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kr
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FT REPORT - FT FUND MANAGEMENT: Credit creation from seesawing markets
By John Bonaccolta
Published: May 21, 2007
Market practitioners are famous for claiming that it is impossible to predict the future from the past. But the most erudite practitioners still look for historical context to understand the present more fully.
In this spirit, much has been written and discussed about liquidity, whereby the term seems to have evolved from its original meaning of the ease with which an asset can be turned into cash, to a more nebulous measure of market activity.
Where many seem willing to use the former definition interchangeably with the latter, Lee Thomas prefers to step back and redefine terms to understand better exactly what people mean by liquidity.
The former chief global strategist at Pimco and current chief investment officer of Alpha Vision Capital Management, a global macro absolute return investment manager owned by Allianz Global Investors, offers cautious words about the Federal Reserve's ability to control liquidity.
"Financial innovation means that liquidity is now being created outside the Fed's control," says Mr Thomas.
In coming to his conclusion, he cites three distinct periods of credit creation in the past 150 years. The first, from 1865 to 1913, was governed by the private decisions of bankers, whereby credit was equal to whatever bankers were willing to lend. In other words, reserves were held according to bankers' own sense of business prudence.
During this period, bank panics were frequent, such as those in 1873, 1893 and 1907.
In response to such panics, the Federal Reserve Act was passed in late 1913, creating the eponymous banking system. The Fed subsequently controlled the total quantity of reserves needed to support the banking system's liabilities, and could pare back or create liquidity accordingly.
In trying to understand how the Fed's control of liquidity provides financial stability, Mr Thomas looks to history.
Although most market practitioners today were taught Keynesian economics in school, he explains, this offers only one theory of employment, interest and money. Arguably, Austrian economics explains recent history better than Keynesianism does.
Austrians such as Von Mises and Hayek argued that a liquidity glut leads to inflation, but noted all prices do not rise simultaneously. Rather, capital goods are affected first, leading to excess profits and rising stock prices in this sector of the economy. During this first stage, consumer prices may be stable or even falling.
Where non-Austrian economists were optimistic during the 1920s, rejecting the idea that liquidity was too abundant by pointing to stable inflation, many Austrian economists were predicting it would all end in tears.
"Events today are evolving as they would in an Austrian world, when liquidity is too abundant," says Mr Thomas.
Recent years mark the third period in this historical construct, according to Mr Thomas. Here two considerations arise: first, for the Austrians, goods price inflation is a late cycle event - asset price inflation comes first; and second, liquidity is being created outside the banking system.
Mr Thomas explains that today, instead of holding assets until maturity, banks sell their assets to be securitised, meaning that debt markets have usurped bank credit, and the Fed has been effectively removed from the picture.
"Debt creation depends on the quantity that securitised debt investors [not bankers] deem prudent to hold. Liquidity - the ability to create debt and the associated assets - is effectively unregulated, just as it was before 1913," says Mr Thomas.
And securitisation is not the only innovation that has reduced the Fed's ability to control liquidity. Derivatives are another. Consider the position of investors who want to own stocks in a leveraged way.
They once had only two choices, both of which were regulated. They could borrow from a bank and invest the proceeds in the stock market, or they could use margin. In either case, regulations held the investorsin check.
Today, instead of borrowing from a bank, a potential leveraged equity investor can simply buy an equity futures contract or enter into a total return swap, and a bond investor can enter a swap agreement or buy bond and note futures.
"As innovation has greased the machine, so to speak, the Fed has given up control in the process," says Mr Thomas.
Arguably, he says, if the Fed controls only one of the levers that can manipulate credit creation, it will have to push or pull that lever more firmly than it would if the slightest touch had a more substantial effect.
"In such a world, we can expect the Fed funds rate to be manipulated more often and with greater vigour than it has been in the past," says Mr Thomas.
"It is difficult to ignore the fact that the last time the Fed stimulated the economy, it felt the need to lower the funds rate dramatically."
He concedes that in the past he would have applauded the idea that regulation of the credit creation process had passed from public to private hands. The invisible hand, he thought, would be better than the iron fist of regulation.
