16/10/15: IG Conference: Markets Outlook

My speaking points on the topic of the Markets Outlook for yesterday's IG conference:

Short themes:

Theme 1: Markets pricing in advanced economies: 

- EV/EBITDA ratios signal overvaluation; 

- EBITDA/Interest Expenses ratio is at below 2010 levels (below 14%) despite extremely cheap debt.

A handy Bloomberg chart:

- Global debt cycle has turned – sovereigns are not leveraging as fast or deleveraging, but corporates leveraged up. 

- Much of pricing today reflects migration from equity to debt

- In this environment – long only allocations are problematic.

Theme 2: Emerging markets, especially BRICS

- Idea of 3rd Wave – Goldman’s thesis – is based on two drivers: duration of the crisis (‘this can’t be going for so long…’) and firewalls (‘this can’t spill into the developed economies…’) both of which are 

- There are no fundamentals to support robust recovery view

- Again, allocations are highly problematic.

So short-term summary is poor when it comes to hard numbers:

- World economic growth for 2015-2017 forecast is down from 14.1% in 2012 to 10.9% today

- Euro area economy forecasts are flat: 5% in 2012 and 4.9% today, holding relatively steady compared to the rest of the world solely because Europe is now Japanified

- Advanced economies down from 8.1% to 6.6% - another miserably Japanese-styled performance compared to past averages

- Emerging and developing economies from 19.55 in 2012 to 14.0%.

On inflationary targets and rates: the only way we are going to get to the inflationary expectations consistent with monetary policy normalization, is by literally superficially jacking up prices through Government controlled sectors and/or via regulatory policies. Which is to say that any inflation above, say 1% or so in the Advanced Economies, today, will be consistent with stripping income out of the economy to prime up financials (in the short run) and public purse.

Longer themes:

As much as I love the good story of innovation and technological revolutions, I am afraid to say my fear is that we are heading for the twin secular stagnation scenario:

Supply side stagnation: 

- Technological returns (productivity growth and new value added) are tapering out

- Substitutability of labour is rising and with it, risks to economic systems

- Regionalisation of trade and production are gaining ground and markets fragmentation is going to play a disruptive havoc with our traditional market valuations

- So expect more volatility on flatter trend.

Demand side stagnation: 

- Demographics 

- Savings/investment imbalances, 

- Debt overhang – across both advanced economies and, increasingly also, emerging markets, so we have a Myth of Post Financial Crisis Deleveraging (via BAML)

Global Debt to GDP

2010-2015: 220 to 240%

2000-2010: 190 to 200%

1990-2010: 170 to 190%

Or a handy chart

- Wealth and income inequalities, including intergenerational effects

- Rebalancing of economic growth drivers (human capital focus pushes incomes gap wider and deeper, but also clashes with current taxation and political systems)

Key forward is to expect:

- Flatter growth trend and more volatility around that trend 

- Higher volatility / instability in higher moments 

- Financial imbalances accelerating and amplifying

- Financial imbalances / cycles leading real cycles (Excess Financial Elasticity hypothesis)

- Economic volatility spilling, increasingly, into political volatility (political economy). 

Key strategy points:

- Focus on lower debt levels on companies balance sheets

- Focus on companies actually paying attention to core basics, e.g. earnings, sales, profit margins, as opposed to subscription bases, user counts etc

- Focus on companies with strong regional reach (not only in product markets, but in logistics and production bases)

- Focus on companies with revenues linked to multi-annual contracts

- Go defensive, stay defensive in core allocation

- Go speculative with low leverage only and on a small share of total wealth

- Go speculative trades on uncertainty and long 5-10 percentile under-performers

16/101/5: Millennials: A Power Poverty Gap?

Having discussed the plight of the Millennials' Generation in global context on numerous occasions, I am too familiar with the problems faced by the current 'younger' middle of demographic pyramid. Hence, not surprisingly, I found this article http://www.independent.ie/opinion/ireland-forces-young-people-to-delay-lifes-milestones-31599496.html to be quite a reasonable summation of the modern reality in which the current younger generations can no longer expect to have better quality of life (measured by more traditional metrics) than their predecessors.

I will ignore the set of prescriptive policies at the end of the article - some make sense, others largely represent well-intentioned economic sentimentality. But the key issue is an important one.

And here is a counter-part piece on the Millennials trends in the U.S.: http://www.nielsen.com/us/en/insights/reports/2015/millennials-in-2015-financial-deep-dive.html.

