Weekly Research Briefing: Summer Moves

@RenMacLLC: This is not a close call. The unemployment rate is climbing & payroll growth is slowing. Conditions in the labor market are cooling off. The trade-offs for the Fed have shifted. If they don't cut this month, they ought to make a strong signal a cut is coming in September.

@dailychartbook: "Macro data has weakened substantially, with the Economic Surprise Index at the lowest level since January 2016, which should lead to inflation cooling with macro and inflation back in sync." - BofA

@ericwallerstein: Core PCE, ex-shelter, has reached the Fed's 2.0% target.

After the debate between Donald Trump and Joe Biden that was widely thought of as disastrous for the sitting president, investors are gaming out an increasing likelihood that Biden will lose the presidential election. Not just that, but many investors are also mapping out the policy implications of Republicans winning a majority in both the US House of Representatives and Senate.

This possibility has traders actively betting on higher inflation in the near term, considering Donald Trump's proposals for extending tax cuts, implementing tariffs and dramatically curtailing immigration.

“I do think that what happened on Thursday meaningfully increases the likelihood of a Republican sweep in November,” said JPMorgan’s David Kelly this morning on Surveillance. “If Joe Biden is the candidate it’s quite possible a lot of independents will stay home and so Republicans will sweep.”

After the debate, Kelly said he became more bearish on longer-term US bonds.

Low interest rates are good for stocks. Are they good for the stock market?

That seems like an odd distinction, but it is one that could weigh on American investors’ future returns. There aren’t nearly as many companies to buy, and the ones that remain just aren’t what they used to be.

Most investors are pleased with their portfolios these days, whether they own some of the popular names like Nvidia, Microsoft and Apple that have been powering the market or mutual funds lifted heavenward by the same group of companies. It is at times of top-heaviness like these that contrarians who want to stay invested have pivoted to the market’s forgotten corner: small stocks...

If you simply sort the market into large versus small and look at published valuation measures, then that problem isn’t obvious. For example, FTSE Russell divides the U.S. market into the largest 1,000 and the next 2,000 stocks. A leading exchange-traded fund tracking the latter group, the iShares Russell 2000 ETF, supposedly has a trailing price-to-earnings ratio below 13 times, whereas the most popular one tracking large stocks, the SPDR S&P 500 ETF, appears far more expensive at about 27 times.

They are both pricey: Barely half of the companies in the small-company ETF are profitable, so they aren’t counted in the denominator of that ratio. Even during past deep recessions a higher share of small companies in that index made some profits.

BlackRock Inc. will acquire private capital database provider Preqin for £2.55 billion ($3.2 billion) in cash, as the world’s largest money manager accelerates its push to become a major player in alternative assets.

The acquisition deepens BlackRock’s ability to oversee risks and analyze data across fast-growing markets for private assets, and also expands its Aladdin technology systems, the New York-based firm said in a statement on Sunday.

“We see data powering the industry across technology, capital formation, investing and risk management,” Rob Goldstein, BlackRock chief operating officer, said in the statement.

Private markets are the fastest growing part of asset management, with alternative assets expected to reach nearly $40 trillion by the end of the decade, according to BlackRock’s statement. That’s prompting surging demand from investors for relevant data with the total addressable market expected to reach $18 billion by 2030, up from around $8 billion today.

@FactSet: The trailing 12-month P/E ratio for $SPX of 26.4 is above the 5-year average (23.4) and above the 10-year average (21.5).

@FactSet: $SPX is expected to report Y/Y earnings growth of 8.8% for Q2 2024, which is slightly below the estimate of 9.1% earnings growth on March 31.

Corning stock was rising sharply after the specialty glassmaker lifted its second-quarter guidance ahead of its earnings report later this month.

The company now expects core second-quarter sales of about $3.6 billion, above its earlier guidance of around $3.4 billion. It also forecast core earnings per share for the quarter “at the high end of or slightly above management’s guided range” of 42 cents to 46 cents, Corning said in a press release...

“We expect second-quarter core sales to exceed our previous guidance and mark a return to year-over-year growth,” CEO Wendell Weeks said in the press release. “The outperformance was primarily driven by the strong adoption of our new optical connectivity products for Generative AI.” This aligns with the company’s “Springboard” plan to add more than $3 billion in annualized sales in the next three years, he said.

@chartsmarter: That is one strong sprint by $IGV last several weeks against $SMH. Bulls would love to see prudent pause before resumption of uptrend.

