From Business Insider:

During TNT's broadcast of the NBA Eastern Conference Finals on Tuesday, Shaquille O'Neal hinted at his involvement in an FTX lawsuit while speaking to Stephen Curry — just hours before getting served. "Thanks for getting me in trouble," O'Neal said to Curry, likely in reference to their joint involvement in the FTX case.

Later that night, O'Neal was reportedly served two legal complaints — one for his involvement in the ongoing FTX lawsuit and another regarding an NFT project — by a process server who attended the game, Adam Moskowitz, co-counsel on the FTX lawsuit, told Insider.

"After months of dodging service, Shaquille O'Neal was just personally served with 2 Complaints, while broadcasting the Heat/Celtics Game 7 [sic] in Miami, Florida," the Moskowitz law firm wrote in a statement this morning. "The process server filmed the event to ensure there was no ambiguity like Shaq has been arguing in the FTX case, but after service, Mr. O'Neil had the process server kicked out of the Arena."

In perhaps the biggest twist of irony, this all went down in the former FTX Arena — the Miami Heat's home [court] named after the crypto exchange in June 2021, before becoming the Kaseya Center this past April.

Investors have a fever, and the only prescription is more AI.  Marvell Technology followed in peer Nvidia’s shoes after delivering fiscal first quarter 2024 results yesterday evening, as shares rocketed 32% after the chipmaker predicted artificial intelligence-derived revenues will “at least double” to around $400 million this year with a similar growth rate in the company’s crystal ball for fiscal 2025.  

“In the past, we considered AI to be one of many applications within cloud, but its importance and therefore the opportunity has increased dramatically,” CEO Matthew Murphy said on the conference call.  Marvell has plenty of company on that score: 110 members of the S&P 500 mentioned AI on their first quarter earnings calls, data from FactSet show, compared to 78 and 53, respectively, during the prior two periods. 

Yet as the market swoons over a lucrative AI-induced spending binge, key tech players deliver a divergent signal. Nick Winkler, founder of research firm DuDil, relays that enterprise cloud provider Workday extended the useful life of its servers and network equipment to five years from three, an accounting tweak that served to trim the firm’s operating loss to $20 million over the three months through April from $50 million thanks to lower depreciation expense. 

Household names such as Alphabet, Meta, Microsoft and Amazon have each recently undertaken similar moves, heling push the industrywide average useful life of servers to 5.6 years per research firm Omdia, from 5.2 years in 2021 and 2022. 

Maybe Jerome Powell and Co. should find a new metric. Friday’s release of the April core personal expenditures index – typically presented in the financial press as the Fed’s “preferred inflation gauge” – showed a 0.4% sequential increase, topping the 0.3% consensus for the hottest reading since January, while annual gains registered at 4.7%, more than double the central bank’s 2% bogey.  At the same time, personal spending jumped 0.8% sequentially last month compared to an expected 0.5%. 

Those data did little to slow the recent reacceleration of short-term interest rates, as markets adapt to the growing odds of additional policy tightening from the current 5.08% funds rate.  Two-year Treasurys today reached 4.54%, approaching levels seen prior to Silicon Valley Bank’s March collapse, while real yields, as measured by Treasury Inflation Protected Securities maturing in April 2025, vaulted above 2.5% this morning compared 1.6% in early April.

Considering that backdrop, it is perhaps no surprise that assets parked at U.S. money market funds reached a record $5.39 trillion as of Wednesday per the Investment Company Institute, up nearly 1% from the prior week and 12% from the start of 2023. 

Meanwhile, the prospect of a debt-ceiling deal could catalyze a further inflow. Citing estimates from JPMorgan, the Financial Times reports that Uncle Sam will issue some $750 billion in short-term bills over the four months following an agreement to help burnish its dwindling cash cache. “To the extent that Treasury has a flood of supply that’s coming to market, it will be received with open arms,” Deborah Cunningham, chief investment officer of global liquidity markets at Federated Hermes, told the FT. 

Might an ongoing migration to cash equivalents put the crimps on percolating risk appetite? Citing data from EPFR Global, Michael Hartnett, chief investment strategist at Bank of America (and speaker at the 2023 Grant’s fall conference – advt.) relays today that investors pulled a net $3.9 billion from stocks over the seven days through Wednesday. 

Thanks to that third consecutive round of weekly redemptions, equity flows are now flat for the year-to-date following net influxes of $175 billion, $949 billion and $182 billion in 2022, 2021 and 2020, respectively.  With financial conditions potentially poised to tighten further in the coming weeks and interest rate futures now pricing 64% odds of a further Fed rate hike on June 14, “we expect another bout of risk-off [trading conditions] in late June,” Hartnett writes. 

Euphoria reigns into the holiday weekend, as the S&P 500 jumped another 1.4% to establish fresh-year-to-date highs while the Nasdaq 100 ripped 2.6% to extend its 2023 gains to more than 31%. Treasurys flattened with the long bond settling at 3.96% from 4.01% Thursday and WTI rose to near $73 a barrel while gold stood still at $1,947 per ounce. The VIX slipped back below 18 after reaching 20 on Wednesday.

