8/6/21: This Recession Is Different: Corporate Profits Boom

 

Corporate profits guidance is booming. Which, one might think, is a good signal of recovery. But the recession that passed (or still passing, officially) has been abnormal by historical standards, shifting expectations for the recovery to a different level of 'bizarre'.

Consider non-financial corporate profits through prior cycles: 

Chart 1 above shows non-financial corporate profits per 1 USD of official gross value added in the economy. In all past recessions, save for three, going into recession, corporate profit margins fell below pre-recession average. Three exceptions to the rule are: 1949 recession, 1981 recession and, you guessed it, the Covid19 recession. In other words, all three abnormal recessions were associated with significant rises in market power of producers over consumers. And prior abnormal recessions led to subsequent need for monetary tightening to stem inflationary pressures. Not yet the case in the most recent one.

The second chart plots increases in corporate profit margins in the recoveries relative to prior recessions. Data is through 1Q 2021, so we do not yet have an official 'recovery' quarter to plot. If we are to treat 1Q 2021 as 'recovery' first quarter, profits in this recovery are below pre-recovery recession period average by 2 percentage points. Again, the case of two other recessions compares: the post-1949 recession recovery and post-1980s recovery are both associated with negative reaction of profits to economic cycle shift from recession to recovery.

Which means two things:

1. Market power of producers is rising from the end of 2019 through today, if we assume that 1Q 2021 was not, yet, a recovery quarter (officially, this is the case, as NBER still times 1Q 2021 as part of the recession); and
2. Non-financial corporate profits boom we are seeing reported to-date for 2Q 2021 is a sign not of a healthier economy, but of the first point made above.

In effect, some evidence that Covid19 pandemic was a transfer of wealth from people to companies that managed to trade through the crisis. 

27/521: Euromoney on China's Belt-and-Road Initiative

 

Euromoney recently covered update of risk analysis involving development of China-led Belt and Road initiative: https://www.euromoneycountryrisk.com/article/b1rs0cw1v2yv4d/ebri-q1-2021-results-chinas-belt-and-road-potential-outweighs-challenges. Includes my POV.

7/5/21: Record Wealth in the Post-Covid World... for the select few

 Demolishing American middle class... one year at a time

5/4/21: The Entrepreneurship Boom: Forced, Voluntary and Funded

 

My recent article for The Currency covering the ongoing global developments in entrepreneurship: The US is experiencing an entrepreneurship boom. So, what is going wrong in Ireland?: https://thecurrency.news/articles/40790/the-us-is-experiencing-an-entrepreneurship-boom-so-what-is-going-wrong-in-ireland/

3/2/21: Monetary Easing and Stock Market Valuation

There has been quite a puzzling development in recent years in the monetary policy universe. A decade plus of ultra low interest rates has been associated with rising, not falling, risk premium in investment markets. In other words, a dramatically lower cost of new and carried debt induced by lower interest rates - a driver for lower risk, is being offset by something else. What?

Laine, Olli-Matti paper "Monetary Policy and Stock Market Valuation" (September 18, 2020, Bank of Finland Research Discussion Paper No. 16/2020: https://ssrn.com/abstract=3764721) tries to explain. 

To start with, some theory - especially for my students in the Investment and Financial Systems courses. Per author, "the value of a stock is the present value of its expected future dividends... Hence, the changes in stock prices must be explained by 

• either changes in dividend expectations or 
• changes in discount rates. 

The discount rate, or (approximately) expected rate of return, can be thought as a sum of a risk-free rate and a risk premium. Theoretically, monetary policy should have an effect on stock prices through the risk-free rates. In addition, monetary policy should affect dividend expectations, for example, through the output or debt interest payments of firms. The effect on the risk premium (not to mention the term structure of risk premia), however, is less clear."

Looking at Eurostoxx50 index components, Laine shows "...that the average expected premium has increased considerably since the global financial crisis. This change is explained by the change in long-horizon expected premia. ... monetary policy easing has had a positive impact on the expected average premium."

