07.23.2021
China Doll
Once is happenstance, twice is coincidence and the third time it’s enemy action.

Once is happenstance, twice is coincidence and the third time it’s enemy action.  Reports that regulators are considering forcing for-profit education firms to migrate towards a not-for-profit structure hammered Chinese schooling stocks today, with shares of the New Oriental Education & Technology Group (EDU on the NYSE) enduring a 54% swan-dive.  

That follows Beijing’s ongoing broadside against Didi Chuxing (which includes a Bloomberg report yesterday claiming “unprecedented penalties” may be forthcoming) over alleged data collection abuses following the ride share giant’s celebrated June 30 listing on the NYSE and last fall’s salvo against Alibaba after co-founder Jack Ma dared to publicly criticize the Chinese Communist Party.  Foreign investors have taken the hint. Since logging its peak in mid-February, the Nasdaq Golden Dragon China Index, composed of American Depository Receipts tracking local businesses, is off a hefty 41%. 

Gimme Shelter
Euthanasia of the renters?

Euthanasia of the renters? The National Multifamily Housing Council’s quarterly survey, released today, shows the tightest market conditions on record going back to at least 2006. A reading above 50 indicates that supply conditions are shifting in landlords’ favor, and vice versa. 


 
Source: The National Multifamily Housing Council

With activity on the hop and availability historically limited, tenants may be forced to pay up for some time.  “We calculate the market won’t be fully in balance until 2023 or 2024,” Ali Wolf, chief economist at real estate advisory firm Zonda, told the Financial Times Wednesday. “Assuming the economy continues to improve, and we continue to see the job growth numbers get better, I do think there will continue to be some upward pressure on rents.”  That trend could wield no small influence on broader inflation expectations.  “People don’t buy a used car every month whereas many pay rent every month,” Oregon University professor Tim Duy added.

The housing market has likewise gone into hyperdrive, in short order reverting to the sonic boom-like conditions that rival the headiest days of the mid-aughts.  Data released yesterday by the National Association of Realtors showed that the median “existing” home price reached $363,300 in June. That’s up a cool 23.4% from a year ago and 57.7% above the housing bubble peak logged in July 2007. 

Shelter, both for sale and for rent, is of course a lynchpin for the future course of inflation. The owners’ equivalent rent (OER) metric, which attempts to capture the change in a homeowners estimated proceeds from renting his or her dwelling, represents 23.7% of the Consumer Price Index.  Rent of primary residence, which measures contracted rental and prices, accounts for an additional 7.6% of the CPI.  Overall, the shelter component registered a modest 2.6% year-over-year advance in June, up from 1.5% in February but well below the 3% to 3.6% run-rate seen from 2016 to 2019, let alone the 5.4% advance in headline CPI.  

As rental contracts typically last one year and inflation indices capture prices on currently occupied domiciles as opposed to asking prices on vacant units, it takes about five quarters for trend changes in measured home or rental prices to appear in the CPI data, a June 9 analysis from Fannie Mae economist Eric Brescia finds. That suggests that last year’s deep freeze is still working its way through the system and will soon abate. 

Meanwhile, a dearth of affordable housing supply complements the ultra-tight rental conditions identified by the NHMC. Citing data from Freddie Mac, The Wall Street Journal relayed Wednesday that the annual construction pace of homes sized 1,400 square feet or less (a category typically denoting starter homes for first-time buyers) has remained stuck between 55,000 and 65,000 units per annum in recent years, compared to more than 400,000 new units in the late 1970s. 

“What was really striking to me was the consistently of the decline. . .irrespective of geography,” Sam Khater, chief economist and head of Freddie Mac's Economic and Housing Research division, told the Journal. “It’s all over the U.S. It doesn’t matter where.” 
Indeed, today’s heady conditions set the stage for persistently elevated inflation tomorrow.

Utilizing data from Zillow and Apartment List, Ben Breitholtz, data scientist at Arbor Research, predicts that OER will accelerate to between 4.8% and 6.3% year-over-year by December, equivalent to as many as 1.5 percentage points CPI from that 23.7%-weighted component alone.  

Fannie Mae’s Brescia comes to a similar conclusion. Under the economist’s baseline scenario, the shelter component will add 1.9 percentage points to the index by the second quarter of 2022, nearly accounting for the Federal Reserve’s entire 2% annual inflation target before the other two-thirds of the CPI come into play.   

Then, too, the lagging effects visible in the inflation data can work in the other direction once the boom runs its course.  Thus, while the S&P CoreLogic Case-Shiller 20-City Composite Index rose 105% from January 2000 to April 2006, OER rose only 20.3% over that period.  Over the following six years, the Case Shiller gauge declined by 33.9%, but OER registered an 11.7% increase. 

Transitory is a relative term.   

Recap July 23

Stock jockeys enjoyed another euphoric day, as the S&P 500 managed another 100 basis point rally to complete a 3.6% four-day rally to emphatically erase Monday’s large decline and leave the broad index higher by 17.5% year-to-date. Treasurys settled down from their recent volatility with the 10- and 30-year yields holding at 1.28% and 1.92%, respectively. Gold slipped to $1,802 an ounce, WTI rose above $72 a barrel and the VIX pulled back by a modest 3% to finish just above 17. 


- Philip Grant

07.22.2021
Upstairs, Downstairs
We can go lower.

We can go lower.  The European Central Bank declared today that it will hold benchmark interest rates at or below their current minus 50 basis points until measured inflation gains a lasting foothold north of 2%. That strategy shift from a previous goal of near- but below-2% inflation, the ECB notes in this morning’s statement, “may also imply a transitory period in which inflation is moderately above target.” Headline Eurozone CPI advanced by 2.5% from a year ago in June but has averaged just 1.4% since the central bank took its deposit rate below zero for the first time in May 2014. 

As the mandarins in Frankfurt pledge to goose the cost of living in hopes of delivering an economic jolt, colleagues down Mexico way take a more conventional approach.  After today’s release showing a 5.75% annual CPI rise over the first two weeks of July, marking the highest reading for that period since 1999, Mexico central bank board member Jonathan Heath took to Twitter to characterize that development as “definitely bad.”  The Mexican central bank hiked its benchmark policy rate to 4.25% from 4% at its most recent meeting on June 23, reversing a similar cut four months ago and marking the first tightening move since the end of 2018.

Stock Drawer
Monday’s 1.6% decline in the S&P 500 marked the worst day for stocks in two months, but Joe and Jane six-pack were ready:

Monday’s 1.6% decline in the S&P 500 marked the worst day for stocks in two months, but Joe and Jane six-pack were ready:  Individual investors purchased a net $2.18 billion of equities during Monday’s selloff per data from Vanda Research, the largest such shopping spree on record.  For context, net retail purchases never topped $1.5 billion from June 2016 until the lockdowns began last spring but have since regularly exceeded that threshold. 

Those dip-buyers are now sitting pretty. The S&P 500 swiftly recovered over the following two days to once more approach its high-water mark and extend the streak since its last 5% drawdown to nine months, the longest stretch since 2018.  The broad index has seen a 3% pullback four times so far this year, swiftly recouping those losses on each occasion.

Much of Monday’s buying power was concentrated away from single name equities.  Exchange traded funds accounted for 44% of Monday’s retail inflows, Vanda finds, up from about 29% on an average day.  That was no fluke.  Year-to-date ETF inflows footed to $488.5 billion as of last Thursday, Bloomberg relayed last week, already on the cusp of topping the full-year record influx of $497 billion established last year with more than five months to spare. 

New products are naturally proliferating to meet that surging demand, introducing some operational quirks.  Bloomberg reports that the Direxion Low Priced Stock ETF (LOPX on the NYSE Arca), which debuts today with a mandate to target equities trading at between $2 and $5 per share, maintains a near 7% weighting in AMC Holdings Entertainment.  Following a roughly 1,800% year-to-date gain including a near six-fold advance from mid-April to early June, that leading meme stock finished trading yesterday north of $40 a share.   Though the underlying Solactive Two Bucks Index went live in April, Bloomberg notes that the AMC holding would have entered the LOPX last year, when shares fetched around $4. 

“We’re going to sell it,” relays David Mazza, head of product at ETF manager Direxion, of next month’s scheduled portfolio rebalancing. “And hopefully, we’ll buy another company that could have the same potential.”

Indeed, the hordes of retail traders bidding AMC and its meme-stonk peers represent a target market for that new ETF product. “This is a very interesting time in the market on multiple levels,” Mazza adds. “Some of the newer investors have been accustomed to only having outsized returns.”   

QE Progress Report
A chunky $95 billion weekly increase in Reserve Bank Credit pushed the quantity of interest-bearing assets on the Fed balance sheet to a new fresh high of $8.174 trillion.  That’s up 18.6% from a year ago and 117% from July 2019, prior to Mr. Market’s major malfunction. 
Recap July 22

Stocks edged into the green to leave the S&P 500 higher by 2.5% over the past three days following Monday’s selloff, while Treasurys also caught a bid after some bearish recent price action, with the 10- and 30-year yields settling at 1.27% and 1.9%, respectively. Gold went nowhere one again to finish at $1,807 an ounce, WTI crude approached $72 a barrel to continue its strong rebound and the VIX held just below 18. 

- Philip Grant

07.20.2021
It's All Transitory
“Inflation is expected to follow a volatile course in the short term due to various supply and demand factors,”

“Inflation is expected to follow a volatile course in the short term due to various supply and demand factors,” the Central Bank of the Republic of Turkey wrote after last Wednesday’s meeting. The CBRT, which kept rates unchanged for a fourth consecutive month, has endured heavy staff turnover in recent years under the auspices of strongman president and easy money advocate Recep Erdogan, culminating in the March 20 termination of Governor Naci Agbal two days after hiking the key rate to 19% from 17%. Perhaps dissuaded against further tightening, the CBRT last week promised that the future course of inflation “will be monitored closely.” 

There is lots to monitor.  Turkish CPI advanced at a 17.5% annual clip in June, the highest since the bug bit but well below the 25.2% local peak logged in 2018. Meanwhile, inflation has bounded higher at a 13.5% average annual rate since Erdogan tightened his grip on power following a failed coup d’état five years ago, compared to an average 8.1% over the five years through July 2016.  The foreign exchange market takes a dim view of the politically-hobbled CBRT’s ability to tamp down those raging price pressures, as the lira vs. dollar pair remains stuck near a record low exchange rate of 8.57 to the buck. 

Tack and Spend
The world’s largest miner takes a pause.

The world’s largest miner takes a pause.  This morning, BHP Group announced that it will hold production steady over the next year, projecting between 278 and 288 million tons of iron ore output.  That compares to the 284 million tons of production over the 12 months through June 30 and is slightly below the company’s long-term target of 290 million tons per annum.

A sparse longer-term pipeline further colors that decision, as The Wall Street Journal notes that the company has just two major projects in development and is a minority partner to BP in one of those.  During the commodity price boom of a decade ago, BHP had 18 such ventures in the hopper. 

“Chasing production does not really make sense,” CEO Mike Henry told analysts in March. “The industry has a great track record of being quite pro-cyclical and that has ended in tears all too often.”  That discipline is paying off industrywide, as the world’s top 40 miners will earn $118 billion in net profit this year, nearly double that of 2019, if estimates from PricewaterhouseCoopers are on point.

