Once upon a time, I spent a lot of effort promoting the concept of a "virtual pub" as the heart of a good financial market research team (or any other research team, for that matter).
A pub (in my experience at least) is a place where colleagues, friends and acquaintances can go and argue vociferously without falling out. The rules of engagement are that you arm yourselves with alcohol, stand very close to each other and disagree about almost anything, sometimes because you hold different views, and sometimes just because it's more fun to argue than agree. Views are expressed with considerable conviction (helped by tongues alcoholically-lubricated) and fingers are often poked in the direction of other debaters' faces. But it is considered extremely bad form for the argument to become violent, and it is of absolute imperative importance that at the end of the evening/argument, all participants leave, still friends and still respecting each other. If anyone drinks too much, or crosses any social lines of decent behaviour, a huge amount of embarrassed apology is required the following day.
I have had pub arguments about many things though perhaps mostly about cricket, football, politics, and economics. Lots of them. Not all of these debates answered important questions, but they were almost all the very opposite of the group-think which is the arch-enemy of constructive thought and analysis. It's easy for a sterile office discussion to end up with a bland consensual view of the world; much harder to get to that point in a pub argument where if someone says something stupid, there will be heart-felt howls of derision, rather than polite nodding of heads.
An American once told me that a pub argument is a very British concept and that other folks are a little too straight-laced to be able to cope without being offended. Maybe that is true. In certainly find that if I embark on a tirade against the accepted view of the world or of a particular asset market, I get a lot of silence and nervousness from continental European colleagues. Which is a shame because I am not trying to upset them, only to shake them out of their railway-track thought process. It's easy enough to see with hindsight that most asset bubbles, (EM, credit, dotcom, to name the last three) are the product of, or the very least aided and abetted by, groupthink.
What has this got to do with social media? I think that Twitter, in particular is replacing the virtual pub as the best mechanism for checking consensus and challenging it. If I think that someone on Twitter is talking codswallop, I don't have to start a fight, nor do I have to agree and seek a middle ground with a consensual view. I can gently challenge, or I can move to a different part of the pub. I can argue with the more robust souls who like that kind of thing, and I can listen in on the arguments and conversations of others without causing offence. I might try and be polite, but the worst someone can do is 'unfollow' me.
Facebook and Linkedin serve very different purposes. Linkedin would (I am told) allow me to keep tabs on the vast legions of people I have worked with, studied with, played with. Which might be useful if I were any good at networking. But I'm not. If Ex-colleagues, and clients, tend to ask if they can be on my research distribution list and the answer is usually yes. if they send me an email asking if i want a beer or coffee, the answer's usually yes, too. Why would I want Linkedin?
Facebook is a way for me to keep in touch with my friends - something I am incredibly bad at doing. But it appears time-consuming. I have agreed to befriend my wife, because it seemed wise and my brothers and sisters out of politeness. I know my children don't want me as a Facebook friend. To anyone else, I recommend sending me an email.
So one of the main social media helps people network, but I don't do that, and another is a way to chat with friends, but I've got better ways of dong that than Facebook. Twitter allows me to discuss with kindred souls about a subject dear to my heart but without leaving the comfort of my study. I can save my real pub time for arguments about politics and football. As for fellow tweeters, those I follow or those that follow me - I'm grateful for the debate, for agreeing with me or for telling me I'm talking horse-manure. This is how I find my way to answer questions about where the world's markets are headed. FF to you all, as they say on Twitter.
Friday, 5 April 2013
Monday, 1 April 2013
Super Cycles.. not the end, perhaps the beginning of the end
David Stockman has written a piece in the NYT ahead of the launch of his latest book, The Great Deformation: Capitalism Corrupted which is out tomorrow. There has been plenty of fuss and he's succeeded in annoying Paul Krugman amongst others.
Mr Stockman blames crony capitalism, badly designed fiscal stimulus, financial bailouts and easy money for the woes of the US. And of course, he predicts than when the next bubble bursts, the US will be left defenceless and the effects will be awful. Cue a decent Easter debate (that's the polite term) in the press, and on social media.
Away from the rhetoric and the politics, there's at least a core of truth in some of what he writes. Anyone interested in the subject really ought to start by studying the work of the Bank Credit Analyst and you could do worse than google the term 'debt super-cycle'. Since the end of the Volcker era at the Federal Reserve, the US has seen a long-term downtrend in both nominal and real interest rates. That's the reward for the defeat of (consumer price) inflation, in turn helped by Mr Volcker but also thanks to the benign effects of globalisation.
What the Fed has done, is use the freedom created by subdued CPI, to adopt incredibly easy monetary policy at the first sign of danger, and keep rates very low regardless of the effect on other parts of the US economy. They started in the early 1990s, when the Fed cut rates to 3% in response to the S&L crisis. The denouement in 1994 and onwards, was fine for the US but catastrophic for many countries which had tied their currencies to the dollar. Some of you may say 'so what?' but it was hardly great global leadership. In 1998, the Fed cut rates far too quickly after the LTCM 'crisis' and was too slow to raise them, starting the housing bubble which lasted a decade and lighting the fuse for the dotcom bubble. And after a very mild recession at the turn of the Millennium, a period of crazy monetary policy was as much the cause of the credit bubble which ended with the 'Great Recession' as lax bank supervision and greedy bankers.
In 2008, I thought the debt super-cycle had ended. It seemed obvious that households and companies would reduce their leverage and that the financial sector would be forced by regulators and natural caution to lend less, and build up more defensive balance sheets. What I hadn't reckoned on, was that the public sector could take over so much of the debt and that the Fed would respond by adopting even easier monetary policy. The asset bubble whose explosion triggered the recession, was caused by negative real interest rates. Economic recovery is being built on even more negative real interest rates, which have indeed triggered a recovery in asset prices from equities to housing.
