Tuesday, May 16, 2017

16/5/17: Navigating the Bubbling Up Investment Seas


Here are the slides from my presentation at the IPU Conference 2017 two weeks ago:





















16/5/17: Technology: Jobs Displacement v Enhancement


Technological innovation is driving revolutionary changes across the labour markets and more broadly, markets for human capital. These changes are structural, deep and accelerating, and, owing to their nature, are not yet sufficiently understood or researched.

One theoretically plausible aspect of the technological innovation in terms of human capital effects is the expected impact of technology on demand for (and therefore supply of) different occupations. For example, we know that technology can act as a complement to or a substitute for labour.

In the former case, we can expect advancement of technology to create more jobs that are closely linked to enhancing technological innovation, deployment and productivity. In other words, we can expect more geeks. And we can expect - given lags in education and training - that as demand for geeks rises, their wages will rise in the short run before falling rather rapidly in the longer term.

In the latter case, there is a bit less certain, however. Yes, technology’s primary objective is to lower costs of production and increase value added. As a result, it is going to displace vast numbers of workers who can be substituted for via technological innovation. However, not all substitutable workers are made of the same cloth and not all technological innovation is capable of achieving unambiguous returns on investment necessary to sustain it. Take, for example, an expensive robot that costs, say, USD 600.000 a pop, but can only replace 3 lower skilled workers in a laundromat, earning USD16,000 per annum. So with benefits etc factored in, the cost of these 3 workers will be around USD70,000 per annum. It makes absolutely zero sense to replace these workers with new tech at least any time before the tech systems become fully self-replicating and extremely cheap. So, for really lower skills distributions, we can expect that jobs displacement by technology is unlikely to materialise soon. But for mid-range wages, consistent with mid-range skills, there is a stronger case for jobs displacement.

All of which suggests that we are likely to see a U-shaped polarisation process arising when it comes to jobs distribution across the skills segments: higher wage segment rising in total share of employment, as complementarity effects drive jobs creation here; and the lower wage segment also rising in total employment, as robots-induced increase in value added across the economy translates into greater demand for low-skills jobs that cannot be efficiently displaced by technology, yet. In the middle, however, we are likely to witness a cratering of employment. Here, the workers are neither complementary to robots, nor are they earning low enough wages to make expensive robots non-viable as a replacement alternative for labour.

Interestingly, we are already witnessing this trend. In fact, we have been witnessing it since the early 1990s. For example, Harrigan, James and Reshef, Ariell and Toubal, Farid paper titled “The March of the Techies: Technology, Trade, and Job Polarization in France, 1994-2007”, published March 2016, by NBER (NBER Working Paper No. w22110: http://ssrn.com/abstract=2755382) looked into “employee-firm-level data on the entire private sector from 1994 to 2007” in France.

The authors “show that the labor market in France has polarised: employment shares of high and low wage occupations have grown, while middle wage occupations have shrunk.” So the story is consistent with an emerging U-shaped labour market response to technological innovation on the extensive margin (in headcount terms). And more, the authors also find that inside margin also polarised, as “…the share of hours worked in technology-related occupations ("techies") grew substantially, as did imports and exports.”

However, the authors also look at a deeper relationship between technology and jobs polarisation. In fact, they find that, causally, “polarisation occurred within firms”, but that effect was “…mostly due to changes in the composition of firms (between firms). [And] …firms with more techies in 2002 saw greater polarization, and grew faster, from 2002 to 2007. Offshoring reduced employment growth. Among blue-collar workers in manufacturing, importing caused skill upgrading while exporting caused skill downgrading.”


16/5/17: Insiders Trading: Concentration and Liquidity Risk Alpha, Anyone?


Disclosed insiders trading has long been used by both passive and active managers as a common screen for value. With varying efficacy and time-unstable returns, the strategy is hardly a convincing factor in terms of identifying specific investment targets, but can be seen as a signal for validation or negation of a previously established and tested strategy.

