Weekly Research Briefing: Ring of Fire

So, I remain today where I first announced myself in early August: Absent a stark turn in what I see in the data and hear from contacts, both in one-on-one conversations and in forums like this, I believe that we are at the point where we can hold rates where they are.

Look, we did a lot, and we did it very fast. In barely more than a year, we increased the policy rate by more than 5 percentage points and to its highest level in more than two decades — 11 rate hikes in a span of 12 meetings prior to September.

We also turned around our balance sheet policy, and we turned it around fast — and we continue to tighten financial conditions by shrinking the balance sheet.

But the workings of the economy cannot be rushed, and it will take some time for the full impact of the higher rates to be felt. Holding rates steady will let monetary policy do its work. I am sure policy rates are restrictive, and as long they remain so, we will steadily press down on inflation and bring markets into a better balance.

By doing nothing, we are still doing something. And, actually, we are doing quite a lot.

We are also giving ourselves a chance to navigate some of the current uncertainty — labor strikes, oil prices, and the not-fully-exorcised specter of a government shutdown included.

“There is a lot saying that inflation is trending down compared with what it has been and that’s what we want,” he said. “It’s undeniable this is a trend. It wasn’t a one-month blip . . . we have to hope and keep an eye out to make sure that continues.”...

“One of the worst things you can do is tie this monetary policy decision to what did the last data show the last month. You want to take a broader view,” said Goolsbee, who stressed he had yet to make up his mind about a November rate rise.

However, he said, the Fed had been “rapidly approaching” a point where the policy debate was shifting away from how high to raise interest rates to how long they needed to be maintained at this level. Nothing in the data in the past six weeks had changed that.

Retirees’ Social Security checks got much bigger cost-of-living adjustments than usual the past two years. That won’t be the case in 2024.

Starting in January, the average monthly Social Security check for retired workers will rise 3.2%, or $59, to $1,906, the Social Security Administration said Thursday.

That is a significantly smaller increase than the 8.7% raise retirees received this year, reflecting a cooling in inflation. The cost-of-living adjustment, or COLA, helps Social Security benefits keep pace with inflation over time.

Still, inflation remains elevated and price pressures persist, posing a challenge to Americans on fixed incomes.

Thursday’s announcement of the increase “will probably feel disappointing to folks because the COLA was so high this year,” said Bill Sweeney, senior vice president for government affairs at AARP.

"...the financial markets are tightening up and they're going to do some of the work for us. So it's not like we didn't see this before we're just keeping a very close eye on that and then we'll see how these higher rates feed into what we do in policy in the coming year." - US Federal Reserve Governor Christopher J. Waller

"Consumer spending remains strong with third quarter year-over-year growth rates for both credit and debit card spending increasing from the second quarter." - Wells Fargo & Co CEO Charles Scharf

"Consumer spend growth has now reverted to pre-pandemic trends with nominal spend for customer stable and relatively flat year-on-year. Cash buffers continue to normalize to pre-pandemic levels with lower income groups normalizing faster." - JPMorgan Chase CFO Jeremy Barnum

"As expected, net charge-offs have continued to increase from historical low levels, and we increased our allowance for credit losses primarily driven by our office portfolio as well as growth in our credit card portfolio. Delinquencies have continued to deteriorate at a relatively slow consistent rate without signs of acceleration across our portfolios." - Wells Fargo & Co CEO Charles Scharf

"In the euro area and the U.K., the picture has turned distinctly more negative. The summer weakness in industrial economies is spreading south and the weight of structurally higher labor and energy costs suggests a more enduring competitiveness challenge for that region" - Citigroup Head of IR Jennifer Landis

“As far as Europe is concerned, I would say that most -- we've seen notable change in Q3. Most nationalities in Europe used to be high single-digit to low double-digit. They are now mid-single digit down in Q3. So that's the main change” - LVMH ($LVMHF) CFO Jean-Jacques Guiony

The surge in bond yields is worrying on many levels, but it’s a boon for pension managers. Higher yields on bonds allow pension funds to buy a guaranteed income more cheaply, and hence reduce the value of their liabilities (the amount they owe to pension members). Rising stocks (which increase their assets), combined with rising bond yields (which reduce their liabilities), are just what managers of defined benefit plans need. And they’ve helped.

