Nomura rounds up markets’ biggest misses in 2016

Forecasting markets a year in advance is never easy, but with “year-ahead investment themes” season well underway, Nomura has provided a handy reminder of quite how difficult it is, with an overview of markets’ biggest hits and misses (OK, mostly misses) from the start of 2016. The biggest miss among analysts, according to Nomura’s Sam […]

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Spanish construction rebuilds after market collapse

Property developer Olivier Crambade founded Therus Invest in Madrid in 2004 to build offices and retail space. For five years business went quite well, and Therus developed and sold more than €300m of properties. Then Spain’s economy imploded, taking property with it, and Mr Crambade spent six years tending to Dhamma Energy, a solar energy […]

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Euro suffers worst month against the pound since financial crisis

Political risks are still all the rage in the currency markets. The euro has suffered its worst slump against the pound since 2009 in November, as investors hone in on a series of looming battles between eurosceptic populists and establishment parties at the ballot box. The single currency has shed 4.5 per cent against sterling […]

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RBS falls 2% after failing BoE stress test

Royal Bank of Scotland shares have slipped 2 per cent in early trading this morning, after the state-controlled lender emerged as the biggest loser in the Bank of England’s latest round of annual stress tests. The lender has now given regulators a plan to bulk up its capital levels by cutting costs and selling assets, […]

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China capital curbs reflect buyer’s remorse over market reforms

Last year the reformist head of China’s central bank convinced his Communist party bosses to give market forces a bigger say in setting the renminbi’s daily “reference rate” against the US dollar. In return, Zhou Xiaochuan assured his more conservative party colleagues that the redback would finally secure coveted recognition as an official reserve currency […]

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Archive | November, 2016

The high art of helping cities work better

Posted on 29 September 2015 by

the Broad Museum, city of Los Angeles©Iwan Baan

Design piece: the Broad Museum is another attempt by the city of Los Angeles to reinvigorate its centre

You can sense in the grand museums of the historic US downtown areas the idea that, if these rapidly expanding, late-19th-century cities were to become credible competitors to their European counterparts, they would need neoclassical domes, porticos and pictures.

Chicago’s Art Institute, Boston’s Museum of Fine Arts, St Louis’s Art Museum, Philadelphia’s Museum of Art and New York’s Met — huge monuments executed on the scale of ancient Rome — were intended to anchor these exploding industrial giants in a world of culture and self-improvement. They were the markers that announced their cities had arrived.

    More than a century later, the overlords of the emerging industrial metropolises of Asia faced a similar situation, in which municipal politicians put their faith in the architecture of culture as a symbol of wealth and taste, a sign that these rapidly expanding cities would become a presence on the global scene.

    The fundamental difference was in funding. In the US, it was the robber-barons-turned-philanthropists; in China, it was the all-powerful state — with the corresponding problem that while the robber barons had huge art collections, Chinese cities are struggling with what exactly to put in their massive new museums.

    Nevertheless, the intention and the effect are comparable. Retail and residential — no matter how lively a US Main Street or an Asian mall might have been — were not enough to give credibility to a city.

    The US institutions have thrived. Even when the downtown areas emptied out and wealthier populations fled to the suburbs, the museums in particular maintained their education programmes and their prestige as palaces of the people, symbols of the city. Often, even in the most blighted centres (think of Detroit or Baltimore), they stood almost alone as markers of the municipal: a sense of civic pride, albeit hanging by a thread.

    In recent years, the role of cultural architecture in stimulating a mixed-use city has been more marked than at any time for more than a century. The museum has again emerged as a tool for engendering a sense of the collective consciousness of otherwise fractured communities.

    The opening this month of the Broad Museum in downtown Los Angeles — a striking building designed by architects Diller & Scofidio — is another piece in a puzzle which began with Frank Gehry’s nearby Disney Concert Hall, through which, over two decades, the city has attempted to reinvigorate its centre.

    Once the classic “doughnut city” — with the “hole” in the centre left to the most disenfranchised residents as the middle classes deserted for the suburbs — LA has been determined to make its centre urban again, through a blend of start-ups, residential lofts and independent retailers. And it has worked.

    Museums are palaces of the people, symbols of the city and the source of civic pride

    Perhaps the most ambitious urban cultural intervention in Asia is the huge M+ in Hong Kong. This is a scheme with a lot riding on it. The old island, despite its thriving economy, was notoriously short on culture. The authorities are attempting to address this gap with a massive new mixed-arts centre. It is also attempting to use the project to move the historical bias from the old colonial centre of Hong Kong Island across the water to Kowloon.

    The shift has already started with the skyscrapers of the business district, luxury residences, new malls and outstanding transport infrastructure. But somehow it has not gelled, failing to attract tourists or top-end residents.