The senior portfolio manager, best known for his “Big Short” bet against subprime mortgages ahead of the global financial crisis, owns “a lot” of the chipmaker’s shares and considers it a long-term play that’s going to be relevant for years to come, he said Tuesday in an an interview on Bloomberg Television...

“One of the things I learned running a hedge fund is that shorting a stock solely because of valuation is a death wish,” he said, adding that people purchase a stock even when it’s perceived to be expensive because they’re buying into a story. “As long as the story is intact — like Nvidia is obviously intact — the story is going to continue. I don’t think all that much about the valuation of Nvidia.”

The early stages of a long-awaited recovery in investment banking fees is set to boost Wall Street lenders when they report second-quarter earnings starting this week, with mergers and debt deals picking back up after a lacklustre two years.

Analysts expect investment banking revenues at JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup will on average rise more than 30 per cent from a year earlier during the second quarter, according to estimates compiled by Bloomberg.

“You’re beginning to see a nice rebound in investment banking activity,” said Oppenheimer analyst Chris Kotowski. JPMorgan, Citi and Wells Fargo report results on July 12. Goldman publishes earnings on July 15, followed by Morgan Stanley and BofA a day later. Overall, rising defaults are expected to contribute to muted earnings growth for many of the largest US lenders this quarter.

The resurgence of dealmaking, though, could be a bright spot. Analysts predict the bottom lines of Goldman and Morgan Stanley, whose businesses have the biggest exposure to investment banking, will benefit the most.

