THE DEAL OF THE CENTURY BY JULIAN HE, CHRIS WU, AND RYAN AZARRAFIY
Spring 2013 issue
The Princeton
Financier FALL 2014 Volume 4 | Issue 1
EDITOR-IN-CHIEF DHRUV BANSAL ‘17
MANAGING EDITORS ERIC HUANG ‘16
LE T T ER FR O M T H E ED I TO R
DESIGN & LAYOUT ARIANNE CARPIO ‘16 Alan du ‘17 YOU-YOU MA ‘16 jenny zhang ‘18
CONTRIBUTORS GRACE CHANG ‘17 SHUYANG LI ‘16 CRISTOPHER YU ‘17
PCFC Board PRESIDENT Darwin li ‘16
EDUCATION & MENTORSHIP ASHLEY KIM ‘16 DONG YI ‘16
MARKETING you-you ma ‘16
COMMUNICATION & TECHNOLOGY John Su ‘16
INDUSTRY INSIGHT ryan azarrafiy ‘16 BRENDAN HUNG ‘17 DIANA TURBAYNE ‘16
FINANCE DANIEL KIM ‘16
EQUITY RESEARCH ERIC HUANG ‘16
CLUB MANAGEMENT ben Huang ‘15 ALL CORRESPONDENCE MAY BE DIRECTED TO: The Princeton Financier 0666 Frist Center Princeton, NJ 08544 pcfc@princeton.edu www.princetoncfc.com
A rush of events marked the second half of 2014, as the American economy seemingly surged to recovery while the global economy stagnated. The events spanned industries and countries: the drop in oil prices, Alibaba’s IPO, the largest in history, and the strong tremors in Japan and the European economy all reflected the complex nature of the world’s slow trudge from the deep pits of the recession. Accordingly, this issue of the Financier attempts to place the lessons of each of these seemingly disparate events into a broader context. The future of Abenomics in Japan, for example, holds consequences for European policy as the European Central Bank continues to examine ways to jumpstart the Eurozone out of its doldrums. The drop in oil prices clearly has global consequences, but just how much the losers will drag down the winners remains unclear. Collectively, the articles paint a picture of the dramatically increased volatility that has characterized this past year and worried economists and policy makers seeking to stabilize the teetering international economy. This issue also marks a shift in style for the Financier. The magazine has long provided high quality content for those with a strong working knowledge in finance. In a bid to align the magazine closer to Princeton Corporate Finance Club (PCFC)’s mission to educate the entire Princeton undergraduate community on all things related to finance, this issue includes reviews of the fundamental concepts underpinning many of the articles published and the articles assume less prior knowledge. Now, a broader audience of students and professionals can
pick up the magazine and walk away with a deeper understanding of the current state of the financial world. This change in accessibility reflects broader shifts within PCFC as the club continues to grow and adapt at a tremendous rate. This semester, PCFC introduced a new equity research division, a wing dedicated exclusively to developing a successful investment strategy. The focus of the equity research division is to educate the broader Princeton community on sound investing principles and give students with little prior experience a chance to learn more about how investment strategies actually work. The pilot semester proved a roaring success, as an overwhelming turnout made the division one of the most popular in PCFC. Further capitalizing on this demand, PCFC is partnering with Farallon Capital Management to host a stock pitch competition this spring that will allow any student to compete for grand prizes and hone their investment skills. Put together, the past semester marked an exciting new chapter in PCFC’s steady expansion, and the next semester promises even more opportunity to push forward with the club’s mission. The officer corps persists in outdoing themselves with their incredible dedication to focusing PCFC on her mission, the sponsors are only increasing their support, and the broader community grows more enthusiastic about our efforts with every initiative. For this, I remain thankful and assured that the astonishing trajectory PCFC has followed will only endure for the foreseeable future. Enjoy this semester’s issue of the Financier!
- Dhruv Bansal ‘17
The Princeton
Financier INSIDE: 4 8 12 16 20
ABOUT PCFC
Year in Review by Dhruv Bansal Finance 101: Cracking the Jargon of Wall Street by Shuyang Li The Oil Bust: The Winners and Losers of the Price Crash by Christopher Yu The Future of Abenomics: Recommitting to “Whatever it Takes� by Grace Chang The State of the Economy: Forecasts vs. Reality by Dhruv Bansal
The mission of the Princeton Corporate Finance Club is to provide an educational and networking platform for Princeton students interested in investment banking, private equity, venture capital, and the field of corporate finance at large. Established in March 2011, the Princeton Corporate Finance Club has quickly become a prominent club on the Princeton campus with over 400 student members and 30 officers working in seven divisions: Education, Mentorship, Industry Insight, Finance, Marketing, Communication & Technology, and The Princeton Financier. Our core values are fraternity, entrepreneurship, leadership, responsibility, integrity, professionalism, and mutual respect.
