Another Big-Time Short Squeeze Boosts Markets

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5-24-2016 4-52-08 PM

Explanations for Tuesday’s market rip higher are initially hard to explain.

The Philly Fed President Harker stated late Monday he expected two to three interest rate hikes in 2016. The theme had been, if so, this wouldn’t be bullish for markets. Meanwhile other regional Fed governors, Boston, New York, Chicago, Minneapolis, Dallas, Philadelphia, Atlanta and St Louis recommended keeping the discount rate unchanged.

But with expectations increasing for higher rates the dollar moved higher on weaker expectations from Europe and Japan. This action drove down gold and other commodities but not crude oil which rose on declining rig data.

Let’s remember the largest weights in the S&P for example are Technology, Financials and Energy. All three gained on the day. Tech gained since higher interest rates historically would drive money to the best earnings sector. The same would apply to financials/banks since higher interest rates means better earnings on deposits and lending. And, with oil prices stronger that sector rose as well. So “presto” up we went as another short squeeze was at hand.

Economic data was mixed as the Richmond Fed Manufacturing Index fell to -1 vs prior 14 and into contraction. On the other hand, New Home Sales soared to $619K vs 531K with spring weather the likely cause. And, regarding housing it’s important to note the what’s going on with what you can only call “bicoastal” housing inflation.

Fly-over country data doesn’t matter naturally. That provides the Fed with enough data to dilute the overall data so as to not feature housing inflation data. But it features where high paying jobs are combined with high cost housing.

Article here: Dramatic Time Lapse Animation Showing America's Absurd Million Dollar Home Bubble
As indicated stocks rallied across the globe but clearly not supported by volume reflecting weak participation once again.

Below is the heat map from Finviz reflecting those ETF market sectors moving higher (green) and falling (red). Dependent on the day (green) may mean leveraged inverse or leveraged short (red).

5-24-2016 3-44-15 PM

Volume was light given the magnitude of the advance and breadth per the WSJ was positive.

5-24-2016 3-44-53 PM
 
 12-17-2015 9-04-44 PM Chart of the Day


5-24-2016 3-56-10 PM KBE
 
 
Charts of the Day


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    The NYMO is a market breadth indicator that is based on the difference between the number of advancing and declining issues on the NYSE. When readings are +60/-60 markets are extended short-term.



  • NYSI WEEKLY

    NYSI WEEKLY
    The McClellan Summation Index is a long-term version of the McClellan Oscillator. It is a market breadth indicator, and interpretation is similar to that of the McClellan Oscillator, except that it is more suited to major trends. I believe readings of +1000/-1000 reveal markets as much extended.

  • VIX WEEKLY

    VIX WEEKLY
    The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge". Our own interpretation has changed due to a variety of new factors including HFTs, new VIX linked ETPs and a multitude of new products to leverage trading and change or obscure prior VIX relevance.













It’s hard to know if good news or bad news is bullish or bearish given Tuesday’s light volume burst. But that’s old news now.

What isn’t is what lies ahead and that’s unknown. Obviously Tuesday’s conflicting reaction to higher interest rate enthusiasm is difficult to digest.

But there it is and we won’t know more, barring leaks and Fed talking heads, until mid-June when the next Fed Meeting takes place.

Let’s see what happens.


Barron's Cover

Byron Wien: What’s Ahead for the Markets

At 83, the investing legend and Blackstone strategist is still trotting the globe. What’s next for stocks, bonds, and the economy.

By Andrew Bary


At 83, Blackstone Group strategist Byron Wien continues to engage investor audiences around the world with his views on the economy and markets, as well as life lessons forged from a hard-luck upbringing in Chicago and more than 50 years on Wall Street.

After a broken hip suffered on a tennis court kept him largely confined to New York last year, Wien is back in his groove, traveling regularly to meet with leading global investors, central bankers, and government officials.

He uses opinions and information gleaned from those encounters to write a lively and insightful monthly investment-strategy essay and to offer his views at what probably will be 100 investor meetings this year, mostly with Blackstone’s (ticker: BX) institutional clients, wealthy individuals, and financial advisors. Few on Wall Street network and travel as extensively as Wien does. His monthly strategy essay has an e-mail distribution list of 17,000, and total readership is probably much more than that.

Blackstone is one of the leading private-equity and real estate investors, with more than $340 billion under management. It also runs funds focused on high-yield investments.

“Byron is an 83-year-old man chronologically, but in temperament, he is 45,” says Jim Tisch, CEO of Loews, who has known Wien for more than 20 years. “His passion is the markets and the world around him, and that comes shining through anytime you talk to him. He’s well connected and well informed and is always looking to gain new insights.”

