Is efficient-market theory becoming more efficient?
BUILD a better mousetrap, the saying goes, and the world will beat a path to your door. Find a way to beat the stockmarket and they will construct a high-speed railway. As investors try to achieve this goal, they draw on the work of academics. But in doing so, they are both changing the markets and the way academics understand them.
The idea that financial markets are “efficient” became widespread among academics in the 1960s and 1970s. The hypothesis stated that all information relevant to an asset’s value would instantly be reflected in the price; little point, therefore, in trading on the basis of such data. What would move the price would be future information (news) which, by definition, could not be known in advance. Share prices would follow a “random walk”. Indeed, a book called “A Random Walk Down Wall Street” became a bestseller.
The idea helped inspire the creation of index-trackers—funds that simply buy all the shares in a benchmark like the S&P...Continue reading
What the German economic model can teach Emmanuel Macron
IT IS heartening that the euro area has a knack for surviving near-fatal crises. Yet confidence in the durability of the single currency might be stronger if it suffered fewer of them. Europe dodged its latest bullet on May 7th in France, when Emmanuel Macron, a liberal-minded (by local standards) upstart centrist, defeated Marine Le Pen for the presidency. Even so, an avowed nationalist and Eurosceptic captured 34% of the vote, leaving Mr Macron with five years to assuage widespread frustration with the economic status quo. An obvious model lies just across the Rhine, where the unemployment rate—below 4%, down from over 11% in 2005—is testimony to the potential for swift, dramatic change. Yet Germany’s performance will not be easy to duplicate.
It would be unfair to call France the sick man of Europe; half the continent is wheezing or limping. Yet there is certainly room for French improvement. Real output per person has barely risen in the past decade. Government spending stands at 57% of GDP, outstripping the tax take; France’s budget deficit, at 3.4% of GDP, is among the largest in the euro area’s core. The biggest worry, however, is the labour market. The unemployment rate, now 10.1%, is stubbornly high. Nearly a quarter of French young adults are unemployed. Worklessness, especially among young people, is a source of rising social tension and a...Continue reading
To forecast share returns, count buy-backs as well as dividends
WHAT is the point of buying shares? Ultimately investors must hope that the cash they receive from the company will offer an attractive long-term return.
Over the long run, reinvested dividends rather than capital gains have comprised the vast bulk of returns. But since the 1980s American firms have increasingly used share buy-backs, which have tax advantages for some investors. Buy-backs have been higher than dividend payments in eight of the past ten years.
In a buy-back, investors receive cash for a proportion of their holdings. A new paper* in the Financial Analysts Journal argues that adding this to dividend receipts to calculate a total payout yield gives a better estimate of future returns than the dividend yield alone. It also reveals a much better match between stockmarket performance and overall economic growth.
Using data going back to 1871, the authors find that the average dividend yield has been 4.5% and the total payout yield 4.89%. Since 1970 the dividend yield has dropped to 3.03%, but the total payout yield has averaged 4.26%. Looked at on that basis, the overall income return from shares has been not that far below historical levels.
The return from shares can be broken down into three components: the initial income yield; growth in the income stream; and any change in valuation. (If shares become more...Continue reading
May’s mandate melts
UK politicsRead more British election coverage
THERESA MAY, Britain’s prime minister, called a surprise election for June 8th arguing that she needed a strong mandate for negotiating Brexit. The pound rallied on the news, in the belief that a large Conservative majority would allow Mrs May the flexibility to do a deal with the EU, and see off the hard-liners among her party.
For a while, it looked as if the plan was going well. The Conservatives had a 20-point lead in some polls. But the party’s campaign, heavily reliant on the appeal of its leader and the...Continue reading
- Machine-learning promises to shake up large swathes of finance
MACHINE-LEARNING is beginning to shake up finance. A subset of artificial intelligence (AI) that excels at finding patterns and making predictions, it used to be the preserve of technology firms. The financial industry has jumped on the bandwagon. To cite just a few examples, “heads of machine-learning” can be found at PwC, a consultancy and auditing firm, at JP Morgan Chase, a large bank, and at Man GLG, a hedge-fund manager. From 2019, anyone seeking to become a “chartered financial analyst”, a sought-after distinction in the industry, will need AI expertise to pass his exams.
