Weekly Research Briefing: And it begins...

October 12, 2021

The snowflakes will begin to drop this week here in Colorado along with the start to the Q3 earnings season. While the first snow is always a welcome sight, the same cannot be said for this reporting season. Six months ago, we would have thought the third quarter would have been another smoking year-over-year gain as the economy powered upward helped by the COVID recovery. But, we didn't anticipate that third/fourth big wave of cases. Nor did we foresee the much larger supply chain bottlenecks in manufacturing and shipping. There also seems to be an ongoing labor shortage in the U.S. for low paying jobs that few want. And now we have fuel prices rising because of inadequate supplies and means of transportation. The five percent pullback in the market is also telling you that it is concerned. So, grab your most comfortable blanket for the cold and be prepared to pull it over your eyes, because you know that there will be some epic earnings misses and guidance this month. Hopefully, the stock reactions in your portfolio will be more like Sherwin-Williams, and less like FedEx.

The Fed's taper is still on deck for November or December...

Last Friday brought a good jobs report, but the headline numbers were messy and didn't tell the whole story. Education stole about 300,000 jobs from the non-farm payroll data as many delayed a return to the fall semester. Also, there was a +169,000 job revision to the previous two months. The household survey showed over 500,000 jobs created which helped to push the unemployment rate down to 4.8%. And average hourly earnings (+4.6% ann.) plus hours worked jumped meaningfully. Now if we could only find more people wanting to work.

U-3 Unemployment Rate

@LizAnnSonders: Average hourly earnings move up +4.6% y/y (in line with expectations) vs. +4% in prior month (rev down from +4.3%)

Average hourly earnings

The Fed's taper will begin this year and the rate hikes will begin in 2022...

Or so the fixed income markets are betting.

Implied Fed Funds rate

As we continue to look forward for the markets, get ready for a fun and exciting December...

The month of December, normally a relatively quiet and sleepy time in markets, promises to be anything but this year with gov’t funding set to expire on 12/4, the debt ceiling coming back into effect on the same day (although the ceiling probably won’t actually become binding until a bit later), possible action on a reconciliation bill (likely in Nov or Dec), the Biden-Xi virtual summit (before the end of the year), and the commencement of Fed tapering (also likely in Nov or Dec).
(Vital Knowledge)

For the short-term, let the earnings games begin...

As always, we will start off with a heavy dose of banking and financial stocks. All eyes will be turned toward their comments about credit quality. We don't think anyone has direct Chinese real estate exposure, but some could have indirect exposures near their loan books. Delta Airlines, Domino’s Pizza and Alcoa will also provide valuable insight into the COVID, hourly labor, food costs and materials demand parts of our mosaic.

Most Anticipated Earnings Releases


The markets are approaching this earnings season on high alert…

Analysts expect that earnings from companies in the S&P 500 grew 28% in the third quarter from a year earlier—a time when businesses were working to recover from the effects of the pandemic.

But as countries emerge from the restrictions of the pandemic, bottlenecks in global supply chains are leading to shortages of the components needed to produce finished goods. A jump in costs for raw materials is also pressuring manufacturers’ bottom lines.

Wall Street is betting that company profitability has edged lower, in part as a result of the unevenness of the pandemic recovery: The net profit margin for the S&P 500 is forecast to come in at 12.1% for the third quarter, down from a record of 13.1% in the previous quarter, according to FactSet.

Even so, Morgan Stanley strategists say they don’t believe supply-chain problems have been fully factored into the market’s expectations for corporate earnings—and if they are right, there could be room for some unpleasant surprises in coming weeks.


Last week, both Pepsi and Lamb Weston still foresaw rising costs for their businesses...

"I expect we’ll probably see a little bit more pricing increases in the first quarter of next year as we deal with the fact that input costs are just higher…That’s just the reality for us and everybody else.” - PepsiCo (PEP) CFO Hugh Johnston

“Highly inflationary input and transportation costs, labor availability, and upstream and downstream supply chain disruptions, will result in higher costs as the year progresses, and significantly pressure our earnings. Accordingly, we expect our gross profit margins to remain below pre-pandemic levels through fiscal 2022.” (Tom Werner, President and CEO of Lamb Weston)

But maybe the double and triple ordering of shipping containers has ended as prices seem to be breaking...

The cost of shipping goods from China to the US has finally slumped. The chart below shows the spot rate (that is, the rate it costs to take a shipment half-way round the world ASAP) for taking a 40ft container from China to the US West Coast halved between September and October...

It is, industry bods note, largely the result of Covid-19 outbreaks and power shortages in China. So will prices remain this low?

Shabsie Levy, founder and CEO of Shifl, thinks so, arguing that agents who took advantage of price increases and congestion by buying up capacity are now (perhaps sensing the market has peaked) looking to unload it fast.

“For shippers [somewhat confusingly, a term that refers to exporters and not the shipping lines] with inventory still in China, access to capacity at rates is great news,” Levy says. “But the big question now is whether or not there will be products to fill these containers.”