I've learnt to be wary of saying that the Fed is out of bullets. QE and ZIRP are working. There is collateral damage in the form of increased economic inequality and in terms of overvalued exchange rates in some emerging economies, but the US is going to out-grow most other developed economies in the next few years. And since ZIRP, QE and the dollar's reserve currency status all combine to allow the US to borrow money at deeply negative real yields, I don't even see why the government wouldn't go on postponing sensible fiscal policies. If I could borrow 10-year money at less than 2% per annum to invest in an economy growing at 4 1/2% in nominal terms, I would. And after all, political gridlock in Washington doesn't look that bad when you compare it to the synchronised fiscal masochism in Europe.
I wouldn't rule out a longer period than many expect when US bond yields can stay below nominal GDP growth, continuing to support asset prices; when globalisation keeps on keeping wage growth down and CPI inflation under control; and the US can give a very decent impression of being in the early stages of an OK economic recovery. The rest of us, wearing our hair shirts and struggling to get out debt levels under control in the face of recession, will be thankful for any growth we can import from the US.
That's where I disagree with Mr Stockman. 2008 didn't signal the last 'mini-cycle' of the debt super-cycle; maybe it didn't even signal the last-but-one. The philosophical rights and wrongs of mad money and ever-rising public sector debt levels, can fuel debate but when Ben goes and Janet takes over, the policy recipe could just stay the same. So Mr Stockman may find that he is an awful lot older before he is ever proved right in his warnings of doom...
Mr Stockman blames crony capitalism, badly designed fiscal stimulus, financial bailouts and easy money for the woes of the US. And of course, he predicts than when the next bubble bursts, the US will be left defenceless and the effects will be awful. Cue a decent Easter debate (that's the polite term) in the press, and on social media.
Away from the rhetoric and the politics, there's at least a core of truth in some of what he writes. Anyone interested in the subject really ought to start by studying the work of the Bank Credit Analyst and you could do worse than google the term 'debt super-cycle'. Since the end of the Volcker era at the Federal Reserve, the US has seen a long-term downtrend in both nominal and real interest rates. That's the reward for the defeat of (consumer price) inflation, in turn helped by Mr Volcker but also thanks to the benign effects of globalisation.
What the Fed has done, is use the freedom created by subdued CPI, to adopt incredibly easy monetary policy at the first sign of danger, and keep rates very low regardless of the effect on other parts of the US economy. They started in the early 1990s, when the Fed cut rates to 3% in response to the S&L crisis. The denouement in 1994 and onwards, was fine for the US but catastrophic for many countries which had tied their currencies to the dollar. Some of you may say 'so what?' but it was hardly great global leadership. In 1998, the Fed cut rates far too quickly after the LTCM 'crisis' and was too slow to raise them, starting the housing bubble which lasted a decade and lighting the fuse for the dotcom bubble. And after a very mild recession at the turn of the Millennium, a period of crazy monetary policy was as much the cause of the credit bubble which ended with the 'Great Recession' as lax bank supervision and greedy bankers.
In 2008, I thought the debt super-cycle had ended. It seemed obvious that households and companies would reduce their leverage and that the financial sector would be forced by regulators and natural caution to lend less, and build up more defensive balance sheets. What I hadn't reckoned on, was that the public sector could take over so much of the debt and that the Fed would respond by adopting even easier monetary policy. The asset bubble whose explosion triggered the recession, was caused by negative real interest rates. Economic recovery is being built on even more negative real interest rates, which have indeed triggered a recovery in asset prices from equities to housing.
I've learnt to be wary of saying that the Fed is out of bullets. QE and ZIRP are working. There is collateral damage in the form of increased economic inequality and in terms of overvalued exchange rates in some emerging economies, but the US is going to out-grow most other developed economies in the next few years. And since ZIRP, QE and the dollar's reserve currency status all combine to allow the US to borrow money at deeply negative real yields, I don't even see why the government wouldn't go on postponing sensible fiscal policies. If I could borrow 10-year money at less than 2% per annum to invest in an economy growing at 4 1/2% in nominal terms, I would. And after all, political gridlock in Washington doesn't look that bad when you compare it to the synchronised fiscal masochism in Europe.
I wouldn't rule out a longer period than many expect when US bond yields can stay below nominal GDP growth, continuing to support asset prices; when globalisation keeps on keeping wage growth down and CPI inflation under control; and the US can give a very decent impression of being in the early stages of an OK economic recovery. The rest of us, wearing our hair shirts and struggling to get out debt levels under control in the face of recession, will be thankful for any growth we can import from the US.
That's where I disagree with Mr Stockman. 2008 didn't signal the last 'mini-cycle' of the debt super-cycle; maybe it didn't even signal the last-but-one. The philosophical rights and wrongs of mad money and ever-rising public sector debt levels, can fuel debate but when Ben goes and Janet takes over, the policy recipe could just stay the same. So Mr Stockman may find that he is an awful lot older before he is ever proved right in his warnings of doom...
Sunday, 24 March 2013
Brevity is the soul of wit - how Twitter changes research
140 characters are enough to make a point, but only if you avoid wasting words. The age of the tweet has arrived and I welcome it with open arms. Social media commentary is already having a profound impact on journalism, and I suspect its impact will be felt increasingly in investment bank research too. In my life, that is already the case.
