Private Wealth

Weekly Research Briefing: Time to Fade?

February 15, 2022

The year to date moves in inflation expectations and interest rates have been incredible. This was due to occur given that a generation of current investors have never witnessed broad inflation, while many others just wanted to believe that the low cost of capital, increased productivity and the ability to create supply at will would keep inflation low forever. Of course, Covid had other plans for our short-term supply and demand imbalances. But while inflation has reared its ugly head in the short term, throwing the Fed and the markets into a panic over future rate moves, is it possible that the worries have gone too far? We started the year with thoughts of two-to-three Fed Fund rate increases of 25 basis points each. Now the market is leaning to bet on seven rate increases with the possibility of a +0.50% starting jump and maybe even an inter-meeting hike? Does it feel like the markets are beginning to get ahead of themselves? Maybe this is what the Fed wants to do. Just talk its way into an economic slowdown. Maybe Bullard is playing the role of the 'bad cop' right now. If so, hand him an Oscar for his performance on Thursday because that really took the wind out of the market's sail. Stocks and credits were trading fine after the CPI report. It wasn't until Bullard grabbed the mic did the markets lose their grip.

We know that the Fed needs to raise rates and withdraw liquidity to help cool the U.S. economy and put some chips in the bank for the next rainy day. But the rapid swing in the Fed's thinking, combined with an increase in volume from some of its members is causing the financial markets to become more stressed. Growth and unprofitable equities have already been hit from the rise in interest rates. But now credit spreads are beginning to inch higher which doesn't make much sense given the balance sheet strength of corporations, households and the U.S. banking system. It could be that the markets are getting cautious and preparing for something more wicked 12 months down the road. That is what the forward interest rate curves are suggesting: an inverted yield curve in 2023. If that is the case, then maybe a recession of some form in 2024. It doesn't seem likely given where we sit today, but anything is possible.

I think that these moves have all happened too quickly. That chart of the 2-year Treasury yield is crazy from 1.6% to zero to 1.6% in a visual that looks like a cereal bowl. We know how the left side adjusted so quickly, but how could we get the right side so wrong? It seems like a good time to fade these moves. I'd look for the sprints higher in short-term rates and commodity prices combined with the collapse in growth stock prices to speed the Fed's efforts in slowing the economy. The U.S. will still recover and move to a more normal looking economy with kids going to school, adults returning to work and then all to a well-deserved vacation. But the tide of Fed and market liquidity will continue to recede, causing future financing to be more expensive, lesser projects to not get a greenlight, and weaker companies to no longer exist. Good companies with cash flow generation will still have access to capital and should be attractive to investors, but with risk-free rates higher, the cost of that capital will become a bit more expensive, and the investor appetites will be just a little smaller. This is the normal cycle of the markets and Investing 101. As interest rates rise, valuations go lower. Even Coca-Cola will still sell their products, make money, and pay dividends, but the multiple that the average investor might want to pay will be a smidge lower. More importantly, that 4x leveraged hedge fund that was buying KO now can only invest in half as many shares because their leverage has been cut back to 2x by their prime broker.

So that is where I stand as I watch the markets move around. Still no opinion on Ukraine or crypto (which I was asked about at a record rate this weekend). Have a great week. Congrats, Rams. Awesome halftime show.

The CPI report surprised to the upside, with inflation hitting multi-decade highs...

The top-line number came in hot. The markets knew it could and were fine with it until Bullard grabbed the megaphone.


The Daily Shot

The price of the CPI components/categories were strong across the board...

Let's see if a return to work will help mute the food gains going forward via more workers in restaurants and meat plants. Auto prices have begun to decelerate as car factories ramp production.

Percent changes in CPI


What Are LPs Talking About?

Read our latest article

Restaurant prices are seeing significant increases right now...

But this should be little surprise given the number of restaurants that have shut down and number of workers who were sidelined by Omicron in January.

US CPI YoY: Food Away from Home

The Daily Shot

The kids were being paid whatever they wanted to show up for any job in January...

