AM | @agumack
"Stormy weather in Shortville" — Elon Musk
- Global liquidity is recovering. Since the low of $3.19tn in late 2016, the EU Finance Club Global Dollar Liquidy indicator has staged an impressive recovery (*). The stock of U.S. Treasuries held by 'foreign' central banks stands now at $3.34tn. The $146bn recovery was led by the People's Republic Bank of China. Mr. Xi Jinping himself is said to lead the campaign to calibrate out-bound investment flows in order to stem capital flight. Judging from the FX reserves standpoint, the strategy appears to be working. But what will it do in terms of the chronic misallocation of capital?
(*) Federal Reserve: "Factors Affecting Reserve Balances".
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- Short-sellers losing money. Short-sellers are "nursing loses of almost $8bn this year" (*). The most shorted stocks appear to be the Faangs: Facebook, Amazon, Netflix and Google. In addition to the Faangs, Tesla is "comfotably the most shorted stock in the US"—and here short-sellers are losing $4.7bn this year. (Note this quote from Tesla's founder Elon Musk: "Stormy weather in Shortville"). Given the tremendous recovery in global liquidity, I'd be very reluctant to join the list of short-sellers.
(*) Robin Wigglesworth & Nicole Bullock: "Big tech companies in short-sellers crosshairs", Financial Times, 14 August 2017.
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- Meditation & Behavioral finance. I'm old enough to remember the bond bear market of 1994, with one European fund manager telling the Wall Street Journal that, instead of staring at his screen in agony, he'd rather go to a ... meditation retreat. And of course we know that Bridgewater Associates' Ray Dalio is a fan of transcendental meditation. Now Goldman Sachs is offering free meditation training to employees. When we'll discuss behavioral finance in Financial Markets BCO224 I'll make sure that I mention this topic. Want to know more on medidation? Here's a good piece from Wired (*).
(*) Robert Wright: "Is mindfulness meditation a capitalist tool or a path to enlightenment?", Wired, August 2017.
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- Maersk. There are two articles on AP Moller-Maersk, the 113-year old Danish conglomerate (*). This line from CEO Søren Skou caught my attention: "Mr Skou's plan for Maersk is about shrinking the company to grow — a 'counterintuitive' approach, he concedes". It's all about getting rid of under-performing assets and invest in businesses with higher profit margins.
(*) Richard Milne: "Maersk chief forecasts further container sector consolidation" and "Global shipping boss charts course through troubled waters", Financial Times, 14 August 2017.
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Monday, August 28, 2017
Sunday, July 2, 2017
QUICK VALUATION NEWS, No. 3
AM | @agumack
"... a CVD, Chief Value Destroyer" — Dan Loeb
[1] Nestlé. What a great story (*). This is exactly what we discussed in the Summer I course on Security Analysis BSF313—how companies can enhance their own value to make themselves less attractive to potential predators. (We used Prof. Damodaran's book and his excellent VIDEO on the topic). Just days after activist hedge fund manager Daniel Loeb took a 1.25% stake in the $263bn venerable Swiss company, management announced the equivalent of $21bn in stock buybacks. According to this Bloomberg article, any CEO who'd oppose Mr. Loeb would be branded a 'CVD'—Chief Value Destroyer. Note that Nestlé [NESN: VX] now "aims to gear up its balance sheet, setting a target of 2 times net debt to ebitda, up from 1.3 times at the end of last year". A debt-financed stock buyback is just what the doctor would order for a mature, underlevered company that seeks to enhance its value in the equity market.
(*) Ralph Atkins & Scheherazade Daneshkhu: "Nestlé unveils $21bn buyback days after activist Loeb urges shake-up", Financial Times, 28 June 2017.
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[2] Uber. Prof. Damodaran is valuing Uber—again (*). In his book Narrative and Numbers. The Value of Stories in Business, he came up with at $23.4bn valuation in his most optimistic DCF valuation. Now he applies a different method —a bottom-up approach called 'user-based valuation'— and he estimates Uber's value of equity at $37.2bn. "Talk about a moving target!", he says. I am also noting that in his recent valuations, Prof. Damodaran is putting more effort in the estimation of cash flows, and less in the calculation of discount rates. It's a bit less fun, but more useful.
(*) "User/Subscriber Economics: An Alternative View of Uber's Value", Musings on Markets blog, 28 June 2017.
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"... a CVD, Chief Value Destroyer" — Dan Loeb
[1] Nestlé. What a great story (*). This is exactly what we discussed in the Summer I course on Security Analysis BSF313—how companies can enhance their own value to make themselves less attractive to potential predators. (We used Prof. Damodaran's book and his excellent VIDEO on the topic). Just days after activist hedge fund manager Daniel Loeb took a 1.25% stake in the $263bn venerable Swiss company, management announced the equivalent of $21bn in stock buybacks. According to this Bloomberg article, any CEO who'd oppose Mr. Loeb would be branded a 'CVD'—Chief Value Destroyer. Note that Nestlé [NESN: VX] now "aims to gear up its balance sheet, setting a target of 2 times net debt to ebitda, up from 1.3 times at the end of last year". A debt-financed stock buyback is just what the doctor would order for a mature, underlevered company that seeks to enhance its value in the equity market.
(*) Ralph Atkins & Scheherazade Daneshkhu: "Nestlé unveils $21bn buyback days after activist Loeb urges shake-up", Financial Times, 28 June 2017.
______________
[2] Uber. Prof. Damodaran is valuing Uber—again (*). In his book Narrative and Numbers. The Value of Stories in Business, he came up with at $23.4bn valuation in his most optimistic DCF valuation. Now he applies a different method —a bottom-up approach called 'user-based valuation'— and he estimates Uber's value of equity at $37.2bn. "Talk about a moving target!", he says. I am also noting that in his recent valuations, Prof. Damodaran is putting more effort in the estimation of cash flows, and less in the calculation of discount rates. It's a bit less fun, but more useful.
(*) "User/Subscriber Economics: An Alternative View of Uber's Value", Musings on Markets blog, 28 June 2017.
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Wednesday, June 7, 2017
THE WIZARD OF LIES
AM | @agumack
"It's been a total disaster" — Harry Markopolos
In our course on Ethics in the Financial World BSF211 we study the Bernard Madoff case [VIDEO]. From a teaching standpoint, it is a gold mine because it illustrates the role played by custodians and asset managers, the differences between broker-dealers and investment advisors, and much more. The case also allows us to show the Sharpe ratio in action—it was one of the tools used by whistleblower Harry Markopolos [see]. I then ask students to apply the Sharpe ratio to a number of hypothetical investment funds. The first student to spot the 'too-good-to-be-true' scenario (a Sharpe ratio > 4) is awarded ... a whistle.
* * *
HBO Movies is now releasing The Wizard of Lies, a Madoff biopic starring Robert de Niro and Michelle Pfeiffer. We are lucky to have lots of movies to illustrate different aspects of financial markets. Let us see how this one goes (*).
(*) Back in February, the FT's John Authers had lunch with Edward Thorp, one of the superstars in the world of quantitative asset management: "In 1991, Thorp did some due diligence for a consultancy that asked him to look through their hedge fund investments. Madoff’s returns instantly looked too good to be true, he says." (See John Authers: "The man who beat the casinos, then the markets", Financial Times, 4/5 February 2017). And what about this recent scam?
____________________
"It's been a total disaster" — Harry Markopolos
In our course on Ethics in the Financial World BSF211 we study the Bernard Madoff case [VIDEO]. From a teaching standpoint, it is a gold mine because it illustrates the role played by custodians and asset managers, the differences between broker-dealers and investment advisors, and much more. The case also allows us to show the Sharpe ratio in action—it was one of the tools used by whistleblower Harry Markopolos [see]. I then ask students to apply the Sharpe ratio to a number of hypothetical investment funds. The first student to spot the 'too-good-to-be-true' scenario (a Sharpe ratio > 4) is awarded ... a whistle.
* * *
HBO Movies is now releasing The Wizard of Lies, a Madoff biopic starring Robert de Niro and Michelle Pfeiffer. We are lucky to have lots of movies to illustrate different aspects of financial markets. Let us see how this one goes (*).
(*) Back in February, the FT's John Authers had lunch with Edward Thorp, one of the superstars in the world of quantitative asset management: "In 1991, Thorp did some due diligence for a consultancy that asked him to look through their hedge fund investments. Madoff’s returns instantly looked too good to be true, he says." (See John Authers: "The man who beat the casinos, then the markets", Financial Times, 4/5 February 2017). And what about this recent scam?
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Monday, June 5, 2017
QUICK VALUATION NEWS No. 2
AM | @agumack"On ne demande pas son âge à une jolie femme" — Frédéric Mazella
[1] Start-up valuation. The French weekly business magazine Challenges reports on the « radar des valos », a survey of more than a hundred French start-up tech companies with a valuation above the €20 million mark (*). BlaBlaCar is still the only Unicorn—defined as a private company valued at more than €1bn. There is little on the valuation methodology; we are told, however, that Challenges worked in tandem with boutique investment bank Cambon partners. The companies are presented in five categories: software/adtech, biotech, objects connectés, fintech, and services et e-commerce.
(*) Laure-Emmanuelle Husson: "La valorisation des start-up reste un tabou", Challenges, 31 May 2017.
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[2] William Sharpe. Barry Ritholz defines William Sharpe as "the man who figured out how to price portfolios via the capital-asset-pricing model, and how to measure risk via the 'reward to variability ratio', or what has come to be known as the Sharpe ratio". We use the CAPM in all of of our DCF valuation cases in class. Now Mr. Sharpe is turning his attention to ... retirement planning (*).
(*) Barry Ritholz: "Tackling the Nastiest, Hardest Problem in Finance", Bloomberg, June 5, 2017.
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[3] Infinite cash-flows. Last week in Security Analysis BSF313 I stayed a few minutes after class with a student to show that our calculations were OK (it was an old case from Prof. Damodaran on Procter & Gamble with the two-stage growth Dividend Discount Model). In the end, we agreed on the valuation. By throwing cash-flows for a ridiculously long number of years —something that Excel allows you to do in a matter of seconds— you can check your calculations. This is very useful when discount rates change, and when there are doubts about the discount rate that applies to the Terminal Value (TV) and to the PV of the TV. Remember to use discount factors when discount rates change!
