Fall Fashion

Call it the not-so-nifty 50:  An even 10% of S&P 500 components logged a 52-week low yesterday, relays Charles Schwab chief investment strategist Liz Ann Sonders. That’s the highest such share since October 2022, as last year’s selloff reached its climax. 

Though the broad average sits lower by nearly 5% for the month with one session remaining, recent seasonal trends burnish the suddenly beleaguered bull crowd. Over the three years through 2022, the S&P 500 has followed an average 6% September decline with a 9.8% advance over the final three months of the year per Bespoke Investments.

Over the Handlebars
SoftBank Group Corp. is set to pour upwards of $1 billion into an Open AI-backed

SoftBank Group Corp. is set to pour upwards of $1 billion into an Open AI-backed startup aiming to produce the “iPhone of artificial intelligence,” the Financial Times reports.  Discussions on the nascent consumer products enterprise, which include iconic Apple hardware designer Jony Ive, have reportedly featured SoftBank CEO Masayoshi Son angling for a heavy role for his firm’s 90% owned chipmaker Arm, which floated a $5 billion IPO on the New York Stock Exchange on Sept. 14. 

Negotiations between the parties “are said to be ‘serious,’” the pink paper relays, though a formal announcement could be months away, while “the process of identifying a design or device [to sell] remains at an early stage with many different options on the table.” 

Today’s bulletin was long in the making, as SoftBank’s boss vowed an AI-centric “counteroffensive” in June following a lengthy corporate retrenchment, including an ill-timed 2019-era sale of a $3.6 billion stake in industry lynchpin Nvidia, which has since returned some 1,100%. Son’s renewed push into the groundbreaking technological realm, of course, comes with plenty of company: OpenAI is in talks to raise capital at a valuation of as much as $90 billion per The Wall Street Journal, which compares to a $29 billion price tag logged in a late April funding round.

More broadly, this year’s tech-led rebound in asset prices has likewise provided a lift to SoftBank – long deemed the epitome of the cycle by Grant’s Interest Rate Observer (Dec. 15, 2017) – and its Vision Fund in-house venture capital division, which absorbed a whopping $32 billion loss over the 12 months through March. The firm managed to list two of its portfolio firms in recent weeks: Arm shares enjoyed a 35% first day trading pop, remaining some 7% above the listing price (which itself represented the top end of the underwriter’s range) following a recent pullback. On the other hand, last month’s debut of online mortgage lender Better Holdings via a special purpose acquisition company has proven less than remunerative for public investors, with Better shares languishing below $0.50 from as high as $17 just before the blank-check merger.

Tellingly, perhaps, those moves elicited a mere golf clap from the rating agencies. S&P Global affirmed SoftBank’s double-B rating last week while revising its outlook to positive, stopping short of the company’s hoped-for upgrade from its perch near the penthouse of junk. In an interview with the FT last Friday, SoftBank CFO Yoshimitsu Goto declared himself “deeply disappointed” in S&P, declaring that “it’s completely mind-boggling why there is no upgrade” and grousing that S&P doesn’t “trust our management in terms of financial discipline or investment policy.”  

Capital market machinations color the finance chief’s evident dismay, as Bloomberg reported Monday that SoftBank’s telecommunications unit is seeking to issue ¥120 billion ($800 million) of so-called bond type class shares, or debt-like securities that will trade on the Tokyo Stock Exchange, to retail investors in Japan.

Christopher Whalen, publisher of the Institutional Risk Analyst, pointed to that prospective debt offering as potential evidence that the equity tap has run dry for Son et al., while mincing no words on the S&P dustup: “Most reasonable people don’t trust SoftBank’s management because of the firm’s very apparent lack of internal systems and controls,” adding thus: “So much of the image of success used by SoftBank to raise billions in private [capital] in past years was predicated on the illusion of value in a zero-interest rate environment. In today’s market, however, we think risk managers and investors ought to ask themselves whether the public behavior of SoftBank’s executives deserves to be met with confidence or terror.”

QT Progress Report
Reserve Bank credit slipped by $23 billion from a week ago, leaving interest-bearing assets on the Fed balance sheet at $7.98 trillion.  That’s down nearly 11% from the high-water mark early last year, and represents the first sub $8 trillion weekly reading since June 2021. 
Recap Sept. 28

Bondholders finally got some relief as Treasury yields dipped lower across the curve, with the long bond settling at 4.71% from 4.73% Wednesday, while stocks also caught a solid bid with the S&P 500 up a bit more than half a percent, though the broad average did finish well off its best levels of the day.  WTI crude likewise took a breather, pulling back below $92 per barrel, gold tumbled to $1,866 an ounce and the VIX retreated to 17. 

- Philip Grant

Decentralized Booking

The devolution will be televised. From CoinDesk:

Crypto influencer Ben Armstrong has been released on bail after he was arrested during the late hours of Monday after an apparent confrontation with his former business partner, part of which was live streamed on X, formerly Twitter.

An online record at the Gwinnett County Sheriff’s Department site shows one "Benjamin Charles Armstrong" was arrested for "loitering/prowling" and for "simple assault by placing another in fear" with a bond amount of $2,600. Armstrong was apparently carrying a gun in the backseat of his car, and was traveling with one other person, a live-stream snippet on X indicated.

BEN tokens, floated by Armstrong earlier this year, dropped 30% as reports of the arrest leaked early on Tuesday.

Indication of Interest
How many happy returns, exactly?

How many happy returns, exactly? Tuesday marks an even two months since the effective Fed Funds rate topped 5% for the first time in the post-Lehman era, with the prospect of even higher borrowing costs looming as an unsettling possibility (JPMorgan boss Jamie Dimon floated the possibility of 7% benchmark rates to the Times of India this morning).  As the following trio of examples demonstrate, various constituencies are adapting to the constrictive current backdrop in their own way: 

Investment-grade firms are increasingly turning to the convertible bond market, issuing some $12 billion’s worth so far this year according to Bank of America, accounting for more than 30% of total supply for the category. That’s the highest such share in at least a decade, up from just $2 billion and 7% of total convertible issuance during all of 2022, as the contraptions are typically confined to the purview of junk-rated borrowers.  

Convertibles, which can be swapped for stock if the issuer’s share price reaches a predetermined level, allow issuers to borrow more cheaply thanks to that optionality. “Investment-grade companies need to save on coupons as well,” Bank of America strategist Michael Youngworth tells the Financial Times today, adding that convertibles can generally be sold with coupons two to three percentage points lower than conventional bonds. “They’re obviously plagued by the same higher financing cost backdrop that high-yield companies are.” 

Lacking such creative recourse, individual borrowers are suffering collective sticker shock. Fixed 30-year mortgage rates now average 7.75% per Bankrate.com, compared to less than 3% in early 2021, helping push the National Association of Realtors’ Housing Affordability Index to four-decade lows.  The median American household will likewise need to cough up 42 weeks of income to buy a new car as of August, reckons Moody’s chief economist Mark Zandi, up from 33 weeks’ worth three years ago.  New home and vehicle purchases are now “completely unaffordable for the typical American household because you’re mixing the higher borrowing costs with the higher prices,” Zandi told The Wall Street Journal.

Considering that dynamic, it is little surprise that nationwide credit card balances topped $1 trillion for the first time during the second quarter, according to the data from the New York Fed, up from less than $800 billion during the pandemic. That’s despite the fact that the average credit card carried a 20.7% interest rate in May, compared to 14.6% right before the Fed began its aggressive, belated tightening cycle early last year. Total non-housing related household debt reached a record $4.71 trillion as of June 30, up 12.2% over the prior two years. 

