This April, the 2016 Middle East Investment Conference, Beyond Borders: MENA’s Role in the Global Economy, will convene amid a market maelstrom of volatile oil prices, negative interest rates, geopolitical drama, and national budget revisions. Ahead of the event, we are delighted to share some thoughts published in CFA Institute’s Conference Proceedings Quarterly by speakers at some of our recent events.
At last year’s conference, economist Nouriel Roubini discussed the opportunities and challenges for MENA investors. “Even the decline in oil prices is a net positive for the global economy,” said Roubini, “as well as an economic pain and difficulty for economies like those in the Persian Gulf region that are oil and energy exporters.” For Roubini, one positive result of lower oil prices is that, “high oil prices were inducing countries that had very high marginal costs of production to increase production and increase capacity.” Another unintended consequence could be that lower oil prices ultimately wipe out the competitors to lower-cost MENA producers by bankrupting those in high-cost countries, such as the United States.
It’s harder to find a silver lining in the world of central banks and monetary policy, where market expectations of Fed policy have swung as violently as Chinese stock markets. Anne Pettifor, speaking on Central Banking, State Capitalism, and the Future of the Monetary System at a previous event, argued that the economics profession has at its core a flawed theory of money creation. This theory is wrongly based on the supply and demand for savings. For Pettifor, most people also have a flawed understanding of interest rates and how they are managed. “Flawed economic theories can severely distort investment priorities and fail in the analysis and prediction of crises,” said Pettifor. “The people and organizations the world depends on for sound economic advice do not seem to be providing that advice.” Too much accumulated debt, especially in the United States, and persistent global imbalances, doom the world to an endless cycle of destabilizing crises.
It seems to be a face-off between central bankers and the markets, or at least footloose hedge funds. But how representative are short-term traders of modern markets? Speaking at last year’s Financial Analysts Seminar in Chicago, James Bianco said, “The financial markets have seen some significant historical changes in recent years, some of which have been driven by the Fed’s accommodative monetary policies. The correlation between stock returns and bond returns has gone from positive to negative, and correlations between stocks have surged to more than 50%.” This has driven the trend for active managers to underperform. In the final analysis, “The markets have a completely different opinion than the Fed does,” says Bianco. Stay tuned for a happy ending.
Another recent, and pertinent, development in capital markets is the growth of large sovereign wealth funds (SWFs) with a super-long time horizon, according to Scott Kalb. Originally, SWFs were almost all commodity-based, but that number has fallen to about 60%. The top 75 SWFs have nearly doubled since 2010, increasing from $4.4 trillion in 2010 to $7.7 trillion in 2014. “One of the most important ways sovereign funds are moving forward is by aggressively diversifying their portfolios,” said Kalb. They are moving aggressively into alternatives (perhaps even the hedge funds taking on the central banks) and developing a collaborative model, teaming up with other sovereign wealth funds and external parties to reduce fees and costs.
A final worry for investors is the development of shadow banking, which now represents about 125% of banking assets in the United States and 60% of banking assets in the UK and the eurozone. According to IMF economist Nico Valckx, this can be a good thing, facilitating risk sharing, but it can also promote risks, such as bank runs, leverage, and cyclicality, which are larger for shadow banks than for traditional banks, not least because of the lack of a backstop. All of this is an argument for tighter regulation, so it seems that regulation is having a tough time keeping up with market maelstrom, too.
Global Economic Outlook: Opportunities and Challenges for MENA Investors by Nouriel Roubini. The global economy today abounds with uncertainties and advantages, with challenges and opportunities. The energy and oil sector, quantitative easing, and renewed growth in some countries are especially important as the world continues to move past the global financial crisis.
Central Banking, State Capitalism, and the Future of the Monetary System by Anne Pettifor. The role of commercial and central banks in the process of providing credit may seem to be clearly understood by economists, bankers, and policymakers. But there are common misunderstandings about money creation, equilibrium, public money, central banks, and interest rates. The outlook for the global monetary system is not overly optimistic in the absence of overcoming these misunderstandings and altering the philosophies of bankers.
Diverging Markets and Shades of 2007 by James A. Bianco. The financial markets have seen some significant historical changes in recent years, some of which have been driven by the Fed’s accommodative monetary policies. The correlation between stock returns and bond returns has gone from positive to negative, and correlations between stocks have surged to more than 50%.
Sovereign Wealth Funds in the Global Capital Markets: Reintermediation and New Collaborative Models by Scott E. Kalb. Sovereign wealth funds (SWFs) have grown significantly over the past two decades, and they have become a powerful force in capital markets. SWFs have been moving away from traditional investment models in favor of new collaborative models that include partnerships and joint ventures with companies, financial intermediaries, institutions, and other SWFs. SWFs are increasing their exposures to alternative assets; most are built perfectly to invest in these illiquid assets and hold them over the long term.
Shadow Banking: Global Trends and Policy Developments by Nico Valckx. Shadow banking is a form of credit intermediation with a growing presence worldwide. Despite possessing a certain notoriety, shadow banking provides a beneficial service. But its structure and activities lack transparency, and it is prone to a variety of risks. Regulators are thus establishing international standards to mitigate those risks while preserving its benefits.
Co-hosted by CFA Society Bahrain and CFA Institute, the 2016 CFA Institute Middle East Investment Conference offers a unique opportunity for delegates to gain firsthand insights from leading experts and network with like-minded peers. Register now to attend the event and join us in Bahrain this April.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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