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[4] Amazon'stock price. And Amazon [NYSE: AMZN] hits $1,000. Chapeau! Warren Buffett recently acknowleged what a miss it had been. But he added that it was too late to buy the stock now. Analysts, though, remain quite bullish:
Analysts on Wall Street are overwhelmingly bullish — only one brokerage has a hold and none have "sells", according to Bloomberg terminal data, and some of the most optimistic see shares hitting $1,250 in the next 12 months. Few want to miss out on one of the Internet's biggest stock runs. Amazon shares are up 38% from a year ago and 14 times more valuable than they were a decade ago (*).
I am currently reading Prof. Damodaran's latest book Narrative and Numbers. The Value of Stories in Business, which contains his most recent valuation of Amazon. I plan to review it here. Spoiler: even his most favorable scenario yields a value per share that is well below current prices.
(*) Elisabeth Weise: "Amazon stock hits $1,000. What will keep it from $2,000?", USA Today, 30 May 2017.
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Thursday, June 1, 2017
JPM & THE YIELD CURVE
AM | @agumack
At the start of last semester's course on Bank & Treasury Management (BSF222), I told students that I would gladly buy them (individually!) a cup of coffee at Via Café if, by the end of the course, the stock price of JP Morgan [NYSE: JPM] was higher (lower) and the yield curve flatter (steeper) compared to the levels seen the first day of class. I should have been more prudent, as I was caught off-guard by the initial euphoria on bank stocks after November 4. Yes, the yield curve became steeper —which justified higher valuations— but other factors were contributing to the surge in the stock, such as the expectation of lighter regulation ahead, a possible end to the annual stress-tests, and even a rumored withdrawal from the BIS and its pesky capital adequacy rules.
The yield curve, as measured by the yield difference between 10- and 2-year notes, peaked at 1.31% in mid-December, sharply up from its pre-election level of 0.99%. It then began to flatten, surely but slowly, as the Fed thightened while inflation expectations were being kept in check. JPM, however, continued to surge, closing at $93.30 on March 1. By that time, I would surely lose my bet —as I did in the end. (No student, however, has claimed his/her right to a cup of coffee). But see how things have changed in just a couple of weeks! With the yield curve down again (now at 92 bps), JPM closed yesterday at $82.15, a 12.6% decline from its intraday high of $93.98.
An investor could make a living by trading the stock of JPMorgan off the changes in the shape of the yield curve. The sheer size of its balance (north of $2.5 trillion) makes it naturally sensitive to changes in interest rates. Could we build a model for that?
____________________
At the start of last semester's course on Bank & Treasury Management (BSF222), I told students that I would gladly buy them (individually!) a cup of coffee at Via Café if, by the end of the course, the stock price of JP Morgan [NYSE: JPM] was higher (lower) and the yield curve flatter (steeper) compared to the levels seen the first day of class. I should have been more prudent, as I was caught off-guard by the initial euphoria on bank stocks after November 4. Yes, the yield curve became steeper —which justified higher valuations— but other factors were contributing to the surge in the stock, such as the expectation of lighter regulation ahead, a possible end to the annual stress-tests, and even a rumored withdrawal from the BIS and its pesky capital adequacy rules.
* * *
The yield curve, as measured by the yield difference between 10- and 2-year notes, peaked at 1.31% in mid-December, sharply up from its pre-election level of 0.99%. It then began to flatten, surely but slowly, as the Fed thightened while inflation expectations were being kept in check. JPM, however, continued to surge, closing at $93.30 on March 1. By that time, I would surely lose my bet —as I did in the end. (No student, however, has claimed his/her right to a cup of coffee). But see how things have changed in just a couple of weeks! With the yield curve down again (now at 92 bps), JPM closed yesterday at $82.15, a 12.6% decline from its intraday high of $93.98.
An investor could make a living by trading the stock of JPMorgan off the changes in the shape of the yield curve. The sheer size of its balance (north of $2.5 trillion) makes it naturally sensitive to changes in interest rates. Could we build a model for that?
____________________
Tuesday, May 30, 2017
QUICK VALUATION NEWS
AM | @agumack
[1] Value of private companies hits $490bn. With Uber valued at $68bn and Airbnb at $30bn, the value of late-stage private companies in the US and Europe has soared above $490bn, according to an index created by Scenic Advisement, a San Francisco boutique investment bank (*).
(*) Leslie Hook: "Value of private companies hits high of $490bn as tech start-ups shun markets", Financial Times, 29 May 2017.
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[2] Zalando's business model. Zalando, Europe' biggest online fashion retailer, "is looking to transform itself from an online store into a digital platform where brands can transact directly with customers. Zalando then charges a commission on each purchase" (*). Two comments: (1) clearly, the company is changing its narrative, as Amazon Fashion lurks in the background; (2) I suspect that PE ratios for a 'digital platform' company are considerably higher than for online stores.
(*) Guy Chazan: "Zalando fashions a response to Amazon threat", Financial Times, 29 May 2017.
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[3] EM currencies and the carry trade. Some see danger ahead for those involved in the carry trade (buying high-yielding EM currencies with cheap EUR and USD funding). Harvard economist Jeffrey Frankel once likened carry trading to "picking up pennies in front of a steam roller" (*).
(*) Natasha Doff: "History says Emerging Markets carry trade can only end in tears", Bloomberg, 30 May 2017.
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[4] Equity Risk Premium. This is quite a story. In a letter published by the Financial Times, a Chicago-based portfolio manager argues that the decline in the Equity Risk Premium is mostly driven by a confusion: "The widespread adoption of passive investment in equities due to lower costs has increased the valuation of stocks because the investing public has confused low cost with low risk, thus decreasing the equity risk premium demanded by investors and driving up share prices".
(*) Daniel Mauro: "After correction comes the pain for low-cost investors", Financial Times, 2 May 2017. See also Prof. Damodaran' ERP calculations.
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[1] Value of private companies hits $490bn. With Uber valued at $68bn and Airbnb at $30bn, the value of late-stage private companies in the US and Europe has soared above $490bn, according to an index created by Scenic Advisement, a San Francisco boutique investment bank (*).
(*) Leslie Hook: "Value of private companies hits high of $490bn as tech start-ups shun markets", Financial Times, 29 May 2017.
__________
[2] Zalando's business model. Zalando, Europe' biggest online fashion retailer, "is looking to transform itself from an online store into a digital platform where brands can transact directly with customers. Zalando then charges a commission on each purchase" (*). Two comments: (1) clearly, the company is changing its narrative, as Amazon Fashion lurks in the background; (2) I suspect that PE ratios for a 'digital platform' company are considerably higher than for online stores.
(*) Guy Chazan: "Zalando fashions a response to Amazon threat", Financial Times, 29 May 2017.
__________
[3] EM currencies and the carry trade. Some see danger ahead for those involved in the carry trade (buying high-yielding EM currencies with cheap EUR and USD funding). Harvard economist Jeffrey Frankel once likened carry trading to "picking up pennies in front of a steam roller" (*).
(*) Natasha Doff: "History says Emerging Markets carry trade can only end in tears", Bloomberg, 30 May 2017.
__________
[4] Equity Risk Premium. This is quite a story. In a letter published by the Financial Times, a Chicago-based portfolio manager argues that the decline in the Equity Risk Premium is mostly driven by a confusion: "The widespread adoption of passive investment in equities due to lower costs has increased the valuation of stocks because the investing public has confused low cost with low risk, thus decreasing the equity risk premium demanded by investors and driving up share prices".
(*) Daniel Mauro: "After correction comes the pain for low-cost investors", Financial Times, 2 May 2017. See also Prof. Damodaran' ERP calculations.
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Friday, March 31, 2017
POLITICAL RISK ANALYSIS IS BOOMING!
AM | @agumack"... political risk analysis is booming" — Huw van Steen
Political risk is back! That's great news for those of us who find the issue relevant—especially when it comes to cost of capital calculations. In early 2015 I took part in a symposium at Institut des Sciences de l'Homme in Lyon about the great Italian economist/thinker Ferdinando Galiani (1717-1787), who in his book Della Moneta (1751) established an explicit link between the supply of credit and the quality of governance [see]. I have also constructed an 'Index of Checks and Balances' [see], which I compared to each country's stock of local currency bonds in terms of GDP.
Unsurprisingly, the cost of capital tends to be lower in well-run countries (the Nordics in particular). Now one member of the EU Business School Finance Club will write a thesis about these issues. Great news!
* * *
Motivated by recent political events, the Financial Times has been publishing some interesting articles on political risk. I will single out Huw van Steen's March 15 piece and Gillian Tetts' take on Bridgewater Associates' analysis of populism (*). You may also want to watch this video by the FT. (Gillian is back with a fresh piece on political risk in Silicon Valley). Do you have ideas/suggestions for a political/country risk index? Can we harness the diversity of our student base to get a sense of perceptions of political risk in Kazakhstan, Colombia and ... the United States?
(*) Huw van Steen: "An emerging market toolkit is now essential for investors in the West", Financial Times, 15 March 2017; Gillian Tett: "Populism emerges as a key economic influence", Financial Times, 23 March 2017.
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Thursday, March 9, 2017
MORE STORIES ON QUANTS
AM | @agumack
"... backward looking data can fizzle out" — Robin Wigglesworth
There are three very interesting stories on quants in today's FT (make it four if you count John Authers' piece on smart beta). Robin Wigglesworth —who writes more persuasively on quants than on markets and interest rates— mentions a Two Sigma competition in which contestants are given three months to code a trading algorithm based on four gigabytes of financial data. The winner will pocket $100,000 (*). His 'Big Read' piece is also pretty interesting, as he mentions the 2007 débâcle of Goldman Sachs' Quantitative Investment Strategies. The sector has since then recovered, and assets under management for quantitatively-oriented hedge funds are approaching the $1 trillion mark. (Don't miss the short section on GS' alternative risk premia unit).
* * *
Can we possibly use some of this material in class? Yesterday in the Financial Markets exam I had students estimate two entry points using 20-day and 50-day moving averages. Shortly I'll be testing some (extremely simplified) exercises with 'Natural language processing'. We could take speeches from the Fed chair, or a sample of research reports. Here's Dennis Walsh of Goldman Sachs:
Goldman's algorithms can systematically look for verbal clues from analysts on a call that might indicate whether they were pleasantly or unpleasantly surprised at the results—and therefore upgrade their outlook in response. "There's a tendency towards praise to keep in management's good books, but only marginally. If 20 out of 30 analysts say 'great quarter' then it probably was".
