06.30.2022
Fee 'Fi Fo Fum
A crypto crewcut:
A crypto crewcut: Digital currency exchange FTX is set to purchase lending platform BlockFi for some $25 million, CNBC reports this afternoon. The provisional price tag represents a 99% discount to the $4.8 billion valuation that BlockFi garnered in a series E fundraising round from the likes of Third Point, Bain Capital and Tiger Global just 11 months back, and follows FTX’s extension of an emergency $250 million line of credit to the lender a week ago.
 
Trouble started brewing at the stricken outfit long before the crypto market entered its current tailspin. BlockFi, which slashed advertised interest rates on bitcoin deposits to as little as 0.1% from 8% last fall, agreed to cough up $100 million to the SEC and state regulators in February to settle allegations of false statements on the corporate website concerning risks on its platform and misrepresentation of the collateral backing its loans. An excerpt from the complaint: 
 
As BlockFi took ownership of the loaned crypto assets from investors in the BlockFi Interest Accounts (BIAs), [it] used the commingled assets to, among other things, make loans to institutional and retail borrowers, stake crypto assets, and purchase crypto asset trust shares and interests in private funds.
 
As some industry participants labor to stay afloat, others branch out into business ventures not entirely consistent with crypto’s decentralized ethos. The Intercept reported yesterday that Coinbase, the largest such currency exchange in the U.S., “is selling Immigrations and Customs Enforcement a suite of features used to track and identify cryptocurrency users.”
Clogged Pipe
The band plays on, sort of.
The band plays on, sort of. It’s been a bumper year for large-scale mergers and acquisitions, with 25 announced deals of at least $10 billion logged over the past six months, the Financial Times reports today, based on data from Refinitiv. That double-digit year-over-year increase came as global M&A volume registered at $2 trillion, down some 20% from last year’s record pace, while domestic deal volume of $950 billion is off 28% from the first half of 2021. 
 
Of course, the swift and drastic shift in financial conditions has caused plenty of would-be bidders to think twice. A hefty $286 billion worth of deals have been abandoned altogether, the largest such tally since at least 2019. 
 
"We’re in a transition phase where sellers have high expectations of value, but buyers have repriced to lower multiples,” David Higgins, partner at law firm Kirkland & Ellis, tells the FT. “That, together with issues around the quantum and pricing of debt available, has led to some processes being withdrawn or postponed.”
 
Cash-needy corporations now face roadblocks beyond rising interest rates and widening credit spreads. Bloomberg reported Tuesday that banks, struggling to clear out a bulging $80 billion backlog of debt backing leveraged buyouts, are now offering to finance deals only at highly unfavorable terms for borrowers -- effectively pricing themselves out of the market rather than risk being on the hook for additional debt commitments. Career risk is now front-and-center, as Bloomberg relays that corporate higher-ups have warned some bankers that undertaking further unprofitable LBO business “could result in job losses.” Accordingly, the bourgeoning private credit industry is taking up the slack.
 
“Banks do not have appetite currently to underwrite loans without very significant flex [the ability to shift pricing within a given range according to demand], meaning borrowers are looking to private credit for certainty of execution for even the largest transactions, that would traditionally have accessed public markets,” Taj Sidhu, head of European illiquid credit at Carlyle, told Bloomberg.
 
The confluence of adverse market conditions and gun-shy financiers has taken its toll, as domestic junk bond supply stands at a puny $67 billion this year, off 76% from a year ago and the slowest issuance pace since 2009. Borrowers that do manage to reach the finish line are obliged to pay dearly for the privilege.  
 
Yesterday, equipment firm FTAI Infrastructure sold $450 million in eight-year, senior secured, single-B/single-B-minus-rated bonds at a 10.5% coupon and 94.585 original issuer discount, leaving the issue priced to yield 12%. Not only is that up from initial price talk of an 11% yield and an average yield of 9.2% for similarly rated issuers, but bookrunners Morgan Stanley and Barclays were forced to cut the offering from an initially planned $500 million thanks to insufficient demand.  
 
Beggars can’t be choosers: With one session remaining before the July 4 holiday weekend, that deal represents the only activity in the domestic primary high-yield market all week. 
QT Progress Report
An $11 billion sequential decline in Reserve Bank Credit leaves interest bearing assets on the Fed balance sheet at $8.89 trillion, $35 billion below the March peak but up 27% from two years ago. 
Recap June 30
The bulls are going to need a Herb Brooks-worthy halftime pep talk. Stocks finished lower yet again to wrap up the second quarter with the S&P 500 off by 21% and the Nasdaq 100 down 30% year-to-date, the worst such showings since 1970 and 2002, respectively.  Treasurys maintained a strong bid as economic warning signs accumulate, as the 10-year yield fell 12 basis points to 2.98% to mark a four-week low.  WTI crude pulled back to $106 a barrel, gold retreated to $1,807 an ounce and the VIX ticked to near 29 to maintain its rangebound position just below 30. 
 
- Philip Grant
06.29.2022
Fury Road
Tesla, Inc. laid off some 200 staffers
Tesla, Inc. laid off some 200 staffers working on its so-called autopilot function, Bloomberg reports, closing a San Mateo, Calif. office dedicated to the project in the process.  Bloomberg notes that the cutstargeted hourly workers who evaluate customer vehicle data. 
 
Such downsizing is a potentially telling development, considering the nascent technology’s central role in the Tesla investment story and the company’s exalted status among investors. Musk mused on a January 2021 earnings call that Tesla vehicles could soon serve as self-driving “Robotaxis,” generating revenue for owners throughout the day via Tesla’s forthcoming, in-house ride-share app—putting the firm’s profitability into overdrive in the process: “If you made $50 billion worth of cars, it would be like having $50 billion of incremental profit, because it’s just software.” Applying a 20 times earnings multiple to that figure would yield a $1 trillion market capitalization, “and the company’s still in high-growth mode,” he added. 
 
The subsequent downshift in asset prices has hardly shaken Wall Street’s faith in that brave new world, as evinced by Tesla’s $703 billion market cap, equivalent to more than eight times the consensus full-year revenue guesstimate. By comparison, Ford and General Motors sport $46 billion and $48 billion respective valuations against projected 2022 sales of roughly $150 billion each, while investors bestow a $85 billion market cap on European rival Volkswagen A.G., which is expected to generate $288 billion in sales this year.
 
While Mr. Market patiently awaits the coming up Musk’s Tomorrowland, more analog solutions will have to suffice:
 
Laughing Bones
When in doubt, lift the offer.
When in doubt, lift the offer. MicroStrategy, Inc. (MSTR on the Nasdaq) announced in a filing today the purchase of 480 bitcoins over the past two months at a roughly $10 million aggregate outlay, equivalent to $20,817 per bitcoin. 
 
Of course, such purchases have become old hat for the business software firm-turned-crypto speculation vehicle: MSTR’s holdings of the digital ducats now stand at roughly 130,000 bitcoins, at an aggregate $4 billion purchase price. For reference, the company generated $510 million in revenues last year.
 
“Go big or go home” may as well be the corporate motto. “If you want to turn $250 million into $6 billion, buy bitcoin, not gold,” MicroStrategy CEO Michael Saylor advised the masses in April’s bitcoin Miami conference, adding that Russia’s invasion of Ukraine serves as a “use case” for wider bitcoin adaptation. With the subsequent bear market ushering in an unwelcome 50% off sale since that conclave, Saylor advised his Twitter followers to “stay humble” and “stack sats” yesterday, referring to the bulls’ philosophy of steady bitcoin accumulation regardless of price moves. 
 
Yet the broad recent selloff leaves the price of bitcoin south of $20,000, compared to the company’s total cost basis of near $31,000. As MicroStrategy’s bitcoin position is well underwater, the potential for painful impairment charges loom should the “crypto winter” persist. To that end, a company spokesperson told an inquiring Bloomberg reporter this morning that it will hold off on any early disclosures regarding the selloff’s impact. “Typically, we do it in the [form 10-Q]. We will continue that practice.” The firm is scheduled to report second-quarter results on July 29. 
 
A series of debt deals successively higher up the capital structure have financed MicroStrategy’s shopping spree, as the company issued a combined $1.7 billion in convertible bonds in December 2020 and February 2021, followed by a $500 million offering of first-lien 6 1/8% notes due in 2028 a year ago.  It didn’t take long for those senior creditors to get cold feet, as the single-B-rated bonds last changed hands at 82 cents on the dollar for a 690 basis point option-adjusted spread over Treasurys, wide of the 578 basis point pickup on offer for the single-B-rated tranche of the Bloomberg High Yield Index.
 
Equity bears are likewise congregating on the scene. According to data from S3 Partners released on Monday, MicroStrategy attracted a whopping $840 million in notional short interest last week, equivalent to 4% of its total float. That’s the largest uptick as a percentage of tradable shares across the broad Russell 3000 Index, topping a 3.5% increase for recreational vehicle retailer Camping World Holdings, Inc.  
 
The legion of devoted bitcoin bulls has not, however, given up the ghost. “Many may laugh at him now, but Saylor will get the last laugh in time,” Changpeng Zhao, founder and CEO of crypto exchange Binance, Tweeted this morning. 
 
See the current edition of Grant’s Interest Rate Observer dated June 24 for a first-hand account of “crypto event of the year”: the eighth annual Consensus conference in Austin, Texas earlier this month. 
Recap June 29
Stocks managed to claw back from moderate losses on the S&P 500 to settle little changed on the day, as the broad index sits lower by 15.4% since March 31 with one session remaining in the second quarter.  Treasurys fared better as yields worked lower across the curve, led a decline in the benchmark 10-year note to 3.1% from 3.2% yesterday, while WTI crude pulled back to $110 a barrel and gold once again went nowhere at $1,820 per ounce. The VIX finished at 28, maintaining its recent rangebound status. 
 
- Philip Grant
06.28.2022
Lawyers, Guns and Money
File this one under – “things you don’t want to read as a stake-hodler.” A statement from crypto lender Celsius Networks to Cointelegraph:
 
All Celsius employees — including our CEO — are focused and hard at work in an effort to stabilize liquidity and operations. To that end, any reports that the Celsius CEO has attempted to leave the U.S. are false.
Alternate Side Parking
Timing is everything.
Timing is everything. Upwards of 100 local, city and state government entities added leverage to their pension fund portfolios last year, double the previous record sum, The Wall Street Journal reported yesterday, based on data from Municipal Market Analytics. Industry giants are set to follow suit. The California Public Employees’ Retirement System (Calpers), which boasts $440 billion in assets, will attempt to juice returns through borrowing beginning in July, marking a first in its 90-year history. 
 
Of course, red has been in fashion this year, as both stocks and bonds have absorbed hefty losses following the bull market bacchanal that characterized the prior 18 months. Industrywide median first quarter returns registered at negative 4% according to the Wilshire Trust Universe Comparison Service.  
 
Some observers have earned their distaste towards portfolio leverage the hard way. Former Pasadena city manager Steve Mermell has repeatedly lobbied against the strategy, after witnessing a similar move backfire at the turn of the century following the 9/11-induced swoon in asset prices, burdening Pasadena’s local pension fund with additional debt payments without investment returns to show for its additional debt load. “It’s like going to the ATM in Vegas and then going to the roulette wheel and it comes up red and you go back to the ATM,” he told the Journal.  
 
