Your “springboard” guide to current market concerns, presented in a logical and concise manner, with direct links to more details.
The sudden upsurge in volatility has been a boon for the market’s intermediaries. For high-frequency traders the last 10 days have been an oasis in the desert.
Most of these companies, such as DRW Holdings, Citadel Securities and Two Sigma, account for the majority of volume on global equities, futures and foreign exchange markets.
They use their own money to trade and quote bid and offer prices, and earn profits by using computer algorithms to exploit differences in the spread between bid and ask prices, ending the trading day with minimal open positions.
After a boom during the financial crisis years, the industry has been hard hit in recent years by low volatility, rising technology costs and a regulatory crackdown on behaviour and practices in electronic trading. Many of the smaller market competitors have been sold to rivals.
Most are small and private but two, the US’s Virtu Financial, and Flow Traders of the Netherlands, are listed on their home markets, with market capitalisations of $5bn and €1.4bn respectively. Shares in both have surged by more than a quarter in the last seven days on investors’ hopes that higher market volatility will lead to improved corporate profits.
“The environment where you have a lot of price changes during the day is the ideal environment for a market maker,” said Doug Cifu, chief executive of Virtu.
For him last week’s blow-up in products related to the performance of the Vix volatility index was not an issue. “We make markets in 2,000-ish exchange-traded products around the world and if a small handful of them are having issues, it really has no impact at all on our performance going forward.”
But investors should be wary; there have been notable spikes in volumes and volatility in the past and it has not translated into sustained earnings. Whether this is cyclical or temporary remains to be seen. Philip Stafford
The S&P 500 has entered official correction territory, having fallen more than 10 per cent from its peak of 2,872 late last month. Selling has been concentrated in US large-cap equity funds, tech and healthcare, says Bank of America Merrill Lynch in their weekly review of investor flows that includes Monday’s rout on Wall Street.
Some measure of support should beckon in the form of the 200-day moving average at 2,538. The market last tested the 200-day MA just before the US election presidential election in November 2016.
BofA thinks this level represents a good entry point in the coming weeks.
One element of caution is that when the 200-day breaks, the market can take a while to heal its wounds. At the start of 2016, the S&P broke down and didn’t climb back above this measure of momentum until mid-March. This reflects how the process of creating a market low takes time or, in other words, we need to see the S&P 500 bounce up and down and make a second test of a certain level (1,810 in January, and February of 2016 was the low point for that correction)
Another important point is that plenty has changed in the past two years, not the least a gain of more than 40 per cent in the S&P 500 from its mid-March 2016 nadir. Then, investors worried about a China-led global economic slowdown. Falling bond yields and still very accommodative central banks ultimately helped equities find their footing.
Now the worry is higher bond yields and inflationary concerns as the global economy boasts its best run of synchronised growth since the financial crisis.
Next week’s US inflation data looms as a critical piece of the puzzle facing investors and likely determines whether we get some relief or a bigger test of the downside.
As Lena Komileva at G+Economics notes: “The severity of market moves has exposed how unprepared and unhedged markets are to a return to a more normal rates and liquidity environment.”
She also highlights that the UK market’s sharp reaction to the Bank of England’s hawkish message this week illustrates “how acutely sensitive investor portfolios are to the end of the crisis-era policy stimulus”. Michael Mackenzie
Exchange-traded products that allow investors to wager on the tranquility of Cboe’s Vix index, a measure of stock market volatility, have helped drive Cboe’s profits in recent years. The exchange-traded notes relied on Vix futures, which can only be traded at Cboe.
But analysts fear the slide in value of two big notes and funds this week will have a bigger impact. Goldman Sachs estimated Vix futures contributed about 40 per cent of Cboe’s earnings growth between 2015 and 2018, excluding its 2016 deal for Bats Global Markets.
Kenneth Worthington, an analyst at JPMorgan, said the liquidation of the exchange-traded notes was “potentially the tip of the iceberg” as trading activity in Vix futures fell away in coming months. If the market moves from its preferred strategy of shorting volatility to one where hedging its risk was dominant, investors might look to other futures contracts, such as CME’s E-mini, he said. Philip Stafford
Should investors worry about debt in emerging markets? The past week’s global market sell-off, and the rise in US interest rates that lies behind it, suggest they should at least keep a very close eye.
Our chart shows the total debts of 21 EM countries compiled by the Institute of International Finance, an industry association and data gatherer. It includes debts owed by governments, households, companies and the financial sector, in local and foreign currencies.
One of the selling points of EMs during the rally in their stocks and bonds over the past two years has been the improvement in their macroeconomic fundamentals. Dangerous current account deficits have largely been dealt with, the narrative goes, and the debt overhangs of the past have been reduced, thanks partly to a transition from foreign currency debts, which leave borrowers exposed to foreign exchange movements beyond their control, into local currency debts, which governments can do more about (such as inflating them away in times of difficulty).
Indeed, there is much less EM debt today than there was in the crisis years of the 1980s and 1990s. But since the global financial crisis of 2008-09, EM debts have been on the rise again. In dollar terms, in the IIF’s 21 countries, they quintupled from $12tn in March 2005 to $60tn in September last year. In relation to gross domestic product, they rose from 146 per cent to 217 per cent.
Significantly, as the chart shows, the amount of debt owed in foreign currencies has also risen over the same period, both in absolute terms and as a share of GDP.
The picture is far from even across EMs. But in aggregate — which is how many investors view them — emerging markets are more indebted today than at any point since the 2008-09 crisis. As global financial conditions begin to tighten, that is something to watch. Jonathan Wheatley
Rising bond yields as central banks slowly retreat from the era of easy money has already been a challenge for dividend-paying companies. So far this year, Wall Street dividend payers are lagging behind the broad market. We are also seeing an interesting trend from the UK, where a number of companies have issued profit warnings and cut their payouts.
Andrew Lapthorne at Société Générale notes that their monthly dividend risk screen of high dividend yield stocks with poor quality balance sheets is dominated by the UK. Of the current 50 companies that comprise the list, 21 are listed in the UK.
In broader terms, what makes this all the more interesting is whether the UK is the proverbial canary in the coal mine. Loading up balance sheets with debt and keeping dividends flowing has not just been a UK story during the easy money era for many companies around the world.
