Pillars of financialisation

In my column for Mint on Tuesday (my last column for the year), I wrote that two important and promising developments – although small – have happened recently. One is that the International Monetary Fund has a serious rethink on capital controls and its usefulness. It used to look down upon capital controls. No longer, it seems. See here.

Then, there was the OECD draft proposal on taxation of international companies. One hopes that the developed world would adopt it. It would vastly discourage companies from doing ‘taxation shopping’. I had written on it in a column for Mint.

The pillar that is still holding up financialisation (asset bubbles, executive compensation, stock buybacks, etc.) is central bank policy. The recourse to Quantitative Easing and Negative interest rates without any shred of evidence that it has been beneficial, on balance, is what continues to fan social, political and economic imbalances. The major central banks continue to embrace QE/Negative interest rates without any audit or honest appraisal of the costs and benefits. See this article and the second chart embedded.

In that sense, it is good that Swedish Riksbank, thanks to public pressure is turning its back on negative interest rates.

If 2020 sees a rethink on the part of major central banks, if they return to normalcy, the world can avert a bigger replay of 2008. Or, is it already too late?

I don’t understand

Been more than two weeks since I wrote a blog post. By my standards, it has been crazy travel. The book that Gulzar Natarajan and I wrote, ‘The Rise of Finance: Causes, Consequences and Cures’ was launched by the Honourable Finance Minister of the Government of India, Ms. Nirmala Seetharaman on Nov. 10 in Delhi. After that, my travels took me to Madurai, Mumbai and Ahmedabad with a day in between at Sri City!

I do not understand many things, in any case, let alone I can blog about them. I do not understand what is happening in Hong Kong.

I do not know why the Indian Sensex Index is trading at 40K points.

I do not know why the S&P 500 is at 3000 points+. But, John Authers thinks he has found the answer.

I do not know why Chile has erupted.

Sandipan Deb does not know why Aatish Taseer’s OCI card was revoked and having done that, why it cannot be explained cogently, either.

Gulzar Natarajan and I thought that India was not financialised (negative connotation) so much as the West had. But, Ashoka Mody knows better. A ‘must-read’ article.

Nor do people seem to know why they are empathetic. Or, if they are empathetic at all.

Fama does not know why he wants behavioural economists should produce an alternative model of the financial market. If it is possible to show that financial markets are not sane, that should suffice because it is impossible to model insanity. There is no cap on insanity.

So, I am not sure if I would have been able to blog even if I had time on my hands. I do not seem to be able to make sense of many things.

Market efficiency, anyone?

Having watched the stock of his company appreciate nearly 14-fold during the dotcom bubble, and then collapse 95% during the bust, Sun MicroSystems Founder Scott McNealy was bemused that investors ever considered paying what now looks like a rather diminutive 10 times sales for the computer hardware company’s stock at its peak in 2000.

Why? This is what he told Businessweek in 2002:

At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realise how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking? [Link]

The above is worth recalling as stocks scale new highs in the United States. Are private markets faring any better? No. They are delivering superior returns through financial engineering, says this article in FT (ht: Gulzar).

Who is responsible for this? Central banks with their zero interest rates and QE policies. What are they doing now? They are doubling down on both.

Do not know when but it is not going to end well.

Financial market straws in the wind

The turmoil in the repo market in the USA last week is well explained here. The answer: more QE!

The significance of the postponement of Wework IPO and the resignation of its CEO Neumann is explained here. ‘Blitzscaling’ would not have been possible without the QE policies of central banks. Malinvestments flourished as money lost its value.

IPO market is waking up. When will the broader stock market see the light?

Andrew Smithers’ valuation model – Q ratio – shows US stocks overpriced (ht: John Authers). Do not fail to read his comment on the volatility in published profits vs. profits as per NIPA and what it means for US corporate leverage. Read John Authers too on this in his ‘Points of return’ column in Bloomberg.

Two op.-eds from Germany (DB Research) on negative interest rates and on the calls for fiscal stimulus from Germany are worth reading here and here.

Insider selling of stocks in the US reach two-decade high. Data excludes sales of stock linked to corporate executives exercising stock options. It also strips out sales carried out for tax purposes, which are typically carried out automatically over the year. [Link]

Negative yields

Dreihaus Capital has tweeted that excluding America, nearly 45% of the global bond market is trading in negative yields.

Michael Lebowitz has a wonderful piece in ‘realinvestmentadvice.com’ and unfortunately or mysteriously or both, it is not available there. It is available via Zerohedge.

This explanation of negative yields, in particular, is brilliant:

It implies that the future is more certain than the present – that the unknown is more certain than the known!

Enjoy reading it as much as I did.

In the meantime, President Trump tweeted exactly the opposite of what Michael Lebowitz is trying to convey:

The Economy is doing really well. The Federal Reserve can easily make it Record Setting! The question is being asked, why are we paying much more in interest than Germany and certain other countries? Be early (for a change), not late. Let America win big, rather than just win! [Link]

and this:

Germany sells 30 year bonds offering negative yields. Germany competes with the USA. Our Federal Reserve does not allow us to do what we must do. They put us at a disadvantage against our competition. Strong Dollar, No Inflation! They move like quicksand. Fight or go home! [Link]

Desperate for re-election, he is forgetting all that he said before getting elected for the first time in 2016. Negative interest rates all along the German bund yield curve is a sign of sickness and not health. European banks are hurting from negative yields.

