Friday, March 31, 2006

Stock exchange markets : Its predictive power (I)

In 1983 while I was studying in the New York University (USA),I watched on TV Mr Paul Samuelson saying that Stock Exchange markets does no predict economic recessions. Later that decade, in 1987 the New York stock exchange felt down by 20% but it did not mean a recession for the American economy that year. Instead, it came about later in the beginning of the nineties and for different reasons. Does this l necessarily means that stock exchange moves on their own with no connection with the real economy? .Of course not. What about the European experience or the Latin America experience with its own stock exchange markets?.
If we take the Capital asset market pricing model, (William Sharpe, 1964)the portfolio combination maximize its short run returns based on perfect information ,frictionless markets and homogeneous risks assets. Given rational expectations, investors make decisions with all the information available in one year period. So, every unexpected event occurring during any specific year, is considered in the risk evaluation of every portfolio as a “new event” ,to make investment decisions.-
Whether there is a supply side shock (increasing oil prices) , or a demand side shocks (increasing raw materials world demand ),investors include this shocks in its asset price estimation and so on its expected total short run returns and risk evaluations. But , there is no consideration whether either it is a new trend , or a transitory shocks. Perfect information and rational expectation will solve the doubt, as long as time goes by. For instance, it seems that there is no major concerns on stocks markets with oil prices on the level of sixty dollars a barrel it has today , because markets have incorporated that shock as a trend, oil prices will continue to be higher than before , so it has charged every asset price on the proper risk magnitude that such event means for the energy cost on firms financial result. Take a look to the Air lines stock value. Most of them, have been in trouble to keep on track, unless they increase productivity, reduce cost or cut jobs. There is no another way to avoid markets bias to punish its market value . So, at this moment, it should be necessary a very high unexpected increase in oil price ,to shake financial markets .and pull them down. Every price increase within the trend , is already incorporated into the market expectations.-
Back again to the Stock exchange markets predictive power, it is clear that any economic recessions does not appear without any medium term warning signals, but stock exchange markets will consider that warnings as an isolated event , mixed with other signals either positives or negatives. Given that short run portfolios diversify risks, those warning signals induce investors to move away from the riskier sectors. So, the stock exchange markets might moves down in the economy affected by such a risk, but on the global scenario , those resources will move over to anywhere with lower economic recessions risks.-
Following the Asian crisis, foreign resources flew away from Latin America after it became clear its effect on domestic product, pushing downward the local stock exchange markets ,but pushing upwards those more secure foreign stock exchange markets. Neither stock exchange market, nor investment models predicted such a recession .
So, Stock exchange markets seeking to maximize short run portfolio returns, are not good at predicting economics recessions signalled by medium terms events ,because they always maximize short run portfolio returns rather than long run returns . The recent Dubai ´s Firm failure to move forward on the east coast American economy ports deal ,moved down the stock exchange market in Dubai, while another ones move up. Stock exchange markets looks better at reacting than predicting.-

Friday, March 24, 2006

Mergers regulations :Should it means Capital flow restrictions ? (II)

Following last week article, let looks additional issues: Assuming as regulator does, that it prevail the same goal between the agent and the principal, the main objectives mergers are orientated at , would be to take advantage of new opportunities arising in growing markets .Institutional framework will have to take care of markets implications specially the chance of collusive price behaviour. However, there is empirical evidence that in mergers and acquisitions firms, internal factors have a strong influence on the success of any strategy implementation. Half of mergers end up in failure because internal cultural values may not match well to move along the complicated process of working out the new organization and its new strategy. The initial higher stock exchange value, very usual in the first stage of mergers, might decline further into the following stages because of wrong internal strategic decisions.
How to assemble different human resources realities? If there is no internal strategy to follow through to fix it up these differences, the whole process might end up either in a complete failure or important losses of market value. So, regulatory authority should take into consideration the issue of potential failure when it comes to intervene in a merger project, otherwise what it is assumed to be a saving for consumers ,can really be a loss of welfare . This means ,it is better to apply regulation to a merger successfully working when it eventually implies a threat to consumers welfare, than to avoid it and nullifying its potential benefits .
In fact, mergers can also imply gains for welfare consumers. When Citicorp joined with an insurance company to broadening its service spectrum to its clients, there was not too much concern on the impact of such merger on insurance industry, because it was an innovation effort to offer new products to consumers. In Chile mergers in banking industry have allowed a better quality service, lower fixed cost for loans evaluations. and a better access to technology based service for customers. If regulatory authority had intervened stopping this mergers ,because of the ex ante perception of collusive behaviour, none of theses benefits would have come up in the short run.-
What about global scale mergers?. In this case it could also be considered as a capital flow. So, the more it is restricted ,the less efficient is the global allocation of resources, loosing welfare gains for the global society as a whole. How is it ?. Capital resources do seek the best alternatives to maximize profits, both in terms of markets and organizational arrangements, assuming capital holders are not risk averse. .Mergers , (beyond the scope of each firm ´s strategy ),are also a way of allocation of resources to a higher levels of outcomes than what otherwise would be . This has been the case on global banking industry, insurance industry, financial and logistic services industry. If regulations restrict mergers because of ex ante assumptions, capital will not flow to where it has the highest return, but where it get the highest rent. Global welfare will be reduced because this regulations restrictions will be equivalent to protectionism.
Then, Merger Regulations could be applied on the basis of real measured rather than expected behaviour, allowing a period of time to get the benefits for consumers to be in practice, at the same time freeing entry barriers. In other words, merger regulators should allow conditions to protect the benefit of consumers ,rather than punish the benefit of each mergers which on a broader perspective of capital flow ,might also be the benefit of global society.-

