Private Wealth

Weekly Research Briefing: Up, Down, Up, Down

December 07, 2021
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What's all the fuss? The market was down only 1% last week and ended down 4% from its all-time high. The world's largest stock, Apple, Inc., was +3% and that was in a week where it told its suppliers to expect slower orders. The recent economic data looks good in the U.S. with a solid ISM Services report last week and a confusing, but very encouraging, jobs report. As the Fed enters its blackout period until next week's FOMC meeting, it's given us much to chew on. For example: 'Transitory' is dead, the taper will accelerate, and inflation is hot because of the economy. Speaking of which, this week the U.S. CPI release is the big data chestnut.

Oh, and about that new variant. More information shows that it is spreading, with a transmission rate near 3.0. However, the good news is that most infected people do not know that they have it and it isn't causing the many respiratory issues of the previous variants, thus not filling up the hospitals. So, if you wanted to paint a perfect scenario, consider this comment: “So I actually think there is a silver lining here and this may signal the end of Covid-19, with it attenuating itself to such an extent that it’s highly contagious, but doesn’t cause severe disease. That’s what happened with Spanish flu.” (Richard Friedland, chief executive officer of Netcare Ltd., the largest private health-care network in South Africa)

With that hopeful thought, let's dig into some charts and data. Have a great week.


While the daily 1% moves and a volatility index above 30 may be concerning, the larger U.S. market is trading well within a 10% range...

S&P 500 Large Cap Index

@hmeisler


Why all the recent volatility? Much more uncertainty...

In the end, stock markets are networks for price discovery. When the outlook is well understood, agreement around the price of an asset tends to be fairly easy to find. But when the outlook becomes uncertain, such agreement becomes problematic. And with rising cases of the virus, a less accommodative Fed, and tougher growth comps in the year ahead, the uncertainties around the outlook may simply be building -- resulting in a more volatile environment for price discovery.

Goldman Sachs


The Fed's feathers and talons lengthen during Powell's testimony to Congress last week...

1. Despite a balanced prepared statement, Chair Powell’s testimony to the Senate Banking Committee today was hawkish. Powell stated three times, with increasing firmness, that it would be appropriate to discuss accelerating the pace of tapering at the December FOMC meeting, concluding that the FOMC is “going to have a conversation at our next meeting about accelerating the taper and ending our asset purchases a few months early.” He stressed that “every dollar of asset purchases does increase accommodation," and that “we now look at an economy that is very strong and inflationary pressures that are high.”

2. Powell highlighted the importance of price stability and argued that “the economy needs to have stable prices” for the labor market expansion to continue. He also stressed that inflation pressures “have spread much more broadly" and that “the threat of persistently higher inflation has grown.”

3. Chair Powell’s remarks signal that the Fed leadership is open to accelerating the taper, and we continue to expect the FOMC to double the pace of tapering in December and then to deliver the first rate hike in June.

Goldman Sachs


Many others on the Federal Reserve Board also no longer see price increases as transitory...

Expect the taper to accelerate as is being dictated in next week's FOMC meeting. Now place your bet on the first Fed Fund's interest rate hike.

Fed officials for months have stressed the risks of raising rates to cool the economy if supply-chain bottlenecks resolve themselves. But if stimulus and wealth effects are driving stronger demand, “that’s something that monetary policy is made to respond to” by raising interest rates, said Mr. Quarles.

Even some of those officials who have placed great focus in public remarks on the Fed’s commitment to an inclusive and broad-based employment recovery have signaled the need to pay greater attention to the risks that inflation stays above their 2% target for too long.

“If we didn’t have higher inflation readings, you might let the economy go a little bit more to see if we can get through Covid and have those [unemployed] individuals come back,” said San Francisco Fed President Mary Daly during a webinar last Thursday. “But the same people who might be sidelined and not getting jobs, they’re also paying higher prices. And inflation is a pretty regressive tax.”

Wall Street Journal


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Who would have guessed that too much economic strength would have become a problem for President Biden?

Inflation an economic & political problem now

@BofAML


Speaking of economic strength, the unemployment rate looks to be targeting ZERO...

Yes, the Non-Farm Payroll was a miss, but no way that number sticks given all the positiveness in the household phone survey.