THE YEAR IN
A RUNDOWN OF THE
THE PRINCETON FINANCIER | 4
BIGGEST
REVIEW: FINANCIAL NEWS IN 2014
THE PRINCETON FINANCIER | 5
THE YEAR IN REVIEW:
THE PRINCETON FINANCIER | 6
A RUNDOWN OF THE BIGGEST FINANCIAL NEWS IN 2014
THE PRINCETON FINANCIER | 7
Piece written on November 4, 2012
AN EXCERPT FROM
Finance 101: Cracking the Jargon of Wall Street Arbitrage, small firm effect, reversion to mean: these terms are thrown around all the time by finance-savvy journalists, bankers, and professors, but it’s easy to gloss over what exactly they mean. Yet, understanding these terms remains crucial to analyzing the current market and predicting future trends of the financial world. Just in time for interview season, writer Shuyang Li rounds up a few of these key concepts in an easy to understand primer.
Arbitrage Arbitrage underpins much of how financial markets make money. Broadly, arbitrage is deriving profit from a mispricing of an asset. In theory, the market price of an asset reflects its value, and assets are priced appropriately since a mispriced asset is expected to quickly return to its appropriate price. To do so, arbitrageurs purchase the asset if it’s valued too low and short the asset if it’s valued too high. Then, once the market drives the value up or down to the appropriate price, the arbitrageur either resells the stock if it had been purchased or buys the stock if it had been shorted. By repeatedly taking advantage of such mispricings, the
THE PRINCETON FINANCIER | 8
arbitrageur can accumulate arbitrage profits. Although in the financial world, arbitrage primarily occurs with fiscal assets, an illustrative example can be found in arbitrage of physical commodities such as clothing or technology. For example, an unlocked iPhone 6 (128 GB) starts at $849 when sold in the United States. However, the price of the same iPhone in China is 7,788 RMB, which converts to about $1200. Here there is an arbitrage opportunity: buying phones in the United States for the lower price and selling them back in China. After transaction costs, the arbitrageur is guaranteed a profit. The resale value of an iPhone 6 in China
is estimated to be around $1100 (resale price below Apple’s price to make it more attractive to customers), and the round trip flight ticket from Shanghai to New York and back will be roughly $940. For each iPhone 6 bought in New York and sold in Shanghai, the arbitrageur will earn roughly $250 in profit. If the arbitrageur sells more than 4 phones, the plane ticket cost is also negated. Small-scale physical arbitrage is a relatively simple matter, but financial markets frequently use a wide variety of other forms of arbitrage. One form takes advantage of the fact that places with different currencies have different interest rates. Arbitrageurs borrow in the country with the lower interest rate and lend in the country with the higher interest
rate. The rush to convert between currencies would push the exchange rate up or down until interest rates in each currency are the same. To preserve profits, arbitrageurs fix the exchange rate they will trade using a forward contract, a contract between two parties that specifies a certain exchange rate at a specified date in the future. To demonstrate, suppose the United Kingdom interest rate is 8% and the United States interest rate is 5%, with the spot conversion rate at $1.5/ pound and a forward rate of $1.4/ pound, then the arbitrageur can borrow $100,000 in pounds, lend the money in the United States to earn 5% interest, convert it back to pounds using the locked-in forward rate, and then pay off the initial loan and its 8% United Kingdom interest to earn 3,000 pounds of profit without any risk at all. Efficient Market Hypothesis The Efficient Market Hypothesis (EMH) posits that the market can be categorized into three main forms: Weak form, Semi-Strong form, and Strong form. In fact, these categories can be depicted as nested sets in context of market information. The smallest subset is the set of past market information and historical records. The Weak form
EMH reflects this subset and states that market prices reflect all past market information (price, volume, etc.). The past information subset is contained within the larger set of all public information. The SemiStrong form then reflects this bigger subset and indicates that market prices reflect all public information. Finally, the public information set is additionally contained within the set of all relevant information (private and public). The Strong form EMH then reflects this largest subset and indicates that market prices reflect all
