Bloomberg reports today that the Saudi Arabian Oil Company, a.k.a. Aramco, is undertaking a strategic review of its upstream operations. Options under discussion include inviting foreign energy companies to participate in joint venture projects or even outright sales of operating stakes at select oil fields. 

Any such deal, which “could raise billions of dollars for Aramco,” per Bloomberg, would also mark a sea change for the state-owned enterprise, which has largely limited foreign investment to downstream operations since its 1980 nationalization.  That review comes following a Saudi government budget deficit equivalent to 12% of GDP last year, triple that of 2019.

Perhaps the Kingdom needs cash. 

Not even Wall Street can keep up with the raging bull market in stocks, as it took just over three months for the S&P 500 to blow past the average year-end price target of 11 sell-side strategists surveyed by Bloomberg.  With an 11% year-to-date advance at today’s intraday highs, the broad index stood 2% above the 4,099 consensus expectation for Dec. 31.  Thanks to that push, the market now trades at a 10-year, inflation-adjusted Shiller p/e ratio of 37.5, topped only by the 1999-2000 period as the most expensive reading over the last 150 years. 

Might blistering post-pandemic earnings growth help spur stocks to even greater heights? On that score, so far, so good.  Of the 108 S&P 500 components that have announced first quarter earnings through this morning, a healthy 85% have topped consensus earnings expectations.  

Evercore ISI chief strategist Ed Hyman predicts today that S&P 500 earnings are likely to foot to a record $190 a share, up a cool 38% year-over-year. Bulging bottom lines across corporate America have historically augured good things for the bulls.  Hyman concludes that, “in the past, the S&P has peaked when earnings have peaked, and that is likely to be years from now.” 

Potentially less-bullish facts color that percolating earnings growth.  Bank of America’s sell-side indicator, which tracks the brokers’ equity allocation recommendations, reached a 10-year high this month, while equity inflows of $576 billion over the past five months top the total inflow over the prior dozen years. Citigroup’s Panic/Euphoria Model sentiment gauge, which tracks factors including short positioning, commodity pricing and fund flows, has remained squarely in “euphoria” territory for most of 2021, typically suggesting a near 100% certainty of down markets over the next 12 months. 

Writing in the Financial Times today, Citigroup chief U.S. equity strategist Tobias Levkovich relayed that the last time such giddy conditions persisted without triggering a pullback was the 1999 tech bubble, an upside ride which famously culminated in a 49% drawdown from its early 2000 peak. Levkovich identified other salient facts:  Namely, household ownership of stocks as a percentage of total assets remains near 50-year highs, while, on the institutional side of the ledger, a late March Citi survey found that money managers held a median 3.5% cash position, down from 10% as the market recovered a year ago and below the 5% long-term average.  

Indeed, the coming years could prove to be frustrating ones for investors if the estimates of one venerable asset manager are on the beam.  GMO’s seven-year real return forecast, released on Tuesday, calls for negative 7.3% and negative 8.1% annual performance for U.S. large- and small-caps, respectively, through March 2028. 

Afternoon reports that the Biden administration is pursuing sharply higher capital gains taxes threw stocks for a loop, as the S&P 500 promptly erased modest gains and finished the day nursing losses of nearly 1%.  Treasurys continued their rally, with the 10-year yield sliding to 1.54% and the long bond declining to 2.22%, its lowest since the beginning of March. Gold pulled back to $1,784 an ounce, WTI bounced back to near $62 a barrel, and the VIX advanced towards 19 to sit 15% higher for the week so far. 

- Philip Grant

Of course, they are.  WeWork Cos. announced today that it “will begin servicing a new economy” by accepting payment in bitcoin, ethereum “and several other cryptocurrencies” (no mention of dogecoin).  The shared office space firm will also offer the ability to pay landlords and other third party vendors with the digital ducats.  Newly public Coinbase, Inc., will not only serve as the venue for those outbound payments, but will also be the first WeWork customer to pay its leasing expenses with crypto.   

Yet that exciting news did little much to stir the same animal spirits which formerly helped WeWork garner a $47 billion private-market valuation back in early 2019.  Shares in the BowX Acquisition Corp., the blank-check firm which agreed to take WeWork public on March 26, slipped by 3% today to $11.50 per share. That’s below the BOWX closing price on the day the merger was announced and 16% off its April 5 peak.  

Might a pivot to the electric vehicle business be in order? 
 

As economies reopen and commodity prices remain on the hop, a potent fundamental one-two punch looks to take shape for the dry bulk shipping industry.  

Prices are off to the races, as spot rates for capesize bulk ships (the largest dry cargo vessels) averaged $28,800 per day last week according to data from Clarksons Platou Securities. That’s up 48% from a month ago and nearly triple the seasonal average during the five years through 2020.  Panamax and supramax vessels are currently priced at $21,100 and $20,300 per day, respectively, each more than double their respective five-year averages.