One heavyweight fiduciary, meanwhile, battens down the hatches. Paula Volent, who joined Rockefeller University as chief investment officer in August after quadrupling Bowdoin College’s endowment over the past 20 years, cautioned that “this is going to be a harder time to generate returns” in a Bloomberg Television interview airing today. “It’s the time to protect capital, not to shoot the lights out to get some great return.” 
 
Instead, the dimmer lights of the private markets offer a tempting proposition for those public stewards. Thus, Calpers reported a positive 1.14% total return for the first quarter according to data from Aon plc., bucking the poor results from its peers. So-called alterative assets such as hedge funds, real estate, private equity and private credit (which, of course, are infrequently traded and are not valued on a mark-to-market basis as public securities are) were primarily responsible for that relatively strong showing, Aon relays. 
 
Rival systems accordingly look to keep up with the Joneses.  In a landslide 139 to 10 vote last month, the New York State legislature passed a bill increasing maximum state pension allocations to alternative assets to 35% from 25%. That comes eight years after erstwhile Governor Andrew Cuomo vetoed a similar measure allowing for up to 30% of assets in alternatives, citing “the increased risk and higher fees frequently associated” with those asset classes. Calpers will likewise bump its “real assets” portfolio share to 15% from 13% as of July 1, with private equity allocations rising to 13% from 8% and private credit garnering a newly minted 5% share. 
 
State and local pension funds have allocated some 25% of their $5 trillion in assets into alternatives, according to data from the Center for Retirement Research. Private equity holdings among state and local pension funds stand at $480 billion per Preqin, up 60% from 2018. Yet that breakneck pace has slowed with the bull market in retreat, as such fundraising totaled $64.8 billion during the first quarter, off 26.8% from the same period last year. 
 
Then again, a recent survey from Natixis found that two-thirds of institutional fiduciaries plan to ramp up alternative investments at the expense of conventional fixed income in order to “generate yield,” compared to just over half of respondents in a 2017 poll. 
 
The prospect of a bruising stretch for the pension industry at large colors the migration into the deeper end of the risk swimming pool. An analysis from Moody’s Investors Service last Wednesday projects a systemwide 12.2% loss over the 12 months through June 30, far below the assumed 6.8% return target. That shortfall would leave assets sufficient to cover 6.9 years of retirement benefits, down from 8.3 years in mid-2021 and the lowest figure since at least 2016. 
 
Moreover, the ratings agency noted that “a persistent environment of high inflation would likely drive up wages for active employees and cost-of-living adjustments for retirees, increasing future pension obligations and governments' budget outlays.” State-directed efforts to contain raging price pressures may prove less-than-effective, as California Governor Gavin Newsom announced plans to distribute $1,050 direct stimulus checks to 23 million local residents “who are grappling with global inflation and rising prices of everything from gas to groceries,” his office declared. 
 
Nothing a bit more leverage and alternative assets can’t fix. 
Recap June 28
The quarter-end rally went on hiatus today, as stocks emphatically reversed strong early gains to leave the S&P 500 nursing a 2% loss while the Nasdaq 100 fell by 3%.  Treasurys finished little changed meanwhile, with the two-year yield edging higher to 3.1% while the long bond ticked down to 3.3%, WTI crude advanced to $112 per barrel and gold settled at $1,821 an ounce. The VIX rose above 28, finishing two points above its early nadir. 
 
- Philip Grant
06.27.2022
Wake of the Flood
If at first you don't succeed, try and try again.
If at first you don’t succeed, try and try again. The ARK Innovation ETF (ARKK on the NYSE Arca) has garnered net inflows in each of the past eight trading days, totaling $639 million, or about 7% of total assets at Cathie Wood’s flagship fund, data from Bloomberg show. That marks the longest such winning streak since March 2021. 
 
Subsequent developments render investors’ steadfast devotion to the growth-chasing, tech-focused outfit even more impressive, as ARKK shares have absorbed a 70% loss from their February 2021 highs, incinerating nearly $20 billion in assets under management. 
 
True to form, the uber-bulls at ARK see a future so bright that we will all need shades. For instance, here’s an excerpt from an in-house research note singing the praises of Zoom Video Communications, Inc. earlier this month: “According to [our] open-source research and model, Zoom’s share price could approach $1,500, compounding at a 76% annual growth rate, in 2026.” Under a bearish scenario, the ARK team reckons that Zoom shares will reach $700 by the end of 2026, equivalent to a 48% compound annual growth rate. 
 
Zoom!
Majority Rules
Doubling down in the Land of the Rising Sun:
Doubling down in the Land of the Rising Sun: the Bank of Japan’s government debt holdings have reached ¥514.9 trillion ($3.8 trillion), equivalent to 50.4% of total JGBs outstanding, Nikkei Asia relays today. That compares to a 48.2% share at the end of March and just 10% in 2013, when Governor Haruhiko Kuroda embarked on his ultra-stimulative policies in hopes of goosing consumer prices higher.  
 
Ominous tidings accompany that rapid portfolio buildup. The market is testing the BoJ pledge of unlimited purchases as needed to keep 10-year yields capped at 25 basis points, pushing above that limit on numerous occasions in recent months. Japanese government bond purchases sum to ¥14.8 trillion ($109 billion) so far in June, Nikkei Asia reports, blowing past the previous monthly record of ¥11.1 trillion established back in November 2002.  
 
More comprehensive debt monetization may be in the offing. The Japan Center for Economic Research reckons that the BoJ will need to bolster its current portfolio by another ¥120 trillion to adequately defend its self-imposed line in the sand, a sum which would equate to 60% ownership of total JGB supply. Meanwhile, the inflation beast is stirring once more, as measured CPI ex-fresh food popped to 2.1% year-over-year in both April and May, after averaging virtually zero growth over the prior 12 months.
 
Needless to say, Japan’s monetary mandarins’ commitment to overt interest rate administration comes with its share of side effects, such as fallow trading conditions that include full sessions without any benchmark 10-year notes changing hands. “Market functioning and liquidity have deteriorated sharply with the BoJ’s massive JGB purchases,” Barclays strategists led by Shinji Ebihara observed on June 16. The central bank’s growing struggles to maintain the 10-year yield ceiling “strengthen [the] possibility that the BoJ will eventually move toward a revision” of that open-ended purchase regime,” Barclays believes, as unrealized losses on its existing holdings “could further heighten concerns around [the BOJ’s] finances.”
 
Currency markets are expressing their own worries. The yen retreated to 136.6 to the dollar last Tuesday, marking its weakest level since the Asia currency crisis in 1998. The pace of deterioration has hastened as foreign central bankers turn off their own monetary taps; the yen fetched less than 115 per greenback in March and sports a five-year average near 110.  
 
Japan’s corporate sector likewise takes a dim view of that interest rate suppression campaign and the resulting currency weakness, as a May 23 to June 1 poll by the Japanese Association of Corporate Executives found that 74% of the 197 respondents report harmful economic effects stemming from the yen’s retreat. Similarly, 46% of the public surveyed by Nikkei expressed a desire for the BoJ to throttle back its aggressive easing regime, topping the 36% share who support the strategy. Nearly two-thirds of the citizenry reported that they “cannot tolerate” the recent surge in prices, compared to 29% who said they can handle the updraft. 
 
For now, at least, Kuroda et al. are sticking to their guns, as minutes from the BoJ’s June 16-17 meeting released today indicate nothing if not resolve (or obstinacy). “While assessing data in real time, particularly on underlying inflation and inflation expectations, the bank should continue with monetary easing until it becomes certain that wages have increased as a trend and the price stability [sic] target is achieved in a sustainable and stable [sic] manner,” the summary read.
 
The grand monetary experiment continues apace. 
Recap June 27
Stocks managed to mostly consolidate last week’s monster rally, as the S&P 500 lost a modest 40 basis points and the Nasdaq 100 pulled back by 70 basis points. A weak five-year Treasury auction headlined another bearish day for bonds, as the 30-year yield rose to 3.31% to close within 14 basis points of the multi-year closing highs reached on June 14.  WTI crude hedged higher to $110 per barrel, gold went nowhere again, settling at $1,824 an ounce and the VIX slipped below 27.  
 
- Philip Grant
06.24.2022
Wizard of Oz
The searing depiction of Australia’s housing bubble featured in yesterday’s ADG was originally created by Minack Advisors founder and eponym Gerard Minack, rather than Evergreen Gavekal, as presented in this space.  
 
Behold a chart so nice, we’ll run it twice:
 
He Said it
Here’s St. Louis Fed President James Bullard, gracing a Zurich audience today with a look into his crystal ball:
 
It is a little early to have this debate about recession probabilities in the U.S. . . This is in the early stages of the US recovery -- or US expansion, we are beyond recovery. It would be unusual to go back into recession at this stage.
Under Lock and Key
Whither the luxury goods industry?
Whither the luxury goods industry? Punishing inflation, in tandem with the wholesale reversal in global asset prices from the virus-era bull stampede, presents a daunting backdrop for high-end discretionary goods. 
 
Sure enough, stateside trends in this brave new world are less than encouraging. According to data from Bank of America, credit card spending on an inflation-adjusted basis among those earning at least $125,000 per annum turned negative on a year-over-year, seasonally-adjusted basis in May. That compares to an 11% growth rate in November and 35% in May 2021. 
 
Ultra-high end wares are hardly immune. A gauge of 30 frequently transacted luxury timepieces compiled by Watchcharts.com finished yesterday at $21,665, down 12.3% from its late March highs.  Prior to that reversal, the index has enjoyed a cool 42% rally dating back to last Christmas.  
 
Girding for a rough-and-tumble operating environment, one knowledgeable observer offered a pointed assessment of the current predicament. “Central banks have behaved irresponsibly,” Richemont chairman Johann Rupert lamented last month. “The people who did not need money got access to free capital. If you get something for free, you abuse it. Now, unfortunately, the party is ending.” 
 
Perhaps nowhere is that hangover more evident than the Middle Kingdom. China’s lynchpin real estate market has gone into deep freeze, an ominous macroeconomic development (the industry accounts for up to one third of nationwide GDP according to some estimates) and an extraordinarily leveraged financial system (bank assets registered at $56.5 trillion as of March 31, compared to less than $23 trillion in the U.S.). To wit: measured home sales have declined on an annual basis for 11 straight months. “This is the worst property downturn on record,” Lu Tin, chief China economist at Nomura, told Bloomberg Wednesday. “This time it’s different, as Beijing has attached national strategic importance to reining in bubbles.” 
 
Harsh lockdowns in the name of “Zero Covid” have likewise taken their toll. “Right now, I think we don’t need luxury,” a young Shanghai resident told the Financial Times Tuesday. “Because when you can’t even have the security of basic human rights, there is no need for petit bourgeois consumption.” 
 
Citing a May survey of some three dozen industry executives conducted by Oliver Wyman, CNBC reported last week that high-end consumer and luxury brands now expect Chinese sales growth of just 3% this year from 2021, compared to an 18% earlier this year. The consulting firm notes that, even in areas unaffected by lockdowns, some respondents reported seeing in-store foot traffic decline by 50%, with the number of visitors actually making a purchase off by as much as 30%. 
 