A similar dynamic is underway among stateside energy majors. In April, Exxon reiterated full-year capex guidance at $16 billion to $19 billion for 2021, down from $21.4 billion last year and some $31 billion in 2019. The oil giant expects that figure to remain at between $20 billion and $25 billion from 2022 to 2025, down from a pre-virus projection of $30 billion to $35 billion in annual capital spending over that period.  Rival Chevron now targets $14 billion to $16 billion in capex through 2025, which is less than half of its spending levels in 2014 when WTI crude hovered near $100 a barrel. 

That belt tightening from major resource producers represents an increasingly stark contrast with other areas of the economy. Callum Thomas, head of research at Topdown Charts, noted in a June 15 blog post that capex among the energy and materials components of the S&P 500 have reached a record low relative to the index as a whole.  At the same time, the tech sector accounted for some 40% of S&P 500 capex, its highest share since at least 1981. 


 
That slimmed-down spending regime from energy and materials producers, Thomas believes, “helps sow the seeds for a sustained bull market in commodity prices.” At the same time, “one can’t help but notice how the record high capex by tech companies seems to echo the same pattern seen during the peak of the dot com bubble.”

Recap July 20

The hair-raising rally in Treasurys was dramatically interrupted, as the benchmark 10-year yield turned tail from an intraday low near 1.13% to finish at 1.23%, while the long bond rose to 1.88% from 1.81% yesterday.  Stocks enjoyed a 1.5% gain for the S&P 500 to all but erase yesterday’s losses, while the VIX settled near 20, compared to 18.5 as of Friday’s close.  WTI crude rebounded nearly 2% to $67.5 a barrel, and gold remained in a tight range at $1,811 an ounce. 

- Philip Grant

07.19.2021
Let Them Trade Stonks
Another blockbuster initial public offering beckons.

Another blockbuster initial public offering beckons. Commission-free trading venue Robinhood Markets, Inc., which has long marketed itself as democratizing finance for the masses, announced today that it will sell 52.4 million shares to the public at a range of $38 to $42 per share, raising upwards of $2 billion at the high end of that range.  The company will commence its IPO roadshow this week and expects to begin trading on the Nasdaq under the ticker HOOD on July 29.

Robinhood would achieve a $35 billion market cap at the top of its range, down from a prior $40 billion valuation target. That scaled-down ambition may prove wise, as larger entrants have languished in this bumper crop IPO year:  The half-dozen newcomers that raised $2 billion or more in 2021 now trade 1.4% below their average debut price, Bloomberg noted this morning. 

The platform’s rapid growth trajectory provides further succor for the bulls.   First quarter revenue of $522 million represented a 309% increase from the same period in 2020, while monthly active users more than doubled to 17.7 million.  Adjusted Ebitda swung into the black with $115 million, compared to a measured $47 million loss in the first three months of 2020. 

Yet vulnerabilities to the company’s business model could be growing more acute. While Robinhood famously charges no commission to execute its orders, the firm instead generates revenue through peddling customer order flow to high-frequency trading firms. Such payment for order flow (PFOF) represented 75% of revenues last year, and 81% of the first quarter’s top line. 

That controversial practice duly caught the eye of key regulatory figures. Noting in a speech last month that he has asked his staff to investigate payment for order flow and recommend rule changes, SEC chair Gary Gensler took aim at the broker:

Robinhood explicitly offered to accept less price improvement for its customers in exchange for receiving higher payment for order flow for itself. As a result, many Robinhood customers shouldered the costs of inferior executions; these costs might have exceeded any savings they might have thought they’d gotten from zero commission trading.

Regulatory bodies across the Atlantic turn a similarly jaundiced eye. Last week, the European Securities and Markets Authority issued a statement noting that that payment for order flow probably does not comply with so-called MiFID II regulations governing brokers’ obligations to secure best execution for their customers. 

Any protracted crackdown would sting. The company warns in today’s filing that: 

Because certain of our competitors either do not engage in PFOF or derive a lower percentage of their revenues from PFOF than we do, any such heightened regulation or ban of PFOF could have an outsize impact on our results of operations. 

Might routine cyclical shifts represent an even bigger pitfall? Runaway asset prices and widespread lockdown-induced boredom helped facilitate Robinhood’s rapid growth.  The opposite set of conditions could hardly enhance it.  To that end, a Bloomberg-compiled basket of 37 meme stocks fell by as much as 4.4% this morning, building on its worst five-day showing since February. 

Similarly, a Goldman Sachs gauge of unprofitable tech stocks has lost substantial altitude in recent months, remaining 26% below its February peak as of this afternoon. 


 
Goldman Sachs Non-Profitable Tech Basket, five-year view. Source: The Bloomberg

Bearish developments in the digital currency realm will likewise do Robinhood no favors. Crypto assets under custody footed to $11.6 billion as of March 31, more than triple the $3.6 billion seen at year-end, while crypto-related business accounted for 17% of first quarter revenue, compared to 4% of the top line from October to December.  For context, the price of bitcoin doubled over the three months through March, to $59,000 from $29,000, a move that has now all but completely retraced. 

Preliminary results indicate that growth has indeed slowed from the breakneck figures posted in the first quarter. The updated filing projects revenue of between $546 million and $574 million for the quarter ended June 30, marking a 135% year-over-year increase (less than half that of three months earlier) and 10% sequential advance at the high end of that provided range. Adjusted Ebitda will foot to between $59 million and $103 million for the second quarter, the company reckons, well below the $115 million posted in the first three months of the year.

As for the company’s stated goal of “democratizing finance for all,” that high-minded mission is one step closer to reality. Today’s filing notes that up to one-third of that $2 billion-plus share offering will be allocated to Robinhood users, via the IPO access feature on the trading platform.  

Then again, only near-silent partners are welcome:  Co-founders Baiju Bhatt and Vladimir Tenev, who will each own a 7.9% economic interest in Robinhood, will maintain effective control with a combined 65% voting interest in the company thanks to their ownership of super-voting class B shares. 

Democracy for some.

Recap July 19

The recent rates rally kicked into fifth gear today, as the 10- and 30-year Treasury yields each plunged by 12 basis points to their lowest since February at 1.19% and 1.81%, respectively.  That red flag was too large for stock jockeys to ignore, as the S&P 500 sank by 1.6% for its worst day in two months, trimming the year-to-date advance to 13.4%, while the VIX jumped 22% to 21.5.  WTI crude was hammered by 7% to finish near $66.5 a barrel, and gold edged lower to $1,812 an ounce. 

- Philip Grant

07.16.2021
The Ride
The Department of Justice has opened a formal investigation into electric truck startup Lordstown Motors Corp.

The Department of Justice has opened a formal investigation into electric truck startup Lordstown Motors Corp. (RIDE on the Nasdaq), the company disclosed in a filing yesterday.  That inquiry follows a pair of subpoenas from the SEC pertaining to its October merger with special purpose acquisition company DiamondPeak Holdings Corp. 

Confusing corporate communications color that development. Back on June 8, Lordstown warned in an amended form 10-K that it was running out of cash and its status as a going concern was increasingly in question. 

Evidently attempting to calm nervous investors, Lordstown president Rich Schmidt declared one week later that the company had an order book that would cover its output for 2021 and 2022, adding that: “I don’t know the exact facts of the legal aspect of that, but they are basically binding orders that are committed here in the last two weeks, reconfirmed orders. They’re pretty solid, and I think that’s on the light side or conservative side.”  Two days later, Lordstown “clarified” in a filing that existing orders “do not represent binding purchase orders or other firm purchase commitments.” RIDE shares are down 57% year-to-date, leaving the pre-revenue firm’s enterprise value at $900 million. 

For more on Lordstown, and the other nine SPAC-related picks-to-not-click comprising the analysis “Short this index,” see the Dec. 25 edition of Grant’s Interest Rate Observer.

Bell Bottoms
A new escalation in China’s crackdown on newly public Didi Chuxing (DIDI on the NYSE):

A new escalation in China’s crackdown on newly public Didi Chuxing (DIDI on the NYSE):  This morning, seven separate government departments paid the rideshare giant a visit to conduct a cybersecurity review, including the police, primary antitrust regulator and Ministry of State Security. That comes days after the Cyberspace Administration of China accused Didi of improperly collecting user data and two weeks after authorities barred the company from signing up new members and delisted its app. Shares traded lower by 4% in immediate reaction to that bulletin and remain 34% below the intraday peak on its June 30 IPO date.

Of course, today’s developments represent the latest instance of Beijing publicly asserting its dominance over China’s domestic technology champions, a phenomenon which began last fall with a crackdown on Alibaba after co-founder Jack Ma publicly criticized the Communist Party. 

That broadside is making some on Wall Street a little nervous. Goldman Sachs CEO David Solomon lamented in a Tuesday CNBC interview that “a large number of companies that have been planning to come [public in] the U.S. . . [but] because of the actions the Chinese government has taken, I think some of those companies will not come to the market at this point in time. . . I was surprised that this played out the way it did.” 

Lingering Sino-American tensions further complicate the calculus.  The Biden administration yesterday warned U.S. investors that doing business in Hong Kong is an increasingly risky endeavor, as mainland China continues to tighten its grip on the long independent city. “The situation in Hong Kong is deteriorating, and the Chinese government is not keeping its commitment that it made, how it would deal with Hong Kong,” Biden declared at a press conference ahead of the advisory.  

That follows China’s diplomatic snub earlier this week, as the Financial Times reported yesterday that Beijing refused a meeting with deputy secretary of state Wendy Sherman. That would have been the highest level powwow since the two sides endured a frosty summit in Alaska earlier this year. “China’s move is a dangerous one,” Georgetown professor Evan Medeiros told the FT. “It increases distrust, tension and risk of miscalculation during an already-fraught period.”

Investors in the 244 U.S.-listed Chinese American Depository Receipts are perhaps experiencing similar sentiments.  As Bloomberg’s Francis Chan noted Wednesday, those certificates tracking the price of Chinese stocks are off by 30% from their mid-February levels on average. Wall Street pros have taken notice, as China-related fears led investors to “sharply” curtail their exposure to emerging market equities as a category, Bank of America’s Global Fund Manager Survey for July finds. Even some die hard bulls are heading for the hills, as fund manager Cathie Wood cut the allocation to Chinese stocks in her ARK Innovation ETF to less than 1% from 8% five months ago. “From a valuation point of view, these stocks have come down and again from a valuation point of view, probably will remain down,” Wood told to Bloomberg Tuesday.

Yet those developments are of little concern to the throngs of emboldened retail punters. Instead, as animal spirits reign supreme, dip-buyers arrive en masse.  Bloomberg notes that the KraneShares CSI China Internet Fund (KWEB on the NYSE Arca), which is off by 40% from its mid-February highs, attracted a hefty $631 million worth of inflows over the first four days of the week, equivalent to more than 10% of the fund’s total assets. Meanwhile, the number of outstanding call options reached a record high last week, more than double that of puts. “Between all the call buying last Friday and all the inflows this week, it certainly seems like investors are trying to pick a bottom,” noted Chris Murphy, co-head of derivatives strategy at Susquehanna. “Maybe Cathie Wood getting out was the final contra sentiment indicator those investors needed.”

