With worries about China raising rates hitting commodities recently, I found the picture presented in this blog quite amazing: Shanghai in 1990 vs 2010. H/T FT Alphaville.
With worries about China raising rates hitting commodities recently, I found the picture presented in this blog quite amazing: Shanghai in 1990 vs 2010. H/T FT Alphaville.
Apologies, but I need a rant this morning.
This morning I work up in a great mood that was soon dashed. I've thoroughly enjoyed living in Vancouver throughout the winter Olympics. There has been a great atmosphere in the City with residents keen to soak up the atmosphere and get involved where possible. The outpouring of Canadian pride has been a pleasure to behold with all their sporting success.
It's not just the hockey, every medal and has been celebrated with style. What a hockey game it was last night, I barely understand the game but was never high 5'd so many strangers in the bar last night. There were great celebrations and not a fight to be seen despite a crowd crush near Robson square (which I was in the middle of).
I've been embarrassed by the coverage in the British press, like the articles from this poindexter. The decision to host some (emphasis some) of the events at Cypress was a gamble that shouldn't have been made. I understand why they did it, to get as many events as possible close to the city, but it was a gamble at the end of the day.
However, largely missed by the British press is the fact that they soldiered through admirably and the events held there were a great success barring the cancellation of a number of tickets. Speaking to friends back in the UK, you'd think the whole olympics were ruined due to lack of snow, when most of the blue ribbon down hill events were on Whistler which is having a record snow year.
With regard to the luger, it was of course tragic and there should be a full independent inquiry. Anyone found to be at fault should be held liable. At the same time though, it was one event the games should have stopped because of it.
A friend read me some criticism of the games from A Russian newspaper. It was a dumb article that veered well away from the games and spoke of Canadas little brother status and colonial overhang. None of which was accurate or had anything to do with the games. The journalist? A British Expat living in Russia.
I raise all this, because I woke up to this:
I currently earn £ but am living in Canada hence my bad mood this morning.
That's the pound vs Canadian dollar exchange rate. My records only go back to 1990, but its certainly the lowest levels since then.
It's not just the Canadian dollar.
I realised I missed off the GBP/ USD, but you get the picture!
According to some commentators, the pound is increasingly trading like an emerging market currency.
Today's falls have been attributed to fears of a hung parliament and while that may be true, it's not the root cause of the sell off. Why would a hung parliament be so bad? Because the UK's structural deficit would not be dealt with so effectively or so quickly.
Let's not lose focus on that, for that is the real issue here. It's like blaming the short sellers for bringing down RBS and HBOS. The problem was the massive bets those banks made that went sour, not the short sellers (although they didn't exactly help things either).
The UK's finances are a mess, yet the party that created this mess (a decade in power is too long a time to go back and blame the old lot) is still in with a sporting chance of holding to power in some form or other.
Come on British media, instead of crowing over an amazing sporting event, how about you focus on a real disaster - The UK economy.
Last week, there was a flurry of positive stories after the UK GDP numbers came at better than expected 0.3% vs 0.1%. "strong" was the word being used to describe the numbers in traditionally right leaning newspaper websites such as the telegraph and times. Yet almost immediately the pound sank because traders realised it wasn't an upwards revision at all. It was a downgrade because past data was revised downwards. The recession was worst than previously feared.
The papers led with headlines that the figures boosted Brown's election chances. These were pulled after it became evident that the figures weren't as positive as first thought, but the damage was still done. Why oh why did they go to Brown or Darling for a reaction to the news instead of looking at what the markets thought. I know who I trust for a more accurate reaction.
Why are politicians on both sides still being allowed to get away
with vague answers on budgets? If a business CEO acted in this way,
they'd be reported to this FSA.
"In a bad tempered exchange on BBC Radio 4's Today programme, Mr Denham refused seven times to quantify the amount councils may have to cut spending.He insisted that cuts in front line services would not be necessary if councils made efficiency savings elsewhere."
Ah the old efficiency savings chestnut. Why is it left to bloggers like Guido Faulks to do the investigative journalism?
The bookies currently put the odds of hung parliament at 2.25 to 2.5, that's implied odds of 44%. Taking into account the bookie overround, the prediction is currently something like 40% chance. Still too close for my liking.