• Carlyle and KKR have won an auction for a $10bn student loan book from Discover Financial, clinching one of the largest loan portfolio sales of the year, according to four people with knowledge of the matter. The joint bid from the two private investment groups eclipsed a competing offer from Sixth Street, BlackRock and the Canada Pension Plan Investment Board, with the loan book selling above par, two people added. The auction attracted some of the biggest names in private credit, including Ares, Blackstone and Oaktree, as private investment firms become larger financiers of consumers and Main Street businesses. Discover announced its plan to sell the portfolio late last year, after it agreed to sell itself to rival bank and credit card issuer Capital One for $35.5bn. The auction offered a rare opportunity for investors to buy a large private student loan book. (Financial Times)
• Paramount Global (PARA - $7.8b mkt cap - S&P 500 component) agreed to merge with David Ellison’s Skydance Media in a complicated deal that ends the Redstone family’s involvement with the Hollywood company. Shari Redstone is selling her family’s controlling stake in Paramount Global and merging the entertainment giant with Skydance Media, drawing to a close a nearly four-decade run by her and her father as entertainment power players. Skydance and its investors have agreed to spend more than $8 billion to acquire National Amusements, the family company that controls Paramount, and invest in the new iteration of the iconic company. (WSJ)
• Brookfield Asset Management agreed to buy a majority stake in France’s Neoen ($6b mkt cap) the first step toward a full acquisition in a deal that values the renewables company as a whole at 6.09 billion euros ($6.54 billion). With the deal, Brookfield aims to bolster exposure to renewables and battery-storage technology and to accelerate Neoen’s portfolio expansion. The deal between Brookfield and some Neoen shareholders covers a 53.12% stake in the company, but the investor plans to launch a tender offer for the remaining shares after completion of the majority-stake acquisition, the companies said Tuesday. Paris-based Neoen has a portfolio of solar and wind power plants and energy-storage facilities, with operations in France, Finland, Mexico and Australia. The capacity of company’s portfolio of assets in operation and under construction stands at more than 8.3 gigawatts. (WSJ)
• Devon Energy (DVN - $29b mkt cap) announces strategic acquisition in the Williston Basin from Grayson Mill Energy (private company) for $5B, consisting of $3.25B of cash and $1.75B of stock; The transaction is immediately accretive to Devon’s key per-share financial measures, including earnings, cash flow, free cash flow and net asset value. The assets were acquired at less than 4-times EBITDAX, with an estimated free cash flow yield of 15 percent at an $80 WTI oil price. The acquisition adds a high-margin production mix that further positions Devon as one of the largest oil producers in the U.S. Pro forma for the transaction, the company estimates its oil production to average 375,000 barrels per day, with total production reaching an average of 765,000 oil-equivalent barrels (Boe) per day across its diversified portfolio of assets. (TradetheNews)
• Grifols SA ($4.8b mkt cap) said that its founding family and asset manager Brookfield have made an approach to buy and delist it, after the pharmaceutical producer lost billions in market value amid a short-seller attack. The shares jumped the most in four months. Brookfield and the Grifols family “have reached an agreement to evaluate a possible joint takeover bid to acquire all” the shares of the company and take it private, the Barcelona-based firm said in a regulatory filing Monday. The company has a market value of €5.5 billion ($6 billion)... The offer is the latest twist in a crisis that started in January, when the company came under a short-seller attack from Gotham City Research. As Grifols sought to calm investors, it removed all family members from executive positions, hired an outsider as chief executive officer and named a new chief financial officer. Prior to the news, the stock has fallen by 36% since Gotham published its report, where it accused the company of manipulating its debt and profit figures. The plunge wiped some €3.2 billion from its market value. (Bloomberg)
• Private equity firm KKR & Co agreed to acquire Varsity Brands, a U.S. maker of sports uniforms and school yearbooks, from buyout firm Bain Capital for about $4.75 billion, including debt, people familiar with the matter said on Wednesday. KKR will own Varsity Brands through its Americas private equity fund, the sources said, requesting anonymity because the deal has not yet been announced. KKR has committed to offering rank-and-file employees of its North America portfolio companies equity in these companies, and will do so with Varsity Brands, the sources said. This is an incentive the corporate world traditionally reserves for senior executives. (Reuters)
• •Boeing (BA - $113b mkt cap) agrees to acquire Spirit AeroSystems (SPR - $3.8b mkt cap - Russell 1000 component) for $4.7B, or $37.25 per share, in an all-stock deal. The total transaction value, including Spirit's net debt, is approximately $8.3B. Spirit shareholders will receive 0.25 $BA shares for each Spirit share. Boeing will ensure continuity of Spirit operations while selling Spirit’s Belfast, Prestwick, and Subang operations. Concurrently, Airbus will acquire certain commercial work packages Spirit performs for Airbus. The transaction is expected to close mid-2025. (@wallstengine)
• Carlsberg ($19.9b mkt cap), opens new tab has agreed to buy British soft drinks maker Britvic ($4b mkt cap), opens new tab for 3.3 billion pounds ($4.23 billion), a move the Danish brewer said would forge a UK beverage "powerhouse" and that sent both companies' shares higher. Carlsberg clinched the takeover with a sweetened bid of 1,315 pence per share - comprising cash and a special dividend of 25 pence a share - after the British company rejected 1,250 pence per share last month. The acquisition will create value for shareholders, contribute to growth and forge a combined beer and soft drink company that is unique in the UK, CEO Jacob Aarup-Andersen told investors on a conference call. "With this transaction we are creating a UK powerhouse," he said. (Reuters)
• •Private-equity firm Carlyle Group is in exclusive talks to acquire medical-device maker Baxter’s kidney-care spinoff Vantive for more $4 billion, including debt... The separation of Vantive from Baxter was expected to take place in the second half of this year. Baxter’s kidney-care company had about $4.5 billion in revenue last year and more than 22,000 employees. (WSJ)
• Eli Lilly (LLY - $869b mkt cap) has agreed to buy biopharmaceutical company Morphic Holding (MORF - $1.6b mkt cap - R2000 component) for $3.2 billion in a deal that bolsters the drugmaker’s immunology pipeline. Eli Lilly on Monday said it would pay $57 a share for Morphic, a 79% premium to Friday’s closing price of $31.84 for the Waltham, Mass., company. Morphic is developing therapies for the treatment of serious chronic diseases, with a lead program targeting the inflammatory bowel diseases ulcerative colitis and Crohn’s disease. (WSJ)
• EQT AB has agreed to sell a majority stake in Idealista to private equity firm Cinven in a deal valuing the online real estate platform at €2.9 billion ($3.1 billion). Cinven is buying a 70% stake in Idealista with EQT retaining an 18% holding in the business, according to a statement on Friday. Apax Partners and Oakley Capital will sell their holdings, while Jesus Encinar, founder and chairman of the real estate platform, plans to keep his stake and continue to lead the firm alongside the management team. Idealista operates in Spain, Italy and Portugal, according to its website. EQT, which manages €242 billion in assets, acquired Idealista in 2020 at €1.3 billion valuation. (Bloomberg)
• The parent of Saks Fifth Avenue sealed a $2.65 billion deal to buy rival Neiman Marcus, creating a powerhouse in luxury retailing that seeks to hang on to wealthy shoppers—all with a little help from Amazon.com. The department-store chains had been negotiating for months and had explored a combination several times over the years. Both have struggled as some consumers spent less on pricey goods and fashion brands opened their own flagship stores... The combined company will have about $10 billion in annual sales and more than 150 locations, including Saks Fifth Avenue, Saks OFF 5th, Neiman Marcus and Bergdorf Goodman. (WSJ)
• A consortium led by Swedish private equity group EQT has agreed to acquire Irish video games company Keywords Studios ($2.4b mkt cap) in a £2.2bn deal, underlining the fertile hunting ground for buyers in London’s stock market. Keywords, based in Dublin and listed on London’s junior market Aim, accepted a lower price than a previous bid from EQT after Keywords announced that some projects had been delayed and cancelled. The £2.2bn deal, which includes debt, comes after the Financial Times reported in May that EQT had made four unsolicited proposals to buy the video games company. (Financial Times)
• Blackstone and MBK Partners said on Wednesday the U.S. private equity firm is selling Japanese drugmaker Alinamin Pharmaceutical to the North Asian buyout fund. The deal size would be 350 billion yen ($2.17 billion), a source said on Tuesday, however neither Blackstone nor MBK in their separate statements disclosed the transaction value. Blackstone acquired Alinamin in 2020 from Takeda Pharmaceutical in what it said was the largest healthcare transaction in Japan. (Reuters)
• KKR will pay some $2.1 billion for 18 developments built by Lennar that spread from California through Texas, Colorado, Georgia, Florida, and North Carolina, to New Jersey. Coming after a couple of other multifamily deals by private equity, Wedbush analyst Richard Anderson says that real estate investment trusts that focus on apartments are seeing the light at the end of the Sunbelt tunnel. (@barronsonline)
• SM Energy (SM - $5b mkt cap) said on Thursday it had agreed to buy some shale assets of oil and gas producer XCL Resources for about $2 billion, extending its footprint in the Uinta region in Utah, sending its shares down 10%. XCL, backed by EnCap Investments and Rice Investment Group, is one of the largest producers in the region with an output of around 55,000 barrels of oil equivalent per day. Denver-based SM Energy, which operates in the Eagle Ford and Midland Basins in Texas, plans to finance the acquisition through a combination of debt and cash on hand. (Reuters)
• •Nokia confirms it will acquire Infinera (INFN - $1.4b mkt cap - Russell 2000 component) at $6.65/shr for an enterprise value of $2.3B; Acquisition is Expected to be accretive to Nokia’s comparable op profit and EPS in year 1 and to deliver 10%+ comparable EPS accretion in 2027; Creates a highly scaled and truly global optical business with increased in-house technology capabilities and vertical integration. Strengthens Nokia’s optical position, specifically in North America. Accelerates Nokia’s customer diversification strategy, expanding webscale presence. Offer split at least 70% cash and up to 30% stock; Infinera shareholders can elect cash, Nokia stock or a combination. Nokia to increase share buyback to offset dilution; deal financed from Nokia’s cash on hand. (TradetheNews)

