6/5/20: S&P500 and Fundamentals: What should matter, doesn't

S&P500 and earnings per share: what should matter, doesn't

We are now in extreme territory of the markets ignoring basic corporate fundamentals.

28/9/19: Evidence of Systemic Risk from Major Cybersecurity Breaches

In our post for Columbia Law School's CLS Blue Sky Blog, myself and Shaen Corbet explain in non-technical terms our ground-breaking findings on systemic nature of cybersecurity risks in financial markets:

• LexBlog link: https://www.lexblog.com/2019/09/26/evidence-of-systemic-risk-from-major-cybersecurity-breaches/
• CLS link: http://clsbluesky.law.columbia.edu/2019/09/27/evidence-of-systemic-risk-from-major-cybersecurity-breaches/
• Original working paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3033950
• Published paper: https://www.sciencedirect.com/science/article/pii/S1057521919300274.

Our study is the first in the literature showing evidence of systemic contagion from cyber attacks on one company to other companies and stock exchanges.

Based on these findings, we have a chapter forthcoming in an academic volume on the future of regulation, proposing a novel mechanism for regulatory detection, monitoring and enforcement of cybersecurity risks. We will post this chapter when it goes to print, 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: https://macromon.wordpress.com/2018/10/03/alea-iacta-est/.  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 (https://www.yardeni.com/pub/buybackdiv.pdf)

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.

2/1/16: Financial digital disruptors and cyber-security risks

My and Shaen Corbet's new paper titled Financial digital disruptors and cyber-security risks: paired and systemic (January 2, 2017), forthcoming in Journal of Terrorism & Cyber Insurance, Volume 1 Issue 2, 2017 is now available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2892842.

Abstract:
The scale and intensity of digital financial criminality has become more apparent and audacious over the past fifteen years. To counteract this escalating threat, financial technology (FinTech) and monetary and financial institutions (MFI) have attempted to upgrade their internal technological infrastructures to mitigate the risk of a catastrophic technological collapse. However, these attempts have been hampered through the financial stresses generated from the recent international banking crises. Significant contagion channels in the aftermath of cybercriminal events have also been recently uncovered, indicating that a single major event may generate sectoral and industry-wide volatility spillovers. As the skillset and variety of tactics used by cybercriminals develops further in an environment of stagnating and underfunded defensive technological structures, the probability of a devastating hacking event increases, along with the necessity for regulatory intervention. This paper explores and discusses the range of threats and consequences emanating from financial digital disruptors through cybercrime and potential avenues that may be utilised to counteract such risk.