One More Cup of Coffee
A grande slam?

A grande slam?  Starbucks Corp. has filed trademark paperwork that would pave the way for bestowing its name on a stadium or entertainment venue, Bloomberg reports today. The java giant would join mega-firms such as Wells Fargo and American Airlines in pursuing that branding strategy, Bloomberg notes. 

Then again, as stadium rights branding deals are a distinctly bull-market endeavor, Starbucks would also join some infamous company from prior booms – Enron Field in Houston, CMGI Field in Foxboro, Mass., PSINet Stadium in Baltimore, Adelphia Coliseum in Nashville, Trans World Dome in St. Louis, and MCI Center in Washington, D.C. Sometimes the ballparks outlast the sponsors.

Think it over, SBUX.

Fad Blocker
Citing data from Morgan Stanley, the Financial Times relays that assets under the stewardship of private capital

Citing data from Morgan Stanley, the Financial Times relays that assets under the stewardship of private capital firms (an umbrella term covering investments in unlisted enterprise, most often private equity) reached $7.4 trillion as of Dec. 31, roughly double that of five years prior.  There’s plenty of room for good times ahead, the investment bank reckons, penciling in $13 trillion in industrywide assets by 2025. 

As the rise of indexing has upended the public investment business model, Wall Street has responded by pivoting towards the private market, which favors active management thanks to its generally illiquid nature while offering enhanced flexibility to value securities. “For traditional asset managers, fees will be relatively harder to defend given the commonization of the industry and existing margin challenges,” Morgan Stanley wrote yesterday. “As a result, we expect traditional asset managers to. . .  [lean] into alternatives with its fatter fee pool and private markets with its higher structural growth.” 

Meanwhile, deal activity looks set to accelerate. Last Saturday, a consortium of private equity firms announced a leveraged buyout of closely-held medical supply giant Medline Industries, Inc. at a $34 billion valuation, marking the largest such deal since the collapse of Lehman Brothers.  

As that acquisition would mark only the 11th LBO of $10 billion or more in the dozen-plus years since the financial crisis, compared to 18 between 2005 and 2007, some observers think conditions are ripe for another M&A boom. “This could be the transaction that opens up the floodgates,” Dusty Philip, co-chairman of Global M&A at Goldman Sachs, told The Wall Street Journal. “You have ideal conditions for large LBOs: low interest rates, aggressive financing markets and a significant amount of dry powder.”  Indeed, undeployed funds at p.e. firms stand at more than $1.6 trillion according to Preqin, a record figure and up from $1 trillion at the end of 2017. 

Upcoming buyouts are likely to feature aggressive terms, if recent trends are any indication. Thus, the average domestic LBO purchase price footed to 12.8 times Ebitda last year according to data from McKinsey, with debt equivalent to 6.8 times trailing Ebitda.  That compares to an average 9.4 times average purchase multiple and 6.1 turns of leverage at the crest of the prior cycle in 2007. 

Meanwhile, the proliferating quantity of deal-hungry firms ensure that competition for targets will remain fierce.  More than 11,000 private capital outfits were active globally as of year-end by McKinsey’s count, compared to about 9,000 hedge funds. The number of private capital firms have grown at an 8% compound annual rate since 2015, while the hedge fund universe has contracted at a 2% annual clip over that five-year period and remains well below its high water mark reached in 2005.

Might the hedge fund industry’s recent struggles prove instructive to today’s private capital stampede?  A bearish analysis of hedge fund purveyor Man Group plc. in the April 9, 2004, edition of Grant’s Interest Rate Observer included a trio of pointed questions regarding the-then mushrooming investment category: “What are the barriers to entry in the hedge fund business, in which a 26-year-old can raise $50 million? Can investors in hedge funds expect to succeed over a complete investment cycle, given high fees and the fast-growing population of magna cum laudes picking over the same opportunities? And: When has an investment fad not ended badly?”

Asset allocators, please copy. 

Recap June 11

Treasurys gave back early gains as the recent rally ran out of steam this afternoon, leaving the 10- and 30-year yields at 1.45% and 2.14%, respectively.  Stocks went nowhere as the S&P 500 logged a 0.3% gain for the week to sit at new highs, WTI crude pushed towards $71 a barrel and gold sank to $1,879 an ounce.  The VIX sank below 16, logging a fresh virus-era closing low.   

- Philip Grant

Leaps and Bounds
Today’s reading of the May Consumer Price Index

Today’s reading of the May Consumer Price Index showed a 5.0% year-over-year increase, the hottest since September 2008, while the 3.8% advance excluding food and energy prices was the largest in nearly three decades.  Then, too, Bianco Research notes that the combined 2% jump in core CPI over the past three months marks the fastest such stretch since 1982, equivalent to an 8.3% annual growth rate. 

It could have been worse. Rent of primary residences and owners’ equivalent rent rose by 1.8% and 2.1%, respectively, from a year ago.  That compares to a 5.4% increase in annual rental prices in May, according to ApartmentList.com, while home prices appreciated by 13.2% per Zillow. 

The pair are heavy hitters within the CPI, accounting for a combined 31.5% of the total index.  If measured rental and OER prices had accelerated at the same 5% as the headline figure, headline CPI growth would have topped 5.9% last month. 

Wake of the Flood
A pandemic year bumper-crop.

A pandemic year bumper-crop. Total global wealth, or financial and real assets such as real estate less liabilities, reached a record $431 trillion as of Dec. 31, a new report from Boston Consulting Group finds.  That’s up 7.9% year-over-year and 38% from the end of 2015. 

Both ultra-easy monetary policy, which helped levitate financial investments by 11.3% last year, and fiscal largesse contributed to the wealth windfall. Net new savings, encompassing cash and deposits, accelerated by 10.6% to mark the best annual showing in 20 years. “The world was in lockdown and there were not that many alternatives to spend and invest,” Anna Zakrzewski, global head of wealth management at BCG and coauthor of the report, observes to Barron’s

Indeed, the average FICO score rose slightly to 682 in February 2021 from 678 in March of last year, data from LendingTree show, a most unusual development in a recession year.  For instance, it took until 2013 for consumer credit scores to exceed their pre-crisis levels following the events of 2007 to 2009. This time, individuals paid down outstanding credit card balances at the highest rate since 2000 in the first quarter, Roger Hochschild, CEO at retail-focused Discover Financial Services, observed on an April 22 earnings call.  That doesn’t necessarily spell good news from the lender’s point of view. “We are very focused on returning to growing loans,” Hochschild said. “Delinquencies can’t get much lower than they are now, but if your loans keep shrinking, your revenues come down [and] margins will get worse.” 

Competition is heating up accordingly, as banks vie for suddenly scarce business.  On Tuesday, Wells Fargo announced the debut of the Active Cash card, which will offer users a 2% cash-back rate on all purchases with no annual fee.  Not to be outdone, Citigroup today trumpeted plans to launch its own credit card which will automatically credit 5% cash back on up to $500 in monthly spending in a customer’s most active category of spending (such as dining, gas or travel) for that period, along with 1% back on everything else. 

Beyond furnishing increasingly generous terms in hopes of generating business, lenders look for ways to deal with a towering glut of cash that has come to act as something of an industry millstone. The Wall Street Journal reported yesterday that, with total deposits at U.S. commercial banks topping $17 trillion as of late May, up from $13.5 trillion as the bug bit, some banks are encouraging corporate customers to take their unwanted dollars elsewhere.  Total loans equaled 61% of deposits as of May 26, according to the Federal Reserve, down from 75% in February 2020. Low yielding cash balances, in tandem with the Fed’s EZ monetary policy, have pushed industrywide net-interest margins to record low levels in the first quarter, per the Federal Deposit Insurance Corp. 

For more on the financial side effects of last year’s epic monetary and fiscal interventions, see the analysis “A case of overstimulation” in the April 2 edition of Grant’s Interest Rate Observer

QE Progress Report
A $25 billion weekly increase in Reserve Bank Credit pushed interest-bearing assets on the Fed balance sheet to $7.905 trillion.  That’s up 7.6% year-to-date, 11.9% year-over-year and 110% from the commencement of “not QE” in fall 2019. 
Recap June 10

Who needs real yield?  Investors responded to this morning’s inflation data with a feverish bid for Treasurys, as the 10-year yield to 1.46%, its lowest in more than three months. Stocks also liked what they saw, with the S&P 500 gaining 50 basis points and the Nasdaq 100 rallying by more than 1%, while WTI crude pushed back above $70 a barrel and gold held at $1,902 an ounce.  The VIX retreated to just above 16, its lowest close since the virus took hold.  

- Philip Grant

It's a Strategy
Tripling down on the brave new world,

Tripling down on the brave new world, mobile software firm MicroStrategy, Inc. announced it will upsize its sale of senior secured notes to $500 million from the $400 million offering announced yesterday. Strong demand underpinned that enhanced deal, as the issue priced at 6.125% compared to price talk of 6.25% to 6.5%, with the order book reaching about $1.6 billion per Bloomberg. 

While Mr. Market’s friendly reception would generally be seen as par for the course in the current credit boom, MicroStrategy’s financing is unusual in that proceeds will used for the purchase of additional bitcoins, following the issuance of $1.7 billion in convertible senior notes in February and December of last year for the same purpose.  

MicroStrategy, which currently owns 92,000 of the digital ducats, disclosed yesterday that it will take an impairment charge of at least $285 million (equivalent to more than half of consensus 2021 revenue) following mark-to-market losses after bitcoin fell to $36,000 from as much as $64,000 on April 14.  Bitcoin went on to sink to as low as $31,400 in mid-day trading, before bouncing back above $33,000 following news of the upsized bond offering. 

Game Stop
Securities and Exchange Commission chair Gary Gensler fired a salvo at corporate America yesterday,

Securities and Exchange Commission chair Gary Gensler fired a salvo at corporate America yesterday, noting at a Wall Street Journal-hosted conference that the agency is looking to tighten restrictions around so-called 10b5-1 trading plans.  The existing format allows executives to sell their shares on a pre-scheduled basis, providing a bulwark against legal liabilities arising from allegations of insider trading based on non-public information, of which corporate executives are, of course, in constant possession. 

