20/5/16: Migrating Extremism: Long Run Impact on Voters Preferences

What happens when there is a systemic pattern of migration across borders and geographies that captures migration by political extremists?

This is neither a trivial question nor an esoteric one. It is non-trivial, because, to the best of my knowledge, we are yet to have a good understanding of what happens in the aftermath of military and political efforts to curb extremism. Curbing extremism pushes some of it into underground, but if attempts to curb extremism are not uniform across various geographies, it also incentivises selective migration of large numbers of extremists to those locations, where the efforts to curb their ideologies and behaviour are less strong. If so, when such a migration is feasible on large enough scale, asymmetric treatment of extremists across two geographies can lead to a concentration of extremists in that geography where they are treated more leniently.

This is the logic. What about the evidence?

Here is a fascinating study by Ochsner, Christian and Roesel, Felix, titled Migrating Extremists (March 10, 2016) published so far as a CESifo Working Paper (Series No. 5799: http://ssrn.com/abstract=2763513).

Quoting their abstract (emphasis is mine):

• "We show that migrating extremists shape political landscapes toward their ideology in the long run. 
• "We exploit the unexpected division of the state of Upper Austria into a US and a Soviet occupation zone after WWII. Zoning prompts large-scale Nazi migration to US occupied regions. 
• "Regions that witnessed a Nazi influx exhibit significantly higher voting shares for the right-wing Freedom Party of Austria (FPÖ) throughout the entire post-WWII period, but not before WWII. 
• "We can exclude other channels that may have affected post-war elections, including differences in US and Soviet denazification and occupation policies, bomb attacks, Volksdeutsche refugees and suppression by other political parties. 
• "We show that extremism is transmitted through family ties and local party branches. We find that the surnames of FPÖ local election candidates in 2015 in the former US zone are more prevalent in 1942 phonebook data (Reichstelefonbuch) of the former Soviet zone compared to other parties."

This is pretty much nuclear. Migration of individuals holding extremist beliefs, when systematically biased in favour of a specific location, does lead to concentration of extremist voters and such concentration is robust over time. Big lessons to be learned for today's migration regulation and institutional environment, as well as the systems of incentives and pressures that drive the migrant selection mechanisms.

17/5/16: US Earnings Recession: Four Quarters Long... but How Much Longer?

Recently, I have been highlighting in my Risk & Resilience course for MBAs at MIIS and on this blog the perils of corporate earnings gaming, including the rather worrying trend toward companies posting negative net cash flows (basically using debt to fund shares repurchases).

Here are two of my lecture slides from two weeks ago:

And to add to the pile of evidence, as 1Q 16 earnings rolled in, the numbers were coming in at a frankly put brutal squeeze: we had the fourth consecutive quarter for the S&P 500 earnings running in the red, with 1Q 16 decline being the steepest since 2008-2009 at 6.3%:

However, some interesting insight on the matter of forward earnings guidance was recently published by the Deutsche Bank Research and here is a link to the article discussing it: http://www.valuewalk.com/2016/05/earnings-q1-marks-darkest-hour-just-dawn-says-db/.

Yes, DB's model for earnings for S&P500 is an interesting one. No, without seeing actual standard econometric tests, I can't tell if it makes any sense in reality or not (just because it has high R-sq means diddly nada without knowing how the residuals behave). And no, I am not sure I am buying the idea of 'all factors in favour' arguments presented by DB Research. I am, however, pretty certain that probabilistically a bet should be for more moderate earnings performance in 2Q compared to 1Q, which of course will prompt DB Research lads cheering confirmation of their own model. So I am skeptical, but... still, the article is worth a read.

17/5/16: Euro Area Exports of Goods Down in 1Q 2016

Euro area trade in goods data for 1Q 2016 is out today and the reading is poor.

On annual basis (not seasonally-adjusted figures), extra-EA19 exports of goods were down in 1Q 2016 to EUR485.8 billion from EUR492.0 billion a year ago, a decline of ca 1% y/y. Imports - sign of domestic demand and investment - dropped 3%. As the result, EA trade balance for goods trade only rose from EUR46.8 billion in 1Q 2015 to EUR53.9 billion in 1Q 2016.