    Culture is seen as the answer. M+ (the keystone of which will be a museum of art, design and architecture by Swiss team Herzog & de Meuron) is an attempt to fill that physical and cultural gap.

    The museum will follow theatres, music venues and traditional opera houses as the element which redesignates West Kowloon, once a no man’s land, as a cultural district. The development around it is mixed-use, but the most critical ingredient is still seen as culture.

    Nowhere has approached this concept with more brio than Abu Dhabi, where Saadiyat Island was conceived as a cultural anchor to the Emirate’s business and retail landscape. Gehry’s Guggenheim is a vast undertaking, but it is French architect Jean Nouvel’s Louvre outpost (due to open next year) with its shallow, pierced dish of a roof that is most impressive.

    There are, however, concerns that culture is not quite enough, and retail is increasingly impinging on the landscape. Will this be a place of culture interspersed with the indispensable retail, or will this be a huge mall with a few museums scattered around it?

    Culture was once seen as high art, as a civilising factor in the emergence of a dignified central district. Its purpose was edifying rather than commercial — albeit always imbued with a huge dose of donor ego.

    Now, arguably, the architecture of culture is conceived more as a tool for regeneration or for imparting prestige for a new development.

    Yet, even at its most superficial, it does create a more rooted, more mixed community and, when done well, can be the mechanism that allows the city the space to think about what life in the metropolis should be.

    Carney warns of ‘huge’ climate change hit

    Posted on 29 September 2015 by

    The Governor of the Bank of England, Mark Carney, speaks at a dinner at Lloyd's of London in London on September 29, 2015. Carney spoke of risks posed by climate change to financial stability and long-term prosperity in a speech to business leaders hosted by insurers Lloyds of London. AFP PHOTO / POOL / DOMINIC LIPINSKIDominic Lipinski/AFP/Getty Images©AFP

    The governor of the Bank of England has thrown down the gauntlet to the fossil fuel industry with a blunt warning that investors face “potentially huge” losses from climate change action that could make vast reserves of oil, coal and gas “literally unburnable”.

    In a sweeping assessment of the financial risks posed by global warming, Mark Carney acknowledged there was a danger the assets of fossil fuel companies could be left “stranded” by tougher rules to curb climate change.

      “The exposure of UK investors, including insurance companies, to these shifts is potentially huge,” he told a Lloyd’s of London dinner on Tuesday night, explaining 19 per cent of FTSE 100 companies were in the natural resources and extraction industries.

      “The challenges currently posed by climate change pale in significance compared with what might come,” he said. “Once climate change becomes a defining issue for financial stability, it may already be too late.”

      The governor did not suggest the BoE would itself attempt to enforce stricter climate risk regulations for financial institutions.

      But his comments are still likely to irk fossil fuel industry executives confronting climate campaigners who argue the risk of so-called stranded assets shows why investors should divest from fossil fuels.

      Several oil and gas companies, including Royal Dutch Shell, say the concept overlooks projected demand for energy, especially in fast-growing developing countries.

      The prospect of tougher global climate action has grown as delegates from nearly 200 countries prepare to broker a UN climate change accord in Paris in December.

      Once climate change becomes a defining issue for financial stability, it may already be too late

      – Mark Carney

      It is still far from clear if the agreement will deliver the cuts in global greenhouse gas pollution that scientists say are needed to ensure global temperatures do not rise more than 2°C from pre-industrial times, a goal governments have already agreed to meet.

      But Mr Carney said scientists had calculated the “carbon budget” the world could afford if it is to meet the 2°C target, and it amounted to between one-fifth and one-third of the world’s proven reserves of oil, gas and coal.

      “If that estimate is even approximately correct it would render the vast majority of reserves ‘stranded’ — oil, gas and coal that will be literally unburnable without expensive carbon capture technology, which itself alters fossil fuel economics,” he said.

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      “A wholesale reassessment of prospects, especially if it were to occur suddenly, could potentially destabilise markets,” he said, echoing warnings from the Carbon Tracker think-tank in London that pioneered the stranded carbon assets idea several years ago.

      China takes a lead on global climate change

      A coking factory discharges a plume of exhaust in Linfen, Shanxi Province, China on Thursday, 03 December, 2009.

      Beijing’s commitments on the environment should be praised

      Read more

      Mr Carney was speaking as the BoE’s Prudential Regulation Authority, published a report identifying potential climate risks for the UK insurance industry it supervises, which manages nearly £2tn in assets.

      Mr Carney told the Lloyd’s of London dinner that suggestions that banks and insurers should face new requirements to encourage low-carbon investment were “flawed”.

      Instead, he said the Financial Stability Board, an international body monitoring the global financial system that Mr Carney chairs, may recommend G20 countries make it easier for investors to compare the “carbon intensity” of different assets.

