19/5/17: U.S. Household Debt: Things are Much Worse Than Headlines Suggest

Those of you who follow this blog know that I am a severe/extreme contrarian when it comes to median investor perceptions of the severity of leverage risks. That is to say, mildly, that I do not like extremely high levels of debt exposures at the macroeconomic level (aggregate real economic debt, which includes non-financial corporations debt, household debt and government debt), at the financial system levels (banking debt), at the microeconomic (firm) level, and at the level of individual investors own exposure to leverage.

With this in mind, let me bring to you the latest fact about debt, the fact that rings multiple bells for me. According to the data from the U.S. Federal Reserve, household debt in the U.S. has, as of the end of 1Q 2017, exceeded pre-2008 peak levels and hit an all-time high by the end of March.

Let's crunch some numbers.

• Total Household Debt in the U.S. stood at USD 12.725 trillion at the end of 1Q 2017, up on USD 12.576 trillion in 4Q 2016. Previous record, reached in 3Q 2008 was USD 12.675, while the pre-Global Financial Crisis average was USD 10.112 trillion.
• During pre-crisis period, Mortgage Debt peaked at USD 9.294 trillion in 3Q 2008. In 1Q 2017 this figure remained below this peak levels at USD 8.627 trillion. As flimsy as house price valuations can be, this means that there is no 'hard' asset underlying the new debt peak. If anything, the new overall household debt mountain is written against something far less tangible than real estate.
• Student loans are up on previous peak (4Q 2016 at USD 1.310 trillion) at USD 1.344 trillion, as consistent with continued growth in the student loans crisis in the U.S.

Chart below illustrates the trends for total household debt:

Another key trend in household debt relates to debt defaults and risks. Here too 1Q 2017 data is far from encouraging. Pre-Global Financial Crisis average delinquencies (120 days or more overdue loans and Severely Derogatory delinquencies) average 2.07 percent of total debt outstanding. In 1Q 2017, some 29 quarters of deleveraging later, the comparable percentage is 3.0 percent. This is bad. Worse, take together, all household debt that was in delinquency in 1Q 2017 was 4.8 percent, which is still above 4.56 percent average for pre-2008 period. 

While overall delinquencies are not quite at problematic levels, yet, we must keep in mind the underlying conditions in which these delinquencies are taking place. Prior to the onset of the Global Financial Crisis, interest rates environment was much less benign than it is today toward higher levels of debt exposures: debt origination costs (direct cash costs) and debt servicing costs (income charge from debt) were both higher back in the days of the pre-2008 boom. Today, both of these costs are lower. Which should have led to lower delinquencies. The fact that delinquencies still run above pre-2008 levels implies that we are witnessing poorer underlying household fundamentals against which the debt is written.

Sadly, you won;t read this view of the current debt and debt burden issues from the mainstream media and analysts.

18/7/17: Greece in Recession. Again.

Per recent data release, Greece is now back in an official recession, with 1Q 2017 growth coming in at -0.1%, following 4Q 2016 contraction of 1.2%. Worse, on seasonally-adjusted basis, Greek economy tanked 0.5% in 1Q 2017. The news shaved off some 0.9 percentage terms from 2017 FY growth outlook by the Government (from 2.7% to 1.8%), with EU Commission May forecasting growth of 2.1% and the IMF April forecast of 2.15%, down from October forecast of 2.77%.

Greece has been hammered by a combination of severe fiscal contractions (austerity), rounds of botched debt restructuring, and extreme fiscal and economic policy uncertainty since 2010, having previously fallen into a deep recession starting with 2008. Structural problems with the economy and demographics come on top of this and, at this stage in the game, are secondary to the above-listed factors in terms of driving down the country growth.

In simple terms, this - already 10 years long - crisis is fully down to the dysfunctional European policy making.

In real terms, Greek economy is now down almost 3 percentage points on where it was at the end of 2000 and even if we are to assume that the economy expands 2.15% in 2017, as projected by the IMF, Greece will still end 2017 some 0.76 percentage points below where it was at the start of its tenure in the euro area.

Meanwhile, the 2.1-2.15% forecasts are likely to be optimistic. Past record shows that, so far, since the start of the crisis, IMF’s forecasts were woefully inadequate in terms of capturing the true extent of the crisis in Greece.

As chart above shows, with exception of just two forecasts’ vintages, covering same year estimates (not actual forward forecasts), all forecasts forward turned out to be optimistic compared to the outrun (thick grey line for April 2017).

