Under the Bridge
Talk about higher for longer:

Talk about higher for longer: This morning’s reading of non-farm payrolls for May featured a net 339,000 advance, way above the 195,000 consensus and catching the bond market off-guard, as evidenced by the 15-basis point leap in two-year yields, to 4.49%, as of mid-afternoon. 

As Bianco Research relays, that marks the 14th consecutive monthly reading in which payrolls topped economist expectation. That’s easily the longest streak since record keeping began in 1997, towering over the prior peaks of five straight “beats” in 1998 and 2020. 

Service Animal
Who said trees can't grow to the sky?

Who said trees can’t grow to the sky?  The U.S. Senate passed legislation suspending the $31.4 trillion national debt ceiling and capping federal spending through 2024 in a bipartisan 63-to-36 vote yesterday, wrapping up weeks of well-ventilated political haggling. “We’ve saved the country from the scourge of default,” crowed Senate majority leader Chuck Schumer (D. – N.Y.).

Observers outside the Beltway took a slightly more jaundiced view. Bloomberg economists Anna Wong and Maeva Cousin wrote Tuesday that the spending freeze “will deal an additional short-term blow to an economy already vulnerable to recession. Yet [it will] barely dent the unsustainable medium-term trajectory of U.S. federal debt – which we estimate is still on track to rise from 97% of GDP in 2022 to more than 130% of GDP by 2033.”  At the turn of the century, Washington’s output-adjusted borrowings stood below 30%.

The post-Covid inflation updraft and accompanying upward lurch in federal borrowing costs continue to reverberate. Net interest expense registered at 1.9% of output last year, topping the 1.5% long-term average.  That metric will reach 2.7% next year, if guesstimates from the Congressional Budget Office are on the beam, on their way to 3.7% by 2033. For context, the post-WWII peak stands at 3.2%, logged in 1991. 

To be sure, Uncle Sam has company in the struggle to keep his obligations in check.  Fitch Ratings warned yesterday that Europe’s leading economies will have trouble whittling down their sovereign debt loads despite a revenue-driven fiscal improvement last year. The Covid-era borrowing binge will continue to weigh on the bloc, the rating agency reckons, as euro area debt to GDP stood at 92% at year-end, down from 95.5% in the prior year but well above the 84% seen in 2019. 

With price pressures still percolating on the Old Continent, European Central Bank governing council member Klaas Knot pushed back on market expectations of an easing pivot in 2024, likewise warning of side effects from elevated government indebtedness including “rising interest expenses.” Benchmark borrowing euro costs currently rest at 3.25%, following the ECB’s eight-year experiment with negative nominal rates. 

Then there’s China, where debt-soaked local authorities labor to stay above water. Nearly one half of the revenue last year, a new report from Rhodium Group finds, up from one-third of municipalities in that predicament during calendar 2021. A sample of 2,892 government financing vehicles (LGFVs) – the contraptions used to fund infrastructure spending projects – saw their cash positions collectively slip by 10.3% year-over-year to RMB 7.8 trillion ($1.1 trillion), the first such decline since 2018, while interest bearing debt stood at RMB 54 trillion along with an additional RMB 5 trillion in payables to contractors and suppliers. 

“The current weakness of localities’ finances prevents Beijing from utilizing fiscal policy to support the economy,” the Rhodium analysts conclude. “In fact, this is the primary reason that there has been no meaningful fiscal support for China’s recovery this year.”  For more on the Middle Kingdom’s local debt problem, see the issue of Grant’s Interest Rate Observer dated May 19. 

Indeed, the combination of towering obligations and elevated borrowing costs relative to the post-crisis norm make for a heady brew. “At close to $305 trillion, global debt is now $45 trillion higher than its pre-pandemic levels and is expected to continue increasing rapidly,” the Institute of International Finance relayed in a mid-May analysis. “Despite concerns about a potential credit crunch. . . government borrowing needs remain elevated.” 

Recap June 2

Stocks stormed higher again to the tune of 1.3% as of mid-afternoon, when your correspondent had to leave, while the VIX continued its freefall to a sub-15 reading, its most placid since t

- Philip Grant

Assume the Positioning
From the “markets make opinions” file:

From the “markets make opinions” file:  As the S&P 500 hovers at its best levels since August, a weekly sentiment poll conducted by Investors Intelligence finds that just 23.3% of respondents are bearish on stocks (hat tip to Helene Meisler). That’s roughly half the proportion logged last fall and the lowest such share since January 2022, as the market scaled the summit of the everything bubble.

Rising risk appetite likewise emboldens speculation in the bond market, as the Direxion Daily 20+ Year Treasury Bull Exchange Traded Fund has gathered nearly $1.3 billion so far in 2023, Bloomberg reported yesterday. That influx more than doubles assets under management for the vehicle, which aims to provide three times the daily performance of long-dated government debt. “You eat a little bit in decay costs while you wait in a leveraged ETF, but this could take off really quickly,” Bloomberg analyst Athanasios Psarofagis comments. “And it’s already long duration, so this will have some big moves.”

If You Build it
Too tight for flight?

Too tight for flight?  Average contract rates on 30-year mortgages registered at 6.91% over the week ended May 26, the Mortgage Bankers Association relayed yesterday. That’s up from 6.69% over the prior seven-day stretch and the most elevated reading since last November.  In 2020 and 2021, that weekly data series never topped 4%. 

Considering that backdrop, it is no surprise that both current and aspirational homeowners are opting to stay put. MBA’s in-house Market Composite Index, which measures mortgage loan application volume, slumped 3.7% on a seasonally adjusted, sequential basis to extend its year-over-year decline to 45%.  

Then, too, sales of so-called existing homes registered at a seasonally adjusted 4.28 million in April per the National Association of Realtors, down 23.2% from the year earlier reading and off 3.4% from March, a telling sequential downshift considering that activity typically picks up during the spring as weather improves.  Overall, the tally of unsold homes marked for sale languishes at 1.04 million, equivalent to 2.9 months of supply, compared to a long-term average of 2.3 million units and a 4 to 5 monthly sales backlog that generally connotes a balanced market.  

The shriveling supply is no localized phenomenon, as analysts at Barclays found last week that only a single market out of the nation’s top 50 – that would be Austin, Tex. – features more listings now than in April 2019, with most locales stuck far below their respective pre-pandemic baselines.  Homebuilders are doing their best to fill the void, as newly completed inventory represents 32% of total homes for sale, double the average share going back to 1983. 

Meanwhile, pent-up demand has slowly mounted as the mid-aughts housing bubble and painful fallout faded into the rear-view. Barclays likewise points out that 7 million U.S. households earning at least $100,000 per year lived in rentals as of 2021, up from 2.5 million 10 years earlier (for context, median household incomes averaged $70,084 in 2021 per the Federal Reserve Bank of St. Louis, up 15.9% from 2011).  

Those disparate dynamics leave the dwelling construction industry in the catbird seat, Barclays concluded. “In an environment of ‘higher rates for longer,’ we think builders are in an advantaged position to benefit from the ongoing shortage of existing home supply,” analysts led by Matthew Bouley wrote. “If rates stay elevated, current homeowners have disincentive to sell and supply remains depleted. [But] if rates fall, more buyers should enter the housing market.”

See the brand-new edition of Grant’s Interest Rate Observer dated June 2 for a closer look at the dynamics driving today’s most-peculiar market action. 

QT Progress Report
Reserve Bank credit fell $25.9 billion from a week ago, leaving interest-bearing assets on the Fed balance sheet at $8.38 trillion.  That’s down $123 billion from the beginning of May, slightly ahead of the Fed’s targeted $95 billion monthly pace, and 6.1% below the March 2022 peak of $8.924 trillion. 
Recap June 1

Dovish chatter regarding a potential June pause from the Fed spurred a  near 1% gain for the S&P 500, leaving the broad average sporting an impressive 11% advance so far this year, while the two-year yield sank to 4.33% from 4.54% last Friday. In turn, gold pushed back to the doorstep of $2,000 per ounce, WTI crude jumped 3% to $70 a barrel and the VIX swan-dived more than two points to settle south of 16.

- Philip Grant

Broad Street
Some 61% of U.S. adults are invested in the stock market,

Some 61% of U.S. adults are invested in the stock market, an April poll from Gallup found. That’s the highest share since 2008, up from 58% last year and 52% as recently as 2016.

A paucity of income-generating opportunities during the post-crisis E-Z money epoch (witness the sub-1% average interest rates on offer for five-year certificates of deposit from 2012 to 2017 and 2020 to mid-2022, per data from Bankrate.com) can explain the growing popularity, some believe. “My overarching conclusion about why equity ownership is relatively high is that the ‘there is no alternative’ principle was alive and well, until very recently,” Christine Benz, direct of personal finance and retirement at Morningstar, told Yahoo! Finance Thursday. 

By the same token, last year’s outsized losses from “Super Safe” Treasurys as interest rates climbed off the mat factors into the migration. “Although 2022 was a bum year for [both] stocks and bond[s]. . . investors expect volatility and periodic losses from stocks, they don’t expect it from bonds,” Benz added. 

The Young and the Restless
Welcome to the spin zone.

Welcome to the spin zone. Atmus Filtration Technologies, Inc., formerly a division of Cummins, Inc., made its New York Stock Exchange debut in style on Friday, enjoying an 11% rally after raising $275 million.  

Marking the seventh-largest U.S. initial public offering of 2023 thus far, that transaction underscores healthy investor demand for corporate spin-offs, which represent a bright spot within still-dormant equity capital markets.  On May 4, Johnson & Johnson listed its consumer health products unit Kenvue, Inc. in a $4.37 billion deal – marking the only stateside IPO of $1 billion or more in the year to date – with shares subsequently higher by 16%. Overall, those commercial offspring have accounted for four of the five largest debuts over the past year, data from Bloomberg show, reflecting ongoing risk aversion following last year’s protracted market weakness. 

“Typically, the spinoff IPOs tend to have a better track record of profitability as well as a greater cushion of capital,” Roth MKM analyst Rohit Kulkarni observed to Bloomberg.  Considering “today’s risk-off market, such offerings are better received by investors.” 

Of course, the Covid-era capital markets bacchanal colors that newly chastened attitude, as the aftermath of the supersonic boom in special purpose acquisition companies presents a lingering headache for Mr. Market. The Wall Street Journal warned last month that more than 100 firms that merged with those blind pools are at risk of running out of cash within the next year, potentially joining a dozen of the so-called de-SPACS which have already filed for bankruptcy protection during this cycle.  On average, that cadre retains cash and short-term investments sufficient to cover only five months of operations. 