- Philip Grant

Credit Suisse has thrown in the towel on efforts to salvage some $400 million in mid-level employee bonuses following its shotgun March marriage with UBS, the Financial Times reports.  

The now-defunct lender withdrew an appeal to Switzerland’s Federal Administrative Court (FAC) over the so-called contingent capital awards (CCA), which date to 2014, vest over three years and typically compose 10% to 15% of total bonuses for director level staff. 

Some 5,000 employees received CCAs in 2021, the last year in which they were on offer. Those zeroed-out payouts were linked to Credit Suisse’s additional tier 1 bonds, which are designed to be written down in the event of distress, providing an extra capital buffer for the bank but leaving investors (or, in this case, employees) exposed to a crypto style “rug pull.” Sure enough, Swiss regulators did just that in facilitating the distressed merger.

Unsurprisingly, that decision proved to be less than popular in some quarters, as the FAC has received some 230 appeals from 2,500 petitioners over the AT1 wipeout. Sympathy from one corner is minimal, however. “With respect, read the prospectus,” UBS chair Colm Kelleher declared at an event this morning. “It was very clear in the Swiss prospectus that viability was a wipe-out issue – very clear.”  

Mr. Market is coming around to the “higher for longer” concept, as hopes for an imminent reversal of the Federal Reserve’s tightening cycle go by the wayside. 

Interest rate futures now price in a 4.82% funds rate by the end of the year, still south of the 5% to 5.25% band currently in force but well above the 4.2% anticipated just two weeks ago, let alone the 3.7% investor guesstimate following the late spring regional banks blowup. The policy-sensitive two-year Treasury yield, meanwhile, settled at 4.31% today, its highest close since the memorable March 10 session.

An unwelcome, increasingly established culprit helps explain those shifting expectations. “Core inflation is proving more stubborn than expected and remains well above central banks’ 2% targets,” analysts at BlackRock noted recently, adding that “we see a recession ahead. But unlike in the past when central banks would cut rates to stimulate a struggling economy, we think the unresolved inflation problem makes that unlikely this time.” Excluding food and energy, the Consumer Price Index will grow 5.3% year-over-year in June, if economist consensus is on point. 

Plainly, the prospect that full-bodied interest rates are here to stay is no pleasant one for large swaths of the corporate sector following the freewheeling E-Z money epoch. Thus, S&P Global relayed last week that worldwide defaults registered at 50 over the first four months of the year, nearly double last year’s pace and 25% north of the 10-year average. The rating agency now pencils in a 4.25% default rate over the 12 months through next March, up from a 4% guesstimate for calendar 2023 as of April and a 2.5% trailing rate as of the end of the first quarter. 

Sellers of floating-rate, speculative-grade bank debt are similarly evincing growing stress. S&P’s tally of so-called weakest links – or leveraged loan issuers rated single-B-minus or lower along with a negative outlook – reached 148 at the end of the first quarter from 143 on Dec. 31 and 96 last summer. Meanwhile, rating downgrades outpaced upgrades by a 2.46:1 clip in March, marking the 10th consecutive month of such net credit demotions. As a result, 29% of the Morningstar LSTA Leveraged Loan Index now sports a single-B-minus rating, up from 25% two years ago, while the share of single-B-rated components has slipped to 23% from 29% over the same period.   

On the surface, at least, signs of trouble are nowhere to be seen in the stock market, as the S&P 500’s 8% year-to-date gains and euphoric price action for firms leveraged to the artificial intelligence craze (witness the 134% rip this year in mega-cap chipmaker Nvidia, encompassing the immediate reaction to its post-close earnings release) demonstrate.  Yet credit concerns are already manifesting in one respect: a Bloomberg compiled basket of U.S. companies with relatively strong balance sheets sits higher by 14.5% in the year-to-date through Tuesday, trouncing the 1.1% gain for a similar gauge of highly indebted firms. 

“Slowing economic growth calls for a focus on quality companies – those defined by high profit margins, low debt levels, high free cash flow yields and return on capital,” Helen Jewell, Global Director of Research for Fundamental Equities at BlackRock, tells Bloomberg today.

Might those dynamics take on a greater urgency as 2023 progresses? The average cash balance of S&P 500 components has dropped by 13% over the past 12 months, analysts at Goldman Sachs find. 

Stocks remained in retreat with the S&P 500 slipping another 0.7%, while Treasurys finished mostly weaker, highlighted by more head-spinning volatility in short-dated bills as the debt ceiling negotiations drag on. Gold pulled back to $1,962 per ounce, WTI crude rallied to near $74 a barrel and the VIX managed to match a one-month high just above 20. 

- Philip Grant

From the New York Post:

They’re hoping to make money from it raining on Taylor Swift’s parade. Fans who braved the wild weather over the weekend to attend Swift’s concert in Foxborough, Mass., have come away with more than just an unforgettable experience — capturing rainwater in containers they’re now trying to sell online.

The pop star is currently performing the US leg of her sold-out Eras Tour, taking to the stage at Gillette Stadium on Saturday amid a heavy downpour. The “Anti-Hero” singer dazzled despite getting drenched in rain — which some entrepreneurial fans are capitalizing on and trying to flog online for $250.

