Weekly Research Briefing: Many Crossed Wires

“We do see some evidence of softening in labor market conditions, but overall you’re near a 50-year low in unemployment…we do see some softening. We see new labor supply coming in. These are very positive developments. But the labor market is very, very strong.” - US Federal Reserve Chair Jerome Powell

@KathyJones: Nonfarm payroll growth beat expectations at 253K, but downward revisions pull 3 mo average falls to 222K.

@conorsen: The Fed's Q4 2023 unemployment rate forecast in March was 4.5%. The unemployment rate was 3.4% in April. There's no credible way to get to 4.5% by Q4 without a very near-term downward spiral in the labor market.

@WhiteHouseCEA: While the overall LFPR held steady at 62.6 percent, the closely watched “prime-age” (25-54 year-olds) LFPR ticked up 20 basis points (two-tenths of a percentage point) to 83.3 percent. The prime-age LFPR is now above its pre-pandemic level and the highest since March 2008.

Average hourly earnings rose by almost 0.5% month-on-month in April, which is right at the top of the normal range (the following chart excludes the two or three extreme months from the pandemic in 2020 for legibility). This isn’t evidence of a terrifying “wage-price spiral”; but it certainly doesn’t suggest the Fed will feel comfortable to relent on rates any time soon.

Average hourly earnings for temp workers grew 1.5% y/y in March (latest data point available), moderating from 2.5% growth in February and 1.8% growth in January. Temp wage growth is at its lowest level in 22 months and has dipped below perm wage growth for the fifth consecutive month. For comparison, average hourly earnings for permanent workers increased 4.4% y/y in April, up fractionally from 4.3% in March. We expect US temp wage growth to remain depressed in the low-single-digits and trend lower in the coming months as demand for temp labor eases in connection with an economic slowdown.

@LizAnnSonders: March JOLTS job openings at 9.59M vs. 9.736M est. & 9.974M in prior month (rev up from 9.931M)

“You will have noticed that in the statement for March, we had a sentence that said the committee anticipates that some additional policy firming may be appropriate. That sentence is not in the statement anymore...you will know that the summary of economic projections from the March meeting showed that in—at that point in time that the median participant thought that this was—this was the appropriate level of the—of the ultimate high level of rates.“

“...we on the committee have a view that inflation is going to come down not so quickly, that it’ll take some time. And in that world, if that forecast is broadly right, it would not be appropriate to cut rates and we won’t cut rates.” - US Federal Reserve Chair Jerome Powell

(US) Fed’s Bullard (Non-Voter): Supported the 25 bps hike this week, thought it was a good next step; My sense is that regional banks will do just fine

• This move puts Fed rate above 5%; The Fed has done a lot, but there is still a lot of inflation in the economy
• Base case is for slow growth and declining inflation; Should not have recession as a base case
• Today's jobs report was again stronger than expected
• Labor market is very tight and it will take time to cool off
• Financial intermediation in the US is not bank-centric
• My sense is that regional banks will do just fine; Bank stresses can be managed
• The economy is doing well and loan portfolios are paying
• The regional banks had some issues, but the case of SVB was very 'quirky'; Top takeaway from Vice Chair Barr's report on SVB failure is that no amount of regulation will fix bad management
• The strong labor market suggests consumption will hold up, which increases my confidence in continued economic growth
• Feel like we can bring inflation down by permitting labor market to get back to normal, but not to high unemployment
• The Pandemic has put the US bank into an 80/90's style of central banking focused on tamping down inflation
• Wall Street seems to be betting heavily on recession; Would likely take a shock of some sort to send US in recession
• Reiterates committee thinks we are in the territory of being sufficiently restrictive (echoes Powell from Wednesday press conf)

“We are seeing the effects of our policy tightening on demand in the most interest-rate-sensitive sectors of the economy, particularly housing and investment…the strains that emerged in the banking sector in early March appear to be resulting in even tighter credit conditions for households and businesses. In turn, these tighter credit conditions are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain.” - US Federal Reserve Chair Jerome Powell

WASHINGTON, D.C. -- Amid turbulence in the U.S. banking system, nearly half of Americans are anxious about the safety of the money they have in accounts at banks or other financial institutions. A total of 48% of U.S. adults say they are concerned about their money, including 19% who are “very” and 29% who are “moderately” worried. At the same time, 30% are “not too worried” and 20% are “not worried at all.”...

