Private Wealth

Weekly Research Briefing: Inflation everywhere, except in snow

November 16, 2021
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Those of us who live in Denver spent the weekend watering our trees and yards, which is highly unusual for the middle of November. The latest first snowfall for Denver occurred on November 21, 1934 during the Dust Bowl. We are going to crush that date because there is no humidity (or cold) in the forecast for the rest of this month. Usually Mount Evans has a bit of a snow cap, even during the summer months, but right now as I look out the window, I have never seen it so bare on top. Hopefully La Niña will shift and send some of those Pacific Northwest rainfalls along with an Arctic blast to whiten us in December. Otherwise, the only thing Colorado skiers will be hitting in the mountains this year will be fast golf balls.

As I jump back into the saddle this week and size up the data and the markets, I see:

  • Inflation UP
  • Consumer sentiment DOWN
  • Jobless quits UP
  • Holiday travel angst UP
  • Holiday gift buying ACCELERATING and Retailers selling prices UP
  • The U.S. dollar moving UP and to 12-month highs suggesting continued U.S. growth and rising interest rates
  • Gold prices UP and hitting 5-month highs exciting the inflation-istas
  • Long Treasury bond prices FLAT and confused
  • Stock prices UP suggesting continued growth, moderating inflation, and a peaceful Fed
  • Bank stocks UP and Junk bonds STABLE suggest no black clouds in the 9-12 month credit outlook

Some are suggesting we are near peak year-over-year inflation while others think the higher price party has just started. The supply chain bubbles combined with a return to post-COVID growth and long-term lack of investment in core business infrastructure has caused all of this 2021 inflation pain. Over the next few months, we will get to see if the supply pressures will ebb, and price increases can slow. Last week, Toyota announced that all of its Japanese factories will be running by the end of the month. This is a big deal given that new 4Runners are selling for $15,000 over their $40,000 list price (if you can even find one on a dealer lot). With economic growth on track, I will bet that all of the fun will be watching the weekly inflation data. Any moves that prices have moderated and there could be some interesting moves in the fixed income and precious metals markets.

While I was away from the desk, Samurai Futaba visited the Global 100. If only John Belushi was alive today, he would have been down on the floor of the NYSE slicing his way through the trading stands of GE, Johnson and Johnson, and Toshiba. Expect more corporate separations to occur in the future as the role of the conglomerate has outlived itself. With the capital markets open as wide as ever possible, there is no longer a need for size to attain a lower capital cost. So, unless one business can have a direct synergy with another, there is little need to keep them together. And sell the mega-headquarters because few employees are working out of the big square footprints anymore.

Christmas is now less than six weeks away. With the S&P 500 +25% year to date, the wind should be at its back to enjoy the Santa Claus rally unless some big news or data drops on the tape. Not a lot of tax harvesting to do this year unless you spend the bulk of your time on the long side of the emerging markets or on the short side of anything else equity related. Interestingly enough, fixed income investors could have some tax loss harvesting to do this year.

Inflation hit my household hard last week...

Kikkoman Corp. said Friday it will raise the price of soy sauce, a key item for Japanese cuisine, by up to 10% from February in its first price hike since 2008 due to rising raw material costs and logistic fees.

(Bloomberg)

soy sauce

(Pexels)

For non-soy sauce-oriented households, the jump in last week's CPI was equally significant...

The inflation bells were ringing this week as the consumer price index (CPI) climbed a hefty 0.9% in October and pushed the year-over-year rate over 6%, the highest in over three decades. While it was expected that inflation was heating up, the gain shattered the already-high expectations for a 0.6% gain over the month. Fingers also cannot be pointed at just a few pandemic-related sectors for the increase, as price pressures have broadened out. Daily necessities such as food and energy saw prices climb higher as prices rose 1.0% at grocery stores, 0.8% at restaurants and over 6% at the pump in October. But apart from household staples, core CPI, which excludes energy and food, was still up 0.6% during October and 4.6% since this time last year.

