Low, Lower, the Lowest

LOWLOWER THE LOWEST

Volume 2 - Issue 1FALL 2015

NIC Undergrad Review

NIC Undergrad ReviewVolume 2 - Issue 1

Contents04 Welcoming Remarks05 Looking Left and Right10 Divergent Monetary Policy and Its Consequences12 (Not so) Super Mario13 Danger Ahead? Carl Icahn on the Fed15 Imagine There’s No Hike18 Should I Invest in the World I’m in? Or the One I Want?20 Marchionne’s Way22 On Trump and Boris Leading the West24 Telecom Industry Calls for Consolidation26 Reputational Economy27 Real Estate: Today’s Ultimate Asset Class31 Russia’s Gas and Oil: a Tale of Two Strategies33 Power Games35 "Lost! Lost! My Precious is Lost!"38 Chinese Hard Landing?40 The Perfect Storm42 How to Hedge Against a Left-Wing Government in Portugal

Manuel de OliveiraManuel VassaloMariana FernandesMariana Ruivo Miguel AmaralMiguel GarçãoMiguel Moita de DeusPedro LeãoPedro Filipe RodriguesSebastião FernandesTiago Louro AlvesTiago Reganha

The TeamAfonso BorgesAndrey DmitrievCarlos Gonçalves Catarina Castela Diego TremiterraFilipe Berjano Francisco Gonçalves Gonçalo MarquesJoana MartinsJosé Alberto FerreiraInês CunhaManuel Antunes

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As the Editor-in-Chief of the NIC Undergrad Review, it is truly a pleasure for me to join the Nova InvestmentClub Undergraduate Division in welcoming you to the first issue of this magazine’s second volume. As thefirst undergraduate student-run business magazine in Portugal, the Nova Undergrad Review is theculmination of our experience, dedication, and work.

It is also our most ambitious project so far, both with regards to its content and international dimension. Forthis, we would like to give our warmest thanks to the Bocconi Students Investment Club for theircollaboration. We hope this is the beginning of what will become a very fruitful partnership.

Our goal is to provide insight and knowledge to the community at Nova. We want to engage students andpromote dialogue on the most current and relevant topics – from business, economics, and finance to ethics,politics, and technology.

Ultimately, we want to become one of the guiding lights of this community.

Having studied in the United States in an education that is very much built around intensive extracurricularstudent participation, I know for a fact that this club embodies a step in the right direction. Not unlike otherstudent activities, we want to help change students’ perspective of what constitutes the university experience.We want them to look past the curricula and identify the bigger picture. It is a picture of student initiative andcohesiveness, one which portrays an unwavering commitment to expanding and redefining our limits asstudents. It is an illusive quest of exploration and inquisitiveness – and it does not end.

For this reason, I truly believe that the fact that this is the work of undergraduate students does not takeaway from the magazine in any way whatsoever. Everything has been set to the highest of standards. Suchquality is a function of our belief in the extraordinary capacities of the student-body at Nova. Our studentshave demonstrated time and time again that they have the potential to magnificently follow any endeavor.

As a club, this is precisely what we attempt to achieve day in and day out. As such, we cannot emphasize itmore – namely, that we invite students at Nova to call upon us for whatever it is they need in their pursuit ofexcellence. This is both our most significant responsibility and our most fervent aspiration.

Above all, I would like to acknowledge the team. Extremely talented, each one of them is a force of nature.They bring a novel voice to the club – but above all, they are my peers. Needless to say, I had the easy job asEditor-in-Chief. My peers’ sacrifice and their drive to make these issues their own was instrumental. It followsthen that their passion is branded in each article.

Last but most certainly not least: a word to our founding members. Thank you. Thank you for taking the timeto create this unique platform for students at Nova. Thank you for caring, for lending us a helping hand inour times of need – for guiding us in our academic, professional, and social path. This, too, is yours.

Carlos Gonçalves

Welcoming Remarks


Looking Left and Right

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2015, what a time to be alive! Oilgoes bust, China slows down,M&A is through the roof and theMiddle Eastern turmoil goesglobal. NIC Undergrad Reviewwalks you through what was mostinteresting in this turbulent year.

MarketsIn 2015, oil prices made theheadlines once again. Withplunging oil prices, now at a 7-year low, many pundits expect itmay take years before oil pricesreturn to previous levels. It seemsthat even if US shale companiesor OPEC were to reduce supply,the fact is that demand sideproblems would likely persist.With December 2016 WTI oilfutures trading at around $46 abarrel, the Chinese economyslowing down, and Europebecoming more and more energy-efficient, it is not clear if oil priceswill rebound anytime soon. Toughtimes are likely to be ahead foroil-producing states such asVenezuela, Iran, Nigeria,Ecuador, Brazil and Russia.

2015 has also been a negativeyear for commodities, with majorcontracts posting 17% averagedeclines. The BloombergCommodity Index, for example,which tracks prices of futurecontracts in 22 raw materials,posted a 22% homologousdecline. The exception this yearhas been cotton, a market valuedthis year at $4.4bn and that rose5.4% in 2015. Cotton was one ofthe four commodities whose price

increased in 2015 – along withcocoa (14%), sugar (5.7%) andorange juice (0.5%).

American equities have also hadan interesting year. Despite a hardhit in late August, which left manyinvestors around the globe in afrenzy, the S&P 500 stood abovethe 2000 mark for almost all of2015. The NASDAQ 100exhibited steady growth,surpassing the all-time 4691.61record from the year 2000. TheDow Jones Industrial Average,has roamed the 18000 mark,performed mediocrely relative toits growth rate figures from thepast five years – exhibiting a clearslowdown.

As far as Asia is concerned, Julyand August were critical for theChinese economy. Chineseequities crashed approximately60% during the Summer as thegovernment tried to regulate theexcessive levels of investment.The Communist Party couldn’tprevent the booming of thefinancial bubble by enactingmeasures to limit short selling,stopping any IPO’s andtemporarily suspending the stocktrade, what motivated fear andterror among investors, whoturned to safer investinginstruments as U.S. treasuries.Hence, Chinese stock marketcollapsed, with the ShanghaiComposite and the Hang Sengplunging 8% on August 24th.

M&A activity also hit record

levels in 2015 during thebeginnings of December. At thetime of this article, M&A activityfor 2015 is at an estimated$4.3tn, a value that, according toexpectations, is supposed to landaround the $4.7tn by end of2015. Whatever happens inDecember, this year will go downas a golden one for M&A deals,as boardroom confidence, cheapdebt financing and pressure tobecome as efficient as possible ina slow-growth economy haspushed towards mergers ortakeovers.

The desire to avoid taxes in 2015has also been a main driver tomany of these newly-mergedcompanies, such as Pfizer Inc.and Allergan PLC, which had aroughly $160bn merger, the thirdlargest M&A deal of all time (afterAmerica Online’s acquisition ofTime Warner and Mannesmann’spurchase by Vodafone Airtouch,both by around $185bn). Othermassive deals this year were themerger of Charter with TimeWarner Cable, valued at $78.7bn,and Dell’s acquirement of EMCCorp. (for a valuation of $67bn).Overall, in 2015, we have seennine transactions valued at over$50bn, and fifty-eight valued at$10 billion or more – two recordsthat, again, have made 2015 oneof the best years on record forM&A activity. By comparison, in2014, only thirty-five of all dealsmade had a valuation over $5bnor more.

Reviewing 2015 and Sizing 2016 Up

NIC-UD First-Year Students


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A small note as well to theGoldman Sachs Group Inc. for itsranking as the top M&A adviser -advising roughly on $1.6tn worthof deals during 2015.

Outside the OfficeIn 2015, we have also beenwitnesses to the truly globalconsequences of the conflict thathas been escalating in the MiddleEast, particularly in Syria.

In 2015, the militant andextremist jihadist group Daeshhas seen its territory and influenceexpand but also shrink at times,as Russia and the US-led coalitionintensified their bombings and asSyrian and Iraqi governmentforces and the Free Syrian Armygained ground. Also fighting onthe ground are the Kurds, seekingto finally gain sovereignty, and theAl-Nusra Front, an Al-Qaedaaffiliate.

Though the war-torn region hasbeen pushing waves of refugeestowards Europe for some timenow, media coverage on the issueonly really intensified in 2015,sparking discussions after picturesof a drowning of a young Syrianboy. This has also sparkeddiscussion of the problems andthe fragility of the Schengen areaand the European borders.

Since the Daesh attacks in Paris,international authorities havecome to talk more and moreabout a global anti-DaeshCoalition. These efforts are,according to the West, beingfrustrated by Putin’s decision ofnot abandoning Assad, animportant ally to the Russians in ageopolitically crucial region. Inthe meantime, western powers

are coordinating bombings onDaesh positions.

The Kremlin has been giving airsupport to the Syrian Army after arequest from Assad. Russia has adifferent definition of “terroristgroups in Syria” and so it bombsnot only Daesh targets, but alsothe Al-Nusra Front and someelements of the Syrian opposition.Russian bombings also intensifiedafter Turkey shot down a Russianwarplane on the Turkish-Syrianborder. The Kremlin claimsTurkish behavior is due to its oilsmuggling from Syria incooperation with Daesh. Acontroversial accusation sinceTurkey has no interest in havingradical forces pushing refugees totheir borders.

In Europe, 2015 also saw theECB’s “Single SupervisoryMechanism” be put into place.The year also kicked off with theECB’s long-awaited QE program(€60bn a month) in the hopesthat economic growth in Europewould pick up (which, as it turnsout, has not been the case –insofar that the ECB justrecently increased the duration of

the QE program until at leastMarch 2017).

Besides the refugees and thestruggle to achieve significantgrowth levels, the EU has hadother problems on its handsduring 2015. June and July wereparticularly chaotic – with theradical leftwing Syriza, which wonthe Greek elections in early 2015,defaulting on an IMF payment.This led to an intensified periodof discussions and a nationalreferendum to vote on a bailoutpackage. To no avail, Syrizawould be later forced to accept aharsher bailout package than theone it had voted to reject. Overall,2015 was a shaky year for theEuropean project – tensions withrefugees, a sluggish economicgrowth and the rise ofEurosceptic and anti-establishment parties havedamaged the European project.

Turning over to the U.S., DonaldTrump has been making headlinesduring the Republican primariesfor the US presidency. On theDemocratic side, Hillary Clintonleads the polls.

“Rock or Bust”: 2015 was a crucial year for Eurozone, as ECB continued to use as many instruments as possible to reaffirm the strength of the Euro globally

Gun policy was also underdebate, after a number ofshootings throughout the year. Inthe economy, though the US hada rough start to 2015,contracting during the firstquarter, the fact is that strongsecond and third quarter data onlabor markets have led many tobelieve that Janet Yellen and therest of the FOMC board memberswill finally raise interest ratesduring the upcoming meeting inDecember 2015.

As the Year of the Monkeyapproaches, China’s economy isstill waning as investment and

manufacturing have not adjustedyet to the lower levels in globaldemand. 2015, much like inEurope and in the US, was also acritical year for China. Besides thefact that in November, theChinese currency was voted to beincluded in the IMF’s SpecialDrawing Right Basket,recognizing the extent of China’sprogress over the last few decadesin moving towards a more openand market-based economy, thefact is that volatility anduncertainty around slowingChinese economic growth alsodefined China for the year of2015, with financial marketssdfsdfsdfsdfsdfsdf

having undergone a tumultuoussummer as a result of thecontinuous injection of moneyinto the stock market by a risingmid-class. The ChineseGovernment aggressively tried tocontrol this crisis, with thePeople’s Bank of China cuttinginterest rates to a record low anddevaluing the CNY, limiting shortselling, etc.

China’s crisis also impliesdemographics: the rapid ageing ofpopulation led not only to adecrease in the workforce for thefirst time since 2010, but also leadto a plunge in nativity rates. 2015was also historical for China inthis regards, as in October, theCommunist Party abolished itsone-child policy amid fears of theeffects of changing demographicson a slowing economy.

