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Please note: The Frank Talk articles listed below contain historical material. The data provided was current at the time of publication. For current information regarding any of the funds mentioned in these presentations, please visit the appropriate fund performance page.

Modi’s Demonetization Is a Cure Worse Than the Disease
December 1, 2016

overnight indian prime minister narendra modi killed 90 nations currency

Next Tuesday will mark four weeks since Indian Prime Minister Narendra Modi made his surprise demonetization announcement that has sent shockwaves throughout the South Asian country’s economy. In an effort to combat corruption, tax evasion and counterfeiting, all 500 and 1,000 rupee banknotes are no longer recognized as legal tender.

I've previously written about the possible ramifications of the “war on cash,” which is strengthening all over the globe, even here in the U.S. Many policymakers, including former Treasury Secretary Larry Summers, are in favor of axing the $100 bill. In May, the European Central Bank (ECB) said it would stop printing the 500 euro note, though it will still be recognized as legal currency. The decision to scrap the “Bin Laden” banknote, as it’s sometimes called, hinged on its association with money laundering and terror financing.

Electronic payment systems are convenient, fast and easy, but when a government imposes this decision on you, your economic liberty is debased. In a purely electronic system, every financial transaction is not only charged a fee but can also be tracked and monitored. Taxes can’t be levied on emergency cash that’s buried in the backyard. Central banks could drop rates below zero, essentially forcing you to spend your money or else watch it rapidly lose value.

Inevitably, low-income and rural households have been hardest hit by Modi’s currency reform. Barter economies have reportedly sprung up in many towns and villages. Banks have limited the amount that can be withdrawn. Scores of weddings have been called off. Indian stocks plunged below their 200-day moving average.

indian stocks tumble following modis demonetization announcement
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Demonetization has also weighed heavily on the country’s manufacturing sector. The Nikkei India Manufacturing PMI fell to 52.3 in November from October’s 54.4. Although still in expansion mode, manufacturing production growth slowed, possibly signaling further erosion in the coming months.

Indian Manufacturing Cools in December
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India Runs on Cash

The two Indian bills in question, worth $7.50 and $15, represented an estimated 86 percent of all cash in circulation by value. No two bills in the U.S. so dominate transactions quite like the Rs500 and Rs1,000 notes, but imagine if tomorrow the Treasury Department killed everything north of the $20 bill. Despite the widespread availability and acceptability of electronic payment systems, this would be devastating to many American consumers who prefer cash or who are underbanked.

Because India’s economy relies predominantly on cash, the effects will be far greater. ATMs are scarce, and few rural Indians have a credit or debit card. An estimated 600 million Indians—nearly half the country’s population—are without a bank account. Three hundred million have no government identification, necessary to open an account. By comparison, about 7 percent of Americans are unbanked, with an additional 20 percent underbanked, according to the Federal Deposit Insurance Corporation (FDIC).

In india cash is king
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This is one of the main reasons why Indians have traditionally held gold in such high demand. Many have little faith in banks and other financial institutions, preferring instead to store their wealth in something more reliable and tangible. So great is Indians’ appetite for the yellow metal that prices have historically surged in September, following the end of the monsoon season and ahead of Diwali and the wedding season, when gifts of gold jewelry are typically given.

“Gold is a need of the [Indian] people,” says Suresh Jain, owner of India’s B.J. Jain Jewellers, as quoted in the Financial Times. “It is not a luxury item. It is essential.”

Ironically, though, Modi’s demonetization scheme will likely hurt gold demand in the long run, “by dramatically reducing the stock of black money hitherto used in a large chunk of purchases,” according to the Financial Times.

In the three days following the announcement, Apple iPhone sales surged, equaling three quarters of the sales that typically happen in a month, as people tried to move their black money. Shopkeepers obliged by backdating receipts. Demand for other luxury items, such as Rolex watches, also surged.

Last year, our office was visited by the founders of MoneyOnMobile, which provides full point-of-sale services to Indians who don’t have ready access to ATMs. Think of it as the Indian version of Square. It’s likely that with demonetization wiping out so much paper currency, demand for services such as MoneyOnMobile’s will skyrocket.  

