Adjusting the CAPE measure

Equity valuations are high. But other options look even worse

A favoured market ratio is not much use as a short-term indicator

EVERY investor would like to find the perfect measurement tool to tell them when to get into, and out of, the stockmarket. The cyclically adjusted price-earnings ratio (CAPE), as calculated by Robert Shiller of Yale University, averages profits over ten years and is used by many as an important valuation indicator. Currently it shows that American shares have hitherto been more highly valued only in 1929 and the late 1990s, periods that were followed by big crashes.

That seems ominous. But as a paper by Dylan Grice and Gregor Obrecht of Calibrium, a Zurich-based private-investment office, makes clear, it is far from conclusive. The CAPE is not much use as a short-term indicator; it has been well above its long-term average for several years now, as it was in the late 1990s.

The main argument for the CAPE is a long-term one. If you divide all past CAPE values into quintiles, the annual returns earned over the subsequent decade by investing in equities when the CAPE was in its most-expensive quintile were more than eight percentage points below the returns earned when the CAPE was in its cheapest quintile (see chart).

However, the case is less cut-and-dried than those numbers seem. First, Messrs Grice and Obrecht point out that this approach is subject to hindsight bias. The long-term valuation range may be clear now; past investors did not know the range when they were actually buying shares. If the data are adjusted to reflect the historical data available to investors at the time, then the outperformance gap falls by more than a percentage point.

A more serious problem relates to the quantity of the data. Mr Shiller has 146 years of numbers for earnings; that breaks down into only 14 completely independent ten-year periods. It is pretty difficult to create a robust statistical case from such a paucity of numbers.

The authors calculate that, based on current valuations, the best forecast for ten-year real annual returns from American equities is 2.6%, well below the historical average. But the range of returns can only be estimated with reasonable confidence to be between -3.4% and +8.7%; something that is likely to seem too broad to be of much use to professional investors.

These criticisms are fair. So why, nevertheless, does it still seem likely that a high CAPE portends lower future returns? Future equity returns can come from only two sources—growth in profits, or the market’s placing a higher valuation on those profits. For example, a high CAPE might be justified when profits are unusually low, by the hope that earnings will recover.

However, profits are high, relative to GDP, at the moment. Perhaps this is the result of a shift in power in favour of capital, at the expense of labour; perhaps it is the result of the greater concentration of some industries, which has given certain businesses monopoly-like margins. It is possible that this shift is permanent, and that profits will not fall back as they have in previous cycles. But it seems the height of optimism to believe that profits will grow faster than GDP, ie, that the overall share of capital will rise even further.

GDP growth is itself largely driven either by an increasing number of workers or by a rise in their productivity. Since the size of the workforce is rising more slowly (and is set to fall in some countries), and recent productivity growth has been disappointing, it is hard to be more optimistic on this score. So rapid growth in either GDP or profits looks difficult to achieve.

Turning to valuation, some believe that the CAPE has trended higher in recent decades because of better accounting standards and corporate governance. Earning high returns in an era of sluggish profits growth would require valuations to rise even further, reaching dotcom-era levels. Even a partial reversion to the mean (the long-term CAPE average is 16.8 compared with about 30 today) would be very bad news. Here, too, there is a natural limit on returns.

However, the authors point out that investors are not looking at equities in isolation; they are choosing between asset classes including cash (yielding virtually nothing) and government bonds. Government-bond yields are very low in historical terms; in other words, valuations are very high. A comparison of the expected returns from equities and bonds shows equities should perform much better, even given the high level of the CAPE.

That insight chimes with the views of many fund managers. They are nervous about equity valuations but they find government bonds deeply unattractive. So they are stuck with the stockmarket as the “least dirty shirt” on offer.

jueves, noviembre 30, 2017




Why Leaders Are Made, Not Born

Game Theory

Inspired by her own struggles, Harvard Business School historian Nancy Koehn turned to figures from the past who overcame adversity to leave a lasting mark on civilization. She learned that true leaders are those who can forge through impossible odds with intelligence, compassion and resilience. Koehn has captured the stories of five inspiring historical figures in her book, Forged In Crisis: The Power of Courageous Leadership in Turbulent Times. They include Abraham Lincoln, who presided over the United States at a pivotal time in its young history; Frederick Douglass, an abolitionist who escaped slavery to become a writer and a statesman; Dietrich Bonhoeffer, a German clergyman who became a double agent against the Nazis; Ernest Shackleton, a polar explorer who survived a shipwreck on an ice floe; and Rachel Carson, a scientist whose work sparked the modern environmental movement. Koehn recently joined the Knowledge@Wharton show on SiriusXM channel 111 to discuss her book and why true leaders are made, not born.

An edited transcript of the conversation follows.

Knowledge@Wharton: Where did the idea for this book come from?

Nancy Koehn: Ironically, the germs of the book came from finding myself in a series of completely unexpected crises, both personal and professional. My father died. Three months later, my husband walked out after 15 years of marriage. I got cancer with no risk factors. A couple of years passed, I got cancer again, befuddling all the doctors. I was beset by high waves and huge, big, strong winds.

