Enjoy the show. Shares in movie theater chain AMC Entertainment Holdings, Inc. rose by 301% today, bringing three day gains to 466% and pushing the cineplex’s market cap to $8.1 billion, nearly 11 times AMC’s market value on the eve of the pandemic at year-end 2019.  Helping spur that heretofore-inconceivable rally was a Monday announcement that the company had secured $917 million in fresh financing, covering six months of operating expenses and taking the risk of imminent bankruptcy “completely off the table,” according to CEO Adam Aron.

A filing with the Securities and Exchange Commission on Monday conveyed slightly less optimism: “In the absence of any increase in [cinema] attendance levels and assuming continued landlord concessions and no additional liquidity, our existing liquidity would extend our operations through to July 2021.”  Analysts S&P concluded yesterday that “even if the company makes it past July 2021. . . it will carry unsustainably high leverage and face significant deferred interest and lease costs that it will likely be unable to pay.” 

Yet the subsequent share-price melt-up looks set to potentially alter the company’s fundamental prospects. This afternoon, AMC issued a press release announcing the completion of a 63 million share “at the market” stock offering, with proceeds of $305 million flowing to the corporate coffers. That covers about one-quarter of the projected free cash flow shortfall for calendar 2020. 

Although the capital infusion would have been far higher if AMC had waited another day (the average price on that offering comes to about $4.80 per share, compared to a $19.90 closing price today) creditors are pleased with the move.  AMC’s second-lien, 12% pay-in-kind bonds rallied above 65 cents on the dollar today, compared to 28 cents two weeks ago. 

Meanwhile, some Redditors are turning towards another old economy relic in search of their next target.  A screenshotted post from today:

Today’s Federal Open Market Committee meeting was a stand-pat affair, with the monetary mandarins opting to maintain the funds rate near zero and monthly asset purchase schedules at their current $120 billion monthly pace.  A new reference to a “moderated” recent pace of economic growth and employment was one of the few changes to the policy statement, potentially suggesting the Fed is even further from removing accommodation that they were at the time of the Dec. 16 meeting.

Similarly, the committee reiterated its vow to hold stimulus in place until measured consumer inflation rises “moderately above two percent for some time” as part of its newfangled symmetrical inflation targeting policy (i.e., allowing measured prices to run hot in order to make up for past shortfalls).   

Current circumstances could serve to extend the status quo still farther. At this afternoon’s post-meeting press conference, Fed chair Jay Powell declared that a post-pandemic pop in prices wouldn’t necessarily convince the Fed to pull back.  “Expect us to wait and see and not react,” to a move higher in inflation gauges, Powell declared today, as it would likely be “transient.”   

While the Fed plots a continuation of its E-Z money course, competitive considerations with its cross-Atlantic peer move closer to center stage. Bloomberg reports today that decision makers at the European Central Bank “are uncomfortable that investors appear to be largely ruling out more rate cuts and have agreed to stress that such stimulus remains a viable option.”  Currency concerns feature prominently, as one anonymous official told Bloomberg that “investors shouldn’t rule out such action at a time when. . . the euro remains relatively strong.” 

Frankfurt’s frustration with Mr. Market is somewhat understandable: Despite the central bank’s imposition of deeply negative interest rates along with more aggressive asset purchases relative to the size of the economy than the Fed’s, the euro remains near multi-year highs both against the dollar and on a trade-weighted basis, crimping the ECB’s own efforts to hot up domestic consumer prices (Almost Daily Grant’s, Jan. 19). 

Might more of the same do the trick? Dutch central bank president and ECB governing council member Klaas Knott declared in an interview with Bloomberg Television this morning that: “We’ve explored the effective lower bound, but we haven’t found it yet,” he said. “There is still room to cut rates.” 

The search continues. 

Stocks were clubbed, with the S&P 500 sinking 2.4% to erase all of its January gains, while Treasurys maintained their recent strength with the 10- and 30-year yields sinking to 1.01% and 1.77%, respectively. WTI crude held at $52.5 a barrel despite a large weekly inventory drawdown, while gold edged lower once again, finishing at $1,840 an ounce.  The VIX made its best GameStop impression, rising 61% to finish north of 37. 

