Private Wealth

Weekly Research Briefing: Early Earnings Glimpse

April 19, 2022
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With earnings season now upon us, last week's early reports have given us a small read into what the rest of the corporate reports might have in store. The biggest banks remain a bit cautious with inflation, interest rate and global macro uncertainties, while also seeing solid loan growth, current credit trends and healthy customer balance sheets. Among the non-banks, Fastenal had a solid report with an optimistic outlook. Delta Airlines painted a very blue sky for the second quarter and the outlook for other airlines. And today's Schwab outlook might highlight that individual investors are pulling back from investing and trading in the public markets. With only a few percent of the major company reports in the door, we will have much more data to look at for the next three weeks as over 75% of the S&P 500 reports earnings.

Away from earnings, the markets remain focused on inflation, rising interest rates and increasing chances for an economic slowdown. Last week's CPI and PPI, while big on a year-over-year basis, did include some better-than-expected items. Core goods inflation slowed as used car prices reversed course as many had expected. Next up will be a focus on energy and food prices, which remain high due to both the economy and the war in Ukraine. And while the Industrial Production and Empire State Manufacturing figures surprised to the upside, we are finding other evidence of cooling. Higher interest rates and prices are beginning to cool the vacation and second home markets. Also slowing their price growth are some transportation costs (see shipping container rates and trucking prices). The Federal Reserve will continue to have both hands on the flight controls lining up their soft economic landing while weighing the strengths and weaknesses in this current economy. And as Treasury interest rates continue to reach for the stars, at what point will investors decide that bonds are better investment than equities? If that risk free rate is 3%, then you had better check your Treasury screen.

Have a great week. And goodbye winter.


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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I know it is early days for earnings, but so far, so good...

US job vacancies rate

Nice to see the early estimate revisions not hurting the earnings outlooks...

US job vacancies rate

@EarningsScout


A handful of earnings comments from last week...

"What I have pointed out in my letter is very strong underlying growth, right now, which will go on. It's not stoppable. The consumer has money. They pay down credit card debt. Confidence isn't high, but the fact that they have money, they're spending their money. They have $2 trillion still in their savings and checking accounts, business are in good shape. Home prices are up. Credit is extraordinarily good." - JPMorgan (JPM) CEO Jamie Dimon

"Consumer credit card spend remained strong, up 33% from a year ago. All spending categories were up with the highest growth in travel, entertainment, fuel, and dining. After strong growth in the first quarter of 2021, driven by stimulus payments, debit card spending increased 6% in the first quarter of 2022." - Wells Fargo (WFC) CEO Charlie Scharf

"Our revenue recovery in the March quarter reached 79% of 2019 levels, five points ahead of the midpoint of our initial guidance." - Delta Air Lines (DAL) CEO Ed Bastian

"As we exited the quarter, Domestic corporate sales improved to approximately 70% recovered versus 2019, and our recent survey results show that 90% of our corporate accounts anticipate travel volumes to increase in the June quarter as offices continue to reopen." - Delta Air Lines (DAL) President Glen Hauenstein

The Transcript


The next three weeks will give us the bulk of earnings reports for the largest corporations...

Market pricing for the number of 25 bps Fed rate hikes

BofA Global Research


Here is the big lineup for this week...

SPX move from yield curve invesion to the market peak

@eWhispers


Bank of America's earnings showed a strong appetite for borrowing and saving...

Wide distribution of outcomes after historical yield curve inversions

Inside of last week's Industrial Production data, the Manufacturing component is showing few hints of an impending recession...

@RenMacLLC: Manufacturing production rose 0.9% after a 1.2% burst in February, the third consecutive monthly increase. The level of manufacturing production is now the highest it has been since 2008! Note that this has happened even though the ISM Manufacturing PMI peaked in March 2021.

Wide distribution of outcomes after historical yield curve inversions

Helping the figures were a rebound in auto production...

Wide distribution of outcomes after historical yield curve inversions

The Daily Shot


The economy is getting used...

