07/2018 Market Commentary

Aug 2, 2018 | Market Commentary

Triple C Priced to Perfection

We opened a market brief on Bloomberg (no public link available; for anyone with a terminal: {NSN PCQ8R66K50Y0 <GO>}) by accident to close out the month on July 31, but it made us pause. Key lines of the brief are as follows:

  • CCC yield fell to 7.89% (lower since Sept. 22, 2014) after the steepest drop since Dec. 30, 2008.
  • CCC spreads are closed at a 4Y low of +512, the biggest decline in 10 years.
  • Morgan Stanley warned investors about ‘significant potential downside’ in CCC credits.

For starters, we don’t often find ourselves in the camp on Morgan Stanley, and yet here we are. Investors are still evidently zealous for yield. This surprises us with all the talk of bond bubble, record weakness in covenants, and zombie companies. We think there are a lot of places to not be invested at this point in the cycle and this part of the credit curve is (generally) one of them.

We think yield-starved investors continue to push capital wherever yields surface. We suspect the biggest conduits and investors to be Business Development Corporations (publicly traded small and medium enterprise lenders) and Collateralized Loan Obligations (CLO), and they are the primary enablers for this market. The former is available to and popular with retail investors, while the latter has been hot with institutional investors.

CLO's are Forever

Until they are not. Quantitative minded investors have been effective at observing historical losses of the asset class and calculating excess returns. If you are an institution looking for good relative value, this has been the place to be. With the recent resurgence in CLO interest (since the last cycle end – Great Financial Crisis), many new CLO managers have surfaced and met rising demand for their product. The problem is the CLO owner is beholden to many things out of their control, and when the market turns, liquidity goes away. It is not until then that investors will find out how good their CLO manager is – only with hindsight. And those historical losses – we’ll see if the next is the same as the last. In the meantime, sounds like the CLO market started to flash warning signs.

Tesla Tesla Tesla

A reference to the Brady Bunch or summoning Candyman? Elon Musk was summoned by a critic of Tesla, writing under the pseudonym Montana Skeptic on Seeking Alpha, and Musk silenced the critic. The analyst and an editor of Seeking Alpha both commented on the event and confirmed. Montana Skeptic, to keep his employer from public scrutiny, as well out of legal wrangling, agreed to cease writing about Tesla.

That was not it though, as a lot happened during July for Tesla. Remember, Tesla’s cash flow has been of critical focus, and many suspect the company will need to do raise capital – which Musk has strongly denied. In addition to the silencing mentioned above, we summarize the month here:

  • Tesla is thinking about building a Tesla Gigafactory in Europe. This could provide cover for capital raise…even though it is not needed…
  • Tesla is thinking about building a Tesla Gigafactory in China. This could provide cover for a capital raise…even though it is not needed…
  • There were more high profile executive departures.
  • There was distraction with sending help (ultimately determined unneeded) and equipment to the Thai cave rescue.
    • Elon Musk then, very publicly, skirmished with the rescue lead and certain divers about ego things.
    • Elon Musk disparaged at least one diver in an unacceptable way, deleted the Tweet, and publicly apologized.
  • Car sale prices increased in China.
De-FANG-ed?

The FANG index, comprised of the crème de la crème of tech high fliers (Facebook, Apple, Netflix, Google, Amazon, Twitter, Tesla, et al), was soaring, but it hit turbulence in late July and has plummeted to correction territory. Leading the charge lower was Netflix, Facebook, and Twitter with poorly received quarterly financial results. While the index may not be Icarus, some of the constituents may be. The result is something we recommend staying away from. We continue to strategize ways of expressing our views around these select names in ways that are productive to accounts, but these are expensive times in the tech investment world.

GDP Hits 4.1%

Where is the beef? It is one quarter, and the reading spikes on occasion. Not to mention, it is often later revised as lower. The annual reading is likely to be no different than the previous few years. While headline unemployment is giving people something to cheer about, employment slack is a huge overhang for the next few years. Wages, in real terms, have treaded water (at best) for the last decade. Inflation is not budging. Celebrate not. We are not out of this yet.

Marginal Buyer. Minsky Moment?

