Root, Branch and Limb
No guts, no glory:

No guts, no glory: The time is nigh for John Q. Public to put idle cash to work, Citi Global Wealth chief investment officer David Bailin argues to Bloomberg today, as the tantalizing prospect of lower benchmark rates next year along with steady earnings growth form a potent tailwind for the classic portfolio mix of 60% stocks and 40% bonds.  

That investment strategy generated a stellar 9.6% return in November alone per analysts at Bank of America, good for the best single-month performance in more than 30 years. Yet the alure of near 5% risk-free income remains too attractive to pass up for much of the public, even with the S&P 500 and Nasdaq 100 posting 19% and 46% year-to-date gains, respectively. Money market funds attracted a net $62 billion during the seven days through Wednesday according to data from the Investment Company Institute, pushing industry AUM to a record $5.9 trillion.  

“I’m not sure what investors are waiting for,” Bailin puzzled. “The U.S. economy is going to stay strong and, eventually, money market rates are going to come down, so why are people not buying core 60/40 portfolios?”

Might a 100/0 strategy better fit the bill? A trio of academics made the case earlier this fall, as finance professors Scott Cederburg at the University of Arizona, Aizhan Anarkulova at Emory University and Michael S. O’Doherty at the University of Missouri posited in a Nov.2 white paper that “an even mix of 50% domestic stocks and 50% international stocks held throughout one’s lifetime vastly outperforms age-based, stock-bond strategies in building wealth, supporting retirement consumption, preserving capital, and generating bequests.”  A review of variables including labor earnings, social security benefits and actuarial data in the context of U.S. retirement savings leads the group to conclude that “Americans could realize trillions of dollars in welfare gains by adopting the all-equity strategy.”

Stateside shareholders, at least, face an uphill climb to long-term outperformance, as historically lofty valuations could crimp future returns. The ratio of corporate equity value (as measured by the Wilshire 5000) to GDP – a.k.a. the Buffett indicator – stood at 180.5% at the end of last month per data from VettaFi research analyst Jennifer Nash.  That’s down from its fall 2021 peak of 208.2% but still well above the 159.2% logged at the climax of the dot.com bubble, which represents the richest pre-Covid reading going back to at least 1950. 

Yet as it pertains to the pursuit of stonk market riches, American ingenuity remains second to none. Thus, GameStop Corp. (ticker: GME) unveiled an eye-catching strategy pivot Thursday, disclosing in a filing that it will permit newly minted CEO Ryan Cohen to purchase equities with the corporate purse rather than just short-term debt. What’s more: Cohen, the retailer’s largest shareholder, is permitted to buy for the company’s account the same stocks as he holds in his own. 

The news duly caused a stir on Wall Street, with Wedbush analyst Michael Pachter describing Cohen’s new arrangement as “one of the most inane moves we’ve ever seen,” adding thus:

Investors have a myriad of investment vehicles available to them and therefore do not need GameStop to act as a mutual fund. The company’s decision to invest in equities other than its own is alarming, implying that GameStop management believes it will earn better returns by buying equities aside from its own.

Mr. Market doesn’t appear to be bothered, at least, as GME shares jumped 10% following that bulletin. Though the stock remains 81% below their January 2021 blow-off peak, investors value the purveyor of video games at 114 times Wall Street’s adjusted earnings per share forecast for the fiscal year ending January 2025.

Recap Dec. 8

A solid November payrolls report spurred weakness across the Treasury curve as the two-year note jumped 13 basis points to 4.71% and the long bond rose to 4.31% from 4.25% Thursday, though stocks were unconcerned as the S&P 500 racked up modest gains to settle higher by 1% for the week.  WTI crude extended its bounce above $71 a barrel, gold fell to $2,003 per ounce and the VIX retreated to near 12. 

- Philip Grant

Flexible Average Inflation Targeting, in Practice
Here’s Federal Reserve Governor Christopher Waller

Here’s Federal Reserve Governor Christopher Waller in May 2021, after the so-called core consumer price index advanced at a 3% annual clip, far above the 2.3% consensus:

Despite the unexpectedly high CPI inflation report yesterday, the factors putting upward pressure on inflation are temporary, and an accommodative monetary policy continues to have an important role to play in supporting the recovery. We will not overreact to temporary overshoots of inflation.

And Waller late last month, after core CPI printed 4% versus a 4.1% economist expectation:

I am increasingly confident that policy is currently well positioned to slow the economy and get inflation back to 2%. . . if we see this [decline] continuing for several more months . . .  you could then start lowering the policy rate just because inflation is lower… it’s just consistent with every policy rule I know from my academic life and as a policymaker. If inflation goes down, you would lower the policy rate.

Twenty-Four on the Floor
Let there be deals!

Let there be deals! A bulging mergers and acquisitions pipeline may be set to flow forth in the new year. “There’s a huge backlog of transactions,” Moelis & Co. founder and eponym Ken Moelis advised attendees at a Goldman Sachs-hosted conference yesterday, as the dust settles from the Federal Reserve’s aggressive, belated post-Covid tightening cycle, with substantially lower borrowing costs in store next year if bets in the interest rate futures market prove accurate. 

Such a renewed buyout boom would, of course, provide a jolt to the leveraged finance machine. Domestic new-issue institutional leveraged loan volumes registered at $76 billion in the third quarter according to PitchBook, the best showing since the opening three months of last year but roughly half of the quarterly average across 2021.  

Even the white-hot private credit market, which has seen assets double to $1.75 trillion over the past five years according to S&P Global, could use a nudge per some practitioners. “One of the few disappointments of 2023 was the lack of new deal flow and M&A,” Florian Hofer, director of private debt at Golding Capital Partners, told Bloomberg. “The debate now is if there’s going to be more of that in 2024.” 

Yet as industry players eagerly await a pickup in activity, one regulator looks to slam the brakes.  In its biannual Financial Stability Report released yesterday, the Bank of England called out leveraged loans and private credit as “particularly vulnerable” to “sharp revaluations of credit risk,” as the post-2021 updraft in borrowing costs puts the squeeze on cash-strapped borrowers within those floating-rate categories.  

Fast-waning debt service capacity in the syndicated lending realm lends credence those concerns, as the ratio of Ebitda to interest expense on a weighted-average basis within the Morningstar LSTA Leveraged Loan Index slipped to 3.8 times in the three months through September per PitchBook, the fifth straight quarterly decline from 5.6 times in the spring of 2022. The share of issuers laboring to keep their heads above water is likewise on the march, as 26% of the index sports trailing 12-month Ebitda (less capital expenditures) of less than 1.5 times interest expense, double the prior year’s tally and approaching the 29% virus-cum-lockdown era peak. 

Might a similar deterioration be at play beyond Mr. Market’s prying eyes? The BoE warned yesterday that “the opacity of private credit markets makes risks in the sector challenging to monitor in the U.K. and globally.” To that end, Reuters relays that the BoE’s Prudential Regulation Authority has instructed megabanks JPMorgan, Goldman Sachs and Bank of America to report their exposures to the asset class, including the account details of individual clients.

The prospect of a renewed M&A boom adds urgency to those concerns. Analysts at Moody’s Investors Service wrote on Sept. 26 that, as “private credit lenders have been building a considerable arsenal of dry powder,” rising competition to consummate deals “will likely cause pricing, terms and credit quality to erode, fueling systemic risks.”  

As industry assets pile sky-high, typically tight legal language protecting creditors may now be going by the wayside, the rating agency concluded in an Oct. 26 report, following a review of 28 private credit transactions and 15 broadly syndicated loans:

Despite a history of stronger terms, private credit is dropping maintenance covenants in larger deals. For years private credit has offered superior covenants. However, as these lenders increasingly compete with the bank loan market, key protections such as term loan maintenance covenants are falling away from large private credit deals (a more recent phenomena in this market), consistent with well-established trends for syndicated loans. 

See the brand-new edition of Grant’s Interest Rate Observer dated Dec. 8 for a look under the private credit hood within the context of “leverage, interest rate, cyclicality and regulatory arbitrage,” along with the Nov. 24 edition for a bearish analysis on one prominent industry player whose blue-sky valuation arguably obscures a risky portfolio and perhaps-unsustainable fee structure. 

QT Progress Report
Reserve Bank credit stands at $7.697 trillion following a $71.5 billion weekly decline. The Fed’s portfolio of interest-bearing assets now sits $125 billion below its early November levels and 13.7% from its March 2022 highs. 
Recap Dec. 7

Animal spirits percolated ahead of November payrolls tomorrow, as the Nasdaq 100 advanced 1.4% to settle within 4% of its fall 2021 peak. Treasurys were mixed with the long bond edging higher by three basis points to 4.25% and the two-year ticking to 4.58% from 4.6% Wednesday, gold stayed at $2,058 an ounce and WTI crude managed only a modest bounce south of $70 a barrel

- Philip Grant

Moth to the Fame

You can’t keep a good influencer down (or up, in this case). From the New York Times:

A YouTuber who intentionally crashed his plane in Southern California and recorded a video of it in a scheme “to gain notoriety and to make money” has been sentenced to six months in prison for obstructing an investigation into the crash by destroying the wreckage, federal prosecutors said Monday.

