12/1/2015: Euro area and Russian Economic Outlooks: 2015

My comments to the Portuguese Expresso, covering forecasts for 2015 for Russia and the Euro area:

- Russia

Despite the end-of-2014 abatement of the currency crisis, Russian economy will continue to face severe headwinds in 2015. The core drivers for the crisis of 2014 are still present and will be hard to address in the short term.

Geopolitical crisis relating to Eastern Ukraine is now much broader, encompassing the direct juxtaposition of the Russian strategy aimed at securing its regional power base and the Western, especially Nato, interest in the region. This juxtaposition means that risks arising from escalated tensions over the Baltic sea and Eastern and Central Europe are likely to remain in place over the first half of 2015 and will not begin to ease until H2 2015 in the earliest. With them, the prospect of tougher sanctions on Russian economy is unlikely to go away.

While capital outflows are likely to diminish in 2015, Russia is still at a risk of increased pressures on the Ruble due to continued debt redemptions calls on Russian companies and banks. In H1 2015, Russian companies and banks will be required to repay ca USD46 billion in maturing debt, with roughly three quarters of this due to direct and intermediated lenders not affiliated with the borrowers. These redemptions will constitute a direct cash call of around USD25 billion, allowing for some debt raising in dim sum markets and across other markets not impacted by the Western sanctions. USD36.3 billion of debt will mature in H2 2015, which implies a direct demand for some USD17-20 billion in cash on top of H1 demand. The peak of 2015 debt maturity will take place in Q1 2015, which represents another potential flash point for the Ruble, especially as the Ruble supports from sales of corporate foreign exchange holdings requested by the Government taper off around February.

Inflation is currently already running above 10 percent and this is likely to be the lower-end support line for 2015 annual rate forecast. Again, I expect spiking up in inflation in H1 2015, reaching 13-14 percent, with some stabilisation in H2 2015 at around 11 percent.

Economic growth is likely to fall off significantly compared to the already testing 2014.

Assuming oil prices average at around USD80 per barrel (an assumption consistent with December 2014 market consensus forecast), we can expect GDP to contract by around 2.2-2.5 percent in 2015, depending on inflation trends and capital outflows dynamics.

Lower oil prices will lead to lower growth, so at USD60 per barrel, my expectation is for the economy to shrink by roughly 4-5 percent in 2015. Crucially, decline in economic activity will be broadly based. I expect dramatic contraction in domestic demand, driven by twin collapse in consumer spending and private investment. In line with these forces, demand for imports will decline by around 15 percent in 2015, possibly as much as 20 percent, with most of this impact being felt by European exporters. Public investment will lag and fiscal tightening on expenditure side will mean added negative drag on growth.

About the only positive side of the Russian economy will be imports substitution in food and drink sectors, and a knock on effect from this on food processing, transportation and distribution sectors.

To the adverse side of the above forecasts, if interest rates remain at current levels, we can see a broad and significant weakening in the banks balance sheets and cash flows arising from growth in non-performing loans, and corporate and household defaults, as well as huge pressure on banks margins and operating profits. This can trigger a banking crisis, and will certainly cut deeper into corporate and household credit supply.

On the downside of my forecast, a combination of lower oil prices (average annual price at around USD50-60 per barrel) and monetary tightening, together with fiscal consolidation can result in economic can result in a recession of around 7 percent in 2015, with inflation running at around 13 percent over the full year 2015.

Even under the most benign assumptions, Russian economy is facing a very tough 2015. Crucially, from the socio-economic point of view, 2015 will see two adverse shocks to the system: the requirement to rebalance public spending on social benefits in order to compensate for inflation and Ruble devaluation pressures, and the rising demand on social services from rising unemployment. Volatility will be high through H1 2015, with crisis re-igniting from time to time, causing big calls on CBR to use forex reserves and prompting escalating rhetoric about political instability. We can also expect Government reshuffle and rising pressure on fiscal policy side. The risk of capital controls will remain in place, but. most likely, we will have to wait until after the end of Q1 2015 to see this threat re-surfacing.


- Eurozone

2014 was characterised by continued decoupling of the euro area from other advanced economies in terms of growth. Stagnation of the euro area economy, arising primarily from the legacy of the balances sheet crisis that started in 2007-2008 will remain the main feature of the regional economy in 2015. Despite numerous monetary policy innovations and the never-ending talk from the ECB, the European Commission and Council on the need for action, euro area's core problems remain unaddressed. These are: public and private debt overhangs, excessive levels of taxation suppressing innovation and entrepreneurship, a set of substantial demographic challenges and the lack of structural drivers for productivity growth.

