Weekly Research Briefing: Time to Migrate?

September 14, 2021

Plenty of movement going on this September. Not only are the ducks headed north, but also students in the U.S. have returned to school, (some) employees are moving back to the office, many corporations are tapping the bond and stock markets, and most football fans are wading back into their stadiums. As the nighttime temps begin to cool, it feels like a more normal Fall is upon us in America. For the markets, this also means it is time for that always fun September/October seasonality.

This year, the markets have a growing field of reeds to chew on as investors contemplate their year-end positioning. COVID remains front and center due to its impact on demand and supply of most goods and services. As companies hit the (virtual) conference season hard this September with updates, the mood going into Q3 earnings season is getting a bit darker. Input costs and labor wages are becoming even more uncertain. Where new orders and pricing might be in line with management's projections, global supply chain issues and the ability to hire is erasing all visibility going into year end. Plenty of pre-announcements this week and last, highlighting the greater difficulties. So for the first time in several quarters, forward-earnings estimates may not increase as we go through the October earnings season. It might take an implosion of COVID cases globally to increase optimism surrounding future demand and a more normal supply chain. Then again, if the world reverts right back to normal, will the cost side of companies’ income statements remain controllable in a world flush with full wallets and savings accounts? It feels like the markets are going to need to thread a needle while doing 100mph on a motorcycle to keep these high valuations happy.

Bond yields are inching higher as the inflation datapoints continue to reveal themselves, and as the U.S. Federal Reserve readies itself to drain the tapering punchbowl. Not waiting long after the end of summer, 54 corporations last week decided to hit the markets with $77.8 billion in debt sales. With interest rates so low, you can hardly blame them. There looks to be another $35 billion on deck for this week's capital raising as Treasurers want to lock in today's certain rates rather than gamble on the future. Companies are also lining up to sell equity into the public markets either to IPO or to top off their capital tanks while the markets remain near highs. So far this month, over $40 billion in stock has been sold by companies, with many more offerings on the come. Do not ignore all this supply, especially as flows into equity funds begin to slow.

Meanwhile, Washington, D.C. continues to negotiate and fiddle as they march toward their infrastructure and stimulus plan. Over the weekend, we got a good look at how the Democrats want to pay for it. The markets should be pleased with corporate and individual capital gains tax rate hikes that are lower than initial thinking. But still a long way to go here and the senior Senator from West Virginia holds the big hand of cards.

Enjoy the cooler temps and the return to the office. Also, a big congrats to 'The Ducks' and our HL office in Oregon for the big win on Saturday. The bedtimes for BCS College Football fans just increased by four hours for the next three months.

Looks like the airline and hotel bounce will be further delayed according to American Airlines...

"…as we look at it, August and September revenue is trending below the forecast due to the rising cases of the Delta variant and associated headlines. So in light of those current trends, as you mentioned, this morning, we did revise our third quarter revenue guidance to be down approximately 24% to 28% as compared to the third quarter of 2019." - American Airlines (AAL) CFO Derek Kerr


Delta Airlines echoed similar comments as corporate travel remains pinned by Zoom and Teams...

Airlines and hotels had hoped that business travel—one of the most lucrative pillars of their business—would start to bounce back in the coming months. Those hopes are fading as the busy summer travel season peters out, and the spread of the Delta variant of Covid-19 postpones some companies’ plans to return to offices and resume in-person meetings and events.

“I’d say it’s a pause, as compared to continued growth. That said, we understand why it’s paused,” Delta Air Lines Inc. Chief Executive Officer Ed Bastian said in an interview last week.

Delta said U.S. corporate travel returned to about 40% of pre-pandemic levels this summer, and the airline was predicting it would climb to 60% by September.

“We won’t be at 60%,” Mr. Bastian said...

“We’re not traveling internationally, period,” said KPMG U.S. Chief Executive and Chair Paul Knopp, who leads roughly 33,000 U.S. employees at the professional-services firm. “We use Microsoft Teams, where I say I can be on three continents in one day.”


Of course, a few companies continue to benefit from the ongoing trend in WFH...

Congrats to all who backed up the truck in March 2020 to buy size in Lululemon, Nike and Restoration Hardware.

Tweet from @borrowed_ideas

Good luck to anyone trying to build or remodel a house right now...

Tweet from @RickPalaciosJr


Supply managers must be the busiest employees in the company right now...

