“Stocks at 40 times profits are cheap, Wall Street has discovered.” That tongue-in-cheek headline comes from Bloomberg today, referring to the fast-growing, strongly profitable and richly valued Facebook, Apple, Amazon.com, Microsoft and Google parent Alphabet (a.k.a. Faamg) quintet. The group has a fan in Maneesh Deshpande, head of equity derivatives strategy at Barclays, who recently advised his clients to upsize their holdings. Deshpande notes that, though the Faamg’s sport a 35% premium to the S&P 500’s 30 times trailing price-to-earnings ratio, they trade at a roughly equivalent valuation to their December 2019 levels.
By contrast, the S&P trades at a premium to the 21 times trailing earnings seen at year-end 2019. “It’s like saying New York real estate is cheap right now, but it’s not going to be as cheap as Montana ever,” the strategist reasons to Bloomberg. The group “is cheaper relative to where it was. That is still notable.”
Mr. Market seems to be coming around to that view, as that Faamg cohort has enjoyed an average 6.3% month-to-date advance through yesterday, handily topping the 1.5% gains for the broader S&P 500. That’s a change from the opening five months of the year, when the group managed an 8% advance on average, lagging the 12% move for the broad index
Yet political risk factors lurk, as Washington increasingly appears to have big tech in its crosshairs. The House Judiciary Committee advanced a series of bills overnight, including a pair of measures which would target Silicon Valley giants: The American Choice and Innovation Act, which would bar tech platforms from conduct that “advantages the covered platform operator’s own products, services, or lines of business over those of another business user,” as well as the Augmenting Compatibility and Competition by Enabling Service Switching Act, which would compel big tech to allow users to more easily transfer their personal data from one platform to another.
Then, too, the Senate last week confirmed outspoken Biden administration nominee Lina Khan to the Federal Trade Commission. That provides the five-member FTC panel with a three-seat Democrat majority, with each of that trio previously advocating for greater government oversight of big tech, as well as enhanced antitrust enforcement.
A government crackdown on the big tech business models could hurt, as the Faamg’s account for a combined 22% weighting in the S&P 500, with Apple and Microsoft alone representing 11% of the broad stock market gauge. For context, no single stock had topped the 6.4% S&P 500 share achieved by then-unstoppable IBM in 1985 until Apple managed to briefly top that threshold late last year. The intervening 36 years have been less kind to Big Blue, as IBM now stands as the 64th largest component in the market cap-weighted index with a modest 0.36% weighting.
Meanwhile, flagging market-wide internals suggest those mega-cap monoliths may need to carry an increasingly heavy load to help stocks maintain their bullish momentum. Thrasher Analytics founder and eponym Andrew Thrasher noted on Twitter yesterday that, with the major indices at or near their respective high-water marks, just 3% of stocks within the tech-heavy Nasdaq composite logged a fresh six-month high yesterday. That’s down from more than 20% in late February.
Stocks bounded higher after yesterday’s breather, with the S&P 500 extending to a hearty 2.4% for the week so far, while a strong seven-year note auction didn’t spur much action in Treasurys, as the long bond remained at 2.1%. WTI crude pushed back above $73 a barrel, gold edged lower to $1,775 an ounce and the VIX slipped below 16 to approach its COVID-era lows.
- Philip Grant
A barrage of repricing transactions has descended upon the leveraged loan market. Following projections from last week’s Federal Open Market Committee meeting of interest rate hikes from current near-zero levels as soon as 2023, Bloomberg relays that 25 issuers of floating-rate, speculative-grade bank debt have returned to market to secure more favorable terms. Repricing deals have accounted for 30% of new offerings in June, up from 25% and 20%, respectively, in May and April.
Yield-needy investors have been all too happy to accommodate issuers’ opportunistic moves, as leveraged loan mutual funds have enjoyed 23 consecutive weeks of inflows, according to Refinitiv Lipper. Then, too, not just any old loan will do. Scott Macklin, director of leveraged loans at AllianceBernstein, tells Bloomberg that recent demand "has been especially acute" for higher spread, lower-rated issues.
If you don’t like the price, just wait five minutes. Bitcoin briefly dipped below $29,000 this morning, down 20% from Sunday afternoon to wander into negative territory year-to-date, before snapping back to $32,500 as the stock market closed. The global cryptocurrency market currently sports a $1.29 trillion valuation per Coinmarketcap.com, roughly half the $2.56 trillion peak logged in May but more than triple its levels from a year ago.
That manic price action colors the instructive story of business intelligence software provider-turned-bitcoin speculation vehicle MicroStrategy, Inc. (MSTR on the Nasdaq). The company announced last year that it bought $425 million worth of BTC between August and October, when the digital asset fetched between $11,000 and $14,000. That kickstarted a virtuous financial cycle, as the ensuing crypto boom pushed MSTR’s market cap to as high as $12 billion in February, nearly 10 times that from six months earlier. Subsequent bitcoin purchases have been financed through successively higher rungs in the capital structure, with the issuance of a combined $1.7 billion in convertible bonds in December and February followed by a June 8 offering of $500 million in senior secured 6 1/8% notes maturing in 2028.
Using the proceeds from that junk bond deal, the company then snapped up an additional 13,005 bitcoins at an average price of $37,617, CEO Michael Saylor announced on Twitter yesterday, bringing the combined total cache to 105,585 bitcoins at an average $26,080 purchase price for a $2.76 billion total outlay. While the current price sits comfortably above that aggregate $26,080 cost basis, the most recent shopping spree helps demonstrate MicroStrategy’s limited room for error. Bloomberg calculates that, based off yesterday’s $31,735 intraday nadir, the company faces a $77 million write-down on that most recent 13,005 bitcoin tranche under generally accepted accounting principles. That compares to an aggregate net income of $67.6 million across the three years through 2020.
As for MSTR’s newly minted senior creditors, fundamental factors suggest that sleepless nights could be in store. S&P, which rates the notes single-B-minus and pegs the issuer at triple-C-plus, calculated June 9 that pro-forma leverage now tops 20 times Ebitda following the bond offering. The rating agency duly concluded that “MicroStrategy is dependent on favorable financial conditions to support its capital structure over the long term.” Early returns so far are less than encouraging, as the notes slipped below 98 cents on the dollar this morning.
On the bright side, a fresh supply of junior securities will soon burnish the creditors’ position. Last week, MSTR filed a registration with the SEC to sell $1 billion worth of common equity in an at-the-market offering. Then again, the balance sheet may not remain fiat-fortified for long, as proceeds will go towards general corporate purposes, as well as (all together now): “the acquisition of bitcoin.”
For shareholders unversed in financial history, the Y2K-era experience of the firm adds further context. MSTR shares rose a cool 3,000% over the 10 months through mid-March 2000, before turning tail to the tune of a 95% wipeout over the following two months. Following that round trip, CEO Saylor paid a $350,000 civil fine and returned $8.3 million under a disgorgement order to settle SEC allegations that the company “materially overstated” revenues and earnings since first going public in 1997.
Back in the current day, short interest stands at more than 30% of the float, up about 10-fold from a year ago.
The bulls remained in control, as stocks enjoyed another round of solid gains to build on yesterday’s rally, while Treasurys also caught a bid with the 10-year ticking to 1.46% and the VIX fell below 17 to extend its two-day decline to 20%. Gold edged lower to $1,777 an ounce, and WTI held near $73 a barrel.
- Philip Grant
Mega property developer China Evergrande Group (3333 on the Hang Seng) will repay a $1.47 billion offshore bond this week, Reuters reports, a few days ahead of a June 28 deadline. In reaction to that bulletin, along with an announced $400 million in asset sales, shares jumped by nearly 10% to log their biggest gain since February.
Of course, the outsize response to those routine corporate events suggests that not all is well at single-B-plus-rated Evergrande, which stands as both Asia’s largest issuer of junk bonds as well as the world’s most-encumbered real estate firm with a marketable debt load of RMB 717 billion ($108 billion) as of Dec. 31. Indeed, Evergrande’s dollar-pay, senior secured 8 3/4% notes due 2025 changed hands at 72.5 on Friday for a yield-to-worst of 18.8%. The company aims to trim its debt load to RMB 560 billion by year-end, as it attempts to reach compliance with Beijing’s three red lines policy governing capping developer’s debt loads on pain of restrictions against further liability growth.
“What worries us is the possibility that Evergrande has just reported the tip of the iceberg,” Zhou Chunayi, credit analyst at Lucror Analytics, told the South China Morning Post over the weekend. The fact that the company, currently outside each of the three red lines, is effectively blocked from accessing the credit markets, further complicates matters.
Then, too, another, unusual source of financing may be on the fritz, as Caixin’s WeNews division reported last week that, as part of a planned bailout of stricken lender Shengjing Bank, authorities have notified Evergrande that they are likely to dilute the developer’s controlling stake in Shengjing. The pair have a deeply intertwined relationship, as Evergrande coughed up RMB 13.2 billion (paying a 40% premium in the process) in the summer of 2019 to raise its stake in the bank to 36% from 17%, while Shengjing, for its part, holds “large amounts” of Evergrande debt on its books, per WeNews.