Even Communist party functionaries concede that there’s a problem. Nationwide retail sales dropped by 6.7% from a year ago in May, government statisticians report, following April’s 11.2% year-over-year decline. For context, the first three months of 2022 logged a 3.3% increase from the prior such period. 
 
How to capitalize on the unfolding metamorphosis? See “Lashed to – gulp! – China” in the May 13 edition of Grant’s Interest Rate Observer for a bearish look at one luxury outfit potentially poised to disappoint a bulled-up Wall Street. 
Recap June 24
Another monster rally in stocks left the S&P 500 up a whopping 6.7% for the week, though the broad index ascended only back to just above its June 10 closing price.  Treasurys remained under pressure following yesterday’s late reversal, with the long bond settling at 3.26% versus its year-to-date highs of 3.45% on June 14.  WTI crude rebounded above $107 a barrel, gold edged higher to $1,828 an ounce and the VIX slipped to 27.  
 
- Philip Grant
06.23.2022
Home Run
One for the history books Down Under:
One for the history books Down Under: As David Hay, co-chief investment officer at Evergreen Gavekal, chronicles on Twitter today, Australia’s residential real estate sector (as measured by the value of land owned by households) clocks at some 330% of national GDP.  That exceeds the high water mark, on an output-adjusted basis, of Japan’s mighty real estate bubble of the late 1980’s.  
 
 
Source: Evergreen Gavekal 
 
Sharply higher interest rates will put the staying power of that phenomenon to the test. On Monday, the Reserve Bank of Australia raised the cash rate by 50 basis points to 0.85%, following a 25-basis-point increase in May which marked the central bank’s first tightening move since 2010. Westpac chief economist Bill Evans predicts today that the RBA will continue on that rarely trod path, pushing benchmark borrowing costs to 2.6% by February 2023. 
Lipstick on a Pig
Reddit versus credit:
Reddit versus credit: Though last year’s speculative fever-dream has largely been relegated to the financial dustbin, vestiges of those heady times remain. Yesterday, shares in Revlon, Inc. (REV on the NYSE) jumped by 32%, extending the cosmetics mainstay’s rally to a cool 336% over three sessions prior to a modest 10% pullback today, leaving REV’s market cap at $393 million. Trading volumes have averaged 137 million shares over the past four sessions, up more than 100-fold from the one-year average prior to that ignition. Similarly, 210,000 options contracts traded yesterday per FactSet, a sum equivalent to roughly seven times REV’s total derivatives turnover during the first five months of the year. 
 
The only problem: the 90-year-old firm filed for Chapter 11 bankruptcy protection last Wednesday, with CEO Debra Perelman citing a “challenging capital structure,” which “limited our ability to navigate macro-economic issues.” Indeed, long-term debt registered at $3.31 billion as of March 31 against $70 million in cash, while the firm logged a $201 million operating loss last year.  
 
Buying up the equity of bankrupt companies has typically been a surefire route to capital incineration (creditors must be made whole prior to any compensation for equity holders), but recent history emboldens those intrepid punters. Recall that, back in the salad days of summer 2020, Hertz Co. became the subject of intense buying interest following its own Chapter 11 filing, allowing the firm to raise money and stockholders to ultimately receive a package of cash, stock and warrants equivalent to roughly $8 per share. 
 
Hopeful bulls will need some serious luck to reap similar rewards, as Bloomberg analyst Phil Brendel reckons the company would need to achieve a $4 billion valuation before any recovery accrues to shareholders. Indeed, the bond market appears less than sanguine about those prospects, as Revlon’s senior unsecured, 6 1/4% notes due 2024 changed hands at 10 cents on the dollar yesterday, equivalent to a 172% yield-to-maturity.  
 
Revlon’s post-filing wild ride casts a renewed spotlight on an instructive (and ongoing) pandemic-era imbroglio. Recall that, back in August 2020, Citigroup mistakenly wired some $900 million to a cadre of hedge fund leveraged loan creditors, that sum representing the principal amount outstanding of the loan rather than an interest payment that the bank intended to make. Yet several of those recipients refused to return the funds, alleging “manipulative” tactics in a dispute several months earlier.  
 
The lenders claim that Revlon, with Citi’s help, borrowed additional funds via a revolving credit facility against their wishes, using investment bank Jefferies’ status as a (temporary) creditor to tip the voting scales in favor of a debt exchange. Following that maneuver, Revlon shunted valuable intellectual property to a newly formed subsidiary, subordinating the hedge funds in the capital structure. 
 
A federal judge sided with those spurned creditors last year, leading to a subsequent appeal by Citi. In the event that their petition is denied, Citi confirmed in a filing last week that they will assume the remaining $500 million claim against Revlon if the appeals court upholds the current verdict.  
 
Serious money now hangs in the balance, as that first-lien debt has since plummeted to 34 cents from 99.5 cents at issuance, leaving an effective yield of 103%. In the meantime, confusion reigns as the courts deliberate. “The company effectively has had, since August 2020, no 2016 Term Loans counterparty with which it can negotiate,” Revlon lamented in last week’s filing. 
 
Maybe it can negotiate with itself.
QT Progress Report
It was another slow week for the balance sheet “normalization” project, as Reserve Bank Credit ticked to $8.9 trillion, up $7 billion from last week’s reading.  Interest-bearing assets on the Fed balance sheet are $24 billion below their late March high-water mark. 
Recap June 23
Stocks pushed higher to the tune of 1% on the S&P 500, leaving that broad index on the verge of snapping its string of 10 weekly losses in 11 tries as it sits higher by 3.5% over the past four days. Bonds also caught a bid with the 10-year yield slipping to 3.09%, though that benchmark issue finished well off its best levels of the day.  Gold pulled back to $1,827 an ounce, WTI crude retreated to $104 per barrel and the VIX held steady at 29. 
 
- Philip Grant
06.21.2022
Perception is Reality
There’s more than one way to fight inflation. From the Daily Mail:
 
A man has had his favorite pair of shoes tattooed onto his feet because he’s ‘tired of paying’ for new ones.
 
Manchester-based tattoo artist Dean Gunther, 34. . .recently went viral after saving [another customer] a fortune on a gym membership by giving him a permanent six-pack tattoo. 
All Rights Reserved
Last one out turns out the lights.
Last one out turns out the lights. Foreign investors have quit the Bosporus in droves, as Turkey’s investment flows have turned negative to the tune of nearly $100 billion on a rolling three-month basis, data from the Institute of International Finance show. That approaches the virus-induced tumult in early 2020 for the worst such stretch going back to 2010.  
 
Persistent currency weakness is a primary culprit, leaving investors “tired of devaluation after devaluation in Turkey,” IIF chief economist Robin Brooks Tweeted yesterday.  With measured inflation percolating at a 73.5% annual pace in May (easily the highest in the G-20), the lira to dollar exchange rate now stands at 17.2 to one, compared to less than nine to the buck a year ago.  
 
The remedy to that inflationary spiral, courtesy of President Recep Erdogan: easier monetary policy.  Turkey’s strongman, who has shown four central bank heads the door since 2019 on account of insufficient dovishness, has overseen a reduction in the benchmark rate to 14% from 19% last August.  Following upwards of $150 billion in FX market interventions since 2018 in a fruitless effort to support the lira, Turkey’s net foreign reserves slumped to roughly $7 billion last week, a quartet of economists estimated to Reuters, the lightest war chest in 20 years. 
 
That capital flight leaves the local banking system in an increasingly precarious position. Analysts at S&P Global estimated last week that Turkish lenders held $154.8 billion in liquid foreign reserves as of March 31, a sum sufficient to cover the $85.7 billion in debt maturities over the following 12 months. However, the rating agency added that $75.9 billion of those funds were housed at the Central Bank of the Republic of Turkey, raising the specter of a wider financial crisis: 
 
As such, under a hypothetical extreme scenario, the central bank could restrict access to these assets given its already weak foreign exchange reserves, and push banks to default. Clearly, a significant increase in foreign exchange demands by depositors would add pressure on the local currency and, in turn, on already low central bank foreign exchange reserves, increasing the risk of capital controls.
 
How to remedy this precarious situation? Bloomberg reported last week that the CBRT will offer sweetened terms, including access to cheaper credit, for exporters who agree to convert more of their foreign-currency earnings into lira. This follows the CBRT’s elevation of the minimum required conversion threshold to 40% of exporter income from 25% in April. Financial markets are skeptical that those measures will prove effective, as five-year credit protection costs surged to 870 basis points last week, marking the most elevated reading in nearly two decades and more than double the five-year average.  
 
The political class is likewise getting restless. Ali Babacan – who served as minister of Economy, minister of Foreign Affairs, and deputy prime minister under Erdogan before founding opposition party Democracy in Progress – sounded the alarm in a speech last Wednesday: “I am worried because the default risk of our country, namely the risk of bankruptcy, has reached an unprecedented level. . . We are faced with a matter of economic and financial survival.” Babacan went on to exhort his erstwhile boss to change course: “Do what is necessary for the management of the economy and finance based on reason and science. Appoint qualified staff to the central bank and the Turkish Statistical Institute immediately and do not intervene in these independent institutions.” 
 
Unfortunately, those exhortations are likely to fall on deaf ears. “This government will not raise rates,” Erdogan promised (or warned) on June 6. “We will continue cutting them.” 
Recap June 21
The bulls strike back: Stocks roared higher to reverse a large chunk of last week’s losses, with the S&P 500 jumping 2.5% and finishing near its highs of the session.  The bond market meanwhile endured another rough day, with the long bond rising nine basis points to 3.39%, approaching the 3.45% high-water mark established last Tuesday. WTI crude bounced to $110 a barrel, gold finished little changed at $1,836 per ounce and the VIX retreated to 30, down one point on the day.  
 
- Philip Grant
06.17.2022
Funny How Time Slips Away
“One of the questions that we always
“One of the questions that we always get asked is, when’s the party going to end?” Orlando Bravo, co-founder and one-half eponym of buyout firm Thoma Bravo, rhetorically asked the Financial Times back in December. But the analogy was wrong, he said, because a party has “a finite end.”
 
And here’s Bloomberg-collected snippet from the Gabriel Caillaux, co-president and managing director of peer General Atlantic, at the SuperReturn International conference in Berlin this week: “I think those who hadn’t adjusted their underwriting decisions [in recent months] are going to wake up with a terrible hangover.” 
 
See “Private equity cha cha” in the April 1 edition of Grant’s Interest Rate Observer for an early look at the unfolding sea change. 
Seller's Strike
Exactly zero U.S. high-grade
Exactly zero U.S. high-grade corporate bonds came to market this week, according to data from Bloomberg, as at least six issuers thought twice about selling debt. That marks the first time this year that investment grade firms were shut out of the primary markets entirely. 
 