Much of this corresponds to my personal experience over the years, and is hardly that controversial. However, despite sufficient evidence to the contrary, insiders’ disclosures are still being routinely used for simultaneous asset selection and strategy validation. Which, of course, sets an investor for absorbing the risks inherent in any and all biases present in the insiders’ activities.

In their March 2016 paper, titled “Trading Skill: Evidence from Trades of Corporate Insiders in Their Personal Portfolios”, Ben-David, Itzhak and Birru, Justin and Rossi, Andrea, (NBER Working Paper No. w22115: http://ssrn.com/abstract=2755387) looked at “trading patterns of corporate insiders in their own personal portfolios” across a large dataset from a retail discount broker. The authors “…show that insiders overweight firms from their own industry. Furthermore, insiders earn substantial abnormal returns only on stocks from their industry, especially obscure stocks (small, low analyst coverage, high volatility).” In other words, insiders returns are not distinguishable from liquidity risk premium, which makes insiders-strategy alpha potentially as dumb as blind ‘long lowest percentile returns’ strategy (which induces extreme bias toward bankruptcy-prone names).

The authors also “… find no evidence that corporate insiders use private information and conclude that insiders have an informational advantage in trading stocks from their own industry over outsiders to the industry.”

Which means that using insiders’ disclosures requires (1) correcting for proximity of insider’s own firm to the specific sub-sector and firm the insider is trading in; (2) using a diversified base of insiders to be tracked; and (3) systemically rebalance the portfolio to avoid concentration bias in the stocks with low liquidity and smaller cap (keep in mind that this applies to both portfolio strategy, and portfolio trading risks).


Monday, May 1, 2017

30/4/17: The Scariest Chart in the World


The scariest chart in the world this week, indeed this month, comes from the U.S. and plots U.S. real GDP growth with 1Q 2017 print at just 0.7% y/y.

Yes, the print ranks 13th from the bottom for any positive growth quarter since 2Q 1947. And yes, the rate of growth is (a) preliminary (subject to revisions) and (b) seeming one-off (driven by fall-off in consumer demand, despite strong indicators on consumer confidence side). There are reason and heaps of arguments why this print should not be treated as huge concern and that things might improve in 2Q and on.

But... the really scary stuff is longer-term trend in U.S. growth. And that is illustrated in the chart below:

Look at the grey bars: these take periods of expansion in the U.S. economy and average rates of growth over these periods. Notice the patter? Why, yes, the average expansion-consistent rates of growth have fallen, steadily, since 1975 through today. Worse, controlling for volatile growth (average rates) in pre-1975 period, an exponential trend for average expansion-consistent growth rates (the yellow line) is solidly trending down.

The latest period of economic expansion is underperforming even that abysmal trend. And 1Q 2017 is underperforming that worse than abysmal average.

Now, let me highlight that point: yellow line only considers periods of consistent growth (omitting official recessions, and one unofficial recession of  2001). So, no: the depth of the Great Recession has nothing to do with the yellow line direction. If anything, given the depth of the 2008-2009 crisis, the most current grey bar should have been at around 4%, almost double where it sits today.

That is what makes the chart above the scariest chart of April. And will probably make it the scariest chart of May too.

30/4/17: Did Russia Really Cut 2017 Defense Budget by a Quarter?

Headline figures from the Federal Treasury of the Russian Federation show a budgetary cut to the country defense spending of a whooping 25.5% y/y for 2017: from RUB3.8 trillion (USD65.4
billion) to RUB2.8 trillion.

However, the headline figure of 25.5% is misleading, because it is based on a fiscal defense allocation in 2016 that includes the federal funding for defense industry debt reductions.

Let me explain.