Outside the office, Volkswagenalso made the headlines. InSeptember, and for the wrongreasons – as it was revealed thatspecial software had beeninstalled in some 11 millionVolkswagen diesel-poweredvehicles designed to defeat


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The geopolitical conflict in the Middle East will continue to intensify in 2016, forcing Syrians and Iraqis to leave their lands

The Chinese “double-trouble”: investors fear the consequences of not only a slowdown in the economic growth pace but also an ageing population


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emissions testing. A move tomake cars seem cleaner for theenvironment than they actuallywere, ended up catalyzing anelectric-car turn movement in theautomotive industry.

On July 14, the New Horizonsspacecraft, launched nine yearsearlier, made its closest approachto Pluto and its flock of fivemoons while taking the highestquality images of the planet ever.

Finally, in November, the WorldHealth Organization declared atlast that the outbreak of the Ebolaepidemic in Liberia was over,after more than a year.

The NIC-UD Oracle2016 is likely to spell trouble foroil and the rest of commodities –as a stronger dollar, lower oilprices, trouble in EmergingMarkets and a slowing ChineseEconomy (the main driver ofgrowth in commodities for the lastdecade) prove to be a dangerousconcoction.

After the 2015 M&A galore,some industry watchers point toidiosyncrasies of some of thesedeals to inject a note of caution,and warn that the current pacemay not be sustainable. With thediverging monetary policies andthe fed hiking rates soon, it will beinteresting to observe how globalsales of corporate debt affectM&A activity.

Regarding 2016, there isskepticism towards the growth ofthe global stock markets, mainlybecause American indices haveclimbed higher than anticipated,raising red flags for investors, whomay become fearful of investing in

those stocks that compose thethree main American indices. Thiscould result in a shift of attentionto other asset classes, such asbonds or even commodities likegold or oil.

In the Middle-East, even top areascholars and analysts find it hardto predict how the situation willdevelop. Even though, there is thepossibility that in 2016 theconflict will intensify, as tensionsbetween Russia and Turkeydevelop and the Syrian Armygains momentum. We believe thatDaesh will lose more territory asforeign bombings intensify. Nomatter what route the conflict inSyria and Iraq takes, the humancalamity is likely to persist for theupcoming year of 2016. For thisreason, a reduction in the flow ofrefugees is not expected, althoughcoordinated efforts with Turkeymight induce a slight reduction ofthis inflow. We also anticipatethat the anti-immigration feelingwill most likely not fade, as right-wing parties gain influence andEurope becomes further polarizedon the issue.

In 2016, expect higher borrowingcosts, as the Fed is likely to startthe process of gradually raisingthe federal funds rate during itsDecember meeting, with Fed fundfutures pricing a 84% probabilityof a rate hike still in 2015 and a40% probability that US ratesreach 0.75% by mid-2016. On theother hand, the ECB bond-buyingprogram is to continue at leastuntil March 2017, showing thatlow inflation is here to stay (atleast for the short term – despitethe fact that the ECB holds a 1%forecast for HICP-measuredinflation by the end of 2016). Themonetary policy divergence

between the two sides of theAtlantic is bound to mark 2016.Note, however, that a strongdollar is not necessarily good forUS, as it might inducedisinflationary trends. On theother hand, Euro to Pound rate isexpected to hit low levels in early2016 (0.67, as DB’s estimationspoint).

Shifting towards technology, wesee 3D-printing becoming thenext thing in 2016 after a strongyear for 3D-printers. Moreover,new devices from HTC Vive andOculus Rift (a Facebook-ownedventure) will leave techenthusiasts hyped as they comeout in the first quarter. Increasedautomation in the automotiveindustry is also predictable for thenext year as Apple is rumored toenter the competition followingGoogle and Tesla. Finally,SpaceX's massive Falcon Heavyrocket is set to launch in Spring2016. The company plans torecover the stage one rocketboosters by landing them back onEarth after launch, a possiblebreakthrough for spaceexploration.

At NIC UD, though none of usare truth seers, and though it iscertainly most unwise to predictwhat the future will bring, it hasbeen an interesting exercise to tryand foresee what 2016 will haveto offer. We want to thank ourreaders for this opportunity, andhope they enjoy the rest the otherarticles in this publication.

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Now back to you, Yellen


Divergent Monetary Policy and Its ConsequencesBoE and Fed vs BoJ and ECB

Filipe Berjano and Tiago Alves

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The world economy has beenquite slow to recover from theGreat Recession.

Having recently achieved robustlabor market statistics, the UKand the US are the exceptions.Both countries have witnessedconsiderable and stable economicgrowth since 2014 – the year inwhich the Fed ended its QEprogram. Similar to the Fed’slikely experiment with aDecember rate rise, the BoE hasalso begun to unwind its QEprogram, projecting a rate rise inthe near future.

As the UK and the US prepare totighten monetary policy, the BoJand the ECB are doing preciselythe opposite due to low growthand inflation. In fact, the BoJincreased the dimension of its QEin October 2014 as the countrystruggled with a stagnant

economy. In the Eurozone, asrisks of deflation doomed large,ECB President Mario Draghiimposed a large scale bond buyingprogram worth €60bn per monthuntil September 2016.

Whereas both the Fed and the BoEstarted their stimulus programsshortly after the fall of LehmanBrothers, their European andJapanese counterparts only begunsimilar processes much later. Thiscan be partially explained by thedifference in mandates of eachcentral bank.

Namely, the Fed is expected tokeep stable prices and fullemployment, whereas the othersare focused mainly on keepinginflation below a set target. Since2012, Japanese monetary policyhas also been deeply influencedby Prime Minister Shinzō Abe’seconomic policy of strong

government stimulus. Thisprogram consists of very lowinterest rates, high publicinvestment financed by budgetdeficits, correction of excessivecurrency appreciation, andmonetary easing throughextensive bond buying programs.

With regards to economic growth,countries that started QE earlierhave had a greater and fasterrecovery. The effects of QE weremost notable in short-term andlong-term government bondyields, as well as in overall stockmarket rallies. From an economicperspective, central banks havehad a difficult time trying tostimulate inflation, mainly due tothe sharp fall of commodity pricesthat begun in 2014 – particularlyin the case of oil, which iscurrently near a seven-year low.

The coexistence of monetary


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policies – specifically of tighteningin the US and the UK and ofeasing in Europe and Japan – hascaused great appreciation of theUSD and the GBP against theEUR and the JPY. The strongUSD has impacted commodityprices and is one of the reasonsfor the continued maintenance oflow rates. Moreover, a rate hikein the US would furtherstrengthen the USD, hurting USexports. On the other hand, lowcommodity prices and weakcurrencies are positive news toboth the Eurozone and Japan,which have seized the opportunityfor a decrease in imports and amuch-needed boost in exports..

Independently of the specificmacroeconomic priorities of eachcentral bank, its main purpose isto position their respectiveeconomies at a sustainableequilibrium with the help ofmonetary policy. However, theeffects on currencies and

emerging markets have to betaken into consideration in thiscontext of diverging policymarked by the Fed and the BoEon one hand and the ECB andBoJ on other hand. Given thepolicy scope, it must be – at thevery least – acknowledged thatcommunication and discussion ofconcerns and policy choice areimportant tools for central banks,enabling effective forwardguidance with the capacity ofmitigating adverse outcomes andspurring desired results.

Given the USD dominance in worldtrade and financial markets, USmonetary policy has worldwideconsequences involving riskpremiums, volatility, and credit.

The Fed’s QE provoked largecapital inflows from the US toemerging economies, leading tothe appreciation of theircurrencies and a decline in theirexports. Now the tables have

turned. A hike in interest rates bythe Fed could result in furtherappreciation of the USD againstmost currencies present inemerging markets. Thisphenomenon would aggravatetheir current situation; after all, asignificant number of companies,governments, and institutionshold USD denominated debt.These agents would see their debtburden increase as theircurrencies depreciate. Emergingeconomies account for more thanhalf of the world’s GDP inpurchasing power parity terms. Assuch, the slowdown in emergingmarkets is one of the reasons whythe ECB has been probing theprospect of boosting its QEprogram. However, the Fed isresolutely considering a rate rise.Although the US economy hasconsistently displayed somestrength, a rate increase couldnegatively impact global demand.

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(Not so) Super Mario Draghi’s Recent Fall from Grace

Afonso Borges

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How I miss Christmas beforeuniversity life and January exams.Not a worry in the world. All thetime in the world to play SuperMario Bros.

Of course, I can name someactivities more deserving of yourtime. Yet, Super Mario Bros isworth mentioning because it aidsthe understanding of one of themost important events of thisholiday season: monetary policy.

For those of you who are notfamiliar with the game, here ishow it goes. Little Mario isminding his own business until hefinds a mushroom. Little Marioeats said mushroom and becomesBig Mario. This Mario was MarioDraghi in January 2015 as heannounced the QE program forthe Eurozone. And so, life goeson. Big Mario comes across aturtle. Big Mario is hit by saidturtle and becomes Little Mario

again. This Mario was MarioDraghi in December 2015 as heannounced that the ECB wascutting its deposit rate to -0.3% aswell as extending its QE programuntil March 2017 “or evenbeyond."

You might say that this view hasan unnecessarily long image andthat December announcementssure sound more like a mushroomthan a turtle.

Not so fast. While the ECB'spolicies announced in earlyDecember represent an evenmore accommodative monetarypolicy, they fell below what themarket was expecting and hadpriced in. As a consequence, onthe day of the central bank'spolicy announcements, the EURwas up 3% against other majorcurrencies, European stocks soldoff 3% and yields on Europeanand even American bond yields

increased – meaning prices wentdown.

To understand how expectationswork, imagine that last Christmasyour ever-so-generous uncle,aware of your interest in thesubject, gave you a yearlysubscription to The Economist.So far, you have enjoyed KAL'scartoon and felt flattered by thelooks your colleagues threw yourway as you held the magazine.The big difference, however, isthat this year you will not beimpressed by a repetition of lastyear's gift.

Sure, you would not mind anotheryear of the magazine, but youruncle – being ever-so-generous –could have thrown in a yearlysubscription to Netflix as well.Similarly, as Uncle Draghi tried toreplicate January’s recipe,Nephew Market said "not cool.”


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As an activist investor, Carl Icahnis the sort of individual who isused to shaking up managementand having his say. After aphilosophy degree in Princetonand an unsuccessful run atmedical school, Mr. Icahn is oneof the most revered figures inWall Street. Often takingsubstantial – including controlling– positions in individualcompanies, Mr. Icahn and hisaffiliated companies ownbusinesses in a wide range ofindustries, such astelecommunications, real estate,industrial services, oil refining,transportation andmanufacturing.

What does Mr. Icahn have to sayabout the Fed? In a recent video,published in his website andentitled “Danger Ahead: AMessage from Carl Icahn,” theactivist investor was critical ofFOMC’s decision not to raise thefederal funds rate on September17.

The decision to raise or not raisethe federal funds rate is certainlya controversial one. Taking intoconsideration the crash that hitthe US in the housing market andbanking sector between 2007 and2009, as well as the globalcontagion of the financial crisis inpart due to the securitizationcomplexities in financial markets,the Fed – then led by BenBernanke – resorted to a varietyof monetary policy tools toprevent the US economy fromcollapsing.

To keep the economy afloat andpreserve price stability, theFOMC, which is in charge ofsetting monetary policy in the US,began lowering the federal fundsrate on September 2007 to4.75%, effectively changing theinterest accrued by commercialbanks when these borrow fromthe excess reserves kept inregional federal reserves to meettheir daily capital requirements.The federal funds rate proceededto decline over the span of oneyear, hitting the 0% and 0.25%ultra-low range in December2008. It has stayed there eversince.