Levy adds: “These rates could go even lower. We’re already seeing long-term rates for shipping 40-foot containers from China to the U.S. go below $5,000.”

Prices to ship


Chinese property worries remain top of mind as Evergrande continues to not make its interest payments...

China Evergrande Group

More property companies are being dragged in as others find themselves in near-term cash crunches...

Chinese property developer Modern Land (China) Co. 1107 -2.11% asked investors for permission to defer repaying a $250 million bond due later this month, in the latest sign of the financial stress that has gripped China Evergrande Group and many of its rivals...

Restrictions on credit to the sector have helped trigger a crisis at Evergrande and put pressure more broadly on developers’ stocks and bonds. A default last week by Fantasia Holdings Group Co. on $206 million of dollar bonds caused the bond-market selloff to intensify.

Shares of Modern Land have fallen more than 40% this year. Its dollar bonds due March 2024 crashed to 25 cents on the dollar as of last Friday, according to Tradeweb, down from 72 cents at the end of September.

Price of a Modern Land bond


The property worries continue to infect the rest of the risky Chinese credit markets sending yields to new extremes...

Bloomberg China USD HY Bond Index

And the weight of the broken high-yield markets is now affecting government bond yields...

China 10yr Government Bond Yield

The U.S. and European credit markets seem little affected by the problems in China...

Historical Loan and Bond Yields

But, the 10-year yield is breaking higher as inflationary worries build...

CBOE 10-Year US Treasury Yield Index


Of course, rising interest rates and a steeper yield curve tend to be better news for bank stocks which are now breaking out...

KBW Bank Index


Banks are having a strong 2021, which is a good sign for the credit markets...

The KBW Bank Index has surged almost 40% in 2021, more than doubling the broader S&P 500 Index’s 17% gain, as investors keep buying lenders amid growing expectations that a U.S. economic recovery will spur the Federal Reserve to scale back is massive asset purchase program and eventually begin raising interest rates.

Strong Gains


The other U.S. stock sector breaking to new highs as the market pulls back is energy...

Energy Select Sector


And U.S. crude oil is now trading above $80/bbl for the first time since 2014...

For those who bought last year when oil had a -40 handle, you have been bestowed the 'Legendary Trader' award.


Important to note which major industries are raising and lowering their capital expenditures...

The significant outlook for free cash flow among energy companies is also having a positive impact on their valuations.

The urge to splurge


J.P. Morgan makes the case for oil now following coal prices higher...

“We believe that the evolution of coal prices might reflect supply, demand, cost of capital and energy transitioning issues for all fossil fuels, and it would certainly be possible that oil prices will follow the same pattern (inflation adjusted for oil, that would be in a $150-200/bbl range). So the risk is that coal is a proverbial “canary in a coal mine” for the much more important commodity oil (figure below). Laws of physics (law of conservation of energy) would indicate that various forms of energy are interchangeable, as we are seeing currently with some oil for gas substitution, or firing up of coal plants above certain thresholds of electricity prices, private power generation, etc. The linkage between various sources of energy has been true in financial markets as well, and historically energy assets have been correlated (averaging about 20-30% correlation of price returns). For this reason, investors should consider hedging for higher oil prices, which can be expressed in asset class (long commodities, short bonds), sector (long energy), style (long value, short growth) or thematic form. The most likely outcome of the current energy crisis is increased production at significantly higher energy prices, which would stabilize the global economy and energy infrastructure, but also temporarily slow down the energy transition.”


Is coal a canary in a coal mine for higher oil prices


Can you say natural gas shortage?

U.S. Propane Inventory Trends Potential For Supply Squeeze

Most fertilizer is made from energy molecules. So, the rise in fuel costs will have an impact on future food prices...

The fertilizer market has been hit hard this year due to extreme weather, plant shutdowns, sanctions and rising energy costs in Europe and China, pushing prices past levels that traders and farmers hadn’t seen since the global financial crisis.

The energy squeeze in Europe and Asia has created a critical situation for the fertilizer industry, according to the biggest manufacturer in Hungary. Companies such as CF Industries Holdings Inc. and Yara International ASA have had to shut plants or reduce production as prices for natural gas, the main feedstock for most nitrogen fertilizer, have surged. In India, the government has directed producers to refrain from raising prices...

The price spike of the crop nutrients deemed vital for producing enough food to supply a growing global population is stoking concerns of more inflation when many people still struggle to feed their families due to job losses and other lingering economic impacts from the pandemic. Expensive fertilizer could push U.S. corn farmers’ cost of production 16% higher, according to Bloomberg’s Green Markets.

Fertilizer Frenzy


If you are looking to play the stagflation card, here is your stock selection crib sheet...

Sector and factor returns in stagflationary environments

(Goldman Sachs)

The global insurance industry continues to rotate away from liquid assets and into private assets...

