A 24-hour tour? From the Los Angeles Times:

A dispute between bond king Bill Gross and his next-door neighbor over a $1-million outdoor sculpture has devolved into police calls to their Laguna Beach mansions, multiple legal actions — and allegations that the billionaire investor blared the “Gilligan’s Island” theme song on a loop at all hours to annoy his neighbor.

If things escalate further, “Baby shark” would presumably be the nuclear option. 

How low can it go?  This morning the Turkish lira traded above 8 to the dollar for the first time.  For comparison, less than 6 lira equaled a buck at the beginning of the year, while the exchange rate stood at just 3.5 lira per dollar at the time of a failed coup against President Recep Erdogan in the summer of 2016.  

Government inaction stands as the catalyst for the latest selloff: Last week, the Central Bank of the Republic of Turkey (CBRT) opted to keep its benchmark one-week repo rate unchanged at 10.25%, defying market expectations of a 175 basis point hike and spurring the latest round of lira weakness.  

Raging inflation helps put the FX market’s concerns into context. Thus, year-over-year CPI growth registered at 11.8% in September, the 11th consecutive double-digit increase.  Other measures suggest an even more rapid clip.  Data from the Inflation Research Group finds that prices rose at a 3.61% sequential pace between August and September, nearly four times higher than the 0.97% figure supplied by the Turkish Statistical Institute. 

While easy monetary policy in the face of raging inflation and pronounced currency weakness may strike some as counterproductive, Erdogan himself espoused this economic philosophy in July 2019: “As far as I’m concerned, the most important reason behind high inflation is high interest. If you don’t bring down high interest rates, then high inflation will not come down.” The CBRT, under the leadership of finance minister and Erdogan son-in-law Berat Albayrak, dutifully cut the key rate to as low as 8.25% in May from 24% 11 months earlier. 

“If you look at the policies, (they have) become very hard-headed. And frankly trying to make something logical out of the irrational has become difficult,” Angus Blair, investment banker-turned-professor at the American University of Cairo, told CNBC on Oct. 15. 

While the lira’s value evaporates, a series of regional and international disputes further muddy the waters.  Turkey is currently at odds with fellow North Atlantic Treaty Organization member Greece over disputed territory in the eastern Mediterranean,  and is facing the prospect of U.S. sanctions for purchasing Russian S-400 missiles and for its role in the Azerbaijan vs. Armenia conflict. Erdogan took the opportunity to taunt Uncle Sam over the weekend: "You don’t know who you are dancing with. Whatever the sanctions are, don’t be late. Do it. . . We are not a tribal state, we are Turkey.”  

Then, too, a dispute with France over perceived anti-Muslim bias spurred a call from Turkey’s President to boycott French goods. Erdogan yesterday also opted to advise French President Emmanuel Macron to consult mental health professionals: “He needs to get himself checked out.”  In response, France recalled its ambassador from Turkey. 

As inflation rages and the lira spirals, Turkey’s foreign-currency cache has dwindled to dangerous levels.  Gross FX reserves fell to $42.8 billion as of Oct. 16, down from $80 billion at the beginning of the year and the lowest level since late 2005.  Further declines could prove problematic, as Moody’s downgraded Turkey’s sovereign credit rating to junk in September, warning that “external vulnerabilities are increasingly likely to crystalize in a balance-of-payments crisis.”  In a subsequent downgrade of a dozen Turkish banks, Moody’s analysts speculated that “capital controls and restrictions on foreign currency outflows” could be in the cards.  Erdogan offered a nonchalant response to the Moody’s’ warnings: “Do what you want to do, your ratings are of no importance.”

Meanwhile, the head of another emerging market mainstay looks to take a page from Erdogan’s monetary policy-playbook.  On Friday, Mexican President Andres Manuel Lopez Obador weighed in on the Central Bank of Mexico’s next policy move, following an easing cycle that took the overnight rate to 4.25% from 8.25% in August 2019: “Interest rates are still high. The Bank of Mexico is lowering them, but it has to go even lower for people to want to take out loans.” A hotter-than expected CPI over the first two weeks of October (measured prices rose 4.09% from a year ago, higher than all but two economist estimates) appeared not to figure into AMLO’s calculus. 

Stocks came for sale, as the S&P 500 lost nearly 2% while the VIX ripped higher by 18% to 32.5, its most elevated finish in nearly two months.  Treasurys were well bid, with the yield on the long bond falling five basis points to 1.6%, while WTI crude sank to $38.5 a barrel.   Gold held near $1,900 an ounce.

- Philip Grant

Top of the heap no more. International Business Machines Corp. reported third quarter earnings on Monday, including $17.56 billion in revenues.  That’s down 2.6% from a year ago and 3.1% sequentially and the weakest result since the first quarter of 1997. 

