Thought Bubbles from the Deep

[DeepState]

DS,

What are your thoughts on infrastructure? Do you think it is a separate "asset class" in terms of an investment strategy? Do you account for it separately in your investment strategy, and if so, do you have any thoughts for exposure for retail investors?

I understand that options are quite limited in Australia, as it's either government owned, or held by a number of managed funds or private equity. Access to a very wide range of assets would seem to be either impossible, or too expensive, for a small investor IMO, which is probably why most Australian investment literature doesn't mention it.

Hi Ves, hope all's good.

Infrastructure is treated as a separate asset class by Insto investors. Separate management teams, different characteristics (revenue risk sharing, illiquid, sovereign risks etc). Furthermore, broken into debt and equity components. Some will be specific on whether to invest in greenfield or brownfield. Some insto asset owners will directly invest into individual assets. Others will appoint third party asset managers.

The consensus view is that the absolute price of trophy assets is bid far too high, but the buyers use liability matching arguments to justify it (large Canadian Defined Benefit Plans, for example) or strategic reasons (Port of Darwin). There are still opportunities in mid range assets on a case by case basis.

There are listed infrastructure funds and unlisted ones also which are available to retail investors.

Could be considered as an alternative to bonds, albeit with more credit risk of a different kind.

 

[fraa]

Delayed reaction doesnt look that way today and reaction is very positive.

http://macro-man.blogspot.co.id/2016/03/the-aftermath.html

risk on in most things.

The ECB announcement reaction is akin to the weak BoJ outcome (Equities drop and currency rises). Gold is rising. The lower bound for the short end has been reached. Innovative elements include adding investment grade corps to the eligible monetary purchases and targeted lending initiatives. Big question: is lack of economic activity the result of credit being priced too high in real terms (Secular Stagnation) or because there is no/limited demand for credit at any price (Debt Overhang)? It is worse for the EZ because there is no way the EZ can launch fiscal stimulus to offset a weak monetary response or monetise debt (helicopter money). Central banks are running out of room. The ECB looks spent. On a broad read, the market is positioning accordingly.

The Draghi Put is being replaced with the Yellen Call.

 

[qldfrog]

Delayed reaction doesnt look that way today and reaction is very positive.

http://macro-man.blogspot.co.id/2016/03/the-aftermath.html

risk on in most things.

And the AUD is jumping higher as a result:
All is good again.
I still can only see this as a good opportunity to buy more USD before the next change of mind.I really really believe the world economy is in a pretty sick state.Where is my finances Noah's ark ?

 

[fraa]

And the AUD is jumping higher as a result:
All is good again.
I still can only see this as a good opportunity to buy more USD before the next change of mind.I really really believe the world economy is in a pretty sick state.Where is my finances Noah's ark ?

Hahhahahah... Dont take this guy seriously, but since you are looking for the Ark...

http://ibankcoin.com/flyblog/2016/02/29/markets-disappoint-the-ark-floats/

I believe the Ark's license plate has "TLT" on it

 

[DeepState]

Delayed reaction doesnt look that way today and reaction is very positive.

http://macro-man.blogspot.co.id/2016/03/the-aftermath.html

risk on in most things.

Very cool that you are interested in this stuff. Macro Man is very reasoned on the whole.

The ECB announcement had surprisingly positive and negative points. On the positive side was an expansion of the quantity of asset purchases. The market had expected this to be extended to E70bn per month, instead it was moved to $80bn per month. In addition, the qualifying assets were expanded to include investment grade bonds for Euro Area 'established' non financial corporations. There was also an extension and an increase in potency of the Targeted Long Term Refinancing Operations via incentives that could see the lending rate get as low as -0.4% per annum. Paid to lend. Please note that these target loans to non financial corporations and residents except for property purchases.

The Deposit rate was cut to -0.4% as expected. But the other main rates were shaved a tiny bit.

A negative was that the Asset Purchase Program was not extended, possibly a trade off with the higher monthly spend.

The market reaction was initially positive, but this was quickly erased and reversed when Draghi essentially agreed with an increasingly common view that negative interest rate policy was not having the expected outcome due to the rates not being passed to depositors. The instrument is basically exhausted.

The Euro sold off. Equities initially fell. This initial reaction is important. It marks a very sharp contrast to the general pattern of financial market developments following previous stimulatory announcements. Until an underwhelming reaction to the last ECB stimulus efforts late in 2015, and the complete opposite-to-desired outcome from the BoJ cut very recently, these had been strongly positive. Now, we have three of the most recent monetary policy stimulus efforts unable to generate heat and light. In addition, we have the Fed with risk towards holding for a very long time but wanting to tighten. Stimulus and efforts to remove stimulus, are failing. When the CBs have been the only thing going for the period since the GFC took hold (apart from bail-outs, of course), this is an important development.

