The Wall Street Journal 20131015

VOL. XXXI NO. 181 TUESDAY, OCTOBER 15, 2013 The Real Odds on Gambling PERSONAL JOURNAL 29 DJIA 15275.35 À 0.25% Nasdaq 3811.62 À 0.52% Stoxx Eur 600 312.22 À 0.20% FTSE 100 6507.65 À 0.32% DAX 8723.81 g 0.01% CAC 40 4222.96 À 0.07% Euro 1.3582 À 0.17% Pound 1.6000 À 0.35% EUROPE EDITION WSJ.com $1.75 (C/V) - KES 250 - NAI 375 - £1.70 Thousands of Muslim pilgrims climbed Mount Mercy on the plains of Arafat as the annual hajj near the holy city of Mecca in Saudi Arabia continued on Monday. Muslims Make Mount Mercy Ascent as Hajj Pilgrimage Builds Up Reuters Why IKEA Lingers Over Kitchens ÄLMHULT, Sweden—It takes car companies about three years to design a sedan, and handset makers can churn out a new smartphone in six months. But an IKEA kitchen takes half a decade to create. The Swedish company uses a painstaking development process to produce cheap and sensible home-design items, all of which have quirky names and many of which must be assembled at home from kits. IKEA’s dogged pur- suit of engineering products to bring down the price is helping fuel growth in emerg- ing markets such as China and Russia. IKEA has cut prices for de- cades, and plans to shave prices 1% in the fiscal year that began Sept. 1. But sales at the world’s largest furni- ture maker aren’t growing as quickly as they once were, and one of the challenges for IKEA’s new chief executive, Peter Agnefjäll, will be to pro- tect the long lead times built into IKEA product design, such as those five years of de- velopment on a single kitchen. “It’s five years of work into finding ways to engineer cost out of the system, to im- prove the functionality,” Mr. Agnefjäll said of the com- pany’s “Metod” kitchen, a new model, during an interview at a store in his hometown of Malmo, located on Sweden’s southwest coast. The Metod kitchen (trans- lated as “Method” in English), is the brainchild of a clutch of designers sitting near IKEA’s headquarters here. The goal is to achieve “democratic de- sign,” products that will work in homes whether they are lo- cated in Beijing, Madrid or Topeka. IKEA—known for minimal- ist design—packs enormous complexity into a kitchen. Me- tod consists of 1,100 different components, and distilling them all into a cheap, green and easily shippable package has proved arduous. Take the bamboo orga- nizer for utensils and cutlery. Created by a team led by Gerry Dufresne, a 49-year-old Canadian designer, the item took several iterations to per- fect. “The first version had a slight smell of wood. I loved it,” he said. “But customers didn’t like it in tests, so we Please turn to page 21 BY JENSHANSEGARD Russia, EU Spar Over Neighbors More than 20 years after the Cold War’s end, Vladimir Putin’s Kremlin has been step- ping up the rhetoric and turn- ing the trade screws on nearby states that were once part of the Soviet Union but are moving now toward closer ties with the West. Moscow is already savor- ing a renewed role in the Mid- dle East after heading off what seemed to be an immi- nent U.S. airstrike on Syria over chemical weapons last month. Some in Europe see an echo of those East-West power struggles closer to home that could determine geopolitical alignments for de- cades. “Russia wants to restore its influence over the post-So- viet territories,” said Arseniy Yatsenyuk, an opposition chief in Ukraine who, like the ruling party, wants to align with the European Union. “It’s a new type of Soviet Union, Version 2.0,” he added, echoing a comment made last year by then-Secretary of State Hillary Clinton. Moscow recently blocked wine imports from Moldova after the statelet signaled its intent to align with the EU; slapped restrictions on cakes, chocolates and other goods from Ukraine, which has also made such intentions clear; and limited dairy purchases from Lithuania, an EU mem- ber that advocates pulling more of Russia’s neighbors into the Western orbit. Armenia, which had planned to sign a pact with the EU, abruptly switched sides under Kremlin pressure last month and said it would instead ally with Russia, which it relies on for natural gas and security. Nearby Geor- gia is still pushing to align with the EU, despite the pres- ence of Russian troops in dis- puted regions since 2008. The chief target in this tug-of-war, though, is Ukraine, with its 46 million people, sprawling wheat fields and blast furnaces. Russians feel close to Ukraine and trace their histor- ical and cultural roots back to Kiev. Yet Ukraine, independent since 1991, is looking more to the West these days, having been burned more than once in recent years by Russian strong-arming over such is- sues as natural-gas supplies. Ukraine hopes to sign its EU “association agreement,” which will lift trade barriers, at a Nov. 28-29 summit. In ex- change, Ukraine has to com- mit to such democracy-pro- moting measures as stronger laws on elections and courts. But the key moment could come this month: The EU wants Ukraine to release jailed opposition leader Yulia Tymoshenko, a demand Presi- dent Viktor Yanukovych has Please turn to page 6 By James Marson, Naftali Bendavid and Laurence Norman  Russia detains hundreds of migrant workers after riot... 3 U.S. budget talks raise hope for end to crisis U.S. News ............... 