Recap July 16

Stocks came under late pressure, with the S&P 500 and Nasdaq 100 each finishing near session lows to wrap up the week with a 1% loss, while Treasurys consolidated their impressive recent gains as the 10- and 30-year yields finished at 1.29% and 1.92%, respectively. The VIX jumped 8% to 18.4, gold pulled back to $1,812 an ounce and WTI crude held near $71 per barrel. 

- Philip Grant

07.15.2021
The Few, The Proud
Yesterday’s seemingly routine 40 basis point decline in the S&P 500 included an historic footnote:

Yesterday’s seemingly routine 40 basis point decline in the S&P 500 included an historic footnote:  A whopping 429 members of that index finished lower on the day, marking the smallest decline with that many red components since at least 1996, Callie Cox, senior investment strategist at Ally Invest, relays to Bloomberg.

Of course, with the broad indices holding near record highs despite deteriorating internals, persistent strength in the usual mega-cap suspects helps explain the market’s resilience.  An octet of names, including the so-called Faamg cohort of Facebook, Amazon, Apple, Microsoft and Google parent Alphabet along with Netflix, Nvidia and Tesla, accounted for more than half of the 7.6% gain logged by the S&P 500 from May 12 through yesterday, data from Bespoke Investment Group show.  Those eight stocks now command a 27% weighting in the SPX. 

For the most part, that lopsided market cap concentration cannot be attributed to lofty valuations.  Thus, the Faamg’s traded at 27.8 times forward earnings as of June 30, Sanford Bernstein analyst Toni Sacconaghi finds, below the 30.8 times for the broader tech sector excluding that contingent.  That’s the first time the Faamg segment has traded at that particular valuation discount since 2013.   

Great expectations help explain the Faamg’s relatively cheap price-to-earnings price tag, as the Street is penciling in a forthcoming profit gusher. For instance, Amazon will generate $47.7 billion in net income in 2022, if the sell side is on the beam, compared to $21.3 billion last year.  Alphabet is expected to earn $71.4 billion in 2022, double last year’s levels, while Facebook’s bottom line will swell to $46.7 billion next year from $29.1 billion in 2020, analysts reckon. 

Yet unfriendly government policy could crimp that expected windfall, as the change in presidential administrations ushers in chilly winds for the big tech ranks. In June, the Senate confirmed Biden administration nominee Lina Khan as chair of the Federal Trade Commission, giving big tech-critical Democrats a three seat majority on the five member committee.  That appointment appeared to strike a nerve, as Amazon and Facebook have each recently filed petitions arguing that Khan should recuse herself from antitrust cases involving the pair, as her previous assertions of monopolistic behavior by big tech indicate she has already made up her mind as to their legal liabilities. For her part, the new FTC chair told the Senate in June that she has no financial conflicts that would command recusal under pertinent ethics laws. 

That fight is now shifting towards multiple fronts. Last Friday, the President signed an executive order directing the federal government to promote corporate competition. Among the key planks of that enhanced scrutiny are big tech’s mergers and acquisition strategies and data collection efforts. 

“Big tech is on the radar screen more than ever,” Eleanor Fox, professor of trade regulation at NYU Law School, told Bloomberg last week. “With Biden and the FTC on the same page, the biggest tech companies aren’t going to be able to just buy up all their competitors like before.” 

Congress likewise looks to make its mark in bringing those West Coast high-fliers down to earth.  Last month, the House Judiciary panel approved a half-dozen antitrust bills, including the “Ending Platform Monopolies Act,” which would make it easier for government to intervene and break up big tech. While those bills have yet to be put to vote on the House floor, members of the Senate Judiciary Committee on either side of the aisle are putting together similar legislation, Bloomberg reported yesterday. Chuck Grassley (R-Iowa) declared Tuesday that “we have to take some dramatic action,” while Amy Klobuchar (D-Minnesota) noted Monday that she was in negotiations with Republicans to introduce a number of bills, adding “stay tuned.” 

With Silicon Valley now firmly in Washington D.C.’s crosshairs, what will become of the bull market which has become ever more reliant on that cadre of tech giants? Longtime Merrill Lynch fixture Bob Farrell, Wall Street’s greatest market technician by the lights of 16 separate annual Institutional Investor polls and speaker at the spring 2019 Grant’s Conference, put it this way in the seventh entry of his 10 rules for successful investing: “Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.” 

One thing’s for sure: Antitrust-focused attorneys won’t be in want of gainful employment anytime soon. A Monday dispatch in The American Lawyer noted that law firms are scrambling to secure sufficient staffing to handle an expected influx of new business, as Uncle Sam and big tech get set to do legal battle. “I believe we’re in for a very dynamic time,” Ted Hassi, partner at Debevoise & Plimpton, told the Lawyer. “Everyone I speak to is incredibly busy.”

QE Progress Report
Reserve Bank Credit rose by $31.9 billion from a week ago, pushing interest-bearing assets on the Fed balance sheet to $8.08 trillion.  That’s up 9.9%, year-to-date, 16% from a year ago and 114% from July 2019. 
Recap July 15

Stocks came under modest pressure for a second day, with the S&P 500 and Nasdaq 100 declining by 30 and 70 basis points, respectively, to dip into negative territory for the week. Treasurys continued their relentless rally with the long bond diving to 1.93%, gold edged higher to $1,830 to maintain its warm streak and WTI slipped to $71.5 a barrel.  The VIX rose to 17 but finished well off its session high.  

- Philip Grant

07.14.2021
All Things Reconsidered
Markets make opinions, crypto edition.

Markets make opinions, crypto edition. Last week, Guggenheim chief investment officer Scott Minerd told CNBC that he believes bitcoin is undergoing a “crash” that could take the price to as low as $15,000.  That’s a stark reversal from late last year, when the digital ducats broke to a then-record high near $21,000 and Minerd concluded that “our fundamental work shows that bitcoin should be worth about $400,000.”

Other Wall Street luminaries are similarly rethinking the digital revolution. For instance, consider the below headline from Decrypt on April 15, two days after bitcoin logged its high-water mark near $63,000:

BlackRock CEO Sings Bitcoin’s Praises as Future ‘Great Asset Class’

That was then. A headline from CoinDesk today, with the price cut nearly in half from three months ago, strikes a different tone: 

BlackRock CEO Larry Fink Says There’s ‘Very Little’ Demand for Crypto

Bail Mary
All aboard in the Middle Kingdom:

All aboard in the Middle Kingdom:  Foreign investors around the world hold a record $806 billion worth of Chinese assets, the Financial Times reports today. That’s up more than 40% from a year ago.  Bond holdings account for nearly three-quarters of that sizable sum. 

A dovish policy pivot colors that capital influx into the world’s second-largest economy. Last Friday, the People’s Bank of China slashed the reserve ratio requirement, or the amount of cash that banks must hold for a rainy day, by 50 basis points, unleashing some $154 billion in previously dormant cash into the financial system. The PBoC’s move follows months of softer-than expected loan growth and a relatively sluggish pace of money supply expansion. A further 50-basis-point cut is forthcoming later this year, economists surveyed by Reuters yesterday predict. 

“It is a signal, it’s a higher profile message I think, that the authorities are paying attention and alert to the possibility of downside risks,” Andrew Tilton, chief Asia economist at Goldman Sachs, told CNBC Monday. 

Rising distress in the local credit market represents one such pitfall. Some RMB 99 billion ($15.3 billion) worth of onshore bonds defaulted over the first six months of the year, a 35% increase from last year’s pandemic-addled total.  “We expect the number of defaults to jump in the next few months,” Wang Feng, chairman of Shanghai-based Ye Lang Capital, tells the South China Morning Post today. “Real estate companies and some debt-ridden state-owned enterprises are grappling with difficulties in managing their cash flows and are being closely watched.”

Property developer China Evergrande (3333 on the Hang Seng), Asia’s largest issuer of junk bonds and the world’s most-encumbered real estate firm, has earned no small dose of scrutiny. Higher-ups at China’s Financial Stability and Development Committee “urged” Evergrande founder and chairman Hui Ka Yan to “solve his company’s debt problems as quickly as possible,” Bloomberg relayed last week.  The discussed remedies include bringing strategic investors on board to help fortify the company’s shaky financials.   Net debt footed to RMB 570 billion in late June, which is down from RMB 717 billion at year-end but still equivalent to nearly seven times consensus 2021 adjusted Ebitda. The company hopes to trim that burden to RMB 350 billion by mid-2023, as it attempts to reach compliance with regulators’ three red line restrictions governing property sector balance sheets. 

Asset sales represent another avenue toward that goal, though the developer seems less than eager to embrace this strategy.  Evergrande yesterday responded to Chinese social media reports that it will sell property worth billions of dollars to rival firms by telling English language news service Yicai Global that it “reserves the right to hold such rumor spreaders legally accountable.”

Financial engineering, on the other hand, is front and center in the corporate “toolkit.” Bloomberg noted last week that Evergrande has turned to short-term commercial bills (which are not classified as debt securities) to finance itself, with its primary onshore subsidiary owing some $32 billion of those IOU’s as of December. “The amount of Evergrande’s outstanding commercial bills is massive,” Dong Ma, partner at BG Capital, observed. “It has apparently become a vital fundraising channel.”  B2/single-B-plus-rated Evergrande’s dollar-pay, senior-secured 8 3/4% notes due 2025 changed hands today near 65 cents, for a 2,191 basis point spread over Treasurys. A 1,000 basis point pickup typically connotes distress. 

The key question for the bulging ranks of China’s foreign creditors: might Beijing ride to the rescue if Evergrande proved unable to pay its debts?  Last week, a development fund led by the Jiangsu provincial government purchased a 16% stake in e-commerce outfit Suning.com, a subsidiary of conglomerate Suning Appliance.  Suning fell into distress after now deposed co-founder Zhang Jindong waived an RMB 20 billion payment due from Evergrande in September, a move that helped “his friend and Evergrande chairman Hui Ka Yan save his own company,” Bloomberg noted last month.

The transaction is an ominous development, some observers believe. A report from CreditSights last Wednesday argued that, rather than a bailout of existing debt-holders, capital injections of that nature serve to allow “local governments with good financial resources to acquire strategic investments at bargain prices. . . it is worth noting that the Jiangsu government did not directly inject capital into Suning Appliance but only invested in the crown jewel of the company, Suning.com.”  CreditSights also offered the following caveat: “government-backed liquidity assistance typically emerges in the debt restructuring process and might not be timely enough to avoid bond defaults.”

Recap July 14

Treasurys continue to evince little concern over recent inflation data, as a strong rally across the curve left the long bond yield at 1.98%, while stocks gave back early gains to finish little changed. Gold rose to a near one-month high at $1,829 an ounce, WTI crude slipped below $73 a barrel and the VIX pulled back to near 16. 

- Philip Grant

07.13.2021
Pop and Shop
Up, up and away:

Up, up and away: This morning’s eye-catching release of the June Consumer Price Index featured no shortage of superlatives.  Headline prices jumped 0.9% sequentially (nearly double the 0.5% consensus) and 5.4% from a year ago, each at their fastest pace since 2008, while the 4.5% year-over-year advance excluding food and energy marked the hottest reading since November 1991, more than double the Federal Reserve’s 2% annual inflation target. 

