Thursday, September 13, 2018

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: http://theirrelevantinvestor.com/2018/09/10/making-private-public/

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 pre-dot.com bust era averages. And, as other evidence presented shows, this is not the feature of the dot.com bubble build up phase: in fact, numbers of IPOs have been running well below the 1980-2000 average since the dot.com 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:

 and

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 https://sushantacharya.github.io/sushantacharya.github.io/pdfs/hysteresis.pdf) 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: http://trueeconomics.blogspot.com/2017/07/27717-us-labor-markets-are-not-in-rude.html and the associated trend of low labour force participation rates, e.g. discussed here: http://trueeconomics.blogspot.com/2018/06/8618-human-capital-twin-secular.html. 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:
https://www.rt.com/usa/436604-alan-dershowitz-cohen-jaywalking/


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 https://www.zerohedge.com/news/2018-08-30/some-observations-argentinas-imf-sponsored-collapse


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 https://www.businesspost.ie/business/end-calm-storm-424321


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, https://voxeu.org/article/corporate-philanthropy-tool-political-influence) 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: https://blokt.com/news/bakkts-cryptocurrency-exchange-is-coming-but-will-institutional-investors-follow. 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: http://trueeconomics.blogspot.com/2018/08/18818-monpolization-trends-in-advanced.html.

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: http://trueeconomics.blogspot.com/2018/01/6118-spent-putins-call-means-growing.html.