Raise the Roof

Cause and effect, and cause.  A July 10 headline from the Associated Press:

California fast food workers now earn $20 per hour. Franchisees are responding by cutting hours

And a Wednesday bulletin from Restaurant Business:

Another wage hike could be set this month for California's [Quick Service Restaurants]

The Alchemist
It's the latest in American ingenuity:

It’s the latest in American ingenuity: BlackRock’s July 1 announced acquisition of financial data firm Preqin for £2.55 billion ($3.22 billion) – the equivalent to 13 times the target firm’s 2023 revenues – could mark a new day for the exchange traded fund realm. BlackRock aims to “index the private markets,” as CEO Larry Fink put it on a subsequent investor call, while, in reference to the firm’s iShares ETF division, CFO Martin Small added that “we have a great platform. . . to be able to take some of this data, use it and create investible indices through. . . things like exchange traded products.”

The appeal of such an initiative is straightforward enough. “Everyone is talking about private assets because private assets have a higher margin,” Kenneth Lamont, senior fund analyst for passive strategies at Morningstar, told the Financial Times Monday. “Everyone is stampeding towards that.”   Such readily accessible private exposure “is not going to be cheap,” he pointed out.

Yet characteristics inherent in the off-exchange realm, including infrequent transactions and sometimes-material valuation discrepancies between private and public iterations of comparable assets, complicate the “ETF-ization” of that asset class. “I can see how they’d use the Preqin data to create indexes and benchmarks for private assets,” industry consultant Sean Tuffy told the pink paper. “However, I’m not sure how easily that would translate into an ETF.”  Underscoring that pitfall, BLK announced in June that it will wind down its iShares Frontier and Select Emerging Markets ETF thanks to “persistent liquidity challenges.” 

Then, too, an ETF wrapper may serve to defeat the purpose of privately held assets, onto which investors famously bestow a so-called illiquidity premium. “One of [the category’s] attractions is that it’s uncorrelated to the market,” Lamont observes. “When you make that a liquid investment that can be traded throughout the day, it loses that allure.”  

An opposing dynamic is on display in the crypto realm, as the famously 24/7 asset class has enjoyed a seamless transition to the workaday exchange format: witness the 37% jump in aggregate capitalization following the mid-January launch of bitcoin spot ETFs.  Thus, the 11 such U.S. listed vehicles gathered a cool $1 billion over the three days through Tuesday, while the iShares Bitcoin Trust (ticker: IBIT) sports some $21 billion of assets, already surpassing long-lived vehicles such as the iShares MSCI Emerging Markets ETF (EEM) and the Consumer Discretionary Select Sector SPDR Fund (XLY).  

As Bloomberg’s Eric Balchunas pointed out last week, three quarters of the 500 ETFs which launched last year boast $121 million or less in assets. For its part, IBIT has hoovered up at least $100 million on at least 60 separate sessions already this year.

Increasingly, uh, creative contraptions further underscore crypto’s crashing of the ETF party.  On Wednesday, Direxion announced the debut of LMBO and REKT, an aptly named pair of funds designed to replicate 200% and minus 100%, respectively, of the Solactive Distributed Ledger & Decentralized Payment Tech Index’s daily price moves. “LMBO and REKT provide focused exposure for traders to express their short-term conviction on companies building the future of a crypto-driven, decentralized economy,” commented Direxion managing director, Edward Egilinsky.

LVRG and FEES:  Coming in 2025? 

Recap July 19

Un-bullish tidings persisted Friday, as stocks retreated by two-thirds of a percent on the S&P 500 to settle 2% lower for the week, while the Nasdaq 100 lost a further 0.9% to settle 4% in the red over the past five days and the Russell 2,000 slipped 0.5% to trim its weekly gain to 1.7%. 

Treasurys came under modest pressure with two- and 30-year yields rising by one and four basis points, respectively, to 4.49% and 4.45%, while WTI crude tumbled to $78 a barrel and gold sank below $2,400 per ounce. Bitcoin bucked the sea of red by advancing toward $67,000 and the VIX settled at 16.5, up nearly four points from Monday morning. 

- Philip Grant

Gool's Gold
Here's a Bloomberg headline from this afternoon,

Here’s a Bloomberg headline from this afternoon, referencing remarks from Chicago Fed president Austan Goolsbee: 

Goolsbee Says Fed Risks ‘Golden Path’ If It Doesn’t Cut Soon

Of course, that’s not the first time that Goolsbee has busted out the catchphrase, which describes the happy convergence of disinflation, economic growth and low unemployment. A sample of recent instances:

Chicago Fed president still sees inflation on ‘golden path’ to 2%, but housing costs need to come down before rates cut (Chicago Tribune, April 4) 

Fed’s Goolsbee says ‘golden path’ of a huge drop in inflation without a recession is still possible (CNBC, Nov. 7, 2023) 

Fed's Goolsbee says he hopes 'golden path' is within reach (Reuters, Sept. 7, 2023) 

Will that Windy City-concocted slogan catch on with fellow monetary mandarins, perhaps in lieu of the ubiquitous “soft landing?”  Time will tell. 


Bachelor of Arts
Sacramento doubles down on the buyout barons:

Sacramento doubles down on the buyout barons: It’s a good news/bad news proposition for municipal staffers in the Golden State, as the California Public Employees Retirement System (Calpers) posted a 9.3% return over the 12 months through June, pushing assets in the largest U.S. pension above $500 billion and comfortably outpacing the fund’s 6.8% annual target. 

On the one hand, that figure serves to push rolling five-year annual returns to 6.6%, up from 6.1% at this time a year ago, while future obligations are now 75% funded, up three percentage points from mid-2023.  On the other hand, Calpers continues to lag the average 80.6% funding ratio for state and local pensions as of June 30, the Equable Institute finds, while that cohort collectively managed to improve funding levels by nearly five points from the 75.8% seen a year ago.

By way of remedy, Calpers revealed plans earlier this year to enhance the targeted private equity allocation to 17% of assets from 13%, further bumping its bogey from 8% as of late 2021.

Though noteworthy in its aggressive nature, Calpers’ strategy pivot reflects the industry at large. A collection of 54 prominent public pensions analyzed by Center for Retirement Research at Boston College committed an average 13% of assets to p.e. as of fiscal 2023, up from 7% in 2008. 

Might still-dicey demand for initial public offerings, in tandem with the sharp post-Covid rise in borrowing costs, render that broad-based migration problematical?  

Private equity exits in the U.S. registered at $141.4 billion over the first six months of 2024 per data from Cambridge Associates, laboring to match 2023’s near $300 billion full-year pace, which marked the slowest showing since 2012. Cash distributions to limited partners likewise registered at 11.2% of fund net asset values in calendar 2023 according to Raymond James, the weakest figure since 2008 and less than half of the 25% median logged over the past quarter century (Grant’s Interest Rate Observer, March 29). 

Evidence of a lurch higher in portfolio company problem-children accompanies that slowdown. The tally of distressed debt among holdings of the 50 largest p.e. firms reached $42.7 billion, Bloomberg-compiled data show, up 18% from the middle of March. To contend with the post-2021 updraft in borrowing costs, p.e. players increasingly opt to shift troubled assets to new entities that they themselves manage, with the number of so-called continuation funds seeing a “considerable uptick” over the three months through June, according to Jeff Hammer, global co-head of secondaries for private markets at Manulife Investment Management. 

Loose legal documentation for buyouts during the freewheeling, bygone ZIRP-era credit cycle likewise serves to obscure the true state of play. “You don’t know if there are defaults because there are no covenants, right?” Zia Uddin, president and co-portfolio manager at private credit firm Monroe Capital, rhetorically asks Bloomberg. “So, you see a lot of amend and extend that may be delaying decisions for lenders.”  

The fact that 99% of secondary market transactions for p.e. holdings last year took place at or below the net asset value according to Jefferies, up from a 73% share in 2021, may represent an ill omen for cash-hungry LPs.

On the bright side for public pension Johnny-come-lately’s, any prospective misery from an extended industry downturn would certainly be shared across the most hallowed halls of academia.  

Thus, endowments for the eight colleges constituting the Ivy League, along with Stanford University and the Massachusetts Institute of Technology, allotted an eye-watering 36.7% of assets to p.e. on average during fiscal 2023, a newly released report from Markov Processes International finds, while the ratio of unfunded commitments to liquid portfolio assets at Brown University, Harvard University and Princeton University stood at 78%, 60% and 52%, respectively. 

