09.21.2021
Windowless Van
Talk about vacant lots.

Talk about vacant lots. Last week, IHS Markit took a hatchet to its automobile production forecasts, slashing its expected global output by 5.02 million vehicles for this year and 8.45 million in 2022, representing declines of 6.2% and 9.3%, respectively, from their prior guesstimates. The magnitude of those cuts caught Wall Street off guard, with Credit Suisse analyst Dan Levy terming next year’s expected decline “a big surprise” and adding that “as far as we can tell it was IHS’s largest-ever cut for an annual forecast.”

With new vehicle production remaining on the fritz, the used-car market stands to benefit, a fact underscored by a 3.6% year-over-year rise in prices over the first 15 days of the month according to recent data from Manheim, extending to a 24% gain from a year ago.  Carvana Co. (CVNA on the NYSE), the cyberspace-based retailer which famously dispenses its inventory via giant vending machines and delivers the vehicles to buyers’ homes, has particularly flourished. 

Thanks in part to its socially-distant business model, the pandemic treated Carvana well.  Revenues footed to $9 billion over the 12 months through June 30, up from $3.9 billion across calendar 2019, while the company was able to eke out $50 million in adjusted Ebitda over the past four fiscal quarters, compared to a $216 million adjusted Ebitda loss in 2019. Carvana shares have raced higher by more nearly 1,000% from their March 2020 lows, including a 70% rally since Grant’s Interest Rate Observer dubbed the company a pick-to-not-click in the Aug. 7, 2020 issue. 

That price appreciation has put CVNA in rarified air.  Enterprise value now foots to $55 billion, equivalent to 186 times consensus 2022 Ebitda, compared to 6.8 times EV-to-Ebitda for profitable and slow-growing retailer AutoNation. Creditors are also bulled up, as Carvana’s Caa2/triple-C-plus-rated 5.5% senior unsecured notes due 2027 last changed hands at 103.25 cents on the dollar for a 392 basis point pickup to Treasurys, well inside the 520 basis point spread quoted for the Caa-rated portion of the Bloomberg Barclays High Yield Index. With the company posting a $392 million net income deficit since the start of 2017, great expectations underpin the story. The Street pencils in $20.9 billion in revenues by 2023, with net income projected to swing to a $326 million profit. 

Not just in a fancy valuation does Carvana distinguish itself.  An Aug. 15 dispatch from The Wall Street Journal highlighted the company’s practice of packaging and offloading all but a sliver (as required by law) of the auto loans it extends to customers, often at a premium to face value. As used vehicle prices race higher and interest rates remain in the basement, that practice plays a featured role in the corporate playbook: Carvana derived 36% of its per-vehicle gross profit from those securitizations in the second quarter and sold $3.1 billion worth of auto loans to investors over the first six months of the year, double that of 2020.  

The firm likes to keep it in the family, utilizing Bridgecrest Acceptance Corp., to service its loans.  Bridgecrest is a subsidiary of DriveTime Automotive Group, the Tempe-based dealer which was formerly Carvana’s parent company prior to CVNA’s 2017 IPO and which is owned by Ernie Garcia II, father of Carvana CEO Ernie Garcia III. 

Other striking facts color the Carvana story.  As the Journal noted last Thursday, the elder Garcia has banked a cool $3.6 billion worth of share sales on the open market since October of 2020, twice modifying his 10b5-1 automated sale plan to upsize the amount of stock being offloaded. That follows his participation in a discounted $600 million share offering to certain existing investors during the height of the covid market panic, a sale which diluted holders by expanding the quantity of publicly-traded shares by 26%. Carvana’s management structure “has allowed [the Garcia’s] to run this $60 billion public company as if it’s a family firm and for the family’s benefit,” Daniel Taylor, professor of forensic accounting at the Wharton School, told the WSJ. “It’s amazing.”  As for the pair of amendments to the sales parameters, Taylor added that, in studying 20,000 such 10b5-1 plans, “I can’t recall another of this size where there are modifications every six months.” 

That’s not the only remarkable feat of corporate governance. As an analysis yesterday from Probes Reporter relays, Carvana disclosed a “voluntary request” from the Securities and Exchange Commission in an unrelated 8-K filing early last year, seeking information on related party transactions and accounting policies, including procedures for loan sales. The SEC confirmed on Sept. 2 that an “active and ongoing” investigation into the company remains open, though Carvana has remained mum on the topic. Probes Reporter John Gavin minced no words in assessing the situation:

We are used to companies using clever wording and leaving things out when they disclose their SEC investigations. We [are] also used to them providing cut-and-paste repeats of earlier disclosures in place of substantive updates on SEC investigations. We see it all the time.

But we cannot recall another instance where we saw a company make a stealth disclosure of SEC investigative activity; say nothing further about it for 18 months and then engage in massive insider selling during much of that period.

We see images of rats fleeing a sinking ship. 

Recap Sept. 21

Stocks finished little changed, with the S&P 500 giving back a near 1% early advance to remain 4% off its Sept. 2 highs, while Treasurys also consolidated yesterday’s move with the 10- and 30-year yields settling at 1.32% and 1.86%, respectively.  Gold extended its bounce with a move to $1,773 an ounce, WTI crude edged higher towards $71 a barrel and the VIX pulled back by a relatively modest 6% to 24, holding 16% above Friday’s close. 

- Philip Grant

09.20.2021
Barbarians at the Gate

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

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

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

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

On Second Thought
At least eight U.S. investment-grade bond issuers pulled their offerings today, Bloomberg reports.

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

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

Magic Beans
As markets fret over Evergrande,

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

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

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

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

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

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

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

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

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

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

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

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

Recap Sept. 20

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

- Philip Grant

09.17.2021
All Rights Reserved
A hectic day in the stock market,

A hectic day in the stock market, featuring quarterly options expiration and extensive index rebalancing, helps usher in the new class. Sixty-eight U.S. stocks which have recently come public joined the Russell 1000 and Russell 2000 indices as of today’s close, Bloomberg notes, marking the biggest inclusion of newly minted IPOs into the Russell gauges since data collection began in 2010. 