With the zero-rate era that accompanied the 2020 and 2021 SPAC issuance boom now firmly in the rear-view, onerous terms await those firms looking to bolster their flagging coffers. “The financings that are available to these failing companies are just going to accelerate their demise,” Adam Epstein, founder of Third Creek Advisors, contended to the Journal

The bygone SPAC bubble may have given way to heavy financial weather for frail corporate citizens, but one contingent emerges from the financial wreckage in shipshape.  A WSJ review of 460 de-SPACS found that corporate officers, directors and other insiders at 232 of those sold an average $22 million in shares per company “through well-timed trades, profiting before share prices collapsed.” Some 20% of that group monetized at least $100 million of company stock, while insiders at a dozen firms offload $500 million or more into the market. 

Recap May 30

Stocks gave back some early gains to finish unchanged on the S&P 500, though the Nasdaq 100 managed a 0.5% advance thanks to the usual suspects like Nvisda, which added another 3% to finish near the $1 trillion market cap milestone. Treasurys caught a strong bid with the two-year yield dropping to 4.46% and the long bond to 3.9%, down eight and six basis points on the day, respectively, while gold rebounded to $1,978 per ounce and WTI crude slipped below $70 a barrel. 

- Philip Grant

Trust the Process

From Business Insider:

During TNT's broadcast of the NBA Eastern Conference Finals on Tuesday, Shaquille O'Neal hinted at his involvement in an FTX lawsuit while speaking to Stephen Curry — just hours before getting served. "Thanks for getting me in trouble," O'Neal said to Curry, likely in reference to their joint involvement in the FTX case.

Later that night, O'Neal was reportedly served two legal complaints — one for his involvement in the ongoing FTX lawsuit and another regarding an NFT project — by a process server who attended the game, Adam Moskowitz, co-counsel on the FTX lawsuit, told Insider.

"After months of dodging service, Shaquille O'Neal was just personally served with 2 Complaints, while broadcasting the Heat/Celtics Game 7 [sic] in Miami, Florida," the Moskowitz law firm wrote in a statement this morning. "The process server filmed the event to ensure there was no ambiguity like Shaq has been arguing in the FTX case, but after service, Mr. O'Neil had the process server kicked out of the Arena."

In perhaps the biggest twist of irony, this all went down in the former FTX Arena — the Miami Heat's home [court] named after the crypto exchange in June 2021, before becoming the Kaseya Center this past April.

Gotta Serve Somebody
Investors have a fever, and the only prescription is more AI.

Investors have a fever, and the only prescription is more AI.  Marvell Technology followed in peer Nvidia’s shoes after delivering fiscal first quarter 2024 results yesterday evening, as shares rocketed 32% after the chipmaker predicted artificial intelligence-derived revenues will “at least double” to around $400 million this year with a similar growth rate in the company’s crystal ball for fiscal 2025.  

“In the past, we considered AI to be one of many applications within cloud, but its importance and therefore the opportunity has increased dramatically,” CEO Matthew Murphy said on the conference call.  Marvell has plenty of company on that score: 110 members of the S&P 500 mentioned AI on their first quarter earnings calls, data from FactSet show, compared to 78 and 53, respectively, during the prior two periods. 

Yet as the market swoons over a lucrative AI-induced spending binge, key tech players deliver a divergent signal. Nick Winkler, founder of research firm DuDil, relays that enterprise cloud provider Workday extended the useful life of its servers and network equipment to five years from three, an accounting tweak that served to trim the firm’s operating loss to $20 million over the three months through April from $50 million thanks to lower depreciation expense. 

Household names such as Alphabet, Meta, Microsoft and Amazon have each recently undertaken similar moves, heling push the industrywide average useful life of servers to 5.6 years per research firm Omdia, from 5.2 years in 2021 and 2022. 

Trickle Down
Maybe Jerome Powell and Co. should find a new metric.

Maybe Jerome Powell and Co. should find a new metric. Friday’s release of the April core personal expenditures index – typically presented in the financial press as the Fed’s “preferred inflation gauge” – showed a 0.4% sequential increase, topping the 0.3% consensus for the hottest reading since January, while annual gains registered at 4.7%, more than double the central bank’s 2% bogey.  At the same time, personal spending jumped 0.8% sequentially last month compared to an expected 0.5%. 

Those data did little to slow the recent reacceleration of short-term interest rates, as markets adapt to the growing odds of additional policy tightening from the current 5.08% funds rate.  Two-year Treasurys today reached 4.54%, approaching levels seen prior to Silicon Valley Bank’s March collapse, while real yields, as measured by Treasury Inflation Protected Securities maturing in April 2025, vaulted above 2.5% this morning compared 1.6% in early April.

Considering that backdrop, it is perhaps no surprise that assets parked at U.S. money market funds reached a record $5.39 trillion as of Wednesday per the Investment Company Institute, up nearly 1% from the prior week and 12% from the start of 2023. 

Meanwhile, the prospect of a debt-ceiling deal could catalyze a further inflow. Citing estimates from JPMorgan, the Financial Times reports that Uncle Sam will issue some $750 billion in short-term bills over the four months following an agreement to help burnish its dwindling cash cache. “To the extent that Treasury has a flood of supply that’s coming to market, it will be received with open arms,” Deborah Cunningham, chief investment officer of global liquidity markets at Federated Hermes, told the FT

Might an ongoing migration to cash equivalents put the crimps on percolating risk appetite? Citing data from EPFR Global, Michael Hartnett, chief investment strategist at Bank of America (and speaker at the 2023 Grant’s fall conference – advt.) relays today that investors pulled a net $3.9 billion from stocks over the seven days through Wednesday. 

Thanks to that third consecutive round of weekly redemptions, equity flows are now flat for the year-to-date following net influxes of $175 billion, $949 billion and $182 billion in 2022, 2021 and 2020, respectively.  With financial conditions potentially poised to tighten further in the coming weeks and interest rate futures now pricing 64% odds of a further Fed rate hike on June 14, “we expect another bout of risk-off [trading conditions] in late June,” Hartnett writes. 

Recap May 26

Euphoria reigns into the holiday weekend, as the S&P 500 jumped another 1.4% to establish fresh-year-to-date highs while the Nasdaq 100 ripped 2.6% to extend its 2023 gains to more than 31%. Treasurys flattened with the long bond settling at 3.96% from 4.01% Thursday and WTI rose to near $73 a barrel while gold stood still at $1,947 per ounce. The VIX slipped back below 18 after reaching 20 on Wednesday.

- Philip Grant

Champion Chip Belt
Nvidia Corp. sent its legion of fans into delirium

Nvidia Corp. sent its legion of fans into delirium after guiding fiscal second quarter revenues to about $11 billion, blowing away the $7.2 billion sell-side consensus. Shares in the artificial intelligence darling vaulted higher by 24% in response, extending year-to-date gains to 165%. 

Today’s bull frenzy leaves Nvidia in rarefied air, adding nearly $250 billion to its market valuation at its intraday highs. As Richard Bernstein Advisors points out, only 25 members of the S&P 500 sport market capitalizations greater than that sum.  

Then, too, the eye-popping move shatters a venerable record: Kevin Duffy, co-founder of Bearing Asset Management, relays that Nvidia’s $940 billion market cap stands at 64 times gross profits over the 12 months through April.  At the peak of the dot-com bubble, shares of tech darling Cisco crested at a mere 53 times trailing gross profit.  

Clear as Mud
Them's fightin' words:

Them’s fightin’ words: S&P Global downgraded SoftBank Group Corp. to double-B from double-B-plus Tuesday, warning that “asset risk in [the firm’s] investment portfolio is rising more than we had assumed,” and that “its liquidity and creditworthiness are likely to remain materially weakened for the next year or so.”  

The $100 billion Vision Fund and its $40 billion sequel represent the primary culprits, as cumulative, unrealized losses from those in-house venture capital divisions stood at $8.5 billion as of March 31.  SoftBank had logged $66.4 billion in paper profits as the private capital bubble climaxed in spring 2022 after pouring $44.3 billion into startups over the preceding 12 months, before slamming the brakes to the tune of just $3.1 billion of investments over the subsequent fiscal year as greed gave way to fear.

On form, SoftBank declined to turn the other cheek, critiquing S&P’s decision thus: “over the past year, our strict defensive financial management has strengthened our financial position as never before. . . it is extremely regrettable that our financial soundness was not properly assessed.” Recall that, in response to a two-notch downgrade from Moody’s in 2020, SoftBank effectively fired the agency for its “biased and mistaken views” by ceasing to furnish financial information. 

While SoftBank continues its tradition of sparring with the rating agencies, the pending IPO of chipmaker and portfolio company Arm Ltd., which will reportedly raise some $10 billion, looms as a potentially decisive moment for Masayoshi Son’s firm. As S&P noted in its downgrade, unlisted companies composed 69% and 85% of Vision Fund 1 and 2’s assets, respectively, as of March 31.  

Increasingly bruising conditions in the v.c. market at large color that concentration.  Industrywide internal rates of return slumped to negative 7% over the 12 months through September 30 (the most recently available figure), PitchBook relayed earlier this month, marking the worst such annual showing since 2009. IRRs have now deteriorated for five consecutive quarters, the longest losing streak in over a decade, with another decline likely on tap for the final three months of 2022, the data service advises.

Indeed, some industry Johnny-come-lately’s may not survive the cull. “There is a segment of the venture market that has little traction and no real prospects for raising additional capital,” Jay Ripley, head of investments at Global Endowment Management, told The Wall Street Journal last week, adding that numerous startups funded during the Covid-era boom “are presumably going to be written down to zero, or near zero.”

As the v.c. realm wallows in despair, the aptly dubbed “epitome of the cycle,” (Grant’s Interest Rate Observer, Dec. 15, 2017) looks for greener pastures. Bloomberg reported Monday that SoftBank “is working on plans to become a lender in the $1.5 trillion world of private credit,” prospectively targeting “low double-digit yields [from] the strategy.”

Fair warning, direct lenders. 

QT Progress Report
A $42 billion weekly decline in Reserve Bank credit leaves the Fed’s portfolio of interest-bearing assets at $8.405 trillion.  That’s $100 billion above its mid-March levels prior to the regional bank mini-crisis, and $519 billion south of the early 2022 high-water mark. 
Recap May 25

The (artificial) intelligent investor: stocks enjoyed a near 1% advance on the S&P 500 and a 2.4% jump for the Nasdaq 100 as the Nvidia results stirred animal spirits, while Treasurys were hammered on the short end with the two-year yield ripping 19 basis points to 4.5%. Gold continued its descent to $1,941 per ounce, WTI crude slipped below $72 a barrel and the VIX pulled back to near 19.  

- Philip Grant

Treat Me Subject
Credit Suisse has thrown in the towel

Credit Suisse has thrown in the towel on efforts to salvage some $400 million in mid-level employee bonuses following its shotgun March marriage with UBS, the Financial Times reports.  

