Tuesday, May 3, 2016

2/5/16: There's Only One Position of Integrity on TTIP: Kill It

In a recent op-ed in FT, Wolfgang Münchau raised a very valid point that globalisation, free trade and markets liberalisation do produce both winners and losers. Nothing new here. But the key point is that this realisation must be timed / juxtaposed against political and social realities on the ground

Quoting from Münchau (emphasis is mine): “In the past two years, there has been a dramatic reversal of public opinion in Germany about the benefits of free global trade in general, and TTIP in particular. In 2014, almost 90 per cent of Germans were in favour of free trade, according to a YouGov poll. That has fallen to 56 per cent. The number of people who reject TTIP outright has risen from 25 per cent to 33 per cent over the same period of time.  These numbers do not suggest that the EU should become protectionist. But… [EU leaders] should be more open-minded about the political costs of this agreement. …A no to TTIP would at least remove one factor behind the surge in anti-EU or anti-globalisation attitudes.

The marginal economic benefits of the agreement are outweighed by the political consequences of its adoption.

What advocates of global market liberalisation should recognise is that both globalisation and European integration have produced losers. Both were supposed to produce a situation in which nobody should be worse off, while some might be better off.”

See the full text here: http://www.ft.com/cms/s/0/a4bfb89a088511e6a623b84d06a39ec2.html

Perhaps it is this dynamic - of the excess supply of losers and the over-concentration of winners - that is behind the dire state of global trade growth:

Wolfgang Münchau's article came in days ahead of the leaks that revealed the duplicit nature of EU and U.S. negotiating positions on TTIP (see Leaked TTIP documents cast doubt on EU-US trade deal), well before we knew that (again, emphasis is mine) "These leaked documents give us an unparalleled look at the scope of US demands to lower or circumvent EU protections for environment and public health as part of TTIP. The EU position is very bad, and the US position is terrible. ...The way is being cleared for a race to the bottom in environmental, consumer protection and public health standards."

In simple terms, TTIP is risking to further magnify the chasm between the winners in the Agreement (larger corporates on both sides of the Atlantic, plus Governments) and the losers (consumers, small firms and entrepreneurs).

The documents reveal that under the TTIP, "American firms could influence the content of EU laws at several points along the regulatory line, including through a plethora of proposed technical working groups and committees." If so, the TTIP will only increase bureaucratic costs and amplify impact of large corporates lobbying power at the expense of smaller firms and start ups.

As bad as the U.S. position, is, EU's position is even worse. Despite making lots of political noise about protecting European consumers, environmental and health standards etc, the EU negotiators have clearly adopted a two-faced-Janus position vis-a-vis different stakeholders. For example, on many points of more controversial U.S. proposals, "the EU has not yet accepted the US demands, but they are uncontested in the negotiators’ note, and no counter-proposals have been made in these areas." In other words, the EU leadership is saying one thing to the European audiences (advancing a virtuous position of a defender of consumer rights and environment) while positing no explicit objection to the U.S. proposals. In simple terms, the EU leadership appears to be outright lying and manipulating public opinion.

How do we know this?

"In January, the EU trade commissioner Cecilia Malmström said the precautionary principle, obliging regulatory caution where there is scientific doubt, was a core and non-negotiable EU principle. She said: “We will defend the precautionary approach to regulation in Europe, in TTIP and in all our other agreements.” But the principle is not mentioned in the 248 pages of TTIP negotiating texts." In plain English, Malmström is lying.

Another example: "The public document offers a robust defence of the EU’s right to regulate and create a court-like system for disputes, unlike the internal note, which does not mention them." Again, what is said for public consumption is at odds to what the EU is saying at the negotiating table.

Wolfgang Münchau pointed that "The marginal economic benefits of the agreement are outweighed by the political consequences of its adoption".  

But you can also add to his equation negative social consequences of the TTIP and adverse consequences to SMEs and entrepreneurs. By the time you do the sums, it is clear that TTIP is not an agreement about free trade, but an agreement about corporatist  system takeover of transcontinental trade and investment flows. As such, its marginal benefits are negative to begin with.

2/5/16: Top 100 People To Follow To Discover Financial News On Twitter 2016 Rankings

Delighted to be included in the StreetEye's second annual The Top 100 People To Follow To Discover Financial News On Twitter listing:

Great company all around!

Thursday, April 28, 2016

27/4/16: The Debt Crisis: It Hasn't Gone Away

That thing we had back in 2007-2011? We used to call it a Global Financial Crisis or a Great Recession... but just as with other descriptors favoured by the status quo 'powers to decide' - these two titles were nothing but a way of obscuring the ugly underlying reality of the global economy mired in a debt crisis.

And just as the Great Recession and the Global Financial Crisis have officially receded into the cozy comforters of history, the Debt Crisis kept going on.