The internet and social media accelerate the speed at which information and views are transmitted, running the risk that facts aren't checked, gossip is spread and the quality of reporting deteriorates. At the same time, we have seen the emergence of a thought-leading 'commentariat' whom everyone respects, or at least listens to and who now have a far wider audience than before.
London coffee shops used to be where news and opinion spread. By the time I started work, opinion-sharing and forming, at least in financial markets, had moved to the bars around Cheapside. And the press were meeting in bars off Fleet Street. But the City spread to Broadgate and Canary Wharf, the journalists were scattered to the four winds and licensing laws and commuting encouraged us all to go home instead of the pub, anyway.
At the same time the financial exchanges we worked in closed and dealing rooms became quieter as more trades were undertaken electronically. With the increased 'sophistication' of the instruments we trade, we surround ourselves with great banks of screens that cut out conversation with all but our closest neighbours. The modern-day Master of the Universe is an increasingly solitary soul, working long hours, doing deals, and returning home.
Social media are filling the void that was left as we abandoned social intercourse. On Twitter, we engage in debate about the world, much as one would in a bar after work, but without collateral damage to livers. The risks are clear: When someone tweets something, it can be accepted as being true even if it isn't. Malicious gossip spreads like wildfire and the only form of quality control is peer pressure. High quality factual journalism is no longer valued (or at least no longer paid for). 'Opinion' may or may not be objective. If you rely on social media for news and don't check facts, you're a fool. But as well as allowing us to be immediately notified of the latest thoughts of the intellectual great and good, Twitter brings us any number of very clever people offering 150 character analysis of the events which shape our world. Better still , many of them are writing thought-provoking and detailed analysis on websites and blogs, to which they kindly attach links. How cool is that?
The press has been quick to respond, largely embracing Twitter and other social media.Financial markets too, are increasingly embracing the new media. What we rather pompously call 'sell-side research' is grappling with the issues and lagging behind. But it certainly can't ignore what is happening.
When I first started writing, I produced a weekly telex comment for clients, progressing to a printed piece which was sent in the post. Then there was email, then there were websites and then there was Elliott Spitzer and large-scale tightening up of the rules surrounding how "research"could be distributed.
The tightening up of standards and rules surrounding research published by investment banks, has left a gap which social media are filling enthusiastically. A traditional research note on the impact of events in Cyprus this weekend can't clear compliance much before 9 a.m on Monday morning, too late for markets in search of instant gratification. But then, what market participants want isn't a traditional research note, with 'buy' and 'sell' recommendations carefully vetted and caveats strewn around like confetti. "What has happened, and what does it mean?" is the first question, followed by a deluge of follow-ups "yes, but what if...." and so on.
Whether you are a trader, a salesperson, a fund manager, a Master of the Universe or indeed an interested by-stander, what you want is information, opinion and debate and Twitter gives it to you. For the traditional common-or-garden sell-side analyst, this demands a change of approach. The public dissemination of non market-moving information and broad macro-economic views should not be subject to restraint by regulatory authorities. At the same time, the analyst does not necessarily know for sure how markets will react to news. In the instance of Cyprus' woes, we have all known for a long time that a bailout was needed as a result of losses incurred by over-leveraged banks as the Greek crisis deepened. Whether the terms of a bailout will cause further risk aversion and contagion is a matter of opinion, and the best way to establish how the mood in financial markets will evolve, is to express an opinion and open it up to a wider debate.
So 300 years ago, I would have headed for Covent Garden this morning, with my top hat and my cane, in order to sound out the mood of those I respect. Today, I am more likely to go to Starbucks in Crouch End before returning home, coffee in hand to shoot the breeze on-line. I'll be doing so in a personal capacity, and I'll be wary of the need to comply with regulations surrounding the publication of research that were written long before the social media revolution happened, but just because my business card says 'Strategist' rather than "Middle-aged bald bloke trying to figure it out" doesn't mean I can do without the debate.
The internet and social media accelerate the speed at which information and views are transmitted, running the risk that facts aren't checked, gossip is spread and the quality of reporting deteriorates. At the same time, we have seen the emergence of a thought-leading 'commentariat' whom everyone respects, or at least listens to and who now have a far wider audience than before.
London coffee shops used to be where news and opinion spread. By the time I started work, opinion-sharing and forming, at least in financial markets, had moved to the bars around Cheapside. And the press were meeting in bars off Fleet Street. But the City spread to Broadgate and Canary Wharf, the journalists were scattered to the four winds and licensing laws and commuting encouraged us all to go home instead of the pub, anyway.
At the same time the financial exchanges we worked in closed and dealing rooms became quieter as more trades were undertaken electronically. With the increased 'sophistication' of the instruments we trade, we surround ourselves with great banks of screens that cut out conversation with all but our closest neighbours. The modern-day Master of the Universe is an increasingly solitary soul, working long hours, doing deals, and returning home.
Social media are filling the void that was left as we abandoned social intercourse. On Twitter, we engage in debate about the world, much as one would in a bar after work, but without collateral damage to livers. The risks are clear: When someone tweets something, it can be accepted as being true even if it isn't. Malicious gossip spreads like wildfire and the only form of quality control is peer pressure. High quality factual journalism is no longer valued (or at least no longer paid for). 'Opinion' may or may not be objective. If you rely on social media for news and don't check facts, you're a fool. But as well as allowing us to be immediately notified of the latest thoughts of the intellectual great and good, Twitter brings us any number of very clever people offering 150 character analysis of the events which shape our world. Better still , many of them are writing thought-provoking and detailed analysis on websites and blogs, to which they kindly attach links. How cool is that?
