Wednesday, July 27, 2016

What Solar Impulse Means to the Energy Sector

Today is a big day for solar energy as the world's first solar-powered airplane completed its circumnavigation of the globe. The journey marked the first time a plane has circled the globe without the need for fuel. Solar Impulse 2, the name of the craft that made the trip, was flown over 21,000 miles by two pilots rotating in the cockpit. After layovers in five different continents, the lightweight plane landed where it started in Abu Dhabi. Despite being wide than a Boeing 747, the solar-powered craft weighs only 5,000 pounds according to WIRED. Four 17.4-horsepower motors account for most of the weight, but when equipped with 17,000 photovoltaic panels, the machine becomes capable of flying at an average speed of about 47 mph. Yes, this plane is still painfully slow, but it introduces renewable energy potential to the air. The motors generated well over 10 MWh of energy an impressive feat that compares to some systems on the ground. Proving that energy can be successfully created in transit while propelling a weight through the air safely will boost the prospects for solar air cargo and even solar commercial flights.

Some big names in business flew behind the two pilots in their grueling journey that lasted well over 2 months. Google, the tech-savvy search engine, supported the project as an official partner. The firm helped promote the flight with the assortment of Google platforms such as Google+ and Google Earth. In fact, the pilots took part in an occasional Google Hangout as a way to generate buzz on social media. In addition to multimedia support, Google provided some financial backing. Nestle's research segment provided dietary support as they were responsible for feeding the pilots for the entirety of the journey. Covestro, one of the world's largest polymer companies, showed their support by designing and constructing the lightweight systems on the plane. The German energy giant, Siemens, used its engineering technology from its PLM Software branch to optimize the design of aircraft. Most of these companies stood to gain nothing from the completion of the historic feat, but individually, their contributions could be indications of their involvement in the future of solar flight. Covestro's interest, for example, might go beyond social responsibility as lightweight materials will be a necessity as this technology continues to develop. It is also interesting to note that three mission partners came from the booming renewable industries of China and India, two countries which will account for a major share of renewable energy growth in the future.

So where from here? Obviously, the only direction is up (literally). Like Wilbur and Orville's first flight at Kitty Hawk, Piccard and Borschberg's feat will revolutionize the aerospace industry and encourage developments in this renewable energy niche. The flight of the Solar Impulse 2 speaks especially to progress made in the quality of photovoltaic panels. The company that supplied the technology, SunPower Corp, has a lot to be proud of as the successful journey will become a milestone in its photovoltaic development going forward. Participation in this project should catapult the solar company to new opportunities in solar-powered aviation in the future. In the same way, Covestro's lightweight polymers will be invited to the party that is not too far away. Another interesting company to mention amidst the celebration of Solar Impulse 2's landing is Solar Flight Inc, headed by President Eric Raymond. The small firm has already introduced four solar powered airplanes to the public including its latest, the SUNSTAR. The aircraft, which came out almost two years ago, flies at high altitudes and can act as an unmanned drone or a piloted vehicle. The project demonstrates advances in weight efficiency and solar power capacity and leads to plans of an even more impressive craft.

solar electric airplane

The picture above is a rendering of a 6-seat solar transporter that Solar Flight has posted on its website. There is no signal as to whether the project has been started or how much progress has been made, but any kind of prototype or evidence of headway should interest any major names in the aerospace industry. Boeing, for example, has been fidgeting with its own interpretations of the fuel-free craft. GeekWire reports on some of the designs, all of which are limited to unmanned devices. Technology that has been developed by the team behind Solar Flight would be especially valuable to a big commercial name like Boeing. Speaking of the team behind Solar Flight, guess who shows up again...SunPower. It's clear that this company has its eyes on solar flight and may find partners in companies like Boeing, Facebook, and Google who are considering prototypes for solar commercial flights and free internet access to remote parts of the world (see The successful circumnavigation of globe in the Solar Impulse 2 is a feat that should be praised. In the solar power industry, it should be heralded as a great milestone that rivals the creation of the solar powered car. Investors should be keen to watch out for opportunities in this sector of the renewable energy industry. Something tells be SunPower is not finished creating solar-powered planes.

