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Low Yields and High Equities Cannot Last Forever

The S&P 500 Index clambers to ever new highs. Over the past couple of weeks, this has even been accompanied by rising bond yields. But we remain far from normality: 10-year U.S. Treasury yields have climbed by almost 25 basis points from their trough of two weeks ago, and the German 10-year Bund yield is up by a similar amount, and yet that “jump” still only took the yield in Germany a shade over zero.

Rock-bottom bond yields are consistent with the new global growth outlook published by the International Monetary Fund last Tuesday. It cut its 2016 forecast from 3.2% to 3.1%, and its 2017 forecast from 3.5% to 3.4%. These numbers assume benign Brexit negotiations. Without that, the IMF reckons global growth could tumble to a mere 2.8% for the next two years. Meanwhile, there’s an attempted coup in Turkey, seemingly non-stop terrorist attacks in Europe, and some kind of experiment with reality-TV politics going on in the most important economy in the world.

What are we to make of this conundrum of record low bond yields and record high prices for equities?

No Flight from Risk, But No Embrace of Risk, Either
Investors still appear willing to take risk, but this remains a very unloved equity-market rally, led by defensive sectors such as consumer staples and utilities, or by income generators such as REITs and MLPs. High-yield bonds and emerging market debt have also fared extremely well this year. When government bond yields and growth expectations are so low, and there is fear about market volatility, investors willing to take on risk in search of return may have a bias to income rather than solely capital appreciation.

Investing this way is understandable. For investors willing to move further out on the risk-return spectrum, there are some attractive alternative sources of yield outside of lower-risk traditional fixed income. Around two-thirds of S&P 500 Index stocks offer a higher yield than that of the 10-year U.S. Treasury. Every stock in the world out-yields the German Bund. My colleagues in fixed income tell me that if you calculate the price-to-earnings ratio for the 30-year U.S. Treasury it comes out at 50 times. That shines a flattering light on U.S. utilities yielding 3.5% with a trailing P/E ratio of 20 times. One could easily imagine that reaching 25 times or more with bond yields at current levels.

‘Bond Proxies’ That Are Not Bonds
But there is an obvious danger in thinking about equity income as a “bond proxy.” Having an income component does not mean investments, such as dividend yielding equities, are “bond proxies.” Equities have an altogether different risk-return profile than fixed income and are much further out on the risk-return spectrum. We know all too well that the value of equities can decline much more significantly than the price of most bonds. A big sell-off could wipe out almost a decade of income from a 4%-yielding stock—in fact, it may imply that this income isn’t going to be paid at all.

What could trigger such a change in market sentiment? Joe Amato has discussed the way low bond yields push up equity P/E ratios, arguably making them look more expensive than they really are. Another way to think of this is that lower yields, and therefore lower discount rates, bring the value of future earnings forward in time. If we don’t believe that earnings will grow, there is less incentive to wait patiently to receive earnings years into the future, because much of their value is already priced into the present value of the asset.

This should heighten an investor’s sense of caution, especially if one thinks interest rates are going up again. But equally, if one anticipates significant deflation and rates falling much further, earnings priced in today may not be realized in the future. At some point, holding onto these assets requires investors to believe in some kind of benign environment—not severe enough to threaten your earnings, or so severe that the authorities will intervene on an unprecedented scale to protect them.

End-of-Cycle Excesses Cannot Last Forever
That is not fundamentals-based investing, but this environment makes fundamentals-based investing a challenge. The market is sending contradictory signals and at some point those signals are going to come back in line, one way or the other. If we see evidence of real, sustainable growth, we may begin to be more constructive on equity risk. Until then, from a fundamental multi-asset standpoint, we favor remaining neutrally positioned, prepared for a downturn in sentiment without giving up too much of the upside.

“Barbelling” a portfolio can help, perhaps by pairing some higher-yielding bonds, higher dividend-paying equities, and, for those able to lock up capital for some time, some private market investment, with very liquid high quality assets that can be monetized and redeployed when volatility creates opportunities.

But banking on ever more aggressive central bank interventions such as “helicopter money,” or some kind of magical perpetual multiple expansion, could be a mistake. End-of-cycle excesses can last longer than anyone anticipates, but they cannot last forever.

Neuberger Berman’s CIO insight by Erik L. Knutzen

Anything But “Me-Too” Management

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¿Han dejado de creer los inversores en la generación de alpha? — CC-BY-SA-2.0, FlickrPhoto: Cheryl Marble. Anything But "Me-Too" Management

The decision to hire an active manager requires a belief that markets are inefficient. But in the last five years, active managers have been losing significant market share to passive vehicles, which suggests investors no longer believe markets are inefficient and instead have adopted the “efficient market hypothesis” theory.