Anecdotal signs of liquidity trouble bring the situation into further relief. As the SCMP relayed, Chinese social media users report that local banks have begun rejecting commercial acceptance bills (CABs), or IOUs issued by Evergrande to its suppliers, in recent weeks.
“We cannot get paid with Evergrande’s CABs and our company will die soon,” one lamented on June 2. A screenshot included by the complainant showed CABs worth RMB 400,000 which had expired back in March. Others corroborated that experience, with another Evergrande contractor noting that a payment is now two months in arrears, compared to last year when all outstanding CABs were settled within 20 days.
The unfolding Evergrande saga is taking a toll on the Chinese offshore bond market, as yields on the ICE BofA Asian Dollar High Yield Corporate China Index rose to 9.93% on Friday, up from 8.5% as recently as May 26 and far above the 4.65% on offer for the equivalent U.S. gauge. That 536 basis point spread marks a near-decade high, apart from a brief spasm during the March 2020 liquidation. Yet, that rough price action hasn’t derailed insatiable investor appetite for yield: Chinese developers sold $20.3 billion in dollar bonds through June 2 per Refinitiv, up 16% from last year’s pace and running “completely contrary” to investor expectations for subsiding deal flow, Owen Gallimore, head of credit-trading strategy at ANZ, commented to The Wall Street Journal.
More broadly, as a debt-fueled fixed asset investment and a bloated financial system (featuring $50.3 trillion in banking assets as of March 31, more than half the $84.5 trillion in global GDP last year) stand as the centerpieces of the Chinese economic miracle, a brisk pace of economic growth is paramount for avoiding trouble.
Yet on that score, recent data are less than encouraging, as total social financing (i.e., aggregate credit and liquidity flows) came to RMB 1.92 trillion in May, light of the RMB 2 trillion consensus estimate to mark the third straight negative surprise. Similarly, M2 money supply growth registered at 8.3% year-over-year in May, down from 10.1% three months earlier and near the lowest level since at least 1996, while the credit impulse (or growth in borrowing as a percentage of GDP) slipped to 25.6% last month, down from 31% in February and the lowest reading since early 2020.
Twice bitten, thrice shy: Credit Suisse has ceased doing business with SoftBank Group Corp., The Wall Street Journal reports today. That move follows heavy losses inflicted on the investment bank thanks to the recent collapses of leverage-happy hedge fund Archegos Capital Management along with SoftBank-backed supply-chain lender Greensill Capital. Apparent conflicts of interest served as an aggravating factor in the latter event, as SoftBank acted as both a lender and a borrower via an investment in Greensill supply-chain funds managed by Credit Suisse, which in turn lent money to SoftBank-backed companies.
That shift is significant, as the bank and its former customer had previously enjoyed extensive ties. Credit Suisse has long acted as a financial advisor for the Vision Fund, SoftBank’s in-house venture capital arm, as well as for several of the fund’s portfolio companies. As recently as February, SoftBank boss Masayoshi Son had $3 billion in stock loans outstanding at the bank with company shares pledged as collateral, an arrangement that had been in place for nearly two decades.
Credit Suisse’s retreat comes as SoftBank has fully capitalized on the stark asset price-rebound from last year’s virus-addled panic, with shares 176% above their March 2020 nadir even after a 30% pullback since late February. With global asset prices percolating, the Vision Fund and its successor booked a staggering $58 billion investment gain for the fiscal year ending in March. The firm has also logged several prominent recent wins, such as South Korean e-commerce firm Coupang, which went public in March as the largest New Yok Stock Exchange IPO since Alibaba in 2014, leaving SoftBank’s 36% stake valued at some $25 billion. The imminent IPO of Chinese ride-share player Didi Chuxing, in which SoftBank holds a 20% stake, at a reported $70 billion valuation represents more good news.
Yet those recent windfalls have done little to tidy up SoftBank’s balance sheet. A report from CreditSights last month noted that consolidated net debt, inclusive of margin loans and prepaid forward derivatives contracts, rose to ¥9.1 trillion ($83 billion) as of March 31 from ¥7.9 trillion in the prior quarter and down only marginally from ¥9.8 trillion a year earlier, when COVID and a series of blunders including the spectacular collapse of portfolio company WeWork Cos. crippled operating results. Indeed, Moody’s relayed in a March 8 report that an estimated ¥5.6 trillion in asset sales yielded no increase in net cash, as SoftBank instead channeled those funds towards investments into publicly listed technology stocks.
CreditSights argues that thanks in part to “governance issues” and “a history of aggressive and creative financing choices,” SoftBank’s double-b-rated senior bonds are mis-rated, with single-b a more appropriate designation.
Such creative financing continues apace. After pricing a hefty ¥405 billion corporate debt offering in early June, Japan’s largest such deal so far this year, the company in early June finalized a $10 billion margin loan backed by its holdings in Alibaba, a transaction upsized from an original $8.125 billion thanks to ready financing from a cabal of 32 banks. Then, too, Bloomberg reported last week that SoftBank is in negotiations to borrow a further $7.5 billion against the expected cash proceeds from the sale of portfolio company Arm Ltd. to rival Nvidia Corp., a deal which is still pending regulatory approval.
Meanwhile, the Vision Fund’s stable of loss-making Unicorns will seemingly require the ongoing good graces of Mr. Market to thrive. For instance, Coupang, logged a $295 million net loss in the first quarter, a 180% year-over-year increase in red ink, while revenues rose by just 74%. At the same time, SoftBank’s crown jewel continues to tread water, as Alibaba shares remain 30% off their October 2020 highs with co-founder and former executive chairman Jack Ma remaining off the grid after running afoul of the Chinese Communist Party last fall.
While equity holders can, of course, fully participate in outsize gains which can accrue from winning speculative investments, creditors are in line for no more than the return of their principal and their contractually stipulated interest payments. Might concern about the company dubbed “the epitome of the cycle” in the Dec. 15, 2017 edition of Grant’s Interest Rate Observer be creeping back into the bond market? Yesterday, SoftBank credit default swaps jumped by 8.8 basis points according to CMA data, marking the biggest one-day increase since September.
Another round of chaotic price action saw the Treasury curve continue to flatten drastically, as the two-year yield to jumped 0.25%, its highest since early 2020, while the 30-year long bond fell to 2.02% from 2.21% just two days ago. Stocks came under heavy pressure late, with the S&P 500 logging a 1.3% loss to wrap up the week lower by nearly 2%, though the tech-heavy Nasdaq 100 held up better with a 90 basis point loss. Gold continued its tailspin with another leg lower to $1,763 an ounce while WTI held firm near $71 a barrel, and the VIX jumped to near 21 to finish the week higher by 32%.
- Philip Grant
A different kind of U-turn. Electric vehicle hopeful Lordstown Motors (RIDE on the Nasdaq) disclosed in a filing today that existing production agreements with customers “do not represent binding purchase orders or other firm purchase commitments.”
That represents quite a reversal from management’s assessment from just two days ago. “Currently, we have enough orders for production for 2021 and 2022,” Lordstown president Rich Schmidt declared Tuesday at an event hosted by the Automotive Press Association. “These are firm orders for the next two years.” Asked about the status of Lordstown’s order book, Schmidt had this to say: “I don’t know the exact facts of the legal aspect of that, but they are basically binding orders that are committed here in the last two weeks, reconfirmed orders. They’re pretty solid, and I think that’s on the light side or conservative side.”
The state of Lordstown’s backlog took on a new urgency last week. On June 8, the company, which raised $600 million last fall via a merger with special purpose acquisition company DiamondPeak Holdings Corp., filed an amended form 10-K with a warning that cash was running low, placing RIDE’s status as a going concern at risk in the absence of additional fundraising. Six days later, CEO Steve Burns and CFO Julio Rodriguez tendered their resignations, following an internal investigation into published accusations from short seller Hindenburg Research terming the company’s order book “largely fictitious and used as a prop to raise capital and confer legitimacy.”
Other details suggest things may not be on the up-and-up at the two-year old, pre-revenue startup, which commanded a market cap of as much as $5 billion in February. That revised 10-K filing also disclosed that the Lordstown c-suite determined that “material weaknesses” in the firm’s internal controls existed as of Dec. 31, just nine weeks after completing its merger with DiamondPeak and less than a month after it had filed its form S-1 with the SEC. In addition, Lordstown revealed that an inquiry from the Securities and Exchange Commission, characterized in the original 10-K as a “request. . .for the voluntary production of documents and information,” was instead a formal investigation, in the form of a pair of subpoenas.
There’s more. Citing analysis from Wharton associate professor Dan Taylor, journalist and CPA Francine McKenna relayed last week that multiple members of the Lordstown executive office, including the now-departed CFO, traded some $8 million worth of company shares more than a month after the end of the fourth quarter and within 31 days of the March 17 earnings announcement, an event which spurred a 14% decline in RIDE shares thanks to a larger-than expected quarterly loss. Typically, executives would consider that stretch to be a “quiet period” and refrain from trading in company shares, in order to avoid the appearance of improperly acting on insider information. For more from Taylor on problems with the existing regime of 10b5-1 executive stock sale plans, see the March 19 edition of Grant’s Interest Rate Observer.