8 Opinion...............16,18 Italy firms face funding challenges Heard .................... 32 Inside Economics NobelGoes To Three Americans Three American scholars swept the Nobel Prize in eco- nomics Monday, for pioneer- ing research in the workings of financial markets, asset prices and behavioral eco- nomics. The Royal Swedish Acad- emy of Sciences in Stockholm honored Eugene Fama and Lars Peter Hansen of the Uni- versity of Chicago and Robert Shiller of Yale, citing the trio’s “empirical analysis of asset prices.” Messrs. Fama, Shiller and Hansen, who have researched separately how stocks and bonds are priced and why, won for advances that have reshaped portfolio manage- ment, given rise to the index fund and created a fundamen- tal tool used in econometric analysis. Mr. Fama, the senior mem- ber of the trio, is seen by many as the father of modern finance, for his 1960s-era work on the theory of effi- cient markets. Mr. Fama—af- ter meeting with little success in stock-picking—found that when markets work well, as- set prices reflect all the latest information. Hence, attempts to profit by picking stocks or timing the market were often fruitless. Those findings helped spark an industry of index funds. Please turn to page 8 BY BRENDA CRONIN AND NICLAS ROLANDER 32 | Tuesday, October 15, 2013 THEWALL STREET JOURNAL. HEARDON THE STREET Email: heard@wsj.com FINANCIAL ANALYSIS & COMMENTARY WSJ.com/Heard Peugeot’s Uncertain Chinese Take-Away Beware of unmarked obsta- cles. PSA Peugeot Citroën confirmed Monday it is look- ing at industrial and commer- cial deals with different part- ners, lending credibility to talk the French auto maker might seek to raise fresh capital from its Chinese joint venture partner Dongfeng Motor and the French government. That looks like an opportunistic move by Peugeot to take ad- vantage of a near doubling of its share price since the begin- ning of this year. But capital alone is unlikely to solve the firm’s long-term problems. Many investors had given up on Peugeot, but the French group has been proving the naysayers wrong. An aggres- sive restructuring plan aims to cut 8,000 jobs in France and close a plant on the outskirts of Paris by the end of next year. If car sales stabilize, Peu- geot’s auto division might break even in 2014, compared with an expected €1 billion ($1.35 billion) loss this year, estimates Deutsche Bank. But the long-awaited recovery in European car sales has yet to materialize: New car registra- tions in the European Union, a proxy for volumes, fell 5.2% in the first eight months of this year from the year-earlier pe- riod, according to the Euro- pean Automobile Manufactur- ers’ Association. A deal with Dongfeng could bring some benefits. True, Peugeot doesn’t face li- quidity pressures. It expects to halve cash-burn this year from €3 billion in 2012, thanks to spending cuts. But more capital could allow the auto maker to maintain invest- ment, needed to secure its competitive position long- term. Peugeot is 50% smaller by volume than global peers, putting it at a disadvantage. What isn’t clear, is how a partner such as Dongfeng would help Peugeot achieve greater scale or reduce its re- liance on Europe, where it generates two-thirds of sales. The conservative Chinese gov- ernment-controlled auto maker, while cash-rich, seems more interested in protecting its joint venture at home than using Peugeot as a launch pad for global expansion. Meanwhile, the prospect of a large Chinese investor raises questions about the status of Peugeot’s other alliances, no- tably with General Motors in Europe. And existing inves- tors—including GM and the Peugeot family—face heavy di- lution. Little wonder the shares dropped 9% Monday. Peugeot has turned down a bumpy road. —Renée Schultes Italy’s Companies Face Test What the telecom crisis of the early 2000s couldn’t man- age, the euro-zone malaise has. Telecom Italia has be- come the first major incum- bent European telecom opera- tor with a “junk” credit rating: Moody’s downgraded it to Ba1 last week, and Stan- dard & Poor’s may follow suit. But the financing challenges faced by corporate Italy go much further than Telecom Italia. The poor performance of the Italian and global econ- omy and steady downgrades of Italy’s sovereign rating to the mid-triple-B area are weighing on corporate credit quality. Telecom Italia isn’t alone; defense and aerospace company Finmeccanica fell to junk earlier this year, and auto maker Fiat has long been a speculative-grade com- pany. But the drift has implica- tions for Italy’s role in the Eu- ropean corporate-bond mar- ket—a channel for