Tory cuts vs Labour investment. Do we still have a choice? Greece has largely had that choice taken away by the EU because it was living in a fiscal fantasy world.
Going back to Canada, it's not a perfect country. It has a large government involvement in certain areas of life such as health care. In BC car insurance is largely state run, leading to exorbitant insurance premiums. The downtown East side is problem brushed under the Olympic carpet.
It's not perfect, but judging by the recent exchange rates, its doing something right. Today Canadian GDP came in above expectations and has been out of recession since November. It's no picnic here in Vancouver, jobs aren't exactly abundant, but people are getting through it.
Back in the 90's Canada was faced with a huge public sector deficit and dealt with it head on. It dealt with it head on with hard, large scale public sector cuts.
It's the Tory's election to lose because they've pussy footed around the issue of cuts. Tell us like it is and for once tell us exactly what you are going to do with real numbers. The Tory poll numbers are quite frankly a disaster given what labour has done to the country. Show us a) you have a clear plan on what to cut b) you're not going to sugar coat the message.
So with data to hand, I looked at whether you could time the S&P 500 depending on whether it was expensive on a historical basis.
Expensive is of course a relative term, so I played around with a few numbers.
Get out out the market when the P/E 10 is above a certain level. Invest £1,000 and let profits compound.
The data allows me to go back to 1881, but I wanted to see things in a modern era so I chose 1979 as a starting point as that's the year I was born. I stopped at May because the compounded returns went nuts with the rally from March. The effects from everything were the same for before and after my testing period.
No account for commissions, interest on cash or dividends has been made.
Buy only if the P/E 10 is below 25
The method does a pretty good job of sidestepping the volatile periods.
Then something struck me. What would returns be like if you only bought if the P/E10 was below 25 and the market was in an uptrend. I defined an uptrend by using simple 10 month percent rank. If above 0.5 = uptrend, if below = downtrend.
The logic is that markets can stay expensive for sometime and not correct. Instead, they might continue to go up, but on a slower basis.Therefore, only get out of the market if its expensive AND there's a downtrend. In other words, everyone else has finally decided that it's too expensive/ risky.
In the UK, people were warning about a housing crash for years, but up and up it went. I don't know off the top of my head, but I imagine its still above the points were people started saying it was expensive, even now. Might be wrong on this, but you hopefully get the analogy.
Buy only if the P/E 10 is below 25 & Trend >0.5
But what if we push things a little. We want the market to be valued at below 20 on the P/E and be trending at below 0.8.
Very good indeed. Note, if you had the returns since May, the compounding will have made the returns even higher, but it looked like a moon shot so I've removed it.
For the record, here's the returns since 1881 to the start of Jan. No doubt lower if you updated the data with the recent sell off.
Question, would return on cash while out of the market compensate for any dividend uplift the might increase returns on buy and hold?
It's interesting to read the various reactions to the Volcker plan. Some are calling Obama a communist while others are backing it.
Unfortunately there seems to be little by the way of solid detail on the plans, but I agree in principle that something major had to be done. Separating retail and more speculative banking was one way of doing hits. The devil is of course in the detail. One of the best posts I've read on it is here from someone who used to be in the thick of prop trading activity.
"Never mind the issue of if my friend trading merger arb with my deposits is any more or less risky than his bank instead taking the money and lending it out to small businesses and homebuyers (cause that's what they do!) - I think the past few years have cemented the fact that mortgage lending is not necessarily less risky, but it certainly looks better on paper, in terms of subjective categories like benefit to society."
This leads nicely to an interview with Richard Thaler, one of the leading lights in behavioural economics.
Again, another choice quote:
"What was the ultimate cause of the financial crisis? Poor regulation? Greed? Bad market signals? Human frailty?
Leverage caused the crisis—and I would say that is a pretty uncontroversial statement. Human frailty comes into play at two levels. One, the people who were taking out the subprime mortgage loans—many of them didn’t understand what they were doing. Two, the C.E.O.s clearly didn’t understand what their traders were doing. I call that the “dumb principal” problem. Go down the list—A.I.G., Citigroup, Bear Stearns, Lehman Brothers. These companies were destroyed or devastated by a small part of the firm that was hurtling forward and was risking the entire firm. The people in charge were either greedy or stupid, or possibly both"
Going back to Kid Dynamite:
"In addition to trying to separate commercial banking and prop trading, wouldn't a good first step to be to actually separate the commercial banks from the non commercial banks? People aren't mad because GS is making money trading - they're mad because GS is making money trading with what they (the people) think is taxpayer money or taxpayer backstops.
