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Investors right to see through the gloom to economic upturn

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It is richly paradoxical. Both the S&P 500 and the Dow Jones Industrial Average indices hit record levels earlier this week. At the same time, the US economy is struggling to recover, the jobs market is weak and both the public and private sectors are racking up record levels of debt thanks to a devastating pandemic.

The imminent expiry of policy safety nets in the US points to yet more unemployment along with rising corporate defaults next year. The story is much the same across the developed world.

It is tempting to call the investor mood Panglossian optimism. Yet the market is right to look through this apparent amplification of the disconnect between stock prices and the real economy. Since the coronavirus-induced panic in March, equities have been driven by heavily expansionary fiscal and monetary policies. Taken together with recent good news about vaccines, that pretty much ensures a powerful economic upturn in 2021.

Chris Watling of Longview Economics points out that the US corporate sector generated spare free cash flow in the second quarter of this year despite the economic downturn, which typically marks the start of new economic cycles. Households around the world, he adds, have considerable levels of excess savings, amounting to 7.5 to 10 per cent of gross domestic product — enough to spark high levels of potential spending and economic stimulus.

Investors should nonetheless recognise that a market that is substantially driven by policy is often storing up future trouble. This is certainly the case here because the ultra-low interest rates resulting from the central banks’ asset-buying programmes have unhinged the normal relationship between risk and reward.

One obvious example relates to the discipline imposed by bond market vigilantes when excessive government bond issuance threatens a return of inflation. There is simply no point investors refusing to absorb government paper if the central banks will mop it up regardless.

In his General Theory of Employment, Interest and Money, John Maynard Keynes talked of the euthanasia of the rentier where investors relying on interest income would struggle to survive as rates fall. In today’s world of low and negative interest rates we are witnessing both the euthanasia of the rentier and of the bond vigilante.

By forcing investors into a search for yield, the central banks have also ensured that credit risk is being mispriced. A striking example this week was Peru issuing sovereign debt with a 100-year term and a coupon of 3.23 per cent immediately after a constitutional crisis. Peru is not Argentina but this is still taking a very generous view in this historically default-prone region.

The most insidious consequence of unconventional central bank policies is moral hazard. Ultra-low interest rates provide an incentive to borrow because they take the pain out of debt servicing. The result has been an extraordinary debt binge. The Institute of International Finance, a finance trade body, estimates that global debt will rise more than $20tn from 2019 levels to $277tn by the end of the year, equivalent to 365 per cent of GDP.

This accumulation of debt appears to have a diminishing ability to generate growth. This is worrying because the complementary monetary policy toolbox is close to bare. Earlier this month Gita Gopinath, chief economist of the IMF, wrote in the Financial Times that we are in a global liquidity trap. That is, interest rates are so low that households and companies hoard cash. When that happens, monetary stimulus ceases to have much impact on the price level.

Hence many passionate speeches by central bankers calling for fiscal policy to take up more of the burden in addressing the pandemic. Yet in the US plans for further fiscal expansion are gridlocked on Capitol Hill, while in Europe, Hungary and Poland are holding up ratification of the EU budget and proposed coronavirus recovery fund.

It is hard to blame the central banks for their actions since the great financial crisis of 2007-08. Without them a depression would have been inevitable. The snag is that the world will be increasingly vulnerable in due course to inflation because central banks will be reluctant to destabilise the economy and financial system by raising interest rates when debt is at unprecedented levels for fear of jeopardising their independence.

Equities are on heady valuations. In the short term the market will toss and turn in response to coronavirus and vaccine news. With fund managers’ cash holdings now back down to pre-coronavirus levels, according to the Bank of America global fund managers’ survey, a wobbly period may be due. But long-term investors should sit it out. News on fiscal policy will probably improve and a recovery is undoubtedly coming.

john.plender@ft.com



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What’s in a name? DWS eyes ESG refresh for funds

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Hello from New York, where I am hoping you are looking forward to some rest and relaxation this month. While it might be fun-and-games time for some of us, Deloitte’s employees are headed to school — climate school.