Hence, we have arrived:

Source: http://www.zerohedge.com/news/2016-04-27/debt-growing-faster-cash-flow-most-record

U.S. corporate debt is going up, just as operating cashflows are going down. And so leverage risk - the very same thing that demolished the global markets back in 2007-2008 - is going up because debt is going up faster than equity now:

As ZeroHedge article correctly notes, all we need to bust this bubble is a robust hike in cost of servicing this debt. This may come courtesy of the Central Banks. Or it might come courtesy of the markets (banks & bonds repricing). Or it might come courtesy of both, in which case: the base rate rises, the margin rises and debt servicing costs go up on the double.

Wednesday, April 27, 2016

27/4/16: MIIS Team Comes Second in 2015-2016 The Economist MBA Case Competition

Well done to our MBA students at MIIS (http://www.miis.edu/) on taking the second place in The Economist MBA case competition: Real Vision Investment Case Study. See the details of the case study here: http://www.economist.com/whichmba/mba-case-studies/case-study-competition-2016. The winners were from Ryerson University. Our students second place project is described here: http://www.economist.com/whichmba/mba-case-studies/case-study-competition-2016/middlebury-institute-international-studies. Awesome result!

This comes on foot of 2015 win by MIIS team in The Economist MBA case competition: Muddy Waters Investment Competition, the details of which are available here: http://www.economist.com/whichmba/mba-case-studies/mba-case-competition-2014-15.

Which, of course, attests not only to the brilliance of students, but also to the consistently top quality of the programme.

Sunday, April 24, 2016

24/4/16: Silicon Valley Blues Go Into a Sax Solo...

In recent weeks, I have been covering growing evidence of pressures in the ICT sector bubble (the Silicon valley blues of shrinking VC valuations and funding). You can track this coverage from here: http://trueeconomics.blogspot.com/2016/04/21416-taking-sugar-from-kids-pantry.html.

Now, with its usual tardiness, the Fortune arrives to the topic too, in a rather good exposition here: http://fortune.com/silicon-valley-tech-ipo-market/.

Good summary graphic from Renaissance Capital:

But, of course, what is more interesting in the sector development is the horror show of earnings reporting that is unfolding across mature segment of the tech sector. These are well-covered here: http://wolfstreet.com/2016/04/24/apple-iphone-revenue-decline-sinks-tech-sector-earnings/, offering the following summary:

So let's see: earnings in mature segment are falling or the 5th quarter in a row (even when you control for Apple performance); earnings of Apple (tech leader) are into their second consecutive quarter of severe pressures. And unicorns (which don't even offer any serious basis for fundamentals-based valuations, including those on the basis of earnings) are rapidly taking on water. You don't really need a CFA to get this one right...

Friday, April 22, 2016

22/4/16: Russian Economy: Renewed Signs of Pressure

Earlier this week, I posted my latest comprehensive deck covering Russian economy prospects for 2016-2017 (see here: http://trueeconomics.blogspot.com/2016/04/20416-russian-deck-update-april-2016.html). Key conclusion from that data was that Russian economy is desperately searching for a domestic growth catalyst and not finding one to-date.

Today, we have some new data out showing there has been significant deterioration in the underlying economic conditions in the Russian economy and confirming my key thesis.

As reported by BOFIT, based on Russian data, “Russian economy has shrunk considerably from
early 2015. Seasonally adjusted figures show a substantial recovery in industrial output in the first three months of this year. Extractive industries, particularly oil production, drove that growth with production in the extractive sector rising nearly 3.5 % y-o-y. Seasonally adjusted manufacturing output remained rather flat in the first quarter with output down more than 3 % y-o-y.”

As the result, “the economy ministry estimates GDP declined slightly less than 2% y-o-y in 1Q16. Adjusting for the February 29 “leap day,” the fall was closer to 2.5%.”

Meanwhile, domestic demand remained under pressure. Seasonally adjusted volume of retail sales fell 5.5% y/y and is now down 12% on same period in 2014. “Real household incomes contracted nearly 4% y-o-y. Driven by private sector wage hikes, nominal wages rose 6 % y-o-y, just a couple of percentage points less than the pace of 12-month inflation.”

A handy chart:

Oil and gas production, however, continued to boom:

What’s happening? “Russian crude oil output was up in January-March by 4.5% y-o-y to record levels. Under Russia’s interpretation of the proposed production freeze to January levels, it could increase oil output this year by 1.5‒2%. The energy ministry just recently estimated that growth of output this year would only reach 0.5‒1%, which is quite in line with the latest estimate of the International Energy Agency (IEA). However, Russia’s energy ministry expects Russian oil exports to increase 4‒6% this year as domestic oil consumption falls.”

It is worth noting that the signals of a renewed pressure on economic growth side have been present in advanced data for some time now.

