Private Wealth

Weekly Research Briefing: Chop, Chop, Chop

September 20, 2022

If the stock market was a fine dining kitchen, it would currently be midday and we would all be busy at the chop block with a knife in hand and tubs of vegetables to prep. Stock prices are waiting for a signal and just biding their time. Up, down. Up, down. Carrots, celery, onions, mushrooms. Chop time is not a lot of fun, but it is very necessary to build the elements for the timing of that next market move (as well as to make the base for that excellent pot of stock).

The market had hoped that last week's CPI number would have provided the base for a market launch higher. But instead, the surprise pop in the core inflation figure sent the markets 4-5% lower as economists and strategists lifted their Fed Fund rate hike expectations. It now looks like the FOMC will hike by 75 basis points this week (to 3.00 - 3.25%) and the market is planning on a peak Fed Funds rate of 4.25-4.5% by the Q2 of 2023. Will 4% rates in 2023 do enough to slow the U.S. economy? Many individual inflation series are rolling over, but the more lagging ones (like shelter) will stay higher for a while. Unfortunately, the Fed does not get an immediate response to its Fed Fund Rate dial which is why it has baby stepped into this. Many investors and business leaders are calling for restraint on the rate hikes, while others push for more. And so welcome to the chop of this directionless market.

While higher interest rates are being felt by some sectors of the economy, many companies that gave business updates last week suggested that things appear fine. Banks, travel/leisure, restaurants and even many technology companies had more positive than negative things to say. Some of the basic materials companies had to lower guidance as reduced demand, higher raw material, energy and/or transportation costs hit their budgeted outlooks. And just not sure what to think about the 20%+ plunge in FedEx on Friday. For such a large company with operations in so many countries and industries, it is surprising that others are not also seeing their same difficulties. I see UPS down only a few percentage points over the last two days and think that the miss at FedEx stays at FedEx.

Have a great week and know that in one 24-hour window, there will be 16 central bank rate decisions (including the Brazil, Egypt, Indonesia, Japan, Norway, Philippines, South Africa, Switzerland, Taiwan, Turkey, UK, and U.S.)

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Welcome to FOMC week. Time for another +75bps followed by...

@lisaabramowicz1: It is now consensus that the fed funds rate will be above 4% by year end, at least based on Wall Street analysts and market pricing. What's less understood (or agreed upon) is how much economic pain that will cause.

The Fed is raising by 75bps this week because of last week's miss on the CPI...

August core CPI rose by 0.57% month-over-month, well above expectations, and the year-on-year rate rose two tenths to 6.3%. The composition was strong, with broad-based strength in cyclical and wage-sensitive services categories including shelter, restaurants, medical care, education, and personal care. Airfares declined 5%, in line with our expectations. Headline CPI rose 0.1%, with the year-on-year rate falling two tenths to 8.3% on lower gasoline prices.

Goldman Sachs

Market bulls need a lower, low on that 'Core' series...

@bencasselman: Inflation remains high on a year-over-year basis, although it's fallen from its peak as gas prices have dropped. But core inflation, which the Fed is watching closely, picked up.

Food for thought...

About half of US income is earned by households making more than $100,000 per year, with most owning their own homes. So the largest expense for these households isn’t rising even w/tighter Fed policy, but wages are going up, perhaps explaining why core inflation is so sticky.

Morgan Stanley

Also, plenty of chop in the regional economic data...

The Philadelphia Fed manufacturing index declined back into contractionary territory in September, below consensus expectations. The underlying composition was weak, as the new orders, shipments, and employment components all decreased.

The Empire manufacturing index increased by more than expected in September but remains in contractionary territory. The composition of the report was strong, as the new orders, shipments, and employment components all increased.

Goldman Sachs

J.P. Morgan

Consumer inflation expectations continue to fall according to the University of Michigan. Now we need to see more falling in the CPI...

University of Michigan: At 2.8%, median long run inflation expectations fell below the 2.9-3.1% range for the first time since July 2021.

@LizAnnSonders: CPI #inflation (green) is rolling over alongside inflation expectations from Umich (5-10y, blue) and 5y5y inflation swaps (orange) … note different axes

Away from all the talk about the Fed and inflation, the labor economy remains very healthy...

@bespokeinvest: In the average year, non-seasonally adjusted jobless claims have bottomed by this point of the year. This year, however, claims have continued to fall and have reached the lowest level since October 1969.

But as mortgage rates move thru 6%, investors in the home flipping business have seen their returns evaporate...

The US housing market’s sharp downturn has been bad for builders, flippers and almost anyone who had plans to sell a home when rising mortgage rates shut down the pandemic buying frenzy.