Longview Economics, for example, estimates that some 12 per cent of US companies are “zombies” — defined as having earnings before interest and tax that do not cover their interest expense.
The big difference at the moment is that a weaker UK economy compared with the rest of the world is a catalyst for profit warnings from indebted companies that herald a dividend cut.
As global bond yields rise, Mr Lapthorne says we are seeing a substantial move against low-quality credit. Any tempering of global growth will weigh against companies with weak balance sheets that pay chunky dividends. Michael Mackenzie
It is not true that humanity cannot learn from history. It can and, in the case of the lessons of the dark period between 1914 and 1945, the west did. But it seems to have forgotten those lessons. We are living, once again, in an era of strident nationalism and xenophobia. The hopes of a brave new world of progress, harmony and democracy, raised by the market opening of the 1980s and the collapse of Soviet communism between 1989 and 1991, have turned into ashes.
What lies ahead for the US, creator and guarantor of the postwar liberal order, soon to be governed by a president who repudiates permanent alliances, embraces protectionism and admires despots? What lies ahead for a battered EU, contemplating the rise of “illiberal democracy” in the east, Brexit and the possibility of Marine Le Pen’s election to the French presidency?
What lies ahead now that Vladimir Putin’s irredentist Russia exerts increasing influence on the world and China has announced that Xi Jinping is not first among equals but a “core leader”?
The contemporary global economic and political system originated as a reaction against the disasters of the first half of the 20th century. The latter, in turn, were caused by the unprecedented, but highly uneven, economic progress of the 19th century.
The transformational forces unleashed by industrialisation stimulated class conflict, nationalism and imperialism. Between 1914 and 1918, industrialised warfare and the Bolshevik revolution ensued. The attempted restoration of the pre-first world war liberal order in the 1920s ended with the Great Depression, the triumph of Adolf Hitler and the Japanese militarism of the 1930s. This then created the conditions for the catastrophic slaughter of the second world war, to be followed by the communist revolution in China.
In the aftermath of the second world war, the world was divided between two camps: liberal democracy and communism. The US, the world’s dominant economic power, led the former and the Soviet Union the latter. With US encouragement, the empires controlled by enfeebled European states disintegrated, creating a host of new countries in what was called the “third world”.
Contemplating the ruins of European civilisation and the threat from communist totalitarianism, the US, the world’s most prosperous economy and militarily powerful country, used not only its wealth but also its example of democratic self-government, to create, inspire and underpin a transatlantic west. In so doing, its leaders consciously learnt from the disastrous political and economic mistakes their predecessors made after its entry into the first world war in 1917.
Domestically, the countries of this new west emerged from the second world war with a commitment to full employment and some form of welfare state. Internationally, a new set of institutions — the International Monetary Fund, the World Bank, the General Agreement on Tariffs and Trade (ancestor of today’s World Trade Organisation) and the Organisation for European Economic Co-operation (the instrument of the Marshall Plan, later renamed the Organisation for Economic Co-operation and Development) — oversaw the reconstruction of Europe and promoted global economic development. Nato, the core of the western security system, was founded in 1949. The Treaty of Rome, which established the European Economic Community, forefather of the EU, was signed in 1957.
This creative activity came partly in response to immediate pressures, notably the postwar European economic misery and the threat from Stalin’s Soviet Union. But it also reflected a vision of a more co-operative world.
Economically, the postwar era can be divided into two periods: the Keynesian period of European and Japanese economic catch-up and the subsequent period of market-oriented globalisation, which began with Deng Xiaoping’s reforms in China from 1978 and the elections in the UK and US of Margaret Thatcher and Ronald Reagan in 1979 and 1980 respectively.
This latter period was characterised by completion of the Uruguay Round of trade negotiations in 1994, establishment of the WTO in 1995, China’s entry into the WTO in 2001 and the enlargement of the EU, to include former members of the Warsaw Pact, in 2004.
The first economic period ended in the great inflation of the 1970s. The second period ended with the western financial crisis of 2007-09. Between these two periods lay a time of economic turmoil and uncertainty, as is true again now. The main economic threat in the first period of transition was inflation. This time, it has been disinflation.
Geopolitically, the postwar era can also be divided into two periods: the cold war, which ended with the Soviet Union’s fall in 1991, and the post-cold war era. The US fought significant wars in both periods: the Korean (1950-53) and Vietnam (1963-1975) wars during the first, and the two Gulf wars (1990-91 and 2003) during the second. But no war was fought among economically advanced great powers, though that came very close during the Cuban missile crisis of 1962.
The first geopolitical period of the postwar era ended in disappointment for the Soviets and euphoria in the west. Today, it is the west that confronts geopolitical and economic disappointment.
The Middle East is in turmoil. Mass migration has become a threat to European stability. Mr Putin’s Russia is on the march. Mr Xi’s China is increasingly assertive. The west seems impotent.
These geopolitical shifts are, in part, the result of desirable changes, notably the spread of rapid economic development beyond the west, particularly to the Asian giants, China and India. Some are also the result of choices made elsewhere, not least Russia’s decision to reject liberal democracy in favour of nationalism and autocracy as the core of its post-communist identity and China’s to combine a market economy with communist control.
Yet the west also made big mistakes, notably the decision in the aftermath of 9/11 to overthrow Iraqi leader Saddam Hussein and spread democracy in the Middle East at gunpoint. In both the US and UK, the Iraq war is now seen as having illegitimate origins, incompetent management and disastrous outcomes.
Western economies have also been affected, to varying degrees, by slowing growth, rising inequality, high unemployment (especially in southern Europe), falling labour force participation and deindustrialisation. These shifts have had particularly adverse effects on relatively unskilled men. Anger over mass immigration has grown, particularly in parts of the population also adversely affected by other changes.
Some of these shifts were the result of economic changes that were either inevitable or the downside of desirable developments. The threat to unskilled workers posed by technology could not be plausibly halted, nor could the rising competitiveness of emerging economies. Yet, in economic policy, too, big mistakes were made, notably the failure to ensure the gains from economic growth were more widely shared. The financial crisis of 2007-09 and subsequent eurozone crisis were, however, the decisive events.
These had devastating economic effects: a sudden jump in unemployment followed by relatively weak recoveries. The economies of the advanced countries are roughly a sixth smaller today than they would have been if pre-crisis trends had continued.