Investors, meanwhile, contend with the ongoing regime change in their own way. Bloomberg’s Eric Balchunas relays today that, over the past week, the iShares 20 Plus Year Treasury Bond ETF (ticker: TLT) gathered $750 million in assets, bringing its net inflow during the year-to-date to $16.3 billion, equivalent to nearly half of the vehicle’s $38.2 billion in total assets.  

That’s despite the fact that TLT wrapped up today’s session at its weakest closing price in a dozen years, down nearly 50% from its August 2020 high-water mark. Terming that relentless dip-buying “amazing,” Balchunas marveled on X that he “can't recall an ETF taking in so much money while being down so much and so consistently.”

Who said hope isn’t a strategy?

Recap Sept. 26

Stocks were hammered to the tune of a 1.5% drop on the S&P 500, as the broad average logged its lowest finish since early June, while the pain in Treasurys continued with the long bond reaching another cycle high at 4.7%, up three basis points on the session. WTI crude climbed back above $90 a barrel, gold retreated to $1,901 per ounce and the VIX popped to a four month high near 19.  

- Philip Grant

Magic Eye

Who needs NFTs anyway?  From CBS News last Wednesday:

In 2021, a Danish artist was given $84,000 by a museum to use in a work of art – and he found a clever and devious use for the cash: He pocketed it. Instead of using the money in his work, Jens Haaning turned in two blank canvases, titling them "Take the Money and Run." A court in Copenhagen ruled this week he has to pay at least some of it back.

The Kunsten Museum of Modern Art in Aalborg, Denmark had asked Haaning to update two of his previous works, which used actual money to show the average incomes of Denmark and Austria, the museum said in a news release. . . But Haaning refused to turn in the money, according to BBC News. And after a long legal battle, the artist was ordered to refund the court 492,549 Danish kroner – or $70,623 U.S. dollars. 

The sum is reduced to include Haaning's artist fee and the cost of mounting the art, according to BBC News.

Careful Discretion
Shop till you drop, writ large:

Shop till you drop, writ large: Minneapolis Fed president Neel Kashkari sang the praises of the indomitable U.S. consumer late last week, remarking thus in an address to the Economic Club of Minnesota: “I would have thought [that] with 500 basis points or 525 basis points of interest rate increases, we would have slammed the brakes on consumer spending, and it has not slammed the brakes on consumer spending. It continues to exceed expectations.”

Mr. Market has likewise given the resilient retail cohort its due, as the S&P 500 Consumer Discretionary sector bounded higher by 35% in the year through mid-September, comfortably topping the 16% gain for the S&P 500 itself.  Yet investors are reappraising that bullish verdict, as the segment absorbed a 6.3% decline over the five days through Friday, more than double that for the broader index.

Might that shifting dynamic signify more than a short-term blip? “This price action is picking up on slowing consumer spend, student loan repayments resuming, rising delinquencies in certain household cohorts, higher gas prices and weakening data in the housing sector,” contends Morgan Stanley strategist Mike Wilson. 

A separate Wall Street sentiment gauge lends credence to that view, identifying widespread angst over the end of the Covid-induced student loan holiday. A Jefferies poll this month of more than 600 U.S. consumers with outstanding student loan balances shows that nearly 90% of respondents “are at least somewhat concerned about meeting all of their monthly expenses, [with] apparel, footwear, accessories, restaurants and big-ticket items” among the categories most exposed to a retrenchment in spending.  Sure enough, the Capitol Forum relays that “demand for used vehicles sold by several online retailers has declined significantly over the past month.” 

The prospect of exhausted pandemic-era nest eggs for large swaths of the populace could amplify that dynamic. Thus, real household savings within the middle class – defined as those within the 40th to 80th wealth percentiles – dipped below their March 2020 levels at the end of the second quarter, the Federal Reserve’s newly released survey of household finances shows, while the wealthiest cohort retains an 8% inflation-adjusted increase relative to when the bug bit. As of early 2022, those excess savings figures stood at roughly 15% and 30%, respectively.  The bottom 40% of households, meanwhile, have absorbed a near 10% decline in inflation-adjusted savings since early 2020.

Recap Sept. 25

Another day, another post-2007 high for long-dated Treasury yields, as the 10-year note jumped 11 basis points to 4.55% while the 30-year bond settled at 4.67%, compared to 4.53% Friday and 4.2% at the end of August. Stocks managed to snap a four-session losing streak with the S&P 500 settling higher by 0.4%, while WTI crude stayed near $90 a barrel, gold retreated to $1,916 per ounce and the VIX edged back below 17. 

- Philip Grant

The Descent
The Conference Board’s Leading Economic Index

The Conference Board’s Leading Economic Index – which aims to capture significant turning points in the business cycle and near-term growth trajectory – fell on a sequential basis yet again in August according to data released yesterday, marking the 17th consecutive monthly downtick. 

“The leading index continued to be negatively impacted in August by weak new orders, deteriorating consumer expectations of business conditions, high interest rates, and tight credit conditions,” commented Justyna Zabinska-La Monica, senior manager of business cycle indicators at The Conference Board. “All these factors suggest that going forward economic activity probably will decelerate and experience a brief but mild contraction.”

Others express a slightly less sanguine view. Noting that the current string of declines is the second-longest on record going back to 1992, behind only 2007-2009, Société Générale strategist Albert Edwards quips thus: “It seems to me if the U.S. can avoid a bloody deep recession, it will warrant a new Christmas film entitled: ‘Miracle on Main Street.’”

Glut Feeling
Is a grand new era of electric mobility upon us?

Is a grand new era of electric mobility upon us? “Currently, there is not enough lithium hydroxide being produced in the world to power the growing electric vehicles demand,” Austin Devaney, chief commercial officer at Piedmont Lithium, Inc. told MarketWatch on Wednesday, referencing the availability of a key component in the batteries powering the burgeoning auto type.  

EVs accounted for 14% of worldwide auto sales last year according to the International Energy Agency, up from a 4% share in 2020. A 50% market penetration is in store by 2030, if IEA guesstimates are on the beam.

Yet Mr. Market plainly has his reservations. Spot lithium carbonate prices in China settled below RMB 173,000 ($23,700) a ton today from RMB 600,000 a ton in November of last year, following a near 10-fold run-up from the early 2020 lows. Global supply of the silvery-white metal will register at 990,065 metric tons this year, per estimates from S&P Global Commodity Insights, compared to 928,717 metric tons of demand. That 61,348-ton surplus, which compares to an estimated 10,061 of excess tonnage a year ago, will be followed by roughly 43,000 metric ton surplus in 2024, with the market not swinging into deficit until 2027, S&P believes. 

Meanwhile, legacy automakers are struggling to profitably integrate the mushrooming EV category into their conventional offerings. In late July, Ford Motor Co. increased projected operating losses in its electric division to $4.5 billion this year from a previously expected $3 billion shortfall, while pushing back its planned production schedule of a 600,000 annual pace to sometime next year from late 2023. “The near-term pace of EV adoption will be a little slower than expected, which is going to benefit early movers like Ford,” CEO Jim Farley commented on the analyst call. 

A mainstay of the EV revolution likewise looks to be curtailing its ambitions.  As Bloomberg documents today, Tesla’s Elon Musk conveyed a cautious tone in conversation with a senior Indonesian official at a Jakarta CEO forum on Sept. 6: “He gives a very clear message about what happened to the global economy, and concern also about the overcapacity today,” Luhut Pandjaitan, Indonesia’s coordinating minister for maritime affairs, detailed to Bloomberg. “So, they’re not going to do any expansion for the next one or two years.” Tesla’s inventory of unsold Model 3, Model Y, Model S and Model X vehicles reached 121,000 as of the end of the second quarter according to estimates from Bernstein, up from 79,000 on Dec. 31 and 23,000 at the end of 2021. 