 “Jealous I didn’t come up with this scam first,” one user commented on an Instagram post showing a screenshot of the optimistic seller.

Can’t we all just get along? President Joe Biden raised hopes for a Sino-American détente Sunday, telling the press that “I think you’re going to see that [relationship] begin to thaw very shortly.” He added that his administration may soon lift sanctions against Chinese defense minister Li Shangfu to help grease the diplomatic wheels. 

Beijing may not have received the memo. Thus, the Cyberspace Administration of China announced yesterday that it has banned essential infrastructure companies from using semiconductors produced by Boise, Idaho-headquartered Micron Technology, stating that the products pose “significant security risks to our critical infrastructure supply chain.”  

The implications of that move are unambiguous to some observers. “No one should understand this decision by CAC as anything but retaliation for U.S. export controls on semiconductors,” Holden Triplett, FBI counterintelligence official turned founder of consulting firm Trenchcoat Advisors, tells Bloomberg.  “No foreign business operating in China should be deceived by this subterfuge. These are political actions, pure and simple, and any business could be the next one to be made an example of.” 

In a similar vein, The Wall Street Journal reported Thursday that Nasdaq-listed trading platforms Futu Holdings and Tiger Brokers will remove online store apps allowing Chinese citizens to trade foreign stocks.  

Recent police raids of Western outfits including Bain Capital, Mintz Group and Capvision, along with the abrupt May 1 disconnection of data service Wind Information Co. for foreign users, likewise underscore the Middle Kingdom’s reluctance to share information with outsiders, a crackdown reportedly spearheaded by security service veteran Chen Yixin under orders from President-for-life Xi Jinping. Duly receiving the message, “some Western firms have paused research work in China, especially when related to technology and other sensitive areas,” the WSJ relayed Friday. 

Might non-geopolitical considerations figure in China’s self-imposed isolation? A titanic local government debt burden of some $14 trillion per Goldman Sachs – more than four times the equivalent figure in the U.S. – presents one such pressure point.  Importantly, the bulk of those borrowings are of the off-balance sheet variety, furnished by so-called local government financing vehicles (LGFVs), or entities that fund infrastructure projects central to China’s debt-driven, real estate-centric economic model. 

As the property market remains in the doldrums following the collapse of mega-developer China Evergrande and sweeping Covid-zero lockdowns, those municipalities are increasingly gasping for air, struggling to service their outsized borrowings.  

Bloomberg documented yesterday that the northeast city of Hegang, Heilongjiang Province, has been forced to enact drastic budget cuts to help manage a boated debt burden that stood at 209% of total fiscal income last year, leaving residents without heating last winter and government employees at risk of job loss along with belated or diminished pay. “Many cities will become like Hegang in a few years’ time,” warns Houze Song, economist at U.S. think tank MacroPolo. “The central government may be able to keep things stable in the short term by asking banks to roll over local governments’ debt,” but without such forbearance, “the reality is that over two-thirds of the localities won’t be able to repay their debt on time.”

Recent developments in the corporate realm likewise illustrate China’s fragile state of financial affairs. Dalian Wanda Group Co.’s double-B/single-B-plus-rated 6 7/8% notes due July 23 slumped to 70 cents from 75.5 today, marking the fourth consecutive selloff after the sprawling conglomerate detailed plans to downsize some business units while denying local media reports that heavy layoffs are forthcoming.  The 34-year-old firm’s fall from grace is striking, Bloomberg notes, considering that “Wanda was once viewed as among China’s few high-quality names in the junk bond market after paring leverage and selling assets” in the wake of a debt-driven shopping spree following the 2008 financial crisis.  

Considering that forbidding backdrop, it is perhaps no surprise that Xi and Co. have opted to pull down the metaphorical blinds. See the analysis “Great wall of paranoia” in the current issue of Grant’s Interest Rate Observer dated May 19 for an informed speculation on the state of China’s debt-driven “economic miracle.”  

A flat showing for the S&P 500 masked visible strength elsewhere, as the small-cap Russell 2000 advanced 1.2% and the tech-heavy Nasdaq 100 rose 0.5%, while Treasurys were again unable to catch a bid as two- and 30-year yields each established multi-month highs at 4.29% and 3.97%, respectively.  Gold edged lower to $1,974 an ounce, WTI crude held near $72 a barrel and the VIX settled just above 17.

- Philip Grant

D.C. drama spills onto Wall Street. The normally staid market for short-term U.S. obligations continues to spasm in response to the ongoing debt ceiling debacle, as Treasury sold $35 billion of four-week bills this afternoon at 5.37%. That’s down from 5.6% in last week’s auction and a record 5.84% rate in early May, though sharply above the 3.19% on offer less than a month ago.  Underscoring the preternatural volatility: existing four-week bills yielded between 5.52% and 5.22% in today’s session alone. 

