18/7/16: Stock Markets Crashes: 1955-2015

A good summary of all stock markets crashes since 1955 through 2015 via Goldman Sachs:

The caption to the chart says it all.

18/6/16: Brexit, U.S. Elections & State of Discontent

My interview with ItalVideoNews’ Concetto La Malfa about Brexit and the US Elections:
https://alternativeeconomics.co/tubeline/#/view/PuaUax7A1sc.

17/6/16: Credit markets on the ropes?

In their research note, titled aptly “Credit Metrics Bode 1ll”, Moody’s Analytics produced a rather strong warning to the corporate credit markets, a warning that investors should not ignore.

Per Moody’s: “The current business cycle upturn is in its latter stage, aggregate measures of corporate credit quality suggest. The outlook for the credit cycle is likely to deteriorate, barring improved showings by cash flows and profits, where enhanced prospects for the latter two metrics depend largely on a sufficient rejuvenation of business sales.”

In other words, unless corporate performance trends break to the upside, credit markets will push into a recessionary territory.

“Recessions materialized within 12 months of the year-long ratio of internal funds to corporate debt descending to 19.1% i n Ql -2008, Ql-2000, and Q4-1989. As derived from the Federal Reserve's Financial Accounts of the United States, or the Flow of Funds, the moving year long ratio of internal funds to corporate debt for US non-financial corporations has eased from Q2-2011's current cycle high of 25.4% to the 19.1% of Ql-2016.”

Moody’s illustrate:

Now, observe the ratio over the current cycle: the peak around the end of 2011-start of 2012 has now been fully and firmly exhausted. Current ratios sit dangerously at 4Q 2007 and close to 1-3 quarters distance from each previous recession troughs.

The safety cushion available to the U.S. corporates when it comes to avoiding a profit recession is thin. Per Moody’s: “The prospective slide by the ratio of internal funds to corporate debt underscores how very critical rejuvenations of profits and cash flows are to the outlooks for business activity and credit quality. Getting profits up to a speed that will keep the US safely distanced from a recession has been rendered more difficult by the current pace of employment costs."

Here’s the problem. Employment costs can be cut back to improve profitability in a normal cycle. The bigger the cut back, the more cushion it provides. But in the current cycle, employment costs are subdued (do notice that this environment - of slower wages and costs inflation - is the same as in 2004-2007 period). Which means two things:

1. U.S. corporates have little room to cut employment costs except by a massive wave of layoffs (which can trigger a recession on its own); and
2. U.S. corporates have already front-loaded most of the risk onto employment costs during the Great Recession. Which means any new adjustment is going to be even more painful as it will come against already severe cuts inherited from the Great Recession and only partially corrected for during the relatively weak costs recovery period since then. 

Moody’s are pretty somber on the prospect: "As inferred from the historical record, restoring profits through reduced labor costs is all but impossible without the pain of a recessionary surge in layoffs. Thus, barring a recession, employment costs should continue to expand by at least 5% annually."

That’s the proverbial the rock and the hard place, between which the credit markets are wedged, as evidenced by the recent dynamics for both Corporate Gross Value Added (the GDP contribution from the corporate sector) and the nominal GDP:

Again, the two lines show steady downward trend in corporate performance (Corporate GVA) and slight downward trend in nominal GDP. In terms of previous recessions, sharp acceleration in both trends since the end of 4Q 2014 is now long enough and strong enough to put the U.S. onto recessionary alert.

Per Moody’s: "As of early June, the Blue Chip consensus projected a 3.2% annual rise by 2016's nominal GDP that, …signals a less than 3% increase by corporate gross value added. [This]... implies a drop by 2016's profits from current production that is considerably deeper than the - 2.5% dip predicted by early June's consensus. Moreover, as inferred from the consensus forecast of a 4.4% increase by 2017's nominal GDP, net revenue growth may not be rapid enough to stabilize profits until the second-half of 2017, which may prove to be too late for the purpose of avoid ing a cyclical downturn."

