PING PONG PANG #2

Dear Readers

My last PPP (#1) Blog suggested buying USD, €, & £ sterling assets whilst the AUD is where it is. Given the money printing in all of these countries (and Japan), it seems inevitable that those currencies will devalue against the AUD and the Renminbi (if China doesn’t follow suit). One noted economist has the AUD at USD1.40. The USD has lost around 95% of its value since Richard Nixon decided to leave the Gold Standard.  Given the policy purity in the Reserve Bank and the demand for Australian Government AAA securities, it is unlikely that Australia will follow a competitive currency devaluation strategy anytime soon, if at all.

Again, it’s a great time to buy foreign assets, but it is going to get worse for trade exposed SME’s or those who want to import venture capital to build them. There is a dearth of domestic venture capital in Australia since the comparative returns do not presently justify the risks. And importing it does not work for offshore venture capitalists in this devaluation climate.

The only thing you can do is offshore yourself. Sorry about employment prospects here, but we are talking survival, at least for a while. Rectification will take substantial reductions in nominal interest rates in Australia, further declines in commodities prices and volumes, and dealing with the flow-on effects in the Australian property finance market. If you don’t have a job, you can’t afford a mortgage. Doesn’t matter how cheap money is. 1991 here we come!

ABOUT DAVID MILLHOUSE:

An international entrepreneur based in Brisbane, with more than 30 years in venture capital and private equity internationally, David Millhouse is a specialist in venture financing and capitalisation. He is renowned for his management of high growth companies, many of which proceed to IPO and he has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. David is a scientist by original profession, with an MBA and LLM from Bond University in Australia.

VENTURE CAPITAL IN AUSTRALIA

My last blog referred to the paucity of venture capital in Australia and a consequential inability to fund emerging growth companies in the SME and technology sectors. If you read the Australian newspaper report on the imminent Australian Venture Capital and Private Equity Association conference (AVCAL, 18^th September 2012), it describes in more detail my blog of yesterday.

In particular, the withdrawal of public sector investment and the reluctance of superannuation fund trustees to authorise investments of this nature. The report stated that there had been NO investment from superannuation industry funds since 2008/9.

This forces entrepreneurs and companies offshore where the investment environment is more conducive, or to conduct an IPO, usually years ahead of when they should adopt this strategy.

The AVCAL Conference runs this week and there should be more reports from it. I expect that the inability of the remaining private equity and venture funds to raise new capital will feature significantly.

ABOUT DAVID MILLHOUSE:

An international entrepreneur based in Brisbane, with more than 30 years in venture capital and private equity internationally, David Millhouse is a specialist in venture financing and capitalisation. He is renowned for his management of high growth companies, many of which proceed to IPO and he has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. David is a scientist by original profession, with an MBA and LLM from Bond University in Australia.

WHERE HAS ALL THE CAPITAL GONE?

I am approached at least twice a week by companies and entrepreneurs trying to obtain capital. There is nothing new about this.

In 1994 I founded Corporation Builders because the lack of available venture capital was starving SME’s and technology companies. They could not develop. Most of them needed early stage equity. Hence the founding of enterpriseangels with the assistance of the Queensland Government in 1996. Since those times, Corporation Builders, with strong Australian Federal Government, State Governments, NZ Government and Singapore Government support, operated in all of those countries and states. The need for capital was universal and constrained the SME sector.

The 2000’s saw more capital flowing and more credit availability. Governments in all these countries supported the growth the venture capital sector.

That cycle stopped in 2009 and has not restarted. We are back to where we were in 1991. Private investors do not have the discretionary capital they once did, governments are tightening the seat belts apart from some headline projects like the NBN in Australia, and pension fund trustees are under increasing pressure not to approve investments in unlisted assets, although it is common practice in the United States. Hence Silicon Valley.

It is also true that many project proponents are woefully unprepared to raise capital. They can come back to Corporation Builders for some one-on-one coaching. No promises of capital, but at least it minimises the opportunity cost of valuable entrepreneurial time.

ABOUT DAVID MILLHOUSE:

An international entrepreneur based in Brisbane, with more than 30 years in venture capital and private equity internationally, David Millhouse is a specialist in venture financing and capitalisation. He is renowned for his management of high growth companies, many of which proceed to IPO and he has conducted business in the UK, Germany, Switzerland, USA, Canada, Singapore, Hong Kong, Australia and New Zealand. David is a scientist by original profession, with an MBA and LLM from Bond University in Australia.

PING, PONG, AND PANG

No, not the Puccini Turandot version of the Three Ministers in 19^th century Beijing. This is a little more serious. The three this time are the US, German-led Europe, and China.