Out of the original EA12 countries, Ireland was the only one posting an increase in extra-EA19 exports in 1Q 2016 compared to 1Q 2015 (+3%), while the largest decrease was recorded by Greece (-20%) and Portugal (-17%).

On a seasonally-adjusted basis (allowing for m/m comparatives), exports extra-EA19 fell from EUR167.3 billion in February 2016 to EUR165.1 billion in March 2016, reaching the lowest point in 12 months period. Due to an even sharper contraction in imports, trade balance (extra-EA19 basis) rose to EUR22.3 billion from EUR20.6 billion.

More details here: http://ec.europa.eu/eurostat/documents/2995521/7301989/6-17052016-AP-EN.pdf/70c12e75-2409-44f5-9403-fdb3eb816d1a 

17/5/16: Village May 2016: Buzz Wrecked

My article for Village magazine highlighting some longer-term risks for the Irish economy: http://villagemagazine.ie/index.php/2016/05/buzz-wrecked/.

Plenty of opportunities to the upside, but risks are material and require careful policy balancing between fiscal prudence, institutional supports for domestically-anchored companies and entrepreneurs, with a concerted effort to move away from the FDI-or-bust policies of the past 30 years.

16/5/16: 1Q 16 GDP growth and other recent stats on Russian Economy

Russian GDP (preliminary estimate) shrunk 1.2% y/y in 1Q 2016, with the rate of contraction in the economy moderating from 3.7% for the full year 2015 and from 3.8% drop recorded in 4Q 2015. So the economy is still shrinking, albeit at a slower pace, and slower, yet, than consensus annual forecast for the decline of 1.7%.

Some interesting developments on inflation front too.

April CPI was up 0.4% m/m and 2.5% y/y which is well below m/m and y/y inflation recorded in April 2015 at 0.5% and 7.9%, respectively. Food inflation was running at 5.3% y/y in April 2016 against 21.9% registered in April 2015. January-April 2016 y/y inflation in food prices was 'only' 6.5% which compares against 22.2% inflation in food prices registered in January-April 2015. HICP inflation for April 2016 was 7.6% y/y and January-April 2016 period HICP inflation was 8.8% y/y, against corresponding figures for April 2015 and January-April 2015 at 17.5% and 16.6%, respectively. Amongst food products: Meat and poultry (-0.2% y/y for the first four months of 2016), Sugar (refined) (-0.2%) and Fruit & Vegetables (-1.9%) registered deflation in prices over the first four months of 2016 compared to 2015. During the corresponding period of 2015, all categories of food products registered double-digits inflation.

Consumer price index evolution in 2015 and 2016 by month

Source: State Statistics Committee http://www.gks.ru/

Trend toward much more subdued inflation continued in the first ten days of May 2016, based on preliminary data.

Meanwhile, imports substitution policies are starting to finally show some positive payoffs (albeit, helped heavily by massive ruble devaluations of the recent 18 months):

• Beef production rose 4.34% in 2015 compared to 2010-2013 average;
• Pork production was up massive 73.6%
• Meat products are up 18.8%
• Fish & sea food however shrink 5.82% in 2015 compared to 2010-2013 average;
• Milk and milk products output was up 5.99% in 2010-2013 average.

16/5/16: Earnings Surprises and Share Price Impact

A very interesting summary graph from Factset on the impact of earnings performance relative to consensus expectations on share prices

In basic terms, upside to consensus is systemically rewarded, while downside impact decays over time. The chart reflects 5 years worth of data, so capturing the period of declining earnings, where positive surprises should naturally be priced at a premium. The question the data above raises is whether coincident or subsequent shares repurchases provide support to the upside for underperforming firms and/or for outperforming firms.

Remember, recent McKinsey research showed that deviations from consensus forecast do not matter that much when it comes to underwriting longer term returns:

16/5/16: Another Top 100 for Trueeconomics

Just got a note that TrueEconomics is ranked 72nd in Top 100 Economics Blogs for 2016 by the IntelligentEconomist.com : https://www.intelligenteconomist.com/top-economics-blogs-2016/

15/5/16: Don't Rush the Cheers for Eurozone Growth, Yet

Remember record-busting 0.6% preliminary flash estimate of the first estimate GDP growth figure for Euro area released back in April? Well, it sort of was true, sort of...

