Summary of business news and analysis

from bubbles to "free lunches" through appreciation to defaults.. interesting new paper ... where are various markets in right now?

Kakarot-Handtke, Egmont, Make a Bubble, Take a Free Lunch, Break a Bank (October 26, 2012). Available at SSRN: http://ssrn.com/abstract=2167234

Keywords: Bubble Economics, Investment Cycles

Steven J. Davis, John C. Haltiwanger, Ron S. Jarmin, Josh Lerner, Javier Miranda, Private Equity and Employment, NBER Working Paper No. 17399, September 2011

Abstract:

"Private equity critics claim that leveraged buyouts bring huge job losses. To investigate this claim, we construct and analyze a new dataset that covers U.S. private equity transactions from 1980 to 2005. We track 3,200 target firms and their 150,000 establishments before and after acquisition, comparing outcomes to controls similar in terms of industry, size, age, and prior growth. Relative to controls, employment at target establishments declines 3 percent over two years post buyout and 6 percent over five years. The job losses are concentrated among public-to-private buyouts, and transactions involving firms in the service and retail sectors. But target firms also create more new jobs at new establishments, and they acquire and divest establishments more rapidly. When we consider these additional adjustment margins, net relative job losses at target firms are less than 1 percent of initial employment. In contrast, the sum of gross job creation and destruction at target firms exceeds that of controls by 13 percent of employment over two years. In short, private equity buyouts catalyze the creative destruction process in the labor market, with only a modest net impact on employment. The creative destruction response mainly involves a more rapid reallocation of jobs across establishments within target firms." Source: NBER

Keywords: Private Equity, Employment

Related:

Adveq: Research shows significant employment increase at private equity-backed companies based in Europe; Biggest employment increase at companies owned by small buyout funds

Achleitner, Ann-Kristin Klöckner, Oliver, Employment contribution of private equity and venture capital in Europe, CEFS working paper series 2005-05

Schlumpf, Felix, Tessera, Genene and Martínez Gutierrez, Catalina , Market Risk of Real Estate (October 24, 2012). Available at SSRN: http://ssrn.com/abstract=2172299

Abstract:

"Direct real estate is the largest asset class without readily available prices. The market capitalization is comparable to that of equities and fixed income, and much larger than that of other alternative asset classes like private equity or hedge funds. Nevertheless, because of the missing price information, it is difficult to estimate the market risk of direct real estate. We propose a simple methodology that uses data on indirect real estate to provide a better understanding of the real estate market risk. Our model uses widely available data and solves the problems posed by the appraisal and transaction-based indices, as well as by the hedonic approach, which are difficult to implement in practice. In particular, we use data on Real Estate Investment Trusts (REITs) returns, determine their factor exposures to other asset classes, and delever these exposures according to REITs’ balance sheets. We find that the existing direct indices understate real estate market risk. Indeed, using data from the UK, the volatility of the real estate asset class that our model entails is almost three times that of appraisal-based indices, and two times that of transaction-based ones. In addition, the correlations to other asset classes are materially different and higher, which is important in a portfolio context. We argue that these findings can have important empirical implications, as they can be useful for practitioners aiming at achieving a simple, transparent and more accurate risk management of their portfolios. Moreover, our findings can help to better understand extreme risks in the real estate market, which have a high impact on the overall economy, as was observed in the recent financial crisis." SSRN

Keywords: Public and Private Real Estate, Real Estate Risk

Dear Mervyn
....
Best Wishes, George

Letter from the Chancellor to the Governor, Nov. 9, 2012

Keywords: Central Banking, Central Bank Independence

Keywords: Technology, Entrepreneurship

Things go into the right direction:

Labour costs have to adjust if you take a look at productivity differences among EU countries:

Labour productivity growth and wage growth in the EU

Keywords: EU Labour Costs, EU Productivity

A 2009 survey (see below) showed that "building wealth" is an important objective for entrepreneurs. Private equity offers an excellent opportunity for entrepreneurial managers to achieve such goal.

