5/11/2012: Lehman Bros & Irish ISEQ - II

And a bit more on indices dynamics:

Some interesting longer term trends from the major indices and VIX revealing the underlying structure of the Irish and the euro area crises. Note: data covers period through September 2012.

Starting from the top, here are indices of major stock prices, normalized back to February 2005 for comparative purposes. Relative to the peak, currently, CAC40 stands at around -41.9%, while FTSE MIB is at -62.5%, FTSE Eurotop 100 at -31.7%, FTSE ALL Shares at -11.22%, DAX at -8.41%, S&P500 at -6.15% and IBEX35 at -48.5%. Meanwhile, 'special' Ireland's ISEQ is at -66.9%.

Chart Index 1.0 and Index 1.1.

Clearly, Ireland is the poorest performer in the class.

Now, it is worth noting that Ireland's stock market is also 'distinguished' by a very 'special' characteristic of being the riskiest of all markets compared, with STDev of returns at 36.45 (on normalized index). Compared to the French market (STDev=22.34 for the period from the start of 2005 through today), Italian market (STDev = 28.95), FTSE Eurotop 100 (STDev = 18.90), FTSE All Shares (STDev = 13.70), German DAX (STDev = 23.05), S&P500 (STDev =14.55) and Spanish market (IBEX STDev = 23.70), Ireland is a risky gamble. Given that the direction of this bet, in the case of Ireland has been down from May 2007, virtually uninterrupted, the proposition of 'patriotic investment' in Ireland's stocks is an extremely risky gamble.

Normalizing the indices at their peak values (set peak at 100), chart below clearly shows the constant, persistent underperformance of the ISEQ.

Chart Index2.0

Now, let's take a look at the core driver of global fundamentals: risk aversion as reflected in VIX index. In general, rising VIX signals rising risk aversion and should be associated with falling stock valuations. Once again, for comparative reasons, we use indexed series of weekly returns for 1999-September 2012. Up until the crisis, Irish stock prices behaved broadly in line with the same relationship to VIX that holds for all other major indices. Chart below illustrates this for FTSE Eurotop 100, but the same holds for other major indices. VIX up, risk-aversion up, stock indices, including ISEQ, down.

Chart VIX1.1

Around Q1 2009 something changed. ISEQ lost any connection with 'reality' of the global markets and acquired life of its own. Or rather - a zombie life of it own. No matter what the global appetite for risk was doing, Irish stocks did not have much of a link with global investment fundamentals.

Another interesting point of the above chart is that Lehman Brothers were not a trigger for Irish crisis (as many of us have been saying for ages, despite the Government's continued assertions to the contrary). Irish market peaked in the week of May 21st, 2007, Lehman Brothers folded on September 15th, 2008, with most of the impact in terms of our indices occurring at September 15th-October 6, 2008, some 16 months after Irish markets began crashing. Prior to Lehman Brothers bankruptcy, ISEQ dropped from a peak of 147.3 to 61.6, while following the Lehman Brothers and until the global stock market trough of March 2, 2009, ISEQ fell to roughly 31.9 reading. So even in theory, Lehman bankruptcy could have accounted for no more than 29.7 point drop on the normalized ISEQ, while pre-Lehman drivers collapsed ISEQ by 85.7 points. 

More revealingly, ISEQ steep sell-offs through out the entire crisis have led, not followed, sell-offs in major indices. In other words, if Lehman caused the global market meltdown, then ISEQ 'caused' Lehman bankruptcy. Which, of course, is absurd.

There are many other stories that can be told looking at the Irish Stock Exchange performance, especially once higher moments to returns distribution are factored in, but I shall leave it to MSc students to explore.

5/11/2012: Lehman Bros & Irish ISEQ

Here's an interesting little factoid. The theory - usually advanced by the Irish Government - goes that Lehman Brothers bankruptcy has been a major driver of the Irish crisis. I have disputed this for ages now and more and more evidence turns up contrary to that when more and more data is considered.

Now, here's a new bit.

Suppose Lehman Bros did contribute significantly to the Irish crisis gravity. In that case, given Lehman Brothers bankruptcy contributed adversely to the global markets, we can expect a dramatic contagion from the global markets panic to Irish markets. One way to gauge this is to look at the changes in correlations between the measure of overall 'panic' in the international markets and the behaviour of the returns to Irish stock market indices.