The response to the crisis also undermined belief in the system’s fairness. While ordinary people lost their jobs or their houses, the government bailed out the financial system. In the US, where the free market is a secular faith, this looked particularly immoral.
Finally, these crises destroyed confidence in the competence and probity of financial, economic and policymaking elites, notably over the management of the financial system and the wisdom of creating the euro.
All this together destroyed the bargain on which complex democracies rest, which held that elites could earn vast sums of money or enjoy great influence and power as long as they delivered the goods. Instead, a long period of poor income growth for most of the population, especially in the US, culminated, to almost everyone’s surprise, in the biggest financial and economic crisis since the 1930s. Now, the shock has given way to fear and rage.
The succession of geopolitical and economic blunders has also undermined western states’ reputation for competence, while raising that of Russia and, still more, China. It has also, with the election of Donald Trump, torn a hole in the threadbare claims of US moral leadership.
We are, in short, at the end of both an economic period — that of western-led globalisation — and a geopolitical one — the post-cold war “unipolar moment” of a US-led global order.
The question is whether what follows will be an unravelling of the post-second world war era into deglobalisation and conflict, as happened in the first half of the 20th century, or a new period in which non-western powers, especially China and India, play a bigger role in sustaining a co-operative global order.
A big part of the answer will be provided by western countries. Even now, after a generation of relative economic decline, the US, the EU and Japan produce just over half of world output measured at market prices and 36 per cent of it measured at purchasing power parity.
They also remain homes to the world’s most important and innovative companies, dominant financial markets, leading institutions of higher education and most influential cultures. The US should also remain the world’s most powerful country, particularly militarily, for decades. But its ability to influence the world is greatly enhanced by its network of alliances, the product of the creative US statecraft during the early postwar era. Yet alliances also need to be maintained.
The essential ingredient in western success must, however, be domestic. Slow growth and ageing populations have put pressure on public spending. With weak growth, particularly of productivity, and structural upheaval in labour markets, politics has taken on zero-sum characteristics: instead of being able to promise more for everybody, it becomes more about taking from some to give to others. The winners in this struggle have been those who are already highly successful. That makes those in the middle and bottom of the income distribution more anxious and so more susceptible to racist and xenophobic demagoguery.
In assessing responses, two factors must be remembered.
First, the post-second world war era of US hegemony has been a huge overall success. Global average real incomes per head rose by 460 per cent between 1950 and 2015. The proportion of the world’s population in extreme poverty has fallen from 72 per cent in 1950 to 10 per cent in 2015.
Globally, life expectancy at birth has risen from 48 years in 1950 to 71 in 2015. The proportion of the world’s people living in democracies has risen from 31 per cent in 1950 to 56 per cent in 2015.
Second, trade has been far from the leading cause of the long-term decline in the proportion of US jobs in manufacturing, though the rise in the trade deficit had a significant effect on employment in manufacturing after 2000. Technologically driven productivity growth has been far more powerful.
Similarly, trade has also not been the main cause of rising inequality: after all, high-income economies have all been buffeted by the big shifts in international competitiveness, but the consequences of those shifts for the distribution of income have varied hugely.
US and western leaders have to find better ways to satisfy their people’s demands. It looks, however, as though the UK still lacks a clear idea of how it is going to function after Brexit, the eurozone remains fragile, and some of the people Mr Trump plans to appoint, as well as Republicans in Congress, seem determined to slash the frayed cords of the US social safety net.
A divided, inward-looking and mismanaged west is likely to become highly destabilising. China might then find greatness thrust upon it. Whether it will be able to rise to a new global role, given its huge domestic challenges, is an open question. It seems quite unlikely.
By succumbing to the lure of false solutions, born of disillusion and rage, the west might even destroy the intellectual and institutional pillars on which the postwar global economic and political order has rested. It is easy to understand those emotions, while rejecting such simplistic responses. The west will not heal itself by ignoring the lessons of its history. But it could well create havoc in the attempt.
For the most ardent supporters of Brexit, the election of Donald Trump was a mixture of vindication and salvation. The president of the US, no less, thinks it is a great idea for Britain to leave the EU. Even better, he seems to offer an exciting escape route. The UK can leap off the rotting raft of the EU and on to the gleaming battleship HMS Anglosphere.
It is an alluring vision. Unfortunately, it is precisely wrong. The election of Mr Trump has transformed Brexit from a risky decision into a straightforward disaster. For the past 40 years, Britain has had two central pillars to its foreign policy: membership of the EU and a “special relationship” with the US.
The decision to exit the EU leaves Britain much more dependent on the US, just at a time when America has elected an unstable president opposed to most of the central propositions on which UK foreign policy is based.
During the brief trip to Washington by Theresa May, the UK prime minister, this unpleasant truth was partly obscured by trivia and trade. Mr Trump’s decision to return the bust of Winston Churchill to the Oval Office was greeted with slavish delight by Brexiters. More substantively, the Trump administration made it clear that it is minded to do a trade deal with the UK just as soon as Britain’s EU divorce comes through.
But no sooner had Mrs May left Washington than Mr Trump caused uproar with his “Muslim ban”, affecting immigrants and refugees from seven countries. After equivocating briefly, the prime minister was forced to distance herself from her new best friend in the White House.
The refugee row underlined the extent to which Mrs May and Mr Trump have clashing visions of the world. Even when it comes to trade, the supposed basis for their new special relationship, the two leaders have very different views.
Mrs May says that she wants the UK to be the champion of global free trade. But Mr Trump is the most protectionist US president since the 1930s. This is a stark clash of visions that will be much harder to gloss over — if and when Mr Trump begins slapping tariffs on foreign goods and ignoring the World Trade Organisation.
In addition, any trade deal with the Trump administration is likely to be hard to swallow for Britain and would involve controversial concessions on the National Health Service and agriculture.
The British and American leaders also have profoundly different attitudes to international organisations. Mrs May is a firm believer in the importance of Nato and the United Nations. (Britain’s permanent membership of the UN Security Council is one of its few remaining totems of great power status). But Mr Trump has twice called Nato obsolete and is threatening to slash US funding of the UN.
The May and Trump administrations are also at odds on the crucial questions of the future of the EU and of Russia. Mr Trump is openly contemptuous of the EU and his aides have speculated that it might break up. This reflects the views of Nigel Farage and the UK Independence party — but not of the current British government.
