Global Investing

Euro emigration – safety valve or worker drain?

Four years of relentless austerity in many of the euro zone’s most debt-hobbled countries have forced many of their youngest and sometimes brightest workers to grab the plane, train or boat and emigrate in search of work. For countries with a long history of emigration, such as Ireland, this is depressingly familar — coming just 20 years after the country’s last debt crisis and national belt-tightening in the 1980s crescendoed, with the exit of some 40,ooo a year in 1989/90 from a population of just 3-1/2 million people.

The intervening boom years surrounding the creation and infancy of the Europe’s single currency and expansion of the European Union eastwards saw huge net migration inflows back into the then-thriving euro zone periphery  — Ireland, Greece, Portugal, Spain and Italy — and created a virtuous circle of rising workforces, higher demand for housing/goods and rising exchequer tax receipts.

But all that has gone into reverse again since the credit, property and banking crash of 2008.

While the exodus takes short-term pressure off dole queues and national welfare bills, there is growing concern that the timing of this latest wave of young worker emigration comes as underlying societies are ageing, dependency ratios are rising and longer-term pressure on government finances from pension commitments is set to grow.

In a note to clients on Tuesday, Citi economist Michael Saunders details the extent of the renewed migration from the periphery and reckons prolonged austerity is exaggerating the shift and damage to the long-term financial sustainability of these countries’ already battered finances. With Europe’s impending pension shortfalls, he argues, they need higher working populations, not smaller ones.

Funds will find a chill Wind in the Willows: Lipper

“Asset managers are emerging from their comfortable burrow to face a battery of lights.”

Sheila Nicoll, Director of Conduct Policy at Britain’s Financial Services Authority (FSA), had perhaps been reading Kenneth Grahame before her recent speech, and her words are likely to have sent a chilly wind through the willows of the UK funds industry.

The warning “poop poop” being sounded by the regulator has been getting louder and louder. Indeed the FSA may even be traveling faster than Labour Party leader Ed Miliband, who has recently suggested that he would impose a 1 percent cap on pension charges.

Making the most of the shareholder spring

We’ve had a fair while to ponder the implications of a British AGM season which saw investors oust a few CEOs and deal bloody noses to a few others. We’ve also had some data which implies the revolt wasn’t as widespread as advertised, but Sacha Sadan at Legal and General Investment Management thinks we have seen something important, and something that must be exploited.

His take is that austerity is at the heart of the matter. While the public suffers in a faltering economy, and investors stomach dwindling returns, it was never going to fly that pay deals for bosses should survive unchallenged. Add to that government and media pressure on remuneration, plus a new era of investor collaboration thanks to the stewardship code, and you get an ideal set of factors to drive the ‘shareholder spring’.

Of course, austerity won’t (let’s hope) last forever; governments are unlikely to sustain a narrative around ‘fat cat’ bosses; and the media always moves on. For Sadan that makes it crucial for investors to strike while the iron is hot.

Put down and Fed up

Given almost biblical gloom about the world economy at the moment, you really have to do a double take looking at Wall Street’s so-called “Fear Index”. The ViX , which is essentially the cost of options on S&P500 equities, acts as a geiger counter for both U.S. and global financial markets.  Measuring implied volatility in the market, the index surges when the demand for options protection against sharp moves in stock prices is high and falls back when investors are sufficiently comfortable with prevailing trends to feel little need to hedge portfolios. In practice — at least over the past 10 years — high volatility typically means sharp market falls and so the ViX goes up when the market is falling and vice versa. And because it’s used in risk models the world over as a proxy for global financial risk, a rising ViX tends to shoo investors away from risky assets while a falling ViX pulls them in — feeding the metronomic risk on/risk off behaviour in world markets and, arguably, exaggerating dangerously pro-cyclical trading and investment strategies.

Well, the “Fear Index” last night hit its lowest level since the global credit crisis erupted five-years ago to the month.  Can that picture of an anxiety-free investment world really be accurate? It’s easy to dismiss it and blame a thousand “technical factors” for its recent precipitous decline.  On the other hand,  it’s also easy to forget the performance of the underlying market has been remarkable too. Year-to-date gains on Wall St this year have been the second best since 1998. And while the U.S. and world economies hit another rough patch over the second quarter, the incoming U.S. economic data is far from universally poor and many economists see activity stabilising again.

