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

    U.K. Heads for Hung Parliament as May Election Gamble Fails

    Here is the opening of this report from Bloomberg:

    Britain’s political future was thrown wide open after a shock exit poll indicated that Prime Minister Theresa May might not win a majority after Thursday’s general election, casting doubt over her political future just days before Brexit negotiations were due to begin. 

    The pound fell to the lowest since April after the BBC and other broadcasters said May’s Conservative Party is on course to win just 314 seats in the 650-strong House of Commons. That’s down from the 330 she held before calling the snap election seven weeks ago and less than the 326 needed for a majority. Jeremy Corbyn’s Labour Party will win 266 seats, compared with 229 before the election, according to the joint exit poll. 

    Such polls have generally been reliable, although political leaders on both sides immediately said it’s too early to read too much into it. The first two results from northeast England indicated that Labour is not doing as well as the exit poll suggested.

    Investors are balking at the prospect of another round of political turmoil less than a year after Britain voted to leave the European Union. While May could still win a majority, attention will turn to her future after the decision to call an early election and strengthen her mandate backfired. She will now need to decide whether to resign or try to form a new government. Another election is also a possibility.

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    No One Has Ever Made a Corruption Machine Like This One

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

    By Odebrecht’s admission in U.S. District Court in Brooklyn last December, Structured Operations doled out some $788 million in bribes in Brazil and 11 other countries, securing more than 100 contracts that generated $3.3 billion of profit for the company. Odebrecht and petrochemicals affiliate Braskem SA agreed to pay $3.5 billion in fines to Brazil, the U.S., and Switzerland tied to the activities of the division in Miami and beyond. It’s the biggest corruption-related fine ever levied on a company, eclipsing a $3.16 billion fine in Brazil tied to corruption allegations against another target of the Car Wash probe, Brazilian beef giant JBS SA.

    For decades, Odebrecht has cultivated a certain corporate lore. It goes something like this: The company’s ascent to the upper ranks of the world’s engineering and construction companies came from an obsession with hard work, expertise, and customer service. Top executives imbibe the teachings of the company’s founder, the late Norberto Odebrecht, via his three-volume guide to best practices, the Odebrecht Business Technology system. But last Dec. 13, when Emílio Odebrecht, Norberto’s 72-year-old son, took a seat before a microphone in a 1970s-era attorney general’s building in Brasília, Brazil’s capital, he described a family empire built on graft.


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    Veggie Burgers Go Mainstream with Bloody Impossible Burger

    This article by Jen Skerritt and Deena Shanker for Bloomberg may be of interest to subscribers. Here is a section:

    While alternatives to meat won’t replace the real thing, more companies are investing in the industry and reformulating recipes so consumers can’t tell the difference, said Kenneth Shea, a food analyst at Bloomberg Intelligence in Skillman, New Jersey.

    “Consumers, more and more, think in terms of sustainability,” Shea said. “They’re looking to eat more plants as opposed to red meat due to the perceived health benefits.”

    While most consumers want to keep eating meat, they’re becoming more informed about the consequences on the environment and sustainability. It takes about 15,000 liters (3,963 gallons) of water to produce 1 kilogram (2.2 pounds) of beef, compared with 1,600 liters for a kilo of wheat, according to estimates from the Water Footprint Network. 

    “Clean meat” production requires far less land and water than conventional meat, requires no antibiotics, and eliminates the environmental repercussions of animal waste and contamination during runoff, according to a report from Washington-based non-profit The Good Food Institute.
    Still, most Americans don’t want to sacrifice taste.

    “They’re hungry for a solution,” Beyond Meat’s Brown said. “It’s up to science and our efforts to get it to the point where it’s completely indistinguishable from its animal equivalent.”