      He suggested a “climate disclosure task force” could be set up to create a voluntary standard for the information companies producing or emitting carbon should disclose.

      Information about companies’ carbon footprints would give investors a better idea of potential risks at a time when scientific evidence was showing that eventually, “climate change will threaten financial resilience and longer term prosperity”, Mr Carney said.

      “While there is still time to act, the window of opportunity is finite and shrinking.”

      Letter in response to this report:

      Insurers committed to a climate-resilient future / From Andrew Kendrick and others

      A stronger capital markets union for Europe

      Posted on 29 September 2015 by

      The euro's weakness boosted European equities©Reuters

      The euro’s weakness boosted European equities

      Europe needs stronger, deeper capital markets. Our economy is about the same size as America’s, but our equity markets are less than half the size of theirs — and our debt markets less than one-third.

      In the US, small and medium-sized companies raise about five times as much funding from capital markets as in the EU. If European venture capital markets were as deep as those in the US, our companies could have raised an extra €90bn over the past five years. And the differences between EU countries are even bigger than those between Europe and the US.

        The benefits of stronger capital markets are also clear. We could give Europe’s businesses more choices over funding, helping them to invest and grow; increase investment in infrastructure; draw in more funding from outside the EU; help businesses sell into bigger markets; and help those saving for their old age. And, by reducing reliance on bank funding, we could help make the financial system more resilient, particularly in the eurozone.

        All 28 members of the EU share this view. So does the European Parliament.
        We will identify the barriers to the cross-border flow of investment and, in building our capital markets union, work out how to overcome them step by step.

        Some of the big questions are longstanding. How will we encourage investors to make cross-border investments when national insolvency laws are so different? How can investors gain access to comparable credit information on SMEs? How do we overcome national barriers, such as “passporting fees” if businesses operate in multiple countries?

        Solving problems such as these will not be straightforward. I do not want to disrupt markets that are working well in pursuit of some theoretical perfection. But it should be possible to make progress in all these areas over time. Meanwhile, we have some clear priorities for early action.

        To help free up banks’ balance sheets, making it easier for them to increase lending, I am proposing a new EU framework, with lower capital requirements, to encourage simple, transparent and standardised securitisation. We need to make it more attractive to invest in infrastructure, so today I will announce a new infrastructure asset class that will attract lower capital requirements under the Solvency II regime for insurers.

        Start-ups in need of capital should not be forced to go to the US, so I will be proposing measures — including changes to legislation — to encourage the European venture capital scene to thrive. We need to make it easier for companies to raise funds on the public markets, too. So before the end of the year I will propose plans to overhaul the prospectus directive, which governs what companies must tell investors before floating on the stock exchange, to make it less burdensome for business.

        Lord Hill’s EU capital markets union plans expose UK concerns

        EU commissioner Lord Hill said he had no intention of disrupting markets in pursuit of 'some theoretical perfection'

        Britain seen as delaying project that would benefit City of London

        Read more

        To channel more investment from Europe’s citizens to its businesses, we need to improve retail financial services. This means looking at them from the consumer’s point of view. And we also need to look into the combined effect of the legislation introduced in recent years in response to the financial crisis. This is not to question the overall architecture but to ask whether the laws we have passed are working as hoped. I will today begin a consultation to see whether the legislation has had unintended consequences — for example, making it harder for businesses to invest in the economy.

        The creation of a capital markets union is a big opportunity for Europe. The UK, as Europe’s leading financial services centre, has a major contribution to make.

        This is a good example of the practical benefits that membership of the single market can bring. But to make the most of it, and to help influence the rules which will set the terms of engagement for years to come, the UK needs to be shaping the system — not looking on while others set the rules.

        The writer is European commissioner for financial stability, financial services and capital markets union

        HK tycoon Li brushes off China criticism

        Posted on 29 September 2015 by

        Hong Kong tycoon Li Ka-shing wishes memb...Hong Kong tycoon Li Ka-shing wishes members of the media a happy lunar new year as he arrives for a press conference in Hong Kong on February 26, 2015. Li Ka-shing's conglomerate said on February 26 its year-on-year net profit more than doubled in 2014, following a shopping spree for international assets and announcing a major overhaul for his business empire. AFP PHOTO / Philippe LopezPHILIPPE LOPEZ/AFP/Getty Images©AFP

        One of Asia’s richest people has dismissed a personal attack from China’s ruling party mouthpiece as a “brouhaha” after it criticised his sale of some mainland assets as immoral and ungrateful amid a worsening downturn.

        The unusually personal online attack from Peoples’ Daily on Li Ka-shing, the 87-year-old Hong Kong property, telecoms and port tycoon worth nearly $33bn, followed a spate of articles in mainland media online criticising him for apparently withdrawing from China via a series of asset sales, and domiciling his flagship vehicles offshore rather than in Hong Kong following a reorganisation earlier this year.