The press has been quick to respond, largely embracing Twitter and other social media.Financial markets too, are increasingly embracing the new media. What we rather pompously call 'sell-side research' is grappling with the issues and lagging behind. But it certainly can't ignore what is happening.
When I first started writing, I produced a weekly telex comment for clients, progressing to a printed piece which was sent in the post. Then there was email, then there were websites and then there was Elliott Spitzer and large-scale tightening up of the rules surrounding how "research"could be distributed.
The tightening up of standards and rules surrounding research published by investment banks, has left a gap which social media are filling enthusiastically. A traditional research note on the impact of events in Cyprus this weekend can't clear compliance much before 9 a.m on Monday morning, too late for markets in search of instant gratification. But then, what market participants want isn't a traditional research note, with 'buy' and 'sell' recommendations carefully vetted and caveats strewn around like confetti. "What has happened, and what does it mean?" is the first question, followed by a deluge of follow-ups "yes, but what if...." and so on.
Whether you are a trader, a salesperson, a fund manager, a Master of the Universe or indeed an interested by-stander, what you want is information, opinion and debate and Twitter gives it to you. For the traditional common-or-garden sell-side analyst, this demands a change of approach. The public dissemination of non market-moving information and broad macro-economic views should not be subject to restraint by regulatory authorities. At the same time, the analyst does not necessarily know for sure how markets will react to news. In the instance of Cyprus' woes, we have all known for a long time that a bailout was needed as a result of losses incurred by over-leveraged banks as the Greek crisis deepened. Whether the terms of a bailout will cause further risk aversion and contagion is a matter of opinion, and the best way to establish how the mood in financial markets will evolve, is to express an opinion and open it up to a wider debate.
So 300 years ago, I would have headed for Covent Garden this morning, with my top hat and my cane, in order to sound out the mood of those I respect. Today, I am more likely to go to Starbucks in Crouch End before returning home, coffee in hand to shoot the breeze on-line. I'll be doing so in a personal capacity, and I'll be wary of the need to comply with regulations surrounding the publication of research that were written long before the social media revolution happened, but just because my business card says 'Strategist' rather than "Middle-aged bald bloke trying to figure it out" doesn't mean I can do without the debate.
Sunday, 17 March 2013
Cypriot precedents
The news that Cyprus, in return for an EU-led bailout, will impose a debt for equity swap 'haircut' on bank depositors, is reverberating around the blogosphere and press. There is plenty of outrage on offer, though in fairness viable alternative proposals were thin on the ground.
This is the first time in this crisis that a large proportion of the cost falls on depositors, rather than tax-payers. That creates a precedent or two, though whether it is 'fairer' for a country's taxpayers to foot the whole bill, than for some to be borne by bank depositors, isn't completely obvious.
The problem, as many people understand, is that Cyprus' banks invested too much in Greek Government debt and lent too much money in Greece. Since the value of all Greek debt fell dramatically, the Cypriot banks lost sums that were too big to be covered through their own reserves, or those of their Government.
Investment by Europe's banks in European government bonds was once thought to be a 'safe' thing to do with savers' and shareholders' funds. But the term "European Government Bonds" was and still is misleading. Europe doesn't issue government debt. European Union member countries do. And they are not necessarily backed by the rest of the EU. Greece's debt certainly wasn't.
In the short term, I suspect that the most exaggerated fears surrounding events in Cyprus will not materialise. There may be queues at cash machines this weekend but the Euro won't collapse and we probably won't see all that much contagion across Europe's banking system. One of the reasons Europe is in recession is an excess of savings, and most of that excess will remain in the banking system.
Major change is however already under way as a result of this crisis. Cross-border investment and cross-border banking have been hit within Europe. A French or German saver is already more likely now to keep his/her savings in a large domestic institution. And that institution is more likely to invest that money at home. In financial terms, Europe is de-unifying from the bottom up.
There has always been a solution to this problem, and it has always seemed unpalatable to much of Europe - jointly issued and guaranteed Euro-bonds. If Europe wants to avoid gradual splintering of its financial system (which would leave a loose but inefficient structure of regulation and bureaucracy surrounding one-size-fits-all currency) it is going to have to move closer to a Federal structure with a Federal central bank to control the creation of money and a Federal debt issuer to raise money for its members. Europhiles who don't want to go that far need to work out where they want Europe to go.
This is the first time in this crisis that a large proportion of the cost falls on depositors, rather than tax-payers. That creates a precedent or two, though whether it is 'fairer' for a country's taxpayers to foot the whole bill, than for some to be borne by bank depositors, isn't completely obvious.
The problem, as many people understand, is that Cyprus' banks invested too much in Greek Government debt and lent too much money in Greece. Since the value of all Greek debt fell dramatically, the Cypriot banks lost sums that were too big to be covered through their own reserves, or those of their Government.
Investment by Europe's banks in European government bonds was once thought to be a 'safe' thing to do with savers' and shareholders' funds. But the term "European Government Bonds" was and still is misleading. Europe doesn't issue government debt. European Union member countries do. And they are not necessarily backed by the rest of the EU. Greece's debt certainly wasn't.
In the short term, I suspect that the most exaggerated fears surrounding events in Cyprus will not materialise. There may be queues at cash machines this weekend but the Euro won't collapse and we probably won't see all that much contagion across Europe's banking system. One of the reasons Europe is in recession is an excess of savings, and most of that excess will remain in the banking system.
Major change is however already under way as a result of this crisis. Cross-border investment and cross-border banking have been hit within Europe. A French or German saver is already more likely now to keep his/her savings in a large domestic institution. And that institution is more likely to invest that money at home. In financial terms, Europe is de-unifying from the bottom up.