Good Intentions, Bad Execution

India is right to tackle corruption

Admittedly, high cash usage often comes with a cost. In 2013, research firm McKinsey found a strong correlation between high cash usage and the size of a country’s shadow economy. The size of India’s own shadow economy—which includes black market transactions and undeclared work—is roughly a quarter the size of gross domestic product (GDP).

Indeed, India suffers from a serious rash of corruption, which hurts honest, hard-working families. According to Transparency International, the South Asian country ranks 76 out of 168 countries in its 2015 Corruption Perceptions Index. In May, Indian government data showed that a scant 1 percent of Indians pay income taxes.

So yes, corruption is a problem. But in the case of ditching paper money altogether, the cure is worse than the disease.

In a New York Times op-ed, Indian economist and World Bank Vice-President Kaushik Basu strongly criticized the policy, rightly pointing out that it’s “mostly hurting people who aren’t its intended targets.”

“The government’s wish to tackle these problems is laudable,” Basu added, “but demonetization is a ham-fisted move that will put only a temporary dent in corruption, if even that, and is likely to rock the entire economy.”

I agree. Demonetization will hurt low-income and rural families the most, while those who’ve benefited from the country’s deep shadow economy will likely find other avenues to traffic in corruption.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The S&P BSE SENSEX (S&P Bombay Stock Exchange Sensitive Index), also-called the BSE 30 or simply the SENSEX, is a free-float market-weighted stock market index of 30 well-established and financially sound companies listed on Bombay Stock Exchange.

The Nikkei India Manufacturing PMI is based on data compiled from monthly replied to questionnaires sent to purchasing executives in over 400 industrial companies. The panel is stratified by GDP and company workforce size. The manufacturing sector is divided into the following eight broad categories: Basic Metals, Chemicals & Plastics, Electrical & Optical, Food & Drink, Mechanical Engineering, Textiles & Clothing, Timber & Paper and Transport.

The Corruption Perception Index, developed in 1995 by Transparency International, ranks almost 200 countries on a scale of zero to 10, with zero indicating high levels of corruption and 10 indicating low levels. Developed countries typically rank higher than developing nations due to stronger regulations.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 9/30/2016.

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Fidel Castro’s Cuba vs Lee Kuan Yew’s Singapore: A Tale of Two Economies (UPDATE)
November 29, 2016

On Friday, November 25, Fidel Castro died at age 90. The former revolutionary and hardline dictator of Cuba was among the 20th century’s longest-serving leaders, third only to Elizabeth II and Bhumibol Adulyadej, the King of Thailand, who passed away in October.

Castro’s death comes at a pivotal moment in U.S.-Cuban relations. With trade between the two countries on the path to normalization, and with U.S. airlines making scheduled flights to Havana for the first time in more than 50 years, President-elect Donald J. Trump has pledged to reinstate many of the Cold War embargos that were lifted by President Barack Obama.

“If Cuba is unwilling to make a better deal for the Cuban people, the Cuban/American people and the U.S. as a whole, I will terminate deal,” Trump tweeted on November 28.

In light of Castro’s passing, we are rerunning this Frank Talk from March 2015, in which Frank compares and analyzes the widely divergent economies of Cuba and Singapore under their now-deceased leaders, Castro and Lee Kuan Yew. 

A Victoria's Secret in the Toronto Pearson International AirportIt would be nearly impossible to find two world leaders in living memory whose influence is more inextricably linked to the countries they presided over than Cuba’s Fidel Castro and Singapore’s Lee Kuan Yew, who passed away this Monday at the age of 91.

You might find this hard to believe now, but in 1959—the year both leaders assumed power—Cuba was a much wealthier nation than Singapore. Whereas Singapore was little more than a sleepy former colonial trading and naval outpost with very few natural resources, Cuba enjoyed a thriving tourism industry and was rich in tobacco, sugar and coffee.

