How rosy equities mask a wave of investor nerves

Jarring rallies ‘belie cynicism’ over the power of central banks

Michael Mackenzie

A couple wears face masks as a preventative measure against the COVID-19 coronavirus, as they walk along the promenade in Tsim Sha Tsui of Hong Kong on February 14, 2020. - The death toll from China's virus epidemic neared 1,400 on Friday with six medical workers among the victims, underscoring the country's struggle to contain a deepening health crisis. (Photo by Philip FONG / AFP) (Photo by PHILIP FONG/AFP via Getty Images)
The coronavirus outbreak has replaced last year’s rumbling trade war as the darkest storm cloud bearing down on markets © AFP via Getty Images


Watching financial markets at the moment triggers questions about the wisdom of the crowd.

Record-breaking equities appear at odds with the gloomy message from the bond market, with 10-year government bond yields loitering within sight of all-time lows. Sharply lower industrial metal and oil prices hardly paint a picture that a V-shaped global economic recovery beckons in the coming months.

The coronavirus outbreak has replaced last year’s rumbling trade war as the darkest storm cloud bearing down on markets. Investors can only wait to see whether a China growth scare takes hold from here, or whether this hurricane warning is downgraded to a passing bout of turbulence.

The divergent messages from different asset classes show how a fear trade feeds on itself and ultimately results in record highs in equities, led by quality and growth companies.

Meanwhile, quality companies with strong cash flows are a neat alternative for fund managers who are tired of government bonds’ meagre fixed rates of interest. Popular investment strategies such as risk parity, which combines both bonds and equities, intensify this phenomenon.

Passive investing flows also pump up the value of large companies compared with their smaller peers, as highlighted by higher returns generated since January and over the past year for the Nasdaq 100 and S&P 100 in contrast with their broader benchmarks. In effect, both government bonds and high-quality stocks are fear trades.

Alberto Gallo at Algebris Investments describes the present situation as one of investors “hiding in assets which benefit from central bank liquidity while shunning what depends on growth”.

That’s all well and good for investors who have enjoyed the ride up to now. But there is a long-term cost. Mr Gallo identifies how years of easy money from central banks have created a “winner-takes-all” climate.

“Large firms in a leadership position are able to tap cheap capital and can easily implement consolidation strategies and buy out their competitors. In turn, lower competition reduces economic dynamism and productivity,” Mr Gallo said.

These well-entrenched macro trends fan concerns that crowding further into a narrow cohort of quality and growth companies represents a financial stability accident waiting to happen.

The longer bond yields remain stuck in the basement, the more that growth and quality stocks extend their rise. As investors are well aware, this is fine until it is not. The reckoning, whenever it comes, will be painful.

Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, worries that current market positioning “belies a cynicism about the ability of the Federal Reserve to reflate the economy and drive lasting improvements in the business cycle”.

This, she argues, leaves investors “entering uncertain territory where only the cyclical stocks are valued for the risks of policy failure”.

With that in mind, aside from the health crisis here, which fund managers of course do not ignore, just how do China and other countries respond as the coronavirus growth shock fully registers in economies and markets in the coming weeks?

Given how unreliable leading equities benchmarks are as a gauge of global economic health, riskier and more macro sensitive assets, such as commodities and emerging-market currencies will probably offer a more useful guide. So far, rebounds in those markets have been rather more shallow.

One source of optimism is the hope that China and other countries across the region will deliver smart and vigorous packages of support. If they do, then mix in the soothing in trade tensions, and the hope that the virus subsides, and on paper at least, things look brighter.

Patrick Zweifel, chief economist at Pictet Asset Management, expects a V-shaped recovery in China after a first-quarter decline with tax cuts for sectors hurt by the coronavirus a likely policy response. That sets the stage for a rebound across emerging markets and a weaker US dollar as the year lengthens.

Such an outcome would hopefully provide a foundation for stronger capital expenditures and provides companies geared towards the economy with much needed leverage to boost their earnings growth and absorb higher input costs.

The alternative, and arguably more scary scenario, is that interest rates will be held “lower for longer” but they will support only an expensive niche of equities. That is not a comforting situation, for 2020 or beyond.

The longer this risk runs on, the more urgent it becomes for policy to deliver real-life results.

As Ms Shalett argues: “This is no longer ‘Goldilocks’. Either low rates and excess liquidity make their way into the real economy, driving an uptick in growth rates or cyclical stocks, or they feed an increasingly fragile and risky asset bubble.”