There has always been a solution to this problem, and it has always seemed unpalatable to much of Europe - jointly issued and guaranteed Euro-bonds. If Europe wants to avoid gradual splintering of its financial system (which would leave a loose but inefficient structure of regulation and bureaucracy surrounding one-size-fits-all currency) it is going to have to move closer to a Federal structure with a Federal central bank to control the creation of money and a Federal debt issuer to raise money for its members. Europhiles who don't want to go that far need to work out where they want Europe to go.
Saturday, 19 January 2013
MPC new man does nothing to lift the gloom...
Ian McCafferty gave his first public speech as an MPC member yesterday. I found it faintly depressing, which doesn't mean it wasn't interesting. It's just that the policy prescription for the UK is wrong.
The most interesting part of Ian's speech was about the labour market. His contention is that with a shortage of skilled labour, and with more flexible wages, we have seen downward pressure on wage growth at the same time as employment has held up far better than expected in this downturn. hence very weak productivity. Certainly, the growth of the bonus as a part of annual compensation for more workers, has provided scope for compensation to go down as well as up, and the notion that we have seen companies keep people on while cutting wages is plausible and supported by the data - at least in the private sector.
Ian moved on to talk about exports - which have grown over the last decade, but by less than some had hoped since the financial crisis, given the pound's fall. His view is that companies used the pound's fall to boost profit margins rather than export volumes to some degree, perhaps as a way of financing labour hoarding. I have a permanent bee in my bonnet about the idea of using the pound to re-balance the economy because when I look at UK exporters, I don't see ones where a small move in the pound boosts volumes much. If BAE is the country's biggest exporter r then I am not sure the number of fighter jets they sell is affected much b the currency. Likewise Cosworth's car engines, Dyson's vacuums, or Westland's helicopters. The UK moved out of the most price-sensitive industries years ago. The notion that the weak pound improves (sterling) revenues from exports more than the volume of exports, makes lots of sense. And if we want to improve our export performance, we need to export more to big growing markets - like China to whom we sell less than we do to the Belgians; for goodness' sake. See ONS data here:
So far, I have an image of an economy which has 'used' a weaker pound to help profits, and reacted to weaker demand by cutting worker compensation, rather than cutting jobs. As the speech moved on to QE, the verdict was, largely, that most companies have taken advantage of the fall in funding costs to sort out their balance sheets rather than to increase investment and economic activity. This is true in the UK and in the US and in Europe, so no controversy here. Companies pay back expensive short-dated debt, and borrow for longer, and at lower rates. This works well for big companies and especially ones with access to the bond market Less well (as in, not well at all) for small and medium-sized companies. The view is that it would be good to find a way for these smaller companies to access the capital market. Once upon a time, they could, to a greater degree - banks lent money, and the loans were re-packaged in the form of CLOs. The death of the structured credit market, and the increased capital requirements placed on the banks, and (let's be fair) the stupidity of the senior management of banks in abusing what could have been helpful technology, have all put paid to that.
The funding for lending scheme is intended to help get money to borrowers other than the bond-issuing big companies. It has worked, it seems to me, better in terms of helping the mortgage market than the corporate sector. That's good, but again with a caveat. The government and the MPC want the mortgage market to recover. But there is a general hue and cry to avoid house prices rise any further (at least in the South East). But on a small, easily flooded island with a rapidly-growing population and very little room to build new homes, increased availability of funds to buy homes will inevitably push prices up. Maybe the FLS should be focused outside the South East, but more than anything, I wish there were clarity on the topic. Do the Government and MPC think increased household indebtedness is a good idea and if so why? Are they relaxed about rising house prices, as long as house building picks up? Once you get into the business of micro-managing the economy, especially when you try and micro-manage with monetary policy (or use 'More targeted measures than QE' to drive growth, to use Ian McC's phrase), you inevitably run the risk of policy mess.
The MPC is going to fiddle around trying to find ways to help the economy. It is also going to go on worrying about inflation. The persistently high level of inflation has several causes; part of it comes down to the pound's weakness. Part, shared with other countries is related to food prices and the weather. A really big part though comes from fiscal policy. We have required many (most) utilities to increase investment since they were privatised and allow them to raise prices irrespective of competition in order to finance it. So the price of water, electricity, gas, transport, etc. all go up faster than inflation. Government austerity then pushes up the cost of local services as cash-poor local government reacts to decreased central funding. There are no competitive pressures standing in the way of these price increases. And there absolutely nothing that monetary policy can do about except drive deflation in the rest of the economy to compensate.
Because the MPC is still worried about persistent inflation and because the fret that if/when growth picks up there will be more inflation (my guess us that given there was inflation works in the UK there'll be less), we will continues to see current policies left in place. That is, the pound will be talked down, rates will remain at zero, the government will raise taxes and cut spending. As the economy stagnates, the corporate sector (which pays lower taxes than the household sector) will try and maintain profit margins and revenues Employment will hold up but wages won't and consumer spending will remain weak, as will tax revenues. This could all go on for a depressing long time before economic recovery gathers any momentum....
So thanks, Ian, I enjoyed the speech, but it left me rather gloomy.....
The most interesting part of Ian's speech was about the labour market. His contention is that with a shortage of skilled labour, and with more flexible wages, we have seen downward pressure on wage growth at the same time as employment has held up far better than expected in this downturn. hence very weak productivity. Certainly, the growth of the bonus as a part of annual compensation for more workers, has provided scope for compensation to go down as well as up, and the notion that we have seen companies keep people on while cutting wages is plausible and supported by the data - at least in the private sector.