(*) Robin Wigglesworth: "Lessons from the quant quake" and "Funds adopt novel methods to hunt down new talent"; John Gapper: "Technology outsmarts the human investor". See also John Authers: "Popular 'smart beta' strategies reveal their true value in trial". All from the March 9 issue of the Financial Times.
_______________
"... backward looking data can fizzle out" — Robin Wigglesworth
There are three very interesting stories on quants in today's FT (make it four if you count John Authers' piece on smart beta). Robin Wigglesworth —who writes more persuasively on quants than on markets and interest rates— mentions a Two Sigma competition in which contestants are given three months to code a trading algorithm based on four gigabytes of financial data. The winner will pocket $100,000 (*). His 'Big Read' piece is also pretty interesting, as he mentions the 2007 débâcle of Goldman Sachs' Quantitative Investment Strategies. The sector has since then recovered, and assets under management for quantitatively-oriented hedge funds are approaching the $1 trillion mark. (Don't miss the short section on GS' alternative risk premia unit).
* * *
Can we possibly use some of this material in class? Yesterday in the Financial Markets exam I had students estimate two entry points using 20-day and 50-day moving averages. Shortly I'll be testing some (extremely simplified) exercises with 'Natural language processing'. We could take speeches from the Fed chair, or a sample of research reports. Here's Dennis Walsh of Goldman Sachs:
Goldman's algorithms can systematically look for verbal clues from analysts on a call that might indicate whether they were pleasantly or unpleasantly surprised at the results—and therefore upgrade their outlook in response. "There's a tendency towards praise to keep in management's good books, but only marginally. If 20 out of 30 analysts say 'great quarter' then it probably was".
(*) Robin Wigglesworth: "Lessons from the quant quake" and "Funds adopt novel methods to hunt down new talent"; John Gapper: "Technology outsmarts the human investor". See also John Authers: "Popular 'smart beta' strategies reveal their true value in trial". All from the March 9 issue of the Financial Times.
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Tuesday, March 7, 2017
THE OUTSIDER
AM | @agumack
"Des volumes de cette importance ne passent pas inaperçus" — François-Xavier Demaison
I watched L'Outsider over the week-end. This is the movie about Société Générale trader Jérôme Kerviel, whose bets on the Euro Stoxx 50 (traded on Eurex), Xetra DAX (traded on Eurex) and FTSE 100 (traded on Euronext.liffe) cost €4.9 billion to the bank in January 2008. We discussed this stunning affaire in Ethics in the Financial World. I thouroughly enjoyed the movie. Because Kerviel was well-versed in all things IT, he was able to conceal a sizeable portion of his trades. Who is to blame? Christophe Barratier, the film director, skillfully leaves that question open (*).
Not long before the implosion of Kerviel's trades, in October 2007, Eurex complained to Société Générale that Kerviel's positions amounted to 30% of open interest in DAX futures. In the movie, members of the trading desk refer to futures positions as Spiel. There was obviously a massive failure of compliance—although the bank had a strong reputation in that regard. What also transpires is a world totally dominated by ... men. Apart from Kerviel's lover, his mother and a strong-minded compliance official who shows up towards the end, women play no role in the movie. And this was precisely part of the problem.
Too much testosterone in the (trading) room!
(*) "Kerviel n’aurait jamais dû être trader", L'AGEFI, 22 June 2016
_________________
"Des volumes de cette importance ne passent pas inaperçus" — François-Xavier Demaison
I watched L'Outsider over the week-end. This is the movie about Société Générale trader Jérôme Kerviel, whose bets on the Euro Stoxx 50 (traded on Eurex), Xetra DAX (traded on Eurex) and FTSE 100 (traded on Euronext.liffe) cost €4.9 billion to the bank in January 2008. We discussed this stunning affaire in Ethics in the Financial World. I thouroughly enjoyed the movie. Because Kerviel was well-versed in all things IT, he was able to conceal a sizeable portion of his trades. Who is to blame? Christophe Barratier, the film director, skillfully leaves that question open (*).
Not long before the implosion of Kerviel's trades, in October 2007, Eurex complained to Société Générale that Kerviel's positions amounted to 30% of open interest in DAX futures. In the movie, members of the trading desk refer to futures positions as Spiel. There was obviously a massive failure of compliance—although the bank had a strong reputation in that regard. What also transpires is a world totally dominated by ... men. Apart from Kerviel's lover, his mother and a strong-minded compliance official who shows up towards the end, women play no role in the movie. And this was precisely part of the problem.
Too much testosterone in the (trading) room!
(*) "Kerviel n’aurait jamais dû être trader", L'AGEFI, 22 June 2016
_________________
Friday, February 17, 2017
DAMODARAN WATCH: THE KIM KARDASHIAN OF VALUATION
AM | @agumack
Students know that I am a fan of Professor Aswath Domadaran. In class, I call him "The Lionel Messi of Finance". But it turns out that he calls himself "The Kim Kardashian of Valuation"! That's because, as he tells Barry Ritholz in the podcast below, he "shows everything". This is of course a reference to the tonnes of material that he publishes online. You can see some of the relevant links to the right. Anyway, here are some recent ideas from the man himself. Enjoy!
[1] Apple valuation. Prof. Damodaran calls Apple [Nasdaq: AAPL] the "Greatest Cash Machine in History" [see his detailed post]. (I remember that we used to say the same thing about Google a few years ago). In his Free Cash Flow to the Firm (FCFF) valuation, he arrives at a value per share of $129.02. As the market closed yesterday at $135.35, the shares are "fullly valued", although he will wait for a price of $140 before selling his position. Well done! In class at EU Business School, I use Apple as an example of how a company can successfully 'declare war on its WACC'. The Cupertino giant does that by outsourcing its production (lower beta), by turning the iPhone into a non-discretionary good (lower beta), by gently increasing its debt ratio, and by aggressively using interest rate and foreign currency swaps (lower cost of debt).
[2] Podcast. Listen to this Barry Ritholz podcast with Professor Damodaran; he calls himself "The Kim Kardashian of Valuation". And he discusses lots of topics about finance, valuation, active vs. passive asset management, etc.
[3] Equity Risk Premium. On his Twitter account, Prof. Damodaran publishes his monthly estimation of the Equity Risk Premium. Instead of relying on historical data, he estimates the expected return on the S&P500 index by projecting cash flows in a two-stage growth version with a Terminal Value. We might take a look at that method this summer in Corporate Finance at EU Business School. The latest estimate: 5.59%.
______________
Students know that I am a fan of Professor Aswath Domadaran. In class, I call him "The Lionel Messi of Finance". But it turns out that he calls himself "The Kim Kardashian of Valuation"! That's because, as he tells Barry Ritholz in the podcast below, he "shows everything". This is of course a reference to the tonnes of material that he publishes online. You can see some of the relevant links to the right. Anyway, here are some recent ideas from the man himself. Enjoy!
[1] Apple valuation. Prof. Damodaran calls Apple [Nasdaq: AAPL] the "Greatest Cash Machine in History" [see his detailed post]. (I remember that we used to say the same thing about Google a few years ago). In his Free Cash Flow to the Firm (FCFF) valuation, he arrives at a value per share of $129.02. As the market closed yesterday at $135.35, the shares are "fullly valued", although he will wait for a price of $140 before selling his position. Well done! In class at EU Business School, I use Apple as an example of how a company can successfully 'declare war on its WACC'. The Cupertino giant does that by outsourcing its production (lower beta), by turning the iPhone into a non-discretionary good (lower beta), by gently increasing its debt ratio, and by aggressively using interest rate and foreign currency swaps (lower cost of debt).
[2] Podcast. Listen to this Barry Ritholz podcast with Professor Damodaran; he calls himself "The Kim Kardashian of Valuation". And he discusses lots of topics about finance, valuation, active vs. passive asset management, etc.
[3] Equity Risk Premium. On his Twitter account, Prof. Damodaran publishes his monthly estimation of the Equity Risk Premium. Instead of relying on historical data, he estimates the expected return on the S&P500 index by projecting cash flows in a two-stage growth version with a Terminal Value. We might take a look at that method this summer in Corporate Finance at EU Business School. The latest estimate: 5.59%.
______________
Sunday, February 12, 2017
FIRST MEETING OF THE EU BUSINESS SCHOOL'S FINANCE CLUB
AM | @agumack
We finally had the first meeting of the EU Business School Finance Club. Congratulations to Luka! Let us remember the date: February 7, 2017. It's all about persevering! We discussed a number of ideas about ... what to do at the Club. The truth is that we still don't know in what direction we are going to take it. We discussed some proposals about running investment portfolios. Nikita showed us how a Swedish bank was sponsoring a portfolio contest at a Latvian university—with both long-term and short-term investments. The winners get real money. Interesting idea! Another participant suggested inviting guests to discuss big data and the use of algorithms in the context of asset management. That would be really useful.
I briefly discussed my views on what to do at the Club. I am a rather bookish person, so book reviews will always be part of my suggestions. I could review Ruchir Sharma's The Rise and Fall of Nations. Forces of Change in the Post-Crisis World (New York: W.W. Norton, 2016); I already mentioned the chapter about "Good Billionaires, Bad Billionaires" in the course on Ethics in the Financial World. And Prof. Damodaran's book is high on my agenda too (we have already ordered it at EU Business School).
At the next meeting I plan to introduce three 'products':
1. The EU Business School Finance Club's Financial Conditions Index. It combines a number of credit market indicators (spread Treasuries/speculative grade bonds, the US yield curve, the iTraxxEurope Crossover CDS index and the iTraxxBRIC CDS index), a few exchanges rates to the USD, and some commodity prices. It is already up and running, so I'll post shortly about it.
2. The EU Business School Finance Club's Global Dollar Liquidity Indicator. It comprises the stock of foreign central banks' holdings of US Treasury bonds under custody of the US Federal Reserve, and the Fed's own 'Fed credit' item on the asset side of the central bank's balance sheet. See our first post.
3. The EU Business School Finance Club's Country Risk Index. It combines a series of governance measures —judicial independence, freedom of the press, network readiness and central bank independence— that indicate the strength of political checks and balances in each country. I trust that the diversity of our student base will help us to improve the index over time.
Finally, I provided some views on the extraordinary challenges faced by active asset managers. On the one hand, the Vanguard juggernaut continues unabated. On the other hand, quants appear to be the only salvation for active asset managers. But where does that leave traditional discounted cash flow valuation? Questions, more questions.