"But experience and history convince me that markets are manic depressive, veering from too much optimism to too much pessimism," says Mr Thomas.
"Because commercial banks no longer control credit creation and the Fed no longer even effectively controls commercial banks, expect financial markets to increasingly resemble casinos. This is how Keynes, himself a successful speculator and an early global macro player, described them," he adds.
Copyright The Financial Times Limited 2007 |
my bank got pwnd |
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kr
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Everybody is constantly talking about 'too much liquidity', and it's been that way for some time now. I've had my own thoughts, coming from my own obscure corner of the market, and I thought yesterday's FT article summed them up fairly well.
Concurrently, I am studying business cycles and doing a bit of background reading on the Austrians. I guess it is not a complete coincidence that they appear here.
But there is one part of the Austrian framework that I am uncomfortable with... maybe a trained economist can lend a hand here. I would say it comes from the fact that the original ideas predate Modigliani-Miller. The 'concertina-derived' argument assumes that the most basic and capital-intensive industries are the lowest-yielding. You have an implicit ordering of industries in the Hayekian triangle that might seem plausible to a theoretician. But I don't see why this should be.
The thing is, yes those capital-intensive industries are low-yielding as a fully-funded corporate entity. But the market counteracts this by maxing out the capital structure and pushing things off balance-sheet. This makes even dull projects interesting to the capitalist, and low interest rates aren't really required to make them more interesting. Instead this would be driven more by credit spreads, which as the article states, are largely beyond policymaking. And indeed in these days of very tight credit spreads, you are seeing evidence of capitalists through the LBO proxy, taking down all kinds of
dull businesses like coal mines and airports, because leverage can be maxed out.
What seems inconsistent though is that leverage has gone up rather than down. Tighter spreads would make less-levered and 'more cyclical' businesses still deliver the hurdle equity return. We may be seeing some of this (for instance, SLM, finco's and energy becoming LBO targets), but I wouldn't say it's uniform (again, leverage on property has gone up).
At the end of the day, I am trying to grab something a bit better than credit correlation. I'm not convinced that cycles exist, but the theory doesn't seem tested enough against the facts. Any thoughts? |
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Bachelier
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| Transparent Doppelgänger |
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"The 'concertina-derived' argument assumes that the most basic and capital-intensive industries are the lowest-yielding. You have an implicit ordering of industries in the Hayekian triangle that might seem plausible to a theoretician. But I don't see why this should be."
You’ve hit on a flaw in the Austrians, as written, that hasn't been fully explored (mainly because the school was so out of favour by rent-seeking Keynesians) and is actually against their aims. Your criticism is correct.
Trouble is, like reading Greek Theatre, you have to imagine the times and aims of the writers to fully appreciate what their views on credit were.
In the Austrians world, credit was formed at a tiny, inconsequential micro level at the retail level ("pay me for the groceries on payday, mr. wardavichinski, i know you get your pay every other Friday at the button factory" and at the macro level by governments with currency (signorage) and govies (perpetually rolled over), and then by *banks*
and only *banks*
and only *banks* created M2 and M3*
The Austrians hoped for in a tangential way, but could not conceive of the world we have now, where credit is extended by hedge funds, you and me (via competitive deposit vehicles) and supra-national entities like GE in addition to banks. Their world of credit was three discrete nodes with huge jumps between, whereas our world is nearly continuous choices.
This is actually a world they should have more fully imagined….as the auction of savings became less centralized away from these discrete nodes (credit cards (competitive ones!**) for mr. wardavitchinski), lots of choices for govies (remember STRIPS? And how revolutionary they were?), and now an explosion of methods of credit for former-bank level (hedge funds are now the biggest lenders?).
How does this mitigate the concertina business cycle? It goes to the root of your point on mundane industries. Airports once had to be public or at best public-private to reach the project finance costs and then combat a business cycle. The arguments for this hard-public equity cushion often extended to heavy industry (which is why in Latin America there is still a round robin of nationalizing and privatizing a large swath of production….the question isn’t settled because the terms of credit are still medieval).
