Weekly Research Briefing: Current Animal Spirits

“We have to let this play out and watch it, but for now, it is clearly a tightening in financial conditions,” Powell said. The whole point of raising interest rates is to “affect financial conditions, and higher bond rates are producing tighter financial conditions right now.”

When longer-term interest rates go up, that influences a range of borrowing costs from mortgage and auto loans to business debt. In recent days, U.S. mortgage lenders have been quoting rates near 8% on the 30-year fixed rate loan, a level last seen in 2000.

Asked whether the recent jump in borrowing costs could substitute for further Fed increases, Powell added, “At the margin, it could.”

Still, robust economic activity has made it difficult for the Fed to declare an end to rate rises, and Powell stopped short of doing so Thursday. But his comments approvingly cited recent declines in inflation and an apparent cooling in labor markets in ways that revealed greater comfort with the Fed’s policy stance, raising the bar for another increase in December or beyond.

"...we went from zero rates to 5% in effectively the fastest period since the 60s, early 70s, fastest rate increase. What's remarkable is we haven't had a recession, by the way, but -- and I personally don't think we're going to. But with that, I mean, if you're an advisor and you've got a client sitting on a lot of cash earnings zero, I would hope you're telling them to put it in treasuries or something. So that's exactly what's happened." - Morgan Stanley CEO James Gorman

"I would say, our previous forecast did not anticipate the sudden jump in rates that has come in the last month and a half. We thought that treasuries were going to settle in the mid-3s, not mid-4s, maybe mid to high 3s and not mid-4s or approaching 5. So that I think has taken and shifted some of the demand out." - Prologis CEO Hamid Moghadam

"Today, we can originate high-quality senior loans with all-in yields of over 12% its sub 40% loan to value ratios." - Blackstone - COO Jonathan Gray

US retail sales increased in September by more than forecast in a broad advance that suggests durable household demand as the third quarter drew to a close.

The value of retail purchases, unadjusted for inflation, increased 0.7% after an upwardly revised 0.8% gain in August, Commerce Department data showed Tuesday. Excluding gasoline, September sales advanced 0.7%

So-called control group sales — which are used to calculate gross domestic product and exclude food services, auto dealers, building materials stores and gasoline stations — rose a better-than-expected 0.6%.

In the three months ended in September, control group sales rose an annualized 6.4%, the largest end-of-quarter advance since June 2022. Purchases rose in eight out of 13 categories last month, including stronger receipts at restaurants, motor vehicle dealers and personal care stores.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2023 is 5.4 percent on October 18, unchanged from October 17 after rounding. After this morning's housing starts report from the US Census Bureau, the nowcast of third-quarter real residential investment growth decreased from 5.5 percent to 4.8 percent.

@MikeZaccardi: Disinflationary impulse: Measures of asking rents versus US owners’ equivalent rent of residences YoY (26% weight in headline CPI)

We expect sustained higher rates to have the most pronounced impact in 2024 on housing turnover. Exhibit 3 shows that nearly all mortgage borrowers have interest rates below current market rates, and that almost 90% have rates more than 2pp below and over 60% have rates more than 4pp below. The combination of mortgage borrowers refinancing at low rates en masse either last cycle or early in the pandemic and the high current level of mortgage rates has created a significant implicit financial cost for a substantial share of households that otherwise might consider moving, as buying a new home would require them to prepay their current mortgage and take out a new mortgage at a significantly higher rate. We expect this “lock-in” effect to push existing home sales even lower in the coming months and to limit any rebound next year: we expect existing home sales to decline to 3.8mn in 2024, the lowest level since the early 1990s.

Early reactions to earnings are also lackluster. With about a fifth of S&P 500 members having reported, companies that lagged behind analysts’ estimates on the earnings-per-share metric have seen their stock underperform the benchmark index by a median of 3.7% on the day of results, according to data compiled by Bloomberg Intelligence. That’s the worst performance in the data’s history going back to the second quarter of 2019.

Even companies beating estimates have trailed the S&P 500 by 0.6% — the first such showing since the fourth quarter of 2020.

