Weekly Research Briefing: Current State?

July 13, 2021


I hope so. Looks like a great way to escape. And according to market volumes, news flow and TSA data, many of you might be toes up in the water right now. If so, enjoy the water for me.

What are the markets watching right now? The Delta COVID variant is having an impact on surprising new case growth numbers for those geographies with large unvaccinated populations. It's giving parts of the market fits and starts as it considers current and second half 2021 economic growth. The variant is causing economic pauses for the Olympics in Japan, as well as Eastern Australia, England, several other parts of Europe, and Missouri. The only good news on this new wave of COVID is that the increase in hospitalizations is not (yet) leading to worse outcomes. Another good reminder to those that haven't yet gotten their vaccine.

The highly anticipated Fed minutes showed us little new information last week. No big changes in directions, disagreements, or food fights noted in the official minutes. Treasury yields continued to fall the last two weeks, tapping 1.25% before bouncing on Friday. Several weaker economic reports in the U.S. (ISM, JOLTS, and Jobless Claims) and overseas were to blame along with COVID. Not to be left out, Chinese yields followed U.S. rates lower as the Chinese economy begins to slow from peak levels at the same time that the government moved to restrict its private technology companies from listing on foreign exchanges.

A big reason to get out of the water this week would be the start to the second quarter reporting season. The biggest U.S. banks will start us off with the majority of the S&P 500 to follow over the next three weeks. We will be listening for clues about current demand, price inflation and labor availability/wages. Uses of capital will also go under the microscope as managements make decisions to invest in the business and/or return capital to investors.

If you live in a vacation town, your world probably looks as busy as it can be. From my perspective, our office building of 14 floors is still 80% empty, traffic to work is manageable, and the restaurants are not running at full capacity (but still tough to find a table). For the few markets in the west that I watch closely on Zillow, new listings are beginning to accelerate. A good mix of remodeled homes that have been finished with 25 -50% price increases and other long-time owners just looking to test the market after seeing 20-30% year-over-year gains. So, let's see how this new supply will be absorbed. Also reading in several surveys where the home improvement retailers are seeing a slowdown in their growth rates. Maybe consumers are done fixing up and going on vacation instead? The continued weakness in the airline, hotel, casino, and cruise stocks do not suggest this. Maybe expectations just got too high for the recovery and the jets need to cool a bit. Then again, maybe some are now saving their chips for a trip to space. Expensive now but just wait until Virgin Space becomes a hole punch on your Disneyland multi-day pass. Sign me up!

Goldman sees the job market accelerating, but economic demand slowing...

On the positive side of things, the US job market is accelerating, especially as benefits roll off and seasonal workers get back on the job. On the negative side, demand is slowing, and we do expect growth will slowdown later in the year as the reopening finally concludes and fiscal support dissipates. Our global GDP growth forecasts of 6.6% in 2021 and 4.8% in 2022 remain optimistic in absolute terms, but are now closer to the consensus than at any point since April 2020.

(Goldman Sachs)

Regarding the increasing labor tightness, my trash pickup day has been skipped three times this summer...

"Now all of a sudden, we're seeing pretty significant labor inflation...we're hearing that across North America. I mean, everywhere. By the way, it's not just our industry. And so now we're starting to see competition from Amazon, from UPS, from FedEx. So I think you're going to see a long-term dearth in terms of labor. And so we've got to figure out a path to make us more labor-efficient.”
- Waste Management (WM) CEO Jim Fish


It's not all about jobs and wages right now. Affordable housing is becoming an equally big problem...

KETCHUM, Idaho—Ethan McKee-Bakos has had no trouble finding work since he moved to this upscale mountain town last February, earning $60,000 a year from two jobs. But Mr. McKee-Bakos spent nearly six weeks living out of his SUV in the nearby Sawtooth National Forest, unable to afford rent for a condo.

“If you live in Ketchum, there’s no shortage of work. There’s just a shortage of where you can live,” said Mr. McKee-Bakos, who works as a supply manager at a local hospital and a bouncer at a bar. “This is the first time I’ve experienced any type of homelessness.”

Like many towns in the West with economies built around tourism, Ketchum is facing a cascading housing crisis caused by a rush of new residents during the Covid-19 pandemic, growing demand for workers during the economic boom that has followed, and a shortage of affordable homes that was years in the making.

Businesses in this community of 2,700, located in central Idaho near the Sun Valley ski resort, are struggling to fill open positions, forcing some to cut hours. Some workers live in trailers or tents in the Sawtooth National Forest. And the waiting list for the 113 affordable-housing units for sale or rent in surrounding Blaine County is years long.

