Category: Market Action

Jason Zweig of the Wall Street Journal has some good advice for fixed income investors in a piece titled Investors: Do the Hard Thing, Don’t Do the Easy Thing:

The reach for yield is becoming a reckless lunge.

While high-quality bonds still have their place, too many investors are buying high-risk bonds instead.

Since June 30, according to TrimTabs Investment Research, a firm in Sausalito, Calif., that tracks how money moves in and out of the financial markets, investors have poured $1.2 billion into exchange-traded funds specializing in bonds from emerging-market countries. So far in July, investors have pumped another $2.8 billion into high-yield ETFs holding so-called junk bonds issued by below-investment-grade companies.

Put simply, one out of every 14 dollars invested in those two fund categories arrived in the past three weeks.
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The easy thing is to submit to your worst instincts and reach for riskier investments that pay higher income — for now.

What is hard is to be patient and ornery. As bonds yield less, save more. Remember that you can get higher yield only by buying longer-term or lower-quality bonds — which will also raise your risk. With interest payments so low, long-term bonds are particularly vulnerable to an unexpected rise in rates.

So now it’s official: it’s not what you know, it’s who you know:

Among currently employed workers, those who found their job through a referral from their network had an average weekly salary of $772.20, or roughly $40,000 per year. Those who did not find their job via a referral had an average weekly salary of $725.84, or nearly $38,000 per year. On average, salaries were 6 percent higher if workers found their job through their networks.

Further, their earnings are even more positively skewed. One way to interpret this is that network searchers have more “upside” risk: They can potentially draw a variety of wages, but there are more very high potential outcomes through the network, To quantify this, Kelley’s statistic is 0.6 for network-finders and 0.44 for others, meaning that 80 percent rather than 74 percent of the dispersion between 90th and 10th percentile is accounted for by the top half (from 90th percentile to 50th).

The distribution of wage offers should typically be different from the distribution of wages among employed workers. Not all offers are accepted, and workers at lower wages tend to make more over time through selective job mobility and pay increases on the job. Still, even among the distribution of wage offers, we see a premium associated with those who found jobs through their network. Workers who were searching while unemployed received offers through their networks that averaged 62 percent more than those found through direct contact. Workers searching while employed received network offers that were 12 percent higher, on average.

This is based on a working paper by Marcelo Arbex, Dennis O’Dea, and David Wiczer titled Network Search: Climbing the Job Ladder Faster:

We introduce an irregular network structure into a model of frictional, on-the-job search in which workers find jobs through their network connections or directly from firms. We show that jobs found through network search have wages that stochastically dominate those found through direct contact. Because we consider irregular networks, heterogeneity in the worker’s position within the network leads to heterogeneity in wage and employment dynamics: better connected workers climb the job ladder faster and do not fall off it as far. These workers also pass along higher quality referrals, which benefits their connections. Despite this rich heterogeneity from the network structure, the mean-field approach allows the problem of our workers to be formulated tractably and recursively. We then calibrate and study the wage and employment dynamics coming from our job ladder with network heterogeneity. This quantitative version of our mechanism is consistent with several features of empirical studies on networks and labor markets: jobs found through networks have higher wages and last longer.

The war on markets continued today with the arrest of Mark Johnson, HSBC’s global head of foreign exchange cash trading in London:

The two allegedly conspired to take advantage of inside information about an unidentified company’s plans to sell part of its stake in an Indian subsidiary, according to the complaint. The client was Cairn Energy Plc, which was selling the unit to Vedanta Resources Plc, according to people with knowledge of the transaction. HSBC was hired to trade about $3.5 billion in proceeds of the sale to pounds. Johnson and Scott began buying pounds in the days before the transaction, anticipating that they would cause the price of pounds to spike — a practice known as “ramping” — then execute the transaction, making the pounds they’d bought earlier more valuable, according to the complaint.