The slump has been especially harsh for Opendoor Technologies Inc., pioneer of a data-driven spin on home-flipping known as iBuying.

The company, which sells thousands of homes in a typical month, lost money on 42% of its transactions in August, according to research from YipitData. Opendoor’s performance — as measured by the prices at which it bought and sold properties — was even worse in key markets such as Los Angeles, where the company lost money on 55% of sales, and Phoenix, where the share was 76%.


One of the largest landlords believes the Fed is moving too aggressively...

If housing prices are falling and rental increases are slowing, these will eventually impact CPI data. But notice the big lag in the chart below...

@AndreasSteno: This is also the most lagging variable at ALL - the shelter index in the CPI basket lags the housing price development by up to 18 months. So if house prices drop today, it will take more than a year for the CPI methodology to realize this

Just flipping thru my screen of 52-week lows notes some big names with some big dividend yields...

4% yielders: IP STX WHR DLR


6% yielders: VZ T LYB DOW

Of course with most U.S. Treasuries nearing a 4% yield, the interest in stock dividends has taken a back seat (for now)...

@LizAnnSonders: Spread between S&P 500’s dividend yield and 10y U.S. Treasury yield remains negative and has dipped back down again … now hovering near level early 2011 level

If New York City is back, doesn't that also mean the U.S. economy is strong?

In New York, where white-collar workers have been slower to go back to their desks than in other cities around the country, this month has offered tentative signs that employees are finally returning in earnest.

Offices in the New York City area were nearly half full this week, leaping from about 38 percent during the prior week, the biggest increase since Labor Day of any major metropolitan region, according to Kastle Systems, an office security firm.

On Wednesday, subway ridership surpassed 3.7 million riders for the first time since March 2020. And weekday ridership on the Long Island Rail Road and Metro-North Railroad, which carry suburban commuters into the city, also reached pandemic-era highs in the last two weeks. Officials for New Jersey Transit said the system was on pace for its highest month in fare revenue since the onset of the health crisis.

The New York Times

Starbucks founder sees only strength...

[SBUX] Interim CEO Schultz: So far we have been immune to any recognition whatsoever that there is a downturn in customer traffic, a downturn in average ticket
- Investor Day
- Implied the Company has not seen a material change in customer behavior as a result of inflation
- Seeing record demand in US and worldwide
- Company will produce double-digit revenue, double-digit EPS growth with continued strength in comp store sales- Delivery business is 'on fire' today


Disney theme parks also see strength...

Theme Parks. DIS keeps a close eye on the macro environment, and believes it has internal systems that can better deal with macro headwinds, citing its reservation system as a leading indicator of strong demand into the future. Management highlighted that it has demand in excess of supply in spite of the macro conditions, with no indication that the macro environment is impacting its business. The company believes it has created a fortuitous loop of success with a focus on the guest experience.

Goldman Sachs

Delta Airlines is seeing stronger international demand and is hiring 200 pilots a month...

S&P 500


JetBlue also sees its business better than expected...

JBLU (JetBlue) issued a bullish update on the state of its business – the company continues to see the strong demand environment extend beyond the summer peak, with robust demand for travel in September and beyond. Ancillary revenue also continues to perform well, aided by record co-brand spend. JetBlue now expects revenue per available seat mile for the third quarter of 2022 to increase between 22% to 24% year over three, compared to prior guidance for a 19% to 23% increase.

Vital Knowledge

The biggest banks don't see a cliff approaching...

[JPM] Exec: Q3 shaping up to be a solid quarter for markets business, expects Q3 trading revenue up 5%
- Barclays conf comments
- Bank expects Investment Banking fees down 45-50%
- Bank saw ~8% loan growth

[WFC] CFO: Credit card payments remain high; Lower income customers are seeing signs of financial stress
- Barclays conf comments
- Loans running up 5% YTD but growth has moderated in Q3
- Have seen deposit declines in Q3
- Could see a little pressure on $51.5B cost guidance
- Not seeing systematic stress

[AXP] Exec: We feel 'even better' about our multi-year outlook we provided back in January
- Barclays conf
- Travel and entertainment spend outside US has 'ticked up a little bit'
- Don't see any 'significant signs of weakness' anywhere in the parts of the economy that we cover; This is reflective of most recent quarterly results we presented
- As a general matter for our business model a 'modest and steady rate of inflation' is actually a positive for our business though inflation has put 'some pressure' on our cost structure
- We are currently trending to be 'at or above higher-end' of our FY22 EPS guidance range (Guided FY22 $9.25-9.65 v $9.87e)
- Forecasts level of sustainable Rev growth beyond FY22 to be above 10%


Another big bank CEO had many positive things to say about his retail consumers...