In the past few months, Wien has been offering a bearish view on the U.S. stock market, which he thinks may have a down year in 2016—and “investors will be lucky to get a 5% to 7% annual return” in the coming years. He also believes that the global economy will grow at just 2% this year, below early-year official forecasts of more than 3%. He’s cautiously optimistic on China and worried about Japan. The U.S. economy will be hard-pressed to expand at more than a 2% annual rate, he says. “I don’t think that’s satisfactory to many Americans who want higher growth and the benefits that come with that,” he told Barron’s during a recent visit to Blackstone’s Manhattan office.

A great raconteur, Wien wins over his audiences with his financial forecasts, observations on recent travels, and one of his most popular creations, his list of “Life Lessons.” He came up with that idea three years ago at a conference in Vail, Colo., when he was asked by the host to scrap his usual financial talk and offer a more personal presentation. Initially annoyed at having to shift gears, Wien quickly came up with 12 ideas, which he has since expanded to 20.

Among them: Network intensely, read all the time, travel extensively, and never retire. And unlike many wealthy Wall Streeters, his approach to philanthropy is “to try to relieve pain rather than spread joy. Music, theater, and art museums have many affluent supporters, give the best parties, and can add to your social luster in the community. They don’t need you. Social service, hospital, and educational institutions can make the world a better place and help the disadvantaged make their way toward the American dream.”

Reflecting his philosophy, Wien has endowed two professorships at Harvard University, his alma mater, as well as made gifts supporting Harvard’s financial aid, including a scholarship for orphans. Wien, who was orphaned at 14, excelled in high school and got a lucky break when a Harvard admissions representative came to his Chicago school and asked the guidance counselor to recommend a single student for an interview with an admissions dean.

“The guidance counselor called me in and said, ‘Wien—they called you by your last name then—you’re our pick. Go downtown and don’t make a fool of yourself.’ That changed my life,” Wien says.




At that time, he notes, “Harvard was looking for smart kids from public schools to offset the prep-school kids that were the base of the student body. That was Harvard’s idea of diversity in 1950.”

At a meeting a month ago with financial advisors and their clients at New York’s 21 Club, Wien was in good form. He spoke to the group of about 100 for an hour without notes, outlining his views on the markets and the economy, and offering some insights from a just-completed trip to Asia, where he had a series of meetings in Singapore, Shanghai, Beijing, Hong Kong, and Tokyo. After a florid introduction in which the host likened him to such greats as Jim Thorpe, Vince Lombardi, Michael Jordan, and even Socrates, Wien said, “I sure wish my first wife could have heard that.”

At the 21 Club meeting, he went through his life lessons, emphasizing some career advice: “Don’t try to be better than your competitors; try to be different.” He also said that while many focus on the importance of diet and exercise, he feels that sufficient sleep is underappreciated.
“Sleep is the fuel of performance.”

WIEN’S OFFICIAL JOB TITLE at Blackstone is vice chairman of multi-asset investing, but his real role is as a strategist, advisor, and brand ambassador. He rarely mentions Blackstone products in his presentations. “My job is to advise the firm and its clients on economic, investment, political, and social issues,” he says.

Reflecting his clout and charm, Wien orchestrates a series of lunches each summer in the Hamptons that bring together leading investors and other notables to discuss the markets, the economy, and the world. Participants have included Carl Icahn, Bill Ackman, Wilbur Ross, George Soros, David Koch, and Tisch. Wien then writes about those meetings in a strategy essay, usually without mentioning names.

He acknowledges that the consensus view of the smart money can be wrong, as it was this past summer regarding the now likely Republican presidential nominee Donald Trump: “They thought he wouldn’t last until Thanksgiving.”

Wien’s fans include Peter Thiel, the billionaire PayPal Holdings (PYPL) co-founder and new-economy investor, and Facebook (FB) Chief Operating Officer Sheryl Sandberg. She particularly likes Wien’s life lesson about reading. He advises readers to have a “point of view before you start a book or article and see if what you think is confirmed or refuted by the author.”



And, says Henry McVey, who worked with Wien as a strategist at Morgan Stanley for several years and now is head of global macro and asset allocation at KKR (KKR), the private-equity firm, “Byron possesses two traits that distinguish him from others: humor and curiosity. He uses both effectively to engage clients, business leaders, and government officials. He has an ability to simplify the complex, which is a testament to his intellect.”

Wien’s monthly essays are meant to inform and provoke. His latest piece—“China’s Slowing, So What?”—came after his April trip to Asia. Wien wrote that he has been “projecting (guessing) that Chinese economic growth is running at 4.5%, below official forecasts of close to 7%, and arguing with clients and analysts if I am too high or low.” That debate, he wrote, is missing the key point: “If growth in China were closer to 5% than 7%, is that so bad? China will still be able to create 10 million or more jobs annually. The U.S., Japan, or Europe would be thrilled to grow at that rate.”

Wien is also upbeat on the Chinese consumer, drawing in part on Blackstone’s in-house experts. The firm’s real estate chief Jon Gray told him, “Our malls in China had annual sales increases of 18% a few years ago and then that went down to 12%, and now it’s 8%—but 8% is pretty good.”