My expectation is for the euro area economy to expand by around 0.8-1 percent in 2015 in real terms, with inflation staying at very low levels, running at an annual rate of around 0.6-0.7 percent. Inflation forecast is sensitive to energy prices and is less sensitive to monetary policy, but it is relatively clear that consumer demand is unlikely to rebound sufficiently enough to lift inflation off its current near-zero plateau. Corporate investment will also remain stagnant, with exception of potential acceleration in M&A activities in Europe, driven primarily by the build up in retained corporate earnings on the balance sheets of the North American and Asian companies.

Barring adverse shocks, growth will remain more robust in some of the hardest-hit 'peripheral' economies, namely Ireland, Spain and Portugal. This dynamic is warranted by the magnitude of the crisis that impacted these economies prior to 2013. Thus, the three 'peripherals' will likely out-perform core European states in terms of growth. Italy, however, will remain the key economic pressure point for the euro area, and Greece will remain volatile in political terms. Within core economies, recovery in Germany will be subdued, but sufficient enough to put pressure on ECB and the European Commission to withdraw support for more aggressive monetary and fiscal measures. France will see little rebound from current stagnation, but this rebound will be relatively weak and primarily technical in nature.

Crucially, the ECB will be able to meet its balance sheet expansion targets only partially in 2015. Frankfurt's asset base expansion is likely to be closer to EUR300-400 billion instead of EUR500 billion-plus expected by the policymakers. The reason for this will be lack of demand for new funding by the banks which are still facing pressures of deleveraging and will continue experiencing elevated levels of non-performing loans. In return, weaker than expected monetary expansion will mean a shift in policymakers rhetoric toward the thesis that fiscal policies will have to take up the slack in supporting growth. We can expect, therefore, lack of progress in terms of fiscal consolidations, especially in France and Italy, but also Spain. All three countries will likely fail to meet their fiscal targets for 2015-2016. Thus, across the euro area, government debt levels will not post significant improvement in 2015, carrying over the pain of public sector deleveraging into 2016.

As the result of fiscal consolidation slack, growth will be more reliant on public spending. While notionally this will support GDP expansion, on the ground there will be little real change - European economies are already saturated with public spending and any further expansion is unlikely to drive up real, ROI-positive, activity.

Overall, euro area will, despite all the policy measures being put forward, remain a major drag on global growth in 2015, with the regional economy further decoupling from the North American and Asia-Pacific regions. The core causes of European growth slump are not cyclical and cannot be addressed by continuing to prime the tax-and-spend pump of traditional European politics. Further problem to European growth revival thesis is presented by the political cycle. In the presence of rising force of marginal and extremist populism, traditional parties and incumbent Governments will be unable to deploy any serious reforms. Neither austerity-centric deleveraging approach currently adopted by Europe, nor growth-focused reforms of taxation and subsidies mechanisms will be feasible. Which simply means that status quo of weak growth and severe debt overhangs will remain in place.

The above outlook is based on a number of assumptions that are contestable. One key assumption is that of no disruption in the current sovereign bonds markets. If the pick up in the global economy is more robust, however, we can see the beginning of deflation in the Government bonds markets, leading to sharper rise in 'peripheral' and other European yields, higher call on funding costs and lower ability to issue new debt. In this case, all bets on fiscal policy supporting modest growth will be off and we will see even greater reliance in the euro area on ECB stance.

11/1/2015: ECB's Favourite Inflation Expectations Indicator is Smokin...

And here's a nice reminder courtesy of @SoberLook.com of the markets' view of 5-year-to-10-year forward inflation expectations for the euro area:

Note: 5y/5y inflation swap basically measures expected inflation for the period of between 5 years from now and 10 years from now (5 years over 5 years from now). Here is a note on its importance to ECB policy http://www.itcmarkets.com/news-press/itc-egbs-questions-regarding-draghis-reference-to-5y5y-forward-rate-and-inflation.

Needless to say, at ECB inflation target of 2% over the next 1-2 years, we should be expecting 5y/5y to be above 2% mark, not below it. And if previous (2004-2007 period) should be our guide for growth, we should be looking at 5y/5y swap rate at around 2.4%.

Which means the 'flashing red' indicator for ECB is now smoking.