You say risk-on everywhere yesterday. Yes, it looks that way, but it is important to look underneath it. Also, I should be careful not to assign too much to the following observations.

+ Yesterday saw a rally in financials and energy. Financials trailed energy. Energy is the greatest threat to the solvency of banks at present. That link should be evident. There were inventory figures which boosted the outlook for energy. This was not the work of the ECB.
+ The expanded TLTRO program does not extend to offshore lending. It is extremely tenuous to argue that any stimulus to EA lending arising from TLTRO would flow through to the likes of JP Morgan. US Treasuries sold off when EZ bonds came in.
+ The net gain in EZ equities vs rest of world is not special in any way. Compare this to the QQE program outcome in Japan and what had been achievable by the Fed and ECB previously. The ECB did not impress equity investors in European markets.

The prior TLTRO program helped to stop bank lending from declining further, but there has been negligible movement in the stock of lending via the bank channel. This latest program is more powerful, but you have to ask whether the extent of lending will truly increase that much when:
+ the liquidity holdings of the major banks is so large relative to the loan books
+ the loan books have a lot of property asset loans
+ disintermediated credit for large and medium sized corporates has already grown heaps.

The returns now available from bank liquidity holdings will reduce at the same time as bank deposit rates with the ECB are lower which can't be passed on. Not good. The banks remain over-levered. Remember Deutsche recently. In order to loan, these guys have to issue stock. They have been reluctant to do so. This looks like some degree of pushing on string going on with the TLTRO.

Buying investment grade corporate debt does very little to help with disintermediated credit to the small business. This is the capital starved and high employment generating sector of the economy. IG corporate is able to source credit already, dropping the borrowing costs a bit will definitely help, but will cause distortions as well and, strangely, will encourage some sub-investment grade corporates to deleverage as they shrink their way to higher profits.

The Euro strengthened and the US Treasury, Australian Treasury and UK Treasury securities all saw their bonds sell off. EZ bonds came in. Growth is expected to bleed from the EZ.

On the whole, this picture is one of where monetary firepower in the ECB is clearly losing potency. It is interesting that Vice President of the ECB, Constancio, was just expressing concern that it is not a good idea to voice such a view when monetary policy is the only thing going...it'll be alright if we don't talk about it.

His comments introduce my final closing points. The EZ is not like other sovereign states with their own central banks. It cannot simple engage in a spend and monetise (helicopter money) routine. Further, due to austerity and EA agreements about deficit limitations, it cannot expand sovereign balance sheets strongly even as yields go to zero. It has less going for it than Japan in this regard.

Monetary policy in the EZ could be reaching its limits. If so, it doesn't mean crash and burn necessarily. It means finally accepting that it will be in a very protracted period of low growth. Maybe it will ignite a round of productivity enhancing activity, but the voters are looking increasingly to unconventional outcomes. The ECB/Draghi Put is less solid. Meanwhile, Yellen is intent to tighten policy at any reasonable opportunity...the Yellen Call. This latest outcome is a bear signal for your suite of considerations.

 

[McLovin]

Great summary, DS. Thanks.

 

[fraa]

Hi Ds I know very litle, but I read his blog not because of his calls, but because the issues raised and discussed in the comments have a habit of becoming market issues down the line.

Will take some time to read your post in detail when I am not on the run.

ps read polemics blog called polemics paine (He was the previous incarnation of macro man). He is expecting risk on (I linked the wrong blog entry).

 

[fraa]

Hi DS - I am a noob so I cannot contribute anything meaningful to the "known unknowns" (below), but hope I can reply with a mismash of the more "bullish" views (no point if I just agreed with you right ?).

My brain dump.

1. ECB is abandoning using the EUR FX rate as a transmission mechanism to stroke demand. Hence going forward, no more negative rate cuts and by extension ECB no longer focused on weaker EUR. 2 main impacts.

1.1 Impact of negative rates on bank NIMs (i.e. re profits) has been negligible up to now (I think ? I read prior comparions using Sweden as a yard stick on how much ECB go could negative and they came up figure much higher then now). Market fear was around how deep potential negative rates could get. ECB has removed this fear.

1.2 Currency war - Market fears around devaluation i.e. to race to the bottom. CBs so far (except Fed) have engaged in currency devaluation. ECB has said (jawboned ?) no more EUR devaluation. So another fear has been removed (if you take ECB at face value).