Yet perhaps tellingly, interest rate futures betrayed no concern that the current price pressures will disrupt the Fed’s oft-verbalized hypothesis that inflation will prove transitory. Alex Manzara, interest rate options trader at R.J. O’Brien, relays this morning that key calendar spreads in the Eurodollar market barely budged following the CPI release, continuing to price in less than 100 basis points of Fed Funds rate hikes between December 2022 and December 2024. 

The potentially imminent downside reversal of one soaring component could help bolster that transitory rationale. Measured used vehicle prices, weighted at 3.2% of the index, sped higher by 10.5% from May and 45.2% from a year ago, accounting for nearly half of the 0.9% sequential headline increase in core CPI.  Yet other indicators suggest that the remarkable rise may finally be abating, as the Manheim Used Vehicle Value Index ticked lower by 1.3% in June from a month ago, marking the first decrease since December. 

Other data paint a different picture.  The National Federation of Independent Business survey for June found that a seasonally-adjusted, net 47% percent of owners reported raising average selling prices, the highest reading since January 1981, while a net 39% of respondents face rising employee compensation costs, up from 34% in May to mark the highest reading on record going back to 1984.  Nearly 90% of small employers attempting to add staff report finding few or no qualified candidates for the position.  

Larger corporate concerns are likewise scrambling to adjust to the new, perhaps-transitory price regime.  This morning, packaged food behemoth Conagra Brands cut its earnings forecast for the next four quarters by about 7% on account of accelerating input costs. While management now expects price pressures “to be materially higher than we anticipated,” three months ago, the c-suite promised investors an “aggressive and comprehensive action plan. . . which includes broad-based pricing [increases].”  The food at home subcomponent accounts for a 7.65% weighting in the headline CPI. 

Perhaps most concerningly for those espousing the transitory inflation argument, the crucial shelter component, which accounts for nearly one-third of the total index, could be set for a protracted upside march. For context, owners’ equivalent rent (or the estimated rental rate that homeowners could achieve), which commands a hefty 23.7% index weighting, grew by a relatively modest 2.3% from a year ago in June, while rent of primary residence (a measure of contracted rental prices), which counts for 7.6% of the total, rose by just 1.9%.  That’s well below the 3% to 4% annual increases for each seen across 2018 and 2019. 

Noting that one-year rental lease terms produce a lagging effect, and that inflation metrics capture current rents (where owners are often reluctant or legally unable to raise rents on existing tenants), rather than asking prices on vacant units, a June 9 report from Fannie Mae economist Eric Brescia concluded that changes in measured house prices typically lead the shelter metrics in CPI by about five quarters. Thus, a decline in asking rents as the bug bit last year is likely still being reflected in the data.  

As Brescia noted, the national rental market bottomed in the fourth quarter of 2020 and has since shown signs of a rapid rebound. Using a model incorporating the change in house prices, inflation expectations and rental vacancies, the economist predicts that the shelter component will account for 1.9 percentage points of the core CPI by the second quarter of 2022, approaching the Fed’s entire inflation target by its lonesome.  “If inflationary expectations move up more aggressively then we assumed or house prices fail to decelerate in 2022,” Brescia warns, “inflationary pressure would be even stronger and could persist well into 2023 or 2024.”

Meanwhile, the monetary mandarins at the Federal Reserve, evidently in no hurry to relax their unprecedented virus-era stimulus, instead adjust their rhetoric in the face of scalding inflation data. The following visual aid from rates and volatility trader Jessica Nutt via Twitter summarizes one way of looking at the current evolution, using commentary from San Francisco Fed president Mary Daly: 


 

Recap July 13

Treasurys initially held firm after this morning’s CPI data, but a soft long bond auction was a different story: rates ended the day well higher across the curve, with the 10- and 30-year yields settling at 1.42% and 2.05%, respectively.  Stocks similarly reversed early gains with the S&P 500 finishing lower by 35 basis points, while the VIX rose 6% to 17.  Gold edged higher to $1,808 an ounce, and WTI crude jumped back above $75 a barrel.  

- Philip Grant

07.12.2021
Heaven's Gate
“Welcome to the dawn of a new space age,”

“Welcome to the dawn of a new space age,” tweeted Richard Branson yesterday.  The British billionaire’s successful foray into suborbital space yesterday duly stirred animal spirits, as shares in his Virgin Galactic Holdings, Inc. (SPCE on the NYSE) touched a record $59.99 in the pre-market, up more than 150% year-to-date. 

SPCE’s voyage represents a “massive marketing coup,” writes Canaccord Genuity analyst Ken Herbert, a triumph which the company wasted no time in attempting to monetize. Virgin announced in a filing this morning that it will sell up to $500 million worth of common equity through a trio of investment banks, catalyzing a sharp reversal to leave shares south of $41 at the bell, down 18% from Friday’s close.  

Intraday roller-coaster aside, Virgin Galactic, which was at the vanguard of the recent special purpose acquisition company boom with a stock market debut back in October 2019, remains the apple of Mr. Market’s eye. Pre-revenue SPCE, which burned through $240 million of cash over the 12 months through March 31, currently commands a $9.5 billion enterprise value, equivalent to 17 times consensus 2025 revenue and 65 times adjusted Ebitda four years from now. 

Meanwhile, a fellow would-be space explorer and stock promotion expert provided his imprimatur.  The Wall Street Journal reports today that Tesla CEO Elon Musk has purchased a ticket on a future Virgin Galactic voyage. Branson may reciprocate, telling London’s Sunday Times that “Elon’s a friend and maybe I’ll travel on one of his ships one day.” 

Dream Catcher
High hopes abound as second quarter earnings season gets underway this week.

High hopes abound as second quarter earnings season gets underway this week.  S&P 500 components will grow their bottom lines by a cool 63.6% from last year’s pandemic-depressed levels, if estimates from FactSet are on point.  That would mark the fastest pace of year-over-year earnings growth since the end of the financial crisis in 2009.  

During the second quarter, Wall Street analysts bumped up their aggregated earnings estimates across the S&P 500 to $45.03 a share from $41.97.  That 7.3% bottom-up estimate increase is the highest since FactSet began tracking the metric in 2002.  On average, analysts have trimmed their bottom-up earnings projections by 4% during each quarter over the past 10 years.  Early indications on that front are validating today’s atypical optimism:  66 S&P 500 companies issued positive earnings guidance relative to expectations this quarter as of July 2, marking the highest such proportion going back to at least 2006. 

Of course, that prospective windfall looks to be thoroughly discounted by eager investors, as the broad equity index has enjoyed a 17% year-to-date advance and sits at nearly double its March 2020 nadir.  The S&P 500 trades at nearly 22 times forward earnings, FactSet notes, well above the five- and 10-year averages of 18.1 and 16.1 times, respectively. 

Recent earnings boom aside, today’s fancy valuations are increasingly divorced from traditional fundamental underpinnings. As Bloomberg’s Cameron Crise has observed, equities derive their value from their net assets and future earnings prospects, as well as a third, vaguer component encompassing the expectations of a better tomorrow. To that point, a chart prepared by Bianco Research president and eponym Jim Bianco last week shows that just 36% of the S&P 500 valuation can be attributed to the index’s current book value and net present value of earnings estimates over the next three years.  The surplus 64% “hopes and dreams” component represents the highest proportion of the S&P 500’s value since 2000. 


 
That Y2K-era analogue should give investors pause, considering the dismal epoch which followed.  Jill Mislinski, research director at Advisor Perspectives, notes today that once the worm turned following the early 2000 market peak, it took the S&P 500 until mid-2007 to briefly reclaim its nominal peak price level. Of course, the financial crisis followed soon thereafter, and the broad index failed to reclaim its 2000 bull market crest again until early 2013.  The tech-heavy Nasdaq didn’t manage to match its March 2000 high water mark until 2015.  Adjusted for inflation, as measured by the CPI, the S&P and Nasdaq remained underwater for 15 and 18 years, respectively, after the tech bubble burst.

Recap July 12

Smooth three- and 10-year Treasury auctions headlined a day of gently rising yields, as the 10-year note finished the day at 1.37%, while stocks enjoyed a modest bid with the S&P 500 cruising higher by 35 basis points to log another fresh high.  Gold and WTI crude each edged lower to $1,806 an ounce and $74 a barrel, respectively, and the VIX gave back an early 8% advance to remains near 16 at day’s end. 

- Philip Grant

07.09.2021
The Icky Shuffle
Talk about cashing your chips.

Talk about cashing in your chips.  Peter Thiel-backed crypto exchange startup Bullish Global will join the SPAC parade, announcing this morning that it will merge with blank check firm Far Peak Acquisition Corp., which is helmed by former New York Stock Exchange president Tom Farley.  The deal will be valued at a cool $9 billion, Bullish projects. 

This price tag is eye-catching even in the context of the current everything bubble.  Risk factors in the Bullish investor presentation put it this way: “as an early stage company entering a highly competitive market with a limited operating history, the operations of Bullish are nascent, unproven and subject to material legal, regulatory, operational, reputational, tax and other risks.”  What’s more, “Bullish has not yet fully developed, tested or launched any products.” 

As for Farley, who will serve as CEO of Bullish upon completion of the transaction, it’s back in the saddle.  Four years ago, the then-NYSE boss had this to say about short selling in testimony to the House Financial Services Committee: “It feels kind of icky and un-American, betting against a company.”

Better to be Bullish, it seems. 

Private Equity
The European Central Bank unveiled the results of its first strategy review in 18 years yesterday,

The European Central Bank unveiled the results of its first strategy review in 18 years yesterday, featuring a material tweak to its longstanding policy goal of measured inflation of near, but less than, 2% per annum.  Instead, Frankfurt will now target a 2% “symmetric” inflation rate, meaning that deviations below that figure are just as undesirable as hotter readings north of 2%.  

ECB president Christine Lagarde added in the subsequent press conference that she would utilize “especially forceful or persistent monetary policy action” in the case of stubbornly lagging inflation.  That line is telling as headline CPI has averaged just 0.9% on a year-over-year basis since the central bank first cut its deposit rate below zero in June 2014. The ECB is charged with a single mandate of maintaining price stability, as opposed to the Federal Reserve’s dual mandate of stable prices and full employment. 

“The symmetry point is something that Lagarde has been talking about for some time,” wrote Marchel Alexandrovich, senior European economist at Jefferies. “All things being equal, the new target allows the doves on the council to argue for the ECB continuing with easy monetary policy.”   The potential for even easier money looms, some believe. “Lagarde is leaving the door open for further forceful action,” Annalisa Piazza, analyst at MFS Investment Management, tells the Financial Times

Some on the policy-setting Governing Council appear reluctant to pursue such an escalation, as minutes from the June meeting published today show that the body debated scaling back asset purchases under the €1.85 trillion ($2.2 trillion) pandemic emergency purchase program, a facility which has €615 billion of funds remaining as of June 30 and is scheduled to run through March of 2022.  

In the end, the council opted for the status quo, deeming that financial conditions were “too fragile” to pull the monetary training wheels.  Lagarde had forcefully argued against early tapering in May, deeming any such discussions “far too early” and “actually unnecessary.” Benchmark German 10-year yields currently crouch at minus 0.3%, with French and Greek 10-year paper priced to yield 0.05% and 0.73%, respectively, while, between the PEPP and public sector purchase program (which ran from 2015 to 2018, then resumed in fall 2019), the ECB directly holds about €3.6 trillion of sovereign bonds, equivalent to some 37% of euro area government debt securities outstanding. 

