Wednesday, December 19, 2018

19/12/18: Ten Years of True Economics


Just a quick note to say that yesterday, True Economics celebrated its tenth anniversary.  It has been a long walk without a destination.


19/12/18: Schroders' Lloyds deal signals more bank-asset manager tie-ups


My comment on consolidation in asset management industry and the Schroders' Lloyds deal via S&P Global Market Intelligencehttps://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/47696173.


Saturday, December 8, 2018

8/12/18: Back to the 1950s: Tracing Out 25 Years of the Credit Bubble


While the current cycle of declining interest rates has been running for at least 25 years, the most recent iteration of the period has been exceptionally benign. Since the end of the global financial crisis, Corporate and, to a greater extent Government, borrowing costs have run at the levels close to, or even below, those observed in the 1950s-1960s.


Since 2002-2003, FFR, on average, has been below the risk premium on lending to the Government & corporates. This has changed in 4Q 2017 when Treasuries risk premium fell below the FFR and stayed there since. In simple terms, it pays to use monetary policy to leverage the economy.
Not surprisingly, the role of debt in funding economic growth has increased.


And, as the last chart below shows, the relationship between policy rates (Federal Funds Rate) and Government and Corporate debt costs has been deteriorating since the start of the Millennium, especially for Corporate debt:


In simple terms, risk premium on Corporate debt has been negatively correlated with the Federal Funds Rate (so higher policy rates imply lower risk premium on Corporate bonds) and the positive relationship between Government debt risk premium and Fed's policy rate is now at its weakest level in history (so higher policy rates are having lower impact on risk premium for Government bonds). In part, these developments reflect accumulation of Government debt on the Fed's balancesheet. In part, the glut of liquidity in the banking and financial system (leading to mis-pricing of risks on a systemic basis). And, in part, the disconnection between Corporate debt markets and the policy rates induced by the debt-financed shares buybacks and M&As, plus yield-chasing investment strategies, all of which severely discount risk premia on Corporate debt.

8/12/18: Shares Buybacks Hit Diminishing Marginal Returns



The S&P 500 Buyback Index Total Return data tracks the performance of the top 100 stocks with the highest buyback ratios in the S&P 500 in terms of total return. As the chart below shows, the Buyback Index has generally and significantly outperformed S&P500 returns since 2008:





with three discernible periods of outperformance highlighted in the second chart:


In simple terms, since December 2015, the Buyback Index Total Return performance relative to S&P500 returns has stagnated, despite accelerating buybacks by the S&P500 corporates. In part, this is driven by the increased buybacks activity in the less active companies (not constituents of the Buyback Index), but in part the data suggests that the returns to buybacks are generally tapering out.

At the same time, correlation between S&P500 returns and Buyback Index returns has been weakening from around the same time:

All of the above indicates a breakdown in the traditional post-2008 pattern of returns, as buybacks role as the drivers for improved ROE performance for top S&P500 shares re-purchasers is starting to run into diminishing returns.

Thursday, December 6, 2018

6/12/18: Are Younger Americans More Comfortable With a Multipolar World?


When it comes to challenging status quo heuristics, the younger generations usually pave the way. The same applies to the heuristics relating to geopolitical environment. While the older generations of Americans appear to be firmly stuck in the comfort-seeking status quo ante of 'Cold War'-linked hegemonic perception of the world around us - the basis for which is the alleged positive exceptionalism of the U.S. confronted by the negative exceptionalism of Russia and, increasingly, China, Americans of younger cohorts are starting to comprehend the reality of multipolar world we inhabit.

At least, according to the Pew Research data:

The gap between the tail generations (the Z-ers and the Boomers) is massive, and the spread within the generations is relatively more compressed for the Z-ers.

6/12/18: When it comes to geopolitical & socio-economic anxiety, Europe's problem is European


Europe is a sitting duck for major geopolitical risk, but the U.S. is getting there too:



And volatility surrounding the uncertainty measure is also out of line for Europe, both in levels and trends:

Just as the Global Financial Crisis in Europe was not caused by the U.S. financial meltdown, even if the latter was a major catalyst to the former, so is the current period of extreme policy anxiety and instability is not being driven by the emergence of the Trump Administration. Europe's problem seems to be European.

5/12/18: Bitcoin: Sell-off is a structural break to the downside of the already negative trend


Bitcoin has suffered a significant drop off in terms of its value against the USD in November. Despite trading within USD6,400-6,500 range through mid-November, on thin volumes, BTC dropped to a low of USD3,685 by November 24, before entering the ‘dead cat bounce’ period since. The Bitcoin community, however, remains largely of the view that any downside to Bitcoin is a temporary, irrationally-motivated, phenomena (see the range of forward forecasts for the crypto here: http://trueeconomics.blogspot.com/2018/11/201118-bitcoins-steady-loss-of.html).

Dynamically, Bitcoin has been trading down, on a persistent. albeit volatile trend since January this year. Based on monthly ranges (min-max for daily open-close prices), the chart below shows conclusively that as of mid-November, BTCUSD has entered a new regime - consistent with a new low for the crypto.





This regime switch is a relatively rare event in the last 11 months of trading, singling that the BTC lows are neither secure in the medium term, nor are likely to be replaced by an upward trend. While things are likely to remain volatile for BTCUSD, this volatility is unlikely to signal any reversal of the downward pressures on the crypto currency.

Consistent with this, we can think of two possible, albeit distinctly probable, scenarios:

  1. Scenario 1 (the more likely one): BTCUSD will, in the medium term of 1-3 months, drop below USD3,000 levels, and
  2. Scenario 2 (least likely one): BTCUSD will repeat its December 2017 - January 2018 ‘hockey stick’ dynamics.


Noting the above dynamics, the lack of any catalyst for the BTC upside, and the simple fact that since mid-November, larger volumes traded supported greater moves to the downside than to the upside, current trading range of USD3,900-4,100 is unlikely to last.

Scenario 2 supports going long BTC at prices around USD3,800, but it requires a major, highly unlikely and unforeseeable at this point in time, catalyst. A replay of the 2017 scenario needs a convincing story. Back then, in September-October 2017, a combination of the enthusiastic marketing of bitcoin as a 'solve all problems the world has ever known' technology, coupled with the novelty of the asset has triggered a massive influx of retail investors into the crypto markets. These investors are now utterly destroyed, financially and morally, having bought into BTC at prices >$4,000 and transaction costs of 20-25 percent (break-even prices of >$5,000). The supply of new suckers is now thin, as the newsflow has turned decidedly against cryptos, and price dynamics compound bear market analysis. Another factor that led BTC to a lightning fast rise in December 2017 was the promise of the 'inevitable' and 'scale-supported' arrival of institutional investors into the market. This not only failed to materialise over the duration of 2018, but we are now learning that the few institutional investors that made their forays into the markets have abandoned any plans for engaging in setting up trading and investment functions for their clients. In the end, today, the vast majority of the so-called  institutional investors are simply larger scale holders of BTC and other cryptos, unrelated to the traditional financial markets investment houses.

