Private Wealth

Weekly Research Briefing: The Summer of Pink

August 08, 2023

Barbie wins the Mega Millions jackpot without a trip to the Gas & Sip. Good for Greta Gerwig and everyone involved who made pink the color of the year. I loved 'Oppenheimer' and think that it will be the film to beat come awards season, but I am looking forward to a trip to the theater to see this summer's rose-colored spectacle.

It was a big week for those dark red colored recessionary forecasts. The ongoing strength in the manufacturing and consumer economy was helped by continued solid job gains which led several top firms to erase the negative growth rates on their GDP forecasts. While not every firm was ready to dial their appetites for stocks from red to green, they did at least admit where they were wrongly bearish. That doesn't help those investors who waited on the sidelines with pockets full of cash, but hey, at least you were making 4.5% on your cash.

The earnings reporting season is moving to the back burner now that about 80% of the S&P 500 has reported numbers. As we watch the smaller caps and retailers report, we can sum Q2 earnings as one which was better than feared and where forward comments and guidance was better than expected. While some high-profile earners will continue to hit the tape, our interest in corporate data points will shift toward Q3 business trends.

Away from earnings, this is a very big week for inflation. We get the CPI on Thursday and the PPI on Friday. The market anticipates another slowing in inflation trends as auto prices and travel prices move lower and the shelter component continues to slide with current rental price trends. But lots of moving pieces here so a surprise in either direction is bound to create some early morning trading volatility. The Treasury markets have also gotten a bit jiggy in the last week as Wall Street's new forecasts have pushed investors to consider a stronger for longer outlook. Keep an eye on rates because as we know, the equity markets are not fans of one directional rips. Have a great week and cue up the "I'm Just Ken" dance.

Friday's July payrolls report confirmed the downward trend in US employment growth coming in below forecasts...

Downward revisions to May and June also could help the Fed's future decision making regarding the Fed Funds rate.

The Daily Shot

Of course, it does become more difficult to create jobs when everyone has a job...


But a benefit to slowing job growth and strengthening GDP is ramping productivity growth and lower unit labor costs which are both great for corporate margins...

Nonfarm productivity increased by more than expected in Q2 (+3.7% vs. consensus for +2.2%, both qoq ar), and the year-over-year rate increased 1.9pp to +1.3%. Since 2019Q4, labor productivity has grown at an annualized rate of 1.4%, roughly in line with the pre-pandemic trend. Unit labor costs—compensation divided by output—increased by less than expected in Q2 (+1.6% vs. consensus for +2.5%, both qoq ar), while the year-on-year rate decreased 1.2pp to +2.4%.

Goldman Sachs

The Fed's Barkin sees Barbie, Taylor Swift and businesses afraid of labor shortages as reasons the economy keeps moving forward...

So, why haven’t we seen a recession? I think it’s because the pandemic is still with us — not the public health crisis, thankfully, but the economic dislocation it unleashed.

Businesses experienced severe shortages over the last few years. So, they tell me they are holding on to workers and investing in safety stock. More fundamentally, they are still seeing healthy demand from their customers, and working through order backlogs. And manufacturing and construction are seeing a boost from coming government investments in infrastructure and the like. If your business is healthy, why cut back?

At the same time, consumers continue to spend, funded by excess savings accrued during the pandemic, elevated equity and housing wealth, and a robust jobs market. This year, the drop in gasoline prices has freed up additional spending capacity. In June, the Transportation Security Administration hit a new daily record for number of passengers screened. Barbie grossed $162 million in its first weekend. Taylor Swift is on a billion-dollar tour. Consumer spending is 68 percent of the economy and, while weaker, is still far from weak, as was shown in the most recent strong retail sales report.

You might still ask: Well, how about now? Are we finally going to experience the recession everyone has been predicting? Well, we will someday. As I said up front, no one banished the business cycle, so those who keep predicting a recession will eventually be right.

But most recessions come suddenly. Remember the pandemic or the global financial crisis. Unexpected shocks cause consumers and businesses to pull back in unison. For sure that could happen here; imagine, for example, a cyber shutdown. I’m not going to try to make a prediction on the unexpected.

Richmond Fed

Big news in the world of economic forecasting last week as Merrill Lynch throws in the towel on their recessionary outlook...

"We revise our outlook for the US economy in favor of a soft landing, where growth falls below trend in 2024, but remains positive throughout our forecast horizon. We forecast US GDP growth of 2.0% (4Q/4Q) this year, 0.7% in 2024, and 1.8% in 2025."

BofA Global

J.P. Morgan followed in changing its recession outlook for 2023...

While ramping tax receipts will not fix Fitch's concern's, it does help to point out additional strength in the U.S. economy...

@wabuffo: Federal payroll taxes in July up 11% vs July last year. In fact both June and July 2023 are up more y-o-y than the full year on TTM basis (4.8%)

Q2 earnings are not only coming in better than feared, but forward quarterly earnings estimates have begun to slow their descent...