With distributions on the wane and the timing and scope for future interest rate relief remaining an open question, “there looks to be more artful navigating ahead,” Markov concludes. 

QT Progress Report
Reserve Bank credit ticked lower by $6 billion, leaving the tally of interest-bearing assets on the Fed balance sheet at $7.176 trillion. That’s down $45 billion from this time last month, and 19.6% below the March 2022 highs. 
Recap July 18

It was a red-letter day as stocks followed through on yesterday’s steep declines with the S&P 500, Nasdaq 100 and Russell 2,000 falling by 0.8%, 0.5% and 1.9%, respectively, though each index managed to finish off their worst levels of the session, while Treasury yields rose four to five basis points across the curve to leave the two-year note at 4.46% and the long bond at 4.41%.  WTI crude settled south of $81 a barrel, gold retreated to $2,445 per ounce and bitcoin slipped to $63,600. The VIX leapt nearly 1.5 points to approach 16, its most elevated reading since April. 

- Philip Grant

Token Opposition

From CNBC:

Craig Wright, an Australian man who claimed to be the inventor of bitcoin, was on Tuesday referred to British prosecutors for committing alleged perjury.

On Tuesday, British High Court Judge James Mellor decided to refer a case against Wright’s claim to be the inventor of bitcoin to the Crown Prosecution Service — which is the organization that prosecutes criminal cases investigated by the police in England and Wales. . .

Mellor ruled that Wright attempted to create a false narrative by forging documents “on a grand scale,” presenting them as evidence in court. He added that by advancing his claim to be Satoshi Nakamoto through legal action in the U.K. — as well as Norway and the U.S. — Wright committed “a most serious abuse” of the process of the courts.

Wright’s holding company Tulip Trading was not immediately available for comment when contacted by CNBC.


Duel Mandate
Cut and run, or run and cut?

Cut and run, or run and cut?  The recent one-two punch of cooler-than-expected June CPI data and Fed chair Jerome Powell’s telling Monday remark that “if you wait until inflation gets all the way down to 2%, you’ve probably waited too long [to ease policy]” has changed the game.

Thus, interest rate futures now assign 65% odds of a funds rate of 4.5% to 4.75% or below by year-end, 75 basis points south of the current range.  As of a week ago, that market-derived likelihood of such an outcome stood at 26%. The odds of a September trim likewise stand at a tidy 100%, with the likelihood of a 50-basis point move ticking towards 10% as of Tuesday afternoon. 

Yet as Powell et al. foam the runway for easier money, one mainstream constituency expresses its reservations.  The International Monetary Fund warns in its latest World Economic Outlook that “momentum on global disinflation is slowing,” thanks to ongoing price pressures in the services sector and “brisk” wage growth, while “the escalation of trade tensions could further raise near-term risks to inflation by increasing the cost of imported goods across the supply chain.”  

Such an outcome would not exactly be music to the ears of U.S. citizens. Thus, nearly 80% of respondents to an early July Financial Times and University of Michigan Ross School of Business-commissioned poll of 1,000 nationwide registered voters cited inflation as among their top three sources of financial stress. That response rate towered over other major irritants such as credit card debt, (insufficient) income and medical expenses, with each garnering a sub 50% response rate.  Meanwhile, 32% of the surveyed cohort reported reaping financial rewards from today’s heady bull market conditions, far below the 49% share who enjoy no benefits “at all” from galloping share prices. 

Though lingering price pressures remain a potent political problem, the remedy to that disease presents its own pitfalls following a decade-plus of ultra easy money. Tuesday’s IMF bulletin concludes that “the risk of elevated inflation has raised the prospects of higher-for-even-longer interest rates, which in turn increases external, fiscal and financial risks.” What’s more, strength in the dollar stemming from elevated U.S. rates relative to major global peers “could disrupt capital flows,” placing downward pressure on global commerce. 

Investors increasingly subscribe to that view, bounding asset prices and all.  Thus, 39% of respondents to Bank of America’s latest Global Fund Manager Survey opine that monetary policy is “too restrictive.” That’s nearly double the contingent expressing that viewpoint late last year (with the funds rate since staying put and stock price climbing sharply higher) and the largest such share since November 2008, weeks before the zero-interest rate era began in earnest. 

Recap July 16

Another bull stampede saw small-caps continue their historic run, with the Russell 2,000 tacking on a further 3.4% to bring its five-day gains to an eye-watering 11% (better than four full-year showings during the decade ending 2023), while the S&P 500 rose a mere 0.6% and the tech-heavy Nasdaq 100 spun its wheels with a flat showing. Treasury yields snapped lower with the long bond declining eight basis points to 4.38% and the 10-year note settling at 4.17% to mark fresh four-month lows. WTI crude slipped below $81 a barrel, gold jumped to fresh closing highs at $2,468 per ounce, bitcoin ticked to $64,900 and the VIX remained slightly north of 13. 

- Philip Grant

Rate Accompli

Here’s Fed chair Jerome Powell, laying the groundwork for easier money ahead in Monday remarks at the Economic Club of Washington:

Our test has been for quite some time that we want to have greater confidence that inflation was moving sustainably down towards our 2% target, and what increases confidence in that is more good inflation data. And lately, we have been getting some of that. . .

If you wait until inflation gets all the way down to 2%, you’ve probably waited too long, because the tightening that you’re doing, or the level of tightness that you have, is still having effects which will probably drive inflation below 2%.

Bill of Fair
The Federal Trade Commission turned the screws on Big Restaurant Friday,

The Federal Trade Commission turned the screws on Big Restaurant Friday, unveiling new actions designed to thwart “unfair and deceptive” practices.  Among the items on the regulator’s menu: a crackdown on undisclosed “junk fees” for technology, employee training, marketing and property improvements levied outside of franchise disclosure documents, as well as the use of non-disparagement clauses designed to dissuade complaints over alleged mistreatment.

“Franchising is a chance for Americans to build a business, but the FTC has heard concerns about how unfair franchisor practices, like a failure to fully disclose fees upfront, go unreported thanks to fear of retaliation,” stated FTC chair Lina Khan. “Today, the Commission is making clear that contractual terms prohibiting franchisees from reporting potential law violations to the government are unfair, unenforceable and illegal.”

Enhanced government scrutiny of franchisor vs. franchisee disputes arrives against a rough-and-tumble operating backdrop, as the amply levered dining industry contends with a downshifting consumer and persistent cost pressures. Citing data from Bloomberg, analysts at Bank of America relay that median restaurant sales growth slipped to a 2.2% annual clip in June from 5% in May and more than 6% at the end of last year, while nationwide foot traffic ebbed 3.3% over the first six months of 2024 according to Black Box Intelligence. 

Last week, seafood chain Kura Sushi ratcheted down its full fiscal-year sales forecast to $236 million from $245 million using the midpoint of provided ranges, with management citing a “sudden and unexpected” business slowdown beginning three months ago. Kura, which posted a 28% year-over-year revenue gain over the three months through May, likewise warned that California’s FAST Act, which established a statewide $20 hourly minimum wage for fast food employees, has spurred “a general perception that restaurants as a category have become expensive, introducing industry-wide pressures regardless of a given restaurant's relative value.”

Such sticker shock likewise bedevils casual dining mainstay Darden Restaurants, as analysts at Jefferies downgraded the Olive Garden parent to “underperform” Thursday, introducing a $124 per share price target, 13% south of current levels and the lowest bogey among 31 firms covering the name.  Darden’s “disciplined approach” to discounting could prove a competitive impediment, as an industrywide uptick in promotions threatens the firm’s market share. “In the context of lingering lower-end [consumer] weakness, we believe some recalibration on the value front may be needed,” the investment bank contends.

Meanwhile, planet Earth’s pre-eminent fast-food chain faces an “underwhelming” response to its own high-profile discounting initiative, Gordon Haskett finds, as the McDonald’s $5 meal deal – featuring a McDouble or McChicken sandwich, small order of fries, small soda and four-piece chicken nuggets – which debuted on June 25, was met with a mere 1% annual increase in foot traffic over the 11 days through July 5. The independent research firm added that it expects the Golden Arches to roll out “increasingly aggressive” promotions in the coming quarters.  

Peers at Truist Securities likewise write that the meal deal (which yields profit margins of 1% to 5% rather than the typical 5% to 10% range per estimates from fast-food industry analyst Mark Kalinowski ) “does not appear to have reignited momentum” for the MCD top line, adding that last month ended on a “low note” for Restaurant Brands International-owned peer Burger King. 