Thursday, July 21, 2016

The Global Economy in Charts: The Bank for International Settlements' Annual Report

In late June, the famed Bank for International Settlements produces their annual report for their financial year that ends at the end of March. The financial institution, based in Basel, Switzerland, is known for its international clientele and enduring history of excellent economic analysis. With 60 central banks included in its operations, the BIS has its hands in a group of nations that accounts for about 95 percent of the world's GDP. Hence, a report as extensive and in-depth as its annual publication is widely read and referenced among analysts. Its insights into monetary policy and the dynamics of the global economy are impressive. For that reason, I shall use the charts and graphs in the report to paint a picture of BIS's economic analysis as well as adding my own perspective along the way. Here is the global economy in charts.

All images and quotes can be found in this report.

"The global economy is not as weak as rhetoric suggests"

The media, analysts, and pundits covering economic news aren't told to sell lukewarm. Instead, public figures use extremes and decisive statements to polarize their arguments for the sake of joining the bulls or the bears. Too often, they ignore the average, a state that is the most probable. The BIS, though, successfully disables the extremes of both side with the statement, "the global economy is not as weak as rhetoric suggests." The report acknowledges the existence of weakness but admits that it might be more average than detrimental. The opening BIS statement is supported by these three charts which paint a picture of a stabilizing system that has just undergone a period of disequilibrium. GDP growth's variability reduced across countries, and now a trend of convergence is setting in. Unemployment in advanced economies (AEs) are finally regressing towards the mean while discontent in emerging economies (EMEs) have caused an uptick in recent jobless numbers. In the past six quarters, we've seen oil price fluctuations complicate economic growth in the post-crisis bull market, but those trepidations have largely calmed down. After peaks in 2015 and the first two months of 2016, the CBOE Volatility Index (VIX) is down over 30 percent this year. As fearful trading has subsided, investors with more confidence are buying back into the market. Suddenly, the Dow and S&P are setting new highs.

This interesting environment described by BIS's big picture diagnosis is best explained using the concepts of energy in physics. In mechanics, objects with mass always have energy. With movement and force, kinetic energy represents the amount of energy used to do work. For example, it takes kinetic energy to move a box from one location to the other, to start a car and drive across the country. But an object doesn't have to be moving to have energy. Potential energy is energy that an object with mass has based on its position. A ball on the top of a hill has potential energy because gravity can push it down the slope with the right catalyst. That picture of the ball might be an accurate image of the global economy at this moment. Volatility has slowed down, and a steady positive trend has taken over. Relative to stock movement in August 2015 and January 2016, markets have shown reduced kinetic energy, or volatility, which usually supports an optimistic environment. But, potential energy remains high. Stocks and bonds are tightly wound and give the impression that they could fall at any moment. The BIS points out a "risky trinity" that adds to this negative potential energy: "low productivity growth, global debt levels that are historically high, and narrow room for policy maneuver." BIS's opening statement should not be taken as assurance that weakness is gone; instead, investors should recognize this idyllic trading period as a short respite before the storm.

"...a highly visible and much-debated sign of this discomfort has been exceptionally and persistently low-interest rates"

Because the BIS has access to data and policy from over 60 central banks, its monetary commentary is some of the best in the game. In the low-interest rate environment, it has been quick to be critical of the loose policy that has whitewashed the capital markets in advanced and emerging economies. As the first chart demonstrates, policy rates in Japan, the euro area, and the United States (G3) have been forced into negative territory after adjusted for inflation. The central banks have maintained this policy in order to encourage investment in the equities markets and allow lending to occur at almost no cost to the borrower. As a result, households, governments, and businesses have stacked up on debt, and it has created unsustainable growth. The BIS condemns this trend saying, "debt has been acting as a political and social substitute for income growth for far too long." The global economy will not survive for long if market participants continue to support the imbalance of productivity and credit. Instead of a large-scale shifting of funds, the BIS encourages "an urgent rebalancing of policy to focus more on structural measures, on financial developments, and on the medium term." Policy changes seem easy enough, but complications could arise from the turbulent relationship between monetary and fiscal institutions as they often have before.

