Tag: Sovereign Wealth Funds

October 7 – October 13, 2016

There are the pension obligations kept on the books based on industry guidelines and then there are the books that track what they really think. America’s tech boom has been great for the consumer, but not so much for the employees that have been displaced.

Headlines

Briefs

    • “Sovereign wealth funds have pulled almost $90bn from asset managers over the past two years, as state-backed investment vehicles grapple with low commodity prices and disappointed returns.”
    • “The Norwegian government has tapped the Scandinavian country’s $890bn oil fund, the largest sovereign wealth fund in the world, for almost $6bn this year.”
    • “Moody’s, the rating agency, has predicted that sovereign outflows would be at least 25% higher in 2016 than in 2015, due to the low oil price.”
    • Other reasons stated for the pullback include: poor performance from fund groups, bringing investment management in-house, diversification, and having cash-on-hand for opportunistic investments.
    • “Between 20 and 30% of people in the US and Europe are working independently in the so-called “gig economy” according to a new study that counts moonlighters as well as full-timers.”
    • While many are satisfied with their gig arrangement, “about 30% are doing it as a last resort.”
    • Further, ‘gig’ work is not only for the young. “The survey found that in the UK, 39% of adults aged 55 and over were working independently versus 31% of 25 to 54 year olds. The same pattern was found in Sweden and Germany.”
    • “Scaling up the results of our survey suggests that 50 million Americans and Europeans are independent out of necessity, and more than 20 million of them rely on independent work as their primary source of income.”
    • In an effort to grow its inventory, Airbnb is reaching out to apartment landlords to rent out some of their vacant inventory. So far, most landlords have been declining.
    • Why?  1) “Under Airbnb’s new plan, called the Friendly Building Program, if landlords allow tenants to lease units on Airbnb, they have an opportunity to take a cut of the nightly revenue at a suggested rate of 5% to 15%.” I.E. for a “one-night, $200 stay that means the landlord would make $30 or less, an amount that many landlords say doesn’t justify the hassle.” And 2) as illustrated by “Cortland Partners, which owns 36,000 apartment units primarily in the Southeast, in a recent survey found that nearly 40% of residents would be significantly less likely to renew their leases if the company allowed tenants to rent out units on Airbnb.” Basically, as Margette Hepfner, Senior VP of Lincoln Property Co (manages or owns 175,000 units), so aptly puts it “There’s just inherent risk in allowing unknown guest to come onto your property.”
  • Josh Zumbrun of the Wall Street Journal discussed the findings from the Journal’s recent economist survey. Essentially, economists believe a recession is likely within the next four years.
    • “Economists in The Wall Street Journal’s latest monthly survey of economists put the odds of the next downturn happening within the next four years at nearly 60%.”
    • Why… because “the American economy has never grown for more than a decade without a recession.”
    • “The current expansion began in June 2009, and has now continued for 88 months, making it the fourth-longest period of growth in records stretching to 1854.”
    • However, “to be clear, the length of an expansion bears little relation to its strength. The U.S. economy has grown at a 2.1% annual pace since 2009. That is the slowest growth of any expansion after World War II.”
    • “But over the next four years, few think a recession is absolutely guaranteed. A quarter of economists place the odds below 50%.”
    • “It is precisely because the economy has grown slowly that some think the recovery could last a long time. ‘Slow and steady leaves plenty of fuel to keep going,’ said Russell Price, senior economist for Ameriprise Financial.”
  • Henny Sender of the Financial Times covered the continuing bull run in the Chinese property sector.
    • “Property as an asset class has become important in China – maybe too important. It is critical to the financial system (since 70% of all bank loans are backed by real estate collateral), as a source of economic growth and as a source of savings and wealth for many households.”
    • As Nicole Wong, the regional head of property research for CLSA in Hong Kong puts it “property is an alternative currency in China.”
    • “But no asset class is as sensitive to liquidity’s soothing effect as property and there is a lot of liquidity in China. And as it always does, liquidity is buoying the property market, well beyond the first-tier cities where so many couples go through staged divorces just so that they can each buy a starter home on more attractive terms.”
    • “‘Liquidity is coming from the sky,’ says one Hong Kong-based hedge fund manager, noting that 40% of all global money supply in recent years has come from China. So even as central banks in Japan and the US debate helicopter money for local infrastructure and other ambitious development projects, China comes closest to realizing that concept as it ramps up its money printing presses. China’s total social financing for August was again at highs set earlier this year, while for the first half it amounted to $1.5tn, he adds.”

Special Reports / Opinion Pieces

  • FT – Investors ignore messages from ‘global AGM’ at their peril – Mohamed El-Erain 10/9
    • “In sum, the AGM (Annual General Meeting) reinforces three concerns about the global economy. 1) Its prospects are becoming more fragile in terms of growth, financial stability, indebtedness and, therefore, inclusive prosperity. 2) Bizarre political dynamics add fuel to the fire, directly and by holding back timely policy adjustments. 3) The potential damage now extends beyond forgone opportunities to also undermining future potential, including open trading systems and politically-autonomous central banks.”

Graphics

FT – Gap widens between China’s ‘old’ and ‘new’ economies – James Kynge 10/6

FT_New China economy companies outperforming_10-6-16

Bloomberg – Grocery Prices Are Plunging – Craig Giammona 9/26

Bloomberg_Falling Food Prices_9-26-16

FT – China anti-corruption campaign backfires – Hudson Lockett 10/9

FT_China's top concerns_10-9-16

WSJ – Worries Grow That China Faces a Perilous Property Bubble – Dominique Fong and Lingling Wei 10/7

WSJ_Chinese lending growth_10-7-16

WSJ – Mainland China’s Property Bubble Leaks Into Hong Kong – Jacky Wong 10/12

wsj_mainland-chinas-property-bubble-leaks-into-hong-kong_10-12-16

Visual Capitalist – These 3 Maps Help to Visualize America’s $18 Trillion Economy – Jeff Desjardins 10/12

visual-capitalist_us-states-economic-comparison_10-12-16visual-capitalist_us-metros-economic-comparison_10-12-16visual-capitalist_us-economy-geographic-illustration_10-12-16

Featured

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

A Sour Surprise for Public Pensions: Two Sets of Books. Mary Williams Walsh. New York Times. 17 Sep. 2016.

Turns out, the California Public Employees Retirement System (CalPERS) – and many similar pension funds for that matter – keep two sets of books on calculating their pension obligations and funding requirements.  One based on actuarial values and another based on “market values.”  Well the issue just came to light in a small case for the Citrus Pest Control District No. 2 that just received a very hefty bill to cover a shortfall (plus interest) for deciding to convert to a 401(k) plan.  What changed at the moment of that decision…basically Calpers went from calculating the benefit owed based on actuarial tables to using a more prudent ‘market approach’ considering it no longer had the right to go after the community for future contributions.

What is the ‘market value?” Basically, “the market value of a pension reflects the full cost today of providing a steady, guaranteed income for life – and it’s large. Alarmingly large, in fact. This is one reason most states and cities don’t let the market numbers see the light of day.”

If you want to see the difference between the two values, the Stanford Institute for Economic Policy Research now publishes the two for California pensions.

Thing is that pensions operate on the actuarial standards, standards which exacerbate pension shortfalls.  “Actuarial values determine the annual contributions that states and local governments make to their pension plans, so if the target numbers are too low, the contributions will always be too small. Shortfalls will be compounding, invisibly.”

As Jeremy Gold, an actuary and economist, made note in a speech last year “actuaries shamelessly, although often in good faith, understate pension obligations by as much as 50%… Their clients want them to.”

