Market Commentary

Weekly Research Briefing: You're Hired

May 04, 2021
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Domino’s Pizza is paying $17.65 per hour to deliver pies here in Colorado. Denver’s minimum wage is now $14.77 per hour. If you are fully vaccinated and ready to work, there are new jobs being created daily. What a great time to be a kid looking for a summer gig. Their pockets are going to be full by the time school starts in August. Low wage employers are going to miss those kids when they return to school. This year should be the best of times for any small business as the economy recovers. Unfortunately for many, it might be a profitless prosperity if input and labor prices do not stop flying higher. Maybe inflationary spikes are what will kill the walking dead zombie companies that shouldn’t exist in any economy. We shall soon find out.

From the FOMC statement last week: "Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened... the sectors most adversely affected by the pandemic remain weak but have shown improvement." So, the economy is moving, and the Fed sees that even the most damaged industries are recovering. We expect to see another big monthly job number on Friday. The number of seven figure estimates are building. Will this be the data point that starts the increase in ‘taper’ talks? It looks like the Fed’s Robert Kaplan of the Dallas Fed began his lobbying campaign last week.

The big news for the last two weeks has been corporate earnings. We knew that they would be strong. We didn’t know they would be even better. But despite the spectacular results, the markets shrugged. Even more surprising were the blowouts of the four horsemen (Apple, Amazon, Google and Microsoft) that left the tech sector as a worst performer last week. What gives? Have we factored in all the recovery into the 22x forward multiple of the S&P 500 Index? Maybe. Of course, the way that flows are shifting around, maybe it is just investors reallocating dollars from tech and growth stocks over into cyclical and value stocks. Or maybe it is just the seasonal trade combined with the reopening of our favorite public places which is distracting us from investing. It's all bears watching closely. Have a great week.

Q1 corporate revenues have been so much better than we were guessing...

Aggregate sales beats have surged to a new record

(@ISABELNET_SA)

Unfortunately, the sales and earnings beats did not translate into stock performance...

US: 86% of S&P 500 companies that have reported beat EPS estimates. EPS growth for these companies is running at +57% y/y, surprising positively by 25%. Discretionary, Financials and Materials are the main drivers of the strong EPS growth, while Airlines continue to see contracting bottom line. Top-line growth is coming in at +11% y/y, surprising positively by 4%.

US stock price reaction to quarterly EPS beats/misses

(J.P. Morgan)

Could future cost uncertainty be giving investors pause?

"We're seeing substantial inflation. We're raising prices, people are raising prices to us. And it's being accepted. We really do a lot of housing. The costs are just up, up, up...It's an economy – really, it's red hot. And we weren't expecting it"
— Berkshire Hathaway (BRK) CEO Warren Buffett

"I would tell you the inflationary pressure people see and the headlines that they have on it and all our competitors are feeling is unlike anything I've seen, because it's just not in commodities. It's sort of across the board. And better stated, it's just not raw copper, steel and aluminum. It's across the board because everyone sort of has what I would call a COVID surcharge of inefficiencies that they’re trying to pass on."
— Lennox (LII) CEO Todd Bluedorn

(@TheTranscript_)

High Grade Copper Prices

(@biancoresearch)

Unless OPEC wants to open the spigot, oil prices might make a push to the eight handle...

@carlquintanilla:
GOLDMAN: “.. we expect the biggest jump in oil demand ever — a 5.2 mb/d rise over the next 6m, 50% larger than the next largest increase over that time frame since 2000 .. we see commodities rallying another 13.5% .., with oil reaching $80/bbl .. with risks to the upside.”

Oil demand is likely to rise sharply

(Goldman Sachs)

As commodity prices soar, semiconductors go on allocation...

A good segment on '60 Minutes' last night discussing the global chip shortages. This will not be a short-term issue.

Ford Motor Co. will halt production at its German plants for several weeks due to a lack of semiconductors, the latest sign of the severity of the global chip shortage.

The automaker will stop production at its Cologne plant twice, from May 3rd to June 18th and then from June 30th until workers return from the summer break in mid-August. Output at its Saarlouis factory will also halt for much of the current month and into June, according to the company...

News of outages in Germany comes after Ford last week said the dearth of semiconductors would cut its second quarter production in half, joining a list of automakers flagging fresh stoppages. In recent weeks, Jaguar Land Rover Automotive Plc, Volvo Group and Mitsubishi Motors Corp. and BMW AG have joined the list of carmakers idling factories.