16/10/15: Gold and Bitcoin: Adjacency and Hedging Properties

This week, I spoke at a joint Markets Technicians Association and CAIA seminar hosted by Bloomberg, covering two recent research projects I was involved with on the role of Gold and Bitcoin as safe havens and hedges for other assets.

Here are my slides (omitting section division slides):

The first section was based on the following paper: http://www.sciencedirect.com/science/article/pii/S1057521912001226

A caveat to the above, we are seeing increasing evidence that Gold's hedging properties may be changing over time, especially due to increased financialisation of the asset. In this context, it is worth referencing a recent working paper by Brian M. Lucey et al linked here that I also cited at the seminar.

The Bitcoin section is based on a work-in-progress paper with Cormac Ennis: "Is Bitcoin like Gold? Hedging and Safe Haven Properties of the Virtual Currency". The results of presented below should be treated with serious caution as they are extremely preliminary.

Note: we are extending data set to cover longer period, although even with this extension data coverage for Bitcoin is still suboptimal in both duration and quality. Many thanks to the seminar participant for pointing out two key caveats to the overall data coverage:

1. The 'lumpy' nature of demand around Cypriot banking crisis; and
2. Potential effects on data quality reported for Bitcoin from a small number of high profile pricing events, such as technical glitches and supply/demand shifts linked to large exchanges-linked events (e.g. MtGox).

 Summarising the two papers findings:

16/10/15: Finance@Google 2015

Few weeks back I was taking part in the Finance@Google 2015 conference covering a range of topics from the future trends in Financial Services to more current / shorter-term aspects of the markets for Financial Services (Banking, Insurance and Online Aggregators, amongst a range of other services).

Here are two videos of my presentations:

First: my presentation "Finance at the End of Old Norms" - link here.

Second: my interview "Excuse the Interruption: Financial Expert in the Spotlight" covering a wide range of questions relating to the evolution of Financial Services - link here.

16/10/15: How to Write Perfect Vacuum

Here is one rare occasion where, simultaneously,

1. An academic achieves a certain degree of notoriety laying a claim to authoring just one working paper that no one have seen; and
2. An academic achieves completeness of an argument by not publishing the only paper he claims to have authored that no one have seen.

Consider the following posting on the SSRN site:

Can Philosophy Be Justified in a Time of Crisis?

Nathan J Robinson 

Harvard University

September 3, 2015

Abstract:      

In this paper, I take the position that a large portion of contemporary academic work is an appalling waste of human intelligence that cannot be justified under any mainstream normative ethics. Part I builds a four-step argument for why this is the case, while Part II responds to arguments for the contrary position offered in Cass Sunstein’s “In Defense of Law Reviews.” First, in Part I(A), I make the case that there is a large crisis of suffering in the world today. (Part I does not take me very long.). In Part I(B), I assess various theories of “the role of the intellectual,” concluding that the only role for the intellectual is for the intellectual to cease to exist. In Part I(C), I assess the contemporary state of the academy, showing that, contrary to the theory advanced in Part I(B), many intellectuals insist on continuing to exist. In Part I(D), I propose a new path forward, whereby present-day intellectuals take on a useful social function by spreading truths that help to alleviate the crisis of suffering outlined in Part I(A).

And that's it. 

Point (1). There is no paper enclosed. And I cannot locate a paper anywhere on the web. The author does not seem to have written a single published paper / article / book chapter prior to that with exception of a children's book or beyond a handful of non-academic articles on matters of interest and subject depth of the Huffington Post. The author does not seem to have any specialisation in the subject matters covered in the abstract. 

Point (2). The abstract is bold. But the abstract is also self-contained: if the unique role of an intellectual is to spread "truths that help to alleviate the crisis of suffering", then the role of an intellectual does not include publication of research on themes unrelated to the topic of "alleviating the crisis of suffering". In other words, to complete his own argument by own example, Mr. Robinson is required not to publish his own paper. Which he does. 

And the world is going gaga over a non-published and not-available-anywhere paper... Which is to say, simply, the Huffpo intellectuals go shrill for an abstract. 

Chill, folks... it all might just be a student prank, or a poorly executed attempt at discovering the next Theory of Justice, or neither...or it might just be the denouement to intellectualism: a falsifiable statement that no one will ever be bothered to falsify because... err... it is already refuted by the very existence of an abstract in absence of a paper...

