Author Archives: Sven Carlin


There is a Huge GAP Between Reported and GAAP Earnings

  • Real earnings are currently 25% lower than pro forma reported ones.
  • The other consolidated income statement can also hide surprises.


How would life look if things were as you saw them or exactly like someone presented them? Surreal for sure as it would require a non-human mind to objectively process information and accept a situation as it is. People usually fall in love with the wrong person or feel depressed over nothing important. The same is applicable in business, but it’s strongly biased toward falling in love with one’s business and refusing to see the flaws of it. Such a behavior results in a large gap between pro forma reported earnings and official Generally Accepted Accounting Principles (GAAP) results.

Investors have to be mindful about that when analyzing earnings, and must precisely determine what the real situation is compared to managements’ rosier view. Even Buffett touched on the subject in his last letter to shareholders warning that “it has become common for managers to tell their owners to ignore certain expense items that are all too real” and analysts are part of the culprit as they propagate misleading numbers that can deceive investors.

Gap Between GAAP and Pro Forma Earnings is Widening

Pro forma figures exclude certain items that are considered by management as non-recurring. Some of those expense items include the costs of laying off workers, legal costs, acquisition expenses, cost of stock-based compensation, expenses related to asset volatility, asset write-downs, effects of foreign-currency moves, omitting results from newly opened and recently closed stores and depreciations not related to current operations. By eliminating noise, management’s intention is to present earnings related to the core business as what is happening around it is of no importance. The best way to explain what is going on is to let you read yourself. Apache Corporation (NYSE: APA) reported the following in its annual report:

For the year ending 2015, Apache reported a net loss of $23.1 billion, or $61.20 per diluted common share. On an adjusted basis, Apache’s 2015 loss totaled $130 million, or $0.34 per share. Net cash provided by continuing operating activities was approximately $2.8 billion, and adjusted EBITDA was $3.9 billion in 2015. Total capital expenditures were $4.7 billion for the full year, or $3.6 billion when excluding leasehold acquisitions, capitalized interest, Egypt noncontrolling interest, and spending on divested LNG and associated assets. This was at the low end of the company’s full-year 2015 guidance range of $3.6 to $3.8 billion.

APA’s management managed to turn a loss of $23 billion into an adjusted loss of $130 million and even finish with positive adjusted EBITDA of $3.9 billion. It is practically impossible for an investor not specialized in accounting to understand what is real and what not in such an annual report. Unfortunately, APA is not an exemption in the corporate world but more of a new mainstream.

1 figure gaap and pro forma

Figure 1: Gap between pro-forma and GAAP earnings widening. Source: The Wall Street Journal.

The official GAAP S&P 500 earnings in 2015 were $787 billion versus pro forma estimates of $1.04 billion which means that 25% of expenses are not treated by management as expenses but as mere non-recurring items. It is the widest difference since 2008 and a closer look shows that S&P 500 real GAAP earnings have not increased by 0.4% like pro forma earnings show, but instead declined by 12.7%. The issue is not only related to smaller companies like the above mentioned APA, but also to blue chips. 18 of the 30 Dow Jones Industrial Average (DJIA) members have reported higher pro forma than GAAP earnings.


Figure 2: DJIA average year-over-year change in EPS. Source: FACTSET.

Even blue chips report higher earnings than real earnings, and companies have had a history of treating the ordinary as extraordinary when business conditions worsen. In 2014, the difference between GAAP and pro forma earnings was 11.8% while in 2015 it jumped to 30.7% for the DJIA companies that report pro forma earnings.

3 difference 2014 2015

Figure 3: Difference between (%) pro forma and GAAP earnings for DJIA stocks. Source: FACTSET.

The most notable example from the DJIA is Merck (NYSE: MRK), who reported 2015 GAAP EPS of $1.56 and pro forma EPS of $3.59. The difference, according to management, comes from acquisition and divestiture related costs, restructuring costs and legal fees. The funny part is that in 2014 they excluded the same costs to form pro forma earnings and also forecast 2016 GAAP EPS to be between $1.96 and $2.23 while pro forma reported earnings are expected to be between $3.6 and $3.75. It seems illogical to name costs that occur year after year non-recurring.

Other Comprehensive Income

Another accounting issue that is not so much discussed about in the media is other comprehensive income (OCI). OCI includes revenues, expenses, gains, and losses under both GAAP and International Financial Reporting Standards (IFRS) that are excluded from net income on the income statement and are therefore listed after the income statement. Those items are mostly items that have not yet been realized and might change in the future. For example, an investment in a foreign country and currency is affected by currency fluctuations when the value is translated into the home currency. One year it can have a positive effect while the other a negative effect, therefore those differences are kept in the other comprehensive income statement until realized.

Items included in OCI and excluded from the income statement usually are:

  • Unrealized holding gains or losses on investments that are classified as available for sale.
  • Foreign currency translation gains or losses.
  • Pension plan gains or losses.

Before investing, it is good to take a look at accumulated OCI in order to see if the company has some huge unrealized future risks or benefits. Unfortunately the risks and unrealized losses are always wider than unrealized gains.


A good note for the average investor is that the SEC is looking at the issue and probably is going to regulate the way companies report earnings in order to limit the deceiving of investors. But, in the meantime, each investor should meticulously study the pro forma, GAAP and OCI earnings in order to estimate his investment. To conclude, Buffett applauds companies that report OCI income in the regular income statement and only real GAAP earnings.



Investment Opportunities in Iron Ore

  • Iron ore as a commodity faces long term oversupply.
  • The shift to a service oriented economy lowers Chinese steel demand growth.
  • Short term euphoria makes iron ore and related assets great for trading.


Iron ore is the world’s most mined and commonly used metal as 98% of it is used to make steel. As steel is mostly used for infrastructure and building it is not surprising that China is the world’s biggest consumer of iron. China produces 50% of the world’s steel output and 47% of the world’s iron ore.

Figure 1: Steel consumption in China and the world. Source: LKAB.

Therefore, China is the main factor for iron ore pricing. As Chinese demand for steel grew so did the price of iron ore. Increased iron ore prices brought increased investments in mining, and currently supply is higher than demand. In such a situation, a decline in prices is unavoidable and the decline in iron ore prices has been unstoppable for the last 5 years. From $180 per ton in 2011, the price of iron ore has eroded to the current price of around $60, but also reached prices below $40 in December 2015.

2 figure iron prices

Figure 2: Long term iron ore prices. Source: Iron Ore: Facts.

