05.24.2022
Storm Chaser
Is a split decision forthcoming coming at the European Central Bank?
Is a split decision forthcoming coming at the European Central Bank? Speaking to the World Economic Forum this morning, ECB President Christine Lagarde contended that there is no need for an aggressive tightening regime, as the flare-up in consumer prices can be attributed to crimped supply chains rather than demand pressures: “We have to move in the right direction, obviously, but we don’t have to rush, and we don’t have to panic.” Lagarde predicts a cessation of asset purchases next month, then a gradual move to a 0% deposit rate by September from the current minus 50 basis points. 
 
Asked about the potential for a one-off 50-basis point rate hike to bring benchmark borrowing costs back to zero following an eight-year foray into negative territory, Lagarde waxed philosophical: “When you’re out of negative, you can be at zero, you can be slightly above zero. This is something we will determine on the basis of our projections, on the basis of our forward guidance.” 
 
By contrast, some peers on the rate-setting Governing Council are eager to speed up the process. Robert Holzmann declared today that “a bigger step at the start of our rate-hike cycle would make sense. It would. . . signal to markets that we’ve understood the need to act. Everything else risks being seen as soft.” Colleague Martine Kazaks likewise told the press Monday that a 50 basis point hike is “certainly one thing that we could discuss.” 
 
Mr. Market seems to be coming around to the hawks’ view. Interest rate futures now price in 100 basis points of rate hikes by Dec. 31, double the 50 basis point tightening projected five weeks back. The catalyst for that shift isn’t hard to identify, as Eurozone CPI towered at 7.4% year-over-year in both March and April, easily a record for the common currency era.  
 
There may be more where that came from in the bloc’s largest economy. Peering into their crystal ball Friday, economists at Deutsche Bank predicted a near 8% annual pace of German CPI growth by the fall from 7.4% in April, a level which could set the high-water mark of this cycle, “provided that there is no embargo on Russian gas and Russia does not stop its gas deliveries.” Yet de-escalation of the war in Ukraine is far from the only piece of that puzzle, DB’s Steve Schneider and his team caution: 
 
This forecast also assumes that global supply chain tensions and materials shortages abate during the remainder of the year, allowing the significant corporate price and cost pressures to gradually ease. However, there are no clear signs for such a moderation so far. Indeed, producer prices for goods, services and agricultural products and global shipping tariffs (i.e. transportation costs for imported goods) are still very high.
 
While the path and intensity of an interest rate “lift-off” takes center stage, another pillar of policy normalization looms in the form of run-off of the ECB’s bountiful asset purchase program, which has yielded a build-up of balance sheet assets in excess of 60% of projected 2022 output, nearly double the Federal Reserve’s holdings relative to U.S. GDP. 
 
Cessation, let alone reversal, of Frankfurt’s monetary sponsorship of the encumbered periphery could quickly prove messy. For instance, triple-B-rated Italy’s government debt stood at 150% of GDP as of year-end. That compares to 119% a decade earlier and 134% on the eve of the pandemic.  Yet the ECB’s comprehensive suppression of interest rates helped push debt servicing costs to some 3% of output last year from 5% during the during the teeth of the sovereign debt crisis in 2011 and 2012.  Perhaps with that in mind, Lagarde emphasized her willingness to resume the shopping spree once more in a blog post yesterday, writing that “if necessary, we can design and deploy new instruments to secure monetary policy transmission as we move along the path of policy normalization, as we have shown on many occasions in the past.”
 
Anticipating that rhetorical lifeline, analysts at ING put it this way last week:
 
We interpret talk of a hypothetical facility aimed at preventing fragmentation (ECB parlance for spread widening) as an attempt to restore the ECB put. The strategy seems to deliberately give as little detail as possible to investors. If the strategy is to avoid the market testing specific levels in spreads or in yields, it has its merits, but we think it will fail.
 
In essence, it acknowledges that Italian bonds cannot trade without central bank support. The aim to make this support as light as possible is commendable, but markets have a well-defined record of testing the extent of ECB support. 
 
Might the latest examination now be underway? The Euro Area Systemic Stress Indicator Composite Index, a gauge of 15 financial stress metrics compiled by the ECB ranging from zero (or no systemic stress) to one (a major financial crisis), reached 0.3067 yesterday. That compares to a 10-year average of 0.1155 and marks the highest level since mid-2016, surpassing the Covid panic in early 2020. 
Recap May 24
Stocks came for sale to the tune of 80 basis points on the S&P 500 and 2.2% on the Nasdaq 100, though each of those indices managed to pare steeper initial losses and finish near their best intraday levels, while Treasurys erased yesterday’s weakness and then some as the two- and 10-year yields fell to 2.47% and 2.75%, respectively, each at a near-one-month low.  Gold rose to $1,866 an ounce for its sixth green finish in the last seven tries, WTI crude slipped to $109 per barrel and the VIX held just south of 30 for a fourth consecutive session. 
 
- Philip Grant
05.23.2022
Powder Finger
If at first, you don’t succeed. . . The ProShares UltraPro QQQ exchange traded fund, which seeks to generate three times the daily performance of the Nasdaq 100 Index, has taken in a net $7.7 billion in investor cash in 2022 so far, Bloomberg ETF analyst Eric Balchunas relays.  That stands behind only a trio of Vanguard sponsored, broadly equity-focused funds for the largest inflow into a single ETF so far this year. 
That dogged persistence hasn’t exactly been rewarded: Year to date, the TQQQ sits lower by a cool 66.5%, lapping the 27% decline in the Nasdaq 100. 
Fowl Ball
“All indicators point to an economy in need of monetary tightening.
“All indicators point to an economy in need of monetary tightening. But raising rates isn't politically viable.” Bloomberg analyst Ziad Daoud puts it delicately today, referring to the hemmed-in central bank – not America’s, in this case, but the Republic of Turkey’s. 
 
As the monetary mandarins get set to convene for a policy meeting on Thursday, a status quo outcome is in the cards, economists polled by Reuters predict, in line with President Recep Erdogan’s belief that easy money is the cure for high inflation. There is plenty to cure: annual CPI as measured by the Turkish Statistical Institute reached 69.97% in April, up from 17% in May 2021 and the hottest reading in two decades.  
 
That the market takes a dim view of the strongman’s economic remedy, which has included a cut to the benchmark to 14% from 19% last August, is beyond debate: The Turkish lira has lost 16% against the dollar since the start of the year, the worst showing of any country in the euphemistic emerging markets category. The lira to dollar exchange rate now stands at nearly 16:1, compared to 3.5:1 in the middle of 2016. 
 
What’s more, the inflationary mindset is increasingly entrenched among the Turkish populace.  According to the CBRT’s May survey of inflation expectations, respondents anticipate a 58% CPI as of year-end and 19.5% pace of consumer price increases two years out. That compares to expectations of 23.9% and 14.4%, respectively, at the end of 2021. 
 
Identifying a culprit for that state of affairs is a straightforward endeavor for some observers. “It’s about food and energy price increases but also the spectacular failure of monetary policy in Turkey – and it’s about the abject and total failure of Erdogan’s unorthodox monetary policy,” Timothy Ash, strategist at BlueBay Asset Management, told Reuters earlier this month. 
 
Fallout from those policies is obvious. This morning, the Turkish Treasury auctioned TRY 3.96 billion ($250 million) in four-year, local-pay bonds at a 27.31% yield, with state-owned entities and market makers serving as the bidders.  For context, Turkey sold four-year, lira-denominated bonds in September at a 16.9% coupon.  Five-year sovereign credit protection costs reached 725 basis points on Thursday, highest since the financial crisis and nearly double the five-year average of 370 basis points.  
 
Perhaps most concerningly, Erdogan’s cache of foreign currency is dwindling.  Data from the CBRT released on Friday show that gross reserves tumbled to $61 billion during the week ended May 13, down a hefty $4.8 billion from seven days earlier. Christian Maggio, head of portfolio strategy at TD Securities in London, deemed the weekly decline “shocking” in a note to clients and warned that Turkey is “unsuccessfully leaning against the wind.” Noting late last month that the CBRT has burned through $165 billion over the past two years to finance the current account deficit and support the sagging lira, Erdogan added that “these reserves may be used again.”  As for the spiraling inflation problem, the politician took a sunny view: “Let our people not worry, we will address this problem.” 
 
On Friday, the Turkish Statistical Institute announced the resignation of the head of the department of price statistics on account of health reasons.  That comes four months after Erdogan replaced the TurkStat president after less than a year on the job and follows the dismissal of three separate CBRT chiefs since 2019 for insufficient dovishness.
 
Onto the next scapegoat, then. 
Recap May 23
Eighth time’s the charm?  Stocks caught a Monday bid on the heels of seven straight weekly losses, with the S&P 500 rising nearly 2% and finishing near session highs to give the beaten-down bulls a measure of hope.  Treasury holders had a less pleasant start to the week, as bear-steepening action predominated with the 10- and 30-year yields each rising eight basis points to 2.86% and 3.07%, respectively. Gold advanced to $1,852 an ounce for a near-two-week high, WTI crude edged to $111 a barrel and the VIX settled south of 29. 
 
- Philip Grant
05.20.2022
Non-Fungible Jokin'
ADG gets rugged: The progenitors of the Lonely Ape Dating Club referenced in yesterday’s edition spilled the beans to BuzzFeed’s Katie Notopoulos overnight, admitting that the NFT-centric dating app, ostensibly pulled owing to a dearth of female participation, was a prank all along.   
 
All’s fair in love and crypto.
Luxury Lunge
About that reopening:
About that reopening: Shockingly poor quarterly results this week from retail cornerstones like Walmart, Kohl’s and Target shine a harsh spotlight on the state of the economy.  As inflation rampages around the globe and interest rates lurch higher, the financial position of an increasingly encumbered consumer (U.S. household debt reached a record $15.84 trillion as of March 31 per the New York Fed, up 12% from the end of 2019) grows particularly precarious. 
 
“I don’t think you can have a completely benign soft landing of the economy at this point,” Ethan Harris, head of global economics research at Bank of America, tells Bloomberg today. “We’re either going to have a weak economy or [outright] recession.”
 
Needless to say, an increasingly dicey environment does no favors for discretionary spending, particularly for high-end luxury goods. A gauge of 30 frequently transacted Rolexes compiled by WatchCharts.com demonstrates a pronounced loss of momentum, with average prices slipping to $15,126 today from just under $16,000 on April 2. That rapid decline is particularly striking considering the pace of appreciation prior to the reversal:  Average used Rolex prices raced higher by 21% from late November through that early Spring high-water mark before promptly turning tail. 
 