Similarly, activity in the state- and local-debt market has slowed to a crawl, as this week’s $2.4 billion in new supply marks the slowest week since January, with at least a trio of authorities pulling the plug on planned sales. That comes as Bloomberg’s Municipal Bond Index lost 2.1% over the four days through Thursday, on pace for the worst weekly showing since April 2020. Meanwhile, outflows from muni mutual funds registered at a whopping $5.6 billion Wednesday, Refinitiv Lipper finds, the third worst one-day showing on record. 
School of Hard Knocks
Swedish fintech player Klarna Bank AB is in negotiations for a new financing round for roughly $500 million at a $15 billion valuation, The Wall Street Journal reports today. The only problem: The buy now, pay later outfit was seeking a low $30 billion price tag just last month, and garnered a $45.6 billion valuation one year ago in a $639 million round led by SoftBank Group Corp.’s Vision Fund 2.  Prior to the turn in conditions, the company had reportedly set its sights on a $50 billion-plus figure. 
 
Of course, harsh reality has since intervened: Klarna logged a SEK 2.57 billion ($250 million) first quarter loss, quadruple that of a year ago, while announcing layoffs equivalent to 10% of total headcount last month.  “We decided that we’re going to change the weight of our investments and focus more on short-term profitability over long-term, new, potential investments,” co-founder and CEO Sebastian Siemiatkowski told the FT on May 25.  
 
Even that rapid fall from grace leaves early backers on firm footing, as 17-year old Klarna raised $460 million at a $5.5 billion valuation in August 2019. That yawning gap between pre- and post-pandemic price tags is far from unusual. Late-stage v.c.-backed firms were marked at an average $120 million in the first quarter according to PitchBook, up from $105 million during 2021 and double the pre-pandemic mean.  Similarly, early stage firms enjoyed an average $67 million valuations over the three months through March 31, compared to $45 million last year and $23 million in 2019.  That was then, as illustrated by the Refinitiv Venture Capital Index 61% slump since November to depths last plumbed in April 2020. 
 
As the party meets an abrupt end, crowds throng the exit doors. An ongoing tally from Crunchbase finds that at least 21,000 workers in the U.S. tech sector have been laid off this year as of yesterday.  Employees (current or otherwise) looking to monetize stock options are likewise having a rougher go of it.  The Information reported last week that trading volumes on private market exchanges have dried up, as a dearth of buyers in tandem with overly optimistic would-be sellers result in sharply widening bid/ask spreads. Boldness, accordingly, is in short supply. “We’re not going to go out and set the market,” Hans Swildens, CEO of secondary market-focused firm Industry Ventures, told The Information. 
 
Concurrently, the specter of widespread down rounds, or fundraising conducted at reduced prices from prior levels, looms large. Newly onerous terms from investors who find themselves with the upper hand can compound that pain for cash-hungry startups. Mathias Schilling, founding partner at v.c. firm Headline, tells PitchBook that some recent deals have featured so-called liquidation preferences up to three times, meaning that new investors are entitled up to triple their outlay before anyone else sees a dime. 
 
The proliferation of suddenly-restrictive funding conditions hearkens back to the aftermath of the late 90’s tech bubble, an era often unfamiliar to the new guard. “They literally do not know what these terms mean,” Schilling said, referring to founders raising money now. “I can finally leverage the toolkit I learned 20 years ago.” 
Recap June 17
Stocks sat modestly higher when your correspondent had to leave with an hour or so left in the session, but the S&P 500 remained firmly on track for a tenth weekly loss in its last 11 tries. Treasury yields edged higher in bear flattening fashion, with the two-year note rising six basis points to 3.15% while the long bond held closer to unchanged,  gold declined to $1,840 an ounce and WTI fell to $107 per barrel, which would mark its lowest finish in more than a month.  The VIX retreated towards 31. 
 
- Philip Grant
06.16.2022
Mission Accomplished
From NBC News:
 
Anna Sorokin, known for taking hundreds of thousands of dollars from friends and businesses while posing as a German heiress, says she's trying to move away from the "scammer persona" and plans to launch a collection of NFTs.
Knock-Off Effect
As second quarter earnings season looms next month,
As second quarter earnings season looms next month, one corporate bellwether delivers a less-than-encouraging signal. Kroger Co., the fourth largest grocery chain in the country, this morning reported a 4.1% year-over-year growth rate in same store sales over the quarter ended May 27, topping the expected 4%.  Yet gross margins shrank to 21.6%, down from 21.9% in the prior year period and short of the Street’s 22% expectation, as supply chain problems and “strategic price investments” pressured the bottom line. 
 
The Kroger print follows a currency-related profit warning from Microsoft as outsized dollar strength crimped its international profitability, while retail behemoth Target slashed guidance twice within three weeks on account of suddenly bulging inventories. 
 
A bottoms-up tabulation from FactSet’s Earnings Insight last Friday found that Wall Street is now expecting a 4% year-over-year growth rate in S&P 500 earnings per share during the second quarter, down from a 5.9% guesstimate as of March 31. However, expectations for the back half of 2022 have been rising in turn.  Per data from Refinitiv, the sell side is now penciling in 9.6% full-year earnings growth for the S&P across calendar 2022, compared to 8.8% in early April and 8.4% at the start of the year. 
 
Meanwhile, the plunge into bear market territory leaves the S&P valued at roughly 16 times forward earnings estimates, down from 22.5 times in mid-2021 but not appreciably below its 10-year average price tag of 16.9 times. “We’re not buying the stock drip because valuations haven’t really improved, there’s a risk of Fed overtightening and profit margin risks are mounting,” BlackRock strategists led by Wei Lei wrote on Monday. 
 
To that last point, there is plenty of room for mean reversion. S&P 500 net profits as a percentage of revenue will register at 12.4% if analysts are on the beam. That is off from 13.5% and 13.4% in the third and fourth quarters, respectively, but far above the 8.2% average going back to 1993. 
 
Indeed, the most acute inflationary environment in four decades presents a clear and present danger to the “E” side of that equation. Namely, the ability of corporate America to pass on rising costs remains an open question, as margins remain elevated on a historical basis. Over the past year, the Producer Price Index has advanced at an average 9.4% clip, easily outpacing the 6.7% average annual pace within the Consumer Price Index. Over the largely fair-weather financial decade preceding May 2021, PPI rose by 1.6% on average, comfortably behind the 2.1% growth in CPI. 
 
C-suites across the country continue to grapple with those price pressures: a full 417 S&P 500 components mentioned “inflation” during their first quarter earnings calls (what were the rest of them talking about? –ed.), FactSet finds.  For context, that figure rarely topped 150 and never exceeded 175 in any quarter during the 11 years through 2020. 
 
Consumers are conducting their own damage assessment.  Last Friday’s reading of the University of Michigan’s Consumer Sentiment Index for June cratered to 50 from 58.4 in the prior month and an expected 59, comparable to the depths of the 1980 inflation-cum-recession.  Meanwhile, inflation expectations are increasingly codified, as a survey from Jefferies released yesterday found that 78% of respondents expect prices to continue higher, compared to a 69% share in the April survey.  Queried about responses to higher-than-expected prices, 53% reported trading down in some fashion, 23% said they wait for a sale and 16% cancel the purchase entirely. Kroger CEO William Rodney McMullen likewise observed on today’s earnings call that customers are “aggressively” switching to cheaper, store brand products. 
 
See the April 15 edition of Grant’s Interest Rate Observer for a bearish analysis on a pair of companies that are particularly exposed to downshifting consumer behavior yet retain healthy valuations, the rout in asset prices notwithstanding. 
QT Progress Report
Not much progress to report, as Reserve Bank Credit edged higher to $8.89 trillion, up $12 billion from a week ago and some $30 billion below the mid-May high-water mark.  Interest bearing assets on the Fed balance sheet remain 140% above their fall 2019 levels. 
Recap June 16
Stocks were absolutely rinsed once again with the S&P 500 losing 3.3% and the Nasdaq absorbing a 4% decline on the day.   Treasurys managed to stage a strong intraday rally as yields settled modestly lower across the curve.  WTI crude rebounded to $117 per barrel, gold rallied again to $1,858 an ounce and the VIX jumped another three points to 33. 
 
- Philip Grant
06.15.2022
Rough Tape
Everything must go.
Everything must go. A Deutsche Bank-led consortium priced a six-year, single-B-rated $1.5 billion leveraged loan to fund the leveraged buyout of packaging manufacturer Intertape Polymer Group, Inc. at a heavily discounted 92 cents on the dollar this morning. That’s down from an initially marketed range of 93 to 94, Bloomberg reports, as banks labor to rid themselves of a $50 billion backlog of loans meant to be farmed out to the investing public. 
 
Yet yesterday’s markdown was small potatoes compared to a concurrent $400 million junk bond financing the deal. Credit Suisse and Co. are offering that 6.5-year, triple-C-rated issue at 83 to 85 cents on the dollar, Bloomberg related late yesterday, equating to a yield of as much as 14%. That compares to an 11% to 12% yield offered in last week’s marketing effort and would mark one of the steepest original issuer discounts within high-yield since the financial crisis. 
 
Selling that paper at all would arguably be something of an accomplishment. Investors pulled a net $307 million from the Invesco Senior Loan ETF (ticker: BKLN) on Monday alone, a sum equivalent to 6.1% of the fund’s total assets under management, bringing one-year net outflows to $1.75 billion.  On the fixed-rate side of the coin, the iShares iBoxx and SPDR Bloomberg high yield ETFs finished trading Monday at 1.2% and 1.8% discounts to NAV, respectively, marking the most substantial price dislocations since March 2020 and the aftermath of the 2016 elections. 
 
Those divergences may be justified, some believe. “We still have yet to see [credit] spreads truly reflect the very challenging growth, inflation and policy risks in the corporate bond market,” Goldman Sachs global credit strategist Amanda Lynam warned on Bloomberg Television this morning. 
Discount Double Check
In the wake of recent collapses from digital lender Celsius Networks
In the wake of recent collapses from digital lender Celsius Networks and crypto hedge fund Three Arrows Capital, purveyors of the world’s largest “stablecoin” scramble to avoid a similar fate. This morning, Tether issued a press release calling attention to “rumors being spread that its commercial paper portfolio is 85% backed by Chinese or Asian [borrowers] and being traded at a 30% discount.” A colorful denial duly followed: “These rumors are completely false and likely spread to induce further panic in order to generate additional profits from an already stressed market.” Left unsaid, the actual portion of Asian commercial paper within its portfolio, or the current market price.  
 
The company, which issued a $1 billion loan to Celsius last fall backed by bitcoins (the borrower since repaid half those funds, the Financial Times reported last month), went on to claim that the “overcollateralized” loan “has been liquidated with no losses to Tether.” Celsius customers, it seems, didn’t fare quite so well.  Tether, which briefly traded to 95 cents in mid-May, breaking its $1 per USDT peg, has performed better during this week’s crypto crucible, ticking below 99.8 cents on Monday before rebounding. 
 
However, as Tether’s strident denials might suggest, ongoing skepticism over the nature of its reserves (see the Sept. 18, 2017 edition of Grant’s Interest Rate Observer for one early example) remains something of a sore spot. Yet the company remains reluctant to accede to a formal audit which could help put those concerns to rest. 
 
Recall, that, as part of a $36 million settlement with New York Attorney General A.G. Letitia James to settle her claims that Tether’s assertions of full dollar backing were a “lie,” the company submitted to quarterly attestations conducted by auditor MHA Cayman. As of that March 31 snapshot, commercial paper holdings registered at $20.1 billion, or 24.3% of total assets, while money market funds and U.S. Treasury bills represented 55.7%. Secured loans, corporate bonds, funds, precious metals, and so-called other investments (including digital tokens) comprised the bulk of the remainder. 
 
