Junk bonds are in the spotlight this week with two separate but related posts topping the list of most read at Research Recap. Speculative grade bonds now account for half of all corporate bonds, leading Standard & Poor’s to predict that a
Glut of Junk Bonds Will Boost the Overall Bond Default Rate. Moody’s, meanwhile forecasts a Tripling of Junk Bond Defaults by Year-end.
With oil prices reaching record highs on an almost daily basis, it is no suprise that the IMF’s Speculation Playing “Significant Role” in Oil Price Surge was popular. You know this issue is getting serious when the Financial Times calls for a global oil summit.
Such a summit would have three objectives: to encourage energy efficiency, and so reduce future oil demand; to promote investment in new oil supplies; and to smooth the recycling of billions of dollars in oil revenues from producers back into consuming countries. All three tasks would be easier with international co-operation and there are enough shared interests to make a worthwhile deal possible.
Staying with energy, Freeedonia’ massive Industry Study World Biofuels Demand to Expand 20 percent Annually, drew interest, concluding that ethanol will dominate the industry for some time despite criticism that its is driving up food prices.
Research Recap Quote of the Week:
Maybe working longer is the best answer. After all, the retirement age was set at 65 in 1933, when average life expectancy was 63. With life expectancy today at 78 years, perhaps we should just plan to work until we’re 80.
S&P chief economist David Wyss’s proposed solution for Baby Boomer generation’s projected shortfall in retirement resources.
Oxford Analytica is not persuaded by the Bank of England’s recent suggestion that mark-to-market loss estimates overstate the damage wrought by the subprime crisis.
The BoE’s optimism contrasts with the IMF’s claim that total financial system losses — estimated at $945 billion dollars — remain in excess of writedowns announced so far by banks and other financial intermediaries.
In a new analysis BoE seeks light amid the gloom, OxAn says “it is debatable whether current pricing methods have led to excessively depressed ABS valuations. Mark-to-market pricing, or ‘fair value’ accounting, is strongly endorsed by the accounting profession.”
By arguing that current mark-to-market pricing is overstating financial losses, the Bank of England appears to be seeking to restore confidence in increasingly risk-averse markets, OxAn Says.
However, its contrarian views have called to question its credibility.
“The wide acceptance of ‘fair value’ accounting makes it unlikely to be dropped as common practice. Moreover, the (BoE’s) latest report fails to analyse sufficiently the market for ABCP or the risk of feedback — from a declining economy to the financial system — should present uncertainties be allowed to persist,” OxAn concludes.
The thinning ranks of climate change deniers are confronted with more compelling evidence in this week’s issue of Nature.
Nature reports that a comprehensive analysis of trends in tens of thousands of biological and physical systems has provided more evidence to bolster the near-universal view that man-made climate change is altering the behaviour of plants, animals, rivers and more.
The study, by an international research team featuring many members of the Intergovernmental Panel on Climate Change (IPCC), is a statistical analysis of observations of natural systems over time. The data, which stretch back to 1970, capture the behaviour of 829 physical phenomena, such as the timing of river runoff, and around 28,800 biological species.
Among the warming-linked changes seen in the study are the timing of plant flowering, bird nesting, ice melting, salmon migration and pollen release; declines in populations of polar bears, krill and penguins; and increased growth of Siberian pines and cool-water ocean plankton.
“This paper outlines an extremely robust case for linking a range of observed physical and biological changes to human-induced climate change, specifically warming,” says Roger Jones of the Centre for Australian Weather and Climate Research. “Unfortunately, the coverage of such data is not global and many regions of the world, including Australia, are not very well covered. Many of the regions that lack coverage are also thought to be highly vulnerable to the impacts of climate change.”
Early retirement by baby boomers could be helping keep the unemployment rate down even as payroll employment falls, according to Standard & Poor’s Chief Economist David Wyss.
In Older But Not Wiser: Why Americans Remain Dangerously Unprepared For Retirement, Wyss points out that as the oldest Baby Boomers turn 62, the sharp rise in the number of workers near the average retirement age will result in a group of workers with a less-than-normal need/desire to work. A jump in layoffs could convince many of these workers to retire early—either in response to buy-out offers or as a result of weak job prospects.