_________________
We finally had the first meeting of the EU Business School Finance Club. Congratulations to Luka! Let us remember the date: February 7, 2017. It's all about persevering! We discussed a number of ideas about ... what to do at the Club. The truth is that we still don't know in what direction we are going to take it. We discussed some proposals about running investment portfolios. Nikita showed us how a Swedish bank was sponsoring a portfolio contest at a Latvian university—with both long-term and short-term investments. The winners get real money. Interesting idea! Another participant suggested inviting guests to discuss big data and the use of algorithms in the context of asset management. That would be really useful.
* * *
I briefly discussed my views on what to do at the Club. I am a rather bookish person, so book reviews will always be part of my suggestions. I could review Ruchir Sharma's The Rise and Fall of Nations. Forces of Change in the Post-Crisis World (New York: W.W. Norton, 2016); I already mentioned the chapter about "Good Billionaires, Bad Billionaires" in the course on Ethics in the Financial World. And Prof. Damodaran's book is high on my agenda too (we have already ordered it at EU Business School).
At the next meeting I plan to introduce three 'products':
1. The EU Business School Finance Club's Financial Conditions Index. It combines a number of credit market indicators (spread Treasuries/speculative grade bonds, the US yield curve, the iTraxxEurope Crossover CDS index and the iTraxxBRIC CDS index), a few exchanges rates to the USD, and some commodity prices. It is already up and running, so I'll post shortly about it.
2. The EU Business School Finance Club's Global Dollar Liquidity Indicator. It comprises the stock of foreign central banks' holdings of US Treasury bonds under custody of the US Federal Reserve, and the Fed's own 'Fed credit' item on the asset side of the central bank's balance sheet. See our first post.
3. The EU Business School Finance Club's Country Risk Index. It combines a series of governance measures —judicial independence, freedom of the press, network readiness and central bank independence— that indicate the strength of political checks and balances in each country. I trust that the diversity of our student base will help us to improve the index over time.
Finally, I provided some views on the extraordinary challenges faced by active asset managers. On the one hand, the Vanguard juggernaut continues unabated. On the other hand, quants appear to be the only salvation for active asset managers. But where does that leave traditional discounted cash flow valuation? Questions, more questions.
Friday, February 10, 2017
THE $50BN MALE GROOMING MARKET AND THE DETERMINANTS OF BETA
AM | @agumack
What a great story when you need to teach about beta and the CAPM! Lindsay Whipp reports on the ups and downs of the $50bn market for male grooming [1]. What caught my attention was the following paragraph:
The slowdown in growth for male grooming products is partly explained by lacklustre economic growth, analysts say. Unlike women, who count beauty products as essential items, for many men, particularly those with families, male grooming items —with the exception of razors— more easily drop off the shopping list when money gets tight. Brazil, a top male grooming products market, had been a particularly bright spot, having enjoyed a 16 per cent CAGR increase in the five years to 2015. But as the nation’s economy struggles in a deep recession, growth in 2016 is estimated at 4.6 per cent to $6.79bn.
Remember Prof. Damodaran's 'determinants of beta': "... the degree to which a product's purchase is discretionary should affect the beta of the firm manufacturing the product. Thus, the betas of discount retailers such as Wal-Mart, should be lower than the betas of high-end specialty retailers, such as Tiffany's, because consumers can defer the purchase of the latter's products during bad economic times" [2].
[1] Lindsay Whipp: "Made-up men reflect changing face of male grooming", Financial Times, 6 February 2017.
[2] Aswath Damodaran. Applied Corporate Finance, Fourth Edition. John Wiley & Sons, 2017, p. 117.
________________
What a great story when you need to teach about beta and the CAPM! Lindsay Whipp reports on the ups and downs of the $50bn market for male grooming [1]. What caught my attention was the following paragraph:
The slowdown in growth for male grooming products is partly explained by lacklustre economic growth, analysts say. Unlike women, who count beauty products as essential items, for many men, particularly those with families, male grooming items —with the exception of razors— more easily drop off the shopping list when money gets tight. Brazil, a top male grooming products market, had been a particularly bright spot, having enjoyed a 16 per cent CAGR increase in the five years to 2015. But as the nation’s economy struggles in a deep recession, growth in 2016 is estimated at 4.6 per cent to $6.79bn.
Remember Prof. Damodaran's 'determinants of beta': "... the degree to which a product's purchase is discretionary should affect the beta of the firm manufacturing the product. Thus, the betas of discount retailers such as Wal-Mart, should be lower than the betas of high-end specialty retailers, such as Tiffany's, because consumers can defer the purchase of the latter's products during bad economic times" [2].
[1] Lindsay Whipp: "Made-up men reflect changing face of male grooming", Financial Times, 6 February 2017.
[2] Aswath Damodaran. Applied Corporate Finance, Fourth Edition. John Wiley & Sons, 2017, p. 117.
________________
EU BUSINESS SCHOOL FINANCE CLUB'S WEEKLY GLOBAL DOLLAR LIQUIDITY MEASURE
AM | @agumack
The U.S. Federal Reserve released yesterday its weekly H.4.1 report on monetary aggregates. At the EU Business School Finance Club, we look at the key off-balance sheet item: the stock of U.S. Treasury securities belonging to other central banks, but held in custody at the Fed. Adding back domestic 'Fed credit', we obtain the EU Business School Finance Club Weekly Global Dollar Liquidity measure, now at $7.58 trillion:
Custody holdings recovered by almost $9bn over the week. However, the post-election rally has stalled, courtesy (perhaps) of continued capital flight from China. At this point, we remain skeptical about any significant recovery in world GDP growth.
_____________
The U.S. Federal Reserve released yesterday its weekly H.4.1 report on monetary aggregates. At the EU Business School Finance Club, we look at the key off-balance sheet item: the stock of U.S. Treasury securities belonging to other central banks, but held in custody at the Fed. Adding back domestic 'Fed credit', we obtain the EU Business School Finance Club Weekly Global Dollar Liquidity measure, now at $7.58 trillion:
| USD million | ||
| Custody holdings | $3,166,181 | -2.82% |
| Fed credit | $4,417,599 | -0.61% |
| Global Liquidity | $7,583,780 | -1.54% |
Custody holdings recovered by almost $9bn over the week. However, the post-election rally has stalled, courtesy (perhaps) of continued capital flight from China. At this point, we remain skeptical about any significant recovery in world GDP growth.
Thursday, January 12, 2017
A NEW BOOK BY PROFESSOR DAMODARAN
AM | @agumack Exciting news! Professor Aswath Damodaran is out with a new book! Narrative and Numbers. The Value of Stories in Business has just been published by the Columbia Business School. As he explains in this post from his blog and on this presentation, he develops the valuation of four companies: Uber, Amazon, Alibaba and Ferrari. He is as interested about the story —as it is conveyed by companies themselves— as he is about the raw numbers. Here's Prof. Damodaran on his choices:
1. Uber, the ride-sharing phenomenon: I start with the story that I told about Uber in June 2014, and the resulting value, and how that story evolved over the next 15 months as I learned more about the company and its market/competition changed.
2. Amazon, the Field of Dreams Company: Amazon is a story stock that seems to defy the numbers laws and I use it to illustrate how the value for Amazon can vary as a function of the story you tell about it.
3. Alibaba, the China story: The China big market story has been used to justify the valuations of many companies, but Alibaba is one case where the use of that story is actually merited. In my story, Alibaba continues to dominate the growing Chinese online retail market and my value reflects that, but I also look at how that value will change if Alibaba can replicate its success globally (Alibaba, the Global Story).
4. Ferrari, the Exclusive Club: I value Ferrari as an exclusive club, leading into its IPO, and explore how that value will change if you assume that it will follow a different business model.
Reading Prof. Damodaran's book could be a very interesting undertaking for the Finance Club. Because Uber is still not a public company, I am pretty sure that the analysis will include 'bottom-up' beta calculations for the cost of equity. The Amazon story looks particularly interesting from a narrative point of view, as CEO Jeff Bezos has been incredibly spot-on. Alibaba would take us to the Chinese market (and the cost of capital calculations in the Chinese currency) while Ferrari is in a league of its own.
________________
THE ST. LOUIS FED FINANCIAL STRESS INDEX
AM | @agumack
Economists at the Federal Reserve Bank of St. Louis have developed a 'Financial Stress Index' designed to track signs of distress in financial markets. This is just one among many so-called financial conditions indexes (see the list of components here).
The STLFSI measures the degree of financial stress in the markets and is
constructed from 18 weekly data series: seven interest rate series, six
yield spreads and five other indicators. Each of these variables
captures some aspect of financial stress. Accordingly, as the level of
financial stress in the economy changes, the data series are likely to
move together.
We can build our own 'Financial Conditions Index' at the Finance Club. I would take some of the elements of the St. Louis Fed index, but I would give more weight to credit spreads—as opposed to the S&P500. In other words: it would look more like a credit/money market type of index. The idea is to track its behavior against stocks. I would include an FX component too, perhaps one the Fed's own dollar indexes. This is especially relevant in light of the interpretation of Germany's very low interest rates as a hedge against a eurozone breakup (*).
Also, I would include fixed-income ETFs, as we know that some investors are taking advantage of the liquidity in these instruments to hedge their positions, thereby reducing their reliance on the CDS market (which is more subject to regulations).
(*) Miles Johnson: "German bonds offer the best way to bet on a break-up of the euro", Financial Times, 10 January 2017.
___________________
Sunday, October 23, 2016
READINGS ...
AM | @agumack
"We're not making any idea that pops into his head" — Marcus Lemonis
. Fintech & securitization. Two interesting pieces on the role that Fintech could play in terms of securitizing loans to small businesses. "The idea of securitising loans to small and medium enterprises (SMEs), many of which are heavily reliant on bank lending in Europe, is particularly appealing ... [The] new risks have to be weighed against the desperate need for credit in Europe" (*).
(*) Thomas Haile: "Does securitisation of online loans have a future in Europe?", Financial Times, 10 May 2016 and "Funding circle to tap securitisation market", Financial Times, 14 april 2016.
________________
. Inventory management at micro-caps. On CNBC.com, Marcus Lemonis gives some priceless advice on managing inventories at small businesses. "If you can't track what's selling or not selling, [then] you can't do any forecasting to build inventory. You can't even monitor trends or customer behavior. You have no shot at success" (*).
(*) Zack Guzman: "The Profit' star Marcus Lemonis: Making these inventory mistakes could be disastrous", CNBC.com, 1 September 2016.