Unfortunately for iron ore miners, the outlook is not bright. The World Steel Association (WSA) is forecasting a decrease in steel demand in 2016 of 0.8% and just a slight increase of 0.4% in 2017. Also, unlike other commodities like copper, the world’s iron ore reserves seem enough for many more years of increased consumption. Estimated global reserves are 170 billion tons while current global consumption is 3.2 billion tons per year.

With low prices, high iron ore availability and lower demand for steel, logic would have miners lowering output in order to realign supply with demand to increase iron ore prices. But the world’s biggest miners have chosen a different way, one that has also strongly influenced the above price decline.

The Iron Ore Increased Supply Strategy

The strategy in the iron ore mining sector is one of increased supply in order to force high-cost supply to exit the market. The goal of such a strategy is to increase market share and reach higher profits with lower margins on bigger volumes. The world’s largest miners—Rio Tinto (NYSE: RIO), BHP Billiton (NYSE: BHP), Fortescue and Vale (NYSE: VALE)—are all increasing production. RIO and BHP require iron ore prices at around $25 to break even while Fortescue and VALE require prices to be around $40. 25% of global iron ore production has costs above the current spot price and most of the high cost producers are in China. Therefore, the big global miners hope to reach maximum profits by increasing production and completely conquering global markets.

3 figure cost curve

Figure 3: Iron ore cost curve. Source: Metalycs via

The strategy is not yet showing positive signs as all the above mentioned miners have reported losses (RIO and VALE) or minimal profits (BHP and Fortescue) in the last 4 quarters. In order to see if the strategy is going to pay off in the long term, it is necessary to look at the forecasts for iron ore.


In the short term iron ore prices have quickly recovered from this winter’s lows and are currently boosted by increased building expectations in China. But, Goldman Sachs is describing this increase in prices as temporary because there was no shift in raw-material fundamentals and expects iron ore prices to return to $35 per ton soon. Also, RIO and BHP have warned that prices will come down again.

A mid-term outlook shows that iron ore is bound to stay at low levels as the trade balance outlook remains highly positive through 2020.

4 figure trade balance

Figure 4: Iron ore China trade balance (price is from begin 2015 and has to be adjusted lower). Source: ABM Brasil.

The World Bank estimates that iron ore prices will be around $50 per ton for the next five years as the increase in low cost supply is much larger than the closures of high cost mines.

In the long term, iron ore prices are completely dependent on steel demand and steel demand is not expected to grow at the same rates it used to grow in the last 15 years.

5 figure steel demand forecast

Figure 5: Steel demand forecast. Source: ABM Brasil.

As a country becomes more developed the infrastructure and building necessities become more service oriented and therefore demand for steel diminishes. A case for steel would logically be India as the successor of China in growth and infrastructure building, but it is forecasted that India will mostly be self-sufficient in its steel production.

As low commodity prices limit new investments and commodities are cyclical, somewhere down the line another surge in iron ore prices can be expected. But, according to Wood Mackenzie such a situation should only emerge after 2025 or even later, as current capacity is enough to cover demand and increased production will probably lead to a long term oversupply.

7 figure supply

Figure 6: Supply comfortably exceeds demand for the next two decades. Source: Wood Mackenzie.


Considering everything above, iron ore seems a tricky asset. High availability excludes a copper scenario where it is known that mine grades are bound to be lower in the future. Long term oversupply and a shift in the Chinese economy from a manufacturing and heavy infrastructure investing one to a more service oriented one does not make a strong case for iron. But, iron ore prices have fallen more than 75% from their 2011 peak so there should be opportunities to make profits. Perhaps iron ore should be left to traders that have the stomach to weather huge swings and the knowledge to seize the volatility as the price is influenced by oversupply in the long term but also by short term euphoria like the in the last two months based on increased lending and hopes of a return to previous levels in Chinese infrastructure growth.



Tax Holiday Could Repatriate $2.1 Trillion

  • US companies have more than $2.1 trillion abroad.
  • 12 years have passed since the last tax holiday.


A tax holiday is a government incentive to businesses where it lowers or eliminates a tax for a period of time. The most interesting tax holiday for investors is a corporate income tax holiday on the repatriation of foreign cash. Typically, any repatriated cash is subject to a 35% corporate income tax and therefore US corporations are reluctant to repatriate it and keep their cash abroad. The last tax holiday was voted by Congress in 2004 when companies where allowed to repatriate cash at a 5.25% tax rate. Many companies took advantage and repatriated billions of dollars. 12 years have passed since then and it is time to look at what the investment opportunities are related to an eventual new tax holiday.

Current Situation

As 12 years have passed since the last tax holiday, US companies have stashed billions of cash abroad. The leader is Apple Inc. (Nasdaq: AAPL) with 93% of its $232 billion of cash and marketable securities abroad. If that cash would be repatriated now, AAPL would have to pay $75 billion in US taxes. In the meantime, AAPL’s cash is invested in marketable securities and earning interest. Alphabet Inc. (Nasdaq: GOOG) also has a large percentage (not disclosed) of its $75 billion cash and marketable securities abroad.

A report from October 2015 estimates that US companies hold $2.1 trillion overseas and by doing so avoid paying $620 billion in taxes. The below figure shows the companies with the largest overseas cash balances and how much they have stored overseas.

1 figure 2014

Figure 1: Overseas cash balances at the end of 2014. Source: US PIRG & CTJ.

As the above data is from 2014, the total amount of cash abroad has surely increased due to the high overseas profits US corporations have. All this cash could do wonders for the US economy, businesses and the stock market, but this is more of a political rather than an investing or economic issue for now.

Political Aspect

As the US GDP is around $18 trillion, the $2.1 trillion in cash abroad owned by US companies is a sweet and attractive cake. As companies are taxed on an individual legal entity basis, there is no legal way of forcing companies to repatriate cash and pay US corporate income tax on it because the US has no jurisdiction on their foreign subsidiaries. Therefore, in order to get some benefits, the US government could allow a tax holiday. A holiday would not mean that corporations pay nothing, but that the tax is lowered to a point where corporations find it attractive to bring the cash back home. A low tax would also create an immediate benefit for the US. The last time there was a vote for a proposed tax holiday in 2009, the US Senate voted against such a proposal. The vote was mostly based on the US Senate’s research on the last tax holiday when in 2004 the America Jobs Creation Act (AJCA) permitted U.S. corporations to repatriate income held outside of the US at an effective tax rate of 5.25% instead of the top 35% corporate income tax rate. Proponents of the tax provision argued that increased domestic cash would spur investments and job creation. But, as the research shows that was not the case; US jobs lost rather than gained because the top 15 repatriating companies reduced their workforce by 20,931 while stock repurchases and executives’ compensation increased. Of course, such a report has to be taken with a grain of salt because several other factors affect jobs and corporate politics other than repatriations and there is no counter test to see what would have been the effect on jobs without the tax holiday.