public and private information. In short, the Efficient Market Hypothesis states that equal access to information governs the efficiency of markets and the prices of assets in those markets. If market prices perfectly reflect historical data, public information, and/or private information, then methods of wealth management and money management including technical analysis, fundamental analysis, and valuation methods, will be unable to generate abnormal returns. Since EMH explains the relationship between market prices and different sets of information, we see that market efficiency is affected by the availability of information to the markets themselves. Weak-Form EMH is relatively unaffected by this, since the information it assumes is historical data from the markets. Of course, in certain markets like developing or emerging markets, information storage is inadequate and historical data can be spotty. Semi-Strong and Strong Form EMH, however, are highly affected by market information availability – in established markets
THE PRINCETON FINANCIER | 9
like the USA, London and Hong Kong, market analysis is constantly being generated by large quantities of firms, and thus a great deal of information is public. As such, mispricings and arbitrage are identified and cleared quickly in established markets, while such abnormalities can persist for much longer periods in emerging markets. The speed of information propagation is also a clear difference in markets. Information propagates through communication but also through market trends. In markets in which trades are conducted on a high frequency, pricing shifts extremely quickly, and thus information is constantly updated so EMH is more likely to hold. In slow or less liquid markets, trades occur with low frequency and information is propagated slowly, which can violate EMH and cause mispricings to occur. Finally, legal barriers including regulation of the markets can prevent individuals from utilizing certain information available to them (most easily seen in the prohibition on insider trading). As such, regulation reduces availability of information to actions that would affect the market (e.g., trades). However, highly regulated markets also can call for greater amounts of information released to the public, which facilitates EMH. Small Firm Effect The Small Firm Effect is one of the most well-known market anomalies, and has been extensively studied and put into practice by many wealth management services. In the basic sense, anomalies in the market are events or phenomena that contradict established theory. In this context, market anomalies refer to phenomena that violate the Efficient Market Hypothesis (EMH). As a result, anomalies can help explain abnormal performance in the market.
The Small Firm Effect is indeed an anomaly: market capitalization (existing shares that could be easily sold multiplied by the stock price) is a statistic reflected in all forms of market information, and thus under EMH, the market price of stocks should take into account the market capitalization. Different-sized companies should, in theory, perform as expected relative to each other given their different market caps. Of course, nothing ever goes the way it should. The Small Firm Effect says that when firms are categorized based on market capitalization, the smaller companies tend to outperform the large companies, even when adjusted for risk. The reasoning makes sense: small companies tend to have just started out, and many are formed by industry veterans or researchers who sit at the bleeding edge of their field and are constantly looking for new applications. Thus, it is rational to think that small companies are more likely to make large leaps and bounds in their business, resulting in sales and profit booms, and the associated high returns for shareholders. This is a fact well-noted by hedge funds and mutual funds, which led to the construction of many small-cap funds such as the Vanguard SmallCap Value Index, Fidelity Small Cap Discovery Fund, and Schwab Fundamental US Small Company Index ETF. Reversion to the Mean Reversion to the mean refers to the property of an asset’s price to return to the average market price of an asset over a long period of time. This mathematical property of asset pricing that can inform investment strategies. In short, the rolling average of the market price of an asset is assumed to be its “true” value. The asset price “regresses to the mean” by
THE PRINCETON FINANCIER | 10
falling until it reaches the average if the price is above average, and rising until it meets the average if the price is below average. Using mean regression, investors can identify underpriced assets that they can buy, with the expectation that their price will rise to match the mean. Similarly, investors can short sell overpriced assets, expecting that their price will fall. This suggests that various analytical techniques have been built to calculate the moving averages required to find the mean. Blindly following mean reversion, however, can lead to dangerous investments. Large-scale events that boost or reduce performance can often permanently change the mean. An advance in silicon waferprocessing technology may result in a production advance that permanently boosts a hardware company’s stock price. In this case, an investor might short the stock in expectation of a large reversion to the mean, while ignorant of the fact that the mean has been boosted.
What is Operations Research?