_______________
. Bloomberg & Brexit. Well done Bloomberg! There is now a Bloomberg Twitter account that provides "Full coverage of Britain’s exit from the EU, by @business teams in London, Brussels and around the continent" (*). Very usefull indeed!
(*) @Brexit
________________
. Chouinard on Venture capitalists. "Venture capitalists are such assholes", says Yvon Chouinard, the founder of Patagonia, as he briefly discusses the case of Diamond Equipment in a captivating piece by Nick Paugartner for The New Yorker (*). By the way, Prof. Damodaran has two recent pieces on VCs: a blog post under the title "Venture capitalists don’t value companies, they price them" [see], and a VIDEO [see].
(*) Nick Paumgartner: "Patagonia's philospher-king", The New Yorker, September 19, 2016.
________________
. Paul Krugman: Brexit and the Pound. Paul Krugman on the weakness of the pound: "We face the prospect of seriously increased transaction costs between Britain and the rest of Europe, which creates an incentive to move those services away from the smaller economy (Britain) and into the larger (Europe). Britain therefore needs a weaker currency to offset this adverse impact" (*).
(*) Paul Krugman: "Notes on Brexit and the Pound", The Conscience of a Liberal, October 11, 2016.
_______________
. Vladimir Putin. The Economist is out with a special report on what it calls "Putinism". The gist: "Institutions that would underpin a prosperous Russia, such as the rule of law, free media, democracy and open competition, pose an existential threat to Mr Putin’s rotten state." I think I'm going to buy this one (*).
(*) "The threat from Russia", The Economist, 22 October 2016.
________________
"We're not making any idea that pops into his head" — Marcus Lemonis
. Fintech & securitization. Two interesting pieces on the role that Fintech could play in terms of securitizing loans to small businesses. "The idea of securitising loans to small and medium enterprises (SMEs), many of which are heavily reliant on bank lending in Europe, is particularly appealing ... [The] new risks have to be weighed against the desperate need for credit in Europe" (*).
(*) Thomas Haile: "Does securitisation of online loans have a future in Europe?", Financial Times, 10 May 2016 and "Funding circle to tap securitisation market", Financial Times, 14 april 2016.
________________
. Inventory management at micro-caps. On CNBC.com, Marcus Lemonis gives some priceless advice on managing inventories at small businesses. "If you can't track what's selling or not selling, [then] you can't do any forecasting to build inventory. You can't even monitor trends or customer behavior. You have no shot at success" (*).
(*) Zack Guzman: "The Profit' star Marcus Lemonis: Making these inventory mistakes could be disastrous", CNBC.com, 1 September 2016.
_______________
. Bloomberg & Brexit. Well done Bloomberg! There is now a Bloomberg Twitter account that provides "Full coverage of Britain’s exit from the EU, by @business teams in London, Brussels and around the continent" (*). Very usefull indeed!
(*) @Brexit
________________
. Chouinard on Venture capitalists. "Venture capitalists are such assholes", says Yvon Chouinard, the founder of Patagonia, as he briefly discusses the case of Diamond Equipment in a captivating piece by Nick Paugartner for The New Yorker (*). By the way, Prof. Damodaran has two recent pieces on VCs: a blog post under the title "Venture capitalists don’t value companies, they price them" [see], and a VIDEO [see].
(*) Nick Paumgartner: "Patagonia's philospher-king", The New Yorker, September 19, 2016.
________________
. Paul Krugman: Brexit and the Pound. Paul Krugman on the weakness of the pound: "We face the prospect of seriously increased transaction costs between Britain and the rest of Europe, which creates an incentive to move those services away from the smaller economy (Britain) and into the larger (Europe). Britain therefore needs a weaker currency to offset this adverse impact" (*).
(*) Paul Krugman: "Notes on Brexit and the Pound", The Conscience of a Liberal, October 11, 2016.
_______________
. Vladimir Putin. The Economist is out with a special report on what it calls "Putinism". The gist: "Institutions that would underpin a prosperous Russia, such as the rule of law, free media, democracy and open competition, pose an existential threat to Mr Putin’s rotten state." I think I'm going to buy this one (*).
(*) "The threat from Russia", The Economist, 22 October 2016.
________________
Monday, October 17, 2016
UPDATING SOME VERY IMPORTANT DATA ...
AM | @agumack When governments and companies are able to sell bonds in their own currencies, it means that the quality of governance is improving. You can have enormous amounts of local-currency debt, but the source might be state-onwed banks (like in China). Alternatively, governments and companies can issue large amounts of bonds ... in US dollars (or euros). That is why I take the ability to issue local-currency bonds as the litmus test of the quality of governance. I want to thank Prof. John D. Burger at the Sellinger School of Business (Loyola University Maryland) for sending me the revised calculations of the stock of local currency bonds in terms of GDP for a number of countries [1]. The new calculations update the data from one of my favorite articles, published in 2006 [2].
* * *
Speaking of local-currency bonds, there are some interesting news coming from Argentina: the government has just issued a 10-year bond in pesos. While the yield looks pretty high (15.5%), it shows the impact of renewed confidence in the ability of the Argentinean central bank to deal with the country's perennial inflation problem [3].
[1] John D. Burger, Rajeswari Sengupta, Francis E. Warnock, Vernica Cacdac Warnok: "Us Investment in Global Bonds: As the Fed Pushes, Some EMEs Pull", Economic Policy, October 2015.
[2] John D. Burger & Francis E. Warnock: “Local Currency Bond Markets”, IMF Staff Papers, Vol. 53, 2006. This is one of the most striking findings from the paper: "To gauge the importance of various factors, our estimates in column 1 of Table 3 imply that (other things being equal) if Brazil had Denmark’s rule of law, its bond market as a share of GDP would be 43 percentage points higher"
[3] Nicolás Dujovne: "Menos inflación y crédito más barato, claves del porvenir", La Nación, 17 October 2016.
_____________________
Thursday, September 29, 2016
WELLS FARGO: THE ETHICS ANGLE
AM | @agumack
The (ongoing) Wells Fargo story is just a gold mine from the perspective of a course on Ethics in the Financial World, which I will be teaching in the Fall Semester. I using this post to collect the necessary information. Ideas for debate and conclusions will follow in futher posts.
- General information. A timeline of the Wells Fargo scandal [see].
. On September 8, 2016, the alleged misconduct was revealed when the Consumer Financial Protection Bureau (CFPB), the Los Angeles City Attorney and the Office of the Comptroller of the Currency (OCC) fined the bank $185 million, alleging that more than 2 million bank accounts or credit cards were opened or applied for without customers' knowledge or permission between May 2011 and July 201 [see].
. "In his testimony, Mr. Stumpf gave details about steps the bank has taken to address the problems and to regain customers’ trust. He said that starting in 2013, the bank analyzed questionable behavior related to account openings at its branches and strengthened internal oversight to fix the problems uncovered. The company had already said, following the announcement of the enforcement action, that it was eliminating sales goals for retail bankers for all products. “We should have done more sooner to eliminate unethical conduct and unintended incentives for that conduct to occur,” Mr. Stumpf said. (20 September 2016)" [see; includes VIDEO].
- Reputational risk. Compare the amount of the fines imposed to the loss in market capitalization.
. Bigcharts price quote [see]. Ticker symbol: WFC. Number of shares outstanding: 5.046 billion [see]
- Cost of capital/cost of funding. Credit rating agencies have reacted to the news.
. "Moody's did not signal it would review Wells Fargo's current rating, but said it expects "some immediate damage to Wells Fargo's reputation from this embarrassing episode." However, the Moody's note said Wells Fargo will eventually have a "more durable sales and marketing model" due to expected changes to its sales practices and incentive structures" [see]
. Fitch lowers Wells Fargo's credit outlook to negative: "The outlook revision reflects potential damage to the firm’s franchise and earnings profile following recent regulatory actions regarding improper unauthorized account openings, Fitch said Tuesday in a statement. Fitch reaffirmed the San Francisco-based lender’s rating of AA-/F1+. The ratings company said that even as “customer damages appear limited," the scandal could pressure the bank’s earnings. While WFC emerged from the financial crisis in a much better position than similarly sized peers, Fitch believes this issue creates reputational risk given the issue and allegations are understandable to the general public, in a way that misdeeds at other banks are not, Fitch said, using the lender’s stock symbol [see].
- Clawbacks. Executives have agreed to forfeit part of their pay. Note: it's the Board of Directors, led by its independent members,
. "In seeking to defuse the firestorm over its sham accounts, Wells Fargo & Co.’s board turned to an old, but obscure gambit – getting its top leader to pay up. John Stumpf, the bank's chairman and CEO, will forfeit about $41 million of unvested stock awards and forgo his salary while the company investigates its retail banking sales practices. Carrie Tolstedt, Wells Fargo's former head of community banking, also will forgo her unvested equity stock awards, valued at $19 million, and will not receive retirement benefits worth millions more. Neither Tolstedt nor Stumpf will receive 2016 bonuses. Under the leadership of Stumpf and Tolstedt, hundreds of thousands of sham accounts were opened by employees to meet their sales targets, enraging the customers and triggering ongoing federal investigation. And the bank may not be done with "clawing back" -- as the practice is often called -- the executives' pay. “The independent members of the board will take such other actions as they collectively deem appropriate, which may include further compensation actions,” Stephen Sanger, Wells Fargo’s lead independent director, said Tuesday in a statement" [see].
- Corporate governance. Activist investors push for a shake-up at the top.
. "Banking industry scandals and problems have put a focus on the combined chairman and chief executive role in the past. In 2009, when Bank of America’s Ken Lewis was under fire for his handling of the acquisition of Merrill Lynch, investors voted to separate the roles, in effect stripping him of the chairmanship. Jamie Dimon of JPMorgan Chase defeated proposals to strip him of one of the roles in the wake of the “London whale” trading fiasco. Earlier this year, 17 per cent of Wells shareholders backed Mr Armstrong’s proposal for an independent chairman, the highest level of support since 2013. The activist has presented the proposal for an independent chairman each year since 2012" [see]
- Whistleblowers. Did Wells Fargo fire the whistleblowers?