THE CHINA PIECE included an observation from former Secretary of State Henry Kissinger, with whom Wien had recently dined. Kissinger told Wien that the goal of China’s leader, Xi Jinping, was “to eliminate corruption that resulted in wealth creation, not the corruption that facilitated the ease of doing business,” such as getting delivery of construction materials at opportune rather than government-mandated times. It’s those kind of observations gleaned from influential people that help distinguish his work.

The Japanese mood, however, is downcast amid disappointment with Prime Minister Shinzo Abe’s failed program to stimulate growth. “In conversations with investors there,” Wien wrote, “I got the feeling that many had lost hope that stronger growth and opportunities for wealth creation were ahead.”

Wien is probably best known for his annual list of “10 Surprises” that he has published at the start of each year since 1986; the forecasts involve financial, business, and political events that he thinks have a better-than-50% chance of occurring in the ensuing 12 months, while the consensus puts the odds at 33% or less. The 10 Surprises began after he started work as Morgan Stanley’s chief U.S. investment strategist in 1985. He was looking to showcase his sometimes maverick views and to distinguish himself from a crowd of prominent strategists, including Leon Cooperman, who then worked at Goldman Sachs.

“Morgan Stanley formed a tribunal to review the idea, and they initially turned it down,” he recalls. “They said, ‘Byron, you could get all 10 wrong and you would embarrass the firm and humiliate yourself. Frankly, we don’t give a damn about your humiliation, but we don’t want the firm to be embarrassed.’ ” Under pressure from Wien, the firm relented, and the 10 Surprises became so popular that Morgan Stanley took a service mark on the phrase, which it now licenses to Wien each year for $1.



So far, Wien is looking prescient with his 2016 surprises, with his cautious take on U.S. stocks, the global economy, and the dollar, as well as a benign interest-rate outlook. On politics, his prediction of an election victory by Hillary Clinton and Democratic control of the Senate looks good now, but he forecast the wrong Republican insurgent to win the nomination: Ted Cruz.

With the possibility now of a Trump presidency, he says, “I’m hopeful that the checks and balances in the American political system will restrain Trump from implementing some of his more extreme ideas.”

WIEN MADE HIS REPUTATION during his 20-year stint at Morgan Stanley, where his elegantly written essays gained a wide and influential following. Indeed, he liked the prospect of the Morgan Stanley perch so much that he gave up a successful job in money management and took a pay cut.

After several jobs early in his career, including advertising (which he hated), he was fortunate to get a job as a securities analyst and later a money manager on Wall Street in the 1960s, when entering that clubby world was tough without money, blood ties, or other connections. He joined Blackstone in 2009 after four years as a strategist at Pequot Capital, a New York investment firm.

Wien loves his current job and the platform, influence, and recognition it gives him at an age when few are still active in the investment field. “They are going to have to carry me out of here in a box,” he told Barron’s. “The job is very demanding, and at Blackstone they don’t make adjustments for age. I’m already the oldest person here by more than a decade. As long as I feel physically that I can do it, I will. I don’t feel a whole lot different than I did 20 years ago.” The firm’s second-oldest employee is Wien’s boss, Blackstone’s 69-year-old co-founder, CEO, and chairman, Steve Schwarzman, who calls Wien an “indefatigable worker and provocative thinker.”

Wien does it all with no staff, save for an assistant. He likes it that way. “When I get in front of people, they know it’s the real me,” he says. “It isn’t somebody feeding me material.” His arrangement at Blackstone is similar to what it was at Morgan Stanley. “I can write whatever I want, and they can fire me whenever they want. I have total intellectual freedom here. Blackstone’s strategy is to hire good people and give them a lot of freedom to do their jobs.”

Wien almost never takes as much as a full-week vacation because he likes to participate in the firm’s Monday morning meeting that involves participants from Blackstone offices around the world.

Wien probably will be on the road for two months this year. He plans a trip to Europe next month and the Middle East in September. He always travels commercial, because he likes interaction with people and views private jets as an extravagance. When speaking before audiences of wealthy individuals, he has fielded questions about how to avoid overindulging their children. He warns them about flying their kids in private jets: “It changes them, and not for the better.”

While he lives well, with an apartment on Park Avenue and a summer house in East Hampton, he’s thrifty in some respects, reflecting his Depression-era upbringing. He invariably takes home a doggie bag from lunch, even from Manhattan’s famed Four Seasons restaurant, a Blackstone haunt. And he’s more liberal politically than some of his friends and cares about U.S. economic competitiveness and income inequality. “The world has changed since 1980 due to globalization and technology,” he says. “As a result, the top 20% has improved their standard of living, the middle 60% has held their own, and the bottom 20% has lost ground. Income inequality has been exacerbated since the recession ended.”

