WSJ : Activism’s Long Road From Corporate Raiding to Banner Year

Activism’s Long Road From Corporate Raiding to Banner Year

Change in tactics let industry move beyond controversial past

When activist investor Nelson Peltz demanded board seats at H.J. Heinz Co. in 2006, both the company and its headquarters city were indignant.

The Pittsburgh newspaper ran editorials urging support for the “hometown team.” Heinz gave employees bottles of its signature ketchup with custom labels urging them to vote against Mr. Peltz’s nominees. “We thought, ‘Gosh, we don’t need outside help,’ ” recalls Art Winkleblack, then the company’s chief financial officer.

This June, nearly a decade later, Mr. Peltz’s Trian Fund Management LP got an entirely different reception after buying a 7% stake in Pentair PLC, a Minnesota maker of pumps and valves. Pentair Chief Executive Randall Hogan spoke several times with Trian co-founder Ed Garden about corporate strategies and promptly moved to add Mr. Garden to its board.

“You never know what you don’t know,” Mr. Hogan says of his willingness to listen to the activists.

After decades of being treated as boorish gate-crashers, activist investors are infiltrating the boardrooms of large companies like never before. This year activists launched more campaigns in the U.S.—360 through Dec. 17—than any other year on record, according to FactSet. They secured corporate board seats in 127 of those campaigns, blowing past last year’s record of 107. Activists now manage more than $120 billion in investor capital, double what they had just three years ago, according to researcher HFR.

The industry has come a long way since the 1980s, when Carl Icahn, Saul Steinberg, T. Boone Pickens and other mavericks would amass large stakes in companies and demand a sale of the entire company. They were called “corporate raiders” and “greenmailers” and were widely criticized.

These days activists, while not exactly welcomed in corporate boardrooms, are rarely treated as ill-mannered outsiders. “These activist funds are just a different asset class who have the same pensions and endowments investing in them as other funds,” says Rob Kindler, head of mergers and acquisitions at Morgan Stanley. “The demonization of activists, when really what they are doing is providing returns to the same pension and endowment plans, just seems overdone.”

Several factors contributed to this shift, according to corporate executives, activists, bankers and lawyers. The financial crisis fanned dissatisfaction with corporate executives and brought low interest rates that helped activists thrive. Activists got more sophisticated about analyzing target companies and built alliances with other big shareholders, including mutual funds. And broad shifts in corporate governance gave more power to all shareholders, including activists.

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M&A lawyer Martin Lipton, who for years has represented companies facing battles for board seats, this year called on clients to consider settling with some activists. “There is no timely way anymore for a company to be slow about responding to a decline in performance or pursuit of the strategy,” he noted in an interview.

This year, returns for activist hedge funds averaged 3.4% through November, beating the hedge-fund average of 0.3% and the S&P 500’s 3% total return, according to industry research group HFR. Over the past five years, activist funds have returned an annual average of 8.2%, compared with the average hedge fund’s 3.2% return, HFR says.

The debate about whether activism is good for U.S. companies over the long term hasn’t gone away, most recently popping up in the presidential campaign of Hillary Clinton. She has decried “hit-and-run” activists, while also saying some activists help hold managers accountable.

Mr. Lipton has voiced similar complaints. “Much of what is wrong with America today—slow growth, widespread corporate scandals, inadequate investment in long-term projects, low wages that have not kept pace with inflation, wide swings in the economy accompanied by uncertain employment and rising inequality—is attributable to short-termism and attacks, and threats of attacks, by activist hedge funds,” he wrote recently.

Activist were a different breed back in the late 1970s and 1980s. They made “midnight raids” on stocks, building large, often controlling, stakes. Then they pushed companies to sell themselves to the highest bidder or to the raider himself, or to buy back their positions at above-market prices, a practice known as greenmail.

When Mr. Pickens bought stock in Gulf Oil Corp. in 1982, he was greeted by a lawsuit and spent months trying to get a meeting with the Chief Executive James Lee. Mr. Pickens contended the company was mismanaged, and he wanted to take control.

Other shareholders were suspicious. “One said ‘He’s a fast-buck artist,’ ” Mr. Pickens recalled in a recent interview. “I said, ‘Who in the hell wants to be a slow-buck artist?’ ”

The saga ended two years later when the company later known as Chevron Corp. swooped in to buy Gulf for $13 billion, delivering Mr. Pickens a substantial profit.

In 1984 alone, public companies paid $3.5 billion in greenmail, with payments above market price accounting for $600 million, according to a study by the Securities and Exchange Commission.

Such tactics generally outraged other investors and ensured that raiders remained on the investment world’s fringe. In 1987, the Internal Revenue Service introduced a tax of 50% on profits from greenmail, and several states passed laws making it hard for companies to buy back stakes from short-term investors at a premium.

By the 1990s, when a bull market took hold, those practices had largely faded. Targeting big companies was out of the reach for most activists because their funds remained small. And with stocks booming, there was scant investor demand for taking on prominent CEOs.

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The collapse of Enron Corp. and WorldCom Inc. in the early 2000s led more shareholders to question whether managers were acting in their best interests. It was around that time that today’s activists started forming funds, including what would become Starboard Value Fund and Barry Rosenstein’s Jana Partners LLC.

Mr. Rosenstein, who once worked for corporate raider Asher Edelman, launched his fund in 2001 but found few investors interested in targeting companies and agitating for change.

“One person I pitched said ‘This is not a strategy,’” Mr. Rosenstein recalls. “Nobody was doing it.”

He raised about $20 million, opened shop with just three employees and started investing in small companies, including Herbalife Ltd., then a lesser-known nutritional-shake maker, and York Group Inc., a casket maker.