There is continuous lobbying for a tax holiday and we will have to see how the current slowdown in GDP growth will affect decision makers. The last commotion around a tax holiday was in 2014 when APPL’s CEO Tim Cook commented that the 35% tax rate on repatriated cash is a very high number and that APPL would repatriate at a lower, more reasonable tax rate. A senatorial discussion followed but no action was taken. Perhaps after the presidential elections and, hopefully not, after an economic slowdown the tax repatriation holiday might become a hot topic again.


It seems that Wall Street does not value cash abroad at face value, but instead discounts it by the full corporate income tax. The result is that AAPL is valued at a PE ratio around 11. Any indication of a tax holiday would give a quick boost to the companies mentioned in figure 1 as $2.1 trillion could be redistributed to shareholders via dividends and repurchases or used for acquisitions. Even if a tax holiday is not voted on soon, it always remains a nice buffer for the mentioned companies in case of a market downturn.



Facts, Fears and Opportunities in China

  • Even if China is slowing down, the growth is still excellent and the potential is huge.
  • The Chinese market is 43% down from its 2015 high.
  • Short term fears might give trading opportunities as the long term trend is a growing one.


In the last twelve months there has been a lot of talk around China with various economic forecasts and explanations which resulted in a severe negative influence on markets ranging from stocks to commodities. This article is going to give an overview of what happened in the last year, and some scenarios of what might happen and how that should influence financial markets.


In August 2015, China’s central bank (PBOC) made a move to devaluate the Yuan in relation to the dollar. The move was influenced by the government’s worry about slowing growth and to make the currency more market driven. The move created various market shockwaves and shows what kind of power and effect China has in today’s world. By the end of August, the S&P 500 fell by 12% and commodities further declined to five year lows based on fears of slowing Chinese demand. The devaluation of the currency was made in combination with quantitative easing where the aim was to stop the steep fall of the Chinese stock market. The Shanghai stock index started its steep decline in June 2015.

1 Shanghai

Figure 1: Shanghai Stock Exchange Composite Index. Source: Bloomberg.

From a multi-year perspective, it is clear that the market was in a huge bubble because it grew from 2,000 points in 2014 to 5,166.3 points in June 2015. The current level of the Chinese market is down 43% from its peak, but it is still up 50% from the 2014 levels. The PBOC intervened in order to lower the possible repercussions of a market meltdown. All of the above was mostly influenced by the slower growth of the Chinese economy.

2 China GDP growth

Figure 2: Chinese GDP growth per quarter. Source: Trading Economics.

The slower growth and a switch from a manufacturing economy to a service economy is what has made the global market tremble. The International Monetary Fund expects the Chinese economy to grow at a rate of 6% in 2016 and 2017, and a switch to a service economy is feared to lower demand for commodities. An even slower growth than expected could have repercussions similar to the ones the financial and commodity markets experienced in 2015. The last info about Chinese growth is a 6.8% increase for Q1 2016 which was considered positive news and further fueled the recovery in commodity prices, but the information from the Chinese Bureau of Statistics shows that despite quantitative easing and a stronger real estate market, Chinese manufacturing grew at a slower pace in April in relation to March. The manufacturing index was at 50.1 for April which still indicates expansion but flirts with contraction as it is close to the 50 mark.

With the exception of manufacturing, the question is not if the Chinese economy will continue to grow, but how fast it will continue to grow. As the Chinese GDP per capita increases the country loses some of the competitive advantages it had in comparison to the rest of the world but the increased development enables a different, more service oriented growth. Chinese GDP per capita is currently $7,990 which is only 14% of the US’s and shows how much potential China still has.

But, the service oriented and less construction oriented growth has severe implications. The exports of most emerging countries and Australia are strongly related to Chinese demand and therefore those markets are severely affected by any kind of Chinese slowdown, especially a manufacturing or real estate one.

3 economicst

Figure 3: Percentage of exports to China. Source: The Economist.

Australia, African countries, Middle East oil producers and South American commodity exporters are all highly dependent on the Chinese economy. As the above mentioned countries and regions are big enough to influence the global markets, every investor should keep an eye on what is going on in China.

Short and Long Term Forecasts

It is important to look at China from an objective perspective and not in comparison to what happened in the last 25 years. Growth rates higher than 10% are much more easy to reach when the starting point is low like it was for China. As the economy grows, the global competition kicks in and levels economic growth. The current situation is one where exports are lower, bad loans are rising, and the industrial sector is at its weakest since 2009. Capital outflows in 2015 were $1 trillion and the PBOC is trying to limit the damage by injecting fresh capital into the market.

At the same time industrial and structural trends are turning against China.

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Figure 4: Chinese industry trends. Source: OECD.

As shown above, industrial output growth has declined from 9% to the current 6%, manufacturing investing has fallen and state-owned enterprise profits are falling. This in combination with the negative demographics where the Chinese working-age population is shrinking due to the one child policy, which does not paint a rosy picture. But the forecasts are all still indicating growth, albeit a slower one. Also the demographic fears should reflect on the Chinese economy only in the very long term; currently 47% of the population is between 25-54 years, thus in prime productivity.

The government targets a growth rate from 6.5% to 7% and has planned the highest budget deficit in the last 25 years which should help the economy. The IMF forecasts Chinese growth at 6.3% in 2016 and 6.0% in 2017, while the OECD forecasts 6.2% in 2016. Not to forget that even if the economy will grow slower it will still grow. A growing Chinese economy can only benefit the global economy and markets. Therefore, the question is not if China will grow or not but how much imbalance it will create in financial markets in relation to it over performing or underperforming expectations. In any case, as a well-diversified portfolio should have some assets in the soon-to-be World’s biggest economy, below are some ideas on how to invest in China.

Chinese Investing Opportunities

One way to be exposed to China is to buy stocks of companies that have a strong exposure in China like Alibaba, Baidu or China Life Insurance that are traded on US markets. The list of Chinese stocks traded on US markets can be found on Nasdaq. A warning here, Chinese accounting and the Chinese securities and exchange policies might vary from US ones and deeper scrutiny is necessary to understand what is really going on in the business represented by the stock. Another opportunity to invest is through ETFs.