Much like the Fed announced inMay 2013 that it would begantapering the ongoing bond-buyingprogram – a practice which cameto a final halt in October 2014after having added more than$3.5tn to the Fed's balance sheet– now many agree that the timehas come to end this prolongedera of near-zero rates.

With the US economy nearing fullemployment levels and amidstsome signs that productivity andwage growth might finally pickup, the intuition is that anoverheating jobs market can spura pickup in inflation and wages.Given the Fed’s mandate overprice level stability, many punditsand investors are now positioningthe economy for a rate hike aswell as subsequent increases tothe costs of borrowing. In fact,according to the CME Group’s“Fed Watch Tool,” marketsentiment suggests an 83.3%

chance that the FOMC may cometo increase the fed funds rate intheir next meeting in December2015 to 0.50%.

In “Danger Ahead,” Mr. Icahndirectly relays to audiences hisapprehensions on the USeconomy. Chief among these arethe consequences to the Fed’srefusal to reign in its loosemonetary policy. Along withpulling the US out of the crisis, Mr.Icahn is quick to denounce thenegative effects low rates havehad in flooding markets withcheap and easy credit.

With global sales of corporatebonds eclipsing the $2tn mark forthe fourth consecutive year, heargues that “middle-classinvestors” have been pushed intothe market for the so-called “high-yield” bonds (otherwise known as“junk” bonds).

However, near-zero rates havecreated other problems, withmany American chief executives,according to the activist investor,borrowing and using “financialengineering” to artificially propup earnings (and therefore stockprices) via acquisitions and equitybuybacks. Global sales ofcorporate bonds are not financingcapital expenditure and newmachinery to make the economymore productive.

Mr. Icahn, a self-proclaimedfollower of the BenjaminGraham’s investmentmethodology, is troubled because

Danger Ahead? Carl Icahn on the Fed There’s a Monster in the Closet

Francisco Gonçalves and Mariana Ruivo


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he no longer believes thatcompanies’ fundamentals arebeing reflected in earning figures.In short, Mr. Icahn is a strongproponent of a rate rise and astaunch critic of the Fed forhaving opted out of such anoperation – which begs aninteresting question: what couldpossibly justify a rate hike in theFOMC’s December meeting?

Carl Icahn’s reasoning iscompelling and clear: low interestrates breed asset bubbles.

If the economy is not becomingmore productive, and ifunemployment figures are alreadynearing full employment levels,then perhaps Mr. Icahn is right tosay that easy credit is doing morefor companies’ earnings and stockprices than it is for consumersand job creation.

However, there are also non-trivial cases to be made againstthe rate hike. One of the strongerones lies in the fact that the Fedhas been optimistic concerningthe US economy’s ability to reachthe mandated 2% inflation ratetarget. This worry has beenechoed by Fed Governor DanielTarullo, who expressed hisconcerns that expectations for

inflation are still near-historiclows. Other concerns include theimpact of diverging monetarypolicies and a stronger USD, bothdomestically (as US exports gethurt and US-based firmsoperating across the globe mountfurther losses) as well asinternationally (USD-denominated debts becomeharder to pay off, particularly inemerging markets).

Yet, another argument – andprobably the most caricature ofthem all – is the worry that“zombie companies” (companiesthat have been kept barely aliveby the current, historical period oflow rates) may start filling forbankruptcy soon after a rate hike.The extent of the effect of these“zombies” on the economy’sproductivity and employmentlevels, however, remains unclear.Some argue that this may bolsterthe economy, as competitionforces bad business out of thepicture and frees up labor andresources for more successfulenterprises.

Is Carl Icahn right? Maybe. Data,particularly with regards to USunemployment figures, has beenpositive. Then again, marketscould react in a multitude of ways

come December if the FOMCdoes decide to raise rates. Afterall, data on the labor participationrate, underemployment, and thegrowth of the US manufacturingsectors is not very attractive. Infact, the manufacturing sector iscurrently contracting.

Ha-Joon Chang, author of thebestseller 23 Things They Don’tTell You About Capitalism, wrotethat “contrary to whatprofessional economists willtypically tell you, economics is nota science (...) [for] all economictheories have underlying politicaland ethical assumptions, whichmake it impossible to prove themright or wrong in the way we canwith theories in physics orchemistry.”

Ultimately, when rates do rise, itwill be more important foreconomists to have haddiscussions on the variousscenarios that might emerge –including their consequences,both domestic and international.Anyone that promises somethingdifferent – even if they do go bythe name of Carl Icahn – issomeone to watch out for.


Imagine There’s No HikeBetting Against the Odds

José Alberto Ferreira and Mariana Fernandes

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We live in a prolonged era ofunconventional monetary policy.Since 2008 for the Fed and 2014for the ECB, QE programs haveincreasingly become the norm asinterest rates matured past theireffectiveness. Monetarypolicymakers have gone beyondtheir traditional scope, applyingextraordinary instruments –including QE – whose resultswere not entirely foreseeable.

When the FOMC gathered inOctober, many expected a raterise due to signs of economicrecovery – the first in almost adecade. In the EU and the US,however, inflation remainsanemic. In fact, the the 2% annualtarget is not likely to be metbefore the end of the decade.

Although it did not occur inOctober, the expectation of a ratehike in December by the Fedcontinues to be widespread.Indeed, several analysts believethat – seven years after thebeginning of the Great Recession– banks, firms, and householdsare now ready for such a hike.Others, however, conclude thatnear-zero interest rates shouldremain.

Early this year, federal fundsfutures, which can be used toplace bets on interest rate moves,indicated an overwhelming 99%probability of a rate hike; twomonths ago, however, thelikelihood of a hike was below50%. As such, analysts,economists, and policymakers

have been obliged to consider thecase in which the Fed does notraise the federal funds rate inDecember.

Ultimately, this operation is notsuch a consensual idea – whichbegs a question that goes againstthe odds: what if rates do notincrease?

Those who are contrary to a ratehike, particularly in the US, basetheir views on the slow wagegrowth that has accompanied thedecrease in the unemploymentrate (namely a seven-year low of5% as of October), arguing thatwage-driven inflation is losing itssignificance. After all, lowunemployment traditionallypushes inflation up. In otherwords, the economy is witnessinga nearly inflation-free recovery.

Moreover, if rates were toincrease too soon, low inflationcould possibly shift into deflation– a nightmare that Japan knowsall too well (the BoJ has beenpracticing near-zero rates fornearly two decades). Deflationencourages households topostpone consumption, negativelypressuring the economy andbringing about rate cuts orunconventional monetary policy.

As of recently, companies’revenues have not metexpectations, as proven by themost recent modest earningsseason. Furthermore, thisoutcome is masked by successivebouts of cost-cutting measures.

Moreover, commercial banks’ netinterest margins have reachedsignificantly low values that arebattering their stock value. J.P.Morgan estimates, for instance,that a 100 basis-point rise in rateswould increase its net interestincome by $2.8bn per year.

Recent evidence from both theEU and the US demonstrates thefar-reaching effects of sustaininglow interest rates for long periodsof time. Primarily, low interestrates encourage borrowing andtherefore investment. However,this positive outcome can lead todeflationary pressures once thereexists a shortage of demand orexcess of supply – as the recentUS oil boom has exemplified.

Keeping rates low also leads to anincrease in buybacks throughcheap borrowed debt, which notonly masks equity valuations inthis era of low earnings, but alsoaffects long-term profitability.After all, liquidity is notnecessarily being invested intoCAPEX or R&D. In fact,corporate bond and loan issuancein the US is approaching a two-decade high of $1tn.

Low rates also affect assetallocation. Investors turn to fixed-income bonds with longermaturities as they grow moresensitive to increases in interestrates (e.g. 10-year governmentbonds).

However, this has an impact onall sorts of assets, including real


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estate. House prices in the UK,for example, are at a historic higheven though the availability ofhouses for sale has beendecreasing. This is a result ofowners prioritizing rent as sourceof cash return in midst of cheapcredit that is driving prices up.Emerging markets also suffer in adeflationary environment asdemand for commodities iscontinuously pushed downwards,driving investors away.

Lastly, another aspect of thedrawn-out rate policy regardspension fund and longer, fixed-income financing. The lower theinterest, the more companiescommit to these funds. Theirresources, therefore, are notapplied to production – a concernpointed out by the OECD in2011.

Switching gears to the biggerpicture, a scenario without a ratehike implies that monetary policyis not yet normalized and,therefore, the economy is not

ready to start a new tighteningcycle.

Ultimately, both the ECB and theFed pursue inflation targets; so,given the level of low inflation, it isnot unfathomable that someeconomists believe that the timefor a rate rise has yet to come.

It is a discussion, then, thatfocuses on the timing rather thanon the substance of such anoperation. Overall, central banksseem to be searching for positivenews to put forward rate hikes.They are doing everything in theirreach to normalize monetarypolicy.

policy.

Now more than ever, and despitethe consensus on the long-termdamaging consequences of lowinterest rates, the “intricateeconomic and financial linkages inour global economy” – as JanetYellen puts it – requires centralbanks to be bolder and morecreative. For how much longercan the world economy sustainnear-zero rates? Are central bankswaiting for the right time or theright tool? One way or another,one thing is for sure: “business asusual” is no more for centralbanks.

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Insights


Should I Invest in the World I'm in? Or the One I Want?An Intuitive Approach to a Well-Reasoned Dilemma

Afonso Borges

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UBS’s recent “Life’s Questions”ad campaign gathered an array ofquestion marks that it thinks itsclients might come acrossthroughout their lifetime – only toconclude that “for some of life'squestions, you're not alone” andthat “together we can find ananswer.” One of those questionscould not be more relevant, whichis precisely why I will beaddressing it in this article.

“Socially Responsible Investment”(SRI) is not a new trend.According to the ever-so-resourceful Wikipedia, it may dateback to 1758 when a religioussociety in Philadelphia prohibitedits members from participating inthe slave trade. Throughout time,the concept has evolved, in oneform or another, to excludeinvestments in products such asguns, liquor, and tobacco in the18th century. Moreover, it beganaddressing issues related to

gender equality as well as laborand civil rights in the 1960s.More recently, the scope of theconcept has been shrinking,having increasingly becomesynonymous with environmentallysustainable projects.

In the last few years, the term SRIhas been replaced by ESG, whichstands for “Environmental, Socialand Governance.” According tothe Morgan Stanley Institute forSustainable Investing, Millennialsare the demographic cohort thatis currently most interested inESG Investment. By April 2015,almost 1400 asset-managementfirms with an aggregate of $60tnin AUM have signed the UnitedNations’ “Principles forResponsible Investment.”

While making the case for ESGInvestment, I have often comeacross a misconception amonginvestors that I have sought to

address by proving it wrong.Namely, this is the notion that“sin stocks” tend to outperformthe overall market. HampusAdamsson and Andreas G. F.Hoepner have recently publisheda paper called “The ‘Price of Sin’Aversion: Ivory Tower Illusion orReal Investable Alpha?” in whichthey claim that previous researchon this topic had ignored thesimple fact that “small beatslarge.”

They also concluded that whenaccounting for the differences inmarket cap with value-weightedportfolios, sin stocks “do notexhibit any significantoutperformance” and gamblingstocks actually underperform.

Notwithstanding, the argument Iwant to make is not aboutreturns. Instead, it concernshuman morality.


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Some of the richest people inmodern-day society are also someof its greatest philanthropists. The“Giving Pledge,” an initiativestarted by Warren Buffett and BillGates, has recently seen theaddition of Mark Zuckerberg andPriscilla Chan to their list of 138individuals or billionaire couplesthat have committed to givingaway the majority of their wealthto philanthropy.