SNB posts $50bn profit on boost from Apple and Amazon and co

Windfall makes Swiss central bank one of the world’s most successful investors in 2019

Sam Jones in Zúrich


The Swiss National Bank announced an annual profit of SFr48.9bn ($50.2bn) on Monday, powered by a huge gain in foreign equity investments, including Apple and Amazon, and a holding of more than 1000 tonnes of gold.

The windfall makes the SNB one of the world’s most successful investors in 2019 — outperforming many of the savviest traders in the hedge fund and asset management industries.

In a statement on Monday, the central bank said that its profit from its foreign-currency positions amounted to SFr40.3bn, while it also recorded a valuation gain of SFr6.9bn on its gold holdings. The profit on its Swiss franc positions was much smaller, at SFr2.1bn.

Swiss monetary policymakers have accumulated huge amounts of foreign-currency assets as part of a battle to hold down the value of the franc. Choppy global markets and mounting political risks worldwide have underscored Switzerland’s reputation as a haven for the super-wealthy and the risk-averse, putting significant upward pressure on the franc as a result.

The SNB is five years into an unprecedented experiment in negative interest rates. The benchmark Swiss rate — currently held at minus 0.75 per cent — is the lowest in the world.

Though this year’s bumper payout is a consequence of monetary policy, and is not part of any profit-seeking agenda, its size has increased the political pressure from Bern for the SNB to share the fruits of its success.

The federal government and cantons will now receive SFr4bn from the SNB — double the amount previously paid out — as part of a special agreement struck to cover 2019 and 2020.

The largest part of last year’s profits came from investments in foreign equities, principally in the US. Included in the SNB’s portfolio at the end of December, according to filings with the Securities and Exchange Commission, was a $4.2bn position in Apple, $3.6bn in Microsoft, $2.4bn in Amazon and $1.6bn in Facebook.

In total, the SNB gained SFr33bn last year from rising global equity markets, it said.

Policymakers at the SNB have so far resisted most efforts to distribute a greater portion of gains linked to its holdings. They argue the bank’s primary concern must be the effective pursuit of monetary objectives, and that outsized gains in any given year could easily be matched under different circumstances by big losses. The SNB must maintain a balance sheet strong enough to accommodate such fluctuations, they argue.

At the heart of the SNB’s concerns is the belief that any appreciation in the value of the franc — which could be large, in the absence of SNB controls — would cause damage to the Swiss economy. Export-dependent industries in the wealthy alpine state could be hit by an even stronger currency.

The policy is not without its critics. Switzerland’s banks, in particular, have suffered as negative rates have squeezed their margins to historic lows, leading to substantial underperformance compared with European and US peers.

Swiss pension funds have also been hit hard. The country has gone from having one of the best funded pension systems in the developed world to one of the worst, as ultra-low bond yields have eroded returns for risk-averse strategies.

Deutsche Bank Is Unexpectedly Rising From The Ashes

by: KCI Research Ltd.
 
 
 
Summary
 
- In the financial sector, there are few large banks as loathed as Deutsche Bank.

. Deutsche Bank has underperformed its U.S. peers dramatically as European Banks have struggled mightily with negative interest rates and the fallout post the GFC.

- Proponents of the lower for longer narrative have made DB a fulcrum stock, and the tide appears to be turning.
          

I will go to my grave... believing that really loose monetary policy greatly contributed to the Financial Crisis. There were obviously problems with regulation, but when we had a 1% Fed Funds rate in 2003 after, to me, it was pretty obvious that the economy had turned (up) and I think the economy was growing at 7% to 9% nominal in the fourth quarter of 2003 and that wasn't enough for the Fed. They had this little thing called 'considerable period' on top of the 1% rate just so we would make sure that their meaning was clear. And it was all wrapped around this concept of an insurance cut… I've made some money predicting boom-bust cycles. It's what I do. Sometimes I am right. Sometimes I am wrong, but every bust I had ever seen was proceeded by an asset bubble generally set up by too loose policy…" 
- Stanley Druckenmiller

"Try to buy assets at a discount rather than earnings. Earnings can change dramatically in a short time. Usually, assets change slowly. One has to know how much more about a company if one buys earnings." 
- Walter Schloss

"A 60:40 allocation to passive long-only equities and bonds has been a great proposition for the last 35 years… We are profoundly worried that this could be a risky allocation over the next 10." 
- Sanford C. Bernstein & Company Analysts (January 2017)

"Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria." 
- Sir John Templeton

"Life and investing are long ballgames." 
- Julian Robertson

 Introduction

In their simplest form, the financial markets, and price action for a majority of the current bull market, can be distilled into the belief and expectation for ever lower interest rates, and expectations for lower for longer long-term interest rates, driving valuation multiples higher.
Said another way, market participants are willing to pay into the stratosphere, as I demonstrated with my analysis of Procter & Gamble (PG), for a perceived stream of safe future cash flows and/or dividends.
 