11/1/2015: Ending 2014 with a Bang: Russian Inflation & Ruble Crisis

Couple footnotes to 2014, covering Russian economic situation. Much is already known, but worth repeating and tallying up for the full year stats.

Ruble crisis with its most recent up and down swings took its toll on both currency valuations and inflation. Over 2014, based on the rate tracked by the Central Bank of Russia, the ruble was down 34% against the euro and 42% against the USD. The gap reflects depreciation of the euro against the USD.

Virtually all of this relates to one core driver: oil prices. In 2014, Brent prices lost 48% of their values and Urals grade lost 52% of its value. Urals is generally slightly cheaper than Brent, but current gap suggest relatively oversold Urals. It is a bit of a 'miracle' of sorts that Ruble failed to completely trace Urals down, but overall, you can see the effect oil price has - overriding all other considerations, including capital flight and sanctions.

Ruble valuations took their toll on Moscow Stock Exchange - RTS index, expressed in USD, lost 43% of its value, reaching levels comparable to Q1 2009 (791 at the end of 2014, from 1,388 at the start of January 2014).

And ruble crisis pushed inflation well ahead of 5% short term target from CBR set for 2014. Preliminary estimates for December put inflation at 11.4%, with food inflation at 15% (7.3% in 2013), goods (ex-food) at 8% (4.5% in 2013) and services at 10% (8% in 2013). M/m inflation hit 2.6% in December 2014 - the highest since January 2005). Overall inflation was 6.5% in 2013, 6.6% in 2012, 6.1% in 2011 and 2010 and 8.8% in 2009. Last time Russian inflation hit double digit figures was in 2008 - at 13.3%.

Comment via BOFIT: "The pick-up in inflation at the end of the year reflected the ruble’s sharp depreciation and the ensuing frenzy of household spending. Following the ban on certain categories of food imports last autumn, food prices have risen even if no food shortage has actually emerged." Most of this is pretty much as reported. One point worth highlighting - lack of shortages, which is contrary to some of the hype paraded in the media about Russians suffering greatly from diminished supplies and stores running out of goods.

Again per BOFIT: "Representatives of food producers and retail chains committed in September to a government initiative that their members would not raise prices without good reason or create artificial shortages in the market. There has been no move by the government as yet to impose price controls as in 2010. The agreement could have limited price increases somewhat."

And a chart from the same source illustrating pick up in inflation:

Update: Some more numbers on inflation: Meat prices were up 20.1% in 2014, having posted deflation of 3% in 2013; fish prices were up 19.1% in 2014, a big jump on 7.6% inflation in 2013. Cereals are up 34.6% against 3.2% in 2013.

10/1/2015: Where did Europe's EUR3 trillion worth of debt go?

You know the Krugmanite meme… Euro area is doing everything wrong by not running larger deficits. But here is an uncomfortable reality: since 2007, Euro area countries have managed to increase their debt in excess of 60% of GDP by a staggering EUR3 trillion.

So here's the crux of the problem: where did all this money go?

We know in terms of geographic distribution:

EUR1.6 trillion of this debt increase went to the 'peripheral' countries, and EUR39.2 billion went to the Easter European members of the Euro area. EUR517 billion went to the 'core' economies. And a whooping EUR759.9 billion to France. Now, across the 'periphery' some 20-25% of the debt increase is attributable to the banks measures directly, but the rest is a mix of automatic stabilisers (e.g. increases in unemployment benefits due to higher unemployment) and old-fashioned Keynesian policies.

It might be that Euro area is not spending enough in the right areas of fiscal policy. But to make an argument that it is not spending enough across the board is bonkers. We have allocated some EUR3 trillion in borrowed spending and we will continue to run the debt up in 2015. And still there is no sign of growth on the horizon.

So, again, where is all this money going?

10/1/2015: Irish Retail Sales: November

Irish retail sales figures for November, published by the CSO earlier this week came in at the weaker end of the trend. Here is detailed analysis.

On seasonally-adjusted basis:

• Value of retail sales ex-motors fell 0.31% m/m in November having posted a 1.04% gain in October. 3mo MA through November was down 0.11% on 3mo MA through October, which itself was down 0.07% on 3mo MA through September.
• Volume of retail sales ex-motors was up 0.19% m/m in November, having posted a rise of 0.96% in October. 3mo MA through November was up 0.26% m/m  for the 3 months through November compared to 3mo MA through October, having previous posted identical increase in October, compared to 3mo MA through September.
• Meanwhile, Consumer Confidence was, for a change, more closely aligned with value of sales indicator. Consumer Confidence indicator was down0.23% m/m in November, having posted 0.68% decline in October.

