1/12/15: Markets at a Lower Edge of Growth

During a number of recent financial conferences that I had an honour of contributing to, the repeated leitmotif of Q&As with the audiences has been: "Where's the value in today's markets?" This is hardly surprising, given the state of prime sovereign fixed income and equities markets (both overbought), corporate fixed income markets (closer to fair valuation, but with elevated spreads and volatility), and commodities markets (depressed by long running fundamentals of demand and supply). Short of investing in 17th century furniture futures or philately options, any investor today will be hard pressed to find a broader theme for a buy-and-hold allocation.

Now, the same anecdotal evidence is confirmed by the Morgan Stanley analysts:

Source: Bloomberg

So equities/fixed income allocations for traditionally structured neutral portfolio have converged in returns for both the U.S. and European markets and at levels not worth taking a punt at. Meanwhile, risk-adjusted returns have all but evaporated:

 Source: Bloomberg

A handful of quotes (all via Bloomberg):

"What is notable for 2016 is that, unlike past years, both our long- and short-term forecasts point to muted equity upside.”

"Having been positive on developed market equities in recent years, it is notable that all of our regional index targets now imply little upside for stocks in 2016. Morgan Stanley’s economists forecast that global GDP growth will nudge slightly higher next year (to 3.3 percent from 3.1 percent in 2015), but our regional earnings forecasts suggest companies are having a tougher time turning modest economic growth into decent profit growth."

"The flatness of the [efficiency] frontier means that the optimal portfolio will lie near the left-hand extreme of the red line for a variety of investor utility functions. Relative to prior later-cycle periods, growth looks weaker, central bank policy looks looser, and credit risk premiums are more elevated."

In summary, then: there is no story of growth and with this, there is no story of financial returns uplift. 

1/12/15: Russian Manufacturing PMI: November

Russian Manufacturing PMI released by Markit remained within near-zero growth territory, posting 50.1 in November, down on 50.2 in October. Overall, some positives and key negatives were:

• Both output and new orders rose at fastest pace in 12 months; 
• Growth conditions in manufacturing remain extremely sluggish; 
• New export orders fell “at sharpest rate in seven months”;
• Workforce continued to contract, as “employment levels have contracted in each of the past 29 survey periods”;
• Most of uplift in production was signed to agricultural sector production rise (Russian grain crop posted second strongest performance at 117 mL tons through early November, after there record 2014 crop);
• Majority of new orders increases took place in domestic markets

So overall, Russian Manufacturing showed repeated signs of weak stabilisation, but virtually no signs of recovery.

1/12/15: Euro area Manufacturing PMI and Forward Growth Indicators

Eurocoin for November - euro area's leading growth indicator - remained basically flat at 0.37, rising only marginally from 0.36 in October. Both months are posting readings below 3mo and 6mo averaged (0.373 and 0.392), signalling growth at around Q2-Q3 2015 average.

In summary: little evidence in growth acceleration from 3Q 2015 levels. It is worth noting that preliminary growth estimate for 3Q 2015 came in at 0.3%, joint-lowest since 2Q 2014 (3Q 2014 growth was identical to 3Q 2015). This stands contrasted to today's Markit Manufacturing PMI for Eurozone which posted a reading of 52.8 for November (moderately strong expansion) up on 52.3 in October.

It is worth noting that both PMIs and Eurocoin have posted over-estimates of actual growth conditions in recent months.

30/11/15: WarningSignals on Secular Stagnation Threats

The readers of this blog know that I have been covering the twin theses of Secular Stagnation (long-term trend in slowdown of global growth) consistently over recent years.

Here is an interesting summary of the theses and literature on it, with extensive references to this blog (among other sources): http://www.warningsignals.org/#!Where-are-we-on-Secular-Stagnation/covf/565464fb0cf29e70f2253e70.

My own view summarised most recently here: http://trueeconomics.blogspot.ie/2015/10/41015-secular-stagnation-and-promise-of.html.