Even if China is currently experiencing a slowdown in growth it is almost certain that China will continue to grow in the short term and in the long term. A well-diversified global portfolio cannot miss out on such a growth potential. The Chinese GDP per capita has to grow 7 fold to reach the US GDP and the Chinese seem determined to grow at all costs. If the market has reached its bottom depends mostly on the short term news on Chinese growth and there lies the risk of investing in China, it takes a lot of courage to invest in a market that is more than 40% down in the last year, but such markets also create the best opportunities. For anyone more interested in trading short term, expectation misses in Chinese performance might give good trading opportunities as the underlying long term trend is a growth one.



Monetary Policies – US, Europe, Japan and China

  • Central banks hesitate to increase interest rates.
  • Monetary easing does not manage to fuel inflation.
  • If inflation arises stocks should be the best protection.


The central bank of a country determines the base interest rate at which it gives loans to banks who add a risk premium and give loans to corporate and private customers. The base interest rate is therefore the primary factor for the stimulation of economic growth and reach of target inflation.

In the US, the FOMC (Federal Open Market Committee) meets every 6 to 8 weeks and the market and journalists anxiously expect its decisions and outlook on interest rates and the economy. The same meeting schedule applies for the ECB (European Central Bank) monetary policy meetings. The BOJ (Bank of Japan) decides on interest rates in Japan and the PBC (People’s Bank of China) sets the interest rates in China.

The current interest rate in the US is 0.5%, in Europe it’s 0%, in China it’s 4.35%, and in Japan it’s negative with -0.1%. If the economy is weakening the central bank steps in and lowers the interest rate in order to promote more lending that should lead to economic growth. Those should be the reasons behind interest rate changes, however in 2015 the PBC had lowered its interest rate 5 times in order to prevent the Chinese stock market from falling further.

1 chinese interest rate cuts

Figure 1: Chinese interest rate cuts in 2015. Source: Bloomberg.

The BOJ brought its interest rate to negative in order to prevent a looming recession, but in Japan’s case the low interest rates have not fueled economic growth. Yes, a negative interest rate means that the bank is paying to lend money to banks, as strange as it might sound, it is the truth.

2 japanese interest rate

Figure 2: BOJ interest rate from 1976 to 2016. Source: Trading Economics.

The US is the first major country that is starting to raise interest rates as its economy seems to be doing better.

us interest rate

Figure 3: US interest rates. Source: Trading Economics.

It is important to see how this effects the market in the short and long term.

The Last FOMC Meeting and the Implication for Markets

The FOMC met for a two-day meeting on April 26, 2016 and left interest rates unchanged. The other important takeaways are that labor market conditions have improved further even as economic activity appears to have slowed. Inflation is still running below the 2% target.

Concerning the outlook, the FOMC expects that with gradual adjustments in monetary policy the labor market should remain strong end economic activity should improve at a moderate pace. It also expects that the interest rate is going to remain below expected longer run levels.

The implications for investors should be the following and unfortunately all the implications are double-edged swords. A further increase in the base interest rate would:

  • Strengthen the dollar as global capital flows would be looking for higher yields with low US risk. A strong dollar, as is already the case, makes exports more difficult and therefore lowers corporate revenues, which implies a return to lower interest rates if the economic consequences are too severe.
  • Increase the cost of capital for companies that would consequently lower their earnings.
  • Increase returns on bonds, and consequently expected returns on stocks. If expected returns on stocks increase the price usually goes down which reignites the downward economic cycle.

The above examples demonstrate just how difficult it is to set the correct interest rate. Interest rates that are low for too long should create inflation but the ECB, BOJ and FOMC have failed to reach their target of 2% inflation with the current prolonged low interest rates. This proves how the standard economic theory is failing in the explanation of the current global monetary and financial situation and there is no precedent on which to base estimations. Seeing how active the central banks are in supporting the economy and financial markets, it is plausible that the economic standards of the 20th century do not apply to new circumstances. A very important part for the application of the classical economic theory that is missing is inflation.

4 us inflation calculator

Figure 4: US inflation. Source: US Inflation Calculator.

Surging inflation above 2% would quickly prompt the FOMC to increase interest rates in order to prevent higher inflation rates. With higher inflation rates, stocks should perform well as higher prices increase revenues. Stocks are usually considered hedges against inflation. Bonds should be the worst performers as with higher interest rates and inflation, yields go up and bond values decline.


On April 28 the Bureau of Economic Analysis reported that the US GDP growth in Q1 2016 was the slowest in the last two years. This slowdown also explains the FOMC’s reluctance to increase rates at a faster pace. The reason behind the slowdown is a deceleration in consumer spending and a decline in business investments. It will be important to see if this is the start of a trend or GDP will bounce back in Q2. Also, it’s important to note the fact that as more data becomes available the GDP figures can be revised.

The BOJ and ECB

The BOJ surprisingly did not increase its stimulus for the economy as it needs more time to assess the effect of negative interest rates.

In Europe the policy makers are more eager to improve things as soon as they can. The European Central Bank (ECB) announced last Thursday that it is ready to use “all instruments” available, including further key interest rate cuts plus more quantitative easing.


The above is a lot of information to digest and there is no truth or rule that can help the individual investor. Monetary policies and macroeconomic trends are difficult to forecast and even more difficult to time.

The willingness of central banks to ease monetary policy at the first signs of slowing economies gives a certain perception of security. Until inflation kicks in, the banks have no limits to their easing potential and can fuel slowing economies and declining markets. If inflation does kick in the best hedges should be stocks as corporations can pass on the increasing costs onto the consumer. The financial markets and monetary policies have always been and always will be cyclical. It is up to the individual to assess how much volatility she or he can handle.



An Analysis of the Latest Earnings Reports

  • “Sell in May and go away” doesn’t sound so foolish anymore.
  • The Dow Jones Industrial Index average revenue has declined by 4.1%.
  • High liquidity and employment enables buybacks and pension funding that keep the market at high levels.


Recently there have been some surprising earnings debacles. This article is going to elaborate on them and discuss possible reasons and consequences of the earnings misses.

Summary of Earnings

Apple (NASDAQ: AAPL) reported Q2 EPS at $1.9, missing analysts estimates by $0.1 and a revenue decline of 12.8%, also missing estimates. It guided to lower Q3 revenue of $41-$43 billion which is also below estimates of $47 billion.

In spite of declining revenue AAPL continues its buyback program and increased it from $140 billion to $175 billion. By buying its own shares, AAPL is investing in a company with declining revenue and earnings instead of focusing on growth and development. Only the future can tell if AAPL will manage to turn things around and increase revenue or the buyback strategy is the only plausible strategy for AAPL’s management in order to increase EPS. In the meantime, AAPL’s shares were down 9% after the release.