(Bloomberg)

When will producer cost pressures make it through to the consumer?

NY Fed Empire State Manufacturing Prices Paid and CPI Inflation

(@HumbleStudent)

If Domino's can't find workers with their premium wages, how is any other food delivery supposed to survive this year?

While the following reads odd - this is in the copy I found online, so it is in the transcript.

"Now the final thing I'd like to acknowledge is we close out the discussion on our Q1 results in the US is the very difficult staffing environment that we are in today. The combination of COVID, strong sales, the broader economy reopening and the high level of government stimulus is creating one of the most difficult staffing environments that we've seen in a long time."
— Domino's (DPZ) CEO Ritch Allison

(@TheTranscript_)

Not just delivery drivers causing this wage breakout...

Employment Cost Index

(@SoberLook)

No way that 2-year yield lasts at that level...

Put me in the Jamie Dimon camp. "Friends don't let friends own Treasuries."

US Treasury Yields

(J.P. Morgan)

Europe has lagged the U.S. but it doesn't mean they won't join our economic roar...

@IHSMarkitPMI: The Eurozone Manufacturing #PMI reached a fresh series high of 62.9 in April (March: 62.5), amid record growth in investment goods and across several countries incl. Italy and the Netherlands. Read more: http://ihsmark.it/I6bj50ED5dj

IHS Markit Eurozone Manufacturing PMI

And the German bond market is taking notice...

@jsblokland: The 30-year German bond #yield is up to its highest level since July 2019! However, with #inflation, at 2.1% in March, rising faster than nominal bond yield, real yields remain extremely depressed.

30-year German Bond Yield

Who will be next to join Kaplan on the taper talk?

Dallas Federal Reserve Bank President Robert Kaplan on Friday called for beginning the conversation about reducing central bank support for the economy, warning of imbalances in financial markets and arguing the economy is healing faster than expected.

"We are now at a point where I'm observing excesses and imbalances in financial markets," Kaplan told the Montgomery Area Chamber of Commerce in a virtual appearance in front of a live audience, pointing to "historically" elevated stock prices, tight credit spreads, and surging house prices.

"I do think, at the earliest opportunity, I think it would be appropriate for us to start talking about adjusting those purchases," referring to the Fed's $120 billion in monthly bond buys that, along with near-zero interest rates, are aimed at keeping financial conditions super-easy and bolstering the recovery.

(Reuters)

Meanwhile, Chairman Powell wants to let it run...

"With regard to interest rates, we continue to expect it will be appropriate to maintain the current zero to 1/4% target range for the federal funds rate until labor market conditions have reached levels consistent with the committee’s assessment of maximum employment, and inflation has risen to 2% and is on track to moderately exceed 2% for some time. I would note that a transitory rise in inflation above 2% this year would not meet this standard. In addition, we will continue to increase our holdings of treasury securities by at least $80 billion per month, and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward our maximum employment and price stability goals."

(U.S. Federal Reserve Chair Jerome Powell)

Americans are feeling great about their financial condition right now...

Americans Saying Their Financial Situation is Excellent or Good

(Gallup)

Time to buy some pants With a zipper and a button...

People are dressing up again—sort of—as they venture out to social events and prepare to return to the office. Pent-up demand, combined with stimulus checks, rising vaccine rates, new styles and the weight that many people gained or lost during the pandemic, is expected to drive a surge in clothing sales not seen in years, according to industry executives, shoppers and analysts.

In the past few weeks, pants with buttons and zippers have begun outselling those with drawstrings or elastic waistbands at L.L. Bean Inc. At Saks Fifth Avenue, sales of dresses, blouses and sandals are exceeding levels not seen since spring 2019. And employees at Haggar Clothing Co.’s distribution center are working overtime to replenish trousers and blazers at department stores and other retailers that sell its clothes.

“The fact that sales came back so strongly, so quickly before offices reopened speaks to the need for people to dress up as they get out there and socialize,” said Michael Stitt, Haggar’s chief executive officer.

(WSJ)

Consumer spending could Be record breaking this year...

We expect consumer spending will grow at its strongest pace since 1946

(@OxfordEconomics)

As a result, Moody's Analytics thinks 2022 GDP will run past 5%...

Tweet from @JimPethokoukis

Consumers aren't the only ones about to open up the wallets...

Capex is about to launch which should be further good news for the U.S. economy. And this will be meaningful for small business which sees significant leverage from large company spending increases.