Then, too, the attestation notes an interesting accounting detail: “Certain loans” on Tether’s books are recorded at amortized cost, adjusted for “expected credit loss allowance” rather than market value.  Similarly, digital assets “are valued at cost less any impairment,” while the “other assets” are “valued at amortized cost less any expected credit losses.” In other words, management and attestator have the last word. 
 
The regulators had their turn. With crypto prices in sharp retreat, might Mr. Market be the one to solve the Tether mystery? 
Recap June 15
A mammoth 75 basis point rate hike (the largest in one shot since Bill Clinton’s first term) spurred a moderate relief rally, as the S&P 500 rose 140 basis points, though the broad index did finish well off session highs reached in mid-afternoon. Treasurys likewise caught a bid, with strength concentrated on the short end as the two-year yield dove to 3.2% from 3.45% yesterday, though that policy-sensitive security remains well above its closing levels prior to Friday’s white-hot CPI data. Gold rebounded to $1,837 an ounce, WTI crude slipped to $116 per barrel and the VIX fell below 30, off three points on the day.  
 
- Philip Grant
06.14.2022
Fortress of Solitude
This morning,
This morning, Coinbase CEO Brian Armstrong announced his firm will lay off roughly 18% of staff in a less-than ceremonious manner – via automatic removal of access to the office email server. That bombshell comes just four months after a planned initiative to further hike what was then-mushrooming headcount (see yesterday’s ADG for the details).  Jettisoned staffers will receive 3.5 months of severance pay, plus two additional weeks for each year of employment. 
 
On the bright side, the founder will be able to mull those fast-changing circumstances in style. From the Jan. 3 edition of The Wall Street Journal:
 
Coinbase Chief Executive Officer Brian Armstrong is the buyer of a $133 million Los Angeles estate, according to people familiar with the deal. The transaction, which closed in December, is one of the priciest single-family home sales ever completed in the L.A. area.
 
The seller was a limited liability company tied to Japanese entrepreneur Hideki Tomita, which bought the property for $85 million in 2018, records show.
 
Underpinning that king-sized purchase: Ample liquidity. As the Journal noted May 27, Armstrong and his living trust generated $292 million in proceeds from open market Coinbase stock sales over the 10 months through February. 
Cornered Case
Onward, upward and then what?
Onward, upward and then what? As the Federal Reserve gets set to unleash its latest rate hike tomorrow, a telegraphed tightening from the European Central Bank last week (its first such move since 2011) and conclusion to its comprehensive asset purchase regime ripples across the Old Continent.   
 
This morning, yields on Italian 10-year debt jumped to 4.17% to reach their highest levels since late 2013, pushing the price on the benchmark note to roughly 75 cents from 95 as recently as early in March. The spread between Italian and German 10-year yields have blown out in turn, settling at 242 basis points today, from 200 basis points last week and nearly the double that gap as of year-end.  
 
As the inflationary bonfire burns (annualized euro area CPI ripped higher by 8.1% in May, by far the hottest reading of the common currency era), the ECB faces a delicate balance, hemmed in from forceful response thanks to the periphery’s fragile financial health.  President Christine Lagarde vowed last week to prevent divergent borrowing costs from spiraling into a debt crisis, telling the press that “I can only repeat what I have said, which is that we will not tolerate fragmentation.”  
 
There is no doubt that the bottom scraping borrowing costs imposed by Draghi and Lagarde have incited further credit formation. To wit: triple-B-rated Italy’s government debt stood at 150% of GDP as of year-end, up from 119% a decade earlier and 134% on the eve of the pandemic.  Yet thanks largely to Frankfurt’s tireless efforts, Italy paid only the equivalent of 3% of GDP last year to service its burgeoning debt load, compared to 5% as the sovereign credit crisis raged in 2011 and 2012.
 
That trend is now at risk for reversal, with attendant unpleasant consequences.  Italy faces upwards of €850 billion ($884 billion) in maturities over the next four years according to Bloomberg, equivalent to a third of its total debt load. Increased interest expense could soon be in the offing, as Europe’s third-largest economy pays a weighted average interest rate of roughly 2.5%. For context, Italy’s two-year yield now stand at 2.13%, compared to 0.83% less than three weeks ago. 
 
As percolating inflation demands a response, the ECB finds itself in an increasingly tight spot. “There is no easy fix,” Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, tells Reuters. “We are here today because of the lack of decision in the past six months.” 
 
That’s not to say that the political class won’t give it their best shot.  A paper this month from European Parliament outlined steps that the ECB could take to tackle the fragmentation issue.  One proposed solution: closer fiscal integration, including centralized unemployment insurance programs, allowing the ECB to focus on the liquidity profile of the resulting EU-guaranteed bonds rather than that of the 19 sovereign nations within the bloc. 
 
Not that the lessons of financial history were front and center in the analysis. Of the 27 sources cited in the accompanying bibliography, none is more than a decade old, while all but 10 of those were penned during and after the plague year of 2020. 
 
Learning by doing remains the institutional motto. 
Recap June 14
Another day, another painful session for Uncle Sam’s creditors, as Treasury yields ripped higher once more to leave the 10-year note at 3.49%, its highest since spring 2011, while the two- and 30-year yields converged at 3.45% ahead of tomorrow’s FOMC rate decision.  Stocks consolidated yesterday’s beating with the S&P 500 settling slightly lower and Nasdaq 100 making a now-rare appearance in the green, with WTI crude edging lower at $118.50 per barrel and gold continuing lower to $1,810 an ounce. 
 
- Philip Grant
06.13.2022
It's Lonely at the Top
CME Group, Truist Financial Group, Duke Realty Corp., McDonalds and Dominos Pizza, come on down.  That quintet represents the totality of S&P 500 members that managed a green finish today, with each of those four winners settling higher by less than 2%.  In contrast, 87 S&P 500 constituents saw losses in excess of 6% on the session, with a dozen of those down by at least 8%. 
Hire Burning
Right-sizing, whatever "right" is.
Right-sizing, whatever “right” is. Back in May, Coinbase Global, Inc. (COIN on the Nasdaq) announced it would freeze new hiring initiatives, three months after disclosing plans to add 2,000 staffers, a sum equivalent to nearly half of its global headcount at year end (the corporate payroll tripled in 2021). The digital currency exchange reportedly went so far as to withdraw outstanding offers to applicants in recent weeks. 
 
On the heels of that about-face, Coinbase CEO Brian Armstrong treaded the warpath on Friday afternoon, urging disgruntled staffers who circulated a petition calling for the removal of executives responsible for “plans and ideas that have led to questionable results and negative value” to themselves quit the company, promising that anyone found to be involved in that effort would be fired.  
 
As that series of events might suggest, it’s been tough sledding of late, as Coinbase shares are down 79% this year and sit 85% below the company’s spring 2021 direct listing (see “Disrupters cash out” from the March 5, 2021 issue of Grant’s Interest Rate Observer for a review of the unusual features in that offering). Meanwhile, the exchange’s double-B-plus rated, senior unsecured 3 5/8% notes due in 2028 sport a 764 basis point spread over Treasurys, more than triple the 231 basis point pickup on offer at issuance six months ago and not far from the 1,000 basis point threshold that typically denotes a distressed credit. 
 
Meanwhile, fellow digital exchange Binance will attempt to pick up the staffing slack. Asked at an investment conference yesterday about Coinbase’s hiring freeze, CEO Changpeng Zhao declared that his firm is moving in the opposite direction: “We have a very healthy war chest, [and] we in fact are expanding hiring right now.”  Yet just hours after those reassuring words, Binance temporarily froze bitcoin withdrawals as digital asset volatility shifted into overdrive this morning, subsequently explaining the snafu as a result of “a batch of bitcoin transactions [which] got stuck. . . resulting in a backlog.” 
Reverse Engineering
Liquid gold? Not exactly.
Liquid gold? Not exactly. Scores of bond market investors took their ball and went home last week, as outflows in the iShares iBoxx $ Investment Grade Corporate Bond ETF (ticker: LQD) registered at a record $2.56 billion over the five days thorough Friday per Bloomberg. That’s the highest on record in the LQD’s 20-year history, equivalent to nearly 10% of the fund’s assets under management. More than half of that leakage took place on Friday following the far hotter-than-expected reading of the May Consumer Price Index. 
 
That widespread move to cash has aged well thus far, as the Bloomberg U.S. Corporate Bond logged another 1% loss today to extend its year-to-date return to negative 14%. Credit default protection prices as measured by the CDX Index reached 94 basis points this morning, up from 79 basis points less than a week ago and the most elevated reading since the teeth of the pandemic selloff. 
 
Part and parcel with those bond market spasms: a less-remunerative backdrop for Wall Street.  Data from the Securities Industry and Financial Markets Association show that total supply of domestic fixed-income products slumped to $4.36 trillion over the first five months of the year, off 24.7% from last year’s pace.  Each of the six categories tracked by the trade group experienced a slowdown in activity over that stretch, with declines ranging from 3.6% for Treasurys to 23.2% for corporate debt, with mortgage-backed securities supply off by 45.1% year-over-year. 
 
See the brand new issue of Grant’s Interest Rate Observer dated June 10 for the bear case on a venerable, richly-valued financial institution that has been a primary beneficiary of the multi-decade expansion in credit. 
Recap June 13
Things went from bad to worse for the thinning bull crowd today, as interest rates went parabolic with the two-year yield leaping to 3.4% from 3.06% and the long bond to 3.42% from 3.2% at the end of last week.  Stocks were strafed to the tune of 3.8% on the S&P 500 and 4.6% on the Nasdaq to leave those indices firmly in bear-market territory.  Gold was hammered by 3% to $1,822 an ounce after logging multi-week highs Friday, WTI crude held near $121 per barrel and the VIX settled at 34, up 10 points from Thursday morning. 
 
- Philip Grant
06.10.2022
Goose is Cooked?
A quartet of headlines from Bloomberg: 
 
Turkey to Double Lira Loan Reserves Amid Steps to Boost Currency
 
Turkey Announces New, Revenue-Indexed Bonds to Bolster Lira
 
Turkey to Issue Gold Certificates, Market Regulator Says
 
Lira Swings, CDS Surge as New Measures Fail to Ease Concerns
Broken Thermometer
Forget room temperature.
Forget room temperature. The hits keep on coming for crypto lending platform Celsius Network, as its namesake digital token endured a 32% swan dive between this morning and early afternoon, according to data from CoinMarketCap.  That digital ducat is off 88% following a skeptical examination in the Dec. 3 edition of ADG. 
 
Celsius, which advertises annual percentage yields of 17% for crypto deposits from individual investors on its website (along with a $50 free crypto offer for those who refer a friend to the platform), lost $54 million in December after hackers penetrated the Badger Decentralized Autonomous Network (DAO).  
 
Declining to identify a catalyst in a statement this afternoon, the company instead pointed toward the big picture: “Looking across the entire crypto sector, we are undoubtedly in a crypto winter. The price of all cryptocurrencies have [sic] clearly been affected by a general market downturn. We are squarely focused on building for the long term.” 
 