For several years, China-based investors were the marginal buyer in capital markets. In real estate, market valuations are viewed in terms of cap rates (or the discount rate with which to value a property given its net operating income). A lower cap rate translates to a higher value and vice versa. Rewind a few years and US investors were already taking pause at the historically low cap rates. Then, China-based investors entered, and they drove cap rates even lower. Risks were mounting at home in China, and investors were prepared to take big risks overseas. In an already highly valued (real estate) market, they became the marginal buyer and were seemingly prepared to pay anything. Fast forward to today and these China-based investors are now sellers. But who is the marginal buyer today? Will they pay even lower cap rates?

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06/2018 Market Commentary

Jul 2, 2018 | Market Commentary

How is it July already? In case your summer is flying by as fast as ours, here is a chance to catch up on June’s Market News.

Auto Market

We commented on subprime auto last month. In June, there were a few events that had us scratching our heads. The first – Edmunds said that used-car prices are at a record high – which caused car rental companies like Hertz (ticker: HTZ) and Avis (ticker: CAR) stock prices to surge. The second – Street analyst forecasted a weak outlook for used-car prices – which sent Hertz and Avis plummeting. Ballast would agree with the analyst perspective that bargains are around the corner for vehicles coming off lease.

HTZ EQ - GPO

Hertz Price Chart

General Electric

GE continues to pare its operations to reduce debt and improve profitability. In June, GE announced it would spin-off its healthcare unit and sell its ownership in Baker Hughes. These businesses represent around 1/3 of GE’s revenues. GE will look very different in coming years. Ballast remains interested in the name.

Another mark for GE in June was the historical removal from the Dow Jones Index. GE was a member of the Dow Jones since 1907. Walgreens is the new Dow Jones entrant. Perfect timing…(Amazon acquires PillPack)

Amazon, The Untouchable

Amazon continues to impact other companies. Drug stores, drug distributors, and pharmacy benefit managers just got a tough pill to swallow (or so investor reactions suggest). Amazon agreed to acquire online pharmacy, PillPack, for $1 billion and wiped out $17.5 billion in equity market capitalization from 8 companies. The acquisition is a major step for Amazon into the pharmacy business, where the company plans to deliver medications directly to patients.

Oil

OPEC agreed to raise production. To Ballast’s surprise, oil prices surged. This is because the production increase was lower than expected. West Texas Intermediate crude closed out the month above $74, after spending much of June around $65. Amazing.

Mall Apocalypse?

Miami and Florida officials have approved development of what will be the largest mall in the United States – bigger than the eponymous Mall of America. The same owner is building the new mall. Despite malls around the country suffering greatly from reduced foot traffic and sales as e-commerce draws away market share, this mall is designed with major attractions in hopes of drawing shoppers. The $4 billion mall will have 3.5 million square feet of retail space and 1.5 million of entertainment space, which will include rides, trampoline parks, gyms, and other entertainment.

Bitcoin

The cryptocurrency’s US dollar exchange rate continues to trend lower, reaching new year-to-date lows of around $5,900 at June’s close. This is a nice segue to share two pieces we think explain cryptocurrency and blockchain. The first is an info graphic by Reuters, and the second is excerpt from Bank for International Settlements (like a central bank to central banks) annual economic outlook.

XBTUSD FX - GPO

Tesla

It was a wild month for investors of Tesla stock. The price moved between $286 and $373, an $87 range. There was plenty of news flow around Tesla during June but no particularly noteworthy events. What we found interesting was this piece, which takes a look inside the company’s factory.

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11/2017 Market Commentary

Dec 6, 2017 | Market Commentary

Teva
Yield
Bitcoin
DaVinci
Amazon

Combining our experience and daily focus, we aim to process, distill, and comment on various activities in the market place here in the Market Commentary section. Here are some insights from November events to highlight some of the things we have worked on and thought about on behalf of our clients:

 

Teva

We have introduced and discussed Teva in previous commentaries. There were a few meaningful updates during the month of November. The new CEO began work in early November, and later in the month, the company named the permanent CFO and announced a major restructuring of business operations.