The decision to allow non-banks
access to (near zero cost) Fed funds resulted in these non-banks
making extreme amounts of money which angered the populace.
Putting these two together, I personally gain a sense of clarity on the crux of the problem. I hope it helps you.
As the quotes above have inferred, it's not prop trading, it's not bad loans, its any risk that is over leveraged. If Northern Wreck wasn't so dependent (leveraged) on short term funding it may not have have starred in act 1 of the crisis.
Aleph blog has further thoughts on the role of leverage in the crisis
PS an update to my little conspiracy theory. Goldmans could (surprise surprise) be the bank with the most to lose with a ban on prop trading. By extension, you could argue they are one of the biggest market makers out there. By further conspiratorial extension, you could argue that as Goldman's are one of the most active program traders on the NYSE, they have the ability to nudge the market a little here and there.
Beth's parents may not be able to fly out and spend the Christmas period with us. All thanks to those BA employees who are striking with a 'heavy heart'.
It's always hard to look at a situation like this and get the real facts (and objectively when you are frothing at the mouth). However, I don't understand how BA's crew think that striking will help the short or medium term prospects of a business that is making massive losses with an unsustainable pension deficit. There are some indications that their current remuneration package aint half bad.
Change we can believe in?
There was a heck of a lot of talk in the intimidate aftermath of the credit crunch regarding regulatory changes that would be made, but what if anything has actually been done?
Sure there are some capital ratios that have been tweaked, but what about wider, more pervasive changes?
My argument is that the credit crunch happened due to flaws in human psychology - well duh! you might say.
But if this is such an obvious explanation, why are all the proposed changes still ignoring well known and well researched biases from the world of behavioral economics?
In the years leading up to the bust, banks were run with a testosterone fueled target driven culture. Want your bonus? hit your targets! This comes from the top down. Your boss is screaming at you to make the numbers because his bonus depends on it, you in turn scream at your underlings and so on.
Somewhere in this process corners are cut. Risk factors were ignored.
Picture the broker in this situation. He knows he has to turnover X amount to make his bonus.
He could play it safe or deal with the new fangled CDOs. He might question,
"Is this CDO really worth £X million, should it really be AAA rated?"
He gets that feeling of doubt in his stomach. It doesn't feel 100%, but he knows he's got to make his numbers. Anyway everyone else is dealing in them and if they go kablooey in 2 years, he'll still get his bonus.
Maybe it's not his own greed that's driving this. Maybe its the desire to not let the team down, keep his boss happy. Maybe it's not the money per say but his station amongst his peers. Come bonus time, they'll be buying another flat in Chelsea, how will he feel if he can't even take his wife on that holiday?
Now, I'm not for a minute saying all bankers were or are bending the rules like this. I have some good friends working in the banking industry who are fine upstanding fellows. What I'm trying to demonstrate is how easy it is for someone to start cutting corners and trading in assets they wouldn't otherwise touch with a barge pole.
There are two behavioral traits at work here.
Where does that leave us now?
There's nothing wrong with an aggressive bonus/ target driven culture per se. Many business use this model. It works fine most of the time. However, all too often, aggressive targets can encourage some bending of the rules. This might be selling something to someone you know isn't appropriate for them. Most of the time, this will result in a loss of business. If you sell faulty goods, it usually won't take much time for the client to realise they've been duped and complain, then look for someone else to provide the service.
But what if the payback period is over years not months. What if you could sell something to someone that might have hidden risks, but those risks won't become apparent until next year, or maybe 2 years down the line. What if the risks aren't clear? The seller might be able to justify to themselves that they have no way of knowing how the future will work out and the buyer should be sophisticated enough to know this anyway. You might then be temped to sell something you wouldn't want to put your own money in.
You can see that the financial markets could be highly prone to mis-selling in these circumstances.
The last few major financial bubbles demonstrate this well.
We've had a junk bond frenzy, tech stock bubble, Asian stock bubble and of course mortgage bond mania.
