Category

Economics

The Narratives That Drive Bubbles

By | Economics, Psychology

Tesla recently cut the price of its sport utility vehicle Model Y by $3,000, just four months after its launch, in an effort to maintain sales momentum during the COVID-19 pandemic. This reduction follows price cuts in May on Tesla’s Model 3, Model X and Model S.

Tesla has seen its value skyrocket in recent quarters, rising from a 52-week low share price of $211 to a high of $1,794.99 made on July 13, 2020. That figure, however, is low in the eyes of some. According to a recent report by Piper Sandler, they cite two key factors for their new Tesla price target of $2,322: The company’s edge in manufacturing and resulting unit volume, and the “possibility” that software will allow the company to “eventually” generate operating margins in the mid-20s, currently at 4.7%!

When valuations are so removed from the fundamental value of assets they are considered in a bubble. The hysteria and destruction created by asset bubbles should be something that people have come to be familiar with. In the past twenty years we have experienced the large boom bust bubble of the dot com era and then again in 2008 with the subprime mortgage crisis.

There are many possible causes of these bubbles such as; moral hazard, herding, greater fool theory, extrapolation, or liquidity, but once they expand they are driven by narratives because it is the narrative that infects and influences investors. Economist Robert Shiller once said that the stories investors tell themselves drive their investment thesis, which drives their reason for putting money to work in an economy. They are usually not making rational, cool-headed decisions based upon careful and cautious fundamental analysis. 

The larger theme narratives that seem to be prevailing and driving markets are the Federal Reserve, US/China relations and trade, the pandemic (with its alternating themes of lockdown and vaccines), and the coming US elections. You would think just one of those narratives to be highly influential but you get the full force of the four.

Sometimes a sector is a narrative. Think cannabis stocks or tech stocks in the 1990s — one of the most inflated and irrational bubbles the market has ever seen. Companies with no profits and high expenses were going public. Of course, the bubble burst spectacularly in 2000. The poster child of the promise of growth was pets.com, an online pet food and pet care product retailer. The company lasted about a year. The more product it sold, the more money it lost. We could equate that with today’s gig economy and stock sector. Do you know any stocks like this? (cough – UBER)

There are also individual stock narratives that are just as powerful. Fitbit jumped out to an early lead in the wearable fitness market, an area that many experts believe would see explosive growth in coming years. However, Fitbit’s share price dropped from its IPO price of $20 back in 2015, to shares that now trade at around $6.8. 

Like Fitbit, GoPro is another example of how the narrative drives a company’s stocks to heights that don’t reflect reality.  GoPro’s IPO priced at $24 back in 2014. Today, shares trade at around $4.83.

Sometimes, investors don’t even take the time to develop the full narrative. In 2016, Pokemon GO conquered the world and sent Nintendo’s stock surging. Their stock price rose by over 50 percent, gaining over a billion dollars a day. It totaled over $10 billion in less than a week. There was one problem, Nintendo didn’t actually make Pokemon GO. 

Once the Nintendo spokesperson publicly reminded everyone that the game is made by a different company, the stock price plummeted by more than 30 percent. This “discovery” could have been revealed by a simple Google search or a play-through of the first two seconds of the game. 

When valuations don’t make sense it is the narrative that drives the stock. Everyone loves a story that they can believe in. The fundamental problem with story stocks is their prices are typically bid up by investors who have gone ga-ga over the story. As a result, they often trade much higher than they should relative to their profits, given the financial fundamentals of these companies.

In 1999, Howard Marks of Oaktree Capital Management, wrote in his piece “bubble.com” that “tech stocks had benefited in 1999 from a boom of colossal proportions. They exhibited all of the elements of a market bubble, with an attractive story providing the foundation for a gravity-defying escalation of prices far beyond reason, and for manic behavior on the part of investors.” He urged readers to view the tech stocks skeptically, but also acknowledged that it’s possible for overpriced assets to remain so for a long time. However, at the time he said that he certainly had no idea that the excesses he saw in the market would be remedied as quickly as they did. He also  added that “analysts added little insight in terms of either fundamentals or valuation.”  

In 2019 Tesla sold 367,500 units. In comparison, Toyota sold 10.7 million units. Tesla now has a greater market value than Toyota. Fundamentals or Narrative driven? You be the judge. 

The Hutch Report

The Great Divide Between Cause and Effect

By | Economics, Psychology

Cause and effect is the principle of causality, establishing one event or action as the direct result of another or where the cause is partly responsible for the effect, and the effect is partly dependent on the cause. 

We often look towards correlations in order to identify and resolve cause and effect relationships and there are so many. Is obesity (the effect) directly related to the consumption of fast food (the cause)? Or is obesity related to the fact that people with limited disposable income can only afford to eat at fast food establishments? Or is obesity the result of poor education that leads to poor paying jobs that result in limited disposable income which provokes people to choose affordable fast food outlets?

There is a further complication in that, “Correlation does not imply causation.” Just because two trends seem to fluctuate in tandem, doesn’t prove that they are meaningfully related to one another. As an example we can look at the correlation between the per capita consumption of chicken to total US crude oil imports.  

The Hutch ReportCorrelation is something which we think, when we have limited information at our disposal. So the less the information we have the more we are forced to observe correlations. Similarly the more information we have the more transparent things will become and the more we will be able to see the actual casual relationships. 