Another feature of the more recent forecast is that 2017 IMF outlook for Greece factors in worse expectations for 2018-2021 growth than ALL previous forecasts:

The key driver for this disaster is the EU-imposed set of policies and the resulting policy and economic uncertainty. In fact, if we were to take the lower envelope of growth projections by the IMF - projections that were based on the Fund’s assumptions that the EU will live up to its commitments to accommodate significant debt relief for the Greek economy from around 2013 on, today’s Greek real GDP would have been around 20-21 percent higher than it currently stands.

All in, Greece has sustained absolute and total economic devastation at the hands of the EU and its institutions, including ESM, ECB and EFSF. Yes, structurally, the Greek economy is far from being sound. In fact, it is completely, comprehensively rotten to the core and requires deep reforms. But this fact is a mere back row of violins to the real drama played out by the Eurogroup, the ESM and the ECB. The nation with already woeful demographics has lived through sixteen lost years, going onto seventeenth. Several generations are either face permanently damaged prospects of future careers, or have to deal with demolished hopes for a dignified retirement from the current ones, and a couple of generations currently in lower and higher education are about to join them.

16/5/17: M&As and Investment Climate: 1Q data

As an illustration to the point made a few weeks ago (see http://trueeconomics.blogspot.com/2017/04/28417-vuca-markets.html)  here is the latest data on aggregate deals volumes and deal values for M&As

16/5/17: Navigating the Bubbling Up Investment Seas

Here are the slides from my presentation at the IPU Conference 2017 two weeks ago:

16/5/17: Technology: Jobs Displacement v Enhancement

Technological innovation is driving revolutionary changes across the labour markets and more broadly, markets for human capital. These changes are structural, deep and accelerating, and, owing to their nature, are not yet sufficiently understood or researched.

One theoretically plausible aspect of the technological innovation in terms of human capital effects is the expected impact of technology on demand for (and therefore supply of) different occupations. For example, we know that technology can act as a complement to or a substitute for labour.

In the former case, we can expect advancement of technology to create more jobs that are closely linked to enhancing technological innovation, deployment and productivity. In other words, we can expect more geeks. And we can expect - given lags in education and training - that as demand for geeks rises, their wages will rise in the short run before falling rather rapidly in the longer term.

In the latter case, there is a bit less certain, however. Yes, technology’s primary objective is to lower costs of production and increase value added. As a result, it is going to displace vast numbers of workers who can be substituted for via technological innovation. However, not all substitutable workers are made of the same cloth and not all technological innovation is capable of achieving unambiguous returns on investment necessary to sustain it. Take, for example, an expensive robot that costs, say, USD 600.000 a pop, but can only replace 3 lower skilled workers in a laundromat, earning USD16,000 per annum. So with benefits etc factored in, the cost of these 3 workers will be around USD70,000 per annum. It makes absolutely zero sense to replace these workers with new tech at least any time before the tech systems become fully self-replicating and extremely cheap. So, for really lower skills distributions, we can expect that jobs displacement by technology is unlikely to materialise soon. But for mid-range wages, consistent with mid-range skills, there is a stronger case for jobs displacement.

All of which suggests that we are likely to see a U-shaped polarisation process arising when it comes to jobs distribution across the skills segments: higher wage segment rising in total share of employment, as complementarity effects drive jobs creation here; and the lower wage segment also rising in total employment, as robots-induced increase in value added across the economy translates into greater demand for low-skills jobs that cannot be efficiently displaced by technology, yet. In the middle, however, we are likely to witness a cratering of employment. Here, the workers are neither complementary to robots, nor are they earning low enough wages to make expensive robots non-viable as a replacement alternative for labour.

Interestingly, we are already witnessing this trend. In fact, we have been witnessing it since the early 1990s. For example, Harrigan, James and Reshef, Ariell and Toubal, Farid paper titled “The March of the Techies: Technology, Trade, and Job Polarization in France, 1994-2007”, published March 2016, by NBER (NBER Working Paper No. w22110: http://ssrn.com/abstract=2755382) looked into “employee-firm-level data on the entire private sector from 1994 to 2007” in France.