Activist investor Cevian Capital has disclosed a stake in Smith & Nephew (SNN -$11.7b mkt cap), sending shares in the London-listed manufacturer of medical devices up more than 7 per cent.

Stockholm-based Cevian had a 5 per cent stake in Smith & Nephew as of July 2, the maker of joint implants and surgical devices said on Thursday.

Smith & Nephew has been hit by supply issues in recent years, while it has also suffered from high executive turnover, with three chief executives in five years.

“Smith & Nephew owns fundamentally attractive businesses in structurally growing markets, but the company has not generated shareholder value for many years. Cevian sees the potential to create significant long-term value by improving the operating performance of the company’s businesses,” said Friederike Helfer, a partner in the fund.

The private-credit universe — already one of the fastest-growing markets — has room to balloon to $15 trillion over the next decade from $1.7 trillion today as types of lending broaden and expand, said Bruce Richards, whose Marathon Asset Management invests in a multitude of credit markets.

“It’s going to be $15 trillion, that same sector in the next eight to 10 years, which is a really big number,” Richards said Thursday at an event at New York University’s Stern School of Business.

Private credit has taken off in recent years, filling a gap as banks stepped back from some risky lending amid tightening regulations. Growth in the industry has accelerating amid strong demand from investors including pension funds, endowments and insurers.

The $1.7 trillion private-lending industry is still “in batting practice” before it swells to a $25 trillion market, according to one of its powerhouses, Blackstone Inc.

