Banks shedding asset management businesses

Here is a chart showing the number of transactions that involve acquisitions of an asset management business by year. It tells us about a couple of trends developing in recent years.

1. Increasingly asset managers are bought by other asset managers in strategic acquisitions (and to a lesser degree by financial sponsors).

2. Banks have stopped acquiring asset management businesses. In fact what the chart doesn't tell us is that banks have been actively selling their asset management businesses (especially in alternatives such as private equity) mostly to established asset management firms (which is where the trend in item #1 above comes from). Here are some high profile examples:

• Blackstone buys secondary private equity fund called Strategic Partners from Credit Suisse (see press release).
• Grosvenor (fund of hedge funds) buys private equity fund of funds named Customized Fund Investment Group (CFIG) from Credit Suisse (see story).
• Aberdeen Asset Management buys Scottish Widows fund from Lloyds Bank (see story).
• SunTrust sells RidgeWorth asset management business to Federated Investors (see story).
• Credit Suisse blows out its mezzanine fund business called DLJ Investment Partners to Portfolio Advisors (see story).
• Deutsche Bank to sell its asset management business (see story) - likely to Guggenheim Partners.
• JPMorgan is still trying to sell its private equity business (see story), although the price tag has been a bit too rich for potential buyers (see story).

Why are banks selling these businesses? The obvious answer of course is the looming Volcker Rule. But these funds invest clients' money - why would it impact banks' balance sheets? The answer has to do with alternatives investors' requirement that banks that manage money put some serious "skin in the game". A typical general partner (fund manager) may put in say 1-3% into a fund it manages. A bank however is required to coinvest a much larger percentage with its investors. That's because investors worry that banks will stuff deals which are difficult to sell into their funds, focusing on lucrative investment banking deal fee income at the expense of performance. But the Volcker Rule only permits banks to commit up to 3% to their funds, making the business of managing funds untenable. That, combined with banks' relatively high cost structure and in some cases capital constraints (particularly for European banks), is driving them to shed asset management businesses.

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Don't bet on dollar weakness

The US dollar has been surprisingly weak recently. In fact we are at the lows not seen since just after the US government shutdown when treasury default jitters (see post) sent investors fleeing.

Source: barchart

Why is the dollar so weak? Reasons include some economic improvements in the Eurozone and the ECB's persistent hawkish stance. That's been driving up the euro. But the main reason has been the barrage of soft economic data out of the US in the past couple of months.

Source: ISI Group

However, as discussed earlier (see post), the soft economic patch in the US could be transient. We saw a sign of that in the latest US employment report (see story), which is the justification the Fed needs to continue reducing securities purchases. As the weather across the US improves, economic activity should pick up (some leading indicators already support this thesis) and longer term rates are likely to move higher. And with that we should see the dollar strengthen.

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Ruble hits new lows as Bank of Russia focuses on more "pressing" issues

Capital outflows from Russia seem to be picking up steam.

Bloomberg: - The share of foreigners on the 3.75 trillion ruble ($103 billion) government bond market declined to 22.7 percent on Feb. 1 from 23.9 percent at the start of the year. That’s the lowest level in 12 months, data on Bank Rossii’s website showed today.
... 

“February is expected to be no better,” Leonid Ignatyev, head of fixed income research at BCS Financial Group in Moscow, said in e-mailed comments. “And the beginning of March is going to be far worse because of the Ukraine conflict.”

Overseas holdings of so-called OFZs have fallen 80 billion rubles from a peak on May 1 last year. Funds investing in Russian fixed-income securities had outflows of $3.85 billion from the start of May to March 5, or 10 percent of the assets they manage, Alexey Todorov, an analyst at OAO Gazprombank, said in e-mailed comments today, citing EPFR Global data.

These outflows - combined with the central bank's "weaker ruble" policies and the Ukrainian tensions - are all fueling the ruble sell-off. The ruble resumed its slide this week, hitting another post-devaluation low against the euro.

Source: Investing.com

The prospect of steady taper from the Fed - especially given today's strong employment number - isn't helping either. Higher dollar interest rates have sent other vulnerable emerging market currencies lower as well (South Africa, Brazil, and Turkey are all lower by over 1% today).

