Risk Wire: Climate Change – The Cost of Transition

We have integrated the available industry-level climate change transition research from multiple sources and included climate change transition as the fourth long-lasting trend in Mira ABM*, along with automation, ageing population and globalisation/trade conflicts.

 

The transition of our economy in response to the climate change has begun in the earnest and is likely to continue in the years to come. The ultimate physical impact of climate change is arguably still uncertain, not least because it depends on the speed and extent of the policy reaction of major countries. Yet, there are energy transition facts that are already having significant impact on global supply chains, economic development and consequently, on asset pricing. Most importantly, these transition facts will continue to have impact on asset pricing in the foreseeable future, which qualifies climate change as the fourth long-lasting trend included in Mira ABM – our strategic asset management platform, along with ageing population, automation, and globalisation/trade conflicts.

 
Attempts to account for climate change in asset pricing so far have been focused on top-down macroeconomic analysis. Such analysis often misses the complexity of the underlying supply chain shifts. At the same time, there are detailed industry-specific studies covering climate change; however, they are fragmented and focused on individual industries. In this report, LINKS have tried to combine the body of knowledge on climate change from multiple industries into a single supply chain picture and draw conclusions with respect to asset prices.

 

Mira ABM Risk Severity (July 2019)

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Scenario: Germany Industrial Crisis

The recent fall in the industrial production in Germany appears to be larger than typical quarterly volatility. Year-on-year change was -4.8% in November 2018 – the greatest decline since 2009 (source: Bloomberg).

Source: Bloomberg

A more detailed analysis of the business sentiment – IFO index (source: IFO Institute, Center for Economic Studies) suggests that while the declines are broad, the leader in decline is the chemicals industry. Order backlogs have shrunk most considerably in the chemicals industry, though the declines are evident elsewhere.

Indeed, German chemical companies have reported poor results and reportedly expect poor 2019.

As a quick first step to defining a stress scenario, we have applied a 20% volume decline for the four main industries in Germany: automotive, mechanical engineering, electrical equipment and chemicals.

The scenario results are available for Mira ABM users through the Excel App or linksmira.com.  

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Risk Wire: China – The Threat of Unchecked Leverage

In the six years since LINKS first covered risks of excessive leverage in the Chinese economy, both understanding of and dealing with leverage has been a key focus for the government of China. Despite this focus and even though the debt is domestically funded, the results of deleveraging are less than encouraging. Sustainability of this debt is further away, which has major consequences for global investment portfolios.
In 2012 LINKS Analytics wrote about the looming debt crisis in China (Global Systemic Risks, 2012). At that time, we estimated the size of the local government finance vehicle (LGFV) debt at $4.2 trillion, or nearly double the size of Moody’s estimate. The conclusion was that the size of this debt was too large to grow out of (as China had previously done).
Through the following six years China’s policy makers continued to balance the demands of managing the mounting debt on one hand and delivering the economic growth on the other. China’s economy did not implode under the debt burden but judging by the now widespread recognition of the problem, the debt issue did not go away.
We believe It is now time to revisit the issue of systemic risks posed by China’s economy, focusing specifically on the following questions:

  1. Is China still inefficient and is debt still accumulating?
  2. If so, is it more or less sustainable in 2019 compared to 2012?
  3. What are, if any, signs of imminent distress?
  4. What would be the impact on balanced portfolios in case of an economic collapse?

To answer the last question, we use scenarios in LINKS Mira Agent-Based Model (ABM), which enables assessment of system-wide impact of scenarios on investment portfolios.

Read the full paper and download tools:

  • Analysis of debt levels
  • Assessment of sustainability of debt
  • Analysis of causes of debt accumulation
  • Impact on major asset classes
  • Optional: trial access to Mira Agent Based Model

Data Protection Commitment

LINKS Analytics will not distribute your personal data to third parties – no exceptions made. Upon your first request we will remove your data from our database.