Alphabet Inc. (NASDAQ: GOOG) also missed expectations with revenue growth of “only” 17.4% y/y and EPS of $6.02. GOOG spent only $2 billion on buybacks in the last quarter. Not much when compared to AAPL’s $6.6 billion for buybacks and $2.9 billion for dividends. The above represent two different strategies and focuses. GOOG’s shares were also down 7.3% after earnings.

Another company in the digital world that has seen shares plunge soon after the earnings release is Netflix. Netflix (NASDAQ: NFLX) reported revenue growth of 24.8% y/y and positive earnings per share but the slower than expected growth in subscribers influenced a 15% stock price decline.

The same happened to Twitter (NYSE: TWTR), revenue grew by 36.4% but shares declined by 9.2%. Microsoft (NASDAQ: MSFT) was also down 10% after earnings.

Before moving away from the digital sector, I’ll mention that the S&P 500 was mostly flat while the above companies sustained large losses.

In the financial sector Bank of America (NYSE: BAC) has seen revenue decline by 8% and earnings in-line. American International Group (NYSE: AIG) posted a loss of $1.1 per share but nevertheless increased buybacks by $5 billion and increased its dividend by 14%. Goldman Sachs Group (NYSE: GS) reported a decline of 55% in earnings and a 40% decline in revenue.

The above earnings reports and management actions do not create a positive sentiment. The digital companies like NFLX or social platforms like TWTR are still growing but at a slower rate, the oldies like AAPL and MSFT are not growing anymore and the financial sector is also facing strong headwinds.

In order to see how the market is doing in general—and not to focus on the companies mostly analyzed in the news—a good representation of the market is the Dow Jones Industrial Average Index (DJIA). The below table shows quarterly revenue growth from the 30 companies that constitute the DJIA.

company data

Table 1: DJIA revenue growth per company.

Of the 30 companies in the DJIA 5 companies still have to report earnings and 12 have reported declining revenues, while of the 13 reporting revenue growth only 6 of them have seen revenue grow at a rate above 2.2%. The average revenue decline was -4.1%. With such a strong decline in year on year revenues a similar decline in the Dow Jones index would not be surprising. But what is surprising is that the DJIA has risen 1.8% in the two weeks of the earnings season.

dfow index

Figure 1: DJIA index in the last two weeks. Source: Yahoo Finance.

A reason for the DJIA rising could be that the IRA contributions deadline was on April 15. As the US employment rate is still high and the interest rates are low there was plenty of liquidity to fund pension contributions and consequently the stock market.

unepmloyment rate

Figure 2: US unemployment rate. Source: Bureau of Labor Statistics.

But with declining corporate revenues, management might focus on cost efficiency by laying off employees. Up until now, corporate revenues have been constantly increasing and the consequence was increased hiring. The opposite should happen if the revenue growth trend reverses as the first indications show.

sp 500 sales

Figure 3: S&P 500 Revenue. Source: Multpl.

The previous decline in corporate revenues from the 2008-2009 period had a severe influence on the unemployment rate bringing it up to 10%. Also it was a sharper decline in revenues than the current one, accompanied by a stronger decline in earnings and without quantitative easing.


The high market liquidity influenced by low interest rates enables companies to finance themselves cheaply and reinvest that money into buying their own shares and thus skewing real ratios. A low unemployment rate means that contributions to pensions and financial institutions are high and those can keep the market up, even with revenues declining. But, the declining revenues make the following rule of thumb an interesting perspective:

Sell in May and go away.

FBN Securities researched on how the unwritten rule performed in the last 20 years and the results show that the above rule is surprisingly accurate.

sell in may perfromance

Figure 4: S&P performance by month. Source: FBN Securities.

Returns on being long in May are negative while returns related to the colder months of the year are very positive. As it is very difficult to time the market and very easy to be wrong when selling in May, the above rule of thumb should be taken with a grain of salt. But, seeing that revenues are declining, and declining revenues will eventually have an impact on the economy, it might not be a bad idea to rethink portfolio allocations and risk exposures.



The Buyback Conundrum

  • Buybacks should increase shareholder value, but that’s not always the case.
  • From a book value perspective most companies are destroying value.
  • From a return on investment perspective the logic behind buybacks is open for discussion.


The goal of investing is to enjoy stock price appreciation and dividends, but there is another method for achieving interesting returns: buybacks. With stock buybacks, a company buys its own stocks on the open market. As a public company cannot fully own itself, the purchased stocks lower the number of outstanding stocks and increase the relative ownership of the remaining stockholders. In other words, the company is using its cash to invest in itself.

If a company invests in itself, what has to be calculated—and often is not—is the return on that investment. This article analyzes the mechanics and motivation behind buyback returns and the real effects on investor returns.

The Motivation Behind Buybacks

Buybacks are usually promoted by management as the best use of capital at a specific moment. Buybacks improve financial ratios, and ratios are what analysts focus on. By lowering the number of shares outstanding, earnings per share (EPS) increases, and by spending cash, the company has less assets and equity and therefore return on assets (ROA) and return on equity (ROE) increase.

Another thing covered up by buybacks is dilution. Generous employee stock option plans create dilution, and no regular investor likes that. A good example of dilution coverage is Cisco Systems Inc. (NASDAQ: CSCO). The company spent $4.2 billion on repurchases in 2015 by buying 155 million shares at an average price of $27.22. 155 million shares on a total amount of 5.09 billion shares outstanding in 2014 would imply a nice 3.03% return to shareholders from buyback activity. But the total number of shares outstanding at the end of 2015 was not 4.94 billion, but 5.06. Thus, CSCO lowered the number of shares outstanding by a mere 38 million shares and not by 155 million like they proudly announced in their annual report due to dilution.

The Logic Behind Buybacks

If the stock of a company is really undervalued, buybacks make sense, but if the price is above intrinsic value the buybacks are questionable, or as Warren Buffett said:

In repurchase decisions, price is all-important. Value is destroyed when purchases are made above intrinsic value.

Berkshire Hathaway (NYSE: BRK) is known to buy back stocks but maximally pay a premium of 20% on book value.

1 price to book berkshire

Figure 1: Berkshire buyback activity and threshold. Source: Bloomberg.

The above 20% premium that Buffett is willing to pay does not mean he agrees to paying a premium, it relates to that fact that many of Berkshire’s investments are accounted at cost and therefore not properly reflected in the balance sheet. Think of See’s Candies, bought in 1972 for $25 million.

According to the chart below, Buffett would not agree with the principle that any buyback is a good buyback. The S&P 500 price to book value is currently 2.82 that implies an average 182% premium on buybacks.

