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September 14 2016

Commentary by Eoin Treacy

Gloom Descends on Luxury-Goods Industry

This article by Corinne Gretler and Thomas Buckley for Bloomberg may be of interest to subscribers. Here is a section:

Shares of both companies slid, dragging other luxury stocks down with them. The industry is grappling with another year of waning demand as China’s campaign against extravagant spending is compounded by a drop in tourism after terrorist attacks in France and Belgium, a situation Rupert characterized as a “fiasco.” Richemont’s revenue slid 13 percent, excluding currency shifts, in the five months through August, missing analysts’ estimates.

“The warnings show that macro and geopolitical uncertainties put near-term volume growth in question,” said Zuzanna Pusz, an analyst at Berenberg. “The challenges facing the luxury industry are not over yet.”

 

Eoin Treacy's view -

While in Hong Kong for a day earlier this year I was surprised by the willingness of luxury brands to bargain on price with discounts of over 10% readily available. At least part of the reason for this was because despite the fact there were large numbers of mainland Chinese tour groups milling around few appeared to be carrying shopping bags. The continued “anti-corruption” drive coupled with slowing economic activity have acted to curtail conspicuous consumption at home but terrorist attacks all over Europe are an additional headwind. 



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September 14 2016

Commentary by Eoin Treacy

Copper Rises Most in 3 Months on Signs of Better Chinese Growth

This article by Yuliya Fedorinova and Joe Deaux for Bloomberg may be of interest to subscribers. Here it is in full:

Copper posted the biggest gain in almost three months as strong economic data from China fueled speculation that demand will strengthen in the Asian nation, the world’s largest metals consumer. An index of global mining stocks advanced for the first time in six days.

China’s broadest measure of new credit exceeded estimates in August, rebounding from a month earlier and bolstering evidence that growth is stabilizing. Chinese reports this week on factory output, investment and retail sales all exceeded economist estimates.

“The Chinese data is improved,” Michael Turek, the head of base metals at BGC Partners Inc. in New York, said in an e-mail.

“Credit has been easier. That enables manufacturing to operate more smoothly and profitably and reduces bankruptcies.”

Copper for delivery in three months rose 2.6 percent to $4,771.50 a metric ton ($2.16 a pound) at 5:50 p.m. on the London Metal Exchange, the biggest increase since June 15.

The Bloomberg World Mining index of producers added 0.4 percent, heading for its first gain since Sept. 6.

Users, including power-wiring companies, are stepping up purchases of copper ahead of China’s autumn festival after prices fell, Xu Maili, an analyst with Everbright Futures Ltd., said by phone from Shanghai. The three-day Chinese holiday starts Thursday.

 

Eoin Treacy's view -

The Chinese market is closed tomorrow and Friday for the Mid-Autumn Festival and the annual golden week holiday will be between October 2nd and 7th inclusive. Therefore there is some merit to the argument that stockpiling ahead of the holidays may have contributed to recent firming in copper prices. 



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September 14 2016

Commentary by Eoin Treacy

September 13 2016

Commentary by David Fuller

Mario Draghi of the ECB Has Run Out of Magic as Deflation Closes in

Large parts of the eurozone are slipping deeper into a deflationary trap despite negative interest rates and one trillion euros of quantitative easing by the European Central Bank, leaving the currency bloc with no safety buffer when the next global recession hits.

The ECB is close to exhausting its ammunition and appears increasingly powerless to do more under the legal constraints of its mandate. It has downgraded its growth forecast for the next two years, citing the uncertainties of Brexit, and admitted that it has little chance of meeting its 2pc inflation target this decade, insisting that it is now up to governments to break out of the vicious circle.

Mario Draghi, the ECB’s president, said there are limits to monetary policy and called on the rest of the eurozone to act “much more decisively” to lift growth, with targeted spending on infrastructure. “It is abundantly clear that Draghi is played out and we’re in the terminal phase of QE. The eurozone needs a quantum leap in the nature of policy and it has to come from fiscal policy,” said sovereign bond strategist Nicholas Spiro.

Mr Draghi dashed hopes for an expansion of the ECB’s monthly €80bn (£60bn) programme of bond purchases, and offered no guidance on whether the scheme would be extended after it expires in March 2017. There was not a discussion on the subject. 

“The bar to further ECB action is higher than widely assumed,” said Ben May from Oxford Economics.

The March deadline threatens to become a neuralgic issue for markets given the experience of the US Federal Reserve, which suggests that an abrupt stop in QE stimulus amounts to monetary tightening and can be highly disruptive.

David Fuller's view -

Panic and anger grip the EU and the ECB is in the firing line.  The article above observes: “Public trust in the ECB has collapsed in several countries and the mood in Germany has turned toxic.” 

No doubt but in fairness to Draghi, he saved the EU from an earlier collapse, while repeatedly calling for fiscal spending and investment.  Unfortunately, Herbert Hoovers in the Bundesbank were having none of it.  Meanwhile, Brussel’s contribution was the creation of more regulations.  This is the burning barn that disappointed UK Remain voters wish to run back into.  Some of them like the EU’s unions, employment laws and the 30 to 35-hour week.

A PDF of AE-P’s article is posted in the Subscriber’s Area.



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September 13 2016

Commentary by David Fuller

Bond Markets Hit Another Ukrainian Chicken Moment

Two European companies -- French drugmaker Sanofi and German household products maker Henkel -- last week became the first firms to persuade investors to pay them to borrow euros. By selling bonds yielding minus 0.05 of a percentage point, they may well have signaled the bond market's peak, delivering this decade's equivalent of the "Ukrainian Chicken Farm Moment."


It was massively oversubscribed. A few weeks later, bird flu broke out in Hong Kong. The chicken farm was uninsured. The market immediately discounted the notes and the price crashed 30 percent or more. That moment of supreme belief when anything is possible in the new issues market will always be remembered as "The Ukrainian Chicken Farm Moment."

An investor who buys some of Sanofi's 1 billion euros ($1.12 billion) of bonds and holds them until they're repaid in three years is guaranteed to lose money. The same goes for owners of Henkel's 500 million euros of two-year notes. It's the equivalent of lending a dollar and five cents to your neighbor, knowing that you'll only be repaid a dollar. It's further evidence, if it were needed, that the negative interest-rate policies being pursued by policy makers, including the European Central Bank, are making areas of the financial markets look increasingly similar to conditions prior to the financial crisis of almost a decade ago. Then, as now, investors trying to boost returns in a low-yield environment loaded up on risk. Today's negative-yielding bonds are the equivalent of the highly-leveraged derivatives that were all the rage in the middle of the last decade.

David Fuller's view -

These are moments which we can all look back on some time later and see that investors’ behaviour was totally irrational. 

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September 13 2016

Commentary by David Fuller

Draghi: EU Must Redistribute Wealth and Strengthen Borders to Save the Union

 

The European Union will grind to a halt in a mire of ever-worsening unpopularity if it fails to tackle inequality, tighten external borders and co-ordinate defence policies,according to European Central Bank President Mario Draghi.

Anti-globalisation forces are closing borders and reversing progress made in recent years, he said, with policies which “have at times been reminiscent of the interwar period: isolationism, protectionism, nationalism”.

The message is a stark warning from the ECB’s chief, who has taken a new tack to push politicians to act. He has spent several years telling governments that they should use the breathing room granted by low interest rates to reform their economies to boost employment, productivity and growth.

But little of that has happened, forcing Mr Draghi to resort to stronger language to describe economic problems as a threat to the political project’s viability.

“The more recent years of the European project have been characterised by growing dissatisfaction,” Mr Draghi said, noting the Brexit vote.

“For some EU countries, these years have entailed the most serious economic crisis since the war, with unemployment, especially among the young, reaching unprecedented levels and welfare states constrained by low growth and stretched public finances.”

Combined with the fall of the Soviet Union, terrorism, climate change, new technologies and mass migration, “these factors have, in a short period of time, interacted with the economic consequences of globalisation and intensified feelings of insecurity, especially in a world that was inattentive to how the extraordinary benefits of that globalisation were being distributed”.

If the EU wants to serve its citizens and continue to bring its members closer together, he said, then politicians should listen to voters and address their concerns.

“The integration process needs to be guided towards outcomes that are more efficient and more directly aimed at the people, their needs and their fears,” he said in a speech as he received the De Gasperi award – a prize named for one of the EU’s founders and given to leaders who promote a more united Europe.

David Fuller's view -

Well said Mario Draghi, although too many arrogant leaders may not listen.  



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September 13 2016

Commentary by Eoin Treacy

Gold Sags in Longest Slump Since June as Demand Ebbs on Dollar

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

“You have rising expectations that there is the possibility of a rate increase this year,” Mike Dragosits, a senior commodity strategist at TD Securities in Toronto, said in a telephone interview. “A December rate hike is a distinct possibility that’s hurting the gold market.”

Gold futures for December delivery fell 0.1 percent to settle at $1,323.70 an ounce at 1:44 p.m. on the Comex in New York. The losing streak is the longest since June 23.

Precious-metals traders have been in thrall to contrasting comments from Fed officials before the Fed’s policy meeting next week. Boston Fed President Eric Rosengren said Friday that the economy may overheat if the bank waits too long.

Eoin Treacy's view -

Gold does best when people are most worried about the integrity of their respective currency; when it is being eroded by negative interest rates in response to deflation or purchasing power is being destroyed by inflation. However between those extremes gold needs an additional catalyst to rally and if the Fed is going to gradually raise interest rates that represents a headwind. 



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September 13 2016

Commentary by Eoin Treacy

Dairy Farmers Think Almond Milk Is Bogus But Americans Love It

This article by Leslie Patton and Lydia Mulvany for Bloomberg may be of interest to subscribers. Here is a section:

Almond milk is boosting the nut’s popularity, too. Last year, Americans bought $890 million of the stuff, three times the amount of soy milk’s $286 million, according to IRI. By contrast, consumers bought $9.2 billion of lowfat and skim milk. Retailers have caught on to the trend. Starbucks Corp. is adding almond milk to its lineup of non-milk alternatives, which already includes coconut and soy milk. And as of last month, Dunkin’ Donuts offers it in all its stores.

Milk alternatives have faced scrutiny for not containing very many nuts or natural ingredients. WhiteWave Foods Co.’s Silk brand of almond milk, for example, also contains sugar, salt, gellan gum and sunflower lecithin.

A lawsuit filed last year against Blue Diamond Growers, which supplies Dunkin’ Donuts, said its almond milk contained just 2 percent almonds. Blue Diamond’s U.K. website confirms the product’s almond content. Water and sugar are listed as ingredients before almonds. Alicia Rockwell, a company spokeswoman, declined to comment.

Among the biggest almond-milk sellers are WhiteWave and Blue Diamond, along with retailers like Target Corp. and Aldi Inc. that have private-label brands. Niche companies are also riding the wave, like NüMoo Nut-Milks, which makes an organic, cold-milled chocolate almond milk.

 

Eoin Treacy's view -

Almond milk with its low fat / high protein / low glycemic index credentials tends to tick a lot of boxes for the current trend of health conscious diets. As a result it is boosting demand for the nut amidst what has already been a growth trend in Asian consumption. In a battle of marketing against regular milk it is winning and gaining market share. A clear health scare or drop in Asian demand would likely be required to check that trend. 



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September 13 2016

Commentary by Eoin Treacy

Libor's Reaching Point of Pain for Companies With Big Debt Loads

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

Companies that took out floating-rate loans knew they would have to pay more to borrow once rates started rising, but they haven’t experienced real increases for years. Even when the Federal Reserve started hiking rates in December, many companies did not have to pay higher rates on their loans until Libor breached key levels, because of the way their floating rates are calculated. Rising interest payments would only add to pain for U.S. borrowers that are already suffering from falling profits and higher default rates. And Libor could rise further-- JPMorgan Chase & Co. strategists recently forecast it could reach 0.95 percentage point by the end of this month.

There will be some companies “for which it might become an issue," said Neha Khoda, a high-yield credit strategist at Bank of America Corp. With Libor having risen above key levels like 0.75 percentage point, many issuers have to think about how they will pay the extra interest, she said. Three-month Libor now stands at 0.86 percentage point, and has been rising as new money market fund rules curb investor demand for companies’ short-term debt. 

Interest rates on loans in the leveraged loan market are calculated by starting with a benchmark borrowing rate like three-month Libor and adding a margin known as a "spread." About $230 billion of the loans in the market have a minimum benchmark level, or "floor," equal to 0.75 percentage point, meaning that even if Libor has fallen below that level, the borrower must pay the minimum plus the spread. Most of the debt in the $900 billion leveraged loan market has Libor floors, which is often set around 1 percent.  

 

Eoin Treacy's view -

High yield issuers of floating rate notes are at an obvious disadvantage as the prospect of short-term rates rising is priced in. That represents an important consideration because floaters are one of the primary destinations for bond investors seeking to hedge their exposure to rising interest rates since they would avail of higher yields.



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September 13 2016

Commentary by Eoin Treacy

Bugs on Screen

This article by Ekaterina Pesheva for the Harvard Medical School may be of interest to subscribers. Here is a section:

Over two weeks, a camera mounted on the ceiling above the dish took periodic snapshots that the researchers spliced into a time-lapsed montage. The result? A powerful, unvarnished visualization of bacterial movement, death and survival; evolution at work, visible to the naked eye.

The device, dubbed the Microbial Evolution and Growth Arena (MEGA) plate, represents a simple, and more realistic, platform to explore the interplay between space and evolutionary challenges that force organisms to change and adapt or die, the researchers said.

“We know quite a bit about the internal defense mechanisms bacteria use to evade antibiotics but we don’t really know much about their physical movements across space as they adapt to survive in different environments,” said study first author Michael Baym, a research fellow in systems biology at HMS.

The researchers caution that their giant petri dish is not intended to perfectly mirror how bacteria adapt and thrive in the real world and in hospital settings, but it does mimic more closely the real-world environments bacteria encounter than traditional lab cultures. This is because, the researchers say, in bacterial evolution, space, size and geography matter. Moving across environments with varying antibiotic strengths poses a different challenge for organisms than they face in traditional lab experiments that involve tiny plates with homogeneously mixed doses of drugs.

 

Eoin Treacy's view -

There are encouraging advances occurring in the development of antibacterial medicines using new kinds of antibiotics, phages and genetics. Considering the rates at which bacteria can mutate we are going to need them all. 

 



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September 12 2016

Commentary by David Fuller

Six Reasons Why Post-Brexit Britain Can be Like Others That Thrive Outside the Single Market

So much of the current discussion about our future relationship with the EU is about access to the single market. If we could have all the benefits of belonging to the single market without being obliged to obey its rules, be able to make our own laws, control our own borders, abolish the EU’s tariffs on our imports, make no contributions to the EU budget and make our own trade deals around the world, then I would support being a member. But such a package is unobtainable.

Of the realistic options, some people have argued that we should seek a deal like Norway’s or Switzerland’s. We should want neither of these. Rather, we should seek to be like all other countries in the world, that is to say, outside the single market but trading extensively with it. In realising this vision, our officials and ministers need to bear in mind six key points.

Single market membership is not the be-all and end-all

First, contrary to the propaganda, membership of the single market is not of overwhelming importance. If it were, how would it be possible for non-member countries from all around the world to sell to it so successfully, and why would its members be doing so badly? Why haven’t single market member countries been carried forward on a wave of prosperity created by the mutual recognition of standards and the absence of border checks?

The benefits of the single market have been sufficiently small that they have been outweighed by other factors: the macroeconomic disaster that is the euro and the micro-economic disaster that is the web of regulations, laws and interferences that reduce market efficiency across the union.

Tariffs might be a price worth paying 

Second, tariffs are not a big issue. By all means, let’s try to get a deal under which our exports to the EU face no tariffs. But this is not worth paying much for – or enduring much of a delay for. If our exporters end up having to pay the EU’s common external tariff this would not be a killer blow. The average tariff on manufactured goods is about 4pc.

If it comes to it, even the 10pc tariff on cars would be more than compensated by the lower exchange rate for the pound. And if the City loses passporting rights, that isn’t a killer blow either. The key requirement is to be outside the EU’s icy regulatory embrace. In the long term, securing this would be well worth enduring some short-term loss.

David Fuller's view -

Roger Bootle’s analysis make sense to me.  However, we can expect international banks and many other City firms to take a somewhat different view.  They may only be lobbying in their perceived best interests, but we hear plenty of talk about partial moves to various regions of the EU.  Some of that may be inevitable but Mrs May’s Government will need to remain diplomatic and in close contact with these firms, while also holding its line on a reasonably swift and complete exit from the EU. 

A PDF of this article is posted in the Subscriber's Area.



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September 12 2016

Commentary by David Fuller

Parliament Calls for Carbon Capture to Revive British Industry and Slash Climate Costs

A high-level Parliamentary inquiry has called for a massive national investment in carbon capture to revive depressed regions of the North and exploit Britain's perfectly-placed network of offshore pipelines and depleted wells.

Lord Oxburgh's cross-party report to the Government has concluded that the cheapest way to lower CO2 emissions from heavy industries and heating is to extract the carbon with filters and store it in the North Sea oil.

The advisory group said the technology for carbon capture and storage (CCS) is ready to go immediately and should cut costs below £85 per megawatt hour by the late 2020s if launched with sufficient conviction and on a large scale, below the strike price for the Hinkley Point nuclear project. 

It could be fitted on to existing gas plants or be purpose-built in new projects, and could ultimately save up £5bn a year compared to other strategies. Unlike other renewables CCS does not alter with the weather or suffer from intermittency. It can be “dispatched” at any time, helping to balance peaks and troughs in power demand. 

“I have been surprised myself at the absolutely central role that CCS has to play across the UK economy,” said Lord Oxburgh, a former chairman of Shell Transport and Trading.

“We can dramatically reduce our CO2 emissions, create tens of thousands of jobs, and give our domestic industry a great stimulus by making use of technologies which are now well understood and fully proved,” he said.

No other country is likely to take the plunge first since few have the magic mix of industrial hubs, teams of offshore service specialists, and cheap, well-mapped, sea storage sites all so close together. “CCS technology and its supply chain are fit for purpose. There is no justification for delay,” says the report, to be released today.

Lord Oxburgh said the state must take the lead and establish the basic infrastructure in the early years.

The report called for a government delivery company modelled on Crossrail, or the Olympics Authority, taking advantage of rock-bottom borrowing costs. It could be privatised later once the CCS has come of age.

The captured CO2 is potentially valuable. Some could be used for market gardening in greenhouses, to produce biofuels, or for industrial needs.

Most CCS in North America is commercially exploited to extract crude through enhanced oil recovery by pumping CO2 into old wells, a technology that could give a new lease of life to Britain’s depleted offshore fields. “We could keep North Sea production going for another hundred years,” said Prof Jon Gibbins from Sheffield University.

David Fuller's view -

In this exciting new, varied and fast changing era of energy, tech-savvy nations should way outperform over the longer term.  What energy systems will they have?

This item continues in the Subscriber’s Area, where a PDF of the article is also posted. 



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September 12 2016

Commentary by David Fuller

An Allocation Only a Mother Could Love

GMO’s Jeremy Grantham and Lucas White came out with a report entitled An Investment Only a Mother Could Love this past week laying out the prospects for natural resource equities. Here’s the executive summary of their findings and thoughts:

  • We believe the prices of many commodities will rise in the decades to come due to growing demand and the finite supply of cheap resources.
  • Public equities are a great way to invest in commodities and allow investors to:
    • Gain commodity exposure in a cheap, liquid manner
    • Harvest the equity risk premium
    • Avoid negative yields associated with rolling some futures contracts
  • Resource equities provide diversification relative to the broad equity market, and the diversification benefits increase over longer time horizons.
  • Resource equities have not only protected against inflation historically, but have actually significantly increased purchasing power in most inflationary periods.
  • Due to the uncertainty surrounding, and the volatility of, commodity prices, many investors avoid resource equities. Hence, commodity producers tend to trade at a discount, and they have outperformed the broad market historically.

The team from GMO makes some good points here. If you’re looking to gain long-term exposure to commodities, it rarely makes sense to invest directly in the commodities themselves. You’ll get cash-like returns with stock-like volatility.

I wanted to look back at the performance history of these stocks to check out their other claims. The longest running fund I could find is the Vanguard Precious Metals & Mining Fund (VGPMX). It may not be a perfect match with what GMO is doing but it has a performance history going back to 1985.

David Fuller's view -

I have long held Jeremy Grantham in high regard and I maintain that we have only seen this year’s initial recovery for industrial commodities and precious metals.  However, I question this opening bullet point:

We believe the prices of many commodities will rise in the decades to come due to growing demand and the finite supply of cheap resources.

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September 12 2016

Commentary by Eoin Treacy

What Samsung's Disastrous Galaxy Note 7 Recall Means for Apple

This article by Chris Nolter for TheStreet may be of interest to subscribers. Here is a section:

The announcement of the iPhone 7 and 7 Plus was "lackluster," in the view of Gartner analyst Tuong Nguyen, who expressed skepticism that the problems with Samsung's flagship smart phone will lead to an outflowing of customers to Apple.

"We've chosen our battlegrounds already," Nguyen said, suggesting that U.S. users are mostly either in the Android an iOS camps. Shifting from one to the other is "at the least annoying" and involves relearning the quirks of a new platform and accounting for apps that have been bought or downloaded.

"I feel it's more likely that the Samsung incident will push people towards other Android makers like LG more so than towards Apple," Nguyen said. Shifts to a new platform could be more pronounced in emerging markets with burgeoning middle classes who may not have been able to afford iPhones before.

