Tag: Interest Rates

July 1 – July 7, 2016

The bad debt in Italian banks is looking like a BIG problem. The world has become more reliant on Middle Eastern oil. Not looking so rosy for hedge fund reinsurers.

Headlines

Briefs

    • As yields the world over drop “the effective yield on 7-to-10 year investment-grade corporates was 3.19%, according to Bank of America Merrill Lynch.” But relative to everything else, that’s really quite attractive.
    • “Indeed, in the universe of investment-grade debt, U.S. corporate bonds are close to the only game in town for investors looking for any yield. BofA Merrill Lynch credit strategist Hans Mikkelsen calculates that U.S. corporate bonds account for around 12% of all investment-grade debt outstanding world-wide yet they now represent about 33% of investment-grade yield income. Put otherwise, U.S. corporate bonds generate one out of every three dollars paid out by the entire universe of investment-grade debt.“
    • “Almost 87% of Japanese government bond yields are now below zero.”
    • “Unlike other major central banks, the BOJ is a buyer at almost any price and mainly purchases government bonds, which represent almost two-thirds of negative-yielding global sovereign debt globally.”
    • “Further buying will only push yields lower. Cutting back, while helpful in the short- to medium-term, means that the BOJ has to find other Japanese securities. But, unlike Europe or the U.S., asset-backed securities and corporate bonds are hardly an option because of their relatively small market sizes.”
    • For reference, “the BOJ now holds almost 30% of its government’s bonds.”
  • Rich Miller and Steve Matthews of Bloomberg called attention to the challenge that Janet Yellen faces in regard to setting rates when the US economy is running short of labor.
    • “Seven years into the economic expansion, the U.S. is showing signs it’s running short of job seekers qualified to fill openings. The shortfall, which has been evident for some time for highly skilled workers, is spreading to workers with less education as unemployment falls further.”
    • “We are now close to eliminating the slack that has weighed on the labor market since the recession.” – Janet Yellen, Federal Reserve Chair on June 6
    • “At 4.7% in May, the jobless rate is around the level that most Fed policymakers consider to be full employment.”
  • Central Banks are putting a squeeze on the bond market according to Min Zeng and Christopher Whittall of the Wall Street Journal.
    • “A buying spree by central banks is reducing the availability of government debt for other buyers and intensifying the bidding wars that break out when investors get jittery, driving prices higher and yields lower.”
    • “Central banks themselves are having trouble finding all the bonds they need. The ECB, for example, can’t buy bonds with a yield lower than its deposit rate of minus -0.4%. As of July 1, 58% of German bonds eligible for ECB purchases traded below that level, according to Frederik Ducrozet, a senior economist at Pictet Wealth Management.”

Special Reports

Graphics

FT – Government bond yields fall to fresh record lows led by UK Gilts 7/1

FT_UK 10 year gilt yield_7-1-16

FT_US 10 yr treasury yield_7-1-16

WSJ – Debt for Cheap: U.S. Companies Can Profit from Sinking Rates – Justin Lahart 7/1

WSJ_Debt for Cheap, U.S. Companies Can Profit from Sinking Rates_7-1-16

The Big Picture – China spends more on economic infrastructure annually than North America and Western Europe combined 7/4

The Big Picture_China economic infrastructure spending_7-4-16

FT – Bad-debt warnings triggers fresh fears for Italian banks 7/4

FT_Italian banks bad debt fears_7-4-16

Visual Capitalist – This Map Shows the Average Income of the Top 1% by Location 7/6

Visual Capitalist_Avg income of top 1%_7-6-16

WSJ – Central Bank Buying Puts Squeeze on Bond Market – 7/6

WSJ_Central bank holdings of govt bonds_7-6-16

Featured

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

Bad Debt Piled in Italian Banks Looms as Next Crisis. Giovanni Legorano. Wall Street Journal. 4 Jul. 2016.

“In Italy, 17% of banks’ loans are sour. That is nearly 10 times the level in the U.S., where, even at the worst of the 2008-09 financial crisis, it was only 5%. Among publicly traded banks in the eurozone, Italian lenders account for nearly half of total bad loans.”

“Although Italy has only one bank classified as globally significant under international banking regulations – UniCredit – some analysts say bank stresses worsened by Brexit could threaten Italy’s stability and, potentially, even that of the EU.”

According to Lorenzo Codogno, former director general at the Italian Treasury, “Brexit could lead to a full-blown banking crisis in Italy. The risk of a eurozone meltdown is clearly there if Brexit concerns are not immediately addressed.”

“The profitability of Italian banks has long been among the worst in Europe, weighed down by bloated staffs and too many branches, leaving the banks with little extra capital to cover loans that go bad. Today’s low interest rates have hit Italian banks especially hard because of their heavy focus on plain-vanilla lending activities, with relatively little in fee-generating activities such as asset management and investment banking.”

“…impaired loans at Italian banks now exceed €360 billion – quadruple the 2008 level – and they continue to rise.”

“Banks’ attempts to unload some of the bad loans have largely flopped, with the banks and potential investors far apart on valuations. Banks have written down nonperforming loans to about 44% of their face value, but investors believe the true value is closer to 20% or 25% – implying an additional €40 billion in write-downs.”

“One reason for the low valuations is the enormous difficulty in unwinding a bad loan in Italy. Italy’s sclerotic courts take eight years, on average, to clear insolvency procedures. A quarter of cases take 12 years.”

“There is an epidemic, and Italy is the patient that is sickest… if we don’t stop the epidemic, it will become everybody’s problem… The shock of Brexit has created a sense of urgency.” – Pierpaolo Baretta, an undersecretary at the Italian Economy Ministry

However, European officials are loath to let the Italians use the Brexit as an impetus to gain permission to bend the rules of the banking regime that were only just established at great pains.  The Italians though are concerned “about the €187 billion of bank bonds in the hands of retail investors that would be wiped out by a bank resolution under the EU banking rules.”

IEA warns of ever-growing reliance on Middle Eastern oil supplies. Anjli Raval and David Sheppard. Financial Times. 6 Jul. 2016.

“The world risks becoming ever more reliant on Middle Eastern oil as lower prices derail efforts by governments to curb demand, the west’s leading energy body has warned.”

“Middle Eastern producers, such as Saudi Arabia and Iraq, now have the biggest share of world oil markets since the Arab fuel embargo of the 1970s.”

“Demand for their crude has surged amid a collapse in oil prices over the past two years that has cut output from higher-cost producers such as the US, Canada and Brazil.”

“Middle Eastern producers now make up 34% of global output, pumping 31m barrels a day, according to IEA data. This is the highest proportion since 1975 when it hit 36%. In 1985, when North Sea production accelerated, their share fell to as little as 19%.”

Further, the adoption of more fuel efficient vehicles has slowed since the cost of gas has come down significantly. “In the US, more than two-and-a-half times as many sport utility vehicles were being bought compared with standard cars.” – Fatih Birol, executive director of the International Energy Agency.

“Even more concerning for policymakers is China, where more than four times as many SUVs were bought, suggesting the country’s rapidly growing car culture has adopted America’s taste for larger more fuel-hungry cars.”

“Lower oil prices are proving to be bad news for efficiency improvements.” – Fatih Birol

Bottom line, “‘the Middle East is reminding us that they are the largest source of low-cost oil,’ said Mr. Birol. He said the region was expected to meet three-quarters of demand growth over the next two decades.”

“Mr. Birol said policymakers needed to impose stricter fuel efficiency targets to reduce demand, arguing it was not feasible in a world market to completely sever reliance on Middle Eastern oil.”

“US oil production will increase, but it is still an oil importer and will be for some time.” – Birol

S&P sounds alarm on hedge fund reinsurers. Alistair Gray and Miles Johnson. Financial Times. 6 Jul. 2016.

“So-called hedge fund reinsurers (HFRs) have failed to make a profit from providing reinsurance cover for more than four years, according to Standard & Poor’s.”

“S&P found that HFRs had performed considerably worse than traditional reinsurers, which have complained that the entry of new money into their sector has driven profitability down for all.”

“Conventional reinsurers tend to invest their income in conservative assets such as corporate bonds, since they do not know in advance how much they will need to pay out in claims.”

“In contrast, HFRs pursue what S&P described as ‘meaningfully risker’ investment strategies. Their assets are managed by their affiliated hedge funds. Allocations vary but include exposure to speculative-grade leveraged loans, private equity and short positions.”

“So-called combined ratio for the HFRs – claims paid and expenses incurred as a proportion of premium income 0 has been above 100 in every year since 2012, meaning a loss from underwriting.”

“Last year the ratio came in at 110.2%, compared with a profitmaking 88.6% for their conventional reinsurance peers.”

“S&P said the HFRs’ investment performance had also been ‘rough’. Overall net investment income dropped 63% from 2014 to $247m last year.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bisnow – SMU, Yale Endowments Unload Real Estate Assets Due to Cooling Markets 7/1

Bloomberg – Blackstone Tenants Get a Shot at Buying Their Rental Houses 7/4

Bloomberg – Treasuries Deliver $700 Billion Windfall to World Safety Seekers 7/6

CNBC – This private equity giant wants to give landlords millions – here’s how 6/30

FT – Mexico raises interest rates to shore up peso 6/30

FT – Zenefits agrees to halve its valuation to $2bn 6/30

FT – Puerto Rico declares moratorium on debt payments 6/30

FT – Cash-starved Zimbabwe closes in on IMF deal to clear debts 7/6

MarketWatch – This economist thinks China is headed for a 1929-style depression 7/1

NYT – Italy’s Plan for Banks Could Roil Europe 7/6

Vanity Fair – Are We At The Start Of  A Tech World War? 7/6

Wharton – The Case for ‘Regrexit’: Why Britain Won’t Really Leave the EU 6/30

WSJ – Manhattan Apartment Sales Sputter 6/29

WSJ – Why Vanke Sank After Its Wake-Up Call 7/4

WSJ – Foreign Interest in U.S. Homes Cools 7/6

 

June 10 – June 16, 2016

The shipping world is about to change with the opening of new Panama Canal locks. U.S. shale reserves: now you see me, now you don’t.