I realized I’m a historian by training, so I grabbed for books of Abraham Lincoln’s writings. I started at the back of his life, the end of the Civil War, and I reread backwards. With each of his letters and speeches and columns he wrote for newspapers, I kept thinking to myself, “Nancy, you think you have crises; Lincoln had much more to deal with, both in terms of being president and dealing with all kinds of personal losses he and his wife had suffered.”

That was the genesis. How do we navigate through crisis? How do leaders? Because this was so clear in Lincoln’s case. How do leaders not only navigate and lead their followers through crisis, but how do they become better, stronger, more embracing of a worthy purpose with more access to their muscles of moral courage? I thought that was such a compelling question.

That was really the beginnings of the book. Then I found these other four fascinating people with their jaw-dropping, gripping stories, and I was off to the races.

Knowledge@Wharton: Lincoln’s story is well-known to most Americans, as is perhaps the story of Frederick Douglass. But the other people you selected — Ernest Shackleton, Rachel Carson and Dietrich Bonhoeffer — are not exactly household names.

Koehn: That was part of the reason to include these stories I stumbled on. I didn’t know much about Douglass, even though I’m a historian. I was trained as a European historian. I think a lot of Americans don’t know the astounding challenges he overcame as a slave who escaped to the North to get his freedom, and then as a tireless activist to abolish slavery.

Ernest Shackleton was this explorer whose boat goes through the ice off the coast of Antarctica in 1915. He’s stranded with lifeboats, some canned goods and no means of communication, and somehow he’s got to get his 27-man team home alive.

Dietrich Bonhoeffer was a German Lutheran pastor who was active in the resistance to Hitler throughout the 1930s. In the 1940s, he becomes a double agent within with the Nazi government to try and kill Hitler and overthrow the Third Reich.

Rachel Carson is this very quiet, retiring scientist and writer who literally rocks the world and almost single-handedly launches the environmental movement when she publishes Silent Spring in 1962.

I just thought these stories are amazing. They’re like the best movies we’ve ever seen. I’ve got to tell them.

Knowledge@Wharton: Bonhoeffer’s story as a double agent and a pastor is something that a Hollywood movie scriptwriter would love.

Koehn: I could not agree more. You can’t make this stuff up. Here’s a man who’s a pacifist, who’s a deeply committed Christian, who has spent years of his young adult life lecturing on Jesus’s Sermon on the Mount as the noose of Nazi evil tightens. He has family members who are working inside the government as resistors, so he knows the inside story of what the Nazi government is doing, including the beginnings of what we call today the Holocaust. He is more and more frustrated by his inability to do something, through alternative churches that he and others have helped found, to resist the Nazi government.

Eventually, he has to come to terms with this terrible moral dilemma, which is, “We may have to kill Hitler in order to stop a much greater evil. Yet we cannot escape the moral consequences of what we’re doing.” He grapples with that and ultimately decides to cross that line and do that. The story is fascinating inside and out in terms of what he experienced.

Knowledge@Wharton: Wasn’t one of his problems also the fact that Adolf Hitler and Nazis really didn’t respect the church that much to begin with?

Koehn: Not at all. They had no patience for the true teachings of Christianity, either in the Old Testament or in the New Testament, and for Judaism. They had absolutely no respect for the nobler messages of a lot of great religions. They were doing everything they could to manage and control churches toward messages that supported their power, that supported Nazi teachings. Again, here’s someone who, everywhere he turns, is stymied by an authoritarian regime bent on war and bent on making war on its own citizens, anyone they considered enemies of the state. Some of the really interesting and gripping parts of the chapter are the Gestapo trying to trap Bonhoeffer.

Knowledge@Wharton: Unfortunately, Bonhoeffer was assassinated. At that time, that was the only option that Nazis considered. If you were thought to be against their establishment, they were willing to get rid of you and not even think twice.

Koehn: Right. And Bonhoeffer was from a very well-connected family in Berlin, a storied family with a great deal of power. They were not supporters of the Nazi regime, but they were historically very important people. It speaks to their determination to literally eliminate suspected enemies that they murdered Bonhoeffer. He is killed by the German state in April 1945. Two weeks later, the place where he is murdered is liberated by Allied Forces advancing into Germany. But for a couple of weeks, this brave, serious, very courageous man would have lived.

Knowledge@Wharton: Did I read correctly that he spent some time in the United States?

Koehn: He spent a critical year in New York, teaching and lecturing and learning at the Union Theological Seminary. He was back there again in 1939. His friends in Germany had spirited him off for a year away before he was either called up for conscription, because the Nazis were making war in 1939, or he was arrested by the Gestapo. He goes to New York and realizes, “I cannot be here in good conscience. I have to go back and join my brethren in the struggle to overthrow Nazi Germany.” He gets on one of the last ships to sail for Germany from America before war breaks out, a month before World War II begins.

Knowledge@Wharton: You said there are elements of Douglass’s life that a lot of people don’t really know or understand. Take us deeper.