Those headwinds aside, one giant in the lithium “space” proceeds apace with its capacity expansion plans. Earlier this month, worldwide number two refiner and miner by sales and Grant’s Interest Rate Observer pick-not-to-click Albemarle Corp. (ticker: ALB) announced a nonbinding agreement to buy early-stage, pre-revenue lithium mine developer Liontown Resources for A$6.6 billion ($4.3 billion) in cash, upsized from a previous $3.7 billion bid in March and representing a 97% premium to the target’s undisturbed share price prior to that early spring approach. Albemarle shares are off 13% from that April 7 analysis, compared to a 6% return for the S&P 500.

As miners grow their production capabilities during a dicey economic backdrop (see the item above), a major new find could further muddy the waters. A study published this month in the journal Science Advances trumpets a potential massive lithium discovery in the McDermitt Caldera volcanic lakebed straddling the Nevada/Oregon border.  The find is estimated at between 20 million and 40 million metric tons of lithium carbonate, likely exceeding the estimated 23 million tons housed in the salt flats of Bolivia, home of the world’s largest deposits.  

“If you believe [the scientist’s] back-of-the-envelope estimation, this is a very, very significant deposit of lithium,” Anouk Borst, a geologist at KU Leuven University who did not participate in the study, told Chemistry World. “It could change the dynamics of lithium globally, in terms of price, scarcity of supply and geopolitics.”  

Belated QT Progress Report
Reserve Bank credit ticked lower by a chunky $59.2 billion over the seven days through Wednesday, leaving the Fed’s holdings of interest-bearing assets at $8.003 trillion.  That’s down just over 10% from the high-water mark established in March 2022. 
Recap Sept. 22

A quiet session followed yesterday’s broad-based pain, as Treasurys managed a modest bounce across the curve with 2- and 30-year yields dropping two and three basis points, respectively, to 5.1% and 4.53%, while the S&P 500 settled slightly below unchanged. Gold edged higher to $1,925 per ounce, WTI crude rebounded above $90 a barrel and the VIX stayed above 17. 

- Philip Grant

The Incredible Bulk
Talk about skipping leg day:
Talk about skipping leg day:  The 10 largest holdings in the S&P 500 now collectively command a 30.5% share of the market-cap weighted index, Creative Planning chief market strategist Charlie Bilello relays on social media platform X.  That’s the highest such share since at least 1980 according to data from S&P Dow Jones, topping the 29.9% figure seen in 2021.  The pre-pandemic peak of market concentration stands at 25.5%, logged in 1980 as well as 1999. 
Frozen Two
"Japanification," with Chinese characteristics?

“Japanification,” with Chinese characteristics? A broad-based economic malaise appears to be setting in across the world’s second-largest economy, The Wall Street Journal posits today, as the combination of elevated debt levels, a deflating property bubble and unfavorable demographic trends conjure comparisons with Japan’s experience following the culmination of its epic asset-price run-up in the mid- and late-1980s.  

Though China’s ratio of total property value to gross domestic product peaked in 2020 at 260% according to Morgan Stanley, or less than half that logged by Japan three decades prior, total public debt in China reached 95% of output last year after accounting for off-balance sheet borrowings from local governments, per data from J.P. Morgan.  That compares to just 62% for Japan in 1991. China’s population, meanwhile, tipped into outright decline in 2022, a phenomenon first seen in Japan in 2008, nearly 20 years after the benchmark Nikkei 225 logged its blowoff top. 

Drawing a similar comparison, analysts at Goldman Sachs led by Hui Shen write that, over the past 18 months, “investment by private companies has contracted, consumer confidence remains depressed and forecasters have revised down China’s medium-term GDP growth projections notably.”  

Contending that weak overall growth expectations hampered Japan’s economy following the popping of its dual stock market and real estate bubble, the Goldman team urged Beijing to “circuit-break” mounting concerns over its economic health as China’s economy pivots from its property-focused, fixed-asset-driven growth model, primarily by “improv[ing] policy predictability and coordination to raise investment demand of private companies.” 

Indeed, there is plenty of room for improvement. Foreign direct investment declined by 5.1% year-over-year during the first eight months of 2023 according to state-compiled data, while just 52% of respondents to a recent survey from the American Chamber of Commerce’s Shanghai outpost expressed optimism over the five-year business outlook in China, the lowest reading since the poll began in 1999.  

To that end, the Chinese government rolled out the red carpet for Western firms earlier this week:  CNN reported Tuesday that the People’s Bank of China hosted a symposium attended by representatives from J.P. Morgan, Tesla and other household-name corporations, with a meeting designed to “increase financial support to help stabilize foreign trade and foreign investment” by upgrading the “investment environment” for overseas businesses, according to a joint statement from the PBOC and State Administration of Foreign Exchange.

Yet, as ever in the Middle Kingdom, economic initiatives take a backseat to other considerations. Bloomberg reported last month that staffers at BlackRock “have been called to attend lectures” on Xi Jinping Thought, or the “often-arcane” ideologies expressed by China’s strongman, who began an unprecedented third five-year term in March.  “Some bank executives and business heads have to take around a third of working time to study Xi Thought, [including] activities and courses, or reading four books from Xi every month,” Bloomberg relays, adding that attendees will be obliged to submit essays detailing what they’ve learned from the [re]-education sessions.

“Wall Street people always think that every country should put their financial sector ahead of everything else,” Zhiwu Chen, professor of finance at the University of Hong Kong Business School, told Bloomberg. “They don’t realize that over the past 10 years the Chinese Communist Party has been saying that politics should be first and foremost on everybody’s mind. Not economic benefits, not economic profits.” 


Recap Sept. 21

Avert your eyes, bulls: stocks and bonds each endured a ferocious selloff, as the 30-year Treasury yield vaulted 16 basis points to 4.56%, establishing a fresh post-2007 high while the S&P 500 fell 1.6%, finishing at its lowest levels of the day and bringing cumulative losses from Friday’s cash open to 3.5%.  Gold retreated to $1,919 an ounce, though rebounding a bit from mid-morning, WTI crude held just south of $90 per barrel and the VIX settled at 17.5, up a bit more than two points on the day. 

- Philip Grant

Five Feet High and Rising
Primary activity in high-yield

Primary activity in high-yield credit has swung into overdrive of late: companies raised nearly $10 billion across 15 tranches over the past five days per data from Bloomberg, marking the busiest one-week stretch since the virus-era bull market climaxed in November 2021.  

Those newcomers received a warm welcome from Mr. Market, as all but 1 of the 15 deals that debuted this week changed hands above their respective issue price. More broadly, option-adjusted spreads on the ICE BofA U.S. High-Yield Index settled at 378 basis points Thursday, matching the tightest level since early 2022. 

Yet danger may be lurking for large swaths of the market, as this week’s hotter-than expected reading of August core CPI illustrates the potential for elevated benchmark borrowing costs to persist.  Thus, interest rate futures now price in a 4.39% Fed funds rate in January 2025, up from 3.79% two months ago.  That dynamic elicited some cautious commentary this morning from Bank of America credit strategist Oleg Melentyev: 

The Fed has no choice but to keep rates higher for longer given the inflation backdrop. The maturity wall is now a year closer, and issuers face decision time regarding what to do with their debt loads. Higher-quality names will likely choose to de-lever given their strong ability to generate cash; and lower-quality names have no other way to deal with this but to de-lever. The end result is likely less capex, hiring, M&A, and share buybacks.

We further explore our framework of fundamental impact from coupon resets in the next two years. We think that the credit market can live with a 3% CPI scenario even at current stretched valuations. A sticky 4% CPI is likely to see cumulative defaults at 10% and meaningful CCC downgrades. A re-acceleration to 5% CPI could cause a full-scale default wave.

