A special snowflake, indeed.  Fast growing, money losing cloud data warehouse Snowflake, Inc., is on the rampage, with shares enjoying a blistering 32% two-day rally after the company posted its third quarter results, which featured a $169 million quarterly net loss, double that of a year ago.  That brings share-price gains to 220% from SNOW’s Sept. 15 Nasdaq debut, while the company’s market cap now at a cool $109 billion, up from $12 billion in the most recent private fundraising round in February (2020). 

That runaway share price spells a windfall for one well-placed executive.  Bloomberg reports that CEO Frank Slootman is cashing in on his company’s raging success, pocketing equity options equivalent to nearly $100 million per month at the current share price.  Bloomberg notes that, as the award package features monthly option grants vesting over a four year period, the package could be worth as much as $4.8 billion through early 2023, based on the current price. 

That payout is material even relative to the most pie-in-the-sky metrics.  Recall that, in its S-1 filing ahead of the IPO, Snowflake estimated that “the addressable market opportunity for our Cloud Data Platform is approximately $81 billion as of January 31, 2020.” 

Peak capex?  As the price of both West Texas Intermediate and Brent crude climb to their best levels since early March (north of $46 and $49 per barrel, respectively) with the Organization of the Petroleum Exporting Countries coming to terms on a production agreement into next year, a pair of lynchpin corporate strategy shifts may reverberate. To review: 

Yesterday evening, integrated oil giant Chevron Corp. announced drastically scaled-back capital expenditure plans in coming years.  The company now projects an annual capex budget ranging from $14 billion to $16 billion per year through 2025.  That’s down 27% from the midpoint of the prior forecast and represents less than half of Chevron’s capital spending budget in 2014, when WTI regularly traded north of $100 a barrel. 

That follows fellow energy behemoth ExxonMobil Corp.’s Monday announcement that projected capex will foot to between $16 billion and $19 billion next year, followed by $20 billion to $25 billion from 2022 to 2025. Those figures represent 46% and 31% declines, respectively, from XOM’s prior $30 billion to $35 billion annual capex guidance over the next five years.  Writing off various poor-performing assets across North and South America, CEO Darren Woods told analysts that high-grading, or drilling their best wells first, will be a prominent feature of Exxon’s near-term strategy. 

The pair’s deep planned cuts amplify existing industry trends.  Thus, Ross Atkinson, director at Simmons Energy, estimated at a conference last month that global exploration and production capex will total some $228 billion this year, down from a prior $325 billion forecast before the bug bit.  A Nov. 17 analysis from Rystad Energy forecast that drilling and completion capex from domestic shale operators will roughly halve this year from the $98.7 billion in spending seen in 2019, with 2021 shale capex spending set to shrink another 13% from this year’s levels.  Weakened output potential follows that spending slowdown, as shale production will decline by 2% to 3% in 2021 following on this year’s 3.1% decline, if Rystad’s estimates are on the beam. 

Indeed, Coronavirus’ unwelcome arrival appeared to exacerbate a trend which was already beginning to take shape.  Thus, analysts at J.P. Morgan concluded on March 3 that the oil industry “is not well-placed to meet global energy needs in the medium term . . . Cumulative underspend on oil projects, on track to reach $1 trillion by 2030, means the industry is at a point of no return with supply set to peak at 102 million barrels per day in 2022.  Continued pressure on oil prices is only going to accentuate a structural supply deficit that has already taken hold.” Of course, that continued price pressure quickly materialized, culminating in the dramatic collapse into negative territory seen in April. 

How to capitalize on a potential bullish sea-change in the energy patch?  See the most recent edition of Grant’s Interest Rate Observer for more. 

Rendering the prospect of additional fiscal stimulus that much more likely, a weaker-than-expected reading of November nonfarm payrolls spurred a sharp Treasury selloff, with the 10- and 30-year yields each moving to the cusp of post-March highs at 0.97%, and 1.74%, respectively.  Stocks meanwhile remained firmly in euphoria mode, with the S&P 500 finishing at the highs of the day to log a 1.7% gain for the week and reach a fresh record high, up 14.5% this year.   WTI crude finished above $46 a barrel, gold paused at $1,840 an ounce and the VIX pulled back to 20.6.  

- Philip Grant

Modern sovereign borrowing, with European characteristics.  On Nov. 19, China sold €4 billion in euro-pay sovereign debt including a five-year tranche priced-to-yield minus 0.152%.  That’s the Middle Kingdom’s first foray into the negative-rate club, according to Dealogic. The deal was covered four-and-a-half times over, according to Deutsche Bank head of China capital markets Samuel Fischer, who helped oversee the sale. 

“People want more exposure to China,” Fischer commented to The Wall Street Journal. “China’s financial markets are opening, but there is still a broad scarcity of the sovereign [debt] among investors. The story of China’s COVID turnaround and the resilience of its economy are also things people like.” 

While that offering went off without a hitch, Chinese debt is slightly less popular in other contexts.  Bloomberg reports today that corporate dollar-pay bond issuance sank to $9.9 billion in November, down 52% on a sequential basis and the lowest monthly total since April.  That slump comes at a potentially inopportune time. According to data from Debtwire, Chinese state-owned enterprises face more than $3 billion in high-yield dollar bond maturities in the first quarter of next year, by far the busiest quarterly maturity schedule through at least 2023. 