On the surface, I can understand why. Alpha has been elusive in this market recovery. Consequently, many active managers have responded by documenting the reasons why and when alpha may become abundant. I believe, however, it’s our job as active managers to showcase the inefficiency of markets and distinguish between what is coincidental and causal when it comes to understanding what truly drives stock prices. We also need to build confidence that over a full market cycle investors in active portfolios won’t be overpaying for market beta.

Investors throughout time have anchored to the wrong things. Consider how often investors source their market view to the economic backdrop. A statistical regression of GDP growth between countries from multiple regions and their respective equity markets showed no relationship between the two. And yet, investors get caught up in determining when the Fed is going to raise rates or the results of the upcoming U.S. Presidential election and how it may impact stock prices. This is a “me too” investment thesis with binary outcomes. That isn’t what stock pickers focus on, because it isn’t important to alpha generation.

What drives stock prices long term – and what we want to understand as active managers – is a company’s steady state value plus future cash flows. While many of us learned this in school or early in our careers, it has gotten lost in today’s investment climate.

Another way to think about it, is where a company’s product or service fall on its industry’s “S curve.” Is the product in early awareness phase? Or has it reached escape velocity and at the point of commoditization where it’s under threat from “me too” copy cats? Determining where a company’s products exit in its maturation cycle is critical to understanding what has driven a company’s stock price versus what may drive its stock price in the future.

If we look back over the last 150 years, we can think of multiple products that have scaled up through the S curve: railroad, telephone, radio, automobiles, refrigerators, dishwashers, to name just a few, and most recently the internet and smartphones. The stocks of the original equipment manufacturers (OEMs) in all of these areas were massive outperformers as adoption cycles were escalating. Most often there were one, maybe two, horses in each race that enjoyed the lion’s share of unit growth and explosion of profits. However as the products reached escape velocity, investors behaved like they always behave, and continued to have linear expectations that what has happened would continue. Often they were unaware that margins were poised to decelerate and the stock’s outyear valuation was unrealistic.

With smartphone penetration rates in the developed world nearing potential peak levels, will these massive OEMs that are also enormous benchmark constituents because of past performance, continue to be strong outperformers? History suggests otherwise. ETFs and passive vehicles are constructed linearly based on what has already happened. Ultimately those icebergs become melting ice cubes and long-term underperformers.

Instead, let’s look at the impact of smartphone penetration on other profit pools and ask the question – are there alpha opportunities as a result? Advertising is an industry that will be significantly impacted, for example, as people spend more time watching programming on their hand held devices than sitting in front of a TV, reading magazines or going to the movies. Though only a small percentage of advertising is currently done through online platforms, this channel affords higher efficacy because it’s more targeted, measurable and cost effective.

As an active manager, we have to recognize disruptors and work to understand their impact on profit pools. That intelligence is critical to our ability to generate alpha – whether we’re trying to own the winners or trying to win by avoiding the secular losers.

Robert M. Almeida, Jr. is MFS Institutional Portfolio Manager.

Four Messages From Draghi’s Meeting

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Los cuatro mensajes del BCE que el jueves dejaron frío al mercado — CC-BY-SA-2.0, Flickr. Four Messages From Draghi's Meeting

The European Central Bank’s (ECB) Governing Council met on Thursday, marking the first of a series of high profile meetings scheduled over the next few days (the Federal Open Market Committee (FOMC) meeting on July 27th, the Bank of Japan (BoJ) meeting on July 29th, Bank of England (BoE) on August 4th), which have become a strong focus for investors globally.

Past experience taught us never to take Mr Draghi and the Council for granted: whenever they needed to, they managed to surprise the market and that’s why this meeting was one to watch. The monetary stimulus is meeting its objectives of reducing credit fragmentation, and spreads between core and peripheral European government bonds. The programme has still quite a few months to go before its initial “end-date”, and more importantly the ECB has managed to provide stability to both Government and Corporate bonds during the past few volatile weeks.

Mr Draghi announced the following:

No news is good news: the Governing Council kept all key policy rates and asset purchases unchanged. Monthly purchases in particular have exceeded, so far, the ‘target’ of €80bn per month. He said that at the moment the stimulus package in place is sufficient – but that the ECB won’t hesitate to add fresh measures if needed.
It ain’t over till it’s over: the current Quantitative Easing programme was initially scheduled to go on until March 2017, but Mr Draghi stated that (i) the programme will run until a “sustained inflation adjustment” is seen and (ii) should the economic scenario deteriorate significantly, the Governing Council would act by using all instruments available within its mandate.
“Believe me, it will be enough”: Mr Draghi famously spoke these words in 2012, and they echoed in our mind when he said he would “stress readiness, willingness and ability to do so” regarding the ECB’s attitude to tackle any negative impact of Brexit on the broader European economy.
Non-Performing Loans (NPL’s) and Banks: When asked about initiatives to address the current NPL problems that the European banks (and Italian banks in particular) are facing, Mr Draghi said that addressing legacy NPL issues “will take some time” and, more importantly that any public backstop would be a useful measure but that it will need to be “agreed with the European Commission according to existing rules.”