Fast forward about 55 years, and things couldn’t have reversed more dramatically, as you can see in the images below.

Cube in 1950, Singapore in 1950, Cuba today, Singapore today

The ever-widening divergence between the two nations serves as a textbook case study of a) the economic atrophy that’s indicative of Soviet-style communism, and b) the sky-is-the-limit prosperity that comes with the sort of American-style free market capitalism Lee introduced to Singapore.

Sound fiscal policy, a strong emphasis on free trade and competitive tax rates have transformed the Southeast Asian city-state from an impoverished third world country into a bustling metropolis and global financial hub that today rivals New York City, London and Switzerland. Between 1965 and 1990—the year he stepped down as prime minister—Lee grew Singapore’s per capita GDP a massive 2,800 percent, from $500 to $14,500.

Since then, its per capita GDP based on purchasing power parity (PPP) has caught up with and zoomed past America’s.

Lee Kuan Yew's Singapore Flourished while Fidel Castro's Cuba Floundered
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Under Castro and his brother Raúl’s control, Cuba’s once-promising economy has deteriorated, private enterprise has all but been abolished and the poverty rate stands at 26 percent. According to the CIA’s World Factbook, “the average Cuban’s standard of living remains at a lower level than before the collapse of the Soviet Union.” Its government is currently facing bankruptcy. And among 11.3 million of Cuba’s inhabitants, only 5 million—less than 45 percent of the population—participate in the labor force.

Compare that to Singapore: Even though the island is home to a mere 5.4 million people, its labor force hovers above 3.4 million.

Singapore Had Third-Highest GDP Based on Purchasing Power Parity (PPP) Per Capita

Because of the free-market policies that Lee implemented, Singapore is ranked first in the world on the World Bank Group’s Ease of Doing Business list and, for the fourth consecutive year, ranked second on the World Economic Forum’s Global Competitiveness Report. The Heritage Foundation ranks the nation second on its 2015 Index of Economic Freedom, writing:

Sustained efforts to build a world-class financial center and further open its market to global commerce have led to advances in… economic freedoms, including financial freedom and investment freedom.

Cuba, meanwhile, comes in at number 177 on the Heritage Foundation’s list and is the “least free of 29 countries in the South and Central America/Caribbean region.” The Caribbean island-state doesn’t rank at all on the World Bank Group’s list, which includes 189 world economies.

Many successful international businesses have emerged and thrived in the Singapore that Lee created, the most notable being Singapore Airlines. Founded in 1947, the carrier has ascended to become one of the most profitable companies in the world. It’s been recognized as the world’s best airline countless times by dozens of groups and publications. Recently it appeared on Fortune’s Most Admired Companies list.

Singapore AIrlines

We at U.S. Global Investors honor the legacy of Lee Kuan Yew, founder of modern-day Singapore. He showed the world that when a country chooses to open its markets and foster a friendly business environment, strength and prosperity follow. Even on the other side of the globe, the American Dream lives on.

 

 

The Global Competitiveness Index, developed for the World Economic Forum, is used to assess competitiveness of nations. The Index is made up of over 113 variables, organized into 12 pillars, with each pillar representing an area considered as an important determinant of competitiveness: institutions, infrastructure, macroeconomic stability, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market sophistication, technological readiness, market size, business sophistication and innovation.

The Ease of Doing Business Index is an index created by the World Bank Group. Higher rankings (a low numerical value) indicate better, usually simpler, regulations for businesses and stronger protections of property rights.

The Index of Economic Freedom is an annual index and ranking created by The Heritage Foundation and The Wall Street Journal in 1995 to measure the degree of economic freedom in the world's nations.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. None of the securities mentioned in the article were held by any accounts managed by U.S. Global Investors as of 9/30/2016.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

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The Great American Splurge
November 28, 2016

Retail madness: more than 137 million american consumers plan to shop thanksgiving weekend

In a Frank Talk last week, I discussed the surge in small-cap stocks since Donald Trump’s election. A bet on smaller domestic stocks, I wrote, is a bet that Trump will deliver on his promise to “make America great again.” He plans to lower taxes, streamline regulations and spend big on infrastructure—all of which has led to a rally in the small-cap Russell 2000 Index and the 10-Year Treasury yield.

big moves in small-cap stocks and treasury yields since trump's election
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The ramifications of government policy change under Trump, especially fiscal policy, have the potential to be huge. Since Election Day, we’ve seen the strong U.S. dollar hurt gold, while the Canadian dollar and Chinese renminbi have dropped.

