Private Wealth

Weekly Research Briefing: What does the Fed see on the road ahead?

November 01, 2022
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On Wednesday the FOMC will meet and give us a peek at what they think is around the next corner on their road toward driving inflation back toward 2-3%. We are highly certain that this week's Fed Funds rate increase will be +0.75%. But the market is split on whether the December 14 increase will be +50bps or +75bps? That hike will likely be very dependent upon the next six weeks of economic and price data combined with the FOMC's thoughts about the impact of their past hikes on the forward economy. So far, their rate increases have had a significant impact on some parts of the economy (like housing) and little to no impact on others (like travel). Non-semiconductor supply chain prices are moderating across many industries, but labor wage inflation remains sticky. The Fed's actions are working, but will it be fast enough for their inflation goals?

Something that wasn't expected to inflate during the third quarter earnings period was stock prices. But as it sits now, 2022 could mark the best October ever for the Dow Jones Industrial Average, with a 14% gain. Slowing growth, falling margins and disappointing outlooks, they said. Boo to that! The stock market is so much more than receding growth rates, margins, and cash flow at the mega technology companies. Did you see Coke and McDonald's numbers? What about Honeywell and Caterpillar? Someday we might have fun in the metaverse but when it comes to investing, today we want to own consistent top line growth, expanding margins and big cash flow generation.

Another big week for the markets as 150 reporting S&P companies will take us about three-quarters of the way through this earnings period. Also, the U.S. FOMC and Bank of England meetings and rate hike actions happen this week. For data, look toward the ISM surveys, the JOLTS and then Friday's jobs report. Full throttle ahead this week. You can downshift one gear next week.


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Right now, the markets are torn between a 50 or 75 basis-point hike in December...

CME Group


It looks like the bond market was oversold a week ago...

The 5% bounce during the week was a perfect picture of capitulation selling followed by weaker that expected economic data: Case-Shiller, Richmond Fed, Consumer Confidence, Pending Home Sales, and a dovish surprise from the Bank of Canada.


Meanwhile, the U.S. economy recovered in Q3 to grow at a 2.6% rate which happens to be near its 10-year average...

Q3 ADVANCE GDP ANNUALIZED: Q/Q: 2.6% V 2.4%E (moves out of technical recession)

PERSONAL CONSUMPTION: 1.4% V 1.0%E

Q3 ADVANCE GDP PRICE INDEX: 4.1% V 5.3%E; CORE PCE Q/Q: 4.5% V 4.5%E

TradetheNews

The Daily Shot


More importantly, the GDP data showed us that the price index inside has peaked...

The PCE price index decelerated – this measure of inflation was up just 4.2% the lowest level in 1Q21, suggesting that the Fed’s rate increases may be starting to have an impact. (D.A. Davidson)


Wage inflation remains sticky as Friday's employment cost index showed...

The Daily Shot


Supply chains have fully moderated as mid-Atlantic vendors are now hunting for orders...

@LizAnnSonders: Crash in vendor lead times component within @RichmondFed Manufacturing Index underscores significant easing in supply side stress.


This composite of Fed Regional surveys of prices received should be near the top of this week’s FOMC analysis pack...

@LizYoungStrat: A composite of the Prices Received components from regional Fed surveys (blue) has decelerated a lot. Historically, it has tracked y/y CPI (purple...is it purple or magenta?) really well (correlation=0.79). Spells downward path for future CPI.


The top Wall Street strategist now sees a market rally as both inflation and the Fed near a pivot point...

The end of the Federal Reserve’s campaign to raise interest rates is approaching, according to Morgan Stanley strategist Michael Wilson, who until recently was a prominent stock market bear who correctly predicted this year’s slump in equities.

Indicators including the inversion of the yield curve between 10-year and three-month Treasuries -- a recession indicator with a perfect record -- “all support a Fed pivot sooner rather than later,” Wilson wrote in a note on Monday. “Therefore, this week’s Fed meeting is critical for the rally to continue, pause or even end completely.”...

