08/2018 Market Commentary

Trade War Continues

Neither the United States nor China were willing to back down this month, and so, tariffs continue to increase on each side of the ocean. The two countries agreed to relaunch dialogue, but that did not stop president Trump from threatening new tariffs. Much like a kinetic war, many are harmed in the effort to win. So too, in a trade war, many are harmed before a victory may be claimed. At first, casualty in the United States hit farmers. Already affected by a pullback in the Ag cycle, crop prices have dropped even more in response to China’s tariffs. Trump has asked farmers to take the long view for the country, but that can be difficult to do as their livelihood suffers. Realizing the pain, the present administration has provided USDA assistance.

Consumer Unstaples

It used to be that consumer staples were defensive investments because consumers would reliably purchase these products, and the companies would produce stable results. (Think personal paper products, beverages, or even breakfast cereals) Each of these have been under attack lately, with sales at mature companies declining, as marketing schemes of new companies chip away at old brands. In the case of beverages, consumers are not drinking less. They are just shifting to “healthier” choices. Global soda sales are declining, and this has led Pepsi and Coca-Cola to take decisive action. The former has acquired Soda Stream to participate in the healthy shift, while the latter has made its own acquisitions and market experimentation. Coca-Cola announced that it would acquire UK-based coffee house Costa, putting Coca-Cola in competition with Starbucks.

Marginal Buyers

Last month, we discussed marginal buyers in a high valuation market. This month, we noticed an article highlighting one of the more highly valued real estate markets in the United States. In New York City, the luxury apartment market had soared for a few years, and then, it stagnated. In recent months, sales have declined, and prices have plummeted with them. We think this is a sign the marginal buyers are leaving. This can be either bad or good – bad because prices will fall or good because those with liquidity will have better buying opportunities. Will this show up in the rest of the market? We hope so. When? We don’t know.

Leveraged Loans

This leveraged loan cycle won’t be like the last one. Recovery rates are expected to be lower because the market has reached a larger size, and loans are of lower quality (fewer covenants) relative to past cycles (according to research by Moody’s Investors Service). Further, the previous cycle and the current cycle were all underwritten on assets, producing income in a declining interest rate environment. We wonder what happens to the debt service of companies struggling to make money as interest rates rise. The Moody’s warning should make investors cautious about owning BDCs, CLOs, and high yield funds through any downturn.


Another month, a lot more Tesla. The month kicked off with Tesla’s CEO burning short sellers by announcing boldly via Twitter that he planned to take the company private for $420 per share. The stock price soared until analysts began penciling out how it could be done… it couldn’t, it wouldn’t. The price fell back to its previous trading range after a week or so of active news flow. It turns out when the CEO boldly said “funds secured” that was not the case. It also turns out that he did not discuss taking the company private with the board before making the announcement – nor with any investing group. Other circumstances surrounding this event cause plenty of head scratching. The Securities Exchange Commission is now investigating the matter. We do not expect much to result from the investigation, but we think if nothing to date gives pause, then this should cause investors to press for better governance at Tesla. This CEO needs a leash; at the very least, take his social media away or require that he screen his posts through the legal department first. Big money managers have a fiduciary responsibility to their clients’ capital. What about Tesla? It is up to investors to force corporate responsibility through governance.

Tesla has made plenty of splashes during the month over whether it could meet production goals (which have been elusive throughout the company’s entire history) for the month of August and the rest of the year. Evercore analysts toured the production facilities and concluded Tesla was on track for producing 6,000 Model 3s per week by the end of August. Then, Tesla concluded August by missing the Model 3 production target by 30%. Don’t worry. They still expect to meet third quarter production goals…

Elsewhere, a UBS analyst says the $35,000 Model 3 cannot be made profitable, but then again, did Tesla ever intend to sell a $35,000 mass market car? Not without tax credits, it seems.

Here is one final note related to Tesla, referencing this article. Something you should never be caught saying, especially not quoted as saying is: “I was impressed with their negative free cash flow.”

Bond Bubble

The bond bubble rhetoric continues. Although not the point of this article, often we hear “don’t buy bonds because there is a bubble, buy stocks”. However, if we are to believe there is a bond bubble, then why own stocks and why no mention of a stock bubble? Stocks are a residual, junior claim of the earnings and assets of a company. If one is to expect losses to bond holders, then what are we to expect of stock holders? At least with bonds the holder can expect to be paid regular cash flows and have contractual claim to principal value. What do stocks holders get? higher prices? We think not, but we’ve been wrong before.