          Mr Li, who fled the then war-torn mainland in poverty as a teenager and began his business empire producing plastic flowers, is considered an inspiration by many in China and Hong Kong, where he has been dubbed “superman” for his investing prowess.

          On Tuesday he said in a three-page statement that his companies continued to seek investments around the world, including in the mainland.

          “Over the past two years, the group has been more prudent towards property investments, as certain property markets in the mainland [have] supply and demand imbalance[s],” the statement said.

          As China’s economic growth falls to its weakest pace in a quarter-century, Mr Li’s sales have been interpreted by some outlets as a sign of fading confidence in the mainland.

          In the original article, the People’s Daily, mouthpiece of the Chinese Communist party, said: “Li Ka-shing’s choices do appear particularly brazen. In the eyes of ordinary people, we shared comfort and prosperity together in the good times, but when the hard times come he abandons us. This has really left some people speechless.”

          Local media that he had sold about Rmb100bn ($16bn) of assets in mainland China and Hong Kong in just the past three years.

          Inflaming his critics, Mr Li’s companies at the same time made deals in Europe, including this year’s purchase of Britain’s O2 mobile network from Telefónica and a merger between his Italian mobile unit and that of Russia’s VimpelCom.

          Li Ka-shing moves to simplify empire with $12bn Power Assets deal

          Hong Kong tycoon Li Ka-shing

          Offer pushes the region’s dealmaking total past $700bn for only the second time on record

          Read more

          Mr Li defended his China sales, saying 90 per cent of the property his companies developed was typically sold and that he had never hoarded empty lots — a practice speculators use to try and push prices higher.

          “Reducing property investments does not imply we are not investing in the Mainland,” the statement said.

          More than two-thirds of companies, including Chinese-state-owned enterprises, are domiciled in overseas jurisdictions such as the Caymans or the British Virgin Islands, for Hong Kong listing purposes.

          His statement said: “Mr Li, through the reorganisation process, has not reduced his holdings nor reaped any proceeds, therefore there is no truth in the ‘withdrawal’ accusations.”

          Mr Li pointed to his retail unit, which includes the rapidly growing Watson’s pharmacy chain, and said the group had increased its number of mainland stores 77 per cent to 2,300, in the past two years.

          Tuesday’s statement included expressions of support for the reform agenda of China’s president Xi Jinping, as reiterated this week during his state visit to the US.

          “We are confident that the leadership in China is, and will commit to, improving governance and continue on a path of economic reform,” it said.

          Stalled dollar debt sales signal EM angst

          Posted on 29 September 2015 by

          Brazil Flag©Dreamstime

          The scale of emerging markets’ weakness is palpable in the rapid stalling of foreign currency debt sales in Brazil and Russia and a sharp slowdown in several other countries, according to research by Nomura.

          A debt “bonanza” was witnessed across EM in 2012-14, with around $250bn issued in each of those years. But it is clear that period is over, said Nomura’s Global FX strategist, Jens Nordvig.

            This year has seen net bond issuance in EM grind to a halt, with the sole exception of China where corporates have issued around $50bn of debt.

            This shift is a reflection of economic weakness across EM countries and is likely to put pressure on balance sheets “regardless of whether there is an emerging crisis dynamic at play”, Mr Nordvig said.

            Debt build-ups in EM are a persistent concern, highlighted again by the International Monetary Fund. In its latest Global Financial Stability Report, the IMF said EM corporate debt of non-financial companies reached $18tn last year, more than four times the level of 2004, and there was a risk of corporate failures.

            Nomura said gross issuance has been close to zero for a while in Brazil and Russia, the latter mostly the result of sanctions.

            On a net basis, debt issuance has been firmly negative in Brazil and Russia over the past 12 months, the decline noticeably steeper in the past three to six months.

            But other EM countries are also seeing a significant slowdown in net debt issuance, including India, Mexico, Thailand and Malaysia.

            The likes of Chile, Colombia, South Africa and Indonesia have defied the pressure on EM assets of recent months and achieved respectable net issuance. But these could slow down if credit markets continued to deteriorate, said Nomura.

            There were two redeeming features in this gloomy EM landscape, Nomura said. One was that there was little room for hard currency issuance in EM to fall much further.

            “This does not mean that flow pressure overall cannot accelerate further. If domestic capital flight takes hold, the potential is very large,” Mr Nordvig suggested.

            “But it does suggest that pressure from basic issuance and maturity dynamics is already close to a peak in a number of places.”

            The second was that the notional value of maturing bonds for the fourth quarter was not rising. That may calm worries of currency instability from the credit markets and could stay the hand of central banks considering intervention, Nomura said.

