12/1/19: Global Liquidity Conditions

Things are getting ugly in the global liquidity environment.

1) The U.S. Treasuries demand from foreign buyers is drifting down - a trend that has been on-going since mid-2016. As of mid-4Q 2018, the combined foreign institutional holdings of U.S. Treasuries was at its lowest levels since the start of 2015.

2) The U.S. Dollar strength is now at its highest levels since early 2002.

Meanwhile, liquidity is falling:

3) Global liquidity supply is turning down, having trended relatively flat since the start of 2015

This is not a good set of signs, especially as this data is not reflecting, yet, the ECB tightening.

11/1/19: Herding: the steady state of the uncertain markets

Markets are herds. Care to believe in behavioral economics or not, safety is in liquidity and in benchmarking. Both mean that once large investors start rotating out of one asset class and into another, the herd follows, because what everyone is buying is liquid, and when everyone is buying, they are setting benchmark expected returns. If you, as a manager, perform in line with the market, you are safe at the times of uncertainty and ambiguity. In other words, it is better to bet on losing or underperforming alongside the crowd of others, than to bet on a more volatile expected returns, even though these might offer a higher upside.

How does this work? Here:

Everyone loves Corporate debt, until everyone runs out of it and into Government debt. Everyone hates Government debt, until everyone hates corporate debt. It's ugly. But it is real. Herding is what drives markets, even though everyone is keen on paying analysts top dollar not to herd.

11/1/19: A Behavioral Experiment: Irish License Plates and Household Demand for Cars

While a relatively well known and understood fact in Ireland, this is an interesting snapshot of data for our students in Behavioral Finance and Economics course at MIIS.


In 2013, Ireland introduced a new set of car license plates that created a de facto natural experiment in behavioural economics. Prior to 2013, Irish license plates contained, as the first two digits, the year of car production (see lower two images). Since 2013, prompted by the ‘fear of the number ’13’’, the license plates contain three first digits designating the year and the half-year of the make.

Prior to 2013 change in licenses, Irish car buyers were heavily concentrated in the first two months of each year - a ‘vanity effect’ of license plates that provided additional utility to the earlier months’ car purchasers from having a vehicle with current year identifier for a longer period of time. Post-2013 changes, therefore can be expected to yield two effects:
1) The ‘vanity effect’ should be split between the first two months of 1H of the year, and the first two months of 2H of the year; and
2) Overall, ‘vanity effect’ across two segments of the year should be higher than the same for th period pre-2013 change.

As chart above illustrates, both of these factors are confirmed in the data. Irish buyers are now (post-2013) more concentrated in the January, February, July and August months than prior to 2013. In 2009-2012, average share of annual sales that fell onto these four months stood at 44.8 percent. This rose to 55.75 percent for the period starting in 2014. This difference is statistically significant at 5% percent level.

The share of annual sales that fell onto January-February remained statistically unchanged, nominally rising from 31.77 percent for 2009-2012 average to 32.56 percent since 2014. This difference is not statistically significant at even 10%. However, share of sales falling into July-August period rose from 13.04 percent in 2009-2012 to 23.19 percent since the start of 2014 This increase is statistically significantly greater than zero at 1 percent level.

Similar, qualitatively and statistically, results can be gained from looking at 2002-2008 average. Moving out to pre-2002 average, the only difference is that increases in concentration of sales in January-February period become statistically significant.

In simple terms, what is interesting about the Irish data is the fact that license plate format - in particular identification of year of the car make - strongly induces a ‘vanity effect’ in purchaser behaviour, and that this effect is sensitive to the granularity of the signal contained in the license plate format. What would be interesting at this point is to look at seasonal variation of pricing data, including that for used vehicles, controlling for hedonic characteristics of cars being sold and accounting for variable promotions and discounts applied by brokers.

11/1/19: Euromoney on U.S. and Global Credit Risk: 2018 in review

My comment on key trends in the U.S. credit risk changes in 2018 and a glimpse into 2019 'crystal ball' for Euromoney and ECR: https://www.euromoney.com/article/b1cmrkm17q1cm9/ecr-survey-results-2018-us-decouples-from-improving-g10-trend-angola-egypt-lead-africa-recovery.

11/1/19: Capital Gains Tax: Human Capital vs Other Forms of Capital

This is exactly the source of policy-induced wealth inequality in the modern advanced economies: the disparity between labor income tax and capital gains tax that (1) incentivises accumulation of capital gains generating assets; (2) increases wealth inequality arising from non-meritocratic transfers (spousal and inheritance); and (3) reduces gains from meritocratic investment in human capital.

Now, factor this into tax-adjusted returns on various forms of capital: Intangible Capital returns are taxed at a corporate tax level at below the Physical Capital returns tax rates, which fall lower than the Capital Gains tax rate. Meanwhile, returns to the [intangible] Human Capital are taxed at the rates of higher margin Income tax rates. Go figure why wealth inequality is rising (as entrepreneurship is shrinking).

10/1/19: QE or QT? Look at the markets for signals

With U.S. Fed entering the stage where the markets expectations for a pause in monetary tightening is running against the Fed statements on the matter, and the ambiguity of the Fed's forward guidance runs against the contradictory claims from the individual Fed policymakers, the real signals as to the Fed's actual decisions factors can be found in the historical data.

Here is the history of the monetary easing by the Fed, the ECB, the Bank of England and the BOJ since the start of the Global Financial Crisis in two charts:

Chart 1: looking at the timeline of various QE programs against the Fed's balancesheet and the St. Louis Fed Financial Stress Index:

There is a strong correlation between adverse changes in the financial stress index and the subsequent launches of new QE programs, globally.

