Weekly Research Briefing: Under Pressure

May 14, 2024

Time for another monthly inflation measure. April PPI drops on Tuesday and the CPI on Wednesday. Will housing prices continue to be stubborn in their retreat? Will auto insurance again surprise to the upside while the prices of the vehicles that they insure tumble lower? What about health insurance cost trends? From the looks of the street inflation guesstimates, expect some market volatility because there is a clear lack of consensus. Also, this week will bring some good hard data on industrial production, retail sales and housing starts. A basketful of retailers will also report their earnings which will tell us much about consumer activity.

As you sort all the week's tea leaves, the markets should remain active as summer inches closer. Companies continue to refinance their balance sheets and buy, sell or IPO their assets. With the equity and credit markets in "bull" mode, vacations will be canceled, and Manhattan food delivery services will be busy. This is harvesting time for those holding assets and planting time for others with free cash flow and dry powder. The financial sector indexes, Goldman Sachs and KKR & Co are trading at all-time highs for a reason right now, and it is not because bankers and traders are going to be spending their summer at the beach. Have a great week.

It is CPI week, and the 'Fed Whisperer' zeroes in on housing inflation. Interesting...

Stalled inflation this year hasn’t derailed the Federal Reserve’s plans to eventually cut interest rates. That’s because it expects a slowdown in housing costs to eventually drag inflation close to its 2% target.

The problem: It has been waiting for that slowdown for 1½ years now, and it still hasn’t arrived. The slowdown might simply be delayed. But some analysts worry it’s not going to happen because of changing dynamics in the housing market. If so, that would significantly weaken the case for lower rates.

Housing has played a large role in the inflation of recent years because its cost rose so much and carries such large weight. It is one-third of the consumer-price index and around one-sixth of the price index of personal-consumption expenditures, the Fed’s preferred inflation measure.

It is also, in theory, predictable. Government statisticians don’t use home prices to calculate inflation because a home is partly an investment. Instead, they use monthly rents to capture what tenants pay to rent a house or apartment, and what a homeowner would in theory pay to rent her own home...

Because only a minority of leases turn over each year, changes in market rents are reflected in inflation with a lag. Accounting for that lag, Fed officials, Wall Street investors, and private-sector economists have expected housing inflation to slow since late 2022 based on what has already happened with market rents.

Housing inflation has indeed slowed from a peak of 8.2% one year ago—but only to 5.6% in March, “a much slower pace than pretty much anybody anticipated,” said Jay Parsons, head of residential strategy at Madera Residential, a Texas-based apartment owner.


Morgan Stanley continues to see lower inflation and Fed interest rate cuts...

@carlquintanilla: MORGAN STANLEY: “.. regardless of the [CPI] print, we remain confident that inflation will trend lower over the year, making the question when, not if, the Fed will cut. .. If we are wrong, the market will likely adjust the implied timing of the first cut earlier or later, but we do not think that the path for the year is likely to change much. Where the signal is greatest, it points to disinflation. And where the data suggest upside risk, they are the noisiest.” #CPI

Meanwhile, corporate earnings estimates continue to rise, and not just among U.S. companies...

Goldman Sachs

The cruise ship industry has created its own flywheel: more cruise demand, bigger ships needed and more employees sought after...

The number of people taking cruises hit a record in 2023, and with the surge in demand and larger vessels, labor needs are growing. Tourism boards and port operators from around the world said Royal Caribbean is looking to hire worldwide and the company confirmed it will hire around 10,000 workers this year.

Royal Caribbean's sea-based workforce at the end of 2023 totaled about 88,700 employees, 6% lower than the year prior, according to the company's annual filing. The company's land-based workforce including private destinations consisted of approximately 9,500 full-time employees, up 17%.

Bookings hit a record in the first quarter, boosting quarterly revenue to $3.73 billion, up 29%, and the company's stock price doubled in the past year to hit a new record.


Higher-end furniture retailer not seeing any signs of a consumer slowdown...

Arhaus analyst question:

There's been a lot of chatter about weakening more on the lower income side in the last, call it, three to four weeks. Curious if there's any of that? Does it feel like the industry has bottomed in terms of demand that's reverted post-COVID and now bouncing along the bottom or maybe even getting better?

