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

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

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

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

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

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

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

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 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