@LizAnnSonders: Capacity utilization surged to 78.3% in March, up from 77.7% in prior month and now at strongest since January 2019

Wide distribution of outcomes after historical yield curve inversions

A solid economic bounce in the Empire State...

@RyanDetrick: Missed this last week, but the @NewYorkFed Empire State manufacturing index just came in at the second largest print ever.

Wide distribution of outcomes after historical yield curve inversions

Expect there still to be a swing from big ticket durables into services as post COVID trends accelerate...

Cumulative personal savings in the pandemic

BofA Global Research


Mortgage rates ripping higher plus soaring home prices beginning to pull the housing market back from its boiling point...

U.S. April NAHB Housing market index 77 versus 79 in March;

April index of current single-family home sales 85 versus revised 87 in March;

Index of home sales over next six months 73 versus 70 in March;

April index of prospective buyers 60 versus revised 66 in March.

Hammerstone Markets


But as Goldman Sachs's data shows, the extreme tightness in today's U.S. housing market will keep it from collapsing...

The extreme supply-demand imbalance in today’s housing market will likely dampen the hit to activity from higher rates. Using state-level data, we show that existing home sales are only one-third as sensitive to changes in rates in a supply-constrained environment, though the recent decline in purchasing intentions and the broader reduction in affordability—the average monthly payment on new mortgages has increased by over 40% in the last year—suggest that sales should meaningfully decline this year.

We also find that housing starts have historically been unresponsive to changes in mortgage rates in a supply-constrained environment, likely because homebuilders are able to continue building with little fear that homes will sit vacant after completion...

While higher mortgage rates will help to slow home price growth, we estimate that the current tightness of the housing market and blistering near-term momentum will support just over 10% home price growth this year (Q4/Q4). We expect home price growth to slow more substantially beyond this year: our model points to low single-digit home price growth by mid-2023, a pace we previously did not expect to reach until 2024.

Goldman Sachs

Wide distribution of outcomes after historical yield curve inversions

All eyes were on the CPI report last week which arrived with a big year-over-year print...

Wide distribution of outcomes after historical yield curve inversions

@M_McDonough


But under the hood, core goods showed a surprising retreat from the previous month which excited the markets...

@WhiteHouseCEA: Core goods subtracted 9 basis points from monthly inflation in March, largely due to a decrease in used car prices.

Commodities

One-third of last year's CPI gain was due to used cars, which are now in a good retreat...

Best Year for Commodities

The cost of housing continues to add upward pressure to the CPI...

@WhiteHouseCEA: Rent of primary residence rose by 0.4 percent as did owners’ equivalent rent. Together they contributed about 17 basis points to monthly core CPI inflation, versus 11 basis points on average pre-pandemic, reflecting challenges in the housing market.

Best Year for Commodities

And rising corn prices might be great news for Iowa, but it will add to food CPI inputs...

After the Flood

The Daily Shot


It looks increasing likely that $20 per hour is the new minimum wage as two biggies bump theirs up today...

Verizon is raising the minimum wage for new employees to $20 an hour for Customer Service and $20 an hour (when base salary plus target commission are combined) for its Retail and Inside Sales employees. Existing employees on any of these teams who currently receive less than $20 an hour will be raised to this new rate automatically. And it’s adding premium pay differentials for assistant managers who work on holidays, Sundays and for those who are bilingual. In addition to the increase in starting wage, in many markets around the country, Verizon is also offering a sign-on bonus for retail specialist and assistant manager positions.

Fifth Third Bancorp announced it will raise its minimum wage to $20 per hour beginning July 4. Concurrently, the Bank will provide a wage adjustment for its first four job levels that are above the Bank’s new minimum wage. In total, more than 40% of the Bank’s workforce will receive a midyear compensation increase. “This wage increase is simply the right thing to do. It will make a meaningful difference in the lives of our team members, who are the face of Fifth Third and who are impacted disproportionately by rising costs of living,” said Tim Spence, president of Fifth Third Bancorp and the recently announced CEO effective July 5, 2022. “Under the leadership of Greg Carmichael, our CEO, Fifth Third has been a leader in increasing our employees’ wages. Fifth Third led the industry in 2018 by increasing to $15 and was among the first to increase to $18. We are carrying our leadership forward with this additional wage and midyear pay increase. We are incredibly proud to be among the top quartile of our peers for employee retention according to leading research, and we believe our competitive compensation and benefits are essential to our ability to continue to attract and retain the best and brightest talent to serve and support our valued customers.”