- Philip Grant

With the S&P 500 jumping 74% since March to near a fresh high, scores of newly minted retail traders, including an active contingent on the Reddit WallStreetBets forum, throw their weight around. According to Bianco Research, an average 40.5 million in call options have traded over the past 10 days, a record figure and roughly double the 2019 baseline. Thanks to that cascade of new money in tandem with buoyant sentiment, price action in a handful of securities has taken a manic turn.  Let’s review:

This morning shares in retailer GameStop Corp. soared as much as 145% to $159 per share, briefly reversed all those gains then finally finished at $77 each.   That compares to $43 on Thursday afternoon, $17 three weeks ago and $5 in September. For context, GameStop is expected to generate $5.6 billion in revenue and $114 in negative free cash flow for the 12 months ending in January 2022, down from $9.3 billion in revenue and $483 million in positive free cash flow in fiscal 2016, while the average price target among the quartet of sell-side analysts compiled by Bloomberg stands at $14. 

That epic rally was kicked off by the Jan. 11 announcement that former Chewy, Inc. co-founder Ryan Cohen would join the 37-year old retailer’s board of directors. Perhaps more importantly, the stock’s elevated short interest, last week exceeding the number of shares outstanding according to S3 Partners, provided kindling for the retail traders’ bonfire.  Trading volume of 197 million shares on Friday represented 20 times the one-year average turnover, while today’s 176 million shares traded was nearly three times that of the SPDR S&P 500 ETF, which has $330 billion in assets compared to a $6 billion market cap for GME. 

Then, too, that explosive move has dealt serious pain to conventional money managers caught offside.  This afternoon, hedge fund Melvin Capital secured a $2.75 billion investment from Citadel LLC and Point72 Asset Management, to help the fund deal with losses including those from a short position in GameStop.  

Sympathy seems to be in short supply among the newly-flush GME bulls. One user on the WallStreetBets page summarized the zeitgeist:

[F*ck] the shorts, [F*ck] fundamentals, this is a once in a lifetime opportunity.

Similar eye-catching action is visible across the Pacific. Shares in electric vehicle manufacturer China Evergrande New Vehicle Group, a division of the world’s most indebted property developer China Evergrande, jumped by as much as 67% after announcing plans to sell HKD $26 billion ($3.4 billion) worth of shares to an investor consortium.  Nearly 81 million shares changed hands today, nine times the one-year average daily trading volume. 

That brings the post-June rally in those shares to a cool 625%, leaving Evergrande auto with a $51 billion market cap.  That not only tops the $44 billion market value for industry mainstay Ford Motor Co. but also the $28 billion market cap for China Evergrande, the owner of 68% of the E.V. hopeful, which has yet to commence commercial sales of its products. Nigel Stevenson, analyst at Hong Kong-based forensic accounting firm GMT Research, tells the Financial Times that most of the deal proceeds will accrue to the corporate parent, as its biggest cash outlay in 2019 was investment in properties under development. “Evergrande Auto remains a property company,” he concludes.  

As the retail hordes are both emboldened with recent successes and soon-to-be-fortified with a capital infusion from forthcoming stimulus checks, other names come in for the GameStop treatment. This morning, iconic legacy smartphone maker-turned “intelligent security software” provider BlackBerry Ltd. shares spiked as much as 45% on 350 million share trading volume (nearly 30 times its one-year average), extending year-to-date gains to 170% and spurring the company to issue a press release declaring it is unaware of any “material change in its business or affairs” that would account for the stock surge.  

Indeed, the fundamental picture remains less than exciting.  BlackBerry, which has a current market cap of $10 billion, is expected to generate $1 billion in revenue and $130 million in free cash flow for the fiscal year ending in February 2022.  For comparison, the company posted an $11 billion top line and $1.1 billion on free cash flow in fiscal 2013. 

Anecdotal, rather than analytical information, may best explain the current phenomenon.  This morning, one Reddit user reported a purchase of just over $100,000 worth of BlackBerry stock, writing that he “took [his] dad’s life savings. . . [and] told him It’s either retirement on a yacht or food stamps for him.”

