A grande slam?  Starbucks Corp. has filed trademark paperwork that would pave the way for bestowing its name on a stadium or entertainment venue, Bloomberg reports today. The java giant would join mega-firms such as Wells Fargo and American Airlines in pursuing that branding strategy, Bloomberg notes. 

Then again, as stadium rights branding deals are a distinctly bull-market endeavor, Starbucks would also join some infamous company from prior booms – Enron Field in Houston, CMGI Field in Foxboro, Mass., PSINet Stadium in Baltimore, Adelphia Coliseum in Nashville, Trans World Dome in St. Louis, and MCI Center in Washington, D.C. Sometimes the ballparks outlast the sponsors.

Think it over, SBUX.

Citing data from Morgan Stanley, the Financial Times relays that assets under the stewardship of private capital firms (an umbrella term covering investments in unlisted enterprise, most often private equity) reached $7.4 trillion as of Dec. 31, roughly double that of five years prior.  There’s plenty of room for good times ahead, the investment bank reckons, penciling in $13 trillion in industrywide assets by 2025. 

As the rise of indexing has upended the public investment business model, Wall Street has responded by pivoting towards the private market, which favors active management thanks to its generally illiquid nature while offering enhanced flexibility to value securities. “For traditional asset managers, fees will be relatively harder to defend given the commonization of the industry and existing margin challenges,” Morgan Stanley wrote yesterday. “As a result, we expect traditional asset managers to. . .  [lean] into alternatives with its fatter fee pool and private markets with its higher structural growth.” 

Meanwhile, deal activity looks set to accelerate. Last Saturday, a consortium of private equity firms announced a leveraged buyout of closely-held medical supply giant Medline Industries, Inc. at a $34 billion valuation, marking the largest such deal since the collapse of Lehman Brothers.  

As that acquisition would mark only the 11th LBO of $10 billion or more in the dozen-plus years since the financial crisis, compared to 18 between 2005 and 2007, some observers think conditions are ripe for another M&A boom. “This could be the transaction that opens up the floodgates,” Dusty Philip, co-chairman of Global M&A at Goldman Sachs, told The Wall Street Journal. “You have ideal conditions for large LBOs: low interest rates, aggressive financing markets and a significant amount of dry powder.”  Indeed, undeployed funds at p.e. firms stand at more than $1.6 trillion according to Preqin, a record figure and up from $1 trillion at the end of 2017. 

Upcoming buyouts are likely to feature aggressive terms, if recent trends are any indication. Thus, the average domestic LBO purchase price footed to 12.8 times Ebitda last year according to data from McKinsey, with debt equivalent to 6.8 times trailing Ebitda.  That compares to an average 9.4 times average purchase multiple and 6.1 turns of leverage at the crest of the prior cycle in 2007. 

Meanwhile, the proliferating quantity of deal-hungry firms ensure that competition for targets will remain fierce.  More than 11,000 private capital outfits were active globally as of year-end by McKinsey’s count, compared to about 9,000 hedge funds. The number of private capital firms have grown at an 8% compound annual rate since 2015, while the hedge fund universe has contracted at a 2% annual clip over that five-year period and remains well below its high water mark reached in 2005.

Might the hedge fund industry’s recent struggles prove instructive to today’s private capital stampede?  A bearish analysis of hedge fund purveyor Man Group plc. in the April 9, 2004, edition of Grant’s Interest Rate Observer included a trio of pointed questions regarding the-then mushrooming investment category: “What are the barriers to entry in the hedge fund business, in which a 26-year-old can raise $50 million? Can investors in hedge funds expect to succeed over a complete investment cycle, given high fees and the fast-growing population of magna cum laudes picking over the same opportunities? And: When has an investment fad not ended badly?”

Asset allocators, please copy. 

Treasurys gave back early gains as the recent rally ran out of steam this afternoon, leaving the 10- and 30-year yields at 1.45% and 2.14%, respectively.  Stocks went nowhere as the S&P 500 logged a 0.3% gain for the week to sit at new highs, WTI crude pushed towards $71 a barrel and gold sank to $1,879 an ounce.  The VIX sank below 16, logging a fresh virus-era closing low.   

- Philip Grant

Tripling down on the brave new world, mobile software firm MicroStrategy, Inc. announced it will upsize its sale of senior secured notes to $500 million from the $400 million offering announced yesterday. Strong demand underpinned that enhanced deal, as the issue priced at 6.125% compared to price talk of 6.25% to 6.5%, with the order book reaching about $1.6 billion per Bloomberg. 

While Mr. Market’s friendly reception would generally be seen as par for the course in the current credit boom, MicroStrategy’s financing is unusual in that proceeds will used for the purchase of additional bitcoins, following the issuance of $1.7 billion in convertible senior notes in February and December of last year for the same purpose.  

MicroStrategy, which currently owns 92,000 of the digital ducats, disclosed yesterday that it will take an impairment charge of at least $285 million (equivalent to more than half of consensus 2021 revenue) following mark-to-market losses after bitcoin fell to $36,000 from as much as $64,000 on April 14.  Bitcoin went on to sink to as low as $31,400 in mid-day trading, before bouncing back above $33,000 following news of the upsized bond offering. 