Consumer Price Index

(Wells Fargo Economics)

Regarding inflation, Goldman Sachs is pointing its finger toward durable goods...

They feel that once the supply chain problems ebb, these constrained prices will move from inflationary to deflationary. Fixed income investors and pensioners can only hope that they are right.

Core PCE Inflation

Morgan Stanley also thinks added supply is on the horizon...

@carlquintanilla: MORGAN STANLEY: “A sizeable inventory build is coming. We expect continued easing of supply-chain bottlenecks toward more normalized flow by end-2022. .. The substantial swing in inventories as clogged supply chains ease is the greatest story for the 2022 outlook yet untold.”

2022 US Economic Outlook

Ditto for J.P. Morgan...

Global supply chain pressures are easing — if this persists S&P 500 should continue to deliver strong revenue growth and record margins. That said, there has been a growing concern among investors that supply chain challenges will linger and weigh on earnings growth. Based on 3Q earnings season, however, there is little evidence to support this pessimistic view. S&P 500 companies delivered much stronger than expected results (16% y/y revenue growth vs. 14% estimate, ~13.5% net income margin vs. pre-COVID ~12%) and some key companies gave an encouraging outlook on supply chains. Our view all along has been that supply and labor shortages would be temporary and normalize with a decline in COVID-19. JPM proprietary textual analysis of management discussions confirm that trends are stabilizing with the worst likely behind us.

(J.P. Morgan)

Prices to move global freight are beginning to come in quickly as workers increase their hours...

Tentative signs of improvement in freight congestion

(Goldman Sachs)

But not everyone is happy with their current employer as the quits rate hits a new all-time high of 3.0%...

US Job Quits

(DailyShot)

The lack of urgency in taking a job has little to do with U.E. benefits...

@carlquintanilla: GOLDMAN: Workers are citing many “non-economic reasons for not looking for work.” Elements of the WH spending package - “especially the child tax credit and the child care tax credit — could have meaningful and offsetting effects on the structural participation rate ..”

Reasons Cited by Unemployed Workers

(Goldman Sachs)

Actually, most of those who have exited the labor force are over the age of 55 and don't want a job...

Exhibit 1 decomposes the change in persons not in the labor force since the start of the pandemic. The first key takeaway is that most labor force exiters are over age 55 (3.4mn) and do not want a job right now, reflecting 1.5mn early retirements, 1mn natural retirements due to population aging, and 900k exits for other reasons. We expect that an improving virus situation, increased vaccination, and new antiviral drugs from Pfizer and Merck should alleviate the health concerns that are particularly relevant for older workers and encourage some to return to work. However, shifts into retirement tend to be stickier than other labor force exits, and we therefore expect that the participation shortfall from early retirees will unwind relatively slowly through fewer new retirements going forward.

Reasons Cited by Unemployed Workers

(Goldman Sachs)

While I was out, the Fed announced its long-awaited tapering…

So, let's quickly move on to their next big announcement: Fed Funds rate hikes!

Against the backdrop of a robust recovery, the Federal Open Market Committee ended its two day policy meeting with a pledge to reduce its purchases of Treasury securities by $10bn a month. The central bank will also reduce its purchases of agency mortgage-backed securities by $5bn a month. The FOMC said it was able to withdraw the stimulus because it had achieved “substantial further progress” towards its twin goals of maximum employment and inflation that averages 2 per cent.

The tapering process is set to begin in mid November, which suggests the stimulus programme will cease in June 2022. The purchases would be reduced by the same amount in December and further reductions were deemed to “likely be appropriate” each month thereafter. The Fed committee said it was “prepared to adjust the pace” of the tapering process “if warranted by changes in the economic outlook”.

At a press conference following the announcement, Jay Powell, Fed chair, said the central bank was prepared to “speed up or slow down” as needed. “If we feel like something like that is happening, then we’ll be very transparent. We wouldn’t want to surprise markets,” he said, adding that even after the Fed stops expanding its balance sheet, its holdings of securities will continue to “support accommodative financial conditions”.