2 sp 500 book value

Figure 2: S&P 500 Price to book value from 2000 to 2016. Source: multpl.

The question now is: are buybacks creating or destroying value? The lowest S&P 500 price to book value was recorded in March 2009 and was 1.78. Thus, according to Buffett’s logic, the bulk of buybacks should have taken place in 2009. Of course, that is far from the truth.

3 buybacks in millions

Figure 3: Quarterly share repurchases ($M) and number of companies repurchasing shares. Source: Factset.

In Q1 2009, buybacks were at their lowest with only $30 billion of stocks being repurchased. Not surprisingly buyback activity is the highest at market peaks, as evidenced by Q4 2007 when $180 billion was spent. This shows that management is not keen on following Buffett’s logic.

According to Bloomberg, a strong factor for buyback activities is that CEOs’ paychecks are based on EPS metrics (39% of it) and by buying back shares, a CEO can increase his paycheck even if sales are not growing. The focus on increasing EPS through buybacks limits the use of available cash for long term investments. Currently S&P 500 buybacks are 70% of the net income companies make, consequently only 30% of the net income is used for growth or dividends.

4 buyback and net income

Figure 4: Trailing buybacks to net income for the S&P 500. Source: Factset.

The current stock market situation reflects a fall in net income and an increase in share buybacks that is very similar to the situation at the end of 2007. This does not mean much as history is not a good predictor for financial markets, but it’s good to keep in mind.

How to Check if Value is Increased or Destroyed by Buybacks

There are a few things to check. A company should buy back shares only if that is the best investment possible. An investment is assessed by looking at its book value if you want to listen to Buffett, or by looking at the current return if you want to be more trendy. With the first option, if the company is buying back shares and paying more than book value, it is destroying shareholder value because it would be better to use that money to grow the business as the business itself is more valuable than its book value. For the second option, if the company is buying back shares and the return on those shares is lower than the company’s cost of capital, the company should be better off if it would pay of some debt.

The return on the stock is easily calculated by using the PE ratio. 100 divided by the PE ratio gives the investor’s return on the stock. For example, Microsoft (NASDAQ: MSFT) bought back stocks for $17 billion in the last 4 quarters. It’s PE ratio is 40.1 that implies a 2.5% return from MSFT’s stock. MSFT’s interest expense on its long term debt is 2.8% which adjusted by MSFT’s tax expense of 30% would be 2%, thus below the 2.5% threshold. On a book value basis, MSFT is destroying value because it is paying $50 for something that is worth $9, and on a return on investment basis, the shareholder creation/destruction dilemma can be left for further discussion.


The use of financial engineering to achieve growth could also mean that a company is at the top of its business cycle and there are no better investments than buying its own stocks.

The mania of buying back stocks resembles picking low hanging fruit. By using financial engineering management, a company can improve the required ratios and increase its remuneration. Such behavior leads to a huge and not calculable cost: the opportunity cost. A company could use that cash to do acquisitions or to invest in R&D, and who knows what good might come out of that.

Every investor should individually assess each of their portfolio components and see if the management is creating or destroying value with buybacks.



Copper as an Investing Opportunity

  • Copper has declined due to a strong dollar, increased production and a slowdown in China.
  • In the long term a supply deficit is expected as mining grades are constantly getting lower and demand is steadily growing.


Commodities in general have been in a slump for the last 5 years; the Dow Jones Commodity Index peaked exactly 5 years ago on April 26 2011. High 2011 commodity prices induced new investments that—combined with low interest rates—made it easier to finance new projects, eventually increasing supply. With limited growth in demand the inevitable result was a contraction in prices.

538 figure 1

Figure 1: DOW Jones Commodity Index. Source: S&P Dow Jones Indices.

But, commodities are known to be a cyclical business. The current low prices put off new investments and developments that limits further increases in supply and should bring to a commodity upturn cycle.

As commodity prices are mostly influenced by demand in relation to the business cycle, supply and production constraints, political issues, the value of the US dollar and investments funds speculation, those are the factors one should focus on when researching a commodity to invest in. This article will take a deeper look at how copper fits into the above picture.


Copper’s malleability, strength and conductivity make it useful in a range of building and electrical applications, and as it is found in nearly every home and vehicle, copper is the third most mined metal in the world.

538 2 figure copper prices

Figure 2: Copper prices. Source: Nasdaq.

Copper prices had been slowly falling since 2011 and further fell in 2015.

Copper Supply

One of the interesting things about copper is that many expect a looming copper supply crunch due to the fact that demand is constantly growing alongside global GDP growth, but the copper mining grades are getting lower and at current prices many of the new projects in development are not feasible.

The International Copper Study Group (ICSG) released its copper forecast for 2016/2017 back in March. World mine production is expected to increase by around 1.5% in 2016, already much lower than the 3.5% growth experienced in 2015 due to production cuts in the Democratic Republic of Congo and mine closures in Chile. In 2017 growth is expected to be 2.3% fueled by the expansion of existing projects and new mine developments.

In the longer term, there are several issues expected to limit copper supply. The first issue is that it takes more and more time from a discovery to actual production due to geological, environmental and political challenges. An example of that is the Oyu Tolgoi mine in Mongolia owned by Turquoise Hill (NYSE:TRQ). The site was discovered in 2001, first open pit mining began only in 2013 and underground mining that contains the main resources is expected to begin only in 2021, political and financing conditions permitting.

538 figure 3 years to production

Figure 3: Number of years from discovery to production. Source:

In total the average number of years from discovery to production has gone from an average of 7 years two decades ago to the current average of 20 years as new feasible mining opportunities are mostly found in difficult environments, like Mongolia for example.

The second issue is low mining grades. Due to the fact that the low fruit is usually picked first in the longer term copper is expected to become much scarce. The lower the grade of copper the more ore has to be mined in order to produce the same amount of copper. More mining means higher costs.

538 4 declining grades

Figure 4: Copper mining and reserve grades. Source:

Back to our previous example, the Oyu Tolgoi mine, which is the main copper development project for Rio Tinto (NYSE:RIO), as RIO owns 51% of TRQ, it has a reserve grade of 0.85%. Escondida, the world’s largest copper mine, owned by BHP Billiton (NYSE:BHP) is also experiencing lower grades. BHP anticipates 27% lower grades in 2017.

Lower mining grades and longer lead times should strongly effect copper supply.

Demand for Copper

Copper is used in various industries and the diversification provides a margin of safety in relation to potential disruptions in copper demand.

538 5 figure copper consumption

Figure 5: Copper consumption per sector. Source: London Metal Exchange.