Any supply-driven relief from that pricing surge would be off in the horizon, thanks in part to regulatory uncertainty regarding the International Maritime Association’s stated but unfinalized plans to introduce tighter emission standards by 2030, building on rules rolled out last year that cap the sulfur content of bunker fuel utilized by dry bulk vessels. 

Cleaves Securities analysts led by Joakim Hannisdahl relayed in a report Sunday that, thanks to a weaker-than-expected pace of new orders in the first quarter, the industry orderbook now stands at just 5.6% of the total existing fleet by deadweight tonnage.  That’s the lowest on record going back to 1996 and a fraction of the 24% mean over that period.  In 2010, the order book footed to a cool 50% of existing tonnage in response to a multi-year boom, leading to supply saturation and depressed industry conditions throughout much of the previous decade. 

Might an opposing dynamic be in the cards?  Hannisdahl and Co. conclude that “super-cycle is a strong expression, but the probability [of that outcome] is increasing each day at the current ordering trend.”  Cleaves guesstimates that the basket of dry bulk names that they track could be in store for triple-digit share price appreciation over the next year. 

Meanwhile, one industry player looks to maximize the current tailwind. Genco Shipping and Trading Ltd. (GNK on the NYSE) announced yesterday that it plans to introduce a variable quarterly cash dividend payable by the first quarter of next year.  The shareholder payouts are subject to operating results, with debt amortization, capital expenditures and a cash reserve as the first priorities. The company explained its thinking in the press release: “For quarterly dividends to be meaningful and sustainable in a historically cyclical business, low to no leverage is paramount in maintaining a low cash flow breakeven rate in order to provide visibility and sustainability.” 

Net debt fell to $237 million on March 31, down from $270 million at the end of last year.  Genco, which sported a net 28% loan-to-fleet-value ratio at the end of the first quarter (the best in its dry bulk peer group, the company presentation boasts), is targeting a 20% LTV by year-end.  Working under the perhaps-conservative assumption of a $15,000 per day time charter equivalent rate, Genco forecasts that available cash flow for dividends would foot to $1.10 per share, or a 7.3% indicated annual yield based on the current share price. 

For more on Genco, the bull case for dry bulk shipping and analysis of another industry pick-to-click, see the issue of Grant’s dated March 5. 

Stocks came under pressure again with the S&P 500 losing 70 basis points to mark its first back-to-back sell-off in nearly a month, while Europe’s Stoxx 600 Index sank by 1.9% for its worst day since December.  Treasurys were well bid with the 30-year bond yield reaching a six-week low at 2.25%, gold rose to $1,780 an ounce and WTI crude fell below $63 a barrel.  The VIX jumped to near 19, extending its two-day gain to 15%. 

- Philip Grant

Greenlight Capital’s annual client letter highlights the latest stock market singularity: Hometown International (HWIN on the pink sheets), a New Jersey-based purveyor of “home-style” sandwiches and other fare.

Hometown, which sported a $105 million market cap as of yesterday following a 795% rise from the end of 2019, operates a single deli in the township of Paulsboro which generated about $36,000 in total sales over the past two years. That’s equivalent to about $2,900 in market cap per dollar of revenue during that period.  Mr. Market’s generosity amply supplemented that thinly-sliced revenue stream.  Thanks to a $2.5 million equity raise, net cash from financing jumped to $2.2 million last year, up from $160,000 in 2019. 

 
Sandwich-as-a-Service. Yours for about $100 million

Other details paint the picture of an outfit focused on more than slinging high-quality grub. As Jonathan Maze of Restaurant Business Online notes, Hometown spent $320,000 on consulting fees last year, including $15,000 monthly to Tryon Capital Ventures for research and development and $25,000 monthly to Macau-based firm VCH Limited to “build a presence with high net worth and institutional investors."  Language in the 10-K that the company intends to seek out “a business combination with a private entity whose business presents an opportunity for shareholders” potentially suggests that HWIN could serve as a vehicle for a reverse merger transaction. 

All things considered, the fact that pre-revenue battery concern QuantumScape, which is the subject of a scathing report by a short seller (see yesterday’s ADG), and joke cryptocurrency Dogecoin have garnered valuations of $13 billion and $50 billion, respectively, makes $100 million for a sandwich shop sound positively value-laden.  Buy low. 

Smooth sailing ahead in junk bonds, perhaps. On Tuesday, Fitch Ratings revised its 2021 and 2022 high-yield default rate forecasts to 2% and 3% from 3.5% and 4.5%, respectively. Abundant liquidity and limited near-term maturities following a wave of refinancing activity have taken most pandemic-related economic risks off the table, the rating agency believes. 

Mr. Market seems to agree, as spreads on the ICE BAML High Yield Index finished at 325 basis points over Treasurys yesterday, well below the 554 basis point average across the 1997 to 2020 period and near the 316 basis points post-crisis nadir established in October 2018.   