The YouTuber, Trevor D. Jacob, 30, of Lompoc, Calif., pleaded guilty in June to one count of destruction and concealment with the intent to obstruct a federal investigation, after he removed the wrecked plane from the crash site in December 2021, just over two weeks after the episode, according to a plea agreement filed in U.S. District Court in Los Angeles. . . In the statement provided by his lawyers, Mr. Jacob said he had learned more about himself from the criminal case than in his entire life previously.

“I am excited to continue my positive growth as a person through my six-month term in prison,” he said. “This was a massive learning experience.”

Exchange Place
Everyone into the pool:

Everyone into the pool: November’s euphoric price action was on full display within the exchange traded fund realm, as investors poured a net $95 billion into the asset class per data from Bloomberg, the fifth-highest monthly inflow on record. Upwards of 1,400 ETFs took in net cash, the most ever, while 27 saw a $1 billion-plus influx, a figure topped on only two other occasions.

Building anticipation of a regulatory green light for spot bitcoin ETFs underpins that asset gathering spree.  Crypto-focused investment products have taken in net inflows for 10 straight weeks to the tune of $1.76 billion according to CoinShares, the best such stretch since the introduction of bitcoin futures ETFs in October 2021.  

That dynamic has spurred some less prominent digital players to eye-watering heights.  As the Financial Times relays today, the Grayscale Filecoin Trust (ticker: FILG) settled yesterday at $34 per share, a near-700% premium to its net asset value, while similar Grayscale trusts tracking solana, chainlink and Decentraland’s mana token each change hands at between two and four times their respective NAVs.  

“There is a very strong appetite for crypto products at the moment as the crypto winter has melted,” Grayscale CEO Michael Sonnenshein told the pink paper. Bryan Armour, director of passive strategies research North America at Morningstar, puts it a bit differently: “I wouldn’t know what [investors] could be thinking buying at these prices. A lack of understanding can easily be part of it.”

While risk appetite in the crypto realm reaches feeding frenzy territory, a new frontier in short-term speculation is at hand. As CNBC reported Friday, the Nasdaq has recently launched a quintet of ETFs derived from zero-day to expiration options tracking oil, natural gas, gold, silver and long-dated Treasury bonds.  Those avant-garde offerings follow an explosion of popularity for the ultra-short-term contraptions, as zero-day options account for more than 40% of derivatives volumes tied to the S&P 500 so far this year per the CBOE, compared to 5% in 2016.  

Noting that demand for the commodity-based 0DTE products primarily stems from institutions looking to add leveraged exposure without the need to settle their positions, VettaFi financial futurist Dave Nadig added that “I think most individual investors probably don’t have any business in here at all.”

Luckily, punters looking to enhance their risk profile have just the ticket.  The Bank of Montreal launched an S&P 500-based exchange traded note designed to deliver four times its daily performance today, the most amply geared ETN available in the U.S. according to CFRA. 

The notes, which trade on the NYSE Arca under ticker symbol XXXX, sport a 95-basis point expense ratio and reset after each session to maintain the stated leverage ratio. Accordingly, “their performance over longer periods of time can differ significantly from their stated daily objectives,” BMO points out in the prospectus. “The notes are riskier than securities that have intermediate- or long-term investment objectives and are not suitable for investors who plan to hold them for a period other than one day or who have a ‘buy and hold’ strategy.” 

BMO’s caveats aside, some observers see big things ahead for such high-wire vehicles. “I suspect the [demand for leveraged products] will continue to grow as retail continues to adopt these,” Todd Sohn, ETF analyst at Strategas Securities, told CNBC. “Now you have retail traders able to [transact] from their phone anywhere they want, and these products help to cater to that.” 

Recap Dec. 5

News from the Labor Department that domestic job opening slipped to 31-month low in October spurred another bid in Treasurys, as 2- and 30-year yields settled at 4.57% and 4.3%, respectively, down 7 and 13 basis points on the day.  Stocks by contrast remained on the back foot following Monday’s relatively weak showing, with the S&P 500 finishing just below unchanged, while WTI crude fell below $73 a barrel and gold retreated to $2,019 per ounce. The VIX stayed put south of 13. 

- Philip Grant

Upstairs Downstairs

Place your bets.  A pair of headlines today from Bloomberg:

Investors Yank Money Out of ETFs Tracking Inflation-Hedged Bonds

Gold Calls Bid Up as Metal Closes in on Record

Time out of Mind
The recent bull stampede has served to crack open

The recent bull stampede has served to crack open the window for initial public offerings once more.  CNBC relays that fast-fashion retailer Shein, last valued at $66 billion, is preparing for a U.S. exchange debut in 2024. Casual dining chain Panera Bread, bought by JAB for $7.5 billion in 2017, filed confidential paperwork with the Securities and Exchange Commission for the same purpose according to the Financial Times. Private credit firm HPS Investment Partners, which was carved out of JPMorgan in 2016 at a $1 billion price tag and now manages roughly $100 billion, has done the same per Bloomberg, as has Kim Kardashian-backed shapewear firm Skims, which recently attained a $4 billion bogey. 

A revived pipeline can’t materialize soon enough for some, as this year’s rousing rebound in the major indices has so far proved insufficient to revive moribund equity capital markets. Domestic IPO volume sums to just $20 billion since Jan. 1 per Dealogic, slightly above last year’s pace but off some 90% from the 2021 bumper crop.  

What’s more, those few firms managing to run the IPO gauntlet are often obliged to swallow less favorable terms to do so, as high-profile names Instacart and Klaviyo debuted at 77% and 8% respective discounts to their previously attained private market prices. Overall, median public listing exit valuations stand at $157 million in the year to date per a Nov. 8 PitchBook analysis, the lowest figure in a decade.

That dynamic has duly begun to ripple across the venture capital industry, as evidenced by the growing share of deals taking place at a discount to their prior price tag. So-called down rounds accounted for 19% of all such financings so far this year according to equity management firm Carta, up from 5% in 2021, with more pain potentially in store. “There’s a pile-up of financings coming for the first half of 2024,” Chris Douvos, a limited partner in early-stage venture funds, told The Information last month. “That pig is slowly working through the snake.”

Another round of “right sizing” from one industry bellwether will do little to burnish optimism on that score. Bloomberg reported yesterday that Tiger Global has marked down its largest fund by 18% after cutting internal valuations across a variety of portfolio companies. Among the notable changes: a 69% markdown in a Bored Ape Yacht Club nonfungible token collection, as well as a 94% discount in holdings of NFT marketplace OpenSea.  Those valuation cuts follow a 33% haircut to Tiger’s v.c. holdings in 2022.

Waning industrywide activity accompanies those eye-catching concessions. Venture funding activity by both deal count and deal value is tracking at its lowest level since 2019, PitchBook relays, while median late-stage deal sizes slipped to $5.8 million over the first nine months of the year, down 42% from 2021 and on pace for a six-year low. 

A protracted slump could spell big trouble for the teeming ranks of highly valued, cash needy startups facing a daunting road to the public markets, as the global roster of privately held firms valued at $1 billion or higher has ballooned to 1,230 per CBInsights, more than double that seen three years ago. 

Thus, The Information relayed Monday that eco-friendly construction startup Veev “is in the process of shutting down,” likely spurring a total wipeout for investors who poured $600 million into the firm and marking the third so-called Unicorn to wind down in the past six weeks.  More broadly, 532 startups gave up the ghost via bankruptcy or dissolution from January through September according to Carta, well above the 467 seen during all of last year.  The three months through September alone saw 212 startups fold, the largest such tally on record.

There’s always a bear market somewhere. 

Recap Dec. 1

The asset price party continues in full effect, as stocks rose another 0.6% on the S&P 500 while Treasury yields plummeted with the two-year note and long bond settling at 4.56% and 4.4%, respectively, down 17 and 14 basis points on the session. Gold reached the cusp of a new peak at $2,071 an ounce, WTI crude, WTI crude tumbled below $75 a barrel and the VIX stayed south of 13. 

- Philip Grant

Midnight Scrambler

Let’s call it regulatory arbitrage. From the Associated Press:

Powerball losers in Iowa were actually winners for about seven hours this week after the state’s lottery mistakenly posted the wrong winning numbers for the game. Lottery officials blamed an unspecified “human reporting error” for the wrong numbers being posted for Monday night’s Powerball drawing.