 

Eoin Treacy's view -

The app ecosystem of various platforms represents a significant hurdle to moving from an iOS based phone to Android. That represents a major incentive for companies like Apple and Google to encourage as many programmers as possible to develop apps for their respective languages. Google’s announcement in July that it plans to fund education for up to 2 million programmers in India is a direct reflection of that theme.



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September 12 2016

Commentary by Eoin Treacy

Thailand

Eoin Treacy's view -

The majority of ASEAN markets have benefitted from increasing international investor flows over the last few months and Thailand is no exception. It has received net inflows of nearly $16 billion year-to-date but this has done little to support the stock market in currency adjusted terms. Just about every Asian market pulled back today but Thailand has been leading on the downside. 
 

 



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September 12 2016

Commentary by Eoin Treacy

N.Z.â's Key Says Don't Break Out Champagne for Parity Party Yet

This note by Matthew Brockett for Bloomberg may be of interest to subscribers. Here it is in full:

New Zealand Prime Minister John Key speaks at post-cabinet press conference in Wellington on Monday.

Says NZ dollar’s recent gains generally reflect economic fundamentals of New Zealand
On prospect of NZD reaching parity with Australian dollar,     says “just before people break out the champagne for a parity party, we’ve been there many times before and not quite got over the finishing line”

Most New Zealanders would prefer NZD “was a little bit lower”

“With dairy prices recovering, that’s the thing I think that’s actually underpinning the exchange rate now”: Key says his view on currency intervention is it’s “not a terribly effective tool”

 

Eoin Treacy's view -

The New Zealand Dollar has not traded above parity against the Australian Dollar in at least 30 years so it represents a psychological Rubicon for investors and a potent threat to the competitiveness of Kiwi exports to its largest neighbour. The rate has contracted steadily over the last month and a break in the short-term progression of lower rally highs, currently near NZ$1.04, will be required to signal Australian Dollar demand is returning to dominance. 



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September 12 2016

Commentary by Eoin Treacy

September 09 2016

Commentary by Eoin Treacy

Global Economics and Strategy Day

Thanks to a subscriber for this report from Morgan Stanley covering a number of macro topics. Here is an important slide highlighting how economists compute productivity figures:

Eoin Treacy's view -

A link to the full report is posted in the Subcsriber's Area.

I’m sure I’m not the only one to puzzle over how our opinion of future productivity growth and that of many economists can differ so widely and thought the above chart was highly instructive.

To my mind technological innovation is sharply deflationary but it also contributes to productivity gains by ensuring that every worker can produce more. However the decline in Multifactor Productivity questions that hypothesis. Therefore we have to ask the question whether the deflationary impact of technology on the velocity money, which is a symptom of the wider disintermediation of the internet, is reducing the multifactor contribution to how productivity in measured. 

 



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September 09 2016

Commentary by Eoin Treacy

Turning Points

Thanks to a subscriber for this link to Jeff Gundlach’s most recent presentation. Here is one of the more interesting slides:

Eoin Treacy's view -

More than any other chart this gives us a graphic illustration for why Wall Street continues to trade close to historic highs. If earnings do in fact rebound then valuations will retreat and investors will have some rational justification for paying all-time high prices. 

Of course the flip side is that if earnings do not rebound in nearly the same fashion as expected. That would contribute to a great deal of navel gazing mong investors and would lead to less appetite for shares at these prices. 
 

 

 



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September 09 2016

Commentary by Eoin Treacy

September 09 2016

Commentary by Eoin Treacy

Gold Investors Brace for Lower Prices on Interest-Rate Outlook

This article by Luzi Ann Javier for Bloomberg may be of interest to subscribers. Here is a section:

More than 2,500 lots exchanged hands Friday for a put option giving owners the right to sell October futures at $1,300 an ounce, making it the most-traded option for the second straight day. The most active contract on the Comex slipped as much as 0.6 percent to $1,334.10. Holdings in exchange-traded funds backed by gold fell for a second day on Thursday.

There’s reason to be worried. Federal Reserve Bank of Boston President Eric Rosengren, who shifted his stance in recent months in favor of monetary tightening, warned Friday that waiting too long to raise interest rates risks overheating the economy. Higher rates make bullion less competitive against interest-bearing assets. The comments come a day after the European Central Bank played down the prospect of an increase in asset purchases.

“The markets are quite nervous that an interest-rate hike might actually happen this month,” Phil Streible, a senior market strategist at RJO Futures in Chicago, said by telephone.

“Investors and traders know that gold futures have held above $1,300 and this looks like a key level of support. It’s rational for investors to be looking at protective put options at $1,300 in the event a surprise interest rate increase occurs.”

 

Eoin Treacy's view -

Total Known ETF Holdings of Gold have not been affected by the pullback witnessed in precious metals markets this week suggesting the action is more driven by traders than investors. 



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September 08 2016

Commentary by David Fuller

US Recession Jitters Stoke Fears of Impotent Fed and Fiscal Paralysis

Here is the opening and a latter section from this interesting column by Ambrose Evans-Pritchard for The Telegraph:

An ominous paper by the US Federal Reserve has become the hottest document in high finance.

It was intended to reassure us that the world's hegemonic central bank still has ample firepower to overcome the next downturn. But the author was too honest. He has instead set off an agitated debate, and rattled a lot of nerves.

David Reifschneider's analysis - 'Gauging the Ability of the FOMC to Respond to Future Recessions' - more or less concedes that the Fed has run out of heavy ammunition.

The Federal Open Market Committee had to cut interest rates by an average of 550 basis points over the last nine recessions in order to break the fall and stabilize the economy. It could not possibly do so right now, or next year, or the year after. Quantitative easing (QE) in its current form cannot compensate, and nor can forward guidance. They are largely exhausted in any case.

"One cannot rule out the possibility that there could be circumstances in the future in which the ability of the FOMC to provide the desired degree of accommodation using these tools would be strained," he wrote.

This admission is painfully topical as a plethora of data suggest that the US economy may have hit a brick wall in August. The ISM gauge of manufacturing plunged below the boom-bust line to 49.4, and the services index dropped to a six-year low, with new orders crashing nine points.

My own tentative view is that these ISM readings are rogue surveys. The Atlanta Fed's 'GDPNow' tracker points to robust US growth of 3.6pc in the third quarter. The New York Fed version is coming in at 2.8pc. 

Yet the US expansion is already long in the tooth after 87 months, and late-cycle chemistry is notoriously unpredictable. Warning signs certainly abound. Corporate profits have been slipping for six quarters, the typical precursor to an abrupt slump in business spending. "The only thing keeping the US out of recession is the US consumer. If consumption stalls then we really are in trouble," says Albert Edwards from Societe Generale.

I am willing to bet against him for now. The M1 money supply - often a good leading indicator - has picked up after a weak patch earlier this year and is now surging at a rate of 10.1pc. This pace would normally signal a burst of torrid growth a few months later. It is in stark contrast to the monetary contraction before the Lehman crisis.

My presumption is that the day of reckoning has been pushed well into 2017, but in the dead of the night I have a horrible sweaty feeling that Mr Edwards may be right. It is not a time to be chasing stock markets already at vertiginous levels.

And:

History will judge that those nations best able to weather the next global downturn are those that grasp the essential character of our desperate deflationary age, and can cast aside deeply-ingrained and totemic beliefs about debt. The losers will be those spooked by shadows on the wall.

The winners - or survivors - will be those most willing to seize on the cheapest borrowing costs in history to fight back, preferably combining fiscal and monetary in a radical fashion. Call it helicopter money if you want, or 'overt monetary financing' of deficits. The accounting terminology is irrelevant.

Since no country can risk watching its precious national stimulus leak away to free riders in the austerity camp - at least in a crisis - this may imply some degree of calibrated protectionism. The twin liberal pieties of progressive public policy and global free trade may ultimately come into conflict. That is tomorrow's battle.

David Fuller's view -

Yes, the Fed would like a cushion in terms of higher interest rates as a defence for limiting the next recession.  However, we do not live in an economic environment which would make that possible at this time.  Moreover, we can only guess as to when and to what extent circumstances are likely to change in future.  So far, the Fed has wisely held off on raising rates, which could make a soft economy even weaker, particularly if the Dollar Index rose, as it most likely would.

However, it would be mistaken to think that the Fed is in charge of the economy, beyond its role as the regulator of US monetary policy.  The traditional three engines of economic growth are consumer, corporate and government spending. 

This item continues in the Subscriber’s Area, where a PDF of AEP’s column is also posted.



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September 08 2016

Commentary by David Fuller

EU Retreat From US Trade Deal Leaves the Field to Britain

They’ve managed it. The naysayers have succeeded in killing off what would have been the first trade deal signed between the world’s two biggest economic blocs.

“TTIP”, or the Transatlantic Trading and Investment Partnership between the EU and the US, was meant to be part of the plan for a renewed, competitive Europe, helping its indebted economies to carry the deadening weight of the euro. Instead, it is becoming a potent symbol of EU dysfunction.

After years of protests, petitions and successful peddling of terrifying myths about the deadly threat this deal posed to rights, democracy, safety and the environment, European politicians are capitulating. EU mandarins are trying to keep it together in the face of a tough US stance and competing demands by 27 countries but, in the crystal clear estimation of French trade minister Matthias Fekl, the deal is “dead”.   

The Eurocrats will continue to insist that, like a convalescent dictator, it is very much alive and well. But to be sure, it is simply resting! Taking the air! But they know as well as anyone else that TTIP - and the useful €120 billion boost they said it would bring the EU economy - is at best being put into a long, deep freeze.

The good news, of course, is that this clears that enormous “queue” for trade deals with the US that Barack Obama was warning us about when he visited Britain before the EU referendum. A post-Brexit UK, he said, would be “at the back” of this queue, and at the G20 last week, he again declared that a UK-US deal won’t be a priority. With TTIP dead, however, there is no queue. Saying that Britain is at the back of it is rather like saying that Mr Obama is at the back of the queue of lame duck US presidents leaving office: he’s also at the front of it.

Any decision on trading terms between the US and its allies will be down to Mr Obama’s successor. Pessimists argue that the anti-globalisation mood taking hold across the pond will preclude any deal making. Donald Trump has demonised trade and even Hillary Clinton has gone lukewarm. But although there is a worrying rise in such hostility, there are reasons to think that Brexit Britain can slip around this roadblock.

The multilateral, sprawling agreements currently running into problems, like TTIP and its Pacific equivalent, are totemic, regional pacts with explicitly geopolitical aims. They are agreed only after torturous negotiations between dozens of countries with different cultures and priorities. They establish remote – and therefore scary-sounding – new regulatory and legal systems and the backlash against them feeds on the idea of a faceless, nationless technocratic class taking over the levers of power at the expense of citizens.

By contrast, a single-country deal with a reliable ally, whose legal system and economy already have much in common with the US, is a less threatening prospect and is unlikely to worry former car workers in Detroit. That is one of the reasons that Mr Trump can insouciantly declare that Britain would certainly not be “at the back of the queue” for a deal, as he did in May.

Mr Trump might not be the most reliable ally. But there are geopolitical reasons why it would make sense for the US to consider a deal, especially if Mrs Clinton wins. It would signal that the UK, a useful US ally in Europe, is not out in the cold. It would help, in a less ostentatious way than TTIP, to expand the sway of economic relations based on the rule of law and regulations, rather than the rule of might favoured by Russia and China. It would also establish a framework to which the EU would hopefully be added in future decades.

David Fuller's view -

The global region of greatest uncertainty right now is in the EU.  It gives me no satisfaction to point this out but the EU’s leaders have brought it on themselves, although the real cost is borne by the citizens of their countries, particularly in the Mediterranean nations.

Today, we can forget all about forecasts of tortuous Brexit negotiations over several years, designed to ensure that the EU was an alliance which countries could join but never leave.  The EU’s political programme to create ‘a United States of Europe’ has been derailed because it had no popular support.  The absence of border controls in Europe seems like a nice idea but makes no sense in a world where traffickers will swamp countries by bring the world’s poor from different cultures to richer democratic nations.  A political backlash is underway, not least within Germany and France.

This item continues in the Subscriber’s Area, where a PDF of Juliet Samuel’s article is posted.



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September 08 2016

Commentary by David Fuller

The Weekly View: The Danger of Looking Back: Lessons From Lost Decades

My thanks to Rod Smyth for his ever-interesting letter, published by RiverFront Investment Group.  Here is the opening paragraph:

Our industry’s most ubiquitous disclaimer, “Past performance is no guarantee of future results,” is good advice.  Despite this advice, many investors make decisions based on the emotional journey of past performance – money follows performance.  US investors are now pulling money out of international stocks following a decade of flat returns and 6 years of underperformance relative to US stocks; meanwhile, at RiverFront, we are adding to our international holdings.  

David Fuller's view -

Rod Smyth is a very good contrarian thinker.  This is a fascinating issue – a collector’s item for students of stock markets. 

The Weekly View is posted in the Subscriber’s Area.

 

Please note: I will be away on Friday.



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September 08 2016

Commentary by Eoin Treacy

Draghi Dialing Down the Drama May Mark Wane of Monetary Activism

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

Take European Central Bank President Mario Draghi, who on Thursday talked up the effectiveness of his institution’s stimulus policies to date, but damped expectations that he’ll load up with fresh asset-buying soon. His only new announcement after again downgrading euro-area growth forecasts was that officials will look into how to ensure the current program overcomes a worsening scarcity of bonds.

Even with the scheduled end of the 1.7 trillion-euro ($1.9 trillion) plan just six months away, Draghi said policy makers meeting in Frankfurt haven’t yet discussed what they’ll do when that day comes. If a new laissez-faire tone is creeping in to replace years of hyperactivity, it may be a signal that the division of labor between central banks and governments in providing economic support is shifting.

“Draghi doesn’t sound like a central banker who’s in any hurry to ease further,” said Tim Graf, head of European macro strategy at State Street in London. His stance “fits in with the G-20 statements about using all actors to support growth, including the fiscal side. Taking ever-easier monetary policy for granted is becoming less valid.”

 

Eoin Treacy's view -

The ECB faces a number of obstacles to employing a US style quantitative easing program within its jurisdiction. Among these are the relative depths of the respective markets. The ECB has self-imposed rules about how much of any particular issue it can own and how much debt of any one country it can purchase. Additionally, the EU’s corporate bond and asset backed markets are not nearly as liquid as their US equivalents, which represent a challenge for the size of purchases the ECB needs to make to have an influence on the market.



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September 08 2016

Commentary by Eoin Treacy

Duterte Outbursts Taking Toll as Philippine Stock Losses Mount

This article by Ian C Sayson for Bloomberg may be of interest to subscribers. Here is a section:

“The latest incident raises concern that President Duterte’s unpredictable behavior in politics will be disruptive and could eventually spill into economics and business,” said Jonathan Ravelas, chief market strategist at BDO Unibank Inc., the Philippines’ biggest lender. It’s “further weakened a market that’s already been made vulnerable by uncertainty over U.S. interest rates, elevated valuations and overseas fund withdrawals,” he said.

The Philippine index is trading at 18.3 times 12-month estimated earnings. While that’s down from 19.6 in July, it’s still the highest in Asia and at a 32 percent premium to the MSCI Asia Pacific Index. The country’s economy expanded 7 percent last quarter from a year earlier, after 6.8 percent growth in the first three months of 2016.

Investors may be better off holding cash in the near term as the index could test its 7,500 support level, said BDO Unibank’s Ravelas. The gauge could fall as low as 7,330 in the next two months over concerns the budget deficit will rise when taxes are cut and spending raised, April Lee-Tan, head of research at COL Financial Group Inc. in Manila, said Monday.

“Smart investors should take advantage of the weakness and accumulate because this is all sentiment-driven," said Rizal’s Palma Gil. “Other than incendiary statements and killings related to the drug war, investors like Duterte’s economic and fiscal policies or at least what has been communicated so far,” he said, adding that he expected the index would go back up to 8,000.

 

Eoin Treacy's view -

Duterte was elected on a law and order and anti-corruption ticket and admitted in his inaugural address that his methods were unorthodox and would not be approved of by many observers. Here is a link to a video of that address. 



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September 08 2016

Commentary by Eoin Treacy

Email of the day on bitcoin prices

Regarding Bitcoin, after a summer lull it looks like it is coming into form once again - would welcome another update on the charts/ medium term view which hopefully is of interest to other subscribers. I must say it does have elements that remind me of the 90's tech bubble (volatile, illiquid, devoted followers etc) and I have been following it closely. Many thanks

Eoin Treacy's view -

Thank you for this reminder that Bitcoin is a market where fully committed advocates contrast sharply with those who doubt it will ever become a viable medium of exchange. The blockchain foundation on which the market for bitcoin rests has significant potential in recording transactions and reducing the cost and inefficiency of banking, accounting and record keeping over the next few years before it is eventually superseded by quantum computing. 



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September 08 2016

Commentary by Eoin Treacy

GW Pharmaceuticals Jumps on Report It May Be Acquisition Target

This article by Caroline Chen for Bloomberg may be of interest to subscribers. Here it is in full:

GW Pharmaceuticals Plc jumped after Reuters reported that the company had hired Morgan Stanley as an adviser after being approached by several drugmakers interested in an acquisition.

GW gained 20 percent to $101.47 at 3:31 p.m. in New York trading, its biggest intraday gain since March. Reuters cited people familiar with the matter in its report.

The U.K. company, with a market value of $2.56 billion, develops drugs derived from cannabis. Its leading asset is an experimental treatment for epilepsy, and it’s also working on candidates for cancer, type 2 diabetes and schizophrenia. GW has one approved drug, Sativex, which is used to control involuntary muscle spasms from multiple sclerosis.

Insys Therapeutics Inc., which develops drugs based on synthetic cannabis, rose 5 percent to $15.67.

GW, based in Cambridge, England, isn’t currently interested in a sale, Reuters reported, citing people familiar with the matter. A representative for GW declined to comment.

 

Eoin Treacy's view -

Cannabis is increasingly being recognised for its uses as a pain reliever and mood stabiliser; confirming what millions of users in the illicit market have testified to for decades. With the tide of public opinion turning there is a race on to secure interests in the sector as companies bet on the potential for further legalisation to be approved in the USA, not least during the November ballot. 



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September 07 2016

Commentary by David Fuller

Apple Introduces iPhone 7: Water Resistant, Faster, New Camera

Apple Inc. unveiled new iPhone models Wednesday, featuring a water-resistant design, upgraded camera system and faster processor, betting that after six annual iterations it can still make improvements enticing enough to lure buyers to their next upgrade.

First Look at the New iPhone 7 and iPhone 7 Plus

The iPhone’s main improvement revolves around the new camera. Past models have had only one lens on the back, but the new version features a dual-lens system on the larger iPhone 7 Plus. The technology allows for sharper, brighter photos with better ability to zoom without degrading quality. Apple released a few details about the new phone on its Twitter account while Chief Executive Officer Tim Cook was giving a presentation at an event at San Francisco’s Bill Graham Civic Auditorium. 

Even as iPhone demand has waned in recent quarters, partly due to the lull between product launches, the device continues to be the biggest source of Apple’s revenue. The iPhone is at the center of an ecosystem of products from Apple TV to the Apple Watch that are designed to function in connection with it. The new models will be critical to the holiday quarter, and the world’s most valuable company is counting on them to prop up sales ahead of an expected overhaul of the line in 2017, the iPhone’s 10th anniversary.

David Fuller's view -

There are clearly a number of improvements but will it be enough to top Samsung? Many of us will be interested in the reviews, not least from Which Magazine as far as I am concerned.  It definitely preferred Samsung’s phone a few months ago but Apple clearly has some significant improvements. 

This item continues in the Subscriber’s Area and includes a discussion of Apple’s stock market prospects relative to Samsung.



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September 07 2016

Commentary by David Fuller

EU Fiscal Stimulus Is Just a Rule Change Away

Here is the opening of this topical article from Bloomberg:

The European Central Bank is expected to extend its quantitative easing program further during the meeting of its governing council this week. The irony is that while the ECB has various options for continuing a program that isn't working, national governments have relatively few options for embarking on one that most agree is sorely needed. As Mario Draghi and others have said on multiple occasions, the ECB cannot deliver on its own. It needs governments to use fiscal levers to help stimulate spending and growth.

What prevents European governments from doing that right now is ostensibly the Maastricht deficit and debt limits (3 percent and 60 percent of gross domestic product respectively). While the European Commission has said that it would not count some investment spending in those limits, the rules are unclear and make it difficult for countries in breach to invest. What is needed is a change that brings national accounting more in line with reality and the sound principles used in the private sector.

Infrastructure investment in Europe is currently counted as an expense that gets added to (already bloated) national budgets. That fails to account for any multiplier effect the measures might have or the increase in productivity that is unleashed when, say, digital infrastructure is expanded or new transport links are created.

An investment, rather, should be amortized over the period it will be used for, just as it is in the private sector. A company that invests in new machinery, for example, amortizes it over many years. The same could even be true for R&D spending, which can deliver many gains in a knowledge economy. 

David Fuller's view -

The EU’s political leadership, mainly self-appointed by Germany and France, has tried to align what were 28 separate nations before Brexit occurred.  They sought to do this with one-shoe-fits-all rules.  These have not worked very well and any attempt to enforce them had been the equivalent of trying to herd 28 cats. 

Europe may have more success with fiscal spending, which many financial observers have long said was overdue, including Mario Draghi, president of the European Central Bank.

