Thursday, April 28, 2016

27/4/16: The Debt Crisis: It Hasn't Gone Away

That thing we had back in 2007-2011? We used to call it a Global Financial Crisis or a Great Recession... but just as with other descriptors favoured by the status quo 'powers to decide' - these two titles were nothing but a way of obscuring the ugly underlying reality of the global economy mired in a debt crisis.

And just as the Great Recession and the Global Financial Crisis have officially receded into the cozy comforters of history, the Debt Crisis kept going on.

Hence, we have arrived:


U.S. corporate debt is going up, just as operating cashflows are going down. And so leverage risk - the very same thing that demolished the global markets back in 2007-2008 - is going up because debt is going up faster than equity now:

As ZeroHedge article correctly notes, all we need to bust this bubble is a robust hike in cost of servicing this debt. This may come courtesy of the Central Banks. Or it might come courtesy of the markets (banks & bonds repricing). Or it might come courtesy of both, in which case: the base rate rises, the margin rises and debt servicing costs go up on the double.

Wednesday, April 27, 2016

27/4/16: MIIS Team Comes Second in 2015-2016 The Economist MBA Case Competition

Well done to our MBA students at MIIS ( on taking the second place in The Economist MBA case competition: Real Vision Investment Case Study. See the details of the case study here: The winners were from Ryerson University. Our students second place project is described here: Awesome result!

This comes on foot of 2015 win by MIIS team in The Economist MBA case competition: Muddy Waters Investment Competition, the details of which are available here:

Which, of course, attests not only to the brilliance of students, but also to the consistently top quality of the programme.

Sunday, April 24, 2016

24/4/16: Silicon Valley Blues Go Into a Sax Solo...

In recent weeks, I have been covering growing evidence of pressures in the ICT sector bubble (the Silicon valley blues of shrinking VC valuations and funding). You can track this coverage from here:

Now, with its usual tardiness, the Fortune arrives to the topic too, in a rather good exposition here:

Good summary graphic from Renaissance Capital:

But, of course, what is more interesting in the sector development is the horror show of earnings reporting that is unfolding across mature segment of the tech sector. These are well-covered here:, offering the following summary:

So let's see: earnings in mature segment are falling or the 5th quarter in a row (even when you control for Apple performance); earnings of Apple (tech leader) are into their second consecutive quarter of severe pressures. And unicorns (which don't even offer any serious basis for fundamentals-based valuations, including those on the basis of earnings) are rapidly taking on water. You don't really need a CFA to get this one right...

Friday, April 22, 2016

22/4/16: Russian Economy: Renewed Signs of Pressure

Earlier this week, I posted my latest comprehensive deck covering Russian economy prospects for 2016-2017 (see here: Key conclusion from that data was that Russian economy is desperately searching for a domestic growth catalyst and not finding one to-date.

Today, we have some new data out showing there has been significant deterioration in the underlying economic conditions in the Russian economy and confirming my key thesis.

As reported by BOFIT, based on Russian data, “Russian economy has shrunk considerably from
early 2015. Seasonally adjusted figures show a substantial recovery in industrial output in the first three months of this year. Extractive industries, particularly oil production, drove that growth with production in the extractive sector rising nearly 3.5 % y-o-y. Seasonally adjusted manufacturing output remained rather flat in the first quarter with output down more than 3 % y-o-y.”

As the result, “the economy ministry estimates GDP declined slightly less than 2% y-o-y in 1Q16. Adjusting for the February 29 “leap day,” the fall was closer to 2.5%.”

Meanwhile, domestic demand remained under pressure. Seasonally adjusted volume of retail sales fell 5.5% y/y and is now down 12% on same period in 2014. “Real household incomes contracted nearly 4% y-o-y. Driven by private sector wage hikes, nominal wages rose 6 % y-o-y, just a couple of percentage points less than the pace of 12-month inflation.”

A handy chart:

Oil and gas production, however, continued to boom:

What’s happening? “Russian crude oil output was up in January-March by 4.5% y-o-y to record levels. Under Russia’s interpretation of the proposed production freeze to January levels, it could increase oil output this year by 1.5‒2%. The energy ministry just recently estimated that growth of output this year would only reach 0.5‒1%, which is quite in line with the latest estimate of the International Energy Agency (IEA). However, Russia’s energy ministry expects Russian oil exports to increase 4‒6% this year as domestic oil consumption falls.”

It is worth noting that the signals of a renewed pressure on economic growth side have been present in advanced data for some time now.

