In the UK the economy has grown but wages have declined. Does your bond index have Chinese bonds – it will soon. The Puerto Rican teacher’s pension ponzi scheme (really several US states and cities aren’t far away from a similar situation).

Headlines

WSJ – Macau Casinos Face Impending Shuffling of Decks 3/2. Two of the six casino operators will see their gambling concessions expire in 2020 and the other four in 2022. At that time expect the cost-of-doing business to increase enormously, the public tender to go to mainland Chinese companies (as opposed to foreigners), or the number of concessions to increase – either way, competition will be fierce.

NYT – Sweden Reinstates Conscription, With an Eye on Russia 3/2. Abolished in 2010, Sweden is reinstating the draft starting next year.

FT – Wealth of China’s richest 200 lawmakers tops $500bn 3/2. “According to Hurun data, the 200 richest members of the National People’s Congress and Chinese People’s Political Consultative Congress, an advisory body, have combined fortunes worth nearly Rmb3.5tn ($507bn). The wealth of the 100 richest lawmakers soared over the past four years to Rmb3tn, up from Rmb1.64tn in 2013.”

FT – US and North Korea on collision course, says China 3/7. The U.S. has sent its THAAD missile defense system to South Korea in light of increasing aggression from North Korea – despite concern from China.

Bloomberg – L.A. Voters Reject Measure AIDS Group Backed, Developers Opposed 3/8. LA voters rejected ballot Measure S that sought to put a two-year moratorium on development in LA.

Economist – The Iraqi army is on the brink of defeating Islamic State 3/8. “But the government must move fast if it is not to squander its victory.”

Bloomberg – Manhattan Rents Fall for Every Apartment Size, Even Studios 3/9. “Apartments available for rent at the end of February totaled 6,872, a jump of almost 12% from a year earlier. The number of new leases fell 28% last month to 3,634, while the median monthly rent for units of all sizes slipped 0.9% to $3,350.”

Special Reports / Opinion Pieces

• NYT – How to Escape Your Political Bubble for a Clearer View – Amanda Hess 3/3
• FT – A word of caution on the bond-stock decoupling – Mohamed El-Erian 3/6
  • “The net impact of all this is not to doubt the validity of the view that bond and stock markets are on different wavelengths. Rather, it is to caution against making too much of the divergence at this stage, pending more detailed analysis.”
• FT – Investors spy clouds on the bond market horizon – Danielle DiMartino Booth 3/6
  • “What a difference a few months can make. In August 2016, the value of negative-yielding bonds reached $13.4tn as QE shifted into overdrive. Should next week’s Fed Statement nod to the possibility of shrinking the balance sheet, investors would be well advised to make sure their seat belts are fastened in the event that the brakes are slammed on the bond market’s magnificent 36-year run.”
• NYT – Self-Driving Cars Can’t Cure Traffic, but Economics Can – Conor Dougherty 3/8
• FT – Pope Francis’ reforms spark revolt of the hard-right – James Politi 3/7
• WP – Laziness isn’t why people are poor. And iPhones aren’t why they lack health care. – Stephen Pimpare 3/8
• Civil Beat – Honolulu Rail Is Too Much, Too Late – Cliff Slater and Randall Roth 3/9