Last fall, Celsius raised $750 million in an upsized series B fundraising round, valuing the company at $3.5 billion. Duly emboldened, CEO Alex Mashinsky told Cointelegraph that he expected his company’s valuation to “double or triple” from that figure within the following 12 months. Underpinning that confidence, a relationship with an infamous crypto cornerstone: As Mashinsky informed Bloomberg last fall, Tether, the progenitor of so-called stablecoins under the same name, loaned $1 billion to Celsius at an interest rate of roughly 5% to 6%.
Walk to the Light
It's alive!
It’s alive!  The leveraged loan market has enjoyed something of a revival recently on the heels of a brutal May, which featured a 2.56% total return loss on the S&P/LSTA Index for the third-worst monthly showing since 2009.  Funds investing in the floating-rate, speculative grade bank debt have enjoyed two consecutive weeks of inflows following the largest weekly withdrawal since March 2020, while the primary market has in turn shown signs of life. 
 
A trio of borrowers were able to price deals yesterday at tighter-than expected spreads, Bloomberg relays. Demand for a term loan from auto software manufacturer CDK Global, Inc., was sufficiently brisk to allow for both an upsized $3.6 billion sale (from an initial $3.35 billion) and offering price at 450 basis points over the Secured Financing Overnight Rate instead of a planned 475 to 500 basis points, to finance its buyout by Brookfield Asset Management.
 
That recovery sets the stage for a bigger test. Bloomberg reported Wednesday that the banks sitting on $15 billion in debt commitments tied to the buyout of Citrix Systems, Inc. are looking to launch a deal as soon as next month. That mammoth offering, one of the largest of the post-crisis epoch, has been in dry dock since January, when Bank of America, Credit Suisse and Goldman Sachs agreed to help finance Vista Partners’ purchase of Citrix. Better late than never, those lenders might say, as the deal was originally supposed to be syndicated in the spring, before Mr. Market developed other ideas. 
 
As might be expected, private equity promoters haven’t been spared by the lurch higher in interest rates. LBO-affiliated loans have sported an average 5.7% yield to maturity so far in 2022, data from LCD show, compared to 5% last year. Along with retreating equity prices, that dynamic has helped put the crimps on supply. That coincides with a marked slowdown in private equity activity, as year-to-date domestic deal volume stands at $373 billion per Dealogic, down from $570 billion at this time in 2021.  Loan supply to fund those buyouts registered at $51 billion through May 25, trailing last year’s $65 billion pace.  
 
That slowdown is impacting Wall Street headcounts, employment site eFinancialCareers reported earlier this week. "I know a few banks had planned to add senior folks this year, but they've pulled the roles. The market is quiet,” lamented one director focused on leveraged finance origination.
 
Mushrooming popularity for a leveraged loan alternative isn’t helping that dynamic.  Direct lending continues to gain market share, accounting for 17.6% of leveraged finance last year from 2.6% in 2010, The Wall Street Journal reports, citing data from Blue Owl Capital Partners. Those private credit firms drew some $229 billion from investors globally in the first quarter, according to alternative asset manager Hamilton Lane, virtually maintaining last year’s $1 trillion pace. Underpinning that ascent: increasing availability to issuer-friendly features once available only within the syndicated market, such as hollowed out legal protection for creditors. “Now, you can effectively get covenant light” via direct lenders, Anne Hayes, senior partner at Riverside Co., told the Journal.
 
But wait, there’s more.  A survey of 181 private lenders released this week from Proskauer Rose LLP finds that nearly 40% of respondents would consider participating in a deal carrying 7.5 turns of leverage, double the share open to such a heavily encumbered borrower in last year’s survey.  Recall that, back in 2013, bank regulators deemed loans carrying six times leverage as worthy of “special concern.” Similarly, only 32% of respondents ruled out participation in any covenant light deal, compared to 46% who vowed to pass on those structures last year. 
Recap June 10
Read ‘em and weep.  A ghastly 8.6% annual growth rate in May CPI (along with a 1% sequential leap) set the stage for another rout in asset prices, with the S&P 500 clubbed by 2.9% and the Nasdaq 100 by 3.5%, leaving each at or near their closing lows for 2022.  Treasurys also sold off sharply in bear-flattening formation, as all maturities two years and longer now yield more than 3%. WTI crude held at $120 a barrel, gold vaulted to a five-week high at $1,875 per ounce after reversing early losses, and the VIX rose two points for a second straight day, settling near 28. 
 
- Philip Grant
06.09.2022
Mind the Store
Here’s Sam Bankman-Fried, CEO of crypto exchange FTX, discussing the difficult price action in digital currencies at an investor conference today:
 
There’s been an enormous amount of attention on the Fed, on what’s happening to monetary supply. [The dollar] and anything denominated in dollars is going to move, whether it’s Bitcoin or whether it’s equities, in the same direction.
 
In other words, bitcoin and peers are effective stores of value, as long as inflation is low and money is easy. 
'98 Pound Weakling
No flip-flopping in the Far East.
No flip-flopping in the Far East.  As the Federal Reserve embarks on its belated inflation-fighting quest and even Christine Lagarde’s European Central Bank lays the groundwork for its own furtive “lift off,” the pre-eminent purveyor of E-Z money now stands alone.  
 
On Monday, Bank of Japan governor Haruhiko Kuroda reiterated that, in spite of a 2.1% year-over-year rise in April core CPI (up from a 0.8% annual pace just a month prior and the highest reading in seven years), “Japan is absolutely not in a situation that warrants monetary tightening.” To the contrary, “the BoJ will be unwavering in its stance of maintaining powerful monetary easing, so that recent changes such as a rise in inflation expectations. . . lead to sustainable price growth.” Central to that aim, the BoJ promised in April to purchase an unlimited quantity of 10-year Japanese government bonds in order to maintain a 0.25% yield cap. 
 
Meanwhile, Kuroda’s heavy hand has rendered the JGB market less than dynamic. On Tuesday, not a single benchmark 10-year government bond changed hands, marking the first such volume-free trading session in 2022.  That comes a month after the BoJ’s quarterly survey of dealers found that 97% report market functioning at a “low” or “not very high” level. 
 
With the bond market under the BoJ’s thumb and central banks across the West scrambling to contend with an unwelcome version of “sustainable price growth,” foreign exchange emerges as the pressure valve. The yen today slumped as low as 134.56 to the dollar in the wee hours. That approaches its weakest level since the 1998 Asian currency crisis, comparing to less than 115 to the buck as recently as March and 103 early last year.
 
Captains of industry aren’t thrilled about that rapid depreciation: A May 23 to June 1 poll of 197 c-suite honchos by the Japanese Association of Corporate Executives found that 74% of respondents report deleterious effects on the economy stemming from the yen’s comprehensive weakness, which includes multi-year lows against the euro and Australian dollar this week. 
 
Other constituencies see the silver lining:  As Bloomberg reports today, Prime Minister Fumio Kishida’s administration has recently abandoned a pledge to balance the budget by the fiscal year ending in March 2026.  That comes on the heels of a ¥132 trillion ($984 billion) stimulus package unveiled this spring featuring subsidies to gasoline wholesalers, along with direct payments to lower income citizens. With Japanese government debt already footing to 257% of last year’s GDP (more than double that of the U.S. and EU), de minimis borrowing costs are all but essential. “The BoJ has already become a part of debt management policy from the government’s point of view,” Ryutaro Kono, chief Japan economist at BNP Paribas, told Bloomberg. “Yield curve control makes policy makers wrongly assume that the cost of spending is zero.” 
 
Indeed, the costs of Japan’s singularly easy monetary stance could be set to ripple far and wide. Namely, the prospect that persistent yen weakness could force export-heavy China to devalue the renminbi in response looms as a financial wild card (recall the tumult that followed Beijing’s surprise August 2015 currency debasement). “If we see Japan sticking to yield curve control and we see bond yields continuing to rise in the U.S., this kind of momentum and the fallout could create real problems in Beijing,” Jim O’Neill, erstwhile chairman of Goldman Sachs Asset Management turned chair of Chatham House, told Bloomberg today. “The parallels to the Asian financial crisis are perfectly obvious and it would be perfectly rational for China to intervene [in the currency market] with its own economy weak right now.” 
 
The old Goldman hand might be on to something.  See the analysis “No market is an island” in the April 1 edition of Grant’s Interest Rate Observer for more on this critical topic.  A prediction: “’Currency wars,’ the phrase bandied so freely around 2015, may at last prove descriptive.” 
QT Progress Report
Reserve Bank Credit held steady following last week’s $22 billion decline, with interest-bearing assets on the Fed balance sheet remaining at $8.9 trillion to sit 138% above its fall 2019 level. 
Recap June 9
Stocks absorbed aggressive selling pressure ahead of tomorrow’s CPI data, with the S&P 500 nose-diving from near unchanged at lunchtime to finish 2.4% lower, leaving the broad index roughly 3% above its year-to-date lows.  Treasurys finished flat to slightly weaker, with the two-year yield rising five basis points to 2.83% and the long bond holding at 3.18%, five basis points below the multi-year highs reached last month, while WTI pulled back to $121 per barrel and gold finished at $1,851 an ounce. The VIX took todays selloff in stride, rising two points to 26, still near the lower end of its one-month range.   
 
- Philip Grant
06.07.2022
Watch and Burn
Patience is often a virtue.
Patience is often a virtue. Total assets across Cathie Woods’ Ark Investment Management’s suite of nine exchange traded funds were whittled down to $15.3 billion as of June 1, Bloomberg relays, off a cool 48% from the start of 2022. That marks the largest such decline among the 25 largest domestic ETF issuers.  Assets at the flagship Ark Innovation ETF (ticker: ARKK) slumped to $8.5 billion last Wednesday, down from $16 billion at year-end and roughly $28 billion as the Covid-era tech boom reached its first climax in February 2021. 
 
Instructively, price drawdowns, rather than investor outflows, have driven that downshift, as the Ark funds have attracted a net $167 million this year. Needless to say, that fact represents an impressive feat of marketing and name recognition (ARKK is down 54% this year, compared to “just” 23% for the Nasdaq 100), from true believers and skeptics alike.  
 
“Diehard Cathie Wood loyalists, ‘disruptive tech’ bottom fishers, and ETF shares being created for short sellers are all helping to staunch outflows,” Nate Geraci, president of advisory firm The ETF Store, told Bloomberg. “It seems that one or more of these groups will have to throw in the towel before Ark experiences meaningful outflows.”
Rise and Whine
The worm turns, sharply.
The worm turns, sharply.  Nationwide commercial property sales registered at a mere $39.4 billion in April, The Wall Street Journal reports, citing data from MSCI Real Assets, down 16% from the year-ago period.  That decline marks a jarring course shift, as property transactions had enjoyed year-over-year growth for 13 consecutive months as the pandemic ebbed, including a 57% jump in March from its comparable 2021 level. 
 
“To have it go from a very fast pace of growth the month before – the speed of that transition is shocking,” Jim Costello, chief economist at MSCI Real Assets, remarked to the Journal.  As volumes typically lead price in the fragmented and illiquid real estate sector, that stark reversal in activity augurs no good things. Sure enough, Green Street’s Commercial Property Price Index logged a 1.2% sequential decline last month, its first drop since the virus ran roughshod in 2020. 
 