Another consequence of persistently low-interest rates is a topsy-turvy bond market with yields that discourage investment in that arena. The chart on the right catalogs some of the lowest yields in the world, and surprisingly, they have fallen below zero. Japan's yield has fallen to about -0.125 after its central bank began experiments with interest rates set at negative values. France, Denmark, and Sweden, the three lowest yields in the euro zone are results of low rates and heavy quantitative easing from Draghi's ECB. The BIS sees this as a signal that, "market participants look to the future with a degree of apprehension." Trust in monetary policy is quickly falling as inflation struggles to pick up and growth settles into a new, low "normal." The solution to global economic weakness will not come from the halls of major central banks, but instead, will be left to the whims of the crowd. Large-scale asset purchases have exhausted bond markets in advanced economies forcing money to chase riskier segments, a dynamic that would accelerate a crash if one were to come. In addition to this risk, unconventional adjustment of long-term interest rates will not be an option in the next downturn as they have already been flattened to dangerous levels.

"Global debt continues to rise and productivity growth to decline"

The above charts produced by the BIS go hand-in-hand with the four-part series just published on Black Gold Disease called Predicting a Crash. In it, I discussed the incredibly high levels of debt across every kind of economy. From 2007 to 2015, government, corporate, and household debt has been on a clear climb upward with AEs and EMEs all reporting debt that is over 150 percent of GDP. That growth might not be troubling if justified by a simultaneous increase in output, income, and consumption, but these characteristics of a healthy expansion are mostly absent. As evidenced by the chart on the left, labor productivity has remained below 2000-2005 levels even though a robust recovery after the financial crisis was supposed to take place. For that reason, these two issues are set as the first two pillars of BIS's "risky trinity." The truth is, employment supported by borrowed capital is not sustainable and has lead to a crowding out of growth that is sustainable. In the end, there will be a correction in one of these areas. Either productivity will see a robust recovery in the next few years, a positive growth scenario, or debt levels will be forced downwards, a catastrophic scenario that would lead to a crisis.

"The spotlight shone especially brightly on China, which for several years had been seen as the global growth engine"

The BIS identifies "the first episode of market turbulence" as the global sell-off in the third quarter of 2015 largely lead by weak Chinese fundamentals. Major market indices in China's equity markets revealed a relative trend of overvaluation as its people sought yield for its savings glut. The largest Asian nation is also known for its high savings rate which causes its domestic firms to be less reliant on domestic consumption. The chart on the right shows how prices and P/E valuations topped out in the middle of 2015. After the peaks, volatility set in as traders sold heavily before buying back into the trend. Currently, valuations are still higher than 2015 Q2 levels, but fundamentals such as manufacturing and GDP growth rate have stabilized countering uncertainty. Still, the BIS sees fragility in Chinese equities as the 2015 sell-off, "shook confidence in China’s ability to achieve a 'soft landing' scenario after years of rapid credit-fuelled growth." The Chinese government, which remains very exposed to debt in many advanced economies, might experience even more distress if a global credit crunch ensues. In the end, investors should never let their eyes stray far from this nation as its currency fluctuations (middle and left graph) and large demand have the power to sway the world's economy.

"The plunge in commodity prices weakened the economic prospects of commodity-exporting countries and of commodity-producing firms"

