Mario Greco, CEO, Generali: a change of gear in Italy
Mario Greco, chief executive of Italy’s Generali, Europe’s third-biggest insurer by premiums, speaks softly but gives every sign of being ready to do battle. It is not surprising: after turning the company round over the past three years, he still faces residual scepticism, fresh challenges and outside expectations about how corporate Italy should act.
“This is a company that is coming back,” he insists of the insurer, whose share price has nearly doubled since he took the top job three years ago. A competitive road cyclist in his free time, he sits on the edge of his chair in Generali’s Milan headquarters, his foot persistently tapping as if reaching for unseen pedals.
“Generali is coming back from nowhere because we started from a very low level,” he says. “We are changing gear. We are finishing a turnround story and we are opening a value story, which is a significant change. To people who say ‘you haven’t fixed it’, [I say] ‘look at the numbers’.”
Mr Greco, who studied international economics in the US and started his career at McKinsey, is in the vanguard of a rising generation in Italian capitalism.
His pugilistic talk is new at the top of corporate Italy — but he is not alone. His fellow CEOs at the country’s leading companies, such as Intesa Sanpaolo, Telecom Italia, Eni and Enel, were all installed after the financial crisis and the eurozone sovereign crisis triggered share price crashes. All are confronting tough turnrounds at their respective businesses after the drubbing dealt by the crises. And all are faced with the task of restoring corporate Italy’s image in the outside world, marred by a long economic stagnation and a reputation for crony capitalism.
Mr Greco, 56, joined Generali from Zurich Insurance Group in the heat of the eurozone debt crisis. The board, in a typically bloody Italian board coup, had just ousted its chairman, Cesare Geronzi, and CEO, Giovanni Perissinotto, in swift succession after the insurer lost two-thirds of its value in five years.
Mr Greco’s appointment was significant because of the size of the group — Generali has €500bn in assets under management, a behemoth in a country dominated by small and midsized businesses — and its place in Italian corporate culture.
The insurer under its old guard was an example of the type of Italian crony capitalism that raises a red flag for foreign investors in the eurozone’s third-largest economy. Generali sat amid a web of cross-shareholdings, which in the good times gave it unmatched influence but in the crises became the network through which contagion spread fast.
Mr Greco has cut costs and slashed its shareholdings in companies that included Telecom Italia, selling nearly €4bn in assets to boost its capital.
“People bet I would make a capital increase three years ago — they can keep on making this bet,” he says. Mr Greco reiterates that he still has no intention to raise capital since the asset sales have boosted Generali’s economic solvency ratio, a key measure of financial strength, to 186 per cent at the end of 2014, more in line with its peers Axa and Allianz.
Mr Greco presents himself as a straight-talking numbers man, in a deliberate distinction from the avuncular manner of Italy’s older executives.
Generali aims to pay €5bn in dividends over the next four years compared with €900m last year. “We are now on a different journey to remunerate shareholders and increase the value of the company, and do that above the market average. This is completely new.”
Mr Greco may have dragged Generali’s governance and strategy into the 21st century but, like the leaders of many Italian businesses, he must now confront new problems spawned by technology and globalisation.
The International Monetary Fund warned earlier this year that the business models of European insurers are becoming unsustainable after a slump in interest rates. Mr Greco says he is prepared to deal with low bond yields “until 2018”. He is shifting Generali’s business mix to more fee-earning products to boost profits and away from life insurance, where setting up new contracts incurs heavy costs upfront. He also faces more competition arising from big data and is increasing spending on technology to better understand customer needs.
In addition, he has hired outsiders and foreigners to reflect Generali’s presence in more than 60 countries with 78,000 employees and 72m customers. He hired New Delhi-born, Cambridge and Harvard-educated Nikhil Srinivasan as chief investment officer, who is now Italy’s most prominent non-Italian executive.
His bet on new blood appears to have paid off. For 2014, Generali posted an investment return of 10 per cent on assets exceeding €400bn, which beat its peers, according to a report from research company Sanford Bernstein.
But for some analysts with the memory of eurozone crisis contagion still fresh, the focus remains on Generali’s €50bn of Italian government debt and €90bn of Italian liabilities, which remain a concern and a sign that the effects of its change may be superficial.
Mr Greco will have none of it. “The fact that we are strong in Italy, is this a sin? Is this a mistake? Is this something I have to feel regretful about? I don’t think it is,” he snaps, showing an exasperation shared by many of Italy’s executives about the perception of the country internationally. “This is one of the top 10 countries in the world by GDP. We make profits in Italy, we have high market share, Italy is growing,” he says.
Another exhalation of frustration greets a suggestion that Generali might provide credit to small and midsized businesses, since traditional bank lending has shrivelled during the downturn.
“Never, never,” he says of the popular idea among lawmakers that insurers such as Generali could disintermediate banks. “I have been very clear with everyone at a European level and a national level. We can’t help . . . It is not that we don’t want to . . . We cannot do things that we do not have the competence to do,” he says, his foot still urgently tapping out its staccato beat on the floor.