The result could be a drop in payroll employment with a less-than-expected rise in the unemployment rate. Labor statistics might not even count these workers as “discouraged” because they will report themselves as retired.
This could explain why in the last few months, we have seen such a sharp drop in the number of people employed, while unemployment claims have remained relatively low, Wyss writes.
Employers could be shedding workers into retirement rather than into unemployment.
The report outlines the challenges facing Baby Boomers as they near retirement:
The S&P 500 will have its worst decade since the Depression if it closes below 1,469 at the end of 2009. The decline in home prices is also eroding wealth.
Low interest rates mean low incomes for retirees. The 10-year Treasury note is yielding only 3.9%, up from the lows of a few weeks ago but well below its 6.9% average since 1960.
Retiring in a period like this strains assets in the best case—and this is far from the best case. Asset values have been declining, while saving rates have hovered near 0%. If older workers aren’t adding to their wealth and if their asset values are falling, the prospects of a comfortable retirement are receding. The average household had wealth equal to 558% of after-tax income at the end of 2007, down from 569% a year earlier and 618% at the market peak in 1999.
Wyss’s bottom line: “We’re in trouble. The average American is worried about retirement but is doing little to provide for it.”
Maybe working longer is the best answer. After all, the retirement age was set at 65 in 1933, when average life expectancy was 63. With life expectancy today at 78 years, perhaps we should just plan to work until we’re 80.
It looks like everything would have to go right for the US to meet President George Bush’s goal of meeting 20 percent of US energy needs through wind power by 2030.
A new study for the Department of Energy concludes that the goal is technically feasible, but also identifies the many challenges that need to be overcome. Put simply it would require a major national commitment by business and government and a change to business as usual.
The DOE report “20 Percent Wind Energy by 2030”, identifies requirements to achieve this goal including reducing the cost of wind technologies, new transmission infrastructure, and enhancing domestic manufacturing capability. The report identifies opportunities for 7.6 cumulative gigatons of CO2 to be avoided by 2030, saving 825 million metric tons in 2030 and every year thereafter if wind energy achieves 20 percent of the nation’s electricity mix.
The analysis concludes that reaching 20 percent wind energy will require enhanced transmission infrastructure, streamlined siting and permitting regimes, improved reliability and operability of wind systems, and increased U.S. wind manufacturing capacity.
There are significant costs, challenges, and impacts associated with the 20% Wind Scenario presented in this report.
“There are also substantial positive impacts from wind power,” the report says.…”expansion on the scale and pace described in this chapter are not likely to be realized in a business-as-usual future. Achieving this scenario would involve a major national commitment to clean, domestic energy sources with minimal emissions of GHGs and other environmental pollutants.”
Specific challenges include:
- Investment in the nation’s transmission system so the power generated is delivered to urban centers that need the increased supply;
- Larger electric load balancing areas, in tandem with better regional planning, so that regions can depend on a diversity of generation sources, including wind power;
- Continued reduction in wind capital cost and improvement in turbine performance through technology advancement and improved manufacturing capabilities; and
- Addressing potential concerns about local siting, wildlife, and environmental issues within the context of generating electricity.
Other highlights of the report include:
- Annual installations need to increase more than threefold. Achieving 20 percent wind will require the number of annual turbine installations to increase from approximately 2000 in 2006 to almost 7000 in 2017.
- Costs of integrating intermittent wind power into the grid are modest. 20 percent wind can be reliably integrated into the grid for less than 0.5 cents per kWh.
- No material constraints currently exist. Although demand for copper, fiberglass and other raw materials will increase, achieving 20 percent wind is not limited by the availability of raw materials.
- Transmission challenges need to be addressed. Issues related to siting and cost allocation of new transmission lines to access the Nation’s best wind resources will need to be resolved in order to achieve 20 percent wind.
The recent surge in oil prices cannot be explained by economic factors alone, meaning speculation has played a “significant role,” according to the International Monetary Fund.