Despite the scepticism of many, including, surprisingly, some “quant” hedge funds that specialise in algorithm-based trading, machine-learning is poised to have a big impact. Innovative fintech firms and a few nimble incumbents have started applying the technique to everything from fraud protection to finding new trading strategies—promising to up-end not just the humdrum drudgery of the back-office,...Continue reading
- A trade deal between the EU and east Africa is in trouble
THE winds that waft along the Swahili coast change direction with the seasons, a boon to traders in times past. Shifts in the political winds are harder to predict. Last July a proposed trade deal between five countries of the East African Community (EAC) and the EU was thrown into disarray when Tanzania backed out at the last minute. An EAC summit, scheduled for months ago, was meant to find a way forward. Held at last on May 20th in Dar es Salaam, after many postponements, only two presidents showed up. The deal is in the doldrums.
The pact is one of seven “Economic Partnership Agreements” (EPAs) the EU wants to sign with regional groups in Africa, the Caribbean and the Pacific. The first was agreed with the Caribbean in 2008; southern Africa followed suit last year. But progress in west Africa has also stalled, with Nigeria raising objections. The EPAs were promoted as a new breed of trade deal, and...Continue reading
- A new code aims to clean up the foreign-exchange market
FINANCIAL-MARKET traders have earned a pretty shocking reputation in recent years. From manipulating LIBOR, a benchmark interest rate, to rigging the daily fix of foreign-exchange (FX) rates, traders have shown themselves ready not just to stretch the rules, but to collude in outright illegality.
A global code of conduct for the FX market, unveiled on May 25th, aims to put things on a sounder footing. Drawn up over the past two years by a coalition of central bankers, known as the FX Working Group (FXWG), and supported by a panel of industry participants, the code’s 55 principles lay down international standards on a range of practices, from the handling of confidential information to the pricing and settlement of deals.
Such standards seem long overdue in the massive FX market. Roughly $5trn is traded every day (see chart). Many companies, pension funds and money managers depend on banks to hedge their exposure to currency fluctuations. Yet in the past traders colluded with one another...Continue reading
- How becoming a Hong Kong pensioner can save you tax
THE global war on tax evasion rumbles on. What began as an American onslaught, with the Foreign Account Tax Compliance Act (FATCA) of 2010, has been joined by more than 100 countries through an initiative called the Common Reporting Standard (CRS). Under this, governments will exchange tax information on their financial firms’ clients on a regular, “automatic” basis, without having to be asked for it, starting this year. Holdouts such as Panama, the Bahamas and Lebanon have, one by one, been frogmarched into line.
But tax-dodgers and their advisers are enterprising sorts, eager to clamber through the smallest loophole—and gaps in the CRS there are. One involves becoming a pensioner in Hong Kong.
The territory, home to a big financial centre, has a type of pension known as an ORS (for Occupational Retirement Scheme). The beauty of ORS from a tax evader’s point of view is that anyone can get one and they are not...Continue reading
- One bitcoin is worth twice as much as an ounce of gold
Fans of bitcoin, a crypto-currency, have long called it digital gold. Now this sounds like an insult: continuing its stellar rise, and adding more than 30% to its value in just a week, one bitcoin is worth more than $2,600, over twice as much as an ounce of gold. As The Economist went to press all bitcoins in circulation were worth over $43bn. A sum of $1,000 invested in bitcoins in 2010 would now be worth nearly $36m. Other crypto-currencies are also marching upward: together this week they were worth $87bn. But if the history of gold is any guide, what goes up will come down—and then go up again.
- Machine-learning promises to shake up large swathes of finance