Agcapita - July 26 2012 Briefing


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So with that context in mind, I believe it is putting it mildly indeed to say that we have arrived at a point where the vast majority of financial institutions are simply regulatory oligopolies with asset-harvesting business models more concerned with fees and proprietary speculative activities than with providing any useful services to savers and retail investors.

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Agcapita - July 26 2012 Briefing

  1. 1. Agcapita UpdateJuly 26, 2012
  2. 2. Agcapita UpdateTHE RETREAT OF FINANCIALISATIONLet me start by saying that I do not adhere to the mistakenbelief that banking is intrinsically “bad’. Banking andfinance serve a productive purpose in the economy byintermediating savings and investments. However I believethat what passes for much of modern banking, or moreaccurately post 1971 banking with its dysfunctional centralbank/private bank nexus and its anti-competitive naturecourtesy of regulatory barriers to entry, is not productiveand is actually acting as an impediment to the underlyingeconomy by destroying vast amounts of real capital - akabailouts.So with that context in mind, I believe it is putting it mildlyindeed to say that we have arrived at a point where thevast majority of financial institutions are simply regulatoryoligopolies with asset-harvesting business models moreconcerned with fees and proprietary speculative activitiesthan with providing any useful services to savers and retailinvestors.The mainstream financial sector has indoctrinated an entiregeneration to buy and hold because it suits their businessmodel that is asset-driven rather than performance-driven.Large financial firms have an intrinsic institutional bias to bebullish on everything - they have no incentive to tell you notto invest in something as they will usually be operating a fundin that area. Hence such sophistry as being “underweight”unattractive asset classes rather than encouraging outrightselling. Ultimately they have little investment insight otherthan everything will go up in the long-run. Of course in thelong-run it has been quipped that we are all dead. To addinsult to injury they seldom outperform their benchmarksover long periods and charge management fees for what iseffectively closet indexing. 1
  3. 3. Agcapita Update (continued)Once again, I am not a knee-jerk critic of the financial firms that were prudently managed leading up to thesector but I do believe that it has become too large. crisis should have benefited from the demise of theirCorporate profits attributable to the US finance sector poorly-run competitors - in a free economy capitalwere effectively stable from the 1950s to the early would have flowed to the profitable businesses rather1980s from 5% to 15%, then as the growth in the than the loss making ones. The fact that this didn’tmoney supply turned sharply higher on a sustained happen creates a perverse “if you can’t beat’em,basis in the 1980s they peaked at 40% in the early join’em” mentality with respect to risky and imprudent2000s and still remain around 30% - substantially business practices.higher than long term averages. Lets be clear on one thing, the primary purpose ofOn an asset basis the numbers tell a similar story. The low interest rates is not to save the economy, it is20 largest banks in the US have combined assets of to save the banks and allow them to continue allapproximately 90% of GDP. The five largest banks - this risky, bonus-generating behavior. Low interestJPMorgan Chase, Bank of America, Citigroup, Wells rates are simply a case of robbing Peter to pay PaulFargo, and Goldman Sachs - have combined assets as capital is being “strip-mined” from savers via lowof approximately 60% of GDP. These numbers are interest rates and in effect “donated” to the financialroughly 3 times what they were in the 1990s. sector. I would argue that the enormous size of the financial sector coupled with its current insolvency,Given the finance sector’s intimate relationship with which the constant bail-outs are attempting togovernment and central banks it is not surprising that disguise, will be a drag on growth for years unlessit grows faster than the underlying economy. Newly losses are allowed to take place via free marketprinted money flows into and through the finance mechanisms.sector acting as a wholesale subsidy that drivescorporate profits, compensation and speculation. Perhaps another interesting indicator of theDespite widespread belief to the contrary, financialisation of western economies is the ratio ofgovernment intervention into broad swathes of the the Commodities Research Bureau Index versus thefinancial sector to support “too big to fail” banks S&P 500. The long-term average is around 1.5 times.or, more accurately, to prevent capital destroying Simplistically, this ratio indicates how much S&P 500business activity from being eliminated to the benefit stock you can buy with a fixed basket of commoditiesof the entire economy is not a positive for future – a rough indicator of the growth of financial assets ingrowth. When it is funded via expansionary monetary relation to real assets so to speak:policy it seems to me that at best it is laying thegroundwork for stagflation. – During the commodity bull market of the 1970s, the ratio was consistently higher than 2 times forThere is an economic truism that whatever you over 10 years - it peaked at around 4 times.subsidize you get more of - hence by subsidizing – The ratio is currently at around 0.2 times - farfailure we are ensuring bigger failures in the future below the 1.5 times long-term average andand worst of all penalizing well-run businesses. The far below the 4 times peak seen in the last 2
  4. 4. Agcapita Update (continued) commodity bull market. We still appear to be at investors seek safety outside of the insolvent an all time low relative valuation between “hard financial system and financial assets. assets” versus “financial assets.”– If history is a guide, the ratio of real assets to I would not suggest that this ratio is perfectly financial assets will return something closer to its predictive, but it is certainly food for thought and historic average. perhaps another data point supporting the premise– How? Stocks will fall and/or commodities will that the process of financialisation will tend to retreat climb – most likely a combination of both as rather than grow from here. 3
  5. 5. DISCLAIMER: The information, opinions, estimates, projections and other materials contained herein are provided as of the date hereof and are subject to change without notice. Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Agcapita Partners LP (“AGCAPITA”) and its affiliates make every effort to ensure that the contents hereof have been compiled or derived from sources believed to be reliable and to contain information and opinions which are accurate and complete. However, neither AGCAPITA nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which maybe contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to AGCAPITA and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. Additional information is available by contacting AGCAPITA or its relevant affiliate directly.#205, 120 Country Hills Landing NW Tel: +1.403.608.1256 www.agcapita.comCalgary, AB T3K 5P3 Fax: +1.403.648.2776Canada