With the sovereign bond market duly brought to heel, high-minded considerations rise to the forefront: The ECB announced yesterday an “ambitious roadmap to further incorporate climate change considerations into its policy framework.” In particular, climate change will figure in policy decisions ranging from corporate sector asset purchases to financial disclosures and risk assessment communications. “We would be failing on our mandate if we did not account for climate change when it comes to understanding and measuring inflation,” Lagarde reasoned last month.

Imminent regulatory action should complement the central bank’s eco-conscious goals. Next week, the European Commission will propose revisions to a 2003-era energy directive, mandating a 65% drop in emissions from new cars sold by 2030 from current levels with a zero emission goal by 2035. The Commission will also look to impose a Europe-wide minimum levy on jet fuel usage, per draft documents.

Those sweeping new policies won’t prove too inconvenient for the Old Continent’s elite, it seems. As Argus Media reported Tuesday, EU Commission draft rules carry an exemption for private jet usage, under a classification for aviation of passengers or goods as an “aid to the conduct of their business.” Then, too, “’pleasure’ flights, whereby an aircraft is used for ‘personal or recreational purposes’” will also enjoy an exemption from the new tax regime, Argus notes.  

Such a loophole is no small detail, as a single four-hour private flight produces eight tons of C02 emissions, equivalent to a full year’s worth of such pollution from the average citizen, Belgium based Transport & Environment finds.  Private jet emissions rose by 31% from 2005 to 2019, topping the 25% seen in commercial aviation over that period, while private travel activity returned to its pre-covid levels by July of 2020, as commercial flights languished at 60% below the prior year levels. 

That’s a relief

Recap July 9

Stocks caught a strong bid to erase yesterday’s losses, leaving the S&P 500 up by 1.1% for the week and 16.3% year-to-date, while Treasurys pulled back from their torrid recent rally with the 10- and 30-year yields jumping to 1.36% and 1.99%, respectively.  Gold rose to $1,809 for its sixth green finish in seven tries, WTI advanced to near $75 a barrel and the VIX retreated to near 16 to complete a two-day round trip. 

- Philip Grant

07.08.2021
Team America
Keeping the band together:

Keeping the band together: With Fed chair Jay Powell’s four-year term set to expire in less than eight months, a former colleague and Biden administration bigwig likes what she sees. Treasury Secretary Janet Yellen “has told those close to her that she has a good relationship with Powell, and is pleased with how he has steered monetary policy through the pandemic-induced crisis,” Bloomberg reported yesterday.  That support could be crucial for Powell’s prospects of renomination, as alternative candidates more closely “aligned with administration priorities such as inequality and tighter banking regulations” remain under consideration.

While palace intrigue takes center stage in D.C., a seismic policy shift quietly continues as the monetary mandarins reverse one element of the unprecedented stimulus measures launched during last year’s depths.  The New York Fed noted in a statement this morning that it will begin “gradual and orderly” sales from its corporate bond portfolio held under the Secondary Market Corporate Credit Facility, beginning Monday. 

The SMCCF, established on March 23, 2020, accumulated a relatively modest $13.8 billion in corporate bonds and ETFs before the Fed announced the beginning of ETF sales last month (sometimes, it’s the thought that counts). The central bank has set a Dec. 31 deadline for full liquidation of the portfolio. 

Cain and Stable
Cryptos and blank check firms: a match made in heaven?

Cryptos and blank check firms: a match made in heaven? Fintech concern Circle Internet Financial, Inc., issuer of the USD Coin (USDC), will go public via a merger with Concord Acquisition Corp., Circle announced today.  The entity will be listed on the NYSE under the ticker CRCL upon completion of the deal, at a $4.5 billion valuation.  

Circle, which offers a high-minded mission of “raising global economic prosperity through the frictionless exchange of financial value,” has lofty aspirations to match. The company, issuer of the second-largest stablecoin, or digital currency purportedly backed one-for-one by U.S. dollars, cites a total addressable market of $165 trillion, composed of $130 trillion in global M2 money supply and $35 trillion in global payments.

Of course, pie-in-the-sky financial projections from SPAC-affiliated companies are old hat, a phenomenon that has recently drawn the attention of key regulators (Almost Daily Grant’s, May 19). Circle predicted that assets under management will soar to $190 billion by the end of 2023 from $25.9 billion today. Total revenue will foot to $886 million in 2023, a 177% compound annual growth rate from this year’s projected $115 million top line, while active accounts will jump to above 30,000 in 2023 from 2,786 accounts expected this year, if management projections are on point. 

That breakneck pace of growth will likely translate to a modest bump in its gussied-up bottom line, as adjusted Ebitda would foot to $76 million in 2023, compared to an expected $76 million adjusted Ebitda loss this year. Favorable external forces, rather than rapid growth, may be the ticket to corporate prosprity.  A simultaneous 200 basis point jump in the yield curve next year would equal $940 million in incremental interest income, the company reckons. Such a move in 2023 would spell a $2.22 billion windfall. 

Yet unwelcome regulatory attention could serve to disrupt that stairway to financial Valhalla.  The Internal Revenue Service seeks documentation of customers who have undertaken crypto transactions equivalent to $20,000 or more on the venue between 2016 and 2020, the Department of Justice announced in April.   U.S. District Judge Richard Stearns acceded to the IRS summons, writing that “there is a reasonable basis for believing that cryptocurrency users may have failed to comply with federal tax laws.” 

Legal scrutiny has also served to exacerbate missteps from the c-suite. The company disclosed today that it took a $156.8 million loss stemming from its ill-fated acquisition of crypto exchange Poloniex in early 2018, near the first peak of crypto prices. Beyond a realized loss on the subsequent resale of Poloniex for $33.2 million in 2019, Circle also noted that it has accrued a $10.4 million contingent liability for a Securities and Exchange Commission complaint against Poloniex “with regards to the trading of cryptocurrencies that may be characterized as securities.” Furthermore, Circle estimates that a pair of subpoenas from the Treasury Department’s Office of Foreign Assets Control and an “Iranian government agency” concerning potential sanctions violations will result in further penalties of up to $2.8 million.

Meanwhile, a familiar problem stalks USDC: questions over the composition of assets backing the world’s second-largest stablecoin, just as with its larger peer Tether. CoinDesk columnist JD Koning noted Tuesday, that, as recently as Feb. 28, 2020, Circle held all customer accounts at U.S. banks under the auspices of the Federal Deposit Insurance Corp. In a subsequent attestation a month later, Circle added the category “approved investments,” suggesting that it was branching out into less secure collateral in hopes of generating income as short-term yields collapsed.  That is a particularly significant change considering that USDC issuance has mushroomed by more than 50-fold from the $400 million outstanding in early 2020. Then, too, Koning notes, different state laws allow for sometimes drastically divergent standards in terms of what constitutes approved investment products, leaving outside observers guessing as Circle declines to disclose which state guidelines it follows.

See the brand new edition of Grant’s Interest Rate Observer dated July 9 for more curious doings in crypto. 

QE Progress Report
Reserve Bank Credit, or interest-bearing assets at the Fed, rose to $8.048 trillion, up $8 billion from last week’s reading.  That’s up 9.5% year-to-date, 14.7% over the past 52 weeks and 114% from July 2019.
Recap July 8

The feverish rally in Treasurys put the crimps on stocks today, as the S&P 500 lost nearly 1% to erase its gains for the week as the 10-year yield fell to 1.29% and the long bond to 1.92%.  The VIX advanced to 19, extending to a 26% three-day gain after logging a fresh virus-era low on Friday, while WTI crude bounced back above $73 a barrel and gold held just over $1,800 an ounce.  

- Philip Grant

07.06.2021
On the Boil
“The lake is so warm you feel like you’re in a hot tub,”

“The lake is so warm you feel like you’re in a hot tub,” Abi Buddington of Dresden, New York complained to NBC News yesterday regarding Seneca Lake, the deepest such body of water in the Empire State.  The apparent culprit: a gas-fired power plant on the shoreline which has been repurposed for the lucrative practice of cryptocurrency mining. 

The plant, operated by private equity-sponsored Greenidge Generation, LLC, utilizes at least 8,000 high-powered computers to accumulate digital ducats by performing mathematical crossword puzzles. The firm is looking to expand its mining operations.  

While the facility failed inspection on 16 of the 17 items reviewed by the Environmental Assessment Office last fall, the current economics of the project speak for themselves.  Greenidge CEO Jeff Kirt relays that the company mined 1,186 bitcoins at an average cost of $2,869 over the 12 months through Feb. 28, compared to the $34,000 currently fetched on the open market. 

Twin Peaks
The bond market rides again.

The bond market rides again.  As Treasury yields retain a powerful downward momentum with the long bond dipping below 2% for the first time since February, capital continues to pour into the asset class. Citing data from the Investment Company Institute, the Financial Times notes today that domestic fixed income mutual funds and ETFs have attracted $372 billion this year through June 23, more than double the $160 billion in equity flows over that period.  

That’s a pronounced divergence from overseas trends, as global equity funds have gathered a whopping $580 billion net inflow through the first two quarters of the year. This exceeds the total combined capital influx of the past two decades, Bank of America strategist Michael Hartnett finds. 

As the U.S. stock market has enjoyed a towering post-pandemic advance, with the S&P 500 virtually doubling from its March 2020 nadir to reside at its most expensive cyclically-adjusted valuation since the tech bubble, some big players look to cash in their chips. “Pension plans are today at much better funding levels, and it is a prudent strategy to lock in their equity gains and immunize the portfolio against the risk of a large drawdown in stocks,” Mark Vaselkiv, chief investment officer of fixed income at T Rowe Price, tells the FT. “We expect a further rotation into bonds from asset allocators.” 

While sticker shock and flagging internals (Almost Daily Grant’s, June 18) may make prospective U.S. equity investors think twice, the specter of non-transitory inflation continues to loom over “risk-free” Treasurys, given that benchmark interest rates remain well below zero on a real basis (the Core Personal Consumption Expenditures Price Index rose by 3.4% year-over-year in June, the hottest reading since 1992).  The corporate sector has duly taken notice of the post-pandemic regime change. A June 4 chart prepared by London-based Ruffer LLP shows that a net 35% of U.S. companies reported higher selling prices this year, the highest such proportion since at least 1986.  

A non-transitory bout of price pressures could carry major implications. A June 16 analysis from AllianceBernstein president and CEO Seth Bernstein in the FT argues that, with monetary and fiscal policy now working in concert to promote reflation along with economic recovery, fixed-income investors are facing growing duration risk as ever-dwindling yields have left bond prices increasingly sensitive to changes in interest rates.  That setup carries ramifications for the traditional 60% equity and 40% fixed income portfolio allocation, which has long benefited from a negative correlation between stocks and bonds, i.e., weakness in one asset class would typically be balanced by countervailing strength in the other. Persistent inflation could well imperil that dynamic. 

Accordingly, Bernstein believes that investors should increase allocations to so-called real assets such as infrastructure and real estate, and also pursue the anachronistic strategy of buying securities at a discount to their intrinsic worth, or value investing. Bernstein argues that “such assets generally have higher yields and so a larger part of the present value is from cash flows in the near term. Hence, they are less sensitive to shifts in long-run interest rates.”

