Some Thoughts On the SNB’s decision

Thomas Jordan SNB

“Only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffett

The Swiss National Bank’s (SNB) shock abandonment of the CHF 1.20 per Euro peg shows the risks that abound when investors rely on the central banks’ every word to deploy capital and make investment decisions. It brings to the fore the reason why leverage (debt) should be abstained from generally in an investment. The extremely one-sided nature of the EUR/CHF trade, being long the euro, shows the risks of having a crowded and lopsided trade which leads to illiquidity and difficulty exiting.

James Grant of Grant’s Interest Rate Observer had written months before about the risks that lurks in Europe due to the SNB’s peg. He states the some of the unintended consequences of such monetary largesse from the SNB and the its effects on exacerbating the fragility of the insurance industry already suffering from low returns in a ZIRP world.

Investors that based their investment decisions on the word cloud emanating from the central banks have been given a rude awakening to the reality of the present investing climate. Due to the era of quantitative easing (QE), zero interest rate policy (ZIRP), negative interest rate policies (NIRP) and forward guidance investors have become complacent to risks and have come to view these as put options (the right but not the obligation to sell an asset at an agreed price within the period of the contract) on their positions. The implosion of Alpari UK, Everest Capital and FXCM show the risks that lurk in markets when firms employ excessive leverage and exercise poor risk management. Incidentally, JPMorgan reportedly made about $300M on its currency bets

More black swan events exist in the global economy which are constantly being explained away by the central banks and market participants. These include the markets’ believe in the Chinese soft-landing, Abenomics being the panacea to Japan’s ills, the limited risks that Venezuela’s default pose to the global economy and containment of core and peripheral Europe’s debt crisis to name a few. The power of governments to shape and control markets will be severely tested.

The saying “Don’t fight the Fed” may prove to be a foolish saying some years from now. Fundamental analysis of investment theses and strong risk management would help weather the storms that come ahead. When market sentiment switches from euphoria to fear, those that perform deep fundamental analysis would come out relatively unscathed.

Photo: Valentin Flauraud/Bloomberg

Oil drop should push Nigeria to action

Oil prices keep on sliding further. WTI fell below $70/barrel yesterday and the benchmark Brent Crude has tumbled about 36% as shown by the chart below.

commodity-brent-crude-oil

As expected, this is good news for oil consumers such as Turkey, the US and the Eurozone. Also, those that bought put options on oil futures contracts would be very happy having speculated correctly. However, the producers especially the high cost producers with bloated budgets such as Venezuela, Iran and – you may may have guessed – Nigeria.

This article would concentrate a great deal on Nigeria, Africa’s largest oil producer.

First off, I am Nigerian. Due to the higher oil prices that existed prior to the 2008 oil shock (where crude dropped by almost 66% from a high of over $140/barrel to just over $40/barrel), the Nigerian government was saved by the rapid rebound in oil prices to over $100/barrel range. When the government was accruing forex reserves hands over fist, it simply ignored a huge segment of the economy – such as manufacturing and agriculture – and assumed that the 2008 shock was an exception. Who would want to do the hard work of repairing the refineries or privatising it when the dollars were flowing into the national coffers. There was a lot of money to distribute to various constituencies and those with the right connections could get into the refined oil importation business known as “oil marketing” locally. Nigerian politicians had a field day with corruption rife as the treasury was looted by all and sundry. This could be seen by the series of corruption charges brought against several state governors and lawmakers. Nigeria is and was suffering from the oil curse.

Despite the amount of forex reserves accumulated by the government with a peak of $68 billion in 2008, reserves have almost halved at about $35 billion currently.

The shale oil boom in America is now the wildcard the oil market. A recent report by the EIA suggests that just about 4% of US shale production will needs oil at $80 and above to be profitable. American shale production, especially those in the Bakken formation would still be profitable even up to $40/barrel according to the IEA. With Saudi Arabia – responsible for about 11% of global production and about 32% of the OPEC cartel’s output – adamant to cut its production and the uber efficient American shale oil drillers, oil prices may still have some way to go before finding a bottom. Nigeria, being a relative price taker in the oil market, is in for a lot of pain. Increasing supply from America, tepid demand worldwide and relative calm in the Middle East are no friends of the Nigerian government.

The challenge for the Nigerian government will be to increase the tax base, cut spending or both. However, the approach taken by the Finance Ministry by taxing luxury goods would do little to raise revenue. Wealthy Nigerians would find ways of reducing the tax liabilities which could include a reduction in the purchase of luxuries in the country and ramp it up elsewhere such as Ghana. Therefore people in those industries would lose their jobs thereby becoming a social burden. Alternatively, it could also lead to more corruption as the wealthy could pay off tax officials to enjoy their luxurious living tax-free. All in all, it is not a very efficient way of collecting taxes.