Kohn: Let me give you one example that still stays with me. I use it in my own life to steel my own muscles of courage. Douglass was a strong, very intelligent, very resourceful teenager who couldn’t stand being a slave. His owner sends him off to a man named Edward Covey, who is known as a slave-breaker. These were people whose job it was to intimidate slaves into more docility and more subservience through both through physical violence and emotional abuse.

Owners often sent recalcitrant black men to these people.

Douglass is with the slave-breaker and he’s scared. Covey’s been beating him. He had run away to his owner to seek some kind of redress. His owner had sent him back to Covey. He’s worried that Covey’s going to attack him, and Covey comes at him one hot summer Monday morning. Douglass decides in that moment to step into the fear and confront Covey. They have this huge physical fight. It goes on for two hours. They’re wrestling. They don’t have weapons. Covey calls other slaves to come help him, and the black man and woman he calls refuse to get involved. They watch. And for two hours, these men wrestle. In the end, it’s a draw. Neither brings the other to the ground decisively. But a draw for Frederick Douglass is a victory. Covey relents and never, ever touches Frederick Douglass again.

In his first autobiography, Narrative of a Slave, Douglass says, “You have seen how a man is made a slave. Now you see how a slave was made a man.” He recovers his self-confidence. He recovers his sense of identity. He rips through, cuts through the years of varnish of depression and loss of agency that slavery, and particularly this man, has imposed on him, and he is made, he has access to his stronger self. That is such a powerful lesson for all of us, when we face some of our worst fears and take the first small step into that fear to discover our truer, braver, stronger self. It’s an amazing story, and there are many more like it in his life’s journey.

Knowledge@Wharton: He is considered to be one of the most important African-Americans of the 19th century.

Koehn: Oh, I think he was. I think he’s one of the most important leaders in American history.

The book makes the point that these two leaders of the five, Abraham Lincoln and Frederick Douglass, ended up working for a common purpose to end slavery. They came to know each other, and they came to respect each other.

I make this point, which is not always made when we talk about Lincoln as the great emancipator, that Lincoln could never have done what he did — issue the Emancipation Proclamation, then prosecute the rest of the war as a war to end slavery and save the union — without all the work on the ground that Frederick Douglass did as a spokesperson, an activist, a man who was changing political momentum of northern whites towards slavery, working with ordinary citizens, working with politicians, working with journalists. You can’t get to the end result of the Civil War and the restoration of America to its original promise without slavery if you don’t have both Frederick Douglass and Abraham Lincoln. This man made a huge, important, positive difference.

Knowledge@Wharton: Let’s talk about Ernest Shackleton, the polar explorer who is shipwrecked on the ice. We’ve heard shipwreck stories before, but leadership is at the core of being able to overcome the worst situations.

Koehn: That’s exactly right and spot on, and that’s why it’s at the top of the book. It’s there for two reasons. One, this is such a stark example of what you just said. Against all odds, when the stakes could not be higher, you can accomplish the nearly impossible, just as he did. You read the story and keep turning the page, and you go, “It can’t keep getting worse. This can’t be this hard. He can’t be facing this roadblock.” And he keeps coming through them. He somehow keeps that resilience, that commitment to mission, that dedication. You read this and think, “Shackleton can teach us a lot about what we are capable of if we really access our core muscles of strength and courage.”

The second reason I put him at the top of the book is because most of us don’t know this story, and because it’s so gripping. It’s such a page turner.

Knowledge@Wharton: Give us more of the story of Rachel Carson.

Koehn: She’s the last person in the book and the only woman. As much as I fell in love with every one of these people, I have a very special place in my heart for her. She was born to poor parents and went to college in the 1920s, when most women didn’t go to college and most women didn’t complete college. If they did, they certainly weren’t biologists, as she was. They didn’t seek a living in science, as she did.

She quickly becomes the only breadwinner for her birth family, financially supporting and caretaking for her father, her mother, her brother, her sister, her nieces. At the same time, she’s getting a master’s in zoology at Johns Hopkins University and beginning a career that will ultimately marry this incredible poetic grace and beauty she has with language to her deep commitment to scientific rigor and truth in articles and books that make the natural world completely accessible to people, without dumbing down the science.

She pursues and marries these two gifts and nurtures them and learns all these things about herself while going home at night and putting her nieces to bed, making dinner, cleaning up and putting laundry in, like lots of women today. In the early 1950s, she writes a book called The Sea Around Us, about the majesty and importance and environmental diaspora of the ocean, in a way that every lay-reader can understand. It’s a bestseller, which gives her the freedom to leave her job at U.S. Fish and Wildlife Service, where she’s been doing all kinds of things for many years, mostly editorial content tasks and responsibilities.

She searches around for her next project and bumps into the issue of pesticides that are being used in huge, largely untested ways by farmers, big chemical companies and for household use.

The more she learns as she puts on her detective cap, the more anxious she gets, the more concerned she gets about the possible effects of this. A bit like lots of things we’ve discovered about chemicals and environmental dangers in our own lifetime.

