A headline from today’s Financial Times:
McKinsey Partners Sacrifice Leader in ‘Ritual Cleansing’
The recent upside lurch in interest rates has roiled asset prices and dealt some investors outsized pain. For instance, the 30-year Treasury has absorbed a 14% total return loss year-to-date. Only 1980 and 2009 featured comparably poor starts to the year for the long bond, according to Ben Breitholtz at Arbor Data Science.
For now, at least, domestic monetary mandarins aren’t too concerned. John Williams, president of the Federal Reserve Bank of New York, attributed the move to a stronger economic outlook and the Fed’s existing policies, while Atlanta Fed president and fellow FOMC voting member Raphael Bostic declared that yields “have definitely moved at the higher end, the longer end, but right now I’m not worried about that. I’m not expecting that we’ll need to respond.”
But while the Fed remains sanguine, central banks across the Pacific have already sprung into action in hopes of keeping benchmark interest rates right where they want them.
This morning, Australian three-year government bond yields reached as high as 0.15% at the market open, far above the 0.1% ceiling established by the Reserve Bank of Australia last November under its yield curve control policy. The RBA accordingly pledged to buy up to A$3 billion ($2.3 billion) in three-year paper in an unscheduled operation just one day after undertaking the largest purchases since March, successfully pushing yields back down towards that 0.1% bogey by day’s end.
In a report predicting that the RBA will wait until July before deciding whether to tweak its existing policies, Andrew Boak, Goldman Sachs chief economist for Australia and New Zealand, noted yesterday that “there are no modern day precedents for a central bank exiting yield curve control.”
A similar struggle is underway in the Land of the Rising Sun. Japan, which instituted yield curve control back in 2016 with a targeted 0% yield on the 10-year government bond, is now facing a test of its resolve: The yield on 10-year government debt reached 0.175% this morning, the highest since the debut of that program. “I want you to understand that we aren’t aiming to raise our target from around 0%,” BOJ governor Haruhiko Kuroda declared in an address to parliament this morning, a message surely intended for Mr. Market as well.
Meanwhile, a scaled-down bond selloff on the Old Continent looks to spur the powers that be to further impose their will on the market. Yesterday, German 10-year yields reached minus 0.23%, near a one-year high and up from minus 0.53% one month earlier, three days after ECB president Christine Lagarde declared she is “closely monitoring the evolution of longer-term nominal bond yields.”
In light of that dizzying ascent to minus 0.23%, one of her colleagues appears ready for action. “In my view, there is an unwarranted tightening of bond yields, so it would perhaps be desirable for the ECB to accelerate the pace of [asset] purchases to ensure favorable financing conditions during the pandemic,” Greek central bank governor Yannis Stournaras told Reuters this afternoon.
Of course, some might note the irony that, as markets begin to finally discount the potential for rising consumer inflation long pined for by central bankers, the ECB would consider responding by further ratcheting up its interference in the market. Russell Napier, financial strategist and author of the Solid Ground investment commentary, writes today that a move toward yield curve control in the face of growing inflationary pressures would represent both a financial and political game-changer in this era of activist central banks:
Elsewhere in the world financial repression likely comes through the acts of elected governments, but in the Eurozone the ECB seems prepared to act now to force the hands of the politicians to take the continent in a very clear political direction.
That such control will take them even further beyond the constitutional limits of the ECB is beyond doubt. Such are the economic consequences of yield curve control, and such control, it seems, is entirely within the gift of a ‘transnational elite immune from domestic constraint and scrutiny’.
There are likely to be profound long-term social and political consequences emanating from the fact that Europe has been set upon such a radically new course by the actions of those without any democratic authority to choose it.
For more on yield curve control and other similarly urgent topics of the day, see the Feb. 23 webcast recording of Russell in conversation with James Grant: “Playing the bear market in money,” available for professional investors on the Electronic Research Interchange website.
A strong bounce in the Treasury complex left the two-, 10- and 30-year yields at 0.13%, 1.41% and 2.13%, respectively, while stocks came under late pressure to leave the S&P 500 lower by 50 basis points on the day and 3.1% south of its high-water mark reached two weeks ago. WTI crude and gold each declined by between 2% and 3% to $61.70 a barrel and $1,731 an ounce, respectively, bitcoin sank about 5% to $46,600, and the VIX pulled back to 28.
- Philip Grant
From strategists at Deutsche Bank:
Retail sentiment remains positive across the board, regardless of age, income or when the investor began trading. Retail investors say they expect to maintain or add to their stock holdings even as the economy re-opens.
A value restoration project is underway in the realm of state and local debt. This afternoon, benchmark triple-A 10-year municipal bond yields reached 1.15%, compared to 0.68% just two weeks ago.
Premium pricing on both a relative and absolute basis allowed plenty of room for correction. Even after that sharp selloff, the Bloomberg BVAL Triple-A Muni 30-Year Yield Index currently trades at a ratio of 82% of the corresponding 30-year Treasury yield (the lower the ratio, the more expensive munis are on a relative basis), up from a record low 68% set nine days ago but well below the five-year average of 102%. During the March 2020 market convulsions, that ratio briefly reached as high as 250%.
An asset price panacea for serially underfunded government pension plans? According to a fall 2020 survey from the National Conference on Public Employee Retirement Systems, funding levels for state and local pensions jumped to 75.1% last year from 72.4% in 2019, thanks to a robust 8.1% projected average one-year return, topping long-term return targets of about 7%.
As the market swiftly transitioned from outright panic to euphoria last year, cash-strapped localities doubled down on bets that a rising tide would lift all actuarial boats. Enter so-called pension obligation bonds, a type of arbitrage in which a municipality borrows at a certain interest rate, then attempts to generate a return in excess of that borrowing cost, thus reducing its total financial burden. Cities and states across the U.S. sold $6.1 billion in pension obligation bonds in 2020, according to data from Municipal Market Analytics, the most active year since 2008.
Reciprocally, an uncooperative market will spell trouble. “You’re essentially gambling with taxpayer funds that you’re going to be able to make a return that’s higher [than the borrowing cost],” Lisa Washburn, managing director at Municipal Market Analytics, told Bloomberg on Jan. 21. “To the extent that falls short, you’re saddling taxpayers with the additional cost.”
The Dec. 11 edition of Grant’s Interest Rate Observer shone an analytical spotlight on POBs, describing them as securities which exist “at the crowded intersection of low yields, underfunded liabilities and Covid-19-busted budgets.” The Los Angeles suburb of West Covina, Calif. Is one such poster child. In July, the town issued $204 million in POBs, rated single-A-plus at S&P. Three months later, state auditor Elaine Howle excoriated the town’s fiscal management and warned of a potential bankruptcy. That episode underscores one truism: “Municipal bonds are particular and specific to a remarkable degree,” as investor Paul Isaac observed to Grant’s.
A new report from Moody’s echoes that sentiment, while warning of a potential ripple effect from any protracted turmoil in asset prices:
With persistently low interest rates for high-grade fixed-income securities, public pension systems continue to rely on highly volatile equities and alternatives to meet return targets, posing a material credit risk for some governments.
The rating agency’s so-called tread water indicator, which captures the cost to governments to forestall growth in unfunded liabilities, illustrates the risks that asset price turbulence poses to the pension system. For instance, government entities within the Teacher Retirement System of Texas need to contribute roughly 11% of payroll this year to sustain current funding levels, assuming the system reaches its 7.25% return hurdle for 2021. In the case of a 7.5% loss this year (representing a one-standard deviation loss, according to Moody’s estimates), payroll contributions would immediately need to jump to more than 14% to maintain the status quo.
Mr. Market giveth, Mr. Market taketh away.
Another brutal selloff in the Treasury complex, lowlighted by a dismal seven-year note auction this afternoon featuring the weakest bid-to-cover ratio on record, left the two-, five- and 10-year yields at 0.17%, 0.79%, and 1.49%, respectively, up 5, 18 and 12 basis points from a day ago. The stock market expressed its concern, with the broad S&P 500 falling 2.5% to erase more than half of this year’s gains and the tech-heavy Nasdaq hammered by 3.6% for its worst one-day showing since October.
WTI held steady above $63 a barrel, gold fell 1.5% to $1,769 an ounce and the VIX jumped to 29, up a cool 35% on the day.
- Philip Grant
Dispatches from the parabola chronicles: As the bull market in stocks continues to rage, euphoric price action of electric vehicle (EV) manufacturers, in tandem with proliferating ranks of publicly-traded players, stand as one of today’s top market singularities.
According to data compiled by FT Alphaville, the electric vehicle complex (including 23 manufacturers, nine battery/cell producers and nine charging station businesses) reached an aggregate $1.15 trillion market cap as of yesterday, down from a peak of $1.59 trillion but still more towering over the $464 billion total market cap commanded by 10 of the largest legacy automakers.