            The IMF, warning EM countries and bond markets to prepare for a rise in corporate insolvencies, said the amount of total EM corporate debt trading in the bond market had nearly doubled in the 2004-14 period to 17 per cent.

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            Buffett cuts stake in reinsurer Munich Re

            Posted on 29 September 2015 by

            Billionaire investor Warren Buffett speaks at an event called, "Detroit Homecoming" September 18, 2014 in Detroit, Michigan©Getty

            Warren Buffett

            Warren Buffett has cut his stake in the German reinsurer Munich Re, in the latest sign of the billionaire investor’s cooling ardour for the reinsurance market.

            In a regulatory filing, Munich Re said that Berkshire Hathaway and National Indemnity Company, both controlled directly or indirectly by Mr Buffett, had cut their holdings in the German group from around 12 per cent to 9.7 per cent.

              The 9.7 per cent holding — worth around €2.7bn — means that Mr Buffett remains Munich Re’s largest shareholder.

              Whether that will remain the case is unclear. In recent months, Mr Buffett has been outspoken about his reservations over the state of the reinsurance market.

              At Berkshire Hathaway’s annual meeting in May, Mr Buffett said that reinsurance was a business “whose prospects have turned for the worse and there’s not much we can do about it”, adding that outlook for the industry for the next 10 years “will not be as good as it has been in the last 30”.

              Berkshire Hathaway has also been limiting its own reinsurance underwriting since 2010 as new entrants to the market have pushed premium levels lower than it feels comfortable with.

              “For most property/casualty coverages, and for property catastrophe coverages in particular . . . rates, in our view, are generally inadequate,” the company said in its second quarter filing.

              The first indication that Mr Buffett was a shareholder in Munich Re came in 2008, when he said in an interview with the German magazine, Der Spiegel, that he had invested in the reinsurer.

              In 2010, he increased his position, raising his stake to more than 3 per cent in January, and to more than 5 per cent in February, becoming Munich Re’s biggest shareholder. In October that year, he increased his holdings to more than 10 per cent.

              In the 2008 Der Spiegel interview, Mr Buffett said that the stake had been bought to generate trading profits. “There are 76 companies that we own permanently. And then there is a trading inventory. Munich Re is part of the second category,” he told the magazine.

              Jörg Schneider, Munich Re’s chief financial officer, said the group was “pleased that Warren Buffett has been a significant shareholder for many years”, and added that Munich would “ensure that our shareholder community remains spread over many countries and different investor groups”.

              Shares in the German group were down 1.7 per cent at €164.45 in afternoon trading in Frankfurt.

              IMF warns of rate hit on emerging markets

              Posted on 29 September 2015 by


              Christine Lagarde, the International Monetary Fund chief

              The International Monetary Fund has warned that emerging economies and bond markets need to prepare for an increase in corporate failures if and when the US Federal Reserve and other central banks in advanced economies begin raising rates.

              The IMF, which has urged the Fed to wait until next year to raise rates for the first time in almost a decade, and others have expressed growing concern about the surge in dollar-denominated debt in emerging economies and the potential impact that a sudden increase in rates would have. The issue is likely to be among the most discussed when central bankers and finance ministers from around the world convene for next week’s annual meetings of the IMF and World Bank in Lima, Peru.

                In a chapter of its Global Financial Stability Report prepared for those meetings and released on Tuesday, IMF economists warn that a surge in corporate leverage has preceded many emerging market financial crises in history.

                Fed by the cheap cost of money, over the past decade the corporate debt of non-financial firms across major emerging market economies more than quadrupled from $4tn in 2004 to more than $18tn in 2014. In the same period, the average ratio of emerging market corporate debt to gross domestic product grew by 26 percentage points, the IMF said.

                Although by some other measures those corporate debt levels remained below historical peaks, the prospect of an increase in rates and debt servicing costs meant that the looming end of a post-crisis era of cheap money posed a “a key risk for the emerging market corporate sector”, the IMF said.

                That in turn posed a broader threat for emerging economies.

                “As advanced economies normalise monetary policy, emerging markets should prepare for an increase in corporate failures and, where needed, reform corporate insolvency regimes,” IMF economists wrote.

                Among the IMF’s concerns is the significant share of emerging market banks’ assets now tied up in corporate debt. That means any shocks to the corporate sector could quickly spill over to banks and cause them to stop lending, in what would be another drag to the already slowing growth in many emerging economies.

                A growing portion of corporate debt in emerging economies also trades in the bond market, the IMF said. In 2004 just 9 per cent of the total corporate debt in emerging economies was made up of bonds. That figure had almost doubled to 17 per cent in 2014.