Russian defense budget (excluding debt payments) in 2016 was RUB3.07 trillion. Debt payments added ca RUB700-800 billion to that amount. Which means that 2017 defense allocation represents a decline of just 7% on 2016 actual defense spending figure, slightly deeper cut, but still in line with previously budgeted 6% reduction. In other words, relative to October 2016 projections for 2017, latest budgetary proposal is to reduce defense spending by an additional RUB230-240 billion, not by RUB1.06 trillion associated with 25.5% cut figure.

Since the start of 2014 economic crisis, and the associated funding crisis (relating to sanctions against a range of Russian lenders and corporates), Russian defense sector has suffered from sustained debt pressures. In December last year, the Ministry of Finance, made a one-time payment to defense contractors to reduce their commercial debt levels, amounting to between RUB700 and RUB800 billion. The range of numbers that reflects timing of payments and exchange rates used, plus rounding differences.

Multi-annual budgetary framework implies that on top of 7% cut in 2017, defense budget will also face reductions of 3.8% in 2018 and 4.8% in 2019. On top of this, the reductions in 2017-2019, even if implemented (a big if) come on foot of Russian defense spending expansion in 2011-2014 that saw nominal defense spending rising at almost 20% per annum. Even with a 7% cut, 2017 defense spending will still be some 14.4% above 2014 levels (in nominal terms).

Based on the ludicrous mistake of including one-off debt repayment into defense budget figures, the Stockholm International Peace Research Institute (SIPRI) - a defense spending watchdog - reported that "Russia increased its spending by 5.9 per cent in 2016 to $69.2 billion, making it the third largest spender. Saudi Arabia was the third largest spender in 2015 but dropped to fourth position in 2016. Spending by Saudi Arabia fell by 30 per cent in 2016 to $63.7 billion, despite its continued involvement in regional wars." Even though the same report admits that "late in 2016 actual spending was pushed substantially higher by a decision to make a one-off payment of roughly $11.8 billion in government debt to Russian arms producers. Without this debt repayment, Russia’s military spending would have decreased by 12%".

This, in the nutshell, is the circus that is 'analysis' of Russian data: with actual spending down, and amounting to ca USD57.4 billion, Russia is still behind Saudi Arabia in terms of military expenditures. The one-off payment of debt in the State Owned semi-commercial military suppliers, hardly represents an expenditure that materially increased Russian army, navy of its airforce, in as much as, say Greek debt restructuring did not materially increase country investment or output. But, the narrative of 'Bad Kremlin is beefing up its military to start WW3' is simply too delightful to pass.

Thing is, personally, I am not a fan of either increasing spending on the military (for any country, including Russia) or subsidising debt loads of State (or private) enterprises. However, if we are to bother reporting fiscal spending across specific programmes, debt relief is not equivalent to increased spending on core programmes relating to defense. It's a waste of taxpayers' resources. But it is not a waste that has gone into funding new bombs or howitzers.

Friday, April 28, 2017

28/4/17: Macron v Le Pen: Data Maps


The must-see set of data maps relating to upcoming Macron-Le Pen Presidential election (round 2) in France is available here: https://www.bloomberg.com/graphics/2017-french-election-maps/. Their relative positions (slightly changing since round 1) are explained here: http://trueeconomics.blogspot.com/2017/04/15417-naughty-and-not-very-nice-french.html.


28/4/17: The VUCA Markets


My regular column with the Cayman Financial Review covering the current development of the risk-uncertainty frameworks in the markets is now available here: http://www.caymanfinancialreview.com/2017/04/26/welcome-to-the-vuca-world/.


28/4/17: Euromoney on Italian Risks


Euromoney article on the continued evolution of the Italian crisis: http://www.euromoney.com/Article/3712913/Country-risk-Italy-is-the-volcano-waiting-to-erupt.html, quoting - amongst others - myself.


28/4/17: Trump Tax Plan: Impact on Ireland


My (quick) take on the potential impact of the U.S. corporate tax reforms for Ireland: https://www.thesun.ie/news/917087/ireland-could-benefit-from-donald-trumps-cuts-to-us-tax-rates-according-to-a-top-economist/. Hint: don't panic.