In the case of Citrus Pest Control District No. 2, Calpers was calculating the municipality’s obligations at an assumed rate of return on assets “now generally around 7.5%,” but when calculating the ‘market value’ of the obligation when the Citrus made the switch, Calpers used a more realistic (based on the current risk-free rate for a similar duration) 2.56%.  Boom, $447,000 shortfall – this is for only 6 people.

‘Houston we have a problem.’

America’s Dazzling Tech Boom Has a Downside: Not Enough Jobs. Jon Hilsenrath and Bob Davis. Wall Street Journal. 12 Oct. 2016.

The highlight is that for all the wealth created from the tech boom, jobs have been cut rather than added.

“Google’s Alphabet Inc. and Facebook Inc. had at the end of last year a total of 74,505 employees, about one-third fewer than Microsoft Corp. even though their combined stock-market value is twice as big. Photo-sharing service Instagram had 13 employees when it was acquired for $1 billion by Facebook in 2012.“

“American tech workers are getting a smaller piece of the economic pie created from what they produce. As of 2014, employee compensation in computer and electronic-parts making was equal to 49% of the value of the industry’s output, down from 79% in 1999, according to the Commerce Department.”

wsj_superstar-tech-cos-create-fewer-jobs_10-12-16

“WhatsApp had more than 450 million users world-wide when Facebook bought the messaging service for $19 billion in 2014, turning founder Jan Koum into a billionaire several times over. At the time of the acquisition, WhatsApp had 55 employees.“

“Economist call the phenomenon ‘skill-biased technical change.’ The spoils of growth go to those few people with skills and luck and who are best positioned to take advantage of new technology.”

“The five largest U.S.-based technology companies by stock market value-Apple, Alphabet, Microsoft, Facebook and Oracle Corp.-are worth a combined $1.8 trillion today. That is 80% more than the five largest tech companies in 2000.”

“Today’s five giants have 22% fewer workers than their predecessors, or a total of 434,505 as of last year, compared with 556,523 at Cisco Systems Inc., Intel, IBM, Oracle and Microsoft in 2000.”

“Harvard University economist David Deming estimates that the hollowing-out of work spread to programmers, librarians and engineers between 2000 and 2012. As much as $2 trillion worth of human economic activity could be automated away using existing technologies, such as Amazon’s robots, in coming years, consulting firm McKinsey & Co. estimates.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – China Property Bubble Could Cause $600 Billion in Bad Debts 10/6

FT – Italy’s 50-year bond – mind the valuation gap 10/6

FT – Renminbi eyes lows as China enjoys reserve currency status 10/9

FT – The Saudis’ strategic failure 10/9

FT – China approves controversial debt-for-equity program 10/10

FT – More millennials switch off social media 10/10

FT – Norway’s oil fund warns on lack of stock market listings 10/11

FT- China corporate raider’s wealth soars ninefold to $17bn 10/12

FT – Dividend or disaster? Nigeria grapples with demographic conundrum 10/12

NYT – Behind Duterte’s Bluster, a Philippine Shift Away From the U.S. 10/9

NYT – This City Is 78% Latino, and the Face of a New California 10/11

WSJ – Recession Odds: Fed Says Don’t Count On It 10/9

WSJ – WeWork Raises $260 Million, Capping Off $690 Million Funding Round 10/12

 

July 29 – August 4, 2016

Insurers having to rethink their business model. India makes a giant leap forward in tax reform.

Headlines

Briefs

    • “Sovereign wealth funds are investing less money directly than at any time in the past five years. This marks the end of a safety net whereby state-backed vehicles mopped up assets in times of market stress, according to research.”
    • “The Bocconi report found that state funds invested €48bn directly last year, down 57% from €112bn in 2008.”
    • “Given the low oil-price environment and lower revenues for oil producers, [state funds] no longer have the cash positions to get into the markets once they correct.” – Sven Behrendt, managing director of GeoEconomica, a consultancy
    • “What if all Londoners, no matter how young or frail, smoked for at least six years? In effect, they already do. The city’s air pollution exacts an equivalent toll on each resident, cutting short the lives of nearly 10,000 people each year and damaging the lungs, hearts and brains of children.”
    • Bottom line, more needs to be done to track and publish long-term air-quality indexes similar to the existing short-term gauges that people and cities can utilize to alter behaviors and make informed life choices.
  • Jonathan Wheatley of the Financial Times called attention to the demand that Emerging Market bonds have seen as the world has become devoid of ‘safe’ income yielding products.
    • “With an estimated 30% of global government debt now offering yields of less than zero, he (Daniel Senecal, head of credit research at Newfleet Asset Management) says traditionally conservative investors are being pushed into new areas.”
    • “If you’re a pensions guy you have to do something. With German 10-years at zero, you need to change your mindset. Your whole view migrates into US high-yield and EMs.” – Daniel Senecal
    • Geez it’s a tough world to invest in right now…

Special Reports

Graphics

WSJ – Why Bank of Japan Dipped Into Bag of Small Tricks 7/29

WSJ_Why Bank of Japan Dipped Into Bag of Small Tricks_7-29-16

Visual Capitalist – The Rise and Fall of Yahoo 7/29

Visual Capitalist_The rise and fall of Yahoo_7-29-16

Economist – Comparing urban air pollution 8/1

Economist_Nitrogen dioxide city comparison_8-1-16

FT – Japan launches $45bn stimulus package – Robin Harding 8/2

FT_Japan stimulus_8-2-16

FT – Emerging market bonds lure investors seeking yield – Jonathan Wheatley 8/2

FT_EM sovereign rally_8-2-16

WSJ – Bank of England Cuts Key Interest Rate to New Low 8/4

WSJ_Bank of England rate reaction_8-4-16

Featured

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

Insurers: Forced to dig deep. Oliver Ralph and Alistair Gray. Financial Times. 1 Aug. 2016.

“Insurers globally are having to come to terms with the idea of ‘lower for longer’ interest rates, making deep changes to business models that had been unaltered for decades. Whereas previously they might have clung to the hope that higher rates were around the corner, there is a realization that the industry has to do things differently – from investing in assets that might once have been seen as too risky, to experimenting with new products.”

As to how much cash are we talking about, PwC estimates that by 2020, insurance companies will manage about $35tn worth of assets.

“Traditionally, much of that has gone to relatively safe homes, such as bonds. At the end of last year, bonds made up about 68% of US property insurers’ total investments and 76% of life insurers’, according to S&P Global Market Intelligence. When those bonds offered decent yields there was no problem. Insurers could fulfill promises to customers and still have plenty left for shareholders.”

But “by last year the net yield on US life insurers’ overall invested assets had fallen to 4.7% – about a quarter lower than 2002 levels.”

Hence, the performance of US life insurance companies has tended to move in tandem with the 10-year Treasury yield…

FT_US life insurance companies and bond yields_8-1-16

In regard to attaining higher returns, insurers can either take on higher risks or tie up cash for longer.  “Many prefer the latter, investing in more illiquid assets such as property. UK insurer Aviva says 80% of the new investments it is making to back its annuity business will be in long-duration assets rather than traditional gilts or corporate bonds.”

“Infrastructure investments are particularly popular as they offer the long-term cash flows life insurers need to back their promises. Germany’s Allianz, for example, is one of the main backers of London’s £4.2bn supersewer.”

Consider the alternative…“Nobody likes to invest at negative yields but life insurers have so much cash that they need to invest, and they need to do something with it.” – James Peagam, head of global insurance solutions at JPMorgan Asset Management

As to the other side of the equation, ‘new products’ or raising premiums, this is already underway.