But we know that the best IRR for something dull like a brick factory, a refinery or an airport is actually to be levered out the wazoo. In the Austrian’s world, these sort of industries were still owned by a local bourgeois (or cronies), whose large equity cushion absorbed the “business cycle” sometimes through generations. He could not lever it so as to ride out the business cycle. It goes without saying that this locked up capital in a hugely inefficient place for most of the business cycle.
But nowadays, any enterprise can “tranche” itself and folks take a (any proportion they want) ride and return on the “business cycle” wherever they choose: from securitized trade payables to junior equity.
“oh brave new world….”
I’m fairly certain this larger auction of credit creation dampens the old “business cycle.” We may have an exogenous shock (a nuclear war), but otherwise the very world the Austrians wanted (on the credit side) is here.
As we read them now, it is difficult to imagine the world of Menger, Böhm-Bawerk, Wieser, Mises, Hayek, Schumpeter, Haberler, Rothbard, Israel Kirzner, George Reisman, Hazlitt, and Hopp because they only thought *banks* were *banks*.
In our brave new world, everyone is a bank.
It is odd they didn’t see this, as it is the irreducible conclusion of human action and the power of a contract and our life cycle of consumption and then savings.
*I think among the reasons M3 is dropped is that money is being created beyond the ability to capture.
**I’m still convinced that one of the reasons for the decline of Sears was that it, for years, missed the boat on taking MasterCard and Visa for purchases, insisting on it’s own credit card. |
"You don't understand....bond holders are there to be screwed." |
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kr
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Thanks - very helpful.
You _almost_ sound like you are saying that we've seen the end of business cycles altogether (i.e. barring nuclear war), but I'd think instead you'd be in the credit-bubble camp. If you take subprime as an example, with hypercompetition, the mirror image of Austrian credit climate drove down quality, impacted macro statistics, and the question is whether there is a longer-term contagion effect (i.e. blowback from ABS CDOs could lead to higher margins on lev loans).
One might argue that the reason everyone is a bank right now is the massive US expansion of money supply. From a different point of view, the tradeoff between savings and consumption seems to have moved sharply into the consumption side, even though equity returns aren't projecting anything special - if anything, lower returns than previously.
I am trying to digest the Kydland/Prescott stuff which is nice b/c it is very testable at least... |
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Bachelier
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"even though equity returns aren't projecting anything special - if anything, lower returns than previously"
I take the CFA Institute Conference straw poll very seriously. When you have 1100 CFAs in one room, even with only a 50% response rate, that is a very good sample of expected equity returns.
This year the average equity premium from the survey is 3.4%.
"The survey is not scientific, but it is highly suggestive. Asked to put a number on the equity risk premium – the extra return investors should demand in return for the extra risk they take when investing in equities rather than government bonds – the average response was 3.4 per cent."
I'm in HY, so I'm senior to that equity so I have to take a spread tighter than that.
No wonder the iTRAXX x-over trades inside 200.
"You _almost_ sound like you are saying that we've seen the end of business cycles altogether"
I probably do, but it is just squish brain thinking. When some of this covenant lite stuff comes puking out 18 months from now and trades at the distressed discount it deserves I'll preach "Business Cycle!" to the skies and buy when there is blood in the streets.
I'm filing the paers now for "Bachelier's Distressed Boutique, LLC BVI"
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"You don't understand....bond holders are there to be screwed." |
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A bit short on time at the moment and it may have already been mentioned but following up on Bachelier's comment
"In the Austrian’s world, these sort of industries were still owned by a local bourgeois (or cronies), whose large equity cushion absorbed the “business cycle”...
One of the main Austrian theories regarding the business cycle is that "savings" based economic growth is sustainable but that leverage based growth is not, as in the mind of the Austrian, leverage inevitably leads to booms and busts. And that while a "savings" based economic expansion and a "central bank" initiated expansion might have similar effects on capital structure in the short run, in the long run you still end up with the previously mentioned sustainable growth vs. booms and busts.
