Category Archives: Finance

Politics and Spin Over Observation

The March 30th US print edition of the Wall Street Journal carried an Opinion piece titled, “Britain’s Monetary ‘Stimulus’ Has Fed the Pension Crisis“. The article highlights the plight of many firms whose pension funds are under water and how persistently low interest rates have crippled the chances to grow the returns on a number of investment vehicles. This is due to the widening gap between the value of assets and liabilities. The article happens to highlight this plight in conjunction with true fight in Britain over a venerable old British firm, GKN, who has impressively damaging pension liability any suitor needs to accommodate.

The real point of the article however is not really about GKN. It is that the Bank of England recently published a paper that argued its loose monetary policy and massive quantitative easing were in fact good for us. The argument of the report is that things would have been much worse, therefor whatever we have must be better. This is a strange argument. Much research has been published that correlated near-zero interest rates and QE with debt and credit price distortions, record-levels of M&A, record-levels of stock buy-backs, Stu only low capital investment levels, low productivity, and to top it all off, increased inequality. To be fair, if you didn’t watch the news and all those around you, the Bank of England report might be credible. If we had had a real crash, the pain might have been worse for a while, but the economy would have recovered as fast as other recessions due to the lack of credit and debit distortions.

The article closes on a useful warning and observations. Old firms with such large pension obligations and short-falls are suffering from a double-whammy. Such firms have to divert funds to stem the pension fund blessing that might otherwise have helped source the needed growth in the future to pay for those persons. Even if central banks had not kept rates so low for so long and stuff they investor-classes pockets with cheap money, such firms might still be in trouble-or anyway.

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What Will Go Wrong in 2018?

James Mackintosh of the Wall Street Journal posts in today’s US print edition on “The 3 Things That Can Go Awry in 2018“. The article details three dynamics that, if played out as he suggests, could cause the global economy to trip in 2018. His summaries are good and compelling and, given our amazingly positive outlook today as 2017 comes to a close with all major nations growing at roughly the same time (an odd occurrence in its own right), they come at a good time to consider conservative actions against possible shifts next year.

The three are:

  1. Monetary Tightening. The story here looks at Fed and central bank interest rate hikes. We all know that interest rate raises have started, at least in the UK and US, even though the EU remains firmly stuck taking that drug. Japan is taking it slow, even as its economy shows much signs of improved life – Japan will have to continue pushing rates up in 2018, just as the EU will have to follow the US’s lead. The problem with this item is that there are us a lot of debt out there – corporate debt, public debt and yes, some consumer debt. It is not the same kind of debt that was part of the run-up to the crash that put us where we are today, but for some firms and some governments its big risky debt. As an example, and tangentially related, another article in the WSJ reports on a few firms that are high in debt that will be financial impacted by Trump’s tax reform – see Tax Plan Downside for Dell, Others in Debt. A lot firms have issues debt in the last few years in response to QE and near zero interest rates. As rates increase, debt load and repayments will increase. If inflation were to join the party, it could be a messy time for a number of firms and governments.
  2. China. This story has been used before since China has been the source of two recent periods where the US stock market (in fact the global stock market) fell by about 10%. As such, China’s management of its economy – shifting from a producer-based to consumer-based economy – is a major challenge. Debt remains a problem, and capital controls and currency exchange rates just add more menu items for Chinese leadership to wrestle with. Should China sneeze, so the saying goes, we would all fall could of a cold or something worse. Worse, there is no coordination between east and west – so we are somewhat at the behest of the Fed and People’s Bank of China – and we all hope they do the right thing. Of course, they will both do the right thing for their own constituents – or try to. Hence the lack of cooperation.
  3. A Correlation Correction. This for me is the more interesting and most likely issue to blow up in 2018, and it is the least talked about in the press since it is not as well understood. Mr. Mackintosh states, “one reason investors hold bonds is to cushion losses in a stock-market downturn.” This approach has worked for quite a while, as prices have diverged short-term all the while converging over the long-term. The risk is that should inflation appear in 2018 the relationship between stocks and bonds may revert to how it was in the 1980s and early 1990s, with rising bond yields being bad for share prices. The problem for me is that I think inflation will rise in 2018 to just levels that this will be the catalyst for change in the markers. If you read the tea leaves, there is ample evidence of a change underway. Many commodity prices are doing very well. Copper prices are, as an example, reportedly at recent high’s due to increased production. If you look at producer prices in the US, they are inching up now over 3%. Even though wage pressures remain subdued, the pressure is building. Though participating rates for males in the US aged 25-54 are at near all-time lows, yes the employment rates seems low and may go lower, but there remains some slack to take up the growth we will see. But that pressure is there. I think that by the second half of the year, certainly by Q3, US inflation forecasts will show that 3.5-4% are on the horizon. This won’t cause a panic, but it will lead the change and correction that will come. On top of this the author suggests that the Fed may just “give in” to the needs to cap the bloated asset prices we see all around us, to nip the bubble before it becomes unsustainable. Trump’s tax deal will push this peak out a year or two, but the dynamics are in play.