Nonfarm payrolls increased only 210K, less than half of the consensus estimate. Although the previous two months were revised up by 82K, this miss means that with just one final employment report left in 2021, nonfarm payrolls are still roughly four million jobs below their pre-pandemic level. The bright spot was a 0.4% decrease in the unemployment rate, as it dropped to 4.2% from 4.6%. The decline was also for the right reasons, as it occurred due to a 542K drop in the number of unemployed people while the civilian labor force rose almost 600K and the participation rate increased to 61.8%. Employment in the leisure and hospitality industry rose just 23K in November, and still lingering 1.3M below pre-pandemic levels, it would take several more years to catch up at November's pace of growth. With COVID cases on the rise and Omicron fears running rampant, it may be a few months before leisure and hospitality employment materially accelerates. Retail trade had a disappointing 20K job decline as seasonal holiday hiring may have been pulled forward, and government payrolls fell 25K in their fourth consecutive decline.

WellsFargo


Expect the Non-Farm Payroll figure to see an upward adjustment next month given the near 1m job difference with the Household survey...

Non-Farm Payroll

The Daily Shot


(In Oprah's voice)... "And you get a job, and you get a job, and everyone gets a job!"

Great to see the all-encompassing U-6 rate below 8%. This rivals even the economic strength of 2007.

U-6 Unemployment Rate


Further strength seen in the ISM Service datapoint, which set a record and was strong across the board...

ISM Services PMI

@TeddyVallee


Credit still seems fine...

Yes, a bit of an uptick in the last month likely dictated more by the worries in the equity markets rather than any economic weakness or structural lending problems. If this series breaks higher, then we will need to worry about our risk exposures.

US Domestic HY Index

JPMorgan


While inflation costs and the supply chain have taken many of the headlines, several incremental items suggest a return toward more normal...

  • GM raised its 2021 guidance due in part to easing supply shortages and a slightly less hostile cost environment.
  • Costco talked Wednesday evening about how inflation pressures moderated somewhat in November.
  • Copper prices are likely to drop to ~$3.80-3.90/pound in 2022 vs. ~$4.30 currently according to Codelco, the world’s largest copper producer.
  • The falloff in prices paid and supplier deliveries indices from their summer highs means that materials are still expensive and wait times are long, but things are not quite as bad as they were during the frenzy of the past six months.

WellsFargo

Container Ships Waiting to Offload


Semiconductor companies continue to be a source of strength in this more volatile equity market...

Semiconductor Index

@hmeisler


Here is why semiconductor and semi equipment stocks continue to outperform...

New chip demand is not slowing. If the supply chain for semis remains tight as JPMorgan foresees, then semiconductor companies remain in a good position for future profitability.

The persistently constrained supply chain has resulted in historically lean inventory levels with distribution/channel inventories remaining 30-50% below pre-COVID 19 levels (with signs of heading lower) and direct customer inventories (as measured by consignment/finished goods) at 15-35% below (see Figure 1). More importantly, true inventory metrics (calculated in days/weeks) we believe are potentially LOWER than actual reported results as they don’t take into account the un-fulfilled revenue/demand that was requested to be shipped in the current/out quarters. Lead times also continue to stretch out, with most of our semi companies quoting 30-50+ weeks, and equipment companies’ leadtimes to foundry / IDM / memory customers of 9-12 months from order placement to first production of wafers.

JPMorgan

Distribution Inventory Days


Salesforce's comment last week validates Barclays' weekend research that 10-20% of office space demand could just disappear without being missed...

“Gavin and I took that trip to Europe, talked to over 60 customers. And really interesting to see a wide range of industries going through different issues, whether it's the supply chain or the Great Resignation. But there's one theme in all those conversations. Every customer reinforced that work is not somewhere you go, but something you do. Every single company I spoke with is building their digital headquarters because they know their teams need to be successful from their home or from this office in this new era of hybrid work” - Salesforce (CRM) COO Bret Steven Taylor

The Transcript


Salesforce comments help to explain the lack of construction spending on commercial real estate...

@SoberLook: Residential and nonresidential construction spending trends in the US continue to diverge.

Commercial RE


Interesting look at relative P/Es around the globe...

Surprised to see the size of the contractions year to date. Not surprised to see the U.S. continue to trade the most rich vs. history.

Fwd P/E across key geographies

JPMorgan


Santa hasn't even gotten out of bed yet. Will do yoga next week. Then lift-off in the third week of December?

@RyanDetrick: December might be strong for stocks, but remember it is the second half of the month when Santa tends to show up.

December Sees Santa Come Later In The Month

LPL Research


J.P. Morgan was comparing private markets deal prices to the public markets last week...

