9/10/18: BRIC Services PMIs 3Q 2018: Slower Growth Ahead

Having covered Global Composite PMIs for 3Q 2018 here: http://trueeconomics.blogspot.com/2018/10/31018-global-pmis-tanked-in-3q-2018.html as well as BRIC Manufacturing PMIs here: http://trueeconomics.blogspot.com/2018/10/11018-bric-manufacturing-pmi-dips-down.html, here is an update on BRIC Services PMIs for 3Q 2018.

In summary: things are getting less promising for 2H 2018 growth in world's largest emerging and middle-income economies.

Brazil Services PMI posted second consecutive quarter of contraction in 3Q 2018, falling from 48.8 in 2Q 2018 to 47.9 in 3Q 2018. Since 3Q 2014, Brazil's Services PMIs posted readings below 50.0 mark (zero growth mark) in all, but one quarter (1Q 2018 when the PMI was at 51.0). Importantly, 3Q reading was statistically significantly below 50.0 mark.

Russia Services PMI fell marginally from 54.0 in 2Q 2018 to 53.6 in 3Q 2018, signalling weaker, but statistically-speaking, still positive growth. PMIs fell in all three last quarters from the 4-quarters peak of 56.0 in 4Q 2017. Q3 2018 was the lowest growth reading in 9 consecutive quarters. Despite this, Russia Service sector growth signalled by the PMIs is the fastest of all BRIC economies.

China Services PMI also fell to 52.6 in 3Q 2018 compared to 53.2 in 1Q 2018, marking the third consecutive decline in PMIs. China posted the second highest rate of growth in Services sectors amongst the BRIC economies.

India Services PMI rose, breaking the BRIC trend, in 3Q 2018 to 52.2 (weak growth) from 51.2 in 2Q 2018, marking the second consecutive quarter of above-50 readings. This marks the strongest growth signal in 8 quarters, albeit the level of PMI is anaemic.

Overall BRIC Services PMI computed by myself based on Markit data and global economy weights for BRIC countries, has moderated from 52.5 in 2Q 2018 to 52.2 in 3Q 2018, suggesting weakening growth momentum in the Services sector of the BRIC economies. This development was in line with the Global Services PMI movements (down from 54.2 in 2Q 2018 to 53.5 in 3Q 2018). For BRICs, Services PMI is now at the lowest reading in three quarters, and for the Global Services PMI -  in 7 consecutive quarters.

All BRIC economies Services sectors are now trailing (Brazil, India and China) or barely matching (Russia at 0.1 points higher) the Global Services PMI.

9/10/18: Euromoney on 3Q 2018 Changes in the Global Risk Environment

Euromoney on global risk changes in 3Q 2018, with comments from myself:
https://www.euromoney.com/article/b1b7sx84cgkn1y/ecr-survey-results-q3-2018-analysts-caution-over-em-selloff-uschina-tensions-and-italian-saga.

9/10/18: Russian Growth, 'Putin;'s Call' and the Middle Income Growth Trap

Quick chart showing relative underperformance in the Russian economy in recent years, incorporating latest 2018 forecasts:

The above clearly shows that since 2013, Russian economic growth has statistically underperformed the 'Putin's Call' levels of growth, defined as rates of growth in real GDP achieved during the period after the immediate post-1998 crisis recovery and into 2012, omitting the period of the Global Great Recession impact of 2009. 'Putin's Call' rate of growth is set at around 6% pa, with the 95% confidence interval around this at [2.83, 9.15].

The lower bound of this confidence interval is important. While no one can expect the Russian economy to grow at the 'Putin's Call' levels of 6%, let alone the upper bound levels of 9.15%, Russian economy does require longer-term average growth rates at around 2.8-3%, slightly above the lower bound of the 'Putin's Call'. As of consensus forecasts forward, the economy is expected to expand at around 1.5-1.8 percent pa over 2018-2023, which implies significant cumulative underperformance relative to medium term growth requirement.