28/4/17: Russian Economy Update, Part 4: Aggregate Investment

The following is a transcript of my recent briefing on the Russian economy. 

This part (Part 4) covers outlook  for aggregate investment over 2017-2019. Part 1 covered general growth outlook (link here), part 2 covered two sectors of interest (link here) and part 3 concerned with monetary policy and the ruble (link here).

From the point of Russian economic growth, investment has been the weakest part of the overall ex-oil price dynamics in recent years.

Rosstat most recent data suggests that the recovery in seasonally adjusted total fixed investment continued in 1Q 2017, with positive growth in the aggregate now likely for the 2Q 2017:

  • 4Q16 investment was down about 1% from 2015
  • Total investment rose from 22.12% of GDP in 2015 to 25.63% in 2016, and is expected to moderate to 22.23% in 2017, before stabilsing around 22.9% in 2018-2019
    • The investment dynamics are, therefore, still weak going forward for a major recovery to take hold
    • However, 2017-2019 investment projections imply greater rate of investment in the economy compared to 2010-2014 average
  • However, last year fixed investment was down by 11% from 2014
    • This is primarily down to Rosstat revision of figures that deepened the drop in investment in 2015
  • About a quarter of total aggregate investment in Russia comes from small firms and the grey economy
    • Rosstat data suggests that such investment was roughly unchanged in 2016 compared to 2015
  • Other fixed investments, which are mostly investments of large and mid-sized companies, shrank by about 1% in 2016
    • This compounds the steep drops recorded in the previous three years (down 10% in 2015 alone), so the level of investment last year remained below that of the 2009 recession
    • Investments of large and mid-sized companies within oil & gas production sector rose robustly in 2016
      • This marked the third consecutive year of growth in the sector
      • Much of the increases was driven by LNG sub-sector investments which is associated (at current energy prices) with lower profit margins 
      • On the positive side, investments in LNG facilities helps diversify customer base for Russian gas exporters - a much-needed move, given the tightening of the energy markets in Europe
    • In contrast to LNG sub-sector, investment in oil refining continued to shrink, sharply, in 2016 for the second year in a row, 
    • Other manufacturing investment also recorded continued sharp declines
    • The same happened in the electricity sector
    • In contrast, following two years of contraction, investment in machinery and equipment stabilised for the mid- and large-sized corporates
    • Construction sector activity was down 4% y/y in 2016, marking third consecutive year of declines
      • Exacerbating declines in 2015, commercial and industrial buildings completions fell again in 2016
      • Apartments completions also fell y/y marking the first drop in housing completions since 2010

As the chart above illustrates:

  • The forecast if for 2017-2019 improvements in investment contribution to growth, with trend forecast to be above 2010-2014 average
  • However, historically over 2000-2016 period, investment has relatively weak/zero correlation (0.054) with overall real GDP growth, while investment relative contribution to growth (instrumented via investment/growth ratio) has negative correlation with growth even when we consider only periods of positive growth
  • This implies the need for structural rebalancing of investment toward supporting longer-term growth objectives in the economy, away from extraction sectors and building & construction

Going forward:

  • Russia's industrial / manufacturing production capacity is nearing full utilisation 
  • The economy is running close to full employment
  • Leading confidence indicators of business confidence are firming up
  • Corporate deleveraging has been pronounced and continues
  • Corporate profitability has improved 
  • Nonetheless, demand for corporate credit remains weak, primarily due to high cost of credit 
    • Most recent CBR signal is for loosening of monetary policy in 2017, with current rates expected to drop to 8.25-8.5 range by the end of 2017, down from 10% at the start of the year
  • Irrespective of the levels of interest rates, however, investment demand will continue to be subdued on foot of remaining weaknesses in structural growth and lack of reforms to improve business environment and institutions

Taken together, these factors imply that the recovery in fixed investment over 2017-2019 period is likely to be very slow, with investment recovery to pre-2015 levels only toward the end of forecast period.

