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  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:

Tuesday, October 9, 2018

9/10/18: BRIC Composite PMIs 3Q 2018: A Tale of Growth Slowdown

Previous posts on 3Q 2018 PMIs have covered:

  1. BRIC Manufacturing PMIs:;
  2. BRIC Services PMIs:; and
  3. Global Composite PMIs:

Now, let’s take a look at the BRIC Composite PMIs that combine Services and Manufacturing sectors growth signals. As Global Composite PMI signalled slowing growth momentum in the global economy, BRIC Composite PMIs all trailed global growth indicator.

Brazil Composite PMI fell deeper into contraction territory in 3Q 2018 (48.5) compared to 2Q 2018 (49.1), marking the fourth consecutive quarter of contraction in the economy, as signalled by the combination of PMI indices in Services and Manufacturing sectors. 3Q 2018 was the lowest Composite PMI reading for the South America’s largest economy in 6 consecutive quarters.

Russia Composite PMI slipped from 53.4 in 2Q 2018 to 52.4 in 3Q 2018, marking slowdown in the rate of economic expansion. This was the lowest reading in Russia Composite PMIs since 2Q 2016. Despite this, Russia Composite PMI was the second largest in the BRIC group (marginally below India’s 52.5 reading).

China Composite PMI posted a modest decline in the growth rate falling from 52.5 in 2Q 2018 to 52.1 in 3Q 2018, the latter reading marking the lowest rate of expansion in 3 quarters. In fact, China Composite PMIs have been singling weak growth dynamics in every quarter since 4Q 2016 - something that is yet to be reflected in the official growth figures for the country.

India Composite PMI bucked the BRIC trend and rose from 51.9 in 2Q 2018 to 52.5 in 3Q 2018, for the first statistically significant growth signal in 5 quarters. Despite this, growth momentum in India remains below global PMI levels.

Global Composite PMI declined from 54.0 in 2Q 2018 to 53.3 in 3Q 2018.

Overall, slowing global growth momentum is being matched by a slowdown in the BRIC economies. Both Manufacturing and Services sectors of the BRIC economies are underperforming their Global counterparts and the overall trend is toward declining global and BRIC growth.

9/10/18: BRIC Services PMIs 3Q 2018: Slower Growth Ahead

Having covered Global Composite PMIs for 3Q 2018 here: as well as BRIC Manufacturing PMIs here:, here is an update on BRIC Services PMIs for 3Q 2018.

In summary: things are getting less promising for 2H 2018 growth in world's largest emerging and middle-income economies.

Brazil Services PMI posted second consecutive quarter of contraction in 3Q 2018, falling from 48.8 in 2Q 2018 to 47.9 in 3Q 2018. Since 3Q 2014, Brazil's Services PMIs posted readings below 50.0 mark (zero growth mark) in all, but one quarter (1Q 2018 when the PMI was at 51.0). Importantly, 3Q reading was statistically significantly below 50.0 mark.

Russia Services PMI fell marginally from 54.0 in 2Q 2018 to 53.6 in 3Q 2018, signalling weaker, but statistically-speaking, still positive growth. PMIs fell in all three last quarters from the 4-quarters peak of 56.0 in 4Q 2017. Q3 2018 was the lowest growth reading in 9 consecutive quarters. Despite this, Russia Service sector growth signalled by the PMIs is the fastest of all BRIC economies.

China Services PMI also fell to 52.6 in 3Q 2018 compared to 53.2 in 1Q 2018, marking the third consecutive decline in PMIs. China posted the second highest rate of growth in Services sectors amongst the BRIC economies.

India Services PMI rose, breaking the BRIC trend, in 3Q 2018 to 52.2 (weak growth) from 51.2 in 2Q 2018, marking the second consecutive quarter of above-50 readings. This marks the strongest growth signal in 8 quarters, albeit the level of PMI is anaemic.

Overall BRIC Services PMI computed by myself based on Markit data and global economy weights for BRIC countries, has moderated from 52.5 in 2Q 2018 to 52.2 in 3Q 2018, suggesting weakening growth momentum in the Services sector of the BRIC economies. This development was in line with the Global Services PMI movements (down from 54.2 in 2Q 2018 to 53.5 in 3Q 2018). For BRICs, Services PMI is now at the lowest reading in three quarters, and for the Global Services PMI -  in 7 consecutive quarters.

All BRIC economies Services sectors are now trailing (Brazil, India and China) or barely matching (Russia at 0.1 points higher) the Global Services PMI.

9/10/18: Euromoney on 3Q 2018 Changes in the Global Risk Environment

9/10/18: Russian Growth, 'Putin;'s Call' and the Middle Income Growth Trap

Quick chart showing relative underperformance in the Russian economy in recent years, incorporating latest 2018 forecasts:

The above clearly shows that since 2013, Russian economic growth has statistically underperformed the 'Putin's Call' levels of growth, defined as rates of growth in real GDP achieved during the period after the immediate post-1998 crisis recovery and into 2012, omitting the period of the Global Great Recession impact of 2009. 'Putin's Call' rate of growth is set at around 6% pa, with the 95% confidence interval around this at [2.83, 9.15].

The lower bound of this confidence interval is important. While no one can expect the Russian economy to grow at the 'Putin's Call' levels of 6%, let alone the upper bound levels of 9.15%, Russian economy does require longer-term average growth rates at around 2.8-3%, slightly above the lower bound of the 'Putin's Call'. As of consensus forecasts forward, the economy is expected to expand at around 1.5-1.8 percent pa over 2018-2023, which implies significant cumulative underperformance relative to medium term growth requirement.