The now-defunct lender withdrew an appeal to Switzerland’s Federal Administrative Court (FAC) over the so-called contingent capital awards (CCA), which date to 2014, vest over three years and typically compose 10% to 15% of total bonuses for director level staff. 

Some 5,000 employees received CCAs in 2021, the last year in which they were on offer. Those zeroed-out payouts were linked to Credit Suisse’s additional tier 1 bonds, which are designed to be written down in the event of distress, providing an extra capital buffer for the bank but leaving investors (or, in this case, employees) exposed to a crypto style “rug pull.” Sure enough, Swiss regulators did just that in facilitating the distressed merger.

Unsurprisingly, that decision proved to be less than popular in some quarters, as the FAC has received some 230 appeals from 2,500 petitioners over the AT1 wipeout. Sympathy from one corner is minimal, however. “With respect, read the prospectus,” UBS chair Colm Kelleher declared at an event this morning. “It was very clear in the Swiss prospectus that viability was a wipe-out issue – very clear.”  

Up in the Air
Mr. Market is coming around

Mr. Market is coming around to the “higher for longer” concept, as hopes for an imminent reversal of the Federal Reserve’s tightening cycle go by the wayside. 

Interest rate futures now price in a 4.82% funds rate by the end of the year, still south of the 5% to 5.25% band currently in force but well above the 4.2% anticipated just two weeks ago, let alone the 3.7% investor guesstimate following the late spring regional banks blowup. The policy-sensitive two-year Treasury yield, meanwhile, settled at 4.31% today, its highest close since the memorable March 10 session.

An unwelcome, increasingly established culprit helps explain those shifting expectations. “Core inflation is proving more stubborn than expected and remains well above central banks’ 2% targets,” analysts at BlackRock noted recently, adding that “we see a recession ahead. But unlike in the past when central banks would cut rates to stimulate a struggling economy, we think the unresolved inflation problem makes that unlikely this time.” Excluding food and energy, the Consumer Price Index will grow 5.3% year-over-year in June, if economist consensus is on point. 

Plainly, the prospect that full-bodied interest rates are here to stay is no pleasant one for large swaths of the corporate sector following the freewheeling E-Z money epoch. Thus, S&P Global relayed last week that worldwide defaults registered at 50 over the first four months of the year, nearly double last year’s pace and 25% north of the 10-year average. The rating agency now pencils in a 4.25% default rate over the 12 months through next March, up from a 4% guesstimate for calendar 2023 as of April and a 2.5% trailing rate as of the end of the first quarter. 

Sellers of floating-rate, speculative-grade bank debt are similarly evincing growing stress. S&P’s tally of so-called weakest links – or leveraged loan issuers rated single-B-minus or lower along with a negative outlook – reached 148 at the end of the first quarter from 143 on Dec. 31 and 96 last summer. Meanwhile, rating downgrades outpaced upgrades by a 2.46:1 clip in March, marking the 10th consecutive month of such net credit demotions. As a result, 29% of the Morningstar LSTA Leveraged Loan Index now sports a single-B-minus rating, up from 25% two years ago, while the share of single-B-rated components has slipped to 23% from 29% over the same period.   

On the surface, at least, signs of trouble are nowhere to be seen in the stock market, as the S&P 500’s 8% year-to-date gains and euphoric price action for firms leveraged to the artificial intelligence craze (witness the 134% rip this year in mega-cap chipmaker Nvidia, encompassing the immediate reaction to its post-close earnings release) demonstrate.  Yet credit concerns are already manifesting in one respect: a Bloomberg compiled basket of U.S. companies with relatively strong balance sheets sits higher by 14.5% in the year-to-date through Tuesday, trouncing the 1.1% gain for a similar gauge of highly indebted firms. 

“Slowing economic growth calls for a focus on quality companies – those defined by high profit margins, low debt levels, high free cash flow yields and return on capital,” Helen Jewell, Global Director of Research for Fundamental Equities at BlackRock, tells Bloomberg today.

Might those dynamics take on a greater urgency as 2023 progresses? The average cash balance of S&P 500 components has dropped by 13% over the past 12 months, analysts at Goldman Sachs find. 

Recap May 24

Stocks remained in retreat with the S&P 500 slipping another 0.7%, while Treasurys finished mostly weaker, highlighted by more head-spinning volatility in short-dated bills as the debt ceiling negotiations drag on. Gold pulled back to $1,962 per ounce, WTI crude rallied to near $74 a barrel and the VIX managed to match a one-month high just above 20. 

- Philip Grant

BBB Advised
Tremors in investment grade:

Tremors in investment grade: the triple-B-rated portion of the Bloomberg U.S. Corporate Bond Index sports a 53-basis point yield premium to single-A’s as of this afternoon, up from 45-basis points in March and representing the largest such pickup in six months. 

That gradual creep wider comes as some $11.4 billion worth of formerly high-grade issuers were downgraded to junk by Barclays’ count in the first quarter. The investment bank predicts the full-year tally of so-called fallen angels will reach as much as $80 billion, a figure exceeded on only three occasions (2009, 2016 and 2020) over the past two decades.  

Performance Art
“No bears allowed,”

“No bears allowed,” read a sign at the entrance of last week’s spring bitcoin conference in Miami, reports The Wall Street Journal. Crypto bulls were likewise in shorter supply, as attendance at the annual conclave of true believers reportedly registered at about half of last year’s 26,000-strong headcount.  

Spirits weren’t exactly glum, however. A gospel choir led attendees in a rendition of “When the Saints go Marching in” Thursday with one singer carrying a “Hallelujah Bitcoin” sign, while pallbearers lifted an open casket filled with dollar bills and affixed with a “#FiatFuneral” label. “It’s really a pep rally. It’s really what this is,” Kurt Wuckert, Jr., chief bitcoin historian at CoinGeek, told the Journal.

Enthusiasts can use some extra encouragement, as digital assets are collectively valued at $1.14 trillion per Coinmarketcap.com following a 44% year-to-date rebound but remain at less than half of the $2.8 trillion seen in fall 2021. Beyond that still-daunting drawdown, a precipitous decline in trading activity highlights the industry’s malaise. Bitcoin liquidity on U.S. exchanges sits at roughly half its early 2023 levels, data provider Kaiko finds, while peer Coin Metrics relays that daily bitcoin trading volume sank to some $4 billion last week from $20 billion in early March. 

Helping drive the sharp curtailment in turnover: Bloomberg reported Friday that major proprietary players like Jane Street and Jump Trading have recently throttled back their crypto presence in response to enhanced scrutiny from U.S. regulators and the demise of industry mainstays Silvergate Bank and Signature Bank.  That retrenchment has duly rippled across the industry, as the Wall Street names “brought real gravitas and legitimacy to an industry that was kind of on the fringes and made it feel more mainstream, more secure,” Michael Safai, co-founder of London-based proprietary high-frequency crypto trading firm Dexterity Capital, told Bloomberg. “There’s [now] a bunch of other shops out there like us, that are so small that you have probably never heard of.” 

Waning activity makes for a curious contrast for one of the industry’s foremost pieces of financial artifice. So-called stablecoin tether, which is purportedly backed 1:1 by U.S. dollars and which serves as a prominent means for traders to convert their fiat to crypto and back again, saw its market value reach $82.9 billion yesterday, nearly matching the $83 billion peak logged in early 2022, despite daily volumes languishing at multi-year lows and market share remaining steady relative to competing tokens. 

The divergence is a “questionable” one, Kaiko concluded in a Monday analysis, which noted that “historically, changes in trade volume have been loosely correlated with changes in tether’s market cap, with occasional surges during periods of notable market activity. Today, the correlation is at zero.” For an early, skeptical look at the mechanics underpinning crypto’s Grand Central Station, see the Sept. 18, 2017 edition of Grant’s Interest Rate Observer.

While tether maintains its intriguing buoyancy, a fellow industry mainstay faces renewed questions about its treatment of customer assets. Reuters reports today that Binance, the world’s largest crypto exchange, comingled client funds with its own during late 2020 and 2021. Monies running into the billions of dollars were, reportedly, improperly mixed on a near-daily basis during that time, via accounts that Binance held at the aforementioned Silvergate Bank.  

For its part, Binance denied Reuters’ contention, with a spokesperson stating that the accounts in question “were not used to accept user deposits, [but rather] . . . to facilitate user purchases” of the bourse’s in-house dollar-backed crypto, BUSD. 

Former U.S. regulators took a dim view of those arguments, noting that, during the period in question, Binance’s website described such dollar transfers as “deposits” to be “credited” to customer trading accounts in BUSD, with those funds available for withdrawal as fiat currency. “These representations created the expectation that clients’ funds would be safeguarded in the same way as traditional cash deposits,” one anonymous regulatory alum added to Reuters. 

Of course, “safeguard” is a relative term in crypto. CoinDesk reports today that defunct digital exchange FTX may soon get another lease on life, as expense filings show that new CEO John Ray III spent nearly seven hours of April work time on items related to “2.0” (likely meaning FTX 2.0), “restart” or “reboot,” among other terms potentially pointing to a sequel to Sam Bankman-Fried’s disgraced outfit.  Those hints follow some hopeful commentary regarding a restart, as Ray told the WSJ in January that “everything is on the table. If there is a path forward on that, then not only will we explore that, we’ll do it.” 

To that end, animal spirits die hard, multi-billion-dollar (alleged) frauds aside.  FTX’s in-house FTT token snapped higher in response to the CoinDesk dispatch, pushing its market value to $375 million this morning from $315 million in the wee hours on Monday. 

Recap May 23

Stocks came under pressure with the S&P 500 slipping 1.1% for its worst showing in an even three weeks, though Treasurys finally caught a bid as the two-year yield fell three basis points to 4.26%, bolstered by a strong auction this afternoon. WTI crude rallied above $73 a barrel, gold stayed little changed at $1,977 an ounce and the VIX jumped above 18. 

- Philip Grant

Race to the Swift

From the New York Post:

They’re hoping to make money from it raining on Taylor Swift’s parade. Fans who braved the wild weather over the weekend to attend Swift’s concert in Foxborough, Mass., have come away with more than just an unforgettable experience — capturing rainwater in containers they’re now trying to sell online.

The pop star is currently performing the US leg of her sold-out Eras Tour, taking to the stage at Gillette Stadium on Saturday amid a heavy downpour. The “Anti-Hero” singer dazzled despite getting drenched in rain — which some entrepreneurial fans are capitalizing on and trying to flog online for $250.

 “Jealous I didn’t come up with this scam first,” one user commented on an Instagram post showing a screenshot of the optimistic seller.

The Secret Garden
Can't we all just get along?