But, really, can we have a paper, Nathan?.. Please, pretty?..

15/10/15: Budget 2016: Tech & Entrepreneurship Perspective

My take on the Budget 2016 from the perspective of tech sector: https://www.siliconrepublic.com/video/dr-constantin-gurdgiev-on-budget-2016-stimulating-consumption-by-taking-credit-card-on-future

And more of the discussion of the Budget from technology sector and entrepreneurship perspective here: https://www.siliconrepublic.com/video/dr-constantin-gurdgiev-on-budget-2016-stimulating-consumption-by-taking-credit-card-on-future

Thanks to @iia for hosting the event and to the Silicon Republic for putting the discussions into broader public domain.

I covered the Budget in broader setting of economy-wide entrepreneurship and start ups formation here: http://trueeconomics.blogspot.ie/2015/10/141015-there-isnt-ireland-without-mnc.html.

14/10/15: There isn't Ireland without MNC Inc.: Budget 2016

Budget 2016 went in like a circus convoy entering a sleepy town: all pomp and all the excitement with little substance of change in tow.

Budget 2016 is a political budget and not an economic one. The point of all the smaller taxation measures in it, relating to people working for living, is simple: get those voters, vulnerable to swing Left to stay Centre. Sinn Fein got punched, few independents too; Labor got cookies to hand out. But even on this count, Budget 2016 was a fizzle of a firecracker with mostly smoke to show in the end:

1. Much lauded idea of exempting from USC all earners
2. Virtually all net gains for low income earners from this Budget do not accrue from Michael Noonan spending tax revenue or Government cash, but from minimum wage increase. Just how exactly does minimum wage hike (a mandated cost imposed onto employers - rightly or wrongly is not the point here) qualify as a fiscal policy measure (aka, Government fiscal management of the economy) beats me. Proper economics have no room on fiscal policy side for the scenarios where Government spends not its own money on stimulating its own votes. Note: Employer PRSI change is virtually immaterial, costed by the Department of Finance at only EUR7 million over full year. Where this might help somewhat is in alleviating pressure on employers to cut working hours.

Besides the above aberrations, the Budget was a net positive for current consumption spending, and was a net zilch for investment. Now, here the Government logic is completely off the charts. We are borrowing money to fund the Budget 2016 measures. And we are channeling this borrowed cash into activities that are not expected to generate a return, since these are non-investment activities. Multipliers for current consumption are miserable - most of the stuff we will be buying with the few quid we got in Budget 2016 is stuff made elsewhere and all we can collect in this economy from it is a small gross payout on labour in the retail and logistics sector. Whatever the social imperatives can be for such a 'stimulus' (and they are quite sound in some cases), it is poor economics and poor strategy.

When it comes to economics: Budget 2016 continues with a well-established theme of doing everything possible to demolish productive entrepreneurship spirit in the country. This time around, it is doing it with a flavour of simultaneously pretending that we are pro-entrepreneurs. 

Take the following post-Budget 2016 numbers:

1. Income tax: What maters here from entrepreneurship and modern economy activity is the upper marginal tax rate, not the base rate. Why? Because people do not choose to become entrepreneurs to earn EUR34,000 a year. It is that, brutally, simple. So in Ireland post-Budget 2016 we have a 40% upper rate kicking in at EUR33,800. Across the pond, in the UK, this happens at EUR59,900. Get it? Forget entrepreneurs, we are talking about school teachers being high earners according to our tax codes.
2. Dividends taxation: You get dividends on your investments (rare, but happens in normal economies). Your upper tax on these is 55% here in Ireland, whilst in the UK it is 38%. Darn, those rich retail investors who carefully select better quality long-term non-speculative shares (majority of which pay dividends). Whack them hard, shall we?
3. Capital gains Tax: We are a basket case. We have general rate of CGT of 33% which is higher than UK's 28%. We have now a new measure that allows for some reduced CGT on the first EUR1 million at 20%. Minister Noonan thinks that is a great way to reward successful entrepreneurs. In the UK, they think a reward should involve 10% CGT for such investors. For investment returns of up to EUR13 million 'entrepreneurship Island' reserves an effective (reduced by Budget 2016) rate of 32%. In the UK it is 10%. There is no CGT exemptions for qualifying investors and no CGT rollover for reinvestment in Ireland, whilst both measures are available in the UK. Case closed.
4. Capital gains structural incentives: For years Irish policymakers and Enterprise Ireland have been struggling with the fact that majority of Irish entrepreneurs opt for early exits from companies - in other words, instead of building large Multinational Enterprises, our entrepreneurs too often opt for a sale of company early on. It has been an explicit objective for Irish development agencies to stimulate growth of companies beyond certain thresholds in size in the past. And Budget 2016 just created an added (albeit small) incentive to exit earlier, rather than later (the cap on preferential rate being set at EUR1 million). Classic example of incentives contradicting objectives.
5. VAT: in Ireland, post-Budget 2016, this stays 23% and the crazy situation of charging VAT on services provided to non-VATable entities remains in place. In the UK, VAT is 20%. Thresholds: in Ireland VAT accrues for traders with revenue of >EUR37,500, but in the UK the threshold is Stg82,000. Get that, all of you self-employed and sole traders.