Reading between the lines you can see that all three of the authors ideas overlap and intersect. Inflation is mentioned directly in 2 of the 3; growth is everywhere; public policy too. As such he has hedged his bets and tried to call out the category of challenge. I will try to break the triggers into more simplistic sections.

As such, I give the following percentage probability for each driving a correction by the end of 2018:

  1. Monetary Tightening, most likely US led, due to over heating: 15%
  2. China growth, debt to currency issues: 28%
  3. EU or euro-zone debt or banking crisis: 15%
  4. Inflation-driven policy changes: 22%
  5. Japan public debt or growth challenges: 10%
  6. Emerging Market currency or debt issues: 5% (this one won’t trigger in isolation but might follow from one of the others, namely 1, causing a currency drain)
  7. Significant War triggering financial panic: 5%

One small picture says it all

Standing about 2-3 inches tell and 1-2 inches across, a small chart in page A6 of this last weekend’s Wall Street Journal, sums up our economic predicament. The article, Japan Firms End Yearslong Price Freezes, reports that a growing number of businesses are reporting that labor shortages and increasing demand are leading to price increases. The chart shows a pleasing, gradual but clear rise in prices in Japan over the last year, now approaching 1%. This is important.

Though 1% inflation sounds measly for Japan it could be a short-term boon. The nation has been bedeviled for over 20 years with meager growth, stagnant wages, and tepid productivity growth. In fact some economist suggest that Japan’s fall from economic grace that preceded the West’s financial crisis of 2007, demonstrated early what would happen in a deflationary economy with massive quantitative easing. QE did not drive Japan’s economy to growth; it does not seem to have done so in the west, though it may have saved it from crashing and now we see how it’s persistence has led to financial and investment dislocation.

The news all around us is quite positive:

  • Most recent quarterly GDP in US was restated up to 3.3%, almost unimaginable a year ago.
  • EU economic growth rates are forecasted to grow above their recent meager levels in recent OECD reports
  • ‘Currency war’ reports appear in the press infrequently, even though global trade remains torn by the idea that the US wants a stronger negotiating position (for what is, essentially, a very small part of the US economy).

But inflation remains stubbornly low almost everywhere. If Japan soon demonstrates ongoing growth in inflation, and global commodity prices push up, the result will be a wave of input price increase around the world. Some months later the US and more clearly the EU will see producer price increase and so consumers may see pass-through increases. This will encourage central banks to continue their march toward normality.

The downside with a return to inflation: Debt servicing becomes more onerous as interest rates increase in response to inflation increases. As such, governments and businesses that stocked up on cheap debt during QE and the near-zero interest rate period will have to squirrel away more cash to pay their interest charges. This will reduce what’s available for investment, thus slowing down growth.

The cycle feeds on itself so it can sometimes stabilize or other events can kick it into maddening swings. We will just have to see what happens. It may depend on how fast inflation growth returns. But for now, that little picture on page A6 looks very nice in a chilly autumn morning.

