Thursday, November 23, 2017

Greek Banking: The Fat Lady Sings

It ain't over till the fat lady sings.  

I am not a huge fan of opera, but the dramatic gyrations of financial markets from boom to bust and back again are  melodramatic.  And just like in opera, there are plenty of signs that the show is over, one way or another. The key is to know the clues.

The worst that can happen to you in the opera house, if you are not an aficionado, is a mild case of embarrassment when you applaud all by yourself before the proper time. But markets can be extremely punishing if you join a show too late or too soon, by going long near the top or short at the bottom.

So, let's look for a "fat lady" clue in banking.

Here's what a complete boom-bust-boom cycle looks like for US commercial banks. Net income as a percentage of assets (ROA) started collapsing in late 2006 (yes, that's when I started Sudden Debt!) and bottomed out two years later.

Picking JP Morgan as an example, its stock performance tracks closely with the above chart. You definitely did not want to buy late in 2006 or be short in 2009.

Notice the time lag between ROA and stock performance: ROA started going down before JPM's price peaked in 2007 and started rebounding sharply before the stock bottomed out in 2009.  In other words, the fat lady started singing and giving notice well before the "boom" and "bust" cycles were over. 

 So.... How about Greek banks? Is there a "fat lady"?

I'll look at one of the four big systemic banks - again, I won't mention its name because (and I stress this very strongly again) this is NOT AN INVESTMENT ADVICE blog.

Earnings turned to heavy losses in 2010, necessitating massive re-capitalizations, the latest in 2015 (the same happened to all Greek banks). Things are  on the mend now - the bank eked a tiny profit in 2016 and is on surer ground in 2017 (figures are 6m annualized).
... and here is its stock chart, with all other clues removed to protect the innocent and/or greedy. I think the "fat lady" sings in Greek too.  

Conclusion? I like Verdi best :)

Tuesday, November 21, 2017

Of Cats And Mice

Deng Xiaoping famously said that it doesn't matter if a cat is black or white so long as it catches mice.  Given China's extraordinary economic performance since, I'd say he was the best cat manager in human history.

In late 2014 Greeks elected their first ever Leftist government and then re-elected them in September 2015 in a snap election.  Despite early warnings of total fiscal derailment (arguably well founded, given some of the "interesting" characters then in ministry posts) results were not what many feared.  In fact, the opposite.  VERY opposite.

The Greek Government budget is benefiting from an extraordinarily tight fiscal policy, completely in line with the most conservative edicts.  Tight control of core expenses and expansion of the tax base (Greeks were/are notorious tax cheats).

In the following chart you can easily see the tax base expansion (green bars). Core expenses (blue bars) include: salaries, pensions, social and health services and operational costs.

They exclude public works, inter-government transfers, defense materiel, loan guarantees and other such non-core expenses.  They are basically either constant over the years or one-time items, and they don't alter the overall picture.

The net of the two, which I call adjusted primary budget surplus (before interest), is shown in orange: up  a massive 32% in three years.

(Note: I have just added the 2018 budget projections.  The positive pattern continues - this time with another cut in expenses, mainly due to lower pensions). 

 This government is turning into the best "mouser" ever, when it comes to fulfilling budgetary promises made to Greece's lenders.  Which explains why EU/ECB officials (and very grudgingly IMF) are lately so enamored with the "leftist" Greek government.


Monday, November 20, 2017

Confidence Is The Name Of The Game

If the economy is all about psychology, as the latest Nobel Prize makes abundantly clear (*), then bond markets and banking are certainly all about confidence, aka trust.  

Confidence in Greek bonds and banks evaporated in 2010 and then slowly started to mend in 2013-14, only to deteriorate badly when the Leftist government took over. Deposits rushed out, capital controls were imposed, yields on bonds soared.  

And then... Left did an about face and went Right. Quite right!  

So, where is confidence in Greek bonds and banking now?  If you only listen to various Greek "analysts" you would think that things are still in the proverbial outhouse. Actually, trust and confidence are coming back very nicely. 

 Here are two charts.

  • Since the beginning of 2017 the yield curve on Greek Government Bonds has moved down sharply across the  board. Medium term 3-7 year maturities have seen the biggest improvement, as one would expect.  As trust is restored, investors first buy the less volatile shorter maturities and then gradually extend to the longer end of the curve.
  • Greek banks' reliance on the ECB's expensive Emergency Liquidity Assistance is coming down fast.  In just ten months it is down 47% by a whopping 24 billion euro, making their funding much cheaper (and increasing profit margins, aka NIM).  The decline became more pronounced starting in May.  Given that retail deposits have not yet come back in volume, where is the funding coming from to replace the ELA? Some of the decline comes from balance sheet deleveraging through asset sales, but a chunk of it must come from the wholesale market, i.e. interbank transactions with foreign counterparties, mainly in repos. This means credit lines are being restored, a major vote of confidence in the health of Greek banks.