John Reed, CEO Arhaus:

I'm not an expert in what other people do. All I know is our business, and it's very strong. We've not seen anything changed in the last four, five, six weeks at all. That's first I'm hearing of that.

So yeah, I can't answer that. I stick to what we're doing and executing our plan and coming out with incredible product, executing it well, getting into customers' homes who are delighted with the systems we're using and how we're delivering it to them. And then they're telling their friends and neighbors, and they're coming in and buying it.

So I don't know. I've not heard anything about things or bottoming out, especially on the lower end.

Yahoo Finance

U.S. Bancorp sees continued consumer resiliency...

"Consumer spend is continuing to hold up pretty stable. And I would say that the things that are impacting them is inflation. The labor market is tight. Unemployment is only at 3.9%. All those things kind of come back to -- from a consumer perspective, they've been pretty resilient." - US Bancorp Chief Administration Officer Terrance Dolan

The Transcript

Torsten Slok has the charts for why higher rates are not hurting the U.S. consumer...

If anything, higher rates are actually helping any U.S. consumer who has money in the bank earning 5% interest rates up from zero 2-3 years ago.

The transmission mechanism of monetary policy is weaker because a rising share of US homes don’t have a mortgage, and about half of all mortgages have an interest rate locked in below 4%, see charts below.

Apollo Academy

Rising home equity, stock portfolios and wages is lifting household net worth up and to the right...

We expect consumer spending “to stay high as Baby Boomers, done with paying college tuitions and mortgage loans, spend their sizable nest eggs. (Many apparently are buying big-ticket items such as light trucks, for cash!)”


The consumer to corporation flywheel is accelerating which is good for everyone but equity and credit shorts...

@carlquintanilla: JPM DESK: “:. we may be witnessing a ‘virtuous cycle’ where a strong consumer keeps corporate margins stable .. the strength of corporate balance sheets means that we are unlikely to see a significant spike to layoffs and thus the unemployment rate. Relatedly, the interest rates on money market funds continue to help both consumers and corporations grow their cash.”

And stronger corporations are leading to an increase in equity repurchase activity...

BofA Global

Speaking of confidence in your stock, Incyte just put $2b on the Dutch Auction table...

Shares of Incyte surged Monday after the biopharmaceutical company said it was purchasing billions of dollars worth of its own shares.

Incyte (INCY), based in Delaware and Switzerland, sells cancer and inflammation and autoimmune drugs. The company is offering to buy up to $1.672 billion worth of its stock in a modified “Dutch Auction,” according to a press release on Monday.

It’s a type of auction where the company specifies a range of prices and shareholders can offer to sell whatever quantity they choose within that price range. Incyte will buy back shares at the lowest figure that would allow it to make the entire purchase.

In addition, the company has agreed to repurchase up to $328 million of stock from Julian Baker, a member of its board, and other entities, bringing the total buyback value to up to $2 billion.


CEO confidence will lead to even more spending on stock repurchases, M&A and capital expenditures...

@LizAnnSonders: CEO Confidence Index from @Conferenceboard moved up in 2Q2024 to 54 … second consecutive quarter in which index was above 50, indicating that CEOs are cautiously optimistic following 2 years of gloom.

Meanwhile, the credit markets remain wide open and are creating paper as fast as the machines will allow...

Businesses have rushed to tap lenders in the $10tn US corporate bond market this week, taking advantage of feverish investor demand and low borrowing premiums to issue swaths of new debt.

High-yield or junk-rated companies have issued over $14bn worth of dollar-denominated bonds this week across more than 20 deals, according to data from LSEG and FT calculations, the highest totals since late 2021.

Investment-grade borrowers, which typically have much more consistent access to capital markets because of their stronger credit quality, have sold $56.7bn of new bonds across 45 issuances — the largest weekly dollar amount raised since late February and the greatest deal count in two-and-a-half years...

The latest spate of borrowing in investment-grade and high-yield comes as credit spreads, or the premiums that corporate borrowers pay to issue debt over US Treasury bonds, have approached their lowest levels in almost two decades this week. Spreads have been squeezed as big investors stampede into the market to lock in attractive yields.