Demand for copper is strongly related to global GDP as population growth and development leads to housing growth and more vehicles and technology being bought. Albeit with ups and downs, the global economy is expected to continue growing and therefore the demand for copper is also expected to grow. When this is combined with the previous supply analysis the following estimation is the result.

538 6 supply deficit

Figure 6: Copper supply deficit. Source:

Lower mining grades and higher demand could create a 10 million ton supply deficit in the long term.

In the short term demand disruption might result from a slowdown in Chinese economic growth as China is responsible for about 40% of global copper consumption. The current slowdown in China is the main cause for copper falling below $2.00 per lb. A continuation in Chinese growth and global development should remove fears around copper.

Another interesting variable is the increase in the number of produced electrical vehicles and a shift towards cleaner energy sources. The production of an electrical car necessities three times more copper than a gasoline powered car. Also, an average of 3.6 tons of copper is used to create a megawatt of wind power capacity.

Copper and the Dollar

Copper prices are expressed in US dollars and therefore copper prices are strongly influenced by US dollar movements.

538 7 dollar copper

Figure 7: Copper vs. the US dollar. Source: Stapleford.

The long term 0.8 negative correlation between copper and the US dollar means that 80% of the changes in copper prices can be explained by changes in the US dollar. Therefore, copper could be also considered as a strong dollar hedge.


The supply deficit should be offset by increased prices that could lead to increased production but at that point the gains from investing in copper should already have been made. Wood Mackenzie estimates that the global supply deficit for copper should amount to 10 million tons by 2028. By looking at the current production cost curve for copper such a supply deficit would trigger an immense boom in prices.

538 8 cost curve

Figure 8: Copper cost curve. Source: SNL Metals & Mining.

With copper demand expected to grow constantly and limited low cost production, the above cost curve indicates that a supply deficit could easily bring to copper prices of $4.00 per pound or higher. Any increase in copper prices above the cash costs is pure profit for the miners and therefore a copper supply deficit could create extraordinary returns.

The best way to invest in copper would be to find a miner that has low debt and low production costs so that it can survive the current slump and a long mine life in order to fully grasp potential future supply deficits. If you are less inclined to investing directly into a miner, a good option is copper ETFs.


A Broader Perspective on the Global Economy

  • Easing monetary policies go on globally but do not seem to fuel sustainable growth.
  • China is slowing, Japan is looking toward another recession, and the global outlook is adjusted downwards.
  • Bad news might be around the corner, but good news is as well.


News is usually focused on the latest happenings. The fact that the human brain is set up in a way that it always tries to focus and eliminate marginal information brings to the consequence that most people do not objectively analyze the world around them. An example: How many blue cars have you seen today? Probably none because you were not looking for them, but as soon as you focus on them you will be surprised by how many you will see. The same applies to finance.

Just two and a half months ago the S&P 500 was 12.5% lower than now and headlines were filled with negative scenarios. Oil prices were below $30 and investors looked to avoid any kind of risk by selling stocks and buying bonds. Then, on February 11, FED Chairwoman Yellen hinted to Congress that “the central bank had increased trepidation over the path of interest-rate increases, pointing to accumulating risks to the economy in recent weeks.” The market focused on prolonged low interest rates and not on the accumulating risks in the economy. This article is going to give a broader perspective on the current state of the global economy in relation to financial markets by taking a look at the situation in the strongest economies.

The US

The main economic indicator, albeit one that shows only what has happened, is the Gross Domestic Product (GDP).

Figure 1: US GDP estimates and actual. Source: The Wall Street Journal – Economic Forecast.

The Wall Street Journal has surveyed 60 economists and their estimations are positive and project stable growth of more than 2%. As shown in the figure above, the previous estimates (red line) are usually stable and positive, while actual results (grey columns) are much more volatile and with negative surprises.

There is a rule in finance where if you are wrong with your estimation alongside others the collective wrongness saves you, but if you are wrong and your opinion is far from consensus, your career is at risk. Unfortunately, this usually brings stable, similar estimates close to each other and big actual surprises.

A more scientific way of estimating GDP is done by the Federal Reserve Bank of Atlanta with GDPNow, as it uses only econometrical models based on economic data variables. Figure 2 shows how this metric diverges from the general consensus above.

Figure 2: Atlanta FED GDPNow forecast. Source: Federal Reserve Bank of Atlanta – GDPNow.

The GDPnow model is forecasting only 0.3% growth for Q1 2016. The first advanced estimate from the Bureau of Economic Analysis (BEA) for the first quarter 2016 is due on the 28th of April and will show who is correct, in any case it could be market moving news.


Japan is still finding it tough to reach stable economic growth. “Abenomics,” the monetary easing policy implemented by Japan’s prime minister Shinzo Abe in 2012, is failing to produce the expected results. If Japan experiences another quarter without growth it will be just another recession that has plagued Japan’s economy in the last two decades.

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Figure 3: Japan’s GDP growth. Source: Trading Economics.

A recession in Japan should not make a big influence in international markets as it is generally expected that Japan stagnates, but both the incapacity of creating economic growth—even with a negative 0.1% interest rate—and the aging population strongly resembles the situation in Europe.


The Eurostat will publish preliminary flash estimates of quarterly GDP for the EU area on the 29th of April, synchronizing publications with the BEA (usually 15 days later). This is another piece of information that will be interesting for markets.

Estimates from the European Commission are that the EU area will grow by 1.9% in 2016, but the European Central Bank’s (ECB) decisions do not support such a positive forecast. Last week ECB president, Mario Draghi, left the current low interest rate and market purchases policy unchanged and hinted towards further easing in order to bring the EU economy to the expected levels. Almost two years of interest rates close to zero and the ECB purchasing even corporate bonds did not yet push the EU economy towards the hoped levels, an indication that strong growth for the EU might be difficult to reach. Also, Markit’s Composite Flash Purchasing Managers’ Index is showing signs of slowing growth, falling to 13 month lows in March 2016 for the EU.

Other political issues threaten European growth in 2016. The UK will vote on whether to remain in the EU in June and the pre vote polls do not indicate a clear winner. The UK leaving the EU would have significant economic repercussions and increase the political uncertainty that would strongly influence the Euro and the markets. The immigrant crisis from the Middle East is still a concern and possible increases in border controls might further slow economic trade.

Apart from the negative view, there is always hope that the easing policies will work, the weak Euro promotes exports, the UK might vote to stay in the EU, and immigration might help improve the negative demographics in Europe.

China and Emerging Markets

A fact that was soon forgotten is that the Chinese economic growth in the last few quarters was the slowest in the last 25 years.