Mrs May knows that her difficult negotiations with the EU will become all-but-impossible if member states believe that the UK is actively working to destroy their organisation in alliance with Mr Trump.
Her official position is that Britain wants to work with a strong EU. She probably even means it, given the economic and political dangers that would flow from its break-up.
Not the least of these dangers would be an increased threat from a resurgent Russia. The British government worked closely with the Obama administration to impose economic sanctions on the country after its annexation of Crimea. But Mr Trump is already flirting with lifting sanctions.
The reality is that the UK is now faced with a US president who is fundamentally at odds with the British view of the world. For all the forced smiles in the Oval Office last week, the May government certainly knows this. For political reasons, Boris Johnson, the British foreign minister, is having to talk up the prospects of a trade deal with Mr Trump.
Yet only a few months ago, Mr Johnson was saying that Mr Trump was “clearly out of his mind” and betrayed a “stupefying ignorance” of the world.
Were it not for Brexit — a cause that Mr Johnson enthusiastically championed — the UK government would be able to take an appropriately wary approach to Mr Trump. If Britain had voted to stay inside the EU, the obvious response to the arrival of a pro-Russia protectionist in the Oval Office would be to draw closer to its European allies.
Britain could defend free-trade far more effectively with the EU’s bulk behind it — and could also start to explore the possibilities for more EU defence co-operation. As it is, Britain has been thrown into the arms of an American president that the UK’s foreign secretary has called a madman.
In the declining years of the British empire, some of its politicians flattered themselves that they could be “Greeks to their Romans” — providing wise and experienced counsel to the new American imperium.
But the Emperor Nero has now taken power in Washington — and the British are having to smile and clap as he sets fires and reaches for his fiddle.
Warren Buffett will go to great lengths to stop Berkshire Hathaway using consultants. “If the board hires a compensation consultant after I’m gone, I will come back,” he promised its annual shareholder meeting on Saturday. It was a joke, but from the heart.
Mr Buffett’s low opinion of overpaid hedge fund managers, whom he describes as “compensated on the basis of something that in aggregate cannot be true”, is well known. He extends that scepticism to other intermediaries — investment bankers, brokers, and consultants of every kind.
It makes him highly unusual, since the corporate world is heading in the opposite direction. Everywhere one looks, there are more and more consultants — on strategy, investment, operations, compensation, digital transformation, technology, marketing. Some businesses seem to have been entirely occupied by consultants.
What was a niche for a handful of wizards in firms such as McKinsey & Co and Boston Consulting Group has turned into a thriving industry that keeps on growing faster than many of its clients. Consultants now do many jobs that companies once performed themselves.
Global revenues of management consulting firms grew 7 per cent last year to $133bn, according to Source Global Research. Some top firms, such as Bain & Co, are enjoying double-digit expansion, and have for several years. The large accounting firms, which mostly left consulting in the early 2000s, are back: 44 per cent of EY’s revenues last year came from advisory work.
Consultancy is at the heart of professional services: of 2.2m people who work in financial and related professional services in the UK, 477,000 are consultants, compared with 421,000 bankers, according to the City UK trade group. What is going on?
One answer is that they are needed. Many companies shed employees and retreated to their core after the 2008 financial crisis, outsourcing activities from manufacturing to technology. Hiring expertise as required — management as a cloud service — is a natural next step.
Technological change is also a boon for consultants. The rise of digital technology and data analytics is upending many industries, including retailing and media. Companies wanting to remake how they operate have turned to consulting firms, particularly larger ones with tech expertise.
That can mean everything from how a company collects and analyses data to how it advertises products to consumers through Facebook and delivers them to their homes. Marketing companies such as WPP and Publicis compete with digital divisions of consulting firms such as Accenture.
These changes have serious implications for the nature of the company itself. A generation ago, the chief competitive advantage of US corporations such as General Electric and Procter & Gamble was management. They trained cadres of executives to run operating subsidiaries smoothly.
Consulting offers a substitute — the ability for companies to outsource chunks of strategy and operations. It begs the question of what a large consumer goods company, for example, does. If trends continue, it could soon amount to a few managers overseeing consultants and contractors.
Even for those that do not go that far, using consultants has attractions. It offers flexible use of a well-trained group of managers and professionals — the top echelon of what Accenture calls the “liquid workforce”. Hiring consultants who have undertaken similar projects elsewhere is reliable and fast.
But there are dangers, which can be overlooked amid the rush. One is that companies are buying off-the-shelf solutions that make them operate more like others. They are being sold similar ideas and similar methods for reaching customers. The curse of the consultants is that anyone can hire them, so their ideas soon spread.
It is a version of the conformity problem in asset management so scorned by Mr Buffett — originality is very difficult to come by. Berkshire is deliberately eccentric and obstinately operating in its own way has produced enormous rewards. As he wrote in his 2014 shareholder letter, “there are worse things in life than having a prosperous business one understands well”.
The second danger is that consultants become a habit — once they get inside the building, they are hard to eradicate. They have an interest in keeping the relationship going, either by persuading clients that the challenges are complex, or by selling them more services.
A company that needs a few tasks done quickly can become enmeshed. Many US corporations have “an expensive bureaucratic culture internally while a growing corps of financial advisers bids to sell shareholders a wide range of costly services”, writes Lawrence Cunningham, a professor at George Washington University.
Consultants are alluring in a world of changing technology and regulation, as their growth shows. But it is also wise for the buyer to beware of what they offer. One thing we do know: if Berkshire ever joins the bandwagon, Mr Buffett will turn in his grave.
This rating of the country’s leading management consultants is based on recommendations by clients and peers.
Compiled with Statista, the data company, it assesses work in 29 categories. Ratings range from four stars for “recommended” to five for “frequently recommended” and six for “very frequently recommended” (see methodology).
Click on sectors or consulting services to see ratings, or on companies in the alphabetical list below to see in which categories they appear. Read FT management editor Andrew Hill’s analysis of the ratings and the FT special report, The UK’s Leading Management Consultants 2018.
A decade ago, I spent a sleepless night worrying about a Spanish trash bin. The reason? On Thursday August 9 2007, financial markets suddenly seized up.