29/11/15: Simple analysis of the EU-Turkey 'deal' on refugees

What does EU-Turkey refugees 'deal' means:

• With closure of land-crossing, duration of refugees passage to Europe over sea is going to be up;
• This means that cost of smuggling refugees will rise, which means safety of refugees during crossing is down (due to quality of boats / procedures, as their ability to pay higher costs is severely restricted, and due to longer crossing routes); 
• Thus, risk of losses of lives is up 
• Which will require greater sea monitoring & rescue missions efforts to avoid horrific losses of lives (unless EU abandons all and any humanitarian considerations);
• Which means EU dilemma of what to do with sea-crossing refugees has gone even less solvable, whilst adding a new dilemma of facing Turkey acting as a physical barrier for legitimate refugees, triggering potential humanitarian crisis on Turkish borders.

So, in summary, it is hard to see how the 'deal' is not a humanitarian crisis gone more acute.

27/11/15: More Tiers, Lower Risks, But Higher Costs: FSB Latest Solutions to Systemic Crises

The Financial Stability Board (a mega quango set up under the G20 cover to make policy recommendations aimed at assuring that Too-Big-To-Fail banks are brought under some international oversight) has recently issued its position on the bank capital shortfalls under the assessment of their balance sheets designed to ‘prevent taxpayers bailouts of lenders’.

The FSB report based on stress tests stated that big international banks operating globally will have to raise anywhere between EUR42 billion and up to as much as EUR 1.1 trillion in funding by 2022 to cover the shortfall in bailable (special) tier debt that can be written down in the case of a bank running into trouble in the future. The tests explicitly covered what is known as banks’ Total Loss Absorbing Capacity (TLAC) - debt that can be converted into equity when a bank fails, in effect forcing debt holders to shoulder the cost of bank collapse and freeing taxpayers from the need to step in. The TLAC approach to bank funding also breaks the pari passu chain of rights distribution across the banks’ liabilities, separating (at last) depositors from bondholders. (1)

In releasing its estimates for TLAC shortfall, the FSB also provided final guidance as to the levels of TLAC it expects to be held by the globally important TBTF banks: 16% of total bank risk-weighted assets by 2019, rising to 18% by 2022. (2)

To be clear, the TLAC cushion is not an iron-clad guarantee that in a future crisis, depositors’ bail-ins and taxpayers’ supports won’t ever arise. Instead, it is just a cushion, albeit at 18 percent target - a significant one. And the cost of this insurance will also be material and likely to be shared across depositors and borrowers worldwide. Current estimates show the cost of 16% hurdle for TLAC to be around 2% of total income of the largest banks, spread over roughly 4 years, this would imply that up to 1/3 of average bank interest margin can be swallowed by the accumulation of cushion. Maintenance of this cushion will also require additional costs as TLAC instruments will likely carry higher cost of funding.

In a silver-lining for Western banking groups, the hardest hit banks amongst the 30 Globally Systemically Important Banks (GSIBs) (3) FSB are four Chinese banks: Agricultural Bank of China, Bank of China, China Construction Bank and Industrial and Commercial Bank of China, will no longer be exempt from TLAC. These banks currently hold no senior debt liabilities that can count as a part of TLAC cushion. In total, there are 60 GSIBs covered by TLAC, but in Europe, some 6,000 smaller banks are also covered by the Minimum Requirement for Eligible Liabilities (MREL) due in January 2016.

The core point for both, the MREL and TLAC is the issue of ‘loss-absorbing capital’. While the issue has been with regulators since the end of the Global Financial Crisis (2010), there is still no clarity on the mechanics of how this concept will work in the end. Currently there are three channels through which liabilities can be subordinated (bailed-in) in case of a crisis. All relate to bank-issued debt instruments:

1. Contractual channel for subordination: banks can issue senior subordinated debt (tier-3 debt) which ranks ahead of tier-2 debt already outstanding in case of normal crises, but is bailable in the case of a structural crisis. 
2. Statutory channel: bank-issued debt can be subordinated by statute.
3. Structural channel: bailable debt is issued through a holding company to be subordinated to debt issued by the bank itself.