Fiscally, structurally lower rates of growth are sustainable for Russia, but socio-politically, Russia needs serious acceleration in its growth rates to offset adverse demographic pressures (rising pensions dependencies) and global economic pressures (much faster growth rates in the Emerging Markets). The lower bound of the 'Putin's Call' and Russian economy's sub-par performance relative to it is a clear illustration of the Middle Income Growth Trap that Russia has entered ca 2010 post-GFC and the Great Recession (see https://www.global-economic-symposium.org/knowledgebase/escaping-the-middle-income-trap for the definition and here http://trueeconomics.blogspot.com/2015/04/18415-escaping-middle-income-trap.html for discussion. My earlier post on the subject for Russia here: http://trueeconomics.blogspot.com/2014/01/2212014-russia-and-middle-income-trap.html).

3/10/18: Global PMIs tanked in 3Q 2018

While Markit continue to publish Services and Composite PMIs for BRIC economies, here is a quick update on Global PMIs for 3Q 2018 which are now out:

• Global Manufacturing PMI averaged 52.5 in 3Q 2018, down from 53.2 in 2Q 2018. This is the lowest reading for the index in 8 quarters, signalling slowest growth in global manufacturing sector since 3Q 2016. It also marks the second consecutive quarter of declining Global Manufacturing PMI.
• Global Services PMI averaged 53.5 in 3Q 2018, the lowest reading in 7 consecutive quarters, matching the lowest point in 8 consecutive quarters. This marked the first quarter of declines in Services sector activity, and the drop was sharp: down from 54.2 in 2Q 2018.
• Global Composite PMI averaged 53.3 in 3Q 2018, down from 54.0 in 2Q 2018 and 54.2 in 1Q 2018, marking the lowest reading in 8 consecutive quarters. The slowdown in the overall global economic indictor has also been sharp in 3Q 2018 and most of this slowdown took place in August and September.

Overall, these are not great signs for the global economy. 

For BRIC Manufacturing PMIs analysis for 3Q 2018, see here: http://trueeconomics.blogspot.com/2018/10/11018-bric-manufacturing-pmi-dips-down.html. BRIC Services PMIs and BRIC Composite PMIs analysis is to follow, so stay tuned.

3/10/18: Dumping Ice bags into Overheating Reactor: Bonds & Stocks Bubbles

Wading through the ever-excellent Yardeni Research notes of recent, I have stumbled on a handful of charts worth highlighting and a related blog post from my friends at the Global Macro Monitor that I want to share with you all.

Let's start with the stark warning regarding the U.S. Treasuries market from the Global Macro Monitor, accessible here: https://macromon.wordpress.com/2018/10/03/alea-iacta-est/.  To give you my sense from reading this, two quotes with my quick takes:

"Supply shortages, induced mainly by central bank quantitative easing have been a major factor driving asset markets, in our opinion.  Not all, but a big part." So forget the 'not all' and think about risks pairings in a complex financial system of today: equities and bonds are linked through demand for yield (gains) and demand for safety. If both are underpricing true risks (and bond markets are underpricing risks, as the quote implies), it takes one to scratch for the other to blow. Systems couplings get more fragile the tighter they become.

"The float of total U.S. equities has shrunk dramatically, in part, due to cheap financing to fund share buybacks.   The technical shortage of stocks have helped boost U.S. equity markets and killed off most bears and short sellers." In other words, as I have warned repeatedly for years now, U.S. equity markets are now dangerously concentrated (see this blog for posts involving concentration risks). This concentration is driven by three factors: M&As and shares buy-backs, plus declined IPOs activity. The former two are additional links to monetary policies and, thus to the bond markets (coupling is getting even tighter), the latter is structural decline in enterprise formation and acceleration rates (secular stagnation). This adds complexity to tight coupling of risk systems. Bad, very bad combination if you are running a nuclear power plant or a major dam, or any other system prone to catastrophic risk exposures.

How bad the things are?

Since 1Q 2009, total cumulative shares buy-backs for S&P500 amounted (through 2Q 2018) to USD 4.2769 trillion.

Now, those charts.

