Weekly Research Briefing: B.Y.O.P.

September 28, 2021

(Image source: Aston Martin)

It's finally Bond Week in the U.K. With 90% of Petrol stations reporting gasoline outages this weekend, we can already guess what 007 will be hunting for in 'No Time to Die'... Petrol Truck Drivers! Since Aston Martin does not yet have an electric version in the market (coming in 2025), you will need to leave your car in its box and take the Tube to opening weekend.

Like many things in our current world, there is not a shortage of petrol, but there is a shortage of drivers to get the stuff to market. Blame an increase in demand. Blame COVID. And blame Brexit. The U.K. wanted less immigration and higher wages for workers, and they are about to get them by the double digits. The rest of the globe is seeing other supply chain issues get worse as semiconductors remain on allocation, the major U.S. ports cannot unload container ships fast enough, and now energy supply/demand issues are causing China to order cutbacks on industrial production. If you see a perfect storm brewing that will lead to a shortage of boxed holiday gifts, then you are not alone. It probably doesn't matter that there are less than 90 days until Christmas, because most of us will be gifting our best homemade cooking and gift cards anyway.

All this talk about shortages and rising global energy prices is giving a new life to Treasury yields. This is good for banking and financial stock prices (at least for those without Chinese real estate exposure). But rising yields are not good news for technology and growth stock valuations which rely on low yields to inflate future DCF values. We are seeing some of this rotation in the markets currently.

Also helping Treasury yields was some increased hawkishness by the Fed as indicated by Chairman Powell's comment: “While no decisions were made, participants generally view that, so long as the recovery remains on track, a gradual tapering process that concludes around the middle of next year is likely to be appropriate.” So, you are now safe to pencil in at least $15 billion of asset tapering per month starting at the November meeting.

Evergrande and Washington, D.C. remain two very fluid and uncertain situations for investors. In Beijing, the Chinese government looks to be allowing interest payments to Evergrande investors to lapse, while also wanting to help the property buyers to be certain that they are delivered their purchases. In Washington, Congress appears once again to be taking the debt ceiling battle to the 19th hole as they fight over the infrastructure and social spending packages and jeopardize the global financial system. No one knows how either of these situations is going to play out right now. Your time and money is better spent on James Bond tickets.

Oil prices following the trajectory of semiconductors, used cars and residential window components...

Too much demand, plus not enough inventory, topped with supply chain delivery constraints. It's gonna be a better season for the Houston Oilers!

ICE Brent

Goldman Sachs jumping on the Bum Philips/Earl Campbell train and upgrading their oil price forecast...

Brent oil prices have reached new highs since October 2018, and we forecast that this rally will continue, with our year-end Brent forecast of $90/bbl vs. $80/bbl previously. While we have long held a bullish oil view, the current global oil supply-demand deficit is larger than we expected, with the recovery in global demand from the Delta impact even faster than our above consensus forecast and with global supply remaining short of our below consensus forecasts.

In particular, hurricane Ida has more than offset the ramp-up in OPEC+ production since July with non-OPEC+ non-shale production continuing to disappoint. On the demand side, low hospitalization rates confirm that vaccines are effective and are leading more countries to re-open, including to international travel in particularly COVID-averse countries in Asia. Winter demand risks are further now squarely skewed to the upside as to the global gas shortage will increase oil fired power generation.

(Goldman Sachs)

Helping oil/gas prices has been the energy industry's retreat from investing into the industry...

Even though oil and gas prices have surged this year as the world recovers from the Covid-19 pandemic, major producers have been reluctant to invest their cash in new projects, a shift in behavior from previous upswings. That’s leading to concerns of shortages. Already, Europe is facing its worst natural gas crunch in decades, with prices rising to record levels even before winter when demand is typically at its strongest.

One reason executives are wary to plow investment dollars into new supply is shareholders haven’t shown they’re in their corner. They want cash returned to them immediately rather than seeing it re-invested in new developments. Although soaring commodities markets are “signaling we could invest more,” equity prices are sending boardrooms a different sign, Wirth said.

“There are two signals I’m looking for and I’m only seeing one of them” right now, he said. “We could afford to invest more. The equity market is not sending a signal that says they think we ought to be doing that.”