The situation has gotten so extreme that Ketchum’s mayor recently raised the idea of allowing local workers to temporarily erect tents in a park so they could have a place to live while searching for something permanent.


Rising post-COVID and summer travel demand is pushing gasoline prices...

According to the Energy Information Administration, fuel demand jumped to 10 million barrels a day during the week leading up to the July 4th holiday. This comes as no surprise, considering 2.19 million people passed through TSA checkpoints in airports on July 2 (a post-pandemic high) and an estimated 44 million people traveled by car over the Independence Day weekend. With more people out and about, gas prices have risen to $3.14 a gallon, the highest since the onset of the pandemic.

Gas Prices


The energy industry's new focus on investor returns and cash flows could keep prices higher for the future...

The public and private capital markets are no longer giving the energy industry cheap money like in the past. Now the drillers and producers need to focus on profitable projects and cash flow generation. This is leading to a reduction in capital expenditures as more cash flow is allocated to shareholders.

Shale companies pumped with abandon anytime oil prices rose sharply last decade. But as crude tops $70 a barrel, they are barely doing enough to sustain U.S. production.

Frackers have been forced to rein in spending and live within their means after many investors lost faith in the companies following years of poor returns, lenders reduced their credit lines and capital markets showed little interest in funding expansive new drilling campaigns.

The result is that shale drillers, which in the past have played the role of the oil world’s swing producer by quickly increasing output to meet demand, are largely standing pat for now, as the reopening of Western economies leads to a resurgence of global oil and gas prices.

The companies are raking in more cash than ever. Public shale companies that drill primarily for oil collectively generated a record $4.1 billion in free cash flow in the first quarter of 2021 and are poised to take in almost $15 billion for the year if prices remain higher, according to consulting firm Rystad Energy…

In the heyday of the shale boom, publicly traded oil producers typically reinvested more than 100% of the cash flow they made from operations back into drilling campaigns. Now they are using about half of the income they generate on new drilling and are only growing output slightly, if at all.

Devon Chief Executive Richard Muncrief said in an interview that the Oklahoma-based driller will reinvest about 45% of its operational cash flow, down from about 60% a few months ago as oil prices have risen. That discipline has attracted some investors that haven’t traditionally invested in energy to Devon—seeking energy exposure as prices rise, and drawn by Devon’s variable dividend, he said.

Free Cash Flow


Another big factor influencing energy company spending is the private markets shift away from investing in fossil fuels...

Private equity funds that invest solely in renewable energy assets raised about $52 billion last year—a record, according to Preqin, a data provider. On top of that, the money garnered so far this year for such funds is outpacing fossil fuel asset fundraising by a factor of roughly 25…

Private Equity Going Green

Private equity remains a significant investor in the energy sector, completing $261 billion of deals since 2017, around 20% of total transactions, according to data compiled by Bloomberg. U.S. renewable energy investments by private equity firms topped $23 billion in 2020, the largest annual amount to date, according to the American Investment Council.

Unlike a mutual fund owner, who typically holds a tiny percentage in hundreds of publicly listed stocks, a buyout fund can drive change through control over management and board appointees. That’s important because with capital usually locked up for a decade both managers and investors need to consider how regulation and environmental changes will crimp operating profits and impact the value of any asset over that time.

The fear of being stuck holding an unsellable asset is one reason some managers won’t touch anything that doesn’t meet ESG metrics.


So, if energy CapEx falls while oil prices rise, shouldn't the remaining energy stocks gush free cash flow?

Oil prices and Consensus capex

(Morgan Stanley)

Energy prices might be higher, but the Chinese bond market looks to be anticipating an economic slowing...

Interesting that both the U.S. and Chinese bond markets are not concerned with runaway growth or inflation.

Tweet from @jpicerno

Mohamed El-Erian sees stocks as facing headwinds if bond yields fall lower from here...

I have to agree with him because if we see the 10-year yield challenge the 1% level again, it could imply a much more significant economic slowdown.

The sharp drop in yields on US government bonds seen last week is good news for stock investors, or so you would think given recent experience.

But that was not the feeling in markets on Thursday with a broad-based sell-off in equities, leading more people to start asking the key question of whether we could be having too much of a good thing — that is, interest rates that are artificially very low for too long. The question becomes even more important as investors get ready to digest this week news on inflation and US Federal Reserve policy.