She starts to piece together a very complicated, very serious, very high-stakes story about the dangers of these. She’s doing her homework painstakingly; it takes her years to do this. She’s double-, triple-, quadruple-checking everything. She’s very careful to not release anything before its time. But as people get wind of it, there are threats against her, threats against her family, because Dow Chemical and the U.S. Department of Agriculture, and lots of places don’t want this story out there. Yet, she’s determined. She said, “I could never look myself in the face if I kept silent on this.” She has stumbled into her life’s work. At the same time, in the middle of her research and the beginnings of her writing, she is diagnosed with aggressive, metastasizing cancer.

The second half of the chapter is the story of her race against the clock and her commitment to do this work right and to get it out there in a way that will call for citizens to action on behalf of the Earth, not in an impractical and romantic way, but in a pragmatic and morally responsible way. It’s an astounding book that still sells many copies. And it’s a page-turner because she writes so well and she makes it so easy for us to understand, and she’s so careful.

Big Tech’s Bad Day

The selloff in tech stocks Wednesday was less surprising than the rally in downtrodden names

By Dan Gallagher

Price as multiple of forward wearnings

The rubber band snapped back.

A wave of selling hit technology stocks on Wednesday, which isn’t that surprising after their big run-up. What made the move potentially significant is the rebound in certain downtrodden stocks, which rose more than the tech giants fell.

The Nasdaq-100 Technology Sector Index, which contains the industry’s biggest names, fell by more than 3% Wednesday. That follows a gain of more than 40% this year compared with a 28% rise for the broader Nasdaq Composite. Several tech subgroups, such as chips, internet and software, were hit particularly hard.

Market watchers seemed perplexed by the sudden shift, but it was a day for doubts to creep in about frothy assets everywhere. Bitcoin, the red hot cryptocurrency that started the year worth around $1,000, cracked the psychologically significant $10,000 mark overnight and then $11,000 in early trading Wednesday before sinking to near $8,500 within hours.

Yet the day’s trading action wasn’t a classic risk-off moment, in which recently loved stocks or assets plunge and dowdy ones such as bonds or dividend-paying stocks represent a relative safe harbor. Instead, it was a swift and brutal rotation. The shares of companies that have been almost a mirror image of technology shares saw perhaps their best day of the year, even when they had nothing to do with one another.

Many of the names in question share two things in common—they had been doing as poorly as tech stocks had been doing well, and they are perceived to be vulnerable to the rise of For example, home-goods retailer Bed Bath & Beyond rallied by as much as 8.5% after being down by 46% year-to-date through Tuesday, sporting goods chain Foot Locker rallied as much as 7% after having been down by 42% and drugstore chain Rite Aid was up by over 20% at one point but had been down by 77% for the year.

Amazon, by contrast, was down nearly 3% by the afternoon even as the company was unveiling the latest additions to its fast-growing AWS cloud service, as well as boasting of record sales during Cyber Monday. None of those was cause for disappointment. But Amazon’s share price had just tipped a fresh record high two days prior after having jumped 60% for the year. Its valuation of more than 190 times forward earnings proved a ripe target for skeptics.

A similar dynamic affects other big tech names. Investors have poured into megacap techs like Amazon, Facebook, Apple Inc. and Google parent Alphabet Inc. on the assumption that their massive scale will continue to accrue growth at the expense of older or more traditional competitors. That isn’t inaccurate, though the swelling valuations may also be ignoring the growing risk that scale brings—particularly in the form of lawmakers openly wondering if the sector is growing too powerful.

The risk of scrutiny remains hard to quantify but doesn’t yet seem priced in. The Nasdaq Composite is now averaging 23 times forward earnings—its highest multiple in at least 10 years. That isn’t yet a reason to flee the sector, but investors looking to lock in some profits clearly didn’t need much of a push.

Senate Considers Making a Terrible Tax Bill Even Worse


Credit Selman Design

This is how Senate Republicans compromise these days: They could make their enormously unpopular tax bill, which lavishes benefits on corporations and wealthy families, more generous to real estate tycoons and hedge fund billionaires to win over a couple of lawmakers who say the legislation doesn’t do enough for small businesses.

Even by the collapsing standards of Congress this is astounding. The change demanded by the two unhappy senators — Ron Johnson of Wisconsin and Steve Daines of Montana — would further lower the tax bills of people like President Trump who earn most of their income through limited liability companies, partnerships and other “pass through” businesses that do not withhold taxes on the money passed along to their owners. About 70 percent of all pass-through income goes to people in the top 1 percent of Americans who receive any income whatsoever.

Under the Senate bill, business owners could claim a 17.4 percent deduction on their pass-through income before paying taxes. Mr. Johnson and Mr. Daines want a higher deduction, meaning that moguls would pay taxes on less of their earnings. It is conceivable that this could benefit some mom-and-pop businesses, but only modestly so. This is really about stuffing the pockets of people like Mr. Trump, who controls his real estate, licensing and hospitality empire through more than 500 pass-through businesses, according to his lawyers.