Some investors are unwilling to back new projects after oil and gas companies wasted billions of dollars on low-return operations over the past decade. Others are watching signs of climate change and trying to gauge whether companies are making changes fast enough. The risks are real: Royal Dutch Shell Plc was ordered to reduce carbon emissions by 45% by 2030 by a Dutch court earlier this year, and Exxon Mobil Corp. was forced to backtrack on an aggressive expansion plan amid Covid-19 and shareholder unrest.

Spending Cuts


The holidays will be the most challenging operating environment EVER for retailers...

There will be no sales promotions anywhere and retail shelves will have empty gaps. Whoever figures out how to sell for future delivery will win the day. Gift cards will be the most given gift ever this year. Oh, and fruitcakes.

Nike Inc. doesn’t have enough sneakers to sell for the holidays. Costco Wholesale Corp. is reimposing limits on paper towel purchases. Prices for artificial Christmas trees have jumped 25% this season.

Despite mounting shipping delays and cargo backlogs, the busiest U.S. port complex shuts its gates for hours on most days and remains closed on Sundays. Meanwhile, major ports in Asia and Europe have operated round-the-clock for years.

“With the current work schedule you have two big ports operating at 60%-70% of their capacity,” said Uffe Ostergaard, president of the North America region for German boxship operator Hapag-Lloyd AG . “That’s a huge operational disadvantage.”

The American supply chain has so far failed to adapt to the crush of imports as businesses rush to restock pandemic-depleted inventories. Tens of thousands of containers are stuck at the ports of Los Angeles and Long Beach, Calif., the two West Coast gateways that move more than a quarter of all American imports. More than 60 ships are lined up to dock, with waiting times stretching to three weeks…

Nike executives said Thursday that the amount of time it takes to move a cargo container from Asian factories to North America is now about 80 days, or twice as long as it was before the pandemic. Moving items such as paper towels or furniture within the U.S. is also a challenge, with Costco executives saying it can be difficult to find trucks or drivers on short notice.

“If you work a gate 24/7 it will improve your velocity” only if all participants are involved, said Wim Lagaay, chief executive of APM Terminals North America, which operates a terminal in Los Angeles. “Up to 30% of overall truck appointments are not met because there are not enough trucks, drivers or chassis.”


If your holiday gift is still on the water, you likely won't see it until 2022...

Anchored containerships in Los Angeles and Long Beach


As a key infrastructure bill makes its way thru Washington politics, we can only hope that members of Congress are reading the daily news headlines and preparing to act on them...

The Wall Street Journal cover

China isn’t going to step in and salvage Evergrande as it wants to send a powerful message...

The Chinese government doesn’t want to move in yet because it hopes Evergrande’s struggles will show other Chinese companies that they need to be disciplined in their finances, say people with knowledge of its deliberations who insisted on anonymity. But it has an array of financial tools that it believes are strong enough to stem a financial panic if matters worsen.

The government is “still going to provide a guarantee” for much of Evergrande’s activities, said Zhu Ning, deputy dean of the Shanghai Advanced Institute of Finance, “but the investors are going to have to sweat.”…

By not forcefully signaling an Evergrande bailout, the Chinese government is essentially trying to force both investors and Chinese companies to stop channeling money to risky, heavily indebted companies. Yet that approach carries risks, especially if a disorderly collapse upsets China’s legions of home buyers or unnerves potential investors in the property market.


The trick for the government will be to support property prices while they let overleveraged developers fail...

The housing market represents 60% of total urban households assets in China

But has the property monster gotten too big for the economy?

As the Harvard economist Ken Rogoff showed last year in a paper co-authored with Yuanchen Yang of Beijing’s Tsinghua University, real estate plays an even bigger role in China’s economy today than it did in the U.S. economy on the eve of the financial crisis. The impact of real estate-related activities amounted to 18.9% of U.S. GDP in 2005, its pre-crisis peak. The equivalent figure for China in 2016 was 28.7%. None of the 10 other countries in their sample come close, except Spain on the eve of the financial crisis (28.7% in 2006).

The detail is eye-popping. In all, around 27% of Chinese bank loans come from the real estate sector. Real estate is the main form of collateral for loan securitization. In 2017, almost 18% of the urban labor force was employed in real estate and related industries. In 2018, the sale of land by local governments accounted for as much as 35% of their revenues.

