Won’t Get Fooled Again



The U.S. Federal Reserve is slowly raising the cost of borrowing after seven years of exceptionally loose monetary policy. But by taking so long, there’s a danger the central bank under Chair Janet Yellen may need to cut rates again relatively soon. While a swift retreat might be insignificant on paper, the Fed’s credibility would suffer.

GDP will grow by 2.3 percent in 2016, according to Goldman Sachs, after expanding 2.5 percent in 2015. The unemployment rate, now at 5 percent, could dip lower, and the rate of inflation is below 2 percent. This all fits the Fed’s mandates covering full employment and stable prices, though Yellen et al would prefer stronger price increases. The data-driven picture is not, however, especially robust. It’s easy to imagine scenarios which throw a few assumptions about future growth off course.

One possibility is that as U.S. monetary policy diverges from the European Union and Japan, it lifts the dollar further and slams exports. Then, capital flight from emerging markets to safer dollar-denominated assets provokes a crisis, or even defaults, roiling global markets.

Another risk is that the post-2008 recovery cycle and the accompanying market buoyancy turn sharply. Rumbles in the high-yield bond market, including the closure of a Third Avenue Management mutual fund could, in the worst case, be early signs of exactly that.

U.S. and global sentiment, tourism and trade could suffer, too, should Islamic State jihadists carry out further attacks, following murderous sprees in Paris and California and the downing of a Russian passenger airplane over Egypt.

Some of these possibilities are baked into forecasts. Goldman says a euro may buy only $0.85 by the end of 2016, for instance, from about $1.10 recently. And JPMorgan estimates the probability of a recession in 2016 at below 25 percent.

But a combination of unexpected events could alter the forecasts. The Fed could find itself needing to inject stimulus. Yellen wouldn’t have much ammunition if rates have only by then made it up to 1 percent, say.

More worryingly, it would look bad for the Fed to reverse course so soon after taking years to get to the point of liftoff. Politicians, including Republican presidential contenders, are already campaigning to curtail the Fed’s powers and audit its inner workings. Any appearance of flip-flopping would boost their case.

Published December 2015

(Image: REUTERS/Brendan McDermid)



The next big move in the price of oil will be up. For now, OPEC producers are flooding the market with cheap crude. But low-cost OPEC producers will win the hydrocarbon price war because they can fight harder for longer. And when they win, the price of oil will rise.

Brent crude has fallen about 40 percent over the last year to less than $40 a barrel as the Organization of the Petroleum Exporting Countries has sought to defend its market share by pumping record volumes of oil and driving profit out of higher-cost production. Shale oil drillers in America and offshore operators in areas such as the UK’s North Sea are among the most vulnerable. Improving wellhead efficiency has softened the blows thus far. But these gains will be harder to repeat in 2016.

The International Energy Agency (IEA) expects shale oil production in the United States to shrink by more than 600,000 barrels per day next year if current low oil prices persist. At that rate, daily U.S. shale production would soon fall below 5 million barrels per day.

Lower prices will accelerate shutdowns in areas like the North Sea, too. Energy consultancy Wood Mackenzie reckons that over a third of the area’s 330 fields could be threatened by early closure if prices remain below $85 per barrel for an extended period.

Like shale, the North Sea was once seen as a serious rival to OPEC’s cheap oil, but now it looks like its first victim. Wood Mackenzie reckons that at least 1.5 million barrels of daily global production are uneconomic at $40. Those volumes make up no more than a couple of percent of supply. But the global oil market is finely balanced. Small changes can lead to big shifts.

As more high-cost production is either shut down or slowed down, OPEC’s pricing power will come to the fore. The IEA says oil prices will swill around the bottom of the barrel until 2018. If demand for oil rises with a global economic growth spurt – fuelled perhaps by the low cost of energy – the oil price will move up sooner than that.

The precise price to be seen at any moment in 2016 is unpredictable. But elemental oil market forces suggest that a barrel of black stuff will revert back towards its 10-year mean above $80.

Published December 2015

(Image: REUTERS/Mark Blinch)



Bill Clinton’s 1992 presidential campaign knew to focus on “the economy, stupid.” Hillary Clinton, the Democratic front-runner hoping to become America’s first female commander-in-chief in November, is ahead in early polls and at the bookies. But GDP and employment gains under President Barack Obama may not be enough to keep Republicans like Donald Trump, Ted Cruz or Marco Rubio at bay.