Thematically, there is a significant investment gap remaining across a range of sectors with strong returns potential, including:

  • Food production, processing and associated SCM;
  • Transportation and logistics
  • Industrial machinery and equipment, especially in the areas of new technologies, including robotics
  • Chemicals
  • Pharmaceuticals and health technologies


28/4/17: Russia Cuts Headline Rate by 50bps


Bigger than forecast move by the Russian Central Bank to cut rates (down 50bps against consensus - and my own - forecast of 25bps cut) signals the CBR's comfort with inflationary expectations forward.


As noted in my regular advisory call on the Russian economy earlier this week (transcript here), inflation fell substantial in 1Q 2017, with current FY 2017 forecast sitting at around 4.3 percent. In line with this, CBR started cutting rates at the end of March, moving from 10% to 9.75% for its benchmark one-week auction rate. Today, the CBR lowered the rate to 9.25%.

According to CBR: "“Inflation is moving towards the target, inflation expectations are still declining and economic activity is recovering. Given the moderately tight monetary policy, the 4 percent inflation target will be achieved before the end of 2017 and will be maintained close to this level in 2018-2019.”

Median Bloomberg estimate is for the rate to fall to 8.5% by the end of the year. As I noted in the call: "I expect ...year-end (2017) rate target of around 8.25-8.5% if inflation remains on the path toward 4.3% annual rate, or 8.75-9% range if inflation stays around 4.6% annual rate".

The latest move helps the cause of the Federal budget (championed by the Economic Ministry) that needs to see ruble lose some of its attractiveness as a carry trade currency. In recent months, ruble has been the third best performing currency in the world, resulting in investors willing to borrow in foreign currencies to invest in rubles denominated assets. The net effect of this on the Russian economy is improving demand for imports and deteriorating budget dynamics (as Russian budget operates ruble-based expenditure, funded to a large extent by dollar and other forex revenues from exports of primary materials).

Nabiulina's move today, however, should not be interpreted as the CBR surrender to the Economic Ministry agenda of lowering ruble value. Instead, the rate cut is clearly in line with inflation targeting and also in line with previously stated CBR concerns about investment environment in Russia. Russian aggregate investment has been extremely weak in recent years, and economic recovery needs to involve a dramatic reversal of investment volumes to the upside, especially in areas of technology, R&D, and product and processes innovation. High interest rates tend to significantly reduce investment by making capital expenditure more expensive to fund.

Thursday, April 27, 2017

27/4/17: Russian Economy Update, Part 3: Ruble and CBR Rates


The following is a transcript of my recent briefing on the Russian economy. 

This part (Part 3) covers outlook  for ruble and monetary policy for Russia over 2017-2019. Part 1 covered general growth outlook (link here) and part 2 covered two sectors of interest (link here).

Outlook for the ruble and CB rates

The ruble has appreciated this year about 6.6% against the US dollar, from 61.15 at the start of 2017 to just above 57.10 so far, and 3% against the euro from 64.0 to 62.06, compared to the start of 2016, ruble is up on the dollar ca 21.3% and on the euro some 22.4%

  • The ruble has been supported by the strengthening in the trade surplus in late 2016 into early 2017, and by improved foreign investment inflows
  • The ruble has been on an upward trend after hitting the bottom at the start of 2016
  • However, rate of appreciation has fallen in recent months, while volatility has risen
  • March real effective (trade-weighted) exchange rate (RER) was up nearly 30% y/y, as reported by BOFIT (see chart below)
  • As noted by some researchers (e.g. BOFIT), “in Russia, exchange rate shifts tend to pass through relatively quickly and strongly to consumer prices, so ruble strengthening tends to curb inflation” which, in turn, increases private and fiscal purchasing power
  • Another effect of the ruble appreciation is that it lowers government ruble-denominated tax revenue through direct link between energy exporting taxes (oil and gas) and oil prices, which are denominated in dollars 