Cognitive Biases

WSJ Numbers explored some flawed consumer thinking that we found interesting and thought we would share. What’s better – 50% more product or 33% lower price? Here is the article.


We have not talked about Teva Pharmaceuticals in a while. The major news during August was that Teva’s competing product to EpiPen was approved by the FDA. Now, we will wait for the business execution. EpiPen is a commercial name that is ubiquitous for the product, which we think could make it a difficult market to penetrate. We are hopeful, and the timing couldn’t be better since EpiPen (parent company Mylan) has experienced a few controversies in recent years and is currently suffering a supply shortage.


Apple’s market capitalization reached $1 trillion during August. A first for the market. Wow. That is twelve zeros and one big company. A quarter of the trillion value sits on balance sheet as cash.

07/2018 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.

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?

04/2018 Market Commentary

10 Year Treasury Above 3%

Bond bears received a little more fuel on their fire as the ten-year treasury bond rose above 3% for the first time since 2013.

MC Pic

[10-year Treasury Rate, Source: Bloomberg]


Many pundits will have you fear higher interest rates. Ballast welcomes them. We want to earn higher returns, and such returns have been lacking in recent years. While we think inflation remains contained and growth remains tepid, the supply and demand imbalance of treasuries could still send rates higher, regardless of what the economy can bear. That would require willful disregard of the Fed. As stated in February’s Market Commentary, Ballast thinks this will move the front-end of the curve more than the long-end.

Ballast encourages our investor clients to not only embrace higher interest rates for the opportunities they bring, but to also not worry about the mark-to-market bond losses that it may cause on account statements (which is the thing pundits seem most concerned about). Unlike stocks, bonds contractually require return of principal. Any price decline must ultimately trend back to par. In the meantime, coupon payments are contractually made, and investors can reinvest the cash flows at more attractive interest rates, as well as in other attractive opportunities.

Discount Airlines Discounted

It was not a good month for discount airlines (and maybe not for airlines in general).

The first adverse airline event this month was when CBS 60 Minutes aired an episode questioning Allegiant’s maintenance and safety track record. Allegiant’s stock (ticker: ALGT) promptly fell in value by as much as 12% over a couple of days, moving from $165 to $145, but then, it moved back up to $160 by the month’s end. Roundtrip, it was hardly an event, despite risks of serious consumer preference shifts. The one-month price movement was 6% lower.

The next, adverse event struck Southwest Airlines (ticker: LUV), but it likely carried far broader implications if anything serious were to result from the investigation that is currently taking place. This includes the possibility of more problems for General Electric. A Southwest flight from New York to Dallas experienced an engine explosion, and debris from the explosion penetrated the aircraft, leading to depressurization of the cabin, which nearly sucked a passenger from the aircraft. The aircraft landed safely, but the injured passenger tragically died, despite efforts of the crew and fellow passengers.

The serious, broader implications (we think) relate to the engine, which is a very common piece on that type of aircraft. The engine is manufactured by a joint venture between General Electric and France-based Safron. The joint venture is called CFM International. If a flaw were to be found with the engine and if it were to be a common flaw among that particular engine or others (both of which are hypothetical as the investigation is ongoing), it would be bad for CFM, ergo General Electric. It would also be bad for most other airlines who then might need to take aircraft offline to fix engines. In the meantime, the aircraft could be filled with liabilities if another engine were to experience a similar catastrophe. This may well be tail-risk (low probability and high impact), but Ballast is not convinced market prices reflect this risk in prices of GE stock or the other airlines.

Ballast maintains little investing interest in airline equities, but we are, however, interested in and own several aircraft securitizations issued by US airlines. These structures are secured by the airlines’ aircraft and produce attractive intermediate-term yields.

Kimberly Clarke and Other Staples

The consumer staple sector has had a few uneasy years. The narrative varies – e-commerce, natural brands, cost inflation, etc. – but the trend has been the same: lower share prices. Take Kimberly Clark (ticker: KMB) as an example. Kimberly-Clark makes Huggies, Depend, Kleenex, and Kotex, to name a few. The share price is 21% lower for the trailing 12 months ending April 30. At the latest quarterly earnings release, the stock fell to a five year low of $97. This is a stock now valued at a modest (by today’s standard) 15x price-to-earnings ratio, the company has high quality single-A credit ratings, shareholders receive a dividend yield of more than 3.85%, and the company produces consumer staple products. Ballast finds this attractive.