The 1992 campaign unseated Republican George H.W. Bush partly by critiquing his economic record, which included a recession. Obama’s 2008 election run coincided with the financial crisis and another downturn under George W. Bush. The economy matters.

This time around, Hillary Clinton is set to win the Democratic nomination over left-wing challenger Bernie Sanders, the senator from Vermont. She’s also a better-than-even favorite to win the White House on online betting sites. Polls, though unreliable at this stage, mostly show her winning against Republican rivals.

But all presidential races are close. Clinton’s danger may be that Obama’s economic record is too tepid. Using a respected predictive model developed by Ray Fair, a Yale University economist, the pace of growth in U.S. GDP per capita would have to run above 4 percent for the first three quarters of 2016 for the Democrat to win 50 percent of the two-party vote.

That would require an even higher overall growth figure, because the population is expanding. Current forecasts – the World Bank’s 2.8 percent for U.S. GDP growth in 2016, for example – fall well short. One related factor is that, despite the low 5 percent unemployment rate in November, half the post-crisis high during Obama’s first year in office, hourly wage growth is still muted at 2.3 percent year-on-year. Median household income in 2014 remained well below the 2007 peak, according to the Census Bureau – an economic statistic that’s close to home for voters.

Fair’s model hands the incumbent party an automatic disadvantage when there’s no sitting president seeking re-election. That reflects history, but the sample is small and the bias questionable. Plus there’s time for wages to pick up: Moody’s Analytics, for instance, predicts 3 percent earnings growth in 2016.

It’s possible that the Republican who emerges from the fractious Trump-dominated selection process will polarize voters along ideological lines that swamp economic factors. More likely, though, Hillary Clinton’s success will rest on improving home economics.

Published December 2015

(Image: REUTERS/Mike Segar/Files)



Data points to HSBC leaving the United Kingdom. The global bank is reviewing the location of its head office based on considerations such as economic importance, transparency and tax. Breakingviews has crunched the numbers to compile its own rankings. Our figures suggest Singapore, Hong Kong and even Canada would be more attractive than HSBC’s current home.

The bank has said it is reviewing its location based on 11 criteria. In an attempt to approximate HSBC’s approach, Breakingviews compiled statistics for each category. We then used them to rank six cities: London; Hong Kong and Shanghai, where HSBC was founded 150 years ago; and Singapore, Asia’s other main financial hub. We included Paris as the most likely destination within the euro zone, since HSBC is big in France but not Germany; and Toronto, home of the bank’s largest presence in North America. We then added up all the scores to arrive at an overall ranking.

graphic-new2-Numbers add up to HSBC leaving London

(Source: HSBC, KPMG, IMF, World Bank, Transparency International, World Economic Forum, Breakingviews estimates and calculations. REUTERS/Peter Thal Larsen, George Hay.)

If economic size and future growth were all that mattered, HSBC would be moving to China. The world’s second-largest economy promises by far the biggest potential increase in GDP over the coming years.

But Shanghai scores poorly in matters such as transparency, competitiveness and the rule of law. As a result, the Chinese city finishes near the bottom of the list.

Only Paris does worse. The French capital is less attractive for talented staff, while its corporate tax rate of 33 percent is the highest of the six potential locations.

London finishes fourth. Despite its long-established position as one of the world’s largest financial centers, the British capital doesn’t stand out on any of the chosen metrics. Even though the government has pledged to phase out the banking levy that was proving so expensive for HSBC, and is lowering the corporate tax rate to 18 percent, a planned 8 percent profit tax surcharge on banks diminishes Britain’s appeal.

Toronto, meanwhile, scores surprisingly well. HSBC earned more pre-tax profit in Canada than in the United States last year. The largest Canadian city is joint top of the pack alongside Singapore when it comes to the rule of law, according to the World Bank-backed Worldwide Governance Indicators (WGI), and was also most attractive for attracting and retaining skilled staff, according to the IMD World Talent Ranking.

Less surprising is that Hong Kong is also near the top of the list. HSBC’s home until 1994 remains the bank’s largest single market, while its proximity to China promises future growth opportunities. The former British colony boasts the lowest corporate tax rate among the contenders, the highest possible score for regulatory quality according to the WGI rankings, and a government that is keen to keep Hong Kong developing as a financial center.

