Equity investors should raise a glass to low rates

BIS calculations highlight just how important central bank easing has been

Gillian Tett

 Ingram Pinn illustration of Gillian Tett column

This year, equity investors have been shouting “three cheers” for central banks.

When Jay Powell, Federal Reserve chairman, dramatically loosened monetary policy in March, he halted a market rout. 

Since then, US stock markets have hit new highs — fuelled most recently by a new Fed inflation policy that was reinforced by the central bank’s comments on Wednesday. 

However, if the boffins at the Bank for International Settlements are correct, the precise quantity of cheers that Mr Powell and his ilk actually deserve is closer to one and a half out of a possible three, for American assets, and a half cheer out of three for Europe.

As part of its latest quarterly assessment on the financial system, the BIS attempted to quantify how much of this year’s equity rally since March has been driven by low rates; the calculation suggests that loose monetary policy accounts for “close to a half and a fifth of the rebound in the US and euro area equity prices, respectively”.

This number-crunching deserves attention given the Fed’s promise not to raise rates until inflation has been above 2 per cent “for some time” and the fact that central banking groups rarely publish such sums. Remember that the BIS is often dubbed the central bank to the central banks.

Let’s put these numbers in perspective. Central bankers all acknowledge in private that low rates are like rocket fuel for asset prices; indeed, this is considered a key transmission channel for monetary policy. But few will admit in public that they are responsible for this summer's stock market surge, either because they do not want to create a “put” for the markets, or get blamed for increasing wealth inequality or become scapegoats if a bubble pops. Or all three.

The BIS, unlike national central banks, does not answer to a specific government. Thus it can be more outspoken about the flaws of modern monetary policy. And this week’s report reveals deep unease at the Basel-based institution about the fact that today’s sky-high asset prices seem at odds with underlying economic data. 

Stock market bulls might retort that recent equity price records reflect a secular shift. Indeed one reason US stock markets have surged is that investors have dashed into Big Tech as the Covid-19 pandemic amplified the power of digital platforms. Indeed, Big Tech mania is now so extreme that the sector’s weight in the S&P 500 index has risen to 45 per cent.

The combined weighting for the tech and communications sector plus Amazon represents “the greatest concentration issue that either equity or credit markets have faced in 50 years,” calculates JPMorgan in a recent note. Even during the craziest moments of last decade’s credit bubble, finance was “only” a little more than 20 per cent.

But that lopsided pattern does not fully explain the entire equity market surge. Nor does the dismal growth outlook. “[Market] levels contrast sharply with the continuing dire state of the economy,” Matt King, analyst at Citi, noted last week.

Hence the BIS interest in calculating the role played by low rates.

The number-crunching exercise was not easy — that’s partly why such efforts are unusual.

The BIS team started by assuming that the value of a share price should represent the sum of the present value of the stream of all expected future dividend payments. It also assumed that short- and long-term dividend expectations could be extrapolated from prices in the futures market. Then it presumed that short-term expectations expressed investors’ views about an economic future that is close enough to imagine.

Meanwhile, long-term expectations (anything beyond five years) were shaped by the “time value” of cash, which they took to mean the rate of return on risk-free assets such as US Treasuries. The BIS economists then calculated the short-term dividend outlook for the S&P 500 and Euro Stoxx 50 indices and then extrapolated the long-term element by comparing short-term components to the full prices of the indices.

This exercise revealed three things.

First, implied short-term dividend projections collapsed in the spring, when the pandemic shattered growth projections.

Second, the long-term element increased because the risk-free rate fell too. 

Third — and most important — when the BIS team calculated what would have happened if rates had remained at February levels, they found that “the long-term components of US and European stock prices would have been roughly 18% and 6% lower than they were on 4 September, respectively”. The short-term component of stock prices would also have declined but only slightly.

This in turn implies that low rates fuelled half of this year’s US rebound and one-fifth of that for Europe.

This methodology is not perfect. But it should make investors ponder what might happen if rates rise. That seems unlikely in the short term because the Fed’s new view suggests that interest rates will stay at rock bottom until at least 2023.

But therein lies the rub. “The more central banks drive real yields down and valuations in risk assets up, the more they will need to keep buying just to keep them there,” Mr King observes.

That could set a nasty trap for central banks and investors alike.

And it is a good reason to keep watching those BIS boffins. 

 The new energy order

Is it the end of the oil age?


