Centre Street Cambridge Corporation

Private Investment Counsel


April 2012

Shipping is an ancient business and globalization is not just a modern phenomenon. Throughout recorded history cargo-carrying vessels of all sorts have plied the earth’s rivers, lakes, and oceans, bringing goods from one place to another and tying together far-flung regions. Indeed, the remains of watercraft found at the bottom of the sea (along with some of their cargoes) have furnished insights into the economies of ancient cultures and the private lives of their inhabitants. Consumers of today benefit as never before from trade over the seven seas (yet most pay little heed to how the products on big box store shelves, in car lots, or at gas station pumps got there from where they were made.)

Shipping’s evolution into world-spanning fleets of container ships and huge crude oil carriers reflects this on-going globalization and the tighter linkages among economies. As an important enabler of trade amongst nations, the industry is exquisitely sensitive to the world economy’s health, and gauges of shipping activity, such as the Baltic Dry Index, are closely watched as economic barometers. Lately, the BDI has been quite weak, leading some to fear an imminent return to recessionary conditions. Despite some recovery in business conditions following the financial crisis, the index has fallen 80% from its high in November of 2009. However, the BDI’s readings, which measure changes in the cost of shipping dry ocean-going freight, have been skewed by the entering into service of large numbers of new ships. Many were ordered during the boom period before 2008 when the demand for capacity seemed limitless; others were built in China as part of a policy to keep shipyards in that country busy. Regardless of the source, the impact of the new tonnage on rates has been depressing to operators. For example, the daily cost to hire one type of ship dropped from $32,000 in late 2009 to $6,600 now—barely covering operating costs.

Despite the fiscal and political pressures plaguing Greece and its relatively small economy, the country plays a prominent role in shipping as home to the world’s largest fleet—a fitting position given its long history as a seafaring nation. The subject of a recent Financial Times piece, the Greek shipping business offers insights into the impact on businesses of modern forms of corporate governance, a subject that should be of interest to all with a stake of one kind or another in free-market capitalism, especially shareholders and taxpayers. As we discuss below, this case reveals the consequences for the important business function of capital investment of different types of business organization, with their contrasting incentives and constraints.

Out of the 700 shipowners in Greece, about 600 are private, family-owned and -operated companies. This is in stark contrast to Germany, the third-largest ship-owning country, where almost all fleets are owned by investment funds and run by professional managers. Hundreds or thousands of private investors contribute relatively small amounts of money to the funds, meaning that no one person has control. This arrangement should sound familiar to anyone familiar with business organization, as it typifies modern corporate capital and managerial structures.

We find the experience of German and Greek shipowners during the boom and bust of the last several years to be highly instructive. Greek owners, with their long individual experience and intimate knowledge of and attachment to their companies, were skeptical of high industry earnings in 2007-08 and expected an eventual downturn, which they prepared for by building cash reserves. German managers, on the other hand, responded to the boom by ordering large numbers of new ships. The latters’ decisions entailed great expense, but the Germans expected to be able to foist the cost off onto investors at some point down the road. The Greeks were well-prepared to weather the storm that followed and compete going forward. In Germany, however, investor funding dried up, and many owners are now facing bankruptcy.

There are other differences between industry conditions in the two nations—Greek shipowners have certain tax advantages, or example—but the impact of the ownership and control structure is critical. To paraphrase one German shipowner: the fundamental difference between the two markets is that in Greece most owners are playing with their own money, while in Germany the vast majority are playing with other people’s money.

We have long argued that having “skin in the game” on the part of decision-makers is essential for good capital allocation, and to ensure that adequate attention is paid to risk. Need we say more?

Economic Function of Financial Markets?

We have never really understood the academic notion that financial markets serve to channel resources to their most productive use. It has always seemed to us that the most productive channeling is done by wise and experienced individuals (whether they be Greek shipowners or the Buffetts of the investment world), and usually, in spite of the markets. In fact, we have observed that resources are most productively put to work when the markets are practically shut as a source of new capital. Buffett’s activities in 2008-09 in providing large amounts of capital to a few of the biggest players in finance and industry are the most recent prominent examples that come to mind, but there have been many investors who have operated along similar lines, if on a smaller scale.

We believe that a decidedly unproductive channeling of funds may be occurring now in the stock and bond markets. According to a recent report, $400 billion left stock mutual funds between 2008 and early 2012. During the same period, $800 billion moved into bond funds. Accompanying these fund flows has been a collapse in interest rates, producing record low yields on almost all qualities and maturities of debt instruments, including those of junk-rated bonds (indeed, low-rated issuers are overjoyed at the chance to finance themselves at such low cost). These figures undoubtedly reflect the stock market trauma of 2008-09, yet it is interesting to see the trend continue even after a doubling of stocks since early 2009. An unusual and infrequent aligning of the stars made for seemingly good longer-term results that no doubt have contributed to bonds’ being in favor; figures showing bond returns exceeding those of stocks over the last 30 years were much ballyhooed at one point last year. What many people may have overlooked was the fact that it took interest rates going from record highs in the early 1980s to record lows currently to produce such an achievement (bond prices rise as rates fall, thereby contributing to results). In addition, equity returns weren’t helped by the fact that stocks fell off a cliff twice within a decade. As usually happens when an asset’s price goes in one direction for a while, buyers are enthusiastic about bonds now, much as they were about stocks in the balmy days of 1999.

That sentiment, if not the cash flows, may slowly be changing. A sharp pop in interest rates in March, as well as an encouraging rise in stocks so far in 2012, has led some Wall Street opinion-leaders to change their views. Some see an end to the 30-year bull market in bonds taking place; others maintain we are witnessing a once-in-a-generation opportunity to switch from bonds into stocks. One wonders where these bullish stock market prognosticators have been since March 2009 during the sharp rise from the crisis bottom, but it is typical of Wall Street to predict moves that have already occurred. Nevertheless, our Wall Street colleagues will probably turn out to be correct—eventually. It is difficult for us to foresee how bonds can continue to produce the returns that investors have become accustomed to for three decades running. In Japan, yields are approaching 0%, but this seems unlikely here under U.S. circumstances, and the economic situation required to produce such low yields is probably not something we would want to experience. Stocks are a more complicated story, but prices are reasonable and could produce decent returns going forward. The “once-in-a-generation” call seems a little far-fetched, however.

We are sympathetic to the view that stocks will do well over the very long haul, even if we cannot work up much excitement over them in an immediate sense. We are more interested in equities when future returns are rising (i.e., when prices are falling), and with the exception of the sharp declines of last summer, future returns have ben falling as prices have risen for the last three years.

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March closed out one of the best quarters for stocks in many years, a rise that is all the more remarkable for its taking place during a time of great skepticism about the markets and the economy. The popular averages mostly rose in the 8% to 12% range. The S&P 500 had its best first quarter since 1998, an impressive result despite the fact that one stock—Apple Inc.—accounted for fully 14% of its gain. The NASDAQ stood out with its 18.7% jump, besting all first periods for that average since 1991. Stocks were popular (at least among the cognoscenti) around the globe: Asian equities advanced over 13%, with Japan a standout, and even Europe, the source of so much hand-wringing last year, saw gains of almost 8%. Thus, the broader U.S. market has already produced what would normally be above-average annual results in just three months, and if it continues at this rate we could see stocks rise 57% in 2012! That happy circumstance would be a welcome boon to the customers of certain hedge fund operations whose high-end fees have produced not much more than flea-market results of late. Sadly, such an outcome is highly unlikely, but either 2012 will turn out to be a very good year for equities, or the remainder of the year will test investor resolve.


Dennis Butler, MBA, CFA