An abrupt, unwelcome turn in conditions is likewise apparent at the corporate level, spanning well beyond America’s borders. This morning, Swiss luxury watch and jewelry concern Richemont reported €3.39 billion ($3.56 billion) in operating profits during 2021, shy of the €3.79 billion consensus.  Chairman Johann Rupert added some downbeat commentary to the mix, stating that even in the wake of the pandemic, “we face a global environment which is the most unsettled we have experienced for a number of years.” As for the catalyst to the current disquiet, the executive wasn’t shy about apportioning blame: “Central banks have behaved irresponsibly. The people who did not need money got access to free capital. If you get something for free, you abuse it. Now, unfortunately, the party is ending.” 
 
On the other side of the world, China’s heavy-handed Covid-zero policies further muddy the waters, crimping a market that represents roughly one-third of Richemont’s revenues. Noting that 40% of its stores in the country remain shut on account of widespread lockdowns, Rupert told the press that the road back to normalcy will be a bumpy one: “Even when China comes out of isolation, the bounce back will not be as quick and as immediate as we have seen in Europe and the United States.”
 
Protracted pain in the Middle Kingdom would resonate. Chinese shoppers accounted for 21% of global luxury goods demand last year according to data from Bain & Co., with the consultancy predicting that China will surpass the U.S. and Europe for the number one luxury market by 2025.   Shifting consumer attitudes could imperil that coronation, however. “Luxury clothing or handbags, I definitely think are unnecessary right now, [because of] uncertainty around my financial situation,” one Shanghai-based beauty brand marketing manager, who typically purchases one to two high-end handbags per year, tells Reuters today. “I definitely feel that we need to protect ourselves from this uncertainty around the economy.”  That view is far from unique.  Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis, concludes that China’s 400 million strong middle class “is clearly being squeezed in the current pandemic.”
 
Who else might be feeling the pinch? See the May 13 issue of Grant’s Interest Rate Observer for a bearish analysis on one luxury purveyor potentially poised to struggle against today’s rough-and-tumble economic backdrop. 
Recap May 20
A late rally pushed the S&P 500 back to unchanged from a 2.3% mid-afternoon loss, though the broad index absorbed a 3%, five-day decline to mark its seventh straight weekly loss, the longest such losing streak since 2001. Treasurys continued to enjoy a bid, with the long bond dipping to 2.99% for its lowest close since April 29. Gold edged higher again to $1,844 an ounce, WTI crude did the same at $111 per barrel, and the VIX settled just below 30 after testing 33 as stocks made their intraday lows. 
 
- Philip Grant
05.19.2022
The Final Frontier
A tale in two parts: A February press release announced the debut of the Lonely Ape Dating Club. Marketed as “the first dedicated dating app for NFT collectors,” the outfit required would-be lovers to present ownership of a Bored Ape non-fungible token for membership.  The creators introduced themselves thus: “we are a ragtag team of hackers and NFT collectors interested in how we can integrate crypto and Web3 with the dating space.”  
 
Alas, those plans proved fleeting. Yesterday, a Twitter account connected to the initiative delivered the bad news: “Unfortunately, due to a vastly uneven ratio of men to women who signed up for our waitlist, we have decided to put the [Bored Ape] dating app on hold indefinitely.  Too many bros!”
 
Perhaps all the women went to the metaverse instead. 
Pass the Ketchup
Talk about a value meal.
Talk about a value meal.  Arcos Dorados Holdings, Inc. (ARCO on the NYSE), McDonalds’ master franchisee operating in Latin America, reported first quarter results yesterday featuring $791 million in revenue, up 42% year-over-year and well ahead of the $724 million analyst consensus.  Earnings per share registered at $0.12, compared to a $0.13 per share loss during the year-ago period and double the Street’s $0.06 guesstimate.  
 
Then, too, $80 million in adjusted Ebitda (that metric accounts for property write-offs as well as gains from the sale of or insurance recovery of property and equipment) marked a record for the first quarter and represented 10.1% of sales.  That’s up from a 4.3% margin in the first quarter of 2021. 
 
Mr. Market has duly taken notice of that currently-rare success story, as ARCO has returned 33% since a bullish analysis in the July 23 edition of Grant’s Interest Rate Observer, compared to a 11% loss after dividends for the S&P 500 over that period. 
 
Suffice it to say, the current positive momentum is a welcome change, as Arcos shares absorbed a
punishing 92% drawdown from their post-IPO highs through the early 2016 nadir. Various factors conspired to deliver that result, as the ARCO made its exchange debut on April 2011, a day after the MSCI EM Latin America Index notched its post-crisis peak.  A pie-in-the-sky initial valuation compounded that luckless timing, as Arcos debuted at 31.5 times 2011 earnings, compared to just 14.6 times for McDonalds itself. 
 
Then, too, Arcos generates revenues in local currencies while borrowing in dollars, an arrangement which quickly proved sub-optimal as Latin America endured numerous spells of economic hardship during the middle of the prior decade. Woes like Venezuelan hyperinflation and a series of Argentinian sovereign debt defaults worked their malevolent magic as net leverage ballooned to 4.38 times Ebitda by the midpoint of 2014, up some 2.5 turns in a mere six months. 
 
While the pandemic-induced interruption of commerce briefly left Arcos on shaky financial footing, silver linings from that dark cloud are now apparent. As of last summer, some 30% of the total LatAm restaurant industry remained shut on account of Covid, analysts at J.P. Morgan found, limiting competition and paving the way for increased market share. Arcos, which boasts 2.5 times as many locations in Brazil (its largest market) as any restaurant competitor, generated $312 million in Brazilian revenues during the first quarter, 25% above the same period in 2019 and a 14.8% Ebitda margin, up 160 basis points from that pre-virus comparison point. Then, too, a management-instituted currency hedging program, in which Arcos deploys swaps to convert half its debt load into Brazilian reals, could help forestall a sequel to the unpleasant 2014 to 2016 experience.
 
 
With Covid (we hope) in the rear-view, liquidity concerns have likewise faded. Net debt at Double-B-rated Arcos sank to a modest 1.3 times Ebitda as of March 31, down from a hefty 7.9 times in the year-ago period as the virus crimped profitability.  
 
Along with a suddenly spick-and-span balance sheet, positive earnings momentum appears well established: The 10 analysts covering Arcos now expect the franchisee to generate $0.45 in earnings per share in 2023, up from sub $0.30 per share in August of last year. Arcos now sports a $2 billion enterprise value, equivalent to less than 6.5 times full-year 2022 consensus Ebitda. 
 
Steven Grey, chief investment officer and eponym of Grey Value Management, minces no words in his conviction to Almost Daily Grant’s: "ARCO is the most transparently underpriced, underleveraged value play in the western hemisphere. They're 10 times the company they were when they went public in 2011 at $17, and they're currently trading at less than half that price."
Recap May 19
No bounce today, as stocks continued lower by about half a percent on both the S&P 500 and Nasdaq 100 in choppy trading following yesterday’s wipeout.  Treasurys caught a modest bid led by the short end, as two year yields fell five basis points to 2.63%, while WTI crude rebounded to $109 a barrel and gold climbed to $1,840 an ounce.  The VIX pulled back below 30 despite the continued weakness in equities. 
 
- Philip Grant
05.18.2022
John, Come Later
When you got to go, you got to go. From Bloomberg:
 
A former portfolio manager for the Allianz SE unit that agreed to pay $5.8 billion over the implosion of its hedge funds in 2020 saw no escape from the questioning of the SEC’s lawyers.
 
So, Stephen Bond-Nelson excused himself to use the bathroom and never returned.
 
At least, not until he decided to plead guilty and cooperate in the investigation of the fraud.  
Spinning Wheels
Let's ride.
Let’s ride.  Exercise equipment concern Peloton Interactive, Inc. managed to sell a $750 million, five-year first lien term loan with ease yesterday, as investor demand registered at a cool $2 billion, Bloomberg reports.  That torrent of interest helped underwriters price the floating-rate loan at an effective yield of just over 8%, compared to price talk north of 9%.  What’s more, the loans broke higher in early trading this morning, jumping towards 98 cents on the dollar after being priced at an original issuer discount of 95.5 cents. 
 
A decisive factor in that now-rare financing success story: The mushrooming private credit sector. As the Financial Times notes today, mega lenders such as Blackstone and Apollo helped fortify Peloton’s loan book, marking a signpost “of how lines are crossed between two distinct capital markets.” Then, too, brisk demand allowed the company to bypass some conventional steps. “The deal concluded so quickly that Peloton did not get a rating on the debt, which is typically necessary to draw in investors,” the pink paper relays. 
 
Those eager lenders are facing an uphill battle, as the pandemic-era darling does not exactly boast an envy inducing financial profile. Peloton counted 2.96 million subscribers on its global fitness platform as of March 31, up from 712,000 at year-end 2019.  In spite of that feverish growth, adjusted Ebitda registered at minus $194 million during the recently completed quarter, compared a $28.4 million adjusted Ebitda shortfall during the final three months of 2019.  
 
Non-cash charges excluded from that ultra-forgiving profitability metric continue to percolate. During the first three months of 2022, Peloton doled out $117 million in stock-based compensation, up 181% from the same period last year. Back in February, the firm announced plans to lay off 2,800 staffers, equivalent to 20% of corporate headcount, while CEO Barry McCarthy warned last week that the company is “thinly capitalized” after unrestricted cash and cash equivalents slipped to $879 million as of March 31, from $1.6 billion at year-end. 
 
***
 
As that experience suggests, private credit’s rapid ascent is increasingly difficult to ignore.  The industry counted $1.6 trillion in assets as of March, a report from Netherlands-based Intertrust Group finds, up 53% over the past five years.  “There was a time when [private debt] sounded more exotic to institutional investors, but now, it’s a standard part of the conversation” Randy Schwimmer, senior managing director at Churchill Asset Management, told Institutional Investor last week. Indeed, an early April survey of 62 such funds from capital markets newsletter The Lead Left found that 95% of respondents plan to increase their private debt allocations over the following 12 months. 
 
The ultimate utility of that wholesale migration remains up for debate.  A report yesterday from Moody’s Investors Service shone a harsher spotlight on the nascent financing class, contending that private credit providers are less attuned to rate volatility than their publicly-focused brethren.  However, the rating agency cautions that such funding is typically directed towards “leveraged buyouts and perceived higher-return investments [rather] than on operational funding needs for the rising tide of lower-rated underperformers. This could accelerate default risk for those that need funding support.” 
 
Firms rated the equivalent of single-B or lower constitute almost 60% of the overall speculative grade universe, Moody’s finds, compared to about 40% during the previous LBO party in 2006. Those rated single-B-minus or worse account for a quarter of the total speculative-grade debt realm, double the pre-crisis population. 
 