On the opposite side of the investment ledger are companies whose cash flows are relatively uncertain, including commodity-oriented producers, even though many of these companies, such as Range Resources, which I profiled here, are materially undervalued, and companies who are impaired by low interest rates.

Collectively, these out-of-favor, harder-to-value investments have been driven to unprecedented low valuation multiples, creating a historic bifurcation between "have" and "have not" stocks.
 
Within the financial sector, this bifurcation of "haves" and "have nots" can be clearly demonstrated by the performance of U.S. large-cap banks and their European banking peers.
 
Deutsche Bank (DB) happens to be the most loathed of these European banks, with a clear bullish and bearish divide, which I have illustrated privately in a member article.
 
Building on this narrative, Deutsche Bank has become a fulcrum security, held lower by those who espouse Steve Eisman's view that Deutsche Bank is a "problem bank" (keep in my that Eisman shorted Tesla (TSLA) too so he has had his successes and failures like we all have had), and more importantly, held lower by those that believe interest rates will stay lower for longer.
 
Against this backdrop, something interesting has started to happen. Specifically, Deutsche Bank has started to outperform U.S. large-cap banks, and even its European peers, rising 39.5% year-to-date, and potentially, quietly, sending out a signal that the historic capital rotation I have long been awaiting, potentially triggered by higher long-term sovereign interest rates, which almost nobody expects or is positioned for, is finally on the horizon.
 
Investment Thesis
 
Deutsche Bank is a fulcrum security that stands on the dividing line of the lower for longer narrative that dominates financial markets today. Rising global sovereign interest rates, particularly at the long end of the curve, would be massively bullish for Deutsche Bank, the financial sector in general, and this development has the potential to spark a historic capital rotation.
 
 
Deutsche Bank Shares Have Been Crushed
 
Over the past decade, in a roaring global equity bull market, Deutsche Bank shares have lost a majority of their value, as the long-term chart below shows.
 
(Source: Author, StockCharts.com)
 
 
Strikingly, Deutsche Bank shares trade materially below their 2008/2009 lows and a shockingly far distance from their 2009 recovery highs, let alone their 2007 peak levels.
 
Interestingly, as noted in the introduction, there has been a notable bounce from the lows in Deutsche Bank shares that we will address more later in this article.
 
Relative Performance Has Been Abysmal Too
 
Compared to its European banking peers, including Barclays (BCS), Lloyds Group (LYG), and Royal Bank of Scotland (RBS), Deutsche Bank has been at the bottom of the pack in terms of performance the past decade.
 
(Source: Author, StockCharts.com)
 
 
Looking at the above, Deutsche Bank's relative performance has been very poor compared to its European banking peers over the past decade, however, that is nothing compared to how Deutsche Bank has fared vs. its U.S. banking large-cap peers, JPMorgan Chase (JPM), Bank of America (NYSE:BAC), Wells Fargo (WFC), and Citigroup (NYSE:C) over the past 10 years.

(Source: Author, StockCharts.com)
 
The performance numbers above make it hard to believe that Deutsche Bank is operating a similar businesses, specifically western developed market banking, including often competing against their U.S. peers in capital markets businesses.
 
A Ray Of Light At The End Of The Tunnel
 
Over the last six months, Deutsche Bank shares have actually outperformed both their U.S. and European banking peers, gaining 56.1%, including a 39.5% year-to-date rise in 2019.
 
(Source: Author, StockCharts.com)
 
 
What is sparking this recent out-performance?
 
From my view, it is two factors.
 
First, German interest rates, specifically longer-term interest rates, have recovered from their late summer 2019 lows, as the chart below of the German 10-Year Treasury Yield shows.
 
(Source: Author, StockCharts.com)
 
 
German 10-Year Treasury Yields actually traded above their 200-day moving average in December 2019 and January 2020, before retreating, as global sovereign bond yields have been dragged lower by coronavirus fears, specifically fears of the virus negatively impacting global economic growth (in addition to its devastating human impact) for an undetermined amount of time.
 