As humans, we generate and evaluate explanations in a very spontaneous manner. In fact, to do so is fundamental to our sense of understanding. We don’t like uncertainty and ambiguity. From an early age we respond to issues of uncertainty by spontaneously generating plausible explanations. In our rush for an explanation, we tend to produce fewer hypotheses and search less thoroughly for information. We are more likely to form judgments out of first impressions and fail to account enough for situational variables. This happens very often amongst economists and “may” explain why they are so often wrong in their conclusions. 

As an example, central banks believed that accommodative monetary policies would encourage banks to extend credit to borrowers. Available information regarding lending decisions pre- and post- negative interest rate policy (NIRP), however, indicates that banks did not increase their marginal propensity to lend. Instead, the suppression of rates on behalf of the central banks narrowed banks’ net interest margins and thereby discouraged credit expansion. Loan growth in Europe and Japan has remained weak and, despite the significant rally in global equity markets, bank stocks did not fare better after the arrival of NIRP. This example in itself is vastly over simplified as there are a number of issues that may have played a part in coming to this conclusion. 

So if this is really the case where we, as individuals, tend to jump to conclusions, spontaneously generate plausible explanations or find correlations where there are none, how can we be certain that our leaders, bankers, managers, the media etc, are not doing the same thing?

The general public is provided little to no insight into the detailed thought processes that go into many governmental decisions. How do we know our officials have considered all the angles and come to the best decision possible? All we are given is their decision and a political sound bite designed to provide the appearance of an explanation. We buy into these explanations because they provide us with a sense of certainty. 

If we look towards current events, we see that we are now experiencing an unprecedented level of income inequality in the country but what is the cause of this effect? It forces us to go back into a vicious cycle of thought where we once again are prone to jump to conclusions, explanations with limited information etc. 

To better understand the complexity of these issues you can try coming to your own conclusion with the use of the Five Whys technique. The five whys is an iterative interrogative technique used to explore the cause-and-effect relationships underlying a particular problem. As an example we have taken the recent riots and just brainstormed through the exercise. This doesn’t mean to say we have come to the proper conclusion or have exhausted all the whys, but you can see how finding causality can quickly become a complex issue. 

Effect: Riots

Why? – People are frustrated and are lashing out

Why? – They lack opportunities, equal opportunities and income / they are drowning in debt / injustice

Why? – Available jobs pay low salaries / expenses are increasing / fewer job opportunities / people living beyond their means / inequalities within the justice system

Why? – Increased productivity through technology has led to layoffs / poor levels of education

Why? – Management compensation is linked to increased shareholder value / Decrease costs and increase profits anyway possible / broken education system

If anything, this should persuade you to look deeper into our current state of affairs, question everything you hear and not to assume the explanations that you are being fed are anymore accurate than what you could conclude on your own. The divide between cause and effect is greater than you can imagine. 

The Hutch Report

Where does the stock market and economy meet?

By | Economics, Markets, Psychology

This idea of buying and selling stock in a company was originated by the Dutch in 1602. As the practice spread to other countries the volume of shares increased.  At this point the need for an organized marketplace to exchange these shares became necessary. The modern concept of a stock market took hold in England where traders would meet at a London coffeehouse.  In 1773, the traders took over the coffee house and changed its name to the “stock exchange.” The first exchange, the London Stock Exchange, was thereby founded. The idea made its way to the American colonies with an exchange started in Philadelphia in 1790 and eventually the New York Stock Exchange in 1817. 

The term Stock is used to symbolize an investor’s ownership in a company. Upon purchase of the stock the investor theoretically owns a percentage of everything the company owns or owes. The company’s profitability, or lack thereof, determines whether its stock is traded at a higher or lower price. The practice began as many pioneer merchants wanted to start huge businesses. This required substantial amounts of capital. It was an amount of capital that no single merchant could raise alone. Therefore, groups of investors pooled their savings and became business partners and co-owners with individual shares in their businesses to form joint-stock companies.

Psychological effects

The US economy’s GDP is primarily driven by spending (70%) and investment (18%). The stock market affects gross domestic product primarily by influencing financial conditions and consumer confidence. This confidence spills over into increased spending, which can lead to major purchases, such as homes and automobiles and thereby increase the GDP.  So, when the value of stocks are increasing there tends to be a great deal of optimism surrounding the economy and the prospects of various stocks. In comparison, when the value of stocks are falling, it can have a negative effect on sentiment at which point investors rush to sell stocks to prevent losses on their investments. Those losses typically lead to a pullback in consumer spending, especially if there’s also the fear of a recession (two quarters of negative growth). When GDP rises, corporate earnings increase, which makes it bullish for stocks. The inverse occurs when GDP falls, leading to less spending by businesses and consumers, which drives the markets lower. At least that is the theory. 

Todays reality

Looking at the extraordinary events of today, the stock market looks increasingly divorced from economic reality. The United States is on the brink of the worst economic collapse since the Hoover administration. Corporate profits have crumbled. To date more than 1.8 million Americans have contracted the coronavirus, and hundreds are dying each day. Add to that the death of an unarmed man at the hands of a police officer which has led to daily and nightly protests, widespread anger and looting in cities across the country. You would think that would be enough to destroy consumer confidence. 