. "CNN Money has found multiple whistleblowers from Wells Fargo who were willing to go on the record and report that they were fired in retaliation for coming forward to report the massive fraud in which Wells Fargo employees opened up 2,000,000 fake accounts in their customers' names, raiding their real accounts to open them, then racking up fees and penalties, and trashing their customers' credit ratings.CNN also spoke to a former Wells Fargo HR manager who explained how the retaliatory firings worked: employees who blew the whistle would be monitored closely for minor infractions (e.g. being two minutes late for work), then fired "with cause."[see]
__________________
The (ongoing) Wells Fargo story is just a gold mine from the perspective of a course on Ethics in the Financial World, which I will be teaching in the Fall Semester. I using this post to collect the necessary information. Ideas for debate and conclusions will follow in futher posts.
- General information. A timeline of the Wells Fargo scandal [see].
. On September 8, 2016, the alleged misconduct was revealed when the Consumer Financial Protection Bureau (CFPB), the Los Angeles City Attorney and the Office of the Comptroller of the Currency (OCC) fined the bank $185 million, alleging that more than 2 million bank accounts or credit cards were opened or applied for without customers' knowledge or permission between May 2011 and July 201 [see].
. "In his testimony, Mr. Stumpf gave details about steps the bank has taken to address the problems and to regain customers’ trust. He said that starting in 2013, the bank analyzed questionable behavior related to account openings at its branches and strengthened internal oversight to fix the problems uncovered. The company had already said, following the announcement of the enforcement action, that it was eliminating sales goals for retail bankers for all products. “We should have done more sooner to eliminate unethical conduct and unintended incentives for that conduct to occur,” Mr. Stumpf said. (20 September 2016)" [see; includes VIDEO].
- Reputational risk. Compare the amount of the fines imposed to the loss in market capitalization.
. Bigcharts price quote [see]. Ticker symbol: WFC. Number of shares outstanding: 5.046 billion [see]
- Cost of capital/cost of funding. Credit rating agencies have reacted to the news.
. "Moody's did not signal it would review Wells Fargo's current rating, but said it expects "some immediate damage to Wells Fargo's reputation from this embarrassing episode." However, the Moody's note said Wells Fargo will eventually have a "more durable sales and marketing model" due to expected changes to its sales practices and incentive structures" [see]
. Fitch lowers Wells Fargo's credit outlook to negative: "The outlook revision reflects potential damage to the firm’s franchise and earnings profile following recent regulatory actions regarding improper unauthorized account openings, Fitch said Tuesday in a statement. Fitch reaffirmed the San Francisco-based lender’s rating of AA-/F1+. The ratings company said that even as “customer damages appear limited," the scandal could pressure the bank’s earnings. While WFC emerged from the financial crisis in a much better position than similarly sized peers, Fitch believes this issue creates reputational risk given the issue and allegations are understandable to the general public, in a way that misdeeds at other banks are not, Fitch said, using the lender’s stock symbol [see].
- Clawbacks. Executives have agreed to forfeit part of their pay. Note: it's the Board of Directors, led by its independent members,
. "In seeking to defuse the firestorm over its sham accounts, Wells Fargo & Co.’s board turned to an old, but obscure gambit – getting its top leader to pay up. John Stumpf, the bank's chairman and CEO, will forfeit about $41 million of unvested stock awards and forgo his salary while the company investigates its retail banking sales practices. Carrie Tolstedt, Wells Fargo's former head of community banking, also will forgo her unvested equity stock awards, valued at $19 million, and will not receive retirement benefits worth millions more. Neither Tolstedt nor Stumpf will receive 2016 bonuses. Under the leadership of Stumpf and Tolstedt, hundreds of thousands of sham accounts were opened by employees to meet their sales targets, enraging the customers and triggering ongoing federal investigation. And the bank may not be done with "clawing back" -- as the practice is often called -- the executives' pay. “The independent members of the board will take such other actions as they collectively deem appropriate, which may include further compensation actions,” Stephen Sanger, Wells Fargo’s lead independent director, said Tuesday in a statement" [see].
- Corporate governance. Activist investors push for a shake-up at the top.
. "Banking industry scandals and problems have put a focus on the combined chairman and chief executive role in the past. In 2009, when Bank of America’s Ken Lewis was under fire for his handling of the acquisition of Merrill Lynch, investors voted to separate the roles, in effect stripping him of the chairmanship. Jamie Dimon of JPMorgan Chase defeated proposals to strip him of one of the roles in the wake of the “London whale” trading fiasco. Earlier this year, 17 per cent of Wells shareholders backed Mr Armstrong’s proposal for an independent chairman, the highest level of support since 2013. The activist has presented the proposal for an independent chairman each year since 2012" [see]
- Whistleblowers. Did Wells Fargo fire the whistleblowers?
. "CNN Money has found multiple whistleblowers from Wells Fargo who were willing to go on the record and report that they were fired in retaliation for coming forward to report the massive fraud in which Wells Fargo employees opened up 2,000,000 fake accounts in their customers' names, raiding their real accounts to open them, then racking up fees and penalties, and trashing their customers' credit ratings.CNN also spoke to a former Wells Fargo HR manager who explained how the retaliatory firings worked: employees who blew the whistle would be monitored closely for minor infractions (e.g. being two minutes late for work), then fired "with cause."[see]
__________________
Monday, September 26, 2016
DOCUMENTS: STANDARD & POO'S 'INSITUTIONAL' CRITERIA FOR SOVEREIGN RISK
AM | @agumack
The material from this post (including the tables) comes from Standard & Poor's document Sovereign Credit Methodology, published in December 2014. Note the importance attached to the notion of checks and balances. For an attempt at measuring the strength of checks and balances worldwide, I have proposed an Index of Checks and Balances in my other blog (in Spanish). You can see it here. Broadly speaking, 'checks and balances' refers to the distribution of political power within a nation. Nobody denies the need for a strong executive power, but that strength should be (at least partially) balanced by the existence of other political institutions that are independent for that power. The legislative and the judiciary obviously come to mind, althought in some well-run parliamentary democracies, the executive is taken from members of the legislative body itself. This is why, in my own index, I give paramount importance to survey-based measures of judicial independence. My index also gives some weight to central bank independence—but this a matter to be discussed separately.
Material for Standard & Poor's
The sovereign rating methodology (we use "criteria" and "methodology" interchangeably here) addresses the factors that affect a sovereign government's willingness and ability to service its debt on time and in full. The analysis focuses on a sovereign's performance over past economic and political cycles as well as on factors that indicate greater or lesser economic policy flexibility in future economic cycles. The five key factors that form the foundation of our sovereign credit analysis are:
Institutional and governance effectiveness and security risks (reflected in the institutional assessment).
. Economic structure and growth prospects (economic assessment).
. External liquidity and international investment position (external assessment).
. Fiscal performance and flexibility as well as debt burden (fiscal assessment).
. Monetary flexibility (monetary assessment).
The institutional and economic profile reflects our view of the resilience of a country's economy, the strength and stability of its civil institutions, and the effectiveness of its policymaking. It is the average of the institutional assessment (see Paragraphs 30-42) and the economic assessment (see Paragraphs 43-53). Very high institutional risk and high debt burden. A sovereign with an institutional assessment of '6' cannot be rated higher than 'BB+', regardless of any potential upward adjustment for a large asset position (see Paragraph 25). The track record of sovereign defaults suggests that institutional risks are among the main causes of the poor economic policies that lead to default, which is why the institutional assessment receives this particular weight. A sovereign with an institutional assessment of '6' and a debt assessment of '5' or '6' (see Table 7) cannot be rated higher than 'B+', given the heightened risks such a combination entails. The institutional assessment comprises an analysis of how a government's institutions and policymaking affect a sovereign's credit fundamentals by delivering sustainable public finances, promoting balanced economic growth, and responding to economic or political shocks. The institutional assessment captures these factors:
. The effectiveness, stability, and predictability of the sovereign's policymaking and political institutions (primary factor).
. The transparency and accountability of institutions, data, and processes as well as the coverage and reliability of statistical information (secondary factor).
. The sovereign's debt payment culture (potential adjustment factor).
. External security risks (potential adjustment factor).
Effectiveness, stability, and predictability of policymaking, political institutions, and civil society. The criteria analyze the effectiveness, stability, and predictability of policymaking, political institutions, and civil society based on:
. The track record of a sovereign in managing past political, economic, and financial sector crises; maintaining prudent policymaking; and delivering balanced economic growth. This includes a timely implementation of various reforms (such as to health care or pensions, to ensure sustainable public-sector finances over the long term), prudent monetary policy management, and effective management of external pressures.
. The predictability in the overall policy framework and developments that may affect policy responses to a future crisis or lead to significant policy shifts.
. Actual or potential challenges to political institutions, possibly involving domestic conflict, from popular demands for increased political or economic participation, or from significant challenges to the legitimacy of institutions on ethnic, religious, or political grounds.
. The cohesiveness of civil society, as evidenced by social mobility, social inclusion, prevalence of civic organizations, degree of social order, and capacity of political institutions to respond to societal priorities.
Effective policymaking and stable political institutions enable governments to address periods of economic distress and take measures to correct imbalances. This helps sustain long-term growth prospects and limit the risk of sharp deterioration of a sovereign's creditworthiness. Stable and well-established institutions generally ensure a certain degree of predictability in the general direction of policymaking, even when political power shifts between competing parties and policy details change as a result. Conversely, succession risks, a high concentration of power, and potential or actual challenges to political institutions are factors that can pose risks to institutional stability and, in turn, lead to substantial policy shifts and affect the continuity of key credit characteristics. The analysis of the risk of challenges to political institutions is based on the history of internal political conflicts, including extra-constitutional changes of government.
The accountability and transparency of institutions, data, and processes are based on the analysis of the following:
. The existence of checks and balances between institutions.
. The perceived level of corruption in the country, which correlates strongly with the accountability of its institutions.
. The unbiased enforcement of contracts and respect for the rule of law (especially in the area of property rights), which correlates closely with respect for creditors' and investors' interests.
. The independence of statistical offices and the media, as well as the history of data revisions or data gaps, as measures of the transparency and reliability of the information.
The transparency and accountability of institutions bear directly on sovereign creditworthiness because they reinforce the stability and predictability of both political institutions and the political framework. They do this even though they may not reinforce the stability of a ruling political class or party. In addition, transparent and accountable institutions, processes, and data are important because they enhance the reliability and accuracy of information and help make known in a timely manner any significant shifts in a country's policymaking or the occurrence of risks relevant to sovereign credit risk.
________________________
Document. Standard & Poor's downgrades Poland (January 2016) [see]
This is the part of the statement that refers to political institutions.