Have a look at the Chicago Federal Reserve National Activity Index. It measures what is happening in the real United States economy. The news is more of the same – slow growth, not recessionary, although US Federal fiscal contraction could produce that. But, no indications of that wonderful energy which historically has driven the US and led the rest of the world.

German-led Europe – more of the same. The end result will probably be what the Europeans want – more political and economic integration for long run political stability. But no huge demand drivers yet.

China: read any newspaper! “The country’s growth model has changed”; “greying population”; “Does not need to continue creating low-skilled construction jobs to ensures stability”; “That’s why more steel mills are sure to cut production or close”. (AFR 1-2 September 2012). “Iron ore rout could end up in a hard landing”; “economists are speculating about the risk next year of the R-word”. (Australian September 1-2 2012). China is changing: its economy is maturing, its population expected to peak in 2015, and ageing. In short, China is going to feel more like “Old Europe” to quote a former US politician.

These three will dance around, just like Ping, Pong, and Pang. Expect competitive devaluations or other forms of domestic advantage.

Where does Australia fit? Recession probably if the Gillard-Swan governments still try to achieve a surplus. Where do Australians fit? Use the A Dollar whilst it is at these levels. At some point, it will not be when international investors and sovereign investors realise that it is priced on an evaporating commodities boom. Today, invest offshore in USD or Euro denominated assets. Sell Australian domestic equities and property. The likelihood is deflation. You will be able to buy them cheaper later with much stronger foreign currencies v/v the AUD.

PROFITS TO BE MADE IF YOU HOLD AUSTRALIAN DOLLARS

The likelihood is that the Australian dollar will rise further against the USD, Euro, and pound sterling. This will continue to damage much of the Australian SME sector. For Australian investors, though, it will provide a generational opportunity to acquire assets in other countries. The time to buy German property was before 2010. Investment grade asset prices on ASX are relatively high, so asset allocations should be increased in non-Australian $ assets.  You will need to be careful with Swiss and German real estate: the flood of liquidity in Europe is driving prices up. The China slowdown is likely to mean easing of Chinese monetary policy which in effect means exchange rates will change making Chinese exports cheaper for consumers. That will also damage the Australian SME sector. That slowdown will also mean less demand for some commodities. Australian imports will rise, exports drop. Hope Wayne Swan doesn’t want a balanced Federal budget since he won’t be getting his revenue, especially now the States are increasing minerals royalties. The aggregate macroeconomic numbers are not going to look as great in 2013.

It’s a great time to be an investor if you have the wherewithal to invest offshore: not so great if you’re trying to run a business in Australia, or only have limited capital to invest.

IS THE GLASS HALF FULL?

(click image to enlarge)

The world press almost uniformly predicts slow or no economic growth for the next few years and devastating economic consequences for many countries and individuals. However, there have been suggestions this week that the “bottom” may have been reached, whatever that means.

If you look at the chart, this is the (US) S&P composite returns index since 1900. What it demonstrates is long cycle periodicity in investor composite returns. What it doesn’t show (without my annotations) is the source of wealth creation in periods of rising equities prices.

After WW1, equities price upswings were largely driven by consumption spending, home construction for the soldiers, and innovation based manufactures. After WW2, military R&D investment generated completely new industries in plastics, aerospace, vehicles, consumer electronics etc, financed by the advent of readily available consumer credit for the first time. In the 1980’s, US military R&D expenditure on the development of the internet, the revolution in molecular biology, and the advent of a venture capital market led directly to the iPhone and modern medical care. Fortunes were made by technical entrepreneurs in these sectors based on science, government funded R&D, commercialisation skills, and access to venture capital. The 1987 stock market crash destroyed some of what had been created, but then rising Asian demand for commodities and western lifestyles underpinned yields even if equity prices themselves remained static. That came to end, other than in resources at least, in 2008.

So where am I investing for the future? And when?

Firstly, the when. The glass is half full. Equity markets will improve. Capital will become more readily available. From 2013 onwards.

Where? Please have a look at www.millhouse.co  The demand drivers will be: the entrepreneurial United States, becoming once again an energy independent economy with the worlds’ best Universities. Supported by German- led Europe with tremendous science and engineering skills enabling manufacture of best of breed products in a high cost economy. Selling to: SE Asia, China, and other countries in those regions who can afford western-style consumption products, food, and healthcare for an ageing population. These dynamics will drive trade and investment for the next cycle and companies with these exposures will benefit from an upturn in their equity prices.

These dynamics will govern the world as we shall know it from 2013 onwards.

davidmillhouse.com.au