Headlines

Briefs

    • “About 40 trillion yen ($365 billion) in cash has piled up in homes across Japan, according to a Dai-ichi Life Research Institute estimate – equivalent to about 8% of GDP.”
    • “What it means for 40 trillion yen to be sleeping under mattresses is that the deflationary mindset is deeply rooted, and Japanese have become hypersensitive to risk.” – Hideo Kumano, chief economist at Dai-ichi Life
    • This of course has been a boon to safe manufacturers, with “sales of safes in March were up 86% from a year earlier, the highest level ever, according to government data.”
    • “The People’s Bank of China has spent about $473bn in foreign exchange reserves since it surprised global markets last August by changing the way it sets its daily guidance rate for the currency, according to Financial Times estimates based on official data.”
    • As a central bank official so aptly put it “the most important factor is confidence, both globally and within China. The cost of intervention in terms of reserves has been high but this policy can’t be evaluated just in terms of numbers. Once confidence is lost it can’t be easily restored. Then a lot of bad things can happen.”
  • Shawn Donnan and Tom Mitchell of the Financial Times highlighted how concern over China’s corporate debt balances is spreading, even to the likes of the IMF.
    • “China’s corporate debt risks sparking a bigger crisis if the authorities fail to tackle it, the International Monetary Fund has warned.”
    • “Mr. Lipton (David Lipton – the IMF’s number 2) highlighted the state-owned enterprises, which he said were responsible for 55% of the corporate debt pile despite representing 22% of economic output and which ‘are essentially on life support.'”
    • “While concluding the issue is ‘manageable’, he warned that a recent IMF estimate that put the potential losses for China’s banks from bad corporate loans at 7% of GDP was a conservative estimate that excluded exposures in the ‘shadow banking’ sector.”
  • With declining investment yields the world over and an abundance of negative government debt, Attracta Mooney of the Financial Times points to how sovereign wealth funds have been piling into real estate to boost returns.  As an aside, Yahoo Finance drew attention to a recent Urban Land Institute PricewaterhouseCoopers survey that indicated that many U.S. real estate pros are not as enthusiastic about U.S. property as their foreign counterparts.
    • “State-backed investment vehicles, which are used by countries either to save for a rainy day or to provide money for future generations, increased their allocations to property by 29% last year, according to research looking at 77 sovereign funds with $8tn in assets.”
    • “The push into property comes as interest rates have reached record lows, forcing investors into alternative asset classes in the search for better returns.”
    • “Sovereign wealth funds posted average returns of 4.1% last year, despite having a combined target of 5.9%, according to Invesco, the asset manager that carried out the research.”
    • “The study did not provide a breakdown of returns by asset class, but Norway’s fund said in March it had achieved 10% returns from its investments in property last year. Fixed income, in contrast, returned just 0.3%.”
    • On an allocation basis, there is plenty of room for increased real estate commitments “property still accounts for a tiny proportion of sovereign funds’ portfolios: 6.5% last year, up from 4.1% in 2014, according to Invesco.”
  • Data is data. Sometimes it’s good and other times not so much. Further, interpretation varies and can be misleading as the Economist points out in why the weak jobs report belies the resilience of the American economy.
    • Despite the weak jobs report, things aren’t that bad in America. “Personal consumption, adjusted for inflation, is up by 3% in the past year, having surged in April.”
    • The University of Michigan’s consumer-confidence index has been exceeding the average held during the 2003-2007 boom. “According to a recent Fed survey, 69% of Americans say they are ‘doing okay’ or ‘living comfortably’, up from 62% in 2013.”

Special Reports

Graphics

FT – Stocks under pressure as bond yields rise 6/10

FT_JGB 10 year yield_6-10-16

FT – China spent $470bn to maintain confidence in renminbi – Gabriel Wildau and Tom Mitchell 6/12

FT_China spent $470bn to maintain confidence in renminbi_6-12-16

Mauldin Economics – Hot Summer Economic Weirdness – John Mauldin 6/11

Mauldin Economics_Race to Negative Bond Yields_6-11-16

WSJ – German Benchmark Bond Yield Dips Below Zero 6/14

WSJ_German 10-year bund drops below zero_6-14-16

The Big Picture – Foreigners selling US equities at record pace – Torsten Slok 6/15

Big Picture_Foreigners losing confidence in US equities_6-15-16

WSJ – China’s Suddenly Shrinking Corporate Bond Market 6/15

WSJ_China’s Suddenly Shrinking Corporate Bond Market_6-15-16

Visual Capitalist – The Shift to a Cashless Society is Snowballing – Jeff Desjardins 5/17

Visual Capitalist_Going Cashless Around the World_5-17-16

Bloomberg – China Dumping More Than Treasuries as U.S. Stocks Join Fire Sale 6/15

Bloomberg_China dumping US Stocks_6-15-16

Featured

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

Panama Canal, the Reboot. Alex Nussbaum, Naureen Malik, and Christopher Cannon. Bloomberg. 2 Jun. 2016.

“Nine years of construction work, at a cost of more than $5 billion, have equipped the Panama Canal with a third set of locks and deeper navigation channels, improvements that will double its capacity. When the new locks slide open for the first time in late June, the reverberations will be felt at Asian gas terminals, on Great Plains farms, and in ports from Long Beach, Calif., to Santiago, Chile.”

Bloomberg_Panama Canal, the reboot_6-2-16

Why Billions in Proven Shale Oil Reserves Suddenly Became Unproven. Asjylyn Loder. Bloomberg. 14 Jun. 2016.

“Ultra Petroleum Corp. was a shale success story. A former penny stock that made the big leagues, it was worth almost $15 billion at its 2012 peak.”

“Then came the bust. Almost half of Ultra’s reserves were erased from its books this year. The company filed for bankruptcy on April 29 owing $3.9 billion.”

“Proven reserves – gas and oil resources that are among the best measure of a company’s ability to reward its shareholders and repay its debts – are disappearing across the shale patch. This year, 59 U.S. oil and gas companies deleted the equivalent of 9.2 billion barrels, more than 20% of their inventories, according to data compiled by Bloomberg.  It’s by far the largest amount since 2009, when the Securities and Exchange Commission tweaked a rule to make it easier for producers to claim wells that wouldn’t be drilled for years.”

For reference, after the 2009 rule change “reserves surged 67%” in the following five years based on the 53 companies with records that far back.  “Almost half the gains came from wells that existed only on paper.”

“Drillers face pressure to keep reserves growing. For many, the size of their credit line is tied to the measure.” Thing is that “there are two ways to increase reserves: buy more or find more.  Fracking made it easier to do the latter, and the industry lobbied the SEC to count more undeveloped acreage as proved reserves…”

“The SEC agreed, with two key limits. First, the wells must be profitable to drill at a price set by an SEC formula. The companies got a temporary reprieve for 2014 because the SEC number was about $95 a barrel even though crude had plummeted to less than $50 by the time results were reported in early 2015.”

“That advantage has disappeared.”

“The SEC also requires that undeveloped wells be drilled within five years of being added to a company’s books.”

Other Interesting Articles

The Economist

Bloomberg – Earth’s Heat Extends Unprecedented Streak of Shattered Records 6/16

FT – Nigerian economy drops further into freefall 6/8

FT – Chinese tourists search far and wide for Japan’s rare whiskies 6/9

FT – The hedge fund fee structure consumes 80% of alpha 6/11

FT – Why hasn’t the productivity crisis caused a bear market (yet)? 6/12

FT – Tax rises on foreign homebuyers in Australia 6/13

FT – Japanese government bond yields fall to fresh lows 6/13

FT – MSCI A-shares denial sends Beijing clear message 6/15

FT – Gold is no safe port in this storm 6/15

FT – Uber points to profits in all developed markets 6/16

Herald News – Wood tower at the University of British Columbia a game-changer for construction 6/14

NYT – A Russian Cybersleuth Battles the ‘Dark Ages’ of the Internet 6/10

NYT – At the Birthplace of a Graft Scandal, Brazil’s Crisis Is on Full Display 6/10

NYT – The Overinflated Fear of Being Priced Out of Housing (Robert Shiller) 6/10

REBusiness Online – French Billionaire Buys Manhattan Office, Retail Building from Thor Equities for $525M ($5,250 PSF) 6/13

WSJ – These Chinese Developers Shed Property in Name Only 6/10

WSJ – China’s Banks: How Fixing Problems Can Make Them Worse 6/10

WSJ – China Economy: That Sputtering Sound Returns 6/13

WSJ – MSCI and China: Why There’s No Fear of Missing Out 6/15

Yahoo Finance – Real estate pros see recession by 2017, survey shows 6/16

June 3 – June 9, 2016

The volume of Chinese wealth-management products is becoming unwieldy. Banks have had enough of this negative interest rate nonsense.

Headlines

Briefs

    • “China today boasts roughly five workers for every retiree. By 2040, this highly desirable ratio will have collapsed to about 1.6 to 1.”
    • “At the same time, the number of Chinese older than 65 is expected to rise from roughly 100 million in 2005 to more than 329 million in 2050 – more than the combined populations of Germany, Japan, France, and Britain.”
    • “With the number of working-age Chinese men already declining – China’s working-age population shrank by 4.87 million people last year – labor is in short supply.”
    • “By hastening and amplifying the effects of this decline, the one-child policy is likely to go down as one of history’s great blunders.”
    • “As a result, by 2020, China is projected to have 30 million more bachelors than single women of similar age.”
    • “By the end of the century, China’s population is projected to dip below 1 billion for the first time since 1980. At the same time, America’s population is expected to hit 450 million.”
    • A May 26 auction of non-performing loans (NPLs) was met with tepid reception and was primarily an event of banks shuffling bad debt between each other.
    • Thing is, if this strategy doesn’t catch on with private sector investors, “a failure to purge lenders of their NPLs may fuel expectations for a government-led bailout, which Standard Chartered Plc estimates could cost as much as $1.5 trillion.”
    • According to Bloomberg Intelligence, “China has about $2.4 trillion of corporate debt at risk of default.”
    • Hopefully the debt products being sold become more transparent and easier to asses from a risk perspective so that the private sector can reasonably jump in.

Special Reports

Graphics

FT – Argentina set to tumble 22 places on global wealth list – Steve Johnson 5/27

FT_Latin America GDP growth_5-27-16

Featured

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

Long Shadow Hangs Over China’s Banks. Anjani Trivedi. Wall Street Journal. 6 Jun. 2016.

“The growth of off-balance sheet WMPs (Wealth Management Products) is exploding, with issuance rising 7.3 trillion yuan ($1.1 trillion) last year, up nearly three-quarters from the previous year, according to Charlene Chu of Autonomous Research. That is equivalent to nearly 40% of China’s 19 trillion yuan credit growth in 2015, including debt issuance under a local government bond-swap program. And while customers are told most WMPs aren’t principal guaranteed, that distinction may be shaky in China’s financial system rich with moral hazard.”

While this isn’t the first time that debt issuance has surged from WMPs; however, “the structures this time around are increasingly complex. Investors in China’s interbank market – including banks – took up almost a third of WMP buying last year, up from 2% the previous year. Most of that is from WMPs essentially buying other WMPs, creating an opaque layering of obligations, Ms. Chu said, echoing the collateralized debt obligations made famous during the U.S. housing bust.”

“Then there is duration risk. Over three quarters of these investment products mature within six months, putting constant repayment pressure on banks. To meet these products’ yield demands, WMPs have been heavy buyers in China’s rip-roaring bond market. A sustained reversal of the bond market could trigger pain on WMPs.”

WSJ_Growth of WMPs in China_6-6-16

Negative rates stir bank mutiny. James Shotter and Claire Jones. Financial Times. 8 Jun. 2016.

“Lenders in Europe and Japan are rebelling against their central banks’ negative interest rate policies, with one big German group going so far as to weigh storing excess deposits in vaults.”

“The central bank policies have hit bank profitability in both regions and German banks have been vocal in criticizing Mario Draghi, European Central Bank president, accusing him of punishing savers and undermining their business models. The policy cost German banks €248m last year, according to the Bundesbank.”

“Japanese banks have been more muted but Bank of Tokyo Mitsubishi UEJ has become the first leading lender to break ranks, confirming it is considering giving up its primary dealership status for sales of Japanese government bonds.”

“The more central banks think that they can violate the zero-bound, the more likely it is that banks will look at ways to limit their costs. And that means they will hold more cash if they can find efficient means to do so.” – Adalbert Winkler, professor at the Frankfurt School of Finance and Management.

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bisnow – WeWork to Halt Hiring, Make Major Cuts to Staff 6/6

FT – Crisis-era tremors shake property funds 6/2

FT – Emerging markets to slow as convergence theory takes hold 6/2

FT – The period of maximum danger for bond investors is yet to come 6/6

FT – Saudi Arabia considers income tax for foreign residents 6/7

FT – Bank of Korea unexpectedly cuts rates to 1.25% 6/8

FT – Bill Gross warns over $10tn negative-yield bond pile 6/9

NYT – Toxic Fish in Vietnam Idle a Local Industry and Challenge the State 6/8

WSJ – Bank loans: Why it Feels Like 2008 All Over Again in Asia 6/6

WSJ – How to Time a Chinese Banking Tipping Point (2019) 6/7

WSJ – China’s Property Prices Rebound, but Stocks Tell Another Story 6/7

WSJ – Rock-Bottom Bond Yields in Europe Hit All-Time Lows 6/8

WSJ – REIT Surprise: How Real Estate Crushed the Stock Pickers 6/8

Yahoo Finance – JPMorgan: The odds of a recession starting in 12 months has hit a high 6/3

May 27 – June 2, 2016

Loans taken out by commodity rich countries in the good old days to be paid back in oil have become a major liability. The financial outlook for Chinese firms isn’t looking so good. Negative yields on corporate bonds – hey, it’s better than what you can get for the government stuff.