If GDP growth is weak and monetary policy near zero percent is harming savers and banks, while benefiting only stock markets, fiscal spending to assist economies looks like a logical and necessary response.  To the extent that it helps GDP growth, it may also cushion the next stock market downturn.       



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September 07 2016

Commentary by David Fuller

Japan Demand for Seamless Brexit is a Timely Warning Against Hubris

It [Japan] wants continuation of the ‘single passport’ system for financial services, and clearing of euro transactions in London. “If Japanese financial institutions are unable to maintain the single passport obtained in the UK … they might have to relocate their operations from the UK to existing establishments in the EU,” it said.

The task force insists on mutual recognition of ‘Authorized Economic Operators’, which could not occur if Britain fell back to the minimalist terms of the World Trade Organisation. If the UK fails to retain the European Medicines Agency, Japanese pharmaceutical companies might shift research and investment to mainland Europe.

It wants guaranteed “access” for EU and UK nationals to work in each other’s country, which is not the same thing as free movement of labour or benefit rights. While the paper stresses that Japan “respects the will of the British people”, it cleaves to the status quo. “The message is essentially that nothing should really change,” said Raoul Ruparel from Open Europe.

The wish-list could perhaps be achieved through a halfway house such as entry into the European Economic Area, the ‘Norwegian model’. It is totally incompatible with the hardline demands of the Brexit triumvirate.

The task force paper is probably music to the ears of 10 and 11 Downing Street, and its release during the G20 summit may have been co-ordinated. It strengthens Theresa May’s hand as she tries to steer through treacherous waters, and pushes within the cabinet for a compromise soft Brexit - or a “seamless Brexit” as Tokyo calls it.

Japan’s demarche should not be read as a threat to Britain. The document is equally addressed to the EU, making it clear that the EU’s own credibility is on the line and that any attempt to ‘punish’ Britain would be intolerable.

It urges the EU to recognize that Britain cannot on its own deliver these terms, and that EU officials must “heed the voices of Japanese businesses to the fullest extent and to do their utmost to cooperate in taking the necessary measures to advance the Brexit negotiations,” it said.

David Fuller's view -

AEP’s article is more cautious than The Telegraph’s other article regarding Japan which I posted on Tuesday.  A lot is in play right now and the EU is likely to change radically over the lengthy medium term, as I have said before.  However, the more immediate question is - might it actually concede to the UK a separate deal in terms of autonomy and sovereign rights, including control over its own borders?  There is currently no precedent for this, although it would be in the sensible interests of European trade with the rest of the world.  Alternatively, the UK may have no other option but to go for full Brexit, in its best long-term interests.  In other words, leave the EU, lock, stock and barrel. 

A PDF of AEP's article is posted in the Subscriber's Area.  



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September 07 2016

Commentary by David Fuller

Why London will be an economic powerhouse after Brexit

London has retained its crown as the leading global city of opportunity and will remain a top destination for years to come despite the UK’s decision to leave the EU, according to PwC.

The Big Four accounting firm said the capital’s status as an economic powerhouse and magnet for innovation had helped it to “pull away” from global rivals this year.

Its report, which ranks the world’s 30 leading cities via a series of measures including ease of doing business, economic clout and liveability, put London at the top for the second straight year, ahead of cities including Singapore and Toronto.

PwC said London’s dynamism meant it would remain “agile and resilient” in the face of the Brexit vote, helping it to take advantage of “opportunities” and overcome challenges in the years ahead.

PwC’s research was conducted well before UK’s decision to leave the EU on June 23. However, it said the prospects for London remained bright.

“We cannot predict what Brexit may mean to the future of London as a pre-eminent world city, we do know it is today one of the world’s most cosmopolitan and well balanced cities, as shown by our research.

"Any effects Brexit may have on London will take place in a process that will evolve over time and not overnight,” it said in a report.

Sadiq Khan, the Mayor of London, said he was confident that London would continue to be “the best place in the world to do business”.

David Fuller's view -

PwC is certainly an influential firm but surely this is a very subjective article and rating.  The important assessments of Britain post Brexit will come several years from now.  Personally, I am very optimistic about the UK’s prospects but they will require good governance and hard work, just like any other important achievements in the histories of countries. 

A PDF of this article is posted in the Subscriber’s Area.



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September 07 2016

Commentary by David Fuller

Email of the day

On the post Brexit future for Britain:

David, I have the impression that City AM is running a series of articles to raise spirits in the City in this first week back from the holidays. Well, not a bad thing to do in comparison with the post-Brexit stuck-in-the-mud approach of some other papers I won't name. I particularly like this article in today's edition of city AM.

This is a truly uplifting article. It makes so may good points it is hard to choose one or two (though I know you will agree that London is the coolest place to live on the planet). Its main point is that wages in China have increased 5 fold in 3 years and at the same time, after one region in the USA, "the next most competitive location is the British Midlands from Birmingham to Manchester and beyond, plus the High Tech triangle that runs between King’s Cross, Cambridge and Oxford." I travel the world a lot and my impression is exactly as recorded in this article. I am very excited about the post Brexit future for Britain.

 

David Fuller's view -

Thanks for a very interesting and enthusiastic email of general interest.  (Note for subscribers: I have attached the two links which came with this email so that you can access them without leaving the Fuller Treacy Money site.)

There is certainly no harm in raising spirits in the City or anywhere else, with genuine good will and realistic optimism. What those of us who favour Brexit need to avoid is hubris – a repellent and destructive state of mind.  There are big, exciting challenges ahead, requiring a realistic can-do spirit. We also need to encourage rather than alienate disheartened Remain voters.  The UK needs their energy and constructive input.  Personally, I remain very optimistic about Brexit, but I do not underestimate the challenges. 

Incidentally, Pippa Malmgren, who wrote the article for City A.M. above is an interesting contributor.  An American and successful businesswoman, she was a financial advisor to President George W Bush, before moving to London where she now lives and works.  Similarly, the author of this email is a key participant in the High Tech triangle which runs between King’s Cross, Cambridge and Oxford.   



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September 07 2016

Commentary by Eoin Treacy

Flows vs. Fundamentals the upside risk to EM EPS

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

The EM equity rally continued in July and August (+8%), albeit at a slower pace than the furious January-March rally (+20%), with MSCI EM sitting at 898 currently, or 2% off the cycle highs from two weeks ago. EM FX has corrected a bit more sharply in recent days, and our EM FX index currently sits just 0.5% above its March 31 close. Although sovereign credit spreads remain near cycle-tight levels, EM credit and local bonds have softened their rally as well in recent days (USD debt +4%, local debt +1% since end-June). As we discussed earlier this summer, an EM-friendly environment with equity being the strongest performer tends to occur during a ‘growth up, rates up’ phase of the cycle, and this has indeed been the macro backdrop (see EM Cross-Asset Strategy Part 1: Identifying ‘EM Risk’).

Much of the discussion surrounding the EM rally has focused on flows and positioning, but EM fundamentals have shown signs of a tepid improvement. EM GDP growth accelerated sequentially in the first quarter of 2016, and monthly data (such as Industrial Production) continued to improve in 2Q (see Exhibit 1). This is not the first time that EM growth has picked up since the global financial crisis – we have seen a few oscillations in sequential growth momentum and the bounce came off a low base in 4Q 2015. However, perhaps more importantly, the differential of EM vs. DM growth has improved in the past two quarters, a development we have not seen since early 2012 (see Exhibit 2).

We have long argued that an improvement in the EM growth outlook is the essential  ingredient in adopting a positive outlook on EM equity – both in absolute and relative terms. Consequently, while we are unsurprised that the EM rally coincided with improving growth earlier this year, we have remained sceptical on the rally for two mains reasons: (1) the GDP acceleration did not drive EM EPS higher, and (2) EM growth picked up off a very low base and amid a sharp rise in commodity prices (oil and metals) in late Q1 and Q2, something we do not expect to continue in 2H. Below, we discuss the upside risk

 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

Negative yields in some of the world’s largest developed markets has set off a global search for yield which has burnished the allure of many emerging markets. Meanwhile the rebound in commodity prices may have provided the bullish catalyst required to stoke interest in the asset class and is likely to remain a tailwind for the sector as long as prices are rallying. 



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September 07 2016

Commentary by Eoin Treacy

Enbridge May Have Just Touched Off a 'Supermajor' Race for Pipes

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

With Enbridge Inc. planning a $28 billion takeover of Spectra Energy Corp., some investors say the industry’s in store for more deals as pressure mounts on the likes of Enterprise Products Partners LP and Kinder Morgan Inc. to follow suit. The biggest pipeline deal of the year foreshadows a feeding frenzy as those companies that survived the collapse in oil and natural gas prices step up the hunt for bargains. TransCanada Corp. got the ball rolling with the $10.2 billion purchase of Columbia Pipeline Group Inc. earlier in the year.

“We’ve just come through a very tumultuous period,” said Libby Toudouze, a partner and portfolio manager at Cushing Asset Management in Dallas. “Being able to survive the trough in the energy cycle, especially one like this last one that was so long, means you have to be bigger, faster, stronger.”

Enbridge’s deal would vault the Calgary-based company into North America’s largest energy pipeline and storage player. It could also mark the beginning of the "supermajor" era for the industry, according to Rebecca Followill, head of research at U.S. Capital Advisors, since it might “light a fire in the bellies” of the larger pipeline players, setting off a wave of consolidation that could accelerate through the end of 2016.

“Enterprise Products Partners is the other big 800-pound gorilla out there,” Toudouze said. “This puts a little more pressure on them to try to do something in the space.”

 

Eoin Treacy's view -

The MLP sector, which is heavily weighted by pipelines, crashed lower with oil prices. The high leverage employed in the business models of pipeline companies was a major contributing factor in this underperformance. However with increased evidence that oil prices have hit medium-term lows, the relative resilience of North American economic growth and continued low interest rates, it is a natural time for companies to think about acquisitions. 



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September 07 2016

Commentary by Eoin Treacy

Bond Traders Pare Fed Wagers as Goldman Reverses September Shift

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

"With slightly softer data and less ‘time on the clock,’ a rate increase this year now looks a bit less certain," Jan Hatzius, chief economist at Goldman, wrote in a note to clients Tuesday. "While this is just one indicator, the surprise was meaningful, and there may have been some Fed officials feeling lukewarm on a September hike to begin with."

The central bank meets Sept. 20-21 after officials have stood pat on rates this year and twice pared projections for the path of increases. San Francisco Fed President John Williams on Tuesday said the U.S. economy is “in good shape and headed in the right direction” without indicating whether he was leaning one way or another regarding a rate increase.

 

Eoin Treacy's view -

With a wall of debt that needs to be either retired or refinanced coming due in the next few years the Fed is understandably cautious about raising rates without robust economic growth to swell government coffers. In fact since monetary easing has not quite achieved the growth rates envisioned by central bankers, the case for fiscal stimulus is growing, regardless of the potential for it to create a bigger problem later. 



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September 07 2016

Commentary by Eoin Treacy

September 06 2016

Commentary by David Fuller

Japan Threat to Cut Investments in the UK Would Hurt but is Unlikely to Come True

Japan’s companies could flee the UK post-Brexit, the country’s government has warned, if Britain is cut off from Europe and the world.

The bold statement does not reflect the public aims of Britain’s leaders nor those of the EU, but Japan’s warning reflects worries over the potential shock to global trade if ties with other nations are severed altogether.

“Japanese businesses with their European headquarters in the UK may decide to transfer their head-office function to continental Europe if EU laws cease to be applicable in the UK after its withdrawal,” the government said in a statement at the G20.

The document handed a list of demands to the UK and EU, warning that tariffs on international trade “could suppress the revenues of businesses” while burdensome red tape on trade between the UK and EU would “increase the costs of logistics operations, which would have a significant impact on business operations”, and that retaining and banking passport is vital.

In plain English, it is a threat of less investment and fewer jobs.

Japan is certainly a major investor in the UK. Almost 1,000 UK firms are owned by Japanese investors, with a combined turnover of £72bn last year and gross value added to the economy of £14.5bn, according to the Office for National Statistics.

Foreign direct investment into the UK from Japan totalled a net £2.2bn in 2014, with the UK receiving half of the country’s investment into the EU, seeing Britain as a gateway to Europe.

The Japanese ambassador estimates 10,000 Japanese firms operate in the UK, employing 140,000 people.

The impact of a wholesale shift away from the UK by any large firm could be significant, particularly when companies focus in one particular region.

Nissan and Hitachi are both big Japanese manufacturers with major operations in the North East of England – Nissan’s car plant in Sunderland employs 6,100 staff, and claims that more than 24,000 jobs are created in the wider supply chain supporting the factory.

David Fuller's view -

This is an informative article, well worth reading.  I hope the headline above is correct, but am concerned that it may be overly optimistic.  Japan will not want to move any of its expensive plant and it already has good, reliable labour in the north of England and elsewhere within the UK. 

However, some EU countries have long hoped that they could attract business away from the UK.  Brexit reopens covetous instincts.  Nevertheless, is the insistence that the UK maintain open borders (an increasingly unrealistic and unpopular policy within the EU) more important than mutually beneficial free two-way trade with the UK?  I don’t think so but more importantly Mrs Merkel still does.  She may also be in the twilight of her political career, apparently determined to tell her public which way to vote rather than listen to their concerns.

Is there a hint of hypocrisy in all this?  See also: Germany braces itself for invasion of Polish workers as it follows EU immigration rules.  Published by The Telegraph in May 2011, you may find it interesting.  My thanks to Eoin for providing it.

This item continues in the Subscriber’s Area, where a PDF of the leading article is also posted.



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September 06 2016

Commentary by David Fuller

Quantum Computers Are Coming. The World Might Not Be Ready.

Quantum mechanics, Carl Sagan once observed, is so strange that "common sense is almost useless in approaching it." Scientists still don't understand exactly why matter behaves as it does at the quantum level. Yet they're getting better at exploiting its peculiar dynamics -- in ways that may soon upend the technology business.

One of the most interesting applications is in computing. In theory, quantum computers could take advantage of odd subatomic interactions to solve certain problems far faster than a conventional machine could. Although a full-scale quantum computer is still years off, scientists have lately made a lot of progress on the materialsdesigns and methods needed to make one.

And that could have some striking benefits. Quantum computers could simulate how atoms and molecules behave, to the great advantage of chemists and drug designers. They could solve optimization problems -- say, how to efficiently route airplane traffic -- far faster than current technology can. They could speed advances in artificial intelligence, improve sensors, and lead to the design of stronger and lighter industrial materials.

Unsurprisingly, then, investment in the field is surging. IBM,Microsoft and Google are all building quantum research labs. Startups are gearing up. Banks are very interested indeed. Governments see applications for space explorationmedical research and intelligence-gathering. America's National Security Agency, in fact, has been quietly trying to build a quantum computer for years, in the hope that it would make an unstoppable code-breaker.

And that suggests a looming problem. To simplify a bit, the cryptographic tools commonly used to protect information online rely on very hard math problems, such as factoring large integers, that normal computers can't solve in a reasonable time frame. Quantum computers, though, could probably make quick work of such equations.

As a result, they could undermine the security of everything from mobile phones to e-commerce to cloud computing. Within two decades, by some estimates, quantum computers may be able to break all public-key encryption now in use. "The impact on the world economy," says the nonprofit Cloud Security Alliance, "could be devastating."

David Fuller's view -

For computer security specialists, this is the equivalent of: ‘… and just when you thought it was safe to go back into the water.’

For instance, quantum computers should have no problem in outsmarting the latest, albeit not fully developed, blockchain security system.  And how will quantum computers hold up against self-programming artificial intelligence?

We live in increasingly interesting times. 

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September 06 2016

Commentary by David Fuller

Can More Bad Times Be Ahead for EM?

My thanks to Bernard Tan for his ever interesting and original research, illustrated with lots of graphs which you may not have seen.  Here is the opening:

 

It has become increasingly popular to turn bullish on Emerging Markets (EM). I am not a believer.

The biggest EM market is China. But the most important driver of China’s economy, the M2 monetary aggregate, has turned down again.

Already with each passing quarter, the Chinese economy is generating less GDP for every dollar of M2. And now, M2 growth is decelerating sharply.

There’s no big recovery ahead for China. Just more drift and struggle.

Meanwhile after rising relentlessly since 2010, the US inventory to sales ratio for various sectors like retail, wholesale and manufacturing have begun to fall, starting from Apr 2016.

David Fuller's view -

This is further evidence that stock markets are borrowing from the future by floating higher on a cushion of liquidity, which the current economic data and corporate profits do not support.  Stock markets can be lead indicators but if the fundamentals do not catch up reasonably soon, investors will start to wonder if they have run off a cliff.  We can expect more anxious calls for fiscal spending. 

 Bernard Tan’s report is posted in the Subscriber’s Area.



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September 06 2016

Commentary by Eoin Treacy

China's Productivity Growth is the Worst Since the Asia Crisis

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

Labor productivity in the world's second-largest economy increased 6.6 percent last year to $7,318 per person, National Bureau of Statistics and International Labour Organization data show. The level, calculated as average inflation-adjusted gross domestic product per employed person per year, measures the efficiency of workers economy-wide.

China kicked off a big surge in efficiency in the early 2000s after entering the World Trade Organization, implementing aggressive reforms to streamline state corporations and allowing more of a private real estate market. But even after those gains it still lags far behind more productive economies in Europe, Japan and the U.S.

 With a shrinking working-age population already hurting economic growth, China must boost the value created by each worker if it is to join the ranks of the world's wealthy economies.  The hope is that upgraded machinery, services sector advances and a shift up the value chain will help make workers more efficient--and maybe even shorten the  badminton lunches.

 

Eoin Treacy's view -

At over $7000 per person China is squarely in the middle income bracket of global economies. However that figure is distorted by the inequality evident within a population of over 1 billion where extraordinary wealth contrasts with profound poverty in the hinterland. If China is going to march towards continued standard of living improvements then productivity growth will need to continue and that will be contingent on government appetite for economic reform. 



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September 06 2016

Commentary by Eoin Treacy

Rupee Jumps to 4-Month High as Patel Begins Innings as RBI Chief

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

Indian sovereign bonds also advanced on Tuesday. Urjit Patel assumed charge as the Reserve Bank of India’s 24th governor on Sept. 4, succeeding Raghuram Rajan. Patel’s first test will come Oct. 4 -- a scheduled monetary policy review -- where investors will gauge if governorship reduces his traditional reticence.

“An interest-rate increase by the Fed is unlikely,” said Rohan Lasrado, Mumbai-based head of foreign-exchange trading at RBL Bank Ltd. “Inflows into stocks remain strong and that’s supporting the rupee.”

The rupee climbed 0.5 percent to 66.5250 a dollar at the close in Mumbai, according to prices from local banks compiled by Bloomberg. It rose to 66.49 earlier, the strongest level since May 9. Tuesday’s gain reduced the currency’s 2016 loss to 0.6 percent, Asia’s worst performance after China’s yuan. RBL Bank expects the rupee to appreciate to 66.40 a dollar in the near term should equity flows sustain their momentum, Lasrado said.

“We don’t expect a change in the RBI’s foreign-exchange management under the new leadership,” he said. “They will love to buy dollars at dips and refrain from intervening should the rupee weaken in line with Asian fundamentals.”

 

Eoin Treacy's view -

The RBI engaged in a reserve accumulation policy which put pressure on the Rupee between mid-2014 and early this year when the currency tested its spike lows against the US Dollar. However it has stabilised over the last six months with the 6.5% base rate looking increasingly attractive in an environment where so many government bonds are trading on negative yields. 



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September 06 2016

Commentary by Eoin Treacy

Brent Oil Declines as Saudi-Russia Deal Falls Short of a Freeze

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

"The failure of Russia and Saudi Arabia to take any steps to support the market is sending us lower," said Bob Yawger, director of the futures division at Mizuho Securities USA Inc. in New York. "The Saudi oil minister actually talked the market lower, which is going to cost his country billions." 

Brent rose the most in three weeks on Friday after President Vladimir Putin said he’d like OPEC and Russia to agree to an output freeze, speaking before he traveled to China to meet Saudi Deputy Crown Prince Mohammed bin Salman. Oil had rallied in August on speculation that members of the Organization of Petroleum Exporting Countries and other producers would agree to cap output when they meet informally in Algiers later this month. A similar proposal was derailed in April over Saudi Arabia’s insistence that Iran participate. 

 

Eoin Treacy's view -

Russia, more than most countries, must want to see oil trading at higher prices. It’s by far their most important export and is responsible for funding not only public services but the country’s adventurism in Eastern Europe and The Levant. Saudi Arabia on the other hand has deliberately used oil as a policy tool in its attempt to deprive Iran, against whom it is engaged in open conflict in Syria, Yemen and Iraq, from deriving any advantage from the loosening of sanctions. If Saudi Arabia were to agree to Russia’s terms without a commensurate move from Iran it would be an admittance of failure which would be hard to countenance at this stage. 



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September 05 2016

Commentary by David Fuller

As the EU Undermines Ireland Over Apple and Tax, Britain is in the Right Place to Benefit

Here is part the opening and also the conclusion of this powerful column by Janet Daley for The Telegraph:

We are getting out in the nick of time. The keepers of the European Union’s dying project have gone beyond the denial phase of mourning and are now utterly deranged. A historic bridge was crossed last week when the European Commission, in the person of its competition commissioner Margrethe Vestager, announced that Apple’s tax arrangements with Ireland were illegal and, as a consequence, the company would have to pay £11 billion pounds in back taxes to the Irish government – which it does not want. Indeed, so adamant is the Irish coalition government on this point that it is now appealing against the EU ruling.