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Even cavemen knew it was a dumb idea to burn your food for fuel. |
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kr
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Just studying the competing theories, I got a lot out of Kydland/Prescott, but rather than become an economist I noticed it's almost easier to just translate into engineering-speak and work the math from there. Their model has:
- positive feedback (positive shock to total factor productivity increases labor as returns to labor rise)
- concave nonlinearity (declining returns to capital and labor as capacity slackens)
- resonance scale (invested capital is long-lived i.e. time-to-build)
- stochastic technology shocks
I think those are the only ingredients needed to create an oscillator on a lab bench... |
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AndyM
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Kydland / Prescott stuff is not too persuasive; its just a band aid for a degenerate research agenda which has disappointingly little to say about the business cycle. Its appeal is to those who like to keep things neat and tractable, but doesn't translate well from the blackboard to the real world.
Austrians are being revisited because of their focus on the central role of investment and the forces that promote / amplify malinvestment. Add in a dollop of Minsky and you have a useful framework for analysing aspects of the current environment. It will arguably be a much more useful framework than the random shocks to productivity school. |
Homage to catatonia. |
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kr
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I tried to digest the monetarist cycle stuff but am a bit too rational to really accept it. I guess I come back to my previous statement, that nobody really structures the capital analysis part in a useful way because financing / sponsorship is ignored. There is also the idea of 'liquidating capital', when even there, for every seller there is a buyer, and at a buyer's lower price, the capital will continue to produce output.
What I really liked about Prescott was his comment that "people who only lived supply vs. demand ceased to be economists", his point being about relatives in both investment and time preference. What's not useful is that markets always clear in their context, whereas financing markets open and close in a very observable way. I guess you might complain that there isn't enough real-world in K/P to get comfortable with it... I can see agree with that.
The same criticisms about financing apply to investment, since providing finance is an investment. What's not clear to me is the structure of the connection between 'liquidity everywhere' and 'search for yield'. Credit-risky capital expansion comes from both the funding and the equity subordination. I see the funding coming ultimately from massive expansion in the money supply, and I see low real yields (as measured by the consumer) as pushing a portfolio rebalancing and demand for equity. The technological advance in the form of securitisation provides a sink for both equity capital and loose money, but limited availability of capital projects for any number of reasons has put the financing availability as a package far beyond the financing requirements. |
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AndyM
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| This thread has encouraged me to dust down James Grant's 'Money of the Mind'. |
Homage to catatonia. |
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uranasss
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Don't do it, you'll end up buying puts on everything and expecting the world to end!
Haven't heard him comment on CPDO's yet, but that ought to be a fun one. |
It all boils down to two things: squeezes and liquidations. |
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kr
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Questions raised over how long buy-out funding can last
By Paul J Davies
Published: May 24 2007 20:11 | Last updated: May 24 2007 20:11
Richard Bernstein expressed a thought this week that is almost complete heresy in current markets. The chief investment strategist for Merrill Lynch in New York wondered whether liquidity was actually starting to ebb?
The thought came from two pieces of anecdotal evidence suggesting the cost of leveraged buy-outs could be on the rise: firstly that US debt financing for some deals was rising and secondly that equity investors were demanding higher premiums to pass companies into private hands.
His comments echo the concerns recently expressed by the noted British fund manager Anthony Bolton; namely that cheap debt is fuelling higher asset prices and that this state of affairs is not permanent.
“My point was that if the cost of financing is starting to rise and investors are beginning to demand a higher premium, then LBOs will get more expensive,” Mr Bernstein says.
“People talk about the ‘private equity put’ on the stock markets like they used to talk about the ‘Greenspan put’. Who knows how long it will last, but the notion that it’s permanent is not true.”
He says today’s market is a lot like 1988-90’s.
“There is a huge LBO boom, a huge real estate boom and people then ascribed permanence to the liquidity that was financing it and they forget now how quickly that dried up when it did.”
There is very little evidence so far from the US or European loan markets that the cost of leveraged finance is beginning to rise in the way that Mr Bernstein’s “knowledgable sources” have told him it is.
There has been some talk of investors pushing back on deals they did not like. Chemicals company Ineos this week narrowly avoided a showdown with creditors over cutting the interest on it loans while increasing their size and there were rumours earlier this year that many investors would protest over the removal of subordinated debt in the loans to Numericable, a French cable group, although they kept quiet in the end. But such examples are few.
