3/12/17: Russian and BRICS debt dynamics since 2012

Back in 2014, Russia entered a period of recessionary economic dynamics, coupled with the diminishing access to foreign debt markets. Ever since, I occasionally wrote about the positive impact of the economy's deleveraging from debt. Here is the latest evidence from the BIS on the subject, positing Russia in comparative to the rest of the BRICS economies:

In absolute terms, Russian deleveraging has been absolutely dramatic. Since 2014, the total amounts of debt outstanding against Russia have shrunk more than 50 percent. The deleveraging stage in the Russian economy actually started in 1Q 2014 (before Western sanctions) and the deleveraging dynamics have been the sharpest during 2014 (before the bulk of Western sanctions). This suggests that the two major drivers for deleveraging have been: economic growth slowdown (2013-1Q 2014) and economic recession (H2 2014-2016), plus devaluation of the ruble in late 2014 - early 2015.

The last chart on the right shows that deleveraging has impacted all BRICS (with exception of South Africa) starting in 2H 2013 - 1H 2014 (except for China, where deleveraging only lasted between 2H 2015 and through the end of 2016, although deleveraging was very sharp during that brief period).

In other words, there is very little evidence that any aspect of Russian debt dynamics had anything to do with the Western sanctions, and all the evidence to support the proposition that the deleveraging is organic to an economy going through the structural growth slowdown period.

2/12/17: Bitcoin Craze Heads for the Moon

Just about 10 days ago, I wrote about the Bitcoin being a bubble. And since then, few things happened:

1. The bubble has now gone into public euphoria stage, witnessed by an ever-growing number of discounted brokerage platforms actively selling access to Bitcoin markets with leverage in excess of 100:1.
2. The bubble has gone from hyperbolic to hyperbolic+ trajectory, adding a massive degree of volatility to the trend. Earlier this week, Bitcoin managed to drop some 21 percent within a day and then go back above pre-drop levels within less than 24 hours. The confirmation phase is now complete with buy-on-the-dip 'investors' triggering waves of herding.
3. And the hype has gone institutional. In my post, I said "This is not just a shoe-shine-boy moment, folks. It is white-powder-under-the-nose-and--empty-bottles-of-vodka-on-the-floor hour for high school dropouts with cash to burn." Yeah, read this from as always excellent Matt Levine of (not always excellent) Bloomberg View: "One of the presenters at the conference... “Decentralization will change more in our lives over the coming years than possibly any other technological shift we’ve seen,” he says, likening the crypto rush to the Reformation. He describes building anarcho-capitalist city-states on the back of the blockchain. “If you’re going to built a new city, you’re not going to have the DMV – we don’t like the DMV,” he says at one point. Later: “We can actually tokenize the moon with a startup society.” When I ask him about the SEC’s role in the space, he waves the question off as irrelevant. “Under crypto-anarchy,” he explains, “we’ll get to determine the government that we want.”" Nasa should worry now, not just the SEC, for one day, the International Space Station will have to be flying through clouds of Bitcoins spread around space by the Moononizers of anarcho-capitalist-libertarian variety who securitized their moonhomes using blockchain contracts enforceable only under the anarchy laws.

Yes, bottles of vodka are empty now. 'Investors' have moved onto magic mushrooms.

1/12/17: Euro - Unfit for Diverging Economies

An interesting chart from Bloomberg on intra-EU productivity divisions: https://www.bloomberg.com/news/articles/2017-11-29/eu-s-productivity-split

The key here is not the current spot observation or the trend forecast forward, but the dynamics from 2008 on. Since the GFC, productivity divergence within the EU has been literally dramatic. And the two interesting markers here are:

1. Divergence in productivity between the ‘North’ and the ‘South’ - highlighted in the Bloomberg note, but also
2. Divergence in productivity between Germany and France

In simple terms, until about 2010, the Euro monetary union was not quite working for the ‘South’ while it did work for the ‘North’. However, since 2010-2012, the divergence between the ‘North’ and the ‘South’ has spread to France vs Germany divide as well. The Euro, it appears, is not quite working for France either.