Scenario 1 implies you should cut your losses or book your gains, by selling BTC.

5/12/18: BRIC PMIs for November: A Moderate Pick Up in Growth


BRIC PMIs are in, although I am still waiting for Global Composite PMI report to update quarterly series - so stay tuned for more later), and the first thing that is worth noting is that, based on monthly data:

  1. Brazil growth momentum has accelerated somewhat, in November (103.2) compared to October (101.0), although both readings are consistent with weak growth (zero growth in my series is set at 100). November reading is the highest in 9 months, although statistically, it is comparable to growth recorded in March, April and October this year).
  2. Russia growth momentum de-accelerated from 111.6 in October to 110 in November, although, again, statistically, the two numbers are not significantly different from each other. November was the second highest reading in nine months, and the third highest reading in 2018.
  3. China growth has improved from 101.0 in October to 103.8 in November. Despite this, last two months remain the lowest since April this year. From statistical significance point of view, October reading was distinctly below November reading, but November reading was consistent with August-September.
  4. India posted substantial rise in growth conditions, from already robust 106.0 in October to a 24-months high of 109.2. This reading is statistically above all other period readings, with exception of being tied with July 2018 level of 108.2.
Thus, overall, BRIC Composite growth indicator rose from 102.8 in October to 105.3 in November, the highest in 10 months. BRIC ex-Russia reading was at 105.4 in November, compared to 102.7 in October. November reading for ex-Russia BRIC growth indicator was also the highest since February 2013.

Couple of charts to illustrate monthly data trends:

While the chart above clearly shows that Russia supports BRIC block growth momentum to the upside, this effect is somewhat moderating due to both ex-Russia BRIC growth momentum rising and Russia growth momentum slowing slightly.

The chart below highlights BRIC estimated growth contribution to global growth momentum:


Overall, as the chart above shows, BRIC economies contribution to global growth momentum has accelerated in November, but remains bound-range within the longer-term trend of weaker BRIC growth for the last five and a half years.

As noted above, I will be posting more on BRIC growth dynamics signalled by the PMIs once we have Global Composite PMIs published by Markit. Stay tuned.

Friday, November 30, 2018

30/11/18: Turning Europe into Greece


My latest column for the Cayman Financial Review is out, discussing how the lessons from the Global Financial Crisis, not learned by Europe, are creating new ghosts of VUCA across the European financial and economic landscapes:  https://www.caymanfinancialreview.com/2018/10/31/turning-europe-into-greece/.


30/11/18: Ireland’s Dependency Ratio Problem?


Ireland seems to have a twin dependency. or rather a triple dependency problem:

  • Younger population means larger share of population is either below the working age or in education;
  • Older population largely working less in their post-retirement age due to a number of factors, such as family/household work (‘grandparents duties’ in absence of functional childcare and early education systems), and tax effects (low thresholds for the upper marginal tax rate application act as disincentive to supply surplus labor over and above retirement income), plus the workplace practices and regulations that restrict post-retirement age work; and
  • Working-age adults in large numbers drawing various forms of allowances (labor force participation rate being low for Ireland despite a relatively benign unemployment statistics).

All of which means that the aggregate (and very broad) dependency ratio for Ireland is yet to recover from the decade-old crisis, and is below that for other small, open economies, for example, Iceland:


The latter observation was true before the crisis, but the onset of the GFC and the Great Recession have pushed Ireland’s employment to population ratio to such dire lows that the country is yet to recover from its woes. Iceland recovered its pre-crisis levels of employment to population ratio back in 2016. It also endured much less pronounced impact of the crisis in terms of ratio decline (peak to trough) and duration of the peak-to-peak cycle. Ireland is still climbing out of the mess, and the rate of recovery is expected to slow down dramatically in 2018 (based on the IMF data).

While many observers and analysts are quick to discount this ratio, the reality is that economy’s resilience to shocks, its productive capacity today (and, via on-the-job training, learning by doing and other forms of career-linked investments in productivity growth, its future capacity) are determined by how many people work in the economy per capita of population. The lower the ratio, the less income producing capacity the economy has, the lower the absorption capacity of the economy in the face of adverse shocks.

30/11/18: The Myth of Social Mobility and Wealth Inequality


Three charts, related topics.

Global wealth inequality has been a much-discussed problem these days, with both longer-term economic and social, not to mention political, impacts being assigned to it across both the Advanced Economies and the Emerging Markets. Setting aside the causes and drivers for this development, here is the latest evidence on the wealth distribution around the world from Credit Suisse:


The 3.211 billion people, accounting for 63.9% of the total estimated world population are holding USD6.2 trillion worth of wealth (1.9% of the world total value of assets). Another 26.6% of population or 1.335 billion people, hold 13.9% of total global wealth. Thus, 90.5% of population hold combined 15.8% of the total global wealth. In the top 10 percent category, those with wealth of USD100K to 1 million account for 8.7% of global population and hold 39.3 percent of total global wealth. The 0.8% of population (42 million people) have combined holdings of wealth around USD142 trillion or 44.8% of total global wealth.

This is striking and it is problematic. Even if most of our own wealth inequality referencing is done across the adjoining class of comparatives, the gap between the top of the pyramid and the bottom is so insurmountably vast, that any idea that there is some sort of meritocratic division of wealth in our global society flies out of the window. The problem is not so much income inequality, but the inequality arising from inherited wealth, which generates income returns from invested assets that cannot be offset or diluted by merit of effort, talent and work, no matter how hard one works. Even stripping out luck effects of self-made millionaires and billionaires, the pyramid above is the evidence to the endurance of inter-generational wealth transfers.

The dynamics of evolution in wealth inequality that got us here are presented in the following charts via Goldman Sachs Research:


These figures are for the U.S. economy and they are frightening, just as much as the wealth pyramid above is frightening. Share of wealth held by the top 1% wealth-holders grew from just above 21% in the late 1970s-early 1980s to closer to 37% in 2014. Since then, it has increased more. Share of wealth held by the remaining top 10 percenters declined from ca 44% in the early 1970s to around 35% from the late 1990s on. But the share of wealth held by middle America collapsed to below 27% since the high of around 36% in mid-1980s. Things were never brilliant for the bottom 50 percent of Americans to begin with, but since the Global Financial Crisis, lower middle of America has had negative net wealth through 2014. even though it might have risen since then somewhat, at no time in modern history have the middle and lower-middle class Americans enjoyed holding more than 2 percent of the total wealth.