TradeTheNews.com


Plenty of Fed talk last week about inflation...

"I think that it will take some time to get inflation down because as you know, there's other things going on in the economy that are adding to price pressures, including the commodity price increases and energy price increases that are happening as well. So, I think inflation will remain above 2% this year and even next year, but the trajectory will be that it will be moving down." - Federal Reserve Bank of Cleveland President & CEO Loretta Mester

"The best short-term path for us is to move rapidly to the neutral range and then test whether pandemic-era inflation pressures are easing, and how persistent inflation has become. If necessary, we can move further” - Richmond Fed President Thomas Barkin

"We need to really focus on bringing inflation down to our 2% longer-run goal, and to do that over the next few years. So, that is the number-one focus, and I say that because the economy is strong. So I do think from a monetary policy point of view, it does make sense for us to move expeditiously towards more-normal levels of the federal funds rate" - New York Fed President John Williams

The Transcript


Fed's Bullard remains focused on a +50bp hike at the next FOMC...

Bullard supports the Fed raising rates by half a percentage point at the next policy meeting in May, something he urged the FOMC to do at its gathering in March, when it raised them by a quarter-point.

More officials now back such a move, as well as a reduction in the size of the Fed’s $9tn balance sheet soon.

He said the Fed’s benchmark policy rate should move up “sharply” after the May meeting and endorsed a 3 percentage point increase in the federal funds rate from its current range of 0.25 per cent to 0.50 per cent by the third quarter.

Bullard acknowledged that such a level was “aspirational” in such a short period of time, but warned the Fed’s credibility would be on the line if it did not take action.

“If markets and households get the idea that the Fed’s not going to do the right thing and not going to keep inflation under control, then you have to gain credibility by actually doing things that show them that you are serious,” he said.

Financial Times


Speaking of yields... too far too fast?

S&P 500

As interest rates have soared, the Global Bond market has lost almost 10% of its value...

S&P 500 Growth/Value Ratio QoQ

The Daily Shot


If there is now an alternative, at what yield would investors begin to rotate?

US IPO Proceeds and Activity

And 'inverted yield curve' searches on Google fall to zero...

Wide distribution of outcomes after historical yield curve inversions

Maybe reflective of Schwab's earnings results today, individual investors are not fans of the stock market right now...

@bespokeinvest: This week's AAII Bullish Sentiment reading came in at just 15.8%. This is the least bullish individual investors have been since September 1992! http://aaii.com #investorsentiment

National average office occupancy level

How could they be with all the worries over recession, rising rates, inflation and war...

Although the war in Ukraine is quickly taking a back seat.

Reduction of person days on business premises

Goldman Sachs increased its odds of a U.S. recession occurring in the next 24 months...

Soft landings have been more common in other G10 countries, where 58% of tightening cycles avoided a recession for one year after the last hike, and 44% for two years. And although the odds of avoiding a recession for two years fall to just over 20% and the odds of avoiding a recession and reversing most of an inflation overshoot fall to just under 15% when core inflation has risen by as much as it has in the US today, the odds of avoiding a recession rise to almost 80% when the private sector financial balance is as elevated as it has recently been.

Taken at face value, these historical patterns suggest the Fed faces a hard path to a soft landing as it aims to narrow the jobs-workers gap and bring inflation back towards its 2% target. We still do not see a recession as inevitable, however, particularly since the FOMC's goal of cooling the economy while avoiding a recession will be helped by post-covid normalizations in labor supply and durable goods prices. Nevertheless, the historical G10 evidence suggests the odds of a recession are higher than normal, and we now assign roughly 15% odds to a recession in the next 12 months and 35% within the next 24 months.