Then, too, Moody’s analysts led by Christina Padgett find that roughly 80% of that single-B-minus cohort are sponsored by private equity firms.  Accordingly:
 
Rising investor flows into private credit will bolster liquidity for leveraged transactions, but with so much capital chasing already leveraged, sponsor-owned companies, underwriting standards have deteriorated.
 
Looser lending terms provide borrowers financial leeway as rates rise, but the effects may be temporary and will likely result in lower ultimate recoveries than in prior credit cycles.
 
Mounting evidence, meanwhile, suggests that the cycle may indeed be turning.  This afternoon, benchmark credit protection costs as measured by the Markit CDX North America Investment Grade Index rose six basis points to top 90 for the first time since May 2020, placing that gauge comfortably above its 30-year average of 78 basis points. 
 
For more on private credit, including a representative “recurring revenue” loan underscoring the prolific deal activity seen during the halcyon days of 2021, see the Nov. 12 edition of Grant’s Interest Rate Observer. 
Recap May 18
Bulls, avert your eyes.  Stocks were bludgeoned by 4% on the S&P and 4.9% on the Nasdaq, sending both of those major indices to fresh 2022 closing lows with the latter off 27.5% from its Jan. 3 high-water mark.  A strong 20-year auction this afternoon helped catalyze a bull-flattening rally in Treasurys, with the long bond dipping to 3.06% from 3.17% yesterday while the two-year edged lower by three basis points to 2.68%.  WTI crude fell to $107 a barrel, gold held steady at $1,815 an ounce and the VIX jumped to 31, up five points on the day. 
 
- Philip Grant
05.17.2022
Divide and Conquer
The Securities and Exchange Commission
The Securities and Exchange Commission issued a press release this morning detailing its complaint against three portfolio managers at Allianz Global Investors’ U.S. subsidiary, alleging that the trio conducted “a massive fraudulent scheme that concealed the immense downside risks to a complex options trading strategy they called ‘Structured Alpha.’” Along with $5 billion in restitution payments, Allianz also agreed to pay $1 billion to settle the SEC’s charges. 
 
“This case once again demonstrates that even the most sophisticated institutional investors, like pension funds, can become victims of wrongdoing,” SEC chair Gary Gensler commented. The trading strategy may have been complex and victims sophisticated, but the alleged manipulation, less so. An excerpt from today’s missive:
 
Defendants reduced losses under a market crash scenario in one risk report sent to investors from negative 42.1505489755747% to negative 4.1505489755747% -- by simply dropping the single digit 2.  In another example, defendants “smoothed” performance data sent to investors by reducing losses on one day from negative 18.2607085709004% to negative 9.2607085709004% -- this time by cutting the number 18 in half.    
 
On the bright side, the numbers to the right of the decimal point were ship-shape. 
Lots of Luck
China’s battered property sector look to get off the mat.
China’s battered property sector look to get off the mat. Yesterday, a trio of developers hand-picked by the government announced plans to sell a combined RMB 2 billion ($295 million) in onshore debt. There is, however, a twist: Country Garden’s, Longfor Group’s and Midea Real Estate Group’s bond offerings will be backed by either credit default swaps or so-called credit risk mitigation warrants, i.e., securities provided by a bank or other third party giving creditors the right to make a claim against the certificate provider in the event of a default, ratings downgrade or other adverse event.  
 
As that proposed structure suggests, there is no shortage of credit risk to hedge within the Chinese property realm, which accounts for some 30% of total economic output.  Hamstrung by fast-eroding revenues even before the recent “zero Covid” lockdowns, along with crushing leverage and tightened fundraising restrictions under the Communist Party’s three red lines regulatory regime, local developers have issued just RMB 55 billion in onshore debt so far this year, the slowest such pace since 2015. Meanwhile, in the wake of the defaults from industry giants China Evergrande and Kaisa Group Holdings late last year, 60% of the dollar-pay bonds issued by property firms yet to default now trade at below 40 cents on the dollar, relays Avanti Save, managing director of Asian credit strategy at Barclays. 
 
The planned introduction of third parties into the proposed developer trio’s financing is ironic, considering recent experience. Recall that back in late March, Chinese banks seized $2.1 billion in deposits stored in China Evergrande’s majority-owned subsidiary, Evergrande Property Services (a sum representing nearly all its cash holdings as of June 30), claiming that those funds were used as collateral for loan guarantees to unknown entities. That revelation turned up the heat on already perturbed bondholders: “The atmosphere in the [creditors meeting] room is one of boiling blood,” one observer put it to the Financial Times.  In announcing that it would establish an independent committee to investigate, Evergrande went on to warn that other subsidiaries may have made similar loan guarantees.
 
Considering that backdrop, some observers remain skeptical of Beijing’s efforts to reopen the capital markets. “Investors are monitoring for when stimulus and support translate into actual sales and liquidity improvement,” Wonnie Chu, managing director of fixed income at GaoTeng Global Asset Management, tells Bloomberg. “So far we have not seen that materialize.”
 
Indeed, the benefits of direct government intervention for overseas creditors remain murky.  Out of 32 instances in which the Chinese government provided bailouts to floundering companies, Fitch Ratings finds today, default resulted in 24 of those cases. That roster of supplicants included 10 state owned enterprises, five of which were ultimately unable to pay their creditors, while all but three of the 22 privately held firms were forced to restructure. 
 
If all else fails, the CCP can at least turn to a familiar page in the playbook: information suppression.  Bloomberg reports today that China’s Foreign Exchange System trading platform, which typically reports foreigners’ bond market transactions one day after a trade is executed, has not been updated since May 11, a day which featured hefty net outflows from overseas investors.  That follows a net RMB 52 billion drop in foreign holdings of Chinese government bonds in March, easily the biggest monthly decline on record going back to 2014. 
Recap May 17
Stocks caught a strong bid with the S&P 500 rising 2.1% and the Nasdaq 100 jumping by 2.6% to lift the averages well off the 2022 lows probed last week, though Treasury holders had a rough day of it with the long bond jumping eight basis points to 3.17% and the two-year yield finishing at 2.71% from 2.58% yesterday. Gold edged lower to $1,813 an ounce, WTI crude retreated to $112 a barrel and the VIX fell to near 26 for the first time since early May. 
 
- Philip Grant
05.16.2022
Atlas Rugged
Your headline of the day, from Fortune:
 
Ethereum co-founder says every ‘average smallholder’ impacted by Terra’s stablecoin crash should be made whole, cites FDIC’s $250,000 [insurance] as ‘precedent’
Captain of Industry
Last month, the White House tapped University of Michigan law professor
Last month, the White House tapped University of Michigan law professor and Treasury department alum Michael Barr for nomination as the Federal Reserve’s vice chair for supervision.  The role, created in 2010 to enhance oversight of the banking industry as part of the Dodd-Frank Act, was filled by Randal Quarles prior to his resignation from the Fed last fall.  
 
According to the form 278e public financial disclosure report dated April 8, Barr holds positions in dozens of financial technology firms in his portfolio, including several involved in cryptocurrencies. Separately, the nominee continues to serve as a consultant at a quartet of fintech outfits around the country. The Prospect executive editor David Dayen, who unearthed Barr’s extensive industry ties on Twitter this morning, quips of the prospective senior regulator: “The bored ape we need.” 
Margin Call
The rough start to 2022 has done a number on valuations,
The rough start to 2022 has done a number on valuations, as the S&P 500’s blended 12 month forward price-to-earnings ratio has fallen by nearly 30% since the start of the year, data from Charles Schwab show.  That’s on par with the price tag contraction seen during the teeth of the pandemic panic in early 2020.  The broad gauge now fetches 16.8 times projected earnings over the next year according to Refinitiv, down from a cyclical peak of 24.1 times logged in September 2020 but slightly above its 20-year average multiple of 15.7 times forward earnings. 
 
While the recent correction has pulled valuations back down to earth, corporate earnings power looks to be following suit.  Wall Street’s bottom-up tabulation currently calls for 4.3% year-over-year earnings growth for S&P 500 components during the second quarter, Bianco Research relays.  That’s down from a 6% guesstimate a month ago and sits well below the current 8.3% growth rate in the consumer price index. Yet at the same time, revenue expectations continue to ratchet higher, with the sell side now penciling in a 9.8% top-line advance for the second quarter relative to a year ago, compared to a 7% projected clip back in February. 
 
That nascent pressure on corporate earnings power marks a pronounced shift from the Covid-era bonanza. Net profit margins for the S&P 500 stood at 12.3% during the first three months of the year, down from 13.5% and 13.4% in the third and fourth quarters, respectively, but far above the 8.2% average seen since 1993.  
 
A readily identifiable culprit for that retrenchment: Of the 445 S&P 500 members that had reported first quarter earnings as of Friday, 377 of those cited the term “inflation” during their earnings calls, an analysis conducted by FactSet found. That marks the highest such frequency on record since at least 2010 and compares to a five-year average of 155 components mentioning the phenomenon in a given quarter. 
 
Top-down data corroborate those concerns. The Producer Price Index has sported an average 8.7% year-over-year growth rate over the past 12 months, compared to “just” 6.4% for the Consumer Price Index during that period.  The accelerated price pressures on the producer side of the coin are a new phenomenon within the modern financial epoch: Over the 20 years preceding the inflationary dustup commencing in early 2021, PPI averaged a 2% annual growth rate, compared to 2.1% for CPI.  
 
As valuations and corporate profitability alike recede from historically lofty levels, John Q. Public is zigging when maybe he should be zagging. U.S. equity mutual funds and ETFs gathered a cool $1.2 trillion in assets last year according to Morningstar, nearly double the previous $689 billion high-water mark set in 2017.  
 
See the April 29 edition of Grant’s Interest Rate Observer for more on the less-than-ideal backdrop for stocks, and the brand new May 13 issue for a look at the Federal Reserve’s self-inflicted predicament as the monetary mandarins attempt to tame inflation without spurring a financial pileup.
Recap May 16
Stocks edged lower in a relatively low-wattage start to the week, with the S&P 500 and Nasdaq 100 retreating by 0.4% and 1.2%, respectively, while Treasurys saw mixed results that included strength in the belly of the curve and slightly higher yields on both the two-year note and long bond. Gold got off the schneid with a bounce to $1,822 an ounce, WTI crude broke to fresh two-month highs at $114 per barrel and the VIX slipped below 28. 
 
- Philip Grant
05.13.2022
Nothing Ventured
The epitome of the cycle? You bet.
The epitome of the cycle? You bet. Yesterday, SoftBank Group Corp. reported results that could be described as ghastly, featuring a ¥1.71 trillion ($13.2 billion) annual loss over the 12 months through March 31. The Vision Fund, the firm’s in-house venture capital arm, was the culprit, logging a cool ¥3.5 trillion shortfall over that stretch.
 