One potential explanation for the financing slowdown: A string of recent defaults from those state-owned enterprises across various geographical regions and sectors, including Henan-domiciled Yongcheng Coal and Electricity Holding Group Co. Ltd. and Shenyang-based Brilliance Auto Group Holdings Co (a joint venture partner with BMW). Those defaults helped trigger a selloff dealing creditor losses equivalent to RMB 60 billion ($9 billion), a local broker estimated to Caixin on Nov. 24.  Some 10 SoE’s have defaulted so far this year, representing 40% of total such defaults over the past five years.  

Suddenly skittish investors have tightened their wallets in response, forcing cash-hungry outfits to pay up, with an unnamed Shanxi-based coal miner reportedly paying 5% coupon for ultra-short-term financing. “This might be a historic credit crisis,” one anonymous investor, who held bonds issued by both Yongcheng and Brilliance, told Caixin.  One senior regulator showed limited sympathy regarding those fears, rhetorically asking in response: “When creditors lent so much money to [now-stricken SoEs], did they conduct their risk control properly?” 

One thing’s for sure, state-owned entities have played a starring role in China’s economic miracle. A report today from S&P Global estimates accumulated debt from local and regional government nonfinancial SoE’s at 60% of Chinese GDP (for context, total U.S. corporate debt stood at $10.9 trillion as of the second quarter, equivalent to just over half of last year’s nominal output). The analysts conclude that, as local governments now “have fewer resources to support” those suddenly flailing entities, “higher tolerance for SoE defaults are likely as these governments dig out from COVID.” 

A key feature of the recent credit scare: A Lake Woebegone-type ratings regime, in which virtually all comers are well above average. More than 98% of outstanding bond issuance in China comes from those rated double-A and above according to Wind Data Services, while some 57% of all onshore corporate debt garnered a triple-A-rating as of mid-October per asset manager Invesco Ltd, up from 38% five years earlier.  Indeed, both Brilliance and Yongcheng had enjoyed pristine triple-A ratings from China’s onshore credit rating agencies.  The recent spate of trouble has done little to change that. According to Wind Data Service, only five Chinese companies out of more than 5,000 have been downgraded below the double-A threshold since the Yongcheng and Brilliance defaults.

“China’s rating agencies are even worse than [those] in the U.S.” Andrew Collier, managing director of Orient Capital Management, groused to the Financial Times. “They’re not only beholden to the customer but also [to] the government.” 

Like a home-plate umpire, the Chinese Communist Party is always right. 

Stocks took a pleasant pause, with the Nasdaq 100, S&P 500 and Russell 2,000 indices each finishing flat or slightly higher to nurse year-to-date gains to 43%, 13.5% and 10%, respectively.  Treasurys settled down a bit from yesterday’s steep selloff but maintained their steepening bias, with the 10- and 30-year yields rising to 0.94% and 1.69%, respectively.  Gold rallied back to $1,834 an ounce, WTI crude rebounded back above $45 a barrel, and the VIX rose to 21.2 after testing the 20 threshold for the first time since February in the pre-market yesterday.

- Philip Grant

The bond market gives thanks. Citing data from Refinitiv, The Wall Street Journal reports today that global debt issuance so far this year reached a record $9.7 trillion as of Thursday, surpassing all prior full-year tallies.  That record figure includes $1.4 trillion from U.S. investment grade corporates (up 54% from a year ago) and $337 billion in domestic junk bonds (a 70% year-over-year uptick). 

Of course, surging debt issuance and disappearing yields the world over (see the $17.4 trillion pile of nominal negative yielding debt worldwide), has been little impediment to a rip-snorting, broad-based rally in credit, as the Bloomberg Barclays High Yield Index has generated a 31% return from its March lows and 7.5% from a year ago, while spreads on triple-C-rated corporate bonds have dived to 736 basis points, from 1,815 in March and 970 basis points a year ago. 

That comes despite deteriorating corporate fundamentals at the deeper end of the credit pool. According to data from Deutsche Bank, net leverage among U.S. high yield corporate issuers jumped to more than 8 times adjusted Ebitda in the second quarter from about 5 turns a year prior, while interest coverage collapsed to less than 2.5 times as of June 30 from roughly 3.5 times coverage in mid-2019 and a 4.5 times interest coverage buffer in 2018. Strategist Craig Nicol notes that the issuance spree “flies in the face of what we have typically seen during other periods of stress or recessions when we've seen conditions much more akin to a credit crunch.” 

Seemingly insatiable demand for debt has been the key. “There has been no problem in absorbing the massive debt issuance seen in 2020 due to the combination of central-bank asset purchases and the sharp rise in private savings,” Gene Frieda, global strategist at Pacific Investment Management Co., tells the Journal. 

A healthy economy is notably absent from that calculus, as global output is set to shrink by 4.4% from a year ago, if estimates from the International Monetary Fund are on the beam. 

Prolonged malaise could spell trouble.  According to a Nov. 18 report from the Institute of International Finance, developed markets lugged debts equivalent to 432% of GDP at the end of the third quarter, up from 380% total debt-to-output at year-end 2019.   The United States is on track to reach $80 trillion in total debt by year end (equal to 370% of nominal 2019 output), up from $71 trillion a year ago.  “There is significant uncertainty about how the global economy can deleverage in the future without significant adverse implications for economic activity,” the IIF concludes. 

A new entrant looms in the publicly-traded food delivery realm.  DoorDash, Inc. filed its amended form S-1 today, revealing plans to sell 33 million shares at $75 to $85 each, valuing the company at as much as $32 billion on a fully diluted basis.  That’s up smartly from the $16 billion valuation that DoorDash garnered during its most recent private fundraising round back in June. 