The current 10b5-1 structure features numerous loopholes, including the absence of required public disclosure (though many companies do so voluntarily to avoid the perception of impropriety), as well as the fact that executives can trade immediately upon enacting the plans and are free to cancel them at their discretion. 

“In my view, these plans have led to real cracks in our insider-trading regime,” Gensler concluded. “I worry that some bad actors could perceive this as a loophole to participate in insider trading.” 

A recent academic study can help the regulators quantify the frequency of such c-suite shenanigans.  The Stanford Graduate School of Business released a January paper “Gaming the System: Three ‘Red Flags of Potential 10b5-1 Abuse,” documenting the shortcomings of the 10b5-1 format.  The analysis, which assessed restricted stock sales from 2016 through May 2020, found that 38% of the plans during that time were filed and executed before the company had issued its next scheduled round of quarterly earnings, while nearly half resulted in a single, often well-timed stock sale rather than a gradual divestment.  

For instance, a May 13 dispatch from the Washington Post chronicled the events at athletic apparel manufacturer Under Armour, Inc. Back in October 2015, four months after a bearish analysis in the pages of Grant’s and at the tail-end of a 26 quarter stretch through fall 2016 in which the company generated annual revenue growth of 20% or higher, founder and then-CEO Kevin Plank declared “great confidence [in] the future,” and that “we are just getting started,” on the earnings call. 

Six days later, the executive entered into a 10b5-1 plan that resulted in $138 million in proceeds over the following six months.  A subsequent probe into Under Armour’s accounting covering that 2015 to 2017 period led the SEC to conclude on May 3 that Under Armour had failed “to disclose material information about its revenue management practices that rendered statements it made misleading.”  The company paid $9 million to settle the charges without admitting or denying wrongdoing, while Plank and the rest of the c-suite averted individual charges. Shares are down about 55% since Plank began to unload that chunk of stock. 

The erstwhile Under Armour boss has company.  Daniel Taylor, associate professor at the University of Pennsylvania Wharton and co-author of the Stanford paper in tandem with David Larcker, Branford Lynch, Phillip Quinn and Brian Tayan, furnished to Grant’s another pair of examples of corporate executives executing large and curiously-well timed stock sales ahead of bad news. For more on this topic, including the authors’ recommended remedies, see the analysis “What’s your edge?” from the March 19 edition of Grant’s Interest Rate Observer

Recap June 8

Another strong rally in the Treasury complex pushed the 10-year yield to a near two-month low at 1.53%, while stocks continued to coil with the S&P 500 logging its 11th straight finish within a less than 1% range, as the broad index sits higher by 12.5% year-to-date. Gold edged lower to $1,896 an ounce, WTI pushed above $70 a barrel for the first time since October 2018, and the VIX finished at 17. 

- Philip Grant

The Bond Market Buys the Dip
Twelve separate investment-grade bond deals came to market today,

Twelve separate investment-grade bond deals came to market today, Bloomberg reports, marking the busiest session since March 3.  Household names, such as Goldman Sachs Group, Inc., General Motors Co. and Deere & Co. are among the firms availing themselves of fresh capital.

With high-grade spreads holding near record lows and the Federal Reserve announcing last week the unwind of its pandemic-era Secondary Market Corporate Credit Facility, some observers think it’s time to strike while the iron is hot. Credit analysts from Citi write today that “market factors. . . should encourage highly-rated, lower-levered firms to take advantage of a market hungry for dollar-denominated spread product by pulling forward borrowing plans.”

Borrowers at the other end of the credit pool have their own designs. Unrated MicroStrategy, Inc. announced it will sell $400 million in senior secured notes, with pricing set to follow a two-day roadshow concluding tomorrow and early talk ranging from 6.25% to 6.5%. Proceeds will be earmarked for the purchase of bitcoins.  The mobile-software firm, which also disclosed a $285 million impairment charge stemming from mark-to-market losses on bitcoins acquired at higher prices, showed net debt of $1.68 billion as of March 31, equivalent to 17 times the consensus estimate for 2022 adjusted Ebitda. 

Plus Pitch
Lower-for-longer is so 2019.

Lower-for-longer is so 2019.  Treasury Secretary Janet Yellen offered some pointed remarks following a weekend meeting with finance ministers from the G-7.  “If we ended up with a slightly higher interest rate environment it would actually be a plus for society’s point of view and the Fed’s point of view,” the Treasury Secretary argued yesterday. “We’ve been fighting inflation that’s too low and interest rates that are too low now for a decade.”

That overt policy shift towards generating inflation shines a light on the composition of relevant data points, in light of the seismic events of the past year-plus. As the Bureau of Labor Statistics calculates inflation statistics using a basket of goods meant to correspond with consumer spending habits, the pandemic threw a wrench in those finely-calibrated indices.  

As the May 15, 2020, edition of Grant’s Interest Rate Observer noted, grocery prices jumped 2.6% sequentially in April of last year, marking the fastest rise in food inflation since February 1974.  By the same token, gasoline prices collapsed by 20.6% sequentially, while apparel, auto insurance, airfares and lodging away from home sank by 4.7%, 7.2%, 15.2% and 7.1% from the previous month.  In other words, “the things that locked-at-home consumers didn’t buy. . . plummeted in price.” Overall, the so-called core CPI sank by 0.4% sequentially in April 2020, the most severe monthly decline on record going back to 1957. 

Those distortions made no small impact across the virus-riddled 2020. As a Friday bulletin from the Financial Times relayed, an analysis from Harvard economics professor Alberto Cavallo concluded that U.S. inflation metrics understated price pressures by 0.5% last year.  That colors the reported 1.6% advance in core CPI across 2020, which matched the lowest reading since 2010.

That was then.  The May CPI, which is set to be released on Thursday, will feature a 3.4% year-over-year advance in the core component if economist consensus is on point.  That would be the hottest reading since April 1993.  

While the vagaries of data collection and shifting consumer behavior cloud assessments of inflation indices across different eras, some apples-to-apples comparisons suggest the economy was far more prepared to handle inflationary pressures 28 years ago. Thus, spring 1993 featured a 3% federal funds rate, 6% yield on the 10-year Treasury note and total federal debt of $4.2 trillion, equivalent to 63% of nominal GDP.  That compares to a near-zero funds rate, 1.57% 10-year yield and $28.2 trillion aggregate federal debt load (about 135% of GDP) today. 

Recap June 7

A listless summer session saw stocks finish little changed, as the S&P 500 and Nasdaq 100 remain rangebound near their respective high-water marks, while Treasurys came under modest pressure with the long bond yield rising to 2.25%.  Gold rose back above $1,900 an ounce, WTI crude retreated towards $69 a barrel, and the VIX held near 16.5. 

- Philip Grant

Recovery Room
Get in line, John Q. Taxpayer.

Get in line, John Q. Taxpayer.  Creditors of bankrupt New York-based Cosmoledo LLC, (owner of the French Maison Kayser bakery chain) argue that funds from the pandemic-era Paycheck Protection Program secured by the company should be diverted towards making them whole, rather than returned to the government, according to a Bloomberg dispatch.  

Cosmoledo, which filed for Chapter 11 last September listing secured debts of $72.7 million, received a $6.7 million PPP loan from Uncle Sam three months earlier.  The company withdrew its request to return the remaining $5.3 million to the government and says it has come to an agreement with both its lenders and the Small Business Association, which will be made public in tandem with its bankruptcy resolution plan.  

The outcome may reverberate, as Bloomberg notes that “at least several dozen companies that borrowed tens of millions of dollars under the loan program filed bankruptcy last year. . . [while] creditors in Cosmoledo may have been the first to fight for the unused proceeds.” 

Stabilizing the Stabilizer
The Chinese government has taken the reins in the saga involving stricken lender China Huarong Asset Management Co.,

The Chinese government has taken the reins in the saga involving stricken lender China Huarong Asset Management Co., Reuters reports today, instructing Huarong to dispose of various non-core assets. More importantly for the firm’s international creditors, Beijing is set to “informally” back Huarong’s roughly $20 billion in dollar-denominated debt. 

In response to that report, Huarong’s senior unsecured, dollar-pay 3 3/4% notes due next April rose to 82 according to Bloomberg, up from a prior transaction at 76.5 back on May 18. 

Yet as that ongoing discount to par suggests, the situation is far from resolved despite a potential government bailout.  S&P Global noted yesterday that, as Huarong has thus far failed to produce its 2020 annual report, the company faces a late-August deadline to furnish those results under the terms of an existing bond and stave off technical default.  The ratings agency maintained its triple-B-plus long term rating with a negative outlook on Huarong, which, “acts as a financial stabilizer” in soaking up the assets of other troubled financial institutions, serving as the largest buyer of domestic distressed assets over the past three years.  Accordingly, S&P reasoned, Huarong “would likely receive government support if needed.”

The clean-up job could prove complicated, and not only because Huarong's total assets mushroomed to RMB 1.7 trillion ($272 billion) as of year-end 2019 from just RMB 315 billion seven years prior.  Reuters relays that “Deutsche Bank plans to buy Huarong’s stake in their joint venture investment firm, Huarong Rongde Asset Management,” according to a “source with direct knowledge of the deal.”  However, “Germany’s largest lender rejected this claim, saying that it has no such plans.”

Recap June 4

Both stocks and rates looked to rally after a weaker than expected headline reading of May nonfarm payrolls, as the S&P 500 sat higher by nearly 1% as of mid-afternoon, while the 10- and 30-year Treasury yields sank to 1.56% and 2.24%, respectively. Gold jumped 1% to $1,892 an ounce to recoup half of yesterday's losses, WTI crude advanced to $69.5 a barrel and the VIX was slammed by nearly 10% to 16.5. 

- Philip Grant

Get to the Chopper
The Federal Reserve had a surprise yesterday,

The Federal Reserve had a surprise yesterday, announcing that it will wind down its pandemic-era Secondary Market Corporate Credit Facility. The SMCCF, which accumulated $13.8 billion in corporate bonds and ETFs, will start offloading assets next Monday and has set a Dec. 31 target for fully divesting the portfolio. 