However, there are signs that investors in specialist investment vehicles that buy much of this debt on both sides of the Atlantic are demanding higher premiums since late February or early March (see chart).
Furthermore, many bankers in the leveraged finance industry are aware that in the heat of the competition to get a slice of the private equity action, they are underwriting increasingly aggressive structures.
It is often said that banks do not have to worry about underwriting standards in this market because they can quickly sell it on to other investors.
But this is far from the case, according to bankers. They say that a lot can change in the long lead times between committing to underwrite a deal and reaching the point when the debt can be sold– the warehouse period.
“Deals are increasing in size and structurally becoming more complex. As a consequence, we are extremely focused on disciplined risk management,” says Kristian Orssten, head of high yield and loan capital markets at JPMorgan in London.
Hamish Buckland, head of European leveraged finance origination at JPMorgan, adds: ”Whenever a bank underwrites a deal, it is taking market risk and operating risk until the loan is syndicated [or sold] into the market. Anybody who remembers the last turn in the cycle knows that changes in risk appetite or a company’s performance can quickly affect the success of transactions.”
Other leveraged finance bankers on both sides of the Atlantic identify this as their biggest single concern about the current loan markets. It is the “warehousing” risk that caused significant pain for a number of banks in the US subprime mortgage market recently.
That crisis illustrates just how quickly a market for selling loans on to investors can shut down. Furthermore, the close inter-relations between different securitised debt markets – the vehicles that provide liquidity to leverage loans, mortgages and other types of debt – mean that subprime mortgage has had an impact on the funding for leveraged loans and other kinds of debt.
Spreads – or risk premiums – on the more junior notes issued by collateralised loan obligations, the vehicles that buy a significant portion of leveraged loans, have widened significantly. Part of this is due to concerns among investors that there could be similar problems with lax underwriting standards as in subprime mortgages.
Another part of the problem for CLOs is that structured finance collateralised debt obligations – which are dedicated to investing in the junior slices of mortgage backed securities along with CLOs and other types of securitisation – have seen demand almost entirely disappear because of their direct exposures to subprime-backed bonds.
Removing a source of demand for junior CLO debt has made funding the entire vehicle more difficult – and expensive.
Finally, the competition among CLOs to buy debt is one of the things that has encouraged lower costs and looser protections for lenders. This makes it more difficult for CLOs to generate the returns they have promised investors without taking on more exposure to riskier kinds of debt, which in turn leads investors to ask for higher premiums.
This is all happening while many CLO managers – particularly newer ones – are already concerned about their ability to generate good enough returns to pay their investors.
It is far from certain how CLOs and their investors will react to these dynamics even before a rise in default rates. Mr Bernstein’s warning about the current surfeit of liquidity seems well worth heeding.
Copyright The Financial Times Limited 2007 |
my bank got pwnd |
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AndyM
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Uranass, you don't have to believe everything you read 
But reading bearish authors is always a bracing corrective to all the happy talk we get fed every day.
JG is a first-rate historian with a droll wit and a fantastic eye for great anecdotes. Always worth a read... (I suspect you agree). |
Homage to catatonia. |
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uranasss
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| Wouldn't own the book otherwise--signed copy to boot! |
It all boils down to two things: squeezes and liquidations. |
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IAmEric
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Remember those old "Jack in the Box" toys? Those things always phreaked me out. You wind the crank and that song plays menacingly, the more it winds the more intense the anticipation becomes.