While investors and pundits alike read the political tea leaves, the aftermath of an agreement could prove dicey, one observer warns. Ari Bergmann, founder of fund manager Penso Advisors, predicts to Bloomberg that once the debt ceiling is raised, Treasury will burnish its dwindling coffers by selling upwards of $1 trillion of bills by September. Such a deluge would serve to sop up cash currently parked at banks and in other assets. “We’ve seen before that such a drop in liquidity really does negatively affect risk markets, such as equities and credit,” he said. 

Sticker shock abounds for New York City apartment dwellers. Median rental prices in Manhattan, Brooklyn and northwest Queens (comprising Long Island City and Astoria) each established new record highs last month, a report today from appraiser Miller Samuel and brokerage Douglas Elliman Real Estate finds.  

In Manhattan, the median rent registered at $4,241 per month in April, up 1.6% from March’s previous high-water mark and an 8.1% year-over-year increase, while the luxury category registered a 13% increase to $11,310.  In Brooklyn, median prices surged 14.8% from April 2022 to $3,473, while northwest Queens apartment residents coughed up $3,663 per month at the midpoint, up a hefty 6.7% from March and 12.8% above the year-ago figure. 

“There’s a lot of demand and it’s not just for one type of apartment,” Miller Samuel president and one-half eponym Jonathan Miller relays to Bloomberg. “This is an equal opportunity pain-maker for tenants.”  Evidence of such financial discomfort may be taking shape. Manhattan lease signings totaled 3,869 in April, off 20% from the prior month; typically, leasing activity picks up as spring progresses.

Conditions some 90 miles to the east mark a stark contrast with the acute and broad-based pricing pressure faced by Big Apple residents.  As CNBC reported yesterday, price cuts of 20% or more are de rigueur in the Hamptons this summer, as teeming rental supply meets with downshifting demand following a poor Wall Street bonus season in 2022 and announced job cuts at various bulge bracket banks.  

Simple mean reversion also factors in the drought following the Covid-induced sonic boom:  median sales prices skyrocketed to $1.2 million in 2020, up 40% year-over-year.  With the pandemic in the rear view, area newcomers who anted up now face a rude awakening: “I’ve got clients coming to me saying, ‘I want to rent my house for $250,000,’” Corcoran Group broker Gary DePersia told CNBC. “I tell them it’s not realistic anymore. The game has changed.” 

Indeed, the absentee owner of a Central Park South penthouse may be reaching a similar conclusion. Saudi real estate tycoon Fawaz Alhokair cut the asking price for his six-bedroom, panoramic-view trophy apartment at 432 Park Avenue by more than 20% to $130 million, The Wall Street Journal reports today, ending an unsuccessful, two-year quest to offload the unit at a $169 million price tag. Alhokair spent nary an evening in the property after acquiring it in 2016 for $87.66 million, listing agent Tal Alexander told the WSJ, adding that “we’re in an environment now where no one necessarily wants to pay the asking prices. People want to make a deal.”

Might a similar dynamic be taking shape for non-NYC based financial mortals? Nationwide median prices of so-called existing homes (as opposed to those on the metaverse) slipped to $388,800 last month, the National Association of Realtors relays, down 1.7% from April 2022 to mark the worst such year-over-year showing in over a decade. That data series now sits 6% south of the $413,800 peak logged last June. 

Stocks rolled higher again as the bulls have seized command following the recent sideways stalemate, as the Nasdaq 100 logged a fresh 52-week high with a cool 27.5% year-to-date advance. Treasurys remained under pressure, however, as two-year yields popped 12 basis points higher to 4.24%, while the 10-year settled at 3.65%, its highest since March 10.  WTI crude slipped to $72 a barrel, gold tumbled to a two month low at $1,960 a barrel and the VIX retreated to 16. 

- Philip Grant

Dog day doldrums have rolled in early this year, as the S&P 500 has finished each of the last six weeks with a sub 1% move in either direction.  As Charles Schwab chief investment strategist Liz Ann Sonders notes today, on only a single occasion last year did the major average go even two weeks without moving by at least 1%. 

This preternatural calm is testing the patience of some observers, Citigroup strategist Stuart Kaiser contends, writing today that “the past six months is among the most painful range [trading environments] since 1980.” 

The calm before the storm, perhaps. Last week’s reading of the Federal Reserve’s most recent quarterly survey of senior loan officers was a “snooze,” strategists at Bank of America wrote Friday, providing “little new information away from the obvious, [that] banks didn’t feel good about lending in late March” in the wake of Silicon Valley Bank’s demise and related stress among regional lenders.  A net 46% of respondents reported tightening credit to small and medium sized businesses, up slightly from 44.8% in the prior poll. 

Though the early-spring credit curtailment is readily explainable, high-yield investors should nonetheless take careful heed of that dynamic.  Going back to 1997, the proportion of loan officers tightening credit compared to those easing it has never been as high as its current level outside of recession, Lehmann, Livian, Fridson Advisors chief investment officer Marty Fridson relayed Sunday.  

Considering that the metric accounts for nearly half of long-term variance in high-yield spreads over time, by Fridson’s assessment, spreads are accordingly “way out of line,” the dean of high-yield argues. Prior to this year, the narrowest monthly spread seen during periods of a net 40 to 49.9 percentage point tightening in the survey going back to 1997 was 644 basis points, with the median gap registering at 771 basis points. By contrast, the option-adjusted spread on the ICE BofAML High Yield Index finished Friday at just 476 basis points. 