The incorrect numbers were posted on the Iowa Lottery’s website at about 12:30AM Tuesday and it took until 7:15AM before anyone noticed the mistake, took down the numbers and halted payoffs.  The lottery said the initial, incorrect numbers would have resulted in prizes ranging from $4 to $200 – officials didn’t specify how many people won. 

Anyone who got up early and cashed in a winning ticket will be able to keep the money.

The Greatest Story Ever Told
To infinity and beyond!

To infinity and beyond! Banner showings for benchmark assets was the name of the game for November, as Mr. Market ponders a future bright enough to require shades.  A review of recent financial superlatives now follows: 

Thus, the Bloomberg U.S. Aggregate Index, a broad gauge of the domestic investment-grade fixed income universe, generated a 4.91% return from the start of November through Wednesday, on the verge of easily establishing its best one-month performance since May 1985. Bourgeoning optimism over a reversal of the Fed’s post-pandemic tightening cycle has helped drive that historic run, highlighted by Fed Governor Christopher Waller’s Tuesday remark that “you could then start lowering the policy rate just because inflation is lower.” 

Indeed, the Personal Consumption Expenditures Core Price Index rose at a 3.5% annual clip in October, data released today show, the slowest growth rate since April 2021 and down from 4.9% at the start of the year.  Though that figure remains well above the central bank’s self-imposed 2% “price stability” target, interest rate futures now pencil in a 4.22% Fed Funds rate by year end 2024, compared to 4.67% on Halloween.  

Complementing those slowing price pressures: sequential third quarter GDP advancing at a blistering 5.2% annualized clip, the Commerce Department relayed yesterday, revised from a prior 4.9% estimate.  “We’ve been getting economic data recently that reinforces the idea of the Goldilocks slowdown,” Rebecca Patterson, chair of the board of the Council for Economic Education, told Bloomberg. “Inflation is coming down, and at the same time it hasn’t been unduly impinging growth.” 

That happy dynamic has not escaped the attention of equity bulls, as the S&P 500 vaulted by 8.9% for November, marking its best month since July of last year and third strongest monthly performance since 2020.  Similarly, the CBOE Volatility Index (VIX) marked a fresh post-pandemic nadir Friday, settling a bit north of 12. 

The tantalizing prospect of interest rate relief with brisk earnings growth (Wall Street collectively anticipates an 11.6% EPS expansion for the S&P 500 in 2024, per tabulations from FactSet) makes for a potent combination, though, with year-end in sight, other considerations may be taking hold. “Don’t underestimate performance-chasing,” former Beam Capital Management chief investment officer Mohannad Aama opined to MarketWatch Wednesday. “As someone who has managed money professionally, there are huge incentives to go all-in.” 

On that score, a net $101.5 billion has flown into exchange traded funds since the start of November, Bloomberg analyst Eric Balchunas relays, marking only the second monthly inflow north of $100 billion on record, while equity funds attracted a net $57 billion, nearly four times that seen in October. 

Highly speculative names, meanwhile, have been on a rampage.  The Ark Innovation ETF (ticker: ARKK), which invests in high-growth, often-unprofitable firms in search of “disruptive innovation,” logged a 31% advance for November, establishing the best monthly showing on record for the nine-year-old fund.  Helping drive that outsize move: a 62% November rally in crypto exchange Coinbase Global, which commands an 11.3% weighting in ARKK’s portfolio.

Unsurprisingly then, animal spirits have been on display in the digital asset realm, as Bloomberg’s Galaxy Crypto Index appreciated by a snappy 18% this month following a 20% jump in October.  As investors impatiently await regulatory approval for various spot bitcoin ETF’s, bullish sentiment reaches the stratosphere: “Could we go to old highs [in the price of bitcoin] by this time next year?” Galaxy Digital Holdings CEO Michael Novogratz mused on Bloomberg TV a day ago, answering: “Of course.”  The pre-eminent crypto currently sits just south of $38,000, implying an 82%, one-year rally could be in the cards to take out the previous high-water mark of near $69,000 established in November 2021.  Not to be outdone, analysts at Standard Chartered predict that spot bitcoin approval in the first quarter of next year will “pave the way for institutional investment,” powering the digital ducats to a cool $100,000 by the end of next year.

December, you’ve got a tough act to follow. 

QT Progress Report
Reserve Bank credit edged lower by $6.9 billion, leaving the Fed’s portfolio of interest-bearing assets at $7.769 trillion.  That’s down $92 billion from four weeks ago and 12.9% below the early 2022 high-water mark. 
Recap Nov. 30
A late ramp left the S&P 500 higher by 0.4% to wrap up the month in appropriate fashion, though Treasurys gave back some ground with 2- and 30-year yields settling at 4.73% and 4.54%, respectively, up 9 and 10 basis points on the day. Gold settled at $2,036 to mark a fresh monthly closing high, WTI crude fell below $76 a barrel and the VIX stayed south of 13. 
Helium of Exchange
Pre-med, pre-law, what's the difference?

Pre-med, pre-law, what’s the difference? Here’s your (excerpted) corporate press release of the day, via Nate Anderson at Hindenburg Research:

WeTrade disclosed that the third quarter financial statements released by WeTrade Group Inc.. . . (NASDAQ: WETG) were not signed and released by the current management of the company. The data disclosed in the statements is not true, as follows:

On page one of the financial report, the announcement disclosed that the main administrative office area is Room 519, 5th floor, Building T3, Unit 2, Qianhai Excellence Financial Center, Guiwan District, Nanshan District, Shenzhen, China.  However. . .  the company has never had any registration information at this address. The actual address of the company is Room 101, 1st floor, Building 8, Courtyard 18, Kechuang 10th Street, Beijing Economic and Technological Development Zone.

In the financial report regarding cash and cash equivalents, as of September 30, 2023, the company held cash in bank in the amount of $1,416,885 in the bank. . . In fact, the company's U.S. bank account deposit is $163.

Earth Sway
A big-three automaker takes the off ramp:

A big three automaker takes the off ramp: General Motors unveiled an instructive strategy shift this morning, increasing its quarterly dividend to $0.12 per share from $0.09 and authorizing a $10 billion share repurchase program – the largest in its history – which includes $6.8 billion in immediate purchases. For context, GM’s market cap currently stands at $44 billion.  

Funding for that monster capital return program, which dwarfs the $4.2 billion reverted to shareholders over the past seven quarters, will partly come “by freeing up capital previously earmarked for the development of electric vehicles,” notes The Wall Street Journal.  

Though CEO Mary Barra deemed herself “disappointed” with halting progress on the development of GM’s Ultium batteries, which are meant to underpin the company’s next-generation electric vehicle lineup, the executive declared that “there’s really no reason that EV demand won’t be higher in the years ahead.” 

Global sales within the category grew by a more-than-respectable 49% clip over the first six months of the year according to research firm Canalys, but more recent trends cast some doubt on the GM boss’ upbeat appraisal. Thus, average used EV prices registered at just under $35,000 in October, newly released data from analytics firm iSeeCars.com show, off 33.7% year-over-year. That compares to a 9.6% drop for hybrids and a 5.1% decline for all used cars. 

Citing data from Edmunds, the Financial Times likewise relayed on Nov. 13 that average discounts for new EVs in the U.S. now stand at $2,000, double that seen for conventional internal combustion engine autos and up from zero in January. “There are clear signs of carmakers pushing EVs,” Mike Tyndall, autos analyst at HSBC, told the pink paper. “This was almost unthinkable at the start of the year.” 

Domestic auto dealers accordingly sound the alarm. Bloomberg reported yesterday that an industry trade group dubbed EV Voice of the Customer penned a letter to the Biden administration asking for relief from ambitious pro-EV mandates, including one calling for battery electric vehicles (BEV) to account for two-thirds of all auto sales by 2032: “The reality is that electric vehicle demand is not keeping up with the large influx of BEVs arriving at our dealerships prompted by current regulations. BEVs are stacking up on our lots.” 

Relatively high costs, lengthy charging time and the loss of range in extreme weather are among the factors hindering the EV revolution, the group contends, while Mickey Anderson, president of the Baxter Auto Group, likewise tells Bloomberg that “as many as half of all American’s don’t even have a garage,” rendering at-home charging nigh impossible.  

That growing consumer pushback is mirrored on Wall Street, as investors turn tail from environmental, social and governance-themed strategies. Thus, Morningstar determined earlier this month that fund flows in the so-called sustainable space have remained in negative territory for six of the past seven quarters after more than three years of uninterrupted quarterly inflows. Then, too, the third quarter marked the first time in which ESG-focused fund liquidations and marketing pivots from that theme outstripped new launches and sustainability-focused fund rebrandings.  