Scott and Johnson — his supervisor at the time — told the client the deal should take place at 3 p.m. “so there’s an element of surprise” to get a better rate, according to the complaint, which quoted from recorded phone calls and messages between the two and their client. There was less liquidity at the 3 p.m. fix than the one at 4p.m., making it easier to manipulate, though they told their client they were about the same.

They and other traders they directed ramped the price, sending the pound to its highest in two days at 2:56 p.m. London time. When Scott told Johnson the client was still going ahead with the full transaction despite the spiking price, Johnson said “Ohhhh, f***ing Christmas,” according to the complaint. In the end, HSBC and the men’s internal accounts reaped about $8 million from the front-running, according to Brooklyn U.S. Attorney Robert Capers.

Click for Big

Well, the main thing that sticks out in this story to me is the fact that whoever it was at Cairn Energy who negotiated this deal is a complete idiot. Converting $3.5-billion into pounds in one trade at one specific time? Didn’t it occur to anybody to think, gee, this is kind of a big trade? It also looks as if this idiot who somehow managed to be in charge of $3.5-billion has no idea whether the guys at HSBC are fiduciaries or counterparties – and the idiot had a responsibility to know that.

The second thing to jump out at me is the question of what the authorities suggest HSBC should have done. They were told to convert $3.5-billion at the 3pm fixing, so they did. As they are not as stupid as the moron at Cairn Energy, they laid off their end in pieces. Does anybody care to guess in the comments what the execution price of the trade would have been if the entire order had been placed electronically as a market order at 2:59:59?

The White House has published a study pooh-poohing the theory that student debt has begun to harm the economy:

The White House just released a big report on student debt that contains all the familiar horrors about for-profit schools, indebted dropouts and students defaulting on their loans. But it has an interesting conclusion: That growing stack of $1.3 trillion in student debt is helping, not hurting, the U.S. economy.

That conclusion is sure to rankle the many student advocates and special-interest groups—from real-estate agents to employers seeking new tax breaks for their young workers—that argue student debt is a big “drag” on the economy. (Hillary Clinton and Donald Trump have each decried the rise in student debt.) But the 77-page report from the White House Council of Economic Advisers backs up its claim with numerous charts and studies from economists and academics.

The report itself, titled INVESTING IN HIGHER EDUCATION:
BENEFITS, CHALLENGES, AND THE STATE OF STUDENT DEBT, rebuts my main concern:

The rise in student loan debt has created challenges for some borrowers with lower earnings, but has not been a major factor in the macroeconomy.

• • Despite its steady rise over the past decade, aggregate student loan debt remains small relative to aggregate income. In 2015, total student loan debt was 9 percent of aggregate income, up from 3 percent in 2003. By itself this is considerably smaller than the rise in mortgage debt prior to the crisis and it has also been accompanied by a reduction in other forms of consumer debt.
• • Additional student debt, as an investment in education, is associated with additional income, putting many households in a better position to buy homes or start businesses. By age 26, households with student debt are more likely to buy a house than those that did not attend college. By age 34, college attendees with and without student debt are equally likely to buy a home, and both much more likely than those without a college education. Research studies have found that conditional on a given education, higher student debt explains, at most, a small fraction of the decline in homeownership among younger households.
• • At the same time, the increase in defaults on student loans as well as the increase in high-loan balances for low earners can be real concerns at the individual level, potentially leading to compromised credit and reduced home buying for some individuals.

My problem with the paper is that it concentrates on proving that post-secondary education is still worth-while, even if it involves taking on debt, which isn’t quite the problem I have focussed on. Debt+Degree is better than nothing, sure, but Degree is better than Debt+Degree! And the paper does admit that yes, there is a measureable effect on home ownership rates:

Work by Mezza et al. (2016) tries to identify the causal relationship and finds a larger, negative estimate of student debt on homeownership.31 Using only the variation in student loan debt due to differences in home-state tuition, they estimate that a 10 percent increase in student loan debt leads to a 1 to 2 percentage point decline in homeownership rates for the borrower. Their estimated effect of student loan debt on homeownership is larger than the Cooper and Wang (2014) or Houle and Berger (2015) studies. It is important to note that all of these studies focus on younger households, so it is possible that rising student loans have delayed but not reduced lifetime homeownership. In addition, these studies hold constant the level of education such that they focus only on the impact of debt, not on the education that the debt helped to fund, thereby excluding the positive boost to homeownership from increased education-related earnings.