Lastly, Mr Draghi reiterated that actions beyond monetary policy are the job of politically elected representatives – and that governments should support monetary stimulus with reforms aimed at raising productivity and improving the business environment.

The market reaction to Thursday’s meeting was relatively contained: we saw core rates correcting on the back of the lack of “new” news, and we share this view. We think this was a reassuring performance on behalf of the ECB, but a non-event from a market perspective.

We think investors are now in a “one down, four to go” mode and are awaiting for actionable catalysts from the meetings of FOMC, BOJ and BOE, as well as the results of European Banking Authority (EBA) Stress tests expected over the coming ten days.

Column by Pioneer’s Tanguy Le Saout

Chinese Nominal GDP Rebounds, Money Signal Still Positive

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Stronger Chinese monetary trends late last year suggested that economic growth would recover during the first half of 2016, contrary to consensus expectations of a further slowdown. Key indicators firmed through the spring but by less than had been expected here. Second-quarter GDP and June activity numbers released today were, on balance, more encouraging, while the monetary signal remains positive.

Annual growth of GDP in volume terms was unchanged at 6.7% last quarter but the more significant news was that nominal GDP expansion rose for a second successive quarter to 8.2%, the strongest since the third quarter of 2014. A rebound had been signalled by a pick-up in money growth from mid-2015. Annual increases in narrow and broad money (as measured by “true” M1 and M2 excluding financial sector deposits) were little changed in June, with recent growth the fastest since 2010 and 2013 respectively.

June activity numbers were mixed. Annual growth of industrial output and retail sales value rose to 6.2% and 10.6% respectively in June, beating consensus expectations. Fixed asset investment, however, slowed further, with an annual value rise of 7.3%, close to a September 2015 low of 6.8%.

Capex weakness reflects the private sector component, which stagnated in the year to June.

Prospects for private investment, however, are judged here to have improved. Industrial profits lead private capex and are rebounding on the back of stronger nominal GDP growth. A pick-up in growth of deposits of non-financial enterprises over the past year is a further positive signal.

An investment revival coupled with continued solid consumer spending expansion and an export pick-up driven partly by recent exchange rate depreciation may result in stronger volume as well as value growth of GDP during the second half, despite some reduction in fiscal stimulus.

*”True” M1 includes household demand deposits, which are excluded from the official M1 measure. Financial sector deposits are excluded from M2 because they are volatile and less relevant for assessing spending prospects.

Column by Henderson’s Simon Ward. Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

The World Turned Upside Down

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Four days before the Brexit vote, I wrote about how strange it was to see Germany’s 10-year bond yield go negative at the same time as U.S. equities were just 2.5% off their all-time highs.

Well, last week U.S. equity indices broke through those highs, and interest rates have gone even lower. Germany actually issued a Bund at a negative yield. On July 8, as the U.S. reported the creation of almost 300,000 jobs in June, the 10-year U.S. Treasury yield, paradoxically, fell to an all-time low of just under 1.36% and in the Netherlands the 10-year yield slipped below zero for the first time in 500 years.

We’ve all become somewhat used to bad news in the economy translating into good news for equities, as investors anticipate that rates will be kept low and unconventional monetary stimulus will be maintained. This seems to have reached a new pitch of intensity following Brexit, however. It truly feels as though the world has been turned upside down—politically as well as economically.

Politicians Have a Pro-Growth Role to Play
Indeed, should the U.K.’s referendum prove a lastingly important moment for the global economy, it may be because it marked the point at which the political overtook the fundamental as the primary driver of economic and monetary policy. Central banks seem to be running out of ammunition, but politicians haven’t appeared to care until now. When voters start delivering painful election results, however, it becomes much more difficult for them to ignore the role they have to play in growth and job creation.

Much attention has been directed at the dangers of populism, particularly of the anti-trade and anti-immigrant kinds. But there is also the potential for today’s political energies to be translated into pro-growth policies.

Brad Tank floated a similar suggestion last week. Riskier assets recovered from Brexit thanks to reassuring words from central banks, he observed. But one of the few tools they have left is “helicopter money”—putting new money directly into the hands of consumers, or using new money to finance fiscal spending. Implementing that requires government cooperation, Brad noted, which might in turn move governments toward structural reform of things like tax codes and regulation, possibly starting in Japan.

Infrastructure Spending Could Be on the Agenda
Politics may simply be too polarized for that. What we might see, however, is some momentum behind the idea that central bank stimulus should be augmented with fiscal stimulus, particularly infrastructure spending. Both left and right can get behind that because it’s good for jobs and business.