Bigger picture, German 10-Year Treasury Yields have been trending lower ever since the Great Financial Crisis, putting tremendous pressure on the European banking sector.
 
 
 
Put into perspective, the fledgling upturn in German 10-Year Treasury yields is a blip on the long-term chart.
 
Having said that, German Treasury Yields have been leading global sovereign bond yields lower, and a sustainable upturn may very well lead global sovereign bond yields higher.
 
The second factor driving the recent surge in Deutsche Bank shares is the return of a prominent investor, specifically the Capital Group Companies, which many investors may know from their retail oriented mutual fund business, which is branded American Funds. This article in the Seattle Times from last Thursday highlights the re-entry of Capital Group in Deutsche Bank shares.
 
 
(Source: Seattle Times)
 
 
With roughly $2 trillion in assets under management, Capital Group Companies is one of the largest active asset managers, so their return to Deutsche Bank shares, after previously exiting, is an encouraging sign.
 
For perspective, Vanguard has roughly $6 trillion in AUM, and Blackrock (BLK) has roughly $7 trillion in AUM, so Capital Group has tremendous reach, size, and scale.
 
Personally, I have experience working with Capital Group directly, including visiting their Los Angeles offices on multiple occasions. From my personal experience, I can attest to the rigorous nature of their due diligence, and additionally to the fact that they are long-term oriented value investors, tending to hold their positions for many years.
 
Their 3.1% stake in Deutsche Bank is right behind Hudson Executive Capital's 3.14% stake, a hedge-fund founded by a JPMorgan alumni, and Blackrock's 4.5% position in DB shares.
 
Notably, Deutsche Bank is Hudson Executive Capital's largest position, showing that even a former JPMorgan executive sees the value disparity between U.S. banks and their European peers.
 
Closing Thoughts - Change Is In The Air and Deutsche Bank Is Leading The Charge
Deutsche Bank, one of the worst performing large-cap European banks, is the poster child between the disparity of returns between the in-favor equities and their out-of-favor counterparts.
 
Additionally, Deutsche Bank has become a fulcrum security for many market participants who believe interest rates will be lower for the foreseeable future.
 
These twin narratives, the bifurcation of performance and the belief in lower interest rates forever, have driven growth investments to a greater period of out-performance vs. value investments than we even saw in late 1999/early 2000.
 
(Source: Bloomberg)
 
 
With capital flows increasingly directed toward price insensitive and valuation insensitive passive index funds and ETFs, many rightly question what could reverse the tide.
 
The rationale is that the leading market capitalization stocks, specifically Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), (GOOG), Amazon (AMZN), and Facebook (FB), which collectively compromise a greater percentage of the S&P 500 Index, as measured by the SPDR S&P 500 ETF (SPY), than even Microsoft, General Electric (GE), Cisco (CSCO), Exxon Mobil (XOM), and Walmart (NYSE:WMT) comprised at the end of 1999, will continue to be the recipient of market inflows.
 
This is one of the main reasons by the way, specifically the influx of fund flows where larger market capitalization firms benefit disproportionately, for the out-performance of JPMorgan Chase's common equity, which was detailed earlier in the article.
 
The answer to this concern is that very similar to 1999/2000, narrative follows price action.
 
Thus, when the current equity market bubble bursts, and rest assured, it's a market bubble in U.S. equities that is greater than the ones we saw in late 1999/early 2000, or in 2007, the leading market capitalization equities today, will see the brunt of the selling pressure.
Wilshire 5000 Version
 
 
When the dam breaks, the "have not" stocks, like Deutsche Bank (DB) will be out of harms way, as they have built their current homes nowhere near the raging rivers and tides of market liquidity.
 
In closing, ironically, Deutsche Bank, a poster child for the negative impact of lower for longer sovereign interest rates, might be sending a warning signal, rising as German long-term interest rates move off what has the potential to be a secular bottom. As Mark Cuban said recently, only one thing matters, and that's interest rates, and the rise in Deutsche Bank's equity may be a sign that they are headed higher.

Ukraine and Turkey: The Foundations of a Strategic Partnership

By: Ridvan Bari Urcosta


Last week, Ukrainian president Volodymyr Zelensky met with his Turkish counterpart, Recep Tayyip Erdogan, in Kyiv. During the visit, Erdogan promised to strengthen military and economic cooperation with Ukraine and emphasized his support for the Crimean Tatars. After all, Crimea has long been central to Turkey’s relationship with Ukraine.