Specifically (emphasis added): "a negative shock to the shadow rate is estimated to increase average expected premium persistently. Instead, the results show that monetary policy easing temporarily decreases short-term expected [risk] premia. This means that expansionary monetary policy steepens the slope of the term structure of risk premia."

This is not exactly new, as Bernanke and Kuttner (2005) observed that "expansionary monetary policy generates an immediate rise in equity prices followed by a period of lower-than-normal excess returns. ...However, Bernanke and Kuttner (2005) do not study the effect on the long-run excess returns. My results show that effect on long-horizon expected premia has a different sign. This effect on long-horizon premia seems to more than offset the effect on short-horizon premia."

Interestingly, "Contractionary monetary policy increases the short-term premia temporarily, but decreases long-horizon premia persistently. The effect on average expected premium is negative. Thus, monetary policy tightening actually makes stocks expensive relative to the expected stream of dividends. The results provide no evidence that expansionary monetary policy causes stock market bubbles..."

Here is (annotated by me) a chart showing evolution of implied and actual risk premia:

From theory perspective, therefore, monetary policy "can affect equity prices through the dividend expectations, expected risk-free rates or expected premia":

• "The effect of expansionary monetary policy on the dividend expectations is probably positive, because expansionary monetary policy can be expected to increase output and firms’ earnings.
• "Expansionary policy probably lowers the risk-free rates, but it is also possible that the effect is totally different. Central bank’s rate cut can increase risk-free rates, if people think that the rate cut eventually increases inflation. 
• "As for the expected premium, the sign of the effect is unclear. ... Gust and López-Salido (2014) show theoretically that expansionary monetary policy lowers the premium ... where asset and goods markets are segmented. When it comes to quantitative easing, ... investors who have sold their assets to the central bank rebalance their portfolios into riskier assets, which lowers their expected returns. ... Theoretically, it is also possible to argue that monetary policy easing actually increases the expected premium. If one assumes that there exists mispricing like Galí (2014) and Galí and Gambetti (2015), then the sign of the response is ambiguous. ... This means that monetary policy easing increases the expected premium implied by dividend discount model (see Galí and Gambetti, 2015, p. 250-252)."

So, onto the empirical results by Laine: 

1. "Interest rates have declined considerably since the global financial crisis, yet the expected average stock market return has remained quite stable at around 9 percent. This implies that expected average stock market premium has increased remarkably. This rise is mainly explained by the premia over a discounting horizon of four years.
2. "These results may seem unintuitive as the prices of stocks have risen, and ratios like price-to-earnings have been historically high. However, high price-to-earnings ratios do not necessarily mean that stocks are expensive, because the value of a stock is the present value of its expected future dividends.
3. "When it comes to the role of monetary policy, the results show that monetary policy easing decreases short-horizon required premia, but increases longer-horizon premia. 
4. "The effect on expected average premium is positive, i.e. expansionary monetary policy lowers the prices of stocks in relation to the expected dividend stream."

2/2/21: The Disaster of Investing via Smartphones?

Some stuff I've been reading that (sometimes) falls into current newsflow: 

Kalda, Ankit and Loos, Benjamin and Previtero, Alessandro and Hackethal, Andreas paper, titled "Smart(Phone) Investing? A within Investor-Time Analysis of New Technologies and Trading Behavior"from January 2021 (NBER Working Paper No. w28363, https://ssrn.com/abstract=3772602) :

The authors tackle an interesting issue relating to the automated and low cost investing platforms (proliferating in this age of fintech). Per authors (emphasis is mine, throughout): "Technology has dramatically changed how retail investors trade, from placing orders using direct dial-up connections in the 1980s or Internet-based trading in the 1990s to the more recent rise of robo-advisers. With few exceptions, the introduction of these new technologies is generally associated with a decline in investor portfolio efficiency." In addition, "whether good or bad for investors, it is accepted that new technologies influence investor behavior". 