What’s more, the distress ratio, or share of junk issues trading at a 1,000-basis point spread, stood at just 9.9% as of Friday, far below the historic range of 17.61% to 38.75% seen during similar bank lending backdrops. “The only explanation I can see for the market’s extraordinarily low perception of credit risk in the face of very tight credit is overoptimism about how soon the Fed will reverse course and start lowering interest rates,” Fridson concludes.

To that end, futures markets now price 90% odds of a 25-basis point decrease in the benchmark Funds rate by November, arguably a fanciful expectation considering persistent price pressures and relatively calm financial conditions. Though measured inflation has steadily waned to 4.9% last month from 9.1% in June, further progress may be harder to come by. So-called core CPI, which excludes food and energy prices, grew 5.5% from last year, not far below its post-Covid peak of 6.6% in September.  “It’s really hard to see core inflation coming down to anything that’s approaching 2% by the end of this year,” Omiar Sharif, president of research firm Inflation Insights, told the Financial Times, adding “we’ll be fortunate to be about double that.”  Atlanta Fed President Raphael Bostic delivered a similar message on CNBC this morning, declaring that “my baseline case is we won’t really be thinking about cutting rates until well into 2024.”

Speculative-grade borrowers are accordingly obliged to pay up: from the start of April through May 9, new high-yield offerings priced at an 8.77% all-in-yield on average according to PitchBook, up from 8.16% in the first quarter from just over 5% in the spring of 2021.  Then, too, increasingly picky creditors foment a bifurcated backdrop. “If you give that kind of double-B [rated], less cyclical, really good business model impression in the marketplace, you can, for the most part, get the terms you want,” Will Smith, director of U.S. high yield credit at AllianceBernstein, told PitchBook. “But if you’re in that other camp, the trickier situations, that’s where investors are still driving the truck, if you will, and are able to get more investor protection, tighter covenant language, less leverage, etc.” 

A raft of announced restructurings brings the rugged conditions for the bottom of the credit barrel into sharp relief. Over the past 48 hours, seven large companies have filed for Chapter 11 bankruptcy protection, Bloomberg relays this morning. That’s the largest two-day tally among firms with at least $50 million in liabilities since at least 2008. 

Stocks caught a modest bid as the S&P 500 rose one-third of a percent, while Treasurys came under some pressure on the long end with 30-year yields settling at 3.84% from 3.78% Friday. Gold finished little changed at $2,021 per ounce, WTI crude edged back above $71 a barrel and the VIX settled just north of 17. 

- Philip Grant

What’s the opposite of a perfect crime? From WDAF-ABC, Kansas City:

Deputies in Kansas stopped a driver on Friday who may have been having a little too much fun on Cinco de Mayo. Franklin County deputies south of the metro pulled over a suspected drunk driver in the northbound lanes of Interstate 35. 

When they asked the driver to exit his car for a field sobriety test, deputies discovered he wore a Bud Light beer can costume over his clothes. Deputies eventually arrested the driver on suspicion of driving under the influence and transported him to the Franklin County, Kansas Jail in Ottawa. The suspect has since posted bond and is no longer in custody.

There’s plenty of junk for everyone. Primary activity in the high-yield market remains on the upswing, as a pair of deals for a combined $1.5 billion priced yesterday, leaving month-to-date supply at nearly $9 billion, per data from Bloomberg. That’s already double the full-month output logged in May 2022. Year-to-date issuance now stands above $65 billion, on track to easily eclipse last year’s paltry $102 billion. 

Spreads likewise evince relative calm, as the ICE BofAML High Yield Index finished yesterday at a 478-basis point option-adjusted pickup over Treasurys, in line with May 2022 levels and only modestly wider than the pre-pandemic baseline in fall 2019.

Fair financial weather in the asset class has not gone unnoticed. Bloomberg reported Tuesday that speculative-grade credit investors have increasingly favored high-yield over leveraged loans, as the prospect of stabilizing or even declining borrowing costs in response to slowing inflation spurs a migration to fixed- from floating-rate securities.  

Diverging credit quality likewise looms large, as Barclays strategist Bradley Rogoff finds that 47% of high-yield index constituents are rated double-B (the penthouse of junk), compared to a 31% share within leveraged loans. “Some of the improvement in the high-yield market is directly attributed to more aggressive lending in the loan market,” Michael Chang, senior portfolio manager at Vanguard Group, told Bloomberg. 

Sure enough, trailing 12-month loan default rates rose by 90 basis points to 3.1% between December and March, UBS strategist Matthew Mish calculates, while junk bond defaults rose by a modest 30 basis points over the same period, to 2.1%. Loans will default at an 8.5% clip by March 2024, Mish guesstimates, compared to 6% for high yield. Barclays’ Rogoff concurs with that sentiment, relaying thus: 

We see early warnings of increasing stress for smaller issuers amid severely tightening lending standards. We expect defaults to rise from here, and believe loans will be affected sooner.