A more involved view of the continued divergence in the Euro area is here: https://media.arbeiterkammer.at/wien/PDF/varueckblicke/R.Fulterer_I.Lungu_Yec_2017.pdf.

1/12/17: Eonia's strange vaulting

What concentration risk and liquidity risk can do to you when both combine?

Eonia (Euro OverNight Index Average) is the 1-day interbank interest rate for the Euro zone. In other words, it is the rate at which banks provide loans to each other with a duration of 1 day (so Eonia can be considered as the 1 day Euribor rate). In other words, it is a measure of short-term liquidity.  Eonia is an average of actual rates charged, so it is, in theory, a reflection of the market demand for short term liquidity. But Eonia is a tiny market, trading normally daily at around EUR7 billion or less. And in a tiny market, there can be a sudden shift in trading volumes. This is what happened on Wednesday and Thursday. Eonia rose from -0.36 basis points on Tuesday to -0.30 bps on Wednesday to -0.24 bps on Thursday.

Eoinia's volumes are 90% direct borrowing by prime banks (and the balance is brokered), so a handful of large institutions use the market to any significant extent. Which induces concentration risk. Worse, Eonia is a secondary/supplementary market, because the ECB currently provides extremely cheap liquidity in unlimited volumes on a weekly basis. Which is another risk to Eonia, as it is thus set to absorb any short term variation in liquidity demand (below 1 week).

Bloomberg speculated that "The most likely explanation is a technical hitch, rather than some sudden crisis warning. The cause of the spike could be a U.S. financial institution that has switched its year-end accounting period from Dec. 31 to Nov. 30. This may have driven a sudden need for short-term liquidity, thereby causing a squeeze. It was month-end for many financial institutions on Thursday, on top of which we are approaching year-end periods, when cash and collateral rates often get squeezed. A bit of indigestion shouldn’t be a surprise. But a move this big is."

If Friday close gets us back toward Tuesday opening levels, the glitch might just be a glitch. If not, something might be happening beyond 'technical' hitches.

The strangest bit is that the move signals a potential liquidity squeeze in a market that has, if anything. too much liquidity. And the matters are not helped by the shallow trading volumes, that imply a concentrated move.

Something to watch, folks, if anything - for just another illustration of the concept of correlated risks.

30/11/17: Efficiency of Enforcement vs Volume of Regulation

Yesterday, in our class on Economics, we talked about the distinction between regulation (volume of rules) and efficient enforcement (monitoring, investigatory, enforcement and pre-emptive functions of regulatory authorities). As an example, we referenced the repeated chain of customer-level scandals at the Wells Fargo Bank.

Here is the latest scandal, unveiled earlier this week that I mentioned: http://www.zerohedge.com/news/2017-11-28/it-tuesday-time-another-banking-scandal.

From our stand point, this case is really pushing the gap between regulation and enforcement out into new widths. Previous scandals, e.g. false accounts being created by bank employees, were harder to detect, pre-emptively, from regulatory point of view. The latest one was out in plain view for any supervisor/regulator to spot.

The bank signed a contract with its customers (standard terms of contract applying to all specified groups of customers) for ca 0.15% commission on foreign currency exchanges. The bank charged its customers (in 88% of all cases analyzed) higher fees, ranging to as much as 4%.

As ZeroHedge notes, this is absurd level of charges. And this charge comes on already absurd banks' spreads on buying and selling currency (so it is not the only charge customers pay). And yes, as ZeroHedge also notes, there are multiple service providers who do the same for much much lower fees. I use a service that charges me a flat rate fee of $1 for transaction, including transfers of money from one bank to another, plus exchange from one currency into another and trades currency at quoted market rates (average over 2 hours prior to transaction timing). So, in effect, I pay zero spread margin and my total cost of exchanging anything between $10 and $1 million is $1.00.  Were I to have used Wells Fargo services to do my last transaction, I would have paid somewhere around $29 more for the honor of wiring money into my Wells Fargo account than I did, judging by rates quoted to me for the date by Wells Fargo, as opposed to the rate I obtained from my service provider.