Chart 1, via Yardeni Research's "Stock Market Indicators: S&P 500 Buybacks & Dividends" book from October 3rd (https://www.yardeni.com/pub/buybackdiv.pdf)

What am I looking at here? The signals revealing flow of corporate earnings toward investment, or, the signs of the build up in the future economic capacity of the private sector. The red line in the lower panel puts this into proportional terms, the gap between the yellow line and the green line in the top panel puts it into absolute terms. And both are frightening. Corporate earnings are on a healthy trend and at healthy levels. But corporate investment is not and has not been since 1Q 2014. This chart under-reports the extent of corporate under-investment through two things not included in the red line: (1) M&As - high risk 'investment' strategies by corporates that, if adjusted for that risk, would have pushed the actual investment growth even lower than it is implied by the red line; and (2) Risk-adjustments to the organic investments by companies. In simple terms, there is no meaningful translation from higher earnings into new investment in the U.S. economy so far in 2018 and there has not been one since 2014. Put differently, U.S. economy has been starved of organic investment for a good part of the 'boom' years.

Chart 2, via the same note:

Spot something new in the charts? That's right: buybacks are accelerating in 1H 2018, with 2Q 2018 marking an absolute historical high at USD 1.0803 trillion (annualized rate) of buybacks. Guess what does this mean for the markets? Well, this:

And what causes the latest spike in buybacks? No, not growing earnings (which are appreciating, but moderately). The fiscal policy under the Tax Cuts and Jobs Act 2017, or Trump Tax Cuts.

Let's circle back: monetary policy madness of the past has been holding court in bond markets and stock markets, pushing mispricing of risks to absolutely astronomical highs. We have just added to that already risky equation fiscal policy push for more mispricing of risks in equity markets.

This is like dumping picnic-sized bags of ice into the cooling system to run the reactor hotter. And no one seems to care that the bags of ice are running low in the delivery truck... You can light a smoke and watch ice melt. Or you can run for the parking lot to drive away. As an investor, you always have a right choice to make. Until you no longer have any choices left.

2/10/18: Government Debt per Employed Person

We often see Government debt expressed in reference to GDP or in per capita terms. However, carry capacity of sovereign debt depends not as much on the number of people in the economy, but on the basis of those paying the lion’s share of taxes, aka, working individuals. So here is the data for advanced economies Government debt expressed in U.S. dollar terms per person in employment:

Some interesting observations.

Ireland, as a younger, higher employment economy ranks fifth in the world in terms of Government debt per person employed (USD 115,765 in debt per employed). In terms of debt per capita, it is ranked in the fourth place at USD 54,126.

Plucky Iceland, the country hit as hard by the Global Financial Crisis as Ireland and often compared to the latter by a range of analysts and policymakers, ranks 22nd in terms of Government debt burden per employed person (USD 56,185) although it ranks 13th in per capita terms (USD 32,502). In simple terms, Iceland has higher employment rate than Ireland, resulting in lower burden per employed person.

When one considers the fact that non-Euro area countries have more sovereign control over their monetary policies, allowing them to carry higher levels of debt than common currency area members, Irish debt per employed person is the third highest in the world after Italy and Belgium, and higher than that of Greece.

Out of top ten debtors (in terms of Government debt per employed person), six are euro area member states (10 out top 15).

Looking solely at the euro area countries, Ireland’s position in terms of debt per capita is woeful: the country has the highest debt per capita of all euro area states at EUR43,659 per person, with Belgium coming in second place with EUR40,139. In per-employee terms, Ireland takes the third highest place in the euro area with EUR93,378 in Government debt, after Italy (EUR98,314) and Belgium (EUR94,340).

1/10/18: BRIC Manufacturing PMI dips down in 3Q 2018

BRIC Manufacturing PMIs turned south in 3Q 2018 in line with Global trend, but leading that trend to the downside. Per latest data through September 2018:

Russia Manufacturing PMI averaged miserly 49.0 in 3Q 2018, down from anaemic 50.2 in 2Q 2018. This was the lowest quarterly reading since 3Q 2015 when the Russian economy was in an official recession. Russia is the only BRIC economy nominally in contraction territory, when it comes to PMIs-signalled manufacturing sector activity, and 49.0 is statistically close to being sub-50 reading as well.