Since I was running the Financial Times markets team, I spent two days frantically trying to identify the reason for the panic. Nobody knew. But that weekend I suddenly woke in the middle of the night with an image of a Spanish bin in my head.
A month earlier I had attended a credit conference in Barcelona, where I read brochures about a little-known, and supposedly safe, entity known as a “structured investment vehicle”. The material had seemed achingly dull. So on the way home I tossed the papers into an airport bin — and forgot it. But, somehow, my subconscious knew that had been a mistake. So I awoke and went online to uncover what I had left in that bin.
By dawn I had realised that those widely ignored investment products were a key culprit in the market mystery: the details were complex, but essentially these SIVs held toxic mortgages and were plagued with dangerous asset-liability mismatches that had caused investors to panic.
There is a lesson in this tiny piece of personal history, as we look back from the 10th anniversary of the drama to assess what happened — and not just to observe that our brains can work in mysterious ways.
Sometimes, market shocks occur because investors have taken obviously risky bets — just look at the tech bubble in 2001. But other crises do not involve risk-seeking hedge funds, or products that are evidently dangerous. Instead, there is a ticking time bomb that is hidden in plain sight, in corners of the financial system that seem so dull, safe or technically complex that we tend not to focus attention on them.
In the 1987 stock market crash, for example, the time bomb was the proliferation of so-called portfolio insurance strategies — a product that was supposed to be boring because it appeared to protect investors against losses. In the 1994 bond market shock, the shocks were caused by interest rate swaps, which had previously been ignored because they were (then) considered geeky.
And in 2007 it was not just those SIVs and conduits that were a trigger. Products such as collateralised debt obligations or credit default swaps, which had also been ignored, were another problem.
The good news today is that it does not seem as if the financial system faces an imminent threat of another “boring” time bomb causing havoc. Western banks are well capitalised, regulators are alert, the global economy is growing and central banks are providing monetary support.
But the bad news is that precisely because the system has become so flush with cash — and seemingly calm — there is complacency; and not just about the dangers of clearly risky bets (say, Argentine bonds), but about the perils of “safe” assets too.
Consider the world of exchange traded funds. This sector has recently exploded in size: with more than $4tn in assets under management globally and about $3tn in the US, it eclipses hedge funds. ETFs do not usually attract much attention, since the sector — yet again — seems geeky and dull.
But they have profound consequences: Marko Kolanovic, a senior JPMorgan strategist, estimates that passive and quantitative investors now account for about 60 per cent of the US equity asset management industry, up from under 30 per cent a decade ago.
This is changing market flows in potentially unpredictable ways that investors and regulators do not entirely understand, and spawning some esoteric products. This year, for example, investors have rushed into an obscure “Inverse Vix” ETF that benefits from low volatility. This ETF is now the world’s 34th most actively traded equity security, exchanging hands more often than the stock of Chevron or Pfizer, and has returned almost 100 per cent this year. It appears to have distorted measures of volatility this year, creating an impression of calm. But, as my colleague Robin Wigglesworth notes, those Vix trades could spark a whiplash effect if sentiment shifts.
Or consider Treasury bonds. Most investors assume that Treasuries are the risk-free pillar of modern finance, and that government bond yields will stay low for a long time. But only a few days ago Alan Greenspan, former Federal Reserve chair, warned that the bond prices “are in a bubble” and “when they [real long-term interest rates] move higher they are likely to move reasonably fast”.
If so, this could create some unexpected chain reactions in the bond and derivative portfolios of investors, banks and insurance companies. And if the US Congress fails to raise the debt ceiling this autumn, sparking a technical default on some Treasuries, more feedback loops could emerge too.
Don’t get me wrong. I am not arguing that such shocks are imminent or likely. But the key point is this: if we want to avoid a replay of 2007, we must keep questioning our assumptions — and peering at the parts of the system that seem “boring”, “geeky” and “dull”.
Our mental bins can sometimes hold time-bombs; particularly when investors are intoxicated by an asset-price boom.
The ranks of investment bank research analysts have fallen by one-tenth since 2012, as tighter regulation and falling profits have forced financial institutions to cull their brigades of economists, bond strategists and stock pickers.
The number of analysts working at the world’s 12 biggest investment banks fell to 5,981 last year, according to fresh numbers from Coalition, a data provider on the industry. That is down from 6,282 at the end of 2015, and 6,634 at the end of 2012, when Coalition began to collect the numbers.
The cuts are expected to deepen in the coming years. “We will have massive cost pressures in an industry that is not ready for it at all,” said Matthew Benkendorf, chief investment officer at Vontobel Asset Management. “They’ll have to gut things pretty hard.”
The profitability of “sellside” research has been eroding ever since dotcom bust, when allegations of biased research led to tighter use on the rules around using analysts to drum up investment banking business. Then, after the financial crisis, newly cost-conscious banks started slashing staffing of research departments, because they made little direct contribution to earnings.
Incoming EU regulations are expected to deepen the research cull, because money managers that operate in the region will be required to pay banks directly for any research they consume. Currently, research is largely funded through commissions on trades. Some asset managers are therefore bulking up their own analysis departments and many plan to cut spending on outside research.
While these new regulations only apply in the EU, many of the bigger US asset managers are likely to follow the same path. A survey of 30 global investment groups and investment banks by Quinlan & Associates last year indicated that research budgets would be cut by 30 per cent.
“It’s going to get worse before it gets better,” said George Kuznetsov, head of research at Coalition. “There is a lot of overcapacity that will be resolved in the coming years.”
Coalition collates its data from scraping the names on research reports published by many of the biggest banks, such as JPMorgan, Deutsche Bank, Barclays, Goldman Sachs, Morgan Stanley and HSBC, but many smaller brokerages have also made substantial cuts.
For example, David Ader and Ian Lyngen were earlier this year voted the top US Treasury analyst team in Institutional Investor’s prestigious poll for the 11th year running, but at the time both were unemployed as CRT Capital Group, their company, was in the process of being shuttered.
“It’s a different game today and folks like us may be valued by you readers but are a cost,” Mr Ader wrote in his farewell email to clients.
“If I ever again hear the question ‘how do we monetise you?’ applied to our work I think I’ll go back to bong hits and not worry about drug tests in the next job . . . if there is a next job.”