Great expectations underpin the EV crowd’s sky-scraping valuations, as the subsector commands an aggregate enterprise value equivalent to 19 times trailing 12-month sales, compared to 0.4 times EV-to-sales for the incumbent auto producers. While the 10 old economy auto manufacturers trade at a combined enterprise value equivalent to less than five times trailing Ebitda, only six of that 41-strong public EV cohort managed to generate positive Ebitda over the last 12 months. Tesla, Inc., the most profitable on that adjusted basis, sports an enterprise value equivalent to 83 times consensus 2021 Ebitda.
One poster child for the current zeitgeist: 14-year-old Lucid Motors, Inc. After Bloomberg reported that special purpose acquisition company Churchill Capital Corp. IV (CCIV on the NYSE) was in negotiations with Lucid on Jan. 11, shares of the SPAC skied higher by 472% through Monday.
It appears that Mr. Market may have got ahead of himself. Yesterday Lucid announced that production on its debut electric model will commence later in 2021, as opposed to prior projections for a second quarter debut. That helped spur a 48%, two-day pullback.
Even so, that sharp correction represents a mere flesh wound for the early bird investors. At $29 a share, Lucid (which has yet to sell a vehicle) still sports an implied $49 billion market capitalization, based on the 16.1% equity interest allocated to CCIV shareholders. That compares to a $16 billion total valuation, inclusive of cash, paid by Churchill at the $10 per share SPAC deal price, and a $24 billion price tag for institutional investors who followed suit in a private investment in public equity (PIPE) deal at $15 a share.
Investors bidding CCIV’s market cap to a level comparable to Ford Motor Co. may want to get comfortable in the wait for operational progress. On a conference call yesterday, Lucid executives broke out the crystal ball to forecast Ebitda and free cash flow of just under $3 billion and $1.5 billion, respectively, in calendar 2026. As for the introduction of a mass-market EV, CEO Peter Rawlinson told Bloomberg television yesterday that: “quite frankly Lucid is about eight or nine years away in terms of its infrastructure and maturity to even contemplate such a project.”
While one EV entrant pumps the brakes, another looks for open road. Shares in manufacturer Workhorse Group, Inc. (WKHS on the Nasdaq) have been clubbed by more than 50% since yesterday following news that the U.S. Postal Service awarded a $6 billion contract to rival Oshkosh Defense. The contract calls for delivery of up to 165,000 of combustion-powered and electric vehicles over 10 years. In response to the snub, Workhorse announced it will "explore all avenues that are available to non-awarded finalists in a government bidding process."
Despite the setback, Wall Street retains high hopes for the 23-year-old business, which came public in 2010. Sell-side analysts expect revenues to reach $130 million this year and $498 million in 2023, up from $1.8 million last year and $1.2 million combined across 2019 and 2018. With shares up a cool 327% over the past year despite the recent downdraft, Workhorse currently sports a $1.9 billion enterprise value.
Meanwhile, new entrants anxiously await their day in the sun. Yesterday, 29-year-old French racing champion Olivier Lombard announced that the first high-end zero-emission hydrogen powered sedan prototype is slated for arrival in June. Aptly, the vehicle will be called the Hopium Machina.
Another round of pressure on rates saw the 10-year yield rise above 1.4% on an intraday basis for the first time in a year, while the long bond reached 2.24%, pushing its yield premium over the five-year note to its widest since summer 2014.
Stocks caught a strong intraday bid, reversing early losses to leave the S&P 500 higher by 1.1% and at the cusp of a fresh record high, as speculative plaything GameStop Corp. took flight once again to the tune of a 104% advance. WTI crude reached a fresh post-pandemic high at $63.5 a barrel, gold edged lower to $1,802 an ounce, and the VIX pulled back to near 21.
- Philip Grant
From the Onion:
Facebook Announces Plan to Break Up U.S. Government Before It Becomes Too Powerful
Resolution has finally arrived in the saga involving the so-called stablecoin tether, which is used to trade from fiat currencies to cryptos and back again while sidestepping know-your-customer and anti-money-laundering laws. This morning, New York attorney general Letitia James announced a settlement with Tether and closely affiliated crypto exchange Bitfinex, ending a multi-year investigation into Tether’s claims that it was fully backed by U.S. dollars on a one-for-one basis.
The penalties appear manageable. The pair agreed to shell out a modest $18.5 million fine while neither admitting nor denying any wrongdoing. Tether agreed to provide quarterly reports on the nature of its reserves for the next two years and will cease all trading activity in the state of New York.
Some observers cheered the news as marking the removal of a major regulatory overhang. “On the grand scale of things, it’s less than a speeding ticket,” Antoni Trenchev, managing partner of London-based crypto lender Nexo, tells Bloomberg.
While crypto bulls look to turn the page, the investigations findings and language in the report may prove to be instructive. The AG’s press release put it bluntly: “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.” When reviewing Tether’s prior claims, room for interpretation appears narrow. As the settlement agreement notes, Tether had maintained from its 2014 inception through 2019 that “Every tether is always backed 1-to-1, by traditional currency held in our reserves. So, 1 USDT [tether] is always equivalent to $1.”
Indeed, as of mid-2017 (as crypto prices embarked on their “first wave” bull market) Tether “had no access to banking, anywhere in the world, and so for periods of time held no reserves to back tethers in circulation.”
The snafu appeared to commence in March 2017, after Wells Fargo opted to terminate its relationship as correspondent bank, leaving Tether unbanked through mid-September. Yet despite being unable to accept dollar deposits during that period, tethers in circulation more than quadrupled to $442 million in the three months through September 2017, backed only by a $61.5 million deposit at the Bank of Montreal under the name of Tether’s general counsel.
In summer 2017, the pair hired U.S.-based Friedman LLP for an (uncompleted) audit to alleviate concerns about Tether’s backing. After Tether subsequently downscaled Friedman’s effort to a verification of its cash balances, the examination took place on Sept. 15, the day that Tether opened an account at Noble Bank (which was co-founded by Brock Pierce, who also co-founded Tether).
On the morning of Sept. 15, 2017, Bitfinex transferred an additional $382 million from its account at Noble Bank to Tether’s, ahead of Friedman’s cash balance verification later that day. The AG concludes:
No one reviewing Tether’s representations would have reasonably understood that the $382,064,782 listed as cash reserves for tethers had only been placed in Tether’s account as of the very morning that Friedman verified the bank balance.
One year later, Bitfinex ran into another potential iceberg after increasingly relying on third-party processors, most notably Panama-based firm Crypto Capital Corp., to handle deposits and withdrawals. As of summer 2018, Crypto Capital held more than $1 billion on behalf of Bitfinex, representing upwards of 80% of total deposits.
That soon became problematic once officials in Portugal and Poland froze accounts holding $490 million in customer funds. Subsequent attempts by the exchange to access even a portion of its deposits were thwarted, with Bitfinex’s Crypto Capital contact citing various excuses including “tax complications, hurdles placed by various compliance personnel at various banks, bankers being on vacation, typos in wire instructions and corruption in the Polish government.”
Getting nowhere with Crypto Capital and fearing liquidity trouble (yet continuing to direct client funds to the processor), Bitfinex borrowed $400 million from Tether in summer 2018, which the former repaid by transferring funds from the Bitfinex Crypto Capital account to the Tether account then redeeming 400 million tethers on the open market, effectively co-mingling client and corporate funds. The pair then executed a similar maneuver, totaling $475 million, in fall 2018 utilizing Bahamas-based lender Deltec Bank. Those transactions went unmentioned by either entity.
While Tether and Bitfinex characterized today’s settlements as “resolving allegations related to public disclosures,” fresh legal headaches could be in store. Namely, a November 2019 class action lawsuit accused the pair of undertaking “a sophisticated scheme to fraudulently inflate the price of crypto commodities [including] bitcoin.”
Any disruption to the stablecoin system could loudly reverberate. Tether represents a veritable Grand Central Station of digital currency, accounting for roughly 55% of bitcoin trading volumes, according to data from CryptoCompare.
The key question: Might the fast-growing crypto complex be supported by wobbly financial architecture? As the price of bitcoin surged to $55,000 on Friday from $11,000 last fall and $7,500 as of Dec. 31, 2019, Tether supply has ballooned to a current $34.7 billion, up from $18 billion last fall and $4 billion at the end of 2019. For more on bitcoin, see the Feb. 19 issue of Grant’s Interest Rate Observer.
Stocks took the scenic view back to unchanged, as the S&P 500 absorbed near-2% early losses before rebounding this afternoon to barely snap its five-session losing stream, while the VIX pulled back to 23. Treasurys held steady with the 10-year yield edging lower to 1.35% and the long bond ticking higher to 2.19%, and gold and WTI crude also cruised sideways to finish at $1,805 an ounce and $62 a barrel, respectively. Bitcoin fell to $48,000, down 12% from yesterday but off its afternoon lows near $45,500.
- Philip Grant
Is an interest rate regime change finally underway? Today the 10- and 30-year Treasury yields each hit their highest levels in more than one year at 1.36% and 2.17%, respectively. Globally, the stock of nominal negative yielding debt fell to near $14 trillion on Friday, down from more than $18 trillion in mid-December.
