21/03: March Market Commentary
Credit Suisse Cheese
Holey balance sheet! Over the course of March, Credit Suisse has lost what could be double-digit billions of dollars in capital once all the dust has settled and losses are fully accounted for. The company has been mum about the numbers thus far, but they had a spectacular quarter end finish when a large family office collapsed under outsized leverage and Credit Suisse drew the short straw in the prime brokerage community and now appears to be one of the more serious casualties. The details are still being sorted out and so the following is an attempt to give some idea of the two major events to rock Credit Suisse. The details are likely to change as more reporting is done on the matters. Note these events are not isolated to Credit Suisse but the bank is key to both.
Greensill Capital was a supply chain lender. They were considered best in class and Sir Greensill was tied into influential names among the UK government. His firm lent into the global supply chain and sold the debt to investors. Its most recent investment partner was Credit Suisse, who had a series of investor funds that bought the loans. Since the loans were of various quality supply chain companies, they were covered by credit insurance to protect in the event of default. Sometime in February, it seems, the various counterparties began to realize something was amiss. The insurers pulled coverage (did not renew) and the loans turned out to be questionable if not outright fraudulent. So as much as $10 billion in loans have gone very sour. Now begins the very long process of investigation and courtroom battles to see who is left holding the bag. What is clear is that Credit Suisse will experience a loss, how much remains to be determined. The $10 billion figure is very big and is bound to hurt whoever’s lap it lands on.
Archegos Capital was the family office of a convicted criminal former hedge fund manager that was recently unleashed by the SEC and allowed to trade again. Some of the reported numbers suggest he had grown his capital to $15 billion and that various banks gave him 5-6x (maybe more) leverage using derivative contracts (essentially equity swaps). He was a well-regarded guy and so the big investment banks gave him the leverage without perfecting their security interest in his collateral. He over-pledged his collateral. Sometime towards the end of March the banks realized that there was not enough collateral to go around. At this point, Archegos Capital was defaulting on margin calls. Credit Suisse, realizing the gravity of its own situation attempted to broker a truce with the other prime brokers. Some of the other brokers, sensing advantage, were able to seize collateral and sell it off in size with minimal pain before markets became fully aware of what was happening. This came at the expense of the other prime brokers. Over a chaotic weekend in which prime brokers were trying to shop the rest of the collateral, related asset prices were falling and creating bigger holes in the balance sheets of any prime brokers left trying to close positions. Credit Suisse is thought to be among the worst hit and they have yet to disclose any details. The highest rumored amount was up to $7 billion loss. Since we just passed the quarter end mark we are bound to see a news release from them soon.
Note that Credit Suisse reported $3.85 billion income in 2020 and $3.67 billion income in 2019 (both converted to USD). The losses described above are much more than an earnings event, they are a balance sheet event. It was a terrible, horrible, no good, very bad month for Credit Suisse.
The canal channels some 10% of global trade, providing key passage between west and east. The day travel savings for seafarers is approximately 9 days if you used Singapore and Rotterdam as end points (WSJ). That is the additional time it takes for a trip around Africa’s horn. Not to mention extra savings realized from reduced pirate exposure. These time and safety savings were available until a massive cargo shift caught wind and hydrodynamics took over, driving the bulb (part of the ship beneath the bow) of the ship through the canal wall and the stern of the ship embed into the opposing wall. Traffic through the canal stopped immediately. While the canal was blocked other ships were queueing – sitting ducks, if you will – and faced the tough question of waiting an unknown period or recharting travel. Crews worked feverishly for days tugging, dredging, and digging to free the ship. The ship first became stuck on March 23 and was freed on March 29. The damage to trade is untold, but at this point is par for the course with all the supply chain problems rippling through from COVID shutdowns. Into April now, there are some preliminary reports of losses in the reinsurance market.
We back! WeWork, after a failed IPO in 2019 and a tough pandemic filled year in 2020, is seeking to become a publicly traded company through the SPAC market, which has entered a craze of sorts. Last time, WeWork didn’t.
How fitting would it be for this group to mark the market top again with a failed/pulled SPAC offering. We are highly skeptical of anything commercial office space in large city centers right now. We are no less skeptical of WeWork considering it is effectively an office space wholesaler – they lease large amounts of space from landlords on long lease terms and sub-lease these spaces on short lease terms – month-to-month in many cases. Further, WeWork entered most of their leases during peak office space demand and now face a weak office space outlook. This would be akin to buy high and sell low. However much one might view their product offering as marginally benefiting during an economy rotating from centralized office and work to remote work and on-demand office space it is hard to see a lease-up here that covers needed economics.
WeWork lost $3.2 billion last year. But hey, that gets you a $9 billion valuation nowadays. At least we are not talking the $47 billion valuation from two years ago. Step right up, folks!
More of the same here. GameStop’s stock price has ebbed and flowed. Below is a price chart of GME during March. Notice the month’s trading range. The price moved from a low of $99.97 on March 1 to a high of $348.50 on March 10 to a quarter close of around $189.82. Look at March 10 alone; the price ranged from $172 to $348.50. That is $176.50 of range in one day, or 65.5% of $269.43 open price that day. Clearly there is something more to this stock than just retail investors buying and selling. We look on and feel like the markets are being gamed. Derivatives play a big part. Just look at the Archegos story above. No thanks.
In another pivot, Intel is investing $20 billion (surely with government assistance) to build new manufacturing plants in Arizona with the aim of manufacturing more chips for other companies. Previously, as we noted here and here, Intel signaled it would give up on the US and begin outsourcing chip manufacturing. While the former is no longer true, the latter remains the plan, at least in part. We viewed a shift to completely outsourced chip manufacturing as national security risk, and it seems Intel does too. Now Intel needs to focus on execution.