Let's take ISEQ index for Irish markets and VIX for a measure of the panic sentiment in the global markets. Let's take weekly returns in ISEQ and correlate them to weekly changes in VIX. I use log-differencing in that exercise and 52 weeks rolling correlations.

What should we expect to see? If the 'Lehmans caused Irish crisis or worsened it' theory holds, we should expect correlation between ISEQ weekly returns and changes in weekly VIX readings to be negative (VIX rising during the crisis signals rising risk aversion in the markets). For Irish markets to be influenced significantly, or differently from other markets around the world, such negative correlations should be larger in absolute value than for other countries.

What do we see? Here is a table of averages:

Contrary to the hypothesis of 'Lehmans caused Irish crisis', we see that throughout the period of the crisis, ISEQ suffered shallower, not deeper, spillover from global risk aversion to equity valuations, save for Spanish IBEX index. In other words, evidence suggests that Irish 'disease', like Spanish 'disease' was driven more by idiosyncratic - own market-specific - factors rather than by global panic.

Here's the chart, showing just how consistently closer to zero ISEQ correlation to VIX was during the post-Lehman panic period:

And here is a chart showing skew in the distribution of weekly returns which shows that during the crisis, Ireland's ISEQ suffered less from global markets 'bad news' spillovers (at the point of immediate global markets panics, such as Lehmans episode), but exhibited  a much worse negative skew than other peers in the period from June 2010 through Q1 2012.

Economics 17/01/2010: Back to the future in risk-aversion?

Are markets settling for a renewed pressure of higher risk aversion strategies?

Given the fact that the US (and generally OECD) economic conditions remain extremely weak, the markets might be signaling a reversal of the risk attitudes - overdue after the rallies of the second half of 2009. The first signals came in from the bond markets, where even sick puppies, such as Ireland, have enjoyed some bounce in recent weeks. One can argue that the Greeks are getting away with a murder, as their CDS and spreads are following much shallower dynamic than one would have expected in light of continued concerns as to the credibility of their fiscal adjustment plans.

But the real ticker for troubles potentially brewing ahead is the overall markets behavior.

Here is one interesting chart:

 

For last week: TIPS up, bonds up, everything else - down. Not exactly a confidence game. And this is compounded by the January effect not playing out this year so far.

Now, VIX:

Now, not yet as pronounced as on level performance for the markets themselves, but note MCAD cross over and reduced divergence in the last 5 trading days, teamed up with S&P negative movement. Both suggest that VIX downward trend might be breaking.

Irish data is yet to show a clear trend/pattern or resistance breaks -

IFIN is pointing to a gently rising momentum in volatility, ISEQ broader index shows a gentle decline. Plus the highest frequency data I do have relates to daily close prices.  But, of course, there are lags relative to the US markets, so something to watch here.

Economics 23/12/2009: Ending 2009 in Red

As 2009 is drawing to a close, let's take a quick look at the broad shares performance in Ireland. starting with a 10-year picture for ISEQ, S&P500 and Nasdaq:
This clearly shows just how dreadful the crisis has been for Ireland - in terms of total decline on the peak valuations. A five-year view confirms this:
But it also shows that 2008 was much worse for Ireland Inc than it was for the benchmarks. And despite the deceptive nature of statistics (remember - we started 2009 at a much lower valuation than other indices, so we could have expected a much stronger bounce from the bottom over 2009 bear rally), we remain heavy underperformers over 5 year horizon.
Ditto over the two year horizon although much closer/tighter view on the 2009 alone:
And if you were swayed by the 'buy' signals from our ever-optimistic brokers in the H2 2009, here is what you've been aiming for:
Yeeeks... At the beginning of the year, I predicted that the markets will continue discounting Ireland throughout 2009 on the back of the adverse news flow (deeper recession, failures in fiscal governance and collapse of banking) relative to the broader global indices. Clearly, they did.

Oh and one more reminder - back in July-August 2008 an MD of our top-5 stockbrokerage firms issued a fanfare-sounding Green Jersey note telling his clients that 'markets come back'.
Were we to listen - we would be buying ISEQ at 5,070 and valuing it today at under 3,000 - a 40.8% drop. Some price for a Green Jersey.