Those head-spinning losses mark a night-and day contrast from a year ago for CEO Masayoshi Son’s firm, which featured a ¥5 trillion profit during the prior fiscal year, a record haul for any Japanese company.  The subsequent setback dropped net asset value at the Vision Fund to ¥18.5 trillion as of March 31, down 28% year-over-year and 16% below the average over the prior two years. 
 
On form, tighter purse-strings are following that washout, as SoftBank needs to be “more careful when we invest new money,” Son said during the presentation. The Vision Fund dished out $2.5 billion in net investments over the three months through March 31, down from $10.4 billion in the prior quarter and a $33.3 billion pre-Covid peak. 
 
That newfound discipline didn’t come from nowhere. A mid-March swoon in shares of portfolio cornerstone Alibaba Group Holding Ltd. to $73 from $138 in early January left SoftBank “insanely close” to triggering a $6 billion margin loan secured by the position, one insider told the Financial Times (Alibaba shares currently change hands at $88). 
 
Subsequent price moves haven’t exactly been kind, however; the Nasdaq 100 has lost an additional 17% since the end of the fiscal first quarter, pushing the average decline among publicly traded companies within the Vision Fund portfolio to 62% from their IPO prices. The torrents of red ink through March 31 “could pale in comparison to the current implosion in the value of its listed holdings”, Amir Anvarzadeh, Japanese market strategist at Asymmetric Advisors, wrote yesterday. “We suspect SoftBank is having notable capital constraints that could only get worse should this market correction continue.” 
 
****
 
Gale-force crosswinds abound in the venture capital industry at large.  According to data from PitchBook, valuations for late-stage firms continued north throughout the first quarter, reaching $120 million from $105 million across 2021 and just $60 million in 2019.  Similarly, early stage firms enjoyed an average $67 million price tag over the three months through March 31, up from $45 million last year and $23 million before the bug bit. The number of privately held businesses valued at $1 billion or higher now stands at 1,107 globally per CB Insights. That’s up 16% since the start of 2022.  
 
So-called down rounds comprised only 5% of completed v.c. deals during the first quarter, PitchBook finds. That compares to more than 10% of fundraising rounds coming at relatively lower valuations during the eight years leading up to the pandemic and 7.3% during the peak of the euphoria last year. 
 
On the other hand, springtime has been one of discontent throughout the industry.  According to Refinitiv’s Venture Capital Research Index, a gauge designed to simulate broader industry conditions through both individual portfolios and publicly traded stocks, v.c. endured a 24.2% wipeout in April, by far its worst month since the aftermath of the first tech bubble. 
 
As the stock market absorbs a painful “right-sizing,” one v.c.-heavy corner of the economy is increasingly following suit. Citing data from employment tracker Layoffs.fyi, The New York Times reported yesterday that 55 tech companies have announced plans to cut staff or shut down entirely this year, compared to 25 such casualties at this time in 2021. In a similar vein, the number of individuals and groups looking to dump their shares in startups doubled in the first quarter on a sequential basis, reports Phil Haslett, founder of pre-IPO marketplace EquityZen. 
 
The diametric shift in conditions has duly prompted its share of soul-searching. Mathias Schilling, co-founder at v.c. firm Headline, sums it up to the Times: “Everything that has been true in the last two years is suddenly not true.”
 
That’s not to say that the speculative fervor witnessed in spades prior to 2022 has fully abated.  As the FT notes today, v.c. heavyweights Andreesen Horowitz and Paradigm “have begun directly investing in non-fungible tokens,” while “several specialist money managers have also raised tens of millions of dollars in new NFT funds.” 
 
Rome wasn’t unbuilt in a day.
Recap May 13
Stocks enjoyed a strong rally with the S&P 500 rising by 2.4%, though the broad index finished the week with a 1.2% decline to mark its sixth consecutive weekly drop. Treasurys were hammered with the long bond finishing at 3.1% from 3% yesterday, while gold sank to $1,809 an ounce to continue its slump and WTI crude broke above $110 per barrel for the first time since late March. The VIX finished just south of 29, marking a near-three-week low. 
 
- Philip Grant
05.12.2022
On the Sauce
Crypto’s Grand Central Station undergoes urgent repairs.
Crypto’s Grand Central Station undergoes urgent repairs.  Pre-eminent “stablecoin” tether briefly followed algorithmic peer TerraUSD down this morning, breaking its 1-to-1 peg to the dollar and trading as low as 95 cents, data from CryptoCompare show.  
 
By way of response, Tether management encouraged its crypto flock to claim the ostensibly free money on offer by arbitraging that discount. Chief technology officer Paolo Ardoino claimed on Twitter early this morning that the company had redeemed more than $300 million in tethers over the prior 24 hours “without a sweat drop.” Vowing to “maintain the U.S. dollar peg at all costs,” Ardonio added today that Tether held “a ton” of Treasury debt, which it was prepared to liquidate in support of the peg.
 
Investors will have to take the executive’s word for it, as Ardoino’s firm has famously resisted calls to produce an audit verifying the composition of the reserves backing its $82 billion market capitalization. In a late February press release, Tether trumpeted the results of its legally mandated attestation of its reserves conducted as of Dec. 31 at 11:59pm, highlighting “an increase in the group’s investments in money market funds and treasury bills as well as A1+ commercial paper holdings over the previous quarter, which further fortifies the resilience of Tether’s stablecoins.”  
 
Recall that those quarterly snapshots were ordered by New York Attorney General Letitia James in February 2021, following a settlement in which the A.G. concluded that Tether’s longstanding claims of full dollar backing were “a lie” (see the issues of Grant’s Interest Rate Observer dated Sept. 18, 2017, Nov. 2, 2018 and Oct. 2, 2020 for early, skeptical analyses of the stablecoin’s actual underpinnings). Short term government securities accounted for 44% of reserves as the ball dropped in Times Square, accounting firm MHA Cayman found. 
 
While the market for Uncle Sam’s IOUs is widely known as the world’s most liquid, with investors typically able to trade in and out of huge positions with ease, one can’t be too careful.  Asked by the Financial Times this afternoon for more information on its Treasury holdings, including the custodian and trading counterparties, Ardoino demurred: “This is information that is privileged. . . we don’t want to give our secret sauce,” he said. “We keep that information [to] ourselves, but we are working with many big institutions in the traditional financial space.” 
 
In other words: Top. . . firms.
 
Floating Machine
The bond market’s growth engine hits stall steed.
The bond market’s growth engine hits stall steed. The S&P/LSTA Leveraged Loan Index has endured a 14 session losing streak through yesterday, leaving that gauge below 96 cents on the dollar for the first time since December 2020. 
 
Perhaps unsurprisingly, the heretofore wide open primary market has faltered of late, with no new deals pricing today to mark the sixth consecutive barren session, Bloomberg relays.  That development is concerning, as banks are sitting on a backlog of at least 10 loan deals, including a $615 million transaction to finance Bain Capital’s leveraged buyout of outsourcing firm VXI.  
 
Indeed, the problem has been festering for some time. Credit Suisse, Goldman Sachs and Bank of America have committed some $15 billion in bridge financing for a leveraged buyout of Citrix Systems, Inc., yet the debt funding that transaction remains stuck on bank balance sheets nearly four months after the deal was announced.  
 
Meanwhile, increasingly ominous financial conditions stemming from a belatedly hawkish Federal Reserve render the floating-rate credit complex increasingly vulnerable. In a blog post yesterday, a trio of portfolio managers at Pacific Investment Management Co. warned that, in the event of a 300 basis point increase to the benchmark Fed funds rate, a typical single-B-rated issuer of floating-rate bank debt will incur a 60% to 70% annual increase in its interest costs. Such a development “could materially erode debt servicing capacity and challenge companies’ ability to generate free cash flow,” Pimco believes, as single-B credits typically generate annual Ebitda equivalent to roughly two times interest expense. 
 
A further jolt higher in interest rates could inflict wider mayhem, considering the increasingly aggressive deal structures undertaken during the scrounge for yield seen during the post-crisis cycle.  A report from LCD last week found that 55% of the S&P/LSTA Index components sport ratings of single-B or single-B-minus as of April 30, up from less than 40% as recently as late 2017.  Nearly $400 billion of par value securities, representing a 27% share of the loan market, are now rated single-B-minus, compared to $200 billion of single-B-minus-rated debt comprising 13% of the market in early 2019.  
 
Then, too, borrowers rated single-B-minus from at least one rating agency accounted for 30% of primary issuance during 2019 and 2020 and topped 40% of last year’s record $615 billion in leveraged loan supply.  That compares to an 11% share of such low-rated credits during the eight years leading up to the financial crisis and 17% during the eight years following 2010.
 
“How much breathing room do B-minus rated borrowers have?” LCD asks. At this rate, we may find out sooner than later. 
Recap May 12
Stocks mostly stayed on the back foot despite a late rally, as the S&P 500 and Nasdaq 100 each finished just below unchanged to sit lower by 4.7% and 5.9%, respectively, so far this week, while Treasurys enjoyed a bull-steepening rally with the two-year yield sinking to 2.56%, its lowest since April 26.  Gold remained under pressure at $1,822 an ounce, WTI crude rose to $107 a barrel and the VIX held near 32. 
 
- Philip Grant
05.10.2022
Austerity Mandate
The 2022 version of price stability comes home to Frankfurt.
The 2022 version of price stability comes home to Frankfurt. From Bloomberg:
 
European Central Bank President Christine Lagarde rejected calls by staff to link salary increases to inflation, which has hit a record in the euro area and is far in excess of the minimum pay boost handed out this year.
 
In an email to employees on May 5. . . Lagarde said she understood that some were ‘disappointed’ by this year’s rise but insisted that future adjustments must be ‘reasonable.’
 
‘I understand that the [raise schedule] has disappointed many of you because of high inflation,’ she wrote in the email. ‘We understand why inflation is a concern for many of you, as it is for many people outside the ECB.’
Peg Leg
Zero-gravity finance:
Zero-gravity finance: Bitcoin’s Monday swoon below $30,000 coincided with severe damage across the digital asset realm, headlined by the emphatic dislodging of so-called algorithmic stablecoin TerraUSD (UST), which underpins the Luna cryptocurrency, from its intended anchor. TerraUSD, the third-largest stablecoin with some $18 billion in assets prior to the recent dustup, is designed to maintain a 1:1 peg with the dollar to facilitate transactions into crypto from fiat and back again.  
 