US Government Sets Up Next Financial Crisis & Brexit Not the Risk at All

Two articles came accross my desk this week – one caused consternation on my part and the other seemed to offer a sanity check.  The former concerned the US economy and specifically how there are signs that consumers, and lenders, are returning to the same behavior that led to the financial crisis at the source or our current economic challenges.  The latter concerned the hype and over blown concern with Brexit and its impact on Britain’s economy.

In the US print editions of the Wall Stree Journal (Wednesday January 11th) there was an article titled, “New Loans, Same Old Dangers“.  This front page article described a government-led initiative (Property Assessed Clean Energy) that provides subsidies loans to encourage homeowners to buy energy saving devices.  The article gives an example of a homeowner who is not able to afford the loan is still encouraged to take it out.  As is common practice this loan is then sliced up with other loans and sold on as a bond – what is called securitization in the financial industry.  This is analogous to the risky mortgage loans offered, and taken up by people who should have known better, and sold on to governments in Iceland as “AAA” opportunities.

The market is very small – the article suggests around $3.4bn of loans have been made so far – but the model is just damning.  FIrst you have big government trying to force its policies on a free market.  With the housing issues that triggered the financial crisis this was Government demanding ever greater home ownership among poor people and those that could not afford it.  Second you have the lowering of standard for the setting up of loans.  This is identical to what happened with dubious sales efforts of mortgage brokers during the 1990’s and early 2000s.  Finally you have the build up of risky loans and owners of the loans not knowing where the real risk is.

The popular uprising that has brought Trump to the White House would do well to heed these stories.  After all people will be people and when offered a bad apple that looks and smells sweet, many will take it.  Perhaps we should not fault those that do – or should we expect a stronger moral aptitude?  Either way we need to get big government out of the way.  It should not seek to foist its social or political wants on you and me – we should be free to do what we want, how we want, when we want, as long as it does not harm our fellow citizen.  Innovation and opportunity will drive improvement in the energy sector.  And perhaps tax credits would be a safer way to encourage small changes in behavior that do not create risky loans.  

The other article, a commentary piece in the US print edition of the Financial Times (Thursday Janary 12th) was titled, “The City has nothing to fear from Brexit“.  It was penned by Stanislas Yassukovich who is a former chief executive officer of European Banking Group.  The article is a breath of fresh air since it refutes many of the risks and issues that most other “specialists” report in the press.  For example we have heard a lot about “passporting” – the idea that a financial institution authorized to trade in one country of the EU can freely trade in another country.  It turns out that non-member states can use this capability quite easily – so it’s not even needed as a negotiation.  The article goes further.

Passporting was a means to try to level set the complexities of rules across what was meant to be a single market.  It turns out that even with passporting there remains complex and different rules that still need to accommodated when trading across the member-states.  As such, “core retail financial activities – residential mortgages, deposit and savings products and so on – remain almost entirely national, and highly protected.”   This whole think stinks to me.  

The recent news that PM Thresa May fired her senior most civil servant who worke with the EU was greeted in the press as bad news.  It seems he kept repeating to the PM that it was not going to be possible to complete all negotiations in time before the two year window closed for leaving the EU.  Why is this?  He may have had a practical view on things but he certainly did not have a positive view on what is possible.  I think we need clean out the cupboard and get a fresh new look at everything.  Good for PM May to do so.  If the author of this article is right, there is little we should fear from Brexit.   

France and the EU: Great Parallels Between 2016 and 1967

On May 16 1967 Charles de Gaulle, premier of France who were, at the time the largest and dominant economy of the ‘European 6’ that had formed the Common Marker, or European Economic Community (EEC); forerunner to the EU, prevented Britain from joining. The other five nations including Germany were keen to have Britain join. de Gaulle’s decision was in fact a repeat to his original, “Non!” in 1962/3 when Britain first applied.