Two charts to illustrate:

The first chart above plots longer-range series, showing two main insights:

1. Consumer confidence continues to vastly outpace actual retail sales performance in terms of both value and volume of sales, although we are starting to see de-acceleration in consumer confidence growth in terms of trend. Nonetheless, consumer confidence bottomed-out around July 2008. Actual retail sales did not bottom out until June 2012 (in Volume and Value of sales terms).
2. Since bottoming out, retail sales have been performing with virtually divergent dynamics. Trend in Volume of sales is relatively strong, upward. Meanwhile, trend in Value of sales is relatively flat, upward. In more recent months, this divergence is increasing once again.

The above is again confirmed in November data and in year-on-year comparatives too, as shown in the next chart.

Year on year (based on seasonally unadjusted data):

• Value of retail sales ex-motors rose 1.33% y/y in November having posted a 1.91% gain y/y in October. 3mo MA through November 2014 was up only 1.4% on 3mo MA through November 2013.
• Volume of retail sales ex-motors was up robust 3.92% y/y in November, having posted a rise of 4.40% in October. 3mo MA through November was up 3.7% y/y.

The above data clearly supports trends identified in previous months: Irish consumers are not striking, nor are they holding back consumption. Instead, they are willing to buy when they see value. Unfortunately for our retailers, that means more sales with lower profit margins. As the chart below shows, we now have 13 consecutive months of growth in volume of sales outstripping value of sales and out of the last 21 months, only one posted growth rate in value of sales in excess of volume of sales.

Using my Retail Sector Activity Index to plot underlying activity across the sector (note: the RSAI has much higher correlations with both indices of retail sales than consumer confidence), chart below shows that in 2014, growth rate in overall sector activity slowed down significantly compared to 2013.

The above, of course, is rather natural for the recovery that first produces a faster bounce up and then settles into more 'sustainable' over time rate of growth. The problem, however, is that current activity by value of retail sales is still 39.1% below the pre-crisis peak levels and for volume of sales it is 34% below peak. Even compared to the pre-crisis average (2005-2007), activity is down 11.2% in value terms and 3.2% lower in volume terms.

9/1/2015: Advisor-Driven Investment Management: Partial, Biased and Risky?

My post for Learn Signal blog on the issue of sell-side advice and inherent conflicts of interest and biases that are material to advice-driven investments: http://blog.learnsignal.com/?p=142

7/1/2015: China Threat: Europe's Exports Under Pressure

Recently, Irish Times run an article about threats and challenges to Irish economic model (whatever it might be - I have no idea), concluding that all is down to 'political leadership' (whatever that might be is also something I can't comprehend). But in reality, a key threat to Irish economy is the threat of changing nature of global production and demand patterns, related to

• Challenges from China and other emerging economies (which increasingly produce goods and services for global consumption that rival in quality European goods and services);
• Challenges from growing regionalisation of trade (with producers, including the MNCs, moving closer to the demand growth centres - which are nowhere near Europe); and
• Challenges from growing regionalisation of investment and capital flows, including financial and human capital (which puts pressure on our funding models for enterprise formation and growth).

There is little in the above that is subject to our policymakers' 'leadership' and much in the above that is subject to our internal market competitiveness.

But, setting aside the above considerations, what is the evidence of the growing threat from the emerging markets economies? Take a look at a recent paper by Benkovskis, Konstantins and Silgoner, Maria Antoinette and Steiner, Katharina and Wörz, Julia, titled "Crowding-Out or Co-Existence? The Competitive Position of EU Members and China in Global Merchandise Trade" (ECB Working Paper No. 1617: http://ssrn.com/abstract=2354238).

Keep in mind - this is ECB, so all conclusions might have been relatively placated or moderated to suit the prevalent narrative that things are going fine for Europe.

In their paper, the authors "analyse export competition between individual EU Member States and China in third-country goods markets."