Fiscally, structurally lower rates of growth are sustainable for Russia, but socio-politically, Russia needs serious acceleration in its growth rates to offset adverse demographic pressures (rising pensions dependencies) and global economic pressures (much faster growth rates in the Emerging Markets). The lower bound of the 'Putin's Call' and Russian economy's sub-par performance relative to it is a clear illustration of the Middle Income Growth Trap that Russia has entered ca 2010 post-GFC and the Great Recession (see for the definition and here for discussion. My earlier post on the subject for Russia here:

Thursday, October 4, 2018

3/10/18: Global PMIs tanked in 3Q 2018

While Markit continue to publish Services and Composite PMIs for BRIC economies, here is a quick update on Global PMIs for 3Q 2018 which are now out:

  • Global Manufacturing PMI averaged 52.5 in 3Q 2018, down from 53.2 in 2Q 2018. This is the lowest reading for the index in 8 quarters, signalling slowest growth in global manufacturing sector since 3Q 2016. It also marks the second consecutive quarter of declining Global Manufacturing PMI.
  • Global Services PMI averaged 53.5 in 3Q 2018, the lowest reading in 7 consecutive quarters, matching the lowest point in 8 consecutive quarters. This marked the first quarter of declines in Services sector activity, and the drop was sharp: down from 54.2 in 2Q 2018.
  • Global Composite PMI averaged 53.3 in 3Q 2018, down from 54.0 in 2Q 2018 and 54.2 in 1Q 2018, marking the lowest reading in 8 consecutive quarters. The slowdown in the overall global economic indictor has also been sharp in 3Q 2018 and most of this slowdown took place in August and September.

Overall, these are not great signs for the global economy. 

For BRIC Manufacturing PMIs analysis for 3Q 2018, see here: BRIC Services PMIs and BRIC Composite PMIs analysis is to follow, so stay tuned.

3/10/18: Dumping Ice bags into Overheating Reactor: Bonds & Stocks Bubbles

Wading through the ever-excellent Yardeni Research notes of recent, I have stumbled on a handful of charts worth highlighting and a related blog post from my friends at the Global Macro Monitor that I want to share with you all.

Let's start with the stark warning regarding the U.S. Treasuries market from the Global Macro Monitor, accessible here:  To give you my sense from reading this, two quotes with my quick takes:

"Supply shortages, induced mainly by central bank quantitative easing have been a major factor driving asset markets, in our opinion.  Not all, but a big part." So forget the 'not all' and think about risks pairings in a complex financial system of today: equities and bonds are linked through demand for yield (gains) and demand for safety. If both are underpricing true risks (and bond markets are underpricing risks, as the quote implies), it takes one to scratch for the other to blow. Systems couplings get more fragile the tighter they become.

"The float of total U.S. equities has shrunk dramatically, in part, due to cheap financing to fund share buybacks.   The technical shortage of stocks have helped boost U.S. equity markets and killed off most bears and short sellers." In other words, as I have warned repeatedly for years now, U.S. equity markets are now dangerously concentrated (see this blog for posts involving concentration risks). This concentration is driven by three factors: M&As and shares buy-backs, plus declined IPOs activity. The former two are additional links to monetary policies and, thus to the bond markets (coupling is getting even tighter), the latter is structural decline in enterprise formation and acceleration rates (secular stagnation). This adds complexity to tight coupling of risk systems. Bad, very bad combination if you are running a nuclear power plant or a major dam, or any other system prone to catastrophic risk exposures.

How bad the things are?
Since 1Q 2009, total cumulative shares buy-backs for S&P500 amounted (through 2Q 2018) to USD 4.2769 trillion.

Now, those charts.

Chart 1, via Yardeni Research's "Stock Market Indicators: S&P 500 Buybacks & Dividends" book from October 3rd (

What am I looking at here? The signals revealing flow of corporate earnings toward investment, or, the signs of the build up in the future economic capacity of the private sector. The red line in the lower panel puts this into proportional terms, the gap between the yellow line and the green line in the top panel puts it into absolute terms. And both are frightening. Corporate earnings are on a healthy trend and at healthy levels. But corporate investment is not and has not been since 1Q 2014. This chart under-reports the extent of corporate under-investment through two things not included in the red line: (1) M&As - high risk 'investment' strategies by corporates that, if adjusted for that risk, would have pushed the actual investment growth even lower than it is implied by the red line; and (2) Risk-adjustments to the organic investments by companies. In simple terms, there is no meaningful translation from higher earnings into new investment in the U.S. economy so far in 2018 and there has not been one since 2014. Put differently, U.S. economy has been starved of organic investment for a good part of the 'boom' years.

Chart 2, via the same note:

Spot something new in the charts? That's right: buybacks are accelerating in 1H 2018, with 2Q 2018 marking an absolute historical high at USD 1.0803 trillion (annualized rate) of buybacks. Guess what does this mean for the markets? Well, this:
And what causes the latest spike in buybacks? No, not growing earnings (which are appreciating, but moderately). The fiscal policy under the Tax Cuts and Jobs Act 2017, or Trump Tax Cuts.

Let's circle back: monetary policy madness of the past has been holding court in bond markets and stock markets, pushing mispricing of risks to absolutely astronomical highs. We have just added to that already risky equation fiscal policy push for more mispricing of risks in equity markets.

This is like dumping picnic-sized bags of ice into the cooling system to run the reactor hotter. And no one seems to care that the bags of ice are running low in the delivery truck... You can light a smoke and watch ice melt. Or you can run for the parking lot to drive away. As an investor, you always have a right choice to make. Until you no longer have any choices left.

Tuesday, October 2, 2018

2/10/18: Government Debt per Employed Person

We often see Government debt expressed in reference to GDP or in per capita terms. However, carry capacity of sovereign debt depends not as much on the number of people in the economy, but on the basis of those paying the lion’s share of taxes, aka, working individuals. So here is the data for advanced economies Government debt expressed in U.S. dollar terms per person in employment:

Some interesting observations.

Ireland, as a younger, higher employment economy ranks fifth in the world in terms of Government debt per person employed (USD 115,765 in debt per employed). In terms of debt per capita, it is ranked in the fourth place at USD 54,126.

Plucky Iceland, the country hit as hard by the Global Financial Crisis as Ireland and often compared to the latter by a range of analysts and policymakers, ranks 22nd in terms of Government debt burden per employed person (USD 56,185) although it ranks 13th in per capita terms (USD 32,502). In simple terms, Iceland has higher employment rate than Ireland, resulting in lower burden per employed person.

When one considers the fact that non-Euro area countries have more sovereign control over their monetary policies, allowing them to carry higher levels of debt than common currency area members, Irish debt per employed person is the third highest in the world after Italy and Belgium, and higher than that of Greece.

Out of top ten debtors (in terms of Government debt per employed person), six are euro area member states (10 out top 15).

