A Different Perspective
Asking the Right Questions
Bank of England Inflation Report
In his latest inflation report press conference, Mark Carney, Governor of the Bank of England (BOE), concluded that the UK economy “is returning to a semblance of normality”. The BOE have reduced their central estimate of “slack” in the economy to around 1% of GDP but also their estimate of wage growth, which they noted has been “remarkably weak”. As a result, the BOE will now be “placing particular importance on the prospective paths for wages and unit labour costs”. Unlike the previous quarter, Carney offered no sporting analogy on how the economy was performing, most likely because of England’s dismal performance at the World Cup, a similar fate he will be keen to avoid in his quest for the “prize of a strong, sustained and balanced expansion”.
Eurozone Economic Recovery & Pressure on the ECB
The flash estimate of second quarter GDP, published by Eurostat, showed that the Eurozone economy was flat in the second quarter after growing by a mere 0.2% in the first quarter. While many of the peripheral countries recorded faster growth there was weakness was in the core of Europe, Germany and France. The French economy stagnated for a second consecutive quarter while the most disappointing news was the German economy contracting by -0.2%, combined with a big drop in the Zew Indicator of Economic Sentiment for August. The survey noted that “The decline in economic sentiment is likely connected to the ongoing geopolitical tensions that have affected the German economy by now.”
Everyone and their grandmother is now calling for the European Central Bank (ECB) to do more, namely follow the other major central banks down the QE path of bond purchases. However, while financial markets have clearly benefited, the effectiveness of these massive bond purchase programs in the US, UK and Japan on bringing about a sustainable recovery in the real economy is still up for debate. Also, the long term side effects may have yet to show themselves. Central banks have become the dominant player in bond markets, raising liquidity concerns. Then there are the risks associated with fiscal dominance which is when “the central bank finances government deficits through the printing press”, as put bluntly by Bundesbank President Jens Weidmann in a 2013 speech.
Either way, the ECB are unlikely to make any new move in the near term as their targeted long term refinancing operations (TLTRO’s), announced in June, only come into effect in September. The first step on the QE path will be via an ABS bond purchase program which is still in the early design stage. Fixing the banking channel in Europe is more of a pressing concern than simply playing to the market’s tune for buying government bonds. Ultimately though, the ECB’s efforts are all pointless without real structural reform at a country level.
ECB: Update on Intensive Preparatory work on ABS Purchases
As expected the European Central Bank (ECB) made no change to monetary policy, with Draghi reiterating the usual spiel that monetary policy will remain accommodative, inflation expectations remain in check and of course the Governing Council is “unanimous in its commitment to also use unconventional measures, like ABS, like QE”. It was in June that Draghi first told us that the ECB was “intensifying preparatory work for outright purchases in the ABS (asset backed securities) market”. It has clearly been a busy few months for the “various committees of the ECB” working on this. Their initial conclusion? They cannot do it alone and are hiring a consultant “to help design this programme in the best possible fashion”.
So it seems it is time for the financial “engineers” who orchestrated the mess to come to the rescue and unblock the banking channel that is impairing the ECB’s monetary policy transmission mechanism and hence the economic recovery. In a market environment driven by the reach for yield, it is noteworthy that the major financial market participants have not already moved to revive the ABS market. The issue has to be price and the true value of some of the loans the European banks are sitting on, hence the need for the financial engineers!
Premier League 2014/15: We go again!
While the world’s political leaders grapple for power, as they have always done and will always do, a more entertaining battle for supremacy kicks off on Saturday with the start of the 2014/15 Premier League season. The great thing about a new season is the unfettered hope that springs eternal among all football fans, whether their club is in the lower leagues or in the upper echelons of the Premier League. Old defeats and disappointments have been laid to rest with fans everywhere proclaiming ‘this is our year’. Well at least as a Liverpool fan that’s how I see it but maybe we’re a special breed. Of course the big money clubs like Manchester City and Chelsea will be favourites with Arsenal likely putting up a stronger fight this year while Liverpool will have the added pressure of the Champions League. So who do I think will win the league? Liverpool of course, this is our year!
Buy Irish Property, you can’t lose?!
“Your house will be worth 20pc more by 2017 – ESRI” read the headline of an article in the Irish Independent last week referring to a paper released by the Economic Social and Research Institute (ESRI) entitled Bubble, Bubble Toil and Trouble? An Assessment of the Current State of the Irish Housing Market.
The paper is worth a read with the author making the case, based on four fundamental house price models and other comparative analysis, that residential property prices “overcorrected”. With residential property now undervalued, according to their models, the ESRI is forecasting real Irish house prices to grow by 8% in 2014, 9% in 2015, 4.9% in 2016 and 3.9% in 2017.