Applications
Theory
Game Theory
Simulation
Statistics
Business
MAT 378: Theory of Games ECO 418: Strategy and Information ECO 317: Economics of Uncertainty ORF 245: Introduction to Statistics ORF 350: Introduction to Big Data
Scheduling
ORF 407: Fundamentals of Queueing
ORF 409: Monte Carlo Simulation ORF 417: Dynamic Programming ORF 418: Optimal Learning ORF 401 - Electronic Commerce
Financial Engineering
ORF 335: Financial Mathematics ORF 435: Risk Management
Princeton Operations Research Society
THE PRINCETON FINANCIER | 11
princetonors.weebly.com
For most American consumers, the recent plummet in gas prices spells good news. A trip to the pump doesn’t cost nearly as much as it did last year, with the average price of gas in the US dropping below $2.50 per gallon—the lowest price since October 2009. Yet across the globe, not all consumers have been as lucky. With the large drop-off shaking economies of major oil-producing countries, winters have become much bleaker for many living under the crumbling hands of the global economy’s oil giants, and the domino effect of the recent economic
increased supply of crude oil from both North America and the Middle East have caused the price of the commodity to drop to its lowest price since 2009. Crude oil sits below $58 per barrel as of mid-December, falling from more than over $100 per barrel the same time last year. OPEC, under pressure by Saudi Arabia, shows no signs of budging on its decision to maintain current crude output volumes even as the price per barrel threatens to reach dangerous lows. The cartel seeks to force out American oil producers, who operate at a much
The economic implications of OPEC’s decision continues to ripple across the globe, with far-reaching consequences.
drop shows no indication of slowing down over the next year. Stagnant global demand and a steady, THE PRINCETON FINANCIER | 12
higher cost than its mostly Middle Eastern member states while relying on built up economic reserves to sustain losses until American producers shut
down, decreasing supply and naturally increasing prices back to profitable levels. The economic implications of OPEC’s decision continue to ripple across the globe with far-reaching consequences. Major economies have been put in disarray as global investors push currencies on almost every continent into freefall. Beset from Western economic sanctions atop the decline in oil prices, Russia’s ruble has stumbled to a near six-year low against the US dollar, suffering its steepest drop in 16 years. Venezuela, one of the only two South American OPEC member states, has fared no better; with oil accounting for 95% of the country’s exports, the price of Venezuelan bonds has plummeted as investors now worry Venezuela may default on its debt. In Africa, Nigeria, whose government receives more than 75% of revenue from oil exports, has felt the backlash of the crumble, cutting its fiscal budget by 12% while the naira continues to hit record lows below 190 to the dollar. Oil-importing nations including the US, China, Japan, and many within Western
Europe have and will likely continue to benefit from the recent plunges. However, some emerging markets not dependent on oil exports have suffered as a result of instability within global financial markets caused by the recent oil price volatility. Many currencies, already pushed down by strong demand for the US dollar as the American recovery continues unabated, continue to drop. The Indian rupee has hit 13-month lows and contagious drawdowns of Asian currencies have led to a chain effect that has in pulled out over $3 billion of foreign investments from the stock markets of South Korea and Taiwan. With the Russian ruble facing significant depreciation, trading partners of the oil giant face significant exposure to further jostling as investors evaluate unecessary risk and look into more stable currencies. The International Monetary Fund (IMF), however, remains confident that recent drops will lead to economic growth: since oil consumers often spend more of their gains than oil producers cut back on their consumption, a redistribution of wealth from oil producers to consumers should spark net growth in the long run. While US Federal Reserve Chair Janet Yellen is hopeful the US will come out positive despite inevitable decreases in US domestic drilling, the recent trend of oil prices will have lasting impacts on individual states and smaller industries across the board. Alaska’s Department of Revenue anticipates multi-billiondollar deficits as the state’s oil revenue is expected to fall from $5 billion to significantly under $2 billion, with the numbers continuing to fall as calculations made on the average price of oil per barrel suddenly become dramatic overestimates due to dropping numbers. And while the airline industry suddenly finds itself much more profitable, the fracking industry is quickly being forced to improve the efficiency of their methods and the precision of their approach—a change that ultimately signals an early Christmas present for the environment-conscious activist and the risk-averse investor—lest the North American fracking and shale industry fall to the rising costs incurred by OPEC competition.