Shipping backlogs, semiconductor manufacturing, hurricanes, labor unrest at EM metal mines, etc. At least no locust excuses.

Sherwin Williams lowered its Q3 net sales guidance to be “up or down by a low-single digit percentage YoY” from “up mid-to-high-single-digit percentage” due to industry-wide issues with raw material availability, including impact of Hurricane Ida (the lower forecast follows a similar update from PPG yesterday).

Pulte Group cut its Q3 deliveries outlook to be up 8% from a year ago to 7,000 homes, but that's below the deliveries guidance range provided on July 27 of 7,300 to 7,600. The company cut guidance on several key metrics due to building material shortages and "increased production volumes across the homebuilding industry". A rush by builders to complete homes before year-end has been met head-on with a greater number of material shortages... supply chain problems are widespread, with trusses and windows the most significant national shortages, and block, brick, siding, and numerous other products short regionally.

Toyota Motor Corp cut its production forecasts for September and October, blaming shortages of chips and other parts as suppliers; said it will produce 70,000 fewer vehicles than previously planned this month, and 330,000 fewer vehicles next month.

(Hammerstone Report)

One of yesterday's big pre-announcements was from 3M...

3M stock was falling Monday after the company said that inflation was running hotter than it had expected.

Speaking at a Morgan Stanley conference, 3M CFO Monish Patolawala upped the cost impact on earnings from a range of 50 to 100 basis points to a range of 100 to 150 basis points, citing the rising price of raw materials, labor, and logistics.”[Despite] taking price up, getting the positive, we are seeing inflation outstrip price,” Patolawala said.


Aluminum is a broadly used economic input...

We have mentioned aluminum a few times this year. And now again as prices continue to surge. We already recycle 75% of existing aluminum, but don't be surprised to see your recycling container to become more popular.

Aluminum reached $3,000 a ton in London for the first time in 13 years amid expectations that supply disruptions are here to stay, while demand keeps rising.

The metal has surged about 14% over the past three weeks as supply risks increase throughout the industry, from bauxite mining in Guinea and alumina refining in Jamaica to aluminum smelting in China and beyond.

Chinese producers were dealt a fresh blow on Monday as Steelhome reported that Yunnan province, one of the largest aluminum producing provinces in the Asian nation, will enforce production curbs from this month in an effort to meet energy intensity reduction goals. Smelters in the European Union are also facing rising costs with both carbon credits and power inputs at record highs, Goldman Sachs Group Inc. said.

Dramatic Move


The PPI came in hot as expected last week...

@johnauthers: Producer Price Inflation is above 10% for the first time since 1981 on a finished goods basis (the main measure used until 2011). On a final demand basis, it's 8.3%, highest since inception in 2011. Either way, it's worryingly high.


Goldman Sachs sees high consumer prices today as leading to much lower prices in the future...

A Bigger Overshoot Now Implies a Bigger Drag on Spot Inflation Down the Road

(Goldman Sachs)

J.P. Morgan also thinks that we will get past the current speed bumps...

Tweet from @carlquintanilla

There are now more U.S. jobs than there are those looking for work...

@LizAnnSonders: Demand for labor clearly still strong, given job openings have surged to nearly 11 million … continuing to see openings outnumber total number of unemployed individuals.

Unemployed Persons

Job openings could increase even more if workers act like they survey...

In a recent Washington Post-ABC News poll, an astounding 42% of respondents (all of whom were unvaccinated and with employers that, at the time, did not require proof of vaccination) said they were willing to quit their job if their employer made them get the vaccine:

Willing to Quit


Amazon will now pay for college for its employees...

Tweet from @MorningBrew

The early U.S. tax draft should make the markets happy as the tax increases are lower than initially considered...

Democrats are proposing an increase in the corporate rate that’s currently 21%, offering less than the 28% Biden sought, the people said on condition of anonymity because the measures aren’t public yet. The top rate on capital gains would rise from 20% to 25%, instead of the 39.6% Biden proposed that would have been equal to a new top rate on regular income, the people said.

Democrats are also proposing a 3% surtax on individuals with adjusted gross income in excess of $5 million and to treat cryptocurrency the same as other financial instruments, raising an estimated $16 billion.

