Monday, July 24, 2017

The Repercussions of the Federal Reserve's Monetary Experiment

With the Federal Reserve finally making moves toward normalizing monetary policy by raising interest rates and reducing the size of its bloated balance sheet, it's an interesting exercise to look at what has motivated this move outside of the supposed health of the economy.  As you will see in this posting, there is a repeated theme in comments made by various Federal Reserve insiders.

Let's start with the head of the Federal Reserve.  Here's a recent exchange from Janet Yellen's July 12, 2017 testimony before Congress on the subject of asset prices: (starting at the 57 minute 55 second mark):

Ms. Carolyn Maloney (D - NY 12th):  The Fed has suggested that the stock market is currently overvalued.  Are there other markets that you consider or see as overvalued as well and do you think a correction in any of these markets would cause problems for financial stability?

Janet Yellen:  So, in looking at asset prices and valuations, we try not to opine on whether they are correct or they're not correct.  But, on...as you asked, what the potential spillovers or impacts on financial stability could be on asset price revaluations.  My assessment of that is that as asset prices have moved up we've not seen a substantial increase in borrowing based on those asset price movements.  We have a financial system, a banking system that's well capitalized and strong and I believe it's resilient."

Here's Eric Rosengren, President Federal Reserve Bank of Boston from a speech given May 9, 2017 entitled "Trends in Commercial Real Estate":

"While an overheated economy followed by a recession is only one possible scenario, and certainly not my prediction, it helps to illustrate one way in which low cap rates might be of concern in the event of such a reversal. While all market participants should consider how their positions would be impacted by adverse scenarios, Figure 15 shows that leveraged institutions and government-sponsored entities have significant exposures to commercial real estate. In the
event of an adverse scenario such as a recession, these exposures could pose significant risks to these institutions.

While I am certainly not expecting such a scenario to occur, central bankers are charged with thinking about adverse risks to the economy. So current valuations in real estate are one such risk that I will continue to watch carefully."

Here's Figure 15 which shows that the banking sector has been a massive investor in commercial real estate, currently owning 53 percent of the total, up 9.6 percent on a year-over-year basis:



Here's Jerome Powell, Member of the Board of Governors of the Federal Reserve from a speech given January 7, 2017 entitled "Low Interest Rates and the Financial System":

"Low-for-long interest rates can have adverse effects on financial institutions and markets through a number of plausible channels, as listed on the next slide.  After all, low interest rates are intended to encourage some risk-taking.   The question is whether low rates have encouraged excessive risk-taking through the buildup of leverage or unsustainably high asset prices or through misallocation of capital.  That question is particularly important today. Historically, recessions often occurred when the Fed tightened to control inflation.  More recently, with inflation under control, overheating has shown up in the form of financial excess.  Core PCE inflation remained close to or below 2 percent during both the late-1990s stock market bubble and the mid-2000s housing bubble that led to the financial crisis.  Real short- and long-term rates were relatively high in the late-1990s, so financial excess can also arise without a low-rate environment.  Nonetheless, the current extended period of very low nominal rates calls for a high degree of vigilance against the buildup of risks to the stability of the financial system."

Here is slide 8 from his presentation which shows the risks associated with "low-for-long interest rates":


Here's Stanley Fischer, Vice Chairman of the Federal Reserve from a speech given June 20, 2017 entitled "Housing and Financial Stability": 

"It is often said that real estate is at the center of almost every financial crisis. That is not quite accurate, for financial crises can, and do, occur without a real estate crisis. But it is true that there is a strong link between financial crises and difficulties in the real estate sector…. 

But memories fade. Fannie, Freddie, and the Federal Housing Administration are now the dominant providers of mortgage funding, and the FHLBs have expanded their balance sheets notably. House prices are now high and rising in several countries, perhaps as a result of extended periods of low interest rates...

But there is more to be done, and much improvement to be preserved and built on, for the world as we know it cannot afford another pair of crises of the magnitude of the Great Recession and the Global Financial Crisis."

Here's John Williams, President Federal Reserve Bank of San Francisco from an interview on Australia Broadcasting Corporation television interview June 27, 2017 (11 minute 55 second mark): 

"We are seeing some reach for yield and some maybe excess risk-taking in the financial system with very low rates...


I am somewhat concerned about complacency in the market...The stock market still seems to be running pretty much on fumes.  It's very strong in terms of that.    It's something that clearly is a risk to the U.S. economy, some correction there -- it's something we have to be prepared for to respond to if it does happen."
 