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    Bail-Ins, Social Norms and Cows

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

    But that is a weird coincidence! It is strange that the hole in Popular's balance sheet can be precisely filled -- well, precise to within 1 euro -- by the amount of capital securities (Additional Tier 1 and Tier 2) that it had outstanding. Naively you might expect the valuation to find that there's a little extra money after assuming the senior debt, so the Tier 2 holders should get 10 cents on the euro or something. Or else there's not quite enough money to assume the senior debt, so the senior debt holders should also get a haircut and get 95 cents on the euro or something. But, no: The senior debt holders get exactly 100 cents on the dollar, the Tier 2 holders get exactly zero. (Well, 1 euro between them, but we'll come back to that.)

    That coincidence seems unlikely to be explainable by accounting; you will not figure out what is going on by carefully valuing each asset on Popular's books. Instead it is a matter of regulatory and negotiating dynamics. Additional Tier 1 and Tier 2 capital instruments are meant to assume the risk of a bank's losses, so by gosh they are going to assume some losses. As Aaron Brown points out by email: "When Santander, which wants the lowest possible price, negotiates with the government, which wants the least chance of future problems and perhaps wants to punish Popular investors, it's hard to think anyone is pushing hard for Tier 2 rights." If you are imposing some losses on capital securities, the temptation on both sides -- the buyer and the regulator, that is, not the buyer and the seller, who doesn't get much say -- is to impose maximal losses on those securities. George Whittle at FIIG Securities writes: "It is challenging to comprehend any circumstances where a regulator believes a liquidity crisis is sufficiently dire that it justifies the extraordinary step of bailing in capital instruments to facilitate a coercive equity raising or sale, but isn’t sufficiently concerning to bail in everything they can." 

    On the other hand, there's also a temptation to stop there: Zeroing capital securities feels virtuous, but haircutting senior debt feels risky. A regulator will not want to trigger systemic worries about bank debt by haircutting one bank's bonds. (On the other hand some regulators might feel like haircutting bank bonds is also a virtuous thing to do: The notion of "total loss absorbing capital" bail-in-able senior bonds does rather encourage that.) Even the buyer might not want to pay less than the value of the senior debt: Santander is going to need to go back to the debt markets, and treating Popular's bondholders well might help its credibility in the future. 

    So Popular's textbook result -- zeroing all the capital instruments, paying off all the debt -- is an equilibrium point that you would expect to occur a lot more often than is justified by the economics. That is ... fine, I guess? But it does rather wipe out the distinction between Tier 1 and Tier 2 capital, and between senior bank debt and risk-free debt. The choices are categorical as much as they are financial; they encourage holders of risky securities to worry about risk, and holders of senior securities not to, but it's not clear that they force anyone to quantify it carefully.


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    Demographically challenged

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

    A deep dive into demographics suggests a dire outlook for property prices
    Following an in-depth demographic study for Hong Kong, we have turned more negative on housing demand. Taking into account weaker demand and rising supply (we published a FITT report on supply in Sept-16) we have cut our medium-term (2018E-21E) residential price forecasts significantly. We now expect vacancy to surge to 9% (4% now) and ASP to slide 48% by 2026 from current levels. We reiterate our view that developers will be forced to change their business model from land-banking to asset turnover. Hence, we overhaul our valuation methodology from discount-to-NAV to SOTP, using P/E to value development businesses. We downgrade HLD, Kerry and NWD to Hold.

    Several negative demographic trends
    In this report, we identify several notable demographic trends in Hong Kong, with the most significant being: 1) natural population growth has already peaked and is likely to turn negative by around 2027; 2) reduced immigration; 3) the quick shrinkage of the 25-44 years age group to 26% of the total population by 2025, from 38% in 1995 (vs. 29% now); 4) the rise in people aged over 60 years to 30% of the total population, from the current 22%. Hong Kong already has the second-highest over-60 population in Asia, as a percentage of total population, behind Japan.

    Aging population constrains financing, translating into lower affordability
    In our view, housing affordability will be severely affected by an aging population. We believe affordability (debt servicing) is a function of property prices, mortgage rates, loan tenures and income. As the population ages, fewer households will be able stretch their mortgages to the maximum tenure of 30 years. On our new estimates, we expect only 11.5% of total households will be able to afford an average private housing unit by 2019. Moreover, by factoring in upcoming rate hikes, we expect overall affordability to worsen and ASP to decline by 48% over 2017-26 to restore the supply/demand equilibrium.