But as classrooms open, will the 25+ age groups return to compete for those wages? Most likely.

@LizAnnSondersWages +10.6% y/y for those ages 16-24 … strongest growth rate on record per data from ⁦@AtlantaFed

US Atlanta Fed Wage Growth Tracker

Rent/Housing is 40% of the CPI so we all watch it closely...

If the four handle becomes a five handle, Bullard may get to be right.

US CPI YoY: Rent of Primary Residence

The Daily Shot

Even the smallest items and services are having an impact as the U.S. normalizes beyond Covid...

Remember in 2020 when U.S. workers stopped going into the office, and half of the dry cleaning stores in your neighborhood shut down? Well, now we want our clothes dry cleaned again.

US CPI YoY: Laundry and Dry Cleaning Services

The Daily Shot

If the ISM Price survey acts like in the past, then maybe CPI is about to cool...

ISM Prices index

Piper Sandler

Bullard speaks and the market freaks...

• “I’d like to see 100 basis points in the bag by July 1,” Bullard, a voter on monetary policy this year, said in an interview with Bloomberg News on Thursday. “I was already more hawkish but I have pulled up dramatically what I think the committee should do.”

• “There was a time when the committee would have reacted to something like this to having a meeting right now and doing 25 basis points right now,” Bullard said. “I think we should be nimble and considering that kind of thing.”


If the entire FOMC shows at the next meeting wearing L.A. Rams' jerseys, then we will know that Bullard is in the doghouse...

Tweet from @NickTimiraos

Jared Dillian is right. It looks more like a half-pipe...

@lisaabramowicz1: Yields on 2-year Treasuries bump up against the highest levels since 2019 as St. Louis Fed President Jim Bullard says he's worried the Fed isn't moving fast enough, will have to react and be more nimble in this new era.

Two Year Treasuries

As of this morning, the market is edging toward a bet on +0.5% at the March meeting...

March Meeting

Jones Trading

And the market has also moved to +175bps in 2022...

Probability of a 1.75% total Fed rate increase

The Daily Shot

The CEO of Loews is a good investor, plus he has a very big book of assets to manage for his insurance liabilities, so he watches the markets closely...

" we are on the fourth-quarter call and the Fed has finally woken up to the problem that they should have foreseen a year ago. The problem now is that the Fed is taking its sweet time putting in place their action plan to deal with the skyrocketing inflation and the overheating economy. Instead of doing something about the 7% year-over-year increase in the CPI, the Fed is only talking about it. And the Fed has led the market to perceive that they will raise Fed funds rates four times in the course of this year. That's 100 basis points this year, meaning that at this pace, it will take them seven years to get Fed funds to the current level of inflation. While I don't think that inflation will stay at the 7% level, I do believe that with our quicker and more decisive action by the Fed, it will be seen that they are fighting a forest fire with a water pistol. As long as interest rates are below the inflation rate, the proverbial punch bowl is still there for all market participants to grab a drink. I understand that the Fed doesn't want to cause a panic and that they have to be careful about what they say. But still, there's something to be said for acknowledging the scope of the problem and beginning the process of interest rate normalization."
- Loews (L) CEO James Tisch

The Transcript

Could one of the biggest markets in the world be so wrong about future inflation?

I could see where the U.S. Treasury market would be a little off. And yes, I know that the Fed does own many Treasuries. But still, if long-term inflation was going to run closer to 5% than 2% there is no way that the 10-year yield would trade where it does currently. The market's greed is just too great.



Time to start loosening your tie if the GS Financial Conditions Index begins to rise with Treasury yields...

In past tightening episodes, increases in front-end treasury yields have catalyzed movements of a comparable magnitude (in basis-point terms) in equity discount rates and in broader financial conditions—for example in 1969, 1973, 1979-81, 1994-95, 2017-18. Key historical exceptions are the equity-market resilience during the 1999-2000 dot-com bubble and the easy FCI and high equity valuations during the mid-2000s housing bubble.

Equities and Overall Financial Conditions

Goldman Sachs

Might even need to unbutton your collar after looking at this chart...

