A tale in two tweets. First, from venture capitalist Slava Rubin at the crypto get together Mainnet 2021:

lol I just witnessed a guy get served by the SEC at the top of the escalator at #mainnet2021 right before going on stage for his panel.

And a subsequent missive from Ryan Selkis, founder of crypto research firm Messari, which hosted the event:

If you’re wondering when I actually decided to run for Senate, it was when these f*ckers came to my event, didn’t buy a ticket, and served one of the speakers a subpoena. Enough talk. More war on our out of control regulatory state.

At least eight U.S. investment-grade bond issuers pulled their offerings today, Bloomberg reports. Those ditched plans come as the ICE BofA US Corporate Index finished last week at a mere 90 basis point option-adjusted spread over Treasurys, near the post-crisis low of 86 basis points logged in June.

“With the market priced as well as it is, it doesn’t take much to start the selling,” commented David Knutson, head of U.S. fixed income product management at Schroders Plc.

As markets fret over Evergrande, another major concern looms this week in the form of Wednesday afternoon’s policy decision from the Federal Open Market Committee. Signals over the potential end of the pandemic-era stimulus gusher are front and center.  According to a Bloomberg survey of 51 economists conducted between Sept. 10 to 15, two-thirds of respondents expect the Fed to formally announce a tapering of the current $120 billion in monthly asset purchases by November, with the pullback beginning a month later.  That’s a quicker timeline than had been expected in the previous July survey, which featured a consensus predicting an early 2022 taper commencement. 

Bounding inflation adds urgency to the debate, with the 5.3% annual jump in August CPI triple its post-2008 average. Non-PhDs in economics taken notice: Last week’s New York Fed Survey of Consumer Expectations showed an average inflation guesstimate of 5.2% over the next year and 4% over the next three years, each a record high for the survey going back to 2013.  

As former FOMC vice chairman, New York Fed President and Goldman Sachs chief U.S. economist Bill Dudley writes in a Bloomberg opinion piece today, such elevated figures present a problem:

A longer-than-expected bout of higher inflation could raise doubts about the central bank’s commitment to its inflation objective. As a result, people’s expectations of future inflation could rise, leading them to respond in ways that would make actual inflation more persistent. 

Dudley, who believes that “inflation appears likely to climb higher, for longer than anticipated,” notes that intangible factors loom large.  Namely, central bank “credibility is a powerful tool for keeping inflation in check. If persistently high inflation calls that credibility into question, the Fed’s job will become much more difficult.”  

Central bankers across the Atlantic have encountered a similar dynamic, as ongoing emergency monetary policies run headlong into a post-pandemic spurt of inflation: Harmonized European CPI rose 3% from a year ago in August, also nearly triple its post-2008 average.   On Sept. 9, the European Central Bank’s Governing Council announced that it will conduct asset purchases at a “moderately lower pace” than the €80 billion ($94 billion) monthly clip seen over the past two quarters, though President Christine Lagarde was quick to add, with some third-person flair, that “the lady isn’t tapering” in the subsequent news conference. 

Recent commentary suggests that the lady enjoys plenty of support in keeping an ultra-dovish regime in place. “I believe that, at the moment, fears of excessive euro area inflation are overstated and that the current price pressures reflect transitory factors that will fade out over time,” governing council member Gabriel Makhlouf predicted in a speech Friday.  Bank of France governor Francois Villeroy de Galhau clairvoyantly weighed in this afternoon: “There is no doubt that inflation in the euro area will come back below our 2% target between now and 2023.”  

With the German 10-year yield stuck at a (nominal) minus 32 basis points, the market seems to concur with that assessment. Then again, the ECB itself plays no small role in establishing government borrowing costs: balance sheet assets are equivalent to 63% of nominal euro zone GDP last year, compared to 40% for the Federal Reserve, while only about 25% of German bunds outstanding are held outside of central bank control per Bloomberg, compared to 65% of U.S. Treasurys.  

While Frankfurt has managed to bring the sovereign bond market to heel, lingering side effects from the pandemic and its response could complicate matters, if inflation fails to cooperate and turn lower.  For instance, the ECB’s annual Financial Stability Review, published in May, highlighted rising vulnerabilities in the corporate sector: 

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

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

External events may control the central bankers, as opposed to the other way around, but institutional self-confidence is rarely in short supply.  As Vitas Vasiliauskas, who served on the ECB governing council for a decade before his term ended in April, put it this way back in 2016: “Markets say the ECB is done, their box is empty.  But we are magic people.  Each time we take something and give it to the markets – a rabbit out of a hat.”

An aggressive late bounce for stocks narrowed the S&P 500’s losses on the day to 1.7% from near 3% at 3:15 ET, leaving the broad average 3.9% from its Sept. 2 high at day’s end, while Treasurys caught a strong bid with the 10-year yield dropping five basis points to 1.31%. Gold rose 80 basis points to $1,766 an ounce, WTI slipped to $70.50 a barrel and the VIX finished near 26, up 23% on the day. 