The European Central Bank, originally modelled after the German Bundesbank, had become absolutely reckless and it believes that it has saved the single currency. Perhaps, it did, temporarily only to make the problem re-appear much later. It is inevitable.

The fact that the German economy is contracting in less than a year after enjoying a weak Euro for years and ultra-low interest rates says a lot about the non-efficacy of ultra-low and negative interest rates.

Through his constant haranguing of the Federal Reserve, he is staking a lot more than his re-election. More on that on another occasion.

Finally, it is impossible not to feel disappointed with the Independent Evaluation Office (IEO) of the International Monetary Fund (IMF) for its kid-glove treatment of the Fund on its advice during the post-crisis years with unconventional monetary policy. It was not even a rap on the knuckles. The costs of UMP have far exceeded the short-term benefits and the costs continue to mount. The Fund cheer-led it. IEO has nothing to say on the consequences – political, social and economic – of UMP. Egregious pricing of junk bonds (negative yields!) and tech. unicorns and some of them being able to get away with accounting and other practices weirder than the ones that prevailed in the dotcom mania years of 1996-2000 are also traceable to ultra-cheap money.

IMF warns today about the consequences of real estate bubbles and leveraged loans. But, UMP is directly responsible for both. IMF endorsed and encouraged. It discouraged the Federal Reserve from raising rates even gingerly in 2015 and in 2016. IEO has neither done evaluation nor is it independent.

For a true independent evaluation, read ‘The Rise of Finance’. Available here.

Should S&P bring back ‘core earnings’?

This chart shows how S&P 500 Companies’ Operating Earnings has now reached a high share of the overall National Income measure of corporate profits. The last time it did so was in 1999-2000!

Source: https://twitter.com/GauravSaroliya/status/1156536674517753857

I remember that, in 1999-2000, Standard & Poor’s had introduced a concept called ‘core earnings’ because companies had begun to state whatever they wished under ‘Operating Earnings’. Perhaps, it is time to bring it back.

In another sign of market craziness, the 5-year Greek bond yield (1.27%) is lower than the 5-year US Government bond yield (1.5%). Does the prospect of Euro appreciation over US dollar dominate the credit risk of Greece (in comparison to the USA) or is it that the market is very confident of the European Central Bank and the European Commission rescuing Greece in the light of any default risk? Both stretch credulity, in my view. (ht: tweet by David Rosenberg).

Sovereign dollar bonds

Many of you might have noticed that the Indian government announced a plan to borrow in dollars in international capital markets. It will be India’s first foreign currency sovereign borrowing from capital markets.

In one short sentence, it is ill-advised. If you thought that the issue of ‘Masala’ bonds (rupee bonds issued for foreigners to subscribe) were safer, that is wrong too. Happy to elucidate. Have done so here.

I wrote about it in my column on the budget published the day after the budget was presented:

One headline that grabbed attention pertains to the government announcing its intention of issuing sovereign debt in foreign currencies. Apparently, India thought of it in 2013 but did not go ahead as the macro fundamentals were deemed dodgy then. But, probably the best time to borrow would be when the domestic currency is undervalued. The Indian rupee in the second half of 2013 was close to being undervalued. Right now, India’s macro fundamentals are not weak, although big question marks remain over the economy’s growth rate, its sustainability and vulnerability to a global stock market correction. In other words, the risk is tilted towards further weakness of the Indian rupee. In 2013, it was tilted towards its strengthening after a hefty correction.

On the other hand, the timing is opportune in another sense because global central banks are back to considering further crazy monetary easing moves. To that extent, raising foreign currency borrowing now is a case of good timing. Another upside is that the government would not be crowding out domestic savings, which have declined in recent years and show no signs of reviving. That is a good thing. [Link]

The above two paragraphs only focused on the micro issue of timing the bond issuance in foreign currency. But, the argument in favour of issuing foreign currency denominated bonds in terms of it not crowding out domestic borrowers is not entirely correct, I admit, because Dr. Y.V. Reddy had pointed out lucidly as to why it is no help to domestic non-sovereign (private sector borrowers).

The argument is this: if India’s safe current account deficit is 2% of GDP and if Government of India borrows from foreigners (it is part financing of the CAD), then the amount available for other domestic borrowers in foreign currency is going to be reduced by that amount. The ‘ceiling’ is unofficially set by the ‘safe’ current account deficit for the country.

Then, on July 9, I wrote more extensively for MINT on the dangers of the Indian government borrowing in foreign currency. [Link]. It might open the door, together with other measures announced in the budget, for greater financialisation of the economy at a time, when its macro-economic health and performance are brittle.

Besides Dr. Y.V. Reddy’s piece, one of the best comments on this subject came from Sanjaya Baru. It is well worth a read.

In this piece, Shankkar Aiyar suggests alternatives to raising dollar resources through sale of sovereign bonds:

Yes, India must raise additional resources and in dollars to finance the aspiration for high growth. Why not raise dollar resources by listing LIC? Why not aggregate surplus land with government into a land bank and call for bids? Why not transfer government ownership of public sector banks and enterprises into an exchange-traded sovereign fund?