Sunday, October 22, 2017

22/10/17: Framing Effects and S&P500 Performance

A great post highlighting the impact of framing on our perception of reality:

Take two charts of the stock market performance over 85 odd years:

The chart on the left shows nominal index reading for S&P500. The one on the right shows the same, adjusted for inflation and using log scale to control for long term duration of the time series. In other words, both charts, effectively, contain the same information, but presented in a different format (frame).

Spot the vast difference in the way we react to these two charts...

22/10/17: Leverage risk and CAPE: Why Rob Shiller Might Be Wrong

Rob Shiller recently waxed lyrical about the fact that - by his own metrics - the markets are overpriced, yet no crash is coming because there is not enough 'leverage in the system' to propagate any shocks to systemic levels.

The indicator Shiller used to define overpricing is his own CAPE - Cyclically Adjusted PE Ratio - and the indicator does indeed flash red:

CAPE is defined by dividing the S&P 500 index by the 10-year moving average of index components' earnings. The long-run average of CAPE is 16, and the index currently sits above 31, making the current markets valuations trailing those of the bubble peak (using recent/modern comparatives).

So the markets are very expensive. But what Shiller says beyond this mechanical observation is very important. His view is that these levels of valuations are 'sustainable' in the medium term because there is very little leverage used by investors in funding these levels of stock prices. In the nutshell, this says that if there is any major correction in the markets, investors are unlikely to be hit by massive margin calls, triggering panic sell-offs. So any correction will be short-lived and will not trigger a systemic crisis.

All fine with the latter part of the argument, if we only look at the stock market brokerage accounts leverage, ignoring other forms of leverage.  And we can only do this at a peril.

Investor is a household. Even an institutional one, albeit with a stretch. When asset prices correct downward, income received by investors falls (dividends and capital gains are cut) and investor borrowing capacity falls as well (less wealth means lower borrowing capacity). But debt levels remain the same.  Worse, cost of funding debt rises: as banks and other financial intermediaries see their own assets base eroding, they raise the cost of borrowing to replace lost income and capital base with higher earnings from lending. Normally, the Central Banks can lower cost of borrowing in such instances to compensate for increased call on funds. But we are not in a normal world anymore.

Meanwhile, unlike in the bubble era, investors/households are leveraged not in the investment markets, but in consumption markets. Debt levels carried by investors today are higher than debt levels carried by investors in the and pre-2007 era. And these debts underwrite basics of consumption and investment: housing, cars, student loans etc (see Which means that in an event of any significant shock to the markets, investors' debt carry costs are likely to rise, just as their wealth is likely to fall. This might not trigger a market collapse, but it will push market recovery out.

An added leverage dimension ignored by Shiller is that of the corporates. During the crises, cash-rich and/or liquid corporates can compensate for falling asset prices by repurchasing stocks. But corporates are just now completing an almost decade-long binge in accumulating debt. If the cost of debt carry rises for them too, they will be the unlikely candidates to support re-leveraging necessary to correct for an adverse asset prices shock.

I would agree with Shiller that, given current conditions, timing the markets correction is going to be very hard, even as CAPE indicator continues to flash red. But I disagree with his view that only margin account leverage matters in propagating shocks to a systemic level.

22/10/17: Oh my... Germany Looks Like Japan ca 2000-2001?

A pic worth a 1,000 words:

Via Holger Zschaepitz @Schuldensuehner

In simple terms, despite its current fortunes, on the longer time horizon, German economy is suffering the same fate as the Japanese one, with two caveats:

  1. A lag of a couple decades; and
  2. An adjustment for institutional structures (e.g. greater openness to migration).
These are reflected in the distance between the German yields today and the Japanese yields in the 1990s and 2000s. That distance, of some 1,000 basis points, is material to the debt carry capacity (meaning Germany has much greater borrowing capacity than Japan had back in the early 2000s). But it is also more uncertain, as ECB monetary policy cannot fully converge to the German conditions alone (it can be dominated by these conditions for quite a long while, but neither perpetually, nor fully).