Since its inclusion in a bespoke basket of SPAC-affiliated firms in the Dec. 25 Grant’s analysis “Short this index,” RIDE shares have duly downshifted by 50%, while the index as a whole has pulled back by 41%. Electric vehicle concerns took center stage in that gauge of picks-to-not-click, with five of the 10 components pursuing EV-centric business models.
Even with those SPAC-related hiccups, the S&P Kensho Electric Vehicles Index sports a $1.65 trillion market cap, up a cool 135% from a year ago. Yet Lordstown’s troubles reflect the contrast between widespread investor exuberance towards EVs and unpleasant realities. “This is a massively capital intensive industry,” Jeff Schuster, president of global forecasting at LMC Automotive, told The Wall Street Journal last week. “That’s exponentially higher when you’re talking about a startup.”
Meanwhile, industry mainstays are directing their substantial war chests towards the electrification movement, further complicating life for the bevy of hopefuls. Reuters reported yesterday that General Motors (which has invested $75 million in Lordstown) now plans to undertake a $35 billion capital commitment towards autonomous vehicles over the next five years, up 30% from a prior estimate three months ago, with electric vehicles a primary lynchpin of that strategy. That comes less than a month after rival Ford Motor Co. announced it will allocate $30 billion in EV-focused capital expenditures through 2030, up from a prior projected outlay of $22 billion.
Notable moves abound ahead of a major options expiration day tomorrow, as investors continue to price in the potential for a less dovish Fed. Treasurys saw major bull flattening action, with the long bond yield sinking 11 basis points to 2.1% (its lowest since early February) and the 10-year note rallied to 1.51%, while the 2-year note rose to 0.21%, its highest in more than a year. The tech-heavy Nasdaq 100 enjoyed that development, racing to a 1.4% gain while the S&P 500 went nowhere. Gold was clubbed yet again to $1,779 an ounce, extending to a 6.5% five-day decline and finishing at six-week lows, WTI pulled back towards $71 a barrel and the VIX finished slightly lower to snap its three-day winning streak.
- Philip Grant
Dispatches from the everything bubble: Greek five-year yields wandered into negative territory on Monday, quite an achievement for a country which endured a punishing debt crisis just a decade ago and continues to sport a speculative-grade, double-B sovereign credit rating. Such details are now of little concern for investors, as last week’s €2.5 billion ($3 billion) sale of 10-year notes at a near 0.9% yield attracted a record €30 billion order book.
During the March 2020 crucible, European Central Bank president Christine Lagarde asserted that she “isn’t here to close spreads,” a contention cast into doubt by last week’s announcement that the central bank will buy bonds in the coming quarter “at a significantly higher pace than during the first few months of the year” despite a fast-improving economic outlook along with measured inflation above the bank’s near 2% per annum goal. Other priorities come first. “In the near term the ECB is very, very clear,” Nic Hoogewijs, portfolio manager at Lombard Odier, told the Financial Times on Monday. “They do not want to see a tightening of financial conditions and funding costs for sovereigns really is key.” Hoogewijs, who noted his firm owns several such peripheral government bonds, added that “you can’t really position on sovereign spreads based on economic fundamentals. That’s not what drives pricing.”
Anomalous activity in the bond market is likewise readily apparent on this side of the Atlantic. Also on Monday, junk bond yields as measured by the Bloomberg Barclays High Yield Index reached 3.84%, the lowest level on record. A lack of supply doesn’t look to figure in the equation, as year-to-date issuance stands at $267 billion, topping the $210 billion record for the first six months of the year set in 2020 with two weeks left in the period.
While speculative-grade debt often thrives in periods of strong growth due to the sensitivity of those borrowers to financial and economic conditions, the current go-go environment poses its own risks to creditors. Thus, real yields on the ICE Bank of America High Yield Index dropped into negative territory for the first time on record last month. Indeed, inflation-adjusted junk yields rarely dipped below (positive) 3% before the bug bit.
On the equity front, Mr. Market is feeling his oats with the S&P 500 sporting its second-richest valuation on record as measured by the cyclically-adjusted Schiller price-to-earnings ratio. Bank of America’s Global Fund Manager Survey for June concludes that “investors [are] bullishly positioned for permanent growth, transitory inflation and a peaceful Fed taper.” More than two-thirds of respondents believe that inflation will dutifully cool and that the next recession won’t take hold until at least 2024, while 57% expect that any trouble in stocks would spell less than a 10% retreat from the current all-time highs. Equity allocations have reached their highest of the year, BofA finds.
It’s not just the pros who are pushing their chips to the center of the table, as hunky-dory conditions have helped facilitate a wholesale migration into the asset class. Stocks represented 45.7% of total household financial assets as of March 31, Ned Davis Research relays today. That tops prior high-water marks of 44.5% 2000 and 37.5% on the eve of the Financial Crisis, and towers over the 27.8% average going back to 1950. Then, too, data from FINRA show that margin debt among member firms reached a record $861.2 billion in May. That’s up 11% so far this year and 44% from the May average across 2018 through 2020, while the $308 billion year-over-year increase is more than double the largest such jump from any prior cycle.
Come on in, the water’s warm.
Investors gleaned a hawkish takeaway from this afternoon’s largely status-quo FOMC rate decision, as the monetary mandarins now guesstimate a pair of rate hikes in far-flung 2023. Treasurys came under significant pressure as a result, with the 2-, 10- and 30-year yields rising to 0.2%, 1.58% and 2.21%, respectively, up four, eight and two basis points on the day. Stocks also came for sale, with the S&P 500 retreating by half a percent, while gold was clobbered by 2.5% to a six week low at $1,813 an ounce and WTI crude slipped below $72 a barrel. The VIX jumped above 18, extending its three-day rally to 16%.
- Philip Grant
Buy American, still? Despite a snappy 14% year-to-date advance, the S&P 500 continues to lag the 16% gains posted by the Euro Stoxx 600 Index (each return is priced in dollars), a trend which has been in place since January, Bloomberg noted yesterday. While that 200 basis point gap is far from insurmountable, 2021 is on pace to snap a five year winning streak for the broad U.S. gauge relative to its cross-Atlantic rival.
A heavier index composition towards cyclical companies is currently working in favor of the Europeans, as the Stoxx features a near 30% weighting in commodity producers and banks, compared to 17% for that pair in the S&P 500. Investor positioning seemingly presents another tailwind, as strategists from Goldman Sachs relay that European stocks enjoyed 10 consecutive weekly inflows through June 4, yet allocations as a percentage of global equity assets remain near a 10-year low for the region.
Then, too, Europe’s nascent pace of virus rebound relative to the U.S. could work to the advantage of bulls on the Old Continent. “So, investors make that rotation of, ‘OK, I took the U.S. trade and I’m going to go into Europe because they have more time until a full recovery,’” Michael O’Rourke, chief market strategist at Jones Trading, tells Bloomberg. “They basically have a longer runway to reach the point where the U.S. economy is today.”
The flip side of the world being underweight Europe is apparent stateside, as the MSCI USA Index commands an aggregate $38 trillion market cap, double that of the MSCIA World ex-USA Index, which tracks other developed markets across the globe. That 66.5% market share for the United States tops the prior high water mark of 59% set in the early aughts and compares to a 43% share of developed market GDP in 2021, if estimates from the International Monetary Fund are on point.
It’s not the first time that a nation’s stock market has punched far above its economic weight class. For instance, a dual equity and real estate bubble propelled Japanese equities to command 41% of global market cap in 1988 according to the World Bank, while accounting for just 16% of total GDP. Nowadays, the Land of the Rising Sun is little more than an afterthought, with its 10.3% share of IMF-projected developed market GDP this year reflected in a modest 6.8% share of global market cap, as measured by MSCI.
Beyond relatively undemanding valuations (the Tokyo Stock Exchange sports an enterprise value equivalent to 9.6 times consensus 2021 Ebitda, compared to 15 times for the S&P 500), secular, shareholder-friendly changes are afoot in the third-largest economy. Namely, the TSE will soon reorganize into three classes (prime, standard and growth) based on free-float market cap and other corporate governance considerations. Accordingly, local companies are undertaking steps such as unwinding minority stakes in other businesses and improving corporate governance in a bid to secure a coveted prime designation (thus retaining eligibility in the Bank of Japan’s expansive ETF buying program) ahead of a June 30 preliminary reference date, after which the exchange will begin notifying companies of their projected status. See the Jan. 22 and May 28 editions of Grant’s Interest Rate Observer for the bull case on a handful of Japanese equities and closed-end funds.
Even in today’s bubbleicious domestic stock market, compelling value propositions can occasionally slip through the cracks. The Feb. 7, 2020, edition of Grant’s shone a spotlight on Texas Pacific Land Trust (TPL on the NYSE), a 133-year old outfit which stands among the largest property owners in Texas and generates income through royalties, water rights and grazing fees, as well as selling land.