That influx reflects a bumper-crop year for equity capital markets.  Traditional IPO issuance topped $100 billion year-to-date this week by Renaissance Capital’s count, already surpassing the $97 billion record established back in 2000 with three-and-a-half months to spare.  “Animal spirits are alive and well,” Steven DeSanctis, U.S. equity strategist at Jefferies, observed to Bloomberg. “We’ve had numerous years where we had very little or no IPO activity and there’s a real thirst for new companies.”  

But while the conventional IPO machine remains in high gear, recent market fads now sputter. Special purpose acquisition companies brought 32 businesses public in July according to Dealogic, with shares rallying less than 1% on average on the day of the deal announcement. By comparison, 57 traditional IPOs took place during the month, with those firms enjoying an average 30% pop on their debut.  

A longer-term view likewise confers no particular glory on the once-white-hot corner of the stock market, as the IPOX SPAC Index sits 27% below its February high-water mark. Reviewing post-merger SPAC data going back to the beginning of last year, Goldman Sachs chief U.S. equity strategist David Kostin finds that the median such firm lagged the Russell 3000 Index by a whopping 42% in the six months after the deal closed, while the basket of 10 SPACs comprising the “Short this index” analysis in the Dec. 25, 2020 edition of Grant’s Interest Rate Observer have lost 55% since publication time. 

That poor performance has taken its predictable toll on sentiment. According to data from University of Florida professor Jay R. Ritter, 94 of the 131 SPACs which have announced mergers since last fall now trade below their $10 per share IPO price. Then, too, 438 SPACs that have raised an aggregate $130 billion have yet to find an M&A dance partner, a pile-up that may make some promoters nervous:  Blank-check firms which fail to complete a merger within two years of formation are typically compelled to return that capital to investors. 

“We as an industry raised too much money too quickly. The party is over for the moment,” Douglas Ellenoff, a SPAC-focused attorney at Ellenoff Grossman & Schole LLP, lamented to Reuters. 

As the good times fade, some companies find themselves left in the lurch. Bloomberg reported yesterday that a trio of SPACs which have recently completed deals are having trouble collecting cash that investors had previously committed via private investment in public equity (PIPE) financing.  Those shortfalls can be substantial: Deep-sea mining startup TMC the metals company (sic), Inc. (TMC on the Nasdaq), which made its stock market debut last Friday, has received only one-third of the $330 million in PIPE funding previously promised by investors.  

TMC told Bloomberg that it “intends to aggressively enforce” existing commitments, but noted that those efforts may prove unsuccessful.  That cash would come in handy: pre-revenue TMC, which projected back in March that it will generate $7 billion in adjusted Ebitda by 2027, also estimated it needs $7 billion in capital to engage in large-scale commercial production.

Even one of the shining luminaries of the blank check gold rush is now hedging his bets. Chamath Palihapitiya, dubbed the “SPAC King” by Bloomberg during the height of the frenzy, provided something of a postmortem to the Financial Times today: “What’s happened is you’ve had a lot of folks who are extremely talented, credentialed people do deals that were a bit of a headscratcher. That’s caused the market to trade off in a significant way.” As for his long-bullish view on asset prices, Palihapitiya added that “I reserve the right to change my mind.” 

Recap Sept. 17

The bears had the last word today, as stocks came for sale with the S&P 500 dropping nearly 1% to extend to a 2.3% pullback from its early September highs, while the Nasdaq 100 lost 1.2% for what is tellingly its worst one-day showing since May.  Treasurys also were under pressure, with the 10-year yield rising towards its 200-day moving average at 1.37%, while WTI crude slipped below $72 a barrel and gold remained in the dumps at $1,752 an ounce.  The VIX rose 10% to near 21, marking its first back-to-back weekly close above 20 since March. 

- Philip Grant

09.16.2021
Sea Here
The head of product at non-fungible token trading venue OpenSea improperly traded

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

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

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

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

Labor Party
Amazon.com announced Tuesday that it is looking to hire 125,000 new workers

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

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


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

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

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

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

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

QE Progress Report
Reserve bank credit rose by $35 billion from a week ago, leaving interest bearing assets on the Fed balance sheet at $8.35 trillion.  That’s up 19% year-over-year and 123% from September 2019. 
Recap Sept. 16

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

- Philip Grant

09.14.2021
Early Risers
The Nasdaq is for pikers:

The Nasdaq is for pikers.  Initial-stage venture company valuations reached an average of $93.1 million over the first six months of the year, according to data from PitchBook, while those of later stage tech concerns ascended to $914 million. Those represent year-over-year growth rates of 50% and 98%, respectively. 

While buoyant asset prices and itsy bitsy interest rates play their featured role in those bulging figures, other factors loom large. Namely, a rush of VC outsiders into the early-stage “space,” leading to increasingly bloated price tags.  The median pre-money valuation of late-stage deals including nontraditional investors reached $235.5 million year-to-date through June 30, more than four times the $54 million median pre-money deal featuring only traditional VC investors.  That compares to a median $116 million nontraditional pre-money valuation last year and a $34 million median for those purely VC-backed. Nontraditional funding reached a total $119 billion this year through June 30, nearly matching the record $125.6 billion in deal value across full-year 2020.

Much of that torrent of capital is coming from a particular place.  Hedge funds have participated in 770 private deals year-to-date at a total $153 billion valuation, analysts at Goldman Sachs reported last week, with early-stage venture capital investments accounting for nearly three-quarters of that sum.  That compares to 753 such transactions at an aggregate $96 billion across calendar 2020.  

Those extra-large checks are making no small impact. Hedge funds have accounted for 27% of total capital invested with private companies this year, while participating in just 4% of private market transactions.  Most of those monies came from just 10 firms, including Wall Street household names Tiger Global Management, Coatue Management and the SoftBank Vision Fund. 

“We could have named almost any number and we would be able to raise the money,” Job van der Voort, co-founder and CEO of human resources startup Remote, which raised $150 million earlier this summer at a $1 billion valuation, told CNBC back in July.  Ditching the conventional VC playbook, the industry newcomers “are happy to take smaller returns over longer time periods, so they become very competitive,” van der Voort added. “They can basically say, we’re going to fund a lot of different start-ups at really high valuations,” elbowing out traditional players in the process. 

