Welcome to the June edition of the Burrell Blog for 2017.
ResMed, Valuations, New World Disorder and Chinese Debt
Healthy sleep, good nutrition and physical fitness are the triumvirate of health proposed by Dr William C Dement, Director, Stamford Sleep Disorders Clinic and Research Centre, Stamford University, USA. Amongst specific sleep disorders, the most serious in terms of morbidity and mortality is obstructive sleep apnea (SDB). “It is time for the nation to wake up to the staggering impact of sleep disturbances on the health and welfare of our society, an impact that rivals that of smoking”. In a paper to the Stockbrokers and Financial Advisors Association National Conference in Sydney on 25 May 2017, Dr Peter Farrell AM, Founder & Chairman of ResMed showed sleep apnea is highly prevalent in key diseases: Stroke (63%) Depression (45%) Type 2 Diabetes (72%) Obesity (77%) Heart Failure (76%) Drug-Resistant Hypertension (83%) Coronary Artery Disease (57%) A-fib (49%).
Sleep apnea significantly impacts the four major causes of death in the Western World:
- ↗ Cardiac disease: 50% of patients seeing a general cardiologist have SDB/OSA at some level
- ↗ Cancer: SDB significantly accelerates death from solid tumours
- ↗ COPD: 57% of patients with moderate to severe chronic obstructive pulmonary disease (COPD) have significant SDB.
- ↗ Stroke: up to 75% of patients with stroke have SDB
Peter Farrell started the ResMed business with six employees. The ResMed mission is to become the global leader in development, manufacture and marketing of innovative products for the diagnosis, treatment and management of sleep/disorder breathing. ResMed now has 6,000 employees worldwide, estimated FY 2017 annual revenue of US$2.2B, is listed on the NYSE and the ASX with a market cap over $9B and operates in more than 100 countries. ResMed has either the #1 or #2 market position in all major markets in which they operate. ResMed made the Forbes 200 best small companies in America for 10 consecutive years (1997/2006) until it became too large (> $750M in revenues). NPAT is approximately 20% of revenues.
In the last 18 months, ResMed has released a new platform, released new masks and airflow generators, and now following the acquisition of a major software house, has apps and Wi-Fi technology which allow the medical profession and users to better understand the management of their sleep breathing issues. Rather than being a mature opportunity, Peter Farrell concluded “the SDB opportunity is a marathon and we are only lacing our shoes; it’s time for the nation and the world to wake up to sleep”.
ResMed is a company which Burrells have supported over a number of years. The support appears justified from the presentation.The Russell Investments Conference 30 May 2017 was also held in Sydney. Andrew Pease, Global Head of Investment Strategy, Russell, London commenced by noting the political uncertainties caused by a number of factors including 1) delayed reaction to and a slow recovery from Global Financial Crisis (GFC); 2) Baby boomers retiring and creating demands on governments. Our Stone Age brains have a run from fear mentality. This bias is not helpful if you’re trying to manage investments. Of the other limitations, the group think bias is the most dangerous. A structured process is essential to correct these behavioural biases.
The Russell Investment strategists’ philosophy involves 3 time horizons and 3 buildings blocks. If considering a 10 year horizon, all that matters is value. But as the horizon shortens, cycle becomes important ie. changes in the macroeconomic environment that influences asset price behaviour. On an even shorter timeframe, sentiment is important ie. price momentum v contrarian indicators that signal overbought/oversold conditions. So the 3 building blocks are value, cycle and sentiment.
Applying this framework to the US stock market, the Schiller P/E based on a 10 year trend of earnings is currently at 30x. It’s only been at this level twice in the last 100 years being the 1999/2000 internet tech bubble and in 1929. Thus on valuation, the US market is very expensive.
The cycle for the US market is neutral. There is a low probability of recession, fiscal easing is likely to be offset by the Fed, and profit growth will be held down by the existing high margins, rising labour costs and lack of pricing power. The wage share of US GDP will rise and the profit share will fall back to more “normal” levels as these shares are still correcting post GFC. US sentiment is slightly negative. The market is overbought and complacent, as shown by the low volatility VIX. Conclusion: moderately negative. Buy the dips and sell the rallies. Sell the current rally.
It’s different in the rest of the world. Europe, emerging markets and to a lesser extent, Japan rate positively overall. In Australia, the cycle is neutral, value slightly expensive and sentiment neutral.
In terms of Brexit, UK is about to have a tough time. The UK stockmarket is quite unrelated to the UK economy given the level of overseas earnings. So as the currency falls, the UK stockmarket has been going up.
