Newsletter Q2 2006
April 13, 2006
Sand in the Global Economic Gears
The Department of Commerce
recently reported that the annual U.S. current account deficit expanded further
to $804.9 billion in 2005 from $665.4 billion in 2004. As a percentage of GDP,
the current account deficit rose to 6.4%. Foreign investors have continued to
purchase U.S. assets in large quantities to offset the current account deficit
and forestall a decline in the value of the U.S. dollar. During 2005,
foreign-owned assets in the United States increased by $1292.7 billion while
U.S.-owned assets abroad increased by $491.7 billion. The net difference of
$801 billion represents the net demand for the U.S. currency created by
investment flows.
As the trade and financial
position of the U.S. deteriorates, Congress is turning to protectionist
legislation. For now, Senators Schumer and Graham have deferred a floor vote on
their proposal for a “currency equalization tariff” of 27.5% that would be
levied on Chinese imports. Since wages in the Chinese manufacturing sector are
approximately 4% of U.S. wages, it would take a significant change in the yuan/US$
exchange rate to have much impact on the U.S. trade deficit with China.
A broader legislative
option on trade has emerged recently – the “United States Trade Enhancement Act
of 2006 (USTEA06)” proposed by Senators Grassley and Baucus. USTEA06 would
empower a new office in the U.S. Treasury to identify external imbalances and
nations guilty of currency misalignments. Remedial actions range from
restrictions on trade finance, IMF voting rights, and the classification of a
country’s trading status with the U.S.
The U.S. Senate Banking
Committee is also considering major changes to the approval process for foreign
mergers and acquisitions of U.S. companies. The proposed legislation would
lengthen the review time for acquisitions of U.S. companies by state-owned
foreign acquirers. It would also require national security investigations for
transactions deemed to impact America’s critical infrastructure (including
energy assets), critical technologies, and domestic production linked to
national defense requirements.
The squelching of the Dubai
Ports deal and the acquisition of Unocal by a Chinese oil company has not gone
unnoticed abroad. Stephen Roach, economist at Morgan Stanley, traveled to both
Beijing and Dubai during March and found growing frustration with America’s
attitude:
From Beijing to Dubai, there is a
growing undercurrent of economic anti-Americanism. The irony of it all is truly
extraordinary: The US has the greatest external deficit in the history of the
world, and is now sending increasingly negative signals to two of its most
generous providers of foreign capital - China and the Middle East. The United
States has been extraordinarily lucky to finance its massive current account
deficit on extremely attractive terms. If its lenders now start to push back,
those terms could change quickly - with adverse consequences for the dollar,
real long-term US interest rates, and overly indebted American consumers. The
slope is getting slipperier, and Washington could care less.
Additions
Chevron Corp. (CVX) and
Devon Energy Corp. (DVN) were purchased for selected accounts. Both CVX and DVN
sell at substantial discounts to their estimated values of oil and gas reserves
and other assets. Chevron and Devon sell at P/E ratios of 8.0 and 8.3X 2006
estimated earnings, respectively.
The Macquarie Global
Infrastructure Total Return Fund (MGU) was purchased for many accounts. MGU is
a closed-end fund that invests on a global basis in equity, debt and other
securities of companies that operate or manage infrastructure assets. The four
largest industry sectors are pipelines, electric utilities, electricity and gas
distribution, and airports. MGU has a current dividend yield of 6.4%.
Compania Anonima Nacional
Telefonos de Venezuela (VNT) is the leading telecommunications service provider
in Venezuela with 3.4 million fixed access lines in service, 5.2 million mobile
subscribers, and 307 thousand broadband subscribers. Revenue for the company
increased by 32.7% in local currency terms during 2005. The Board of Directors
has proposed that shareholders approve a dividend which amounts to $2.28 per ADR.
During the fourth quarter conference call, VNT’s management provided 2006
earnings guidance of approximately $3.92 per ADR.
Verizon Communications Inc.
recently announced that it had entered into an agreement with a joint venture
owned by American Movil (AMX) and Telefonos de Mexico (TMX) to sell its 28.5%
interest in VNT. The AMX/TMX joint venture intends to make a tender offer for
the remaining VNT shares after the initial transaction is completed.
Positions in Ocean Power
Technologies, Inc. (OPWT or OPT in London) were increased during the quarter.
The company continues to make progress and announced its first project in the
United Kingdom. OPT has been selected to occupy a position at the South West
Wave Hub Project. Its wave power station in the Hub Project will have 5
megawatts of capacity and will consist of approximately 30 PowerBuoys to be
deployed during 2007-2008. Given the growing concern about global warming,
there should be additional interest in the company’s wave power technology.
Deletions
Tele Centro Oeste Celular
Participacoes SA (TRO) was sold at a profit. As the result of a merger plan,
TRO will be combined with three other Brazilian mobile phone companies into a
single entity to be named Vivo Participacoes. According to the pro forma
combined income statements in the prospectus for the merger, if the four
companies had operated as a combined entity during 2004 and 2005, it would have
had significant operating losses. The combined entity does not appear to have
an attractive valuation that would justify holding it.
Positions in Canadian
Natural Resources Ltd. (CNQ) and Methanex Corp. (MEOH) were reduced during the
quarter. Although the fundamentals for both companies remain positive,
positions in the two companies had become overweighted due to price
appreciation. Proceeds from the partial reductions will be used to diversify
portfolios further.
Many of the closed-end
fixed income funds were either reduced or sold during the quarter. In a rising
interest rate environment, net asset values of many of these funds are likely to
decline, and discounts to net asset value could widen.
Updates
In March, Sinovac Biotech
Ltd. (SVA) announced that SVA will become the exclusive distributor in China for
the hepatitis B vaccine manufactured by LG Life Sciences, a South Korean
company. Health experts estimate that 60% of China’s 1.3 billion people have
been infected with hepatitis B at some time during their lives and 10% are
infected at the present time. SVA does not have a hepatitis B product of its
own and currently buys a vaccine from another company to incorporate into its
hepatitis A/B combination vaccine.
If you have any questions
regarding your accounts, please contact us.
Sincerely,
Robert G. Kahl
CFA, CPA, MBA
Sabino
Investment Management, L.L.C.