Eurostat now puts 1Q 2016 growth at 0.5% q/q in its updated estimate released today - 0.1% lower than the April estimate. This figure is tied jointly for highest q/q growth figure since 1Q 2011 when it hit 0.8%.

Sounds good? Brilliant - the euro area outperformed both the U.S. and the UK. But when one looks at annual rates of growth... things are not as shiny.

In annual terms, growth rate actually fell in 1Q 2016, from 1.6% in 2Q 215 through 4Q 2015 to 1.5% in 1Q 2016. You won't be jumping with joy on that. And as the euro area lead growth indicator, Eurocoin suggests, rates of growth have been declining over the last three months through April 2016, dropping from cyclical high of 0.48 in January 2016 to a 13-months low of 0.28 in April 2016:

There is a strong smell of smoke from the Eurostat figures. Demand side of the economy is apparently booming. Despite the fact that retail sales are tanking:

Meanwhile, external trade is also underperforming (on foot of euro appreciation from November 2015 lows against both the US dollar and British pound):

Euro bottomed out at around 1.057 to the dollar at the end of November, and steadily gained against the USD every month since, with current valuation around 1.13-1.14 range. This hardly supports European exports to the U.S. Controlling for volatility, similar trend is against British Pound. About the only thing going the euro way today is yen and it is immaterial to the Euro area’s economy.

So euro zone economic growth appears to be loosing momentum since the start of 2Q 2016. And there are both short term drivers for this and long term ones.

Short term drivers, as outlined above suggest that current risks environment appears to be titled to the downside:

• Eurozone Composite Output Index by Markit posted 53.0 in April against March 53.1. Statistically-speaking, the rate of growth effectively remained static. 
• German Composite PMI was at 53.6, which is an 11-months low, French Composite index reading was 50.2 (barely above the 50.0 line, but still at 3mo high), while Italian Composite PMI in April came in at 53.1, also 2 months high. 
• Importantly, the euro zone PMI indices have been moving out of step with the Global PMI readings. In April, while eurozone PMI declined marginally compered to the end of 1Q 2016, Global PMI reading marginally picked up, rising from 51.5 in March to 51.6 in April. 
• The ongoing stagnation in France continued, while solid expansions were noted in Germany, Italy, Spain and Ireland.
• Developed markets saw all-industry output rise at the fastest pace in three months during April. However, the rate of increase still one of the weakest registered during the past three years. Growth remained only modest in both the US and the UK (UK growth slowed to its weakest pace since March 2013). This puts pressure on demand for eurozone exports and, in turn, pressures profit margins and investment.
• Given 1Q growth estimate at 0.5% (q/q growth) from the Eurostat, current level of Eurocoin suggest quarterly growth slowdown to around 0.4%. 
• Ifo’s Economic climate indicator for the Euro area has now been on a clear declining trend since mid-2015 and is now at its lowest levels since 1Q 2015 and second lowest reading in two-and-a-half years.
• In Germany, consensus estimates put gross domestic product growth at 0.3 percent in the current quarter and 0.4 percent in 3Q and 4Q, with full year growth of around 1.5 percent.

My view: we might see 2Q growth coming in at 0.3-0.4 percent, if April trends continue into the rest of 2Q. Overall, I expect 2016 growth to be around 1.4-1.5 percent which is just about to the downside on current consensus estimate of 1.5 percent.


Long term drivers for structural euro zone growth weakness: Even with positive 1Q 2016 print on growth side, it is fairly clear that euro zone lacks serious growth catalysts.