“This kind of price action isn’t unusual toward the end of the cycle particularly as the Fed moves closer to the end of its tightening campaign, something we think is approaching,” said Wilson, who was ranked the best portfolio strategist in the latest Institutional Investor survey. The rally will hold up until the next 12-month earnings-per-share estimates pull back more meaningfully, he said.

Bloomberg


Economists join the market in seeing 5% as the terminal Fed Funds rate in 2023...

Federal Reserve officials will maintain their resolutely hawkish stance next week, laying the groundwork for interest rates reaching 5% by March 2023, moves that seem likely to lead to a US and global recession, economists surveyed by Bloomberg said.

The Federal Open Market Committee will raise rates by 75 basis points for a fourth consecutive meeting when policymakers announce their decision at 2 p.m. in Washington Wednesday, the survey found.

Officials got further reason to stay the course when US government data on Friday showed employment costs rising at a firm pace in the third quarter and the central bank’s preferred inflation gauge still well above its 2% goal.

Rates are projected in the survey to rise another half point in December, then by quarter points the following two meetings. Fed forecasts released at the September meeting showed rates reaching 4.4% this year and 4.6% next year, before cuts in 2024.

Bloomberg


But even with the Fed's rate hikes, Bank of America CEO Brian Moynihan is not seeing a slowdown...

Interest rate hikes by the Federal Reserve are starting to be felt in the housing and auto markets, and renters will see their budgets squeezed as landlords pass on higher costs, he told CNBC’s “Squawk Box Europe.” But he stressed that consumer spending remains strong.

“If you raise rates and slow down the economy to fight inflation, the expectation is you have a slowdown in consumer spending. It hasn’t happened yet. So it could happen, but it hasn’t happened yet,” Moynihan said.

“You’re seeing a mitigation of the rate of growth, not a slowdown. Not negative growth.”

CNBC


And consumers look to remain confident now that gas and energy prices have moderated...

@tEconomics: Consumer Confidence in the United States increased to 59.90 points in October from 58.60 points in September of 2022.

@tEconomics


In a sure sign of strength, U.S. consumers, businesses and municipalities have excess savings, low debt costs, and distant maturities...

U.S. households still have around $1.7 trillion in savings they accumulated through mid-2021 above and beyond what they would have saved if income and spending had grown in line with the prepandemic economy, according to estimates by Fed economists. Around $350 billion in excess savings as of June were held by the lower half of the income distribution, or around $5,500 per household on average.

Businesses were also able to lock in lower borrowing costs as interest rates plumbed new lows in 2020 and 2021. Just 3% of junk bonds, or those issued by companies without investment-grade ratings, mature over the next year, and only 8% come due before 2025, according to Goldman Sachs.

State and local governments are also flush with cash, leaving them in a far better position than after the recession of 2007 to 2009.

WSJ


Even the rating agencies think that U.S. corporations are under leveraged...

"U.S. corporates are in pretty good shape from a leverage standpoint. When we look at free cash flow to debt, that’s one way to look at it across our rated U.S. corporates. It’s at about 11%. That’s the best that it’s been since 2011. So that, to me, means that corporates still have some room to take on some additional leverage." - Moody's CEO Rob Fauber

The Transcript


With the price of natural gas on its heels, you really don't want Santa to bring you coal for Christmas...

Natural-gas prices have fallen more than 40% since hitting shale-era highs in late August, reducing the risk of budget-busting heating bills this winter for millions of Americans and potentially easing a major cost pressure for manufacturers.

The decline is due to warm autumn weather, record domestic production and gas-storage facilities that have filled up fast since the end of air-conditioning season. Now, one of the big drivers of inflation costs roughly the same as it did a year ago.

Analysts warn that unusually cold weather could send prices soaring anew this winter, especially in the Northeast where maxed out pipelines have effectively capped output from Appalachia’s prolific producers.