- Philip Grant

The head of product at non-fungible token trading venue OpenSea improperly traded the digital keepsakes using insider information, the company confirmed yesterday.  That admission follows assertions from a Twitter sleuth that the executive had accumulated several prominent NFTs before turning around and selling them shortly after a general release to the public. The employee, Nate Chastain, tendered his resignation this afternoon. 

Unwelcome public attention looks to spur the imposition of some conventional financial norms on the famously free-for-all NFT realm. Terming Chastain’s actions “incredibly disappointing,” the firm added that it will now bar employees from trading NFTs with non-public information, whether “on the OpenSea platform or not.”  The venue hosted some $3 billion worth of token transactions in August, up more than 10-fold from July. 

Coolidge-era trading stratagems are only one remarkable feature of the NFT frenzy. See the brand new edition of Grant’s Interest Rate Observer for an in-depth look at the phenomenon, along with a pertinent historical allegory. 

Back in the staid land of fiat, CNBC notes that Fed chair Jay Powell “directed staff to review the central bank’s ethics rules for appropriate financial activities” after various regional bank presidents engaged in multiple multi-million dollar stock trades from their personal accounts last year.  “The trust of the American people is essential for the Federal Reserve to effectively carry out our important mission,” a spokesperson said. 
 

Amazon.com announced Tuesday that it is looking to hire 125,000 new workers in the U.S. at an average hourly wage of $18, topping the prior $17 average per-hour pay scale introduced four months ago.  That follows last week’s move by the e-commerce behemoth to subsidize college expenses, including books, for 750,000 domestic staffers looking to secure their bachelor’s degrees.  Employees will become eligible for the program after 90 days on the job. 

Such workforce concessions come as American employees enjoy growing clout.  Job openings reached 10.9 million in July according to the Bureau of Labor Statistics, easily topping the 10 million consensus and well above the pre-covid peak 7.4 million.  At the same time, continuing weekly jobless claims edged lower to 2.67 million this week, a fresh virus-era nadir (the metric topped out north of 23 million last May) and below the 2.75 million average reading covering the 50 years through 2019.  Headline unemployment of 5.2% now sits solidly below its long-term average of 6.1%. 
 

Amazon is far from alone in upping the ante.  As Bloomberg Businessweek relays today, rivals such as Walmart and Target, along with Best Buy and Chipotle Mexican Grill have each recently hiked starting pay to at least $15 per hour, while 10 states have passed laws gradually pushing minimum wages towards $15, more than double the current federal floor of $7.25 per hour. Fewer than 20% of all U.S. workers remain stuck under the $15 hourly threshold, according to data from the Economic Policy Institute, compared to upwards of 30% at the start of 2021. 

“I think people are looking at $15 [per hour] as the new normal, kind of the new standard,” Aaron Lee, co-founder at outsourced customer service firm Smith.ai, tells Businessweek.  

Even a recent waning of hiring activity failed to slow the trend. Despite a meager 235,000 gain in headline payrolls for August, a fraction of the 720,000 expectation, average hourly earnings rose by 0.6% month-to-month per the Bureau of Labor Statistics, double the economist consensus. Wages in the leisure and hospitality sector posted a 1.3% sequential advance and a 10.3% year-over-year gain, despite zero jobs growth for the month.   

The fight for $15 may be all but won, but broader dynamics render that victory a pyrrhic one: the weighted three-month average rate of rise in the Atlanta Fed’s Wage Growth Tracker reached 4.4% for August, the highest reading since the 2008 financial crisis. Yet even that decade-plus high falls well short of the 5.2% jump in headline CPI for the month.

Might the awakening of the labor market help usher in the end of the virus-era firehose of monetary stimulus, with attendant consequences for asset prices? “The 5.2% unemployment rate and rapidly rising wages suggest building inflationary pressure that will ultimately lead to more hawkish policy,” Andrew Hollenhorst, chief U.S. economist at Citigroup, wrote earlier this month. 

Stocks shook off early pressure to finish little changed, as the S&P 500 logged its seventh red finish in the past nine sessions but sits just 1.4% from its early September highs.  Treasury yields edged higher with the long bond finishing at 1.88%, gold was hammered by 2.5% to a fresh one-month low at $1,752 an ounce and WTI consolidated near $73 a barrel.  The VIX rose 3% to near 19. 

- Philip Grant

The non-fungible singularity has arrived.  A headline over the weekend from tech publication The Verge:

You can now buy a $475 NFT ticket to see Beeple’s $69 million NFT at an in-real-life party

Meanwhile, a press release from GlobeNewsWire at the stock market open today trumpeted Walmart’s decision to let customers pay for wares using litecoin, news which was greeted with a 29% straight-line surge in the digital ducats.  The only problem:  The news wasn’t true, as Walmart subsequently confirmed.  The price of litecoin promptly retraced all of those gains.

Never a dull moment in crypto. 