Unlike stablecoin peers such as Tether, which claims to be collateralized with actual greenbacks, an inherent arbitrage opportunity between TerraUSD and Luna is the mechanism by which UST is supposed to remain ensconced at $1. In theory, traders observing a decline in TerraUSD below $1 would swap into newly-minted Luna, “burning” (i.e., removing from circulation) the Terra in the process, and vice versa.  That ingrained regulation of supply and demand would, in theory, maintain a self-correcting equilibrium between the two and underpin the peg.
 
Suffice it to say, recent events have demonstrated vulnerabilities within that algorithmic stablecoin edifice, a feature of the decentralized finance (DeFi) banking system that undergirds the broader crypto market. As The Wall Street Journal notes, UST began to falter from its peg over the weekend following a series of large TerraUSD withdrawals made by crypto lender Anchor Protocol (which promises annual interest rates of up to 20% for those lending out their TerraUSD coins), slipping to 99 cents from its purportedly “stable” $1 price, before those losses accelerated during and after Monday’s broad-based rout.  
 
TerraUSD reached as low as 60.5 cents late yesterday evening (thank goodness for 24/7 trading!), before rebounding back above 90 cents today after Terra’s sponsors sold some 28,000 bitcoins from its reserve to purchase UST and issued $1.5 billion in bitcoin- and UST-denominated loans to prop up the price. Yet substantial damage from the episode remains visible: Luna, UST’s sister token, is nursing 65% losses over the 48 hours late Tuesday after drifting lower throughout the regular market session. 
 
While sporadic financial accidents have long been part-and-parcel of the crypto experience, the recent Terra drama comes at a particularly inopportune time, as Uncle Sam takes a heightened interest in decentralized finance and the stablecoin structure.  The Federal Reserve’s biannual Financial Stability Report, released yesterday, featured a prominent warning about the financial stability risks inherent in such a structure:
 
Stablecoins typically aim to be convertible, at par, to dollars, but they are backed by assets that may lose value or become illiquid during stress; hence, they face redemption risks similar to those of prime and tax-exempt money market funds. These vulnerabilities may be exacerbated by a lack of transparency regarding the riskiness and liquidity of assets backing stablecoins. 
 
Additionally, the increasing use of stablecoins to meet margin requirements for levered trading in other cryptocurrencies may amplify volatility in demand for stablecoins and heighten redemption risks.
 
That view is not confined to the Eccles Building. Asked during an appearance in front of Congress today about the viability of enhanced regulation of stablecoins, Treasury Secretary Janet Yellen answered that a formal oversight regime “is important, even urgent” and that enactment of such regulation by the end of 2022 would be “highly appropriate.” 
 
What exactly is this parallel financial universe, how does it work and who ultimately benefits from decentralized finance? For more, see the indispensable primer “DeFi for boomers” in the June 25, 2021 edition of Grant’s Interest Rate Observer, which includes a potentially instructive post-mortem of one waylaid stablecoin pair. 
Recap May 10
Stocks managed only a modest bounce after yesterday’s smackdown, with the Nasdaq 100 gaining 1.3% and the broad S&P 500 eking out a 25 basis point advance, while Treasurys continued their rally ahead of tomorrow’s CPI print with the long bond falling to 3.12% from 3.23% on Friday. Yet more dollar strength kept the pressure on key commodities, with gold slipping to $1,839 an ounce and WTI crude retreating to $100 a barrel, and the VIX pulled back a couple points to 33.  
 
- Philip Grant
05.09.2022
Down in the Bottom
Time to tweak a game plan or two?
Time to tweak a game plan or two? As financial storm clouds gather, a pair of earnings reports last week from Silicon Valley heavyweights provide a timely reminder of the market’s embrace of unproven business models during the roaring post-crisis bull market.  Let’s review: 
 
First up, food delivery behemoth DoorDash, Inc. (DASH on the NYSE), which offered seemingly pleasant results last Thursday, headlined by a 35% revenue jump from a year ago to $1.46 billion, topping Wall Street’s $1.38 billion consensus estimate and sending shares higher by 9% in early trading on Friday.  The only problem:  total expenses advanced at a 38% year-over-year clip, pushing DASH’s operating loss to $175 million, up 74% from the first three months of 2021. 
 
DoorDash, which has posted a cumulative net loss of $1.7 billion from the start of 2019 through March 31, will finally swing into the black by 2023 and will earn $508 million by 2024, the sell side believes, or, at least, says.  Even following a 56% year-to-date downdraft, shares remain priced at 49 times that consensus 2024 earnings figure.  
 
Time will tell if that still-fancy valuation proves justified. Matt Maloney, then-CEO of rival Grubhub, candidly explained the limitations inherent within third party delivery back in 2019: “Extremely large delivery/logistics companies can generate slim margins, but only because of the hub and spoke efficiencies they gain at substantial scale. The point-to-point nature of our business mostly eliminates that aspect of operating leverage.”  
 
Other knowledgeable actors have expressed similar sentiments: “In 60 years, we’ve never made a dollar delivering a pizza. We make money on the product, but we don’t make money on the delivery. So, we’re just not sure how others do it,” former Domino’s Pizza CEO Stuart Levy explained early last year.   
 
Meanwhile, a lynchpin of the app-based economy looks to finally break into the black.  Ride share pioneer Uber Technologies, Inc. (UBER on the NYSE) saw revenues balloon to $6.85 billion during the first quarter, a 136% year-over-year advance.  Then, too, the firm’s prettied-up adjusted Ebitda metric rose to $168 million from negative $359 million at the start of 2021, well ahead of the Street’s $135 million guesstimate. 
 
Coming on the heels of a disastrous report from ride-share rival Lyft, Inc., Uber’s relatively strong results had management feeling its oats on the subsequent earnings call: “We're confident that our leadership position, our global scale, and our innovation and platform advantages will allow us to deliver significant profitability and durable growth as investors rightly expect from globally scaled technology platforms,” CEO Dara Khosrowshahi declared.
 
Conventional financial analysis might lead an observer to question that upbeat analysis.  Using generally accepted accounting principles, Uber remained firmly in the red during the first quarter with a $482 million operating loss, bringing its cumulative shortfall to a cool $29 billion since the start of 2015.  
 
Yet optimism continues to reign: the sell side similarly expects the 13-year old firm to reach net income profitability next year and earn $2.7 billion in 2024, despite taking down 2022 GAAP earnings per share estimates to minus $2.94 from a predicted $0.60 loss last fall.  Following a 44% year-to-date decline, shares are priced at 21 times those far-flung 2024 consensus earnings.  
 
Though Mr. Market continues to hold Uber in high regard, the recent bloodletting in asset prices has prompted the c-suite to rethink its long-rewarded strategy of chasing rapid (and, yes, profitless) revenue growth. As CNBC first reported, Khosrowshahi sent a firmwide email yesterday evening detailing a comprehensive strategy pivot:
 
After earnings, I spent several days meeting investors in New York and Boston. It’s clear that the market is experiencing a seismic shift and we need to react accordingly.
 
We have to make sure our unit economics work before we go big. The least efficient marketing and incentive spend will be pulled back. We will treat hiring as a privilege and be deliberate about when and where we add headcount. We will be even more hardcore about costs across the board.
 
Ready or not, a new era beckons. 
Recap May 9
A late bounce Friday proved a short-lived reprieve, as stocks were hammered once more with the S&P 500 and Nasdaq 100 losing 3.2% and 3.9% respectively to each reach fresh 2022 closing lows.  Treasurys, on the other hand, enjoyed a strong bull-steepening bounce as two-year yields dropped to 2.61% from 2.78% four sessions ago, while the long bond settled at 3.19% compared to 3.22% on Friday.   
 
Gold slumped to $1,852 per ounce and WTI crude retreated to $102.50 a barrel as the Dollar Index achived its highest close since 2002, while the VIX advanced to 34.75, within two points of its 52-week highs logged on March 7.
 
- Philip Grant
05.06.2022
Hide Away
Defense wins championships:
Defense wins championships: Though precarious price action abounds, some safety-minded investors have fared just fine of late. The Wall Street Journal relayed yesterday that the iShares Core High Dividend ETF (ticker: HDV), which tracks a basket of 75 largely old economy stocks and sports an indicated 2.9% dividend yield, has generated a 5.4% gain this year through mid-day, lapping the 13% decline on the broad S&P 500, let alone the 29% face plant for the NYSE FAANG+ Index.   
 
With inflation on the march, the Treasurys market similarly under siege and valuations remaining less-than inviting (the S&P 500 remains priced at 32 times the Shiller cyclically adjusted price-to-earnings ratio), dividend payers represent a logical sanctum, some believe.  “I don’t want high risk. I want a cereal company with a dividend that I know is coming,” Steve Chiavarone, senior portfolio manager at Federated Hermes, told the Journal.
 
The spring squall in asset prices may help usher in wider regime change.  Charles Schwab strategist Liz Ann Sonders noted this morning that the Bloomberg Pure Value Portfolio outperformed its Pure Growth Component by 10.8 percentage points this year through Thursday, its best relative showing since 2008. 
Though the growth contingent has gotten the worst of the 2022 selloff, one informed observer believes that there may be more where that came from, especially among the heretofore-invincible FAANG types.  In an interview with Yahoo! Finance last week, Research Affiliates founder and chairman Rob Arnott offered a frank appraisal of big tech’s investment prospects: 
 
The tech sector is stretched by any measure. I view Apple, for instance, as being priced for aggressive assumptions leading into the future, but not implausible assumptions. It’s very possible that the growth will justify the current price. Not so for Tesla, Facebook, Netflix, Amazon.  A lot of these are priced for implausible long-term growth.  
 
And that means you turn your attention, to value.  Value is pretty cheap in the U.S., even now, after recovering quite drastically in the last few months.
 
Indeed, the growth stock jubilee seen during the post-crisis epoch has left plenty of room for retrenchment. Speaking at the fall 2021 Grant’s conference, Arnott observed that, using the admittedly-blunt valuation instrument of price-to-book value, growth stocks sported even richer price tags relative to their value brethren than seen at the climax of the 2000-era tech mania.  During the seven years following the bursting of the bubble, value went on to trounce growth by “well over 100 percentage points,” Arnott added.
 
Are the conditions in place for a similarly supercharged relative run?  One thing’s for sure, growth’s true believers continue to stick to their guns.  Over the first three days of the week, the Ark Innovation ETF (ticker: ARKK) attracted nearly $600 million in inflows, Bloomberg reports, including $367 million on Tuesday alone to mark its biggest one-day infusion in a year. 
 