Can’t we all just get along? President Joe Biden raised hopes for a Sino-American détente Sunday, telling the press that “I think you’re going to see that [relationship] begin to thaw very shortly.” He added that his administration may soon lift sanctions against Chinese defense minister Li Shangfu to help grease the diplomatic wheels. 

Beijing may not have received the memo. Thus, the Cyberspace Administration of China announced yesterday that it has banned essential infrastructure companies from using semiconductors produced by Boise, Idaho-headquartered Micron Technology, stating that the products pose “significant security risks to our critical infrastructure supply chain.”  

The implications of that move are unambiguous to some observers. “No one should understand this decision by CAC as anything but retaliation for U.S. export controls on semiconductors,” Holden Triplett, FBI counterintelligence official turned founder of consulting firm Trenchcoat Advisors, tells Bloomberg.  “No foreign business operating in China should be deceived by this subterfuge. These are political actions, pure and simple, and any business could be the next one to be made an example of.” 

In a similar vein, The Wall Street Journal reported Thursday that Nasdaq-listed trading platforms Futu Holdings and Tiger Brokers will remove online store apps allowing Chinese citizens to trade foreign stocks.  

Recent police raids of Western outfits including Bain Capital, Mintz Group and Capvision, along with the abrupt May 1 disconnection of data service Wind Information Co. for foreign users, likewise underscore the Middle Kingdom’s reluctance to share information with outsiders, a crackdown reportedly spearheaded by security service veteran Chen Yixin under orders from President-for-life Xi Jinping. Duly receiving the message, “some Western firms have paused research work in China, especially when related to technology and other sensitive areas,” the WSJ relayed Friday. 

Might non-geopolitical considerations figure in China’s self-imposed isolation? A titanic local government debt burden of some $14 trillion per Goldman Sachs – more than four times the equivalent figure in the U.S. – presents one such pressure point.  Importantly, the bulk of those borrowings are of the off-balance sheet variety, furnished by so-called local government financing vehicles (LGFVs), or entities that fund infrastructure projects central to China’s debt-driven, real estate-centric economic model. 

As the property market remains in the doldrums following the collapse of mega-developer China Evergrande and sweeping Covid-zero lockdowns, those municipalities are increasingly gasping for air, struggling to service their outsized borrowings.  

Bloomberg documented yesterday that the northeast city of Hegang, Heilongjiang Province, has been forced to enact drastic budget cuts to help manage a boated debt burden that stood at 209% of total fiscal income last year, leaving residents without heating last winter and government employees at risk of job loss along with belated or diminished pay. “Many cities will become like Hegang in a few years’ time,” warns Houze Song, economist at U.S. think tank MacroPolo. “The central government may be able to keep things stable in the short term by asking banks to roll over local governments’ debt,” but without such forbearance, “the reality is that over two-thirds of the localities won’t be able to repay their debt on time.”

Recent developments in the corporate realm likewise illustrate China’s fragile state of financial affairs. Dalian Wanda Group Co.’s double-B/single-B-plus-rated 6 7/8% notes due July 23 slumped to 70 cents from 75.5 today, marking the fourth consecutive selloff after the sprawling conglomerate detailed plans to downsize some business units while denying local media reports that heavy layoffs are forthcoming.  The 34-year-old firm’s fall from grace is striking, Bloomberg notes, considering that “Wanda was once viewed as among China’s few high-quality names in the junk bond market after paring leverage and selling assets” in the wake of a debt-driven shopping spree following the 2008 financial crisis.  

Considering that forbidding backdrop, it is perhaps no surprise that Xi and Co. have opted to pull down the metaphorical blinds. See the analysis “Great wall of paranoia” in the current issue of Grant’s Interest Rate Observer dated May 19 for an informed speculation on the state of China’s debt-driven “economic miracle.”  

Recap May 22

A flat showing for the S&P 500 masked visible strength elsewhere, as the small-cap Russell 2000 advanced 1.2% and the tech-heavy Nasdaq 100 rose 0.5%, while Treasurys were again unable to catch a bid as two- and 30-year yields each established multi-month highs at 4.29% and 3.97%, respectively.  Gold edged lower to $1,974 an ounce, WTI crude held near $72 a barrel and the VIX settled just above 17.

- Philip Grant

Intelligence Asset
There’s nothing artificial about his hype skills.

There’s nothing artificial about his hype skills. Here’s Elon Musk expounding on Tesla’s virtues in a most contemporary fashion Tuesday (hat tip @TheTranscript):

Very few people, even in the AI community, do not [sic] appreciate just how much capability Tesla has in AI. It's by far the most advanced real-world AI. There's no one even close.

Tesla shares are up 46% this year but remain 32% below levels seen when Grant’s Interest Rate Observer had its bearish say on Sept. 30. 

Communication Breakdown
In the words of screenwriter William Goldman, “nobody knows anything.”

In the words of screenwriter William Goldman, “nobody knows anything.” Investors have been thrown for a loop in attempting to divine the course of monetary policy, as evidenced by the helter-skelter path of interest rate futures. Markets currently anticipate 21% odds of a further 25-basis point increase to the current 5.08% funds rate at the June meeting; compared to 3% in early May and 31% on Thursday.

Spurring today’s reversal: dovish commentary from Fed chair Jerome Powell, who cited side effects from the central bank’s acute-yet-belated tightening from near zero in early 2022. “We’ve come a long way,” he said. “The stance of policy is restrictive, and we face uncertainty about the lagged effects of our tightening so far and about the extent of credit tightening from recent banking stresses.” 

Today’s remarks, fittingly delivered in a panel with uber-dovish, Nobel-prize winning predecessor Ben S. Bernanke, represent an evolution in the Fed head’s public messaging. Recall that Powell channeled Paul Volcker himself at his annual Jackson Hole address a mere nine months ago: 

The FOMC’s overarching focus right now is to bring inflation back down to our 2% goal. . . Without price stability, the economy does not work for anyone. . . The burdens of high inflation fall heaviest on those who are least able to bear them.

While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.

One of Powell’s more prominent colleagues, meanwhile, carries a torch for the ultra-low borrowing costs of yore, despite the 5.5% annual increase in April core CPI. New York Fed President John Williams waded into hypotheticals in Washington D.C. this morning, informing listeners-in that the so-called r-star, or “the real short-term interest rate expected to prevail when an economy is at full strength and inflation is stable” remains near 1%, in-line with its pre-virus level and below the 2% to 3.5% range seen from 1985 to the financial crisis. “Importantly, there is no evidence that the era of very low natural rates of interest has ended,” Williams concluded. 

Imaginary interest rates aside, the Fed has company in its current predicament, as policymakers at the Bank of England and European Central Bank likewise contend with the consequences of their failure to identify bourgeoning inflationary pressures and throttle back on Covid-era stimulus showers in a timely manner.  

Stephen King, senior economic advisor to HSBC, argues in the Financial Times today that monetary mandarins’ overconfidence in their own ability to shape public expectations surrounding inflation backfires when reality doesn’t comport. As price pressures mount and persist contrary to policymaker messaging, the citizenry instead comes to believe that “the central bank is talking nonsense,” spurring aggressive rate hikes in a bid to maintain institutional credibility. 

To that end, a new report from the ECB today shines a light on off-the-record musings from central bankers to the press, discovering that 368 news stories over the 20 years through 2021 were based on such leaks. “Our findings suggest that market participants would be well advised to ignore such unattributed communications in most cases,” the authors conclude.

Attributed ones, too, perhaps. 

Recap May 19

Stocks finished just south of unchanged to wrap up another banner week for the bulls with 1.5% and 3.6% gains for the S&P 500 and Nasdaq 100, respectively.  Treasurys traded weaker once more, with the policy-sensitive two-year yield rising to 4.28% from 4.24% yesterday (not 4.02% as typo’d here) and the long bond likewise rising four basis points to 3.95%. Gold bounced to $1,978 an ounce, WTI crude remained near $72 a barrel and the VIX edged higher towards 17. 

- Philip Grant

Ceiling Fan
D.C. drama spills onto Wall Street.

D.C. drama spills onto Wall Street. The normally staid market for short-term U.S. obligations continues to spasm in response to the ongoing debt ceiling debacle, as Treasury sold $35 billion of four-week bills this afternoon at 5.37%. That’s down from 5.6% in last week’s auction and a record 5.84% rate in early May, though sharply above the 3.19% on offer less than a month ago.  Underscoring the preternatural volatility: existing four-week bills yielded between 5.52% and 5.22% in today’s session alone. 

While investors and pundits alike read the political tea leaves, the aftermath of an agreement could prove dicey, one observer warns. Ari Bergmann, founder of fund manager Penso Advisors, predicts to Bloomberg that once the debt ceiling is raised, Treasury will burnish its dwindling coffers by selling upwards of $1 trillion of bills by September. Such a deluge would serve to sop up cash currently parked at banks and in other assets. “We’ve seen before that such a drop in liquidity really does negatively affect risk markets, such as equities and credit,” he said. 

Slickered Up
Sticker shock abounds for New York City apartment dwellers.

Sticker shock abounds for New York City apartment dwellers. Median rental prices in Manhattan, Brooklyn and northwest Queens (comprising Long Island City and Astoria) each established new record highs last month, a report today from appraiser Miller Samuel and brokerage Douglas Elliman Real Estate finds.  

In Manhattan, the median rent registered at $4,241 per month in April, up 1.6% from March’s previous high-water mark and an 8.1% year-over-year increase, while the luxury category registered a 13% increase to $11,310.  In Brooklyn, median prices surged 14.8% from April 2022 to $3,473, while northwest Queens apartment residents coughed up $3,663 per month at the midpoint, up a hefty 6.7% from March and 12.8% above the year-ago figure. 

“There’s a lot of demand and it’s not just for one type of apartment,” Miller Samuel president and one-half eponym Jonathan Miller relays to Bloomberg. “This is an equal opportunity pain-maker for tenants.”  Evidence of such financial discomfort may be taking shape. Manhattan lease signings totaled 3,869 in April, off 20% from the prior month; typically, leasing activity picks up as spring progresses.

Conditions some 90 miles to the east mark a stark contrast with the acute and broad-based pricing pressure faced by Big Apple residents.  As CNBC reported yesterday, price cuts of 20% or more are de rigueur in the Hamptons this summer, as teeming rental supply meets with downshifting demand following a poor Wall Street bonus season in 2022 and announced job cuts at various bulge bracket banks.  

Simple mean reversion also factors in the drought following the Covid-induced sonic boom:  median sales prices skyrocketed to $1.2 million in 2020, up 40% year-over-year.  With the pandemic in the rear view, area newcomers who anted up now face a rude awakening: “I’ve got clients coming to me saying, ‘I want to rent my house for $250,000,’” Corcoran Group broker Gary DePersia told CNBC. “I tell them it’s not realistic anymore. The game has changed.” 

