David Fuller and Eoin Treacy's Comment of the Day
Category - General

    The birth of the surplus

    Thanks to a subscriber for this report from RBC which may be of interest. Here is a section: 

    Surplus about to increase significantly as higher discount rates are adopted…
    In addition, we expect DB schemes are about to see a step change improvement driven by an increase in the assumed rate to discount the liabilities. Under IAS19, the assumed discount rate is a high quality corporate bond yield. However such corporate bonds are few and far between at durations in excess of 30 years. Therefore discount rates tend to be based on gilt yields at those long durations. Actuarial consultants are starting to encourage schemes to adopt a (higher) corporate bond yield at long durations. We expect schemes will increase discount rates by 0.3%, in line with the move by Tesco, and calculate that the aggregate surplus will improve by £41bn. The triennial funding valuation, which determines the employer contribution, should be unaffected.

    …which adds to mortality gains…
    This positive thesis adds to our work on life expectancy. In Death of the deficit, we flagged that UK pension schemes are using older mortality tables which have not yet taken account of the slowdown in life expectancy improvement since 2011. We expect scheme liabilities will reduce by £12bn when the latest tables are adopted.

    ...leading to a surplus of £54bn
    The combination of the expected imminent increase to discount rates and the adoption of the latest mortality tables would boost the aggregate FTSE100 pension position to a surplus of £54bn. We do not believe share prices have factored in this improvement and recommend investors buy a basket of pensions-exposed stocks highlighted in this report.


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    Xi's China a boon for mining

    This article from mining.com may be of interest to subscribers. Here is a section:

    And Xi's enormous power also means his pet projects should receive the full backing of the state.

    The One Belt One Road initiative to recreate the Old Silk Road connecting Asia with Europe was mentioned five times during the speech. (Mao Zedong and Deng Xiaoping received four mentions each)

    Another mega-undertaking, Beijing-Tianjin-Hebei integration, which includes the Xiongan New Area, Xi mentioned twice.
    And even if the party's priorities are shifting away from market-orientated reforms, Beijing's transformation of its heavy industries coupled with programs to fight pollution has already benefitted mining.

    For instance, eliminating overcapacity has boosted profitability in the domestic steel industry and in the process steelmaking raw material prices have been dragged higher. At the end of last year consensus forecast for the iron ore price was $57 a tonne during 2017. Year-to-date it's averaging $71.


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    Musings from the Oil Patch Ocotber 24th 2017

    Thanks to a subscriber for this edition of Allen Brooks’ ever interesting report for PPHB. Here is a section:

    If you are Saudi Arabia, a one-product (oil) economy, and you are watching the aggressive adoption of government policies around the world to stop the sale of internal combustion engine cars, you have to be concerned.  Given that France and the UK have announced bans on the sale of ICE vehicles by 2040, auto industry executives are assuming China will adopt a similar date.  The Netherlands just adopted a 2025 ban on the sale of new ICE cars, with a 2030 date for all ICE cars to be off Dutch roads.   

    For China, the world’s largest car market, having sold over 28 million cars last year (nearly a 14% year-over-year increase), the banning of ICE vehicles will shrink the need for, and eventually eliminate motor fuels, which will have a material impact on Saudi Arabia’s long-term oil export opportunities.  When considering that Saudi Arabia has been fighting Russia and Iran to gain an increased share of the Asian, and especially Chinese, oil markets, anything threatening the long-term success of that fight is of concern, even if it is a future event.
     Is the industrial policy to ban ICE vehicles a signal of the impending end of the Petroleum Age, much like Sheik Yamani predicted?  Is that prospect part of the motivation behind Crown Prince Salman’s plan to sell off a portion of Saudi Aramco, either in an initial public offering or through a direct sale to sovereign wealth funds to raise money now for diversification investments?  In a way, current industry developments and future prospects are similar to the forces that drove OPEC’s formation in 1960.  A brief review of history may help put into perspective why OPEC is struggling to remain relevant now, and will likely continue to struggle in the future. 


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    Volatility and the Alchemy of Risk

    Thanks to a subscriber for this report from Artemis which I consider the best one I’ve read on volatility and what is contributing the record low levels currently evident. Here is a section:

    The death of the snake…
    Volatility fires almost always begin in the debt markets. Lets start with what volatility really is. Volailitiy is the brother of credit… and volatility regime shifts are driven by the credit cycle. Volatility is derived from an option on shareholder equity, but the equity itself can be thought of as a perpetual option on the future success of a company. When times are good and credit is easy, a company can rely on the extension of cheap credit to support its operations. Cheap credit makes the value of equity less volatile, hence tightening of credit conditions will lead to higher equity volatility. When credit is easily available and rates are low, volatility remains suppressed, but as credit contracts volatility rises. 


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    World's Most Daring Monetary Experiment Powers on With Abe's Win

    This article by Enda Curran and Toru Fujioka for Bloomberg may be of interest to subscribers. Here is a section:

    "Globally, the BOJ’s continued policy accommodation should help cushion the blow from the Fed’s balance sheet normalization and the ECB’s expected tapering next year," said Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc in Hong Kong. "The BOJ will not be able single-handedly to keep rates low everywhere, but its commitment to continued monetary accommodation should restrain any possible global yield rise."