We have now seen Japanese Prime Minister Shinzo Abe’s ruling coalition consolidate its position after last weekend’s elections. Abe took this as a mandate to “accelerate Abenomics,” and there has been widespread speculation about a stimulus package worth perhaps 2%-4% of GDP. Japanese equities rallied in response.

Similarly, in the U.K. Brexit has been followed by the surprisingly quick succession of Prime Minister Theresa May and her new cabinet, also eager to test its mandate. While May has appointed a somewhat hawkish chancellor, her own rhetoric marks a significant shift away from the austerity associated with the Cameron-Osborne administration.

Obstacles Remain but Momentum Is Building
There is a long way to go before we see realization of fiscal stimulus—and even longer before we can speak of a globally coordinated infrastructure spending program. Could we see such a thing in the U.S., for example? The need is clear enough. But to my mind, this initiative would be in danger of getting caught up with other political footballs, such as corporate tax reform. The likelihood of an infrastructure deal being done will depend on a number of factors, such as control of Congress and the White House, and the state of the economy: The more unified the political control and the worse the economy is doing, the more likely we are to see a deal.

What might this mean for corporate earnings? We’ve been concerned about this through a number of our CIO Perspectives, thinking about the catalysts that might end the current earnings recession. Firmer oil prices, a weaker dollar and some stability out of China helped set the foundations. Concerted action on infrastructure spending would certainly build upon them. And while these are early days and big obstacles remain, voters may be reminding governments that they cannot leave the business of growth and job creation to central banks alone.

Neuberger Berman’s CIO insight by Joe Amato

What Effect Might ‘Helicopter Money’ Have On Markets?

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¿Qué efecto puede tener el helicóptero monetario en los mercados? — CC-BY-SA-2.0, FlickrPhoto: Vadim Timoshkin. What Effect Might ‘Helicopter Money’ Have On Markets?

Helicopter money refers to the situation where a central bank finances the fiscal expenditure of a government. The government prints money instead of raising taxes or debt to fund spending.

The economic effects of QE are still being debated, but they are presumed to be positive to date. With helicopter money, there would be a direct fiscal expansion financed by central bank purchase of (and cancellation of) government bonds. This direct fiscal spend would be economically expansionary, unless the announcement of helicopter money represented a shock to households and firms that was suficiently significant to offset the fiscal stimulus. The economic effects of fiscal expansion combined with new QE appear identical to those of helicopter money.

The market effect of the recent experience of QE has been lower discount rates, a weaker currency, and a strong environment for risk assets. We might guess that the market’s reaction to helicopter money would be similar, but given that past episodes of dominance by the fiscal authority over the central bank have been associated with fiscal indiscipline and high inflation, there is a reasonable chance that markets could react in a meaningfully different and negative way. The truth is that we just don’t know.

Ampliar

Figure 1 outlines the impacts of QE, of helicopter money (where debt is purchased by the central bank and written-off), and a combination of QE and fiscal expansion. With the unknown market impact of helicopter money, with prospective policy tools in the hands of central banks narrowed through debt cancellation, and with the economic benefits associated with helicopter money rather than straight fiscal expansion de minimis, it is not clear why policymakers will choose the path of helicopter money. Perhaps the real lesson is that monetary policy has its limits and that in the event of an economic slowdown, aggregate demand is best supported by fiscal rather than monetary policy. In the event that new fiscal expansion requires supplemental monetary support in the form of additional QE, this is a decision that could be made at some point in the future.

Helicopter money is often associated with incidence of hyperinflation. In their study of the 56 incidents of world hyperinflation during the last 300 years, Hanke and Krus found hyperinflation to be ‘an economic malady that arises under extreme conditions: war, political mismanagement, and the transition from a command to market-based economy to name a few’. By contrast, monetary financing has been used widely in the developed and developing world over time without ending in hyperinflation.

Until the US Fed Accord in 1951 the US operated a policy of fixing long-term bond yields, and as such increasing or decreasing the amount of reserves in the banking system, depending on private sector demand for these instruments. Canada used monetary financing for 40 years until 1975 under a free-floating exchange rate regime without calamitous macroeconomic effects, and India operated a policy of debt monetisation until 2006. Further examples abound. Indeed, of the 152 central bank legal frameworks analysed by the IMF, 101 permitted monetary financing in 2012. This is not to say that helicopter money is a desirable policy. It would be, in my opinion, a backwards step. But neither is it to be necessarily associated with hyperinflation.

So, in conclusion, helicopter money is not a weird and wacky new form of money. Indeed, once we understand how money works helicopter money looks pretty straightforward. The prospective economic, monetary and fiscal effects of helicopter money (absent the sticker-shock of a new unfamiliar policy being implemented) look identical to a normal fiscal expansion supplemented with additional QE. As such, it could be argued that the UK, US, and Japan have all already effectively experienced helicopter money. It is harder to say the same about the Eurozone, consisting as it does of government entities that are not monetary sovereigns. Indeed, the Eurozone is much more complicated.