In other words, there is a storm brewing in the U.S. economy and the credit markets are exhibiting stress consistent with normal pre-recessionary risks. Which is, of course, somewhat ironic, given that debt issuance is still booming, both in the USD and Euro (a new market of choice for a number of U.S. companies issuance in response to the ECB corporate debt purchasing programme):

Just as the corporate credit quality is deteriorating rapidly:

You really can’t make this up: the debt cornucopia is rolling on just as the debt market is flashing red.

17/6/16: Forget Brexit. Think EUrisis

Swedish research institute, Timbro, published their report covering the rise of political populism in Europe. And it makes for a sobering reading.

Quoting from the report:

“Never before have populist parties had as strong support throughout Europe as they do today. On average a fifth of all European voters now vote for a left-wing or right-wing populist party. The voter demand for populism has increased steadily since the millennium shift all across Europe.”

Personally, I don’t think this is reflective of the voter demand for populism, but rather lack of supply of pragmatic voter-representing leadership anywhere near the statist political Centre. After decades of devolution of ethics and decision-making to narrow groups or sub-strata of technocrats - a process embodied by the EU systems, but also present at the national levels - European voters no longer see a tangible connection between themselves (the governed) and those who lead them (the governors). The Global Financial Crisis and subsequent Great Recession, accompanied by the Sovereign Debt Crisis and culminating (to-date) in the Refugees Crisis, all have exposed the cartel-like nature of the corporatist systems in Europe (and increasingly also outside Europe, including the U.S.). Modern media spread the information like forest fire spreads ambers, resulting in amplified rend toward discontent.

Again, per Timbro:
“No single country is clearly going against the stream. 2015 was the most successful year so far for populist parties and consistent polls show that right-wing populist parties have grown significantly as a result of the 2015 refugee crisis. So far this year left-wing or right-wing populist parties have been successful in parliamentary elections in Slovakia, Ireland, Serbia, and Cyprus, in a presidential election in Austria and in regional elections in Germany. A growing number of populist parties are also succeeding in translating voter demand into political influence. Today, populist parties are represented in the governments of nine European countries and act as parliamentary support in another two.”

Net: “…one third of the governments of Europe are constituted by or dependent on populist parties.”

And the direction of this trend toward greater populism in European politics is quite astonishing. Per Timbro, “discussions on populism too often focus only on rightwing populism. Practically everything written on populism, at least outside Southern Europe, is almost entirely concerned with right-wing populism. Within the political sciences the study of right-wing populist parties has even become its own field of study, while studies on leftwing populism are rare.”

This skew in reporting and analysis, however, is false: while “…it is the right-wing populism that has grown most notably, particularly in Scandinavia and Northern Europe. However, in Southern Europe the situation is the opposite. If the goal is to safeguard the core values and institutions of liberal democracy we need a parallel focus on those who challenge it, regardless of whether they come from the right or the left. It is seriously worrying that seven per cent of the population in Greece vote for
a Nazi party, but it is also worrying that five per cent vote for a Stalinist one. The second aim of this report is therefore to present an overview of the threat of populism, both right-wing and left-wing, against liberal democracy.”

Here are some trends:

The chart above shows that authoritarian left politics are showing a strong trend up from 2010 through 2014, with some moderation in 2015, which might be driven more by the electoral cycle, rather than by a potential change in the trend. The moderation in 2015, however, is not present in data for right wing authoritarianism:

So total support for authoritarian parties is up, a trend present since 2000 and reflective of the timing that is more consistent with the introduction of the euro and subsequent EU enlargements. An entirely new stage of increase in authoritarianism tendencies was recorded in 2015 compared to 2014.

Save for the correction downward in 2007-2009 period, authoritarian parties have been on an increasing power trend since roughly 1990, with renewed upward momentum from 1999.

You can read the full study and reference the study definitions and methodologies here: http://timbro.se/sites/timbro.se/files/files/reports/4_rapport_populismindex_eng_0.pdf.