Then largely overlooked by mechanical index buyers BlackRock, Vanguard and State Street (the trio owned just 0.51% of shares outstanding as of last February) Texas Pacific counts a more discerning investor among its ranks. Steve Bregman, president and co-founder of Horizon Kinetics, termed TPL “an internal compounding machine” to Grant’s last year. Bregman added that, owing to the company’s regular stock repurchases and land sales, “if you just hold your shares and don’t sell them, in 20 or 30 years you might be the largest shareholder and you would be incredibly wealthy.” On that score, so far so good, as shares have since returned a cool 102% inclusive of dividends, duly attracting the passive Johnny-come-lately’s in the process. The BlackRock, Vanguard and State Street trio now report a combined 9.7% stake in the enterprise, less than half of Horizon Kinetics’ holdings.
Stocks came under modest pressure ahead of the conclusion of the two-day Fed meeting tomorrow, as the S&P 500 declined by 20 basis points and the Nasdaq 100 retreated by 70 basis points to offset yesterday’s price action. Treasurys consolidated yesterday’s weakness with the 10- and 30-year yields holding at 1.49% and 2.19%, respectively, while WTI crude rose above $72 a barrel and gold slipped to $1,860 an ounce for its fifth red finish in six sessions. The VIX jumped above 17, extending its two-day gain to 9%.
- Philip Grant
A plot twist in the rates market. Last week’s collapse in the 10-year Treasury yield to a low of 1.43% on Friday from 1.63% a week earlier was a seemingly curious one, coming one day after the Bureau of Labor Statistics reported that consumer price inflation accelerated at the fastest pace in 13 years in May. As the Federal Reserve has repeatedly argued that currently percolating inflation will prove transitory, Mr. Market appears to be sympatico with that line of thinking.
Might expectations of a renewed bout of post-reopening economic weakness figure into the bullish reversal? The fact that the Treasury curve (as measured by the two- and 10-year yields) inverted in August 2019, while the U.S. was enjoying the tail end of its longest economic expansion on record and Covid remained a gleam in the eye of a Chinese lab technician, suggests that bonds may know something that inflation-minded observers do not. David Rosenberg, president and eponym at Rosenberg Research, argued that point on Friday, telling CNBC that he expects the current growth-cum-inflation surge to fizzle in short order: “That’s the story for the second half of the year. . . The bond market is sniffing that out right now. My forecast is slower growth, inflation peaking out and rolling over and a bull flattening in the yield curve.”
Idiosyncratic factors might be playing a starring role in that rates rally. As the Dollar Index remains near the trough of its five-year range, that weakness is helping attract funds from far-flung places suffering from an even more acute yield famine. “If I [had] to buy a bond market, which is the case for a lot of investors, I would buy the U.S. Treasury,” Laurent Crosnier, chief investment officer at the London office of Amundi (one Europe’s largest asset managers) told The Wall Street Journal Friday. That relative appeal is straightforward, as strategists at Saxo Bank calculate that the 10-year Treasury offers a 90 basis point yield after accounting for three-month currency hedges, compared to an equivalent 69 basis points for triple-B-rated Italy or a measly three basis points for Japan.
More broadly, the investment-grade bond market may soon catch its own tailwind of relatively price-insensitive buying interest, thanks to the gangbusters post-March 2020 rally in stocks. The average private pension plan was 98.8% funded in May, Bank of America credit strategist Hans Mikkelsen relayed last week, compared to just 82% in July of last year. An imminent rise above the 100% threshold, Mikkelsen wrote, will trigger “a significant rotation out of equities into corporate bonds as companies lock in their vastly improved fortunes.”
Meanwhile, the release of idle funds from the Treasury general account, which houses the proceeds from government bond sales at the Federal Reserve, may have helped amplify last week’s move. A barrage of new Treasury supply unleashed during the pandemic pushed the size of the TGA to $1.6 trillion as recently as February 2021, compared to an average of $220 billion from 2015 to 2019.
Uncle Sam has since drawn down much of those funds to cover Washington’s elevated spending needs, leaving the TGA at $673 billion as of last Wednesday, down from $812 billion sequentially. That has led to concomitant increases in bank reserves, flooding the system with cash (for instance, today’s reverse repurchase operation took in $584 billion in cash, a record figure and more than 10 times that of two months ago) and applying downward pressure on interest rates. To that end, Treasury issuance, net of retirements, footed to negative $46 billion in May. That compares to a positive $60 billion of net supply in April and $223 billion in March, when USTs were hammered with the 10-year yield rising to 1.74% on March 31 from 1.41% a month earlier.
Did Treasury yields fall, or were they pushed? We will know more later.
A late ramp in stocks pushed both the S&P 500 and Nasdaq 100 indices to fresh closing highs, up 20 and 90 basis points on the day, respectively, while the VIX also jumped 5% after logging a fresh pandemic-era low on Friday. Rates came under pressure after last week’s intense rally, with the 10-year yield rising to 1.5% and the long bond finishing at 2.19%, WTI held above $71 a barrel and gold sank to a near-one-month low at $1,866 an ounce.
- Philip Grant
A grande slam? Starbucks Corp. has filed trademark paperwork that would pave the way for bestowing its name on a stadium or entertainment venue, Bloomberg reports today. The java giant would join mega-firms such as Wells Fargo and American Airlines in pursuing that branding strategy, Bloomberg notes.
Then again, as stadium rights branding deals are a distinctly bull-market endeavor, Starbucks would also join some infamous company from prior booms – Enron Field in Houston, CMGI Field in Foxboro, Mass., PSINet Stadium in Baltimore, Adelphia Coliseum in Nashville, Trans World Dome in St. Louis, and MCI Center in Washington, D.C. Sometimes the ballparks outlast the sponsors.
Think it over, SBUX.
Citing data from Morgan Stanley, the Financial Times relays that assets under the stewardship of private capital firms (an umbrella term covering investments in unlisted enterprise, most often private equity) reached $7.4 trillion as of Dec. 31, roughly double that of five years prior. There’s plenty of room for good times ahead, the investment bank reckons, penciling in $13 trillion in industrywide assets by 2025.
As the rise of indexing has upended the public investment business model, Wall Street has responded by pivoting towards the private market, which favors active management thanks to its generally illiquid nature while offering enhanced flexibility to value securities. “For traditional asset managers, fees will be relatively harder to defend given the commonization of the industry and existing margin challenges,” Morgan Stanley wrote yesterday. “As a result, we expect traditional asset managers to. . . [lean] into alternatives with its fatter fee pool and private markets with its higher structural growth.”
Meanwhile, deal activity looks set to accelerate. Last Saturday, a consortium of private equity firms announced a leveraged buyout of closely-held medical supply giant Medline Industries, Inc. at a $34 billion valuation, marking the largest such deal since the collapse of Lehman Brothers.
As that acquisition would mark only the 11th LBO of $10 billion or more in the dozen-plus years since the financial crisis, compared to 18 between 2005 and 2007, some observers think conditions are ripe for another M&A boom. “This could be the transaction that opens up the floodgates,” Dusty Philip, co-chairman of Global M&A at Goldman Sachs, told The Wall Street Journal. “You have ideal conditions for large LBOs: low interest rates, aggressive financing markets and a significant amount of dry powder.” Indeed, undeployed funds at p.e. firms stand at more than $1.6 trillion according to Preqin, a record figure and up from $1 trillion at the end of 2017.
Upcoming buyouts are likely to feature aggressive terms, if recent trends are any indication. Thus, the average domestic LBO purchase price footed to 12.8 times Ebitda last year according to data from McKinsey, with debt equivalent to 6.8 times trailing Ebitda. That compares to an average 9.4 times average purchase multiple and 6.1 turns of leverage at the crest of the prior cycle in 2007.
Meanwhile, the proliferating quantity of deal-hungry firms ensure that competition for targets will remain fierce. More than 11,000 private capital outfits were active globally as of year-end by McKinsey’s count, compared to about 9,000 hedge funds. The number of private capital firms have grown at an 8% compound annual rate since 2015, while the hedge fund universe has contracted at a 2% annual clip over that five-year period and remains well below its high water mark reached in 2005.
Might the hedge fund industry’s recent struggles prove instructive to today’s private capital stampede? A bearish analysis of hedge fund purveyor Man Group plc. in the April 9, 2004, edition of Grant’s Interest Rate Observer included a trio of pointed questions regarding the-then mushrooming investment category: “What are the barriers to entry in the hedge fund business, in which a 26-year-old can raise $50 million? Can investors in hedge funds expect to succeed over a complete investment cycle, given high fees and the fast-growing population of magna cum laudes picking over the same opportunities? And: When has an investment fad not ended badly?”
Asset allocators, please copy.