The authors “show that the labor market in France has polarised: employment shares of high and low wage occupations have grown, while middle wage occupations have shrunk.” So the story is consistent with an emerging U-shaped labour market response to technological innovation on the extensive margin (in headcount terms). And more, the authors also find that inside margin also polarised, as “…the share of hours worked in technology-related occupations ("techies") grew substantially, as did imports and exports.”

However, the authors also look at a deeper relationship between technology and jobs polarisation. In fact, they find that, causally, “polarisation occurred within firms”, but that effect was “…mostly due to changes in the composition of firms (between firms). [And] …firms with more techies in 2002 saw greater polarization, and grew faster, from 2002 to 2007. Offshoring reduced employment growth. Among blue-collar workers in manufacturing, importing caused skill upgrading while exporting caused skill downgrading.”

16/5/17: Insiders Trading: Concentration and Liquidity Risk Alpha, Anyone?

Disclosed insiders trading has long been used by both passive and active managers as a common screen for value. With varying efficacy and time-unstable returns, the strategy is hardly a convincing factor in terms of identifying specific investment targets, but can be seen as a signal for validation or negation of a previously established and tested strategy.

Much of this corresponds to my personal experience over the years, and is hardly that controversial. However, despite sufficient evidence to the contrary, insiders’ disclosures are still being routinely used for simultaneous asset selection and strategy validation. Which, of course, sets an investor for absorbing the risks inherent in any and all biases present in the insiders’ activities.

In their March 2016 paper, titled “Trading Skill: Evidence from Trades of Corporate Insiders in Their Personal Portfolios”, Ben-David, Itzhak and Birru, Justin and Rossi, Andrea, (NBER Working Paper No. w22115: http://ssrn.com/abstract=2755387) looked at “trading patterns of corporate insiders in their own personal portfolios” across a large dataset from a retail discount broker. The authors “…show that insiders overweight firms from their own industry. Furthermore, insiders earn substantial abnormal returns only on stocks from their industry, especially obscure stocks (small, low analyst coverage, high volatility).” In other words, insiders returns are not distinguishable from liquidity risk premium, which makes insiders-strategy alpha potentially as dumb as blind ‘long lowest percentile returns’ strategy (which induces extreme bias toward bankruptcy-prone names).

The authors also “… find no evidence that corporate insiders use private information and conclude that insiders have an informational advantage in trading stocks from their own industry over outsiders to the industry.”

Which means that using insiders’ disclosures requires (1) correcting for proximity of insider’s own firm to the specific sub-sector and firm the insider is trading in; (2) using a diversified base of insiders to be tracked; and (3) systemically rebalance the portfolio to avoid concentration bias in the stocks with low liquidity and smaller cap (keep in mind that this applies to both portfolio strategy, and portfolio trading risks).

30/4/17: The Scariest Chart in the World

The scariest chart in the world this week, indeed this month, comes from the U.S. and plots U.S. real GDP growth with 1Q 2017 print at just 0.7% y/y.

Yes, the print ranks 13th from the bottom for any positive growth quarter since 2Q 1947. And yes, the rate of growth is (a) preliminary (subject to revisions) and (b) seeming one-off (driven by fall-off in consumer demand, despite strong indicators on consumer confidence side). There are reason and heaps of arguments why this print should not be treated as huge concern and that things might improve in 2Q and on.

But... the really scary stuff is longer-term trend in U.S. growth. And that is illustrated in the chart below:

Look at the grey bars: these take periods of expansion in the U.S. economy and average rates of growth over these periods. Notice the patter? Why, yes, the average expansion-consistent rates of growth have fallen, steadily, since 1975 through today. Worse, controlling for volatile growth (average rates) in pre-1975 period, an exponential trend for average expansion-consistent growth rates (the yellow line) is solidly trending down.

The latest period of economic expansion is underperforming even that abysmal trend. And 1Q 2017 is underperforming that worse than abysmal average.

Now, let me highlight that point: yellow line only considers periods of consistent growth (omitting official recessions, and one unofficial recession of  2001). So, no: the depth of the Great Recession has nothing to do with the yellow line direction. If anything, given the depth of the 2008-2009 crisis, the most current grey bar should have been at around 4%, almost double where it sits today.

That is what makes the chart above the scariest chart of April. And will probably make it the scariest chart of May too.

30/4/17: Did Russia Really Cut 2017 Defense Budget by a Quarter?

Headline figures from the Federal Treasury of the Russian Federation show a budgetary cut to the country defense spending of a whooping 25.5% y/y for 2017: from RUB3.8 trillion (USD65.4
billion) to RUB2.8 trillion.