Where's the beef? See the analysis “With a side of debt” in the current edition of Grant’s Interest Rate Observer dated July 5 for more on the inherent tension between so-called asset light restaurant owners and their often-put-upon franchisees, as well as broader industry tribulations in the wake of the pronounced post-Covid inflation. 

Recap July 15

Stocks assumed their usual green hue, with the S&P 500 and Nasdaq 100 each settling higher by about 0.3% after giving back stronger early gains, while the small-caps remained white hot with the Russell 2,000 logging a near 2% advance to bring its cumulative three gains to 6.8%.  Treasurys saw some bear steepening as the long bond rose seven basis points to 4.46% and two-year yields ticking to 4.44% from 4.45% Friday, while WTI crude edged below $82 a barrel. Gold pushed above $2,420 per ounce to draw within about 1% of its prior peak, bitcoin rebounded to $63,700 and the VIX toggled above 13. 

- Philip Grant

American Idle

From Bloomberg:

Boeing Co. has notified some 737 Max customers in recent weeks that aircraft due for delivery in 2025 and 2026 face additional delays, another reminder that production of its cash-cow jetliner faces a long road to recovery.

The plane maker has cautioned that delivery timelines continue to slip by three to six months on top of already-late handovers, according to people familiar with the matter. In some instances, deliveries scheduled for next year have spilled into 2026, said the people, who asked not to be identified as the discussions are confidential.

On the bright side, what’s safer than an undelivered plane? 

From Here to Eternity
Number go up, snail-mail edition:

Number go up, snail-mail edition: The United States Postal Service is increasing the price of its so-called Forever stamps to $0.73 from $0.68 as of Sunday, marking the second such uptick of 2024 following a mid-January bump from $0.66.  Cumulative price hikes over the past three years will reach 33% after this weekend’s latest upward adjustment, bringing the total increase for first-class, one ounce postage to 78% since the Forever stamps were introduced in 2007. 

As USA Today’s Mike Snider notes, more aggressive pricing strategies feature prominently in Postmaster General’s Louis Dejoy’s 10-year Delivering for America plan, enacted in March 2021 to drain a sea of postal red ink. The USPS is on track to lose $8 billion over the fiscal year ending Sept. 30 and has requested $14 billion in aid from the White House per the Washington Post.

Outlier's Poker
Which one doesn't belong?

Which one doesn’t belong?  Thursday’s spin-cycle session in stocks remains noteworthy well after the fact, as those historic price swings contrast with an utterly banal backdrop. Thus, small-cap equities, as measured by the Russell 2,000 Index, outperformed large-cap counterparts in the Russell 1,000 by 424 basis points. 

As Bianco Research finds, such a yawning one-day performance spread has occurred on only a handful of occasions in recent decades, taking place during the March 2020 Covid panic, the October 2008 post-Lehman Brothers liquidation, October 1987 ( a.k.a., Black Monday), the European Sovereign debt crisis climax in October 2011 and the April 2000 dot-com bubble unwind, as the tech-heavy Nasdaq was in the midst of a 25%, one-week drop.  

That quintet of memorable sessions featured average readings on the Chicago Board Options Exchange's CBOE Volatility Index (which tracks one-month options-implied volatility on the S&P 500) of 62 and change, more than triple the long-term average of 19.7.  By contrast, that gauge settled yesterday at 12.92, comfortably below the average closing level of 13.73 logged during the largely blue-skies 2024.

Thursday’s preternatural calm from that benchmark volatility gauge is no fluke.  Bank of America’s Global Financial Stress Indicator, a broad-based risk metric tracking financial risk, hedging demand and investor sentiment, held near multi-year lows Thursday, while BofA’s in-house indicator of financial stress in the United States remains at its lowest level on record dating to 1990. 

Recap July 12

Big tech got back on track to the tune of a 0.6% advance with the S&P 500 matching those gains, though both indices finished well below their best levels of the day following a late downturn, while Treasurys maintained their momentum with two-year yields declining a further five basis points to 4.45%, the lowest finish since early February. WTI crude toggled back below $83 a barrel, gold reversed early losses to finish little changed at $2,411 per ounce, bitcoin did the same at $57,500 and the VIX fell half a point to settle slightly above 12. 

- Philip Grant

Robo Cop
I'd buy that for a dollar!

I’d buy that for a dollar! Incorrigible Tesla boss Elon Musk took to his X social media platform to trumpet the electric vehicle’s full self-driving technology, responding to a video demonstration of the latest iteration, known as FSD version 12.4.3, with the following: “Buying anything except a Tesla will seem like buying a horse & buggy.”

On that score, time will tell.  As the Washington Post documents today, the automaker faces parallel investigations from the U.S. Department of Justice, California’s Department of Motor Vehicles and the Securities and Exchange Commission regarding the veracity of claims to customers and investors regarding FSD and Autopilot, Tesla’s software suite powering the nascent technology, which retails for $8,000. 

“Contrary to Tesla’s repeated promises that it would have a fully self-driving car within months or a year, Tesla has never been merely close to achieving that goal,” allege litigants in a civil complaint logged with the U.S. District Court for the Northern District of California. 

Meanwhile, Bloomberg reports that Musk et al. are pushing back a showcase of the firm’s so-called Robotaxi to October from Aug. 8, marking the latest setback for the long-promised driverless car service. As the Post notes, Musk declared in 2019 that Tesla would deploy one million Robotaxis by the end of 2020, utilizing existing but idle vehicles. “The fleet wakes up with an over-the-air update,” he explained prior to the pandemic. 

Or, as the case may be, hits the snooze button. 

Uncle Spam
Call it Schrödinger’s coin:

Call it Schrödinger’s coin: The crypto category contends with simultaneous bull- and bear-market conditions, as digital assets sport a combined valuation north of $2.1 trillion by Coinmarketcap.com’s count, up nearly 100% year-over-year, though that figure is likewise down 20% from early March. Similarly, bitcoin enjoys a near 90% gain from mid-July 2023, while nursing a 17% drawdown over the past five weeks. 

Indeed, recent developments highlight the concurrent states of prosperity and gloom. This morning, industry mainstay MicroStrategy announced a 10:1 stock split effective in early August, as the software provider-cum-bitcoin speculation vehicle looks to render its shares “more accessible to investors and employees.”  Following a 238%, one-year rally, loss-making MicroStrategy sports a $24 billion market cap, nearly double the $13.1 billion valuation assigned to its cache of 226,331 BTC.

Yet as one digital avatar basks in Mr. Market’s adulation, another throws its backers for a loop. Bloomberg reports today that investors owning some 70% of Skybridge Capital’s crypto-focused hedge fund asked for their money back in the latest redemption window earlier this year, with the fund, which is structured to return investor cash via tender offers, buying back only 7% of shares outstanding during that period.  

That development marks a curious contrast with the $1.6 billion fund’s 46.4% gain over the 12 months through March, though Skybridge Founder and short-lived former Trump administration communications director Anthony Scaramucci told Bloomberg that the deliberate pace of redemptions is within “the ambit of the prospectus.”

Farther-flung corners of the crypto universe, meanwhile, are slogging through the summer heat. The Capriole Investment’s Crypto Speculation Index, which measures the share of alternative tokens outperforming bitcoin on a rolling 90-day basis, has slumped to 7% from a near 60% share in January.  

Nearly 15,000 so-called altcoins are in circulation by data firm CoinGecko’s count. Most of that cohort “are illiquid and struggle to prove their use cases,” as CoinDesk puts it, though prior sub-10% readings from that indicator preceded substantial, broad-based crypto rallies in early 2019, late 2020 and the back half of 2023. 

A pair of prominent such tokens could certainly use a renewed jolt of speculative appetite: Doland Tremp and Jeo Boden – memecoins depicting the current Presidential nominees – are off 74% and 96% from their respective peaks in early June and early April, leaving those unofficial avatars valued at $39 million and $25 million, respectively.  

The inspiration for one of those coins duly plays his part in trying to turn the tide. Challenger and erstwhile commander-in-chief Donald Trump will deliver a 30-minute address at a bitcoin themed conference in Nashville on July 27, organizers announced yesterday, a speech “likely to further burnish a self-assigned image of crypto booster,” CoinDesk predicts. 