As hedge fund whales vie for early-stage prizes, due diligence is increasingly optional.  For instance, investors now require legal opinions (or assurances that a target’s corporate house is in order) only about half the time, Jon O’Connell, partner at law firm Crowell & Moring, told The Information last month, compared to closer to 75% three years ago. “Law firms are really busy,” O’Connell added. “It’s becoming harder for certain law firms to go through a diligence exercise and get to a position where they can give an opinion, given the workload that those attorneys face.”

With prices racing higher and investors clamoring for exposure to the early stage market, founders are increasingly capitalizing on their advantageous position by selling shares into those early funding rounds, accommodated by investors all too eager to make a deal.  “It used to be that founders would ask for [secondary market liquidity]. Now, venture capitalists are coming out of the gate with it,” Louis Lehot, partner at law firm Foley & Lardner, told The Information yesterday. “Half of series A and series B deals now have some secondary component for founders.” 

Though life events such as the purchase of a home or an expanding family can often explain a decision to quickly take chips off the table, The Information notes that some founders are allocating their sales proceeds towards investing in other startups. Then, too, forward sales contracts (or agreements to sell in the future for cash now) are increasingly popular.  “Such transactions,” the tech-focused publication notes, “can be carried out without alerting board members or other employees, a level of secrecy that may raise a red flag for the startup’s backers.” 

For more on the implications of the early-stage sonic boom, and an in-depth analysis of a key cog in that machine, see the Sept. 3 edition of Grant’s Interest Rate Observer

Recap Sept. 14

A slightly cooler-than-expected round of August CPI spelled solid gains for the Treasury complex, as 10- and 30-year yields declined to 1.28% and 1.86%, respectively, though that data was no help to stocks as the S&P 500 logged its sixth red finish in seven tries to finish the day 2.1% from its Sept. 2 high-water mark.  Gold edged above $1,800 an ounce for the first time in nearly two weeks, WTI crude consolidated recent gains at $70.50 a barrel and the VIX held at 19.5. 

- Philip Grant

09.13.2021
Party On

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

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

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

Never a dull moment in crypto. 

Parts and Wreck
“Unprecedented” inflation has taken hold,

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

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

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


 
Prices go parabolic:  Manheim’s Used Vehicle Value Index

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

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

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

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

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

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

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

Recap Sept. 13

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

- Philip Grant

09.10.2021
First Mover

He’s one committed dip-buyer. A headline today from the New York Post:

Rapper Dan Sur Gets Gold Chain Hooks Surgically Implanted into Scalp

Noting that he is “the first rapper to have gold hair implanted in human history,” Dan Sur told his near two million followers on Tik Tok that “I hope not everyone copies me now.”

A contrarian’s lament. 

Tight Rope
Reading the tea-leaves:

Reading the tea-leaves:  The Federal Open Market Committee (FOMC) is coalescing around an early November start date for a taper of its $120 billion per month asset purchase program, The Wall Street Journal reports.  The upcoming Sept. 21-22 meeting may serve as a platform for a formal announcement of the plan, WSJ Fed reporter Nick Timiraos relays, while the current plan calls for a full wind-down of the quantitative easing regime by the middle of next year. 

“I think it’s clear that we have made substantial further progress on achieving our inflation goal,” New York Fed President John Williams declared in a speech yesterday.  It sure seems that way, as this morning’s release of the August Producer Price Index showed an 8.3% headline advance from a year ago, nearly five times greater than the average 1.7% reading over the past decade.  Meanwhile, the latest Fed Beige Book disseminated Wednesday afternoon featured reports from several districts “that businesses anticipate significant hikes in their selling prices in the months ahead.” 

On the labor side, last year’s virus-induced crisis has given way to something resembling normality.  While total payrolls remain 5 million short of the 152 million peak logged in February 2020, headline unemployment of 5.2% in August stands well below the average 6.2% reading from 1969 to 2019, while continuing weekly jobless claims footed to 2.78 million this week, near the long-term average of 2.75 million over the 50 years through 2019.  Job openings currently stand at 10.9 million per the Bureau of Labor Statistics, towering above the pre-pandemic peak of 7.4 million. 

With inflation on the boil and the labor market mending, tighter monetary policy is an increasingly consensus view. More than 70% of economists surveyed by the Financial Times this past week expect a rate hike some time next year, with nearly 20% of respondents predicting one in the first six months of 2022.  For context, the FOMC projected in its July 28 meeting that the benchmark funds rate will rise 50 basis points from its current near-zero levels by the end of 2023. 

“If sustained higher inflation were to become a serious concern,” Fed chair Jay Powell assured listeners-in at the virtual Jackson Hole conclave on Aug. 27, “the FOMC would certainly respond and use our tools to assure that inflation runs at levels that are consistent with our goal.”  Yet, as Grant’s Interest Rate Observer argued last week, the remedies for an overheated inflationary regime could prove to be bitter medicine, testing the resolve of the monetary mandarins if conditions deteriorate: 

Would they have the nerve to raise interest rates at the cost of a falling stock market?  In the teeth of a rising jobless rate? In the midst of a clamor that, for all their talk about equity and inclusiveness, they are no better than the blue-suited bullies that pushed mortgage rates to 20% to ‘save Wall Street’ in 1979 to 1981? 

See the Sept. 3 edition of Grant’s Interest Rate Observer for an in-depth overview of the Fed’s current predicament, as well as a practical proposal for curtailing the central bank’s increasingly outsized role in financial markets. 

Correction and Update: Let Them Eat Yellowcake

Yesterday’s edition of ADG incorrectly asserted that the Sprott Physical Uranium trust has “recently” purchased 24 million pounds of uranium.  Instead, the investment firm has accumulated some 6 million pounds of the radioactive metal since it launched its C$300 million ($237 million) at the market (ATM) equity offering on Aug. 17 but had acquired the balance of its 24 million pound cache as the Uranium Participation Corp. prior to its merger with Sprott earlier this summer.

