Private Wealth

Weekly Research Briefing: Not a time to stick your neck out

May 10, 2022
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With massive volatility continuing across all financial market assets and significant selling volumes outpacing significant buying ones, now is a time for equity investors to play defense. Financial excesses are being wrung out of the markets and last year's diamond hands are being vaporized. Even defensive investors can quickly lose a pinkie finger as Monday's market action showed, with energy and REIT stocks leading the declines. While it is always a possibility that investors will sell all of their liquid stocks, bonds, ETFs, ETNs, and digital assets, it is unlikely. More likely is that investors will retreat into the assets that bring them comfort and security in the form of free cash flow and income, while reducing exposures to those assets that don't. The saying "Friends don't let friends own unprofitable growth stocks" still rings true. This will continue to be the case until 1) the market sees the runway for the Fed's soft landing, 2) China curtails its zero-COVID lockdowns, 3) the war in Ukraine ends, and/or 4) an unknown positive mystery gift (a significantly better battery storage technology, a space elevator, a cure for cancer or another favorite of your choosing).

Last week's up and down equity rollercoaster surrounding the FOMC event again confirmed that the market is rapidly reevaluating its thoughts and readjusting its investment portfolios. A 70%+ upside volume day on Wednesday followed by an 80%+ downside day on Thursday and then two 90%+ downside days on Friday and Monday is proof that this equity market does not know what to do and would rather have higher cash holdings than more equity exposure. Investors are equally torn about whether the Fed has inflation under control or is driving the U.S. economy right into an inflation-fueled recession. As uncertainty increases, the markets get volatile.

Jerry and the Fed last week took the Fed Funds rate up 50 basis points and strongly suggested that the next two moves would also be in the 50bp range. While only time will tell if these actions will be enough, we do know that the financial markets are moving quickly on their own to take some hot air out of the economy. As interest rates rise and hurdle rates for investors move higher, unprofitable companies are being forced to cut costs and slow or even pause hiring. We are now seeing this as wage growth slows and client companies reduce revenue expectations. Meanwhile, the impacts of a locked-down China and war impacted Europe are continuing to weigh on industrial commodity prices. Could oil prices be the next to fall, even with the supply chain impacts from Russia? Energy prices falling 6% on Monday was not a positive item for the outlook for global GDP, so this will be something to keep a close eye on. And don't forget earnings. While the Q1 reporting season had been better than many of us expected, last week was a bit of a disappointment as there were a few more clunkers among the next tier names. Hopefully not the start of a new trend but also something to watch closely. So tough to own stocks in this environment when your reward for a company that beats is +0-5% versus the punishment of a miss falling 5-30% depending on its risk profile. Be careful out there.


Hamilton Lane is a leading private markets investment management firm providing innovative solutions to individual and institutional investors around the world.

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Let's start off with some important and valuable quotes this week...

“Assuming that economic and financial conditions evolve in line with expectations, there is a broad sense on the Committee that additional 50 basis point increases should be on the table at the next couple of meetings.” – U.S. Federal Reserve Chair Jerome Powell

“The age of yield curve intervention has ended. Since 2008, the Fed has basically controlled not only the short end of the yield curve but also the entire maturity spectrum in the fixed income markets….unfortunately, the Fed kept the proverbial punchbowl out for so long that there are no easy solutions to the inflation problem that the Fed is currently trying to fix. The market now is in the beginning stages of a big adjustment as investors, and not the Fed, determine term interest rates…As a result of the high inflation and the Fed no longer controlling the yield curve, the Fed put, which basically guaranteed that the stock market would not decline by unacceptable amounts, is now gone.” – Loews (L) CEO Jim Tisch

“Clearly you don’t want to own bonds and stocks. You start with that. It’s going to be very, very, a very negative situation for either one of those asset classes. Right? You can’t think of a worse macro environment than where we are right now for financial assets. And, again, one of the reasons I think maybe the biggest differentiator between now and those other periods over the past 40 years is to look at the level of overvaluation that we were both in rates as well as in stocks. So that’s one reason why even with this tightening in financial conditions, we’ve still, the Fed still probably has to raise rates to get inflation under control.” – Tudor Investment Corporation Co-Founder Paul Tudor Jones

“Most people dramatically underestimate the remarkableness of this bull run. Such things are unstoppable … until they aren’t. Markets teach. The lessons can be painful” – Amazon (AMZN) Former CEO Jeff Bezos