Goldman Sachs

Flipped Home Transacations
Flipped Home Transacations

Portfolio Managers have also diminished their global growth outlook to an all-time low...

Flipped Home Transacations

If all this negativity and increased recession outlook is justified, then you will never guess which public asset class is moving to the on-deck circle...

Riskier assets have tended to perform well when the expansion is still in its penultimate year because this period, which historically overlaps a Fed hiking cycle, takes place when growth is strong. Strong growth means healthy corporate earnings, a stable labor market, low corporate defaults and bankruptcies, all of which support the performance of equities and high yield credit. However, by the final 12 months before a recession, rate hikes have tightened financial conditions and slowed economic growth. This environment tends to see lower-risk, longer-duration assets outperform riskier sectors. It is at this point, just a year out from recession, that investors should look to become more defensive. Because as Sir John Templeton famously said, the four most costly words in investing are “This time is different.”

Guggenheim Partners

Spring 2022

Round Two about to begin in Ukraine. Could UKR be the favorite now?

While the 200,000 Russian troops arrayed along the Ukraine border seems like a large invading force, the Ukraine army is equally large, and larger with the population as part of the defense. Invading and holding a country as large as Ukraine with 200,000 soldiers and a population that wants you out is impossible. For some sense of reference, the coalition forces that were assembled to invade and free Kuwait from Iraqi occupation in 1991 numbered over 800,000. Ukraine is 34 times bigger than Kuwait, with almost 15 times the population. How did Russia assume it could defeat and control the country with a quarter of the forces?

Mario Giannini, Hamilton Lane


Hurricanes, Wildfires and Southwest Hydro-electric outages look to be lining up the U.S. for another very costly year of catastrophe losses...

I wonder which state in our union doesn't suffer cat losses. Maybe Vermont?

EV Models Will Double

Wells Fargo


Trains should be gaining from trucks right now...

"U.S. freight railroads, the diesel-electric power generation are 3 to 4x more fuel-efficient than trucks. Think about that for just a moment. One ton of freight can be moved by rail almost 500 miles per gallon of fuel. Additionally, moving freight by train instead of trucks reduces greenhouse gas emissions by up to 75% per tonne travel, and it reduces congestion on wear and tear on bridges and byways." - Greenbrier Companies (GBX)

The Transcript


Morgan Stanley thinks that EV batteries will provide the 'Mother of All Capex Cycles"...

When I meet new people in the course of doing business or even on the street, I feel an urge to ask them… “Yeah but can you make batteries?” We need batteries… and at very high scale. Where do we need them? Everywhere energy is generated. Everywhere energy is consumed. Everywhere things move. How much battery capacity is needed? This is a topic that deserves further analysis, but we estimate the order of magnitude of battery capacity required to move 100% of the global light vehicle fleet to electric + gridlevel/distributed stationary storage may be in the 20 to 40 TWh range, depending on a host of policies, technologies and other factors. At a capacity cost of roughly $80mm per GWh of capacity, the capex required for battery manufacturing alone could be in the $1.5 to $3tn range. That's just the battery factories. Add in the upstream mining/refining, downstream grid upgrades, renewable energy supply, charging infrastructure and related automobile manufacturing plants, recycling, service and support and we're talking figures potentially on the order of $10 trillion to $20 trillion or more over a 20 year period. If you can think of a capex cycle bigger than this one, you know where to find us.

Morgan Stanley


Expect many more studies commissioned to double and triple check this work that shows that employees are more productive in a hybrid work environment...

Now go and reconsider your investment portfolio's office real estate exposure.

Just one or two days in the office is the ideal setup for hybrid work, according to a new study, as it provides workers with the flexibility they crave without the isolation of going fully remote.

The findings, in a paper from Harvard Business School, were based on an experiment in the summer of 2020 where 130 administrative workers were randomly assigned to one of three groups over nine weeks. Some spent less than 25% of their work days in the office, some were in more than 40% of the time, while a third “intermediate” cohort landed in the middle, translating to a day or two per week. That subset turned out more original work than the other groups, and “this difference was significant,” the authors wrote.

