So far in 2014, commodities are the exception to positive overall returns, with the majority of asset classes in the green for the year. Hard assets are also the weakest when looking back over the last 3 years. The gap between U.S. stock market performance versus other global markets has continued to widen over the last 5 years:
Straight out of the gate as the month began, energy giant Kinder Morgan (KMI) offered $44 billion to "buy-in" outside shareholders in its family of pipeline companies at premiums of between 12 and 16 percent, making it the second largest deal ever in the energy sector (remember Exxon-Mobil?). By simplifying its structure through the bundling up of three companies, the combined group will be able to raise dividends, cut its cost of capital, and use its shares as an acquisition currency.
Due to the rapid growth of oil and gas production from shale rock in the U.S., estimates for the required infrastructure build-out have reached as high as $500 billion for the next decade. KMI's play will give them an enterprise value of nearly $140 billion, reaching critical scale to capture this coming wave of spending. This American success story could point the way toward solutions for other markets, notably the Eurozone, which is coming to loath its dependence on Russian gas.
Also in August, Australian metals and mining giant BHP Billiton unveiled a similar transformative deal by announcing a de-merger of its ancillary businesses in aluminum, manganese, nickel and silver assets. Once simplified, the new BHP will be almost exclusively focused on long-life iron ore, copper, coal, petroleum and potash. With fewer assets and a greater upstream focus, BHP should be able to reduce costs and improve the productivity of its largest businesses more quickly. That should mean greater free cash for to return to shareholders via dividends, the lack of which has formed a complaint that has persisted for years amongst current BHP shareholders.
The BHP demerger marks the end of an era for pell-mell expansion in the materials sector. Management has learned that buying assets to bulk up does not translate into steady and rising growth. These and other companies will be much more effective resource managers going forward, with an eye towards smart allocation of capital to only the most productive assets at any given time.
These two deals follow closely on July's announcement that America Movil, the largest telecom company in Latin America, would also spin-off its fixed line assets and tower businesses. Although regulatory caps played a role in this deal, it is clear that there is a growing emphasis by corporate stewards around the globe to be more rational about their capital allocation and asset productivity decisions (you might call all of them "Rational Nationals"!). That is a double win for shareholders, because their companies are seen as undervalued and asset rich, while boards are now determined to unlock that value and reward the patient investor. The same could be said for other sectors. The net of all this is that many companies are well run and offer significant value, re-butting those who say the stock market is over-valued.
The most interesting development we saw in the markets last month was the continued drop in Eurozone government bond yields. If you think .5% is a lousy yield on a two year U.S. Treasury Note, try living in Europe: Germans get negative -.01%, while the Swiss give up negative -.07%. The Netherlands and France are barely positive at .01% and .03% respectively.
EU economic activity is weakening sharply, and the bond market is reacting. The ten year German Bund hit a 200 year low yield last month, breaching the 1% level. Even long time pariah Ireland has gotten a tinge of respectability back:
All of this is occurring just as the Russian sanctions are "coming online", and it doesn't bode well for Germany, Europe's leading growth engine. With Chancellor Angela Merkel's CDU party ruling in a "grand coalition" alongside the rival Social Democratic Party (SDP), any hint of trouble could split the marriage of convenience and necessitate federal elections. The euro-skeptics and homeland first movements will be in a strong position to force change. Europe has a tradition of violence when things get tough, so the severity of this downturn could provide the harshest civil protests yet against the EU. Whatever is coming, the fate of the Eurozone resides in Berlin. 2015 is shaping up to be a very interesting year.
Central bankers from around the world convened in Jackson Hole Wyoming to ponder these and other issues at their annual gathering in late August. For her part, U.S. Fed Chair Janet Yellen went to great lengths to describe the slack in today's labor markets, and the need for its improvement, despite the drop in the official U.S. unemployment rate over the last several years. Following on the last FOMC Statement that presaged the end of QE in the U.S., it left many wondering just how the long the U.S. might to have to continue its zero interest rate policy (ZIRP) to fire up the jobs machine again.
Unlike Yellen, ECB head Mario Draghi wrestles with deflation (a lack of rising prices). Departing from prepared remarks at J-Hole, he issued a kind of blunt confession that he and his colleagues had run out of excuses for the ongoing depressed level of inflation across the Eurozone, and that maybe some sort of catalyst was required (i.e. the commencement of their version of quantitative easing.) Official sources were quick to deny it, but Eurozone markets are now anticipating more money balm to support them, duplicating the Fed's QE back-stopping of stock and bond markets. Don't fight the Euro Fed?
Geopolitical tensions remained constant in August, with Russia and the Ukraine intensifying their stand-off. Global players like the U.S., NATO and the EU are becoming increasingly confrontational, so the situation looks set to escalate. Markets remain very nervous, but, as we have observed before, the U.S. is seen as a safe haven, so any capital fleeing trouble is likely to wind up here.