SPAC to the Future
Where we're going, we don't need roads.

Where we’re going, we don’t need roads.  VinFast Auto Ltd.’s shares have declined by more than 50% over the past two weeks, largely reversing an eye-watering run-up that saw the Vietnamese electric vehicle firm briefly garner a $190 billion market capitalization.  Ford and General Motors, by comparison, are valued at a combined $97 billion.   

Six-year-old VinFast (ticker: VFS), which came public on Aug. 15 via a merger with special purpose acquisition company Black Spade Acquisition Co., subsequently enjoyed a near 700% 10-day rally spurred by spotty liquidity:  VFS sports a floatation of only 7.3 million shares per data from Bloomberg compared to 2.3 billion total shares outstanding, as founder Pham Nhat Vuong controls 99.7% of shares outstanding through various entities.

More supply is on the way, as VinFast registered some 11 million shares for sale in a filing with the Securities and Exchange Commission earlier this week, with the bulk of that offering coming from the exercise of warrants from the SPAC merger. 

Though public investors will soon get the opportunity to increase their share of ownership, the closely held firm’s operations remain a family affair. Barron’s relayed Tuesday that nearly two-thirds of the 11,300 vehicles that the company delivered during the first half of the year were to Vietnam-based taxi company Green and Smart Mobility, which is controlled by local conglomerate Vingroup, VinFast’s parent company.  

The peculiar dynamics at play invite ready comparisons with a bedrock of the meme stonk craze. “This is equally as comical as GameStop,” Matt Simpson, managing partner at Wealthspring Capital and an investor in blank check firms, told The Wall Street Journal. VinFast’s run-up “was completely divorced from reality.” 

Almost Daily Grant’s will resume next Thursday, 9/21. 

Recap Sept. 15

Stocks came under pressure as of mid-afternoon, when your correspondent had to leave, with the S&P 500 lower by a bit more than 1% and the Nasdaq 100 nearly 2% in the red. Treasurys failed to catch a bid as two-year yields hovered near 5.03% and the long bond at 4.41%, while WTI crude tested $91 a barrel and gold advanced to $1,925 an ounce.  The VIX bounced by 8% to approach 14 after logging its lowest finish since January 2020 on Thursday. 

- Philip Grant

Punters Delight
Cometh the hour, cometh the exchange-traded fund.

Cometh the hour, cometh the exchange traded fund. Defiance ETFs launched a new product today that writes ultra-short-dated puts on the Nasdaq 100, as the boom in zero-day options opens a new frontier.  The ETF, which sports a 99-basis point expense ratio, will sell 24 hour, at-the-money or slightly-in-the-money puts (i.e. when the option to sell is priced at or above current levels, respectively) on the tech-heavy gauge each trading day, with cash and short-term Treasurys serving as collateral.

“These ETFs exemplify our commitment to innovation and to meeting the evolving needs of investors,” Definance states in its press release. Ayako Yoshioka, senior portfolio manager at Wealth Enhancement Group, puts it a bit differently to Bloomberg: “Everybody is looking for that free money. [Zero-day options] fuel speculation.” 

Hot Rod
Having your yellowcake and eating it too:

Having your yellowcake and eating it too: Spot U308 uranium prices reached $62 per pound this week according to market data firm UxC, up some 30% in the year-to-date and touching the highest level in more than a decade. 

“There’s a shortage of uranium at a global level but it’s particularly pronounced in the Western-aligned countries,” Kevin Smith, managing director for energy metals at commodity trading firm Traxys, told The Wall Street Journal yesterday.

Lengthy cycles famously predominate for the grey metal, which peaked in 2007 near $140 a pound and was quoted at $73 as recently as 2011, before a partial meltdown in Japan’s Fukushima Daiichi plant served to crimp world-wide demand. Global uranium capital expenditures plummeted to $483 million in 2018, some 77% below the $2.1 billion in spending in 2014, while prices reached as low as $18 per pound five years ago.  The lag time between new U308 discoveries and production ranges from 8 to 15 years, while America’s first newly constructed nuclear plant in more than three decades came online this summer. 

Current supply and demand dynamics, indeed, paint a stark picture. Reactors worldwide will require nearly 130,000 tons by 2040 according to estimates from the World Nuclear Association’s newly released, biennial Nuclear Fuel Report, up from the industry group’s 112,300 guesstimate in 2021 and roughly double the current level.  For context, global supply registered at just 49,355 tons a year ago per the WNA, down 22% from 2016’s output. 

“Significantly higher prices will be required to justify large capital investments in new mine capacity,” Scott Melbye, executive vice president of mining firm Uranium Energy Corp., told MarketWatch last month. 

Recent developments suggest that stunted supply picture may persist.  Long-time Grant’s Interest Rate Observer pick-to-click Cameco Corp. (shares are up 88% from the most recent analysis on June 11, 2021, compared to a 10% total return for the S&P 500) slashed full-year production estimates at its Cigar Lake and McArthur River mines to a combined 30.3 million pounds earlier this month, an 8% downshift from its prior outlook. The world’s second-largest producer cited “equipment reliability issues,” along with supply chain and staffing snafus, for those downsized targets. 

Political risk likewise factors in, as evidenced by this summer’s coup in Niger, the source of roughly 5% of global output per estimates from Morgan Stanley. 

Meanwhile, the emergence of non-commercial buyers adds another wrinkle to the bull case, as secondary supply gradually goes by the wayside. Last week, the Sprott Physical Uranium Trust announced it will sell $125 million in shares in an at-the market offering, with proceeds earmarked for purchases of the physical commodity. Sprott now holds 61.7 million pounds of U308, up from 24 million pounds two years prior.  

Might a further upside spasm in prices be in the offing? “By the end of this year, we expect commercial inventories will be back to 250 million pounds, covering reactor demand by less than 18 months,” natural resource investors Goehring & Rozencwajg conclude in their second quarter commentary, adding that “the cumulative deficit between 2023 and 2030 will likely exceed 250 million pounds, completely depleting all commercial stockpiles.”

QT Progress Report
Reserve Bank credit crept lower by $3 billion from a week ago, leaving the Fed’s portfolio of interest-bearing securities at $8.06 trillion.  That’s 9.7% below the peak logged in March 2022. 
Recap Sept. 14

Stocks caught a bid after yesterday’s flat showing, with the S&P 500 bounding higher by nearly 1% to close to within 2% of its best levels this year, while Treasurys came under some pressure with 2- and 30-year yields settling at 5% and 4.39%, respectively, up four and five basis points on the session. WTI crude advanced above $90 a barrel for the first time since November, gold finished little changed at $1,910 an ounce and the VIX logged multi-year lows below 13.  

- Philip Grant

Franchise Player
Call it a drive-through financing.

Call it a drive-through financing. Burger King parent company Restaurant Brands International came to market today with a monster $5.16 billion term loan, marking the largest such floating rate offering since early 2022. 

Ba2/double-B-plus-rated RBI priced the deal – which was upsized from a planned $4.16 billion – at 99.5 cents on the dollar and a 225-basis point premium to the Secured Overnight Financing Rate according to Bloomberg, tightening from initial price talk of 98.5 to 99 cents and a 250-basis point pickup to SOFR.  Proceeds will be used to refinance a term loan maturing in 2026. 

Gap Year
They're here for a good time, not a long time.

They’re here for a good time, not a long time.  Citing data from London Stock Exchange Group, the Financial Times relays that newly issued corporate bond maturities in the domestic investment grade market have averaged 10.5 years so far in 2023, the shortest such interval of the post-crisis era and down from 16 years as recently as 2020. Average maturities in the junk realm have similarly slumped to six years, the lowest on record going back to 1990. Effective yields on ICE BofA’s investment-grade and high-yield indices settled yesterday at 5.82% and 8.4%, respectively, compared to 2.35% and 4.35% at the end of 2021.  