As discussed on May 31, 2016 there is at least some reason to believe that student debt has harder-to-measure effects than the simple home-ownership binary:

A 2013 report by the think tank Demos found that student debt has a negative effect on income, by making borrowers more risk-averse and discouraging them from moving to another city or taking gambles on new jobs or launching a new business.

This paper, by Robert Hiltonsmith, titled At What Cost? How Student Debt Reduces Lifetime Wealth, was not addressed by the White House researchers.

There is also the underlying problem with student debt, that the ready availability of loans has caused tuition to skyrocket and that this additional revenue for the universities has not led to any meaningful increase in the quality of their product, but merely to an increase in the quantity of their administrators and the amount of marketing frills they offer (such as improved accommodation, meals, football stadiums, etc.).

So, while I appreciate the intervention of the White House in the issue, I do not consider their pronouncement to be the final words on this matter.

So guess who’s financing your mortgage!

Canadian Imperial Bank of Commerce has become Canada’s first bank to benefit from Europe’s rush to debt with subzero yields.

CIBC sold €1.25-billion ($1.79-billion) worth of six-year covered bonds – with a yield of negative-0.009 per cent – on Monday. According to a person familiar with the transaction, investor demand was so strong that the value of orders roughly doubled the deal size.

Not only is CIBC the first Canadian bank to issue such debt at a negative rate, it is also the first non-European bank to do so. In March, Germany’s Berlin Hype was the first lender to borrow at negative rates, cashing in on a hunger for quality debt, coupled with Europe’s unique fixed-income markets.

At the start of this month, nearly $12-trillion (U.S.) worth of government debt carried negative yields. As CIBC’s latest foray into the market highlights, the phenomenon is now spreading to other types of bonds, as investors search for securities that pay at least a tiny yield – or cost less to own than sovereign bonds.

Update: Here is a link to a brief explanation of Covered Bonds

Wal-Mart is continuing its battle with Visa:

Wal-Mart Stores Inc. can no longer count Marlene Gosparini and her employer as regular customers in Thunder Bay after the world’s largest retailer stopped accepting Visa Inc. credit cards at its three stores in the Canadian city.
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Wal-Mart prepared its Thunder Bay customers for the change in June when it posted a statement on its website. There were signs in stores leading up to the shift, and on Monday store greeters, employees and managers approached customers as they walked in to remind them of the change. Some cashiers even offered customers a chance to sign up for a Wal-Mart Mastercard.
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Visa ran ads in Thunder Bay’s newspaper Monday offering cardholders a C$25 online gift card for making purchases of C$75 or more at Thunder Bay grocery stores.
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Wal-Mart’s Canada unit, which pays more than C$100 million to accept credit cards annually, called the fees Visa charges “unacceptably high” in a June 11 statement on its website.

Better late than never!

Today’s hot news is the Bank of Canada statement:

In Canada, the quarterly pattern of growth has been uneven. Real GDP grew by 2.4 per cent in the first quarter but is estimated to have contracted by 1 per cent in the second quarter, pulled down by volatile trade flows, uneven consumer spending, and the Alberta wildfires. A pick-up to 3 1/2 per cent is expected in the third quarter as oil production resumes and rebuilding begins in Fort McMurray. Consumer spending will also get a boost from the Canada Child Benefit.