Looking solely at the euro area countries, Ireland’s position in terms of debt per capita is woeful: the country has the highest debt per capita of all euro area states at EUR43,659 per person, with Belgium coming in second place with EUR40,139. In per-employee terms, Ireland takes the third highest place in the euro area with EUR93,378 in Government debt, after Italy (EUR98,314) and Belgium (EUR94,340).

1/10/18: BRIC Manufacturing PMI dips down in 3Q 2018

BRIC Manufacturing PMIs turned south in 3Q 2018 in line with Global trend, but leading that trend to the downside. Per latest data through September 2018:

Russia Manufacturing PMI averaged miserly 49.0 in 3Q 2018, down from anaemic 50.2 in 2Q 2018. This was the lowest quarterly reading since 3Q 2015 when the Russian economy was in an official recession. Russia is the only BRIC economy nominally in contraction territory, when it comes to PMIs-signalled manufacturing sector activity, and 49.0 is statistically close to being sub-50 reading as well.

Brazil’s Manufacturing PMI remained broadly unchanged on 2Q 2018 reading of 50.9 at 50.8 in 3Q 2018. Although notionally above 50.0 mark, statistically, the reading was not significantly different from zero growth signal of 50.0. This means that both Russian and Brazilian economies registered deteriorating PMIs over two consecutive quarters in the case of Brazil and 4 quarters in the case of Russia.

China Manufacturing PMI was at disappointing 50.5 in 3Q 2018, down from a weak 51.1 reading in 2Q 2018. This marks the worst reading in China PMI in five quarters. As with Brazil, China’s Manufacturing PMI for 3Q 2018 was not statistically distinct from 50.0.

India Manufacturing PMI was the only one that remained statistically in expansion territory at 52.1 in 3Q 2018, basically unchanged on 52.0 in 2Q 2018 and barely up on 51.8 in 1Q 2018.

Meanwhile, Global Manufacturing PMI averaged 52.5 in 3Q 2018, down from 53.2 in 2Q 2018 and 54.0 in 4Q 2017 and 1Q 2017. All in, Global PMI has finished 3Q 2018 at the lowest level in 8 consecutive quarters.

1/10/18: Irish Times on Enterprise Ireland Venture Capital Programs

Recent article in the Irish Times looks at some of the industry views on entrepreneurship in Ireland and Enterprise Ireland funding programs. Some of the comments included are from myself.


Tuesday, September 18, 2018

18/9/18: Extreme Concentration Risk: Bitcoin's VUCA Bomb

I wrote before both, about the general problem of concentration risk and the specific problem of this risk (more accurately, the concentration-implied VUCA environment) in the specific asset classes and the economy. Here is another reminder of how the build up of concentration risks in the financial markets is contaminating all asset classes, including the off-the-wall crypto currencies:

The added feature of this concentration risk is extreme (87%) illiquidity of major Bitcoin holdings. This means that under the common 'Mine and Hold' strategy, already monopolized, highly concentrated mining pools literally create a massive risk buildup in the Bitcoin trading systems: with 87% of wallets not trading for months, we have a system of asset pricing and transactions that effectively provides zero price discovery and will not be able to handle any spike in supply, should these accounts start selling. Worse, the system is tightly coupled, as Bitcoin holdings are frequently used to capitalize other leveraged crypto currencies undertakings, such as investment funds and ICOs.

The extent of latent instability in the crypto markets is currently equivalent to a Chernobyl reactor on the cusp of the human error.

Thursday, September 13, 2018

13/9/18: Shares Buybacks Swallow much of Trump's Corporate Tax 'Reforms'

A recent post from the U.S. Fed looked at how companies with large holdings of cash abroad have used those funds following the Tax Cuts and Jobs Act of 2017 (the TCJA, or the Republican Tax Cuts), which incentivised the repatriation of foreign earnings stashed by the U.S. corporations abroad, including Ireland.

Per Fed note: "by the end of 2017, U.S. MNEs had accumulated approximately $1 trillion in cash abroad, held mostly in U.S. fixed-income securities", aka - bonds. Which, of course, also explains why Ireland is one of the largest domiciles for U.S. Treasuries.

The TCJA moved the U.S. "to a quasi-territorial tax system in which profits are taxed only where they are earned" so "...U.S. MNEs' foreign profits will therefore no longer be subject to U.S. taxes when repatriated. As a transition to this new tax system, the TCJA imposed a one-time tax (payable over eight years) on the existing stock of offshore holdings regardless of whether the funds are repatriated, thus eliminating the tax incentive to keep cash abroad."

As of Q1 2018, the U.S. firms "repatriated just over $300 billion, roughly 30% of the estimated stock of offshore cash holdings."

This "quantity of cash repatriated since the passage of the TCJA might have a notable effect on firm financing patterns and investment decisions in the near term". The Fed note argues "that funds repatriated in 2018:Q1 have been associated with a dramatic increase in share buybacks; evidence of an increase in investment is less clear at this stage, as it is likely too early to detect given that the effects may take time to materialize."

The top 15 U.S. firms (by cash holdings abroad) "account for roughly 80 percent of total offshore cash holdings, and roughly 80 percent of their total cash (domestic plus foreign) is held abroad... following the passage of the TCJA ...share buybacks spiked dramatically for the top 15 cash holders, with the ratio of buybacks to assets more than doubling in 2018:Q1. In dollar terms, buybacks increased from $23 billion in 2017:Q4 to $55 billion in 2018:Q1." Worse: "among the top 15 cash holders, the largest holders accounted for the bulk of the share repurchases: In 2018:Q1, the top 5 cash holders accounted for 66 percent, and the top holder alone accounted for 41 percent." Note: the top holder is... Apple.

Of course, "firms can also pay out cash to shareholders through dividends; however, unlike buybacks, dividends were little changed for the top 15 cash holders relative to the same period last year."

"...unlike in the case of share buybacks, there is no obvious spike in investment among the top 15 cash holders in 2018:Q1 relative to the previous quarter. Indeed, it appears that the top 15 cash holders have already been on a slight upward trajectory relative to other firms for a few years."

The repatriation "may also have been used to pay down debt; however, the aggregate debt of the top 15 cash holders declined only about $15 billion, or 2 percent of their total debt outstanding, suggesting limited paydowns so far."

Thus, in simple terms, and allowing some conditionality for lags in investment, the TCJA 2017 has primarily went to stimulate stock market activity, as opposed to either corporate deleveraging or corporate investment. This is consistent with 2004 repatriation amnesty, when the bulk of funds brought by the U.S. MNEs back to the U.S. went to fund shares repurchases in 2005.