Briefs

• Cat Rutter Pooley and Attracta Mooney of the Financial Times highlighted that US pension funds have halved their private equity allocations.
  • “Big US investors have halved their allocations to private equity this year. It is the first sign that pension funds are concerned investment returns will suffer as buyout houses struggle to deploy record levels of cash.”
  • “Pension funds and other institutional investors gave $3.2bn to private equity funds in January and February compared with $8.9bn announced during the same period last year, according to data from MandateWire, the FT news service that collected the figures.”
  • Why… “investors are now worried about lower returns and difficulties exiting their investment in the future, as the number of initial public offerings decreases.” Further, “there are also concerns that the private equity market has become overcrowded, with buyout companies struggling to find suitable businesses to back.”
  • “According to a report from Pitchbook, the data provider, the level of cash, so-called dry powder, that private equity companies have to invest hit a record high of $754bn in 2016.”
  • “More than 80% of the capital raised by private equity companies in 2015 has yet to be deployed, said Pitchbook.”
• Gabriel Wildau of the Financial Times covered the milestone that China has overtaken the eurozone as the world’s biggest banking system.
  • “China’s banking system has surpassed that of the eurozone to become the world’s largest by assets, a sign both of the country’s increased influence in world finance and its reliance on debt to drive growth since the global financial crisis.”
  • “While China’s gross domestic product surpassed the EU’s economic bloc in 2011 at market exchange rates, its banking system did not take over the top spot until the end of 2016, Financial Times analysis shows.”
  • “Chinese bank assets hit $33bn at the end of 2016, versus $31tn for the eurozone, $16tn for the US and $7tn for Japan. The value of China’s banking system is more than 3.1 times the size of the country’s annual economic output, compared with 2.8 times for the eurozone and its banks.”
  • As Esward Prasad, former China head at the International Monetary Fund and an economist at Cornell University, “the massive size of China’s banking system is less a cause for celebration than a sign of an economy overly dependent on bank-financed investment, beset by inefficient resource allocation, and subject to enormous credit risks.”
  • 
• Bloomberg News illustrated that capital controls have triggered a backlash amongst China’s corporate titans resulting from scrapped deals.
  • “Chinese corporate chiefs are turning vocal critics of the nation’s capital controls as the pile of scrapped deals grows.”
  • “The complaints reflect a tumble in foreign deals, with the $19 billion of acquisitions abroad announced by Chinese companies so far this year amounting to a 74% drop from a year ago, according to data compiled by Bloomberg.”
  • 
  • “China’s leadership faces a balancing act in trying to stoke domestic companies’ influence on the international stage while avoiding the kind of bad investments that Japanese firms became famous for in the 1980s. The more immediate concern has been record outflows of capital that have only diminished in recent months after a steady tightening in oversight of and limits on cross-border transactions.”
  • 
• Justin Lahart of The Wall Street Journal discussed a taxing problem for investors…
  • “A corporate tax cut could provide a big boost to companies’ profits. The boost might not be quite as big, or come as soon, as investors think, though.”
  • “Yes, the U.S. corporate tax rate, at 35%, is among the world’s highest. President Donald Trump and the Republican-led Congress aim to change that. Mr. Trump has proposed dropping it to 15%, while the plan that House Republicans drew up last June would lower it to 20%.”
  • “So by how much would a tax cut juice corporate profits? The first thing to recognize is that few large public companies pay the statutory rate. By Goldman Sach’s reckoning, the effective tax rate for companies in the S&P 500 – which includes not just federal, but also state and local taxes – is 28%. Under the House plan, Goldman figures it would drop to 24%, boosting after-tax earnings by about 10%.”
  • “That could make the stock market look significantly less rich. The S&P 500 now trades at about 18 times analysts’ expected earnings for 2016, according to FactSet. Raise earnings by 10% and that price / earnings ratio slips to a more reasonable but still expensive 16.4.”
  • However, “a lower corporate tax rate also might convince some companies to reassess their use of tax havens, notes Tax Policy Center co-director Eric Toder. Any profits they direct toward the U.S. would then be subjected to a higher tax rate (20% is low, but Bermuda’s 0% is lower), raising their tax rate. Thus, the effective rate might not fall as much as advertised.”
  • Bottom line, “stock prices are supposed to be a reflection of expected future earnings. If investors are expecting too much from a corporate tax cut, and expect it to come too early, then prices will have to come down.”
• Ben McLannahan and Barney Jopson of the Financial Times highlighted that over the past election cycle Wall Street spent a record $2bn on US election influence.
  • “Wall Street spent a record $2bn on lobbying and campaign contributions during the last US election cycle, according to a new survey, as big banks, hedge funds and other financial institutions stepped up efforts to reshape rules to their advantage.”
  • “Contributions of $1.1bn in the two years ended December 2016, combined with payments to lobbyists of $898m, meant that spending by Wall Street topped $2bn, about 25% higher than the previous high in 2007-2008.”
  • “The election contributions went to both presidential campaigns and congressional races, with donors sticking to the common practice of spreading their largesse across both parties.”
  • “The sums do not include so-called ‘dark money,’ or support to non-profits which do not have to disclose their donors. Nor do they include spending on research or policy staff who are not registered as lobbyists.”
  • “The financial sector is by far the largest source of campaign contributions to federal candidates and parties and ranks as the third-largest spender on lobbying, according to the survey [done by Americans for Financial Reform, a left-leaning coalition of consumer, labor and community groups], which was based on data collected by the Center for Responsive Politics. Insurers (excluding health insurers) were the biggest spenders during the last cycle, with $224m, followed by securities and investment ($192m) and real estate ($183m).”
  • Lisa Donner, executive director of Americans for Financial Reform, “noted that there were few outright victories for Wall Street in recent years, as lobbyists sought to roll back Dodd-Frank reforms. One example was a battle in December 2014 which allowed the big banks to continue to fund derivatives trades using federally-insured deposits.”
  • “But she said that much of the lobbying had succeeded in ‘slowing or weakening’ proposed reforms. Rules on curbing incentive pay, for example, have yet to see the light of day, even though such measures appear to have broad support among voters.”
  • “‘That is really what the money story is about; we end up with outcomes that are not what people voted for,’ said Ms. Donner.”