“I think that’s just a function of how expensive it’s gotten for companies to borrow versus where it was just a year-and-a-half ago,” Matt Brill, head of U.S. investment-grade credit at Invesco, told the pink paper. “You don’t want to be paying this high coupon for any longer than you have to. . . I think most corporations feel like they’ll have a better opportunity to borrow for cheaper – meaning yields will be lower – in 2024 or 2025.”

Might Washington D.C.’s spendthrift ways throw a wrench into the works?  Yardeni Research president and eponym Ed Yardeni warned in a Monday analysis that ebbing inflation may not be sufficient to help push rates back down, as an increasingly grim fiscal backdrop could serve to hamper investor demand for government obligations.  

After accounting for distortions stemming from the Supreme Court’s decision to block the Biden administration’s student loan forgiveness plan this summer, the federal deficit will balloon to $2 over the 12 months through September according to the estimates from the Congressional Budget Office.

That’s double the $1 trillion student loan-adjusted shortfall logged in the prior fiscal year and a record sum outside the pandemic, a “highly unusual dynamic” in the context of a growing economy featuring measured unemployment near its lowest on record. Typically, the deficit rises relative to GDP during times of economic turmoil, as tax receipts decline alongside increased spending on unemployment insurance and other stimulus, while receding during good times.

Supply and demand dynamics could likewise prove problematic for low-rate aficionados, Yardeni believes. Commercial banks are letting their bond portfolios roll off, “using the proceeds to offset net deposit outflows,” while the Federal Reserve’s ongoing quantitative tightening regime, which serves to reduce its Treasury holdings by some $60 billion per month, puts the onus on households and institutional investors to soak up “the rapidly increasing supply of U.S. debt,” Yardeni notes. “They will undoubtedly do so. The only question is whether interest rates are high enough already to attract these buyers or whether rates would have to go higher to do so.”  

Recap Sept. 12

Stocks came under some pressure to mostly reverse yesterday’s gains, with the S&P 500 slipping a bit more than half a percent.  Treasurys caught a modest bid across the curve, though this afternoon’s 10-year auction was awarded at 4.289%, the highest yield since November 2007, while WTI crude logged a fresh year-to-date highs near $89 a barrel and gold slipped to $1,913 per ounce. The VIX crept above 14. 

- Philip Grant

Decant Swim

That’s one way to let it breathe. From the U.K. Daily Mail:

Winemakers painted the small Portuguese town of São Lourenco do Bairro red after two of its tanks accidentally spilled 2.2 million liters of red wine down a quiet street. A fast-moving river of red wine flowed down a steep hill in the small town, near the coast of Portugal, after two tanks owned by Levira Distillery suddenly gave way on Sunday. 

Baffled locals looked on as the wine, nearly enough to fill an Olympic swimming pool, swept through the streets of the town. The spill was so massive that local officials triggered an environmental alert and were forced to divert the wine to stop it contaminating the nearby Certima River. . . Firefighters said that a basement in a home near the distillery was flooded with wine. 

Levira has since apologized, and said it later dredged the wine-soaked land.

Pin Cushion
Can Uncle Sam stick the landing?

Can Uncle Sam stick the landing?  The end of the ultra-low-rate regime doesn’t necessarily portend wider pain, as Treasury Secretary Janet Yellen told Bloomberg yesterday that the coveted soft-landing scenario of moderating price pressures without undue pain in the labor market is within reach. “I am feeling very good about that prediction,” Yellen said, adding that “I think you’d have to say that we’re on a path that looks exactly like that.” 

Researchers at the Chicago Fed offered a concurring opinion in a white paper released last Wednesday, arguing that “the policy tightening that’s already been done is sufficient to bring inflation back near the Fed’s target by the middle of 2024 while avoiding a recession.”  

The central bank’s 525-basis points of cumulative rate hikes since March 2022 will serve to push real gross domestic product and the headline Consumer Price Index lower by 300 basis points and 250 basis points, respectively over the coming quarters, the Chicago Fed crystal ball shows, thanks in no small part to the central bank’s own communication efforts: “A shift in policymaking over time that puts more emphasis on the expected policy path, such as a heavier reliance on explicit forward guidance, may have made the expectations channel more important and thus shortened the apparent lags of transmission.” 

Corporate executives are, likewise, increasingly comfortable with the broader economic picture.  According to FactSet, only 62 companies within the S&P 500 mentioned the word “recession” on their second quarter earnings calls, the fourth straight sequential decline. The tally of member management teams uttering that magic word registered at 238 one year prior. 
Yet the experience of John Q. Public doesn’t quite comport with that high-level optimism. 

Today’s release of Bloomberg’s latest Markets Live Pulse Survey shows that more than three-quarters of the 526 respondents anticipate that personal consumption – a crucial input for broader economic growth – will contract on a quarterly basis by March of next year.  

Rising rates are taking their toll, as household interest payments excluding mortgages stand at roughly 4.2% of wages according to the Bureau of Economic Analysis, compared to about 2.5% in mid-2021. Credit availability is likewise on the wane: According to the New York Fed’s Survey of Consumer Expectations for August, nearly 60% of respondents report that credit is harder to come by now than a year ago, the highest share since the poll began in mid-2013. 

History, meanwhile, suggests that those predicting a smooth digestion of the higher-rate regime face daunting odds.  Francois Trahan, founder and eponym of Trahan Macro Research, relayed on “X” yesterday that recession has ensued during all but three of the Fed’s 13 hiking cycles since the onset of World War II.  The exceptions to that dynamic, in the mid-1960’s, mid-1980s and mid-1990s, however, all featured relatively low inflation, while economic contraction followed each instance of tightening in response to a CPI north of 5%. 

“If you believe that the economy is headed for a soft landing after one of the most aggressive tightening cycles in generations, then you are arguing that things are truly unique,” Trahan concludes.  “It's not impossible, but I'm not sure those pushing the soft-landing narrative are aware of the odds.”

See the analysis “In the absence of interest rates” in the current edition of Grant’s Interest Rate Observer for more on the unfolding impact of the Fed’s aggressive, belated tightening efforts, along with a review of the ZIRP-era distortions that have set the stage for today’s cloudy growth picture. 

Recap Sept. 11

Stocks caught a solid bid as the S&P 500 rose two-thirds of a percent, while a mixed showing in Treasurys saw the long bond rise four basis points to 4.37% and the two-year ticking to 4.97% from 4.98% Friday. WTI crude held at $87 a barrel, gold edged higher to $1,922 per ounce and the VIX remained below 14. 

- Philip Grant

Cold Cereal
Here’s some eye-catching commentary

Here’s some eye-catching commentary from General Mills chairman and CEO Jeffrey Harmening at an investor conference on Wednesday (hat tip to Rahul Sharma): 

As we look at the promotional environment, frequency is up a bit [year-over-year], but still down 10% versus pre-pandemic. Importantly, price points are still up dramatically.  If you look at total food and beverage, price points are up 35% since pre-pandemic. Our categories are up even more; 40%. 

Considering those striking figures, it is perhaps no surprise that the executive went on to flag slowing growth within the at-home food business, owing to “increased value-seeking behaviors from consumers.”  

Mr. Market, meanwhile, conducts his own value restoration project, as General Mills shares have declined by nearly 20% in the year-to-date after accounting for dividends, compared to a 17% total return for the S&P 500.  See the issues of Grant’s Interest Rate Observer dated January 13 and May 19 for a look at the bear case. 