The persistent bid in credit has rendered the “high-yield” term increasingly archaic. Analysts from Goldman Sachs found last week that only about 10% of the junk market offers a 500 basis point pickup over Treasurys, compared to 25% in November. Similarly, yields on the triple-C-rated component of the Bloomberg Barclays High Yield Index sit near a record low 6.26%, down from 10% as recently as October.

Dwindling creditor compensation juxtaposes with limited room for operational error among that highly-speculative cohort.  A report today from Bank of America calculates that, even after excluding the bottom 10 percentile from the index and assuming 25% Ebitda growth over the next 12 months, triple-C’s sport a hefty 14 turns of implied forward leverage along with just 1.3 times interest coverage. 

Might the placid current environment be helping mask stress within those ranks? In a Tuesday commentary for LCD, Lehmann Livian Fridson Advisors chief investment officer Marty Fridson observed that the current 3.1% ratio of distressed issues (defined as those trading with at least a 1,000 basis point option-adjusted spread over Treasurys) marks a notable contrast with persistent industrial slack.  

Thus, the 74.4% reading for March capacity utilization sits 520 basis points below the 1972 to 2020 average, per the Federal Reserve.  As Fridson notes, over the 17 monthly occasions since 2001 in which capacity utilization fell below 75, the high-yield distress ratio averaged 25.5% with a prior low reading of 10.7%, more than triple the current figure.  The dean of high yield writes that:

I believe the [most] likely explanation of [that divergence] is that the Fed’s current, unprecedentedly aggressive intervention is distorting market signals. 

If the market were reflecting high-yield issuers’ credit measures in a more customary fashion, spreads would exceed 1,000 basis points on a great many bonds that are currently flying below the radar but possibly fated to crash land within the next 365 days. 

Treasurys took a breather following their sharp rally this week, as the 10- and 30-year yields rose slightly to 1.59% and 2.28%, respectively.  The path of rates appears to matter little to the currently-bulletproof stock market, as the S&P 500 rose another 40 basis points to wrap up the week with a 1.4% gain and extend to an 11.5% year-to-date advance.  Gold reached a seven-week high at $1,776 an ounce (that’s the spirit!), WTI pulled back towards $63 a barrel, and the VIX marked another virus-era low near 16. 

- Philip Grant

From Bloomberg:

Fears that Europe’s post-pandemic economic recovery will prompt central banks to take their foot off the gas are brewing in the bond market.

While a brightening outlook potentially imperils the current paradigm of aggressive monetary support, a long-term supply deluge has perhaps also played a role in the rise in benchmark German 30-year yields to 0.26% from minus 0.20% as of year-end.  Roughly 15% of continental sovereign debt sales featured maturities of 25 years or longer in the first quarter according to data from Nordea Bank, a record share.   

Not everyone, however, views this as a problem.  European Central Bank general council member and Bank of Italy governor Ignazio Visco told CNN today that: “There is demand for very long term debt and not enough supply.” 

The red sea flows stateside.  More than a quarter of U.S. stocks failed to generate positive net income last year, Bernstein analysts led by Toni Sacconaghi reported yesterday, the highest proportion in at least the past 50 years.  Technology companies were amply represented within that group, with 37% of sector constituents generating a loss in 2020. 

No profits, no problems, as that tech subset generated a 65% equal-weighted total return and 92% market-cap weighted return last year, easily topping the 40% figure for the domestic tech sector as a whole.  That run-up has helped foment some fancy valuations, as 36% of the money-losing tech universe garnered market caps equivalent to at least 15 times sales, topping the previous 33% peak in 2001 as well as the 24% logged during the depths of the financial crisis. 

As Sacconaghi and co. relay, that not only stands at nearly double the share of similarly expensive, lossmaking companies within the broader market, but also spells bad news in terms of historical performance.  Over the past 50 years, highly-valued and unprofitable equities have lagged the broader market by an average of 1% on a one-year basis, and 10% on a five-year view. The tech stocks within that expensive cohort have seen a 1% average one-year excess return, but that is overshadowed by a meaty 28% relative performance deficit over a five-year horizon. 

While equity investors who choose wisely in high-risk enterprises can enjoy outsized gains, creditors seeking the return of principal along with a little extra have traditionally given a wide berth to such speculative tech concerns.  That appears to be changing, as private lenders increasingly dabble in the sector via private loans which can then be packaged into asset-backed securities. 

The Wall Street Journal reported Friday that firms such as Golub Capital, Owl Rock Capital Partners and AllianceBernstein have extended some $2 billion in such loans to fast growing, unprofitable software companies since November, underscoring the ability of those firms to access capital in a variety of different formats. Golub, which has never suffered a default on those private loans since commencing the practice in 2013, last week priced an ABS deal to yield 3.2%, down from 4.72% in its first such structured transaction in fall 2019. 