Two charts below show Russian (and other BRIC) Manufacturing and Services PMIs:

Both indicate effectively no recovery in the two sectors in 1Q 2016. While Services PMI ended 1Q 2016 with a quarterly average reading of 50.0 (zero growth), marking second consecutive quarter of zero-to-negative growth in the sector, Manufacturing PMI posted average reading of 49.1, below the 50.0 zero growth line and below already contractionary 49.7 reading for 4Q 2015.

Russia’s composite quarterly reading is at 49.9 for 1Q 2016 an improvement on 4Q 2015 reading of 49.1, but still not above 50.0.

In simple terms, the problem remains even though its acuteness might have abated somewhat.

21/4/16: Drama & Comedy Back: Grexit, Greesis, Whatever

Back in July last year, I wrote in the Irish Independent about the hen 'latest' Greek debt crisis: http://www.independent.ie/opinion/comment/expect-a-harder-default-for-greeks-and-less-democracy-for-the-rest-of-us-31368677.html. Optimistically, I predicted that a full-blown crisis will return to Greece in 2018-2020, based on simple mathematics of debt maturities. I was wrong. We are not yet into a full year of the Greek Bailout 3.0 and things are heading for yet another showdown between the Three-headed Hydra the inept Greek authorities, the delusional Germany, and the Lost in the Woods T-Rex of the IMF.

Predictably, IMF is still sticking to its Summer 2015 arithmetic: Greek debt is simply not adding up to anything close to being sustainable: an example of the rhetoric here. Meanwhile, the FT is piping in with a rather good analysis of the political dancing going on around Greece: here. The latter provides a summary of new dimensions to the crisis:

  1. Brexit
  2. Refugees crisis
But there is a kicker. Greece is now in a primary surplus: latest Eurostat figures put Greek primary balance at +0.7% GDP for 2015, well above -0.25% target. And Greek Government debt actually declined from EUR320.51 billion in 2013 to EUR319.72 billion in 2014 and EUR311.45 billion in 2015. This can and will be interpreted in Berlin as a sign of 'improved' fiscal performance, attributable to the Bailout 3.0 'reforms' and 'assistance'. The argument here will be that Greece is on the mend and there is no need for any debt relief as the result.

Still, official Government deficit shot from 3.6% of GDP in 2014 to 7.2% in 2015. Annual rate of inflation over the last 6 months has averaged just under -0.1 percent, signalling continued deterioration in economic conditions. Severe deprivation rate for Greek population rose to the crisis period high in 2015 of 22.2 percent, up on 21.5 percent in 2014. Industrial production on a monthly basis posted negative rates of growth in January and February 2016, with February rate of contraction at -4.4% signalling a disaster state, corresponding to 3% drop on the same period 2015. Volume of retail sales fell 2.2% y/y in January marking fourth annual rate of contraction in the last 5 months. Unemployment was 24% in December 2015 (the latest month for which data is available), which is down from 25.9% for December 2014, but the decline is more likely than not attributable to simple attrition of the unemployed from the register, rather than any substantial improvement in employment.

In simple terms, Greece remains a disaster zone, with few signs of any serious recovery around. And with that, the IMF will have to continue insisting on tangible debt relief from non-IMF funders of the Bailout 3.0.

It is a mess. Which probably explains why normally rather good Washington Post had to resort to a bizarre, incoherent, Trumpaesque coverage of the subject. This, https://www.washingtonpost.com/news/wonk/wp/2016/04/20/the-crazy-reason-we-might-be-facing-a-huge-crisis-in-greece-again/, in the nutshell, sums up American's disinterested engagement with Europe. 

Enjoy. Grexit is back for a new season to the screens near you. And so is Greesis - that unique blend of fire and ice that has occupied our newsflows for 6 years now with high drama and some comedy.

Thursday, April 21, 2016

21/4/16: Taking Sugar From the Kids Pantry: Tech Sector Valuations

In a recent post I covered some data showing the trend toward more sceptical funding environment for the U.S. (and European) tech start ups: http://trueeconomics.blogspot.com/2016/04/15416-tech-sector-finance-gravity-of.html.

Recently, Quartz added some interesting figures to the topic: http://qz.com/664468/investors-are-slashing-startup-valuations-and-not-even-uber-and-airbnb-are-safe/.

Things are not quite getting back to fundamentals, yet... but when they do, tech sector hype will blow up like a soap bubble in a tub. When the entire sector is valued on the basis of some nefarious stats instead of hard corporate finance parameters, you are into a game that is what Russian Roulette is to a Poker table.

21/4/16: Economic Outlook: Advanced Economies

My article on economic outlook forward for the Advanced Economies is now out at the Manning Financial quarterly: https://issuu.com/publicationire/docs/mf_magazine_april_2016_web_19042016?e=16572344/35062140.