Euromoney recently covered these channels, concluding that whilst all three channels are complex, contractual channel is the hardest to structure. It appears that FSB view is that the contractual channel is the one to be pursued. In contrast, Italian authorities have pursued statutory channel, with legislative proposal to make un-guaranteed depositors super-senior liabilities, bailable only in the last instance. German legislation currently in draft stage will make all bonds suboridinatable in the case of bank insolvency. Another case of statutory instrument that defines contractual subordination channel is Spanish regulator introduction of a legislation that will simply subordinate all tier-2 debt by creating a tier-3 debt wedged between senior and tier-2 debt. In contrast, two Swiss GSIBs - Credit Suisse and UBS - have issued at holding company bonds in 2015, opting for the structural channel to subordination. Finally, in the U.S. the Federal Reserve already applied (as of October 30, 2015) the TLAC standards, covering eight of the biggest U.S. banks, with total shortfall of long-term debt arising under TLAC rules estimated at $120 billion. On November 9, U.S. giant Wells Fargo & Co announced that it will need to issue between $40 billion and $60 billion in new debt to cover TLAC requirements, with $40 billion representing the minimum required volume.

Per Fed, U.S. GSIBs will be required to hold:

• A long-term debt balance of 6% of their respective GSIB surcharge of risk-weighted assets or 4.5% of total leverage exposure, whichever is greater; 
• Maintain a TLAC amount of 18% of RWAs or 9.5% of total leverage exposure, whichever is greater. 
• Maintain sufficient high-quality assets (proposed in 2014) as well as a cushion to raise capital levels by an additional $200 billion, over and above the industry requirements. (4)

The key problem with the most functional - contractual and statutory - channels is that TLAC approach requires creation of a new tier-3 debt that has to be ‘wedged’ between current senior and tier-2 levels. And this, as noted in Euromoney article (5) can violate the pari passu clauses already written into existent bank debt.

In simple terms, the regulatory innovations aiming to address the need to break the link between the state and the banks, including for the systemically important banks, seems to continue going down the route of creating added tiers of risk absorption that improve, but not entirely remove the problem of banks-sovereign contagion. At the same time, all these innovations continue to raise the cost of running basic banking operations - costs that are likely to translate into more expensive credit and lower credit-related activities, such as capex and household investment. On long enough time frame, if successful, the new tier of bank debt can, if taken to higher ratios, displace the problem of pari passu vis-a-vis the depositors. Question is - at what cost?


(1) Some basic details are available here: http://www.financialstabilityboard.org/2015/11/total-loss-absorbing-capacity-tlac-principles-and-term-sheet/,  http://www.euromoney.com/Article/3408580/TLAC-what-you-should-know.html and http://www.financialstabilityboard.org/2015/11/total-loss-absorbing-capacity-tlac-principles-and-term-sheet/

27/11/15: The Welfare State Going Broke, and You Know It...

Bruegel’s  Pa Huttl and Guntram Wolff have recently posted on Capx.co results of their study, under a handy title “Lack of confidence in the welfare state in the year 2050” (link here).

One chart sums up key evidence:

Thus, across eight European countries,

• Majority of those polled felt that by 2050 public welfare systems will provide inadequate supports for pensions (59.5% of those polled) and for the unemployed (52.4%). 
• Roughly half of those polled thought that care for the elderly (49.5%) will be inadequately supplied by the public welfare systems, and 
• Over 45% thought that healthcare supply will fall short of their expected standards (45.4%). 

Darn scary numbers these are, even though, in my opinion, these are still too optimistic. The levels of implied state debt relating to what we call 'unfunded obligations' - contractually specified future commitments across pensions and healthcare benefits (excluding statutory, but non-contractual obligations) implies much lower probabilities of the modern welfare states being able to sustain current levels of funding.