This is a double-ugly conclusion, because it simultaneously runs against two key propositions on which the American society rests: the proposition of social cross-class mobility upwards from lower wealth classes to middle class, and the proposition that social progress in the American society is distinct from the ‘basket cases’ dynamics in the larger emerging economies (the likes of India and China). In a way, America replicates the world in terms of both, wealth inequality and its dynamics. And that is not a good thing for a society based on exceptionalism values.

The added dimension to this is that, given the above dynamics and the degree of elites entrenchment / capture within the political establishment, we are facing an impossible task of rebalancing the above wealth inequalities without triggering some serious political discontent. Worse, we have no tools for doing so, other than traditional socialist tools (expropriation via taxation of income), which are not effective in dealing with this problem. One of the reasons why these tools are ineffective is that broad-based income tax measures impact more adversely those who work for living (higher income earners) and do not touch those who experience wealth appreciation through capital gains on inherited wealth (as long as they re-invest their wealth-generated income). Another reason, is that higher income earners, on average, can claim merit as a source of their income more than those who hold inherited wealth. A third reason is that redistribution through taxation is highly inefficient: the funds flow to the politically-empowered, not to merit-deserving, and the losses on tax funds are high due to the cost of Government bureaucracy.

Which leaves us with the unpleasant dilemma: tax inherited wealth (during inheritance transfer in the future, and retro-actively, via tax on existent wealth, in the past). Which in itself is highly problematic for the following reasons: (1) wealth is mobile across borders, and financialized wealth is especially so; (2) a significant tax on wealth is likely to trigger repricing of all assets to the downside (liquidation of wealth to cover tax liabilities), adversely impacting wealth acquired by the first generation of entrepreneurs and investors; and (3) inducing a sizeable decline in the life-cycle expected wealth of the current younger generations, resulting is a large scale re-leveraging of these generations.

Neither of these effects is easy to address.


Monday, November 26, 2018

25/11/18: Russian South Stream 2.0 Comes Out of the Shadows


Russia and Turkey have announced that the two countries have reached significant progress in reviving the November 2014-shut down South Stream gas pipeline intended to land Russian gas across the Black Sea. The project is the part of the already secured open tender contracts for purchases of gas signed between Gazprom, Bulgaria, Serbia, Hungary, Slovakia and Austria.

Source: Kommersant

The new Black Sea gas pipeline Turkish Stream will run under sea from Krasnodar to a landing hubv just west of Istanbul. On November 19, presidents Vladimir Putin and Recep Tayyip Erdogan met in Istanbul to announce the completion of pipeline's off-shore section.

Pipeline capacity is for 30 bullion cubic meters, bcm, although initial phase capacity will be closer to 17bcm (the first pipe). Currently, Gazprom supplies the above volume (30bcm) to Turkey (ca 16bcm), Bulgaria, Serbia, Slovakia, Hungary and Austria. Turkish market has been supplied via Blue Stream pipeline, and the other countries are supplied via Ukraine.

Based on reports from Russia's Kommersant (https://www.kommersant.ru/doc/3806415), Gazprom has managed to achieve two feats:

  1. Gazprom has completed laying two (not one) pipes for Turkish Stream, one intended to supply Turkey and another, to supply Southern Europe, 
  2. Gazprom secured tenders for purchases of gas from all EU states to be connected to the South Stream project (Bulgaria's open tender closes in December 2018, but all other countries have already signed onto supply agreements).


Significantly, the tenders were secured in compliance with the EU Energy Directives. This means that Gazprom latest venture has addressed the main cause of the EU's original objections to the same pipeline prior to 2014. In the case of open tenders process, Gazprom used exactly the same scheme to secure capacity orders for its Nord Stream 2 pipeline to Germany, Czech Republic and Slovakia back in 2017. According to the experts cited by Kommersant, this makes in impossible for the EU to shut down the project.

Of course, history reminder due, South Stream was primarily killed off not by the EU, but by the U.S. keen on protecting Ukraine's near monopoly on Russian gas transit. The Obama Administration exerted massive pressure on Bulgaria and other South Stream-receiving countries to prevent landing Russian gas in Southern Europe. So far, there has been little indication what Washington's position on the latest iteration of the South Stream might be, but I doubt it will be welcoming.

Kommersant-quoted stats on South Stream are impressive: according to the paper sources, Gazprom signed delivery tenders with Slovakia for seven years from October 2022 for 4.3bcm, of which Austria will get 3.8bcm, 4.7bcm will go to Hungary, 2bcm to Serbia, and 4.8bcm to Bulgaria. So, comes October 2022,  the South Stream (or Turkey Stream, or whatever you want to call this) will be pumping into Southern Europe the equivalent of the current transit through Ukraine.

Between two new pipelines, Gazprom can easily deliver its current supply contracts to Europe by-passing Ukraine, although, if European demand continues to expand at the current rates, it is likely that Gazprom will need to retain some Ukrainian transit capacity into the future. Even in 2021, before South Stream comes fully on stream, Russian gas transit via Ukraine can fall to below 10bcm per annum.

These developments are undoubtedly a major concern for Ukraine - the country already raised criticism of the South Stream on November 19 - as transit of Russian gas via Ukraine is a major revenue earner for Kyiv. Based on the European Council on Foreign Relations data, between 1991 and 2000, Ukraine accounted for 93 percent of Russian gas transit to Europe; by January 2014, this amounted to 49 percent. Naftogaz, Ukrainian State gas company, tried repeatedly to extract monopoly-level revenues from Gazprom. Back in 2008, Naftogaz tried to charge Gazprom $9 per tcm/100km in transit fees - triple the price charged for transit by Slovakia and Poland, and more than double the fee charged by the majority of the Western European states. This pricing came on top of Ukrainian authorities expecting Gazprom to supply gas to Ukraine for domestic consumption at severely subsidised prices. It is, of course, worth noting that Gazprom itself is a monopoly and has, in the past, used its dominant market positions to exercise market power. There are no innocents (other than European buyers of gas) in the long-running disputes between Naftogaz-Ukraine and Gazprom-Russia.

Nonetheless, the situation is asymmetric. Russia currently continues to rely on Ukraine for transit of its main traded commodity, while Ukraine continues to rely on Russia for a large share of its economic activity. In a recent note, Bruegel (http://bruegel.org/2018/01/the-clock-is-ticking-ukraines-last-chance-to-prevent-nord-stream-2/) estimated that Nord Stream 2 coming on line can cost Ukrainian economy ca 2-3 percent of GDP in foregone Russian gas transit earnings. South Stream is likely to add another 1.5 percent.  In the longer run, overall cost to Ukraine of losing Russian gas transit routes can cost as much as 5-6 percent of GDP.