"So the trend -- there is like still a bit of normalization going on. So, if you look at our delinquency rates, they're fairly flat. If you squint a little bit, you're going to see a couple of basis points increase. And that's effectively what I meant when I said that you should expect that reserve rate to increase a little bit. There's still a little bit of normalization happening here, but as you know well, those delinquency rates and write-off rates are very strong relative to our historical performance and of course, relative to peers. So there's nothing that gives me concern in that comment. It's just to preempt a little bit what we are seeing." - American Express CFO Christophe Caillec

"Credit card utilization is increasing, credit card delinquency rates for prime consumers which represent about 20% of the market are stable but are above pre-pandemic levels in less than 1%. However, subprime borrower delinquencies which have been increasing over the past year are now above pre-pandemic levels and approaching the levels we saw in 2009 and 2010. Auto delinquency rates for prime consumers, which represent about 20% of the market, are also stable but above pre-pandemic levels and still well below 1%. Delinquencies for subprime consumers are above pre-pandemic levels as well above levels that we saw in 2009 and 2010." - Equifax CEO Mark Begor

@TheTranscript_: $ALLY: "Dealers built vehicle inventory in anticipation of potential strike. Used values relatively flat on a year-to-date basis and down 4% in 3Q ‘23. Current outlook implies 4% decline in values in 4Q ‘23, potential for outperformance if strike persists"

@dailychartbook: M&A deal count fell in September but deal spending increased by 7% MoM. @FactSet

Chevron said it would buy Hess in an all-stock deal worth $53 billion in the second major oil tie-up this month, after Exxon Mobil’s deal to buy Pioneer Natural Resources.

The U.S. energy company said buying Hess would upgrade and diversify its portfolio, marking Chevron’s entrance into an Exxon-led partnership overseeing a generational oil find in Guyana, while picking up additional U.S. shale assets largely in North Dakota.

The transaction, less than two weeks after Exxon’s acquisition of Pioneer, shows America’s second-largest oil company is similarly tying its future to a bet that the world will continue to have an appetite for oil for decades, even as many countries are seeking to cut emissions and transition toward green energy.

The major oil companies’ doubling down on fossil fuels follows a recent prediction by the International Energy Agency that fossil-fuel demand globally would reach its zenith this decade...

The biggest prize for Chevron is Hess’s nearly one-third share of the estimated 11 billion barrels of oil and gas found off the shores of Guyana. Exxon and its partners, Hess and China’s Cnooc, have revved up Guyana’s oil production from nothing in 2019 to 400,000 barrels a day.

The partners expect to be pumping 1.2 million barrels a day by 2027, making it one of the world’s fastest-ever oil developments. By then, the former British colony will be the source of $180 billion in market value for the consortium, some analysts have said.

The smell of mergers and acquisitions is in the air following more than $110 billion worth of oil megadeals this month—Chevron’s agreement to buy Hess HES and Exxon Mobil’s deal for Permian giant Pioneer Natural Resources PXD. Who’s next?

Deal talks are already under way. Devon Energy, another top Permian producer, is said to be eyeing targets that include Marathon Oil and CrownRock, according to a report from Bloomberg. Gas producer Chesapeake Energy is reportedly considering an acquisition of Southwestern Energy, according to Reuters.

Between the declining pool of quality shale inventory and the limited number of sizable targets in the prolific Permian Basin, energy companies could soon be forced into deal-making action.

“The FOMO [fear-of-missing-out] component of it is only going to accelerate. See one or two more deals, and there could be a scarcity premium that starts to emerge,” said Dan Pickering, chief investment officer at Pickering Energy Partners...

In its analysis of filings for the five largest active fund managers (including Fidelity and J.P. Morgan), it found that those managers’ holdings of the five largest energy companies in the S&P 500 expanded from 40% to 53% of U.S. energy holdings in the second quarter of 2023, compared with the same period five years earlier. At the same time, holdings of smaller energy companies declined. In other words, investors won’t even cast a glance at energy companies below a certain market value.

As such, the valuation gap between the energy giants and the smaller producers has widened. An index that is heavily weighted toward Exxon Mobil, Chevron and other large producers now commands a valuation, measured as enterprise value as a multiple of forward-12-month Ebitda, that is 44% higher than an index tracking smaller producers. The premium averaged 14% over the past 17 years and, at the peak of optimism about the shale patch, there was a time when small, fast-growing frackers were valued more highly than larger, less nimble peers.

Textainer shareholders will receive $50 a share in cash, representing a premium of 46.41% to Friday's close. The deal has an enterprise value of about $7.4 billion. Textainer said it will no longer be listed on the New York Stock Exchange and Johannesburg Stock Exchange after the closing of the deal.

"After 16 years of operating in the public equity markets, we are very excited to start this new chapter as a private company," said Hyman Shwiel, chairman of the board of Textainer. Following the completion of the transaction, Textainer will continue to be led by its president and CEO, Olivier Ghesquiere, and will continue to be headquartered in Hamilton, Bermuda, the statement said.

Bermuda-based Textainer is a lessor of intermodal containers with about 200 customers, according to its website. It has 14 offices and around 400 depots worldwide. New York-based Stonepeak is an alternative investment firm specializing in infrastructure and real assets with approximately $57.1 billion of assets under management.