Treasurys gave back early gains as the recent rally ran out of steam this afternoon, leaving the 10- and 30-year yields at 1.45% and 2.14%, respectively. Stocks went nowhere as the S&P 500 logged a 0.3% gain for the week to sit at new highs, WTI crude pushed towards $71 a barrel and gold sank to $1,879 an ounce. The VIX sank below 16, logging a fresh virus-era closing low.
- Philip Grant
Today’s reading of the May Consumer Price Index showed a 5.0% year-over-year increase, the hottest since September 2008, while the 3.8% advance excluding food and energy prices was the largest in nearly three decades. Then, too, Bianco Research notes that the combined 2% jump in core CPI over the past three months marks the fastest such stretch since 1982, equivalent to an 8.3% annual growth rate.
It could have been worse. Rent of primary residences and owners’ equivalent rent rose by 1.8% and 2.1%, respectively, from a year ago. That compares to a 5.4% increase in annual rental prices in May, according to ApartmentList.com, while home prices appreciated by 13.2% per Zillow.
The pair are heavy hitters within the CPI, accounting for a combined 31.5% of the total index. If measured rental and OER prices had accelerated at the same 5% as the headline figure, headline CPI growth would have topped 5.9% last month.
A pandemic year bumper-crop. Total global wealth, or financial and real assets such as real estate less liabilities, reached a record $431 trillion as of Dec. 31, a new report from Boston Consulting Group finds. That’s up 7.9% year-over-year and 38% from the end of 2015.
Both ultra-easy monetary policy, which helped levitate financial investments by 11.3% last year, and fiscal largesse contributed to the wealth windfall. Net new savings, encompassing cash and deposits, accelerated by 10.6% to mark the best annual showing in 20 years. “The world was in lockdown and there were not that many alternatives to spend and invest,” Anna Zakrzewski, global head of wealth management at BCG and coauthor of the report, observes to Barron’s.
Indeed, the average FICO score rose slightly to 682 in February 2021 from 678 in March of last year, data from LendingTree show, a most unusual development in a recession year. For instance, it took until 2013 for consumer credit scores to exceed their pre-crisis levels following the events of 2007 to 2009. This time, individuals paid down outstanding credit card balances at the highest rate since 2000 in the first quarter, Roger Hochschild, CEO at retail-focused Discover Financial Services, observed on an April 22 earnings call. That doesn’t necessarily spell good news from the lender’s point of view. “We are very focused on returning to growing loans,” Hochschild said. “Delinquencies can’t get much lower than they are now, but if your loans keep shrinking, your revenues come down [and] margins will get worse.”
Competition is heating up accordingly, as banks vie for suddenly scarce business. On Tuesday, Wells Fargo announced the debut of the Active Cash card, which will offer users a 2% cash-back rate on all purchases with no annual fee. Not to be outdone, Citigroup today trumpeted plans to launch its own credit card which will automatically credit 5% cash back on up to $500 in monthly spending in a customer’s most active category of spending (such as dining, gas or travel) for that period, along with 1% back on everything else.
Beyond furnishing increasingly generous terms in hopes of generating business, lenders look for ways to deal with a towering glut of cash that has come to act as something of an industry millstone. The Wall Street Journal reported yesterday that, with total deposits at U.S. commercial banks topping $17 trillion as of late May, up from $13.5 trillion as the bug bit, some banks are encouraging corporate customers to take their unwanted dollars elsewhere. Total loans equaled 61% of deposits as of May 26, according to the Federal Reserve, down from 75% in February 2020. Low yielding cash balances, in tandem with the Fed’s EZ monetary policy, have pushed industrywide net-interest margins to record low levels in the first quarter, per the Federal Deposit Insurance Corp.
For more on the financial side effects of last year’s epic monetary and fiscal interventions, see the analysis “A case of overstimulation” in the April 2 edition of Grant’s Interest Rate Observer.
Who needs real yield? Investors responded to this morning’s inflation data with a feverish bid for Treasurys, as the 10-year yield to 1.46%, its lowest in more than three months. Stocks also liked what they saw, with the S&P 500 gaining 50 basis points and the Nasdaq 100 rallying by more than 1%, while WTI crude pushed back above $70 a barrel and gold held at $1,902 an ounce. The VIX retreated to just above 16, its lowest close since the virus took hold.
- Philip Grant
Tripling down on the brave new world, mobile software firm MicroStrategy, Inc. announced it will upsize its sale of senior secured notes to $500 million from the $400 million offering announced yesterday. Strong demand underpinned that enhanced deal, as the issue priced at 6.125% compared to price talk of 6.25% to 6.5%, with the order book reaching about $1.6 billion per Bloomberg.
While Mr. Market’s friendly reception would generally be seen as par for the course in the current credit boom, MicroStrategy’s financing is unusual in that proceeds will used for the purchase of additional bitcoins, following the issuance of $1.7 billion in convertible senior notes in February and December of last year for the same purpose.
MicroStrategy, which currently owns 92,000 of the digital ducats, disclosed yesterday that it will take an impairment charge of at least $285 million (equivalent to more than half of consensus 2021 revenue) following mark-to-market losses after bitcoin fell to $36,000 from as much as $64,000 on April 14. Bitcoin went on to sink to as low as $31,400 in mid-day trading, before bouncing back above $33,000 following news of the upsized bond offering.
Securities and Exchange Commission chair Gary Gensler fired a salvo at corporate America yesterday, noting at a Wall Street Journal-hosted conference that the agency is looking to tighten restrictions around so-called 10b5-1 trading plans. The existing format allows executives to sell their shares on a pre-scheduled basis, providing a bulwark against legal liabilities arising from allegations of insider trading based on non-public information, of which corporate executives are, of course, in constant possession.
The current 10b5-1 structure features numerous loopholes, including the absence of required public disclosure (though many companies do so voluntarily to avoid the perception of impropriety), as well as the fact that executives can trade immediately upon enacting the plans and are free to cancel them at their discretion.
“In my view, these plans have led to real cracks in our insider-trading regime,” Gensler concluded. “I worry that some bad actors could perceive this as a loophole to participate in insider trading.”
A recent academic study can help the regulators quantify the frequency of such c-suite shenanigans. The Stanford Graduate School of Business released a January paper “Gaming the System: Three ‘Red Flags of Potential 10b5-1 Abuse,” documenting the shortcomings of the 10b5-1 format. The analysis, which assessed restricted stock sales from 2016 through May 2020, found that 38% of the plans during that time were filed and executed before the company had issued its next scheduled round of quarterly earnings, while nearly half resulted in a single, often well-timed stock sale rather than a gradual divestment.
For instance, a May 13 dispatch from the Washington Post chronicled the events at athletic apparel manufacturer Under Armour, Inc. Back in October 2015, four months after a bearish analysis in the pages of Grant’s and at the tail-end of a 26 quarter stretch through fall 2016 in which the company generated annual revenue growth of 20% or higher, founder and then-CEO Kevin Plank declared “great confidence [in] the future,” and that “we are just getting started,” on the earnings call.
Six days later, the executive entered into a 10b5-1 plan that resulted in $138 million in proceeds over the following six months. A subsequent probe into Under Armour’s accounting covering that 2015 to 2017 period led the SEC to conclude on May 3 that Under Armour had failed “to disclose material information about its revenue management practices that rendered statements it made misleading.” The company paid $9 million to settle the charges without admitting or denying wrongdoing, while Plank and the rest of the c-suite averted individual charges. Shares are down about 55% since Plank began to unload that chunk of stock.
The erstwhile Under Armour boss has company. Daniel Taylor, associate professor at the University of Pennsylvania Wharton and co-author of the Stanford paper in tandem with David Larcker, Branford Lynch, Phillip Quinn and Brian Tayan, furnished to Grant’s another pair of examples of corporate executives executing large and curiously-well timed stock sales ahead of bad news. For more on this topic, including the authors’ recommended remedies, see the analysis “What’s your edge?” from the March 19 edition of Grant’s Interest Rate Observer.
Another strong rally in the Treasury complex pushed the 10-year yield to a near two-month low at 1.53%, while stocks continued to coil with the S&P 500 logging its 11th straight finish within a less than 1% range, as the broad index sits higher by 12.5% year-to-date. Gold edged lower to $1,896 an ounce, WTI pushed above $70 a barrel for the first time since October 2018, and the VIX finished at 17.
- Philip Grant
Twelve separate investment-grade bond deals came to market today, Bloomberg reports, marking the busiest session since March 3. Household names, such as Goldman Sachs Group, Inc., General Motors Co. and Deere & Co. are among the firms availing themselves of fresh capital.
With high-grade spreads holding near record lows and the Federal Reserve announcing last week the unwind of its pandemic-era Secondary Market Corporate Credit Facility, some observers think it’s time to strike while the iron is hot. Credit analysts from Citi write today that “market factors. . . should encourage highly-rated, lower-levered firms to take advantage of a market hungry for dollar-denominated spread product by pulling forward borrowing plans.”