Another aspect to consider of this recent decline in oil prices is the effect on the alternative and renewable energy industry, whose future is largely dictated by interest in the field caused by high oil prices. In the short run, lower crude prices have significantly damaged alternative energy stocks, with shares of companies such as First Solar Inc. (NASDAQ: FSLR) tumbling around 34%; SunPower Corp. (NASDAQ:SPWR) falling 31%; SolarCity Corp. (NASDAQ:SCTY) dropping 25%; and Fuel Cell Energy Inc. (NASDAQ: FCEL) losing about 36% of its value from last October to December. On the other hand, energy analysts at AllianceBernstein, a global asset management firm, remain confident: cost per unit of energy of renewable
middle class homeowners in Russia flood stores in hopes of buying large-value items while the ruble still has value. In both countries, consumers among every class have begun to make great lengths to acquire food and basic necessities. Lines have gotten longer and longer outside grocery stores as consumers attempt to acquire food and staple goods in daylong waits, a task made even more difficult for some consumers after the Venezuelan government began rationing food for its citizens in October, going so far as installing fingerprint scanners in some stores to prevent hoarding. Items such as cooking oil and milk remain scarce, and often times even after long waits, price-controlled items such as chicken, rice, toothpaste, detergent, and water are
With the Russian ruble facing significant depreciation, trade-linked countries surrounding the oil giant face significant exposure to further jostling by investors evaluating unnecessary risk and looking into more stable currencies. energy and fossil fuels are in the long run heading in opposite directions, and considering the importance of renewable energy in developing areas, investment in the industry should eventually recover, presenting a good opportunity to buy into the sector in the present while oil prices as low. Furthermore, solar companies as a whole remain up 7% year over year. As global markets continue to oscillate between safety and danger, uncertainty remains as to how exactly the global economy will restructure itself once oil prices re-stabilize. Meanwhile, the condition of consumers living in major oil-producing nations is only worsening. As domestic and foreign investors rush to transfer funds to more stable currencies, small business owners in Venezuela struggle to acquire the foreign currency necessary to buy imported goods sold or used in local business. Upper and
sold out and in shortage. In Venezuela, while gas per gallon sits at a fixed price of US $0.08, simple consumable items such as diapers require going as far as showing a child’s birth certificate to purchase, highlighting the sharp contrast in the impact of dropping oil prices on consumer prospects between oil producing countries and oil importing countries. Yet, as with Alaska, and the United States, the plummeting prices are wielding disparate economic consequences even within countries benefitting overall. Clearly, slumping oil prices pick winners and losers on a broad scale: just how much the winners will gain and the losers will lose remains ambiguous, however, only to be clarified as the complex interactions of US oil producers, OPEC countries, and global consumers plays out in the year to come.
THE PRINCETON FINANCIER | 13
MARK YOUR CALENDARS For the BCF Spring Speakers Series Thursday, February 19, Carl Fields Center, 9 am -5 pm “Finance, Inequality and Long-run Growth” Fourth Annual Conference of the Julis-Rabinowitz Center for Public Policy and Finance (Registration required—https://www.princeton.edu/jrc)
Thursday, March 5, 4:30 pm, Dodds Auditorium, Robertson Hall Thomas Piketty, Associate Chair, Professor of Economics, Paris School of Economics Author, “Capital in the Twenty-First Century” (ticketed event)
Thursday, April 2, 12:15 -1:15, BCF 103 “The Changing Landscape and Role of Investment Banking” Lunch talk with Julie E. Silcock ’78, Managing Director Co-Head of Houlihan Lokey’s Investment Banking practice (Southwest and Southeast regions)
Thursday, April 16, 6 pm, BCF 103 Sallie Krawcheck, Chair, Ellevate – Invest in Women #9 in Fast Company’s 100 Most Creative People 2014 Former senior executive at Smith Barney, Merrill Lynch & US Trust
April 28, 29, & 30 Andrei Shleifer, Harvard University 2014 Princeton Lectures in Finance
Bendheim Center for Finance 26 prospect Avenue rsvp: bcf@princeton.edu
When Shinzo Abe became prime minister after the December 2012 snapback election that brought his party, Japan’s Liberal Democratic Party (LDP), back into power, he promised to “… implement bold monetary policy, flexible fiscal policy and a growth strategy that encourages private investment.” These three policies eventually formed the “three arrows” of what became known as “Abenomics”, Abe’s radical plan that promised to accomplish something that had eluded Japan for two decades: an end to chronic deflation and the creation of self-sustaining growth. Popular with the public and armed with a supermajority in the parliament, Abe had the support to implement monetary and fiscal stimuli, the first two arrows of “Abenomics,” in 2013. As part of Abe’s plan, Japan’s central bank, the Bank of Japan (BOJ), launched a massive stimulus spending campaign and its governor, Haruhiko Kuroda, pledged to do “whatever it takes” to reach the inflation target of 2% within two years. Within a month of THE PRINCETON FINANCIER | 16
becoming prime minister, Mr. Abe also introduced a plan for 10.3 trillion yen ($117 billion) in fiscal stimulus through increased government spending. The quick succession of bold actions drew international attention, placing Japan back into the spotlight as the world watched to see if Mr. Abe’s economic experiment would reinvigorate the world’s third largest economy or send it deeper into crushing debt. By the end of 2013, with two of the three Abenomics arrows fired, Abenomics appeared to have succeeded in propping up the Japanese economy. However one year later, with the release of official third quarter 2014 data on November 17th, the numbers show that the Japanese economy is back in a technical recession, its fourth since 2008. . In a devastating turnaround from 2013, inflation is stagnating well-short of the 2% target set by the BOJ despite efforts to rapidly expand Japan’s monetary base through huge infusions of stimulus spending and private consumption
remains weak. With domestic support for Abe and Abenomics deteriorating, the future of Abenomics after 2014 is uncertain. The Source of the Problem Many have taken the disappointing third quarter figures as indicators that Abenomics is failing, and while it is true that Abenomics is falling short of its lofty expectations, the roots of Japan’s economic woes in 2014 stem from a separate entity: the government’s increase of the consumption tax. The consumption tax hike, the first in 17 years, was to double the tax from 5% to 10% over two stages of tax increases. The government implemented the first stage of the tax increase, which increased the tax from 5% to 8%, at the start of the second quarter in 2014. However, while the unpopular tax hike was implemented under Abe, it was actually planned under Abe’s predecessor Yoshihiko Noda of the Democratic Party of Japan (DPJ).