The question now is whether Federal Reserve Chair Janet Yellen will put the brakes on the so-called Trump rally. She asserts that Fed policy is not politically motivated, but I wonder how many people actually believe that. She’s already criticized Trump’s plans to tear up or at least significantly weaken Dodd-Frank Wall Street Reform.

Both former Fed Chair Alan Greenspan and billionaire investor Warren Buffett have recently suggested Dodd-Frank needs to go, with Greenspan telling CNBC that he’d love to see the 2010 law “disappear.” Buffett, meanwhile, commented in an interview this month that the U.S. is “less well equipped to handle a financial crisis today than we were in 2008. Dodd-Frank has taken away the Federal Reserve’s ability to act in a crisis.”

Retail madness: more than 137 million american consumers plan to shop thanksgiving weekend

Since the election, banks have seen strong inflows, as investors are betting that the financial industry could be one of the largest beneficiaries of Trump’s administration.

According to Evercore ISI analyst Glenn Schorr, “Animal spirits and higher confidence have returned, and investors are now expecting a better revenue, expense, tax, capital and regulatory profile for financials.” In addition, “we might have just flipped from feeling pretty late cycle right back to early cycle depending on how much we want to buy into Trump’s pro-growth agenda.”

Americans Take Advantage of Low Inflation

Last year, lower gas prices helped American households save $700 on average. Although savings aren’t likely to be as much this year, Americans managed to save in other ways—namely, food and beverages.

According to the American Farm Bureau Federation (AFBF), the cost of a typical Thanksgiving meal for 10—consisting of a turkey, stuffing, sweet potatoes, cranberries, a pumpkin pie and other traditional sides—fell 24 cents from last year’s average to $49.87. That translates to a per-person cost of just under $5, confirming that “U.S. consumers benefit from an abundant high-quality and affordable food supply,” says AFBF Director of Market Intelligence Dr. John Newton.

As I’ve said multiple times before, the U.S. shale oil boom helped deliver an “oil peace dividend” to the world, which drove transportation costs and, therefore, food and beverage costs down over the past two years.

A Thanksgiving Meal fell below $5 per person this year
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Low fuel costs also encouraged a huge number of families to hit the highway this Thanksgiving weekend. According to AAA, roughly 50 million people—about 1 million more than last year— journeyed 50 miles or more from their homes, the most since 2007.

With gas prices at their second lowest level in a decade, driving remains the most popular mode of transportation. But as I previously shared with you, flying has also become more and more affordable for many Americans. This week, an estimated 27 million passengers flew on U.S. airlines, an increase of 2.5 percent over last year.

27 million passengers will fly U.S. airlines this Thanksgiving week, up 2.5 percent from last year

Black Friday Is the New Cyber Monday

It isn’t just travel that’s back to pre-recession levels. This year, it appears more Americans than ever before—enjoying low inflation and rising wages—will be spending their savings on gifts for friends and family, if estimates from the National Retail Federation (NRF) are accurate.

According to the retail trade association, as many as 137.4 million consumers planned to shop this Thanksgiving weekend, nearly a whopping 60 percent of Americans. This figure is up from last year's 135.8 million people. This includes both in-store shopping as well as online shopping, which, as you might have noticed, is becoming a huge deal.

Black Friday remains the busiest shopping day, with 74 percent of consumers telling the NRF they planned to venture out into the crowds to take advantage of gotta-have-it bargains.