The timing of that shopping spree left something to be desired, as ARKK took a 9% shellacking yesterday to extend its year-to-date losses to 50%. All but one of Ark’s 35 portfolio holdings are down on the year.  That bullish outlier: the BNY Mellon Dreyfus Cash Management Fund. That money market fund, which is up three basis points during 2022 so far, accounts for about $4 million of ARKK’s $9.4 billion in assets. 
Recap May 6
Stocks remained moderately lower of mid-afternoon (your correspondent had to leave at 2pm ET), while Treasurys were hammered once again as the long bond topped 3.2% for the first time since 2018 and the iShares 20 Plus Year Treasury Bond ETF plumbed fresh multiyear depths, down 19% year-over-year.  Gold drifted sideways at $1,884 an ounce, WTI pushed towards $110 a barrel and the VIX held near 31. 
 
- Philip Grant
05.05.2022
Public Record
Don’t stop believing.
Don’t stop believing. The venture capital industry keeps chugging along after a 2021 that beggared belief.  According to data from PitchBook, U.S. deal volume registered at $70.7 billion over the first three months of the year, off the fourth quarter’s record $95.4 billion haul but still far above the pre-pandemic norm (no quarterly figure in 2019 topped $40 billion).  
 
Though activity cooled slightly from last year’s frenzied pace, price tags continued to march higher at the onset of 2022. Median valuations for late-stage firms reached $120 million during the first quarter, PItchBook finds, compared to $105 million across 2021 and $60 million in 2019.  Similarly, early stage firms garnered an average $67 million price tag over the three months through March 31, up from $45 million last year and $23 million before the bug bit.  The number of privately held businesses valued at $1 billion or higher continues to creep upward, now at 1,100 globally per CB Insights from 956 at the onset of 2022. 
 
Optimism among industry insiders remains sky-high. The Switzerland-based firm Partners Group foresees a continuation of the parabolic growth in alternative assets, predicting that the private market will reach $30 trillion by 2030 from $10 trillion in 2020 (AUM had likewise trebled over the prior 10 years beginning in 2010).  Similarly, the top 25 institutional investors will allocate 15% to 20% of assets into private investments by 2030, Partners believes, up from 9% in 2020 and 2021 and 4% at the turn of the last decade (for a review of the bear case on Partners, see the April 1 edition of Grant’s Interest Rate Observer. Shares have lost 17% in dollar terms since that update). 
 
Coming to a similar conclusion via a slightly differing data set, data analytics firm Preqin predicts that total alternative assets will reach $23 trillion by 2026, compared to $13.3 trillion at the end of last year.  That would represent an acceleration from the fair-weather environment seen of late, with a projected 11.7% compound annual growth rate over the next four-plus years following an observed 10.7% CAGR from 2016 through 2021. “The global alternatives market not only weathered the storm through unprecedented change in the past couple of years, but emerged stronger than ever,” Preqin concludes.  
 
Of course, conditions in public markets have turned less than hospitable, with the Nasdaq 100 slipping into bear market territory after rising 136% from the Covid lows through Dec. 31.  Though privately held assets allow managers far more leeway in marking their books, the pain is increasingly difficult to ignore.  Citing data from Refinitiv’s Venture Capital Research Index, which tracks both individual portfolios and publicly traded stocks to simulate broader industry conditions, Robin Wigglesworth of the Financial Times relayed yesterday that benchmark monthly returns logged an eye-watering minus 24.2% figure in April, easily the gauge’s worth monthly showing since the aftermath of the first technology bubble. 
 
Yet with deal volumes remaining robust well into 2022, a potentially bigger problem looms in the form of blocked exit doors. The IPO pipeline remains thoroughly clogged, as a mere 37 new entrants came public during the first quarter, raising an aggregate $4.1 billion. That’s down 94% year-over-year and the weakest start to the year since 2016.  
 
Meanwhile, the investment public may be less than eager to swallow more v.c. offerings, if recent experience is any indication.  The 10 largest v.c-backed listings during the 2021 bacchanal, including prominent names such as Rivian, Coinbase and Roblox, now combine for a $121 billion market capitalization, less than half of the aggregate $278 billion commanded in post-money exit valuations. 
 
On the bright side, there’s always 2030.  
Recap May 5
About that rally: Stocks were strafed to the tune of 3.6% on the S&P 500 and 5% for the Nasdaq 100, giving up yesterday’s feverish post-FOMC advance with room to spare and settling near and at their respective year-to-date lows.  Treasurys were likewise slapped around, as the benchmark 10-year yield logged a fresh post virus high at 3.05%, up from 2.54% a month ago.  Gold managed a modest advance to $1,878 an ounce, WTI crude ticked above $108 per barrel and the VIX jumped to 31.5, up six points on the day.
 
- Philip Grant
05.04.2022
Spread 'Em
Big doings in the bond market.
Big doings abound in the bond market.  Yesterday, the German 10-year bund yield powered above the 1% mark for the first time since 2015, up from negative territory as recently as March 7.  Widening sovereign credit spreads accompany that interest rate regime change, as triple-B-rated Italy’s 10-year paper now sports a 1.9% premium over its German counterpart. That compares to 1% late last year and marks the widest spread since the bug barged in. 
 
“What we’re seeing in markets is the realization that ECB tightening is at the door,” Rohan Khanna, fixed income strategist at UBS, told the Financial Times. “It’s a double whammy for the most vulnerable sovereigns of increasing funding costs right when growth expectations are being downgraded.” A downshift in the ECB’s feverish asset purchase pace further muddies the waters:  Frankfurt will absorb a mere 40% of net eurozone government bond supply this year, reckons Pictet Wealth Management strategist Frederik Ducrozet, compared to upwards of 120% across 2020 and 2021. 
 
Stateside, conditions for speculative grade corporate borrowers are getting a little hairy. This morning, medical device firm Bioventus shelved a $415 offering of triple-C-plus rated notes after investors balked at the proposed terms, which included a 9.75% to 10% coupon and original issue discount, Bloomberg reports.  The reluctance is understandable, considering the triple-C-rated portion of the Bloomberg High Yield Index posted losses for nine consecutive sessions through Tuesday to sit at 10.59%, its highest since summer 2020.   
 
On the better-groomed end of high yield, some 25% of the population of double-B-rated corporate bonds had slumped below 90 cents on the dollar as of Friday, strategists at Barclays find, approaching the highest such tally since the 2008 era. 
The Substitute
Is a round of belt tightening in store for John Q. Public?
Is a round of belt tightening in store for John Q. Public? As the stimmy-fueled virus-cum-lockdown era gives way to bounding inflation, consumption habits could be poised for a reset. 
 
Consumer spending rose by 1.1% on a seasonally adjusted basis between March and February, the Department of Commerce relayed last Friday, well ahead of the 0.7% consensus.  However, financial resources are fast dwindling: the personal savings rate slumped to 6.2% in March, down from 8.4% at year-end and its lowest reading since December 2013.  That shift comes after credit card balances rose by $52 billion over the three months through Dec. 31 according to the New York Fed, the biggest quarterly jump since the turn of the century. 
 
More recent evidence suggests that large swaths of the populace are suffering from sticker shock.  Last month, analysts at Jefferies surveyed 3,500 domestic consumers to gauge the response to the percolating CPI.  Of that cohort, only 37% maintain confidence that their wages will keep pace with price pressures.  Accordingly, a plurality plan lifestyle tweaks to withstand dwindling real incomes. To wit: 60% of respondents plan to switch to low cost alternatives when prices appear “too high,” with 48% already swapping into cut rate, private label products to help stretch their dollar. Fifty-eight percent are outright reducing the quantity of goods purchased. 
 
Dairy Queen CEO Troy Bader made a similar point during last weekend’s Berkshire Hathaway annual meeting: "Inflation is hot. Consumers are spending more on housing, fuel for our vehicles, utilities, healthcare, and on and on. The discretionary income we have is smaller."
 
Perhaps most concerningly, even smokers are pulling back on their fix.  Cigarette sale volumes in the U.S. sank 9.4% year-over-year during the four weeks ended March 26, data from Nielsen show. Coming on the heels of a 7.9% annual contraction in February, the March data are paired against a much easier year-over-year comparison relative to the prior month. Considering that the cigarette industry is thought of as highly price inelastic, those drastic declines underscore the shift in consumer behavior.  
 
How might a prudent investor hedge against, or even capitalize on, an inflation-induced spending downshift?  See “Workers of the world” in the April 15 edition of Grant’s Interest Rate Observer for a bearish analysis of a pair of heretofore thriving, consumer-facing businesses potentially set to struggle with the current backdrop. 
Recap May 4
Bulls on parade:  Soothing rhetoric from Jerome Powell following the Fed’s 50 basis point rate hike ignited a 3% rally on the broad S&P 500, while the Nasdaq 100 jumped 3.3% to exit bear market territory with an 18% year-to-date decline.  Short-dated Treasurys similarly caught a frenzied bid, leaving the curve well steeper as the long bond yield edged lower to 3.01%.  WTI crude jumped to $107 a barrel, gold climbed to $1,884 an ounce and the VIX sank four points to 25.  
 
- Philip Grant
05.03.2022
Sine Language
A member of the monetary cognoscenti embarks on a course correction.
A member of the monetary cognoscenti embarks on a course correction.  Kenneth Rogoff, Harvard economist and author of the 2016 book The Curse of Cash, sounded the alarm over price pressures on Bloomberg Television this morning, opining that “I think they’re going to have to raise interest rates to 4% or 5% to bring inflation down. . . it’s clear that things are way out of control.” 
 
What a difference two years can make. In the May 5, 2020 edition of Project Syndicate, Rogoff laid out the case for administered interest rates of negative 3% or lower to help turbocharge the Fed’s support for the economy via levitated asset prices: 
 
For starters, just like cuts in the good old days of positive interest rates, negative rates would lift many firms, states, and cities from default. If done correctly – and recent empirical evidence increasingly supports this – negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment. 
 
So, before carrying out debt-restructuring surgery on everything, wouldn’t it better to try a dose of normal monetary stimulus?
 
As recent experience shows, normal can be a relative term. 
 
Meanwhile, the side effects of a decade-plus of interest rate suppression continue to manifest.  According to data from Deutsche Bank, upwards of 18% of U.S. listed firms at least a decade old have failed to generate sufficient operating income to cover interest expense for the last three straight years. That’s up from a sub-6% share on the eve of zero-interest-rate policy in 2008.  
Guest of the Government
“We think the Chinese economy at this moment is in the worst shape in the past 30 years.”
“We think the Chinese economy at this moment is in the worst shape in the past 30 years.” That plainly-worded warning came from Weijian Shan, chairman at Hong Kong based private equity firm PAG, the Financial Times reported last week. 
 
As the world’s second-largest economy continues to pursue comprehensive lockdowns in hopes of controlling the virus, economic indicators indeed reflect a sub-optimal situation. Purchasing managers data released over the weekend showed factory and services activity at their weakest levels since early 2020, while the International Monetary Fund sliced its projected 2022 GDP growth forecast to 4.4% on April 19, down from a prior 4.8% view and representing the second-lowest growth rate since 1990, apart from the 2020 plague year. 
 