However, stocks keep climbing. The coronavirus crisis has cost some 36.5 million American jobs in two months with experts warning that figures could peak above the Great Depression in 1933, yet Nasdaq is less than 1% from its all time highs set back in February and the S&P 500 is down a mere 9 percent from its all time highs.

Economists who have studied the performance of stock markets over time say there’s relatively little evidence that economic growth matters to the outcome of the market at all. According to Ed Wolff, an economist at New York University who studies the net worth of American families, “Stock ownership among the middle class is pretty minimal.” He stated that “The fluctuations in the stock market don’t have much effect on the net worth of middle-class families.” A relatively small number of wealthy families own the vast majority of the shares controlled by U.S. households. According to an analysis by Wolff the most recent data from the Federal Reserve shows that the wealthiest top 10 percent of American households own about 84 percent of the value of all household stock ownership. The top 1 percent controlled 40 percent of household stock holdings.

Ok, this may be true but it still doesn’t take into account the psychological impact of the consumer previously presented. Even if US households own very little stock, the effects of the events we are currently experiencing are putting the brakes on consumer spending. This is already leading to a large number of insolvent businesses. This has a profound impact on GDP and will eventually impact the stock market. Or will it?

Much of the effect of the rising stock market has been explained as the effect of the money printing by the Fed. The theory is the Fed prints money, drives down interest rates which push investment into riskier assets thereby driving up the stock market. There is also the moral hazard effect whereby investors take on additional risk because they believe that no matter what happens the Fed will bailout the markets. 

The Federal Reserve President, Jerome Powell recently explained that in a liquidity crisis, otherwise healthy firms collapse because they can’t access credit. The Fed can resolve such a crisis because it can print and lend unlimited amounts of money. However, in a solvency crisis, companies can’t survive no matter how much they can borrow: they need more revenue. The Fed can’t solve that.

FEBRUARY 12: Federal Reserve chairman Jerome Powell testifies before the Senate Banking, Housing and Urban Affairs Committee on the “Semiannual Monetary Policy Report”
on Wednesday, Feb. 12, 2020. (Photo by Caroline Brehmanl)

So, despite its critical role in the economy, the stock market is not the “same” as the economy. The stock market is driven by the emotions of investors. They can exhibit irrational exuberance which normally occurs during an asset bubble and the peak of the business cycle. Equally we have seen that consumer optimism or lack thereof can impact spending, which makes up 70% of GDP, and also has an effect on stock market performance. So what we essentially have is a situation where investor exuberance is battling underlying deteriorating fundamentals. So far investor exuberance is winning, up until they take Jerome Powell’s words of caution that the Fed has no solution for business insolvency. So the stock market is not the economy but it is influenced by the economy. 

Musical chairs

John Maynard Keynes probably explained it best. According to Keynes, the stock market is not simply an efficient way to raise capital and advance living standards, but can be likened to a casino or game of chance. “For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs–a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops.”

The Ticking Trust Bomb

By | Economics, Psychology

Of all the principle forces that hold our world together the one that acts as the glue of society is called trust. Trust is what keeps relationships in tact by allowing people to live together, work together, feel safe and belong to a group. Trust in our leaders allows organizations and communities to flourish, while the absence of trust can cause fragmentation, conflict and war.

Confidence is the feeling or belief that one can have trust in or rely on someone or something. When trust deteriorates so does confidence, and it is more prevalent in our functioning society than people realise.

Think about the simple act of driving a car. The reason why we even get in one at all is because we have a high level of confidence that the car driving towards us on the same road, at 100km an hour, will not suddenly cross over into our lane and cause a deadly head on collision. 

Think of airplane travel. Everytime we decide to fly we have confidence in the ability of the pilot to get us from point A to point B safetly. Yet on 24 March 2015 the passengers of a Germanwings aircraft were deceived. The Airbus A320-211, crashed 100 km (62 mi; 54 nmi) north-west of Nice in the French Alps. All 144 passengers and six crew members were killed. It was Germanwings’ first fatal crash in the 18-year history of the company. The investigation determined that the crash was caused deliberately by the co-pilot, Andreas Lubitz, who had previously been treated for suicidal tendencies and declared “unfit to work” by his doctor. Lubitz kept this information from his employer and instead reported for duty. Shortly after reaching cruise altitude and while the captain was out of the cockpit, he locked the cockpit door and initiated a controlled descent that continued until the aircraft impacted a mountainside.

Following the incident, Lufthansa and Germanwings said that the crash has not had an impact on booking numbers and many analysts expected only a brief short-term hit and then demand to recover quickly. 

So as catastrophic as this event was, it did not deter millions of passengers from taking a flight that same day or any other following day. So this prompts the question, “How much deception and mistrust does a person have to endure before they lose confidence in that something or someone?” 

We find ourselves in a situation where trust seems to be deteriorating on a number of levels. There is lack of trust in the government, news organizations, international organizations, science, banks, business leaders, health organizations and the list goes on. In fact, seeding distrust among the masses has proven to be an effective weapon against others. But we can’t identify the tipping point.