“Unprecedented” inflation has taken hold, 3M Co. chief financial officer Monish Patolawala declared at an investment conference today.  Citing price pressure across raw material, labor and logistics, the conglomerate now expects inflation to outstrip its recently-implemented price increases, trimming its third quarter earnings forecast as a result.

While today’s inflationary surge is a broad-based one, the automobile market is one worthy of particular attention.  Thanks to a persistent global shortage of semiconductors, 3M now expects domestic auto production to slide by 6% from a year ago in the second half of 2021, compared to a prior estimate of a 3% decline. The supply disruption will persist into next year, 3M management believes.

While auto OEM’s struggle to provide adequate supply, the used vehicle market puts the pedal to the metal.  Even with a 0.4% sequential decline, the August reading of the Manheim Used Vehicle Value Index showed a hefty 18.8% price increase from a year ago.  Then, too, rising sales conversion rates (atypical for the month of August) suggest “that buyers have become more aggressive than the behavior we saw in June and July,” Manheim notes. 

 
Prices go parabolic:  Manheim’s Used Vehicle Value Index

The used-car gold rush spells good news for some.  Dallas-based Copart, Inc., (CPRT on the Nasdaq) which transports, processes and repairs salvaged vehicles before monetizing those assets at auction, reported $749 million in revenue and $302 million in operating income over the quarter ended July 31, up 42% and 47%, respectively, from a year ago.  Global average selling prices rose by 20.7% from a year ago in the just-completed quarter, following a 48% leap in the three months through April and a 35% jump over the quarter before that.  

While Covid-crimped figures last year make for some easy comparisons, auction prices have logged year-over-year growth in each quarter but one (February through April last year) since fiscal 2018.   Then, too, as Bloomberg’s Brooke Sutherland noted on Thursday, the sweep of progress offers its own helping hand for the automobile intermediary: As increasingly-sophisticated vehicles render collision repairs increasingly expensive, “insurers [have] a greater economic incentive to declare a banged-up vehicle totaled and sell it through Copart rather than try and repair it.” 

The proof is in the press release.  Copart’s GAAP net income jumped to $936 million over the 12 months through July 31, compared to $700 million over the prior period, $394 million in fiscal 2017 and $220 million two years before that.  At the same time, net income margins continue to grind higher, reaching 35% over the recently-completed fiscal year. That’s up from up from 31.5% in 12 months through July 2020, 27% in fiscal 2017 and 19% in 2015. 

That stellar performance has made soothsayers of the Copart bulls, John Hughes, founder of Quantum Capital Management, among them.  Hughes described Copart’s investment virtues at the Grant’s fall conference back in 2006: “A proprietary technology company that enjoys incumbent competitive advantages. . . masquerading as a junkyard company.”  Over the past 15 years, CPRT has generated a cool 1,872% return, leaving the 343% gain for the S&P 500, inclusive of dividends, in the junkyard. 

Of course, that zoom to prosperity featured some notable bumps in the road, including a 32% drawdown in fall 2018 as the Fed tightened monetary policy and a 44% pullback in spring 2020 during the virus-induced selloff. Yet Hughes remained a steadfast Copart bull on the heels of the covid liquidation, telling Grant’s Interest Rate Observer on May 1, 2020 that the company represented the top holding in his portfolio, terming it a hallmark high-quality component of an investment portfolio offering all the features of “sustained capital compounding.”  Namely: “capital efficiency, competitive advantage, ability to grow profitably and managed by excellent capital allocators and operators.”  

That view has paid off: CPRT shares have since appreciated by 83%, topping the 60% gain for the S&P 500 over that period.  As Mr. Market gives the company its due, the bar is raised accordingly, as shares trade at a hefty 35 times consensus earnings per share for the year ending next July, up from 28 times forward earnings last spring.  

Hughes tells Grant’s today that Quantum has trimmed its Copart position in light of the recent run-up, but that the stock remains a top four portfolio holding.  More broadly, Hughes reasons, “if you have confidence in management’s ability to be adaptive and make rational operational and capital allocation decisions, our bias is to be long term owners.” 

Treasurys caught a bid with the 10-year yields dropping a couple basis points to 1.32%, while stocks finished little changed after last week’s modest selloff.  WTI crude pushed to a six-week high near $71 a barrel, gold remained just south of $1,800 an ounce for a fifth straight session and the VIX pulled back below 20. 

- Philip Grant

The price of uranium pushed above $40 a pound yesterday, marking its first trip above that threshold since November 2014.  The grey-colored metal, designated as U3O8 (Triuranium octoxide), has gone radioactive in recent weeks, extending to a 45% gain since the beginning of March.

External factors are assisting in that run-up, as Bloomberg noted yesterday that natural resource investors Sprott, Inc. has accumulated some 24 million pounds on the open market. That’s a hefty sum relative to the 92 million pounds in total spot trading volume last year, as utilities source the majority of their uranium supply through long-term contracts. 