Headlines

Briefs

    • “A third of the units in some newly built high-rises are back on the market, though most are listed for more than their owners paid in the pre-construction phase. At the current sales pace, it would take 29 months to sell the 3,397 condominiums available in the downtown area, according to South Florida development tracker CraneSpotters.com.”
    • “8,000 units are under construction and nine towers were completed since the end of 2013.”
    • “Condo purchases from January through April slid 25% from a year earlier, while the average price fell 6% on a per-square-foot basis, CraneSpotters data show.”
    • “The concern is we’re in a price-discovery phase, and the prices people are trying to get for their condos is a lot higher than the market will bear. That may signal a coming price correction.” – Andrew Stearns, founder of StatFunding.com, a provider of residential mortgages for foreign nationals.
  • So what do you do if you’re a pension fund (or an individual investor for that matter) that ‘needs’ to achieve a certain rate of return (if you don’t want to save more or increase your unfunded liabilities)… as Timothy Martin in the Wall Street Journal points out, you pile on the risk and cross your fingers.
    • “What it means to be a successful investor in 2016 can be summed up in four words: bigger gambles, lower returns.”
    • “In 1995, a portfolio made up wholly of bonds would return 7.5% a year with a likelihood that returns could vary by about 6%, according to research by Callan Associates Inc., which advises large investors. To make a 7.5% return in 2015, Callan found, investors needed to spread money across risky assets, shrinking bonds to just 12% of the portfolio. Private equity and stocks needed to take up some three-quarters of the entire investment pool. But with the added risk, returns could vary by more than 17%.”
    • Brazil’s economy contracted 5.4% year-over-year leading economists to “say the once high-flying emerging market is suffering a deep recession that is starting to show characteristics of a depression.”
    • “GDP contracted for the fifth straight quarter in the three months to March and has declined or been virtually flat in eight of the past 10 quarters.”
    • “Goldman Sachs economist Alberto Ramos said a depression was defined as a recession that lasts eight or more straight quarters in which there is a decline in real GDP of 10% or more.”  Well, according to Ramos, “Brazil’s recession has been running for two years and has reduced the size of the economy to the level of late 2010 with a decline in real per capita GDP of 9%.”
    • Thing is it won’t be easy to turn this ship around.  “Marcos Casarin of Oxford Economics predicted it would take 10 years for Brazil to recover the level of per capita GDP of 2013.”  That’s even taking into consideration the government’s new economic team that has decent credibility.
    • Hopefully the Summer Olympics help… ole, ole, ole, ole…

Special Reports

Graphics

Bloomberg – Miami’s Condo Frenzy Ends With Inventory Piling Up in New Towers – Prashant Gopal 5/26

Bloomberg_Downtown Miami Condo Boom cooled_5-26-16

FT – Big oil groups raise net debt by a third to cope with low prices – Ed Crooks 5/29

FT_Big oil, bigger borrowing_5-29-16

FT_Net debts of largest US and Euro oil cos_5-29-16

WSJ – Pension Funds Pile on Risk Just to Get a Reasonable Return – Timothy Martin 5/31

WSJ_Rolling the dice on investment returns_5-31-16

FT – China – FTCR Underground Lending Index falls after credit boom 5/31

FT_China Underground Lending Index_5-31-16

FT – Earnings fall betrays shaky state of China’s economy – Yusho Cho and Kenji Kawase 5/31

FT_Chinese profits down_5-31-16

FT – Brazil’s GDP reveals depths of recession – Joe Leahy and Samantha Pearson 6/1

FT_Brazil's economy in crisis mode_6-1-16

Featured

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

Debt repayments in crude cripple poorer oil producers. Libby George and Dmitry Zhdannikov. Reuters. 24 May 2016.

“Poorer oil-producing countries which took out loans to be repaid in oil when the price was higher are having to send three times as much to respect repayment schedules now prices have fallen.”

“Angola, Africa’s largest oil producer has borrowed as much as $25 billion from China since 2010, including about $5 billion last December, forcing its state oil firm to channel almost is entire oil output toward debt repayments this year.”

“This year Angola, Nigeria, Iraq, Venezuela and Kurdistan are due to repay a total of between $30 billion and $50 billion with oil…”

“Repaying $50 billion required only slightly over 1 million barrels per day (bpd) of oil exports when it was trading at $120 per barrel but with prices of around $40, the same repayment would require exports of over 3 million bpd.”

“All of those oil nations – Angola, Nigeria, Venezuela – have taken money for survival but haven’t got any money left for investments. That is very damaging to their long-term growth prospects. People tend to look at current production volumes but if you have committed your entire production to China or other buyers under loans – then you cannot invest to keep growing and won’t benefit from higher prices in the future.” – Amrita Sen from Energy Aspects, a think-tank.

“China has also become Venezuela’s top financier via an oil-for-loans program which since 2007 has funneled $50 billion into Venezuelan coffers in exchange for repayment in crude and fuel, including a $5 billion deal last September.”

“While details of the loans have not been made public, analysts from Barclays estimate Caracas owes $7 billion to Beijing this year and needs nearly 800,000 bpd to meet payments, up from 230,000 bpd when oil traded at $100 per barrel.”

“Iraq is trying to renegotiate contracts for investment and development of new oil fields that it has with companies including Exxon, Shell and Lukoil. It was supposed to repay the companies $23 billion this year with oil but is now arguing that it will only have enough crude to repay $9 billion.”

“In contrast, OPEC’s Gulf Arab members – Saudi Arabia, the United Arab Emirates, Kuwait and Qatar – have very few joint ventures with oil companies, do not have pre-payment deals with China and do not need to borrow from trading houses.”

“It may ultimately be mounting supply disruptions in stressed states, rather than collective cartel action, that causes an accelerated market rebalancing.” – Helima Croft, head of commodity strategy at RBC Capital

Chinese firms’ financial outlook worsens at record rate. James Kynge. Financial Times. 26 May 2016.

“The share of rated issuers in China with a negative outlook bias…has increased to a record high of 69%,” according to a Moody’s report authored by Michael Taylor, Moody’s chief credit officer for the Asia Pacific region, and colleagues. This proportion was up from 15.7% at the end of last year and 33.3% at the end of March this year.”

“The previous peak proportion of rated Chinese debt issuers with a “negative outlook bias” was 45.5%, a level hit in May 2009 as the Chinese economy suffered in the aftermath of the financial crisis.”

FT_Negative ratings basis for Chinese issuers_5-26-16

“But, in spite of the growing worries, Moody’s said in its report that China had the capacity to avoid a financial unravelling.”

As to the reasons for the spike in the negative outlook, 1) the amount of capital now required to generate growth, 2) increasing debt levels, and 3) returns on assets are on the decline.

“In 2014, 6.3 units of capital investment were required to generate a unit of growth, the highest level since the 2008 crisis and far above the pre-crisis 2.9 times seen in 2007.”

FT_Declining productivity for capital investment in China_5-26-16

In regard to debt, “the rising interest burden from elevated debt levels could eventually crowd out productive investment, reducing the economy’s long-run growth potential” according to the Moody’s report.

As to returns on assets, “overall state-owned enterprises (SoE) returns on assets slipped to 2.9% in 2015 from a post-crisis high of 5.9% hit in 2010.”

FT_Declining profit margins for Chines cos_5-26-16

Corporate bonds join negative yield club. Eric Platt and Gavin Jackson. Financial Times. 2 Jun. 2016.

“More than $36bn of corporate bonds with a short-term maturity currently trade with a sub-zero yield…”

“The yield on a host of short-term paper sold by groups including Johnson & Johnson, General Electric, LVMH Moet Hennessy Louis Vuitton and Philip Morris now trade below zero in the secondary market. While no corporate bond has yet been sold with a negative yield, recent debt offerings from French pharmaceuticals market Sanofi and consumer goods conglomerate Unilever were issued as zero coupon securities.”

“Separate data tracked by Tradeweb put the value of negative yielding corporate bonds at $380bn – a figure that includes euro denominated bonds maturing in the next year that are not captured by some of the main index providers. The total sum could be greater when counting bonds issued in Swiss franc or Japanese yen, data provider Markit noted.”

As Iain Stealey, a portfolio manager with JPMorgan Asset Management so aptly put it “as bonds get to a shorter and shorter maturity, you’ll see more trade with a negative yield. Everything is relative and zero is not the lower bound anymore.”

“As a dealer, you are happy to bid through zero because you know the ECB (European Central Bank) will keep buying.” – Barnaby Martin, head of European credit strategy at Bank of America Merrill Lynch

Bottom line, “the central bank has said it will be permissible for it to purchase investment grade corporate bonds so long as they yield more than the ECB’s deposit rate of minus 0.4%.”

“Companies have sought to take advantage of the drop in borrowing costs. More than $1tn of corporate debt has been issued globally since the year began, the fourth consecutive year bond sales crossed that threshold by the start of June, according to Dealogic.”

“Maybe a highly-rated company can issue a two or three year bond with a zero coupon, but if they can issue a 10-year bond with a 1% coupon, that might be a better long-term relative value.” – Marc Fratepietro, head of Americas investment grade debt capital markets at Deutsche Bank

Other Interesting Articles

The Economist

Bloomberg – Apartment Owners Fall as NYC, San Francisco Rents Seen Soft 6/1

Bloomberg – Hilton Property Spinoff to Create Park Hotels & Resorts REIT 6/2

FT – Malaysia letters deepen mystery over fate of 1MDB cash 5/27

FT – Age survey underlines pressures on Japan 5/28

FT – Collusion keeps debt problems at bay in China’s private sector heartland 5/29

FT – Abe rolls dice on delay to Japan sales tax rise 5/30

FT – US peer-to-peer lending model has parallels with subprime crisis 5/30

FT – Russian and Saudi investors cut US assets 5/31

FT – Chinese students ‘brainwashed by western theories’, say scholars 6/1

InvestmentNews – Report says REIT changes proposed by AR Global would remove investor protections 5/31

NYT – In China, Homeowners Find Themselves in a Land of Doubt 5/31

WSJ – U.S. Home Prices Jump as Supply Pinch Plays Out 5/31

WSJ – China’s Real-Estate Firms Rush to Tap Capital Markets 5/31

 

May 13 – May 19, 2016

Remember, crises end (oil prices most likely won’t stay low forever).