The yield curve is expected to invert next year, which typically signals a recession within 6-18 months.

USD OIS 10yr

This is the chart that makes me start thinking four-letter words...

If credit begins to breakdown, then the Fed might have to go for it on the fourth down. And the market is going to have to reel in risk in a much greater way than it has done so far.

Credit asset class performance since November 22, 2021.


Goldman Sachs

I'll leave it to you to decide if having 40% of your loan book in one of the riskiest categories of lending is a good thing at this point in the cycle...

OZK’s $7.7 billion in construction and land development loans made up 42% of all loans on its balance sheet as of September. That is the highest percentage for any bank with more than $5 billion in assets, and more than 10 times the weighted industry average. The Little Rock lender holds more construction debt than Citibank, which is about 65 times as large, in terms of assets.

Unlike bigger banks, OZK doesn’t usually ask borrowers to pledge their personal wealth as collateral, and it doesn’t sell off parts of a loan to other lenders, according to brokers who have worked with the bank. That helps it win business, but it also means OZK has more exposure in the event of a default.

OZK said it can minimize that risk by funding about half a project’s cost on average, leaving the rest to other investors, as well as by backing experienced developers and insisting that it gets paid first in the event of a default. Only 0.2% of the bank’s loans were nonperforming as of December. Last year, the bank’s profits hit a record, company filings show.


Betting the Bank on Construction

On the flip side, the financial health of households is in a good place...

Thank you to housing prices and stock market appreciation.

US household leverage


On occasion, it is always good to take Randall Pearson's advice and look right into the worst-case scenario...

@TheEconomist: The financial system is in better shape than it was in 2008. But make no mistake: it faces a stern test. Our cover this week

The Economist cover

This weekend, Goldman Sachs took the higher risk-free rates and factored them into their stock market valuations...

Following 4Q results, we reiterate our 2022 S&P 500 EPS estimate of $226 (+8% year/year growth) and lift our 2023 EPS estimate to $240 (+6% growth) to reflect our previously discussed scenario assuming no tax reform. However, since our November outlook, inflation has surprised to the upside. Our economists now expect 7 Fed hikes in 2022 and real yields to drive a 33 bp rise in the nominal 10-year Treasury yield to 2.25%. We expect the ERP will decline, resulting in a forward P/E multiple of 20x, unchanged from today but below our previous forecast of 22x. We lower our S&P 500 year-end 2022 price target to 4900 (from 5100) but continue to expect upside to US equities as prices rise alongside earnings.

Goldman Sachs

Scenario analysis

European equities were beginning to see strong inflows a week ago...

Now let's see if the interest and demand can stay as Putin plays RISK.

Largest inflow to Europe equities since May 17

U.S. major indexes through Friday...

@bespokeinvest: The S&P 500 $SPY is now beating the Nasdaq 100 $QQQ by more than ten percentage points over the last 12 months. $SPY also up 14% versus -10% for small-caps $IWM.

US major indexes

International equity ETFs through Friday...

@bespokeinvest: Last 12 months: Canada ETF $EWC up 20%, China ETF $ASHR down 20%. Brazil is closing in on flat over the last 12 months after a 15% jump to start 2022.

International Equity

When will energy stocks act like the rest of the market and take a rest?

Energy Select Sector SPDR Fund


Current market insight from my list of large cap all-time new highs...

At the end of each trading day, I take a look at the new highs in the market. This helps to give me a better sense of what is currently working in the market and where the big investors are placing their chips for the future. I actually post the large cap all-time new high list on Twitter each day. You can find it at @361Capital. When I reviewed the all-time new highs from last week, here is what I found and thought:

• CVX LNG SHEL - for the first time in quite a while, the energy stocks are beginning to notch new highs.

• MAR EXPE H - travel names hitting highs tells me that the U.S. recovery is hitting full stride.

• KO HSY TSN ADM - defensive food names in favor and these big food companies are able to pass along their inflationary pressures.

• NTR CF - fertilizer companies riding the food wave and also have pricing power.