Might that pivot carry implications for the Fed’s ongoing ultra-easy policies, including near-zero overnight rates and $120 billion of monthly Treasury and mortgage-backed securities purchases? Yesterday’s announcement follows the disclosure from the April Fed meeting minutes that “a number of participants” felt a discussion over QE tapering “might be appropriate in upcoming meetings,” while San Francisco Fed president Mary Daly told CNBC last week that “we are talking about talking about tapering.” That’s a marked shift from her May 10 remarks that “it’s not yet time to start thinking about talking about relaxing the accommodation we’ve given.”  

One prominent member of the Federal Open Market Committee begs to differ, as NY Fed president John Williams declared this afternoon that the economy is “on a good trajectory, but in my mind, we’re still quite a ways off from reaching the ‘substantial further progress’ that we’re looking for, in terms of adjustments to our purchases.”

Measured prices sure seem to be making substantial progress, as evinced by the 4.2% rise in headline CPI last month. Global food prices surged a whopping 40% from a year ago and 6% month-over-month in May, according to an index compiled by the UN Food and Agriculture Organization.  Stateside, home prices jumped 13.2% from a year ago in March, the largest increase since December 2005, while used vehicle prices accelerated by 21% year-over-year and 10% sequentially in April.   Analysts at Goldman Sachs pencil in an average 2.7% rise in core CPI across next year.  

The labor market seems to offer stronger footing in the argument for continued stimulus, as total payrolls remained 8.2 million below their pre-pandemic levels in April per the Bureau of Labor Statistics. Yet signs of rapid improvement remain visible ahead of tomorrow’s May jobs report. Today’s reading of 385,000 weekly jobless claims marked a fresh virus-era low, down from 590,000 claims just six weeks ago.  In addition, the quits rate (or workers opting to hit the bricks as a percentage of total employment) held at 2.4% in March, matching the highest since at least 2000.  Even last month’s disappointing payrolls report featured headline unemployment of 6.1%, not far above the 5.8% long-term average going back to 1947.  

Government largesse further muddies those waters. Some 15.4 million Americans received unemployment benefits in mid-May, The Wall Street Journal relays, up nearly sevenfold from early 2020.  Noting that credit card delinquency rates have declined since the onset of the pandemic in sharp contrast to the 2001- and 2008-era recessions, John Silvia, founder and CEO of Dynamic Economic Strategy, writes today that “the current unemployment data may be overstating the degree of financial stress for households.” 

Some who might be in the know believe that the status quo will remain intact for some time longer.  Former New York Fed president William Dudley told Bloomberg television this morning that he “would not take [yesterday’s] decision as implying anything about the timing of [QE] taper and the timing of actually lifting off and raising short-term interest rates.”  Investors, well trained over the past decade-plus, may tend to agree. “The Fed is a bit like a helicopter parent when it comes to the bond markets,” Nicholas Elfner, co-head of research at Breckinridge Capital Advisors, commented to Bloomberg this afternoon. “Their involvement in the bond market is assumed at this point.” 

Yet some observers believe that the SMCCF’s demise is cause for caution, regardless of past experience.  Credit analysts from Bank of America write today that: 

Clearly the Fed has little in terms of a successful track record in selling assets and also most of the time [simply] adjusts policy to market expectations. This is why the Fed's announcement today - which was 100% surprising - to begin gradually selling their portfolio of corporate debt acquired during the liquidity crisis last year is very negative for risk assets. 

Clearly the Fed feels sufficiently emboldened by the scarcity of credit assets in the front end of the curve and high valuations to be comfortable testing markets in this way.  However, to us this is a symptom of the post-coronavirus reality of getting back to normal much earlier than expected, suggesting a much faster rate hiking cycle than currently priced in the market. 

Then, too, the introduction of the bond-buying program sparked a virtuous circle, as a recent paper co-authored by Fed vice chair Richard Clarida noted that the SMCCF’s “announcement effect led to rapid improvements in financing conditions in corporate and municipal bond markets well ahead of the facilities’ actual opening.” The BofA analysts warn that an opposing dynamic may now be in store: 

Now the Fed holds only $5.21bn of corporate bonds and $8.56bn of ETFs, so sales will be a drop in the bucket compared to any issuer that could come to the market by surprise. But, as it took very little Fed buying to stabilize the market last year, it should take very little selling to convince investors the tightening cycle is underway. We expect wider investment grade credit spreads.

We’ll know more soon enough: The next FOMC meeting is set for June 16. 

QE Progress Report
A $9 billion weekly decline in Reserve Bank Credit left interest-bearing assets on the Fed balance sheet at $7.88 trillion.  That’s up 21% on an annualized three-month basis, 13% year-over-year and 110% from the fall of 2019. 
Recap June 3

Stocks came under pressure after a string of sideways finishes, with the S&P 500 declining by 40 basis points and the Nasdaq 100 slipping 1.1%, while Treasurys gave back recent gains with the 10- and 30-year yields finishing at 1.62% and 2.3%, respectively.  Gold sank nearly 2% to $1,873 an ounce, WTI crude consolidated recent gains at $69 a barrel, and the VIX held near 18. 

- Philip Grant

Green Screen
German industrial giant HeidelbergCement AG (HEI on the DAX)

German industrial giant HeidelbergCement AG (HEI on the DAX) announced plans to build the world’s first carbon-neutral cement plant today.  The facility, to be located in Sweden with a scheduled 2030 debut, will utilize carbon capture technology to secure and store 1.8 million metric tons of CO2 per year, four times that of a Norway-based carbon capture plant set to come online in 2024.  “This will be a game changer for our industry,” declared CEO and chairman of the managing board Dominik von Achten.  

Recent months have been kind to investors in Heidelberg, the world’s foremost producer of aggregates, second-largest cement maker and a Grant’s Interest Rate Observer pick-to-click last fall. The company has enjoyed a 35% euro-denominated return, inclusive of dividends, from that November 13 analysis, nearly double that of the Euro Stoxx 600 Index.  Yet long-term performance remains a slog, as the company has generated a mere 5% annual return including reinvested dividends over the past 25 years, compared to a 7.6% annual increase for the Stoxx 600 over that period.  

Ill-timed moves, including the 2007 acquisition of British building materials manufacturer Hanson Ltd. for £9.2 billion ($13.1 billion today and $18.7 billion at the time), equivalent to 11 times trailing Ebitda, factor prominently in those lagging performance figures.  Thanks to leverage topping five turns in the wake of that deal, Heidelberg then conducted a dilutive equity offering of 62.5 million shares (equivalent to nearly one-third of outstanding shares today) in the 2009 bear-market depths to repair its balance sheet.

Mr. Market will believe it when he sees it, currently bestowing on HEI an enterprise value equivalent to six times consensus 2021 Ebitda.  Yet recent management changes (von Achten took the big seat right before the bug bit in winter 2020) in tandem with improved asset allocation, could augur better days ahead.  Heidelberg announced on May 24 that it will sell the bulk of its operations in the western United States to Martin Marietta Materials, Inc. for $2.3 billion in cash, a price equivalent to about 16 times the unit’s annual Ebitda per estimates from Deutsche Bank.  

Terming the deal “a very value-accretive exercise for Heidelberg” thanks in part to lower margins in that outgoing unit relative to the rest of its U.S. operations, the DB analysts guesstimate that HEI will generate a return on invested capital “significantly above 8%” by year-end following the asset sale, up from 7.9% last year and 6.5% in 2019. 


Heidelberg’s efforts to go green could prove material beyond its own corporate profile.  As cement production is a dirty business, accounting for nearly 10% of worldwide greenhouse-gas emissions, the benefits accruing to Mother Earth from that strategy pivot could prove substantial. Yet the growing ranks of environmental, social and governance-focused investors have given the company the cold shoulder, as evidenced by HEI’s still-modest valuation.  

Indeed, the current ESG landscape arguably reflects both an index-hugging mentality and a heavy emphasis on business models with little impact on the environment. For instance, both the Vanguard ESG U.S. Stock ETF and the BlackRock Advantage ESG U.S. Equity Fund feature tech mainstays Microsoft Corp., Apple, Inc., Amazon.com, Inc. and Alphabet, Inc. among their top five holdings.  

Some investors propose an alternative way to look at the movement. Noting that roughly half of global carbon emissions come from industries which currently have little-to-no economically viable way to decarbonize, a fall 2020 white paper from Massif Capital argued thus:   

That firms such as Apple and Microsoft, two of the most widely held businesses in ESG portfolios, pollute less than copper miners and aluminum producers is a meaningless observation in the context of a desire to invest for impact. 

That firms like Apple and Microsoft depend on copper miners and aluminum producers for their businesses means that the question investors should be asking is how one balances environmental impact and economic criticality, not simply how one limits a portfolio’s overall environmental impact.

Rather than simply directing capital towards businesses which attain high ESG ratings while avoiding those from high-pollution industries, Massif proposes another way forward: 

The alternative is to consider climate change as a problem that can be addressed and invest in companies that will aid or benefit from the transition to a low carbon economy.

Any such philosophical shift among the ESG-minded could carry substantial implications, as torrents of capital continue to pour into the “space.”  Such funds had gathered nearly $2 trillion in assets under management at the end of the first quarter, Morningstar reported April 30.  That’s up 18% from Dec. 31 and nearly double that of year-end 2019.  Europe has been front-and-center in that effort, accounting for 79% of ESG flows in the first three months of the year.  

What’s next as the ESG movement takes hold of Wall Street and thoughtful investors look to skate to where the puck is going?  Will Thomson, founder and managing partner at Massif Capital, will share his thoughts from the podium at the Grant’s fall 2021 conference on Oct. 19 (advt.). 

Recap June 2

More absurd price action in the meme stocks didn’t result in much headline-level excitment, as the S&P 500 went nowhere for a fourth straight day to remain near its high-water mark while Treasurys also traded sideways with the 10-year yield finishing at 1.59%.  WTI crude pushed to a fresh 30-month high near $69 a barrel, gold advanced to $1,911 an ounce and the VIX slipped to 17.5. 

- Philip Grant

Mind's Eye
Talk about intangible assets.

Talk about intangible assets. Italian artist Salvatore Garau sold an invisible sculpture titled ‘Io Sono’ (I am) for €15,000 ($18,300) in a May 18 auction overseen by contemporary house Art-Rite, Italy 24 News reported.   That compares to pre-auction estimates of €6,000 to €9,000 in proceeds.