And, last but not least, let's wrap up this posting by looking at what Janet Yellen had to say on 

June 27, 2017 in conversation with Nicholas Stern at the British Academy (1 hour 7 minute 45 second mark):

"Asset valuations are somewhat rich if you use some traditional metrics like price-earnings ratios, but I wouldn't try to comment on appropriate valuations and those ratios ought to depend on long-term interest rates and of course there is uncertainty about that...so...yes, by standard  metrics some asset valuations look high but there's no certainty about that."

As I recall, the last time we heard about the abandonment of traditional metrics for stock valuations was back in the late 1990s and very early 2000s when measures like price-earnings ratios were tossed out the window when tech sector stock prices were unhinged from reality.  We all know how that movie ended, don't we?

Here is a chart showing the trailing price-to-earnings ratio for the S&P 500 going back to 1987:


While not at the levels seen during the tech stock boom (or during the extraordinary period during  the Great Recession's plunge in profits), the PE ratio certainly appears to be reaching the point of  being "rich".

While the braintrust at the Federal Reserve rarely show their hand, there seems to be a subtle yet repeated comments about the possible negative repercussions of their long-term near-zero interest rate policies, in particular, the impact on asset prices.  One would think that they learned from their experiences with low interest rates and the bubble created in the American housing market but, apparently, some lessons are harder learned than others.



Friday, July 21, 2017

Washington - Which Nation is Really Interfering in the Electoral Process?

While the American media and Washington are expending substantial energy on the alleged Russian interference in the United States political theatre during the 2016 election cycle, another nation and its American promoters that invest substantially in Washington generally fly under the radar when it comes to political influence-peddling.

According to Open Secrets, the pro-Israel "industry" has made the following political contributions since 1990:


Here is how these contributions were divided along party lines:


Over the two and a half decades, Democrat candidates received $83.16 million or 62 percent of the total compared to $49.95 million or 38 percent of the total for Republican candidates.  As shown on this table, while the majority of the long-term benefits have gone to the Democrats, that amount has varied from a low of 49 percent in 2006 to a high of 75 percent in 1994:


As well, the pro-Israel "industry" has ranked between 27th and 60th place in a field of more than 80 other industries when it comes to their political contribution generosity.  Obviously, the pro-Israel "industry" is not a massive donor like the Securities and Investment, Real Estate and Legal industries but it is still a substantial player in Washington when it comes to "buying" political influence through political donations.

Here is a listing of the major pro-Israel sector donors during the 2016 election cycle: 


Here is a graphic showing more detail on how the donations from the pro-Israel sector were split in the 2016 election cycle:


And, lest we forget, here are the individuals who benefitted the most from the pro-Israel sector's generosity during the 2016 election cycle:


Look who appears at the top of the list - none other than Democratic candidate, Hillary Clinton!  Interestingly, Donald Trump does not even appear on the list of the luckiest recipients, in fact, he receive a mere $69,730 from the pro-Israel sector as you can see on this list of presidential candidates:


Let's look at the other side of political influencing in Washington, that of lobbying.  Here is a graphic showing how much the pro-Israel sector has spent on lobbying on an annual basis since 1998:


The latest election year saw the greatest amount spent by the pro-Israel sector with $4,537,343 spent in 2016.  A decade ago, that amount was only $1,779,535 or about 39 percent of the spending in 2016.

Here are the six clients that represented the pro-Israel sector in 2013:


Not surprisingly, the American Israel Public Affairs Committee or AIPAC was responsible for the vast majority of the pro-Israel spending on getting legislators to see things Israel's way in 2013.

Here is a list of the 23 lobbyists that represented Israel's interests in Washington during 2016:


Of the 23 reported lobbyists, 4 or 17.4 percent are classified as "revolvers", that is, former federal employees who are now employed as lobbyists.   It's interesting to see that at least one of the "revolvers", Gordon Bradley, has been employed as a political analyst by the Central Intelligence Agency, and has served on the Senate Foreign Relations Committee twice prior to his employment by AIPAC in 1995.  He obviously has an inside track to influencing decision-makers.

In closing, let's switch gears for a moment.  According to the Jewish Virtual Library, since 1949, U.S. foreign aid to Israel has totalled $129.808 billion with $79.823 billion of that being military aid and $30.897 being economic aid.  Military aid has steadily risen from around $300 million annually in the early 1970s to $3.1 billion annually in the period between 2013 and 2017.  There is no about; Washington is a big investor in Israel.