Of course, there is one, just one, area where Irish Government continues to impress the world: Multinationals-linked Tax Optimisation schemes. Ireland now has a Knowledge Development Box bestowing 6.25% corporate tax rate on... err... we don't quite know what. Promise is - it will apply to 'certain' patents and software copyrights. Which is just a tiny sub-set of actual business innovation and knowledge acquisition. And it is the subset that MNCs dominate. The Department of Finance estimate this measure to cost the Exchequer EUR50 million. Which really tells you just how much real activity this Knowledge Development Box is going to generate (answer is: very little) as opposed to how much of the old tax optimisation loopholes it is expected to absorb (answer is: plenty).

NY Times headline from yesterday says it all, really:

Our Knowledge Development Box is 'boxier' than that of the UK - our 6.25% tax beats their's 10% one. Case closed: MNCs win, and there is no economy beyond that which matters.

Anyone noticing that the world around us and the world inside Ireland is shifting toward supporting human capital-centric growth (yes, not labour or PAYE or specific sector, but Human Capital-centric)? Well, over 40 submissions from various bodies and individual analysts to Budget 2016 did. They also spelled out that this shift entails two key things:

• The need to recognise the risks assumed by workers and entrepreneurs working in this New Economy; and
• The need to recognise the fact that human capital-endowed workers are higher earners (not the rich, but well above the average).

People like myself have been drumming this beat for ages now. Still, Budget 2016 does nothing to resolve discriminatory taxation of human capital under the USC system, discriminatory taxation of human capital in self-employment under the USC system and broader income tax system, and it has done nothing in terms of even considering asymmetric risk loadings that entrepreneurs and self-employed carry compared to PAYEs. The Budget does help by introducing Earned Income Tax Credit to offset, partially (by 1/3rd) the glaring discrimination against self-employed inherent in the PAYE tex credit system. But this is hardly a measure to fully address the problem of the taxation system vastly out of tune with realities of modern economy.

Time to ask that pesky question, thus: Does this Government understand modern economy or do we still have leadership that thinks in terms of early 20th century proletarian world?

The sop of the 'entrepreneurship' measures unveiled in Budget 2016 is illustrative to the above question:

• Corporation tax exemption for start ups for the period of 3 years has been extended. The measure 'costs' the Exchequer EUR2 million per annum (per Budget 2016 estimates) same as the estimate for the measure in Budget 2015. Apparently, even by Department own figures, there is zero growth in uptake of this measure year on year. 
• The Knowledge Development Box - which is for all intents and purposes is about useful for entrepreneurs and start ups as the Beats by Dre headphones are to the donkey.
• The EIIS scheme to incentivise investment into start ups has been 'fixed' (by increasing company limit from EUR5 million to EUR15 million). Except, the fix addresses non-existent problem and the real problems remain not tackled. You see, you gotta be a fabled unicorn (in Irish market terms) to raise EUR15 million as a start up. Majority of entrepreneurs need far less capital than EUR5 million. So the old ceiling was not a barrier in EIIS scheme. However, EIIS is excruciatingly  bureaucratic and difficult to navigate, which it remains such after Budget 2016. And EIIS is not suitable for raising small funding that majority of start ups really need up front - EUR100,000-200,000. Which, once again, Budget 2016 left unaddressed.