That upside jolt was months in the making.  As the June 11 edition of Grant’s Interest Rate Observer pointed out, Sprott’s then-imminent, since completed purchase of Uranium Participation Corp. would free the investment vehicle to issue shares to U.S. investors via low cost at-the-market offerings, accumulating uranium with the proceeds.  As Sprott earns a fee commensurate with the size of its since rebranded Physical Uranium Fund and is thus incentivized to issue shares to snap up U3O8, a new, more-abundant liquidity regime may be at hand. “For the first time in 10 years, we are going to find out where spot uranium prices really are,” Marcelo Lopez, senior portfolio manager at L2 Capital Partners, told Grant’s in June. 

Uranium bulls hope improved price discovery presages an enduring rally: the compound remains far below its $136-per-pound peak in 2007 and a $73 interim top in 2011, before the Fukushima disaster spurred a global backlash against nuclear power and curtailed demand for the compound.

Sprott’s presence in the market amplifies an already-intriguing fundamental picture. Global uranium consumption will foot to 178 million pounds this year, research firm UxC estimates, outstripping the 166 million pounds in expected supply.  Then, too, the World Nuclear Association’s annual Nuclear Fuel Report predicts that global reactor requirements will rise to 79,400 tons by 2030 and 112,300 tons by 2040 from this year’s 62,500 tons, but production volumes at existing mines are projected to decrease by more than half from 2030 to 2040, after remaining stable through the late 2020s. Global uranium capital expenditures plummeted to $483 million in 2018, some 77% below the $2.1 billion in spending in 2014. 

Industry players have taken notice. Timothy Gitzel, CEO of longtime Grant’s pick-to-click Cameco Corp. (CCJ on the NYSE and CCO in Toronto) noted on a July earnings call that a pair of long-producing mines have reached the end of their reserve lives this year, adding that “we should be investing now to replace that lost production, but at today’s prices it makes zero sense” to do so. Gitzel concluded thus: “So we believe that in the current market, the risk to uranium supply is far greater than the risk to uranium demand.”  CCJ shares have returned 169% since a bullish analysis in the March 6, 2020 issue of Grant’s Interest Rate Observer, triple that of the S&P 500 over that period. 

Subsequent developments reinforce Cameco’s view.  Kazakhstan’s NAC Kazatomprom JSC, which commands a near 40% share of the global markets, cautioned in a presentation today at the World Nuclear Association Symposium that “given both conventional and unconventional demand, there might not be enough guaranteed supply for everybody.”  The state-owned firm projects that it will keep production constant through 2023, adding that it will not be selling any uranium into the market for the rest of the year, but is rather accumulating supply on the spot market “to ensure its delivery schedule and inventory levels.” 

Of course, continued price appreciation would do no small part in coaxing forth additional supply. “There are more than adequate project extensions, uranium resources and other projects in the pipeline to accomplish this need,” the World Nuclear Association’s annual report asserts, “but it is essential for the market to send the signals needed to launch the development of these projects.”

May the bullish signals continue. 

Stocks came under late pressure to leave the S&P 500 lower for a fourth straight session, though the broad index remains just 1% off its recent highs logged last week.  Treasurys rallied again following a strong 30-year auction this afternoon, as the 10-year yield finished at 1.3%. Crude oil sank below $68 a barrel following a smaller than expected weekly inventory drawdown, gold managed only a weak bounce to finish at $1,795 an ounce and the VIX rose by 5% to near 19. 

- Philip Grant

More curious doings in the crypto realm:  The price of bitcoin endured a swift swan-dive this morning, briefly falling to near $43,000 from its perch above $52,000 in the wee hours. Ethereum dipped to some $3,100 from $3,800 overnight, while Cardano, the third-largest crypto by market value following a near-trebling in the past two months, slumped to $2.04 from $2.85 hours earlier.  

That trio moved in tandem, with snowballing weakness culminating in a straight-line downward lurch shortly after 11 A.M. followed by a sharp snap-back rally.  While digital currencies famously trade 24 hours a day seven days a week, those looking to react to those moves were largely thwarted:  Major crypto exchanges including Coinbase, Bitfinex and Gemini reported service interruptions this morning before coming back online after lunchtime as prices recovered.  That follows a similar outcome back in May, when major bourses including Coinbase and Binance went offline during conventional U.S. market hours as digital assets went into spin-cycle. 

No news is good news.  The Nasdaq Golden Dragon China Index, which tracks mainland Chinse companies listed in the U.S., jumped by 4% this morning, reaching its best level in six weeks and extending to a 23% bounce off its Aug. 19 nadir. A lack of further enforcement action from the Chinese government against the beleaguered private sector over the long weekend helped catalyze today’s rally, Bloomberg judges.  Indeed, Chinese Vice Premier Liu He declared in a speech earlier today that the private sector needs “vigorous” state support, adding that “there are no changes in the principles and policies for supporting the development of the private economy.” That rhetoric is noteworthy, coming on the heels of rolling state crackdowns on private sector firms spanning e-commerce, for-profit education, ride-sharing and financial technology in recent months. 