While $2.58 in headline earnings per share was down 4% from a year ago, a series of salutary one-time adjustments spruced up that figure, which was 27% above the $1.89 per share derived from generally accepted accounting principles.  Even those GAAP results were flattered by a meager 7% corporate tax rate.  In 1985, when then-dominant IBM commanded a 6.4% share of the market cap-weighted S&P 500 (a record single-stock concentration until this year), Big Blue paid out 44% of its bottom line in taxes. 

With three quarters of its 2019 revenue base (the information technology infrastructure hardware, software and sales units) under pressure thanks to widespread adaptation of the cloud, you can’t say that IBM is sitting on its heels.  After completing a $34 billion acquisition of open source software provider Red Hat in July 2019, the company announced Oct. 8 that it will spin off its legacy managed infrastructure services unit.  CEO Arvind Krishna explained: “This will accelerate our growth strategy and better position IBM to seize the $1 trillion hybrid cloud opportunity.” 

That rationale is understandable, as the I.T. services unit, which includes the soon-to-be-spun-off division, endured a 6.1% revenue decline in 2019.  The move earned the rousing approval of Mr. Market, as shares closed higher by 6% on the day of the announcement, but good days for the bulls have been few and far between.  Since a bearish analysis in the Feb. 21 edition of Grant’s, IBM shares have lost 21% after accounting for dividends, compared to a 5% gain over the S&P 500. 

While shedding that growth albatross is seemingly a positive step, other concerning signs abound.  For instance, IBM’s global business services (i.e. management consulting) revenue registered just $4 billion, down 5% from a year ago, a concerning sign as the division should be largely inured against the cloud craze. Even the 19% top-line expansion from the cloud unit was well below the 30% year-over-year revenue growth logged in the second quarter.   

Analysts remain circumspect, with six Wall Street analysts rating IBM shares “buy” while 12 judge the stock either a “hold” or “sell.” Following Monday’s earnings report, Keith Bachman of BMO Capital Markets wrote that “underlying business conditions remain weak such that patience will be required, particularly since the spin-off is a year away,” while Bloomberg Intelligence’s Anurag Rana concludes that the flagging top line “may not see any dramatic improvement until the second half of 2021 at the earliest.” 

Then, too, efforts to bolster cloud unit growth haven’t come cheap, as IBM coughed up fancy valuation for Red Hat (10 times revenues, 53 times Ebitda and a 63% premium to the target’s pre-bid closing price). That’s pushed single-A-rated IBM’s net leverage to 2.9 times consensus 2022 adjusted Ebitda, up from 1.5 times Ebitda prior to the deal announcement and 2.0 times net leverage for the median single-A-rated corporate issuer, according to a September analysis from Moody’s.  IBM’s net leverage can be expected to drift still higher, if form holds. Thus, Street consensus currently calls for $18.8 billion in adjusted Ebitda next year, down from a $20 billion 2021 Ebitda guesstimate a year ago. 

Perhaps most concerningly, fast-deteriorating cash generation has further hampered management’s efforts to turn the ship around.  IBM generated just $1.1 billion in free cash flow in the third quarter, far below the $2.3 billion analyst consensus and well short of the $1.5 billion in dividends paid out over the same period.  

Might IBM be facing an extended stay in corporate stagnation purgatory?  Bernstein analyst Toni Sacconaghi noted Tuesday that while CEO Krishna thinks IBM can grow “mid-single digits” by 2022 following the I.T. spin-off, organic revenue declined 6% in the third quarter from a year ago and has fallen by a meaty 11% so far this year. Such a massive top-line turnaround “seems ambitious given that IBM management stated that 70% of its revenues were largely unaffected by the pandemic” in the third quarter.  Bernstein “continues to believe that IBM’s normalized growth rate today is -1%,” and “might be 0% to 1% post its spin-out.” 

The slog continues. 

The printing press is heating up anew, as Reserve Bank credit jumped to $7.11 trillion, up $65 billion from a week ago.  That pushed the three-month growth rate of interest bearing assets at the Fed to 7.5% from 4.9% a week ago, even as the year-over-year comparison continued to edge lower, reaching 80.2% growth this week compared to 81.1% on Oct. 15.  

Rates were routed once more, as Treasurys came under pressure across the curve again with the 30-year yield rising to 1.68%, its highest since mid-March. Stocks caught a moderate bid, with the S&P 500 finishing 60 basis points in the green to narrow its loss for the week so far to less than 1%.  Gold pulled back to $1,907 an ounce, WTI crude crept up toward $41 a barrel, and the VIX slipped 2% to 28. 

- Philip Grant

A pair of Bloomberg headlines, concerning Brazilian President Jair Bolsonaro:

From Oct. 7:

Bolsonaro Declares Brazil Corruption-Free and Ends Carwash Probe

And from Oct. 15:

Bolsonaro Ally Resigns After Covid Cash Found in Underpants

From the unintended consequences files:  The Financial Times reported over the weekend that Federal Reserve higher-ups are considering beefed-up regulation to combat risks associated with the current low-and-lower interest-rate regime.  