Headlines

Briefs

    • “The flattening in the yield curve suggests longer-term borrowing costs are moving closer to shorter-term costs, and signals investor concerns about the longer-term outlook for the economy.”
    • “And then of course there is the matter of historic precedence: The 83-month economic expansion (assuming the economy expanded in April and May) is the fourth longest on record going back to 1857, data from the US National Bureau of Economic Research show. It is also far longer than the median 30 month expansion over the same period.”
    • Moody’s downgraded its rating for Saudi Arabia one notch from Aa3 to A1.  It’s the first rating downgrade by the company since it began rating the kingdom two decades ago.  The new rating puts Saudi Arabia’s credit on par with Japan.
    • Standard & Poor’s and Fitch have already made similar moves.
    • “Bankers believe the kingdom is likely to start issuing international bonds this year, after agreeing to a $10bn loan with lenders, as it seeks to slow a sharp fall in its foreign reserves to $576bn. Moody’s forecasts reserves declining to $460bn by 2019.”
    • “Total external debt is expected to rise to 30% of GDP by 2018 and to about 40% by the end of the decade, Moody’s estimated.”
    • “In recent years a tide of Chinese money has hit global property markets, with buyers from the country now the largest single group of foreign investors in residential property in the US, UK and Australia.”
    • “But after inflows of $110bn into US real estate between 2010 and 2015, investment in residential American property is expected to drop in the next two years, according to the report by the US-based Asia Society and the Rosen Consulting Group.”
    • Bottom line, “…China is still in foreign exchange preservation mode, and is going with a tooth comb through capital outflows.” – Frederic Neumann, co-head of Asian Economic Research at HSBC
  • James Kynge of the Financial Times called attention to the perhaps unknown reality that China has become the global leader in financing developing economies.
    • “Two Chinese policy banks – the China Development Bank (CDB) and the Export-Import Bank of China – had outstanding loans to overseas borrowers amounting to an estimated $684bn at the end of 2014, just short of the $700bn owed to the six western-backed multilateral development institutions.”
    • “In terms of individual lending institutions, the CDB has overtaken the World Bank as the world’s biggest provider of international development finance with estimated outstanding overseas assets of $375bn at the end of 2014.”
  • Time to safeguard your hard currency in Zimbabwe again as the Economist reports.
    • “Zimbabwe finally tamed inflation in 2009, when it abandoned the Zim dollar and started using American dollars and other foreign currencies instead. (It converted bank balances to US dollars at a rate of $1 for every 35 quadrillion Zim dollars.)”
    • Well, “this time it insists it is not bringing back the reviled ‘new’ Zim dollar, but is printing notes that are ‘backed’ by some $200m that Zimbabwe has borrowed from the African Export-Import Bank.”
    • Clearly to the government doesn’t want a run on the banks, so “banks have had to restrict dollar withdrawals, in some cases to as little as $20 a day. The last bout of hyperinflation wiped out savers and pensioners. Savers are braced to be robbed again.”

Special Reports

Graphics

FT – Global equities suffer investor flight – Eric Platt 5/13

FT_Global equity outflows_5-13-16

FT – Crude soothsayers should recall cautionary tale of ‘Peak Oil’ – John Authers 5/13

FT_Oil supply and demand_5-13-16

Reformed Broker – Global Ageing Stats Will Blow Your Mind – Josh Brown 5/15

Reformed Broker_Global Aging_5-15-16

FT – Chinese credit growth slows as leadership warns of over-leverage – Yuan Yang and Gabriel Wildau 5/13

FT_China credit growth slows_5-13-16

FT – China becomes global leader in development finance – James Kynge 5/17

FT_China becomes leader in development finance_5-17-16

Featured

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

Crude soothsayers should recall cautionary tale of ‘Peak Oil’. John Authers. Financial Times. 13 May 2016.

Take caution when adjusting your narratives to fit the facts.  Just because oil is low today, that doesn’t mean that they will remain so forever.  Of the interesting narratives in the zeitgeist about the future of oil is the one posited by geopolitical strategist and former diplomat Peter Zeihan.

“He suggests that oil will cease to be a global market. The US has achieved self-sufficiency in oil, which means that it does not have to be dragged into the next conflict in the oil producing regions. The availability of shale will put a ceiling on oil prices, not far above their current level.”

“Elsewhere, this will drive the incentive for conflict, as oil producers are hurting and fighting for market share. As conflicts resume – whether between Iran and Saudi Arabia, or between Russia and its neighbors – supply will grow erratic, leading to price spikes. Without US intervention to stop prices rising, the rest of the world could see more expensive oil.”

“The ripples would be global. Mr. Zeihan pointed out that China, Japan, Taiwan and South Korea, all dependent on oil imports, are geographically far removed from any oilfields. They risk being drawn into conflict with each other, as they compete to send navies to escort tankers all the way home.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Burbank Sees U.S. Recession, China Devaluation Within Year 5/10

Bloomberg – U.S. Discloses Saudi Holdings of Treasuries for First Time 5/16

FT – Demise of Brazilian leftism will reverberate across the Americas 5/12

FT – Apple invests $1bn in China Uber rival Didi Chuxing 5/13

FT – Deflation – the elephant on your smartphone 5/13

FT – A billion prices can’t be wrong 5/13

FT – GAAP’s never been holy writ – just ask Silicon Valley 5/13

FT – Goldman Sachs emerges as growing natural gas player 5/15

FT – ‘China’s Future’, by David Shambaugh 5/15

FT – Brent crude extends rally to near $50 on supply fears 5/16

FT – Buyout firms’ secondary market is of prime concern 5/16

FT – Dell bonds draw $85bn in investor orders 5/17

FT – Nigeria under fire for not tying fuel price and currency reform 5/17

WSJ – Retail Troubles: It Isn’t Just About Amazon 5/13

WSJ – Amazon to Expand Private-Label Offerings – From Food to Diapers 5/15

WSJ – Flood of Foreign Cash Flattens Yield Curve 5/17

 

April 1 – April 7, 2016

The virtuous cycle of Chinese real estate development. Global liquidity trap. What’s driving the China M&A boom?

In an effort to ease readability and to assist with navigation of the weekly posts I have updated the format this week.  I am removing the featured articles/themes from the introductory paragraph – so there may at times not be an introductory paragraph, rather I will get right into Headlines (article links with a headline of what the article is about), followed by Briefs (currently featured as the “other items” section), Special Reports, Graphics, Featured (the featured themes/articles from the week), and will conclude with the Other Interesting Articles.  Happy readings.

Headlines

Briefs

    • “The IMF predicts that inflation will be 720% in Venezuela this year, a figure Zimbabwe hit in 2006. By 2008 Zimbabwe was racked by hyperinflation so crippling that beggars who were offered billion-Zimbabwe-dollar bills would frown and reject them.”
    • “Suppliers, rather than giving goods away at the official price, prefer to sell them on the black market.”
    • In the case of a tanker of subsidized gasoline, “you can sell the cargo legally in Venezuela for $100, or drive across the border to Colombia and sell it for $20,000. The pitifully paid border police will be easy to square.”
    • “By the most overvalued official exchange rate, ten bolivares are worth one American dollar. On the black market, the same dollar fetches 1,150 bolivares. Zimbabwe abandoned its worthless currency not long after monthly inflation hit 80 billion percent in November 2008.”
  • Konrad Putzier of The Real Deal illustrated the growing cash piles of private real estate funds and their lack of placement opportunities.
    • “As of March, private real estate investment funds worldwide had $231 billion in aggregate dry powder – or capital commitments from fund investors ready to be spent – according to research firm Preqin. That’s the highest figure in history and a 10% increase since December.”
    • “Dry powder has grown in part because fund managers are having an increasingly difficult time finding profitable investments – not just because they are raising huge sums from investors.”
    • “In a year-end Preqin survey, 56% of fund managers polled said they see finding attractive investment opportunities as their biggest challenge – far ahead of raising funds (27%).”
    • 2015 was the year of the unicorn, 2016 may be the year of the dead unicorn (private companies with valuations in excess of $1bn).
    • In late 2013 there were 39 unicorns (a phrase introduced by Aileen Lee, founder of Cowboy Ventures – a venture capital firm), now there are 156 globally “with a cumulative valuation of $550bn, according to CB Insights.”
    • Interesting thing is growing investment amounts by non-traditional VC investors, specifically large money managers like Fidelity and BlackRock.  So called “crossover investments in private technology companies rose 51% last year, to more than $40.9bn across 800 deals, CB Insights data show.”
    • While crossover investments still make up a small portion of the VC funds in private companies, the question is whether the investors in these fund managers are equipped for VC investing?  “58 tech start-ups suffered “down rounds” since the start of 2015.” Not to mention the lack of liquidity in these investments.
    • Natural gas goes through two primary seasons, an “injection season” when gas is put into storage during the warmer months of the year and a “withdrawal season” when gas is drawn down for use during the winter months for heating and the like.
    • Well two things have happened, 1) record amounts of gas is being produced, and 2) it’s been a lot warmer than usual during the winter months.
    • “The problem is that there is so little room to put gas between now and November. On Thursday, with one week to go in withdrawal season, the amount in underground storage was at an all-time record of 2.47 trillion cubic feet, some 52% higher than the five-year average. That is a whopping trillion cubic feet more than a year ago.”
    • “Last year, so much excess gas was produced in the following seven months that storage reached its theoretical limit. If this year is like 2015, then storage might be full by the middle of August. Gas would have nowhere to go, and producers would have to “shut in” production or sell it for nearly nothing until heating demand appears.”
    • “The biggest source of fresh cash in American equities isn’t speculators or exchange-traded funds – it’s companies buying their own stock, by a 6-to-1 margin.”
    • Companies have “executed about $550 billion of buybacks last year, according to data compiled by S&P Dow Jones Indices. That compares with a net $85 billion of deposits by customers of mutual and exchange-traded funds, the biggest gap since 2012.”
    • “Peer-to-peer lenders, who raise money from investors and then lend it out at higher interest rates, made 924 million yuan ($143 million) in down-payment loans in January, more than three times the amount made in July, according to Shanghai-based consultancy Yingcan.”
    • “Agents say these loans can attract annual interest rates of up to 24%.”
    • “Trying to reduce housing inventory by encouraging individuals to increase borrowing is a dangerous experiment. Enormous risks are lurking behind the surging property prices in first-tier cities.” – Ming Zhang, a senior economist at the Chinese Academy of Social Sciences, a government think tank.
    • “Industrywide, nonperforming loans rose to 1.67% of total loans last year from 1.25% in 2014, according to official data. But analysts estimate the true ratio this year could be 8% or more. In the U.S., 14.6% of subprime loans made in 2005 defaulted, according to the Federal Reserve Bank of Chicago.”
    • “Steven Woods of Moody’s, the credit rating agency, says the entire US oil industry is under financial stress with prices at today’s levels.”
    • “At $40, the industry doesn’t work. Companies can’t earn an adequate return on capital.” – Mr. Woods
    • “The number of rigs drilling for oil and gas in the US has dropped 77% since September 2014, falling a further 14 last week to 450, the lowest level since the data were first collected in 1940.”
    • “To stabilize total US production and stop it falling, oil would need to be about $40 to $50 a barrel, he adds. To go back to the boom years of 2012-2014, when the US was adding about 1m barrels a day of additional supply every year, oil would need to be more than $80.”
    • “The shale revolution will not be reversed; in fact, the technology is continuing to advance. But every revolution needs to be followed by a period of consolidation, and this one is no different. The high-growth period of the industry’s history is over, perhaps for a long time.”
    • “Government subsidies have helped wind and solar get a foothold in global power markets, but economies of scale are the true driver of falling prices: The cost of solar power has fallen to 1/150th of its level in the 1970s, while the total amount of installed solar has soared 115,000-fold.”
    • “Just since 2000, the amount of global electricity produced by solar power has doubled seven times over. Even wind power, which was already established, doubled four times over the same period. For the first time, the two forms of renewable energy are beginning to compete head-to-head on price and annual investment.”
    • “The International Consortium of Investigative Journalists (ICIJ) this weekend went public with its findings that the firm (Mossack Fonseca) had, wittingly or unwittingly, helped clients evade or avoid tax, launder money or mask its origins. More astonishing than their methods, which are well known, was the scale of activity and the people involved. The 2.6 terabytes of data are thought to contain information about 214,500 companies in 21 offshore jurisdictions and name over 14,000 middlemen (such as banks and law firms) with whom the law firm has allegedly worked.”
  • Hannah Kuchler of the Financial Times covered Facebook’s plan to expand its live streaming service.
    • Here is a link from the horse’s mouth.
    • Just imagine how much content Facebook is going to put out in the near future. “Live is like having a TV camera in your pocket. Anyone with a phone now has the power to broadcast to anyone in the world.” – Mark Zuckerberg, founder and chief executive of Facebook.
    • This is a game changer. Think the Kardashian’s get too much play, you ain’t seen nothing yet.