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                What is unclear, the IMF said, is how active companies have been in hedging their exposure to foreign exchange swings, such as a stronger dollar.

                But it also warned that as the main reason for the surge in corporate debt had been “external factors”, less attention had been paid to the risks posed by individual countries or companies in recent years. As a result “markets may have been underestimating risks”.

                The IMF said: “If rising leverage and issuance have recently been predominantly influenced by external factors, then firms are rendered more vulnerable to a tightening of global financial conditions.”

                US junk bonds cracking after debt binge

                Posted on 29 September 2015 by

                Merchandise is displayed in the window of Sears' flagship store in the Loop in Chicago, Illinois©Getty

                After the debt binge comes the bill, and that is the grim message for investors looking at the present performance of the US corporate bond market.

                As the third quarter draws to a close, slowing global economic activity threatens the earnings power of many US companies, which have amassed $7.8tn in debt. Years of easy monetary policy that kept borrowing costs low, a wave of mergers and acquisitions and the spectre of shareholder activism have all contributed to an erosion of balance sheet quality.

                  Most vulnerable are junk-rated companies, which account for $2.5tn of the recent US corporate debt binge, with bonds worth roughly $1.5tn set to mature over the next five years, according to S&P. Refinancing that amount may prove a hurdle for corporate executives and chief financial officers if earnings come under more pressure.

                  Michael Contopoulos, a strategist with Bank of America Merrill Lynch, said: “Finally investors are starting to wake up. They are starting to trade on earnings and they’re starting to trade on downgrades.”

                  For the first time since the financial crisis, total returns from speculative grade US debt — generally riskier bonds issued by companies rated BB+ or lower by Standard & Poor’s or Ba1 by Moody’s — are set to decline. The Barclays US high yield index is down 2.3 per cent for 2015.

                  As borrowing costs rise and defaults have accelerated, investors have withdrawn more than $14bn from junk bond funds since the middle of April. The yield on the BofA Merrill Lynch high yield index has climbed to 7.98 per cent from 6.52 per cent a year ago.

                  “We are in the late stages of the credit cycle,” said Edwin Tai, a distressed debt portfolio manager at Newfleet Asset Management. “Cycles last five to seven years and we’re in the seventh year. It’s when the US economy slows that you have defaults across the board.”

                  Already in 2015, more US companies have defaulted than at any time since 2009, according to S&P. The list of 47 filings includes RadioShack, Patriot Coal and Quiksilver, the surfwear retailer.

                  S&P analysts expect the default rate to nearly double to 2.9 per cent by June 2016 from June 2014, warning that “the current crop of US speculative-grade issuers appears weak to us and particularly susceptible to any sudden or unanticipated shocks”.

                  Lists of the companies that occupy the lowest rating rungs compiled by both Moody’s and S&P have swelled and include well-known groups such as Sears, Getty Images, Advanced Micro Devices, California Pizza Kitchen, Caesars Entertainment and Goodrich Petroleum.

                  What began as weakness in the coal sector 18 months ago has swept across the energy sector following sharply falling oil prices, say strategists with BofA Merrill Lynch. But that fragility has also spread across the retail, food, semiconductor and telecoms industries.

                  Investors are demanding a greater premium from junk-rated companies seeking to secure funding.

                  Last week Altice, the French cable giant, was forced to lower the size of a bond offering to finance its takeover of Cablevision.

                  Weakening equity and bond prices reflect falling profits at US junk-rated companies, which face the dual challenges of sliding commodity prices and slowing international growth.

                  Earnings before interest, taxes, depreciation and amortisation tumbled 39.3 per cent in the second quarter from a year earlier — the greatest decline since at least the turn of this century, according to Bank of America Merrill Lynch.

                  Nicholas Colas, chief market strategist at Convergex, said: “It is not just the dollar, it is not just oil any more, it is beginning to be worries about the state of the US economy.”

                  Excluding the energy sector, ebitda has slipped by nearly a tenth at companies in the BofA Merrill Lynch high-yield index, which encompasses roughly 60 per cent of the US junk bond market.

                  The slide in earnings has also elevated leverage to its highest level in almost 15 years. The debt burden of high-yield companies climbed to 4.82 times trailing 12-month earnings at the end of the second quarter, according to BofA Merrill Lynch.

                  Mr Contopoulos characterised the rise in leverage as “unsustainable”, as companies increasingly earmarked debt offerings for shareholder returns — including buybacks and dividends — and mergers and acquisitions.

                  DoubleLine Capital, the bond fund manager, has lowered its allocation in its core fixed income fund away from junk bonds, portfolio manager Kapil Singh notes.

                  “The US economy feels like it is continuing to muddle along,” Mr Singh said. “It’s clear to see over the past year . . . that growth is slowing in sales and ebitda.”