Toby Nangle has been the Head of Multi-Asset and Portfolio Manager at Threadneedle Asset Management Limited since January 1, 2012.

It’s Getting Late In The Business Cycle

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Atención a las señales de fin de ciclo — CC-BY-SA-2.0, FlickrPhoto: Paramita. It's Getting Late In The Business Cycle

While the United Kingdom’s decision to leave the European Union (Brexit) has temporarily undermined market confidence, my confidence in equities was on the decline in advance of the vote. So let’s take a break from Brexit for a few minutes and look at some longer-term fundamentals.

I remain disenchanted with stocks and I need to see improvement in five key metrics before changing my view:

Improved pricing power for US based multi-national companies
Better consumer spend on goods and services
A weaker dollar relative to other currencies
Rising capital expenditures, especially in information technology
Moderating labor and health care costs

I’m focused on the behaviour of the private sector and its ability to generate free cash flows. During this business cycle, which began in July 2009, the US and many developed markets experienced record high profit margins, best-ever free cash flows relative to the size of the overall economy and high returns on equity. This surprised many cautious investors given that both the global and US growth rates had fallen below trend. The reasons for the high profit generation, which were complex, included gains in manufacturing sector efficiency, productive use of technology, rapid asset turnover, capital-light strategies, employment of global labor, use of operating leverage instead of financial leverage and low energy costs.

During the last three quarters most of these tailwinds for risk markets began to falter. Margins narrowed not just in the materials and mining sectors, but throughout much of the S & P 500, countering well-established trends that dated back to 2009. Now, selling, general and administrative (SG&A) expenses have been rising as a percentage of revenues. Financial leverage is replacing operating leverage, and both return on equity and margins continue to weaken into midyear.

All of these measures feed into a very important metric for me—the share of US gross domestic product going to the owners of capital. When the share of the economy going to the owners as profits begins to subside, a direct casualty is capital expenditure and durable goods spending.

Ampliar

Both are now weakening. Big ticket expenditures like purchases of machine tools by manufacturing firms and information technology spending by most firms, are a key to future growth of both jobs and profits and tend to perpetuate the cycle. These large expenditures by businesses have been weakening and the trend is downward.

The US consumer is doing better. Spending is increasing, but consumers have not spent the extra income afforded by the earlier oil price decline. And now, worryingly, energy prices are rebounding. The US dollar had been weak during much of this cycle, but now because of interest rate differentials and a flight to safety, the dollar has been heading back up. The strong company fundamentals that were the signature of this longer-than-usual cycle, have weakened in almost all categories.

Overall I am biased toward being underweight equities. Within equities I would favor US shares relative those of the UK, Eurozone and Japan. Some emerging markets look attractive, particularly Latin America and Eastern Europe, but selectivity is very important, as always. In fixed income I prefer high yield because fundamentals in the US remain solid with odds favoring the US avoiding recession near-term, in my view.

History tells us a weakening of the profit cycle can herald recession. Usually a profits recession comes as rising interest rates hijack consumer and business spending. US recession risks are rising, but the risk of rates rising seems remote now. Rather than a recession unfolding soon, I see a continuing plague of profit disappointments but no economic collapse. A kind of investor’s limbo, if you will. I hope the five points above reverse, but unless they do, late cycle flags should be a caution to investors.

James Swanson, CFA, MFS Chief Investment Strategist.

The Implications Of Brexit For The Emerging World

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Cuatro implicaciones del Brexit para los mercados emergentes — CC-BY-SA-2.0, FlickrPhoto: Moyan Brenn. The Implications Of Brexit For The Emerging World

In the end, the implications of Brexit are larger for the UK and Europe than for the emerging world. But this does not mean that Brexit does not impact EM.

Firstly, if there is a prolonged risk aversion in global markets, eventually it should affect the weakest links most. Large parts of the emerging world are still suffering from weak growth, the excessive leverage built up in the past years that limits the room for a domestic demand recovery, a high reliance on foreign capital and increased political risk.

Secondly, Brexit has increased the likelihood of an extended period of US dollar strength. This is never good for emerging markets: EM currencies are likely to depreciate and capital outflows should increase. Also, a stronger USD index normally means that the price of oil and other commodities declines. This affects the commodity‐ exporting countries, which in general are the fundamentally weaker economies.

Thirdly, the uncertainty caused by Brexit should lead to an adjustment in growth expectations for the UK and Europe. This hurts central Europe and Asia, for which Europe is the main trading partner. And global trade was already weak. It has recovered a bit in recent months, from ‐3% in January to +2% in April, but we should question the sustainability of this pick‐up now. Also relevant in this context is the weakening of the euro. This does certainly not help the Asian exporters.

