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.

Ford, Fallen Angels, & Opportunities

Ford Motor was recently downgraded to Baa3 and placed on negative watch by Moody’s.  Why is this significant?  Well, at Ballast, we acquire assets in portfolios and believe we are capturing more return for the fundamental risk than we are taking.  Ford’s downgrade and this article address an area where we like to troll for opportunities – which are Fallen Angels.

Fallen Angels are companies whose credit rating has fallen from Investment Grade (IG) to High Yield (HY), and they are an area where market pricing sometimes reflects technical currents rather than economic fundamentals.  Even the Fed seems to agree – so let’s examine why.

The universe of IG is much larger then the universe of HY, both from a supply and a demand side.  On the supply side, the Bloomberg IG index is just over $5 trillion in size, while the Bloomberg HY index is $1.27 trillion.  On demand side, there are many more dollars allocated to IG than to HY. A quick example of this is an insurance company.  An average insurance company may have 50-55% of their total general account allocated to IG issuers, while their allocation to HY may be mid-single digits.  So, an insurance company (just like pensions, banks and other regulated institutions) has capital allocated to IG that is a multiple of what it allocates to HY.


Why does this matter?


Well, if a company is a large borrower – like in the case of Ford (which has about $35 billion in the IG index) – then it is heavily dependent on the debt markets for financing needs. Whether those needs be for operations, capex, or debt rollover, they are met by market participants (insurance, pensions, banks) that have lots of capital ready to be deployed. However, when a credit deteriorates and moves to HY from IG, then things get interesting.


Typically, large institutions (banks, insurance, pensions) have policies and/or risk-based capital charges that either restrict their ability OR make it very costly for them to invest in non-IG bonds.  Therefore, when an issuer no longer meets IG ratings, then that market participant no longer purchases that debt and, more likely, begins to sell the debt it already owns.  This selling pressure (from pure policy/regulated reasons) provides opportunities.


Simply put, when you have a lot of paper moving from a large pool into a small pool, it takes time and adjusted prices for you to reach equilibrium.  It is during this time that credit-minded investors can assess and source paper that provides attractive opportunities.


Note: Some fallen angels that we currently own are Diamond Offshore and TEVA Pharmaceuticals. 

It remains to be seen whether down the road Ford bonds will present an opportunity or not. However, rest assured we are following this – and other potential Fallen Angels – for opportunities to acquire assets at prices that don’t reflect their intrinsic value.

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.

Market Correction? Yes. Buy the Dip? No.

The Dow Jones Industrial Average (“DJI”) fell from a high of around 26,600 on 1/26 to an intraday low of approximately 23,800 on 2/6, a downswing of 2,800 or 11.7% from top to bottom. By definition – typically considered 10% price movement – it was a “market correction”. We think “market correction” tends to carry an underlying investible opportunity connotation – a buy-the-dip moment. The January-February market correction was astonishing to most people, but not to Ballast because we looked at it quite differently. Here are some of the ways we put it into perspective:

Prior Performance

Year-over-year price performance of the DJI from December 31 of 1900 to 2017 yields another perspective. Index price returns for December 31 over the prior year-end from 1900 to 2017 generates 117 observations. For the year 2017, the index price return was 25%. This is right at the 20th percentile of observed returns. This means 80% of all the return observations were lower than 25%. For context, the range of returns were -52.7% in 1931 and 81.7% in 1915, all with a mean of 7.4%.


We consider the correction a modest giveback considering the generous returns provided up to January 26, and we would not expect an equally benevolent remainder of the year.


From the beginning of the year at 24,800 to the peak of 26,600, the index gained 7.2%. That annualizes to more than 86% (a level even the most bullish can agree is unsustainable). From the beginning of the year, the DJI was down a paltry 4% to the intraday low, and it was essentially flat by close of February 6. Remember, this was just one month into the year. There are no alarm bells going off here.

Days Not Years

To us, it hardly seemed like a market correction, or at least the buy-the-dip, investible variety. Each leg down in value, we looked back in time and measured the decline in terms of days, weeks, and months since the last time the DJI was at that price. In other words, the price gain that was eroded during the retreat. At its lowest intraday price of 23,800 during the correction, the DJI only retreated to November 28, 2017 price levels. To us, that is hardly a noteworthy movement. If anything, the reverse was true – the run-up from November 28, 2017 to January 26, 2018 was awesome. If the market had retreated more than a year we might be wowed and seek greater opportunity. What this highlights to us, and hopefully to you, is how uncharacteristically one directional (up) the market has been for the past few months and year. It was simply unsustainable, and so, the trend reset.


Think of the market as an intense workout. The athlete needed a break to cool down, but the athlete didn’t have a medical emergency. However, the media would have you believe the market was on life support.

Relative Strength Index

In fact, a popular technical indicator, the Relative Strength Index (“RSI”), which measures average price advances as a ratio of average price declines for a specified period, was at its highest level for DJI since 1904. We saw an internet commentator digitally overlay an image of a protractor on an index price chart with a caption that said, “just checking”. He was making sure the index price chart had not gone to 90° – straight up. It wasn’t far off. We found it funny because we held similar thoughts (a 2-year price chart shows increasing upward acceleration from November 2017 through January 2018). Some call this a “melt-up”, which is something common in late stage bubbles – yep, bubble. It happens as FOMO takes hold and indiscriminate buyers enter en masse.