Stocks managed to rebound from a sharp, 150 basis point late morning selloff on the S&P 500, as the broad index climbed back into positive territory by day’s end, while Treasurys caught a strong bid with the 10-year yield falling to a three-week low at 1.03%.  WTI crude advanced to near $53 a barrel, gold held at $1,854 an ounce and the VIX rose 6% to 23, after spiking to near 27 intraday. 

- Philip Grant

To the victor goes the spoils.  Fund manager ARK Invest attracted a fresh $1 billion yesterday across their seven exchange traded funds according to Bloomberg senior ETF analyst Eric Balchunas, bringing year-to-date inflows to $6.7 billion. That tops the fundraising efforts of longstanding industry players BlackRock and State Street, and follows on an $8.2 billion inflow in December, besting all competitors and representing a 35% sequential increase per Morningstar. ARK’s total assets footed to $34.5 billion as of Dec. 31, up more than tenfold from the end of 2019. 

Blowout performance has both preceded and accompanied that firehose of fresh capital.  The seven actively-managed funds have generated two-month returns ranging from 20% for the ARK Fintech Innovation ETF to 45% for the ARK Genomic Revolution and 3D Printing ETFs, while the flagship ARK Innovation ETF has returned 172% over the last year, dusting the 47% return for the Nasdaq 100 Index.  

Having conquered planet earth, ARK now looks skyward. Last week, the fund manager submitted a regulatory filing disclosing plans to launch a “Space Exploration ETF,” spurring 20% one-day share price pops in presumptive components Virgin Galactic Holdings, Inc. and Maxar Technologies, Inc. (SPCE and MAXR, respectively, on the NYSE).  

The investment manager’s fast-growing bank account is helping it build several highly concentrated positions. ARK held more than 10% of the float in at least 26 companies concentrated in the biotech and technology industries, according to a recent analysis from Barron’s.

As funds continue to pour in and ARK’s ownership stakes grow, the manager’s investment decisions could begin to take on a life of their own. “There is this degree of reflexivity almost,” Ben Johnson, director of global ETF research at Morningstar, told Barron’s on Friday. “If the ARK team casts its gaze on a particular name, just by the virtue of doing so, the share price might respond. Today, they respond favorably. If this is in any way symmetrical, the market may respond equally disfavorably if they sour on a particular stock, especially if investors start to pull their capital.”

More broadly, ARK’s parabolic ascent underscores the evolution of ETFs from simple, cheap ways to track the broader market toward highly specialized, “thematic” products that are increasingly designed for a torrid market conditions and a restless investment public.  According to data from ETF provider Global X, thematic funds controlled $104 billion in assets as of Dec. 31, up 78% from the prior quarter. 

Yet recent academic research shows that retail investors chasing outsize returns through thematic ETFs have instead floundered.  Utilizing data from the Center for Research in Security Prices ranging from 1993 to 2019, a Dec. 22 paper from a quartet of finance professors including Itzhak Ben-David and Byungwook Kim from Ohio State University, Francesco Franzoni of USI Lugano, and Rabih Moussawi from Villanova University, concluded thus: 

Our results suggest that thematic ETFs fail to create value for investors. These ETFs tend to hold attention-grabbing and overvalued stocks and therefore underperform significantly: they deliver a negative alpha of about 4% a year. 

This underperformance persists for at least five years since launch. We find no evidence that the negative performance corresponds to the price that investors are willing [to] pay to insure against some relevant risk factor. Instead, our evidence suggest that thematic ETFs are launched just [at] the very peak of excitement around an investment theme.

Watch the space. 

Stocks finished flat to higher, with the S&P 500 treading water following a two-day rally to remain up 2.3% for the week so far, while the Nasdaq continued to percolate with a 80 basis point advance to bring its three-day gain to a meaty 4.8%.  The Treasury curve steepened, with the 10-and 30-year yields rising to 1.1% and 1.87%, respectively, WTI slipped back to $53 a barrel and gold held at $1,870 an ounce. The VIX closed at a six week low near 21, but today’s risk-happy results had one glaring exception: Bitcoin was smoked by 8% to $32,000, leaving the digital currency 22% below its Jan. 9 high-water mark. 