Financial Times

And if you need evidence that the debt financing markets remain super accommodating...

CVS is -45% from its two-year high and just plunged -20% after reporting its recent quarterly results, yet bond buyers are lining up for their recent debt offering.

CVS Health Corp. is selling $5 billion worth of bonds less than a week after shares plunged the most since 2009 on a downbeat quarterly report and cut 2024 outlook, joining a bevy of firms hitting the debt market following earnings season.

The drug-store heavyweight and health insurer is offering notes in five parts, according to a person with knowledge of the matter. The longest portion of the deal, a 30-year security, will yield 1.5 percentage point above Treasuries, after initial discussions of 1.75 percentage point, said the person, who asked not to be identified as the details are private...

This week has seen a flood of companies hit the US debt markets, including the investment-grade segment that CVS is issuing notes. Spreads there are at their tightest relative to government debt in 2 1/2 years and more high-grade issuers have entered the primary dollar bond market the past two days than at any other point in 2024.


Banks have even stepped up their lending activities...

@RenMacLLC: Less of a lending headwind? Bank lending has picked up this year. Last year, loans and leases in bank credit rose by roughly two percent, stalling through most of Q4. So far this year, the pace has picked up, up 7 of the last 8 weeks and on track for twice the pace last year.

And if the bank lending market does not suit one's need, then the private credit market might be a better fit for your company...

Intel is in advanced talks for a transaction in which Apollo Global Management would supply more than $11 billion to help the chip giant build a plant in Ireland.

The two firms are in exclusive talks for a deal that could come together in the coming weeks, according to people familiar with the matter, assuming the plans don’t get derailed.

A number of alternative-investment firms, including KKR and infrastructure investor Stonepeak, had also been in the running before Apollo recently pulled ahead.

Apollo’s High Grade Capital Solution business, which typically provides financing to large investment-grade companies, is spearheading the deal for the asset manager.


Or if your full faith and credit is not in a near perfect state, then you can increasingly borrow against your future royalty streams...

Nothing Bundt Cakes, a chain of bakeries known for one type of cake, is marketing a $240 million bond backed by nearly all of its assets, adding to the stream of esoteric offerings in the securitized debt market.

The Texas-based cake maker is borrowing in the whole-business asset-backed securities market for the third time after its initial foray in 2021, when it sold $355 million in bonds. This time, proceeds from the bond sale led by Barclays Plc will be used to refinance all of the company’s 2023-1 Class A notes and possibly to fund a payout to shareholders, according to a person familiar with the matter.

Nothing Bundt Cakes has grown over 50% to 582 total bakeries in the US and Canada since 2021, as of the first quarter this year, according to a report by Kroll Bond Rating Agency, which is rating the new single-tranche deal BBB-. The total system is 97% franchised, according to the report.

The whole business securitization market is a common pathway to raise capital for restaurants that franchise their stores. In such transactions, restaurants will pledge their franchise royalty streams and other assets as collateral. That structure allows credit investors to offer cheaper financing than other debt markets because it gives money managers more control if the company falls into distress.


Both Moody’s and Starwood are seeing an increase in risk appetite...

  • "The global economy has certainly demonstrated resilience, and that's also going to be reflected in declining high-yield default rates, which are now projected to range between 3% to 3.5% by year-end. And we see some strong investor demand for riskier assets that's kept spreads tight." - Moody's CEO Rob Fauber
  • "...we are seeing tailwinds in increased transaction volume and credit spread tightening, which will help our borrowers as they seek accretive refinancing alternatives. Recent issue BBB minus CMBS credit spreads, which are a good proxy for mezzanine CRE lending has tightened by over 300 basis points in the last six months and are back to second half of 2022 levels today." - Starwood Property Trust President Jeff DiModica

The Transcript

The breadth is strong in this market move. Don't fight it...


And the market strength is not just a U.S. thing...

The ACWI is made up of 2,840 companies across 47 developed and emerging market countries covering 85% of the global investable public equity universe by market cap. U.S. companies represents 63% of the total weighting.


Higher prices with low volatility are giving companies and investors a big reason to push the deal button...