Boston Fed president Eric Rosengren told the FT that “if you want to follow a monetary policy. . . that applies low interest rates for a long time, you want robust financial supervisory authority in order to be able to restrict the amount of excessive risk-taking occurring at the same time.”  Neel Kashkari, president of the Minneapolis Fed, added: “I don’t know what the best policy solution is, but I know we can’t just keep doing what we’ve been doing. As soon as there’s a risk that hits, everybody flees and the Federal Reserve has to step in and bail out that market, and that’s crazy. And we need to take a hard look at that.”

A pullback in market interventions may be one way to limit moral hazard. Thus, a report last Thursday from the Congressional Oversight Commission recommended that the Fed wind down its Secondary Market Corporate Credit Facility (SMCCF) bond purchase program initiated during the teeth of the spring panic, explaining that: “Given the Federal Reserve’s success in buoying corporate bond markets and recognizing that primary market investment-grade corporate bond rates are now below pre-pandemic levels, the Commission does not believe that further secondary market corporate bond purchases through the SMCCF are necessary.” 

Indeed, this year’s severe economic shock has visited no lasting damage on financial assets, with the stock market near record highs and credit spreads not far removed from their pre-virus levels, while year-to-date junk bond issuance reached $351 billion on Friday according to Bank of America, some $30 billion above the prior high-water mark set in the 12 months of 2012.  

To be sure, animal spirits are percolating: This morning, Caa1-rated satellite communication concern Ligado Networks (née LightSquared) managed to sell a total of $3.85 billion in first- and second-lien three-year secured debt at 15.5% and 17.5% coupons, respectively, allowing the company to forestall a potential return to bankruptcy (Ligado’s exit financing, a first-lien term loan due in December, fell as low as 48 cents on the dollar in March).  The offering is pay-in-kind, meaning the company will provide interest in the form of additional debt, rather than cash. 

As the Fed’s monetary exertions have reached unprecedented heights during the crisis-wracked 2020, there is every reason to expect more of the same when trouble strikes next. After speculating that the recession may already be over in a speech today, vice chairman Richard Clarida nevertheless declared that “additional support from monetary – and likely fiscal – policy will be needed.”

The seeming convergence between fiscal and monetary policy stands as a singular feature of the current monetary epoch, as exploding federal deficits ($3.1 trillion in the 12 months through September, more than double the prior record set in fiscal 2009) coincide with ballooning Reserve Bank credit at the Federal Reserve, as the central bank currently buys about $80 billion in Treasurys per month, net of reinvestments. Randal Quarles, Fed vice chair for supervision, offered some eye-opening candor in that regard last Wednesday:

It may be that there is a simple macro fact that the Treasury market being so much larger than it was even a few years ago, much larger than it was a decade ago and now really much larger than it was even a few years ago, that the sheer volume there may have outpaced the ability of the private market infrastructure to support stress of any sort there.  

Will there be some indefinite need for the Fed to provide — not as a way of supporting the issuance of Treasuries, but as a way of supporting a functioning market in Treasuries — to participate as a purchaser for some period of time?

It sure seems that way. 

Stocks came under heavy pressure with the S&P 500 losing 1.6% and finishing near its worst levels of the day, leaving the broad index up 6% so far this year.  The Treasury curve steepened a bit with the 30-year yield climbing two basis points to 1.55%, while gold held at $1,905 an ounce and WTI crude remained near $41 a barrel.  The VIX jumped above 29 to approach a five-week high.

- Philip Grant

A clearance sale with Chinese characteristics:  China Evergrande Group, (3333 on the Hong Kong exchange) announced it will sell 490 million shares in a so-called top-up placement at a 13% discount to this morning’s closing price, using the midpoint of management’s provided range. The move would raise just over $1 billion, as the world’s most encumbered property developer – with net debt equivalent to a cool 11.2 times trailing Ebitda – tries to clean up its balance sheet.  

“The placement should tide them through,” Kerry Goh, chief investment officer at Kamet Capital Partners, comments to Bloomberg. “But I don’t think $1 billion is sufficient for them to be able to pare down their large debt. This is just sending a signal to buy some time from creditors to work out the capital structure through the sale of assets or fundraising.”  Evergrande watchers won’t have to wait long for the next financial litmus test, as the company is set to offer RMB 2 billion ($300 million) worth of five-year onshore debt later this week. 

Evergrande managed to escape a major liquidity scare in late September, coming to an agreement with private investors to keep their shares in a company business unit and forego some $13 billion in contractually-owed payments, a move which Breakingviews described as “another miraculous escape” for the developer and its founder Hui Ka Yan.   “The agreement solves the core issue of Evergrande, which is liquidity concern,” added Raymond Cheng, a property analyst at CGS-CIMB Securities. Mr. Market agreed, as the stock price jumped nearly 20% while the benchmark 2025 8 3/4 dollar bonds rallied to 80 cents from 75.