Deloitte has started to roll out a new climate learning programme for all 330,000 of its employees worldwide. The new programme, developed in collaboration with the World Wildlife Fund, is designed to help Deloitte advise clients. Remember, in June rival Big Four firm PwC said it would add a whopping 100,000 staffers to capture the booming environmental, social and governance (ESG) market.

Clearly, people are eager for ESG information, and we hope we can help fill the void with this newsletter. Read on. — Patrick Temple-West

DWS re-engineers European ETF to lure ESG investors

Corporate name changes are often the focus of public snickering. Standard Life Aberdeen’s switch to Abrdn in April, for example, was widely mocked on the Financial Times website. The FT’s Pilita Clark has even argued that corporate rebranding is a waste of time.

Last week, DWS, Deutsche Bank’s asset management arm, announced the renaming of nine of its ETFs to incorporate the ESG label and track a new index. The new index provided by MSCI, which includes ESG screens, replaces Stoxx indices.

The move is part of a larger trend to appeal to ESG investors. JPMorgan and Amundi were among the companies that overhauled more than 250 conventional funds to add sustainability language and investment criteria in 2020, according to Morningstar. 

Companies that have failed to capture investor interest are now adding “a coat of green paint” on funds, says Ben Johnson, director of ETF research at Morningstar. The changes are “an attempt to revitalise this particular product,” Johnson said.

© Bloomberg

DWS is also adding securities lending activities to the ETFs, the company said. Funds will often lend shares to short sellers to liven up returns, but the practice could raise concerns from ESG investors. In 2019, Hiro Mizuno (pictured), the former head of the world’s largest pension fund, stopped lending out securities from the Japanese scheme because he believed shorting was antithetical to his mission of long-term value creation.

Refurbishing existing funds to give them an ESG-friendly look has limitations, Johnson said.

“There are ESG-like exclusionary screens that are hardly what we would think of as best in class ESG intentional index strategies,” Johnson said. 

And renaming a fund to hoover up ESG money has caught the eye of regulators. Last week, Securities and Exchange Commission chair Gary Gensler said he wanted the agency to revisit its “names rule”, which prohibits funds from using materially deceptive or misleading names.

“Labels like ‘green’ or ‘sustainable’ say a lot to investors,” Gensler said. “Which data and criteria are asset managers using to ensure they’re meeting investors’ targets — the people to whom they’ve marketed themselves as ‘green’ or ‘sustainable’?” (Mariana Lemann)

Climate campaigners allege central banks aren’t doing enough to avoid a ‘hothouse world’

© AP

When the Federal Reserve in December finally joined the Network for Greening the Financial System (NGFS), all systemically important banks worldwide fell under the organisation’s climate risk oversight. With the US onboard, the NGFS can command significant influence over the financial industry’s role in climate change mitigation.

NGFS research is already being used by central banks around the world. To build their stress tests, the Banque de France, European Central Bank and Bank of England have used NGFS forecasts, including the frightening “hothouse world” scenario in which global warming imposes extreme costs on everyone.

© S&P Global Ratings

And companies are taking the financial implications seriously. For example, Global Partners, a US petrol company, has warned shareholders that bank financing could get more difficult as NGFS’s climate stress tests are implemented. 

But the NGFS has flaws, according to Reclaim Finance, a Paris-based activist group founded in 2020 by Lucie Pinson. In a report provided exclusively to Moral Money, Reclaim Finance argued that NGFS climate risk forecasts rely too heavily on carbon capture and storage, which would not sufficiently reduce fossil fuels investment enough to limit global warming to 1.5°C.

In July, NGFS updated its climate risk scenarios to limit global warming to 1.5°C. However, Reclaim Finance takes issue with NFGS’s assumptions about how banks would reduce their carbon footprint to get there. A false sense of security could prompt companies to decelerate efforts to reduce their fossil fuel assets.