Special Reports

Graphics

The Real Deal – Private real estate funds have a record $231B to spend – but few places to put it.

Real Deal_Real Estate Dry Powder_3-31-16

Wall Street Journal – No Mercy Rule for Glutted Natural-Gas Market.

WSJ_Natural Gas Glut_4-1-16

Financial Times – US oil and gas sector reboots to survive.

FT_US oil and gas guidance_4-4-16

Bloomberg – Wind and Solar Are Crushing Fossil Fuels. Investment in Power Capacity, 2008-2015 (Source: BNEF, UNEP)

Bloomberg_Investment in Power Capacity_4-5-16

Featured

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

Price falls keep China’s property developers grounded. Ben Bland. Financial Times. 4 Apr. 2016.

Seeking an example of the credit boom in China fueling property developments that maybe should not be undertaken?  Look no further than Hong Kong developer Goldin Properties’ Goldin 117 a $10bn project in Tianjin (30 minutes by high-speed train from Beijing).

Founder Pan Sutong (also the individual who had $13bn wiped off his paper fortune in a single day due to stock market girations) and China Cinda Asset Management “one of the state-run ‘bad banks’ with a mission to lend to distressed companies” are putting in Rmb9bn ($1.4bn) each recapitalize the project.

“Anne Stevenson-Yang of China-focused research house J Capital, argues that the use of government-backed funds to support Goldin is symptomatic of the wider misallocation of capital weighing upon China’s economy.”

“It’s a miniature picture of what China is all about, demonstrating scale in order to capture more financing. China’s asset management companies and banking establishment are dedicated to maintaining the value of their collateral because if they allow it to drop and they have to mark their real estate holdings to market, it would be a disaster for banks, depositors and cities.” – Ms. Stevenson-Yang

Because “Chinese banks are reluctant to continue lending to ambitious and overstretched developers,” the “government is pushing asset managers such as Cinda to extend more credit to ailing companies and has proposed allowing Chinese banks to swap debt in struggling enterprises for equity.”

“The government is using its financial arms to provide further guarantees to the real estate sector and other industries that are plagued by overcapacity. It’s setting a bad precedent and there is a very big risk of moral hazard because developers know that, in the end, the government will bail everyone out.” – Zhu Ning, a professor at the Shanghai Advanced Institute of Finance

The global liquidity trap turns more treacherous. Scott Minerd (global chief investment officer at Guggenheim). Financial Times. 5 Apr. 2016.

“…when monetary policy is the only game in town, negative rates are likely to beget even more negative rates, creating a perverse cycle with important implications for investors.”

“There is a strong argument that when rates go negative it squeezes the speed at which money circulates through the economy, commonly referred to by economists as the velocity of money.”

“The empirical data support this view – the velocity of money has declined precipitously as policymakers have moved aggressively to reduce rates.

A decline in the velocity of money increases deflationary pressure. Each dollar (or yen or euro) generates less and less economic activity, so policymakers must pump more money into the system to generate growth.”

Recall Kevin Wilson’s article: Japanese Policy Failure Means Disaster For Us All from the March 5 – March 10 post.

Japanese Velocity of Money_Q3 2015

“As consumers watch prices decline, they defer purchases, reducing consumption and slowing growth. Deflation also lifts real interest rates, which drives currency values higher.“

“The Bank of Japan and the European Central Bank are already executing massive quantitative easing programs, but as their balance sheets expand, assets available to purchase shrink.”

“The BoJ now buys virtually all of the Japanese government bonds that are issued every year, and has resorted to buying exchange traded funds to expand its balance sheet.”

China’s M&A boom – Money bags. Economist. 2 Apr. 2016.

Subheader: China’s global investment spree is fueled by debt

“Chinese firms with little international experience and lots of debt have emerged as the biggest buyers of global assets. They have announced nearly $100 billion in cross-border M&A deals this year, already more than their $61 billion of foreign acquisitions last year.”

What is being missed are the motivations. General theories are concern over the Chinese economy or a pending yuan devaluation; however, what it really comes down to is that foreign acquisitions are a cheap (relative to what’s available in China) source of growth.

“Chinese buyers, by and large, are far more indebted than the firms they are acquiring. Of the deals announced since the start of 2015, the median debt-to-equity ratio of Chinese buyers has been 71%, compared with 44% for the foreign targets, according to The Economist’s analysis of S&P Global Market Intelligence data. Cash cushions are generally also much thinner for Chinese buyers: their liquid assets are roughly a quarter lower than their immediate liabilities. The forbearance of their creditors makes these heavy debts more bearable in China than they would be elsewhere. But the Chinese buyers are financially stretched, all the same.”

“Chinese banks see lending to Chinese firms abroad as a safe way of gaining more international exposure. The government has encouraged them to support foreign deals. As long as the firms to be acquired have strong cash flows…”

“For the buyers, there are two strong financial rationales for the deals…

“First, debt-funded buyouts can actually make their debt burdens more tolerable. Take the case of Zoomlion, a construction-equipment maker with 83 times more debt than it earns before interest, tax, depreciation and amortization. It wants to buy Terex, an American rival with debt just 3.5 times larger than its earnings, for $3.4 billion. Even if the purchase consists entirely of borrowed cash, the combined entity would still have a debt-to-earnings multiple of roughly 18, a marked improvement for Zoomlion.”

“Second, Chinese buyers know that one key financial metric works to their advantage: valuations in the domestic stock market are much higher than abroad. The median price-to-earnings ratio of Chinese buyers is 56, twice that of their targets. In effect, this means they can issue shares domestically and use the proceeds to buy what, from their perspective, are half-price assets abroad.”

“…so long as their banks and shareholders are willing to stump up the cash, Chinese companies see a window of opportunity.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Saudi Arabia Plans $2 Trillion Megafund for Post-Oil Era: Deputy Crown Prince 3/31

Bloomberg – Norway Frees Wealth Fund to Add $17 Billion in Real Estate 4/4

CoStar – REITs Reverse Course on Investment Strategy, Become Big Net Sellers 4/6

FT – China group seals record trove of M&A deals 3/31

FT – Hong Kong’s retail sales drop hardest in 17 years 3/31

FT – What is the Petrobas scandal that is engulfing Brazil? 3/31

FT – Anbang chairman Wu Xiaohui’s ‘wings clipped’ by regulators 4/1

FT – Even oil barons are giving up on fossil fuels 4/2

FT – Whatever you read about alternative investing is true 4/2

FT – Russia learns to live with the fallen rouble 4/2

FT – Business is right to use its superpowers for social change 4/3

FT – Investors should ignore the hype about fintech 4/3

FT – Investment strategy: The new property barons 4/3

FT – Panama Papers: what we know so far 4/3

FT – PE investors face tougher exit environment 4/4

FT – Currency wars backfire for Japan and Europe 4/5

FT – M&A failures: deep breaths 4/6
FT – Japan lashes out against rise of yen 4/7

LinkedIn – Learning to Code Yields Diminishing Returns (Douglas Rushkoff) 3/30

NYT – With ‘Gigs’ Instead of Jobs, Workers Bear New Burdens 3/31

NYT – The Cities on the Sunny Side of the American Economy 3/31

NYT – Insider’s Account of How Graft Fed Brazil’s Political Crisis 4/3

WSJ – NYSE Margin Debt Falls to Lowest Since 2013 3/30

WSJ – Why Oil and Gas Companies Are Bracing for Bad News From Banks 3/31

WSJ – Why Investors Are Crazy to Chase This Bond Yield Lower 4/5

WSJ – How the Reserve Bank of India’s Policy Might Finally Be Paying Off 4/5

WSJ – Chinese Developers Aim to Expand in China 4/5

WSJ – Surge in Land Prices Adds Froth to Vancouver Market 4/5

WSJ – Pfizer Walks Away From Allergan Deal 4/6

WSJ – Another Reason Investors Should Fear a Strong Yen 4/6

WSJ – China’s Currency Victory Hides Scars of War 4/7

 

February 19 – February 25, 2016

China’s media censorship. Life insurance companies face a daunting future. S&P earnings not quite so. Commercial real estate values in limbo.

Some weeks I wonder if there will be enough quality material to post and then there are weeks like this one when there is a deluge.  I am going to focus on four themes, three that apply to everyone and one that is specific to commercial real estate.  1) The New York Times provided some great coverage this week highlighting Beijing’s increased censorship of the media, first in Edward Wong’s “Xi Jinping’s News Alert: Chinese Media Must Serve the Party” and second in Edward Wong and Neil Gough’s “As China’s Economic Picture Turns Uglier, Beijing Applies Airbrush”, 2) was an article in The Economist “The fallout from low interest rates (2): The lowdown” that highlights the effect low and negative interest rates are having on life insurance companies, 3) is a must read by Justin Lahart “S&P Earnings: Far Worse Than Advertised” in The Wall Street Journal, and 4) for the commercial real estate professionals is Tracy Alloway’s Morgan Stanley Says U.S. Commercial Real Estate Price Growth Will Be Flat in Bloomberg.

Other items that are worth a mention (there is quite a bit this week):

  • World trade records biggest reversal since crisis in 2008. “The value of goods that crossed international borders last year fell 13.8% in dollar terms – the first contraction since 2009 – according to the Netherlands Bureau of Economic Policy Analysis’ World Trade Monitor. Much of the slump was due to a slowdown in China and other emerging economies.”
  • Jamil Anderlini of the Financial Times wrote a great article around the theme of recessions following development of ‘the world’s tallest tower’ in The Chinese chronicle of a crash foretold.
    • “Today, some analysts describe the Chinese real estate market as the single most important sector in the global economy – and the biggest risk factor. This is less fantastic than it sounds when you consider that in two years – 2011 and 2012 – China produced more cement than the US did in the entire 20th century.“
    • “The building boom of recent years has led to enormous excess inventory but the true scale is impossible to estimate because developers and local governments are offered incentive to under-report the problem.”
    • “An outright decline in real estate investment, which is surely coming, will also have profound implications for the rickety, debt-laden Chinese financial system. Analysts estimate that more than 60% of Chinese bank loans are directly or indirectly tied to real estate.”
    • “According to officials in several Chinese cities, their solution is to break ground on entirely new districts and to offer land to “better quality” property developers at marked down prices. The hope is that developers will abandon the existing empty blocks, and build higher quality apartments that can be sold to consumers for big discounts because of the lower land costs.”
    • Never mind the write offs and losses that would have to take place on the unused buildings. Question: are they completely uninhabitable or is really a matter of demand?
  • The Buttonwood column in The Economist does a good job of pointing out one of the larger problems of the weak markets.
    • “Since the crisis commercial banks seem to have retreated from their market-making role. The impact of this shift has been disguised by the huge amounts of liquidity injected by central banks. But as central banks scale back their support, the underlying investors (pension funds, insurers, hedge funds and the like) will have to rely on each other to act as willing buyers and sellers. That seems highly likely to result in more volatile markets than in the past, especially when the outlook for the economy is unclear. Buckle up.”
  • A good but somewhat sad read in the NYT, Reporting on Life, Death and Corruption in Southeast Asia.
  • If you want to scare yourself… China’s Ticking Time Bomb: A Runaway Banking System Bloated With Hidden Bad Loans and Singapore Lawyers Warn of 1998-Like Pain as Debt Defaults Spread
  • Lastly, all commercial real estate professionals, especially those on the retail side of the business should read Weak Holidays Force Retailers to Shrink, Rethink Web

Interesting graphics:

From The Economist, all is not well in Hedge Fund land.