The financial crisis of 2008 battered the level of trust of the population in their financial system. That loss of confidence created a run on many banks and spawned “Occupy Wall Street.” Eventually the leaders managed to regain a certain amount of trust for the financial system to start working again. The anger dissipated and the Occupy Wall Street movement disappeared. However, confidence in the system was weakened and that distrust and skepticism in our leaders to do what is in the best interest of the population still remains today. 

Seeing bankrupt company leaders receive enormous bonuses, or watch the Federal Reserve state how strong the economy is while justifying printing trillions of dollars to support it are contradictions that are not going unnoticed. In fact, it just slowly adds to the current level of distrust in these institutions.

According to Edelman’s Trust Barometer, 66% of those surveyed do not have confidence that, “Our current leaders will be able to successfully address our country’s challenges.” 

The Hutch ReportWe began by saying that trust and confidence are essentially what keeps our society glued together. What we don’t know is how much confidence and trust has to be lost before society becomes unglued. That lack of information makes the potential for disaster that much greater. 

I was speaking with a fund manager recently about the current actions of the Federal Reserve, bankers and our leaders in general.  I asked him what worried him most. He told me his biggest fear was the next potential crisis which promises to be the greatest crisis of all…..a crisis of confidence. 

The Hutch Report

In a Negative Rate World, Cash is King

By | Economics

If you don’t understand how negative interest rates work yet then you should probably learn quickly.  The stock markets are, once again, close to an all time high and the economy is (depending on who you talk to) booming. However, the Federal Reserve has been signalling there could be the possibility of a rate cut, or in fact a few of them. But with yields already historically low, the Fed does not have much room to manoeuvre (before they hit zero), especially if they find themselves having to battle another recession. 

As we saw during the last crisis of 2008, many central banks reduced policy interest rates to zero to boost growth (It is interesting to read, some 9 years later, Ben Bernanke’s Washington Post Op-Ed on why the Fed did what they did). Since then, we have seen many of them take it a step further and implement a “negative” interest rate policy. 

The amount of negative-yielding government bonds outstanding through 2049 has risen by 20% this year alone. In fact, there is now more than $11 trillion in negative-yielding debt, which means that roughly 30% of developed countries’ sovereign debt yields less than zero. Roughly 6.7 Trillion of the total currently comes from Japan and 3.8 Trillion comes from Europe. Another 800 billion is credit related. 

So what exactly is a negative rate? Think of when you open up a deposit or savings account at your bank, the bank offers you interest for keeping your money with them. Over the years, this interest accumulates and your bank account grows. It is the fee the bank pays you for the opportunity to use your money (see Who Owns the Money in your Bank Account: Hint, it is not you). Equally, you can also purchase government bonds (you lend the government money) which in return will pay you interest over the life of the bond. In the case of negative interest rates, instead of receiving money on deposits, depositors must pay the bank a fee for the luxury of keeping their money there on deposit. That’s right, you deposit money in your bank account and the bank not only uses your money but they take a portion of it for themselves. 

The main reason central banks implement such a policy is to drive investors out of safe assets into risky assets with the intention of crowding out investors to try and jump start the economy. Results of low rates are a weaker currency which helps exporters of that country’s goods, which in turn helps power the economy. Switzerland was the first government to charge a negative interest rate. It implemented this policy between 1972 and 1978. The reason they adopted this strategy was to help stabilize the economy and to prevent its currency from rising too much from foreign investors buying its currency.

But why would anybody want to purchase bonds with a negative yield? As the Financial Times pointed out, “The idea of investing in bonds where you are guaranteed to lose money — if you hold them to maturity — has always seemed paradoxical. But it begins to make sense in a world where you are sure to lose even more money if you stick the cash in a bank.” Notice they said, “if you hold them to maturity”. If you purchase a negative yielding bond with the outlook that rates will continue to get even more negative, then the holder’s of the bonds can walk away with a gain as the price of the bond increases as yields continue to decrease. 

The Hutch ReportIn turn, why would you want to keep your money in a bank that not only does not promise you a return, they charge you a fee to keep your money there? The truth is you probably would not. When a central bank has a negative interest rate, it means that commercial banks have to pay a fee whenever they deposit money into the central bank’s reserves. The commercial bank then makes the decision to pass on those negative rates to the clients of the bank.

If they do not pass on these rates, the negative interest rates therefore result in a direct decline in interest margins for the bank, and result in a decrease in profitability. Competition between the banks and the option for clients to hold liquidity in cash do not allow for the negative interest rates to be passed on to individual clients. The bank essentially takes the hit. In addition, they know that there is a good chance that customers would flee in large numbers to the nearest bank offering a positive rate of return. So you would imagine that banks would never do it. Wrong!

When the SNB first initiated their negative rate policy, it didn’t take long before banks chose to pass the charge onto their customers. The Alternative Bank was the first Swiss retail bank to implement negative interest rates. It charged negative interest of 0.125% on up to 100,000 Swiss francs held in a private account and 0.75% for amounts in excess of 100,000 francs. PostFinance, the Swiss postal bank, was the second retail bank to implement a negative interest rate. The negative 1% annual interest rate applied to customers who hold more than 1 million francs of savings in PostFinance accounts. The Zürcher Kantonalbank (ZKB) introduced a  negative 0.75% annual interest rate for specific high-net-worth customers.