And:

Ironically, the great explosion of technological enterprise from which Ireland has hitherto been in a position to benefit will now be quite likely to shop for a new home – and the UK will be a perfect candidate with the same advantages of transatlantic connections and English language that Ireland had. But the kind of bilateral trade deals with us which Ireland, as a small independent economy, might once have enjoyed will not be possible so long as it remains an EU member.

There will be limitless opportunities for an industrious, entrepreneurial country no longer bound by the parochialism of the EU with its obtusely outdated post-war view of economics. An infinitely adaptable tax structure and a frankly competitive approach to encouraging investment – perhaps with a serious cut in corporation tax and a further lowering of National Insurance contributions for start-up businesses – could allow partnerships to be formed with eager, equally adaptable, emerging powers as well as the possibility of instantaneous response to new technologies and markets. If ever there was a moment to throw off hidebound assumptions and ideological restrictions, this is it.

Talk of adopting the Norway (or the Swiss) model is absurdly self-limiting. Our circumstances as a large, variegated and flourishing economy are unique. Without the encumbrance of Brussels protectionism and perverse anti-competitiveness, our new arrangements can be bespoke and endlessly flexible – surely the keys to survival in a globalised economy.

The dream of a European union was seen from the outset as a way of undermining the nation state with its dangerous tendency to evoke febrile nationalism. The war crimes of the 20th century were to be repudiated forever by deconstructing that demonic vision. Almost entirely forgotten has been the lesson of an earlier century: that the concept of self-governing nationhood, with a government accountable to its own people and free to set its own economic goals, was one of the most progressive ideas in human history. 

It may be time for the British to offer a new version of that model which was once their gift to the world.

David Fuller's view -

This column, which I commend to subscribers, shows Janet Daley at her best.  Exceptionally perceptive regarding the EU, she is also well aware of the excitement felt by the 17.5 million who voted for Brexit.  Their ranks are growing by the day as many marginal Remain voters are encouraged by the prospect of a fully independent United Kingdom, leaving the EU much sooner than previously feared, pursuing global interests with a free-market economy, while also maintaining strong but separate alliances with our friends and allies in Europe.

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September 05 2016

Commentary by David Fuller

Summer Holidays Are Over. It is Time to reassess the World Economy

This is the week when the world of work returns to normal. It is often also when economists and financial markets reassess how things are after the summer break. This weekend the leaders of the G20 countries have been making their assessment at a meeting in Hangzhou in China.

How does the world economy look now?

A year ago the markets were in a funk about the Chinese stockmarket and, by extension, the Chinese economy.  I argued at the time that the stockmarket weakness was nothing to write home about and, although the Chinese economy had slowed, this was not extraordinary and would not lead to anything like a hard landing.

A year on, this view now seems to be widely accepted. The Chinese stockmarket is roughly flat over the past year, and it looks as though the Chinese economy has grown by 7pc according to the official data, and in reality by perhaps 4.5pc.

Of course, China is not going to be able to grow at the rate it managed a few years ago, but something like 5pc to 6pc is eminently achievable.  Moreover, given the scope for effective policy action if the growth of aggregate demand falters, something like these rates of growth should be realised.

In Japan it looks as though Shinzo Abe’s ambitious plans to raise the country out of its torpor are not succeeding. Japan will probably grow by only about 0.5pc this year.  Mind you, because of a contracting workforce, this is probably about all the economy is now capable of. Admittedly, this is poor, but the world has had to get used to weak Japanese growth for many years.

Meanwhile, most of the rest of Asia has recently experienced an acceleration in growth.  More importantly, worries about the fragility of the US economy have not been vindicated. It will probably grow by about 2pc this year, and employment is still increasing at a decent, although unspectacular, pace, as confirmed by the jobs figures on Friday.

 Interest rates are likely to rise soon, perhaps even later this month, although more probably in December. But the pace of increases over the next two years is likely to be moderate. For much of the past year the markets have also been concerned about the global effects of low oil prices.

This seemed paradoxical, because previously low oil prices were thought to be a good thing for the economy, and for a number of countries they have indeed been good this time round. But the markets were worried about the adverse effects of low oil prices on oil producers, including in the United States and, of course, on a large number of countries whose prosperity is heavily dependent upon oil.

In recent months, however, these worries have been, to some extent, allayed. The oil price is off the bottom and seems to have stabilised at about $50 a barrel. Meanwhile, there are signs of stabilisation, if not quite improvement, in some of the countries that the markets have been worried about, particularly Russia.

To my mind, the biggest source of legitimate concern is the eurozone. By its own low standards, recent economic performance in the zone has actually not been bad. Over the past year, the eurozone as a whole has grown by about 1.5pc. Even the Italian economy has managed to perk up a bit.

David Fuller's view -

The global economic news has been a little better than widely feared earlier this year.  Liquidity from QE remains abundant; interest rates are near record lows; everybody says bonds are in a bubble phase, including me.  They are; in fact, how could they not be?  However, the Merrill Lynch Treasury 10-Yr Future Total Return Index remains in an orderly uptrend, so the bubble has yet to burst. 

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September 05 2016

Commentary by David Fuller

Britain Can Leave EU and Still Thrive, Says Stiglitz

Here is a latter section of this interview from The Telegraph:

Stiglitz, a one time adviser to the Scottish government on independence and briefly a member of Jeremy Corbyn’s now disbanded economic advisory panel, has been in the UK to promote his new book, The Euro, and its Threat to the Future of Europe.

In it he argues that the root cause of Europe’s political and social ills lies in the creation of the euro, which rather than driving convergence among nations as intended has resulted in politically and economically destabilising divergence.

“The Brexit referendum was a shock”, he concludes.

“My hope is that the shock will set off waves on both sides of the Channel that will lead to a new, reformed European Union.”

Europeans were finally waking up to the idea that there is not going to be a euro without a crisis on the doorstep”, he told the Telegraph, “and that’s a gloomy prospect” likely to drive “a political backlash against the establishment standing behind the euro.”

However, the euro is not the only thing that has gone wrong in the European Union, Stiglitz argues.

“There were other mistakes. It is fairly clear that the EU has imposed more regulatory harmonisation than is necessary, and that this excessive enthusiasm for regulatory harmonisation is one of the things that has gotten the EU into trouble with the British”.

David Fuller's view -

Joseph Stiglitz is saying what most people in the UK who have been following EU developments over the years already know.  However, perhaps the international reputation of this Nobel Prize winning economist will open some political eyes from the USA to Japan, where people have been seeing what they want to see.  The EU is a political and economic train wreck, as its own long-suffering citizens know better than anyone else.    

A PDF of this interview is posted in the Subscriber’s Area.



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September 05 2016

Commentary by David Fuller

Email of the day

On Joseph Stiglitz:

Dear David and Eoin. 

I guess you saw this article. 
http://www.telegraph.co.uk/business/2016/09/04/britain-can-leave-eu-and-still-thrive-says-stiglitz/

Joseph Stiglitz makes some good points. He says:
"There are two scenarios. If Europe adopts the Juncker approach, which is to say we’ll cut off our nose to spite our face and punish Britain for leaving, then that’s not so good."

“But it really wouldn’t be in Europe’s interests to do this. The US is actively engaged in Europe, in manufacturing, services and finance, and our trading relationship with Canada, where we have a free trade agreement, but no single market and no free movement, works well, actually really well, for Canada.

“So you should be no worse off than Canada is with the United States. I find it quite hard to believe that you [Britain] would be treated worse by Europe than the US or Canada, or Canada is by the US. This would be hard to justify”.

David Fuller's view -

Thank you for your email, plus the article link and quotes.  Yes, I did see it because I read The Telegraph before anything else.  I had posted the article in my copy above, along with my own brief comments. 

I think Junker has been marginalised because there is no appetite right now for ever ‘more Europe’ within the EU.  However, plenty of EU politicians are understandably, disappointed, frustrated and angry about the economic and political morass in which they find themselves.  A few of them are lashing out although Brexit is a symptom rather than the problem.  Privately, my guess is that the UK is admired more than disliked for leaving the EU. 

 



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September 05 2016

Commentary by David Fuller

September 02 2016

Commentary by David Fuller

AEP: Dollar Hegemony Endures as Share of Global transactions Keeps Rising

The US dollar is tightening its grip on the global financial system at the expense of the euro, entrenching American hegemony and rendering the US Federal Reserve more powerful than at any time in history.

Newly-released data from the Bank for International Settlements (BIS) show that the dollar’s share of the $5.1 trillion in foreign exchange trades each day has continued rising to 87.6pc of all transactions.

It is the latest evidence confirming the extraordinary resilience of the dollar-based international order, confounding expectations of US financial decline a decade ago.

Roughly 60pc of the global economy is either in the dollar zone or closely tied to it through currency pegs or ‘dirty floats’, and the level of debt issued in dollars outside US jurisdiction has soared to $9 trillion.

This has profound implications for monetary policy. The Fed has become the world’s central bank whether it likes it or not, setting borrowing costs for much of the global system.

The BIS data shows that the volume of transactions in which the euro was on one side of the trade has slipped to 31.3pc from 37pc in 2007. The dollar share has ratcheted up to 87.6pc over the same period.

It is much the same picture for the foreign exchange reserves of central banks, a good barometer of global trust. The dollar share has recovered to 63.6pc, roughly where it was a decade ago.

The euro share has tumbled over the last eight years from 28pc to 20.4pc, and is barely above Deutsche Mark share in the early 1990s.

 “There are no foreseeable rivals to the dollar as a viable reserve currency,” said Eswar Prasad from Cornell University, author of “The Dollar Trap: How the US Dollar Tightened Its Grip on Global Finance”.

“The US is hard to beat. The US has deep financial markets, a powerful central bank and legal framework the rest of the world has a great deal of trust in,” he said.

The eurozone is crippled by the lack of a unified EU treasury, joint bond issuance, and a genuine banking union to back up the currency. It would require a change in the German constitution to open the way for fiscal union, an unthinkable prospect in the current political climate.

David Fuller's view -

There is much to ponder in the section above and also in the remainder of this column, which I commend to subscribers.  While the article is mostly about Dollar hegemony, which will certainly increase over the next few years, part of the flip side is the unravelling of the eurozone which is now underway. 

A surprisingly large proportion of geopolitical commentators and politicians do not recognise or understand this, partly because they want and even need to believe in the eurozone.  They include plenty of intelligent people in the USA.  Knowing that two World Wars in the first half of the last century started in Europe, they have long viewed post-WW2 reconciliation by European nations as a ‘noble experiment’, and they would be alarmed by its failure.  

Arguably, it was a noble experiment, at least until the Maastricht Treaty of 1993, which I commented on yesterday.  However, governance is everything, as this service never tires of saying.  I am convinced that future historians will cite the EU as a textbook example of how not to create a large, successful federation consisting of a number of states.  The first and widely predicted blunder was the conversion to a single currency before a fiscal union has been established, assuming this could have occurred, which I doubt.  Currently, it would require a change in the German constitution to salvage the eurozone, an all but unthinkable development given present circumstances, as the article above points out.

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September 02 2016

Commentary by David Fuller

It Is Time to Repeal the New EU Corn Laws

Every so often, one single number can change an entire political conversation. So here, dear reader, is my candidate for this weekend’s game-changing fact, which reveals why it is desperately important that Brexit be used to negotiate a much better deal for British shoppers.

On average, prices paid by EU consumers are 6pc higher than the prevailing world price; in many cases, prices are much higher than average, with EU consumers paying 31pc more for beef and veal, for example; two hugely important products.

It’s the real and entirely unacceptable cost of living in the EU; a far greater problem than the membership fee that richer countries must pay to Brussels

The reason for such rip-off prices? Europe’s protectionism, though lack of competition doesn’t help either (and is related to barriers to trade with the rest of the world). As ever, it is the poor who are hit the hardest: they spend a higher share of their income on essential products such as food.

The figures, from the OECD, were unearthed by Andrew Tyrie, the Tory MP, who has just written an interesting report on Brexit published by Open Europe. I disagree with some of Tyrie’s broader arguments, but his paper is well worth reading.

My point is this: there are, of course, costs as well as benefits to Brexit. The Government’s great, historic task is to maximise the upside while minimising the downsides. To deliver the best possible solution, it will be key to tackle the absurdity of consumers having to pay such elevated prices, and push through policies that bring these down to global, free-market levels as soon as possible.

A 6pc drop in prices would represent an immense gain in welfare terms: it is one of the great pots of gold at the end of the Brexit rainbow, with the added benefit of truly existing. There are many other gains to be had, but lower prices are the most immediately tangible benefit.

David Fuller's view -

I agree, and the benefits of Brexit should not be postponed by years of tortuous negotiations.  The best course, in my opinion, is to invoke Article 50, leave with minimal or even no negotiations, and very closely thereafter, simply declare unilateral free-trade.  The UK would save a considerable amount of money and hassle by doing this.  Thereafter, using our membership of the World Trade Organisation, we would find Germany and many other EU countries all too happy to recommence trade agreements with Britain.  

A PDF of Allister Heath's article is posted in the Subscriber's Area.



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September 02 2016

Commentary by David Fuller

Email of the day

On selecting dividend stocks

Firstly thank-you for the excellent service you have provided over the years. I am wondering at these somewhat turbulent times as to what proportion of "dividend stocks" one would be advised to include in one’s investment portfolio. Would it be possible to comment on whether or not these should be weighted in terms of denomination of currency or if of an international trading base, preferred region of trading? I have looked through the chart library and found it quite difficult to identify individual aristocratic dividend stocks.

David Fuller's view -

Thank you for your thoughtful comments and topical question of general interest.

First, I would go to the Chart Library ‘Selections’ in the grey bar above lists and charts, and click on ‘International Equity Library’.  At the top of the left-hand column, you will see ‘Autonomies’ – a list of over 180 large, leading multinational companies, approximately half of which are headquartered in the USA.  Most of these pay dividends.  Immediately below Autonomies, you will see ‘Dividend Aristocrats’, which has a number of sub-sections.  Personally, I would not look any further if you are seeking a diversified, international portfolio of sector leaders and also dividend aristocrats, so called because they have raised dividends every year for a specified number of years. 

The next point I would consider is timing.   

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September 02 2016

Commentary by David Fuller

Clive Hale: Market Commentary

My thanks to the experienced author for his Albemarle Market Commentary: September 2016. Here is the opening, which starts with a Bill Gross quote:

"I and others, have, for several years now, suggested that the primary problem lies with zero/negative interest rates; that not only do they fail to provide an “easing cushion” should recession come knocking at the door, but they destroy capitalism’s business models – those dependent on a yield curve spread or an interest rate that permits a legitimate return on saving, as opposed to an incentive for spending. They also keep zombie corporations alive and inhibit Schumpeter’s “creative destruction” which many argue is the hallmark of capitalism. Capitalism, almost “commonsensically”, cannot function well at the zero bound or with a minus sign as a yield." Bill Gross – Janus Capital Group

Not always the most consistent of commentators, but there is no denying that his latest epistle carries more than a hint of truth. Markets are broken and trying to divine an investment strategy is more akin to going through the card at Newmarket; the odds at the race course will be a lot fairer than the ones currently on offer in bond world. Savers in search of income are being forced into areas which from a risk perspective they wouldn’t normally touch; high yield bonds, emerging market debt, equities and property all of which stand close to all-time highs and are seriously “expensive”, beset with liquidity issues or provide little or no downside cushion.

Worse still, the pensions industry still clings to heroic assumptions about growth rates in all manner of markets. Underfunding has been an issue for many a year but if realistic growth rates were factored in the shortfall would be catastrophic for insurance companies and pension fund trustees alike. In the US the American Academy of Actuaries and the Society of Actuaries has scrapped its long time joint Pension Task Force and banned the dissemination of its paper highlighting this dilemma, under threat of legal action against would be transgressors. As one pensions expert put it, “an inferno in the making, but without the benefit of Dante’s poetry.”

David Fuller's view -

What follows from Clive Hale is a sensible review of global asset classes which subscribers may find refreshing and helpful for the perspective it provides. 

I will address the opening quote with my further thoughts on this report.  It was the mild mannered academic Ben Bernanke who first introduced QE in our era.  For a refresher on this subject, it is worth re-reading the FT’s article: US Federal Reserve: The Bernanke years, published on December 15, 2013. 

Bernanke was appointed to lead the Fed in 2005, because he was an expert on the Great Depression and had promised to never allow another one to occur.  As fate would have it, he was soon challenged in 2008 when US banks could have caused a depression with their ‘liar loans’, leveraged many times by some firms. 

Bernanke’s series of QE programmes over several years were intended to lift the stock market sufficiently to boost confidence, preventing a depression mentality from persisting and cushioning the economy.  Bernanke succeeded in achieving this, although he was widely criticised by many financial commentators for ‘stoking future inflation’, which has yet to appear because of all the deleveraging which followed 2008.

Critics also said that by preventing a much sharper but probably shorter economic collapse, Bernanke had prevented the economy’s self-clearing mechanism from occurring (a euphemism for crash and burn) which in agricultural terms is soon followed by green shoots of recovery.  I disagreed, having heard from my parents about the Great Depression and also having seen how my mother never really got over that experience.  However, we will never really know how a supposedly benign neglect approach would have played out over the years following 2008. 

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September 02 2016

Commentary by Eoin Treacy

The Credit Strategist

Thanks to a subscriber for receiving permission to post this edition of Michael Lewitt’s ever interesting report. Here is a section on junk bonds:

Junk bonds may be rallying but it has little to do with corporate credit quality, which keeps deteriorating. As of the end of August, 113 companies had defaulted on their debt in 2016, already matching the total number of defaults from 2015. The year-to-date default count was also 57% higher than a year earlier. In case anyone is paying attention (it appears they are not), the last time defaults were this high was in 2009 when 208 companies failed during the financial crisis. Standard & Poor’s is now projecting that the annual default rate will hit 5.6% by June 2017 with 99 junk-rated companies expected to default in the 12 months ending June 2017. That would significantly exceed the 79 U.S. companies that defaulted in the previous 12-month period ending June 2016, which resulted in a 4.3% default rate. While low oil prices are a major contributor to this ugliness, energy companies only accounted for 57% of the defaults in the 12 month period ending in June 2016. That means that there is plenty of distress to go around

Even more disturbing is the fact that defaults are rising rapidly while many leveraged companies continue to enjoy low borrowing costs courtesy of the Federal Reserve. If interest rates were remotely normalized, the default rate would already be well above 5% and heading to the high single digits. None of this appears to bother investors, who are chasing yield in the rare places they can find it, which is always in all the wrong places. As a result, the normal spread-widening that occurs when defaults spike is not occurring, which is a very unhealthy phenomenon because it signals high levels of risk-taking and complacency on the part of investors. 

The history of the modern junk bond market teaches that most returns are earned in compressed periods after the market suffers a sharp sell-off. The rest of the time, investors are pushing water uphill as they invest in securities that offer poor-to-mediocre risk-adjusted returns until the point when the bottom falls out and they suffer catastrophic losses. There is good reason why very few credit hedge funds or other large investors made any money in junk since mid-2014, when the market began a sharp sell-off that coincided with the slide in oil prices and the slowdown in China. This sell-off ended early this year when the market began to rally based on the realization that the Federal Reserve lacks the intellectual capacity to understand the consequences of its own policies or the moral courage to change them. But investors are chasing zombies because numerous companies are not generating enough cash flow to reduce their debts or repay them when they mature. Instead, they are just living on fumes and waiting for the day of reckoning when their debt matures and they can’t pay it back. More of them will hit the wall when their debt comes due and they can’t refinance it at a reasonable interest rate because they are financially infirm. Standard & Poor’s is telling us that more of these companies are heading to the boneyard. Investors should be selling rather than buying this risk.

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

I don’t think there is any argument that central bank measures to inflate asset prices through, previously unimaginably, low interest rates and outright purchases of bonds have had a distorting effect on asset prices. In fact that was the whole purpose of the policies in the first place. After-all quantitative easing was conceived to avoid an even more calamitous crash and succeeded on many fronts.  The problem is that we are now more than seven years into an era of extraordinary monetary policy and the self-sustaining robust growth that could upend dire warnings of overvaluations has been slow to appear. In fact because much of the G7 is contending with weak growth the extent of the dislocation in valuing bonds has increased. 



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September 02 2016

Commentary by Eoin Treacy

Mosquitoes Are Deadly, So Why Not Kill Them All?

This article from the Wall Street Journal may be of interest to subscribers. Here is a section:

Aedes aegypti is high on the hit list of more scientists now that Zika has spread from Brazil to Miami , spawning an epidemic that has left hundreds of babies with devastating birth defects.
The same type of mosquito caused dengue to proliferate from Southeast Asia through tropical regions world-wide during the last quarter of the 20th century. The dengue virus infects an estimated 390 million people a year, killing thousands of them.

Aedes aegypti also is a carrier of chikungunya, a crippling disease that causes lasting joint pain, and yellow fever. In southern Africa, officials are struggling to contain a large outbreak of yellow fever, which can lead to fatal liver disease.

“Aedes aegypti is literally probably the most dangerous animal in the world,” says Omar Akbari, a molecular biologist and assistant professor of entomology at the University of California, Riverside. His conclusion is based on the number of infections to which the mosquito is linked.

 

Eoin Treacy's view -

Commerce and shipping ensured the Aedes aegypti followed humans from its roots in Africa to just about every warm wet climate region in the world. The fact mosquitoes proliferate most aggressively where people are least equipped to combat the threat they pose testifies to the fact economic growth is the most effective way of dealing with the many problems facing humanity. Gene editing, bacterial infection and radiation treatment all have a role to play in combating the significant health threat posed by mosquitoes. 