If there was one sector that lost in the 2015 year, it was energy. Since the second quarter of 2014, oil and gas firms have been grappling with the new trend of low oil prices. And while some institutions claimed that the fluctuations were temporary, Brent and WTI spot price movement is shaping up to reflect a lower-for-longer scenario. Oil and natural gas saw their prices drop by well over 50 percent, but they weren't alone. Metal and foodstuff saw similar debilitating movements on the futures markets, a cumulative effect that weighed on inflation. Deflationary pressures caused by these volatile commodity prices (middle chart) forced monetary institutions to be cautious in their policymaking, a sentiment not well received by market participants. We saw energy prices take a toll on market dynamics but they also played a role in an industrywide earnings loss. As illustrated by the graph on the right, energy stocks almost 50 percent in 2015 putting many of the weaker issuers in danger of bankruptcy. In fact, these companies played a large part in debt growth as, "their bonds
outstanding increased from $455 billion in 2006 to $1.4 trillion in 2014, or by 15% per year; and their syndicated loans rose from $600 billion to $1.6 trillion, 13% per year." The BIS and many other analysts blame this weak sector for the losses in the high yield sector, a segment of the market that is just now starting to rebound. Energy volatility has recently started to cool, and that will support investors looking to buy oil and gas producers at a cheaper price. But, oil prices don't appear to be increasing anytime soon. This could create imbalances in power among oil importing and oil exporting nations.

"The likelihood of divergent monetary policies between the United States, on the one hand, and the euro area and Japan, on the other, contributed to renewed dollar strength"

The BIS stresses monetary analysis in its report and provides excellent insight on how different policy affects each corner of the economy. In these charts, it looks at the performance of the dollar in relation to interest rate expectations in the euro zone, Japan, and the U.S. The Federal Reserve looked to be the most eager to raise rates as 2016 was once projected to have as many as five rate hikes occur. At the same time, the Bank of Japan and the ECD were both reluctant to raise rates in what they determined was a weak economic state. As the BIS comments, the diverse global economy experienced "uneven global momentum" as fluctuating commodity prices affected markets in different ways. This individualistic approach to cohesive monetary policy appears to have failed as the expansive setting that has been maintained since 2009 is failing to produce a positive effect. Investors are trading the uncertainty and division by flocking into the dollar, the currency in which most debt is denominated. This dynamic has weighed on the Federal Reserve's hopes for growth in foreign demand forcing them to be even more dovish. Investors have responded by selling more bonds and flattening the forward interest rate curve (right graph). Every meeting in the Fed, ECB, and the BOJ seems to be conducted on a tightrope as options are limited. The BIS cites this lack of flexibility as a problem that plagues economic stability and something that must be fixed if a crash is to be avoided.

The annual report of the Bank for International Settlements is a must-read document for investors who pay attention to macroeconomics. Its expertise on monetary policy and accessible charts allow investors the opportunity to discover many critical insights. The fragile state of the global economy demands an accurate analysis of the forces that underpin its movements, whether they be positive or negative. This publication provides many different perspectives looking at the problem of weakness in financial markets and could be the reason why you avoid losing big in the next crisis.

Friday, July 8, 2016

Predicting a Crash: Part Four

So far in our investigation, we've looked at the existing fundamental condition of the global economy to support the proposition that a crash is coming. Debt levels have continued to rise since the financial crisis in 2008, and companies and households continue to increase their leverage despite mini-crashes in August of 2015 and January of 2016. The declining health of corporate and governmental balance sheets has endangered the survivability of many national stock markets which are faced with the risk of crisis similar to the Greek debt crisis that happened a couple of years ago. These debt conditions are allowed to prevail because of the loose behavior of the world's central banks, namely the Federal Reserve, the European Central Bank, and the Bank of Japan. Cheap credit has encouraged a growth in business loans, mortgages, auto loans, and credit card use that has surpassed the levels seen in the years leading up to the financial crisis. The conditions just described are not necessarily indicative of a global crisis, but if a degrading fundamental position is paired with an overvalued asset market, a dangerous game of musical chairs ensues. In closing this investigation, we will look at and analyze some of the trends in stock evaluations that have developed in the seven-year bull market that followed the worst recession since the Great Depression. With any luck, the bystanding investor can use this investigation to develop an exit strategy before the storm hits.