But e-commerce is quickly catching up, with the internet-only Cyber Monday second in sales to Black Friday. For the first time this holiday season, online purchases are expected to account for more than 10 percent of all retail sales, according to consumer research firm eMarketer. “Online sales,” reports Bloomberg, “are likely to climb to $94.7 billion, representing almost 11 percent of total sales in November and December, an all-time high.”

E-commerce is set to account for a record share of retails sales this holiday season
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The growing popularity of online shopping has prompted more and more brick-and-mortar retailers to push their e-commerce sales earlier to Black Friday and even Thanksgiving Day. In years past, retailers waited until Cyber Monday to post digital discounts, but today they risk losing market share among shoppers who increasingly prefer making purchases off their laptop and smartphone.

One of these retailers is Walmart, which will start offering online sales two days in advance, in a bid to stay ahead of competitor Amazon.  In a press release, the Arkansas-based behemoth announced it has tripled its assortment of online products, from 8 million last year to more than 23 million today.

Another Record Year for Packages Delivered

The rise in e-commerce has had the inevitable effect of giving more business to ground and air delivery companies such as FedEx and United Parcel Service (UPS). It’s expected that, with online sales jumping 17 percent this year, the number of packages handled and shipped will jump to a record high.

According to Business Insider, UPS—the world’s largest delivery company—projects it will ship a record-setting 700 million packages between Thanksgiving and Christmas, or 70 million more than the same time last year. FedEx hopes it can ship 10 percent more than the 325 million it delivered last year.

Meanwhile, Amazon’s plans to establish its own in-house transportation network have hit a setback. About 250 pilots contracted with Amazon partners Air Transport Service Group and Atlas Air Worldwide Holdings went on strike Tuesday over a “longstanding labor dispute.” The Jeff Bezos-run retailer has been determined to deliver its own products after bad weather in 2013 delayed millions of Christmas deliveries, but it appears these efforts are off to a rough start.

Wishing You Health, Wealth and Happiness!

I wish to conclude by giving thanks to our loyal Investor Alert readers as well as investors. Visit us on Facebook or Twitter and let us know what you’re thankful for this season!      

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The Russell 2000 Index is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000. The Russell 3000 Index consists of the 3,000 largest U.S. companies as determined by total market capitalization.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of 9/30/2016: United Parcel Service Inc.

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Small-Cap Investors See Big League Growth Under Trump
November 23, 2016

I’ve been in the financial industry a long time, and I’m continually amazed at the market’s astuteness in making reliable, actionable forecasts.

Consider the run-up to this year’s election. Nearly every poll pointed to Hillary Clinton taking the White House, with many pegging her chances at greater than 90 percent. The market took these prognosticators to task. Historically, when the S&P 500 has turned negative between July 31 and October 31, it’s spelled doom for the incumbent party candidate. This year, the market fell more than 2 percent, setting the stage for a Donald Trump victory. 

The Wisdom of Crowds: Market Accurately Predicted President-Elect Trump
click to enlarge

A thought-provoking Atlantic article asserts that “the press takes [Trump] literally, but not seriously; his supporters take him seriously, but not literally.” This is ostensibly how many Trump supporters were able to excuse his more off-color language and instead focus on his proposals. Markets were willing to do the same.  

Now, those same markets seem to be placing their bets on the likelihood that Trump’s “America First” policies will benefit small-cap companies especially.

The media is already calling it the “Trump rally.” As I write this, the Dow Jones Industrial Average closed above 19,000 for the first time ever, with the S&P 500 Index and Nasdaq Composite Index having recently set all-time highs.

But small-cap stocks have fared even better. Since Election Day, the small-cap Russell 2000 Index has made “big league” gains, surging more than 11 percent and hitting a record high. The index has been up for 13 straight days—its best run since 1996.

The Wisdom of Crowds: Market Accurately Predicted President-Elect Trump
click to enlarge

But why are investors focused on small-cap stocks specifically? Simply put, a bet on domestic small caps is a bet that Trump will deliver on his promise to “make America great again.”