Forgotten in this deal-making are the millions of poor and middle-class families whose tax and health insurance premiums would rise under the Senate bill. Republican lawmakers keep talking about how middle-class families would see tax cuts of about $1,000, or about $19 dollars a week, but those cuts would last only a few years before expiring after 2025. By 2027, families making under $75,000 a year would on average pay more in taxes, according to the Joint Committee on Taxation. All told, half of all taxpayers would pay more by that year and two-thirds of people in the middle 20 percent of the income distribution would pay more, according to the Urban-Brookings Tax Policy Center. People earning $40,000 to $50,000 would collectively lose $5.3 billion by paying more in taxes and receiving less in government spending in 2027 while millionaires would gain $5.8 billion, according to the Joint Committee and the Congressional Budget Office.

The bill would also repeal the Affordable Care Act’s mandate that most Americans have health insurance or pay a penalty. As a result, up to 13 million could lose coverage, and premiums would rise 10 percent a year for the next 10 years, the C.B.O. says. Senator Susan Collins of Maine has correctly noted that any temporary tax cuts for the middle class would be more than offset by the higher cost of health insurance — a good reason for her to vote against the bill.

Because it would cut corporate taxes so deeply — to 20 percent, from 35 percent — this bill would blow a huge hole in the federal budget. Over the next 10 years, it would add more than $1.4 trillion to the federal deficit. That hole would have to be filled somehow, someday. That would probably mean even higher taxes on the middle class in the future and cuts to Medicare, Medicaid and other important government programs. Several Republican senators — Bob Corker of Tennessee, Jeff Flake of Arizona, James Lankford of Oklahoma and Jerry Moran of Kansas — have expressed concerns about the deficit. If they are genuinely troubled, they will uphold their demand that Congress not pass the buck for tax cuts to future generations and will vote no on this bill.

The majority leader, Mitch McConnell, is trying to rush the bill to a vote by the end of the week. This self-imposed deadline is intended to give lawmakers and the public as little time as possible to analyze and understand the bill. The Senate has held no hearings on this legislation, which has been cooked up behind closed doors by Republicans without Democratic input.

Senator John McCain of Arizona gave a stirring speech in July about the need for the Senate to be “deliberative” and “bipartisan” during the debate about repealing the A.C.A. The mad dash to get a tax bill passed before Christmas has been a prime example of what Mr. McCain was railing against. If he stands for the principles he spoke about so eloquently, he will vote no on this bill, just as he did on the deeply flawed health care legislation.

Republican senators have a choice. They can follow the will of their donors and vote to take money from the middle class and give it to the wealthiest people in the world. Or they can vote no, to protect the public and the financial health of the government. There’s no compromise on that.

Japan’s Radical Pursuit of Revival


Japan is positioned to become East Asia’s foremost economic and military power in the coming decades, but it’s traveling a bumpy road to get there. Growing strategic challenges in its backyard related to China’s rise give it little choice but to push for a dominant role in the region, and it has the underlying fundamentals needed to do so. Yet at the same time, it is locked in a decades-long economic slump and is contending with a worsening demographic crisis – factors that could hinder its rise as a regional leader. And it is only beginning to shed the self-imposed pacifistic constraints that have blunted its military ambitions since World War II. Thus, at the moment, early indicators of Japan’s ascendance must be balanced against signs that it’s merely spinning its wheels.

Japan’s ambitions to break free from its internal limitations have become particularly acute under Prime Minister Shinzo Abe’s government, which won re-election last month. Under Abe, Japan has been laying the groundwork to take a more decisive role in regional affairs by, for example, pushing to revise war-renouncing clauses in its pacifist constitution and modernize the military. Underpinning this strategy is a policy platform known as “Abenomics” — a radical and risky attempt to shock the economy out of the doldrums and, as a result, give Japan the capacity to develop true military clout.

This report takes stock of Japan’s unorthodox attempt at economic revival and examines how it fits into Tokyo’s geopolitical strategy — both its efforts to counter China’s growing economic and political influence in East Asia and its pursuit of a more robust military presence in the region. It makes the case that the Abenomics approach, particularly its focus on aggressive monetary easing, is already bolstering Japan’s regional influence, despite only mixed success at reviving the economy at home. However, the pace and scale of Japan’s remilitarization will hinge on the economy’s ability to exit stagnation without triggering a debt or financial crisis.
Japan cabinet Shinzo Abe
Japanese Prime Minister Shinzo Abe (front row, center) and his Cabinet members walk down the stairs following their first Cabinet meeting at Abe’s official residence in Tokyo on Nov. 1, 2017. KAZUHIRO NOGI/AFP/Getty Images
Abenomics Explained
If Japan appears to be throwing a Hail Mary under Abe, it’s because the country has been mired in an interminable economic slump triggered by a massive asset bubble collapse in 1990 — an extended period of stagnation that has made a mockery of its original moniker, “The Lost Decade.” Between the mid-1990s and mid-2000s, economic growth flatlined as Japanese banks tightened credit, average land values plummeted by some 70 percent, and a deflationary cycle set in. Powerhouse electronics and auto exporters lost ground to competitors from emerging neighbors such as South Korea. And just when Japanese growth was returning to pre-crisis levels, the economy was slammed by the global financial crisis beginning in 2008. By 2012, real wages were still roughly 5 percent below their 1995 peak.