(*) The 2017 Nobel Prize for Economics was awarded to Richard Thaler for his work on Behavioral Economics, a radical departure from the Chicago School's efficient market hypothesis.  Funny enough, the latter's "father" is Eugene Fama who also got a Nobel.  And they both teach at the University of Chicago!

Sunday, November 19, 2017

Is It Greek To You?

Is Greece a good place to invest these days? Is it a "steal" or a "stay away"?

First, the bad news.  The World Economic Forum publishes an annual Global Competitiveness Report ranking 137 countries.  This year Greece is at the 87th place, behind even Bhutan (82), Iran (69) and Rwanda (59). The biggest bugaboos are high taxes, a notoriously inefficient government bureaucracy, policy and political instability.

These obstacles have been around for decades; limited access to financing is a more recent negative caused by the ongoing crisis, capital flight and weaker banks. You can see the whole list below.
You get the picture.. a backwater of Europe, populated by corrupt lazy people governed by crooked pols who bleed them dry on taxes (IF they pay, of course). Yup, that's the way Bild et. al would have you see things - it sells papers and pixels.

Is it true? (a)Yes. (b)No. (c)Depends. (d)Doesn't matter.  Keep this in mind, I will revisit the question at the end.

On to the positives, then. And there are quite a few.

  • Workforce. You may be surprised to learn that nearly 100% of young Greeks now enroll in tertiary education - far more than, say, Switzerland or the UK (the EU average is 71%).  Note how recent this development is: the enrollment ratio started shooting up in 2000, meaning that Greece has a lot of highly educated young people. With youth unemployment running over 40%, most of them are without a job or severely underemployed. 

  •  Wages. Total labor costs are now at half the eurozone average.  

  • Real Estate.  Prices for homes are down 42%, shops down 38%, office space down 35%.  Rents for shops and offices  are lower by 50% and 30% respectively. 

  •  Business Confidence.  The Economic Sentiment Index is bouncing back after the 2015 snafu and is now above the 10-year average (Greece is in green, its average the dotted line, EU and eurozone in blue and red).

  • Capital Investment Plans. Greek businesses intent to increase investment 19% during 2017. If it happens, Greece will swing from #22 on the list in 2016 to #4 in 2017.  The EU average is +4%.

  •  Bond Market. There is a marked improvement in the Greek Government Bond market since the beginning of the year, reflecting increasing confidence by the more sophisticated fixed-income investors.

In summary: Greece offers a large educated workforce available at low wages plus cheap real estate, both at a time when confidence is rebounding and businesses plan to raise capital spending significantly.  I believe these are very good reasons to think of Greece as an investment opportunity.

Let's now revisit the thorny issues raised by that embarrassing 87th place on the WEF list. The answers to "Is it true?" were: "Yes". "No". "Depends". "Doesn't matter".  Which one did you pick?

Well, don't worry because it was a trick question. All four answers apply. Are you confused yet, is it Greek to you?

By way of explanation, a small story: The most accurate description of Greece is one I got 25 years ago from an American expat lady sitting next to me at a wedding reception (not my own, ha ha): "My dear boy (those were the days...), in Greece you may be happy, get angry or become mad.. but the one thing you will NEVER be, is bored!" It still holds true, bless her soul.

What she meant was that even the most prosaic day to day activities can never be taken for granted in Greece. Very little happens as planned (Greek planning is an oxymoron). I like to put it this way: Greeks believe and act as if it is impossible to easily and successfully accomplish the most trivial of activities (case in point: the recent disaster in issuing electronic metro passes).

Therein lies opportunity: Greece's glaring defects can be exploited  by smart professionals who will view them as opportunities to profitably apply commonsense solutions.  To put it metaphorically, the Greek economic highway is full of potholes just begging to be filled.
It doesn't take a rocket scientist, or much capital, to fill the simple "potholes" of the Greek economy.

I'll give you an example: a friend with zero trading experience within two years became one of the largest exporters/intermediaries between organic Greek farmers and German food wholesalers.  When she asked her German clients why they chose her over larger, more established Greek competitors the answer was: "You answered our emails and phone calls".  Duh!

Here's another example: Taxi Beat was founded in Greece; it became immediately successful, branched out globally and was eventually sold to a subsidiary of Mercedes Benz for 43 million euro. Why? Because the taxi business was so inefficient and unprofessional that it created a host of problems for Greek taxi users. Ergo, solution begat profits.