The official art of the unofficial presidential altcoins

QT Progress Report
A $7.2 billion decline in Reserve Bank credit leaves the Fed’s holdings of interest-bearing assets at $7.18 trillion. That’s down $40 billion from the middle of June, and 19.5% below the March 2022 high-water mark. 
Recap July 11

A cooler-than-expected June CPI print spurred an intense rotation in stocks, with the small-cap Russell 2,000 vaulting nearly 4% and the tech-heavy Nasdaq 100 slumping 2.2%, while the S&P 500 settled 0.9% in the red. Treasurys enjoyed a frenzied short-end rally in anticipation of imminent Fed rate cuts, with two-year yields dropping a dozen basis points to 4.5%, while the long bond saw a more measured decline to 4.41% from 4.47% Wednesday. WTI crude advanced to $83 a barrel, gold ripped to $2,414 per ounce to approach its May peak near $2,450, bitcoin edged modestly lower at $57,500 and the VIX remained below 13 once more. 

- Philip Grant

Reference Bait

One for the fall guy(s). From the Financial Times:

Deutsche Bank has settled a lawsuit brought by an exonerated former trader who alleged he was the “fall guy” of the Libor rate-rigging scandal.  Matthew Connolly, 58, was convicted of fraud in 2018 in one of the highest-profile U.S. trials over the rate manipulation saga that cumulatively cost banks billions of dollars in penalties and fines. He was later branded “the least culpable person” at Deutsche by the federal judge who oversaw the case and fully acquitted on appeal. 

The former head of Deutsche’s New York derivatives trading desk, Connolly sued Deutsche in November 2022, seeking $150 million in damages and accusing the bank of framing him for the crimes of others. . .

Deutsche has already paid $2.5 billion in fines over the Libor scandal, in a 2015 settlement with U.S. and U.K. law enforcement. The bank was also forced to fire seven employees, but its management board, which claimed it was unaware of any misconduct, emerged unscathed. . . 

Connolly and [colleague Gavin] Black had their convictions quashed on appeal in early 2023, in a ruling that concluded “the government failed to show that any of the trader-influenced submissions were false, fraudulent, or misleading.”

Charges against other bankers allegedly involved in the Libor-rigging scandal were also tossed out in the same year, including those brought against former UBS and Citi trader Tom Hayes and former trader Roger Darin. 

Cutting Room Floor
A blockbuster slasher film in the works?

A blockbuster slasher flick in the works?  Paramount Global’s investment-grade imprimatur may soon go by the wayside, as Moody’s placed the firm on review for downgrade yesterday in response to “significant secular pressures” on the Baa3-rated film studio’s business.

Paramount, which on Monday agreed to merge with Skydance Media in an all-stock deal valued at $4.5 billion, saw S&P Global slice its credit rating by one notch to double-B-plus in March, meaning a similar move from Moody’s would formally relegate the fallen angel to junk status.

Such a ratings action would also serve to shift $14.7 billion of debt into the high-yield market, analysts at Barclays calculate. That would be sufficient to leave Paramount as the third largest component in Bloomberg’s broad junk gauge (trailing only Charter Communications and Altice USA) with a 1.1% weighting by par amount, as well as a near 25% share of the media entertainment sector subcomponent, the investment bank finds.

More broadly, Paramount’s predicament highlights an instructive dynamic in the speculative debt category, as upwards of $660 billion of sub investment-grade bonds, representing roughly 50% of the domestic asset class, sport a double-B rating according to data from Bloomberg.  That’s up from a 45% share as of Dec. 31 and 41% at the end of 2014.  

Noting a predilection for that credit category among junk tourists, Bloomberg’s James Crombie warns that investors “on a mission to bag the fattest yields in decades are largely ignoring ever decreasing compensation for company risk. . . junk is junk for a reason.” Indeed, average spreads per turn of leverage in the double-B contingent reached 84 basis points as of March 31, the lowest reading in at least a decade and a fraction of the 214 basis points on offer as of mid-2022. 

Concurrent with the well-attended soiree in the penthouse of high yield, an eye-catching development in the primary market underscores today’s freewheeling backdrop. Bloomberg reports that chemical manufacturer Calderys is marketing a $300 million, 3.85-year junk offering with a pay-in-kind toggle feature, providing the issuer with the option to defer interest payments in return for an upsized coupon. That prospective transaction, which is on track to price tomorrow, will mark the first sale sporting a PIK toggle in U.S. high-yield since 2021.  

Then, too, the bonds will be sold at the holding company level in order to avoid tripping debt covenants designed to forestall additional borrowing, while proceeds are earmarked for a so-called dividend recapitalization payable to Calderys’ private equity promoter Platinum Equity.

By way of response, Moody’s trimmed the firm’s rating to B2 from B1 (equating to single-B from single-B-plus), writing that the deal “will result in a material deterioration in credit metrics” and that “the rating action further reflects governance considerations associated with the proposed debt-funded shareholder distribution, which is considered an aggressive financial policy.” 

Upstairs, downstairs or none of the above: Take your PIK. 

Recap July 10

Skies of blue, and seas of green predominated Wednesday, with stocks cruising higher by TK on the S&P 500 to mark the broad index’s maiden finish north of 5,600 and its sixth consecutive record high. A strong 10-year auction ahead of Thursday’s June CPI print meanwhile helped push long rates slightly lower (the two-year yield held steady at 4.62%), while WTI crude rebounded back above $82 a barrel and gold advanced to $2,372 per ounce. Bitcoin edged a bit lower at $57,500 and the VIX crept towards 13. 

- Philip Grant

The Laws of Power (Pitching)

From the Sporting News

The Congressional Baseball Game isn't the only place you can watch politicians play ball in 2024—just look to Sioux City, Iowa, where Iowa state representative J.D. Scholten (D) just pitched a strong outing after a 17-year hiatus from American baseball.

Scholten played baseball in various independent leagues from 2003-07, pitching for Sioux City for the majority of the time. He then took time off from the sport and eventually found himself running for Iowa congress. 

Somehow, amid his political career, he has found his way back to the diamond and has been successful in doing so. His first appearance back in his home state went as well as one could have hoped: a 6.2 inning performance where he struck out two and gave up seven hits and two runs.

Flip and Slide

A real estate battle royale takes shape in U.S. District Court: Realtor.com parent firm Move, Inc. filed a lawsuit against CoStar Group (ticker: CSGP) in California last week “over the alleged theft of portal data and documents,” as HousingWire first reported on July 3.  

According to the complaint, a longtime Realtor.com staffer who migrated to CoStar unit Homes.com earlier this year subsequently accessed sensitive information from his former employer on dozens of occasions, gathering user traffic metrics along with contact information and compensation data for other Realtor.com employees in violation of state and federal statutes. “There is nothing wrong with lawful – even intense – competition,” the complaint reads. “But competitors should never be allowed to cheat and steal to get ahead.” 

CoStar offered no dull soundbite in its own defense:

The employee in question is a mid-level manager who writes and edits stories about condos. [It’s] safe to say he has zero input into Homes.com’s strategy. And even Move’s creative writing exercise doesn’t pretend that CoStar itself engaged in any misconduct. . . Realtor.com is losing the battle with Homes.com and its attempt to change the story doesn’t change that reality.

As HousingWire notes, the rival firms have long vied for the mantle of second-largest residential real estate portal behind Zillow, as the industry adapts to a March settlement between the National Association of Realtors and litigating home sellers which could serve to cut broker commissions by some 30%, per estimates from Keefe, Bruyette & Woods.

Indeed, Move’s complaint asserts its number two status by the lights of “every independent third-party [data] source [it] can identify,” including Comscore, Nielsen and others, adding that “Homes.com is last” among the industry’s four entrants. Realtor.com ranks 21st within the lifestyle section of the Apple App Store, behind only Zillow at number three and far ahead of Homes.com’s 128th position (fellow entrant Redfin sits in 25th place). 

CoStar has led a largely charmed existence from its 1987 founding, growing into a leading aggregator of commercial real estate data before branching out into the residential business. Witness the ongoing 52 straight quarters of double-digit year-over-year revenue growth, 20%-plus compound annual share price appreciation spanning the 10 years through March, universal admiration of Wall Street analysts (none of the 17 polled by Bloomberg say “sell”) and wide berth from the bears, with short interest summing to 2.3% of the float. 

Yet slowing growth, execution risk surrounding an ambitious, an expensive Homes.com advertising campaign and a skyscraping valuation equivalent to 160 times projected 2024 earnings informed a bearish verdict in the March 29 edition of Grant’s Interest Rate Observer (“Sell a great stock”). Shares have since logged a 26% decline, lagging the 7% rise in the S&P 500 including reinvested dividends and minus 3% return for its equally weighted counterpart.