A Quiet Place
Last crypto punter out turns off the lights:

Last crypto punter out turns off the lights: total trading volume across the spot and derivatives markets for digital currencies summed to $2.09 trillion in August according to CCData, down 11.5% from July and representing the second-lowest monthly total since October 2020, when bitcoin began its parabolic pandemic-era rally. Turnover on centralized exchanges registered at $5.9 billion on August 26, the single weakest one-day volume since Feb. 7, 2019, the data service likewise relays, when bitcoin changed hands south of $4,000 compared to the current $25,800 (upwards of a six-fold increase, let the record show).

That downshift comes as the long-running regulatory drama surrounding spot bitcoin exchange traded funds winds closer to conclusion. On Aug. 29, the U.S. Court of Appeals ordered the Securities and Exchange Commission to reconsider an application from Grayscale Investments to convert its eponymous bitcoin trust (ticker: GBTC) into a spot ETF, concluding that the agency’s prior rejection of Grayscale’s petition was “arbitrary and capricious,” as it has already approved such products tracking bitcoin futures. 

Though that ruling appears to clear the way for a slew of spot ETFs from household names like BlackRock and Vanguard, investors have greeted the news with a collective shrug. Bitcoin prices quickly gave back their 8% rally in response to the news, while Google search volumes for the digital ducats remain near their lowest of the past five years.  

“Just about every metric you could imagine from a trading perspective is lower,” Stéphane Ouellette, CEO of digital capital markets and advisory firm FRNT Financial, told Bloomberg last week, adding that overall activity is at “incredibly depressed levels,” particularly in North America. 

Earth’s largest crypto exchange is bearing the brunt of that slump.  According to CCData, Binance’s market share within the spot category fell for a sixth straight month in August to 38.5%, its weakest in an even 12 months, while its share of derivatives activity ebbed to 53.5%, the lowest since June 2022. 

Binance -- reportedly under criminal investigation by the Department of Justice for flouting Russian sanctions and violating anti-money laundering regulations and the recipient of 13 civil charges from the SEC for “blatant disregard of securities law,” including operating an unregistered exchange and improperly comingling customer assets – likewise faces an exodus of high-level talent. As crypto publication Decrypt documents today, a quintet of senior executives have left the firm in recent days, following suit after the bourse’s general counsel, chief strategy officer and senior vice president for compliance opted to hit the bricks earlier this summer. 

On form, Binance boss Changpeng “CZ” Zhao took to social media platform X (née Twitter) to put a sunny spin on things, characterizing concerns over “negative news/rumors, bank runs, lawsuits, closing of fiat channels, product wind downs, employee turnover” as “FUD,” i.e., fear, uncertainty and doubt.

Might apathy present a more pressing concern? 

Recap Sept. 8
Stocks settled little changed on the S&P 500 to leave the broad index slightly lower for this holiday-shortened week, while Treasurys flattened a bit with the two-year rising four basis points to 4.98% and the long bond declining to 4.33% from 4.36% Thursday. WTI crude rose back above $87 a barrel, gold stayed at $1,919 per ounce and the VIX edged below 14. 
Feet's Don't Fail me Now

From Spanish national sports magazine Marca:

Around 11,000 competitors have been disqualified from the 2023 Mexican Marathon after their tracking data showed that they did not complete the required distance of 42.195 kilometers. The runners are said to have failed to meet the checkpoints placed every five kilometers to ensure they are not cutting the distance needed to claim a finishers medal.

The investigation began following anonymous complaints and some strategies are said to include using vehicles and public transport to reduce the length of the endurance challenge.

Some 30,000 runners (or passengers, as the case may be) participated in the event.  

Chips and Dip
China's government is taking a bite out of Apple,

China’s government is taking a bite out of Apple, The Wall Street Journal reported yesterday, instructing employees at state-affiliated firms not to use iPhones or bring them to work.  Both national security and commercial considerations factor into the decision, former China-focused White House official Paul Haenle told the WSJ, as local carrier Huawei’s recent rollout of its own 5-G capable smartphone colors that news. 

Beijing’s crackdown may be set to widen, Bloomberg relays, as a “plethora” of state-owned and government-affiliated entities (no small constituency within China’s command economy) will soon be subject to restrictions on iPhone use. The Middle Kingdom, which likewise houses large swaths of Apple’s global supply chain, accounts for just under 20% of the company’s total revenues. 

Those developments shine a renewed light on a December 2021 revelation from The Information. The tech publication detailed a clandestine 2016 agreement in which Chinese authorities worked to shield Apple from fallout related to the Sino-American trade dispute and maintain access to its vast smartphone market in return for a variety of investment commitments within China’s economy, an outlay that reportedly topped $275 billion over the subsequent half-decade, along with a promise to “strictly abide by Chinese laws and regulations.” The deal covered five years, plus an automatic one-year extension in the absence of objection from either side. 

That was then, as Apple reportedly began laying the groundwork to shift some production capacity outside the Middle Kingdom late last year, with yesterday’s thunderbolt suggesting a new state of geopolitical play. 

More broadly, might this week’s drama mark a turning point for one of the darlings of the post-2008 bull run? The subject of a bearish analysis in the July 22, 2022, edition of Grant’s Interest Rate Observer (shares are since up 16%, slightly outpacing gains from the S&P 500), Apple has, of course, logged an enviable financial track record featuring a 4,700% total return since the iPhone debuted in June 2007.  That indomitable momentum has stalled of late, however, as year-over-year revenue growth has slumped into negative territory for the past three fiscal quarters. Total worldwide smartphone unit shipments will slip below 1.2 billion units this year according to estimates from the International Data Corp. It would represent the weakest such tally since 2013. 

To that end, Bernstein analysts led by Toni Sacconaghi penned a provocative analysis Tuesday, drawing comparisons between Steve Jobs’ brainchild and IBM, which dominated the business and financial landscape for decades before stagnating. 

Among the similarities between Apple and heyday-era Big Blue: each represented Berkshire Hathaway’s largest holding, commanded large weightings within their benchmark market capitalization indices and were beneficiaries of the notion that owning them “couldn’t get you fired,” owing to near unanimous admiration from investors.  

“IBM’s strength in mainframes and associated account control once seemed unassailable, but the world moved to standard industry servers and the cloud,” Sacconaghi et al. relay. “Apple’s key risks are that the iPhone is relaced by a new computing/internet access platform, or that a super app emerges that obviates Apple’s strong customer lock-in.” 

Xi Jinping might be said to constitute another risk factor. 

QT Progress Report
Reserve Bank credit fell by $22 billion from a week ago, leaving the Fed’s portfolio of interest-bearing assets at $8.065 trillion.  That’s 9.6% below the high-water mark reached in spring 2022. 
Recap Sept. 7

Stocks again came under modest pressure with the S&P 500 rebounding from early losses but still finishing 30 basis points south of unchanged for its third straight red finish, while Treasurys caught a bull-steepening bid with the two-year note settling at 4.94% from 5.01% Wednesday. WTI took a breather with a pullback below $87 a barrel, gold ticked up to $1,919 per ounce and the VIX stayed near 14.5. 

- Philip Grant

Walk the Line
Has the grand experiment

Has the grand experiment by the Bosphorus finally concluded? Here’s a striking declaration from Turkey’s President Recep Tayyip Erdogan – long a self-described “enemy” of high interest rates – from his Ankara residence today:

With the help of tight monetary policy, we will bring inflation back down to single digits. We will maintain fiscal discipline, which we see as the foundation of confidence and stability in our economy.

Wait, maybe high interest rates really do cause inflation. 

Action Park
From the beach to the Street:

From the beach to the Street: Corporate debt sales have resumed in full force following the typical summer lull, as more than $36 billion in domestic high-grade supply from some 20 borrowers came to market yesterday, by Bloomberg’s count, marking the busiest day so far this year by either metric.  