- Philip Grant

How low can we go?   Yesterday, the triple-C-rated component of the Bloomberg Barclays High Yield Index finished at a 6.71% yield-to-worst, the skimpiest since June 2014 and within 25 basis points of all-time lows, while the option-adjusted spread of 617 basis points over Treasurys sits well inside the year ago and 10-year average levels of around 832 basis points.  

An apparent leap of faith underpins those calm credit waters.  “[T]he U.S. high-yield market is implicitly forecasting a non-energy default rate equivalent to the lowest [ever],” Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors LLC, noted in a Tuesday commentary for S&P’s LCD unit. To determine the market forecast, Fridson looks at the number of sub-investment bonds trading at distressed levels, i.e., with option-adjusted spreads over 1,000 basis points. 

Crowded ranks among the most speculative-grade credits mark something of a contrast with Mr. Market’s sanguine view.  According to a Dec. 1 report from S&P Global, 237 North American companies sported a triple-C rating as of Oct. 31, up from about 140 such shaky credits in late 2019.  

Default data, both observed and projected, also belie those rosy assumptions. Thus, global corporate defaults totaled 226 last year, according to S&P Global, nearly double 2019’s tally and the highest figure since the 266 in 2009 (each year since included fewer than 150 defaults, with the lone exception of 2016).  In its 2021 North American Outlook released in early December, Moody’s Investors Service forecast a baseline 10.4% peak trailing 12-month default rate in March, followed by a continuation near the current 8.3% rate throughout 2021. Under a pessimistic scenario, defaults could reach as high as 15.2% later this year, nearly double the current pace.  

Investors in less risky areas of the bond market may likewise be leaving themselves precious little room for error. This morning the Bloomberg Barclays U.S. Investment Grade Index traded to a 92 basis point spread over Treasurys, the narrowest in three years and within eight basis points of the post-financial crisis low set in early 2018.  Similarly, the index’s 1.87% yield-to-worst remains near the all-time low of 1.74% set on Jan. 4. 

Then, too, corporate America has capitalized on the ultra-low rate epoch not only by adding extra dollops of debt (gross leverage among investment grade borrowers reached a record 3.7 times Ebitda at year end, according to Bank of America) but also borrowing for longer periods, thus increasing duration, or sensitivity to changes in interest rates. 

Needless to say, that combination reflects a daunting risk vs. reward proposition for corporate creditors.  Bloomberg noted yesterday that the Sherman Ratio, (named after the inventor, DoubleLine’s deputy chief investment officer Jeffrey Sherman) which measures the amount of yield on offer for each unit of duration, reached a record low of 0.1968 on Dec. 31, down nearly half from the 0.3468 seen at the start of 2020. In other words, as Bloomberg’s Brian Chappatta put it yesterday, “investors were more susceptible to losses from a move higher in interest rates than at any time in history.”  Demonstrating that point, the I.G. index is down more than 1% in January despite ongoing spread tightening, thanks to some upward pressure on Treasury yields. 

Indeed, current day corporate bondholders are a particularly put-upon lot, contending with shareholder- (and stock price-) focused management teams, as well as a Federal Reserve determined to inflate away the value of the currency in which their claims are denominated. The April 6, 2018 edition of Grant’s Interest Rate Observer put it this way: 

Creditors are the loneliest corporate stakeholders. Management disdains them. The Fed debases them. Give them this, at least (it’s a kind of virtue, anyway): They never complain.

The bears enjoyed a rare upper hand as fourth quarter earnings season got underway, with the S&P losing 75 basis points to settle 1.5% lower for the week.  Treasurys were well bid, with the 10-year yield falling back to 1.1% to erase its weekly losses. The VIX jumped 5% to finish north of 24, WTI slipped 3% to $52 a barrel and gold dropped to $1,826 an ounce as the Dollar Index closed at its highest level in more than a month. 