Borrowers at the other end of the credit pool have their own designs. Unrated MicroStrategy, Inc. announced it will sell $400 million in senior secured notes, with pricing set to follow a two-day roadshow concluding tomorrow and early talk ranging from 6.25% to 6.5%. Proceeds will be earmarked for the purchase of bitcoins. The mobile-software firm, which also disclosed a $285 million impairment charge stemming from mark-to-market losses on bitcoins acquired at higher prices, showed net debt of $1.68 billion as of March 31, equivalent to 17 times the consensus estimate for 2022 adjusted Ebitda.
Lower-for-longer is so 2019. Treasury Secretary Janet Yellen offered some pointed remarks following a weekend meeting with finance ministers from the G-7. “If we ended up with a slightly higher interest rate environment it would actually be a plus for society’s point of view and the Fed’s point of view,” the Treasury Secretary argued yesterday. “We’ve been fighting inflation that’s too low and interest rates that are too low now for a decade.”
That overt policy shift towards generating inflation shines a light on the composition of relevant data points, in light of the seismic events of the past year-plus. As the Bureau of Labor Statistics calculates inflation statistics using a basket of goods meant to correspond with consumer spending habits, the pandemic threw a wrench in those finely-calibrated indices.
As the May 15, 2020, edition of Grant’s Interest Rate Observer noted, grocery prices jumped 2.6% sequentially in April of last year, marking the fastest rise in food inflation since February 1974. By the same token, gasoline prices collapsed by 20.6% sequentially, while apparel, auto insurance, airfares and lodging away from home sank by 4.7%, 7.2%, 15.2% and 7.1% from the previous month. In other words, “the things that locked-at-home consumers didn’t buy. . . plummeted in price.” Overall, the so-called core CPI sank by 0.4% sequentially in April 2020, the most severe monthly decline on record going back to 1957.
Those distortions made no small impact across the virus-riddled 2020. As a Friday bulletin from the Financial Times relayed, an analysis from Harvard economics professor Alberto Cavallo concluded that U.S. inflation metrics understated price pressures by 0.5% last year. That colors the reported 1.6% advance in core CPI across 2020, which matched the lowest reading since 2010.
That was then. The May CPI, which is set to be released on Thursday, will feature a 3.4% year-over-year advance in the core component if economist consensus is on point. That would be the hottest reading since April 1993.
While the vagaries of data collection and shifting consumer behavior cloud assessments of inflation indices across different eras, some apples-to-apples comparisons suggest the economy was far more prepared to handle inflationary pressures 28 years ago. Thus, spring 1993 featured a 3% federal funds rate, 6% yield on the 10-year Treasury note and total federal debt of $4.2 trillion, equivalent to 63% of nominal GDP. That compares to a near-zero funds rate, 1.57% 10-year yield and $28.2 trillion aggregate federal debt load (about 135% of GDP) today.
A listless summer session saw stocks finish little changed, as the S&P 500 and Nasdaq 100 remain rangebound near their respective high-water marks, while Treasurys came under modest pressure with the long bond yield rising to 2.25%. Gold rose back above $1,900 an ounce, WTI crude retreated towards $69 a barrel, and the VIX held near 16.5.
- Philip Grant
Get in line, John Q. Taxpayer. Creditors of bankrupt New York-based Cosmoledo LLC, (owner of the French Maison Kayser bakery chain) argue that funds from the pandemic-era Paycheck Protection Program secured by the company should be diverted towards making them whole, rather than returned to the government, according to a Bloomberg dispatch.
Cosmoledo, which filed for Chapter 11 last September listing secured debts of $72.7 million, received a $6.7 million PPP loan from Uncle Sam three months earlier. The company withdrew its request to return the remaining $5.3 million to the government and says it has come to an agreement with both its lenders and the Small Business Association, which will be made public in tandem with its bankruptcy resolution plan.
The outcome may reverberate, as Bloomberg notes that “at least several dozen companies that borrowed tens of millions of dollars under the loan program filed bankruptcy last year. . . [while] creditors in Cosmoledo may have been the first to fight for the unused proceeds.”
The Chinese government has taken the reins in the saga involving stricken lender China Huarong Asset Management Co., Reuters reports today, instructing Huarong to dispose of various non-core assets. More importantly for the firm’s international creditors, Beijing is set to “informally” back Huarong’s roughly $20 billion in dollar-denominated debt.
In response to that report, Huarong’s senior unsecured, dollar-pay 3 3/4% notes due next April rose to 82 according to Bloomberg, up from a prior transaction at 76.5 back on May 18.
Yet as that ongoing discount to par suggests, the situation is far from resolved despite a potential government bailout. S&P Global noted yesterday that, as Huarong has thus far failed to produce its 2020 annual report, the company faces a late-August deadline to furnish those results under the terms of an existing bond and stave off technical default. The ratings agency maintained its triple-B-plus long term rating with a negative outlook on Huarong, which, “acts as a financial stabilizer” in soaking up the assets of other troubled financial institutions, serving as the largest buyer of domestic distressed assets over the past three years. Accordingly, S&P reasoned, Huarong “would likely receive government support if needed.”
The clean-up job could prove complicated, and not only because Huarong's total assets mushroomed to RMB 1.7 trillion ($272 billion) as of year-end 2019 from just RMB 315 billion seven years prior. Reuters relays that “Deutsche Bank plans to buy Huarong’s stake in their joint venture investment firm, Huarong Rongde Asset Management,” according to a “source with direct knowledge of the deal.” However, “Germany’s largest lender rejected this claim, saying that it has no such plans.”
Both stocks and rates looked to rally after a weaker than expected headline reading of May nonfarm payrolls, as the S&P 500 sat higher by nearly 1% as of mid-afternoon, while the 10- and 30-year Treasury yields sank to 1.56% and 2.24%, respectively. Gold jumped 1% to $1,892 an ounce to recoup half of yesterday's losses, WTI crude advanced to $69.5 a barrel and the VIX was slammed by nearly 10% to 16.5.
- Philip Grant
The Federal Reserve had a surprise yesterday, announcing that it will wind down its pandemic-era Secondary Market Corporate Credit Facility. The SMCCF, which accumulated $13.8 billion in corporate bonds and ETFs, will start offloading assets next Monday and has set a Dec. 31 target for fully divesting the portfolio.
Might that pivot carry implications for the Fed’s ongoing ultra-easy policies, including near-zero overnight rates and $120 billion of monthly Treasury and mortgage-backed securities purchases? Yesterday’s announcement follows the disclosure from the April Fed meeting minutes that “a number of participants” felt a discussion over QE tapering “might be appropriate in upcoming meetings,” while San Francisco Fed president Mary Daly told CNBC last week that “we are talking about talking about tapering.” That’s a marked shift from her May 10 remarks that “it’s not yet time to start thinking about talking about relaxing the accommodation we’ve given.”
One prominent member of the Federal Open Market Committee begs to differ, as NY Fed president John Williams declared this afternoon that the economy is “on a good trajectory, but in my mind, we’re still quite a ways off from reaching the ‘substantial further progress’ that we’re looking for, in terms of adjustments to our purchases.”
Measured prices sure seem to be making substantial progress, as evinced by the 4.2% rise in headline CPI last month. Global food prices surged a whopping 40% from a year ago and 6% month-over-month in May, according to an index compiled by the UN Food and Agriculture Organization. Stateside, home prices jumped 13.2% from a year ago in March, the largest increase since December 2005, while used vehicle prices accelerated by 21% year-over-year and 10% sequentially in April. Analysts at Goldman Sachs pencil in an average 2.7% rise in core CPI across next year.
The labor market seems to offer stronger footing in the argument for continued stimulus, as total payrolls remained 8.2 million below their pre-pandemic levels in April per the Bureau of Labor Statistics. Yet signs of rapid improvement remain visible ahead of tomorrow’s May jobs report. Today’s reading of 385,000 weekly jobless claims marked a fresh virus-era low, down from 590,000 claims just six weeks ago. In addition, the quits rate (or workers opting to hit the bricks as a percentage of total employment) held at 2.4% in March, matching the highest since at least 2000. Even last month’s disappointing payrolls report featured headline unemployment of 6.1%, not far above the 5.8% long-term average going back to 1947.
Government largesse further muddies those waters. Some 15.4 million Americans received unemployment benefits in mid-May, The Wall Street Journal relays, up nearly sevenfold from early 2020. Noting that credit card delinquency rates have declined since the onset of the pandemic in sharp contrast to the 2001- and 2008-era recessions, John Silvia, founder and CEO of Dynamic Economic Strategy, writes today that “the current unemployment data may be overstating the degree of financial stress for households.”
Some who might be in the know believe that the status quo will remain intact for some time longer. Former New York Fed president William Dudley told Bloomberg television this morning that he “would not take [yesterday’s] decision as implying anything about the timing of [QE] taper and the timing of actually lifting off and raising short-term interest rates.” Investors, well trained over the past decade-plus, may tend to agree. “The Fed is a bit like a helicopter parent when it comes to the bond markets,” Nicholas Elfner, co-head of research at Breckinridge Capital Advisors, commented to Bloomberg this afternoon. “Their involvement in the bond market is assumed at this point.”