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September 02 2016

Commentary by Eoin Treacy

Solid Hiring Without Wage Jump Tests Fed Hopes for Inflation

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

The August employment report released Friday will sharpen the debate. The figures showed a monthly net gain of 151,000 jobs, an unemployment rate holding at 4.9 percent and a slowdown in wage growth. There’s ammunition in the latest data for officials who want to delay a rate increase as they look for signs of continued tightening in the job market. A critical component in Fed officials’ forecast is a rise in wages that boosts demand and drives prices higher.

“Nobody understands the inflation process, including the Fed,” said Torsten Slok, chief international economist at Deutsche Bank AG in New York. “When we are near full employment, why has inflation been so incredibly well-behaved?”

After the report, traders trimmed their bets on a rate hike at the Sept. 20-21 FOMC meeting to a roughly 14 percent chance, according to federal funds futures contracts.

The mystery of weak wage growth is troubling, for the short run and the longer-term. If Yellen and the FOMC majority are wrong, inflation could remain stuck below their target, setting the economy up for lower rates of inflation in the next downturn.

 

Eoin Treacy's view -

Wages are one of the most important figures to watch to decipher what the direction of Fed policy is likely to be because it cannot simply be headoniced out of the data. For example unemployment is a factor both of how many people are unemployed but also how many are looking for jobs. Lower participation rates flatter unemployment. You can’t do that with wages and because wage demands rise when workers feel they need more money to meet their liabilities they act as a barometer for inflation. 



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September 02 2016

Commentary by Eoin Treacy

September 01 2016

Commentary by David Fuller

Apple Travesty is a Reminder Why Britain Must Leave the Lawless EU

Europe's Competition Directorate commands the shock troops of the EU power structure. Ensconced in its fortress at Place Madou, it can dispatch swat teams on corporate dawn raids across Europe without a search warrant. 

It operates outside the normal judicial control that we take for granted in a developed democracy. The US Justice Department could never dream of acting in such a fashion.

Known as 'DG Comp', it acts as judge, jury, and executioner, and can in effect impose fines large enough to constitute criminal sanctions, but without the due process protection of criminal law. It misused evidence so badly in pursuit of the US chipmaker Intel that the company alleged a violation of human rights.

Apple is just the latest of the great US digital companies to face this Star Chamber. It has vowed to appeal the monster €13bn fine handed down from Brussels this week for violation of EU state aid rules, but the only recourse is the European Court of Justice. This is usually a forlorn ritual. The ECJ is a political body, the enforcer of the EU's teleological doctrines. It ratifies executive power.  

We can mostly agree that Apple, Google, Starbucks, and others have gamed the international system, finding legal loopholes to whittle down their tax liabilities and enrich shareholders at the expense of society. It is such moral conduct that has driven wealth inequality to alarming levels, and provoked a potent backlash against globalisation.

But the 'Double Irish' or the 'Dutch Sandwich' and other such tax avoidance schemes are being phased out systematically by the G20 and by a series of tightening rules from the Organisation for Economic Co-operation and Development (OECD). The global machinery of "profit shifting" will face a new regime by 2018.

We can agree too that Apple's cosy EU arrangements should never have been permitted. It paid the standard 12.5pc corporate tax on its Irish earnings - and is the country biggest taxpayers - but the Commission alleges that its effective rate of tax on broader earnings in 2014 was 0.005pc, achieved by shuffling profits into a special 'stateless company' with its headquarters in Ireland. 

"The profits did not have any factual or economic justification. The “head office” had no employees, no premises and no real activities," said Margrethe Vestager, the EU competition chief.

This may be true but that does not empower the Commission to act arbitrarily, retroactively, and beyond the rule of law. What is really going on - as often in EU affairs - is a complex political attack on multiple fronts. It is a reminder of why Britain must remove itself entirely and forever from the clutches of this Caesaropapist construction.

Apple's chief executive, Tim Cook, has a €13bn axe to grind, but he is almost certainly right in arguing that Mrs Vestager is making up state aid rules as she goes along, and has yet to produce evidence that Dublin granted Apple a sweetheart deal on taxes. "This claim has no basis in fact or in law," he said.

"The Commission’s move is unprecedented and it has serious, wide-reaching implications. It is effectively proposing to replace Irish tax laws. This would strike a devastating blow to the sovereignty of EU member states over their own tax matters, and to the principle of certainty of law in Europe," he said.

David Fuller's view -

The EU’s contempt for democracy among its unelected officials and even its elected politicians has long been obvious to anyone paying attention.  The horrendous precedent for today’s flailing and foundering EU was the Maastricht Treaty in 1992, which I last mentioned in yesterday’s lead article.  This project led by Helmut Kohl and François Mitterrand, basically scrapped the successful European Economic Community (EEC) and the European Free Trade Association (EFTA).  They were replaced by the European Union (EU), which the German and French leaders largely controlled. 

This remains the case today – Germany and France are the inner core of EU power, although it is clearly not an equal weighting in terms of economic influence.  Little countries such as Ireland have minimal influence within the EU.  This is why it has been smacked down by Europe’s Competition Directorate for the entrepreneurial audacity of its tax haven policies towards Apple and other US Autonomies.    

The USA is obviously not pleased by the prospect of losing potential tax revenue from American companies, should the EU charges prove successful.  The USA’s most effective bargaining chip is its funding for NATO.  I suspect that Putin is smiling in the Kremlin.    

A PDF of AE-P’s column is posted in the Subscriber’s Area.



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September 01 2016

Commentary by David Fuller

A New Low Tax Economy Can Both Liberate US and be Socially Just

We should all be grateful to Brussels for showing us, yet again, why we are right to be leaving the European Union, an entity now irrevocably set on a course of long-term decline.

There have always been two tendencies at work in the EU: one pro-competition, pro-market and pro-individual freedom; the other collectivist, centralising and madly interventionist. The latter faction won, spectacularly so.

The EU’s proposed trade deal with America is dead, demolishing the argument that remaining in the EU would have been the best way for Britain to deliver global free trade; and now the European Commission is waging war on tax competition. Forget about the technicalities of the Commission’s allegations against Apple and Ireland: the intent is to preserve the high-tax, high-spending social democratic model, and that means crushing those smaller, weaker nations with the temerity to seek to make themselves more attractive to potential job-creators.

As the EU shrinks after Brexit and globalisation proceeds apace, this is the economic equivalent of a new Maginot line, a doomed attempt at bucking international competition.

But its ineffectiveness at propping up a discredited model ought to be the least of Europe’s worries. By retroactively changing the rules, it has introduced immense uncertainty into corporate decision-making, and not just for American firms. Many other investors are realising they could be next, they too could suddenly be landed with an entirely unpredictable, postdated tax bill. Contracts between companies and nations are being reopened; promises torn up, not by those who made them but by an unelected, unstoppable bureaucracy.

Inevitably, Brexit implies temporary uncertainty, rattling the nerves of many big firms (consumers, by contrast, are pretty upbeat). The good news for UK Plc is that what little fleeting advantage the EU had gained as a result has now vanished. If Britain gets its act together, our kind of uncertainty – rebooting our society, politics and economics – will soon be seen as the good sort, while Europe’s will be understood as purely negative. How many City firms would, under such circumstances, still mull relocating anything more than a trivial number of their staff to Ireland or Luxembourg? At some point, the penny will also drop that France, Italy and Spain all exhibit high and rising geopolitical risk.

David Fuller's view -

Remember David Cameron?  He held the Brexit referendum at an early date – June 23rd, because he feared the EU’s refugee crisis would worsen over the summer.  That was not a difficult forecast and he was right.  Moreover, I cannot think of anything that has happened in the EU since June 23rd which would not have hurt the Remain cause.  Most significantly, the EU’s retroactive tax on Apple this week will hurt Ireland far more than the successful company currently run by Tim Cook.  If the referendum had been scheduled for tomorrow or anytime thereafter, I think the Leave majority would have been significantly larger.  

This item continues in the Subscriber’s Area where a PDF of Allister Heath’s article is also posted.



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September 01 2016

Commentary by David Fuller

September 01 2016

Commentary by Eoin Treacy

September 01 2016

Commentary by Eoin Treacy

Zinc, Lead, Tin Reach Highest Since 2015 on China Factory Data

This article by Joe Deaux and Agnieszka de Sousa for Bloomberg may be of interest to subscribers. Here is a section: 

Zinc, lead and tin climbed to the highest in more than a year after China’s official factory gauge unexpectedly rose last month, signaling improved demand from the world’s top metal user.

The manufacturing purchasing managers index rose to 50.4 in August, near a two-year high, the statistics bureau said Thursday, up from July’s 49.9 and compared with the 49.8 median estimate of economists surveyed by Bloomberg. The pickup strengthens the case that China’s economic stabilization remains intact even as credit growth slows and the central bank refrains from cutting interest rates. Copper was little changed in New York as traders assessed the prospect of strikes at two mines in Chile, the biggest copper-producing nation.

“Metals largely post gains as elements of Chinese manufacturing data display some improvement,” Michael Turek, the head of base metals at BGC Partners Inc. in New York, said in an e-mail. “Continuing Chilean labor unrest could become more pertinent for copper.”

 

Eoin Treacy's view -

Positive factory output figures from China represent a welcome development for the industrial resources sector which has been plagued by fears that the Chinese economy is in serious decline. Perhaps better economic data is a reflection of the fact that continued government support in the form of loose monetary and fiscal stimulus are having the desired effect on demand. 
 

 



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September 01 2016

Commentary by Eoin Treacy

IBM's Watson supercomputer creates a movie trailer

This article by Rich Hardy for Gizmag may be of interest to subscribers. Here is a section:

But perhaps the most beguiling, and subversive, aspect of Watson's trailer was how much it de-emphasised the monstrous nature of the human/nanotech hybrid. The irony of this entire project is that we have a film where a form of AI turns violent and kills humans, but the AI tasked with making the film's trailer ends up playing down that entire facet of the narrative.

Aside from being a fun experiment in computer-generated creativity, this project also proposes a speedy alternative to a generally costly and time-consuming process. The construction of a film trailer is usually an intensive practice taking several weeks to produce, but this trailer took only 24 hours to construct, from Watson "watching" the film to a human editor delivering the final product.

Making a good film trailer is a delicate balance between art and commerce. If anything this experiment still goes to show that a strong human hand is necessary even when producing what many would determine to be a disposable advertisement. Still, I wouldn't mind getting Watson's perspective on a few sci-fi films that vilify artificial intelligence. Maybe there is a Terminator trailer on the cards that sympathizes with Skynet or a view on 2001: A Space Odyssey where HAL 9000 is the film's hero?

 

Eoin Treacy's view -

IBM is in the midst of redeploying its knowhow from a company that delivered hardware to one almost entirely focused on software/computing as a service and Watson represents a big part of that. Meanwhile IBM is also advancing the development of quantum computers where it already has a 5-qubit prototype that it hopes to offer third party access too shortly. 



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August 31 2016

Commentary by David Fuller

Brexit Britain Could Be New Sweetheart After EU-US Relations Soured by Apple Tax Ruling

My thanks to a subscriber for this informative article by Lynsey Barber for City A.M.  Here is the opening:

Souring relations between the US and Europe in the wake of the EU competition watchdog ordering Apple to pay a record multi-billion pound tax bill could hand the UK a post-Brexit boost.

Britain could be the big winner from the tax feud between Europe and the US after the EU competition commission ruled Apple should pay a record €13bn in back taxes.

It could position itself as a more attractive destination in the region than Ireland, the Netherlands and Luxembourg, where the majority of the biggest US tech companies are headquartered, away from the growing stranglehold of state aid laws and EU Commission, which Ireland accused of trying to influence tax policy.

Apple slammed the ruling by competition commissioner Margrethe Vestager after a two year investigation which concluded it paid an effective tax rate of less than one per cent in 2014, amounting to state aid and compelling Ireland to collect a decade’s worth of back taxes. Both Apple and Ireland will appeal the decision, a process which is expected to take several years to make its way through the courts.

Apple finance chief Luca Maestri called the ruling "devastating" for the European economy while chief executive Tim Cook essentially accused the commission of moving the goal posts.

"Beyond the obvious targeting of Apple, the most profound and harmful effect of this ruling will be on investment and job creation in Europe. Using the Commission’s theory, every company in Ireland and across Europe is suddenly at risk of being subjected to taxes under laws that never existed," he said, adding that it remained committed investing in Ireland.

The US Treasury said the ruling would "undermine foreign investment, the business climate in Europe, and the important spirit of economic partnership between the US and the EU" after last week warning the commission of the “chilling effect” it was likely to cause to investment.

Apple is also among a group of top Silicon Valley firms to have warned the Netherlands that changes to its tax regime would risk foreign investment and jobs.

ETX Capital analyst Neil Wilson said: “This is building into a tussle between the EC and US companies, but it’s also a turf war between US and European regulators. For Apple and others like it, this could be a watershed. Caught between an aggressive EC and the Obama regime’s clampdown on tax inversions, it’s looking increasingly tough for multinationals to avoid paying the going tax rate.

“Britain could benefit. If Ireland cannot offer sweetheart deals within the EU, the City of London can perhaps offer something more appealing outside the bloc.”

David Fuller's view -

“Those whom the gods wish to destroy they first make mad.”  When historians rake over the ashes of the EU, they will marvel over the absence of good governance.  How could it have happened when there was so much goodwill among the world’s democracies for this historically interesting and cultivated region but too often a war-torn continent? 

Actually, it started well with the European Economic Community (EEC) created by the Treaty of Rome in 1957.  The EEC’s initial aim was economic integration among the six founding members: Belgium, France, Italy, Luxembourg, the Netherlands and West Germany.   Three years later the European Free Trade Association (EFTA) was formed in 1960, consisting of Iceland, Liechtenstein, Norway and Switzerland.  

The two links above will provide further details but the EEC and EFTA worked rather well, leading to an enlargement in 1973 when Denmark, Ireland, the United Kingdom.  Then Greece, Spain and Portugal joined in the 1980s. 

Arguably, these sensible economic arrangements became problematical with the Maastricht Treaty in 1992.  Its main architects were Helmut Kohl and François Mitterrand, creating a much closer political alliance called the European Union (EU).  The Euro was introduced in 2002.      

This was a triumph of political ambition over economic common sense.  There was certainly no groundswell of public opinion in favour of a Federal Europe, consisting of widely diverse cultures.  Consequently, democracy was compromised in the push for ‘more Europe’, meaning a single European state.  However the tragic mistake, which many people with economic backgrounds realised, was to introduce the single currency way before there was any realistic prospect of, let alone agreement for a Federal European state. 

The consequences have been apparent for years – a moribund economic performance within the Eurozone, compounded by largely socialist policies, leading to tragically high unemployment in the EU’s Southern regions, increasing political tensions within many of the EU states, and an unelected and increasingly powerful European Commission which in this latest instance has retrospectively trampled over what used to be the sovereign rights of Ireland.  It has also created a row with the US government, angered Apple and no doubt some other American Autonomies.  The EU’s Federalist train is derailed. 

Returning to the article above, I would encourage PM May to have all of the government’s departments ready with clear plans for post-Brexit action.  In fact, this is what she is probably doing.  There is no need to follow the EU’s untested script, which is just a web of details requiring endless ratifications, as a means of deterring countries from leaving.  It worked with poor, demoralised Greece but the UK is another matter. 

Once PM May thinks her government is ready, I assume she will declare Article 50, hopefully in January 2017 at the latest.  Article 50 means that the country would then have two years to negotiate, but why should it take that long?  The UK requires full-Brexit to regain its sovereignty.  There is nothing to negotiate; we are leaving the EU lock, stock and barrel. 

(See also: The Apple fiasco shows why corporation tax is an outdated anachronism, by Allister Heath of The Telegraph)



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August 31 2016

Commentary by David Fuller

We Should Seize the Benefits of Brexit Sooner Rather Than Later

The new trade department has exciting scope for free-trade agreements. For 43 years trade has been the ''exclusive competence’’ of the EU. During the referendum we were told that no one would want to do deals. But countries are queuing up.

The most worthwhile agreements are with fast-growing emerging economies that have high tariffs. As long as we remain in the EU there is no chance of deals with the two biggest countries – India ended talks with the EU in frustration at 28 member states demanding exclusions and China will not accept the EU’s political conditions for talks. But China has a deal with Switzerland, and India is negotiating one. Both would be keener still for one with us. Deals involving 28 countries take forever but bilateral trade deals typically take less than two years. And we can ensure they cover crucial UK industries such as services, which many EU deals exclude.

And:

Every week that we delay Brexit costs the British taxpayer nearly £200 million in membership fees. So both the Treasury and Health (which will have first call on extra spending) should be pushing for a speedy exit.

Although we will still be able to recruit EU nurses if we wish, leaving should be a stimulus to the NHS and our universities to expand training. At present we turn away up to three quarters of British applicants for nursing courses.

The new Department for Business, Energy and Industrial Strategy will want to incorporate all EU law and regulations into UK law to give business certainty and enable it to prune, amend and replace items which are unnecessarily burdensome. Assuming the UK retains the Climate Change Act commitment to reduce emissions by 80 per cent it will be able to reduce the cost of doing so by scrapping EU renewable targets.

David Fuller's view -

Full-Brexit will be the most promising step the UK has taken in decades.  Mrs May’s government will lower taxes to confirm to the world that we are open for business and the most entrepreneurial economy in Europe, with the world’s leading international financial centre. 

What about our current trade partners in the EU?  In the days immediately following full-Brexit we should not be surprised if Germany and our other trade partners within the EU signal that they remain open for business. 

(See also: May Spells Out Immigration Limits as the First Brexit Red Line, reported by Bloomberg)



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August 31 2016

Commentary by David Fuller

This Is Your Company on Blockchain

You don’t have to be an expert on digital currencies like bitcoin to be intrigued by the potential of the technology underlying them.Blockchain, as it’s called, is something new in computing. It mashes up cryptography and peer-to-peer networking to create what amounts to a shared database of transactions and other information—which can be open to all, controlled by no one. It’s not just for securely recording payments in crypto-coinage; a blockchain can handle complex transactions, even entire contracts. True believers say blockchain could reduce the need for businesses to organize as companies, which get work done via command and control. Using blockchain, they say, collaborators will be able to work together as free agents instead of under a hierarchy of bosses.

“Imagine for a moment if people could coordinate themselves in a much more organic and distributed manner, just like ants. But without giving up on the complexity and the free will that is characteristic of human societies. We can do that,” blockchain researcher Primavera De Filippi said in a TEDxCambridge talk last year.

The poetic vision of a blockchain society is a flock of starlings at dusk: decentralized yet perfectly coordinated. Blockchainers like to show video clips of murmurations—those enormous clouds of birds that pivot and wheel, climb and dive, split and merge with amazing grace. Blockchain, in this vision, could replace gobs of bankers, accountants, and lawyers, as well as escrow accounts, insurance, and everything else that society invented pre-21st century to verify payments and the performance of contracts.

David Fuller's view -

That last sentence hooked me.  While still a work in progress, Blockchain has the potential to be far more efficient and reliable than any system previously invented.   



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August 31 2016

Commentary by Eoin Treacy

Gold's rate-risk, enhanced

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

Janet Yellen's view of the world. Last Friday at Jackson Hole, the US Federal Reserve Chair, Janet Yellen, largely re-iterated her moderately positive take on the US economy: that the impact of a soft business environment and USD crimped export demand growth is being offset by rising economic activity elsewhere, featuring robust household spending. Indeed, Ms. Yellen believes that net-growth has been sufficient to deliver almost full employment, while inflation remains sub-2%. In coming years, the Fed expects moderate real-GDP growth + tightening of the labour market + inflation lifting above 2%. 

Implications for gold. Ms. Yellen delivered nothing new at this event. Her view of the current state of the US economy and its outlook could reasonably be described as balanced – confirmed by the subdued general market response to the event. Her most provocative statement regarding the cash rate itself was that the case for a hike had ‘strengthened in recent months’ – but any such move would require more economic data, and no time frame was offered. What does this all mean for the gold price? Ms. Yellen’s growth statements appear subtly more bullish, more insistent; comments on rate positioning probably less dovish – enhancing the risk of a short-term rate hike. This, in turn, constrains the short term upside of gold’s price (i.e. lifts demand for US$-assets; reduces demand for non-yielding gold).

 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

The Fed’s very gradual policy of raising interest rates, against a background where most other major central banks are still easing, or experimenting with negative rates, represents a moderate tailwind for the US Dollar. However when we consider the impact this might have on gold it is really worth considering in what currency one is denominating the metal in. 



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August 31 2016

Commentary by Eoin Treacy

D.E. Shaw Considering Major Stake in TerraForm

This article by Nathan Reiff appeared in Investopedia and may be of interest to subscribers. Here is a section:

D.E. Shaw is one of the most recent companies to express an interest in buying SunEdison's shares of TerraForm. Shaw already owns about 6.7% of TERP shares following a negotiation made to forgive SunEdison debt. While this is a significant stake already, it is nowhere near SunEdison's huge percentage of ownership of the company. By purchasing up additional "Class B" shares in TerraForm, D.E. Shaw would attempt to capitalize on SunEdison's bankruptcy declaration by acquiring one of its most valuable holdings.