Securities and Exchange Commission chair Gary Gensler fired a salvo at corporate America yesterday, noting at a Wall Street Journal-hosted conference that the agency is looking to tighten restrictions around so-called 10b5-1 trading plans.  The existing format allows executives to sell their shares on a pre-scheduled basis, providing a bulwark against legal liabilities arising from allegations of insider trading based on non-public information, of which corporate executives are, of course, in constant possession. 

The current 10b5-1 structure features numerous loopholes, including the absence of required public disclosure (though many companies do so voluntarily to avoid the perception of impropriety), as well as the fact that executives can trade immediately upon enacting the plans and are free to cancel them at their discretion. 

“In my view, these plans have led to real cracks in our insider-trading regime,” Gensler concluded. “I worry that some bad actors could perceive this as a loophole to participate in insider trading.” 

A recent academic study can help the regulators quantify the frequency of such c-suite shenanigans.  The Stanford Graduate School of Business released a January paper “Gaming the System: Three ‘Red Flags of Potential 10b5-1 Abuse,” documenting the shortcomings of the 10b5-1 format.  The analysis, which assessed restricted stock sales from 2016 through May 2020, found that 38% of the plans during that time were filed and executed before the company had issued its next scheduled round of quarterly earnings, while nearly half resulted in a single, often well-timed stock sale rather than a gradual divestment.  

For instance, a May 13 dispatch from the Washington Post chronicled the events at athletic apparel manufacturer Under Armour, Inc. Back in October 2015, four months after a bearish analysis in the pages of Grant’s and at the tail-end of a 26 quarter stretch through fall 2016 in which the company generated annual revenue growth of 20% or higher, founder and then-CEO Kevin Plank declared “great confidence [in] the future,” and that “we are just getting started,” on the earnings call. 

Six days later, the executive entered into a 10b5-1 plan that resulted in $138 million in proceeds over the following six months.  A subsequent probe into Under Armour’s accounting covering that 2015 to 2017 period led the SEC to conclude on May 3 that Under Armour had failed “to disclose material information about its revenue management practices that rendered statements it made misleading.”  The company paid $9 million to settle the charges without admitting or denying wrongdoing, while Plank and the rest of the c-suite averted individual charges. Shares are down about 55% since Plank began to unload that chunk of stock. 

The erstwhile Under Armour boss has company.  Daniel Taylor, associate professor at the University of Pennsylvania Wharton and co-author of the Stanford paper in tandem with David Larcker, Branford Lynch, Phillip Quinn and Brian Tayan, furnished to Grant’s another pair of examples of corporate executives executing large and curiously-well timed stock sales ahead of bad news. For more on this topic, including the authors’ recommended remedies, see the analysis “What’s your edge?” from the March 19 edition of Grant’s Interest Rate Observer. 

Another strong rally in the Treasury complex pushed the 10-year yield to a near two-month low at 1.53%, while stocks continued to coil with the S&P 500 logging its 11th straight finish within a less than 1% range, as the broad index sits higher by 12.5% year-to-date. Gold edged lower to $1,896 an ounce, WTI pushed above $70 a barrel for the first time since October 2018, and the VIX finished at 17. 

- Philip Grant

Get in line, John Q. Taxpayer.  Creditors of bankrupt New York-based Cosmoledo LLC, (owner of the French Maison Kayser bakery chain) argue that funds from the pandemic-era Paycheck Protection Program secured by the company should be diverted towards making them whole, rather than returned to the government, according to a Bloomberg dispatch.  

Cosmoledo, which filed for Chapter 11 last September listing secured debts of $72.7 million, received a $6.7 million PPP loan from Uncle Sam three months earlier.  The company withdrew its request to return the remaining $5.3 million to the government and says it has come to an agreement with both its lenders and the Small Business Association, which will be made public in tandem with its bankruptcy resolution plan.  

The outcome may reverberate, as Bloomberg notes that “at least several dozen companies that borrowed tens of millions of dollars under the loan program filed bankruptcy last year. . . [while] creditors in Cosmoledo may have been the first to fight for the unused proceeds.” 

The Chinese government has taken the reins in the saga involving stricken lender China Huarong Asset Management Co., Reuters reports today, instructing Huarong to dispose of various non-core assets. More importantly for the firm’s international creditors, Beijing is set to “informally” back Huarong’s roughly $20 billion in dollar-denominated debt. 

In response to that report, Huarong’s senior unsecured, dollar-pay 3 3/4% notes due next April rose to 82 according to Bloomberg, up from a prior transaction at 76.5 back on May 18. 

Yet as that ongoing discount to par suggests, the situation is far from resolved despite a potential government bailout.  S&P Global noted yesterday that, as Huarong has thus far failed to produce its 2020 annual report, the company faces a late-August deadline to furnish those results under the terms of an existing bond and stave off technical default.  The ratings agency maintained its triple-B-plus long term rating with a negative outlook on Huarong, which, “acts as a financial stabilizer” in soaking up the assets of other troubled financial institutions, serving as the largest buyer of domestic distressed assets over the past three years.  Accordingly, S&P reasoned, Huarong “would likely receive government support if needed.”