“We found that the demand for ESG investing, by financial professionals working with retirement-plan participants, was more limited than we anticipated,” Ron Rice, vice president for marketing at Pacific Financial, told the WSJ

Money’s green, too. 

Recap Nov. 29

Treasurys remained red hot as yields darted lower across the curve, leaving the two-year note at 4.64% and the long bond at 4.44%, down nine and eight basis points, respectively, though stocks were unable to follow suit as the major indices gave back solid early gains to each finish just south of unchanged. Gold edged higher to $2,044 per ounce, WTI crude advanced towards $78 a barrel and the VIX soared a quarter point to near 13. 

- Philip Grant

Inert Wallet
Here for a good time, not a long time:

Here for a good time, not a long time: Roundhill Investments will liquidate its eponymous Meme ETF (ticker: MEME) by the end of the year, the company announced last week. The contraption, which was spawned in December 2021 to capitalize on the Covid-era retail trading frenzy by screening portfolio companies for elevated social media presence and short interest, gathered only $2.6 million in assets and logged a 57% decline from its inception, with the S&P 500 remaining flat over that period after including dividends. 

“A 2021 phenomenon wrapped in an ETF simply doesn’t work in today’s environment,” Nate Geraci, president of advisory firm The ETF Store, told Bloomberg. “A niche strategy, zero financial adviser participation and massive underperformance is a classic recipe of ETF closure.” 

There’s always next lockdown. 

Zhong and Wrong
The long arm of the law extends once more in the Middle Kingdom.

The long arm of the law extends once more in the Middle Kingdom. Beijing police have taken “criminal coercive measures” (i.e., made arrests) against employees of stricken Zhongzhi Enterprise Group Co., The Wall Street Journal reported Monday, after the shadow banking giant revealed a $36 billion-plus hole in its balance sheet.

Trouble at the conglomerate first became apparent over the summer, when the firm’s Zhongrong International Trust asset management subsidiary defaulted on several high-yield investment products. Upwards of 17 publicly listed Chinese businesses have subsequently revealed missing interest or principal payments from Zhongrong-managed vehicles. Creditors in the parent company, meanwhile, are facing a paltry 13% recovery rate on its RMB 440 billion ($62 billion) in debt, China Vision Capital founder Sun Jianbo estimates to Bloomberg, after accounting for transaction discounts typically applied to soured assets. 

Revelation of the latest leak of a key vessel in China’s debt-soaked financial system underscore the perilous state of play in the world’s second-largest economy, as fleeing Western capital compounds a bruising bear property market. Thus, foreign direct investment inclusive of retained earnings slipped by $11.8 billion from July through September according to China’s State Administration of Foreign Exchange, marking the first quarterly decline on record going back to 1998.  

More broadly, cumulative FDI registered at a mere $15 billion during the first nine months of the year, down 92% from the same period in 2022.  Nicholas Lardy, senior fellow and China watcher at the Peterson Institute for International Economics, identified a primary driver of that stark downshift in a Nov. 17 white paper:

Foreign firms operating in China are not only declining to reinvest their earnings but – for the first time ever – they are large net sellers of their existing investments to Chinese companies and [are] repatriating their funds. . . These outflows exceeded $100 billion in the first three quarters of 2023 and are likely to grow further based on trends to date.

Anecdotal evidence burnishes that view, as a survey of U.S. and European CEOs released by the Conference Board last week found that 40% of respondents plan to decrease capital expenditures in China with 37% anticipating headcount reductions over the next six months, up from 9% and 9% in a poll conducted in May. 

A tenuous security backdrop for foreign businesses provides little help on that score. Thus, the Financial Times relays today that “some of the world’s biggest audit and consulting firms are asking staff to use burner phones when they visit Hong Kong.” Citing the “risk of infiltration by a state-backed hacker,” a senior cybersecurity executive relayed to the pink paper that “we have been recommending for several years that clients treat the risk of being in Hong Kong as the same as in Mainland China. I think what you’re seeing is that message sinking in now.” 

Recap Nov. 28

Dovish commentary from Federal Reserve Governor Christopher Waller spurred another strong rally in rates, as two-year Treasury yields dove 13 basis points to 4.73%, the lowest since mid-July, while the long bond edged to 4.52% from 4.53% Monday and stocks settled marginally higher after giving back a chunk of their initial pop. WTI crude rose above $76 a barrel, gold approached a 52-week high at $2,040 per ounce and the VIX remained south of 13.  

- Philip Grant

The Son Also Rises

From Reuters:

No one is a prophet in their own land, including European Central Bank President Christine Lagarde, who admitted on Friday that her son lost "almost all" of his investments in crypto assets, despite copious warnings. . . "He ignored me royally, which is his privilege," Lagarde told a town hall with students in Frankfurt. "And he lost almost all the money that he had invested."

Lesson learned - always listen to the central bankers. 

Lever House
Lower for longer?

Lower for longer?  Bullish tidings abound within the speculative credit realm, as the yield on the Bloomberg U.S. High Yield Index settled Friday at 8.61%, down 88 basis points since the start of November.  That’s on pace for the most pronounced monthly decline since July of 2022, while the gauge’s 3.52% post-Halloween return tracks at its best since January. 

That percolating performance has not escaped Mr. Market’s attention:  corporate bond funds attracted a net $16 billion inflow this month through Nov. 20 per EPFR, already the strongest such showing since July 2020, with junk funds garnering $11.4 billion of that sum. With interest rate futures pricing 90 basis points of rate cuts by the end of next year and Wall Street simultaneously penciling in 11.6% earnings growth for the S&P 500 across 2024, investors are basking in today’s largely blue-sky backdrop. “We have seen a very big change in sentiment across markets,” Will Smith, director of high-yield credit at AllianceBernstein, observed to the Financial Times Wednesday. 

Rising credit quality – owing in part to the emergence of private credit as an alternative financing avenue for more speculative borrowers – underpins that enthusiasm, as roughly half of BAML ICE High Yield Index constituents now sport a double-B rating (i.e., the penthouse of junk) up from 29% in the aftermath of the dot.com bubble. Conversely, only 256 firms, representing roughly 11% of that gauge, are rated single-C, compared to 474 a decade ago. 

Yet as Corporate America adapts to the emphatic end of the post-crisis zero rates regime, weaker players continue to fall by the wayside. Fifty domestic companies filed for bankruptcy in October according to S&P Global Market Intelligence, bringing the year-to-date total to 561 firms.  That’s nearly double the 10-month total seen last year and the highest such tally since 2010, excluding the plague year.  

Noting that “bank lending conditions continue to tighten, the yield curve remains inverted after over a year, corporate profits declined last quarter and the ratio of downgrades and weakest links (firms rated single-B or below with a negative outlook) remain elevated,” the rating agency guesstimated on Nov. 16 that trailing 12-month speculative-grade corporate defaults will accelerate to a 5% clip by fall 2024, up from 4.1% as of September and 3.2% on the eve of the pandemic. 

The ongoing erosion of debt covenants, or legal language designed to protect creditors, adds further urgency for credit investors.  Thus, the recovery rate on defaulted senior unsecured bonds has averaged a paltry 25 cents on the dollar since the start of 2021, Moody’s Investors Service finds, less than half of its previous baseline of 55 cents.  Average recoveries on subordinated debt have likewise plunged to 12 cents from 40 cents over the same period.  

See the analysis “Just you wait” in the current edition of Grant’s Interest Rate Observer dated Nov. 24 for a review of the risks and opportunities at hand in the junk realm, with a closer look at one representative credit currently on offer. 

Recap Nov. 27

A relatively soft two-year Treasury auction this afternoon didn’t arrest recent momentum in rates, as yields fell across the curve with the long bond settling at 4.53% from 4.6% Friday, while stocks ticked slightly lower in forgettable post-holiday trading.  The VIX bounced a bit towards 13, WTI crude pulled back below $75 per barrel and gold logged a six-month high at $2,015 an ounce.

- Philip Grant

Mix it with the Relish

Uncle Sam looks for seconds. From Politico:

Amid its high-profile assaults on Amazon and Microsoft, the FTC isn’t too busy to worry about people’s lunch.

The Federal Trade Commission is investigating if the $10 billion purchase of Subway creates a sandwich shop monopoly with Jimmy John’s and Arby’s. The latter two, in addition to McAlister’s Deli and Schlotzky’s, are owned by private equity firm Roark Capital, which inked a deal to buy Subway in August. The government is focused in part on whether the addition of Subway gives Roark too much control of a lucrative segment of the fast-food industry, the people said.

Eye, Robot
Talk about a fork in the road.

Talk about a fork in the road. High profile corporate drama has not been confined to the artificial intelligence realm, as a senior staff exodus at General Motors’ majority-owned Cruise division throws another nascent technology niche for a loop.  Yesterday, the self-driving auto unit’s co-founder and chief product officer Daniel Kan resigned from his post, following Cruise CEO Kyle Vogt’s departure on Sunday evening. 