Mr. Rosenstein and his fellow activists hoped to follow a path to respectability blazed by private-equity funds, who had largely shed their image as buyout “barbarians” and transformed themselves into respected, publicly traded institutions. To do that, activists needed to persuade others, including potential allies at mutual funds, they were interested in building value at target companies, not just making a quick buck.

It was during this period that Mr. Peltz launched his proxy fight at Heinz. When company shareholders met to elect the board, the tension was thick. Mutual fund Capital Research & Management Co., a large shareholder, voted for some Trian nominees, stunning Heinz executives and helping put Mr. Peltz and an ally on the board.

After winning the vote, Trian didn’t push a quick sale, but stayed around. Board members say Trian helped focus the company on cutting certain costs and increased spending on marketing, and sped up the company’s timetable for moves that improved profit margins.

“They didn’t come in with a sledgehammer saying you have to do it this way,” says Mr. Winkleblack, then CFO.

Investor T. Boone Pickens, left, greeted Gulf Oil CEO James Lee in 1983 after he bought stock in the company. ENLARGE
Investor T. Boone Pickens, left, greeted Gulf Oil CEO James Lee in 1983 after he bought stock in the company. PHOTO: GENE J. PUSKAR/ASSOCIATED PRESS
“It was so seminal because it was a huge company to go after at that time,” says Chris Young, an activism-defense banker at Credit Suisse Group AG. “It was operational in nature, and you got mainstream, long-only investor support. That, I think, started opening people’s minds to the art of the possible.”

In 2013, Heinz was sold to Brazilian private-equity firm 3G Capital Partners LP and Warren Buffett’s Berkshire Hathaway Inc. William Johnson, then Heinz’s CEO, now is an adviser to Trian, and Mr. Winkleblack was a Trian board nominee at DuPont Co.
The financial crisis that began in 2008 was a setback for many activists, who saw their funds lose billions. But ultimately it created fertile conditions for the current activism boom.

In the wake of the crisis, many corporate executives took a more-conservative approach, not wanting to be seen as risk-takers. They hoarded cash and avoided big spending. When interest rates dropped, they borrowed money not for expansion, but to buy back stock and increase dividends—exactly what some activists were pushing for. Critics of such moves say companies would be better off using capital on long-term investments such as infrastructure, research and employees, but activists say managers have proven poor spenders and shareholders can handle the money better.

At the same time, changes in corporate governance were making it easier for activists to win board seats. Between 2011 to 2014, a group at Harvard University led by professor Lucian Bebchuk campaigned to get more than 100 major companies to put their entire boards up for annual election, instead of staggering directors in multiyear terms.

Annual elections give activists leverage because boards can be overturned in one fell swoop rather than over a series of years. In 2000, 300 of the S&P 500 companies had staggered boards. This year, only 49 do.

Barry Rosenstein found few investors interested in activism when he launched Jana Partners in 2001. ENLARGE
Barry Rosenstein found few investors interested in activism when he launched Jana Partners in 2001. PHOTO: ERIC THAYER/REUTERS
Perhaps the most important change, according to both activists and their detractors, is that activists got more sophisticated about analyzing how to improve operations at target companies. They recruited executives with experience in the relevant industries to work alongside them on campaigns.

In 2012, for example, William Ackman’s Pershing Square Capital Management LP launched a proxy fight against Canadian Pacific Railway Ltd. When Pershing Square called the former boss of rival Canadian National Railway Co., Hunter Harrison, for advice, it found a willing partner. Pershing Square campaigned with Mr. Harrison as its CEO candidate, eventually winning seven board seats and putting Mr. Harrison in charge.

Mr. Rosenstein’s Jana Partners, which now employs more than 50 and runs more than $10 billion in assets, typically presents companies with several-step plans about how they can cut costs, restructure their balance sheets, shed assets and change strategy.

Last year, drugstore chain Walgreen Co. agreed to put Mr. Rosenstein on its board and gave him a say in two other seats, all without a threat of a public fight and a stake of only 1%.

Similarly, in 2013, Microsoft Corp. said it would add a ValueAct Capital Management LP partner to its board, even though ValueAct held a stake of just 1%. Behind the scenes, ValueAct had support from some of Microsoft’s biggest shareholders, including Franklin Templeton Investments and Capital Research.

Trian has gained board seats, without a fight, at companies ranging from fast-food chain Wendy’s Co. to Bank of New York Mellon Corp. This year, it took a stake in food distributor Sysco Corp. and was given two seats only a week after meeting management.

“They aren’t on a search-and-destroy mission,” says Wesley von Schack, the lead director of Bank of New York Mellon. “They come in and speak to the right issues.”

Activist thinking now appears to be influencing even executives who haven’t been targeted. Executives now routinely talk about the return on every dollar spent—a frequent focus of activists. Chief executives appointed this year by McDonald’s Corp. and United Technologies Corp. have called themselves internal activists.

“We’re the activists at UTC,” United Technologies CEO Gregory Hayes said in October. “If an activist wants to come in and make a suggestion that we do it, we can say, ‘Been there, done that.’ ”

General Electric Co. Chief Executive Jeffrey Immelt has gone so far as to invite one activist to get involved in his company.

When GE announced in April that it would shed GE Capital, its finance arm, Mr. Peltz, who wasn’t an investor, called to congratulate Mr. Immelt.

“I’d love to have you in the stock,” Mr. Immelt told Mr. Peltz.

As Trian did due diligence, it urged Mr. Immelt and his team to eliminate more of GE Capital than planned and to tap the debt markets for buybacks. GE executives felt the activist was in the right ballpark. Trian invested $2.5 billion, its biggest investment ever.

A month after the stake was disclosed, GE’s stock crossed $30 a share for the first time since the financial crisis.