Ten-year Treasury yields plummeted from around 1.70 per cent at the end of the first quarter to 1.25 per cent during Thursday’s trading session before recovering somewhat on Friday. Three main explanations have been suggested for this counter-intuitive move given higher growth and inflation outcomes.

The most worrisome is that the markets are pricing a significant deterioration in growth prospects due to less strong data in China and the US, and concerns about the spread of the Covid Delta variant in Europe and much of the developing world. Yet it is hard to argue that these headwinds to the global recovery warrant such a move down in yields, let alone the very low levels of both nominal and real rates.


Abby Joseph Cohen also sees stocks having no room for error...

Investors should assess their appetite for stocks “carefully, very carefully” given higher inflation and an S&P 500 that’s nearing fair trade value, said Abby Joseph Cohen, senior investment strategist at Goldman Sachs Group Inc.

“When you’re at fair value, there is no margin for error,” Cohen said in a Bloomberg TV interview. “If there are disappointments, be it on interest rates or OPEC, that’s where you start to see a big increase in volatility within the market itself.”

Citing her colleagues who see 4,300 as fair value, Cohen said, “We’re sort of at a knife’s edge,” with the S&P index trading near 4,350 today. Against the unusual backdrop of low nominal yields and negative real yields, investors should consider their next moves “carefully, very carefully,” said the strategist, whose market assessments are closely followed on Wall Street.


As the chart shows, forward P/E valuations remain stretched...

S&P 500 Index at inflection points


International equities continue to have the value advantage over U.S. stocks...



And international equities have underperformed for 13 years...

Cycles of U.S. equity outperformance


A big reason for the outperformance of U.S. stocks has been for its overweight in tech and underweight in cyclicals...

Weights in MSCI All Country World Index


And we know what has happened to U.S. Technology sector valuations...

The biggest challenge for the stocks is maybe what do 5-, 10- and 20-year taxable owners of the stocks do with them at these prices? Sell them, pay a big tax bill, and then reinvest in what?

S&P 500 Tech Sector: Price-to-Sales Ratio


Irrespective of geography, global stock funds are taking in a record amount of inflows right now...

Record inflows in global equity funds in H1

(Goldman Sachs)

Or looked at another way...

This is a stunning chart from Bank of America.
On an annualized basis the flows into equity markets in the first 6 months are greater than the prior 20 years combined.....
This really is something, well done Jerome.

H1 annualized equity inflows greater than prior 20 years

For all the excitement over stock fund flows, bond fund flows have done even better...

Long term net new flows via mutual funds and ETFs

(Financial Times)

$130 trillion now sitting in publicly traded bonds globally...

Global bond market


One could say that bond fund inflows have gone too well...

This is bordering on ridiculous now. What year in the future will we point back at this chart and say that we should have seen it coming?

Investors’ headlong embrace of risk passed a new milestone in recent sessions: The return that investors receive for investing in the riskiest U.S. companies fell below inflation.

A rally in corporate debt rated below investment grade has pushed yields to record lows around 4.54%, according to ICE Bank of America data, while consumer prices rose 5% in May compared with a year earlier. That marks the first time on record junk-bond yields have dropped below the rate of inflation, according to Bespoke Investment Group.

The move upends the conventional logic of investing in bonds, which are typically prized for protecting investors’ money. Junk-rated companies include those most likely to miss interest payments or go bankrupt. Buying bonds that yield less than inflation means locking in a loss.

Junk-bond yields minus consumer-price index


Record low interest rates are pushing this big fiduciary to increase its allocation into the private markets...

The OTPP is moving from 20% to over 30% of its plan assets into private assets. If one has flexibility in investing with a longer time horizon in mind, why wouldn't they lock up some liquidity to shoot for the higher returns that private assets can offer?

The Ontario Teachers’ Pension Plan is gearing up for a fresh C$70bn push into private markets, spanning assets from infrastructure to real estate, as one of the world’s largest retirement plans tries to escape the punishing effect of low interest rates.

The C$221bn plan, which is responsible for managing the retirement savings of more than 300,000 Canadians, intends to invest the sum in private markets over the next five years, marking a break from the public markets it and other pension funds largely rely on for their returns.

“We are investing a lot more in private activities and will do so over the next five years — so the best part of C$70bn will go into private activities around the world,” said Jo Taylor, the president and chief executive of the OTPP.

“For now, with very low yields available (from fixed income) we are looking to secure better, more balanced returns in other asset categories,” he added.