While this is a remarkablecontribution, it is arguably easierfor a billionaire to give away alarge proportion of his or herwealth than it is for the averageJoe or Jane to give away anythingat all. After all, doing so mightvery well compromise his or hersafety net. Moreover,philanthropic schemes by theultra-rich often entail some formof tax benefits – as pointed out byDealBook’s Jesse Eisinger. OnDecember 3, Mr. Eisinger wrote:“Mark Zuckerberg did not donate$45 billion to charity. You mayhave heard that, but that waswrong. Here’s what happened

instead: Mr. Zuckerberg createdan investment vehicle.”

Controversy aside, it is generallybelieved that allocating funds tohumanitarian causes is a nicething to do. At one point oranother, I hope we will all look atour wealth and wonder howmuch of it we should give away.Other relevant questions thatemerge when considering theissue of donating wealth includethe specific causes that deservethe funds that we have worked sohard to earn, as well as the pointin time in which we should startgiving it away.

As for the causes, one must findsomething he or she can relate to.This is something that I cannothelp you with; however, I do hopeto convince you that if you indeedhave the desire and the capabilityto donate a portion of yourwealth at some point, now is thebest time to do so.

The most common explanation Ihave heard as to why one should

postpone his or her donationscheme is that wealth has beenincreasing at a high rate over theyears. Thus, it follows that if onewas to wait one more year, theamount one would be able to giveaway – both in nominal and inreal terms – would be higher thanit would have been otherwise.

Although this logic can very wellbe true for business-owners,entrepreneur, and investors alike,there exists a missing piece. Whilewealth tends to grow over time,the other side of the coin is thatthe necessities of those in needalso grow over time – and, mostimportantly, that the latterarguable compounds faster thanthe former.

Unfortunately, I do not havestatistical evidence for such astatement. Yet, it seems intuitiveenough that the sooner weaddress urgent issues such asglobal warming and risinginequality of opportunities, thegreater the benefits we will beable to reap.


Marchionne’s WayDeciphering the Method to His Madness

Diego Tremiterra

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The Fiat brand needs nointroduction. Founded in 1899 byGiovanni Agnelli, it quickly grewto gain a control of 87% of theItalian market in 1925. AfterWWII, Giovanni’s grandson,Gianni, developed aninternational expansion plansupported by the boom in globaldemand for cars. Having all thecompetencies and instruments tobecome a worldwide success, theItalian carmaker somehow failedto become an established brandand started facing toughchallenges in the beginning of thetwenty-first century.

As a result, Sergio Marchionnewas hired in 2004. He was thefifth CEO in three years and Fiatwas losing money since 2000,seeming destined to insolvency.

Marchionne decided to step in andtake charge; this is the story ofwhat later became one of the mostsignificant carmakers in theworld.

As soon as he joined thecompany, Marchionne spottedseveral faults with Fiat’sleadership management.

Consequently, he began rounds oflayoffs in order to promote youngand risk-taking talent. With arenewed team, reinforcedtechnology and a more efficientproduction process, Marchionnebrought to the market the FiatCinquecento in 18 months,beating the previous four-yearbenchmark to put a car in thestreets. This car model was amassive success; in fact, highdemand caused Fiat to ramp upproduction by 60% in the firstyear. Between 2004 and 2008,Marchionne increased netrevenues from €46.7bn to€59.5bn (+27.5%), whileincreasing profit margin from -0.2% to 5.4%.

Everything was en route – untilthe automotive industry was hitby the Great Recession, bringingabout the toughest years ever forthe industry: 2008 and 2009. Infact, a good year for the Americansegment of this industry is sales of15 million units; by 2009,however, Americans bought onlyaround 10 million units (-33.3%).Nevertheless, Marchionne had toreach the critical and sustainablemass of over 6 million vehicles

sold per year. To materialize thispriority, Marchionne looked toChrysler as the most favorablestrategic alliance. Moreover, withits 50,000 employee base,Chrysler in the US was leakingcash and lacking consumer love.

Therefore, Marchionne made adeal with the US government(which at the time waspredominantly preoccupied withthe US job outlook): 20% ofChrysler plus a $6bn high yieldloan (19.7% interest) to be paidback in 2017. With Chrysler,Marchionne adopted the samestrategy he employed at Fiat: nomore of grumpy high-rankingmanagers and a focus on youngand creative minds. He brought in26 such leaders that would speakdirectly to him, stronglyimproving the decision-makingprocess. As a result, Chrysler,under Marchionne’smanagement, repaid the loan in2011, six years before the duedate. On January 2, 2014, Fiatsecured the remaining 41,5%stake of Chrysler for $4.35bn – amerger that proved to generatesignificant synergies: Chrysler was


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a considerable player in SUV,mini-vans, and light trucks,whereas Fiat’s strengths lied insmaller and more fuel-efficientcars. That was the moment whenthe current seventh biggestautomaker in the world was born:Fiat Chrysler Automobiles (FCA).

As of today, FCA has a five-yearcorporate strategy that forecasts asales volume growth of more than50%, while reducing debt (fromanywhere between $0.5 to $1bn by2018) and investing €48bn inbetween 2013 and 2018. Ideally,the plan is to grow FCA’s positionin fast growing and high-marginmarkets.

The restructuring of theChrysler’s brand enhances theexposure to growth markets. InNorth America, it will give up itsattempt to position itself in theluxury market segment. Dodge’smission will be to focus on musclecars (even if that means a dip involumes), whereas Jeep willpursue product penetrationproduction in growth markets.

The Ferrari spin-off followed by

its IPO was the first step ingrowing FCA’s high-marginexposure. Marchionne did so toget financing, so that he couldincrease production from 7,000models to 10,000 per year. Butthe method to the madness doesnot end there. The revival of theAlfa Romeo is also underway; infact, over 200 engineers havebeen secretly working in the lasttwo years on how to revitalizeAlfa Romeo’s brand equity, alongwith the powerful and seductivebrand narrative it enjoyed in the60s. With that, they areattempting a change in the type ofdrive from front-wheel to rear-wheel; the objective is to return todrivers the old-but-solid-goldexperience, thus more fearfullytargeting BMW’s and Mercedes-Benz’s market coverage. Theautomaker also has a wideexpansion plan for the US, inwhich it plans to leverageChrysler’s existing distributionchannels.

The automotive industry will befacing many challenges: increasedcapital requirements, newemissions and safety regulations,

and increased consumer’sdemand for car connectivity andautonomy. Nevertheless,Marchionne is exceptionallyaware of that, as he showed in his“Confessions of a Capital Junkie”presentation. At heart,Marchionne is a mix of themodern and straightforward CEOwith touch of investment banking.

Precisely because of this, he hasmanaged one of the mostsuccessful turnarounds in historyand is currently pursuing anambitious (outrageous for some)strategy which, if successful, willknock it out of the park and bloweveryone’s mind. Including mine.

Did You Know?Another important response tothe Great Recession was thedemerger of Fiat Industrial, sothat Marchionne could focuson growth and consolidationopportunities. This operationwould come as a consequenceof different earning cycles, aswell as volatility and capitalrequirements betweenautomotive and the industrialmanufacturing processes.


On Trump and Boris Leading the WestA Hypothetical Exercise

Inês Cunha and Miguel Garção

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What if the West was lead by twoshowmen? Though the chancesfor this to happen may not appearto be great, it actually might bepossible in a matter of months oryears.

Having similar physicalcharacteristics, both BorisJohnson and Donald Trump areknown for speaking their mind.Donald Trump, an Americantycoon, is running for President ofthe US in the 2016 elections andhas consistently been the front-runner for the Republican Party inthe last months. Boris Johnson,the mayor of London since 2008and a Member of Parliament since2015, is seen as the people’schoice to be the next leader of theConservative Party. Therefore, heis a potential candidate as thenext Prime Minister of the UK –after all, David Cameron hasruled out serving a third term atDowning Street, thus triggering aleadership contest ahead of 2020.Despite having refused this ideaand also failed to directly pursuesupport, Boris currently hassubstantial backing within theConservative Party.

However, not all is alike. Perhapsmost significantly, Boris has hadextensive experience a publicservant; on the other hand,Trump has no such politicalexperience. He has never beenelected to any form of politicaloffice – and paradoxicallyenough, that is precisely one ofhis campaign’s unique sellingpoints. Moreover, the

businessman is said to be worth$4bn – needless to say, noteveryone can compete with such alevel of wealth.

With regards to personality,whereas Trump – rarely describedas open-minded or intellectual –clearly exploits his wealth to catchvotes, Boris is an Oxford-educatedand sophisticated thinker whocomes across as charming andtolerant. People like Boris andthey laugh with him, regardless ofwhether or not they agree with hisidea. His behavior and inter-personal skills contributes to hislikeability – and unlike Trump,who either does not comprehendsocial boundaries or simply doesnot care for them, Boris usuallyunderstands how to walk betweenthe fine line of politicalcorrectness.

Indeed, Trump is notorious forhow often he indults individualsand communities (his most recentscandal involves mockery of adisable reporter). Obviously, such

behavior heavily influences thepublic’s perception of Trump asarrogant and crass. By contrast,when Boris insulted the city ofLiverpool by criticizing its griefover the kidnapping anddecapitation of Ken Bigley, helater apologized.

Ultimately, some people have saidthat Boris is a genius pretendingto be an idiot. Well-humored, hebelieves in social justice andcontrast. On the other hand,Trump's "rich loudmouth"personality is, in fact, much closerto the real Donald Trump – andthis makes the businessmanexponentially moreconfrontational.

Regardless, the likelihood of Boris’and Trump’s political prominencehas never been more realistic. Assuch, it is time for a hypotheticexercise: what would actuallyhappen if these two charismaticshowmen were to lead two of theWest’s most significanteconomies?


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When it comes to foreign policy,Donald Trump has said he would“absolutely” withdraw refugees’passports, shut down mosques,and ban Muslims from enteringthe US in order to fight Daesh.He has justified such aggressivepolicies by claiming, for instance,that he saw Muslims cheering the9/11 attacks in Atlantic City, NewJersey (despite the lack ofevidence and credible reports).Boris, in deep contrast, firmlybelieves that the “jihadi madness”is rejected by the great majority ofMuslims. His answer to Daesh isconsiderably softer: “we need tobe able to monitor these vipersnursed at the breast of the Britishstate: their movements, theircommunications, and sometimeswe need to be able to separatethem from others who could aidand abet their plans.”

Both of these showmen have astrong view on immigration.Trump wants to build a wall onthe Mexican border and deport11 million undocumentedimmigrants. The feasibility of suchmeasures, however, is doubtful tosay the least; more so, the USeconomy, in particular industriesthat are dependent on cheapimmigrant labor, would benegatively affected – particularlywith regards to its job outlook.

Boris, on the other hand, hasstated that while he is not againstimmigration as long as immigrantswork and pay taxes, he is againstthe EU’s excessive influence onthis matter. In short, Boris isdemanding significant changes inits immigration policy. Still withregards to EU reform, anotherobjective is to decrease EUbusiness regulations. Theseconditions are all vital for Boris if

the UK is to remain in the EU.However, he still believes that it isbest for the UK to remain in theEU – which is not to say that, asBoris has previously stated, that aBrexit is not inevitable. After all,with the Greek government-debtcrisis, the price of getting out ofthe EU has never been lower.

More controversially, Boris isexcessively conservative withregards to gender equality andwomen’s rights, having previouslystated that women “have got tofind men to marry” in universities.As such, it would be unwise toexpect any sort of progressrelated to the gender gap andprotection for women in theworkplace.

Financial services and businesswould theoretically benefit withboth figures if most of their ideaswere achieved. Trump’s tax plan,which includes getting rid ofcorporate taxes, would make USbusinesses more competitive andimprove the economy in the short-term; however, Trump has failedto clearly mention how he wouldcompensate such measure. Afterall, an increase in the deficit andthe budget debt is expected tooccur in any situation in which taxrevenues decrease, ceterisparibus. Eventually, the marketmight not be a fan of this scenariosince no investor would keepinvesting in a country that isdeliberately driving towards afiscal cliff. Moreover, the Trump’s20% tax on imports would be aviolation of nearly all the US’trade laws and treaties. No matterhow skilled a negotiator Trump is,it would be tough for him – if notimpossible – to overcome thesepolicies’ illegality.

