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

    Email of the day on Japanese equity index composition

    I wonder if you could please analyse why the historic charts of Japan's main equity market are so divergent? 

    As you know, the Tokyo market reached its "bubble era" peak in Jan. 1990 at 38,564 but has since recovered to around 19,063. 

    The Topix bank index peaked at the same time at 1,480 but is still languishing at a fraction of that level, 182.64 today. 

    The Topix 2nd Section index on the other hand is now at an all-time high from its peak of 4,500 reached in 1990 to approaching 6,000. 

    Normally the banks are the lead indicator but Japan's banks underwent immense restructuring so I can understand why they have languished but the discrepancy between these charts seems huge.


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    Europe's Diesel Decay Set to Accelerate in VW Cheating Fallout

    This article by Elisabeth Behrmann and Tom Lavell for Bloomberg may be of interest to subscribers. Here is a section:

    Diesel cars’ popularity in Europe has been waning as Volkswagen’s emissions-test manipulation scandal, which emerged in late 2015, compounded concerns that pollutants from the fuel are outweighing the benefits of its lower CO2 emissions. Mercedes outlined plans last week to accelerate a rollout of battery-powered cars by 2022, saying combustion engines would continue to be refined only for a transitional period.

    “Diesel’s share in Europe has been declining for years because of stricter emissions regulation making the technology more expensive,” and potential restrictions on the models in cities such as Munich will probably damp sales further, Thomas Schlick, an automotive consultant at Roland Berger, said by phone. “The longer-term implications for a drop in combustion- engine demand are significant for the industry as by our calculations about one-third of jobs in the auto industry are related to drive-train technology.”

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    Email of the day on the Swiss Franc spot rate:

    The Incredible Shrinking Universe of Stocks, The Causes and Consequences of Fewer U.S. Equities

    Thanks to a subscriber for this report from Credit Suisse which contains a great deal of useful information. Here is a section: 

    The number of listed companies in the U.S. rose 50 percent from 1976 to 1996 and fell 50 percent from 1996 to 2016. This has not happened in other parts of the world, opening a U.S. listing gap. This is important because the U.S. comprises one-half of the value of the world’s stock market.
    A company’s decision to list involves weighing costs and benefits. Net benefits appeared to be positive in the first 20 years of this period and have turned negative in the last 20 years. As a result, delistings have exceeded new listings by a large margin since 1996.

    Regulation appears to have played a role in two ways. The cost of being public, especially after the implementation of the Sarbanes-Oxley Act in 2002, has risen in the past two decades. That said, the shrinkage in the population of listed companies started well before that law was implemented. Further, relatively accommodative anti-trust enforcement allowed for robust M&A activity.

    As a result, listed companies today are on average larger, older, and more profitable than they were 20 years ago. Further, they operate in industries that are generally more concentrated. The overall size and maturity of listed companies means they are more likely to pay out cash to shareholders in the form of dividends and share buybacks than companies were in the past.

    We speculate that the maturation of listed companies has also contributed to informational efficiency in the stock market. Gaining edge in older and well established businesses is likely more difficult than it is in young businesses with uncertain outlooks. In turn, the greater efficiency may be one of the catalysts for the shift that investors are making from active to indexed or rule-based strategies.

    The chief investment officer (CIO) of an institution in the mid-1970s could gain reasonable exposure to U.S. equities by investing in an early stage venture fund and a large market index such as the S&P 500 (itself not an easy thing to do at the time). Today, that CIO needs to participate in early- and late-stage venture capital, a private equity buyout fund, and the S&P 500. Only a few investors have access to all of these alternatives.

    The universe of alternative investments, including venture capital, buyout funds, and hedge funds, has grown sharply in the past 20 years to provide some investors with access to more investment opportunities as well as to employ more sophisticated methods to generate excess returns. The growth of these asset classes has led to lower returns for investors.

    Venture capital funds launched in the 1990s outperformed public markets. But funds started since 2000 have underperformed public markets, with an improvement in recent years. Buyout funds with vintage years before 2006 outperformed public markets, but those launched in the last decade have only equaled the returns of the market. Hedge funds have also seen diminishing excess returns in the past decade. The difference between the top and bottom performers is larger in venture capital than in buyout funds.


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    The Mad Rush to Undo Online Privacy Rules

    This article by Siva Vaidhyanathan for Bloomberg may be of interest to subscribers. Here is a section:

    Republicans in Senate and then House did the opposite this past week, voting along party lines to reverse the consumer protections. Comcast, AT&T, Verizon, and other companies have long wished to leverage personal data, seeing Google and Facebook making billions from it through customized advertising revenue. Most web sites, including Bloomberg.com, track Web use in order to deliver relevant advertisements to users.

    The ISP’s could not win a policy argument before the FCC, but Congress was willing to act quickly amid the flurry of big issues confronting the public in the first 100 days of the new administration.

    Once President Trump signs this bill into law, as he has pledged to do as part of his assault on Obama-era regulation regardless of their value, these telecommunication companies will be able to monitor all sorts of data use and cross-reference it with a user’s location, the time of day, and even the concentration of other service users. As more commerce occurs through phones, these companies could launch payment applications that muscle out similar services from Apple or Google. That kind of consumer data is especially valuable. Then, telecommunication companies could sell ads on the locked or home screen of a phone -- something even Google and Facebook can’t do.

    Beyond that, Congress is also removing regulations that made telecommunication companies responsible for the leads of valuable -- and possibly dangerous -- private information through security breaches.