Financial metrics appear to be on the upswing, though consistent profitability remains elusive for the seven year old enterprise. Sales through the first nine months of the year registered at $1.9 billion, more than treble the top line over the same period last year, while net losses narrowed to $149 million compared to $533 million over the first three quarters of 2019.   Nevertheless, persistent red ink appears endemic to the food delivery business, as peer Uber Eats reported adjusted Ebitda of negative $183 million in the third quarter, despite seeing revenues more than double to $1.5 billion (for more on Uber, see the most recent edition of Grant’s Interest Rate Observer). 

For DoorDash, the revelation of extra-legal shenanigans clouds those efforts to push into the black.  Last week, the company paid $2.5 million to settle a lawsuit from Washington D.C. Attorney General Karl Racine alleging that DoorDash helped itself to millions of dollars in driver tips.  In addition to that restitution, the company agreed “to maintain a payment model that ensures all tips go to workers without lowering their base pay, and it will be required to provide clear and easy-to-access information about its policies and payment model to workers and consumers."

The timing of the settlement is ironic. Founder and chief executive Tony Xu, who owns some 42% of all super voting class B shares, wrote in a founder’s letter accompanying the filing that “fighting for the underdog is part of who I am and what we stand for as a company.”

Stocks took a breather, with the S&P 500 losing 40 basis points and the Russell 2,000 suffering a 1.8% pullback, though those indices logged gaudy 11% and 18% gains for November.  Treasurys went absolutely nowhere, with the long bond holding at 1.57%, while WTI crude remained just above $45 a barrel.  Gold slipped to $1,779 to continue its slump, a marked contrast to “digital gold’ as bitcoin moved to a record high near $19,500.  

- Philip Grant

Credit risk is on the hop in China: Yields on double-A-rated corporate bonds, generally considered to be more speculative than similarly-rated western issues, reached 4.38% on Friday, according to Wind Data Service.  That’s up from 3% earlier this year and the highest yield since January 2019. 

The powers-that-be have taken notice. Attributing a recent spate of defaults among state-backed corporations to  “cyclical, institutional and behavioral factors,” (Almost Daily Grant’s, Nov. 17) China’s Financial Stability and Development Committee declared it will “investigate and deal with fraudulent issuance, false information disclosure, malicious transfer of assets,  misappropriation of funds and other illegal activities.”  

Beijing’s hard line comes as China’s largest and most encumbered property developer, China Evergrande Group, which faces a mammoth RMB 836 billion ($125 billion) burden as of the end of June (equivalent to an eye-watering 11 times Ebitda), looks to dig out of a debt-ridden morass.  

Bloomberg reports today that government-linked entities will chip in an RMB 30 billion equity investment for Evergrande’s Hengda Properties Unit, which holds many of the company’s crown jewel mainland assets. In addition, the investor coalition agreed to buy a 7% stake in services division Evergrande Property Services Group Ltd., helping underpin an upcoming Hong Kong-domiciled IPO which will raise a projected HK$15.8 billion ($2 billion) with pricing set for Thursday. Recall the parent company netted $555 million through an equity offering in October, barely half its target sum of $1.1 billion. 

Evergrande scored a crucial victory earlier this fall, when a quorum of investors agreed to hold off on asking for repayment of upwards of RMB 130 billion in funds linked to a scrapped backdoor listing on the mainland Chinese market, equivalent to virtually all of the cash and near-cash on hand as of June 30. The company has since attempted some creative (or desperate) measures to finance itself, including making approaches to offshore and onshore trust companies about issuing debt at coupons above 15%, Reuters reported on Oct. 30 (the investors passed on the deal, owing to “concern over the developer’s high debt level”). 

Instead, Evergrande has all but ceased utilizing the trust market for its financing needs, issuing roughly RMB 3 billion monthly from August through October according to data from industry provider Use Trust. That’s down from about RMB 10 billion per month from January to July. Non-bank financing has figured prominently in the company’s strategy, as trust products accounted for about 40% of total borrowings at year-end 2019 per Use Trust. 

The potential for intensifying regulatory pressure also factors in. Next year, Beijing will roll out the “three red lines” rules for property developers, introducing balance sheet restrictions including debt-to-asset ratios below 70%, net gearing below 100% and short-term debt no greater than cash reserves. Companies which fail these tests (Evergrande reported a net gearing ratio of 199% and cash equal to less than half of short-term maturities as of June 30) will be barred from growing liabilities for one year. 

Use of non-traditional funding sources is likely to come under additional scrutiny, as developers will also need to provide financing information covering not only bank loans and bond issuance, but also less conventional forms of funding like off-balance sheet arrangements and securitization of accounts receivable. 

As Evergrande works to stay afloat, investors face their own problems.  Bloomberg reported on Nov. 10 that bonds issued by companies controlled by billionaire Zhang Jindong have come under severe pressure following his surprise decision to forego early repayment on an RMB 20 billion investment with Evergrande.  

Suning Appliance Group Co.’s privately-traded bonds fell to around 70 cents on the renminbi in recent weeks, while e-commerce platform Suning.com Co. (on which Zhang is the chairman and largest shareholder with a 20% stake), one of China’s largest non-government affiliated retailers, has seen its RMB-pay senior unsecured 5.2% notes maturing next year plunge to 86 cents on the renminbi for a yield-to-worst of 43%. 

There appears to be valid cause for concern, as Suning.com’s interest coverage ratio plunged to 0.76 at the end of June from 1.61 a year prior, per an interim financial report.  “Now you would need to be very bold to lend money to the company,” Shen Chen, partner at Shanghai Maoliang Investment Management LLP, told Bloomberg.