Top of the line finding is that "competitive pressure from China is strongest for small and peripheral EU members, especially for the Southern periphery, Ireland and Central, Eastern and South-eastern European EU members. While we find no hard evidence for "cut-throat" competition between China and EU countries, we see an increasing tendency of smaller EU exporters leaving markets that are increasingly served by China." And another note of caution: data only goes to 2011, which means that whatever intensification in competition that might have happened in 2012-2014 - the years when European producers saw increased incentives to export due to sluggish growth in Europe, while Chinese exporters faced similar incentives to export due to decline in domestic returns on capital, and changing nature of domestic investment markets.

So some details.

Authors note that "the extent of existent competition between individual EU members and China (observed at the margin of the markets served by EU members) is fairly homogeneous across all EU countries." Figure 1 below (labeled Figure 7 in the paper) "shows that the fraction of trade links where both China and the given EU member are active in two consecutive periods amounts to roughly 62% in 2009, up from 49% in 2001. Thus, mutual competition increased for all EU members."

More per Chart above: "With an overlap of 65% and beyond in 2009, countries like Portugal, Sweden, Ireland, Denmark and the Czech Republic face the strongest existent competitive pressure from China in terms of the fraction of markets where they are directly exposed to China. The group of large exporters shows an overlap of existent markets between 60% and 64%, while many small Eastern European countries and Greece only serve between 56% and 59% of their export markets jointly with China."

Out of all EU countries, therefore, Ireland is 4th most-exposed to competition from China. Good luck devising a 'policy leadership' for that.


What about the markets where China is not operating, yet? Authors have the following to say on this: "the fraction of “newly conquered markets”, i.e. newly established trade links by either an EU member or China where the other exporter did not already operate (figure 8 below), declined from 5.6% in 2001 to 2.4% by 2009 on average across all EU members. Thus, with heightened existent competition, the number of new market conquests where China was not active decreased in all countries over time. The decline was particularly pronounced for large exporter such as Italy, Spain, Germany and Finland. But a number of CESEE-10 countries likewise shows a relatively strong decline, such as Lithuania, Hungary, Poland and Slovakia."

Ireland faired a little better in terms of "new market entry" for China risks, but that is because we already face much more direct pressure from China's competition.


Next up, the potential for Chinese exporters crowding out Irish (and other European) exporters.

Per study: "the most interesting type of competitive pressure is depicted in figure 10. The four combinations which are summarized here all represent different forms of potential crowding-out of one exporter by its competitor. …As a first interesting observation, even taken together, these cases are less important than the creation of new competition. However, we observe an increasing trend over time. Furthermore, with 10% or more of all cases, in particular CESEE-10 countries and the small peripheral EU members are especially affected by this type of competition."

And, by the above chart, Ireland is under some serious pressure here too.

The authors disaggregate the bars in the above figure in order to "extract information on the crowding-out of EU countries by China."

"Figure 11 [below] shows the share of crowding-out cases in which an EU country exits a market which China has just entered or continues to operate. …[in] Germany [case] crowding-out is observed for only 4.8% of all trade links in 2009 [see chart above] and Germany crowds out China in half of these cases (Figure 11 below). In contrast, evidence for the CESEE-10 is mainly characterized by China crowding out the CESEE-10 countries (Figure 11), and, furthermore, the incidence of crowding-out increased markedly over time (Figure 10 above). The same holds true for the EU’s small peripheral countries Ireland, Portugal and Greece. In all three countries, 90% of all crowding-out cases refer to their exit from a market where China enters or is active (Figure 11 below). Compared with 2001, crowding-out by China has generally gained importance over crowding-out of China, particularly for the core EU members."

Again, Ireland is under huge pressure here from China.

Overall, the paper conclusions are uncomfortable.

"In general, we find that export growth is mainly driven by the intensification of existing trade relationships rather than by the formation of new trade links (extensive margin)." Here's a problem: Irish policy has been about opening new markets (jumping head-to-head into competition with China and other exporters), instead of maximising presence in the already serviced markets (holding onto and expanding exports presence in already profitable markets). And that is despite the fact that "…the extensive margin turns out to be more important for the CESEE-10 than for the EU periphery, the core EU countries or even China."

"Small and peripheral countries are more exposed to competition from China than the large EU export nations." And Ireland is even more exposed here, since we rely almost exclusively on exports as the driver for growth.

"…the crowding-out potential is considerably higher for the CESEE-10 and the small peripheral EU countries than for larger EU members…" As commented earlier, this is about the need to pursue more intensification of our exports, rather than constantly attempting to chase 'new markets' as the core exports growth strategy.


Finally, for illustration purposes, chart below maps the composition of European exports by category of goods.