Barron's : Emerging Markets: Best and Worst Bets for 2016

Emerging Markets: Best and Worst Bets for 2016

Countries most capable of contending with higher U.S. rates and lower commodities prices include Korea and Mexico. Latin America is the most vulnerable.

After a series of challenges in 2015, emerging markets are expected to recover somewhat in the year ahead. However, the journey is likely to be slow and the path tortuous.

Countries with winning stock markets in 2016 will likely be those that succeed in making structural reforms, attracting foreign investment, and maintaining monetary and fiscal discipline amid political pressure. Tighter monetary policy in the U.S. and lower commodity prices remain the most significant risks across virtually all emerging markets.

Among those in the best position at the starting gate are Korea and Mexico. Each economy is growing and its central bank has some room to maneuver. In turn, much of Latin America, aside from Mexico, will face strong headwinds.

Although Mexico is an oil exporter, it has been relatively unaffected by China’s economic slowdown because 80% of its overall exports (much from manufacturing) head north to an expanding U.S. economy. In addition, expectations for annual inflation, which is at the lowest level in 45 years, have recently fallen to 2.2%, mainly due to the collapse of oil prices, a slow-growth economy, and a credible central bank whose mandate is to keep inflation under 3%. Mexican GDP is expected to rise 2.45% in 2015 and 2.74% in 2016. With inflation contained, Mexico was able to raise rates by a quarter of a percentage point to 3.25% in mid-December, keeping pace with the Federal Reserve’s rate hike.

Korea, one of the largest importers of oil, is projected to grow output by 2.7% for 2015, once the books are closed, and by 3.1% in 2016, due in part to government stimulus. That has driven a rebound in domestic demand after the negative effects on exports related to slower global and Chinese growth.

Research firm Capital Economics says there are signs that consumer spending in oil-importing emerging markets is accelerating. In emerging Asia, excluding China, it expects growth in consumer spending to rise from the 3.9% annual average of the past decade to an average of 4.7% a year from 2015 to 2020. That should be a help in countries like Korea.

By contrast, most countries in Latin America have little room to tighten monetary policies aggressively if the Fed accelerates the pace of hikes. Countries such as Brazil have large debt burdens in foreign currencies and it will become more expensive to service this debt as the dollar appreciates, and as investors repatriate cash to invest in higher-yielding and safer assets in the U.S.

GDP growth in most parts of the region is decelerating and inflation is growing. According to Fitch Ratings, the region will see average GDP contract by 0.6% in 2015, with just 0.6% growth in 2016. Most of the deceleration will be caused by Brazil’s worsening economic crisis and impeachment proceedings against President Dilma Rousseff. Brazil and Colombia will have a hard time attracting or retaining foreign investment. Venezuela, whose oil revenues account for about 95% of export earnings, could be headed to a default unless prices rise.

Still, there are optimists about emerging markets. “Concerns about the outlook for emerging markets look increasingly overdone,” says Neil Shearing, chief emerging-markets economist at Capital Economics. “Pockets of vulnerability exist, but…emerging-market growth is more likely to recover over the next three to six months than it is to suffer a fresh downturn.” That could make for an interesting bet in 2016, although it’s one many investors shunned in 2015.

Barron's : Looking for 2016 Winners

Looking for 2016 Winners

At year’s end, investors are often tempted to buy poorly performing stocks in the hope that mean reversion will boost the losers in the next 12 months. This bull market’s numbers, however, don’t support that approach.

At year’s end, investors are often tempted to buy poorly performing stocks in the hope that mean reversion will boost the losers in the next 12 months. This bull market’s numbers, however, don’t support that approach. Bespoke Investment Group compared buying the 50 best-performing stocks in the S&P 500 index to the 50 worst since 2009, and found that sticking with the winners was better, on average. (See table.) But it wasn’t a whole lot better than the index on an equal-weighted basis.

Other data suggest fortune favors the fortunate. When choosing sectors for the new year, according to Sam Stovall, U.S. equity strategist at S&P Capital IQ, “history says you are better off owning the three best sectors of the previous year.”

Going back to 1990, picking the three best sectors from the previous year provided a mean 10.4% total return the next year. That’s better than both the 9.1% index return and 8.7% from selecting the three worst-performing sectors. Additionally, the three best groups outperformed two-thirds of the time while the worst, only 40% of the time. As of Thursday’s close, the three best sectors of 2015 are consumer discretionary, up 9%; health care, up 6%; and technology, up 5%.

Tom Stringfellow, president of Frost Investment Management, expects good things from consumers next year, due to job and wage growth and lower gasoline prices. He believes increased consumer spending could help the auto, airline, and hotel companies.

The energy sector, down 22% after a 10% drop in 2014, appears ripe for mean reversion, but it is still too early, as oil seems not to have bottomed. The first part of 2016 could prove treacherous, although by the end of 2016 energy might be looking better. From a technical standpoint, we’d like to see the stocks stop falling in lockstep with the commodity.

On Dec. 18 crude plunged to a new 52-week low of $34.73 per barrel, the S&P Energy Sector falling along with it. To get more optimistic, an improvement in that dynamic is desirable: That is, energy stocks should stay flat or even inch up when oil slips. If that happens, it indicates the stocks are washed out, an encouraging sign.

We waxed enthusiastic about ExxonMobil (XOM) in a recent column, and consider it attractive for an investor with a two-year timeframe. With a near-4% dividend that seems secure, you are paid to wait, and a double-digit return seems unchallenging once oil stabilizes.

Financial stocks, banks in particular, seem a better bet for 2016. Down 2.6% for the year through Thursday, the sector isn’t in line to finish as one of the top three performers of 2015. However, rising interest rates, which boost loan income and net interest margin, argue in favor of the group.