Graphics

WSJ – Daily Shot: Statista – Tech IPO performance 3/2

WSJ – Daily Shot: Reliance on Undocumented Labor 3/2

WSJ – Daily Shot: Migrant Hosting and Sending Countries 3/2

WSJ – China Shifts Stance, Letting Dying Firms Go Bankrupt – Chuin-Wei Yap 3/3

WSJ – Daily Shot: Goldman Sachs – US Auto Inventory 3/5

Bloomberg – Saudi Arabia Still Bears Brunt of Oil Cuts as OPEC Output Drops – Angelina Rascouet and Julian Lee 3/2

NYT – ‘Superstar Firms’ May Have Shrunk Workers’ Share of Income – Patricia Cohen 3/8

WSJ – Americans Are Richer Than Ever, But They Don’t Feel That Way – Steven Russolillo 3/8

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

How wages fell in the UK while the economy grew. Valentina Romei. Financial Times. 2 Mar. 2017.

“Between 2007 and 2015, the UK was the only big advanced economy in which wages contracted while the economy expanded. In most other countries, including France and Germany, both the economy and wages have grown.”

“Britain’s GDP went back to pre-crisis levels in the third quarter of 2013 and it is now nearly 10% larger than in the second quarter of 2008. Yet in 2014 wages were almost 10% lower than seven years before. During the same period, salaries in France and Germany grew 7%.”

“Only the US and Canada have greater flexibility in labor market regulation than the UK, according to the OECD. Thanks to a more flexible job market, people were able to find jobs quicker than in other countries. Employment expanded by 2.4% in the six years to 2013, while in France there was no job expansion and the EU as a whole experienced job losses.”

What gives…

“After the crisis, labor supply increased, but these ‘unusual increases in labor supply’ were absorbed by the market, writes the OECD in its latest country survey. Pension reform and other policies contributed to the increase in supply with a rising number of older workers and incentives to work rather than live off benefits. Meanwhile ‘sustained inflows of well-educated immigrants have boosted the working-age population,’ says the OECD.”

“Such employment expansion coincided with the loss of labor bargaining power due to the risk of unemployment and ‘slack’ remaining higher than pre-crisis levels. Unemployment, underemployment and involuntary part-time working, for example, were far above their levels in 2008. Coupled with low and falling levels of unionization, employment growth came at the expense of a fall in real wages.”

While the economy is close to full employment, instead of tight labor conditions pushing up wages, there is enough slack and labor demand that wages are soft.

Unfortunately, “inflation is likely to squeeze real wages in the next couple of years just as it did after the crisis.” Rather than higher prices for goods and services feeding into higher profits and higher wages, productivity growth has languished, so people are dealing with lower living standards.

“Between 2007 and 2015 the UK had one of the highest inflation rates among big advanced economies, largely because of high energy prices and the depreciation of the pound. Consumer prices expanded at an annual rate of over 5% at their peak in September 2011, well above the rate of expansion of nominal earnings.”