Brian Moynihan, CEO of Bank of America Corp:
And so what are we seeing right now? In the month of August 2022, consumers spent 10% more than they spent in August 2021. And you'll hear a lot about credit and debit card spending. That's only about 25% of the way a consumer lose money. And so the whole thing for us is well over $4 trillion now in an annual basis. That grew – August grew 10% over last August transactions grew 5.5% to 6%. So the challenge people say, well prices are up there, therefore it's growing. You say no, people don't go out there twice on the same night. So the transaction volume is going up too. They don't pay rent twice. They don't pay – they don't buy clothes twice, et cetera. So that's good news.

So the three things to think about: the customers are spending more. They have – the amount of money and accounts is not going down. It's been relatively flat. In the month of August, it basically give us a little bit down and lower cohorts from July 12%, 13%, 15% year-over-year growth all the way up through cohorts to be like $75,000, $100,000 earning households.

So they have the money in their accounts. They're spending it at a good clip. Their capacity to borrow. All credit cards are still enough to where they were in pandemic. Our home equity loans are still down and you look across the industry capacity to borrow. So the consumer is in very good shape. And you sort of say, why is that true in the discussions with various people, it's pretty simple. They're getting employed. They're getting paid more. And on a multiple year wage growth that actually exceeds the inflation rate.

So what's interesting is Labor Day was bigger than last Labor Day by about 17%, Labor Day weekend travel and things. So consumers are spending and that bodes well for the economy. It's also the toughest thing the Fed has to deal with, because what consumers are spending money on now services travel things like that take a lot of labor content, which means employment situation is going to be tight. And that's the struggle they're doing is they can't get easing in employment markets, because everybody started traveling. Demands in hotels, restaurants, the airlines, et cetera was high unemployment kept coming up.

Seeking Alpha

But not all is good as Scotts Miracle Gro illustrates...

The company is caught in the retail shopping maelstrom. Also probably doesn't help that so many western Americans have given up on their lawns due to the cost or availability of water.

Just months ago, the chief executive of Scotts Miracle-Gro Co. was bracing for the biggest summer ever. After two years of struggling to fill store shelves, the company had ramped up production to catch up with consumer demand for lawn seed, fertilizer and other garden products. Investments in new manufacturing capacity were paying off as the 67-year-old CEO prepared for the usual rush of May orders from retailers looking to replenish their stocks.

The orders never came, and by Memorial Day, Mr. Hagedorn knew his company was in trouble. Scotts has already cut about 450 jobs, or around 6% of its workforce, since May, and more layoffs are coming. Manufacturing plants have been slowed. Cash is dwindling. Nobody is getting bonuses. Instead, the company is in full-blown crisis mode.

“I love working, but this isn’t exactly the s—hole I was planning to live in toward the end of my career, working my way out of a goddamn latrine,” Mr. Hagedorn said. “But that’s what it is and that’s where I am.”


On the winning side of the climate change teeter-totter is Carrier Corp, who is doing fine in commercial HVAC and crushing it in heat pumps in Europe...

David Gitlin, CEO of Carrier Corp:
What I would tell you is there's really no new news today. Everything that we said on our 2Q call continues to track. Orders are something that we watch very closely and they're consistent generally with what we said on our 2Q call that more than half of our business have seen orders up double digits. Commercial HVAC has had 6 quarters in a row of double-digit orders. That continues to go well. Fire & Security orders are strong. Where we saw some weakness in orders are things like resi and transport. That's generally been consistent with what we had seen and basically completely in line with expectations because we've been saying for a year straight that resi orders would be down."

Seeking Alpha

Big chemical companies like Dow and Eastman have too many headwinds right now...

DOW (Dow Chemical) at the Credit Suisse conf. said the economic situation in Europe is weakening while the US is also witnessing headwinds and China still hasn’t seen a big recovery due to the ongoing COVID restrictions (the company says Q3 revenue and EBITDA will fall short of the St consensus by about $600MM).

Vital Knowledge

[EMN] Cuts Q3 Adj ~$2.00 v $2.60e (prior EPS 'solid growth' v $2.46 y/y), as demand has slowed more than expected in Aug and Sep as well as higher than expected costs

- CEO: “There are three main factors negatively impacting our volume and product mix in the third quarter,” said Mark Costa, Board Chair and CEO. “While demand across some end markets, including agriculture and personal care, is demonstrating resilience, demand has slowed more than expected in August and September, in particular in the consumer durables and building and construction end markets and the European and Asian regions. At the same time, logistics have been challenged by an acceleration of marine logistics issues on the US East Coast, particularly impacting high-value specialty products in Advanced Materials bound for other regions. Operational issues have also impacted volume and product mix, as recovery of our polymer lines from an electricity outage in July at our Kingsport facility took longer than expected,”

- Certain costs have trended higher than expected and are impacting third-quarter performance, particularly for natural gas in the US, which reached a 14-year high during the quarter. A stronger US dollar against a number of currencies, including the euro and the yen, is also negatively impacting results.