NGFS scenarios could allow for significantly more fossil fuel extraction investments in the 2030s, Reclaim Finance said. The International Energy Agency said in May that energy companies must stop all new oil and gas exploration projects from this year to halt global warming.

“These scenarios rely too heavily on carbon capture and storage and permit ongoing investments in fossil fuels, a recipe for climate chaos and stranded assets,” said Paul Schreiber, a campaigner at Reclaim Finance. (Patrick Temple-West)

Inside the fight to eliminate microplastics

© Getty Images

Polymateria, a London-based company, has published findings this month identifying a new type of plastic that can decompose into harmless wax.

Imperial College London scientists proved the technology worked in the Mediterranean, home to the world’s highest global microplastic concentration, according to Niall Dunne, chief executive of Polymateria.

Microplastic, a traditional plastic, is harmful to the environment because over time it fragments into tiny particles less than 5mm in size. These particles are easily digested by aquatic animals and can travel through the food chain.

While there is significant interest and demand for an alternative to plastics, innovation has lagged, Dunne told Moral Money.

Convenience store chain 7-Eleven has begun implementing the sustainable plastic into its packaging, as has Pour Les Femmes, a clothing brand created by House of Cards actress Robin Wright.

“Our awareness on the issue is thankfully rising but sadly robust research and innovation is still lagging behind,” said David de Rothchild, the British environmentalist known for building a plastic boat and sailing it around the Pacific Ocean.

(Kristen Talman)

Tips from Tamami

Nikkei’s Tamami Shimizuishi helps you stay up to date on stories you may have missed from the eastern hemisphere.

To attract more foreign investors, the Tokyo Stock Exchange is instituting the biggest reform of Japan’s stock markets in a decade.

From next April the exchange will require companies to be more aligned with global corporate governance and financial standards. As part of the overhaul, the Tokyo bourse will split into three sections — prime, standard, and growth. To list in the prestigious “prime” section, companies must meet tighter criteria, such as liquidity standards.

Companies in the prime group are also recommended to fill a third or more of their boards with external directors and to disclose climate risk.

Approximately 30 per cent of the companies that are listed on the top-tier group in the exchange fall short of the requirements for staying in the prime section, Nikkei said.

To stay in the top group, some companies are scrambling to unwind long-criticised practices such as cross-shareholdings and cash-hoarding. The new requirement triggered harsh competition among companies to find qualified candidates for their boards. Weekly Toyo Keizai magazine estimates that Japan Inc will face a shortfall of 3,000 outside directors next year.

The companies that failed to qualify for the prime section this time around can apply again with new information by December.

The reshuffle in the exchange is creating new investment opportunities as well as risks. If you are an investor in the Japanese stock markets, it is a good time to take a look with fresh eyes.

Chart of the day

Global impact fundraising activity

With TPG and Brookfield launching $12bn for new climate funds, the impact investing space has never been hotter. Globally there are 675 impact funds representing about $200bn in commitments so far in 2021, according to a July 27 report from PitchBook, a data provider.

These funds include private equity, and early-state venture capital. “We estimate that there is about $73bn in dry powder targeting impact investments,” PitchBook said.

Grit in the oyster

  • DWS has struggled to implement an ESG strategy and allegedly exaggerated ESG claims to investors, according to the company’s former sustainability chief, Desiree Fixler. Fixler, who provided internal emails and presentations to the Wall Street Journal, said she believed DWS misrepresented its ESG capabilities. The former sustainability chief was fired on March 11, one day before DWS’s annual report was released.

© AFP via Getty Images
  • Hundreds of Activision Blizzard workers walked out in protest last week at the company’s handling of a California state lawsuit alleging sex discrimination, harassment and retaliation. The case alleged a “pervasive ‘frat boy’ workplace culture” at the Santa Monica-based company. On Tuesday, J Allen Brack, a top executive at Activision Blizzard left the company in a management shake-up that promised to bolster “integrity and inclusivity”. Read the FT’s story here.