Another key factor in this relationship is a common adversary: Russia. Ankara has sought to use Ukraine and its long-standing connections there to its advantage as it engages with Moscow. Erdogan’s trip to Kyiv happened to coincide with a recent shift in Turkey-Russia relations, particularly in Syria, where the two countries appear to be getting closer to a potential confrontation in Idlib, and in Libya, where they support opposing sides in the civil war.

Erdogan knows that Ukraine is an especially sensitive issue for the Kremlin, which sees a partnership between its critical buffer to the west and its historical rival to the south as a threat to its strategic interests in the Black Sea. By building closer ties to Kyiv, Ankara sees an opportunity to block Russian expansion in a strategic region historically known as the Pontic Steppe.




Turkey’s Interests in the Pontic Steppe

At its peak, the Ottoman Empire stretched from the Atlas Mountains in the west to the Zagros Mountains and the Persian Gulf in the east, and to the Balkans and the Caucasus in the north.

Former Ottoman territories still play a large role in contemporary Turkish foreign policy, particularly in Erdogan’s ambitious agenda to re-establish Turkish influence in the Persian Gulf, Levant, Black Sea, Eastern Mediterranean and North Africa.

As GPF forecast, Turkey has already begun to expand its presence in some of these areas, but while its involvement in places like Syria and the Eastern Mediterranean has garnered much attention of late, its relationship with Ukraine seems to have been mostly overlooked.

Russian Military Presence Around Turkey


Crimea is at the heart of Turkey’s engagement with Ukraine. Beginning in 1475, the Crimean Peninsula came under Ottoman rule, though it still had some autonomy. The Crimean Khanate was useful to the Ottomans as a bulwark against the Russians in the Black Sea for three centuries. With the Ottomans’ help, the khanate controlled strategically important chokepoints in the Black Sea and the Sea of Azov.

These chokepoints are still an integral part of modern-day Turkey’s geopolitical strategy and are crucial in understanding Turkey’s quest to expand its influence north. The Ottomans also controlled three regions north of Crimea that now belong to Ukraine: Odessa, Nikolayev and Kherson. When the Ottoman Empire lost the Crimean Khanate in 1783, it was forced to retreat from many other theaters, particularly the Caucasus and the Pontic Steppe. The Russian Empire then took over these areas that had been occupied by the Turkic people for centuries.

Following the Russo-Crimean Wars in the 16th century, competition between the Ottomans and Russia in Crimea expanded. After the Russo-Turkish War of 1768-1774, Crimea was officially handed over to the Russians with the signing of the 1774 Treaty of Kucuk Kaynarca, regarded as a watershed moment marking the beginning of the Ottoman Empire’s protracted decline.

After years of revolt against Russian rule, the Russian Empire annexed Crimea in 1783 and began to Slavicize Crimea and the surrounding areas. (Interestingly, Russia’s revival of the Novorossiya, or New Russia, concept in 2014 included claims to the Pontic Steppe. Russia used this concept to justify its incursion into Donbass in eastern Ukraine, though Novorossiya extends beyond Donbass to include Kharkov to the north and Odessa to the west.)

Russia had realized that without destroying the Crimean Khanate, it would have been nearly impossible to carry out military operations deep into the Balkans because the Turks and Crimean Tatars would have been able to sever Russian communications and lines of supply in central Ukraine. With Crimea under Russian control, Russian expansionism was formidable and could be stopped only with the emergence of the Russian Revolution in 1917. The Russian Empire thus expanded in two directions: into the Caucasus and into the Balkans.

For Turkey, the loss of Crimea once again reinforced the geostrategic importance of the Pontic Steppe (present-day Ukraine). Though Russia has failed to regain control of much of this area, it has managed to bring Crimea under its jurisdiction, which Turkey will inevitably see as a threat to its security. Turkey’s strategy in Ukraine, therefore, has been to support not just the Crimean Tatar nation but also Ukrainian sovereignty and territorial integrity. So long as the Tatars – who, for the most part, opposed Russian annexation and pledged their support to Kyiv – remain a factor in Crimea, Ankara will have some degree of influence on the península.