In looking through 1,800 deals over 12 years, they show the trend in prices paid as higher since the GFC, but recent prices have nowhere near accelerated like the move in stock prices.

Average LTM EBITDA purchase multiple

In addition, the analysis showed that the private market companies had more stable annual revenue and EBITDA growth.

Average annual revenue growth rate

Source: Cambridge Associates, FactSet, Frank Russell Company, J.P. Morgan Asset Management. Growth Equity and Buyout represent PE-owned companies. Outlier for both private and public companies were identified and removed from the analysis. *Growth Equity and Buyout growth rates post-2017 are derived using a linear regression that utilizes S&P 500, S&P 500 Information Technology and Russell Indices. **Russell 2500 data post-2017 is calculated using FactSet estimates. (Top) The analysis includes 1,408 buyout companies and 393 growth equity deals. (Middle) The analysis includes 1,383 buyout companies and 600 growth equity deals. (Bottom) The analysis includes 1,321 buyout companies and 395 growth equity deals.
Data is based on availability as of November 30, 2021.

JPMorgan


Charlie Munger has seen a few investment cycles...

Investors who haven't been through one full cycle needed earmuffs this week to listen to Charlie talk about the current state of the markets.

Berkshire Hathaway Inc.’s Charlie Munger told a conference Friday that markets are wildly overvalued in places and that the current environment is “even crazier” than the dotcom boom of the late 1990s that subsequently led to a bust.

“I consider this era an even crazier era than the dotcom era,” Munger, 97, said at the Sohn conference in Sydney, The Australian Financial Review reported.

Munger also said that he wished cryptocurrencies didn’t exist, and praised China for taking action to ban their use, according to the AFR.

“I wish they’d never been invented,” he said. “And again I admire the Chinese, I think they made the correct decision, which was to simply ban them. In my country, English-speaking civilization has made the wrong decision, I just can’t stand participating in these insane booms, one way or another.”

Bloomberg


David Solomon also had some wisdom to share...

"I think markets generally, when I step back and I think about my 40-year career, there have been periods of time when greed has far outpaced fear. We were in one of those periods of time and generally speaking my experience says that you know those periods are not long-lived. Something will rebalance it and bring a little bit more perspective certainly given that it feels like inflation's rubbing above trend. Chances are interest rates will move up and if interest rates move up, that in and of itself will take some of the exuberance out of certain markets " - Goldman Sachs (GS) CEO David Solomon

The Transcript


And Paul Singer picked up the pen for today's Financial Times...

Despite recent jitters over the Omicron variant, global stock market prices remain at or near their highest valuations in history. Bond prices reflect the lowest interest rates in history. And is it any surprise that inflation has broken out of the boundaries of the last 20 years, given the stated goal of policymakers to create more of it? Across the market landscape, risks are building, many of them hidden from view.

Yet, in a surprising twist, a growing number of the largest investors in the world — including socially important institutions such as pension funds, university endowments, charitable foundations and the like — are currently lining up to take on more risk, which could have catastrophic implications for these investors, their clients’ capital and the stability of broader public markets. What is driving this behaviour?

In the main, it is driven by the radically expansionary monetary and fiscal policies undertaken by developed-world governments since the end of the global financial crisis, which were accelerated after the Covid-19 pandemic rattled markets and depressed economic activity last year. And in part it is driven by benchmarking — the practice of institutional investors measuring their performance against a benchmark such as the S&P 500.

As monetary and fiscal policies have pushed securities valuations to new heights, institutional investors have been tempted to overweight their portfolios to stocks, even at record-high prices, for fear of missing out on extraordinary gains. The buying pressure created by these strategies is only driving prices higher and herding capital into risk assets.

Financial Times


John Malone explains the problems of low capital costs for the strong incumbent players...

"If you have capital that's willing to settle for very low returns, it's a big threat. I mean, the biggest threat has always been the guy, the stupid guy with a lot of money coming into your business because they may not end up with much profitability, but they sure as hell can damage the profitability of the incumbent and I believe the vulnerability of incumbents varies very much from market to market depending on specifics, depending on just how cheap it is to overbuild and just how cheap it is for the incumbent to upgrade. So, you could well be in a situation where the incumbent is forced to expend capital that it otherwise wouldn't or does it early in order to repel a competitive overbuilder. The whole - - the long experience of overbuilders in our cable industry was quite negative. The ultimate returns were very poor." - Liberty Media (LSXMB) Chairman John Malone

The Transcript


But maybe the tide has begun to move out for the most expensive companies...