• MCK ABC - drug distributors business is returning to normal after COVID disruptions.

• ABBV - Only big pharma name to hit all-time new highs last week (or maybe even in the last month) so they must be doing something right.

• A long list of financial stocks. U.S. banks, Canadian banks, Diversified Financials and Insurance companies. Financials remain an interest to investors given the rise in interest rates.

We knew that earnings could help save this market...

Unfortunately, for those companies that missed their top and bottom lines, this season has been especially brutal.

@SoberLook: Companies haven’t been punished this much for missing earnings forecasts in over a decade.

Median Selloff on Earnings Misses


How does the semiconductor shortage fix itself?

During a capital-allocation call with analysts last week, TI executives outlined plans to increase substantially capital expenditures for the next few years—beyond the significant boost Wall Street was already projecting. The plan calls for an outlay of around $3.5 billion annually through 2025, which is about $1 billion a year higher than what analysts were projecting for that period.

More notably, the plan represents capital expenditure equivalent to a high-teens percentage of TI’s annual revenue for those years, based on Wall Street’s current projections. That is a huge jump—the company averaged 5% of annual revenue over the past decade...

The plan isn’t risk-free. Chip makers across the globe are pouring billions of dollars into expanding manufacturing. Intel and Taiwan Semiconductor Manufacturing Co. are projected to invest a combined $67 billion this year alone. And while TI has an advantage in focusing on lower-cost manufacturing lines that have actually been the most acute areas of production shortages of late, the potential for overbuilding that could result in expensive fabrication facilities not being fully used can’t be ignored.

Morgan Stanley analyst Joseph Moore wrote that “the fact that many semiconductor companies are making substantial capital investments this year does suggest that global utilization is likely to face pressure” in the long term.


Chipping In

European travel and leisure is also recovering strongly...

Ryanair Holdings Plc has seen a “dramatic recovery” in bookings over the past two weeks as the easing of pandemic travel curbs across Europe encourages people to fly again.

The Irish low-cost carrier’s planes are flying about 75% full and could reach 90% of capacity by the peak of the summer high season, Chief Executive Officer Michael O’Leary said at a briefing in Milan Wednesday.

Ryanair expects fares to remain “very low” through May before rising for summer, by which point it’s possible that a combination of strong demand and limited capacity could see them climb above pre-coronavirus levels, O’Leary said.


Disney's results last week showed a complete recovery in their Parks business, and that is even with one-fifth of their customer base still missing...

"We haven't yet seen the return of our international guests. And remember, historically, and we always hit this historical boundary of our band of 18% to 22% of our Walt Disney World guests came from outside of the U.S., and they haven’t even yet started to return."
- Walt Disney (DIS) CFO Christine McCarthy

The Transcript

Parks & Recreation


In other entertainment spending news, Formula One is looking at Super Bowl-like ticket prices for their Miami race...

@JoePompliano: The demand for the race in Miami has been insane.

Tickets sold out instantly, and the cheapest ticket on the secondary market is currently over $2,000.

Prices via @SeatGeek

Parks & Recreation

The melding of private and public investing continues as hedge funds seek better returns...

Dmitry Balyasny, head of one of the largest US hedge funds, has said he expects an increasing number of his peers to begin investing in private companies, despite fears of overheating in the crowded market.

All large hedge funds will eventually invest in start-ups because the divisions between private and public markets are becoming irrelevant, Balyasny told the Financial Times. “Markets are pretty efficient, and one of the sources of inefficiency is when you have artificial lines,” said the chief of the $13bn Balyasny Asset Management.

“The line between public and private is an artificial line that creates different types of investors, and that creates opportunity.” His comments come as hedge funds, typically known for investments in publicly traded assets, have started to pour resources into private companies in an effort to fire up returns.

Financial Times

Public pensions know where their best returns are coming from...

@Cunningham_PI: Buoyed by private equity's amazing returns alternative investments are now more than 30% of an average public DB plan in the U.S.