Wadhwa, Vivek, Holly, Krisztina, Aggarwal, Raj and Salkever, Alex, Anatomy of an Entrepreneur: Family Background and Motivation (July 7, 2009). Kauffman Foundation Small Research Projects Research. Available at SSRN: http://ssrn.com/abstract=1431263 or http://dx.doi.org/10.2139/ssrn.1431263

Abstract:

"Entrepreneurs are among the most celebrated people in our culture. Celebrity entrepreneurs such as Steve Jobs, Bill Gates, Sergey Brin and Larry Page, often grace the covers of prominent publications. These company founders and innovators fuel economic growth and give the nation its competitive edge.

Keywords: Entrepreneur, Entrepreneurship

The Next President Is Lucky; Whoever wins the election will get to preside over a growing economy and look like a genius, Nov. 5, 2012

..."The key reason jobs will almost certainly grow at at least a tepid rate is monetary policy. Ellis Tallman and Saeed Zaman have shown in research for the Cleveland Federal Reserve bank that the kind of objective economic conditions that existed in 2009 would have justified a federal funds rate of minus 5 percent—if such a thing were possible. But it’s not possible for the Fed to set nominal interest rates below zero, and the Fed hasn’t been willing to try to raise its inflation target to reduce real interest rates. Consequently, with interest rates stuck at zero, we got exactly what you would expect in a country where the central bank sets rates five percentage points too high—soaring unemployment and a sluggish recovery."

Kewords: US Economy, Economic Growth, Monetary Policy

Countercyclical monetary policy.. proof of concept has to follow.
Philippe Aghion CERGE-EI Lecture "Monetary Policy, Liquidity and Growth" 11 June 2012

Global Manufacturing Activity Graph

Manufacturing in the US grew in October at its slowest pace in more than three years and appears likely to act as a drag on overall growth in the final months of 2012. Markit said its U.S. Manufacturing Purchasing Managers Index fell to 51.0 this month, below a preliminary estimate of 51.3 and September’s reading of 51.1. Today’s graphic shows how key economies performed in October based on Manufacturing PMI. see graph

Keywords: Global Manufacturing Activity, Manufacturing in World Regions

A new paper shows the global multi-asset market portfolio 1959-2011. It represents the views of the market crowd with respect to the pricing and value of all asset classes. In 2011, for the first time in the observation period, equities no longer outweigh government bonds.

Doeswijk, Ronald Q., Lam, Trevin W. and Swinkels, Laurens A. P., Strategic Asset Allocation: The Global Multi-Asset Market Portfolio 1959-2011 (November 2, 2012). Available at SSRN: http://ssrn.com/abstract=2170275

Abstract:

"The portfolio of the average investor contains important information for strategic asset allocation purposes. This portfolio shows the relative value of all assets according to the market crowd, which one could interpret as a benchmark or the optimal portfolio for the average investor. We determine the market values of equities, private equity, real estate, high yield bonds, emerging debt, non-government bonds, government bonds, inflation linked bonds, commodities, and hedge funds. For this range of assets, we estimate the invested global market portfolio for the period 1990-2011. For the main asset categories equities, real estate, non-government bonds and government bonds we extend the period to 1959-2011. To our understanding, we are the first to document the global multi-asset market portfolio at these levels of detail for such a long period of time." Source: SSRN

Keywords: Strategic Asset Allocation, Optimal Portfolio

Keywords: US Budget, Fiscal Cliff

Axel Merk and Nick Reece of Merk funds have some good thoughts in their latest newsletter:

"American consumers (and Chinese exporters) have been subsidized by the artificially weak Chinese currency, to the detriment of Chinese consumers who have faced stunted purchasing power. However, we believe this dynamic will continue to change and suggest that a stronger RMB is very likely not only on Bernanke, Obama, and Romney’s wish list, but increasingly in China’s own interest. That would mean the tables getting turned on the American consumer." Source: Merk Funds

Read the Newsletter here:

Axel Merk Funds: U.S. of A(sia) - United to Weaken the Dollar?! Axel Merk & Nick Reece, Merk Investments

Keywords: Currencies, Exchange Rates, Renminbi, RMB, US Dollar

Strong Share buy back activity is a logical consequence in an environment of shareholder value maximization and modest innovation. Consequently, we need policies which foster quality innovation and not The Great Stagnation.