The only way the banks sustain the business model that provides them with such an opportunity to earn a huge profit off simple transactions is the model of monopolistic competition with price discrimination: the banks price their services at the high end of transaction cost in full knowledge that those of us who need the service often enough (like myself) will use other service providers, while those who use this service only infrequently will opt to pay higher price to avoid the cost of searching for better alternative.

But that absurd inefficiency of the services provided by the banks is a secondary point from our point of view. The primary one is the regulation in relation to consumer protection.

Let's face the music: the financial regulators receive data from the banks regarding their volumes of transactions carried out for customers in foreign exchange on a regular basis. They also receive the breakdown of costs and margins these transactions generated. It is a matter of excel-level algorithm to detect the discrepancy between the contractual 0.15% charge and the effective charge that - on the aggregate for Wells Fargo - would have been well in excess of 0.15%.

A red flag would have gone up at that stage. The timing to that would have been within one month (per reporting lags).

A sample of actual transactions could have been requested as soon as the flag was up and the actual fees charged could have been identified against the contractual fees. Assume that would have taken a lag of, say, another month.

Within two months from the start of the scam, Wells Fargo would have been under investigation. Damages to customers would have been limited, costs to the bank of complying with the regulations and consumer protection laws would have been limited, the enforcement system would have worked.

Is any of this feasible in the current regulatory and monitoring environment? You bet. Why was it not done? Because there is no pro-active analytics of reported data when it comes to smaller scale transactions. And because the culture of regulation is based on the assumption that too-big-to-fail banks are too-big-to-mistrust.

Either way, Wells Fargo governance and strategy misfires continue to deliver new lessons for us all. The lesson this week is that when the regulators talk the fine talk about protecting the small folks, it is actually whistleblowers or the media or competitors who most often do the heavy lifting on this front - they do the enforcement bit of job that the regulators are de facto walking away from. Efficiency of enforcement, when neglected, undermines the promise of regulation, even when the latter is backed by volumes of rules.

29/11/17: Four Omens of an Incoming Markets Blowout

Forget Bitcoin (for a second) and look at the real markets.

Per Goldman Sachs research, current markets valuation for bonds and stocks are out of touch with historical bubbles reality: https://www.bloomberg.com/news/articles/2017-11-29/goldman-warns-highest-valuations-since-1900-mean-pain-is-coming. As it says on the tin,

“A portfolio of 60 percent S&P 500 Index stocks and 40 percent 10-year U.S. Treasuries generated a 7.1 percent inflation-adjusted return since 1985, Goldman calculated -- compared with 4.8 percent over the last century. The tech-bubble implosion and global financial crisis were the two taints to the record.”

Check point 1.

Now, Check point 2: The markets are already in a complacency stage: “The exceptionally low volatility found in the stock market -- with the VIX index near the record low it reached in September -- could continue. History has featured periods when low volatility lasted more than three years. The current one began in mid-2016.”

Next, Check point 3: Valuations are not everything. In other words, levels are not the sole driver of blowouts. In fact, per Goldman, valuations explain “less than half the [markets] variation since 1900.” But, when blowouts do happen, involving 60/40 portfolios “over the past century [these] amounted to 26 percent in real terms on average, lasting 19 months. It took two years to get back to previous peaks, on average.” And the problem with this is that there might be no firepower to fight the next blowout. “Central banks “might not be able or willing to buffer growth or inflation shocks.” They also face fewer options to ease monetary policy given low rates and big balance sheets.”

So to sum the above up: levels of market valuations are screaming bubbles in both bonds and stocks; investors are fully bought into the hype of rising valuations; and there might be a shortage of dry powder in store at the Central Banks.