The ESRI is simply forecasting a price rise so it’s an ambitious use of the word “will” by the author of the Irish Independent article, but perhaps another sign that the Irish love affair with property is being reignited. The ESRI even noted on page 16 of the report “This is not to say that increasing house prices are either inevitable or desirable”; but I guess that wouldn’t have made much of a headline.
Weekly Market Recap: 11th August 2014
Market Recap
Global equity markets struggled again last week with investors finally beginning to reassess the potential impact of the standoff between the West and Russia, along with the escalating crisis in the Middle East. European equity markets were also hurt by some weaker than expected economic data, including confirmation that Italy moved back into technical recession in the second quarter. However, most concern was centred on Germany, the engine of growth for the Eurozone economy, as manufacturing orders fell 3.2% in June following recent weakness in the IFO business climate survey. At present, the ECB’s Mario Draghi is putting the weakness down to “technical factors…..namely less working days” but he did concede that “if the geopolitical risks materialise, it’s quite clear that the next two quarters will show lower growth”.
Whatever the reason for the economic weakness, German equities are still falling with the DAX Index down another 2.2% last week bringing the YTD decline to -5.7%. The peripheral markets were harder hit with the major indices in Italy and Spain down 5.7% and 3.9% respectively. In Asia, Japan’s Nikkei 225 Index was the worst performing major index, declining 4.9% for the week after a drop of 3% on Friday. US equity markets bucked the negative trend ending the week marginally higher, unperturbed by the US airstrikes in Iraq. Core government bond yields continued to move lower with the German 10-Year government bond yield closing the week at 1.05% while the yield on the German 2-Year note turned negative.
Week Ahead
European equity markets have opened higher this morning following a positive session in Asia overnight. Japan’s Nikkei 225 Index recouped some of the losses sustained last week with a gain of 2.4%. It is a busy week on the macro front this week with reports on industrial production, retail sales, employment and inflation from around the globe as well as second quarter GDP data for the Eurozone, UK, Japan and Russia.
The initial estimate of second quarter GDP growth is published for the Eurozone on Thursday with the consensus estimate at 0.4%, up from the weaker than expected 0.2% recorded in the first quarter. The official data and the survey data are slightly at odds on how well the Eurozone economy is performing so a weaker than expected print would not be a surprise. Meanwhile, the Japanese economy weakened in the second quarter after the front loading of spending in Q1 ahead of the April 1st consumption tax increase. It is simply just a case of how steep the slowdown was and whether it is temporary or a waning of the Abe effect.
The Bank of England will release their quarterly inflation report on Wednesday which will provide further insight into their outlook for the UK economy and hence monetary policy. Investors will be hoping for further clarity from Mark Carney on the Bank’s measurement of “economic slack”, given the strong performance of the UK economy and concern about financial stability risks, most notably the buoyant housing market.
Is Herbalife (NYSE:HLF) a Pyramid Scheme?
“[T]he organization is deemed a pyramid scheme if the participants obtain their monetary benefits primarily from recruitment rather than the sale of goods and services to consumers”. Peter J Vander Nat; William W Keep
The legendary hedge fund manager Bill Ackman, founder of Pershing Square Capital Management, believes so and since December 2012 he has embarked on what has been referred to as a “crusade” against Herbalife. Ackman says his fund has spent over $50 million investigating the company and last Tuesday he delivered a presentation on Herbalife which he called “the most important presentation that I have made in my career”. His mammoth presentation along with his research, including undercover work, is posted online at http://www.factsaboutherbalife.com/.
Herbalife describe themselves as “a global nutrition company that has helped people pursue healthy, active lives since 1980”. Whereas Ackman claims “the customers are fictitious, the business opportunity is a scam, and the university degree is a fraud” (referring to the Herbalife “Success University” training program). The core issue is whether the company is deriving their revenue from the sale of a product or through the recruitment of new individuals (“independent distributors”), sold the dream of what their website calls “a proven business opportunity”.
Check out this video from a couple of “Chairman’s Club Members” entitled “Duplication is the Key to Stable Royalties”. Cindy sells the audience the dream, the rise from poverty to building their own home on an “unlimited budget” and ‘spending $100,000 in a Paris flea market in five minutes’. The reaction from the audience to her nonsense would suggest that Herbalife are definitely appealing to the desperate who just want to ‘believe’. Anyway, fast forward to 8:20 on the video for the “recruitment” spiel from her husband Kurt. What is he drawing? Looks like a pyramid to me!