Garau explained his uber-minimalist work: “The vacuum is nothing more than a space full of energy, and even if we empty it and there is nothing left, according to the Heisenberg uncertainty principle, that nothing has a weight. Therefore, it has energy that is condensed and transformed into particles, that is, into us.” 

‘Io Sono’ is meant to be displayed in a 150 by 150 centimeter space free from obstructions, the artist went on to explain.  In addition to his own slice of the void, the buyer will also receive a signed and stamped certificate of authenticity, as well as peace of mind:  The work boasts a net-zero carbon footprint. 

Class Superlatives
It was another banner month for the bottom of the barrel

It was another banner month for the bottom of the barrel in credit, as the triple-C-rated portion of the Bloomberg Barclays High Yield Index generated a 0.7% return in May. That outpaced the 30 basis point return for the broad index to mark the seventh consecutive month in which triple-Cs outperformed.

More broadly, investors can’t get enough speculative-grade debt despite a fast-diminishing return profile, as junk spreads over Treasurys remain below 300 basis points, near their narrowest since 2007.  On Friday, the iShares iBoxx $ High Yield Corporate Bond ETF declared a $0.29093 per share dividend for May, a mere 4% indicated yield and the lowest monthly payout in the fund’s 14-year history.  Meanwhile, issuers continue to make hay: New junk supply for 2021 has topped $270 billion per Refinitiv, already marking a record high for the first half of the year with four weeks left. 

Supermarket Sweep
The “smart money” goes shopping.

The “smart money” goes shopping. Private equity firms have completed 131 acquisitions of publicly-traded companies in the United Kingdom so far this year at an aggregate £25.7 billion ($36.6 billion), Pitchbook reports today.  That already tops the previous £17.5 billion, full-year high-water mark established last year and sits far above the roughly £5 billion worth of p.e. transactions in both 2018 and 2019. 

Relatively inviting valuations reign following the Brexit and virus one-two punch, as Fidelity International found in March that U.K. stocks trade at a hefty 40% discount to world markets according to a metric incorporating forward price-to-earnings, book value and dividend yields.  Similarly, data from Bloomberg show that the FTSE 100 Index trades at 20 times its 10-year average inflation adjusted earnings, far below the 37.5 times Shiller earnings ratio for the S&P 500.  

Meanwhile, recent economic data point to more prosperous days ahead.  The May edition of the Lloyds Business Barometer survey showed that sentiment surrounding the economy rose to its best level since 2016, while overall business confidence ascended to a three-year high. Then, too, the Nationwide Building Society announced today that U.K. home prices jumped by 1.8% from a month ago, double the economist consensus, with the 10.9% annual increase marking the fastest pace of price appreciation since 2014.  

Indeed, Great Britain appears to provide a commanding value proposition for discerning investors.  See the April 30, Feb. 5 and Dec. 11, 2020 editions of Grant’s Interest Rate Observer for bullish analyses on a host of U.K.-based enterprises, including a pair of housing-related picks-to-click.   

Recap June 1

The energy patch enjoyed another strong day, as WTI crude advanced towards $68 to mark its best close since fall 2018, up 90% from late October.  Stocks went nowhere to start the short week, while Treasurys likewise finished little changed with the 10- and 30-year yields settling at 1.61% and 2.29%, respectively. Gold remained just above $1,900 an ounce, and the VIX jumped 7% to 18.  

- Philip Grant

Business Model Under Review

A tight labor market spurs drastic measures in Las Vegas (h/t Christian Hill):

The 95 Percent
It was another restless night for crypto hodlers,

It was another restless night for crypto hodlers, as the price of bitcoin retreated to as low as $35,000 this morning.  That’s down double digits from Thursday morning and 40% from its high-water mark reached last month.   With the assets trading around the clock, volatility has consistently remained at nausea-inducing levels of late: Bitcoin logged an 18% decline on Sunday followed by a 16% snapback the next day. 

Those manic swings are not going unnoticed. Bank of Japan governor Haruhiko Kuroda observed in an interview yesterday that “most of the [bitcoin] trading is speculative. . . it’s barely used as a means of settlement.”  

As the sheen comes off the recent upside rampage (bitcoin enjoyed a near six-fold rally over the six months through mid-April), the bull crowd looks to diagnose the market malady.  Cathie Wood, manager of the wildly popular Ark Investment funds, provided her analysis at a conference hosted by CoinDesk yesterday: “It was precipitated by the ESG [environmental, social and governance] movement and this notion, which was exacerbated by Elon Musk, that there are some real environmental problems with the mining of bitcoin. A lot of institutional buying went on pause.”

Efforts to curtail environmental damage yield their own side effects. The popularity of Chia Network, a “green” bitcoin alternative which allocates new supply based on empty hard disc space rather than energy-intensive mining utilized by bitcoin, has spurred a global disc shortage. Some 12 million terabytes of hard disc space are currently being used to mine Chia, New Scientist reported on Wednesday, quadruple that of just two weeks ago. “We’ve kind of destroyed the short-term supply chain,” admitted Chia president Gene Hoffman. 

Those concerns aside, more prosaic financial factors may have played a starring role in the turn, namely, outsized leverage.  Citing data from Bybt.com, Bloomberg reported earlier this month that a mere $9.4 billion in margin liquidations drove some $600 billion in total crypto market cap losses between May 18 and May 19.  

Some crypto devotees remain steadfast despite the recent shakeout.  Buccaneers quarterback Tom Brady declared his allegiance to the digital ducats in an appearance at yesterday’s CoinDesk conference: “The world is changing, we all just have to understand it’s constant change and you can either be ahead of the curve or behind it and I’m choosing to be ahead of it,” the gridiron great declared. “As someone who wants to be on the forefront of things, I’m going to help create the trend and adopt it and recognize this is where the world is heading.”

Meanwhile, one of the engines of the crypto machine continues to work overtime.  Tether, the most widely-traded crypto and the de facto source of liquidity for exchanges that cannot get access to traditional banking, has exploded in circulation of late.  As of this morning, some $61 billion of tethers are outstanding according to Coinmarketcap.  That’s up 4.4% from a week ago, 30% from bitcoin’s high-water mark in mid-April and 76% from Feb. 23, when New York Attorney General Letitia James declared that “Tether’s claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.” 

It seems fair to wonder just what assets stand behind that flood of new stablecoin supply in the context of a bear market. Tether disclosed on May 13 that, as of the end of the first quarter, cash and T-bills accounted for just 5% of reserves. 

See the Feb. 19 edition of Grant’s Interest Rate Observer for a thorough analysis of the bitcoin boom, including risks and opportunities therein. 

Recap May 28

Stocks enjoyed solid gains as of mid-day, when ADG dropped the pick, with the S&P 500 and Nasdaq each up by about half a percent.  Treasurys remained in a tight trading range despite more hot inflation data, with the 10- and 30-year yields edging lower to 1.6% and 2.28%, respectively.  Gold remained at $1,900 an ounce, WTI crude held near multi-year highs at $67 a barrel, and the VIX fell to near 16. 

- Philip Grant

Bettor Man

Here’s CNBC personality Jim Cramer on Twitter this morning, helping to organize the process of price discovery in Beyond Meat (BYND on the Nasdaq):

Wall Street Bets guys, thanks for considering Beyond Meat. You have the fire power to add a third. Heavy shorts. And enough with the praise of me and my highlight film. LOVE YA! $GME and $AMC

That exhortation proved successful, as BYND shares jumped higher by as much as 15%, spurring a subsequent tweet in early afternoon: 

Wall Street Bettors, i am in your debt; i think there is much room to go on $BYND. Very glad i got the sellers to walk away. Again i thank everyone who has praised me on that one; impressive

Indeed, it definitely makes an impression. 

Margin Call
With earnings season all but in the books,

With earnings season all but in the books, the blended profit margin for S&P 500 components footed to 12.8% in the first quarter, FactSet found last week.  That’s the most bountiful result since at least 2008, topping the 12% achieved in the summer of 2018.

Here’s another bountiful result.  As Charles Schwab chief investment strategist Liz Ann Sonders observed yesterday, the 9.5% year-over-year jump in headline producer prices towered over the 4.2% consumer price figure in April. That 530 basis point gap is the largest monthly reading since 1974. 

Faulty Towers
A real estate division of China Oceanwide Holdings Co. (715 on the Hang Seng) defaulted

A real estate division of China Oceanwide Holdings Co. (715 on the Hang Seng) defaulted on a $280 million dollar bond earlier this week, Bloomberg reports.  The conglomerate, which was only able to repay roughly half that principal sum using the proceeds of a recent private bond offering, stated in a filing that the rest of the funds are forthcoming in the next three months. A scuttled attempt at $1 billion-plus of U.S. asset sales preceded this week’s development. 

Oceanwide has been in trouble for some time. Two years ago, the company abruptly ceased construction on a $1 billion downtown L.A. condominium, hotel and retail complex “due to a recapitalization of the project,” as the Los Angeles Times put it.  

The property sector remains in focus for all the wrong reasons, as Chinese developers had already accounted for more than a quarter of the $20 billion in missed bond payments this year as of last week, according to data from Bloomberg. 

In response, the authorities look to crack down on financial shenanigans within the all-important property realm.  To that end, Caixin reports that regulators are scrutinizing mega-developer China Evergrande (3333 on the Hang Seng) for its ties to lender Shengjing Bank.  Per the report, Shengjing holds “large amounts” of Evergrande debt on its books, while Evergrande is Shenjing’s largest shareholder. 

The pair have a history. Back in summer 2019, Evergrande shelled out RMB 13.2 billion ($2.1 billion) to raise its stake in Shengjing to 36% from 17%, paying a 40% premium to the bank’s share price.  Subsequent reports indicated that the Chinese government “encouraged” the deal to help recapitalize Shengjing. 

In response to today’s news, the developer’s dollar-pay 8 3/4% notes due 2025 dropped to 81 from 84, for a 1,429 basis point spread over U.S. Treasurys (traditionally, a pickup in excess of 1,000 basis points indicates borrower distress). Single-B-plus-rated Evergrande sports $117 billion in net debt, equivalent to 8.5 times consensus 2021 Ebitda.  The company has pledged to cut its debt load in half by the end of 2023, as it attempts to reach compliance with Beijing’s recently implemented “three red lines” governing property developer balance sheets. 