The last of a series of three prime ministers from the DPJ, Noda saw the public support for his party evaporate under his term as the Japanese economy descended into its third recession in five years. Nevertheless, Noda was determined to pass his unpopular tax bill, which he believed was necessary in order to control Japan’s massive debt and enforce muchneeded fiscal responsibility. Unable to gather enough support from within his own fractured party to ensure the bill’s passage, Noda reached out to Abe and the LDP. By promising to dissolve the lower house of the parliament to call for early elections in return for support of the bill’s passage, Noda effectively traded his political career and the political power held by his party for the passage of the tax bill, a trade Abe and the LDP were more than willing to make. Departing from Abenomics: A (Premature) Call for Fiscal Responsibility After winning the December 2012 election in a landslide, Abe and the LDP set to work in implementing the early stages of Abenomics. Through October 2013, the world watched as the Nikkei rose 40%, inflation rates increased on target along with private consumption, and the Japanese economy logged over 3% (up from 1.4% in 2012) growth for the first two quarters. Encouraged by the positive numbers and confident in his programs, Abe, in his own “Mission Accomplished” moment, announced “Japan is back,” a claim now proven premature. With the success of Abenomics seemingly imminent to some, calls for fiscal austerity and fiscal responsibility gained traction by the end of 2013. With a debt of over 240% of its GDP and
from the International Monetary Fund (IMF) and seeing the positive numbers as evidence of an “economic upturn,” Mr. Abe decided in October to go ahead with the first stage of the consumption tax increase from 5% to 8% scheduled for April 2014 under Noda’s original bill. The previous consumption tax increase
By the end of 2013, with two of the three Abenomics arrows fired, Abenomics appeared to have succeeded in propping up the Japanese economy. in 1997 from 3% to 5% had pushed Japan from economic recovery into a recession, and in the fall 2013 issue of The Financier, the authors of the article “Abenomics: Death by Taxes” expressed concerns that the Japanese economy would repeat that past trajectory and fall back into recession. While there were concerns at the time that the new tax would create a similar effect as the 1997 tax hike, most expected that the added stimulus implemented by the government to accompany the tax hike in addition to the positive effects of the ongoing fiscal and monetary stimuli would be enough to largely offset the shock of the 3% increase in the consumption tax. While some analysts remained skeptical, most projected that the effects would be mainly contained within one quarter and forecasted overall positive economic growth of about 1.7% for 2014. Even the most bearish estimates failed to predict the Japanese economy’s 1.6% contraction in the third quarter, a quarter that was
With the success of Abenomics seemingly imminent to some, calls for fiscal austerity and fiscal responsibility gained traction by the end of 2013. an annual deficit of about 8%, Japan has the dubious distinction of having the highest proportion of debt to GDP in the developed world. Under advice
the Japanese economy into an 18 month recession and led to the resignation of then PM Ryutaro Hashimoto, only produced an initial 3.8% drop in GDP, which rebounded to a 1.7% growth in GDP in the next quarter. In comparison, the third quarter figures are alarming, and knowing the consequences that
supposed to show signs of recovery from the effects of the tax hike that caused Japan’s real GDP to fall 7.3%. Even the catastrophic 1997 tax increase, which sent
followed the 1997 tax increase, the next few months will be a critical period for Abe and Abenomics. In light of these disappointing numbers and the purported role of April’s tax increase in causing them, Abe has postponed the second planned tax hike, originally scheduled for October 2015, 18 months while he focuses on stimulating economic growth and reaching the 2% inflation target. For a program like Abenomics to work, it needs to create confidence through consistency. In many ways, by prematurely pushing forward the tax hike before the Japanese economy was sufficiently primed for the blow, Abe effectively took a step backwards from the “whatever it takes” mentality that characterized Abenomics. As a result, Abe both impeded the progress of his own program and decreased the overall confidence in Abenomics. In order to gain the confidence of the Japanese people, the Japanese government must operate with the realization that the government’s growing debt, while a serious problem, comes second to ensuring Japan’s economic recovery. A Return to Abenomics: Kuroda and the BOJ With the second tax hike postponed indefinitely, Abe can redouble his efforts to revive the Japanese economy through Abenomics, and the BOJ and its governor Haruhiko Kuroda, who was appointed to the position by Abe, are instrumental to Abe’s plans. Currently, the BOJ under Kuroda has engaged in an aggressive monetary stimulus program through a THE PRINCETON FINANCIER | 17