The ambition is a significant step up from the C$45bn that the OTPP has in real assets. Its plans could see the share of real asset holdings rise to around a third of the portfolio, up from a fifth at the end of last year.

Private markets encompass both real assets, such as real estate and infrastructure, as well as the debt and equity of privately-owned companies.


I came across this long-term chart of SMID Buyout Fund returns over the break and thought it was notable...

What it shows is the dispersion of returns across 900 Small/Midcap Buyout funds with vintage years from 1982 to 2016. The distribution may be surprising given how frequently SMID is touted to be a preferred part of the market, but it is a good reminder of the importance of fund selection. If we instead broke this down by quartiles, you needed to beat a 19.9% return to be top quartile, 12.1% to be above median and above 5.7% to beat the bottom 25%. Compare that to large at 20.4%, 13.7% and 9.1% for top-quartile, median and bottom-quartile, respectively, smaller is not always better.

SMID Buyout Funds Dispersion of Returns

China's move to restrict foreign listings will challenge current valuations in that market...

The cost of capital for Chinese companies will get more expensive which should dampen companies’ ability to raise capital. This is a pretty significant move by the government.

U.S.-listed Chinese stocks have come under fresh pressure in recent days, after China’s government launched a cybersecurity probe into the newly listed Didi Global Inc. and said it would tighten rules for companies that are listed abroad or are seeking to sell shares overseas. The actions add to a clampdown on China’s tech sector, which has already focused on issues like anticompetitive behavior and financial stability.

Chinese authorities are working to revise longstanding rules governing variable-interest entities, or VIEs, The Wall Street Journal reported. Many Chinese tech companies, including Alibaba and Didi, use such corporate structures to get around restrictions that disallow foreign investments into companies in technology, media and other sensitive industries.

New rules on VIEs may restrict future listings and it isn’t clear how companies whose depositary receipts already trade in the U.S. could be affected, said Tan Eng Teck, a senior portfolio manager at Nikko Asset Management.

“When you have such uncertainty, it becomes a big issue,” he said.

S&P/BNY Mellon China Select ADR Index


The Financial Times was counting unicorns last week...

The herd is experiencing a population boom thanks to COVID benefitting many technology companies.

Unicorn population explosion


Last decade's unicorn performance sheet...

Looking at the 2010 thru 2019 vintage years, here is a chart from J.P. Morgan using our data showing how venture capital performed versus the other private market strategies. Higher risk and much higher return potential.

Venture outperformed buyout

2021 has become a big year for unicorn trading...

In H1 2021, VC and Growth funds distributed $180.15B compare that to $57.76B for H1 2020 or $60.24B for H1 2019. In dollar terms, this is record breaking but when adjusting for the growth of valuations seen the rate of distribution for Q1 2021 and Q2 2021 are 4.7% and 7.5%, respectively compared to long-term quarterly average of 5.1% and Q2 2021 is not even in the top decile.

For 6 out of the last 20 years, H2 distributions have outpaced H1 and if long-term averages played out in 2021 then we should expect $220B more to be distributed before the year is out.

Global exits blow way past pandemic lows to reach new high


And the numbers show that VC/Growth funds are taking in a record amount of funding this year...

Global venture capital funding in the first half of 2021 shattered records as more than $288 billion was invested worldwide, Crunchbase numbers show. That’s up by just under $110 billion compared to the previous half-year record that was just set in the second half of 2020…

Crunchbase numbers show that global venture funding in the first half of 2021 surged 61 percent compared to the prior peak of $179 billion in the second half of 2020. That’s up 95 percent compared with the first half of 2020, when venture investors deployed $148 billion globally…

Record funding was invested at every stage in the first half of this year. Late-stage funding peaked the most, more than doubling year over year, per Crunchbase numbers. Early-stage funding grew more than 60 percent over the prior two half-year time-frames and seed funding gained 40 percent year over year.

Global venture dollar volume through H1 2021

At the half-year mark in 2021, 250 companies have joined the Crunchbase Unicorn Board, compared to 161 new unicorns for the whole of 2020. The board now counts 879 private companies collectively valued at close to $3 trillion that have altogether raised $564 billion.

Of these 250 companies newly valued $1 billion and above, 161 — more than half — are headquartered in the U.S.

China and Canada score the next highest count with 10 each. India and Germany have nine new unicorns each, and Israel, the U.K. and France each have seven…

Seven companies made public market debuts above $10 billion this past quarter, bringing the total number to 15 so far in 2021. That’s the highest count in the last decade.