Solvency trouble at Evergrande, which Grant’s predicted in fall 2017 will eventually take its place in history alongside “Bank of United States” and “the Hindenburg,” could reverberate far and wide. Chinese corporate borrowers face a hefty $1.3 trillion in domestic debt maturities over the next 12 months, per data from Bloomberg, with $900 billion of that falling due before year end.  That compares to $1 trillion by June 2022 and $600 billion by December 31 for U.S. companies, and $800 billion and $400 billion, respectively, in principal repayments for European corporate borrowers.  Chinese firms have already defaulted on more than RMB 100 billion of onshore debt this year, marking the first time that threshold had been crossed before September

For now, Mr. Market continues to whistle past the high-rise.  Bloomberg notes that a quartet of Chinese property developers (Yango Group, Greenland Hong Kong Holdings, Times China Holdings and New World Development Company) are marketing dollar bonds today. 

QE Progress Report
A $14 billion increase in Reserve Bank Credit pushed interest-bearing assets at the Fed to $7.89 trillion.  That’s up 14% year-over-year, 21.4% on an annualized three-month basis and 112% from the fall of 2019. 
Recap May 27

Stocks finished little changed, as the S&P 500 and Nasdaq 100 indices sit higher by about 1% and 2%, respectively, so far this week.  Treasurys pulled back after a recent rally, with the 10- and 30-year yields rising to 1.61% and 2.28%, while gold held at $1,900 an ounce and WTI rose to near $67 a barrel.  The VIX slipped below 17 for the first time in six weeks. 

- Philip Grant

Easy Does It
Turkish President Recep Erdogan has once again made waves,

Turkish President Recep Erdogan has once again made waves, dismissing deputy central bank governor Oguzhan Ozbas via decree in the wee hours. Ankara University professor and presidential advisor Semih Tumen will take his place.   

That comes two months after Erdogan sacked Central Bank of the Republic of Turkey governor Naci Agbal, the third top monetary mandarin fired in the last two years, following a hike in the benchmark repo rate to 19% from 17% to counter raging inflation, since measured at 17.1% year-over-year in April. Following today’s reshuffle, four of the seven members of Turkey’s monetary policy committee have been at their post for less than one year. 

“The latest change. . . is another step in an expected sequence towards naming an entire monetary policy committee of low interest rate advocates,” writes Tatha Ghose, emerging markets strategist at Commerzbank.  Jason Tuvey, senior emerging markets economist at Capital Economics, tells the Financial Times that the significance of the committee’s composition is dwarfed by “the symbolism of Erdogan removing people and replacing them with people who are perceived to be his stooges.” 

Indeed, that symbolism (or reality) hasn’t escaped investors’ notice. The lira has lost a further 8% against the dollar since the market first digested the news of Agbal being shown the door, extending to a 66% decline from when the strongman began consolidating power following a failed coup in the summer of 2016. Thanks in part to unsuccessful attempts at propping up the lira, Turkey’s gross exchange reserves have shrunk to below $50 billion, half the hoard of five years ago and near its post-2005 nadir. 

Voters are similarly miffed at the state of affairs.  Bloomberg relays today that an April survey conducted by Metropoll showed support for Erdogan’s AK Party at just 27%, the worst showing in the 20-year history of the party. Similarly, 17% of respondents who voted AK in the 2018 general election vow to never do so again, while the president currently lags well behind rivals Ekrem Imamoglu and Mansur Yavas ahead of a June 2023 election. 

“The breaking point for Erdogan’s supporters was the dismissal of Naci Agbal,” Can Selçuki, director of polling service Turkiye Raporu, tells Bloomberg.  “People started to realize that Erdogan’s radical changes in the economy are not making things better.” 

For now, at least, the monetary experiment in the Bosporus continues apace. The CBRT is set to conduct its next policy meeting on June 17. 

Fear Factor
A new bull market marker:

A new bull market marker: Today the Collaborative Investment Trust Series has officially rolled out the FOMO exchange traded fund.  Rather than concentrated bets, the FOMO (meaning fear of missing out) holdings will range between 75 and 100 stocks, with weekly portfolio rebalances. As of today’s launch, top holdings include healthcare information technology firm IQVIA Holdings, Inc., Chinese search engine Sogou, Inc. and medical device purveyor Medtronic plc. 

Keeping up with the Joneses is no small task, as reflected by FOMO’s relatively steep 90 basis point expense ratio.  Matthew Tuttle, who manages the fund, explained to U.S. News in an April 14 interview that, in addition to names in popular sectors demonstrating strong current momentum, FOMO will target laggards that could be primed for a bounce: 

I want to find the 20 that have been the weakest over the past week. Here, I'm looking for countertrends: What happens a lot in the markets is over the medium term and long term, things trend. Over the longer term, Tesla is in an up-trend. But over the short term, Tesla can get sold. And what tends to happen is it sells off too far too fast, then snaps back. So, what we want to do is find the stocks that are trending over the medium and longer term, but we also want to find stocks that are undervalued in the short term.

Once we have our basket of stocks, we compute how volatile they've been. The more volatile stocks on the downside are given smaller weightings in the portfolio. And we rebalance on a weekly basis, so that by the time we decide what's FOMO, it's not like we're waiting a quarter, and something is obsolete.

As for his recommended portfolio allocations, Tuttle had this to say:

I would say, for most people, between 10% to 20%. But if you said, "Hey, Matt, what if I made it 50%?" I wouldn't argue with you because we aren't as concentrated as some of the other single-area focus funds.

In other words, there’s always room for a little more FOMO. 

Recap May 25

Treasurys enjoyed another strong bid, with the 10- and 30-year yields each breaking to multi-week lows at 1.55% and 2.25%, respectively, while stocks finished little changed with the S&P 500 down 20 basis points and the Nasdaq flat.   WTI crude retreated below $66 a barrel, gold advanced above $1,900 an ounce for the first time since early January, and the VIX edged towards 19.  

- Philip Grant

Fair Weather Friend
It’s been a bumper year for collateralized loan obligations,

It’s been a bumper year for collateralized loan obligations, or packaged and securitized collections of leveraged loans.  Citing data from LCD, The Wall Street Journal reports that issuers have sold $59 billion in CLOs year-to-date, the highest since at least 2005. 

The looming threat of rising inflation bolsters the appeal of floating-rate leveraged loans (as opposed to fixed-rate junk bonds), as loan funds have enjoyed 19 consecutive weeks of inflows, the longest winning streak since early 2017.  CLO’s purchased some 70% of new leveraged loans last year, analysts from Citigroup find.    

“The default environment has been very benign and will be because the capital markets are open to companies that may be struggling a little bit,” Tom Shandell, CEO of Marble Point Credit Management, tells the Journal.   

Improving corporate health has helped underpin that feeding frenzy, as upgrades across the S&P/LSTA Leveraged Loan Index exceeded downgrades by a ratio of 2.1 times over the three months through April, the best such showing since the spring of 2012.  For context, downgrades dwarfed upgrades at a 43-to-1 clip during the depths of the pandemic. With the worst of the virus hopefully in the rear view, the credit markets appear to have weathered last year’s tumult with relative aplomb.  A Moody’s analysis published last Tuesday found that the total trailing-12 month U.S. speculative-grade default rate peaked at 8.9% last year, far below the 14.7% high-water mark logged in the Great Recession.   

Mr. Market has taken notice. The average spread on triple-A-rated CLOs reached 116 basis points over Treasurys on Friday per Refinitiv, down from 131 basis points in December and within range of the record low 98 basis points reached in March 2018. 

With spreads tight and capital markets welcoming, dealmakers look to prime the pump, as acquisition financing accounted for a hearty 24% of loan volume in the first quarter according to Bloomberg, after all but drying up last year. Christina Minnis, global head of acquisition finance at Goldman Sachs, noted in a Bloomberg television interview Friday that the investment bank has floated five bridge loans of at least $10 billion to fund leveraged buyouts so far in 2021, on pace to top its record of eight such deals across a calendar year.  “The world of the large LBO is back,” Minnis concluded. 

That resurgence is manna for the private equity industry, which now enjoys a green light to help itself to debt-financed payouts.  Those so-called dividend recapitalizations reached $20 billion domestically in the first quarter, the busiest such period since the end of 2016.  Similarly, 13 separate backed companies in Europe have sold loans for that purpose in the year-to-date, the most active start to the year since at least 2008.  

Income-starved investors are happy to take what they can get. “If people want to put capital to work, they’re just buying anything with a bit of yield, regardless of what the proceeds are for,” Mark Benbow, fund manager at Aegon Asset Management, observed to Bloomberg Friday.  “It’s easier to keep adding debt when business multiples are so high that the market still thinks there is plenty of equity below the bonds.”  

Yet the proliferation of covenant-light deal structures, featuring limited legal protections for lenders, could spell trouble when the cyclical tides turn anew. Thus, Moody’s calculates that recovery rates on first-lien term loans that fell into bankruptcy between March and November last year stood at just 55%, far below the 77% average recovery across 1988 to 2019.

Increasingly top-heavy capital structures could exacerbate that trend, as the average debt cushion below first-lien, cov-lite loans fell to 15.5% last year, less than half its average prior to 2009.   Then, too, fundamental damage from last year’s ordeal remains visible despite the recent thaw, as S&P finds that loans rated single-B-minus or lower comprised 32% of the total market as of the end of April, compared to 26% at year-end 2019. 

Financial tides can turn quickly, and with nary a lifeguard in sight. 

Recap May 24

Score one for the bulls, as stocks rallied to the tune of 100 basis points on the S&P 500 and 140 basis points on the Nasdaq 100, leaving those indices within 1% and 3% of their respective high-water marks, while Treasurys were also bid with the 10-year yield reaching a fresh two-week low at 1.6%. WTI crude pushed back toward $66 a barrel, gold advanced to $1,884 an ounce and the VIX sank to 18.4, its most placid finish since May 7. 

- Philip Grant

Red Wedding
At least you can count on some things.

At least you can count on some things.  Headline-grabbing coworking concern WeWork reported in a filing today that its first quarter net loss came to a whopping $2.1 billion, compared to a $556 million shortfall in the same period last year.  Non-cash charges, including stock awards to top investor SoftBank Group Corp. and a settlement with ousted former CEO Adam Neumann, accounted for a large chunk of that growth in red ink, as adjusted Ebitda of minus $446 million was nearly identical year-over-year.  Net revenues footed to $598 million, down 10% from 2020. 