Kroll Bond Rating Agency, which assesses the private loans, notes that the bulk of the borrowers sit near the basement in terms of credit quality, with ratings equivalent to single-B or triple-C, suggesting that the loans are vulnerable to impairment in the event of adverse business or economic conditions.  “It is a relatively new asset class with limited recovery data,” the rating agency adds. 

A very strong long bond auction this afternoon helped solidify a bullish day for Treasurys, as the 10- and 30-year yields each fell towards multiweek lows at 1.62% and 2.30%, respectively.  Stocks caught another bid with the S&P 500 enjoying its seventh green finish in nine tries to extend to a 10.3% year-to-date gain.  Bitcoin rallied to a new high near $63,000, WTI crude pushed back above $60 a barrel and gold rose 80 basis points to $1,746 an ounce. 

- Philip Grant

Time to hit the beach then?  With a 2.7% rally this week and 10% gain year-to-date, the S&P 500 finished the day at 4,128.  That exceeds the average 4,099 year-end price target among 11 surveyed Wall Street strategists, Bloomberg reports.

With first quarter earnings season set to commence next week, member companies within that broad index have a high bar to clear.  The sell side is calling for an aggregate 23% earnings growth from a year ago, which would mark the largest bottom-line expansion since 2018, when the effects of the Trump-era corporate tax cuts took hold. 

Behold the supersonic boom in special purpose acquisition companies.  More than 300 such blind pools have come public so far this year according to SPACInsider, raising an aggregate $99 billion. That blows past the prior $83 billion, full-year record established in 2020.  For context, the pre-coronavirus peak in aggregate IPO proceeds stood at just $64.8 billion. 

Lofty promises have been part and parcel of the recent deal craze, as SPAC promoters have availed themselves of the ability to issue long-dated and perhaps rose-colored operating forecasts that are prohibited in traditional IPOs.  The Financial Times notes that a cohort of nine auto-focused tech companies that listed via SPAC last year projected an aggregate $26 billion in revenues by 2024, slightly above the group’s combined $139 million top line in 2020 (that target represents a 270% compound annual growth rate). 

Even the regulators are noticing. The process in which a blank check company combines with an operating business looking to list on a public exchange, “gives no one a free pass for material misstatements or omissions,” John Coates, acting director of corporate finance at the SEC, declared in a statement yesterday, adding that such deals should feature “the full panoply of federal securities law protections – including those that apply to traditional IPOs.”

There is no doubt that the SPAC frenzy is helping fuel historic deal activity, particularly in the glamourous technology sector. Global tech M&A spending footed to $302 billion in the first quarter, according to 451 Research. For context, that figure averaged $119 billion across the four quarters of 2019, while quarterly tech M&A volumes only exceeded $200 billion twice over the 2002 to 2019 period.

Then, too, promotors have coughed up a pretty penny to secure their tech industry prizes.  SPAC-sponsored deals took place at a median price of 12.9 times sales in the first three months of the year, more than triple the 4.1 times median price-to-sales ratio for non-blank check transactions.  451 Research analyst Brenon Daly wrote Monday that: “So far this year, SPACs have, to some degree, overshadowed rival buyers with far more financial and operational stability, not to mention much more time-tested M&A track records.” 

Regulatory scrutiny aside, elevated price tags in tandem with saturated supply have crimped the ability of operators to secure PIPE (i.e., private investment in public equity) financing, a key cog in the SPAC machine. With 117 SPAC-related deals announced so far this year, 497 blank-check entities are currently seeking their own dance partner, according to Refinitiv, while only about a quarter of all SPACs listed in 2020 or 2021 have completed a transaction. 

The clock is ticking:  Entities that fail to find a merger target within two years are typically unwound, with promotors obliged to return capital to investors.  “There is a lot of indigestion,” a senior bank executive tells the FT. “The pendulum has swung to where, if you’re in the market with a PIPE right now, it’s going to be really hard and painful” to attain financing.  “There’s only so much illiquid exposure that investors are going to want to take,” added another. 

For an in-depth analysis of SPAC mechanics and a survey of 10 representative blind pools (seven of which acquired automotive tech or mobility-related businesses), see the analysis “Short this index” in the Dec. 25 edition of Grant’s. 

Another whiff of inflation, this time the form of a 4.2% year-over-year advance in the March Producer Prices Index (topping the 3.8% consensus and the highest reading since 2011), helped apply some modest pressure on rates, as the 10- and 30-year Treasury yields backed up to 1.66% and 2.33%, respectively.  Stocks enjoyed a late ramp to finish higher by about 70 basis points on the broad S&P 500, while WTI crude dipped to near $59 a barrel and gold retreated to $1,743 an ounce.  The VIX marked another virus-era low at 16.70, down 1.5% on the day. 