Smart reads

  • As the SEC drafts unprecedented regulations to require ESG disclosures, the oil and gas industry is ramping up an effort to dilute the climate reporting rules, Myles McCormick and Patrick Temple-West wrote this week. Some fossil fuel companies are lobbying the SEC for the first time.

  • John Browne, a point person on General Atlantic’s new $3bn climate solutions fund, has written in the FT that one of its key goals is to avoid greenwashing.

“Business has a reputation for clinging to the past and greenwashing its way through the climate debate,” Browne said. “Now is the time for businesses, and the investors who back them, to play a decisive role in the greatest challenge humanity is likely to face this century.”

  • Electric cars are celebrated by investors and customers alike as causing less environmental damage than their combustion engine counterparts. But, their supply chain is muddled with a mining and manufacturing process that could be become an “environmental disaster”, FT’s Patrick McGee and Henry Sanderson write. Advocates for a circular economy are hopeful that an increase in urban mining, or breaking down and repurposing batteries, “can close the emissions gap and ease supply chain concerns”.

Recommended reading

  • ESG Returns Emerge as Key Focal Point for US Institutional Investors (Fund Fire)

  • Inequality Has Soared During the Pandemic — and So Has CEO Compensation (New Yorker)

  • US forest fires threaten carbon offsets as company-linked trees burn (FT)

  • Beyond Meat boss backs tax on meat consumption (BBC)

  • Does Positive ESG News Help a Company’s Stock Price? (Northwestern School of Management, Kellog)

  • Olympic sponsors need to ‘walk the talk’ on values (FT)



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US stocks rise as investors weigh strong earnings against spread of Delta variant

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Equities updates

Stocks on Wall Street edged higher on Tuesday as strong company earnings and economic data offset worries about the spread of the Delta coronavirus variant and fears over another regulatory clampdown from Beijing.

The blue-chip S&P 500 was up 0.7 per cent by mid-afternoon in New York, its best performance in more than a week. The tech-focused Nasdaq Composite climbed 0.3 per cent.

Investor sentiment was lifted by June data for US factory orders, which typically feed into estimates of gross domestic product. New orders for goods rose 1.5 per cent on the month before, well above the consensus estimate of 1 per cent.

In Europe, another wave of strong earnings results helped propel the continent’s stocks to a fresh record. The region-wide Stoxx 600 index rose 0.2 per cent after Paris-based bank Société Générale and London-listed lender Standard Chartered reported profits that beat analysts’ expectations.

London’s energy-leaning FTSE 100 index rose 0.4 per cent, aided by oil major BP, which rallied after announcing a $1.4bn share buyback programme and an increase in its dividend.

Line chart of Stoxx Europe 600 index showing Strong earnings help propel European shares to record high

On both sides of the Atlantic, earnings have been strong. More than halfway through the US reporting season, 86 per cent of companies have topped expectations on profits, while in Europe 55 per cent have outperformed so far, according to data from FactSet and Morgan Stanley.

“The continued healthy earnings outlook is a key driver of our view that the equity bull market remains on solid footing,” analysts at UBS Wealth Management wrote in a note. Such a growth rate is, however, “flattered by depressed levels in the year-ago period,” they said. “But the results are still impressive compared with pre-pandemic earnings.”

Oil slipped in a choppy session as the global benchmark Brent crude fell 0.7 per cent to $72.37 a barrel on fears that the spread of the Delta variant could depress demand for fuel.

The seven-day rolling average for new coronavirus cases in the US, the world’s largest economy, have hit nearly 85,000 from about 13,000 a month ago, according to the Financial Times coronavirus tracker. Similar trends have taken hold in other countries as well as authorities race to vaccinate larger swaths of their populations.

A log-scale line chart of seven-day rolling average of newcases showing that US coronavirus case counts rise from just over 10,000 in mid-June to nearly 100,000 by early August

In Asia, investors were again focused on regulation after Chinese state media criticised the online video gaming industry, calling it “spiritual opium”. Shares in Tencent, the Chinese internet group, fell 6 per cent before announcing it would implement new restrictions for minors on its gaming platform. NetEase and XD, two rivals, dropped 7.8 per cent and 8.1 per cent, respectively.