He has some regrets, including not having children. He does have a close relationship with his godchildren. And he shares many common interests—reading, theater, sailing—with his second wife, Anita Volz Wien, to whom he has been married for 37 years. She’s chairman of the Observatory Group, an economic and political advisory firm.

Wien loves living in New York and wouldn’t think of moving to Florida or another low-tax state, although he won’t criticize investment managers and other superrich people who have made the move. “I might have a different attitude if I made a few billion dollars a year,” he says. “I’ve made enough money; the taxes don’t hurt. It’s a privilege to live in New York. Besides the theater and culture, there are so many interesting people. That’s what life is about, exchanging ideas with interesting people.”

“Kissinger is a hero of mine because he is still well connected and relevant at 93,” Wien wrote recently. He hopes to follow Kissinger’s lead and be active and influential for at least another decade.


Antibiotics

When the drugs don’t work

How to combat the dangerous rise of antibiotic resistance
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SOME people describe Darwinian evolution as “only a theory”. Try explaining that to the friends and relatives of the 700,000 people killed each year by drug-resistant infections.

Resistance to antimicrobial medicines, such as antibiotics and antimalarials, is caused by the survival of the fittest. Unfortunately, fit microbes mean unfit human beings. Drug-resistance is not only one of the clearest examples of evolution in action, it is also the one with the biggest immediate human cost. And it is getting worse. Stretching today’s trends out to 2050, the 700,000 deaths could reach 10m.

Cynics might be forgiven for thinking that they have heard this argument before. People have fretted about resistance since antibiotics began being used in large quantities during the late 1940s. Their conclusion that bacterial diseases might again become epidemic as a result has proved false and will remain so. That is because the decline of common 19th-century infections such as tuberculosis and cholera was thanks to better housing, drains and clean water, not penicillin.

The real danger is more subtle—but grave nonetheless. The fact that improvements in public health like those the Victorians pioneered should eventually drive down tuberculosis rates in India hardly makes up for the loss of 60,000 newborn children every year to drug-resistant infections. Wherever there is endemic infection, there is resistance to its treatment. This is true in the rich world, too. Drug-resistant versions of organisms such as Staphylococcus aureus are increasing the risk of post-operative infection. The day could come when elective surgery is unwise and organ transplants, which stop rejection with immunosuppression, are downright dangerous. Imagine that everyone in the tropics was vulnerable once again to malaria and that every pin prick could lead to a fatal infection. It is old diseases, not new ones, that need to be feared.

Common failings
 
The spread of resistance is an example of the tragedy of the commons; the costs of what is being lost are not seen by the people who are responsible. You keep cattle? Add antibiotics to their feed to enhance growth. The cost in terms of increased resistance is borne by society as a whole.

You have a sore throat? Take antibiotics in case it is bacterial. If it is viral, and hence untreatable by drugs, no harm done—except to someone else who later catches a resistant infection.

The lack of an incentive to do the right thing is hard to correct. In some health-care systems, doctors are rewarded for writing prescriptions. Patients suffer no immediate harm when they neglect to complete drug courses after their symptoms have cleared up, leaving the most drug-resistant bugs alive. Because many people mistakenly believe that human beings, not bacteria, develop resistance, they do not realise that they are doing anything wrong.

If you cannot easily change behaviour, can you create new drugs instead? Perversely, the market fails here, too. Doctors want to save the best drugs for the hardest cases that are resistant to everything else. It makes no sense to prescribe an expensive patented medicine for the sniffles when something that costs cents will do the job.

Reserving new drugs for emergencies is sensible public policy. But it keeps sales low, and therefore discourages drug firms from research and development. Artemisinin, a malaria treatment which has replaced earlier therapies to which the parasite became resistant—and which now faces resistance problems itself—was brought to the world not by a Western pharmaceutical company, but by Chinese academics.

Sugar the pill
 
Because antimicrobial resistance has no single solution, it must be fought on many fronts. Start with consumption. The use of antibiotics to accelerate growth in farm animals can be banned by agriculture ministries, as it has in the European Union. All the better if governments jointly agree to enforce such rules widely. In both people and animals, policy should be to vaccinate more so as to stop infections before they start. That should appeal to cash-strapped health systems, because prophylaxis is cheaper than treatment. By the same logic, hospitals and other breeding grounds for resistant bugs should prevent infections by practising better hygiene.

Governments should educate the public about how antibiotics work and how they can help halt the spread of resistance. Such policies cannot reverse the tragedy of the commons, but they can make it a lot less tragic.

Policy can also sharpen the incentives to innovate. In a declaration in January, 85 pharmaceutical and diagnostic companies pledged to act against drug resistance. The small print reveals that the declaration is, in part, a plea for money. But it also recognises the need for “new commercial models” to encourage innovation by decoupling payments from sales.

That thought is taken up this week in the last of a series of reports commissioned by the British government and the Wellcome Trust, a medical charity. Among the many recommendations from its author, Jim O’Neill, an economist, is the payment of what he calls “market-entry rewards” to firms that shepherd new antibiotics to the point of usability. This would guarantee prizes of $800m-1.3 billion for new drugs, on top of revenues from sales.