The clean-up job could prove complicated, and not only because Huarong's total assets mushroomed to RMB 1.7 trillion ($272 billion) as of year-end 2019 from just RMB 315 billion seven years prior.  Reuters relays that “Deutsche Bank plans to buy Huarong’s stake in their joint venture investment firm, Huarong Rongde Asset Management,” according to a “source with direct knowledge of the deal.”  However, “Germany’s largest lender rejected this claim, saying that it has no such plans.”

Both stocks and rates looked to rally after a weaker than expected headline reading of May nonfarm payrolls, as the S&P 500 sat higher by nearly 1% as of mid-afternoon, while the 10- and 30-year Treasury yields sank to 1.56% and 2.24%, respectively. Gold jumped 1% to $1,892 an ounce to recoup half of yesterday's losses, WTI crude advanced to $69.5 a barrel and the VIX was slammed by nearly 10% to 16.5. 

- Philip Grant

German industrial giant HeidelbergCement AG (HEI on the DAX) announced plans to build the world’s first carbon-neutral cement plant today.  The facility, to be located in Sweden with a scheduled 2030 debut, will utilize carbon capture technology to secure and store 1.8 million metric tons of CO2 per year, four times that of a Norway-based carbon capture plant set to come online in 2024.  “This will be a game changer for our industry,” declared CEO and chairman of the managing board Dominik von Achten.  

Recent months have been kind to investors in Heidelberg, the world’s foremost producer of aggregates, second-largest cement maker and a Grant’s Interest Rate Observer pick-to-click last fall. The company has enjoyed a 35% euro-denominated return, inclusive of dividends, from that November 13 analysis, nearly double that of the Euro Stoxx 600 Index.  Yet long-term performance remains a slog, as the company has generated a mere 5% annual return including reinvested dividends over the past 25 years, compared to a 7.6% annual increase for the Stoxx 600 over that period.  

Ill-timed moves, including the 2007 acquisition of British building materials manufacturer Hanson Ltd. for £9.2 billion ($13.1 billion today and $18.7 billion at the time), equivalent to 11 times trailing Ebitda, factor prominently in those lagging performance figures.  Thanks to leverage topping five turns in the wake of that deal, Heidelberg then conducted a dilutive equity offering of 62.5 million shares (equivalent to nearly one-third of outstanding shares today) in the 2009 bear-market depths to repair its balance sheet.

Mr. Market will believe it when he sees it, currently bestowing on HEI an enterprise value equivalent to six times consensus 2021 Ebitda.  Yet recent management changes (von Achten took the big seat right before the bug bit in winter 2020) in tandem with improved asset allocation, could augur better days ahead.  Heidelberg announced on May 24 that it will sell the bulk of its operations in the western United States to Martin Marietta Materials, Inc. for $2.3 billion in cash, a price equivalent to about 16 times the unit’s annual Ebitda per estimates from Deutsche Bank.  

Terming the deal “a very value-accretive exercise for Heidelberg” thanks in part to lower margins in that outgoing unit relative to the rest of its U.S. operations, the DB analysts guesstimate that HEI will generate a return on invested capital “significantly above 8%” by year-end following the asset sale, up from 7.9% last year and 6.5% in 2019. 

***

Heidelberg’s efforts to go green could prove material beyond its own corporate profile.  As cement production is a dirty business, accounting for nearly 10% of worldwide greenhouse-gas emissions, the benefits accruing to Mother Earth from that strategy pivot could prove substantial. Yet the growing ranks of environmental, social and governance-focused investors have given the company the cold shoulder, as evidenced by HEI’s still-modest valuation.  

Indeed, the current ESG landscape arguably reflects both an index-hugging mentality and a heavy emphasis on business models with little impact on the environment. For instance, both the Vanguard ESG U.S. Stock ETF and the BlackRock Advantage ESG U.S. Equity Fund feature tech mainstays Microsoft Corp., Apple, Inc., Amazon.com, Inc. and Alphabet, Inc. among their top five holdings.  

Some investors propose an alternative way to look at the movement. Noting that roughly half of global carbon emissions come from industries which currently have little-to-no economically viable way to decarbonize, a fall 2020 white paper from Massif Capital argued thus:   

That firms such as Apple and Microsoft, two of the most widely held businesses in ESG portfolios, pollute less than copper miners and aluminum producers is a meaningless observation in the context of a desire to invest for impact. 

That firms like Apple and Microsoft depend on copper miners and aluminum producers for their businesses means that the question investors should be asking is how one balances environmental impact and economic criticality, not simply how one limits a portfolio’s overall environmental impact.

Rather than simply directing capital towards businesses which attain high ESG ratings while avoiding those from high-pollution industries, Massif proposes another way forward: 

The alternative is to consider climate change as a problem that can be addressed and invest in companies that will aid or benefit from the transition to a low carbon economy.

Any such philosophical shift among the ESG-minded could carry substantial implications, as torrents of capital continue to pour into the “space.”  Such funds had gathered nearly $2 trillion in assets under management at the end of the first quarter, Morningstar reported April 30.  That’s up 18% from Dec. 31 and nearly double that of year-end 2019.  Europe has been front-and-center in that effort, accounting for 79% of ESG flows in the first three months of the year.  

What’s next as the ESG movement takes hold of Wall Street and thoughtful investors look to skate to where the puck is going?  Will Thomson, founder and managing partner at Massif Capital, will share his thoughts from the podium at the Grant’s fall 2021 conference on Oct. 19 (advt.). 