It's back to the future folks.

Full note:

13/9/18: Concentration Risk: IPOs, New Firms Arrivals & Super Stars

One of my favourite long-run tail risks to watch in the financial markets (and indeed, due to ongoing monopolisation trends, in the entire economy) is concentration risk. Here is an absolutely epic post from @michaelbatnick on the subject of increasing concentration in equity markets driven by the growing trend toward keeping new tech mega starts private:

Aside from compiling a treasure trove of data, the post brings to light some interesting observations, not necessarily central to the author's core arguments.

Take, for example, this chart:

The post correctly views this as evidence that both volumes and numbers of IPOs have been relatively steady over the recent years. Albeit, both are running woefully below the bust era averages. And, as other evidence presented shows, this is not the feature of the bubble build up phase: in fact, numbers of IPOs have been running well below the 1980-2000 average since the bust.

Maturity to IPO duration is also longer:

Which, of course, supports higher median IPO size in the chart above. Controlling for this, the collapse in IPOs activity in 2001-2018 period is probably much more dramatic, than the first chart above indicates. Or, put differently, IPOs are now more concentrated in the space of older, and hence more able to raise funds, companies. That is a phenomenon consistent with concentration risk rising.

It is also a phenomenon consistent with the hypothesis that entrepreneurialism is declining in the U.S. as younger, more entrepreneurial ventures are clearly less capable of accessing public equity markets today than in pre-2001 period.

There is a lot, really a lot, more worth reading in the post. But here are two more charts, speaking directly to the issue of concentration risk:


Yes, the markets are dominated by a handful of stocks when it comes to providing returns. Namely, Facebook and Alibaba account for a whooping 85% of the total market cap gains since 2012. $85 of each $100 in market cap increases went to just these two companies.

This is concentration risk at work. Even tightly thematic investment strategies, e.g. ESG risk hedging investments, cannot avoid crowding into a handful of shares. Any tech sector blowout is going to be systemic, folks.

Tuesday, September 11, 2018

11/9/18: Slow Recoveries & Unemployment Traps: Hysteresis and/or Secular Stagnation

The twin secular stagnations hypothesis (TSSH, first postulated on this blog) that combines supply-side (technological cyclicality) and demand-side (demographic cyclicality) arguments for why the world economy may have settled on a lower growth trajectory than the one prevailing before 2007 has been a recurrent feature of a number of my posts on this blog, and has entered several of my policy and academic research papers. Throughout my usual discourse on the subject, I have persistently argued that the TSSH accommodates the view that the Global Financial Crisis and the associated Great Recession and the Euro Area Sovereign Crisis of 2007-2014 have significantly accelerated the onset of the TSSH. In other words, TSSH is not a displacement of the arguments that attribute current economic dynamics (slow productivity growth, slower growth in the real economy, reallocation of returns from labour and human capital to technological capital and, more significantly, the financial capital) to the aftermath of the structural crises we experienced in the recent past. The two sets of arguments are, in my view, somewhat complementary.

From this later point of view, a research paper, "Slow Recoveries & Unemployment Traps: Monetary Policy in a Time of Hysteresis" by Sushant Acharya, Julien Bengui, Keshav Dogra, and Shu Lin Wee (August 2018 offers an interesting read.

The paper starts with the - relatively common in the literature - superficial (in my opinion) dichotomy between the secular stagnation hypothesis and the "alternative explanation" of the slowdown in the economy, namely "that large, temporary downturns can themselves permanently damage an economy’s productive capacity." The latter is the so-called 'hysteresis hypothesis', "according to which changes in current aggregate demand can have a significant effect on future aggregate supply" which dates back to the 1980s. The superficiality of this dichotomy relates to the causal chains involved, and to the impact of the two hypotheses.

However, as the authors note, correctly: "While the two sets of explanations may be observationally similar, they have very different normative implications. If exogenous structural factors drive slow growth, countercyclical policy may be unable to resist or reverse this trend. In contrast, if temporary downturns themselves lead to persistently or permanently slower growth, then countercyclical policy, by limiting the severity of downturns, may have a role to play to avert such adverse developments."

The authors develop a model in which countercyclical monetary policy can "moderate" the impact of the sudden, but temporary large downturns, i.e. in the presence of hysteresis. How does this work?

The authors first describe the source of the deep adverse shock capable of shifting the economy toward long-term lower growth rates: "in our model, hysteresis can arise because workers lose human capital whilst unemployed and unskilled workers are costly to retrain". This is not new and goes back to the 1990s work on hysteresis. The problem is explaining why exactly such deep depreciation takes place. Long unemployment spells do reduce human capital stock for workers, but long unemployment spells are feature of less skilled workforce, so there is less human capital to depreciate there in the first place. Retraining low skilled workers is not more expensive than retraining higher skilled workers. In fact, low skilled workers seek low skilled jobs and these require only basic training. It is quite possible that low skilled workers losing their jobs today are of certain demographic (e.g. older workers) that reduces the effectiveness of retraining programs, but that is the TSSH domain, not the hysteresis domain.

One thing that does help this paper's hypothesis is the historical trend of growing duration of unemployment, e.g. discussed here: and the associated trend of low labour force participation rates, e.g. discussed here: I do agree that unskilled workers are costly to retrain, especially in the presence of demographic constraints (which are consistent with the secular stagnation on the demand side).

But, back to the authors: "... large adverse fundamental shocks can cause recessions whose legacy is persistent or permanent unemployment... Accommodative policy early in a recession can prevent hysteresis from taking root and enable swift a recovery. In contrast, delayed monetary policy interventions may be powerless to bring the economy back to full employment."

"As in Pissarides (1992), these features [of long unemployment-induced loss of human capital, sticky wages that prevent wages from falling significantly during the downturns, costly search for new jobs, and costly retraining of workers] generate multiple steady states. One steady state is a high pressure economy: job finding rates are high, unemployment is low and job-seekers are highly skilled. While tight labor markets - by improving workers’ outside options - cause wages to be high, firms still find job creation attractive, as higher wages are offset by low average training costs when job-seekers are mostly highly skilled." Note: the same holds when highly skilled workers labour productivity rises to outpace sticky wages, so one needs to also account for the reasons why labour productivity slacks or does not keep up with wages growth during the downturn, especially when the downturn results in selective layoffs of workers who are less productive ahead of those more productive. Hysteresis hypothesis alone is not enough to do that. We need fundamental reasons for structural changes in labour productivity that go beyond simple depreciation of human capital (or, put differently, we need something similar to the TSSH).