Signs of a renewed economic boom, in tandem with pockets of price pressure, color that move in rates. Bianco Research notes today that Wall Street economists now expect U.S. real GDP growth of nearly 5% this year (a rapid pace “more commonly found in developing countries”), up from guesstimates of 3.7% in early November. Today the Bloomberg Commodity Spot Index closed at its highest level since early 2013, up 67% from its March lows.
Investors are buying the reflation story. The Bank of America Global Fund Manager Survey for February finds that sentiment for global growth has reached a record peak with allocations to stocks and commodities each at their highest level since 2011, while cash holdings declined to a near-eight year low. As for tail risks to the market, inflation and a reprise of the 2013 “taper tantrum” yield spike were two of the three most-cited potential pitfalls.
Of course, Washington’s two-pronged stimulus charge figures prominently in that thesis, as interest-bearing assets on the Fed balance sheet have jumped 80% from last year, while Uncle Sam ran a budget deficit equivalent to 15% of output in fiscal 2020, a gap exceeded only in 1864, 1919 and 1943 to 1945 (each era coincided with or was soon followed by a fast-rising price level). But, as inflation takes hold as the Wall Street consensus, economic policymakers see nothing of the sort.
According to the minutes from the January FOMC meeting released last week, most committee members “still viewed the risks [to inflation] as weighted to the downside.” “There are disinflationary pressures that are quite profound and seem to be continuing,” Richmond Fed president Thomas Barkin (currently a voting member on the Federal Open Market Committee) today told the Maryland Bankers Association. Deeply ingrained psychological factors will reign supreme, Barkin believes. “As long as you’ve got those disinflationary headwinds, it’s just going to be hard for businesses to believe that you’re going to have the market power to increase prices.”
Similarly, Treasury Secretary Janet Yellen downplayed the chances of inflationary resurgence in a CNBC interview Thursday, instead advocating for a continued stimulus by arguing that, “if properly measured,” the headline unemployment rate would be closer to 10% than the current 6.3% (the fidelity of the Fed’s preferred inflation gauge, the personal consumption expenditures index, went unmentioned). “The price of doing too little is much higher than the price of doing something big,” she concluded.
As the powers that be get set to add more stimulus to the mix, sufficient tinder for a monetary bonfire is perhaps already in place. M2 money supply jumped an eye-popping $4 trillion, or 26%, in the 12 months through February. That’s up from a 5.8% average annual growth rate in the decade ending 2019 and the largest uptick since 1943.
Fresh currency continues to flow in 2021. Writing today in The Wall Street Journal, Invesco chief economist John Greenwood and Johns Hopkins University professor Steve Hanke calculate that, even with no additional loan growth or corporate borrowing, M2 is set to jump another 12% this year thanks to Fed asset purchases and runoff in the Treasurys General Account, which will be allocated toward federal spending initiatives. The pair conclude that the M2 growth rate “spells trouble – inflationary trouble.”
Might policymakers, firmly believing that they control economic events, find that events in fact control them? Bianco Research president and eponym Jim Bianco put it this way to Grant’s last week:
The point is, the last two policy changes have been market-driven. The market takes a big right turn or left turn, and the Fed is forced to react to it. And, so, when the Fed says . . . we could let the average inflation rate run above 2% . . . we don’t have to raise rates. I keep screaming, ‘It’s not your call. It’s the market’s call. If you let inflation go up to 2.5% and the markets are okay with it, you’re okay with it. If inflation goes up to 2.5% and the market throws a fit, you’re 10 days away from raising rates. You just don’t know [that] you are yet.’
For a survey of potentially profitable strategies to help weather today’s extreme monetary backdrop, see the new issue of Grant’s Interest Rate Observer dated Feb. 19.
Stocks came under pressure, with the S&P 500 losing 75 basis points to log its fifth straight red session after reaching a fresh high-water mark on Feb. 12, while ongoing weakness in long-dated Treasurys pushed the yield curve, as measured by the gap between the two- and 10-year notes, to its steepest since March 2017. WTI crude jumped back to near $62 a barrel for the first time since November 2018, gold rallied by nearly 2% to $1,807 an ounce, and the VIX rose to 23.5, up 6% on the day.
- Philip Grant
Talk about getting in on the ground floor. The recent upward jolt in interest rates has had little ill effect on the booming high-yield market, as the average yield on double-B-rated companies reached a record low 2.98% earlier this week, dropping below the dividend yield on the S&P Utilities Index for the first time. On the other end of the credit spectrum, yields on the triple-C-rated component of the Bloomberg Barclays Index also reached a record low 6.1% earlier this week.
Evaporating yields have flipped traditional dynamics upside down. Bloomberg reported on Feb. 5 that income-hungry investors have resorted to “calling up companies and pressing them to borrow, instead of waiting for bankers to bring new deals to them.”
Shaky borrowers have duly obliged. Triple-C-rated companies raised at least $3.5 billion across three separate weeks in January, only the seventh time that has occurred in the last 20 years, according to Bank of America strategist Oleg Melentyev. Bloomberg relays today that triple-Cs have accounted for one-quarter of February issuance. For comparison, the triple-C portion of the Bloomberg Barclays High Yield Index features $204 billion of outstanding debt, comprising less than 14% of the domestic sub-investment grade category. Those hardy triple-C creditors have been duly rewarded of late as that group has seen a 2.7% total return so far this year, double the gains on the broader junk index.
As yields descend towards sea level and dodgy credits proliferate, investors find themselves in a predicament. “The prudence that may have been there before is now non-existent,” Jerry Cudzil, head of credit trading at TCW, told the Financial Times on Tuesday. “In the near to medium term you will have a difficult time keeping up if you don’t buy some of this stuff. That doesn’t mean they are good deals. As a matter of fact, [participating now] is a good way to lose money long term.”
Commencing countdown, engines on. Today the price of bitcoin reached a fresh record high above $55,000, up a cool 445% since the end of August. That pushed the total market value of the legacy crypto past the $1 trillion mark for the first time.
As the digital ducats take flight and bitcoin bulls justifiably celebrate, the structural soundness of a key cog in the crypto machine remains very much up for debate. Tether, which is widely used as a way to trade into cryptos from fiat and back again, without adhering to the bothersome know-your-customer and anti-money laundering regulations seen in traditional banking, has assumed a starring role in the digital boom. According to data from the New York Digital Investment Group, such so-called stablecoins have facilitated as much as 60% of all bitcoin trading since 2019.
Questions about the veracity of tether’s claims of full dollar backing have long swirled (see the issue of Grant’s dated Sept. 8, 2017), including in the office of New York Attorney General Letitia James. Back in September, the Empire State’s top cop asked Tether for all documents related to the disappearance of $850 million in customer funds to Panama-domiciled Crypto Capital. In response, Tether’s lawyers wrote that it was “literally impossible” to comply with that demand.
Some on Wall Street remain concerned, as analysts at J.P. Morgan cautioned yesterday that any disruption to the tether mechanism could spur chaos:
If any issues arise that could affect the willingness or ability of both domestic and foreign investors to use tether, the most likely result would be a severe liquidity shock to the broader cryptocurrency market, which could be amplified by its disproportionate impact on high-frequency trading-style market makers which dominate the flow.
That’s not the only contingency that should give pause to thoughtful bitcoin bulls. For a comprehensive look at the crypto phenomenon, including the risks and opportunities inherent in bitcoin’s migration towards financial respectively, see the brand new edition of Grant’s Interest Rate Observer.
Yet another round of selling pressure left the 10- and 30-year Treasury yields at 1.34% and 2.13%, respectively, each at or near a one-year high and up from as low as 0.81% and 1.2% last summer. Stocks drifted sideways again to finish the week little changed, WTI crude continued its pullback by sinking to $59 a barrel and gold ticked higher to $1,780 an ounce. One inflationary sighting: Copper reached a fresh nine-year high above $4 a pound, up 93% from its late April lows.
- Philip Grant
SPAC check: Following another busy deal day, some 154 special purpose acquisition (a.k.a. blank check) companies have come to market so far in this young 2021, raising a total $46.7 billion according to data from SPACInsider. That compares to $83 billion in such deals all of last year (itself eclipsing all total prior fundraising for the vehicles), and an average $44 billion in annual proceeds from conventional U.S. initial public offerings from 2011 to 2019 per Renaissance Capital.
Luckily for promoters, the current zeitgeist is helping to absorb that wall of supply. The Wall Street Journal reports that Oakland-area rapper Cassius Cuvée recently released a music video dubbed “SPAC Dream,” on YouTube, garnering the attention of investor Bill Ackman on Twitter. It’s not just an artistic muse. Cuvée notes that roughly half of his $1 million stock portfolio is allocated to the blank check enterprises.
A pair of divergent strategies Down Under. In response to proposed Australian legislation mandating new protections for publishers against global big tech, Google parent Alphabet, Inc. came to terms with local media groups Nine Entertainment and Seven West Media, along with News Corp., to license their content on the Google platform.
Facebook, Inc. opted to go in another direction, following through on a prior threat to block Australian publishers from posting anything on the social network from anywhere on earth, as well as all news sites from sharing their own stories in the country. The social media behemoth was not shy about swinging the virtual axe. Some unrelated sites, including public broadcasters and those related to public health and meteorology, were also temporarily taken offline.