“Intermediate hybrid work is plausibly the sweet spot, where workers enjoy flexibility and yet are not as isolated compared to peers who are predominantly working from home,” said the paper, co-authored by Harvard associate professor Prithwiraj Choudhury. “Intermediate hybrid might offer the best of both worlds.”…

The key with hybrid arrangements, though, is organizing things so that teams are in the office together on the same days, preventing the problem of workers commuting in only to spend half their day on Zoom calls with remote colleagues.

“You want people to try and come in together, so office time is together time,” Bloom said by email. “Well-organized hybrid does seem to be the sweet spot.”

Bloomberg


Goldman Sachs had a good long report out last week on the positive outlook for the Global Private Markets...

We believe future industry AUM growth dynamics of private markets will be driven by seven key factors over the medium term, including track record vs. public markets, interest rates, and the retail opportunity, among others. Assessing each of these factors in this report, we see an overall positive backdrop for industry AUM growth to continue. Moreover, we combine this 7-point framework with Preqin’s 2026 industry AUM forecast of $17.8tn and through-cycle growth since 2000 to assess the potential pathways over the next 5Y, including a blue-sky $30tn+ scenario for private markets (ie >3x from today). (Goldman Sachs)

Wordle Video

Goldman Sachs


The Private Markets today are a fraction of the Global Public Markets...

Spring 2022

Meanwhile, almost half of the money raised today is occurring in the Private Markets...

Spring 2022

"If you build it, they will come"...

Increased capital raising is occurring because of the better returns.

Spring 2022

And as more capital moves into the Private Markets, more companies will go there (and stay there)...

Spring 2022

The buyout announcement of SailPoint by Thoma Bravo last week highlights many advantages of going private...

A top player in the security IT space, SailPoint was being held back by an investor base with a short-term earnings focus in an industry that is capable of very high top-line growth. To attain faster growth, new product development would need to accelerate along with a possible change to its revenue model. Bigger acquisitions might also be needed as the security IT industry consolidates. With all the work that SailPoint needs to get done, why not find more aligned long-term investors who aren't focused on a daily stock price, the Federal Reserve or the battle between growth and value stocks. The private market investor can also assist the company in funding its own growth with debt or equity without any reliance on the public markets. Of course, the easiest reason for the executive team to go private might be... No more public investor calls or meetings!

With its agreement to be acquired by private equity firm Thoma Bravo for $6.9 billion, SailPoint will gain the chance to “potentially go faster and even more aggressively” in its expansion within the enterprise identity security space — potentially through M&A activity of its own, CEO Mark McClain told VentureBeat.

The deal comes as research firm MarketsandMarkets forecasts that spending on identity and access management (IAM) will surge to $25.6 billion by 2027, up from an expected $13.4 billion this year.

In an interview Monday, McClain said that the planned acquisition by Thoma Bravo could enable SailPoint to do more around acquiring other vendors, as well as accelerate its in-house development of new capabilities. “They do see … both organic and inorganic” growth opportunities, he said.

“We have places where we know we can build and develop additional capabilities, and launch products or extend our product offerings,” McClain said. “But we also see opportunities around us to potentially accelerate some of our vision through potential acquisition.”

While SailPoint has made “small” acquisitions in the last few years, “potentially now we can do those at either greater speed or greater scale. And that’s part of the attraction,” he said. “The speed and the scale at which we can do some of that, as a mid-cap company, is different than when we have a parent with a very deep checkbook.”...

Thoma Bravo is also highly familiar with SailPoint, given that the private equity firm was the majority investor in the vendor prior to its initial public offering in 2017.

In addition to the greater financial resources, the acquisition of SailPoint by Thoma Bravo also does “potentially free them up” by reducing some of the requirements that publicly traded companies have, said Merritt Maxim, a vice president and research director at Forrester.

This could equate to making more acquisitions, or to investing more heavily in product development, without worrying about the scrutiny of the public markets, Maxim said.

VentureBeat


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