However, the headline figure of 25.5% is misleading, because it is based on a fiscal defense allocation in 2016 that includes the federal funding for defense industry debt reductions.

Let me explain.

Russian defense budget (excluding debt payments) in 2016 was RUB3.07 trillion. Debt payments added ca RUB700-800 billion to that amount. Which means that 2017 defense allocation represents a decline of just 7% on 2016 actual defense spending figure, slightly deeper cut, but still in line with previously budgeted 6% reduction. In other words, relative to October 2016 projections for 2017, latest budgetary proposal is to reduce defense spending by an additional RUB230-240 billion, not by RUB1.06 trillion associated with 25.5% cut figure.

Since the start of 2014 economic crisis, and the associated funding crisis (relating to sanctions against a range of Russian lenders and corporates), Russian defense sector has suffered from sustained debt pressures. In December last year, the Ministry of Finance, made a one-time payment to defense contractors to reduce their commercial debt levels, amounting to between RUB700 and RUB800 billion. The range of numbers that reflects timing of payments and exchange rates used, plus rounding differences.

Multi-annual budgetary framework implies that on top of 7% cut in 2017, defense budget will also face reductions of 3.8% in 2018 and 4.8% in 2019. On top of this, the reductions in 2017-2019, even if implemented (a big if) come on foot of Russian defense spending expansion in 2011-2014 that saw nominal defense spending rising at almost 20% per annum. Even with a 7% cut, 2017 defense spending will still be some 14.4% above 2014 levels (in nominal terms).

Based on the ludicrous mistake of including one-off debt repayment into defense budget figures, the Stockholm International Peace Research Institute (SIPRI) - a defense spending watchdog - reported that "Russia increased its spending by 5.9 per cent in 2016 to $69.2 billion, making it the third largest spender. Saudi Arabia was the third largest spender in 2015 but dropped to fourth position in 2016. Spending by Saudi Arabia fell by 30 per cent in 2016 to $63.7 billion, despite its continued involvement in regional wars." Even though the same report admits that "late in 2016 actual spending was pushed substantially higher by a decision to make a one-off payment of roughly $11.8 billion in government debt to Russian arms producers. Without this debt repayment, Russia’s military spending would have decreased by 12%".

This, in the nutshell, is the circus that is 'analysis' of Russian data: with actual spending down, and amounting to ca USD57.4 billion, Russia is still behind Saudi Arabia in terms of military expenditures. The one-off payment of debt in the State Owned semi-commercial military suppliers, hardly represents an expenditure that materially increased Russian army, navy of its airforce, in as much as, say Greek debt restructuring did not materially increase country investment or output. But, the narrative of 'Bad Kremlin is beefing up its military to start WW3' is simply too delightful to pass.

Thing is, personally, I am not a fan of either increasing spending on the military (for any country, including Russia) or subsidising debt loads of State (or private) enterprises. However, if we are to bother reporting fiscal spending across specific programmes, debt relief is not equivalent to increased spending on core programmes relating to defense. It's a waste of taxpayers' resources. But it is not a waste that has gone into funding new bombs or howitzers.

28/4/17: Macron v Le Pen: Data Maps

The must-see set of data maps relating to upcoming Macron-Le Pen Presidential election (round 2) in France is available here: https://www.bloomberg.com/graphics/2017-french-election-maps/. Their relative positions (slightly changing since round 1) are explained here: http://trueeconomics.blogspot.com/2017/04/15417-naughty-and-not-very-nice-french.html.

28/4/17: The VUCA Markets

My regular column with the Cayman Financial Review covering the current development of the risk-uncertainty frameworks in the markets is now available here: http://www.caymanfinancialreview.com/2017/04/26/welcome-to-the-vuca-world/.

28/4/17: Euromoney on Italian Risks

Euromoney article on the continued evolution of the Italian crisis: http://www.euromoney.com/Article/3712913/Country-risk-Italy-is-the-volcano-waiting-to-erupt.html, quoting - amongst others - myself.

28/4/17: Trump Tax Plan: Impact on Ireland

My (quick) take on the potential impact of the U.S. corporate tax reforms for Ireland: https://www.thesun.ie/news/917087/ireland-could-benefit-from-donald-trumps-cuts-to-us-tax-rates-according-to-a-top-economist/. Hint: don't panic.