What is most galling about this whole historical situation is that it was Britain who first sold the idea of some ‘United States of Europe’ toward the end of World War II. And it was Britain that first set up an organization to develop the initial instruments. It was only the fact that France, recognizing it was also losing its own empire in Africa who decided to try to preserve it, just as Britain was seeking to jettison its own empire troubles peacefully, usurped the idea as its own! France reinvented the idea and took the hapless but thankful Germans along for the ride.

But the analogy today is striking. France was not getting everything its own way back then. During the negotiations with its Western allies it decided to withdraw NATO, partly as a tactic to limit what it saw as Anglo-Saxon control of NATO that was pivoting against the Soviet Union. Yes, France actually withdrew from NATO. She withdrew in 1966 and in fact was keen to build a ‘European Europe’ distinct from an Anglo-Saxon structures. France led other nations to contemplate its own European defense force to operate independent of NATO.

So here we again in 2016 and we see and hear and read of France trying to do the same thing. Only a few weeks ago we heard France float the idea of an independent military force. This remains, as it was in the 60’s, a detrimental idea. NATO acts as the true umbrella for western defense and the US acts as the back-stop to it. Ideological politicians who are against the US and more in favor of self-aggrandizement are now stepping up the arguments, using Trump’s campaign rhetoric.  

Trump has and will not reject NATO; we heard President Obama say yesterday in his press briefing that, during his recent 1-1 with president elect Trump, NATO came up and it was clear Trump is firmly behind it. Of course he is! He simply called out, during his election rhetoric, that NATO needs to pay its fair share of the bill. This was and is always fair. And the fact that the US highlighted this is little different to the period in the 40’s when Britain’s empire was shrinking and its commercial operations contracting and funds were drying up. It too had to make some tough calls.

Brussels, and France, need to step up and be honest with themselves and the rest of us. Europe cannot operate militarily outside of NATO. Europe can’t even yet financially support the very service that keeps them safe! How can they afford their own army?  

Give up the rabble-rousing European defense force idea and get back into bed with the US. Of you don’t, you will have many more troubles than what you envisage with Britain leaving the club. Trump will soon enough stand tall with NATO. Then where will you be? At the foot of table, not near its’ head.

When Connecting the Dots Disagrees with the Data: Something Fishy in the Housing Market.

My original title for this blog was going to be just, “Something Fishy in the Housing Market”. But I changed the title once I realize that this blog was more about how conclusions, based on data change, once triangulation of that data is sustained.
First the good news from the Global Dailty Economic News alert from the World Bank’s Economic Prospects Group October 26, 2016:  Advanced Economies, US:

“New U.S. single-family home sales rose 3.1 percent (m/m, saar) to 593,000 in September, from downwardly revised 8.6 percent decline to 575,000 sales in August, and above the market expectations of a 1 percent decline. On a yearly basis, new home sales jumped 29.8 percent in September, according to the Commerce Department. Demand for new homes remains strong, reflecting employment growth, wage gains, positive demographics and mortgage rates near all-time lows.”

So it seems good news. The economy is functioning well, yes? 

Now the bad news Bloomberg July 28, 2016: Homeownership Rate in the U.S. Drops to Lowest Since 1965.  

The U.S. homeownership rate fell to the lowest in more than 50 years as rising prices put buying out of reach for many renters.

The share of Americans who own their homes was 62.9 percent in the second quarter, the lowest since 1965, according to a Census Bureau report Thursday. It was the second straight quarterly decrease, down from 63.5 percent in the previous three months.

Now the analysis that emerges when you overlay the two data points.

Per the World Bank, it seems that demand for housing is up. But per Bloomberg, the new housing is not actually housing that is sold. It so happens that many new (and old) houses are being acquired – that’s true. But who is buying them? It turns out, according to Bloomberg, that large swathes of the housing sector are being snapped up by cash rich organizations that are then renting the property. 

Actual home ownership is down – which is caused by a number of factors. One is that many cannot afford the first-time costs, either through lack of a job, low wages, or a bad credit score. And as more and more housing is purchased and turned into rental property, the pricing for those houses increasing, making the challenge harder.