Making Domestic Stocks Great Again

The president-elect’s proposals are aggressively inward-facing, which bodes well for companies with little foreign exposure. As a group, small caps have far less exposure to foreign markets than larger, multinational companies do. Because they rely a lot less on exports, they’re not as negatively affected by a strong U.S. dollar, which has the effect of making American-made products more expensive for foreign buyers.

Today the dollar is trading at 14-year highs, with expectations of moving even higher after a possible rate hike next month, followed by Trump’s inauguration in January.

The Wisdom of Crowds: Market Accurately Predicted President-Elect Trump
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According to his website, Trump plans to create at least 25 million new jobs over the next decade and grow the economy at 3.5 percent per year on average. He will manage to do this, he says, by lowering taxes and “scaling back years of disastrous regulations unilaterally imposed by our out-of-control bureaucracy.”

As I’ve shared with you before, regulations cost the U.S. economy approximately $2 trillion a year.

The president-elect also plans to spend as much as $1 trillion on infrastructure over the next 10 years, which the market has responded to approvingly.
This market behavior is yet another example of the “wisdom of crowds,” which I’ve discussed numerous times before. In one of my favorite books, 2005’s The Wisdom of Crowds,business writer James Surowiecki convincingly makes the case that large groups of people will nearly always be smarter and better at making predictions than an elite few.

The Wisdom of Investors

The Wisdom of Crowds BookAt first blush, this idea might seem counterintuitive. We’ve all heard of mob mentality. Indeed, giant crowds of people are sometimes capable of making impulsive, irrational and destructive decisions. Think of the Salem witch trials, which ended with the execution of 20 people, or the Holocaust.

But Surowiecki’s thesis says that large groups of diverse and independently-deciding people—investors, for instance—are far better at analyzing and aggregating mass amounts of information than individuals, even experts.

As an example, Surowiecki explores the market’s now-famous response to the tragic Challenger shuttle explosion in 1986. In the minutes following the televised disaster, “investors started dumping the stocks of the four major contractors who had participated in the Challenger launch: Rockwell International, which built the shuttle and its main engines; Lockheed, which managed ground support; Martin Marietta, which manufactured the ship’s external fuel tank; and Morton Thiokol, which built the solid-fuel booster rocket.”

One of these names, however, was hit the hardest—Thiokol. By the end of the trading day, it was down almost 12 percent, more than six standard deviations in the three months before the explosion, according to economists Michael Maloney and Harold Mulherin. What the market seemed to be saying is that Thiokol was to blame.

Investors Accurately Faulted Morton Thiokol for Challenger Explosion
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The thing is, there had been no public comments implicating the now-defunct manufacturer. It wouldn’t be for another six months, during a presidential commission hearing on the disaster, that evidence was released showing Thiokol’s O-ring, which is supposed to prevent hot gases from escaping the booster rockets, had been faulty.

On that day, Surowiecki writes, the stock market was “working as a pure weighting machine, undistorted by the factors—media speculation, momentum trading and Wall Street hype—that make it a peculiarly erratic mechanism for aggregating the collective wisdom of investors.”

Similarly, the market in 2016 managed to cut through the ugly campaign noise and rhetoric to select the candidate who eventually emerged as victor. And now, they appear just as convinced that Trump’s policies can unleash American growth and ingenuity.

 

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry. The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks. The Russell 2000 Index is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000. The Russell 3000 Index consists of the 3,000 largest U.S. companies as determined by total market capitalization.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of 9/30/2016: Lockheed Martin Corp.

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Surprise! Buffett Books a Flight on Airline Stocks
November 21, 2016

warren buffett bets big on airlines

It’s never too late to change your mind.

After years of deriding the airline industry, Warren Buffett confirmed last week that his holding company, Berkshire Hathaway, has invested nearly $1.3 billion in four big-name domestic carriers: American, Delta, United and Southwest.

Domestic Airlines Surge Buffett Investment News
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The stake is a dramatic reversal for the 86-year-old investing wizard, who previously called the industry a capital “death trap” and once joked that investors would have been served well had Orville Wright’s plane been shot down at Kitty Hawk.