Meanwhile, the company’s fall sales blitz continues apace, as unprecedented base discounts of up to 30% have helped spur an active “Golden Week” season.  Evergrande announced Friday that it had made some RMB 142 billion in contracted property sales from Sept. 1 through Oct. 8, over 70% of its sales goal for the crucial two-month period.  However, the discounts are taking a toll, as those figures equal an average selling price of RMB 8,627 per square meter, down 11% from August levels. 

Time will tell if that discounting strategy will be enough, as nearly half of Evergrande’s RMB 836 billion debt load was scheduled to fall due in the next year as of June. “We are skeptical of the company’s willingness to deleverage given its poor record of adhering to its plans over the years,” CreditSights analyst Luther Chai told the South China Morning Post last Friday. 

Late this summer, Chinese authorities rolled out a trio of new restrictions on property developer balance sheets, including capping debt-to-asset ratios at 70%, net gearing at 100% and short-term debt lesser than or equal to cash reserves.  Firms that fail the “three red lines guidance” test, like Evergrande (which sported a bloated net gearing ratio of 199% and cash equal to less than half of short-term maturities as of June 30), are barred from expanding their liabilities for a year. 

Then, too, Evergrande’s successful efforts to dodge short-term catastrophe haven’t mollified its heretofore-patient lenders. Bloomberg reports that “several” of its largest creditors are cutting their exposures to Evergrande, while a quartet of large banks instructed branches to cease offering new unsecured loans to the developer.  Instead, “large state-owned lenders will only consider new financing for the developer if it’s linked to specific projects with ample collateral and risks that are segregated from Evergrande as a group.” 

The bond market continues to express its own doubts, as single-B-plus-rated Evergrande’s dollar-pay senior secured 8 3/4 notes of 2025 trade near 77 cents on the dollar for a 1,545 basis point spread over Treasurys.  For context, the single-B-rated component of the Bloomberg Barclays High Yield Index currently sports a 454 basis point option-adjusted spread over Treasurys.  

This avatar of the Chinese economic miracle first caught the eye of Grant’s in the June 2, 2017 issue, which speculated that Evergrande would one day reside in the history books alongside “Bank of United States” or “Hindenburg.”  For an update to that analysis, as well as a review of the broader implications of a longer slowdown in China’s property market, see the Oct. 2 edition of Grant’s. 

Apparently, stocks only mostly go up, as the S&P 500 fell by 65 basis points to snap a five-session winning streak and leave the broad index higher by 8.7% year-to-date.  Treasurys were well bid, with the long bond yield falling six basis points to 1.51%, while gold lost nearly 2% to $1,895 an ounce and WTI held near $40 a barrel.  The VIX rose 4% to 26, building on yesterday’s resilience in the face of a ripping stock market.

- Philip Grant

Many happy returns? After a nine-month hiatus, state-owned oil behemoth Petróleos Mexicanos (a.k.a. Pemex) enjoyed a successful foray in the bond market yesterday, selling $1.5 billion in five-year dollar-pay notes, priced-to-yield 6.95%. That compares to initial coupon projections of a 7.5% to 8% on a $1 billion offering size. The issuer-friendly terms were most welcome for Pemex. “They have refinancing needs, so absent more government support they do need to raise money,” Shamaila Khan, head of emerging-market debt at AllianceBernstein, tells Bloomberg.

Government support is a key selling point for Pemex’s creditors. Left-leaning populist President Andrés Manuel López Obrador (AMLO) has made returning Pemex to national glory a central plank of his platform, routinely criticizing the market-based reforms undertaken by his predecessor, which included introducing foreign competition into Mexico.  In July 2019, AMLO awarded Pemex the contract to build a 340,000 barrel per day (bpd) capacity refinery in his hometown of Tabasco, as the front-runner supplied both a lower bid and quicker construction timetable than the foreign competition. 

More fundamental changes may be in store. Bloomberg reported Sept. 22 that AMLO “will consider tweaking his predecessor’s energy reform if his goals of strengthening Pemex. . . can’t be met under current laws.” 

Indeed, the status quo doesn’t seem to be working. On Sept. 29, Bloomberg noted that Pemex’s gasoline market share has slipped by 13% during the 21 months in which AMLO has been in power, compared to a 4.5% market share loss in the preceding 35 months. 

Meanwhile, the long-term production decline from 2004’s peak output of 3.4 million barrels per day (mbpd) continues apace thanks to steady depletion at the offshore Cantarell field (long one of the world’s largest). July production registered at just 1.54 mbpd, the lowest output figure since the 1970s.  Budget Committee Chair Erasmo Gonzalez told Bloomberg in early September that Pemex is now targeting 1.86mbpd in output next year, down from a prior 2.07mbpd goal and increasingly distant from AMLO’s pre-election promises to oversee 2.6mbpd by 2024. 