I wonder if at the G20 the ECB, FED, BOC and BOJ had a few words and realized that the currency war at this point was MAD (pun intended) and had some informal agreement going forward. BOJ and FED next week will be interesting.

2. ECB LTRO I read was around assisting in 1.1 (i.e. alleviating impact of existing negative rate on euro bank NIMs). This is my first "known unknown" - not sure if this is pure signaling or has a concrete impact.

3. ECB will now refocus efforts targeting domestic credit creation directly (i.e. IG purchases). This is my second "known unknown" - I have no idea if this will work. I think your view is that this is likely to be ineffectual (others have shared this view).

But I think this also has signalling value - there was been a view that CBs are now out of bullets (firmed up by the BOJ epic fail recently). But with ECB heading down a new road (i.e. no longer focusing on using FX as transmission mechanism), this does give the "out of bullets" view pause as this is a new direction.

While an personal assessment that ECB efforts are ineffectual could be made, there is still doubt whether the market agrees (or how long it takes until it comes around - i.e. 2nd order thinking). Until there is an objective definitive signal that these measures are ineffectual - I think its prudent to keep an open mind and remove the air of doom/inevitibility that has hovered around CB efforts.

4. Re market reactions. During the 1st day when Euro stocks fell and EUR strengthened, oil/commods and other general risk on flags (i.e. AUD) hardly budged. Thats y I didnt think it was a general risk off and was just a change of market regime (particularly around the EUR). If there was a gentleman's agreement around the CBs (i.e. 1.2) then FX correlations going forward will change (algo impact ?).

I wonder what could be a catalyst that takes us down again. I think the market "expects" something to break (hightened reactions to the CoCo issue etc) but nothing has so far and we have bounced back up. Sentiment wise overall is bearish (BoAML funds report has very high levels of cash - fat pitch blog does regular weekly blog entries about it) so if on a longer term basis the bear case fails to materialise and sentiment shifts to bull, cash will move back into equities and we could get a strong rally. Considering that the prior rally up we have not had euphoria, I wonder if this recovery from a bear phase will provide that euphoria.

Its all about timeframes I guess - CBs could be out of bullets and ECBs efforts prove ineffectual, but we could get a rally that gives the euphoria, and down the line ECB efforts fail and then down we go.... But this is all spinning wishful narratives at this point which confirms my biases so I will stop now

 

[Ves]

Hi Ves, hope all's good.

Infrastructure is treated as a separate asset class by Insto investors. Separate management teams, different characteristics (revenue risk sharing, illiquid, sovereign risks etc). Furthermore, broken into debt and equity components. Some will be specific on whether to invest in greenfield or brownfield. Some insto asset owners will directly invest into individual assets. Others will appoint third party asset managers.

The consensus view is that the absolute price of trophy assets is bid far too high, but the buyers use liability matching arguments to justify it (large Canadian Defined Benefit Plans, for example) or strategic reasons (Port of Darwin). There are still opportunities in mid range assets on a case by case basis.

There are listed infrastructure funds and unlisted ones also which are available to retail investors.

Could be considered as an alternative to bonds, albeit with more credit risk of a different kind.

Thanks mate. That's helpful.

From a quick look at the listed ASX infrastructure companies (APA, SKI, AST and the NZ power companies) I tend to agree that better assets are priced fairly high at the moment. Which makes sense given your comments re alternative to bonds. The trade seems to be perceived as leveraged low-risk beta.

It appears there isn't really a diversified "passive" investment approach for these types of assets, unless you want to pay in excess of 1.2-1.5% annual management fees (some times more, no thanks). I'm thinking that's a bit rich for assets that probably won't earn more than 7-8%pa over the cycle.

 

[DeepState]

Saudi Aramco to IPO. Saudi Arabia is taking too much pain for this low oil rice to be sustained. Unless they are going to reduce Lamborghini purchases they have an incentive to increase the price of oil. They will strategically cripple themselves trying to keep Iran down unless they can do a lot of work on the expenditure side.

 

[DeepState]

Interactive Brokers keeps coming up as the go-to on-line broker of choice. I am not presently a client and am reticent given its offerings are an order of magnitude cheaper than the alternatives. Why would this be?

What am I missing? Are they trading off client protections in some way?

 

[qldfrog]

Interactive Brokers keeps coming up as the go-to on-line broker of choice. I am not presently a client and am reticent given its offerings are an order of magnitude cheaper than the alternatives. Why would this be?

What am I missing? Are they trading off client protections in some way?

Do you actually own the shares you purchase and where is your cash 'stored"?
these are the questions i would ask;
How have you been?
Been a while since the last posts.All good?