In 2017, UBS introduced fees on big euro deposits held by private clients at the Swiss bank. The move was in response to negative interest rates levied by the European Central Bank on cash deposits.

The IMF Blog pointed out that, “One option to break through the zero lower bound would be to phase out cash.” They go on to say that by doing so, “Central banks would have much more flexibility in policy as they could easily reduce the rate from 2 percent to negative 4 percent to counter a severe recession. The interest rate cut would automatically transmit to bank deposits, loans, and bonds.” Without cash, depositors would have to pay the negative interest rate to keep their money with the bank, making consumption and investment more attractive. This would jolt lending, boost demand, and stimulate the economy.

When cash is available, as is the case in many countries, cutting rates significantly into negative territory becomes much more difficult. Instead of paying negative interest, one can simply hold cash at zero interest. Cash is a free option on zero interest, and acts as an interest rate floor. 

The Hutch ReportIf negative interest rates are to become a long term reality whereby the banks are free to charge customers as they wish, cash will have to be removed from society. As long as cash still circulates in society, banks are at a disadvantage and will risk a run on the bank should they attempt to charge depositors negative rates. However, beware, because negative rates, first designed as a short-term jolt, have now become an addiction.

The Hutch Report

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Drowning in Nestle

By | Economics, Health

Did you know that the human right to safe drinking water was first recognised by the UN General Assembly and the Human Rights Council as part of binding international law in 2010?

However, whenever something is so important that our lives depend on it, there are those that will exploit it for their own gain. Studies in Africa and Asia show that the poorest 20% of the population spend between 3 to 11% of their household income on water. 

Today there are thousands of bottled water companies worldwide but Nestlé is the biggest globally in terms of sales, followed by Coca-Cola, Danone, and PepsiCo, according to Euromonitor International.

Nestle Waters is the water division of Nestle. It owns nearly 64 bottled water brands produced from roughly 100 bottled water factories in 34 countries around the world with 5 million litres sold worldwide. Some of its most popular water brands are PureLife (having the largest market share worldwide), Deer Park, Poland Spring, Acqua Panna, San Pellegrino, Perrier, springs, Water Park, Waterline.

Nestlé states that it supports the human right to water as a basic need, yet they makes billions bottling water that they pay nearly nothing for. 

Their marketing efforts for water have very little to do with it being necessary to sustain life and more to do with selling to the consumer. As they highlight on their site. 

“It is sometimes believed that water is just… water. In fact, every water is different. These differences depend on their origin, consistency, composition, type of protection, and treatment. As a result, every water tastes different. Nestlé Waters offers three categories of water, represented by our 51 unique brands.”

They often overlook the necessities of the water sources to communities when they step in to take them. 

Nestlé faced boycott threats in 2016 after the company purchased a well in Ontario that a small Canadian township had been trying to buy. The Swiss company was also criticised that year for increasing the amount of water it was pumping from a source in Michigan, 120 miles from Flint, a city known for its water crisis. The company was paying just $200 in extraction fees, according to a 2017 investigation by Bloomberg

State of California officials carried out a 20-month investigation and concluded in December 2017 that the company took an average of 62.6 million gallons of water from the San Bernardino spring each year from 1947 to 2015, but didn’t have valid rights for much of the water it has been drawing. However, Nestlé is disputing the findings of the investigation, arguing the company is entitled to keep piping water out of the San Bernardino National Forest — even more water than it has been bottling and selling in the past few years.

More recently, on April 2, 2018, the Michigan Department of Environmental Quality approved a widely-protested plan that would allow Nestlé to pump 250 gallons of water a minute from White Pine Springs. Although there is plenty of water in the Great Lakes area of Michigan (except maybe for Flint), groundwater is rapidly depleting across the United States, and therefore, drought looms ever and ever larger.

Nestlé’s annual sales of bottled water alone total roughly CHF 10 billion ($10.05 billion).

The Hutch Report

The New Economic Hitmen

By | Economics, Finance, Politics

John Perkins original book, “Confessions of an Economic Hitman” and his current book, “New Confessions of an Economic Hitman” brought to light some of the strategies the US has used over the years in order to gain control of foreign reserves that American companies may want to seize, such as oil. 

According to Perkins, the method of achieving this end was to use external consultants such as the one he worked for. They would arrange large loans for those countries via the World Bank and its partner organizations. However, the governments in question never received the money. Instead, the money would be transferred, directly or indirectly, to American companies, including construction firms like Halliburton or suppliers like General Electric. These American entities would then launch infrastructure projects which may have included power grids, or industrial parks and highways. These projects generated huge profits. However, not surprisingly, those profits went to the American companies and a few rich local familes. In the end, these countries that were already weighed down by huge debts just saw their debts grow larger, which in turn pressured the already poor and middle class. 

Typically, a developed country with a dictator that sits on a perch makes for a soft target. Dictators are often propped up by failed systems like corrupt police force and military. They are usually the most eager to redeem their images so if you can take photos with them signing agreements about huge infrastructure projects it will help soften their soily images.  Therefore, they are happy to stand on the podium and tell their ill-informed, semi-literate populace about the development the government is bringing to their country. 