 

Teva will be cutting a big chunk of its Israeli and US workforces. Considering Teva is based in Israel, we wonder how well that will go over –  even though it is crucial to righting the Teva ship. The company will not proceed with the sale of previously announced asset sales (offers were not high enough), and the specialty drug division will be consolidated into the generics division. This means that Teva will become a purely generic pharmaceutical company. This latter development does not surprise us, as the key specialty drug of Teva became subject to generic competition, so it would only make sense that it be consolidated into generics. We think this consolidation is the reason for layoffs – redundancy – and is an important step in rectifying the credit situation.

 

Again, we find ourselves wondering how the credit rating agencies S&P and Moody’s continue to rate the company as investment grade. Each step of the way, results have confirmed Teva is not near the track it laid out for maintaining investment grade ratings at the time of the major debt-funded acquisition of Actavis from Allergan. The asset sales and layoffs may better highlight the challenges to credit rating agencies. Credit spreads traded wider during the month and have signaled that bond investors are seeing through the credit ratings.

Yield

Times are good – or so we hear and read about almost daily. Did you know negative yielding bonds around the world reached $11 trillion (yes, that’s a ‘T’) again in November? We ask – why would central banks and investors remain committed to driving interest rates negative when things are going great? Remember, a negative yielding bond is a bond that is guaranteed to lose money if held to maturity. What negative yielding bonds suggest is that the alternatives are worse, and there is a possibility of deflation.…

Bitcoin

November was a good month for Bitcoin, as it set a record high of nearly $11,400. This is up from as little as $200 only two and a half short years ago. One record after another, Bitcoin has been a hot and obscure sensation.

 

Currencies are broadly defined as representing store-of-value, unit-of-account, and medium-of-exchange. We do not believe Bitcoin has yet accomplished any of these. Store-of-value is hard to get comfortable with when each day is a 10+% point swing in value. Unit-of-account is obvious, as no one is yet reporting income and financials in stated Bitcoins. As for medium-of-exchange, how many businesses are advertising acceptance of your Bitcoins? Did you know that the transaction fees spending Bitcoin set a recent average of $10.00 USD? That $5.00 latte just cost you $15.00. How is that for medium-of-exchange?

 

On the other side of these is the investing world (our focus). At current, only individual investors have entered the fray. No asset manager can own it currently. But institutional adoption is not far off. This may soon come to an end as CME Group, the Chicago Mercantile Exchange, has announced intentions to launch a futures contract referencing Bitcoin. CME has futures contracts for everything from S&P 500 and WTI oil to lean hogs. Having such an exchange-cleared product is likely to turn the Bitcoin heat up even more, but we still plug our nose around this hog. Speaking of heat, Bitcoin has redefined parabolic – see accompanying chart. We called your attention to several interesting bubble and market mania books back in August, and will point you there again.

X=Time (Month & Year)   Y=Price
       X= Time (Year)   Y= Price          
https://www.linkedin.com/pulse/dax-tulips-kiril-vasilev/

Da Vinci

Speaking of bubbles, Leonardo Da Vinci’s 500-year-old piece “Salvator Mundi” fetched $450 million at a recent auction in New York. Maintaining such art work is a negative carry – think costs of insurance, cleaning, security, et cetera. Priceless…

Amazon

We were struck by an Amazon announcement during November. The company scrapped plans to build a bundled video service, one that would compete with the likes of online video services SlingTV and DirecTV NOW, which compete with traditional cable and satellite providers. Amazon stopped talks with industry partners because the service would not generate enough profit. We laughed and wonder when that has ever stopped Amazon. In the nine month period ending September 30, 2017, Amazon generated $1,176 million income on $117,413 million sales (that’s $1 billion and $117 billion). That’s a 1% net margin. Amazon is 1% margin away from running a benevolent operation.

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10/2017 Market Commentary

Nov 6, 2017 | Market Commentary

Celgene
Spain
China
Teva
Amazon Rivals

 

Combining our experience and daily focus, we aim to process, distill, and comment on various activities in the market place here in the Market Commentary section. Here are some insights from October events to highlight some of the things we have worked on and thought about on behalf of our clients:

Celgene

Here is a mini-case study in Celgene stock ownership. We are not currently interested in owning the Celgene stock or bond, but we think this is a topical example that highlights the perils of equity versus bond ownership.