Two charts below show Russian (and other BRIC) Manufacturing and Services PMIs:

Both indicate effectively no recovery in the two sectors in 1Q 2016. While Services PMI ended 1Q 2016 with a quarterly average reading of 50.0 (zero growth), marking second consecutive quarter of zero-to-negative growth in the sector, Manufacturing PMI posted average reading of 49.1, below the 50.0 zero growth line and below already contractionary 49.7 reading for 4Q 2015.

Russia’s composite quarterly reading is at 49.9 for 1Q 2016 an improvement on 4Q 2015 reading of 49.1, but still not above 50.0.

In simple terms, the problem remains even though its acuteness might have abated somewhat.

21/4/16: Drama & Comedy Back: Grexit, Greesis, Whatever

Back in July last year, I wrote in the Irish Independent about the hen 'latest' Greek debt crisis: Optimistically, I predicted that a full-blown crisis will return to Greece in 2018-2020, based on simple mathematics of debt maturities. I was wrong. We are not yet into a full year of the Greek Bailout 3.0 and things are heading for yet another showdown between the Three-headed Hydra the inept Greek authorities, the delusional Germany, and the Lost in the Woods T-Rex of the IMF.

Predictably, IMF is still sticking to its Summer 2015 arithmetic: Greek debt is simply not adding up to anything close to being sustainable: an example of the rhetoric here. Meanwhile, the FT is piping in with a rather good analysis of the political dancing going on around Greece: here. The latter provides a summary of new dimensions to the crisis:

  1. Brexit
  2. Refugees crisis
But there is a kicker. Greece is now in a primary surplus: latest Eurostat figures put Greek primary balance at +0.7% GDP for 2015, well above -0.25% target. And Greek Government debt actually declined from EUR320.51 billion in 2013 to EUR319.72 billion in 2014 and EUR311.45 billion in 2015. This can and will be interpreted in Berlin as a sign of 'improved' fiscal performance, attributable to the Bailout 3.0 'reforms' and 'assistance'. The argument here will be that Greece is on the mend and there is no need for any debt relief as the result.

Still, official Government deficit shot from 3.6% of GDP in 2014 to 7.2% in 2015. Annual rate of inflation over the last 6 months has averaged just under -0.1 percent, signalling continued deterioration in economic conditions. Severe deprivation rate for Greek population rose to the crisis period high in 2015 of 22.2 percent, up on 21.5 percent in 2014. Industrial production on a monthly basis posted negative rates of growth in January and February 2016, with February rate of contraction at -4.4% signalling a disaster state, corresponding to 3% drop on the same period 2015. Volume of retail sales fell 2.2% y/y in January marking fourth annual rate of contraction in the last 5 months. Unemployment was 24% in December 2015 (the latest month for which data is available), which is down from 25.9% for December 2014, but the decline is more likely than not attributable to simple attrition of the unemployed from the register, rather than any substantial improvement in employment.

In simple terms, Greece remains a disaster zone, with few signs of any serious recovery around. And with that, the IMF will have to continue insisting on tangible debt relief from non-IMF funders of the Bailout 3.0.

It is a mess. Which probably explains why normally rather good Washington Post had to resort to a bizarre, incoherent, Trumpaesque coverage of the subject. This,, in the nutshell, sums up American's disinterested engagement with Europe. 

Enjoy. Grexit is back for a new season to the screens near you. And so is Greesis - that unique blend of fire and ice that has occupied our newsflows for 6 years now with high drama and some comedy.

Thursday, April 21, 2016

21/4/16: Taking Sugar From the Kids Pantry: Tech Sector Valuations

In a recent post I covered some data showing the trend toward more sceptical funding environment for the U.S. (and European) tech start ups:

Recently, Quartz added some interesting figures to the topic:

Things are not quite getting back to fundamentals, yet... but when they do, tech sector hype will blow up like a soap bubble in a tub. When the entire sector is valued on the basis of some nefarious stats instead of hard corporate finance parameters, you are into a game that is what Russian Roulette is to a Poker table.

21/4/16: Economic Outlook: Advanced Economies

My article on economic outlook forward for the Advanced Economies is now out at the Manning Financial quarterly:

20/4/16: Russian Deck Update: April 2016

Updated version of my Russian markets deck

Tuesday, April 19, 2016

19/4/16: Leverage and Equity Gaps: Italy v Rest of Europe

Relating to our previous discussions in the MBAG 8679A: Risk & Resilience: Applications in Risk Management class, especially to the issue of leverage, recall the empirical evidence on debt distribution and leverage across the European countries corporate sectors.