Markets remain firmly on the back foot, as the MSCI China Index is off 17% year-to-date, in line with the poor performance logged by major U.S. indices. The only difference: the China MSCI Index also lost 22% last year, compared to a 26% gain in the Nasdaq 100 across 2021. 
 
That extended run of pain is spurring a range of Western investors to say uncle. Swiss private bank Union Bancaire Privée, which counts $131 billion in assets, has exited the onshore equity markets as of March, the South China Morning Post reports, while peer Julius Baer announced in April that Chinese equities are no longer a core asset class in its portfolio. Similarly, research firm Alpine Macro threw in the towel on long positions in the MSCI China and CSI 300 indices following 34% losses within its model portfolio. 
 
As foreign capital taps out, China’s Communist Party prepares to tighten its loving embrace of domestic enterprise. The Wall Street Journal reported Thursday that the Chinese government is set to take 1% equity stakes in local tech champions Tencent Holdings Ltd. and Meituan, expanding on an existing initiative including social media outlets ByteDance Ltd. and Weibo Corp. That arrangement offers something of a win-win proposition, the Journal explains:
 
By taking a small equity stake and more of a role in companies’ operations, the government ensures that the tech companies are aligned with its broader policies, while the companies themselves generally don’t oppose the government stakes, reasoning that it helps them manage otherwise uncertain policy risks. 
 
As Beijing throws its weight around, captains of industry take pains to avoid incurring Big Brother’s displeasure. Senior executives at Didi Chuxing and Lenovo have hidden social media posts from public view, the SCMP relayed yesterday, following similar moves from the CEOs of ByteDance and Meituan during 2021. 
 
Recent events emphasize the logic behind those moves.  This morning, shares in Alibaba Group Holding Ltd. tanked by nearly 10% following reports from state television that the local government in Hangzhou had detained an individual with the last name “Ma.”  As Alibaba co-founder Jack Ma has famously been on the outs since criticizing the CCP last fall, such a development would have done no good for the e-commerce behemoth, which now sits some 68% below its fall 2020 highs.  Following a clarification from China Central Television that the unlucky individual was someone else, Alibaba shares promptly recouped the bulk of that early downdraft. 
Recap May 3
Wait-and-see was the theme of the day ahead of Wednesday’s FOMC rate decision, as stocks floated slightly higher while Treasurys came under moderate pressure led by the policy sensitive two-year yield, which rose to 2.7%.  WTI crude slipped to near $102 a barrel, gold finished little changed at $1,864 an ounce and the VIX settled near 29. 
 
- Philip Grant
05.02.2022
FIXer-Upper
Time to tighten up.
Time to tighten up. As the Federal Open Market Committee gets set to convene for a two day meeting tomorrow, interest rate futures now anticipate a 50 basis point hike to the benchmark funds rate.  At the same time, quantitative tightening is in the cards, with the monetary mandarins set to potentially unveil a new asset-lightening program eventually reaching $95 billion per month. That would represent nearly double the monthly cap during the Fed’s last attempt to trim their balance sheet in 2017 and 2018, The Wall Street Journal’s Nick Timiraos notes today.  
 
Better late than never, investors are getting the message: the 10-year yield punched above 3% this afternoon. That’s the highest since fall 2018 and up from 1.75% as recently as two months ago.  
 
Adding to the pressure on the rates complex, Uncle Sam’s largest foreign creditor said sayonara to a chunk of its holdings.  Japan has dumped a net $60 billion in Treasury debt over the past three months, data from BMO Capital show.  Foreign exchange markets serve as a primary culprit in dimming the appeal of those higher yields, as currency hedging costs have ratcheted to 155 basis points, the highest level since the early 2020 Covid panic and more than triple the cost early this year.  
 
With the market expecting some 250 basis points in rate hikes this year, punters are in no rush to establish new positions. “The Fed is being super aggressive,” John Madziyire, portfolio manager at Vanguard Group, mused to Bloomberg. “Are you really going to buy when Treasurys will probably get to more attractive levels?”
 
Dour conditions in a formerly-euphoric stock market further complicates matters.  As Compound Capital Advisors founder Charlie Bilello noted this morning, the 13% and 11% drawdowns in the S&P 500 and Bloomberg Barclays Aggregate Index from their respective peaks through Friday marks the first time ever (recordkeeping began in 1976) that benchmark equity and fixed-income gauges have endured simultaneous double-digit losses.  
 
Those figures represent a rude awakening for practitioners of the widely used 60% equity and 40% fixed income portfolio construction model. So-called 60/40 portfolios returned 18% per annum over the three years ended Dec. 31 and have earned an average 7.5% inflation-adjusted return on a rolling 12-month basis going back to 2000, Morningstar found in March.  That was then, as the Bloomberg BMA 60/40 Index logged a 7% slide in April for its worst monthly showing since March 2020, extending its year-to-date decline to 12.2%, on pace for its biggest drawdown since the financial crisis. 
 
“For the past 20 years, stock and bond prices have moved in the opposite direction,” Harley Bassman, managing partner at Simplify Asset Management and the brains behind the MOVE Index tracking volatility in the Treasury market, commented to Bloomberg today. “But there have been times when they ride up and down in unison, and that [can] be a disaster for a 60/40 portfolio.”
 
How might a prudent investor protect against an ongoing regime of precarious stock market price action without corresponding strength in the rates realm? From the podium at the Grant’s 2021 fall conference, Bassman furnished the audience with a strategy for mitigating losses were the 40-year bond bull market to meet its expiration date:
 
I’m not saying [interest rates] will go up, although I think they will. But I’m not saying that. I’m saying, if they do, we have a problem. I want insurance on that.
 
What we did was we created an ETF that is called PFIX. It is listed and trades right now. We [allocated half of total assets into] a 5-year Treasury, and the rest is in a 7-year option on [a higher] 20-year rate. And that’s it. There’s no management. There’s no adjustment. You can model it on Bloomberg. It’s just that simple.  
 
And if new money comes in, like today, I’ll go and buy a 4 1/2-year Treasury and I’ll buy a 6 ½-year option. As rates move higher, it goes up. As rates go down, it goes down in price.
 
The PFIX ETF has jumped by 50% from the time he spoke, including 10% in the last week, offering a cost-effective portfolio hedge. “How I weight this is, if you’ve got a million dollars of interest rate risk, you buy $50,000 of this product – not shares, the product. . .  It costs like 43 basis points to carry this hedge, it’s nothing,” Bassman told the assembled masses. 
 
Indeed, a little can go a long way.  See the analysis “Inflation repellent review” in Jan. 22 edition of Grant’s Interest Rate Observer for a menu of strategies to help withstand unmoored price pressures. 
Recap May 2
A late rally saved the day in stocks, as the S&P 500 erased steep losses during the final hour to eke back into positive territory, while the Nasdaq 100 managed a 1.2% rebound after nursing a further 1% pullback in mid-afternoon.  Treasurys were again weak across the curve, with the two-year yield settling at 2.75% and the long bond at 3.04%, while gold was hammered to $1,862 an ounce for its lowest close since mid-February and WTI crude continued to consolidate at $106 per barrel. 
 
- Philip Grant
04.29.2022
Reverse Engineering
Damage assessment, Nasdaq edition:
Damage assessment, Nasdaq edition: Sundial Capital Research founder Jason Goepfert laid out the gory details on Twitter this morning, noting that half of index components are down 50% from their respective highs, while 22% are off by 75% and 5% have registered a 90% drawdown.  With the formerly high-flying ranks of the speculative technology realm now laid low, a review of a representative trio’s plight could prove instructive. 
 
Crypto exchange Coinbase Global, Inc. (COIN on the Nasdaq) has taken its lumps during the recent turbulence, with shares at their lowest in its 54-week stretch as a public company, off 65% from the post-listing highs last year. 
 
Not taking that salvo sitting down, Coinbase management has sprung into action, announcing April 11 that it will produce an interactive film trilogy based on the Bored Ape Yacht Club line of non-fungible tokens. Large-scale M&A is also on the menu, with MergerMarket reporting last week that Coinbase has signed a term sheet to acquire Istanbul-based exchange BtcTurk for some $3.2 billion. 
 
Following the recent selloff, COIN’s market cap stands at $29 billion, with shares priced at 65 times consensus adjusted EPS and 32 times the 2023 guesstimate. Generating that pace of earnings growth next year may prove a tall order, however: Coinbase’s market share in its core business has slipped to 8% from 12% last fall, analysts at Mizuho relayed earlier this month, including “a steep drop between March and April.”
 
Whether the COIN c-suite manages to turn the ship around or not, they have been well compensated for their efforts. Insiders have conducted $212 million in open market stock sales over the past six months, at an average price of $330 per share, 63% north of current levels. 
 
Our second entry: Electric vehicle firm Lucid Group, Inc. (LCID on the Nasdaq). Fourteen-year-old Lucid, which had never sold a vehicle prior to late last year, rode the wave of special purpose acquisition companies following its merger with a blank check firm last summer, eventually commanding a $91 billion market capitalization at its November highs. Thanks to that eye-popping surge, Lucid bestowed a $556 million pay package on CEO Peter Rawlinson, Bloomberg reported yesterday, including $263 million in performance-based equity awards. That marks one of the largest payouts to any corporate executive in the country last year.  
 
Such generosity comes as shares now sit 67% from their November peak and with cash needs growing more prominent. Bloomberg analysts now expect the company to burn through $9 billion by the end of next year, compared to a prior $7.5 billion estimate, while Lucid’s $2.1 billion in convertible notes have slumped to 70 cents on the dollar from 98 cents as recently as late January.
 
Last but not least, the final frontier of financial democratization. Robinhood Markets, Inc. (HOOD on the Nasdaq) plumbs new depths as a public company, dipping below $9 per share in the wee hours this morning to mark an 86% decline from its post-IPO peak last August. Concerns that the 2021 meme stonk wave has crested were put into sharp relief in yesterday’s first quarter earnings announcement, which featured a $392 million net loss on $299 million in revenues, with monthly active users slumping to 15.9 million compared to an 18.2 million expectation while the company announced it will no longer provide revenue guidance. That follows Tuesday’s announcement of corporate “right sizing,” with up to 9% of full-time staffers facing a pink slip. 
 