In this unique study, the authors used data that comes "from two large German retail banks that have introduced trading applications for mobile devices. For over 15,000 bank clients that have used these mobile apps in the years 2010-2017, we can observe all holdings and transactions, and, more important, the specific platform used for each trade (e.g., personal computer vs. smartphone). [As the result of having such a granular data over time] we can conduct all our main tests comparing trades done by the same investor in the same month across different platforms."

The authors present four sets of results:

1. "First, we study if the use of smartphones induces differences in the riskiness of trades. Comparing trades by the same investor in the same year-month, we find that the probability of purchasing risky assets increases in smartphone trades compared to non-smartphone ones. 
• "smartphone trades involve assets with higher volatility and more positive skewness. [Thus], smartphones increase the probability of buying lottery-type stocks by 67% of the unconditional mean for smartphone users."
2. "Second, we examine the effects of smartphones on the tendency to chase past returns. We find that smartphones increase the probability of buying assets in the top decile of the past performance distribution. Smartphones increase the probability of buying assets in the top 10 percent of past performance by 12.0 percentage points (or 70.6% of the unconditional mean)." In other words, smartphones trades involve severe and pervasive biases in investor decision making.
3. "Third, we investigate if investors selectively use smartphone to execute their risky, lottery-type, and trend-chasing trades. In this scenario, investors could simply substitute their trades from one device to another, without any real consequences for their overall portfolio efficiency. ....We find that, following the launch of smartphone apps, investors are—if anything—more likely to purchase risky and lottery-type assets and to chase hot investments also on non-smartphone platforms. ...this evidence potentially suggests that investors are learning to become overall more biased after their initial use of smartphones to trade."
4. "...smartphone effects are stronger during after-hours (i.e. following exchange closure). Institutional differences between trading on official exchanges and in after-hours markets do not drive this heterogeneity. Given that individuals are more likely to rely on the more intuitive system [System 1-type] later in the day (Kahneman,2011), stronger effects during after-hours are consistent with smartphones facilitating trades based more on [intuitive] system thinking."

As an interesting aside, it is worth noting that the above results have nothing to do with the demographic biases or the potential lack of trading experience by smartphone-using investors. As noted by the authors: "German investors that adopt smartphone trading are, on average, 45 years old with nine years of experience investing with the banks."

Another aside is that authors also tested if the adverse effects of smartphones-based trading can be attributed to the first / early usage of these devices. It turns out not: "The effects of smartphones are stable from the first quarter of usage up to quarter nine or afterwards. The effects on volatility and skewness of trades, and probability of purchasing past winners are also stable over time."

To conclude: "Collectively, our evidence suggests that investors make more intuitive (system 1-type) decisions while using smartphones. This tendency leads to increased risk-taking, gambling-like activity, and more trend chasing. Previous studies have linked these trading behaviors to lower portfolio efficiency and performance. Therefore, the convenience of smartphone trading might come at a cost for many retail investors."

Ouch! Then again, this is fitting well with what we are observing happening in the markets these days: amplified herding, trend chasing, lottery-like speculative swings in investment capital flows, recency effects of overbidding for previously outperforming stocks and so on. 

13/11/20: The economy has two chronic illnesses (and neither are Covid)

My column for The Currency this week covers two key long-term themes in the global economy that pre-date the pandemic and will remain in place well into 2025: the twin secular stagnations hypotheses and the changing nature of the productivity. The link to the article is here; https://thecurrency.news/articles/28224/the-economy-has-two-chronic-illnesses-and-neither-are-covid/. 

 

31/10/20: Gold Coins Market is Still Hedging Residual Covid Risk

Sales of the U.S. Mint gold coins have moderated off their pandemic highs, but remain elevated by historical standards, especially controlling for higher gold prices:

Since hitting a pandemic-period high of 216,500 oz in March 2020 (the highest sales volume since April 2013), the demand has moderated through June, topped 145,000 in July and 149,000 oz in August, and has been around 91,500 through the four weeks of October. This puts October sales above the last three years' average.