Whether the Bank of Russia will move in aggressively to defend the currency remains unclear. It has been busy with other matters recently. Putin is using the central bank as a political and financial tool to push his agenda, including pressuring the Ukrainians. Taking over a major Ukrainian bank in Moscow is an example.

Reuters: - Russia's central bank is taking steps to prevent the bankruptcy of the Moscow subsidiary of Ukraine's Privatbank, the Bank of Russia said on Friday, after Privatbank accused it of putting Moskomprivatbank under administration for political reasons.

The central bank said it was taking the measures under a law on banking system stability which enables the state-run Deposit Insurance Agency to provide financial assistance to banks, acquire their property and liabilities, acquire shares, and sell collateral.

The Deposit Insurance Agency has been appointed as the bank's temporary administrator, the central bank said.

See press release here

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China's credit markets under pressure

China's corporate sector has been hit with escalating credit problems. Here is the latest:

1. Shanghai Chaori Energy Science and Technology is about to miss a coupon payment on its bond (see story).

2. As a result, Suining Chuanzhong Economic Technology Development and 2 other companies scrapped their bond offerings - demand for new issue corporate bonds has dried up.

3. Secondary corporate bond trading has also slowed materially. This is fairly new for China since it has never really experienced large scale credit problems in its nascent bond markets.

4. There are indications that banks are cutting back lending as a result. In particular lines have been cut to natural resource wholesalers, traders, and importers (iron ore, steel, cement, etc.). These borrowers in turn are forced to sell inventory that is ofren used as collateral for these loans. Inventory sales depress prices of some of the raw materials, generating further losses for these businesses. This is compounded by the nation's slack industrial demand, with steel mills now running at 50-70% of capacity.

Iron ore April futures contract (source: barchart).

5. With banks cutting back on lending, demand for interbank funding fell materially, sharply lowering China's money market rates. Both 7-day repo and the 1-week SHIBOR are at lows not seen in quite some time. While lower money market rates are good for banks, at this point there is ample liquidity in the system with far less demand.

7-day repo rate (source: chinamoney)

1 week SHIBOR

These developments are quite negative for China's economy. Confidence in the nation's credit markets - both bank lending and corporate bonds - has taken a hit. It remains unclear however just how pervasive these problems could become - some think this is just the tip of the iceberg (see story).

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Will the slowdown in US services sector reverse with warmer weather?

In trying to assess the trajectory of the US economy, one is struck by the recent divergence between the manufacturing and the services sectors. Manufacturing in the United States has picked up steam recently in spite of some weather-related headwinds (see chart). The service sector on the other hand took a turn for the worse, which is negatively impacting the labor markets in this service-oriented economy (see story). A couple of key indicators point to slower non-manufacturing activity:

1. The ISM non-manufacturing PMI came in at the lowest level in years.

Source: Investing.com

The detail behind the decline shows the big hit to employment in the service sector, which is what we see in the ADP private payrolls today.

Source: ISM

2. The Markit PMI measure paints a similar picture.

Markit: - Adjusted for seasonal influences, the final Markit U.S. Services PMI™ Business Activity Index dipped sharply to 53.3 in February, from 56.7 in the previous month. Although the index was above the 50.0 no-change mark and signalled a solid pace of expansion, the latest reading was the lowest since October 2013 [US government shutdown]

Most analysts blame this weakness in the service sector and the resulting softness in the labor markets on the weather.

ISI: - There’s hardly a lamer excuse than weather, but that’s probably the case for ADP’s +139k for Feb. It presents downside risk to our best guess for payroll employment of +185k. 

Markit: - With the exception of last October, when the government shutdown hit the economy, the service sector grew at its slowest rate since March of last year. This time, the extreme weather was to blame for the slowdown.

If that is indeed the case, as temperatures cimb, we should see a material rebound in service oriented businesses and therefore some big improvements in the jobs picture later this spring. That would mean more Fed taper and higher yields. 

For those who subscribe to the weakness in the services sector being mostly weather related and therefore transient, now may be a good time to get back into that treasury short trade. 