The thing is, Buffett held these opinions long before airlines began making the fundamental changes that would flip their fortunes from bankruptcy to record profitability. When Buffett first tried his hand at making money in the aviation industry in 1989, airlines were still struggling in a fiercely competitive marketplace. Many carriers called it quits, including President-elect Donald Trump’s Trump Shuttle, which ceased operations in 1992. Others spent years in bankruptcy court.

But following the massive wave of industry consolidation between 2005 and 2010, a new business environment emerged, one characterized by disciplined capacity growth, new sources of revenue, greater efficiency and a commitment to repairing balance sheets. I’ve written about these changes for the past 18 months, all of which are summarized in this brief five-minute video.

2 million people fly us every day

Buffett also likes airlines now for the same reason he’s long been a fan of railroads—namely, the barriers to entry are extremely high if not entirely impenetrable to new competitors. This is the “moat” Buffett refers to when talking about rail.

As a value investor, he prefers inexpensive stocks, and among industrials, airlines are cheapest of all, based on price-to-earnings and cash flow.

Airlines Least Expensive Among Industrials
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Buffett’s bullish rotation into airlines was followed by news last week that Citi also made fresh buys of Southwest, Delta, American and Allegiant shares, on the “broad theme that sector consolidation and an improved economy will reap benefits,” according to Seeking Alpha’s Clark Shultz.

Challenges still remain, of course, but domestic airlines today are profit-making, dividend-paying machines. In the first nine months of 2016, the top nine U.S. carriers—Alaska, Allegiant, American, Delta, Hawaiian, JetBlue, Southwest, Spirit and United—reported combined net income of $18.3 billion. That’s quite an improvement from the $11.2 billion they pocketed for the entire year in 2014.

Domestic airlines 11 billion shareholders nine month 2016

Over the same nine-month period, airlines returned $11.4 billion to shareholders via stock buybacks ($10.5 billion) and dividends ($912 million), according to industry trade group Airlines for America (A4A).

Here’s Why Blue Skies Could Last

In the near-term and long-term, airlines continue to look very attractive. Air travel demand is rising as incomes grow and the size of the global middle class expands.

This Thanksgiving week, more than 27 million passengers are expected to fly on U.S. airlines, an increase of 2.5 percent over the previous year, according to A4A. Much of the demand is being driven by affordable airfare, which is at its lowest in seven years.

The picture looks just as optimistic further down the road. The International Air Transport Association (IATA) sees global passenger demand nearly doubling over the next 20 years. The group expects 7.2 billion people to fly in 2035, up dramatically from 3.8 billion last year.

chinas middle class overtakes us

The Asia-Pacific region should be the biggest demand driver, with China displacing the U.S. as the world’s largest aviation market. As I’ve written about before, the U.S. and China both agreed to extend visas for business travelers, tourists and students, which has already led to increased travel between the two nations. When I last visited the New York Stock Exchange recently, I noticed that half of the tourists appeared to be from China.

What Effect Might President Trump Have on Airlines?

In the week following the presidential election, we saw modest gains in several sectors, including airlines. Evercore ISI’s proprietary Company Surveys, designed to monitor the economy on a weekly basis, showed a post-election bounce, rising 1.1 points to 49.6.

steady improvement week following election
click to enlarge

In many more ways than one, Donald Trump is unlike any other person ever to occupy the White House, bringing with him a unique set of skills and experiences that no other president can claim. As I mentioned earlier, he will become the first U.S. president who was formerly an airline executive. He also boasts an extensive background in tourism and hospitality, having built and managed everything from hotels to resorts to golf courses

Donald Trump first US president airline executive

Industry leaders, therefore, hope Trump will prove to be a powerful ally and take their side on several key issues. For starters, many are encouraged that the president-elect has proposed as much as $1 trillion in infrastructure spending on “our highways, bridges, tunnels, airports, schools, hospitals,” as he announced the day following last week’s election.