In 2020, 13 venture-backed companies debuted at a valuation above $10 billion. We count a total of 16 public market debuts above $10 billion in the prior nine years.

Notable global IPOs in Q2 2021


If you want a good visual of the current herd of global unicorns, CB Insights has you covered here...

Global Unicorn Club


Not to be left out of the private market discussions, Infrastructure Assets got a big endorsement last week...

Investors need to get used to the fact that many more ASX-listed companies will go down the same path as Sydney Airport and be taken into private ownership.

Mario Giannini, the chief executive of Hamilton Lane, which has $US719 billion ($958 billion) in assets under management and supervision, says the sheer scale of funds in private capital markets means the public to private trend will gain momentum.

Giannini tells Chanticleer from his home office in Philadelphia that there are many reasons why investors are queuing up to tip larger proportions of their assets into private capital markets.

He says privately managed companies can respond more quickly to external shocks and private ownership allows greater alignment between shareholders and the interests of managers who own big equity positions. Also, the implementation of longer-term investment strategies means private owners can pay more for assets.

The fact that the Sydney Aviation Alliance offered a 43 per cent premium to Sydney Airport’s previous trading price says something about the ability of public markets to price long-term value.

Giannini says public listing have gone down by about 50 per cent in the United States over the past decade. “That’s more than just people saying, ‘Oh, yeah, I’d rather be private,’ ” he says. “In the private sphere, everybody involved – the owners and the managers – all have a real stake in the outcome, and they can take actions quickly, and it matters to them.

“I think the problem in the public sphere is you have owners in the form of pension funds and institutions who are not really active. They’re sort of these passive investors, and you have management that generally doesn’t own a huge amount of the company that are making decisions.

“It’s a governance model that isn’t as effective, I think, as the private model.”

Giannini says private markets have a good track record, having outperformed public markets for 19 of the past 20 years.


The Q2 earnings season begins this week led by the big banks...

Most Anticipated Earnings Releases


This Q2 will be the peak in the earnings growth rate y/y due to the COVID hit a year ago...

@ISABELNET_SA: Goldman Sachs expects median stock to grow EPS by 24% yoy in 2Q

The median stock is expected to grow EPS

Black Widow showed over the weekend that there is money to be made in tentpole movies again...

Interesting to see that the movie did 28% of its revenues thru Disney+ where the company should make significant margins in taking its own studio picture direct to consumers. With the remaining 72% of the revenues going through the ticket window box office, theater owners should be ecstatic but both movie theater stocks are getting crushed on Monday. So, is the excitement of the short-term box office revenues being overwhelmed by the long-term threat of studios going more direct?

Disney and Marvel’s superhero adventure “Black Widow” captured a massive $80 million in its first weekend, crushing the benchmark for the biggest box office debut since the pandemic.

The film, starring Scarlett Johansson, is the first from the Marvel Cinematic Universe to open simultaneously in movie theaters and on Disney Plus, where subscribers can rent “Black Widow” for an extra $30. Disney reported that “Black Widow” generated more than $60 million “in Disney Plus Premier Access consumer spend globally,” marking the rare occasion in which a studio disclosed the profits made from streaming.

Directed by Cate Shortland, “Black Widow” collected an additional $78 million from 46 international territories, boosting its global box office haul to an impressive $158 million. Combined with Disney Plus numbers, the final weekend figure sits at $215 million. Curbing overall ticket sales, however, is the fact that “Black Widow” still doesn’t have a release date in China, which is an all-important moviegoing market for the Marvel franchise.


Image from Black Widow


I was surprised to see how much empty office space there was available in Houston...

The Houston office market is huge, with 192 million square feet (msf) of office space. Of this space, 31.3% are currently on the market available to lease, according to Savills. In terms of Class A office space, 33.3% is available for lease.

By submarket the availability rates range from 10% in Medical Center/South Houston to 52% in North Belt/Greenspoint. In the Central Business District, availability is 34.7%. These are the effects of years of oil-and-gas bankruptcies, downsizing, layoffs, and since 2020, the effects of working-from-home (chart via Savills).

Leasing activity, at 2.0 msf, was down 41% from Q2 2019.

Houston Office Market


Hotel numbers are recovering, but if you are looking for a discounted vacation getaway right now, consider the cities on the right side of this chart…

Although Denver hotels will not be cheap this week as the MLB All-Star game is in town.

Top markets continued to underperform

(Goldman Sachs)


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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