 

Celgene (ticker CELG) is a global pharmaceutical company with concentrated revenues in a key drug, Revlimid. The discerning investor may dig a little bit deeper and become less excited because of ongoing lawsuits filed by competitors trying to allow for generic competition of Revlimid. In other words, if the patent is lost, then so too may the revenues and earnings be lost. In mid-October, Celgene announced it would discontinue a late stage drug trial that would have expanded treatment use of an existing, acquired drug, Otezla. This was an important pivot strategy Celgene had undertaken to diversify revenue and earnings away from the key drug and its apparent business risks. The failed trial of Otezla sent the stock price down 10% from $136 to $122. One week later, Celgene announced quarterly financial statements and revised guidance on revenues and earnings to lower numbers. This sent the stock price down another 18% from $120 to $98. We think this example highlights one of the perils of owning stock – rapid adverse price change.

 

Alternatively, during the same period (month of October), Celgene’s credit spread for bonds due in 2045 widened from 125bps to 150bps above equivalent treasury rate. This caused the Celgene bond price to decline approximately 4%, but the owner of the bond would continue to expect 4% of annual yield from interest payments each year until principal/par is returned at contractual maturity – so long as the company does not default. (This is unrelated to the price decline.) As we highlighted above, Celgene’s stock price fell 30% during the same period thanks to concentrated underlying business no longer performing well. Celgene does not pay dividends, so the owner does not receive compensation in the interim for holding the risk. The stock owner just hopes that the future will bring higher price. The swinging stock price hurts those that owned it and we think there may be more problems to come for Celgene. Stay tuned.

 

Spain

Spain has made headlines lately because a region within the country, Catalan, took its long-pursued independence campaign to vote and received majority favor. There is plenty of controversy around whether simple majority is sufficient enough to move forward, but political turmoil has resulted, and it could translate to the economy. The independence vote resulted in immediate wrangling with Spain as Catalan began dialogue with the country, which then sought to stifle further progress of independence. The Catalan government responded by declaring independence.

 

Why does this matter? Spain is the ‘S’ in the peripheral European countries, commonly referred to as the PIIGS (“pigs” – Portugal, Italy, Ireland, Greece, and Spain). These countries have strapped the monetary union with weak economic performance and high debt burden. Spain remains in a challenged economic position to this day, and so, splitting the country would be complicated and likely disastrous. Catalan, the northeast region of Spain that includes Barcelona and that is adjacent to France, is a large economic contributor to Spain. According to The Guardian data, Catalan represents 6.3% of Spain land area, 16% of the population, 25.6% of exports, and comparatively lower unemployment rate.

 

Separating Catalan creates doubt about Spain’s ability to repay debts, which in turn, reverberates to broader Europe because of the monetary union AND because the European Central Bank has backstopped sovereign debts. Doubt is all that it takes for a crisis to form, and a crisis in Spain, we think, could mean a crisis for all of Europe. We are not suggesting this will happen. We are only suggesting that it is a major risk – one amongst a growing number that make us question price/risk across markets.

China

The Chinese communist party met for national congress in October, an event that takes place every five years to affirm leadership of the communist party. Xi Jinping, the incumbent president, retained and consolidated power, including elimination of critical voting. The run-up to October was preceded by relative economic and financial market stability – despite major reforms in progress (that include working through some credit losses in what has become a highly leveraged financial system).

 

It is important to note that China, over the last two decades, has been a global economic driver as a fervent infrastructure builder and commodity consumer. We wonder what having the national congress settled – with consolidation of powers and removal of economic targets – will bring to the investment markets. In the year or two ahead we think there may be some house cleaning (so to speak) of the excesses created during China’s substantial growth period. Moreover, we wonder what this would mean for a global investing community who may have grown accustomed to a continuous growth engine in Asia.