- Philip Grant

Let the spinning wheel spin.  Last year marked a watershed for the Nasdaq, as the exchange announced yesterday that it led all exchanges in total equity options trading volume, including a record 2.58 billion options contracts, a 52% jump over 2019.  Similarly, CME Group, the world’s largest derivative exchange, reported that daily volume within its equity index and option categories footed to 5.6 million contracts last year, up 63% from the 2019 level. 

Some observers think the trend has more room to run. Noting that only about 20% of customers on the popular Robinhood trading app currently deal in options, Cboe Global Markets head of derivatives and global client services Arianne Criqui told Bloomberg in an interview last November that she sees “great upside” for the category. 

Vanilla trading activity is likewise on a rampage.  Some 14.8 billion shares changed hands daily last week across major U.S. exchanges, “ranking,” according to Bloomberg, “among the busiest stretches of all time.” One particular demographic can take credit:  Retail investors threw their collective weight around like never before in the pandemic-riddled 2020, accounting for as much as 25% share of daily trading activity on peak days, according to a July estimate from Citadel Securities head of execution services Joe Mecane.  In 2019, that figure was closer to 10%. 

As Mr. Market continues to reward those newcomers with a gangbusters bull market, speculative elements take center stage. The Wall Street Journal noted yesterday that Chinese electric vehicle maker NIO, Inc. has been one favorite target of the day-trading hordes, with the company mentioned on Twitter some 6,800 times per day in November compared to 100 daily mentions at the start of 2020, while the stock has mushroomed to $62 per share today compared to less than $4 a year prior.  NIO, which is expected to post adjusted Ebitda of negative $239 million this year, now has a $98 billion market capitalization (approaching that of Ford and General Motors combined) and was the second-most actively traded stock in the U.S. last year with an average 111 million share daily trading volume, trailing only Apple, Inc. 

That modern day success story has spawned plenty of would-be competition. According to data from Themis Trading, six penny stocks (meaning those trading for less than $1 a share) accounted for 18% of total stock market trading volume on Monday, with a combined 2.6 billion shares in turnover. “I thought it was pretty odd,” Joe Saluzzi, co-head of equity trading at Themis, told Bloomberg. “There’s a risk it may not end well.”  Yet, so far, so good. Stocks within the Russell 3000 priced at less than $1 a share jumped by an average 13% through the first six trading days of the year, while those priced below $5 were up nearly 10%. The index itself rose a bit less than 2% over that period.

As Joe and Jane Six Pack chase stock market riches, one avatar of the current mania looks to cash in. Robinhood, which garnered an $11.7 billion valuation in a Series G funding round in September, is preparing to launch an initial public offering as soon as the first quarter. Keeping with the spirit of the times, the company is looking to dance with who brung them. Bloomberg reported last week that Robinhood “has weighed allocating a significant minority of the shares it will list” to its own users.  

On Dec. 17, the commission-free trading venue paid a $65 million fine to the Securities and Exchange Commission to settle allegations that Robinhood, from 2015 to 2018, “made misleading statements and omissions in customer communications” related to “its largest revenue source,” i.e. receiving payment from high frequency traders for its order flow, in turn leading to its customers receiving “inferior trade prices.” By way of response, chief legal officer Dan Gallagher declared that the fine “relates to historical practices that do not reflect Robinhood today.” In any event, that regulatory smackdown (or wrist slap) appears not to have stung too badly. TechCrunch noted in December that Robinhood saw revenues from order flow payments reach $180 million in the second quarter of last year, double that of the first quarter. 

Robinhood users-cum-shareholders paying themselves for their own order flow: A coming 2021 singularity? 

A strongly bid long bond auction spurred another extension of yesterday’s Treasury rebound, as the 10- and 30-year yields dropped in bull flattening fashion to finish at 1.09% and 1.83%, respectively.  Stocks caught another bid, with the S&P 500 logging its sixth green finish in seven tries following a near 2% pullback to open the trading calendar year.  WTI crude slipped back below $53 a barrel, gold ticked higher to $1,849 an ounce, and the VIX dropped below 22 to extend its two day loss to 8%. 