In an analysis in its Regional Economic Outlook for the Middle East and Central Asia, the IMF says “The recent surge in the oil price (from $80 to over $100 a barrel) seems to go well beyond what would be indicated by the growth of the world economy.”
Producers in particular argue that fundamentals would yield an oil price of about $80 a barrel, with the rest being the result of speculative activity.
The IMF says one way to get a sense of speculative activity is to compare movements in the real price of oil with the real price of gold. This relationship has been surprisingly close for a long period of time. Gold is well known to be a highly speculative commodity, driven by factors other than derived demand, the IMF said.
“One could reasonably argue that this relationship, which has continued in 2008, is
evidence of speculative behavior in oil. If the oil price does fall significantly in the near term, it may reflect more the unwinding of speculative positions in both gold and oil than indicate that a recession is under way.”
“In summary, it appears that speculation has played a significant role in the run-up in oil prices as the U.S. dollar has weakened and investors have looked for a hedge in oil futures (and gold). ”
As financial market conditions settle down, fundamentals should take over and oil prices should come down further from the highs recently observed.
The OECD’s latest composite leading indicators continue to point to a slowdown in economic activity in most major economies, with the exception of Russia. Brazil’s CLI dropped most sharply and has declined 2.5 points in the latest two months.
March 2008 data indicate a weakening outlook for all the major seven OECD economies. The latest data for major OECD non-member economies indicate a potential downturn in Brazil, China and India while continued expansion is ahead in Russia, the OECD said.
The CLI for the OECD area fell by 0.5 point in March 2008 and was 3.2 points lower than in March 2007.
The United States fell by 0.9 point in March after dropping 0.1 point in February and was 3.6 points lower than a year ago. The Euro area’s CLI decreased by 0.7 point in March after a 0.3-point drop in February and stood 3.3 points lower than a year ago.
The CLI for the United Kingdom fell by 0.7 point in March 2008 after dropping 0.3. point in February and was 2.6 points lower than a year ago.
Japan’s CLI matched February’s increase of 0.4 point, but it was 4.3 points lower than a year ago.
The CLI for China was up by 0.1 point in March 2008, after dropping 0.7 point the month before, but still stood 1.6 point lower than a year ago. Russia reversed the prior month’s 0.1 point drop, increasing by 0.1 point in March, and its level was 3.2 points higher than a year ago. In March 2008 the CLI for Brazil dropped 1.9 point after losing 0.6 point in February , and it was 1.4 points lower than a year ago.
India’s CLI data, which lags by a month fell fell by 1.3 point in February 2008 after a 0.7-point decline in January,and was 1.6 point lower than in February 2007.
Corporate donations to political campaigns reveal a lot about mutual back-scratching in the political and business arenas. Now new research from Harvard Business School suggests that corporate giving may consist of more than monetary contributions. The evidence shows that firms involved in potentially controversial business activities—outsourcing, for example—understate their earnings if it might boost a candidate’s chances of election.
A new study by HBS professor Karthik Ramanna and a colleague from MIT, Professor Sugata Roychowdhury, suggests that accounting information itself may function as an important political contribution.
The authors studied “573 Democratic and Republican candidates in the 2004 congressional races,” and found that of “338 corporate donors that gave at least $10,000 to closely watched races—those races with greater uncertainty and higher visibility, involving 95 candidates of the total—were more likely to understate their earnings in the two quarters prior to the election.”
This so-called “‘downward earnings management,’ as it is known in accounting, seems to have been motivated by the desire of contributing firms to not taint preferred candidates with association to the political red flag of 2004—outsourcing—as well as to ensure future benefits and avoid future costs in regulatory matters. ”
Firms manage accounting numbers to avoid regulatory scrutiny. The implication is that firms manage accounting numbers to influence political decisions.
Importantly, the authors conclude, “While corporate donors in general do not exhibit evidence of downward earnings management, corporate donors to candidates in closely watched races exhibit significant evidence of downward earnings management in the second and third calendar quarters of 2004.”