What we are witnessing in the above trends is continuation of a long-running theme: the backlash by the voters, increasingly of younger demographics, against the status quo regime of narrow elites. Yes, this reality does coincide with economic inequality debates and with economic disruptions that made life of tens of millions of Europeans less palatable than before. But no, this is not a reaction to the economic crisis. Rather, it is a reaction to the social, ideological and ethical vacuum that is fully consistent with the technocratic system of governance, where values are being displaced by legal and regulatory rules, and where engineered socio-economic system become more stressed and more fragile as risks mount due to the technocratic obsession with… well… technocracy as a solution for every ill.

While the EU has been navel gazing about the need for addressing the democratic deficit, the disease of corporatism has spread so extensively that simply re-jigging existent institutions (giving more power to the EU Parliament and/or increasing member states’ voice in decision making and/or imposing robust checks and balances on the Commission, the Eurogroup and the Council) at this stage will amount to nothing more than applying plasters to the through-the-abdomen gunshot wound. Brexit or not, the EU is rapidly heading for the point of no return, where any reforms, no matter how structurally sound they might be, will not be enough to reverse the electoral momentum.

For those of us, who do think united Europe can be, at least in theory, a good thing, time is to wake up. Now. And not to oppose Brexit and similar movements, but to design a mechanism to prevent them by re-enfranchising real people into political decision making institutions.

13/6/16: Twin Tech Challenge to Traditional Banks

My article for the International Banker looking at the fintech and cybercrime disruption threats to traditional banking models is out.

The long-term fallout from the 2008 global financial crisis created several deep fractures in traditional-banking models. Most of the sectoral attention today has focused on weak operating profits and balance-sheet performance, especially the risks arising from the negative-rates environment and the collapse in yields on traditional assets, such as highly rated sovereign and corporate debt. Second-tier concerns in boardrooms and amidst C-level executives relate to the continuously evolving regulatory and supervisory pressures and rising associated costs. Finally, the anemic dynamics of the global economic recovery are also seen as a key risk to traditional banks’ profitability.

However, from the longer-term perspective, the real risks to the universal banks’ well-established business model come from an entirely distinct direction: the digital-disruption channels that simultaneously put pressure on big banks’ core earnings lines and create ample opportunities for undermining the banking sector’s key unique selling proposition—that is, security of customer funds, data and transactions, and by corollary, enhancing customer loyalty. These channels are FinTech innovations—including rising data intensity of products on offer and technological threats, such as rising risks to cybersecurity. This two-pronged challenge is not unique to the banking sector, but its disruptive potential is a challenge that today’s traditional banking institutions are neither equipped to address nor fully enabled to grasp.

Read more here: Gurdgiev, Constantin, Is the Rise of Financial Digital Disruptors Knocking Traditional Banks Off the Track? (June 13, 2016). International Banker, June 2016. Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2795113.

12/6/16: Few Thoughts on Anglo Trial Verdicts

A friend recently did me a small service by summing up my comments on twitter on the Anglo Irish Bank - Irish Life & Permanent roundabout loans verdict:

I have provided an expert testimony on the matter in April in a court case involving the Central Bank, the Department of Finance and the Attorney General of Ireland, focusing precisely on the nature of the relationship between the Irish Financial Regulation authorities and the misconduct by banks and banks boards prior to 2008 Global Financial Crisis.  Quoting from my expert opinion:

"Part 4: Regulatory enforcement effectiveness and efficiency

46. In my opinion, and based on literature referenced herein, objectives of the function of enforcement in financial regulation are best served by structuring enforcement processes and taking robust actions so as to:
1. Target first and foremost the core breaches of regulatory and supervisory regimes, starting with systemic-level breaches prior to proceeding to specific institutional or individual level infringements [Targeting];
2. Timely execute enforcement actions, both in the context of market participants’ timing and timing relevant to the efficiency and effectiveness of uncovering the actual facts of specific alleged infringements [Timely execution];
3. Prevent or at the very least reduce, monitor and address any potential conflicts of interest in enforcement-related actions [Conflict of interest minimisation];
4. Assure that enforcement actions are taken within the constraints of the regulatory regime applicable at the time of alleged committing of regulatory breaches, while following well-defined and ex ante transparent processes [Applicability and quality of regulation and enforcement];

5. Assure that regulatory enforcement actions do not contradict or duplicate other forms of enforcement and remedial measures, including legal settlements [Consistency of legal and administrative frameworks]."

