Tag Archives: finance

Artificial Intelligence and Universal Basic Income

Lately, I have been about AI (artificial intelligence), and pondering the long-term impact of this new “industrial revolution”. In the first cycle, and I think we are in it right now, AI will automate most of the tasks which require human intervention, but through technological revolution, have been easy to computerize (e.g. finance, accounting, law, medicine and diagnosis). Stage 2 will be when AI will start to wreak havoc on other industries when all of the easy fruit has been picked. I think the most immediate impact of AI should be felt in the financial industry, as computer should be able to automate most of the back office tasks easily, and without much due effort (as long as most of the forms are standardized etc).

More to follow …..

Executive Summary of IMFs Global Financial Stability Report

It is a long report – but good read nonetheless.

Here is the executive summary for those who are interested:

Financial stability has improved in advanced economies

Financial stability has improved in advanced economies since the April 2015 Global Financial Stability Report. This progress reflects a strengthening macrofinancial environment in advanced economies as the recovery has broadened, confidence in monetary policies has firmed, and deflation risks have abated somewhat in the euro area. The Federal Reserve is poised to raise interest rates as the preconditions for liftoff are nearly in place. This increase should help slow the further buildup of excesses in financial risk taking. Partly due to confidence in the European Central Bank’s (ECB’s) policies, credit conditions are improving and credit demand is picking up. Corporate sectors are showing tentative signs of improvement that could spawn increased investment and economic risk taking, including in the United States and Japan, albeit from low levels.

Risks continue to rotate toward emerging markets, amid greater market liquidity risks

Despite these improvements in advanced economies, emerging market vulnerabilities remain elevated, risk appetite has fallen, and market liquidity risks are higher. Although many emerging market economies have enhanced their policy frameworks and resilience to external shocks, several key economies face substantial domestic imbalances and lower growth, as noted in the October 2015 World Economic Outlook (WEO). Many emerging market economies relied on rapid credit creation to sidestep the worst impacts of the global crisis. This increased borrowing has resulted in sharply higher leverage of the private sector in many economies, particularly in cyclical sectors, accompanied by rising foreign currency exposures increasingly driven by global factors. This confluence of borrowing and foreign currency exposure has increased the sensitivity of these economies to a tightening of global financial conditions (see Chapter 3). As emerging market economies approach the late stage of the credit cycle, banks have thinner capital cushions, while nonperforming loans are set to rise as corporate earnings and asset quality deteriorate. In China, banks have only recently begun to address the growing asset quality challenges associated with rising weaknesses in key areas of the corporate sector. These developments in emerging market banking systems stand in contrast to those in advanced economies, where banks have spent the past few years deleveraging and repairing balance sheets, raising capital, and strengthening funding arrangements. Against a challenging backdrop of falling commodity prices and weaker growth, several emerging market sovereigns are at greater risk of losing investment-grade ratings in the medium term. Pressures on sovereign ratings could intensify if contingent liabilities of stateowned enterprises—with a large and rising share of emerging market corporate bond issuance—have to be assumed by the sovereign, for example, from firms in the oil, gas, and utility sectors.

Policymakers confront a triad of challenges

The baseline outlook for financial stability, consistent with the October 2015 WEO, is characterized by continuing cyclical recovery, but with weak prospects for medium-term growth in both advanced economies and emerging markets. In advanced economies, improvements in private balance sheets and continued accommodative monetary and financial conditions have spurred a cyclical recovery, but the handover to higher levels of self-sustaining growth is incomplete. Emerging markets face substantial challenges in adjusting to the new global market realities from a position of higher vulnerability. Successful normalization of financial and monetary conditions would bring macrofinancial benefits and considerably reduce downside risks. This report analyzes the prospects for normalization according to three scenarios: the baseline, an upside scenario of successful normalization, and a downside scenario characterized by disruptions in global asset markets. Against this backdrop, the global financial outlook is clouded by a triad of broad policy challenges in evidence over the past several months:

Emerging market vulnerabilities—As examined in the WEO, growth in emerging markets and developing economies is projected to decline for the fifth year in a row. Many emerging markets have increased their resilience to external shocks with increased exchange rate flexibility, higher foreign exchange reserves, increased reliance on FDI flows and domestic currency external financing, and generally stronger policy frameworks. But balance sheets have become stretched thinner in many emerging market companies and banks. These firms have become more susceptible to financial stress, economic downturn, and capital outflows. Deteriorating corporate health runs the risk of deepening the sovereign-corporate
and the corporate-bank nexus in some key emerging markets. China in particular faces a delicate balance of transitioning to more consumption-driven growth without activity slowing too much, while reducing financial vulnerabilities and moving toward a more market-based system—a challenging set of objectives. Recent market developments, including slumping commodity prices, China’s bursting equity and margin-lending bubble, falling emerging market equities, and pressure on exchange rates, underscore these challenges.
• Legacy issues from the crisis in advanced economies—High public and private debt in advanced economies and remaining gaps in the euro area architecture need to be addressed to consolidate financial stability, and avoid political tensions and headwinds to confidence and growth. In the euro area, addressing remaining sovereign and banking vulnerabilities is still a challenge.
• Weak systemic market liquidity—This poses a challenge in adjusting to new equilibria in markets and the wider economy. Extraordinarily accommodative policies have contributed to a compression of risk premiums across a range of markets including sovereign bonds and corporate credit, as well as a compression of liquidity and equity risk premiums. While recent market developments have unwound some of this compression, risk premiums could still rise further. Now that the Federal Reserve looks set to begin the gradual process of tightening monetary policy, the global financial system faces an unprecedented adjustment as risk premiums “normalize” from historically low levels alongside rising policy rates and a modest cyclical recovery. Abnormal market conditions will need to adjust smoothly to the new environment. But there are risks from a rapid decompression, particularly given what appears to be more brittle market structures and market fragilities concentrated in credit intermediation channels, which could come to the fore as financial conditions normalize (see Chapter 2). Indeed, recent episodes of high market volatility and liquidity dislocations across advanced and emerging market asset classes highlight this challenge.
Strong policy actions are needed to ensure “successful normalization”

The relatively weak baseline for both financial stability  and the economic outlook leaves risks tilted to the downside. Thus, ensuring successful normalization of financial and monetary conditions and a smooth
handover to higher growth requires further policy efforts to tackle pressing challenges. These should
include the following:

• Continued effort by the Federal Reserve to provide clear and consistent communication, enabling the smooth absorption of rising U.S. rates, which is essential for global financial health.
• In the euro area, more progress in strengthening the financial architecture of the common currency to bolster market and business confidence. Addressing the overhang of private debt and bank nonperforming loans in the euro area would support bank finance and corporate health, and boost investment.
• Rebalancing and gradual deleveraging in China, which will require great care and strong commitments to market-based reforms and further strengthening of the financial system.
• More broadly, addressing both cyclical and structural challenges in emerging markets, which will be critical to underpin improved prospects and resilience.
Authorities in emerging markets should regularly monitor corporate foreign currency exposures, including derivatives positions, and use micro- and macroprudential tools to discourage the buildup of excessive leverage and foreign indebtedness.
• Safeguarding against market illiquidity and strengthening market structures, which are priorities, especially in advanced economies’ markets.
• Ensuring the soundness and health of banks and the long-term savings complex (for example, insurers and pension funds), which is critical, as highlighted in the April 2015 GFSR.

 

With bold and upgraded financial policy actions detailed in the report, policymakers can help deliver a stronger path for growth and financial stability, while avoiding downside risks. Such an upside scenario would benefit the world economy and raise global output 0.4 percent above the baseline by 2018. Further growth-enhancing structural reforms, detailed in the WEO, could bring additional support to growth and stability.

Full report here.

Reading List: Enjoy!

Law firms investigating Zynga for insider stock sell-off (Arstechnica)

Schubert, Jonckheer, & Kolbe, LLP; Johnson & Weaver, LLP; Bronstein, Gewirtz, & Grossman, LLC; Levi & Korsinsky; and Wohl & Fruchter, LLP have all announced they are actively investigating whether executives and shareholders including CEO Mark Pincus breached their fiduciary duty and broke securities law in selling over $500 million worth of stock in a secondary stock offering this April. In selling that stock at $12 a share—well above the current $3 share price brought on by the weak earnings report—the executives allegedly “misrepresented and/or failed to disclose materially adverse facts about its business and financial condition.” In other words, they knew this was coming, and they sold their own interests rather than warning the general shareholders.