Alan Lancz, who runs money manager Alan B. Lancz & Associates, likes financials. Among them, Bank of Nova Scotia (BNS), a solid Canadian bank, with a 5% dividend yield, could do well when oil stabilizes, he says. Mutual-fund manager AllianceBernstein Holding (AB), another favorite for 2016, has been hurt by volatility in the high-yield market, but is cutting costs and the stock is near its lows, he says. His firm owns both.

A financials exchange-traded fund might be a good way to play the sector, as it removes the single-stock risk. One popular ETF is the Financial Select Sector SPDR Fund (XLF), but there are plenty more. More ETF choices can be found at etf.com.

Barron's : Whither the Market in 2016?

Whither the Market in 2016?
It’s time for The Trader to consult his crystal ball for clues to the U.S. stock market’s prospects next year.

It’s time for The Trader to consult his crystal ball for clues to the U.S. stock market’s prospects next year. Twelve months ago, we suggested the S&P 500 would rise 5% to 10% this year. That’s off the mark, but less so than other widely held forecasts for a double-digit return.

What worries us? Well, oil prices might fall further, with unhealthy ripple effects on more than just energy stocks, although it would be a positive for consumer sectors. The dollar could bulk up some more in 2016, but probably most of that move is done.

“Head winds are abating. The repricing of the dollar is behind us and oil could stabilize,” says Mike Ryan, chief investment strategist for UBS Wealth Management Americas. Earnings growth is likely to recover from this year’s stall, he adds.

Then there’s the Federal Reserve, which will likely raise rates more slowly than it has indicated. Yet, this might not go smoothly. “Investors will continue to see volatility over the pace of the Fed hikes,” predicts E. William Stone, chief investment strategist at PNC Wealth Management. “The market will struggle with that at times.”

“The Fed proved much more of a hostage to [volatility in] global financial markets than people desired,” says James McDonald, chief investment strategist at Northern Trust. Nevertheless, the Fed will likely move more slowly than its own predictions indicate. “The Fed will be the dog that doesn’t bite,” he adds.

One thing the Fed doesn’t want to do: cut rates after having raised them, if the global economy doesn’t pick up.

There’s a good chance earnings for S&P 500 companies will end up declining for this year, no small factor in the market’s malaise. Next year, however, we see a little bit of growth, if only because poor quarterly earnings comparisons caused by lower oil and the higher dollar should improve.

Still, we are worried about profits because revenue growth seems hard to find. In the third quarter, the gap between the number of companies beating the earnings per share consensus and those beating revenue estimates was the widest since the dark days of the first quarter of 2009, according to Bank of America Merrill Lynch. A recession isn’t expected, but The Trader doesn’t see the U.S. or the global economy perking up much, either.

That suggests no market-multiple expansion, and perhaps some decline. The trailing S&P 500 price/earnings ratio should remain around 17 times, while S&P 500 EPS could rise to $125 in 2016 from $118 this year. Given that investor confidence seems wobbly, at least anecdotally, the market will be hard- pressed to advance more than 5%, short of major improvements in global growth.

Yet, a boxer is rarely felled by the expected punch, and inflation is one threat not much discussed. If it flares up, it could force the Fed to move faster than the market desires in raising rates. China’s economic growth could weaken more, too, causing problems for other markets.

Perhaps the biggest risk to stocks is geopolitical, ranging from more violence in the Middle East to more terrorist attacks elsewhere. The awful attacks in Paris give us little hope for a respite

Barron's : Niall Ferguson Takes on the World

Niall Ferguson Takes on the World
Ferguson sees more trouble ahead for Europe, China, and Saudi Arabia. But countries with cheap stocks and political stability could beckon investors.

Niall Ferguson, the historian, Harvard professor, and author of more than a dozen books on the nexus of economics, finance, and geopolitics, argues that America’s abdication of its role as the world’s policeman is one cause of the global economic malaise. U.S. policies, or lack thereof, have allowed terrorism to breed and dictatorial states such as Russia and China to assume a larger role in world affairs.

The author of Civilization: The West and the Rest, Ferguson says China’s attempt to move to a true market economy probably will fail, potentially causing serious disruptions to other markets. He likens Saudi Arabia to Iran in 1979—a state ripe for destabilization. In the U.S., he sees tax reform coming, but worries that America’s love affair with regulation will continue to dampen its growth prospects. India gets a thumbs-up, but Europe’s prospects are bleak.

Ferguson recently announced that he’ll leave Harvard next year to become a senior fellow at Stanford University’s Hoover Institution. He spoke with Barron’s at our offices just after November’s terrorist attacks in Paris, and was every bit as thoughtful and provocative as when we last chatted, three years ago.

Barron’s: The U.S. economy has been growing by only 2% to 3% a year. Why isn’t it firing on all cylinders?

Ferguson: There are at least three theories. The seven-year hangover theory suggests that the U.S. will shake off the effects of the 2008 financial crisis next year. The secular-stagnation theory posits that, for a variety of reasons, the economy is in a depressed state. That is most obviously [expressed] in interest rates.

I’m attracted to a third argument, the geopolitical one, that says growth in modern American history has tended to be high at times of national strength and low at times of national weakness, because our weakness has ramifications for the world as a whole. One has to combine the three theories to understand why growth is lower than expectations. It isn’t low based on a pretty long-term average, but it is sluggish compared with the glory days of the Cold War.

What was so glorious about the Cold War?

There were two phases of growth, one associated with the Eisenhower and Reagan administrations, and one with the depressed period in between. Since 9/11, things have gone from bad to worse. We find ourselves in a deflationary version of the 1970s, marked by stagnation, not stagflation. [Russian President Vladimir] Putin is doing his best to give us reasons to man up. But we’re not really doing so.