The 2024 annual earnings estimate has also slowed its decline...

@dailychartbook: S&P 500 earnings estimates for 2023 and 2024 have improved slightly in recent weeks. (via JPMorgan)

Maybe the most important lesson from this earnings season is the strength in positive guidance...

@SouthernValue95: BofA: “W/ ~90% of SP500 earnings out, results are 4% better than consensus estimates. Better margins drove the bulk of the beat. Historically, there’s more negative than positive guidance but this quarter was the opposite, with a guidance ratio of 1.3x, the strongest since ‘21.”

Cardboard box volumes will tell you much more about the economy than any phone, email or faxed survey will...

We have heard from the #1 and #3 player in cardboard. Now here is the #2 player, Westrock.

David B. Sewell - CEO, President & Director - Westrock Company:

The -- our corrugated business was really pretty stable in the quarter from Q2 to Q3. But what's just really encouraging to us as we went into Q4 and in July, our order rate was up mid-single digits. And as I alluded to earlier, we are experiencing the strongest backlogs we've had this calendar year. So we really like the momentum of corrugated as we move forward.

Yahoo Finance

Many other forward-looking comments from last week's earnings calls were equally positive...

"We have seen an uptick in business over the past few days, in particular. But really, I think that over the past few weeks, we have started to start seeing a little bit better trend, if you will, and it goes back to maybe beyond that. I think we're at the end of a long, slow cycle.” - Old Dominion Freight Line CFO Adam Satterfield

"...Across our North America and international results, inflation headwinds also continue to ease, most notably in fuel prices, linehaul rates, ocean and rail rates." - Amazon CFO Brian Olsavsky

“My sense, talking to customers, is that while the macro environment is still challenging, it has stabilized. And for the first time in several quarters, sentiment among IT buyers does not appear to be getting worse." - Cloudflare CEO Mathew Prince

"Global leisure demand and ADR remained robust…Demand in this market has been stabilizing on a year-over-year basis with travelers from the region increasingly taking vacations overseas now that pandemic-related travel restrictions are behind us." - Marriott International Co-CEO Anthony G. Capuano

"Our order book remains stunningly high across all geographies in the full product range thanks to our robust order intake." - Ferrari CEO Benedetto Vigna

The Transcript

I see reaccelerating growth and now profitability in one of the biggest cloud players...

@TheTranscript_: Google Cloud posted a second consecutive quarter of operating profits: "We see continued growth with Q2 revenue of $8 billion, up 28%, and operating profit of $395 million"

Always a good sign for GDP when the biggest dirt digging equipment company is blowing the doors off...

Caterpillar’s revenue surged 22% in the second quarter as demand for its construction products rose despite higher prices.

The construction-equipment manufacturer has faced higher costs of materials, which has prompted price increases. But those price increases haven’t caused customers to pull back: In the first quarter, the company also reported that it sold more construction equipment even as the goods became more expensive.

Caterpillar expects this demand to remain strong. Elevated U.S. spending on infrastructure, in part brought by the $1 trillion bipartisan infrastructure bill, has boosted sales of Caterpillar’s construction equipment. Nonresidential construction—projects on commercial buildings—account for a majority of the company’s equipment sales.

Caterpillar’s results come as the construction sector is booming. Contractors have been inundated with projects from multifamily to infrastructure to industrial plants, prompting some concern about the availability of workers and materials.


Thank you to Congress for unleashing the public/private partnership known as the CHIPS Act...

All of this spending activity is sending many Industrial and Construction companies to the Large Cap All-Time New High list...

As the industrial economy ramps up, long dated Treasury bond yields have surged higher...

Too much too soon has become a new headwind for the equity market. Especially for companies with long duration earnings, like Solar companies, Biotechs or today's non-earners.

The sprint in long risk-free rates is also quickly un-inverting the yield curve...

Probably a good idea to read up on the Materials sector while on vacation this month...

@dailychartbook: Across asset classes, only base metals are discounting a recession.

Speaking of metals, if you were planning on installing copper gutters on your house in the future...good luck finding any!

@dailychartbook: "Copper remains on track for a near stock depletion by end of year." - Goldman Sachs

Speaking of commodities...

Difficult to consider spending years in college studying the oil & gas industry when the world is only a noble prize away from turning that degree into literal fossil fuel. This summer's advancements in fusion and superconductors are only pulling forward the date that petroleum loses transportation as a significant end market.


Both corporations and households are doing just fine with higher rates because they have locked in and extended duration...