Note: the latest developments in the Sea of Azov can put significant political pressure on the South Stream project, if the EU and the U.S. choose to significantly escalate their pressure on Russia in the wake of the Russian blockade of trade routes through Kerch Straits and in response to the naval incidents reported today. Both, the reported blockade and the naval incident, are worrying developments, and the onus is on Russia to rapidly de-escalate the already volatile situation in the Azov Sea. There are no justifiable reason for restricting Ukraine's access to trade routes, and for increasing military tensions in the region.

Saturday, November 24, 2018

Tuesday, November 20, 2018

20/11/18: Bitcoin's Steady Loss of Fundamentals


Base rate fallacy is one of the key behavioral heuristics or biases in economics and finance, defined as a cognitive error whereby too little (or too much) weight is placed on the base (original) rate of possibility (e.g., the probability of A given B). In behavioral finance,

  • Base rate neglect is the case of giving not enough weight to the prior/original fundamentals in analyzing a complex phenomena, focusing analyst's attention instead on more proximate/more recent trends. Put differently, analysts tend to assign greater weight to a rare category / outrun when tested with a single symptom whose objective diagnosticity was equal for all possible outruns; and 
  • The inverse base rate fallacy is the case when too much weight is given to the complex priors / original fundamentals, downgrading newer information. In other words, people tended to give higher probability to a rare outrun when tested with a combination of conflicting priors or cues.

Some research has shown that the key effect of the base rates on judgement error is that base rate presence distorts our analysis by making more frequent outruns of uncertain events more important in our analysis. Thus, more common realizations of the uncertain gambles are magnified in perceived frequency, overriding either the original priors (neglect) or the changing nature of the priors (inverse neglect).

You really can't avoid stumbling on both of these manifestations of the fallacy in today's Bitcoin markets analysis.

Take for example this:

A 'guru' of Bitcoin investment world has been issuing absurd forecasts like a blind drunk armed with an AK47: fast, furious and vastly inaccurate.

The dude, armed with 'fundamentals' (unknown to anyone in the finance research universe, where predominant consensus is that Bitcoin has no defined price fundamentals), has predicted BTCUSD at $22,000-$25,000 for the end of 2018 some months ago (back in January). He upped the ante around March by 'forecasting' BTCUSD at $91,000 some time before the end of 2019, and scaled this back to $36,000 in May. He then re-iterated his $25,000 target in July, just around the same time another 'Hopium sniffing' 'analyst' - Julian Hosp - put a target of $60,000 for BTC in 2018. Four days ago, Lee scaled back his 'forecast' for the end of 2018 to $15,000. This comes on foot of the guru adding lots of mumbo-jumbo to qualify his optimism, saying in early November 2018 that he was "pleasantly surprised" by Bitcoin's stability around the newly found price floor close within the $6,400-$6,500 range.

Taking decreasing doses of the sell-side drug-of-choice, Mike Novogratz was a bit more 'reserved'. In November 2017, struck by the recency bias (the fallacy of not even bothering considering any information other than hyperbolic BTC price dynamics around the end of 2017), he 'forecast' Bitcoin to reach $45,000 by November 2018. This 'forecast' was trimmed back to $9,000 for the end of 2018, issued by Novogratz on October 2, 2018.

There were madder ravings still on offer this year. Mid-April 2018, Tim Draper and CNBC's Brian Kelly pushed out (separately) 'research' arguing that BTC will be hitting $250,000 by 2022. Lee's prediction for 2022 target was $125,000 per BTC mid-January 2018, and advised investors to follow his alleged strategy: "We expect bitcoin's major low to be $9,000, and we would be aggressive buyers around that level... We view this $9,000 as the biggest buying opportunity in 2018."

Note: this drivel has been reported by the likes of Bloomberg, CNBC, et al - the serious analysis folks, employing a bunch of CFAs. I mean, you wouldn't be conflicted if you employed institutional investors trading in Bitcoin as your analysts, would you? Of course, not! Next up: CNBC to hire Wells Fargo sitting executive to analyse Wells Fargo.

But returning to the behavioral anomalies, both base rate neglect and inverse base rate effect can (and do), of course, take place in the same analysts' decisions and calls. Framing - conditioning on surrounding attributes of the decision making - determines which type of the base rate fallacy holds for which 'analyst'. Hence, this:


Ever since the collapse of the parabolic trend, Bitcoin price dynamics can be seen as a series of down-trending sub-cycles, with only one slight deviation in the pattern since mid-September 2018 (the start of the 6th cycle). I wrote about this back in August, suggesting that we will see new lows for BTCUSD - the lows we are running through this week.

When you look at liquidity (trading volumes), you can see that the 'price floor' period from mid-September through the start of November has been associated with extremely low trading. This runs contrary to the 'fundamentals' stories told by the aforementioned 'analysts': the increasing efficiency of the cryptos networks and mining, the growing rates of cryptos adoption in the real economy, and the rising interest in cryptos from institutional investors.

Put more simply, the period of 'calm' (and it wasn't really a period of low volatility, just a period of lower volatility compared to the internecine levels of volatility that BTCUSD investors have been conditioned to accept in the past) was the period when the Bitcoin Whales (large miners) stuck to their mine-and-hold strategies, so that pump-and-dump scams were running wreckage across smaller investors portfolios. The events of the last two weeks seem to have broken that pattern, removing the supports from one of the only two fundamentals Bitcoin has: the fundamental factor of cross-collaterlization a myriad of junky ICOs with Bitcoin capital.  (see volume dynamics below)


As the ICOs crash, their collateral Bitcoins are being dumped into the markets to recover some sort of liquidity necessary for a shutdown or a run from the creditors and regulators, the only floor that BTCUSD has is the floor of the Whales still sitting on large BTC holdings accumulated from mining. Which is not the good news the BTC 'analysts' can hang onto with their 'forecasts'. Cost of mining is rising (as local energy utilities are jacking up electricity rates on large scale mining operations). Just as profit margins on mining are turning negative (at current prices). This means that in the short run, Whales are going to start dipping into their BTC reserves to sustain operations. In the longer run, two things can happen:

  1. If the miners shut down their operations to cut on variable costs of mining, BTC might find a new temporary 'floor' until another regulatory assault on Bitcoin takes place and the downward momentum returns; or
  2. If the miners decide to double-down in hope of price stabilization and continue to beef up their fiat cash reserves to pay for loss making mining, there will be a new sell-off coming soon.
Behaviorally, both mean that at some point in the future (no, I am not talking about end-of-2022 outlook, but something much sooner), the Whales will decide to cut losses and sell their holdings. As usual in such circumstances, first off, retail investors will step in to soak up some of the supply avalanche. The first sellers in this game will be the winners. The followers will be the relatively uninjured party. The hold-outs will end up with the proverbial bag in the end of the game. It is how all bubbles end up playing out in the end.


Now, go on, listen to the idiot squad of BTC 'analysts'. Everything will be fine. $15,000 --> $25,000 --> $36,000 --> $91,000 --> $125,000 --> $250,000 --> Takeover of the Universe. The Death Star is powering its lasers...