Economist_Hedge funds_2-25-16

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

Xi Jinping’s News Alert: Chinese Media Must Serve the Party. Edward Wong. The New York Times. 22 Feb. 2016.

As China’s economy downshifts to a ‘new normal,’ the party heads in Beijing are finding the media to be a thorn in their side particularly when it relates to information that isn’t positive.  Thus…

“All news media run by the party must work to speak for the party’s will and its propositions, and protect the party’s authority and unity” – Xi Jinping, according to Xinhua, the state news agency.

“Mr. Xi also wants to curb the presence of foreign media companies. Last week, government agencies announced a regulation that would prevent foreign companies from publishing and distributing content online in China. That could affect Microsoft, Apple and Amazon, among others.”

Hardly seems sporting.

“An essay in China Daily, the official English-language newspaper, offered an explanation on Monday about why Mr. Xi was unveiling his policy now.

“It is necessary for the media to restore people’s trust in the party, especially as the economy has entered a new normal and suggestions that it is declining and dragging down the global economy have emerged,” the essay said.

“Some political analysts note that Mr. Xi’s attempts to impose total control over the media say as much about his personal insecurities as they do about any Marxist-Leninist ideological vision that he holds.

“The most important thing is for him to announce his absolute authority,” said Zhang Lifan, a historian. “He doesn’t feel effective and confident in dealing with problems, and he lacks a sense of security.”

Mr. Zhang added, “He worries the Chinese Communist Party will lose political power, and he also worries that his peers will shove him from his position.”

A subsequent and related article:

As China’s Economic Picture Turns Uglier, Beijing Applies Airbrush. Edward Wong and Neil Gough. The New York Times. 25 Feb. 2016.

“‘Data disappears when it becomes negative,’ – Anne Stevenson-Yang, co-founder of J Capital Research, which analyzes the Chinese economy”

“In January data released last week, the Chinese central bank omitted or hid one key number and altered the parameters of another that gave insight into what the central and commercial banks were doing to prop up the country’s currency.”

“When you go around and meet state-owned industry people, everybody laughs at the national statistics, so I don’t know why foreigners believe them,” – Ms. Stevenson-Yang.

Unfortunately, political control of the media is not unique to China (think Russia, Venezuela, etc.), the issue is how important to the global economy China has become and yet the country’s data is questionable at best making it difficult for other policy makers to ascertain appropriate steps to help the global economy along.

 

The fallout from low interest rates (2): The lowdown. The Economist. 20 Feb. 2016.

Subtitle: Insurers regret their guarantees

This article articulates the challenges that life insurers are facing (let alone banks, pensions, etc.) in the low-to-negative interest rate environment.

“Insurers tend to be prudent investors who like steady returns, which is why around 80% of their assets are in fixed-income securities. This served them well during the financial crisis, but today – with bond yields at historic lows, and even in negative territory-it hurts their investment income. This is particularly true for life insurers, which own over $21 trillion of the industry’s $28 trillion (of) assets, and rely heavily on this investment income to pay policy holders.”

“European insurers are especially exposed. Over two-thirds of life-insurance policies in force in the EU today offers some sort of guarantee.”

“Moody’s, a rating agency, reckons those most at risk tend to be in Germany, the Netherlands, Norway and Taiwan, where average duration gaps are especially large (14 years in Norway) or guaranteed rates are eye-wateringly high (4-5% in Taiwan).”

“The average returns promised to German policyholders are far higher than the yields on government bonds that insurers can now buy. Corporate bonds offer returns that are barely higher, which leaves two options: invest in riskier assets such as equities (which will require the insurer to put more capital aside), or face the fact that annual payouts to policyholders will outstrip income, a recipe for losses.”

“Faced with this prospect, life businesses are doing what they can to push risk back to the customer. In some countries, such as France, the promises made to existing policyholders have the built-in flexibility to be scaled back. But mostly the burden falls on new policyholders, who are no longer sold products with guarantees.

Ironically this de-risking creates a different danger: that the industry becomes irrelevant. By removing the key selling point of an insurer over a mutual fund – the assurance that a policy will pay out no matter what – the industry risks negating its business proposition to investors looking for security.”

“The classic model thrives on short-term interest rates of between 2-6%, government bonds yielding at least 4% and no worries about defaults.”

 

S&P Earnings: Far Worse Than Advertised. Justin Lahart. The Wall Street Journal. 24 Feb. 2016.

This article is an eye opener.

“With most calendar-year results now in, FactSet estimates companies in the S&P 500 earned 0.4% more per share in 2015 than the year before. That marks the weakest growth since 2009. But this is based on so-called pro forma figures, results provided by companies that exclude certain items such as restructuring charges or stock-based compensation.

Look to results reported under generally accepted accounting principles (GAAP) and S&P earnings per share fell by 12.7%, according to S&P Dow Jones Indices. That is the sharpest decline since the financial crisis year of 2008. Plus, the reported earnings were 25% lower that pro forma figures – the widest difference since 2008 when companies took a record amount of charges.

The implication: Even after a brutal start to 2016, stocks may still be more expensive than they seem. Even worse, investors may be paying for earnings and growth that aren’t anywhere near what they think.”

WSJ_The GAAP Gap - 2-25-16

“Companies ostensibly provide pro forma figures to better reflect the underlying tenor of their operations… But companies have had a history of treating the ordinary as extraordinary when business conditions worsen.

Indeed, outside of 2008, the only other times the GAAP gap was as wide as last year was in 2001 and 2002. That was back when companies wrote off billions of dollars worth of dot-com bubble-era investments.”

“Companies sometimes will also look past charges that result from big swings in the value of their assets. Chesapeake Energy, for example, on Wednesday reported a full-year 2015 loss of $14.9 billion under GAAP.

But the company said that after adjusting for items “typically excluded by securities analysts in their earnings estimates,” it lost just $329 million. The major item Chesapeake and many other energy companies left out of their 2015 pro forma results were charges related to the steep decline in energy prices.”

About our oil reserves being worth tens of billions less, hey look at that squirrel over there…

“This is why skeptics tend to call pro forma figures EBBS, or earnings before bad stuff.”

“Energy companies registered some of the biggest differences between GAAP and pro forma earnings. In total, S&P 500 energy companies had an estimated GAAP loss of $48 billion. That stands in stark contrast to the $45 billion of income they reported on a pro forma basis.“

Come again… that’s a $93 billion swing.

“Materials companies reported $13 billion in GAAP earnings compared with $30 billion in pro forma earnings. And health-care companies earned $104 billion under GAAP versus $157 billion pro forma.”

“And then there was tech: Under GAAP, S&P 500 tech companies earned an estimated $176 billion in 2015, $42 billion less than their pro forma earnings of $218 billion”

“Overall S&P 500 earnings under GAAP came to $787 billion last year, S&P Dow Jones Indices estimates. That is $256 billion less than the pro forma estimate of $1.04 trillion.”

 

Morgan Stanley Says U.S. Commercial Real Estate Price Growth Will Be Flat. Tracy Alloway. Bloomberg. 23 Feb. 2016.

“Morgan Stanley analysts last week predicted U.S. commercial real estate prices would grow by a big fat zero percent in 2016, replacing a previous forecast of 5% growth over the course of the year.”

“We recognize the very important role that the lending markets have played in the recovery in CRE prices,” the analysts write. “Indeed, our analysis shows that a 10 percentage point decline in the loan-to-value ratio (from 70% to 60%) requires 2.25 percentage annual net operating income growth to offset the lower leverage.”

“Throw in higher financing costs-U.S. financial conditions have already tightened following the Federal Reserve’s decision to raise interest rates back in December – and required income needs to increase even more.”

Bloomberg_CRE Price Sensitivity_2-23-16

This article ties well into the one above along with Weak Holidays Force Retailers to Shrink, Rethink Web.  If the tenants, users of space, are experiencing margin squeeze, how likely is it that they’ll be able to absorb meaningful rent growth?  At this point commercial real estate appreciation (on the whole) is reliant on the cost of financing equity and debt [described in the chart as Weighted Average Coupon (WAC)].  Fortunately, as a result of low-to-negative interest rates, life insurers and SWFs are looking for yield.  However, only for the best stuff as highlighted by the growing yields in BBB CMBS offerings due to declining demand.

 

Other Interesting Articles

Bloomberg Businessweek

The Economist

 

Bloomberg – The U.S. States Where Recession Is Already a Reality 2/21

Bloomberg – China’s Debt Seen Rising Through 2019, Peaking at 283% of GDP 2/21

Bloomberg – Sovereign Wealth Funds May Sell $404 Billion of Equities 2/22

Bloomberg – Singapore Lawyers Warn of 1998-Like Pain as Debt Defaults Spread 2/22

Bloomberg – Can Things Get Any Worse for Russia? You’re About to Find Out 2/23

Contra Corner (Business Insider) – China’s Ticking Time Bomb: A Runaway Banking System Bloated With Hidden Bad Loans 2/19

CoStar – Four Major Property Sectors Showing Weaker CMBS Loan Underwriting 2/22

FT – China central bank moves to strengthen control of money supply 2/18

FT – Uber losing more than $1bn a year in China 2/18

FT – San Francisco: bubble fears fail to curb rush to build new condos 2/19

FT – Smart beta ‘could go horribly wrong’ 2/22

FT – Helicopter drops might not be far away 2/23

FT – South Korea household debt pile mounts 2/23

FT – Venture capital starts to tune out of on-demand services 2/24

FT – The Chinese chronicle of a crash foretold 2/24

FT – Exports from China to Brazil collapse as recession deepens 2/25

FT – World trade records biggest reversal since crisis 2/25

FT – Oil industry tormented by latest price slump 2/25

Investment News – FBI raids offices of Texas REIT (UDF) 2/18

NYT – In Zika Epidemic, a Warning on Climate Change 2/20

NYT – Reporting on Life, Death and Corruption in Southeast Asia 2/21

NYT – Indian Caste Protests in Haryana Choke Delhi’s Roads and Water Supply 2/22

NYT – Seas Are Rising at Fastest Rate in Last 28 Centuries 2/22

NYT – Once a Coup, Energy Transfer Deal Becomes a Nightmare 2/25

WSJ – IPO Market Dries Up as Investors Retreat 2/18

WSJ – U.S. New-Home Sales Fell Sharply in January 2/24

WSJ – Bank-Stock Bloodbath: The Cycle Financials Can’t Escape 2/24

WSJ – Weak Holidays Force Retailers to Shrink, Rethink Web 2/25

 

February 5 – February 11, 2016

Negative yielding government bonds. Lending to Emerging Markets hits the brakes. Japanese 10-year bond crosses the zero bound.

Three key articles that stand out this week are 1) Elaine Moore, Robin Wigglesworth, and Leo Lewis’ “Government bond yields send recession signal” in the Financial Times, 2) Jonathan Wheatley’s “Lending to emerging markets comes to halt” in the Financial Times, and 3) Richard Barley’s “Japan and the Strange Case of the Negative Bond Yields” in The Wall Street Journal.

Other items that are worth a mention:

  • Blackstone is considering entering the public nontraded REIT (Real Estate Investment Trust) market. No surprise considering the increased volatility in the world, lack of yield in traditional investment products, that Blackstone is probably one of the best (if not the best) suited Alternative Asset Managers with the best pedigree, and that the largest player in the market (ARC) has been brought down by an accounting scandal (only the tip of the iceberg).  Watch how quickly this product category grows for Blackstone.
  • Bank profit margins are hurting from the declining spread between 10-year and two-year U.S. Treasuries.