That long-term decay is exacerbated by an abrupt output downturn at the Ku-Maloob-Zaap field, currently Mexico’s most bountiful (Almost Daily Grant’s, June 7, 2019). Output in the Maloob field plunged to 276,000 bpd in July according to IHS Markit, down 30.8% from a year ago.  

The events of 2020 have further sullied what was a less-than pristine balance sheet. As of June 30, net financial debt of $106 billion, along with a further $65 billion in pension liabilities, while second quarter Ebitda of $858 million was down more than 80% from a year ago. The company is on track to burn cash for a tenth straight year, posting a cool $82.5 billion in aggregate negative free cash flow from the beginning of 2010 through June 30 of this year.   

On April 17, Moody’s cut its rating on Pemex debt to junk at Ba2 (equivalent to double-B), joining a similar verdict from Fitch and officially sending Pemex’s more than $50 billion of dollar-pay marketable debt into the “fallen angel” category.  The timing of those downgrades is less than ideal, as Pemex may need to return to the bond market sooner rather than later. 

Analysts at Bloomberg Intelligence noted Sept. 15 that the company’s $1.6 billion cash balance as of June 30 represents just over 10% of short-term financial debt.  Since a bearish analysis in the March 23, 2018 edition of Grant’s, Pemex’s 6 3/4% bonds due 2047 have seen their spreads widen to 699 basis points from 390. Over that period, five-year credit default swaps have jumped to 573 basis points from 193 basis points. Despite catching downgrades from all three rating agencies this spring, Mexico’s sovereign CDS have barely budged, last changing hands at 118 basis points compared to 114 in March 2018. 

Might a hypothetical future Pemex bailout further pressure Mexico’s sovereign credit profile? AMLO appears unconcerned. An anonymous source explained the President’s thinking to Reuters on Sept. 22: “He said the free market is like ‘a fox guarding the hen house’ and that what we need to do is have the regulators and the government give the market to the state companies so that they can run the market.”

Another banner day for the bulls, as the S&P 500 jumped nearly 1% to wrap up the week almost 4% higher.  Gold also caught an aggressive bid, jumping 2% to $1,938 an ounce, while WTI pulled back to near $40.5 a barrel.  Treasury yields finished little changed with the long bond settling at 1.57%, and the VIX fell to 25, down 5% on the day. 

- Philip Grant

Instructive bond market action Down Under:  Yesterday evening, Australia’s Treasurer Josh Frydenberg presented a budget to parliament anticipating an A$214 billion ($152 billion) deficit in the fiscal year ending June 30, equivalent to 11% of gross domestic product, as the country tries to climb its way out of its coronavirus-related economic hole. The economists’ consensus calls for an 8% unemployment rate by year end, a figure which would represent a 22-year high.

Australia’s sovereign creditors, already under the yoke of “yield-curve control” (the ReserveBank of Australia has established a 25 basis point ceiling on debt out to three years), reacted to the news of runaway deficits with something less than alarm.  The yield on three-year government bonds sank to a record-low 12 basis points, down from 16 basis points on Tuesday. The 30-year bond yield, which is not under the yoke of yield-curve control, stayed little changed at 1.77%. 

The fiscal stimulus saga continues apace in the nation’s capital, as President Trump tweeted yesterday evening: “If I am sent a Stand Alone Bill for Stimulus Checks ($1,200), they will go out to our great people IMMEDIATELY.” That’s a change from roughly eight hours prior, when POTUS declared: “I have instructed my representatives to stop negotiating until after the election.”  Naturally, those conflicting tweets sent asset prices into spin cycle. 

As the political class continues to bicker and markets gyrate, our monetary mandarins strike a consistent chord.  Fed chair Jerome Powell seemingly addressed the fiscal powers-that-be in a speech yesterday: “The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.” 

By Powell’s reckoning, the more the better: “At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship. . . even if policy actions ultimately prove to be greater than needed, they will not go to waste.”  

“He’s become a broken record,” Diane Swonk, chief economist at Grant Thornton, tells The Wall Street Journal. “There is nothing all that new in the message, but the urgency is getting greater.”   

From an output perspective at least, there is good reason for concern.  As Bianco Research notes today, Wall Street economists now expect fourth quarter GDP to expand at a 3.6% annualized rate, a solid figure in normal times but far below the 11.5% fourth quarter estimate seen on June 11, as the U.S. economy wrapped up its worst quarter on record with a 31.4% sequential annualized contraction.  