The downgrade reflects our view that Poland's system of institutional checks and balances has been eroded significantly as the independence and effectiveness of key institutions, such as the constitutional court and public broadcasting, is being weakened by various legislative measures initiated since the October 2015 election. Poland's new ruling party Law and Justice (PiS), which holds an absolute majority in the parliament (Sejm) and the senate, has set out to make fundamental changes to Poland's institutions. For example, the constitutional court's ability to work efficiently and independently will likely be undermined, in our view, by changes to the court's composition and decision-making process. The government's new media law, as another example, gives the government extensive powers to appoint and control the directors and supervisory boards of public broadcasters. A third law terminates contracts of all current senior, career civil servants and removes a constraint regarding previous party membership, therefore enabling the new government to change the structure of the civil service. In our view, these measures erode the strength of Poland's institutions and go beyond what we had anticipated regarding policy changes from the general election.
___________________
Document. Standard & Poor's downgrades Saudi Arabia (October 2015) [see]
This is a reference to Saudi politics:
We analyze Saudi Arabia as an absolute monarchy in which decision-making resides with the king and the ruling family. In our view, reconciling intrafamily issues around sucession could make the kingdom's policy decisions more challenging and difficult to predict. Two new councils, the Council for Political and Security Affairs and the Council for Economic and Development Affairs, have been created to form government policy more efficiently. Power is devolved to the crown prince and deputy crown prince, who respectively head these two bodies. The king approves the decisions of the councils. Broader institutional checks and balances are still at early stages of development.
____________________
Document. Standard & Poor's downgrades Russia Foreign Credit Rating (January 2015 [see]
This is a reference to Russian institutions:
We view Russia's institutional and governance effectiveness as a rating weakness. Political power is highly centralized with few checks and balances, in our opinion. We do not currently expect that the government will be able to effectively tackle the long-standing structural obstacles (perceived corruption, the weak rule of law, the state's pervasive role in the economy, and the challenging business and investment climate) to stronger economic growth over our 2015-2018 forecast horizon.
___________________
The material from this post (including the tables) comes from Standard & Poor's document Sovereign Credit Methodology, published in December 2014. Note the importance attached to the notion of checks and balances. For an attempt at measuring the strength of checks and balances worldwide, I have proposed an Index of Checks and Balances in my other blog (in Spanish). You can see it here. Broadly speaking, 'checks and balances' refers to the distribution of political power within a nation. Nobody denies the need for a strong executive power, but that strength should be (at least partially) balanced by the existence of other political institutions that are independent for that power. The legislative and the judiciary obviously come to mind, althought in some well-run parliamentary democracies, the executive is taken from members of the legislative body itself. This is why, in my own index, I give paramount importance to survey-based measures of judicial independence. My index also gives some weight to central bank independence—but this a matter to be discussed separately.
Material for Standard & Poor's
The sovereign rating methodology (we use "criteria" and "methodology" interchangeably here) addresses the factors that affect a sovereign government's willingness and ability to service its debt on time and in full. The analysis focuses on a sovereign's performance over past economic and political cycles as well as on factors that indicate greater or lesser economic policy flexibility in future economic cycles. The five key factors that form the foundation of our sovereign credit analysis are:
Institutional and governance effectiveness and security risks (reflected in the institutional assessment).
. Economic structure and growth prospects (economic assessment).
. External liquidity and international investment position (external assessment).
. Fiscal performance and flexibility as well as debt burden (fiscal assessment).
. Monetary flexibility (monetary assessment).
The institutional and economic profile reflects our view of the resilience of a country's economy, the strength and stability of its civil institutions, and the effectiveness of its policymaking. It is the average of the institutional assessment (see Paragraphs 30-42) and the economic assessment (see Paragraphs 43-53). Very high institutional risk and high debt burden. A sovereign with an institutional assessment of '6' cannot be rated higher than 'BB+', regardless of any potential upward adjustment for a large asset position (see Paragraph 25). The track record of sovereign defaults suggests that institutional risks are among the main causes of the poor economic policies that lead to default, which is why the institutional assessment receives this particular weight. A sovereign with an institutional assessment of '6' and a debt assessment of '5' or '6' (see Table 7) cannot be rated higher than 'B+', given the heightened risks such a combination entails. The institutional assessment comprises an analysis of how a government's institutions and policymaking affect a sovereign's credit fundamentals by delivering sustainable public finances, promoting balanced economic growth, and responding to economic or political shocks. The institutional assessment captures these factors:
. The effectiveness, stability, and predictability of the sovereign's policymaking and political institutions (primary factor).
. The transparency and accountability of institutions, data, and processes as well as the coverage and reliability of statistical information (secondary factor).
. The sovereign's debt payment culture (potential adjustment factor).
. External security risks (potential adjustment factor).
Effectiveness, stability, and predictability of policymaking, political institutions, and civil society. The criteria analyze the effectiveness, stability, and predictability of policymaking, political institutions, and civil society based on:
. The track record of a sovereign in managing past political, economic, and financial sector crises; maintaining prudent policymaking; and delivering balanced economic growth. This includes a timely implementation of various reforms (such as to health care or pensions, to ensure sustainable public-sector finances over the long term), prudent monetary policy management, and effective management of external pressures.
. The predictability in the overall policy framework and developments that may affect policy responses to a future crisis or lead to significant policy shifts.
. Actual or potential challenges to political institutions, possibly involving domestic conflict, from popular demands for increased political or economic participation, or from significant challenges to the legitimacy of institutions on ethnic, religious, or political grounds.
. The cohesiveness of civil society, as evidenced by social mobility, social inclusion, prevalence of civic organizations, degree of social order, and capacity of political institutions to respond to societal priorities.
Effective policymaking and stable political institutions enable governments to address periods of economic distress and take measures to correct imbalances. This helps sustain long-term growth prospects and limit the risk of sharp deterioration of a sovereign's creditworthiness. Stable and well-established institutions generally ensure a certain degree of predictability in the general direction of policymaking, even when political power shifts between competing parties and policy details change as a result. Conversely, succession risks, a high concentration of power, and potential or actual challenges to political institutions are factors that can pose risks to institutional stability and, in turn, lead to substantial policy shifts and affect the continuity of key credit characteristics. The analysis of the risk of challenges to political institutions is based on the history of internal political conflicts, including extra-constitutional changes of government.
The accountability and transparency of institutions, data, and processes are based on the analysis of the following:
. The existence of checks and balances between institutions.
. The perceived level of corruption in the country, which correlates strongly with the accountability of its institutions.
. The unbiased enforcement of contracts and respect for the rule of law (especially in the area of property rights), which correlates closely with respect for creditors' and investors' interests.
. The independence of statistical offices and the media, as well as the history of data revisions or data gaps, as measures of the transparency and reliability of the information.
The transparency and accountability of institutions bear directly on sovereign creditworthiness because they reinforce the stability and predictability of both political institutions and the political framework. They do this even though they may not reinforce the stability of a ruling political class or party. In addition, transparent and accountable institutions, processes, and data are important because they enhance the reliability and accuracy of information and help make known in a timely manner any significant shifts in a country's policymaking or the occurrence of risks relevant to sovereign credit risk.
________________________
Document. Standard & Poor's downgrades Poland (January 2016) [see]
This is the part of the statement that refers to political institutions.
The downgrade reflects our view that Poland's system of institutional checks and balances has been eroded significantly as the independence and effectiveness of key institutions, such as the constitutional court and public broadcasting, is being weakened by various legislative measures initiated since the October 2015 election. Poland's new ruling party Law and Justice (PiS), which holds an absolute majority in the parliament (Sejm) and the senate, has set out to make fundamental changes to Poland's institutions. For example, the constitutional court's ability to work efficiently and independently will likely be undermined, in our view, by changes to the court's composition and decision-making process. The government's new media law, as another example, gives the government extensive powers to appoint and control the directors and supervisory boards of public broadcasters. A third law terminates contracts of all current senior, career civil servants and removes a constraint regarding previous party membership, therefore enabling the new government to change the structure of the civil service. In our view, these measures erode the strength of Poland's institutions and go beyond what we had anticipated regarding policy changes from the general election.
___________________
Document. Standard & Poor's downgrades Saudi Arabia (October 2015) [see]
This is a reference to Saudi politics:
We analyze Saudi Arabia as an absolute monarchy in which decision-making resides with the king and the ruling family. In our view, reconciling intrafamily issues around sucession could make the kingdom's policy decisions more challenging and difficult to predict. Two new councils, the Council for Political and Security Affairs and the Council for Economic and Development Affairs, have been created to form government policy more efficiently. Power is devolved to the crown prince and deputy crown prince, who respectively head these two bodies. The king approves the decisions of the councils. Broader institutional checks and balances are still at early stages of development.
____________________
Document. Standard & Poor's downgrades Russia Foreign Credit Rating (January 2015 [see]
This is a reference to Russian institutions:
We view Russia's institutional and governance effectiveness as a rating weakness. Political power is highly centralized with few checks and balances, in our opinion. We do not currently expect that the government will be able to effectively tackle the long-standing structural obstacles (perceived corruption, the weak rule of law, the state's pervasive role in the economy, and the challenging business and investment climate) to stronger economic growth over our 2015-2018 forecast horizon.
___________________
Saturday, June 18, 2016
PROF. DAMODARAN ON 'BOTTOM-UP BETAS'
AM | @Mackfinance
"I'm actually wedded to bottom-up betas" — Aswath Damodaran
I have recently decided to devote more attention in class to what Prof. Damodaran calls 'bottom-up' betas. Students seem to find it interesting too. Here's some video material with the explanations:
1. Identify the business or businesses that make up the firm whose beta we are trying to estimate.
2. Calculate the levered betas of other publicly traded firms that are primarily or only in each of those businesses. Use regression analysis. In most businesses, there are at least a few comparable firms and in some businesses, there can be hundreds. Begin with a narrow definition of comparable firms, and widen it if the number of comparable firms is too small. Consider the possibilities of widening your search globally to get more firms in your sample. Do hundreds of regression! [TABLE]
3. Calculate the average of levered betas for each relevant sector.
4. Use the average debt-to-equity ratio (D/E) for each sector [this information will be provided] to ‘unlever’ the average beta with the formula: βU = βL / [ 1 + (1 – t) (D/E)]. This is the average unlevered beta for each division.
5. Calculate the bottom-up unlevered beta of the firm as a weighted-average of the unlevered betas for each division. But what weights do we use? There are two possibilities: use the proportion of the enterprise value of the businesses relative to the total enterprise value of the firm (enterprise value = market value of debt + market value of equity – cash). Or you could just use the revenues (sales) by sector.