So here we have it, folks, our value systems (reflected in demographics) have Japanified Germany... before our fiscal policies did... 

21/10/17: Prague Pages Brussels... Following Vienna

Just after Austria, the Czech Republic too has swung decisively in the direction of embracing populism as Populist billionaire's Eurosceptic party wins big in Czech Republic.

As Radio Praha describes it: "The Czech Donald Trump or Silvio Berlusconi, maverick millionaire, political populist, mould breaker; these are all labels that have been tagged on to ANO leader Andrej Babiš".

Jakub Patocka for the Guardian: "Open racism has become a normal part of public discourse. Trust in democratic institutions and the European Union has been crumbling before our eyes. It is shocking how easily and quickly this has happened. Many Czechs are going to the polls with grim fears for the future. A broad coalition of democratic parties is not likely to have enough votes to control parliament. Apart from the far right, communists and a peculiar Czech version of the Pirate party are expected to do well."

The headlines from Prague are sounding more like something the 'Kremlin-backed' news outlets would produce. Except, they are printed by the mainstream international media this time around.

But things are much worse than Babis and ANO victory and 29.8 percent of the vote implies. Four out of top five parties by voting results are now parties with populist leanings, far removed from the traditional Czech elites. The mainstream opposition conservative party, the Civic Democrats, are now a distant second with only 11.2 percent of the vote. Czech Republic's "most radical anti-migration, anti-Islam and anti-EU party, Freedom and Direct Democracy", came in the third place with 10.8 percent of the vote, statistically indistinguishable from the Civic Democrats. Another populist party - the Pirate party - is on 10.6 percent with a Parliamentary representation for the first time in its history. And the Communists got 7.9 percent. In simple terms, more than 59 percent of the voters have gone either extreme Left or extreme Right of the Centre, and backed populist politics.

Credit: Petr David Josek/Associated Press

In a recent paper, we explain how the trends amongst younger voters around the world are shifting away from support for liberal democratic values. These shifts are now starting to translate into votes.
Corbet, Shaen and Gurdgiev, Constantin, Millennials’ Support for Liberal Democracy Is Failing: A Deep Uncertainty Perspective (August 7, 2017):

Saturday, October 21, 2017

20/10/17: Lancet Report on Impact of Pollution

A top-level, comprehensive report compiled by the Lancet Commission details estimates of economic and human costs of pollution worldwide. The full report is available here:

Before I summarise some of its main findings, it is worth noting that such an undertaking is, by definition, a difficult one and the one that involves a lot of assumptions, models, estimates and uncertainty around its findings. There will be debates and there will be those who disagree with the report findings. However, two things are clear:

  1. Pollution is costly in terms of health, life, quality of human capital (young age development, etc), and economically;
  2. Incidences of pollution impacts are bound to be concentrated in the areas where other factors (e.g. poverty, location of extraction industries, etc) are also at play.
Here are the key findings of the report:

  • Pollution (in all forms: from water pollution to air pollution to soil contamination, from spills to accidental discharges to regular releases and so on) is linked to 9 million deaths in 2015 with pollution-linked diseases accounting for ca 1 in six deaths worldwide
  • By one measure, pollution led to economic damages to the tune of USD 4.6 trillion or roughly 6 percent of global GDP
  • In emerging economies, pollution related health and life costs are resulting in a labour productivity decline that accounts for the reduction in potential economic output of around 1-2 percent of GDP annually. And this is only due to productivity declines.
  • Map below shows deaths from pollution:

  • As the above map indicates, much of the impact of pollution in terms of deaths is concentrated in the emerging economies and Eastern Europe. Three countries with strong presence of extractive industries: Russia, Chile and Australia all have lower pollution-related deaths
  • In China, almost 20 percent of all deaths are linked to pollution. And that is hardly the worst record. India and Bangladesh, two major population clusters, have the rates closer to 25 percent
  • The likes of Ireland may be faring way better than that, but airborne pollution being the biggest killer, the idea of sticking an outright pollution intensive trash incinerator in the middle of the country largest city is clearly signaling and entirely wrong political agenda

Quoting from the report:
"Pollution is the largest environmental cause of disease and premature death in the world today. Diseases caused by pollution were responsible for an estimated 9 million premature deaths in 2015—16% of all deaths worldwide — three times more deaths than from AIDS, tuberculosis, and malaria combined and 15 times more than from all wars and other forms of violence. In the most severely affected countries, pollution-related disease is responsible for more than one death in four.