Another of Lord O’Neill’s suggestions is to expand a basic-research fund set up by the British and Chinese governments in order to sponsor the development of cheap diagnostic techniques.

If doctors could tell instantaneously whether an infection was viral or bacterial, they would no longer be tempted to administer antibiotics just in case. If they knew which antibiotics would eradicate an infection, they could avoid prescribing a drug that suffers from partial resistance, and thereby limit the further selection of resistant strains.

Combining policies to accomplish many things at once demands political leadership, but recent global campaigns against HIV/AIDS and malaria show that it is possible. Enough time has been wasted issuing warnings about antibiotic resistance. The moment has come to do something about it.  


Global Markets: Is the Calm After the Storm Over?

The U.S. Federal Reserve’s renewed appetite for rate increases challenges the status quo in markets.

By Richard Barley
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After careening wildly through the first quarter, global financial markets have been far calmer so far in the second. Now, this fragile stability may be coming to an end.

It is surprising, in fact, how little distance many markets have covered in April and May across a range of asset classes. Take the S&P 500. In the first quarter, it swung in a 230-point range; by Feb. 11 it was down 11% for the year. By March 31 it had regained its poise and was up 0.8% for the year. In the following seven weeks, the index has moved in a 60-point range and is little changed overall.

The dollar fell sharply in the first quarter, too—declining 4.5% against the euro by the end of March—but moves since then have been more muted. The rapid emerging-market rally, which got going in February, has petered out in the past few weeks. Gold rose 17% in the first quarter, but has moved mostly sideways since March.

So the path taken by financial markets in the second quarter has been extremely narrow, relying in part on the murky economic outlook and the central-bank status quo persisting—hardly an ideal state of affairs. But the apparent determination of the U.S. Federal Reserve to challenge the market’s complacent view on interest-rate increases—with an explicit reference to the likelihood of a move in June in the minutes of April’s meeting—may cause renewed volatility.

After all, among the reasons for better-behaved markets have been lower U.S. Treasury yields and a softer dollar based on waning expectations of a Fed rate increase. But markets that have regained their poise can actually encourage the Fed to believe it has room for maneuver. This is the “ Yellen call,” the opposite of the so-called Greenspan put that investors once thought underpinned asset prices.


And if the Fed takes advantage of that, investors will have to reconsider a range of asset prices.

Consider that one of the more striking features of markets in the second quarter has been the ability of both government bonds and stocks to do well. Ten-year U.S. Treasury and German bund yields fell sharply in the first quarter—by around half a percentage point—and remain close to their lows even now.


If the Fed is on the move, that poses a clear challenge for ultra-low yields; an added factor is that oil prices have rebounded a long way, which may lead to higher headline inflation measures later this year.

What will be crucial to watch is whether financial conditions tighten in a world where growth still appears fragile and sluggish, and potential spillover effects of this. Already, there are signs of nerves on China’s exchange rate—a key factor in the turmoil that hit markets last summer and at the start of this year.

It is time for investors to buckle up.


Inequality in China

Up on the farm

Rising rural incomes are making China more equal
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THE main street of Hangbu, a town in Anhui, one of China’s poorer provinces, features the usual mix of rural businesses. Shops selling seeds and fertiliser; others stocked with tools and machinery; a few simple restaurants and a motel. And then there is a shop with a shiny display of iPhones and iPads.

The gadgets are a clue that rural China, long overshadowed by the country’s booming cities, is beginning to do better. More controversially, it also suggests that inequality, epitomised by a huge gap in wealth between cities and the countryside, may be declining. “I would not have opened up if people didn’t have money to buy,” says Yuan Yue, owner of the shop selling iPhones. “The money comes from sweat and toil, but incomes are rising.”

The gains from China’s remarkable growth of the past 35 years have not been evenly shared.

Studies, both official and independent, show that the country has changed from a very equal society into a deeply unequal one. The most commonly used measure of income inequality is the Gini coefficient, a number between 0 and 1 (0 means that all people have the same income, while 1 means that one person has everything). Officially, China’s Gini went from less than 0.3 in the 1980s, making it one of the world’s most equal countries, to nearly 0.5 today, making it one of the least.

Other sources indicate that the deterioration has been even more severe. In a widely cited survey, China’s Southwestern University of Finance and Economics concluded that the Gini had soared to 0.61 by 2010, in the same league as the world’s most unequal countries, such as South Africa. The discrepancy arises in large part because private surveys try to capture a broader range of income sources, including business and investment revenue, whereas official numbers focus on wages.