6. Use the debt-to-equity ratio of the company to arrive at the levered beta, using the formula: βL = βU [ 1 + (1 – t) (D/E)]. That’s it!
_______________
"I'm actually wedded to bottom-up betas" — Aswath Damodaran
I have recently decided to devote more attention in class to what Prof. Damodaran calls 'bottom-up' betas. Students seem to find it interesting too. Here's some video material with the explanations:
1. Identify the business or businesses that make up the firm whose beta we are trying to estimate.
2. Calculate the levered betas of other publicly traded firms that are primarily or only in each of those businesses. Use regression analysis. In most businesses, there are at least a few comparable firms and in some businesses, there can be hundreds. Begin with a narrow definition of comparable firms, and widen it if the number of comparable firms is too small. Consider the possibilities of widening your search globally to get more firms in your sample. Do hundreds of regression! [TABLE]
3. Calculate the average of levered betas for each relevant sector.
4. Use the average debt-to-equity ratio (D/E) for each sector [this information will be provided] to ‘unlever’ the average beta with the formula: βU = βL / [ 1 + (1 – t) (D/E)]. This is the average unlevered beta for each division.
5. Calculate the bottom-up unlevered beta of the firm as a weighted-average of the unlevered betas for each division. But what weights do we use? There are two possibilities: use the proportion of the enterprise value of the businesses relative to the total enterprise value of the firm (enterprise value = market value of debt + market value of equity – cash). Or you could just use the revenues (sales) by sector.
6. Use the debt-to-equity ratio of the company to arrive at the levered beta, using the formula: βL = βU [ 1 + (1 – t) (D/E)]. That’s it!
_______________
Monday, February 15, 2016
LEHMAN BROTHERS & THE EFFICIENT MARKETS HYPOTHESIS
"A generalised mutual suspicion" — John Plender
There is a new book out on the Lehman Brothers crisis. The author is Oonagh McDonald. There is much praise for the book from the Financial Times' reviewer John Plender, although he complains about MacDonald's "harshness based on hindsight" (*). The most interesting part comes from the critique of the Efficient Markets Hypothesis:
MacDonald examines how, one weekend in September, Lehman went from being valued by the stock market at $639bn to being worth nothing at all. It did not require much to make Lehman go up in smoke. At the end of its last financial year, it was so highly leveraged that its assets had only to fall in value by 3.6 per cent for the bank to be wiped out. The response of these Wall Street wizards to the credit crunch that began in mid-2007 was pure hubris. Having survived episodes of financial turmoil when many expected the bank to fail, Mr Fuld and his colleagues decided to take on more risk. Meanwhile, they neglected to inform the board that they were exceeding their self-imposed risk limits and excluding more racy assets from internal stress tests.
The board, conspicuously short of expertise in risk management and financial plumbing, enthusiastically endorsed the policy. A strength of McDonagh’s book is that it recognises that this was really a property-based crisis. Much of the decline in the value of Lehman’s assets came from direct exposure to property. Because Lehman brought other banks into these transactions, word about the deterioration in the quality of its assets quickly spread. A generalised mutual suspicion about the value of other banks’ assets became a hallmark of the crisis.
But the conclusion is a broader, provocative exploration of the concept of market value, in which McDonald tilts at the efficient market hypothesis that underlay much of the thinking in finance ministries, central banks and regulatory bodies before the crisis. This incorporates the notion that competition between market participants will ensure that prices reflect all publicly available information. It leads to the conclusion that bubbles do not exist, which in light of the crisis many find absurd.
(*) John Plender: "Lehman Brothers crisis: A crisis of value. By Oonagh McDonald", Financial Times, 15 February 2016.
______________
Sunday, February 14, 2016
SOME ARTICLES ON BASEL, SYTEMIC RISK
AM | @Mackfinance
"A large range of uncertainty" — The Bank of England
. John Vickers: "The Bank of England must think again on systemic risk", Financial Times, 14 February 2016.
______________
"A large range of uncertainty" — The Bank of England
. John Vickers: "The Bank of England must think again on systemic risk", Financial Times, 14 February 2016.
______________
Saturday, February 13, 2016
NOW EVERYBODY TALKS ABOUT THE YIELD CURVE!
AM | @Mackfinance
"Curve inversion will come quickly" — Harvinder Sian
The yield curve, one of our favorite indicators, is making an astonishing comeback. Now everybody seems to talk about it! Here are some links to recent articles on the yield curve.
. Robin Wigglesworth: “Yield curve recession indicator sends warning on US economy”, Financial Times, 13 February 2016.
. Robin Wigglesworth: “US yield curve narrows to 8-year low”, Financial Times, 10 February 2016
. Bloomberg: “Citigroup: The Best Predictor of a U.S. Recession Will Resurface Sooner Than You Might”, 2 December, 2015
. Dean Croushore & Katherine Marsten: “The Continuing Power of the Yield Spread in Forecasting Recessions”, Federal Reserve Bank of Philadelphia, Research Paper No. 14-5, February 2014
_______________
"Curve inversion will come quickly" — Harvinder Sian
The yield curve, one of our favorite indicators, is making an astonishing comeback. Now everybody seems to talk about it! Here are some links to recent articles on the yield curve.
. Robin Wigglesworth: “Yield curve recession indicator sends warning on US economy”, Financial Times, 13 February 2016.
. Robin Wigglesworth: “US yield curve narrows to 8-year low”, Financial Times, 10 February 2016
. Bloomberg: “Citigroup: The Best Predictor of a U.S. Recession Will Resurface Sooner Than You Might”, 2 December, 2015
. Dean Croushore & Katherine Marsten: “The Continuing Power of the Yield Spread in Forecasting Recessions”, Federal Reserve Bank of Philadelphia, Research Paper No. 14-5, February 2014
_______________
Friday, February 12, 2016
BUSINESS TO BUSINESS IN ASSET MANAGEMENT: INDEX PROVIDERS
AM | @Mackfinance
"Profits generated by index providers have risen significantly" — Chris Flood
. Chris Flood: "Profiting from passive aggression", Financial Times, 16 November 2015.
_______________
"Profits generated by index providers have risen significantly" — Chris Flood
. Chris Flood: "Profiting from passive aggression", Financial Times, 16 November 2015.
_______________
THE ETF REVOLUTION: SOME NUMBERS
AM | @Mackfinance
"The growth is scary" — Anonymous ETF provider
. New record. The ETF market has set a new record for global asset gathering (inflows): some $372bn for 2015. In December alone, ETFs posted net inflows of $55bn, marking the 23rd consecutive month of positive net flows, according to research firm ETFGI. Over the past five years, the inflows reach $1.5tn after growing dissatisfaction with the high fees and widespread underperformance of actively managed traditional mutual funds.
. Total ETF assets. Total assets stand at $2.99tn—a figure consultancy PwC expects to hits $5tn by 2020.
. The Big Three. BlackRock, Vanguard and State Street Global Advisors together control more than two-thirds of the ETF industry's global assets and in 2015 grabbed 55% of the new cash allocated by investors to ETFs, according to ETFGI.
. Others. Some of the notable beneficiaries of investors' growing interest in ETFs include WisdomTree and Deutsche Asset Management, which both saw inflows to ETFs more than triple in 2015 compared to the previous year.
. Minimum size. ETFGI estimates that more than 6,100 ETFs are now available to investors globally, but around 70 per cent of those funds have less than $100m in assets, the minimum level generally regarded as necessary to break even.
. Innovation. Providers have to strive to be different. It is vital to have the right products in an increasingly crowded market place, to build ETFs that meet specific client needs. WisdomTree, the New York based manager, runs a pair of currency hedged European and Japanese equity ETFs that were two of the fastest growing products globally in 2015.
. Japan. Figures released by the Japan Exchange Group in February 2016 put the combined January trading value of all ETFs at record Y7.94tn—a 100% increase on the same period last year and a 53.4% month-on-month rise from December 2015. The increase in ETF traded volume was even more marked, jumping 128% year-on-year. (Note the role of the BoJ).
Sources. ETFGI; PwC: "ETF 2020: Preparing for a new horizon"; Leo Lewis: "ETFs set Japan record", Financial Times, 3 February 2016; Chris Newlands: "Is it time to halt the rise of the ETF machine?" and Chris Flood: "Dominance of big three forces wave of innovation", Financial Times, 1 February 2016.
________________
"The growth is scary" — Anonymous ETF provider
. New record. The ETF market has set a new record for global asset gathering (inflows): some $372bn for 2015. In December alone, ETFs posted net inflows of $55bn, marking the 23rd consecutive month of positive net flows, according to research firm ETFGI. Over the past five years, the inflows reach $1.5tn after growing dissatisfaction with the high fees and widespread underperformance of actively managed traditional mutual funds.
. Total ETF assets. Total assets stand at $2.99tn—a figure consultancy PwC expects to hits $5tn by 2020.
. The Big Three. BlackRock, Vanguard and State Street Global Advisors together control more than two-thirds of the ETF industry's global assets and in 2015 grabbed 55% of the new cash allocated by investors to ETFs, according to ETFGI.
. Others. Some of the notable beneficiaries of investors' growing interest in ETFs include WisdomTree and Deutsche Asset Management, which both saw inflows to ETFs more than triple in 2015 compared to the previous year.
. Minimum size. ETFGI estimates that more than 6,100 ETFs are now available to investors globally, but around 70 per cent of those funds have less than $100m in assets, the minimum level generally regarded as necessary to break even.
. Innovation. Providers have to strive to be different. It is vital to have the right products in an increasingly crowded market place, to build ETFs that meet specific client needs. WisdomTree, the New York based manager, runs a pair of currency hedged European and Japanese equity ETFs that were two of the fastest growing products globally in 2015.
. Japan. Figures released by the Japan Exchange Group in February 2016 put the combined January trading value of all ETFs at record Y7.94tn—a 100% increase on the same period last year and a 53.4% month-on-month rise from December 2015. The increase in ETF traded volume was even more marked, jumping 128% year-on-year. (Note the role of the BoJ).
Sources. ETFGI; PwC: "ETF 2020: Preparing for a new horizon"; Leo Lewis: "ETFs set Japan record", Financial Times, 3 February 2016; Chris Newlands: "Is it time to halt the rise of the ETF machine?" and Chris Flood: "Dominance of big three forces wave of innovation", Financial Times, 1 February 2016.
________________
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