Like most of Italy’s new corporate class, Mr Greco was a supporter of 40-year-old reformist prime minister Matteo Renzi when he came to power 18 months ago. With his combative attitude, Mr Renzi was their political counterpart. Since then, business leaders’ affection has cooled as deep reforms have failed to materialise and the government growth target of 0.7 per cent this year is starting to look a stretch.
“We need much more reform as Europeans, and we need much more as Italians,” is all Mr Greco will say.
But he stresses that he wants to applaud Mr Renzi and his team for the efforts they have made to ask Italy’s corporate leaders how they can support them internationally, such as through trade missions. That this is a great step forward reflects as much as anything how broken Italy’s corporate system had become during 20 years of economic stagnation under its discredited political class of the right and left.
“The government is acting in a way where you can see that they are trying to help companies like ourselves. I feel that we are starting to have the support of the country,” Mr Greco says. “This is a simple thing but important. You feel you belong to a place.”
EM turmoil and strong franc cast shadow over Swiss luxury industry
It has been a tough year for Swiss watchmakers.
At home, they have had to cope with a surging Swiss franc, after the Swiss National Bank unexpectedly dropped its cap on the currency. Abroad, they have been hit by weakness in a number of key markets.
The biggest problems have come in Asia, where demand has faltered in China and Japan, and collapsed in Hong Kong. But other markets have also proved difficult: the gyrations of the rouble have hit Russian demand — and sales in the UAE, an increasingly important market, have declined.
“There has been a lot of turmoil and no one has any idea what will happen next,” says Aldo Magada, chief executive of Zenith, one of the French luxury group LVMH’s stable of brands. “There has been a loss of confidence among consumers in general because they don’t know what will happen with the economy.”
The net result is that the value of Swiss watch exports between January and July was SFr12.49bn ($13bn), 1.2 per cent below the level reached in the same period in 2014. The figures in July were particularly weak, with watch exports 9.3 per cent lower than the same month last year.
The slowdown is reflected in the results of Switzerland’s two biggest watch groups, Richemont and Swatch. The latter reported in July that its sales rose just 2.2 per cent in the first six months of the year. In May, Richemont said its sales in the first six weeks of its financial year, which runs from April to March, had been flat once currency fluctuations had been taken into account.
In response, analysts — whose predictions for growth in Swiss watch exports stood somewhere between 4 and 7 per cent at the beginning of the year — have been reining in their forecasts.
“I still assume there will be growth in the overall market this year, due to the pick-up in watch sales in the US and Europe, and continued purchases by Chinese customers abroad. But it will be muted,” says Jon Cox, an analyst at Kepler Cheuvreux in Zurich.
Others are less optimistic. “After the figures for July, the main question is whether the Swiss watch industry can grow at all this year,” says René Weber, an analyst at Bank Vontobel. “I think it will probably be flat.”
Analysts expect growth to be fastest in Europe, where a pick-up in domestic demand so far this year, allied with continuing purchases by Chinese tourists, has led to double-digit growth in a number of countries, including France and the UK. In the US, where sales are up 4 per cent, positive growth is also expected.
The main focus of industry executives and observers, however, is Asia. Even before the recent stock market turmoil, the slowdown in Chinese demand was rippling through the region and casting a shadow over the watch industry’s prospects. So far this year, Swiss watch exports to Hong Kong, the world’s largest watch market, are down 20.8 per cent. To China, the third largest, they are down 4 per cent and to Japan, the fifth largest, they are down 5.8 per cent.
The question is whether China’s recent stock market turbulence, which began in the summer, and intensified in August after the Chinese government devalued the renminbi, will make things worse.
“There is a close correlation between the value of real assets, such as the stock market, and the purchasing of high-end luxury goods. Overall, the volatility will have a damping impact on volumes,” says Mr Cox.
Others are not so sure. “When the stock market rose so dramatically over the past year, we didn’t see a surge in watch purchases, so I’m not sure that the fall in the market now will necessarily stop people from buying watches,” says Mr Weber.
Yet even if the stock market turbulence does not harm watchmakers too badly, the underlying slowdown in the Chinese economy — which was what prompted the government to devalue the renminbi — may have a longer-lasting effect.
This is particularly true in Hong Kong, long a popular destination for Chinese tourists. Inventories remain high in the territory, and Jean-Claude Biver, head of LVMH’s watchmaking business, said in August that Tag Heuer, one of its brands, would shut a store in one of the city’s main thoroughfares as a result of falling demand and high rental costs.
The other issue on Swiss watch executives’ minds is how to deal with the strength of the franc. The currency has risen more than 10 per cent against the euro since the SNB dropped its cap in January.
For any Swiss company with a cost base largely in francs and a portion of its sales in foreign currencies, the SNB’s decision raises problems. But it is particularly tricky for Swiss watchmakers, which have long touted production in Switzerland as a guarantee of quality. One obvious response — shifting production to cheaper countries — is not an option.
Swiss watchmakers have responded with a mixture of price cuts in Switzerland and price increases elsewhere, a process that has left some executives slightly frazzled.