The global economy needs a strong hegemonic power to reduce conflict, ensure freedom of the seas, and so forth. In the 19th century, it was Great Britain, and for much of the 20th, the U.S. But in 2013, President Obama said there was no global policeman. There are deleterious consequences if the leading power in the world abdicates its leadership role.

What are some of these ramifications?

Part of the reason the world isn’t as buoyant as it might be is that Europe is doing much worse than the U.S. It doesn’t help Europe to have a massive influx of real and “not so real” refugees. Some 220,000 people arrived in the European Union in October, a direct consequence of the disintegration of order in a whole bunch of countries, Syria principally, but not only.

The U.S. walking away from the Middle East has had a direct impact. We’re only beginning to see the ramifications, in Paris most recently. It isn’t going to stop there. There is growing anxiety in East Asia about the rise of China. Japan remains a large economy, but a depressed one in yet another recession. Economists tend to underestimate geopolitical factors because they aren’t in their models. Global order and stability need to be underwritten. It doesn’t just happen spontaneously.

Are you suggesting that the U.S. ought to be the world’s policeman?

Somebody’s got to do it. It better not be the Chinese or Russians. The market system requires an effective state that enforces the rule of law. That is true internationally, as well. As the world becomes less secure, it becomes a less safe place to do business.

A world in which the U.S. yields regional power to China or Russia is one in which the rule of law is driven back. We underestimate the extent to which the age of globalization depended on an American underwriting, and that is gradually unraveling.

Can the U.S. afford to keep the peace?

The U.S. has a fundamental problem: Gradually, its national security is being squeezed by Social Security, particularly its health-care system. It will be squeezed by the burden of interest payments on Federal debt as interest rates go up. In theory, as the biggest economy in the world, the U.S. should be able to afford to build up its military power. In practice, the congressional budget sequester was a blunt instrument applied to the defense budget, cutting it indiscriminately.

The U.S. should be investing to maintain its lead, particularly in areas where it is vulnerable, such as cybersecurity. No matter how many aircraft carriers we have, it might not be that big of a technological leap for us to be matched in the new theaters of war that are emerging.

But as you note, our finances are hobbled.

Entitlements are the obvious problem. Republicans discovered that if you want to cut entitlements, it is hard to win the presidency. I’m optimistic that the U.S. can make its health-care system far more efficient and less expensive as new technology comes into place. With the application of technology, we will start seeing not only stuff about our own health, but also which doctors and hospitals do which things best.

The employer-pays insurance system is loopy and ripe for revolution, in the way that Uber is revolutionizing transportation. We will see similar types of companies revolutionizing health care. At that point, you may be surprised to find that costs start coming down. I can’t imagine in 10 years’ time that when you visit your doctor, someone will hand you a clipboard with a badly photocopied form that you’ll have to fill out for nth time. That’s ludicrous.

You have written about the toxic combination of litigation and regulation in the U.S. What are the odds of reform?

I don’t see any light at the end of the tunnel. The Federal Register has never been so large. The Dodd-Frank and Affordable Care Acts alone produced a staggering volume of regulation. Now we have the Trans-Pacific Partnership Agreement, with a document even larger than Dodd-Frank. It is really disheartening. That there hasn’t been more rapid U.S. growth is due at least in part to these head winds.

Many U.S. companies won’t bring home the cash they have overseas because it would be subject to a hefty tax. Is there any chance this might change soon?

The income-tax code has to be simplified, and corporate tax has to be reduced to some internationally competitive rate. Otherwise, corporations are going to continue to emigrate to wherever the tax burden is lower. Tax reform must be on the agenda of the next president in year one. Tax reform will happen. The political class gets it; the voters get it. It is much harder to tackle excessively complex regulation because there are too many people who benefit from it.

Let’s turn to Asia. You have said that regarding China as an emerging market is absurd. Why?

It is now the second-largest economy in the world, or the largest based on purchasing-power parity, with an influence on the global economy second only to the U.S. China is sui generis. Is China is going to go further in the direction of a market economy? Will it reduce the importance of state-owned enterprises and remove the state from the financial system? Is it going to open its capital account and allow the Chinese to invest abroad freely? Each answer has ramifications for the rest of us like no other economy.

Give us your answers.

We don’t know whether China will be more of a market economy 10 years from now. It is risky for a one-party state to continue increasing the economic freedom of its citizens. President Xi Jinping, who is more interested in power than anything else, understands this well. Consequently, plans for privatization of state-owned enterprises, liberalization of the financial system, and the opening of the capital account will remain plans, but won’t be implemented.

China has created the biggest middle class in history, but middle-class people want property rights. That implies law courts and officials who aren’t corrupt. The moment you demand these things, you are asking the one-party state to loosen its grip on power. The Chinese are terrified of anything like that.

What impact might Jinping’s foreign policy have on markets around the world?

To ensure the one-party state’s legitimacy, Jinping won’t shy away from a relatively saber-rattling foreign policy, because this plays well [domestically]. There is also an element that isn’t propaganda. China is building up its naval capability, modernizing its pretty antiquated army. It has a financial diplomacy that has proved effective. The Chinese have been using their considerable resources to win friends and influence people around the world, including in Central Asia and Africa. China says, “Let us build your infrastructure.” That increases its leverage over a whole bunch of countries that the U.S. has neglected.

What is the outlook for India?

The Indian economy looks to be growing faster than the Chinese economy. India is good for a couple of reasons, including demographics, which turn out to be a lot more important than most people thought. India didn’t have the one-child policy, unlike China, whose workforce is shrinking.