“Even after dramatic declines, it is difficult to call a bottom in the high-growth, high-valuation end of the tech sector, especially given that many of these companies relied on stock-based compensation and controversial accounting and reporting techniques. It appears that many of the companies which used this type of compensation to attract employees may have retention difficulties, leading to increased dilution for future stock grants or increased cash wages, which could weigh on margins for analysts who rely on adjusted measures rather than old-fashioned GAAP” – ThirdPoint CEO Daniel S. Loeb

The Transcript


Now for some good news: For the first time in this cycle, Goldman Sachs is reducing its year end 2022 core PCE forecast...

On the inflation front, average hourly earnings growth came in slightly weaker-than-expected in Friday's Payrolls report at 0.3%. And the 3-month annualized growth rate has now declined to just under 4% from 6% in 2H21. Consequently, we are now more confident that both headline and core inflation have peaked in year-on-year terms and, in fact, our latest PCE forecast revision was actually lower for the first time in a long time. (Goldman Sachs)

US job vacancies rate

Goldman Sachs


A now contracting global economy should also help dampen future price inflation...

Of course, let's all hope that it doesn't contract too much to cause a credit or banking crisis.

Market pricing for the number of 25 bps Fed rate hikes

The Daily Shot


The largest exporting nation in the world and the second largest global economy is going to have to give up on its zero-COVID policy...

Market pricing for the number of 25 bps Fed rate hikes

The Daily Shot


Slowing global GDP is directly related to the collapsing prices for these leading industrial metal commodities...

Market pricing for the number of 25 bps Fed rate hikes

The Daily Shot


Used auto prices in the U.S. are now in reverse...

And with the peak in prices now in the rear-view mirror, it is likely that prices will continue to slowdown as auto dealers send any excess inventory back to the auction houses because now product sitting on the lot no longer appreciates in value. Remember that auto prices were a significant contributor to last year's CPI jump.

Wide distribution of outcomes after historical yield curve inversions

@GuyDealership


Increasing evidence from builders and real estate agents that the purchase market is slowing down...

But this was inevitable given the 60-70% increase in the monthly cost of a mortgage versus 2-4 years ago.

Wide distribution of outcomes after historical yield curve inversions

@TheIdeaFarm


Wage earnings gains are beginning to slow, which could also help future inflation readings...

@carlquintanilla: “We expect inflation to peak this summer between 6%-7% and to recede to 3%-4% next year with no recession. … We may have spotted the first signs of peaking inflation already, in lower three-month than y/y rises of several price and wage measures.” - @yardeni

Wide distribution of outcomes after historical yield curve inversions

Companies also finding evidence of a slight slackening in their labor markets...

"On the labor front, there are still significant issues that we're seeing, both in what we manage and as we talk to our franchise community, what they're seeing. Over the last 6 months, we've seen a very significant increase in labor coming back into the labor force and our ability to get folks in the hotels, which obviously are needed, given the demand profile and the increases in demand across all segments, as I already described. So we're not all the way anywhere near where we want to be, but the issues are not -- they're not as extreme as they had been at other points in the pandemic, including recently." - Hilton Worldwide (HLT) CEO Christopher Nassetta

"...we believe that we're at peak or have passed the peak of wage inflation in the U.S. It's still high, but when we look at some of our most recent trends, we can see some easing off in the growth rates, which we believe is positive overall -- as it relates to the U.S. specifically, we are starting to see a little bit of an easing and we believe that we've seen the peak of wage increases." - ManpowerGroup (MAN) CEO Jonas Prising

The Transcript


And don't forget that the strengthening U.S. Dollar will continue to make U.S. manufacturing and services a bit less competitive...

Wide distribution of outcomes after historical yield curve inversions

The Daily Shot


438 companies in the S&P 500 index have now reported 1Q 2022 results...

But for the first time this earnings season, the forward estimates took a big hit. Not a good sign for stock prices.

Cumulative personal savings in the pandemic

@EarningsScout


Several technology companies led among earnings downgrades last week which helps to explain the further breakdown in the Nasdaq index...

The Nasdaq Composite has now solidly broken through its 2022 lows. Without the helpful catalysts of 1) a Fed soft landing, 2) a re-accelerating China, 3) an end to the war in Ukraine, and/or 4) something positive out of the mystery bag, then it is it looks like this index wants to test the four figure handle.