The Communist Party’s heavy hand has stung many a stateside investor.  The KraneShares CSI China Internet Fund (KWEB on the NYSE Arca) has diverged markedly from the Nasdaq 100 ETF in recent months, enduring a 47% selloff from its mid-February peak while its U.S. counterpart has ground inexorably higher: 
 

Emboldened dip-buyers have responded to that divergence with unbridled optimism. Assets in the fund reached $7.6 billion on Friday, up from less than $5 billion three weeks ago and less than $3 billion in early September of last year.  Institutions, however, have proven more reticent.  Citing data from Copley Fund Research, the Financial Times relays that the average exposure to China and Hong Kong among 381 global equity funds has slipped to 3.8%, the lowest level since 2016 and down from a 5.1% allocation at the beginning of the year. 

Those with a longer time horizon have good reason to worry. Thanks to passage of the Holding Foreign Companies Accountable Act last December, all Chinese companies currently trading on U.S. markets face delisting by 2024, unless Beijing reverses its law barring American accounting watchdogs from accessing Chinese audits. 

More immediately, the prospect of contagion in China’s lynchpin property market looms as developer China Evergrande (Asia’s largest junk bond issuer with upwards of $300 billion in total liabilities) continues to teeter, with its dollar-denominated, senior-secured 8 3/4% notes due 2025 falling below 26 cents today. Any Evergrande-led property crack-up could loudly reverberate: Property loans inclusive of mortgages footed to RMB 70 trillion ($10.8 trillion) late last year, representing 39% of total outstanding loans according to the China Banking and Insurance Regulatory Commission.  Things are already trending in the wrong direction, as nonperforming real estate loans on the books of China’s five largest banks jumped 30% over the first six months of the year to RMB 97 billion, Nikkei Asia relayed yesterday. Were a crisis to materialize, things could get ugly. Total Chinese bank assets reached $52 trillion as of June 30, upwards of 60% of global nominal GDP last year. 

“The property sector may be once again at center stage, testing the nerves of both China’s government and global investors,” Ting Lu, chief China economist at Nomura, told Nikkei Asia.  The markets are getting increasingly nervous, as mainland-listed banks now trade at a record low 0.4 times book value, down from 0.75 times book earlier this year and 1.2 times in 2019. Similarly, the Bloomberg Barclays gauge of Chinese dollar-pay high-yield credit has blown out to a 1,256 basis point spread over Treasurys (a 1,000 basis point pickup typically indicates distress).  That’s up from less than 800 basis points in early June.  

How might trouble in the world’s second largest economy affect a wellspring of global capital markets activity and “fountain of the idea that the twin concepts of risk and valuation are as obsolete as the telegraph?” See the most recent edition of Grant’s Interest Rate Observer dated Sept. 3 for more. 

Red was a featured color today, as stocks came under modest pressure to the tune of 30 basis points on the S&P 500 while Treasury yields jumped across the curve, pushing the long bond to back near 2%, while gold and WTI sank below $1,800 an ounce and $69 a barrel respectively with the dollar well bid.  The VIX snapped above 18, up 10% on the session. 

- Philip Grant

Spotted at the Apple Gourmet deli on 225 Broadway in lower Manhattan, near the Grant’s office:

 
A roast beef on a Kaiser roll along with a Spindrift sparking water now comes to $14.38. That’s up 3.9% from a month ago. 

Is the party over for special purpose acquisition companies?  A Dow Jones-tracked basket of 137 former blank-check firms that have completed mergers has endured a 25% downdraft since February, The Wall Street Journal relays today. That compares to a 10.5% pullback for the Renaissance IPO ETF over that period, while the broad S&P 500 has continued higher by 15%. 

“Air has come out of the bubble,” Roy Behren, managing member at Westchester Capital Management and a SPAC investor, tells the Journal. “That’s the cost of speculating in companies that have potentially bright but uncertain futures.” 

As the late Richard Russell observed, markets make opinions.  To that end, some three-quarters of SPACs which have announced merger plans but haven’t completed them are currently trading below their $10 per share listing price.  That’s a pronounced change from the winter, when deal announcements typically presaged share-price pops in the acquiring shell company. (For a skeptical look at the SPAC phenomenon from near the peak of the mania, see the analysis “Short this index” from the Dec. 25 edition of Grant’s Interest Rate Observer).  Those shell companies raised a hefty $180 billion over the five quarters through March 31, data from Bloomberg show.  For context, the annual pre-virus record for conventional IPO fundraising was $97 billion in 2000, according to Renaissance Capital.   

In their typical timely manner, regulators are now turning their attention to the phenomenon. Bloomberg reports today that the International Organization of Securities Commissions formed a SPAC Network, an offshoot designed to determine if the blank-check route represents a viable alternative to traditional IPOs and private equity, or if it is instead a vehicle to exploit legal and regulatory loopholes.