Jay Ritter has some insights on the relationship between economic growth and investor returns:

Ritter, Jay R., Is Economic Growth Good for Investors? (Summer 2012). Journal of Applied Corporate Finance, Vol. 24, Issue 3, pp. 8-18, 2012. Available at SSRN: http://ssrn.com/abstract=2161183 or http://dx.doi.org/10.1111/j.1745-6622.2012.00385.x

Abstract:

"When measured over long periods of time, the correlation of countries' inflation-adjusted per capita GDP growth and stock returns is negative. This result holds for both developed countries (for which the correlation coefficient is ¨C0.39 using data from 1900¨C2011) and emerging markets (the correlation is ¨C0.41 over the period 1988¨C2011). And this means that investors would have been better off investing in countries with lower per capita GDP growth than in countries experiencing the highest growth rates. This seems surprising since economic growth is generally assumed to be good for corporate profits. In attempting to explain this finding, the author begins by noting that economic growth can be achieved through increased inputs of capital and labor, which don't necessarily benefit the stockholders of existing companies. Growth also comes from technological advances, which do not necessarily lead to higher profits since competition among firms often results in the benefits accruing to consumers and workers. What's more, it's important to recognize that growth has both an expected and an unexpected component. And one explanation for the negative correlation between growth and stock returns is the tendency for investors to overpay for expected growth. But there is another - and in the author's view, a more important - part of the explanation. Along with the negative correlation between long run average stock returns and per capita growth rates, the author also reports a strong positive association between (per share) dividend growth rates and overall stock returns. Such an association is not surprising since unusual growth in dividends is a fairly reliable predictor of increases in future earnings. But another effect at work here is the role of dividends - and, in the U.S., stock repurchases too - in limiting what might be called the corporate overinvestment problem, the natural tendency of corporate managers to pursue growth, if necessary at the expense of profitability. One of the main messages of this article is that corporate growth adds value only when companies reinvest their earnings in projects that are expected to earn at least their cost of capital - while at the same time committing to return excess cash and capital to their shareholders through dividends and stock buybacks." Source: SSRN

Keywords: Economic Growth, Returns

Keywords: Venture Capital, Funding

Keywords: Apple, Capital Expenditures, Microsoft, Amazon

Related:

The Economist: we need more public companies

Today, UBS announced a massive downsizing of its investment bank. Other banks are in the same process of will follow. This is a logical consequence after various of the investment banks had reached a "bubble stage" prior to the financial crisis. Excesses happened in an environment of governmental regulation of the US real estate market and weak governance of various banks. The current process will not at all be the end of investment banking. In contrary, firms from main street (as opposite to Wall Street) are in urgent need of services which help them to finance projects, to get advice in acquisitions and capital market transactions, to make optimal use of the financial resources etc. Downsized and less risky investment banks can be a more reliable partner in this respect.

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MarketObservation: Nature of investment banks today and in the future, October 11, 2007:

Banks such as UBS have lost billions in the subprime mortgage crisis. This business was done out of the investment banking departments of such banks. It is questioned again whether it could make sense to spin off investment banking from large banking conglomerates as they might have a negative impact on overall risk-adjusted value of such conglomerates.

It is argued that the break up value of a bank such as UBS might be substantially bigger than the current market capitalization of the bank. When thinking about such scenarios it is also important to look at the nature of todays large investment banking operations. They are not homogenous at all within themselves. The investment banking business is a combination of highly computerized, scaleable businesses and businesses where tacit skills are highly important (e.g. M&A deal making). When discussing possible investment banking spin offs from banking conglomerates a differentitated view, looking at the various risk profiles of investment banking businesses, should be taken.