More absurd price action in the meme stocks didn’t result in much headline-level excitment, as the S&P 500 went nowhere for a fourth straight day to remain near its high-water mark while Treasurys also traded sideways with the 10-year yield finishing at 1.59%.  WTI crude pushed to a fresh 30-month high near $69 a barrel, gold advanced to $1,911 an ounce and the VIX slipped to 17.5. 

- Philip Grant

A tight labor market spurs drastic measures in Las Vegas (h/t Christian Hill):
 

It was another restless night for crypto hodlers, as the price of bitcoin retreated to as low as $35,000 this morning.  That’s down double digits from Thursday morning and 40% from its high-water mark reached last month.   With the assets trading around the clock, volatility has consistently remained at nausea-inducing levels of late: Bitcoin logged an 18% decline on Sunday followed by a 16% snapback the next day. 

Those manic swings are not going unnoticed. Bank of Japan governor Haruhiko Kuroda observed in an interview yesterday that “most of the [bitcoin] trading is speculative. . . it’s barely used as a means of settlement.”  

As the sheen comes off the recent upside rampage (bitcoin enjoyed a near six-fold rally over the six months through mid-April), the bull crowd looks to diagnose the market malady.  Cathie Wood, manager of the wildly popular Ark Investment funds, provided her analysis at a conference hosted by CoinDesk yesterday: “It was precipitated by the ESG [environmental, social and governance] movement and this notion, which was exacerbated by Elon Musk, that there are some real environmental problems with the mining of bitcoin. A lot of institutional buying went on pause.”

Efforts to curtail environmental damage yield their own side effects. The popularity of Chia Network, a “green” bitcoin alternative which allocates new supply based on empty hard disc space rather than energy-intensive mining utilized by bitcoin, has spurred a global disc shortage. Some 12 million terabytes of hard disc space are currently being used to mine Chia, New Scientist reported on Wednesday, quadruple that of just two weeks ago. “We’ve kind of destroyed the short-term supply chain,” admitted Chia president Gene Hoffman. 

Those concerns aside, more prosaic financial factors may have played a starring role in the turn, namely, outsized leverage.  Citing data from Bybt.com, Bloomberg reported earlier this month that a mere $9.4 billion in margin liquidations drove some $600 billion in total crypto market cap losses between May 18 and May 19.  

Some crypto devotees remain steadfast despite the recent shakeout.  Buccaneers quarterback Tom Brady declared his allegiance to the digital ducats in an appearance at yesterday’s CoinDesk conference: “The world is changing, we all just have to understand it’s constant change and you can either be ahead of the curve or behind it and I’m choosing to be ahead of it,” the gridiron great declared. “As someone who wants to be on the forefront of things, I’m going to help create the trend and adopt it and recognize this is where the world is heading.”

Meanwhile, one of the engines of the crypto machine continues to work overtime.  Tether, the most widely-traded crypto and the de facto source of liquidity for exchanges that cannot get access to traditional banking, has exploded in circulation of late.  As of this morning, some $61 billion of tethers are outstanding according to Coinmarketcap.  That’s up 4.4% from a week ago, 30% from bitcoin’s high-water mark in mid-April and 76% from Feb. 23, when New York Attorney General Letitia James declared that “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.” 

It seems fair to wonder just what assets stand behind that flood of new stablecoin supply in the context of a bear market. Tether disclosed on May 13 that, as of the end of the first quarter, cash and T-bills accounted for just 5% of reserves. 

See the Feb. 19 edition of Grant’s Interest Rate Observer for a thorough analysis of the bitcoin boom, including risks and opportunities therein. 

Stocks enjoyed solid gains as of mid-day, when ADG dropped the pick, with the S&P 500 and Nasdaq each up by about half a percent.  Treasurys remained in a tight trading range despite more hot inflation data, with the 10- and 30-year yields edging lower to 1.6% and 2.28%, respectively.  Gold remained at $1,900 an ounce, WTI crude held near multi-year highs at $67 a barrel, and the VIX fell to near 16. 

- Philip Grant

Turkish President Recep Erdogan has once again made waves, dismissing deputy central bank governor Oguzhan Ozbas via decree in the wee hours. Ankara University professor and presidential advisor Semih Tumen will take his place.   

That comes two months after Erdogan sacked Central Bank of the Republic of Turkey governor Naci Agbal, the third top monetary mandarin fired in the last two years, following a hike in the benchmark repo rate to 19% from 17% to counter raging inflation, since measured at 17.1% year-over-year in April. Following today’s reshuffle, four of the seven members of Turkey’s monetary policy committee have been at their post for less than one year. 

“The latest change. . . is another step in an expected sequence towards naming an entire monetary policy committee of low interest rate advocates,” writes Tatha Ghose, emerging markets strategist at Commerzbank.  Jason Tuvey, senior emerging markets economist at Capital Economics, tells the Financial Times that the significance of the committee’s composition is dwarfed by “the symbolism of Erdogan removing people and replacing them with people who are perceived to be his stooges.” 