Good example is the U.S. where current official debt stands at around USD18.5 trillion, whilst unfunded civilian and military pensions, plus Social Security and Medicare, inclusive of other contractually set Federal commitments and contingencies add another USD46-47 trillion to that (you can read more on this here)

26/11/15: Counting Down to ECB's Big Surprise...

Counting the week to December 3rd ECB meeting, I have to ask one simple question: does anyone over in Frankfurt has a clue what they are doing?

Earlier this week, Reuters reported on a conversation with an unnamed ECB source

Here’s what we have learned:

1. Things are far from smooth in the Euro area. We had some serious talking up on Money Supply side earlier this week, and we had incessant chatter about improving credit conditions. We even had promises of accelerated purchases in December (to offset holidays). But the ECB still appears to be directionless in so far as it still views QE road as insufficient. Menu of options is as wide as ever: more government bonds buys, deeper cuts to deposit rates, including a possible two-tier charge, purchases of municipal and regional debt, and even “buying rebundled loans at risk of non-payment has been discussed in preparatory meetings, although such a radical step is highly unlikely for now”. You really have to wonder: do they have any sense of direction (other than strictly forward)?
2. "There are some who say you should surprise markets. But you cannot surprise indefinitely. Sooner or later, you are bound to disappoint." That is per ECB official. Wait a second, sooner or later? Just how many iterations of this circus will we be looking at? ECB’s commitment (rumoured) to push through a major surprise is a desperate bet. If surprise works, markets are likely to overshoot fundamental valuations on all fronts: from EUR/USD and EUR/Sterling to major equities indices and bond prices. But overshooting is not likely to hold unless the ECB continues to surprise the same markets. If, as likely, inflation remains anchored at low levels over the time of these surprises, the ECB will find itself in a situation where the only way to trigger any positive response from the markets will be to double down on every turn. Scared yet?..
3. ”We have deflation, so you have to do something," said a second person. "How this all looks in a few years, nobody knows." And that is the scary bit - it appears that no one is willing to venture a field view deeper than a few months. Back to that directionless driving…
4. Things, however, are clearly not working for Count Draghul: “Failing to [surprise the markets with expanded QE] so risks disappointing investors who expect ECB policy-setters to bolster a one-trillion-euro plus programme of quantitative easing when they meet on Dec. 3, in a move so significant it has been dubbed 'QE2’.” It seems the Euro area monetary policy is now equivalent to showing up in an alligator park with a crate of chickens: the faster you throw them, the closer you get to becoming a meal yourself, yet try not throwing any at all and you are a meal. And as an aside, what kind of a strategist bets on surprise and then pre-leaks all possible routes for such a surprise?..  
5. Meanwhile, the gators are getting a sight of the chicken man slipping into their pond: “One person familiar with the matter said [non-performing loans that ECB might consider buying] could be packaged with more creditworthy loans before being put up for sale [to ECB]. "You could buy rebundled non-performing loans, combined with good loans," said the person. "If we get to that, then things are very bad.”” Oh dear, slice-and-dice tranches of MBS anyone? The ECB is moving closer and closer to tracing Lehman strategy ca 2006…
6. If the ECB does buy municipal and regional debt, we are in yet another fiscal corner. Buying such paper will absolutely nothing to stimulate private sector capex. But it will loosen the purse for local governments, thus undoing all the ECB-led efforts to reign in fiscal profligacy. And, given the horrific state of public finances across the Euro area, it will set up the ECB to support municipals and regions for many years to come.

So for now, we have captain Draghi steering the ship at faster speeds and with greater determination. Except we don't quite have any idea of the exact course. Thursday should be fun…

26/11/15: Ireland on Inequality Heat Map

Much has been said about inequality in Ireland. On TV off TV and elsewhere. Much of it is, sadly put, locked out factoids.

You see, inequality is a tough thing to measure. So we have loads of various metrics to go by and none are ‘perfect’.