series of massive bond purchases on the scale of 60-70 trillion yen ($527615 billion) annually, which would have doubled the monetary base in a two year period. In a surprise announcement on October 31st, Mr. Kuroda announced that the BOJ would increase bond purchases to 80 trillion yen ($703 billion) annually in order to fight deflation. The news sent stocks skyrocketing up to seven year highs and sent the yen to its steepest five day drop in nearly twenty years. The BOJ’s quantitative and qualitative easing (QQE) program has contributed to the weakening of the yen, which has fallen from 87 yen per dollar to 117 against the dollar since Mr. Abe began his term as prime minister and has staved off deflation. The BOJ’s QQE program has increased profits for Japanese exporters, who are reaping the benefits from the more favorable exchange rates and has increased profits for investors after a year that has produced record stock market levels. However, the additional monetary stimulus announced in October, when paired with the disappointing third
spending with a five-to-four split among the members due to concerns over the accumulating costs of QQE. Japan’s Deflationary Mindset Given the success of the BOJ’s QQE program in raising stock prices and stimulating exports, it may seem surprising that these successes have not translated into increased consumer confidence. The inflation generated by the BOJ’s policies was intended to force the Japanese to increase consumption instead of stowing away their earnings. However, weak domestic demand persisted into the third quarter as consumers chose to forgo big-ticket items such as houses and cars following the tax hike, and the BOJ’s QQE program is partially to blame. While the weaker yen resulting from the BOJ’s monetary stimulus program is benefitting exporters, it has hurt domestic consumers by making imports more expensive. For a country as resource-poor as Japan, the increase in import prices has hit the Japanese people particularly hard, and while companies and rich individuals are making enormous profits from the effects brought about by Abenomics,
In many ways, by prematurely pushing forward the tax hike before the Japanese economy was sufficiently primed for the blow, Abe effectively took a step backwards from the “whatever it takes” mentality that characterized Abenomics. quarter economic figures, show that Abe’s second arrow is not quite making the mark it was expected to. Furthermore, the 2% inflation by 2015 goal, an important cornerstone of Abenomics, has been adjusted so that the time has become more open-ended as it becomes increasingly obvious that the 2015 deadline will not be met. In addition to this revision, Kuroda’s ability to continue the BOJ’s aggressive monetary stimulus is another source of worry. In the vote for the October stimulus, the BOJ’s ninemember board barely passed the stimulus THE PRINCETON FINANCIER | 18
these windfalls have not been distributed back to the majority of the Japanese in the form of increased wages. Real wages have fallen, and with companies sitting on their profits, Japanese consumers have also retained their “deflationary mindset” and have not increased their consumption to expected levels. Worse still, the perception that Abenomics is a program that primarily benefits the wealthy is hurting public support for Mr. Abe’s policies. Although Mr. Kuroda has encouraged businesses to raise wages and spend assuming a 2% inflation rate, the
deflationary mindset of the Japanese, a mindset that has understandably been deeply ingrained after nearly two decades of the economy cycling through bouts of recession and short recoveries, must be combated for Abenomics to reach its full potential. The Third Arrow and Moving Forward Of course, while monetary stimulus by the BOJ and fiscal stimulus by the government are both important components of Abenomics, only the implementation of structural reforms to address the inefficiencies and distortions of the Japanese economy will lead to long-term self-sustaining growth. Never completely fleshed out by Mr. Abe, the third arrow of Abenomics is to consist of the deregulation of markets and the inclusion of women into the workforce, among other reforms. With Abe’s waning popularity and the general reticence of Japanese unions change their ways, the third arrow will be challenging to implement. Additionally, while Abenomics has become the calling card for Mr. Abe, two of his other policies, collective selfdefense and nuclear power, should also be carefully considered in relation to the Japanese economy. A nationalist, Abe’s views have, on several instances, offended China and Korea, which has been detrimental for trade between Japan and two of its most important trading partners. Separately, Abe’s eagerness to reemploy nuclear power production, which was halted after the 2011 Fukushima disaster, while unpopular, could be the answer to alleviating Japan’s growing energy costs. “Whatever it Takes” The greatest immediate obstacle that Abe and the Japanese government must face is the populace’s lack of confidence in Abenomics, a lack of confidence that will not be helped by inconsistencies in government policy. Overall, the third-quarter figures, while dismal, will hopefully serve as motivation for the Japanese government to recommit to Abenomics in order to promote economic recovery. By recommitting to the spirit of “whatever it takes,” the light at the end of the tunnel for Japan may just be around the bend.