Indeed, the absentee owner of a Central Park South penthouse may be reaching a similar conclusion. Saudi real estate tycoon Fawaz Alhokair cut the asking price for his six-bedroom, panoramic-view trophy apartment at 432 Park Avenue by more than 20% to $130 million, The Wall Street Journal reports today, ending an unsuccessful, two-year quest to offload the unit at a $169 million price tag. Alhokair spent nary an evening in the property after acquiring it in 2016 for $87.66 million, listing agent Tal Alexander told the WSJ, adding that “we’re in an environment now where no one necessarily wants to pay the asking prices. People want to make a deal.”

Might a similar dynamic be taking shape for non-NYC based financial mortals? Nationwide median prices of so-called existing homes (as opposed to those on the metaverse) slipped to $388,800 last month, the National Association of Realtors relays, down 1.7% from April 2022 to mark the worst such year-over-year showing in over a decade. That data series now sits 6% south of the $413,800 peak logged last June. 

QT Progress Report
Reserve Bank credit ticked lower by $12 billion from last week.  That leaves the Fed’s holdings of interest-bearing assets at $8.448 trillion, down $476 billion from the March 2022 highs and $135 billion above the pre-Silicon Valley Bank collapse level. 
Recap May 18

Stocks rolled higher again as the bulls have seized command following the recent sideways stalemate, as the Nasdaq 100 logged a fresh 52-week high with a cool 27.5% year-to-date advance. Treasurys remained under pressure, however, as two-year yields popped 12 basis points higher to 4.24%, while the 10-year settled at 3.65%, its highest since March 10.  WTI crude slipped to $72 a barrel, gold tumbled to a two month low at $1,960 a barrel and the VIX retreated to 16. 

- Philip Grant

Heal Thyself

Pfizer, Inc. has launched a mammoth $31 billion, eight-part offering of senior unsecured notes to help fund the purchase of biotech firm Seagen, Inc. Today’s sale, the fourth-largest corporate bond sale in history, attracted a cool $85 billion order book for the provisionally single-A-plus-rated obligations, Bloomberg relays, which feature maturity ranges of between two and 40 years. 

Thanks to that brisk demand, each of the eight tranches projects to price some 20 basis points inside of initial price talk as of this afternoon, with the 40-year maturity set to carry a 165-basis point pickup to Treasurys. For context, the single-A-rated portion of the Bloomberg U.S. Corporate Bond Index sports a 126-basis point option-adjusted spread. 

East of Eden
Good things come to those who wait (and wait).

Good things come to those who wait (and wait). Japan’s Topix Index logged a 0.6% gain Tuesday, pushing year-to-date gains to 13.9% in local currency terms and leaving that gauge at a 33-year high. The market cap-weighted Topix remains 26% below its blow-off peak logged in the late stages of 1989 in nominal terms, with a 19% return over that stretch after accounting for reinvested dividends.   

An influx of overseas capital colors today’s market milestone. Citing data from the Tokyo Stock Exchange (TSE), the Financial Times relays that net inflows from non-Japanese investors reached nearly $30 billion over the past five weeks, among the largest such outlays over the past 10 years. 

That’s not to say that foreigners are suddenly enamored of the Land of the Rising Sun: Bank of America’s latest Global Fund Manager Survey, undertaken in early May and released this morning, shows that respondents were a net 11 percentage points underweight Japan on average, down slightly from minus 10 percentage points in the prior reading. While the Topix has been spinning its wheels for more than three decades following the titanic 1980s equity and real estate bubble, the S&P 500 has returned more than 2,000% since the start of 1990. 

Might better days finally be ahead? “We have entered a two- to three-year bull market period for Japan now,” Macquarie deputy head of Japan research Neil Newman told Bloomberg. “This has legs. Liquidity is good and with corporate earnings looking solid now, [Japan] will draw further attention.”

Structural factors also loom large, in the form of an institutional nudge for publicly traded firms to enact investor-friendly reforms. Last year, the Japan Exchange Group rolled out a reorganization of the Tokyo Stock Exchange, creating a “prime” category of the Topix earmarked for constituents who “center their business on constructive dialogue with global investors.” More recently, newly minted Japan Exchange Group head Hiromi Yamaji urged executives to focus on improving shareholder returns last month, while the TSE in January ordered member firms trading at less than book value to draft capital improvement plans to remedy that state of affairs.  

Sure enough, dividends and buybacks reached nearly ¥27 trillion ($200 billion) over the 12 months through March, data from Jefferies show, up from ¥19 trillion two years earlier.  “More has happened with this [project] in the last two years than in the [prior] 30,” Jeff Atherton, head of Japan equities at Man GLG, told the FT. Even so, nearly half of publicly traded Japanese firms still sport net cash on their balance sheet, the brokerage finds, compared to 22% in the U.S.

Warren Buffett’s imprimatur further underscores Japan’s investment story.  Berkshire Hathaway’s boss visited the nation last month, revealing that his firm has upsized its stakes in Japan’s five largest trading houses, or wide-ranging conglomerates, and may further ratchet up its position in the coming months. 

Preceding the Oracle of Omaha by some six months, Grant’s Interest Rate Observer levied a bullish verdict on trading house Mitsubishi Corp. in the Feb. 7, 2020 issue (shares are since up 73% in dollar terms, compared to 31% for the S&P 500) also flagging the publicly traded Nippon Active Value Fund as a way to potentially capitalize on nascent investor activism, with that vehicle since returning 48% in dollar terms. “You have the beginning of something that really hasn’t existed before, and that is a market for corporate control in the Japanese context,” Gifford Combs, a member of Nippon Active Value Fund’s investment adviser, relayed to Grant’s in spring 2021.  

Relatively undemanding valuations – witness the sub-14 times price-to-forward earnings multiple for the Topix, compared to a bit more than 18 times stateside – complement the bull case. “You can find value in almost any sector in Japan,” Kevin Durkin, founder and chief investment officer of Ballina Capital LLC, reported to Grant’s last month.  See the issue of Grant’s Interest Rate Observer dated April 21 for a profile of the investor, featuring a trio of long ideas to play a further capital markets revival in the world’s third-largest economy. 

Recap May 16

Red was in fashion today:  Treasury yields rose across the board with the long bond settling at 3.87% for its most elevated finish since the day before Silicon Valley collapsed in early March.  Stocks absorbed a late selloff as the S&P 500 settled some 0.7% lower, gold fell to $1,993 an ounce and WTI crude slipped below $71 a barrel. For its part, the VIX jumped 5% to 18. 

- Philip Grant

Range Rover

Dog day doldrums have rolled in early this year, as the S&P 500 has finished each of the last six weeks with a sub 1% move in either direction.  As Charles Schwab chief investment strategist Liz Ann Sonders notes today, on only a single occasion last year did the major average go even two weeks without moving by at least 1%. 

This preternatural calm is testing the patience of some observers, Citigroup strategist Stuart Kaiser contends, writing today that “the past six months is among the most painful range [trading environments] since 1980.” 

What Seems to be the Problem, Officer?
The calm before the storm, perhaps.

The calm before the storm, perhaps. Last week’s reading of the Federal Reserve’s most recent quarterly survey of senior loan officers was a “snooze,” strategists at Bank of America wrote Friday, providing “little new information away from the obvious, [that] banks didn’t feel good about lending in late March” in the wake of Silicon Valley Bank’s demise and related stress among regional lenders.  A net 46% of respondents reported tightening credit to small and medium sized businesses, up slightly from 44.8% in the prior poll. 

Though the early-spring credit curtailment is readily explainable, high-yield investors should nonetheless take careful heed of that dynamic.  Going back to 1997, the proportion of loan officers tightening credit compared to those easing it has never been as high as its current level outside of recession, Lehmann, Livian, Fridson Advisors chief investment officer Marty Fridson relayed Sunday.  

Considering that the metric accounts for nearly half of long-term variance in high-yield spreads over time, by Fridson’s assessment, spreads are accordingly “way out of line,” the dean of high-yield argues. Prior to this year, the narrowest monthly spread seen during periods of a net 40 to 49.9 percentage point tightening in the survey going back to 1997 was 644 basis points, with the median gap registering at 771 basis points. By contrast, the option-adjusted spread on the ICE BofAML High Yield Index finished Friday at just 476 basis points. 

What’s more, the distress ratio, or share of junk issues trading at a 1,000-basis point spread, stood at just 9.9% as of Friday, far below the historic range of 17.61% to 38.75% seen during similar bank lending backdrops. “The only explanation I can see for the market’s extraordinarily low perception of credit risk in the face of very tight credit is overoptimism about how soon the Fed will reverse course and start lowering interest rates,” Fridson concludes.

To that end, futures markets now price 90% odds of a 25-basis point decrease in the benchmark Funds rate by November, arguably a fanciful expectation considering persistent price pressures and relatively calm financial conditions. Though measured inflation has steadily waned to 4.9% last month from 9.1% in June, further progress may be harder to come by. So-called core CPI, which excludes food and energy prices, grew 5.5% from last year, not far below its post-Covid peak of 6.6% in September.  “It’s really hard to see core inflation coming down to anything that’s approaching 2% by the end of this year,” Omiar Sharif, president of research firm Inflation Insights, told the Financial Times, adding “we’ll be fortunate to be about double that.”  Atlanta Fed President Raphael Bostic delivered a similar message on CNBC this morning, declaring that “my baseline case is we won’t really be thinking about cutting rates until well into 2024.”

Speculative-grade borrowers are accordingly obliged to pay up: from the start of April through May 9, new high-yield offerings priced at an 8.77% all-in-yield on average according to PitchBook, up from 8.16% in the first quarter from just over 5% in the spring of 2021.  Then, too, increasingly picky creditors foment a bifurcated backdrop. “If you give that kind of double-B [rated], less cyclical, really good business model impression in the marketplace, you can, for the most part, get the terms you want,” Will Smith, director of U.S. high yield credit at AllianceBernstein, told PitchBook. “But if you’re in that other camp, the trickier situations, that’s where investors are still driving the truck, if you will, and are able to get more investor protection, tighter covenant language, less leverage, etc.” 

A raft of announced restructurings brings the rugged conditions for the bottom of the credit barrel into sharp relief. Over the past 48 hours, seven large companies have filed for Chapter 11 bankruptcy protection, Bloomberg relays this morning. That’s the largest two-day tally among firms with at least $50 million in liabilities since at least 2008. 

Recap May 15

Stocks caught a modest bid as the S&P 500 rose one-third of a percent, while Treasurys came under some pressure on the long end with 30-year yields settling at 3.84% from 3.78% Friday. Gold finished little changed at $2,021 per ounce, WTI crude edged back above $71 a barrel and the VIX settled just north of 17. 