Then again, existing programs, like the $2 trillion-plus CARES Act signed in March, have pushed government red ink to previously unimaginable levels.  A striking chart, posted on Twitter yesterday by Bianco Research co-founder and eponym Jim Bianco, puts this year’s exertions into historical context:

This afternoon’s release of the minutes from the Sept. 15-16 meeting of the Federal Open Market Committee laid out one argument for returning to the fiscal well : “Participants viewed fiscal support from the CARES Act as having been very important in bolstering the financial situations of millions of families, and a number of participants judged that the absence of further fiscal support would exacerbate economic hardships in minority and lower-income communities.”

Of course, Mr. Market hasn’t waited for Congress. Instead, ultra-loose monetary policy has seemingly done the trick, as evidenced by euphoric price action in stocks and speculative corners of the bond market since the spring. 

One constituency seems to be faring pretty well in this pandemic-plagued 2020. The Financial Times relays some striking data, courtesy of UBS’s recently published annual report documenting the richest of the rich. The Swiss bank finds that the billionaire cohort had amassed a record $10.2 trillion of wealth as of July, topping the prior high-water mark set in 2017 and well above the $8 trillion logged in April. 

The report puts it this way: “When the storm passes, a new generation of billionaire innovators looks set to play a critical role in repairing the damage.”  Investment from tech-oriented billionaire investors, the report argues, “has the potential to help bridge financial social and environmental deficits.”

Or, perhaps, the opposite. 

Stocks raced higher with the S&P ripping nearly 2% to close within 4.5% of its Sept. 2 high-water mark, while Treasurys gave back some of yesterday’s feverish late rally with the 30-year yield rising to 1.58%.  WTI crude fell below $40 a barrel following an unexpected weekly inventory supply build, while gold slipped back below $1,900 an ounce and the VIX retreated toward 28.  

- Philip Grant

The health of corporate America is on the upswing, at least according to investor sentiment regarding leveraged loans, or tradable bank debt issued by speculative-grade borrowers.  A portfolio manager survey conducted by S&P Global’s LCD unit last week found that respondents now expect loan defaults to top out at 6.6% in the middle of next year, down from an anticipated peak of 7% to 8% surveyed in March.  Fitch Ratings likewise offers an improved assessment, now penciling in a 2021 default rate of 7% to 8% from a prior 8% to 9% forecast range.  

That projected improvement follows an impressive price recovery, as the LSTA Leveraged Loan Index has clawed nearly all the way back to unchanged for 2020, having erased the harrowing 12.5% decline in March.   

The sharp rebound has helped to reopen funding markets, as issuance jumped to $87 billion in the third quarter, up 60% sequentially, while some $16 billion in deals are expected to price this week alone, according to Bloomberg.  The ratio of issuer friendly “price flexes” to such moves favoring investors approached 16 to one in the third quarter, by far the highest disparity since at least 2016.  Opportunistic issuers are making sure not to miss their chance:  new loans used to finance dividend recaps (i.e., payouts to the issuer’s private equity sponsor) footed to $15.8 billion in the third quarter, the busiest such period since the first quarter of 2017.  

Improving sentiment has brought echoes of cycles past.  Bloomberg reported Friday that Cerberus Capital Management has formulated a triple-A-rated securitized debt product comprising triple-B-minus-rated commercial mortgage backed securities, in a move recalling the infamous collateralized debt obligations of the last cycle (see the March 23, 2007 edition of Grant’s for a preview of that pileup).  Some 9% of all commercial mortgage debt which has been bundled into bonds was delinquent at the end of August, according to data from Trepp. 

As investors and issuers alike celebrate the apparent return to business as usual, the events of 2020 continue to take a toll on broad corporate health. In a separate report last week, LCD relays that some 33% of all outstanding loans are from issuers rated single-B-minus (“adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments”) or worse as of Sept. 22, up from 23% a year ago.  While the unpleasant events of 2020 figure prominently in that deterioration, its worth noting that the downgrade-to-upgrade ratio for institutional loans reached three-to-one in the second half of 2019, the worst such showing since 2009.

The ubiquity of so-called covenant-lite documentation adds another wrinkle to the dirty shirt. As data from S&P suggest, widespread adaptation of borrower-friendly legal structures (accounting for about 80% of the loan market, compared to 17% in 2007) have adversely impacted default recovery rates:

The cohort of [restructured cov-lite loans] issued after the credit crunch — the 2.0 incarnation — remains thin, at just 39 observations. However, the data indicate that these loans have underperformed cov-lite 1.0 loans, with an average recovery of 59%, versus 77% for those issued prior to 2010. These 39 loans had an average debt cushion [meaning debt that is subordinated to loans] of roughly 15%, vs. 32% for 2004-2010 cohort.

Importantly, the post-crisis cov-lite proliferation coincided with a secular boom in leveraged loans.  Thus, the loan market grew at a 10.2% compound annual rate from 2010 to 2019, nearly triple that of junk bonds.