No science here. Just look at it visually.

Buy the dip or revert to trend?

Earnings Breakeven

Another way we look at it is to ask how long it would take for an investor to recoup the lost market value in terms of earnings. (We prefer to think in terms of cash flow, but we’ll settle on earnings here.) The DJI constituents reported 1,240 in 2017 earnings per DJI “share”, according to Bloomberg. The 2,800 peak-to-trough price swing would take 2 ¼ years to regain through earnings. This is nothing to balk at, but the peak price-to-earnings ratio (“PE”) was 21.5x, a lofty valuation by historical standards. As reference, the DJI PE last saw those levels in the Dot-Com bubble. We would say, owning an asset at 21.5x earnings starts with expecting stable long-term intrinsic value, investing without earnings in mind, or expecting strong growth. In any of those cases, the 2 ¼ year breakeven should not now be concerning.

The ABCCC’s of Bond Investing

A bond’s total return comes from a number of factors, but the three largest are Coupon, Credit and Curve.  If you can remember these, you can help your chance of buying the right bond at the right time.

Coupon –

Coupon is the rate that the borrower agrees to pay you, and historically, it is the largest contributor to total return (See graph on Left).  The coupon on a bond is determined at the time the loan is originated.  Most bonds are issued with a fixed coupon.  This coupon defines the cash flow you receive over the life of the loan.  Since this coupon is set at the time the company issues the bond, the coupon reflects the credit worthiness of the company when it issued the bond.  Obviously, credit worthiness of companies improves or deteriorates over time – but the coupon doesn’t change (in some rare instances bonds have coupon steps where the coupon increases based on a rating agency’s rating, but these are few and far between).  Therefore, the way the market adjusts for any changes in a companies’ credit worthiness is through the price.  If a company was very credit worthy at the time of issuance but has declined in credit worthiness, an investor probably will expect a higher return (lower price) for that stream of future coupon payments.

Credit –

Credit refers to the ability to repay a loan.  Rating agencies have a rating system where the highest (most credit worthy) companies are triple A (Aaa  for Moodys and AAA for S&P & Fitch) and moves lower to AA, then A then BBB.  These ratings represent companies that have strong metrics in categories such as their business position, operating margins, leverage, management financial policy and whatnot.   If a company has a very strong ability to repay you, you would expect them to borrow at a lower rate versus a credit where repayment risk is higher.  The most credit worthy companies are grouped in a category called ‘investment grade’.  Less credit worthy borrowers are in a category called ‘high yield’.  High yield borrowers might have strong metrics in some categories, but they may have less credit worthy metrics in others.


This ‘C’ is the most important C of the bunch – since it doesn’t matter what your coupon is unless you have confidence your principal is being repaid.  The last thing you want is to generate 4% – 5% in income for 2 or 3 years – and then lose 50% of your capital.

Curve –

Curve refers to the length of maturity of the bond.  The treasury curve is usually positively sloped – which means that a borrower can expect to pay a higher rate if they want to borrow your money for a longer period of time.  The longer the maturity, the more time there is for something to go wrong with the company.  Therefore, when lending money for a long period, we prefer either to ‘move up in credit’ (which is lend to companies that have a bigger safety margin to their risk profile) or move down in price (find bonds that trade at steep discounts [see below] that mitigate the risk of principal loss but provide some upside opportunity).


This C is out of your control, and as treasury rates move (‘yield curve’), the price off the bond will move up and down.  However, our philosophy in Core Fixed Income is to buy bonds and hold until maturity. Therefore, we are less concerned with this factor as long as we get the right coupon and right credit.

What does all this mean?  For Ballast, it means a couple things:

  • Targeting Yield – We can control the yield on a portfolio by a number levers – a couple of which are ‘down in credit’ (1) lend to more risky companies or (2) ‘go out on the curve’ and buy a 10 year bond versus a 5 year bond. In either case, the yield is higher.  However, since at Ballast we control exactly what bonds go into a portfolio, we can solve for a number of different cash flow requirements.  Unlike a bond fund (which tends to own all the bonds in an index – or at a minimum tries to mirror that index), it ends up owning a lot of bonds that as a lender you likely would not have chosen.  For example, we had one client who transferred in a bond fund, and the fund owned a negative yielding bond.  We are not big believers in paying others to hold your money – regardless of what academic literature might say.
  • Finding Opportunity – Since credit quality changes over time AND a rating agencies’ ratings affect not only the price of bonds (borrower) but also the economics of those who own them (regulated investors like banks, insurance and index managers) – the price sometimes reflects other factors besides the credit worthiness of the issuer. For example, if a bond gets downgraded from investment grade (IG) to high yield (HY), it likely means that the corporation has become riskier due to some fundamental reason.  However, it also means that accounts that owned the bond when it was IG could be forced to liquidate, or they are charged more to hold that bond (risk based capital).  In both scenarios, you have what we call ‘forced selling’.  We believe – and research supports this belief – that forced selling presents opportunities.  Therefore, we constantly scour the capital markets for this type of situation. See Study here.

The three C’s of bonds are simple things to think about, but below the surface there is quite a bit that goes on. However, that is why finding an investment advisor with experience in the capital markets is valuable, and it can make a very big difference on one’s portfolio.