Pollution disproportionately kills the poor and the vulnerable. Nearly 92% of pollution-related deaths occur in low-income and middle-income countries and, in countries at every income level, disease caused by pollution is most prevalent among minorities and the marginalised. Children are at high risk of pollution-related disease and even extremely low-dose exposures to pollutants during windows of vulnerability in utero and in early infancy can result in disease, disability, and death in childhood and across their lifespan."

This is a very important report, worth reading.

Wednesday, October 18, 2017

17/10/17: Intel Opens the Era of Unemployed Insurance Brokers...

If you have a job structuring and selling, marketing and monitoring/managing car insurance contracts, you should stop reading this now... because, Intel has developed the first set of algorithmic standards for self-driving vehicles that aim to ensure that any accident involving a self-driving vehicle cannot be blamed on the software that operates that vehicle.

How? Read some scant details here:

What does this mean? If successful, regulating algorithmic standards, most likely more advanced than the one developed by Intel, will mean that self-driving vehicles collision will be by system definition blamed only on human drivers, bicyclists and pedestrians. Which will, de facto, perfectly standardise all insurance contracts covering vehicles other than those operated by people. The result will be rapid collapse in demand for car insurance as we know it.

Instead of writing singular (albeit standardised) contracts to cover individual drivers (or vehicles driven by them), using actuarial risk models that attempt to identify risk profiles of these drivers, insurance industry will be simply writing a single contract to cover software running millions of vehicles, plus a standard contract to cover the vehicle (hardware). There will be no room left for profit margins or for service / contract differentiation or for pricing variation or for bundling of offers. In other words, there will be no need for all the numerous marketing, sales, investigative, enforcement, actuarial etc jobs currently populating the insurance industry. Car insurance sector will simply shrink to a duopoly (or proximate) providing cash management service to autonomous vehicles owners.

There will be lots of armchair-surfing for currently employable insurance industry specialists in the near future...

Tuesday, October 17, 2017

17/10/17: ECB Boldly Goes Where It Was Going Before

'News' have become quite volatile to the upside these days... you hit a "Publish" button on one blog post dealing with QE ( and another stream of numbers rushes in to fill the void left behind by the completed post...

With a h/t to Holger Zschaepitz @Schuldensuehner:

In summary terms:

  • ECB (world's largest holder of Government junk err... debt... err assets...) has ramped up its QE purchases by EUR34 billion, reaching the new historical high of EUR4.371 trillion. 
  • Currently, ECB asset holdings amount to 40.5 percent of the euro area GDP.
Of course, much of this 'purchasing' goes to fund fiscally insolvent 'austerity' implementing Governments of Europe (with exception of Greece). Courtesy of the above blue mountain, majority of European Governments today can avail of the negative yielding money from 'the markets'.

17/10/17: Welcome to the Keynesian Monetarist Paradise

Via IMF, a chart plotting changes in sovereign debt holdings across Government, International & Central Bank agencies (so-called G-4 Official) and private debt holders:


  1. These are changes in the stock of debt, not the actual stock of debt;
  2. These are changes in the stock of debt of only four largest advanced economies;
  3. These are changes in the stock of only sovereign debt, excluding quasi-sovereign, private and household debts; and
  4. The years of forward forecast are, allegedly, the years of QE unwinding.
This debt bubble is a money-printing bubble which is a Keynesian Government 'stimulus' bubble. Look at the above. QED.

And, if you have not reaped its upside, you will pay its downside. Now, check your pockets.

Monday, October 16, 2017

15/10/17: Calling Brussels from Austria: Change Is Badly Needed in Europe

Austria just became a *new* flashpoint of European politics that can be best described as a slow steady slide into reappraisal of the decades-long love affair with liberalism.