Oil fuelled the 20th century—its cars, its wars, its economy and its geopolitics. Now the world is in the midst of an energy shock that is speeding up the shift to a new order. As covid-19 struck the global economy earlier this year, demand for oil dropped by more than a fifth and prices collapsed. Since then there has been a jittery recovery, but a return to the old world is unlikely. 

Fossil-fuel producers are being forced to confront their vulnerabilities. ExxonMobil has been ejected from the Dow Jones Industrial Average, having been a member since 1928. Petrostates such as Saudi Arabia need an oil price of $70-80 a barrel to balance their budgets. Today it is scraping along at just $40.

There have been oil slumps before, but this one is different. As the public, governments and investors wake up to climate change, the clean-energy industry is gaining momentum. Capital markets have shifted: clean-power stocks are up by 45% this year. With interest rates near zero, politicians are backing green-infrastructure plans. 

America’s Democratic presidential contender, Joe Biden, wants to spend $2trn decarbonising America’s economy. The European Union has earmarked 30% of its $880bn covid-19 recovery plan for climate measures, and the president of the European Commission, Ursula von der Leyen, used her state-of-the-union address this week to confirm that she wants the eu to cut greenhouse-gas emissions by 55% over 1990 levels in the next decade.

The 21st-century energy system promises to be better than the oil age—better for human health, more politically stable and less economically volatile. The shift involves big risks. If disorderly, it could add to political and economic instability in petrostates and concentrate control of the green-supply chain in China. Even more dangerous, it could happen too slowly.

Today fossil fuels are the ultimate source of 85% of energy. But this system is dirty. Energy accounts for two-thirds of greenhouse-gas emissions; the pollution from burning fossil fuels kills over 4m people a year, mostly in the emerging world’s mega-cities. Oil has also created political instability. For decades petrostates such as Venezuela and Saudi Arabia, with little incentive to develop their economies, have been mired in the politics of handouts and cronyism. 

In an effort to ensure secure supplies, the world’s big powers have vied to influence these states, not least in the Middle East, where America has roughly 60,000 troops. Fossil fuels cause economic volatility, too. Oil markets are buffeted by an erratic cartel. Concentration of the world’s oil reserves makes supply vulnerable to geopolitical shocks. Little wonder that the price has swung by over 30% in a sixth-month period 62 times since 1970.

A picture of the new energy system is emerging. With bold action, renewable electricity such as solar and wind power could rise from 5% of supply today to 25% in 2035, and nearly 50% by 2050. Oil and coal use will drop, although cleaner natural gas will remain central. This architecture will ultimately bring huge benefits. 

Most important, decarbonising energy will avoid the chaos of unchecked climate change, including devastating droughts, famine, floods and mass dislocation. Once mature, it should be more politically stable, too, because supply will be diversified, geographically and technologically. Petrostates will have to attempt to reform themselves and, as their governments start to depend on taxing their own citizens, some will become more representative. 

Consuming countries, which once sought energy security by meddling in the politics of the oil producers, will instead look to sensible regulation of their own power industry. The 21st-century system should also be less economically volatile. Electricity prices will be determined not by a few big actors but by competition and gradual efficiency gains.

Yet even as a better energy system emerges, the threat of a poorly managed transition looms. Two risks stand out. Autocratic China could temporarily gain clout over the global power system because of its dominance in making key components and developing new technologies. 

Today Chinese firms produce 72% of the world’s solar modules, 69% of its lithium-ion batteries and 45% of its wind turbines. They also control much of the refining of minerals critical to clean energy, such as cobalt and lithium. Instead of a petrostate, the People’s Republic may become an “electrostate”. In the past six months it has announced investments in electric-car infrastructure and transmission, tested a nuclear plant in Pakistan and considered stockpiling cobalt.

China’s leverage depends on how fast other economies move. Europe is home to giant developers of wind and solar farms—Orsted, Enel and Iberdrola are building such projects around the world. European firms are leading the race to cut their own emissions, too. 

America’s trajectory has been affected by the rise of shale oil and gas, which has made it the world’s largest oil producer, and by Republican resistance to decarbonisation measures. If America were to act on climate change—with, say, a carbon tax and new infrastructure—its capital markets, national energy laboratories and universities would make it a formidable green power.

The other big risk is the transition of petrostates, which account for 8% of world gdp and nearly 900m citizens. As oil demand dwindles, they will face a vicious fight for market share which will be won by the countries with the cheapest and cleanest crude. Even as they grapple with the growing urgency of economic and political reform, the public resources to pay for it may dwindle. This year Saudi Arabia’s government revenue fell by 49% in the second quarter. A perilous few decades lie ahead.