Stocks act as the barometer of the economy measuring the fluctuations of business strength and individual sentiment on a daily, weekly, and yearly basis. Stock market patterns always react to a brewing recession and often lead economic downturns that are unexpected. One measure of overvaluation, and perhaps the most popular is the price-to-earnings ratio of the S&P 500 over time. The chart above shows the historical data for this measure. Upon observation one notices many peaks which are followed by consolidation periods that eventually lead to another peak. Another interesting observation is that overvaluation was not typically a problem until after the 1980's. While there is a smaller peak around the 1929 mark, the P/E valuation measure would have said very little about the market crash that led to the Great Depression. However, major peaks before market downturns in 2000, 2003, and 2009 have proven to be very accurate in describing overvaluation. After P/E ratings reached over 70 in 2009, they settled in the mid- to low-teens. From 2012 to now, S&P 500 growth has lead to a 63 percent increase in the corresponding P/E measure. These levels compare to those seen just before the tech bubble popped in 2000. So bubble territory is not out of the question. The truth is earnings have not grown as robustly as they were supposed to coming out of the recession. A slowdown in European growth and recent stagnation in the Chinese economy has jeopardized the expansion of many multinational firms that aggressively expanded after the financial crash even though the Federal Reserve support them with low-interest rates. In conjunction with encouraging business investment, the Fed also set out to bolster equity investment by dropping bond yields lower forcing money managers to look for alternate forms of high yield.

With a low-interest rate and low bond yields, investors can expect cheaper debt financing and higher earnings for the equities in which they invest. In any investing situation, such conditions allow for larger dividends and stock price appreciation. In the end, stock demand increases and the cycle feeds back into itself. Bubbles form in these conditions when market psychology gets overly positive and the crowd maintains a laser sharp focus on expansion. This kind of over-zealous attitude was (and still is) consistently encouraged by loose monetary policy and their own analysis which replicated the optimism that fueled the rise in stock prices. This mismanagement and dovish approach to recovery have resulted in the current trend of overvaluation, and any attitude or policy change to the contrary could knock down the house of cards that has been built. Central banks and other monetary institutions have a responsibility to summarize the current state of the economy, not push an agenda of stock market expansion. While investors will trade news events positively, they will also correctly price the current economic condition whether it is bad or good. In the end, unhealthy, unstable, or weak fundamental positions will be realized by the general investing public, and when this occurs, traders usually find things worse than what they expected.

Another interesting measure of overvaluation to observe is the growth rate of the S&P 500 index against the growth rate of the U.S. economy. The idea is to look for periods where the quarterly growth in the stock market superseded the economy it is supposed to represent. In the chart above, one can observe similarities in the years preceding major market crashes, Just before the mysterious 1987 crash, stock growth peaked well above GDP growth and fell successively until it reached almost zero at the turn of the decade. The introduction of the internet and the popularization of that mass communications technology caused great speculation to inflate the stocks of companies that listed on the market. Actual economic prosperity failed to reflect investment growth and the bubble popped. Stock market quarterly growth once again peaked just before the 2008 crisis. Notice that economic expansion seemed to match those levels hinting that there might not have been overvaluation. This may be true as the bubble that popped was in the housing market. Nevertheless, it was clear that the stock market had warmed up quickly in the quarters before the financial crisis. Following the crash, S&P 500 and U.S. GDP growth both tanked and soon recovered. The disparity between stock market growth and the growth of the economy soon formed and has remained through 2015. So if a crisis is brewing, when will it occur? The past three markers did not last very long which suggests it could be sooner than you think.

We've reached our final argument, and we must come to a conclusion about whether or not an asset bubble has formed on the stock market. On this article's day of publication, the Dow Jone Industrial Average grew to its highest level over 18,000 on news of an exceptionally strong jobs report. The appreciation appears real, supported by robust job market improvement because of the Federal Reserve's patient hand. All the while. FOMC governors and Chairwoman Janet Yellen are huddled, preparing a strategy for gradual monetary tightening. Knowing this could be the demise of the seven-year bull market, investors should heed the Fed's words and thoroughly investigated every Fed publication in the second half of 2016. The cues of the beginning of the next crisis will come from these prophetic words, and they are not to be underestimated. As long as companies are allowed to grow freely in a low-interest rate environment, speculation will be justified. But, demand for equities and the higher amounts of risk will soon dry up endangering accessibility to corporate finance. When this time comes, a crisis will be upon us, and views in hindsight will be the only perspectives left as stocks sell-off once again.