Indeed, that symbolism (or reality) hasn’t escaped investors’ notice. The lira has lost a further 8% against the dollar since the market first digested the news of Agbal being shown the door, extending to a 66% decline from when the strongman began consolidating power following a failed coup in the summer of 2016. Thanks in part to unsuccessful attempts at propping up the lira, Turkey’s gross exchange reserves have shrunk to below $50 billion, half the hoard of five years ago and near its post-2005 nadir. 

Voters are similarly miffed at the state of affairs.  Bloomberg relays today that an April survey conducted by Metropoll showed support for Erdogan’s AK Party at just 27%, the worst showing in the 20-year history of the party. Similarly, 17% of respondents who voted AK in the 2018 general election vow to never do so again, while the president currently lags well behind rivals Ekrem Imamoglu and Mansur Yavas ahead of a June 2023 election. 

“The breaking point for Erdogan’s supporters was the dismissal of Naci Agbal,” Can Selçuki, director of polling service Turkiye Raporu, tells Bloomberg.  “People started to realize that Erdogan’s radical changes in the economy are not making things better.” 

For now, at least, the monetary experiment in the Bosporus continues apace. The CBRT is set to conduct its next policy meeting on June 17. 

A new bull market marker: Today the Collaborative Investment Trust Series has officially rolled out the FOMO exchange traded fund.  Rather than concentrated bets, the FOMO (meaning fear of missing out) holdings will range between 75 and 100 stocks, with weekly portfolio rebalances. As of today’s launch, top holdings include healthcare information technology firm IQVIA Holdings, Inc., Chinese search engine Sogou, Inc. and medical device purveyor Medtronic plc. 

Keeping up with the Joneses is no small task, as reflected by FOMO’s relatively steep 90 basis point expense ratio.  Matthew Tuttle, who manages the fund, explained to U.S. News in an April 14 interview that, in addition to names in popular sectors demonstrating strong current momentum, FOMO will target laggards that could be primed for a bounce: 

I want to find the 20 that have been the weakest over the past week. Here, I'm looking for countertrends: What happens a lot in the markets is over the medium term and long term, things trend. Over the longer term, Tesla is in an up-trend. But over the short term, Tesla can get sold. And what tends to happen is it sells off too far too fast, then snaps back. So, what we want to do is find the stocks that are trending over the medium and longer term, but we also want to find stocks that are undervalued in the short term.

Once we have our basket of stocks, we compute how volatile they've been. The more volatile stocks on the downside are given smaller weightings in the portfolio. And we rebalance on a weekly basis, so that by the time we decide what's FOMO, it's not like we're waiting a quarter, and something is obsolete.

As for his recommended portfolio allocations, Tuttle had this to say:

I would say, for most people, between 10% to 20%. But if you said, "Hey, Matt, what if I made it 50%?" I wouldn't argue with you because we aren't as concentrated as some of the other single-area focus funds.

In other words, there’s always room for a little more FOMO. 

Treasurys enjoyed another strong bid, with the 10- and 30-year yields each breaking to multi-week lows at 1.55% and 2.25%, respectively, while stocks finished little changed with the S&P 500 down 20 basis points and the Nasdaq flat.   WTI crude retreated below $66 a barrel, gold advanced above $1,900 an ounce for the first time since early January, and the VIX edged towards 19.  

- Philip Grant

At least you can count on some things.  Headline-grabbing coworking concern WeWork reported in a filing today that its first quarter net loss came to a whopping $2.1 billion, compared to a $556 million shortfall in the same period last year.  Non-cash charges, including stock awards to top investor SoftBank Group Corp. and a settlement with ousted former CEO Adam Neumann, accounted for a large chunk of that growth in red ink, as adjusted Ebitda of minus $446 million was nearly identical year-over-year.  Net revenues footed to $598 million, down 10% from 2020. 

Those ghastly figures left the c-suite undaunted. “The demand for WeWork space today is higher than it was prior to the pandemic,” WeWork CEO and SoftBank chief operating officer Marcelo Claure assured listeners-in at a Bloomberg virtual event earlier this week.   A company spokeswoman added that: “Sales are back to pre-pandemic levels, and our sales pipeline is strong.” Unfortunately, that pre-pandemic baseline hasn’t exactly spelled corporate prosperity. A $3.2 billion net income loss last year followed $3.5 billion and $1.8 billion in red ink for the years 2019 and 2018, respectively. 

Yet Mr. Market still carries a torch for WeWork, which is set to complete its merger with blank check firm BowX Acquisition Corp. later this year at a $9 billion valuation.  Shares in BOWX finished the day at a 28% premium to net asset value, up 9% from the WeWork deal announcement on March 26.  

The German Bundesbank predicts in its most recent monthly report that measured inflation “could temporarily rise to 4%” in the coming months, a figure unseen in the 20-plus-year common currency era. Headline consumer prices across the Eurozone rose 1.6% from a year ago in April, up from 0.9% two months prior and near the European Central Bank’s “below, but close to 2%” inflation target.   

As the ECB is charged only with a single mandate of maintaining price stability, as opposed to the Federal Reserve’s dual directive of stable prices with maximum employment, that uptick in inflation would seemingly argue for a rollback of the ECB’s stimulus shower.  The bank’s benchmark deposit rate crouches at minus 50 basis points, with the seventh anniversary of sub-zero borrowing costs coming up next month, while total assets on the ECB balance sheet footed to €7.6 trillion ($9.3 trillion) as of last week, equivalent to 57% of pre-pandemic nominal GDP in 2019.  That compares to $7.9 trillion in assets held by the Federal Reserve, equivalent to 37% of 2019 output. 