Meanwhile, Japan has been grappling with an inexorable demographic crisis. The country has had the world’s oldest population since the mid-2000s, and the problem is only getting worse. Last year, annual births fell below 1 million for the first time, while deaths reached a postwar high of around 1.3 million. Over the next 40 years, Japan’s population is expected to fall to just 92 million people, down from a peak of 128 million in 2015. Retiring workers aren’t being replaced, hurting productivity and weighing on consumer demand. It also heightens the strain on Tokyo’s coffers, with a greater share of the budget having to go to pensions and health care. Moreover, the Japanese public has historically been staunchly opposed to opening the country to immigration, making it difficult to fill gaps in the workforce.

Abenomics aims to address some of these problems. It is based around three “arrows.” The first is aggressive monetary easing, with the Bank of Japan printing yen and buying its own sovereign bonds at a breakneck pace to keep the currency weak (and thus support domestic exporting industries), ensure firms have ample access to credit and boost inflation to a healthy level (to encourage consumers to spend). The second arrow is fiscal stimulus, using targeted government spending to promote consumer demand. The third is a sweeping set of structural reforms, including labor, tax and regulatory overhauls, with the goal of boosting the competitiveness of Japanese firms against foreign rivals and softening the demographic crisis by, for example, nudging women into the workforce.

In practice, however, Abe has leaned most on the first arrow: monetary easing. This is, in large part, because it’s the easiest policy to implement. Abe’s government, via his like-minded central bank chief, Haruhiko Kuroda, has been able to prime the pump at will since 2012. The central bank’s buying spree of Japanese government bonds has left it with a balance sheet with more than 500 trillion yen ($4.4 trillion) in assets. At the beginning of 2016, Japan introduced negative interest rates on some commercial bank deposits, and it has kept 10-year bond yields at about zero, to push savings into the real economy.

In comparison, structural reforms tend to be long-term projects that inevitably face resistance from affected interest groups. Or they conflict with cultural norms and thus can fall victim to more immediate political concerns. The government can do only so much to improve labor mobility, for example, in a culture that places high value on career-long loyalty to a single employer. Convincing people to have more babies is not exactly in any government’s wheelhouse.

Similarly, since fiscal stimulus measures also must be passed through Japan’s parliament, they likewise are subject to getting twisted for political aims, watering down their potential economic impact. Stimulus spending is also constrained by concerns over Japan’s soaring debt, which is forcing Tokyo to devote an increasing share of the budget to debt servicing. In 2014, for example, Abe’s own Ministry of Finance balked at plans for additional stimulus spending, leading instead to a 2 percent consumption tax hike that largely undid the wage gains of the previous two years and sent the economy into recession. This year — despite it being an election year — focus has again returned to paying down debt.

The result has been a tangible but fragile recovery. Corporate profits hit a historical high in the first half of this year, accompanied by a surge in corporate capital expenditures. A tightening labor market has pushed unemployment below 3 percent. The economy has grown for seven consecutive quarters, its second-longest growth streak since World War II, and there are signs that inflation is on the verge of finally ticking upward.

But this has yet to translate into success by many of the government’s own metrics. Inflation remains well below the central bank’s target of 2 percent. And the bank admits it is unlikely to get there until a tightening labor market pushes up wages and the costs are passed onto consumers; this is how modest inflation occurs in a healthy economy. The labor market has tightened somewhat, but wages have shown only scant signs of increasing, and household spending remains low. Moreover, with government debt hovering around 250 percent of gross domestic product, the Abe government feels it has little choice but to finally move forward with another consumption tax hike, from 8 percent to 10 percent. Though its debt risk is somewhat mitigated by the fact that most of the debt is held by the domestic market or the central bank, Tokyo is playing a costly game that’s eating into government coffers and exposing the market to more violent swings whenever rates begin to rise again. Meanwhile, Japan’s labor force isn’t getting any younger.

Still, time and again, Japan has shown a remarkable resilience to crisis, as well as a remarkable ability to take on radical transitions without collapsing into major social upheaval. Even the slump of the past quarter century has been notable as much for its social stability as its stagnation – a resilience that countries like China deeply envy. Despite the depth and longevity of the Lost Decade, Japan has yet to lose the confidence of outside investors. And Japanese firms remain world leaders in artificial intelligence research, automation and robotics, the sorts of technologies that will help the country sustain productivity amid the demographics crunch. This is why Tokyo has been emboldened to take such extreme measures in the first place. Our bet is Japan finds a way to pull through on the homefront yet again.
Reaching Abroad
Abenomics was never solely about reviving the domestic economy. And on the foreign policy front, there’s an overlooked ancillary benefit of this approach, particularly the emphasis on monetary easing: It plays directly into Japan’s regional strategy.

Simply put, between the abundance of cheap credit and sky-high corporate profits, Japan’s economy is awash in capital. With Tokyo doing everything it can to discourage savings, much of this liquidity needs to go somewhere, and the Japanese consumer market and industrial footprint can absorb only so much. Thus, a record amount of Japanese capital is heading overseas, at a time when Tokyo is keen to help weaker states avoid becoming overly dependent on China’s surging foreign aid and outbound investment. Annual Japanese outbound foreign direct investment has increased nearly 58 percent since 2011, according to figures from the Japan External Trade Organization and the Organization for Economic Cooperation and Development. Meanwhile, overseas mergers and acquisitions by Japanese companies hit an all-time high in 2015, according to Thomson Reuters.