WSJ_Yield Squeeze_2-8-16

  • From a post that Nouriel Roubini did for Project Syndicate: “…financial markets haven’t reacted very much, at least so far, to growing geopolitical risks, including those stemming from the Middle East, Europe’s identity crisis, rising tensions in Asia, and the lingering risks of a more aggressive Russia. How long can this state of affairs – in which markets not only ignore the real economy, but also discount political risk – be sustained?”

Interesting graphics:

From The Wall Street Journal, the Baltic Dry Index continues to fall (side note for the Hawaii readers, Matson just had its earnings call and indicated that while they’re having difficulties in its other markets – understandably considering the dramatic fall in shipping prices – things are going just swell for them in Hawaii.  Thank you Jones Act.)

WSJ_Baltic Dry Index - 2-9-16

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

Government bond yields send recession signal. Elaine Moore, Robin Wigglesworth, and Leo Lewis. Financial Times. 5 Feb. 2016.

“In Germany, the average yield on all government debt is now negative, while Japan is on course to become the first major bond market with a 10 year bond that yields nothing. In Europe and Japan, government bonds worth nearly $6tn now trade at such highs that buyers will make a loss if they hold the paper to maturity.”

FT_Amount of negative bonds_2-5-16

So shortly thereafter, the Japanese 10 year bond did cross the zero threshold.

“At these levels the bond market is forecasting recession.” – Marcus Brookes, a fund manager at Schroders

“The Janet and John way to explain it is that for the next 10 years you have to think inflation will be much, much lower than 2% to want to buy these bonds. Otherwise you’d be locking in a loss.” – Brookes

“Investors face the difficult prospect of assessing whether low inflation has become ingrained thanks to the collapse in commodity prices. A greater concern: has central bank interference in the financial markets made pricing so opaque that investors are risking the sort of losses incurred last April, when a European Central Bank driven rally in bond markets suddenly expired?”

“The lifespan of the rally in government bonds will depend on how long investors keep faith in central banks, says Tad Rivelle, chief investment officer for fixed income at TCW, a Los Angeles based asset manager. Every economic cycle has a grand narrative that eventually unravels, he says. In the late 1990s it was the information revolution, in the 2000s it was housing prices.

‘This cycle the narrative has been that central banks have got the ball, know what they’re doing and can keep the game going as long as they want,’ he says. ‘But humans have not found a way to abolish cycles.'”

 

Lending to emerging markets comes to halt. Jonathan Wheatley. Financial Times. 5 Feb. 2016.

More good news.

“The surge in lending to emerging markets that helped fuel their own – and much of the world’s – growth over the past 15 years has come to a halt, and may now give way to a “vicious circle” of deleveraging, financial market turmoil and a global economic downturn, the Bank for International Settlements has warned.”

“That reversal has already taken place, according to BIS data released on Friday.

The total stock of dollar-denominated credit in bonds and bank loans to emerging markets – including that to governments, companies and households but excluding that to banks – was $3.33tn at the end of September 2015, down from $3.36tn at the end of June.

It marks the first decline in such lending since the first quarter of 2009, during the global financial crisis, according to the BIS.“

“The Institute of International Finance, an industry body, said last month that emerging markets has seen net capital outflows of an estimated $735bn during 2015, the first year of net outflows since 1988.“

Hyun Song Shin, head of research at the BIS, noted that “while some advanced economies had reduced leverage after the crisis, debt had continued to build up in many emerging economies. ‘Recent events are manifestations of maturing financial cycles in some emerging economies.'”

Shin “noted that the indebtedness of companies in emerging markets as a percentage of GDP had overtaken that of those in developed markets in 2013, just as the profitability of EM companies had fallen below that of DM ones for the first time.”

“Now that the dollar is strengthening, we have turned into a deleveraging cycle in Ems. So there is a sudden surge in measurable risk; all the weaknesses are suddenly being uncovered.“

 

Japan and the Strange Case of the Negative Bond Yields. Richard Barley. The Wall Street Journal. 9 Feb. 2016.

“Japanese 10-year government bond yields turned negative for the first time ever Tuesday, and now stand at minus 0.03%. The feat has already been recorded elsewhere – the Swiss 10-year bond yields minus 0.4% – but this is the first time a member of the Group of Seven economies has seen such a development.”

“The JGB (Japanese Government Bond) market has for many over the years looked like an accident waiting to happen. The country’s debt stands at a staggering 2.4 times gross domestic product, a level far above its peers, and still rising. The International Monetary Fund thinks the ratio could reach 2.9 times by 2030. Japan lost its triple-A rating from Moody’s as long ago as 1998; it currently stands at A1.”

“Across global fixed-income markets, there are now $8.7 trillion of bonds sporting a negative yield, or 21.1% of the total outstanding, according to Bank of America Merrill Lynch data.”

And yet the Yen keeps getting stronger…. To help understand Why the Yen Just Keeps Getting Stronger, see Alex Frangos’ article in The Wall Street Journal.

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – More Wall Street Strategists Are Cutting Their S&P 500 Estimates 2/6

Business Journals – Small businesses have the blues this winter 2/9

Forbes – China: Land of the Setting Sun (Gary Shilling) 2/8

FT – Why it would be wise to prepare for the next recession 2/4

FT – Hedge funds target a weaker renminbi 2/8

FT – Google passes significant barrier in its plan for driverless cars 2/9

FT – Outflows from China top $110bn in January 2/9

FT – Riksbank cuts rates deeper into negative territory 2/11

FT – BNP Paribas to curb lending to US energy sector 2/11

Investment News – Blackstone considering getting into nontraded REIT market 2/4

NYT – If There Is a Recession in 2016, This Is How It Will Happen 2/4

NYT – Stung by Low Oil Prices, Companies Face a Reckoning on Debts 2/9

Project Syndicate – The Global Economy’s New Abnormal (Nouriel Roubini) 2/4

WSJ – Corporate Credit: Less Than Angelic 2/8

WSJ – Tech Stocks: Why the Selloff Could Get Worse 2/8

WSJ – Bank-Stock Carnage: This Number Is Killing Them 2/8

WSJ – Global Recession? What This Key Indicator Says About It 2/9

WSJ – Voluntary Job-Quitting Hits Highest Level in Nine Years 2/9

WSJ – This Chinese City’s (Shenzhen) Property Market Is Out of Control 2/10

WSJ – As Economy Suffers, Economic Theory Flourishes 2/10

WSJ – Why the Yen Just Keeps Getting Stronger 2/11

 

Special Reports

NYT – Traveling Through Venezuela, a Country Teetering on the Brink 2/9

 

January 22 – January 28, 2016

Challenges of being born a millennial. Continued struggles for Energy & Mining companies. Zika virus.

While these postings cover articles from Friday – Thursday, I would be remiss not to mention the Bank of Japan’s move to lower the interest rate on excess reserves from 0.1% to minus 0.1% today.  Inflation has yet to gain traction in Japan (note that Q4 2015 GDP growth in the U.S. came in at a lower than expected 0.7% today as well), and so the policy makers are stepping up efforts.  While the negative interest rates in Japan only apply to a portion of deposits, the key in this is that as Aaron Back of The Wall Street Journal points out in “Japan’s Negative-Rate Plunge More Like a Toe in the Water” is that this policy directive is modeled on the Swiss and it is likely that there is more to come.  The world is at a challenging crossroads, desperately seeking economic growth central banks are trying to do their part resulting in monetary stimulus measures just trying to get something going.  Note that US interest rates continue to drop (the 30-year fixed rate mortgage rate as reported by Freddie Mac came in at 3.79% yesterday down from over the 4% reached after policy rates were first raised) as investors expect US policy rates to stay unchanged or even to revert back to zero.  Good for asset owners, but all this uncertainty continues to prove challenging for employees.

This week there was a special feature in The Economist and the Financial Times did a good article on the challenges the current economic environment has had on millennials.  The brief from The Economist can be found in the Other Interesting Articles section below and I’ll go into Sarah O’Connor’s “Tragedy of the millennials is they are not entitled enough” in the Financial Times.  The other article I am going to cover is Christopher Adams, James Wilson, and Mark Vandevelde’s “Moody’s puts 175 energy and mining companies on downgrade watch” in the Financial Times that highlights the continued symptoms of the energy crunch.  Lastly, for those that haven’t been following the progress of the Zika virus, here are two good articles from The New York Times and The Washington Post to help you understand what’s going on and how quickly it’s spreading.  As a parent, this scares me… especially considering the “first case of the mosquito-borne virus in a birth on U.S. soil” was here in Honolulu.

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

Tragedy of the millennials is they are not entitled enough. Sarah O’Connor. Financial Times. 26 Jan. 2016.

Full disclosure, I like Sarah O’Connor am a millennial (granted, at the very front end of the generation).  Further, I always find it interesting when I hear or read ‘experts’ making statements that certain trends have changed forever because millennials have different tastes than their predecessors – millennials don’t want single family homes, they want to live in the city… millennials prefer flex work spaces rather than private offices… etc..   The thing is we’re not that different from those that have come before us.  Yes technology has enabled certain behaviors that our parents couldn’t tap into as easily, but bottom line, the reason certain buying and work habits haven’t taken hold yet is that the majority of millennials are 25 and for most of our working career the jobs economy has been shaky while asset prices have been shooting for the moon.  Buying habits have been simply delayed – maybe forever as some experts have stated, but not for reason of taste, rather out of a lack of ability.

From Ms. O’Connor, using the example of the U.K., but applicable in general.

The general consensus of millennials in the work place is that they “expect different things from employers than previous generations – rapid promotions, constant positive feedback, flatter corporate structures, a better work-life balance and a sense of purpose beyond profit. The press releases wrap up with a few quotes from experts urging companies to adapt to this new generation.”

“Most millennials – those born between the early 1980s and early 2000s – entered the labor force in the aftermath of a brutal downturn. It is almost a decade since the financial crisis, and global youth unemployment remains about 13%. Far from demanding that employers adjust to their needs, many young people have bent over backwards to persuade anyone to give them a foothold in the labor market.”

“While the income of the median UK household finally regained its pre-recession level last year, the income of the average 22-to-30 year old is still about 8% lower than in 2008.”

“…everyone should be rooting for the unlucky ones who had a tough start, since it will fall to them to pay for the pensions and healthcare of the generations ahead of them. This will be a heavy responsibility: the world has only three “super-aged” societies today (countries where more than one in five of the population is 65 or older) but by 2020 it will have 13. The more long–term the damage to young people’s careers, the less they will earn over their lifetimes and the less tax they will be able to pay.”

In regard to a speech by Minouche Shafik, a deputy governor at the Bank of England, “She was trying to figure out why wage growth is still so weak in Britain even though joblessness has fallen to pre-recession levels. This is a puzzle in the US and Japan too. Perhaps, she said, the crisis was so severe that it had a lasting effect on employees’ psyches and made them reluctant to push for pay rises or switch jobs in pursuit of higher salaries.

If this is true for the average worker, you can see why it might be particularly true for a young person who has never known a time when the economy seemed truly secure.”

Moody’s puts 175 energy and mining companies on downgrade watch. Christopher Adams, James Wilson, and Mark Vandevelde. 22 Jan. 2016.

While this article is from a week ago and oil prices have rebounded somewhat over the last week, the structural challenges remain.

“Several of the world’s biggest oil and gas groups – including Royal Dutch Shell, Total and Chesapeake Energy – are among 175 energy and mining companies at risk of rating downgrades following a collapse in crude and other commodities markets, Moody’s warned on Friday.”

“Moody’s has put on review for downgrades 69 US-based companies – including Schlumberger and Chesapeake.”

“Multi-notch downgrades are particularly likely among issuers whose activities are centered in North America, where natural gas prices have declined dramatically along with oil prices,” said the rating agency.”