However, China’s Gini, though high, has started to decline. Officially it has been falling for seven years, from 0.49 in 2008 to 0.46 last year. The Southwestern University survey records only a tiny dip, from 0.61 in 2010 to 0.6 in 2014, but nevertheless corroborates the view that the worst might be past. “Even if official data understate the degree of inequality, the trend of lessening inequality is believable,” says Li Shi of Beijing Normal University.
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From a national perspective, the biggest contributor to rising inequality had been the chasm between the countryside and cities. Now it appears to be the main reason for the decline in inequality. In 2009 the average urban income was 3.3 times higher than the average rural income. The gap has since narrowed to 2.7 times, following six consecutive years in which rural incomes have grown more quickly (see chart). Many of these rural folk in fact work in urban areas, staffing factories or toiling in basic service jobs, but China’s restrictive residency system prevents them from settling permanently in cities.

One explanation for the improving fortunes of such migrants is China’s demographic shift. The country’s working-age population has started to shrink. That has helped fuel wage growth for blue-collar workers. Another factor is that companies searching for cheap labour have moved farther inland, reaching parts of the country that are relatively deprived. Mr Yuan says he started selling iPhones in Hangbu after the arrival of a small cluster of electronics factories just outside the town.

Along the road to Hangbu’s industrial zone, a man sits at a stall trying to recruit workers.

Salaries of 3,000 yuan ($460) a month are just a bit lower than the norm for similar jobs in cities. “Trying to find employees is basically a year-round activity. It comes down to salary. If they aren’t happy, they leave,” says the recruiter.

This exemplifies a theory laid out in 1955 by Simon Kuznets, a Nobel-prize-winning economist.

He argued that as a country starts developing, a big gap opens between those lucky enough to work in better-paid jobs and those languishing in agriculture. But as growth continues, enough people are eventually absorbed into modern parts of the economy to reduce inequality again. Although the theory breaks down as countries get even richer, China seems to be following it for now.
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Yet the shift has not occurred entirely spontaneously. It stems in part from redistributive policies.

Over the past decade China has expanded basic health insurance and welfare, made the first nine years of school free in rural areas and abolished a centuries-old agricultural tax.

Much more can still be done. Government spending on rural areas is still too low, especially through the state pension system. More fundamentally, Chinese law condemns country people to second-class status. In addition to the restrictions on moving to cities, they cannot sell their land, depriving them of what would otherwise be their most valuable asset. Without changes, inequality will continue to plague China. “If we purely rely on economic development, inequality won’t truly fall,” says Gan Li of the Southwestern University of Finance and Economics.

Moreover, the idea that income inequality may be declining is not obvious to many. Inequality of wealth (what people own, as opposed to what they earn) remains extreme. China has more dollar billionaires (596) than America (537), according to the 2015 Hurun rich list. A study by Peking University earlier this year found that the top 1% of Chinese households controlled a third of the country’s assets.

Ostentatious displays of wealth are less frequent since Xi Jinping took over the Communist Party in late 2012 and began a crackdown on corruption. But sports cars, ritzy restaurants and luxury clothing stores are still common in big cities. They are reminders of the riches of a small urban elite, even if the odd rural iPhone points to rising incomes in the countryside.


Finishing What Einstein Started

Marek Abramowicz
. Newsart for Finishing What Einstein Started



GÖTEBORG – A long time ago in a galaxy far, far away, two enormous black holes – each with a mass roughly 30 times larger than that of the sun – collided and merged, sending out a short, powerful blast of gravitational waves. The energy from the blast spread across the universe at the speed of light, diluting its power into the immense vastness of space.
 
More than a billion years later, the energy from the blast reached Earth as an incredibly weak signal, lasting for about a tenth of a second. On September 14, 2015, scientists from the Laser Interferometer Gravitational-Wave Observatory (LIGO) in the United States detected the gravitational wave as gentle chirp on their instruments – providing the first confirmation of a prediction made by Albert Einstein 100 years earlier.
 
LIGO, which operates under the direction of the US National Science Foundation, uses two advanced interferometers. These high-tech wonders, located at opposite ends of the country and put into operation shortly before the successful measurement of the gravitational wave (known as GW150914), operate using the principle of light interference. They detect the strains in space/time geometry induced by gravitational waves by measuring alterations in the arm-lengths of the interferometers. In the case of GW150914, the length changed by less than one-thousandth of the size of a proton.
 
The challenges in detecting such a small change were enormous, given the various types of noise that could influence the measurement and destroy its integrity. LIGO dug the tiny, short chirp out from the omnipresent chaos of space by comparing the measurements of the two interferometers. The noise at one is not correlated with the noise at the other – unlike the signal from a passing gravitational wave, which would occur first at one location and then the other.
 
The signal from GW150914 coincided with such impressive accuracy that any possibility of it being a spurious chance event was excluded.
 
Whether such a feat should win a Nobel Prize is beyond doubt; the only question is who should receive it. LIGO’s success is not only a triumph of technology; it is also – and more importantly – the result of a century of work by theorists on mathematical descriptions of gravitational waves – not just Einstein, but also Leopold Infeld, Joshua Goldberg, Richard Feynman, Felix Pirani, Ivor Robinson, Hermann Bondi, and André Lichnerowicz.
 