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Can the rally in global commodities be sustained?

We are seeing broad improvements across global commodity markets. To be sure, commodity valuations are still at depressed levels relative to the past decade, but after a prolonged decline, broad indices seem to have stabilized.

CRB BLS broad commodity index (source: barchart)

The rally across a number of commodity sectors however resulted from a variety of factors, most of which are believed to be transient. For example the cold winter pushed up US natural gas prices (though exports could provide a floor - see post) and hot/dry conditions in Brazil sent coffee prices flying (see chart). Some argue that the two unusual weather patterns are related - a scary thought.

The Ukrainian crisis on the other hand pushed up wheat and corn prices.

WSJ: - Wheat prices rose as much as 6.8% before easing in midday trading. Wheat for March delivery at the Chicago Board of Trade settled at $6.26 a bushel, up 27 cents, the highest closing price in nearly three months.

May US corn futures (source: barchart)

Corn futures also gained from the Ukraine unrest, finishing at their highest price in more than five months. Corn for March delivery rose 6 cents, or 1.4%, to $4.64 a bushel in Chicago.

Ukraine grain exports continued Monday despite the unrest. However, looking ahead, grain buyers that would normally consider the country for grain shipments are largely turning elsewhere, three Europe-based traders who deal in physical grain supplies said Monday. The traders said difficulty obtaining financing due to the country's turmoil is slowing business for Ukraine-based grain companies.

Gold has also been recovering recently - up 12% for the year on slow Fed taper and better demand.

It's not clear if these higher prices across a number of commodities can be sustained. Slower growth in China (combined with weaker yuan) is not helping base metals such as copper for example. Many analysts are also quite bearish on crude oil. Should the geopolitical risks subside, we may get a correction there. Nevertheless we haven't had a commodities rally like this in quite some time.

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Russia's central bank hikes overnight rate, ruble continues to weaken

Russia's central bank finally raised its overnight rate to 7% (from 5.5%) to stabilize the ruble. Apparently there is only so much currency depreciation the central bank is willing to allow.

Longer term rates response to the central bank action was muted, with the 10y yield rising just over 50bp for the day. With Brent crude jumping 2% this morning, more hard currency will be flowing to Russia. The fiscal situation therefore is expected to be stable, reducing the risk on longer-term paper.

The currency depreciation continues in spite of the rate hike. The ruble fell below 50 rubles per euro for the first time.

Chart shows EUR appreciating against RUB (source: Investing.com)

With the ruble weakening (which should reduce imports) and oil prices higher (which will increase the value of exports), the nation's current account will improve. Putin's economic advisers will not be losing any sleep over the current geopolitical tensions.

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Residential construction weakness - looking beyond the cold weather

Recently we've had a visible slowdown in housing starts in the US, which has largely been attributed to the weather (see chart).

USA Today: - Housing starts fell sharply in January for the second straight month as cold and stormy weather continued to batter the recovering housing market.

Starts of single-family houses and apartments fell 16% to a seasonally adjusted annual rate of 880,000 last month after declining dramatically in December, the Commerce Department said Wednesday. Extreme winter weather is largely blamed for both poor showings after starts jumped to their highest level in a year in November.

But is there more to the sluggish construction data than freezing temperatures? If weather was the only factor, markets would be expecting a strong recovery in construction later in the year.  But as this chart shows, weakness in July lumber futures points to rather subdued expectations for home construction this summer.

Some point to higher mortgage rates generating a drag on the overall housing market. The "taper-driven" spike in rates has definitely been unusually sharp, but mortgage rates have now stabilized below 4.5% - still quite low by historical standards.

To understand the non-weather factors of the sudden slump in private construction, we want to go back to one of the key sources of improvements in housing back in 2012. It was the boost in household formation (see post) that kick-started the housing market. Now, to many economists' surprise, the number of households has stopped growing in recent months - detracting materially from housing demand.

Source: US Census Bureau

To be sure, home construction should improve in the coming years simply because of demographics. Home building in the US simply hasn't kept up with population growth in recent years. But the big improvements will only take place once we see substantial gains in household formation.

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