The Capital Note: Yield Curve, Corporations & Climate
Welcome to the Capital Note, a newsletter about economics, finance and economics. On the menu today: investors looking to rebound, ESG everywhere, and big tech antitrust.
Yield curve steepness
US Treasury bond yields are at their highest level since June, a sign that investors are optimistic about the economic recovery. While many thought the pandemic would put a lasting drag on economic growth, the latest data suggest otherwise. Bankruptcy filings reported by the American Bankruptcy Institute have fallen below their pre-pandemic trend, and most business closings have proven temporary, according to Goldman Sachs Research. The labor market has now recovered faster this year than after previous recessions.
And while Trump and the Democrats have not yet reached an agreement on another financial package, the elections will likely pave the way for further incentives. The expectation of an increase in federal spending has raised inflation expectations, driving bond yields higher, while increasing expected federal government issuance of debt.
The combination of increased risk appetite and growing supply of government bonds is responsible for a moderate increase in bond yields. While that's a good sign for the economy, a sustained hike in government bond yields would likely slow the recovery in stocks, driven by growth stocks, which benefit most from a falling discount rate.
The big question mark is how the Fed will proceed with quantitative easing. If central bankers view rising long-term interest rates as an undesirable tightening of monetary policy, they could “check yields” and buy longer-term bonds to lower interest rate expectations. In a research report this week, analysts at TD Securities said they "believe that a 10-year sell-off above 1 percent would cause the Fed to step in" and extend the duration of the QE.
An announcement would come after the election. Until then, fund managers could see falling bond prices as an opportunity to hedge against election uncertainty.
Company & climate
In yesterday's Capital Note I discussed how the growing climate activism of JPMorgan Chase (and not just JPMorgan Chase) threatens not only shareholder value, but at least in part the democratic political order.
As I mentioned earlier, two principles seem to apply to the junkyard:
A company has a duty to its shareholders.
Environmental policy should be the responsibility of democratically elected governments, not a group of corporations, activists, NGOs, representatives of the "international community" and politicians who are too arrogant to go through the usual legislative channels to pursue their agenda.
My own view? This is not a good thing.
But the ambitions of those interested in separating the power of capital from ownership of capital as the first - and essential - stage (which is what "stakeholder capitalism" is about) and then using that power as the second stage on an activist agenda Tracking (climate-related or otherwise) is not just limited to pushing companies around.
From the Financial Times two days ago: "BlackRock launched a government bond ETF to weight countries according to their risk from climate change in order to steer the debate about sustainable investments into the political arena."
Note for the FT: It already exists. it just needs to be expressed louder, more openly and more democratically.
The FT: "National debts from Germany, Spain, the Netherlands, Belgium and Ireland are underweighted in the new ETF due to their higher greenhouse gas emissions or a higher risk for climate change."
BlackRock is, of course, reinventing itself as a leader in "socially responsible" investing (we can talk about its involvement in China another time).
But back to the FT:
“Climate change could have a significant impact on public finances. We have argued that there is a link between climate change and creditworthiness, ”said Scott Harman, director of product management for fixed income at FTSE Russell, who designed the index behind the fund. He added that it was the world's first climate ETF to track government bonds.
To date, the investment industry has largely focused on corporate-level climate risk, with companies viewed as particularly exposed to global warming and their stocks and bonds being shunned by those determined based on environmental, social and governance (ESG) factors. invest.
The activist strategy has been to increase the cost of capital for companies that fail to meet certain purposefully ill-defined ESG criteria (and no, the fact that E, S, and G are bundled together makes little sense: focusing on G can improve performance , E and S not so much) and therefore urge them to change their allegedly socially irresponsible ways.
This new fund is supposed to be a step in the same direction, but the pressure is now on countries, not companies.
The iShares Govt Bond Climate Ucits ETF (SECD), which was traded on the Frankfurt Xetra exchange on Monday, is intended to help close the gap.
The benchmark weighting of each country in the new index is calculated using three “pillars” of climate risk.
The transition risk reflects the work a country must do to meet the goal of limiting global temperature rise to 2 degrees Celsius. Physical risk represents a country's economic exposure to the physical effects of climate change. Resilience encompasses a country's willingness and the measures it takes to deal with its climate-related risk.
FTSE Russell claims the index is 26 percent better aligned on a 2-degree Celsius path than the equivalent vanilla euro-zone government bond index, which weights countries based on the size of their government bond market. A portfolio built with the climate index would have 7 percent fewer greenhouse gas emissions than the traditional one, he added.
It would take a heart of stone not to laugh at the downgrading of Germany, the home of another failure of Angela Merkel, her catastrophic and ruinously expensive "transformation" (the energy turnaround) of the country's energy supply, a transformation that will continue to grow by (checks notes) Russian gas and inspired by overlapping but in some cases conflicting panic layers.