While the fundamental elements of the Bank’s projection are similar to those presented in April, the forecast has been revised down in light of a weaker outlook for business investment and a lower profile for exports, reflecting a downward adjustment to US investment spending. Real GDP is expected to grow by 1.3 per cent in 2016, 2.2 per cent in 2017, and 2.1 per cent in 2018.
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The Bank forecasts that the output gap will close somewhat later than estimated in April, towards the end of 2017. Underlying this judgement is the downward revision to business investment, which lowers the profile for both real GDP and, to a lesser extent, potential output.

While inflation has recently been a little higher than anticipated, largely due to higher consumer energy prices, it is still in the lower half of the Bank’s inflation-control range. Most measures of core inflation remain close to 2 per cent but would be lower without the impact of past exchange rate depreciation. The temporary effects of exchange-rate pass-through and past declines in consumer energy prices are expected to dissipate in late 2016, and the Bank projects that inflation will average close to 2 per cent throughout 2017 as the output gap narrows.

Overall, the risks to the profile for inflation are roughly balanced, although the implications of the Brexit vote are highly uncertain and difficult to forecast. At the same time, financial vulnerabilities are elevated and rising, particularly in the greater Vancouver and Toronto areas. The Bank’s Governing Council judges that the overall balance of risks remains within the zone for which the current stance of monetary policy is appropriate, and the target for the overnight rate remains at 1/2 per cent.

In addition the July 2016 Monetary Policy Report was released:

In the housing market, new construction and resale activity remain robust in British Columbia and Ontario, supported by strong demand, in part attributable to population and employment growth. The same factors are fuelling house price increases in these regions, particularly the greater Vancouver and Toronto areas. Sharply rising prices in these markets over the past year raise the possibility that prices are also being driven by self-reinforcing expectations, making them more sensitive to an adverse shock to housing demand. In contrast, housing activity and house prices in the energy-producing provinces have declined; elsewhere in the country, housing growth has been modest, with most markets appearing balanced. Over the projection horizon, the contribution of residential investment to real GDP growth is anticipated to decrease and household sector vulnerabilities to stabilize.

Incompetent traders rejoice! The world got safer for complacent, incompetent traders today!

Michael Coscia, the first person convicted of spoofing after it was made a crime under the Dodd-Frank Act, was sentenced to less than half the prison time sought by federal prosecutors.

Coscia, 54, who had argued for probation, was sentenced Wednesday to three years in prison by U.S. District Judge Harry Leinenweber in Chicago. The only explanation for Coscia engaging in fraud while he was making $150,000 a month trading futures and had a net worth of $15 million was greed, the judge said.

“This is a serious crime with serious consequences,” Leinenweber said before handing down the sentence. He noted that spoofing has been going on for a long time.

Spoofing, which became illegal under the Dodd-Frank Act, carries a maximum of 10 years in prison. The practice typically consists of systematically placing orders without intending to execute them to trick the market into thinking there’s interest in buying or selling that doesn’t actually exist.

Today’s Wall Street Journal brings an attack on Universal Basic Income:

Jason Furman, chairman of the council, suggests that multiple forces, including globalization, automation, and incarceration (many jobs are closed to ex-convicts) has reduced demand for low-skilled workers. What employers will pay for unskilled labor is below what economists refer to as the “reservation wage”: Some workers simply won’t work for so little money.

What’s the solution? If outside forces are depressing low-skilled wages, that strengthens the case for subsidizing those wages so that they will work for what employers can pay. This can be done by expanding the earned-income tax credit, which tops up poor worker’s salaries, and wage insurance, which pays a laid-off worker to accept a lower-paying job. This can’t be done through UBI, which is paid regardless of whether the recipient works, and, according to some studies, encourages some recipients to quit.

Try as I might, I fail to see a problem here. We can agree, I think, that yes, a Universal Income will decrease the number of people willing to work as a Starbucks barista for $15/hour. Many will continue to do it because they just want to get out of the house, others will do it for the extra income, but for the sake of an argument, let’s assume that the require wage goes to $20/hour.