LIGO’s discovery, specifically, was made possible by the Polish physicist Andrzej Trautman, who provided gravitational wave theory with sharp mathematical rigor, and the French physicist Thibault Damour, who developed practical mathematical tools for using observed wave fronts to decipher information about the waves’ sources. Their work established the solid mathematical base of the theory that made the success of LIGO possible.
 
Einstein’s Theory of General Relativity is mankind’s greatest intellectual achievement. And yet nobody has received a Nobel Prize for developing its mathematical foundations. The prize has been given to experimental physicists who made observational confirmations of some of the theory’s important predictions. And it has been given to quantum physicists for purely mathematical works. But it has never been awarded to a pure theorist researching relativity.
 
I hope that this year the Nobel committee will recognize the importance of theoretical work and give the prize in the correct proportions: to a single experimental physicist, for developing the technological concepts behind LIGO, and to two pure theoreticians: Trautman and Damour.
 
There is so much more for LIGO – and its European counterpart, called Virgo – to discover.
 
Measurements of gravitational waves will not only provide insights into phenomena that until now were completely out of reach, such as the Big Bang, black hole horizons, and the interiors of neutron stars; they could also revolutionize our understanding of the universe.
 
The Theory of General Relativity describes large-scale physical phenomena: humans, rocks, planets, stars, galaxies, the entire universe. Quantum Mechanics, on the other hand, is equally successful at describing the universe at the smallest scales: quarks, electrons, atoms, and molecules.
 
And yet these fundamental theories of modern physics are incompatible, and perhaps even contradictory. No quantum-gravity theory has been found so far, despite laborious efforts.
 
Several provisional quantum-gravity models of particular phenomena involving black holes have been proposed; but, because none has been tested experimentally, no one knows whether these models are correct (indeed, some lead to acute paradoxes).
 
Many physicists are convinced that these problems indicate a missing ingredient in our understanding of the fundamental principles of nature. In desperation, often mixed with arrogance, some are suggesting completely crazy quantum-gravity concepts, including bizarre alternatives for standard Einsteinian black holes – with no experimental foundation.
 
As a result, for many physicists today, the genuinely fundamental problem of reconciling the two theories has degenerated into pompous, meaningless humbug.
 
What is needed are solid experimental facts to sweep away all this nonsense and perhaps even inspire a solution to the dilemma. And that is exactly what future measurements of gravitational waves could provide.
 
 

miércoles, mayo 25, 2016

WHAT WENT WRONG WITH AIG? / KELLOGG INSIGHT

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What Went Wrong at AIG?

Unpacking the insurance giant's collapse.

Based on the research of Robert McDonald and Anna Paulson
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AIG Financial Crisis

Yevgenia Nayberg
 
The collapse and near-failure of insurance giant American International Group (AIG) was a major moment in the recent financial crisis. AIG, a global company with about $1 trillion in assets prior to the crisis, lost $99.2 billion in 2008. On September 16 of that year, the Federal Reserve Bank of New York stepped in with an $85 billion loan to keep the failing company from going under.
 
Because AIG’s near-failure was a prominent and iconic event in the financial crisis, it provided a touchstone for subsequent financial reform discussions, and a great deal of information about AIG and the rescue is in the public domain. Both the Congressional Oversight Panel and the Financial Crisis Inquiry Commission produced detailed reports that included accounts of AIG, and the Federal Reserve Bank of New York made public a detailed account of its involvement.

Nevertheless, many of us—economists included—remain fuzzy about what happened. How, exactly, did AIG get to the point of failure? In a recent paper, Robert McDonald, a professor of finance at the Kellogg School of Management, and Anna Paulson of the Federal Reserve Bank of Chicago, pull together disparate data and information to create an economic narrative of what went wrong.

“AIG is a mystery to a lot of people and it’s very complicated,” McDonald says. “There were multiple moving parts.”

The company’s credit default swaps are generally cited as playing a major role in the collapse, losing AIG $30 billion. But they were not the only culprit. Securities lending, a less-discussed facet of the business, lost AIG $21 billion and bears a large part of the blame, the authors concluded.

What’s more, McDonald and Paulson examined the assertion that the mortgage-backed securities underlying AIG’s transactions would not default. “After the crisis, there was a claim that these assets had been money-good,” meaning they were sound investments that may have suffered a decline in the short term but were safe overall, McDonald says. “I was deeply interested in learning whether that was true.”


Their analysis showed, in fact, that these assets ended up losing money in the long term—meaning AIG executives’ assertions about the safety of these investments were incorrect.
Risky Credit Default Swaps
Most of the post-mortems of AIG focus on its selling of credit default swaps, which are financial instruments that act like insurance contracts on bonds. In these transactions, the insurance seller (in this case, AIG) in some ways becomes the bond owner.

