For our big picture podcast this week we feature Binyamin Appelbaum’s pessimistic take on economists’ influence on US policymaking since the late 1960s. He argues that economists have failed to deliver the benefits promised and economics should now re-associate itself with other disciplines to become more effective.
On markets we feature a JPMorgan discussion on private credit. The current low / negative yield environment leaves scope for niche players to benefit despite the increased prevalence of borrower friendly terms.
Finally, we feature two ESG podcasts this week but from very different angles. The first, discusses the estimated $900bn in carbon-rich assets that could become “stranded” in the shift towards cleaner energy. And it’s not just the coal companies who should be worried. Our second green podcast this week comes from Deutsche Bank where their credit strategists discuss the dynamics of the tiny, but rapidly growing, green bond market.
We also feature an exclusive on Mike Bloomberg from veteran strategist John Tierney. Despite Bloomberg’s disappointing debate performance this week John thinks it’s too soon to rule Bloomberg out.
Don’t Rule Out Bloomberg Just Yet (3 min read) Is Michael Bloomberg done? As in, is he out of the presidential race for all practical purposes, or is he simply biding his time?
You could fall either side of that question after watching his debate performance on Wednesday night in Nevada. On the negative side, Bloomberg mostly stood stony faced as the other candidates devoted much of their time to pounding his record, reputation, and wealth. He didn’t try to respond and (surprisingly) moderators rarely let him.
That said, when he did defend himself by laying out his views about stop-and-frisk, or about promoting women in his business and foundation over the years, he was factual and to the point – but also dry and ill at ease. One could be forgiven for thinking it pained him to have to explain himself.
(John Tierney │ 21st February, 2020)
Did Economists Ruin The Economy With Binyamin Appelbaum (Capitalisn’t, 39 min listen)
• Binyamin Appelbaum, New York Times editorial writer and author of the Economists’ Hour, discusses economists’ influence on US public policy since the late 1960s.
• Economists argued that if their advice was followed; the economy would grow more quickly, the benefits would be broadly distributed and that democracy would be strengthened by relying on markets. But history hasn’t played out this way.
• Examples of economists influencing policy are; the ending of mandatory conscription into the US army, deregulation of the transport and telecoms markets, the Fed’s shift in monetary policy from unemployment to inflation, support for globalisation and shifting anti-trust legislation towards a narrow focus of consumer welfare.
• Appelbaum argues that consumer welfare was not the original intent as claimed, but acknowledges that inconsistencies in anti-trust legislation meant something needed to change. This should have been determined by politicians, however, not economists.
• Efficiency came at the expense of equality. Both the right and left accepted this trade-off despite no empirical foundation, except at extremes.
• Economics would benefit from re-associating itself with other disciplines. Take what’s good about economics but recognise its limitations.
• There is a lag between when ideas are influential in academia and when they influence policy but he views policymakers as still in the grip of what he calls older economics.
Why does this matter? Widening inequality has been a catalyst for rising populism / nationalism and a reversal of the trend towards increased globalisation. If economics can help to recalibrate policy and pivot towards a fairer and more inclusive society the political shifts seen in the UK/US and elsewhere in recent years may not be repeated
Private Credit: Opportunities To Generate Alpha Above Public Debt (Center For Investment Excellence, JPM Asset Management, 17 min listen)
• David Lebovitz, Global Market Strategist at JPM Asset Management, and Jonathan Seagull, Co-CIO at High Bridge Capital Management, discusses private and public credit market trends in a low yield environment.
• Negative yielding debt currently stands at $13trn, this is predominantly government bonds but there is an increasing amount of negative yielding corporate credit.
• Higher investment return targets have led investors to enter higher quality liquid parts of high yield market (BB) and avoid less liquid CCC issues.
• Investors are more active outside of traditional public credit markets. Private credit markets have doubled in size since the financial crisis and investors are entering deals at every worsening terms in search for yields.
• Abundant liquidity has incentivised borrower-friendly behaviour like add backs, Earnings (EBITDA) adjustments, covenant light issuance and sponsored back lending.
• Seagull explains that such behaviour is emblematic of late-cycle dynamics. We are witnessing coupon compression, covenant erosion and weaker underwriting requirements in traditional direct and mezzanine lending. Covenant light loans in institutional leverage lending in the US has reached 80% in 2018 and has increased every year since the crisis.