Yet many are forecasting that prices will be lower on average in 2023 than they were this year. They expect rising supply from increasingly efficient North American drillers along with slower-growing demand from an economy throttled back by central bankers trying to slow inflation with higher borrowing costs.

WSJ


This was not the scariest earnings period ever...

Why such positivity in the market response, then? Because even though this wasn’t in their estimates, plenty of investors were worried about an all-out earnings crash. With the prominent exception of Meta, this hasn’t happened. Stocks had had a discount applied to them, which has been removed as shareholders realized they didn’t have to stay in the trench with their fingers in their ears. As Dennis DeBusschere of 22V Research puts it:

Beat percentages have been skewed lower than normal, with more 5-10% beats than usual and fewer 10%-plus surprises. That is a BIG shift from even 2Q, when beats were skewed higher than normal. Earnings growth is slowing, which needed to happen. The reason this season has proven to be a positive catalyst for equities is that earnings are NOT crashing.

The relief that things weren’t even worse has helped the slight pickup in earnings estimates for this quarter, from seriously low levels which according to 22V imply an imminent recession. And the general level of anxiety shows up in the way companies that beat estimates are being rewarded, and those that don’t are punished. Reactions are far more extreme than usual, as illustrated by 22V:

Bloomberg


A final big week of earnings with about 25% of the S&P 500 reporting...

@eWhispers


But wait, Mercedes can't do that? What happened to the recession and broken supply chains?

Mercedes-Benz raised its full-year profit forecast on Wednesday as strong demand for luxury cars and cost savings offset the supply chain bottlenecks that have hampered industry output this year. Mercedes reported Q3 results and raised its guidance for the year as demand continues to outstrip supply.

Bloomberg


And someone call the Hamburglar because McDonald put up a whopper global comps figure of +9.5% versus the +6% expectation...

McDonald's


Chipotle gets margin leverage as in-store sales return and price hikes don't detour sales...


And just like Pepsi, Coca-Cola's earnings bubbled past all estimates...

[KO] Reports Q3 $0.69 v $0.64e, Rev $11.1B v $10.6Be; Organic Rev +16%; Raises FY22 outlook

  • Guides Q4 EPS 'expected to include a 9% currency headwind', Rev 'expected to include an 8% currency headwind'
  • Raises FY22 comparable EPS +15-16%, Organic Rev +14-15%, Affirms Capex $1.5B (prior comparable EPS +14-15%, Organic Rev +12-13%, Capex $1.5B)
  • The company is encouraged by the underlying topline momentum, and will leverage its capabilities to sustain topline growth amidst the ongoing inflationary backdrop.
  • The company expects global inflation to continue to impact its expenses across the board, and also expects commodity prices to remain volatile. The company has benefited from its hedges in 2022 and expects elevated inflation on a per case basis in 2023.
  • Organic Rev +16% v +10%e
  • CEO: “Our business is resilient amidst a dynamic operating and macroeconomic environment. We are investing in our strong portfolio of brands, which is a cornerstone of our ability to deliver long-term value for our stakeholders.”

TradetheNews

Coca-Cola Company


Southwest Airlines could use more capacity but is making a ton of money without it as travel demand remains straight up...

[LUV] Reports Q3 $0.50 v $0.41e, Rev $6.22B v $6.32Be

  • Guides Q4 Op Rev +13-17% v Q4'19
  • Guides Q4 ASMs -2% v Q4'19
  • Load factor 85.4% v 83.5% y/y
  • CEO: "Following record summer leisure travel demand, revenue trends remained strong in September 2022, bolstered by improving business travel trends post-Labor Day. Leisure and business demand remains strong, and we currently expect revenue trends to improve sequentially from third quarter to fourth quarter 2022, despite lower capacity.

TradetheNews


No slowdown at Hubbell as the importance of distributed and measured electrical power gains significance...