Further “employment growth was driven largely by self-employment and part-timers, while the number of full-time jobs shrank. ‘The rapid rises in employment over the past few years have been made up by a larger than usual share of low-skilled jobs which tend to be lower paid,’ say Capital Economics.”

China’s Massive Bond Market Coming to Index Near You. Anjani Trivedi. The Wall Street Journal. 7 Mar. 2017.

“China’s bond-market dreams could finally be coming true. But global investors should tread with care.”

“Citigroup announced Tuesday that mainland Chinese bonds were eligible for inclusion in its widely followed indexes of investment-grade bonds. Once included, most passive investors could end up holding Chinese bonds in some way in their portfolios. Citi says the entry will be staggered over three months given the overall Chinese market’s $9 trillion size.”

“Index inclusion is big business – and isn’t a sleep subject. Opening the world up to China, also opens the world up to a host of risks that investors haven’t quite figured out how to price.”

“Even though Beijing is seemingly freeing up its bond markets, repatriating funds remains an issue. A recently introduced currency-hedging tool helps, but details are still fuzzy. And the risk of sudden capital controls perpetually looms.”

“For China, this could mean much needed inflows into its financial markets to counter the billions of monthly outflows. Around $2 trillion of assets under management track Citi’s World Government Bond Index. That could mean inflows of up to $120 billion if China has a 5% to 6% weight, according to Goldman Sachs. ETF’s like Tokyo-listed Listed Index Fund also track the Citi World Government Gond Index as do some BlackRock government bond funds.”

To be fair, it’s hard not to include bonds from the world’s second largest economy.

“There are fundamental issues to contend with especially the market’s lack of discernment between safe and risky bonds as reflected in narrow credit spreads. Foreign presence is unlikely to instill such discipline anytime soon.”

“Concerns around a host of trading technicalities abound…. Along with adding China to its main indexes, Citi has created two new ones that cap exposure, perhaps a hint that for many, China’s inclusion is too soon.”

“Ready or not, China’s bond market is joining an important club.”

The Chinese government, but more importantly, Chinese corporates will be able to pass on their debt risks to foreign investors and the sheer mechanics of indexes create a relatively indiscriminate buyer… the proverbial can continues to be kicked down the road.

In Puerto Rico, Teachers’ Pension Fund Works Like a Ponzi Scheme. Mary Williams Walsh. The New York Times. 8 Mar. 2017.

“Puerto Rico, where the money to pay teachers’ pensions is expected to run out next year, has become a particularly extreme example of a problem facing states including Illinois, New Jersey and Pennsylvania: As teachers’ pension costs keep rising, young teachers are being squeezed – sometimes hard. One study found that more than three-fourths of all American teachers hired at age 25 will end up paying more into pension plans than they ever get back.”

“‘I think they’re really being taken advantage of,’ said Richard W. Johnson of the Urban Institute, a co-author of the research. ‘What’s so tragic about this is, often the new hires aren’t aware that they’re getting such a bad deal.'”

“The problem is magnified by the fact that the Puerto Rico teachers union – like many teachers and police unions around the country – opted out of Social Security long ago, hoping it could save both workers and the government money by not paying Social Security taxes.”

Conceptually, “pension funds are supposed to be giant, largely self-sustaining pools of money, contributed by taxpayers and often workers, that earn investment income. Over time, the money is supposed to grow enough to pay retirees. Knowing this, teachers might reasonably expect to get a pension worth more than what they invested.”

However, in Puerto Rico “the pension funds are so short of cash that money contributed by working teachers basically flows straight out to retirees. None of Puerto Rico’s current teachers can expect to get their money back, because the fund is due to run out of money in 2018, long before they retire.”

“That is, essentially, a Ponzi scheme. But this structure is legal in Puerto Rico because of a complicated series of changes in the law brought about in recent years by the island’s financial crisis.”

Back to pension programs in general, “benefits are typically backloaded. This means that teachers build up their benefits very slowly in their early years – even as they make big contributions – then speed up in middle age and earn the biggest part just before they retire.”

“But because of high turnover and other factors, relatively few teachers reach the sweet spot where they earn a pension larger than their contributions. Most change jobs or move away first, leaving behind money that subsidizes the pensions of the relative few who teach for decades.”