[OLK] To be acquired by Thermo Fisher for $26/shr cash in $3.1B deal (74% premium to last close)

• Boards of directors have approved Thermo Fisher’s proposal to acquire Olink for $26.00 per common share in cash, representing $26.00 per American Depositary Share (ADS) in cash. The transaction values Olink at approximately $3.1 billion which includes net cash of approximately $143 million.
• Olink is on track to deliver over $200M of revenue in 2024 and, as part of Thermo Fisher, is expected to grow mid-teens organically. In the first full year of ownership, the transaction is expected to be dilutive to adjusted EPS by $0.17. Excluding financing costs and non-cash deal related equity compensation costs, the transaction is expected to be accretive by $0.10 in that period. Thermo Fisher expects to realize approximately $125 million of adjusted operating income from revenue and cost synergies by year five following close. The expected strong long-term business growth and synergy realization profile make the financial returns on the transaction very compelling.

[ESMT] Confirms to be acquired by Vista Equity Partners for $23.00/shr in cash

Announced that it has entered into a definitive agreement to be acquired by an affiliate of Vista Equity Partners, a leading global investment firm focused exclusively on enterprise software, data and technology-enabled businesses, in an all-cash transaction valued at approximately $4.0 billion. Under the terms of the agreement, EngageSmart stockholders will receive $23.00 per share in cash upon completion of the proposed transaction. The purchase price represents a premium of approximately 23% to the unaffected closing price of EngageSmart’s common stock on October 4, 2023, and a premium of approximately 30% over the volume weighted average price of EngageSmart’s common stock for the 30 days ending October 4, 2023. Upon completion of the transaction, affiliates of Vista will hold approximately 65% and affiliates of General Atlantic, a leading global investor, will hold approximately 35% of the outstanding equity.

[KCT.UK] Apax Partners offers to acquire Kin and Carta for 110p/shr in cash

• Apax views Kin and Carta as a high-quality business with a strong platform in the Digital Transformation ("DX") sector, particularly in view of its impressive roster of blue-chip enterprise customers, recognised brand and capabilities in key areas of the sector. The Company is led by an experienced management team, with a clear vision and strategy for the future direction of the business.
• However, the changing economic backdrop has highlighted the importance of scale and diversification in the DX sector. Apax believes that as a private company Kin and Carta will be better placed to make the investments necessary to position the business for long-term success.
• Apax believes it is well positioned to support Kin and Carta's next phase of growth given its significant experience and track record within this sector. Apax intends to provide operational expertise, and the Apax Funds intend to provide capital, to support the business in order to accelerate growth both organically and inorganically to continue building scale in key areas. A partnership with Apax and the Apax Funds away from the public markets is expected to improve the potential for value creation compared to the status quo as a listed business and better position the Company to create long-term value for the benefit of customers, employees and other stakeholders.

[WH] Choice Hotels proposes to acquire Co. for $90/shr in ~$10.0B cash-and-stock transaction (13% premium to latest close); Choice Hotels notes few weeks ago Wyndham privately decided to disengage with the deal

• Choice is making its latest proposal public following Wyndham's decision to disengage from further discussions with Choice, following nearly six months of dialogue.
• Under Choice's proposal, the $90.00 per share to be received by Wyndham shareholders would consist of $49.50 in cash and 0.324 shares of Choice common stock for each Wyndham share they own. Choice's proposal represents a 26% premium to Wyndham's 30-day volume-weighted average closing price ending on October 16, 2023, an 11% premium to Wyndham's 52-week high, and a 30% premium to Wyndham's latest closing price. The proposal implies a total equity value for Wyndham of approximately $7.8 billion on a fully diluted basis. With the assumption of Wyndham's net debt, the proposed transaction is valued at approximately $9.8 billion.
• Anticipates meaningful annual run-rate synergies, estimated at approximately $150M, through the rationalization of operational redundancies, duplicate public company costs, and topline growth potential CEO: "A few weeks ago, Choice and Wyndham were in a negotiable range on price and consideration, and both parties have a shared recognition of the value opportunity this potential transaction represents. We were therefore surprised and disappointed that Wyndham decided to disengage. While we would have preferred to continue discussions with Wyndham in private, following their unwillingness to proceed, we feel there is too much value for both companies' franchisees, shareholders, associates, and guests to not continue pursuing this transaction.

Across the $100 trillion asset-management industry, money managers have confronted a tectonic shift in investor appetite for cheaper, passive strategies over the past decade. Now they’re facing something even more dire: The unprecedented run of bull markets that buoyed their investments and masked life-threatening vulnerabilities may be a thing of the past.

About 90% of additional revenue taken in by money managers since 2006 is simply from rising markets, and not from any ability to attract new client money, according to Boston Consulting Group. Many senior executives and consultants now warn that it won’t take much to turn the industry's slow decline into a cliff-edge moment: One more bear market, and many of these firms will find themselves beyond repair.