As an example, in the 70s, large loans were provided to build a power grid in Panama. The real goal was to force the then Dictator Omar Torrijos into a situation where he owed the US a lot of money in order to have something to blackmail him with because at that point, his bankrupt country would be beholden to them. As Africans would say, you hold both the yam and the knife. In 1977, Torrijos signed a deal with the US, which guaranteed that the government of Panama would have full control of the Panama Canal starting 1999. In 1981, he was killed in a car crash.

Omar Torrijos

Looking at the situation today with the number of sanctions and tariffs being thrown around one has to wonder who the principle targets of the current administration are. Russia? The truth is, Russia and the US have been playing spy games on each other for years. The real targets are the emerging economies. “I have no doubt that there are economic hitmen targeting emerging economies like Turkey’s,” Perkins said in an interview to the Turkish based Anadolu Agency. But Turkey is not the only country where the US has imposed sanctions and tariffs. Currently, sanctioned countries include the Balkans, Belarus, Burma, Cote D’Ivoire (Ivory Coast), Cuba, Democratic Republic of Congo, Iran, Iraq, Liberia, North Korea, Sudan, Syria, and Zimbabwe.

In today’s globalised world economic hitmen are no longer only US based. Today they may come from any number of other countries, including Russia and China. Globalisation has created huge opportunities for economic hitmen around the planet.

Trump’s administration sees infrastructure as one of the key areas to boost US economy. However, the recently published Infrastructure plan has been criticised for lack of money and is highly dependent on private capital. The US is already running large deficits and the national debt now currently stands at $21.8 trillion. 

China, with its strong infrastructure achievements and the largest amount of foreign exchange reserves (China has by far the largest foreign currency reserves with over two and a half times more than the second largest reserve holder, Japan. When China and Hong Kong reserves are considered together, the total is $3.6 trillion), is constantly looking for low-risk long-term investment projects to achieve asset preservation and appreciation. By targeting the US, China could balance its foreign exchange levels while accelerating the rejuvenation of American infrastructure. This would also transform China into a job creator in the US. 

The Hutch Report

The Hong Kong–Zhuhai–Macao Bridge, 55 kilometres long.

China is currently employing this strategy throughout Africa along with their One Belt, One Road initiative. China has been the largest trading partner of Tanzania for many years with some 350,000 Tanzanians doing jobs related to trade with China. Also Chinese companies have built a number of mega projects in Tanzania, including roads and bridges, creating about 150,000 jobs. 

Interestingly, on his last trip to the continent just before being replaced, Rex Tillerson said that African countries should be careful not to forfeit their sovereignty when they accept loans from China, the continent’s biggest trading partner.

Would Trump be open to outsourcing the development of the US infrastructure to Chinese firms? The short term boost to Trump’s reputation may blind him to the longer term complications. Could the US itself become a target of the economic hitmen?

The Hutch Report

The Slippery Slope of Oil

By | Economics

WTI Oil has been falling steadily from the October high of $76.9, trading currently at $50.96. That is a 33.7% decline in just over a month and a half. Although this may be good news for the end consumer it is causing serious problems elsewhere.

One of the more complicated situations regarding the price of oil has arisen in the province of Alberta. In fact, Alberta is currently in a crisis as the province’s oil is being sold at a discount of about $45 a barrel to WTI. Alberta Premier Rachel Notley has said the price gap between Canadian and U.S. crude is costing the Canadian economy $80 million a day.

You would think that oil being sold for that much of a discount would be bought up in no time, however the reality is more complicated. Where the oil is produced geographically matters, because it needs to be transported from its point of production to a refinery. This impacts the price received for the oil.

Tim McMillan, president and CEO of the Canadian Association of Petroleum Producers, said the main issue is there isn’t enough pipeline capacity. In late August of this year, a Federal Court of Appeal ruling put a halt on the Trans Mountain expansion project; in 2017, the federal government scrapped the Northern Gateway pipeline; and Keystone XL is still hung up in legal wrangling in the United States.

A Scotiabank Economics report ,released this week echoed that point where they said, “Alberta’s oil producers are facing an extraordinary challenge caused by pipeline bottlenecks combined with growing production.” As of 2017, the oil sands were filling up some 2.7 million barrels per day, according to Natural Resources Canada. When that’s combined with other oil sources, the oil awaiting export is roughly the same as pipeline capacity from Western Canada, and so there’s a pinch point: If pipeline capacity is reduced for maintenance, or if companies book pipeline space, but don’t actually send oil — so-called air barrels — then there’s a backlog.

So not only is the falling price of oil exacerbating the current situation in Alberta, we may expect to find a similar situation south of the border. The Permian Basin, which covers 75,000 square miles over West Texas and southeast New Mexico, is the most prolific oil producing basin in the country – so much so that it’s become difficult to find ways to get the product to market. Wells Fargo recently projected that oil pipeline constraints in this area may last until 2020, versus its previous prediction of the third quarter of next year. That means more transport by rail or truck.

The International Energy Agency (IEA) wrote just recently in a report on energy investment that, “Higher prices and operational improvements are putting the US shale sector on track to achieve positive free cash flow in 2018 for the first time ever.” How quickly things can change as the sector may be forced to relive the last downturn where the ink on the chapter 11 filings has hardly had time to dry.