- Philip Grant

Some Assembly Required
Omaha is so last week.

Omaha is so last week. From the New York Times:

The city of Kyle, Texas, is calling all Kyles, from anywhere in the world, to join their similarly named brethren at a fair this month. The assignment: Snatch the world record for the largest meeting of people with the same first name, set in 2017, when 2,325 men called Ivan gathered in a town in Bosnia.

The gathering of Kyles, from May 19 to 21, will be the city’s first ever Kyle Fair. . . An 11,000-strong community of Kyles on Reddit, known as a “place for Kyles and Kyle enthusiasts,” shared links to the Texas event, seeking carpools and spreading the word.

“My fellow brothers, it is now our time!” a Kyle wrote.

The Cheese Stands Alone
Talk about haves- and have-nots.

Talk about haves- and have-nots. Large cap technology firms continue to carry the load for the bull crowd, with the S&P 500 Information Technology subsector up 21% this year. Driving that strength: the NYSE’s FANG+ Index, an equal-weighted ten-stock gauge of mainstays like Apple, Amazon, Tesla and Nvidia, has logged an eye-popping 45% advance thus far in 2023, pushing the group’s collective market capitalization above $9 trillion from $6.5 trillion at year-end. 

That $2.5 trillion in additional market cap virtually matches gains for the broad S&P 500 – which is up 8% in the year-to-date – while an equally weighted version of the broad index remains stuck almost unchanged. Let’s review some of the factors driving that striking dynamic.

The budding artificial intelligence boom, spurred by the splashy debut of Microsoft-backed ChatGPT, looms large: witness the 96% upside jolt for Nvidia shares since January. Strategists at Société Générale conclude today that “without the AI-popular stocks, the S&P 500 would be down 2% this year.”  That dynamic is certainly not lost on the rest of Silicon Valley, as Alphabet, Meta Platforms, Microsoft, Amazon and Apple collectively mentioned “AI” 190 times on their first quarter conference calls, Statista analyst Felix Richter relayed yesterday, up from 36 a year ago. 

Persistent stock purchases likewise play their role. Apple, Microsoft, Alphabet and Meta have collectively spent $50 billion on buybacks this year through Wednesday according to Bloomberg.

Though that’s 10% below last year’s pace, the S&P 500 at large has seen a 24% decrease in repurchase activity, pushing that quartet’s share of total buybacks to 27% from 24% at this stage in 2022.  “These companies still print lots and lots of cash and they’ve got to find somewhere to deploy that cash,” noted Scott Landner, chief investment officer at Horizon Investments. 

Financial nip-and-tucks have likewise served as a tailwind. As The Wall Street Journal documented last week, tech firms including Alphabet, Meta, Microsoft and Amazon are burnishing their income statements by extending the useful life of servers, network equipment and other key assets. That accounting maneuver serves to decrease depreciation expense by spreading the cost over a longer period: servers’ average useful life now stands at about 5.6 years, research firm Omdia finds, up from 5.2 years in 2021 and 2022. 

In the case of Alphabet, that change served to add $770 million of net income over the three months through March, equivalent to 5.1% of its bottom line. In February Google’s parent company projected a $3.4 billion drop in depreciation expense this year relative to 2022. 

Some observers are skeptical over the lasting utility of those tweaks: “You’re going to see a boost in net income in current quarters that isn’t a sustainable growth mechanism,” Kris Bennatti, chief executive of investment research firm Bedrock AI, told the WSJ. “Investors and the rest of the market will just have to be careful to know what’s driving those profitability figures,” added Julie Bhusal Sharma, technology equity analyst at Morningstar.

Meanwhile, earnings prospects are on the wane, as Wall Street now expects the S&P 500 technology sector to log a 7.3% annual decline in profits for the second quarter according to data from Bloomberg, compared to a negative 6.3% guesstimate as of March 31. Likewise, the sell-side now pencils in a 1.5% year-over-year decline in third quarter earnings per share, down from a positive 0.6% figure six weeks ago.  

Though such downshifts in earnings expectations are not unusual, rich valuations leave the bulls with limited room for error: the S&P 500 technology group now trades at more than 26 times forward earnings estimates, compared to a 10-year average valuation of roughly 20 times, while the NYSE FANG+ gauge commands a 35-times forward earnings multiple, up from just under 20 last fall. “It’s just too rich for my blood,” comments Bloomberg analyst Michael Casper on the sector. “The fundamental picture still isn’t where you want it to be.” 

Recap May 12

Stocks again finished little changed on the S&P 500 as the broad index finished a forgettable week 0.3% lower, while Treasurys came for sale with the two-year yield jumping nine basis points to 3.98% and the long bond rising to 3.78% from 3.73% yesterday. WTI crude fell to $70 per barrel, gold edged lower to $2,016 an ounce and the VIX crept above 17. 

- Philip Grant

Brilliant Disguise

What’s the opposite of a perfect crime? From WDAF-ABC, Kansas City:

Deputies in Kansas stopped a driver on Friday who may have been having a little too much fun on Cinco de Mayo. Franklin County deputies south of the metro pulled over a suspected drunk driver in the northbound lanes of Interstate 35. 

When they asked the driver to exit his car for a field sobriety test, deputies discovered he wore a Bud Light beer can costume over his clothes. Deputies eventually arrested the driver on suspicion of driving under the influence and transported him to the Franklin County, Kansas Jail in Ottawa. The suspect has since posted bond and is no longer in custody.

Shift Key
There’s plenty of junk for everyone.

There’s plenty of junk for everyone. Primary activity in the high-yield market remains on the upswing, as a pair of deals for a combined $1.5 billion priced yesterday, leaving month-to-date supply at nearly $9 billion, per data from Bloomberg. That’s already double the full-month output logged in May 2022. Year-to-date issuance now stands above $65 billion, on track to easily eclipse last year’s paltry $102 billion. 

Spreads likewise evince relative calm, as the ICE BofAML High Yield Index finished yesterday at a 478-basis point option-adjusted pickup over Treasurys, in line with May 2022 levels and only modestly wider than the pre-pandemic baseline in fall 2019.

Fair financial weather in the asset class has not gone unnoticed. Bloomberg reported Tuesday that speculative-grade credit investors have increasingly favored high-yield over leveraged loans, as the prospect of stabilizing or even declining borrowing costs in response to slowing inflation spurs a migration to fixed- from floating-rate securities.  

Diverging credit quality likewise looms large, as Barclays strategist Bradley Rogoff finds that 47% of high-yield index constituents are rated double-B (the penthouse of junk), compared to a 31% share within leveraged loans. “Some of the improvement in the high-yield market is directly attributed to more aggressive lending in the loan market,” Michael Chang, senior portfolio manager at Vanguard Group, told Bloomberg. 

Sure enough, trailing 12-month loan default rates rose by 90 basis points to 3.1% between December and March, UBS strategist Matthew Mish calculates, while junk bond defaults rose by a modest 30 basis points over the same period, to 2.1%. Loans will default at an 8.5% clip by March 2024, Mish guesstimates, compared to 6% for high yield. Barclays’ Rogoff concurs with that sentiment, relaying thus: 

We see early warnings of increasing stress for smaller issuers amid severely tightening lending standards. We expect defaults to rise from here, and believe loans will be affected sooner.

Then, too, leveraged lenders can expect an additional dose of pain in case of restructuring, thanks to now-ubiquitous lax legal documentations known as “covenant-lite.” Armen Panossian and Danielle Poli, managing directors at Oaktree Capital Management, highlighted that dynamic in an April 20 analysis, warning that recovery rates for defaulted loans will wane relative to their long-term average of about 65% and adding that “we’re in a credit picker’s market and dispersion by sector and issuer is likely to increase moving forward.” By contrast, defaulted junk bonds should expect to recover about 40 cents on the dollar, the pair believe, in-line with the historical norm. 

More broadly, the confluence of a cooling economy, abrupt lurch higher in borrowing costs and ongoing retrenchment in bank lending activity helps make for a precarious backdrop. New York University Finance Professor and financial historian Edward Altman sounded the alarm in a May 3 analysis for the Creditor Rights Coalition, concluding that the worm has turned, and not for the better:

My current assessment is that the benign credit cycle we have enjoyed since 2010, with the exception of a few months in early 2020, is over. We recently reached an inflection point to an average credit risk scenario. 

If we continue to incur unexpected shock catalysts, similar to the recent Crypto and Silicon Valley Bank and other banking meltdowns, combined with a “hard-landing” economic recession, we could witness another financial-credit crisis, with non-financial corporate risky debt default rates rising to perhaps 10%, or more, over one or two years.

QT Progress Report
A $42 billion weekly decline in Reserve Bank credit leaves interest-bearing assets on the Fed balance sheet at $8.46 trillion.  That’s 5.2% below the March 2022 highs, and 1.8% above the Fed’s holdings two months ago just before Silicon Valley Bank went to heaven.
Recap May 11
Scoreboard Watching
The results are (mostly) in.

The results are (mostly) in.  With 91% of domestic investment-grade issuers having reported first quarter figures, earnings per share and revenue topped consensus estimates by 5.7% and 2.3% on average, respectively, well above the pre-virus baselines of 3.7% and 0.7%, strategists at Bank of America tabulate.

An apples-to-apples comparison lends itself to a less sunny conclusion, however. Excluding the particularly volatile energy and financials categories, earnings in the first quarter slumped 8.3% year-over-year on a nominal basis, while revenues rose 3.3%, well below measured inflation. That follows a 10.9% annual decline in fourth quarter earnings among the ex-energy and financials contingent. 

'Iye of the Storm
It’s voter appreciation season by the Bosporus.

It’s voter appreciation season by the Bosporus. As hotly contested Turkish elections loom on Sunday, President Recep Tayyip Erdogan spares no expense in his efforts to keep the big chair, unveiling a 45% pay hike for some 700,000 government employees yesterday, while vowing that he will “not let anyone be crushed by inflation.”  

That outlay follows an April 23 announcement that households would enjoy free natural gas for a month, complementing other recent gifts from the public purse including subsidized electricity prices, increased pensions for the public sector and free internet for students. Various polls show Erdogan locked in a tight race with opposition coalition head Kemal Kiliçdaroglu, with a May 28 runoff in store if neither candidate manages to garner 50% of the vote.

Relatively good news on the inflation front colors the strongman’s generosity, as measured inflation fell to 43.7% year-over-year last month, down from 50.5% in March and a cool 85% in October. Then again, food prices jumped 54% over the 12 months through April, while the lira remains stuck near record lows against the dollar, having lost 65% of its exchange value since early 2021. 