Another bull day for stocks saw the S&P 500 rise 60 basis points while the small-cap Russell 2000 ripped by nearly 2%, extending to a 9% advance this year to draw closer to the SPX’s 10.7% year-to-date advance. Treasurys came for sale with the long bond rising to 1.56%, WTI crude climbed above $43 a barrel, gold sank to $1,833 an ounce and the VIX dropped 4% to finish below 23.  

- Philip Grant

A synchronized global crackdown on big tech? From east to west, governments of all stripes look to agree on one topic: Reining in the corporate kingdoms of Silicon Valley.  Let’s review: 

While China’s last minute, Nov. 3 decision to pull the plug on Ant Group Co.’s gargantuan $37 billion initial public offering drew plenty of attention, subsequent happenings suggest that decision was not made in a vacuum.  Last week, local regulators rolled out new rules designed to curtail monopolistic practices among tech giants, spurring notable selloffs in industry mainstays Alibaba Group Holding, Ltd. and Tencent Holdings, Ltd. 

“Beijing has felt that tactics by ecommerce companies are not leading to healthy development of the retail industry. . . They don’t want three or four companies [dominating], they want 1,000s of companies,” Wong Kok Hoi, chief investment officer at APS Asset Management, told the Financial Times. “This is big, this is a game changer.”

China isn’t the only Asian nation flexing its sovereign muscle, as Reuters reports that Vietnam “has threatened to shut down Facebook, Inc. in the country if it does not bow to government pressure to censor more local political content on its platform.” International political squabbles spur additional headaches: Bloomberg reports that Russian legislators submitted a draft law earlier today which would allow Russia to block Facebook and Alphabet, Inc.’s YouTube in response to those platforms’ apparent censorship of Russian state media outlets. 

Supranational authorities likewise look to tighten their grip on big tech. Last week, the European Commission announced that it had reached a preliminary view that Amazon.com, Inc. has violated EU competition rules.  A second investigation is now underway to determine if the “everything store” has improperly tipped the scales towards its own products and away from unaffiliated marketplace sellers. 

There could be more where that’s coming from. A new report from the European Court of Auditors criticized the E.U.’s antitrust apparatus for overly-narrow interpretations of potential abuses and slow walking investigations, “negatively affect[ing] the effectiveness of the [body’s] decisions.”   That opinion comes ahead of the forthcoming Digital Services Act, which is “likely to require dramatic changes in [industry] business practices and even business models,” Thomas Vinje, a partner at the law firm Clifford Chance, told CNBC on Nov. 5.  

Stateside, bipartisan pressure on the big tech cohort looks set to intensify.  The Washington Post reported yesterday that state and federal authorities are set to bring charges for alleged anticompetitive behavior related to Facebook’s purchases of Instagram and WhatsApp in 2012 and 2014, respectively. The charges, per the Post, will underpin a potential “wide-ranging political salvo. . . ultimately threat[en] to saddle Facebook with its toughest regulatory challenge in its nearly 17-year history.”  The legal bandwagon is filling up, as the Capitol Forum reports that a coalition of at least 30, and potentially up to 40, state attorneys general is set to join the lawsuit. 

Then, too, the Federal Trade Commission (which levied a $5 billion fine on Facebook in July 2019) is reportedly preparing its own antitrust lawsuit centering on the Instagram deal. Alex Kantrowitz, proprietor of the Big Technology Blog, commented on the likely legal ramifications last Thursday:

When you examine previous big tech antitrust cases, the laws the FTC has at its disposal, and the state of Facebook’s business, it becomes evident that Zuckerberg’s crown jewel is under threat. 

Facebook is, of course, not the only one getting the side-eye from Uncle Sam, as Google parent Alphabet’s own U.S. antitrust case will likely commence in December, The Wall Street Journal reported yesterday.  Recall that the Department of Justice sued the behemoth on Oct. 20 for alleged anticompetitive conduct related to its core search engine and advertising businesses.  The lawsuit also alleges that the defendant’s payments to Apple, Inc. to make Google its default search engine contravene U.S. law.  Google remits an estimated $10 billion a year to Apple, equivalent to roughly 15% of the latter’s annual operating income. 

Tangible evidence now suggests that pressure is making an impact.  Apple announced yesterday that it will cut its commissions from app developers producing up to $1 million in annual revenue to 15% from the 30% take rate since the iPhone’s debut in 2008.  The income stream from app developers, described by Bloomberg as “key to Apple’s growing services businesses,” generated $54 billion in revenue during the fiscal year ended Sept. 30, equivalent to just under 20% of the consolidated top-line and about 95% of total net income. 

For more on the implications of this apparent regulatory sea change, including the bull case on an industry giant currently absent from the government’s cross-hairs, see the October 16 edition of Grant’s.  

Stocks worked off early losses with the S&P 500 rising 40 basis points to revert to unchanged for the week so far, while Treasurys caught another bid with the long bond falling to a two-week low at 1.56%.  WTI crude remained near $42 a barrel, gold slipped once more to $1,868 an ounce, and the VIX fluttered back to 23. 

- Philip Grant

From CBS News in Sacramento:

A man wanted for his role in an alleged $35 million Ponzi scheme was arrested Monday after evading FBI agents by swimming into California's largest reservoir using an underwater "sea scooter," federal prosecutors said. Matthew Piercey spent about 25 minutes in frigid Lake Shasta using the Yamaha 350Li submersible device before he eventually resurfaced and was handcuffed.