In 2014, the market downturn forced a bunch of companies operating on the edge out of business. Nearly 100 shale companies filed for bankruptcy in 2015 and 2016. Oil was trading around $40 at the time. Although this downturn forced drillers to become more efficient, the BNEFestimated that break-even prices still range from $31.61 a barrel for the best Permian Midland wells to $188.25 for the weakest Permian Delaware wells.

GlobalData Energy came out with an interesting report in June that analysed recent wells drilled by 26 operators in the area. It found that the break-even oil prices for wells with lateral lengths of 4,500 to 10,500 feet ranged from $21 to $48 per barrel. So if you assume somewhere from $30 to $50 breakeven then we can expect to soon see another flood of bankruptcies as oil continues to tank.

The Hutch Report

Vancouver Real Estate – Is the bubble deflating?

By | Economics, Politics

“It is different this time,” “This is the place everybody wants to be,” has been the talking points when referring to the impressive rise of Vancouver and its real estate market. Unfortunately all markets that experience a rapid escalation of asset prices, as we have seen in Vancouver, eventually experience a painful contraction whereby, as macro investor Raoul Pal puts it, “The big uglies come out.” Are we starting to see what those big uglies are in the Vancouver real estate market?

Vancouver has been the victim of a number of economic events in the world that have culminated in the development of its current dangerous real estate bubble. Central bankers driving interest rates down to historic lows and keeping them there for years, the rapid rise of China’s economy along with the massive number of its newly printed Chinese millionaires, the rise of corruption in China, the exodus of this corrupt money along with Chinese government efforts to reign it in, are just a few of these events.

Life in Vancouver, where the talk of real estate riches and Vancouver suddenly becoming the place to be, has become the favourite subject among its residents, although they may not be aware that other regions in the world have experienced the same impact and will experience the same result. 

Top residential real estate brokerages in the US have been promoting US homes to investors in China for years. Brokerage firms in Canada, Australia, New Zealand, and other countries have done the same. They have set up units in China and have partnered with Chinese real estate portals, such as juwai.com. However, one place where the real estate bubble is most prevelent is in China itself. According to a recent report by Bloomberg, a fifth of China’s housing is empty. That’s 50 Million homes! 

This is what happens when rampant speculation in a market is not contained. Unfortunately when there is money to be made people disregard the splitting hangover that the all night party can bring. 

So what has the impact been in Vancouver?

For too long Vancouver disregarded the longer term risks and turned a blind eye to the massive amounts of corrupt speculative money that was pouring in from China. The low interest rates fuelled the building in Vancouver in order to satisfy the insatiable thirst for Vancouver real estate. (This was pretty much the same story in Australia and New Zealand). There was a rapid rise in prices pushed up by Chinese buyers, in addition to Vancouver residents rushing into the market for fear of missing out. The result was Vancouver real estate became quickly unaffordable to many of its own residents. 

Only recently has the government tried to halt the rise. In 2016, Vancouver became the first Canadian City to collect an empty homes tax, charging one per cent of the home’s assessed value if the owners are not living in it or are renting it out for less than six months. In addition, the government also imposed a 20% foreign property buyers tax.  

Elsewhere, New Zealand’s parliament banned many foreigners from outright buying existing homes in the country – a move aimed at making properties more affordable. New Zealand is also facing a housing affordability crisis which has left home ownership out of reach for many.

Canada, New Zealand and others are not the only ones taking measures to reign this in. China has begun cracking down. Over the last decade, an estimated $3.8 trillion in capital has left China. Net foreign direct investment over the same period of time has amounted to $1.3 trillion, leaving the country with a net loss. To reduce capital flight, the Chinese government has developed a complex system of capital controls, such as limiting transfers of $50,000. However, that has not stopped the Chinese from being creative. The CEO of a Chinese company moved $750,000 from China to Metro Vancouver for a real estate deal with the help of nine strangers who each brought $50,000 into Canada for “tourist purposes,” according to a B.C. Supreme Court judgment.

But in spite of these controls the damage has been done and now increasing interest rates may just be fuelling the fire as the news starts to trickle in. 

According to economists at the Royal Bank of Canada, owning a home in Vancouver is the most unaffordable it has ever been in any Canadian City. In fact, they found affordability to now be “at crisis levels” where it would take a record 88.4 per cent of one’s income to cover ownership costs. Statistics Canada reported that, “Credit market debt as a proportion of household disposable income increased to 169.1 per cent as growth in debt outpaced income. In other words, Canadians owed $1.69 in credit market debt for every dollar of household disposable income.”

Credit reporting agency TransUnion released data showing that Vancouver residents have the highest debts among those who are in major cities, owing an average of $38,753 in non-mortgage, consumer debt through the first quarter of 2018.

Vancouver residents, and Canadians in general, are growing increasingly anxious about their ability to handle higher interest rates, with a new survey showing a rising proportion of consumers fear they will be pushed over the brink. Rightly so, they are concerned mostly about their high-ticket items such as a mortgages and car loans.

As we began this article, the explanation for Vancouver’s real estate rise was its attraction as a city, at least according to many of its residents, its natural beauty and idyllic west coast location. Although in my opinion this is true (considering it is my home town) to a point. There is a difference between speculation and purchasing a home to live in. The first clue that we were dealing with speculators, as is the case in China, should have been the number of empty houses and condos in Vancouver (which was the reason the city eventually created the empty homes tax). 