Attached article provides a valuable overview of the current nature of investment banking operations:

Investment Banking: past, present and future, by Alan D. Morrison, Saïd Business School, University of Oxford and William J. Wilhelm, Jr., McIntire School of Commerce, University of Virginia, 2007

Key conclusions are:

• Investment banks emerged as intermediaries in informationally sensitive transactions.
• The banks established long-term profi table relationships with key information providers and used this information, together with a valuable reputation for probity,
  to attract security issuers.
• The traditional investment banker had a largely tacit skill set. He learned his trade during a long on-the-job apprenticeship in a firm that could provide the close relationships, the mentoring, and the peer-group monitoring upon which tacit skills rely.
• Due to the information technology revolution of the late 20th century many traditionally tacit skills were codified, and massive economies of scale became possible.
• Investment bankers jettisoned the partnership form that had fostered their creation and use of tacit skill in favor of joint stock incorporation, which gave them access to the
  capital required to harness the new economies of scale.
• Tacit skill did not become irrelevant but it became more difficult to reconcile it with the formal reporting lines and the increased scale of the older investment banks.
• An industry reorganization was perhaps inevitable. Using new communications
  technologies, investment banks have started to spin off their most human capital-intensive activities into boutique investment houses.
• Settlement, trading, and analysis tasks were retained

Author's guess about the future:

• Further technical advances, coupled with an increasingly strident regulatory state, will likely result in more codification, more systematization, and more consolidation in the largest investment banks.
• This trend will take the biggest players farther from their origins in tacit human capital businesses.
• But tacit skill andinformal contracts based upon reputation will remain central
  features of informationally intensive security market trades.
• The challenge for the large investment banks will be to reconcile their large scale operations with the operations where tacit skills are a key success factor.

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MarketObservation: Daniel A. Kukla about "The Boundary of the Investment Firm ", August 31, 2010:

Kukla, Daniel A., The Boundary of the Investment Firm (August 13, 2010). Available at SSRN: http://ssrn.com/abstract=1658541

Abstract:

"The central concept of an investment firm is fuzzier than might immediately appear. Why do investment firms exist at all? What should be the range of their activities? This exploratory study investigates forces which shape the boundary of the investment firm by analyzing firms in the Private Equity industry. The PE industry offers a rich ground for research, given that substantial parts of the PE universe have been rapidly migrating from traditional single-product PE firms towards multi-business investment firms. Based on interviews with senior investment professionals and executives from leading PE firms and based on case studies, I find that the boundary of the firm is determined by the trade-off between expansion enhancers, in particular ‘deal sourcing advantages’, ‘capital sourcing advantages’, ‘procurement cost advantages’ and ‘information sharing advantages’, and expansion inhibitors, particularly ‘conflicts of interest’, ‘asset allocation authority’, and ‘parenting disadvantages’. Moreover, I speculate that if the new generation of multi-business investment firm models succeeds, they may fill the gap which most recent regulation has created in the commercial and investment banking industry, given that multi-business firms are not scrutinized to the same extent."

Keywords: Private Equity, Multi-Business Investment Firm

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Selected other MarketObservation posts about investment banking in the past:

MarketObservation: Ownership structure of banks matters, March 26, 2011

MarketObservation: Forderung nach einer differenzierten Betrachtung des Investment Bankings, April 26, 2008

You find below selected feeds of think tanks, institutes and institutions which support the idea of liberty and free markets.

You find here comprehensive lists of libertarian think tanks around the globe:

List of libertarian think tanks (global list)

Stockholm Network (European)

Videos (on Youtube) of the Cato Institute (United States)

Podcast feed of the Cato Institute (United States)

The American Enterprise Institute (United States)

Mercatus Center (George Mason University, United States)

The Circle Bastiat(Mises, United States)

Videos (on Youtube) of The Adam Smith Institute (United Kingdom)

Institute of Economic Affairs IEA (United Kingdom)

Fondation pour L'Innovation Politique (France)

Fascinating! You can feel the "animal spirit".

2008

Keywords: Silicon Valley, Entrepreneurship

The great economist about inflation and stimulus.

Keywords: Inflation, Quantity of Money

Find here a presentation by a professor of the University of St. Gall about causes and consequences (as related to institutional investing) of financial repression:

Institutionelle Anlagen unter veränderter finanzieller Repression und danach, Prof. Dr. Rico von Wyss, Swiss Pensions Conference, Rüschlikon, 28. 09. 2012

Keywords: Institutional Assets, Financial Repression, Real Interest Rates

Related:

Handelsblatt: Welche Länder ihre Sparer am stärksten schröpfen, August 13, 2012