Recent developments illustrate a new, potentially less lucrative state of play for CoStar investors. On April 22, the firm announced the acquisition of data provider Matterport for $1.6 billion in an even mix of cash and stock, forking over a 216% premium to the target’s undisturbed share price and equivalent to just over 10 times Matterport’s 2023 revenue (top line growth registered at 16% last year). Following the close of business on July 3, the firms disclosed receipt of request for additional information from the Federal Trade Commission, suggesting unwelcome regulatory scrutiny towards the prospective transaction, which is slated to close in the fourth quarter. 

Rivals in the fiercely competitive industry, meanwhile, maintain a full court press. Late last month, Zillow revealed a new venture with Moody’s in which the rating agency will furnish data and analytics for its multifamily residential division, while Zillow will provide multifamily rental property data for Moody’s own CRE platform.  “It seems like they have joined forces to attack CSGP,” muses an informed friend of Grant’s

On the bright side, those recent struggles don’t look to be keeping CoStar founder and CEO Andy Florance down. The Wall Street Journal reported last week that Florance parted with a one acre, 9,700 square foot beachfront home in the Florida panhandle for $28.5 million, topping a $25 million deal logged in 2022 to mark the highest transaction price ever recorded in the so-called redneck Riviera. Florance purchased the dwelling for $15.1 million in 2020. 

Recap July 9

Stocks crept higher by 10 basis points on the S&P 500 as molasses-type price action persists at the index level, while a strong three-year auction headlined another quiet day for Treasurys as the yield on the long bond rose to 4.49% from 4.46%. WTI crude slipped below $82 a barrel, gold edged higher at $2,364 per ounce, bitcoin climbed to $57,900 and the VIX notched its 11th straight session south of 13. 

- Philip Grant

GPU Tiara

From the New York Post:

She’s top of the bots. Kenza Layli, a hijab-wearing bionic belle from Morocco, has been crowned the world’s first-ever Miss AI.  “While I don’t feel emotions like humans do,” the chaste cyber siren revealed in an exclusive interview with The Post, “I’m genuinely excited about it.”

Crowned the crème de la crème of artificial intelligence models, the leggy Layli — a lifestyle influencer in her home country — crushed more than 1,500 computerized challengers for the coveted title, which comes with a $20,000 grand prize for the human tech exec from her home country who brought her to life.

The unprecedented pageant, commissioned in April by the Fanvue World AI Creator Awards, or WAICAs, invited artificial intelligence visionaries from around the globe to flaunt their programming prowess. . . 

Contestants who scored the highest marks in categories such as beauty, technology and social media presence earned bragging rights as the top 10 finalists. A panel of judges, made up of both human and android pageant experts, then hand-picked the final three to digitally duke it out for the win.

Treetop Flier
Both sides of Wall Street anticipate big things from the upcoming second quarter earnings season,

Both sides of Wall Street anticipate big things from the upcoming second quarter earnings season, which commences in earnest later this week with reports from the likes of JPMorgan, Citi and Wells Fargo. Analysts collectively pencil in nearly 9% annual earnings growth across the S&P 500, data compiled by FactSet show, which would mark the fastest clip since the opening three months of 2022. 

Earnings-related optimism has likewise manifested in unusually sticky projections, as the sell side trimmed its anticipated EPS bogey by only 0.5% from March 31 to June 30, representing a fraction of the average 4% downward mid-quarter revision seen over the past 20 years.  Index-wide net profit margins, meanwhile, will register at 12% if consensus estimates are on the beam, up from 11.8% over the prior quarter and a five-year average of 11.5%. 

Similar optimism is in abundant supply among investors, as the broad index now changes hands at 21 times forward earnings estimates following a snazzy 35% run-up since the end of October. That’s the richest ratio since the late 2021 bacchanal and compares to an average of 17.9 times forward earnings over the past decade 

Will corporate America manage to justify today’s heady price tag? “Given the lofty implied growth expectations, markets likely need to see [guidance] raises coupled with solid, execution-driven [earnings] beats to sustain recent gains or push higher from here,” writes Citigroup strategist Scott Chronert. “The concern is that, while fundamental trends are positive and consensus estimates are attainable, valuations suggest the buy side will demand more.”

Historic levels of bifurcation, perhaps, reflect those increasingly daunting hurdles.  As the S&P 500 logged a fresh closing high on Friday, a mere 43% of index components finished that lightly attended, post-holiday session north of their respective 50 day moving average, Brown Technical Insights founder and eponym Scott Brown reports on X, representing the narrowest such participation since December 1999.  Dean Christians, senior analyst at SentimenTrader, similarly relays that the proportion of S&P 500 firms outperforming the index on a rolling 21-day basis reached the lowest level in the gauge’s history on Friday.

Conversely, the S&P 500’s 10 largest stocks have generated 58% of the index’s 55% return from its fall 2022 lows, pushing that cohort’s share of the market cap-weighted gauge to some 37%.  For context, the top 10 names collectively commanded 27% of the S&P 500 at the climax of the dot-com boom in March 2000, JPMorgan Asset Management pointed out last month. 

A visible operating downshift among the top half of that elite group further colors those gaudy gains. The quintet of Nvidia, Apple, Amazon, Microsoft and Meta will see annual earnings growth slow to 30% on average in the just-completed quarter from 38% over the January to March period, if estimates from Deutsche Bank are on the beam. 

Steve Sosnick, chief market strategist at Interactive Brokers, puts it this way to the Financial Times: “We may not be priced to perfection, but we’re priced for really, really good.”

Recap July 8

Stocks edged slightly higher in sluggish summer trading, logging a fourth consecutive high-water mark on the S&P 500 and leaving the broad average higher by nearly 17% in the year-to-date. Treasurys likewise saw low wattage moves with the two-year note climbing two basis points to 4.62% and the long bond ticking to 4.46% from 4.47% Friday.  WTI crude pulled back towards $82 a barrel, gold slipped to $2,359 per ounce (recent ADGs featured typos erroneously pegging the yellow metal at $3,200 plus), bitcoin stabilized from a recent tumble at $56,300 and the VIX remained a bit above 12. 

- Philip Grant

Height Club

If it’s not on your phone, did it really happen?  From the Independent:

Two couples were filmed fighting with each other at an observation deck in Tibet allegedly to secure the best selfie spot while attempting to climb Mount Everest.

The incident took place on June 25 after a tour guide asked the group to pose together on the viewing platform next to the Everest Elevation Measurement Monument for a photo.

Westerly Wind
Command and patrol:

Command and patrol: Beijing is putting the finishing touches on laws to establish a financial stability guarantee fund to backstop stricken institutions and snuff out potential contagion. 

To be sure, tinder for such an imagined conflagration is in abundant supply. Commercial banking assets in the Middle Kingdom reached $58.2 trillion at the end of May, equivalent to more than half of last year’s GDP (not China’s, but the world’s) and towering over the U.S.’s $23.3 trillion figure.The tally of debt amassed by so-called local government financial vehicles, or municipal entities which fund output-flattering spending projects, reached some $9 trillion as of Dec. 31 per the IMF, up 65% from the year-end 2020 figure and far above the $3.3 trillion in aggregate borrowings among U.S. state and local authorities. 

A now-sketchy growth picture brings that towering debt stack into sharper relief.  Yields on China’s onshore 10-year sovereign bonds touched 2.18% yesterday, marking the lowest level on record dating to 2002 and underscoring a “pessimistic mood on the economy,” per Bloomberg chief Asia FX and rates strategist Stephen Chiu. 

China’s lynchpin housing market, meanwhile, continues to sag. Home prices across 70 major cities fell by 0.71% month-over-month in May per the National Bureau of Statistics, the steepest sequential drop in that government-compiled data series since October 2014.  Property-sector investment likewise sank 10.1% year-over-year from January to May, further downshifting from a 9.8% decline during the first four months of 2024.

Tellingly, perhaps, Wall Street is packing its bags. The Financial Times relays today that a sample of seven U.S. and European-headquartered investment banks have slashed their headcounts in China by a combined 13% from levels seen in 2022, as year-to-date IPO volumes in the world’s second-largest economy reached only $8.3 billion as of May 31 per Dealogic, the worst such start to a year since 2009.