By way of response, Erdogan obliged the Central Bank of the Republic of Turkey to cut interest rates to 8.5% from 14% last year in hopes of bringing down inflation, removing a trio of governors since 2019 who were not inclined to play ball with his counterintuitive easy-money strategy.  “We used to be able to buy three to four bags of groceries for 150 to 200 lira,” Istanbul-based barber Hakim Ekinci laments to Reuters. “Now we can barely fill two bags.” 

What’s more, Turkish authorities have spent no small sum of financial firepower to prop up the faltering currency. The CBRT has burned through nearly $177 billion via backdoor interventions since December 2021 – equivalent to nearly 20% of nominal output last year – Bloomberg  economics calculated yesterday, with April’s tally alone topping $30 billion as the imminent elections ratchet up urgency among the political class. Net of swaps (i.e., short-term borrowings from local banks), central bank reserves slumped a further $10.5 billion last month to reach negative $68.4 billion. 

Balance of payment shortfalls likewise continue to mount. Turkey’s current account deficit footed to 5.5% of GDP across 2022, up from a 0.9% such gap in the prior year, leaving the external financing hole (which also includes debt maturities) at upwards of $230 billion, or about one-quarter of nominal output. “Another year with current policies would be impossible,” Caglar Gogus, CEO of Turkish conglomerate Dogan Holdings, told the Dunya newspaper. 

One thing’s for sure, foreign financiers aren’t sticking around to find out. Non-Turks now hold just 0.68% of domestic sovereign debt per the finance ministry, down from nearly 20% in 2017, while net external assets now stand at minus $10 billion after accounting for swaps according to Goldman Sachs, down from positive $17 billion at the start of 2023. 

Regardless of the ultimate election outcome, might an imminent course correction spur better days ahead? “If [Erdogan] was to change his view and adopt a more conventional policy, it will be very well received,” a senior emerging markets banker told the Financial Times Monday, hopefully musing that, in the event the incumbent emerges victorious, he may “realize now is the time he can pivot and re-attract foreign funds.” 

Kieran Curtis, head of EM local currency debt at U.K.-based assert manager Abrdn, added that “to the market, it doesn’t matter who is doing the policy. It’s a matter of [Turkey] doing the policy.” Tellingly, perhaps, economists now collectively project that the benchmark one-week repo rate will jump back to 23% by year end, data collected by Bloomberg show, nearly triple the current level.

If something can’t go on forever, it won’t – probably. 

Recap May 10

Stocks finished higher by one-half percent on the S&P 500 in see-saw trading following a slightly softer than expected reading of April headline CPI, while Treasurys caught a bull-steepening bid with two-year yields diving 11 basis points to 3.9% and the long bond settling at 3.8% from 3.85% Tuesday.  Gold edged lower to $2,038 an ounce, WTI crude slipped below $73 a barrel and the VIX slumped below 16.5. 

- Philip Grant

Silent Partners

From Bloomberg:

JetBlue Airways Corp. orchestrated a campaign to flood the government with thousands of comments in favor of the airline’s bid to merge with Spirit Airlines, Inc. – including some from employees who said they didn’t write them and don’t support the deal.

Roughly 90% of the more than 10,000 comments on the Transportation Department’s public comment page are identical and are identified as coming from JetBlue and Spirit crew members who wrote that they believe the $3.8 billion merger will improve their lives, according to a Bloomberg News review of the database.

It’s not uncommon for U.S. airlines to ask employees to email or call members of Congress to lobby on a particular issue, sometimes providing wording or forms that could be filled out. Carriers used such an effort to help secure $54 billion in federal aid during the pandemic.

But critics have complained for years that it’s too easy for special interests to game public comments to the government. . . The New York Attorney General, in a 2021 report, found that more than 80% of the 22 million comments on Federal Communications Commission net neutrality rules were fake.

Leaping up with the Joneses
Fingers crossed for tomorrow’s CPI report,

Fingers crossed for tomorrow’s CPI report, but Friday’s reading of April employment data provided little comfort to those hoping for an end to the sharpest monetary tightening cycle of the past four decades. Nonfarm payrolls rose by 253,000, topping the 185,000 consensuses, while measured unemployment registered at just 3.4%, matching the lowest levels in 54 years.  

Average hourly earnings meanwhile accelerated to a 4.4% annual growth rate, up from 4.3% in March and defying economist expectations of a downshift to 4.2%. On a sequential basis, wages increased 0.5%, the sharpest one month since March 2022, when headline CPI growth topped 8%. 

Data from non-government sources likewise point to an ongoing paradigm shift for employee compensation, as Economic Policy Institute’s nominal wage tracker for April shows a 4.5% From 2010 through the eve of the pandemic, that metric popped above 3.5% on only a single occasion. “The Fed left the door open for additional hikes [last week] for a reason,” KPMG chief economist Diane Swonk commented to Bloomberg. “The data are not as reassuring on a pause as we would like.”

As persistent pay hikes potentially spur further policy response in the U.S., staffers in Japan face a more forbidding backdrop. Nominal wages in Japan increased 0.8% from a year ago in March, data released today reveal, the 15th straight increase but the third straight month featuring a sub 1% bump from the same period in 2022. Headline inflation meanwhile chugged along at a 3.7% clip, leaving real wage growth in negative territory for a 12th consecutive reading. 

That cumulative shortfall may be beginning to bite, as household spending fell 1.9% year-over-year in March, far below expectations of a 0.4% increase and the largest such decline in 12 months. Overall, the average wage-earner saw a meager 6% nominal raise from 1990 to 2021 per the Finance Ministry. Stateside, increases totaled 50% over the same stretch. 

Might corporate Japan be obliged to loosen the purse strings to burnish faltering employee purchasing power?  Larger companies committed to average wage increases of nearly 3% in annual “shunto” spring negotiations, Reuters reported in March, citing the Keidanren business lobby, exceeding the previous recent peak of 2.9% back in 1997.  Smaller firms are likewise targeting 3% annual wage hikes on average according to the Rengo labor union, up from 1.9% last year. 

The Bank of Japan is optimistic that a virtuous cycle can take hold, as newly installed BoJ governor Kazuo Ueda declared in a press conference last week that “there is a good chance that we [soon] reach the conclusion that sustainable 2% inflation will be achieved by looking at economic variables that would impact next year’s wages.”  

Generating ‘’sustainable” inflation has been no problem on the Old Continent, as preliminary April CPI data showed a 7% annual headline increase across the eurozone, topping the expected 6.9% and marking the 13th reading of 7% or more in the last 14 months, while core CPI advanced at a 5.6% pace, just off the record 5.7% print for the common-currency era logged in March.  Accordingly, more rate hikes are in the cards, European Central Bank’s Klaas Knot declared on Dutch television Sunday: “we have more ground to cover, and we are not pausing.”

Signs of stabilization, at least, are evident, as an ECB survey of 61 large employers last week found that wages will increase 5% over the next year on average, matching a similar poll conducted in February.  Not everyone at the central bank is cheering that development, however. As the Financial Times reports today, the ECB has launched a staff wage review to “consider proposals for semi-automatic salary increases when prices rise.” That initiative comes amid union displeasure with the ECB’s 4.07% pay increase in 2023, which was less than half of the 8.5% uptick in CPI. 

For their part, ECB negotiators noted that staff turnover was only 1.3% in 2022, implying solid employee satisfaction (or inertia). Besides, as ECB President Christine Lagarde reflected back in fall 2019:

We should be happier to have a job than to have our savings protected. . . I think that it is in this spirit that monetary policy has been decided by my predecessors and I think they made quite a beneficial choice.

Everybody happy?

Recap May 9

Stocks and Treasurys each came under modest pressure with the S&P 500 slipping 0.4%, and 10-year yield rising a basis point to 3.53%. WTI crude edged to $73.5 a barrel, gold climbed to $2,042 per ounce and the VIX rallied nearly a point to approach 18. 

- Philip Grant

Wide Right
Bills lose again.

Bills lose again. The U.S. Treasury sold three-month obligations at 5.14% this afternoon, up from an average 4.95% over the previous six auctions and marking the highest interest rate for that tenor in 22 years. That follows Thursday’s eye-catching issuance of $50 billion in four-week bills at a hefty 5.84%, the highest on record going back to the turn of the century and sharply above the 3.83% logged in the prior sale on April 26, after Treasury Secretary Janet Yellen warned that the government is on pace to breach the debt ceiling by June 1 if lawmakers fail to reach an agreement on raising the cap. 

“The optics are not great for Treasury debt when you see gap moves in auction yields,” Subadra Rajappa, head of U.S. interest rate strategy at Société Générale, told Bloomberg.  One thing’s for sure, a visual representation of short-term borrowing costs since the turn of the century is worth at least 1,000 words:

Three-month U.S. Treasury bill auction yields. Source: The Bloomberg

Herd Migration
A Sunday night rug-pull:

A Sunday night rug-pull:  The world’s largest crypto exchange closed the exit doors in the wee hours, as Binance twice suspended bitcoin withdrawals overnight, citing a “a congestion issue” stemming from “the large volume of pending transactions.” Binance relayed in a tweet that it will increase fees for pending transactions to encourage miners to process them, adding that “rest assured, [customer] funds are SAFU,” meaning safe under industry jargon. 

A barrage of trading volumes indeed spurred that service interruption, as 24-hour turnover on the digital bourse reached $6.9 billion as of this morning per Coinmarketcap.com, more than eight times the closest competitor.  As CNBC points out, the episode underscores structural limitations within the bitcoin network: namely, transactions get processed at a rate of seven to 10 per second, “making it unviable as a major global payment platform.” For context, Visa handles roughly 24,000 transactions per second. 

While Binance labors to keep its operations running smoothly, an industry peer attempts to beat the heat from Washington D.C. Coinbase CEO Brian Armstrong took to CNBC this morning to protest Securities and Exchange Commission chair Gary Gensler’s assertions that Coinbase improperly sells unregistered securities to investors, arguing that the regulator is out of step with fellow financial policymakers. “The SEC is a bit of an outlier here. . .I don’t think [Gensler] is necessarily trying to regulate the industry as much as curtail it.”  Recall that in March the SEC issued Coinbase a Wells Notice, i.e., a warning that enforcement action is forthcoming. Upwards of 35% of Coinbase revenues could be at risk depending on the government’s course of action, analysts at Jefferies guesstimate. 

Accordingly, Coinbase looks overseas to drive growth.  Continuing his media tour at the Dubai Fintech Summit, Armstrong told Bloomberg Television that “we are looking for a home to set up an international hub that could serve the long tail of countries in the world,” adding that the United Arab Emirates could fit the bill: “I would say that the UAE’s [regulatory] approach has been more forward thinking than the U.S.’”  