Here is a slightly more comprehensive view via @Jim_Edwards

What the above shows is that across comparable economies, Ireland is mid-range in terms of inequality. Right next to Canada and Austria - two societies that few would consider to be viciously unfair to their residents. Not that there is no room for improvement, mind.

That said, the chart does miss some relevant data for Ireland - the wealth distribution. Which we are, arguably, not a shining example of.

I am not going to repeat my arguments about the relationship between tax system and wealth inequality (you can read them here: http://trueeconomics.blogspot.ie/2014/08/2182014-thomas-piketty-powerful.html), but it is worth noting that we rank well in terms of real wages growth and gender pay gap, as well as health status. We rank average in terms of all other metrics, save for involuntary part-time employment, which - by the way - is improving. I am not too keen on including arbitrary metric of ‘Digital Access’ in the scoring, however.

As an aside, the above table also fails to measure underemployment (you can read on this here: http://trueeconomics.blogspot.ie/2015/11/241115-over-skilled-under-employed.html).

26/11/15: Refugee Camps Are the Cities of Tomorrow

Given the plight of refugees and the current global crisis involving movements of people displaced by wars, famines, natural disasters and internecine governments, the problem of designing facilities for refugees is non-trivial and extremely important. Here is a fantastically informative interview by DeZeen on the topic: http://www.dezeen.com/2015/11/23/refugee-camps-cities-of-tomorrow-killian-kleinschmidt-interview-humanitarian-aid-expert/.

Quote: "These are the cities of tomorrow," said Kleinschmidt of Europe's rapidly expanding refugee camps. "The average stay today in a camp is 17 years. That's a generation. In the Middle East, we were building camps: storage facilities for people. But the refugees were building a city."

26/11/15: On a long enough time line: Irish corporate inversions

Recently, I covered the Pfizer-Allergan ‘merger’ just as Irish media navel gazed into the usual ‘jobs for Ireland’ slumber.  [You can trace much of it from here: http://trueeconomics.blogspot.ie/2015/11/201115-inversion-debate-isnt-over.html]

Now, few links that catch up with my analysis:

1. Irish Times reported that the Exchequer may gain up to EUR620m in Pfizer’s Allergan deal, annually. Key quote: “Last year, Pfizer paid an effective tax rate of 26.5 per cent as a US company. Post-merger, it expects to pay between 17 and 18 per cent across the group. In Ireland, it will pay our 12.5 per cent tax rate on any international income routed through the new Dublin operation.” Err, Irish Times, no. Pfizer will be paying lower effective rate than 12.5% because it will be able to avail of the famous/infamous OECD-allegedly-compliant ‘Knowledge Development Box’. How much lower? Ah, who knows. http://www.irishtimes.com/business/health-pharma/state-may-gain-up-to-620m-in-pfizer-s-allergan-deal-1.2441324
2. Bloomberg covers the same deal with a heading: “Pfizer's Viagra Tax Dollars Head to Dublin as U.S. Loses Again”. A bit of a miss, as Ireland already milks Viagra fortunes, though with the new ‘investment’ that will most likely increase. http://www.bloomberg.com/news/articles/2015-11-23/pfizer-s-viagra-tax-dollars-head-to-dublin-as-u-s-loses-again. Key quote: ““We are not pushing for inversions,” Irish Finance Minister Michael Noonan told reporters in Brussels on Monday, referring to the controversial transaction meant to cut corporate tax rates. The agency charged with winning investment for Ireland “never promotes inversions. It’s a decision for the two companies.” While Noonan said Allergan and Pfizer were plainly merging for “tax advantages,” the government has no problem with the deal as both companies had “substantial” operations in Ireland.” You have to be laughing… the same defence [we are not doing anything, all their fault] has been used in the past by Swiss and other tax havens to justify the arrival of tax-‘optimising’ money into the banks vaults. Now, it is Ireland’s turn. But for comical relief, we have this: “Patrick Coveney, chief executive of Greencore Group Plc, the Irish food company that’s the biggest sandwich maker in the U.K., told state-owned RTE Radio in Dublin on Tuesday that Pfizer’s proposed deal builds on its and Allergan’s presence in Ireland.” Yes, sandwich maker knows a thing or two about pharma and biotech. Next up: newsagent comments on new nuclear power plant design in the UK…
3. Not to be left behind, U.S. politicians are jumping on a carbon copy of the bandwagon too scared to actually join the bandwagon itself. Per Zerohedge: http://www.zerohedge.com/news/2015-11-23/hillary-slams-unfair-tax-inversions-after-sanders-calls-pfizerallergan-deal-disaster “Hillary Slams "Unfair" Tax Inversions After Sanders Calls Pfizer/Allergan Deal "Disaster For Americans”” Apparently, following in the footsteps of the completely out-of-touch Bernie Sanders, Hillary Clinton “firmly believes businesses should get ahead by building a stronger economy here at home, rather than using tax loopholes to shift earnings overseas, or to move abroad to escape paying their fair share.” Hillary went on to do what politicians do best: promise to do something. “In the weeks ahead [no idea when] I will propose specific steps to prevent these kind of transactions… I urge Congress to act immediately [pretty definitive timeframe when urging other to do something though] to make sure the biggest corporations pay their fair share, and regulators also should look hard at stronger actions they can take to stop companies from shifting earnings overseas.” So in basic term, Hillary has nothing to say other than that she has to say something. That’s novel.