Then, too, rising debt levels among speculative-grade corporate borrowers ensure heavy burdens in coming years.  A brand new report from Moody’s finds that U.S. junk-rated companies now sport a record $1.41 trillion in debt maturing between 2021 and 2025, up 19% from the 2020 to 2024 period measured only a year ago. Leveraged loan and revolver maturities account for $903 billion of that sum, up 20% from the year-ago figure.  

A rout in Treasurys, as the back end of the curve was hammered with the long bond jumping 10 basis points to 1.57% while the 2- vs 30-year spread reached 142 basis points, testing the multi-year highs set in early June.  Stocks caught another bid with the S&P 500 gaining 1% to leave the broad index up 5.5% year-to-date, while WTI crude ripped back above $39 a barrel and gold rose to $1,918 an ounce.  The VIX finished at 28. 

- Philip Grant

Nudie mag Playboy announced today that it will go public via a merger with blank-check “SPAC” Mountain Crest Acquisition Corp. at a $415 million valuation. Once the deal receives regulatory approval, Playboy will trade on the Nasdaq under the ticker PLBY.  As CNBC’s Leslie Picker notes, the new company will feature an all-male board of directors. 

Due diligence? They probably read it for the articles. 

The Commodity Futures Trading Commission and Southern District of New York today announced charges against the BitMEX exchange for illegally offering crypto derivative contracts and for failing to conduct anti-money laundering checks. The filing explained:

BitMEX touts itself as the world’s largest cryptocurrency derivatives platform in the world with billions of dollars’ worth of trading each day. Much of this trading volume and its profitability derives from its extensive access to United States markets and customers.

Nevertheless, BitMEX has never been registered with the CFTC in any capacity and has not complied with the laws and regulations that are essential to the integrity and vitality of the U.S. markets.

The Hong Kong-headquartered company has long been at the vanguard of crypto, offering customers up to 100 times leverage on certain crypto futures. 

For more on recent developments in crypto-land and their implications, see the center section in the brand new edition of Grant’s. 

The gnomes have been busy. Yesterday, The Swiss National Bank announced it spent CHF 90 billion ($98 billion) intervening in currency markets over the first six months of the year in a bid to keep a lid on franc appreciation against the euro as well as the dollar.  Bloomberg notes that that six-month figure represents a larger currency intervention than the past three years combined.  

To hold down the franc, the SNB buys euros then diversifies into dollars and other currencies, buying, amongst other things, U.S. stocks. As of June 30, 2020, the SNB held $118.3 billion in American equities, including, for instance, $4.6 billion worth of Amazon, $6.3 billion of Apple and $1.1 billion in Home Depot.

Those accelerating efforts have had limited success. The venerable “swissie,” which has long served as a currency safe haven, reached a five-year high of 1.05 to the euro in May (the lower the cross, the stronger the franc), since easing a bit to 1.09 but still much stronger than the 1.21 per euro rate last seen in mid-2018.  

There is more where that came from, as a statement from the bank last week explained:

The SNB’s expansionary monetary policy is necessary to ensure appropriate monetary conditions in Switzerland and to stabilize economic activity and price developments. . . In view of the fact that the Swiss franc is still highly valued, the SNB remains willing to intervene more strongly in the foreign exchange market.

In a further effort to discourage FX inflows, Switzerland “boasts” the lowest policy rate in the world at an eye-watering minus 75 basis points. With the powers-that-be hesitant to dive deeper into the negative rate abyss, currency price suppression stands as the next-best option.

SNB chairman Thomas Jordan made the argument at a speech to the International Monetary Fund in July: 

Even though we still have scope for further interest-rate cuts, the fact remains that one cannot lower interest rates indefinitely. For this reason, interventions in the foreign exchange market, in which we buy foreign currencies and sell Swiss francs, also play a central role in our policy mix.

Those open-market exertions are having an impact in at least one respect. The SNB’s balance sheet now stands at CHF 950 billion as of Aug. 31, equivalent to nearly 150% of 2019 nominal GDP.  That compares to 33% and 49% ratios of central bank assets-to-trailing output for the U.S. and eurozone, respectively. 

A bubbly domestic housing market is part and parcel of the SNB’s efforts to beat back unwanted currency gyrations. UBS’s Swiss Real Estate Bubble Index jumped sharply in the second quarter towards bubble territory, as falling incomes from the pandemic and lockdowns contrast with a 4% jump in owner-occupied home prices versus the second quarter of 2019, the biggest such gain in seven years. That helped push price-to-annual rent and price-to-household income ratios to near 33 times and seven times, respectively, up from about 31 times rent and 6.3 times income five years ago.  