Meanwhile, Sprott looks set to factor into the uranium market for some time yet.  This afternoon, the firm announced an amended shelf registration upsizing its ATM equity offering facility by C$1 billion, allowing the firm to issue a total of C$1.3 billion in shares with which to buy uranium (it has sold C$244 million worth of stock thus far).  The price of U3O8 edged higher to $40.40 per pound today, marking a fresh post-2014 high, while shares in Grant’s pick-to-click Cameco Corp. barreled higher by an additional 6%. 

Recap Sept. 10

Another round of late pressure on stocks left the S&P 500 lower by 80 basis points, extending to a 1.8%, five-session drop after logging a record high on Sept. 2, while Treasurys also came under pressure with the 10- and 30-year yields rising to 1.34% and 1.93%, respectively.  WTI crude jumped to near $70 a barrel, gold sank to $1,788 an ounce and the VIX rose to near 21, logging its most elevated close since Aug. 18. 

- Philip Grant

09.09.2021
Let Them Eat Yellowcake
The price of uranium pushed above $40 a pound yesterday,

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

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

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

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

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

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

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

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

May the bullish signals continue. 

QE Progress Report
Reserve Bank Credit, or interest-bearing assets on the Fed balance sheet, rose $10 billion from a week ago to $8.32 trillion.  That’s up 13% year-to-date, 19% from a year ago and 132% from September 2019. 
Recap Sept. 9

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

- Philip Grant

09.08.2021
Paper Tiger
Back with a vengeance:

Back with a vengeance: Yesterday saw 21 investment-grade bond deals come to market in the U.S. by Bank of America’s count, raising an aggregate $33 billion.  That’s a single-day record for high-grade bond issuance, with an additional 17 primary bond deals today (including a mammoth $7 billion offering from Walmart) helping establish a fresh two-day high-water mark.  While the return from Labor Day weekend generally spells a spate of supply pent up from the summer doldrums, “it’s still a lot of deals” Matt Brill, head North American investment grade credit at Invesco, commented to Bloomberg.  

“The engine of supply is running on all cylinders,” Jeanmarie Genirs, head of syndicate for U.S. investment grade at Deutsche Bank, told the Financial Times on Friday. “While the market is engaged, we are telling people, ‘Please, if you are ready to go, now is the time.’” Indeed, yesterday’s bonanza worked out well for corporate America:  Spreads on that paper came in 15 to 20 basis points tighter, on average, than preliminary levels indicated early in the day, Bloomberg notes. 

At the same time, bond investors have gotten used to the diminished compensation.  The iShares iBoxx Investment Grade Corporate Bond ETF now sports a 2.1% indicated dividend yield, down from 3.1% in February 2020 and 4% in November of 2018.  That’s with headline CPI advancing by 5.4% from a year ago in July, compared to a 2.3% advance in winter 2020 and 2.2% in fall 2018. 

With measured inflation currently towering over investment-grade yields, creditors duly gravitate towards riskier issues.  The domestic junk bond market will see some $47 billion in primary supply this month, Bank of America estimates, matching the September peak established last year, while Deutsche Bank pegs the figure at $60 billion, which would top March 2021 for the busiest single month on record. 

Investors have the wind at their backs, as the asset class has posted a positive total return for 11 consecutive months (the longest such winning streak since 2012 and 2013).  Yet further good times may prove harder to achieve:  The iShares iBoxx High Yield Corporate Bond ETF sports a record low 3.75% indicated 12 month dividend yield, down from 5% before the bug bit in 2020 and 6% as the Fed tightened in November 2018. 

Then, too, keeping up with the currently-bounding rate of inflation is proving virtually impossible even within the speculative corner of the debt market. As Deutsche Bank strategist Jim Reid points out today, some 85% of the high-yield realm currently fetches a negative real yield.  Prior to this year, no more than 10% of the index had ever dipped below the measured rate of inflation going back to at least 1996. 


 
Reid also notes that the current aggregate real yield of minus 1.5% on offer in the domestic junk market compares with a 25-year average of positive 450 basis points, concluding that the yawning 600 basis point gap “pretty much ensures that historical returns are absolutely no template for the future.”  

While an inflationary cloud hovers over the credit markets, casting all but the most speculative issues in its shade, a strong economy replete with robust corporate earnings and percolating asset prices remains a lynchpin of the bull case.  Indeed, S&P forecasts a 12-month corporate default rate of just 2.5% through June 2022, down slightly from the seven-year low of 2.8% established during the 12 months through August.  

Yet the rating agency spots some dark clouds of their own, as balance sheet damage wrought during the pandemic is still apparent in the form of a large swath of vulnerable issuers. To wit:  Nearly 40% of the speculative grade universe carries ratings of single-B-minus or below.  That compares to less than 30% at the peak of the 2008-era financial crisis, and about 20% during the aftermath of the 2000-era tech bubble and the early-1990s savings & loan crisis.   S&P analysts conclude that “the only alternative to more defaults down the road is if markets are willing to accept more risk at lower yields than at any prior point.”

On that score, at least, so far, so good.  

Recap Sept. 8

Stocks recouped the bulk of their early losses to leave the S&P 500 within 10 basis points of unchanged, though the broad average logged its third straight red finish after setting a new high last Thursday. A strong 10-year auction helped Treasurys catch a bid, with the long bond yield falling to 1.95% to reverse yesterday’s weakness, while gold slipped below $1,790 an ounce and WTI jumped back above $69 a barrel.  After approaching 20 early in the day, the VIX closed just below 18. 

- Philip Grant

09.07.2021
Coincident Indicator
More curious doings in the crypto realm:

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

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

Risky Business
No news is good news.

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

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

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

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

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

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

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

Recap Sept. 7

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

- Philip Grant

09.03.2021
Security Guard
Enforcement attorneys at the Securities and Exchange Commission have opened an investigation into crypto exchange Uniswap Labs

Enforcement attorneys at the Securities and Exchange Commission have opened an investigation into crypto exchange Uniswap Labs, The Wall Street Journal relays.  The regulator is seeking information related to Uniswap’s operations and its marketing, as well any internal analysis concerning whether cryptocurrencies should be classified as securities and subject to appropriate regulation. 