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    Empty reservoirs, dry rivers, thirsty cities' and our water reserves are running out

    Thanks to a subscriber for this article from the Guardian which may be of interest. Here is a section:

    The gap between water supply and demand – predicted to reach 40% by 2030 – will not be filled by surface water resources, so aquifers are being exploited more and more for agriculture, power generation and daily use in fast-growing cities.

    About 30% of the world’s freshwater comes from aquifers, yet a third of the 37 largest aquifers studied by the University of California between 2003-13 were severely depleted, receiving little or no replenishment from rainfall.

    Some of the most stressed aquifers are in the world’s driest regions such as Asia, up to 88% of which is water-stressed. South Asia accounts for half the groundwater used globally, but the continent’s aquifers – many of which were formed millennia ago when areas like northern China had a more humid climate – are no longer being replenished regularly by rainfall.

    Boreholes are getting deeper and water tables are falling. In Pakistan’s Punjab province, over-pumping is lowering the water table by up to a half a metre per year, threatening food and water security and making thirsty crops, such as sugarcane and rice, tougher to grow.


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    Fading Trump Rally Threatened by Rare Contraction of US Credit

    Credit strategists are increasingly disturbed by a sudden and rare contraction of US bank lending, fearing a synchronised slowdown in the US and China this year that could catch euphoric markets badly off guard.

    One key measure of US corporate borrowing is falling at the fastest rate since the onset of the Lehman Brothers crisis. Money supply growth in the US has also slowed markedly. These monetary and credit signals  tend to be leading indicators for the real economy.

    Data from the US Federal Reserve shows that the $2 trillion market for commercial and industrial loans peaked in December. The sector has weakened abruptly as lenders tighten credit, especially for non-residential property. Over the last three months it has dropped at a rate of 5.4pc on annual basis, a pace of decline not seen since December 2008.

    The deterioration in the broader $9 trillion market for loans and leases has been less dramatic but it too is shrinking, falling at a 1.6pc rate on a three-month basis. “Corporate lending has ground to a halt and I am staggered that the Fed is raising rates. They have made a very big mistake,” said Patrick Perret-Green from AdMacro.

    Credit experts at several big US banks have issued warnings over recent days, albeit sotto voce. "We’ve been surprised how little attention the slowdown in US bank lending has garnered," said Matt King, global credit strategist at Citigroup.

    While they are not yet alarmed, their concerns are worth heeding. Credit has tended to pick up signs of trouble several weeks before equity markets in recent episodes of financial stress.

    "Without another big dose of momentum, the cracks in the global reflationary consensus are liable to grow bigger. All around, existing trends are being called into question," he said.

    Net corporate bond issuance has also stalled, indicating that borrowing by US firms as a whole is in decline. "So much for a Trump-driven expansion. Beneath the surface, we think a seismic battle is taking place," he said.

    Elga Bartsch and Chetan Ahya from Morgan Stanley said the credit squeeze is a warning sign and needs watching closely. “On our estimates, the credit impulse turned negative at the end of 2016. We have not seen such a sharp deceleration in bank lending to US corporates since the Great Financial Crisis,” they said.

    “Historically, credit downturns have led recessions. The plunge could reignite concerns that a highly leveraged US corporate sector may react strongly to even limited interest rates increases,” they said.

    Monetary tightening in the US so far this cycle has been equal to 13 rate rises under the Fed’s Wu-Xia model, which includes the effects of withdrawing stimulus from quantitative easing. Nobody knows where the pain threshold lies in a global financial system that is more leveraged than at any time in history, including Fed officials themselves.

    A study by the International Monetary Fund of 122 recessions in rich economies since 1960 shows that these slumps are typically preceded by a slowdown in credit starting to four to five quarters earlier.

    Morgan Stanley said there may be less to worry about this time since the M1 money supply is more or less holding up. This indicator has “reliably contracted” before eight of America’s post-war recessions.

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    We Were Right to Join and We Are Right to Leave: Where Did the EU go Wrong?

    In the early years of the EU’s existence, apart from the Common Agricultural Policy (CAP), which involved a ludicrous waste of money, it did not make any monumental economic mistakes. Nor was it obvious that the EU was going to become the bureaucratic nightmare that we know today. But before too long, the regulatory bandwagon started rolling. The single market became the mechanism through which the same crackpot over-regulation would be applied across the whole of the European Union.

    For all its faults, provided that the world economy remained fairly stable, the EU would probably have been able to stagger on reasonably well. The trouble is, though, that over the past few decades the world has undergone three enormous shocks: the collapse of communism, the advent of globalisation and the communications revolution. These shocks demanded the utmost flexibility in order for the economy to adjust to them. But flexibility is exactly the thing the EU has learnt not to do.

    Not only that, but more recently it has made three big mistakes. The first is the formation of the euro, which many economists, including me, correctly identified as a prosperity-destroying machine long before its inception. The second was the failure to amend the free movement rules once the EU had been extended to encompass the former communist countries of eastern Europe. The third was the introduction of the Schengen passport-free travel zone, which has proved to be a security nightmare at just the time that security is at a premium.

    In my view, these bad decisions should not be viewed as one-offs. The EU is so badly formed and its institutions so weak and brittle that it has an in-built tendency to make poor decisions. This means that whenever a serious issue emerges that demands efficient decision–making and good governance, it will be likely to fall short.

    There are also two big issues coming up in the lift that will pose serious challenges to the EU: the ageing population and the advent of artificial intelligence and robotics. I confidently expect the EU to make a botch of both.

    I suppose you could say that the fundamental source of all its mistakes was there right from the beginning of the EU, namely the belief on the part of its elites that the countries of Europe should transform themselves into a single or federal state. In 1973 and 1975 I failed to see the full consequences of this vision. Today, in common with the majority of my fellow citizens, I can see them all too clearly.

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