The Hang Seng Tech index, which includes Tencent and its peers, dropped 1.5 per cent, lagging behind the wider Hong Kong bourse, which slipped 0.2 per cent. The CSI 300 index of large Shanghai- and Shenzhen-listed stocks was flat.

Unhedged — Markets, finance and strong opinion

Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday



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Why it might be good for China if foreign investors are wary

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Chinese economy updates

The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center for Global Policy

The chaos in Chinese stock markets last week was exacerbated by foreign investors selling Chinese shares, leaving Beijing’s regulators scrambling to regain their confidence while they tried to stabilise domestic markets. But if foreign funds become more cautious about investing in Chinese stocks, this may in fact be a good thing for China.

In the past two years, inflows into China have soared by more than $30bn a month. This is partly because of a $10bn-a-month increase in the country’s monthly trade surplus and a $20bn-a-month rise in financial inflows. The trend is expected to continue. Although Beijing has an excess of domestic savings, it has opened up its financial markets in recent years to unfettered foreign inflows. This is mainly to gain international prestige for those markets and to promote global use of the renminbi.

But there is a price for this prestige. As long as it refuses to reimpose capital controls — something that would undermine many years of gradual opening up — Beijing can only adjust to these inflows in three ways. Each brings its own cost that is magnified as foreign inflows increase.

One way is to allow rising foreign demand for the renminbi to push up its value. The problem, of course, is that this would undermine China’s export sector and would encourage further inflows, which would in turn push China’s huge trade surplus into deficit. If this happened, China would have to reduce the total amount of stuff it produces (and so reduce gross domestic product growth).

The second way is for China to intervene to stabilise the renminbi’s value. During the past four years China’s currency intervention has occurred not directly through the People’s Bank of China but indirectly through the state banks. They have accumulated more than $1tn of net foreign assets, mostly in the past two years.

Huge currency intervention, however, is incompatible with domestic monetary control because China must create the renminbi with which it purchases foreign currency. The consequence, as the PBoC has already warned several times this year, would be a too-rapid expansion of domestic credit and the worsening of domestic asset bubbles. 

Many readers will recognise that these are simply versions of the central bank trilemma: if China wants open capital markets, it must give up control either of the currency or of the domestic money supply. There is, however, a third way Beijing can react to these inflows, and that is by encouraging Chinese to invest more abroad, so that net inflows are reduced by higher outflows.

And this is exactly what the regulators have been trying to do. Since October of last year they have implemented a series of policies to encourage Chinese to invest more abroad, not just institutional investors and businesses but also households.

But even if these policies were successful (and so far they haven’t been), this would bring its own set of risks. In this case, foreign institutional investors bringing hot money into liquid Chinese securities are balanced by various Chinese entities investing abroad in a variety of assets for a range of purposes.

This would leave China with a classic developing-country problem: a mismatched international balance sheet. This raises the risk that foreign investors in China could suddenly exit at a time when Chinese investors are unwilling — or unable — to repatriate their foreign investments quickly enough. We’ve seen this many times before: a rickety financial system held together by the moral hazard of state support is forced to adjust to a surge in hot-money inflows, but cannot adjust quickly enough when these turn into outflows.

As long as Beijing wants to maintain open capital markets, it can only respond to inflows with some combination of the three: a disruptive appreciation in the currency, a too-rapid rise in domestic money and credit, or a risky international balance sheet. There are no other options.

That is why the current stock market turmoil may be a blessing in disguise. To the extent that it makes foreign investors more cautious about rushing into Chinese securities, it will reduce foreign hot-money inflows and so relieve pressure on the financial authorities to choose among these three bad options.

Until it substantially cleans up and transforms its financial system, in other words, China’s regulators should be more worried by too much foreign buying of its stocks and bonds than by too little.



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