“The first part of the year was a complete nightmare as far as price adaptations were concerned,” says Mr Magada. “We had to raise prices in the eurozone after the franc appreciation, raise them twice in Japan because of the yen and cut them in Hong Kong so that the prices there are still competitive with the prices in euros and dollars.”
However, some analysts say that, with the franc still strong, more adjustments may be needed. “The price increases in Europe were about 8 per cent on average, but they haven’t been enough to compensate for the margin erosion,” says Mr Weber.
“I think that another round of price increases is likely to try and make up the difference. We will probably see this by Baselworld next year at the latest.”
Despite these challenges, Swiss watchmakers can take heart from the fact that one much discussed threat has proved milder than expected. The launch of the Apple Watch in March was seen in some quarters as a danger to the industry — at least at the low end.
So far, however, it has been the makers of electronic watches that have borne the brunt of the impact. Although analysts still expect lower-end Swiss watch brands, such as Tissot, to be affected in the long run, for the industry as a whole smartwatches could prove as much an opportunity as a challenge.
“Apple’s move is helping to create a new segment, and some Swiss watchmakers are already moving in. Swatch has launched their fitness band, which undercuts the Apple Watch, and we will see others follow suit,” says Mr Cox.
Size is not everything for talented portfolio managers
The industry is full of bloated, mediocre businesses with too many funds, says Jon Little
Fund management is a people business”; “our assets go up and down every day”. These are two of the most glib, overused phrases in the fund management business. What offends me is less their ubiquity than that those who use them have spent little, if any, time thinking what they mean.
Fund management has many peculiar characteristics but it is by no means unique. We no longer live in a society where most people earn a living making or building things.
For many of today’s workers, knowledge and skill are their crafts. Amid the four factors of production, labour is the most rewarded and prized. Yet many fund managers are wedded to outdated notions of what constitutes success and how businesses should develop and grow.
After the industrial revolution, scale and size were the goals of business. Growing bigger, producing and selling more, was the recipe for success. Greater scale means lower unit cost, leading to higher revenues and profits. However, this formula does not work for most people businesses, especially fund management operations.
Unfortunately, too many have been infected by the belief that growing in size and complexity somehow makes them better.
First, think about what it means to manage money actively. Done properly, it consumes every working hour of those rare souls who do it well. Managing a research-driven portfolio requires delving into multiple industries and understanding the dynamics of pricing, competition and strategy. It is hard, intellectually challenging and stimulating.
But stimulation is only part of it. Fund management is unusual in that success and failure are easily measurable. For those who care little about short-term results (the only decent managers as far as I am concerned), there is the excitement of unearthing something the market has missed, testing the theory, then taking a contrarian position that may, for months, seem to be a losing bet. Then the slow glow of being proved right and, more importantly, visible results in terms of published performance and higher profits for clients.
The satisfaction talented managers get is not, however, directly scaled to the size of their portfolio. Managing $5bn in large-cap equities is probably just as satisfying as managing $10bn or even $25bn. What is in the portfolio is what matters. Its size — within reason — is largely irrelevant.
Investment management businesses do not need to grow beyond a certain critical mass to be profitable. In fact, the optimum business would comprise an investment team, the largest group within the company, some support staff and just enough marketing and service staff to look after clients. Any functions would be just large enough to be effective. Unfortunately, this is rarely the case. The industry is full of bloated, mediocre businesses with too many funds and products and too many competing priorities.
In these companies I find the investment team has ceased to be the largest group of employees. Herein lies the issue. Sales people want to sell more product, marketing people want to expand client channels, product development people want to launch more product. These desires indirectly feed more expansion.
More product leads to more systems support; geographical expansion leads to greater compliance and IT support; more sales channels require more finance people. All of this leads to business complexity and a bigger HR team.
The business loses focus because suddenly there are employees whose success is judged by criteria that have little or nothing to do with investment performance or client outcomes. If the business is not growing constantly, they quickly become expensive and demotivated. At that point, even if it is sensible to restrict growth or close to new business, those responsible for running the company find it impossible to take these decisions.
The tragedy is that these bloated businesses are normally less profitable per employee and per dollar of revenue and find it harder to retain clients and investment staff. Put simply, every investment business should ask itself: “Would we be better off if we focused on managing money in one key asset class where we have a competitive advantage and ditched everything else?” The answer is yes.
Brazil’s disastrous budget
All fall down
Brazil is in an economic hole—and still digging
The end of the global commodity boom and a confidence-sapping corruption scandal, after years of economic mismanagement, have extinguished growth. Brazil’s GDP is expected to contract by 2.3% this year. Fast-rising joblessness, together with falling real private-sector pay and weak consumption, are squeezing tax receipts. Meanwhile rising inflation, allied to a free-falling currency, means investors demand higher returns on government debt. The result is a budgetary disaster. This year a planned primary surplus (ie, before interest payments) has
Faced with the prospect of public finances slipping out of control, Brazil’s policymakers have stuck their heads in the sand. The 2016 draft budget sent to Congress this week by the president, Dilma Rousseff, builds in a primary deficit for the first time in the post-hyperinflation era (see article). The very legality of a budget with a primary deficit has been questioned: a fiscal-responsibility law passed in 2000 has long been interpreted as banning spending that outstrips receipts. But whatever the legal debate, the budget is calamitous.