One doesn’t have to look hard for similar stories. Proctor & Gamble, Newell, Kelloggs, General Mills, etc. all have similar tales, prices charts, credit ratings, and dividend yields.

Are investors really panning companies like Kimberly Clark because of, or in favor of, exciting companies like Amazon? Where are Amazon’s margins? Amazon doesn’t pay a dividend. What does Amazon have to offer besides the hope of someday expanding margins by selling products made by the Kimberly Clarkes of the world?

As an investor, would you rather receive a dividend and wait for opportunity or receive no dividend and hope for opportunity? Ballast strongly favors the former.


The race to renegotiate NAFTA is on, and the deadline for terms are due in early May. Canada and Mexico are expected to concede ground, but whether this can be done by the deadline is the question. Mexico is in midst of an election that could present risk for the NAFTA delay. It is assumed that if there is any chance for NAFTA to survive (and in its renegotiated form), it must meet the deadline and be signed into law before Mexican elections this summer. New NAFTA or no NAFTA, the potential disruption to supply chain will be something to watch, and it has Ballast’s attention.

Tesla Model Y?

Tesla was discussed in the last month’s newsletter piece, and Ballast remains skeptical of Tesla’s high valuation, given the scaling and cash flow challenges. We think it is likely that Tesla will need to raise more capital, and we see the company’s ability to access capital as becoming more difficult. Historically, Tesla seems to have relied on excitement about future products, as well as prospects for bigger, bolder ideas, as distractions from operational and financial shortcomings. This month (of bad news, in our opinion) marked perhaps another attempt at distracting stakeholders with the announcement that Model Y would begin production in November 2019. Remember, Tesla has not realized any prescribed timeline we are aware of, and the Model 3 production and production ramp has been abysmal – Tesla’s CEO has even acknowledged this.

All of this is just to say that we are astonished that a company struggling on the bread-and-butter product (Model 3) is even entertaining moving forward with the next model.

Aluminum Price

Aluminum prices have whipsawed with recent tariff actions. Stocks of companies involved in the production and processing of the commodity have tracked the commodity price. Alcoa (ticker: AA) saw its stock price move from $45 at the beginning of April to a mid-month high of $62 (+37%) only to fall to $52 (-16% from the high) to close out the month. That is volatile, and Ballast is not sure investors have any clearer of a picture on what to expect for the industry.

Apple Chips

Apple is said to be exploring building its own microchips. This would be detrimental to the chip industry, including Intel. Various speculations as to reasoning have been floated, but we wonder why building their own chips makes sense. Building the capacity and expertise, while trying to eke out a profit, is doubtful. Neither set of investors – the Intels or the Apples – appears to be very rattled by the revelation.

Oil Price and Projects

As we’ve previously highlighted, although we have expected status quo for oil prices, industry minds that we respect have called for dramatically higher oil prices, and the market seems to be trending this way. West Texas Intermediate, the US benchmark price per barrel of oil, reached $69, a price not seen since 2014. As recently as July 2017 the price was $42.

Whether oil prices are high or low, Ballast has been interested in the offshore drill rig companies. These companies are asset-intensive, and they suffered immensely in the oil price downturn (since oil and gas exploration companies stopped unprofitable projects, dropping rig utilization). The offshore oil rig industry appears to have rightsized and is treading water until oil prices rise and exploration companies begin to pursue new projects

Ballast wonders if we are beginning to see the green shoots. Exploration auctions have taken place around the globe, namely in Mexico and Brazil, and BP announced it would drill two projects in the North Sea.

Sprint + T-Mobile: 1+1 < 2

Sprint and T-Mobile, number 3 and 4 US wireless carriers, agreed to merge after what seemed like an on-again/off-again relationship. We’re not sure whether it is good for the pair, but we suspect it is at least marginally negative for their larger competitors AT&T and Verizon. Primarily, it likely means the wireless plan pricing war is set to continue.

What caught Ballast’s attention and why we write about the pair here is that ordinarily, the market knee-jerk reaction of investors following a merger and acquisition announcement is often telling of who the winner is. Sometimes, both stock prices rise – win-win. Other times one rises, and the other falls – win-lose. This time, the price of both stocks fell dramatically – lose-lose. This is rare. T-Mobile’s (ticker: TMUS) share price fell from $64.50 just before the announcement to around $60.00 by mid-day April 30, or down 7%. Sprint’s (ticker: S) share price fell from $6.50 just before the announcement to around $5.50 by mid-day following announcement, or down 15%. Investors do not seem impressed.