KKR does an annual survey with the CIOs of the global insurance industry. This year they got feedback from 20% of the global capital base which oversees $6.7 trillion in assets. Insurance companies are a fairly conservative bunch of investors given their ability to directly match investment assets directly to their insured liabilities. So you will always see lots of fixed income in their portfolios. For us as investors, this is great insight to see where the largest bond investors in the world are hunting for returns. The full report is an insightful read. Below shows a summary of the shifts in the portfolios over the past five years. As you can see, some big moves out of liquid equities and fixed income and into private assets.

Non-Traditional Investments Have Gained Market Share in Recent Years


Hamilton Lane got involved in something very cool last week. It is called Novata...

Think of Novata as the hub for ESG data and metrics – helping private markets firms and private companies more broadly to navigate the ESG landscape. Novata will provide users with relevant reporting metrics, a contributory database to store information, and tools for analysis and reporting to key stakeholders, including limited partners and regulators.

Major philanthropic foundations and private-equity firms have come together to form a centralized system for reporting on private companies’ environmental, social and governance performance.

The system, called Novata, aims to be a central database for gathering, reporting and benchmarking companies’ performance on factors such as carbon emissions, resource management, employee diversity and workplace safety.

The lead investors in Novata are the nonprofit Ford Foundation, philanthropic investment firm Omidyar Network, private-equity manager Hamilton Lane and financial-data company S&P Global Inc. Around eight private-equity firms advised on the project, including Bridgepoint, Clearlake Capital Group, Kohlberg & Co., the Vistria Group and KPS Capital Partners, while Clearlake, Kohlberg and Vistria also invested.

Launched Thursday, Novata aims to be a “hub” for private companies and private-markets investors to store, share and analyze ESG data, said Alex Friedman, Novata’s chief executive. The company is structured as a public-benefit corporation—a for-profit company that also aims to generate public good—and its system is open-architecture and free, Mr. Friedman said…


The best mystery read of the week...

Tether still hasn’t disclosed where it’s keeping its money. The only financial institution I could find that was willing to say it’s currently working with the company was Deltec Bank & Trust in the Bahamas. I met the bank’s chairman, Jean Chalopin, in Deltec’s office, on the top floor of a six-story building ringed with palm trees in a nice part of Nassau. In a past life, Chalopin co-created the cartoon Inspector Gadget, and a painting of the 1980s trenchcoat-wearing cyborg policeman hung on his office door. Magazine covers featuring Chalopin’s wife, a former model, and his daughter, a singer, were displayed on a shelf. Now 71, Chalopin has a mop of red hair and wears rimless round glasses. As we sat down, he pulled a book about financial fraud, Misplaced Trust, off the shelf. “People do funny things for money,” he said, cryptically.

He made himself a cup of tea and told me he’d come to the Bahamas in 1987 after selling his first animation studio, DIC Entertainment. The sale had made him rich—he bought a castle outside Paris and a pink colonial in the Bahamas, which later served as the villain’s home in the 2006 James Bond film Casino Royale. He banked at Deltec, then befriended its aging founder.

The bank, which once conducted investment banking throughout Latin America, had dwindled to just a few billion dollars of assets. Chalopin invested, eventually becoming the biggest shareholder. Bahamian banks are often depicted in movies as a haven for money launderers, but Chalopin said Deltec’s edge was customer service, not secrecy...

Chalopin said he investigated Tether for months before taking the company on as a client in November 2018. He signed a letter vouching for its assets. He was surprised that critics still insisted Tether’s currency was not backed by cash. “Frankly, the biggest thing was at the time ‘the money doesn’t exist,’ ” he said. “We knew the money exists! It was sitting here.”

But when I asked Chalopin if he knew for sure that Tether’s assets were fully secure now, he laughed. It was a difficult question, he said. He only held cash and extremely low-risk bonds for Tether. But recently the company had started using other banks to handle its money. Only a quarter of it—$15 billion or so—is still with Deltec. “I cannot speak about what I cannot know,” he said. “I can only control what’s with us.”

After I returned to the U.S., I obtained a document showing a detailed account of Tether Holdings’ reserves. It said they include billions of dollars of short-term loans to large Chinese companies—something money-market funds avoid. And that was before one of the country’s largest property developers, China Evergrande Group, started to collapse. I also learned that Tether had made loans worth billions of dollars to other crypto companies, with Bitcoin as collateral.


Non-Traditional Investments Have Gained Market Share in Recent Years

The best video of the week...

This news report will make you want to stay very active and develop lifelong skills and interests.

When Tony Bennett's family announced he had Alzheimer's disease in February, few of the 94-year-old singer's fans imagined they'd ever see him on stage again. But this summer, with his family's help, the legendary crooner began rehearsing for two concerts at Radio City Music Hall, with his friend Lady Gaga. No one knew for sure if Tony would be able to pull it off, but his family believed that Tony's story could give hope to others struggling with Alzheimer's. And invited us to follow him preparing for, what would likely be, his final act.

Tony Bennett



The author has current equity ownership in: Sherwin-Williams Corp. and FedEx 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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