First, Brazil would have to borrow to cover all its interest payments—a risk for a country with by far the highest real interest rates of any sizeable economy, at a time of recession and wider emerging-market jitters. Second, a primary deficit sends a bleak message about Brazilian economic management. Since the turn of the century Brazil’s government has been guided by three principles: a credible inflation target, a floating currency and primary surpluses, ideally large enough to bring public debt down. This “tripod” allowed it to move away from its hyperinflationary past, convinced ratings agencies to grant it an investment-grade badge and underpinned growth that propelled millions out of poverty. All this is now in jeopardy.
Ms Rousseff is not the only one to blame. She had hoped to run a primary surplus, despite the recession, by resurrecting a tax on financial transactions that was abolished in 2007. But her political weakness put paid to that plan. At just 8%, her public-approval rating has hit depths unplumbed by any previous Brazilian president, undermining her authority in Congress. Lawmakers are also angered by her finance minister’s attempts to rein in pork-barrel spending, and alarmed by a wide-ranging investigation into corruption at the state-controlled oil giant, Petrobras. Knowing that the new tax would be unpopular—and hoping to weaken Ms Rousseff further—they made it clear that they would block it.
Congress, Ms Rousseff’s advisers say, must now find a way to pay for the spending it refuses to cut. But it is stuffed with short-termists who are more concerned with lining their pockets than securing Brazil’s future. Many, both in the opposition and among her supposed allies, are wasting their energy trying to impeach Ms Rousseff, rather than finding a way to fix the budget. Unless this impasse is resolved quickly, business and consumer confidence will fall further and foreign investors will pull out. Brazil will be headed for a multi-year slump and a ratings downgrade.
Heaven can wait
So how might Brazil reach a primary surplus? By far the best solution would be to cut public spending, which accounts for more than 40% of GDP, much more than in other middle-income countries. Ms Rousseff has scaled back some discretionary spending, for example by promising to merge some ministries. But the 2016 budget includes plans to raise the minimum wage and many welfare payments by a whopping 10%. Congressional gridlock and a constitution that is chock-full of unaffordable spending commitments mean that only rarely have Brazilian governments managed to trim outgoings—and only under presidents endowed with remarkable political and leadership skills. Ms Rousseff falls far short of that ideal.
That leaves the sticking-plaster. The proposed financial-transaction tax would be, like so many Brazilian taxes, poorly designed and hard on growth. But it would still be better than ramping up spending with no way to pay for it. If not this tax, then some other is needed—and after that, the business of reforming Brazil’s greedy and profligate government.
The Real Housewives of Ukraine
Despite revolution and war, Ukraine’s capital is a Mecca for glamorous young girls on the make. And there’s no shortage of eager sugar daddies.
Golden Vintage boutique is hidden in a private villa nestled among other townhouses in an elite district of Kiev called Pechorsky. There was no sign on the entryway, only the small letters “GV” on a security phone to let the visitor know she was at the right address. The boutique sells presents for Ukrainian gold miners—or more exactly, diggers. Inside, in dramatically decadent décor, a shopper can find forests of silk and velvet designer cocktail dresses, rows of Birkin, Hermes, and Channel purses, expensive diamond rings, necklaces, armies of Jimmy Choo and Christian Louboutin shoes, some covered with golden spikes. Almost all shoes had thick platforms or enormous heals, for beautiful long-legged Ukrainian girls to look even longer-legged.
That is not an ordinary shop. The items on sale were gifts that wealthy Ukrainian men, bankers, businessmen, or bureaucrats give their so called “girls of glamour,” their gold-diggers. Similar showrooms pop up all over Kiev these days, some in private houses or apartments. “Here is how it works,” the Golden Vintage shop assistant, Andriy, explained, full of smiles, unveiling the lifestyle secrets of the Ukrainian elite. “The girl normally asks two of her wealthy lovers for the same present, so one gift she can sell, and the other wear, not to offend any of the gift givers.” Andriy pulled out a box of Chanel shoes for $8,000—“adored, exclusive items”—and then a Marc Jacobs watch worth $300,000.
If only Andriy were a woman, he said, he would not mind wearing some of the most interesting clothes and shoes that the Golden Vintage offered. “Our clients are smart business ladies, they know that exclusive Marc Jacobs watch or every girl’s dream, a 25cm Birkin purse, will have great value in a year or two, so smart ladies ask for the right presents,” he said. At the time when Ukraine is mired in war, poverty, a flagging economy, its golden youth acted as if they were inhabiting an Eastern European Belle Époque.
The most shocking were the plastic surgeries.