"The economy, however, can also be trapped in a low pressure steady state. In this steady state, job finding rates are low, unemployment is high, and many job-seekers are unskilled as long unemployment spells have eroded their human capital. Slack labor markets lower the outside options of workers and drive wages down, but hiring is still limited as firms find it costly to retrain these workers." Once again, I am not entirely convinced we are facing higher costs of retraining low skilled workers (as argued above), and I am not entirely convinced we are seeing the problem arising amongst the low skilled workers to begin with. Post-2008 recovery has been associated with more jobs creation in lower skilled categories of jobs, e.g. hospitality sector, restaurants, bars, other basic services. These are low skilled jobs which require minimal training. And, yet, we are seeing continued trend toward lower labour force participation rates. Something is missing in the argument that hysteresis is triggered by cost of retraining workers.

Back to the paper: "Importantly, the transition to an unemployment trap following a large severe shock can be avoided. If monetary policy commits to temporarily higher inflation after the liquidity trap has ended, it can mitigate both the initial rise in unemployment, and its persistent (or permanent)
negative consequences. Monetary policy, however, is only effective if it is implemented early in the downturn, before the recession has left substantial scars... [otherwise] ...fiscal policy, in the form of hiring or training subsidies, is necessary to engineer a swift recovery."

The paper tests the model in the empirical setting. And the results seem to be plausible: "allowing for a realistic degree of skill depreciation and training costs... is sufficient to generate multiple steady states.... this multiplicity is essential in explaining why the unemployment rate in the U.S. took 7 years to return to its pre-crisis level. In contrast, the standard search model without skill depreciation and/or training costs predicts that the U.S. economy should have fully recovered by 2011. ...the model indicates that had monetary policy been less accommodative or timely during the crisis, leading to a peak unemployment rate higher than 11 percent, the economy might have been permanently scarred and stuck in an unemployment trap. Furthermore, our model suggests that the persistently high proportion of long-term unemployed in the European periphery countries may reflect a lack of timely monetary accommodation by the European Central Bank."

Fraction of Long-term unemployed (>27 weeks) in select countries. 
The figure plots five quarter moving averages of quarterly data. 
The dashed-line indicates the timing of Draghi’s “whatever it takes” speech. 

Source: Eurostat and FRED.

This seems quite plausible, even though it does not explain why eventual 'retraining' of low skilled workers is still not triggering substantial increases in labour productivity growth rates in Europe and the U.S.

One interesting extension presented in the paper is that of segmented labour markets, or the markets where "employers might be able to discern whether a worker requires training or not based on observable characteristics - in particular, their duration of unemployment... [so that, if] skilled and unskilled workers searched in separate markets, the economy would still be characterized by hysteresis, but it would take a different form. There are two possibilities to consider. [If] ... the firm’s share of the surplus from hiring an unskilled worker, net of training costs, is large enough to compensate firms for posting vacancies in the unskilled labor market, ...after a temporary recession which increases the fraction of unskilled job-seekers, it can take a long time for these workers to be reabsorbed into employment. Firms prefer to post vacancies in the market for skilled job-seekers rather than the market for unskilled job-seekers in order to avoid paying a training cost. With fewer vacancies posted for them, unskilled job-seekers face a lower job-finding rate and thus, the outflow from the pool of unskilled job-seekers is low. In contrast, the skilled unemployment rate recovers rapidly - in fact, faster than in the baseline model with a single labor market... [Alternatively], the segmented labor markets economy could experience permanent stagnation, rather than a slow recovery, [if] unskilled workers are unemployable, since firms are unwilling to pay the cost of hiring and training these workers. Thus unskilled workers effectively drop out of the labor force."

We do observe some of the elements of both such regimes in the advanced economies today, with simultaneous increasing jobs creation drift toward lower-skilled, slack in supply of skills as younger, educated workers are forced to compete for lower skilled jobs, and a dropout rate acceleration for labour force participation. Which suggests that demographics (the TSSH component, not hysteresis component) is at play at least in part in the equation.

In summary, a very interesting paper that, in my opinion, adds to the TSSH arguments a new dimensions: deterioration in skills due to severity of a demand shock and productivity shock. It does not, however, contradict the TSSH and does not invalidate the key arguments of the TSSH. As per effectiveness of monetary or monetary-fiscal policies in combatting the long-term nature of the adverse economic equilibrium, the book remains open in my opinion, even under the hysteresis hypothesis: if hysteresis is accompanied by a permanent loss of skills twinned with a loss of productivity (e.g. due to technological progress), adverse demographics (older age cohorts of workers losing their jobs) will not be resolved by a training push. You simply cannot attain a catch up for the displaced workers using training schemes in the presence of younger generation of workers competing for the scarce jobs in a hysteresis environment.

And the Zero-Lower Bound on monetary policy still matters: the duration of the hysteresis shock will undoubtedly create large scale mismatch between the sovereign capacity to fund future liabilities (deficits) and the longer-run inflationary dynamics implied by the extremely aggressive and prolonged monetary intervention. In other words, large enough hysteresis shock will require Japanification of the economy, and as we have seen in the case of Japan, such a scenario does not lead to the economy escaping the TSSH or hysteresis (or both) trap even after two decades of aggressive monetary and fiscal stimuli.