Japan’s neighbors have not been the only beneficiaries; a majority of Japanese investment over the past seven years has gone to either the U.S. or Europe, as well as adjacent manufacturing hubs like Mexico. But East Asian economies, particularly in Southeast Asia, have certainly enjoyed a hearty slice of the pie. Japanese FDI in members of the Association of Southeast Asian Nations tripled from 2011 to 2015, to more than 20 trillion yen. Through the first half of 2017, this figure was up again by around 2.3 percent, compared to the same period a year earlier. The heaviest focus has been on Singapore, Thailand, Malaysia, Vietnam, the Philippines and Indonesia — all either parties to the South China Sea dispute or historical contributors to the U.S.-alliance structure in the Western Pacific. Japan is also investing heavily in Myanmar, which is at the center of the burgeoning competition between China and India, as well as India itself. Meanwhile, as Japanese firms have been increasingly moving operations out of China over the past decade, the largest share of them have headed to Southeast Asia.

The Japanese corporate sector is uniquely equipped to put this money to use in the region. Japanese supply chains have crisscrossed the globe for half a century, as Japanese firms were among the first to move operations to countries with lower labor costs. The stresses of the Lost Decade only cemented Japan’s outbound strategy as it sought to reduce the dependence of its economy on the domestic consumer market. (In fact, though Japan’s economy remains heavily dependent on exports, it has been increasingly relying on earnings from investments abroad. Its primary income account, which gauges how much Japan profits from FDI, has soared by as much as 65 percent since 2012, while its trade surplus has been more volatile.)

As a result, Japanese firms play outsize roles in emerging economies like those of Southeast Asia, with Japan’s aims largely seen as complementary to those of regional governments. This is because Japanese firms are viewed as critical job creators and inherently supportive of local efforts to move up the manufacturing value chains and build a middle class. (Japanese investment fueled the modernization of Singapore, Thailand and Malaysia, in particular.) Moreover, the high-tech Japanese products being assembled in middle-income countries, particularly electronic components and auto parts, don’t usually compete with goods made by local firms – unlike lower-end Chinese goods – easing Tokyo’s ability to strike favorable economic pacts with Asian governments. Japanese firms aren’t viewed as a threat to local workers for importing their own – a common, if overstated, accusation against Chinese firms. And Japanese technology and expertise in areas like high-speed rail is viewed as unmatched, giving Japan an edge (albeit hardly a decisive one) in Southeast Asia, a geographically fragmented region that, according to the Asian Development Bank, needs to spend some $60 billion on infrastructure annually until 2030 to sustain its economic growth.

Compared to their Chinese competitors, Japanese firms also don’t have to contend as much with ethnic complications in countries like Indonesia and Malaysia, where minority ethnic Chinese populations are often scapegoated by populist political movements. (On the flip side, the dominance of ethnic Chinese populations over various local sectors in Southeast Asia can often give mainland Chinese firms a substantial leg up against other foreign competitors.) Lingering memories of Japanese imperialism notwithstanding, Japanese firms also do not face political blowback related to territorial disputes, unlike, for example, the Chinese businesses that were the target of South China Sea-linked riots in Vietnam in 2014.

To amplify the political influence accrued through FDI, Tokyo has long actively relied on official development assistance, or ODA, to channel funding to sectors prioritized by partner governments, particularly infrastructure. (It uses its influence in the Asian Development Bank, every president of which has been Japanese, for similar aims.) And under Abe, coordination of ODA with the private sector has increased substantially and taken on a more strategic bent. From a commercial perspective, private sector involvement in ODA is becoming particularly important to Japanese firms’ ability to remain competitive in certain sectors, since Beijing is encouraging Chinese state-owned firms to underbid competitors – even at terms likely to prove unprofitable – on big ticket road, rail and port projects that support China’s strategic imperatives.
Abenomics and Hard Power
It’s difficult to gauge how much soft power tools such as aid and investment really matter on the geopolitical stage. Even relatively poor countries like the Philippines rarely willingly subsume their core security imperatives to their economic interests, even if their military weakness leaves them with little choice but to try to exploit regional competition between stronger powers for economic benefit. Cultivating political influence through aid and investment is only one part of Tokyo’s regional strategy. Japan’s ability to ramp up defense spending and security assistance to the region matters more. But this requires Tokyo to find a way to put its economy on sound long-term footing.

Since 1961, Japan has spent no more than 1 percent of its GDP on its military annually. Its budget is nothing to sniff at – in 2016, it was seventh-highest in the world in dollar terms. And it has given the military sophisticated defensive capabilities, such as a world-class submarine fleet (designed for operations in Japan’s near abroad), missile defense systems and a burgeoning fleet of F-35 fighter jets. But Japan’s military has little in the way of expensive offensive capabilities, particularly in the maritime realm, despite steps in this direction over the past decade.