“Life assurance customers may see the biggest changes. For decades, the industry has offered savings and retirement products that offer guaranteed minimum returns. In the future, these may no longer be on offer.”

“This would be a major shift. In the US, products with guarantees account for 60-80% of the US life insurers’ balance sheets, Moody’s estimates. The average outstanding guarantee is returning between 2% and 4%.”

The replacement product: “unit-linked products. These make no promises: customers’ investments simply rise and fall with the markets. They are similar to traditional asset management products.”

Which of course puts them in direct competition with traditional asset managers that are facing a major business model challenge from low-cost index fund companies like Vanguard and BlackRock.

“As Jon Hocking, an analyst at Morgan Stanley, points out, the unit-linked model distances insurers from their customers. ‘The risk is that you open Pandora’s box and the industry loses its dominant position in the long term savings market. The customer chooses between products and the only distinction is the fund performance” and fees…

So which insurers are under particular pressure, in the US these are the companies specializing in long-term care (“low interest rates have exacerbated the problems caused by rising treatment costs”) and those that have sold ‘universal life’ protection (“policies that combine death benefits with tax-advantaged savings”).

“Transamerica, a large US provider, is being sued by the advocacy group Consumer Watchdog on behalf of policyholders who bought coverage decades ago. It said consumers who had been offered guaranteed interest of at least 5.5% a year had been stung by premium increases of almost 40%.”

India’s economy: One nation, one tax. Economist. 4 Aug. 2016.

India just passed a new goods-and-services tax (GST) that will “unify the country’s 29 states and 1.3 billion people into a common market for the first time.”

“Few countries are fiddlier than India when it comes to paying taxes; the World Bank ranks it 157th out of 189 for simplicity… Because the rates differ between states, making stuff in one and selling it in another is often harder within India than it is in trade blocs such as NAFTA or the European Union.”

“That should change with the GST, essentially an agreement among all states to charge the same (still to be decided) indirect tax rates.”

“Better yet, the GST will be due on the basis of value added. That avoids businesses being thwacked by taxes on the entire value of the products they buy and sell rather than the value they create – a situation that often made it cheaper to import stuff rather than make it locally. Just as importantly, by requiring businesses to document the prices at which they buy inputs and sell products, it will force vast swathes of the economy into the reach of the taxman.”

The tax is supposed to be enacted in April 2017. There is a lot to be buttoned up by then and chances that exceptions will be inserted; however, it is good step forward and has the chance of boosting India’s GDP by 1-2 percentage points.

Other Interesting Articles

The Economist

Bloomberg – Rich Investors Fear Fortunes Will Fade While They’re Playing Golf 7/28

Bloomberg – Fragile U.S. Economy Now Facing a Slowdown in Building Boom 7/31

Bloomberg – Allianz Buys Stake in Manhattan’s 10 Hudson Yards Skyscraper 8/1

Bloomberg – Where First-Time Homebuyers Can Go Big 8/2

Fast Co. Design – An Exclusive Look At Airbnb’s First Foray Into Urban Planning 8/2

FT – The US student debt bubble is a study in financial dysfunction 7/29

FT – Ant’s Alipay challenges China Unionpay’s dominance 7/31

FT – US $18bn credit card debt spree sparks fears 7/31

FT – WTI closes in bear market 8/1

FT – Microsoft sells $20bn of debt to fund LinkedIn Deal 8/2

FT – European bank shares fall in brutal start to August 8/2

FT – Star designers side with Apple in Samsung patent case 8/4

LAT – As new apartments flood downtown L.A., landlords offer sweet deals 8/3

NYT – Harnessing the Immune System to Fight Cancer 7/30

NYT – Zika Cases in Puerto Rico Are Skyrocketing 7/30

NYT – Russia’s Acres, if Not Its Locals, Beckon Chinese Farmers 7/31

NYT – Bank of England Cuts Interest Rate to Historic Low, Citing Economic Pressures 8/4

WSJ – The Divide Between GDP and Jobs 7/29

WSJ – Uber in China: Why Foreigners Never Win in Tech 8/1

WSJ – Chinese Head to the Web to Feed Infants 8/2

WSJ – Why Investors Everywhere Should Watch Japan’s Bond Market 8/2

WSJ – Rio Projects Fail to Reach the Finish Line 8/2

WSJ – Chinese Insurers Need Another Leg to Stand on 8/3

WSJ – What Oil in the $40s Means for Oil Majors 8/4

WSJ – London Falls Behind New York and Hong Kong in Most Expensive City Rankings 8/4

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

April 15 – April 21, 2016

The Wall Street Oil Crash in charts. Chinese $3tn bond market not looking so good.

This week is a very graphic heavy week, just happens that way sometimes.  Additionally, I want to call attention to a report that me and my business partner put out for our real estate development and management business (FP Honolulu Condominium Market Insights) in the Special Reports section.  While it is geared to those interested in the Honolulu Condo market, there is a good deal of text and charts that are pertinent to macro issues at large.  Enjoy.

Headlines

Briefs

    • “Driving all this activity: easy money. Real interest rates have fallen. And nominal GDP grew faster than real GDP for the first time in five quarters, which in theory makes servicing debt easier.”
    • “What should trouble investors is that while China’s economic activity is ticking up, debt is piling up faster. The stock of total financing in the economy, including bond issuance as part of a local government bailout program, rose 15.8% in March from a year ago, the fastest rate since mid-2014. With nominal GDP growing 7.2%, Beijing’s plans to deleverage the economy continue to be overwhelmed by the need to support growth.”
  • In the Wall Street Journal, Madeleine Nissen and Paul Davies point to how negative interest rates are taking their toll on German insurance companies.
    • “German regulators are so concerned about the impact of negative interest rates on the country’s life insurers that they have said they can only be sure the sector is safe through 2018.”
    • “Some insurers need to earn a continuing investment yield of more than 5% to meet guarantees to their policy holders, a report from Germany’s central bank found in 2014.”
    • “What is dangerous is that the return on many investments is no longer reflective of the underlying risk involved. Many investors feel forced into taking higher risks.” – Nikolaus von Bomhard, chief executive of Munich Re
  • If you think it’s been hotter than usual.  You’re right.  As Tom Randall of Bloomberg illustrates, the Earth’s Temperature Just Shattered The Thermometer.
    • “The Earth is warming so fast that it’s surprising even the climate scientist who predicted this was coming.”
    • “Last month was the hottest March in 137 years of record keeping, according to data released Tuesday by the National Oceanic and Atmospheric Administration. It’s the 1th consecutive month to set a new record, and it puts 2016 on course to set a third straight annual record.”
  • Turns out Millennials – like their predecessors before them – want to own their own home.  But, there is a ‘tiny’ problem for millennials living in the big cities.  The down payment.  As Catarina Saraiva of Bloomberg shows us, for many it will take years to save the down payment necessary to buy a home.
    • “Of the generation known for renting everything from designer handbags to desks in a shared office space, 79% say they want to purchase a home, according to a report published Wednesday by Apartment List, an online rental marketplace.”
    • In San Francisco, a 20% down payment on a median priced home equates to $142,800. “Surveyed millennials reported current savings at $14,469, monthly savings of $360 and help from outside sources of $8,264, on average. At that pace, it’ll take them nearly 28 years to save enough money for a down payment, even though 37% of millennials said they’re planning to buy between three and five years from now.”
  • It’s been tough to be a hedge fund lately.  Mary Childs and Lindsay Fortado of the Financial Times point out that $15bn has been pulled out from hedge funds by investors in the last quarter.
    • “Hedge funds have suffered their worst quarter in seven years after more than $15bn was pulled out by investors starting to fight back against the high fees being charged across the industry.”
    • “The total amount invested in hedge funds fell to $2.86tn in the first three months of the year, marking the first time since 2009 that the sector has faced two consecutive quarters of net outflows, according to data from Hedge Fund Research.”
    • But I wouldn’t go predicting the demise of hedge funds.  Ben Carlson of the blog A Wealth of Common Sense did a great job of explaining Why People Invest in Hedge Funds in October 2015.
  • Want to see what arbitrage looks like…Jacky Wong of the Wall Street Journal paints a picture with the reverse migration of many Chinese companies moving their public stock listings from Hong Kong to Mainland China.
    • “A reverse migration by Chinese companies from Hong Kong to mainland stock markets is under way. Juicy valuations are the main draw. But the winners are unlikely to be these companies’ current shareholders.”
    • “Dalian Wanda Commercial Properties, China’s largest shopping-mall owner, said last month its major shareholder is considering delisting the company from Hong Kong, less than two years after its initial public offering. The minimum takeout price is the same 48 Hong Kong dollars (US$6.19) a share that the company listed at in 2014. Meanwhile, a document sent to prospective investors on the mainland said Wanda expects its valuation to more than triple once it is relisted there.”