The latest readings are similar to those in 2008. In September of that year, shortly after the collapse of Lehman Brothers, which remains the largest bankruptcy filing in U.S. history, 45% of U.S. adults said they were very or moderately worried about the safety of their money.

@thedailyshot: US bank deposits declined further going into April month-end.

Buffett said that the potential for depositors to quickly move money out of a bank made Berkshire far more “cautious” than in previous financial crises. He warned: “the fear is contagious.”

The American people are “probably as confused about banking as ever and that has consequences,” he added.

“You don’t know what happened to the stickiness of deposits at all . . . and that changes everything. You can have a run in a few seconds.”...

Buffett added that while Berkshire had been on the sidelines, it had the capital ready in case an opportunity presented itself.

“We keep our money in cash and Treasury bills at Berkshire . . . because we want to be there if the banking system even temporarily gets stalled,” he said. “I don’t think it will, but it could.”

The Federal Deposit Insurance Corp. is considering whether to offer loss-sharing agreements to private equity firms and other nonbanks that acquire parts of failed lenders, after the regulator was left holding a large portfolio of Signature Bank loans following its collapse.

The move, described by FDIC officials, could entice such firms to buy loans and assets from collapsed institutions if interest-rate hikes topple more regional lenders. Potentially, the FDIC could get higher bids from a wider range of firms by offering to share the risks involved with buying such assets...

More participation by private equity firms could ease some of the stress on the FDIC’s insurance fund by garnering higher bids on the assets it’s selling, and deflect criticism that the agency isn’t getting fairly compensated. The agency benefited after two recent failures from equity-sharing arrangements with banks that acquired the defunct lenders, but shares of the new owners soared beyond the point where the FDIC’s stake was capped — raising questions about whether the FDIC could have gotten better terms.

@SamRo: this terminal even has a room for shareholders of regional banks

The extreme skepticism over regional bank stocks has gone so far that it prompted one of the few holdouts on Wall Street to turn bullish on a trio of the hardest-hit lenders.

JPMorgan analyst Steven Alexopoulos said the last time he saw this many bearish investors was toward the end of the Global Financial Crisis, right before legislators intervened in the form of the Troubled Asset Relief Program, or TARP, which quickly flipped sentiment around.

Today, “the mood on regional banks only needs to get slightly less negative in order to see a potential significant re-rating,” he said, raising his rating on Western Alliance Bancorp, Zions Bancorp and Comerica Inc. to the buy-equivalent recommendation of overweight...

“We have covered the bank sector for more than two decades and we’ve never seen a situation before where a seemingly perfectly healthy bank one day can end up in the hands of the FDIC the next,” he wrote. Once First Republic went into receivership, “this was the tipping point that empowered short-sellers to go on a hunt for ‘who’s next’ as well as for long-only funds to head for the hills.”

@LizAnnSonders: Price/book ratio for KBW Bank Index starting to hover near March 2020 low (and low in 2011)

@DeItaone: BUFFETT SAYS APPLE IS A BETTER BUSINESS THAN ANY OTHER BUSINESS BERKSHIRE OWNS; WOULD BE HAPPY TO SEE BERKSHIRE'S STAKE INCREASE PAST CURRENT 5.6%

"975 million paid subscribers across all of its services vs. 825 million YoY for 18.1% growth."
"2 out of 3 Apple Watch purchases came from new customers this quarter."
"Apple believes it took more smartphone share in China during the quarter along with other key emerging and international markets. The new iPhone has a 99% customer satisfaction rate per 451 Research."

Considering that Apple is still thought of as a hardware company and that its products grab most of the headlines, it’s easy to underestimate the size of Apple’s services segment, which includes the App Store, iCloud and Apple Care as well as Apple Music, Apple TV+ and Apple Pay, among others. While clearly overshadowed by the immense size of the iPhone business, Apple’s services segment has grown into a beast of its own in recent years. In the first three months of 2023, it generated almost $21 billion in revenue, making it larger than many Fortune 500 companies, including household names such as Nike, Boeing, Coca-Cola or McDonald’s.

@charliebilello: Apple has bought back $586 billion in stock over the past 10 years, which is greater than the market cap of 493 companies in the S&P 500.

@carlquintanilla: Best upside earnings surprises in over a year, so far. (via @MikeZaccardi) B of A

Revenue per available room increased 34% worldwide in the first quarter from the same period in 2022.

