Private Wealth

Weekly Research Briefing: Many Crossed Wires

May 09, 2023

The FOMC raised rates, but now may be done. The Fed Chairman hinted at no rate cuts in 2023. Meanwhile, the fixed-income markets are betting on a cut in the Fed Funds rate which is a bet on future economic weakness. Shouting "Wrong!" is the stock market which is priced for a soft landing with continued earnings growth. But within the equity market, many investors are betting on defensive companies which will benefit from a slowdown or mega-cap growth companies that will benefit from falling interest rates. The only consensus is that no investor wants to own U.S. banking stocks as the KRE (regional bank ETF) short interest heads toward 100%. Good luck making heads or tails of the markets many directional bets.

Friday's jobs numbers showed an economy still very strong today with an unemployment rate at 50-year lows and employment levels that are over 3 million jobs greater than before COVID. The previous month's revisions did reduce some of the figures fire, but +4.4% wage growth did dial it back up. Bottom line, the U.S. labor market is cooling but it will still burn the roof of your mouth. Wall Street has now underpredicted payroll growth for 13 straight quarters. And the only way for the Fed's economists and Wall Street's strategists mid-4% UE rate to happen by year end is for job growth to start printing negative numbers. This is always possible but seems out of reach with a 3-month average above 200,000 and economic surprises and strong earnings continuing.

Continuing positive earnings reports and the likely end to the Fed rate hike cycle was overshadowed by the continued worries in the U.S. banking sector. Some stocks are moving in double digit percent changes on a daily basis as rumors on deposit flows and capital raising send weak longs running and embolden the shorts. At some point this will end, but it might take a government action to stabilize the sector. It sure doesn't help that the banking volatility is occurring while the people in Washington D.C. are juggling the gasoline torches known as the U.S. debt limit. This will all end at some point and hopefully in a logical and positive way.

Next week, we will receive data on the CPI and PPI. Earnings reports wind down massively from the past three weeks but still a few big companies like Disney, Nutrien and Occidental Petroleum will report. Have a great week.

The Fed Chairman sees that everyone who wants a job, can get a job...

“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

The Transcript

And even with the downward revisions, Friday's jobs data drove home that point...

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

Next time you meet with a Fed economist or Wall Street strategist, ask them when the downward spiral will begin?

@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.

Labor force participation is the strongest in 15 years, which should act to slow wage growth in the future...

@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.

Wage growth did not slow in April which should keep the Fed from cutting rates anytime soon...

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.


But temporary wage growth is slowing quickly and should also weigh on future total wage growth...

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.

Goldman Sachs

We are getting the expected softness in job openings which could also limit future wage gains...

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

The Fed Chairman commented on the 'pause' and future cuts...

“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 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

The Transcript

“The imminent demise of the U.S. economy is greatly exaggerated,” James Bullard

And the Fed heads were released to the public with Bullard sounding a bit more dovish than usual.

(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)

The bond market has become the grumpy old man in the trading room...

Fixed-income investors are betting on a future with eight 25 basis point cuts to the Fed Funds rate over the next 14 months. The upcoming cage match between stocks and bonds is going to break records.

CME Group

The economic impact of the bank lending slowdown is still a significant unknown...

“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

The Transcript

But as BofA Global charts below, rapid rate increases always damage something...

0% to 5% in 15 months (Chart 2); Fed hiking cycles always ‘break’ something.

BofA Global

Shattered bank stocks in March have now worried U.S. depositors...

The Fed and Treasury need to inject this chart into their brains and then act before they begin to lose 'insured deposits'.

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.


This trend is not bank-investor friendly or creditor friendly...

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

Warren talked about the banking issues on Saturday...

He is watching and waiting for an opportunity.

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.”

Financial Times

The FDIC knows that it needs more help in securing the U.S. banking system...