Brazil’s Manufacturing PMI remained broadly unchanged on 2Q 2018 reading of 50.9 at 50.8 in 3Q 2018. Although notionally above 50.0 mark, statistically, the reading was not significantly different from zero growth signal of 50.0. This means that both Russian and Brazilian economies registered deteriorating PMIs over two consecutive quarters in the case of Brazil and 4 quarters in the case of Russia.

China Manufacturing PMI was at disappointing 50.5 in 3Q 2018, down from a weak 51.1 reading in 2Q 2018. This marks the worst reading in China PMI in five quarters. As with Brazil, China’s Manufacturing PMI for 3Q 2018 was not statistically distinct from 50.0.

India Manufacturing PMI was the only one that remained statistically in expansion territory at 52.1 in 3Q 2018, basically unchanged on 52.0 in 2Q 2018 and barely up on 51.8 in 1Q 2018.

Meanwhile, Global Manufacturing PMI averaged 52.5 in 3Q 2018, down from 53.2 in 2Q 2018 and 54.0 in 4Q 2017 and 1Q 2017. All in, Global PMI has finished 3Q 2018 at the lowest level in 8 consecutive quarters.

1/10/18: Irish Times on Enterprise Ireland Venture Capital Programs

Recent article in the Irish Times looks at some of the industry views on entrepreneurship in Ireland and Enterprise Ireland funding programs. Some of the comments included are from myself.

Link: https://www.irishtimes.com/business/innovation/phelan-decries-scattergun-approach-to-seeding-foreign-start-ups-1.3639788.

28/9/18: 10th Anniversary of the Irish Banking Crisis

Yahoo Finance's Edmund Heaphy on 10th Anniversary of the Irish Bank Guarantee: https://uk.finance.yahoo.com/news/destructive-goal-decade-irish-bank-guarantee-090447485.html with extensive quotes from myself.

18/9/18: Extreme Concentration Risk: Bitcoin's VUCA Bomb

I wrote before both, about the general problem of concentration risk and the specific problem of this risk (more accurately, the concentration-implied VUCA environment) in the specific asset classes and the economy. Here is another reminder of how the build up of concentration risks in the financial markets is contaminating all asset classes, including the off-the-wall crypto currencies: https://thenextweb.com/hardfork/2018/09/18/cryptocurrency-bitcoin-blockchain-wallet/.

The added feature of this concentration risk is extreme (87%) illiquidity of major Bitcoin holdings. This means that under the common 'Mine and Hold' strategy, already monopolized, highly concentrated mining pools literally create a massive risk buildup in the Bitcoin trading systems: with 87% of wallets not trading for months, we have a system of asset pricing and transactions that effectively provides zero price discovery and will not be able to handle any spike in supply, should these accounts start selling. Worse, the system is tightly coupled, as Bitcoin holdings are frequently used to capitalize other leveraged crypto currencies undertakings, such as investment funds and ICOs.

The extent of latent instability in the crypto markets is currently equivalent to a Chernobyl reactor on the cusp of the human error.

13/9/18: Shares Buybacks Swallow much of Trump's Corporate Tax 'Reforms'

A recent post from the U.S. Fed looked at how companies with large holdings of cash abroad have used those funds following the Tax Cuts and Jobs Act of 2017 (the TCJA, or the Republican Tax Cuts), which incentivised the repatriation of foreign earnings stashed by the U.S. corporations abroad, including Ireland.

Per Fed note: "by the end of 2017, U.S. MNEs had accumulated approximately $1 trillion in cash abroad, held mostly in U.S. fixed-income securities", aka - bonds. Which, of course, also explains why Ireland is one of the largest domiciles for U.S. Treasuries.

The TCJA moved the U.S. "to a quasi-territorial tax system in which profits are taxed only where they are earned" so "...U.S. MNEs' foreign profits will therefore no longer be subject to U.S. taxes when repatriated. As a transition to this new tax system, the TCJA imposed a one-time tax (payable over eight years) on the existing stock of offshore holdings regardless of whether the funds are repatriated, thus eliminating the tax incentive to keep cash abroad."

As of Q1 2018, the U.S. firms "repatriated just over $300 billion, roughly 30% of the estimated stock of offshore cash holdings."