But is all that enough for the lowest level of “fear” since the fateful August of 2007? The answer is likely rooted in another sort of “put” outside the options market — the policy “put”, essentially the implied insurance the Fed has offered investors by saying it will act again to print money and buy bonds in a third round of quantitative easing (QE3) if the economy or financial market conditions deteriorate sharply again. Reflecting this “best of both worlds” thinking, the latest monthly survey of fund managers by Bank of America Merrill Lynch says a net 15% more respondents expect the world economy to improve by the end of the year than those who expect it to deteriorate but almost 50 percent still believe the Fed will deliver QE3 before 2012 is out.  In other words, things will likely improve gradually in the months ahead and if they don’t the Fed will be there to catch us.

Next Week: “Put” in place?

 

Following are notes from our weekly editorial planner:

Oh the irony. Perhaps the best illustration of how things have changed over the past few weeks is that risk markets now fall when Spain is NOT seeking a sovereign bailout rather than when it is! The 180 degree turn in logic in just two weeks is of course thanks to the “Draghi put” – which, if you believe the ECB chief last week, means open-ended, spread-squeezing bond-buying/QE will be unleashed as soon as countries request support and sign up to a budget monitoring programme. The fact that both Italy and Spain are to a large extent implementing these plans already means the request is more about political humble pie – in Spain’s case at least.  In Italy, Monti most likely would like to bind Italy formally into the current stance. So the upshot is that – assuming the ECB is true to Draghi’s word – any deterioration will be met by unsterilized bond buying – or effectively QE in the euro zone for the first time. That’s not to mention the likelihood of another ECB rate cut and possibility of further LTROs etc. With the FOMC also effectively offering QE3 last week on a further deterioration of economic data stateside, the twin Draghi/Bernanke “put” has placed a safety net under risk markets for now. And it was badly needed as the traditional August political vacuum threatened to leave equally seasonal thin market in sporadic paroxysms. There are dozens of questions and issues and things that can go bump in the night as we get into September, but that’s been the basic cue taken for now.  The  backup in Treasury and bund yields shows this was not all day trading by the number jockeys.  The 5 year bund yield has almost doubled in a fortnight – ok, ok, so it’s still only 0.45%, but the damage that does to you total returns can be huge.

Where does that leave us markets-wise? Let’s stick with the pre-Bumblebee speech benchmark of July 25. Since then,  2-year nominal Spanish government yields have been crushed by more than 300bps… as have spreads over bunds given the latter’s equivalent yields remain slightly negative.  Ten-year Spain is a different story – but even here nominal yields have shed 85bp and the bund spread has shrunk by 100bp.  The Italy story is broadly similar.  Euro stocks are up a whopping 12.5%, global stocks are up almost 7 percent, Wall St has hit its highest since May 1, just a whisker from 2012 highs.  Whatever the long game, the impact has and still is hugely significant. An upturn in global econ data relative to recently lowered expectations – as per Citi’s G10 econ surprise index — has added a minor tailwind but this is a policy play first and foremost.

So, climate change in seasonal flows? Well, it was certainly “sell in May” again this year – but it would have been pretty wise to “buy back in June”. Staying away til St Ledgers day would – assuming we hold current levels til then – left us no better off had we just snoozed through the summer.

LIPPER-ETF tiddlers for the chop?

(The author is Head of EMEA Research at Thomson Reuters fund research firm Lipper. The views expressed are his own.)

By Detlef Glow

The exchange-traded fund (ETF) market has shown strong growth since its inception in Europe. Many fund promoters have sought to capitalise on this, seeking to differentiate themselves from rivals and match client needs by injecting some innovation into their product offerings. This has led to a broad variety of ETFs competing for assets, both in terms of asset classes and replication techniques.

Looking at assets under management, however, the European ETF market is still highly concentrated. The five top promoters account for more than 75 percent of the entire industry. On a fund-by-fund basis the concentration is even greater.

A case for market intervention?

As we wait for ECB Mario Draghi to come good on his promise to do all in his power to save the euro,  the case for governments intervening in financial markets is once again to the fore. Draghi’s verbal intervention last week basically opened up a number of fronts. First, he clearly identified the extreme government bond spreads within the euro zone, where Germany and almost half a dozen euro countries can borrow for next to nothing while Spain and Italy pay 4-7%,  as making a mockery of a single monetary policy and that they screwed up the ECB’s monetary policy transmission mechanism.  And second, to the extent that the euro risks collapse if these spreads persist or widen further, Draghi then stated  it’s the ECB’s job to do all it can to close those spreads. No euro = no ECB. It’s existential, in other words. The ECB can hardly be pursuing “price stability” within the euro zone by allowing the single currency to blow up.

