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.

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

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.”

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.” 

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

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.

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. 
 

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. 

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.” 

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

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.

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. 

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

ChatGPT clams up:

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.

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.  

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

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.

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. 

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

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.

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.”

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

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.

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. 

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