12/2018 Market Commentary


Like months past, December had a lot of news around Tesla, Musk, and sister companies. Here are some of the key items that caught our attention:


In case you were living under a rock or just returned from an off-the-grid vacation some place nice, stocks were down in December. What a month. We did say at the beginning of the year that counting on a repeat of 2017’s strong stock market performance was not a good bet. Our caution looked off for much of the year until October when the selloff began. It’s amazing what global central bank shrinking balance sheets can do to asset prices. Throw in rising interest rates, and you have a toxic mix. There are no current plans for central banks to stop the tightening, so stay tuned because the ride down will likely continue.


Much like our commentary earlier this year, we do not yet care for general price levels. We remain cautious and think you should be too. There are select opportunities though, and your team at Ballast continues to look for them.

Credit, Rates, & Commodities

Rates (10yr treasury) and major commodities continue to slide. Credit spreads have widened (risk premium increasing) substantially over the past few months. All of this has happened during what many pundits are saying is a strong economy. However, these things don’t tend to occur during a strong economy. Conversely, they tend to signal weakness. Meanwhile a portion of the interest rate curve has inverted, and an inverted curve commonly signals an imminent recession. Stay tuned.

Hindsight Capital

This piece is entertaining and provides a good perspective. Maybe someday Ballast will have the abilities to launch a hedge fund, Hindsight Capital.


Everyone is doing it. AB Inbev (parent of Anheuser Busch) and Altria (parent of Marlboro) have entered the cannabis fray. The former is forming a joint venture (pun?) with Tilray, a Canadian cannabis company, to research nonalcoholic beverages. The latter paid $1.8 billion to acquired 45% of Canadian cannabis company Cronos Group. There has been interest elsewhere in the market of large consumable goods as well. All relevant industry groups appear to be gearing up for a different future in the U.S. We think that future is coming but remains, generally, not investible.

China, What's Wrong?

Chinese companies have had great success raising capital lately through IPOs. What’s alarming though is that Chinese company IPOs in the US now exceed those in the mainland. Wait! What!? What’s wrong with China?

Buyer beware. And that means you too, index investors. Your index might contain things you otherwise might not want.


We discussed Netflix previously. Basically, this company spends billions more than it earns to rapidly buy up content in order to appease its subscribers (so they don’t go somewhere else). What’s weird though is that Netflix’s top viewed programs are content owned by others (see chart in middle of page). These shows are owned by other major networks – many of which are building out their own streaming services. If their own shows are not ranking well, then what’s the return on investment for Netflix owned content, you ask? Maybe when the Federal Reserve’s balance sheet is much smaller, we’ll find out.

Absurdity finds limit?

We wrote about SoftBank and WeWork in October, highlighting the high valuation the former has placed on the latter despite the lack of earnings of the latter. It seems absurdity may have found a limit. Key capital partners to SoftBank’s Vision Fund are balking at the latest valuation and proposed investment into WeWork.

CLOs & Leveraged Loans

We have previously discussed leveraged loans and CLOs separately. They are related markets – the latter invests in the former. There has been a lot of commotion recently.

Many market participants are shedding risk in the space.  In fact, some of these groups are beholden to investor redemptions/contributions (or fund flows in industry speak). Flow has been one way for a while, and now it’s going the other way – out. Another market participant, banks, have been unloading leveraged loans to protect their balance sheet. This is causing pricing to fall and discounts to grow.

By the way, banks have been happy to oblige the lending boom to date because the fees have been so good. This is a contributing factor to how you can get risk skewed too far the wrong way. But don’t worry, everything is fine.

This loan market dislocation can present good investment opportunities. Ballast continues to monitor the situation.

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.