Average gold weight per coin sold remains relatively elevated and is co-trending with price per oz, most likely indicating lasting FOMO effect (herding by investors). The correlation is weaker than during prior episodes of major crises and recessions, suggesting that the pandemic-period demand is probably less influenced by the herding effects than in prior crises.

Annualized data through October also confirms precautionary, but not 'flight to safety' type of demand:

As the pandemic re-accelerates, it will be interesting to see how seasonality (uplift in end-of-year sales) plays out against the pandemic-related hedging positioning of investors.

4/10/20: Technological Deepening Is Coming for Our Jobs

 

In my recent article for The Currency (link here: https://trueeconomics.blogspot.com/2020/09/my-recent-article-on-potential-long.html), I argued that COVID19 will act as an accelerator of technological capital deepening in the modern economies, with a resulting faster displacement of workers (including highly skilled ones) by technology. 

McKinsey survey of the developing trends in businesses strategic responses to the pandemic confirms my hypothesis:

Per above, across all sectors, and (peer charts below) across specific sectors, businesses are planning to prioritize deployment of technology in addressing long-term change in response to the current pandemic. 

McKinsey state that "Fifty-five percent of leaders anticipate that at least half of their organization’s workforce will be fully or partially remote postcrisis. While the expectations vary widely by industry—from 69 percent predicting this level of remote work in technology, telecommunications, and media to 43 percent in advanced industries—even in the industries where manufacturing, patient care, and sales transactions often require people at offices, stores, plants, and other company facilities, a significant portion of the workforce may be partially or fully remote." Source: https://www.mckinsey.com/business-functions/organization/our-insights/the-need-for-speed-in-the-post-covid-19-era-and-how-to-achieve-it. And "Our survey results show that executives are focused on three courses of action ... making good decisions more quickly, improving communication and collaboration, and making greater use of technology."

26/9/20: Workers Should Brace Themselves for the post-COVID19 New World

 

My recent article on potential long-term impacts of COVID19 pandemic on corporate development and investment strategies for The Currency: https://www.thecurrency.news/articles/24259/workers-should-brace-themselves-things-will-only-get-worse. 

17/9/20: Stonks are Getting Balmier than in the Dot.Com Heat

Via Liz Ann Sonders @LizAnnSonders of Charles Schwab & Co., Inc. a neat chart summarizing the madness of the King Market these days:

Yeah, right: PE ratio is heading for dot.com madness levels, PEG ratio (price earnings to growth ratio or growth-adjusted PE ratio) is now vastly above the dot.com era peak, and EPS is closer to the Global Financial Crisis era lows. 

What can possibly go wrong, Robinhooders, when a mafia don gifts you some chips to wager at his casino?

25/7/20: Markets and COVID19: Unwinding Restrictions

My column for Manning Financial on the direction of the markets in the period of COVID19 restrictions unwinding: https://cfc.ie/2020/07/10/where-to-mr-market/.

24/7/20: Bonds v Stocks: Of Yields, Investors and Large Predators

Corporates are reeling from the COVID19 pandemic impacts, yet stocks are severely overpriced by all possible corporate finance metrics. Until, that is, one looks at bonds.

Over the 3 months through June 2020, average 10 year U.S. Treasury yield has been 0.69 percent. Over the same period, average S&P500 dividend yield was 2.02 percent. The gap between the two is 1.33 percentage points, which (with exception of March-May average gap of 1.42 points) is the highest in history of the series (from 1962 on).

Given that today's Treasuries are carrying higher liquidity risk (declining demand outside the official / Fed demand channel) and higher roll-over risks (opportunity cost of buying Ts today compared to the future), the real (relative) bubble in financial markets todays is in fixed income. Of course, in absolute returns terms, long-term investment in either bonds or equities today is equivalent to a choice of being maimed by a T-Rex or being mangled by a grizzly. Take your pick.