Spurring that shakeup: the California Department of Motor Vehicles last month suspended Cruise’s autonomous driving deployment and driverless testing permits, citing an “unreasonable risk to public safety.”  That decision followed an early October mishap in which a Cruise vehicle dragged a pedestrian for 20 feet, leading the company to pause all U.S. testing and conduct a comprehensive safety review.  Upwards of 600 self-driving vehicle accidents occurred in the Golden Gate City over the 12 months through June per San Francisco’s Municipal Transportation Authority, while authorities in Austin, Texas report 52 such incidents over the 10 weeks through Oct. 24, the New York Times relays today. 

GM has long held high hopes for Cruise, in which the automaker initially invested in 2016.  A year later, executives targeted a 2019 rollout of driverless ride-hailing “in large scale,” before walking back those ambitions two years later. Undaunted, GM increased its stake in the startup to 80% early last year, with CEO Mary Barra forecasting at a June 5 conference that Cruise – which is on track to lose some $2 billion this year, equivalent to 16% of GM’s projected operating profits – could generate $50 billion in annual revenue by 2030. 

Those stated ambitions promptly ran headlong into regulatory resistance. “We are in fact worried that the industry’s desire for rapid expansion is actually threatening the industry’s success,” Jeff Tumlin, head of San Francisco’s transportation agency, told The Wall Street Journal the same month. The official outlined particular pitfalls in a June 7 interview with the San Francisco Standard:

When a human driver gets confused, they will find a place to pull over safely on the side of the road and sort things out, whereas when an autonomous vehicle gets confused, it just comes to a complete stop wherever it happens to be. If that happens to be in front of a fire station or in the middle of an arterial intersection, that creates some pretty significant traffic and safety problems.

Growing consumer reluctance may represent an even steeper hill to climb for autonomous vehicle proponents. Thus, 68% of respondents to the American Automobile Association’s annual self-driving survey conducted early this year described themselves as afraid of the technology, with only 9% trusting a robo-driver to take the wheel.  By contrast, 54% of respondents expressed trepidation over self-driving autos in 2021, with 14% declaring that they would be comfortable in such a vehicle. 

“We were not expecting such a dramatic decline in trust from recent years,” wrote Greg Brannon, director of automotive research for AAA. “Although, with the number of high-profile crashes that have occurred from over-reliance on current vehicle technologies, this isn’t entirely surprising.” 

Indeed, that broad-based ambivalence marks a striking contrast with the dawn of the automotive era, as Grant’s Interest Rate Observer pointed out in the spring of 2017:

Certainly, today’s cars and trucks are safer, more comfortable and less toxic than the horse-drawn conveyances that Carl Benz, Charles Duryea, Ramson Olds and Henry Ford disrupted. One hundred years ago, city-dwelling Americans fairly begged for deliverance from the animals. No such consumer-driven push is apparent for access to autonomy. . . Nor do you find it in the marketplace. The impetus is rather coming from on high, from the car makers, from the software giants and from [ride-share firms such as] Uber.

See “Sacred cows in the road” in the April 21, 2017 edition of Grant’s Interest Rate Observer for a prescient, history-informed look at the auto industry’s ongoing struggle to bring self-driving technology into the mainstream. 

Recap Nov. 21

The bulls took a breather as the Nasdaq slipped 60 basis points to give up roughly half of yesterday’s rally, while Treasurys remained close to home with the long bond finishing unchanged at 4.57% and the two-year note dipping three basis points to 4.86%. Gold topped $2,000 per ounce intraday before settling near $1,999, WTI crude stayed near $78 a barrel and the VIX remained south of 14 for a fourth straight session.  

- Philip Grant

The Promised Land

It’s easy to make predictions, especially about the future. From the Financial Times:

Brokers would be able to market some investments with projections of future performance and promise targeted returns when they are working with institution[s] and wealthy individuals, under a rule proposed by an industry self-regulatory body.

The rule change floated by Finra would mark a departure from a general ban on brokers promising specific outcomes when they sell securities. That has raised concerns among some investor advocates. 

In the proposal, Finra said the change would pertain to brokers’ sales to institutions and investors with more than $5 million in assets. “A member’s views regarding the projected performance of an investment strategy or single security may be useful,” the authority said in a proposal.

But Stephen Hall, legal director at Better Markets, which lobbies for investor protection, said: “Using projections is one of the easiest ways to mislead people. It’s easy to think the result is guaranteed. [Finra] are really opening up a can of worms.” 

Full Plate
It's the choice of a new generation:

It’s the choice of a new generation: CEOs are dusting off some old-school vernacular in their communications with investors and analysts. The term “choiceful” – whether used by executives to describe cost-conscious consumers responding to recent price pressures or their company’s own strategic actions – has appeared in 15 S&P 500 earnings calls in the year-to-date according to a CNBC tabulation of FactSet data, up from nine mentions last year and just a pair of instances in 2021.  

That adjective, which dates from the late 1500s according to the Oxford English Dictionary but does not appear on Dictionary.com or in the Meriam-Webster edition, typically appears .002 times per million words of modern written English per the OED, residing within a category of terms “which are not part of a normal discourse and would be unknown to most people.” 

Faltering consumption colors that corporate messaging fad, as a trio of retail bellwethers encounter an increasingly rugged operating environment. Thus, WalMart CFO John Rainey warned Thursday of a “softening” in spending activity during the back half of October relative to the rest of its fiscal quarter (which concluded on Oct. 31), a development which “gives us reason to think slightly more cautiously about the consumer versus 90 days ago.” Target CEO Brian Cornell mentioned last Wednesday that “we’ve seen more and more consumers delaying their spending until the last moment,” while Home Depot EVP of merchandising William Bastek relayed Tuesday that big ticket transactions of $1,000 or more slipped by 5.2% year-over-year during the three months through October. 

Growing ranks of cash-strapped Americans, meanwhile, are compelled into some difficult “choicefulness” of their own. Citing data from Fidelity Investments, Bloomberg reports today that 2.3% of domestic workers tapped their retirement accounts via a hardship withdrawal to cover emergency expenses last quarter, up from 1.8% during the same period last year.  By the same token, 2.8% of 401(k) retirement account holders took a loan against their plan in the third quarter, compared to 2.4% a year ago, pushing the share of employees with outstanding 401(k) loans to 17.6% from 16.8% in the third quarter of 2022.  The average retirement balance stood at $107,700 as of Sept. 30, Fidelity finds, virtually unchanged from five years ago.  Over that stretch, the CPI has increased by 21.9%. 

Recap Nov. 20

The weekend drama surrounding OpenAI and Microsoft didn’t slow down the bulls, as the Nasdaq 100 powered higher by 1.2% to reach its best levels since the start of 2022, closing to within 3.5% of its high-water mark, while a strong 20-year Treasury auction this afternoon helped to push yields slightly lower across most of the curve. Gold finished little changed at $1,977 per ounce, WTI crude rose toward $78 an ounce and the VIX stayed below 14. 

- Philip Grant

Stumped Speech

ChatGPT clams up:

Silence Dogood
Sustainability is a relative term:

Sustainability is a relative term.  From Bloomberg:

U.S. borrowers are retreating en masse from the world’s second biggest ESG debt class. The $1.5 trillion market for sustainability-linked loans, in which borrowing is tied to environmental, social or governance goals, has seen an overall slowdown in volumes as both interest rates and greenwashing fears rise. But nowhere has the decline been as precipitous as in the U.S., where the number of new sustainability-linked loans is down 80% from a year earlier. 

And from the Financial Times:

Oil and gas companies face virtually no extra borrowing costs compared with less polluting companies, despite efforts by the UN and international organizations to encourage banks and big investors to reduce their lending to the fossil fuel sector which is behind global warming. 

Since 2010, borrowing costs for oil and gas companies in the US and Europe have largely mirrored those for other debt issuers, except for during sharp falls in commodity prices, according to analysis by S&P Global Ratings seen by the Financial Times

“Environmental concerns seem to be far from the most important factor for funding oil and gas companies,” the rating agency’s analysts said.

The Color of Money
Are cracks in the indomitable U.S. labor market finally beginning to appear?

Are cracks in the indomitable U.S. labor market finally beginning to appear? Continuing applications for unemployment reached 1.87 million, data from the Labor Department released yesterday show.  Marking an eighth consecutive sequential increase from the 1.66 million logged in mid-September, that data series now stands at a near-two-year high. Initial jobless claims likewise popped to 231,000 last week, well above the 220,000 consensus to represent the most elevated reading since August. 