Then, too, leveraged lenders can expect an additional dose of pain in case of restructuring, thanks to now-ubiquitous lax legal documentations known as “covenant-lite.” Armen Panossian and Danielle Poli, managing directors at Oaktree Capital Management, highlighted that dynamic in an April 20 analysis, warning that recovery rates for defaulted loans will wane relative to their long-term average of about 65% and adding that “we’re in a credit picker’s market and dispersion by sector and issuer is likely to increase moving forward.” By contrast, defaulted junk bonds should expect to recover about 40 cents on the dollar, the pair believe, in-line with the historical norm. 

More broadly, the confluence of a cooling economy, abrupt lurch higher in borrowing costs and ongoing retrenchment in bank lending activity helps make for a precarious backdrop. New York University Finance Professor and financial historian Edward Altman sounded the alarm in a May 3 analysis for the Creditor Rights Coalition, concluding that the worm has turned, and not for the better:

My current assessment is that the benign credit cycle we have enjoyed since 2010, with the exception of a few months in early 2020, is over. We recently reached an inflection point to an average credit risk scenario. 

If we continue to incur unexpected shock catalysts, similar to the recent Crypto and Silicon Valley Bank and other banking meltdowns, combined with a “hard-landing” economic recession, we could witness another financial-credit crisis, with non-financial corporate risky debt default rates rising to perhaps 10%, or more, over one or two years.

From Bloomberg:

JetBlue Airways Corp. orchestrated a campaign to flood the government with thousands of comments in favor of the airline’s bid to merge with Spirit Airlines, Inc. – including some from employees who said they didn’t write them and don’t support the deal.

Roughly 90% of the more than 10,000 comments on the Transportation Department’s public comment page are identical and are identified as coming from JetBlue and Spirit crew members who wrote that they believe the $3.8 billion merger will improve their lives, according to a Bloomberg News review of the database.

It’s not uncommon for U.S. airlines to ask employees to email or call members of Congress to lobby on a particular issue, sometimes providing wording or forms that could be filled out. Carriers used such an effort to help secure $54 billion in federal aid during the pandemic.

But critics have complained for years that it’s too easy for special interests to game public comments to the government. . . The New York Attorney General, in a 2021 report, found that more than 80% of the 22 million comments on Federal Communications Commission net neutrality rules were fake.

Fingers crossed for tomorrow’s CPI report, but Friday’s reading of April employment data provided little comfort to those hoping for an end to the sharpest monetary tightening cycle of the past four decades. Nonfarm payrolls rose by 253,000, topping the 185,000 consensuses, while measured unemployment registered at just 3.4%, matching the lowest levels in 54 years.  

Average hourly earnings meanwhile accelerated to a 4.4% annual growth rate, up from 4.3% in March and defying economist expectations of a downshift to 4.2%. On a sequential basis, wages increased 0.5%, the sharpest one month since March 2022, when headline CPI growth topped 8%. 

Data from non-government sources likewise point to an ongoing paradigm shift for employee compensation, as Economic Policy Institute’s nominal wage tracker for April shows a 4.5% From 2010 through the eve of the pandemic, that metric popped above 3.5% on only a single occasion. “The Fed left the door open for additional hikes [last week] for a reason,” KPMG chief economist Diane Swonk commented to Bloomberg. “The data are not as reassuring on a pause as we would like.”

As persistent pay hikes potentially spur further policy response in the U.S., staffers in Japan face a more forbidding backdrop. Nominal wages in Japan increased 0.8% from a year ago in March, data released today reveal, the 15th straight increase but the third straight month featuring a sub 1% bump from the same period in 2022. Headline inflation meanwhile chugged along at a 3.7% clip, leaving real wage growth in negative territory for a 12th consecutive reading. 

That cumulative shortfall may be beginning to bite, as household spending fell 1.9% year-over-year in March, far below expectations of a 0.4% increase and the largest such decline in 12 months. Overall, the average wage-earner saw a meager 6% nominal raise from 1990 to 2021 per the Finance Ministry. Stateside, increases totaled 50% over the same stretch. 

Might corporate Japan be obliged to loosen the purse strings to burnish faltering employee purchasing power?  Larger companies committed to average wage increases of nearly 3% in annual “shunto” spring negotiations, Reuters reported in March, citing the Keidanren business lobby, exceeding the previous recent peak of 2.9% back in 1997.  Smaller firms are likewise targeting 3% annual wage hikes on average according to the Rengo labor union, up from 1.9% last year. 

The Bank of Japan is optimistic that a virtuous cycle can take hold, as newly installed BoJ governor Kazuo Ueda declared in a press conference last week that “there is a good chance that we [soon] reach the conclusion that sustainable 2% inflation will be achieved by looking at economic variables that would impact next year’s wages.”  

Generating ‘’sustainable” inflation has been no problem on the Old Continent, as preliminary April CPI data showed a 7% annual headline increase across the eurozone, topping the expected 6.9% and marking the 13th reading of 7% or more in the last 14 months, while core CPI advanced at a 5.6% pace, just off the record 5.7% print for the common-currency era logged in March.  Accordingly, more rate hikes are in the cards, European Central Bank’s Klaas Knot declared on Dutch television Sunday: “we have more ground to cover, and we are not pausing.”