Obviously, Israel has a great deal of interest in what happens in Washington, so much so that the pro-Israel "industry" is willing to spend tens of millions of dollars to "influence" elections and lobby Congress to stay on the good side of its long-term American benefactor.  But, somehow and in some way, that's different than the allegations of Russian "influence" during the 2016 cycle.


Wednesday, July 19, 2017

Global Carbon Pollution - Who is Responsible?

A recent publication by the environmental charity CDP looks at the role that corporations play in greenhouse gas emissions.  The Annual Carbon Majors Report for 2017 uses data from the Carbon Majors Database which was established in 2013 by Richard Heede of the Climate Accountability Institute.  The database shows us how carbon emissions are directed linked to a relatively small group of companies termed "Carbon Majors".  The report looks at both industrial carbon dioxide and methane emissions derived from fossil fuel producers in the past, present and future, providing investors and other interested parties to better understand the amount of carbon being released by key companies.

In its current form, the Carbon Majors Database consists of the following:

1.) data on 100 fossil fuel producers (the Carbon Majors) which includes 41 publicly traded companies, 16 private companies, 36 state owned companies and 7 state producers.  Whenever possible, the data used in this report data was supplied by corporate responses to the CDP Climate Change information request.   Other data came from estimates of emissions that are directly related to the emissions factor that is specific to the industrial activity (i.e. oil production, natural gas production etcetera).

2.) data on 923 gigatonnes of carbon-dioxide equivalent from direct operational and product-related carbon dioxide and methane emissions between the years of 1984 and 2015.  This data represents 52 percent of the global industrial greenhouse gases that have been released since the beginning of the industrial revolution in 1751. 

3.) data on a wider sampling of 224 companies which representing 72 percent of global industrial greenhouse gas emissions in 2015.

Here is a graphic showing the contribution of the three main fossil fuels to greenhouse gas production since 1988:


Since 1988, 833 gigatonnes of carbon dioxide-equivalent has been emitted compared to 820 gigatonnes in the 237 years between the beginning of the industrial revolution and 1988.  Coal is making up a larger share of fossil fuel production over the past 15 years, leading to an emissions intensity increase of 2.4 percent since 1988 despite the increase in the share of natural gas production, a lower carbon alternative.

With that background, let's take a closer look at the top 25 companies responsible for over half (51 percent) of global industrial greenhouse gas production by year going back to 1988:


In total, all 100 active major fossil fuel producers are responsible for 70.6 percent of global industrial greenhouse gas emissions.  The highest emitting companies since 1988 are as follows:

1.) Investor-owned - ExxonMobil, Shell, BP, Chevron, Peabody, Total and BHP Billiton.

2.) State-owned - Saudi Aramco, Gazprom, National Iranian Oil, Coal India, Pemex and CNPC (PetroChina).

One of the great contributors to the growth of greenhouse gas emissions is connected to the expansion of coal mining in China.  Since 2000, China's coal production has tripled to nearly 4 billion tonnes annually, nearly half of global coal output.  Half of China's coal production in 2015 came from 15 company groups with one-third of national coal production coming from 7 companies; Shenhua Group, Datong Coal Mine Group, China National Coal Group, Shandong Energy Group, Shaanxi Coal Chemical Industry, Shanxi Coking Coal Group and the Yankuang Group.

Here is a graphic showing the product mix for major oil and gas companies and their greenhouse gas emissions intensity:


For those of us who live in Canada, we can see that Suncor, Husky and Canadian Natural all fall high on the greenhouse gas emissions intensity scale, largely because of their oil sands operations, including both surface and in situ projects.  It is these unconventional oil projects that have higher greenhouse gas intensity than conventional crude oil and natural gas projects (i.e. higher carbon emissions on a per barrel of oil produced).

Let's close with this table which shows the top 50 companies in order of their cumulative industrial greenhouse gas emissions between the years 1988 and 2015:


The interesting data in this report will provide both the investing and non-investing public with an understanding of which global companies are responsible for the lion's share of carbon emissions.  Whether you believe that anthropogenic activities are leading to a changing global climate or not, it is interesting to see that a tiny fraction of the world's companies have long history of emitting pollutants that have the potential to create a much different world for the coming generations.