    A new valuation methodology for property development – P/E approach 
    With improving supply and a bleak outlook for the physical market, we expect land-banking to fade as a business strategy, and we anticipate a growing focus on asset turnover. As a result, we believe a discount-to-NAV valuation methodology will become less relevant in valuing the developers, and we advocate adopting a P/E approach for the development businesses. For the investment properties owned by the HK Property companies, we continue to estimate NAVs based on cap rates. We then apply a discount to the investment property NAV of 34% (the average discount over the past 25 years).


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    Pulses, Indian Beef. Bullish Corn

    Thanks to a subscriber for this report by Ned Schmidt which may be of interest. Here is a section:

    Ten years ago India was not a topic of a lot of interest. This month we find ourselves again talking about India twice, on pulses and beef. And when we look at corn we have some optimism to offer up.

    Pulses are basically dry beans, lentils, and peas. Few of us ever thought about them being grown in North America. U.S. and Canada have become major growers, exporting to India and other nations from the Middle East to India. Bottom graph is of U.S. acreage planted in pulses. While expansion has been irregular, roughly 1.5 million acres have been added in last fifteen years. Canada is a major source of pulses. Roughly 65% of world’s lentils are grown in that nation. Acreage dedicated to these crops is probably approaching 10 million acres. Apparently Canada is an ideal place to grow them, and then send them to India, et al

    India is becoming a major customer for world’s food system. Second, world will grow what customers want. Farmers are looking to produce alternative crops in search for profits. The “corn vs. soybean” farmer, while essential, may increasingly become “outdated”.

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    Concerned about the Paris Agreement? There's still hope through girls' education

    This article by Rebecca Winthrop and Christina Kwauk for the Brookings Institute may be of interest to subscribers. Here is a section:

    The good news is that the most effective intervention is not even in the Paris Agreement. Empowering girls and women through a combination of education and family planning is the number one thing the world can do to address climate change, ahead of switching to solar energy, wind energy, or a plant-rich diet. Investing in both girls’ education around the globe and enabling women access to contraception and reproductive healthcare would result in 120 gigatons of carbon reduced by 2050, a staggering amount compared to the 90 gigatons that could be reduced by better management of harmful chemical refrigerants like chlorofluorocarbons (CFCs).

    Demographers, global development specialists, and education advocates have long known about the connection between girls’ and women’s empowerment and smaller, more sustainable families. Research suggests that the difference in family size for a woman with 0 years of schooling compared to a woman with 12 years of schooling is about four to five children. And several studies have projected slower population growth if all girls around the world receive a secondary school education—as much as two billion fewer people on the planet for 2050 than if current fertility rates persist, and over five billion fewer people by 2100. Indeed, reaching a sustainable population growth rate could be realized even more quickly if the 225 million women around the world who want to avoid pregnancy but do not have access to contraception or control over their reproductive lives were given access to safe and voluntary family planning. The majority of these women live in the world’s 69 poorest countries, and it’s no coincidence that many of these countries are where girls have the hardest time going to school.


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    Email of the day 1

    On Theresa May’s disappointing campaign:

    Bullying, yes, and the British always tend to support underdogs. But the Tory campaign has allowed the debate to swing away from Brexit onto domestic, where Labour is generous and Tories realistic. Generosity is more attractive than reality. Her U Turn on Social Care -why introduce a radical domestic change mid-term when you are already incumbent and don't need to? - had many good points but she allowed Labour to characterize it as austerity. Overall, the Tory campaign has lacked bite and energy, allowing opponents to pitch it as arrogant and unnecessarily austere. A Trump factor - disenchantment with the political class - also works against the Tories and in favour of outsider Corbyn and the innumerate amateurism of his acolytes.

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