Meanwhile, this year’s rebound in crypto prices has not been much help for Coinbase. Trading volumes on the platform registered at just $26.8 billion over the first 25 days of April, the Financial Times reported, citing analytics firm CCDatal, down from $49 billion during the previous month and nearly $120 billion in January of 2022. “More capital is needed in the crypto economy,” Armstrong added. 

Though digital asset punters are losing interest in transacting on the San Francisco-based exchange, that’s not to say that speculative fervor has abated. Citing data from Coingecko, CoinDesk relays that so-called meme coins logged $2.3 billion in trading volumes last week, up nearly 500% from the prior seven-day stretch and the highest such reading since the freewheeling days of spring 2021.  Helping drive that explosion: a parabolic rally in three-week-old, frog-themed token pepecoin, which vaulted from virtually zero to a roughly $1.5 billion market value on Friday before retrenching below $700 million as of this afternoon. 

Might those animal spirits signal that durable bull market conditions have taken shape? Not so fast, CoinDesk cautions: “historically, speculative mania in non-serious cryptocurrencies have presaged major market tops or bearish reversals in bitcoin.” 

Recap May 8

Treasurys came under pressure in tandem with a flood of investment-grade corporate bond issuance, as two- and 30-year yields each rose eight basis points to 4% and 3.76%, respectively, while stocks floated through a quiet session with the S&P 500 settling unchanged and the Nasdaq 100 slightly higher. Gold rebounded a bit to $2,028 an ounce, WTI crude snapped back towards $73 per barrel and the VIX slipped below 17.

- Philip Grant

Horatio Hornblower
There’s more than one way to get rich: The Securities and Exchange Commission announced today that it has bestowed a cool $279 million to a whistleblower “whose information and assistance led to the successful enforcement of SEC and related actions.”  That award is by far the highest in the regulator’s history, eclipsing a $114 million prize in October 2020. 
Shower of the Purse
The first cut is the deepest.

The first cut is the deepest.  Hollywood writers went on strike Monday evening, grinding the media entertainment business to a halt in the first such labor disruption since 2008.  Early indications are not promising, as the two sides have no negotiations on the schedule. “There’s no driving force to get a deal done now,” one industry bigwig told Reuters. “I think it will go on for a while.” 

Moody’s Investors Service concurs, guessing that the work stoppage will drag on for at least three months. Such a lengthy interlude would be particularly damaging for “diversified media companies transitioning to streaming,” as relatively high debt loads within that cohort pair poorly with protracted operational interruption.  

Nor will any resolution represent a panacea for the industry, as production costs are set to rise. “We estimate an improved three-year contract for writers will ultimately cost media companies for which we have credit ratings between $250 million to $350 million per year,” the rating agency reckons.  Any increased outlays will particularly sting for cash-hungry streaming operators:  Apart from Netflix, Inc., which posted more than $3 billion in free cash flow last year, that subset collectively burned through roughly $10 billion in 2022. 

One media mainstay is making particularly heavy weather of it. Thursday, Paramount Global (ticker: PARA) reported a $1.2 billion first quarter operating loss on $7.27 billion in revenue, which trailed the $7.43 billion analyst consensus. Crucially, the direct-to-consumer streaming division posted minus $511 million in Ebitda, 12% wider than last year’s prettied-up shortfall, despite a 39% uptick in revenues to $1.51 billion. 

The company likewise slashed its dividend to $0.05 per share from $0.24, a move that will save some $500 million annually, as CEO Bob Bakish conceded that “we are. . . navigating a challenging and uncertain macro environment, and you can see the impact of that in our financials as the combination of peak streaming investment intersects with cyclical ad softness.” 
Investors were in no mood to wait around for better days, as the stock tumbled 28% in response. Shares are now off 14% from a bearish Grant’s Interest Rate Observer on March 10, compared to a 7% advance for the S&P 500.  

Cutting their 2024 free cash flow projections to $64 million from $195 million, analysts at MoffettNathanson did not mince words: “We continue to fail to find any valuation support for the stock, even after today’s decline, with current prices implying a 2024 free cash flow yield of less than 1%.”  As yesterday’s drastic dividend cut would suggest, triple-B/triple-B-minus-rated Paramount’s balance sheet is on increasingly shaky ground, as the research firm projects that net leverage will balloon to 5.7 times Ebitda by Dec. 31 from 4 turns at the start of the year. 

Paramount’s woes underscore a raft of adverse structural dynamics within the media business as streaming takes center stage at the expense of high-margin legacy television. To wit, ferocious competition from the likes of Netflix, Walt Disney and Warner Bros. spurs surplus spending and rising costs of content, while an increasingly saturated market features 89% of U.S. households streaming content and the average family subscribing to 5.4 separate services, a January survey from data analytics firm Kantar found. 

Meanwhile, ample leverage across the “space” adds an additional layer of risk, along with potential rewards for firms able to cut costs, bolster their balance sheet and strengthen cash generation. See the March 10 issue of Grant’s Interest Rate Observer for an upbeat analysis of another industry player which is potentially positioned to do just so. “The flyaway price of its shares” tempered that provisionally bullish verdict, though a pullback over the intervening eight weeks has somewhat alleviated the problem. 

As for Paramount, expense controls remain a talking point, despite CEO Bakish’s assurance yesterday that “we are implementing significant cost-saving measures across certain parts of our business.”  

The Wall Street Journal today details some eye-catching spending habits on the set of hit western Yellowstone. Namely, creator Taylor Sheridan – who “dictates where and how his shows are filmed with little pushback” – charges Paramount as much as $50,000 per week to film at his Texas ranches, rents herds of cattle to the production for $25 a head and “insists on [horses] being outfitted with horseshoes by his preferred farrier.”  Per-episode costs of the Yellowstone prequel “1923” run at upwards of $22 million, the WSJ relates, compared to $16 to $18 million for HBO dystopian drama “The Last of Us” and just under $20 million for fantasy epic “House of the Dragon.” 

Recap May 5

Stocks stormed higher to wrap up a choppy week as the S&P 500 logged a near 2% advance to sit higher by 8.3% so far this year, while Treasurys came under pressure with the long bond rising three basis points to 3.76% and the two-year yield vaulting to 3.92% from 3.75% Thursday. WTI crude rebounded above $71 a barrel, gold pulled back to $2,025 per ounce and the VIX sank nearly three points to 17 and change.

- Philip Grant

Lien in

A Wednesday headline from Bloomberg:

Twitter Said to Make Second Interest Payment on Musk Buyout Debt

And an excerpt from Bloomberg Businessweek:

Small businesses are accusing Twitter Inc. of stiffing them, even as company owner Elon Musk, who has a personal net worth of more than $150 billion, is saying the social network’s finances are finally on the way to recovery.

Twitter is late on more than $10 million of payments to an array of companies that provide services from public relations advice to branded merchandise, according to claims in court filings. In April four vendors filed a joint lawsuit for breach of contract over the company’s allegedly unpaid bills and are seeking class action status. Since December at least 10 vendors
have sued the company on similar grounds. 

Conference Call
Whistling past the junk yard?

Whistling past the junk yard? Calm conditions persist in the high-yield bond market, as option-adjusted spreads on ICE BofA’s benchmark gauge settled yesterday at 479 basis points over Treasurys. That’s up from 422 basis points in February before banking trouble came to the fore, but well inside the 580-basis point pickup logged last July.  

Meanwhile, the primary market continues to show signs of life, as the banks arranging Blackstone’s majority purchase of Emerson Electric Co.’s climate technology division sold $2.25 billion of 6.5-year, double-B-minus-rated senior secured notes today at 6 5/8%, inside initial price talk of 6 3/4%.  High-yield issuance reached nearly $60 billion in the first four months of the year, compared to $102 billion during all of 2022. 

The relative vigor seen in the speculative-grade realm is noteworthy, considering the abundant evidence of mounting stress in the corporate sector. U.S. bankruptcies totaled 54 last month according to S&P Global, leaving the year-to-date figure at 236. That’s more than double the 109 logged in the first four months of 2022 and the highest such tally since the Great Recession’s aftermath in 2010.  Weakening credit quality is likewise apparent, with global bond downgrades totaling 77 in March by the rating agency’s count, the largest single month sum since June 2020. 

Accordingly, national thought leaders are getting nervous. The odds of recession within the next 12 months stand at 99%, the Conference Board warned on April 12, adding that “economic weakness will intensify and spread more widely throughout the US economy over the coming months.”  That perceived risk stood at zero as recently as the end of last year.  

Mr. Market concurs, as interest rate futures price in a 25-basis point cut to the Fed Funds rate in July, anticipating that the central bank will be soon forced into easing mode after raising rates above 5% yesterday to combat un-transitory inflation. Investors likewise ponder the odds of an even more abrupt 180, with swaps now pricing roughly 25% odds of a cut next month. 

On form, high-yield creditors can expect some rough road ahead if economic retrenchment is in the cards. The March 2020 crucible saw spreads vault to 877 basis points, while previous recessions in 2008 and 2002 included 1,977 and 1,059 basis point premiums, respectively. Of course, each of those prior peaks towers over today’s sub-500 basis point figure.

Then, too, a two-quarter contraction in output is no prerequisite for trouble in the roughly $1.5 trillion asset class. Witness the 775-basis point spread in the February 2016 energy meltdown, 841 basis point premium in October 2011 during the U.S. sovereign downgrade cum-E.U. sovereign credit crisis, or 652 basis point pickup in fall 1998 in the wake of Long Term Capital Management’s demise.  

“There’s absolutely no evidence of a recession risk premium” in junk, Goldman Sachs chief credit strategist Lotfi Karoui told The Wall Street Journal last Friday, going on to note that the asset class is often slow to adapt to imminent economic contractions. 

On that score, there’s no time like the present.  Noting that the Conference Board’s gauge of leading indicators slumped by 4.5% over the six months through March, a rate of deterioration seen during each of the past four downturns dating back to 1990 (and without any false positives over that stretch), Société Générale strategist Albert Edwards concludes that the data point “tells us a recession is a done deal, not tomorrow, not next week, but today.” 

QT Progress Report
A $35 billion weekly decline in Reserve Bank credit leaves the Fed’s portfolio of interest-bearing assets at $8.5 trillion. That’s down 4.7% from the early 2022 highs, but 2.4% above the mid-March levels just before Silicon Valley Bank’s collapse. 
Recap May 4

Stocks chopped lower to the tune of 0.7% on the S&P 500 after yesterday’s late selloff, leaving the broad average 1.6% in the red this week so far. Treasurys rallied at the short end with two-year yields settling at 3.75% from 3.89% a day ago, though the long bond edged higher by three basis points to 3.73% as the curve continues to un-invert (two-year yields topped the 30-year by nearly a full percentage point on March 10).  Gold ripped again to $2,059 an ounce, WTI crude held below $69 a barrel and the VIX popped above 20. 

- Philip Grant

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