Alena Loran, a 23-year-old kept woman, bought up ad-space on billboards for “spasibushechki,” or “little thank you” notes—for fur coats, cars, a pair of new red shoes, even for cash money. Then came the little thank you for her new lips, pink and pillowy, which Loran called her “dumplings.” She even appeared in “Casta,” a Ukrainian television series, about the golden youth of Kiev, and published her own book about a provincial girl coming to live in the capital to cheat and fool rich men. It was titled Alice in Wonderland. Loran soon had sugar daddies paying for sculpted cheekbones, eyelids and a sharper chin line. “Just two weeks ago, I had three plastic surgeries,” the diva confessed to The Daily Beast from the OK Bar in Kiev.
Loran blamed the Euromaidan Revolution for causing dark times for the Ukrainian elite. “The revolution did not clean away hypocrisy. When teachers make $100 a month, golden youth spend that on a drink; judging by the Instagram pictures, everybody is now in Monaco or Miami,” she said. “Kiev feels empty.” As for the movement that toppled the crooked Yanukovych government, she wanted nothing to do with it. “I am a girl thinking of my health, I had nothing to do on that square at -20 Celsius.”
It was indeed freezing cold on Kiev’s central Maidan Square when Lesia Litvinova, a well-known filmmaker pregnant with her fourth child, became a volunteer. She joined with the protestors on the square, and then, with three more friends, founded an air organization on Frolovskaya Street to help internally displaced persons, soldiers’ families—anybody who was in need. “Since then, I have not had time to go back to my normal life,” Litvinova told The Daily Beast in an interview at her headquarters last week.“We provide clothes, dishes, toys, and other necessary items for over 500 IDPs coming here every day.” Litvinova’s oldest daughter, a 15-year-old beauty, helped her mother tend to Ukraine’s needy. But Litvinova wasn’t resentful of the 1 percent-ers, gold-diggers in their gorgeous gowns and at their expensive beauty salons. “Some of these rich people contribute big money to volunteer centers,” she said.
Outside, Kiev stood in the full glamour of its green parks and golden cupolas. A place called Tsarsky (Royal) Sport Complex, a gym equipped with the most state-of-the-art and expensive Italian machines, invited Ukrainians to spend $2,500 a month on their health, outdoing New York’s Equinox gym by an order of magnitude. Still, some justified the extravagance as a way of moving on. “Even during these difficult times, business should not stop developing, our people should have ambitions, should choose what they live for, what they work and make money for,” Yekaterina Prokorova, a marketing manager, told The Daily Beast in an interview at Tsarsky. Prokhorova has formerly been a general manager at the Ramada Hotel in Donetsk, home for most international journalists who came to cover the war in the east. Tough, dangerous situations, dealing with armed rebels, made Prokhorova a Buddhist.
Back at the OK Bar, Alena Loran, the ideologist of Kiev’s gold diggers, was planning on writing a second book, instructing provincial girls like her (she arrived here nine years ago) to to be careful. “Ukrainian men are extremely spoiled by the constant flow of beauties their way,” she said. “The perfectly sculpted faces, after plastic surgeries, girls in designer brand clothes, with gorgeous skin and hair. To make a living on your beauty, one needs to be really smart. I want to protect the girls from making some mistakes I made.”
Exposing Russia’s Secret Army in Syria
Some wear uniforms, some don’t, but from highway checkpoints to jet fighters, Russians are being spotted all over the Assad dictatorship’s heartland.
Russian military officers are now in Damascus and meeting regularly with Iranian and Syrian counterparts, according to a source with close contacts in the Bashar al-Assad regime. “They’re out in restaurants and cafes with other high officials in the Syrian Army,” the source told The Daily Beast, “mainly concentrated in Yaafour and Sabboura, areas that are close to each other, and in west Mezze,” referring to a district in the capital where Assad’s praetorian Fourth Armored Division keeps an important airbase. “The Russians aren’t in uniform, but they’re constantly hanging out with officers from the Syrian Army’s central command.”
Other Syrians claim to have seen Russians in uniform.
One family recently traveled from Aleppo to Damascus by taxi before emigrating by plane to Turkey and says it saw a small contingent of Russian troops embedded with Syrians at a military checkpoint in the capital. “We were near the Shaghour district when we noticed two soldiers who were not Syrian,” a family representative said. “They were tall, blonde and blue-eyed and wore different fatigues from the Syrians and carried weapons. I’m telling you, they were Russian.”
The opposition-linked website All4Syria seems to corroborate such eyewitness accounts. Many residents of Damascus, it claimed, have “observed in the first three days of September a noticeable deployment of Iranian and Russian elements in the neighborhoods of Baramkeh, al-Bahsa, and Tanzim Kfarsouseh.” The Venezia Hotel in al-Bahsa “has been turned into a military barracks for the Iranians.”
Such news comes amid a flurry of reports that Russia has made plans for a direct military intervention in Syria’s four-year civil war and may actually have started one already. The New York Times reported Saturday that Russia has sent prefabricated housing units, capable of sheltering as many as 1,000 military personnel, and a portable air traffic control station to another Syrian airbase in Latakia. That coastal province, the Assad family’s ancestral home, has already seen Russian troops caught on video operating BTR-82 infantry fighting vehicles against anti-Assad rebels, atop rumors that Moscow may be deploying an “expeditionary force,” including Russian air pilots who would fly combat missions.