[HUBB] Reports Q3 $3.08 v $2.73e, Rev $1.32B v $1.25Be; Raises FY22 outlook; Notes material costs eased in the quarter

  • Raises FY22 $10.25-10.45 v $9.93e, organic Rev +17-18% y/y (prior: $9.40-9.80, organic Rev +13-15% y/y)
  • Organic net sales +20% y/y
  • CEO: “From an operating standpoint, we continue to effectively navigate a dynamic environment. Supply chain headwinds and significant non-material inflation persist, but price traction remains strong and material costs eased in the quarter. Overall, we are pleased with the year-to-date execution, and remain confident in our ability to continue delivering attractive near-term and long-term results for our shareholders.

TradetheNews


Caterpillar puts up a set of incredibly strong numbers even as our big blue marble slows down...

Caterpillar Inc. surged the most in two years after the company said it sold more of its iconic yellow bulldozers and diggers than analysts expected, weathering supply chain snarls, surging raw material costs and a global economic slowdown.

The bellwether company reported higher shipments of machines and increased prices across its end markets in the third quarter, more than offsetting surging inflation costs that have dogged American companies for over a year. Third-quarter adjusted earnings were $3.95 per share, beating the $3.18 average estimate of 24 analysts polled by Bloomberg...

“We continued to see healthy demand across most of our end markets during the third quarter,” Chief Executive Officer Jim Umpleby said Thursday in the company’s earnings statement.

The machinery maker has been hit by rising freight and material costs throughout the year, eating into profit margins and forcing it to employ different logistics strategies to damp the impact. The third quarter suggests Caterpillar may be getting past the worst of it, and the company indicated in a presentation that it expects fourth-quarter price hikes to more than offset manufacturing cost increases.

Bloomberg


Ditto for Honeywell, which operates with a global reach and with a strong U.S. dollar headwind...

"Honeywell executed exceptionally well in the third quarter, meeting or exceeding guidance for all metrics," said Darius Adamczyk, chairman and chief executive officer of Honeywell. "Despite ongoing challenges across supply chains, we grew sales by 6% on a reported basis and 9% organically, with strong double-digit growth in our advanced materials, commercial aerospace, and building products businesses. Our backlog remains near record levels, closing the third quarter at $29.1 billion, up 9% year over year, and providing us with confidence in our demand expectations against an increasingly uncertain macroeconomic backdrop. We continued to reap the benefits of our Honeywell Digital transformation investments made over the past few years and we leveraged these digital tools to drive agile commercial and operational actions, which enabled us to stay ahead of the inflation curve, expand margins, and beat the high end of our adjusted EPS guidance. We also executed on our capital deployment strategy, deploying $1.2 billion in the quarter, including $0.4 billion of share repurchases, and raising our dividend for the 13th time over 12 consecutive years."

Honeywell


Also impressive at Sherwin-Williams where a housing slowdown and raw material prices were easily absorbed by the strength of their U.S. business...

[SHW] Reports Q3 $2.83 adj v $2.60e, Rev $6.05B v $5.81Be

  • Guides Q4 Core net Rev 'Up high-single to low-double-digit' % y/y
  • Affirms FY22 adj $8.50-5.80 v $8.60e, Rev 'up low single digit' y/y (prior: adj $8.50-8.80, Rev "up high-single to low-double digit %" y/y)
  • Adj EBITDA $834.2M v $848.7M y/y; margin 18.6%
  • Performance Coatings Rev +13.7% y/y
  • Consumer Brands Group Rev +8.5% y/y
  • US and Canada SSS +20.7%
  • CEO: "In The Americas Group, we continued to capture strong demand across all professional architectural markets, as same-store sales increased 20.7% in the third quarter, and we are seeing strong realization from our September 6th 10% price increase. In the Consumer Brands Group, double-digit growth in North America was partially offset by continued tightness in supply of alkyd resins and headwinds in Europe and Asia, while segment margin improved significantly sequentially and year-over-year. Momentum continues in the Pros Who Paint category with our North American retail partners. In the Performance Coatings Group, sales grew in every division as a result of pricing actions across all divisions and contributions from acquisitions. Regionally, sales were up strong double-digits in North America and Latin America, and high-single-digits in Asia, partially offset by a mid-single-digit decline in Europe. Segment margin in this group also meaningfully expanded sequentially and year-over-year.
  • "We expect the strong positive results we experienced in the third quarter to continue into the fourth quarter, driven by continued momentum in both The Americas Group and North American industrial end markets, continued price realization, good cost control, and softer year-over-year comparisons"

TradetheNews

Sherwin-Williams


A bit of a different tone over at Amazon where customers might be shopping at the website less today than when the world was in COVID lockdown...