Australian prime minister Scott Morrison offered some sharp words in response: “These actions will only confirm the concerns that an increasing number of countries are expressing about the behavior of big tech companies who think they are bigger than governments and the rules should not apply to them.” Some may be inclined to agree; lawmakers from the European Union are considering similar legislation (Almost Daily Grant’s, Feb. 9).
While Aussies adapt to their new, sparser digital landscape, some investors may find opportunity from information disintermediation. Bruce Kovner, founder of Caxton Associates and chairman of CAM Capital, told the audience at the 2012 Grant’s fall conference that, in the pre-digital era, he would dispatch a messenger to JFK to snag the first edition of the Financial Times off the plane from London to bring to his door. “It was my edge.”
As Facebook (which has seen its shares rise 59% since a bearish analysis in the Aug. 11, 2017 edition of Grant’s, far behind the 139% gain in the Invesco’s Nasdaq 100 Index ETF) navigates choppy regulatory waters, new legal developments cast a shadow on the true success of its business model.
Freshly unsealed court documents relating to a 2018 class action lawsuit allege that the social network made “a deliberate decision not to remove duplicate or fake accounts,” in order to burnish its self-reported “reach” metric which helped form the basis of Facebook's lynchpin advertising business. The situation had the attention of the c-suite, as chief operating officer Sheryl Sandberg “acknowledged in a 2017 email that she had known about problems with potential reach for years.”
When product manager Yaron Fidler proposed tweaking the definition of reach to make it more accurate, management demurred under the logic that removing duplicate accounts would lead to a double digit decline in the metric and a “significant” hit to revenue. Fidler, according to the documents, responded by observing that “it’s revenue that we should never have made.”
Indeed, concerns about the veracity of Facebook’s data have long been apparent. A report from then-Pivotal Research analyst Brian Wieser that same year underscored the absurdity of some claims:
Through Facebook’s Ads Managers we can see that Facebook claims a potential reach within the U.S. of 41 million 18-24 year-olds, 60 million 25-34 year-olds and 61 million 35-49 year-olds. By contrast, U.S. Census data indicates that last year there are a total of 31 million 18-24 year-olds, 45 million 25-34 year-olds and 61 million 35-49 year-olds. Nielsen estimates for the 2017-2018 season are close to the 2016 U.S. Census figures, with 31 million 18-24 year-olds, 43 million 25-34 year-olds and 61 million 35-49 year-olds.
More recently, Facebook reported total daily and monthly active users of 1.84 billion and 2.8 billion, respectively, at year-end 2020, representing 24% and 36% of the global population. Yet, despite that extensive reported global penetration, FB bulls retain ambitious expectations: The Street pencils in $128 billion in revenue for 2022 and $176 billion for 2024, along with $36 billion and $53 billion in free cash flow for those years. Each of those estimates represents a compound annual growth rate ranging from 20% to 22% from their 2020 levels.
Treasurys came for sale again after yesterday’s bounce, with the 10- and 30-year yields rising back to 1.3% and 2.08%, respectively. Stocks saw modest pressure with the S&P 500 falling 40 basis points to remain unchanged for the week and up by a bit more than 4% so far this year. Energy gave back early gains as WTI slipped back to $60 a barrel, gold rebound from initial weakness to hold at $1,775 an ounce, and the VIX climbed to a two-week high at 22.5.
- Philip Grant
This morning, Italy sold €10 billion ($12.2 billion) in 10-year debt, attracting a record €110 billion of bids. That blistering demand was enough for Rome to trim the auction premium to four basis points over existing 10-year bonds, half the initial guidance. Italy’s benchmark 10-year yield finished the day at 0.57%, near a record low 0.46% reached Thursday and down from more than 7% in the fall of 2011.
The ascension of former European Central Bank president Mario Draghi to prime minister figures prominently in today’s blockbuster sale, as his unity government will attempt to implement budgetary reforms that would help unlock some €200 billion in E.U. funding. There is plenty of work to be done to set the country on the right fiscal course: Triple-B/triple-B-minus-rated Italy sported government debt equivalent to 159% of output as of Dec. 31, up from 135% at year-end 2019.
Antoine Bouvet, senior rates strategist at ING predicts that “The market can continue surfing the Draghi wave for a while longer.” Strategists at UniCredit believe that Italy’s 10-year spread over German bunds could narrow to as little as 50 basis points (which would mark a 13-year low) from the current 91 basis points, under a “Super Mario” scenario.
With or without Draghi, borrowers on the Old Continent are making hay. Last Tuesday, single-A/triple-B-plus-rated Spain sold €5 billion worth of 50-year bonds at a 1.45% coupon, drawing a robust €65 billion in bids. On Feb. 3, triple-B-rated Portugal raised €3 billion of 30-year bonds at a 1% coupon, attracting an order book topping €40 billion. “Portugal had never managed to achieve such favorable financial conditions for a bond with such long maturity, representing significant savings for the country and for taxpayers,” declared the country’s finance ministry.
With demand for long-dated debt remaining red hot, might Italy be ready to take things a step further as it attempts to get its financial house in order? Analysts at Saxo Bank floated the idea of century bonds for the 160 year-old nation state, estimating that such 100-year debt would carry a coupon near 2.5%. “This is the right time for governments to expand bond issuance in ultra-long maturities to fund budget deficits while securing extremely low yields. [This presents] an opportunity that a country like Italy cannot ignore.”
Recent action in rates adds potential urgency to those efforts. Today, the German 30-year bund yield rose to (positive) 0.16%, an eight-month high and up sharply from minus 0.15% a month ago. More broadly, the global stock of negative-yielding debt fell to $15.1 trillion yesterday, from about $18.5 trillion in mid-December.
While the recent move could prove a head-fake, monetary mandarins in Europe’s largest economy are beginning to look ahead to a new consumer price regime. German Bundesbank President Jens Weidmann predicted in a Thursday interview with Augsburger Allgemeine that: “From today’s perspective, the (EU) harmonized consumer price index in Germany should rise to above 3% until the end of the year. One thing is clear: the inflation rate will not remain as low as [it was] last year permanently.”
With yields showing signs of life and the return of inflation an increasing possibility, the onus could soon shift back to the European Central Bank. Last week, the ECB bought €17.1 billion worth of bonds, up 26% on a sequential basis. Piet Christiansen, chief strategist at Danske Bank, believes there’s more where that came from: “I think they will step up. . . I didn’t anticipate them doing [so] already last week, but the increased volume to me indicates that they are more uneasy than first envisaged.”
Whatever It Takes, Part II?
Accelerated selling pressure across the Treasury complex pushed the 10- and 30-year yields to 1.3% and 2.08%, respectively, leaving the 2- vs. 10-year spread at its widest since March 2017 while the gap between the 5- and 30-year yields remains at its broadest since fall 2015. Stocks finished unchanged with the S&P 500 giving back moderate early gains, while the VIX rose 7% to 21.5. Surging rates pushed gold to $1,793 an ounce, while oil continued its breakout as WTI finished above $60 a barrel for the first time since early January 2020.
- Philip Grant
Here’s Social Capital founder and prolific SPAC sponsor Chamath Palihapitiya in an interview with Bloomberg today:
Nobody’s going to listen to Buffett. But there has to be other folks that take that mantle, take the baton and do it as well to this younger generation in the language they understand.
Of course, some elements of the nonagenarian Oracle of Omaha are worthy of emulation:
I do want to have a Berkshire [Hathaway] like instrument that is all things, you know, not to sound egotistical, but all things Chamath.
The federal budget deficit reached $738 billion through four months of fiscal 2021 ended Jan. 31, the Congressional Budget Office reports. That’s up 89% from the year-over-year, pre-bug figure, as receipts largely held steady at $1.2 trillion, while outlays leapt to $1.9 trillion, a record 23% increase. January’s $165 billion gap was five times its year-ago level.
For the full fiscal year, the CBO pencils in a $2.3 trillion shortfall, equivalent to 10.3% of gross domestic output, while the deficit is projected to foot to a massive 16.2% of GDP over the 12 months ending March 31, according to Bloomberg. For context, that number peaked near 9% of GDP in the financial crisis aftermath of 2009 and 2010 and has averaged 3.1% over the last 50 years.
Budget balance as a percentage of GDP, 50-year view. Source: The Bloomberg.
That current-year shortfall is set to grow larger still, as President Biden looks to pass additional stimulus of up to $1.9 trillion, spending which is not currently incorporated in CBO estimates.
Of course, low interest rates make exploding deficits far easier to manage. On that score, so far, so good. Thanks in large part to a 9.5% rally in the Bloomberg Aggregate Treasury Index across calendar 2020, interest payments across the first four months of the year declined 14% on a year-over-year basis. The CBO projects the average interest rate on debt held by the public at 1.5% this year and 1.3% in fiscal 2025, well below the 2% for fiscal 2020.