They may already be doing so. A social media account affiliated with the al-Qaeda franchise Jabhat al-Nusra posted images of what appeared to be Russian Air Force jets and drones flying in the skies of Syria’s northwest Idlib province. They were, specifically, the Mig-29 Fulcrum, the Sukhoi Su-27 Flanker, the Su-34 Fullback and the Pchela-1T drone. These images were analyzed as credible by the specialist website The Aviationist, which also noted that “during the past days, Flightradar24.com has exposed several flights of a Russian Air Force… Il-76 airlifter (caught by means of its Mode-S transponder) flying to and from Damascus using radio call sign ‘Manny 6,’ most probably supporting the deployment of a Russian expeditionary force.”
ISIS isn't in Idlib; the terror army that calls itself the Islamic State was driven out of the province completely. As one U.S. intelligence official put it to The Daily Beast, "The question is, what are Russia's underlying motivations? Are they really there to fight [ISIS], or just to prop up Assad?"
The concern is that Russia could use military strikes against ISIS as a kind of cover or feint for attacking rebel forces as well, including non-Islamist groups. The U.S. sees these forces as a potential bulwark against ISIS. But they also have as one of their primary goals overthrowing Assad—an effort that Washington has been unwilling to support.
The White House has fallen back on its customary posture of wait-and-see as proof mounts that the Russians are coming. Spokesman Josh Earnest told reporters this week: ”We are aware of reports that Russia may have deployed military personnel and aircraft to Syria, and we are monitoring those reports quite closely. Any military support to the Assad regime for any purpose, whether it's in the form of military personnel, aircraft supplies, weapons, or funding, is both destabilizing and counterproductive.” Another unnamed U.S. official told Britain’s Daily Telegraph, ”Russia has asked for clearances for military flights to Syria, [but] we don't know what their goals are.”
Actually, their goals aren't terribly hard to discern, nor do they necessarily contradict implicit White House policy, whatever Josh Earnest says.
Photographs circulated on social media showing what appeared to be Russian soldiers in Zabadani, a city 45 kilometers north of Damascus, which has changed hands several times during the civil war. For months rebels have been fending off a scorched-earth assault by the Syrian army, Hezbollah and Iranian forces, which the U.N. assesses to have led to “unprecedented levels of destruction.” So the injection of Russian legionnaires into a multinational cocktail of combatants duking it out in Zabadani would make perfect sense. The city is considered the sine qua non of Iran’s “strategic corridor” in Syria, which runs from the capital to Lebanon and up along the Mediterranean coastline. The formidable Islamist rebel brigade Ahrar al-Sham knows who’s in charge here—it has even negotiated an ultimately unsuccessful ceasefire directly with the Islamic Republic rather than with Assad.
“The Russians are clearly setting themselves on the ground in regime areas, planting the flag in ‘Alawistan,’ as it were,” says Tony Badran, a Syria expert at the Foundation for the Defense of Democracies, referring to the Alawites, the schismatic Shia sect to which the Assad clan and the more powerful Syrian regime elites belong. “This, ironically, reinforces the Obama administration’s position, which has drawn a clear line around the regime enclave. The opposition is not to enter Damascus and the coastal cities. So the Russian deployment actually fits well with the administration’s approach.”
Right on cue, then, came Russian President Vladimir Putin’s announcement Friday that Syria would soon hold new parliamentary elections and inaugurate a power-sharing government with what he deemed a “healthy” opposition. He did not specify what he considered the diseased opposition, although this would almost certainly include Free Syrian Army fighters the CIA and Pentagon has been recruiting as U.S. proxies.
While Putin dismissed the existence of any Russian combat forces in Syria as “premature,” he did allow that he was “looking at various options” for militarily involving himself in the war. Coming from someone who only admits to Russian invasions after the fact, such a signposting of motive should not be ignored.
Moscow’s close coordination with Tehran, both in Damascus and internationally, is also no coincidence. Iran is now busy shopping a new international “peace plan” for Syria, one that goes beyond the parameters of the previously inked Geneva II protocol.
Intriguingly, just weeks after Iran agreed to a deal to control its nuclear program in exchange for international sanctions relief, Maj. Gen. Qasem Soleimani, the commander of its own expeditionary force, the Islamic Revolutionary Guards Corps-Quds Force, flew to Moscow for talks with Russian officials, violating the international travel ban related to his terrorist activity. No doubt solidifying Russian backing for whatever he has planned for Syria was high up on Soleimani’s agenda.
It’s worth noting that this isn’t the first time since the Syrian war broke out that there’s been chatter about Russian troops in Damascus.
In May 2013, sources close to the Kremlin suggested that Putin had dispatched the Zaslon special forces detachment to the Syrian capital. Formed in 1998, and conceived as a clandestine unit combining the purviews of America’s Delta Force and Secret Service, Zaslon consists of a mere 280 highly-trained operatives. It answers to Russia’s foreign intelligence service, the SVR, and is tasked with protecting high-value Russian officials in uncertain conditions and sometimes even conducting assassinations. It was rumored to have killed Iraqi insurgents in 2006 after the latter had captured and executed Russian diplomats.