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Figure 4: Chinese economic growth from 2010 to 2016. Source: Trading Economics.

China is still growing but many expectations and models that were based on higher growth rates have to be amended. The economic slowdown did induce the huge drop in commodity values in 2015 and that effect will surely reflect itself in local and global economic measures.

China sneezes and emerging markets get a cold. The largest economic downward adjustments are seen in emerging markets, of which Brazil and Russia are the most pronounced. The International Monetary Fund (IMF) expects that the prolonged slump in commodity prices will have a severe impact on emerging markets as they base their economies on exports of primary goods. Africa’s growth is expected to be around 3.7%, thus far from the usual high single digits.


A quick look at what is going on globally does not give much inspiration. The news did not change much since February except that central banks are going to continue with quantitative easing that gave relief to markets. But, the outlook is much bleaker than it was a year ago and the low commodity prices do not contribute to a global increase in economic activity. The IMF predicted in its February outlook that global growth in 2016 would be only 2.5%, which is 35% lower than the average of 3.8% for the last 6 years.

Even if the above data might be a little bit pessimistic, to brighten up the article, China, Africa, the US and Europe are all still growing, albeit at a slower pace so severe economic crises are not expected. But negative news may be just around the corner, so investors should be careful when assessing their risks.


On International Diversification

  • Markets are more correlated in the short term but strongly diverge in the long term.
  • Currency movements further fuel international divergence.
  • Being overweight a certain market or currency means carrying additional risks that could be removed by international diversification.


One issue that is more often off than on investors’ minds is international diversification. Historically, cross-country equity correlations have been far from perfect but they are becoming more correlated in recent times. The higher correlation is not a reason to shun international diversification.

figure 1 correlations

Figure 1: Cross-country correlation of stocks and bonds. Source: Viceira, Wang, Zhou – Harvard Business School.

The main point behind international diversification is that due to the lower correlation between markets it should lower the risks by smoothening the volatility of a portfolio for the same expected return. This happens because the international part of the portfolio is less likely to be affected by domestic market changes. The globalization of trade flows and higher capital markets integration increased the international correlation among markets and consequently lowered the potential benefits. But, as correlation is always measured in the short run, in the longer term it should bring to the expected benefits of reaching the same returns with lower risk because the long term correlation is much lower.

Lower Long Term Correlation of International Markets 

The long term correlation among international markets is lower than the short term due to several reasons. The first one is that even if in the short term the global integration of capital markets makes it look like they are correlated, in the longer term structural influences prevail. The following two figures show the difference between short and long term correlation.

figure 2 1 year correlation

Figure 2: 1-year correlation between the S&P 500, AEX (Dutch index), iBovespa (Brazil) and FTSE (UK). Source: Yahoo.

The difference among the above indexes in one year is only 10% with the AEX being the worst performer. This small difference makes investors forget about international diversification. But in the long term things are completely different.

Figure 3 10 year correlation

Figure 3: 10-year correlation between the S&P 500, AEX (Dutch index), iBovespa (Brazil) and FTSE (UK). Source: Yahoo.

In the longer period of 10 years the differences are much larger. The Brazilian index is the most volatile and the S&P 500, AEX and FTSE move along for a while but strongly diverge in the total period. The above figures show the movement of the relative stock market indices without taking into account currency effects. Currency effects are the second important factor in international diversification. The below figure shows the example of the USD/EUR currency pair.

Figure 4: USD/EUR currency pair from 2006 to 2016. Source:

On top of the previously explained market divergence the dollar strengthened in relation to the EUR from 0.62 EUR per 1 USD in 2008 to the 0.95 EUR per 1 USD. That represents a divergence of more than 50% and shows how the currency effect can influence international correlation in the long term. Currencies are strongly influenced by economic trends and that is the third factor influencing international correlation.

Economic Influences

The below cumulative GDP growth chart shows how countries experience different growth levels in longer periods. The UK and the US have grown 50% faster than the Netherlands while Brazil grew 100% faster than the US in the period from 2000 to 2015.

Figure 5 cummulative GDP growth

Figure 5: Cumulative economic growth for the US, UK, Netherlands and Brazil from 2000 to 2015. Source: World Bank.

Economic divergences are a consequence of longer term structural effects and global cycles. Currently the Euro is considered weak due to the low interest rates in Europe, slow economic growth and no short term positive economic catalysts on the horizon. On the other side, due to the weakness of the currency European products are cheaper internationally and that could influence faster economic growth in the future. In the meantime, the strong dollar makes US products globally more expensive and this could lower the currently stronger economic growth of the US.

The above long term factors also lower the risk of a portfolio in a long term and are important factors to think about when investing. But, even if the benefits of portfolio diversification are clear in the long term, investors stick to their domicile markets. This phenomenon is called the equity home bias puzzle.

Equity Home Bias Puzzle

An interesting feature in the international markets is the home bias. It describes the tendency to invest the largest part of one’s portfolio in domestic securities despite the benefits of international diversification. University of Chicago researchers, Moskowitz and Coval have found that specifically US investment managers exhibit a strong preference for locally headquartered firms that often create asset pricing anomalies. A Morningstar research in 2013 found out that US mutual fund investors keep only 27% of their equity allocation in not US domiciled funds while the Equities not domiciled in the United States accounted for 51% of the global equity market. It is logical that investors prefer the familiar but each investor should assess its own exposure to a certain currency and evaluate his long term risks related to that exposure.

The Strength of the Dollar

Being overweight one market means betting on the success of that currency or market in relation to other markets and currencies. Therefore, such an overweight investor has to assess potential international macroeconomic influences on his portfolio. Such long term economic shifts are very difficult to time and therefore considered betting. US investors have had a great investing performance in the last few years with Europe starting quantitative easing, commodities, that are the main wealth resource of emerging markets faltering and China experiencing a soft landing. But, the below figure that compares the US dollar to a basket of foreign currencies shows how risky an overweight currency strategy can be.

Figure 6 U.S. dollar index

Figure 6: US dollar index from 1967 to 2015. Source: Wikimedia.

An astute investor could also use the above evident shifts and allocate different weights to various markets in relation to their current weakness but that is a different story and requires high macroeconomic knowledge and insight.


The main idea behind this article is to give food for thought. International diversification might not be relevant in the short term but in the longer term it can provide certain benefits. There are various ways of being internationally diversified, through buying different indices or by buying stocks of the same sector that have a different geographic focus. A clear example for that are utilities, they provide relatively stable returns and dividends and when dispersed internationally can lower the volatility of a portfolio.