Conversely, the recent uptick in medium and long-dated Treasury yields underscores the mischief that an inflationary revival and accompanying rising rate regime would inflict. Bloomberg estimated last week that each percentage point increase in yield on the $35 trillion in bonds within the Bloomberg Barclays Global Aggregate Treasury Index would deal some $3 trillion in mark-to-market losses.
Then, too, spiraling deficits could take a toll on financial plumbing, compelling the Federal Reserve to soak up an increasing share of the Treasury market. The Fed’s Treasury holdings stand at $4.78 trillion, double that of a year ago, dwarfing the 26% uptick in public debt outstanding over that period. On Oct. 14, Federal Reserve vice chair for supervision Randal Quarles warned that mushrooming supply “may have outpaced the ability of the private-market infrastructure to support stress.” Quarles went on to hypothetically ask:
Will there be some indefinite need for the Fed to provide, not as a way of supporting the issuance of Treasurys, but as the way of supporting a functioning market in Treasurys, to participate as a purchaser for some period of time?
Leaving those worries for another day, newly minted Treasury Secretary Janet Yellen spread the good news of deficit spending in a virtual meeting with G7 finance ministers this morning. From the Treasury Department’s summary of the call:
Secretary Yellen also stressed the importance of providing further fiscal support to promote a robust and lasting recovery. She emphasized that “the time to go big is now” and that the G7 should be focused on what more we can do to provide support at this time.
The bond bears stirred again, as long-dated Treasurys were hit hard with the 10- and 30-year yields rising to 1.2% and 2%, respectively, up from as low as 0.52% and 1.2% last summer. A late ramp pushed the S&P 500 to fresh highs, with a 1.2% gain for the week and 4.8% so far this year. WTI ripped again to approach $60 a barrel for the first time since January 2020, gold edged lower to $1,822 an ounce and the VIX sank to near 20, its lowest close since the start of the pandemic.
- Philip Grant
Here’s San Francisco Fed president Mary Daly seeming to say something about monetary stimulus (perhaps the need for more of it) in an interview today in The Wall Street Journal:
If you take the lens of my modal outlook, then it’s really continuing to purchase [assets] at the current pace through the end of this year.
Uber Technologies, Inc. fourth quarter results yesterday featured revenues of $3.17 billion, down 16% year-over-year and short of the consensus $3.22 billion. Adjusted Ebitda weighed in at minus $454 million, an improvement from both 4Q19’s gussied up $615 million loss and analyst expectation of minus $507 million.
The pandemic continues to take a toll on the core ride-share business, with fourth quarter trips down 27% year-over-year, partially offset by a 130% top-line surge in its Uber Eats delivery division, which was buoyed by the $2.65 billion all-stock deal for Postmates, Inc. last fall. For the quarter, that unit’s adjusted Ebitda losses narrowed to $145 million from $461 million in the fourth quarter of 2019.
CEO Dara Khosrowshahi struck an upbeat tone on the conference call yesterday, building on a prior pledge to turn the company profitable on an adjusted Ebitda basis by the fourth quarter: “We’re bullish that we can deliver strong growth and expanding margins in the second half of the year.”
Indeed, there’s room for improvement on that score. Uber generated $2.6 billion in negative adjusted Ebitda and a $6.8 billion net loss on $11.1 billion in revenue last year, while adjusted Ebitda for 2019 footed to minus $2.7 billion, with an $8.5 billion net loss on a $13 billion top-line.
Then, too, the 11-year old ride-hail giant looks to keep up with the times. Khosrowshahi told CNBC this morning that “just like we accept all kinds of local currency, we are going to look at cryptocurrency and/or bitcoin in terms of currency to transact.”
To be sure, the company adroitly deals in political currency. Last fall, California voters passed Proposition 22, allowing Uber and its gig-economy peers to continue to classify its drivers as independent contractors rather than employees, and thus avoid paying out healthcare and other benefits. Those lobbying efforts, on which Uber and frenemy Lyft, Inc. reportedly spent some $200 million, have borne abundant fruit: Shares have ripped 86% since early November to push Uber’s market cap to a towering $115 billion. The company now sports an enterprise value equivalent to 7.4 times consensus 2021 revenue, far above the 1.97 times EV-to-sales valuation for the (sometimes profitable) constituents of the NYSE Arca Airline Index
The Street is chock full of believers, with 34 analysts rating shares “buy,” versus five “holds” and a single “sell.” Analysts at Stifel skillfully summarized the bull case in a note yesterday bearing the headline “Pink Elephants Land on the Moon”:
In our opinion, there is a lot of nonsense in financial markets at the moment. It is hard to know whether one should take much of anything seriously until this period of euphoria ends. We are analysts so its better to have something to recommend, even if just on a relative basis. We like Uber…on a relative basis.
It could have actual earnings in a few years and, if our guess proves right, may generate $4 billion in profit in 2024. Uber shares currently trade for 33 times 2024 earnings per share estimates, so if nothing goes wrong in the world (or at Uber) over the next three years, an investor could eke out an okay equity return, assuming current valuations hold up.
Others see things a bit differently. Transportation expert Hubert Horan, who eviscerated Uber’s core ride-share business model from the Grant’s fall conference podium in 2019, took a similarly dim view of Uber Eats’ prospects in a blog post from August:
Food delivery is hypercompetitive (DoorDash, GrubHub, JustEat, Deliveroo), neither customers nor restaurants can afford the true cost of the service, and none of these companies have ever been sustainably profitable. Uber has never presented a plausible argument [that] it will suddenly become the first company to realize returns from investments in this business.
While Uber attempts to staunch the tide of red ink, insiders continue to reap generous equity awards: Stock-based compensation (which is excluded from the company’s preferred adjusted Ebitda metric) footed to $236 million in the fourth quarter, equivalent to 7.5% of total revenue for the period. In 2019, Uber paid out a hefty $4.6 billion in stock-based compensation (equal to one-third of annual revenue), in connection with vesting options awards related to its initial public offering in the spring.
Accordingly, some of those c-suite recipients have not been shy about hitting the bid. CEO Khosrowshahi cashed out some $10.9 million last month in a trio of open market sales, while chief legal officer Tony West sold some $4.1 million worth in the seven months through January. Last year, Jill Hazelbaker, senior vice president of marketing and public affairs disposed of $10.4 million in May and co-founder Garrett Camp unloaded a cool $145.4 million worth of stock over the four months ended May 7.
A weak long bond auction took the air out of the recent bounce in Treasurys, as yields on the 10-year note and 30-year bond rose to 1.16% and 1.95%, respectively. Stocks continued to consolidate near record highs with the S&P 500 finishing little changed for a third straight day. WTI crude pulled back to $58 a barrel to snap its eight-session winning streak, gold slipped to $1,826 an ounce, and the VIX dropped 3% to near 21.
- Philip Grant
This morning’s reading of the January consumer price index showed a 1.4% annual increase for both the headline and core (excluding food and energy) metrics, below the 1.5% consensus for each.
The following chart, courtesy of Barry Knapp, managing partner at Ironsides Macroeconomics, identifies a notable divergence within one major piece of the price puzzle. Below graphs the Federal Housing Finance Agency’s Home Price Index, which jumped 7.8% from a year ago in the third quarter (its most recent reading). By contrast, the shelter component of the January CPI, which is by far the heaviest weighting in the index, rose a modest 1.6% from a year ago in January.
Notably, the FHFA data set appears to have led the CPI metric into both the housing boom and bust of the mid-to-late aughts:
Today’s soft consumer price data aside, a return to inflation appears to be front of mind for Mr. Market. Stocks and key commodity prices remain on the boil, while the Treasury curve has steepened markedly with the long bond yield reaching 2% Monday (up from 1.2% in early August) for the first time in a year, pushing the spread between the five- and 30-year yields to its widest since fall 2015.
One thing is for sure, the inflationistas have a friend at the Eccles Building in Washington. Comments from Fed chair Jerome Powell today that “my colleagues and I are strongly committed to doing all we can to promote” full employment, and "we will not tighten monetary policy solely in response to a strong labor market" suggest that near-zero rates and $120 billion per month worth of asset purchases will persist even as the virus abates.
Mr. Market has read the writing on the wall. According to Bank of America’s January fund manager survey, some 92% of respondents expect rising inflation and 89% call for higher Treasury yields, each near a record level. Similarly, the 10-year breakeven rate, which measures the difference between inflation protected and fixed-rate Treasurys, reached 2.21% yesterday, its highest since mid-2014 (then again, the Fed itself has a thumb on that scale, as its holdings of inflation-protected Treasury securities reached $316 billion last week, up 69% from a year ago).
While the future course of inflation remains a closed book, the reaction in corporate credit to the specter of an inflationary dust-up is nevertheless instructive. Bloomberg reports today that bonds maturing in 10 years or more have lost 3.2% on average so far this year, the worst such performance since 2018 and more than double the losses seen in the wider investment grade category.
As the threat of intensifying price pressures spooks long-dated obligations, the increasing composition of that distant debt bears watching. The average duration (which measures sensitivity to changes in interest rates) for U.S. corporate bonds reached 8.3 years on Monday according to ICE Data Services, up from 6.5 years a decade ago and 5.6 years in 2001. Concurrently, the effective yield on the ICE BofA US Corporate Index sits at 1.89%, down from 2.62% a year ago and near the record low of 1.79% set in January.