Much as happened in Japan in the housing bubble of the late 1980s, the market value of China’s housing stock is now more than double that of the U.S. and triple that of Europe. This means that housing wealth forms a significantly larger share of overall assets in China (78%) than it does in the U.S. (35%). Rogoff and Yang conclude that Chinese households’ consumption is therefore “significantly more sensitive to a decline in housing prices” than that of their American and Japanese counterparts. A “20% fall in real estate activity could lead to a 5-10% fall in GDP, even without amplification from a banking crisis, or accounting for the importance of real estate as collateral.”

To put it simply, China’s growth has been boosted for many years by the construction of an excess supply of housing units. This has been financed by an unsustainable mountain of debt. As the Beijing-based economist Michael Pettis noted last week, “China’s official debt-to-GDP ratio has soared by nearly 45 percentage points in the past five years, leaving it with among the highest debt ratios for any developing country in history.”

Building a Bubble


The Chinese property problems will remain a thorn in the side of the Asian junk bond market...

Evergrande crisis ignites sell-off in riskier Asian dollar bonds

Deepening worries over Evergrande have ignited selling in a $428bn corner of the Asian debt market, underscoring how the crisis at the Chinese property developer is spreading to other assets as traders and investors brace for a crucial payment deadline on Thursday.

The Evergrande bond on which the interest payment was due was trading at around $0.28 on the dollar, a signal of substantial distress, as traders fretted over the potential fallout if the company begins missing payments.

Yields on US dollar-denominated bonds issued by riskier Asian borrowers have soared to almost 12 per cent this week, the highest level since a jump during the early stages of the coronavirus pandemic, according to an Ice Data Services index. The yields stood at 7 per cent at the start of the year.

Property makes up biggest share of Asia high-yield bond market


Jim Chanos remains worried...

“If you try to deflate this bubble, it is fraught with risks,” said Chanos. “I don’t think they’re contagion risks. This is not a Lehman-type situation where there is contagion [within and between banks] and everybody stops lending to everybody else. This is more a risk to the economic model because residential real estate is still such a huge part of GDP there.”


Could this be coming at a worse time?

China may be diving head first into a power supply shock that could hit Asia’s largest economy hard just as the Evergrande crisis sends shockwaves through its financial system.

The crackdown on power consumption is being driven by rising demand for electricity and surging coal and gas prices as well as strict targets from Beijing to cut emissions. It’s coming first to the country’s mammoth manufacturing industries: from aluminum smelters to textiles producers and soybean processing plants, factories are being ordered to curb activity or -- in some instances -- shut altogether.

Almost half of China’s regions missed energy consumption targets set by Beijing and are now under pressure to curb power use. Among the most affected are Jiangsu, Zhejiang and Guangdong -- a trio of industrial powerhouses that account for nearly a third of China’s economy.


And could this be coming at a worse time...

CCP Limits International Aspirations of Chinese Companies...

The Lithuanian Defense Ministry warned that some Chinese brand smartphones are sending secret encrypted messages back to mainland China. Xiaomi phones also contained a censorship module for terms that scare the CCP, which could be turned on at any time without users knowing (the Chinese handset maker denied the accusations). Of Xiaomi’s 53M smartphones shipped in Q2, around 40M of them were sold outside of China. As I think back to only a few years ago, when markets expected China’s Internet giants and growing hardware companies to breakout of the mainland markets and gain a global foothold, it seems increasingly likely that the current trajectory of the CCP will relegate those companies to their home turf, significantly reducing a potential competitive threat to non-Chinese brands and platforms around the world.



Jason Zweig noted this weekend that public stock investors in China would have been better off elsewhere over the last 30 years...

U.S. mutual funds and exchange-traded funds investing primarily in China held $43 billion in net assets at the end of August, up 44% from 12 months earlier, according to Morningstar. Over that time, investors added about $13 billion in new money.

More than one-fourth of the total assets of these funds has come in over the past year alone—just in time for a long march of losses. Since its peak in February, the MSCI China index has lost 30%.

What about the longer term?

Between its inception at the end of 1992 and this Aug. 31, the MSCI China stock index has returned an average of 2.2% annually, including dividends. Over the same period, the MSCI Emerging Markets index grew 7.8% annually; the S&P 500, 10.7%.