"...the macroeconomic environment remains challenging worldwide. The continuing impacts of broad-scale inflation, heightened fuel prices and rising energy costs have impacted our sales growth as consumers assess their purchasing power and organizations of all sizes evaluate their technology and advertising spend. As the third quarter progressed, we saw moderating sales growth across many of our businesses as well as the increased foreign currency headwinds I mentioned earlier, and we expect these impacts to persist throughout the fourth quarter." - Amazon.com CFO Brian Olsavsky

The Transcript


Amazon's cloud business also posted a meaningful stepdown in its growth rate...

@TSOH_Investing


The change in Alphabet's advertising growth was also significantly negative as consumers put down their mice...

Alphabet Inc. isn’t doing so well, but at least it’s growing. A 6.1% increase in third-quarter revenue was the slowest since June 2020 after the Covid-19 pandemic hit. Its Google search-based advertising divisions are outpacing its network affiliate businesses and video service YouTube, while cloud services remain solid.

Bloomberg


Goodbye free cash flow and hello investor disappointment...

Someone forgot to send Mark the memo that this was a year to generate cash, not spend cash. Investing aggressively to fight TikTok and build a Metaverse could pay off in the future, but in 2022 investors will not sit through an expensive and high-risk investment cycle.

$69bn of Capex in 2 Years...as Required Capital Intensity to Differentiate Rises and ’23 FCF Falls by ~60%... META’s $173mn of 3Q FCF was $5bn(!) lower than expected and the $34bn bottom end of ’23 capex guide was 25% ($7bn) higher than modeled. This is due to the fact that META is spending more than thought to build out its AI infrastructure/datacenter footprint…even after $32.5bn of estimated capex in ’22. At a technical level, the '23 capex step-up is being driven by increased spend in more sophisticated GPUs and AI-driven data centers (which come on top of more core incremental data center capacity). On the positive side, META is seeing some early positive signal from these new AI-driven investments (improved matching on Reels and higher watch time, improved ad offerings, etc), but it's very early. But stepping back, we see these investments as a signal of higher required structural capital intensity going forward as META adjusts to the post-IDFA social media landscape that is more driven by short-form video than social content/signal. Material revenue and engagement incrementality from these investments is likely to take time (well into ’23?) and is uncertain. And in the meantime, we see earnings power staying depressed. Consider that our ’23/’24 revenue forecast is falling 1%/1% (modestly slower organic growth and FX)...while ‘23/’24 FCF is falling 59%/48%.

Morgan Stanley


With last week's decline, Facebook is now nearing 10 years of underperformance versus the S&P 500...


Distressed property sales could rise sharply in the next few years as sellers and buyers meet on price...

"Generally, once buyer and seller's expectations align again, sales volumes increase and distressed sales grow significantly. Currently, distressed sales rates are at multiyear lows, but believe they will significantly climb in the intermediate term. In 2008, the year of significant economic dislocation, there were only about 2,900 distressed commercial property sales, and distressed sales took years to peak with about 16,000 distressed sales in 2012. Year-to-date, similar to 2008, there's only been about 2,178 distressed sales. I would not be surprised if the number of distressed property sales quadrupled over the next few years," - CoStar CEO Andrew Florance

The Transcript


Another public company hands in its ticker...

UserTesting is a small cap customer experience platform growing 20-30% and now is going private at a 6x EV/EBITDA valuation. The company IPO'd a year ago at $14. Hit a high of $15.98 and fell to a recent low of $3.31.