As Mark Galeotti, a New York University-based specialist on Russia’s military and security forces, observed two years ago: “According to one Russian report, two Zaslon elements were also deployed to Baghdad in the dying days of the [Saddam] Hussein regime. Their mission was to seize or destroy documents which Moscow would have found embarrassing had they ended up in U.S. hands. Given the scale and depth of Russian support for Assad, it could similarly be that they are also in Syria to cover Moscow’s tracks or else ensure that sensitive military technology — including new surface-to-air systems — does not end up in foreign hands.”
Musings on Markets
The Fed, Interest Rates and Stock Prices: Fighting the Fear Factor
Posted: 04 Sep 2015 04:47 AM PDT
If it feels like you are reading last year’s business stories in today's paper, there is a simple reason. The Federal Reserve's Open Markets Committee (FOMC) meeting date is approaching, and in a replay of what we have seen ahead of previous meetings, we are being told that this is the one where the Fed will lower the boom on stock markets, by raising interest rates. While this navel gazing may keep market oracles, Fed watchers and CNBC pundits occupied, I think that the Fed’s role in setting interest rates is vastly overstated, and that this fiction is maintained because it is convenient both for the Fed and for the rest of us. I think that there are multiple myths about the Fed’s powers that have taken hold of our collective consciousness, and led us into an investing netherworld. So at the risk of provoking the wrath of Fed watchers everywhere, and repeating what I have said in earlier posts, here are my top four myths about central banks.1. The Fed sets interest rates
Myth: The Federal Reserve (or the Central Bank of whichever country you are in) sets interest rates, short term as well as long term. In my last post on this topic, I mentioned my tour of the Federal Reserve Building, with my wife and children, and how sorely tempted I was to ask the tour guide whether I could see the interest rate room, the one where Janet Yellen sits, with levers that she can move up or down to change our mortgage rates, the rate at which companies borrow from banks and the market and the rates on US treasuries.Reality: There is only one rate that the Federal Reserve sets, and it is the Fed Funds rate. It is the rate at which banks trade funds, that they hold at the Federal Reserve, with each other. Needless to say, not only is this an overnight rate, but it is of little relevance to most of us who don't have access to the Fed windows. While there is a tenuous link of Fed Funds rate to short term market interest rates, that link becomes much weaker when we look at long term rates and their derivatives.Why preserve the myth: Giving the Fed the power to set interest rates gives us all a false sense of control over our economic destinies. Thus, if rates are high, we assume that the Fed can lower them by edict and if rates are too low, it can raise it by dictate. If only..2. Low interest rates are the Fed’s doingMyth: Interest rates are at historic lows not just in the United States but in much of the developed world, and it is central banking policy that has kept them there, through a policy of quantitative easing The myth acquires additional sheen when accompanied by acronyms such as QE1 and QE2, which bring ocean liners to my mind and a nagging fear that the next Fed move will be titled the Titanic!Reality: The Fed has had a bond-buying program that is unprecedented and large, but only relative to the Fed's own history. Relative to the size of the US treasury bond market (about $500 billion a day in 2014), the Fed bond-buying (about $60-$85 billion a month) is modest and unlikely to have the influence on interest rates that is attributed to it. So, what has kept rates low? At the risk of rehashing a graph that I have used multiple times, it is far simpler and more fundamental, and it lies in the Fisher equation, which decomposes the nominal interest rate into its expected inflation and real interest rate components:Nominal Interest Rate = Expected Inflation + Expected Real Interest RateIf you make the assumption that in the long term, the real interest rate in an economy converges on real growth rate, you have an equation for what I call an intrinsic risk free rate. In the graph below, I graph out the actual US 10-year treasury bond rate against this intrinsic risk free rate and you can make your own judgment on why rates have been low for the last five years.'