Good times again in the Middle Kingdom?  China’s National Bureau of Statistics reported yesterday that industrial output jumped 6.9% in October from a year ago, topping the economist consensus for a 6.7% uptick.  That figure, along with a 4.3% increase in retail sales compared to October 2019 (up from a 3.3% annual rise in September) “cements the nation’s status as the only major economy tipped to grow this year” according to Bloomberg.   However, signs of increasingly widespread corporate distress belie those happy figures. Let’s review: 

Last week, state-owned enterprise Yongcheng Coal & Electricity defaulted on an RMB 1 billion ($150 million) in triple-A-rated commercial paper, catching investors off guard. “Due to the market’s insufficient expectations of a default at Yongcheng Coal, panic broke out in the bond market,” broker China International Capital Corp. relayed over the weekend.

Balance sheet strain is apparent across a swath of industries. Thus, Caixin reports that chipmaker Tsinghua Unigroup Co. failed to repay a privately issued RMB 1.3 billion onshore bond with a 5.6% coupon that came due yesterday, validating creditor concerns following the company’s decision to waive the repurchase of a privately-issued RMB 1 billion perpetual bond a month ago. Also yesterday, Brilliance Auto Group Holdings Co. (which is partnering with BMW Group in joint venture) defaulted on RMB 6.5 billion in debt.  

The situation has Beijing’s attention, as Bloomberg reports that China’s State Council has requested risk assessments from relevant government agencies, while the National Development and Reform Commission promised today to intensify its oversight of the bond market.  The Financial Times relays that at least 20 Chinese companies have shelved planned bond sales totaling RMB 15.5 billion over the past week thanks to the tumult. 

It’s hard to say credit markets are overly concerned, as the spread between three-year, double-A-rated corporate debt stood at 114 basis points yesterday over comparable government notes, a six-week high but well below the 163 basis point premium seen in late April. “Credit risk is under-recognized” in Chinese state-owned enterprises, analysts at J.P. Morgan conclude today. “We expect more defaults on SOE bonds or loans.”  As for resolution to the problem, the analysts expect that Beijing will “adopt a gradual approach. . . instead of ‘shock therapy.’”  Investors can expect monetary easing to leave rates “eventually approaching the zero interest rate bound,” risking “Japan-style distress and lost economic growth momentum.” 

The banks have their own problems.  Last week, regulators officially declared embattled Baoshang Bank as insolvent, confirming the lender will not repay a RMB 6.5 billion bond or make accompanying interest payments. Baoshang, which had RMB 576 billion in assets prior to a May 2019 government takeover, declared it is “seriously insolvent and unable to survive” in a filing on Friday, Caixin reports. 

Recall that Baoshang’s default, the first from a Chinese bank since 1998, helped spur a broad credit market seizure, a concerning event considering the bank represents a mere rounding error in terms of its size relative to the Chinese economy (Almost Daily Grant’s, July 16, 2019).

At least five other sizable commercial banks have since been forced to restructure, while other financial institutions have seen bad loans go parabolic. Anxin Trust, one of only two trust companies publicly listed in mainland China, reported in March that nonperforming loans stood at 83% of total loans as of Dec. 31, 2019, compared to 9% a year earlier.  Overall, the 68 Chinese trust companies, including 66 closely held ones, oversaw an aggregate $3 trillion in assets as of March 31. 

More broadly, mushrooming balance sheet distress is especially troubling in that it comes from a distended banking system, as Chinese banking assets footed to $43.8 trillion as of June 30, equaling one-half of 2019 global GDP and three times mainland output last year. Waning economic momentum into the pandemic adds into the mix, as last year’s reported output growth of 6.1% was its lowest since at least 1990.   Logan Wright, head of Rhodium Group’s China markets research, laid out one potential scenario in the July 24 edition of Grant’s:

What will happen is these bank failures will rise to larger and larger banks.  Then we will see this transition moment when we go from bailouts to bail-ins, which is a pretty dramatic moment in terms of overall credit growth. This will also have to be public. This isn’t something that you can just cover up using undeclared funds from the central bank balance sheet. At some point you are going to want to announce that you have a plan or strategy for this.

In the meantime, the slow-motion pileup continues. 

Stocks saw a moderate pullback with the S&P 500 slipping 50 basis points, though the bulls are unlikely to shed too many tears as the broad index is still up more than 10% from its Oct. 30 closing level.  Treasurys caught a strong bid with the 10- and 30-year yields falling to 0.86% and 1.62%, respectively. Gold pulled back to $1,888 an ounce, WTI crude edged higher to $41.5 a barrel, and the VIX held below 23 for a second straight session.  

- Philip Grant

Australia’s largest initial public offering of the year is coming down the pike. Dalrymple Bay Infrastructure Ltd., operator of the Dalrymple Bay Coal Terminal (DBCT), yesterday issued terms to investors for its upcoming debut on the Australian Stock Exchange. The prospectus is likely to be filed with regulators next week, with trading set to begin on Dec. 10.  

DBCT is seeking to raise at least A$656 million ($479 million), which would bestow a A$1.3 billion market cap on the 37-year old facility, reports the Australian Financial Review.   The company’s target A$3.1 billion enterprise value is equivalent to just under 17 times forecast fiscal 2020 Ebitda, with a gaudy 7% implied annual distribution yield. 

Dalrymple, currently owned by Canadian alternative asset behemoth Brookfield Asset Management, operates the world’s largest metallurgical, or coking, coal export terminal, handling some 15% of global export volumes in 2019, according to the company. The post-IPO ownership structure will remain close to home, as Brookfield will maintain a 49% stake while the government-owned Queensland Investment Corporation’s Futures Fund has committed A$128.5 million to purchase a 9.99% position. 