Chart 2: looking at the timeline for QE programs and the evolution of S&P 500 index:

Once again, financial markets conditions strongly determine monetary authorities' responses.

Which brings us to the latest episode of increases in the financial stress, since the end of 3Q 2018 and the questions as to whether the Fed is nearing the point of inflection on its Quantitative Tightening  (QT) policy.

9/1/19: Student Debt Bubble Adjusted for Wages and Employment Costs Growth

Student loans debt has been steadily rising in recent years, at rates far in excess of the rates of growth in overall credit to the U.S. households. However, the data shows conclusively, that the degree of leverage risk implied by growing student debt is now out of control. Here are two charts, referencing the levels of student debt to earnings and employment costs since 1Q 2005:

Source: Bloomberg

Source: my own calculations based on data from Fred database

In very simple terms, adjusting for labor compensation to college graduates, student debt growth rates since 1Q 2005 have exceeded the growth rates in returns to college degrees. The rate of this excess, cumulated from 2005-2006 period is around 2.5 times. In other words, student debt has grown 2.5 times more than the growth rate in college degree-holder's labour compensation.

9/1/2019: Assets with Negative Returns: 1901-present [Updated]

Updating the chart for major assets performance 1901-present, based on data from http://trueeconomics.blogspot.com/2018/12/191218-assets-with-negative-returns.html:

This is epic.

9/1/19: Corporate tax inversions and shareholder wealth

Our new paper "U.S. Tax Inversions and Shareholder Wealth" has been accepted for publication in the International Review of Financial Analysis:

The paper abstract:
"We examine a sample of corporate inversions from 1993-2015 by firms active in the U.S. markets and find that shareholders experience positive abnormal returns in the short-run. In the long-run, inversions have a deleterious effect on shareholder wealth. The form of the inversion and country-pair differences in geographic distance, economic development and corporate governance standards are determinants of shareholder wealth. Furthermore, we find evidence of a negative and non-linear relation between CEO total return and long-run shareholder returns."

9/1/19: Banca Carige & the Promise of Euro Banks Insolvency Resolution Regime

Italy has been the testing ground for the European regulatory framework for resolution of insolvent banks for several years, running. In all past sagas, the framework has been shown to fall short of protecting the taxpayers from the risk contagion loops that dominated the banking sector insolvency resolution regimes during the Global Financial Crisis. And the latest problem bank, Carige, is no exception.

Per latest reports (https://www.ft.com/content/b9fe3384-1427-11e9-a581-4ff78404524e) the Italian Government is pushing toward nationalization of the troubled lender in need of at least EUR400 million in fresh capital - capital it can't raise in the markets. The Government is also set to guarantee new bonds sold by Carige.

Carige assets of ca EUR25 billion are set against current capitalization of just EUR84 million. Per V-Lab data, Banca Carige is suffering from a massive spike in liquidity risk, with illiquidity index (a measure of liquidity risk) spiking to its highest levels in more than 21 years:

In late December, the ECB has taken the unprecedented step of placing Banca Carige in temporary administration, with administrators given three-month mandate to reduce balance sheet risks and arrange sale/merger/takeover of the bank. As a part of this work, the administrators are trying to review the Italian Government guarantee (issued in December) that led to the Italian deposits guarantee fund (FITD) purchasing EUR320 million of Carige's bonds.  In a notable development, the purchased bonds are potentially convertible into equity in an event of Carige's capital levels falling below regulatory threshold. In other words, these are CoCo-type bonds, implying the state fund is carrying the entire risk of Carige's future capital breaches. Beyond this, there are on-going talks with the Government on the possible SGA SpA (state-owned bad assets fund) purchase of some of the Banca Carige's non-performing assets. As an important aside, the existent bondholders in Carige are not subject to the bail-in rules the EU has put forward as the core measure for reforming banking sector insolvency regime.

These guarantees, buy-ins into Carige's bonds, lack of bondholders bail-in, and potential purchases of the bank's troubled loans constitute a de facto bailout of the bank using sovereign (taxpayers) funds. In other words, the European banking insolvency regime core promise - of shielding taxpayers from the costs of banks bailouts - is simply an empty one.

9/1/19: Twin Secular Stagnations Thesis: Productivity Growth

For those of you following my coverage of the Twin Secular Stagnations thesis, here is more recent evidence on sluggish productivity, via @soberlook and @oxfordeconomics;

In simple terms, post-2008 crises, we have not recovered in terms of productivity growth in the advanced economy. This is one of the core blocks to the supply-side part of the TSS thesis: a permanently lower expansion in productivity, driven by a range of factors, including demographics and technological innovation (the nature of).

3/1/19: Happy New 2019 or 2018 or 2008...

Happy New Old Year 2019... oh, wait...

As @lisaabramowicz1 notes: "The gap between 3-month T-bill and 10-year Treasury yields has collapsed in the past few weeks and is now at a new post-crisis low." Or, put differently, the short run is the long run and vice versa. Which means that market expectations for longer term funding costs are now on par with markets assessment of the present, and the long term risk premium has been drawn to near zero. It also means that investors no longer view longer term returns as being attractive - a bond markets way of saying that any monetary policy normalization will have to be checked against the markets over-reliance on debt and leverage.

As a chart posted by @boes_ shows: the Fed has managed, so far, to completely flip upside down markets perceptions of forward risk pricing:

The white line above is the U.S. yield curve on the first day of Jay Powell's tenure at the Fed, against the blue line today.

Whether these expectations are macro-driven (concerns about future growth) or risk-driven (concerns about the Fed's capacity to normalize rates and money supply into the short- to medium-run based on liquidity/leverage/financial markets concerns) is an open question. It might be that the markets are now synchronized to price yeans the signs are pretty ugly for 2019 investment contribution to growth as well.