Golden Concord has also recently made it known that it is interested in purchasing now-defunct SunEdison's shares of TERP stock. The company, which is China's largest new energy company that is not government-owned, no doubt also sees a prime investment opportunity. For both D.E. Shaw and Golden Concord, however, added interest in SunEdison's stake in TERP means that the competition for those shares is rising, and the price is likely to go up as well. Throughout Monday, August 29, shares of TERP were trading at higher levels as a result of the increased interest.

 

Eoin Treacy's view -

To coin a pun “solar has been under a cloud of late”. Last year’s decision by Nevada to side with established utilities and force solar power providers to help pay for the grid, which they had being using for free, foreshadowed wider questioning of the subsidies on which the installation sector has relied upon. The bankruptcy of SunEdison and Tesla bailing out/absorbing SolarCity are both symptomatic of the challenges facing the sector. 



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August 31 2016

Commentary by Eoin Treacy

SWIFT discloses more cyber thefts, pressures banks on security

This article by Jim Finkle for Reuters may be of interest to subscribers. Here is a section:

A SWIFT spokeswoman declined to elaborate on the recently uncovered incidents or the security issues detailed in the letter, saying the firm does not discuss affairs of specific customers.
All the victims shared one thing in common: Weaknesses in local security that attackers exploited to compromise local networks and send fraudulent messages requesting money transfers, according to the letter.

Accounts of the attack on Bangladesh Bank suggest that weak security procedures there made it easier to hack into computers used to send SWIFT messages requesting large money transfers. The bank lacked a firewall and used second-hand, $10 electronic switches to network those computers, according to the Bangladesh police.

SWIFT has repeatedly pushed banks to implement new security measures rolled out after the Bangladesh heist, including stronger systems for authenticating users and updates to its software for sending and receiving messages. But it has been difficult for SWIFT to force banks to comply because the nonprofit cooperative lacks regulatory authority over its members.

SWIFT told banks Tuesday that it might report them to regulators and banking partners if they failed to meet a November 19 deadline for installing the latest version of its software, which includes new security features designed to thwart the type of attacks described in its letter.

The security features include technology for verifying credentials of people accessing a bank's SWIFT system; stronger rules for password management; and better tools for identifying attempts to hack the software. 

 

Eoin Treacy's view -

The vulnerability of central banks and financial institutions to cybercrime is truly worrying and the fact the Bangladesh central bank didn’t have so much as a firewall exemplifies just how big the problem is. Swift is a global network with huge vulnerabilities. The problem is the penalty for laxity is so low that governments have been slow to act. It is questionable whether anyone will even lose their job because of the Bangladesh scandal. 



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August 30 2016

Commentary by David Fuller

The City Will Win Again In Brexit Bang

Here is the latter section of this fascinating article by Iain Martin, author of the about to be released book: Crash Bang Wallop: The Inside Story of London’s Big Bang and a Financial Revolution that Changed the World, writing in The Sunday Times:

Of course, just because the pessimists were wrong about the euro’s impact on London does not mean all will go well this time. Indeed, there is a warning from history about potential decline that is worth taking seriously. The City’s worst experience in the modern period came with the outbreak of the First World War, which shut the gloriously open cross-border markets of the Victorian and Edwardian era, when money flowed across continents, largely unimpeded by government intervention. Capital controls, which were introduced in the Second World War and continued after it, restricted businesses and individuals who wanted to move money around the world. It meant the healthy and normal flow of investment in and out of the country was curtailed.

It was a mad approach ended by three uncoordinated innovations. In 1963 the German-Jewish refugee Siegmund Warburg and his team in London invented the Eurobond (nothing to do with the later euro), which created a new way for companies in Europe to borrow and tap into the vast pool of dollars outside America. It became a multitrillion-dollar market and attracted American and Japanese financiers to London.

Then, in 1979, the Conservative chancellor, Geoffrey Howe, scrapped exchange controls. Money could move around freely, a seemingly shocking innovation at the time that transformed the working of the economy. The Big Bang in 1986 completed what amounted to a lifting of the shutters, a reopening after a long shutdown from 1914 to 1963.

What all those innovations had in common was an openness to outside influences. The UK must not cut itself off. But then that is not what is being proposed by Theresa May’s ministers or by most sensible Brexiteers, who seek free trade for the City. If sensible voices prevail it should be possible to arrive at a compromise with the EU in which co-operation and trade continue in return for some common standards.

The City’s biggest advantage, however, is unrelated to the EU. It is simply this: London is brilliantly placed to benefit from the change that is already beginning to sweep through finance. Few areas of economic activity are more ripe for disruption than banking and finance in the West, with its long-established and over-large institutions, powerful central banks and closed networks of licensed operators, gaming regulation and political links.

Thirty years on from the Big Bang, finance is about to be blown apart again, this time by a digital revolution. Many big banks may be stuffed. It will be full-on creative destruction.

Digital disruption — in finance it is called fintech — is ready to destroy elements of the old system, and the City is a leader in that regard already. Three floors of the main tower at Canary Wharf are full of young coders and entrepreneurs launching start-ups, attempting to reinvent finance and London all over again. Elsewhere, in the clusters of tech developments in the East End, the fintech crowd is also a strong presence developing products for investment and retail banking.

Rival centres such as Silicon Valley on the US West Coast and tech-savvy Israel are in the race too, but only London and New York combine fintech with those traditional advantages of being hubs full of people who know about making money from money.

Some of the more obvious changes coming will be noticeable to us as consumers, in the form of new online banks that will make switching accounts so easy that it takes a matter of seconds to complete. New ways to pay (facial recognition instead of even a contactless card) are promised for customers who are already used to getting what they want from online streaming and delivery services.

The UK is particularly well placed partly because it has taken so enthusiastically to the internet and online shopping. Our internet economy has almost doubled in size since 2010. This year it is expected to provide 12.4% of the UK’s GDP. In South Korea it is 8%, in China 6.9%, in the US 5.4% and in Germany 4%.

The British are making the transition to the future fast, creating an opportunity for the City to offer new products to retail customers. By combining new technology and apps with fresh thinking on how to sell shares to individual investors, we may even be able to revive the Thatcherite notion of a share-owning democracy. When interest rates are so ridiculously low and savings return nothing, it might appeal to millions of Britons.

But the biggest changes will be in the main, non-domestic business of the City, deep in the wiring of the international financial system and the giant debt and trading machine that props up our governments, which borrow from it.

The blockchain — digital technology that greatly increases the security of financial transactions — is the most audacious and fashionable fintech innovation of all. It has been invested in heavily by some of the old banks.

The underground digital currency bitcoin (a new form of money) is based on blockchain technology. All that underpins the virtual currency is code, a mathematical calculation that allows it to be produced and traded in a way both sides can see and have total trust in. No government or central bank controls it, and the transaction costs, unlike in traditional banking, are zero.

The best-known proponent of the blockchain is Blythe Masters, a British former JP Morgan financier now based in New York. The insight of the team that Masters runs was that it could be taken mainstream, so that main banks could use the underlying blockchain methodology to move dollars, pounds and euros and transact quickly at low or no cost.

Governments are worried about the potential loss of control involved, of not being able to see what is going on inside the financial system. That is one of the reasons the Bank of England has backed the work of a team of academics from University College London who have come up with RSCoin. It is claimed to be many times faster and more reliable than bitcoin, but the most important respect in which it differs is that it can be controlled directly by the Bank of England and the state, to manage the money supply and help the government ensure financial stability. Although this infuriates the original supporters of bitcoin, the libertarians who want a revolt and a new system entirely free from government interference, it is another example of London’s innovation.

Whatever the outcome of these battles between the old and the insurgent new, it seems that how we pay, save, invest and even think about money is in the process of being transformed. In such a fast-moving situation, the very idea of worrying too much about a large regulatory bloc — such as the EU or the eurozone — handing down orders may soon look out of date, if it does not already.

Having maximum freedom of manoeuvre may be a post-Brexit asset that attracts rather than repels investors to the UK. Brexit is not without its difficulties, of course, but the Square Mile can work its strange magic again. All that one can say for sure is that the City will survive, and prosper. It usually does.

Crash Bang Wallop: The Inside Story of London’s Big Bang and a Financial Revolution that Changed the World, by Iain Martin, is published by Sceptre on September 8 

David Fuller's view -

There is no question in my view that the City would be better off completely outside the EU, which has chipped away at some of its advantages and would love to reintroduce the dreaded Financial Transaction Tax.

Of course there are risks to Brexit, particularly initially.  However, the City remains well ahead of the EU’s considerably smaller financial sectors in terms of international innovation.  Consider blockchain mentioned above and also RSCoin, created by academics from University College London, which can be controlled directly by the Bank of England.

A PDF of Iain Martin’s article is posted in the Subscriber’s Area.



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August 30 2016

Commentary by David Fuller

Apple Ordered to Pay Up to $14.5 Billion in EU Tax Clampdown

Apple Inc. was ordered to pay as much as 13 billion euros ($14.5 billion) plus interest after the European Commission said Ireland illegally slashed the iPhone maker’s tax bill, in a record crackdown on fiscal loopholes that also risks inflaming tensions with the U.S.

The world’s richest company benefited from selective tax treatment that gave it an unfair advantage over other businesses, the European Union regulator said Tuesday. It’s the largest tax penalty in a three-year campaign against corporate tax avoidance. Apple and Ireland both vowed to fight the decision in the EU courts.

Ireland allowed Apple to pay an effective corporate tax rate of 1 percent on its European profits in 2003 down to 0.005 percent in 2014, according to EU Competition Commissioner Margrethe Vestager.

“If my effective tax rate would be 0.05 percent falling to 0.005 percent -- I would have felt that maybe I should have a second look at my tax bill,” she told reporters.

The U.S. Treasury Department, which has pushed back hard against the EU state-aid probes, said the commission’s actions “could threaten to undermine foreign investment, the business climate in Europe, and the important spirit of economic partnership between the U.S. and the EU.”

White House Press Secretary Josh Earnest said that Apple executives have shared concerns about the company’s tax treatment overseas with officials in President Barack Obama’s administration.

Administration officials are broadly concerned that what Earnest called the EU’s “unilateral approach” doesn’t undermine coordinated efforts to prevent an “erosion of the tax base.” Also, he said, they want to ensure that any actions are fair to U.S. taxpayers and U.S. businesses.

Apple, which employs about 6,000 people in Ireland, was one of the first companies caught up in the EU’s backlash against corporate tax-avoidance. The EU, like other global regulators, has targeted firms that sidestep taxes by moving around profits and costs to wherever they are taxed most advantageously -- exploiting loopholes or special deals granted by friendly governments.

David Fuller's view -

Subscriber’s views on this individual case may vary but it certainly marks a deterioration in EU’s relationship with the USA – see this article from The Wall Street Journal: The EU’s Tax Attack on U.S. Business, published four days ago before the Apple case was raised.

See also Tim Cook’s message to the Apple Community in Europe.

Speaking personally, I think the democratic nation of Ireland should be free to set its own tax policies, in the interests of its own citizens.  However, Ireland is no longer a sovereign state within the EU.  The power now resides in Brussels.  



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August 30 2016

Commentary by David Fuller

British Sovereignty Depends on Leaving the EU and the Single Market

Here is the conclusion of this apt column by Gerard Lyons for The Telegraph:

To regain sovereignty and to have a sensible points-based migration system it is necessary to be outside both the EU and the Single Market. That should rule out the Norway option.

That fills some with fear, but it should not. The UK is remaining global in its focus, while at the same time ensuring more share in success through a better migration and domestic economic policy.

There is every reason to expect us to remain a strong and attractive economy in which to invest, while key challenges we face – like our twin deficits – are not the result of Brexit.

Now it is possible the UK may agree a specific deal with the EU. After all, they need the City, and also we are a huge export market for them. But we can’t assume anything.

Hence we should proceed based on leaving and trading under the World Trade Organisation (WTO). On that basis, we can leave at the end of Article 50 being concluded, whatever happens.

The UK is already a member of the WTO and it is there to facilitate trade, not stop it. Outside the EU, we can trade freely under WTO rules and reduce import tariffs.

If we accept that is what would happen if we leave, then that should give the UK greater bargaining power in any EU negotiation. Also, from that base, in time, we could conduct trade deals in our best interests, focused on services, with fast growing markets as well as with the EU.

It is people and firms that trade, not bureaucrats. Being competitive and having something that others want to buy are key. Globalisation, the internet and technical change point to new networks, and highlight that ideas and trade in the 21st century know no bounds.

Dr Gerard Lyons is Chief Economic Strategist at Netwealth Investments and an adviser to Parker Fitzgerald.

David Fuller's view -

If “Brexit means Brexit”, as the PM has repeated, it really should be a swift process of total withdrawal from the EU.  Then, and only then, can the UK government negotiate freely with other nations, including those of the EU.  Anything less than a total withdrawal will waste time and energy in the web of EU rules and regulations designed to prevent countries from leaving. 

PM Theresa May’s biggest challenge may be to gather all the UK support she can for this transition, although the EU is unintentionally helping with its own policies, including the tax claim against Apple and Ireland.    

A PDF of Gerard Lyons' column is in the Subscriber's Area.



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August 30 2016

Commentary by Eoin Treacy

How the European Commission calculated 13bn tax bill

This article by Suzanne Lynch for the Irish Times may be of interest to subscribers. Here is a section:

Ms Vestager said on Tuesday that the commission had concluded that the splitting of Apple’s profits between the two parts of the AOE and ASI companies “did not have any factual or economic justification.”

In short, the commission has concluded that Ireland gave illegal state aid to Apple, in breach of EU law.

It will now fall to lawyers for the accused to contest this.

The refrain from Government circles has long been that the EU may not have liked the tax structures that were in place at the time when the Apple deal was struck but that does not mean that they were illegal.

It may be some years before a definitive answer on this question will be reached.

 

Eoin Treacy's view -

The European Commission has raised important issues for Ireland not least because without its sovereign ability to set taxation there is very little reason for such a large number of Silicon Valley’s best and brightest companies to choose the little island in the North Atlantic as their favoured destination for European headquarters. 



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August 30 2016

Commentary by Eoin Treacy

Ports, a Sign of Altered Supply Chains

This article from the Wall Street Journal may be of interest to subscribers. Here is a section:

“The running joke going around is that flat is the new growth,” said Jett McCandless, chief executive of transportation-technology startup project44.

Freight volumes are stagnating despite strong consumer spending, which rose for a fourth-straight month in July. The problem for traditional retailers: More of those dollars are being spent online, or on entertainment and services such as health care.

Many retailers are stuck with large amounts of unsold goods as a result, reducing their need to import more merchandise. Even after a year of attempting to slim down inventories, retailers’ ratio of inventories to sales, a measure of excess stocks, touched 1.5 in June, close to a seven-year high, according to the Census Bureau. In their most recent earnings reports, Target and Lowe’s reported inventories up more than 4% over the same period last year.

J.C. Penney is placing “slightly smaller orders…or holding back quite a bit” to reduce inventories, Mike Robbins, J.C. Penney’s executive vice president for supply chain, told investors in June. The company has reduced the size of some orders at the beginning of major shopping seasons by as much as 70%.

The focus on reducing inventories is proving to be a drag on growth because it signals that businesses are spending less, and might be pessimistic about future demand. Inventory drawdowns cut second-quarter growth by 1.26 percentage points, to just 1.1%.

Shipping lines are struggling to plan their routes as order volumes become more difficult to predict, said Niels Erich, spokesman for a group of 15 major shipping lines known as the Transpacific Stabilization Agreement. In the past, carriers could count on the peak summer months to make up for slower winter trade.

 

Eoin Treacy's view -

There is no doubt that the disintermediation which characterises online retail has a deflationary impact on how economic growth is measured because it inhibits the velocity of money. I do not view it as a coincidence that the Velocity of M2 has been contracting since 1997 when the internet began to have an impact on the retail sector. 



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August 30 2016

Commentary by Eoin Treacy

The Frozen Concentrated Orange-Juice Market Has Virtually Disappeared

This article by Julie Wernau for the Wall Street Journal may be of interest to subscribers. Here is a section:

Americans drank less orange juice in 2015 than in any year since Nielsen began collecting data in 2002, as more exotic beverages like tropical smoothies and energy drinks take market share and fewer Americans sit down for breakfast.

When they do drink orange juice, they aren’t drinking it from concentrate.

Frozen concentrated orange juice was invented in Florida in the 1940s, primarily as a way to provide juice for the military, readily storable and easy to ship. But frozen juice has been losing favor for years.

Not-from-concentrate orange juice surpassed the concentrated orange-juice market in the 1980s. Now, the 1.4 million gallons of frozen concentrate that Americans drink each month pales in comparison to the 19.1 million gallons of fresh juice consumed each month, Nielsen said.

Louis Dreyfus Co. is scaling back the one citrus facility in Florida that is devoted entirely to concentrated orange juice. The commodities giant is laying off 59 of the plant’s 94 workers as its sells the operation that packs frozen concentrated orange juice into cans for retail.

 

Eoin Treacy's view -

Changing consumption habits where people are more concerned not only with the taste but the quality of the foods they consume are having wide ranging effects on the commodity markets. To most people frozen orange juice does not taste as good as a freshly squeezed navel or Valencia orange. However since squeezing one’s own oranges is both time consuming and expensive the vast majority of orange juice consumed comes from either concentrate or is pasteurized. 



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August 29 2016

Commentary by Eoin Treacy

Macro Morsels

Thanks to a subscriber for this edition of Maybank’s report which in this issue makes a number of bearish points. Here is a section on buybacks:

The new wrinkle is that Trim Tabs Investment Research indicates that corporate buybacks have suddenly plunged. We show the estimated repurchase levels below in dark blue that mirror the lowly levels of 2012. Share buybacks always rise during equity bull markets.

With paltry organic economic growth since the 2009 recovery, share buybacks become a critical source of buying power to maintain rising stock prices. When repurchases fall sharply, stock prices, in general, are more likely to fall as well.

We can theorize this drop is due to (1) anxiety over anti-business policies discussed by both Presidential candidates or (2) uncertainty over the Federal Reserve desire to raise rates making corporate debt issuance for stock buybacks more costly.

Corporate debt issuance has receded about 8% from the record 2015 levels and is still quite high. We suspect that once we get past the November 8th US presidential election, share buybacks will normalize. However, if they remain weak, then expect stock prices to be valued with far more risk.
Federal Reserve Board Presidents have been very vocal these days that strong job growth warrants raising the Fed funds rate sooner rather than later. Sure, the labor market has grown as sharply as any strong economic recovery could and “official” U3 unemployment is low, but the sluggish economy hovering just above stall speed remains a fixture.

U6 unemployment including marginal workers is well over 9%, wage inflation in this strong jobs market has remained below normal and Purchasing Managers Indices (PMI) have stalled. The composite PMI of services and manufacturing indicates a GDP that should be closer to 1% than the 2.5 to 3% many have expected during the 2nd half of 2016.

 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

I’ve argued for much of the last five years that buybacks represent one of the primary arteries for quantitative easing to influence the stock market. The logic is that with ultralow interest rates companies have an incentive to favour debt over equity financing and therefore issue bonds to fud buybacks. This has contributed to trillions of dollars being poured into the equity markets since 2009 and represents a major component of the liquidity that has fuelled the bull market. 



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August 29 2016

Commentary by Eoin Treacy

Has Colombia achieved peace? 5 things you should know

This article from the Brookings Institute may be of interest to subscribers. Here is a section:

The accord is only the beginning: As many have already commented, after the agreement comes the hard work of building peace. This can be broken down very broadly into reestablishing government control over rural areas where state presence has historically been limited or absent, addressing the needs of victims of the conflict, and demobilizing and reintegrating former combatants in ways that contribute positively to society. On the security front, the Disarmament, Demobilization, and Reintegration process (DDR) is already a concern to Colombia watchers. It is unclear if all members of the various FARC combat and support units will agree to demobilize or if they will instead migrate into other insurgent organizations such as the Ejercito de Liberación Nacional or join Colombia’s vast network of criminal organizations. In fact, a recent experience with the demobilization of right-wing paramilitaries affiliated with the Autodefensas Unidas de Colombia under President Uribe showed that a substantial number of former combatants joined criminal organizations, known as BACRIM or Bandas Criminales. The state will have to move swiftly to establish its presence in those areas where the FARC once operated, or else these gaps will be filled by organized crime. For those insurgents that do demobilize, their success will depend on their ability to find legitimate work and the people’s ability to accept former combatants as members of their community.

Eoin Treacy's view -

In Freakonomics Dubner and Levitt make some very instructive points on the incentives drug dealers have to persist in what is typically a dangerous, competitive environment where death is a realistic possibility before the aspiration to achieve riches is every achieved. If we accept that demand for illicit narcotics is a relative constant, subject to a moderate growth rate, then volatility arises as a factor of supply. 



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August 29 2016

Commentary by Eoin Treacy

Yuan Bears Emerge From Hibernation as Fed Threatens G-20 Calm

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

Derivative markets are pointing to renewed bets on yuan depreciation, with a three-month measure of expected price swings poised for the biggest monthly increase since January. Other indicators, such as the premium on options to sell the yuan over those to buy and the discount of forward contracts over the spot rate, have also climbed, indicating rising expectations for declines.

The increased pessimism comes after a period of calm that sent the measures to the lowest in at least nine months as the Federal Reserve held off on raising interest rates and investors bet that China would steady the yuan before it hosts a Group of 20 meeting in September. Traders are probing the People’s Bank of China’s willingness to allow the yuan to fall between the G-20 gathering and the currency’s entry into the International Monetary Fund’s Special Drawing Rights on Oct. 1, especially with the chances of Fed action increasing.