India has rule of law—slow, maybe, but it is there, and a representative government and free press. Unless you think the success of the West is pure luck, which I don’t, those are advantages. There are many thickets of vested interest, but I’m broadly bullish about India’s prospects. The problems India faces are fixable, like infrastructure and housing. China’s problems are much more difficult.

Will the Middle East roil markets in the years ahead?

I expect next year to be more violent than 2015. Many investors don’t realize that since the outbreak of the Arab Spring in 2011, fatalities due to armed conflicts are up by about a factor of four; terrorism is up by a factor of six.

The events in Paris are a reminder that the jihadist network doesn’t confine itself to the majority-Muslim world. It is now embedded in minority-Muslim communities all over Europe. There will be more such attacks, and at some point the terrorists will be successful in the U.S. again. [This interview was conducted before radicalized Islamists killed 14 people in San Bernardino, Calif.] The resources that go into producing radicalism aren’t about to disappear. Networks are difficult to decapitate.

The president has failed to understand this because his model is decapitation. You think, let’s take out the boss. Then you are amazed to find the network [still] grows. We won’t see this go away in the next 10 years. The threat of violent instability in the region will go up, and probably will affect Saudi Arabia. Support for the Islamic State is high among the Saudi population.

Why is that?

An Islamic state can credibly argue that the Saudi royal family is corrupt, Westernized, and hypocritical. The family itself is divided. Saudi Arabia is a weak link, the way Iran was in 1979. If you had to ask what headline would move markets tomorrow morning, a revolution in Riyadh, especially a messy one, would be a pretty good answer. You could see a big terrorist attack on Saudi facilities, and markets would move the price of oil up.

The dollar is strong, and commodity prices are weak. What does that mean for countries like Brazil and Russia?

There comes a point when an investor says, “Hey, that’s attractively priced.” Argentina has been one of the great trades of the year. You might ask, “Where is the political problem horrible, and where is it about to get solved?” It is pretty horrible in Brazil, and I don’t see a fix in the short run. Things will be solved in Argentina, more or less. South Africa? No, that looks bad politically. Turkey? [Prime Minister Recep Tayyip] Erdogan is a dodgy customer. Egypt? I don’t like the way that’s going.

The key is attractive prices and political stability. Money is going to start flowing back into emerging markets that don’t have a political problem, such as Indonesia and maybe Malaysia. In Russia, suppose the sanctions get relaxed, as seems likely next year. Russian bonds have been one of the great performers this year. Everybody was too negative about Russia. There are some interesting opportunities in the rest of the world. It is hard to see the dollar- strength story continuing indefinitely.

What is the biggest risk to global markets?

China. It was so crucial as an engine of growth through the financial crisis. If there is a policy error in China, it could cause huge instability. The government could ease restrictions on cross-border capital flows, which would result in a great wall of money coming out of China. Money would be deployed in Western assets, and it might be difficult for China to cope. Imagine the devaluation impact on the renminbi, and the effect on all other emerging markets, if China suddenly devalues by 20% or 30%.

On the other hand, if Jinping turns the clock back, this could lead to a big downside shock.

Will Europe get its act together?

Europe faces three extraordinary challenges. It wants to have a foreign policy to be able to influence the fate of Syria, but it can’t act independently of the U.S. because it has slashed its defense capability. Secondly, Europe can’t stop this huge wave of refugees. The border is enormous, vastly larger than the Mexican border with the U.S., and much of it is a sea border.

The biggest problem is the fifth column within Europe—people who aren’t loyal to their European states even though they are citizens, second- and third-generation. Potentially, there are thousands of jihadists or sympathizers.

Europe’s problems are unsolvable. Anybody who thinks this great wave of immigration solves Europe’s demographic deficit hasn’t been to the suburbs of Paris.

(ZH) Caught On Tape: Russian Fighter Jets Destroy Huge ISIS Oil Convoy In Tr

http://bit.ly/1Pp53TQ


Caught On Tape: Russian Fighter Jets Destroy Huge ISIS Oil Convoy In Transit To Turkey

 
One month ago, after a farcial year-long campaign to "destroy" ISIS, which achieved absolutely nothing but made the Islamic State grow bigger and stronger, culminating with the numerous terrorist attacks in the month of November, former CIA deputy director Michael Morell told Charlie Rose on PBS that the reason the US had never actually gone after the lifeblood of the ISIS regime, its oil supply chain, infrastructure and products, was because "we didn’t want to do environmental damage, and we didn’t want to destroy that infrastructure."
In other words, the threat of a CO2 emissions spike from bombarding a convoy of ISIS oil tanker trucks far outweighs the millions of dollars in funds it would bring and fund the teaching of hundreds of new terrorists how to blow themselves up in the middle of Paris.
As to not "wanting" to destroy that infrastructure, one wonders why: was it because a down payment had been made by the "president" of NATO-member Turkey?
Luckily as the clip below shows, the Russian military, which has had dramatic success in taking out not only the front end of ISIS (such as today's elimination of the top "rebel leader" Zahran Alloush), but the all too critical back "infrastructure" end, has no such qualms.
So much success, in fact, that the "terrorists", as the Russian Ministry of Defense bluntly calls them, have been forced to deploy new oil trafficking routes to escape the Russian airstrikes.
So far, however, this is not helping, and while ISIS continues to transit as much oil as it possibly can to Turkey where it is subsequently processed and sold to the rest of the world, Russia is making sure that as little of this oil survives and can be monetized, incidentally something the US military should have been doing from day one and paradoxically, something it has yet to do.
Here is a clip released by the Russian Ministry of Defense demonstrating the most severe attack yet by Russian fighter jets on a massive ISIS oil tanker convoy.

 

And just in case it is still unclear where these trucks are headed, here is another clip showing ISIS oil trucks crossing the Syrian-Turkish border.