29/6/20: The Scale and Distributional Effects of Monetary Activism During Pandemic

A neat summary of global monetary policy supports deployed during the COVID19 pandemic via McKinsey & Co:

In effect, globally, monetary authorities are underwriting government and private corporate debt for larger companies. This, naturally, will lead to reduced investment and competition from smaller firms, including more innovative ones, raising the relative cost of debt to these companies. Both, directly and indirectly, the monetary policies favour equity investment in top-tier, larger companies, effectively increasing not only the cost of debt, but the cost of capital in the medium term for smaller and medium-sized companies.

13/6/20: Gold Coins Sales are Up, and the Markets are Screaming Something New

Some interesting movements in demand for gold coins in recent months, worth watching:

Price is up, and volume of sales is quite volatile. Still, sales are hitting highs.

• Following weaker y/y January and February, March 2020 sales rose almost x10 y/y in volume and average coin sold size rose from 0.5 oz in March 2019 to 0.674 oz in March 2020. 
• April 2020 sales were x3.25 times sales in April 2019 by volume, with average coin size rising to 1.0 oz. May saw a major fall-off in demand m/m but still posted sales x2.26 time those of May 2019, with average coin sold size down to 0.538 oz per coin. 
• Through June 13, June monthly sales are already x2.75 times higher than sales for the entire month of June 2019, with average coin size sold so far this June running at 0.985 oz per coin, against 0.625 oz per coin in June 2019. 

It seems investors still showing little signs of moderating safe haven demand for gold, despite robust performance in the financial markets until this week profit-taking blowout. 

Gold can be seen as both a hedge and safe haven against a range of key financial and political risks, but it can also be viewed as a long-run wealth storage tool, and, given its liquid nature, as a precautionary savings instrument for tail risks. If the current demand remains robust in the face of rising gold prices, we are likely witnessing a risk-return relationship/expectations shift amongst the savers and investors, away from considering trend-driven investment strategy of thee recent years and in favour of investing against a major concern for significant tail risks driving the markets in months and years ahead.

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.

6/5/20: S&P500 Earnings and Revenues Growth 1Q 2020

With early effects of COVID19 pandemic in:

Both charts via Factset.

14/2/20: Pandemics, Panics and the Markets

In my recent article for The Currency I wrote about the expected market effects of the 2019-nCov coronavirus outbreak: https://www.thecurrency.news/articles/8490/constantin-gurdgiev-pandemics-panics-and-the-markets.

While past pandemics are not a direct nor linear indicators of the future expected performance, the logic and the dynamics of the past events suggest that while the front end short term effects of pandemics on the economies and the markets can be significant, over time, rebounds post-pandemics tend to fully offset short run negative impacts.

Key conclusions from the article are:

• "...The market appears to worry little about public health risks, after their impact becomes more visible, although the onset of a pandemic can be associated with elevated markets volatility. This volatility is higher the faster the evolution of the health scare, but so is the market rebound from each crisis lows."
• "This is not say that investors have little to worry about in today’s markets. We are still trading in the heavily over-bought market, and concerns about global growth are not getting much of a reprieve from the newsflows. The good news is, to date, the latest global health crisis does not seem to be a trigger for a major and sustained sell off. The bad news is, we are yet to see its full impact."

21/1/20: Investor Fear and Uncertainty in Cryptocurrencies

Our paper on behavioral biases in cryptocurrencies trading is now published by the Journal of Behavioral and Experimental Finance volume 25, 2020:

We cover investor sentiment effects on pricing processes of 10 largest (by market capitalization) crypto-currencies, showing direct but non-linear impact of herding and anchoring biases in investor behavior. We also show that these biases are themselves anchored to the specific trends/direction of price movements. Our results provide direct links between investors' sentiment toward:

1. Overall risky assets investment markets,
2. Cryptocurrencies investment markets, and
3. Macroeconomic conditions,

and market price dynamics for crypto-assets. We also show direct evidence that both markets uncertainty and investor fear sentiment drive price processes for crypto-assets.

15/1/20: S&P500 Historical Performance

Via BAML and @tracyalloway, a chart plotting the distribution of annual returns on S&P500, 1872-2019:

The stylised nature of this plot allows us to see the right-skew in the distribution, across all 

'bins', especially for the last decade.