[USER] Confirms to be acquired for $7.50/shr by Thoma Bravo and Sunstone Partners for $1.3B

  • Entered into a definitive agreement to be acquired by Thoma Bravo, a leading software investment firm, and Sunstone Partners for $7.50 per share, in an all-cash transaction valued at approximately $1.3 billion. The offer represents a premium of approximately 94% over UserTesting’s closing stock price on October 26, 2022 and a premium of approximately 97% over the volume weighted average price (VWAP) of UserTesting’s shares for the 30 trading days ended October 26, 2022.
  • Following the closing of the transaction, Thoma Bravo and Sunstone Partners intend to combine UserTesting and UserZoom, which Thoma Bravo acquired majority control of in April 2022. UserTesting’s CEO, Andy MacMillan, will lead the combined company. Additionally, the combined company will benefit from the operating capabilities, capital support, and industry expertise of Thoma Bravo and Sunstone Partners.
  • The companies’ complementary offerings will create a powerful end-to-end solution in the customer experience space—helping more organizations around the globe innovate, drive revenue, manage risk, and deliver exceptional customer experiences. UserZoom is a user experience (UX) insights company empowering its customers with tools to conduct high quality research and increase research productivity. By combining UserZoom’s multi-method research capabilities, proprietary benchmarking methodology, and research repository with UserTesting’s proprietary contributor network and enterprise-scale experience testing platform, customers will be able to leverage the strength of both solutions to build better product, customer, employee, and brand experiences.

TradetheNews


And the stock market's 50% off sale allows Regal Beloit to get much bigger in robotics...

[AIMC] To be acquired by Regal Rexnord Corp for $62.00/shr in cash valued at ~$5.0B

  • Announced today that it has entered into a definitive agreement to be acquired by Regal Rexnord Corporation (“Regal Rexnord”) for approximately $5.0 billion on an enterprise value basis. Under the terms of the agreement, Altra shareholders will receive $62.00 in cash for each share of Altra common stock, representing a 54% premium to the closing price of the Company’s common stock on October 26, 2022. Regal Rexnord has fully committed debt financing and there are no financing conditions associated with the transaction.
  • Altra’s Board of Directors has approved the merger agreement and the transaction is expected to close in the first half of 2023, subject to customary closing conditions, including approval by Altra shareholders and receipt of regulatory approvals. Upon completion of the transaction, Altra shares will no longer be listed on any public market.

TradetheNews


FAANG had a good run. Could this be the end of market-cap weighted passive equity investing?

Active equity portfolio managers will be lining up to compete against the S&P 500 index now!

WSJ


Lloyd Blankfein sees too many bears...

“The bad news is so stacked up that people are under-appreciating the fact that there are several plausible pieces of good news that could affect the market positively,” he said, citing a change in Russia’s approach to the war in Ukraine, the release of more oil by Saudi Arabia and a pause in rate hikes by the Fed. “Markets are not just the current economy, they look ahead.”

This year’s selloff has been equally punishing for many stocks, he said. “Move into those you wished you owned but were too expensive.”

Mr. Blankfein said it’s worth remembering the challenges of the moment always seem worse than those of the past, if only because the past is resolved. And history, like the markets, has cycles.

WSJ


If some of the market's biggest bears go into hibernation, some of the biggest upside opportunities are likely listed on overseas stock exchanges...

J.P. Morgan


Now that the September valuations are in, it is time for a monthly check of my private market portfolio ballast...

My portfolio couldn't be happier to have exposure to the private markets. Since our acquisition by Hamilton Lane last spring, my most important private market exposure has outperformed the S&P 500 by over 3,700 basis points and the major bond aggregate index by over 4,200 basis points. While I realize that this magnitude of outperformance will be unlikely to continue, I feel confident about the portfolio of companies into which we have invested. And with public company valuations currently depressed, there are now increased opportunities to put fresh capital to work both in public to private buyouts as well as via secondary market transactions which I highlighted last week.