“The lifting of travel restrictions throughout Asia Pacific, particularly in Greater China, significantly boosted first quarter demand in the region,” Chief Executive Anthony Capuano said in the earnings release. “In the U.S. and Canada, we saw solid demand across the leisure and group segments in the quarter, while business transient demand continued to improve.”

Capuano added that while “the global economic picture is uncertain, demand remains strong, and we are not seeing signs of a slowdown."

The hotel chain also raised its full-year earnings guidance. Adjusted full-year earnings are now expected to be between $7.97 to $8.42 a share, compared with previous estimates of between $7.23 and $7.91.

Royal Caribbean Cruises raised its full-year profit forecast past Wall Street’s expectations as demand for its vacations boomed, part of broader upswing in travel fueled by easing pandemic restrictions.

The Miami, Florida-based cruise line now expects adjusted earnings per share of $4.40 to $4.80 compared to previous guidance of $3 to $3.60, coming in well above expectations of about $3.36.

“We knew that demand for our business was strong and strengthening, but we have been pleasantly surprised with how swiftly demand further accelerated,” Chief Executive Officer Jason T. Liberty said in Royal Caribbean’s first quarter earnings report...

For the first three months, booking volumes were significantly higher than the start of 2019, reaching a record level as the wave season — the time of the year when cruise companies run their promotions — started earlier and extended further, it added.

Chase credit card data for “Other Travel and Entertainment”, which includes cruise-related spending, is tracking +47% vs. 2019 year-to-date outpacing Lodging by a more than 40 point spread over the past 8 consecutive months with the initial data inflection in July ’22 coinciding with the CDC ending the COVID-19 restriction program for Cruise Ships.

Johnson & Johnson’s big consumer-healthcare business priced its initial public offering at $22 a share in the biggest new-stock listing of the year.

The offering was priced at the higher end of the $20 to $23 targeted range, with about 10% more shares sold than planned, according to people familiar with the matter. At that price, the offering is expected to raise at least $3.7 billion and value the new company, known as Kenvue, at more than $40 billion.

That would make it by far the biggest IPO of the year, as new-issue activity has been severely depressed by stock-market volatility and economic uncertainty.

@carlquintanilla: STIFEL: “.. raising our $SPX target .. by 5% from our 4,200 prior.. to 4,400 by 2Q/3Q 2023. We continue to prefer the Cyclical over Defensive industry groups .. There are encouraging signs of economic resilience .. which is historically favorable for Cyclical positioning ..”

While we acknowledge that the marginal cost of borrowing has increased, from a fundamental standpoint US HY firms remain in a position of strength. Exhibit 3 shows both median net leverage and interest coverage for US HY bond issuers with interest coverage hovering near all-time lows while net leverage remains the near the lows of the post-GFC era.

@SpecialSitsNews: Buffet on Commercial Real Estate:
o Buffett: “The buildings don’t go away.”
o Munger: “The owners do.”

"The federal government, make no mistake, is leaning across all the banks, big and small, and saying reduce your exposure to the Office segment. I don’t know what they think is going to happen to a $3 trillion asset class but it will take down the banks...When you look at the regional mix, we’re marking their securities to market and seeing that they are virtually insolvent…So it is a serious situation that I hope will improve as the Fed realizes what it’s doing." - Starwood Property Trust CEO Barry Sternlicht

But the tumult isn't over, Rowan (Apollo Global Management Inc. CEO Marc Rowan) warned, as banks are expected to pull back on lending, leading to a crunch in credit conditions. While that's unlikely to lead to a systemic financial crisis, in Rowan's view, it could spell trouble in "concentrated" areas of the market – particularly the commercial real estate market, where small- to mid-sized regional lenders finance 80% of all the industry's debt.

"I think part one of the banking crisis is over," Rowan said. "The interesting thing to me is not whether these banks failed, it's what's the business of regional banking going forward? … Can you lend money, or is your business model going to need to change, going to need to evolve? I think that's what's interesting, and I think we're going to have a second wave in commercial real estate," he added.

While company officials promised a resolution on a $725 million maturing loan covering two hotels in the near future, executives with Park Hotels & Resorts said "all options are on the table" and would not dismiss the possibility of handing back the keys to the properties.

The $725 million, fixed-rate CMBS loan on the Hilton San Francisco Union Square and Park 55 San Francisco — a Hilton hotel — is slated to mature in November and currently carries an interest rate of 4.11%. Speaking during the real estate investment trust's first-quarter earnings call, President and CEO Thomas Baltimore Jr. said he couldn't get into the specifics of Park's plans moving forward due to a confidentiality agreement, but added executives are "in discussions with the servicer and all options are being explored." Wells Fargo is the servicer of the loan.