Everyone is talking about Brexit referendum and the renewal of the Greek crisis as key threats. Put frankly - this is a smokescreen. When it comes to longer term euro zone growth prospects both are irrelevant. Growth within the euro area has nothing to do with the UK. And Greece has been effectively removed from the markets and economic agents' considerations - the country is no longer commanding any serious media attention (with markets fatigued by the never-ending 'crises'). With ESM / EFSF /ECB now seemingly the sole bearers of Greek debt (with IMF likely to take back seat in the Bailout 3.0 as per http://trueeconomics.blogspot.com/2016/05/11516-71-steps-guide-to-greek-crisis.html) Greek funding issues and any risk of a default are unlikely to trigger Grexit. Put more directly, even if Greece were to exit the Euro, no one will bat an eyelid over such an event.

Meanwhile, the real long term problems for the euro area are:

• Capex remains subdued across the entire euro area, including Germany, Italy, France. 
• Fiscal policy is currently largely neutral and it is hard to see how the euro area can find any significant capacity to increase fiscal spending. 
• ECB stimulus is working in the financial markets, but not on the ground - there is still too much debt and too little prospect for a return on capital. Quality borrowers are not rushing to take on loans for capex. And the banks are not too eager to lend to borrowers with legacy leverage problems. 
• Eurozone banking is still a mess: capital and loans restructuring is sporadic, rather than systematic, negative rates taking a bite out of margins, but even if this headwind is taken out, markets volatility is not helping. 

And there are even bigger structural headwinds:

1. Lack of agility in the structurally over-regulated and sclerotic economy: technological innovation is weak, adoption of technological innovation is weak, labour force quality is deteriorating, so productivity growth has collapsed. Entrepreneurship is weak. Employment is sluggish and of deteriorating quality. That’s supply side.
2. Demand side is improving due to a short term boost from the post-Great Recession cyclical recovery. But, legacy issues of debt across corporate and household sectors and public finances are still present.
3. On financial side: banks-intermediated funding model for capex is a drag on growth and there is zero momentum on equity and direct debt issuance sides. Even with ECB going into another round of TLTROs, issuance of new bonds has spiked primarily because of larger corporates issuance, not because of market deepening.
4. On policies front, there is total and comprehensive paralysis. EU is malfunctioning, torn apart by crises of European making. National governments have lost capacity to legislate because of delegation of so much decision making to Brussels in the past. Political discontent is rising everywhere. We now have growing proportions of core European countries’ populations - the Big 4s - wanting to reexamine the entire EU.

Europe has been Japanified. And there is little that it can do to avoid this stagnation trap. There is no hope that  fiscal policy can do what monetary policy has failed to deliver - the great hope of Keynesianistas. And with that, both the monetary and the fiscal sides of European growth equation are out. What's left? Endless low interest rates (with a risk of policy error, should Germans rebel against Draghi's uncountable puts) and endless painful quasi-deflating (through low demand) of debt. Aka, pain.

15/5/16: Gamable EPS and Shares Buybacks

EPS (Earnings per Share) is a corporate metric that is often pursued by the corporate managers and executives to increase their own payouts, and confused by investors for a signal of company health. As is well known (and we show this in our Risk & Resilience course), EPS is a 'gamable' metric - in other words, it can be easily manipulated by companies often at the expense of actual balance sheet quality.

And I have written about this problem here on the blog for ages now.

So here is a fresh chart from the Deutsche Bank Research (via @bySamRo) detailing shares buybacks (repurchases) contribution to EPS growth:

In basic terms, there is no organic EPS growth (from net income) over the last 7 quarters on average and there is negative EPS growth from organic sources over the last 4 consecutive quarters.

As noted in my lecture on the subject of 'EPS gaming', there are some market-structure reasons for this development (basically, rise of tech-based services in the economy):

Source of data: McKinsey

Source: McKinsey

However, as the chart above shows, shares buybacks simply do not add any value to the total returns to the shareholders (TRS) and that is before we consider shift in current buybacks trends toward debt funded repurchases. So, in a sense, current buybacks are rising leverage risks without increasing TRS. Which is brutally ugly for companies' balance sheets and, given debt covenants, is also bad news for future capex funding capacity.

12/5/16: Leaky Buckets of U.S. Data

Recently, ECB researchers published an interesting working paper (ECB Working Paper 1901, May 2016). Looking at the U.S. data that is released under the embargo, they found a disturbing regularity: across a range of data, there is a strong evidence of a statistical drift some 30 minutes prior to the official time of the release. In simple terms, someone is getting data ahead of the markets and is trading on it in sufficient volumes to move the market.