A two-fronted financial assault has combined to put the crimps on the heretofore booming U.S. property market, as rising interest rates have constrained the ability of would-be buyers to finance their deals.  At the same time, lenders have begun to tighten their own purse-strings, particularly for more speculative projects, as financial markets wobble. 
 
Increasingly-frequent busted deals underscore the shifting state of play. Joshua Campbell, senior vice president at commercial real estate brokerage Stan Johnson Co. relays that interested parties who had written letters of intent are having second thoughts. “That was not happening two or three years ago,” he noted to the WSJ. 
 
Others are walking away outright.  Innovo Property Group recently abandoned a deal to purchase a midtown Manhattan office building for $855 million, eating a $35 million deposit in the process. 
 
Unwelcome trends are likewise visible on the residential side.  As industry consultant Mike DelPrete notes on his eponymous website today, transactions per agent at brokerage heavyweight Compass slipped below two during the first three months of the year.  Well off the peak of nearly three per head in the spring of 2021, the first quarter figure represents a 10% year-over-year decline and sits not far above the first quarter of 2020, famously a less-than fruitful stretch for the economy. 
 
Coming on the heels of a dizzying price appreciation, the unscripted rise in rates is wreaking havoc across the rental market realm. Average capitalization rates, or net operating income as a percentage of price, sank below 5% in the first quarter, data from CBRE Group show, down from upwards of 6% in the middle of last decade and 5.5% as the bug rolled in. David Brickman, CEO of NewPoint Real Estate Capital, relayed to the Journal on May 24 that such capitalization rates have since reached as low as 3.5%, leaving investors well underwater as mortgage rates tick north of 4.5%. 
 
How to make sense of the rapidly changing conditions within a cornerstone of the real economy?  See “Don’t ask, don’t sell” for a look at the sharp rise of non-traded real estate investment trusts and the implications therein, along with “Higher and wider” an analysis of skyrocketing prices for so-called interest rate caps (i.e., derivatives designed to protect lenders against credit risks stemming from rising mortgage rates), each within the most recent issue of Grant’s Interest Rate Observer dated May 27. 
Recap June 7
A second profit warning in the last three weeks from retail bellwether Target Corp. didn’t stop the bulls, as stocks rallied by some 1% across the major indices to narrow 2022 losses on the S&P 500 and Nasdaq 100 to 13% and 22%, respectively. Treasurys enjoyed a bull flattening bounce following yesterday’s weakness, with the long bond dropping six basis points to 3.13%, while gold ascended to $1,855 an ounce and WTI crude tested $120 per barrel.  The VIX sank to 24, marking its most placid finish in six weeks.  
 
- Philip Grant
06.06.2022
The Best Laid Plans
On second thought:
On second thought: This morning, business software firm Anaplan announced a reworked deal with Thoma Bravo, with the private equity firm cutting the size on its planned leveraged buyout to $10.3 billion, a 3.4% discount from the originally agreed-upon price.  
 
Those re-negotiated figures resulted from an unspecified dispute over the target’s adherence to the terms of the transaction, with Thoma Bravo contending that its prospective portfolio company had not fulfilled the necessary obligations to consummate the deal. 
 
For its part, “Anaplan’s position is that it acted at all times in good faith in compliance with the merger agreement and that Thoma Bravo remained at all times obligated to close the original merger agreement according to the original terms,” the company responded today.  Ultimately however, the board opted to acquiesce to the slimmed-down price tag “to avoid the risk of lengthy litigation over the disagreement, provide increased closing certainty for its stockholders and close on substantially the same timeline as originally agreed between the parties.” 
 
The board’s willingness to play ball is understandable, considering the revised bid still represents a 41% premium to the software firm’s volume-weighted average share price over the five days prior to the LBO announcement on March 20, while price action this year in publicly-traded software firms hasn’t exactly argued for fancy deal multiples.  
 
Yet vestiges of the grand Covid tech bull market remain firmly intact, as financial innovation helps grease the wheels for that buyout. The private equity giant will help finance the deal for unrated Anaplan (which has lost money on an adjusted Ebitda basis in each year since at least 2016) via a so-called recurring revenue loan calibrated on the company’s top-line prowess (sales registered at $592 million over the 12 months through Jan. 31, up more than 100% from three years ago) rather than cash flow generation.  
 
That relatively newfound practice coincides with the ascent of private credit deals, or loans marketed to nonbanks for borrowers who might struggle to secure more conventional sources of financing. Data service Direct Lending Deals finds that 25 leveraged buyouts featured at least $1 billion in private funding last year, compared to just four in 2020.  Thoma Bravo helped bankroll all but three of its 19 deals undertaken last year via the private credit route. “The private debt market gives us the flexibility to do recurring revenue loan deals, which the syndicated market currently cannot,” Erwin Mock, Thoma Bravo’s head of capital markets, told Reuters. 
When the Circus Comes to Town
Never a dull moment.
Never a dull moment. Tesla CEO Elon Musk had yet another weekend to remember on social media, taking to Twitter on Saturday to declare that corporate headcount at the electric vehicle mainstay “will increase” while salaried positions “should be fairly flat.”  That comes some 24 hours after Musk reportedly told Tesla executives to prepare for layoffs equivalent to 10% of the firms near 100,000 global payroll and a freeze on further hiring, citing a “super bad feeling” over the state of the economy.  
 
Musk’s 180 follows a stark response to that leaked communique, which may signal “looming demand deterioration” for the electric vehicle industry writ large, analysts at Deutsche Bank wrote. Tesla shares absorbed a 9.2% selloff Friday, erasing $80 billion in market capitalization and extending year-to-date losses to 22%.  
 
Strategic whipsaws aside, Mr. Market continues to carry the torch for Musk and Co.  As data compiled by AllStarCharts and Kalish Concepts show, Tesla’s $750 billion market cap is equivalent to half that of the entire energy sector.  That ratio is down from a peak of 120% as the Nasdaq crested late last year, but is 10 times its pre-virus relative valuation.  Tesla shares command a multiple of 6.5 times Wall Street’s consensus revenue estimate for 2023, while legacy peer Ford Motor Co. trades at six times next year’s projected net income.  
 
Meanwhile, Musk’s quixotic quest to acquire Twitter takes another turn, as the Tesla boss today complained in a 13D filing that the social media platform is “actively resisting and thwarting his information rights” by withholding data on spam accounts and reiterated a threat to walk away from the pending $44 billion deal entirely.  
 
That salvo comes a month after Musk announced $7.2 billion in financing commitments from outside
investors to facilitate the Twitter purchase, including $500 million in equity capital from Binance.  The crypto exchange, which garnered a $4.5 billion valuation in a funding round earlier this spring, contends with its own public relations “challenges.” A report from Reuters today finds that “hackers, fraudsters and drug traffickers,” including an entity supporting North Korea’s nuclear weapons ambitions, have illegally laundered at least $2.35 billion through Binance over the last five years.
Recap June 6
Pronounced weakness in “super safe” Treasurys highlighted today’s trading, as the complex sold off across the board with the benchmark 10-year yield jumping above 3% for the first time in nearly a month. An early rip higher in stocks mostly didn’t last, as gains were whittled back to about 30 basis points on the major indices in a particularly quiet session (trading volumes on the SPDR S&P 500 ETF Trust were the lowest of 2022). WTI crude held at $119 a barrel, gold consolidated at $1,844 an ounce and the VIX remained at 25. 
 
- Philip Grant
06.03.2022
Ground Swell
“We haven’t had a refinery built in the United States since the 1970s,” declared Chevron CEO Mike Wirth on Bloomberg Television today. “My personal view is there will never be another new refinery built in the United States,”.
 
Wirth went on to explain the industry’s predicament: “You’re looking at committing capital 10 years out, that will need decades to offer a return for shareholders, in a policy environment where governments around the world are saying: we don’t want these products.” 
Rain Dance
A pair of southbound vessels converge:
A pair of southbound vessels converge: Bloomberg chief equity strategist Gina Martin Adams relays today that the price of the Refinitiv Venture Capital Index crossed below the Nasdaq Composite yesterday, marking its first such price discount since 2018.  As recently as mid-November, that v.c. gauge traded at a 40% premium to the tech-heavy index of public firms, which has itself since fallen 23.5%.  
 
Suffice it to say, treetop valuation data don’t quite reflect that dire state of affairs.  Average valuations for late-stage v.c.-backed firms reached $120 million in the first quarter, data from PitchBook show, up from $105 million during 2021 and double the pre-pandemic mean.  Similarly, early stage firms enjoyed an average $67 million price tag over the three months through March 31, up from $45 million last year and $23 million in 2019.  
 
Of course, the dramatic deterioration in public market conditions renders those sunny first quarter marks positively archaic. “The narrative has gone from rapid growth toward fearing for an imminent collapse,” Cameron Stanfill, venture team lead at PitchBook, wrote yesterday. 
 
Captains of industry are similarly bracing for a rough road ahead. “The era of being rewarded for hypergrowth at any costs is quickly coming to an end,” v.c. mainstay Sequoia Capital warned in a presentation last month. 
 
Such a development would be no good news for SoftBank Group Corp., progenitor of the $100 billion Vision Fund and recipient of the dubious distinction “epitome of the cycle” in the Dec. 15, 2017 edition of Grant’s Interest Rate Observer. Last month, SoftBank disclosed a ¥1.71 trillion ($13.2 billion) annual loss over the 12 months through March 31, as its in-house v.c. arm absorbed a ¥3.5 trillion red-ink gusher over that stretch. Tellingly, 83% of the Vision Fund’s full fiscal year loss took place during the first three months of 2022.  Net asset value at the fund slipped to ¥18.5 trillion, down 28% from March 2021 and 16% from the average during the prior two years, before the bull market went into overdrive. 
 
As might be expected, those horrid results caught the c-suite’s attention. “When it rains, you open an umbrella,” CEO Masayoshi Son reasoned, by way of explaining a shift towards a more cautious corporate stance. Indeed, balance sheet quality is improving, at least by the company’s lights: Softbank’s self-calculated loan-to-value ratio declined to 20.4% on March 31 from 21.6% three months earlier. That metric, reflecting net borrowings as a percentage of the equity value of its holdings, remains comfortably below Masa’s self-imposed 25% ceiling during “normal times.” 
 
Other observers aren’t so sure. CreditSights, which adds asset-backed financing such as margin loans to net debt and also reflects a 30% capital gains tax rate on SoftBank’s Alibaba stake in its calculations, pegs LTV at 46.5%, up from 43.6% on Dec. 31 and 34% in mid-2021. 
 
The bond market expresses its own concerns. SoftBank’s double-B-plus-rated, senior secured 5 1/4% notes due 2031 last changed hands at a 468 basis point spread over Treasurys.  That’s wide of even the 439 basis point pickup on offer for the single-B-rated portion of the Bloomberg U.S. High Yield Index. 
 
SoftBank cancelled a planned sale of five-, seven- and 10-year yen-denominated notes on Monday, citing adverse market conditions. “We’ve been hoping to issue bonds with the same levels of tenors and amounts that we’ve been selling in the past, but we weren’t able to find a fine balance in costs this time,” spokeswoman Rika Takahashi told Bloomberg. “We have enough funds for the time being, so it’s not like we need funds immediately.” 
 