Currently valued at $18 billion, up from $1.3 billion as of Dec. 31, Uniswap stands as the primary hub of decentralized finance (DeFi), representing nearly 70% of total trading volume on DeFi exchanges, per crypto news and data site The Block.  A type of parallel Wall Street for the digital realm, DeFi foments traditional financial activities such as lending, borrowing and, of course, speculation using cryptocurrencies.  

Users can post collateral in the form of a cryptocurrency, which is used to facilitate exchange liquidity in a market-maker capacity and earn sometimes handsome yields in the process. Unlike a traditional bourse which lists and delists securities at its discretion, decentralized exchanges such as Uniswap have no control over what tokens can be traded over its network. Indeed, users can transact in any token they like. 

That unfettered structure has evidently invited the side-eye from regulators, who contend that the products are securities under the law and thus fall under the auspices of the SEC. “Make no mistake,” SEC chair Gary Gensler warned on July 21. “It doesn’t matter whether it’s a stock token, a stable-value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities. These platforms – whether in the decentralized or centralized finance space – are implicated by the securities laws and must work within our securities regime.” 

Five days after that SEC salvo, Uniswap announced it will curtail access to dozens of tokens under its flagship trading umbrella, including derivatives tracking the share price of the likes of Tesla and the QQQ Nasdaq 100 ETF, as well as other tokens tied to the value of key commodities and currency pairs.  Yet users can still access those protocols, or smart contracts, without utilizing the Uniswap app, functionally sidestepping those company-imposed restrictions.  

A recent wholesale push from Washington towards enhanced oversight of the mushrooming crypto industry further colors today’s WSJ report.  Earlier this summer, Gensler, Treasury Secretary Janet Yellen and Sen. Elizabeth Warren (D-MA), each advocated for more stringent rules governing the crypto industry. In late July, New Jersey state regulators accused lending platform BlockFi of selling unregistered securities and ordered the firm to cease offering interest-bearing accounts. Meanwhile, the Justice Department and Internal Revenue Service in May opened an investigation into Binance Holdings, one of the world’s largest crypt exchanges, probing potential money laundering activities and tax evasion.  

Thus far, those efforts have focused on the upper-crust, centralized exchanges. Operating through heretofore-novel smart contracts, DeFi platforms by their nature present challenges to traditional regulation. But today’s reported investigation into Uniswap indicates that Gensler and Co. do not intend for DeFi to remain the Wild West of crypto for much longer.

For an in-depth primer on this bourgeoning corner of the financial world, see the analysis “DeFi for boomers” in the June 25 edition of Grant’s Interest Rate Observer

Recap Sept. 3

A weaker-than-expected round of August payrolls helped put Treasurys under bear-steepening pressure, as the 30-year yield rose five basis points to 1.95%, while stocks went nowhere to wrap up the week with modest gains on the broad S&P 500.  Gold pushed to a five-week high at $1,828 an ounce, WTI slipped back towards $69 a barrel and the VIX finished at 16.4 to wrap up a sixth straight session near that level. 

- Philip Grant

09.02.2021
Inflation Hits Home

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


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

Spinning Wheel
Is the party over for special purpose acquisition companies?

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

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

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

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

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

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

We are shocked by what has unfolded at ATI. 

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

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

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

Uncertain futures, indeed. 

QE Progress Report
A $16 billion sequential decline in Reserve Bank Credit left interest bearing assets at the Fed at $8.31 trillion.  That’s up 23.5% on an annualized three-month basis and 124% from early September 2019. 
Recap Sept. 2

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

- Philip Grant

08.31.2021
Open Table
A full scale ban of payment for order flow (PFOF) is “on the table,”

A full scale ban of payment for order flow (PFOF) is “on the table,” Securities and Exchange Commission chair Gary Gensler told Barron’s yesterday.  The practice, in which brokers peddle customer orders to high-frequency trading firms in lieu of charging commissions, produces “an inherent conflict of interest,” Gensler argued.  PFOF now predominates across the retail trading industry, as brokerages largely migrated towards zero commission business models in recent years. 

Count some observers as skeptical that such a market structure sea change is forthcoming. “Gensler has other priorities and he in unlikely to move directly against PFOF given the complexity of the issue,” Cowen policy analyst Jaret Seiberg wrote this morning.   

Investors in newly public Robinhood Markets (HOOD on the Nasdaq), seem to agree with that sentiment, as shares recouped most of their peak-to-trough losses following the interview’s release yesterday afternoon and remain 16% above the July 28 IPO price. The firm now sports a $37.7 billion market cap. That’s up from an $11.7 billion valuation generated in a series G funding round conducted 11 months ago and equivalent to 52 times consensus 2023 Ebitda, which is itself expected to quadruple over the next two years. 

That said, even marginal changes to the payment for order flow rules could present problems for Robinhood: Transaction rebates, or PFOF across cash equities, options and cryptocurrencies, represented 79% of revenues in the second quarter, up from a 75% share of the top line across 2020 and 61% in 2019.   

Robinhood warned in its pre-IPO S-1 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.” However, executives conveyed a far more sanguine tone on the Aug. 18 earnings call.  Chief financial officer Jason Warnick tabbed the firms average PFOF take at between 2 and 2.5 basis points of a given notional order size, declaring that “it’s not a terribly difficult revenue stream for us to replace.”

Yet with shares priced for sunny weather, might a simple loss of momentum be enough to disrupt the bull case? Average revenue per user clocked in at $112 in the second quarter, analysts at Mizuho estimate. That’s down from $137 sequentially as the meme stock frenzy-cum-crypto bull market kicked into high gear during the first quarter.  While HOOD’s total net revenues vaulted higher by 132% year-over-year to $565 million in the second quarter, that growth rate is less than half the 309% annual clip posted in the first three months of the year and makes for a relatively modest 8.2% sequential pace. 