Throw a frog into a pot of boiling water and it will jump out. Put that frog in a pot of cold water and heat to boiling and the frog will stay in the pot until it is cooked as it doesn’t notice the gradual but catastrophic increase in temperature. Or so they say. Whether or not this is true, it makes for an appealing analogy.
It can be applied to the to all manner of ills in the financal and economic world, from the subprime crisis to global warming.
Another candidate for the boiling frog theory is corporate responsibility and management integrity, where the water appears to be getting warm enough for people to start taking notice.
This was evident in Research Recap’s most popular post of the week, based on an Audit Integrity report identifying stocks with questionable management integrity. Audit Integrity Chairman Jim Kaplan says the ratings are “cause for concern that the companies may be intentionally deceiving their shareholders to mask serious problems,”
Meanwhile, Sir Evelyn Rothschild, former chairman of NM Rothschild & Sons, laments the decline in ethical behavior in the financial sector, in a commentary in today’s Financial Times. “Financial services and banking should set the very highest standards for ethical behaviour, ” he writes.
Ethics is not only a question of acting correctly. It is a matter of not trying to avoid regulation even if one thinks one can get away with it.
“This must be taught at a very early stage and demonstrated in the way a firm is managed. I passionately believe that this is something that has deteriorated in the past few years,” he concludes.
Corporate behavior was also a theme of another popular post, on Berkshire Hathaway’s annual shareholder meeting. In the words of Berkshire’s Charlie Munger, “It’s a crazy culture of greed and overreaching and overconfidence in trading algorithms.”
Signs of improved corporate responsibility were evident in our post on Climate Counts’ latest ranking of companies’ commitment to fighting climate change. A cynic might say that the improvements registered over the past year represent a commercial calculation rather than a sudden ethical awakening. But the outcome is what matters, not the motivation.
American consumers may talk “green” but they have a lot of walking to do to catch up to consumers in Brazil and India when it comes to being environmentally friendly, a new survey finds. The National Geographic Society and the international polling firm GlobeScan have launched “Greendex” a tracking survey of consumer choice and the environment.
Consumers in Brazil and India tied as most “green,” while those in the United States scored lowest, or most wasteful.
To create the survey, GlobeScan conducted Internet surveys of consumers in 14 countries, which together represent more than half of the world’s population and use about 75 percent of its energy. Rather than measuring each nation’s environmental impact, the Greendex compares the behaviors of individuals in four key areas: housing, transportation, food, and consumer goods.
Brazilians and Indians each scored 60 on the sustainable-consumption scale. Citizens of other nations scored as follows: China (56.1); Mexico (54.3); Hungary (53.2); Russia (52.4); Great Britain, Germany and Australia (each at 50.2); Spain (50); Japan (49.1); France (48.7); Canada (48.5); and the U.S. (44.9).
Housing factors included dwelling size; energy use for heating, cooling, and appliances; and water needs. Brazilians topped this category because they typically have smaller homes, rarely use air conditioning or heating, and rely heavily on on-demand, tankless water-heating systems.
Transportation behaviors measured included ownership rates and average usage of motorized vehicles, length of daily commutes, and utilization of public transport. Chinese scored highest on transportation, because, at least for now, most rely on bicycles or walking and drive few motorized vehicles per capita.
The foods category polled consumers on their consumption of locally produced foods, as well as their relative consumption of bottled water, meat, and seafood—products that typically have high environmental impact. Indians had the greenest food habits because they consume little meat and eat many fruits and vegetables.
The goods category looked at the items that people typically buy, reuse, and discard—including both day-to-day purchases and larger items such as televisions. Consumer preference for environmentally friendly products and packaging, as well as overall levels of personal consumption, were also considered.
The Greendex also found that people in developing nations felt more responsible for environmental problems and worried more about the impacts of global warming.
A few interesting findings:
- More than half of houses in the UK, US and Australia have 7 or more rooms.
- Only 5% of US consumers use public transportation most days, compared with 53% in Russia.
- 62% of Brazilians consume beef at least several times a week, the same as the percentage of Japanese who consume fish that often.
- 83% of Germans consume bottled water at least several times a week.
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