Those ghastly figures left the c-suite undaunted. “The demand for WeWork space today is higher than it was prior to the pandemic,” WeWork CEO and SoftBank chief operating officer Marcelo Claure assured listeners-in at a Bloomberg virtual event earlier this week.   A company spokeswoman added that: “Sales are back to pre-pandemic levels, and our sales pipeline is strong.” Unfortunately, that pre-pandemic baseline hasn’t exactly spelled corporate prosperity. A $3.2 billion net income loss last year followed $3.5 billion and $1.8 billion in red ink for the years 2019 and 2018, respectively. 

Yet Mr. Market still carries a torch for WeWork, which is set to complete its merger with blank check firm BowX Acquisition Corp. later this year at a $9 billion valuation.  Shares in BOWX finished the day at a 28% premium to net asset value, up 9% from the WeWork deal announcement on March 26.  

Temp Agency
The German Bundesbank predicts in its most recent monthly report that measured inflation “could temporarily rise to 4%” in the coming months,

The German Bundesbank predicts in its most recent monthly report that measured inflation “could temporarily rise to 4%” in the coming months, a figure unseen in the 20-plus-year common currency era. Headline consumer prices across the Eurozone rose 1.6% from a year ago in April, up from 0.9% two months prior and near the European Central Bank’s “below, but close to 2%” inflation target.   

As the ECB is charged only with a single mandate of maintaining price stability, as opposed to the Federal Reserve’s dual directive of stable prices with maximum employment, that uptick in inflation would seemingly argue for a rollback of the ECB’s stimulus shower.  The bank’s benchmark deposit rate crouches at minus 50 basis points, with the seventh anniversary of sub-zero borrowing costs coming up next month, while total assets on the ECB balance sheet footed to €7.6 trillion ($9.3 trillion) as of last week, equivalent to 57% of pre-pandemic nominal GDP in 2019.  That compares to $7.9 trillion in assets held by the Federal Reserve, equivalent to 37% of 2019 output. 

Yet ahead of an upcoming June 10 policy meeting, a series of recent public communiques suggest that the monetary mandarins are in no hurry to withdraw their extraordinary support. “It’s far too early and it’s actually unnecessary to debate longer term issues,” responded ECB President Christine Lagarde to a question about tapering at a news conference today. 

ECB executive board member Isabel Schnabel came to a similar conclusion in an interview with RTL television in Germany last week: “Our monetary policy strategy is medium-term and that means we look through all of these short-term fluctuations.”  Indeed, the bar for outright hawkish policy response is a sky-scraping one, according to Schnabel: “If we actually see there was suddenly a very rapid development of inflation, which is really not in evidence at the moment, then of course we would have to adjust our measures and of course we would have to do that gradually.” 

Others cast a skeptical eye over the nature of the inflationary uptick. “There are shortages, for example in semiconductors, and there are constraints in some shipping routes and of course when you have an unplanned bottleneck there is going to be some price action, but that is not inflation,” argued ECB chief economist Philip Lane in a webinar yesterday. 

Left unsaid in those remarks: Side-effects from years of ultra-easy policies may now themselves act as impediments to any potential normalization. The ECB’s annual Financial Stability Review, published on Wednesday, lays out the details: 

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

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

The public sector is likewise susceptible to financial ill winds, the report cautions: 

The aggregate euro area sovereign debt-to-GDP ratio rose to 100% in 2020, up from 86% of GDP in 2019, as governments have financed extensive economic support to cushion households and firms. . . Vulnerabilities from the outstanding stock of debt appear higher than in the aftermath of the global financial crisis and the euro area sovereign debt crisis.

Temporary inflation?  The ECB is counting on it. 

Recap May 21

Stocks gave back their early gains, as the S&P 500 finished flat and the Nasdaq 100 slightly weaker as those indices each wrapped up the week within 50 basis points of unchanged. Another quiet day for Treasurys saw some modest curve flattening, with the 10- and 30-year yields edging lower to 1.62% and 2.33%, respectively. Gold finished at $1,881 an ounce, WTI crude bounced to near $64 a barrel, bitcoin was smoked again to near $36,000 currently, down 11% over the past 24 hours, and the VIX settled near 20. 

- Philip Grant

Charter School
No symmetrical inflation targeting here.

No symmetrical inflation targeting here. China’s State Council vowed this morning to combat upward price pressure in the commodity complex by scrutinizing “abnormal trading” and targeting “malicious speculation.”  Along with enhanced regulatory supervision, the cabinet promised to “take comprehensive measures to ensure [sufficient] supplies.”  

That comes two days after China’s National Development and Reform Commission announced it will look to diversify its supply of iron ore, including from overseas, as the Middle Kingdom and Australia, its largest commodity trading partner, remain entangled in a series of diplomatic disputes. 

Of course, such an increase in commodity imports, along with a pivot towards more far-flung trading partners, could serve to stoke an already red-hot shipping market. China is the world’s largest commodity importer, accounting for nearly half of global dry bulk market demand, while other sources of iron ore, such as Brazil, are much farther away than Australia, effectively tying up more ships to deliver the materials and further constraining supply.   The Baltic Dry Shipping Index currently sits near a 10-year high, while rates for capesize vessels (the largest dry bulkers) along with smaller panamax and supramax ships, are each roughly double their respective five-year averages.  

Baltic Dry Index, 30-year view. Source: The Bloomberg

While a lasting commodity super-cycle is no sure thing, a favorable supply picture can help sustain the good times for global shipping.  Namely, the industry order book currently represents less than 6% of the existing fleet by tonnage, according to data from Cleaves Securities. That’s roughly one-quarter of the 25-year average and one-tenth of the 2010 peak, a backlog which helped ensure that the mid- to late-aughts dry bulk bull market gave way to dismal conditions throughout the last decade.  

Then, too, the promise of further tightened emission standards from the International Maritime Organization in coming years acts as a powerful disincentive to further production, as the industry waits for the regulatory regime to take shape. As ships have a useful life of about 25 years and it takes two years to build and deliver a new vessel, owner-operators don’t know what the rules will be for the majority of a new ship’s life and are accordingly hesitant to place orders.

“We do not have this ordering boom that we have always seen when there was a bit of an uptick in rates,” Jan Dieleman, president commodity giant Cargill’s ocean transport division, told Reuters on April 30. Typically utilizing 600 to 700 chartered vessels for its fleet (most all of which in the dry bulk category), Cargill is one of the shipping industry’s largest global customers. 

At the same time, voracious demand as the world emerges from the pandemic has forced the industry to be creative.  Gary Vogel, CEO of Eagle Bulk Shipping (EGLE on the Nasdaq) relayed on a May 7 earnings call that container ship shortages are spurring operators to hire supramax bulkers to haul their cargo, citing recent hauls of bagged cement from China to Guatemala and fertilizer to Peru and Chile.  “It’s definitely meaningful,” Vogel noted. 

With the cyclical winds at their backs, some dry bulk management teams press ahead full steam.  John Wobensmith, CEO of Genco Shipping & Trading (GNK on the NYSE) announced on the company’s call a day earlier that it has secured a 10- to 13-month commitment for a capesize vessel at a $31,000 day rate, along with $23,000 and $25,000 daily rates for supramax and ultramax vessels, respectively, for five to seven month contracts. 

Those locked-in rates may augur good things. In its announcement last month that it would soon commence paying a variable dividend depending on operating results, Genco forecast that, at a now-conservative time charter equivalent rate of $15,000 per day, available cash flow for dividends would foot to $1.10 per share, equivalent to a 7% indicated annual yield.

It’s been a bountiful spring for Genco and Eagle Bulk, as the pair have returned 42% and 40%, respectively, over the past 11 weeks.  Might further upside be in store? For more on those picks-to-click, and the investment opportunities in the dry bulk sector, see the March 5 edition of Grant’s Interest Rate Observer

QE Progress Report
Reserve Bank Credit (i.e., interest bearing assets on the Fed balance sheet) jumped to $7.88 trillion, up a chunky $91 billion from last week’s reading. Despite that relatively large accumulation, the three-month annualized growth rate fell to 22.3% from 22.8% last week, while the year-over-year uptick declined to 15.8% from 17.4% a week ago. 
Recap May 20

Notable dollar weakness looked to help spur some animal spirits, as the S&P 500 and Nasdaq 100 indices rallied by 1.1% and 1.8%, respectively, to sit higher by 11% and 5% so far this year.  Treasurys also caught a bid, with the 10-year yield falling four basis points to 1.63% and the long bond settling at 2.33%.  WTI fell below $62 a barrel as the prospect of sanctions relief for Iran weighs on the energy complex, gold ticked to $1,877 an ounce and the VIX slipped below 21. 

- Philip Grant

Batter Up
Is the party over for special purpose acquisition companies?

Is the party over for special purpose acquisition companies?   Since reaching its high-water mark on Feb. 16, the Defiance Next Gen SPAC Derived ETF (SPAK on the NYSE Arca) has lost 32% and sits near its lowest level since before Election Day.  

That sharp correction comes as the blank check company asset class has never been more prominent.  Despite a virtual cessation of fundraising activity since April 1, blind pools have raised $104 billion so far this year, topping the $83.3 billion across 2020, which itself exceeded all prior SPAC fundraising.  Fancy valuations help define that boom, as SPAC-sponsored deals took place at a median price of 12.9 times sales in the first three months of the year according to 451 Research, more than triple the 4.1 times median price-to-sales ratio for non-blank check transactions.  With share prices in retreat, Main Street is feeling the pain.  “It’s nothing short of a slaughter,” 42-year old physician Garrick Tong, who allocated more than half of his portfolio to SPACs, laments to The Wall Street Journal today. 

Some steely participants remain unfazed by the shakeout. “We like where the space is right now,” retired MLB superstar-cum-SPAC enthusiast-sum-steroid enthusiast Alex Rodriguez tells Bloomberg. “You’ve basically eliminated a lot of the amateur players who just want to participate in the space just because it’s hot. That’s really levelled the playing field.” 