Faced with these dangers, the temptation will be to ease the adjustment, by taking the transition more slowly. However, that would bring about a different, even more destabilising set of climate-related consequences. 

Instead, as our special report in this issue explains, the investments being contemplated fall drastically short of what is needed to keep temperatures within 2°C of pre-industrial levels, let alone the 1.5°C required to limit the environmental, economic and political turmoil of climate change. 

For example, annual investment in wind and solar capacity needs to be about $750bn, triple recent levels. And if the shift towards fossil-fuel-free renewable energy accelerates, as it must, it will cause even more geopolitical turbulence. The move to a new energy order is vital, but it will be messy. 

jueves, octubre 01, 2020

WHO WILL RULE TESLAVERSE? / THE ECONOMIST

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Who will rule the Teslaverse?

The race to make the car of the future is hotting up


Arecent video of Elon Musk taking a spin in a new all-electric Volkswagen with Herbert Diess, the German carmaker’s boss, set tongues wagging. vw was forced to deny that a deal with Tesla was in the offing. A deeper bromance between Mr Musk’s firm and his main rival in the market for electric vehicles (evs) looks unlikely. But the meeting highlights how the car industry is at last taking the impending ev revolution seriously.

Giant new businesses are gearing up to support the switch from petrol to electricity. Besides changing the way cars are propelled, this requires batteries, software to ensure these work in harmony with motors, and data harvested from cars that may one day allow them to drive themselves. Over 250 firms are manufacturing electric motors. Forty-seven battery factories are under construction. Anjan Kumar of Frost & Sullivan, a consultancy, expects total new ev-battery capacity to go from 88 gigawatt-hours in 2019, enough to power Texas for less than two hours if plugged into the grid, to 1,400 gigawatt-hours in 2025. Established carmakers are pondering how to loosen the grip of big tech on software.



The total market capitalisation of listed makers of exclusively electric cars now exceeds $400bn. Add producers of batteries that go into them, and the ev-industrial complex, which makes fewer than 400,000 vehicles annually, is worth at least $670bn (not counting miners of lithium and other battery minerals). That is nearly three-fifths as much as traditional carmakers, which churn out 86m cars a year, nearly all of them petrol-powered (see chart 1). Call it the Teslaverse.

As that moniker suggests, Mr Musk’s firm sits at its centre. In July it overtook Toyota as the world’s most valuable carmaker, and kept accelerating—never mind that it made 370,000 cars against Toyota’s 10m and a fraction of the Japanese firm’s revenues (see chart 2). By August Tesla was worth over $450bn. A market correction lopped a third off its share price but it has since rebounded. What would it mean to take it seriously, as investors appear to be?

Car sales could fall by 25% in 2020 owing to pandemic disruption. But the share of evs on the road will continue to grow as emissions regulations tighten, the price of batteries falls and the choice of models expands. Next year three in every 100 cars sold will be pure electric or a plug-in hybrid. The share may rise to 20-25% by 2030, equal to 20m new evs a year.

At the moment Tesla is the “apex predator”, says Adam Jonas of Morgan Stanley, a bank. It has been manufacturing evs at scale longer than any other carmaker and sells more of them. Its elevated share price translates into the lowest cost of capital in the business. A growing offering, with a lorry and pickup soon to hit the road, will widen its appeal. It attracts the best engineers and possesses in Mr Musk, love him or loathe him, a leader with messianic zeal.

Mr Kumar puts Tesla two to three years ahead of rivals in battery technology. Its batteries have a higher energy density, which means better range and lower costs. On September 22nd Mr Musk is expected to present plans for new production capacity and fresh battery technology. Together, this would extend Tesla’s cost advantage.

The firm’s edge is even more pronounced in software. Rainer Mehl of Capgemini, a consultancy, calls Tesla cars a “shell around the software and applications inside”. Thanks to vertically integrated manufacturing, systems have been interlinked from day one. As Olaf Sakkers of Maniv Mobility, an Israeli fund, explains, big carmakers have outsourced almost all their technology apart from internal-combustion engines to suppliers, and focused on assembly and marketing. This makes for a “bird’s nest of complexity”, says Mr Sakkers. Tesla’s software and mechanics are seamless by comparison.