After London’s financial sectorhaving contributed to one of theUK’s biggest crash and slowesteconomic recovery, Boris hasdeclared that inequality isessential to fostering "the spirit ofenvy" and has even hailed greedas a "valuable spur to economicactivity." Hence, it is unwise toexpect any further form ofbusiness or market restrictionfrom Boris’ political platform –even if markets may come todoubt the security and stability ofan economy where free rein isgiven.

Leaving all scandals aside, it ispossible to say that both BorisJohnson and Donald Trump areincredibly charismatic andenthusiastic. However, this is nota sufficient condition for being theleader of a country – particularlygiven the fact that both of theseshowmen are a bit short on ideas.

Again, we resort to a (perhapsmore significant) hypotheticalexercise: can we imagine a worldin which Boris Johnson or DonaldTrump have access to nuclearcodes?


Telecom Industry Calls for Consolidation Threats and Opportunities in the Italian Market

Bocconi Students Investment Club (BSIC)

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We all know the strong changesthat Internet has brought to oureveryday lives; in fact, the waypeople are connected andcommunicate has changeddramatically over the past years.Phone calls and standard textmessages are increasinglybecoming less popular asalternative communicationservices and apps like WhatsAppor Messenger take over.Customers’ demand has changedand supply has had to adapt, suchthat these new trends havestrongly affected telecom marketsall over the world, including theItalian one.

The Telecom (Tlc) marketaccounted for €34bn in 2014,which represents around 2% ofthe Italian GDP, almost equallysplit between fixed and mobiletelephony. In order tounderstand the drivers of therapid decline intelecommunication prices inrecent years, it is useful to analyzehow the revenue decompositionof Tlc companies has changed inthe recent past. Revenues comingfrom voice telephony have beendeclining rapidly, while the onescoming from data traffic havebeen increasing but not enough tooffset the declining path of thevoice revenues. The dynamic isquite similar both for mobile andfixed telephony.

Among fixed telecom services, itis possible to see a significantdecline in voice revenues due to

the reduction in rates and theprogressive shift of voice traffic tomobile. Many of the fixedoperators have dealt with thisnew challenge by offering moreintegrated services, replacingvoice services with more valueadded content that is more onlinebased.

For what concerns mobiletelecom, revenues fromtraditional service components asvoice and messaging, heavilyimpacted by the strongcompetition of online telecomapps, continued to decline in therecent years. On the other hand,Mobile Broadband has beengrowing and, although yet unableto offset the drop in revenuesfrom traditional services, itrepresents the main strategic andbusiness opportunity for themobile Tlc industry.

In other words, Tlc companieshave had to move away from theirextremely profitable voice andmessages services, cutting pricesand slushing margins – whileentering a new, more competitiveand lesser profitable market,namely traffic data, to keepgenerating revenues. With such adifficult environment for organicgrowth, it is not surprising thatthe main industry players aretrying to sustain margins byrealizing cost synergies alsothrough mergers and acquisitions.

In August 2015, the parentcompanies of the third and the

fourth largest mobile operators inItaly, VimpelCom Ltd. (Wind) andCK Hutchison Holdings Ltd. (3Italia), announced the agreementto form a 50/50 joint-venture,which will become the majorplayer of mobiletelecommunication industry witha market share of 33.5% in termsof customers, followed byTelecom Italia (32.3%) andVodafone Italy (27%). The newcompany is expected to generate€6.4bn of revenues and anoperating profit of more than€2bn and will be run by MaximoIbarra, currently the CEO ofWind. Hutchinson’s move needsto be contextualized in its overallstrategy: the company alreadyacquired other mobile carriers inIreland, Austria and the UK,trying to become one of the majorplayers of the European mobiletelecommunications industry.

Given the substantial reduction ofplayers involved in the market,the deal is subject to the approval


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of the European CompetitionAuthority, expected to release ajudgment about the feasibility ofthe deal within May 2016. Eventhough the same commission hasrecently rejected the mergerbetween the second and the thirdDanish mobile operators, there isoptimism about the final decisionas the number of significantplayers in the Italian market willeventually be three and not two,as there would have been in theDanish market.

The deal will have two majorimplications for the market.Firstly, it is expected to generatean overall amount of €5bn ofsynergies, mainly driven byoperating cost savings andreduction of the capitalexpenditure. This would allow thenew operator to be moreaggressive in terms of pricing,trying to further increase itscustomer market share. Thesecond important point is that themerger could be the first steptowards a broader consolidationof the industry in terms ofpotential convergence betweenmobile and fixed telephony. Inother European markets theconsolidation has led the playersto offer more integrated services

including mobile, fixed telephonyand, in some cases, even pay-per-view TV services.

In the past couple months, a lot ofattention has been built aroundTelecom Italia. The company hasbeen facing many problems eversince its privatization in 1997,and is now dealing with theconsequences of the recentfinancial crisis and recession.With a steadily declining EBITDAover the last 5 years, TelecomItalia is one of the best examplesan European company with goodprofitability prospects, but whichis still in trouble due to itsincapability to overcome theobstacles of the Great Recession.That is, Telecom Italia is currentlycheap; it needs both fresh capitalinjections and an internalreorganization. This makes it aninteresting target for strategic andfinancial acquirers looking to buylow and restructure the company,namely Vivendi and Xavier Niel.

Vivendi SA is a Paris-basedmultinational company operatingin the content and media sector,focusing primarily on digitalentertainment. The companyacquired its first stake in TelecomItalia as a result of a deal with

Telefonica SA, then increased itsholdings to almost 20% throughpurchases made in recent months.Vivendi has recently asked to add4 of its highest executives toTelecom Italia’s board. Theproposal would increase thecompany’s influence on TelecomItalia’s governance, and must beinterpreted in light of an Italianprovision that obliges anyacquirer who has exceeded the25% ownership threshold to makea bid on all of a target’s shares. Itis likely that Vivendi wants toavoid the risky and expensive fulltakeover offer, and is looking foralternative paths to gain control.

Telecom Italia’s infrastructureand customer base couldstrategically justify the acquisition,though the shadow of anopportunistic investment is justaround the corner. Vivendi’sobjective could be to secure agood stake now in order to be aplayer in the future, under theperspective of furtherconsolidation in the Europeantelecom industry.

The same way credit ratingagencies appeared during wheneconomic development demandeda reliable third party opinion onthe credit risk of a firm, today’ssociety demands a reliable thirdparty opinion for almosteverything.

Credit rating agencies appearedwhen the economic expansion inthe US spread the businesses tonew areas in the country,increasing the trading distance. Atthe time, companies neededsomeone who knew thecompanies they were trading withto rate them, in order to decidewhether or not to lend themmoney. Investors were not dealingwith lending among a communitythey knew anymore. The firstfirms appearing in the marketwith a similar goal as creditagencies were the mercantilerating agencies, who rated theability to pay of merchants andpublished it in guides. This wasback in 1837.

The same need for a reliablerating boomed in another marketsince the second half of thetwentieth century – the tourismmarket. When travelling around itwas easy not to find the bestrestaurant in town, nor the besthotel. If you did not know aperson who had gone to thatsame destination, it was likely youwould buy a travel guide beforeyou go in order to plan your trip.Today, the tourism market ismuch bigger, the world is muchmore global, and the connection

between people has increased.Large rating companies becamemore and more popular, and theexperience of each of us is nowmuch more important forbusinesses – consumers are nowthe new rating specialists.

This change in roles madebusinesses more cautious of theservice they were providing. Theimpact of an unhappy costumer isnow much bigger than the impactthat a close group of friends hadbefore.

Quoting Joshua Klein’s ReputationEconomics book: “your network isworth more than your net worth.”

In the end, who benefits the mostout of this transparency isdefinitely the costumer, who canmake wiser choices more easilybased on the market’s opinioninstead of the opinion of a coupleof friends, or a travel guideauthor.

For some businesses, thedevelopment of such a sub-industry became as important asthe product the are offering. Fromthe eBay seller who we need torely on, to the hostel one of us ispicking for Spring Break and thecafé we are looking for to havebrunch; in all of these cases wewill be looking for its onlinereviews. We want to know others’experiences before we have ours.Restaurants, bars, hotels, onlinesellers, job-seeking websites – wewould not be the same withoutthis simple and efficient way of

getting to know people’s insighton the various existing businessesand their services.

The sharing economy is one inwhich the reputational economyreaches its climax. One of themost interesting characteristics ofthis form of economy is that it ismarked by an economicdevelopment of one of the mostnatural human acts: the act ofsharing. At the same time, we willneed to trust, and such trust willonly come from others’ previousexperiences of our product, whicheffectively shapes our reputation.Businesses like Airbnb, Uber (inits pop version), car- and bike-sharing apps, and P2P lendingwould not be as successful as theyare without such a system.

The importance of one’sreputation is such that we need tobe aware of how powerful thisweapon is. After all, “oncesomething goes online, it willnever go offline.”

This article was sparked by the authorsfinding themselves searching online forthe best ice-cream shop in theirhometown. They wanted a gelato.


Reputational Economy#rate4rate #rate4costumer

Gonçalo Marques and Manuel Antunes

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Real State: Today’s Ultimate Asset ClassKeeping the Money at Home, but Not Under the Mattress

Manuel de Oliveira and Pedro Leão

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Amid the low level of interest rates we have seenduring the last couple of years, bonds have become aless attractive investment. Together with QE andother macroeconomic factors that originated acouple of strong bullish years on equity investments,this spurred the investors’ attention towards stocks.However, more recently, as expectations of aninterest rate rise by the Fed increase, stocks are notlooking that attractive anymore. Concerns have beenraised, one of them related to US exports and itsconsequences on companies’ profits for the nextyear, which can hurt stock prices.

It is now time to look at some alternativeinvestments, which brings us to real estate. It isdefined as “property comprised of land and thebuildings on it” – this being an oversimplifiedexplanation for something that is actually not simpleat all. Thus, we hope to shed some light on real estateas an investment, which is much more than justbuying a home.

Real estate as a part of an investment portfolio can

be segmented in two major categories. First, thereare income producing investments, such as offices,retail, industrial and leased residential, which, whenleased, all produce income, in the form of a rent.This is extremely positive as a form of investmentsince not only are you able to get a steady, regularincome out of it (like a bond), but you are alsoexposed to capital appreciation and a propensity tofluctuation in value like with a stock. Secondly, thereare non-income-producing investments, such ashouses, vacation properties or vacant commercialbuildings. These work the same way with theexception of the rent component – this means thatall the return the investor hopes to attain must comeas a result of capital appreciation.

Like all other forms of investment, real estate has itsown benefits and shortcomings. Obvious upsides ofinvesting in real estate (more specifically incomegenerating properties) are that it can be a great wayof substituting the most common fixed incomeinstruments, with higher net cash flows during theholding period.


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In spite of real estate’s attractiveness right now, itcarries clear disadvantages. Most people may nothave either the capital to make an investment likethat or do not have the time and skills required tomanage their investments. Although the upside ofhaving a property is that you can actively manage itand therefore have some control over its marketprice (unlike stocks or bonds), the downside is thatyou are most likely going to have unexpectedmanagement costs from time to time, which can trimdown your net profits.

Either way, there are still some ways you can investin real estate with smaller amounts of money andlittle time. A Real Estate Investment Trust (REIT) isa company that owns or finances income-producingreal estate. REITs provide investors with all types ofregular income streams, diversification and long-termcapital appreciation, providing investors withoutmuch capital the opportunity to invest and still beexposed to the real estate market. To qualify as aREIT, a company must comply with severalrequirements. Firstly, it must invest at least 75% ofits total assets in real estate and derive at least 75%of its gross income from rents from real property,interest on mortgages financing real property orfrom sales of real estate. Also a REIT must pay atleast 90% of its taxable income in the form ofshareholder dividends each year. Next, the companymust be an entity that is taxable as a corporation, ismanaged by a board of directors or trustees, and hasa minimum of 100 shareholders, in which no morethan 50% of its shares held by five or fewerindividuals.