Needless to say, the floatation of a major coal asset comes at a less than ideal time as environmental, social and governance-based investing themes are all the rage currently.  The green zeitgeist is similarly prominent at a national level as several major developed nations, including Germany, Japan and Korea, (the latter pair being major importers of Australian coal) have declared they intend to achieve net-zero carbon emissions by 2050.  Non-ESG factors have also hurt, as China unofficially halted imports on Australian coal in October thanks to an ongoing diplomatic rift between the pair. 

Operational wiggle room looks to be limited, as the company is set to carry pro forma net debt of nearly $A2 billion, equivalent to 10 times consensus 2020 Ebitda.  The virus has, of course, also taken a toll. Volumes over the three months through September came to 12.8 million tons according to the Queensland Port Authority, down 20% from a year ago.  

A bright (projected) future contrasts with those daunting current realities. In an Oct. 28 report, independent investigative journalist Michael West identified a pair of “very aggressive assumptions,” which underpin the deal.  First, Dalrymple’s pro forma financial statements imply that its debt coming due within the next five years will be successfully refinanced into principal-only bullet loans, a prospect which could be difficult considering that the company had to abandon a local bond offering earlier this year.  

The other bullish leap of faith rests on a friendly tweak from the Queensland Competition Authority. Currently regulating the entity as a monopoly, the QCA uses an interest rate-sensitive formula to establish Dalrymple’s revenue rate, a fact which is bad news for shareholders considering this year’s price action in developed-nation sovereign interest rates.  In early June, the QCA extended Dalrymple’s monopoly designation for another 10 years.  

For its part, Brookfield claims that an August draft decision from the QCA raises hope that the regulator may relax its stance and allow the company a more lucrative fee structure (a final ruling is expected in early 2021).  However, West walked through the math related to the repayment of DBCT’s debt load, concluding otherwise: 

Brookfield-generated pro forma financials seen by Michael West Media show that management expects A$98 million in funds from operation (FFO) in 2021. A prudent 60% payout implies that about A$60 million will be available for distribution. 

Many professional investors would adjust financials to incorporate the payment of principal along with interest to estimate a sustainable dividend. If we assume that the debt is amortized over 20 years, distributable cash flow declines 61% to A$38 million. If, a more reasonable proposition, debt is amortized over 15 years, FFO declines 94% to A$5 million, not enough to fund much, [if] any, dividend.

The probability of the QCA making a 180-degree turn and deregulating DBCT seems low. Brookfield’s actions suggest that not even they believe it.

In a follow-up yesterday, West notes that the Queensland pension fund’s large ownership position further muddies the waters: 

How will the QCA make an impartial decision that is best for the market, and the terminal’s owners and users, when a sister branch of government is making a very public bet that it will get a favorable ruling? 

Time will tell, on that score. 

Friday the 13th was no cursed affair for the bulls, as the S&P 500 rose by nearly 1.5% to reach a fresh all-time high, taking out the prior peak reached on Sept. 2. Treasurys took a rest following some volatile trading earlier this week, as the 30-year yield held at 1.64%. WTI crude pulled back toward $40 a barrel, gold lifted to $1,887 an ounce to continue its climb, and the VIX plunged to a 10-week low near 23. 

- Philip Grant

“About as bullish as you could want,” is how Charlie Sernatinger, head of global grain futures at ED&F Man Capital Markets, characterized today’s reading of the USDA’s World Agriculture Supply and Demand Report (WASDE).  Indeed, the report, which forecasts a dry season in international crop mainstay Brazil, helped push soybean prices to their highest level since July 2016, while corn rose to a 15-month high, 37% above its August lows. 

The latest jump in crop prices comes as food inflation has already accelerated across Latin America.  Brazilian consumer price inflation rose at a 0.86% sequential pace last month, its fastest October clip in 18 years, with food and drink prices rising 1.9% from September (following a 2.3% jump from August) as certain staples like rice and tomatoes surged by more than 10% from a year ago.  Brazil’s Selic target interest rate stands at 2%, down from 14.25% in fall 2016. 

In Mexico, October CPI rose 4.1% from a year ago, above the plus-or-minus 1% band on the central bank’s 3% inflation target, as fruit and vegetable prices soared 16.2% year-over-year. That unwelcome development looks set to put the brakes on Banxico’s easing cycle, which has included 11 rate cuts totaling 400 basis points over the past 15 months, leaving the benchmark overnight rate at 4.25%.

Great quarter, guys?  Yesterday, SoftBank Group Corp. reported ¥628 billion ($6 billion) in net income for the three months ended Sept. 30, almost double the high analyst estimate of ¥350 billion. The Vision Fund, SoftBank’s in-house v.c. arm, was the star of the show, generating a record ¥784 billion in profit over that period.  

Key portfolio contributors included Chinese property startup KE Holdings, Inc., along with slightly more seasoned public businesses such as Uber Technologies, Inc. (Almost Daily Grant’s, Nov. 3), as the fund managed to turn the page on last year’s outsized losses following the WeWork fiasco. “The Vision Fund’s performance was very encouraging,” said Bloomberg Intelligence analyst Anthea Lai. “They have pulled off a U-turn.” 

As for the widespread media reports that the Vision Fund acted as the “Nasdaq Whale” over the summer, helping to spur an acceleration of the tech-stock rally through aggressive option trades, Vision Fund CEO Rajeev Misra quipped in October that SoftBank “is not even a dolphin, forget being a whale.” SoftBank founder and CEO Masa Son said the options positions account for just 1.2% of total company shareholdings. However, the company acquired some ¥1.7 trillion worth of “highly liquid listed stocks” in the third quarter, including outsize positions in Amazon.com, Inc., Facebook, Inc. and Zoom Video Communications, Inc.  “I can hear people [asking], what’s he doing now investing in public companies?”  Son asked, then answered: “These are investments in the artificial intelligence revolution.”