A document circulating among members of both parties and obtained by Bloomberg cites preliminary estimates that the new proposals would raise $2.9 trillion in revenue when combined with $700 billion in revenue and cost savings from Medicare drug price changes. To fully pay for the president’s plan, the proposal factors in $600 billion from the estimated economic growth effects of the spending increase.

-Top capital gains rate increases to 25% from 20%
-Top corporate tax rate rises to 26.5% from 21%
-Increases carried-interest holding period to five years from three
-Cuts some estate-tax discounts, no effect on family farms and businesses
-Cuts tax rate for businesses with income of less than $400,000 to 18%
-Crypto subject to wash sale and disguised sale rules
-Estimated revenue from corporate-tax changes likely to total $900 billion
-Estimated revenue boost from high-income individuals ~$1 trillion


The WSJ is now sensing a November 2-3 taper announcement...

Federal Reserve officials will seek to forge agreement at their coming meeting to begin scaling back their easy money policies in November.

Many of them have said in recent interviews and public statements that they could begin reducing, or tapering, their $120 billion in monthly purchases of Treasurys and mortgage-backed securities this year. While they are unlikely to do so at their meeting on Sept. 21-22, Fed Chairman Jerome Powell could use that gathering to signal they are likely to start the process at their following session, on Nov. 2-3.

Under the plans taking shape, officials could reduce those purchases at a pace that allows them to conclude asset buying by the middle of next year...

Fed officials have indicated they don’t want to be in a position where they are still increasing their $8.4 trillion asset portfolio when an interest-rate increase might be needed to keep inflation in check.


Wall Street is moving to the sidelines on the outlook for U.S. equities...

This shouldn't be a surprise given how hard we have pushed both earnings upside and multiple expansion targets. Now should be a good time for a rest.

After a record-breaking bull run for the U.S. stock market this year, many Wall Street analysts are starting to warn that investors could be in for a bumpy ride in the coming weeks and months.

Analysts at firms including Morgan Stanley, Citigroup Inc., Deutsche Bank AG and Bank of America Corp. published notes this month cautioning about current risks in the U.S. equity market. With the S&P 500 already hitting 54 records this year through Thursday—the most during that period since 1995—several analysts said that they believe there is a growing possibility of a pullback or, at the least, flatter returns.

Behind that cautious outlook, the researchers said, is a combination of things, including euphoric investment sentiment, extended valuations and anticipation that inflation and supply-chain disruptions will weigh on corporate margins...

The analysts’ cautious outlook for U.S. stocks presents a contrast to the so-called TINA—or “There Is No Alternative”—motto that has dominated investors’ outlook for much of the past year. Because yields on other assets such as bonds have been so low, many investors have justified their continuous bullish positioning in stocks. Accommodative monetary policy from the Federal Reserve has provided a continuous boost for equities this year, too, as has the lure of big investment returns from a swath of companies, ranging from meme stocks to Covid-19 beneficiaries...

Already there have been signs of weakness within the U.S. stock market in recent trading sessions. All three major indexes declined last week and are currently down for the month. The trend, if continued, would mark the first monthly loss for the S&P 500 since January. In general, September tends to be a historically weak period for the U.S. stock market. This year, in particular, investors are entering the choppy period with uncertainty.

Number of S&P 500 record closes


Financial conditions will have difficulty getting easier than they are today...

Equity valuations, interest rates and credit are all near perfect.

GS US Financial Conditions Index

(Goldman Sachs)

Again, U.S. equities are priced to perfection...

“The S&P 500 has essentially turned into a 36-year, zero-coupon bond,” BofA’s head of U.S. equity and quantitative strategy said in an interview on Bloomberg TV’s Surveillance. “If you look at the duration of the market today, it’s basically longer duration than it’s ever been. This is what scares me.”

The threat is that “any move higher in the cost of capital via interest rates, credit spreads, equity risk premia, that’s basically going to be a huge knock on the market relative to the sensitivity we’ve seen in the past,” she said.

In a note to clients, Subramanian raised her forecast for the S&P 500 to 4,250 at year end from 3,800 and gave a target for next year -- 4,600 -- that represents only a 2% gain. In the interview Thursday, she pointed to “much better than expected” earnings as helping to drive stock values to record highs, with the S&P gauge currently above 4,500.


And U.S. households have never been longer in their direct equity exposures...

So much vacation and out-of-home spending has been saved and put into the financial markets.