Sunday, November 18, 2018

17/11/2018: California Rooftop Solar Mandate: An example of bad groupthink?


In recent news, California legislators have done a gimmick-trick that has earned the state loud applause from the environmentally-minded consumers and activists: California Energy Commission (CEC) recently voted 5-0 to add a new provision to the state’s building code. This includes a requirement that from 2020, all new house and multi-family residences construction of three stories or fewer, along with all major renovations, must be built with rooftop solar panels. Given that the state currently builds ca 113,000 housing units a year, and rising, this should increase significantly already existent solar generation capacity from 15% of the housing stock, currently.

Solar being mandated on virtually all new houses? Sounds like a renewables nirvana, especially given the fact that the state has huge solar generation potential due to its climate. But, as commonly is the case, there is a catch. Or two... or many more... And this means that California's latest policy mandate may be a poor example to follow, and potentially, a bad policy mistake.

Here are the key reasons.

Rooftop solar is about as effective in reducing emissions as waving a broom into the smog. UC Berkeley’s Severin Borenstein argued this in his note to CEC Commissioner (http://faculty.haas.berkeley.edu/borenste/cecweisenmiller180509.pdf). Note: Borenstein also alleges that CEC has failed to involve experts in energy economics in its decision making process - something that is not a good policy formation practice.

UC Davis economics professor James Bushnell accused CEC of “regulatory groupthink.” (https://energyathaas.wordpress.com/2018/10/22/how-should-we-use-our-roofs/) and offered an alternative to roof solar that can generate far greater environmental benefits. There are, of course, other, more efficient ways for deriding emissions, including: mandating more urban density, raising home and cars efficiency standards, expanding the renewable energy mandate, improving grid efficiencies and transmission expansion, and so on. Once again, CEC did not allow for any independent assessment of the proposed plans economic and environmental impacts.

There is an opportunity cost involved in roof solar: California has a state-wide mandate to achieve 50% renewables generation by 2030. Putting more if this target onto roof solar is simply moving generation capacity from one source to the other. Because too top solar is roughly 4-6 times more expensive than industrially-produced renewables, the substitution involves a dramatic reduction in economics of scale. This will raise the overall cost to California of reaching its 2030 target.

Another opportunity cost, this time much more tangible and immediate than 2030 targets is the problem of California grid ability to swallow all the solar generation being put into place. California has to routinely dump excess solar energy supplies during peak generation times, because it is failing to find buyers outside the state. Worse, given the scale of each roof top generation unit, solar electricity from the roof tops cannot be controlled by the grid companies, because smart inverters needed to do this are too expensive for small scale generators.

There is an argument, however, that economics of scale will kick in from a different side: mandating such a huge increase in atomistic (house-level) installations can result in more innovation and lower costs of new technologies going forward. This means that while costs might be high up front, they can potentially be deflated faster over time than absent the mandate. The same argument might hold for improvements in storage.

Worse yet, solar from one roof panel household competes with solar from another roof panel household. All roof top panels generating at virtually the same time across the same time zone state will be simply bidding down the cost of solar during peak generation, not peak demand. Here is an exchange from two experts on this:



Last, but not least, California roof top solar requirements will add new cost, to the housing in a state that is already in the middle of an atrocious housing crisis. CEC own analysis, not tested by any peer review, implies that homeowners are likely to face additional costs of ca $8,000-12,000. Over the depreciation cycle for housing stock, this is likely to translate into $15,600-$23,400 in current dollars (inflation-adjusted, using 2% inflation rate) increase in the cost of housing per household, once property taxes on new build values are factored in. With average house price in California in excess of $420,000, this is equivalent to raising house prices 3.75-5.57 percent. Of course, CEC promises savings that, according the Commission analysis will be net of higher costs. Problem is, no one actually tested these claims, and we simply do not know how the costs of switching all this roof top solar into the grid are going to be distributed across the households.

Macro level view:

Then there is macro level analysis of the solar energy benefits and costs. And California does not come out pretty in this.

A new NBER paper, tiled "Heterogeneous Environmental and Grid Benefits from Rooftop Solar and the Costs of Inefficient Siting Decisions" by Steven E. Sexton, A. Justin Kirkpatrick, Robert Harris, Nicholas Z. Muller (NBER WP 25241, Nov. 2018: https://www.nber.org/papers/w25241.pdf) looked at "federal and state policies in the U.S." These policies "subsidize electricity generation from 1.4 million rooftop solar arrays because of pollution avoidance benefits and grid congestion relief. Yet because these benefits vary across the U.S. according to solar irradiance, technologies of electricity generators, and grid characteristics, the value of these benefits, and, consequently, the optimal subsidy, are largely unknown."

What does this mean? Across the U.S., "policy, therefore, is unlikely to have induced efficient solar investments." The authors provide "the first systematic, theoretically consistent, and empirically valid estimates of pollution damages avoidable by solar capacity in each U.S. zip code". The also link "these external benefits to subsidy levels in each U.S. state, and [estimate] the share of these benefits that spillover to other states." Finally, the authors measure "the energy value of capacity across the U.S. and the value of transmission congestion relief in California."

So what do they find? "Environmental benefits are shown to vary considerably across the U.S., and to largely spillover to neighboring states." Which is not a bad thing in itself, but it also means that some states pay for benefits accruing to other states. These transfers are not voluntary to the payers for solar - the households.

Furthermore, "subsidy levels are essentially uncorrelated with environmental benefits contributing to installed capacity that sacrifices approximately $1 billion per year in environmental benefits." Which, broadly-speaking means that subsidies for rooftop solar are not a great way to achieve environmental benefits.

"...California rooftop solar is shown to generate no congestion relief." Or, as noted above, there are severe grid-related costs involved in rooftop solar in California, the state that decided to mandate it.



Putting more detail on the NBER paper: "Total benefits of solar generation—inclusive of energy values — are estimated to be greatest in the Midwest and Mid-Atlantic. They are least in the West, and particularly the West Coast, where approximately two-thirds of systems are located." Why, given the fact that sunshine is more abundant in California than in the MidWest or Mid-Atlantic?


"These differences are primarily attributable to heterogeneity in marginal responding fossil generation." Oh, wait, that is right: the more solar you put in, the more back up generation you need. And that is before you account for the solar installation possible effects of increasing demand for electricity as the second order effect.

"In California, we find no evidence that rooftop solar capacity systematically relieves congestion. Approximately two-thirds of the 900,000 rooftop solar arrays is located upstream from transmission bottlenecks, contributing to congestion rather than relieving it. If capacity were efficiently allocated, congestion relief benefits in California would have been no more than $15 million in 2017—approximately 7% of total energy value."