- Philip Grant

Dallas Fed President Robert Kaplan defended the Federal Reserve’s decision to maintain near-zero overnight interest rates in tandem with the ongoing $120 billion-per-month in asset purchases in an interview with The Wall Street Journal yesterday: “When we’re in the middle of a crisis, we should be aggressively using our tools, so I agree with what we’re doing now in terms of asset purchases and stance of policy generally.”  The central banker forecasts 6.5% growth in GDP this year, along with a 4% measured rate of unemployment at year-end from 6% in the March reading.  

While Kaplan currently lacks a vote on the Federal Open Market Committee, the decision makers look to fully back that view. Minutes from the March 16-17 FOMC meeting released this afternoon included the following: “Participants noted that it would likely be some time until substantial further progress toward the Committee’s maximum- employment and price-stability goals would be realized.” 

Mr. Market appears to be offering his own dissenting vote.   Following an 82% rally from the March 2020 lows, the S&P 500 commands a Shiller P/E ratio of nearly 37 times inflation-adjusted, 10-year average earnings. That towers over the median 15.8 times valuation over the past 150 years, and is eclipsed only by the 1999 to 2000 period for the most expensive on record. 

Credit markets similarly seem to be enjoying conditions that bear little resemblance to an ongoing crisis. The spread over Treasurys on the Bloomberg Barclays High Yield Index slipped to 292 basis points yesterday, the narrowest premium for speculative-grade corporate bonds since July 2007. Similarly, yields on the triple-C-rated component of the Bloomberg Barclays High Yield Index reached a record low 6.10% yesterday. 

Issuers have duly made hay during the sunny weather, as high-yield supply footed to a record $149 billion over the first three months of the year.  The good times have rolled on into April. This morning, single-B-plus-rated casual dining chain Bloomin’ Brands sold $300 million in eight-year notes at a 5 1/8% coupon in its bond-market debut, well inside of initial price talk ranging from 5.75% to 6%.  Priced at par, the issue promptly broke towards 102 cents on the dollar this afternoon for a 4.74% yield-to-worst. 

Boomtime conditions are likewise visible in leveraged loans, or tradeable, floating-rate bank debt generally issued by speculative-grade borrowers.  Prior to a miniscule 3 basis point decline in March, the S&P/LSTA Leveraged Loan Index enjoyed an 11-month winning streak, garnering a cumulative 20.7% total return over that period. 

Domestic loan issuance footed to $180 billion through March 31, topping the prior quarterly record of $171 billion established in 2017. Creditors had little compunction over backing more speculative concerns, as loans rated single-B-minus or lower accounted for a record 40% of total issuance per S&P’s LCD unit, topping the record 36% share set in 2020. Commensurate with the friendly conditions, outright credit-negative deals have returned in force. So-called dividend recap transactions, or loans used to finance payouts for a borrower’s private equity promoter, reached $20 billion in the first quarter, the busiest such period since the end of 2016.  

Euphoric financial markets are one thing. Bloomberg’s Brian Chappatta relays that RBC Capital economists Tom Porcelli and Jacob Oubina’s aggregate weekly payrolls calculation, which includes average hourly earnings, average weekly hours and headline employment figures, show that private sector workers are now earning more than they did before the bug bit in February 2020. There’s more where that came from. The Labor Department yesterday released its February Job Opening and Labor Turnover Survey, finding that employment vacancies reached 7.37 million, up nearly 600,000 in two months and near the November 2018 record high going back to 1999 of 7.55 million availabilities.

For more on the implications of crisis-era policy overlaid with a fast-recovering economy and white-hot asset prices, see the analysis “A case of overstimulation” in the most recent edition of Grant’s Interest Rate Observer dated April 2. 

Stocks finished flat for the second straight day as the S&P 500 continues to consolidate from Monday’s move to new highs, while Treasurys gave back the bulk of yesterday’s rally with the 10- and 30-year yields rising to 1.67% and 2.36%, respectively.  WTI crude advanced to near $60 a barrel, gold pulled back to $1,738 an ounce, and the VIX retreated to a fresh virus-era low near 17. 

- Philip Grant

Last call in the Middle Kingdom? The People’s Bank of China has instructed banks to tighten lending standards in order to cool down a red-hot property market, reports the Financial Times.  That follows last month’s warning from China Banking and Insurance Regulatory Commission chair Guo Shuqing: “Many people buy homes not to live in, but to invest or speculate,” Guo noted. “This is very dangerous.” 

There looks to be plenty of room for a downshift. Medium and long-term consumer loans, mostly mortgages, ballooned to a record RMB 1.4 trillion ($210 billion) over the first two months of the year, up 72% from pandemic-addled 2020, while new home sales rose by 133% from a year ago.  Last year, Nationwide house prices jumped 7.5%, far outpacing the reported 2.3% rise in GDP.  On Jan. 1, Beijing debuted its “three red lines” policy, which limits developers’ net debt at 100% of equity and liabilities at 70% of total assets while mandating that short term borrowings must not exceed cash reserves.  Those who fail to comply are barred from further borrowings. 