US households direct exposure to equities


Stock breadth is beginning to roll over...

You have to pay me a lot to own a stock trading below its 200-day moving average. And just no big macro catalyst on the horizon to get me to shift from 1st to 5th gear like there was in March of 2020.

S&P above 200d MA

If the top hedge funds are leaving public equities to invest in the private markets, then that should tell you a lot about the valuation differences...

Hedge funds are elbowing their way into Silicon Valley at an unprecedented rate with a record smashing $153bn worth of investments in private companies in just the first six months of 2021.

A report from Goldman Sachs has found that hedge funds have done 770 deals so far this year, already beating the record number of deals set in the whole of 2020, when 753 deals reached a total of $96bn. Just under three-quarters of this year’s deals were so called “venture” bets on companies in their infancy.

The data from Goldman Sachs Prime Services highlights how hedge funds, typically known for investments in publicly traded assets, have been drawn to private markets in an effort to fire up largely lacklustre returns. It also shows how private equity and venture capital have shot in to mainstream finance.

The asset class has now soared to more than $7tn in value and is expected to double again by 2025, while the number of US public companies has roughly halved since 1996. “What has attracted hedge funds is predominantly a function of the opportunity set,” said Freddie Parker, co-head of Goldman’s prime brokerage insight and analytics team.

The bets are concentrated, but they leave a big impact. Hedge funds participated in just 4 per cent of deals in the first six months of 2021 but provided just over a quarter of all capital put in to private companies, according to Goldman. A small group of hedge funds account for the vast majority of deals, the bank added, with roughly threequarters of the capital invested by 10 firms…

The push into private investments coincides with a broader revival in the hedge fund industry, which last year reported its best returns since the aftermath of the financial crisis in 2009 after years of weak performance.

Nevertheless, private investments have performed better than the public assets hedge funds have traditionally favoured. Returns from private equity and venture capital investments have outperformed hedge funds in the decade to the end of last year, with average gains of 14.2 per cent compared with 7.1 per cent for hedge funds, the Goldman report found.

Hedge funds also have abundant opportunities to invest in private companies, which now tend to rely in private funding for longer before they launch on stock markets. The average number of private fundraising rounds companies complete before going public has tripled since 2006, according to Goldman. The explosion of private capital has also created tough competition to participate in private deals.

Hedge funds make more investments in private companies


So, I was playing around with the private markets data in Cobalt again this weekend...

Last week, we looked at the updated returns of PE Buyouts vs. their public market equivalent. This week, we are looking at another big slice of the private markets: PE Growth. Whereas the PE Buyout space is mostly dominated by lower-valued companies that can generate cash and might need some new management help, the PE Growth space is dominated by private companies needing cash to accelerate growth in their current business or into new markets. For a PE Buyout example, think of a grocery store. For a PE Growth example, think of a ride-sharing company.

In looking at the below data, you will find:

  • In the Q1 2021, PE Growth funds doubled the return of the MSCI World.
  • A $1 invested into the PE Growth space returned $69 over 101 quarters of returns. This compares to what we found last week of $40 in the PE Buyout space.
  • Over 101 quarters, PE Growth funds have 20% more volatility in this series versus the PE Buyout space, but have 15% greater returns.

Feel free to calculate what that tuition to your alma mater would be worth today had you skipped college and invested in PE Growth funds 25 years ago.

PE Growth Fund

I know that Secondary PE Funds are also a hot topic today, so I also pulled this out of Cobalt...

Again, if you want to see the full set of raw data, let us know and we will set you up with the Cobalt experts.

When looking at the return output on the Secondaries funds, I thought that I was looking at the return stream for the PE Buyout funds that we ran last week. The average quarterly return is almost identical between the two categories, which should be expected. Of interest is that the Secondary fund returns are 10% less volatile than the PE Buyout fund returns. We should guess that this would be the case given that Secondaries funds hold 10-20x more companies than PE Buyout funds. Also, Secondaries fund company valuations could be a bit more mature than the average PE Buyout fund company.


Neo, don't follow this white rabbit...

The Wall Street Journal research team published a great research piece last week on social media rabbit holes. In it, they created dozens of teenager profile accounts on TikTok and let them run wild for several months. The end result was disturbing, but not surprising to you if you have watched "The Social Dilemma" documentary on Netflix or know how social media algorithms work.