Does anyone else feel that way about the state of the (global) markets today? |
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jungle
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| Chief Rhythm OfficerCSD LLC |
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| You bought a sandwich board yet? Jus' playin'... |
"Don't ever leave if you're there, it's murder on the outside." |
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apine
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iae - it seems like that, but when it is time to allocate capital, the tide against you seems so strong. not only do you risk losses, but then everyone else looks at you (boss, investor, or otherwise) and questions your judgement. it really is taking a big stand.
one strange thing is that it seems like such a strong trend and then apparently John Henry, a trend follower, is not doing well. go figure.
one other thing that i have talked with people about is that everyone is aware that "this is unsustainable." and while it keeps going on, of course, the argument is that it is priced in. after all, the market is aware. but i'm not sure that this time it matters whether the market is aware. i think that participants have no choice but to jump on the ride. unlike in prior years, players HAVE to be fully invested or they get penalized by their investors or simply are required by mandate to be fully invested. so everyone is riding along at 105mph (yes, the American non-metric standard) without their seatbelts on knowing that their will be massive pile-up at some point but unable to use the brake no matter how much they would like to. any comments on this? |
People can't stand two things - randomness and responsibility. -- Art Cashin |
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uranasss
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| JWH and most other large "trendies" have the bulk of their assets in G10 FX & Rates with smaller allocations to energies, metals, stocks, etc... The real juice has been in "risk assets" like emering mtk stocks, commodities (read: base metals/grains/energy), and fx carry (emerging mkts vs. yen/swissy). Campbell is actually down on the year, and they are probably the best in that space for their asset size. |
It all boils down to two things: squeezes and liquidations. |
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dgn2
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| I 100% agree with apine's last statement. I will add that the forces that make this necessary will also make it worse when it comes apart in my opinion. |
...WARNING: I am an optimal f'er |
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Scotty
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The tech boom: in 1997 there was a lot of talk about it being unsustainable. Except it continued for another couple of years. Although it did end in a big way.
Nevertheless...
Competitive pressure between investment banks seems a strong, almost irresistible force. "GS is making a lot of money in private equity and prop - we need to compete!" (regardless of whether we have the culture, skills, infrastructure in place). I presume hedge funds have a similar dynamic. It guarantees an overshoot (too much money into riskier than expected deals with less and less protection).
Hmmm...what can you do with senior management? |
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kr
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[from bloomberg today: Looming Crash Prompts Most Hires for Distressed Debt Since 2002]
BNP Paribas SA, France's biggest bank, hired Steven Franck from New York-based Morgan Stanley this year to increase its distressed debt operation in London to four.
``People have been forecasting a meltdown in credit in the next 12 to 18 months,'' said Michael Gibbons, head of the special situations desk at Paris-based BNP Paribas. ``We tend to crash when we least expect it, rather than when we forecast it.''
...................................................................................................
On the other hand, you have the Chinese market way up essentially because of negative real rates. US consumer confidence seems uncorrelated to things that should be impacting, like fuel costs, higher interest rates, falls in housing prices, slowing growth. I am curious what other people are thinking about inflation these days because we have not really worried about inflation for a long time. I remain convinced that even with slowing growth, inflation is on its way up.
You'd expect that inflation would be perhaps the top concern of retirement savers, and yet investment advisers never seem to factor that in, and it's not at all clear where you'd look if you wanted to hedge your inflation exposure. In 'The Great Wave', (app. F) the author makes the argument that inflation is not all that well-defined and the way different economists use the term is not consistent. He identifies seven different types, so I myself need to be a bit more specific.
I was also thinking that if the US issues inflation-linked debt then it is a bit like having non-domestic-currency-denominated debt. I would think the Fed would not be too eager to issue debt where it has even less control.
Anyhow, we all agree it's unsustainable, and we probably also agree that like the jack-in-the-box, the event which triggers the unwinding is increasingly ominous but still unpredictable... you can hear the spring winding but you won't hear the latch slipping. I'm inclined to think that one can't profit from this structure on either side.
As of Tuesday I have increased my market exposure.
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my bank got pwnd |
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kr
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U.S. Junk-Bond Risk Premiums Decline to a Record Low (Update4)
By Caroline Salas
May 30 (Bloomberg) -- Risk premiums on high-yield, high- risk U.S. corporate bonds fell to a record low on speculation the economy is accelerating, bolstering the ability of companies to meet their debt payments.
...
``We're in the beginning stages of the late cycle: Corporate leverage begins to rise much more in earnest from this point, which goes hand in hand with equity markets performing quite well,'' said Christopher Garman, head of high-yield strategy at Merrill in New York. ``That sort of backdrop can persist for over a year.''