Those dynamics reflect a “vicious cycle” according to Han Lin, China country director at consulting firm The Asia Group. “Weak deal flow means less investment in onshore capability, which further limits deal flow.”  Mincing no words, JPMorgan boss Jamie Dimon commented at a May conference that business had “fallen off a cliff.”  

Recap July 2

Stocks staged a strong intraday advance following dovish commentary from Fed chair Jerome Powell, with the S&P 500 settling higher by two-thirds of a percent to break from its narrow range and top the 5,500 threshold for the first time. Treasurys managed a moderate bounce with the long bond dropping four basis points to 4.6%, while WTI crude ticked to $83 a barrel and gold finished little changed at $2,329 per ounce. Bitcoin slipped back below $62,000 and the VIX stayed at 12. 

- Philip Grant

The Cleanest Dirty Shirt

From the Financial Times:

Drug traffickers chose to launder money through Citigroup because they believed the bank was “more favorable,” with less robust fraud controls, according to senior U.S. law enforcement officials. 

In an indictment unsealed last week, US prosecutors detailed how two California residents, who allegedly worked with the notorious Sinaloa cartel, deposited tens of thousands of dollars at Citi ATMs. . . 

Administration officials told the Financial Times that the duo, alleged to be part of a vast criminal network that cleaned at least $50 million in fentanyl and meth proceeds in the U.S., scoped out several banks before choosing Citi. One senior official said: “There are banks that pay less attention than others.”

In-House Call
Time for some reconstructive corporate surgery:

Time for some reconstructive corporate surgery: Boeing Co. intitiated a course correction Monday, unveiling a formal agreement to buy Spirit AeroSystems, Inc. in a $4.7 billion, all-stock deal, reuniting with its separated supplier following a 2005 spinoff designed to cut costs. Rival firm Airbus will assume control of Spirit divisions that furnish parts for its own aircraft,  receiving $559 million in compensation for its trouble. 

Boeing, which will shell out a 30% premium to its target’s undisturbed late February share price prior to reports of a potential tie-up, looks to escape months of turbulence following January’s mid-flight blowout of a Spirit-manufactured door panel on an Alaska Air 737 Max.  The Justice Department likewise will charge Boeing with criminal fraud in connection with a pair of Max crashes prior to the pandemic, Bloomberg reports. 

“Among the many actions we’re taking as a company, this is one of the most significant in demonstrating our unwavering commitment to strengthen[ing] quality and mak[ing] certain that Boeing is the company the world needs it to be,” outgoing CEO Dave Calhoun commented, adding that the transaction will “fully align” the firm’s production systems and workforces. 

Boeing could certainly use a corporate recalibration. The firm delivered 24 commercial jets in May, down more than 50% year-over-year, while new orders in that period totaled a measly four. Those figures stand at 131 and 103, respectively, in the year-to-date, down 47% from the combined tally over the first five months of 2023. “It is hard not to acknowledge that Spirit’s shortfalls in deliveries have led to inefficiencies and cost growth across Boeing’s business,’ Jefferies analyst Sheila Kahyaoglu writes.  

While the lynchpin U.S. manufacturer works to get its disheveled house in order, external developments serve to hamper that daunting endeavor. Thus, a work stoppage at Safran SA, which produces landing gear for both members of the de-facto aircraft duopoly, now stretches into a sixth week, with striking staffers picketing outside the company’s Montreal-area offices last week as the two sides remain “far from a resolution,” according to Reuters. Safran is offering a 14.5% pay increase over three years, while the union is targeting a 22% bump in average salaries. 

That labor dispute aggravates a broad-based supply snarl. Last week, Airbus announced that it now expects to deliver only 770 jets this year rather than a previously pegged 800, likewise trimming its projected 2024 adjusted earnings before interest and tax to €5.5 billion ($5.9 billion) from a prior €6.5 billion to €7 billion range in an update deemed “shocking” by Deutsche Bank’s Christophe Menard.  “June deliveries are apparently sluggish and there is no guarantee at this stage that the new delivery target will be easy to achieve by year-end,” Menard added. 

Indeed, supply-chain problems are likely to persist for at least the next two years, Airbus boss Guillaume Faury warned in an early June interview, with the CEO noting that the situation has “significantly degraded” in recent weeks thanks to engine-related problems with its flagship A320 model.

Yet time and economic activity march along: Global traffic by passenger count will grow at a healthy 3.8% annual clip over the next two decades, if guesstimates from the International Air Transport Association are on the beam.  How to capitalize on the now-yawning supply and demand divergence? See the analysis “Cheap highflier” in the current edition of Grant’s Interest Rate Observer dated June 21 for a bullish look at one capably managed industry cog arguably well positioned to thrive in today’s backdrop. 

Recap July 1

The third quarter’s opening session brought more of the same, as stocks sleepwalked through another low-voltage outing with the S&P 500 settling some 0.2% in the green, though Treasurys remained on the run with 30-year yields reaching 4.64%, up 21 basis points from Thursday’s close. WTI crude rose above $83 a barrel, gold ticked higher at $2,332 per ounce, bitcoin climbed 1% to $63,300 and the VIX remained just over 12.  

- Philip Grant

Swap Spread

From the Financial Times:

Sales of olive oil have plunged in its Mediterranean heartland as Spaniards and Italians are forced to shun their most beloved culinary ingredient following steep price rises. 

Ignacio Silva, chief executive of Deoleo, the world’s biggest olive oil seller by revenue, said cost-conscious consumers were changing their habits to cope with the impact of droughts that have wrecked harvests. 

“We’ve clearly touched a price that is a problem for Spanish and Italian consumers,” he told the Financial Times, alluding to falling sales of Deoleo brands including Bertolli and Carbonell.

A kilogram of the foundational foodstuff now wholesales for about €7 ($7.49) in global number one producer Spain, data from Expana Benchmark Prices show, compared to a bit more than €1 per kilo at the start of 2021.

Spice of Life
Which way, Mr. Market?

Which way, Mr. Market? Placid price action in stocks following the steep post-October rally is spurring a virtuous cycle in equity derivatives. Thus, Bloomberg reports that straddle and strangle strategies, which entail selling both bullish call and bearish put options at various strike prices in a bet on limited moves, are increasingly en vogue, in turn helping contribute to index level stability. 

The S&P 500 has now gone more than 300 sessions without logging a single day 2% decline, its second longest such streak in the post-2008 era. Similarly, the Chicago Board Options Exchange's CBOE Volatility Index (VIX) has topped 15 on a closing basis only 21 times in the year-to-date, rarely approaching its three-decade average of near 20 over that period. 

“We are seeing absolutely pervasive at-the-money volatility selling from customers,” Nomura cross-asset strategist Charlie McElligott writes. Meanwhile, the broker dealers who stand on the other side of that trade – accumulating calls and puts alike from their income seeking customers – hedge their positions by selling rallies and buying dips, a dynamic which is “simply choking out the ability” for benchmark gauges to sustain material moves, McElligott concludes. 

Yet as plain vanilla pervades at the index level, those looking to add zest to their portfolios have a new recipe at their disposal. Yesterday, exchange traded funds issuer T-Rex Group filed paperwork with the SEC to pave the way for a contraption offering two times the daily return in MicroStrategy, Inc. (ticker: MSTR), the loss-making enterprise software provider-cum-bitcoin speculation vehicle helmed by crypto evangelist Michael Saylor. T-Rex likewise plans to introduce an inverse MSTR fund for those of a bearish bent. 

MicroStrategy, which boasts a cache of 214,400 bitcoins currently valued at just over $13 billion, has seen shares rally by 118% this year, compared to 41% for the blue-chip digital asset, leaving its market capitalization at $24.4 billion. Terming the prospective securities the “ghost pepper of ETF hot sauce,” Bloomberg’s Eric Balchunas elaborated thus on social media platform X: “these are a near-lock to be the most volatile ETFs ever seen in the U.S., [offering roughly] 20 times the volatility of the S&P 500.”

Don’t forget a cold glass of water. 

Recap June 28

Stocks came under modest but persistent pressure following an early ramp to leave the S&P 500 some 40 basis points in the red, trimming year-to-date gains to 15% and change at the halfway point of 2024. Treasurys came for sale following last night’s inspiring redux of Lincoln versus Douglas, with the long bond jumping eight basis points to 4.51% to mark a near-three-week high. WTI crude remained slightly below $82 a barrel, gold edged lower at $2,325 an ounce, bitcoin ticked to $60,100 and the VIX remained south of 13. 