To be sure, aggressive borrowing is endemic across China’s corporate sector, not least in housing-related enterprises. Citigroup economist Li-Gang Liu calculated that some 600 listed companies in China sport leverage ratios at least 20 percentage points above their sector averages, representing a combined RMB 11 trillion in market capitalization, equivalent to one-sixth of the total stock market.  Among that highly indebted contingent, a 100 basis point increase in the benchmark lending rate would consume the equivalent of 30% of their bottom line to meet that increased interest expense.  Within the cohort of notably leveraged property developers (accounting for roughly one-third of the total group), that same 1% tightening would gobble up 42% of their bottom lines. 

Those facts color the efforts of China Evergrande Group (3333 on the Hang Seng), the nation’s largest property developer and Asia’s most prolific high-yield debt issuer, to put itself on the right side of the new regulatory regime.  Evergrande announced on last Wednesday’s earnings call that it plans to cut gross debt to RMB 590 billion by June 30 from the current RMB 674 billion, then to RMB 450 billion and RMB 350 billion in 2022 and 2023, respectively. Currently coloring outside each of the three red lines, Evergrande management predicted that they will be in compliance with two of the three directives by Dec. 31, and all three a year after that.   

Divestitures from Evergrande’s hodgepodge of side businesses, including a 10% stake in online home and auto sales portal FCB Group for a projected $2.1 billion, are central to the deleveraging strategy. Yet listless recent performance from the conglomerate’s core operations may undermine those goals.  Evergrande generated RMB 507 billion in revenue last year, well below the RMB 566 billion analyst consensus.  So-called adjusted core profit slipped by 26% to RMB 30 billion, while gross margins fell to 24% from 28% and 36% in 2019 and 2018, respectively. 

Indeed, the bond market remains skeptical.  B1/single-B-plus rated Evergrande’s senior secured, dollar-pay 8 3/4% notes due 2025 last changed hands at less than 80, equivalent to a 15.52% yield-to-worst and 1,459 basis point spread over U.S. Treasurys. 

Evergrande is far from the only developer caught offsides by the recent sea change.  Last week, Shanghai and Shenzhen-based Yuzhou Group Holdings Co. Ltd. (1628 on the Hang Seng) disclosed a drop in 2020 earnings to RMB 117 million, 97% below its 2019 bottom line of RMB 3.61 billion, earning a downgrade to B1 from Ba3 at Moody’s Investors Service.  The company subsequently told investors that revenues over the first half of 2020 are likely to be restated to as little as RMB 7 billion from the RMB 14 billion reported last August.  Management is said to be seeking a waiver on an interest coverage covenant governing a dual currency loan signed last month. 

By Yuzhou's lights, outside forces were responsible for that dramatic reassessment.  According to a Wednesday dispatch from Bloomberg, the company attributed that profit and revenue evaporation to auditor Ernst & Young’s “strict” revenue recognition standards, which prevented  the company from consolidating certain projects onto its balance sheet. 

Sure, blame the umpire.

Another round of scalding economic data, in tandem with a placid Treasury market, spelled good news for the bulls, as the 10-year yield held at 1.71% after the March ISM Services Index to its highest on record going back to 1997, helping propel the S&P 500 higher by nearly 1.5%.  WTI crude sank below $59 a barrel, off more than 4% on the day, gold held steady near $1,730 an ounce and the VIX rebounded to near 18 after reaching a virus-era low on Thursday. 

- Philip Grant

The golden ticket, 2021 edition. The world has gone wild for non-fungible tokens, i.e., blockchain-based digital collectibles spanning both traditional pop culture such as art, sports and music, and contemporary communication, including memes and GIFs. 

Three-year-old Dapper Labs, which owns collectible platform NBA Top Shot, announced yesterday that it has raised $305 million in a private round led by Tiger Cub hedge fund Coatue Management, dwarfing its prior $52.5 million in total financing and valuing the company at $2.6 billion.  NBA Top Shot, which sells video highlights packaged by the league and garners a 5% commission on all secondary market transactions, saw $200 million in secondary trading volume in February, equivalent to $120 million in annual revenue at that pace. 

Likewise, art world heavyweights are looking to get in the game following last month’s Christie’s-brokered $69 million NFT auction of a piece from Mike Winkelmann, a.k.a Beeple. Contemporary icon Damien Hirst announced in mid-March that he is working on his own line of NFTs consisting of 10,000 paper works created five years ago and now stashed in a vault.  The new project “challenges the concept of value through money and art,” Hirst promised. 

Of course, art collectors and galleries conventionally display things you can touch, a feat that is difficult when the piece in question lives in the digital ether. Looking to tackle the problem, some companies are working to design hardware to allow aficionados to view their prize in analog.  “Sometimes you’ve got to lean on the old world or the familiar to help people navigate the new,” Zoe Scaman, founder of “culture and entertainment strategy studio” Bodacious Ltd., explained to The Wall Street Journal last week.  