"After G-20 ends next Monday, the market may want to test how much yuan depreciation the PBOC can tolerate," said Gao Qi, a strategist at Scotiabank in Singapore. "China doesn’t want the yuan to move too much during G-20 and become a topic of discussion. SDR’s impact will be smaller than G-20." 

 

Eoin Treacy's view -

China is under the spot light as it prepares to host the G-20 summit next week and not least because it wants to use the event as an opportunity to showcase its newly found position as an economic superpower. However the fact the Chinese administration is engaged in a massive transition from an investment and export oriented business model to one more supported by internal consumption, services and high technology cannot simply be ignored. 



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August 26 2016

Commentary by David Fuller

Stock Rally Fizzles After Hawkish Remarks From Fischer; Bonds Fall

Here is the opening and also the concluding paragraph of this report from Bloomberg on a day of churning markets:

Stocks erased gains after Federal Reserve Vice Chairman Stanley Fischer said Chair Janet Yellen’s remarks leave open the possibility of an interest-rate hike in September. Bonds fell, while the dollar rose.

Global equities extended their weekly decline after Fischer told CNBC that Yellen’s remarks were consistent with the possibility of two hikes this year. Stocks had rallied earlier Friday as investors focused on her bullish comments on the U.S. economy. Treasury two-year note yields, among the most sensitive to monetary policy, jumped to the highest since June. The dollar rose against all major peers. Crude traded near $47 a barrel.

“Fischer wants to make September still on the table,” said Mark Kepner, managing director and equity trader at Themis Trading LLC in Chatham, New Jersey. “He mentioned he’s not concerned about the low growth we have had the first six months. He’s saying growth is more a productivity and investment story. There are light volumes, lightly staffed desks and these moves can easily happen.”

And:

“Fischer really maintained the focus on the near-term, whereas Yellen was a bit more comprehensive across the cycle,” said Eric Theoret, a foreign-exchange strategist at Bank of Nova Scotia in Toronto. “That’s where the distinction lies. Yellen’s was a broader discussion, Fischer’s was very much a narrow, near-term discussion and because of that we did see that broad dollar rally.”

David Fuller's view -

I did not actually see or hear the full statements by Yellen and Fischer, but assume that they and their colleagues share many of the same uncertainties and changing or differing opinions as the rest of us.   Meanwhile, the US economy is sort of stronger than those of other developed nations but that is not saying much.  2Q profits are less than inspiring, to put it mildly.  Fischer may be trying to inspire ‘the productivity and investment story’, if that comment in the penultimate paragraph shown above accurately conveys what he said. 

This item continues in the Subscriber’s Area and contains an additional article.  



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August 26 2016

Commentary by David Fuller

French Support for the EU Project is Crumbling on the Left and Right

The drama of Brexit may soon be matched or eclipsed by crystallizing events in France, where the Long Slump is at last taking its political toll.

A democracy can endure deflation policies for only so long. The attrition has wasted the French centre-right and the centre-left by turns, and now threatens the Fifth Republic itself.

The maturing crisis has echoes of 1936, when the French people tired of 'deflation decrees' and turned to the once unthinkable Front Populaire, smashing what remained of the Gold Standard.

Former Gaulliste president Nicolas Sarkozy has caught the headlines this week, launching a come-back bid with a package of hard-Right policies unseen in a western European democracy in modern times.

But the uproar on the Left is just as revealing. Arnaud Montebourg, the enfant terrible of the Socialist movement, has launched his own bid for the Socialist Party with a critique of such ferocity that it bears examination.

The former economy minister says France voted for a left-wing French manifesto four years ago and ended up with a "right-wing German policy regime". This is objectively true. The vote was meaningless.

"I believe that we have reached the end of road for the European Union, and that France no longer has any interest in it. The EU has left us mired in crisis long after the rest of the world has moved on," he said.

Mr Montebourg stops short of 'Frexit' but calls for the unilateral suspension of EU labour laws. "As far as I am concerned, the current treaties have elapsed.

David Fuller's view -

The predictable fragmentation of the Eurozone is likely to be a somewhat angry process as we are already seeing.  That is unfortunate and not without risks but I think many Europeans will also focus on a return to the European Common Market.  This would once again consist of independent democracies with control over their own currencies, freely trading with each other.  They should also consider using a separate commercial unit of exchange for convenience, as I have mentioned previously.  We have seen that the risks of open borders outweigh the benefits and the use of passports or secure identity cards for citizens within the European Common Market is a minor inconvenience. 

The unravelling of the EU will make the UK’s exit less complicated, as there is no need for punitive policies or inane complications, previously strategized by Brussels officials to prevent countries from leaving.  If Germany wants to trade with the UK, and it does, then so will the rest of Europe.        

A PDF of the article is posted in the Subscriber’s Area.



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August 26 2016

Commentary by David Fuller

Apple and the Transatlantic Squabble Over Taxes

Here are the opening two paragraphs and the conclusion of this Editorial from Bloomberg:

The U.S. Treasury thinks it's bad enough that companies such as Apple park piles of cash overseas to avoid paying tax. What's worse is when foreign authorities change the rules that attracted the money in the first place, and tax those holdings for themselves.

In effect, the European Commission is threatening to do just that. Apple and other U.S. companies could soon be hit with retrospective demands for tax running into the billions of dollars. This week the Barack Obama administration objected, accusing the commission of, among other things, exceeding its authority and violating the norms of international tax policy.

And:

With the U.S. tax code in its current state, the administration is hardly in a position to lecture other governments on the subject of clarity and certainty in tax policy. The charge that the commission is violating international tax norms is especially rich, considering that the U.S. is almost unique in taxing its companies on their worldwide income and its citizens regardless of where in the world they live and work.

By far the best remedy for the U.S. complaint would be to fix the U.S. tax system. For corporate taxes, that means two things: Apply a lower, internationally competitive rate to a simpler and broader base. And switch to a so-called territorial system -- as is used almost everywhere else -- which taxes profits according to where they're earned, not where the company resides. These reforms wouldn't eliminate international tax avoidance, but they would reduce it, both directly and by making it easier for governments to cooperate effectively to that end.

The alternative is to feud and strike postures -- a lot easier than comprehensive tax reform, admittedly, but much less productive.

David Fuller's view -

Most of us think multinational corporations should pay regional taxes in countries where they are earning profits.  However, there is also a grey area, I believe, because the responsibility for assessing taxes lies with the countries in question.  I do not blame public corporations for using legal tax avoidance in the interests of their profits and shareholders.  I agree with Bloomberg that the US should switch to a territorial system and their tax programme needs to be modernised.  One can only hope. 

Meanwhile, too many governments and economic regions, from the EU to the USA, are in search of tax revenue to reduce budget deficits and perhaps improve their economies.  Against this background successful multinational corporate Autonomies are viewed as milch cows.    

This item continues in the Subscriber’s Area.     



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August 26 2016

Commentary by David Fuller

Email of the day

More on the next shoe to drop in Europe:

Yesterday I wrote about why I think the UK should leave the EU as rapidly as possible by declaring unilateral free trade. There is another reason that I did not mention which I believe makes it urgent that we do so. I voted 'remain' but I am a pragmatist interested among other things in protecting my financial assets. The ill-conceived Euro and the dysfunctional currency block is an accident waiting to happen and one senses that time is running out. A new phase to the drama may unfold soon.
The financial press has focused on Italy's woes and its coming referendum. This article from back in June in the FT outlines the issues and the risks that come with the referendum.

The Eurosceptic Five Star Movement wants to take Italy out of the Euro but remain in the EU.The party topped the polls in a recent survey with 30.6% support versus 29.8% for the Renzi's ruling Democratic Party.

Whatever the outcome of that poll in October, Italy will remain a huge risk to the Euro. Back in the month of May you posted in your daily comment an article by Ambrose Evans-Pritchard who wrote that "Leaving the Euro may be the only way to avert a catastrophic de-industrialization of the country before it is too late."

Industrial production in Italy is back to where it was in the 1980s.

And here's another one to watch - see attachment and article at this website:

Portugal rocked the Euro boat a few years ago, and concern seems to be reappearing, signaled as ever by the bond market. Yields have been rising over the past couple of weeks. The article opens with:

"The fate of Portugal rests in the hands of DBRS, the last remaining credit rating agency assigning an investment grade rating to its sovereign debt (Fitch, Moody's and S&P have all lowered the country's debt rating to junk).  Due to a requirement that participant countries have an IG rating from at least 1 rating agency, the DBRS rating is literally the only thing allowing Portugal's bonds to remain eligible for the European Central Bank's 1.7 trillion euro bond buying program.  DBRS is set to update its Portugal rating on October 21 and investors in Portugal sovereign risk are starting to get a little nervous."

DBRS are probably feeling the pressure, though with the EU's form of ignoring and reinterpreting rules to shore up the system there must be some doubt the outcome will be as black and white as the article states. But we have been warned. As with Italy, it seems unlikely the Euro can work for Portugal in the mid-term. The article states:

"The socialist minority government that came to power in November 2015 has 

not helped the situation by:

raising the minimum wage, increasing the number of public holidays

 and reversing other key reforms,

that will make it more difficult for the country to meet its EU fiscal targets.  

To be sure, the collapse in oil prices have indirectly taken a toll on Portugal as 

well with exports to it's 4th largest trading partner, Angola, falling by 42% in the 

first half of 2016." 

In summary, the potential for turmoil around the Euro at any time suggests it would be wise for Britain to declare universal free trade and exit the EU as rapidly as possible.

For investors, the question is what can we do to protect ourselves from these or other events as the Euro unravels, as it surely must do, the only issue is the timing. Here are my thoughts and it would be great to have your input too David. The euro comprises 57.6% of the dollar index so any downward pressure on the Euro will have implications for the dollar and hence for asset classes which are priced in dollars. Strengthening USD does seem to be an outcome, possibly later this year but very likely in the mid-term, with consequent attraction towards USD denominated financial assets including the US stock markets, precious metals and US real estate.  Money could move out of the Eurozone into other markets though I read that German bonds are a popular buy on speculation that any eventual total collapse in the Euro will lead to reinstatement of the Deutschmark at a premium. GBP could begin to look a safe haven again. The USA and the dollar could be the biggest draw for financial assets though if the dollar rises too far and too fast that will leave the Fed in a very difficult situation, unable to lower already rock-bottom rates to slow dollar gains and also unable to raise rates if the economy overheats. Eventually a strong dollar could damage the US economy and possibly precipitate the next cyclical bear market. I think that is some way off so let's enjoy this possibly final and remunerating phase of one of the longest bull markets in history.
 

David Fuller's view -

Thanks for this detailed email.  Worldwide free trade is certainly our economic goal and this message cannot be repeated too often.  I also believe that corporations will rapidly redevelop these international business skills, especially with the full diplomatic cooperation of the Conservative government.  I think we should exit the EU in a tactically sensible strategy, which is even more important than haste, especially as time is now on our side.  Theresa May and her appointed team probably have this in hand and she will need the support of many Remain voters, in the interests of the country. 

Re investments, you certainly will have this service’s input.  Also, Eoin and I always welcome the views of subscribers, from which we have all benefitted over the years.  I think one starts with the right questions.  For instance, investors have been wary of EU countries for some time.  So, at what point will they view a breakup of the EU as economic salvation for its better economies and companies?  Also, could the Euro become a firm currency in a considerably slimmed down EU led by Germany, or will the single currency be scrapped because it was always going to cause havoc without the federal state that the majority of Europeans never wanted?   



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August 26 2016

Commentary by Eoin Treacy

Mylan CEO Blamed Obamacare for EpiPen Sticker Shock

This article by Jen Wieczner for Fortune.com may be of interest to subscribers. Here is a section:

Now Mylan appears to be learning the same hard lesson this week that Martin Shkreli and Valeant  VRX -0.51%  learned last year: Investors love when pharmaceutical companies raise drug prices—until everybody else gets really upset about it. Shares of Mylan  MYL 1.66%  have dropped more than 11% this week, down more than 5% on Wednesday alone.

And the EpiPen controversy is drawing comments from some high-profile figures, including Hillary Clinton and Martin Shkreli himself, who tweeted that he thought the EpiPen’s price should even be higher. On Wednesday, Clinton said there was no justification for the price hikes. Her comments came shortly after the Senate Committee on Aging asked Mylan to provide information on the reasoning behind what it called the “drastic” price increase of EpiPen, and the American Medical Association “urge[d]” Mylan to “rein in these exorbitant costs.”

The pricing scandal is happening at the worst possible time for Mylan. This is typically the company’s biggest season, driven by EpiPen sales, which peak during back-to-school shopping as parents and schools equip for the coming year.

Eoin Treacy's view -

Biotechnology companies justify the high price of new drugs with the argument that it is the only way to recoup the cost of developing them. Without high prices there would be no incentive to invest in the uncertainty of R&D and lengthy clinical trials. 



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August 26 2016

Commentary by Eoin Treacy

The Fed is now hostage to Wall Street

Thanks to a subscriber for this interview of James Grant by Christoph Gisiger for Finanz und Wirtschaft. Here is a section:

Obviously, the financial markets like this cautious mindset of the Fed. Earlier this week, US stocks climbed to another record high.

Isn’t that a funny thing? The stock market is at record highs and the bond market is acting as if this were the Great Depression. Meanwhile, the Swiss National Bank is buying a great deal of American equity.Indeed, according to the latest SEC filings the SNB’s portfolio of US stocks has grown to more than $60 billion.

Yes, they own a lot of everything. Let us consider how they get the money for that: They create Swiss francs from the thin alpine air where the Swiss money grows. Then they buy Euros and translate them into Dollars. So far nobody’s raised a sweat. All this is done with a tab of a computer key. And then the SNB calls its friendly broker – I guess UBS – and buys the ears off of the US stock exchange. All of it with money that didn’t exist. That too, is something a little bit new.

Other central banks, too, have become big buyers in the global securities markets. Basically, it all started with the QE-programs of the Federal Reserve.

It is a truism that central banks do this. They’ve done this of course for generations. But there is something especially vivid about the Swiss National Bank’s purchases of billions of Dollars of American equity. These are actual profit making, substantial corporations in the S&P 500. So the SNB is piling up big positions in them with money that really comes from nothing. That’s a little bit of an existential head scratcher, isn’t?

 

Eoin Treacy's view -

One of the most important lessons learned from quantitative easing is that it is highly effective at inflating asset prices. This link to the Nasdaq’s record of Swiss National Bank holdings, primarily of US Autonomies, is a clear example of that. If banks are lending, or printing, money into existence they have an incentive to acquire assets that have a legitimate claim on future cash flows or have an intrinsic value. 



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August 26 2016

Commentary by Eoin Treacy

Dollar Rises as Yellen, Fischer Spur Bets for Fed Rate-Increase

This article by Maciej Onoszko and Lananh Nguyen for Bloomberg may be of interest to subscribers. Here is a section:

 

“Fischer really maintained the focus on the near-term, whereas Yellen was a bit more comprehensive across the cycle,” said Eric Theoret, a foreign-exchange strategist at Bank of Nova Scotia in Toronto. “That’s where the distinction lies. Yellen’s was a broader discussion, Fischer’s was very much a narrow, near-term discussion and because of that we did see that broad dollar rally.”

Investors’ sentiment has oscillated in recent weeks on the pace of Fed monetary tightening after it raised rates in December for the first time since June 2006. The dollar’s 5 percent loss this year reflects a dimming outlook for the U.S. central bank to reduce stimulus and diverge from unprecedented easing in Europe and Asia.

Bloomberg’s Dollar Spot Index, which tracks the currency against 10 peers, rose 0.8 percent as of 2:41 p.m. in New York, reaching the strongest level since Aug. 10. It fell as much as 0.6 percent. The greenback gained 0.7 percent to $1.1201 per euro and added 1.3 percent to 101.81 yen.

 

Eoin Treacy's view -

The Yen has been particularly strong against the Dollar this year while the Euro has been largely locked in a range for more than a year. The prospect of the interest rate differential between the US Dollar and other major currencies widening further represents a tailwind for equity markets fighting deflation with weaker currencies. 



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August 25 2016

Commentary by David Fuller

Mobius Says Helicopter Money Will Be Next Big Experiment By Japan

Here is the opening of this topical article from Bloomberg:

The Federal Reserve signals a reluctance to raise interest rates. The yen strengthens to 90 per dollar. Haruhiko Kuroda decides to act.

Helicopter money is coming, says Mark Mobius, even as soon as next month.

The 80-year-old investment veteran is outlining how he expects central banks to respond to sluggish economic growth. For Mobius, executive chairman of Templeton Emerging Markets Group, traditional easing measures have just made people save instead of spend or borrow. Combined with a stronger yen, he says that’s going to force the Bank of Japan governor to contemplate a policy he’s repeatedly ruled out.

“They’re really beginning to think what ammunition they have,” he said in an interview on a visit to a typhoon-struck Tokyo this week. “The first reaction is to say, OK, let’s go for helicopter money, let’s get money directly into the hands of consumers,” he said. “I think that would probably be the next step.”

Stimulus Flood

Central bankers have flooded their economies with monetary stimulus in the eight years since the global financial crisis, driving up asset prices -- including the stock markets that Mobius invests in -- while struggling to kickstart global growth. A foray into negative interest rates in Japan has been met with the yen surging to about 100 per dollar, falling stocks and dwindling bank profits.

Helicopter money, a kind of last resort in unconventional monetary policy, comes in several forms. The most simple is printing money and giving it to the public, hoping -- and even creating incentives that -- they’ll spend it. Others include financing state spending directly, or in other words putting money into the hands of companies.

David Fuller's view -

That some version of helicopter money will be authorised shortly for Japan is a logical forecast from Mark Mobius.  I think he is right, since the strong yen will increase deflationary pressures which have confounded Japan for so many years. 

Mobius has long been a calm, sensible observer of global markets and few others have his experience.  He is also a natty dresser, usually in an off-white suit.  In fact, I don’t think I have ever seen him in a dark suit.  Is this a worrying omen, or a practical precaution before using chopsticks at a banquet in Tokyo?

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August 25 2016

Commentary by David Fuller

Email of the day

On UK should declare unilateral free trade:

Note: You can access the links in the email below because they were provided by the subscriber and I have loaded them so that you will not be removed from this site when you close them, unlike with links in newspaper articles which I post.

I mentioned briefly when we met a couple of weeks ago that the UK should declare unilateral free trade as it leaves the EU. We didn't get time to explore the thinking behind this so I have collated here some articles which set out the case, very compellingly in my view. First, an article in today's City A.M.  

Roger Bootle, whom I know you respect, has also proposed unilateral free trade. I believe you published this article when it first appeared.

He says "If we declared unilateral free trade, we would immediately cut through the doubts concerning a possible trade deal with the EU and put ourselves in the driving seat with regard to any future negotiations. Because this policy would involve abolishing tariffs on imports from the rest of the world, it would reduce prices and intensify competition in the UK market. Continental exporters would find they would only be able to sell to us at lower prices. The industries that would suffer, such as the German car industry, would put pressure on their governments for a deal with us, which we might accommodate – if it suited us. With one bound, we would be free."

Bootle was one of the very few economists who actually analysed the pros and cons of EU membership and published a book (The Trouble With Europe) arguing the case. Few politicians or economists went to such lengths. One who did is Patrick Minford. He has also written compellingly on this topic and the pdf attached goes into the issue in some detail.

The counter-argument has been put by Martin Wolff in the Financial Times in an article titled "Brexiteers' idea of unilateral free trade is a dangerous fantasy."

This was written before the referendum, and is in tune with the FT's opposition to leaving both before and after the referendum outcome. He finishes by dismissing the idea saying "Forget free trade: the UK will not return to the 19th century." Oops... wasn't that the century in which Britain was Great?

Wolff appears to favour tariffs. In contrast Minford has this to say to those who argue that universal free trade would not work for the UK: "It relies on the idea that under Brexit the UK would move to being a protected economy with tariffs and barriers against the rest of the world including the EU, much as it was back in the 1970s when it was ‘the sick man of Europe’. Yet after three and a half decades of market reforms since those grim times, the UK is now largely a free market economy and Brexit would allow it to join the global market as a free trading nation, able to buy its goods and services from the world market at world prices, and ready to sell its products to the world at those world prices too.

Incidentally, the most egregious article I have seen was this one in the FT arguing that voters should not have been given a referendum as the decision was too complicated (presumably for lesser mortals than the author.)

Incidentally, the most egregious article I have seen was this one in the FT arguing that voters should not have been given a referendum as the decision was too complicated (presumably for lesser mortals than the author.)

What the author conveniently forgets is that the decision to join was made by referendum - presumable he was OK about that. Then, despite his argument that we are not wise enough to decide these things by referendum, he illogically finishes by arguing for a second vote! I guess this is in true EU style: 'Come on you peasants, vote until you give the right answer.' Emotion always trumps reason once belief and self-interest are involved.

I lived and worked in Switzerland for a while and became impressed with their referendum system, held several times each year with many questions each time. The politicians role is to implement what the voters want. Switzerland may be the only true democracy on the planet, and the country wonderfully exemplifies the complete opposite of the attitude in that FT article and the attitude of the EU. Switzerland has a record of many centuries of effective governance and harmony despite having 4 totally distinct races and languages. It's also one of the wealthiest countries perhaps because of these factors. If the EU had been established on the Swiss model maybe it could have achieved similar prosperity, harmony and long-term survival as Switzerland. But the EU model is in many ways the opposite.

