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Zombies Are on the March in Post-Covid Markets

This article by John Authers may be of interest to subscribers. Here is a section:

Recessions are supposed to lead to more bankruptcies, and make it harder for companies to borrow. Rises in debt outstanding, all else equal, should increase the risk of bankruptcies down the line. So what has happened in the last 12 months virtually surpasses understanding. French bankruptcies had steadily declined since the brief recession caused by the sovereign debt crisis, while companies took advantage of the dirt-cheap credit that had been engineered to save the euro to refinance and take on more leverage. When the crisis hit, they were then able to borrow far more, while bankruptcies tumbled.

Logic might dictate that an increase in bankruptcies lies ahead. This should mean that debt investors demand a higher yield to compensate them for the greater risk of defaults. In the U.S., this is exactly what has not happened. The spread between the yield on “high-yield” bonds (which might need to be renamed) over five-year Treasury bonds hasn’t been this low since the summer of 2007. And we know what happened after that:



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A year of disruption in the private markets

This report from McKinsey may be of interest to subscribers. Here is a section:

Dry powder Private equity dry powder stands at $1.4 trillion (60 percent of the private markets total) and has grown 16.6 percent annually since 2015. Dry powder stocks are best viewed in the context of deal volume, and as a multiple of average annual equity investments over the prior three years, PE buyout dry powder inventories have crept higher, growing 11.9 percent since 2017. However, normalizing for abnormally high deal volatility in 2020, PE dry powder as a multiple of deal volume remained largely in line with historical averages (Exhibit 21). Dry powder growth reflects fundraising in excess of capital deployment. Its continued growth in 2020 highlights a common misperception among industry participants and pundits: the belief that stocks of dry powder can be deployed quickly in a market correction. While fundraising fell sharply in the first half of 2020 (–22.8 percent relative to the first half of 2019), so too did deal volume (–22.5 percent). Despite the sharp (and short-lived) decline in mark-to-market valuations in the first half of 2020, PE investors were largely unable to take advantage, as private owners exercised a key feature of PE—the right to hold. Without willing sellers, dry powder stocks rose once again, piling pressure on deal multiples, which once again reached all-time highs in 2020.



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Inflation: The defining macro story of this decade

This is a thought-provoking report from Deutsche Bank’s new What’s in the tails? series of reports. Here is a section:

The Fed’s move away from pre-emptive action in its new policy framework is the most important factor raising the risk that it will fall well behind the curve and be too late to deal effectively with an inflation problem without a major disruption to activity. Monetary policy operates with long and variable lags, and as we have noted, it will also take time to recognize that inflation has actually overshot excessively and persistently. As inflation rises sustainably above target, forward looking expectations are likely to become unanchored and drift higher, adding momentum to the process.

By this point, the Fed will likely be moved to act, and when it does the impact will be highly disruptive to the markets and the economy. In the past, the Fed has not been able to reverse a sustained run-up in inflation without causing a recession and potentially large increase in unemployment. Being behind the curve when it starts will make the event that much more painful. Rising interest rates will also cause havoc in a debt-heavy world, leading to financial crises especially in emerging markets. If the Fed lets up and reverses rate increases in response to rising unemployment and other economic pain as occurred during the 1970s, inflation could back up again, leading to a repeat of the stop-go economic cycles that occurred during that period.

Depending on the timing of this potential inflation scenario, the 2022 midterm elections could be crucial. A surprisingly strong showing on the Democratic side could even pave the way for modifying the Federal Reserve Act to raise the inflation objective. This discussion has been brewing in academic circles for some time, not the least as a way to enhance the Fed’s power to move interest rates into negative territory when needed. But such a move could damage the Fed’s inflation fighting credibility. It could also lead to still higher inflation over time and ultimately intensifying the kind of boom-bust cycle experienced during the 1970s.

In brief, the easy policy decisions of the disinflationary 1980-2020 period appear to be behind us.



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Man Group-Oxford Quants Say Their AI Can Predict Stock Moves

This article from Bloomberg may be of interest to subscribers. Here is a section:

Multi-horizon forecast models using statistical analysis have been around for years now, channeling market variables into predictions about how a stock will move over different time periods. The machine-learning techniques introduced in this research will increase the amount of data that can be processed and the potential accuracy of the predictions over longer time periods.

But to make it work, the AI has to be able to process a huge amount of data quickly. The researchers turned to Bristol, England-based Graphcore’s Intelligence Processing Unit, a pizza box-sized chip
designed specifically to handle the demands of an AI program. In the trials, Graphcore’s chip performed about 10-times faster than GPUs.