Whisper it softly, but there’s something going on beneath the surface of the stock market.

While concerns around the spread of the omicron variant ostensibly helped whipsaw equities in recent days, there were strange moves happening even before worries over the new variant burst onto the scene late last week. Growth stocks, meme favorites and other companies beloved of retail investors or hedge funds had seen their share prices melt despite the overall S&P 500 remaining relatively stable.

It’s what Peter Atwater, president at Financial Insyghts LLC, has called the “Tarantino Market.” While everyone has been focused on the party going on in the front room, he says, no one’s been paying attention to the fact that star stock after star stock is being taken out back for elimination.

For others, the price action is reminiscent of the quant quake which rippled through markets in 2007 as investment factors crumbled and resulted in broad-based hedge fund trauma. The question is whether the recent weakness in single-name stocks might end up infecting the wider market, or be a sign of more pain to come.

“The bodies have piled up so deep and among so many crowd-favorites that folks can no longer step over the problem,” says Atwater. “Below the surface of the broad indices, there is deep trouble.”...

To understand what happens when everyone tries to leave the party at the same time, it’s helpful to look at a Morgan Stanley index of the top-50 most crowded stocks based on 13-F data filed by hedge funds. Excess returns for the ‘Crowded Long Basket’ versus the S&P 500 reached -10.75% in November, the worst performance on record — surpassing even the market crash of March 2020 and helping to explain recent extreme underperformance in investment groupings knowns as factors.

Bloomberg

Rush for the exits


Unprofitable tech stocks just had their second worst week ever...

@LizAnnSonders: Last week was worst week for @GoldmanSachs non-profitable tech basket since March 2020
[Past performance is no guarantee of future results]

Tech stocks


Plenty of great companies in this portfolio, but the market has turned on expensive stocks. It is a tough position to be in...

@PensionCraft: There's a bear market for all but 4 stocks in Cathie Wood's ARKK fund. Is this a buying opportunity or were these just overpriced stocks in a period of euphoria?

Companies


DocuSign is a great example for the current market...

Good company and product, but last week their product growth outlook slowed a bit and the stock fell 40%. So instead of a $50b mkt cap at the beginning of the week, it settled with less than a $30b mkt cap. Even now, the company is trading for over 10x 2023e revenues, 45x EBITDA and 65x earnings. So not the cheapest valuation for a company that just reeled in their earnings outlook.

DOCU (DocuSign) reported FQ3 revs +42% to $545.5MM (vs. the St $531MM) w/billings +28% to $565.2MM (the St was modeling ~$587MM). EPS came in at 58c (vs. the St 46c). For FQ4 they see revs ~$560MM (vs. the St $575MM) w/billings ~$647-659MM (vs. the St $685MM) and OMs of ~18% (the St is modeling ~14%). Bottom Line: even though DOCU is a lot better than CHGG, PTON, ZG, etc., it looks like it’s the latest member of that ignominious club of COVID beneficiaries that have blown up in the last quarter.

Hammerstone

Docusign


Speaking of other expensive stocks…

Elon Musk has now unloaded more than $10 billion in Tesla Inc. stock as the billionaire’s share-selling spree involving his holdings in the electric-vehicle maker stretched into a second month.

Mr. Musk on Thursday sold more than 934,000 Tesla shares valued at just over $1 billion, according to regulatory filings. The sales came as Mr. Musk exercised more than 2.1 million vested Tesla stock options.

The chief executive began selling shares on Nov. 8. Nearly two months earlier, on Sept. 14, he had established a plan to exercise at least some of his nearly 23 million vested stock options set to expire in August 2022 and to sell some of the shares to cover tax withholding obligations. The latest transactions are part of that plan, according to the disclosures.

Mr. Musk last month polled Twitter users about whether he should sell 10% of his Tesla stock, and people on the social-media platform who voted endorsed the idea. Based on his total holdings before the Twitter poll, Mr. Musk likely would need to sell more than 12 million additional shares following his latest transactions to hit the Twitter target.

Wall Street Journal

Tesla


The markets continue to keep a close eye on China's Evergrande situation given that it would rank as the second largest default in the world...

China Evergrande Group, the world’s most indebted property developer, was again flirting with a formal default on Monday as the end of a 30-day grace period on $82.5m in debt repayments loomed.

Shares in the group tumbled by almost a fifth, the first trading since Evergrande’s disclosure late on Friday that it would struggle to meet a $260m guarantee obligation and that its chair Hui Ka Yan had been summoned by regulators.