S&P Capital IQ and Hamilton Lane


Last week's earnings-driven declines in the mega-cap technology names is just one more reminder why investors should consider the private markets...

By including private companies, an investor greatly expands their potential investable universe not just in the smaller sizes of companies available, but also to an increased number of industries and customer end markets. Thus, an investors returns do not have to be dependent and concentrated toward online internet advertising or corporate IT spending cycles.

One could maybe find some of the same diversity inside of a public security index of 1000+ names, but that same index will have an investment concentration toward its largest market caps based on the valuation of the company, not the opportunity of the individual investment.

If one only invests into the public stock markets, then that investor has exposure to the dark blue boxes in the chart below. Why limit one's portfolio to what is only publicly traded? Time for non-institutional investors to expand their investable universes and look at the other 80-90% of the world's companies that they have been missing out on.

Hamilton Lane


One growing area of private market investment has been into the European football business. Here is why...

Unbowed, American investors find English football still a highly appealing investment.

First, they perceive more runway for growth. American investors compare the revenues generated in the NFL with those of the Premier League. The NFL has over twice the turnover of the Premier League, even though the former is a domestic league and the latter has global reach. The new owners believe that there is still significant growth still to come from broadcast rights, merchandising and global tours, and that the Premier League has the potential to overtake the NFL by a big margin.

Second, the Premier League is seen as immune from creative destruction and business obsolescence. Many of its leading names have been prominent for over a century, and although the risk of relegation lingers, the long-term stickiness of fan loyalty gives the type of assurance more commonly associated with an oligopolistic market.

Third, Premier League investors are keen to exploit the opportunities thrown up by multi-club ownership and consequent brand extension, with City Football Group’s progress with clubs in the US and Australia as the model. This model increases the potential for scale sponsorship deals, branding partnerships and the increasingly popular women’s football. The thesis is that this approach will turn club ownership into a franchise, changing the dynamic of negotiations with broadcasters and commercial partners.

Finally, there’s the small matter of currency. Prior to the 2016 Brexit referendum the pound hovered in the $1.50-1.60 range. Today it stands at $1.13, having hit a low of $1.06 in the wake of the UK government’s mini-budget, with a growing current account deficit meaning that the UK will require the “kindness of strangers” to provide capital for some time to come. Now is an ideal time to purchase sterling-denominated assets with global reach, although higher interest rates and weak appetite for sterling debt mean that acquirers will need to stump up more equity. S&P may rate UK sovereign debt as AA, but for asset buyers “Global Britain” is rated BBB — bargain basement Britain.

Financial Times


Bank lending windows are closed which has created a window of opportunity for private market lenders in yesterday’s big $14b HVAC deal...

Emerson Electric Co. is selling a majority stake in its climate-technologies business to Blackstone Inc. in a transformational deal for the industrial company that would value the unit at $14 billion including debt and mark the biggest private-equity buyout in months at a time when such activity has been choked off by market volatility.

The deal, expected to be announced Monday, would give Blackstone a 55% stake in the unit, which sells compressors and other HVAC products and services used in commercial and residential heating and cooling as well as cold storage, executives from both companies said. Emerson would retain a 45% stake.

Blackstone and its co-investors would contribute $4.4 billion in equity toward the deal, which would be supplemented by $5.5 billion of debt financing. Equity that Emerson is rolling over along with a $2.25 billion seller note would account for the remainder of the price tag.

In a typical market, banks would provide the debt financing, carving it up and selling it off to a number of buyers. Banks currently aren't offering such so-called syndicated financing, however, as they grapple with a glut of debt from big buyouts struck before the stock market tumbled earlier this year.

Instead, Blackstone had to place the debt itself, selling it off to an assortment of direct lenders and others in a process that took the better part of a month, the executives said. It is a process the firm has undergone before during times of market illiquidity, most recently in the aftermath of the 2008-09 financial crisis, though never with a deal of this size.

WSJ


If you have any interest in the public credit markets today, then you should be sprinting to research the private credit markets right now...