What other lessons might financial history have to offer at this potentially pivotal moment? For an in-depth review of the prevailing conditions and factors which helped the great inflation of the 1970’s take shape, along with informed speculation of what’s to come, see the June 11 edition of Grant’s Interest Rate Observer

Recap July 6

Stocks shook off some intraday losses with the S&P 500 erasing the bulk of a near 1% pullback to finish within 20 basis points of unchanged, while the Nasdaq edged into the green to log another fresh high. Treasurys finished near their best levels of the day with the 10-year yield settling at 1.37%, down from 1.57% less than three weeks ago. A stronger dollar didn’t stop gold from pushing to near $1,800 an ounce for its best finish since June 16, though WTI crude saw a violent reversal to finish south of $74 a barrel after ticking above $77 this morning.  The VIX settled at 16.5, after ascending to near 18 in midday. 

- Philip Grant

07.02.2021
Dry Heat

From the Associated Press:

Police arrested an Ankeny [Iowa] man after he threatened to blow up a McDonald’s restaurant for neglecting to include dipping sauce with his order of chicken McNuggets.

Big Blew It
International Business Machines’ extensive 18-month email server migration has “gone off the rails,”

International Business Machines’ extensive 18-month email server migration has “gone off the rails,” leaving numerous employees frozen out of the system, tech news site The Register reported Wednesday.  “[Microsoft] Outlook won’t work with the new system, IBM Notes won’t work and the online email called Verse has now gone down,” one company insider groused. “Everyone has been affected and no fix is in sight.”  The snafu is telling, as another employee offered this rhetorical query: “If we can’t even handle our own cloud migration program then why would any customer trust us? 

While the optics of such an internal lapse are less than ideal, IBM pushes on. A spokesperson assured The Register (by phone) that the company is “leveraging a variety of alternative communications tools to ensure minimal disruption to our clients and business while we work to restore full email capabilities.”

See the Feb. 21, 2020, edition of Grant’s Interest Rate Observer for a bearish analysis of this longtime pick-to-not-click. 

Certitude, Inc.
You can't accuse them of mixed messaging.

You can’t accuse them of mixed messaging.  As percolating prices accompany post-virus recoveries across the West, key central bankers continue to bang the drum for ongoing monetary stimulus in tandem with near-zero (or negative) benchmark interest rates in hopes of further greasing the wheels of commerce. 

“We’ve made some progress for sure. We’ve seen progress in employment, we’ve definitely seen a big increase in inflation,” New York Fed president John Williams observed at a virtual meeting June 21. Still, the central banker concluded that: “we are quite a ways off from achieving my interpretation of substantial further progress” needed to curtail the $120 billion pace of monthly asset purchases, let alone an increase in the current 0 to 0.25% federal funds rate. 

As one of the Fed’s most influential members advocates keeping the pedal to the metal, the labor market continues to mend.  This morning’s reading of June payrolls showed headline unemployment at 5.9%, nearly matching the post-WWII average of 5.8%, while the broader U6 “underemployment” metric of 9.8% was below the 10.4% mean going back to 1993. Headline nonfarm payrolls footed to 146.5 million, down from the 153.1 million peak logged right before the virus barged in but nearly matching the five-year average of 147 million. 

On the other hand, the core Personal Consumption Expenditures Price Index jumped by 3.4% year-over-year in May, the hottest reading since 1992 and well above the Fed’s “symmetrical” 2% inflation target.  While the ultimate durability of that surge remains an open question, ongoing supply bottlenecks and labor shortages continue to fuel pockets of raging price pressures in the here-and-now.  A dispatch from The Wall Street Journal today notes that ride share firms Uber and Lyft are forced to serve up increasingly generous incentives to coax drivers onto the road.  Customers sure could benefit from some additional supply: According to data from third party data service Gridwise, fares on those platforms rose by 79% in the second quarter from their pre-pandemic, 2Q 2019 levels.  That comes three days after the release of the S&P CoreLogic Case-Shiller National Home Price Index for April showed that prices rose by 14.6% year-over-year, the fastest pace on record going back to 1987.

A similar dynamic is unfolding across the pond after measured inflation in the U.K. hit 2.1% year-over-year in May, topping all 33 economist estimates gathered by Reuters and marking the hottest reading since July 2019, when the benchmark interest rate stood at 0.75% compared to 0.10% today.  Bank of England governor Andrew Bailey played down that development in a speech yesterday, declaring that: “We expect this rise in inflation to be a temporary feature of the bounce-back. The reasons for taking this view are well-founded. It is not a vain hope or a matter of whistling in the wind.”  Bailey went on to predict that inflation would reach a 3% annual pace of increase later this year, before duly moderating. 

European monetary mandarins see the future even more clearly. This morning, European Central Bank President Christine Lagarde told France’s La Provence that “we will see a return to lower rates of inflation, as indicated in our projections.”  

Good thing, as the Eurozone CPI rose by 1.9% from a year ago in June, following May’s 2% year-over-year advance to mark the second straight month at or above Frankfurt’s inflation target of just under 2%.  As the ECB is charged with a single mandate of maintaining price stability, as opposed to the Federal Reserve’s dual directive of stable prices with maximum employment and the BoE’s secondary mandates of promoting growth and employment in tandem with low and stable inflation, it would seemingly be difficult for the ECB to justify maintaining its negative 50 basis point benchmark rate and ongoing €1.85 trillion ($2.2 trillion) asset purchase program in the face of lasting price pressures.

Meanwhile, the economy on the Old Continent looks to swiftly rebound, as measured unemployment dropped to 7.9% in May from more than 9% in 2017, while the June IHS Markit Manufacturing PMI showed the briskest pace of activity since at least 1997.  

Recap July 2

Stocks continued to only go up, as the S&P 500 and Nasdaq 100 each rallied by near 1% to wrap up another week higher by 1.7% and 2.7%, respectively, while rates continued their recent strength with the 10-year yield reaching 1.43%, its lowest since early March.  Gold rose to $1,788 an ounce to continue its modest rebound, WTI crude held near $75 a barrel to consolidate recent gains and the VIX set another virus-era low near 15, but did manage to rally 5% off its pre-market nadir. 

- Philip Grant

07.01.2021
Big Blind
Short-staffed companies are raising the ante.

Short-staffed companies are raising the ante.  Upwards of 20% of all jobs on employment website ZipRecruiter.com offer a signing bonus for would-be employees, The Wall Street Journal reports, a 10-fold increase from three months ago.  For hourly workers at a $16 to $25 per hour wage, an initial $1,000 payout “is quickly becoming table stakes.”  

Employers “are basically gambling they can hire workers for a one-time payment,” Brad Hershbein, senior economist at the W.E. Upjohn Institute for Employment Research, tells the Journal. “They are going to try that first, and if it’s not enough, then they will have to [grant] persistent wage increases.” 

It will not be long until we get a look at how those initiatives are faring. The June reading of non-farm payrolls is set to be released tomorrow morning. 

Democracy Dies in Darkness
The Financial Industry Regulatory Authority announced

The Financial Industry Regulatory Authority announced yesterday that is has levied some $70 million in fines and restitutions against ubiquitous free retail trading platform Robinhood Markets, Inc. That’s the largest such set of penalties in FINRA’s history, the self-regulatory organization crowed in a press release.  As part of the settlement, Robinhood admitted no wrongdoing. 

The complaint alleged that Robinhood failed to conduct due diligence on new customers, approving more than 90,000 accounts that had been flagged for potential fraud from June 2016 to November 2018. In addition, said FINRA, the company falsely conveyed to 818,000 customers who had been approved for options trading that their accounts were margin disabled (certain derivatives automatically utilize margin), sewing confusion and potentially exposing risk-averse punters to losses in excess of deposited cash. 

A record financial punishment for FINRA looks to be a mere flesh wound for Robinhood. This afternoon, the company filed a form S-1 with the Securities and Exchange Commission, revealing that first quarter net revenues leapt to $522 million from $128 million in the same period last year, while adjusted Ebitda footed to $115 million from negative $47 million in the first quarter of 2020 and funded accounts more than doubled to 18 million as the meme-stock craze led to an explosion of trading volumes and yielded a corporate windfall. This filing paves the way for an initial public offering later this year on the Nasdaq (ticker: HOOD) at a reported $40 billion valuation, up from $11.7 billion just 10 months ago. 

As the teeming masses flock to the ostensibly free trading venue in hopes of quick riches, peddling customer order flow to the high-frequency trading firms that perform the executions remains Robinhood’s bread-and-butter.  That revenue stream contributed $420 million to the first quarter top line, more than quadruple the $96 million generated in the first three months of 2020.  The practice has caught the attention of newly-minted SEC chair Gary Gensler, who noted in a June 9 speech that he has asked staff to investigate and recommend potential rule changes. 

Robinhood’s public debut would have come even sooner, if not for some further unwanted attention from Washington. Bloomberg noted last week that the still-private firm scrapped plans for a June IPO thanks to SEC scrutiny of its cryptocurrency businesses, which accounted for 17% of first quarter revenue and 14% of client assets under custody as of the first quarter.  That compares to 4% of revenue and 2.5% of custodial assets in the first three months of 2020.  Then again, cozy political connections could help forestall any protracted government crackdown. As Zerohedge notes, Robinhood’s chief legal officer Dan Gallagher previously served as one of five SEC commissioners from 2011 to 2015. Gallagher earned about $30 million in compensation last year, with more than 80% of that coming in the form of stock awards.  

Gallagher’s pay could prove to be money well spent, as he looks to have his work cut out for him in keeping the company out of the soup: As the form S-1 notes, Robinhood has been – and may continue to – be subject to investigations from the U.S. Department of Treasury’s Office of Foreign Assets Control, the Massachusetts Securities Division, the New York State Department of Financial Services and the California Attorney General’s Office. What’s more, the U.S. Attorney for the Southern District of New York has executed a search warrant to obtain the cell phone of CEO Vlad Tenev, the filing reveals. 

While regulators nip at Robinhood’s heels, some observers believe that a future shift in market conditions poses a bigger risk for the trading venue. “I don’t know when meme stocks. . . will crash, but we probably do not have to wait too long,” investor Michael Burry, of The Big Short fame, tells Barron’s today. “I believe the retail crowd is fully invested in this theme, and Wall Street has jumped on the coattails.  We’re running out of new money to jump on the bandwagon.” 

In the meantime, the mission of democratizing finance continues apace.  Robinhood is set to allocate as much as 35% of its upcoming IPO to individual shareholders, the filing shows. That compares to a sub-10% retail allocation on a typical deal. 

QE Progress Report
An $11.5 billion sequential decrease in Reserve Bank Credit left interest bearing assets on the Fed balance sheet at $8.04 trillion.  That’s up 20.7% on an annualized three-month basis, 13.4% year-over-year and 95.5% from the March meltdown seen last year. 
Recap July 1

New quarter, same truism: Stocks only go up.  The S&P 500 enjoyed a 50 basis point gain to extend to a near 1% advance for the week, while the tech heavy Nasdaq 100 eked out a green finish to remain higher by 1.5% for the week so far.  Treasurys went nowhere again with the long bond holding at 2.07%, WTI crude surpassed $75 a barrel to draw nearer to its October 2018 interim highs and gold advanced to $1,777 an ounce.  The VIX logged a fresh virus-era low at 15.5. 