Dr Allen Dupont, Founder and CEO, Cognoscenti Group presented a paper entitled The New World Disorder ie. geopolitical risk. His thesis was that today’s geopolitical risk is going to be with us for a long time and this is a new paradigm. Geopolitical risk has doubled since 9/11 per the Bank of England and in the last 12 months even more so. The characteristics of the new world disorder:
- ↗ Rising geopolitical tensions between the major power
- ↗ Loss of western leadership and values
- ↗ Weakening of international institutions
- ↗ Rule of law under threat. Contributor: Declining growth rates particularly in developed world
We are transitioning towards a new world order in which the rules of the game and distribution of power between states, and between states and non-state actors, is rapidly changing.
George Modelski asserted that geopolitical super cycles occur evert 100-120 years. We are in the midst of transition between super cycles. China is the emerging challenger to USA, the current global leader. From 1945 to 2015 was the PAX AMERICANA ie. the American peace post war. We are seeing a shift from PAX Americana to a new more turbulent world.
There are 5 geopolitical drivers:
- ↗ The emergence of China: China wants to be number 1 in Asia. The South China Sea/Silk Road proposals are outward signs of Chinese ambitions.
- ↗ New assertiveness of Russia. Like Xi Jinpng, Putin is dissatisfied with the existing order
- ↗ A disruptive USA. All Presidents until Trump were followers of Pax Americana. Trump says no, he is not protecting the old order. So Trump is also a disruptor.
- ↗ Weaker Europe. Brexit but not Frexit
- ↗ Middle East before the Arab Spring was stable. We have the post-colonial Middle East disintegrating. Sunni Shia divide. Middle East is a mess.
North Korea: no real military solution. So requires a solution as the nuclear missile program is not acceptable to the US. China is the only one that can bring North Korea to heel. Need a game changing event.
So the world is at the beginning not the end of a 20-30 year transition from Pax Americana. China will not rule the world, but neither will US or Russia. The US will remain a pre-eminent player, but the European decline is more difficult to reverse. Politics in the developed world is now the greatest single risk and source of potential volatility in global markets.
Brian Ingram, President, Russell Investment advisors, Shanghai was interviewed on stage with the topic being “China’s debt meets rising interest rates”. There is no doubt that China has a large debt. Within China the debate about which debt matters and which parts to address is a priority. Private corporate debt and state owned enterprises (SOE) debt is the responsibility of the Chinese President. Other private debt has been the responsibility of the PBOC, the Chinese central bank. This debt built up during the GFC with stimulus as in USA and Europe.
President Xi saw the role of the banks being to fund SOE’s in the period up until 2015. He did not have responsibility for and was not overly focused on the banks themselves. As a result, shadow banking and interbank lending resulted in large increasing bank liabilities and this is the scariest and riskiest part of Chinese debt.
The Chinese authorities are now focused on the problem. China is looking for a Marshall Plan investment equivalent into industrial production which would help fund the Silk Road and give time for the debt to be addressed.
Retail investor products with up to 40x leverage resulting in defaults are about to be quarterised by PBOC controls/crack downs. The rates are rising with the Shanghai interbank lending rate up from 2% 12 months ago to 4.5%. The PBOC is intentionally increasing interest rates to stop risky behaviour. The mood in China is optimistic that China will achieve a reasonable outcome on the debt and financial leverage issue.
In the midst of the above, Chinese companies have shown strong profit growth, increased transparency including capital flow and valuations. Discussing this matter with the speaker after the session, he expressed the view to your diarist that Chinese share prices came down materially a couple of years back (Shanghai composite 5166 June 2015; 2738 Jan 2016; 3152 June 2017) and have gone sideways, while profits have grown strongly. Thus P/Es are now attractive in some areas. This contrasts to the discussion 2 years ago when Russell were concerned with the high level of valuations in the Chinese markets.
Jillian Broadbent AO Director Woolworths, Chair SwissRe and Clean Energy Finance Corporation, Chancellor of the University of Wollongong and previously Director of Woodside Petroleum presented the final paper of the day entitled “Climate Change: The Investment Perspective”.
Her opening statement was that the risks of no action are profound.
Australian energy abundance for many decades led to low cost domestic energy. That competitive advantage is now being eroded by a number of factors including old contracts coming up for renewal and global market pricing. Politicising has resulted in stop/start policies including the carbon tax which has provided an uncertain backdrop for corporations to transition to lower carbon emissions.
The speaker noted the global warming has resulted in young people leaving the land and moving into cities. This urbanization is a factor in the Syrian civil war and also the immigration from North Africa to Europe, which has caused other social problems.
Your diarist is grateful to the Stockbrokers and Financial Advisors Association and to Russell Investments for his attendance at these two excellent conferences.
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