Let’s put this into a perspective: there is a scheduled release for private data that is material for pricing the market. The release time is t=0. Some 30 minutes before the official release, markets start pricing assets in line with information contained in the data yet to be released. This process continues for 30 minutes until the release becomes public. And it moves prices in the direction that correctly anticipates the data release. The effect is so large, by the time t=0 hits and data is made publicly available, some 50% of the total price adjustment consistent with the data is already priced into the market.

"Seven out of 21 market-moving announcements show evidence of substantial informed trading before the official release time. The pre-announcement price drift accounts on average for about half of the total price adjustment,” according to the research note.

Pricing occurs in S&P and U.S. Treasury-note futures and data sample used in the study covers January 2008 through March 2014.

Here is the data list which appears to be leaked in advance to some market participants:

1. ISM non-manufacturing
2. Pending home salses
3. ISM manufacturing
4. Existing home sales
5. Consumer confidence from the Conference Board (actually, CB has taken some actions recently to tighten their releases policy)
6. Industrial production (U.S. Fed report)
7. The second reading on GDP
8. There is also partial evidence of leaks in other data, such as retail sales, consumer price inflation, advance GDP estimates and initial jobless claims. 

Overall, plenty of the above data are being released by non-private (aka state) agencies.

The authors control for market expectation, including forecasts drift (as date of release grows nearer, forecasts should improve in their accuracy, and this can have an effect on market pricing). They found that “more up-to-date forecasts” are no “better predictors of the surprise” than older forecasts. In addition, as noted by the authors: “these results are robust to controlling for, among others, outliers, data snooping, nearby announcements and the choice of the event window length.”

The problem is big and has gotten worse since 2008. “Extending the sample period back to 2003 with minute-by-minute data reveals both a higher announcement impact and a stronger pre-announcement drift since 2008, especially in the S&P E-mini futures market. Based on a back-of-the-envelope calculation, we estimate that since 2008 in the S&P E-mini futures market alone the profits associated with trading prior to the o fficial announcement release time have amounted to about 20 million USD per year.”

Two tables summarising there results.

The paper is available here: http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1901.en.pdf?ca0947cb7c6358aed9180ca2976160bf



11/5/16: 7+1 Steps Guide to Greek Crisis Madness

Greece is back in the news recently with yet another round of crisis talks and measures. Here's where we stand on the matter.

After another Eurogroup 'talks' this week, Greek Government is back to drawing up a new set of 'measures' to be presented to the Parliament. These 'measures' are, once again, needed for yet another Eurogroup agreement of yet more loans to the country.

The madness of this recurring annual spectacle that the EU, the Greeks and the IMF have been going through is so apparent and so predictable by now, that anywhere outside Greece itself it is simply banal.

The scenario is developing exactly along the same lines as before:

1. Greeks are running out money
2. Greek loans funds are not being remitted by the EU because of the 'lack of progress on 'reforms' which were never progressed since the Bailouts 1.0 & 2.0.
3. Greek Government insists that no more 'reforms' can be imposed onto the Greek economy because there is already no economy left due to previously imposed 'reforms'
4. IMF threatens to walk out and European authorities become 'doubtful' of Greek commitments to 'reforms'
5. European authorities and Greece get into a room to hammer our (3) as a precondition for (2) both of which are necessary to avoid Greek default and are thus required to prevent (4).
6. Greece agrees to more 'reforms', gets more loans, none of which have anything to do with actually supporting Greek economy
7. Greek government declares another 'victory' on the road of the country 'exit from an era of creditors', whilst creditors become ever more committed to Greece.
8. Within 6 months, (1) repeats anew...

And this is exactly what has been happening over the recent days.

Government partner Panos Kammenos has already heralded “Greece’s exit from an era of creditors" this week in the wake of the promises by Greece to implement new round of 'reforms' aimed at placating the EU and the IMF into providing fresh credit to Greece. The target date for Greek Government putting its tail between its legs for the umpteenth time is May 24th when the Eurogroup is supposed to meet to decide on the next round of debt financing for Greece.
What are the latest 'reforms' about?