(FinancialTimes)

One glance at this chart should tell you that the world is very awash in cash...

And that the Fed is being lobbed 10mph softballs directly over home plate. Time to hike a few notches to use for a rainy day.

GS US Financial Conditions Index

(Goldman Sachs)

This read caught my eye last week...

Increased volatility and widening spreads are a big red flag for me. It seems too early for this to be happening for holiday seasonal reasons.

The trading climate in the $22tn US government bond market has become less hospitable, adding to choppy moves in securities that act as a foundation of the global financial system.

Liquidity — the ease with which an investor can buy or sell an asset — has deteriorated in recent weeks, data show. That has added to the pressure on regulators to improve a market long viewed as a haven during times of trouble.

But regulators are far from any solution, according to a progress report released this week by a federal working group charged with assessing the structure of the US Treasury bond market…

“This seems to be something that has got to be sending sort of a troubling signal to central bankers, because it is not fundamentally driven. There’s clearly some ‘position unwinds’ that are going on as we speak,” said Subadra Rajappa, head of US rates strategy at Société Générale.

This “position unwind” means that speculators are rushing to get out of bets that longer-dated Treasury prices would fall. The trade has been a popular one in recent months, but the relentless move higher in prices has clobbered hedge funds including Rokos Capital Management, Alphadyne Asset Management and Odey Asset Management.

As investors exit these bearish positions, liquidity has been worsening, making the moves even more extreme. JPMorgan Chase research from November 5 showed that market depth, one measure of liquidity, had declined to the lowest levels since summer, when fears about the effect of the Delta variant on the US economy hampered liquidity.

Treasury market liquidity is worsening

(FinancialTimes)

Been a long time since Chinese home prices rolled over...

This will only add more pressure onto the leveraged property lenders and the nation's building industry sector.

China New Home Prices MoM

(DailyShot)

Ongoing property problems continue to send the Chinese junk bond market in one painful direction...

Kaisa, one of the biggest borrowers in the sector, could this week add to a growing list of businesses that have missed interest payments ahead of two imminent deadlines it faces on its offshore bonds. Earlier this week, it pleaded with investors for “more time” after missed payments on wealth management products in mainland China.

Its trajectory echoes that of Evergrande, the world’s most indebted property developer, which initially alerted global markets to the issues across China’s real estate industry when it missed offshore bond payments in September, weeks after problems also arose on wealth management products it guaranteed. Holders of some bonds in Evergrande said they had received payments before a 30-day grace period expired on Wednesday.

Since September, international bond markets have been essentially closed to property developers. The average yield on an Ice Data Services index of Chinese high-yield dollar bonds, which is dominated by property companies, jumped close to 29 per cent this week from 14 per cent at the start of September. The rise brings the key barometer of borrowing costs to the highest level since the 2008-09 global financial crisis.

Chinese junk bond yields

(FinancialTimes)

Investing in housing stocks without listening to Ivy Zelman is like buying a carton of eggs without opening the lid...

So, if you are long any aggressive builders or home buyers, you had better get comfortable with your demographic projections.

“The perception that housing is drastically undersupplied and that a strong demographic picture lies ahead is creating a false sense of security,’’ according to a report by Zelman’s firm entitled “Cradle to Grave.’’ “By our math, both single-family and multi-family production are already ahead of normalized demand and estimates of a housing deficit are grossly exaggerated.’’...

“No, we don’t have a deficit,” Zelman, who founded Zelman & Associates, said in an interview with The Real Deal. “We have a pipeline of activity that actually would put us in an overbuilt situation relative to normalized demand.”

Granted, 2021’s housing landscape differs in some significant ways from 15 years ago. Mortgage underwriting is solid, making it unlikely that a mortgage-backed securities implosion is coming. Yet the oversupply of homes, combined with an aging population and rising mortgage rates, could cause prices to drop in certain markets, leaving home builders stuck with unsold inventory...