For domestic businesses, a stronger ruble:

  • Reduces their price competitiveness with respect to imports, but also 
  • Lowers the cost of imported capital, technology and intermediates
    • Majority of Russian manufacturers are relatively highly dependent on such imports and have very limited non-ruble exports


  • Stronger ruble has very limited effect on the volume of Russian exports, primarily due to heavy bias in exports in favour of dollar-denominated energy and other primary materials
  • Ruble appreciation reduces the costs of foreign debt service for firms (a positive for larger firms and banks) and can lead, over time, to lower borrowing costs within Russian credit markets (a positive for all firms)


In line with the export-import effects discussed above:

  • Volume of Russian exports grew by over 2 % last year (primarily driven by oil and gas prices recovery and continued elevated volumes of Russian production of primary materials), plus by another (second consecutive) year of grain harvests 
    • In 2017, export growth should slow as both harvest and energy prices effects dissipate
    • Volume of exports of goods and services fell 1.87% in 2014, 0.41% in 2015 and 0.68% in 2016. Current forecasts suggest that the volume of exports will rise 4.5-4.6% in 2017
  • Volume of imports was much harder hit by the crisis
    • Volume of imports of goods and services fell 7.6% in 2014, followed by 25.0 drop in 2015 and 4.0% decline in 2016
    • Current forecasts suggest strong, but only partial recovery in demand for imports, with volumes expected to rise 7.0-7.2% in 2017
    • Key driver for imports growth will be the recovery in aggregate demand, plus appreciation of the ruble
    • Key downward pressure on imports will continue to come (as in 2016) from trade sanctions and from ongoing reforms of public and SOEs procurement rules and systems (more on this later)
  • Russia’s current account surplus contracted last year to less than 2% of GDP, printing at USD 22.2 billion, down from USD69 billion in 2015
    • 2017 projections of the current account surplus range widely, although no analyst / forecaster projects a negative print, despite expected increase in imports
    • IMF’s most current (April 2017) projection is for 2017 CA surplus of USD51.5 billion
    • This level of CA surpluses would stand above the 2014-2016 average (USD 49.6 billion), but below 2010-2013 average (USD67.4 billion) and lower than 2000-2007 average (USD 55.7 billion)
    • If IMF projection comes through, CA surplus will be supportive of significantly tighter fiscal deficit than currently projected by Moscow
    • As a percentage of GDP, CA surplus is expected to come in at 3.30% in 2017, slightly above 2014-2016 average of 3.19% and slightly below the 2010-2013 average of 3.42% of GDP


Inflation


  • With Russian inflation falling and current account surplus strengthening, 2017 will witness further pressures on the ruble to appreciate vis-à-vis the dollar and the euro
  • Russia’s annual inflation fell below 5% in 1Q 2017
  • The CB of Russia has kept a relatively tight monetary stance, holding the key rate at nearly 10% through most of 1Q, as consistent with the CBR strict targeting of the inflation rate (4% inflation target set by the end of 2017)
    • CBR dropped rate to 9.75% at the end of March, noting a faster-than-expected drop in inflation and a slight decline in inflation expectations 
  • Inflation fell from 4.6% in February to 4.5% in March and 4.1% as of mid-April
    • 12-month forecast now at 4.3%
    • CBR governor Nabiullina said the central bank does not share the finance ministry's view of a overvalued ruble, which is consistent with her projecting continued cautious stance on inflation
    • Finance Minister, Anton Siluanov, recently stated that the ruble is overvalued by 10–12%
    • Consistent with this, I expect a 25 bps cut at April 28th meeting of CBR Council and year-end (2017) rate target of around 8.25-8.5% if inflation remains on the path toward 4.3% annual rate, or 8.75-9% range if inflation stays around 4.6% annual rate