Sunday, 28 August 2011

Hurricane Irene and Cat Bonds

Hurricane Irene, is increasing the interest in Cat Bonds. It is too early to tell what the effect of the hurricane will be on the catastrophe-bonds market or the North East. Cat bonds are an interesting idea: insurance against catastrophic losses.The Cat bond market is, however, relatively small and hard to collect against.

"Typically, for a cat bond to trigger, you need a bull's-eye to be hit instead of a general shot in the right direction."

"At the end of 2010, there were $12.5 billion in cat bonds outstanding, according to Aon Benfield, the reinsurance broker of Chicago-based Aon."

According to business week, "The catastrophe bond market will provide only $300 million toward up to $34 billion in insurance losses from the Japanese quake."

As Felix Salmon has pointed out. 

The fact is that catastrophe bonds are the capital-markets security of the future, and they always will be: insurers will always accept lower returns on their capital than the kind of ROI that hedge-fund cat-bond buyers are looking for. And as I mentioned back in 2008, beyond that there’s a fundamental, endemic reason why cat bonds won’t take off: the difference between parametric risk and indemnity risk.

Bond investors want to pay out based on science: magnitude of earthquakes as measured by the modified Mercalli scale; hurricanes as measured by wind speed and the like. Insurers and insured, by contrast, want their payouts based on losses. The basis risk between the two is large: Everybody can think of large losses from relatively small events, or small losses from relatively large events. And it’s not easy how that basis risk can be reduced. Unless and until that gap can be bridged, catastrophe insurance will remain the domain of the insurance industry. And the bond markets will only be involved at the very margin."

For some interesting background on cat bonds, see here.

Here is an interesting map showing (prior to Irene), America's 5 worst hurricanes.


Thursday, 25 August 2011

Demographics and the Stock Market

There is some interesting recent research out of the San Francisco Fed on the relationship between demographics and the stock market.

"Historical data indicate a strong relationship between the age distribution of the U.S. population and stock market performance. A key demographic trend is the aging of the baby boom generation. As they reach retirement age, they are likely to shift from buying stocks to selling their equity holdings to finance retirement. Statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades."

The authors, Zheng Liu and Mark M. Spiegel, estimate an error correction model for the p/e ratio and the M/O ratio and then use this model for forecasting the p/e ratio. The details are in their paper. The M/O ratio is the middle-age cohort, age 40–49, to the old-age cohort, age 60–69.

" The model-generated path for real stock prices implied by demographic trends is quite bearish. Real stock prices follow a downward trend until 2021, cumulatively declining about 13% relative to 2010. The subsequent recovery is quite slow. Indeed, real stock prices are not expected to return to their 2010 level until 2027. On the brighter side, as the M/O ratio rebounds in 2025, we should expect a strong stock price recovery. By 2030, our calculations suggest that the real value of equities will be about 20% higher than in 2010."

It is hard to argue with demographics.

Monday, 22 August 2011

Central Bank Gold Reserves

From Zero Hedge, here is a list of central bank gold reserves. Much of this central bank gold sits in bank vaults in London and New York. Think about what is going to happen to the price of gold as Venezuela and Libya start to repatriate their gold.

Notice that Italy, Portugal and  Spain are on the top 25 list. Perhaps the gold reserves of these countries should be used as collateral for future bailouts.

Canada's gold reserves are not enough to place it in the top 25. The Bank of Canada only has around 0.105 million ounces of gold (about 3.3 tons). 

Fukushima is a Big Problem

Here is a video from Australia's 60 minutes reporting on Fukushima.

The Japanese government is also finally admitting that there could be long term depopulation in the areas surrounding the plant.

Renewable Energy Breakthroughs

Here are two really cool recent breakthroughs in renewable energy.

MIT researchers have found a way to print solar panels onto a piece of paper. They can even be folded and reused! Check out the video!

Chinese researchers have developed a fuel cell that can clean water as it generates electricity.

Saturday, 20 August 2011

Climate Change, Coffee and Canada

For BSUS 6600 students here is an interesting article  from the Toronto Star on the effects of climate change on Canadian business.

"Up to 60 per cent of the world’s coffee-growing regions will no longer be viable by 2050 thanks to climate change, according to a recent estimate from the Global Coffee Quality Research Initiative."

Canada does not grow coffee but the coffee example is relevant to Canadian agriculture. Think of the coffee example as the canary in the coal mine for agriculture. Even the Canadian Securities Administrators thinks there is cause for concern. According to CSA, here are some ways that climate change could affect business.

  supply and distribution chain interruptions
  unplanned costs, to address environmental accidents
  loss of a license to operate
  affordability and availability of insurance
  changing consumer preferences

Canadian agriculture and shipping are two industries that could be particularly adversely affected.

More Gloom for Developed Economies

Here is a chart from The Economist showing how economies grew since the fourth quarter of 2007. Emerging  economies have grown the fastest while many developed economies are still below their pre-crisis level. Of the developed countries shown in the chart, Australia, Germany Switzerland and Sweden are above their pre-crisis levels. Germany would have recorded even higher growth had it not been for the poor economic performance and massive debt problems of some of its neighbors. China's economic growth is very impressive, but as my previous post indicates, the Chinese economy may be in a bubble.