What has been the effect of these controls on speculators?

Vancouver is now ranked as the worst place in the world for luxury homebuyers seeking a return on their investment, according to a global survey of 43 “prime residential” cities. The Knight Frank Prime International Residential Index found that, while luxury property prices globally were up an average of 4.2% in the third quarter, compared with the same period in 2017, they fell 11.2% in Vancouver, where luxury home sales have tanked. No other Canadian city made the list, and Vancouver ended up ranked No. 43.

For those in Vancouver who refuse to believe bubble talk and believe that the Chinese will keep purchasing and supporting the real estate market for years to come, they may want to rethink that. Beijing has warned of its zero tolerance for dual nationality. Now some foreign citizens who held on to their Chinese identity documents fear the consequences of returning, according to South China Morning Post. In addition, it is hard to believe that the Chinese will be rushing to give up their Chinese citizenship at a time in history when China promises to be the next great economic powerhouse. 

The problem with living through a bubble is often the most vulnerable get hurt, as we saw very clearly during the housing bubble and financial crisis of 2007 in the US. The same is most likely to be true for the Vancouver residents that extended themselves purchasing overpriced real estate that they could ill afford. The international speculators will move on as they continue their worldwide search for return. As in other locations, it is likely that they will not hang around long enough to see the real damage that remains once all the air has been taken out of the bubble. 

The Hutch Report

A Day of Carnage in the Trading Rooms

By | Economics, Markets

Thirty-one years ago, on Oct. 19,1987, the Dow Jones Industrial Average plunged 22.6%, its largest one-day percentage-point drop ever.

You may have noticed that the financial media has started to highlight the point drops as opposed to the percentages. To say the Dow lost 500 points makes better news than saying it lost 2%. In percentage terms though this years recent plunges pale in comparison to what “could” happen as we have seen in history.

Here are five of the worst stock market crashes in U.S. history, based on daily percentage losses (source: ajc.com):

Oct. 19, 1987

Percentage change: -22.61 percent

About: Known as “Black Monday,” this devastating crash began in Hong Kong, spread to Europe and then hit the U.S. hard.

Oct. 28, 1929

Percentage change: -12.82 percent

About the crash: The Wall Street Crash of 1929, also known as the Great Crash or the Stock Market Crash of 1929 started on Oct. 24 and signaled the beginning of the 12-year Great Depression. Black Monday, the fourth and worst day of the crash, saw a drop of 12.82 percent.

Dec. 18, 1899

Percentage change: -11.99 percent

About the crash: During the Panic of 1896, the U.S. experienced an acute economic depression caused by a drop in silver reserves and deflation.

Oct. 29, 1929

Percentage change: -11.73

About the crash:  Black Tuesday was the fifth day of the the Wall Street Crash of 1929, also known as the Great Crash or the Stock Market Crash of 1929 that started on Oct. 24 and signaled the beginning of the 12-year Great Depression.

Nov. 6, 1929

Percentage change: -9.92

About the crash: Just a week after the height of the 1929 Stock Market Crash, investors saw another dip.

As many often refer to these numbers when speaking about this event the real point of interest should be in what they were saying back then, which not many financial media tend to refer to. Ironically they were saying many of the things they say today.

We looked back at a Nightly News Broadcast of that time in order to gain a better understanding of the mindset of the time. You would be advised to watch the broadcast because in the words of Philosopher George Santayana, “Those who cannot remember the past are condemned to repeat it.” (See The Nightly News Broadcast October 19, 1987 at the bottom of the post)

The 1987 crash lost much more than the crash of 1929, and although (as they said at the time), “Conditions today are much better than they were then,” “today’s precipitate decline struck fear in hearts and pocket books of even Wall Street veterans.”

All the same actors showed up as they do today with the same speech tracks. New York Stock Exchange Chairman at the time, John Phalen, tried to be reassuring. “We are extremely fortunate today that the country is in a very strong position.”

The word of the Economists was that they were worried that the market plunge at the time could impact the psychology of even those that didn’t own stocks. They worried the consumer would stop borrowing and spending which could grind the economy to a halt. Compare those worries of the time to today. They are the same. The big difference is that today consumers are already heavily indebted. They are carrying mortgage debts, auto loan debts, student loan debts and credit card debts that are far higher than they were in 1987.

The broadcast pointed out that, “A week ago most economists were saying that the stock market decline was merely a correction.” This is also familiar territory. Of course it is always a correction until it isn’t, however making that judgement before the fact is just a guess. On October 19, 1987, that guess turned out to be very wrong. They went on to say that, “Today’s plunge was so huge, so shocking, that no economist, no Wall Street analyst was willing to predict where it would end.” Irony so thick you could cut it with a knife.

By the end of the day, everyone was looking to Washington for some action that may help stop the carnage. At the time President Ronald Reagan ignored the plunge and continued to “brag” about the Reagan recovery. This doesn’t sound to different to anything we would expect today. Although we can probably assume that no matter what kind of serious drop that the stock market may go through in the future, Trump will be quick to blame the Federal Reserve (however that will not stop him from taking credit it for it if it keeps moving up).

All in all, it is a fascinating 9 minutes to watch. We shouldn’t expect to hear anything different today than we did 31 years ago and that means we should have a pretty good idea of what to expect in the future.