Even so, Singapore just edges out its Asian rival. Despite its small economy and slender contribution to HSBC’s bottom line, the city-state comes top in terms of competitiveness, stability and transparency. On several other measures it comes second.

Of course, any such exercise is bound to be much cruder than HSBC’s own study. It also attaches equal weight to each factor, whereas the bank may decide some are more important than others. Besides, HSBC hasn’t even said which locations are in the running.

The bank’s board will also have to weigh up the impact of its decision on the rest of the bank. For example, if it picked Singapore, relocating there would be a massive snub to Hong Kong and China.

Nevertheless, what is clear is that – on the checklist HSBC has laid out – it’s hard to make an empirical case for keeping the head office in Canary Wharf. If HSBC does decide to stay put, it will need a strong argument for ignoring data that seems to point east.

Published July 2015

(Image: REUTERS/Bobby Yip)



Here’s a gloomy end-of-year thought: signs of corporate trouble lurk in annual reports – and sometimes you don’t even need to look beyond the cover to see the problem.

Take a few recent doorstoppers, adorned with boasts that now seem painful. Drug group Valeant Pharmaceuticals’ 2014 shareholder communiqué was entitled “a simple philosophy.” That is now under attack. Volkswagen’s self-identification with “moving progress” rings hollow after the German carmaker’s emissions-testing scandal. And Standard Chartered shares have been “leading the way” downwards ever since those words greeted readers on the bank’s 2012 report.

A bit further back, HBOS was “delivering our strategy” while Royal Bank of Scotland was ready to “make it happen.” Then the credit crunch made very bad things happen to the two British banks, and any previous strategy wholly undeliverable.

So is it time to sell short the shares of any company bold enough to slap words such as “scaling new peaks” or “strength to strength” on this year’s report? Well, maybe. But for every VW there’s a Glencore: the commodities house didn’t tempt fate with slogans but still came unstuck in 2015. Besides, corporate verbosity is so widespread that any such strategy would struggle to cope with the many false positives: firms that deliver solid performance despite the vacuous slogans on their annual reports.

Even so, companies would do better to strike a small blow for plain speaking – and avoid creating a hostage to fortune – by not giving their annual report a title. Then investors can go back to searching for nasty surprises where they belong: in the footnotes.

Published December 2015

(Image: REUTERS/Philippe Wojazer)



India will not rescue the global economy in 2016. The subcontinent’s expanding GDP is one of next year’s few economic bright spots. But Indian output is still too small. Any negative shocks from the sluggish United States and decelerating China will reverberate more widely.

India is finally emerging from China’s shadow in the global growth stakes. Helped by a controversial overhaul of its GDP statistics, the Indian economy probably expanded by 7.5 percent in 2015 and is set to swell by a further 7.8 percent in 2016. Contrast that with the People’s Republic, which is struggling to maintain the nearly 7 percent pace promised by its leaders.

The prospect of sustained rapid growth has drawn the attention of prominent central bankers. India’s economy has “enormous potential” to recharge Asia’s growth engine, Stanley Fischer, the U.S. Federal Reserve’s vice chairman, declared in a recent speech.

For now, however, the country’s economic progress has relatively little impact on the rest of the world – although it is enormously important to India’s 1.3 billion citizens. The economy accounts for little more than 3 percent of global output, according to Breakingviews calculations based on World Bank forecasts. China is almost four times as large, while the United States is still responsible for more than a fifth of all economic activity.

graphic-new2-whos driving global growth in 2016

(REUTERS/Katy Weber, Peter Thal Larsen, Robyn Mak)

On current projections, India will produce about 7 percent of global growth in 2016 while the United States and China will together be responsible for about 45 percent of GDP expansion. Put another way, India’s growth rate would need to rise by about 3 percentage points in order to add 0.1 percentage point to next year’s expected global growth rate of 3.3 percent. China could have the same impact with a 1 point increase in the pace of expansion. For the United States, an extra half point would suffice.

With Europe stuck in the doldrums and Japan struggling to recover, the world economy still depends heavily on its two largest growth engines, both of which are sputtering. A severe slowdown in China or a stalled recovery in the United States would be felt around the world. By comparison, India’s economic performance, no matter how impressive, will barely register.