The supposedly unshakable Merkel, who panicked from the political consequences of the population's panic over nuclear power after the accident in Fukushima, has been monitoring the phasing out of nuclear power plants since then. However, increased nuclear energy would have made it possible to deal with another German panic, the panic about the climate, with low CO2 emissions. Trying to fill some of the gap with renewable energies is proving extremely expensive - and takes time. How happy Merkel is that Putin is there to help her. And how happy she is that Germany also has a lot of coal (again, notes) to make sure the lights stay on, which unfortunately was partly at the expense of the overgrown forest. Destroy the planet to save it or something.
Meanwhile, (the FT reports): "The Netherlands' share has fallen from 4.8 percent to just 0.22 percent. This reflects the vulnerability of the low-lying country to rising sea levels and the small size of its renewable energy sector."
If there is one country that has (for centuries) known how to deal with the situation at low sea level, it is the Netherlands (by the way, Dutch engineers drained the equally deep part of England, which I came from in the 17th century) but history seems to matter little.
On the other hand: “France, with the largest nuclear industry on the continent, recorded a weight increase from 25.8 percent in the underlying index to 34.9 percent, while the weight of Finland, which is heavily dependent on nuclear and hydropower, is on 4.2 percent almost tripled. ”
It's a practical thing to do with nuclear power.
In Italy the weighting has increased significantly compared to a more conventional index. This is the same Italy that expects a debt ratio of over 150 percent by the end of the year, which is roughly twice the German level.
Again, it would take a heart of stone not to laugh.
And it would take a stone brain to invest that way.
On the Internet
Should Sam Peltzman win the Nobel Prize?
Peltzman found that the additional regulatory standard significantly increased drug development costs, resulting in a significant decrease in newly developed drugs and multi-year delays in the introduction of approved drugs. Peltzman and other economists who followed his example found that the additional development costs caused hundreds of thousands of deaths from drugs that after long delays never made it or were never launched. A Nobel Prize for Peltzman is long overdue.
The effects of Peltzman can be heard from a variety of sources today, including the Trump Administration calling for the FDA to accelerate the approval of Covid-19 vaccines. Delays in approval can only increase Covid cases and deaths. According to the critics, Peltzman's findings remain applicable.
Reddit day traders have a field day with this one. Vatican plays with derivatives:
The Vatican invested some donations for the poor and needy in derivatives that bet on the creditworthiness of Hertz, the US car rental company that defaulted earlier this year. This is evident from documents from the Financial Times.
Three years earlier, part of a donated Vatican portfolio valued at EUR 528 million bought structured notes with CDS as part of a bet that Hertz would not default on its debt by April 2020, the documents show. The company filed for bankruptcy the following month, giving the Holy See a tight run out of the investment, which is paying off in full.
The spill-over effects of the slate bust:
Wisconsin doesn't produce a drop of oil or gas, but it also went bust, like there was along the entire industrial ecosystem that supported fracking. Dozens of disused open pit mines dot the farmland near the meeting point of Wisconsin, Minnesota, Iowa, and Illinois along the Mississippi. Hundreds of miners in the sparsely populated region have lost jobs. Many others, like Mr. Brush, suffer alongside them.
Companies that supplied trucks, lubricants, and drilling tools have gone bankrupt. Steel workers in Youngstown, Ohio have lost jobs supplying the oil field. Homes and hotels hastily built to house roustabouts in North Dakota and remote parts of Texas have emptied.
Antitrust enthusiasts (I'm not one of them) might want to ponder the impact on their 401ks, as this argument suggests in a recent article by Bloomberg's John Authers.
The performance of the NYSE Fang + Index is still hard to believe. It outperformed the equally weighted version of the S&P 500 by almost exactly 100% over the past 12 months.
Now that the S & P's five largest stocks account for 22% of its market cap, a problem for them could mean a problem for the S&P itself. But it goes beyond that. A fascinating report by Gaurav Saroliya of Oxford Economics shows that US companies in almost all sectors are far more profitable than their counterparts in the rest of the world, as measured by return on equity. Energy is the only major exception.
He suggests that this is due to industrial concentration. American companies enjoy pricing power in their home markets that companies in the rest of the world do not have in a more competitive environment. This explains why US stocks have become so much more expensive than the rest of the world in terms of price-earnings ratio over the past decade. This valuation imbalance, in turn, implies an impending US underperformance ...
To take antitrust law seriously, political attitudes need to be changed. A democratic clean sweep could lead to a new wave of antitrust enforcement that, if well executed, could be good for the economy and, in the short term, dreadful for the stock markets.
Spoiler: It wouldn't run well.
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