All this software means Teslas improve with age, thanks to regular “over-the-air” updates with new features, bug fixes and even performance upgrades. This makes up for a sometimes shabby finish and questionable reliability. Other big carmakers are five years behind, says Luke Gear of idTechex, a consulting firm.

Tesla also seems to have mostly put what Mr Musk has called “production hell” behind it. As Philippe Houchois of Jefferies, an investment bank, notes, a reputation for delivering models late and over budget has become one for being ahead of time and on budget. A rapidly built new factory in Shanghai began shipping in December and “gigafactories” are under construction in Berlin and Texas that will boost capacity from 700,000 units to 1.3m in 18 months, says Credit Suisse, a bank. Tesla cheerleaders talk of 3m-5m new Teslas annually by 2025, out of a global total of around 85m cars. Mr Musk eventually wants to make 20m a year.

Mr Jonas says that Tesla’s current share price implies it will end up with 30-50% of the car market. This overlooks other sources of revenue: from selling batteries, its operating system or an ev “skateboard” of battery pack and running gear to which others can add a body (and in time more futuristic data and self-driving systems). Even the most wildly optimistic scenarios for Mr Musk’s company, then, leave room in the Teslaverse for others.

Start with the established carmakers. Their lowly valuations may be read as implying they ought to give up trying to make the transition to evs and quietly fade away. But even firms with the heftiest petrol-driven legacies should not be written off. Chinese carmakers show why. The government prodded them to go electric with tough mandates in the hope of dominating the future market. Around half the world’s evs are currently sold in China. The likes of Geely and byd (which also makes batteries) want to expand overseas.

There, big Western carmakers face a slog. Though some suppliers, such as Aptiv, have spun off legacy operations to concentrate on evs and self-driving technology, most remain bound to the internal combustion engine. And lots of car firms, in particular the German premium ones, must contend with powerful unions fearful of job losses resulting from the move to evs’ less complex—and thus less labour-intensive—mechanics.

Despite the difficulties, the industry is desperate to make the ev side work. Mr Kumar estimates that 60% of big car firms’ research-and-development spending now goes on evs, up from 5-10% in 2012. Morgan Stanley reckons big carmakers will invest up to $500bn in evs over the next five years. According to Bernstein, a research firm, they have been “terrible deployers of capital” but they are “waking up”. Potential big sellers on sale this year include vw’s id.3 and Ford’s Mustang Mach-e.

Electric power to the people’s car


vw is leading the charge. It will spend €60bn ($71bn) by 2025 on evs and digitisation. Carmakers typically develop 2-5% of software in-house. In an effort to reinvent itself as a software company, vw wants to boost its share to 60% by 2025. Other carmakers and suppliers harbour similar ambitions. Daimler’s recent tie-up with Nvidia, a giant chipmaker, should allow remote updates by 2024. Aptiv already offers integrated software.

Big firms could create distinct units to lure outside capital and talent, and take risks, suggests Morgan Stanley’s Mr Jonas. Some already are. General Motors (gm) has the Cruise self-driving arm, bmw has iVentures and Toyota has its Mobility Foundation. Another tactic is to invest in startups. On September 8th gm said it would buy an 11% stake in Nikola, a controversial electric-lorry firm, for $2bn (see article). Ford has backed Rivian, which hopes to crack the lucrative pickup market.

The likes of Nikola and Rivian are examples of another part of the Teslaverse. Although they face some big barriers, notably in manufacturing and distribution, raising money is not one of them. Capital is pouring in, helping cars move off the drawing board and into production. Chinese Tesla copycats have sprung up. In America Lucid Motors unveiled its first car at its headquarters near San Francisco on September 9th, with a Tesla-beating 800km range. One of its biggest backers is Saudi Arabia’s sovereign-wealth fund. Lordstown, Fisker and Canoo are aiming to follow Nikola, which went public in June through a reverse merger and is now worth $13bn. Firms working on next-generation solid-state battery technology, such as QuantumScape, backed by vw and Bill Gates, plan to go public soon.

Several Chinese Tesla wannabes, such as Nio, Xpeng and Li Auto, are already listed in New York. They enjoy the benefit of cheap domestic labour, a huge local market and proximity of battery-makers such as byd and catl, the world’s biggest such firm. Nio, which teetered on the brink of collapse in February before a bail-out by the city government of Hefei, where it has a big factory, is now valued at around $24bn.