Published December 2015

(Image: REUTERS/Jorge Silva)



Netflix will be recast in the role of the bad guy next year. The video-streaming service was once derided as the “Albanian army” by Time Warner boss Jeff Bewkes but now is worth roughly the same $55 billion as his company. With some 69 million subscribers worldwide, it may be too late for media bosses to do much about this beast they helped create.

It wasn’t long ago when TV and movie producers considered Netflix something of a hero. The company became a new buyer of programming. Now, however, the increasing popularity of Netflix is contributing to the erosion of pay TV, the more lucrative and predictable source of revenue. Consumers are starting to ditch expensive cable bills in favor of a la carte options like Netflix. By 2020, SNL Kagan forecasts that 82 percent of U.S. households will be pay-TV subscribers, down from a peak of 88 percent in 2011.

That’s one reason why Bewkes, Twenty-First Century Fox Chief Executive James Murdoch and Walt Disney boss Bob Iger are signaling a change of heart. Murdoch, for instance, said that Fox is going to do more business with Hulu, the Netflix rival jointly owned by Fox, Comcast and Disney. Those decisions may cause other problems. The producers of hit series “Homeland” on CBS-owned Showtime, for example, are concerned they’re getting a smaller cut of profit because of deals struck with Hulu, according to the Wall Street Journal.

The industry’s wariness may be futile at this point anyway. For one, Netflix’s coffers have grown too big. Its increasing scale should enable it to outspend rival networks in 2016. Though in programming Netflix is still catching up to the likes of HBO, which recently signed up “Sesame Street” and Jon Stewart, Morgan Stanley estimates the company led by Reed Hastings will splash out some $2.5 billion next year in the United States, compared with HBO’s $1.8 billion and Showtime’s $700 million.

Netflix is also scaling up production of original shows like “Master of None” and “House of Cards.” That gave it the confidence earlier this year to opt out of renewing a programming deal with Epix, the venture owned by Viacom’s Paramount Pictures, and Lions Gate, because it couldn’t secure exclusivity. That’s a pretty strong show of force by what was once considered an insignificant military operation.

Published December 2015

(Image:REUTERS/Valentyn Ogirenko)



Nothing scares chief executives of established businesses like the notion that some millennial whiz kid from Silicon Valley will invent a better mousetrap and, to mix clichés, eat their lunch. Bankers aren’t too fussed, though. Their biggest worry is also their greatest protection: regulation.

Banking profit totaled $160 billion in the past 12 months in the United States, according to Federal Deposit Insurance Corporation figures. That explains why investors deposited $15 billion into financial technology companies in the first nine months of 2015, surpassing the $12 billion invested in all of 2014, according to CB Insights data analyzed by Accenture.

Much of that has funded startups embracing innovations in bitcoin’s back end, new lending models and payment systems. On their own, some – say, Venmo in payments, Avant in personal lending or Digital Asset Holdings in blockchain – may transform pieces of the financial-services firmament.

But investors hoping for the next Uber, Google or Amazon will be disappointed. Returns will be generated and new millionaires minted, but the fintech industry will find it tough to swipe away banking-industry profit to the extent their more disruptive Silicon Valley cousins have cut earnings in the newspaper, entertainment, taxi and hotel businesses.

Federal government oversight creates a far higher barrier to entry. The more involved a company becomes in handling people’s money, the more responsibility – and costs – it must bear. That explains how most high-profile fintech startups choose their niche.

Many lend to people or businesses with subpar credit, which banks avoid for fear of prompting another financial crisis and higher costs imposed by watchdogs. Similarly, entrants in consumer payments must piggyback on existing bank accounts, which they cannot replace without succumbing to regulation.

Fintech firms are certainly developing more efficient and technologically proficient ways of doing business. But they’re more likely to partner with, or sell to, larger financial rivals to achieve scale. Several mega-banks like Citigroup and Wells Fargo have already taken stakes.

JPMorgan’s recent venture with business lender On Deck Capital is a case in point. Boss Jamie Dimon let slip that his $250 billion bank was working with an unnamed peer-lending outfit. When $760 million On Deck called itself out, its stock surged nearly 40 percent, though it’s still down 60 percent since its debut.