For the time being, at least, it can continue to lean heavily on the U.S. to cover its deficiencies. (In fact, by allowing Japan to limit defense spending for decades following World War II, U.S. security guarantees contributed directly to the postwar economic dynamism Japan is now trying to revive.) But going forward, we expect emerging threats in Japan’s backyard, along with its perpetual uneasiness with tying its fate to U.S. defense guarantees, to compel Tokyo to shed its pacifist political and legal constraints on taking greater responsibility for its defense needs. This spring, in fact, Abe’s government formally scrapped the 1 percent of GDP cap on defense spending. And this summer, the Japanese Defense Ministry requested another 2.5 percent increase in spending for the 2018 fiscal year, to $48.1 billion, with an eye on defensive-oriented assets such as additional ballistic missile defense systems, fighter jets and anti-mine ships.

Over the long term, Japan will push to address its vulnerabilities farther afield as well, particularly in the maritime realm. Its dependence on the free flow of energy imports through the Malacca Strait and South China Sea makes mitigating threats to the waters, whether from new Chinese warships or dinghy-bound pirates, a matter of existential importance for the Japanese. Toward this end, Japan is gradually ramping up security assistance to weaker states locked in maritime disputes with the Chinese, particularly the Philippines, Vietnam and Malaysia. It is also boosting maritime cooperation with like-minded regional powers Australia, India and Singapore to prepare for the possibility that the U.S. becomes tied down with a crisis and cannot play its role as guarantor of seaborne trade.
All this costs vast amounts of money. Building from the ground up a bluewater navy capable of securing the Malacca and potentially coming to the aid of India or Southeast Asian states would be particularly expensive. A capital-rich economy will aid in this endeavor to a degree as the appetite for investment in Japan’s indigenous arms sector grows. Japan’s high-tech sector has certainly given the country the technological skill base and industrial footprint needed to develop top-end defense systems at home, thus allowing it to rely less on arms imports and even develop a more robust arms exports industry of its own. (Abe formally lifted a ban on Japanese arms exports in 2014.) In this environment, a greater share of Japanese defense spending would be recycled through the broader domestic economy.

Nonetheless, the ability to shovel money into defense in perpetuity requires not just cheap credit but also a fiscal outlook that can accommodate the military’s needs alongside the yawning demands of Japan’s elderly and its public debtholders. And the political and economic fallout of a financial crisis triggered by the debt risks that accompany the Abenomics approach could very well stall Japan’s remilitarization altogether.

The Abenomics experiment remains inconclusive, both on the homefront and abroad. Thus, the trajectory of Japan’s fledgling re-emergence as a dominant regional power is also uncertain. But Japan’s history of radical transformation, industrial edge and social cohesion give us pause before counting the country out. We’ll dive deeper into each of the pivotal variables we outlined in this report – particularly the demographic crunch, Tokyo’s defense spending capacity, and its vulnerability to renewed crisis if the debt load proves unmanageable – in the future, as we track Japan’s peculiar revival.

jueves, noviembre 30, 2017




The “Golden Age of Gas” Is Over

By Jack Hough

Illustration: Getty Images 

The golden age of natural gas is ending, and coal isn’t headed for a comeback. Both will quickly cede market share in U.S. power generation to wind and solar, which will be cheaper than fossil fuels by the end of the decade, especially as technology for electricity storage improves. That’s bad news for General Electric (ticker: GE), which has plenty of exposure to gas turbines. It’s good for Honeywell (HON), Hubbell (HUBB) and Wesco (WCC), which supply equipment for distributing renewable energy and modernizing the electricity grid.

The prediction comes from J.P. Morgan’s Stephen Tusa, who shares his bearish view of GE in this week’s Barron’s magazine. Tusa recently spent two days in meetings with 14 utilities at a conference hosted by Edison Electric Institute, a trade group. Among his takeaways: Mitsubishi Heavy Industries (7011.Japan) seems to be gaining traction relative to GE in turbines. But renewables are clearly where the growth is.

Consider the outlook for Minneapolis-based Xcel Energy (XEL). In 2005, it generated 56% of its power from coal, 23% from gas and 3% from renewables. By last year, coal had dropped to 37%, gas had grown to 25% and renewables were up to 20%. That period marked the “golden age of gas’” according to Tusa. Political rhetoric aside, coal’s decline has had less to do with government regulation than with new drilling technology that has unlocked vast supplies of gas from U.S. shale. A decade from now, however, gas could be relegated to serving as a fill-in power source, like coal. Xcel, for example, plans by 2027 to generate 20% of power from coal, just 17% from gas and 47% from renewables. Many other power companies make similar predictions.

One reason is that renewable power costs have fallen 70% since 2010 and could drop another 20% to 25% by 2020, becoming competitive with fossil fuels. Another is that power companies are quickly investing in electricity storage. AES (AES), based in Arlington, Va., has a joint venture with Siemens (SIE.Germany) to take storage capacity to 30 gigawatts in five years from just three today. In other words, batteries have already spread from powering smartphones to weed whackers to, increasingly, electric cars. Homes will be next, and that’s a long-term concern for gas investors.