Friday, March 17, 2006

Mergers regulations: Should it means capital flow restriction? (I)

Mergers and firm acquisition increased by 12% in the year 2005 in Chile. Telecommunications sector had the higher share with USS 1400 millions, 37% of the total amount involved ( U$$ 4000 millions). In the second place, is commerce with 27%, and in third place forestry sector with 12.5%.(
This amount represent roughly 4% of Chile` s 2006 GDP. This number by itself, does not tell us too much about the underlying issues concerning mergers, because there are a lot of variables involved on them. To mention just a few: capital mobility, firm efficiency levels , rate of return for capital, consumer needs ,market efficiency and level of competition. But high internal capital mobility measured throughout mergers done in a year, is a good signal of the dynamic of economic growth.
Considering the usually defined three type of mergers, (Horizontal, vertical mergers and potential competition mergers),there are some key issues to take into account. The first issue is whether mergers are good or bad for the economy. The answer , will depend of the institutional framework quality(IFQ).Credible organism for markets behaviour supervision, proper legal instrument either to protect the rights of consumers, or to punish privilege use of inside information are key aspect of a proper institutional framework. -
The second issue refers to the regulation of mergers, which apply when it happens that the new firm, increase industry concentration and eventually gets monopoly power and its consequences :Higher prices, lower quality of products, reduced availability of goods or services, and less innovation. By the way, regulatory authority assume that all mergers will function well. But we will see this is not always so.
On the other hand , it is important to keep in mind that concentration ratios by itself , does not necessarily means monopoly power. It also requires entry barriers to markets. So, after a merger in banking industry for instance, the concentration ratio may be higher, but if there is no entry barriers for new banks, there will no be monopoly power, but higher banking industry concentration. That was the case in Chile with the merger of the Spain based “Bank of Santander” and “Bank of Santiago”, which after the merger with the brand of “Bansander” got a 30% of local share markets ,;but because of free entry and the higher profits expectations , three new banks come into the consumer sector increasing competition. Otherwise, with heavy entry barriers, authority intervention throughout regulations and supervision, must protect markets efficiency and above all consumers, stopping mergers suspicious of monopoly intention.
The third issue concerns to the aims underlying the bid for another firm. The movie “Barbarians at the gate” with James Garner, shows that on this regard there is plenty of goal to give attention to. Another matter is whether you like it or not the whole movie. The organizational economy study this phenomenon , within the dilemma of the Agent(Firms executives or CEO) and the Principal (the owners or stakeholders).They either may have the same goal ,let say to maximize the firms profit , or they may have different goals. An example of differing goals? Enron, and Parmalat. When they (agent and the principal) have the same goal, mergers are aimed to firms `s objectives, such as to take advantage of new opportunities in fast grow sectors based on a cost leadership or a differentiation strategy. (A different story is the implementation of such strategy inside the firm). In this case, merger improve firms scale and efficiency, innovation potential because of lower cost , and consumers attention , which will allow the firm to take a greater share of market participation in terms of sales, profit or production. So, these are firms goals all its people agree on.-