Relatively resilient growth, witness this morning’s updated 5.6% reading in the Atlanta Fed’s real-time third quarter GDPNow forecast, along with friendly market conditions – the ICE Corporate Index Option-Adjusted Spread sits near its lowest levels since early 2022 with a 122-basis point pickup – help form a largely placid backdrop for issuers. “The U.S. is defying the economic gravity that is pulling down China and Europe,” David Knutson, senior investment director at Schroder Investment Management, told Bloomberg. “The primary market tends to produce supply until investor appetite is satiated. Given how low volatility is and how tight credit spreads are, I would expect supply to continue until the market gets swampy.” 

Appetite within the deep end of the credit pool remains similarly brisk: speculative-grade firms will issue up to $20 billion in new bonds this month according to dealer estimates.  Primary junk supply stands at roughly $110 billion in the year-to-date, topping the $102 billion tally seen across 2022 but a fraction of the $400 billion-plus logged during the prior two full-year periods. The ICE BofAML High-Yield Index settled at a 383-basis point pickup over Treasurys Tuesday, remaining near its tightest since April of last year.  

“There’s a real hunger from high-yield investors for any kind of new issue,” John Fekete, managing director and head of capital markets at Crescent Capital Group, told Bloomberg.  Debts funding leveraged buyouts are no exception, as more than $15 billion of speculative-grade loans and bonds for that purpose are set to come to market in September, headlined by a projected $8.4 billion financing the buyout of Worldpay, Inc. as soon as next week. 

Though that’s a far cry from the $60 billion pipeline in force at this time in 2019 by LCD’s count, the current backlog marks progress for an LBO financing market that had been all but frozen of late. “The volume of conversation that we’re part of – and we’re probably not unique in that regard – is much higher than it’s been at any time this year,” Daniel Toscano, global head of leveraged finance at Morgan Stanley, relays to Bloomberg. 

Yet as Mr. Market emerges from his summer siesta, side effects from the Federal Reserve’s aggressive, belated tightening cycle in response to raging inflation continue to take shape. August commercial Chapter 11 filings registered at 634 according to data provider Epiq Bankruptcy, up 17% from July and underpinning the 13th straight month featuring some year-over-year increase in total bankruptcy petitions.  Meanwhile, six firms with assets of at least $50 million filed for Chapter 11 last week alone per data from Bloomberg, bringing the August tally to 23. “I think a lot of it is interest rates,” relays Ed Flynn, consultant at the American Bankruptcy Institute. “There have been an unusually large number of large [restructuring] cases.”

A protracted spell of relatively high borrowing costs serves to separate the corporate wheat from the chaff. A Tuesday analysis from Bloomberg’s Sebastian Boyd identifies an interesting dynamic within his firm’s gauge of the global high-yield market, as fundamental deterioration pervades the most speculative type of borrower: net leverage for the triple-C-rated cohort stood at nearly eight times Ebitda as of June 30, up from 6.4 turns in mid-2021 and just 5.1 as of June 2019.  Yet it’s steady as she goes at the penthouse of junk: the median double-B borrower featured just over three turns of net leverage as of the end of June, little changed from the middle of 2021 and 2019. 

Risk-happy investors have thus far been rewarded for shrugging off that dynamic, as the triple-C-rated portion of Bloomberg’s Global High-Yield Index has returned 13.8% in 2023 thus far, roughly double that for the single- and double-B portions. Will that charmed run continue? 

Recap Sept. 6

Stocks maintained a moderately weak tone with the S&P 500 and Nasdaq 100 each slipping a bit less than 1%, though the averages managed to rebound from their early-afternoon lows, while weakness at the front end of the curve headlined today’s Treasury action as the two-year note popped back above 5%. WTI crude logged fresh 52-week highs north of $87 a barrel, gold slipped to $1,917 an ounce and the VIX edged towards 14.5. 

- Philip Grant

Back in Black
Higher for longer, redux?

Higher for longer, redux? The Kingdom of Saudi Arabia announced today that it will maintain its current 9 million barrel per day (mmbpd) pace of oil production through the end of 2023, keeping its output near multi-year lows following a 1 mmbpd cut in July.  

That move from the top dog within the Organization of the Petroleum Exporting Countries caught observers off guard, as 80% of the 25 traders and analysts surveyed by Bloomberg expected those rollbacks to be extended for only a month longer.  Brent crude touched $91 per barrel this morning for the first time since last November, extending its post-June gains to a hefty 24%. West Texas Intermediate, likewise, logged 10-month highs today following a 27% run-up since the start of June, while national gasoline prices stand at $3.81 per gallon according to data from American Automobile Association, the highest seasonal level in all but one year going back to 1994.  

Energy’s rebound carries no shortage of potential implications for both asset prices and broader economic health, as the Federal Reserve works to contain the post-pandemic explosion in prices with its steepest tightening cycle in some four decades.  Investors are betting that the worst is over, with interest rate futures pointing to a 4.22% funds rate by January 2025, over 100 basis points below the current effective rate. 

Though annual headline growth in the consumer price index moderated to 3.2% last month from north of 9% in June 2022, that benevolent trend could soon run out of road. Bianco Research co-founder and eponym Jim Bianco relays today that the Cleveland Fed’s Nowcast real-time inflation tracker points to monthly growth in headline CPI of 0.79% in August and 0.45% in September, which equates to year-over-year readings of 3.82% and 3.91%, respectively. 

“The oil price remains highly relevant for the Fed because of its potential to disrupt inflation expectations,” writes Jefferies global head of equity strategy Chris Wood, adding that the relationship between Brent crude and the so-called five-year, five-year rate – which measures average expected inflation over the half-decade period beginning five years henceforth – has demonstrated a notably tight positive correlation going back to 2011. 

Researchers at the International Monetary Fund, meanwhile, conducted a study last September covering data from 39 European countries over the two decades prior to the pandemic, finding a particularly strong relationship between high energy costs and accelerating wages during periods of acute price pressures: “Of concern is how current high inflation could increase the risk of energy prices causing sizable second-round effects” such as elevated inflation expectations. “To head off such a risk, central banks will need to respond firmly,” the IMF warns. 

Importantly, the energy revival is taking place against a relatively soft industrial backdrop.  Reuters energy analyst John Kemp likewise points that the Institute for Supply Management’s purchasing manager’s index has remained south of 50, the mark delineating expansion and contraction, for 11 consecutive months as of August, a downturn more typical of “a cycle-ending recession (which have generally lasted 11 months or more) than a mid-cycle slowdown”, which generally spans no longer than eight months. 

Yet fuel oil distillate consumption declined by a relatively modest 1% year-over-year during the second quarter according to the Energy Information Administration, representing the 31st percentile for all three-month periods going back to 1980.  That’s with the EIA adjusting distillate supply estimates higher by a total of 23 million barrels across 2022, a 1.6% uptick. 

“Resilient electricity and diesel consumption, and. . . correspondingly low levels of spare generating capacity and distillate inventories imply that the energy system is operating at close it its maximum capacity,” Kemp writes. “In the event of a soft landing followed by a re-acceleration of the business cycle, capacity constraints will re-emerge quickly and likely lead to an early resurgence of inflation.” 

Recap Sept. 5

Stocks lost a bit of altitude following the long weekend with the S&P 500 declining 0.4%, as interest rates remained under pressure with two- and 30-year Treasurys settling at 4.94% and 4.38%, respectively, up seven and nine basis points from Friday. Gold pulled back to $1,925 per ounce, WTI settled just south of $87 a barrel and the VIX rose to near 14.

- Philip Grant

Carpe Diem Doggy

From the San Francisco Chronicle:

Metallica had a four-legged gatecrasher at one of its record-breaking concerts last week in Southern California.