Yet some observers believe that the SMCCF’s demise is cause for caution, regardless of past experience. Credit analysts from Bank of America write today that:
Clearly the Fed has little in terms of a successful track record in selling assets and also most of the time [simply] adjusts policy to market expectations. This is why the Fed's announcement today - which was 100% surprising - to begin gradually selling their portfolio of corporate debt acquired during the liquidity crisis last year is very negative for risk assets.
Clearly the Fed feels sufficiently emboldened by the scarcity of credit assets in the front end of the curve and high valuations to be comfortable testing markets in this way. However, to us this is a symptom of the post-coronavirus reality of getting back to normal much earlier than expected, suggesting a much faster rate hiking cycle than currently priced in the market.
Then, too, the introduction of the bond-buying program sparked a virtuous circle, as a recent paper co-authored by Fed vice chair Richard Clarida noted that the SMCCF’s “announcement effect led to rapid improvements in financing conditions in corporate and municipal bond markets well ahead of the facilities’ actual opening.” The BofA analysts warn that an opposing dynamic may now be in store:
Now the Fed holds only $5.21bn of corporate bonds and $8.56bn of ETFs, so sales will be a drop in the bucket compared to any issuer that could come to the market by surprise. But, as it took very little Fed buying to stabilize the market last year, it should take very little selling to convince investors the tightening cycle is underway. We expect wider investment grade credit spreads.
We’ll know more soon enough: The next FOMC meeting is set for June 16.
Stocks came under pressure after a string of sideways finishes, with the S&P 500 declining by 40 basis points and the Nasdaq 100 slipping 1.1%, while Treasurys gave back recent gains with the 10- and 30-year yields finishing at 1.62% and 2.3%, respectively. Gold sank nearly 2% to $1,873 an ounce, WTI crude consolidated recent gains at $69 a barrel, and the VIX held near 18.
- Philip Grant
German industrial giant HeidelbergCement AG (HEI on the DAX) announced plans to build the world’s first carbon-neutral cement plant today. The facility, to be located in Sweden with a scheduled 2030 debut, will utilize carbon capture technology to secure and store 1.8 million metric tons of CO2 per year, four times that of a Norway-based carbon capture plant set to come online in 2024. “This will be a game changer for our industry,” declared CEO and chairman of the managing board Dominik von Achten.
Recent months have been kind to investors in Heidelberg, the world’s foremost producer of aggregates, second-largest cement maker and a Grant’s Interest Rate Observer pick-to-click last fall. The company has enjoyed a 35% euro-denominated return, inclusive of dividends, from that November 13 analysis, nearly double that of the Euro Stoxx 600 Index. Yet long-term performance remains a slog, as the company has generated a mere 5% annual return including reinvested dividends over the past 25 years, compared to a 7.6% annual increase for the Stoxx 600 over that period.
Ill-timed moves, including the 2007 acquisition of British building materials manufacturer Hanson Ltd. for £9.2 billion ($13.1 billion today and $18.7 billion at the time), equivalent to 11 times trailing Ebitda, factor prominently in those lagging performance figures. Thanks to leverage topping five turns in the wake of that deal, Heidelberg then conducted a dilutive equity offering of 62.5 million shares (equivalent to nearly one-third of outstanding shares today) in the 2009 bear-market depths to repair its balance sheet.
Mr. Market will believe it when he sees it, currently bestowing on HEI an enterprise value equivalent to six times consensus 2021 Ebitda. Yet recent management changes (von Achten took the big seat right before the bug bit in winter 2020) in tandem with improved asset allocation, could augur better days ahead. Heidelberg announced on May 24 that it will sell the bulk of its operations in the western United States to Martin Marietta Materials, Inc. for $2.3 billion in cash, a price equivalent to about 16 times the unit’s annual Ebitda per estimates from Deutsche Bank.
Terming the deal “a very value-accretive exercise for Heidelberg” thanks in part to lower margins in that outgoing unit relative to the rest of its U.S. operations, the DB analysts guesstimate that HEI will generate a return on invested capital “significantly above 8%” by year-end following the asset sale, up from 7.9% last year and 6.5% in 2019.
Heidelberg’s efforts to go green could prove material beyond its own corporate profile. As cement production is a dirty business, accounting for nearly 10% of worldwide greenhouse-gas emissions, the benefits accruing to Mother Earth from that strategy pivot could prove substantial. Yet the growing ranks of environmental, social and governance-focused investors have given the company the cold shoulder, as evidenced by HEI’s still-modest valuation.
Indeed, the current ESG landscape arguably reflects both an index-hugging mentality and a heavy emphasis on business models with little impact on the environment. For instance, both the Vanguard ESG U.S. Stock ETF and the BlackRock Advantage ESG U.S. Equity Fund feature tech mainstays Microsoft Corp., Apple, Inc., Amazon.com, Inc. and Alphabet, Inc. among their top five holdings.
Some investors propose an alternative way to look at the movement. Noting that roughly half of global carbon emissions come from industries which currently have little-to-no economically viable way to decarbonize, a fall 2020 white paper from Massif Capital argued thus:
That firms such as Apple and Microsoft, two of the most widely held businesses in ESG portfolios, pollute less than copper miners and aluminum producers is a meaningless observation in the context of a desire to invest for impact.
That firms like Apple and Microsoft depend on copper miners and aluminum producers for their businesses means that the question investors should be asking is how one balances environmental impact and economic criticality, not simply how one limits a portfolio’s overall environmental impact.
Rather than simply directing capital towards businesses which attain high ESG ratings while avoiding those from high-pollution industries, Massif proposes another way forward:
The alternative is to consider climate change as a problem that can be addressed and invest in companies that will aid or benefit from the transition to a low carbon economy.
Any such philosophical shift among the ESG-minded could carry substantial implications, as torrents of capital continue to pour into the “space.” Such funds had gathered nearly $2 trillion in assets under management at the end of the first quarter, Morningstar reported April 30. That’s up 18% from Dec. 31 and nearly double that of year-end 2019. Europe has been front-and-center in that effort, accounting for 79% of ESG flows in the first three months of the year.
What’s next as the ESG movement takes hold of Wall Street and thoughtful investors look to skate to where the puck is going? Will Thomson, founder and managing partner at Massif Capital, will share his thoughts from the podium at the Grant’s fall 2021 conference on Oct. 19 (advt.).
More absurd price action in the meme stocks didn’t result in much headline-level excitment, as the S&P 500 went nowhere for a fourth straight day to remain near its high-water mark while Treasurys also traded sideways with the 10-year yield finishing at 1.59%. WTI crude pushed to a fresh 30-month high near $69 a barrel, gold advanced to $1,911 an ounce and the VIX slipped to 17.5.
- Philip Grant
Talk about intangible assets. Italian artist Salvatore Garau sold an invisible sculpture titled ‘Io Sono’ (I am) for €15,000 ($18,300) in a May 18 auction overseen by contemporary house Art-Rite, Italy 24 News reported. That compares to pre-auction estimates of €6,000 to €9,000 in proceeds.
Garau explained his uber-minimalist work: “The vacuum is nothing more than a space full of energy, and even if we empty it and there is nothing left, according to the Heisenberg uncertainty principle, that nothing has a weight. Therefore, it has energy that is condensed and transformed into particles, that is, into us.”
‘Io Sono’ is meant to be displayed in a 150 by 150 centimeter space free from obstructions, the artist went on to explain. In addition to his own slice of the void, the buyer will also receive a signed and stamped certificate of authenticity, as well as peace of mind: The work boasts a net-zero carbon footprint.
It was another banner month for the bottom of the barrel in credit, as the triple-C-rated portion of the Bloomberg Barclays High Yield Index generated a 0.7% return in May. That outpaced the 30 basis point return for the broad index to mark the seventh consecutive month in which triple-Cs outperformed.
More broadly, investors can’t get enough speculative-grade debt despite a fast-diminishing return profile, as junk spreads over Treasurys remain below 300 basis points, near their narrowest since 2007. On Friday, the iShares iBoxx $ High Yield Corporate Bond ETF declared a $0.29093 per share dividend for May, a mere 4% indicated yield and the lowest monthly payout in the fund’s 14-year history. Meanwhile, issuers continue to make hay: New junk supply for 2021 has topped $270 billion per Refinitiv, already marking a record high for the first half of the year with four weeks left.
The “smart money” goes shopping. Private equity firms have completed 131 acquisitions of publicly-traded companies in the United Kingdom so far this year at an aggregate £25.7 billion ($36.6 billion), Pitchbook reports today. That already tops the previous £17.5 billion, full-year high-water mark established last year and sits far above the roughly £5 billion worth of p.e. transactions in both 2018 and 2019.
Relatively inviting valuations reign following the Brexit and virus one-two punch, as Fidelity International found in March that U.K. stocks trade at a hefty 40% discount to world markets according to a metric incorporating forward price-to-earnings, book value and dividend yields. Similarly, data from Bloomberg show that the FTSE 100 Index trades at 20 times its 10-year average inflation adjusted earnings, far below the 37.5 times Shiller earnings ratio for the S&P 500.