Rising interest rates will take time to flow through to profit margins and household balance sheets. In contrast to some US banks that made extremely poor decisions to extend asset duration at the lows in rates, many US and European companies extended liability duration and enjoy the lowest levels of interest expense to cash flow in decades. As shown below, for the first time on record, corporate interest expense is falling as the Fed is hiking rates. US household debt service costs are also low. One reason: the average coupon on outstanding residential mortgages is ~3.5%, immunizing many homeowners from the spike in mortgage rates to ~7%. Credit card and auto delinquencies are rising, but from low levels and are now back at 2010-2020 averages.

J.P. Morgan

Guess what? Corporations have new financiers other than the banks...

@SnippetFinance: Bank credit conditions and high-yield spreads have diverged. This is unusual. Source: Apollo

Companies are feeling better about M&A this month as a small size Merger Monday rips through the world of finance...

First, Campbell's Pork and Beans pays 19.8x trailing EBITDA for Rao's Homemade Sauces.

At $2.7 billion, Campbell Soup’s acquisition of Sovos Brands, maker of the premium Rao’s tomato sauce, isn’t cheap. But it makes good strategic sense.

In a release, Campbell Chief Executive Mark Clouse referred to Sovos as “the most compelling growth story in the food industry.” The numbers back that up. Reporting its own second-quarter results Monday, Sovos said it grew organic net sales—stripping out the impact of a divestiture—by 16% from a year earlier, led by 29% growth for the Rao’s brand.

Campbell, which also makes the more down-market Prego brand of pasta sauces, stressed that it sees the two as a separate business serving different customers. Rao’s sauces sell for around $8 a jar compared with less than $3 for Prego.

“We’re not going to mess around much with that great sauce,” Clouse said of Rao’s on a conference call with analysts. “That quality is something we are going to be extremely guarded about.”


Then KKR helps a founding family take its satellite company private...

KKR & Co. plans to take private the German space and technology company OHB SE alongside the founding family as competition in the satellite sector heats up. Investors will received €44 ($48.33) for every OHB share, the company said Monday. That’s 38% higher than the closing price Friday. KKR also agreed to participate in a plan to raise OHB’s capital by 10%.

The news confirms an earlier Bloomberg report that the US buyout firm was close to announcing the deal. A group of Fuchs family shareholders, who together own about 70% of the company, won’t sell any shares. Shares of OHB are flat this year, giving it a market value of about €563 million.

OHB has built satellites and products for Europe’s Galileo navigation system, weather forecasting and the International Space Station. It’s also supplied technology to help search for life on Mars, track comets and support rocket launches, according to OHB’s website.


A smid cap packaging company elects to go private...

Veritiv on Monday agreed to be bought by private equity firm Clayton, Dubilier & Rice (CD&R) in a $2.3 billion deal that would take the packaging firm private.

The buyout of Veritiv, which makes paper-based boxes and cartons, and glass containers, comes against the backdrop of a recent consolidation in the packaging sector, as firms focus on recyclable packaging materials.

Slowing demand has also hit the packaging industry as consumers are cutting down on discretionary spending in the face of higher prices, interest rates and rentals.

Under terms of the deal, CD&R would pay $170 per in cash for each share of Veritiv common stock, representing a nearly 20% premium to its last close.


And the restaurant space remains active as the Pollo Tropical restaurant chain is nearing a deal to be bought by an investment firm for $225 million...

FRGI +6%; to be acquired by Authentic Restaurant Brands for $8.50/share. Upon closing the transaction, Fiesta will operate as a privately held company and Pollo Tropical will remain based in Miami, FL

Hammerstone Markets

A MAJOR bellwether for the IPO markets is going to hit in September...

It's success or failure could lead to a big switch being flipped in the capital markets. Given the high-quality nature of this chip designer and the excitement surrounding AI, this one will get a lot of attention.

SoftBank Group Corp.’s semiconductor unit Arm Ltd. is targeting an initial public offering at a valuation of between $60 billion and $70 billion as soon as September, a sign of bullish interest in artificial-intelligence chips, according to people familiar with the matter.

The roadshow is scheduled to start the first week of September with pricing for the IPO the following week, said one of the people, asking not to be named because the talks are private. The latest target for Arm’s valuation underscores a shift in market mood in favor of technologies linked to generative AI and chips. Earlier this year, bankers were pitching a range of valuations for the chip designer from $30 billion to $70 billion, Bloomberg News has reported.

SoftBank, led by Masayoshi Son, and Arm Chief Executive Officer Rene Haas long considered the bottom of that range too low. Arm executives may still be gunning for a valuation of as high as $80 billion, but the odds of achieving such a target are uncertain, one of the people said.


Private equity is increasingly embracing employee ownership...

We have written about CHI Overhead Doors and RBmedia. Watch this snowball continue to grow in size.

There are signs that workers are more often figuring into value creation plans as GPs explore shared ownership models. KKR, a pioneer of employee ownership, is playing an outsized role in this regard. Early on, the firm developed a conviction that an owner mindset – created by giving workers a voice in decisions – is key to business optimization. It could, for example, address overlooked issues, such as high turnover rates.