Antonio De Socio and Paolo Finaldi Russo recently contributed to the subject in a paper, titled “The Debt of Italian Non-Financial Firms: An International Comparison” (February 25, 2016, Bank of Italy Occasional Paper No. 308:

Per authors, “In the run-up to the financial crisis Italian firms significantly increased their debt in absolute terms and in relation to equity and GDP.” This is not new to us, as we have covered this evidence before, but here are two neat summaries of that data:

What is of greater interest is more precise (econometrically) and robust estimate of the gap in leverage between Italian firms and other European corporates. “The positive gap in firms’ leverage between Italy and other euro-area countries has widened in recent years, despite the outstanding debt of Italian firms has decreased since 2011.”

Another interesting insight is the source of this gap. “We find that, controlling for several firm-specific characteristics (i.e. age, profitability, asset tangibility, asset liquidity, turnover growth), the leverage of Italian firms is about 10 percentage points higher than in other euro area countries. Differences are systematically larger among micro and small firms, whereas they are small and weakly significant for firms with assets above 300 million euros.”

But equity gap, defined as “the amount of debt to be transformed into equity type funds in order to fill the leverage gap with other countries”, is not uniform over time.

“…in order to reach the same average level as other euro-area countries, Italian firms should transform about 230 billion euros of financial debt into equity type finance, corresponding to 18 per cent of their outstanding debt. The gap is largest, at around 28 per cent of outstanding debt, for small firms and micro firms with over 1 million euros of assets.”

Authors note one influential outlier in the data: “A large part of the estimated corrections is due to the comparison with French firms, which on average have one of the lowest levels of leverage in Europe. Excluding these companies, the equity gap would drop to 180 billion euros.”

Dynamically, “the results indicate that the gap has widened somewhat since 2009, from about 180 to 230 billion euros”.

Given the EU-wide (largely rhetorical) push for increasing capital structure gearing toward equity, “the Italian Government recently put in place some incentives to encourage recourse to equity financing by reducing the debt tax shield: a cap on the amount of interest expense that could be deducted from taxable income and tax deductions linked to increases in equity (according to the Allowance for Corporate Equity scheme). Similarly, other measures have also been aimed at strengthening the supply of risk capital for Italian firms. The results of our analysis suggest that Italian firms still need this kind of incentives to strengthen their financial structure.”

18/4/16: Capital Gains Tax & Investment Distortions: Corporate Data from the U.S.

In our MBAG 8679A: Risk & Resilience:Applications in Risk Management class we have been discussing the links between taxation, optimal corporate capital structuring and investment, including the decisions to pursue M&A as an alternative strategy to disbursing cash to shareholders.

Lars Feld, Martin Ruf, Ulrich Schreiber, Maximilian Todtenhaupt and Johnnes Voget recently published a CESIfo Working paper, titled “Taxing Away M&A: The Effect of Corporate Capital Gains Taxes on Acquisition Activity” (January 26, 2016, CESifo Working Paper Series No. 5738: The paper links directly taxation structure to M&A decisions and outcomes.

Per authors, “taxing capital gains is an important obstacle to the efficient allocation of resources because it imposes a transaction cost on the vendor which locks in appreciated assets by raising the vendor’s reservation price in prospective transactions.” Note, this is an argument similar to the effects of limited interest deductions on mortgages and transactions taxes on property in limiting liquidity of real estate.

“For M&As, this effect has been intensively studied with regard to shareholder taxation, whereas empirical evidence on the effect of capital gains taxes paid by corporations is scarce. This paper analyzes how corporate level taxation of capital gains affects inter-corporate M&As.”

Specifically, “studying several substantial tax reforms in a panel of 30 countries for the period of 2002-2013, we identify a significant lock-in effect. Results from estimating a Poisson pseudo-maximumlikelihood (PPML) model suggest that a one percentage point decrease in the corporate capital gains tax rate would raise both the number and the total deal value of acquisitions by about 1.1% per year. We use this result to estimate an efficiency loss resulting from corporate capital gains taxation of 3.06 bn USD per year in the United States.”

I am slightly sceptical about the numerical estimate as the authors do not appear to control for M&A successes. However, since the lock-in mechanism applies to all types of re-investment projects, one can make a similar argument with respect to other forms of capex and investment. One way or the other, this presents evidence of distortionary nature of U.S. capital gains taxation regime.

18/4/16: Taxing 1%?.. Make My Day...