According to Mercer, the actuarial group, corporate pensions run by member companies of the broad S&P 1500 now have their biggest surplus (meaning that their assets exceed their liabilities) since the onset of the Global Financial Crisis in 2007. After running persistent deep deficits, it looks like corporate pension funds are in much better health:

Elevated rates and improved funded statuses will drive pensions to sell $250 billion of US stocks in 2024. Pensions discount their future liabilities at prevailing market interest rates. As a result, the sharp rise in interest rates during the last two years has substantially improved the financial position of most pension funds. As reported by Milliman, the largest defined benefit pension plans in the US are 104% funded, up from 90% at the start of 2021 when 10-year Treasury bonds yielded just 0.9%. Amid the environment of high yielding alternatives to equities, pensions have net sold $315 billion in US equities YTD. As rates stabilize in 2024, we expect pensions will continue selling stocks in favor of yield-bearing assets, though at a slower pace.

"I think it's more of the shape of the yield curve where you're going to start seeing more and more people thinking about immunization. Unquestionably, on the margin, you're going to see some pension funds immunize. And it will, depending on that type of flow, it is going to put some pressure on the equity market as money moves out of equities and permanently go into long-dated bonds. We are having conversations with a lot of organizations on that. And so I can tell you there are a lot of -- there are quite a few pension funds now because our liability rate has been reset at a higher rate. They are getting closer to their -- to matching. This is more corporate plans, not state plans. And that, of course, you're going to see a significant de-risking. Instead of that, we are actually seeing more and more companies looking to earn higher returns in credit and infrastructure right now. They're trying to lock at higher returns that way. But we haven't seen a major shift of duration extension in the treasury market. And I think that's very evident right now. And that's why I think the yield curve is flattening out right now. But we are seeing significant interest level with a lot of pension funds to take -- bring down their, I would say, their exposure in equities, to bring down their exposure in some components of alternatives and focus on income-oriented alternatives to really get an 8%, 9%, 10% type of coupon return." - BlackRock CEO Larry Fink

The era of low interest rates is over, heralding a “sea change” in a world where investors would be better off allocating most of their assets to the credit market, according to Oaktree Capital Management co-founder Howard Marks.

Marks, who made his name in distressed debt, said the past 13 years has been a “difficult, dreary, low-return period” for credit investors, including Oaktree, because low rates reduced potential returns under heightened risks.

But those days seem more aligned with a distant past, after benchmark yields on government and corporate debt surged to multiyear highs this month as the Federal Reserve signals the highest interest rates in decades will stay elevated for longer to curb inflation. Yields on non-investment-grade corporate bonds more than doubled since early 2022 to close to 9%.

“For a number of reasons, ultra-low or declining interest rates are unlikely to be the norm in the decade ahead,” Marks wrote in a note published on his company’s website Wednesday. “If this really is a sea change – meaning the investment environment has been fundamentally altered – you shouldn’t assume the investment strategies that have served you best since 2009 will do so in the years ahead.”...

If higher rates are here to stay, “credit instruments should probably represent a substantial portion of portfolios ... perhaps the majority,” he wrote...

Yields on junk bonds and leveraged loans are now comparable to the average annual return of about 10% in the S&P 500 Index over nearly 100 years, and private loans offer even more yield, he of noted.

“Thanks to the changes over the last year and a half, investors today can get equity-like returns from investments in credit,” he wrote.

Drugs used for weight loss like Ozempic pose a real risk to companies ranging from fast food restaurants to cigarette makers, and credit market prices don’t fully reflect the potential downside, according to a report from Barclays strategists.

Pharmaceuticals known as GLP-1 agonists help people lose weight while anecdotal evidence suggests they also cut urges to consume addictive substances, including alcohol, and cigarettes. The growing popularity of the drugs could hurt demand for companies including PepsiCo Inc., the maker of Pepsi soda and Lay’s potato chips, McDonald’s Corp., and Altria Group Inc,, the cigarette maker, according to Barclays strategists led by Jigar Patel in a note on Tuesday.

Those concerns may be reflected in stock prices: an index of packaged foods is down by about 14% this year, even as the S&P 500 index has risen by around 10%. But in credit derivatives markets, investors seem to believe most of these companies have grown less risky. For example the cost of insuring McDonald’s debt against default for five years has fallen about 6 basis points, or 0.06 percentage point, over the last year to 36 bps.

“The impacts of GLP-1s potentially introduce disruption into a number of industries,” the strategists wrote.

The boom in weight-loss drugs is set to provide a boost to sportswear brands and clothing retailers, according to Deutsche Bank AG analysts.

Slimmer people will likely need to purchase smaller sizes and will be motivated to exercise more to keep the weight off, analyst Adam Cochrane wrote in a note.

He identified sports wear makers Adidas AG and Puma AG as potential beneficiaries, along with apparel retailers Inditex SA, Hennes & Mauritz A/S and the Primark chain owned by Associated British Foods Plc.

Cochrane said the class of drugs known as GLP-1s, which include Novo Nordisk A/S’s Ozempic and Wegovy injectables, could provide a “structural tailwind” for the apparel industry that hasn’t been seen “for some time.”