THE PRINCETON FINANCIER | 19
THE STATE OF THE ECONOMY: FORECASTS VS REALITY Piece written on November 4, 2012
AN EXCERPT FROM
By Dhruv Bansal
After a shaky 2013, the market entered the new year divided over the American economy. Every year, the Federal Reserve Bank of Philadelphia surveys 42 professional forecasters on their predictions of key economic indicators for the upcoming year. This closely watched survey reflects leading academics’ sentiments on the economy. Some were cautiously optimistic, arguing that a real upturn had begun while others remained pessimistic, warning about the potential for global events to disrupt the American recovery. Now, at the end of 2014, the Financier looks back to see how this key set of predictions compared to what actually happened. The Financier in on five key gross domestic unemployment
payrolls, and headline and core Personal Consumption Expenditures (PCE) to take a look at how the predictions panned out. Collectively, these five indicators gauge American economic output, employment strength, and inflation, and paint a picture of a sharp but shaky recovery. Real GDP
chose to focus indicators: Real product (GDP), rate, nonfarm
THE PRINCETON FINANCIER | 20
The real GDP measures economic output of the United States adjusted for inflation. Forecaster’s predictions of the percent change in real GDP failed to match up with the actual increases, although, in light of the negative growth in the first quarter, the prediction of an especially strong second quarter turned out to be essentially correct.
M
Payrolls (000s/month) The nonfarm payrolls indicator reveals the number of jobs added in all non-farming industries, and is widely utilized as a key measure of hiring strength. Reflecting the similar overestimate of unemployment rate, the forecasters underestimated the number of jobs added for all three quarters.
Headline PCE The headline PCE uses changes in spending level of American households (a component of the GDP) to assess inflation, with the assumption that households would buy, on average, the same goods every time period. The actual changes in headline PCE proved to be much more volatile than forecast.
Core PCE The core PCE is formed the same way as the headline PCE, but simply removes energy and food expenses. Again, the actual changes in core PCE proved much more volatile than the steady, gradual increases forecast. The second quarter jump in both expenditures came from unexpectedly strong consumer spending in the second quarter, but overall all figures remained below the Federal Reserve’s annual inflationary target of two percent.
Unemployment Rate The unemployment rate indicates what percent of the job-seeking population is unable to find a job. After essentially hitting right on target for the first quarter, the forecasters slightly overestimated the unemployment rate for the rest of the year, with the American economy adding more jobs than expected.
THE PRINCETON FINANCIER | 21
Make an Impact at Citadel Piece written on November 4, 2012
Number of training courses or books available to employees Average project team size
5
1460
40
Percentage of high-tech engineers and quantitative researchers
THE PRINCETON FINANCIER | 22
Picture yourself as part of a leading global financial institution built on a culture of rapid innovation, technology and entrepreneurialism. We’re looking for the brightest minds with big ambitions who want to make an immediate impact on our firm, the financial markets and the global economy.
MEET CITADEL Number of volunteer hours logged on 2013 Citadel Service Days
492
Information Session Thursday, February 12th at 6:00pm Frist Campus Center, Room 234 Dinner will be provided. On-Campus Interviews Tuesday, February 24th Office of Career Services
CITADEL.COM
THE PRINCETON FINANCIER | 23
Deutsche Bank db.com
Where many different minds meet. At Deutsche Bank, a diverse culture is not just desirable: it’s essential. Collectively, our breadth of ideas, skills, and perspectives helps us to deliver better solutions for our clients every day.
Deutsche Bank Securities Inc., a subsidiary of Deutsche Bank AG, conducts investment banking and securities activities in the United States. Deutsche Bank Securities Inc., is a member of FINRA, NYSE and SIPC. Copyright Š 2013 Deutsche Bank AG.