Cycle back to that California rooftop solar mandate. Does it really make any environmental sense? Because economics-wise, it does not appear to offer much more than a hype and a pump scheme.

Saturday, November 17, 2018

17/11/18: Nine in Ten in the Red: Asset Markets YTD Returns Signal Risk Repricing


According to a recent research note from the Deutsche Bank, 89% of global macro assets are posting losses on year-to-date basis. This is the highest level of losses in more than a century.


Given the scale of financial risk mis-pricing in equities and bonds markets in the post-QE period, we are likely to witness more downward movement in the assets valuations in months to come. A gradual deleveraging that the market trends have been supporting so far remains highly incomplete and requires more pronounced re-pricing of assets to the downside.

Read more on this here: http://trueeconomics.blogspot.com/2018/11/161118-horsemen-of-financial-markets.html

Friday, November 16, 2018

16/11/18: Student Debt Hits Another High in 3Q 2018


Bloomberg @business just now posted that the student loans debt in the U.S. has increased USD37 billion to USD1.44 trillion at the end of 3Q 2018:


And, Flows of student debt into serious delinquency - 90 or more days - rose to 9.1% from 8.6% in 2Q.

This is somewhat at odds with the Fred database which shows Student Loans debt at USD1.5636 trillion in 3Q 2018, up ca USD33.23 billion on 2Q 2018:


While the NY Fed report is already alarming in both delinquencies rates dynamics and overall debt dynamics, the FRED data that includes securitized debt volumes is even more worrying.

By its very nature, student loans debt impacts the segment of the population (younger workers) who are in the need to fund their housing needs just as their careers are only starting (with associated lower earnings). These younger households also need financial resources to achieve sufficient mobility to better match jobs offers and career prospects to their abilities and needs. Student loans fall heavily onto the shoulders of younger families with growing housing needs, healthcare demand and funding calls from childcare. In other words, student loans debt is potentially crippling those households that are demographically going through the period when enhanced mobility and financial resilience are necessary to secure better life-cycle employment and family outcomes.

16/11/18: The Horsemen of the Financial Markets Apocalypse


My column for the Manning Financial  is now available here: http://issuu.com/publicationire/docs/manning_financial_november_2018?e=16572344/65613030.



Thursday, November 15, 2018

15/11/18: BIS on payments systems and cryptos / blockchain


On November 1, Agustín Carstens, General Manager, Bank for International Settlements delivered a pretty punchy speech on the topic of payments systems evolution in modern age of digital technologies. Punchy, in the sense that much of it is focused on, indirectly, enlisting the evidence as to the lack of the markets for the blockchain and cryptocurrencies deployment in the payments systems at the wholesale and retail levels.

Take the following:  "One of the most significant developments in the evolution of money has been its electronification and, more recently, digitalisation. ...Realtime gross settlement (RTGS) systems for interbank payments, ...emerged in the 1980s. ...RTGS systems allow banks and other financial institutions to send money to each other with immediate and final settlement. They are typically operated by central banks and process critical (read: high-value) payments to allow for the smooth functioning of the economy. Today, the top interbank payment systems in the G20 countries settle more than $17.5 trillion a day, which is over 50 times a working day’s global GDP. ...Given the technology cycle, many central banks are currently looking at next-generation RTGS systems to offer more robust operations and enhanced services."

What does this imply for the world of cryptos? In simple terms, there is no market for cryptos as platforms for interbank payments settlements - the market is already served and the speed of services, cost and security are underpinned by the Central Banks.

Next up: retail payments systems.

Starting with back office: "For retail payment systems, ...in Mexico consumer payments operate at the same speed as interbank payments... The beneficiary of a payment is credited money in near real time. That is, if I were to send you money from my Mexican bank account, you would see the funds in your Mexican bank account in 15 seconds or less. ...Based on a BIS analysis, fast payment systems are likely to become the dominant retail payment system by 2023."

Again, what's the market for blockchain systems to be deployed here? I am not convinced there is one, especially as payments latency and costs are, to-date, more prohibitive under blockchain systems than using traditional payments platforms.

Front office: Carstens notes the progress achieved in delivering what he describes as "payments ... made using bank account aliases" in Argentina that are instant in time, and the ongoing trend toward development of the front-end payments interfaces, based on "cashless systems – no cashiers, no lines, no cash, no physical payment devices. Amazon and others envision a future where you walk into a store, take what you want, and are automatically billed for the items using facial recognition and artificial intelligence. Though this approach may seem a bit scary, it is less so than having microchips implanted inside us, which some firms are also piloting! To be frank, though, neither of these options – facial recognition or microchip implants – are particularly appealing to me."

Carstens presents the evidence that shows current Advanced Economies already carrying more than 90 percent of wholesale payments via cheap, lightning fast and highly secure centralized RTGS systems, with 75 percent of payments via the same occurring in the Emerging Markets:


Given this rate of adoption, coupled with the evolving technology curve (that enables similar systems to be deployed in smaller settlements), one has to question the extent to which cryptocurrency solutions can be deployed in the payments systems.

Beyond the not-too-optimistic view of the market niche size, cryptos and blockchain are also facing some serious pressure points from already ongoing innovation in centralized clearance systems. "Although much attention has been focused on cryptocurrencies as the “it” innovation in payments, there’s much unheralded innovation going on" in the Central Banks and elsewhere (read: legacy providers of payments). "Central banks have been pushing the boundaries of what technology can achieve for operational robustness, including switching seamlessly between data centres at short notice and synchronising geographically dispersed data centres."

Carstens notes the potential for the distributed Ledger Tech (aka, blockchain based on private, enterprise-level blockchain) in this space, where innovation is also a domain of the centralized players, as opposed to decentralised crypto markets. "One interesting development in the central banking community is ongoing experimentation with distributed ledger technology (DLT) as a means to enhance operational robustness. People often use DLT and Bitcoin interchangeably, but they are not the same! ...DLT is simply a set of processes and technologies that enable multiple computers to maintain collectively a common database. DLT does not mean mining of coins, public ledgers and open networks. And no central bank that I’m aware of is contemplating these properties in its DLT experimentation."

There are some problems, however, for DLT enthusiasts:
1) "...a Bank of Canada study noting that a DLT-based payment system meeting central bank requirements would be similar to what we have today (ie private ledgers, closed networks and a central operator). The difference is that a network of computers would be used to settle a transaction instead of one computer." In other words, there is a case, yet to be proven, that DLT offers anything new to the payments systems to begin with.
2) "The second is an ECB and Bank of Japan study concluding that processing times would be three times longer using DLT versus current systems." In other words, DLT/blockchain cannot deliver, so far, on its main premise: higher processing efficiency than legacy systems.




Carstens sums it up: "My take is that current versions of DLT are not any better than what we already have today."