"I emphasize all options are being explored, and we expect to have this resolved by the summer," he told analysts after being asked specifically about the possibility of giving up the properties. "Look, these are never cut and dry. So if we were, hypothetically, to give back the keys, there's a forgiveness of debt and the income we would have we are able to shield, certainly most of that, but not all of that. It would result in a potential dividend payout of $150 million to $200 million approximately, in theory. And it obviously reduces our leverage."

Some of the nation’s largest pension funds are looking at pulling back on stocks and adding private credit, while grappling with the possibility of a prolonged economic slowdown.

Board members of the $307 billion California State Teachers’ Retirement System voted Thursday to reduce the fund’s stockholdings to 38% from 42%, a shift staff and consultants said would lower the fund’s risk level without bringing down returns. The public pension fund, the nation’s second-largest, is closely watched by other retirement managers.

Calstrs will also increase inflation-sensitive holdings such as commodities and investment in private infrastructure to a 7% target from 6%. It will bump the target for private equity to 14% from 13%, making it a closer reflection of the amount Calstrs actually holds. The value of private equity holdings had swelled to 15.5% of the fund as of March 31.

The remaining money from stocks—2% of the fund—would go into private credit, an increasingly popular holding for pension funds as interest rates have risen. Pensions typically invest in a pool of loans to middle-market companies whose yields fluctuate with market rates.

Ontario Teachers’ Pension Plan is looking to further boost its exposure to private credit and has been in discussions with banks about acquiring loans, Chief Executive Officer Jo Taylor said. “We’ve been talking to banks who are probably looking to share some of their portfolios, to see whether or not we can do some sort of joint deals where we can acquire a larger portfolio on attractive terms,” Taylor said during an interview with Bloomberg Television on the sidelines of the Milken Institute Global Conference in Beverly Hills, California.

The pension fund, one of Canada’s largest institutional investors, increased its credit portfolio to a record $26 billion in 2022, boosting bets on levered loans and high-yield corporate debt as yields got richer. A year earlier, Ontario Teachers’ had about $18 billion in credit investments.

Institutions that make loans but aren’t banks are known (much to their chagrin) as “shadow banks.” They include pension funds, money market funds and asset managers.

Because shadow banks don’t take in deposits, they’re not subject to the same regulations as banks, which allows them to take greater risks. And so far, their riskier bets have been profitable: Returns on private credit since 2000 exceeded loans in the public market by 300 basis points, according to Hamilton Lane, an investment management firm.

These big returns make private credit an appealing business for institutions that once focused mostly on private equity, particularly when interest rates were low. Apollo, for example, now has more than $392 billion in its alternative lending business. Its affiliate, Atlas SP Partners, recently provided $1.4 billion in cash to the beleaguered bank PacWest. Blackstone has $291 billion in credit and insurance assets under management.

Private equity firms are also some of shadow banks’ biggest customers. Because regulations limit how many loans banks can keep on their books, banks have stepped back from underwriting leveraged buyouts as they struggle to sell debt that they committed before interest rates rose.

“We’ve demonstrated over time to be a reliable form of capital that’s really emerged at the forefront, as banks, in this environment at least, have retrenched,” Mark Jenkins, head of global credit at Carlyle, told DealBook.

Direct lending may get another boost as regional banks pull back, particularly in commercial real estate like office buildings, where landlords may be looking to refinance at least $1.5 trillion in mortgage contracts over the next two years, Morgan Stanley analysts estimate. America’s regional banks have accounted for about three quarters of these kinds of loans, Morgan Stanley’s research shows.

“Real estate is going to have to find a new home and I think private credit firms are a pretty large place for that,” Michael Patterson, governing partner at HPS Investment Partners, told DealBook. More broadly, he said: “Reduced credit availability for corporates, large and small, is a thing, and I think private credit is a big part of the solution.”

"New things coming along don't take away the opportunities. What gives you opportunities is other people doing dumb things. And it's -- and I would say that -- well, the 58 years, we've been running Berkshire. I would say there's been a great increase in the number of people doing dumb things, and they do big dumb things. And the reason they do it to some extent is because they can get money from other people so much easier than when we started." - Berkshire Hathaway ($BRK.B) CEO Warren Buffet