Ian moved on to talk about exports - which have grown over the last decade, but by less than some had hoped since the financial crisis, given the pound's fall. His view is that companies used the pound's fall to boost profit margins rather than export volumes to some degree, perhaps as a way of financing labour hoarding. I have a permanent bee in my bonnet about the idea of using the pound to re-balance the economy because when I look at UK exporters, I don't see ones where a small move in the pound boosts volumes much. If BAE is the country's biggest exporter r then I am not sure the number of fighter jets they sell is affected much b the currency. Likewise Cosworth's car engines, Dyson's vacuums, or Westland's helicopters. The UK moved out of the most price-sensitive industries years ago. The notion that the weak pound improves (sterling) revenues from exports more than the volume of exports, makes lots of sense. And if we want to improve our export performance, we need to export more to big growing markets - like China to whom we sell less than we do to the Belgians; for goodness' sake. See ONS data here:
So far, I have an image of an economy which has 'used' a weaker pound to help profits, and reacted to weaker demand by cutting worker compensation, rather than cutting jobs. As the speech moved on to QE, the verdict was, largely, that most companies have taken advantage of the fall in funding costs to sort out their balance sheets rather than to increase investment and economic activity. This is true in the UK and in the US and in Europe, so no controversy here. Companies pay back expensive short-dated debt, and borrow for longer, and at lower rates. This works well for big companies and especially ones with access to the bond market Less well (as in, not well at all) for small and medium-sized companies. The view is that it would be good to find a way for these smaller companies to access the capital market. Once upon a time, they could, to a greater degree - banks lent money, and the loans were re-packaged in the form of CLOs. The death of the structured credit market, and the increased capital requirements placed on the banks, and (let's be fair) the stupidity of the senior management of banks in abusing what could have been helpful technology, have all put paid to that.
The funding for lending scheme is intended to help get money to borrowers other than the bond-issuing big companies. It has worked, it seems to me, better in terms of helping the mortgage market than the corporate sector. That's good, but again with a caveat. The government and the MPC want the mortgage market to recover. But there is a general hue and cry to avoid house prices rise any further (at least in the South East). But on a small, easily flooded island with a rapidly-growing population and very little room to build new homes, increased availability of funds to buy homes will inevitably push prices up. Maybe the FLS should be focused outside the South East, but more than anything, I wish there were clarity on the topic. Do the Government and MPC think increased household indebtedness is a good idea and if so why? Are they relaxed about rising house prices, as long as house building picks up? Once you get into the business of micro-managing the economy, especially when you try and micro-manage with monetary policy (or use 'More targeted measures than QE' to drive growth, to use Ian McC's phrase), you inevitably run the risk of policy mess.
The MPC is going to fiddle around trying to find ways to help the economy. It is also going to go on worrying about inflation. The persistently high level of inflation has several causes; part of it comes down to the pound's weakness. Part, shared with other countries is related to food prices and the weather. A really big part though comes from fiscal policy. We have required many (most) utilities to increase investment since they were privatised and allow them to raise prices irrespective of competition in order to finance it. So the price of water, electricity, gas, transport, etc. all go up faster than inflation. Government austerity then pushes up the cost of local services as cash-poor local government reacts to decreased central funding. There are no competitive pressures standing in the way of these price increases. And there absolutely nothing that monetary policy can do about except drive deflation in the rest of the economy to compensate.
Because the MPC is still worried about persistent inflation and because the fret that if/when growth picks up there will be more inflation (my guess us that given there was inflation works in the UK there'll be less), we will continues to see current policies left in place. That is, the pound will be talked down, rates will remain at zero, the government will raise taxes and cut spending. As the economy stagnates, the corporate sector (which pays lower taxes than the household sector) will try and maintain profit margins and revenues Employment will hold up but wages won't and consumer spending will remain weak, as will tax revenues. This could all go on for a depressing long time before economic recovery gathers any momentum....
So thanks, Ian, I enjoyed the speech, but it left me rather gloomy.....
Thursday, 10 January 2013
Thursday Rant
A lot going on, some of it pretty silly though the net result is even more asset inflation as normally conservative investors put on lemming-onesies and leap over any handy cliff.
I'll start with a question that I was pondering for a fair bit of the day. Which would you rather put your money in - the UK 50-year index-linked gilt that will pay you (about) 0.016% above the RPI inflation rate (3% at the moment), or the US 30-year bond which yields about 3.07% at the moment? The yields are pretty much the same, so 3% is what you can earn on your savings if you want them to be 'safe'. I'm tempted to conclude that UK index-linked, even after today's rally, is the better yield. Neither exactly sets my pulse racing!
That you can lend money to your government for around 3% for as long as you like, is of course, why equity indices are back at levels we haven't seen in a while, why house prices are so high, why paintings, tuna, truffles and Bordeaux wines are all being sold for prices that blow your mind. Oh, and the price of a premiership footballer -that too.
But the real reason I wanted to rant was about two, related topics. The first is the BOJ, who are widely touted as being on the point of adopting a 2% inflation target. I get lots and lots of emails about this. But how on earth does increasing the inflation target from 1% to 2%, when you have been seeing prices FALL for ages? Why not have a 5% inflation target on this basis? The target is not what will get the country out of deflation. Fortunately, a weaker yen will, and a weaker yen is coming.
There's a ink between the 2% inflation target and the real nonsense story in financial markets - the idea that the US should issue a trillion-dollar coin, made (it is suggested) out of platinum. the purpose of this is to get round the debt ceiling. Issuing a trillion dollar coin, boosts the country';s assets and allows it to borrow more. At one daft level, it is sensible because it gets around the really, really silly risk of a rich country defaulting because having committed to spend money, it decides bot to finance the spending, even though it could. This, in my language is the same as agreeing to buy a house, signing on the dotted line, hiring the movers and then having a meeting with Mrs J, and agreeing that we don't want a mortgage.