Sunday, September 9, 2018

9/9/18: Dershowitz's New Doctrine in Law

Another tweet, different topic: my brief musings on the Harvard Law's Alan Dershowitz's recent invention of new doctrine in law:

9/9/18: IMF and Argentina: New Old Saga

My Twitter comments on Argentina and IMF rescue package were picked up by the folks at ZeroHedge

9/9/18: The end of the clam before the storm

My article on the shifting landscape for monetary policies: U.S. and Euro area for Sunday Business Post

9/9/2018: Corporate Power, Charity, and Social & Policy Impacts

In an important discussion, titled "Tax-exempt lobbying: Corporate philanthropy as a tool for political influence", Marianne Bertrand, Matilde Bombardini, Raymond Fisman, and Francesco Trebbi (02 September 2018, argue that as "special interests use donations to influence the political process", "...philanthropic efforts in the US are targeted, at least in part, to influence legislators. Districts with influential politicians receive more donations, as do non-profits with politicians on their boards. This is problematic because, unlike PAC contributions and lobbying, influence by charity is hard for the public to observe." The resulting conclusion by the authors is that the case of corporate-charity interlinks "amounts to a taxpayer subsidy of corporations expressing their political voice". In other words, concentration of market power causes concentration push in lobbying and, thus, potentially forces policy formation to more closely reflect the interests of the corporate donors at the expense of the taxpayers and ordinary voters.

This is a very important issue in any analysis of the functioning of our democratic processes. But it also raises another 'adjoining' issue, not covered in the paper: American corporations are increasingly relying on other channels to alter social (and related policy) outcomes today. This channel is the companies increasing financial and other commitments to Corporate Social Responsibility and Social Impact (or even broader ESG) targeting. Whilst benign in its core values and ethos, the channel can be open to potential abuse by corporate powers. In addition, like charity status channel, the CSR and SI/ESG channel also avails of public funding link ups to corporate balance sheets (via tax incentives, subsidies, co-financing of projects, etc). The question worth asking, therefore, is the following one: To what extent do modern SI/ESG and CSR strategies of major corporations align with their lobbying objectives? In other words, do corporates use SI/ESG/CSR strategies to promote self-interest beyond purely societal interest?

Surprisingly, very little research in the Social Impact or ESG analysis has been devoted to the potential for corporations to 'game the system' in their favour.

9/9/18: Populism, Middle Class and Asset Bubbles

The range of total returns (unadjusted for differential FX rates) for some key assets categories since 2009 via Goldman Sachs Research:

The above highlights the pivot toward financial assets inflation under the tidal wave of Quantitative Easing programmes by the major Central Banks. The financial sector repression is taking the bite out of the consumer / household finances through widening profit margins, reflective of the economy's move toward higher financial intensity of output. Put differently, the CPI gap to corporate costs inflation is widening, and with it, the asset price inflation is drifting toward financial assets:

This is the 'beggar-thy-household' economy, folks. Not surprisingly, while the proportion of total population classifiable as middle-class might be stabilising (after a massive decline from the 1970s and 1980s levels):

 Incomes of the middle class are stagnant (and for lower earners, falling):

And post-QE squeeze (higher interest rates and higher cost of credit intermediation) is coming for the already stretched households. Any wonder that political populism/opportunism is also on the rise?

Monday, September 3, 2018

3/9/18: Bakkt: One New Exchange, Two Old Exchanges, Same Crypto Story?

My comment on the new #cryptocurrency exchange project involving Intercontinental Exchange (ICE), the New York Stock Exchange (NYSE), Microsoft, Starbucks, and Boston Consulting Group: In the nutshell, hold the hype, but watch it develop...

Friday, August 24, 2018

24/8/18: Moscow's Fiscal Resilience in the Headwinds

Back in September 2017, Fitch (with Russia rating BBB-) estimated that the U.S. sanctions were costing Russia ‘one notch’ in terms of sovereign ratings, with ex-sanctions risk conditions for the Russian sovereign debt at BBB. Last week, Fitch retained long term debt rating for Russia at BBB- with positive outlook, noting the Russian economy’s relative resilience to sanctions.

Budgetary Resilience

Per Fitch, and confirmed by the Russian Finance Ministry analysis, Russia is looking at recording a budgetary surplus in 2018:

Fitch analysis projects the budget surplus to average 0.1% of GDP in 2018 and 0.3% in 2019, from deficits of 1.0% and 0.5%, respectively. This, alongside Russia’s strong performance in monetary policy have been noted by Fitch as core markers of the Russian economy’s resilience to external shocks, including the sanctions acceleration announced back in April 2018.

Looking forward, President Putin's RUB 8.0 trillion (ca USD127 bn) new spending priorities announced back in May will amount to roughly 7.0% of GDP over the next six years. These funds will go to support higher wages and pensions for the recipients of Federal and Local funding, as well as public investment uplift in education and core infrastructure. Per Fitch: “Due to a stronger fiscal position and a robust oil price outlook, the planned measures will not threaten the country's future budget surpluses. The government will also increase available funds by enforcing a tax overhaul and increasing [domestic] borrowing.” (see Chart below)

Policies Resilience

Resilience-inducing policies, when it comes to macroeconomic management of risks arising from sanctions regimes face by Russia include:

  • Increase the Value-added Tax (VAT) rate from 18.0% to 20.0% starting in 2019, which will provide (based on Moscow estimates) ca RUB 600bn (USD 9.5bn) per annum. Social and aggregate demand impacts of VAT increases were mitigated by keeping 10% rate on certain foods, children’s goods, printed publications and pharmaceuticals, or roughly 25% of all goods and services. Some transport services will continue benefiting from 0% VAT rate.
  • A phased reduction of the export duty on oil and petroleum products from 30.0% to zero and a concurrent increase in the tax on the extraction of minerals by 2024
  • The combined tax rate on wages for mandatory social contributions will remain at 22%. 
  • The tax on the physical capital of companies (capped at 2%), will no longer apply to moveable assets (the tax will remain for fixed capital, e.g. for buildings).
  • Russia will also establish special administrative zones on Russky Island next to Vladivostok and on Oktyabrsky Island, which is part of the Kaliningrad enclave. Both will act as offshore centres where foreign-registered firms owned by Russian nationals can “redomicile” their assets. Tax advantages granted in these zones will cover taxes on profits, dividend income and different types of property.
  • A recent increase in the pensionable age (men from 60 to 65, women from 55 to 63) system will lower the burden of an ageing population and a shrinking labour force, “propping up the state Pension Fund's income”

Impact on Debt Markets

Net outrun is that even faced with escalating sanctions, and having unveiled a rather sizeable macro stimulus program, Moscow's finances remain brutally healthy. Fitch research foresees “a contained uptick in government debt levels over the coming years, with the debt burden rising from 17.4% of GDP in 2017 (IMF statistics) to about 18.3% GDP by 2020.” As share of Russian debt held by external funders continues to decline, these forecasts imply increased sustainability of overall debt levels.