While the research and the Graphcore chips that make the model possible are the “logical next step” in the high-speed computations that Man Group is interested in, the fund hasn’t committed to rolling it out, Ledford said.

Meanwhile, not every firm would be able to deploy this kind of strategy. “You would not try this model if you did not have access to fast computation,” said Zohren, who worked with Oxford-Man Institute research associate Zihao Zhang on the research.

 



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Secular Themes Review June 4th 2021



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Fed Reverse Repo Primed to Top Record Demand Level at Month-End

This note from Bloomberg may be of interest to subscribers. Here is a section: 

Volume at the Federal Reserve’s facility for overnight reverse repurchase agreements is poised to climb on the last trading day of the month, surpassing Thursday’s record, as global banks pull back on their balance sheet activity for regulatory purposes.

Wrightson ICAP said it’s likely demand for the Fed’s RRP moves above $500 billion level, but will be looking for some pullback in activity on June -- though any dip may be temporary

RRP usage surged to $485.3 billion Thursday, a record since the facility started in September 2013 and up from $450 billion in the prior session

The rate on overnight GC repo opened at -0.01%, according to Oxford Economics. Treasury bills out to September are yielding less than 1.5bp. On the unsecured side, three-month Libor dropped to a fresh record low of 0.13138% from 0.13463% in the previous session

The glut at the front-end has been spurred by the central bank’s ongoing asset-purchase program, commonly referred to as quantitative easing, as well the drawdown of the Treasury’s general account. The latter has been driven by the looming debt-ceiling reinstatement, which is due to take place at the end of July, and the flow of pandemic stimulus funds to taxpayers

Federal relief payments to state and local municipalities are also adding to the oversupply, and that’s being exacerbated as regulatory constraints encourage banks to turn away deposits, directing that cash into money-market funds



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ECB Expected to Keep Its Higher Bond-Buying Pace Through Summer

This article from Bloomberg may be of interest to subscribers. Here is a section:

The pandemic purchases were ramped up in March when the U.S. rebound was fueling a global rise in borrowing costs while the euro zone was in a double-dip recession. The ECB will unveil new economic projections that should confirm a far brighter outlook as vaccinations pick up.

A European Commission report on Friday showed economic confidence in May at the highest level in more than three years as restaurants, hotels and shops across the region start to reopen.

Yet in a sign that the recovery remains fragile, French data on Friday came in much weaker than expected. Consumer spending fell 8.3% in April from the previous month, more than twice as much as forecast, and first-quarter gross domestic product was revised to show a decline. Finland also posted an unexpected contraction.



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Bank of England likely to raise rates at some point in 2022

This article from Reuters may be of interest to subscribers. Here is a section:

“In that scenario, the first rise in Bank Rate is likely to become appropriate only well into next year, with some modest further tightening thereafter,” he added.

The government’s furlough programme, which pays the wages of more than 2 million workers, does not expire until Sept. 30 and Vlieghe said it would take time for the true health of the economy until early in 2022.

If unemployment in the first quarter of 2021 was low and upward pressure on wages stronger then than the BoE expected, “a rise in Bank Rate could be appropriate soon after, along a slightly steeper path than in my central case,” Vlieghe said.

However, if concerns about COVID infection risks persist - possibly as a result of new variants of the disease - higher unemployment could prove persistent and the economy might need more BoE stimulus. (Reporting by David Milliken and Andy Bruce)



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Email of the day on the value/growth ratio

Eoin, congrats for your most recent calls on crypto etc. well done! You were showing a chart re value over growth outperformance and that it could go on a little longer. What in your view is the best way to play it? iShares ETF value long and short iShares growth? Tkx a lot and keep, up your good work! Dani



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Cars Are About to Get a Lot More Expensive

 This article from Bloomberg may be of interest to subscribers. Here is a section:

Consider a car manufacturer with $100 billion in sales. A 10% decline in sales volume would push earnings before interest and tax down by 40%, the Boston Consulting Group has estimated. That's an optimistic scenario — and this analysis assumed the company could eliminate all variable costs such as raw materials and labor. In the current situation, that’s not quite possible.

No doubt, carmakers could digest the rising cost of production a bit longer by reducing incentives and discounts they’ve used to lure buyers. But that's already been happening in the world’s largest auto markets, the U.S. and China, and you can’t trim back enticements forever. 

Companies have few options to offset creeping manufacturing expenses. With prices already high, consumers aren’t going to be as liberal with their wallets. So far, they have been willing to
accept a 12% premium, or around $5,000 over the sticker price, according to Kelley Blue Book and Cox Automotive. But a U.S. vehicle affordability index has started ticking down, signaling people are beginning to think twice before splashing out. Almost 40% of those who were going to buy cars have now put off their purchases. 



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