“Think about home insurance,” McDonald says. “If you’ve sold insurance on a house, and the house burns to the ground, you have to pay. The insurance seller has the same risk as an uninsured homeowner.” Likewise, if the bonds AIG insured did not pay out, the company was on the hook for those losses.

Over the course of these agreements, the value of the underlying asset will change, and one party will pay the other money, called collateral, based on that change; that collateral can flow back and forth between the two parties as the market moves. AIG’s credit default swaps did not call for collateral to be paid in full due to market changes. “In most cases, the agreement said that the collateral was owed only if market changes exceeded a certain value or if AIG’s credit rating fell below a certain level,” McDonald says.

AIG was accruing unpaid debts—collateral it owed its credit default swap partners, but did not have to hand over due to the agreements’ collateral provisions. But when AIG’s credit rating was lowered, those collateral provisions kicked in—and AIG suddenly owed its counterparties a great deal of money.

On September 15, 2008, the day all three major agencies downgraded AIG to a credit rating below AA-, calls for collateral on its credit default swaps rose to $32 billion and its shortfall hit $12.4 billion—a huge change from $8.6 billion in collateral calls and $4.5 billion in shortfall just three days earlier. While this debt kicked in automatically because of the provisions in AIG’s agreements, rather than the willful terminations of its securities lending agreements, “it’s still a little like a bank run, in the sense that all of a sudden you’re in trouble, and the fact that you’re in trouble means you get a big call on your assets,” McDonald says.

AIG had written credit default swaps on over $500 billion in assets. But it was the $78 billion in credit default swaps on multi-sector collateralized debt obligations—a security backed by debt payments from residential and commercial mortgages, home equity loans, and more—that proved most troublesome. AIG’s problems were exacerbated by the fact that these were one-way bets. AIG didn’t have any offsetting positions that would make money if its swaps in this sector lost money.
Securities Lending Rounds Out the Story
McDonald and Paulson’s analysis showed that there was more to the problem than just the credit default swaps. Securities lending lost the company a massive amount of money as well.

Securities lending is a common financial transaction where one institution borrows a security from another and gives a deposit of collateral, usually cash, to the lender.

Say, for instance, that you run a fund with a large investment in IBM. “There will often be reasons people want to borrow your IBM shares, and this is a standard way to make a little extra money on the stock you have,” McDonald says. AIG was primarily lending out securities held by its subsidiary life insurance companies, centralized through a noninsurance, securities lending–focused subsidiary.

Companies that lend securities usually take that cash collateral and invest it in something short term and relatively safe. But AIG invested heavily in high-yield—and high-risk—assets. This included assets backed by subprime residential mortgage loans.

“They had this propensity to invest in real estate,” McDonald says. “There was this idea that real estate investments were safe because the securities had a AAA credit rating.” In the run-up to September 2008, AIG securities lending business grew substantially, going from less than $30 billion in 2007 to $88.4 billion in the third quarter of 2008.

The borrowers of a security can typically terminate the transaction at any time by returning the security to the lender and getting their collateral back. But since AIG had invested primarily in longer-term assets with liquidity that could vary substantially in the short term, returning cash collateral on short notice was not so easy.

“People were worried about AIG in the summer of 2008,” when an analyst report suggested the company was in for trouble, McDonald said. “AIG’s credit rating had been downgraded by all three major agencies in May and June of 2008, and in August and September, people started to terminate their agreements,” asking for their collateral back.

The values of the securities underlying these transactions were falling, due to falling real estate prices and higher foreclosures, and AIG did not have enough other liquid assets to meet all the redemption requests. And just as a possibly crumbling bank can lead depositors to withdraw their cash in a hurry, AIG’s weakened stance led even more securities lending counterparties to return their securities and ask for their cash—which left AIG worse off still.
Not “Money-good”
Problems in both its securities lending business and its credit default business made AIG doubly vulnerable—and meant it had a great deal of outstanding debts. Wherever counterparties could extract themselves from existing business, or not roll over existing agreements, they did: “Everyone wanted to unwind their position with [AIG],” McDonald says.

And because of that, the firm “simply had to supply billions of dollars they couldn’t easily come up with.”

But lack of liquid assets, McDonald found, was not the only problem.

McDonald and Paulson elicited help from colleagues in the Federal Reserve system to tap a database that has information about every underlying component in a packaged security—meaning each individual mortgage in a mortgage-backed security—to determine how sound AIG’s securities were. They concluded that the securities were not in fact as sound as AIG’s executives had purported.

“The pure liquidity story says that if we’d simply loaned AIG the money and walked away, everything would ultimately have been fine,” McDonald says. “The fact that these underlying assets did end up suffering substantial losses, even though the [government rescue] did save the day, suggests that this wasn’t just about liquidity.” The executives’ claim that the assets were “money-good,” he says, can be soundly rejected.