And that's it. Entrepreneurs and the self-employed, high Human Capital-endowed workers, start ups, their directors and advisers, as well as their key employees - all can now send their 'Thank You' cards to the Minister for all the love and support extended to them yesterday. Or they can continue to send their business to the UK and Northern Ireland, where quietly, without labelling themselves to be the 'Best ... Country to Do Business In' the fiscal powers are trying to run a more benign environment for investors, entrepreneurs and start ups.

11/10/15: Tax Code Simplification and Deadweight Loss of Taxation

In a recent speech (see notes here), I discussed the need for tax reforms in Ireland and, specifically, for flattening of the income tax system.

Here is an interesting, albeit dated, paper on the subject of tax codes simplification as the tool for reducing the Deadweight Loss of compliance and improving tax compliance and enforcement: http://www.columbia.edu/~wk2110/bin/epi.pdf.

H/T to @brianmlucey for the link.

11/10/15: Of Central Banks and Spoons in the Arctic

Much has been said recently about the need for normalisation in the policy rates environment (in plain English - the need to hike interest rates off zero bound) and much has been inked about the feasibility of such normalisation. So the latest G30 intervention on the subject is both banal and late in timing.

But, as posted by @Schuldensuehner a few minutes ago on twitter:

Which is basically telling us two things:

1. Talking of any normalisation, given the quantum of financial assets accumulated since 2007 by the Central Banks is about as realistic as talking about mining Mars for fresh water; and
2. Talking of anything, but the Central Banks, taking up the task of providing liquidity in the current environment is about as sensible as arming an ice-breaker with a spoon: sure it chips ice, but good luck making much of a progress.

11/10/15: Equity Derivatives: Shadow Banks are Clawing Back

Remember them, 'financial weapons of mass destruction'? No, not the CDS, and other debt derivatives, but rather the equity derivatives? Here's a reminder.

Well, the are baaack... baby... with a vengeance on the short term side:

So look at who's printing the stuff in truck loads? U.S. - carry trade of the past, Europe - carry trades of the present...

And when you look at maturity profile - short-termism is in vogue:

But what not to like? Key counterparties are, again, 'other financial institutions' - aka shadow banks:

Smelly stuff, courtesy of cheap credit for the select few from the Central Banks...

Note: Source for the above charts: BIS Quarterly Review, September 2015 

10/10/15: What, When, If the $7 trillion SWFs Gorilla Moves?

Remember this bit about Central Banks' reserves taking a dip globally? And now consider this, about Sovereign Wealth Funds shrinking their income/assets. The alarmism is premature, as the article explain, since SWFs are (1) big, (2) likely to see return to inflows of funds once oil and broader commodities prices recover, and (3) longer-term investment vehicles with broad mandates. Which implies there is not so much panic looming from SWFs downsizing their holdings (selling assets).

But the key is in the second order effects: as long as oil prices remain low, SWFs are not going to be active buyers of assets in the near term (so demand base for assets is taking a knock down, currently being obscured by the Central Banks' demand in some areas - e.g. Euro area, and/or by leveraged plays and carry trades still available on foot of Central Banks (more limited) adventurism. Which means that any 'normalisation' in monetary policies today is likely to coincide with a period of subdued demand from the SWFs for assets. And that is pesky enough of a problem to worry anyone in the markets.

Beyond this concern, note two other problems arising from the current oil price slump:

1. SWFs, having parked their buying for now, are becoming less predictable per strategy they might take when prices do recover (the longer the period of oil prices slump, the higher is uncertainty); and
2. How the future balancing between liquidity risk and returns going to play across the SWFs strategy (again, the longer the period of low oil prices, the more likely exit from the oil price slump will entail SWFs pursuing less risk-loaded assets and opting for greater safety - a sort of precautionary savings motive for the SWFs).

10/10/15: Who Gains From TTP & TTIP? Not Free Trade!

For all those in need of understanding why TPP (the Trans Pacific Partnership Agreement) and TTIP (the Trans-Atlantic counterpart of the TPP) are not about free trade, read this simple summary of the core argument against state-promoted trade.

Key quote (emphasis in italics is mine): "The TPP, like all other trade agreements of its type, was designed to serve the strategic interests of the governments involved, and has nothing to do with opening up new opportunities for free trade among ordinary members of the domestic societies that are taxed to finance the governments involved. There is no doubt that certain large corporate interests with political power will benefit from agreements like TPP. Large interests have the clout and the resources to change and shape these agreements to favor them. Small enterprises and businesses, and small entrepreneurs will only endure greater restrictions."

QED.