This "quantity of cash repatriated since the passage of the TCJA might have a notable effect on firm financing patterns and investment decisions in the near term". The Fed note argues "that funds repatriated in 2018:Q1 have been associated with a dramatic increase in share buybacks; evidence of an increase in investment is less clear at this stage, as it is likely too early to detect given that the effects may take time to materialize."

The top 15 U.S. firms (by cash holdings abroad) "account for roughly 80 percent of total offshore cash holdings, and roughly 80 percent of their total cash (domestic plus foreign) is held abroad... following the passage of the TCJA ...share buybacks spiked dramatically for the top 15 cash holders, with the ratio of buybacks to assets more than doubling in 2018:Q1. In dollar terms, buybacks increased from $23 billion in 2017:Q4 to $55 billion in 2018:Q1." Worse: "among the top 15 cash holders, the largest holders accounted for the bulk of the share repurchases: In 2018:Q1, the top 5 cash holders accounted for 66 percent, and the top holder alone accounted for 41 percent." Note: the top holder is... Apple.

Of course, "firms can also pay out cash to shareholders through dividends; however, unlike buybacks, dividends were little changed for the top 15 cash holders relative to the same period last year."

"...unlike in the case of share buybacks, there is no obvious spike in investment among the top 15 cash holders in 2018:Q1 relative to the previous quarter. Indeed, it appears that the top 15 cash holders have already been on a slight upward trajectory relative to other firms for a few years."

The repatriation "may also have been used to pay down debt; however, the aggregate debt of the top 15 cash holders declined only about $15 billion, or 2 percent of their total debt outstanding, suggesting limited paydowns so far."

Thus, in simple terms, and allowing some conditionality for lags in investment, the TCJA 2017 has primarily went to stimulate stock market activity, as opposed to either corporate deleveraging or corporate investment. This is consistent with 2004 repatriation amnesty, when the bulk of funds brought by the U.S. MNEs back to the U.S. went to fund shares repurchases in 2005.

It's back to the future folks.

Full note: https://www.federalreserve.gov/econres/notes/feds-notes/us-corporations-repatriation-of-offshore-profits-20180904.htm.

13/9/18: Concentration Risk: IPOs, New Firms Arrivals & Super Stars

One of my favourite long-run tail risks to watch in the financial markets (and indeed, due to ongoing monopolisation trends, in the entire economy) is concentration risk. Here is an absolutely epic post from @michaelbatnick on the subject of increasing concentration in equity markets driven by the growing trend toward keeping new tech mega starts private: http://theirrelevantinvestor.com/2018/09/10/making-private-public/. 

Aside from compiling a treasure trove of data, the post brings to light some interesting observations, not necessarily central to the author's core arguments.

Take, for example, this chart:

The post correctly views this as evidence that both volumes and numbers of IPOs have been relatively steady over the recent years. Albeit, both are running woefully below the pre-dot.com bust era averages. And, as other evidence presented shows, this is not the feature of the dot.com bubble build up phase: in fact, numbers of IPOs have been running well below the 1980-2000 average since the dot.com bust.

Maturity to IPO duration is also longer:

Which, of course, supports higher median IPO size in the chart above. Controlling for this, the collapse in IPOs activity in 2001-2018 period is probably much more dramatic, than the first chart above indicates. Or, put differently, IPOs are now more concentrated in the space of older, and hence more able to raise funds, companies. That is a phenomenon consistent with concentration risk rising.

It is also a phenomenon consistent with the hypothesis that entrepreneurialism is declining in the U.S. as younger, more entrepreneurial ventures are clearly less capable of accessing public equity markets today than in pre-2001 period.

There is a lot, really a lot, more worth reading in the post. But here are two more charts, speaking directly to the issue of concentration risk:

 and

Yes, the markets are dominated by a handful of stocks when it comes to providing returns. Namely, Facebook and Alibaba account for a whooping 85% of the total market cap gains since 2012. $85 of each $100 in market cap increases went to just these two companies.

This is concentration risk at work. Even tightly thematic investment strategies, e.g. ESG risk hedging investments, cannot avoid crowding into a handful of shares. Any tech sector blowout is going to be systemic, folks.