- Philip Grant

Here’s NBC Los Angeles, summarizing some Friday commentary from California Governor Gavin Newsom: 

Gov. Gavin Newsom forcefully pushed back on criticisms that California is becoming unfriendly for business, pointing to “all the new billionaires” created by initial public offerings and noting that its richest people are “doing pretty damn well.”

A match made in heaven?  This morning, Intercontinental Exchange, Inc. (ICE) announced that it will take its Bakkt Holdings, Inc. cryptocurrency payment business public.  The deal will take place via a merger with special purpose acquisition company VPC Impact Acquisition Holdings, Inc. at a proposed $2.1 billion valuation.

That intersection of cryptos and blank check companies is a both a notable contemporary signpost and an ironic development. ICE, the parent company of the New York Stock Exchange, would seemingly have little trouble listing Bakkt via a conventional initial public offering, but instead opted for the SPAC route, despite the fact that VPC’s owners will dilute the exchange operator via the blank check company’s promote.  

Less-than stellar operating projections further color the move.  According to the S-1 filing, Bakkt expects to generate negative adjusted Ebitda through calendar 2022 and a modest $285 million in adjusted Ebitda by 2025, despite penciling in $6.6 billion in total revenue for that period, compared to a forecasted $889 million top line this year.

In an interview with The Wall Street Journal, ICE CEO Jeffrey Sprecher termed the two-year old Bakkt a “moonshot” bet, adding today that “it’s well off the launchpad and headed for the moon.”

Bank of England monetary policy committee member Silvana Tenreyro talked up the virtues of negative interest rates in a webcast speech this morning, concluding that sub-zero rates “should, with high likelihood, boost U.K. growth and inflation.”  

Tenreyro continued: “There was some resistance to negative rates – we have all been brainwashed that you cannot go there. We learn it in our textbooks, so there was a big predisposition not to go below zero. . . [However], low rates are here to stay, so it’s important that we consider this as an option.” 

Some on Wall Street are convinced that the BoE will indeed make NIRP a reality.  Strategists at Goldman Sachs write today that: “Although increased fiscal support has weakened the case for a quick rate cut, the U.K. has still been one of the countries worst affected by the pandemic, and, combined with the negative effects of Brexit, it means we continue to expect that the bank will ultimately be forced to take rates negative.” 

In that regard, the Bank of England would have plenty of company. The global stock of negative yielding debt stood at $17.43 trillion as of Friday, near a record high and more than double that seen in March of last year.  As yields evaporate, income-famished investors grab what they can. Last week, triple-B/triple-B-minus-rated Italy sold €10 billion ($12.2 billion) in 15-year debt at a 0.95% coupon, with the offering attracting more than €100 billion worth of bids. “People want Italian bonds,” Imogen Bachra, European rates strategist at NatWest Markets, told Bloomberg. “There will be lots of supply for the market to take down in the next few weeks.”  

Good thing low rates are here to stay. 

Stocks came under some pressure, with the S&P 500 dropping 65 basis points while the tech-heavy Nasdaq 100 saw a 1.6% pullback and bitcoin was hammered by 15%.  Treasurys remained for sale as the 10-year yield rose to a fresh 10-month closing high at 1.14%, gold edged higher to $1,845 an ounce and WTI crude held near $52 a barrel.  The VIX jumped back above 24, finishing the day 12% in the green. 

- Philip Grant

The bond market percolates down Mexico way.  On Monday, Mexico’s finance ministry announced a successful debut sale of 50-year Formosa bonds (dollar-denominated bonds sold on the Taiwanese market) at a 3.75% coupon, with the $3 billion offering more than three times oversubscribed. 

While the triple-B/triple-B-minus-rated Mexican government opportunistically finances itself, state-owned oil giant Petróleos Mexicanos (a.k.a. Pemex) reportedly prepares its own return trip to the bond market. In October the company sold $1 billion, dollar-pay five-year notes priced-to-yield 6.95%, well inside price talk of 7.5% to 8%. 