That covers a nearly 30-year period in which China’s economy often grew by at least 10% a year. Nevertheless, you would have earned much better returns on U.S. Treasury securities than on Chinese stocks. Maybe China, which holds more than $1 trillion in U.S. Treasury’s, knew something that Wall Street didn’t.


Supply chain issues are hurting many manufacturing companies but are also helping some service companies where wages are rising and net worth is growing...

FedEx reported disappointing earnings due to higher labor costs as they need to raise salaries to attract workers. The trend to higher wages is driving higher rates; FDX announced a 5.9% rate increase taking effect in January 2022, 100 bps ahead of prior year rate increases. This is not specific to FDX but an issue plaguing a number of companies.


Nike - While its 16% sales growth in the quarter barely missed our 18% forecast, the firm now anticipates virus-related factory closures in Asia (especially Vietnam) and shipping and distribution delays will result in fiscal 2022 sales growth in the mid-single digits, short of our 13% estimate. Under normal circumstances, about half of Nike’s footwear and 30% of its apparel production is sourced from Vietnam, so it cannot fully overcome the shutdowns of many factories that have plagued the nation since July.


Lennar: Deliveries came in at 15.199K homes (this is light of the St’s ~16K forecast). New orders rose 5% in units (to 16.277K vs. the St’s 16.219K) but 19% in value (to $7.5B vs. the St $7.1B), reflecting the strong pricing environment in housing. "During the third quarter, our company and the homebuilding industry as a whole continued to experience unprecedented supply chain challenges which we believe will continue into the foreseeable future. As a result, our third quarter deliveries of 15,199 homes were about 600 homes below the low end of our guidance. Despite missing our delivery guidance, new home demand remains strong”.

(Vital Knowledge)

“Unfortunately, due to ongoing supply chain challenges, we were not able to ship everything we anticipated in the second quarter, which caused some of our revenue to shift out of the quarter.” - Steelcase (SCS) CEO Jim Keane

(The Transcript)

Equity Residential makes pos. comments on the operating environment – “same store revenue growth remains on track to meet or slightly exceed the Company’s expectations described in its second quarter 2021 earnings release as the Company is finishing a strong leasing season with very healthy demand and pricing for its apartment units”

(Vital Knowledge)

"…consumers have a lot of money still to spend in the United States, so the checking account balances of people who, before the pandemic, ran a balance of, say, $1,500 of average collective balance, or $2,000 type of range, think of that, are now sitting with $6,000 and $7,000 in their checking accounts.” - Bank of America (BAC) CEO Brian Moynihan

(The Transcript)

“I will tell you that there is still a heavy drag on Fine Dining in the major cities. We are still down 40% in our 3 Manhattan locations, a little bit less than that in the other major cities, but we are seeing a big uptick in Suburbia in Fine Dining, which has been fantastic.” - Darden Restaurants (DRI) CEO Gene Lee

(The Transcript)

U.S. stock valuations are beginning to feel some headline heat, but multiples remain big...

Little room for error if Evergrande, Washington, D.C., or supply chain/inflation news gets worse.

S&P 500 Forward Earnings and Valuation


If interest rates rise and corporate margins fall, Goldman Sachs has a table for you to study...

Sensitivity of S&P 500 ROE

(Goldman Sachs)

The Fed moved their dots higher last week...

@business: Here's what the Fed’s new "dot plot" looks like https://trib.al/9bj1drL

The Fed's New Dot Plot

And interest rates followed suit (along with continued inflationary datapoints)...

@HumbleStudent: 5 and 10 year Treasury yields decisively break out

CBOE 10-Year US Treasury Yield

If you need a refresher on where to invest in a rising rate environment, RenMac has you covered...

@RenMacLLC: With 10yr yields breaking out today, it's a good time to understand/review historical industry group sensitivities to yields. In a word: #cyclicality

SP 1500 Industry 10 Yr Yield Sensitivity

Another example of private market investors creating value...

Not only did investors do well in the turnaround of the Cosmopolitan, but also think of the jobs and tax dollars that were saved for Vegas with this one large asset.