For now, at least, investors swim at their own risk. Back in late July, SPAC-backed ATI Physical Therapy, Inc. (ATIP on the NYSE) suffered a 54%, two-day swan dive after providing revenue and earnings guidance well short of consensus expectation. Yet more fundamental problems overshadowed that relatively routine event. Analysts from Barrington Research put it this way: 

The company chose to release its results before it had been able to calculate income tax expense. As a result, the earnings release lacked an EPS figure. The release also lacked a share count, a balance sheet, a cash flow statement or, for that matter, a good defense for why the company’s original guidance (which was maintained up until Monday) ever made sense. 

We are shocked by what has unfolded at ATI. 

More recently, holders of Virgin Galactic Holdings, Inc. (SPCE on the NYSE) received a jolt after the Federal Aviation Administration this afternoon banned the company from further space voyages as it investigates whether a July sojourn to the stars threatened public safety. The trip, with founder Richard Branson aboard, may have flown outside its designated flight path.  SPCE shares slipped by 9% in immediate reaction and currently reside 57% below their February high-water mark. 

Those on the short side have faced their own share of unpleasant surprises. Last Tuesday, SPAC Locust Walk Acquisition Corp. (LWAC on the Nasdaq) announced shareholder approval for a merger with Effector Therapeutics, Inc. Following that bulletin, shares in LWAC rose from $8.76 the previous day to as high as $29.20, before settling at $16.98. The catalyst for that violent move: some 95% of Locust Walk shareholders opted to redeem their shares, receiving their $10 per share payout instead of ownership in the new company. As a result, Locust Walk’s share count shrank by some 17 million, prompting an epic squeeze as short sellers faced suddenly-prohibitive borrowing costs and were compelled to cover their positions.  Shares in the newly combined company have since wandered back towards $9.50. 

A similar dynamic unfolded a day later: Blue Water Acquisition Corp. (BLUW on the Nasdaq) skyrocketed to as high as $31.24 last Thursday morning from $10.45 Wednesday, after announcing approval of a combination with pharma concern Clarus Therapeutics, Inc.  With a shareholder vote set for today, the prospect of a similar redemption rush and subsequent share-count vaporization helped precipitate another spin-cycle. BLUW finished today’s trading south of $8 a share. 

Uncertain futures, indeed. 

Stocks edged higher in a third-straight low voltage session, as the S&P 500 stands higher by 60 basis points for the week thus far, while the benchmark 10-year yield finished little changed at 1.29%.  Gold held at $1,810, the VIX at 16.5, and WTI crude pushed to a fresh one-month high near $70 a barrel.  

- Philip Grant

The big four accounting firms are moving headlong into the realm of environmental, social and governance-based investment, the Financial Times relays today.  The bourgeoning movement presents a dueling opportunity set, the FT notes, including “an expansion of what companies must account for,” as well as the opportunity to “rebrand a scandal-plagued profession as experts on climate change, diversity and winning consumers’ trust.” Back in June, industry mainstay PwC announced a five-year, $12 billion investment plan centered on ESG initiatives, while peer Deloitte earlier this month rolled out a “climate learning plan” for its own staff. 

Commercial factors loom large in that green migration. “One of the challenges the profession has faced. . . is that the audit or financial statements were viewed by some as a compliance function,” a former senior partner at PwC told the FT. “If [companies] look at something as a compliance or commodity purchase, they grind the price. If they look at it as something that adds value, they’re willing to pay the appropriate price for the value that the service provider provides.” 

Investors have proven more than willing to pay up for the sustainability wrapper. ESG-focused equity funds charged investors 20 basis points on average as of year-end 2020, per data from FactSet. That’s comfortably above the 14 basis point fees generated by conventional stock funds. Explosive growth puts that premium into further context: Some $17 trillion of capital tracked ESG-related strategies as of year-end by the lights of the Forum for Sustainable and Responsible Investment, up 42% from 2018 and representing one-third of total U.S. assets under management. 

Considering that backdrop, it is no surprise that companies looking to finance themselves would seek the ESG imprimatur, whether warranted or not. In an Aug. 20 blog posted on Medium, Tariq Fancy, former chief investment officer for sustainable investing at BlackRock, termed the ESG craze “a dangerous placebo that harms the public interest.” Fancy went on to cite the $1 trillion market for “green bonds,” or debt deals earmarked for specific ESG-friendly initiatives, as one area rife with bunkum. “Most companies have a few qualifying green initiatives that they can raise green bonds to specifically fund, while not increasing or altering their overall plans. And nothing stops them from pursuing decidedly non-green activities with their other sources of funding,” the BlackRock alum reasons. 

Then, too, the financial industry faces a similar reckoning, as participants market themselves as members of the ESG vanguard while vying for assets.  Last Wednesday, The Wall Street Journal reported that federal prosecutors and the Securities and Exchange Commission have opened investigations into Deutsche Bank’s DWS asset management division for alleged greenwashing, or falsely burnishing its environmental bona fides. Germany’s Federal Financial Supervisory Authority is conducting a similar probe, Bloomberg relays. While DWS told investors in its March annual report that it had conducted a self-described “ESG integration process” covering more than half of its $1 trillion in assets under management, an internal audit a month earlier determined that “only a small fraction” of its AUM were ESG compliant. “As we are already quite late to the game, we need to set our ambition now and start the transformational process,” ESG product head Oliver Plein entreats his colleagues in an email accompanying that audit.  