                  Hong Kong dollar buoyed by China flows

                  Posted on 29 September 2015 by

                  Hong Kong city skyline©Dan Breckwoldt/Dreamstime

                  Island prize: Hong Kong is the world’s priciest residential property market

                  Hong Kong’s dollar peg is tough. In its 30-plus years it has withstood landmark currency accords, two financial crises and Sars, not to mention perennial debate about its suitability. But now the world’s longest-running unchanged currency regime is facing a new challenge: its neighbour, the renminbi.

                  With data on Chinese capital flows slow to emerge, Hong Kong’s peg to the US dollar has become something of a gauge of just how much the August devaluation has unsettled investors.

                  China’s shock devaluation of its currency last month has whipsawed the Hong Kong dollar within the narrow range of its band versus the US unit. Initially, speculation mounted that a weaker renminbi would force Hong Kong to devalue its currency, pushing it lower. China’s still-tight control of its currency since its mid-August move, however, has eased that pressure.

                  Suspected outflows from China, following the devaluation, have caused the Hong Kong Monetary Authority to intervene and defend the stronger side of the currency’s HK$7.75 to HK$7.78 range.

                    The city-state’s peg is technically a currency board — where its monetary base is fully backed by equivalent dollar reserves — which has given it strong credibility in the markets. Defending strength, too, involves selling local currency, which the HK Monetary Authority can in theory do forever.

                    “A lot of people got that wrong,” says Mitul Kotecha, head of Asia currency and rates strategy at Barclays. “They first looked for what was exposed and saw the Hong Kong dollar, but what was really unappreciated was where flows into China were coming from — which was Hong Kong — and how those could reverse.”

                    Figures for deposits in Hong Kong in August are due later this week and will be scrutinised for any signs of a shift between those held in renminbi — about 10 per cent of the total — and in local currency. As well as money from the mainland, many local savers hold funds in both currencies largely to bet on renminbi appreciation.

                    “People are assuming renminbi deposits will have gone down — although August might be too soon to show this,” says one strategist.

                    The HKMA, meanwhile, has already hinted there has been a shift. In its half-yearly review published last week, it noted that its undertaking to buy dollars at HK$7.75 was triggered “multiple times” during September “possibly because of asset reallocations following the renminbi depreciation”.

                    Hong Kong’s peg has made it over time a haven for various flows of capital seeking a dollar proxy or at least a staging post. Last summer, for example, it was Russia’s turn, when rising tensions with the US and a weakening rouble prompted local companies to move funds to Hong Kong.

                    At 23 days and counting, the peg is seeing its longest period of upwards pressure since December 2012. Then the peg was being buffeted by a flood of US dollars from investors bolstered by quantitative easing seeking higher-yielding investments in the region.

                    Another week and the Hong Kong dollar will have bumped against the top of its band for its longest period since late 2009 and the first wave of QE funds.

                    In practice, however, strategists are mixed on how long the pressure will last.

                    “I can’t see this reversing until we see a stabilisation of flows from China. The [People’s Bank of China] has bought itself some time in the short term by intervening, but if capital wants to flow out, it will find a way,” says Mr Kotecha.

                    But Teck Leng Tan, currency analyst in UBS’s wealth management unit, argues that in the longer term weakening growth in China and Hong Kong itself should eventually push the Hong Kong dollar lower.

                    “The main story here is that people think the renminbi devaluation isn’t over and that stabilisation is only temporary,” he says. “But the flow out of China to Hong Kong isn’t enough to offset flows from Hong Kong to the dollar.”

                    In the longer term, Hong Kong still faces the question of what to do with its peg which now traps it squarely between the tightening expected from a looming US interest rate rise and the damping effect of China’s slowing economy.

                    Over time most investors and strategists expect that Hong Kong will shift to a renminbi-based peg — but there is as little agreement as to when this might happen as there is over its current strength.

                    Some think it could happen within perhaps three years, if China continues to open its capital account.

                    Others disagree, citing local politics — an especially sensitive argument on the anniversary of Hong Kong’s “Occupy” street protest.

                    “It’s really a political decision about identity,” says one locally-based analyst. “You’d have to see the renminbi being used interchangeably in day-to-day transactions first — and a few cash machines aside, we’re a long way from that.”

                    Markets strain to price in historic shocks

                    Posted on 29 September 2015 by

                    A picture acquired from the Historical Archives of Sarajevo on June 28, 2014 shows Archduke Franz Ferdinand and his wife Sophia as they leave Sarajevo City Hall to get into their car, minutes before their assassination on June 28, 1914. The assassination of Archduke Franz Ferdinand by 19-year-old Bosnian-Serb nationalist Gavrilo Princip in Sarajevo, 100 years ago this June 28, is widely considered to have sparked World War I. AFP PHOTO/HISTORICAL ARCHIVES OF SARAJEVO©AFP

                    Archduke Franz Ferdinand of Austria minutes before his assassination

                    If investors could erase their knowledge of history and see a snapshot of financial markets from early July 1914, they would find little to worry them.