Similarly, the firm’s market share has ticked lower of late, as Robinhood garnered 25% of PFOF dollar volumes in the second quarter, analysts at Bloomberg tabulate, compared to 29% in the first three months of the year. Meanwhile, retail investors now drive about 20% of total stock market volumes, still double the pre-pandemic levels but down from as much as 25% earlier this summer. New entrants vie for a slice of that pie, with CNBC reporting yesterday that PayPal is looking to allow its users to trade individual stocks.  That encroachment could be an issue as a survey conducted by Mizuho last fall found that 91% of Robinhood customers also reported using PayPal, easily the highest overlap among financial technology apps. 

Then, too, Robinhood’s ace in the hole may itself be subject to the laws of gravity. Crypto transaction-based revenues skyrocketed to $233 million in the second quarter, more than 40 times the $5.3 million generated in the year-ago period and representing 41% of the consolidated top line. Continued acceleration from that category may be harder to come by, as 60% of Robinhood users already own crypto assets per Bloomberg. 

“What does it take for a once excellent brand to become merely good?” Grant’s Interest Rate Observer rhetorically asked back in 2015.  Robinhood bulls hope they won’t have to find out. 

Recap Aug. 31

Stocks treaded water to wrap up August with a 2.8% gain on the S&P 500, marking the seventh straight monthly advance for the broad index.  Treasurys came under moderate pressure with the 10- and 30-year yields rising to 1.31% and 1.93%, respectively, gold moved towards the upper end of its summer trading range at $1,815 an ounce and WTI crude slipped back to $68.50 a barrel.  The VIX wrapped up the day slightly higher, at 16.5. 

- Philip Grant

08.30.2021
Opportunity Knocks
The big four accounting firms are moving headlong into the realm of environmental, social and governance-based investment,

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

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

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

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

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

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

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

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

Recap Aug. 30

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

- Philip Grant

08.27.2021
Rock the Casbah
The market for the digital artwork known as non-fungible tokens percolates once more.

The market for the digital artwork known as non-fungible tokens percolates once more. Nearly $900 million worth of NFT’s changed hands over the 30 days through Aug. 18, data from analytics site NonFungible show. That’s above the $221 million in sales logged during the previous high-water mark in March, which included the $69 million auction price for a piece from digital artist Beeple. 

Professional attention-seekers have duly taken notice. YouTube star and social media personality Logan Paul Tweeted this morning that he “literally left dinner last night” to snag two NFT’s depicting pixelated rocks, coughing up $150,000 for the pair. “I know it’s ridiculous but it’s digital history and I think they’re pretty cool,” Paul added. 

Hungry Hippos
New York’s City Council yesterday approved legislation to permanently cap food delivery commission rates,

New York’s City Council yesterday approved legislation to permanently cap food delivery commission rates, codifying an emergency measure enacted during the teeth of the pandemic. Firms such as Grubhub and DoorDash (DASH on the NYSE) will be permitted to charge restaurants a maximum 15% delivery service fee, along with 5% for marketing related expenses and an additional 3% for transaction fees. “We’re not here to enable billion-dollar companies and their investors to get richer at the expense of restaurants,” council member Francisco Moya declared.   

That follows a June move from San Francisco lawmakers to maintain a 15% commission ceiling on delivery providers.  All-in industry commission rates had regularly topped 30% prior to the events of 2020. For the delivery firms, those restrictions will continue to sting: Grubhub, a Grant’s pick-to-not-click prior to its June acquisition by Europe’s Just Eat plc. (TKWY in Amsterdam) in an all-stock deal, estimated that those fee caps crimped its profitability by €88 million ($104 million) over the first half of the year, while DoorDash pegged the hit to its bottom line at $26 million in the second quarter.  With major cities on either coast moving to lock in permanent fee caps, those profit impairments look set to persist. 

Other major municipalities are turning the screws. This afternoon, the City of Chicago filed a lawsuit alleging that DoorDash and Grubhub offered delivery services from certain restaurants without the consent of those establishments and priced menu items far above in-person rates, while misleading customers over their fee structures. The Windy City had imposed a temporary 15% fee cap last year, since expired. 

Political blowback aside, the strength of the third party delivery business model remains very much in question. Back in late February, Dominos Pizza CFO Stuart Levy reminded listeners-in that: “In 60 years, we’ve never made a dollar delivering a pizza.  We make money on the product, but we don’t make money on the delivery. So, we’re just not sure how others do it.”   

Don’t take the incumbent’s word for it. In fall 2019, then-Grubhub CEO and current Just Eat board member Matt Maloney penned a 10-page, 4,989-word letter to investors explaining the company’s disappointing quarterly results. In that missive, Maloney indicated that sustained profitability may prove elusive, as even bigger players in the commoditized food delivery realm lack the requisite economies of scale: “Extremely large delivery/logistics companies can generate slim margins, but only because of the hub and spoke efficiencies they gain at substantial scale. The point-to-point nature of our business mostly eliminates that aspect of operating leverage.”

Yet investors and Wall Street analysts alike continue to see sunny skies ahead. DoorDash’s enterprise value now stands near $59 billion, up from a $16 billion valuation garnered on the private market 14 months ago and equivalent to 206 times consensus full-year Ebitda. Just Eat sports a €17 billion enterprise value, equal to 880 times projected 2022 Ebitda (the Street expects a €337 million Ebitda deficit this year). For context, the S&P 500 Restaurants Index trades at a 22 times EV-to-Ebitda ratio.  

Indeed, great expectations underpin those fancy prices, as the sell side expects Just Eat to take away €769 million in Ebitda come 2024, representing 7.9% of projected revenues compared to a 0.3% Ebitda margin for 2022.  DoorDash will see its Ebitda line item balloon to $1.4 billion, or 16.8% of revenues, by 2024, compared to $285 million in Ebitda and 6.9% of revenues this year, if the analysts are on point. 

For its part, the DoorDash inner circle appears to have doubts over that rose-colored future. Over the last month, the firm’s chief legal officer, chief product officer, chief financial officer, chief technology officer, chief operating officer, chief accounting officer and CEO have liquidated a combined $68 million worth of stock on the open market. 