Trump has also promised to swing the pendulum away from monetary policy toward fiscal policy—cutting taxes and relaxing regulations—which has put Federal Reserve Chair Janet Yellen on the defensive. On Friday, she defended the Dodd-Frank Act, which Trump has vowed to dismantle, stating a repeal would increase the likelihood of another financial crisis.

As for the aviation industry, U.S. carriers have been pushing Congress for years to reform air traffic control so that the steering wheel is in the hands not of the Federal Aviation Administration (FAA) but a private, not-for-profit entity. Canada made a similar transition in 1996 when it turned authority of its civil air navigation service over to the privately-run Nav Canada, which today manages approximately 12 million aircraft movements a year.

The industry would also like to see open talks with several state-owned Middle Eastern carriers, whose governments provide tens of billions of dollars in “unfair” subsidies every year.

Jill Zuckman, chief spokesperson for Partnership for Open & Fair Skies, an airline lobby group, has urged Trump, a harsh critic of international trade agreements, to protect the interests of American airlines and workers.

“The Gulf carrier subsidies threaten the jobs of 300,000 U.S. aviation workers and the American aviation industry as a whole,” Zuckman alleged, “and we are optimistic that the Trump administration will stand up to the United Arab Emirates and Qatar, enforce our trade agreements and fight for American jobs.”

Other leaders see headwinds in some of Trump’s more isolationist and nativist rhetoric, particularly his tough stance on immigration from Mexico—currently the number two market for travel and tourism to the U.S.—and Arabic-speaking countries.

Arrivals into the U.S. by Country, 2013
Rank Country Number of Visitors,
in Millions
Percent Share
#1
Canada Flag
Canada
23.39 33.5%
#2
Mexico Flag
Mexico
14.34 20.6%
#3
UK Flag
United Kingdom
3.84 5.5%
#4
Japan Flag
Japan
3.73 5.3%
#5
Brazil Flag
Brazil
2.06 3.0%
#6
Germany Flag
Germany
1.92 2.7%
#7
China Flag
China
1.81 2.6%
#8
France Flag
France
1.50 2.2%
#9
South Korea Flag
South Korea
1.36 1.9%
#10
Australia Flag
Australia
1.21 1.7%

According to the Council on Foreign Relations, a travel ban on Muslims entering the U.S.—a controversial proposal Trump has since softened—could cost the U.S. economy as much as $71 billion a year and up to 132,000 American jobs. As The Economist pointed out in a recent article, travelers from the Middle East tend to be big spenders, shelling out 50 percent more per trip than Europeans on average.

Trump has also expressed interest in reversing current diplomatic relations with Cuba, favoring a reinstatement of old travel and trade embargos. (“The people of Cuba have struggled too long,” he tweeted in October. “Will reverse Obama’s Executive Orders and concessions towards Cuba until freedoms are restored.”) Many U.S. airlines have already begun scheduled flights to Havana, including United, American and Southwest, with others soon to follow (JetBlue, Alaska, Delta and Spirit, among others).

As for whom Trump might name as head of the Transportation Department—which oversees the FAA, Federal Highway Administration, Federal Railroad Administration and other agencies—rumors are circulating that it’s come down to either Rep. John Mica (R-Fla.), former House Transportation Committee chairman; or James Simpson, former commissioner of New Jersey’s Department of Transportation.

The airline industry has proven itself resilient time and again, emerging stronger from a decade ago. For investors, the group is relatively inexpensive and generous with its dividends and stock buybacks. Changes might very well be in the cards, but I remain bullish on airlines, just as Warren Buffett is.

 

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The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.

Cash flow is the total amount of money being transferred into and out of a business, especially as affecting liquidity.

The price-earnings ratio (P/E Ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.

There is no guarantee that the issuers of any securities will declare dividends in the future or that, if declared, will remain at current levels or increase over time.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of 9/30/2016: American Airlines Group Inc., United Continental Holdings Inc., Delta Air Lines Inc., Southwest Airlines Co., Allegiant Travel Co., Alaska Air Group Inc., Hawaiian Holdings Inc., JetBlue Airways Corp., Spirit Airlines Inc. 

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