- Philip Grant

06.30.2021
Unforced Majeure
Dancing while the music plays:

Dancing while the music plays: June leveraged buyout volume footed to $69.2 billion through last Friday, Bank of America reported, already matching the second busiest single month on record.  In tandem with that deal derby, second quarter loan issuance used to fund LBOs reached its highest level since at least 2013, Bloomberg relays. 

That LBO loan deluge is pouring into the market for collateralized loan obligations, i.e., packaged and securitized collections of leveraged loans.  A whopping $200 billion in new supply has come to market already this year, representing about a quarter of existing supply as of year-end.  Bloomberg reports that S&P, the go-to rating agency for CLOs, is already booked solid through August, while Nomura reckons that the firm is reviewing more deals than in 2017 or 2018, two previous bumper crop years. 

As the everything bubble continues to swell, aggressive capital structures proliferate. For instance, Covenant Review finds that 42 loan deals with leverage ratios exceeding seven turns of Ebitda came to market this year through mid-June, compared to 20 over the same period in 2019 and just 11 last year. 

                                                                     ***

Rapidly retreating debt covenants, or fine-print legal protections for lenders, accompany those extra dollops of debt. So-called covenant-lite structures featured in 85.2% of total loans outstanding in May, per S&P’s LCD unit, up from about 66% five years ago and just 17% in 2007.  More qualitative metrics tell the same story, as rival rating agency Moody’s reported last month that its proprietary Loan Covenant Quality Indicator (an aggregated, two-quarter rolling average based on the firm’s assessment of individual issues) deteriorated to easily the weakest level on record as of year-end. 

Those loosey-goosey terms can, of course, come back to haunt creditors when things go wrong, as in the case of a $200 million loan issued by private equity-backed mattress maker Serta Simmons Bedding. Recall that, last summer, financially-stressed Serta undertook a debt exchange with a lender group including asset managers Eaton Vance and Invesco, thereby elevating them in the capital structure over another cohort featuring p.e. mainstays Apollo and Angelo Gordon. For their part, the foiled p.e. contingent had sought to shunt the firm’s intellectual property assets into a new subsidiary, out of reach of the rival creditor group.  “They were threatening to absolutely screw us,” claimed Eaton Vance portfolio manager Craig Russ to The Wall Street Journal a year ago.

Wall Street has learned its lesson, sort of.  A Moody’s analysis last week found that only one-third of a sample of 45 leveraged loan term sheets signed in April and May contained express contract provisions preventing that “uptiering” maneuver utilized by Eaton Vance and Invesco. 

More broadly, the proliferation of cov-lite may not fully convey the erosion of creditors’ legal protections across speculative-grade credit. To that end, a series of recent analyses from Covenant Review have compared the documentations of a senior bond issued by Ancestry.com last November with one issued by First Data in fall 2007, a pair of p.e.-backed transactions representing “the worst sponsored deals” seen by the research firm in each cycle.  The verdict:

The Ancestry debt covenant is far worse than the debt covenant for the First Data bonds, and provides significantly more flexibility for incremental debt incurrence. It’s also far more difficult for a high yield analyst to assess incremental debt capacity under the Ancestry debt covenant, as there is far more flexibility for the issuer to ‘hide the ball’ on how future debt is incurred under that covenant or how existing debt is accounted for under that covenant.

The phenomena of increasingly debtor-friendly deal structures are not confined to the 50 states.  A report last week from the European Leveraged Finance Association shone the spotlight on issuers’ continuing usage of “Ebitdac” (that’s earnings before interest, taxes, depreciation, amortization and coronavirus) as a metric for calculating covenant capacity. As ELFA notes, numerous borrowers have argued that they can not only add back Covid-related costs and expenses to their financial metrics, but also estimated pandemic-related revenue losses.  

What’s more, recent credit agreements on both sides of the pond have featured clauses expressly allowing run-rate Ebitda touch-ups based on any costs, expenses, lost revenues or any other negative shocks arising from any future pandemic, not just Covid.  ELFA writes: 

These add-backs could permit the company to make corresponding adjustments for future pandemics or epidemics (arguably, a bad flu season that dampens demand for the company’s products could qualify). To prevent such a use, investors should, at a minimum, request that these clauses reference the WHO definition of a pandemic. 

Unfortunately, the trend in the drafting of these clauses seems to take the opposite position. 9fin [an ELFA-affiliated analytics platform] reports that the most recent examples of this type of clause have been even broader in scope than previous examples, permitting adjustments not only for future pandemics or epidemics, but also for any ‘outbreak, incident, disaster or similar such disruptions out of the Group’s control.’ 

Recap June 30

Stocks edged higher, wrapping up the fiscal second quarter with the S&P 500 and Nasdaq 100 up by 15.3% and 13.4%, respectively, at the halfway point of 2021.   Treasury yields finished little changed as the 10- and 30-year yields finished at 1.46% and 2.08%, respectively, up from 93 and 146 basis points as of Dec. 31. Gold rebounded to $1,774 an ounce to narrow its first-half decline to 6.5%, while WTI advanced above $73.5 a barrel to log a heady 51.5% six-month advance.  The VIX toggled back below 16. 

- Philip Grant

06.29.2021
Third Time's the Charm?
Tom Brady and Gisele Bundchen will serve as corporate ambassadors

Tom Brady and Gisele Bundchen will serve as corporate ambassadors for crypto derivatives exchange FTX. As part of the deal, the supercouple will receive an undisclosed sum of undisclosed cryptos, as well as an equity stake in FTX. 

“Tom and Gisele are both legends and they’ve both reached the pinnacle of what they do,” Sam Bankman-Fried, the 29-year-old founder and CEO of FTX, tells Bloomberg. “When we think about what FTX represents, we want the best product out there.”  The digital venue is quite literally out there, as it “does not onboard or provide services to personal accounts of current residents of the United States of America.”

Epic professional success aside, the timing of the pair’s previous financial initiatives has left something to be desired. On May 10, seven-time Super Bowl champ Brady donned the “laser eyes” flourish on his social media, denoting his devotion to crypto.  The price of bitcoin has since declined by 37%.  

More traditional currency trades have also gone astray, as supermodel Bundchen unfriended the dollar in fall 2007, demanding to be paid in euros instead.  By spring 2015 the euro had slipped to $1.04, down from $1.40 at the time of her proclamation. 

Hazard Lights
Walking the policy tightrope in the Middle Kingdom:

Walking the policy tightrope in the Middle Kingdom: The People’s Bank of China declared in a statement yesterday that the economy is “operating in a stable manner with more strength and improvement,” an upbeat assessment compared to the outlook three months ago.  The monetary mandarins went on to pledge to cooperate with global economic policies to help forestall “external shocks.”  

That communique establishes “a reassuring policy tone” and “should dispel some fear of more pronounced policy tightening,” economists from Citigroup write.

Things indeed look to be on the upswing, at least in terms of reported output growth.   Chinese GDP will expand by 8.5%, the World Bank predicts today, far above 2019’s 6.1% rate and nearly quadruple the 2.3% recorded in the pandemic-addled 2020.  

But headline GDP growth will slow to 5.4% next year, if the World Bank’s guesstimates are on the beam, owing to dwindling monetary and fiscal stimulus as well as macroprudential measures such as the three red lines policies governing leverage ratios in the debt-laden property sector.  That projected 2022 figure would represent the slowest growth rate since 1990, a potential problem in light of the country’s massive $50 trillion banking system, more than double that of the U.S. 

Some are taking notice. “I’m a little worried about China,” Hiroyuki Ogawa, president and CEO of Japanese construction giant Komatsu, told Bloomberg last week after the company reported weaker than expected performance in the region. “We’ll need to watch how demand shapes up in the coming months.” 

Yet as the government looks to pull back its pandemic-era support, various credit-related indicators suggest that a more pronounced slowdown may be in the offing. Total social financing, i.e., aggregate credit and liquidity flows, have trailed consensus expectation in each of the past three months. Meanwhile, credit growth as a percentage of GDP resides at an 18-month low and year-over-year M2 money supply growth of 8.3% sits well below the 11.4% 10-year average figure and near its lowest level since at least 1996.    

“Everywhere we look in credit we see record lows, most strikingly in state firm borrowing.” Leland Miller, chief executive of the China Beige Book, commented in an interview today. “More concerning still, firms do not see an improved appetite for capital even by 2022; all eight [geographic] regions reported a drop in six-month borrowing forecasts, six of them to all-time lows.” 

Waning credit availability has ushered in waxing corporate distress, as onshore defaults have reached RMB 97 billion ($14.6 billion) per Macquarie, an annual record for this time of year.  The cadre of floundering borrowers is becoming more significant, as a report from S&P Global last week found that defaulting companies have sported an average RMB 8.7 billion in marketable onshore debt so far in 2021. That’s up from RMB 5.4 billion last year and less than RMB 3 billion in 2017.  The rating agency likewise notes that, thanks in part to a pullback in financing for state-owned enterprises, issuance from sub-triple-A-rated companies is on the hop (Chinese rating agencies are far more likely to bestow that pristine rating than are their Western peers).  

Perhaps most strikingly, net financing for the property sector and local government financing vehicles, each a lynchpin of China’s debt-fueled economic boom, turned negative in May.  That’s the first time since at least the beginning of 2019 in which both categories faced bond redemptions in excess of new issuance. 

With credit flows in retreat, authorities are getting creative in resolving messy situations. Bloomberg reports that retail giant Alibaba will assist the Jiangsu regional government in bailing out stricken peer Suning.com, after the latter had fallen into distress following a string of ill-advised acquisitions.  Alibaba is likely eager to get back in the Communist Party’s good graces after chairman Jack Ma ran afoul of the government last year. Alibaba coughed up a hefty $2.8 billion fine in April to settle allegations of monopolistic behavior. 

Other cash-needy firms may put Beijing’s clean up capacity, and willingness to inflict investor losses, to the test.  Stricken state-owned China Huarong Asset Management disclosed in a filing today that it and its auditor remain unsure when it will be able to publish complete 2020 results, nearly three months after the initial filing deadline.  That comes one day after Bloomberg reported that the government ordered fellow state-controlled entity CITIC Group to investigate Huarong’s books, echoing a similar move utilized with distressed lender China Baoshang Bank in 2019, before Baoshang was subsequently taken over by regulators.  A messy Huarong resolution could reverberate, as the firm carries some $23 billion in offshore debt, counting such Wall Street bold-faced names as BlackRock, Goldman Sachs and Warburg Pincus as investors. 

Recap June 29

Stocks gave back early gains but still managed to eke out the sixth green finish in seven tries for the S&P 500, while Treasurys held yesterday’s rally with the long bond yield edging lower to 2.09%.  Gold declined to $1,762 an ounce, WTI rebounded back above $73 a barrel and the VIX held near 16. 

- Philip Grant

06.28.2021
Compactor Compounder
Score one for the Old Economy.  Richard Bernstein, chief investment officer at and eponym of RBA Advisors, notes on Twitter today that the Dow Jones U.S. Waste and Disposal Services Index has generated 11% annual return over the past 21 years, a period including the bursting of the tech bubble, great financial crisis and the pandemic. That’s nearly double that of the tech-heavy Nasdaq 100. 
Until the Music Stops
Wall Street on sale.