Signs of stabilization, at least, are evident, as an ECB survey of 61 large employers last week found that wages will increase 5% over the next year on average, matching a similar poll conducted in February.  Not everyone at the central bank is cheering that development, however. As the Financial Times reports today, the ECB has launched a staff wage review to “consider proposals for semi-automatic salary increases when prices rise.” That initiative comes amid union displeasure with the ECB’s 4.07% pay increase in 2023, which was less than half of the 8.5% uptick in CPI. 

For their part, ECB negotiators noted that staff turnover was only 1.3% in 2022, implying solid employee satisfaction (or inertia). Besides, as ECB President Christine Lagarde reflected back in fall 2019:

We should be happier to have a job than to have our savings protected. . . I think that it is in this spirit that monetary policy has been decided by my predecessors and I think they made quite a beneficial choice.

Everybody happy?

Stocks and Treasurys each came under modest pressure with the S&P 500 slipping 0.4%, and 10-year yield rising a basis point to 3.53%. WTI crude edged to $73.5 a barrel, gold climbed to $2,042 per ounce and the VIX rallied nearly a point to approach 18. 

- Philip Grant

The first cut is the deepest.  Hollywood writers went on strike Monday evening, grinding the media entertainment business to a halt in the first such labor disruption since 2008.  Early indications are not promising, as the two sides have no negotiations on the schedule. “There’s no driving force to get a deal done now,” one industry bigwig told Reuters. “I think it will go on for a while.” 

Moody’s Investors Service concurs, guessing that the work stoppage will drag on for at least three months. Such a lengthy interlude would be particularly damaging for “diversified media companies transitioning to streaming,” as relatively high debt loads within that cohort pair poorly with protracted operational interruption.  

Nor will any resolution represent a panacea for the industry, as production costs are set to rise. “We estimate an improved three-year contract for writers will ultimately cost media companies for which we have credit ratings between $250 million to $350 million per year,” the rating agency reckons.  Any increased outlays will particularly sting for cash-hungry streaming operators:  Apart from Netflix, Inc., which posted more than $3 billion in free cash flow last year, that subset collectively burned through roughly $10 billion in 2022. 

One media mainstay is making particularly heavy weather of it. Thursday, Paramount Global (ticker: PARA) reported a $1.2 billion first quarter operating loss on $7.27 billion in revenue, which trailed the $7.43 billion analyst consensus. Crucially, the direct-to-consumer streaming division posted minus $511 million in Ebitda, 12% wider than last year’s prettied-up shortfall, despite a 39% uptick in revenues to $1.51 billion. 

The company likewise slashed its dividend to $0.05 per share from $0.24, a move that will save some $500 million annually, as CEO Bob Bakish conceded that “we are. . . navigating a challenging and uncertain macro environment, and you can see the impact of that in our financials as the combination of peak streaming investment intersects with cyclical ad softness.” 
Investors were in no mood to wait around for better days, as the stock tumbled 28% in response. Shares are now off 14% from a bearish Grant’s Interest Rate Observer on March 10, compared to a 7% advance for the S&P 500.  

Cutting their 2024 free cash flow projections to $64 million from $195 million, analysts at MoffettNathanson did not mince words: “We continue to fail to find any valuation support for the stock, even after today’s decline, with current prices implying a 2024 free cash flow yield of less than 1%.”  As yesterday’s drastic dividend cut would suggest, triple-B/triple-B-minus-rated Paramount’s balance sheet is on increasingly shaky ground, as the research firm projects that net leverage will balloon to 5.7 times Ebitda by Dec. 31 from 4 turns at the start of the year. 

Paramount’s woes underscore a raft of adverse structural dynamics within the media business as streaming takes center stage at the expense of high-margin legacy television. To wit, ferocious competition from the likes of Netflix, Walt Disney and Warner Bros. spurs surplus spending and rising costs of content, while an increasingly saturated market features 89% of U.S. households streaming content and the average family subscribing to 5.4 separate services, a January survey from data analytics firm Kantar found. 

Meanwhile, ample leverage across the “space” adds an additional layer of risk, along with potential rewards for firms able to cut costs, bolster their balance sheet and strengthen cash generation. See the March 10 issue of Grant’s Interest Rate Observer for an upbeat analysis of another industry player which is potentially positioned to do just so. “The flyaway price of its shares” tempered that provisionally bullish verdict, though a pullback over the intervening eight weeks has somewhat alleviated the problem. 

As for Paramount, expense controls remain a talking point, despite CEO Bakish’s assurance yesterday that “we are implementing significant cost-saving measures across certain parts of our business.”  

The Wall Street Journal today details some eye-catching spending habits on the set of hit western Yellowstone. Namely, creator Taylor Sheridan – who “dictates where and how his shows are filmed with little pushback” – charges Paramount as much as $50,000 per week to film at his Texas ranches, rents herds of cattle to the production for $25 a head and “insists on [horses] being outfitted with horseshoes by his preferred farrier.”  Per-episode costs of the Yellowstone prequel “1923” run at upwards of $22 million, the WSJ relates, compared to $16 to $18 million for HBO dystopian drama “The Last of Us” and just under $20 million for fantasy epic “House of the Dragon.” 