Oh, and it wasn't exactly a ride for the risk-averse, even compared to the scary trender like Nasdaq:
So markets do come back, don't take me wrong - except in their own time and at their own speed. Better luck in 2010, folks!

Economics 15/08/2009: US rally is unlikely to last - implications for Ireland

Some are making lots of hay out of the idea that Germany, France, the US and the UK economies are improving and that this will have a positive effect on Ireland. Let me play a devil’s advocate here.

Yesterday I wrote about my view of GDP growth debate when the premise of growth is predicated on our exports (here).

One more factor is worth considering in this debate: interest rates and FOREX.

Scenario most likely: US is coming out of the recession in Q1 2010. By then, inflationary pressures are building up in the EU (we might be still below the target rate, but Monsieur Trichet is by then fully cognizant of deflation being over and money supply being out of whack by a thousand miles stretch). US inflation is already there, also below the target, but much closer than Eurozone’s. What happens next? Interest rates rise in the US and in the Eurozone. Dollar/Euro rate heads South, boosting our exports somewhat. But our CPI heads North as a combination of high taxes and rising mortgage financing costs wipes out households’ saving nests. Do you call this ‘growth’? or do you call it a disaster? Brendan Keenan and the likes of Davy seems to be happy to say it is the former. I would conjecture it is the latter.

Scenario less likely: US and EU come out of the recession jointly – around the end of Q1 2010. This means all of the above, but with Euro actually staying strong or even appreciating against the dollar. Double whammy then.

So let us cheer carefully any turnaround in the ‘partner’ economies, then…

But now, consider the whole idea of a turnaround. So far, our not too financially savvy media has been confusing stock market rally with economic fundamentals. I fear this is about to change in September/October. Here are three barometers:

Barometer 1: Personal. Last year, the crisis in our markets spelt a dramatic decline in my own income by ca 80% within a span of August-October. This year, the same process has just started anew with my sources of income falling and companies owing me cash falling further behind on their payments. And we are talking non-trivial amounts backlogged for over 90 days on invoices.

Barometer 2: Global trade. Once again, 2008 is perfectly reflected in 2009. In 2008, crisis in global trade and finance was pre-dated by the bottoming out of commodities cycles in late January 2008. In 2009, the same has happened in February 2009. As economy fell in 2008, Bear Sterns got rescued (March 15, 2008). In 2009 it was the turn for the Obama’s economic stimulus package – signed on March 6, 2009. Now, all along, global trade collapse followed smaller pre-shocks. June-August 2008: Baltic Dry Index, having peaked in May, collapsed 28%. June-August 2009, having peaked for the year in June 2009, BDI falls 25%. All seasonally adjusted, mind you. In 2008 this was followed by massive short selling in the financial markets and bottoming out of stock markets on July 15, 2008. Short-covering leads to a rally thereafter with the next two weeks yielding a 5% rise in S&P500. In 2009 the story is slightly different yet the timings are the same and the net impact is the same as well. Banned naked shortselling implies longer lags for translating expectations into price movements, so July 10 stock markets bottom coincident with the Fed injecting some $80bn into the market for the first time in a month, produce a short-covering rally of 12% (S&P500) in exactly the same period as last year.

Barometer 3: Fundamentals. In the meantime, as 2008 short-covering rally was unfolding, global trade was shrinking fast – chart below.

In case you are still wondering, the same has happened in 2009 so far (chart below):

So in both years we have BDI scissoring away from the S&P500 – right before the main wave hits the shores on Wall Street. The real economy took hold with a delay back in 2008 due to the short-covering rallies triggered by regulatory moves. Ditto this year. And trade flows fundamentals are not alone in showing no support for a sustained rally in the stock markets. Here are some other signs:

Short run dynamics in the stock markets are now firmly showing increasing volatility: VIX has declined from July 2008 through August before taking off up the cliff in September 2008. So far, the same dynamics are present in terms of decline and increasing volatility of VIX itself.