Coming on the heels of last month’s acceleration in measured unemployment to 3.9%, the highest since January 2022, along with cooler-than-expected readings of consumer and producer prices in October, “it seems intuitive to conclude the hiking cycle is now done,” JPMorgan strategists conclude. 

The prospect of imminent relief on that front, with interest rate futures now pricing rate cuts by mid-2024, puts some spring into the step of the gold market:  the yellow metal logged a 2% advance over the past week, closing within 5% of its $2,075 per ounce peak logged in 2020 and sitting 15% above its five-year average.  That’s despite the fact that real 10-year interest rates stand at 2.09% per the Cleveland Fed, their highest of the post-crisis era.

Persistent bidding interest from the stewards of price stability has contributed to that resilience, as global central banks snapped up 337 tons of the precious metal during the three months through September per the World Gold Council.  That “voracious” shopping spree, the third most active quarter on record going back to the turn of the century, pushed total purchases to a record 800 tons over the nine months through September, up 14% year-over-year.

Yet brisk demand and resilient price action in the underlying commodity have done little to help the share prices of the firms unearthing the precious metal: the Philadelphia Gold and Silver Index, a market cap-weighted gauge of 30 mining company stocks, sits 22% below its mid-April levels, leaving the ratio of that index to the price of gold at a mere 0.057, a fraction of the average 0.19 going back to 1983.

Might the truism that low prices are the cure for low prices soon be on display for the beaten-down miners?  John Hathaway, managing partner and senior portfolio manager at Sprott Asset Management, argued the case last month: “Many producers are trading at free cash-flow yields of high single digits or more, sport strong balance sheets and are (incredible as it may seem) well-managed businesses."

See the edition of Grant’s Interest Rate Observer dated Sept. 29 for an array of ways to get the jump on Mr. Market’s long-awaited reappraisal of the industry.  

Recap Nov. 17

Another rally at the long end of the Treasury curve left 30-year yields at 4.59%, the lowest in nearly two months, while stocks traded sideways for a third straight session as the S&P 500 wrapped up the week its opening gap higher on Tuesday.  WTI crude rebounded to $76 a barrel, gold stayed at $1,980 per ounce and the VIX slumbered south of 14. 

- Philip Grant

Everything, Everywhere, All at Once

Giant vending machines are so 2021.  A press release today from Amazon.com:

In 2024, auto dealers for the first time will be able to sell vehicles in Amazon’s U.S. store, and Hyundai will be the first brand available for customers to purchase.

This new digital shopping experience will make it easy for customers to purchase a new car online, and then pick it up or have it delivered by their local dealership at a time that works best for them. Customers will be able to search on Amazon for available vehicles in their area based on a range of preferences, including model, trim, color, and features; choose their preferred car; and then check out online with their chosen payment and financing options—all within the Amazon experience they already know and trust.

Clap and Trade
Put on a happy face:

Put on a happy face:  Xi Jinping’s U.S. visit culminated in friendly fashion yesterday evening, with China’s president-for-life (though definitely *not* a dictator) receiving a standing ovation from a cadre of corporate CEOs and other business luminaries. For his part, Xi declared that “there is plenty of room for cooperation” between the two nations, adding that “China is ready to be a partner and friend of the U.S.”  

Not every attendee was impressed with Xi’s message, however. “He offered no hints of concessions or even interest in more investment in the Chinese economy,” an unnamed executive told The Wall Street Journal. “How could he not say anything about trade and investment, given the audience?” wondered another. 

Evidence of a darkening economic picture in the Middle Kingdom further colors those pointed omissions.  Thus, new home prices across 70 major cities dipped 0.3% from a month ago in October, government-compiled data released today show, marking the worst sequential reading since February 2015 as China’s lynchpin growth engine continues to stall out. On the industrial side of the coin, crude steel production fell to 79.09 million tons last month, the National Bureau of Statistics relayed yesterday, down 1.8% from a year ago and the weakest output since the aftermath of the Covid-zero lockdowns last December. 

Monetary mandarins, meanwhile, swing into action, as the People’s Bank of China injected RMB 1.45 trillion ($200 billion) into the financial system Tuesday via its medium-term lending facility, the most in nearly seven years and well above the RMB 850 billion of such bank loans set to mature this month. “The level of liquidity injection went beyond market expectation,” Becky Liu, head of China macro strategy at Standard Chartered, told Bloomberg.

That cash influx follows an unprecedented bout of capital flight. China’s direct investment liabilities, a measure of foreign direct investment which includes retained earnings, fell $11.8 billion over the three months through September, establishing the first decline on record going back to 1998.  Over the past decade, quarterly inflows typically ranged from $40 billion to $80 billion, topping $100 billion on a pair of occasions. 

Broad economic factors arguably help explain that downshift, as the post-pandemic jump in benchmark rates serves to stunt demand for cross-border investment relative to so-called risk-free returns (FDI has likewise turned negative in Europe). 

Nevertheless, some observers point the finger at Beijing: “Some of the most damaging things have been the abrupt regulatory changes that have taken place” Robert Carnell, regional head of research for Asia Pacific at ING Groep, told Bloomberg last week, referring to China’s escalating harassment of foreign firms under the auspices of its anti-espionage campaign. “Once you damage the sort of perception of the business environment, it’s quite difficult to restore trust.”  

A collective eyeing of the exits from buyout barons illustrates today’s rugged state of play. Bloomberg relayed Tuesday that private equity firms that have poured some $1.5 trillion into China are struggling to monetize their investments, with buyers on the secondary market asking for discounts ranging from 30% to upwards of 60% for mainland-based portfolio companies. That compares to roughly 15% markdowns for secondary transactions in the U.S. and Europe.

“We are in more challenging times, very similar to the way we experienced the global financial crisis,” lamented Niklas Amundsson, partner at global private placement agent Monument Group. “China is completely out of favor and global investors are going to put China on hold for now.”  

QT Progress Report
Reserve Bank credit crept lower by $3 billion from a week ago, leaving the Fed’s portfolio of interest-bearing securities at $7.82 trillion.  That’s down $86 billion from mid-October and 12.3% from the March 2022 highs. 
Recap Nov. 16

Treasurys rebounded with the long bond declining five basis points to 4.63% and the two-year note finishing at 4.83% from 4.9% Wednesday, while WTI crude was hammered by nearly 5% to $73 a barrel. Stocks continued to consolidate their recent runup with the S&P 500 and Nasdaq 100 each settling just north of unchanged, gold jumped to $1,981 per ounce and the VIX remained just above 14. 

- Philip Grant

Brand Equity

No lies spotted here.  From the New York Post:

A Florida man with a neck tattoo reading “All Gas, No Brakes” is facing charges after he and a female accomplice tried to elude police before speeding and crashing into a parked car in an Orlando suburb early Monday.

For Whom the Bull Tolls
Touchdown for Uncle Sam?

Touchdown for Uncle Sam?  Yesterday’s calmer-than-expected inflation data marked a happy occasion for fixed-income dip buyers, as the iShares 20 Plus Year Treasury Bond ETF climbed to its best closing level in nearly two months, up nearly 10% from its mid-October nadir.

That bounce colors an interesting dynamic seen during the early fall lurch higher in yields. Citing data from the Treasury Department, Bloomberg relayed last week that $10.3 billion of zero-coupon government bonds came to market in October, marking the second highest monthly supply in at least 10 years. That came as yields on conventional 30-year Treasurys, which most frequently underpin the contraptions, topped 5% last month for the first time since 2007.  

Such zero-coupon strips, which are birthed by primary dealers packaging the interest- and principal-derived future cash flows within Treasury bonds to sell as individual securities, are extraordinarily sensitive to changes in interest rates. Thus, the principal-only portion of the 1.875s of 2051 changed hands at 25 cents on the dollar last month, down from 60 cents at the end of 2021.  

With mounting market expectations of policy easing marking a contrast to largely sturdy economic indicators, more such outsized price swings may be in the offing. “We have to see a pretty severe deterioration in financial conditions to see rate cuts,” Kathryn Kaminsky, chief research strategist at AlphaSimplex Group, told Bloomberg. “Inflation is still an issue. Rates could be higher for longer. So, there’s still a really good chance that we are going to see a lot of volatility rather than a new trend.” 

On that score, a cross-Atlantic divergence may be taking shape. As Charles Diebel, head of fixed income at Mediolanum International Funds, points out to Dow Jones today, interest rate futures in both the U.S. and eurozone are each pricing in roughly 100 basis points of easing during 2024, a notable setup considering that stateside economic data remains “pretty resilient, whereas in Europe the manufacturing [sector] is in trouble while the services side is softening, albeit slowly.”  The money manager believes that the market’s assumptions in Europe are “feasible,” adding that “I am a bit more cautious about the Fed.” 