Similar trends are popping up for any companies that feed off FB or are FB. FB itself was sued over withholding material information from shareholders the day before the IPO. Seems like Zynga is in similar situation. Now what we have to watch out for is the stock dump by FB insiders when they are allowed to sell and the associated decrease in price (could possibly happen). If a significant stock dump happens (which I can sense it will – due to over valuation of the stock), then that is a signal for ‘investors’ to take their money somewhere else.

Zynga Chart from Google Finance

Alpha

Capital Asset Pricing Model (CAPM)

The capital asset pricing model “CAPM” is a model for pricing an individual security or a portfolio. The CAPM in it’s simplistic form takes into account expected rates of return as a function of systematic, non-diversifiable risk (its beta). The CAPM provides the foundation for the very complex Modern Portfolio Theory “MPT”.

The true test of a model lies not just in the reasonableness of it’s underlying assumptions but also in the validity and usefulness of the model’s prescription. In corporate finance applications, several potential sources of error exist in the CAPM:

 a) inadequate description of the behaviour of financial markets

b) betas are unstable through time, and

c) estimates of future risk free rates of return are often subjective

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Occupy Wall Street – so what?

The dilemma the “occupationists” are facing right now is that they are not being heard in the media as they wish they would. Just recently the protestors raised approximately $300K (http://online.wsj.com/article/AP337384456a7249c794f1db2b40ced47f.html). The question remains as in what are the different pathways for the protestors:

I think that there should be certain goals for the occupationists, such as:

1. Separation of banks and everything else (such as trading, hedging, derivatives trading, speculations)

Just like the Church and the state – it is difficult to separate the greedy from money.

2. Effective regulation of the banking sector (a corollary from #1)

3. Legislation to enforce speculations to such a degree that risk the capital of the shareholders without their consent. The shareholders must agree in writing that they are comfortable with losing all their money due to the “investments” the firms may be making on their capital. This is comparable to putting images of people inflicted with throat cancer on cig packages.

And what necessary steps should they be taking next? Lets think about this for now. The occupationists, may have arisen from a crowd that is concious and understands the brewing troubling situation of what we see in the U.S. However, the only way to make legislators feel the wrath is to …. put someone incharge. A leader. A visionary – from amongst them. Only when the Republicans and the Democrats realize that their seats are at steak, only then, they will realize that it may be time for change.

My only concern is that if this protest fails, then we will see less effective protests and gatherings in the future. Don’t make it look like a joke, and don’t let Kanye West or any other celebrity to steal the spotlight from the actual cause.

I hope for the best.

Alpha

Bernanke’s invisible stimulus

So what happened Thursday?

In a recap, the Federal Reserve Chairman Ben Bernanke said that the economy has not deterioated “enough” to need immediate additional stimulus. (Italics by the author). However he believes that if necessary, there could be more stimulus.

The inaction by the Feds is the invisible stimulus all the financial industry has been hoping for. The invisible stimulus is the lack of the increase in interest rates. With the decreased interest rates there is increased appetite for higher-risk assets, and possibly more return. However this is fueling another bubble by itself. Equities have been mispriced for the last two years, fueled mostly by speculation, and not the underlying business. Companies see great volatility in their stock price for an event that may have no connection to the stock. The low interest rates are a terrible incentive since it invites more “investors” ( I use this word loosely, since traders are not really investors) to enter the market and gamble away their money in the hopes of making a quick buck.

However if there is another “major” correction, which is quite possible within the next year (possibly 20% correction), then we will be seeing another round(s) of stimulus. The correction is derived based on the hypothesis that the stock market has reached  pre-2007 crisis level, however the earnings have been consistent or decreasing over the last three years. There is disconnect between the underlying stock and the business. Another assumption is that there is yet another housing bubble that is yet to take place due to high unemployment for the people in the middle trench for CDO’s, the guys who could previously afford the mortgages when they signed their contracts. The 2007 crisis was due to default on mortgages who could not afford their mortgages at all! Their sole reason for getting a property was to sell it back within six months, pocketing the difference, or they were suckered into the mortgage due to the temporary low rates. This next housing bubble is going to hit the whitecollar households where one of the person(s) in the household is unemployed and can barely afford the mortgages.