Given the funding needs for financing data centers and energy transition, there’s room to grow to hit the $25 trillion mark, Michael Zawadzki, Blackstone Credit and Insurance’s global chief investment officer said Friday in an interview with Bloomberg Television.

Higher base rates, the shift from banks to private lenders and the proliferation of strategies to access private credit allow the market to grow larger, Zawadzki said. The private investment grade strategies like asset-backed finance and infrastructure credit are “really compelling” in today’s market, he said. The size of the asset-based finance market is about $5 trillion to $10 trillion, he said.

“You’re financing the real economy — you’re not waiting for M&A transactions to happen,” Zawadzki said. “You’re financing consumers, you’re financing data centers, you’re financing energy transition. Huge growth capital expenditures, that’s what’s really driving the growth.”

For the first time in three years, Wall Street’s equity capital markets bankers appear to have the wind at their backs.

Initial public offerings have gotten off to their best start to a year since the heady days of 2021, with more than $20 billion raised in the first six months, according to data compiled by Bloomberg.

With sales of convertible bonds and shares in already-listed companies also nearing pandemic-era levels, the stuttering activity seen last year has evolved into a regular rhythm. Though surpassing 2021’s historic volume isn’t on the horizon yet, confidence is growing that 2024 is the bounce-back year that a slew of would-be public companies have been waiting for.

“A key reason we’ve been in a better issuance window in recent months is the healthy engagement from the full investor community,” said Andrew Wetenhall, co-head of Americas ECM at Morgan Stanley. Volume is charting to a pace that feels more like a normal year for issuance on a pre-Covid basis, and sovereign investors, pension funds, long-only investors and hedge funds are all enabling deals to get done, he said.

Asia Pacific’s pipeline of initial share sales indicates a solid third quarter, with a clear pickup in activity in Hong Kong and several mid-to-large size deals expected in India.

On June 28, seven companies filed for IPOs in Hong Kong, the most for a single day in one-and-a-half years, according to data compiled by Bloomberg. At least 10 companies are slated to list in the city in July, making it the busiest month for debuts in the Asian hub this year.

After months of muted activity, the number of Hong Kong offerings has been rising with increased support from Chinese authorities.

In India, which has been a busy market for initial and additional share sales amid positive economic prospects and surging valuations, at least 15 companies are working on IPOs that could raise a combined $11 billion. Several of them are set to be executed in the third quarter.

@johnrhanger: Good morning with good news: US solar generation was up 44% in June 2024, compared to June 2023. Wow!
June 2024: 36 TWh
June 2023: 25 TWh
June 2022: 22 TWh
June 2021: 17 TWh
Solar is up ~110% since June 2021. It generated 8.55% of US electricity this June and is vital to USA!

The start of the artificial-intelligence arms race was all about going big: Giant models trained on mountains of data, attempting to mimic human-level intelligence.

Now, tech giants and startups are thinking smaller as they slim down AI software to make it cheaper, faster and more specialized.

This category of AI software—called small or medium language models—is trained on less data and often designed for specific tasks.

The largest models, like OpenAI’s GPT-4, cost more than $100 million to develop and use more than one trillion parameters, a measurement of their size. Smaller models are often trained on narrower data sets—just on legal issues, for example—and can cost less than $10 million to train, using fewer than 10 billion parameters. The smaller models also use less computing power, and thus cost less, to respond to each query.

Microsoft has played up its family of small models named Phi, which Chief Executive Satya Nadella said are 1/100th the size of the free model behind OpenAI’s ChatGPT and perform many tasks nearly as well.

“I think we increasingly believe it’s going to be a world of different models,” said Yusuf Mehdi, Microsoft’s chief commercial officer.

A huge amount of economic value is going to be created by AI. Company builders focused on delivering value to end users will be rewarded handsomely. We are living through what has the potential to be a generation-defining technology wave. Companies like Nvidia deserve enormous credit for the role they’ve played in enabling this transition, and are likely to play a critical role in the ecosystem for a long time to come.

Speculative frenzies are part of technology, and so they are not something to be afraid of. Those who remain level-headed through this moment have the chance to build extremely important companies. But we need to make sure not to believe in the delusion that has now spread from Silicon Valley to the rest of the country, and indeed the world. That delusion says that we’re all going to get rich quick, because AGI is coming tomorrow, and we all need to stockpile the only valuable resource, which is GPUs.

In reality, the road ahead is going to be a long one. It will have ups and downs. But almost certainly it will be worthwhile.