Sooner might be better than later. On Tuesday, Moody’s Investors Service sliced its outlook for SoftBank’s credit to “negative” from “stable” thanks to declining net asset value, in tandem with rising leverage.  In particular, the failure of SoftBank portfolio company Arm to merge with peer Nvidia following regulatory resistance “showcases the challenges around quickly realizing full value for such stakes” within the Vision Fund.  With equity prices in retreat, SoftBank’s subsequent attempt to list Arm in the public market “faces execution risk in the timing and valuation,” the rating agency cautioned. 
 
Not that that feedback was particularly appreciated.  By way of response, SoftBank reiterated a longstanding request for Moody’s to withdraw its rating, as the rating "is based on their subjective assumptions and hypotheses with no reasonable basis for support.” 
 
A motto fit for the perhaps-bygone bull market.
Recap June 3
A better than expected reading of May non-farm payrolls was no good news for asset prices, as stocks came for sale to the tune of 1.6% on the S&P 500 and 2.5% on the Nasdaq 100, leaving each in the red by about 1% for the holiday shortened week after last week’s streak-busting rally. Treasury yields edged higher across the curve with the long bond settling at 3.11%, its most elevated finish since May 17.  WTI crude pushed above $120 per barrel to close within $4 of its March 8 peak, gold retreated to $1,853 an ounce after logging a near-one-month high yesterday, and the VIX stayed put below 25 despite the selloff in stocks. 
 
- Philip Grant
06.02.2022
Space Invaders
Crypto exchange Gemini will lay off some 10% of its staff,
Crypto exchange Gemini will lay off some 10% of its staff, co-founders Cameron and Tyler Winklevoss announced in a blog post this morning addressed to their “fellow astronauts.” The move will impact upwards of 100 employees. 
 
It’s been a swift return to earth for eight-year-old Gemini, which achieved a $7.1 billion valuation in a mid-November fundraising round, 10 days after the price of bitcoin reached its high-water mark near $68,000.  
 
With the price of the preeminent crypto now stuck near $30,000 and high-profile meltdowns like the Luna “stablecoin” bedeviling the digital currency sector, a “crypto winter,” now looms in the form of a “sharp contraction” on the heels of the recent “dramatic [period] of hypergrowth,” the Winklevii twins wrote today.  On the bright side, the current retrenchment will “settle down to a new equilibrium that is higher than the one before,” the blog contended. 
 
Be that as it may, regulatory scrutiny of the “space” appears to be settling into a higher equilibrium of its own.  This afternoon, the Commodity Futures Trading Commission announced it will sue Gemini for allegedly making “false or misleading statements” back in 2017 regarding the ease with which bitcoin futures prices could be manipulated. In particular, Gemini allegedly claimed that it required all crypto transactions to be fully pre-funded, but instead freely loaned bitcoins and even provided advances to help facilitate trading volumes.
 
By way of response, a Gemini spokesperson told Coindesk that “we have an eight-year track record of asking for permission, not forgiveness, and always doing the right thing. We look forward to proving this in court.”
Loan to Groan
Time for some credit market scoreboard watching:
Time for some credit market scoreboard watching:  As the stock market undertook a dramatic rally last week to halt a seven-week losing streak on the S&P 500, corporate bonds across the quality spectrum followed suit.  According to data from CreditSights, investment-grade spreads finished last month at 140 basis points over Treasurys, well inside the 155 basis points reached on May 21 and little changed from the end of April. That drove a 0.6% total return for May, narrowing year-to-date losses for the asset class to 11.9%. 
 
Similarly, junk bonds rode a late May reversal to finish the month in the black with a 0.3% return, as spreads finished at 422 basis points, down from a near 500 basis point peak on May 25, to trim the five-month loss to 7.8%. However, a whiff of credit concern was apparent within that broad category.  The double-B-rated section of the market (the penthouse of high-yield) enjoyed a 1.6% return in May, while the highly speculative, triple-C-rated cohort lost a hefty 3.2%.
 
That migration toward relative safety could augur ominous tidings for the heretofore rock-solid leveraged loan market. S&P/LSTA’s gauge of that speculative-grade, tradable, floating-rate bank debt absorbed a minus 2.56% return in May. As LCD noted yesterday, that loss surpassed December 2018 to mark the third-worst monthly showing since the financial crisis and the ninth worst on record dating back to 1997. Then, too, “uncharacteristic volatility” reigned, as the index rose or fell by at least 0.2% on 18 different occasions and logged seven separate one-day moves of at least 0.4%. That divergence is particularly notable considering loans managed to ride out the first four months of the year largely unchanged, as the fixed-rate bond market came under uniform pressure. 
 
Concerning fundamental developments color May’s notably poor price action. An analysis last week from S&P Global found that, among public filers within the LSTA Leveraged Loan Index, rolling 12-month Ebitda jumped 27% year-over-year through the first quarter, the best such gussied-up bottom-line growth rate since early 2005.  Yet despite that windfall, average debt levels rose to 5.59 times Ebitda on a weighted basis from roughly five turns of leverage in the middle of last year, an ominous sign if that earnings gusher recedes.  
 
Perhaps more concerningly, the share of issuers sporting at least seven times leverage (a figure typically connoting a dangerously encumbered balance sheet) reached 22.8% as of March 31, up from 16.4% six months earlier.  Similarly, 18.7% of LSTA components generated cash flows of less than 1.5 times interest expense in the first quarter, more than double the 9% walking that interest coverage tightrope as of Sept. 30. 
 
You are what your record says you are. 
Recap June 2
The bulls remained in the saddle today, as the S&P 500 jumped nearly 2% to push back into positive territory for the week and leave the broad index at its highest since early May. Treasurys held steady after yesterday’s front end-led selloff, as the long bond remained in the upper end of the 2.97% to 3.09% yield range in force over the past two weeks.  Gold rallied to $1,873 an ounce for a near one-month high, WTI crude reached $117 per barrel to approach its early-March cycle peak, and the VIX finished south of 25 for the first time since  April 21.
 
- Philip Grant
06.01.2022
Field of Dreams
If you build it, never mind.
If you build it, never mind. Bloomberg reports today that the Impact Shares MSCI Global Climate Select ETF (ticker NTZO), which was launched last fall in tandem with the United Nations’ COP26 summit in Glasgow, has since gathered a measly $3 million of assets, a fraction of the $100 million sum needed to cover administrative costs.  Barring a miraculous cash influx by the end of the month, the fund is facing liquidation, Ethan Powell, founder of Impact Shares, warns. 
 
NTZO, which tracks the MSCI ACWI Climate Pathway Select Index and aims “to maximize exposure to companies that can potentially benefit from opportunities arising from the transition to a lower-carbon economy and increase exposure to companies that are setting science-based emission reduction targets or commit to reduction targets,” is off 15.4% in the year-to-date through yesterday, compared with the S&P 500’s 13.5% drop.  
 
As the ETF launched last year with the backing of the U.N.’s Global Investors for Sustainable Development Alliance, a collective of 30 captains of industry controlling an aggregate $16 trillion in assets, that paucity of financial commitment leaves some sponsors thoroughly vexed. “I’m discouraged that you get these high-profile companies and the CEOs involved in an organization that they say trumpets $16 trillion of firepower, and they didn’t contribute a dime,” Jim Healy, former Credit Suisse banker turned initial investor in the fund, lamented to Bloomberg. “It’s a failure of collective action.”
 
On the bright side for NTZO backers, misery loves company. Investors pulled an aggregate $2 billion from equity-focused ESG funds last month, data from Bloomberg show. Not only is that the largest monthly outflow on record, but it marks the first such net withdrawal in any month since early 2019. Yet even that downshift represents a drop in the bucket; upwards of $68 billion has poured into the ESG realm over the past two years. 
 
Enhanced government scrutiny may crimp additional fundraising efforts.  Yesterday, German police raided the offices of Deutsche Bank and its DWS asset management arm as part of an investigation into so-called greenwashing, or making false claims over the environmental bona fides of various investment products.  
 
That probe, similar to a stateside undertaking from the Department of Justice, reportedly focuses on allegations made by former global head of sustainability Desiree Fixler, who alleged last year that while DWS claimed €459 billion ($487 billion) in ESG integrated assets under management in its 2020 annual report, an internal audit revealed prior to publication that ESG compliant assets represented “only a small fraction” of that sum. Sure enough, DWS reported just €115 billion in “ESG assets” in its 2021 annual report, or a quarter of the previous year’s total.  
 
In fairness, the criteria for sustainability remain something of a moving target. An analysis last month from the Review of Finance found that correlations between ESG ratings from a quintet of agencies ranged from 0.38 to 0.71. That’s well below the 0.92 correlation between credit ratings assigned by Moody’s, S&P and Fitch.  
 
Beyond the inherent subjectivity within the category, shifting market conditions have yet to cover the nascent asset class in glory. Among the 556 ESG funds tracked by Morningstar, only four showed a positive performance over the first four months of the year and the cohort lagged the non-ESG indices they track by an average of 2.67% through April 30.  What’s more, ESG funds charge 65 basis points in annual fees on average, Morningstar finds, compared to a 41 basis point expense ratio for the average non-ESG ETF. 
 
Even dyed-in-the-wool sustainability true believers are having second thoughts. On May 10, BlackRock’s Investment Stewardship office released a paper previewing its planned shareholder votes for 2022.  While the investment behemoth, which counted nearly $10 trillion in assets as of March 31, voted in favor of 47% of ESG-focused shareholder proposals last year, the firm is “likely to support proportionally fewer this proxy season than in 2021, as we do not consider them to be consistent with our client’s long-term financial interests.” In particular, initiatives which “implicitly are intended to micromanage companies,” will now get the thumbs-down, as will “those that are unduly prescriptive and constraining on the decision-making of the board or management, call for changes to a company’s strategy or business model, or address matters that are not material to how a company delivers long-term shareholder value.” 
 
That measured approach stands in marked contrast to the sweeping proclamations found in BlackRock CEO Larry Fink’s 2020 letter to his c-suite colleagues (emphasis in original): 
 
Climate change has become a defining factor in companies’ long-term prospects. Last September, when millions of people took to the streets to demand action on climate change, many of them emphasized the significant and lasting impact that it will have on economic growth and prosperity – a risk that markets to date have been slower to reflect. But awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance.
 
Indeed, climate change is almost invariably the top issue that clients around the world raise with BlackRock. From Europe to Australia, South America to China, Florida to Oregon, investors are asking how they should modify their portfolios. They are seeking to understand both the physical risks associated with climate change as well as the ways that climate policy will impact prices, costs, and demand across the entire economy.
 
These questions are driving a profound reassessment of risk and asset values. And because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself. In the near future – and sooner than most anticipate – there will be a significant reallocation of capital.
 
As ever, markets make opinions. 
Recap June 1
Stocks trended south for a second day to start the holiday shortened week, though afternoon strength mitigated the pain as the S&P 500 and Nasdaq 100 each lost about 0.8%.  Treasurys meanwhile saw pronounced bear flattening as the two-year yield leapt to 2.66% from 2.53% yesterday while the long bond edged higher by two basis points to 3.09%. WTI crude held just below $115 a barrel, gold rallied to $1,850 an ounce and the VIX retreated below 26.  
 
- Philip Grant
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