Gates Capital: Why (Free) Cash (Flow) Is King
Gates Capital Management's ECF value fund has earned strong returns for investors since its inception in June 1996. The ECF, or Excess Cash Flow Fund, had returned 12.9% annualized since inception to the end of September 2020. That was compared to 8.9% for the S&P 500 total return index and 7.4% for the HFRI Event-Driven Read More
Red lines indicate who each entity believes should be stuck with the cost
 Spain, Italy and the rest of the Euro Periphery
 The CDU, CSU and FDP
 The Social Democrats and Greens
 The Bundesbank
 The IMF
 The European Central Bank
 EU taxpayers in Core countries
 EU Commission and Finance Ministers
 EU bondholders
Further elaboration about the graphic From JP Morgan:
“This [European sovereign debt crisis] saga has been going on now for 24 months, making it the Berlin Alexanderplatz of Sovereign Debt Crises. However, I think we’re moving closer to the end-game, which begins and ends in Germany…
The end-game is mostly about who pays for the accumulated, unrealized losses of the last decade, and who finances the transition to whatever comes next. [The graphic] 12 players in the EMU Debt Crisis most likely to affect policy from here…[although] There wasn’t room for every entity that impacts European decision-making
In the report, JP Morgan also takes a dark view similar to that of Goldman’s at least for the Euro Zone:
“European banking sector liabilities are 3 to 4 times the size of European GDP, which dwarfs the roughly 1:1 ratio in the US. To be clear, there ….most European banks are well funded for the next couple of months. But if sovereign risk continues to rise, this would be the next flashpoint in the crisis. Bottom line: we remain underinvested in Europe in a big way.”
JPM is a bit more optimistic about the U.S. than Dr. Doom Roubini and Goldman Sachs:
“…..our view right now: 1% [growth] and not a recession However, the best argument against a recession is unfortunately also an indictment for how weak the recovery is. The chart below shows the combined level of durable goods spending (by consumers) and fixed investment (by businesses, in property and equipment).
At 20% of GDP, it’s close to its lowest level in more than 50 years. Since a decline causes recessions, our view is that there’s barely enough of this kind of spending to fall in the first place.”
A cautionary note on Fed’s QE3:
Equity markets are priced cheaply relative to expectations of future earnings, but without more evidence that QE is having more of a positive impact on the US economy, we believe QE-driven equity market gains will be temporary.
Our sense is that US equity markets are pricing in around a 15%-20% decline in earnings, which is consistent with recessions the tech collapse and credit crisis, which were much worse.”
The investment opportunities identified by JPM include the following:
- Leveraged loans
- Merger arbitrage
- Equity notes
- Preferred Stocks in the U.S. banking sector (i.e. the Buffett way with the BofA deal)
Last but not least:
“Inflation is an easier problem to deal with than deleveraging, deflation and austerity budgets. As a result, we are looking at opportunities in Asian equities and credit [and currency], which we expect to improve once the monetary tightening cycle is complete.”
We typically take a dim view of any investment vehicle that’s associated with the word “leveraged”, and would be very careful with banking stocks right now, preferred or common, unless you can get a sweet heart deal like Warren Buffett’s.
As to the Asian market, although equities may appear attractive right now as the Shanghai Composite has under-performed the S&P500 for the past two years, bear in mind that Asian economy is still mostly manufacturing-based and heavily dependent upon exporting to the Western developed countries. Since based on most forecast, the U.S. and Europe will be experiencing a pronounced slowdown if not a flat-out double dip recession, China and Asia are bound to be negatively impacted.
Furthermore, Asia, and China in particular, have their own problems of accounting/loan transparency, over and under capacity depending on which sectors you are talking about, and socioeconomic imbalance all could mean headwinds ahead.
Regarding the U.S., as noted before, we see anemic growth is a more likely scenario than a double dip recession. However, as far as equity markets are concerned, until there are some policy / tax change ((No, QE3 or Operation Twist 2.0 does not count), to really impact the fundamentals of the U.S. economy in terms of, for instance, new jobs creation and business investment, it would be a trader’s market, stuck in between profit taking and bargain hunting.