 

Recap Aug. 27

Dovish rhetoric from Fed chair Jay Powell further emboldened the bulls, as stocks ripped higher to leave the S&P 500 and Nasdaq 100 indices with 1.5% and 2.5% gains for the week, respectively.  Treasurys also rallied with the long bond yield falling four basis points to 1.91%, while WTI crude rose to near $69 a barrel to complete a 10% rally for the week and gold advanced to a near one month high at $1,819 an ounce.  The VIX tumbled back below 16.5, giving back yesterday’s 12% advance and then some.   

- Philip Grant

08.26.2021
Squeeze Box
Who needs Reddit?  Yesterday, Roundhill Investments filed registration paperwork with the Securities and Exchange Commission unveiling the passively managed Roundhill Meme ETF (MEME on the NYSE Arca). The eponymous ETF will screen stocks based on their social media activity (and naturally, short interest), allocating at least 80% of fund assets into meme stocks and charging an annual management fee of 69 basis points.  
Measuring Taper
As the Federal Reserve’s annual Jackson Hole conclave gets underway,

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

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

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

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

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

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

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


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

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

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

QE Progress Report
Reserve bank credit, or interest bearing assets on the Fed balance sheet, rose to $8.32 trillion, up $26 billion from a week ago.  That $8.32 trillion figure represents a 19% year-over-year increase, and 122% higher than the Fed’s holdings in August 2019. 
Recap Aug. 26

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

- Philip Grant

08.25.2021
Package Deal
Today’s rampaging, technology-centric bull market has yielded a telling phenomenon:
Today’s rampaging, technology-centric bull market has yielded a telling phenomenon: seemingly conventional, old economy businesses repackaging themselves into tech or tech-adjacent wrappers and thereby garnering sky-scraping valuations.  Let’s review recent happenings across a quartet of such firms spanning three separate business models.  
 
Yesterday, vehicle maintenance outfit Mister Car Wash, Inc. (MCW on the NYSE) priced a 12 million share secondary offering at $19.57 per share, representing a 4.8% discount to Monday’s closing price. That’s a substantial proportion of the 42 million share float, but a relatively diminutive portion of the total 296 million share count. 
 
Mister Car Wash, which made its public debut just two months ago, will receive no proceeds from the deal.  Instead, corporate insiders are hitting the bid. The roster of sellers includes private equity firm Leonard Green, members of the MCW management team and various other pre-IPO investors.  Company management also offloaded about 3 million shares during the June offering. 
 
Founded in 1996, Mister Car Wash sports a $6.8 billion enterprise value, equivalent to 9.1 times consensus 2021 revenues and 22 times adjusted Ebitda for 2023, if the sell-side consensus is on point.
 
A subscription-based business model helps explain that fancy valuation, as bullish Jefferies analysts term Mister Car Wash’s business model “services as a service,” a play on the “software as a service” moniker often applied to fast-growing and highly scalable technology firms. 
 
Financial technology companies specializing in the “buy now, pay later” (BNPL) business model have similarly captured Mr. Market’s fancy, though recent operating results from some major players have proved wanting. This morning, Swedish firm Klarna announced that operating losses during the second quarter rose to SEK 965 million ($111 million) from SEK 89 million ($10 million) a year ago. Overall, gross merchandise volumes rose 77% over the first six months of the year, but credit losses grew by 55% from the first two quarters of 2020. The privately-held firm, which was founded back in 2005, recently garnered a $46 billion valuation in a June fundraising round led by SoftBank Group Corp., up from a $31 billion valuation three months before that. 
 
Fellow BNPL concern Afterpay Ltd. (APT on the Australian Stock Exchange) reported similarly disappointing results today, registering a net loss of A$156 million ($114 million) over the 12 months through June, up nearly eightfold from the prior year, as both operating expenses and gross loss rates came in higher than expected, analysts at RBC relayed. On Aug. 2, payments giant Square launched an all-stock bid for Afterpay valued at some $29 billion, equivalent to 42 times the target company’s sales over the 12 months through June 30. 
 
Then there’s insurance, a scene onto which the millennial-focused Lemonade, Inc. (LMND on the NYSE) has stormed to explosive results.  Six-year-old LMND currently sports a $3.55 billion enterprise value, valuing the “insurtech” at nearly 29 times consensus 2021 revenues and 8 times book value.  That compares to 1.3 times sales and 3.1 times book value, respectively, for industry leader Progressive Corp.  Lemonade’s m.o. is to cut out the middleman by eschewing insurance brokers, while utilizing artificial intelligence to better underwrite risk. 
 
Yet an embarrassing development underscores high-flying Lemonade’s attempts to disrupt the staid, capital-intensive industry: a landmark 2012 study co-written by Dan Ariely, three-time New York Times best-selling author, psychologist and behavioral economist at Duke University who also acted as Lemonade’s chief behavioral officer from 2016 through 2020, sought to investigate if consumers were less likely to fib on their self-reported driving metrics if “nudged” in a slightly more proactive way. 
 
Ariely and his peers found that insurance holders asked to self-report their odometers who signed an attestation of honesty at the beginning of a document reported driving 10% more miles than those who signed at the bottom of the document.  That simple change, Ariely et al. wrote, “likely reduced the extent to which customers falsified mileage information in their own financial self-interest at cost to the insurance company.”  Ariely built on those conclusions in a Wall Street Journal essay that year, arguing that such minor tweaks “could rein in the vast majority of people who cheat ‘by just a little.’” Indeed, Lemonade implemented the top-of-document attestation in 2017. 
 
However, an Aug. 17 blog post from Data Colada casts serious doubt on that study, as data scientists subsequently attempting to replicate his results were unable to do so. Professors writing in Data Colada found multiple irregularities:
 
All the self-reported figures included numbers to the right of the decimal point.  Typically, many drivers would provide ballpark figures in such a survey.
 
The results from 13,488 respondents featured equally distributed driving distances ranging from nearly zero to 50,000 miles, rather than the expected bell curve-shaped outcome with the bulk of driving distances clustered near the midpoint of a given range.
 
The underlying data was presented in two different fonts.  While this isn’t suspicious per se, the data in each font were “impossibly similar” to one another according to Data Colada researchers. 
 