Barron's : European Stocks Could Soar in the New Year

European Stocks Could Soar in the New Year

With inflation and the euro low, and the ECB pumping money into the economy, European shares might rise by as much as 20% in 2016.


Hopes are high for European equities in 2016, as favorable conditions point toward outperformance. But picking the right stocks will be more important than ever.


The Stoxx Europe 600 index could climb to 413 points by the end of next year, up 12.8% from a pre-Christmas close of 366.28, according to the average of forecasts by six investment banks. Analysts at Citi are among the most bullish, predicting a 20% return on the back of modest growth and a modest re-rating.
In general, investment banks are upbeat on the prospects for European and Asian stocks, but tempered in their enthusiasm for U.S. shares because of the Fed’s rate hike, which came while the European Central Bank is still loosening. The ECB boosted its quantitative easing this month, pulling levers to spur growth. QE has pushed bond yields to abnormally low levels. The yield on 10-year German government debt was 0.63% Thursday, but could rise to 1.2% by the end of 2016, based on the latest German purchasing managers’ index readings, according to analysts at Credit Suisse. Returns on high-yield credit in Europe could be in line with coupons of 6%.
LOW INFLATION, combined with falling energy prices and a weakening euro are creating an environment in which economies could flourish. The euro has shed about 10% of its value in 2015, and could slip to parity against the dollar in 2016, some forecasts say. It traded at $1.09 Thursday.
As Europe continues to recover from the crippling euro-zone debt crisis, its growth is slowly catching up with the rest of the world’s. The euro zone’s gross-domestic-product growth is estimated at 1.6% in 2015 and 1.8% in 2016, versus 3.4% for the global economy, up from 3.1% in 2015.
Not everyone is bullish, of course.


Most long-only funds outperformed in 2015 simply by being underweight commodities, says Graham Secker, chief European equity strategist at Morgan Stanley. But he expects 2016 to be different, since European quality names are expensive and the Fed’s tightening creates worldwide head winds. “It is going to be bloody hard next year,” warns Secker.
Morgan Stanley’s forecasts are among the most pessimistic, pointing to no multiple expansion and just 3% upside for the MSCI Europe index in 2016. And history argues for caution: European stocks appear set to fall short of bank strategists’ expectations this year. With only a few trading days left in 2015, the Stoxx Europe 600 index is ahead just 6.9%, short of the 9% gain that was forecast before the year began.
However, George Evans, chief investment officer for equities at Oppenheimer Funds, says that in his 28-year career in asset management, there haven’t been many times “when things have been aligned so positively for outperformance in Europe.” He cites factors including earnings momentum, appealing valuations, and liquidity.
Corporate earnings are projected to grow 7%, according to a consensus of estimates, although they’re likely to be weaker in the U.K., where the benchmark FTSE-100 index has a disproportionately high exposure to commodities.
EUROPEAN EQUITIES are attractively priced. The Stoxx Europe 600 trades for 14.6 times projected 2016 earnings, compared with 15.8 times for the Standard & Poor’s 500.


Some investors think that banks will do well, as low interest rates in Europe lead to a pickup in lending. Deutsche Bank analysts note in a report that the sector’s 12-month forward return on equity has hit a seven-year high, meriting a price/book re-rating. In addition, the Stoxx Europe 600’s financial sector trades for just 11.2 times next year’s estimated earnings, and the banking group’s average dividend, at more than 4%, is the third-highest after the mining and energy sectors’. The analysts’ picks include Lloyds Banking Group (ticker: LYG), ING (ING), Commerzbank (CBK.Germany), and Societé Générale (SCGLY).
Some strategists also see value in oil and gas, although Societé Générale’s prediction of $60 oil by the end of 2016 seems optimistic. Bulls on the sector favor high-quality names, including Royal Dutch Shell (RDSB) and Repsol (REP.Spain).
Germany could do well again. The benchmark DAX index is ahead 9.4% in 2015, but it is still reasonably priced at 12.6 times next year’s estimated earnings.
On the flip side, the U.K. seems to offer too much uncertainty. A referendum on Britain’s continued membership in the European Union could come in 2016, and observers suggest the result will be close. But the consequences of Brexit—a British exit from the EU—could be so far-reaching that all concerned are likely to do whatever is necessary to ensure that it doesn’t

>>> Weekly Update

Weekly Market Update: Chipotle Suffers, Crude Awakening

**Economic data:
- (FR) France Nov Net Change Jobseekers: -15.0K v -10.0Ke; Total Jobseekers: 3.575M v 3.590Me
- (IL) Israel Nov Unemployment Rate: 5.4% v 5.3% prior
- (RU) Russia Gold and Forex Reserve w/e Dec 18th: $368.9B v $371.2B prior
- (US) Initial Jobless Claims: 267K v 270Ke; Continuing Claims: 1.195M v 2.20Me
- (MX) Mexico Nov Trade Balance: -$1.6B v -$2.2Be
- (MX) Mexico Nov Unemployment Rate: 4.0% v 4.3%e; Unemployment Rate (Seasonally Adj): 4.1% v 4.3%e
- (US) Weekly EIA Natural Gas Inventories: -32 bcf vs. -28 to -24 bcf expected range

Markets lulled into holiday mode on a shortened Christmas Eve trading day and ended flat, with no discernible sign of a Santa Claus rally. Jobless claims came in largely in line with estimates Thursday morning, and the dollar weakened against most major pairs. EIA natural gas inventories fell more than expected, sending prices higher briefly, but couldn't catch the same momentum as crude prices, which gained for the third straight day. In equity news, Omega's Leon Cooperman disclosed an increased stake in REXI, sending its shares up +28%, and Fiat Chrysler announced a recall of 350K SUVs in the US due to a vanity mirror wiring issue.