Friday, March 10, 2006

Business men and theirs farewell to President Lagos

We all learn in school to read books ,but few of us learn how to read history. That is a desirable skills for anyone to be endowed with. President Lagos ,is one of those very few able to read quite well the history .He followed an economic policy , which aulthough it was not his choice, he make it his own by introducing it social values, like integration , fairness, and protection .
He believes in a society whose key traits are not the one given by the markets preferences, but by its people ¨s right. In other words , in Chile the new society style which was coming out after 1990,very much prone to american style, would based on a strong economy, but supported by social values . After all, Society well functioning is beyond markets behaviour.
This path meant a giant step forward for the prospect of further development in Chile , because following the European model ,it integrated economic growth with social compromises . On the other hand, because of its markets inspiration, open up the way to the so called “Third Road” economic model implementation in Latin America as an alternative to the neoliberal approach..
In Chile , few markets analysts ,believed on this approach to be successful. After all ,it was based on additional labor markets regulations, more fiscal expenditures on education , public health, and tax increases. Following the Asian crisis in 1997- 1998 , this policy mix ,implied barriers for the economy recovery so urgently needed , specially because affected flexibility for business decisions, and markets behaviour . There were doubts, mistrust and pessimism in the business community.. Sure, those changes were expected to affected the productions costs., profitability margins , employment levels, and investment.-
However, if the market size increased, the expected higher demand and the scale effects associated with it, would allow to confront the challenge of growth with heavier social burden, without weakening the firms abilities to sustain the creation of wealth. So, it began the Free Trade accord round all over the world markets. Then Business man realized, that the economic policy was not against them, but rather with them, and most of all , was based on them!. So when it comes to say bye, business men embraced him as the leader of a new deal between government and business.-
Following the Mexican and Canadian free trade agreement of early nineties,, it continued with the USA FTA, The European Union FTA (A plus category Free trade accord),China and recently India a probably in the near future Japan.-
Is it too good to be truth ?.Let looks at the data: The average rate of growth between 2000-2006 it is on the range of 4%, average unemployment is 8.8%, and annual inflation is on the range of 2.5%-3,5%. Could it be better?. Sure it could. Lower taxes for investment and saving, more flexibility in key markets would have done a better result.
From the long run perspective for development and growth though, what it count most is that in Latin America there is a new paradigm which is moving away from the “lost decades policies” of the eighties decades. This new paradigm take the best of market to combine it with social requirements, including modernization of the State and strong private sectors, capable of asuming traditional public investment such as highways, airports,ports . President Lagos was not the first, because he arrived to the Presidency when others already started off this path, mainly Former Brazilian President Fernando Henrique Cardoso.However, he took the most advantage of it.-
The lasting effects on Brazil of this symilar approach, was that the new President Lula decided to support it, quite on the contrary to expectations. So, it is also expected to be in Chile with the new President Ms Bachelet .-

Friday, March 03, 2006

Chile `s next government economic policy

The whole new economic team has been announced by the new elected President, and the analyses of the middle term economic orientation and expected results have begun. On this regards it is important to make a distinction between data and variables. Data is a behaviour which has been known in the past ,and there is no chances to change it crucially, while variables are the unpredictable random behaviour, which complicate the markets.-
Let first review the Data. To begin, it is the fiscal prudent approach to its countercyclical macroeconomic policy. The public budget structural surplus is a guarantee for keeping a stable economic growth trend, given the autonomous Central Bank. Also,external conditions are favourable enough to count on increasing demand for export, specially those one which Chilean exports are concentrated most.-
Another data may be found in the new business opportunities arising from retail domestic expansion, because of increasing consumption options specially the one based on commercial credit cards asides from an increasing income.
On the other hand ,the economic team even though is young and less experienced than the current one, have the proper both technical and professional credentials for the job. The official guidelines, favouring productive sectors such as small and medium business will keep the momentum for growth and employment. So, Markets should expect continuity, facilitating to take advantage from new business opportunities, specially in the retail and financial sectors.-
What about the variables ?.There is some needs to improve regulation in those not traditional sectors such as commercial credit cards, and mobile phones due to its important expansion in the latest years. The risk is that when the authority start to regulate, it is hard to control the temptation to go further on the regulatory process. Another variable is on the tax policy. The expected VAT(Value added Tax) reduction for the year 2007 , will not longer be possible because of higher public expenditures levels. Given the fact that the VAT has increased steadily since 1990,there is no assurance that some time in the future it may be increase to the twenties range.-
It seems to me that in the overall balance, it will prevail data over variables. How is it so?. First :It is a four year government, and there is no doubts on the economic fundamentals. Second, Women are traditionally prone to manage financial resources and opportunities properly. In Chile this is a cultural value, for years on the shadow of family realities. Third ,A woman a the first President of Chile will care a lot about her chances of leaving a good legacy for futures female colleagues .Some signals of it, are in the carefully driven designation process of the new team.

PD.I finished my vacations. I went to Montevideo ,Uruguay, and I strongly recommend to visit it. Thank to all those who make comments.