Risk Wire: The Fragile Exposure to Technology

Much has been discussed about the technology sector concentration of S&P 500. Although we find that the degree of concentration is not unusual, once certain myths about the largest companies are dispelled, the nature of exposure and corresponding end-market risks indicate a degree of fragility.
The concentration of the US stock market performance in the technology sector has been source for concern in the last few years. The variedly used FAAMG or FAANG acronym (alternating inclusion of either Microsoft or Netflix along with Facebook, Amazon, Apple and Google/Alphabet) has successfully taken its place next to the old favourites, such as BRICS or PIGS.
Much like the latter two sets of countries, the companies in question have more differences than commonalities and it is the underlying markets that drive the risk profile rather than the companies themselves: fortunes of Google and Microsoft are as aligned as the future performance of Brazil and India. Although there are common drivers, the specific risks are driven by underlying end-market exposures. In this issue of Risk Wire we attempt to zero in on the ultimate sources of risk with respect to the leading technology platforms, dispelling some myths on the way.
To be clear, this is not analysis of the technology sector investments in general. Rather, we attempt to evaluate the exposure of the market to the five leading companies and the underlying risks that exposure implies.

Read the full paper and download tools:

  • Analysis of debt levels
  • Assessment of sustainability of debt
  • Analysis of causes of debt accumulation
  • Impact on major asset classes
  • Optional: trial access to Mira Agent Based Model

Data Protection Commitment

LINKS Analytics will not distribute your personal data to third parties – no exceptions made. Upon your first request we will remove your data from our database.

LINKS Adviser Partner Program

Build your independent advisory business with the assistance and resources required to succeed.
The world is moving away from fixed employment. The regimented hierarchical corporate structures just can’t cope with the pace of change. Unfortunately, building independent advisory practice from scratch is not easy: one has to build a product, a network and market, while funding this process from own savings. A challenge for a new adviser is existing client references: a typical chicken or egg situation. We came up with LINKS Adviser-Partner Program to help independent advisers build their business and clients get the advice and coverage they need.
LINKS will give access to our system, research and data warehouse that was built over the last decade to independent advisers for free. Advisers introduce the systems and their services on the back of LINKS frameworks to the clients as a first-point of contact. Client revenues are shared between LINKS and adviser-partners, whereby advisers retain all advisory revenue. The sales cycle is extremely long in the institutional market, but advisers do not have to wait; LINKS will compensate for every introductory meeting with a qualified client. This will provide the necessary cash flow before your future clients are convinced of the value that we can deliver.
If you have questions about this program, please send us an email at app [at] linksanalytics.com or simply sign up to get in touch – you can always opt out later.

Access

APP Participants will be granted access to Mira ABM – risk management, asset allocation and strategic investment management framework

Build

Build advisory practice by focusing on specific insight needed for the client, while outsourcing all costly data and processes to LINKS. Retain all advisory revenue.

Monetise

Receive compensation for introductory meetings, regardless of eventual success. Build sufficient cash flow to sustain your business before the client contracts are in place.

Market

Benefit from marketing help, client pipeline management, communication materials and in-depth research library already in place at LINKS.

Begin your participation in APP here

Risk Wire: Do Inflationary Concerns Warrant Hedging?

Some sources of inflationary risk are more benign than others. Given the structural headwinds that the global economy faces, a broad inflation hedging programme can be expensive and unnecessary. On the other hand, the likelihood of unexpected inflation driven by regulation or supply shocks is increasing. This points to a more targeted approach when managing inflation risk.
Continuously low interest rates in the face of very low unemployment rate justifiably raise inflationary concerns. Protecting institutional portfolios against inflation does not come cheap – sensible hedge against inflation comes with increasing volatility and adds to the risk of the portfolio. It is therefore worthwhile to consider whether at least in the typical “core” scenarios of pension funds, inflationary concerns are truly justified.
The persistent low-trending levels of inflation in the past two decades are likely to be the effect of the emergence of global value chains and automation. Although there is significant political push-back against globalisation that can in theory reverse its effect on inflation, i.e. cause domestic price increases, our estimates suggest that the disinflationary effects of automation and ageing population in the coming years more than make up for the difference. In fact, if anything, the combined effect of long-term structural trends point at ~ 90 bp lower demand-driven inflation going forward. An active inflation hedging program for demand-driven inflation is therefore likely to cost more than its potential benefit.