The Sept. 19, 2014 edition of Grant’s proposed a speculation in three-year call options on the Swiss/euro exchange rate, figuring that the SNB would eventually be forced to abandon its financial Maginot Line of a 1.2 franc-to-euro exchange-rate established in fall 2011.  That hypothesis indeed came to pass in January 2015, sending the CHF/EUR cross plunging to as low as 0.97 and generating handsome profits for those derivative contract-holders. 

Might the preconditions for a sequel to that 2015 FX regime change already be in place? For context, at the time of that analysis, the SNB held assets equivalent to 83% of output, or just over half of today’s relative balance sheet footings. 

Stocks caught another bid, with the S&P rising 60 basis points to close within 6% of its Sept. 2 peak, while Treasurys held steady after yesterday’s selloff with the long bond holding at 1.46%.  Gold rose to $1,911 an ounce, its best finish in nearly two weeks, while WTI tumbled below $39 a barrel.  The VIX erased early losses to end the day near 27. 

- Philip Grant

Deal of the day:  Big Hit Entertainment, the record label behind Korean boy-band BTS, priced an initial public offering at KRW 135,000 ($115) per share (the top end of its range) for a total valuation of $4.1 billion, which would be South Korea’s biggest IPO in three years.  The institutional tranche of the offering was reportedly oversubscribed by a cool 1,000 times. 

As that chart-topping debut demonstrates, it’s a good time to go public.  Stateside, some $95 billion worth of IPOs have debuted so far this year, already closing in on the full-year post-2000 issuance record of $96 billion established in 2014. 

The deal frenzy has opened the door for all sorts of inventive structures, as so-called special purpose acquisition vehicles, or SPACs (a.k.a. “blank check” companies) have proliferated, raising more than $41 billion in the year to date through Thursday, more than the last 10 years combined.  Up next, “SPACs of SPACs,” as Bloomberg reports that Boston based Easterly Partners is planning a $100 million fund to invest in the blank check funds.  

A headline-grabbing win for Uber Technologies, Inc., as a London court ruled that the ride share giant is “fit and proper” to conduct operations in the city.  The decision beats back a challenge from regulator Transport for London (TfL), which declined to renew Uber’s license last fall following revelations of a spate of unauthorized drivers using fraudulent identification photos. 

It was, however, an incomplete victory, as the court granted an 18-month license, well short of the five-year maximum authorization. As a TfL spokesperson explained, the company remains on something akin to double-secret probation: “This 18-month license with a number of conditions allows us to closely monitor Uber’s adherence to the regulations and to swiftly take action if they fail to meet the required standards.”

Then, too, today’s victory removes only one legal roadblock in London, as the U.K.’s top legal body continues to deliberate over the company’s reliance on independent contractor status for its drivers, allowing Uber to avoid paying health insurance and other benefits, a battle which is also playing out in California and other jurisdictions (Almost Daily Grant’s, Sept. 15).  Britain’s Supreme Court is expected to deliver its ruling as soon as October.  

“If the Supreme Court says that Uber’s drivers are workers, and not genuinely self-employed as Uber maintains they are, drivers will be entitled to holiday pay, the national minimum wage and certain other entitlements,” Joseph Lappin, partner and head of employment at U.K. law firm Stewarts, tells the Financial Times. “I suspect that Uber will lose in the Supreme Court. [In that case], Uber’s costs would swell.”

The good times are here again for the private equity industry, at least if the reappearance of so-called dividend recapitalizations is any indication.  Thus, Bloomberg reports that some $8.6 billion worth of such dividend recap deals (in which funds are used for payouts to a company’s private equity promoters) have been priced this month through Sept. 18. That’s equivalent to about 25% of total loan deal volume and already the busiest full month period for such recap deals in an even three years. 

While p.e. looks to capitalize on the stirring post-March recovery in asset prices, some question the self-reported performance benchmarks which have underpinned the industry’s marketing efforts. Ludovic Phalippou, professor of finance at Oxford’s Saïd Business School, argued in a mid-September online event with the Securities and Exchange Commission that the p.e. industry’s heavy use of subjective and easy-to-game metrics, most notably the internal rate of return (IRR), provide investors with a misleading picture of risk and return.  

Citing documents from p.e. giant Apollo Global Management touting a 39% IRR over the last 30 years, Phalippou dryly retorted: “A $1 billion investment earning 39% annually over 30 years would be worth $20 trillion. And $20 trillion is the GDP of the United States. I think we would have noticed.” 

For a closer look at p.e. through the years, along with a way to profit from a reversal in the torrid current conditions, see the July 10 issue of Grant’s. 

A bull rampage saw the S&P 500 rise more than 1.5%, as the broad index now sits higher by nearly 4% this year so far and has closed to within 6.5% of its Sept. 2 high-water mark.  The Treasury curve steepened a bit with the 30-year yield ticking to 1.42%, while gold jumped 1% to $1,888 an ounce and WTI crude rose to about $41 a barrel.  The VIX gave back early gains, holding near 26. 

- Philip Grant