Turkey-Ukraine Relations After 2014

Russian President Vladimir Putin once called the Soviet Union’s collapse “a major geopolitical disaster.” And it’s not hard to see why. Russia had lost access to Crimea’s strategic ports, controlled just a small portion of the Black Sea coast and required access to the Turkish-controlled Bosporus just to be able to conduct maritime trade beyond the Black Sea. Turkey, on the other hand, had superior naval forces, control over strategic waterways (namely, the Turkish Straits), and more sovereignty over a larger portion of the Black Sea coast than any other country in the region. Suffice it to say, Turkey was satisfied with this state of affairs.



That is, until 2014, when Russia annexed Crimea. Since then, Moscow’s position in the Black Sea has strengthened, and the possibility of confrontation between Turkey and Russia in the Black Sea has intensified. Indeed, without control of Crimea, Russia likely would not have been able to conduct military and naval operations in its Syrian campaign through the Eastern Mediterranean.

Turkey was alarmed over the rapid geopolitical developments in the region and expressed its support for Ukrainian territorial integrity from the very beginning of the Ukraine crisis, even sending then-Foreign Minister Ahmet Davutoglu to Kyiv for talks in early 2014. To this day, it has not recognized Crimea as part of Russia and maintains close relations with the Mejlis of the Crimean Tatar People, a body that represents Crimean Tatars and was banned by Russia in 2016.

Turkey and Ukraine have also expanded military cooperation; they held joint naval exercises in the Black Sea in March 2016, just a few months after Turkey’s downing of a Russian military jet near the Syrian border. For Ankara, showing that it has a presence in Russia’s critical buffer is a way of increasing pressure on Moscow.

However, military cooperation between the two countries goes back further than 2014. In fact, Turkey has some of the closest ties to Ukraine’s defense industry of any NATO member.

Ukraine’s state-owned defense firm Ukroboronprom has collaborated with Turkish companies Hevelsan, ASELSAN and Roketsan, among others. Last year, the two countries set up a joint venture focused on precision weapons and aerospace technologies. They also participated in joint projects to create An-188 and An-178 military transport aircraft, active defense systems for armored vehicles and radar systems.

In 2019, Ukraine acquired Turkish-made Bayraktar TB2 drones, armed with high-precision MAM-L bombs purchased from Roketsan. Ukrainian experts are expected to help Turkey develop a new, indigenously built battle tank. They even discussed collaborating on corvettes and surface-to-air missiles.

One could argue that Turkey is using Ukraine to sidestep collaborating with Russian defense companies and also to bolster its own defense industry to reduce its dependence on NATO. In the process, the Ukrainian defense sector, which was hurt by the complete disengagement with the Russians, is also benefiting from collaborating with a NATO member, bringing its industry into line with NATO standards.

Economic cooperation has also been growing. During last week’s meeting, Erdogan and Zelensky agreed to complete talks on a free trade agreement, negotiations for which began under former President Petro Poroshenko. Zelensky appears ready to sign a trade deal, even though the benefits to Ukraine, as the weaker of the two economies, are still uncertain.

With a deal in place, the two countries hope to bring trade turnover to $10 billion. Turkey also promised to give Ukraine $36 million in military support. Zelensky, in return, promised to help Erdogan on security issues, instructing Ukraine’s Security Service to look into Ukrainian educational centers linked to Turkish cleric Fethullah Gulen, who Erdogan has accused of orchestrating a coup attempt against him.

In an effort to attract more foreign capital, Zelensky has said he wants to lift a moratorium on farmland sales, raising the issue last year during a speech in Istanbul. (The Ukrainian parliament has since passed a bill that would allow the sale of land to foreigners, except Russian citizens and corporations, beginning in 2024.)

Ukraine has also welcomed the Trans-Anatolian pipeline project, which could bring natural gas from Azerbaijan via Turkey to Ukraine, as well as other parts of Europe. Alternative sources of energy are becoming increasingly important as Russia becomes more reluctant to deliver energy to Turkey and Europe via pipelines that pass through Ukraine, such as the Trans-Balkan pipeline.

In addition, Crimea has continued to play a key role in Ukraine-Turkey relations. As part of Turkey’s quest to promote the concept of Neo-Ottomanism, Turkish officials have emphasized the historical and ancestral links between Turkey and the Crimean Tatars. Former Foreign Minister Davutoglu even regularly met with leaders from the Crimean Tatar community.

Before 2014, this may have irritated Kyiv, but since the Russian annexation, Crimean Tatar representatives have been included in delegations on official visits. As Davutoglu once put it, Crimea is now considered “a bridge of friendship” between the two countries.