financing that is becoming ever more important as banks seek to cut their balance sheets. Italy’s companies are rely- ing more than ever on the high-yield market. True, being a high-yield borrower no lon- ger carries the stigma it once did. The European junk-bond market has become far more established, having grown to 2½ times its precrisis size. In 2012, the Italian government moved to ease tax rules for private companies issuing bonds, encouraging some smaller companies to issue debt. But high-yield bonds are still a more volatile source of funding that carry a hefty borrowing premium. Structurally, too, Italy, like other Southern European states, faces problems in mov- ing toward bond-market fund- ing. Despite accounting for 16.5% of the euro-zone econ- omy and having a tradition of investment in bonds, Italy punches below its weight in public debt markets. The country accounts for just 9.1% of the bonds in Bar- clays euro investment-grade corporate-bond index after U.S. and U.K. issues are ex- cluded. A further downgrade for Telecom Italia will result in its bonds falling out of the index, meaning Italy’s pres- ence would shrink substan- tially. And bond markets can go only so far in replacing bank lending. Some 94.5% of Italy’s companies are classed as “mi- cro” enterprises, employing 10 people or fewer, according to Royal Bank of Scotland, compared with 88% in the U.K. and 83.3% in Germany. Such small companies are set to remain reliant on expensive bank loans. All these factors put Ital- ian companies at a funding disadvantage against their peers in Northern Europe. Italian investment-grade bonds trade at an average yield of 3.19%, compared with 1.92% for Germany and 2.16% for France, according to Bar- clays indexes. A heavier reliance on the high-yield market means Ital- ian companies are more ex- posed to volatile funding con- ditions. Ultimately, the funding challenge may weigh on investment and growth— something Italy and its com- panies need urgently. —Richard Barley Europe’s Bank ‘DoomLoop’ Holds When in trouble, stick to- gether. European banks’ balance sheets may be shrinking, but they are managing to buy ever more government bonds. Sovereign debt accounted for 5.6% of all bank assets in the euro zone at the end of Au- gust, up from 4.2% at the end of 2011, according to Euro- pean Central Bank data. In Europe’s troubled coun- tries, the figures are more striking. Italian banks now have 10.1% of their assets in domestic government debt; in Spain, the ratio stands at 9.0%. The banks’ heavy bond buying has helped damp sov- ereign-debt yields in such countries. But it means the so-called doom loop between banks and governments is far from broken. The ECB itself is partly to blame. It provided billions of euros in medium-term fund- ing to banks at the end of 2011 via its long-term refi- nancing operation, or LTRO. Banks in stressed euro-zone countries such as Spain and Italy have used those funds to stock up on high-yielding do- mestic government debt, a profitable “carry” trade. Regulation has encouraged the trend: Since government debt is deemed to be risk-free, banks don’t have to hold capi- tal against those assets. Banks also can use government bonds as collateral to obtain more market funding. Govern- ments, meanwhile, have auto- matic buyers for their debt. But as banks buy more government bonds, they are using less of their shrinking balance sheets for more eco- nomically productive activi- ties such as lending to compa- nies and households. Perverse incentives to invest in govern- ment bonds also could mean their real risk is being mis- priced. Given the still-weak state of some euro-zone countries, a natural return to more nor- mal bank asset allocation looks to be some way off. In- stead, the ECB could help end this situation by declining to prolong the LTRO when it ex- pires at the start of 2015; or regulators could start to dis- tinguish between risky and nonrisky sovereign debt. That could force banks to hold more capital against Italian or Spanish government bonds, making the current trade less profitable. That, though, risks a disor- derly end to the narrowing this year of the spread be- tween government-bond yields in countries such as Spain and Italy and those in Germany. The situation is hardly desirable. But the po- tential turmoil caused by breaking the bank-govern- ment loop is a scary prospect, too. —Andrew Peaple Bond Boost The ECB’s long-term refinancing operation has boosted Italian banks’ buying of Italian government bonds. Domestic sovereign-bond holdings at Italian banks LTRO usage by Italian banks The Wall Street JournalSource: RBC Capital Markets €450billion billion 150 200 250 300 350 400 ’05 ’07 ’09 ’11 ’13 ’05 ’07 ’09 ’11 ’13 €300 0 50 100 150 200 250 Credit-card debt is doing the limbo. While credit qual- ity overall has been improv- ing since the financial crisis, the drop in net charge-offs for plastic is particularly no- table. J.P. Morgan