Cumulative personal savings in the pandemic

@hmeisler


Friday's Large Cap All-Time Lows list amounted to 29 companies from mostly the technology and internet groups...

Plenty of great growth companies in this list. But this current market doesn't matter if your top line is growing 30%, 40% or 50%+ right now. It is focused on the bottom line and the free cash flow that it is generating. Investors are preparing for tougher times ahead as financial conditions worsen and the tide goes out.

Wide distribution of outcomes after historical yield curve inversions

@361Capital


Friends don't let friends own unprofitable tech stocks in this environment...

@LizAnnSonders: Non-profitable tech basket (tracked by ⁦@GoldmanSachs⁩) is suffering its worst drawdown ever; now off peak by 68%

Wide distribution of outcomes after historical yield curve inversions

Any growth stock CEO will hear the same story from its active equity investor base these days...

Uber is now trading at two-thirds of its 2021 high price. The CEO visited investors after earnings last week. They told him what the most important thing in the world is right now: Free cash flow.

After earnings, I spent several days meeting investors in New York and Boston. It’s clear that the market is experiencing a seismic shift and we need to react accordingly. My meetings were super clarifying and I wanted to share some thoughts with all of you. As you read them, please bear in mind that while investors don’t run the company, they do own the company—and they’ve entrusted us with running it well. We get to set the strategy and make the decisions, but we need to do so in a way that ultimately serves our shareholders and their long term interests.

1. In times of uncertainty, investors look for safety. They recognize that we are the scaled leader in our categories, but they don’t know how much that’s worth. Channeling Jerry Maguire, we need to show them the money. We have made a ton of progress in terms of profitability, setting a target for $5 billion in Adjusted EBITDA in 2024, but the goalposts have changed. Now it’s about free cash flow. We can (and should) get there fast. There will be companies that put their heads in the sand and are slow to pivot. The tough truth is that many of them will not survive. The average employee at Uber is barely over 30, which means you’ve spent your career in a long and unprecedented bull run. This next period will be different, and it will require a different approach. Rest assured, we are not going to put our heads in the sand. We will meet the moment.

CNBC


Was it fun while it lasted?

Goodbye meme stocks. Goodbye NFTs. Goodbye to many crypto coins.

It’s ending as fast as it began for retail day traders, whose crowd-sourced daring was the pre-eminent story of pandemic equities.

Nursing losses in 2022 that are worse than the rest of the market’s, amateur investors who jumped in when the lockdown began have now given back all of their once-prodigious gains, according to an estimate by Morgan Stanley. The calculation is based on trades placed by new entrants since the start of 2020 and uses exchange and public price-feed data to tally overall profits and losses.

A craze born of the coronavirus outbreak and nurtured by Federal Reserve largesse is being laid low by a villain of identical lineage, inflation, which global central banks are racing to combat by raising the same interest rates they cut. The result has been a lumbering bear market in speculative companies that surged when the stimulus started flowing in March 2020.

Best Year for Commodities

Bloomberg


In other words, during times of financial market stress, crypto currencies are not a diversifying asset...

Best Year for Commodities

Bloomberg


CEOs of unprofitable growth stocks are dying to get to free cash flow positive right now...

The energy sector does not have this problem and their investors are being rewarded. The hurdle rate for a new dollar of capex is significantly higher today than it was years ago. Past poor investments and lack of discipline colliding with higher ESG scrutiny today will help to keep oil companies’ wallets deep in their pockets. So as long as a bigger, better storage battery does not come along soon to threaten oil and natural gas, the energy sector free cash flow supertanker should continue forward.

Big Oil is raking in historic amounts of cash, but the windfall isn’t being invested in new production to help displace Russian oil and gas. Instead, executives are rewarding shareholders -- setting the world up for an even tighter energy market in the years ahead.

The West’s five biggest oil companies together earned $36.6 billion over and above their spending in the first quarter, or about $400 million in spare cash a day. It was the second-highest quarterly free cash flow on record and enough to relegate billions of dollars of Russia-related writedowns to mere footnotes in their recent earnings reports...

“In prior cycles of high oil prices, the majors would be investing heavily in long-cycle deepwater projects that wouldn’t see production for many years,” said Noah Barrett, lead energy analyst at Janus Henderson, which manages $361 billion. “Those type of projects are just off the table right now.”