As the investing world turns increasingly toward ESG investing, all social media companies will need to figure out how to satisfy the 'S' requirement. Hunting down kids and teenagers and filling them with disturbing content just to satisfy an advertiser’s request (and get revenues) will not suffice. Those companies that don't fulfill the 'S' requirement will lose access to trillions of dollars in new investment. TikTok is one of the most highly-valued private companies in the world. They will need to fill in these rabbit holes quickly before they hope to go public, or they could be leaving billions on the table for their current and future investors.

The account was one of dozens of automated accounts, or bots, created by The Wall Street Journal to understand what TikTok shows young users. These bots, registered as users aged 13 to 15, were turned loose to browse TikTok’s For You feed, the highly personalized, never-ending feed curated by the algorithm.

An analysis of the videos served to these accounts found that through its powerful algorithms, TikTok can quickly drive minors—among the biggest users of the app—into endless spools of content about sex and drugs.

TikTok served one account registered as a 13-year-old at least 569 videos about drug use, references to cocaine and meth addiction, and promotional videos for online sales of drug products and paraphernalia. Hundreds of similar videos appeared in the feeds of the Journal’s other minor accounts.

TikTok also showed the Journal’s teenage users more than 100 videos from accounts recommending paid pornography sites and sex shops. Thousands of others were from creators who labeled their content as for adults only.

Still others encouraged eating disorders and glorified alcohol, including depictions of drinking and driving and of drinking games...

“All the problems we have seen on YouTube are due to engagement-based algorithms, and on TikTok it’s exactly the same—but it’s worse,” said Guillaume Chaslot, a former YouTube engineer who worked on that site’s algorithm and is now an advocate for transparency in how companies use those tools. “TikTok’s algorithm can learn much faster.”



As too many of us already know, it was the hottest summer on record for the western U.S...

Summer temperatures were above average to record warmest from the West Coast to the Great Lakes and into the Northeast as well as across portions of the Mid-Atlantic and Gulf Coast. California, Nevada, Utah, Oregon and Idaho each reported their warmest June-August on record. Sixteen additional states had a top-five warmest summer on record. No state ranked below average for the summer season. Temperatures were below average across portions of the southern Plains and Southeast. Warm overnight temperatures heavily influenced the warm summer temperatures, especially across portions of the Southeast, where daytime temperatures were below average for the season.

Mean Temperature Percentiles


What would fossil fuel reserves be worth if the majority were left in the ground?

An interesting piece of research was running through the team last week that I had never run across.

The vast majority of fossil fuel reserves owned today by countries and companies must remain in the ground if the climate crisis is to be ended, an analysis has found.

The research found 90% of coal and 60% of oil and gas reserves could not be extracted if there was to be even a 50% chance of keeping global heating below 1.5C, the temperature beyond which the worst climate impacts hit.

The scientific study is the first such assessment and lays bare the huge disconnect between the Paris agreement’s climate goals and the expansion plans of the fossil fuel industry. The researchers described the situation as “absolutely desperate”.

“The [analysis] implies that many operational and planned fossil fuel projects [are] unviable,” the scientists said, meaning trillions of dollars of fossil fuel assets could become worthless. New fossil fuel projects made sense only if their backers did not believe the world would act to tackle the climate emergency, the researchers said…

To keep below 1.5C, the analysis says:

  • The US, Russia and the former Soviet states have half of global coal reserves but will need to keep 97% in the ground, while the figure for Australia is 95%. China and India have about a quarter of global coal reserves, and will need to keep 76% in the ground.
  • Middle Eastern states have more than half the world oil reserves but will need to keep almost two-thirds in the ground, while 83% of Canada’s oil from tar sands must not be extracted.
  • Virtually all unconventional oil or gas, such as from fracking, must remain in the ground and no fossil fuels at all can be extracted from the Arctic. Most fossil fuel reserves


The author has current equity ownership in: Nike Inc.

PME (Public Market Equivalent) – Calculated by taking the fund cash flows and investing them in a relevant index. The fund cash flows are pooled such that capital calls are simulated as index share purchases and distributions as index share sales. Contributions are scaled by a factor such that the ending portfolio balance is equal to the private equity net asset value (equal ending exposures for both portfolios). This seeks to prevent shorting of the public market equivalent portfolio. Distributions are not scaled by this factor. The IRR is calculated based on these adjusted cash flows.

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