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What Hurricanes Can Teach Us About Investing

Investment manager and ace investment writer Ben Carlson had written a really interesting blog post recently about “hurricane amnesia” and investing.

The National Oceanic & Atmospheric Administration (NOAA) is a weather research organisation based in the U.S. In late August this year, the NOAA highlighted an interesting statistic: It has been nearly 10 years since the U.S. was last hit by a major hurricane (defined as a Category 3 hurricane or higher).

What’s dangerous though, is this: According to Carlson’s read of NOAA’s data, the U.S. has suffered an average of 2.4 major hurricane attacks per year going back more than a century to 1900. Given the historically frequent prevalence of potentially disastrous weather phenomenon, a near decade-long stretch without a major hurricane attack may lull Americans into complacency. This is what NOAA has called “hurricane amnesia.”

Like how Carlson managed to find parallels with hurricane amnesia and investing in his aforementioned blog post, I too found a strong link between hurricane amnesia and the world of finance.

That link is encapsulated by the experience of London-listed mining behemoth Glencore PLC. The Wall Street Journal had reported on Monday that Glencore will be eliminating its dividends, issuing new stock, selling its assets, and cutting its capital expenditures, among other measures, in order to cut its net-debt and shore up its balance sheet.

Glencore’s predicament had partly been driven by falling commodity prices. As the Journal explains (emphasis mine):

“Standard & Poor’s last week downgraded [Glencore’s] credit rating outlook to negative from stable [a negative outlook means the company’s credit rating may be lowered], citing concerns about the company’s ability to generate enough cash to lower debt as low commodity prices take their toll on earnings. Glencore swung to a [US]$676 million net loss in the six months to the end off [sic] June.”

But, I can’t help but feel that Glencore’s management needs to share some of the blame too. Why? If you check out the chart below, you can clearly see that Glencore’s balance sheet has deteriorated significantly over the years since 2007.

Glencore's balance sheet

Source: S&P Capital IQ; Net-debt refers to Total debt minus Cash & Short-term Investments

The timing is important here. When the Great Financial Crisis of 2008-09 hit, debt became cheap as central bankers around the world – in particular, the US Federal Reserve – slashed interest rates in an effort to prop up their respective economies. This is where I find a link between hurricane amnesia and finance.

The Fed has kept interest rates really low ever since it slashed them during the crisis period (see chart below). This has an effect of depressing borrowing costs for many companies around the world. With low-interest rates having gone on for years, I would think it’s fair to say that Glencore’s management may have forgotten what it’s like for interest rates to rise, judging by the way Glencore’s balance sheet had changed. Interest rate amnesia may well have set in.

Federal Funds Rate

Source: New York Federal Reserve

While the Fed has yet to raise rates, binging on cheap debt – this applies not just to Glencore but to every company – has the effect of lowering a company’s room for error in dealing with any downturns, temporary or permanent, in its business environment.

This is what has done Glencore in – a heavy debt-load became added weight when dealing with low commodity prices. And investors are the ones to suffer. The negative impacts to investors coming from an elimination of dividends is obvious; issuing new shares has the potential to dilute existing investors’ stakes; the sale of assets and the cutting of capital expenditures may stunt the company’s future growth.

Some blue chips in Singapore’s stock market – the 30 constituents of the market benchmark, the Straits Times Index (SGX: ^STI) – which have seen a substantial increase in their level of borrowings since the financial crisis period are Golden Agri-Resources (SGX: E5H), SembCorp Marine Ltd (SGX: S51) and Singapore Press Holdings Limited (SGX: T39).

Ratio of total debt to cash & short-term investments (TDC) for Golden Agri, SembCorp Marine and SPH (2)

Source: S&P Capital IQ

As you can see in the chart above, their ratio of total debt to cash & short-term investments have been climbing since 2007. Have their managements contracted interest rate amnesia? That’s something for investors to think about.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.