All of this would be gas were it not serious. Despite Irish Government promises to curb ‘harmful’ tax practices, despite our vocal ‘compliance’ with the spirit of the OECD ‘reforms’, Ireland remains a premier destination for tax inversions from the U.S. Worse, everyone now knows this, and no one is doing anything about it. Worse, yet, everyone is next going to be aware of the simple fact that no one is doing anything about it.

On a long enough timeline, things will be easier in the short run as Irish Exchequer milks the rest of the world for tax optimising commissions. In the long run… well, we might have to start looking into how we will pay all these future pensions when the penny finally does drop in Washington and Berlin…

25/11/15: Nama: That Gift Horse's Mouth...

Back in June this year, I posted about 10 most egregious cases of apparent mis-pricing of assets relating to Nama sales: http://trueeconomics.blogspot.ie/2015/06/17615-10-cases-worth-asking-nama-about.html

Now, we can add a new one. Per Irish Times report (http://www.irishtimes.com/business/commercial-property/blackstone-to-flip-blocks-for-43m-profit-1.2442098#.VlWtXj-TrWY.twitter):

“Blackstone, the world’s biggest private equity firm, is on track to make a profit of €43 million on two office buildings it bought in Dublin’s south docklands only two years ago. The company has agreed sale terms at €123 million for the Bloodstone Building and an adjoining block on Britain Quay – 54 per cent more than the €80 million paid for them towards the end of 2013.”

In other words, we have vulture fund that bough completed properties two years back and managed to squeeze 54% appreciation out of them by doing virtually nothing new, adding virtually no new value. And Nama added zero value to the buildings as well as it got them off Sean Dunne in fully completed form.

The cherry on the cake (for Blackstone) is that it bought the above buildings for roughly EUR100 million, along with a third building: Hume House on Pembroke Road in Ballsbridge. Blackstone is yet to sell Hume House. So Blackstone actual returns on Nama purchase will be going up and up.


The Irish Times article also references another Nama ‘deal’ for the taxpayers. “Early in 2013, King Street Capital bought the Bishop’s Square office building on Kevin Street for €65 million and last January it sold it on to Hines, the international property company, for €92.5 million – a price rise of more than 42 per cent.”

That would be the deal described here: http://costarfinance.com/2014/10/06/hines-in-pole-position-for-project-cherry-after-knockout-first-round-bid/


So between these two ‘deals’, Irish taxpayers have foregone collective EUR70 million. Thanks, Nama!