Those struggles shine the spotlight anew on the terms of last summer’s IPO, which valued the company at $32 billion, triple that of a private fundraising round in June 2020.  As Christopher Bloomstran, chief investment officer of Semper Augustus Investments Group (and speaker at the upcoming Grant’s fall 2022 conference – advt.) noted at the time, investors poured some $2 billion into Robinhood’s coffers during the IPO, a sum equivalent to nearly 30% of all capital raised by the company since its founding in 2013.  Yet in return for that outlay, those new investors received only 7% economic ownership in the company, with voting rights reflecting even less than that.  
 
On the bright side, management has demonstrated its own trading acuity to the (now thinning) ranks of retail investment aficionados.  After unloading $93 million of stock into the IPO, the HOOD front office sold an additional $41 million into the open market over the past nine months at an average price of $28 per share, some 64% above the current price. 
Recap April 29
Shares in Amazon.com endured a 14% post-earnings swan-dive today, marking its worst one-day showing since July 2006 and setting the broader tone.  The S&P 500 lost a cool 3.7% to finish the month 9% lower, while the Nasdaq 100 shed 13% in April for its worst monthly showing since October 2008.  The rates market was similarly slapped around, as yields rocketed higher across the Treasury complex to leave the long bond at near 3%, testing its post-2019 highs.  Gold bucked that sea of red by edging higher to $1,898 an ounce, WTI crude slipped below $105 a barrel and the VIX settled near 34, up from 28 in midafternoon yesterday. 
 
- Philip Grant
04.28.2022
Many Unhappy Returns
A Tweet today from Jim Bianco, president of the eponymous research firm:
 
‘Transitory’ is a year old today. The April 28th 2021 FOMC statement noted ‘inflation has risen, largely reflecting transitory factors,’ CPI at the time of meeting was 2.6% year-over-year.
 
Over the 365 days following that proclamation, the Fed has hoovered up $1.16 trillion in assets, including $760 billion in Treasurys.  That represents just over 40% of the increase in public debt outstanding over that period. 
Trim Reaper
If at first you don't succeed:
If at first you don’t succeed: Early this morning, the Bank of Japan doubled down in its quest for a demand-led push towards a 2% annual inflation rate, as Governor Haruhiko Kuroda reaffirmed his intention to “support economic recovery by patiently continuing monetary easing.” What’s more, Kuroda unleashed full-scale yield curve control to keep benchmark rates at lawn level, pledging to purchase an unlimited sum of 10-year Japanese Government Bonds at a 25 basis point yield in service of that goal (headline CPI advanced by 1.2% year-over-year in March, the highest reading since fall 2018). 
 
Needless to say, Kuroda’s stance is increasingly at odds with policymakers around the so-called developed world, as fellow central banks turn towards tightening in hopes of keeping a lid on howling inflation.  The response from currency markets has been emphatic:  the yen tumbled to near 132 to the dollar in New York this afternoon, marking a 20-year low and compared to 115 to the buck less than two months ago.  
 
Assets on the BOJ balance sheet foot to 134% of last year’s Japanese GDP, double that of the European Central Bank and four times the Federal Reserve’s holdings. 
 
Then, too, gung-ho fiscal policies complement the BoJ inflationary ambitions. On Tuesday, Prime Minister Fumio Kishida voiced his approval for Kuroda’s easing adventure, declaring that “the government hopes the central bank continues with its efforts to achieve the goal” of revived demand-induced price pressures (with a helping hand from the printing press). Demonstrating his own commitment to that end, Kishida went on to unveil a ¥132 trillion ($1 trillion) aid package including subsidies to gasoline wholesalers, along with direct payments to low-income households.  
 
There will be more where that came from, some believe. Chotaro Morita, chief bond strategist at SMBC Nikko Securities, told Reuters he expects an additional spending bill on order of ¥20 trillion to take shape later this year. 
 
Japanese gross government debt towered at 257% of domestic output as of year-end per the IMF, compared to 120% for the U.S. and 98% for the euro area. Indeed, that fearsome debt load offers precious little room to maneuver: “Raising rates here would be tantamount to opening Pandora’s Box,” Totan Research chief economist Izuru Kato warned last month. 
 
Perpetual easy money in the Land of the Rising Sun could reverberate across Asia and beyond.  In the wake of this morning’s announcement, the Chinese renminbi tumbled to a 6.64 per dollar, down 4.6% for the month so far, on pace for its worst monthly decline since China unified its forex market back in 1994, Bloomberg relays.  With China’s economy in deep freeze as large swaths of the populace remain stuck in lockdown, something has to give. “It makes sense to use controlled currency depreciation as a relief valve for the economy if growth risks were to escalate,” Alvin Tan, head of Asia currency strategy at RBC, told Bloomberg.  
 
What’s good for the goose, in this case, could bode ill for the gander.  Referencing the pronounced yen and renminbi weakness, SocGen strategist Albert Edwards wrote late last week that “surely all of us working in finance realize by now that something is likely to snap in the financial system and probably quite soon.” 
 
For a look at potential ripple effects stemming from the divergent monetary regime now underway, see “No market is an island” in the April 1 edition of Grant’s Interest Rate Observer.  Likewise, the BoJ’s quixotic quest for credibility among investors could yield unpredictable results.  See “The face they save” in the brand new April 29 issue of Grant’s for an analysis of the global push for administrative diktat over market forces.  
Recap April 28
Go figure: A surprise 1.4% real GDP contraction in the first quarter (economists projected a 1% annualized sequential advance) primed the bullish pump, as markets rocketed higher to the tune of 2.5% on the S&P 500, with the Nasdaq 100 enjoyed a 3.6% advance. Treasurys settled down a bit from volatile recent trading, as moderate weakness predominated across the curve with the long bond edging to 2.92% from 2.91% yesterday and the two-year climbing back to 2.63%.  WTI crude jumped above $105 a barrel for the first time in ten days, gold managed a modest bounce to $1,896 an ounce and the VIX pulled back to 30.   
 
- Philip Grant
04.26.2022
Pressure Drop
The credit spigot drips once more in the Old Continent.
The credit spigot drips once more in the Old Continent.  European banks have managed to place the bulk of a £815 million ($1.03 billion) financing package backing Apollo’s leveraged buyout of dwelling builder Miller Homes, Bloomberg reports.  That offering – initially planned for the first quarter after Apollo announced a deal agreement on Christmas Eve before rude market conditions forced a delay -- consists of a sterling-denominated senior secured fixed-rate bond along with a euro-pay floating-rate tranche.  
 
More broadly, the European speculative-grade credit markets had remained shut to primary issuance since Feb. 10.  As data from LCD show, that 10-plus week gap marks the longest such drought in Europe since at least 2009, surpassing the 69-day stretch without a new deal in late 2011 and into early 2012, along with a 47-day, Covid-induced cold streak two years back, for that dubious distinction.
 
A timely reopening of primary activity would come not a moment too soon for one contingent. Bloomberg notes today that, as the deal backlog has piled up in recent weeks, “banks have been fretting about their ability to shift underwritten debt from their balance sheets.” One pending transaction, Clayton, Dubilier & Rice’s takeover of Wm Morrison Supermarkets, has been delayed since late 2021, forcing banks to “consider offloading some of the debt package at a steep discount,” Bloomberg relays. 
Dim Bulb
Move over, deserted growth stocks.
Move over, deserted growth stocks.  This morning, good old General Electric Co. (GE on the NYSE) pegged its bespoke, full-year adjusted earnings projection towards the low end of a previously provided range of $2.80 to $3.50 per share, catching a mostly bulled-up Wall Street (sporting a $3.24 consensus estimate, with 17 of the 24 analysts rating the stock a “buy” with no “sells”) off-guard. Following a 10% selloff, shares are off by 19% from a bearish analysis in the pages of the Feb. 4 edition of Grant’s Interest Rate Observer, compared to a 6% drop for the S&P 500 over that period. 
 
Poor results aside, a labyrinthine set of financials bestows headaches on bulls and bears alike.  Though operating margins slipped to minus 1.4% during quarter from positive 3.1% a year ago using generally accepted accounting principles, GE’s “adjusted” operating margin (which “excludes insurance, interest and other financial charges, non-operating benefit costs, gains, restructuring and other charges and other one-time charges”), expanded to positive 5.8% from 4.9% in the prior year period. Likewise, a $1 per share spread between GAAP and adjusted EPS figures “highlights accounting and disclosure [issues] as a topic” of concern, J.P. Morgan analysts led by Stephen Tusa wrote this morning. 
 
Those convoluted figures are old hat for Thomas Edison’s corporate brainchild.  Mincing no words, Tusa et al. termed GE’s fourth quarter financials “the worst disclosure, least transparent set of numbers we have ever seen in the 20 years following the [industrials] group.”  James Chanos, founder and managing partner at Kynikos Associates, marveled to Grant’s in February that “I’ve never in my life seen as convoluted a fourth-quarter press release as I saw from GE. It makes your head spin.” 
 
Beyond the difficulty in getting a handle on the company’s underlying business conditions, a fancy valuation formed the crux of the most recent bear case for a company that has served as a Grant’s sparring partner going back to the Sept. 14, 1990 issue.  Namely, GE shares traded at 23 times conventionally-calculated Ebitda as of early February, a pretty price considering the corporate profile of a slow-growing firm highly sensitive to the vagaries of the economic cycle.  Even following the recent downdraft, the stock remains priced at 29 times the low end of full-year non-GAAP EPS guidance and 15 times Wall Street’s perhaps overly-optimistic 2023 adjusted earnings guesstimate. That midwinter analysis concluded thus:
 
Paying 20 times sales for fast-growing, profitless companies maybe wasn’t the best idea, growth investors now concede. As to the advisability of paying 20-plus times Ebitda for an expanding cohort of historically humdrum manufacturers and consumer cyclicals, what will tomorrow’s chastened value investors say? We write to anticipate a one-word postmortem: ‘Ouch!’
 
A pertinent historical comparison does the GE bulls no favors, as the late 1990s tech bubble also featured pockets of commanding value within the ranks of so-called Old Economy stocks as the Nasdaq went parabolic, a phenomenon all but absent today.  Asked for a historical analogy to the post-virus bull stampede, Chanos replied that 1999 fits the bill, though the current (or, perhaps, recently concluded) asset price levitation regime resembles that era “on steroids.” 
Recap April 26
Stocks were walloped to the tune of 3.8% on the Nasdaq 100, its worst one-day decline since Feb. 3 to bring that tech-heavy gauge back to bear market territory, while the broad S&P 500 sank 2.8% to extend its year-to-date losses to 12.8%.  Treasurys enjoyed a sharp bull steepening rally headlined by a nine basis point decline in the policy-sensitive two-year note to 2.54%, while gold rebounded to $1,907 an ounce and WTI crude rallied to $102 per barrel.  The VIX skyrocketed to 33.5, up from less than 20 on Thursday morning. 
 
- Philip Grant
Use the search box above to access older ADG content.