Yet ahead of an upcoming June 10 policy meeting, a series of recent public communiques suggest that the monetary mandarins are in no hurry to withdraw their extraordinary support. “It’s far too early and it’s actually unnecessary to debate longer term issues,” responded ECB President Christine Lagarde to a question about tapering at a news conference today. 

ECB executive board member Isabel Schnabel came to a similar conclusion in an interview with RTL television in Germany last week: “Our monetary policy strategy is medium-term and that means we look through all of these short-term fluctuations.”  Indeed, the bar for outright hawkish policy response is a sky-scraping one, according to Schnabel: “If we actually see there was suddenly a very rapid development of inflation, which is really not in evidence at the moment, then of course we would have to adjust our measures and of course we would have to do that gradually.” 

Others cast a skeptical eye over the nature of the inflationary uptick. “There are shortages, for example in semiconductors, and there are constraints in some shipping routes and of course when you have an unplanned bottleneck there is going to be some price action, but that is not inflation,” argued ECB chief economist Philip Lane in a webinar yesterday. 

Left unsaid in those remarks: Side-effects from years of ultra-easy policies may now themselves act as impediments to any potential normalization. The ECB’s annual Financial Stability Review, published on Wednesday, lays out the details: 

Debt-to-equity ratios have increased considerably among the most leveraged firms, with the 90th percentile increasing from 220% at end-2019 to over 270% in the final quarter of 2020. 

Extensive policy support has kept corporate insolvencies unusually low in a period of extreme economic weakness, unlike during previous crisis episodes. The impact of the pandemic on corporates is increasingly concentrated in the services sectors and among small- and medium-sized enterprises. This implies that a sudden tightening of financing conditions or a further delayed economic recovery could have more severe implications for financial stability than the aggregate picture suggests. 

The public sector is likewise susceptible to financial ill winds, the report cautions: 

The aggregate euro area sovereign debt-to-GDP ratio rose to 100% in 2020, up from 86% of GDP in 2019, as governments have financed extensive economic support to cushion households and firms. . . Vulnerabilities from the outstanding stock of debt appear higher than in the aftermath of the global financial crisis and the euro area sovereign debt crisis.

Temporary inflation?  The ECB is counting on it. 

Stocks gave back their early gains, as the S&P 500 finished flat and the Nasdaq 100 slightly weaker as those indices each wrapped up the week within 50 basis points of unchanged. Another quiet day for Treasurys saw some modest curve flattening, with the 10- and 30-year yields edging lower to 1.62% and 2.33%, respectively. Gold finished at $1,881 an ounce, WTI crude bounced to near $64 a barrel, bitcoin was smoked again to near $36,000 currently, down 11% over the past 24 hours, and the VIX settled near 20. 

- Philip Grant

Is the party over for special purpose acquisition companies?   Since reaching its high-water mark on Feb. 16, the Defiance Next Gen SPAC Derived ETF (SPAK on the NYSE Arca) has lost 32% and sits near its lowest level since before Election Day.  

That sharp correction comes as the blank check company asset class has never been more prominent.  Despite a virtual cessation of fundraising activity since April 1, blind pools have raised $104 billion so far this year, topping the $83.3 billion across 2020, which itself exceeded all prior SPAC fundraising.  Fancy valuations help define that boom, as SPAC-sponsored deals took place at a median price of 12.9 times sales in the first three months of the year according to 451 Research, more than triple the 4.1 times median price-to-sales ratio for non-blank check transactions.  With share prices in retreat, Main Street is feeling the pain.  “It’s nothing short of a slaughter,” 42-year old physician Garrick Tong, who allocated more than half of his portfolio to SPACs, laments to The Wall Street Journal today. 

Some steely participants remain unfazed by the shakeout. “We like where the space is right now,” retired MLB superstar-cum-SPAC enthusiast-sum-steroid enthusiast Alex Rodriguez tells Bloomberg. “You’ve basically eliminated a lot of the amateur players who just want to participate in the space just because it’s hot. That’s really levelled the playing field.” 

It's worth noting that beyond the broad speculative frenzy, idiosyncratic, and perhaps transitory, features helped spur the now-dormant SPAC boom.  Namely, the deal structure allows SPAC promoters to issue long-dated and, perhaps, rose-colored forecasts that are verboten in traditional IPOs.  Not a few have availed themselves of that privilege, as the Financial Times calculated last month that nine auto-focused tech companies that listed via SPAC last year projected an aggregate $26 billion in revenues in 2024.  That represents 270% compound annual growth from last year’s $139 million top line across that cohort. 

As prices come back to earth and certain investors lick their wounds, regulators appear on the scene. John H. Coates, acting director of the corporate finance division at the Securities and Exchange Commission, warned on April 8 that belief among promoters that safe harbor laws will protect them against exposure related to unrealistic forecasts may be misguided: 

Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst. Indeed, in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure.  