The US consumer sentiment index fell unexpectedly in early August to 63.2 from 66.0 in July - the lowest reading since March, according to the Reuters/University of Michigan index. Now, as the chart illustrates, UofM survey index also peaked in August 2008 before heading rapidly South.
Although the seasonally adjusted output of the US factories, mines and utilities increased 0.5% last month (for the first time since December 2007), reversing course after a 0.4% decline in June, annual output is still down 13.1% in the past year. But the current bounce is fictitious, as capacity utilization increase from 68.1% to 68.5% was minor and on top of the record low of June – so no restart of an investment cycle any time soon. Worse than that – all gains in industrial output in July were due to teh US car makers deciding to re-supply stocks. Motor vehicle production jumped 20.1% on a back of a planned increase following earlier severe production cutbacks as General Motors and Chrysler went through bankruptcy. So ex autos, industrial output for July was off 0.1% while manufacturing output rose just 0.2%. Output of high-tech industries rose 0.4% in July (still down 20% in the past year).

Finally, unemployment – I wrote about this ‘surprise dip’ in last month’s unemployment figures before (all based on an actual fall in the labour force participation rates, not on a slowdown of jobs destruction. But while ordinary unemployment rate is scarry, the duration of an average unemployment spell (the second chart below) is frightening. Since the Department of Labor started collecting data in the late 1940’s, there hasn’t been unemployment spell that lasted this long: July 2009 at 25.1 weeks. The previous highest peak in the average duration of unemployment: July 1983 = 21.2 weeks.


So nothing, short of something strange brewing in Wall Street’s Caffeteria, underpins the last rally. And this means a nasty September/October market is a distinct possibility.

And what does this mean for Ireland? Ok, there is an interesting analysis to be had on the spillover from the potential correction in the US to that in here. In particular, we should look at the fundamentals behind the financial sector risk exposures to any additional shocks. Remember - in 2008 the meltdown of financials was much deeper in Ireland than it was in the rest of the Euroze. And of course in the rest of the Eurozone it was much deeper than in the US.

Why? Risk exposures differentials due to leverage. Americans had a subprime crisis. True. Eurozone had an over-borrowing crisis. Prior to the onset of the financial crisis, US financial sector leveraging was around 40% of GDP, Eurozone stood at 70% of GDP, in Ireland - at well over 350% of GDP. Hmmm... smelling the rat yet?

Well, take a look at the two charts below (courtesy of R&S - Mediobanca):The first chart shows leverage as % of GDP in the financial sector, the second one - risk exposures measured as total securities relative to net tangible equity. Now, for Ireland, the comparable figures are: leverage at 425% (Q1 2009), risk exposure is simply indetrminable as our banks have been engaged in a wholesale re-shifting of liabilities and rewriting of assets, but it is hard to imagine our risk ratios to be less than 15% (given some of our banks are facing 30-39% stress on their loan books).

So if the US were to catch a cold in October, while Europe is to get another bout of flu, Ireland might come down with something so nasty, we wish we had an H1N1 'swine' flu hitting our financial markets...

What's that stock market equivalent of Tamiflu, then?

Daily Economics Update 21/03/2009

Weekly analysis: Irish shares

The volume of shares traded on the New York Stock Exchange has topped the 50-day moving average on six of the seven days that the stock market has been up since March 6 (the day on which the S&P 500 touched its most recent low). The broad benchmark index has gained 15% since that low, sparking hopes of a recovery. The significant issue here is in the volume figure, not in the actual rise in the index, as stronger volumes on a rising trend tend to support more risk-taking and signal investors' support for the trend.

Interestingly, the same, but less pronounced, process has been starting on Friday in the Irish markets.
Chart above shows last week's movements in ISE Total Price Index (IETP), Irish Financials Index (IFIN), AIB, BofI and IL&P shares. Strong upward trajectories here, with significant volatility. But all underpinned by good (well above the average) volumes, as per chart below.This is less pronounced when we normalize daily volumes by historical average, as done in the chart below.
Less extraordinary change is underway above, because we are using moving averages as normalizing variable, implying that we actually capture the inherently rising volatility in volumes traded here. So the above chart actually suggests that while Friday up-tick in share prices (and pretty much the last three day's rally) was reasonably well underpinned, it will take some time to see if market establishes a solid floor under the share prices.

Monthly results so far remain weak. Only BofI was able, so far, to recover all monthly losses and post some gains. AIB is just hitting the point of return to late February valuations. Given that at the point of sale - at the end of February, beginning of March - the volumes traded were 5-7 times those of the current week's peak, it is hard to see the present recovery as being driven by pure psychology and the spillover from the broader global markets (US' momentary lapse of optimism).