Evergrande also said it had formed a new risk management committee with members from large state-controlled companies.

Financial Times


The Chinese government's required delisting of Didi last week did little to assure the outlook for other Chinese internet companies...

KraneShares CSI China Internet ETF


Alibaba investors would like a do-over...

@SofiaHCBBG: Alibaba lost more than half a TRILLION dollars in market value since Oct. 2020. It's now the 25th largest stock in the world, vs 6th back then. ADRs closed at the lowest since June 2017. This is $BABA vs Nasdaq, normalized:

Alibaba ADRs

If you are a fiduciary with investments in China, last night's "60 Minutes" will lead to further questioning from your constituents...

While the CBS news team went right at the 'why invest in China now' question, the defenders didn't make the best case for shareholders. They should have focused more on the big growth potential of the country. Instead, they left viewers with fewer reasons to click the BUY button.

Keyu Jin: China grew really lawlessly, chaotically, in the last 40 years. And that's all about to change.

Economist Keyu Jin splits her time between the U.K., where she teaches at the London School of Economics, and Beijing, where her father is president of one of China's largest state-owned banks.

Lesley Stahl: Is Xi Jinping killing off capitalism in China?

Keyu Jin: President Xi envisions what he calls a "modern, socialist economy" for China, a much more restricted capitalism. President Xi is with the people. He is with the peasants, the middle class, and unlike his predecessors, he doesn't really care so much about what happens to elites...

Lesley Stahl: To the West, it looks like Xi is killing off the golden goose. Sabotaging what has made China the economic power that it is.

Keyu Jin: That is a complete misinterpretation of what is going on. China's tackling the most intractable problems of Western capitalism ahead of the West. The concept of reducing income inequality has to be done all over the world, except that China's just much faster at implementing some of these policies.

Lesley Stahl: But isn't it communist?

Keyu Jin: No. Because it is really just to give more opportunities to the middle class, and not have the top 1% take away all the opportunities. These companies have a big control over, over the people.

Lesley Stahl: And now the government will have that.

Keyu Jin: The government wants to take that back. Absolutely.

60 Minutes


With so many challenges over the last month, active large-cap portfolio management has taken a bruising...

It has been a challenging 11 months to be an active equity fund manager. Overall, just 32% of large cap mutual funds have beat their respective style benchmarks YTD (21% of core, 16% of growth, and 63% of value funds). Fundamental long/short hedge funds have fared no better, with the typical fund posting a flat YTD return according to Goldman Sachs Prime Brokerage compared with +23% for the S&P 500.

Goldman Sachs

Mutual Fund Performance


Is Web3 Bull#$&t?

Before you think about investing millions into Web3, buy Stephen Diehl a cup of coffee.

At its core web3 is a vapid marketing campaign that attempts to reframe the public’s negative associations of crypto assets into a false narrative about disruption of legacy tech company hegemony. It is a distraction in the pursuit of selling more coins and continuing the gravy train of evading securities regulation. We see this manifest in the circularity in which the crypto and web3 movement talks about itself. It’s not about solving real consumer problems. The only problem to be solved by web3 is how to post-hoc rationalize its own existence.

The blockchain offers nothing new or worthwhile to the universe of technology. It’s a one trick pony whose only application is creating censorship resistant crypto investment schemes, an invention whose negative externalities and capacity for harm vastly outweigh any possible uses. Every single problem proposed to be solved by blockchain hits up against three fundamental technical limitations that inescapably arise from economic or legal concerns. The three technical issues of the narrative are:

  • The Compute Problem
  • The Bandwidth Problem
  • The Storage Problem

StephenDiehl


I miss Japan and can't wait to return. One out of 125 million tells me that we will be able to visit in 2022...

@EricTopol: Deaths (n=1) yesterday in Japan.

Daily new confirmed COVID-19 deaths


Well done "New Yorker"...

The New Yorker's December cover

New Yorker


I have forgotten what snow even looks like...

Why go to Hawaii for the holidays when you can have the temperatures brought to your doorstep?

8-14 Day Temperature Outlook

NOAA


Finally, who doesn't want to be a McCallister for one night during the holidays?

@Airbnb: get ready to celebrate the holidays on the most boring street in the United States of America... because the timeless house where the Home Alone story began is officially bookable on airbnb. 🎄 

filthy animals can request to book on December 7 at 1pm CT.

airbnb Home Alone house

airbnb


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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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