                    In spite of the diplomatic turmoil in Europe that had already followed the assassination of Archduke Franz Ferdinand of Austria, the pending human catastrophe of the first world war that would begin within the month had not yet been reflected in the City of London.

                      “Apart from an upward movement in Austrian bond yields,” writes the economic historian Niall Ferguson, “there were no significant shifts on either the bond market, the money market, or the foreign exchange markets until the final week before the war broke out.”

                      More than a century later, the possibility for markets to be harmed by unanticipated geopolitical shocks has remained — despite their massively increased sophistication and complexity.

                      The decades before the US financial crisis of 2008 were defined by regrettable insouciance about political risk. In developed economies especially it was thought to have been successfully mitigated.

                      The “peace dividend” that flowed from the fall of the Soviet bloc, along with confidence in the ability of policymakers to smooth economic cycles, entrenched the belief that recessions would henceforth be quick and shallow.

                      Perhaps further contributing to investor complacency was a naive interpretation of the efficient markets hypothesis (that asset prices incorporate all relevant and accessible information) and rational expectations theory (that economic actors make choices according to such information).

                      However accurately or not these ideas reflect the real world, their growing acceptance led many to believe that markets were better insulated from political surprises.

                      No longer.

                      The peace dividend has given way to something more complicated and tough to define. The extent to which China will someday emerge as a legitimate geopolitical rival to the United States is unclear — as is the potential for Russia to create more havoc for its neighbours than it already has.

                      We ignore, and ignore, and ignore something until suddenly it becomes the only thing we can focus on

                      – Mark Dow

                      Within the last half-decade the US has also endured a frightening showdown over its debt ceiling, a government shutdown, and large-scale government reforms of its healthcare and financial sectors.

                      Europe, meanwhile, has confronted a long sequence of sovereign debt crises and the rise of isolationist and separatist political parties — as the political complexities of a currency union between countries with disparate fiscal and banking policies have manifested themselves.

                      “The big risk today is all in the politics,” says Chen Zhao of Brandywine Global Investment Management. The problems of anaemic growth and low inflation are, he argues, the result of “countries not willing to take the right steps. The eurozone’s economic problem for example is complicated but it is also completely man-made.”

                      Investors have long known that markets reflect better than they predict. By nature they are better at pricing existing information than pricing the probability and scale of an unexpected event. But they can fail at both.

                      “I just don’t think it’s the case that markets are always forward-looking,” says Mark Dow, head of Dow Global Advisors. “We ignore, and ignore, and ignore something until suddenly it becomes the only thing we can focus on.”

                      Dow highlights the way oil markets only belatedly accounted for the productivity gains of the shale fracking revolution in the US. The precipitous fall in the oil price last year was then intensified when Saudi Arabia chose to protect its market share — more vigorously than investors expected — rather than scale back production.

                      Academic understanding of how political uncertainty affects asset prices also remains inconclusive, limited by scant empirical analysis and the tricky problem of disentangling politics from other influences.

                      “The real crux for researchers is always going to be measurement, because political uncertainty is a nebulous object,” says Bryan Kelly of the University of Chicago, who recently completed an empirical study with his colleagues Lubor Pastor and Pietro Veronosi on how well asset prices capture political risk.

                      The scholars concluded that the options market does price in the uncertainty of election outcomes and global summits. However Mr Kelly adds that such empirical work is in the nascent stages and cautions against extrapolating too widely from their findings.

                      And there is a difference between capturing the political risk of what are seen as routine or continuous events versus that of episodic or discontinuous occurrences, notes Karthik Sankaran of Eurasia Group.

                      Elections, for example, are consequential and bring uncertainty, but they are routine in most developed countries (though in Greece they have become worryingly spontaneous and frequent). On the other hand, a sudden and unexpected change in public policy has more potential to wreak sudden, severe damage.

                      Consider how the recent decision by China to slightly devalue its currency spooked global markets. “The sheer unexpectedness of it, coming so soon on the heels of the country’s stock market interventions, made people wonder about the government’s reaction function,” says Mr Sankaran.

                      China’s efforts to shift its economic model away from state-led investment and exports towards greater domestic consumption were well known. An occasional political mis-step should not be so surprising. The profundity and breadth of the latest reverberations suggest that markets had badly assessed the probability of one like this.

                      Surprising political outcomes continue to be meaningful threats to markets, and ones that are likely never to disappear. Markets are limited as guides to political risk — and will not do investors’ work for them.