Read the full paper and download tools:

  • Analysis of debt levels
  • Assessment of sustainability of debt
  • Analysis of causes of debt accumulation
  • Impact on major asset classes
  • Optional: trial access to Mira Agent Based Model

Data Protection Commitment

LINKS Analytics will not distribute your personal data to third parties – no exceptions made. Upon your first request we will remove your data from our database.

Impact of New Steel and Aluminium Tariffs Imposed in the US

On February 2, 2018 the US administration announced a new set of tariffs to be applied on imports of steel and aluminium. The tariffs of 25% and 10% respectively will disproportionately affect US’ closest ally and trading partner – Canada. The other countries have relatively manageable exposure to the US imports (see the table below).
Although the event can be applied in Mira either by volume or price impact, we have elected to use the price impact as the key input. Price impact values are derived by weighting the value of exports of steel and aluminium into the US and applying respective tariffs. Only steel has been taken into account in the analysis of countries with small exports of aluminium (Brazil, South Korea, Mexico, Turkey and Japan).

Country % of Imports
Steel
% of Imports
Aluminium
Price Impact US as %
of Exports
Volume Impact
Canada 16% 52% 17% 78% 27.1%
Brazil 13% 0 25% 8% 2.8%
South Korea 10% 0 25% 14% 4.9%
Mexico 9% 0 25% 27% 9.3%
Russia 9% 16% 19% 16% 5.6%
Turkey 7% 0 25% 10% 3.5%
Japan 5% 0 25% 7% 2.6%

 
 
A more detailed breakdown of the trade patterns can be found on the MIT OEC website.

Register for Webex: Running The Tariff Stress Scenario in Mira ABM

3 pm Monday, 5 March, 2018

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Investing in the Age of Disruption

The emerging disruptive forces of technological, political and demographic change threaten to destabilise long-term investment performance. It will take special kind of capacity building and flexibility for institutional investors to benefit from disruption rather than fall prey of it.

We live in an age of unprecedented confluence of multiple disruptions. First, there is a generation of twenty-somethings set on disrupting virtually every industry using technology that did not exist or was too expensive a few years back, some of them succeeding in the process. Then there is the macroeconomic disruption brought by ageing population, stagnant productivity. There is the political disruption of Trump, Brexit and all the rest of isolationist and populist tendencies – evidence suggests that reversal of globalisation is progressing fast. Of course, the environmental disruption is hard to ignore. These trends happen very quickly in the historical context and reinforce each other.
What is the implication for the investment policy, if any? In the first issue of the Risk Wire this year, we attempt to take stock of all these disruptive trends and draw some conclusions in terms of the appropriate policy response.

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Risk Scenarios 2018

What Could Possibly Go Wrong?

It is not easy to build plausible yet severe economic scenarios. Doubly so, if those scenarios are assessed in LINKS Mira Agent Based Model (ABM). Unlike conventional models, Mira ABM takes into account unintended consequences of events – both positive and negative. Just like in real life, positive and negative effects cancel each other out, with little impact on investments. So suggest your scenario for 2018 by describing it on our LinkedIn feed, or better still, by downloading Mira ABM and introducing the scenario in our system. The best (or the worst?) scenario will earn you a New Year’s gift and a professional reputation among our institutional clients.

Some effective scenario pointers:

  • Any social, geopolitical or economic hypothetical but plausible event can become a basis for a scenario
  • In order to build a scenario, we will need “the point of first impact”, i.e. an industry in a country that experiences direct economic hardship in terms of changes prices or volumes due to the scenario. For example, an incomplete scenario is “a war in North Korea”. A more complete scenario is: “a war in North Korea cuts production volumes of mobile phones, semiconductors and flat screens in South Korea”.
  • Impactful scenarios tend to be large, across multiple industries and countries with greater trade ties with the rest of the world.
  • You can read more about building scenarios with Mira ABM here.

How to Suggest a Scenario:

You can describe the scenario on our LinkedIn feed., or send as an email: info@linksanalytics.com

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