Less traditional balance sheet machinations are also on the table for highly indebted Pemex. On Dec. 15, the company declared it had carried out a refinancing “financial operation” to relieve some $4.8 billion in near-term debt maturities, including a $2 billion payment scheduled for this month. Pemex, which was downgraded to junk by Moody’s and Fitch in April to become the world’s largest fallen angel, carries some $105 billion in financial debt along with $68 billion in pension obligations as of Sept. 30, a combined sum equal roughly 18 times calendar 2019 Ebitda. Third quarter 2020 Ebitda of $2.4 billion was half that of the year earlier period. 

Acute and long-gestating operational problems compound Pemex’s precarious capital structure, including a cumulative $87 billion free cash flow deficit from 2010 through Sept. 30 of last year.  Persistent production declines, to 1.63 million barrels per day in November from 1.7mbpd in the same month in 2019 and a peak of 3.4mbpd in 2004, further muddy the financial waters. 

“It’s a bigger and bigger hole,” Simon Waever, strategist at Morgan Stanley, told the Financial Times yesterday. Waever projects that Pemex will need to raise another $10 billion from the bond market this year, including $5 billion in January. One unnamed former senior official at the company added that “Pemex’s situation is much worse than the market thinks. They’re burning through cash at the speed of light.”  

Pemex’s woes may compel more assistance from the Mexican government, led since 2018 by Mexican President Andrés Manuel López Obrador (AMLO). The company’s tax rate is expected to foot to 54% of profits this year, deputy finance minister Gabriel Yoro estimated to Reuters on Dec. 9, down from 58% last year and 65% in 2019. Then, too, Fitch Ratings wrote on Dec. 17 that the agency’s base case expectation “incorporates the assumption that Mexico would cover [Pemex’s] expected negative free cash flow projected for the next few years.” Pemex’s projected tax revenues account for 15% of Mexico’s federal budget for 2021. 

Since a bearish analysis in the March 23, 2018 edition of Grant’s, Pemex’s 6 3/4% senior notes due 2047 have seen their spread widen to 573 basis points from 399 basis points, while five-year credit default swaps have jumped to 398 basis points from 192 basis points.  Yet, Mexican sovereign five-year CDS have declined to 81 basis points from 114 basis points over that period, despite a trio of rating downgrades during the spring of 2020.

Might the pair’s fortunes be more closely tied than Mr. Market currently expects? Moody’s warned on Dec. 8 that “a change in our assumptions about government support and its timeliness could lead to a [further] downgrade” for Pemex, while, in the case of a further downgrade to the sovereign, Pemex’s “baseline credit assessment would have to substantially improve” to maintain its own Ba2 rating.   The rating agency pegs Mexico’s sovereign rating at Baa1 (three notches above junk) with a negative outlook.  Indeed, the capacity for sovereign assistance has its limits. “The ability to continually implement ad hoc, one-time support measures is going to diminish over time,” Patti McConachie, senior analyst at Columbia Threadneedle, told the FT. 

Financial fallout from the country’s recent political shift continues to loom large. AMLO, long an advocate for state control over the Mexican energy patch following his predecessor's move to open the industry to outside competition, suspended auctions for deep water drilling licenses for foreign operators shortly after taking office. That move has led to a cascading project pile-up, as more than 200 energy ventures were stalled as of mid-October, Bloomberg reported Dec. 22.  That compares to fewer than 30 such discontinued energy projects six months prior to AMLO’s ascent.

The President’s “clear goal is to change the rules of the game so that the state once again has the upper hand and can dictate the terms on which private money comes into the system,” Duncan Wood, director of the Wilson Center’s Mexico Institute, told Bloomberg. “Everything points to the fact that he wants to close the system again.” 

Pemex and Mexico sovereign creditors alike, please copy. 

Another day, another dollar for the bulls, as stocks ripped higher once more to leave the S&P 500 above 3,800 for the first time, a cool 70% above its March nadir.  Treasurys came under renewed pressure with the long bond yield jumping to 1.86%, leaving the 2- vs. 30-year spread at its widest since May 2017.  WTI crude rose to near $51 a barrel, gold edged higher to $1,915 an ounce and bitcoin touched $40,000 after residing near $36,000 yesterday afternoon.  The VIX fell 11% to settle below 22.5. 

- Philip Grant