20/4/16: Russian Deck Update: April 2016

Updated version of my Russian markets deck

Tuesday, April 19, 2016

19/4/16: Leverage and Equity Gaps: Italy v Rest of Europe

Relating to our previous discussions in the MBAG 8679A: Risk & Resilience: Applications in Risk Management class, especially to the issue of leverage, recall the empirical evidence on debt distribution and leverage across the European countries corporate sectors.

Antonio De Socio and Paolo Finaldi Russo recently contributed to the subject in a paper, titled “The Debt of Italian Non-Financial Firms: An International Comparison” (February 25, 2016, Bank of Italy Occasional Paper No. 308: http://ssrn.com/abstract=2759873).

Per authors, “In the run-up to the financial crisis Italian firms significantly increased their debt in absolute terms and in relation to equity and GDP.” This is not new to us, as we have covered this evidence before, but here are two neat summaries of that data:

What is of greater interest is more precise (econometrically) and robust estimate of the gap in leverage between Italian firms and other European corporates. “The positive gap in firms’ leverage between Italy and other euro-area countries has widened in recent years, despite the outstanding debt of Italian firms has decreased since 2011.”

Another interesting insight is the source of this gap. “We find that, controlling for several firm-specific characteristics (i.e. age, profitability, asset tangibility, asset liquidity, turnover growth), the leverage of Italian firms is about 10 percentage points higher than in other euro area countries. Differences are systematically larger among micro and small firms, whereas they are small and weakly significant for firms with assets above 300 million euros.”

But equity gap, defined as “the amount of debt to be transformed into equity type funds in order to fill the leverage gap with other countries”, is not uniform over time.

“…in order to reach the same average level as other euro-area countries, Italian firms should transform about 230 billion euros of financial debt into equity type finance, corresponding to 18 per cent of their outstanding debt. The gap is largest, at around 28 per cent of outstanding debt, for small firms and micro firms with over 1 million euros of assets.”

Authors note one influential outlier in the data: “A large part of the estimated corrections is due to the comparison with French firms, which on average have one of the lowest levels of leverage in Europe. Excluding these companies, the equity gap would drop to 180 billion euros.”

Dynamically, “the results indicate that the gap has widened somewhat since 2009, from about 180 to 230 billion euros”.

Given the EU-wide (largely rhetorical) push for increasing capital structure gearing toward equity, “the Italian Government recently put in place some incentives to encourage recourse to equity financing by reducing the debt tax shield: a cap on the amount of interest expense that could be deducted from taxable income and tax deductions linked to increases in equity (according to the Allowance for Corporate Equity scheme). Similarly, other measures have also been aimed at strengthening the supply of risk capital for Italian firms. The results of our analysis suggest that Italian firms still need this kind of incentives to strengthen their financial structure.”

18/4/16: Capital Gains Tax & Investment Distortions: Corporate Data from the U.S.

In our MBAG 8679A: Risk & Resilience:Applications in Risk Management class we have been discussing the links between taxation, optimal corporate capital structuring and investment, including the decisions to pursue M&A as an alternative strategy to disbursing cash to shareholders.

Lars Feld, Martin Ruf, Ulrich Schreiber, Maximilian Todtenhaupt and Johnnes Voget recently published a CESIfo Working paper, titled “Taxing Away M&A: The Effect of Corporate Capital Gains Taxes on Acquisition Activity” (January 26, 2016, CESifo Working Paper Series No. 5738: http://ssrn.com/abstract=2744534). The paper links directly taxation structure to M&A decisions and outcomes.

Per authors, “taxing capital gains is an important obstacle to the efficient allocation of resources because it imposes a transaction cost on the vendor which locks in appreciated assets by raising the vendor’s reservation price in prospective transactions.” Note, this is an argument similar to the effects of limited interest deductions on mortgages and transactions taxes on property in limiting liquidity of real estate.

“For M&As, this effect has been intensively studied with regard to shareholder taxation, whereas empirical evidence on the effect of capital gains taxes paid by corporations is scarce. This paper analyzes how corporate level taxation of capital gains affects inter-corporate M&As.”

Specifically, “studying several substantial tax reforms in a panel of 30 countries for the period of 2002-2013, we identify a significant lock-in effect. Results from estimating a Poisson pseudo-maximumlikelihood (PPML) model suggest that a one percentage point decrease in the corporate capital gains tax rate would raise both the number and the total deal value of acquisitions by about 1.1% per year. We use this result to estimate an efficiency loss resulting from corporate capital gains taxation of 3.06 bn USD per year in the United States.”

I am slightly sceptical about the numerical estimate as the authors do not appear to control for M&A successes. However, since the lock-in mechanism applies to all types of re-investment projects, one can make a similar argument with respect to other forms of capex and investment. One way or the other, this presents evidence of distortionary nature of U.S. capital gains taxation regime.