We can't say we weren't warned, plenty of well placed people have shared their experiences of working inside an investment bank or written about the reasons for past explosions.
Richard Thomson's Apocalypse Roulette from 1999, and Phillip Augar's Merchants of Greed (2006) provided some clear examples of the culture running within investment banks and how they gave rise to the current crisis.
Because unless there are real changes, there will be a next time. China? Oil?
So what is the answer?
Gordon Brown's call for a tax on banking won't work, or at least as well as he hopes. You're dealing with 'the smartest guys in the room' who will no doubt find a way to minimize the impact by driving revenue offshore or using over the counter products. No doubt it will be the retail investors who end up bearing the cost without the added protection it is supposed to be bringing.
Brown is right on one level though, any changes need to be applied across the globe.
Ideally, bonuses from the very top down would be tied to long term results. For example, 10 year stock options with tiered payouts that rover the years reward long term performance. This is in an ideal world though and may be hard to implement.
Perhaps the best option as proposed by the likes of Talleb, and ex Fed chairman Volcker etc is to make banks smaller and to split investment banks from retail banks. The speculative operators can therefore gamble away and fail without bringing down the whole system. The trouble with this argument is that the financial system is now so tightly interlinked that a supposedly small independent operator could cause a ripple effect.
There's probably no single solution and mandatory training on previous collapses and insights into human psychology for new employees would probably help too.
Banks do provide training on the dangers of insider trading and brokers have achieve various qualifications before being let loose with client funds. Adding a compulsory module on behavioral economics and lessons from the past sure won't hurt.
Some reflections on the PBR
Greece had its sovereign debt rating downgraded this week. It now has the lowest rating in the eurozone, closely followed by Ireland.
So what does this mean for the UK's credit rating and does it matter?
Following the PBR, UK CDS widened. According to CMA vision, the UK's sovereign debt is now riskier than Portugal's and even Chile.
Also the UK is now bottom of the borrowing league tables ahead of Ireland and Greece for 2010 and 2011.
So far, the UK has not had its debt downgraded because of its perceived ability to keep up its payments. Will this last though?
According to FT Alphaville:
"Alistair Darling, the UK Chancellor, said UK taxes would be going up - especially for the rich - and that public spending would be cut significantly. But there was a lack of detail on the latter point and investors are pricing in some skepticism on the government’s projections, both on the deficit reduction and on the 3.5% growth estimate for 2011 and beyond. UK spreads widened significantly throughout the day, as did Ireland’s"
As for the rest of the PBR, my two penneth worth is that it didn't go far enough in terms of cuts and to increase spending right now is not the right thing to do. I don't think we needed to slash and burn like the Irish government, but I can't believe that no savings could be made from non front line services.
We can only afford this on the assumption that Darling's growth forecasts aren't wildly optimistic……….
There was that old classic 'efficiency savings'. How many much money has been saved from efficiency drives from the government in the last few years?
The bankers' tax probably had to be done, politically, but it will serve little purpose and raises little money in the grand scheme of things. It's interesting that most of the money raised will come from the NIC hike and cap on public pensions. The pain from the former won't be felt until after the election and the impact of the latter will only come through in the long run. Yet the bonus tax is implemented immediately.
In my humble opinion, we have to be pragmatic. The financial services industry is still a major part of the UK economy. Together as tax payers we virtually own RBS (84%) and Lloyds. We're liable for 90% of losses above the £60bn in the case of RBS and they've eaten half way through that. If RBS were to step beyond this £60bn or go under, all the 'efficiency savings' will be a drop in the ocean. It would therefore be in the nation's best interests to make sure that RBS can retain talent that will help become a viable business once again.
Shutting the door after the horse has bolted could be harmful to us as tax payers, no matter how satisfying the blood letting may feel.
In the long run, wholesale changes are needed to the industry – changes that have been talked about, but with no concrete action.
Investment banks need to be split from retail banks. The investment banks can then gamble away with the hedge funds without putting our money on the line. The Glass-Steagall act needs to be reinstated. Even Ex Fed Chairman Volcker believes this as does Mervyn King.
As a wider question, do investment banks serve a socially useful function?
Have a read of this book and it's hard to argue the case.