Slowly but surely, signs of a crackdown emerge.  On its first quarter earnings call Monday, electric-vehicle manufacturer Canoo, Inc. (GOEV on the Nasdaq) disclosed that the SEC has initiated “a fact-finding inquiry” into the company related to its December merger with a blank-check outfit, as well as its “operations, business model, revenues, revenue strategy, customer agreements, earnings and other related topics, along with the recent departures of certain of the Company’s officers.”  

That comes seven weeks after Canoo announced a comprehensive business model shift towards business customers instead of original equipment makers on its first conference call as a public company, with co-founder and then-CEO Ulrich Kranz absent from the call (Kranz resigned weeks later). Canoo, which generated no revenue in the first quarter, has suffered a 65% share-price pullback from the Dec. 11 peak to leave its market capitalization at $1.8 billion.  

The SEC is one thing.  A May 4 analysis on legal intelligence site JD Supra from attorneys at Bass, Berry & Sims plc noted that litigation risks may extend further than some industry promoters might like: 

Private plaintiffs may try to find ways to assert claims against not only the SPAC, but also the target and the target’s board of directors for allegedly aiding and abetting the SPAC directors’ breaches of their state law duties.  If any conflicts exist or projections turn out differently than reported, lawsuits will also likely allege claims under state law for conflicted transactions and securities fraud under the federal securities laws.  

There may be plenty of fertile ground for the lawyers, if a 52%, five-month dive in the Grant’s SPAC Index featured in the Dec. 25 analysis “Short this index,” is any indication. What sort of mischief might a continued spell of risk aversion bring? See the most recent issue of Grant’s Interest Rate Observer dated May 14 for more on SPAC’s, broader risks stemming from the modern-day everything bubble and catalogued investment ideas for a potentially fraught financial moment. 

Stomach turning volatility in crypto, featuring a $43,500 to $30,700 24-hour trading range for bitcoin, headlined today’s proceedings, while stocks shook off early losses to leave the S&P 500 red by 30 basis points and the Nasdaq little changed.  Treasurys came under pressure with the 10-year yield rising to 1.67%, gold edged higher to $1,871 an ounce and WTI sank to near $63.50. The VIX jumped to near 26 this morning, before giving back the bulk of that advance and settling just above 22.  

- Philip Grant

This morning, telecom giant AT&T announced it will spin off and merge its media unit with content provider Discovery Communications.  Telephone will control 71% of the new entity, which will sport a projected $76 billion market cap and $132 billion enterprise value.   

That transaction closes the book on a less-than-blissful corporate marriage, as AT&T coughed up $85 billion for TimeWarner just three years ago. The move nevertheless earned plaudits from a key constituency, as Ma Bell unwinds a growth-by-acquisition strategy under former CEO Randall Stephenson that pushed net debt to $205 billion (inclusive of operating lease and pension liabilities) as of March 31, earning the dubious distinction of the world’s most encumbered non-financial company.  Shareholder Elliott Investment Management deemed the deal “another impressive step in the company's recent evolution.”  

Mr. Market also liked what he saw initially, as shares jumped 4% at the market open to briefly log a fresh 52-week high.  Yet that rally soon faltered (T stock closed lower by nearly 3%), perhaps reflecting another byproduct of the transaction: A forthcoming dividend cut.  AT&T announced today that, following the spin-off, it will allocate between 40% to 43% of free cash flow, now projected at roughly $20 billion this year, for shareholder payouts.  That compares to a projected $26 billion in full-year free cash flow and a dividend payout ratio in the “high 50%s range” as of the first quarter earnings release. 

Income investor pain is the creditors’ gain. This afternoon, Moody’s affirmed its Baa2 senior unsecured debt rating on AT&T with a stable outlook. Though the company remains “weakly positioned for the Baa2 rating,” Moody’s believes that proceeds from that dividend cut will serve to both pay down debt and smooth AT&T’s maturity schedule to eliminate principal repayments in excess of projected free cash flow.  The spinoff will bring the Moody’s-calculated leverage toward 3.6 turns of Ebitda from the current 3.8 times.  

That decision has arguably been a long time coming, as generous shareholder payouts in tandem with an aggressive capital structure (the average Baa rated borrower carried just 2.7 turns of leverage as of last fall) can, of course, make for a dicey combination.  An updated bearish assessment of AT&T in the April 2 edition of Grant’s Interest Rate Observer concluded that, “as a large and frequent borrower, AT&T needs its Baa2 rating. We judge that it needs the rating even more than it needs the gratitude of income-seeking investors.” 

Yet a slimmed-down corporate portfolio doesn’t necessarily spell the end of AT&T’s recent troubles. Analysts at MoffettNathanson argue that this morning’s outcome was an inevitable one, as its onerous debt load constrained the company’s ability to properly invest in the business, including expensive outlays for 5G wireless technology and the HBO Max streaming service rollout.  

While investor focus shifts back toward execution in the core wireless communications business, Ma Bell still faces a tough road ahead thanks to ferocious competition. Namely, rival T-Mobile can now boast both better pricing and a superior network thanks to its recent purchase of spectrum-rich Sprint Corp. last year, while Verizon launched its own 5G salvo by spending $45 billion in a c-band spectrum auction earlier this year, double AT&T’s investment.  MoffettNathanson gets the last word:  

Indeed, the big question for AT&T will be, is even this – including their dividend cut – enough? AT&T will get back $43 billion in cash and/or assumed debt, and 71% of the equity in the new company. 