 

[Wysiwyg]

Saudi Arabia is taking too much pain for this low oil rice to be sustained. Unless they are going to reduce Lamborghini purchases they have an incentive to increase the price of oil. They will strategically cripple themselves trying to keep Iran down unless they can do a lot of work on the expenditure side.

Just an observation ..... With production costs less than 10 bucks per barrel, the lower market price would have meant less considerable profit but a worry probably not. The rig count in U.S. has more than halved in a year indicating which country has been feeling the pinch. I think the Middle East mob know they have the market cornered and how demand fluctuates. Information for general viewing provided below.

 

[So_Cynical]

Saudi Aramco to IPO.

Hell of a time to IPO anything conventional energy.

Interactive Brokers keeps coming up as the go-to on-line broker of choice.

What am I missing? Are they trading off client protections in some way?

You don't own the shares they do, that's the big difference.

 

[skc]

Interactive Brokers keeps coming up as the go-to on-line broker of choice. I am not presently a client and am reticent given its offerings are an order of magnitude cheaper than the alternatives. Why would this be?

What am I missing? Are they trading off client protections in some way?

Alternatives in terms of Australian brokers? Perhaps that says something about the local offerings as necessarily anything wrong with Interactive Brokers? Look at the Big 4 offering in say FX rates vs other online alternatives and I would guess the differences are even more stark.

The biggest problem I have with Interactive Brokers is that the assets are held in Street Name. This may have implications for asset recovery should Interactive Broker goes belly up. If you have a team of international lawyers and accountants able to go through all the fine prints in the PDS, the FDIC policies etc etc and give you the all clear... then that's great. But I don't rate my ability to understand these things that highly.

This risk however is mitigated by the fact that Interactive Brokers are public listed. It is quite rare to see a company goes straight from trading normally to bankruptcy without at least one financial report indicating major problems. Dick Smith is the only one I can think of but it at least have had a trading update.

The question comes down to whether you can easily liquidate your holdings with IB when the $hit hit the fan and withdraw your capital.

I also find IB's report makes local taxation reporting a bit trickier. E.g. they don't recognise that the tax year for trust distributions are determined by the record date and not the payment date. So that's a manual process you need to perform. Again, your team of international taxation experts may make this problem irreverent.

 

[DeepState]

You don't own the shares they do, that's the big difference.

IB offers CFDs as well as normal holdings (over which they offer the opportunity to stock lend to them in exchange for collateral). You cannot lend shares you hold an exposure via CFDs, so I figure that you own the shares if you are buying them through IB as you would if you were doing so via CommSec or Westpac etc. I have not been able to identify how these assets are held in trust away from IB's balance sheet. In Australia, it's via CHESS and is thus bankruptcy remote from the broker. Their Australian Financial Services Guide mentions assets held in custody for clients....which means the clients own them.

So, I still don't understand why the brokerage is so low. It is so even for futures trading, for which IG also seems to be acting as agent.

Even if these assets are held on IG's balance sheet and you happen to access them via swap/cfd, it's the same for other CFD providers. So why are they cheaper again?


I don't understand.

 

[DeepState]

The biggest problem I have with Interactive Brokers is that the assets are held in Street Name.

What does 'held in Street Name' mean?

I think you mean that the securities are held by a nominee custody company. That's standard practice for Custody. For example, National Australia Bank has a custody company called National Nominees. XYZ institution has a fund manager who trades and the securities are booked to that nominee on behalf of the client. It's like owning shares through your family trust. NAB can fall over, but your assets remain your assets.

Source of all truth: https://en.wikipedia.org/wiki/Custodian_bank

 

[DeepState]

Alternatives in terms of Australian brokers? Perhaps that says something about the local offerings as necessarily anything wrong with Interactive Brokers? Look at the Big 4 offering in say FX rates vs other online alternatives and I would guess the differences are even more stark.

It appears to be so even against offshore on-line brokerages. They should be able to replicate the business model, so it's a puzzle to me.

 

[McLovin]

What does 'held in Street Name' mean?

The broker owns the shares. I've never understood how that really works, presumably there are protections somewhere along the line to stop a rogue broker using your shares as security for his holiday home in the Hamptons.

 

[DeepState]

Do you actually own the shares you purchase and where is your cash 'stored"?
these are the questions i would ask;
How have you been?
Been a while since the last posts.All good?

Cash held on trust for clients and invested all over the place in repos and US Government. Looks high quality, but then senior debt is only rated BBB+ and seems a thin layer.

The shares seem to be held in a custody bank in 'Street Name' as per SKC.

All good thanks. Been focusing on currency lately and taken a while to develop a strategy which I have had in mind for years, makes sense to me, and is sustainably implemented. That and other stuff. Hope all's good with you.