“Posturing with big statements on climate action and inclusion without the goods to back it up is really quite harmful as it prevents money and action from flowing to the right place,” whistleblower Desiree Fixler told the Journal. Formerly the chief sustainability officer at DWS, Fixler asserts that she objected to the firm’s claim that they “placed ESG at the heart of everything that we do” and was fired a day after the firm released its annual report.

Yet those greenwashing allegations may be hard to prove, as Bloomberg analyst Sarah Jane Mahmud wrote on Thursday that “fund categorization remains subjective.” Indeed, the primary ESG rating firms employ widely disparate criteria, with MSCI utilizing 37 different metrics to evaluate firms ESG compliance, while Sustainalytics uses 155 categories and Refinitiv 178.  Those agencies also differ on whether to incorporate the industry in which a firm operates into its evaluation.  

One thing we can all agree on: ESG makes for great talking points. "We believe the world has a unique opportunity of rapprochement and coming together to tackle the challenges not only facing us but the entire humanity," Abdul Qahar Balkhi, a member of the Taliban's Cultural Commission, told Newsweek last Tuesday. "And these challenges ranging from world security and climate change need the collective efforts of all.” 

Stocks finished off their best levels of the session, but the S&P 500 managed to push higher by another 40 basis points to extend to a 20.6% year-to-date gain with just over four months left in 2021.  Treasury yields edged lower with the 10-year finishing at 1.28% and the long bond at 1.9%, while WTI held at $69 a barrel and gold pulled back to $1,811 an ounce.  The VIX declined towards 16, finishing the day back near the low end of its recent range. 

- Philip Grant

As the Federal Reserve’s annual Jackson Hole conclave gets underway, establishment figures advocate for a pullback from the current $120 billion monthly monetary stimulus regime sooner rather than later. Speaking on CNBC this morning, St. Louis Fed President James Bullard declared that “we need to get going on [the] taper.” With revised second quarter GDP growth registering a brisk 6.6% annualized pace, Bullard opined that the economy “probably doesn’t need more stimulus at this point.”  Moreover, he wants the Fed to complete the tapering of asset purchases by March 31 of next year. 

Kansas City Fed President Esther George delivered a similar message on Bloomberg Television yesterday evening, stating that “it’s time to begin adjusting the [current] accommodation.” George added that, while she is “open minded” as to the pace of such a taper, “I am less interested in deferring that decision.” 

Dallas Fed President Robert Kaplan added a third voice to the choir earlier today, telling CNBC that “we’d be well served to announce a plan for adjusting purchases” at the next FOMC meeting scheduled for Sept. 21 and 22, “and begin to execute that plan in October or shortly thereafter.” 

While none of that trio of regional Fed presidents is currently a voting member of the Federal Open Market Committee, prominent Wall Street players are similarly coming around to a removal of the Covid-era training wheels. Speaking of a whittling of asset purchases on CNBC this morning, BlackRock’s chief investment officer of fixed income Rick Rieder argued that “it’s time to go. The liquidity [in the market] is too big.” Rieder also opined that “the Fed could have started tapering months ago.”

Of course, the Fed isn’t acting in a vacuum. Consider the near round trip in the Treasury general account, which acts as a checking account housing the proceeds of Uncle Sam’s debt sales. Cash parked in the TGA is essentially sequestered from the financial system. When Treasury Secretary Janet Yellen runs down the account, bank reserves rise accordingly.

As a result of last year’s Covid-induced wave of debt issuance, the TGA ballooned to as much as $1.8 trillion and remained above $1.6 trillion as recently as early February.  That compares to an average of just $220 billion from 2015 to 2019. 

The Treasury Department has since run that TGA balance down to $301 billion, or not so far above its pre-pandemic levels. That release of more than $1 trillion in reserves has flooded the system with cash, thereby complementing the Fed’s debt purchases under QE. You can see this play out in the parabolic increase in the Fed’s reverse repo facility, which reached $1.1 trillion today from less than $200 billion less than four months ago (see the Feb. 2 edition of Grant’s Interest Rate Observer for a preview of this dynamic).  Those abundant reserves have also helped provide a healthy tailwind as the rates market swiftly reversed losses borne earlier this year. 
 

Treasury general account balance, five-year chart.  Source:  The Bloomberg 

As the TGA reverts towards 2019 levels and the Fed (which owns nearly a quarter of all Treasurys outstanding) looks increasingly likely to slow its own pace of purchases, other buyers may need to step to the forefront to help government bond yields maintain their current bottom-scraping levels.  

Yet on that score, a less-than-bullish sign appears: the People’s Bank of China warned in its quarterly monetary policy report earlier this month that the U.S. faces the “most severe” inflation risk of any major economy, thanks to the fast-growing gap between the money supply and economic output. A bearish pivot from the Middle Kingdom would be no small development: China itself holds some $1 trillion in Treasurys, equivalent to 4.5% of total supply. Foreign creditors as a whole hold a record $7.2 trillion, or one-third of the public debt.