The local Animal Hope & Wellness Organization initially reported that a dog named Storm had been abandoned by its owner at the show on Friday, Aug. 25, at SoFi Stadium in Inglewood (Los Angeles County), sharing a photo on Facebook that quickly went viral showing the canine seated in the audience alongside fans. 

But it turns out Storm had independently sneaked out of her owner’s home and found her way into the venue without shelling out hundreds of dollars for a ticket. . . Storm’s owner, Arizbeth Hurtado, told PetHelpful that they live near SoFi Stadium and were surprised to learn about Storm’s musical preferences: “She is apparently a huge Metallica fan who decided to sneak out for the concert!”

Red Letter Day
Mr. Market turns over a new leaf?

Mr. Market turns over a new leaf?  Fall’s imminent arrival will usher in a capital markets revival, as a trio of noteworthy, tech-focused initial public offerings are on tap in the coming weeks. Grocery delivery concern Instacart, marketing software firm Klaviyo and SoftBank Group Corp.-owned chip designer Arm Holdings are preparing their respective debuts, with Arm set to commence its investor roadshow next week and pricing tentatively slated for Sept. 13 per Bloomberg.  

Those entrants – each of which showed positive net income over the first six months of 2023 – are taking every precaution to ensure that their listings go smoothly, working to line up so-called cornerstone investors to underpin demand for the newly public shares.  Instacart has already secured up to $400 million of stock purchase commitments from a trio of fiduciaries, the company revealed in a filing, a sum equal to 50% or more of the total offering according to The Wall Street Journal. Klaviyo and Arm are likewise reportedly working to secure their own lynchpin shareholders. 

Then, too, supply will be at a premium, as each of the trio reportedly plans to sell fewer than 10% of their shares outstanding, a downshift from the previous norm. “The market can still be pretty fragile, and companies may be de-risking this process, so they don’t stub their toe right out of the gate,” Marc Jaffe, capital markets-focused managing partner at law firm Latham & Watkins, told the Journal

Such caution is understandable, considering the boom-and-bust dynamics on display since the bug first barged in. Total domestic IPO volume, encompassing traditional listings as well as corporate spinoffs and special purpose acquisition companies, stands at just $14.4 billion in the year-to-date according to data from Goldman Sachs, a fraction of the $242 billion logged at this time in 2021. Meanwhile, only 22% of the 121 tech firms that launched an IPO in that boom year were profitable according to data from University of Florida finance professor Jay R. Ritter, less than half the total 47% share spanning 1980 through the end of last year. 

That raft of speculative entrants has proven to be less-than rewarding, thus far: Though the Nasdaq 100 sits only 6% south of its November 2021 peak following the index’s 42% year-to-date leap, a mere 14% of the IPO bumper crop from that year traded above their respective offering price as of Tuesday, Fortune reports, citing data from Renaissance Capital. 

“Investors are no longer willing to pay gigantic multiples against future cash flows,” Joseph Endeso, president of private investment platform Linqto, tells Bloomberg. “Those things happened in the last bull market, but I think hard lessons have been learned.”  

Recap Sept. 1

A bear-steepening selloff in Treasurys headlined today’s proceedings, as the long bond jumped nine basis points to 4.29%, while stocks gave back early gains for a second straight day, settling just above unchanged on the S&P 500. WTI crude powered to fresh year-to-date highs near $86 a barrel, gold stayed at $1,940 an ounce and the VIX settled at 13. 

- Philip Grant

Idle Lands
Turn those machines back on!

Turn those machines back on! This morning, the People’s Bank of China established nationwide minimum down payment requirements for both first- and second-time homebuyers at 20% and 30%, respectively, as of Sept. 25, replacing a regional framework that featured down payments of as high as 80%. The central bank likewise encouraged local banks to trim existing mortgage rates, as authorities look to arrest a downward spiral in the lynchpin property realm, which accounts for up to one third of total domestic output by some estimates. 

“The reduction in the interest rate of existing housing loans can save interest expense for borrowers, which helps expand consumption and investment,” the PBOC states. Sales among China’s 100 largest developers sank 33.9% from last year in August, data released today show, roughly matching declines seen in July and June, while new bank loans tumbled to RMB 349 billion ($48 billion) last month per data provider Wind, down nearly 50% year-over-year and the lowest monthly reading since 2009.  

Will Beijing’s machinations help turn the tide?  Overseas investors aren’t waiting to find out, undertaking a net $12.4 billion in net equity sales during August per the Financial Times, easily the largest monthly outflow since China introduced its Stock Connect foreign investment portal in 2014. “Nobody expects a big bang on the fiscal front anymore,” Alicia García-Herrero, chief Asia-Pacific economist at Natixis, told the pink paper. “Now, investors’ clients are focused on the real estate sector policy – that’s the new mantra.” 

Recent occurrences underscore that sentiment shift: developer China Evergrande Group received a rude welcome from Mr. Market, as shares plummeted as much as 87% after a 17-month halt in connection with its 2021 default on dollar-pay bonds.  Evergrande, which has seen its market capitalization shrivel to $460 million from more than $50 billion six years ago, posted a $4.5 billion net loss in the first six months of the year, while total liabilities as of June 30 towered at $329 billion, compared to $240 billion in assets.

While the travails of Evergrande – likened to the doomed dirigible Hindenburg by Grant’s Interest Rate Observer in the summer of 2017 – have long been in public view, mushrooming trouble at what was once China’s largest property player by sales brings the industry’s mounting woes into sharp relief. Yesterday, Country Garden Holdings Co. reported a record $6.7 billion net loss over the first half of the year, down from an $84 million profit over the same stretch in 2022. Though revenues jumped 39% over the same period, efforts to “ensure punctual delivery of finished properties” led Country Garden to “str[ike] a balance between sales volume and selling price at some of its property projects,” as management put it. 

A default of its own may, meanwhile, be in the offing, as Country Garden requested a 40-day grace period from creditors on a renminbi-pay bond maturing next week, with the conclusion of a grace period to repay $22.5 million of dollar-note coupons looming in early September. Country Garden, appraised at the equivalent of double-B at both Moody’s and S&P as recently as November, was cut to double-C at Moody’s this morning, with the rating agency citing “tightened liquidity and heightened default risk, as well as the likely weak recovery prospects for the company’s bondholders.” The firm’s $1 billion worth of first-lien, 8% notes maturing in January last changed hands at less than 13 cents on the dollar.

“With or without an official default, Country Garden will no longer be able to grow, and we have doubt on its ability [to continue] as a going concern,” analysts at JPMorgan Chase warn.  The investment bank predicts that Chinese property firms will account for nearly 40% of global default volumes during calendar 2023.  

More broadly, the crumbling real estate edifice poses no small risk to the Middle Kingdom’s fixed-asset driven growth miracle, one accompanied, of course, by heaping portions of debt. See “China isn’t working” in the brand-new edition of Grant’s Interest Rate Observer for more on the ripple effects that may ensue from an extended stretch of trouble within the world’s second-largest economy. 

QT Progress Report
Reserve Bank credit fell $19.9 billion from last week, leaving the Fed’s portfolio of interest-bearing securities at $8.09 trillion.  That’s down just over $100 billion since the start of the month, and 9.3% from the March 2022 highs. 
Recap Aug. 31

Stocks gave back some early gains to finish modestly lower on the S&P 500, as the broad index wrapped up August with a 1.8% decline, while Treasurys caught a bid with two-year yields falling five basis points to 4.85% and the long bond settling at 4.2% from 4.23% Wednesday. WTI crude jumped more than 2% to approach its 2023 highs near $84 a barrel, gold pulled back to $1,940 per ounce and the VIX settled south of 14. 

- Philip Grant

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