And fourthly, with the globalisation trend already struggling in the past few years, Brexit could turn out to be a new negative factor. Trade between the UK and Europe is likely to be affected in the first years after Brexit and more headwinds for global trade could emerge after the US elections. The emerging economies have poor domestic demand growth prospects mainly due to the large debt overhang after many years of excessive credit growth. As a consequence, global trade has become even more important for a possible recovery. Globalisation in reverse would justify an adjustment in longer‐term growth expectations for the emerging world as a whole.

Willem Verhagen is Senior Economist and Maarten-Jan Bakkum is Strategist, Emerging Markets Equity at NN Investment Partners.

Will Central Banks Look to New Tools?

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Starting in Japan, monetary policy may need to go to the next level.

With a couple weeks to digest the Brexit vote, I see some key takeaways tied to the market rebound.

There was a substantial selloff for the three days after the vote, and then (leaving aside more durable currency effects) a meaningful, if uneven, resurgence for many risk assets. But headlines regarding the bounce have been, I think, a bit misleading.

One notion is that the gains were driven by the fact that separation will take considerable time to implement—but this was known the day of the Brexit vote and seems to me of limited importance to the bounce-back. Another is that the parliament and prime minister may not have to follow through on Brexit at all, that voters “may not have known” what was at stake. Given the sizable turnout and wide margin of victory, I believe the idea of such a turnabout has been debunked. Brexit is real, for better or worse.

More significant for the rebound, in my view, was the response by central banks: The Bank of England announced that it would encourage bank lending through lower reserve requirements; ECB Chair Mario Draghi made reassuring comments about supportive policy; and Federal Reserve minutes reinforced the importance of non-U.S. conditions to its policies.

So investors felt better, which is great.

But I think it’s crucial to understand some key drivers of the vote itself that have far-reaching, global implications. In particular, I’m talking about the issues of trade and immigration, which have become lightning rods for voters, across Western economies, who are frustrated by subpar growth and the lack of opportunity and jobs it has engendered.

In my view, it would be a mistake to dismiss “Leave” voters and their counterparts on the Continent and in the U.S. as being narrow-minded or lacking global perspective. In fact, it is hard to find a good job, especially for the less skilled and the young, and people have latched onto what they perceive to be the most tangible culprits, namely immigration and trade. The reality is that many of the culprits are less tangible, such as inefficient tax codes, excessive regulation and simple demographics.

Could Japan Export Policy Innovation?
So the bigger picture issue becomes, how can you deliver better growth? Unfortunately, although central banks can provide some support, at the end of the day they can’t address the growth issue on their own. Indeed, then Fed Chairman Ben Bernanke was talking about the limits of monetary policy some five years ago, and with major central banks appropriately reluctant to aggressively pursue negative policy rates to spur growth, there are fewer policy options at their disposal.

After the Brexit vote, my CIO colleagues Joe Amato and Erik Knutzen, along with Benjamin Segal, head of the Global Equity team, participated in a webinar in which they discussed what could be done to break the economic logjam. One key market to watch, Erik said, was Japan.

The sharp rise in the Japanese yen is one of the more challenging effects of the referendum vote. The yen has long been viewed as safe-haven currency, and thus recently reached highs not seen since 2014, threatening to undermine progress made via Abenomics.

Given the bleak picture, we think it’s possible that Japan could be the first country to introduce the next stage of the Bernanke playbook, which is “helicopter money”—a term first coined by Milton Friedman to describe central bank policy that, instead of relying on indirect stimulus through banks, put dollars directly in the hands of consumers.

A central bank cannot implement such a policy on its own, of course. It needs the cooperation of executive branch heads and legislatures. This makes the task more challenging, but it also has the advantage of moving governments and economies toward structural reform. This could include increasing economic efficiency by simplifying tax codes, and reducing or streamlining regulation—which are key impediments to healthy growth.

Success in Japan could encourage action elsewhere. At the risk of overstatement, that in turn could prove a turning point in what has become a very long journey toward meaningful global recovery.

Neuberger Berman’s CIO insight by Brad Tank

Cryptocurrency for Dummies: Bitcoin and Beyond

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Bitcoin created a lot of buzz on the Internet. It was ridiculed, it was attacked, and eventually it was accepted and became a part of our lives. However, Bitcoin is not alone. At this moment, there are over 700 AltCoin implementations, which use similar principles of CryptoCurrency.