It's worth noting that beyond the broad speculative frenzy, idiosyncratic, and perhaps transitory, features helped spur the now-dormant SPAC boom.  Namely, the deal structure allows SPAC promoters to issue long-dated and, perhaps, rose-colored forecasts that are verboten in traditional IPOs.  Not a few have availed themselves of that privilege, as the Financial Times calculated last month that nine auto-focused tech companies that listed via SPAC last year projected an aggregate $26 billion in revenues in 2024.  That represents 270% compound annual growth from last year’s $139 million top line across that cohort. 

As prices come back to earth and certain investors lick their wounds, regulators appear on the scene. John H. Coates, acting director of the corporate finance division at the Securities and Exchange Commission, warned on April 8 that belief among promoters that safe harbor laws will protect them against exposure related to unrealistic forecasts may be misguided: 

Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst. Indeed, in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure.  

Slowly but surely, signs of a crackdown emerge.  On its first quarter earnings call Monday, electric-vehicle manufacturer Canoo, Inc. (GOEV on the Nasdaq) disclosed that the SEC has initiated “a fact-finding inquiry” into the company related to its December merger with a blank-check outfit, as well as its “operations, business model, revenues, revenue strategy, customer agreements, earnings and other related topics, along with the recent departures of certain of the Company’s officers.”  

That comes seven weeks after Canoo announced a comprehensive business model shift towards business customers instead of original equipment makers on its first conference call as a public company, with co-founder and then-CEO Ulrich Kranz absent from the call (Kranz resigned weeks later). Canoo, which generated no revenue in the first quarter, has suffered a 65% share-price pullback from the Dec. 11 peak to leave its market capitalization at $1.8 billion.  

The SEC is one thing.  A May 4 analysis on legal intelligence site JD Supra from attorneys at Bass, Berry & Sims plc noted that litigation risks may extend further than some industry promoters might like: 

Private plaintiffs may try to find ways to assert claims against not only the SPAC, but also the target and the target’s board of directors for allegedly aiding and abetting the SPAC directors’ breaches of their state law duties.  If any conflicts exist or projections turn out differently than reported, lawsuits will also likely allege claims under state law for conflicted transactions and securities fraud under the federal securities laws.  

There may be plenty of fertile ground for the lawyers, if a 52%, five-month dive in the Grant’s SPAC Index featured in the Dec. 25 analysis “Short this index,” is any indication. What sort of mischief might a continued spell of risk aversion bring? See the most recent issue of Grant’s Interest Rate Observer dated May 14 for more on SPAC’s, broader risks stemming from the modern-day everything bubble and catalogued investment ideas for a potentially fraught financial moment. 

Recap May 19

Stomach turning volatility in crypto, featuring a $43,500 to $30,700 24-hour trading range for bitcoin, headlined today’s proceedings, while stocks shook off early losses to leave the S&P 500 red by 30 basis points and the Nasdaq little changed.  Treasurys came under pressure with the 10-year yield rising to 1.67%, gold edged higher to $1,871 an ounce and WTI sank to near $63.50. The VIX jumped to near 26 this morning, before giving back the bulk of that advance and settling just above 22.  

- Philip Grant

Pomp and Circumstance

Venture capitalist and crypto evangelist Anthony Pompliano announced the debut of “bitcoin pizza” today.  The nascent national brand will serve as a portal to participating local restaurants, who will make their own pizzas using a standardized menu with a bitcoin-branded box.  Prices will be higher than usual, with proceeds above the underlying pizza shop’s cut going to the Human Rights Foundation's Bitcoin Development Fund.

Pizza lovers will enjoy topical fare such as “Satoshi’s Favorite,” “Laser Eyes” and “Capital Greens,” along with meal supplements like “Buy the F****** Drink.”   Not every feature of bitcoin pizza is compatible with the brave new world of digital ducats; only Google Pay and credit cards are accepted for payment.  Promoters have assured the public they are looking into adding bitcoin as an option. 

Chicken Dance
Moral hazard abounds in the Middle Kingdom.

Moral hazard abounds in the Middle Kingdom.  A major development looks to be taking shape in the saga of China Huarong Asset Management Co., the stricken distressed debt manager.  Huarong has failed to produce annual results for last year well beyond the March 31 deadline, sparking fears of extensive accounting restatements and/or default.  

Citing sources close to the Chinese government, the New York Times reports this morning that “significant losses” are in store for both domestic and foreign creditors of Huarong. Indeed, Beijing is “strongly committed to making sure that foreign and domestic bondholders do not receive full repayment of their principal,” per the Gray Lady.  

Huarong, which was incorporated as a vehicle to absorb nonperforming loans in the wake of a 1990’s-era credit crisis and remains majority owned by the Chinese government, saw its dollar-pay 5 1/2% notes due 2025 fell below 71 cents today, down from 111 cents less than two months ago. 

Despite a sprawling 2018 bribery scandal that resulted in the January execution of former chairman Lai Xiaomin after he admitted to accepting $277 million in illicit funds, Huarong counts household Wall Street names like Goldman Sachs, Warburg Pincus and BlackRock among minority shareholders. Foreign creditors have similarly ingratiated themselves with the company (which carries an investment grade imprimatur from all three major domestic rating agencies), as Huarong and its subsidiaries have issued more than $22 billion in offshore bonds according to Refinitiv.  Nearly $4 billion of those borrowings fall due later this year. 

“The regulator and investors are kind of playing a game of chicken,” Zhangkai Huang, an associate professor at Tsinghua University in Beijing, told the Times. “The regulator is saying there is going to be some serious reform in the financial system. The investors are saying, ‘I bet you don’t have the courage to let this default happen because there will be a crisis.’”

Michael Pettis, finance professor at Peking University, emphasized on Twitter this morning that the CCP’s current conundrum is no unhappy accident: 

As long as Beijing insists on GDP growth rates that exceed the underlying economy’s real capacity, there is no way Beijing can prevent bad debt from rising sharply.  If banks and investors are forced to operate under hard budget constraints, however, it will be impossible for local governments to fund the activity needed to achieve the GDP growth targets. 

Moral hazard, in other words, isn’t some unfortunate characteristic of China’s financial system that can be fixed with the right policies. It is fundamental to the way Beijing’s growth model works. Beijing must backstop the credit markets until it gives up targeting growth.

Recent evidence does suggest that tighter conditions for lenders and borrowers alike are on the way.  Total social financing (i.e., aggregate credit and liquidity flows) came to RMB 1.85 billion in April ($278 billion), well below the RMB 2.29 trillion consensus, while M2 money supply grew by 8.1% year-over-year, well below the expected 9.2% and near the record low going back to 1995 of 8%.   A protracted tightening of financial conditions could unleash all sorts of mayhem, as the distended Chinese banking system featured $49 trillion in assets at year-end, representing nearly 60% of global GDP last year. 

Then again, trouble in the credit markets could complicate any protracted belt tightening.  Chinese firms had already defaulted on RMB 100 billion of onshore debt year-to-date through May 12 according to data from Bloomberg, marking the first time that threshold had been crossed before September.  Offshore defaults have footed to $3.7 billion, already on pace to eclipse 2020’s record $8.3 billion, full-year figure with Huarong still looming.  “Last year the credit risk of Chinese issuers had been delayed, but not eliminated,” Chang Li, China country specialist at S&P Global Ratings commented back in January. “The refinancing risk is very big. Even if the funding costs are very high, (issuers) have to accept that.”

Will Beijing? 

Recap May 18

Stocks came under pressure late in the day to leave the S&P 500 and Nasdaq 100 indices each lower by about 80 basis points, while the VIX jumped above 21.  Treasurys remained rangebound, with the 10- and 30-year yields edging lower to 1.64% and 2.36%, respectively, gold rose to $1,870 an ounce and WTI fell to $65.50 a barrel, pulling back from the multi-year highs reached yesterday. 

- Philip Grant

A Roll-Up Unrolls
This morning, telecom giant AT&T

This morning, telecom giant AT&T announced it will spin off and merge its media unit with content provider Discovery Communications.  Telephone will control 71% of the new entity, which will sport a projected $76 billion market cap and $132 billion enterprise value.   

That transaction closes the book on a less-than-blissful corporate marriage, as AT&T coughed up $85 billion for TimeWarner just three years ago. The move nevertheless earned plaudits from a key constituency, as Ma Bell unwinds a growth-by-acquisition strategy under former CEO Randall Stephenson that pushed net debt to $205 billion (inclusive of operating lease and pension liabilities) as of March 31, earning the dubious distinction of the world’s most encumbered non-financial company.  Shareholder Elliott Investment Management deemed the deal “another impressive step in the company's recent evolution.”  

Mr. Market also liked what he saw initially, as shares jumped 4% at the market open to briefly log a fresh 52-week high.  Yet that rally soon faltered (T stock closed lower by nearly 3%), perhaps reflecting another byproduct of the transaction: A forthcoming dividend cut.  AT&T announced today that, following the spin-off, it will allocate between 40% to 43% of free cash flow, now projected at roughly $20 billion this year, for shareholder payouts.  That compares to a projected $26 billion in full-year free cash flow and a dividend payout ratio in the “high 50%s range” as of the first quarter earnings release. 

Income investor pain is the creditors’ gain. This afternoon, Moody’s affirmed its Baa2 senior unsecured debt rating on AT&T with a stable outlook. Though the company remains “weakly positioned for the Baa2 rating,” Moody’s believes that proceeds from that dividend cut will serve to both pay down debt and smooth AT&T’s maturity schedule to eliminate principal repayments in excess of projected free cash flow.  The spinoff will bring the Moody’s-calculated leverage toward 3.6 turns of Ebitda from the current 3.8 times.  

That decision has arguably been a long time coming, as generous shareholder payouts in tandem with an aggressive capital structure (the average Baa rated borrower carried just 2.7 turns of leverage as of last fall) can, of course, make for a dicey combination.  An updated bearish assessment of AT&T in the April 2 edition of Grant’s Interest Rate Observer concluded that, “as a large and frequent borrower, AT&T needs its Baa2 rating. We judge that it needs the rating even more than it needs the gratitude of income-seeking investors.” 

Yet a slimmed-down corporate portfolio doesn’t necessarily spell the end of AT&T’s recent troubles. Analysts at MoffettNathanson argue that this morning’s outcome was an inevitable one, as its onerous debt load constrained the company’s ability to properly invest in the business, including expensive outlays for 5G wireless technology and the HBO Max streaming service rollout.  