The Data Colada writers concluded: “This is not what real data look like, and we can’t think of a plausible benign explanation for it.” 
 
For his part, Ariely denied allegations of wrongdoing, telling BuzzFeed News Friday that “I can see why it is tempting to think that I had something to do with creating the data in a fraudulent way. . . but I didn’t.”   
 
For more on this topic, including bearish analyses on a trio of conventional businesses disguised in a modern veneer, see the analysis “High-tech dress-up” in the Aug 6. edition of Grant’s Interest Rate Observer
Recap Aug. 25

Stocks grinded higher as the S&P 500 logged a fresh high-water mark, up nearly 20% year-to-date, while Treasurys came under pressure with the 10- and 30-year yields rising to 1.34% and 1.95%, respectively.  Gold slipped to $1,790 an ounce, WTI crude pushed past $68 a barrel to extend its three day rally to 9.5%, and the VIX closed below 17 for the first time in more than a week.  

- Philip Grant

08.24.2021
Tumbling Dice

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

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

Twin Peeks
An offshore oil platform fire broke out in the Gulf of Mexico on Sunday evening,

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

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

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

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

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

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

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

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

Recap Aug. 24

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

- Philip Grant

08.23.2021
How to Spend it
Crypto derivatives exchange FTX has acquired the naming rights for the California Memorial Stadium

Crypto derivatives exchange FTX has acquired the naming rights for the California Memorial Stadium (home of the Cal Golden Bears football team) in a $17.5 million, 10-year agreement, the company announced this morning. That’s the second such foray for the two-and-a-half year-old firm, which inked a $135 million deal to slap its moniker on the arena hosting the NBA’s Miami Heat earlier this summer. 

A remarkably rapid rise to prominence puts that largesse in relief:  FTX raised $900 million last month in a series B funding round from investors including SoftBank Group Corp., at an $18 billion valuation.  That’s up from a $1.2 billion valuation achieved last summer. 

Of course, the potent rally in crypto prices, which took bitcoin to as high as $63,500 in April from less than $12,000 last fall, figures prominently in FTX’s meteoric ascent. After pulling back to as low as $31,000 last month, the most popular digital ducat is once again on the hop, touching $50,000 this morning.  

That resurgence comes in tandem with a fresh round of issuance of tethers, the controversial stablecoin purportedly backed one-for-one by U.S. dollars, a claim which New York Attorney General Letitia James dismissed in February as “a lie.”  After remaining little changed through June and July, tether’s market cap has since advanced to near $65 billion, up from $62 billion on Aug. 7 and $20 billion last fall, as bitcoin began its epic six-month rally.  That recent spate of supply is all the more notable considering the Justice Department is reportedly investigating Tether (the organization) for bank fraud, a development which would seemingly discourage institutional investors from allocating capital to tethers.  

A recent bulletin puts that development into context, while perhaps inviting additional questions. Crypto news site Protos reported on Aug. 12 that a pair of firms have accounted for more than 70% of tether issuance in recent years, towering over the competition as the next largest participant has minted only a few hundred million worth of the stablecoin. One of those tether whales, Alameda Research, is a sister company of FTX, with 29-year old Sam Bankman-Fried the founder and CEO of each firm. 

Thin Gruel
Liquidity in the $22 trillion Treasury market “is lousy,”

Liquidity in the $22 trillion Treasury market “is lousy,” Andrew Brenner, head of international fixed income at NatAlliance Securities, observes to the Financial Times today.  With the Federal Reserve’s annual Jackson Hole confab looming later this week, an event which can presage substantial policy shifts, those fallow conditions “could absolutely cause problems” if chairman Jay Powell “has something big to say.”  

Bulge bracket banks concur with that assessment, as the average spread between bid and offer prices has reached its widest level in nearly six months. “Treasury market depth has continued to decline in recent weeks, and now is at its lowest levels since early March, when yields were moving rapidly higher amid increased volatility and a series of weak Treasury auctions,” J.P. Morgan strategist Jay Barry wrote last week. The bank assesses market depth by tracking the average trade size of the best three bids and offers available between 8:30AM and 10:30AM ET each day. 

Beyond seasonal factors, the downward pressure on yields this summer in the face of percolating inflation has left many investors perplexed. Guneet Dhingra, head of U.S. interest rate strategy at Morgan Stanley, tells the FT that “many clients have not particularly understood how rates markets have moved and that has brought in a degree of caution that you normally wouldn’t see.”

Of course, the Federal Reserve’s ongoing $120 billion in monthly asset purchases, in the context of brisk economic growth and euphoric asset prices, may also factor in the brittle state of the Treasury market. To wit: the Fed’s reverse repo facility, which allows cash-flush financial institutions to exchange their idle dollars for securities and thus generate a bit of incremental yield, continues to expand at a rapid clip, reaching a record $1.136 trillion today. That’s up from $584 billion on June 14 and less than $200 billion in early May.  

Indeed, a decade-plus of radical monetary policies have both altered market structure and helped facilitate mushrooming government liabilities. The net public debt has expanded by 337% since the end of 2007, while total assets on the Fed balance sheet have grown by 836%, towering over the 54% compound growth in nominal GDP over that period. Then too, the central bank responded to the pandemic by assuming an increasingly prominent role in the market. Treasury holdings on the Fed balance sheet stood at $5.3 trillion as of last week, representing 23.8% of Uncle Sam’s debt held by the public. Two years ago, the central bank held just over $2 trillion in Treasurys, equivalent to 12.7% of that total sum.  

Recap Aug. 23

Stocks caught a strong bid with the S&P 500 and Nasdaq 100 rising 90 and 150 basis points, respectively, leaving each of those indices higher by about 19% year-to-date, while Treasurys held unchanged with the 10-year yield remaining at 1.25% and the long bond at 1.88%.  The VIX darted lower at the cash open, wrapping up the day near 17, gold advanced beyond $1,800 an ounce for the first time since Aug. 5 and WTI crude jumped back above $65 a barrel after logging a three-month low on Friday.  

- Philip Grant

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