Turkey is also the top trade partner for the three regions of Ukraine north of Crimea: Odessa, Nikolayev and Kherson (all part of the Pontic Steppe). And Turkish ally Qatar recently won a bid to develop Olvia port in Nikolayev region, which will be the biggest foreign investment in a Ukrainian port in history.

Immediately after Crimea’s annexation, Turkey and the Crimean Tatars asked Kyiv for permission to build ethnic settlements in Kherson (once part of the Crimean Khanate) for Tatars who had fled Crimea. Poroshenko avoided making a decision on the issue, but Zelensky has pledged his support. Russia will likely stir up anti-Tatar sentiments among locals there to try to convince them to oppose it.

There are between 1 million and 3 million Crimean Tatars in Turkey, most of whom tend to be pro-Ukraine. Erdogan, therefore, has a political incentive to woo the region. In 2017, he spoke with Putin on behalf of two Crimean Tatar leaders who were jailed for opposing the annexation. And recently, Zelensky asked Erdogan to intervene in a case over Crimean Tatars convicted on extremism charges after Russian authorities accused them of being followers of Hizb ut-Tahrir, a group that has been banned in Russia.

In addition to political, economic and military links, the two countries have religious connections. In 2019, the Istanbul-based Ecumenical Patriarchate of Constantinople approved the official decree splitting the Orthodox Church of Ukraine from Russia. Erdogan has declined to comment on religious issues in Ukraine but has met with Bartholomew I of Constantinople, who signed the decree.

It’s worth noting, however, that within the Ukrainian political elite, there is some concern over Turkey’s true intentions and loyalties, especially considering that Ankara has not joined the West in applying sanctions against Russia over Crimea. Ukraine has viewed with suspicion the budding relationship between Putin and Erdogan, which continues despite their countries' disagreements.

When Ukraine hoped to import liquefied natural gas through the Black Sea to reduce its reliance on Russian energy, Turkey refused passage of LNG tankers through the Turkish Straits. Turkey has meanwhile kept the straits open to Russian warships that could be used to threaten Ukraine. However, Kyiv hopes the proposed new Istanbul Canal may be blocked for Russian naval ships since, according to Ukraine, it won’t be governed by the Montreux Convention, which regulates transit through the Turkish Straits.

Both countries have benefited from military cooperation and continue to pursue economic ties, including the proposed free trade deal. Turkey sees Ukraine as a key part of its goal to restore its once overwhelmingly dominant position in the Black Sea, and Ukraine sees Turkey as a counterbalance to Russian influence and leverage in the Black Sea.

Their relationship is driven by their own strategic interests. So long as they need allies in the Black Sea, they will look to each other as strategic partners.

California Capitalism

After years of inaction by the US federal government, state governments like California's have forged ahead with solutions to challenges such as climate change and labor-replacing automation. Indeed, the state is developing its own distinctive political economy.

Laura Tyson , Lenny Mendonca

tyson89_Justin SullivanGetty Images_californiagovernornewsom


BERKELEY – Despite multiplying policy challenges, the United States is crippled by political polarization and consumed with rancorous partisan arguments (often on Twitter and without facts). The resulting paralysis at the federal level means that progressive federalism and initiatives by individual states will be the main channels for policymaking in 2020, and likely beyond.

Once again, California, the world’s fifth-largest economy, is leading the way. The state is developing its own distinctive political economy, “California Capitalism,” through fiscal responsibility, innovation, and cross-sector partnerships to foster inclusive, sustainable, long-term growth.

Since its last employment peak before the 2008 financial crisis, California has added more than two million payroll jobs, the unemployment rate has fallen to a record low of 3.9%, and average per capita income has increased almost 25%. Since the expansion began in 2010, California has added 3.4 million jobs, more than 15% of the nation’s total.

With almost four million small businesses, California also leads the country in new business formation, reflecting the fact that it receives more than half of all US venture-capital funding.

Whereas national economic growth is projected to slow in 2020, California will continue to outpace the rest of the country, owing to forward-looking tax credits and its diverse set of global industries – from manufacturing, agriculture, and trade to technology and entertainment.

But “California Capitalism” is not just about raw economic growth. For policymakers, the real focus is on job quality, regional inclusivity, and environmental sustainability. Hence, one of the state’s immediate concerns is to address a simmering housing and homelessness crisis. After creating a $1 billion affordable-housing fund last year, Governor Gavin Newsom’s 2020-21 budget proposal includes an additional $750 million in emergency funding for the homeless, to encourage California companies to invest their own resources and work alongside state and local governments to address the housing problem.