Thursday, 18 August 2011

Sotheby's As a Predictor of the World Economy

There is an interesting article in The Atlantic about how the art  market and in particular Sotheby's is a useful predictor of the world economy. The reasoning is that over investment, overconfidence and easy money  drive up the price of auction house bids.

"In May 2010, an anonymous bidder believed to be Chinese forked over $106 million for Nude, Green Leaves, and Bust, the most ever paid for a Picasso. Five months later, three bottles of Chateau Lafite 1869 sold at Sotheby's for 30-times their pre-auction estimate, at $230,000 per bottle to Chinese bidders. In November, an 18th century vase sold for $70 million. Eight figures for a vase."

Is the Sotheby's indicator pointing to a bubble in China?

Wednesday, 10 August 2011

Debt Crisis Phone In

On Monday August 8, I was on Ontario Today talking about the current global financial crisis. Here is a link to the podcast.

Fiscal Stimulus but No More Monetary Stimulus

Professor Joseph Stiglitz suggests the US needs more fiscal stimulus but no more monetary stimulus. Failed monetary policy helped to create the current economic crisis.

Monday, 8 August 2011

Can the US Ever Pay Off its Debt?

According to this blog post, the answer is, no. At 14 plus trillion dollars it really is not possible to pay off the debt. Moreover, including future liabilities like social security, medical costs and pensions drives the debt load into the stratosphere somewhere between 60 and 70 trillion dollars. In comparison, the entire stock of assets in the US is estimated between 40 and 50 trillion dollars. This post makes me want to re-read the book "The Creature From Jekyll Island". This is an interesting book that details the creation of the US Federal Reserve.

In Europe, the ECB is faced with the task of coming up with several trillion dollars over the next few years to keep the PIIGS from being slaughtered. Money, that will keep these economies afloat for a few years but will ultimately never be paid back in full. With the American and European debt situations so mind boggling, perhaps debt repudiation is the answer. The  alternatives (do nothing or do small patch work debt deals) may well lead to a global depression. As this chart below shows, the biggest problem in America right now is lack of jobs. Japan has shown how it is possible for a major economic powerhouse to sustain two decades of lost economic opportunity with high debt loads and very slow economic growth.. It is now time for the US to decide which path to follow.

Sunday, 7 August 2011

High Frequency Trading

What does high frequency trading look like? For mere mortals, here is a link to an interesting video that shows what one second of high frequency trading looks like as it is spread out over one minute.

High frequency trading is a concern because, by some estimates, it accounts for between 50 and 60 percent of total trading market volume.

NON_CARBON BASED LIFE FORMS from arc w on Vimeo.

Global Smart Phone Sales

RIM has been heavily criticized for lagging sales on its products, but as this chart from Reuters shows, at least RIM sales of smart phones have not fallen as fast as Nokia's. RIM is ready to release some new products. Here in Canada, RIM’s new BlackBerry Bold 9900 and BlackBerry Torch 9810 are scheduled for release in the next few days.

Country Debt Ratings

Courtesy of Thomson Reuters, here is a map of Standard & Poor's sovereign debt ratings by country. The US has just lost its triple A rating and joins China and Spain with a double A plus rating. Notice that Canada belongs to a relatively elite group of countries with a triple A rating.

As for the US downgrade, here are some bright moments from other countries. Canada lost its AAA rating in April 1993 when  the Canadian Bond Rating Service downgraded the country's crediting rating from triple-A to AA-plus. The year after, Canadian stocks gained more than 15%. The Tokyo stock market climbed more than 25% in the 12 months after Moody's downgraded Japan in November 1998.

Felix Solomon has an interesting post on soverign debt ratings as well as a link in his article to all S&P sovereign ratings actions since 1975. A very interesting read.

Friday, 5 August 2011

Emerging Economies Taking a Greater Share of World GDP

In 1990, developed economies share of world GDP was 80% and emerging economies share of global GDP was 20%. The Economist has some nice charts showing how quickly things have changed in the past 20 years. Somewhere around 2019, emerging economies are expected to account for a greater share of world GDP than developed economies.

Tuesday, 2 August 2011

The Big Max Index Gets Beefed Up

The Economist's Big Max Index, long a topic of discussion in many of the courses that I teach has been given an upgrade. In its original form, the Big Max Index compares the prices of Big Macs around the world. The relative price of Big Macs in two countries gives an approximate value of purchasing power parity (PPP). The currency exchange rate between two countries can be compared to this PPP value to get a sense of whether currencies are over or under valued. PPP is a long run concept and is used to determine what exchange rates should be in the long run. PPP, however, is less useful for determining whether current exchange rates are over or under valued. The Big Max itself is not a traded basked of goods, but one could argue that the components of a Big Mac are traded.

The Economist has released a new and improved trade weighted Big Max Index that takes into account GDP per capita. This new index should be better suited for comparing exchange rate valuations in the short term because this index takes into account price differences between countries. On average, prices are cheaper in poor countries. The different versions of the Big  Max Index do give different results for some countries. The differences are large for the BRIC countries. In the case of China, for example, the raw index indicates that the yuan is significantly undervalued while the new index indicates the yuan is close to fair value. For Canada, there is not much difference between the two calculations.