The last time crude was consistently over $100 a barrel in 2013, Big Oil’s combined capital expenditure was $158.7 billion, almost double what the companies are currently spending, according to data compiled by Bloomberg. The group includes Shell Plc, TotalEnergies SE, BP Plc, Exxon Mobil Corp. and Chevron Corp.

After the Flood

Bloomberg


Or as Dan Loeb just penned in his recent Third Point shareholder letter...

Beginning with our large investment last fall in Shell plc, we have found interesting opportunities in energy and other cyclical stocks. We initiated positions in oil and natural gas companies in Q1, as well as in other materials companies that we believe will benefit from inflation, supply shortages, and the adoption of EVs and other renewable sources of energy. US oil and gas companies are particularly interesting; as a result of ill-conceived energy policies enacted by governments in most developed countries (including the US), both commodities will be in short supply relative to demand. The negative effects of these bungled policies were compounded by well-intentioned but disastrous ESG initiatives that together resulted in a dearth of new investments in the sector. These companies will largely return their cashflow to shareholders via debt paydowns, share repurchases, and cash dividends. In most cases, the companies we have invested in will return in excess of 20% of their market capitalizations annually for several years should strip prices remain close to current levels.

Third Point Q1 2022


Want to see a long/short equity manager laugh and giggle like a 5-year-old at a puppet show?

S&P 500

@the_chart_life


There will be some good pieces of private debt being created during these frozen credit markets...

Mumbai Airport Gets $750 Million in Apollo Private Placement
By Bijou George, Bloomberg
4 May 2022


Mumbai International Airport Ltd. has raised $750 million from a private bond sale to Apollo Global Management Inc. after delaying a planned note issue.

The operator of India’s No. 2 airport, controlled by the country’s richest man, sold 7.25-year dollar notes to funds managed by Apollo in order to refinance existing debt and fund new capital expenditure, according to a stock exchange notice. The statement did not lay out the terms of the deal.

A major bond market rout globally has prompted several Asian companies to revise their dent sale plans. Kalyan Jewellers India Ltd. announced last month it had halted a dollar bond sale last month, and India’s local currency debt market has also seen a string of shelved deals over recent months.

Bloomberg


Forget about the 'Fed put'. Welcome to the 'private equity put'...

Expect an acceleration in public to private companies as stock prices stumble in 2022. Here is Elliot Management educating Western Digital on how to double its valuation by cutting the firm in two pieces.

On Tuesday, Elliott Management disclosed a $1bn — or roughly six per cent — stake in Western Digital, the maker of hard drives and flash memory devices. Elliott urged Western to break up those two halves of its business which came together from Western’s $19bn acquisition of SanDisk in 2016.

Most intriguingly, Elliott said it would be willing to put another $1bn into the separated flash unit while also signalling other private capital investors were likely to be interested in some other transaction involving that business.

The move comes as specialist firms such as Elliott, Thoma Bravo, Vista and Clearlake have collectively raised tens of billions in buyout funds. High-profile companies such as Anaplan and Citrix have announced go-private transactions this year valued in excess of $10bn each. Hedge funds are attuned to all the private equity dry powder (cash) waiting to be deployed, so expect more activists to push tech laggards into selling themselves.

Financial Times


Or even the 'public equity put'..

As we discussed last week, it doesn't matter if the buyer is private or public, there will be plenty of stocks disappearing from the market in 2022 if prices continue to move lower.

Intercontinental Exchange Inc. has agreed to buy Black Knight Inc. in a deal valuing the mortgage software provider at about $13.1 billion, as the owner of the New York Stock Exchanges makes a huge bet on the future of the U.S. housing market.

ICE has agreed to pay $85 per share in cash and stock for the Jacksonville, Florida-based company, according to a statement Wednesday. Bloomberg News reported on the potential takeover earlier.

ICE and other exchange operators have been branching into data and other areas of fintech in recent years as growth stalled in the traditional exchange business. Black Knight would complement Ellie Mae Inc., the mortgage-software provider that ICE agreed to buy for $11 billion in 2020...

Black Knight had been exploring a sale after receiving takeover interest from private equity firms, Bloomberg News reported last month. Based in Jacksonville, Florida, the company provides software, data and analytics to the mortgage and home equity lending and servicing and real estate industries. The deal is expected to close in the first half of 2023.