An interesting paper on the dynamics of income inequality from Xavier Gabaix, Jean-Michel Lasry, Pierre-Louis Lions and Benjamin Moll (December 2015, CEPR Discussion Paper No. DP11028:

Take in the abstract alone for key conclusion:

“The past forty years have seen a rapid rise in top income inequality in the United States. While there is a large number of existing theories of the Pareto tail of the long-run income distributions, almost none of these address the fast rise in top inequality observed in the data. We show that standard theories, which build on a random growth mechanism, generate transition dynamics that are an order of magnitude too slow relative to those observed in the data. We then suggest two parsimonious deviations from the canonical model that can explain such changes: "scale dependence" that may arise from changes in skill prices, and "type dependence," i.e. the presence of some "high-growth types." These deviations are consistent with theories in which the increase in top income inequality is driven by the rise of "superstar" entrepreneurs or managers.”

So the key to alleviating inequality increases (if the key were to be found in income / wealth tax territory so frequently inhabited by socialstas) is not to tax all high earners, but to tax the very left tail of the high earners’ distribution, or so-called “"superstar" entrepreneurs or managers”. It’s not a 1% tax, nor a tax on wealth (capital), nor a tax on “anyone earning more than EUR100,000” (the latter being commonly bandied around the countries like Ireland), that is a panacea. It is, rather, a tax on Zuckerbergs and Bloombergs, Bezoses and Ellisons et al.

Which, sort of, means taxing exactly those who create own wealth, rather than inherit it from mommy or daddy… Perverse? If it is the “high-growth types” that are the baddies, not the Rothschilds or the Kochs who inherited wealth, at fault, then the entrepreneurs should be taken out and fiscally shot.

And if you do, here’s what you will be fiscally shooting at: innovation (see The linked paper conclusion: “our findings vindicate the Schumpeterian view whereby the rise in top income shares is partly related to innovation-led growth, where innovation itself fosters social mobility at the top through creative destruction”.

Dust out that ‘tax the 1%’ argument, again… please.

Monday, April 18, 2016

18/4/16: Anti-Discrimination Law’s Unintended Consequence?

The Law of Unintended Consequences in a case of anti-discrimination law? It appears to be so.

A graduate paper from MIT Economics by Alexander Bartik and Scott Nelson, titled “Credit Reports as Résumés: The Incidence of Pre-Employment Credit Screening” (see March 7, 2016, MIT Department of Economics Graduate Student Research Paper 16-01: looks at “recent bans on employers' use of credit reports to screen job applicants – a practice that has been popular among employers, but controversial for its perceived disparate impact on racial minorities.” Controlling for geographic, temporal, and job-level variations the authors “analyze these bans' effects in two datasets: the panel dimension of the Current Population Survey (CPS); and data aggregated from state unemployment insurance records.”

Key finding: “the bans reduced job-finding rates for blacks by 7 to 16 log points, and increased subsequent separation rates for black new hires by 3 percentage points, arguably contrary to the bans' intended effects. Results for Hispanics and whites are less conclusive. We interpret these findings in a statistical discrimination model in which credit report data, more so for blacks than for other groups, send a high-precision signal relative to the precision of employers' priors.”

It is worth noting limitations to the study, clearly identified by the authors, however. In particular those relating to “Catch-22” scenario: “the question of how [survey data] interacts with household balance sheets: if highly levered households are more likely to become delinquent soon after job loss, employers’ use of PECS will make job finding more difficult for these households, thus exacerbating long-run unemployment for an important subset of the population. Indeed, the “Catch-22” of being unable to repay debts because of unemployment, and being unable to become employed because of unpaid debts, has been another salient policy motivation for [use of credit reports in hiring] bans”.

On the other hand, as noted by authors, other studies largely align with the core findings that the ban has been harmful to the category of applicants its is designed to protect.

“Is it reasonable that restrictions on the use of information like PECS in the hiring process can have such a large impact on job-finding rates? Other evidence from the literature suggests yes. Studying the effect of the usage of credit information in hiring in Sweden, Bos et al. (2015) find that the removal of information on past defaults from credit reports results in a 6.5 percent increase in employment rates for affected individuals in the year after the past default information removal. In related work, Wozniak (2014) finds that laws discouraging or encouraging the use of drug-testing in the hiring process have a 7 to 30 percent effect of black employment levels in affected industries. Both of these papers suggest that regulations of information used in the hiring process can have economically large impacts on employment outcomes.34 However, the large magnitude of our results does suggest the need for caution in their interpretation until these findings can be explored in further research.”

And to illustrate:

Figure 6: Event-Time Analysis of the Effect of PECS on Job-Finding
State-Race Fixed Effects (FE), Time-Race FE, Time-State FE

Note: If anyone seen any worthy responses / comments relating to this paper, its findings and/or methodology, do let me know by commenting below. I am sure we are going to see some serious debates emerging over time about these findings.