Goldman’s team, predictably, thinks the likeliest unwinding scenario from the above will involve, you’ve guessed it… a soft landing.

Now to Check point 4:

Source: ZeroHedge

Observe the following simple fact: the rate of the ‘balanced’ portfolio appreciation in the current cycle is sharper than in the 2002-2007 cycle. And it is sharper, in cumulative terms (both nominal and real), than any other cycle in modern (post 1970s - end of Bretton Woods and stagflationary environments) period.

So the Check point 5 adds strong bubble dynamics to bubble signals of levels of out-of-touch valuations, investors complacency and risks to the Central Banks’ commitment.

This is, put frankly, ugly. Because all four components of a major market blowout are now in place. So while the froth might still run for some weeks, months, quarters, … and may be even a year or two, the longer it runs, the worse the fallout will be. And the fallout is coming.

29/11/17: China vs U.S. - the WTO Fight

Per latest reports, there is a renewed spat between the U.S. and China in the WTO. As reported in the FT (https://www.ft.com/content/f7941646-d571-11e7-8c9a-d9c0a5c8d5c9):

"The Trump administration has lambasted China’s bid for recognition as a market economy in the World Trade Organization, citing decades of legal precedent and what it sees as signs that China is moving in the opposite direction under Xi Jinping. The US move to oppose China’s longstanding efforts to be recognised as a market economy in the WTO came in a legal submission filed last week and due to be released publicly on Thursday in a case brought by Beijing against the EU."

Here are background slides to the dispute from my recent lecture @MIIS :

First, what's behind the WTO dispute: the fight between the U.S. and the EU against China and other emerging economies in core Bretton Woods institutions - the IMF and the World Bank

 Plus the geopolitics of trade:

 All of which informs the current fight in the nearly-comatose WTO:

So the case is not new, but the case is highly important. Not because China is or is not a market economy. But because China is directly challenging U.S. (and European) dominance over the post-WW2 international institutions. 

Make no mistake here: trade status is just the current, momentary, battle field in what is a long, and quite outright nasty, geopolitical war.

28/11/17: Price vs value: economics of art

From time to time, I have been posting on the blog links to articles on economics of art. Here is the latest one that caught my eye: The economics of ridiculously expensive art by Bronwyn Coate for CapX: https://capx.co/the-economics-of-ridiculously-expensive-art/?utm_campaign=Echobox&utm_medium=Social&utm_source=Twitter#link_time=1511882539

Without any comment from myself, other than: interesting read.

28/11/17: Hacking the market: Systemic contagion from cybersecurity breaches

Our article for LSE Business Review is now live on the site: http://blogs.lse.ac.uk/businessreview/2017/11/28/hacking-the-market-systemic-contagion-from-cybersecurity-breaches/.

You can read (free) our paper, on which this article is based, in full here: Corbet, Shaen and Gurdgiev, Constantin, What the Hack: Systematic Risk Contagion from Cyber Events (September 7, 2017). Available at SSRN: https://ssrn.com/abstract=3033950.

Enjoy.

26/11/17: FAANGS+ Brewing up another markets storm

One of the key signals of a systemic mispricing of financial assets is concentration risk. I wrote about this in a number of posts on the blog, so no need repeating the obvious. Here is the latest fragment of evidence suggesting that we - the global financial markets and their investors - are at or near the top of froth when it comes to 'irrational exuberance':  http://www.zerohedge.com/news/2017-11-26/david-stockman-derides-delirious-dozen-2017.

So what should investors do? Some lessons from the GFC that can help are summarized here: http://trueeconomics.blogspot.com/2017/11/241117-learning-from-gfc-lessons-for.html. And some additional warning signs of the bubble are summarized here: http://trueeconomics.blogspot.com/2017/11/191117-next-global-financial-crisis.html.

Quote: "...our new Delirious Dozen consists of the FAANGs (Facebook, Apple, Amazon, Netflix and Google) plus seven additional high flyers (Tesla, NVIDIA, Salesforce, Alibaba, UnitedHealth, Home Depot and Broadcom)."

