and turmoil, such as that set off by the threat of U.S.-led military intervention in Syria can overwhelm the effects of a strong dollar in the short run. Gold was up 19% from its June low as of August 29 to $1409.80, but I think gold along with other physical commodities will have a hard time building a sustained rally as long as the U.S. dollar keeps moving up and as long as global growth remains slow enough to remove all fears of inflation. The pressure that a strong dollar puts on commodity prices plus weak commodity prices due to slow demand from China and other developing economies has hit commodity currencies hard. For example, the Australia dollar traded near 89 cents on August 28. That’s down from $1.05 in April.
- A strong dollar isn’t good for emerging market financial assets. In 2012 as the U.S. Federal Reserve expanded its balance sheet, $1.2 billion flowed into emerging financial markets. In 2013 that cash flow has reversed.
- The countries, currencies and financial markets hardest hit by the strong dollar are those running the biggest current accounts deficits. Economies such as India, Indonesia, and Turkey need to attract overseas cash in order to balance those deficits. Turkey, for example, needs to attract $5 billion a month.
- A falling currency can set off a vicious cycle in a current account deficit country. A falling currency makes it harder to attract the cash needed to balance a current account deficit. And worries over a country’s inability to cover its deficit can lead to a further retreat in the currency as investors and traders pull money out of assets that are worth less in dollar terms day by day.
- A stronger dollar and weaker local currencies works to make trade deficits higher in developing economies. For example, India imports about 80% of its fuel. A climb in the dollar price of benchmark Brent crude makes it more expensive to pay India’s fuel bill in rupee. India’s oil imports averaged $14.2 billion a month in the first seven months of 2013, up from $13.9 billion a month in the same period a year earlier. The same dynamic savages companies in emerging economies that collect revenues in local currencies but that have to pay costs in dollars. About 56% of the costs at Brazil’s airlines, for example, are denominated in dollars, mostly for jet fuel. If, as in the case of India, a relatively weak manufacturing sector makes it hard to take advantage of a cheaper currency to increase exports, a falling currency is a lose/lose proposition
- The potential responses by central banks to falling currencies all have nasty side effects. Central banks can intervene by spending down foreign exchange reserves to buy local currencies. That can actually weaken a local currency if the markets believe that the central bank doesn’t have the foreign exchange reserves or the policy will to spend enough to reverse the market trend. That’s the market’s take to date on interventions by India, Indonesia, and Turkey. Another potential response is to defend a currency by raising domestic benchmark interest rates. That has a potential toxic side effect: Higher interest rates slow rates of economic growth. That seems to be happening now in Brazil
- All this has made emerging market stocks and bonds cheaper, but also has led investors and traders to question if these markets are cheap enough yet. For example, the Indian rupee is down 20.1% n 2013 on its way to its worst loss since the 1991 balance of payments crisis forced the government to sell gold to pay for imports. But even at 68.845 rupees to the U.S. dollar on August 28, that may not be a bottom. Speculation now is that the currency will have to sink to at least 70 rupees to the dollar before this crisis is over. No one, right now though, is willing to bet very heavily that 70 rupees to the dollar will make a bottom
- Putting in a bottom in emerging markets in general will probably start with putting in a bottom in individual economies with larger foreign exchange reserves and that look closer to seeing economic growth move from slowing to expanding. Brazil is a strong candidate for an early turn on sufficient foreign exchange reserves, and a central bank that has been early to raise interest rates. But growth in Brazil is still anemic. Mexico is another early recovery candidate, especially if the government’s efforts to increase foreign investment in the country’s oil industry look like they will result in a significant increase in production at Pemex, the national oil company. An overall recovery in emerging markets, however, is probably a 2014 event and will depend on data showing a believable recovery in China’s rate of economic growth. Or at least confidence that growth in China isn’t about to fall much further. From that perspective improved manufacturing data in the August Purchasing Managers Index for China is a very positive step.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of any stock mentioned in this post as of the end of June. For a complete list of the fund’s holdings as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
Biggest effect of a stronger euro and a weaker yen/dollar will be felt in emerging markets such as China and Brazil
Pick your metaphor.
The tide has turned. The weather is changing. The momentum has shifted with the change in quarterbacks.
Anything works as long as it 1) describes the current reversal in strength by the euro against the yen and U.S. dollar and 2) reminds us that the reversal is itself easily reversed and that we don’t know much about the timing of that reversal.
I prefer “tide” myself because it suggests not just the turn in the currency markets but a change in the flows that all financial assets swim against or with. The reversal in the relative strengths of these big three currencies will, after all, have an effect on everything from earnings at big U.S. multinationals such as IBM (IBM) and PepsiCo (PEP) to the price of commodities and commodity stocks to the balance of imports and exports in China to the growth rate of the Brazilian economy.
The biggest effect, though, is likely to be on the prices of stocks in emerging markets such as China and Brazil. Read more
What do you as an investor do with predictions? Even well researched predictions by experienced “predictors” like those at the U.S. National Intelligence Council that produced the recently published Global Tends 2030: Alternative Worlds.
And most challenging of all what do you as an investor do with predictions about which countries will grow most rapidly. I think the default response—put your money into the financial markets in the fastest growing economies—is actually mostly wrong. Or at best it’s the “GDP growth equals market returns” trap. Let me use the recent Global Trends 2030: Alternative Worlds report to explain why I believe that.
By 2030 China will be the world’s leading economic power—with the U.S. second.
The world’s oil producers—especially Russia—will see their influence wane in part because the U.S. will attain energy independence.
For the first time in history—as far as we can know—a majority of the world’s population won’t be impoverished. But half of the world’s population will live in areas with severe shortages of fresh water.
At least 15 countries will be at risk of state failure by 2030—Pakistan, Yemen, Afghanistan, and Uganda among them. Aging populations will slow growth even further in Europe, Japan, South Korea, and Taiwan. China and Brazil will have stepped up to new global roles, and countries that include Colombia, Indonesia, Nigeria, and Turkey will become newly important to the global economy.
Those are some of the conclusions in the recently published Global Trends 2030: Alternative Worlds, a four-year effort by the U.S. National Intelligence Council. (You can get your copy http://www.dni.gov/index.php/about/organization/national-intelligence-council-global-trends/ here in multiple electronic and paper formats.)
Some of the themes—the economic rise of China and the rest of the emerging world, global aging or a scarcity of water, for example–in the study will be familiar to readers of my posts and 2008 book The Jubak Picks (out of print but you can buy a used copy here with http://www.amazon.com/gp/product/0307407810?ie=UTF8&tag=thejubpic-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=0307407810%22%3EThe .)
In other areas—the risk of a computer network attack on global infrastructure that affected millions or the possibility that a global health pandemic could reverse economic globalization—the study raises issues that I haven’t thought about at any length (except in the occasional nightmare.)
But to me as an investor the most useful function of the study is the challenge that it throws down. What, if anything, do I as an investor want to do about these predictions? Read more