In simple terms, systemic lack of imposition of meaningful sanctions on senior policy, regulatory and supervisory decision-makers active in the Irish financial services in the period prior to the Global Financial Crisis severely undermines the signalling and deterrence functions of regulatory enforcements. Convicting bankers for mis-deeds is fine, but not sanctioning regulatory and supervisory officials is not conducive to establishing any tangible credibility to the regulatory enforcement regime. Worse, it establishes a false sense of security that the system has been repaired and strengthened by convictions achieved, whilst in reality, the system remains vulnerable to exactly the same dynamics and risks of collusion between regulators and supervisors and the new financial services executives.

It is, perhaps, telling that my counterparts providing expert opinions in the case on behalf of the Central Bank, Department of Finance and the Attorney General of Ireland have based their analysis on the axiomatic assumption that no regulatory, supervisory and enforcement staff can ever be held liable for their actions or inactions in the events and processes that led to the Global Financial Crisis. No matter what they have done or refused to do. Full impunity must apply.

12/6/16: U.S. Student Loans: A Ticking Time Bomb

If you like hokey stick charts, you’ll love these two covering U.S. student loans debt evolution over time:

The numbers are simply mad: total debt rose from around USD 100 billion ca 2006 to almost USD 1 trillion by the end of 2015. On a per capita of student population basis, same period rise was from around USD 16,000 per student to over USD100,000 per student. More recent data, through May 2016 shows that average student debt is now at USD133,000 and the total quantum of student loans outstanding is at over USD 1.2 trillion.

Data from Bloomberg, through 2014, shows that Federal Government-originated student loans have increased 10-fold since 1990:

 Source: Bloomberg, data from Collegeboard.org 

This is not just worrying - it is outright unsustainable. Students loans are predominantly fixed interest rate loans. However, even in the current benign environment, interest rates on this debt are high:

Source: https://studentaid.ed.gov/sa/about/announcements/interest-rate

So the key risk to the student loans debt is not from interest rates increases, but from the fact that it is a secondary debt: as interest rates rise, households priorities on paying down short term credit (credit cards) will take more precedence over longer-term fixed rate debt. Student loans are likely to suffer from higher risk of non-payment.

Currently, 43% of student loans are in default, representing an improvement over 2014 default rate of 46%. The Wall Street Journal recently attributed this decline to programs that allow some borrowers to lower their student loan payments by connecting them to a percentage of the borrower's income (also known as income-driven repayment). The number of borrowers taking advantage of the schemes nearly doubled since 2015 to 4.6 million.

U.S. student loans are, in very simple term, a ticking time bomb. The indebted generation is in the younger demographic with limited income prospects and the job markets that are longer-term characterised by greater income volatility and lower income trends. This means that repayment of these loans exerts greater pressure on household savings and investments exactly at the period of the household life-cycle when American workers benefit the greatest from the compounding effects of savings and investments on life-time income. In other words, the opportunity cost of this debt is the greatest.

11/6/16: 5,000 Years Record…

A quick classic from the 11-months-old Andrew Haldane’s chart plotting history of interest rates from 3000BC through NIRP/ZIRP

Oh, and yes, this is record low…

You can read the full speech here:
www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  - search for Haldane, June 30, 2015 speech.

11/6/16: Too Little CAPEX? Why, Even Investors are Catching Up

Much has been written about the lagging capex cycle in the global economy and its impact on global growth. Including on this blog. So here’s another nice chart, courtesy of BAML showing that investors currently hold extremely pessimistic view of the companies capex activities on aggregate:

“… and laugh again…” as Leonard Cohen proposed… 

11/6/16: Sovereign to Corporate Risk Spillovers

As noted recently in my posts on the new iteration in the Greek Crisis, we are now into the sixth year (officially) of the Euro area sovereign debt crisis. Alas, of course by unofficial, yet more realistic metrics, we are really into the ninth year of the crisis (who cares what you call it).