• Long only funds focus on IG and large HY issues and cannot invest in companies excluded from the Index. This creates opportunities for niche players.
Why does this matter? The hunt for yield provides opportunities as well as risks. Greece has issued 3-month debt at negative yields (and recently 10-year debt at sub 1%) despite debt/GDP one of the highest in the world at around 175% and huge remaining challenges to reform its economy. Argentina’s sovereign debt is now subject to restructuring following a very sharp run up in fx-denominated debt in just a few years. For both corporates and sovereigns investors must determine where there is still value in credit.
Are Oil And Gas Turning Into Stranded Assets? (News in Focus – Financial Times, 18 min listen)
• FT Lex writer Alan Livsey discusses his estimate of $900bn in “stranded assets” from the shift towards cleaner energy – defined as investment that are no longer able to earn an economic return such as oil, natural gas or coal assets in the ground (i.e a white elephant) perhaps due to a carbon tax or emissions trading scheme.
• Energy companies remain committed to further production even as they diversify to renewables, but the way they treat energy reserves has changed as the long-term risks to oil and gas means reserves not as important as in the past.
• Tough to disaggregate the impact of ESG concerns on share prices but valuation discrepancies between so-called clean and dirty assets are the biggest in 10 years.
• Coal is the dirtiest fossil fuel and one of the easiest to get out of portfolio. Natural gas prices have been weak and this is the competing fuel for coal. Coal stock prices down over 70% since peak in spring 2011. Oil stocks not as much.
• Livsey estimates that if the aims of the Paris climate agreement are met more than 80% of fossil fuel assets would be stranded.
• Which companies have the most to lose? A lot of this is coal but also Saudi Aramco given carbon rich assets (oil), Rosneft and ExxonMobil also vulnerable.
• Energy companies are taking the climate emergency seriously but they don’t know what to do. No competitive advantage in renewables and need to find a way to preserve high dividend yields.
• How can other companies adapt? Renewable capital spend is currently tiny and can be increased. Cost of capital is going up as share prices go down and this cannot be ignored.
Why does this matter? Increased focus on ESG investing under an unchanged pool of assets risks pushing up prices of a small number of assets, like Orsted, that are currently deemed green. But a lack of consistent ESG ratings mean there is no industry-wide standard to define a green asset. And it’s the change that matters. Just because a company is not currently considered environmentally friendly does not mean it won’t be in the future. ESG investors could miss opportunities if they look only at current rather than projected future green performance.
Green Bonds – Increasingly Relevant in the Corporate Bond Market (Podzept – Deutsche Bank Research, 14 min listen)
• DB’s credit research analyst Craig Nicol shares insights on the $250bn green bond market.
• In the absence of an official definition Nicol describes a green bond as: any bond whereby use of proceeds has a positive environmental or climate-change impact.
• Issuer is in charge of labelling a bond as green and then aligning with the required standards. A third party will usually back up this claim. The EU Taxonomy will hopefully develop this further and set out stringent and consistent framework.
• In Europe green bonds have been issued to fund renewable energy, for pollution prevention, to improve energy efficiency in corporate buildings, fund hybrids and EVs.
• “Greenium”, or a premium for green bonds versus a similar vanilla issue. Nicol finds that premiums are small where they exists at all.
• Green bond market is become more balanced in terms of issuers. In 2013-14 corporate and financials accounted for just 20% of issuance with quasi-sovereigns and mortgage-backed issuers dominating. Now corporates and financials account for around 50%.
• But there is a lack of diversification with a few large green issuers skewing aggregates / adding concentration risk. Bank and utility companies make up two-thirds of all issuance.
• Number of corporate issuers is close to 170. This has more than doubled in three years and comes from zero ten years ago.
• Expectations for 2020 issuance is a for similar growth rate, taking issuance to $350-400bn.
Why does this matter? Continued rapid growth of the green bond market will make the lack of a standard definition increasingly problematic and greenwashing could become more prevalent. Increased expectations of green QE from the ECB could well make the problem worse as the currently small pool of investable assets would struggle to meet demand.
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