Special Reports

Graphics

WSJ – China’s Economy Faces Recovery Without Legs – Alex Frangos 4/15

WSJ_China Housing Starts_4-15-16

WSJ – Germany: Where Negative Rates Are Lethal – Madeleine Nissen and Paul J. Davies 4/14

WSJ_Negative yielding debt_4-14-16

WSJ – Why the Great Divide Is Growing Between Affordable and Expensive U.S. Cities – Laura Kusisto 4/18

WSJ_Home value divergence_4-18-16

ValueWalk – 98% of U.S. PE Funds Closed in 1Q Hit Or Exceeded Their Target 4/18

ValueWalk_98% of US PE Funds Hit Target_4-18-16

Bloomberg – It Could Take Years for Big-City Millennials to Save for a Down Payment – Catarina Saraiva 4/20

Bloomberg_Millennials saving for a home_4-20-16

WSJ – Upscale Shopping Centers Nudge Out Down-Market Malls – Suzanne Kapner 4/20

WSJ_Mall Valuations_4-20-16

FT – Beijing rent ranked world’s least affordable 4/20

FT_Beijing is least affordable city for rentals_4-20-16

WSJ – Chinese Reverse Migration Leaves Investors in the Cold – Jacky Wong 4/20

WSJ_Hong Kong v Mainland China listings_4-20-16

Featured

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

Wall Street’s Oil Crash, a Story Told in Charts. Asjylyn Loder. Bloomberg. 15 Apr. 2016.

“JPMorgan Chase & Co., Wells Fargo & Co., Bank of America Corp. and Citigroup Inc., with a combined $190 billion in energy loan exposure, all announced this week that they’re setting aside more money to cover losses.”

Bloomberg_Bank Energy Exposure_4-15-16  

“Many independent drillers, the small producers that drove the shale boom, outspent cash flow even when oil was $100 a barrel, and made up the difference with bank-loans and high-yield bonds. Put simply: No banks, no boom.“

Bloomberg_Shale Cash Shortage_4-15-16 

“Of the four big banks to report results this week, Wells Fargo has the biggest reported exposure to those sub-sectors, at about $14 billion, or 79% of their energy loans outstanding. The bank boosted loan-loss provisions for oil and gas to about $1.7 billion and reported net-charge offs of $204 million.”

Bloomberg_Shrinking credit lines_4-15-16

“Regulators and investors are pushing banks to limit their exposure to the industry. Since the start of the year, lenders have yanked $5.6 billion in credit from 36 oil and gas companies, according to data compiled by Bloomberg.”

It’s All Suddenly Going Wrong in China’s $3 Trillion Bond Market. Bloomberg News. Bloomberg. 18 Apr. 2016.

This is a good follow up to the FT article from last week.

“The unprecedented boom in China’s $3 trillion corporate bond market is starting to unravel.”

“Spooked by a fresh wave of defaults at state-owned enterprises, investors in China’s yuan-denominated company notes have driven up yields for nine of the past 10 days and triggered the biggest selloff in onshore junk debt since 2014. Local issuers have canceled 60.6 billion yuan ($9.4 billion) of bond sales in April alone, while Standard & Poor’s is cutting its assessment of Chinese firms at a pace unseen since 2003.”

“Listed firms’ ability to service their debt has dropped to the lowest since at least 1992.”

“The spreading of credit risks is only at its early stage in China. Many people have turned bearish.” – Qiu Xinhong, a Shenzhen-based money manager at First State Cinda Fund Management Co.

“Economic figures for March reveal a growing dependence on debt. China’s aggregate financing – a broad measure of credit that includes corporate bonds – almost doubled from a year earlier to 2.34 trillion yuan, exceeding all 24 forecasts in a Bloomberg survey as policy makers turned on the taps to support economic growth.”

“The reaction has been swift in China’s 18.8 trillion yuan corporate bond market (a figure that excludes certificates of deposit). The extra yield investors demand to hold seven-year onshore corporate bonds with top ratings over similar-maturity government notes has jumped by 28 basis points from an almost nine-year low in January, to 91 basis points as of Monday.”

Still, very little yield premium compared to the spreads in developed markets.

“Analysts, meanwhile, are getting more downbeat. Twelve-month earnings forecasts for Shanghai Composite companies have dropped by 7.8% this year, the most since 2009, according to data compiled by Bloomberg. S&P has cut its credit ratings or reduced its outlook on 63 Chinese companies this year while upgrading just two, on course for the highest annual ratio of downgrades to upgrades in 13 years.”

“Rising defaults are actually healthy for China’s bond market, said Xia Le, the chief economist for Asia at Banco Bilbao Vizcaya Argentaria SA in Hong Kong.”

“It shows the government is taking away the implicit guarantee. Now risk awareness is rising, so we will see which issuers are swimming naked.” – Xia Le

Other Interesting Articles

The Economist

Bloomberg – America’s Wealth Effect From Rising Home Prices Has Been Cut in Half 4/21

CNBC – Miami real estate is melting down – Robert Frank 4/14

FT – US banks spell out toll of low oil prices 4/14

FT – Foreign governments up US Treasury holdings 4/15

FT – Defaults send chill through China’s bond market 4/15

FT – Will China transform the world’s energy market? 4/17

FT – China’s house prices surge as efforts to cool market fall flat 4/17

FT – Saudi warning on 9/11 law adds to US frictions 4/17

FT – Collapse of Doha talks highlight the rise of Mohammed bin Salman 4/18

FT – 1MDB dispute intensifies as Abu Dhabi ends relationship 4/18

FT – India knocks China from top of FDI league table 4/20

FT – China internet finance crackdown targets fly-by-night operators 4/20

National Real Estate Investor – Foreign Buyers of U.S. Real Estate: By the Numbers 4/14

NYT – Fight to Impeach Brazil’s Leader Tears at Fabric of Daily Life 4/15

NYT – As China’s Growth Slows, Banks Feel the Strain of Bad Debt 4/15

NYT – In Cramped and Costly Bay Area, Cries to Build, Baby, Build 4/16

NYT – Brazil’s Lower House of Congress Votes for Impeachment of Dilma Rousseff 4/17

Reuters – ‘Let them sell their summer homes’: NYC pension dumps hedge funds 4/14

ValueWalk – Is George Soros, 85, Looking For A Fight With China? 4/21

WSJ – How Housing Stacks Up on the Upper West Side 4/13

WSJ – Negative Rates Around the World: How One Danish Couple Gets Paid Interest on Their Mortgage 4/14

WSJ – Why the Great Divide Is Growing Between Affordable and Expensive U.S. Cities – Laura Kusisto 4/18

WSJ – Investors All Mixed Up About Chinese Property Bonds 4/19

WSJ – Negative Rates and Patches of Trouble for Japanese Insurers 4/21

 

March 18 – March 24, 2016

Chinese companies looking for cash flow. The knock on effects of low oil prices. U.S. Commercial Real Estate starting to get that sinking feeling.