Public Defined Benefit Asset Allocation

As for commodity alternatives, there goes gold...

@hmeisler: GLD. The Magic Line on top got broken. New (blue) line.

SPDR Gold Shares

Good news kids, those aluminum can will be worth collecting this summer as their value to recyclers grows…


The U.S. has now become number one in liquid natural gas shipments...

Out of the roughly five dozen U.S. LNG cargoes on the water, more than two-thirds are headed to Europe where low winter inventories and tensions between Russia and Ukraine have sent natural gas prices on the continent soaring to more six times the U.S. benchmark Henry Hub.


Shipping Vessels

Western home prices are becoming insane. And welcome to pink Florida...

Given the move in home prices, some key builder markets have seen a reduction in relative affordability over the last year, with mortgage payments in Florida (16% of 2020 builder deliveries), Georgia (6%), Tennessee (3%), and Nevada (2%) all rising above 30%. That said, they remain better positioned vs more expensive coastal states. Additionally, we highlight Texas (22%) and the Carolinas (10% together) that both remain below this threshold.

Goldman Sachs

State Affordability Tracker

The world needs more Dolly's...

Herschend Enterprises, Dollywood’s parent company, announced Tuesday that Dollywood will pay 100 percent of the tuition costs, fees and books for employees who pursue higher education. Starting on Feb. 24, all 11,000 seasonal, part-time and full-time employees at Herschend’s 25 U.S. attractions, including Dollywood, can register for the GROW U pilot program.

The initiative allows employees to enroll as early as the first day of employment in diploma, degree and certificate programs offered by 30 learning partners. Subjects offered in the higher education program include business administration and leadership, finance, marketing, technology and culinary studies. The company has also pledged to provide partial funding, or up to $5,250 a year, for 150 additional programs in fields such as engineering, human resources, hospitality and art design.

The Washington Post

And ten out of ten pigs would agree that the world needs more Carl's...

Carl Icahn, the billionaire investor known for his relentless campaigns against CEOs and rivals, has a secret cause that he has pursued for a decade.

In 2012, McDonald's Corp. pledged to stop buying pork for its Bacon McDouble cheeseburgers, McRib sandwiches and the like by 2022 from producers who use small crates to constrain pregnant swine. Left unmentioned was that Mr. Icahn had pushed for the change behind the scenes.

A decade on, Mr. Icahn has concluded the original promise was hogwash. McDonald's now often has its producers move pigs out of the containers only after confirming they're pregnant. Many wait to do so until the sows are four to six weeks into their 16-week pregnancies. Mr. Icahn had expected the use of so-called gestation crates to be banned altogether.

The man who helped send TWA into bankruptcy and partly inspired Gordon Gekko, the ruthless corporate raider in "Wall Street," is spending a lot of time advocating for better treatment of pigs, using many of the same tactics.

Mr. Icahn got involved with the Humane Society of the United States, which is leading the push, at the behest of his daughter, Michelle Icahn Nevin, a vegetarian animal-lover who was working there at the time. He learned details of the pigs' plight when he hosted a Humane Society executive for dinner at his Manhattan penthouse. The nonprofit was having trouble getting McDonald's to take action until it corralled Mr. Icahn.


Expect to see many garaged cars/trucks when the weather breaks with gasoline at $4+...

If you could ride a bicycle, moped, or e-kickscooter to work, would you do so? Respondents in the Mobility Ownership Consumer Survey, conducted by the McKinsey Center for Future Mobility in July 2021, were enthusiastic about these options, with almost 70 percent stating that they were willing to use micromobility vehicles for their commute (exhibit).1 (Bicycles and mopeds could be traditional or electric.) These findings suggest that a growing number of workers may gravitate toward smaller, more environmentally friendly forms of transport as pandemic restrictions lift and offices reopen.


McKinsey & Company

Finally, the tweet of the week...

Tweet from @EnergyRosen

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The author has current equity ownership in: Chevron Corp., Cheniere Energy Inc., Shell PLC, Texas Instruments, The Coca-Cola Co. and Abbvie Inc.

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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