Private market credit deal activity is very robust now due to the retreat of the major banks and 'good times only' lenders. While current default rates are only about 1%, they will likely increase as the Fed slows the U.S. economy. But rapidly widening loan spreads and discounted leverage loan pricing is creating opportunities for smart lenders and investors. Private market senior credit has been a great way to participate in a rising rate environment while also offering downside protection. I'll let my credit team explain:

Four ways senior credit can offer downside protection beyond a floating rate hedge

For investors seeking downside protection, risk-adjusted returns and attractive floating cash yield, there are four reasons why senior credit may be the right solution:

  • First lien position. Aside from the advantages of largely floating rate instruments, senior credit also has a lot to offer in terms of structural features that can provide stability and enhance the attractiveness of the asset class as an all-weather strategy. Some of these aspects are relatively intuitive: Senior credit sits at the top of the capital structure in a first lien, dollar one position. While equity and junior debt may offer more upside and return potential, this priority means that senior credit is the last security to be impaired if a company underperforms. And with long-term recovery rates on first lien bank term loans averaging 75%, even in a worst-case scenario, the high potential for capital preservation remains strong.
  • Cash flow. From a cash flow standpoint, senior credit may offer quarterly cash payments and typically provides some level of principal amortization. In addition, as a company pays interest and principal, not only does the company pay down its debt balance – and, by extension, helps reduce its risk exposure – but the lender’s at-risk capital can decrease as it receives cash distributions.
  • Governance. While considerable ink has been spilled over the shift in recent years to covenant-lite structures, senior credit still offers a reasonable amount of controls on the business and sponsor’s activities. Financial reporting, distributions out of the business, transfer of assets and incurrence of additional debt are all areas that may be covered under the affirmative and negative covenants in a credit agreement. Granted, even though the devil is still in the details, lenders are nonetheless afforded these important protections.
  • Sponsor capital. Senior credit, especially within the private debt landscape, often sits alongside investments from a private equity sponsor. In addition to providing a cash equity infusion into the business, sponsors typically offer a level of oversight, resources and direction that may otherwise be lacking in a non-sponsored, middle-market business. And while it’s challenging to lump sponsor activity into a universally consistent approach, very frequently fresh sponsor capital will be the first line of defense if a company needs additional liquidity.

Senior credit has historically shown a considerable degree of outperformance over the last eight years relative to the leveraged loan index.

Even measured against the broader index of private credit, senior credit can offer a favorable level of volatility and risk/return measurement as well.

Hamilton Lane


Public credit and equity players also think that it is a good time to be getting bigger in the private credit markets...

US-based investment manager Nuveen is buying Arcmont Asset Management, one of the largest private lenders in Europe, for over $1bn as traditional asset managers acquire fast-growing private capital firms in order to grow their presence in unlisted markets.

Nuveen, which is the investment manager for US teachers pension fund TIAA, is buying Arcmont to build its lending presence in Europe and expand its overall private credit business as rising interest rates make secured floating rate loans more attractive.

The acquisition comes amid a wave of dealmaking activity in the alternative asset management sector, particularly for private credit lenders that have increased their share of takeover financings this year as large banks pull back from making buyout loans.

Large asset managers such as T Rowe Price, Franklin Templeton and BlackRock have acquired private debt managers in recent years as a response to the rise of passive investments, which have cut into their profitability. Last year, T Rowe acquired Oak Hill for $4.2bn, while BlackRock acquired Tennenbaum Capital in 2018.

Financial Times


If you had any remaining questions about crytpo, the blockchain, bitcoin or NFTs, this is a well written 40,000 word read...

Link is below but you will probably want the full hardcopy from your local newsstand.

Bloomberg


If in Denver this week, we are at booth 424 by the Spotlight Stage...

@hamilton_lane



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DISCLOSURES

The author has current equity ownership in: The Coca-Cola Co., Pepsico Inc., McDonald's Corp. and Caterpillar

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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