While some anticipate big things for NFTs, others see a different role in the cultural zeitgeist. BNP Paribas CEO John Egan commented in an interview with Bloomberg last week that “I don’t think we could find many more risky categories of assets at this point. I think it’s probably akin at this stage to going to the casino. You know you’re going to spend money but maybe you’re doing it for the enjoyment, for the experience.”

Some NFT owners have indeed rolled snake-eyes.  A report yesterday from Vice Motherboard detailed the experience of unlucky collectors whose wares simply disappeared from their digital “wallet,” with only a “404 error” page remaining.  Ontario-based property manager Tom Kuennen explained to Vice that, after shelling out $500 for an Elon Musk-related JPEG file image in February, he noticed that the piece had disappeared without a trace. 

The problem:  When a buyer purchases an NFT, the blockchain registers your ownership and contains a link to a website hosting the image. However, that buyer is then relying on a website to remain active and continue hosting the work while maintaining the proper links to access it.  If the website disappears or otherwise removes the art, the unlucky collector has no recourse. “There was no history of my ever purchasing it, or ever owning it,” Kuennen lamented to Vice. Then again, the anonymous nature of the blockchain confers some social benefits in these situations. “If [the NFT] goes up 100 times, you resell it. If it doesn’t, well, you don’t tell anyone.”

Your secret is safe with us.  

Stocks finished slightly lower for a second straight day, following the S&P 500’s late rally to new highs on Friday, while Treasurys recouped early losses with the 10-year yield finishing unchanged at 1.71% and the long bond dropping three basis points to 2.37%.  A rip to near-five month highs on the Dollar Index helped put the hurt on key commodities with gold and WTI crude falling to $1,683 an ounce and $60.5 a barrel, respectively.  The VIX fell more than 5% to finish below 20.  

- Philip Grant

Like a Phoenix, rising from Arizona:  OId friend WeWork Cos. is back on the scene, agreeing to merge with blank check firm BowX Acquisition Corp. (BOWX on the Nasdaq) at a $9 billion enterprise value.

The co-working concern, which formerly commanded a $47 billion private market valuation following multiple investments from SoftBank Group Corp.’s Vision Fund, famously imploded in 2019, narrowly averting bankruptcy and jettisoning founder Adam Neumann.  As Zerohedge notes, WeWork generated a $9.9 billion operating loss across the five years through 2020, outstripping the cumulative $9.5 billion top line over that period.

That was then.  The marketing document, which touts a “clear path to adjusted Ebitda breakeven” by the fourth quarter, forecasts revenues of near $7 billion in 2024, up from $3.2 billion in both 2019 and 2020, with adjusted Ebitda reaching $2 billion in 2024 compared to a projected $900 million adjusted Ebitda loss this year.  

For now, at least, Mr. Market appears to be looking past snafus towards a bright future.  Shares in BOWX finished the day at a 17% premium to net asset value. 

It’s good to be the boss.  According to data from LCD, supply of domestic leveraged loans used to fund dividend recapitalizations (i.e., payouts to the borrower’s private equity sponsor) have footed to $20 billion so far this year, marking the busiest quarter for loans undertaken for that purpose since the end of 2016. 

While adding debt to reward insiders might appear to be an adverse credit development, some take a more sanguine view.  A Tuesday bulletin from S&P Global Ratings announced an upgrade of Luxembourg-based vehicle glass repair company Belron Group, S.A., to double-B-plus from double-B.  The rationale: “Resilient performance and proposed dividend recapitalization.” 

The imminent reorganization of Japan’s equity market is encouraging some shareholder friendly behavior across the Land of the Rising Sun, Bloomberg reports today.   As the Tokyo Stock Exchange prepares to split into three classes (prime, standard and growth), exchange constituents are unwinding minority stakes in other businesses and bolstering corporate governance in a bid to secure a coveted prime designation ahead of a June 30 deadline.  

“We are seeing some companies move to unwind their cross-shareholdings,” analysts at SMBC Nikko Securities recently observed. “Companies that struggle to meet the [prime] criteria may ask some shareholders to divest their positions and are also considering buybacks or equity issuance” to get on the right side of the stock-market fence. 

The stakes are high: Companies within the prime designation, encompassing those with a free float market cap of at least ¥10 billion ($96 million) will be guaranteed membership in the new Topix Index, thus maintaining representation in major exchange traded funds.  Last week, the Bank of Japan announced that it will only purchase ETFs tracking the Topix Index henceforth.

The BoJ’s stock portfolio was estimated at ¥46.6 trillion, encompassing upwards of 90% of domestic ETFs, as of year-end. “I don’t think that most companies really understand the implications of this, which is that a lot of small-cap companies are going to be, to use the British soccer expressed, ‘relegated’ to the second section,” Gifford Combs, managing director at Dalton Investments, told Grant’s in January. 