There’s more where that came from, if recent history is any guide. Investment grade U.S. companies issued about $420 billion in debt due in 20 years or more last year, according to Bloomberg, more than double the 10-year average. Last week, double-A-plus-rated Apple, inc. sold $1.75 billion of senior unsecured 40-year bonds at a 2.8% coupon, while single-A-plus-rated Alibaba Group Holding Ltd. issued $1 billion of its own senior unsecured 40-year bonds at a 3.25% coupon.
A similar trend is visible in the more speculative corner of the corporate bond market. Analysts from Barclays reported last week that average duration in high-yield debt has jumped to 6.7 years, compared to 6.1 years at the beginning of 2020. Similarly, the effective yield on the ICE BofA US High Yield Index reached a record low 4.12% yesterday, down from 5.19% a year ago. Meanwhile, Bloomberg reported Friday that a voracious hunger for yield has left junk bond investors “calling up companies and pressing them to borrow, instead of waiting for bankers to bring new deals to them.”
“It’s kind of wacky,” Jim Shepard, head of investment-grade bond issuance at Mizuho in New York, told the Financial Times yesterday. “At a time when you would want greater insurance against a rise in interest rates, [people] are buying something more exposed to it.”
Stocks drifted sideways for a second straight day, with the S&P 500 continuing to consolidate its recent run to fresh record highs, while the 10- and 30-year yields dropped to 1.12% and 1.91% following this morning’s CPI data. WTI crude edged toward $58.50 a barrel to log its eighth straight green finish, gold ticked to $1,843 an ounce and the VIX closed above 22 for the first time in a week.
- Philip Grant
Back to the drawing board for big tech. The Financial Times reports today that European Union parliament members are preparing amendments to the forthcoming Digital Services and Digital Markets Acts, which would compel industry behemoths like Facebook, Inc. and Google parent Alphabet, Inc. to pay publishers for their content. That follows similar legislation put forth by lawmakers in Australia late last year.
Among the proposed changes; providing publishers with the option of binding arbitration to adjudicate pricing disputes for licensing agreements, as well as compelling big tech to notify publishers of changes related to news story rankings on their hosted site.
Malta-based lawmaker Alex Saliba, who issued a report on the DSA last fall, praised Australia’s approach as leveling the playing field for publishers previously held hostage by the whims of Silicon Valley:
With their dominant market position in search, social media and advertising, large digital platforms create power imbalances and benefit significantly from news content. I think it is only fair that they pay back a fair amount.
The stakes are indeed high, as the prospect of Australia’s stance catching on elsewhere could hinder big tech’s profitability, a prospect about which the companies are none too pleased. Last year, both Google and Facebook threatened to cease or sharply curtail operations Down Under if the law is enacted.
Stateside, shifting political winds have spurred one publisher to mount a legal challenge of its own. In late January, West Virginia-based HD Media Company LLC filed an antitrust lawsuit against the pair in the U.S. District Court for the Southern District of West Virginia, asserting that Facebook and Google’s wrongful manipulation of the digital advertising market has imperiled the survival of eight local publications including the Charleston Gazette-Mail.
“These companies are more powerful than Standard Oil in its heyday, so no one wants to be first to take them on,” Doug Reynolds, managing partner at HD Media, told The Wall Street Journal last Friday. “We felt the political and legal climate has moved in our favor and [we] are ready to go ahead.”
While politicians and the courts probe the nature of big tech’s pricing power over content providers, the value proposition of the ads themselves could pose a separate problem.
A report from the Australian Competition and Consumer Commission estimates Google’s market share in the country at between 50% and 100%. That dominant position makes it harder for content providers to determine if their digital marketing budget is money well spent. “Google is the only one that can determine the effectiveness of ads, so really often they’re marking their own homework when it comes to the effectiveness of the ads they supply,” ACCC chair Rod Sims told Reuters on Jan. 29.
To that end, one corporate behemoth’s shift in online advertising strategy yielded some interesting results. Citing data from analytics site Pathmatics, online tech magazine The Information reports today that Netflix, Inc. slashed its domestic ad spending on Google to $21.6 million last year from $48 million in 2019. Similarly, data from Kantar Media show that the streaming giant's domestic ad spending across television, print media and digital media sites including Facebook sank 45% from a year prior over the first three quarters of 2020.
Perhaps tellingly, those deep cuts had no evident impact on Netflix’s popularity, as North American subscriber count rose to 73.9 million, up 9% from year-end 2019. While the pandemic and lockdowns certainly factored prominently in those results, mushrooming competition in the streaming category (featuring the recent debuts of Disney+ and HBOMax, who coughed up a combined $700 million in U.S. digital ads last year) perhaps would have argued for the opposite approach. Instead, Netflix seemingly bore no ill effects from tightening its corporate purse strings.
Might other digital big spenders take notice?
Stocks broke their six session winning streak, though the bears made precious little headway as the S&P 500 declined by just a handful of basis points. Treasurys again finished flat to slightly higher, with the 10-year yield ticking to 1.16% while the long bond remained at 1.95%. WTI crude rallied for a seventh straight day to $58.5 a barrel, up 58% from the end of November, gold edged higher to $1,838 an ounce and the VIX managed to eke out its second straight green finish, holding below 22.
- Philip Grant
A double dose of contemporary financial zeitgeist this morning. Telsa, Inc. announced in a Securities and Exchange Commission filing that it has invested $1.5 billion worth of corporate funds in bitcoin and will soon accept payment denominated in the crypto, “subject to applicable laws and initially on a limited basis.” That helped spur a 16% intraday rally in bitcoin to $45,000, up 770% from its mid-March lows, while Tesla’s share price stands at $859, up a cool 1,700% on a split-adjusted basis over the past 16 months.
The digital ducats, which recently garnered the attention of Tesla CEO Elon Musk (who placed the bitcoin logo onto his Twitter profile three days back) make for an interesting dance partner with the sustainable electric-car maker. To wit, bitcoin’s carbon footprint stands at 36.95 megatons per year according to Digiconomist’s Bitcoin Energy Consumption Index, equivalent to New Zealand’s annual emissions. The Cambridge Bitcoin Electricity Consumption Index pegs the crypto’s yearly energy use at 110.53 terawatt hours, topping the Netherlands’ total electricity consumption and equivalent to 0.5% of total global generation. More than one-third of bitcoin mining is powered by less-than green coal energy, by the lights of the Cambridge Center for Alternative Finance.
With prices on the boil, those environmental headwinds are unlikely to abate anytime soon. Charles Hoskinson, the co-founder of the ethereum cryptocurrency, told CNBC on Friday that “the more successful bitcoin gets, the higher the price goes; the higher the price goes, the more competition for bitcoin; and thus, more energy is expended to mine.”
Meanwhile, Musk continues to stir the masses, tweeting a reference yesterday to meme-based crypto dogecoin, which was started as a joke back in 2013. Unusual provenance aside, dogecoin has more than doubled in the past week, pushing its market value above the $10 billion threshold which is traditionally used to delineate large-cap stocks.
A new day in the land of the Rising Sun. Thanks to a 1.8% rally today, Japan’s Topix Index reached its highest closing level since June 1991, following the dual stock market and real estate bubbles of the late 1980s. Similarly, the price-weighted Nikkei 225 Index jumped 2% to finish above the 29,000 threshold for the first time since 1990, though the pair of indices remain 32% and 27% below their respective 1989 high-water marks.
Price-insensitive buying power figures prominently in the recent rally. The Bank of Japan’s domestic stock-market holdings reached an estimated ¥46.6 trillion ($443 billion) worth of exchange traded funds at year-end according to estimates from Nomura, which would top the country’s Government Pension Investment Fund’s ¥45.3 trillion portfolio for the first time. The central bank, which had previously committed to buying at least ¥6 trillion in ETFs per year, may scuttle that target at its upcoming March meeting, Reuters reported on Jan. 29.
As the BOJ ponders its next move, some observers note that the wellspring of liquidity has not lifted all boats equally. “The expensive companies become more expensive, and less expensive companies become less cheap, but not at the same pace,” Jaewoo Nakajima, head of Japan research at Evercore ISI, told Grant’s Interest Rate Observer in January.
Apart from a top-heavy cohort of richly valued concerns, value investors may find plenty to like in Japan, including broadly improving corporate management. Operating margins on the Topix Index fell to 5.8% in pandemic-addled 2020, well above the 3-5% margins seen throughout the early aughts and down relatively modestly from 7.1% the year prior. By comparison, the S&P 500 generated a 10.2% operating margin last year, compared to 13.5% in 2019. Improved structural profitability offers the potential for operational flexibility. A December Evercore ISI survey of corporate management teams found that 83% of respondents intend to increase their dividend, while 58% plan to enhance capital spending.