If the US doesn't want to increase its debt levee, it needs a grown-up debate about that. Cut spending, or raise taxes. The coin is a gimmick that merely highlights the inability of the government to govern. But my real, deep down grouse against the coin is the same as with the 2% inflation target. It is masquerading as a sensible plan by being made out of platinum. They are not going to make a coin whose metal content itself is worth $1trn. Of course not, that would be silly. And counter-productive. So why use expensive metal at all? Plastic would be better and a coin made up of old bottle tops would be even more sensible.
So I've had a silly decision on keeping a silly measure of inflation in the UK. A silly debate about a trillion dollar coin in the US to get around a self-imposed debt ceiling; and a silly decision to raise the inflation target in a country which can't get any inflation (yet). And we're only 10 days into the New Year.
I'll start with a question that I was pondering for a fair bit of the day. Which would you rather put your money in - the UK 50-year index-linked gilt that will pay you (about) 0.016% above the RPI inflation rate (3% at the moment), or the US 30-year bond which yields about 3.07% at the moment? The yields are pretty much the same, so 3% is what you can earn on your savings if you want them to be 'safe'. I'm tempted to conclude that UK index-linked, even after today's rally, is the better yield. Neither exactly sets my pulse racing!
That you can lend money to your government for around 3% for as long as you like, is of course, why equity indices are back at levels we haven't seen in a while, why house prices are so high, why paintings, tuna, truffles and Bordeaux wines are all being sold for prices that blow your mind. Oh, and the price of a premiership footballer -that too.
But the real reason I wanted to rant was about two, related topics. The first is the BOJ, who are widely touted as being on the point of adopting a 2% inflation target. I get lots and lots of emails about this. But how on earth does increasing the inflation target from 1% to 2%, when you have been seeing prices FALL for ages? Why not have a 5% inflation target on this basis? The target is not what will get the country out of deflation. Fortunately, a weaker yen will, and a weaker yen is coming.
There's a ink between the 2% inflation target and the real nonsense story in financial markets - the idea that the US should issue a trillion-dollar coin, made (it is suggested) out of platinum. the purpose of this is to get round the debt ceiling. Issuing a trillion dollar coin, boosts the country';s assets and allows it to borrow more. At one daft level, it is sensible because it gets around the really, really silly risk of a rich country defaulting because having committed to spend money, it decides bot to finance the spending, even though it could. This, in my language is the same as agreeing to buy a house, signing on the dotted line, hiring the movers and then having a meeting with Mrs J, and agreeing that we don't want a mortgage.
If the US doesn't want to increase its debt levee, it needs a grown-up debate about that. Cut spending, or raise taxes. The coin is a gimmick that merely highlights the inability of the government to govern. But my real, deep down grouse against the coin is the same as with the 2% inflation target. It is masquerading as a sensible plan by being made out of platinum. They are not going to make a coin whose metal content itself is worth $1trn. Of course not, that would be silly. And counter-productive. So why use expensive metal at all? Plastic would be better and a coin made up of old bottle tops would be even more sensible.
So I've had a silly decision on keeping a silly measure of inflation in the UK. A silly debate about a trillion dollar coin in the US to get around a self-imposed debt ceiling; and a silly decision to raise the inflation target in a country which can't get any inflation (yet). And we're only 10 days into the New Year.
Sunday, 6 January 2013
Correlations
'Risk-on/risk-off" is nearly as annoying as the fiscal cliff, in terms of over-used expressions used by those who work or play in financial markets. But while it would be premature to say Ro-Ro is dead, I am confident that a shake-up of the cross-makret correlations which are currently seen in market,s is on the way.
Cross-asset correlations are nothing new and most are easily explained. Since 2006, for example, there has been a strong,and logical correlation between the level of the Japanese Nikkei index, and the Dollar/Yen exchange rate. Logical because Japanese exporters' earnings are obviously affected by the value of the currency - a weaker yen means stronger earnings for many bellwether names.
I can play silly games with this correlation too: Dollar/Yen is also closely correlated with the level of US bond yields. Why? Because the willingness of Japanese investors to re-cycle the accumulated financial surpluses of the last few decades, is determined in no small degree by the yields they can get abroad, and US Treasuries are the driver of those. But these two correlations taken together mean that there is a strong and utterly spurious relationship between US bond yields and the Nikkei. Rising US bond yields do not imply that Japanese companies are doing better, except insofar as both reflect a healthier global economy.
There are plenty of these correlations around, but in recent years, they have all been dwarfed by 'risk-on/risk-off'. That is a world which is either 'risk on' and any higher-yielding, more volatile or generally riskier asset does well, or 'risk off', when investors are hiding under rocks, and about the only things which thrive are the dollar and US Treasuries.
For a fund manager, this is frustrating. Brought up to look for ways to build better risk-adjsuted investment portfolios, the fund manager finds instead a world where you have to accurately choose between the equivalent of red and back squares on a roulette table.
The 'risk-on/risk-off' world is a result of Federal Reserve policy, which has caused a breakdown in the relationship between US interest rates and economic activity. The Fed keeps rates at zero, and add as much money to the economy as possible through QE, irrespective of the economic data. So 'good' US economic data don't trigger a re-think about Fed policy or a rise in Treasury yields. Instead, they make investors less afraid of recession, and more desperate to earn some kind of return on their money.