Indeed, the Brussels political apparatchiks are pointing to slower growth ahead. Earlier today, the European Commission trimmed its eurozone GDP forecasts to 0.6% for the current year and 1.3% for 2024, down 10 and 20 basis points, respectively, from its prior guesstimate over the summer. 

Though that tweak marks the second such downward revision since the start of 2023, “the commission’s forecasts still fall into the category of ‘unbeatable optimism,’” ING economist Carsten Brzeski – who pencils in a mere 0.2% output expansion in 2024 – told the Financial Times. “Everywhere we look in the private sector, we see weakness at the moment,” adds Claus Vistesen, economist at Pantheon Macroeconomics. “The main downside surprise seems to be still-soft consumer spending growth even as inflation is falling.” 

How might investors tactically position for ongoing fixed income volatility, and/or a further downshift in the growth and inflation backdrop across Western economies? See the issues of Grant’s Interest Rate Observer dated Oct. 27 and Sept. 1 for a review of beaten-down securities potentially well suited for those contingencies. 

Recap Nov. 15

Stocks managed to eke out another green finish following yesterday’s gangbusters rally, though the S&P 500 settled only 20 basis points higher after losing altitude from an early push higher, while Treasurys gave back a chunk of Tuesday’s advance with 2- and 30-year yields settling at 4.9% and 4.68%, respectively, up 10 and 7 basis points on the session. WTI crude slipped below $77 per barrel, gold ticked lower at $1,959 an ounce and the VIX stayed near 14. 

- Philip Grant

Ground and Pound

Talk about atmospheric pressure.  From the Financial Times:

The Dutch government has shelved plans to reduce the number of flights at Amsterdam’s Schiphol airport, bowing to pressure from airlines, the EU and the U.S. government.  The U-turn represented a blow to one of the most high-profile efforts to limit flying on environmental grounds, and came after the Dutch government said the U.S. threatened “countermeasures” against the restrictions on its carriers landing at the hub airport.  

Mark Harbers, infrastructure minister, said in a letter to parliament on Tuesday that the decision was a “bitter pill to swallow”. But he added that the government remained “committed to restoring the balance between Schiphol and its living environment”, after the Dutch appeals court in July backed the administration’s flight cap.   

Airlines had lobbied furiously against the proposals to reduce the number of flights at the airport by 8 per cent to 460,000 a year at one of Europe’s busiest hubs, which represented the most drastic yet in the EU to tackle noise and pollution caused by the aviation industry.

Great Expectations
“I'm willing to say we're going to win this thing,”

“I'm willing to say we're going to win this thing,” JPMorgan Asset Management chief global strategist David Kelly declared on Bloomberg television, referencing this morning’s cooler than expected reading of October CPI.  “It looks very, very likely that we're going to win this [and] get inflation down to 2% by the end of next year.” Following today’s reveal of a 4% annual uptick in core prices, the slowest such growth rate since fall 2021, interest rate futures now point to roughly 100 basis points of easing from the current 5.33% funds rate by the end of next year, compared to a 75-basis point guesstimate as of yesterday, spurring outsized gains in the major indices and a broad-based drop in yields. 

Bourgeoning bullish sentiment ahead of the print colors today’s euphoric reaction. To wit: Bank of America’s latest Global Fund Manager survey, conducted over the six days through Nov. 9, showed the largest overweight fixed income positioning since 2009, with a net 80% of respondents anticipating lower short-term rates.

Prominent sell-side firms concur with that view, as strategists at Morgan Stanley predict that an easing cycle will commence next June, bringing benchmark borrowing costs to 2.375% by the end of 2025, some 300 basis points south of the current bogey. Peers at UBS anticipate an even more pronounced reversal, penciling in a funds rate of 2.5% to 2.75% by the end of next year and 1.75% to 2% by the end of 2025.  “Inflation is normalizing quickly and by the time we get to March, the Fed will be looking at real rates which are very high,” the UBS team wrote.

For his part, Mr. Market anticipates a blue-sky backdrop as borrowing costs ebb, as the BAML fund manager survey likewise found that two-thirds of respondents peg a soft landing for the global economy as their base case scenario. Overweight equity positions predominate for the first time since April 2022, while managers trimmed average cash balances to 4.7%, a two-year low.  A poll conducted by S&P Global earlier this month reached the same conclusion, with risk appetite among stock investors reaching its strongest since the virus-era bull market reached its crescendo. 

Corporate America faces a high bar to help deliver on today’s broad-based optimism.  Wall Street expects S&P 500 earnings per share to grow by 11.6% next year per tabulations from FactSet, which would represent the strongest figure since 2018, barring the snap-back from the Covid crucible in 2021. For context, projected earnings growth for the current annum now stands at just 0.6%, down from 0.8% at the end of September.

Yet one idiosyncratic indicator suggests that that ambitious bottom-line acceleration may be hard to come by.  Bloomberg relays today that analysts are throttling back on praise for S&P 500 management teams at the fastest clip since the financial crisis, with the frequency of phrases such as “congratulations” and “great quarter, guys” on earnings calls running 35% below the average clip seen over the three years prior to the pandemic.  With interest rates elevated relative to their post-2008 norm (for now at least) and price pressures still nettlesome, “fewer companies are doing well,” Alex Zukin, managing director at Wolfe Research, told Bloomberg. “There’s a higher volume of companies that are in a difficult environment really for the first time.”

Recap Nov. 14

Stocks and bonds alike managed to maintain their steep post-CPI rallies throughout the session, with the Nasdaq 100 settling more than 2% to the green and the small-cap Russell 2000 vaulting by 5.5%, while 2-and 30-year Treasury yields settled at 4.8% and 4.61%, respectively, down 22 and 14 basis points on the day. Gold advanced to $1,963 per ounce, WTI crude stayed above $78 a barrel and the VIX sagged towards 14.  

- Philip Grant


Chase Bank
What the rally hath wrought:

What the rally hath wrought: The Global X Nasdaq Covered Call ETF (ticker: QYLD) is obliged to cover a hefty short position ahead of Friday’s expiration day, Bloomberg relays.  The fund, which employs a so-called buy-write strategy that includes the sales of one-month call options against the underlying index, will need to purchase some $8 billion in futures as its hedge rolls off later this week per Nomura strategist Charlie McElligott.  

With the tech-heavy gauge ripping higher by 2.3% Friday to extend its gains from late October to nearly 10%, “the market has gotten the joke and pre-traded or front-run” the trade, McElligott wrote.  During the prior six instances in which QYLD had to cover short positions that were similarly in the money, the Nasdaq averaged a 2% rally during the five trading days prior to expiration.  Maybe it’s over.

Horse Trading
Winter is coming.

Winter is coming. This year’s relatively strong stock market showing has been little help for moribund initial public offerings, as the pipeline remains largely barren during a typically busy stretch ahead of the looming holidays. “Whatever you are going to get [through] the end of the year should be happening right now,” Don Short, head of venture equity at InvestX, told CNBC Thursday.  Year-to-date fundraising stands at just $18.8 billion according to Renaissance Capital, up from last year’s paltry $7.7 billion figure but a fraction of the average $59 billion over the past decade, let alone the $150 billion-plus output seen in 2021. 

Firms that braved the choppy IPO waters have largely floundered, with prominent recent debuts Arm Holdings remaining near its opening price and Instacart and Klaviyo each stuck well below their own bogeys.  Last week, Arm guided fiscal third quarter revenues and earnings per share of $760 million and $0.245, respectively, short of the $776 million and $0.27 per share analyst expectations, while Instacart posted a hefty $1.99 billion third quarter net loss and Klaviyo absorbed a $297 million earnings shortfall over the three months through September. 

“There is typically no margin for error when IPOs report,” Josef Schuster, founder and eponym of IPOX Schuster, told Bloomberg last week.  Indeed, investors have been well served to steer clear of the category since the bug barged in, as more than 80% of the entrants dating to the start of 2020 languish below their opening levels per Dealogic, despite a largely constructive backdrop with the S&P 500 returning 45% over that period.

That lackluster track record poses a problem for the scores of so-called unicorns hoping to access the capital markets, as IPO candidates face a forbidding funding backdrop with the Covid-era venture capital bacchanal now largely by the wayside. The global tally of such closely held firms valued at $1 billion or above stands at 1,220 by CB Insights count, nearly triple that seen just three years ago. 

“The private financing markets are even worse than the public financing markets, so you really don’t want to be running out of cash right now,” Greg Martin, managing director of Rainmaker Securities, told CNBC, adding that secondary transactions in the private market are now taking place at “much lower prices” relative to fall 2021. “We are starting to see unicorns die. There’s a lot of lower quality unicorns with negative Ebitda, and there’s not much demand for them in the public markets.”