As Japan’s corporate sector engages in some spring cleaning, investors find a bit of relative cushion in terms of valuation.  Currently, the Topix sports an enterprise value equal to 9.8 times consensus 2022 Ebitda, a healthy discount to the 13.1 times EV to 2022 Ebitda for the S&P 500 and slightly below the 10.3 times for Europe’s Stoxx 600 Index.  For more on Japanese stocks, including a review of the upcoming listing criteria change and bullish analyses of a trio of local companies, see the Jan. 22 edition of Grant’s Interest Rate Observer. 

A feverish late-session sprint higher in stocks left the S&P 500 up 1.6% from near unchanged with an hour to go, leaving the broad index at a fresh closing high. Treasurys came for sale with the 10- and 30-year yields pushing to 1.67% and 2.38%, respectively, WTI crude bounded back toward $61 a barrel and gold edged higher to $1,731 per ounce.  The VIX fell below 19, testing its virus-era nadir.  

- Philip Grant

The final chapter has perhaps yet to be written in last year’s explosive late summer rally in technology shares, featuring a frenzied 18.5% ascent in the Nasdaq 100 Index from July 24 to Sept. 2. Coinciding with, and perhaps amplifying, that move: Aggressive call option purchases from SoftBank Group Corp., pegged by The Wall Street Journal at $4 billion, following a reported $10 billion shopping spree in tech stock common shares earlier in the summer. 

Domestic authorities are now putting those machinations under the microscope. In response to a Freedom of Information act submitted by PlainSite founder Aaron Greenspan for materials related to SoftBank’s trading activities last year, counsel at the Securities and Exchange Commission declined the request on the grounds of exemption 7(A).   To wit: 

We have confirmed with [the SEC’s] Division of Enforcement staff that the investigation from which you seek records is still active and ongoing . . .  disclosure could be reasonably expected to cause harm to the ongoing and active enforcement proceedings because, among other things, individuals and entities of interest in the underlying investigation could fabricate evidence, influence witness testimony and/or destroy or alter certain documents. 

"You can't compete against stupidity," commented Starwood Capital Group chairman and CEO Barry Sternlicht on CNBC this morning, regarding the boom in special purpose acquisition companies. "It's a little out of control. No, it's a lot out of control. Don't expect Wall Street to regulate the launch of SPACs. They're making too much money. If you can walk, you can do a SPAC." 

Indeed, there are currently 550 special purpose acquisition companies outstanding according to data from SpacInsider, of which 436 are in search of a merger target.  Sternlicht’s firm has itself sponsored six separate blank check enterprises. 

With the deal market saturated, one promoter looks to Joe and Jane sixpack to carry the load.  Bloomberg reports today that a London-based, retail oriented blank check vehicle, dubbed The People’s SPAC, is set to raise pre-IPO sponsor funding via crowdsourcing. The offering will be capped at $100,000 per accredited investor.  The People’s SPAC will likely target a transaction in the tech or media sectors in Western Europe and hopes to list on the Nasdaq exchange during the second quarter.

Flagging recent performance in various retail favorites might make that a tougher sell. Since reaching a record high on Feb. 17, the IPOX SPAC Index has declined by 22%, returning to its lowest levels since early January.  Similarly, a Goldman Sachs basket of stocks favored by retail traders slipped by 7% over the prior six trading sessions, while the ETFMG Alternative Harvest ETF, which invests in cannabis companies, is off 32% from its Feb. 10 high-water mark.

Then, too, a variety of metrics suggest the retail cohort is losing interest as life slowly transitions back towards normal. Off-exchange equity volumes, which encompass the bulk of retail activity, registered at 42% of total turnover over the past 10 days, compared to 50% in late January, while daily turnover in the ARK Innovation ETF (ARKK on the NYSE Arca) has averaged just over 12.4 million shares over the past five sessions, compared with 26.5 million shares over the five trading days through March 10.  Perhaps most tellingly, free trading app Robinhood is no longer listed as among the top 100 most popular apps on the Apple App store, after holding the top spot just six weeks ago. 

Retail’s staying power may soon be put to the test via that avatar of the current bull market, as Robinhood announced yesterday that is has filed confidential paperwork with the SEC for an initial public offering.  The company has recently seen its private market valuation reach near $40 billion in the secondary market, Bloomberg’s David Ritter finds, compared to an $11.2 billion value in a private series G funding round conducted last August. 

WTI crude jumped by more than 5% to finish near $61 barrel and recoup a chunk of its recent losses, while stocks came under pressure for a second straight day with the S&P 500 declining by 50 basis points and the Nasdaq 100 off by 1.7%. Treasurys caught a modest bid despite a soft five-year note auction, with the 10- and 30-year yields finishing at 1.61% and 2.31%, respectively, gold remained in a tight range with a $1,733 per ounce closing price, and the VIX advanced back above 21. 

- Philip Grant