In it’s recent assessment of the potential impact of the ‘Super-sanctions’ (The Defending American Security from Kremlin Aggression Act of 2018 (DASKAA)) planned by Washington, the worst case scenario of all U.S.-affiliated investors dumping Russian bonds implies 8-10% decline in foreign holdings of Russian Sovereign debt, which will likely raise yields on long-dated Russian Ruble-denominated debt by 0.5-0.8 percentage points. Based on August 6 analysis from Oxford Economics, Russia will have no trouble replacing exiting Western debt holders with Ruble-denominated debt issuance.

Key Weaknesses Elsewhere

The key weakness for Russia is in structurally lower economic growth that set on around 2010-2011 and is likely to persist into 2022-2023 period (see IMF projections below):

Russian GDP growth rose from 1.3% y/y in the 1Q 2018 to 1.8% in the 2Q, with 1H growth reading 1.6% y/y. The uptick was led by faster industrial output growth (rising almost 4% y/y in 2Q) and manufacturing (up 4.6% y/y in 2Q). These are preliminary estimates, subject to revisions and, based on the recent past revisions, it is quite likely that we will see higher growth rates in final reading. 1H 2018 fixed investment rose 3% y/y. Real wages rose 8% y/y in real terms, but household disposable real income was up only 2% at the end of 2Q 2018 due to slower growth in the 'grey economy' and in non-wage income. Despite the rising household credit uptake (up 19% y/y at the end of 2Q 2018), retail sales were up only 2.5%, broadly in-line with real income growth.

All of these trends are consistent with what we have been observing in recent years and are indicative of the structurally weaker economic conditions prevailing in the wake of the post-GFC economic recession and the energy prices shocks of 2014-2017.

24/8/18: The Fed Bites the Bullet on Secular Stagnation

And just like... Federal Reserve Chair confirms the Twin Secular Stagnation Hypotheses in one paragraph of his speech:

Per Powell, "the U.S. economy faces a number of longer-term structural challenges ... For example, real wages, particularly for medium- and low-income workers, have grown quite slowly in recent decades. Economic mobility in the United States has declined and is now lower than in most other advanced economies.2 Addressing the federal budget deficit, which has long been on an unsustainable path, becomes increasingly important as a larger share of the population retires. Finally, it is difficult to say when or whether the economy will break out of its low-productivity mode of the past decade or more, as it must if incomes are to rise meaningfully over time."

For those who might want to read about an even more fundamental (and causally linked to the Powell's challenges) structural decline in the Cayman Financial Review here:

What is note worthy in Powell's passage is the words "in recent decades". Powell is correct (and I pointed this fact out on a number of occasions) that the adverse trends in the U.S. economy have been present for much longer than the post-Global Financial Crisis shocks residual effects. The economic stagnation (expressed in the abysmally low growth rates of economic prosperity for the lower 90 percent of the American population; in woefully slow expansion in productivity, compared to historical trends; in structurally less competitive nature of the economy and growing monopolization and oligopolization of the U.S. markets; in reduced physical and social mobility; in falling pensions savings provisions for the majority of the U.S. population; and so on) has pre-dated the GFC and its roots rest much deeper than the financial disruption of the 2007-2010 crisis.

Wednesday, August 22, 2018

22/8/18: Emerging Markets Risks and International Reserves

Emerging markets are at the point of risk contagion these days, with a potential spillover into advanced economies. This brings us back to the memories of the past EM crises, such as the currencies crises of the late 1990s in the year (and month) that marks the 20th anniversary of Russian Sovereign Default.

Here is an interesting chart that shows just how far Russia has traveled from the past in terms of its macroeconomic management:

What the chart omits, of course, is a simple fact: of all these economies, Russia is the only one that (rightly or wrongly or both) is trading under severe financial and economic sanctions imposed by its major trading and investment partners. Which makes this performance even more impressive.

When it comes to a 'higher altitude' view of the Russian economy within historical and current geopolitical perspective, which is discussed here:

Saturday, August 18, 2018

18/8/18: Monopolization trends in Advanced Economies: my column for CFR

My column for the Cayman Financial Review on the topic of structural monopolization of the global economy and the declining competitiveness.

18/8/18: Kiplinger quotes on equity markets

18/08/18: Euromoney on Italian Banking Risks and Turkey Crisis

Euromoney article on the latent Italian crisis, relative to the ongoing Turkish one:

Thursday, August 9, 2018

9/8/18: BRIC PMIs trace Global economy's slowdown at the start of 3Q

Recent PMIs for BRIC show a weaker start to 3Q 2018, in line with moderating growth outlook for the global economy:

In summary, Composite PMIs for July show Russia, China and Brazil underperforming global composite index, with India being the only BRIC economy trending in line with the global economy.  Much of this dynamic was down to Manufacturing sector, with Services supporting global economy to the upside:

The biggest downside momentum came from Russia's sub-50 reading in Manufacturing, followed by significant decline in growth activity in the sector in Brazil, and a more moderate slowdown in China:

For Russia, weaknesses in Manufacturing sector, for now offset by strengths in Services, are unpleasant reminders that the economy is still fundamentally on near-zero growth path, despite early 2018 hopes for 1.9-2 percent growth projections. For China, there are growing signs of the adverse impact of Trade War with the U.S. taking their toll on growth and cost dynamics.

Saturday, August 4, 2018

4/8/18: Collapsed Labor Share of Economy 1947-2016

The frightening fate of the U.S. labor is best highlighted by the share of labor in economic output. Fred database only provides the data through 2014, and then stops. BLS provides data through 3Q 2016, and then stops. No one bothers to measure the contribution of the largest factor of production to the economy any more. Here is the BLS data:

The share of labor contribution in total economic output has, basically, collapsed. The slide started with the technological revolutions of the 1960s and 1970s, followed by computerization and supply chain management revolutions of the 1980s and 1990s. But the real collapse took place starting with 2002 post-dot.Com bust. Despite the tight labor markets and very low unemployment, labor share never really recovered from this decimation.