Teva

The Teva story, which we discussed in previous newsletters, continues to play out. During October, generic competitor, Mylan NV, received FDA approval for Teva’s multiple sclerosis therapy Copaxone. Competition is expected immediately. Ultimate impact for Teva is to be determined based on the level of discounting from Mylan’s drug relative to Teva’s. Mylan’s ability to convert active users over to the competing drug will also be important. We continue to monitor Teva.

Rivals keep Amazon at bay

We have talked recently about Amazon’s impact on various industries and found this Reuters piece interesting in how certain competitors are keeping Amazon at bay by using the fine print of lease agreements. Because of all the sectors Amazon now operates in, some peers are beginning to use lease document language to block (or limit) Amazon delivery activities, as well as Whole Foods expansion, at certain locations. The Amazon story has progressed seemingly unfettered to date, and although these are small issues, we think this highlights growing challenges at the margin hereafter for Amazon. Execution is always difficult, and Amazon faces a growing number of incumbents.

Closing Note

You may see a theme throughout much of our writing lately – that we are cautious. Some would say we are negative and bearish. Be assured that we look for positive and bullish, but by virtue of our fiduciary responsibility to clients, we worry. With valuations running to high levels relative to risks (we try to highlight these risks throughout our newsletters), we continue to think added caution is warranted.

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07/2017 – Market Commentary

Aug 15, 2017 | Market Commentary

Oil Market
Energy Private Equity
Amazon Retail | Financial Services
China
Greece
AstraZeneca

Combining our experience and daily focus, we aim to process, distill, and comment on various activities in the market place here in the Market Commentary section. Our purpose is to get you thinking about things in order to avoid just re-presenting otherwise meaningless statistics like unemployment level, S&P 500 closing price, etc. Ballast will provide you this commentary on an ongoing basis with the intent of delivering insight and color that is not readily available through public outlets. We assume that you are familiar with common sources for latest readings of Dow or S&P closing prices and that you see the major headlines like the Federal Reserve Bank having increased or decreased the Fed Funds rate.

In our opinion, a great deal of time and energy from sell-side economists is spent addressing unemployment, ISM Index, payrolls and all the other monthly economic releases, speaking to facts without necessarily instilling wisdom. To us, this is an outcome of the age of Google – anyone now has the ability to quickly search the internet for facts and information (and now disinformation). But knowing facts and information is different than having knowledge and wisdom.

Here are some insights from July events to highlight some of the things we have worked on and thought about on behalf of our clients:

Oil Market

With oil prices in decline for most of the month of July, high-yield debt markets began to reflect trouble in energy-related credit again. The Ballast team began re-examining some of the companies/bonds from 2015-2016 to reacquaint ourselves with the energy sector. It’s still early, but we think the opportunity could re-open if WTI oil trades back below $40/barrel, a price not seen since early 2016 when the energy sector “recovered”.

 

There remains a variety of reasons that oil could trade lower.  First, U.S. shale oil producers continue to grow output through increased drilling and well completions (a large number of wells were drilled but uncompleted from before and during the “crisis” of 2015-2016), which are relatively cheap to turn on in the current price environment. Operations are booming again so much so that there is said to be equipment scarcity. What!? Further, OPEC (Organization of the Petroleum Exporting Countries) is struggling to maintain its output reduction quotas due to turmoil across much of the middle east, select members being exempt from the cuts (Nigeria, Iran, Libya, et al), and suspected cheating. Oil demand continues to fall short of projections, which has kept supply in excess of or matched demand, leaving oil storage facilities around the world highly utilized much more so than in recent history. Storage levels have fluctuated regionally and traders have reacted in a number of different ways, with the result being price volatility. We think these points highlight the sensitivity and vulnerability of oil at present and therefore, positively reflect the opportunities that may arise over the next year.

Energy Private Equity

EnerVest, a large energy-focused private equity group based in Houston, Texas, splashed investment headlines during July. They had the distinguished honor of having the first private equity fund of initial size greater than $1.0 billion to go bankrupt – that’s right, their investors are likely to get zero ($0.00) of their capital back. One of EnerVest’s other funds has a NAV (Net Asset Value) described as “pennies on the dollar” and yet another one of their funds is at a material discount to initial contributed capital. We are not surprised to see such news for the industry and would not be surprised to hear of more of these instances in coming years.