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``The ultimate end game comes when price-to-earnings multiples and corporate leverage are high,'' Garman said. ``When you have the Fed tightening into that climate, that's when the capital markets take it in the chin and default rates accelerate in earnest.''
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I endorse this view of the fundamentals and structure - no rush to disaster just yet. |
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IAmEric
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| Phorgy PhynanceBanned |
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I endorse this view of the fundamentals and structure - no rush to disaster just yet.
I would imagine that your investment horizon should have a significant impact on your behavior under such circumstances, right? What is your typical investment horizon? How would you be thinking about things if your horizon was more like 3-5 years?
Most investor's horizons are highly correlated (I would imagine) with their compensation arrangements and most comp packages (I would imagine) are based on yearly performance. In fact, (I would imagine) that a 1-year horizon is probably considered LONG for most people.
If your horizon is 6 months to a year, keep on trucking. But how would things change if your horizon is 3-5 years? We can let this be a record of my opinion that there is a high probability of things blowing up in the next 3-5 years.
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kr
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good one[s] from ft today:
Global awakening' is fuelling gains in asset markets
By Marc Chandler and Marc Glassman
Published: May 31 2007 03:00 | Last updated: May 31 2007 03:00
From Mr Marc Chandler and Mr Jim Glassman.
Sir, Alan Ruskin's Insight column, "A weak dollar is the driving force behind global liquidity" (May 24), offers a useful summary of the conventional view that the accumulation of reserves by foreign central banks - presumably to temper the pace of their currency appreciation against the US dollar - is the main cause of the liquidity pumping up global asset markets and apparently fuelling various forms of speculation....
Just as the business cycle has lengthened and flattened, so too has the credit cycle. Rather than being a binary system where a banker either gives or denies credit, the market has capital for anyone. The only matter for discussion is the price.
Contrary to Mr Ruskin, we suggest another explanation for the global asset market rally and the compression of credit spreads: the world is going through an economic transformation of historic proportions. It is disinflationary and is creating vast new markets, with enormous opportunities for both business and consumers...
==> highlights of this heavy-sellside view: longer, flatter credit cycle, and 'it's different this time'
on the other side of the page we have
Quarter mastered
Corporate earnings just keep on keeping on. In early April, as bond yields dropped, analysts forecast that profits growth would almost grind to a halt for the first quarter of 2007. Yet actual earnings-per-share growth for the S&P 500 has come in at 8 per cent year-on-year, according to Thomson Financial. That is below the mid-teens level over 2006 but still respectable. And, unlike in the fourth quarter, where almost all growth was provided by lower-quality financial profits, the first quarter seems better balanced across sectors.
Yet despite this, it is no time to get complacent about the profits cycle. The quality of growth remains doubtful. The net decline in the S&P 500 share count, reflecting issuance and buy-backs, added about 1 percentage point to eps growth. A weak dollar will have boosted profits somewhat. The contribution of the volatile financials, energy and materials sectors has risen from about 31 per cent in mid-2005 to 43 per cent of the earnings base today.
The perception that profits are being driven by an unsustainable milking of corporate assets also seems to have some basis: first quarter revenue growth slowed to 5 per cent, almost half the level of 2006. The current boom seems to be one in which financial investments and leverage are prioritised over capital investment. In the medium term, return on capital should in principle fall, either because high profitability attracts new entrants or because asset bases are depleted.
How quickly that theoretical process takes in the real world is the big question. But earnings slumps tend to happen pretty sharply: for the seven profits downturns since 1947, the average time between peak and trough earnings is an abrupt 31 months, and the average decline in real earnings per share is just more than 30 per cent. Whether the S&P 500, trading on 17 times trailing earnings, discounts this degree of cyclicality is debatable. But at least public equity investors can rest assured that, unlike some of their brethren in the fixed income and buy-out industries, they still believe a profits cycle of some sort exists.
==> actually the caption for the attached chart argued that the cycle is MORE volatile, on the basis of historical pattern |
my bank got pwnd |
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IAmEric
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