While investor focus shifts back toward execution in the core wireless communications business, Ma Bell still faces a tough road ahead thanks to ferocious competition. Namely, rival T-Mobile can now boast both better pricing and a superior network thanks to its recent purchase of spectrum-rich Sprint Corp. last year, while Verizon launched its own 5G salvo by spending $45 billion in a c-band spectrum auction earlier this year, double AT&T’s investment.  MoffettNathanson gets the last word:  

Indeed, the big question for AT&T will be, is even this – including their dividend cut – enough? AT&T will get back $43 billion in cash and/or assumed debt, and 71% of the equity in the new company. 

Time Warner’s Ebitda supported a little over $43 billion of debt at AT&T, so AT&T is still over-levered after the transaction (about 4.0 times EBITDA including pension and capital lease obligations). With their dividend cut, their payout ratio will drop only modestly and their capital expenditures will increase. But all will still depend on whether they can grow their mobility business. We have our doubts.

Friday’s ADG referenced the Biden administration’s recently passed $1.9 billion stimulus package.  Unfortunately for the deficit-conscious, the actual size of that bill is $1.9 trillion. 
Recap May 17

Stocks edged lower to start the week, with the S&P 500 and Nasdaq 100 each declining by about 30 basis points, while Treasurys also came under modest pressure as the 10- and 30-year yields rose to 1.65% and 2.36%, respectively.  WTI crude jumped above $66 a barrel for its best finish since October 2018, while gold rallied to $1,845 an ounce to extend its six-week gains to 11%.  Bitcoin slumped below $45,000 from $50,000 on Friday evening, and the VIX rose to near 20. 

- Philip Grant

Card Blanche

A headline today from The Wall Street Journal:

JPMorgan, Others Plan to Issue Credit Cards to People With No Credit Scores

Sold to You, John Q.
Passive U.S. equity ETFs attracted some $17 billion in assets

Passive U.S. equity ETFs attracted some $17 billion in assets over the first four days of the week, data from Bloomberg show.  That inflow comes despite a 4% selloff in the S&P 500 between Monday and Wednesday, the worst three-day showing of 2021.  

A raging bull market has ingrained a buy-the-dip mentality in John Q. Public. “We are seeing the reappearance of a familiar pattern in which capital inflows through index-based ETFs give the market some support,” Nomura quantitative strategist Masanari Takada wrote this morning. “It is fair to say for now that equity investors in general, and speculative investors specifically, have managed to avoid letting themselves get overly spooked.” 

While passive buyers show off their diamond hands, other constituencies tap the bid. Corporate insiders have sold $24.4 billion worth of shares in the year-to-date through May 7. That’s on pace to exceed the $30 billion in insider sales over the last six months of 2020 by about 15%.  Chunky sales from big tech household names have been front-and-center in that uptick:  Google co-founder Sergey Brin has sold $163 million of company stock over the past week (his first sales since 2017), while Oracle’s Larry Ellison liquidated $552 million worth of shares over that period. Amazon CEO Jeff Bezos has dumped $6.7 billion in AMZN stock so far in 2021, approaching his $10 billion disbursement across last year.   

Downhill from Here
Help is on the way.

Help is on the way.  The American Rescue Plan, the Biden Administration’s $1.9 trillion covid-relief bill enacted in March, includes some $86 billion in federal grant funding for multiemployer pension plans (i.e., those covering employees from multiple companies, usually within the same industry), Citigroup estimates.  

There is plenty of need for a financial boost.  Beset by fast-growing deficits over the past decade, multiemployer plans face a “very high” likelihood of insolvency by 2026 with the “near certainty” of that outcome a year later, the Pension Benefit Guaranty Corporation warned in its most recent report last September.  The PBGC deemed 124 such plans, representing roughly 1 million U.S. workers and 10% of the total multiemployer universe, to be in “critical and declining status,” projected to lack sufficient funds to pay full benefits within the next two decades.

That recently announced capital influx could reverberate in the bond market, Citi strategists Daniel Sorid and Jason Williams believe.  The pair told Bloomberg in an interview yesterday that they expect multiemployer managers to allocate much of those funds to triple-B-rated corporate bonds, the last stop before junk, in an effort to generate as much income as possible.  The triple-B-rated component of the Bloomberg Barclays Aggregate Bond Index yields 2.48%, compared to 2.21% for the wider investment grade gauge.  Accordingly, that fresh arsenal of taxpayer funds will afford issuers the opportunity to extend their maturities and lock in funding.  “If there was ever a time when 30-year credit should be having its moment in the sun, it’s now,” Sorid told Bloomberg. 

While last year’s pandemic wreaked havoc on the multiemployer system, with those entities suffering their worst quarterly funding decline since 2007 according to Millman, trouble was brewing long before the bug bit.  For instance, vested retirees or other noncontributing members accounted for a whopping 61% of the multiemployer beneficiary population as of 2015, up from just 17% in the 1970s.  Then, too, unrealistically investment return assumptions, in the context of ground-scraping bond yields, understate the funding troubles within the multiemployer universe.  

For a closer look at the woes of those defined benefit plans, and other side effects of ultra-easy monetary policy, see the Jan. 26, 2018 and April 5, 2019 editions of Grant’s Interest Rate Obsrerver

Recap May 14

Stocks enjoyed a second straight rally, with the S&P 500 advancing by 1.5% to wrap up the week with a 1.4% loss, while the Nasdaq managed a 2.2% rip to narrow its weekly decline to 2.4%.  Treasurys were also bid, with the 10- and 30-year yields falling to 1.63% and 2.34%, respectively, gold jumped 1% to $1,842 an ounce and WTI crude climbed to $65.50 a barrel.  The VIX bellyflopped below 19, extending to a 32% two-day drop.   

- Philip Grant

Under the Stable
A thunderbolt from the social media heavens.

A thunderbolt from the social media heavens.  Yesterday evening, Elon Musk announced on Twitter that Tesla would no longer accept bitcoin as payment. The catalyst for that reversal from a mere three months ago: “Concern about rapidly increasing use of fossil fuels for bitcoin mining and transactions, especially coal, which has the worst emissions of any fuel.”  That de-endorsement helped drive down the price of bitcoin to as low as $48,000 overnight from $55,000 yesterday afternoon. 

While Musk’s pivot grabbed the headlines, a potentially far more significant crypto development took place hours later.  This morning, controversial stablecoin tether released its composition of reserves for the first time.  Tether, the most traded crypto by volume, had long claimed to be fully backed by U.S. dollars before gradually relaxing that language in early 2019. Yet the outfit disclosed that, as of March 31, traditional reserve assets such as cash and Treasury bills summed to a mere 3% and 2% of total reserves, respectively.  In lieu of currency and liquid government debt, more esoteric securities filled out the bill: Commercial paper accounted for roughly half of reserves, with fiduciary deposits, secured loans, corporate bonds and precious metals representing about 18%, 13% and 10% of that total. 

That snapshot generates more questions than answers. As CoinDesk notes, “It is unclear what the ratings are on the commercial paper or the corporate bonds, which agencies rated them or which companies issued them. Likewise, Tether declined to identify the borrowers of the loans or the collateral backing them.”

Another eye-catcher: “Reverse repo notes” accounted for 3% of reserves. In a traditional repurchase agreement, a borrower sells an asset with an agreement to buy it back later at a higher price. In reverse repo, a lender buys an asset from a borrower who promises to repurchase it at a later date. Repo and reverse repo are agreements between two counterparties and not publicly traded securities. It is unclear what, if anything, the notes in “reverse repo notes” signifies. 

Indeed, that line item is a curious one, as tether has used obscure, Bahamas-based Deltec Bank & Trust as its primary lender since 2018. As tether is known as a workaround for know-your-customer and anti-money laundering regulations that govern the regulated banking system, today’s disclosure invites the question of who would serve as a counterparty for such a transaction and, if an intermediary helped facilitate that deal, what sort of fees tether would be obliged to pay that third party.  Might the assets underpinning those reverse repo deals be cryptos?

In any event, this morning’s disclosure is unlikely to mollify skeptics either on Wall Street or in the halls of government.  Recall that, in February, New York attorney general Letitia James concluded in a settlement (which levied an $18.5 million fine and barred the company from doing business in the state) that tether’s “claims that its virtual currency was fully backed by U.S. dollars at all times was a lie,” (Almost Daily Grant’s, February 23). That admonishment has done little to slow the breakneck growth in tethers outstanding.  Instead, the quantity in circulation has gone parabolic in recent months:  

Source: Coinmarketcap.com

More broadly, the Financial Times notes today that government entities across the West are stepping up their scrutiny of stablecoins, as concerns over difficulty in tracing transactions, consumer protections and inconsistent disclosure practices proliferate.  “Certainly, the direction of travel is to look at regulating them,” concludes John Salmon, head of law firm Hogan Lovells’ cryptocurrency practice. 

A crackdown on the digital Wild West is perhaps already underway.  Both the Justice Department and Internal Revenue Service are conducting investigations into Caymans-incorporated Binance Holdings, the world’s largest crypto exchange by trading volume, Bloomberg reports this afternoon.  “Officials who probe money laundering and tax offenses have sought information from individuals with insight into Binance’s business,” Bloomberg explains. 

A little heat from Uncle Sam doesn’t seem to bother the Binance c-suite.  Founder and CEO Changpeng Zhao downplayed the significance of that report, and tweeted this morning: “You know what to do in a dip, right?”

QE Progress Report
A $32 billion weekly uptick in Reserve Bank Credit pushed interest bearing assets at the Fed to $7.78 trillion.  That’s up 22.8% on an annualized three-month basis and 89% from mid-March of last year. 
Recap May 13

Stocks managed a modest bounce, with the S&P 500 gaining 1.2% to narrow its loss for the week so far to 2.8%, while the Nasdaq rose by 70 basis points to trim its four-day decline to 4.5%.  Treasurys caught a bid despite a weak 30-year auction this afternoon, with the 10-year yield declining to 1.66%.  Gold edged higher to $1,827 an ounce, WTI crude sank below $64 a barrel and the VIX pulled back by 16% to 23 after reaching a two-month high yesterday. 

- Philip Grant


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