Now, you might just think that at the present, there is little to worry about, as the crisis seemed to have abated, if not completely gone away. But the problem is that the real lesson from the 2008-present crisis should be exactly the acquired awareness that such thinking is dangerous.

Here’s why. In a recent ECB working paper,  Augustin, Patrick and Boustanifar, Hamid and Breckenfelder, Johannes H. and Schnitzler, Jan, titled “Sovereign to Corporate Risk Spillovers” (January 18, 2016, ECB Working Paper No. 1878: http://ssrn.com/abstract=2717352) “quantify significant spillover effects from sovereign to corporate credit risk in Europe” in the wake of the announcement of the first Greek bailout on April 11, 2010.

“A ten percent increase in sovereign credit risk raises corporate credit risk on average by 1.1 percent after the bailout. These effects are more pronounced in countries that belong to the Eurozone and that are more financially distressed. Bank dependence, public ownership and the sovereign ceiling are channels that enhance the sovereign to corporate risk transfer.”

We should worry.

1) Corporate and sovereign bond risks are tied at a hip. And guess what we are witnessing today? A massive bubble in sovereign bonds and a bubble in corporate bonds. When one blows, the other will too. Be warned, per my contribution to the Summer edition of Manning Financial (LINK HERE).

2) Eurozone countries are at a greater contagion risk. Doh… like we never heard that before. But, still, good reminder to remember. I wrote a paper on that for the EU Parliament not long ago (LINK HERE).

3) Bank dependence is bad for contagion - in a sense that it increases contagion, not reduces it. And guess what the Eurozone been doing lately via ECB’s policy and via CMU and EBU? Right… increasing bank dependency. (LINK HERE)

In short, things might be a bit brighter today than they were yesterday, but tomorrow might bring another hurricane.

10/6/16: Italian Manufacturing Capacity post-crisis

A third paper on manufacturing capacity, also from Italy is by Libero Monteforte and Giordano Zevi, titled “An Inquiry into Manufacturing Capacity in Italy after the Double-Dip Recession” (January 21, 2016, Bank of Italy Occasional Paper No. 302: http://ssrn.com/abstract=2759786).

Here, the authors “…investigate the effects of the prolonged double-dip recession on the productive capacity of the Italian manufacturing sector”. The authors “…estimate that between 2007 and 2013 capacity contracted by 11–17%, depending on the method.”

In addition, the authors “…conduct an exercise to quantify the loss with respect to a counterfactual evolution of capacity in a ‘no-crisis’ scenario in which pre-2008 trends are extrapolated: in this case the loss is close to 20% for all methods.”

Summary of the results:

And here is decomposition of the potential output drop by factor of production:

Per authors: “In terms of factor determinants, about 60% of the cumulated drop of potential output in 2007-13 came from labour, while around 25% was attributable to the TFP (Chart above). The reason why the contribution of capital is comparatively small is twofold: first, the industrial
sector is characterized by a large wage share (close to 70%), therefore the contribution of K in the production function is limited; second, capital is a highly persistent variable and the fall in investments recorded during the two recessions, even if remarkably large, has not (so far)
resulted in a dramatic drop of the capital stock.”

The key lessons from all of this are: potential output in Italy fell precipitously across the manufacturing economy in the wake of the Global Financial Crisis. Meanwhile, counterfactual extension of pre-crisis trends was strongly signalling to the upside in manufacturing.

Majority of metrics used suggest that productive capacity in Italy declined by 15-18 percent through 2013, while counterfactual estimates for pre-crisis trend would have implied an average rise of ca 5 percent.