- Philip Grant

Teacher's Pet

From CNBC:

JPMorgan Chase said late Wednesday that the Federal Reserve overestimated a key measure of income in the giant bank’s recent stress test, and that its losses under the exam should actually be higher than what the regulator found.

The bank took the unusual step of issuing a press release minutes before midnight ET to disclose its response to the Fed’s findings.

JPMorgan said that the Fed’s projections for a measure called “other comprehensive income” — which represents revenues, expenses and losses that are excluded from net income — “appears to be too large.”

But is the grade inflation transitory?

21 Club
It's alive!

It’s alive! Recently moribund capital markets have begun to stir of late, as domestic IPO volume has topped $20 billion so far this year by Bloomberg’s count, the best first half showing since the 2021 bumper crop. A trio of debuts have topped $1 billion, compared to only a single such deal during the first six months of each of the past two years. 

That furtive revival comes not a moment too soon for venture capital, which looks to recover from a raging 2021-era bacchanal. The industry raised a record $312.6 billion in that fat plague year, Preqin finds, while 2021-era funds invested 30% of their capital over the first 12 months on average, roughly double the usual pace of deployment. The global tally of unicorns, or startups valued at $1 billion or more on the private markets, stands at 1,237 according to CB Insights, more than double that seen in late 2020. 

As The Wall Street Journal documented yesterday, the fruits of that historic shopping spree have proven less than bountiful. Thus, the median net investment rate of return for 2021 vintage funds focused on early- and late-stage private firms stood at just 2.1% as of September (the most recently available data) according to Preqin, a fraction of the 12.3% figure logged just one year earlier.  

Lingering pain may be in in the cards, as the analytics firm predicts that average annual returns through 2028 will decline by 5% from the 2019 to 2022 baseline, reflecting the poor performance of that peak-year vintage. Broad-based reputational damage is likewise taking hold: “Faith and trust in [v.c.] funds have gone down,” Sterling Snead, a principal at S&S Global Family Office, told the WSJ. “A lot of people are more cautious about who they’ll work with.” 

Against that backdrop, one prominent player forges ahead: SoftBank Group Corp. is helping spreadhead a $250 million funding round in artificial intelligence unicorn Perplexity AI via its Vision Fund venture capital arm at a $3 billion valuation, Bloomberg reports today.  Two-year-old Perplexity, which will harness the budding technology to compete with Google’s search engine, sported $1 billion and $540 million price tags in rounds conducted in early March and January, respectively, TechCrunch relays.

The Perplexity transaction underscores a new day for SoftBank, dubbed “the epitome of the cycle” by Grant’s Interest Rate Observer nearly seven years ago (Dec. 15, 2017). Masayoshi Son’s outfit famously poured torrents of cash into an array of startups during the bygone venture capital bubble, logging an eye-watering $32 billion loss within the Vision Fund complex during the fiscal year ended March 2023 for its trouble.

That was then. SoftBank plans to spend $100 billion on AI-related chips to compete with industry juggernaut and former portfolio company Nvidia (SoftBank sold its 4.9% stake back in 2019, missing out on some $160 billion in profits, and counting, in the process). 

Undaunted, Son took the podium at last week’s shareholder meeting to trumpet artificial super-intelligence (ASI), predicting that the next iteration of machine learning will possess intelligence equivalent to 10,000 times that of the average human within a decade.  The SoftBank boss went on to wax philosophical, musing thus: “SoftBank was founded for what purpose? For what purpose was Masa Son born? It may sound strange, but I think I was born to realize ASI. I am super serious about it.”

QT Progress Report
A $13.2 billion weekly decline in Reserve Bank credit leaves the Fed’s portfolio of interest-bearing assets at $7.208 trillion. That’s down $52 billion from the last week of May, and 19.2% below the early 2022 highs. 
Recap June 27

Stocks crept higher by 0.1% on the S&P 500 in the latest low-voltage session, as the broad index has now moved less than half a percent in nine of the past ten trading days.  Treasurys also finished marginally stronger, with the two-year note edging back to 4.7% and the long bond settling at 4.43%, down one and two basis points on the day, respectively. WTI crude rebounded towards $82 a barrel, gold rose to $2,327 an ounce, bitcoin ticked to $61,400 and the VIX dropped to near 12. 

- Philip Grant

Heat Check

This Citi’s not big enough for the both of us. From Bloomberg:

Citigroup Inc. urged staffers not to get drawn into altercations with protesters targeting the bank’s New York headquarters, a sign that activists’ protracted campaign is beginning to wear on employees and executives alike.  Climate activists have sought to blockade the entrance to the bank’s main office since early June, with video footage showing angry scenes in the public plaza outside the building.

Citigroup’s Security and Investigative Services team is advising employees on how to handle the events, according to a memo to staff seen by Bloomberg. . .  Protesters have dubbed their campaign against Citigroup the “Summer of Heat.” On a website replete with slogans such as “Hot People Hate Wall St.” and “Eat the Rich,” organizers said protesters will be “going hard all summer long. Week after week. Month after month.”

So far, protest organizers say that roughly 200 activists have been arrested as police have lined up almost daily outside Citigroup’s headquarters. Protesters had vowed to avoid physical violence, but they also say their goal is to physically prevent employees from entering the building and doing their jobs.

Blue in Green
Now comes the hard part.

Now comes the hard part. The post-2022 crypto renaissance has worked its magic in one key corner of the market, as heretofore-jilted customers of Sam Bankman-Fried’s infamous outfit FTX have enjoyed no small reversal in fortunes.  

Claimants are set to be made whole and then some, according to a liquidation plan put forth by FTX bankruptcy managers last month, a far cry from the secondary market prices of just 10 cents on the buck seen early last year on trading platform Cherokee Acquisition (the analysis “Pennies on the dollar” in the March 10, 2023 edition of Grant’s Interest Rate Observer proved a timely review of that opportunity).

Yet as The Wall Street Journal documented Monday, several institutional investors enjoying substantial paper gains are now struggling to collect their money, with existing hodlers either demanding a greater share of the winnings or refusing to part with their claims entirely, spurring a series of lawsuits. 

“We have sellers from all over the world that are interfacing with buyers and the bankruptcy court for the first time, and have never experienced a U.S. Chapter 11 case,” Andrew Glantz, chief strategy officer of crypto bankruptcy venue Xclaim, told the Journal. Call it learning by doing. 

Indeed, some crypto “degens” may soon receive a crash course in bankruptcy law. Many prospective sellers don’t have lawyers and “don’t realize that a verbal contract to sell a claim is binding under New York law, where most of these hedge fund [buyers] are based,” claims broker Thomas Braziel likewise commented to the WSJ.

Outsized, unrealized gains have likewise failed to extract other constituents from their crypto winter of discontent. Yesterday, U.S. Bankruptcy Judge John Dorsey gave FTX the green light to poll creditors on a liquidation format which would repay them in fiat currency. As Reuters reports, that plan is going over like a lead balloon in some circles, as the price of bitcoin has mooned above $60,000 from less than $17,000 when the digital bourse bought the farm in fall 2022.  

Earlier this month, a group of claimants filed a class action lawsuit contending that, since FTX never owned customer deposits, the estate must render the full, current value of their digital assets. “Customers must be made aware that the plan’s ‘full recovery’ is nothing of the sort,” the creditors groused. 

That argument overlooks the slipshod state of FTX’s books at the time of its demise, estate attorney Andy Dietderich argued at a court hearing Tuesday: “Everybody was an involuntary investor in this crazy pool of assets, and our job was to turn it to cash.” 

Current CEO John Ray III likewise told Reuters that virtually all the crypto assets under FTX’s purview are long gone, with the bourse holding just 0.1% of bitcoin and 1.2% of ethereum that customers believed it had as of fall 2022. “You cannot pay one creditor more without taking it from another creditor,” Ray explained. “Those arguing for appreciation of ‘their’ tokens would be taking money away from fellow customers who held cash, stablecoin or other crypto.” 

Multi-fold returns, manifold headaches. 

Recap June 26

A noteworthy lurch higher in the rates complex headlined today’s session, with 2- and 30-year yields rising six and nine basis points respectively to 4.71% and 4.45%, while stocks maintained their index level inertia ahead of quarter-end with the S&P 500 snoozing through another virtually flat session (+0.12%). WTI crude remained just south of $81 a barrel, gold slipped to $2,298 per ounce, bitcoin retreated to $60,700 and the VIX ticked to 12.6. 