What the above valuations imply?

•  "Amazon is now valued at $550 billion and thereby trades at 293X its $1.9 billion of LTM net income" - EV/EBITDA ratio of x46.5
• "Broadcom trades at 246X net income"
• "Netflix is valued at 194X" or x107.8 EV/EBITDA ratio
• "Salesforce (CRM) ... is currently valued at $77 billion, and Tesla, which sports a market cap of $54 billion. Yet both had large net losses during the latest 12 months. In fact, during the last five years, CRM has posted cumulative net losses of $650 million and Tesla has lost $3.3 billion." Enterprise Value/EBITDA for CRM is now x154; for Tesla: x80.7 after  the recent price drops.
• NVIDIA sports EV/EBITDA ratio of x44.9 and Alibaba of x43.5
• UnitedHealth is absolutely cheap at x13.3 EV/EBITDA as is Home Depot at x13.9 although the latter does sport a P/BV ratio of x57.3 and that is before it takes a full writedown on the 'value' of its stores, in lines with forward expectations of the changes in the retail environment in the near future
• Facebook EV/EBITDA is x26.6 with expectations forward on earnings bringing trailing P/E ratio from x41 to x27.6 which is really equivalent to saying that there is no business cycle that can impact adversely Facebook's business any time soon.
• Apple's EV/EBITDA is x13.3 - cheap by all 'FAANGS' measures, but forward relative to trailing P/Es imply earnings growth of at least 35-40 percent in 24 months horizon. Which is, again, suggesting no one should ever expect any clouds on Apple's horizon.
• Google's EV/EBITDA is x19, while forward vs trailing P/E ratios imply earnings growth of at least 33-40 percent, similar to Apple's.

There is, quite clearly and transparently, an eyes wide shut moment for the markets. Greenspan might have called this the 'irrational exuberance', while your friendly sell-side broker will undoubtedly call it 'time to buy into the market' moment. But you have to have guts of steel and brain the size of a pea to not spot the trouble ahead with the current markets valuations.

24/11/17: Learning from the GFC: Lessons for Investors

My article, summing up the key lessons from the Global Financial Crisis that investors should review before the next crisis hits is now available via Manning Financial newsletter: http://issuu.com/publicationire/docs/mf_winter_2017?e=16572344/55685136.

21/11/17: ECB loads up on pre-Christmas sales of junk

Holger Zschaepitz @Schuldensuehner posted earlier today the latest data on ECB’s balance sheet. Despite focusing its attention on unwinding the QE in the medium term future, Frankfurt continues to ramp up its purchases of euro area debt. Amidst booming euro area economic growth, total assets held by the ECB rose by another €24.1 billion in October, hitting a fresh life-time high of €4.4119 trillion.

Thus, currently, ECB balance sheet amounts to 40.9% of Eurozone GDP. The ‘market economy’ of neoliberal euro area is now increasingly looking more and more like some sort of a corporatist paradise. On top of ECB holdings, euro area government expenditures this year are running at around 47.47% of GDP, accord to the IMF, while Government debt levels are at 87.37% of GDP. General government net borrowing stands at 1.276% of GDP, while, thanks to the ECB buying up government debt, primary net balance is in surplus of 0.589% of GDP.

Meanwhile, based on UBS analysis, the ECB is increasingly resorting to buying up ‘bad’ corporate debt. So far, the ECB has swallowed some 255 issues of BB-rated and non-rated corporate bonds, with Frankfurt’s largest corporate debt exposures rated at BBB+. AA to A-rated bonds count 339 issues, with mode at A- (148 issues).

It would be interesting to see the breakdown by volume and issuer names, as ECB’s corporate debt purchasing programme is hardly a very transparent undertaking.

All in, there is absolutely no doubt that Frankfurt is heavily subsidising both sovereign and corporate debt markets in Europe, largely irrespective of risks and adverse incentives such subsidies may carry.