For the week, the markets shook off anxieties about rising Fed rates and problems developing in the high yield market, as well as concerns about the inconclusive Spanish election on Sunday, and equity markets lifted on light volume. For the week, the DJIA gained 2.5%, the S&P500 rose 2.8%, and the Nasdaq added 2.5%.

The third and final reading of third-quarter GDP showed the US economy grew at a 2% pace in the quarter. Expectations were for the reading to show the economy growing at a 1.9% pace in the third quarter, down slightly from the preliminary reading of 2.1% reported last month. The slight downgrade was triggered by a larger trade deficit and a smaller buildup in inventories. The November existing home sales report was somewhat concerning, as the annualized sales rate plunged more than 10% from October levels and undershot expectations by approximately the same percentage. The NAR cited a range of possible reasons for the surprisingly weak report, including new regulations that came on line last month, the lead-up to Fed rate hikes and a big rise in median home prices on a y/y basis.

Spain's general elections offered a consolation prize to the anti-austerity camp, but hardly delivered the upset some were predicting. The conservative, ruling Popular Party (PP) won the most seats, but lost its majority as two upstart parties divided the vote. PP ceded a number of seats to leftist, populist Podemos and centrist Ciudadanos, and will either have to look for a partner or attempt to form a minority government, increasing the chances of political turmoil. Spains IBEX index fell more than 3% on the inconclusive election result, while the bond market reaction was more muted: Spanish 10-year treasuries were up a maximum of 20 bps at their weakest on Monday, but had regained nearly half that amount by Tuesday. EUR/USD shrugged off the election almost completely.

In the first half of the week crude futures continued to slide, but with a new wrinkle. Within days of the US Congress lifting a 40 year old ban on oil exports, WTI and Brent prices converged, and by Tuesday Brent has lost its entire premium over WTI. After hitting fresh multi-year lows, crude rebounded sharply on Wednesday and Thursday, helped by an OPEC report forecasting higher oil prices over the long term and by a big draw in weekly DOE crude inventory data.

Nike reported another solid quarter with strong futures orders, but profit taking emerged after shares hit a new all-time high. In the tech sector, Micron mostly met expectations for its first quarter, but gave terrible guidance for Q2, pushing its growth story to the second half of the fiscal year. Home goods retailer Bed Bath & Beyond plumbed a new 52-week low after cutting Q3 guidance, indicating disappointing holiday shopping results. Shares of Chipotle puked again after the CDC announced a second strain of E.coli had sickened restaurant patrons in three new states.

On the M&A front, Pep Boys shares saw more gains as billionaire Carl Icahn is now in an all-out bidding war with Bridgestone. In raising his offer this week, Icahn said he would be willing to outbid Bridgestone by $0.10 a share on any bona fide offer from Bridgestone, up to $18.10/share. Carl Icahn's bid received FTC early termination approval, and now PBY awaits a counteroffer from Bridgestone expected later Thursday afternoon. The FTC rejected Staples' offer to revise its $6.3 billion acquisition of rival Office Depot, casting more doubt on the completion of a merger of the two largest office supply chains. Staples disclosed the FTC had rejected its offer to sell $1.25 billion of contracts in what it described as "an effort to create an acceptable remedy" to concerns that the combined company would have too much control of the commercial market for office supplies.

**Looking Ahead***
All times listed for economic events are denominated in Eastern Standard Time (Add 5 hours for GMT equivalent)
- 18:30 (JP) Japan Nov Jobless Rate: 3.2%e v 3.1% prior; Job-To-Applicant Ratio: 1.24e v 1.24 prior
- 18:30 (JP) Japan Nov Overall Household Spending Y/Y: -2.2%e v -2.4% prior
- 18:30 (JP) Japan Nov National CPI Y/Y: 0.3%e v 0.3% prior; CPI Ex-Fresh Food (Core) Y/Y: 0.0%e v -0.1% prior; CPI Ex Food/Energy (Core/Core) Y/Y: 0.8%e v 0.7% prior
- 18:30 (JP) Japan Dec Tokyo CPI Y/Y: 0.1%e v 0.2% prior; CPI Ex-Fresh Food Y/Y: 0.1%e v 0.0% prior; CPI Ex Food/Energy Y/Y: 0.6%e v 0.6% prior
- 18:50 (JP) Japan Nov PPI Services Y/Y: 0.4%e v 0.5% prior
- 23:00 (JP) BOJ Gov Kuroda speech

Friday events
- 00:00 (JP) Japan Oct Final Leading Index CI: No est v 102.9 prelim; Coincident Index: No est v 114.3 prelim
- 00:00 (JP) Japan Nov Annualized Housing Starts: 890Ke v 862K prior; Housing Starts Y/Y: +0.6%e v -2.5% prior; Construction Orders Y/Y: No est v -25.2% prior
- 03:00 (CN) Shanghai Futures Exchange (SHFE) Weekly Copper Stockpiles: No est v 179.6K prior
- 03:00 (RU) Russia Narrow Money Supply w/e Dec 18th (RUB): No est v 8.20T prior
- 20:30 (VN) Vietnam Q4 YTD GDP Y/Y: 6.6%e v 6.5% prior
- 20:30 (VN) Vietnam Dec Trade Balance: No est v -$200M prior; Exports YTD Y/Y: No est v 8.3% prior; Imports YTD Y/Y: No est v 13.7% prior
- 20:30 (VN) Vietnam Dec Industrial Production Y/Y: No est v 8.9% prior
- 20:30 (VN) Vietnam Dec YTD Retail Sales Y/Y: No est v 9.4% prior

Weekend data
- Sat: 20:30 (CN) China Nov Industrial Profits Y/Y: No est v -4.6% prior