Happy Easter! This week the three major themes/articles are 1) James Kynge, Gabriel Wildau and Don Weinland’s “China Inc: The quest for cash flow” in the Financial Times, followed by a three separate articles in the Financial Times discussing the impact of low energy prices 2a) Eric Platt and Laura Noonan’s “Bondholders suffer $150bn oil price hit”, 2b) Simeon Kerr’s “Gulf states will be forced to tap debt markets, warn Moody’s” and 2c) Henny Sender’s “Lower oil tests sovereign wealth funds” all in the Financial Times, and 3) is Peter Grant’s “Turning Point? U.S. Commercial-Property Sales Plunge in February” in the Wall Street Journal.

Other items that are worth a mention (a way for me to highlight a few more articles – with less content):

  • Following up on the coverage on Anbang from last week, Marriott has since upped its offer ($13.6bn up from $11bn in November 2015) for Starwood and has ‘won’ the bid.  While I’m sure Marriott isn’t too happy with the higher price, the shareholders of Starwood are gleeful.  As an aside, it is also looking like Anbang may not have been able to consummate the deal and may have difficulties closing the Strategic Hotels deal.  Have to be mindful of that capital flight…
  • Foreign media sources in China are on edge.
    • “New Chinese regulations aimed at dramatically restricting the publication of foreign content have introduced a new chill into an already frigid press environment in China.”
    • “The directives, which entered force last week, give China’s government draconian powers to stop foreign companies or partly foreign-owned companies from publishing online material unless they have approval from the broadcast regulator – the State Administration of Press, Publication, Radio, Film and Television.”
    • “Industry analysts say the rules fit a new pattern: whereas formerly the government’s press censorship was widely denied and hidden from view, today the government is making its powers and the limits of dissent more explicit and public.“
  • Entertaining read in the FT, “Every cycle is defined by a hubris trade.”  I.E. Julian Robertson’s position in US Airways in the dotcom era and now Bill Ackman’s Valeant position.
  • Think it’s expensive where you live?  In Hong Kong median home prices are around 19 times gross income levels.  As a result it’s not uncommon for married couples to live separately with their respective parents.
  • Transamerica is being sued for cost increases on universal life insurance contracts.  Basically high annuities are hard to cover in a zero to negative interest rate world, so life insurance companies are having to increase fees for certain products, even on existing contracts.
  • And I would recommend each of the Special Reports below.

Interesting graphics:

From the Financial Times’s “Oil and gas: Debt fears flare up.”

FT_American Energy Junk Bond Issuers_3-21-16

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

China Inc: The quest for cash flow. James Kynge, Gabriel Wildau and Don Weinland. Financial Times. 18 Mar. 2016.

This article followed Anbang’s flurry of activity last week and serves up something of an explanation of why Anbang and other Chinese companies have been aggressive in pursuing foreign acquisitions of late.

In 18 months Anbang, the Chinese Insurance company, “has signed $32bn in overseas acquisitions deals.”  To give you a sense, “Since 2014, Anbang has outbid competitors to snap up the Waldorf Astoria hotel, a US landmark, for $1.95bn; paid $1.6bn for US insurer Fidelity and Guaranty Life; $1bn for a controlling stake in Korean insurer Tongyang Life; and scooped up trophy properties in London and companies in Europe.”

“Within this surge of Chinese deals – which have totaled $102bn since January compared with the record $106bn for all of last year, according to Dealogic – lies a paradox for target companies. While the cash offers can seem too big to refuse, they may also appear to come from the corporate equivalent of deep space, so sparse is the information available on the bidder.”

“Anbang, which is just 12 years old, astounded the Chinese insurance world in 2014 with successive fundraising rounds that expanded registered capital from Rmb12bn ($1.8bn) to Rmb62bn in less than a year, introducing 31 new investors. This propelled it to first place among insurers, outstripping the likes of China Life and the People’s Insurance Co of China, even though they far eclipse it in terms of premiums.”

“The lack of transparency, analysts say, may be linked to the preference among many Chinese bidders for all-cash offers.”

“The serious flaws in Chinese corporate disclosure are why all-cash offers are often required.  The cash is less to make the bid more attractive than to compensate for the fact that these companies either don’t have a desirable level of assets or can’t properly document the assets.” – Derek Scissors, China analyst at the American Enterprise Institute.

“To a significant degree, analysts say, the exodus of Chinese investment capital is in fact a ‘quest for cash flow.'”

“Data from 1,627 domestically listed companies, or 58% of the total, that have reported their 2015 earnings show a clear deterioration in fortunes. Average operating revenues per share fell to their lowest level so far this decade, sliding to Rmb5.4 from Rmb6.55 in 2014, according to Wind Information, a data provider.”

“In addition, just over one-fifth of listed Chinese companies reported negative cash flows during 2015 and about one-third owed at least three times as much in debts as they owned in assets, according to Wind.”

“Nevertheless, it would be wrong to assume that Chinese corporate investments overseas are driven solely by a dash for cash, or by capital flight because of fears that the value of the renminbi may slump. Distinct strategic thinking also underlies the moves.”

 

Bondholders suffer $150bn oil price hit. Eric Platt and Laura Noonan. Financial Times. 21 Mar. 2016.

While I try not to bog you down with too much to read, these three interrelated articles pertaining to the energy sector are well worth the read (if you want more, see the Special Report below “Oil and gas: Debt fears flare up.”

First the investors…

“Investors have suffered losses of at least $150bn in the value of oil and gas company bonds, as the slump in crude prices since the summer of 2014 has fueled fears of a wave of defaults in the US and emerging markets.”

“The 300 largest global oil and gas companies have also seen $2.3tn sliced from their stock market value over the same period, a 39% slide since oil began its decline, an analysis by the Financial Times has found.”

“Borrowing by oil and gas companies has soared over the past decade. Their total debt, including loans, almost tripled from $1.1tn in 2006 to $3tn in 2014, according to the Bank for International Settlements.”

“Low oil prices fuel a reduction in risk-taking, and when there is less risk-taking, asset prices will fall. It can lead to a downward asset price spiral.” – Hyun Song Shin, chief economist of the BIS

“Twenty of Europe’s biggest banks have energy loans totaling almost $200bn between them – enough to wipe out a quarter of their common equity. In the US, twenty of the leading banks have loans totaling $115bn, or 11% of their common equity.”

Gulf states will be forced to tap debt markets, warn Moody’s. Simeon Kerr. Financial Times. 21 Mar. 2016.

Next the resource rich countries…

“Oil-rich Gulf governments will be forced to rely on debt markets as their fiscal deficits rise to $270bn amid an extended period of low oil prices over the next two years, Moody’s has said.”

“Last year, the Gulf states largely used reserves and local banks to finance the deficits that are the largest in their history, widening from 9% of GDP last year to 12.5% this year.”

“Saudi Arabia, for example, faces a forecast deficit of $88bn this year and $65.3bn in 2017, according to Moody’s. In 2009, the deficit was $23bn and the previous oil slump of the late 1990s saw the deficit peak at $13bn in 1998.”