Given this, it is easy to understand why investing in aREIT will give you the possibility of getting exposedto a various different types of real estate properties

by buying units of the trust rather than buying thewhole property. This enables investors to obtainfixed income through dividend payments, as well ascapital gains if the investor decides to sell his or herunits later at a higher price. Additionally, if you arelooking for a diversification opportunity, some REITETFs – such as Vanguard REIT ETF (VNQ), iSharesU.S. Real Estate ETF (IYR), and iShares Cohen &Steers REIT ETF (ICF) – can be good options. Afterall, these give you exposure to a broader range ofREITs instead, combining stakes in the commercial,industrial, residential and office sectors. Just keep inmind that they are more focused in the US realestate market, which currently may very well not bethe most attractive geographical segment.

Some interesting REITs to look for are the ones thatcontain on their portfolio big exposure to industrialbuildings rented to industrial and manufacturingcompanies that depend heavily on exportations andcan profit from a stronger dollar and weaker homecurrency competitive advantage, stimulating agrowth in the industry and driving rent and buildingprices up. Key factors in these type of investmentsare location (specially in terms of accessibility toroads and ports) and facilities’ conditions (in termsof structure, space, accessibility by big vehicles,inside or outside space and refrigeration).Unfortunately, there are not many REITs that fit intothis category and some of them are in alreadyoverpriced markets.

With regards to this type of investment in such anindustry, especially in the case where it is taken as anindividual investment and not as a REIT,information asymmetry can have a huge impact onprofits. That is a way in which you can have the typeof advantage over professionals. That is what PeterLynch used to refer to and emphasize so often in aninvestor’s quest to achieve big profits (even if in thiscase we are not addressing stocks). Of course, thisinvestment strategy is not available to everyone-unless one were to leverage her or himself, a movewhich also has some advantages in a low rateenvironment.

Another advantage is the possibility of getting theupside of capital gains of stocks, at the time ofproperty resale. Besides, it is a great way ofdiversifying your portfolio and reduce risk giventhat


that historically house prices are independent ofbonds and stock markets variations.

As a matter of fact, the lower interest rates are, thebetter it is for those seeking to buy a house. Thishappens because mortgage loan rates walk hand-in-hand with interest rates, and unless you are able topay for the house upfront, taking a mortgage loancan be a problem if you cannot afford the extrainterest. Moreover, usually one of the greatest issueswith getting a bank loan is the amount of interestyou pay during the first installments – after all, whenyou look at it, a large subset of the money you paygoes towards the interest payment and not theprincipal repayment due, which remains almost thesame.

If interest rates are low, you will pay a smallerpercentage of your instalment as interest and abigger portion as reimbursement, which means youwill be able to pay down your debt quicker andtherefore pay a low nominal value (not percentage)of interest on your next installments. Even if therates go up in the future (as they most likely will,

particularly for the US), your principal due is alreadysmaller and the impact of the rate raise is thusreduced.

An example: if you borrow $175,000 for 30 years,your principal and interest payment will only be$835 per month, with a 4% fixed interest rate. Nowconsider the impact of an interest rate increase of2% on a mortgage loan. Borrow $175,000 for 30years at a 6% interest rate and your paymentballoons to $1,049 – a staggering 26% increase inyour loan payment.

Overall, regardless of the type of investor you are andgiven that your investments are realized correctly,you can definitely benefit from the low rateenvironment right now when it comes to buying aproperty.

Be aware, however: some markets in the US and EU(especially the UK) have repeatedly been labeled asoverpriced, so make sure you do your homeworkbeforehand.

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It’s raining oil. What else?


Russia’s Gas and Oil: a Tale of Two Strategies Running from (and Towards) Interdependence?

Andrey Dmitriev and Pedro Filipe Rodrigues

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Russia holds a strategic positionin global energy markets as amajor competitor in gas, oil andcoal. Not only is the energy sectorthe great provider of revenues forthe government, but it is also oneof the reasons why Russia canonce again cope in terms ofgeopolitics with Europe or eventhe US. The environment of lowenergy prices and economicsanctions in Russia has createdadditional pressure to the sectorduring one of its most importantstages of the last decades and maydelay the long-term “EnergyStrategy” adopted by itsgovernment.

Russia-EU relations are muchcentered on the supply of gas towestern markets. As such, theRussian gas industry is a majorpower-projecting tool even morethan the oil industry, regardless ofits sizeable contribution togovernment revenues.

As a geopolitical weapon, Russiangas has been used to mediaterelations with Europe, especiallyin the context of Russia’s largestenergy company, Gazprom. Thesetwo regions have an energeticinterdependence in which the EUdepends on Russian supply – 30%of all imported gas – and Russiadepends on European demand –which accounts for 50% ofGazprom’s revenues, whichcorresponds to one-third of itsgas. Such imbalance results partlyfrom the Russian chronic problemof inefficient resource utilization.

Better energy efficiency wouldallow higher domestic savings andmore gas available to reach othermarkets.

Nevertheless, Western economicsanctions and the recent plunge ofoil prices have proved to be quitea blow to its gas sector. Thesanctions have restricted manyenergy projects from gettingmuch-needed financing from theWest, while low oil prices – whichalso affect gas due to LTC’s oil-indexed-prices - have restrictedRussia’s self-financing capacity.Over the past two years, Russiahas increasingly looked eastward,mostly to China, both forinvestment and as a new marketfor its gas. The Chinese market,which has the potential to matchthe European market, is lookingto decrease its coal use forenergy- generating purposes andsees gas as a less pollutantsdfssdfsd

substitute.

Furthermore, at the currentlocation where most of the gas isextracted, the Nadym Pur Tazovdistrict of Western Siberia,production is expected to dropfrom 500bcm currently to333bcm in 2035. This poses oneof Russia’s current majorchallenges: substituting its old gasfields and building newexploration facilities in times offinancial hardship.

For example, one project whichaims to diversify gas exports andcompensate for decrease ofproduction in traditional areas isthe Yamal LNG, a $27bn joint-project between Novatek,France’s multinational Total,China’s CNPC and The Silk RoadFund. An LNG plant in the Arcticmay be a strategic step for Russia,given that the Northern


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passage goes mostly throughRussian territorial waters andthere would be no need fortransport infrastructure.Moreover, icebreakers may shipliquefied natural gas (LNG) toalmost anywhere in the world,allowing Russia to reach newmarkets. However, even thoughthis LNG plant is to be operatingby 2017, $17.5bn are stillnecessary to complete the project,mostly due to the absence of long-term funding due to sanctions andsome reluctance from the Chinesethat is fueled by its currentslowdown, as well as thepossibility that Australia might bea cheaper source of LNG.

In the context of oil, Russia holdsa prime position in global markets,as it provides one-eight of thetotal volume. About 75% ofRussian oil – both crude andrefined – is allocated to theinternational market and accountsfor 40% of the Russiangovernment revenues.

Russia supports a two-waystrategy for its oil exports, withEurope consuming the bulk of itdue to the geographic proximityand the pipeline linkages withRussian producers However, itsproduct is being increasinglyshifted to Asia, particularly Chinaand India. As stated in its “EnergyStrategy,” its goal is to doubleexports to Asia by 2035.

Regardless of its newfoundobjective, the western market is acash cow for Russia, accountingfor 80% of total exports –especially to Germany, theNetherlands, Poland and Belarus.However, as Russian companiesstruggle to meet the targets forAsia, a part of western oil has

been redirected towards theESPO pipeline network. This ismore lucrative due to the higherpremium of the ESPO blend overthe Urals blend, which is themedium-heavy sour crudeexported to Europe.

Recent estimates indicated that by2035 both markets may be onpar, with Russia shifting most ofits Siberian production towardsits eastern provinces, and signinglong-term “loan-for-oil” contractswith China – currently until 2038– to secure financing to supportthis sharp transition withinRussian oil market. This strategyclearly indicates that Russia istrying to dodge competition fromthe Middle East and that, ratherthan using oil for geopolitics, it ismore concerned with increasingthe security of demand for its oiland diversifying its exports.

With regards to its refinedproducts, Russia is expected tocontinue to compete in westernmarkets, supplying around 90% ofits demand. However,competition will shift fromquantity to quality, as the exportsof higher quality fuels such asULSD are expected to increase

over fuel oil. The strategy is totake advantage of Europe’sdiminishing refining capacity andto acquire stakes in Europeanrefineries at bargain prices, assome companies are selling assetsat low prices due to refineries’high exit costs. Indeed, Russiancompanies seem more willing toupgrade European refineries andsupply them with cheap oil thanto build new ones in Russia.

By providing huge tax breaks tooil companies, President VladimirPutin is pointing to the mineralriches of Russian easternprovinces as the country’s“national priority of the century.”While doing everything within itsreach to promote ESPO to abenchmark crude, low oil pricesand western sanctions havelimited the access to foreigntechnology. This has forcedPutin’s hand as he has finallyopted to support the developmentof Russian technology. However,even if Russia succeeds with its oilstrategy as it did in the past,turning all forces to the easternmarket may ultimately create thesame type of dependence thatRussia is running from in Europe.


Power GamesAn Energy Tug-of-War

Diego Tremiterra

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Everyone knows how dependentwe are on oil. The second half of2014 showed us how volatile theoil market can be, with Brentplunging from $114 on June 20 to$48 on January 23 – such a dropis usually seen in Disney World’srollercoasters, not in financialmarkets. Historically, though, thisdrop is not as impressive asothers: just look at the period oftime between 2008 and 2009,when oil prices dropped from$147 to $32. Regardless, manyreasons could explain such aphenomenon. At first sight, itmight be interpreted as aconsequence of continued (oreven increased, in the case ofSaudi Arabia) production fromOPEC to protect their marketshare from increasingly cheaperextraction prices of shale oil in theUS. As supply increases, ceterisparibus, oil prices fall, hurting theUS shale producers with theirhigher break-even point at around

$60 (see the oil extraction costestimates displayed below). Onthe other hand, we could also finda more structural and deeperexplanation.

Jeff Currie, global head ofCommodities Research at GoldmanSachs, believes that what broughtthe current oil price to around $40is much more than just powergames.

First of all, it is a supply issue,which is more complicated thanjust OPEC’s strategies. Shaletechnology is reshaping theindustry, structurally changing theoil extraction process from capexintensive to variable-costintensive, turning oil productioninto a “manufacturing process.”As Mr. Curries explains,“nowadays, extracting shale oil islike producing paper clips.” Withcurrent technologies, shalecapacity can be increased,

modified or even cut in around 30days. That is mind-blowing,especially when compared to theold mechanism, in which oilrigswould pump oil for ten years andchanging capacity was consideredto be a massive headache. Thisstructural change has increasedcompetition and caught theattention of investors, whoconsider shale oil an interestinginvestment due to the “short”payback period and how rapidly itcan adapt to fluctuations in prices.The increased interest led torenewed investment and,therefore, increased production inthe US, bringing 3.8mn bpd ofincremental oil supply to themarket from 2011 to 2014.

Secondly, we have the issue ofdemand. Historically, the BRICsused to be the base-load demand.For instance, countries like Braziland China used to represent aguarantee for oil demand while


34

the US was seen as the margin ofadjustment, meaning that oilprices would spike or plungedependent upon demand in NorthAmerica. What we witnessnowadays is the exact opposite.With the US ever closer toachieving energetic independence,they are now base-load demand,whereas the BRICs and similarcountries are the margin ofadjustment. This means that oilprices will fluctuate dependent ondemand in countries like China orBrazil. If we track the economicperformance of such countries inthe last year, we can easily verifythat poor growth is translated intolower oil demand, increasing thegap between global consumptionand production.