A theme we have been focused on since politicians and central banks responded to the pandemic has been infrastructure. It has been years in the making. The Trump administration was working on it. Now the Biden administration is rolling out stimulus packages geared towards infrastructure spending. We will see what comes out of the Washington legislative sausage factory. There will be pork in there, but how much may make the difference in getting this country back to productive.
Speaking of infrastructure. Kansas City Southern (KSU), the fourth largest US-based railroad has agreed to be acquired by Canadian Pacific (CP). In hindsight, it is a clear match made from the USMCA (NAFTA 2.0). The merger would perfectly link Canada (CP) and Mexico (KSU) rail lines through the heart of the United States – straight through the Midwest. The deal must be approved by respective governments.
Speaking of railroads. General Electric agreed to sell its airplane leasing unit to AerCap, the largest aircraft leasing company in the world. AerCap acquired insurance giant AIG’s aircraft leasing unit, ILFC, during AIG’s dismantling after the great financial crisis to become one of the largest such companies in the world. Now AerCap picked over the dismantling of GE Capital. AerCap has transformed into a true market force.
It may not be smooth travel for them with the globe still on pandemic alert, but the power of air flight now rests in their hands. See it this way: most of the airlines are now nearly financially ruined whereas they previously had healthy credit standing. The aircraft manufacturers lost their might too because their end market is financially weaker and currently do not have much need for new aircraft (airlines have surplus capacity for the foreseeable future as they parked their fleets in the desert). Boeing faced financial ruin from various missteps, including two-year grounding of its main aircraft, the 737 MAX. All of this should mean that aircraft lessors, which have maintained financial strength, have greater power over the airlines and the manufacturers. AerCap is consolidating the market at a pivotal moment.
There are surely other aircraft lessors on the radar now. Carlyle Group, a large alternative investment group, announced it would acquire Fly Leasing and merge it into Carlyle’s existing group Carlyle Aviation. Brookfield, another large alternative asset manager, just announced it has appointed former Air Canada CEO as advisor. I wonder what they might be interested in.
Non-Fungible Tokens (NFTs) are all the rage right now. They are being sold for eye-popping prices. NFTs are the rights to something digital recorded on the chain – that is the blockchain. The something is tokenized on the chain which then represents indisputable ownership of that item. The something is an original of sorts. An original photo, an original video, et cetera. Some of it is being described as like playing cards of a different era; you wanted to get a rare rookie card. It was collectible and the price appreciated for the right stuff. There is a lot of roar and some eye-popping prices are being realized. We do not understand. What good is an original JPEG, for example, when there are infinite exact digital replicas available on the web?
We think Peter Schiff put it well when he tweeted, “Using overpriced Ether to buy overpriced [NFTs] reminds me of the old joke about a guy who tries selling his pet dog for $10,000. Since he can’t find any buyers actually will pay $10,000 in cash for his dog he ends up trading his $10,000 dog for two $5,000 cats.” Link
Treasury yields continued to back up at the long end of the curve. 10 year and 30 year reach recent highs. Unfortunately, credit spreads seem to be going the other direction so there still is not much to capture for carry. The market is caught between two huge forces: a monetary and fiscal push to reignite the economy and a labor force that remains severely underutilized. Given the historic size of each side this tug-of-war, any movement on either side will continue to lead to volatility in various asset classes. If the labor market does not improve sufficiently then capital markets may go back to disinflationary positioning. If the labor market does improve the capital markets may rip with inflationary views. But that only addresses the US. Much of the rest of the world is still dealing with COVID. Global forces are also driving the dollar and the US capital markets.
US Treasury Curves Steepening:
US Credit Spreads Tightening (Bloomberg Barclays US Agg Corporate Avg OAS):
While the rest of the world goes into hard lock down as COVID variants take hold, the US continues to benefit from vaccine rollout and the relative immunity this brings. There is still a race to head off COVID resurgence in the US with vaccine deployment. The last thing this country needs is a setback, but things are looking bright in the US. Israel is perhaps the brightest spot on the globe. Israel went into hard lock down and vaccinated much of the country’s population. Israel is now basically wide open. For the rest of the world, it is not looking as bright. Some examples:
- Canada entering new lockdown in Ontario region
- France entering new lockdown
- Germany resisted lockdown but urges citizens to stay home over the holiday
- Italy entering new lockdown
- UK slowly coming out of lockdown
- Chile taking measures to close boarders and control case surge
- Brazil, perhaps the scary of cases, is seeing the virus rip through communities that already saw high levels of infection in previous waves
- Peru continues to battle COVID with the Brazilian variant circulating
- Philippines is grappling with surging cases
There are many more examples around the globe. Add to this confusion and fighting in the EU over safety and availability of AstraZeneca’s vaccine. This virus has been and continues to be a real slog.
The point here being that even if the US leads in vaccinations and finds itself immune from the virus, the economy will not be immune from global recession if the virus continues to roll around the globe. Simply put, sickness and death reduce productivity. (We are empathetic and sympathetic to the hardships and losses from this pandemic. Here we make purely an economic and financial point as pertains to viewing the current investment environment.) It is our opinion that the general, near-term outlook remains bleak despite what US stock market prices may suggest otherwise. We may feel elation from going to restaurants or whatever your celebrated normality may be (if indeed you find yourself getting back to normality), but maybe that should not translate to capital market enthusiasm quite yet.