- “In response to these accelerating challenges and continued uncertainty, we are raising prices where appropriate to offset higher costs and implementing measures to control costs across the company”


And again, FedEx looks like a disappointing one-off...

For a company with such broad reach across geographies and industries, why aren't more global corporations singing the same tune. Maybe because they have too much Europe and Asian exposure? Maybe because they didn't price correctly? Did their cost structure get out of whack? Lay down all of your cards FedEx and show us.

FDX - First quarter results were adversely impacted by global volume softness that accelerated in the final weeks of the quarter. FedEx Express results were particularly impacted by macroeconomic weakness in Asia and service challenges in Europe, leading to a revenue shortfall in this segment of approximately $500 million relative to company forecasts. FedEx Ground revenue was approximately $300 million below company forecasts. “Global volumes declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the U.S. We are swiftly addressing these headwinds, but given the speed at which conditions shifted, first quarter results are below our expectations”.

Vital Knowledge

Global economic weakness doesn't even appear in Mike Rothman's chart of oil demand which has now surpassed pre-COVID levels...


Given the backdrop of uncertainty as well as the ability to invest in Government bonds with a positive yield has led investors away from global equities...

BofA Global Research

And the U.S. dollar has moved to the top of the pyramid for investors...

BofA Global Research

A good article highlighting how family businesses are increasingly turning to private equity buyers instead of their competitors as a way to plan for their future succession...

Private-equity firms are joining America’s family businesses. The industry that made its name taking private big corporations has shifted its focus to smaller targets, snapping up car washes, pet-food makers and specialized manufacturers, some of which have been family-owned for several generations.

Family businesses hold particular appeal for buyout firms, and they are throwing out the traditional private-equity playbook to attract them. Management is often left intact. Owners keep big stakes. Buyout firms pledge to retain employees and plow more money into the businesses.

Still, some buyout targets end up carrying heavy debt burdens that can turn a once-profitable company into a money-losing one. Families might ultimately cede control when the business is later sold so their private-equity owners can realize gains. Communities and workers, by extension, can lose their personal ties to a company’s ownership.

At the same time, the deals help aging business owners ensure a future for their companies after they are gone. Many are finding that their own children aren’t interested in taking over. Those whose children want to remain involved recognize that their offspring will need additional technological and financial know-how.

Even owners who want to keep working are often looking to untangle some of their wealth from their businesses. They are ready to share the risk they have shouldered alone for years, but they aren’t prepared to cede their legacy to a bigger competitor.


A big Private for Public deal last week...

Rising interest rates has caused investors to exit their REIT holdings. STORE Capital is a solid company that has been thrown out along with the average REIT. So last week, the private markets moved to take advantage of this short sightedness by buying the entire company.

STORE Capital Corporation, an internally managed net-lease real estate investment trust (REIT) that invests in Single Tenant Operational Real Estate, and GIC, a global institutional investor in partnership with Oak Street, a Division of Blue Owl, one of the largest net lease investors, today announced that they have entered into a definitive agreement under which GIC and funds managed by Oak Street will acquire STORE Capital in an all-cash transaction valued at approximately $14 billion.

Under the terms of the definitive merger agreement, STORE Capital stockholders will receive $32.25 per share in cash, which represents a premium of 20.4% to STORE Capital’s closing stock price as of September 14, 2022 and a premium of 17.8% to the 90-day volume weighted average stock price through that date.

“This all-cash transaction delivers a meaningful premium that provides immediate and certain value for our stockholders in a challenging market environment, while positioning the Company, its customers and its partners for continued success,” said Tawn Kelley, Chairman of the Board of Directors of STORE Capital. “I would like to extend my thanks to the entire Board and management team for their hard work during this process, and for their unwavering commitment to acting in the best interests of our stockholders.”

“We are pleased to partner with GIC and Oak Street to deliver what we believe is an excellent outcome for our stockholders,” said Mary Fedewa, President and Chief Executive Officer of STORE Capital. “This opportunity is an endorsement, by two leading real estate investors with significant access to capital, of the strength of our platform, our experienced leadership team and our disciplined investment approach. We look forward to continuing to grow and support our customers.”