The daftest consequence of all is in the currency market. "Good" economic data in the US don't make anyone think the Fed will raise rates, they just make them less gloomy about investment returns. So good news for the US is bad news for the dollar. Which would be weird were it not for the fact hat the US authorities are pretty happy with a soft dollar anyway.
Regimes come and go, of course. And so will "risk-on/risk-off". It will change when the US economy has enough traction that the normal relationship between Treasury yields and economic activity is restored. That won't only happen when the Fed talks about raising rates, but when people in the markets dream about the notion that the Fed might contemplate the thought that they could perhaps, just perhaps raise rates, one day. When so much money is riding on the same bet - that rates are low for ever - it won't take a solid silver economic recovery to swing market sentiment, just a series of better economic releases, a bit of a debate at the FOMC and a shift in consensus expectations of US growth to, perhaps, 2 1/2-3% or so.
And what then? Higher US yields, for sure. 2-year rates will need to build in a risk premium. 30-year yields will need to price in the likelihood that the first change will be an end to Fed buying. The dollar will then benefit from good news. As for equities, credit and volatility, frankly, who knows? Better economic news is 'good' for them but higher US rates are 'bad'. And there is a huge amount of money invested now in correlations that are a few years old, but won't last for ever. In many ways, a stock-picker will do better than someone guessing where the overall market goes in this world. And hurray to that because what all this means is that there will be winners and losers and smart investors will be able to start building portfolios with decent risk-reward characteristics.
So when? This year but not right now. The Fed isn't about to change tack, or even hint about a possible change of tack. Ben Bernanke is still the King of easy money.
But we have had a taster in recent days of how the world is changing as economic divergence between Europe and the US becomes the single biggest macro story out there. If US debt ceiling talks don't change the gentle thrust of US fiscal policy, and if the European recession doesn't de-rail anyone else, US growth forecasts will be revised up. And then we'll see what the second half of the year brings. Markets are forward-looking and the outlook is getting a little less bleak.
Cross-asset correlations are nothing new and most are easily explained. Since 2006, for example, there has been a strong,and logical correlation between the level of the Japanese Nikkei index, and the Dollar/Yen exchange rate. Logical because Japanese exporters' earnings are obviously affected by the value of the currency - a weaker yen means stronger earnings for many bellwether names.
I can play silly games with this correlation too: Dollar/Yen is also closely correlated with the level of US bond yields. Why? Because the willingness of Japanese investors to re-cycle the accumulated financial surpluses of the last few decades, is determined in no small degree by the yields they can get abroad, and US Treasuries are the driver of those. But these two correlations taken together mean that there is a strong and utterly spurious relationship between US bond yields and the Nikkei. Rising US bond yields do not imply that Japanese companies are doing better, except insofar as both reflect a healthier global economy.
There are plenty of these correlations around, but in recent years, they have all been dwarfed by 'risk-on/risk-off'. That is a world which is either 'risk on' and any higher-yielding, more volatile or generally riskier asset does well, or 'risk off', when investors are hiding under rocks, and about the only things which thrive are the dollar and US Treasuries.
For a fund manager, this is frustrating. Brought up to look for ways to build better risk-adjsuted investment portfolios, the fund manager finds instead a world where you have to accurately choose between the equivalent of red and back squares on a roulette table.
The 'risk-on/risk-off' world is a result of Federal Reserve policy, which has caused a breakdown in the relationship between US interest rates and economic activity. The Fed keeps rates at zero, and add as much money to the economy as possible through QE, irrespective of the economic data. So 'good' US economic data don't trigger a re-think about Fed policy or a rise in Treasury yields. Instead, they make investors less afraid of recession, and more desperate to earn some kind of return on their money.
The daftest consequence of all is in the currency market. "Good" economic data in the US don't make anyone think the Fed will raise rates, they just make them less gloomy about investment returns. So good news for the US is bad news for the dollar. Which would be weird were it not for the fact hat the US authorities are pretty happy with a soft dollar anyway.
Regimes come and go, of course. And so will "risk-on/risk-off". It will change when the US economy has enough traction that the normal relationship between Treasury yields and economic activity is restored. That won't only happen when the Fed talks about raising rates, but when people in the markets dream about the notion that the Fed might contemplate the thought that they could perhaps, just perhaps raise rates, one day. When so much money is riding on the same bet - that rates are low for ever - it won't take a solid silver economic recovery to swing market sentiment, just a series of better economic releases, a bit of a debate at the FOMC and a shift in consensus expectations of US growth to, perhaps, 2 1/2-3% or so.
And what then? Higher US yields, for sure. 2-year rates will need to build in a risk premium. 30-year yields will need to price in the likelihood that the first change will be an end to Fed buying. The dollar will then benefit from good news. As for equities, credit and volatility, frankly, who knows? Better economic news is 'good' for them but higher US rates are 'bad'. And there is a huge amount of money invested now in correlations that are a few years old, but won't last for ever. In many ways, a stock-picker will do better than someone guessing where the overall market goes in this world. And hurray to that because what all this means is that there will be winners and losers and smart investors will be able to start building portfolios with decent risk-reward characteristics.
So when? This year but not right now. The Fed isn't about to change tack, or even hint about a possible change of tack. Ben Bernanke is still the King of easy money.
But we have had a taster in recent days of how the world is changing as economic divergence between Europe and the US becomes the single biggest macro story out there. If US debt ceiling talks don't change the gentle thrust of US fiscal policy, and if the European recession doesn't de-rail anyone else, US growth forecasts will be revised up. And then we'll see what the second half of the year brings. Markets are forward-looking and the outlook is getting a little less bleak.
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