A different sort of revolution is underway at SoftBank itself. Bloomberg reported Friday that the organizational rise of former Wall Street investment bankers has coincided with SoftBank’s recent pivot “from running technology businesses to an investment-holdings model.” Prominently included in those ranks: A quartet of Deutsche Bank alums, each with “a history of making risky bets that characterized the German lender in the years before the 2008 financial crisis.” 

For his part, Son went with a cooking analogy to explain the strategy shift: “If [long-term investing] is spaghetti, this is the spice.”

A pending logistical decision may add some additional seasoning to the dish. The Financial Times reports that the Vision Fund has “been holding internal discussion over whether to relocate” to Abu Dhabi from the United Kingdom.  The move, which has been under consideration for “several weeks,” would be driven by tax considerations as well as the potential to “put distance” between Vision Fund parent SoftBank Investment Advisers and the U.K. regulatory apparatus.  In undertaking such a move, SoftBank would also seem to be distancing itself from both a deep pool of technology investors and the transparent rule of law. 

A flat day for stocks (as measured by the S&P 500) featured another notable rotation away from the high-flyers, as the Nasdaq 100 Index tumbled 1.7% while the small-cap Russell 2000 darted higher by 1.8%.  Treasurys came under pressure again, with the long bond rising to 1.74%, within five basis points of its March highs, while WTI crude extended its rally above $41 a barrel, gold bounced to $1,872 an ounce and the VIX ticked below 25. 

- Philip Grant

“Very large” on the way to “very larger?”  Yesterday’s meeting of the Federal Open Market Committee maintained the status quo, with the funds rate and asset purchase schedule unchanged at a range of 0% to 0.25% and $120 billion per month, respectively.  

While describing the existing monetary stimulus as “very large,” chairman Jerome Powell predicted that “we may reach a view at some point that we need to do more on that front.” 

The chairman went on to prime the rhetorical pump, declaring that: “We understand the ways in which we can adjust the parameters of it to deliver more accommodation if it turns out to be appropriate.” At the same time, Powell continued to bang the drum for another fiscal spending acceleration from Congress: "All of us lived through the years after the global financial crisis, and for a number of those years fiscal policy was very tight. . . Further [economic] support is likely to be needed to avoid further spread of the virus and help individuals who, with the expiration of the CARES Act payments, are seeing their savings dwindle." 

While the Fed urges Congress to turn on the spigots, key legislators instead look for the central bank to help lead the way.  Bloomberg reports that four senators, including minority leader Charles Schumer (D-NY) and Elizabeth Warren (D-MA), sent a letter to Powell and Treasury secretary Steven Mnuchin yesterday urging an expansion of the lending and asset purchase programs enacted during the spring, with the quartet declaring that:  “Absent additional action, these facilities will fail to reach their full potential to support a robust economic recovery.” 

If recent form holds, they won’t have to ask Jerome and Co. twice. 

Income, interrupted.  This morning, the global stock of nominally negative-yielding debt rose to $17.05 trillion, surpassing the previous high-water mark established in August 2019 for the once-inconceivable (prior to this cycle anyway) milestone. That stack of subzero debt includes more than a quarter of all worldwide investment-grade debt, Bloomberg reports. 

Evaporating yields in tandem with rollicking risk appetite form a potent cocktail for the most speculative corners of the credit market.  Following an outsized (by the asset class’ standard) 0.52% two-day rally on Wednesday and Thursday, the S&P/LSTA Leveraged Loan Index has now clawed back into the green year-to-date, fully erasing losses of as much as 20% in March. 

On the corporate bond side of the coin, the most speculative junk bonds have likewise enjoyed a face-ripping rally, with spreads on the triple-C component Bloomberg Barclays High Yield Index collapsing to 831 basis points, down from a peak above 1,800 basis points in March and well below the 949 average pickup over the last 20 years.  The triple-C tranche sports a yield-to-worst of 8.95%, the lowest on a nominal basis since the middle of 2018. 

Yet ongoing fundamental danger belies those impressive price recoveries. S&P noted on Monday that LCD’s “weakest links” (encompassing borrowers rated single-B-minus or worse, along with a negative outlook) footed to 22.5% of the leveraged loan universe as of Sept. 30.  That’s down from a June 30 peak of 25% but double the year-end 2019 level, which in turn roughly doubled from the end of 2018. At the bottom of the ratings barrel, some 10% of the index is comprised of credits rated triple-C-plus and below, up from 6% at the end of 2019. S&P also notes that 25% of the 145 weakest links at year-end 2019 had defaulted as of Sept. 30.  The broad loan default rate stood at 4.64% at the end of the third quarter, the highest level since August 2010. 

It’s a similar story in high yield, as Moody’s B3N List, which also measures corporate borrowers rated the equivalent of single-B-minus or lower along with a negative ratings outlook, accounted for 26.1% of the market as of Sept. 30. That’s down from a June peak of 27.5% but still matches the high of the great recession in May 2009.  Then, too, the default picture is shaping up similarly to that at the the financial crisis’ nadir. Moody’s forecasts baseline and bear-case default rate scenarios of 11% and 14.7%, respectively, next year.  That compares to a 13.3% peak in September 2009, itself a post-1983 high. 

While the fundamental picture echoes that of the end of the last financial crisis, the pricing environment is drastically different. Thus, the triple-C portion of the Bloomberg Barclays High Yield Index traded at a 1,460 basis point pickup on May 31, 2009, 75% wider than today’s levels.  