- Philip Grant

Wager Price Spiral

When hedging goes wrong, via the Financial Times:

[The U.K. Labour party] has suspended a candidate who bet he would lose his bid to become an MP, as a Gambling Commission probe into political betting widened. . .  

Labour said that, after the “receipt of communication” from the Gambling Commission, it had acted to suspend Craig, adding: “The Labour party upholds the highest standards for our parliamentary candidates, as the public rightly expects from any party hoping to serve, which is why we have acted immediately in this case.”  The party is also set to return a £100,000 ($127,000) donation it took from Craig last year, according to officials.  

The suspension drags Labour into a scandal that had hitherto engulfed the Conservatives and the police and will be a relief to Prime Minister Rishi Sunak ahead of a final head-to-head debate with Labour leader Sir Keir Starmer on Wednesday. 

Craig said: “Throughout my life I have enjoyed the odd bet for fun whether on politics or horses. A few weeks ago, when I thought I would never win this seat, I put a bet on the Tories to win here with the intention of giving any winnings to local charities. While I did not place this bet with any prior knowledge of the outcome, this was a huge mistake, for which I apologize unreservedly.”

Free Range
Avert your eyes, doves:

Avert your eyes, doves: Federal Reserve governor Michelle Bowman warned in a London speech today that “we are still not yet at the point where it is appropriate to lower the policy rate” from the current 5.25% to 5.5% band. Jumping the gun on rate cuts may risk a resurgence of price pressures, Bowman said, adding that she remained “willing to [further] raise” the funds rate “should progress on inflation stall or even reverse.”

Bowman – who holds a vote on the rate-setting Federal Open Market Committee – likewise undertook some institutional introspection regarding the central bank’s unfortunate decision to maintain an ultra-easy stance into spring 2022 in the face of a bounding CPI: “It seems likely to me that the U.S. experience during the years leading up to the pandemic, when inflation was persistently low, made it hard for many to foresee how quickly that situation could change.” 

On that score, developments north of the border may give pause to easing-minded FOMC members. This morning’s release of Canadian CPI for May showed a 2.9% year-over-year uptick on the strength of a 0.6% sequential increase, wrong-footing economists who anticipated 2.6% and 0.3%, respectively, and marking the 38th consecutive annualized print of at least 2.8%. That unwelcome surprise comes less than three weeks after the Bank of Canada trimmed overnight rates to 4.75% from 5% and only a day after governor Tiff Macklem predicted a soft landing ahead: “We continue to think that we don’t need a large rise in the unemployment rate to get inflation back to the 2% target.”

Then, too, inflation’s cumulative impact remains an economic wildcard stateside. Citing data from the U.S. Department of Agriculture, the FT relays that real spending on in-home foodstuffs declined by 3.1% year-on-year in 2023, while grocery stores scanned 248 million items over the past 12 months through May per NielsenIQ, down some 20 million units over the same period four years ago. Similarly, restaurant spending reached its lowest monthly pace of 2024 in May, while aggregate customer visits have ebbed for 13 consecutive months, the National Restaurant Association finds. 

On the bright side, silver linings from the price level’s upward march are visible to the Ph.D.-economist trained eye. Late last month, Fed staffers released a whitepaper finding that dispersion, i.e., the extent to which competing vendors vary their charges for the same good in a particular market, “increases steeply around zero inflation and becomes flatter as inflation increases.”  In other words, inflation (not too much, mind you) “can be beneficial for [consumer] welfare.”

With the odds of a September rate cut sitting slightly north of 60% according to interest rate futures, will the monetary mandarins march in lockstep? 

Recap June 25

Back to our regularly scheduled stock-market programming, as a 7% bounce for Nvidia spurred a 1.1% rebound on the Nasdaq 100 and 0.4% S&P 500 gain to erase Monday’s losses. Treasurys enjoyed some bull steepening with two-year yields dropping six basis points to 4.65% and the long bond edging to 4.36% from 4.38%, while WTI crude pulled back below $81 a barrel, gold downshifted to $2,319 per ounce, bitcoin ticked towards $62,000 and the VIX settled south of 13. 

- Philip Grant

Have Fun Staying Pour

Stealth mode engaged, via Benzinga:

Tesla CEO Elon Musk joined Justin Timberlake‘s intoxicated driving discussion by saying the pop singer would not have been arrested had he been driving a Tesla car with its driver assistance features enabled and not a BMW.

Timberlake was arrested in Sag Harbor, New York for intoxicated driving on June 18 after he ran through a stop sign and failed to maintain his lane . . .  Following the [incident], Tesla enthusiast Omar Qazi, who goes by the username Whole Mars Catalog, took to X to say that a Tesla would not have let the singer run a stop sign or a red light, thereby helping him avoid charges. Musk agreed with the user with a short, “True.”

Dancing in the Dark
Four more years!

Four more years!  Staffers at the Federal Deposit Insurance Corporation will be obliged to report to the office only two days each week beginning July 15, The Wall Street Journal’s Andrew Ackerman relays this morning, citing a staff memo circulated Friday.  

Coming nearly a half-decade after the bug first barged in, last week’s decree represents an aspirational downshift for the banking regulator. The FDIC had previously planned to require three days per week of in-person attendance before tweaking its policy in response to “thoughtful feedback from employees and managers.”  Workers at the Dallas and Atlanta regional offices will need to visit the office only once per week, on account of space limitations (or, perhaps, employee surpluses). 

That development deftly illustrates a dim state of play in the office realm. Nationwide vacancy rates approached 20% in the first quarter, data from Moody’s show, up from 16.8% over the last three months of 2019, while delinquencies among U.S. office commercial mortgage-backed securities will reach 8.4% this year and 11% in 2025 if recently issued projections from Fitch are on the beam, up from 8.1% and 9.9% guesstimates issued earlier this year. 

“We maintain a ‘deteriorating’ outlook for the U.S. office sector until the end of 2024,” the rating agency concludes, as adverse market conditions will serve “to increase refinancing difficulties, resulting in higher loan delinquencies and more loan transfers to special servicing.”  (See the March 29 issue of Grant’s Interest Rate Observer for more on the stricken office loan sector, including instructive developments close to our home.) 

The march of technological progress, meanwhile, continues to bedevil other corners of commercial real estate. As the WSJ documents today, Brookfield Property Partners has labored to convert the bulk of its 125-mall portfolio into other residential or commercial uses, successfully redeveloping only two outdated shopping centers over the past six years with a further pair in the pipeline.  

Political red tape and longstanding leases with department stores– which often permit such anchor tenants to veto nonretail development – contribute to that halting progress. Virus-related disruptions, rising construction costs and interest rates further complicate matters. 

“Some things that might have made sense five years ago, we have to go back to the drawing board,” Brian Kingston, CEO of Brookfield’s real estate business told the Journal. “These are big, complicated projects that happen over long periods of time.” The passage of time has not been kind to that category: a $12.4 billion basket of debt securities backing 50 mall properties has slumped by 40% on average since July of 2018, KBRA Analytics finds. 

As secular shifts throw an array of CRE assets for a loop, a shaky fundamental framework further complicates life for investors.  Thus, the Financial Times reported Friday that credit agencies have “mis-rated” upwards $100 billion of debt tied to so-called single-loan deals, with at least a dozen such transactions maintaining upper-tier investment-grade ratings even with the borrowers slipping into default. 

One representative asset, 1407 Broadway in New York’s garment district, faces foreclosure as San Francisco-based owner Shorenstein Properties has failed to make a mortgage payment since July. Yet the $187 million in bonds backing the building continue to enjoy a double-A rating at Fitch.  

That eye-catching dynamic duly evokes unpleasant memories of the great financial crisis, in which a slew of triple-A-rated mortgage debt proved to be nothing of the sort. “It is. . . easily the worst example of mis-rating of major securities that is out there today,” former Moody’s credit analyst turned economics commentator Rod Dubitsky told the pink paper. “The integrity of the ratings process has improved very little” since 2008. 

Recap June 24

Stocks ticked lower by one-third of a percent on the S&P 500 and 1.1% on the Nasdaq 100 as Nvidia extended its three-day drawdown to just under 13%. Treasurys finished little changed with the 2-year yield rising one basis point to 4.71% and the long bond settling at 4.38% from 4.39% Friday, while WTI crude pushed towards $82 a barrel, gold rebounded to $2,333 per ounce, bitcoin slumped to $59,200 and the VIX edged above 13. 

- Philip Grant

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