The Nigerian government should cut waste. Cutting down the number of ministries that exists from the present 27 to 13 would be a starting point. The ministries simply add more bureaucracy that simply makes the economy less efficient. For example, the Ministry of Labour and Productivity should be scrapped with the Ministry of Trade and Investment taking over their roles. The average Nigerian does not seem to experience the benefits of the government parastatals. For example, labour force participation as at 2012 was 56% according to the World Bank. This is despite a governmental action to increase employment. Regulatory agencies should be mandated to reduce red tape and increase enterprise across the country. The Corporate Affairs Commission (CAC; http://new.cac.gov.ng/home) should adopt the digital revolution, reduce the cost of registering a business and incorporating it to reduce the prevalence of the informal sector in the economy and reduce the time it would take to get a name approved. The CAC should act as a helpful and reliable conduit to getting started. The numerous and cumbersome fees need to be reduced and streamlined. The government automatically brings more firms and workers into the tax system and the formal sector while giving thousands of entrepreneurs validation when competing for contracts.

Other regulatory agencies need to be digitised and modernised. Agencies like the EFCC (Economic and Financial Crimes Commission), ICPC (Independent Corrupt Practices and other related offences Commission) and the FIU (Financial Intelligence Unit) need to be merged and workforce downsized in order to increase efficiency and effectiveness while relying on technology to improve productivity.

The four oil refineries (2 in Port-Harcourt; 1 in Warri; and 1 in Kaduna) should be auctioned off to anyone willing to start work on them while eliminating the subsidies for petroleum products; already, most Nigerians do not pay the subsidised price meaning that the subsidy is simply a free-for-all for the oil importers. Furthermore, it is uneconomic for the government to spend money on consumption (oil subsidy) at the expense of much-needed investment in communications and physical infrastructure. This would lay the ground for the next leg of Nigeria’s growth. This could be similar to the Eisenhower administration’s investment in US infrastructure in the 1950s which improved US productivity and connected the country thereby reducing the cost of bringing products to market and paved the way for future growth.

Merely, increasing the supply of companies and the growth of various industries would pave the way for a more sustainable mix of federal and state governments’ revenues which currently is contingent on the oil price, one which Nigeria is a price taker.

Photo: Stakeholder Democracy/Flickr, used under a Creative Commons Licence

The recent market sell-off

Nikkei 225

Since September, markets have been digesting troves of information which suggest that the global economic recovery is not losing steam. Chinese data was soft showing weak increases in economic output and soft housing prices; the Abenomics train in Japan has ground to a halt; Europe is still in a heavy debt-load, stagnant and seemingly deflationary environment; London’s house prices have started falling and wage inflation is tepid; the oil market is in bear market (drop in asset prices by at least 20%) territory. Of course, explaining the daily movement of market prices is a mug’s game but these realities seem to be what could have contributed to lower asset prices (stocks, bonds, real estate).

It seems as though investors are caught in self-delusion that the massive interventions by the fiscal and monetary authorities in the workings of the market will help resuscitate growth and grow the world economy. The IMF, in its recently completed annual meeting of finance ministers tacitly admitted that the heavy doses of stimuli given to the sick patient that is the economy has yielded very little result.

Shinzo Abe, who almost two years ago rode on the wave of optimism that implementing three major policies would lift the Japanese out of their economic doldrums seems to be coming to terms with reality that the Japanese economy is indeed a very sick patient. The easy policies have been implemented with varying successes. Tax hike resulted in a collapse in second quarter GDP and a projected 0.1 – 0.3% increase in GDP (not what it needs to get on top of its huge debt load) according to the IMF.

Markets have been anticipating the unveiling of full-blown or a more watered-down version of quantitative easing in Europe. Some see it as a panacea to curing Europe’s slumber towards deflation. I don’t. Europe, it seems to me, suffers from deep structural problems, high debt levels, an ageing population and a decrease in start-ups. Pumping money into the European economy without sorting out the banks, unclogging the transmission mechanism and tackling the structural challenges would merely lead to a drop in market interest rates and a relief rally in equities.

Finally, the near 20% drop in oil prices starting in June seems to be hurting important OPEC members such as Iran, Venezuela and Nigeria. Russia, a major oil exporter, has added low Brent oil to its growing list of problems. Some speculate that the drop may simply be reflecting slower global economic growth leading to lower oil demand coupled with increasing oil supply from low-cost, more efficient American shale companies churning out the black stuff. This threatens their fiscal stance and their currencies which could lead to imported inflation in those economies. It is also leading to Saudi Arabia, the swing country, pursuing a market share maximizing strategy by undercutting other members and keeping prices lower for Asian customers. This is a boon for commerce in non-oil producing countries as it translates to billions of dollars in increased purchasing power potentially increasing economic output.

All in all, it is hard to attribute the drop in markets to a Eureka moment in investor’s mind. However, the self-delusion in the power of the authorities to solve economic problems seems to have waned.

Photo: ryoki/Flickr, used under a Creative Commons Licence

Aswath Damodaran’s Investment Philosophies

For those that know me, I am very much interested and involved in finance. I recently stumbled upon a blog post by Aswath Damodaran, an NYU finance professor – who is one of the most respected in his field, about developing oneself mentally and technically for investing.

His blog, Musings on Markets, is a regular for me and I enjoin you to visit and give some thoughts to some of his valuation techniques.

The lectures and the accompanying videos can be found here.