For more on investment opportunities and risks in Japan, including a trio of picks-to-click, see the Jan. 22 edition of Grant’s Interest Rate Observer. The investment verdict: “A handful of highly valued Japanese companies masks a host of reasonably valued, well-financed ones.”
The bid goes on, as stocks rose for a sixth straight session to leave the S&P 500 higher by 4.3% so far this year and 17% from a year ago, right before the pandemic burst on the scene. Treasurys finished little changed apart from a modest rebound at the back end to push the 30-year yield to 1.95%, while the VIX bounced by 2% after last week’s 37% selloff. Gold rose by 1% to 1,831 an ounce, and WTI continued its bull run with its first close above $58 a barrel in more than a year.
- Philip Grant
The newly minted governor of Turkey’s central bank tells Reuters today that “it does not seem possible to put interest rate cuts on the agenda for a long time this year.” Instead, says Naci Agbal in his first interview since taking over three months ago, the current benchmark one-week repo rate of 17% could go higher before it goes lower. “If any new data that we come across indicates a risk of deviating from the medium-term target path in inflation expectations and pricing behavior, we will tighten further in advance,” Agbal assured.
Turkey endured an economically brutal 2020 featuring a 30% decline in the lira vs. dollar exchange rate through early November, along with fast-dwindling foreign currency reserves, forcing President Recep Erdogan’s hand. On Nov. 6, the President fired Central Bank of The Republic of Turkey governor Murat Uysal. Hours later, economic czar and Erdogan son-in-law Berat Albayrak tendered his resignation via an Instagram post. The CBRT had bent to the Presidents wishes, slashing rates to as low as 8.25% in May of last year from 24% in June 2019 in the face of percolating inflation.
In contrast, the new monetary mandarin has resisted pressure from President Erdogan, who continues to make his preference for easy money abundantly clear. “There is no way we can reach the inflation target with high interest rates. We can only achieve this with low interest rates,” Erdogan reasoned on Monday.
Mr. Market has taken notice of the new tone at the top. The Turkish lira traded today to 7.06 per dollar, its strongest level in six months and well off the 8.52 per buck nadir reached last fall, while gross foreign exchange reserves have rebounded to $53 billion from $40 billion (a 15-year low) in mid-November. That’s despite resurgent inflationary pressures, as measured prices jumped by 15% in January from a year ago, topping expectations of 14.7% and the hottest reading since August 2019.
“It is easier for the market to accept this negative surprise due to a strong pledge from Governor Agbal to keep interest rates at high levels for a long time,” Rabobank emerging market strategist Piotr Matys commented earlier this week.
Noting the prospects for a shift back towards more orthodox economic policies, in tandem with particularly undaunting valuations, the Nov. 13 edition of Grant’s Interest Rate Observer posited that “bullish things may be afoot in Turkey.”
Indeed, value-seeking investors may find lots to like. Haydar Acun, CEO of Istanbul-based Marmara Capital Asset Management, identified commercial bank Turkiye Garanti Bankasi A.S. (GARAN on the Istanbul Exchange) and beverage bottler Coca-Cola Icecek A.S. (CCOLA in Istanbul) as among the most attractive names on offer. The pair have since flourished, racking up gains of 21% and 38%, respectively, in dollar terms since publication date, while the broad Borsa Istanbul 100 Index has jumped 18% (27.5% in dollar terms) since Nov. 13.
Might there be more upside to come? Reached today via email, Acun tells Almost Daily Grant’s that he remains bullish on both of his prior picks-to-click, as well as the broad Turkish market. Undaunting valuations and the potential for favorable capital flows underpin his rationale:
With currency strength and rising confidence, locals will switch some dollar deposits back into lira, and a little bit of foreign money might trickle in. The market trades at just over seven times consensus 2021 earnings estimates, historically cheap relative to the MSCI emerging markets index.
The celebrated American political satirist believes that he sees the divine hand of Rembrandt in our page-one cartoons. Maybe so, but the artist signs himself Hank Blaustein. Read below P.J.'s fine and funny review of Hank's incomparable work.
A weaker than expected January nonfarm payroll data helped accelerate curve-steepening price action in Treasurys, as the 10- and 30-year yields each rose to near-one-year highs at 1.17% and 1.97%, respectively, while the two-year fell to 0.103% intraday, matching a record low.
Stocks caught a modest bid to wrap up a clean sweep for the bulls, with the S&P 500 logging a 4.7% gain for the week over five green finishes to notch a fresh high and extend its post-March 23 gains to a gaudy 74%. WTI continued its gangbusters rally with a close near $57 a barrel, gold bounced back to $1,811 an ounce and the VIX slipped below 21.
- Philip Grant
Following last year’s record $433 billion in domestic high-yield issuance, a 57% uptick from the 2019 level, the party continues to hum in 2021: A cool $57 billion worth of junk paper priced in January, some 50% above last year’s heretofore record figure and the third busiest single month on record.
Naturally, friendly price action clears the way for that issuance deluge. The yield-to-worst on the Bloomberg Barclays High Yield Index traded below 4.12% yesterday, remaining near the all-time nadir of 4.1% set on Jan. 21. Similarly, some 88% of the domestic high-yield universe is currently trading above par, according to data from CreditSights, up from 73% at the end of October. Prices have remained resilient despite some upward pressure on benchmark interest rates, as the 10-year Treasury yield has jumped to 1.14% from 0.87% on Oct. 30.
Meanwhile, the junkiest concerns have continued to lead the way. The triple-C-rated contingent of the ICE BAML High Yield Index returned 2.36% in January, the 10th straight advance and the third consecutive monthly outperformance relative to the higher-rated junk categories. That helped push option-adjusted spreads on the Caa-rated portion of the Bloomberg Barclays High Yield Index to 583 basis points yesterday, far inside the 842 basis point spread a year ago (right before the bug bit) and within range of its post-2008 lows of 510 basis points set in May 2014.
To be sure, the bond market sees sunny weather ahead. Utilizing a forecast derived from bond issues trading at distressed levels, i.e., with option-adjusted spreads over 1,000 basis points above Treasurys, Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors LLC, noted in a Jan. 12 commentary that the market-implied 12-month default rate forecast is a mere 1% after excluding the energy sector, beating out the 1.04% implied rate seen in 2007 for the calmest projected waters on record going back to 1989.
The rating agencies dissent. Moody’s Investors Service pencils in a total peak 7.3% trailing 12-month rate by March, before improving to 4.7% by December, while S&P Global continues to sound the alarm, projecting a peak 9% trailing-12-month speculative-grade corporate default rate by September.
Even the bulls have a hard time squaring with Mr. Market’s sunny disposition. Fitch Ratings expects a 3.5% default rate in calendar 2021, more than triple the market’s pricing-derived, ex-energy forecast.
While steady improvement has been visible in recent months, ongoing stress among large swaths of the corporate universe adds weight to the rating agencies concern. Some 350 companies remained on Moody’s Investors Service’s latest B3N list, (i.e., rated the equivalent of single-B-minus or lower along with a negative ratings outlook) as of Jan. 31, equivalent to 22.7% of the total speculative-grade corporate universe. That’s off from last year’s peak of 27.5%, but still 70% above the February 2020 level and within range the financial crisis-era high-water mark of 26.1%.
Similarly, the total size of the triple-C-rated market across North America stood at $276 billion as of year-end according to S&P, up 70% since the start of the pandemic. What’s more, 81% of S&P’s triple-C-rated issuers carry either a negative outlook or CreditWatch status, indicating the potential for more downgrades to come if conditions worsen.
Still-strained balance sheets remain front-and-center. S&P reports that median leverage among North American speculative-grade corporate issuers stood at 5.8 times trailing 12-month Ebitda as of Sept. 30, up from 5.3 times as of year-end 2019. Some of those extra borrowings will soon come due. U.S. junk-rated companies face a record $1.41 trillion in debt maturities between 2021 and 2025, Moody’s found last fall, up 19% from the 2020 to 2024 period measured one year prior.
In its 2021 U.S. Corporate Credit Outlook published Jan. 21, S&P expressed concern over a “protracted default cycle, given that the inevitable defaults for companies with very weak credit quality may take time to rumble through the markets.” Then, too, Uncle Sam’s training wheels won’t stay on forever: “Eventually fiscal support will cease, which could expose the full extent of indebtedness and structural headwinds many firms may face.”
Yet for now, investors continue to make hay while the sun shines. David Knutson, head of credit research for the Americas at Schroder Investment Management, puts it this way to Bloomberg: High-yield “demand is driven by a desperate need for yield, combined with hope.”
Stocks caught yet another bid to the tune of a 1% rise for the S&P 500, as the broad index has now rolled up a 4.2% gain for the week so far to erase last week’s losses and ascend to fresh highs. The VIX sank below 22, bringing its four-day loss to 34%, while Treasurys rebounded from early weakness to finish little changed. Gold was crushed by 2% to $1,793 an ounce as the U.S. Dollar Index reached its best close since late November, but the bouncing buck was unable to derail the rally in crude as WTI pushed above $56 a barrel.
