Wednesday, 18 November 2015

Swarm Economics

Whilst a lot of attention has been paid today to the BoAML fund manager survey my attention was more drawn to their lesser mentioned small business report which can be found here.  I was struck by the hugely upbeat nature of it with investment and hirings planned at a pace. This was particularly of interest because I think the world of small business is too often (always) lost in the reportage of big business.

I now run a small business. I used to work for big business. It has been eye opening.

Working for big banks dealing with big clients, analysing big companies and looking at the data that they provide gave me the impression that big business is the driving force in the world. Having left a large institution and been immersed in the small business world I can see just how misinformed and blind I was. Small business is responsible for 50% of GDP yet coverage is naturally biased towards the big companies.

Most small business is privately owned and because of that rarely gets reported on. If there aren’t myriads of investors then the audience for any analysis or reporting is reduced to miniscule. This leads the wires to be swamped with further perception bending pieces on big business alone. And then there is the matter of size distribution. Though that 50% of GDP is made up by small business it is easier to focus a biopsy on an elephant than each individual ant in a huge ant hill. Hence small business is further ignored.

Yet conditions for doing business as small business are improving and it is expanding in response. Technology is making it so much easier to establish small businesses, from cloud software to run accounts, legal functions, HR and reporting, to the internet making communication from a barn in the countryside as practical as sitting in an expensive city centre office. It is not that hard and the advantageous synergies of large business are being whittled down. In fact there are efficiencies in being a private small business compared to a public behemoth that has management sapped by and legions employed in investor relations keeping shareholders and regulators happy.

Small is good and with the model of egalitarian exposure proven for the individual through social media models it is becoming replicable for small business. Now advertising your wares is dependent as much on the viral nature of the idea or product you have rather than how much money you pay to put it through traditional costly media placements. The playing field is being dramatically levelled. I may not be unique in bypassing any tweet or facebook post sponsored by a large corporate, more likely being enticed by something novel from an unknown.

The mistrust of large corporates is not diminishing with the latest VW scandal further pushing large corporate reputation after than of bankers. The fashion for artisanal goods has naturally spread to that of artisanal companies, and the term ‘small’ normally suffices for artisanal.

The idea of a swarm of companies driving the economy, each being technologically enabled to communicate efficiently with each other is seeing the formation of a virtual super corporate and that swarm operative is exhibited in the way the swarm employ too. One of the past disadvantages of running small companies has been the inflexibility of hiring due to the huge commitment just hiring one extra member of staff can make. As a percentage of total employees that one extra body can be large making it hard to fine tune. Thinking you need half a person more results in one or zero. Yet the technology that is making swarm business possible is making swarm employment possible too. Freelancing works and though zero hours gets terrible press it is in fact the most efficient way of employing and, if onerous competitive clauses aren’t invoked by single employers, allow for huge flexibility for the employee too (though I acknowledge than many need security).

Freelancing can be considered as the water poured into that glass of golfballs, marbles and sand that time management consultants like to use as an analogy for efficient planning. I would not be able to run my current business if I couldn’t outsource effectively to specialist services and freelancers when needed. It is not just the oil in the machine, it is now part of the machine itself. Whilst many complain that employees are being exploited by big business on such employment terms, down in the swarm it can be considered as a socialisation of jobs. The relationship between owner and employee is much more entwined at a smaller level and whilst big corporations pay lip service to employee interests few really care. At the small level you have to care.

With the importance of small business and its relative size I do wonder if data is getting missed that is more easily harvested form large corporates. One, for example, is exports. 70% of my clients are overseas yet I have never been asked to report my exports. Earnings data at the small level can get clouded too where director of small businesses tray to take dividends rather than salaries. The change effected in the UK next year with increased taxation on dividends will push the balance back towards salaries so there may well be a jump in reported wage earnings

Big business will continue to monopolise big investment projects where massive R+D spends or vast equipment investmets are needed but I wonder if even there there there is an advantage to fracturing up into a swarm of smaller units. The greatest being the dissemination of risk. If VW, BP or the big banks, rather than being huge mammoths for the litigators and regulators to target, were swarms of smaller companies then corporate malfeasance would be harder to pursue. Attacking a swarm of ants is harder than killing a mammoth. One small component would be sacrificed and bankrupted for the good of the whole and the swarm would continue to function. In VW’s case it could have been the small unit that supplied the cheat software. Perhaps one day the documentation on car sale invoices will stipulate we aren’t buying one make but have separate contracts with each component supplier. Just as we do when we put together our homes.