Imagine you went to your HOA or golf club board meeting and were told that you would need to be assessed 17% of your current years earnings to fix the neighborhood or club house. According to Goldman Sachs, that is the hole that SVB, Signature Bank and First Republic have blown in the U.S. banking reserve. Of course the assessment will not be billed all at once, but you can bet that the future deposit charge is going to hit all bank earnings. But the Fed and Treasury know that future major losses need to be lessened and thus they are now exploring ways to get other public and private capital involved in buying banks or portfolios of loans. This will likely be an opportunity for Berkshire Hathaway and other investors to help save the banking industry from their past bad bank decisions.

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.


Couldn't agree more...

Remember when we used to laugh at European bank stock performance?

It's as if we had been playing football for the past ten years and then the game changed to soccer overnight.

BofA Global

Even the jokes now...

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

Wall Street analysts are beginning to bet against the current psychology and upgrade the stocks...

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.”


Remember, this is a deposit crisis caused by bad bets on interest rates and liquidity...

This is not a credit crisis. But if it becomes a credit crisis, the banks are very well reserved versus the 2008-2009 global financial crisis.


On a pure price to stated book value basis, bank stocks are back down to lows...

Current book values are likely elevated as held to maturity loans and asset values are not marked to market. But even with the haircut that you give asset values, bank stocks are very discounted.

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

Enough about banks. What is the best business that you have ever seen?


Apple's earnings were very impressive...

Nailed it in services, new non-phone customers and even gaining ground in China. And wow, those margins.

"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."

Stock Market Nerd

Remember when Apple said it was going to make services its own business and you ignored it?

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.


Oh, yeah. And the stock buyback and cancellation activity are incredible...

@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.

But not just Apple, so many other companies surprised to the upside this quarter...

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

But even with all the beats, the market is unrewarded if you take out the five mega-caps...

Among the more interesting earnings beats last week, Marriott joined the other hotel companies in crushing it...

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.


And Royal Caribbean joined its cruise ship peers in sailing the best booking numbers ever...

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.


Even the credit card data confirms that people are spending money on adventure and experiences like never before...

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.

J.P. Morgan

As for homebuilding, the newest single family housing data shows inventory falling right now...

This is unusual as inventory typically builds into June. So, if the economy continues on its current pace, expect higher home prices.

Calculated Risk

And what is up with the surge in heavy truck sales?

Fleet expansions or just fleet upgrades? Either way, good news for many industrial suppliers.

The Daily Shot

In a positive sign for the U.S. stock market, a $40 billion market cap went public last week...

But we have to dial down the excitement a notch given that the company is the maker of Tylenol and Band-Aids.

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.


Meanwhile, the Nasdaq 100 moved to 9-month highs...

Wall Street moves to upgrade their outlook as the economy remains solid...

@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 ..”

Plenty of worrying about credit right now, but U.S. companies remain in a decent position today than in years past...

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.

Goldman Sachs

Warren and Charlie had brief thoughts on CRE on Saturday...

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

Barry Sternlicht remains quite negative on the outlook for CRE...

"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

The Transcript

Apollo sees the problems in CRE and is ready to get involved if the banks pull back...

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.


Speaking of pulling back, Park Hotels might hand 2,945 San Francisco hotel room keys back to the CMBS loan owners this summer...

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."


A reminder of upcoming CRE debt maturities that will need to be refinanced or restructured...

Goldman Sachs

But just because a bank has a large amount of CRE, it doesn't necessarily make them uninvestable...

Pay attention to the Loan-to-Value ratios which are that big layer of protection for that CRE value.

Some major institutions are looking to add to Private Debt right now...

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.


Others are talking directly to banks about acquiring loan portfolios...

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.


Private Debt will become much larger in the future as U.S. banks pull back from lending according to the New York Times...

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.”


In times like now, you always have a pocket of cash available to invest in the opportunities from other investors doing dumb things...

"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

The Transcript

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The author has current equity ownership in: Walt Disney Co.

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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