“Moody’s forecasts that the kingdom, which has had negligible debt levels for years, is expected to see government debt rise to around 20% of GDP by next year.”

According to Mathias Angonin, a Dubai-based senior sovereign analyst with Moody’s, “proposed subsidy reforms, capital expenditure cuts and the introduction of sales tax from 2018 would not be enough to balance the deep GCC budget deficits.”

Lower oil tests sovereign wealth funds. Henny Senders. Financial Times. 21 Mar. 2016.

And lastly, the sovereign wealth funds that derive their capital from the resource rich countries…

“Circumstances have changed in the Gulf, bringing in their wake a host of ripple effects. A while ago, the biggest headache for the sovereign wealth funds of the Middle East was finding safe but profitable homes for their portion of swelling oil revenues.”

“That will mean both downward pressure on the prices of some assets that has little to do with fundamentals, and more attractive valuations for new money coming in.”

“Moreover, most governments in the region will probably prefer to run down their reserves than to see their currencies lose value, analysts say. That is another reason these giant pools of money will have less to put to work globally going forward.”

“Global liquidity will shrink because global liquidity basically means dollar liquidity and all the GCC and Saudis need dollars.” – Mohamad Al Hajii, a macro strategist for EFG Hermes UAE in Dubai.

“Already Qatar has been quietly selling commitments to private equity funds and public shares, according to people familiar with the matter.”

“The reduced presence of the regional sovereign wealth funds will be felt more strongly in asset classes that have an especially long-time horizon, such as private equity and infrastructure.”

“Weak exports and slowing domestic economies mean that sovereign funds and other deep pools of money in Asia also have less money to invest globally. That means pension funds in countries from Canada to Korea will have more opportunity. But managers at some of these funds say they are still waiting, convinced that if they are patient, there will be even more bargains in coming months.”

 

Turning Point? U.S. Commercial-Property Sales Plunge in February. Peter Grant. Wall Street Journal. 22 Mar. 2016.

“Sales of U.S. commercial real estate plummeted in February, sending the clearest signal yet that a six-year bull market might be coming to an end.”

“Just $25.1 billion worth of office buildings, stores, apartment complexes and other commercial property changed hands last month, compared with $47.3 billion in the same month a year earlier, according to deal tracker Real Capital Analytics Inc. In January, sales were $46.2 billion.”

“Overall, commercial-property values are leveling off. Green Street’s broad valuation index in February was 8.7% higher from one year earlier, but in the previous year the index rose 11%.”

“The market has slowed primarily because of forces at work in the global capital markets rather than problems stemming from real estate itself. These forces, which also caused global markets to plummet in the first two months of this year, have made debt – the lifeblood of real estate – more expensive and more difficult to obtain.”

“The most dramatic sign has been the sharp decline in bonds backed by commercial mortgages. In 2015, about $100 billion of commercial mortgage-backed securities were issued. This year experts believe volume will fall to $60 billion to $75 billion.”

“As yields of junk bonds soared, real estate became a less attractive investment. At the same time, the spreads between real-estate borrowing rates and Treasury bonds widened greatly.”

“Today loans that would have been made with interest rates in the 4.5% to 5% range are now being made above 5%, market participants say. Borrowers who would have lent up to 75% of a property’s value have reduced their so-called loan-to-value ratios to between 65% and 70%.”

“Buyers have been hearing ‘no’ from lenders for the first time in a while,” said Jim Costello, senior vice president at Real Capital Analytics.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Fidelity Calls U.S. Fairly Attractive as Yield Premium Climbs 3/20
Bloomberg – How Satisfying Millennials Could Save PwC $850 Million 3/23

Civil Beat – Can We Grow Our Economy, Not Our Population (Luke Evslin) 3/18

Daily Commercial News – Twenty major upcoming Hotel/Motel and Retail/Shopping Center construction projects – U.S. 3/23

FT – Emerging market debt: A trawl for yield 3/17

FT – China’s rising exports: less about growth, more about exporting deflation 3/17

FT – Every cycle is defined by a hubris trade 3/18

FT – Hong Kong cost of living forces married couples into separate beds 3/20

FT – China bank governor warns over corporate debt 3/20

FT – CBI chief says Brexit would leave economy weaker 15 years on 3/20

FT – China plays ball with its development lending 3/22

FT – Beijing scrambles to contain vaccine scandal 3/22

FT – Anbang’s bids for US hotel chains thrown into doubt 3/22

InvestmentNews – Transamerica sued for cost increases on universal life insurance contracts 3/23

NYT – Cities to Untangle Traffic Snarls, With Help From Alphabet Unit 3/17

NYT – Scientists Warn of Perilous Climate Shift Within Decades, Not Centuries 3/22

WSJ – Starwood Says Boosted Anbang Bid Tops Marriott Agreement 3/18

WSJ – Lessons in Chinese Debt Restructuring: The Debtor Always Wins 3/18

WSJ – Japanese Land Prices Rise for First Time Since Global Financial Crisis 3/22

WSJ – Big Oil’s Next Big Energy Problem 3/23

Special Reports

 

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

 

November 6 – November 12, 2015

The $860bn gorilla is increasing its real estate allocation, Saudi Arabia wants to borrow money, and Passport Global’s commentary on QE, China, and illiquidity.

This week three articles that stood out were 1) Saleha Mohsin’s two-part article in BloombergBusiness “Norway SWF Says Adding $86 Billion in Properties May Be Best” and “Norway’s Wealth Fund Targets Major Cities After Bonds Hit Zero” that covered Norway’s sovereign wealth fund’s planned increase in real estate allocations, 2) was Simeon Kerr’s “Saudi Arabia to tap global bond markets as oil fall hits finances” in The Financial Times that pointed out that Saudi Arabia is about to tap the international debt markets for the first time, and 3) was posting in ValueWalk “Passport Global Up 6.7% in Q3; Burbank Worries About Liquidity” by Rupert Hargreaves that was a commentary of Passport Global’s portfolio positions.

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

Norway SWF Says Adding $86 Billion in Properties May Be Best. Saleha Mohsin. BloombergBusiness. 5 Nov. 2015.

Norway’s Wealth Fund Targets Major Cities After Bonds Hit Zero. Saleha Mohsin. BloombergBusiness. 5 Nov. 2015.

Basically the world’s biggest sovereign wealth fund ($860bn) has had back-to-back quarterly losses.  The first time in six years.

“The fund lost 273 billion kroner ($32 billion) in the third quarter, or 4.9%, amid a drop in global stocks. Its stock holdings declined 8.6%, while it posted a 0.9% gain on bonds and a 3% return on real estate.”

“…The fund’s annual real return has been 3.55% since 1998, behind a government target of 4%.”

The fund isn’t really reaching for yield at a 4%, but

“Slyngstad (CEO) says record-low interest rates will make it difficult to meet return targets in the years ahead.”

While…

“The fund said that nominal returns on real estate have averaged about 7% to 9% from 2000 to 2013 but have seen a “declining trend in recent years.””

And…

“The vast majority of academic studies come to the conclusion that adding real estate does improve the risk-return profile of a mixed-asset portfolio,” the fund said in a discussion note based on research released on Friday. “Estimates of optimal allocations to real estate vary strongly. The median range of the suggested allocations to real estate in the 30 studies reviewed was 15%.”

Therefore,

“Norges Bank Investment Management, which oversees the fund from within the central bank, held about 3% of its assets in real estate at the end of the third quarter. It aims to build that share to 5% by investing about 50 billion kroner ($5.8 billion) each year in property. The investor has a strategy to focus on 10 to 15 cities globally.”