If this chart offers a stark cross-reference to socio-political environment we are living in today, such cross-referencing is not ad hoc. Labor is what we, people, have to supply in return for the life's necessities and luxuries. For the majority of us, it is ALL that we can supply.  Even our assets, such as homes and pensions savings are, ultimately, tied to labor, not to capital, because their performance is linked to our peers' labor-paid demand. A middle class house is an asset to other middle class households. It is not an asset to the jet-set shopping for homes in the Hamptons. When that demand collapses, as is currently happening in a number of rapidly ageing economies, real assets we hold turn out to be if not completely worthless (, at least severely depressed in value (

So a decline in economic value added share accruing to labor is a transfer of income (and therefore wealth) from those who work for living to those who invest for living (invest in technology and/or financial assets). This game is a zero sum game even after we account for pensions funds and household investments: someone loses (labor), someone gains (investors). It is made even worse by higher taxes on labor and by transfers via monetary policy (Quantitative Easing).

The only way to offset such transfers is to vest labor with claims to financial returns. In other words, by providing workers with shares in the financial markets. Simply taxing and shifting income from higher earners to lower earners won't do the trick, because some higher earners are generating their income through labor (and human capital), while others are doing so through inherited and acquired financial assets. Taxing income of the latter implies taxing incomes of the former, which, in turn, depresses returns to investment in human capital (or, ultimately, returns to investment in labor).

Basic income structure of the future will have to achieve exactly that: create broad share ownership of financial instruments linked to financial and technological capital amongst those supplying labor.

Thursday, August 2, 2018

2/8/18: M&A Activity: More Concentration Risk Signals

In recent media analysis of the markets, less attention that the rise in shares buybacks has been given to the M&A markets. And there are some interesting observations to be made from the most recent data on these.

Top level (see for details) analysis is that the overall M&A markets activity is remaining at cyclical lows:

As the chart above shows both values and volumes of M&A activities are shrinking. But the numbers of mega deals are rising:

Per chart above, overall transactions in excess of $1 billion are at an all-time historical high. Per FactSet: "the first half of 2018 has reported the second-highest level of deals valued over $1 billion with 200 deals; the highest level was attained in the first half of 2007 with 210 deals. It is also worth noting that the streak of billion-dollar deals started in 2013, and since then there have been over 100 billion-dollar deals in each half-year. Even in the run-up to the financial crisis the streak was only three years (2005 to 2007). And to help complete the pattern, the dot-com boom had a similar three-year streak of 100 billion-dollar deals in each half-year from 1998 to 2000."

In other words, markets reward concentration risk taking. Mega deals generally add value through increased valuation of the acquiring firm, and through synergies on costs side. But they do not generally add value in terms of future growth capacity. Smaller deals usually add the latter value. Divergence between overall M&A activity and the mega-deals activity is consistent with the secular stagnation theses.

2/8/18: Shares Buybacks: the Evil Symptoms of an Ever More Evil Disease

Yesterday, I have posted a quite unusual (for my normal arguments) defense of the shares buybacks. Normally, as the readers of this blog know, I see buybacks as a net negative to organic investment. However, that view needs to be anchored to the economic conditions prevailing on the ground. In other words, buybacks are net negative for investment and organic economic growth, unless buybacks are companies' rational responses to specific economic and policy conditions.

With this in mind, here are my thoughts on the subject of buybacks that have accelerated in recent years:

The proposition that shares buybacks are ‘starving’ (aka slowing) the economy is false. And it is false for a number of reasons, listed below:

Reason 1: Stock buybacks can ONLY slow down economic growth in the conditions when new investment by firms can generate higher economic value added than other uses of funds in the economy (e.g. investment by other agents, than the firm, or increasing aggregate demand by investors recycling gains from buybacks into general consumption, etc). Currently, this does not appear to be the case. In fact, firms are hesitant to invest in the economy even when we control for buybacks. Thus, buybacks are similar to dividends: payouts of dividends and higher buybacks rates may signal lack of profitable investment opportunities for the firms.

Reason 2: Stock buybacks can slow down economic growth if they increase cost of capital for the firms. With equity capital (shares) being made superficially more expensive than debt (QE, tax preferences, demographic shifts in clientele reasons, etc), this is not the case. equity capital is currently more expensive than debt as a funding source for new investment for listed companies. While this situation may reverse in time (which it did only on very rare occasions in the past), companies today can borrow cheaply to retire expensive equity. This might not make sense from the economy point of view (rising degree of financial leverage, increasing risk of destabilising increases in debt carry costs, etc), it might make sense from the company and management point of view.

Reason 3: Stock buybacks can harm economic growth if they reduce returns on productivity (theory of labour productivity being unrewarded via slow wages growth). This too is not the case, because labour productivity and TFP have been collapsing since prior to the increases in shares buybacks. I wrote enough about this on this blog before in the context of the twin secular stagnations theses.

So what does the story of skyrocketing shares buybacks really tell us? The reality, consistent with Reasons 1-3 above, is that stock buybacks are a SYMPTOM of the disease, not the disease itself. Shares buybacks are driven by secular stagnation: more specifically, primarily by supply-side secular stagnation (S-SSS), and are second-order related to demand-side secular stagnation (D-SSS). How?

S-SSS implies lack of profitable investment opportunities for short and medium-term investments by the firms. With falling TFP & labour productivity, and with demographically-induced slowdown in demand, this is patently so. S-SSS also implies the need for protracted QE and other distortions in capital funding costs that disincentivise equity capital relative to debt funding channels.

D-SSS implies that with demographic, structural shifts in economic activity across generations, etc, aggregate demand side of the economy is getting pressured. Which means, again, 2nd order effects, adverse pressure on supply side.

So shares buybacks are NOT a disaster, nor a disease. The disease is the structure of the economy, with
- Technological & human capital productivity and innovation stalling,
- Adverse demographics undermining future economic capacity,
- Infrastructure investments yielding lower potential growth uplifts,
- Policies (monetary & fiscal) stuck in the 20th century extremes,
- Increasing concentration, monopolisation & oligopolization of the economy and the markets resulting in reduced entrepreneurial activity.

Shares buybacks & resulting wealth inequality or concentration are not orthogonal sets to the political & policy mismanagement that marks the last 25 years of our (Western) history. They are DIRECT outcome of these.

So, go ahead, political punks. Make the markets day. Shut down shares buybacks, so you can keep gerrymandering the economy, manipulating the markets, & bend the society to your desired ends. The longer you do this, the more you do this, the tighter is the lid on the pressure cooker. The more spectacular the blowout to follow.