As you know, I voted Remain. I could have voted either way, but the desire to avoid breakup of the UK swung my vote. But now that the democratic decision to leave has been made I am fully behind the decision and actually rather happy about it. But we could mess it up by haggling deals with an EU which will be unable to do anything fast or effectively and which will assume it has the upper hand. During my long career as a senior executive in industry I attended several coaching courses on negotiation skills. The most important thing I learned was the concept of BATNA - be very clear what is your 'Best Alternative To A Negotiated Agreement.' You are negotiating from a very weak position if you are not absolutely clear about how you can reasonably walk away. If there is no negotiated agreement with the EU then the willingness of the UK to open to free trade across the world is by far the best option. It may anyway be the best solution.

Which leaves my one remaining concern, the stability of the UK. Phillip Johnson outlined one potential solution that makes very good sense to me, if not maybe for a certain power-hungry politician in Scotland! Though her country-folk may be wiser than her if it came to a vote.

What are your thoughts for and against unilateral free trade?  Do you see any major negatives?

Best wishes

David Fuller's view -

Thanks for a terrific email, certain to be of interest to subscribers in the UK, Europe and probably beyond.  I also appreciate the informative links and reports. 

Replying to your points, I have also posted Telegraph articles by Patrick Minford, Roger Bootle and others on free trade.  It makes sense as we will obviously want to be trading with the world, where possible, not just the protectionist, socialist, slow-growth EU.  Also, we do not want to be slavishly following the EU’s tortuous rules on leaving the Eurozone, which are mainly designed to lock countries in.  

Free trade is desirable, I believe, although it is certainly not without risks.  A number of our industries will be alarmed over the prospect of free trade, even if we have reciprocal agreements with many countries.  China springs to mind, as does any other country with state-controlled industries.  Consider steel - how can you protect Port Talbot or any other industry which China would like to bankrupt through state subsidies, so that they would have greater access to our market? Perhaps we don’t trade with China, although I would be reluctant to close doors on any important country.  Perhaps we need to have a few strategic industries, such as Port Talbot steel, which receive preferential treatment such as very inexpensive energy, for instance.  Other companies would want similar subsidised benefits, but then we would be moving away from free trade. These are challenges, albeit manageable.

Re the FT, it has some good columnists and contributors but too many bad ones in its desire to be the EU’s socialist business (oxymoron?) English language paper.  The article by Richard Thaler is shocking, as you point out. 

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August 25 2016

Commentary by David Fuller

August 25 2016

Commentary by Eoin Treacy

Musings from the Oil Patch August 24th 2016

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

The Obama administration’s Environmental Protection Agency (EPA) and the National Highway Traffic Safety Administration (NHTSA) released their Phase II fuel efficiency and greenhouse gas emissions regulations for heavy-duty trucks. This group includes the largest pickup trucks sold as well as the traditional 18-wheelers on the highways. The standards are to be phased in between the 2021 and 2027 model years. The existing standards, which were designed for the 2014 through 2018 model years, will remain in place until the new standards take effect.

The heavy-duty truck standards come as the government has just begun negotiations with auto manufacturers over the final fuel efficiency ratings for light-duty vehicles where the industry is lagging behind the targets in the standards. Heavy-duty trucks are the second largest and fastest growing segment of the U.S. transportation system measured by their emissions and energy use. They currently account for about 20% of carbon emissions, yet only account for about 5% of the vehicle population. 

Carbon emissions from transportation is now the largest contributor to overall greenhouse gas emissions. Three charts showing annualized sector shares of total emissions confirm this conclusion. It should be noted that the country’s total carbon emissions peaked in January 2008 and have declined steadily since. On an absolute basis, over the past 8 1/3 years there are 1,410.1 million metric tons of less carbon emissions, or a decline of 16.2%. The transportation sector contributed about 9.1% of that decline. The significance is that transportation’s emissions dropped 6.4% over that time span while overall emissions declined 16.2%. The overall figure reflects the sharp decline from coal’s use due to the shale revolution and low natural gas prices along with static electricity consumption. At the same time, the decline and then flat trend in vehicle miles driven coupled with more fuel-efficient autos also helped reduce the transportation sector’s emissions. One can see these trends at work by looking at the sector shares in 1973, 2008 and 2016.

The United States has done well in reducing its carbon emissions by 16.2% since the start of 2008. The weak economy and energy revolution have been primarily responsible. Going forward, the energy policies targeting the transportation sector, coupled with technological improvements in overall energy use, will become more important in driving down carbon emissions. Thus, the reason for the heavy-duty truck standards. They have support from the industry and truck manufacturers who see economic opportunities from more efficient engines. The Independent Truck Owners Association estimates the new standards will add $12,000-$14,000 to the cost of new tractors, which often cost upwards of a quarter of a million dollars, but they hope to recover those higher costs through improved fuel efficiency.

 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area.

The surge in supply of natural gas coupled with the fact it is both cleaner than other fossil fuels and domestically available is supporting a revolution in developing new sources of demand. Toyota is now marketing is hydrogen fuelled Mirai automobile in the USA where the hydrogen will be sourced from natural gas. Improving the efficiency of the heavy vehicle fleet is a laudable goal and will also improve the environment so it can be viewed as a win win which is dependent on natural gas prices staying competitive. 



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August 25 2016

Commentary by Eoin Treacy

If Not Normal, Where Are We in the Cycle? Late

Thanks to a subscriber for this note from Wells Fargo which may be of interest. Here is a section:

Credit Standards: Move to Tighter Standards
Over the economic cycle, banks adjust their lending standards but, unfortunately, the dynamic adjustment of credit standards appears to impart a very pro-cyclical bias to the credit cycle. From the middle graph, we can see that the percentage of banks that tighten credit drops dramatically in the early phase of an economic recovery (1992-1994, 2002-2004, 2010-2011) and remains low for most of the economic expansion. Then the percentage of banks that tighten credit rises sharply just before a recession (1999-2000, 2007-2008). This credit cycle, while certainly rational from an individual bank’s point of view, becomes quite pro-cyclical when viewed in the aggregate. We have entered the tighter credit phase of this cycle.

For Whatever the Reason: A Flatter Yield Curve
Ever since the taper tantrum in 2013, there have been two distinct moves in the yield curve as illustrated in the bottom graph. The long-end of the yield curve has exhibited a bullish flattening trade with the decline in the 10-year/two-year spread. This reflects the yield pick-up for U.S. Treasury debt relative to what is available for investors in Europe and Japan, while also reflecting the incentive of a stronger dollar to attract foreign inflows. Meanwhile, the short end of the yield curve reflects the anticipation of a FOMC increase in rates or at least some form of tighter policy going forward.

Uncertainty in financial markets provides the motivation for two distinct
moves. First, investor uncertainty at the global level has prompted a safehaven move into U.S. Treasury debt. Meanwhile, uncertainty on the economic outlook limits the extent of Fed tightening of policy as well as the private market discounting of future fed funds moves.

 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area. 

With interest rates so low there is very little margin for error when trading in bonds and not least when so many are sporting negative yields. An increasing number of seasoned bond investors are expressing emotions ranging from caution to fear and frustration at the destabilising influence of central bank policy on the markets. They are in a difficult position because pre-empting an end to the 35-year bull market has resulted in underperformance while overstaying one’s welcome, when it eventually does peak, will result in ever larger underperformance. 



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August 25 2016

Commentary by Eoin Treacy

South Africa President Zuma Says He Can't Stop Gordhan Probe

This article by Mike Cohen and Sam Mkokeli for Bloomberg may be of interest to subscribers. Here is a section:

Gordhan, 67, was named finance minister in December after Zuma roiled markets by firing Nhlanhla Nene from the position and replacing him with a little-known lawmaker. His relationship with Zuma has been a fractious one, with the president denying his requests to fire the nation’s tax chief for insubordination and appoint a new board at the state-owned airline.

“President Jacob Zuma wishes to express his full support and confidence in the minister of finance and emphasizes the fact that the Minister has not been found guilty of any wrongdoing,” the Presidency said in a statement. “The negative effect of these matters on our economy, personal pressure on the individuals affected as well as the heads of institutions, however disturbing, cannot be cause for the president to intervene unconstitutionally.” 

The National Prosecuting Authority hasn’t received a docket from the police and there was no indication when they would receive one, Luvuyo Mfaki, a spokesman for the national prosecutor, said by phone. City Press reported that the docket would be handed to the NPA on Friday after the police questioned tax agency officials including Ivan Pillay, the former deputy commissioner, and Oupa Magashula, the ex-commissioner.

 

Eoin Treacy's view -

Standards of political governance have been declining steadily since the ANC assumed what is in effect single party rule. Institutions and laws which support the free market, such as the independence of the judiciary, minority shareholder and property righrs have all been under attack. Continued political turmoil and the volatility of Zuma’s administration are additionally not good for confidence. 



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August 25 2016

Commentary by Eoin Treacy

August 24 2016

Commentary by David Fuller

Hedge Funds Suffer Biggest Redemptions Since 2009 as Returns Lag

Here is the opening of this interesting article from Bloomberg:

For hedge funds, the news is getting worse.

Investors pulled an estimated $25.2 billion from hedge funds last month, the biggest monthly redemption since February 2009, according to an eVestment report.

The withdrawals were the second straight for the beleaguered industry, which saw $23.5 billion pulled in June. They bring total outflows this year to $55.9 billion, driven by “mediocre” performance after a number of funds lost money last year, according to Wednesday’s report.

“Unless these pressures recede, 2016 will be the third year on record with net annual outflows, and the first since the outflows in 2008 and 2009 -- a result of the global financial crisis,” eVestment said.

Hedge funds, which charge some of the highest fees in the money-management business, have faced mounting criticism from clients over steep costs and performance that mostly hasn’t kept pace with stock markets since the financial crisis. The 10 funds with the highest redemptions in July lost an average of 4.1 percent in the first seven months of this year. Industrywide, funds returned an average of 1.2 percent this year through July, according to data compiled by Bloomberg, compared with about 7.6 percent for the S&P 500 Index.

Last month’s withdrawal was the highest since a net $28.2 billion was redeemed in February 2009, according to eVestment.

David Fuller's view -

I would not want to read too much into any one statistic, but unless all of this capital coming out of hedge funds has gone straight into long-only funds, ETFs or privately managed accounts, it does not sound like an encouraging stock market statistic to me. 

On the other hand, money rushing into hedge funds near the top of a market has often warned that stocks were becoming unsustainably overextended.  Conversely, heavy unloading of hedge funds in the teeth of an obvious bear market was a sign of climactic selling prior to an eventual recovery. 

I do not think the current data will add to investor confidence, which was already conspicuous by its absence.  



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August 24 2016

Commentary by David Fuller

Scotland Must Live Within Its Means Instead of Relying On English Taxpayers

Here is the opening of this editorial from The Telegraph:

Public spending in Scotland in the last financial year totalled £68.6 billion. Taxes levied in Scotland amounted to just £53.7 billion, a difference of some £15 billion. Were Scotland an independent country, it would have a budget deficit of around 10 per cent of GDP, among the highest in the world. But Scotland is not independent and these are just figures compiled under the so called Government Expenditure and Revenue Scotland (GERS) statistics. They were introduced by the Conservatives in the 1990s before devolution to demonstrate the importance to Scotland of continued membership of the UK. Never has the point been made more starkly.

In a Union, it should not matter that one constituent part has higher spending and lower revenues than another. Fiscal transfers from wealthier to poorer areas are crucial to national and social cohesion. However, the Scottish National Party does not wish to be part of this Union, even though the Scottish people voted two years ago to stay in. There have been mutterings from the SNP about a second referendum following the UK-wide decision to leave the EU because Scotland voted to remain. But the GERS figures show this to be utterly fanciful. Scotland could not survive on its own, certainly not with the levels of expenditure it has now.

The case for independence was predicated on tax revenues from North Sea oil, but Scotland’s share of these fell by 97 per cent to just £60 million in the last financial year. There is no realistic prospect that Scotland would now seek to turn its back on its main export market. Moreover, to get its public finances into the necessary condition to join the EU as an independent nation, as the SNP promises, would require austerity measures that the nationalists would never contemplate.

David Fuller's view -

I credit Nicola Sturgeon with chutzpah but she has overplayed an increasingly weak hand.  Had Scotland won their 2014 independence referendum when Alex Salmond was First Minister of Scotland, the region would have been in serious financial trouble.  Salmond resigned immediately after the 55 to 44 percent result which rejected independence.  Sturgeon would presumably have to do the same if she dared to call for another referendum and lost.

The recent Olympics were a wonderfully unifying factor for the UK’s young athletes and the goodwill generated has spread across the country.  Canny Scots would reject a second independence referendum, even though Scotland did not support Brexit.  The EU’s Socialist appeal is waning and a united UK is more likely to prosper over the longer term, even though the next year or two may be challenging.  

A PDF of the Telegraph article is posted in the Subscriber's Area.



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August 24 2016

Commentary by David Fuller

The Weekly View: Factors Driving Emerging Markets

My thanks to Chris Konstantinos for this timely publication published by RiverFront Investment Group. Here is a brief sample:

So where does China’s much-maligned economy find itself today? We describe it as stabilizing, albeit at a much lower growth level than in times past.  Important indicators of the “smokestack” part of China’s economy, such as electricity usage and railway freight, have all shown signs of improvement recently, as has the Market Manufacturing PMI (a survey of manufacturers), which is now just back in expansion for the first time in roughly a year (see chart below). “New China” indicators, related to services sectors and the burgeoning middle class consumer, have remained solidly in expansionary territory, with areas like consumer confidence rebounding and home prices in Tier One cities making new highs.

David Fuller's view -

 

This makes sense to me and the rest of this issue is well worth reading.

See also my comments on China posted on Tuesday. 

The Weekly View is posted in the Subscriber’s Area.



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August 24 2016

Commentary by David Fuller

Prince William Helps Celebrate 70 Years of North Rhine Westphalia

Here is a key section of Prince William’s speech:

In short, what began 70 years ago as a relationship of necessity between an occupying power and a region in ruin, is today a partnership of genuine friendship and of massive mutual benefit.    This partnership will continue despite Britain’s recent decision to leave the European Union. The depth of our friendship with Germany and with North Rhine-Westphalia will not change. Bilaterally and internationally we will continue together to lead efforts to promote prosperity, security and stability in the world.

David Fuller's view -

This is a welcome and important statement from one of the UK’s highest-profile public figures.  It can only help to instil mutually beneficial goodwill before the Brexit negotiations commence.  



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August 24 2016

Commentary by David Fuller

August 24 2016

Commentary by Eoin Treacy

UK Industrial Revolution 2.0

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

Potential GDP growth slowed in the UK after the debt crisis and Brexit is another structural shock. Monetary policy does not have the ability to correct these impairments. A structural policy is required, for example, the priority being given by new British PM, Theresa May, to the industrial sector within economic policy. An industrial renaissance is the objective.

We motivate the need for industrial strategy through the new information based theory of economic growth. Over time, knowledge and knowhow is created and embodied into products. The more specialized these products and the broader the range produced, the more complex the economy. Complexity is a medium- to long-term predictor of economic growth.

The UK is not coming from a standing start. The UK has retained or created industrial strengths in sectors from cars and industrial machinery to aerospace and defense. The sizeable depreciation of sterling and relatively low production costs give UK industry an advantage. These cyclical benefits can be secured with a structural policy aimed at maximizing R&D (knowledge) heavy, high-skill (knowhow) manufacturing.

A modern industrial strategy is about creating the right environment for new products and markets to emerge and jobs and income to grow. A successful neo-industrial policy requires a holistic approach. We discuss four areas likely to appear within an industrial strategy: infrastructure (including digital), energy, skills and innovation. Policies here could enhance complexity and the economy’s capacity to generate, share and use information. A consistent policy approach with long-term commitments could counterbalance Brexit-related uncertainty.

The Chancellor, Philip Hammond, is expected to ease the UK’s austerity policy by year-end. We argue the fiscal adjustment needs to be seen through the lens of industrial strategy. Public sector funding costs are extremely low and the Bank of England has re-started gilt-based QE. After the referendum the government has a reason and opportunity to maximize the benefits via an industrial policy.

 

Eoin Treacy's view -

A link to the full report is posted in the Subscriber's Area. 

As we pointed out ahead of the referendum, the UK had a big choice to make. It could become a vassal state subject to an increasing autocratic central government or it could throw out the rule book and refashion itself into a free market example of dynamism that would benefit from its proximity to, but separation from, a much larger neighbour.  I described this latter option as the Hong Kong solution and it would appear to be what the UK is now moving towards. 



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August 24 2016

Commentary by Eoin Treacy

A Grim Outlook for the Economy, Stocks

Thanks to a subscriber for this interview of Stephanie Pomboy expressing a bearish view which appeared in Barron’s. Here is a section:

The presumption supporting equity prices is that all the bad news we’ve seen this year has been due to anomalies—the lagged effect of the strong dollar and weaker energy prices as well as Brexit. Everyone is looking for a significant second-half rebound for earnings and GDP—when the clouds will part and the sun will come out. I strongly believe that won’t happen, in large part because of inventories. Inventory accumulation has been explosive.

What’s caused this growth in inventories?
It isn’t because companies ramped up production. Companies aren’t using cheap capital to increase production and capital expenditures, but are lavishing money on shareholders instead. They bought the lie that consumer spending would turn up any moment, and produced at the same pace. Now they find themselves with a monster inventory overhang. Inventory-to-sales ratios across a variety of industries—manufacturing, machinery, autos, wholesale—are at the highest level since 2009. In prior inventory liquidation cycles, nominal GDP growth is cut in half during the liquidation phase. As for profits, we’re starting with five negative quarters and we haven’t even begun the inventory liquidation cycle. So the second half will be a real eye-opener.

In your view, today’s too-low rates will cause the next financial crisis. Describe it.
In the past rates that were too high were the trigger. Not this time. No. 1, we have basically bankrupted corporate and state and local pensions by having rates at these repressive levels. If you lay on top of that a decline in equity prices, there will be a scramble to plug holes in pensions. Obviously if a state or local government has to divert funds to plugging its pension, it won’t build more roads. The corporate sector has the luxury of kicking the can down the road, and because their spending has been on buybacks, not plants and equipment, the economy would suffer less. For S&P 1500 companies, the pension deficit is roughly $560 billion, but for state and local governments, it’s $1.2 trillion. According to the Center for Retirement Research, if you used a more conservative discount rate, the unfunded liability would go to $4 trillion.

No. 2, you’re pushing consumers to the brink as they try to save enough for retirement at zero rates. You’re already seeing a reluctant return to credit-card usage, a clear sign of distress—they are charging what they previously paid with cash. The credit-card delinquency rate is picking up.

 

Eoin Treacy's view -

The way people generally think about pensions is that you accumulate a pot of money over your lifetime, purchase an annuity with a yield greater than your living costs and a maturity that extends to the end of one’s life. Of course that is not realisable in practice so pension funds have to manage the duration of the overall portfolio so they can plan to meet future liabilities with some degree of accuracy. 

The problem is that in formulating their models they typically assume a 7% yield. That’s OK when nominal interest rates are somewhere close to that level but with rates close to zero, for nearly a decade, they have no choice but to rely on capital appreciation to make up for the absence of yield. The alternative is to take on a lot more risk to capture the yield they require. For example, and this is obviously not a recommendation, Rwanda’s senior unsecured US Dollar B+ 2023 bond currently yields 6.195%. 

 



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August 24 2016

Commentary by Eoin Treacy

Delphi, Mobileye Join Forces to Develop Self-Drive System

This article by Mike Colias for the Wall Street Journal may be of interest to subscribers. Here is a section: 

We’re able to pool the investment as well as the technology and execution risk in one place so it doesn’t have to be duplicated by multiple [auto makers] over and over again,” Mr. Clark said.
The pair will jointly invest “several hundred million dollars” in the effort, but a spokesman declined to provide other details.

In January, Delphi and Mobileye expect to demonstrate a system that can navigate tough road conditions, such as entering a roundabout, merging into highway traffic, or making left turns across multiple traffic lanes.

Both companies have deep relationships with car makers, but their system won’t be ready until 2019. Integrating their tech in future vehicles could take as much as two years, the companies concede, making it unlikely to hit the market until 2021 or 2022.

Mobileye Chairman and Chief Technology Officer Amnon Shashua said the pair hope to overcome any timing hurdles by offering “a new level of driving intelligence,” mimicking a driver’s decision making behind the wheel in complex situations. “If we don’t want to clog a city with robotic systems that get stuck in busy traffic, you must endow these systems with intelligence.”

 

Eoin Treacy's view -

Automotive manufacturers have an incentive to deliver on autonomous vehicles because they believe it would have the same effect on car ownership as the introduction of smart phones did for hand held mobile devices. Prior to the introduction of the iPhone most people already had a mobile phone yet they felt compelled to upgrade when the additional benefits of a smartphone were revealed, For companies trying to differentiate themselves in an increasingly competitive market autonomous vehicles represent a compelling vision for the future. 



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August 24 2016

Commentary by Eoin Treacy

Email of the day - on moving averages for economic data

Moving averages for economic series - i.e. only monthly data exist. How do I get a 12 month or longer moving average? If I put in 12 I get a very jerky looking chart, not as smooth as I would expect...

Eoin Treacy's view -

Generally speaking, economic data is only released once a quarter so a moving average for a year would be only 4 data points which is likely to create a jerky looking chart if you look at two short a time range, or if there is a big difference in the range of the data. For example this chart of UK GDP is smoothed with a 20 quarter MA over 50 years and creates a smooth line. 



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