Whatever Draghi does about this, however, it’s clear the central bank has set itself up for a long battle to effectively target narrower peripheral euro bond spreads — even if it stops short of an absolute cap.  Is that justified if market brokers do not close these gaps of their own accord?  Or should governments and central banks just blithely accept market pricing as a given even if they doubt their accuracy?  Many will argue that if countries are sticking to promised budgetary programmes, then there is reason to support that by capping borrowing rates. Budget cuts alone will not bring down debts if borrowing rates remain this high because both depress the other key variable of economic growth.

But, as  Belgian economist Paul de Grauwe argued earlier this year,  how can we be sure that the “market” is pricing government debt for Spain and Italy now at around 7% any more accurately than it was when it was happily lending to Greece, Ireland and Portugal for 10 years at ludicrous rates about 3% back in 2005 before the crisis? Most now accept that those sorts of lending rates were nonsensical. Are 7%+ yields just as random? Should governments and the public that accepts the pre-credit crisis lending as grossly excessive now be just as sceptical in a symmetrical world? And should the authorities be as justified in acting to limit those high rates now as much as they should clearly have done something to prevent the unjustifiably low rates that blew the credit bubble everywhere — not just in the euro zone? De Grauwe wrote:

Devil and the deep blue sea

Ok, it’s a big policy week and of course it could either way for markets. An awful lot of ECB and Fed easing expectations may well be in the price already, so some delivery would appear to be important especially now that ECB chief Mario Draghi has set everyone up for fireworks in Frankfurt.

But if it’s even possible to look beyond the meetings for a moment, it’s interesting to see how the other forces are stacked up.

Perhaps the least obvious market statistic as July draws to a close is that, with gains of more than 10 percent, Wall St equities have so far had their best year-to-date since 2003. Who would have thunk it in a summer of market doom and despair.  Now that could be a blessing or a curse for those trying to parse the remainder of the year. Gloomy chartists and uber-bears such as SocGen’s Albert Edwards warn variously of either hyper-negative chart signals on the S&P500, such as the “Ultimate Death Cross”, or claims that the U.S. has already entered recession in the third quarter.

GUEST BLOG: The missing reform in the Kay Review

Simon Wong is partner at investment firm Governance for Owners, adjunct professor of law at Northwestern University School of Law, and visiting fellow at the London School of Economics. He can be found on Twitter at @SimonCYWong. The opinions expressed reflect his personal views only.

There is much to commend in the Kay Review final report. It contains a rigorous analysis of the causes of short-termism in the UK equity markets and wide-ranging, thoughtful recommendations on the way forward.  Yet, it is surprising that John Kay omitted one crucial reform that would materially affect of the achievability of several of his key recommendations – shortening the chain of intermediaries, eliminating the use of short-term performance metrics for asset managers, and adopting more concentrated portfolios.  What’s missing?  Reconfiguring the structure and governance of pension funds.

A major challenge facing pension funds in the UK and elsewhere is the lack of relevant expertise and knowledge at board and management levels.  Consequently, many rely heavily – some would argue excessively – on external advisers.  I have been told by one UK pensions expert that inadequate knowledge and skills within retirement funds means that  investment consultants are effectively running most small- to medium-sized pension schemes in Britain. Another admits that trustees, many of whom are ordinary lay people with limited investment experience, are often intimidated by asset managers.

Risks loom for South Africa’s bond rally

Investors are wondering how much longer the rally in South Africa’s local bond markets will last.

The market has received inflows of over $7.5 billion year-to-date, having benefited hugely from Citi’s April announcement that it would include South Africa in its elite World Government Bond Index (WGBI).  But like many other emerging markets, South Africa has also gained from international investors’ hunger for higher-yielding bonds. And the central bank’s surprise rate cut last week was the icing on the cake, sending 5-year yields plunging another 30 basis points.

There are some headwinds however. First positioning. Around a third of government bonds are already estimated to be in foreigners’ hands. Second, markets may be pricing in too much policy easing (Forward rate agreements are assigning a 77  percent probability of another 50 bps rate cut within the next six months).  That’s especially so given local wheat and maize prices have been hitting record highs in recent weeks.