Several of the largest S&P 500 firms have recently announced substantial cash spending plans. AAPL recently announced an acceleration of its domestic investments; it plans to spend $430 billion across the country during the next five years. AAPL noted this initiative would span direct spend with American suppliers, data center investments, and capital expenditures in the US. AAPL and GOOGL also announced $90 billion and $50 billion buyback authorizations, respectively. 444 S&P 500 companies have market caps below the combined $140 billion. The five largest stocks (“FAAMG”) alone accounted for 18% of total cash spending in 2020.

Summary of our W&P 500 cash use forecasts

(Goldman Sachs)

With one-third of 2021 in the books, here is how the major U.S. ETFs have performed...

Growth had a good April, but Value still leads year-to-date thanks to big moves from Energy and Financials.

US ETFs

(@bespokeinvest)

Big pharmaceutical stocks are for sale in this market...

COVID-19 hurt drug makers as it did most other companies. But while most stocks have recovered in the last year, big pharma has not. Some earnings misses so far this earnings season are partially to blame, but those big pipelines should be able to keep those sizable dividends flowing into the future. Post-COVID healthcare spending will return at some point in the future and value buyers could be rewarded.

US Major Pharma Performance vs S&P 500

(@lhamtil)

Maybe flows into Value funds will lift Big Pharma stocks...

Net Flows Into Large-Value Equity Fund Over Past 10 Years

REITs quietly breaking higher on a relative basis as rents roll solidly higher for several sub-categories...

Real Estate vs S&P 500

(@adaptiv)

Semis are rolling lower on a relative basis as chip shortages in some areas affect demand in other areas...

Semiconductor Index

(@HumbleStudent)

In: Large Cap Value Funds,
Out: Large Cap Growth Funds...

Morningstar Categories with the Greatest Estimated Net Monthly Inflows/Outflows

(Morningstar)

See Robinhood break a mirror over a black cat while walking under a ladder on Friday the 13th...

If the last year has taught us anything, it is that people are tired of the Warren Buffetts and Charlie Mungers of the world acting like they are the only oracles of investing. And at Robinhood, we’re not going to sit back while they disparage everyday people for taking control of their financial lives.

(Robinhood)

The stock market is about to run into its annual potential doldrums...

The markets didn't have a chance to sail through the Intertropical Convergence Zone last summer because Captain Powell had strapped a jet engine on the back of the U.S. economy. But this summer could be different with the throttle pushed so far forward that fuel is exploding out the tailpipes. If inflation and labor wage spikes don't slow, the markets could decide to take matters into its own hands rather than wait for the Fed to act.

@RyanDetrick:
The next six months are indeed the worst possible 6 month combo for the S&P 500, up 1.7% on average.
But did you know when the S&P 500 is >5% in May (like '21) then the next six months are up 6.2% on average?

Sell in May?

Does private equity have a seasonal doldrum period like the public markets do?

Ryan's research got me to run down the rabbit hole last week to find out. Since I work for a firm with a large set of data on private assets, it made the digging much easier. To top it off, Friday was the end of the reporting period for year-end 2020 private asset data so the numbers you see below are certifiably fresh.

The longest set of data that we have in private equity is of the buyout category. This is the original and oldest form of private equity, and it includes investments into value, growth, and cyclical companies both small and big. It also includes companies mostly located in the U.S. but also a fair number of overseas buyouts. For the comparison public equity index return, I went for the S&P 500 Index. I know that I should compare an index that has more international and smaller capitalization company investments, but I say, "Go big or go home". Let's see how buyout private equity does against Tom Brady.

As you can see in looking at the buyout data, there is some Q2 & Q4 seasonality, just like there is in the S&P 500 returns. I figured that the public markets likely had some influence on the marks for assets in the PE funds. In talking to some of the experts at Hamilton Lane, I learned that in the older days the Q4 valuation of assets were generally the most scrutinous and unless an event or transaction occurred in a previous quarter, the valuations were little changed. This still occurs in present day for the European funds where assets are most fundamentally revalued in the Q2 and Q4 time periods. But in 2007, FASB statement #157 changed the U.S. accounting practices which required a more fair practice of valuation on a quarterly basis. And you can see its impact in the quarterly results of Buyout returns which became much more smoothed on a quarterly basis going forward. Another minor factor toward some Q4 seasonality is that more exits and distributions typically occur in the Q4 so the final realization would tend to have a more positive effect on returns.