That reaction is instructive. It’s a sign that the leverage in the fledgling fintech universe is still with the banks, thanks to regulators, not the upstarts.

Published December 2015

(Image: REUTERS/Yuya Shino)



Smartphone brands are heading for extinction in 2016. The industry’s growth rate dipped below 10 percent this year. Apple and Samsung’s high-end phones are taking most of the spoils, while upstarts like China’s Xiaomi are picking up first-time buyers. Loss-making brands from HTC to Sony may be forced to conclude the game is over.

The smartphone industry grew at a single-digit rate this year for the first time, according to data from IDC. Just two years ago, the industry was expanding at a breakneck 40 percent. Demand from China – the world’s largest handset market and once the driver of growth – will be flat this year.

The slowdown suggests two things. First, the market is saturated: existing smartphone owners outnumber first-time buyers. The People’s Republic, which accounts for 30 percent of global shipments, has joined North America and Western Europe to become a replacement market where sales are driven by upgrades.

That’s good news for premium handset makers like Apple and Samsung. The $600 billion iPhone maker grabbed a staggering 94 percent of the industry’s profits in the three months to September, analysts at Canaccord Genuity reckon. Samsung remains the only big Android phone maker that is profitable.

Second, first-time buyers in emerging markets will power growth. Handset shipments in the Middle East and Africa rose 50 percent year on year in 2015, IDC estimates. Chinese groups Xiaomi and Huawei – which catapulted to third place in shipments this year – have just entered those markets selling budget phones. Fierce battles are also playing out in India, where locals Micromax and Intex are fighting Samsung.

Those without Apple-level margins or Huawei’s scale may not survive. The loss-making HTC is already on life support as its $1.3 billion cash pile dwindles. The launch of the group’s $500 iPhone rival is unlikely to be a turning point: analysts expect HTC’s market share for next year to stay flat at around 1 percent. Ailing Japanese conglomerates, from Sony to Kyocera, will be under pressure to shut down unprofitable mobile units. Even smartphone pioneer BlackBerry may be forced to give up on hardware if sales of its latest model disappoint. 2016 may be the beginning of the end for many.

Published December 2015

(Image:REUTERS/Kim Hong-Ji)



The mighty United States will most likely take top spot once again in the medals table in the 2016 Summer Olympic Games. But a prediction based on population, GDP, the cost of Nikes and past willingness to dope suggests host nation Brazil could break into the top five. Like Team GB in 2012, that will require capitalising on home advantage.

The national flags of Russia, China and Japan will be the others most frequently raised alongside the star-spangled banner as medals from the modern era’s 31st Olympiad are awarded, according to Breakingviews’ new Olymponomics calculator.

graphic-new-Olymponomics leader board

(Source: World Bank, NationMaster.com, IAAF. REUTERS/Matthew Weber, Himanshu Ojha, Robert Cole, Richard Beales.)

It stands to reason that successful Olympic nations have large populations. That ensures deep pools of raw talent across a wide range of events. Countries with big economies, meanwhile, have the financial resources to equip and train athletes. The cash clout per head may also be relevant, but places like the United States, China, and Russia, which have large resources overall, can direct the biggest sums to train teams of elite sportsmen and women.

National statistics only capture part of the story. Sports participation is critical. The cost of a pair of Nike running shoes is a workable proxy. The rationale is that the cheaper the shoes, the lower the barrier to entry and the greater the likelihood of eventual Olympic success.

Performance can also be enhanced through the illicit use of drugs. Athletes are subjected to stringent anti-doping measures. Cheats, however, may get an outsized share of the spoils if they aren’t detected. The Olymponomics calculation uses recent test results from the International Association of Athletics Federations to identify countries that have been more willing to bend and break the rules, and assumes their representatives may be the most likely to succumb to temptation again.

The analysis includes the 20 countries that have been most successful in the last two Olympiads. That excludes some like India, for instance, whose large population and poor record on doping might otherwise have earned it a place nearer the top of the forecast medals table. The idea is that a nation’s overall athletic prowess takes time to develop, making past performance relevant as well.

Brazil finished way down the medals table in London four years ago and in Beijing in 2008. In 2016, the home team’s green and gold flag may fly a good deal higher.

Published December 2015

(Image: Rob Schumacher-USA TODAY Sports)