Speaking of the triple-C-contingent back in August, Oleg Melentyev, head of U.S. high-yield credit strategy at Bank of America Corp., presciently told Bloomberg that yield-starved creditors “have no choice. They’re going to have to go there.”  Do they have to stay? 

A sideways day for stocks allowed the S&P 500 to close out the election week with a monster 7.3% gain, as the broad average closed within 2% of its Sept. 2 high-water mark, while Treasurys came for sale with the 10- and 30-year yields rising six and eight basis points, respectively, to 0.82% and 1.60%. Gold climbed to $1,952 an ounce, WTI retreated to $37 a barrel, and the VIX slipped below 25 for the first time since August. 

- Philip Grant

The “side hustle” lives. Yesterday, California voters passed Proposition 22, delivering a key win for Uber Technologies, Inc. and its gig economy peers, as the companies can continue to classify their drivers as independent contractors rather than costly employees entitled to healthcare and other benefits.  

In reaction to the successful lobbying efforts (on which Uber and friends reportedly spent more than $200 million), shares in Uber and ride-share peer Lyft, Inc.  jumped 15% and 11%, respectively, adding more than $10 billion to their combined market capitalizations. “Two hundred million plus is much cheaper from their perspective than paying the employees these benefits that the legislature has established for them,” William Gould, professor at Stanford Law School and Clinton-era chairman of the National Labor Relations Board, tells Bloomberg. 

While shareholders celebrate their political triumph, fundamental limitations to Uber’s business model remain firmly in place.  Profitability remains a pipe dream for the 11 year-old enterprise, as Uber has generated a combined $18.8 billion in negative adjusted Ebitda and burned through $18.5 billion in cash over the 4 1/2 years through June 30, while even the bulled-up sell-side (consisting of 36 “buy” ratings compared to only four “holds” and a solitary “sell”) expects both cash burn and “adjusted adjusted” red ink to continue in 2021. Tellingly, the pandemic-related collapse in fares has helped the income statement, as Uber’s second quarter operating loss fell to $1.6 billion, compared to $5.5 billion a year ago. 

At the same time, the company commands a premium valuation, with enterprise value equivalent to 4.4 times consensus 2021 revenue.  By comparison, the sometimes-profitable airline industry trades at 1.3 times EV-to-2021 sales. 

Back to your regularly scheduled programming. 

As the dust settles, some immediate post-election fallout:  A setback for Illinois municipal credit, as a ballot measure to change the state constitution and allow for a graduated income tax instead of the current flat 4.95% rate was soundly defeated at the polls. The state needed 60% of direct amendment votes or 50% of all ballots voting “yes” to pass the amendment. Instead, roughly 55% of those voting directly on the amendment were in the “no” camp. 

The Chicago Tribune termed the result “a huge setback” for governor J.B. Pritzker, who had made the proposal a “signature campaign issue.” Instead, the revenue collection efforts ran headlong into “voter disdain of any tax-raising issue.” 

Now, unpaid bills are piling up.  The state general fund faced a $7.65 billion payable backlog as of Sept. 21, 42% above its June 30 level.  S&P Global noted that that “the odds of Illinois balancing its budget without additional borrowing or a sizable increase in the bill backlog are looking slimmer.” The rating agency, which grades Illinois triple-B-minus with a negative outlook (the last stop before junk), predicts that the state will enact some spending cuts during the fiscal year, “but these will not likely be timely enough or sufficient to address the entire budget gap.” 

The fiscal state of Illinois’ largest city serves to underscore the scope of the problem. Last week, Moody’s cut its outlook on Ba1-rated Chicago to negative, noting that the Windy City’s “revenue base is shared with other large governments,” a factor which could “constrain the city’s ability to continue addressing budgetary challenges with new revenue, especially as organic revenue growth may be slow in the wake of the pandemic.”

What now?  Another trip to the Federal Reserve’s Municipal Liquidity Fund may be in store for the Land of Lincoln, following a $1.2 billion loan from the Fed’s pandemic-era lending facility in early June after Illinois had failed to raise those funds from the muni bond market. 

Pritzker declared on Oct. 9 that, barring federal help or the enactment of the graduated income tax, the state “would need to go to the MLF borrowing facility, but we would also implement cuts.” The fiscal 2021 budget, passed in June, “allows the state to borrow up to $5 billion from the Federal Reserve that could be repaid with anticipated federal aid,” Bloomberg noted at the time. 

Might the crimped revenue potential resulting from today’s setback mean persistently higher borrowing costs?  Noting that spreads on some Illinois general obligation bonds widened by as much as 50 basis points today, Eric Kazatsky, head of municipal strategy at Bloomberg, tells Grant’s that the tax law “appeared to be the line in the sand for some rating agencies and the market, with spreads widening. . . in anticipation for a spate of downgrades and reduced appetite from funds with inability to hold junk rated paper.” 

Kazatsky continues: “The larger concern for me centers around the access to the Fed’s MLF program and if all raters move to junk, the penalty rate will be much higher than the last time they accessed the program.”

Stocks enjoyed another yuge rally, with the S&P 500 tacking on another 2.3% to extend its three-day rally to 5.3% and all but erase last week’s steep selloff.  Treasurys likewise enjoyed a screaming rally, with the 30-year yield plunging 14 basis points to 1.54% and squeezing the shorts (Almost Daily Grant’s, Nov. 3).  Gold pulled back to $1,902 an ounce, WTI rebounded to $39 a barrel, and the VIX collapsed by 17% to 29.5.

- Philip Grant