Chase is a case in point. Its latest charge-off rate for its cards business was at just 2.86% in the third quarter, at a re- cent, historic low and down from 3.31% the prior quarter and 3.57% a year earlier. It even comes in under the 2.99% in the first quarter of 2006, at the height of the credit and housing bubbles. J.P. Morgan isn’t alone. Charge-off rates for big card issuers are generally below January 2008 levels, accord- ing to Barclays, while card balances are down about 17% from their July 2008 peak. This reflects changes in consumer-spending habits and a postcrisis emphasis on paying down debt. It also suggests many banks are getting pickier about their credit-card cus- tomers, trying to move to higher-income spenders. It is tough, though, to see charge-off rates going much lower from here. Then again, that is what most investors and J.P. Morgan itself thought not too long ago. OVERHEARD Inflation Narrows Options for China Chinese policy makers are struggling to strike a balance between maintaining growth and reforming the economy. They also face another head- ache: inflation. Data Monday showed China’s consumer- price index up 3.1% in Septem- ber from a year ago, accelerat- ing from August’s 2.6% to the fastest pace in seven months. Analysts are blaming the usual suspects. The Mid-Au- tumn Festival holiday fell ear- lier this year, boosting de- mand for food in September. A typhoon may also have dis- rupted crop production. But the fundamental cause is the growth of money supply and credit since the start of the year. Year-over-year growth in M2, one measure of the money supply, peaked in April at 16.1%, though this has slowed since June as a bank- ing cash crunch has con- strained liquidity. Total social financing, a broad measure of credit including various forms of nonbank lending, is up 19% for the first nine months. Prices are ticking up after this monetary expansion, led by food prices. But extra li- quidity also is finding its way elsewhere: Housing prices in August were up 7.5% from a year earlier nationwide—and up 14.9% in Beijing. These inflationary pres- sures will limit Beijing’s abil- ity to step in with additional stimulus if the economy dete- riorates. Although indicators such as auto sales suggest that domestic consumption remains strong, weak export data over the weekend under- scored the risk that growth could slow further. China’s exports in Septem- ber were down 0.3% from a year earlier, official data showed. True, it was around this time last year that com- panies started exaggerating their exports, a practice since curtailed by regulators. But even taking this into account, RBS economist Louis Kuijs es- timates exports were up 1.7% in September, a sharp slow- down from August’s 7.2% pace. With the debt-ceiling fra- cas in the U.S. and the pros- pect of reduced Federal Re- serve bond buying still looming, demand for Chinese exports may stay soft. At the same time, always fearful of inflation, the country’s leader- ship may hesitate to pull the trigger on stimulus measures. China’s room to maneuver is narrowing. —Aaron Back Italian firms are at a funding disadvantage against their peers in Northern Europe. Pricey Protection Annual cost to insure €10 million of debt for five years The Wall Street Journal Sources: Markit; Bloomberg News (photo) BT Group Deutsche Telekom Orange Telekom Austria KPN Telefónica Telecom Italia €66,000 67,000 96,000 123,000 130,000 197,000 340,000 2 | Tuesday, October 15, 2013 AM IM UK SW FR IT SP TK BR PL IS AE GR THEWALL STREET JOURNAL. PAGE TWO i i i Business & Finance n EU finance ministers are ex- pected to give their final approval for a new banking supervisor for the euro zone, in the final step for handing supervisory powers to the ECB. 4 n India’s central-bank chief is campaigning to persuade the Fed and other central banks to pay more attention to the conse- quences of their actions for the developed world and do more to mitigate the fallout. 10 n Indian inflation rates contin- ued to accelerate in September, adding to concerns that the coun- try’s central bank is likely to in- crease interest rates again. 10 n Just as France is known for wine, Japan’s government aims to turn the nation’s reputation for ex- pensive but high-quality food prod- ucts into an export opportunity. 13 nMany fixed-income managers have shortened their “duration” to mitigate damage from potential rate increases and trimmed their holdings of haven bonds. 19 n Tata Motors is refreshing its Nano, giving the about $2,000 minicar a face-lift with chrome, sound system, better interior and a higher price in an effort to boost lagging sales in India. 19 n HTC is pinning hopes for sur- vival on China’s large and compet- itive smartphone market after the struggling handset maker fell out of favor among U.S. consumers. 20 n Versace could receive a final of- fer for the stake it is selling by the end of November, with a clutch of funds jostling