So, what do you need to create something like Bitcoin?
Without trying to understand your personal motivation for creating a decentralized, anonymous system for exchanging money/information (but still hoping that it is in scope of moral and legal activities), let’s first break down the basic requirements for our new payment system:

All transactions should be made over the Internet
We do not want to have a central authority that will process transactions
Users should be anonymous and identified only by their virtual identity
A single user can have as many virtual identities as he or she likes
Value supply (new virtual bills) must be added in a controlled way

Decentralized Information Sharing Over Internet
Fulfilling the first two requirements from our list, removing a central authority for information exchange over the Internet, is already possible. What you need is a peer-to-peer (P2P) network.

Information sharing in P2P networks is similar to information sharing among friends and family. If you share information with at least one member of the network, eventually this information will reach every other member of the network. The only difference is that in digital networks this information will not be altered in any way.

You have probably heard of BitTorrent, one of the most popular P2P file sharing (content delivery) systems. Another popular application for P2P sharing is Skype, as well as other chat systems.

Bottom line is that you can implement or use one of the existing open-source P2P protocols to support your new cryptocurrency, which we’ll call Topcoin.

Hashing
To understand digital identities, we need to understand how cryptographic hashing works. Hashing is the process of mapping digital data of any arbitrary size to data of a fixed size. In simpler words, hashing is a process of taking some information that is readable and making something that makes no sense at all.

You can compare hashing to getting answers from politicians. Information you provide to them is clear and understandable, while the output they provide looks like random stream of words.

There are a few requirements that a good hashing algorithm needs:

Output length of hashing algorithm must be fixed (a good value is 256 bytes)
Even the smallest change in input data must produce significant difference in output
Same input will always produce same output
There must be no way to reverse the output value to calculate the input
Calculating the HASH value should not be compute intensive and should be fast

If you take a look at the simple statistics, we will have a limited (but huge) number of possible HASH values, simply because our HASH length is limited. However, our hashing algorithm (let’s name it Politician256) should be reliable enough that it only produces duplicate hash values for different inputs about as frequently as a monkey in a zoo manages to correctly type Hamlet on a typewriter!

Digital Signature
When signing a paper, all you need to do is append your signature to the text of a document. A digital signature is similar: you just need to append your personal data to the document you are signing.

If you understand that the hashing algorithm adheres to the rule where even the smallest change in input data must produce significant difference in output, then it is obvious that the HASH value created for the original document will be different from the HASH value created for the document with the appended signature.

A combination of the original document and the HASH value produced for the document with your personal data appended is a digitally signed document.

And this is how we get to your virtual identity, which is defined as the data you appended to the document before you created that HASH value.

Next, you need to make sure that your signature cannot be copied, and no one can execute any transaction on your behalf. The best way to make sure that your signature is secured, is to keep it yourself, and provide a different method for someone else to validate the signed document. Again, we can fall back on technology and algorithms that are readily available. What we need to use is public-key cryptography also known as asymmetric cryptography.

To make this work, you need to create a private key and a public key. These two keys will be in some kind of mathematical correlation and will depend on each other. The algorithm that you will use to make these keys will assure that each private key will have a different public key. As their names suggest, a private key is information that you will keep just for yourself, while a public key is information that you will share.

If you use your private key (your identity) and original document as input values for the signing algorithm to create a HASH value, assuming you kept your key secret, you can be sure that no one else can produce the same HASH value for that document.

If anyone needs to validate your signature, he or she will use the original document, the HASH value you produced, and your public key as inputs for the signature verifying algorithm to verify that these values match.

How to send Bitcoin/Money
Assuming that you have implemented P2P communication, mechanisms for creating digital identities (private and public keys), and provided ways for users to sign documents using their private keys, you are ready to start sending information to your peers.

Since we do not have a central authority that will validate how much money you have, the system will have to ask you about it every time, and then check if you lied or not. So, your transaction record might contain the following information:

I have 100 Topcoins
I want to send 10 coins to my pharmacist for the medication (you would include your pharmacists public key here)
I want to give one coin as transaction fee to the system (we will come back to this later)
I want to keep the remaining 89 coins

The only thing left to do is digitally sign the transaction record with your private key and transmit the transaction record to your peers in the network. At that point, everyone will receive the information that someone (your virtual identity) is sending money to someone else (your pharmacist’s virtual identity).

Your job is done. However, your medication will not be paid for until the whole network agrees that you really did have 100 coins, and therefore could execute this transaction. Only after your transaction is validated will your pharmacist get the funds and send you the medication.

Miners – New Breed of Agents
Miners are known to be very hard working people who are, in my opinion, heavily underpaid. In the digital world of cryptocurrency, miners play a very similar role, except in this case, they do the computationally-intensive work instead of digging piles of dirt. Unlike real miners, some cryptocurrency miners earned a small fortune over the past five years, but many others lost a fortune on this risky endeavour.

Miners are the core component of the system and their main purpose is to confirm the validity of each and every transaction requested by users.

In order to confirm the validity of your transaction (or a combination of several transactions requested by a few other users), miners will do two things.