In other words: DLT/blockchain solutions appear to be:

  • Not necessary: the technology is attempting to solve the problems that do not exist in the payments systems;
  • Inefficient with respect to its core tenants/promises: the technology is inferior to existent solutions and the pipeline of ongoing improvements to the legacy systems.
Which begs two questions that the DLT/blockchain community needs to answer: What niche can blockchain occupy in payments systems going forward? and Is there a sustainable market within that niche that cannot be captured by alternative technologies?

But there is more. Carstens explains: "Cryptocurrencies, such as Bitcoin, Ether and Tether, do not serve the core functions of money. No cryptocurrency is a true unit of account or a payment instrument, and we have seen this year that they are a poor store of value. This then raises the question: what are they?" The answer should be a wake up call for anyone still long cryptos: "From my perspective, cryptocurrencies are, at best, an asset of some sort. Perhaps an asset comparable to a piece of art for those who appreciate cryptography. Buyers of cryptocurrencies are buying into nothing more than a software algorithm. Some firms are trying to back cryptocurrencies with an underlying asset, such as cash or securities. That sounds nice, but it’s the equivalent of making art from banknotes or stock certificates. The buyer is still buying an idea or a concept or, if you will, an asset that is the equivalent of art hanging on your wall. If people want the underlying asset, they might be better served just buying that."

Carstens previously (February 2018) claimed that the #cryptos are “combination of a bubble, a Ponzi scheme and an environmental disaster.”

Nice perspective. If you are an observer. For a holder of cryptos, this is a serious risk. Playing cards in a casino is fun, but it is not investing. Playing investing in the cryptos world is probably the same.


Note: for an even more 'in your face' assessment of the #Bitcoin and #Cryptos, there is ECB's Executive Board member, Benoit Coeure, who called #BTC the “evil spawn of the [2008] financial crisis, per Bloomberg report of November 15 (https://www.bloomberg.com/news/articles/2018-11-15/cryptocurrencies-are-evil-spawn-of-the-crisis-for-ecb-s-coeure).

The reality of #cryptos investments is that they are, empirically, a massively overvalued bet on the largely undeveloped and unproven (in real world applications) technologies that have only tangential relation to the coins currently traded in the markets. It is, in a way, a derivative bet on a future contract.

15/11/18: The 'New Normal' is a Road to another Tech Sector Bust


The VC land of wonders and waste is awash with cash, thanks to a decade-long loose liquidity pumping across the markets by the Central Banks. Just as in the prior iterations of the same (the Dot.Com Bubble and the pre-GFC assets binge), the outrun will be the same as it was before: a crash.

TechCrunch reports that (https://techcrunch.com/2018/11/11/age-of-the-unicorn/):

  • Over the last 5 years, the number of 'unicorns' - startups with valuations in excess of USD1 billion - has grown from 39 to 376 - almost a ten-fold increase
  • The rate of 'unicorns' emergence is accelerating: in 11 months through November 1, 2018, we've added 81 new 'unicorns' to the roster, which means there is now a new 'unicorn' company launched every four days
  • Mega-deals for start ups - funding rounds in excess of USD100 million - are also on the rise, with their frequency up ten-fold on five years ago. "Back in 2013, there were only about four mega rounds a month, but now there are forty mega rounds a month based..." Thus, "starting from 2015, public market IPO has for the first time no longer been the major funding source for unicorn size companies."

As the chart above shows, there has been a power-law acceleration in the trend since mid-2017 and it is now clearly topping the asymptote.

Two countries dominate the 'unicorns' league: China (with 149 count) and the U.S. (with 146 count). Which implies two things: 
  • Given the close links between the PBOC policies, Chinese Government investment strategies and supports, and China's counts of 'unicorns', majority of these start ups are heavily dependent on debt, and political good will. They are sitting ducks for ESG risks and are extremely exposed to political and policy uncertainty.
  • The U.S. 'unicorns' are completely dependent on the markets ability to cycle cash from corporate and financial sectors debt and private equity into start ups funding, and M&As. There is zero rational valuation happening in this sub-sector.
A dramatic shift in risks from tangible tangible technologies (including strongly patentable innovation or defensible market shares) of the likes of Apple and Google toward less tangible, highly price and income elastic SaaS types of product offers is reflecting the massive buildup in valuations risks. This too is reflected in the article, albeit the authors fail to spot the implications. TechCrunch conclusion is perhaps even more alarming that the stats they present. "Mega rounds are the new normal; staying private longer is the new normal; and the global composition of the unicorn club is the new normal." We've heard exactly the same arguments at the tail end of the Dot.Com boom about the absurdly over-valued early internet age companies. We've heard exactly the same arguments about the real estate sector prior to 2008. We've heard exactly the same arguments about tulip bulbs in Amsterdam some centuries ago too. 

'The new normal' is the old road to a bust.

Tuesday, October 30, 2018

29/10/18: Corporate Credit and the Debt Powder Keg


As it says on the tin: despite growth in earnings, the numbers of U.S. companies that are struggling with interest payments on the gargantuan mountain of corporate debt they carry remains high. The chart does not show those companies with EBIT/interest cover ratio below 1 that are at risk (e.g. with the ratio closer to 0.9) for the short term impact of rising interest rates. That said, the overall percent of firms classified as risky is at the third highest since the peak of the GFC. And that is some doing, given a decade of extremely low cost of debt financing.

Talking of a powder keg getting primed and fused…


Saturday, October 27, 2018

26/10/18: De-democratization of our values?


Do you, my friends love that smell of napalm in the mornings? Does it fill you with confidence about the future - your own and that of the rest of the world? For if you do answer 'Yes' to both of these questions, congratulations: you've made it into the American values (on average).

Here is the data from Pew Research on public trust in institutions:
Source: http://www.pewresearch.org/fact-tank/2016/10/18/most-americans-trust-the-military-and-scientists-to-act-in-the-publics-interest/ft_16-10-18_trustinstitutions_overview/.

Democratic cornerstones of political leadership and the media are trusted by less than 50 percent of the Americans, 27 percent to 41 percent. Command & control institution of the military is trusted by 79 percent. Scepticism over coercive power and centralized counter-democratic system based on rank-command trumps all the softy stuff. even educators are more trusted in the settings involving more deterministic decision-making (e.g. medical sciences and sciences) than in more polemical setting (e.g. general education).

But if you thought European are all softy-dofty democratically minded, think again. In fact, there is not much of difference between the American population and the European ones on the same topic:
Source: http://www.pewresearch.org/fact-tank/2018/09/04/trust-in-the-military-exceeds-trust-in-other-institutions-in-western-europe-and-u-s/.

Yes, yes, I hear you, the choir of Patriots: but in a democratic society, military is subject to democratic checks and balances, so why is this degree of confidence in military a matter for concern?