Stocks stormed higher to wrap up a choppy week as the S&P 500 logged a near 2% advance to sit higher by 8.3% so far this year, while Treasurys came under pressure with the long bond rising three basis points to 3.76% and the two-year yield vaulting to 3.92% from 3.75% Thursday. WTI crude rebounded above $71 a barrel, gold pulled back to $2,025 per ounce and the VIX sank nearly three points to 17 and change.

- Philip Grant

The Reserve Bank of Australia increased benchmark rates to 3.85% from 3.6% while warning that “some further tightening” may be warranted. Tuesday’s decision caught investors offsides, sending three-year government yields higher by 17 basis points (the largest one-day updraft in a year) and spurring “a lot of swearing on the [trading] floor,” as the Australian Financial Review puts it. 

“Inflation in Australia has passed its peak, but at 7% is still too high and it will be some time yet before it is back in the target range," RBA Governor Philip Lowe explained after pushing the cash rate to its highest since early 2012. Less than a year ago, that bogey stood at 0.1%. 

A look at the Aussie central bank’s crystal ball likewise offers little comfort for low-rate aficionados, as Lowe et al. now guesstimate that the consumer price index will register at 4.5% by the end of the year, returning towards 3% (the top end of the RBA’s objective) in the middle of 2025. “This is an awfully long time for inflation to exceed target, and runs the risk that higher inflation expectations will become embedded,” Sean Langcake, head of macroeconomic forecasting for BIS Oxford Economics, told Reuters. 

One share, one vote is no more? S&P Global turned tail last month, announcing on April 17 that it will once again allow firms with dual class stock structures into its suite of indices, including the venerable S&P 500. The decision reverses a 2017 directive prohibiting such founder-friendly formats from its gauges, while grandfathering in existing components such as Meta Platforms and Alphabet.  

Overall, 27 dual class companies are currently in the S&P 500 according to ISS Corporate Solutions, with another 102 firms newly eligible for the benchmark per estimates from Keefe, Bruyette & Woods. That cohort includes private equity behemoths Blackstone & KKR, along with tech firms like Airbnb, Snowflake and Snap. Such an inclusion would be no small development (as evidenced by a 5% rise in Blackstone shares on the day following the announcement) as scores of passive investors would be obliged to add those names to their respective portfolios. 

While super voting C-suiters enjoy the prospect of an upgrade to the indexation big-leagues, fiduciaries take a dimmer view of S&P’s pivot, which hinders minority investors’ ability to influence corporate strategy and governance.  

As the Financial Times documents today, the Council of Institutional Investors – an entity representing pension funds and an advocate for equal voting rights – penned a letter to S&P stating that it “was surprised and disappointed” by the about-face. “We were deeply dismayed to hear of S&P’s retrograde decision,” added Caroline Escott, senior investment manager at £35 billion ($44 billion) U.K. pension scheme RPMI Railpen. “It is currently unclear the extent to which the wider investment industry was appropriately consulted” about the move, she added. 

Whether shareholders like it or not, the phenomenon is an increasingly prominent piece of financial architecture, particularly in the technology realm. During 2021’s IPO barrage, 55 of the 118 tech firms which came public did so via the dual share class route, data from University of Florida Professor Jay R Ritter show, a 46.6% share.  That compares to fewer than 20% of the 112 tech IPOs over the three years through 2016.  Overall, 32.5% of domestic IPOs during 2021 were of the dual class variety, nearly triple the 13% seen during the 2014 to 2016 era. 

What’s more, investors who piled into dual class IPOs were by-and-large rewarded for submitting to diminished voting rights: average three-year buy-and-hold returns for that cohort average 29.7% from 1980 to 2021, Prof. Ritter finds, easily topping the 18.7% return for single class debuts.  Outperformance was even more pronounced within the tech realm, with dual share IPOs posting a 41% three-year average return compared to 19.6% for conventionally structured ones. 

Yet the mushrooming popularity of environmental, social and governance (ESG) based investing presents discordant crosswinds for dual share advocates. To wit, voting power incommensurate to underlying economic ownership plainly runs afoul of the “G” portion of the popular acronym.  

Ironically, S&P itself warned in a February 2020 analysis that “poor governance practices have stood at the core of some of the biggest corporate scandals,” adding that in-house research “has shown that companies which rank below average on good governance characteristics are particularly prone to mismanagement and risk their ability to capitalize on business opportunities over time.”

Stocks came under pressure as the S&P 500 retreated by more than 1% alongside another round of pain for regional lenders, though the index managed to rebound a bit after reaching session lows in late morning. Treasurys caught a strong bid in a reciprocal fashion to yesterday, with outperformance in the short end leaving two-year yields at 3.97% compared to 4.14% Monday while the long bond fell 12 basis points to 3.72%. Gold ripped higher by nearly 2% to $2,026 an ounce, WTI crude dove below $72 a barrel and the VIX jumped to near 18 from 16 a day ago.

- Philip Grant