So the increased demand for new housing is not a sign of increased wages and strong employment, as the World Bank suggests. It’s very likely the investor class, flush with cash from quantitive easing and cheap loans (due to historic low interest rates), are snapping up property and then renting them.

The two articles, taken separately, lead to one conclusion. But when you link the two, a new analysis comes forth. What will happen next? I can foresee several items.

We should now expect socially progressive typesto suggest that the market is working against the middle-class, and that government should force mortgage firms to lower standards and let those with weaker credit scores and low paying jobs to obtain loans for these new houses. The problem is with QE and near-zero interest rates. It is ruining numerous markets and distorting all manner of normal investor practices, such as capital investment for future productivity and now the housing market. 

There is a possible silver lining to all this rental action going on. A third factor is dragging the US economic growth down. It is the reduction in the American worker’s willingness to move to where the jobs are:

“Census Bureau data show that the annual rate at which people relocated to a different state — which is often an indicator of job changes — fell to between 1.4% and 1.7% of the overall population since the Great Recession. That contrasts to interstate migration rates at or close to 3% from 1947 through the middle of the last decade, with only a few exceptions.”  LA Times, June, 2016

If more and more people set up shop in a rental property, it might lead to an increased ability to move. It is possible this may happen and this should help the labor market and the economy – that is assuming there are jobs worth moving for.

But there is also a cloud related to the drop in home ownership. It will likely lead to more instability in the nuclear family, the so called bedrock of modern society. The nuclear family has been under attack since the 60’s as wave after wave of progressives have taken up power and decided they know what’s best for us, even more than we do ourselves. The declines in home ownership will likely undermine the nuclear family again. But we cannot afford, we must not, adjust policy to accommodate the need to encourage the proportion to middle class. We should focus on opportunity and growth instead and let the invisible hand do its work.

Two Long Term Concerns Stand Taller then Brexit

Two articles in this weekend’s US print editions of the Wall Street Journal and Financial Times highlight the real concerns that threaten global growth, far more so than the ministrations of (hopefully) rational politicians soon to embroil in Brexit negotiations. One concerns China and the other Italy.
In “Rising Worries Cloud China GDP“, Alex Frangis of the WSJ reports that GDP continues to show signs of weakness and more importantly, how the declining GDP is accounted for, is more troubling than its decline. It seems private investment continues to decline and public debt continues to raise.
The declining private sector investment is bad since it already represents the lions share of investment. So as that declines, overall GDP declines and the smaller sector of public debt has to step up. But this is exactly the opposite trend China needs to help transition its economy from product based to consumer based.
Housing prices show signs of cooling though by western standards the numbers are impressive. At the same time anecdotal data on unemployment shows troubling shifts too. Overall the article suggests all the wrong data points we need to suggest positive changes. If anything, China is headed towards more problems and with that, so do we.
The second article, “Exploiting the fine print to save Italy’s Banks“, Dan MccRum a and Thomas Hale of the FT, report the troubling challenges facing EU regulators that still have not closed all the leaks that sprang up post the Greek crisis. Forget the fact that Greece’s economy remains a basket case, Italy’s banks are in trouble. Italy never addressed the bed debt problem overhanging their economy; they neither farmed out all major losses to debt holders, nor give off the bad debts to a ‘bad bank’. The chickens are coming home to roost.  
The resolution will be yet another fiddle by the EU. The Italian banks will need a bail out using public funds. Italy is always over budget and should face an EU penalty for financial promiscuity. It will be waived, as it has been waived for France and Germany before. Why do we even accept such rules if they just don’t count?  
If we ignore the politics of rule setting and bypassing then, and just focus on Italy’s financing, we can determine that the fundamental issues facing Greece are not dissimilar to Italy. What differs is how such nations seek to address those challenges. Italy needs to modernize and revamp its banking and investment sector. It needs to address losses that have piled up. Until, and if, it does, the Euro will remain a troubled currency. This is what sits at the heart of a rotten Europe.