“It’s a final act in that many firms that have coasted for decades will no longer be able to coast,” said Ben Phillips, head of the asset-management global advisory business at Broadridge Financial Solutions Inc. “These firms have to change, and they have to pull it off.”…

Despite their hope that clients will return to stock and bond pickers when the going gets tough — and pay for it — the downward trajectory seems irreversible. Passive products have been gaining so much traction, regardless of whether markets go up or down, that by midyear they accounted for half of all assets in US mutual funds and ETFs, up from 47% in 2022 and 44% in 2021, according to data compiled by Bloomberg from asset managers. A decade ago, it was just 27%.

As if fighting the index machines wasn’t enough, there’s now a new enemy to contend with: cash, which is where investors want to keep their money while interest rates remain high. The previous generation of CEOs made myriad attempts to turn things around: They slashed fees (resulting only in lower revenue), they merged with rivals (creating more problems than they solved), they jumped on various bandwagons, such as ESG, hoping to give themselves an edge (and ended up looking more like their competitors than different from them). Nothing worked.

LPs may benefit from the flexibility of evergreen products to manage target allocations more quickly than in closed-ended vehicles.

Though semi-liquid products are designed first and foremost with private wealth investors in mind, GPs are hoping their structural nuances will also appeal to their institutional counterparts. Semi-liquids can potentially offer institutional investors some of the benefits afforded by secondaries funds – a common entry route to the private markets – with even greater liquidity. In an open-ended fund, investors’ money is almost immediately deployed, granting immediate exposure to the asset class without a fundraising process and gradual deployment into portfolio assets.

“If you look at our $43 billion in evergreen AUM today, around 40 percent of that is already from institutional investors,” Christian Wicklein, global co-head of private wealth at Partners Group tells Private Equity International, noting that this capital includes pension funds, endowments, sovereign wealth funds and family offices.

“The whole thinking around hitting your target allocation and remaining invested, it’s very relevant for institutional investors as well. “The big, big benefit is you’re not only invested day one, but you stay invested. Your returns… are compounding over time. You have convenience, you have very solid returns and you have a very diversified exposure.”…

Another potential advantage of evergreen products for institutional investors is the ability to raise or decrease their allocation much more quickly than via closed-end funds. Instead of awaiting capital calls or another fundraise, LPs can decide when to invest more capital and eliminate the discrepancy between allocation and real exposure. “Semi-liquid funds avoid some of the operational complexities of traditional closed-end structures,” says Nick Rosenblatt, wealth management proposition leader at Mercer.

“For example, there are no capital calls to be managed and money is put to work almost immediately.” Some evergreen vehicles offer monthly liquidity rather than quarterly, and often release valuation reports at the same cadence as their redemptions, meaning LPs are also able to gauge their asset exposure with greater frequency. “In private markets, if you’re allocating 10 percent out of your $100 million… it takes you around five years to [deploy] $6 million maybe,” said Kerrine Koh, managing director for client solutions at Hamilton Lane.

@chartrdaily: The share of Americans working from home has fallen below 26% according to new Census data, the lowest level since the pandemic began. There are now only 7 states in the US where more than a third of the workforce have weekly work-from-home days.

AUSTIN — Shooting up from the downtown skyline is a gleaming 66-story glass behemoth, a place “where Fortune 500 companies, high-rise residents and premier retailers come together to create a community of their own,” as sleek marketing brochures put it. The tech giant Meta scooped up all 19 floors of office space as construction was underway in early 2022.

But when Austin’s tallest building officially opens later this year, all that office space will be empty. Meta has ditched its move-in plans and is now trying to sublease 589,000 square feet of offices, 1,626 parking spots, 17 private balconies and a half-acre of green space. So far: no takers.

The skyscraper known as “Sixth and Guadalupe” is the most glaring example in the city that made a huge bet on the post-pandemic commercial real estate economy. While other cities worry about a glut of office space as workers resist returning to the familiar 9-to-5 grind, Austin’s challenges are Texas-sized.

Here, about 6 million square feet of new office space will hit the market in the next few years — equivalent to 105 football fields. Between spaces completed since 2020 and what’s still in the pipeline, the office market will grow nearly 25 percent — the fastest rate on the continent. That includes projects such as the Waterline, which will become the tallest building in all of Texas, at 74 stories, when it opens in 2026, and a mammoth 1.1 million-square-foot complex on the city’s outskirts where a former 3M campus is being redeveloped (into what, exactly, is still unclear).

And the vast majority of projects are blazing ahead without companies lined up to move in. Roughly 87 percent of new office space is expected to open vacant, according to data from the commercial real estate firm Cushman & Wakefield.