Two more charts: recall that in mid February I argued that downgrades in all three financials will come to an end by February's expiration and all three will settle into a nice slow bear rally, running at virtually parallel rates of growth. Chart below shows that this is happening, indeed.Once we normalize prices and account for volumes traded, there is nothing surprising in the share prices movements since the beginning of March. And this is exactly where, as I argued before, the markets should be: awaiting news catalysts...

Market View: Lenihan's Cod Oil Sales Trip?

Weekly round up
We are in a thaw though don’t bet on this being a sign of global warming. The markets have shown some (to some not surprising) bounce in the latest (bear) rally. Across the world and here in Ireland. But the winter isn’t over, yet.

First where it all started from: the US. Some encouraging news:

• The U.S. trade deficit narrowed by 9.7% in January to $36bn, the lowest monthly gap since October 2002. This marks a sixth consecutive decline in the trade deficit, the first case of such extended contraction since the new data collection started in 1992. Oil and petroleum products deficit fell to $14.7bn in January, the lowest since September 2004. Trade deficit with China widened to $20.57bn relative to $20.31bn in the same month last year. Lower prices for inputs and commodities helped. In exports, main decreases were in the areas of capital goods and industrial goods – reflective of the global investment slowdown. Ditto in the area of imports (except that capital goods imports were down less than exports, suggesting companies continue to travel down the cost curve. Details here).
• US University of Michigan/Reuters consumer sentiment index notched up in March to 56.6 from 56.3 one month ago. While this beats analysts’ expectations (55.0), the improvement is hardly significant to signal any improvement in consumer spending and borrowing going forward. This is despite March being the first month of Obama’s massive stimulus plan – not exactly a ringing endorsement (for more on this see here)
  

So the last week came to be a somewhat bullish one with flat US Treasuries, low single-digit gains in commodities and a rally in stocks (up ca 10-14%) with commercial real estate-leading markets, like REITs. Up over 20%.
US Dollar has lost some ground on the Euro, further underlying markets desire to see continued strengthening of the US trade balance. In this beggar-thy-neighbour climate, good news for US is bad news for exports-driven Ireland.

Financials
JP Morgan and Morgan Stanley (first chart below) illustrate the rally for the financials. Most of the sector gains were probably due to rising levels of speculative news flow. If this is a signal of a renewed focus on balance sheet health, expect the rally to turn into a deep correction. Bank of America (BAC) – up some 85% during the week – is a case in point. There is no fundamentally new development, yet this week’s statements about improving outlook on profitability pushed the stock to the top of the financial shares (Citibank (C), Wells Fargo (WFC) etc) performance rankings. The second chart below illustrates, while highlighting the relatively poor performance of non-financials.

Irish Markets
Pretty much the same picture holds for Irish markets. Two of the three remaining banks led the positive momentum with few features of note:

1. Volumes were relatively weak (running at ca ½ of the 52-weeks daily averages);
2. IL&P underperformed (with the markets having little faith in the bank side of the insurer, as in the past);
3. Overall ISEQ posted a lacklustre performance for the week, signaling that the main concerns about Irish economy’s fundamentals are still there.
   

These are illustrated below and show continued theme of volatility around a relatively flat broad markets trend - something I predicted a month ago.
The above concerns, of course are to continue next week as well.

Ireland Inc Sales Pitch
It is now being rumored that Mr Lenihan is going on that 'road trip' to showcase Ireland to UK (and other international) investors. Here is a list of problems that I would put to him at such a sales meeting. All of these basically ask the same question - why would any investor expose herself to Ireland today.

1. Fiscal position: all the indications are that Minister Lenihan will opt for a ‘soft’ solution – raising taxes and refusing to inflict real cuts on the public sector. Thus, ‘savings’ on the current expenditure side will be pushed into 2011 or later as the Minister ‘cuts’ numbers through natural attrition. Taxes will hammer the economy today. Only an insanely naïve person can be convinced by such a strategy.
   