Overall, it is more of a supplythan a demand story. As pricesaveraged $50 in the last year, thismeans that shale in the US hasbeen running at a loss. How havethey been able to survive? Easy:with the help of debt. As ofOctober 2015, the amount ofdebt held by US oil and gasproducers had skyrocketed to$170bn, more than double theamount of debt that existed fiveyears ago. Moreover, the Fed isexpected to hike rates; this willresult in higher interests on bothdebt and inventory, shorteningthe life span for loss-making oilproducers.

Winter is coming for someproducers around the world; thisexplains why we have seen largecompanies cutting costs andreducing their output, as the lowprice environment does notsuggest a rebound, at the veryleast in the short-medium term.For instance, both BP andChevron have been cutting

massive amounts of jobs todesperately try to decrease costsand maintain current dividends.By next year, the US governmentexpects output to decline to anaverage of 8.6mn bpd, down froman average of 9.3m bpd in 2015.

Consequences of low prices arebeing felt globally, with forecastfor non-OPEC production todecrease by 500,000 barrels a dayin 2016 (according to IEAresearch), the biggest cut in thelast 24 years. Goldman Sachs hasgone as far as to estimate that, ifOPEC production continues togrow and non-OPEC demandstays resilient, then we might seeprices as low as $20 a barrel.

The dynamics of the past yearpoint to an overall change in theoil market. Even though OPECseems to be winning the duelagainst shale producers, it is faraway from having the price-making power it once had.

The shale revolution brought lessvolatility to the oil market,flattening the supply curve andeffectively reducing OPEC’smarket power. Historically, OPEChas always increased or decreasedproduction in order to lower orspike prices, respectively. As thesupply curve flattens, however,this strategy will increasinglybecome more inefficient as pricesdo not fluctuate as much.

To add insult to injury, shale isnot the only threat to the OPECdictatorship. Alternative sourcesof energies are becomingincreasingly relevant, playing aglobal role in the energy market.World biofuel production hasdoubled to over 1.2mn bpd since2006. Wind power has grown, in

oil-equivalent terms, to 2mn bpdin 2013 (having doubled since2008). Solar power had grownfrom 20,000 bpd of oil-equivalentenergy to 400,000 in the sameperiod of time. Going forward,albeit cheap shale gas pricesmight create a difficultenvironment for renewables, wewill still manage to witness anincreasingly more diversifiedcombination of energy sources.Furthermore, gas turbines couldhedge the intermittency ofrenewables: Mr. Curries statesthat, in the foreseeable future,electricity production will be ledby natural gas, wind, and solarpower, while transportationmeans will primarily rely uponelectricity, natural gas, and oil.

At the end of the day, we ar ewitnessing a world which isslowly becoming less dependenton oil. With the support oftechnology, mor e diversifiedsources of energy are becomingavailable to the consu mer,threatening oil producers and,most of all, OPEC’s future streamof revenues.


"Lost! Lost! My Precious is Lost!"Gold in an Era of Low Rates, Inflation and Growth

Catarina Castela and Miguel Moita de Deus

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Unless you have been really distracted lately, youhave probably heard that the price of gold has beenquite low these past months. In fact, it has been on asteady free-fall since the 2011 record-high price of$1,921.17. This week’s price was $1,072.6.

But how has such a decrease happened in the firstplace and why has it continued?

We must first understand why gold is so important,from a historical and evolutionary point of view. No:this article is not an exploratory piece on theCalifornian gold rush or the Spanish hunt for ElDorado. It is, instead, our attempt to (hopefully)shed some light on why gold still and always will be athing.

Until WW1, many countries had in place the(in)famous gold standard, which gave citizens andcompanies the possibility of converting paper notesinto gold coins or bar. After the war, however, theUSD began to be increasingly used by the rest of theworld as a reserve currency; this was the beginningof the end of the gold standard’s role in our society.

Gold only really regained its shine in the twentiethand twenty-first century when investors started thepurchase of this commodity not only as a way tohedge against inflation and other economiccalamities, but also for speculative purposes. Sincegold was not as influenced by said factors, this move

enabled investors to minimize their wealth lossduring recessions.

Although global markets are an ever-changingphenomenon, this strategy of “cheating” thevolatility of currency by purchasing gold is still upand running – that is precisely why this shiny metal isstill so important in today’s economy.

So, again, why has gold been on such a downtrend?

For starters, gold prices – not unlike the greatmajority of goods and services – are ultimately afunction of its demand. Moreover, its supply changesslowly; after all, it takes at least ten years or more toconvert a gold deposit into a producing mine. Itfollows then that if prices are down, then demandhas been decreasing.

The justification for such a statement lies with thelow value of inflation, the stronger USD, and theupward trend in the US economy. In 2008, the IMFwent as far as to estimate that 40% to 50% of goldprice shifts since 2002 were related to USD moves.

As of recently, the USD has been appreciatingrelative to other currencies; moreover, as it is stillused as a reserve currency throughout the world,demand for gold has logically decreased, as goldplays the role of an alternative investment source


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that conserves the investor’s wealth. Moreover, theincreasing USD shrinks the relative value of othercurrencies, consequently pushing the demand down.In an era where US inflation has been rock-bottom,now stuck at a seven-year record low rate of 0.2%,demand for gold has also been showing weak signs.Why? Well, investors do not need to shieldthemselves from the fall in the value of papercurrency in terms of the goods and services it canbuy. Usually and paradoxically, inflation level belowthe Fed’s 2% target rate discourages rate hikes,which should constitute positive news for gold.Currently, however, even at the current level ofinflation, there is a wide expectation of a rate hike inthe FOMC’s December meeting.

This is another reason that explains why gold hasbecome so cheap these days. Unlike equities orbonds, gold does not generate any type of return ordividend income. After the Great Recession, whenyields from other assets were low and there existedan associated high risk, investors felt at ease withparking their money on gold. After all, the shinymetal provided a safe haven for those who wanted tokeep their assets’ value.

Currently, however, most financial products areoffering higher yields for lower risk due to theoverall world economic recovery; as such, investorsare increasingly shifting their focus to assets such asstocks, bonds, and futures – thus leaving gold to adarker and more unpolished future.

What does the future hold for gold? Has economicrecovery and subsequent growth established thedawn of a new era of cheap gold?

Although no one can say for sure, some factors canhelp investors understand and perhaps have aglimpse of what the future might hold. One of themis the probable Fed rate rise in December, which willeffectively control inflation but will not bid well forgold, for the reasons previously mentioned.

Another indicator of the (not so) glittering metal isthe actual intrinsic value of the product. A studyfrom two National Bureau of Economic Researchresearchers, namely Claude Erb and CampbellHarvey, suggests that the fair value of gold amountsto $825 an ounce and that “$350 an ounce is the

downside risk to the price of gold given the existenceof a golden constant framework, a prior low realprice of gold and the current level of the U.S.Consumer Price Index.”

All in all, it is (fairly) certain that every time theeconomy is worse off or the USD is weak, goldbecomes investors’ crying shoulder regardless ofhow long it has been neglected.

At the end of the day, the world population isconcerned with economic growth, not gold. In theshort-medium term, it seems the scenario willimprove. Nevertheless, the precious commodity stilland always will have considerable influence in worldmarkets and in the global economy.

Unlike what is prophesized in fairytales, however,one asset will not rule them all – at least that hasbeen the case with gold.

Next stop:economic slowdown


Chinese Hard Landing?Implications for Global Markets and International Trade

Miguel Amaral and Tiago Reganha

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Long gone are the days in whichChina’s double-digit economicgrowth was taken for granted.China is now facing the impact ofover-investment in basic economicsectors, over-borrowing, and thestrength of the CNY.

However, despite the lack ofconfidence that followed China’sstock market crash, its impact onChina’s downturn has been largelyoverestimated.

Currently experiencing a period

of great transition, rather than afinancial crisis, China now hasmore housing space per capitathan Spain – which is notoriousfor its major housing bubble. Thebasic industries sector, financedby over-borrowing from localgovernments to boost real estateand infrastructure construction, isnow in decline and being partiallyreplaced by the service,consumption, and informationtechnology sectors. In fact, steel,cement, and electricity sectorshave experienced negative growth

since early 2015. Sincesince only 2015. Since then, onlythe electricity sector hasrebounded.

More importantly, one must lookat the big picture in order torealize how the situation at hand –both positive and negative innature – is affecting the world’seconomy, trade, and financialmarkets. As this scenario evolves,China’s trading patterns will fail tomaterialize as negatively as it isexpected.

For instance, several analysts havereported that China’s importshave declined this year, which is ahalf-truth. In fact, although thedecline did occur, the actualdecline in volume is less significantthan the decline in the value of theimports. After all, China is a majorimporter of primary and rawmaterials, as well as agriculturalproducts – all of which have seensignificant price drops recently.The same logic explains thedecrease in China’s exports to theEU in which the consecutivedevaluation of the CNY is toblaa


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blame, with a 25% gain on theEUR in just a year. In fact, it islikely that the volume of exports isactually still rising.

The biggest indicators of China’stransition is its trade surplus andratio of trade surplus to GDP –which inversed the trends ofprevious years and will likely staybetween 5.5 and 6% of the GDP for2015 – and new booming sectors,including e-commerce.

While China has been the marketleader for a while, only now arewe seeing their distributionsystems, information technology,and logistics services leapingahead and replacing old andinefficient practices previously inplace. The competitive e-commerce space, coupled withthe decrease in imports of energyand raw materials, is pushing theprices down, causing deflationand one of the causes for thelowering of the GDP.

One of the main causes of theoverestimation of the impact ofChina’s downturn is the

misconception that the country isa major force of global growth. Itstrade and current account balanceproves that its capacity topromote growth outside itsborders is somewhat limited.Ultimately, the major negativeimplications of this downturn willfall upon the countries thatheavily depend on China in thecontext of trading, such asMongolia and Sierra Leone. Bothof these countries have a tradedependency of 90%, followed byAfrican countries that export oiland raw materials, as well asAustralia and Brazil.

Surprisingly, Europe, China’sleading export market, will hardlybe affected as most EU countries’trade with China is below 5%.Nevertheless, an exception shouldbe made for indebted countries,whose burden will be heightenedby the deflationary trend. Overall,China’s slowdown and pricedeflation will have the mostnegative impact on world’sproducers of energy and rawmaterials; on the other hand, itwill have a positive impact for

importing countries. Europe,which does not produce primarymaterials nor has large exportactivity with China, will in factbenefit from China’s hardlanding: the global downwardtrend in the prices of basicmaterials will benefit Europe’simporters while the price drop ofChinese goods will increase theprofit margins of Europeanbusiness – as well as improve thegeneral public’s living standards.

Either way, China’s economictransition will face severalobstacles. In particular, thenegative sentiment of economicagents has the capacity oftrampling such a move towards alarger role of private investmentand consumption – this has beenthe case since the tumble of theChinese stock market in August.Finally, the constant uncertaintyand lack of clarity regarding thedirection of government policy isalso very damaging, including itsrefusal to make major structuralchanges and the incessantmonetary policy alteration.


The Perfect StormRecession, Political Stability, and Commodity Pain in Brazil

Manuel Vassalo and Sebastião Fernandes

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Back in 2010, Brazil’s economygrew three times faster than thatof the US. As millions ofBrazilians moved from povertytowards the middle class,President Luiz da Silva had an83% approval rating.

As a member of the BRIC, a termcoined by economist Jim O'Neill,Brazil and its peers – that is,Russian, India, and China – weresupposed to establish a neweconomic order through fruitfulgrowth rates. For a while thisseemed to be the case as eachcountry grew exceptionally at thesame time that commodities andenergy exports were booming.Then, Brazil was the world’sseventh largest economy.