7/1/2015: Another One for European Century

A chart via @Schuldensuehner this one pointing at another myth of the European Century blowing up: the myth of Euro becoming the global reserve currency.

That's right, Official Reserves held by the Central Banks in euros are down 8.1% in Q3 2014.

This, as Bloomberg notes, is a much faster rate of decline in reserves than during 2010-2011 crisis. "In the third quarter of 2011, the common currency slid 7.7 percent, while its reserves fell 2.8 percent. A deeper plunge of 9.4 percent in the euro in the second quarter of 2010 only prompted a 1.3 percent loss in holdings, the IMF data showed."

Remember, this was supposed to be a European Century (http://www.dw.de/barroso-europe-is-a-success-of-globalization/a-2414542 and http://arc.eppgroup.eu/Activities/docs/berlin_declaration/en.pdf).

6/1/2015: BRIC PMIs: Weaker Outrun in December

Markit released PMIs for all BRIC countries for both Services and Manufacturing covering December 2014. Here are the main results.

Starting with manufacturing:

• Brazil Manufacturing PMI posted its first 50+ reading after 3 months of consecutive sub-50 readings. December PMI came in at 50.2, which is basically signalling no statistically significant growth. On a quarterly basis, Q4 2014 average came in at 49.3 - a contraction, against 49.3 (yep, same) for Q3 2014 and 50.1 (almost no growth) in Q4 2013.
• Russian Manufacturing PMI for December came at disappointing 48.9, marking the first month of sub-50 readings since June 2014. Q4 2014 average is at 50.3 (basically near-zero growth) against Q3 2014 reading of 50.4 (very weak growth) and Q4 2013 reading of 50.0 (stagnation).
• China Manufacturing PMI came in at 49.6, the first monthly contraction that follows six consecutive months of at or above 50 readings. Q4 2014 average was 50.0 - meaning Chinese manufacturing posted flat growth across the quarter. Q3 2014 average was 50.7, same as Q4 2013. Overall, there are some very serious weaknesses in Chinese manufacturing sectors.
•  India Manufacturing PMI jumped from 53.3 in November to 54.5 in December, signalling acceleration in activity in the sector. Q4 2014 average is at 53.1 - up on 52.0 average for Q3 2014 and on 50.5 average for Q4 2013.

Now, Services:

• Brazil's Services PMI was even worse, set at 49.1 in December (a shallow contraction), continuing with sub-50 readings for the third month in a row. Q4 2014 average is at 48.6 (outright contraction), against Q3 2014 average of 50.5 (weak expansion) and 52.1 (stronger expansion) in Q4 2013.
• Russian Services PMI stood at 45.8 - sharp contraction - in December 2014, marking third consecutive month of sub-50 readings. The index averaged less than impressive 45.9 in Q4 2014, showing severe strains from collapse in domestic services, such as financial services. The index averaged 50.1 in Q3 2014 and 53.0 in Q4 2013.
• China Services PMI surprised to the upside, posting 53.4 reading in December, up on 53.0 in November. Q4 2014 average is at 53.1 - faster growth signal compared to Q3 2014 reading of 52.7 and Q4 2013 reading of 52.0.
• India Services PMI, lastly, posted a slight de-acceleration in growth, slipping from 52.6 in November to 51.1 in December. Q4 2014 reading is now at 51.2, which marks a slowdown in growth from 52.2 index reading in Q3 2014 and47.0 reading in Q4 2013.

And a table and a chart summarising changes in both sets of PMIs

Note the increase in weaker growth signals in December data compared to previous month, driven by poorer PMIs in Manufacturing and by unchanged performance outlook in Services. Also note, per chart above, Russia not only acts as a main downward driver for the BRIC overall PMI-related performance, but it shows strong decoupling in the direction of trend from January-March 2014 on, with the divergence now accelerating over the last three months.

6/1/2015: The Darker Side of Sell-Side Research?

My blog post for @LearnSignal blog on the topic of conflict of interest problem with sell-side markets research: http://blog.learnsignal.com/?p=138.