Recap Nov. 13

Stocks floated through a quiet session to pause from the recent run-up with the S&P 500 and Nasdaq each settling slightly south of unchanged, while Treasurys likewise finished little changed with 2- and 30-year yields ending the day at 5.02% and 4.75%, respectively, from 5.04% and 4.73% Friday.  WTI crude rose to near $79 a barrel, gold edged higher at $1,947 per ounce and the VIX climbed towards 15. 

- Philip Grant

The Emperor's New Roads

The City by the Bay puts its best foot forward for Xi Jinping and company. From the San Francisco Chronicle: 

San Francisco officials have been working to clear some of the city’s hot spots for homeless tent camps ahead of world leaders, dignitaries, corporate executives and international journalists descending on the city for this month’s Asia-Pacific Economic Cooperation summit.

A high-ranking official in the city’s Public Works department listed seven intersections in the Tenderloin and South of Market to target in an email to other city officials on Sept. 25.

“With APEC coming, I am concerned about historical encampments that are close to priority areas,” wrote Christopher McDaniels, superintendent of Street Environmental Services, in an email obtained by the Chronicle through a public records request.

Message in a Bottle
These bots should ask for a raise:

These bots should ask for a raise:  A new artificial intelligence frontier was on display this week, as CNBC reported Tuesday that “in a world first, AI demonstrated the ability to negotiate a contract autonomously. . . without any human involvement.”  

Britain-based Luminance managed that breakthrough, with its Autopilot software drawing up a non-disclosure agreement in minutes, a development potentially poised to turn the law industry on its head.  Autopilot “handles the day-to-day negotiations, freeing up lawyers to use their creativity where it counts, and not be bogged down in this type of work,” Luminance chief of staff Jaeger Glucina tells CNBC. The executive estimates that legal professionals currently spend some 80% of their time reviewing and negotiating routine documents, chores now perhaps poised for delegation.

As that impressive feat might suggest, AI represents a shining bright spot within an otherwise-moribund venture capital industry.  Fundraising within the category jumped to $17.9 billion in the third quarter according to PitchBook, up 27% from the same period in 2022, even as total v.c. funding slipped 31% year-over-year to $73 billion.  

The cash spigot has continued to flow in recent weeks, with startup Stability AI raising $113 million in a seed round on Oct. 17 and accounting-focused player Black Ore Technologies gathering $60 million this week in a combined seed and series A deal.  Typically, those early-stage funding rounds top out at $20 million, PitchBook points out. 

Public investors are similarly smitten, as Norway’s mammoth $1.4 trillion sovereign wealth fund is deploying AI to help manage its portfolio, CEO Nicolai Tangen declared at a Reuters hosted conference this week.  The investment ultra-heavyweight, which holds positions in upwards of 9,200 companies and owns roughly 1.5% of all listed stocks worldwide, has turned to the technology to help control transaction costs. 

On that score, Tangen relayed that he recently asked OpenAI CEO Sam Altman about his stated target to improve fund productivity by 10%, a figure that he “plucked out of thin air,” with Altman reportedly replying this: “I think 20%, you can do.”  The SWF boss likewise revealed that his firm has “urged” its sprawling suite of portfolio companies to “responsibly” engage with AI, preparing a set of expectations on the topic over the summer.

Technology firms don’t need to be told twice, as analysts at Bernstein document today:

Across the different [industry] business models, only four companies regularly discussed AI on 2021 and 2022 earnings calls: NVIDIA, IBM and, to a lesser degree, Alphabet and Meta. In the first, second and third quarters of 2023 almost every company did, even in businesses that should seemingly have little direct benefit from AI such as HP, Inc.  While clearly the opportunity will be different across companies it is striking to see the uniformity of the pivot to AI messaging. 

Recap Nov. 10

Stocks enjoyed an early rebound to sit some 60 basis points higher on the S&P 500 as of noon, when your correspondent chose to leave. Long-dated Treasurys likewise caught a bid this morning after yesterday’s selloff (the bond market was not closed today, as Thursday’s ADG mistakenly said), while WTI crude rose above $77 a barrel and gold fell to $1,939 per ounce.  The VIX pulled back below 15.

- Philip Grant

Match Point

An excerpt from a Wednesday report from the IMF:

The outlook for Europe is for a soft landing, with inflation declining gradually.

And former ECB president Mario Draghi Wednesday, speaking at a Financial Times hosted event:

It is almost sure we are going to have a recession by the year-end. It is quite clear the first two quarters of next year will show that.

The Fix is Out
If you build it, they will come?

If you build it, they will come? Calgary-based TC Energy has completed welding on the Coastal GasLink pipeline, the company relayed last week, marking a milestone in the construction of the lynchpin LNG Canada project.  

The budding liquified natural gas processing facility, which represents the largest private sector infrastructure outlay in Canadian history, is expected to begin shipments by the middle of the decade, or perhaps sooner. “Based on everything that we’re hearing and seeing, LNG Canada may start taking some test gas volumes by the middle of [2024],” RBN Energy managing director Martin King told Bloomberg on Oct. 30.

While America’s northerly neighbor beefs up its gas export capabilities, stateside construction activity has likewise swung into high gear. Capital spending within U.S. manufacturing reached a record, $199 billion seasonally adjusted annual clip in September per data from the Census Bureau, up 62% year-over-year and 142% from the September 2021 level, as the Biden administration’s array of infrastructure initiatives swing into second gear.  

Even after accounting for bounding inflation, real construction spending has roughly doubled over the past two years, the Treasury Department found in a June analysis. Notably, “the manufacturing surge has not crowded out other types of construction spending, which generally continue to strengthen,” Treasury added. 

Against that bustling backdrop, general contractor Fluor Corp. (ticker: FLR) has entered Mr. Market’s good graces, with shares up 85%, compared to a 5% total return for the S&P 500, since Grant’s Interest Rate Observer first levied a bullish verdict on June 25, 2021. 

Fluor, which boasts sprawling operations across the energy, chemicals, mining and life-science industries, among others, was laid low in the years leading to the Covid crucible thanks to an ill-fated corporate migration towards large-scale, fixed-price contracts, which left the company exposed to potential outsize losses if a given project proves more expensive than anticipated. Peer McDermott International learned that lesson the hard way following its 2018 acquisition of Chicago Bridge & Iron, as cascading liabilities from fixed-price LNG construction contracts forced McDermott into Chapter 11 in early 2020.  

A well-executed strategy pivot under CEO David Constable, who took the reins in late 2020, has helped drive Fluor’s subsequent success, as 70% the firm’s $26 billion order backlog was of the reimbursable, cost-plus variety as of Sept. 30, well on its way to Constable’s stated 75% target by the end of next year.  Reimbursable contracts represented 58% of the backlog in the fall of last year and only 43% in March 2021.  Crucially, fixed-price exposure to the aforementioned LNG Canada terminal, which represented more than 20% of the $24 billion corporate backlog as of early 2021, appears to now be under control, as Constable relayed on last week’s conference call that the project is 88% complete and “continues to meet management expectations.”

Business, meanwhile, is booming, as Fluor posted $1.02 in third quarter earnings per share, blowing away the $0.56 analyst estimate, while increasing full-year adjusted Ebitda guidance to $600 million from $550 million, using the midpoint of the provided range.  “For the fourth quarter, we are anticipating some sizable reimbursable new awards,” Constable advised listeners-in to the earnings call. 

Might FLR remain an attractive investment opportunity, despite the recent run-up?  Steven Grey, founder and eponym of Grey Value Management, tells ADG via email that the company’s “excellent” backlog in both size and quality, benefits from supply chain “nearshoring” and a “financial boomerang” effect from deferred spending to address “the dangerously decrepit state of much of the infrastructure in the U.S.” underpin today’s bull case. A potentially looming economic slowdown and the inherent opacity and complexity of Fluor’s business model temper that dynamic. 

Shares remain priced at just under 13 times forward earnings estimates for 2024 and roughly 10 times management’s $3.35 EPS guesstimate for 2026. “Fluor has almost too many tailwinds to count, both in terms of macro forces and company-specific factors,” Grey concludes. 

QT Progress Report
Reserve Bank credit now stands at $7.82 trillion following a chunky $39 billion downshift from last week’s reading.  The Fed’s holdings of interest-bearing assets are down $92 billion from mid-October, and 12.3% from the March 2022 peak. 
Recap Nov. 9

A very weak 30-year Treasury auction this afternoon put the brakes on the recent rally, as the long bond jumped 13 basis points to 4.77% and the 2-year note closed north of 5% for the first time in November (the bond market is closed tomorrow for Veterans Day).  Stocks likewise came under pressure with the Nasdaq 100 slipping 0.75% to halt its winning streak at nine days, while WTI crude stayed just above $75 a barrel and gold ticked higher to $1,958 per ounce. The VIX settled north of 15, up a bit less than one point on the day. 

- Philip Grant

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