- Philip Grant
The Federal Communication Commission’s ongoing sale of wireless C-band spectrum rights marks a decisive event for the telecommunications sector. As industry players compete for more digital bandwidth to help roll out 5G services, aggressive bidding looks set to generate a windfall for Uncle Sam. Estimated proceeds will exceed $80 billion, easily topping the prior record of $45 billion for FCC spectrum in 2015.
As the three-way battle for 5G dominance takes shape, former also-ran T-Mobile U.S., Inc. appears to have the jump on competitors Verizon Communications, Inc. and AT&T, Inc., thanks in large part to substantial midrange spectrum frequency gained from last year’s acquisition of Sprint Corp. “For many years, Verizon hammered its competitors time and time again with the ‘best network’ and their big red coverage map,” Sasha Javid, chief operating officer of wireless company BitPath, told Bloomberg on Jan. 22. “Well, the map is looking quite magenta [signifying T-Mobile’s corporate color] today in terms of 5G coverage around the country.”
The incumbents will need to pay up to catch up. Analysts at New Street Research wrote on Jan. 11 that “if T-Mobile spends less than we expect, Verizon or AT&T will likely account for the shortfall. Neither company has the cash on hand to cover what we expect them to spend in the auction at present; we would expect more debt issuance for the group in coming weeks.”
Extra borrowings that accompany Verizon and AT&T’s 5G spending spree look to do no favors for the pair’s respective capital structures. Craig Moffett, co-founder and one-half eponym of MoffettNathanson, LLC, estimated last Tuesday that triple-B-plus-rated Verizon may spend up to $40 billion on 5G digital real estate, enough to add nearly one full turn of leverage to its 2.3 times reported net borrowings (3.2 times after accounting for operating leases and pension liabilities) as of Dec. 31. Moffett wrote:
Higher leverage will mean that capital spending will, by necessity, be pinched and stretched. Lower capital spending will mean that it will take longer to deploy their C-Band spectrum, which, in turn, will mean Verizon will be slower to catch up to T-Mobile.
Meanwhile, Verizon’s other peer has already tapped the credit markets to finance its own shopping spree. This morning, triple-B-rated AT&T officially entered into a $14.7 billion, 364-day term loan offering at 100 basis points over Libor, with proceeds earmarked for general corporate purposes, including the financing of additional spectrum.
The new borrowings color AT&T’s dubious distinction as the world’s most encumbered non-financial company. Net debt footed to $198 billion, inclusive of operating lease and pension liabilities (equal to 3.6 times consensus 2021 adjusted Ebitda) as of Dec. 31, following efforts to diversify into higher growth businesses via the 2015 and 2018 purchases of DirecTV and TimeWarner for $67 billion and $109 billion, respectively. More debt could further complicate efforts to both tame its bloated balance sheet and improve slumping operating results including sharp subscriber losses and fast-retreating Ebitda within the DirecTV business.
Those problems have helped pressure shares to the tune of negative 18% after accounting for dividends since a bearish analysis in the Dec. 13, 2019 edition of Grant’s Interest Rate Observer, compared to a 24% total return from the S&P 500 over that period. By way of response, AT&T has pivoted to asset sales, including recently shopping DirecTV to private equity companies at a reported $15 billion price tag, while prioritizing its quarterly dividend, now at a 7.2% trailing annual rate. On last week’s conference call, CEO John Stankey reiterated plans “to use free cash flow after dividends for the next couple of years to pay down debt.”
Noting that the company is in danger of exceeding the 3.5 times adjusted leverage limit that Moody’s Investors Service has cited as a projected ceiling for AT&T to maintain its investment grade imprimatur, MoffettNathanson wrote last Wednesday that the spectrum sale left Ma Bell with two bad choices:
Sitting out the auction would have left them far behind in 5G; buying spectrum would leave their dividend looking even more unsustainable. Damned if you do, damned if you don’t.
Selling DirecTV now will help slow the overall rate of Ebitda decline, but it won’t solve the basic problem. AT&T’s leverage is far too high for a shrinking company, and their dividend is too high for them to do anything serious about lowering it. Something’s gotta give.
Stocks roared higher again, as the S&P 500 extended its two-day gains to 3% to approach its high-water mark, while “Reddit retail” names like GameStop, the iShares Silver Trust and AMC Entertainment absorbed heavy losses. Treasurys remained under pressure with the 10- and 30-year yields approaching fresh 10- and 12-month highs at 1.1% and 1.87%, respectively. WTI crude jumped above $55 a barrel for its best finish since January 2020, gold slipped to $1,837 an ounce, and the VIX fell below 26 to bring its two-day pullback to 23%.
- Philip Grant
The Reddit retail crowd has once again made its presence felt via en masse arrival into the silver pit: Futures prices jumped as high as 13% to $30 an ounce this morning, the highest since February 2013. Activity could be described as frenzied, as trading volumes in the iShares Silver Trust ETF were nearly double last week’s peak turnover and more than seven times its one-year average.
That influx of new silver aficionados is taking a serious toll on the supply picture. Zerohedge reports this afternoon that the premium for physical silver skyrocketed to $14 an ounce today. For context, that differential normally sits near $2 to $4 an ounce, while the previous high-water mark for physical silver premiums over the past five years was less than $6 an ounce back in March 2020.
“Now we’re seeing nothing, no single offer, which is scary,” Peter Thomas, senior vice president at Zaner Group, told Bloomberg yesterday. “Whatever we sell, people are holding it. There’s no inflow of metal at all.”
Who needs GameStop? Citing data from University of Florida finance professor Jay R. Ritter, The Wall Street Journal reports today that special purpose acquisition companies (SPACs) have enjoyed a 6% average gain on their first day of trading so far this year. That compares to a 1.6% first-day bump across 2020, and negligible debut performance in prior years. Some 117 consecutive SPAC deals have traded higher after their first week since the last red showing, the Journal finds.
Promoters of the blank check companies are eager to satiate Mr. Market’s voracious current appetite. Accelerate Financial Technologies CEO Julian Klymochko declared on Twitter that, with some 32 corporate actions including six new announced combinations and 15 fresh form S-1 filings, today marks the busiest day in SPAC history. That puts year-to-date volume at $25.4 billion, according to SPACInsider, following last year’s $83 billion in supply, a figure which topped SPAC formation in all prior years combined.
A trio of notable deals color the current vintage. Chartered private jet startup Wheels Up, dubbed the “Uber of the sky” by CEO Kenny Dicther and which counts athletes Serena Williams and Lance Armstrong as investors, announced today that it will merge with Aspirational Consumer Lifestyle Corp. at a $2.1 billion enterprise value. That compares to a $1.1 billion valuation garnered in the most recent, series D private funding round in August 2019.
Fertitta Entertainment, Inc., the parent company of Landry’s restaurant chain as well as the Golden Nugget Casinos, announced today that it will merge with blank-check outfit Fast Acquisition Corp. at a $6.6 billion enterprise value. It’s been a long and winding road on the way back to the public markets for Fertitta, taken private by CEO and eponym Tilman Fertitta in 2010. Last April, the Golden Nugget was forced to pay a punitive 14% interest rate, along with a discounted price of 96 cents on the dollar, to secure a $250 million term loan due in 2023.
Meanwhile, a staple of the brick-and-mortar retail industry also looks to get in on the act. Simon Properties Acquisition Corp., a blank check outfit formed by the largest shopping mall operator in the U.S., filed its own IPO paperwork with the Securities and Exchange Commission Friday, declaring its intent "to identify innovative businesses with the potential to disrupt various aspects of the retail, hospitality, entertainment and real estate industries and make a transformative impact on in-person and/or online experiences."
Of course, disruption (not necessarily the bullish kind) reigns supreme in the mall-based retail business. In December, Simon and Brookfield Property Partners bought J.C. Penney’s operating assets out of bankruptcy.
The rationale for that unusual deal: So-called anchor tenants (usually department stores) pay discounted rents in return for generating traffic to the rest of the mall, including to smaller, “inline” tenants, who in turn pay more. As the rise of e-commerce has ushered in hard times across the department store industry, the risk of widespread anchor tenant departures (and tripped co-tenancy clauses, which allow inline tenants to cut their own rents) stands as an unpleasant prospect for the retail landlords.
While SPAC promoters push deals out the door, history suggests that less-than-stellar performance awaits the investors currently pushing prices higher. A paper last November from professors Michael Klausner at Stanford Law School and Michael Ohlrogge at New York University School of Law found that blank-check concerns produced sharply negative one-year post-merger returns throughout the ten years through 2019, with losses ranging from about 10% for the 2010 vintage to more than 70% for the 2014 cohort.
“It’s very strange,” Klausner commented to Bloomberg last week. “I fundamentally don’t understand why these things exist.”
Score one for the bulls, as stocks bounded higher to the tune of 1.6% on the S&P 500, as the broad index finished near the highs of the day to erase about half of last week’s losses. Treasurys finished flat to slightly weaker to leave the 10- and 30-year yields at 1.07% and 1.85%, respectively, gold rose to $1,863 an ounce and WTI crude rallied to near $54 a barrel. The VIX pulled back to 30, down 9% on the day.
- Philip Grant