And the fund is even considering raising their allocation to 15%, an additional $86bn that would be funneled in to real estate.  I’m sure they’re not the only ones.  The implications should assist real estate valuations even if the Fed does raise rates in December.  Basically, cap rates will hold and the spreads over treasuries will shrink.

Saudi Arabia to tap global bond markets as oil fall hits finances. Simeon Kerr. The Financial Times. 9 Nov. 2015.

As low oil prices linger on Saudi Arabia has found itself in a new position of raising debt.  While the Kingdom has plenty of reserves on hand (unlike Russia and Venezuela), the country is raising debt while it is cheap to cover their shortfalls that exists due to extensive social programs/commitments to its citizens.

“The decision to tap bond markets underscores the impact on the kingdom’s revenues from the plunge in the oil price, from $115 a barrel last year to $50 now, as well as Riyadh’s expensive military intervention in Yemen.”

To highlight how new this is,

“The authorities are in the meantime looking to set up a debt management office to help oversee the process of raising local and international bonds.”

While some domestically held debt has been issued, this their first time taping international markets and debt levels may increase to as much as 50% of GDP within 5 years (6.7% in 2015 and 17.3% in 2016).

“Riyadh started to issue domestic bonds in the summer to fund its budget deficit. The government could continue to issue domestically for another 12 to 18 months, officials say, but it will need to diversify globally to leave liquidity available for private sector lending.”

As a reminder,

“Over the past year, Saudi Arabia has seen its foreign reserves decline from last year’s high of $737bn to a three-year low of $647bn in September.”

Thus,

“Standard & Poor’s last month reduced Saudi Arabia’s ratings from ‘AA-/A-1+’ to ‘A+/A-1’, saying it could lower them again “if the government did not achieve a sizeable and sustained reduction in the general government deficit.”

But Moody’s did not change its Aa3 stable rating.

Passport Global Up 6.7% in Q3; Burbank Worries About Liquidity. Rupert Hargreaves. ValueWalk. 6 Nov. 2015.

In this posting Hargreaves provides a review of Passport Global’s third quarter results and brings up Passport’s outlook.  What really stood out to me were the following excerpts from Passport:

“Passport goes on to report that tensions have built up in the global financial system since the Fed initiated QE in 2009:

“The coupling of low U.S. interest rates and asset purchases by the Fed put downward pressure on the U.S. dollar and created the backdrop for a carry trade as interest rates and expected returns were higher in foreign domiciles. However, as experienced in past carry trades, while growth can benefit substantially in the run-up, the unwind can leave lasting scars.”

“The corporate debt of non-financial firms in the largest emerging market economies has more than quadrupled from $4 trillion in 2004 to in excess of $18 trillion in 2014, according to the International Monetary Fund (IMF). Approximately a quarter of bond issuances were done in foreign currency and requires annual servicing costs in excess of $236 billion USD.”

“Along with the prospect of rising interest rates in the U.S., we see the repayment and servicing of this debt to be more straining on emerging market corporates. Simultaneously, we see the U.S. dollar becoming more scarce as petro-dollars and revenues generated from commodities priced in dollars have cratered. The world isn’t being supplied with U.S. dollars at the level it has become accustomed to over the past seven years. The U.S. current account deficit continues to decline, 7.3% from 1Q15 to 2Q15. If the Fed keeps on its current path of raising interest rates, we believe U.S. dollar liquidity around the world will only continue to fall.”

“On China as a risk to markets:

“We believe the big risk for global markets over the next several months is a worsening in China’s economy characterized by non-performing loan (NPL) issues—which could lead China to de-peg from the U.S. dollar, lower rates and, in the process, force the liquidation of risk assets around the world. In our view, investors should prepare for a worsening global economic environment and the potential for recessions in both the U.S. and globally.”

“On market illiquidity:

“Market illiquidity, by our measure, is only getting worse. That has led us to run with a lower gross and a low net exposure. The long U.S. dollar trade is still at work. However, we have to work through all those participants who were assuming the Fed would hike because of strong U.S. growth, and we don’t know how long that’s going to play out. U.S. equities and the S&P 500 in particular appear much safer than emerging market equities and those of most other developed markets around the world.”

Brace yourselves.

Other Interesting Articles

The Economist

AWC: Are The Private Markets Getting Too Crowded? 11/12

BloombergBusiness: Goldman Sachs Sees 60% Chance U.S. Expansion Lives to See Ten 11/9

FT: Low oil lifts credit risk at US banks 11/5

FT: Square IPO: payments group prices shares below private market 11/6

FT: Grasp the reality of China’s rise 11/8

FT: Only a crisis can stop the Federal Reserve 11/6

FT: New York art auction sounds gloomy note 11/9

FT: US is suffering a profits recession 11/9

FT: Oil glut to swamp demand until 2020 11/10

FT: US corporate bond yields near 2013 peak 11/11

NYT: The Mystery of the Vanishing Pay Raise 10/31

NYT: Dizzying Ride May Be Ending for Tech Start-Ups 11/10

The Big Picture: “Where The Money Is – Take a look at America’s Economic Output” – howmuch.net 11/6

WP: Baby boomers are what’s wrong with America’s economy 11/5

WSJ: Apollo’s Deal for Control of Schorsch Real-Estate Empire Falls Apart 11/8

WSJ: What $1.5 Trillion in Stock Buybacks Doesn’t Buy 11/8

WSJ: Takeover Loans Have Few Takers on Wall Street 11/8

WSJ: London Office Development Hits Highest Level in Seven Years 11/10

WSJ: Rental Portion of One57 Is For Sale 11/10

WSJ: China Learns What Pushing on a String Feels Like 11/12

October 23 – October 29, 2015

China’s Economic Transition. Sovereign Wealth Funds – How can we reduce costs and increase returns? Corporate Profits Peaked?

This week three key themes that stood out were 1) how China’s economic transition from an investment-led economy to a consumption-led economy is by no means going smoothly as highlighted by The Wall Street Journal’s China’s Central Bank Moves to Spur Economic Growth and The Economist’s Debt in China – Deleveraging delayed 2) continuing on the reduction of petro-dollars in the investment markets how sovereign wealth funds are restructuring themselves to reduce costs while seeking out higher return investments (see The Financial Times’ Asset managers suffer as oil funds withdraw cash and Qatar fund backs Brookfield’s $8bn Manhattan West project), and 3) was a well written article (Peak Profits – The age of the torporation) in The Economist illustrating that corporations (or at least those that currently make up the major indices like the S&P 500) may have passed their profit peaks.

*Note: bold emphasis is mine.

China’s Central Bank Moves to Spur Economic Growth. Lingling Wei. Wall Street Journal.

First, before China entered into its Fifth Plenum this week and removed it’s one-child policy (changed to a two-child policy), the People’s Bank of China (PBOC) cut its benchmark one-year lending and deposit rates by 0.25% points (to 4.35% and 1.5% respectively), reduced banks’ reserve requirement ratios by 0.5% points and is removing caps on deposit rates that commercial banks can offer.

With the intention of lowering corporate financing costs and pumping liquidity into the economy, this

…was the sixth time since November that the Chinese Central bank has cut interest rates and the fourth across-the-board reduction of the amount of deposits banks are required to hold in reserve.

Zhu Chaoping, China economist at UOB Kay Hian Holdings Ltd., estimates the reduction in banks’ reserve requirements will pump about 680bn yuan ($108bn) worth of funds into China’s banking system.

“Taking such a rare action again means the real economy is performing poorly,” said a senior official at the PBOC. “A lot of companies have seen their profitability falling sharply and that’s a key reason why we took the action again today.”

Profits at Chinese industrial companies are down 8.8% in August year-over-year (the biggest monthly fall since 2011).