Her firm’s report makes the case that U.S. population and household growth will ultimately determine housing demand.

“Population growth — the crucial underpinning of future housing demand — is on a troubled trajectory,” the report said.

The U.S. population has grown just 7.4 percent growth in the past decade, the second-slowest rate on record, the report says. Household growth in the country was the slowest in history at 8.7 percent. Birth rates are declining. And Zelman estimated that more 20- to 39-year-olds lived with their parents or grandparents in 2020 than in 2010.

She brings up the example of Japan, where the population declined significantly and housing production dropped by as much as 70 percent. A similar scenario could play out in the U.S. if the population keeps dwindling.

As of August, single-family starts in the U.S. totaled about 1.15 million from the prior year. Zelman projects that actual or “normalized” demand for these homes is 21 percent below that.

(TheRealDeal)

One more time, European equities continue to look more attractive than American equities...

Seems like every time that we take a glance at the relative valuations, Europe looks like the better bet. Maybe now the increased weighting toward cyclicals and rise of private equity appetites will help them to outperform in 2022.

Global investors have been reluctant to invest in Europe when the US stock market offered higher and safer growth and when EM offered cheaper cyclicality (and in some pockets high growth too). But this narrative has shifted. Europe offers better growth now than it did previously; we find that a high proportion of European companies fit into categories that should do well next cycle.

In addition, the response of European policymakers, both monetary and fiscal, has been stronger in this crisis than in the GFC or the sovereign crisis. The capital positions of European banks have improved, and they have not needed to raise capital. Finally, the attractiveness of other regions has arguably diminished: the regulatory tightening in China means the risks to equity investors there have increased, and in the US there are several emerging risks, including high levels of stock concentration, regulation and taxation.

European stocks also benefit from private equity bids, which are rising sharply, and M&A is strong. Both are a reflection, in our view, of the three attributes: (i) low rates, (ii) good economic growth, and (iii) low valuations versus other asset classes. All three of these are likely to remain in place in 2022.

Bids from private equity on the rise

European valuations remain well below the US

European FCF yields are high versus other DMs

(Goldman Sachs)

2021 is set to be the busiest M&A market ever…

Key points:

  • Through the first three quarters of the year, ~45.5k deals completed for $4.4 trillion of value.
  • Globally, 2021 is the strongest opening nine months of M&A since records began.
  • In the U.S. alone, target M&A has surged 139 percent to $2 trillion.
  • Private equity deals have more than doubled to hit record $839.6 billion, and the number of deals was up by 65 percent.

Worldwide Announced M&A

Private markets cash flows have a similar trend, but the flows can now be measured with a $T...

All Private Market Cashflows

The strongest, private market unicorns have a growing list of hedge funds wanting to invest both before and after IPO...

This is causing the IPO valuations to occur at multiples near 2.5x the value of the private company. Private market owners are enjoying this supply/demand imbalance.

A recent report from Goldman Sachs found that hedge funds invested an incremental $153 billion into private companies in the first half of this year, compared with $96 billion in all of 2020.8

This record level of dry powder combined with the knock on effect of the strong IPO market are clearly having a pronounced impact on the valuations of these high growth private companies, particularly the larger, highest profile names. Yet, while private valuations seem to be soaring to unprecedented levels, the spread between public and private valuations has remained remarkably wide – again, 2.63 times on average in the first quarter (See Exhibit 4).

One factor likely contributing to this public-private spread seems to be a basic supply-demand imbalance. As of September 30, the aggregate value of unicorns reached an estimated $2.8 trillion, but public exposure to this market remains relatively limited. Despite the impressive increase in the number of public offerings this year – 76 tech IPOs through July 31, compared with 44 in all of 202010 – the number of unicorns going public is still only a small fraction of the total. Of the 896 companies that have achieved unicorn status globally in the last five years, 761, or 85%, remained private as of the end of the third quarter.