Last, but not least, “Firms producing basic metals, fabricated metal products and machinery and equipment are found to be the ones that were most penalized by the crisis of the last six years; by contrast, sectors that were already shrinking before 2008, such as the manufacture of textiles, appear not to have performed significantly worse during the double-dip recessions than they had in the early 2000s.”

10/6/16: Italian Industrial Production: 2007-2013

Staying with the earlier theme of industrial / manufacturing sector trends, here is a paper from the Banca d’Italia, authored by Andrea Locatelli, Libero Monteforte, and Giordano Zevi, titled “Heterogeneous Fall in Productive Capacity in Italian Industry During the 2008-13 Double-Dip Recession” (January 21, 2016, Bank of Italy Occasional Paper No. 303: http://ssrn.com/abstract=2759788) looks at the two periods of shocks, separated by one period of brief recovery.

Per authors, “between 2008 and 2013 productive capacity was considerably downsized in the Italian manufacturing sector” based on micro data from the Bank of Italy surveys across “the whole 2008-13 period and in four sub-periods (pre-crisis 2001-07, first phase of the crisis 2008-09, recovery 2010-11, and second crisis 2012-13).”

The study main findings are:
i) “losses of productive capacity varied widely across manufacturing sub-sectors with differences in pre-crisis trends tending to persist in a few sub-sectors during the double-dip recession”;
ii) “large firms were more successful in avoiding major capacity losses, especially in the first phase of the crisis”;
iii) “the share of sales on foreign markets was negatively correlated with performance in 2008-09, but the correlation turned positive in 2012-13”;
iv) “among the Italian macro-regions, the Centre weathered the long recession better” (see charts below);
v) “subsidiaries underperformed firms not belonging to any group”; and
vi) “the negative effects on productive capacity of credit constraints, which discouraged investments, were felt by Italian firms particularly in 2012-13”.

Very interesting outrun by region, presented here in two charts:

Some beef on that point: “The decline in [productive capacity] was not evenly distributed across the Italian macro-regions. The macro-regions more exposed to foreign demand were severely hit by the global financial crisis, with [productive capacity] declining by 8.6% in the North West and 7.0% in the North East.” Now, here’s the irony: Italy was (barely) able to sustain long-term Government borrowing on foot of its extremely strong exporters. During the recent twin crises, this very strength of the Italian economy turned against it. Which sort of raises few eyebrows: strong exporting capacity of Italy led the country to experience sharper shock than in many other states. Yet, the core prescription for growth from across the EU members states is - export!; and core prescription for recovery from the status quo main stream economists is - beef up current ace t surpluses (aka, raise exports relative to imports). Italian evidence does not really sound that supportive of these two ‘solutions’…

“During the temporary recovery, the South under-performed the rest of the country, losing 4.0% of its [productive capacity], while [productive capacity] stagnated in the other macro-regions.”

“The sovereign debt crisis affected the entire country more evenly. As a result, between 2010 and 2013 the loss of [productive capacity] in the South (-8.0%) was roughly twice as large as that recorded in the rest of the country (-4.7%)… The gap reflects the within-country heterogeneity in firms’ characteristics : …South Italy has mainly small firms, with an average of 100 employees (roughly constant during the double-dip crisis). Average firm size is larger in the Centre, just below 150, and in the North East, around 180, and even more so in the North West (consistently above 200). …southern regions have smaller export shares (about 20%), which are higher everywhere else (around 35% at the beginning of the sample); the export share shows a positive trend in all macro-regions.” You can see these reflected in the charts above.

In summary, thus, “the degree of foreign exposure helps to explain why the North suffered more during the global financial crisis. Also, the continuing decline of [productive capacity] in the South since 2007 is consistent with the smaller firm size in that macro-area (discussed above) and the larger decline of domestic demand there”.


So the key lesson here is: in the current environment characterised by rising regionalisation of trade flows and weak global demand, the exports-led recovery is more likely to trigger a negative shock to the economy than support economic growth.

Unless you are talking about a country like Ireland, where exports are booming despite global demand slowdown. Which, of course, cannot be explained by anything other than beggar-thy-neighbour tax optimisation policies.