To me, the answer seems self evident. Interest rates in the US (and Europe) have been low because inflation has been non-existent and real growth has been anemic, and it is my guess that rates would have been low, with or without the Fed’s exertions. In fact, the cumulative effect of the Fed's exertions can be measured as the difference between the intrinsic risk free rate and the US treasury bond rate, and during the entire quantitative easing period of 2008-2014, it amounted to about 0.13%. It is true that the jump in US GDP in the most recent quarter has widened the difference between the treasury bond rate and the intrinsic interest rate, but it remains to be seen whether this increase is a precursor to more healthy growth in the future, or just an one-quarter aberration.Why preserve the myth: I think it is much more comforting for developed market investors to think of low interest rates as an unmitigated good, pushing up stock and bond prices, rather than as a depressing signal of future growth and low inflation (perhaps even deflation) in much of the developed world. That problem will not be fixed by Fed meetings and is symptomatic of shifts in global economic power and a re-apportioning of the world economic pie.3. The reason stock prices are so high is because rates are lowMyth: Stock prices are high today because interest rates are at historic lows. If interest rates revert back to normal levels, stock prices will collapse.Reality: Low interest rates have been a mixed blessing for stocks. The low rates, by themselves, make stocks more attractive relative to the alternative of investing in bonds. But if the low rates are symptomatic of low inflation and low real growth, they do have effects on the cash flows that can partially or completely offset the effect of low rates. One way to decompose the effects is to compute forward-looking expected returns on stocks, given stock prices today and expected cash flows from dividends and buybacks in the future to see how much of the stock price effect is fueled by interest rates and how much by cash flow changes. If this bull market has been entirely or mostly driven by the drop in interest rates, the expected return on stocks should have declined in line with the drop in interest rates. In my most recent update on this number at close of trading on August 31, 2015, I estimated an expected return of 8.50%, almost unchanged from the level in 2009 and higher than the expected return in 2007.At least based on my estimates, the primary driver of stock prices has been the extraordinary fountain of cash that companies have been able to return in the last few years, combined with a capacity to grow earnings over the same period. By the same token, if you are concerned about cash flows, it should be with the sustainability of these cash flows, for two reasons. The first is that earnings will be under pressure, given the strength of the dollar and the weakness in China, and this is starting to show up already, with 2015 earnings about 5-10% below 2014 levels. The second is that companies will not be able to keep returning as much as they are in cash flows; in 2015, the cash returned to stockholders stood at 91% of earnings, a number well above historic norms. In the table below, I check to see how much the index, which was at 1951.13 at the close of trading on September 3, would be affected by an increase in interest rates (increasing the US 10-year T.Bond rate from the 2.27% on September 3, to 5%) as contrasted with a drop in cash flows (with a maximum drop of 25%, coming from a combination of earnings decline and reduced cash payout):
Base: S&P 500 on September 3= 1951.13, T.Bond rate = 2.27%; ERP = 6.34%, g=6.30% If you hold cash flows constant, an increase in interest rates has a relatively small effect on stock prices, with stock prices dropping 8.76%, even if the US T.Bond rate rises to 5%. In contrast, if cash flows drop, the index drops proportionately, even if interest rates remain unchanged. You are welcome to make your own "bad news" assumptions and check out the effect on value in this spreadsheet.Why preserve the myth: For perpetual bears, wrong time and again in the last five years about stocks, the Fed (and low interest rates) have become a convenient bogeyman for why their market bets have gone wrong. If only the Fed had behaved sensibly and if only interest rates were at normal levels (though normal is theirs to define), they bemoan, their market timing forecasts would have been vindicated.4. The biggest danger to the Fed is that the market will react violently to a change in its interest rate policyMyth: The biggest danger to the Fed is that, if it reverses its policy of zero interest rates and stops its bond buying, stock and bond markets will drop dramatically.Reality: While no central bank wants to be blamed for a market meltdown, the bigger danger, in my view, is that the Fed does what it has been promising to for so long, and nothing happens. That is a good thing, you might say, and while I agree with you in the short term, the long-term consequences for Fed credibility are damaging and here is why. The best analogy that I can offer for the Fed and its role on interest rates is the story of Chanticleer, a rooster that is the strutting master of the barnyard that he lives in, revered by the other farm animals because he is the one who causes the sun to rise every morning with his crowing (or so they think). In the story, Chanticleer’s hubris leads him to abandon his post one morning, and when the sun comes up anyway, the rooster loses his exalted standing. Given the build up we have had over the last few years to the momentous decision to change interest rate policy, think of how much our perceptions of Fed power will change, if stock and bond markets respond with yawns to an interest rate policy shift.Why we hold on to the myth: If you buy into the first three myths, this one follows. After all, if you believe that the Fed sets interest rates, that it has deliberately kept interest rates low for the last five years and that stock prices are high because interest rates are low, you should fear a change in that policy. Coupled with China, you have the excuses for your underperformance this year, thus absolving yourself of all responsibility for your choices. How convenient?
What next?
Over the last five years, we have developed an unhealthy obsession with the Federal Reserve, in particular, and central banks, in general, and I think that there is plenty of blame to go around. Investors have abdicated their responsibilities for assessing growth, cash flows and value, and taken to watching the Fed and wondering what it is going to do next, as if that were the primary driver of stock prices. The Fed has happily accepted the role of market puppet master, with Federal Bank governors seeking celebrity status, and piping up about inflation, the level of stock prices and interest rate policy. Market watchers, journalists and economists have found stories about the Fed to be great fillers that they can use to fill financial TV shows, newspaper and opinion columns.
I don't know what will happen at the FOMC meeting, but I hope that it announces an end to it's "interest rate magic show". I think that there is enough pent up fear in markets that the initial reaction will be negative, but I am hoping that investors move on to healthier, and more real, concerns about economic growth and earnings sustainability. If the Fed does make its move, the best news will be that we will not have to go through more rounds of obsessive Fed watching, second-guessing and punditry.
Past PostsData
- The Fed and Interest Rates: Lessons from Oz (June 21, 2013)
- Dealing with Low Interest Rates: Investing and Corporate Finance Lessons (April 2015)
Spreadsheets