The weekly list of M&A, IPOs and financial engineering continues to grow…

  • Website-development company Squarespace has agreed to a $6.6 billion takeover by buyout firm Permira, underscoring private-equity interest in the technology sector. Under the terms of the deal, Squarespace said Monday its shareholders will receive $44 in cash for each share they own, a 15% premium to Friday’s closing price. The deal values Squarespace at more than $6.6 billion on an equity-value basis and roughly $6.9 billion on an enterprise-value basis. (WSJ)
  • CVC Capital Partners is buying a minority stake in Hempel, the Danish owner of upmarket British paint company Farrow & Ball at $3.6B valuation (Financial Times)
  • Bain said to be in talks to take PowerSchool private at a roughly $6B valuation - press - Deal talk is said to be somewhere in the $20's per share (TradeTheNews)
  • KKR alone struck four deals in the region last week. Those deals included acquiring Bengaluru-based medical device maker Healthium Medtech and buying units of Australian fund manager Perpetual. In Japan, KKR’s Logisteed made a tender offer for Alps Logistics and it’s also working with Marriott International after acquiring a portfolio of 14 hotels. (Bloomberg)
  • Owners of Calpine reportedly considering a sale at a valuation around $30B including debt. Calpine was acquired in 2017 for $5.6B by Investor Consortium led by Energy Capital Partners (TradeTheNews)
  • EQT is offering to take one of Sweden’s largest wind park developers private, bolstering its ambitions in the renewable sector in Europe and the US. It’s offering 16.4 billion kronor for OX2. (Bloomberg)
  • Brazilian paper company Suzano has approached International Paper with an all-cash acquisition $42/share acquisition proposal. The deal would imply value of around $15 billion. (Reuters)
  • T-Mobile US and Verizon Communications are in discussions to carve up U.S. Cellular, one of the country’s last major regional wireless carriers, in separate transactions that would give both buyers access to valuable airwaves. (WSJ)
  • Kraft Heinz is exploring a sale of Oscar Mayer. The hot-dog maker could fetch between $3 billion and $5 billion. (WSJ)
  • Blackstone is working with the management of I’rom Group to take the Japanese pharmaceutical services company private. The proposal by the PE firm and I’rom’s management offers a roughly 50% premium to the Tokyo-listed company’s Monday closing price. (Bloomberg)
  • Walgreens is reaching out to potential buyers of the £7 billion Boots drugstore chain in the UK. (Bloomberg)
  • The value of bids for London-listed companies this year has hit the highest level since 2018, as beaten-up share prices help entice suitors and hand the UK a role in the burgeoning recovery in global dealmaking... London-listed groups have received more than $78bn worth of bids this year, with the majority coming from overseas buyers, according to data from Dealogic. (Financial Times)
  • CVC Capital Partners Plc is seeking a valuation of $2 billion to $3 billion in an initial public offering of personal-care business FineToday Holdings Co., people familiar with the matter said, as the private equity firm looks to capitalize on the strong performance of Japan’s stock market. (WSJ)

Multiple news wires and sources

Europe is lining up their summer IPO's...

Spanish clothing retailer Tendam and Greyhound bus owner Flix are considering launching initial public offerings in the coming weeks, seeking to capitalize on the growing recovery in Europe’s equity capital markets.

Tendam, which is backed by CVC Capital Partners Plc and PAI Partners, aims to announce its IPO around the last week of May, people familiar with the matter said. Munich-based Flix is likely to announce its listing plans around the first week of June, the people said...

The listings would give added momentum to the European IPO market, which is rebounding this year from a two-year slump. Companies in the region have raised more than $12 billion in 2024, more than twice as much as in the same period last year, according to data compiled by Bloomberg.


Even Chinese EV companies are soaring on their U.S. listing...

Shares of Chinese electric vehicle maker Zeekr Intelligent Technology Holding (ZK) stock was up 10% Monday after a huge move on Friday, which was the Chinese electric vehicle maker’s U.S. trading debut.

Monday’s gain follows a 35% jump on Friday. Zeekr priced its initial public offering of American depositary receipts at $21 each. The stock closed at $28.26.