Of course, while I am geeking out on the seasonality of the buyout returns versus the S&P 500, other investors might be focused on the relative and absolute performance of private equity versus public equity. The data generally shows higher returns and lower volatility against the performance of the S&P 500 historically. I hope that this will be something that you will pay closer attention to in the future.

Private Equity

*Past performance is not indicative of future results. 

Do not ignore investing in Western Europe either via the public markets or private markets...

If you have missed investing in European stocks over the last couple of decades, you haven't missed much as U.S. stocks now trade at a significant premium. But for private equity investors, had you ignored Western Europe, you likely would have underperformed your peers. While I continue to favor European equities over U.S. ones, the pros here at Hamilton Lane also suggest you continue to keep a focus on Western European private equity.

Western Europe is viewed by many as the new venture. We tend to think about Western Europe as similar to the U.S., just a little smaller. But that characterization overlooks some important attributes that distinguish the markets. The number of general partners in Europe, particularly those of institutional scale and quality, is relatively small compared to most other regions. There aren’t a lot of spinouts and new entrants in the market. Therefore, the investable universe is constrained, particularly because many/most of those managers limit their fund sizes.

Dispersion of Returns by Strategy and Geography

*All PM includes funds-of-funds and secondary fund-of-funds. Past performance is not indicative of future results. 

(Hamilton Lane)

There has been continued strong growth in the private asset industry...

The long-term growth in private markets has been quite substantial. The number of active firms in private markets topped 11,000 in 2020, growing 5.0 percent during the year and 8.0 percent per annum since 2015. Attractive economics and significant liquidity have continued to drive new entrants into the space, even in a challenging year. Private equity represents the largest share of private markets firms at approximately 75 percent of the total, as well as the fastest growing at 9.1 percent per annum. By contrast, the count of active hedge funds continued to decline, shrinking 2.0 percent per annum since 2015.


The number of active private-capital firms has surpassed that of hedge funds

(McKinsey)

This is causing plenty of head snaps in the food world today...

Shouldn't this Michelin-starred restaurant gather up 100% of the future investment meeting dinners that have an ESG mandate? Genius move.

The highly acclaimed Manhattan restaurant Eleven Madison Park said on Monday that it would no longer serve meat or seafood when it reopens next month, becoming one of the most high-profile restaurants to switch to a plant-based menu because of environmental concerns.

Daniel Humm, the chef and an owner, said in a statement on the restaurant’s website, “It was clear that after everything we all experienced this past year, we couldn’t open the same restaurant.”

Mr. Humm said that the coronavirus pandemic, which led to closure and layoffs, had forced the restaurant’s leaders to reimagine its future. “We have always operated with sensitivity to the impact we have on our surroundings,” he said, “but it was becoming ever clearer that the current food system is simply not sustainable, in so many ways.”

Mr. Humm said that the kitchen had spent its days developing new dishes and meat and dairy alternatives, like plant-based milks, butter and creams, flavorful vegetable broths and stocks, and fermented foodstuffs.

“What at first felt limiting began to feel freeing, and we are only scratching the surface,” he said. “All this has given us the confidence to reinvent what fine dining can be.”

Photo of Daniel Humm

(NYTimes)

Google/Waymo continues to lead in the race for the best automated driving system...

Best Automated Driving System

(AutomotiveNews)

Finally, this is possibly the best explanation ever of NFTs...

NFTs

(@mendel)

Catch up on past Weekly Research Briefings >

Disclosure: The author has current equity ownership in: Alphabet Inc. and Microsoft 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.

Endnotes: Strategy Definitions

CI Funds – Any fund that either invests capital in deals alongside a single lead general partner or alongside multiple general partners.

Credit – This strategy focuses on providing debt capital.

Fund-of-Funds (FoF) – A fund that manages a portfolio of investments in other private equity funds. 

Growth Equity – Any PM fund that focuses on providing growth capital through an equity investment. 

Infrastructure – An investment strategy that invests in physical systems involved in the distribution of people, goods, and resources.

Mega/Large Buyout – Any buyout fund larger than a certain fund size that depends on the vintage year.

Natural Resources – An investment strategy that invests in companies involved in the extraction, refinement, or distribution of natural resources. 

Real Estate – Any closed-end fund that primarily invests in non-core real estate, excluding separate accounts and joint ventures.

Secondary FoF – A fund that purchases existing stakes in private equity funds on the secondary market. 

Venture Capital – Venture Capital incudes any PM fund focused on any stages of venture capital investing, including seed, early-stage, mid-stage, and late-stage investments.

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