“Moody’s notice for 120 energy companies and 55 miners is its largest single warning of potential corporate downgrades since the financial crisis.”

“China’s outsized influence on the commodities market, coupled with the need for significant recalibration of supply to bring the industry back into balance indicates that this is not a normal cyclical downturn, but a fundamental shift that will place an unprecedented level of stress on mining companies,” said Moody’s.

This graph below is from a separate FT article, but it illustrates the rising stress in emerging market debt.

FT_Troubled EM Debt_1-25-16

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Saudi Arabia’s Secret Holdings of U.S. Debt Are Suddenly a Big Deal 1/21

Bloomberg – So Yes, the Oil Crash Looks a Lot Like Subprime 1/25

FT – The tiny shifts that can signal huge changes 1/21

FT – A history of betrayal that leads to Donald Trump 1/24

FT – Investors rush online to ditch stakes in China rural lenders 1/24

FT – Emerging markets’ stressed debt reaches record levels 1/24

FT – US junk-rated energy debt hits two-decade low 1/24

FT – Capital controls may be China’s only real option 1/25

FT – Currency risk matters for China’s property sector 1/25

FT – Pay attention to long-term debt cycle (Ray Dalio) 1/25

FT – China mouthpiece warns Soros against shorting renminbi 1/26

FT – South Korea export growth slows to trickle as China demand wanes 1/26

FT – China’s toughest test is within its walls 1/26

FT – Protectionism at play in Sharp takeover drama 1/26

NYT – African Economies, and Hopes for New Ear, Are Shaken by China 1/25

NYT – El Salvador’s Advice on Zika Virus: Don’t Have Babies 1/25

NYT – Inquiry in China Adds to Doubt Over Reliability of Its Economic Data 1/26

Vanity Fair – Hedge Funder John Paulson Puts Up His Own Fortune to Save His Firm 1/26

WSJ – What’s Wrong With The Producer-Price Index? Rent Is Too Damn High 1/14

WSJ – China Cinema Companies Produce Box-Office Hype 1/25

WSJ – Vacant Office Spaces Pile Up in Houston 1/26

WSJ – Tougher Times for Mall Owners 1/26

WSJ – China Sharpens Efforts to Halt Money Outflow 1/27

WSJ – Malaysia Antigraft Agency Asks for Review of Decision to Clear Najib Razak 1/27

WSJ – Heeding Softer Market, Extell Development Furnishes One57 Condo for Sale 1/28

 

December 11 – December 17, 2015

The Fed did it! Diversify, diversify, diversify. Technology offers a chance at low hanging fruit. High Ground Looking over a Swamp, aka Cheniere.

The Fed finally raised interest rates!  Definitely one of the three themes from the week, which I’ll cover only briefly in Christopher Condon’s coverage in BloombergBusiness’ “Fed Ends Zero-Rate Era, Signals 4 Quarter-Point 2016 Increases,” simply because I’m sure you’ve already read about this.  The other two themes covered 1) “Beyond Property: Chinese Developers Look to Diversify” by Esther Fung in The Wall Street Journal and 2) “Digital advances uneven across US economy” by Sam Flemington in The Financial Times.  In addition, I think it’s worth noting the dismal of Cheniere’s founder and CEO, Charif Souki, this past week – see below.

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

Fed Ends Zero-Rate Era, Signals 4 Quarter-Point 2016 Increases. Christopher Condon. Bloomberg. 16 Dec. 2015.

In a nutshell:

“The Federal Open Market Committee unanimously voted to set the new target range for the federal funds rate at 0.25% to 0.5%, up from zero to 0.25%.  Policy makers separately forecast an appropriate rate of 1.375% at the end of 2016, the same as September, implying four quarter-point increases in the target range next year, based on the median number from 17 officials.”

“Prior to 2008, the effective fed funds rate had never dropped below 0.63%, according to data compiled by the St. Louis Fed dating back to 1954.”

While the commentary is that the raising of rates will be gradual, I’m fairly certain that if rates make it to 1.375% by end of next year, it will be jarring.  Granted, hopefully the economy will be firing on all cylinders to justify that rate.  Already Wells Fargo and others have raised their Prime Rate by a quarter point to 3.50%.  The Bank of Mexico has increased rates for the first time since 2008 in order to prevent further weakening of the peso relative to the US dollar.  Hong Kong which has a currency peg to the US dollar is also raising rates. This is only part of the knock-on effects – clearly there is a lot at stake.

Beyond Property: Chinese Developers Look to Diversify. Esther Fung. The Wall Street Journal. 10 Dec. 2015.

For those that don’t know, real estate development in China got “a little” over its skis. As result, it’s been tough for real estate developers, especially those not in the first tier cities.

“… a growing number of developers who see no end to the pain in Chinese real estate and are looking to get out. Other developers are branching off into everything from banking to cosmetic surgery to women’s soccer.”

“Some even suggest a long-term de-emphasis on property as China’s birthrates slow and the population ages.”

“According to Moody’s Analytics, housing and its related industries contributed 18% of the country’s gross domestic product in 2014, down from 23% in 2013.”

“The property sector has turned from being China’s economic growth engine into its burden.” – Ma Guangyuan, a Beijing-based independent economist.

“While housing sales are up 7.9% by volume in the first 11 months this year from a year ago, construction starts have been declining at double-digit levels. Growth in investment in residential property slowed to 0.7% growth in the first 11 months of this year, down from 9.2% for last year.”

Consider the “ghost cities” and all of the empty building inventory that is meant to house the hundreds of millions of rural citizen when they migrate into the cities.  What happens if they don’t migrate?  Consider that the allure of higher wages and the “iron rice bowl” (China’s implicit understanding that companies will look after the welfare of their employees – at least the State-Owned-Enterprises) is fading.  See Mark Magnier’s “China’s Workers Are Fighting Back as Economic Dream Fades” in The Wall Street Journal.

It is no surprise that developers are diversifying.  Real estate development is a cyclical business (even if this cycle in China has been cranking for decades since Deng Xiaoping came to power).

“In May, real-estate firm Shanghai Duolon Industry changed its name to P2P Financial Information Service Co. to diversify into Internet finance and consultancy services, driving its shares sharply higher.”

“Evergrande Real Estate Group Ltd. (also one of the China’s largest developers), which recently spent $2.1 billion buying uncompleted property projects, has delved over the past two years into mineral water, dairy, grains and oil.”

Other examples include Dalian Wanda’s purchase of the Ironman triathlon group, its creation of a financial holding company and its crowdfunding project “Stable Earner No.1” (promising investors annualized returns of 12% – 6% from income and 6% from appreciation).

However, even if the developers themselves are not excited about their prospects, Chinese insurers feel differently. See Jacky Wong’s article in The Wall Street Journal “Why China’s Insurers Are Bidding Up Property Stocks” (it was also listed in last week’s “Other Interesting Articles.”)

Digital advances uneven across US economy. Sam Flemington. The Financial Times. 16 Dec. 2015.

“Research from the McKinsey Global Institute finds that digitization could add $2.2tn to US gross domestic product by 2025 as companies lift productivity by exploiting advanced technologies.

However, the flipside will be further dislocation in the jobs market. Automation could displace between 10-15% of middle-skilled occupations such as clerical, sales and production roles over the period from 2015-25, equivalent to 8m-12m jobs, the report predicts.

That would be nearly twice the displacement rate of recent decades. The report finds that 60% of occupations could have 30% or more of their activities automated.”

The room for improvement in production efficiencies is a case for optimism, but the prospects of job rationalization is cause for concern.  Consider that US median wage has been flat for 45 years (GMO third quarter newsletter) largely due to advances in technology, globalization, and policies that have favored capital over labor (as Ice-T said, “don’t hate the player, hate the game.”)

“Looking at just three big areas of potential – online talent platforms, big data analytics and the internet of things – we estimate that digitization could add up to $2.2tn to annual GDP by 2025, although the possibilities are much wider.”

But digitization is happening “unevenly” with “the US only reaching 18% of its digital potential.”

Industries that have a lot of catching up to do: agriculture, construction, and hospitality.

“After the IT sector itself, the most digitally advanced companies are in media, professional services, finance and insurance, and wholesale trade, the report says.”

Cheniere Energy

The reason I bring this up is because it wasn’t long ago that Bloomberg Businessweek had a feature on Cheniere and Charif Souki, “America’s Most Unlikely Energy Project Is Rising From a Louisiana Bayou” (9/2/15), profiling Souki’s rise and decent and rise again – and now post script decent.

From that article:

“Cheniere Energy, based in Houston, has spent more than a decade, and upwards of $20 billion, turning 1,000 acres of swamp into the first LNG export terminal in the continental U.S.”

Still yet to make any money (the terminal is about to be activated).

To get a sense of the scale of the operation, “Sabine Pass makes its own power. Cheniere paid General Electric $1 billion for 24 gas-fired turbines that were initially designed as jet engines. By the time the terminal is fully operational, they’ll generate about 450 megawatts of electricity, enough to power a city of almost 300,000 homes.”

FYI, America’s natural gas pipeline network leads right to the facility.

A little on Souki, Charif Souki after a stint in investment banking used own/run Mezzaluna in Aspen and LA along with two other restaurants in LA . In 1996 he became and oil and gas executive by purchasing a defunct public company.  The article is really worth the read. Oh and,

“In 2013 his total compensation was $142 million, good enough to make him the highest-paid CEO of a U.S. public company. About $130 million of that came in the form of company stock.”

As Howard Marks, of Oaktree Capital, says “To succeed in the markets you need 1. Aggressiveness, 2. Timing, and 3. Skill.  If you are Aggressive enough and Time it right, you don’t need skill.  Only when the market declines or the timing is bad do you see who had/has skill.”

I’m not implying that Souki doesn’t have skill.  He clearly has grit (aggressiveness).  His timing has been good and bad, but ultimately the commodity slump has been too much and too long leading to Carl Icahn and the board of directors to can him.

Other Cheniere and Souki related articles:

 

Other Interesting Articles

Bloomberg Businessweek

The Economist

 

BloombergBusiness: Blackstone Seeking to Raise $4 Billion for Real Estate Debt Fund 12/10
FT: Wells Fargo warns of ‘stresses’ in its energy portfolio 12/14

FT: Yields on junkiest US bonds breach 18% 12/15

FT: Any end in sight for the big oil slide? 12/15

FT: Celebrate the rise of flawed, febrile China 12/16

FT: Banks raise prime rates after Fed move 12/17

FT: Fed rise – Hong Kong caught between US tightening and China slowdown 12/17

FT: Second rating agency cuts Brazil to junk 12/17

GlobeSt.com: Interest Rates, Cap Rates Don’t Move in Lockstep 12/15

National Real Estate Investor: Net Lease Buyers Develop Bigger Appetite for Medical Properties 12/14

National Real Estate Investor: Private Equity Real Estate Fundraising Surges in 2015 12/16

NYT: China’s Coastal Cities, Underwater 12/11

NYT: Why Very Low Interest Rates May Stick Around 12/14
NYT: Battered, Apologetic and Still Pitching Their Hedge Funds 12/15

WSJ: Private Equity’s ‘Hidden’ Fees Totaled $20 Billion 12/13

WSJ: China’s Workers Are Fighting Back as Economic Dream Fades 12/14

WSJ: The Government’s Financial Watchdog Just Warned Us That Another Third Avenue-Style Bond Fund Run Is Likely 12/15

WSJ: Even as Oil Plummets, China Keeps Prices High 12/16

WSJ: Rent Your Place on Airbnb? The Landlord Wants a Cut 12/16

WSJ: Fed Rate Increase to Cool Hong Kong Property Prices 12/16

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