1. New privatization fund (because previous one did nada, zilch, nothing) to sell state assets (with hugely inflated expected valuations) to investors (read vultures) to generate funds (that will fall grossly short of) required to pay some debt down.
2. New rules for working out non-performing bank loans (foreclosure & bankruptcy reforms) because under (1) above, vultures, sorry 'investors', ain't getting enough.  
3. Load of new taxes (levying coffee, fuel and even web connections, for a modern economy cannot exists in the vacuum of knowledge taxes).
4. Automatic cuts to fiscal spending should the Government breach targets on fiscal deficits assigned under 2015 'deal'.
5. EUR5.4 billion in fresh budget cuts.

In return, Tsipras is getting Eurogroup's usual waffle.

The IMF (that actually holds more central position between the Greek and the EU corners) will probably be allowed to excuse itself from underwriting Bailout 3.0 agreed last Summer. This will load full Greek bailout cost onto the EU institutions - something that Europe is happy to do because the IMF has become a realist thorn in the hopium filled buttocks of European 'policymaking'. IMF will, of course, rubber stamp the Bailout 3.0 programme by remaining an 'advisory' institution (sort of like Irish Fiscal Council - bark, but no bite). In exchange, it will get European funds to repay IMF loans and will walk away from the saga with bruises, but no broken nose. Rumour has it, Germany will accept this role for the IMF but only if Greece agrees to become Europe's holding tank for refugees (it's an equivalent of Turkey Compromise with Athens that will make Erdogan livid with jealousy).

Tsipras will also receive another promise from the EU to examine Greek debt relief. By now, everyone forgot that the EU already promised to do so four years ago (see last page, 2nd paragraph in Eurogroup statement from November 27, 2012 and reiterated it in August 11, 2015 Bailout3.0 agreement). Thus, Tsipras will be able to put a new 'certificate of a promise' (written in French or German or both, for better effect) onto his cabinet wall, while being fully aware that a promise from the EU is about as good as a used car salesman's assurances about a vehicle's transmission. The only chance any sort of relief will be forthcoming is if the IMF amplifies its rhetoric about Greek debt 'sustainability', which may happen at the next G7 meeting next week, or may not happen for another six months... who knows?

Meanwhile, the saga rolls on. Protests in Greece - 'Everyone'sOutraged', are greeted by the markets as 'Things Are Going Swimmingly' just as IMF's team is shouting 'The Patient's Dead, You Morons!' while Germans are saying first 'Nothing's Happening' and a week later changing their minds to 'Things Are so Good, We'll Have a Deal' to the solo of a Greek official singing 'We've Been Half Dozing' and a chorus of EU leaders erupting with a jubilatory 'Lalala'.

Remember: we are in Europe! Mind the gap... with reality.

11/5/16: U.S. Economy: Three Charts Debt, One Chart Growth

In his recent presentation, aptly titled "The Endgame",  Stan Druckenmiller put some very interesting charts summarising the state of the global economy.

One chart jumps out: the U.S. credit outstanding as % of GDP

In basic terms, U.S. debt deleveraging post-GFC currently puts U.S. economy's leverage ratio to GDP at the levels comparable with 2006-2007. Which simply means there is not a hell of a lot room for growing the debt pile. And, absent credit creation by households and corporates, this means there is not a hell of a lot of room for economic growth, excluding organic (trend) growth.

As Druckernmiller notes in another slide, the leveraging of the U.S. economy is being sustained by monetary policy that created unprecedented in modern history supports for debt:

And as evidence elsewhere suggests, the U.S. credit creation cycle is now running on credit cards:

Source: Bloomberg

And the problem with this is that current growth rates are approximately close to the average rate of the bubble years 1995-2007. Which suggests that in addition to being close to exhaustion, household credit cycle is also less effective in supporting actual growth.

Which is why (despite a cheerful headline given to it by Bloomberg), the next chart actually clearly shows that the U.S. growth momentum is structurally very similar to pre-recession dynamics of the 1990 and 2000:

Source: Bloomberg

Back to Druckenmiller's presentation title... the end game...