The ants are making the elephant's life uncomfortable.

Other interesting links -

Monday, 16 November 2015

When in Doubt do Nowt.

The plethora of news headlines ending ‘as/because of Paris attacks’ is hugely infuriating.
The best one must have been the The UK Sunday Times with 'Paris attack rattles markets as ECB readies cash injection’ written on Sunday. Sunday, before the markets had a chance to show any rattledness through price. Pure speculation.

The subsequent move higher in global stocks has had journos scrambling to fudge away their expectation of financial meltdown, but we have to remember that those selling are not selling on the Paris event but how they think others will react to the Paris events.

'Buy the rumour, sell the fact' is better phrased today in a glorious 'Sell the fact, buy the hope'

Moving swiftly on, the moves lower in ‘stuff’ have fitted with my feelings expressed in my last posts at the end of October (Sorry for not posting since then, I have really had nothing to say) as the bullish momentum finally faded. Back then I was surmising that dovish expectation from the FED and ECB were at an extreme and any change would wobble things lower. So it has been with the Fed, where we are now back to expecting a December hike with confidence levels, as represented though Fed futures, at levels not seen since the Fed last moved. So it is very tempting to now think that market disappointment at a hint of no move would be worth playing.

My basic rule is that if we consider this game theory where H= Hawkish Fed and h = hawkish ECB and 'D' and 'd' the dove versions. Dd and Hh are equity trades whilst Dh and Hd are FX trades.
So since last commenting when we were at Dd we are now at Hd and indeed the equity trade has unwound a fair chunk to more neutrality and the FX trade is in play via EUR/USD. ECB expectations appear to be stuck in ‘d’ for awhile yet but there is another chance of Fed to move from H to D.

China - Xi says China GDP will be 7%. Really? Either he has more control of the economy than I thought or he is playing King Canute

Oil.- If ever there was proof that the world isn't expecting the Middle East to blow up to an extent that oil supply would be effected then the price of oil is it. Supply is assumed to be safe. I am surprised that the Saudis are being allowed to get away with such supply aggression. I am surprised that the Saudis are not being leaned on by many western allies to do something about it. I am surprised by many things that centre upon Saudi Arabia. Quizzical too. 

All in all I am worried about the state of the world but that doesn't easily translate into market prices as bad can mean good and good bad. It get's more complicated when I still feel that inflation is the end game and though central banks are shaking hard at the inflation bottle, it contains a genii that will screw everything. 

There are charts of doom everywhere but there have been charts of doom everywhere for the past six months and markets have only oscillated.  Nothing grabs me. So though I have been running short risk for the pat few weeks I am taking a lot of those shorts back. 

When in doubt do nowt. 

Not a Happy Christmas for Bank Employees.

First please forgive me for not commenting on the terrible events in Paris, nor offering any solution. My horror and sympathies are total and absolute but don't need publicly broadcasting and I have no solutions. Instead I am going to ramble about the employment prospect  for financial analysts and traders.

Parkinson’s rule - "work expands so as to fill the time available for its completion".

Parkinson's rule,  data derivative - "data expands to fill the data storage space available".

Polemic’s rule of Fed watching  - "the number of forward Fed moves analysed will fill the amount of analysis available".

This observation was triggered by my first sightings of speculation as to when the next Fed move will be after the one that is ‘obviously’ going to be in December. This reallocation of analyst CPU time to the next task, having decided that the first task is complete or at least now only needs minimal background processing, might be worthy but is probably not. The huge amount of processing power applied to working out the first Fed move has been so inaccurate over the last few years that moving on to the next derivative seems foolhardy at best. The further up the derivative family tree one goes the greater the compounding error factors mount up.

The traditional analyst model is that analysts are much like the CPU in your computer. You have paid for it to sit there so you might as well have it doing something. Most analysts are employed full time by institutions and so are expected to be analysing things for every hour that they are in paid employment. This results in a fixed analyst supply that does not respond to demand, well not swiftly anyway (I’ll come on to that later). So when demand shoots up, usually when markets are flying around, accompanied by economic, financial or political crises, the limitation of supply means there isn’t enough analysis going on, or at least not at the speed needed, but when things are deadly quiet analysts apply themselves with equal vigour to the equivalent of the SETI project, examining noise and trying to find patterns of life in it. Yet most of it really is noise, such as trying to determine when the fourth Fed hike will be or if the colour socks that a CEO wears has any bearing on profitability.