Blackstone Inc. has reached an agreement to sell the Cosmopolitan casino and hotel on the Las Vegas Strip for $5.65 billion, the company said on Monday, and told investors in a private letter that the sale is the company’s most profitable of a single asset ever.

Blackstone acquired the two-tower property for about $1.8 billion seven years ago and spent an additional $500 million on upgrades, including renovating the nearly 3,000 guest rooms, building luxury suites and adding new restaurants and bars.

Total profits after the sale would be about $4.1 billion, including cash flow from the property’s operations, according to a Blackstone letter to fund investors reviewed by The Wall Street Journal. The company made back nearly 10 times the amount of equity it invested in the Cosmopolitan, the letter said...

The Cosmopolitan was one of the most high-profile real-estate flops during the boom years leading up to the 2008 market crash. Deutsche Bank took ownership after developer Ian Bruce Eichner defaulted. The German bank sunk around $4 billion into the Cosmopolitan, first as a lender and then as an owner after it took over the property.

Blackstone acquired the Cosmopolitan in 2014 from Deutsche Bank and began pumping money into a hotel that was charging some of the highest room rates on the Strip with a casino ranked near the bottom in terms of revenue...

The hotel was nearly 87% occupied for the month of September through Friday, with average daily room rates at $448, according to Blackstone.


More companies should have a list of related business activities that they will not do...

Congrats to First Republic Bank for including a description of the businesses that they do not plan on entering. No doubt their discipline helps to explain why their stock has outperformed the average regional bank stock by nearly 3x over the last ten years.

Appendix Business Activities Not Undertaken



Epidemiologist Larry Brilliant has called every twist and turn of COVID, so this is a must read...

You’ve called Delta the Forever Virus, and that’s disheartening. Will I be wearing a mask indoors for the rest of my life? Is this going to kill me one day?

I don't think it's going to kill you. It may. But in this country, it's killed one in 500. Not 499 out of 500. And if you put down the names of all the people who had had two mRNA vaccine doses and who had died this year of Covid, I don't think that those names would cover four or five sheets of paper. The unvaccinated are 99 percent of the people who die, and unfortunately, that now includes some children. And that's where the problem is.

I do think that it's the forever virus, and a lot of people were mad about that title. I wasn't particularly happy that I wrote it. But it's right, unfortunately. But influenza is a forever virus and we live with it. Measles is a forever virus and we live with it. I would argue smallpox was forever for 10,000 years—which isn’t exactly forever, but it's a long enough time. And we found a way to vaccinate people and go about our business until we eradicated it. So I think that Covid or coronaviruses are a new category of forever viruses. But what Covid doesn't need to be is the forever-virus-taking-all-the-oxygen-out-of-the-air-and-ruining-everybody's-life-and-stopping-people-with-heart-attacks-from-going-to-the-hospital virus.

Tell me something optimistic.

I think that in the longer- or medium-term future of this pandemic—six months from now, a year from now—there will be safe spaces. In Hollywood, recently, I worked with Seth MacFarlane—we just completed doing season three of his fantasy sci-fi series called The Orville. We had to prepare protocols so that nobody would be sick. And we did not have a single case of transmission, in a year, of almost five-days-a-week shooting, where the actors were unmasked to do their jobs. What it took was testing either every day during the peaks of the epidemic or—when things were a little better—three times a week.

So you created an island of compliance in a country where millions of people resist compliance.

Maybe if I was 30 years old, instead of being over 70, I'd be looking to keep this as my professional interest. But I don't need any more work. I want it to end more than anybody wants it to end. But we're not doing the things that we have to do to make it end.



The author has current equity ownership in: Nike Inc., Lennar Corp., Bank of America Corp.

The information presented here is for informational purposes only, and this document is not to be construed as an offer to sell, or the solicitation of an offer to buy, securities. Some investments are not suitable for all investors, and there can be no assurance that any investment strategy will be successful. The hyperlinks included in this message provide direct access to other Internet resources, including Web sites. While we believe this information to be from reliable sources, Hamilton Lane is not responsible for the accuracy or content of information contained in these sites. Although we make every effort to ensure these links are accurate, up to date and relevant, we cannot take responsibility for pages maintained by external providers. The views expressed by these external providers on their own Web pages or on external sites they link to are not necessarily those of Hamilton Lane.

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