    Indeed, a sharper divergence between its policy outlook and the rest of the developed world may aid the BOJ’s cause should the yen continue to weaken, helping to accelerate inflation by making imports pricier. The yen slumped to its weakest since July on Monday and shares moved higher as markets digested Abe’s landslide.

    Abe’s decisive win on Sunday will embolden supporters of Abenomics, the prime minister’s signature economic policies centered around monetary and fiscal policy accompanied by structural reforms. It also increases the likelihood of BOJ Governor Haruhiko Kuroda being reappointed when his term comes up in April, according to Bloomberg Intelligence analyst Yuki Masujima, meaning the central bank’s policy framework won’t change.

    Naohiko Baba, chief economist for Goldman Sachs in Japan, noted in a report on Monday that "the largest tangible result" of Abe’s commitment to the very ambitious inflation target has been to keep the yen weak and boost equities. The currency has declined more-than 20 percent since Abe took office in December 2012, while the Nikkei 225 Stock Average has roughly doubled.


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    Macro Morsels October 17th 2017

    Thanks to a subscriber for this report from R. Harding at Maybank which takes a cautionary tone in this issue. Here is a section:

    As the Federal Reserve just recently reported, while the mainstream media continues to tout that the economy is on the mend, real (inflation-adjusted) median net worth suggests this is not the case overall. As stated, the recovery in net worth has been heavily skewed to the top 10% of income earners

    Of course, this explains why the largest number of the population over the age of 65 is still employed as they simply can't afford to retire.  

    The multi-generational households are on the rise, not by choice but by necessity. These are long-term headwinds that suggest economic growth will remain weak, and the rise in delinquencies, slow-down in auto demand, and weak retail sales all suggest consumers may have reached the limits of the debt-driven consumption cycle for now. 
    In other words, individuals are ratcheting up debt, not to buy more stuff, but just to maintain their current "standard of living."

    The disconnect between the stock market and real economic growth can certainly continue for now. Exuberance and confidence are at the highest levels on record, but the underlying stories are beginning to weave a tale of an economy that is very late in the current cycle. 

    Importantly, these are not short-term stories either. The long-term picture for the economy and the markets from the three biggest factors (Debt, Deflation, and Demographics) continues to build. These factors will continue to weigh on economic growth, and market returns, during the next generation as the massive wave of baby-boomers shift from supporters to dependents of the financial and welfare system.


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    Deep Dive into Digital Era of Gaming

    Thanks to a subscriber for this report from Barclays which may be of interest. Here is a section:

    Gaming data points available today point to an industry facing challenges: The number of physical games sold in the US has declined every year for the better part of the last decade, the install base of consoles is well below the prior cycle peak, and the physical attach rate of software is below where it was in the last two console cycles. However, this is the old way of analyzing this business and in the new “Digital Era” of video games, the business has shifted from one that is hit-driven and reliant on physical retail to an industry that is largely online (over 60% digital and could arguably shift completely online longer term), more recurring and predictable, more monetize-able, and significantly more profitable. 

    When we consider that the number of games sold as digital copies continues to grow at 20- 30% each year, notably the market for console software is actually growing – albeit at a single-digit rate. Add to that, the install base of hardware continues to progress towards 100mn+ HD units and, while the physical attach rate of software is below where it was in the last two console cycles, the focus on deeper engagement and higher player monetization through digital content appears to be largely offsetting the impact of fewer game sales. We remain optimistic that newer hardware including Nintendo’s Switch and Microsoft’s Xbox One X can re-invigorate the market for games and are encouraged by some early trends. US retail sales are tracking up mid-single digits year over year in 2017 and, adjusting for sales of digital games, it appears that the number of games sold each year in the US is stable y/y. 

    In the Digital Era, gaming content will always be available and players will have access to games in more ways than ever. The industry will become far more global and fragmented across devices than before, which will increase the potential audience for gaming content substantially. We are cautiously optimistic on the potential for traditional video game publishers to further penetrate the rapidly-growing markets in China and on Mobile, however, and we remain on the sidelines regarding the emerging interest in eSports and VR. Nonetheless, we still believe the value proposition of games remains very high relative to other forms of media and we are encouraged that the new revenue TAM in the Digital Era is dictated only by the amount of time players have to engage with games, rather than by the number of consoles in their hands.


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    Venezuela's Behind on Its Debt and Facing Two Huge Bond Payments

    This article from Bloomberg may be of interest. Here is a section:

    Venezuela could still also make the payments on time. While $10 billion in foreign reserves isn’t much for a country that now owes some $140 billion to foreign creditors, it’s still enough to pay the bills for a while.

    And the Maduro government has surprised the bond market before, making payments the past couple years that many traders had anticipated would be missed. Some of those now betting that these next two payments will also be made actually point to the $350 million currently overdue on the other notes as an encouraging sign. Those arrears indicate, they contend, that officials are prioritizing the payment of bonds with no grace period at the expense of those they can put off without penalty.

    Even if Venezuela can make the payments due this year, investors say that, unless oil prices stage some sort of miraculous comeback, they still see default as an inevitable outcome. Credit-default swaps show they’re pricing in a 75 percent chance of a PDVSA default in the next 12 months and 99 percent in the next five years.


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