Yet supply of 'analysis' is not totally fixed. An increase in demand sees part-time analysts come out of the woodwork, forgoing their other day jobs for an hour or two to do part-time analysis. Yet unlike a normal supply and demand curve where an increase in demand will see prices rise and a better quality of analyst feel it worth getting out of bed to fill the gap, these part time analysts are usually of dramatically lower quality. Every Tom, Dick and Harry jumps on the airwaves to give their analysis, which is usually just a view, making it harder to filter out the wheat from the chaff.

This is how it has been, but the shape of the analyst market is changing fast. Banks are under the cosh as their investment bank arms are dramatically trimmed or closed. The strategy desks in banks have always been as much showmen as market calling geniuses but if no one is willing to pay for the show can we expect the show to go on?

Funds are turning more to algo and roboadvisory, macro funds are performing appallingly and restructuring, even the mighty Brevan Howard let 70 people go last week and tough they are said to be back office and support it is part of a bigger underlying trend. Even the target audience for independent analyst companies are having their spends questioned by investors and regulators.

With strategy and analyst desks being shredded there is a growing population of individuals out there looking to either rejoin other units, coagulate into smaller cooperatives or go it on their own. Going it on your own is exceptionally hard and unless you have been a super-name and can afford to hire an infrastructure around yourself to provide the management and sales support you are most likely to end up as a zero hours contractor hoping that the spiel you put out gets read. It is very hard for a one man show to switch hat at the end of a presentation to become salesmen and negotiate fees. Getting read is hard enough with every bank and house feeling obliged to put something out each day but then getting followed is probably only as good as your last five calls. The horrible reality is that even if you get the first four calls right the chances are the client will act on your fifth which turns out wrong, so despite a 80% hit rate you are back to square one.

The banking layoffs are continuing with a vigour in the trading operations too. The Sunday Times story yesterday 'Bonfire of the bankers" (sorry it's paywalled) encapsulates it but there is a lot more going on below the surface of the headline banks. All the second and third tier global operators who have units in London are going through the same pain. The latest raft of layoff are going to find life even tougher than the first as alternative employment posts have already been applied for. Moving to completely different careers is tough for many as the skill sets developed in dealing rooms are not as transferable as many think.

If traders are hoping to move into the corporate sector they will find that their too restructuring has killed any ‘profit centre’ style trading reducing then back to old fashioned hedging units. Risk taking opportunities in Hedge funds has collapsed too. Macro performance this year has been appalling and the layoffs in that sector continue. Brevan’s lay off of 70 staff last week may be tagged as ‘back office and support’ but that doesn’t hide the trend. The alpha singularity is being approached. The mind boggling application of IQ chasing the finest basis point has driven alpha returns to microscopic levels as trends are lacking and most macro trades are based upon the development of a trend. Even when one does arise it is interesting to see that funds rarely outperform the trend once leverage and risk allocation have been discounted.

So where’s the margin gone? Any one popping into a bank or trying to transact FX at an airport Travelex can see that margin is alive and well but at the lower retail sector leading, in the UK, to a proliferation of new companies stepping in to try to take value out it. If you run a small company you will no doubt be currenty recieving cold call on daily basis from small shops offering you bank beating FX rates. I can only assume that they are growingly staffed by ex-wholesale salesfolk who have managed to find a home before becoming the drivers of FX taxis (even that back stop has been screwed by Uber).

The squeeze in pricing will continue to cascade down the retail tree until even that becomes a margin singularity as someone such as Google or Amazon steps in offering FX services or even, someone (and here’s an idea) sets up the Uber of FX where you type in how much cash you want and the app tells you in real time the location of anyone willing to do the other side of the trade allowing you to meet on a street corner and swap your currency notes. Security would be a problem though, with the app becoming a muggers guide so the next iteration would lead on to centralised Amazon style distribution centers and which point, voila, we have recreated the original biblical hall of the money changers.

The upshot of all if this is that the employment prospects of rafts of university leavers hoping to join a well paid and steady carrier in the City are shot. The whole idea of a City career has been anathema to me for years. Most city workers have a series of jobs, not a career.

However if you are a 15 year old wondering what to do, finance may not be such a stupid choice.  By the time you finish university the banks will have fired too many people and suddenly be desperate to find new cannon fodder.

I will end here and comment on markets in a further post, but I have a feeling that any readership I have in financial institutions will be be dramatically culled in the next month or so. Sorry folks, it isn’t going to be a happy christmas for many.