Since 2013, however, Brazil hasbeen the weakest link. In her firstterm, President Dilma Rousseffenjoyed weak growth rates,averaging 2% per year between

2010 and 2014 – a valueconsidered low relative to Brazil’saverage growth rate of 3.5%between 2002 and 2008. Despitelow growth, global demand forBrazil’s soybeans, iron ore, andoil were quickly increasing.Inflation was soaring (6.4% in2014, which is well above themandated 4.5% target) due toloose monetary and fiscal policy,and a decreasing trend in theunemployment rate took place,from 7.2% in 2010 to 4.3% in2014.

For Brazil, the tables turned in2015; indeed, the Brazilianeconomy has shrunk 2.6% in thelast year, which is by far the worstcontraction in the past 25 years.

Moreover, the country isstruggling with a rising four-yearhigh unemployment rate and acurrency that has lost 25% of itsvalue against the USD. Since last

year, imports have fallen about12% and the stock market isdown 20%. As expected,President Rousseff is having adifficult time with approvalratings of about 8%, the lowestsince 1992 when Brazil’sPresident Fernando de Mello wasimpeached.

Brazil’s economic failures are bestexplained through the currentChinese economic slowdown andtransition, the massive corruptionscandal involving Petrobras(Brazil’s largest oil company), andlow commodity prices.

Exports to China boomed overthe last decade. As of lately,however, China’s attempt totransition towards a consumer-ledeconomy that is less dependent oninvestment and manufacturinghas severely affected its tradeactivity with Brazil.


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Moreover, given that commoditiesrepresent a big part of its GDP,the falling commodity prices –coupled with the depreciation ofthe BRL – have decreased thevalue captured by Brazilianexports, even though the exportvolume has, in fact, increased.

Corruption in Brazil is not a newphenomenon. With Petrobras, theissue at heart is the size of thescandal: as of early 2015, thecompany’s scheme had moved$2bn just in bribes. In July, thepolice arrested executives fromElectrobras – Brazil’s largestelectric utilities company – withcharges related to the latterscandal. Overall, this proved to bea deadly blow to businessconfidence, as investment fellnearly 12%.

As it occurred in much of theemerging market, severalBrazilian companies tookadvantage of the Fed’s monetarypolicy to finance their operations,thus racking up their USD-

denominated debt. Coupled withthe USD rally, the devaluation ofBRL has made debt repaymenteven more expensive – an effectthat has effectively countered thelong-term notion of competitiveexport strength in the face of alower-value currency thataugments exports’ attractivenessin the global market andencourages domesticconsumption.

Some people believe that troublein developing economies mayaffect the US because most of theinvestment growth in the globaleconomy since the financial crisishas been driven by the emergingworld.

At the end of the day, however,the US is not helping at all. It isnot just China causing Brazil aheadache abroad. Things can getworse this very year. If the hike inUS interest rates is to take place,investors may increasingly tend topull their cash out of emergingmarkets like Brazil.

Ultimately, Brazil is paying formistakes it made during its boomyears. Its central bank loweredinterest rates in 2011, triggeringinflation which is now rising bydouble digits.

Marcos Troyjo, an associateprofessor of international affairsat Columbia University and anexpert on Brazil’s economy, hasbrilliantly framed the Brazilianreality:

“If you think about a whole stretchof history from 2010 to 2018,which is almost a decade, Brazil’sgoing to experience very littlegrowth, if any growth at all. It’ssort of a reproduction of what welived through in the 1980s, a timethat economics books called the‘Lost Decade.’ So we are going tohave another Lost Decade.”


How to Hedge Against a Left-Wing Government in Portugal Stability Might Not Be in the Mood from Now On

Gonçalo Marques and Manuel Antunes

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As the Left rises, the Right falls.Some will win and some will lose.How to be within the segment ofindividuals who will not reportlosses by the end of the year?

As a left wing government rose topower on the November 24, long-term perspectives for thePortuguese recovery diminish.The coalition led by AntónioCosta aims to encourage realeconomy, particularly bystimulating households’consumption, neglecting theBudgetary Stability Pact. With theend of a cycle of four years fullydedicated to achieve the goalsestablished by troika, some effectsof the past strategy of retractionwill be lost immediately.

Maybe because of somedreamlike ideas and promises thatcould drive Portugal back to acrisis situation, investor’s may, ata first glance link a left-winggovernment to uncertainty andinstability. The memory of the

legacy of the past Socialists Party(PS) government might not behelping its reputation amonginvestors. PSI 20 Index, thePortuguese main stock exchange,has not registered a defined trendsince the national elections of the4th of October, but faced a lot ofvolatility, registering several gainsand losses since that date. Thetwo things to note in this periodfor this index are (1) a solid gainthe week before and after theelections [10,6% in total] -possibly due to the rise of theright-wing coalition in the electionpolls, and its consequent win -and (2) a decent loss [-7,56%] theperiod before and after thePortuguese right-wing government(PaF coalition) fell. Unfortunately,both situations end up beinginconclusive, in the sense that theother European indexes, FTSE100, DAX, CAC 40 and inparticular the Spanish IBEX andthe Italian FTSEMIB, followedthe same path for those periods.What one can note is that Short

term (2Y) PortugueseGovernment Bonds behavedslightly better than its Spanish andItalian peers the days after thePortuguese elections (October 4),and were more volatile after thefall of the PaF coalition. In longermaturities, despite the consistentfall in Portuguese yields after thenew government took office, nobig divergences from its peershave been registered. So far“uncertain” is the only adjectiveto describe such investor’sbehaviour.

The billion-dollar question is if aleft-wing Portuguese governmentis a threat or not to the economicrecovery and budgetreorganisation that has been seenrecently – GDP growth of 0,9% in2014, 1,7% in 2015 and 1,9% in2016; 2,2% growth of privateconsumption in 2014 and of 2,2%and 1,7% predicted for 2015 and2016; -0,3% decrease inGovernment spending in 2014,


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predicted to continue1 throughnext periods2.

Back to the main topic of thisarticle, facing somewhat of ashortage of flavor on the Bondmarket during this past periods, ashort position in this marketwould make sense for someonebearish on the Portuguese market- someone expecting a bigdownturn in the Portugueseeconomic recovery or expecting adowngrade of the PortugueseBonds investment grade, this timeby DBRS leaving Portuguesebonds out of the ECB bond-buying plan. Unfortunately thereare no ETFs tracking the smallPortuguese bond market, whichwould make this short hedgingsolution a bit more difficult tocreate, since short selling is noteasy to achieve as a privateinvestor.

Considering the uncertainty overthe Portuguese market is here tostay, and consequentially volatilitywon’t be over soon, depending onhow bullish or bearish we are, itwould be interesting to analyzesome derivatives covering thismarket.

Focusing our analysis in theoptions market, we have availablein the Easynext Lisbon longermaturities (03/2016 and06/2016) for strike3 prices closerto today’s spot4 price of the PSI20Index, rather than strike pricesfurther from todays spot.

Knowing the importance of thetime to maturity on the value ofan option, we considered a longermaturity would provide us betterchances to hedge against a morevolatile market. Also, expectinghigher volatility of the market in afuture moment of politicaluncertainty – another change ingovernment – it would beinteresting to hold an option thatwould cover the date of theclosest possible parliamentelections – after the election of aPresident.

A bearish investor on thePortuguese market could opt for aput option out of the money(OTM)5 with a lower strike pricethan the spot price today. Abullish investor would look for acall option with a higher strikethan the spot today. Both, takinguncertainty of the Portuguesestock market as granted for themonths to come, would look foroptions with strike prices thatwould let the option pretty muchOTM, and with longer times tomaturity, in order to benefit themost of the possible volatility ofthe market in the longest periodpossible. Both strategies would bevery risky, due to the exposureonly towards a fall or rise in theprice of the index, but with thelonger time to maturity, and thehigh expected volatility, it isfeasible to believe the changes inthe underlying spot price willstrongly affect the option prices.This effect will be stronger thefurther the maturity date.

An investor who does solelybelieve in the volatility of themarket, with no strong positionon the direction of the Portuguesestock exchange, would prefer tostructure its position in such a

way that would neutralize theeffect of a price increase vs a pricedecrease of the underlying,exclusively benefiting of the pricechange in absolute value, in otherwords, benefiting from thevolatility. The option combinationthat would allow this positionwould be combining a put optionwith strike of 5000 and a calloption for the strike of 5200 andsame maturity. This combinationis called a Long Strangle.

Some other option strategiescould be considered, as seen inthe graph below, but consideringshort selling is not accessible toeveryone, the Long Stranglewould be the most suitableinvestment solution for thissituation.

The pay-off structures representedwere computed for pricesregistered on November 26 ataround 19h00. The maturity ofthe Straddle is 06/2016 and thematurity for the Strangle is12/2015. From the figure one canconclude small changes in thespot price of the underlying fromthree months average -approximately 5200/5250 - canlead to positive pay-offs.

1 This year’s Government expenditure endedup being greater than expected due to theunsuccessful sale of Nova Banco, but this will,sooner or later, no longer represent a weightin the Government Balance Sheet;2 Data from BANCO DE PORTUGAL •Economic Bulletin • October 2015;3 Price set today at which we agreed to tradethe underlying at the maturity date;4 Current price of the underlying;5 When the spot price is far the price enoughto make a profit (when spot>strike, for a call,when strike<spot, for a put).

Did You Know?PT GVMT bonds arenot junk – at leastaccording to DBRS.


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As far as the XXI GovernmentProgram is concerned, theminimum wage, labor market andtaxes will be the main prioritiesfor the next legislature. In fact,the coalition plans primarily toreturn the cuts in the salary ofPublic Function at a pace of 25%in the first quarter, 50% in thesecond, 75% in the third and100% in the last quarter, startingfrom January 2016, with thepurpose of giving back thepurchasing power lost.

At the same time, it will proceedto a phased increase in theminimum wage of €95 until2019, with the salary movingupwards to € 530 in 2016, € 557in 2018, € 580 and to € 600 in2019. Furthermore, pensionerswill benefit directly since theRetirement Supplement will berestored to public sector workers.Pensions will also suffer a newupdate on January 2016, the firstsince 2009. Regarding directtaxation, not only the surtax overIRS, but also the ExtraordinaryContribution of Solidarity (CES)will decrease by half, which willadditionally contribute to a rise inthe wage effectively received atthe end of the month andconsequently in the powerpurchase.

Consumers will not be the onlyones to take the advantage of aleft-wing government. Thecoalition led by the Socialist Party(PS) targets to reinvent the taxsystem for companies. InPortugal, the sustainability ofcompanies is a long-lastingproblem. The Portuguese businessframework is composed in itsmajority by micro sizedenterprises, with 89% of thecompanies having businessvolumes under €2m and 10workers or less. Enterprises thatemploy over 250 employees,which represent 0.3% of the totalframework, are responsible for43% of the total sales volumegenerated in 2014.

The new government is planningto implement a long-lasting idealof incentives to the settlement ofnew companies, easing the laggingprocess.

Due to this specific type ofbusiness framework, and thesmall number of listed companies,it is hard to tell a certain trendamong the consumer goodscompanies’ stocks - the ones mostexposed to available incomeincreases. At the same time, thesesame companies will face greateremployee costs, which will

possibly penalize them in ashorter run, until the actualincrease in available income istranslated into an increase inrevenue. The one sector one cansay will clearly benefit are therestaurants and bars, who will seeits VAT decrease by 10% in 2016,the new government says.

The will of every single measurehas an almost certain positiveimpact in the economy in a veryshort term. The problem is tomanage all that assuring thebudget constraints and theinternational agreements. That issomething hard to believe foreveryone, including investors.That being said, the reason for theuncertainty in the future are thedoubts regarding the achievementof better deficit levels and theadjustment of the public finances,when several expansionisteconomic measures are put inpractice. The past tells us thatwhen those targets are not met,Portuguese people availableincome and the Portugueseeconomy will be punished onceagain.

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