The Friday price values the Zeekr stock at about $7.1 billion.


Get ready for another whole new level of risk taking as GameStop closes +75% on Monday...

If meme-stocks have returned to the financial markets, then you had better be reading Matt Levine who has a few dozen thoughts...

  • 1. What do you think this tweet means? Is it about Gill’s return to YouTube? To active stock trading? To GameStop? To some other stock? Is he getting into computer gaming content? Taking a life drawing class and tweeting his work?
  • 3. What probability would you assign to “he’s gonna be on YouTube talking about GameStop a lot, but now he’s short”? How funny would that be?
  • 7. Consider this hypothetical trade: (1) Keith Gill buys a bunch of short-dated GameStop call options, (2) he tweets a picture of a guy leaning forward in a chair, (3) the stock shoots up, (4) he sells the options for a profit, (5) he never returns to YouTube or otherwise says anything about GameStop at all. Is this a good trade? How many times could he do this? If you bought GameStop on the basis of his tweet, and this turned out to be the trade, how mad would you be?
  • 8. If you bought GameStop on the basis of his tweet, and he turned out to be just tweeting from his drawing class, how mad would you be?
  • 10. Keith Gill seems to have added like $3 billion of market capitalization to GameStop by tweeting a picture of a guy. I assume he captured at most a tiny fraction of this value. Given this very particular skill that he has — the ability to add billions of dollars of value to, at least, this stock, with essentially no effort — what is the best way for him to monetize it? What is the highest-value use that financial markets could find for Keith Gill?


Back to real businesses, do you want to know why utility stocks are the newest market leaders?

AI is about energy. And energy is now about AI. The vast amounts of computing power used to train generative AI and natural language models means that these two things are intertwined.

So prevalent is the data center narrative in the energy industry right now, that there’s some discussion of Big Tech companies influencing the future path of global decarbonization efforts.

To see just how dominant the data center narrative has been, take a look at Dominion Energy Inc., which says it’s connected 94 data centers over the past five years that are collectively consuming about four gigawatts of electricity — or roughly the output of four nuclear reactors and enough to power about three million homes.

Almost every single question on the company’s most recent earnings call was about data centers, and how much Dominion stood to benefit from booming demand. For the same period last year, there was just one question on the topic.


Earnings calls remain flooded with interest about AI data center power demand...

"We're seeing clear signs of a step change in the long-term fundamentals of power demand for multiple catalysts. This marks the departure from an extended period of stagnant power demand during which energy efficiency outpaced usage growth. For the first time in decades, and perhaps in my 40 years in this business, we are experiencing fundamental improvements driven by demand rather than commodity prices. We, along with every other forecasting expert I have read, are now expecting a step change in long-term power demand. This increase in demand is attributed to several factors, including electrification, manufacturing, onshoring, LNG, crypto, greater industrial loads, and data center growth. Recent advancements in Gen AI are compounding and accelerating these factors, leading to the formation of the next power demand super cycle." - NRG Energy Chairman Lawrence Coben

"We're seeing interest in developing projects that are on a size and scale that presently don't exist but will be needed for training systems and other things to kind of build out and support the need for all of these foundational models. I think they're up to 170 plus now. Foundational models that are going to require training, data centers. These things could be aerodynamics or pharmaceuticals, but essentially, these very, very large computers that would do nothing more than train for a period of time on all of the learnings in every country, in every language, from the beginning of time until now, be positioned to answer the questions of the future to advance these different industries. So we're seeing significant increases in the number of those training modules that customers need. It's our understanding that in order to support the training, we're going to need data centers that are of size and dimension from a megawatt standpoint that is far beyond what currently exists out there in the market." - Constellation Energy CEO Joseph Dominguez

"So it's very exciting times right now…the need for data centers, obviously rapidly increased even more so with artificial intelligence. I think in the U.S. market alone, power consumption, to reflect the number of servers that are expected, they're going to need 35,000 megawatts, right, versus, I think, we're at 17,000 megawatts right now by 2030." - Fluor CEO David Constable

The Transcript

The demand should be coming given the high quality of companies writing the biggest capex checks...

Goldman Sachs

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