Since then, Mr Lyngen has found a job at BMO Capital Markets and Mr Ader at Informa Globalmarkets. But many of their former colleagues and counterparts have been less lucky.
Equity analysts, it turns out, have never recovered from the days when Henry Blodget experienced his rise and fall. Among the most infamous of the late 1990s analysts, punting often worthless technology stocks in the dotcom bubble, the Merrill Lynch researcher became emblematic of the conflicts of interest riddling top Wall Street investment banks. Fast forward, and the bank research divisions are being regulated into touch. If this were indeed a tragedy, it would be a tragedy of commons, an example of how banks corrupted what was potentially a public good — ready access to information — in the pursuit of lucrative deals.
The main purpose of regulation, which alongside falling profits has been gradually squeezing out the analysts from investment banks, has been to encourage more objective research. In the case of the dotcom bubble, de facto salesmen tailored their advice to credulous investors to help the big Wall Street banks compete for the business of cash-hungry tech companies issuing shares. Thus Mr Blodget and his like talked up stocks in public while dismissing them in private. For his sins he was fined, banned from the financial sector and later reinvented himself as a highly successful news publisher.
Regulation has since evolved to iron out other wrinkles. The result is attrition. New research suggests that the ranks of research analysts at the world’s top 12 investment banks have fallen steadily — by one-tenth since 2012. There will be still more job losses ahead of new EU rules, which are due to come into effect next year.
These will force fund managers to provide a clear budget for research to their investors. Previously this was a hidden cost in a bundled mix of services provided by investment banks that included payments for equity or fixed-income trading. As a result, asset managers, especially in Europe, intend to cut spending on outside research provided by the banks by 30 per cent.
The business case for investment banks financing analysts is thus continuing to degrade, while increasingly shifting to the buy side. Fund managers are setting up their own research divisions, or paying for customised information from independent outfits.
For those who can pay for it, research may now be of higher quality, and more tailored to demand. But the amount of good research that is publicly, and freely, available will also decrease, giving “edge” to the big institutional investment funds that can afford to buy their own. This might spare the fund managers from information overload and cluttered inboxes. For retail investors, whose access to advice will be limited, the advantages are less obvious. They may avoid getting scammed — as they were during the dotcom bubble. But the price of more transparency, it would seem, will be a lot less democracy.
Healthcare companies have announced almost $30bn of acquisitions since the beginning of the year in the sector’s strongest start for dealmaking in more than a decade, as Big Pharma scrambles to replace ageing blockbusters by paying top dollar for new medicines.
Executives, lawyers and bankers said the January deals frenzy could be a sign of things to come in 2018, as large US drugmakers snap up innovative rivals by spending billions of dollars of cash freed up by Donald Trump’s tax overhaul.
Sanofi, the French pharma company, and Celgene, the US biotech group, unveiled two acquisitions on Monday worth more than $20bn, taking the total value of global healthcare deals announced so far this year to $27bn, according to figures from Thomson Reuters.
That represented the best start to a year for healthcare dealmaking since at least 2007, Thomson Reuters said.
Both drugmakers offered hefty premiums to seal the deals, with Sanofi paying $11.6bn for US haemophilia specialist Bioverativ — 63 per cent more than its undisturbed share price.
Celgene agreed to pay $9bn for Juno, a biotech group developing experimental cell therapies for cancer. The price was almost twice what the Seattle-based company was worth before rumours of a deal prompted a spike in the value of its stock last week.
So far this year, buyers of healthcare companies have agreed to pay an average premium of 81 per cent, according to data provider Dealogic — well above the 42 per cent typically paid in 2018.
Their willingness to agree to such lofty prices underscores a perennial problem for Big Pharma: what to do when successful medicines lose patent protection and revenues evaporate.
Sanofi is trying to offset declining sales of its top-selling insulin, Lantus, which has lost market share following the introduction of cheaper “biosimilar” versions. Celgene is preparing for the loss of patent protection on its top cancer medicine, Revlimid, which will face generic competition from 2022 at the latest.
“As Big Pharma is confronted with drugs going off patent and weak research and development pipelines, they have no choice but to do significant acquisitions despite pushing valuation metrics,” said Frank Aquila, a senior corporate lawyer at Sullivan & Cromwell.
Large drugmakers have often turned to buying smaller biotech groups to replenish flagging pipelines, but a steady increase in the value of such companies has prompted some in the industry to warn of a bubble.
Some executives say the sector could continue to overheat as an indirect consequence of President Trump’s tax reforms, which have enabled large pharmaceutical groups to access billions of dollars of cash that was trapped overseas.
“Given the access to cash that this pool of companies now has, will we see the value of potential targets run up? I do think that’s a risk,” said Rob Davis, chief financial officer of Merck, in a recent interview with the Financial Times.
Mr Aquila added: “The new US tax law puts more cash in buyers’ hands and lower rates make more deals accretive. It’s a powerful combination.”
Baker McKenzie, an international corporate law firm, predicts the tax overhaul will help push the value of global healthcare deals to $418bn this year, up 50 per cent compared with last year.
The chief executive of GlaxoSmithKline has said the UK drugmaker will stop “drifting off in hobbyland” by producing medicines with little prospect of billion-dollar sales, as she seeks to reverse years of underperformance in research and development.
In her first interview since taking the helm in April, Emma Walmsley also disclosed that she will overhaul the company’s incentive structure in an effort to sharpen accountability. Senior executives will see a higher proportion of their bonus targets focused on the performance of their own part of the business, rather than the group overall.
“I want everyone who’s working on the pharma business to be incentivised to win in the pharma business, not incentivised for some random corporate thing,” she said.
GSK is widely seen as having failed to nurture blockbusters — drugs with $1bn-plus sales — to guard against income lost from the end of patent protection on Advair, its asthma treatment, which at its peak of £5.27bn annual sales made up about one-fifth of overall revenues.
Ms Walmsley, who has spent much of the past four months analysing the failings of the R&D division, said the company had produced a high volume of new launches but that most had not yielded large sales. Late last month she announced she was scrapping 30 clinical and pre-clinical programmes.
For many of GSK’s long-serving scientists the change of approach was difficult, she acknowledged. “If you’ve been working on an asset for decades in R&D it’s very hard to decide it isn’t important enough to take forward . . . so it’s not surprising that people’s human motivation is to keep progressing stuff,” she said.