By loosening controls on deposit rates now, the government is attempting to inject market competition into a politically powerful state-run banking sector that has favored big state companies over a more dynamic private sector.

However, removing the deposit-rate ceiling also

“Removes one of the last remaining hurdles to satisfying the technical criteria set by the IMF” for designation of the yuan as a reserve currency. – Eswar Prasad, a Cornell University professor and former IMF China head.

The barrage of easing measures since late last year has had some success in getting more credit flowing in the economy. Chinese banks issued 1.05tn yuan of new loans last month, the highest on record. However, as credit continues to expand while growth slows, China risks a further buildup in debt. An analysis by consultancy McKinsey & Co. shows that China’s debt load increased by 282% of GDP last year from 158% in 2007.

Nice transition into:

Debt in China – Deleveraging delayed. The Economist.

It’s pretty simple, credit continues to grow faster than the economy so debt load to GDP will continue to increase.

China’s economy grew by 6.9% in the 3rd quarter, yet bank loans increased by 15.4% compared with the same period in 2014.

China’s overall debt-to-GDP ratio is continuing its steady upward climb (at 160% in 2007, now more than 240% – 161tn yuan ($25tn)). It has risen nearly 50% points over the past four years alone.

The question remains, what debt-to-GDP ratio becomes too high, and specifically for China (they have a much longer leash than a sovereign that doesn’t control its monetary policy, i.e. Greece, and then there is the whole +/- $3.5tn in reserves)? As Jim Chanos, famed short seller of Enron and founder/president of hedge fund Kynikos Assoc., pointed out in ValueWalk’s Jim Chanos: China Debt Surge Echoes 1990s Japan “we have an economy addicted to credit.”  While the country doesn’t appear to be facing an “imminent collapse,” it is on a trajectory similar to the one Japan was on before its asset-price collapse in 1991 “but on steroids.”

However, surprisingly the weighted interest rate on existing Chinese liabilities has fallen from roughly 6% to 4.5% this year.

Investors are lending to companies as if they were becoming safer borrowers, even as their liabilities increase.

Yang Chen of Bank of America Merrill Lynch notes that some investors are buying bonds with borrowed cash, believing that the government will wade in to spare them from any big defaults – as it has done in the past.

Wait… this seems vaguely familiar.  What’s that term…moral hazard.

Second,

Asset managers suffer as oil funds withdraw cash. Madison Marriage and Chris Newlands. The Financial Times.

Global asset managers are facing a double hit to their fees, as sovereign wealth funds withdraw billions to support their oil-dependent economies – and switch to a cheaper in-house investment approach.

Of the world’s 50 sovereign wealth funds, which collectively oversee about $6.5tn, one-third have reported a reduction in their invested assets. Of those affected, half derive their capital from oil, according to data provider Prequin.

The Saudi Arabian Monetary Agency, the world’s third-largest sovereign fund with $661bn invested – has withdrawn about $70bn from external asset managers.

Azerbaijan’s oil fund, which oversees $37bn of assets, has said in its annual report that it intends to bring the management of all of its assets in-house. It currently has $662m managed by State Street, the US financial service group, and $664m with Swiss bank UBS.

The Abu Dhabi Investment Authority – the second-largest sovereign fund globally with $773bn of assets – has also grown its in-house teams. It reduced its allocations to investment managers from 75% to 65% last year – in effect, a $77bn outflow from external fund houses.

State Street had outflows of $65bn in the second quarter of 2015, which it blamed partly on clients’ need for cash “due to lower commodity prices.”

Now consider this in conjunction with the efforts for transparency and to reduce fees at the likes of giant pension funds ala The California Public Employee’s Retirement System (Calpers) and the “Canadian model” of brining management in-house (the $125.2bn Ontario Teacher’s Pension Plan and the $54.7bn Ontario Municipal Employee’s Retirement System internally manage about 80% and 88% of their assets respectively) and you can see that the investment management field is under assault.  However, don’t misunderstand. Investors (individuals, pension funds, sovereign wealth funds, etc.) will continue to invest with hedge funds.  Ben Carlson of the blog A Wealth of Common Sense covered this extremely well in his October 11, 2015 post “Why People Invest in Hedge Funds,” so I won’t cover it here, basically investors invest in hedge funds because it’s too hard not to.

Hence,

Qatar fund backs Brookfield’s $8bn Manhattan West project. Henry Sender. The Financial Times.

Qatar Investment Authority is taking down a 44% stake in Brookfield’s $8bn Manhattan West real estate project – a 7m sq ft mixed-use development in NYC, west of Pennsylvania Station (part of the Hudson Yards area).

QIA’s investment comes as many sovereign wealth funds have been putting money into real estate at an earlier stage in than in the past – taking on development risk in pursuit of better returns.

Lastly,

Peak Profits The age of the torporation. The Economist.

For the second quarter in a row the sales and profits of members of the S&P 500 are expected to fall; for the three months to September they are forecast to be 3-5% lower than in the same period last year. Half of big listed American firms now have shrinking profits.

Worldwide earnings per share have stopped growing, measured in dollars. In local-currency terms sales growth has stalled in Asia, slowed in Europe and is expected to collapse in Brazil.

Earnings are high relative to two yardsticks: the S&P 500 earnings per share are 28% above their ten-year average and in America profits are stretched relative to GDP.  Further, the three general methods that have worked in the past to generate growing profits are no longer as easily available.  Specifically, 1) globalization – emerging markets are sputtering, the U.S. dollar is strengthening, and years of joint ventures in China have built competitors that better understand Chinese consumers and are better able at serving them, 2) finance – no longer the driver of profits it was up until 2007-2008, think of the finance arms of GE and GM, and 3) since 2007-2008 wages have been suppressed – there is definitely political pressure to change this.

If the share of domestic gross earnings paid in wages were to rise back to the average level of the 1990s, the profits of American firms would drop by a fifth.

So the quick fix has been share buy-backs (running at $600bn a year in America).

IBM spent $121bn on buy-backs over the past decade, twice what if forked out on research and development. Walmart spent $60bn on buy-backs.

Or cutting costs.

Even for Brazilian firm 3G which specializes in buying mature firms and cutting the “fat,” sales at its most recent target, Kraft are falling at a rate of 5% a year.

For all their obsession with growth, big listed firms appear paralyzed. They long to expand, yet also want to protect peak profits, restrain wages and investment, buy back shares and hold armfuls of excess cash on their balance-sheets.

Other Interesting Articles

Bloomberg Businessweek

The Economist

CNBC: America’s best malls have this tenant in common 10/23

FT: Investing in oil is a slippery slope 10/23

FT: China funding UK to build white elephants 10/23

FT: ‘Deflationary boom’ in prospect as China slows 10/26

NYT: A Global Chill in Commodity Demand Hits America’s Heartland 10/23

NYT: Greenland Is Melting Away 10/27

ValueWalk: Venezuela Selling Its Gold As It Runs Out of Cash 10/29

WSJ: How Global Easing Makes the Fed’s Job Harder 10/25

WSJ: Why It’s Not So Easy for China to Ease 10/26

WSJ: Sam Zell Edges Out of Apartments 10/26

WSJ: Morgan Stanley Makes a Comeback in Real Estate 10/27

WSJ: In China’s Alleyways, Underground Banks Move Money 10/27

WSJ: London and Hong Kong at ‘Risk of House Price Bubble’ 10/29

Special Reports

Bank of America Merrill Lynch: Transforming World Atlas – Investment themes illustrated by maps

Howard Marks – “Inspiration from the World of Sports” Memo – made available on www.marketfolly.com