STORE Capital Investor

And in Public for Private deals, Adobe makes the Silicon Valley's VC community and Brown University's day by paying $20 billion to remove a large, growing thorn from its side...

Microsoft buying Figma was the widely predicted endgame. If Adobe was trying to block that outcome with its deal, it is paying a high price. The $20bn cost (half cash, half stock) is double the valuation from Figma’s June 2021 fundraise. It’s 50 times Figma’s reported $400mn of 2022 annual recurring revenue (ARR) and it values Figma employees at about $25mn each.

Here’s Mirabaud analyst Neil Campling:
The strategic decision appears to make sense — better to buy than build, and take out the disrupter before you get fully disrupted. However, a $20bn price tag smacks of a sense of desperation and clearly had to buy the company — before Microsoft did . . . Back of the envelope calculations suggest Adobe is paying c. 12 per cent of market cap for an additional 3 per cent of ARR.

Financial Times

Looking closer at the returns for VC funds...

The team put this chart together last week showing the returns by vintage year since 2011. It will be interesting to see what the returns for new funds raised in 2022 and deploying capital for the next few years will generate. You have got to think that there will be some screaming bargains for those that can grab the bottom in valuations and peak timing needs for startups running out of cash.

Best Year for Commodities

Hamilton Lane/Cobalt

If Stan is correct, fiduciaries are going to have a difficult time in their index equity funds for the next decade...

Stan Druckenmiller: So there's a high probability in my mind that the market at best will be flat for ten years, sort of like the 1966-1982 time period, but the nice thing is there were companies that did very well in that environment back then. That's when Apple computer was founded, and Home Depot was founded, coal and energy companies and chemicals made a lot of money in the 70s.

The Transcript

While the advantages of using '40 Act'* evergreen funds to get private market exposure makes incredible sense for retail investors, many of the same attributes also apply to small institutional clients...

I point this out because many readers of this WRB are fiduciaries to smaller retirement plans or education-based, religious-based, or other charity-oriented foundations and endowments. Increasingly, smaller institutions are making the right decision to shift allocations from their public market holdings into the private markets. Because of where I sit, I get to see and hear many of the conversations that occur at the board of trustee meetings, and quite often I find my palm quickly meeting my forehead when evergreen fund vehicles are not considered.

The last public meeting notes of a $1-2 billion retirement plan that I read online showed the discussion and presentation to begin a double-digit private equity allocation that would target a long-term return pickup of 3-5% with lower volatility over public equities. This strategy change was being closely analyzed to see if it could overcome several implementation factors. The factors considered included liquidity needs, timeframe to deploy, internal resources required, which products to choose, which managers to choose, etc. In other words, all the same issues that an individual investor or advisor would need to consider for their clients.

As I read through the analysis, I quickly realized that '40 Act' evergreen funds were not even included in the analysis as it only considered direct fund investing or a fund of funds program. I found this curious given that investing in evergreen funds would easily solve many of the issues that the institution was evaluating.

Consider these advantages:

  1. With an evergreen fund, the investor can immediately target their desired allocation amount.
  2. Evergreen funds can provide liquidity (typically quarterly).
  3. Evergreen funds provide monthly valuations.
  4. If the goal is to grab the beta of the private markets, most evergreen funds provide immediate diversification.
  5. Fewer resources are needed to build and maintain an allocation to evergreen funds.
  6. Most evergreen funds provide 1099's to their investors and not K-1's.

There have been some big evolutions in the asset management industry during my lifetime. I saw active investing shift to passive investing. Then investors moved from mutual funds to ETFs. While public market investing has been shifting into private market investing at the institutional level for the last 30 years, it has not been easily investable for smaller institutional and retail investors. The rapid ascent of 40 Act evergreen funds changes this dynamic and makes the private markets much easier for a greater universe of investors to get exposure into. This is a good thing.

While I am biased toward our own evergreen fund vehicles because our investment team is one of the largest allocators into the private markets, I am equally fired up about this entire new evergreen fund category. Even if you do not look at our evergreen products, I would urge you to spend time analyzing all the private market evergreen vehicles in our category. '40 Act' evergreen products make all the sense in the world for small institutions and individual investors to get invested into private companies.

(*The Investment Company Act of 1940, sometimes referred to as the “’40 Act,” is legislation passed by Congress in 1940 to regulate the organization and operation of publicly traded investment companies. These companies include both closed-end and open-end funds, including interval funds, ETFs, mutual funds, and traditional closed-end funds.)

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The author has current equity ownership in: Starwood Property Trust, Starbucks Corp., Walt Disney Co., and J.P. Morgan Chase & Co.

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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