The spread between private and public valuations remains large

(iCapitalNetwork)

One investor's piece of trash becomes another's treasure...

While the public markets remain pricey for most companies, there are always opportunities in the private markets for those public companies which hit patches of black ice and lose many of their initial shareholders. Usually, it is a function of investor time horizon that causes this disconnect. Public market investors and managers need year-over-year performance. But private market investors often have multi-year timeframes.

@HammerstoneMar3:
$CSPR - Casper Sleep Inc. to be acquired by Durational Capital Mgt
- $6.90 per share purchase price delivers substantial 94% premium
- Casper will operate as a privately-held company & will remain based in NY
$CSPR - shrs are -44% over past 52-weeks, IPO's in Feb. 2020 at $12

Casper Sleep Inc

There was a very notable acquisition last week in my industry that I must point out...

This deal is another example of evolution within the private market secondary world. Consolidation in the secondaries market is happening as ownership/leadership transitions are necessary and the secondary groups recognize that being part of a larger asset management platform is key to being competitive in the future. Large asset managers have come to recognize the attractiveness of the secondary business and want to get involved – whether that be through a buy or build strategy. These are all signs of a positive nod toward the secondary market overall and reinforces that the secondary market has become a mainstream, stable industry with real value.

Asset manager Franklin Templeton is buying private equity investment specialist Lexington Partners for $1.75bn, in the latest example of a mainstream manager expanding its alternative assets business.

The acquisition will build Franklin’s presence in private equity secondary funds and co-investments, which are designed to offer liquidity to investors in private equity deals with long lockups. It follows a string of recent acquisitions to build its scale in alternatives by the New York-based group, best known for its stock and bond mutual fund products.

These have included the purchase of private credit manager Benefit Street Partners, real estate investor Clarion Partners and hedge fund K2 Advisors. “The acquisition will further diversify our alternative asset management business to include alternative equity, the largest segment of the market,” said Franklin chief executive Jenny Johnson in a statement on Monday.

The addition of Lexington Partners, with $34bn in fee-paying assets under management, will bring Franklin’s assets in alternatives close to $200bn, or about 13 per cent of its overall $1.5tn in assets under management.

The deal comes just days after mutual fund firm T Rowe Price agreed the $4.2bn acquisition of credit manager Oak Hill Advisors, its largest-ever deal. Incoming T Rowe Price chief executive Rob Sharps has highlighted alternatives as a strategic focus as he takes the reins of the firm in January.

Both deals illustrate how mainstream asset managers are pushing into the $7.4tn private capital industry, which is expected to nearly double by 2025, according to analysts at Morgan Stanley.

(FinancialTimes)

Also in the private markets industry, our evergreen platform celebrated yet another milestone, reaching nearly $1.6 billion in just over two years...

As strong historical performance and demand for new sources of return drive investor interest in accessing the private markets, Hamilton Lane’s global evergreen platform has experienced significant growth, standing at $1.6 billion in assets a little over two years after launching its first offering in this space.

(Hamilton Lane)

Finally, if you are looking for a great not-too-historical drama to consume, Dopesick is very well done...

Exploring the epicenter of America's struggle with opioid addiction, from the boardrooms of Purdue Pharma, to a distressed Virginia mining community and to the hallways of the DEA.

First episode date: October 13, 2021

Based on: "Dopesick: Dealers, Doctors and the Drug Company that Addicted America;" by Beth Macy

Executive producers: Danny Strong; John Goldwyn; Warren Littlefield; Karen Rosenfelt; Barry Levinson; Beth Macy; Michael Keaton

(Hulu)

Dopesick television promo


Want to read more about inflation? Read Drew Schardt’s latest piece >


Explore Hamilton Lane:


(8) Source: Goldman Sachs, “Hedge Funds and the Convergence of Private and Public Equity Investments,” September 2021.

(10) Source: Jay Ritter, University of Florida. For illustrative purposes only.

Disclosure

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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