However, drugs had been allowed to “go through too late and too far” without a rigorous assessment of their commercial potential.
GSK had also been too atomised, she suggested, structured as “an R&D organisation, a commercial organisation, a supply chain organisation and a bunch of head office people, not with the same strategy”.
She added that Jack Bailey, GSK’s US head of pharmaceuticals, and Luke Miels, who next month takes up the post of global head of pharma, would be given a far bigger, and earlier, voice in deciding which assets to pursue, based on their commercial potential. “We need to put the discipline in place,” she said.
Mr Bailey’s expanded role reflects a greater focus on the US, which Ms Walmsley said was “the biggest market and it’s an innovation-friendly market so it’s important that we play there competitively and we have room for market share growth . . . definitely in HIV and respiratory”.
Ms Walmsley also implied that the company may have become too risk averse following events three years ago when it was fined almost £300m after being found guilty of bribery by a Chinese court.
She said: “When you go through some of the things we’ve been through as a company, particularly in 2014 . . . people can become afraid to make big bets and by definition in our industry you are making big bets on science.
“You should always be afraid of breaches of compliance. That’s unforgivable. But being unafraid of failure is something I want to bring back because we have to be creative, whether that’s in our brands, in our consumer business or the invention of new drugs.”
When Cary Parton pulled a back muscle playing golf four years ago, he hardly gave it a second thought. But after several fruitless trips to a chiropractor, a series of X-rays led to a grim discovery: Mr Parton was suffering from advanced lung cancer that had spread to his bones and organs. The tumour in his liver was the size of a fist.
He was given two rounds of chemotherapy, neither of them successful, at which point doctors told his wife he might be dead in six months. He was 59.
“The big goal was to see my 60th birthday,” he recalls.
Then, in June 2013, Mr Parton enrolled in a trial at the nearby University of California, Los Angeles, where he received a new type of drug made by Merck & Co, the US pharmaceuticals group. The medicine, Keytruda, was a checkpoint inhibitor — a type of immunotherapy that removes brakes in the immune system to unleash the body as a weapon against cancer.
The drug saved his life. Before starting the treatment, Mr Parton had been virtually crippled by bone tumours that were pressing on his spine, causing multiple fractures. But by the time he celebrated his 60th in October 2013, he “felt pretty good”. The following January he returned to work. Today his weekly exercise regime consists of three trips to the gym, several three-mile walks and a round of golf on Sunday. His tumours have shrunk by 95 per cent.
1. Aug 5 BMS reveals trial of Opdivo had failed against chemotherapy in head to head trial
2. Oct 30 The company publishes full results of clinical trial
3. Jan 20 BMS says it not seek quick approval of its immunotherapy combination
Since the first checkpoint inhibitors went on sale in late 2014, they have produced some remarkable results, helping even the sickest patients survive for months or years longer than might have been expected. Mr Parton is one of the lucky ones — despite all the enthusiasm, the drugs only benefit 20-30 per cent of cancer sufferers. “Immunotherapy is not a silver bullet,” says Bob Hugin, chairman of Celgene, the biotech company. “Checkpoint inhibitors only work in a minority of patients.”
Early hopes that pharmaceutical companies would be able quickly to raise response rates by combining the drugs with other medicines have not yet been borne out by large scientific studies. Now the leading makers of immunotherapies are racing to find a way of extending their benefits to a larger group of patients, while justifying the lofty valuations bestowed on them.
Recent events at Bristol-Myers Squibb, which helped pioneer checkpoint inhibitors, suggest progress will not be smooth. In August, the company dropped a bombshell when it revealed its checkpoint inhibitor, Opdivo, had flunked a large clinical trial, which concluded the medicine was less effective for untreated or “first-line” lung cancer patients than chemotherapy.
Patients taking Opdivo survived on average for four months before their tumours started to grow or spread, whereas those on chemotherapy — the poisonous cocktail of drugs that has been a mainstay of cancer treatment for decades — went for six months before their disease progressed. After sailing through every previous trial, most investors had expected Opdivo to succeed in the study. Mark Schoenebaum, a veteran pharmaceuticals analyst at Evercore ISI, the investment bank, described the failure as “the biggest clinical surprise of my career”.
Bristol-Myers insisted it could recover by developing a combination medicine that paired Opdivo with Yervoy, an older, complementary therapy that releases a different brake in the immune system. The company told investors it might be able to seek rapid regulatory approval to use the combination in first-line lung cancer patients at some point this year, having been encouraged by the results of earlier scientific studies.
But last month the company upset investors again when it said it had “decided not to pursue an accelerated regulatory pathway” for the combination therapy following a review of clinical trial data. Its reluctance to share further details with analysts has left investors speculating as to what prompted such a swift change of heart.
In a statement this week to the Financial Times, Giovanni Caforio, Bristol-Myers’ chief executive, said: “While acknowledging the competitive landscape continues to evolve, we believe the combination of Opdivo and Yervoy has the potential to play an important role in first-line lung cancer [treatment].”
Investors have been unnerved too by the actions of AstraZeneca, which is studying a combination of two immunotherapies that is very similar to the one being investigated by Bristol-Myers. Last month, the Anglo-Swedish drugmaker pushed back the completion date for its large lung cancer trial and altered the design. Some interpreted the move as a sign the company was losing faith in the virtues of twinning the two medicines. Shares in Bristol-Myers have fallen by as much as 30 per cent since August, while its market capitalisation has dropped by more than $35bn to $87bn over the same period
The company’s travails reflect the unpredictability of drug development and the giddy excitement that can take hold on Wall Street in the early stages of a medical breakthrough. Some analysts were predicting that Bristol-Myers would generate up to $12bn of revenues from Opdivo by the end of the decade, as oncologists chose its immunotherapies rather than chemotherapy to treat the majority of lung cancer patients. They proffered such estimates even though there had been no large clinical trials showing the drug was better than existing treatments for most patients.
Since launching Opdivo in December 2014, Bristol-Myers has built a blockbuster drugs franchise, generating nearly $3.8bn in sales last year. It secured regulatory approval to treat melanoma, before winning permission to use the medicine on a range of other cancers including Hodgkin lymphoma and those in the kidney, and head and neck.