Regardless, pension stress resulting from largess promised in good times and a lower investment return world have led to major cuts to younger teachers in the system. “In Illinois, for example, Mr. Johnson of the Urban Institute found that a teacher hired at age 25 who worked for 35 years could earn a pension worth $1.3 million – as long as that teacher had been hired before 2011. If hired after 2011, the same teacher would earn a pension worth only $609,000, even though both groups contribute 8.4% of every paycheck.”

“‘Overall, 84% of all newly hired teachers lose money’ in Illinois, Mr. Johnson said.”

Further, eight states (Delaware, Hawaii, Illinois, Maryland, New York, North Carolina, Pennsylvania, and West Virginia) recently doubled their vesting periods (“the time a teacher must work before vesting, or earning a nonforfeitable right to a pension”) to 10 years. “That is more than three times the maximum allowed for companies.” On top of that, “three of every 10 new teachers will quit in five years or less.” Basically free money for these pension programs.

“Martin F. Lueken of EdChoice, formerly the Friedman Foundation for Educational Choice, looked at the largest school districts in each state and found three where, because of cost-cutting, newer teachers might work their whole careers without ever earning a pension worth the value of their contributions: Boston, Chicago and the northern suburbs of Minneapolis.”

For more see: NYT – The State of State Teachers’ Pension Plans – Karl Russell and Mary Williams Walsh 3/6

Other Interesting Articles

Bloomberg Businessweek

• Fed Turns to Job Hoppers as 1950s Inflation Guide Shows Its Age
• Drug Costs Too High? Fire the Middleman
• An AIDS Charity Fights Builders in L.A.
• The Big Problem With China’s Bridge and Tunnel Addiction

The Economist

• France’s next revolution – The vote that could wreck the European Union
• From worse to bad – Talk of a bad bank in India
• Los Angeles – When homeowners are given vetoes over development, they prevent it
• China’s citizens are complaining more loudly about polluted air
• Buttonwood – Interest rates and investment returns
  • “Indeed, having analyzed the data, Messrs Dimson, Marsh and Staunton reckon global investors are expecting a risk premium of 3-3.5% relative to Treasury bills – a level that is lower, not higher, than the historic average. So something does not add up. American pension funds are optimistic. Businesses are cautious. Shares are trading on very high valuations. Not all these assumptions can be proved right.”
• Taken for a ride – Second-degree moral hazard
• Poised to Pounce – Competition for private-equity deals heats up

Bloomberg – These Economies Are Getting More Miserable This Year 3/2

Bloomberg – Shale Billionaire Hamm Says Industry Binge Can ‘Kill’ Oil Market 3/8

FT – India optimistic of being coal-free by 2050 2/12

FT – Investors place derivate bet against US shopping centers 3/2

FT – Japan returns to inflation for first time since 2015 3/3

FT – Jack Bogle: ETFs have beaten hedge funds 3/4

FT – China warns on hidden local government debt risks 3/5

FT – China defense budget tops Rmb1tn for first time 3/5

FT – Macau’s regional challengers up their casino game 3/5

FT – European businesses attack China high-tech push 3/6

FT – Germany’s trade surplus sparks concern at home and abroad 3/6

FT – Norway’s $905bn oil fund flexes its shareholder muscles 3/7

FT – Global investors return to China’s bad debt market 3/7

GlobeSt – Wave of Apt. Deliveries Will Crest In 2017 3/2

NYT – Here’s the Reality About Illegal Immigrants in the United States 3/6

WSJ – Disturbing New Facts About American Capitalism – Jason Zweig 3/3

WSJ – What GM Is Paying for European Exit 3/6

WSJ – Charity Officials Are Increasingly Receiving Million-Dollar Paydays 3/6

WSJ – Short Sellers Target Mall REITs 3/7

WSJ – Miami Condo Market Cools, but a Big Project Gets Financings 3/7

WSJ – Renovate America, One of America’s Fastest-Growing Lenders, Didn’t Disclose It Made Payments to Some Borrowers 3/8

WSJ – New Force on Wall Street: The ‘Family Office’ 3/8