6/1/2015: Irish PMIs December 2014: Strong End to 2014 Activity

Markit-Investec Irish PMIs releases were finalised today with Services data made public few minutes ago. Here is my quick analysis:

• December 2014 Manufacturing PMI reading stood at 56.9, signaling a strong expansion. The index was at a 4-months high. 3mo average (Q4 average) stood at 56.7, which represents a rise on Q3 2014 average of 56.1. Q4 2014 marked the highest quarter in terms of Manufacturing PMI average. The series are now 4.5 points ahead of post-crisis average.
• December 2014 Services PMI reading stood at 62.6, which, as Markit commentary says is a tie with June 2014 reading for the highest mark since February 2007. It is worth noting that September 2014 reading of 62.5 was, of course, statistically indistinguishable from December and June readings. 3mo average through December (Q4 average) is at 61.9, which is only marginally below Q3 and Q2 averages of 62.1. Relative to longer-period average, December reading is 7.1 points ahead of post-crisis average for the series.

Chart to illustrate:

Predictably, given the levels of both indices, there is some moderation in the growth rate of the index (second derivative, effectively):

Which is not a discouraging sign, as historically, the indices do signal strong growth in both sectors:

And as the chart above shows, uplift in Manufacturing is very strong, relative to historical trends. All good signals so far, but do stay tuned for some longer-range analysis later.

Note: as usual, I do not cover composition of the indices, as Investec refuses to supply actual data on indices components.  Should you want to consult their sell-side analysis, feel free to do so at http://www.markiteconomics.com/Public/Page.mvc/PressReleases

6/1/2015: Glance Back: Grey and Black Swans of 2014

Portuguese blog by Jorge Nascimento Rodrigues quoting my comments on the topic of black swan and grey swan events of 2014: http://janelanaweb.com/novidades/2014-em-revista-cisnes-negros-cinzentos-6-surpresas/

My comment in English in full:

Black swan events are defined not only by their unpredictability ex ante the shock and the magnitude of the shock-related losses, but also by the fact that the rationale for their occurrence becomes fully explainable ex ante the event. In this sense, looking back at 2014, one can only imperfectly interpret key events as either black or grey swans.

One of the major black swan events of 2014 was the flaring up of a major geopolitical crisis involving Russia and the West. This pre-conditions for the emergence of this crisis were present throughout the late 2000s - early 2010s, but its rapid escalation from to the state of a proxy war fought by the two players over the Ukraine was not something we could have foreseen at the end of 2013.

On economic front, the decoupling of the US economy from global economic outlook and acceleration in the US growth was accurately reflected in a number of major forecasts published in the second half of 2013. As was the associated continued downtrend in growth in the euro area. But the simultaneous crisis across the major emerging economies, including Brazil and South Africa, as well as the onset of the outright recession in Russia and the Russian Ruble crisis of Q4 2014 were black swan events.

A good example of the grey swan event - an event with some predictability ex ante, but with unpredictable timing, was a massive decline in global oil prices. The decline was forecastable in 2013, given the rate of growth in potential supply from the non-OPEC countries, primarily Canada and the US. The rates of new wells drilling and the levels of average output and output dynamics from the existent wells should have told us well in advance that the decline in oil prices was coming. Ditto for the signals coming from the natural gas price divergence in North America against Europe and Asia Pacific. But the exact timing of this decline in oil prices was not easily predictable. In the end, the drop in oil prices in 2014 was driven by a combination of two forces. The supply dynamics - largely predictable, and the contraction in demand driven by the black swan shock to global (and in particular emerging markets) growth.

Two major themes that dominated the financial markets in 2014 - continued decline in sovereign debt yields and simultaneous divergence in prices between the US and European equity markets - was hardly a black swan, given the differences in monetary policies between ECB and the Fed. Nonetheless, to some extent both themes were shaped also by the global growth divergence, and as such, both constitute a sort of a grey swan event.

Last, but not least, the flaring up of the euro area peripheral crisis, starting with Q4 2014 political risk flaring up in Greece, was neither a black swan nor a grey swan, and instead constitutes an empirical regularity of long term instability in the euro area periphery. This instability (both political and economic) is driven by the legacy of the debt crisis and the fallout from the policies used to address it. Nothing, absolutely nothing, has been resolved within the euro area when it comes to addressing debt overhangs present in a number of economies. Nothing has been done to address the endemic lack of structural growth drivers in the majority of the peripheral economies. If anything, the structural growth crisis contagion has now firmly spread to the core economies, such as France and Finland, and is impacting even Germany. Despite lots of sabre-rattling, the ECB remains in a passive policy mode, with the central bank balancesheet stubbornly stuck in the post-crisis lows and liquidity fully captured within a fragmented banking sector.