Bloomberg


Fewer public companies means fewer choices for investors, unless they are given more access to invest in private companies...

“When retail investors participate in our markets, how broad a spectrum of investments do they have? I think that spectrum has been getting relatively smaller. Because we have fewer public companies, companies are waiting much longer in their life cycle to go public, which by definition means that retail investors have less access to the market as a whole. And I fear, less access to companies that are well-established, but still growing.”

(Former SEC Chairman Jay Clayton)


In the future, the evergreen fund structure could rise to prominence and challenge the existing LP partnership structure for the private markets....

Evergreen is a compelling solution for all participants:

  • GPs no longer have to sell great companies at the end of a fund's lifespan
  • Investors are fully invested on day 1 and no longer have to deal with future capital call timing
  • Investors have the option for periodic liquidity based on their timing
  • Investors receive 1099s instead of K-1s
  • Evergreen funds tend to be more diversified across a greater number of investments than the typical LP structure, thus reducing concentration risk

While evergreen funds are great vehicles for individual investors to get exposure to private assets, they will also appeal to the institutional investor space. Think of the advantages for a pension fund that becomes overweight in private equity to be able to tap a quarterly liquidity faucet to reduce its overweight exposures versus having to take a part of its portfolio to sell into a secondary market.

Often referred to as evergreen funds because of their perpetual fund life, investors have the ability to enter and exit these vehicles throughout their existence. With some evergreen funds, the investor’s capital is immediately deployed into an already existent pipeline of investments. This is quite different from traditional private investment structures, where the investor commits capital for a multi-year period and the fund’s general partner calls that capital at various times to make investments once targets have been identified.

Thoughtfully constructing a diversified and fully invested portfolio is crucial to the success of these vehicles. For individual investors, certain evergreen fund structures may present potential advantages. Those that are able to deploy capital more can eliminate cash drag. Early deployment also allows for exposure to the private markets sooner, a critical detail for individual investors who have never had exposure, and do not have longer-term investment horizons the way a pension fund or endowment might.

US IPO Proceeds and Activity

Hamilton Lane


Imagine a New York City where bikes and e-bikes dominated above ground transportation...

According to Lyft’s 2022 Multimodal Report, Citi Bike’s 5,000-strong electric fleet made up 32% of the nearly 28 million rides taken in 2021, even though they only make up 20% of the fleet. On average, they’re used three times more often per day compared to classics.

The surge of Citi Bike’s battery-powered rides mirrors a larger trend unfolding on the streets of New York City. Practically everywhere you look, people are riding electric two-wheelers — delivery workers bearing take-out orders, sightseers on Citi Bikes, families on e-cargo bikes, or just individuals on their own models. Three electric bike dealerships have opened within a few blocks from my apartment recently. There is little data on e-bike usage itself, but the nearly 7 million rides on Citi Bike last year, compared to 2.7 million in 2020, is probably a good indication of how electrification has boosted the overall popularity of bicycles in the city.

It’s been a remarkable transformation for a city where all e-bikes were technically illegal until 2018. E-bikes, whether you ride them or not, stand to play an outsized role in shaping the city’s transportation picture for years to come. They could help tame the city’s resurgent traffic and reduce the sector’s stubbornly large carbon footprint by replacing shorter trips now taken in private cars, cabs or ride-hailing vehicles. And their rapid uptake could place greater pressure on planners to adjust city streets accordingly. But thorny issues around costs, infrastructure, equity and safety persist.

US IPO Proceeds and Activity

Bloomberg


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DISCLOSURES

The author has current equity ownership in: Shell PLC, BP PLC, Chevron Corp.

The information presented here is for informational purposes only, and this document is not to be construed as an offer to sell, or the solicitation of an offer to buy, securities. Some investments are not suitable for all investors, and there can be no assurance that any investment strategy will be successful. The hyperlinks included in this message provide direct access to other Internet resources, including Web sites. While we believe this information to be from reliable sources, Hamilton Lane is not responsible for the accuracy or content of information contained in these sites. Although we make every effort to ensure these links are accurate, up to date and relevant, we cannot take responsibility for pages maintained by external providers. The views expressed by these external providers on their own Web pages or on external sites they link to are not necessarily those of Hamilton Lane.

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