Let me explain why:

  • Firstly, irrespective of the democratic or other checks and balances, military is not a pluralist institution that encourages debates, inquiries, and discoveries through dissent. In other words, while military may be framed into the broader democratic constraints, it cannot by itself be a genuinely democratic institution. There is no democracy in command systems. 
  • Secondly, to anyone pontificating on democratic checks and balances, may I suggest revisiting the entire modern history of the U.S. to identify exactly at what point in time did democratic checks and balances imposed onto military do their jobs before the damages were incurred? In Vietnam? Nope. In multiple military engagements in Latin America? Nope, again. In the Balkans? Not really. In Afghanistan or Iraq? Not at all. 
Thus, in real terms, checks and balances do not define a democratic set of values that put strong public preference in favour of the military ahead of much weaker preferences in favour of the immediate democratic and pluralist institutions, such as politics, media, business, education.


What is happening, thus, as revealed by the above data, is the strong drift in public preferences away from democratic and liberal foundations of our modern states and toward more command and control, more coercive power-based institutions, such as military. To paraphrase one semi-failed leader of the past: it's public values de-democratization, stupid.

26/10/18: Visualizing Mental Health Around the World and Across Time


Mental health is one of the key parameters of the quality of social and personal environment we can think of, and changes in the prevalence and the impact of mental health are hugely important measures of socio-economic evolution. Here is a fascinating set of data visualizations and analytical notes on the state of mental health around the world and across the recent decades: https://ourworldindata.org/mental-health.

There are thousands of interesting, and often non-intuitive, observations one can draw from these interactive charts and from the published analysis.


Friday, October 19, 2018

19/10/18: IMF's Woeful Record in Forecasting: Denying Secular Stagnation Hypothesis


A recent MarketWatch post by Ashoka Mody, @AshokaMody, detailing the absurdities of the IMF growth forecasts is a great read (see https://www.marketwatch.com/story/the-imf-is-still-too-optimistic-about-global-growth-and-thats-bad-news-for-investors-2018-10-15?mod=mw_share_twitter).  Mody's explanation for the IMF forecasters' failures is also spot on, linking these errors to the Fund's staunch desire not to see the declining productivity growth rates (aka, supply side secular stagnation).

So, to add to Mody's analysis, here are two charts showing the IMF's persistent forecasting errors over the last four years (first chart), set against the trend and the cumulative over-estimate of global economic activity by the Fund since mid-2008 (second chart):




While the first chart simply plots IMF forecasting errors, the second chart paints the picture fully consistent with Mody's analysis: the IMF forecasts have missed global economic activity by a whooping cumulative USD10 trillion or full 1/8th of the size of the global economy, between 2008 and 2018. These errors did not occur because of the Global Financial Crisis and the high degree of uncertainty associated with it. Firstly, the forecasting errors relating to the GFC have occurred during the period when the crisis extent was becoming more visible. Secondly, post GFC, the hit rates of IMF forecasts have deteriorated even more than during the GFC. As Mody correctly points out, Fund's forecasts got progressively more and more detached from reality.

At this stage, looking at April and October 2018 forecasts from the Fund's WEO updates implies virtually zero credibility in the core IMF's thesis of a 'soft landing' for the global economy over 2019-2021 time horizon.

19/10/18: There's a Bubble for Everything


Pimco's monthly update for October 2018 published earlier this week contains a handy table, showing the markets changes in key asset classes since September 2008, mapping the recovery since the depths of the Global Financial Crisis.

The table is a revealing one:


As Pimco put it: "The combined balance sheets of the Federal Reserve, European Central Bank, Bank of Japan, and People’s Bank of China expanded from $7 trillion to nearly $20 trillion over the subsequent decade. This liquidity injection, at least in part, underpinned a 10-year rally in equities and interest rates: The S&P 500 index rose 210%, while international equities increased 70%. Meanwhile, developed market yields and credit spreads fell to multidecade, and in some cases, all-time lows."

The table points to several interesting observations about the asset markets:

  1. Increases in valuations of corporate junk bonds have been leading all asset classes during the post-GFC recovery. This is consistent with the aggregate markets complacency view characterized by extreme risk and yield chasing over recent years. This, by far, is the most mispriced asset class amongst the major asset classes and is the likeliest candidate for the next global crisis.
  2. Government bonds, especially in the Euro area follow high yield corporate debt in terms of risk mis-pricing. This observation implies that the Euro area recovery (as anaemic as it has been) is more directly tied to the Central Banks QE policies than the recovery in the U.S. It also implies that the Euro area recovery is more susceptible to the Central Banks' efforts to unwind their excessively large asset holdings.
  3. U.S. equities have seen a massive valuations bubble developing in the years post-GFC that is unsupported by the real economy in the U.S. and worldwide. Even assuming the developed markets ex-U.S. are underpriced, the U.S. equities cumulative rise of 210 percent since September 2008 looks primed for a 20-25 percent correction. 
All of which suggests that the financial bubbles are (a) wide-spread and (b) massive in magnitude, while (c) being caused by the historically unprecedented and over-extended monetary easing. The next crisis is likely to be more painful and more pronounced than the previous one.


Tuesday, October 16, 2018

16/10/18: Data analytics. It really is messier than you thought


An interesting study (H/T to @stephenkinsella) highlights the problems with empirical determinism that is the basis for our (human) evolving trust in 'Big Data' and 'analytics': the lack of determinism in statistics when it comes to social / business / finance etc data.

Here is the problem: researchers put together 29 independent teams, with 61 analysts. They gave these teams the same data set on football referees decisions to give red cards to players. They asked the teams to evaluate the same hypothesis: are football "referees are more likely to give red cards to dark-skin-toned players than to light-skin-toned players"?

Due to a variation of analytic models used, the estimated models produced a range of answers, from the effect of skin color of the player on red card issuance being 0.89 at the lower end or the range to 2.93 at the higher end. Median effect was 1.31. Per authors, "twenty teams (69%) found a statistically significant positive effect [meaning that they found the skin color having an effect on referees decisions], and 9 teams (31%) did not observe a significant relationship" [meaning, no effect of the players' skin color was found].

To eliminate the possibility that analysts’ prior beliefs could have influenced their findings, the researchers controlled for such beliefs. In the end, prior beliefs did not explain these differences in findings. Worse, "peer ratings of the quality of the analyses also did not account for the variability." Put differently, the vast difference in the results cannot be explained by quality of analysis or priors.

The authors conclude that even absent biases and personal prejudices of the researchers, "significant variation in the results of analyses of complex data may be difficult to avoid... Crowdsourcing data analysis, a strategy in which numerous research teams are recruited to simultaneously investigate the same research question, makes transparent how defensible, yet subjective, analytic choices influence research results."

Good luck putting much trust into social data analytics.

Full paper is available here: http://journals.sagepub.com/doi/pdf/10.1177/2515245917747646.