Amazon Retail | Financial Services

Amazon never ceases to amaze and bewilder investors. Sears announced it had reached an agreement to sell its Kenmore appliances on the online retailer. The news boosted Sears while competitors in the space – Lowe’s, Home Depot, et al – saw their stock prices fall by 4% or more. This goes back to our thoughts on Amazon from June Market Commentary. While we think the agreement may help Sears at the margin, we remain unconvinced of the near-term implications for Lowe’s, Home Depot, et al.

 

Amazon hasn’t stopped making headlines there, though. In fact, there is nothing this company seemingly cannot disrupt. The latest news here is that Visa, Mastercard, Paypal, et al face long-term disruption from Amazon. Although the news did not seem to move stock prices adversely, we think the article commentary was another example of analyst over-reaction. Otherwise, we hope Amazon does not start an investment advisory business. On that note, robo-advising is on the rise and is likely to be a topic of a future Ballast piece. Stay tuned.

China

Under pressure from both Chinese and U.S. governments, there has been more news of Chinese companies slowing acquisitiveness. We think a significant portion of today’s market valuations reflect takeover premiums – that is that the potential for company to be acquired is reflected in its price. Since Chinese companies have been a large participant in acquisitions in recent years, we think the absence of Chinese buyers will slow acquisitions and cause the equity markets to move sideways until another catalyst emerges for an up or down movement.

Greece

Greece has been in financial trouble for a number of years. The EU, rightly or wrongly, has held Greece financial prisoner. The country has been forced to implement strict measures to shore-up large and long-running deficits in order to stabilize outstanding debts of the country. Further, Greece has been in and out of recession for at least half a decade, and needless to say, the bond issuance from the country has been both infrequent and high-yield. The country is at a level comparable to emerging market countries.

 

Greece was able to issue €3.0 billion five-year bonds to the market at 4.625% yield with the deal two-times oversubscribed, which means there was twice as much interest in the deal than bonds available. While it’s not a century bond like Argentina issued in June, we think the Greek issuance echoes our thoughts on the Argentina bond we commented on in the June Market Commentary piece. Investors appear to be yield-hungry regardless of risk.

AstraZeneca

AstraZeneca (AZN), a global pharmaceutical company, reported  disappointing research of a key trial drug in the company’s pipeline. The drug is an immunotherapy for treating lung cancer, and it was expected to be a blockbuster (high revenue and earnings potential) and a primary treatment for lung cancer patients. On the news, AZN stock promptly traded 16% lower. This made sense to us given the significance the drug represented to future earnings.

 

Thinking this would be an opportunity for the credit side, we looked to the bonds for more attractive value. What we found did not make sense – bond spreads remained at recent tights (low spread means high price) and so the bonds remain richly valued. Having followed the company for a few years, we think the announcement means more than has been reflected in the credit spreads. Front in our mind is that Pfizer (PFE) made an offer to acquire AZN three years ago for £55/share and AZN “successfully” resisted the takeover, causing PFE to walk away. As of this writing AZN shares trade at £42. We’ve seen this type of thing several times in the last five years and cannot understand the governance at some of these pharmaceutical companies.

 

Underscoring our caution with AZN valuation, the CEO was rumored to be a top candidate to take the vacant seat at Teva, another pharmaceutical company – and a story we have followed. The AZN news may be just the thing for its CEO to make the switch. This would open AZN to strategic uncertainty, and it confirms the execution of strategy at AZN is not what was otherwise anticipated, as well as the fact that the Pfizer deal was a good deal. The only thing we can think of is that creditors believe a takeover is now back in play (which would come at the cost of shareholders’ lost opportunity three years prior), and so credit spreads may be reflecting this. A takeover is uncertain and the acquirer could be of weaker credit quality, so tight spreads are of little interest to us here.

 

We think this was a rare instance where the equity analysts and market reacted correctly and the credit analysts and market did not. We passed on AZN for now as the opportunity has not materialized as we expected.

The Ballast investment team continuously monitors events like those outlined above, as well as the opportunities that arise from them.

 

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