Stocks came under moderate pressure with the S&P 500 and Nasdaq 100 indices each falling by 60 basis points, while Treasurys consolidated after recent losses with the 10- and 30-year yields finishing at 1.35% and 1.95%, respectively. WTI crude slipped below $68 a barrel, gold remained stuck south of $1,800 an ounce and the VIX jumped 12% to near 19. 

- Philip Grant

Buy the dip reigns supreme.  Christian Fromhertz, CEO of the Tribeca Trade Group, relays this morning that the KraneShares CSI China Internet ETF (KWEB on the NYSE Arca) attracted a record $537 million worth of inflows yesterday, equivalent to more than 10% of the fund’s total assets under management.  That firehose of fresh capital is all the more notable considering that the ETF had absorbed a hefty 55% drawdown from its mid-February high-water mark.

Those diamond handed ranks were promptly rewarded. Spurred by a stronger than expected set of second quarter results from Bejing-based e-commerce firm JD.com overnight, KWEB enjoyed an 11% bounce.

An offshore oil platform fire broke out in the Gulf of Mexico on Sunday evening, leaving at least five workers dead and injuring a half-dozen more. The blaze, which took place at a facility operated by Petróleos Mexicanos (Pemex), knocked 125 wells out of commission, with a total of 421,000 barrels per day of production now offline.  That represents one quarter of the 1.69 million barrels per day (mbpd) of output the Mexican state-owned oil giant logged in June.  

CEO Octavio Romero told the press that those facilities would likely be back online in the coming days, but that exports will “surely” be lower this month. It’s the latest setback for Pemex, which sports the dubious distinction of the world’s most encumbered energy producer, with financial debt equivalent to nearly 11 times adjusted Ebitda for the 12 months through June 30. Thanks to longstanding depletion of key offshore fields including the Cantarell (once one of the world’s largest), Pemex’s production capabilities are half what they were at the 2004 high-water mark. 

Sunday’s disaster retrains the spotlight on the firm’s unenviable position.  “This is just going to put more scrutiny, more presure on Pemex, at a time when they are just that more vulnerable, given the $115 billion in debt they have outstanding,” John Padilla, managing director at energy consulting firm IPD Latin America, told Bloomberg. “It’s going to become increasingly difficult, if these accidents continue to take place, for investment committees to look the other way.” 

Pemex does have one ace in the hole in the form of steadfast support from the Mexican government, helmed by populist President Andrés Manuel López Obrador (AMLO).  Back in March, AMLO declared that the state will assume some $6 billion in Pemex debt amortization payments this year. And last month, his administration awarded control of the contested Zama oil field to its domestic champion, thwarting a trio of foreign firms which had poured a combined $325 million into that project since making the discovery in 2017. 

Yet AMLO’s efforts have accomplished little beyond papering over ugly operational realities, as evidenced by Pemex’s cumulative $91 billion free cash flow deficit from 2010 through June 30 of this year. Then, too, the company’s status as the teacher’s pet entails its own risks: Two summers ago, AMLO awarded Pemex the contract to build a 340,000 bpd capacity refinery in his hometown of Tabasco, as the front-runner both underbid the foreign competition and provided a quicker timetable for completion of the project.  

That persistent red ink and aggressive capital structure is taking a toll. On July 27, Moody’s downgraded the firm’s credit rating to Ba3, three notches below investment grade, while maintaining a negative outlook on the company.  In the rating agency’s judgement, Pemex’s “liquidity needs and negative free cash flow will rise in the next three years due to high debt maturities and lower operating cash flow derived from the expansion of its refining business.” For his part, CEO Romero told analysts that he “completely disagrees” with Moody’s, terming its decision “shameful.” 

Since a bearish analysis in the March 23, 2018 edition of Grant’s Interest Rate Observer, the spread on Pemex’s 6 3/4% senior notes due 2047 have widened to 616 basis points over Treasurys from 399 basis points, while the company’s five-year credit default swaps have doubled to 399 basis points from 192 basis points. Yet markets remain sanguine over the ailing firm’s sovereign patron, as the cost of Mexican five-year credit protection has edged lower to 93 basis points from 114 basis points at publication time, despite downgrades from both S&P and Moody’s last year.  For context, Pemex’s $115 billion financial debt load is equivalent to nearly 11% of Mexico’s nominal GDP last year.  

Pemex and AMLO appear to be tied at the hip.  Each could do better.  

Stocks finished modestly higher but off their best levels of the day, while Treasurys came under pressure with the 10- and 30-year yields rising four basis points each to 1.29% and 1.91%, respectively.  WTI crude powered back to near $68 a barrel, extending its two-day rally to 8.5% after logging three-month lows on Friday, while gold held at $1,804 an ounce and the VIX remained near 17. 

- Philip Grant