Once companies see their earnings decreasing (due to consistent high unemployment), they will be forced to layoff more people to save their stock prices, thus starting the vicious cycle where the economy is going to shed more jobs than it will create. (Do you remember the 18K jobs created in June vs expectation of 132K?)

 

Gold – a bear’s best friend

If you have been following Gold for the last three months, you must be astonished by the total return received on the yellow metal, a whopping 109% (annualized return). The yellow metal increased in value by 27.4%.  So the question is, what is the reason for the increase in gold prices?

You

Or the investor sentiment. However there is much more that needs to be said about the topic.

Historically, whenever the price of gold goes up, the world sees an increase in the supply of gold. The supply is from Southeast Asia, notably Pakistan, India, Sri Lanka and Bangladesh, where families have been converting excess savings into gold for the last hundreds of years. Traditionally brides are gifted gold jewellery by her parents when she is married, so there is always an ample supply of gold laying around. Whenever the price used to go up, the increase in supply would temporarily dampen the price increase.

Well that is the old gold. The new gold rush is due to the fear of Fiat currency, and notably the prestigious U.S dollar decreasing in value. Investors seek refuge from inflation and growth fears that have been plaguing the Euro and the U.S. As of now, we know that the Euro might as well call it quits. Germany and France are cornered and they do not have a way to get Eruo debt in control. Their only gameplay is more austerity measures on the Euro countries, and devaluing the Euro, which is taking place unsystematic by the market  (unsystematic is a nice way to say, brutally).

Two months ago when the markets were in the fear of Euro, they rushed towards the U.S, because the U.S will always be the safe heaven. Just like the Greeks, the Romans, the Arabs, Chinese empire, and the British empire, the U.S. will always have its cool and be able to repay its debt. (Can you tell if I am being sarcastic enough?) However the market just realized, oh, this is not true any more. There is real growth problems in the U.S. But the bigger problem is the political restlessness that has gripped the U.S, where the politicians bicker and fight about measly decrease in deficits and threaten to default the country. The market will punish U.S for a long time.

As they say it in the olden times; Reputation is like fine china, takes hardwork to keep it in shape, and it only takes one mistake to break it into a million pieces.

I am bearish on the U.S economy, the U.S political system and worst, the U.S social system. As a disclosure, I am long Gold, and will be for the forseeable future.

 

Alpha

Todays sell off – when will we recover?

There is an interesting graphic from JPMorgan funds that I would like to share; it tells how long it takes for the market to recover from its losses.

However, we can never be certain. This market turbulence indicates that the investors need to get into a safe position, rebalance the portfolio for some cash, and decrease equities (unless you have a strong stomach to handle the fluctuations).

I expect that the market may stabalize momentarily, however it still is heading for at least 10% correction (optmistic view).

Here we go:

Time it takes for a bear market to recover

 

Alpha

Market efficiency and relevance of finance taught at universities

There are a few topics that I remember discussing as a student with my professors in Finance class, however most of the time we would discuss the efficiency of the markets, the CAPM model, the risk-free asset and how the last 40 years have changed so much, much thanks to Fama and his breakthrough research paper on the Efficiency of Markets (refer to the attached pdf on a paper re: the above topic).

In my Masters thesis paper I got the opportunity to really discuss the efficiency of the markets, as mentioned by Fama. However, looking back it seems that the efficiency of the market is not always true. It may be true during certain instances, for example during the boom years, however it is certainly not true when there is a financial crisis. The logic is simple; if the market was really efficient, and it readily absorbed all of the information, and came to a valid AND true conclusion regarding the price of a particular security, then there would be no bubbles.  Certainly we know that is not true.

Welcome to the real world, dear Finance Students.

Theory: What you learn at school may not be applicable in real life.

Lemma: Having more degrees does not make you more knowledge and/or expert in your field.

Corollary:  You just wasted 4 years of life, or more.

 

Welcome to layman’s finance.

Alpha