The private equity giant has applied shared ownership principles to its investing since 2011. Beginning with deals in industrials, led by Pete Stavros, co-head of global private equity, activity has expanded to take in control investing in other sectors across the Americas platform...

The firm recently agreed to sell audiobook publisher RBmedia to HIG Capital. This will result in a cash payout to workers based on their tenure, with long-term personnel earning up to 2x their annual salary. HIG reportedly said it would continue RBmedia’s program, possibly the first time this has happened in a sponsor-to-sponsor deal...

In another sign that employee ownership is catching on in private equity, sponsorship of non-profit advocate Ownership Works appears to be growing. This summer, Advent International and Sterling Group joined the organization, upping the number of GP founding partners to 24, Buyouts reported.

Founded in 2021 by Stavros, Ownership Works was initially backed by 19 private equity firms. Including Apollo, Ares Management, Goldman Sachs, KKR, Leonard Green & Partners, Silver Lake, TPG and Warburg Pincus, they pledged to carry out programs in at least three portfolio companies by 2023.

This effort is meeting with success, Ownership Works executive director Anna-Lisa Miller told Buyouts. She said the non-profit has 72 board-approved shared equity programs executed in businesses that are private equity-owned, impacting about 100,800 employees.

Buyouts Insider

If only there was a way to monetize all of that empty dining room space...

Americans are eating their burgers, fries and nuggets at home, in their cars and at the office—increasingly anywhere but at the fast-food restaurants themselves.

At McDonald’s and Burger King, booths are often empty. Customers pick up their orders and head out. People sitting at tables sometimes are workers on their breaks.

Dine-in customers now represent less than 10% of visits in most U.S. McDonald’s restaurants, according to chain franchisees, compared with around a quarter of domestic sales before the Covid-19 pandemic...

“You don’t necessarily need the big dining rooms that you needed in our traditional restaurants,” McDonald’s Chief Executive Chris Kempczinski said during an investor call in July.

McDonald’s and other chains are developing new restaurants centered around drive-throughs and carryout, with very little or no dine-in option.


The person who invented the recycling symbol wants to add a few hundred hours to your life...

Only recycle those plastic containers numbered 1 and 2. Everything else is likely headed to the landfill. Just call and ask your waste company. Even the best recycling programs are only collecting 1s and 2s to be turned into your next pair of Nikes. Everything else will become a seagull toy.

His Recycling Symbol Is Everywhere. The E.P.A. Says It Shouldn’t Be.

The agency wants to stop using the “chasing arrows” logo on plastics that can’t be recycled. The man who designed it more than 50 years ago agrees that the symbol has been misused...

Consumers have long treated the chasing-arrows logo as an indication that an item can be recycled, wrote Jennie Romer, a deputy assistant administrator at the Environmental Protection Agency, in an April letter to the F.T.C.

But when it comes to plastics that can be “deceptive and misleading,” Ms. Romer wrote. Manufacturers often pair the iconic logo with a resin identification code, with numbers from 1 to 7 that indicate the type of plastic in the product.

“Not all resin codes can be recycled currently in the United States,” she wrote. Many plastics, especially those numbered from 3 to 7, “are not financially viable to recycle.”

NY Times

“Money isn’t everything, but everything is money.”...

Jenny Just is a legit self-made billionaire. She won’t say how many billions, but calls a 2022 estimate of one and a half of them “conservative.” You haven’t heard of her, because until now, she’s had no reason to be out in public; with four kids and four companies, she likes to say, she has had plenty to keep her occupied. Plus, rich people often feel safer with a low profile. But during the pandemic, when her already substantial wealth blew up alongside the number of companies using a financial technology platform she and her husband created, she found a cause close enough to her heart to make her step into the limelight. Weirdly, it’s poker. Specifically it’s teaching 1 million women and girls how to play Texas Hold’em.

On the list of challenges that most people acknowledge women are facing in the second quintile of the 21st century—from being shut out of corporate boardrooms to untreated fistulas—the inability to play Texas Hold’em does not rank very high, but Just is all in. Since 2020, she has started a company, Poker Power, hired a staff, woven together a network of female instructors, built an app, bankrolled a number of high-profile events, and introduced about 32,000 women and girls to poker across 40 countries from Monaco to Kenya. “I’m not saying [poker] is the be-all and end-all,” she says. “But if women don’t get in positions of power, all those other things are going to continue to happen. And if you don’t understand the money and how you as an individual tie back to it, you’re not going to sit in that seat of power.”

Time Magazine

Now let me check to see how the Oregon Ducks fared in their last game against a Big 10 team...

Okay, I will allow the transfer. Bring on the Michigan's and Penn States. See you all in Eugene on game day.

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The author has current equity ownership in: McDonald's Corp. and Caterpillar Inc.

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