Wall Street on sale.  Boutique investment bank Perella Weinberg Partners made its stock market star turn on Friday (PWP on the Nasdaq), after completing a merger with blank-check outfit FinTech Acquisition Corp. IV.  That marks a seminal event for the firm, which has been the subject of periodic IPO speculation since shortly after its founding in 2006.  

“Perella Weinberg is entering the next phase of scale and growth, with significant runway ahead,” JMP Securities analyst Devin Ryan wrote today. Indeed, global IPO supply has reached nearly $350 billion so far this year according to data from Bloomberg, easily topping the prior six month issuance record of $282 billion set in the latter half of 2020 and on pace to smash the full-year record of $420 billion established in 2007.  Last week saw more than $6 billion in domestic deal volume, the busiest such stretch this year.

An imminent blockbuster debut will further burnish those heady figures.  Chinese ride-share giant Didi Global, Inc. will soon raise up to $4 billion in a New York Stock Exchange listing, promoters expect, establishing the company’s value at about $67 billion in the biggest domestic IPO since Alibaba in 2014.  Scaled back from a previous $100 billion target valuation, Didi is having little trouble drumming up investor interest, as Bloomberg reports that the company will close its order book today instead of tomorrow as previously planned on account of “heightened demand.”  Overall, a hefty 17 domestic IPOs are set for this week, matching the busiest such stretch since 2006.  Some larger entrants also loom this summer: Retail trading platform Robinhood and automobile battery producer Clarios are targeting July debuts at valuations of roughly $40 billion and $20 billion, respectively, per The Wall Street Journal.  

“We’re all drowning in work,” Matthew Kennedy, senior IPO market strategist at Renaissance Capital, tells Axios. “I know the virtual roadshows of some sizable deals are sparsely attended since fund analysts only have so much time. And we’ve definitely noticed an uptick in prospectus typos” (see Friday’s ADG for one such example). 

Naturally, great expectations underpin the euphoric state of the primary markets.  A global survey of 8,550 individual investors conducted by Natixis this spring found that respondents anticipate a 14.5% post-inflation return over the long term, while small American investors expect to generate a whopping 17.5% over the long term, after accounting for inflation. A separate survey of financial professionals generated more modest figures, in the form of a 5.3% global and 6.7% domestic real returns over the long haul. 

Meanwhile, preternatural calm reigns. The Journal’s James Mackintosh notes today that the S&P 500 has not suffered a single 5% drawdown in the last eight months, marking the longest period since 2017 into early 2018 (a streak snapped by a volatility ordnance in February of that year).  For context, the broad market gauge endured nine such 5% pullbacks across 1999, including a 13% correction lasting from July to October of that year. 

In the long run, we’re all rich. 

Recap June 28

It was another red-letter day for the bulls, as the major indices reached fresh records with the S&P 500 gaining 25 basis points and the Nasdaq 100 advancing by 1.2%, leaving the pair higher by 14.2% and 12.7% year-to-date, respectively.  Treasurys were also well bid as the 10-year yield fell to 1.48% and the long bond to 2.1%, while WTI pulled back below $73 a barrel and gold held steady at $1,780 an ounce.  The VIX finished below 16 for a third straight session.  

- Philip Grant

06.25.2021
Show and Tell
Special purpose acquisition companies take to the heavens once more.

Special purpose acquisition companies take to the heavens once more.  News that Virgin Galactic Holdings, Inc. (SPCE on the Nasdaq) has secured Federal Aviation Administration approval to ferry customers into space riled up some major animal spirits, as shares surged by 39% today on 13 times one-year average trading volumes.  Now boasting a market cap of $13.5 billion, SPCE will generate $395 million of revenue and $71 million in adjusted Ebitda in 2024 if analyst consensus is on point, up from zero and minus $280 million, respectively, over the 12 months through March 31. 

Considering that backdrop, it is perhaps no surprise that other prominent names look to join the blank check-backed ranks.  Yesterday, 14-year-old digital media firm BuzzFeed, Inc. announced it will merge with special purpose acquisition company 890 5th Avenue Partners, Inc. at a targeted $1.5 billion enterprise value. A $150 million convertible note offering will help fund the deal. 

The offering appears fortuitously timed, and not only thanks to friendly market conditions.  Aided by some $30 million in expense cuts, the company managed to turn a profit for the first time since 2014 last year, The Wall Street Journal reported. BuzzFeed duly expects the good times to continue, projecting that adjusted Ebitda will jump to $57 million this year from $17 million in 2020, on its way to $117 million in 2022 and $263 million two years after that, with revenues compounding at a 26% compound annual pace to reach $1.06 billion in 2024 (no word yet on 2040). 

Yet as the content aggregator prepares for its star turn, certain details appear to have slipped through the cracks. As John Sinclair Foley, U.S. editor at Breakingviews, pointed out yesterday, the investor presentation slides feature eight (correctly spelled) instances of the word “millennials,” as well as three misspelled ones – “millenials” – on one page.

Say this for BuzzFeed: They know how to make a memorable slideshow. 

Better Late than Never
Wheeling and dealing in the Land of the Rising Sun:

Wheeling and dealing in the Land of the Rising Sun:  Panasonic Corp. has liquidated its equity stake in longtime battery customer Tesla, ending a decade-plus run as a shareholder in the electric car concern and netting proceeds of about $3.6 billion, securities filings show.  That move followed a review of cross-shareholdings ahead of an imminent reorganization of Japan’s equity market (Almost Daily Grant’s, March 26), spokeswoman Yayoi Watanabe explained, while proceeds will be invested in growth initiatives including the purchase of artificial intelligence software developer Blue Yonder at a reported $7 billion price tag. 

Also today, shareholders in 146-year-old conglomerate Toshiba Corp. ejected chairman Osamu Nagayama, in the wake of a shareholder-commissioned independent investigation concluding that the company colluded with the Japanese government to marginalize activist investors. This ouster comes less than two months after Nagayama and the board rejected a $20 billion buyout bid from private equity firm CVC Partners at a 30% premium to the company’s then price, arguing that the approach lacked sufficient detail. 

That Toshiba development marks something of a watershed for foreign investors, long frustrated by Japan’s long-staid corporate culture. “This report should go some way to encourage them, and to give them confidence that Japan takes corporate governance more seriously than it did in the past,” Joe Bauernfreund, chief investment officer of London-based Asset Value Investors, tells Bloomberg. 

Might bullish tidings follow a long-overdue modernization of Japan’s corporate governance protocols? The sub 10-times enterprise value to forward Ebitda valuation fetched by the Topix Index (compared to near 12 times for Europe’s Stoxx 600 and 15 times for the S&P 500) suggests plenty of room for improvement.  See the Jan. 22 and May 28 editions of Grant’s Interest Rate Observer for a series of picks-to-click in the world’s third-largest economic power. 

Recap June 25

The hottest reading of the core personal consumption expenditures index in nearly 30 years (a 3.4% annual increase for May) spurred some bearish action in Treasurys, as the 30-year yield finished the day at 2.15%, up from 2.01% a week ago.  Stocks caught another bid as the S&P 500 cruised higher by 30 basis points to wrap up the week with a 2.7% advance, gold inched higher to $1,780 an ounce and WTI crude continued its bull rampage with a push to near $74 a barrel. 

- Philip Grant

06.24.2021
Read the Footnotes
A half-dozen French soccer fans gamely traveled to Bucharest, Romania, to watch their squad compete in the Euro 2020 championships earlier this week. The only problem: The game instead took place in Budapest, some 500 miles away.  “It’s like we’re in the movie ‘Home Alone’,” lamented one of the stranded fans to Romania’s Jurnalul National. “For me, until today, there was no difference between Bucharest and Budapest. We need to learn more about Europe.” 
Big Game Hunting
“Stocks at 40 times profits are cheap, Wall Street has discovered.”

“Stocks at 40 times profits are cheap, Wall Street has discovered.” That tongue-in-cheek headline comes from Bloomberg today, referring to the fast-growing, strongly profitable and richly valued Facebook, Apple, Amazon.com, Microsoft and Google parent Alphabet (a.k.a. Faamg) quintet.  The group has a fan in Maneesh Deshpande, head of equity derivatives strategy at Barclays, who recently advised his clients to upsize their holdings. Deshpande notes that, though the Faamg’s sport a 35% premium to the S&P 500’s 30 times trailing price-to-earnings ratio, they trade at a roughly equivalent valuation to their December 2019 levels.

By contrast, the S&P trades at a premium to the 21 times trailing earnings seen at year-end 2019. “It’s like saying New York real estate is cheap right now, but it’s not going to be as cheap as Montana ever,” the strategist reasons to Bloomberg. The group “is cheaper relative to where it was. That is still notable.”

Mr. Market seems to be coming around to that view, as that Faamg cohort has enjoyed an average 6.3% month-to-date advance through yesterday, handily topping the 1.5% gains for the broader S&P 500.  That’s a change from the opening five months of the year, when the group managed an 8% advance on average, lagging the 12% move for the broad index  

Yet political risk factors lurk, as Washington increasingly appears to have big tech in its crosshairs. The House Judiciary Committee advanced a series of bills overnight, including a pair of measures which would target Silicon Valley giants: The American Choice and Innovation Act, which would bar tech platforms from conduct that “advantages the covered platform operator’s own products, services, or lines of business over those of another business user,”  as well as the Augmenting Compatibility and Competition by Enabling Service Switching Act,  which would compel big tech to allow users to more easily transfer their personal data from one platform to another. 

Then, too, the Senate last week confirmed outspoken Biden administration nominee Lina Khan to the Federal Trade Commission. That provides the five-member FTC panel with a three-seat Democrat majority, with each of that trio previously advocating for greater government oversight of big tech, as well as enhanced antitrust enforcement. 

A government crackdown on the big tech business models could hurt, as the Faamg’s account for a combined 22% weighting in the S&P 500, with Apple and Microsoft alone representing 11% of the broad stock market gauge.  For context, no single stock had topped the 6.4% S&P 500 share achieved by then-unstoppable IBM in 1985 until Apple managed to briefly top that threshold late last year. The intervening 36 years have been less kind to Big Blue, as IBM now stands as the 64th largest component in the market cap-weighted index with a modest 0.36% weighting. 

Meanwhile, flagging market-wide internals suggest those mega-cap monoliths may need to carry an increasingly heavy load to help stocks maintain their bullish momentum. Thrasher Analytics founder and eponym Andrew Thrasher noted on Twitter yesterday that, with the major indices at or near their respective high-water marks, just 3% of stocks within the tech-heavy Nasdaq composite logged a fresh six-month high yesterday. That’s down from more than 20% in late February.  

QE Progress Report
The grand monetary experiment continues apace.  Reserve Bank Credit, or interest bearing assets at the Fed, reached $8.05 trillion yesterday following an $86 billion sequential increase, marking the first reading above the $8 trillion threshold.  That’s up 9.5% year-to-date, 96% from the March 2020 selloff and 116% from the repo market seizures seen in September 2019. 
Recap June 24

Stocks bounded higher after yesterday’s breather, with the S&P 500 extending to a hearty 2.4% for the week so far, while a strong seven-year note auction didn’t spur much action in Treasurys, as the long bond remained at 2.1%.  WTI crude pushed back above $73 a barrel, gold edged lower to $1,775 an ounce and the VIX slipped below 16 to approach its COVID-era lows. 

- Philip Grant

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