But the main driver of revenues has been the rapid uptake among oncologists treating “second-line” lung cancer that has already been treated with chemotherapy, but which is no longer responding to the treatment.
The biggest prize is yet to come: the chance to usurp chemotherapy as the drug of choice for untreated first-line lung cancer patients, described by analysts at Leerink, an investment bank, as the “single largest market opportunity in oncology”. The American Cancer Society says about 222,500 people will be diagnosed with lung cancer in the US this year, while about 156,000 will die from it. Only breast and prostate cancer are more common, although they kill far fewer people.
Bristol-Myers’ hopes of dominating the first-line lung cancer market started to fade with the failure of the trial in August, and have dimmed further still since it dashed expectations for a quick approval of its combination therapy. Now some investors say they detect hubris in the company’s strategy.
When the lung cancer trial failed, the company’s subsequent conviction in the effectiveness of combining Opdivo with Yervoy gave false hope, say investors.
“Shareholders are angry — a ton of people loaded up on the shares [after the first trial failed],” says Brad Loncar, founder of the Loncar Cancer Immunotherapy exchange-traded fund, which holds shares in Bristol-Myers. “But in hindsight, they exuded too much confidence about having a plan to get out of the hole in a semi-near timeframe.”
Another investor says the company has been “ideologically dogmatic” about the benefits of combining two immunotherapy drugs.
Analysts suggest the fall in Bristol-Myers’ value has turned it into a takeover target, most likely for Pfizer or Novartis. “Why doesn’t Pfizer just buy Bristol-Myers today, given its floundering share price,” asked Timothy Anderson, an analyst at Bernstein, in a recent note to investors, adding that he expected the drugmaker to bide its time.
Investment bankers have started to chatter about such a takeover, according to one senior banker, who says Wall Street is salivating at the huge fees that would be earned by working on a transaction that has the potential to be the biggest pharma deal of all time.
Analysts say the biggest beneficiary will be Merck. “It is pretty amazing that the company that drove all the innovation is slowly becoming second fiddle,” says one large life sciences investor who holds shares in both companies.
Whereas Bristol-Myers tested its drug in a broad group of lung cancer sufferers, Merck limited its trials to smaller subsets of patients that it thought would be most likely to respond. In doing so, Merck limited the size of its commercial opportunity, but also reduced the chance of flunking a large clinical study.
As a consequence, Merck’s Keytruda has been approved to treat a group of first-line lung cancer patients who have tumours that contain high amounts of a protein known as PD-L1, which is thought to make them good candidates for checkpoint inhibitors. Merck could expand further into the first-line market if the US Food and Drug Administration approves the use of Keytruda in combination with chemotherapy. The surprise submission in January was based on a study of 123 patients, which showed that the drugs shrank tumours in 55 per cent of patients versus 29 per cent for chemotherapy alone.
The FDA often gives the nod to drugs based on limited data, especially when the patients who might benefit are very unwell. Analysts at Leerink believe an approval could help Keytruda generate $3.8bn of sales this year, more than doubling its 2016 revenues, allowing Merck to narrow Bristol-Myers’ lead.
Roche, the Swiss pharmaceuticals group, is also trialling its checkpoint inhibitor, Tecentriq, in combination with various types of chemotherapy in more than 2,400 patients and expects to publish data that might lead to an approval in the second half of this year.
However, it is unlikely that a single combination will provide a one-size-fits-all solution, according to Roger Perlmutter, Merck’s top scientist. “What we are going to see is that different combinations will be more advantageous for different patients,” he says. “This is personalised medicine.”
Dr Perlmutter says that, in an 80-year-old patient who was already suffering from other illnesses, “the idea of giving them a very aggressive chemotherapy regime in combination with Keytruda doesn’t make a lot of sense”, because of the side effects. “Whereas in a patient who is an otherwise vigorous 45-year-old stricken with malignancy who has no other medical problems, you’re going to be a lot more aggressive.”
To that end, drug companies are running more than 800 clinical trials of combination drugs that include an immunotherapy, according to the Cancer Research Institute, testing the medicines alongside older treatments like radiotherapy as well as newer experimental compounds. It is impossible to predict which will work best, as evidenced by Bristol-Myers’ travails.
Dr Perlmutter recounts a story from October, when senior scientists from Merck and Bristol-Myers ended up dining a few tables away from each other at a restaurant in Copenhagen, where they were attending a medical meeting. Merck’s scientists had just unveiled their successful trial, whereas Bristol-Myers had just published the full details of its failed Opdivo study.
“I went over to see them, and they were so pleased, so congratulatory,” he recalls. “I hope that when the shoe is on the other foot — as inevitably it will be — that I will be as gracious as they were.”
First-line This term covers the first treatment most commonly given for a disease. With advanced lung cancer it tends to be chemotherapy.
Second-line This treatment is given when first-line therapy either does not work or stops working. In the case of advanced lung cancer this is usually an immunotherapy.
Types of lung cancer:
Non-small cell lung cancer About 85 per cent of cases are NSCLC. It typically grows and spreads more slowly than small cell lung cancer.
Small cell lung cancer This makes up 15 per cent of cases. The tumours have cells that are smaller than in most other forms of cancer.
Stages of NSCLC:
Stage 0 Only a few layers of cancer cells are discovered in a local area. Treatment consists of surgery to remove the cells. The percentage of patients still alive after five years is 60-80 per cent.
Stage I Cancer is discovered in the lung tissues but has not spread to the lymph nodes. Treatment typically includes removing part or all of the lung, and sometimes chemotherapy or radiotherapy. Five-year survival rate: 60-80 per cent.
Stage II Tumours are larger and have begun to spread to lymph nodes but not to distant organs. Treatment includes surgery, chemotherapy and radiotherapy. Five year survival rate: 20-30 per cent
Stage III Tumours are larger still and may be impossible to remove with surgery, in which case treatment includes chemotherapy and radiation. Five-year survival rate: 10-23 per cent.
Stage IV About 40 per cent of patients are diagnosed at this stage. It is the most advanced form of the disease, in which the cancer has spread to other areas of the body. Surgery is not usually recommended. Chemotherapy is the first-line treatment for patients, followed by a checkpoint inhibitor. Five-year survival rate: less than 10 per cent.
Source for survival rates: Cancer Treatment Centers of America
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