In summary: the People's Party (OVP) has 31.4 percent of the vote, a gain of more than 7 percentage points from the 2013 election; the Freedom Party had 27.4 percent (a jump on 20.51 percent in 2013), and the Social Democratic Party, which governed in coalition with People's Party until today, had 26.7 percent (virtually unchanged on 26.82 percent in 2013).

The People's Party is best described as Centre-Right with a leaning Right when it comes to issues of immigration. Current Foreign Minister Sebastian Kurz, the leader of the People's Party is a charismatic 31-year old populist. He has driven his party further toward the Right position in recent months, as elections neared, and away from his post-2013 governing coalition partners, the Social Democrats. Kurz is, broadly-speaking a pro-EU candidate, with strong preference for more autonomy to member states. He is clearly not a Brussels-style Federalist.

The Freedom Party (FPO) was close to its record vote of 26.9 percent, achieved back in 1999, and now has a good chance of entering the government as a coalition partner to People's Party, for the first time in some 10 years. The FPO was in Government last in 2000-2007 and prior to that in 1983-1987.  It's last stint in Government earned Austria condemnation from the EU. Following the previous coalition, the OVP and the Social Democrats are not exactly best friends, which means that FPO is now in the position of playing a king-maker to the Government. That said, the coalition between OVP and FPO is still an uncertain: FPO leader Heinz-Christian Strache has accused Kurz and OVP of stealing his party's ideas during the election.

All in, almost 60 percent of Austrian voters opted to support anti-immigrant, Right-of-Centre positions. However, in recent years, Austrian Right has shifted away from anti-EU positioning, at least in public, and attempted to shed neo-Nazi tint to its support base.

Turnout in this election was impressive 79.3 percent, up on the 74.9 percent turnout last time around.

All in, Austrian election 2017 confirms the points established in our recent paper Corbet, Shaen and Gurdgiev, Constantin, Millennials’ Support for Liberal Democracy Is Failing: A Deep Uncertainty Perspective (August 7, 2017). Available for free at SSRN: Together with Brexit, renewed uncertainty around Italian political shifts, Catalan Referendum, resilience of the Dutch euroscepticism, instability in core political strata in Germany, Polish and Hungarian populism, and so on - the developing trend across the EU is for a political / voter support drifting further to the extremes (Left and Right) of the ideological divide. In countries where this drift is coincident with rising power of populism, the results are starting to look more and more like validation of the far-Right (and with some time, the far-Left) as the leaders of the official opposition to the increasingly hollowed-out status quo parties.

Sunday, October 15, 2017

15/10/17: Concentration Risk & Beyond: Markets & Winners

An excellent summary of several key concepts in investment worth reading: "So Few Market Winners, So Much Dead Weight" by Barry Ritholtz of Bloomberg View.  Based on an earlier NY Times article that itself profiles new research by Hendrik Bessembinder from Arizona State University, Ritholtz notes that:

  • "Only 4 percent of all publicly traded stocks account for all of the net wealth earned by investors in the stock market since 1926, he has found. A mere 30 stocks account for 30 percent of the net wealth generated by stocks in that long period, and 50 stocks account for 40 percent of the net wealth. Let that sink in a moment: Only one in 25 companies are responsible for all stock market gains. The other 24 of 25 stocks -- that’s 96 percent -- are essentially worthless ballast."
Which brings us to the key concepts related to this observation:
  1. Concentration risk: This an obvious one. In today's markets, returns are exceptionally concentrated within just a handful of stocks. Which puts the argument in favour of diversification through a test. Traditionally, we think of diversification as a long-term protection against risks of markets decline. But it can also be seen as coming at a cost of foregone returns. Think of holding 96 stocks that have zero returns against four stocks that yield high returns, and at the same time weighing these holdings in return-neutral fashion, e.g. by their market capitalization.  
  2. Strategic approaches to capturing growth drivers in your portfolio: There are, as Ritholtz notes, two: exclusivity (active winners picking) and exclusivity (passive market indexing). Which also rounds off to diversification. 
  3. Behavioral drivers matter: Behavioral biases can wreck havoc with both selecting and holding 'winners-geared' portfolios (as noted by Rithholtz's discussion of exclusivity approach). But inclusivity  or indexing is also biases -prone, although Ritholtz does not dig deeper into that. In reality, the two approaches are almost symmetric in behavioral biases impacts. Worse, as proliferation of index-based ETFs marches on, the two approaches to investment are becoming practically indistinguishable. In pursuit of alpha, investors are increasingly being caught in chasing more specialist ETFs (index-based funds), just as they were before caught in a pursuit of more concentrated holdings of individual 'winners' shares.
  4. Statistically, markets are neither homoscedastic nor Gaussian: In most cases, there are deeper layers of statistical meaning to returns than simple "Book Profit" or "Stop-loss" heuristics can support. Which is not just a behavioral constraint, but a more fundamental point about visibility of investment returns. As Ritholtz correctly notes, long-term absolute winners do change. But that change is not gradual, even if time horizons for it can be glacial. 
All of these points is something we cover in our Investment Theory class and Applied Investment and Trading course, and some parts we also touch upon in the Risk and Resilience course. Point 4 relates to what we do, briefly, discuss in Business Statistics class. So it is quite nice to have all of these important issues touched upon in a single article.

Saturday, October 14, 2017

14/10/17: Bitcoin's Rise: Bentleys in Vancouver?

Two charts highlight the recent dynamics of #Bitcoin rise back to the top of the newsflow:

and decomposing the above:

As a fan of blockchain technology (but not a fan of Bitcoin as an asset), here are some notes of worry:

  • The rise has been exponential to-date, while
  • The volatility has been absolutely atrocious (albeit weaker than volatility in Ehterium and Ripple, two other top-3 cryptos); and
  • The periods from peak to next peak are getting more and more compressed
All of which should make you pause and wonder: what fundamentals, if any, can account for the rise of Bitcoin - a question that many tried to answer and few succeeded. As a disclaimer, I have a couple of papers forthcoming on this in the next month or so. And as a taster for the disclaimer, both papers show absolutely no fundamental drivers capable of explaining the rise of Bitcoin from its first day of trading through the end of 1H 2017. The dynamics of Bitcoin are pure memory (Hurst process) and as such contain no bearing with any real asset in the Universe. 

Put differently, Bitcoin is a hedge against things that cannot be hedged in the markets, most notably, the risk of state-administered expropriation / capital controls in... err... China. So if you want an asset that can (at a staggering risk-premium and transaction cost) hedge your Shanghai property yields against Beijing's reluctance to allow you offshore your cash into a Bentley parked in Vancouver, be my guest. If you have no such need, why, sit back and enjoy the wild ride and gyrations of the crypto to USD/BTC 6,000 and beyond... you can do the latter by playing some Russian roulette speculating on BTC, but do avoid becoming a hostage to St. Petersburg Paradox, should a correction pop the frothy top here and there. In other words, should you want to speculate on Bitcoin, by all means - do. But mind the tremendous risks.

Stay tuned for the aforementioned research papers coming soon.

14/10/17: Happy Times in the Rational Markets

Two charts, both courtesy of Holger Zschaepitz @Schuldensuehner:

In simple terms, combined value of bond and stock markets is currently at around USD137 trillion or 179% of global GDP. Put slightly differently, that is 263% of global private sector GDP. There is no rational model on Earth that can explain these valuations. 

Since the start of this year, the two markets gained roughly USD15 trillion in value, just as the global economy is now forecast to gain USD3.93 trillion in GDP over the full year 2017. Based on the latest IMF forecasts, the first 9.5 months of stock markets and bonds markets appreciation are equivalent to to total global GDP growth for 2017, 2018, 2019 and a quarter of 2020. That is: nine and a half months of 'no bubbles anywhere' financial growth add up to thirty nine months of real economic activity.

Happy times, all.