Time Warner’s Ebitda supported a little over $43 billion of debt at AT&T, so AT&T is still over-levered after the transaction (about 4.0 times EBITDA including pension and capital lease obligations). With their dividend cut, their payout ratio will drop only modestly and their capital expenditures will increase. But all will still depend on whether they can grow their mobility business. We have our doubts.

Stocks edged lower to start the week, with the S&P 500 and Nasdaq 100 each declining by about 30 basis points, while Treasurys also came under modest pressure as the 10- and 30-year yields rose to 1.65% and 2.36%, respectively.  WTI crude jumped above $66 a barrel for its best finish since October 2018, while gold rallied to $1,845 an ounce to extend its six-week gains to 11%.  Bitcoin slumped below $45,000 from $50,000 on Friday evening, and the VIX rose to near 20. 

- Philip Grant

A thunderbolt from the social media heavens.  Yesterday evening, Elon Musk announced on Twitter that Tesla would no longer accept bitcoin as payment. The catalyst for that reversal from a mere three months ago: “Concern about rapidly increasing use of fossil fuels for bitcoin mining and transactions, especially coal, which has the worst emissions of any fuel.”  That de-endorsement helped drive down the price of bitcoin to as low as $48,000 overnight from $55,000 yesterday afternoon. 

While Musk’s pivot grabbed the headlines, a potentially far more significant crypto development took place hours later.  This morning, controversial stablecoin tether released its composition of reserves for the first time.  Tether, the most traded crypto by volume, had long claimed to be fully backed by U.S. dollars before gradually relaxing that language in early 2019. Yet the outfit disclosed that, as of March 31, traditional reserve assets such as cash and Treasury bills summed to a mere 3% and 2% of total reserves, respectively.  In lieu of currency and liquid government debt, more esoteric securities filled out the bill: Commercial paper accounted for roughly half of reserves, with fiduciary deposits, secured loans, corporate bonds and precious metals representing about 18%, 13% and 10% of that total. 

That snapshot generates more questions than answers. As CoinDesk notes, “It is unclear what the ratings are on the commercial paper or the corporate bonds, which agencies rated them or which companies issued them. Likewise, Tether declined to identify the borrowers of the loans or the collateral backing them.”

Another eye-catcher: “Reverse repo notes” accounted for 3% of reserves. In a traditional repurchase agreement, a borrower sells an asset with an agreement to buy it back later at a higher price. In reverse repo, a lender buys an asset from a borrower who promises to repurchase it at a later date. Repo and reverse repo are agreements between two counterparties and not publicly traded securities. It is unclear what, if anything, the notes in “reverse repo notes” signifies. 

Indeed, that line item is a curious one, as tether has used obscure, Bahamas-based Deltec Bank & Trust as its primary lender since 2018. As tether is known as a workaround for know-your-customer and anti-money laundering regulations that govern the regulated banking system, today’s disclosure invites the question of who would serve as a counterparty for such a transaction and, if an intermediary helped facilitate that deal, what sort of fees tether would be obliged to pay that third party.  Might the assets underpinning those reverse repo deals be cryptos?

In any event, this morning’s disclosure is unlikely to mollify skeptics either on Wall Street or in the halls of government.  Recall that, in February, New York attorney general Letitia James concluded in a settlement (which levied an $18.5 million fine and barred the company from doing business in the state) that tether’s “claims that its virtual currency was fully backed by U.S. dollars at all times was a lie,” (Almost Daily Grant’s, February 23). That admonishment has done little to slow the breakneck growth in tethers outstanding.  Instead, the quantity in circulation has gone parabolic in recent months:  

 
Source: Coinmarketcap.com

More broadly, the Financial Times notes today that government entities across the West are stepping up their scrutiny of stablecoins, as concerns over difficulty in tracing transactions, consumer protections and inconsistent disclosure practices proliferate.  “Certainly, the direction of travel is to look at regulating them,” concludes John Salmon, head of law firm Hogan Lovells’ cryptocurrency practice. 

A crackdown on the digital Wild West is perhaps already underway.  Both the Justice Department and Internal Revenue Service are conducting investigations into Caymans-incorporated Binance Holdings, the world’s largest crypto exchange by trading volume, Bloomberg reports this afternoon.  “Officials who probe money laundering and tax offenses have sought information from individuals with insight into Binance’s business,” Bloomberg explains. 

A little heat from Uncle Sam doesn’t seem to bother the Binance c-suite.  Founder and CEO Changpeng Zhao downplayed the significance of that report, and tweeted this morning: “You know what to do in a dip, right?”

Stocks managed a modest bounce, with the S&P 500 gaining 1.2% to narrow its loss for the week so far to 2.8%, while the Nasdaq rose by 70 basis points to trim its four-day decline to 4.5%.  Treasurys caught a bid despite a weak 30-year auction this afternoon, with the 10-year yield declining to 1.66%.  Gold edged higher to $1,827 an ounce, WTI crude sank below $64 a barrel and the VIX pulled back by 16% to 23 after reaching a two-month high yesterday. 

- Philip Grant