2. Corporate credit: debts problems continue to plague Irish companies, with more roll-overs and re-negotiations of the covenants. This will be compounded in weeks ahead by an accumulation of arrears to contractors and suppliers. Mini-Budget will spell a war of attrition between smaller services providers and larger contracting companies as the former struggle to extract payments in the environment where Messrs Lenihan and Cowen sneaking deeper into peoples' (and thus companies') pockets.
3. Corporate outlook: PE ratios are still too high for Ireland Inc, implying that there is more room for downgrades. In the US, there is more clarity as to the 2010 PE ratios supported by the markets, with a range in 15-20 perceived to be the top during the recovery part of the cycle (whenever this happens). So the expected downgrading room that is still remaining in, say S&P500 is -150 points or ca 20%. In Ireland, the same figures imply probably a range of sustainable 2010-2011 PE ratios of ca 10 (again assuming that we see some recovery starting in 2010 and companies actually living up to the idea of proper disclosure of losses and impairments – something that few of them have done to date). So the bottom line is that we can see ISEQ travelling all the way to 1,470-1,500 before hitting a sustainable U-turn, while IFin might be tumbling down to 200-215.
4. Earnings and demand are going to continue falling in months to come. Although much of this is already built into expectations, the actual numbers are not yet visible through the fog of corporate denial. Banks still lead in terms of balance sheets opacity and the Government is doing nothing less than destroying in a wholesale fashion private workers’ ability to stay afloat on mortgages repayment and consumption. Dividend yields are now poised to continue downward well into 2010 (optimistically) or even past 2011 (pessimistically). So any bottoming-out of the market will coincide with an on-set of an inverted J-styled recovery – we are not getting back to 4-5% long term growth trend once we come out of this recession. A poultry 2% would be a miracle and a Belgian-style 1.2-1.5% GDP growth over the long run is a more likely scenario.
5. Global growth for Ireland Inc is not going to be a magic bullet. The Government has wasted all chances of reforming the least productive sectors in this downturn and is hell-bent on protecting our excessively high cost base. This means we are unlikely to benefit from any serious global growth upturn.
6. Increased global reliance on Governments interventions is going to hurt Irish exports in the long run as national Governments will tend to reduce incentives for outsourcing, leading many MNCs to gradually unwind transfer pricing activities here in Ireland. There is absolutely no chance our Enterprise Ireland-sponsored companies are going to be able to take up the slack.
7. No recovery in Ireland will be possible until house prices and commercial real estate values stabilize and start improving. High debt, diminishing ability to repay existent loans (courtesy of Government raiding households finances to pay for waste in the public sector and a growing army of consultants – e.g Alan Ahearne & Co) all mean that there is no prospect for a return in house values growth until, possibly, well after 2013. Absent such a recovery, there will be no sustained rallies in other asset classes.
8. Finally, there is a psychological shift that is underway when it comes to Irish public perceptions of asset markets. This shift is now counter-positing a 40-50% decline in house prices against a 90% decline in most popular equity categories and a wipe-out of investors in nationalized (and potentially yet to be nationalized) banks. The return of a growth cycle is unlikely to trigger significant movement of households’ cash into Irish stocks. This will be further compounded by the aversion to leveraging and continued credit rationing (induced via new banking regulations and investor hysteresis).
   

So the conclusion is a simple one – Irish equities recovery is nowhere near becoming a reality. Expect further turbulence on a generally downward trajectory in weeks ahead, followed by a potential spike of misplaced short-term optimism in the wake of the mini-Budget. Once the investors work through the forthcoming Government decisions, it will be down again for ISE.

IL&P: next in line? Update III

And it all is going so swimmingly along the lines of my predictions... except...

Volumes on IL&P were actually up relative to the markets per the first chart below (most likely due to the retail investors still running through some spare cash),and subsequently, correlation between IL&P and the broader sector is staying out of the range where IL&P price deterioration can be attributed to the market-wide downgrade alone (chart below),
but the general price direction of IL&P is pretty much bang on my forecast (per second chart below): after a short uptick earlier in the week, we are again in the rapid downward momentum relative to other banks stocks.The twin stories unfolding alongside each other:

• renewed Bear market momentum for the Irish banking sector, and
• more severe downgrades in IL&P than in the sector itself

are not over yet, so expect a bumpy ride today and more downgrades next week. This week, the catalyst for the sector was a clearly anemic bond issue signaling a threat to the banks guarantee scheme and to the capacity of the state to continue injecting capital into the banking system. Next week - balance sheet worries, lack of any coherent plan on bad assets on behalf of the State plus the Live Register figures - out on Wednesday - will be back to the fore... Oh, and there is an added pressure emerging as well - the rising risk premium on political instability...