California continues to lead the country in environmental and climate policies, too. With its commitment to achieve carbon neutrality by 2045, the state is deploying a variety of tools to slow the pace and reduce the risks of climate change. The proposed budget calls for $12.5 billion of additional government investment over five years in pursuit of these goals, around $4.8 billion of which would come under the state’s innovative cap-and-trade system.

The new budget would also create a $1 billion Climate Catalyst Fund to finance low- or no-interest loans for projects to deploy cleaner technologies and infrastructure in areas neglected by private funding sources.

Finally, the budget calls for a 2020 ballot initiative to approve a new $4.75 billion Climate Resilience Bond, which would finance investments in natural and built infrastructure. Around 80% of bond revenues would be used to address near-term climate risks such as wildfires and floods, and the remaining 20% would be devoted to longer-term risks such as those relating to rising sea levels.

In the past, California has demonstrated its climate leadership by negotiating a breakthrough agreement with four major automakers on tough fuel efficiency standards. The state’s deal with Ford, BMW, Volkswagen, and Honda represents about 30% of the US vehicle market, and would cut these automakers’ emissions by 3.7% per year between 2022 and 2026.

Since 2013, California, along with 14 other states accounting for 40% of the US auto market, has operated under a federal waiver that permits it to regulate greenhouse-gas emissions. In a strong display of “resistant federalism,” California, along with 22 other states and several major cities, has responded to an effort by US President Donald Trump’s administration to revoke that right by suing the National Highway Traffic Safety Administration. Both precedent and public opinion indicate that the states’ lawsuit will succeed.

US states are also filling the leadership void on automation and the future of work, a topic occupying policymakers around the world, even as the US federal government has neglected it.

To develop fact-based policies for managing the impact of technology on employment in California, Newsom has created a Future of Work Commission. Business leaders, civic organizations, non-profits, and academics are charged with crafting solutions to ensure that workers compete in a fair labor market and develop the skills required for good jobs.

The commission, no doubt, will confirm findings from around the world that higher education, retraining, and apprenticeship programs offer invaluable pathways for workers to meet ever-changing labor-market needs.

California is already a leader when it comes to world-class universities, state and community colleges, and state-of-the-art research centers. The state’s community-college system is the country’s largest, accounting for around one-quarter of all US community-college students. Community colleges are and will remain America’s largest source of workplace-skills training, conferring substantial wage and employment benefits on those who complete a two-year degree.

Yet only about one-third of community college students in California and nationally graduate or transfer to a four-year institution. Over 60% of California workers lack a four-year college degree. Around one-third of California jobs (compared to about 44% of jobs nationally) pay less than two-thirds of the median wage.

To address these threats, the 2020 budget envisions continued investments in higher education, focusing on access and timely degree completion, with the goal of creating 500,000 “earn-and-learn” apprenticeships by 2029. To that end, the budget dedicates $165 million over a five-year period for multi-craft, pre-apprenticeship programs in the fast-growing construction industry, and to the High Road Training Partnerships to support industry-based training and job-placement partnerships.

But regional and demographic disparities also loom large in California’s labor markets. Mirroring national trends, job growth in California has been unevenly distributed, with nearly 70% of job growth from 2010 to 2018 concentrated in the coastal areas around Los Angeles, San Diego, and San Francisco. And while Latino Californians make up roughly 40% of the state’s population, about 50% of them make $15 per hour or less, and many live in low-growth rural areas.

To counter these trends, Newsom has launched a new Regions Rise Together initiative, which will convene regional leaders to create a comprehensive plan for developing all parts of the state. To jump-start the plan, the state government will establish offices in the Central Valley, Inland Empire, Central Coast, and North State to help develop key sectors tied to regional economies (for example, wood products in the northern forested counties).

With the federal government paralyzed by Trump, policy innovation in the US now depends on the states. In this sense, California Capitalism is not about the Golden State alone. It is about reviving the American Dream.


Laura Tyson, a former chair of the US President’s Council of Economic Advisers in the Obama administration, is a professor at the University of California, Berkeley's Haas School of Business, a senior adviser at the Rock Creek Group, and a senior external adviser to the McKinsey Global Institute.

Lenny Mendonca is Chief Economic and Business Adviser and Director of the California Office of Business and Economic Development.