First, they will rely on the fact that “everyone knows everything,” meaning that every transaction executed in the system is copied and available to any peer in the network. They will look into the history of your transactions to verify that you actually had 100 coins to begin with. Once your account balance is confirmed, they will generate a specific HASH value. This hash value must have a specific format; it must start with certain number of zeros.

There are two inputs for calculating this HASH value:

Transaction record data
Miner’s proof-of-work

Considering that even the smallest change in input data must produce a significant difference in output HASH value, miners have a very difficult task. They need to find a specific value for a proof-of-work variable that will produce a HASH beginning with zeros. If your system requires a minimum of 40 zeros in each validated transaction, the miner will need to calculate approximately 2^40 different HASH values in order to find the right proof-of-work.

Once a miner finds the proper value for proof-of-work, he or she is entitled to a transaction fee (the single coin you were willing to pay), which can be added as part of the validated transaction. Every validated transaction is transmitted to peers in the network and stored in a specific database format known as the Blockchain.

But what happens if the number of miners goes up, and their hardware becomes much more efficient? Bitcoin used to be mined on CPUs, then GPUs and FPGAs, but ultimately miners started designing their own ASIC chips, which were vastly more powerful than these early solutions. As the hash rate goes up, so does the mining difficulty, thus ensuring equilibrium. When more hashing power is introduced into the network, the difficulty goes up and vice versa; if many miners decide to pull the plug because their operation is no longer profitable, difficulty is readjusted to match the new hash rate.

Blockchain – The Global Cryptocurrency Ledger
The blockchain contains the history of all transactions performed in the system. Every validated transaction, or batch of transactions, becomes another ring in the chain.

So, the Bitcoin blockchain is, essentially, a public ledger where transactions are listed in a chronological order.

The first ring in the Bitcoin blockchain is called the Genesis Block

There is no limit to how many miners may be active in your system. This means that it is possible for two or more miners to validate the same transaction. If this happens, the system will check the total effort each miner invested in validating the transaction by simply counting zeros. The miner that invested more effort (found more leading zeros) will prevail and his or her block will be accepted.

Controlling The Money Supply
The first rule of the Bitcoin system is that there can be a maximum of 21,000,000 Bitcoins generated. This number has still not been achieved, and according to current trends, it is thought that this number will be reached by the year 2140.

This may cause you to question the usefulness of such a system, because 21 million units doesn’t sound like much. However, Bitcoin system supports fractional values down to the eight decimal (0.00000001). This smallest unit of a bitcoin is called a Satoshi, in honor of Satoshi Nakamoto, the anonymous developer behind the Bitcoin protocol.

New coins are created as a reward to miners for validating transactions. This reward is not the transaction fee that you specified when you created a transaction record, but it is defined by the system. The reward amount decreases over time and eventually will be set to zero once the total number of coins issued (21m) has been reached. When this happens, transaction fees will play a much more important role since miners might choose to prioritize more valuable transactions for validation.

Apart from setting the upper limit in maximum number of coins, the Bitcoin system also uses an interesting way to limit daily production of new coins. By calibrating the minimum number of leading zeros required for a proof-of-work calculation, the time required to validate the transaction, and get a reward of new coins, is always set to approximately 10 minutes. If the time between adding new blocks to the blockchain decreases, the system might require that proof-of-work generates 45 or 50 leading zeros.

So, by limiting how fast and how many new coins can be generated, the Bitcoin system is effectively controlling the money supply.

Start “Printing” Your Own Currency
As you can see, making your own version of Bitcoin is not that difficult. By utilizing existing technology, implemented in an innovative way, you have everything you need for a cryptocurrency.

All transaction are made over the Internet using P2P communication, thus removing the need for a central authority
Users can perform anonymous transactions by utilizing asynchronous cryptography and they are identified only by their private key/public key combination
You have implemented a validated global ledger of all transactions that has been safely copied to every peer in the network
You have a secured, automated, and controlled money supply, which assures the stability of your currency without the need of central authority

One last thing worth mentioning is that, in its essence, cryptocurrency is a way to transfer anonymous value/information from one user to another in a distributed peer-to-peer network.

Consider replacing coins in your transaction record with random data that might even be encrypted using asynchronous cryptography so only the sender and receiver can decipher it. Now think about applying that to something like the Internet Of Things!

A number of tech heavyweights are already exploring the use of blockchain technology in IoT platforms, but that’s not the only potential application of this relatively new technology.

If you see no reason to create an alternative currency of your own (other than a practical joke), you could try to use the same or similar approach for something else, such as distributed authentication, creation of virtual currencies used in games, social networks, and other applications, or you could proceed to create a new loyalty program for your e-commerce business, which would reward regular customers with virtual tokens that could be redeemed later on.

Column by Demir Selmanovic featured on toptal