OK, fine. This is not a problem this is just a shift to a new equilibrium in accordance with first year economics. Starbucks will raise the price of their coffee, people will buy less coffee, fewer baristas will be hired and supply will equal demand. Big deal.

The big advantage, not mentioned in the article, is that this will have the same effect on the market as a rise in the minimum wage: low skill jobs will be increasingly automated. Starbucks coffee will go to $6/cup, but there’ll be a new place down the street, Supernovabucks, with fully automated ordering (via your own ‘phone or an in-store kiosk) and robotic coffee making you can see … everything made to order in front of your eyes, with precise settings available for the thickness of the foam on your latte (or whatever it is that is supposed to be so great about Starbucks. I don’t go there). Supernovabucks stores will have only one employee on site, filling up the supply hoppers and cleaning the counters.

And all this will be a Good Thing. Productivity has increased – and it is productivity that makes us rich, not redistribution.

The other problem the WSJ article had was increased taxes. Well, of course marginal tax rates will go up – it can’t be paid for entirely by elimination of suddenly redundant social programmes. Reginald Plutocrat III will be getting his annual cheque for $10,000 and including that in his annual income; if we assume that his current average tax rate is 50% and his income is $150,000, then his average tax rate will have to increase to a little over 53% to make the whole package revenue-neutral for him. And if it’s not revenue neutral – at best – for upper income earners, then the whole thing becomes a wealth transfer from the poor to the rich, which I suspect won’t fly politically.

PerpetualDiscounts now yield 5.21%, equivalent to 6.77% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.70%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 305bp, a sharp narrowing from the 330bp reported July 6.

It seems to me that this here internet thingamajig might be useful for business:

Home renovation chain Rona says its efforts to attract tech-savvy shoppers got a recent boost when the retailer temporarily replaced its printed flyer with an expanded digital offering.

The Montreal-based company says sales doubled at its stores across Canada despite scrapping the printed flyer during a nationwide test one week in February.
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Jean Coutu, one of Canada’s largest pharmacy networks, said it’s also seeing success with its digital efforts. The company said cosmetic sales got a five per cent lift after it twice published a 20-page digital flyer this year enhanced with videos on the Montreal La Presse Plus tablet and website.

How about that new Brookfield infrastructure fund, eh?:

Brookfield Asset Management Inc. (“Brookfield”) (NYSE: BAM, TSX: BAM.A, Euronext: BAMA) announced today that it held the final close on Brookfield Infrastructure Fund III (“BIF III” or the “Fund”) with an aggregate of $14 billion of equity commitments, creating a global infrastructure fund that invests in high-quality, core infrastructure assets on a value basis.

BIF III marks the largest private fund raised by Brookfield and the largest private infrastructure fund ever raised in the industry. In the last 18 months, Brookfield has raised approximately $27 billion across its flagship private fund strategies, including the close of its flagship real estate fund, Brookfield Strategic Real Estate Partners II at $9 billion, and its flagship private equity fund, Brookfield Capital Partners IV at $4 billion. All three funds surpassed their fundraising targets.

To every action there is an equal and opposite reaction:

As recreational and commercially available drones become more advanced, areas that are off limits are having to develop plans to keep drones out. Other than taking a rifle and shooting one down, there really aren’t many options on the market to keep drones away from places like prisons, military bases, and other restricted air spaces. Dedrone is a company seeking to bridge that market gap by creating a drone detection and jamming system. Using an array of sensors, lasers, and jammers, the Dedrone system will detect when a malicious drone enters designated airspace and automatically take defensive action.

There’s a causal link between Brexit and the commercial property chaos:

Some commercial property buyers are invoking “Brexit clauses” written into contracts agreed before Britain voted to leave the European Union, allowing them to walk away from the deals.

In other cases buyers have yet to exercise such get-out clauses but are keeping the option open to try to renegotiate the price down, according to property lawyers and managers.

A third group is playing for time in the hope that the effect of the June 23 referendum result on values becomes clearer, they say.