Medical-device stocks hard hit by the rising popularity of a new class of weight loss drugs are poised to extend a drop into year end.

That’s according to JPMorgan Chase & Co. analyst Robbie Marcus, who says the sector will see more declines before sentiment shifts as big-money investors steer clear. “Long-only portfolio managers are just exiting these positions and avoiding the space,” he wrote in a note Wednesday.

While a case could be made for a near-term recovery, Marcus says it’s prudent to “be realistic and acknowledge that if these levels of fear and doubt remain the primary emotional response, then MedTech could suffer without long-only portfolio managers returning to the space.”

Mania surrounding injectable drugs Ozempic and Wegovy — known as GLP-1s — has wreaked havoc across markets and especially medical technology stocks, sending the iShares U.S. Medical Devices ETF down roughly 15% over the past six months.

[PCTI] Agrees to be acquired by Amphenol for $7.00/shr in cash, valuing it at $139.7M

Announced that it has reached a definitive agreement to be acquired by Amphenol Corporation (NYSE: APH), one of the world’s largest providers of high-technology interconnect, sensor and antenna solutions. Under the terms of the agreement, which was approved by PCTEL’s Board of Directors, PCTEL stockholders will receive $7.00 in cash for each share of common stock they own. The purchase price represents a premium of over 50% to PCTEL’s closing stock price on October 13, 2023, the last full trading day prior to the deal’s announcement. The transaction is expected to close in the fourth quarter of 2023 or early 2024, subject to customary closing conditions, including approval by PCTEL stockholders. Upon completion of the transaction, PCTEL will no longer be listed on any public market.

PCTEL, Inc., together with its subsidiaries, provides industrial Internet of Thing devices (IoT), antenna systems, and test and measurement solutions worldwide. It operates in three segments: Enterprise Wireless, Intelligent Transportation, and Industrial IoT. The company designs and manufactures precision antennas and Industrial IoT devices that are deployed in small cells, enterprise Wi-Fi access points, fleet management and transit systems, and in equipment and devices for the industrial IoT. It also offers radio frequency test and measurement products that enhance the performance of wireless networks with a focus on LTE, public safety, and 5G technologies. The company supplies its products to wireless equipment distributors, public and private carriers, wireless infrastructure providers, and value-added resellers, as well as original equipment manufacturers. PCTEL, Inc. was incorporated in 1994 and is headquartered in Bloomingdale, Illinois.

The U.S. has 22,956 PE-owned portfolio companies, and each one needs a CEO. The PE firm installs a new CEO at the time of the buyout in 70% of the cases. That new CEO is usually from outside the portfolio company and in many cases was a CEO at a publicly traded company, lured away by the riches available when a portfolio company is offloaded successfully three to seven years later. Rather than bid against PE firms for outsider CEOs, companies are increasingly promoting first-time CEOs from within.

But wait—there’s another plot twist. PE is growing fast, and there just aren’t enough CEOs at substantial companies for PE firms to swipe. The number of U.S. publicly traded companies has been falling for years; the recent total was only about 3,700. So PE firms are digging deeper for portfolio company CEOs, often hiring away division presidents and COOs. The trouble is, those executives are often the potential insider CEO candidates that their previous employers may be counting on. In July, KKR hired Barry Lyon, an executive at a subsidiary of Danaher, to be CEO of Industrial Physics, which KKR had recently acquired. Blackstone in June brought in Ross B. Shuster to run its newly acquired Copeland, formerly part of Emerson; Shuster had been running a subsidiary of Chart Industries, a maker of cryogenic equipment.

Bottom line: Private equity has grown into a rival universe, creating a highly competitive market for CEOs. Researchers at the business schools of Harvard University, the University of Chicago, and Georgetown University crunched vast amounts of data to estimate CEO pay at public and PE-owned companies. They found that on average, PE-owned companies pay more.

"Our prediction is that emissions from oil use will peak in 2025 and those from natural gas in 2027. EV uptake and solar PV installations, both of which are now at record levels, are set to continue strongly." - Remi Eriksen, Group President and CEO of DNV

The 250 Greatest Guitarists of All Time

“MY GUITAR IS not a thing,” Joan Jett once said. “It is an extension of myself. It is who I am.” The guitar is the most universal instrument, the most primal, and the most expressive. Anybody can pick up a little guitar in no time at all, but you can spend a lifetime exploring its possibilities. That’s why thinking about what makes a great guitarist is so much fun.

Rolling Stone published its original list of the 100 Greatest Guitarists in 2011. It was compiled by a panel of musicians, mostly older classic rockers. Our new expanded list was made by the editors and writers of Rolling Stone. This one goes to 250.