Carmaking remains a tough business to crack. Assembling bodywork or brakes at scale is different to making gadgets or writing code. Dyson, a British maker of high-tech vacuum cleaners and hand-driers, sunk £500m ($640m) into developing an ev before scrapping the idea. Apple abandoned plans to make a car in 2016, though it is still investing in self-driving systems. Other tech giants are opting instead to invest in startups. In China Baidu, Tencent and Alibaba have backed wm Motor, Nio and Xpeng, respectively. Amazon has put money into Rivian and ordered 100,000 of its electric lorries (in part to show it is serious about reducing its carbon footprint).

To survive in the Teslaverse, companies have to demonstrate they have valuable intellectual property that sets them apart, as many of the upstarts claim. But they must also prove they can sell and maintain their cars, where legacy carmakers have a long track-record. It is too early to divine the winners and losers. Even Mr Musk’s firm could falter. But his vision of an electric future is already emerging victorious.

 Console Makers Now Have Bigger Game to Play

Sony and Microsoft cool their console price war with the new PlayStation and Xbox, as games and services take on greater importance

Sony's PlayStation 5, left, and Microsoft's Xbox Series X will hit stores in November, each priced at $499./ PHOTO: SONY; MICROSOFT

Microsoft Corp. MSFT -1.19% and Sony Corp. SNE +2.64% have cooled their long-running price war over videogame consoles. But that is because a much bigger contest looms.

The two companies have dueled over price since 2006. That is when Sony launched its PlayStation 3 for $100 more than Microsoft was asking for its Xbox 360, which hit the market the year before. That cost Sony some valuable ground, as the PlayStation 3 ultimately sold a little over half the amount of the previous PlayStation model. Microsoft made the same mistake in the next cycle, initially charging $100 more for the Xbox One than the PlayStation 4 when both made their debut in 2013. The Xbox One likewise is estimated to have sold just a little over half the units of its predecessor—and less than half of what the competing PlayStation 4 has sold to date.

Game TheoryMarket value, past 10 yearsSource: FactSet
.billionXbox One launchesMicrosoftSony2011'15'2005001,0001,500$2,000

Both companies seem to have tired of this particular fight. The new flagship models of the Xbox Series X and PlayStation 5 coming out this fall will carry the same price for the first time since 2001, when Microsoft’s first Xbox came on the scene to challenge Sony’s game business. The flagship version of each console will cost $499 when they go on sale in early November.

So who wins? Analysts still give an edge to Sony, given the company’s longer history in games, better-known brand and strength in markets such as Europe and Japan. The initial stock of PlayStation 5 units available for preorder sold out fast this week, and Colin Sebastian, an analyst at Robert W. Baird & Co., noted Thursday that the console was already fetching a 50% premium over its sticker price on eBay. Microsoft, which opens preorders next week, will also lack the next version of its popular Halo game, which was delayed into next year.

However, Microsoft may appeal to some bargain hunters with a $299 version of the new Xbox that lacks an optical drive. But that device also carries a slower processor and less system memory than the flagship, while Sony’s $399 “digital edition” of the PlayStation 5 carries the same components as the main version. Still, Wedbush Securities Inc. analyst Michael Pachter notes that $299 for a next-gen console is a “pretty compelling entry point.”

But ultimately, a war over unit sales becomes less important as the game business evolves. Now entering their third decade of competition, both Sony and Microsoft have enormous bases of players with established game libraries—a growing portion of which is digital games run as a service. Such players are less likely to switch over, given their investment. In its last earnings call in July, Microsoft reported that its Xbox Live membership has hit nearly 100 million players. Notably, Xbox Live membership has more than tripled during the lifespan of the Xbox One, even given that console’s relatively poor performance.

PlayTimeVideogame segment revenue per calendarquarterSource: The company (Microsoft); S&P GlobalMarket Intelligence (Sony)
.billionMicosoftSony2016’17’18’19’200246$8

The success of Xbox Live reflects Microsoft’s larger corporate goal of driving use of its software and cloud services. The company even sells PlayStation versions of Minecraft—the popular world-building game it spent $2.5 billion on in 2014. Sony, by contrast, is far more dependent on its games business, which made up more than a quarter of the company’s revenue for the trailing 12-month period ended in June, compared with about 8% for Microsoft for the same period.

Microsoft’s overall cloud strategy has garnered the company a market value of more than $1.5 trillion—up nearly fivefold since the start of the most recent console cycle in late 2013 and more than 16 times that of Sony’s. PlayStation may keep winning the console war, but Microsoft will be very hard to catch in the much bigger game.