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:

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.