Ironically, the Herbalife (HLF) stock price rose 25% the day Ackman made his career defining presentation. This has left him open to ridicule from the media but Ackman has been here before. He spent the best part of six years taking on MBIA Inc., and in effect the system, which reportedly made his investors more than $1 billion. The story is chronicled in the book Confidence Game: How Hedge Fund Manager Bill Ackman Called Wall Street’s Bluff which I am currently reading. On a side note his current fund is up a reported 25% this year, so those questioning whether Ackman has taken his eye off the ball for his investors, by getting personal, are misguided.
You may ask, why should we care about the Ackman v Herbalife story? I believe it again raises question marks over some of the guiding principles of modern finance but most importantly it reminds investors of why we have active management. I am not talking about active managers who hug their benchmark, paralysed by career risk; I am talking about real active managers, like Ackman. Hedge funds have a bad name, mostly because of their high fees and the wealth of their founders, but they serve an important purpose in the financial system and for investors searching for uncorrelated returns.
UK Economy Surpasses Pre-Crisis Peak in GDP
The UK economy grew by 0.8% in the second quarter, according to the preliminary estimate from the Office for National Statistics. This was in line with market expectations and marks the second consecutive quarter on quarter increase of 0.8%. Much of the headline news focused on the fact that UK GDP is now estimated to be 0.2% above the pre-crisis peak of Q1 2008.
There are two caveats though. First, GDP per capita, i.e. output per individual, remains significantly below the pre-crisis level. Second, the UK economic recovery is “unbalanced”, driven by household spending with borrowed money. The Bank of England Governor, Mark Carney, has been vocal on this point. Therefore, the big challenge will be to sustain the recovery without debt fuelled spending (not unique to the UK) as borrowing to spend simply takes consumption from the future. This is one of the main reasons Carney will delay raising interest rates as long as possible and why normalisation will be very gradual
Weekly Market Recap: 28th July 2014
Market Recap
Many of the major equity indices closed the week in positive territory, despite the brief sell-off on Friday. The decline in the German IFO Business Climate Index, for a third consecutive month, was blamed with the German DAX index and French CAC 40 index losing 1.53% and 1.82% respectively on Friday, among the few indices to finish down for the week. Peripheral European equity markets significantly outperformed with Spain’s IBEX 35 Index up 3.4% while the Athens Stock Exchange General Index was up almost 6%. Still, amidst what appears to me like “risk-on” investor behaviour, core government bonds were in demand with the 10-Year German Government bond yield closing the week down 2bps at 1.15%.
IMF Downgrade and Global PMI Surveys
In their latest World Economic Outlook (WEO) Update, the IMF have cut their forecast for global GDP growth to 3.4%, down from 3.7% in April. They have blamed “one-off factors and slower demand in emerging markets”. While the IMF note that downside risks remain, they are clear that “continued policy efforts are needed to secure a more robust recovery”. Nothing new for investors to digest! The global PMI data released by Markit last week does support the IMF’s view that the global economy is picking up after a disappointing start to the year.
Outlook
European equity markets have opened relatively flat this morning after a mixed session in Asia overnight. It is a busy week on the economic front this week. There is data from Europe on unemployment, inflation and retail sales, while in the US the advance estimate of second quarter GDP will be keenly watched along with Friday’s employment situation report. There is also a host of purchasing manager index (PMI) reports from around the globe which will provide a further update on the direction of the economy. However, the monetary policy meeting at the US Federal Reserve will be centre stage as investors look for clues on the timing of the first interest rate hike. Earnings season continues with more than 140 S&P 500 companies reporting.
Weekly Market Recap: 21st July 2014
Market Recap
Global equity markets finished the week marginally higher despite a deterioration in the geopolitical situation worldwide and mixed economic data. There was only a brief wobble in equity markets on Thursday following the news that a Malaysian Airlines plane was shot down while there has been little reaction to the indiscriminate bombing of Gaza by US-backed Israel. Although equity markets have shrugged off the geopolitical risk and the slowdown in the global economic recovery the bond markets this year have delivered a much less sanguine assessment of events. Last week, the yield on the 10-Year German Government bond yield hit a record low of 1.15%.
Week Ahead
European equity markets have opened lower with the focus on the impact of sanctions on Russian after a mixed session in Asia overnight.
Key macro data this week includes the flash global PMI data, a useful leading indicator on the outlook for the global economy. The UK will release the first estimate of second quarter GDP which is expected to show growth of 0.8%, in line with the first quarter. The Bank of England will release the minutes of their most recent monetary policy meeting with investors searching for any clues on the timing of the first interest rate and their plan for normalising monetary policy. In the US, we will get an update on the housing market with reports on new and existing home sales while durable goods orders will be in focus on Friday after a much weaker than expected reading in May.