Meanwhile, recent economic data point to more prosperous days ahead. The May edition of the Lloyds Business Barometer survey showed that sentiment surrounding the economy rose to its best level since 2016, while overall business confidence ascended to a three-year high. Then, too, the Nationwide Building Society announced today that U.K. home prices jumped by 1.8% from a month ago, double the economist consensus, with the 10.9% annual increase marking the fastest pace of price appreciation since 2014.
Indeed, Great Britain appears to provide a commanding value proposition for discerning investors. See the April 30, Feb. 5 and Dec. 11, 2020 editions of Grant’s Interest Rate Observer for bullish analyses on a host of U.K.-based enterprises, including a pair of housing-related picks-to-click.
The energy patch enjoyed another strong day, as WTI crude advanced towards $68 to mark its best close since fall 2018, up 90% from late October. Stocks went nowhere to start the short week, while Treasurys likewise finished little changed with the 10- and 30-year yields settling at 1.61% and 2.29%, respectively. Gold remained just above $1,900 an ounce, and the VIX jumped 7% to 18.
- Philip Grant
A tight labor market spurs drastic measures in Las Vegas (h/t Christian Hill):
It was another restless night for crypto hodlers, as the price of bitcoin retreated to as low as $35,000 this morning. That’s down double digits from Thursday morning and 40% from its high-water mark reached last month. With the assets trading around the clock, volatility has consistently remained at nausea-inducing levels of late: Bitcoin logged an 18% decline on Sunday followed by a 16% snapback the next day.
Those manic swings are not going unnoticed. Bank of Japan governor Haruhiko Kuroda observed in an interview yesterday that “most of the [bitcoin] trading is speculative. . . it’s barely used as a means of settlement.”
As the sheen comes off the recent upside rampage (bitcoin enjoyed a near six-fold rally over the six months through mid-April), the bull crowd looks to diagnose the market malady. Cathie Wood, manager of the wildly popular Ark Investment funds, provided her analysis at a conference hosted by CoinDesk yesterday: “It was precipitated by the ESG [environmental, social and governance] movement and this notion, which was exacerbated by Elon Musk, that there are some real environmental problems with the mining of bitcoin. A lot of institutional buying went on pause.”
Efforts to curtail environmental damage yield their own side effects. The popularity of Chia Network, a “green” bitcoin alternative which allocates new supply based on empty hard disc space rather than energy-intensive mining utilized by bitcoin, has spurred a global disc shortage. Some 12 million terabytes of hard disc space are currently being used to mine Chia, New Scientist reported on Wednesday, quadruple that of just two weeks ago. “We’ve kind of destroyed the short-term supply chain,” admitted Chia president Gene Hoffman.
Those concerns aside, more prosaic financial factors may have played a starring role in the turn, namely, outsized leverage. Citing data from Bybt.com, Bloomberg reported earlier this month that a mere $9.4 billion in margin liquidations drove some $600 billion in total crypto market cap losses between May 18 and May 19.
Some crypto devotees remain steadfast despite the recent shakeout. Buccaneers quarterback Tom Brady declared his allegiance to the digital ducats in an appearance at yesterday’s CoinDesk conference: “The world is changing, we all just have to understand it’s constant change and you can either be ahead of the curve or behind it and I’m choosing to be ahead of it,” the gridiron great declared. “As someone who wants to be on the forefront of things, I’m going to help create the trend and adopt it and recognize this is where the world is heading.”
Meanwhile, one of the engines of the crypto machine continues to work overtime. Tether, the most widely-traded crypto and the de facto source of liquidity for exchanges that cannot get access to traditional banking, has exploded in circulation of late. As of this morning, some $61 billion of tethers are outstanding according to Coinmarketcap. That’s up 4.4% from a week ago, 30% from bitcoin’s high-water mark in mid-April and 76% from Feb. 23, when New York Attorney General Letitia James declared that “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.”
It seems fair to wonder just what assets stand behind that flood of new stablecoin supply in the context of a bear market. Tether disclosed on May 13 that, as of the end of the first quarter, cash and T-bills accounted for just 5% of reserves.
See the Feb. 19 edition of Grant’s Interest Rate Observer for a thorough analysis of the bitcoin boom, including risks and opportunities therein.
Stocks enjoyed solid gains as of mid-day, when ADG dropped the pick, with the S&P 500 and Nasdaq each up by about half a percent. Treasurys remained in a tight trading range despite more hot inflation data, with the 10- and 30-year yields edging lower to 1.6% and 2.28%, respectively. Gold remained at $1,900 an ounce, WTI crude held near multi-year highs at $67 a barrel, and the VIX fell to near 16.
- Philip Grant
Here’s CNBC personality Jim Cramer on Twitter this morning, helping to organize the process of price discovery in Beyond Meat (BYND on the Nasdaq):
Wall Street Bets guys, thanks for considering Beyond Meat. You have the fire power to add a third. Heavy shorts. And enough with the praise of me and my highlight film. LOVE YA! $GME and $AMC
That exhortation proved successful, as BYND shares jumped higher by as much as 15%, spurring a subsequent tweet in early afternoon:
Wall Street Bettors, i am in your debt; i think there is much room to go on $BYND. Very glad i got the sellers to walk away. Again i thank everyone who has praised me on that one; impressive
Indeed, it definitely makes an impression.
With earnings season all but in the books, the blended profit margin for S&P 500 components footed to 12.8% in the first quarter, FactSet found last week. That’s the most bountiful result since at least 2008, topping the 12% achieved in the summer of 2018.
Here’s another bountiful result. As Charles Schwab chief investment strategist Liz Ann Sonders observed yesterday, the 9.5% year-over-year jump in headline producer prices towered over the 4.2% consumer price figure in April. That 530 basis point gap is the largest monthly reading since 1974.
A real estate division of China Oceanwide Holdings Co. (715 on the Hang Seng) defaulted on a $280 million dollar bond earlier this week, Bloomberg reports. The conglomerate, which was only able to repay roughly half that principal sum using the proceeds of a recent private bond offering, stated in a filing that the rest of the funds are forthcoming in the next three months. A scuttled attempt at $1 billion-plus of U.S. asset sales preceded this week’s development.
Oceanwide has been in trouble for some time. Two years ago, the company abruptly ceased construction on a $1 billion downtown L.A. condominium, hotel and retail complex “due to a recapitalization of the project,” as the Los Angeles Times put it.
The property sector remains in focus for all the wrong reasons, as Chinese developers had already accounted for more than a quarter of the $20 billion in missed bond payments this year as of last week, according to data from Bloomberg.
In response, the authorities look to crack down on financial shenanigans within the all-important property realm. To that end, Caixin reports that regulators are scrutinizing mega-developer China Evergrande (3333 on the Hang Seng) for its ties to lender Shengjing Bank. Per the report, Shengjing holds “large amounts” of Evergrande debt on its books, while Evergrande is Shenjing’s largest shareholder.
The pair have a history. Back in summer 2019, Evergrande shelled out RMB 13.2 billion ($2.1 billion) to raise its stake in Shengjing to 36% from 17%, paying a 40% premium to the bank’s share price. Subsequent reports indicated that the Chinese government “encouraged” the deal to help recapitalize Shengjing.
In response to today’s news, the developer’s dollar-pay 8 3/4% notes due 2025 dropped to 81 from 84, for a 1,429 basis point spread over U.S. Treasurys (traditionally, a pickup in excess of 1,000 basis points indicates borrower distress). Single-B-plus-rated Evergrande sports $117 billion in net debt, equivalent to 8.5 times consensus 2021 Ebitda. The company has pledged to cut its debt load in half by the end of 2023, as it attempts to reach compliance with Beijing’s recently implemented “three red lines” governing property developer balance sheets.
Solvency trouble at Evergrande, which Grant’s predicted in fall 2017 will eventually take its place in history alongside “Bank of United States” and “the Hindenburg,” could reverberate far and wide. Chinese corporate borrowers face a hefty $1.3 trillion in domestic debt maturities over the next 12 months, per data from Bloomberg, with $900 billion of that falling due before year end. That compares to $1 trillion by June 2022 and $600 billion by December 31 for U.S. companies, and $800 billion and $400 billion, respectively, in principal repayments for European corporate borrowers. Chinese firms have already defaulted on more than RMB 100 billion of onshore debt this year, marking the first time that threshold had been crossed before September
For now, Mr. Market continues to whistle past the high-rise. Bloomberg notes that a quartet of Chinese property developers (Yango Group, Greenland Hong Kong Holdings, Times China Holdings and New World Development Company) are marketing dollar bonds today.
Stocks finished little changed, as the S&P 500 and Nasdaq 100 indices sit higher by about 1% and 2%, respectively, so far this week. Treasurys pulled back after a recent rally, with the 10- and 30-year yields rising to 1.61% and 2.28%, while gold held at $1,900 an ounce and WTI rose to near $67 a barrel. The VIX slipped below 17 for the first time in six weeks.
- Philip Grant