Here's another: the pharmaceutical business was notoriously corrupt. Doctors wrote thousands of bogus prescriptions to be filled by private pharmacies at high fixed profit margins, sharing the proceeds with the pharmacists. Ninety percent of all drug spending was covered by the state health system - until it went bust, that is, and had to cut spending sharply.  What did it do? Among other things, it mandated that cheaper generic drugs were obligatory, if available. A shrewd Greek drug manufacturer  who focused almost entirely on the generic market saw business rise sharply. The company was acquired for $562 million by a major global drug company.

See my point?  Greece has LOTS of such problems begging for solutions. Step outside the World Economic Forum box and look for the opportunities inherent in that embarrassing 87th place.

Bottom Line: Greece is cheap and has lots of potholes. Roll up your sleeves, get your spade and bucket and get ready to shovel!

Friday, November 17, 2017

What Next, Greece?

After nearly a decade of economic misery today's title arises spontaneously: where is Greece headed? 

Unlike other economies that got into deep trouble when the Debt Bubble burst in 2007 (e.g. Ireland), Greece hasn't managed to bounce back yet and is scraping along the bottom for four long years.  
For independent confirmation of GDP numbers I look at the total consumption of energy, a more fundamental measure of economic activity. The two charts are in agreement: Greek GDP is down approx. 25% from its peak and is bottoming out.
The reason for the prolonged malaise is the non-productive model of the economy, a situation going back decades.  There is no value in rehashing ancient history here; suffice it to say that when in 1980 the rest of the world went towards economic liberalism with Thatcher, Reagan and Deng Xiao Ping leading the way, Greece went in the exact opposite direction towards state sponsored socialism and - even worse - crony capitalism.  And when the country decided to join the Eurozone twenty years later, it did so without first transforming its economy to match the strict requirements of a strong currency.

I won't delve into Greek politics. I believe it to be a complete waste of time and, besides, there are thousands of other outlets that do nothing else.  Instead, I will focus on hard data.

So, how is the economy doing now?

Public finances are finally under firm control;  the budget runs large primary surpluses and debt has stabilized.

Unemployment peaked at 28% and is gradually falling, reaching 20.6% this past August.

Tourism is hitting records, a major positive contributor this year. Employment in this sector is rising strongly, too.
Hospitality and Food Service Indexes
Black: Employment
Green: Compensation
Orange: Hours Worked

Industrial production, manufacturing and retail trade are all trending up in the last 12-18 months.

Revenue from shipping, a traditional Greek stronghold, has dropped almost 50% from the 2010 high, suffering from the global weakness in shipping rates. However, charter rates have bounced back strongly in the last 18 months, pointing to a more positive outlook.

Overall, it looks like Greece is bouncing back, albeit slowly.  What could make things move faster towards pre-crisis levels?

Let's compare the makeup of GDP  in 2007 and 2017: household and government consumption, capital formation and the import-export balance .

 Two things immediately stand out: the collapse of capital formation (i.e. investment) and the notable rise in exports.
  • The massive trade deficit, which routinely ran 10+% of GDP in the past, is now balanced - a positive development.
  • On the investment side, however, the situation is highly negative. Capital formation imploded 75%, going from 64 billion in 2007 to just 16 billion in 2017.
(An explanation  is necessary here: given the high level of investment in Greece in the past, how come it did not become more productive and competitive?  Because investment was mostly in overpriced residential and commercial real estate, largely built "on spec".  In some years new home building vastly exceeded new household formation, creating a large number of unsold properties.  The debt bubble created a real estate bubble and funded a massive trade deficit.)

It's obvious that rapid and significant incremental growth can only come from investment and secondarily from exports. In fact, the best possible combination would be export-oriented capital investment, e.g. factories producing goods for export and hotels catering to foreign tourists, to mention just two examples.

Capital for such investment is not going to come from Greek banks who have slashed their loans to the private sector by 27% during the long recession.  In any case, until they recover from the vise of NPLs and low deposits they simply don't have the money to lend.

To bounce back Greece must clearly attract foreign direct investment (FDI), where decisions are made based on a country's  comparative economic advantages, including political stability, taxation, legal and labor conditions.  

In the next post I will try to answer two questions: a) is Greece a good FDI opportunity right now and b) how "investment friendly" is it?

P.S.  I just saw this interesting graph from a respected Greek economic research periodical. It shows that residential real estate construction is expected to rise almost 30% in the near future, based on the number and size of building permits issued.  It's the first increase in at least 10 years and, if it materializes as strongly as predicted, it could have a measurable impact on GDP.

Of course, this increase comes from a VERY low base after 10 years of constant decline. The next chart is pretty astonishing, IMHO.  Private construction activity is now just 12% of what it was in 2007. Bars are number of permits, dotted line is total surface area in sq. meters. Truly explains the collapse in the investment component of GDP.