Anthony B. Sanders – Course Notes For Financial Markets
Venture capitalists have poured billions of dollars into fintech unicorns, otherwise known as digital bank startups over the last decade. The biggest question everyone is asking is whether the fintech bubble has already burst.
Taking a look at the fintech mania, Ian Green, principal consultant for data and technology at The Disruption House, has provided the Financial Times with a chart of benchmarking and data analytics of the sector.
Calstrs, which sounds like a cholesterol-reducing medication, is selling $281 million in green municipal debt to fund expansion of their Sacramento headquarters.
(Bloomberg) — The California State Teachers’ Retirement System may have just missed its investment goal but its debut municipal-bond sale Thursday is right on target.
The public pension, the second-biggest in the nation, is selling $281 million in tax-exempt municipal green bonds at a time when wealthy Californians are snapping up such debt to drive down their tax bills and when buyers are increasingly seeking investments intended to lessen the impact of climate change. The pension, which posted a 6.8% return shy of its 7% expectation for the year that ended in June, is using the bond proceeds for an expansion of its West Sacramento headquarters designed to meet high environmental standards, including the ability to achieve zero net energy consumption.
While investors generally haven’t paid higher prices for assets complying with environmental, social and governance principles, that may change in the future, [famous last words] said Eric Friedland, director of municipal research at Lord Abbett & Co. That makes the Calstrs bonds, which are already linked to a strong state credit because of the financing California provides for the pension system, even more appealing, he said. (or appalling).
“If you believe that there will be more of an ESG focus going forward, and that people will pay a premium for green bonds, then you’re basically getting that for free right now,” Friedland said.
The new building, a 10-story tower, will link to the current headquarters and ultimately encompass 510,000 square feet serving 1,200 employees, according to bond documents. Elements include a child-care center, “irresistible stairwells” to encourage people to take stairs instead of riding an elevator and a cafe offering healthy meals with ingredients from the on-site garden, Calstrs Chief Financial Officer Julie Underwood said during the Environmental Finance conference at the Milken Institute in October.
Vanessa Garcia, a spokeswoman for Calstrs, said in an email that officials wouldn’t make public statements on the bond issuance through the California Infrastructure and Economic Development Bank until after the closing of the sale. The building is expected to open in 2022.
The pension hired Kestrel Verifiers to vouch that the securities meet the standards for green bonds from the Climate Bond Initiative. It makes sense that Calstrs would sell green bonds given how it uses its influence as a shareholder to drive social and environmental change, said Ksenia Koban, a municipal-credit analyst at Payden & Rygel Investment Management in Los Angeles. Calstrs, for example, has pressured Duke Energy to cut carbon emissions and retailers to adopt best practices for firearms sales.
Calstrs officials are “putting money where their mouth is in mainstreaming ESG practices and ideas,” said Koban, who called the bond offering “a great issuance.”
The state, which has booked years of surpluses thanks to its growing economy, plays a large role in the pension’s bottom line: it directly made 36% of all contributions Calstrs received last fiscal year and provides significant aid to school districts, which make their own payments to the pension. California lawmakers in this year’s budget made a supplemental payment to pay down the state’s share of the unfunded liabilities for the organization that represents more than 960,000 educators and their beneficiaries.
The system, which by law has limits on how much it can hike contribution rates, is five years into a plan to reach 100% funded by 2046. It has about 64% of the assets needed to cover its liabilities, according to the latest data.
The new bonds are rated A+ by S&P Global Ratings, which gives the rating a stable outlook because it expects the pension’s funded ratio to improve over the next two years. Moody’s Investors Service ranks the debt A1 and Fitch Ratings grades it AA.
Like many US pension funds, Calstrs is only 67.2% funded
Note that Calstrs has lowered their private equity investment target to 13% and raised their equity target to 47%.
Like other pension funds, Calstrs is heavily weighted in the technology sector.
And yes, California munis keep growing (with historic low interest rates and a still growing state economy).
There is a China trade rally going on!
A 2% post-Thanksgiving slump in the U.S. stock market couldn’t have come at a worse time for investors in exchange-traded funds. More than $38 billion flowed into equity-focused ETFs in November, the biggest monthly influx in almost two years, data compiled by Bloomberg show. The inflows accounted for about 77% of cash absorbed by U.S. ETFs in the period through Nov. 30, the highest proportion since April.
Fortunately for the stock market, the latest good news about US trade with China helped bolster a rally. Until we find out tomorrow that …
Or is it Fools Rush In?
It has been the longest bull market in modern history, enabled by massive Central Bank intervention. But with trade wars raging, Brexit, Presidential impeachment over something, etc., there remains a significant risk of a recession over the next 12 months.
If we look at the normalized change in the 10Y-3M curve minus normalized change in 10Y yields, we can see a heightened recession risk.
Lower yields and steeper curves are not a good recipe.
And then we have the decline in S&P 500 earnings estimates.
Recession coming?
Another consequence of Central Banks pushing interest rates extremely low … and ever negative.
(Bloomberg) — Investors plowing cash into private assets may recall the words of Wall Street legend Barton Biggs: There’s no asset class that too much money can’t spoil.
One of the most fertile grounds for funds harvesting returns in a world of negative-yielding bonds and expensive public companies — private equity — is being swamped.
Historically high valuations for leveraged buyouts has the likes of Morgan Stanley Wealth Management saying the industry has hit its peak after generating a decade of double-digit returns. That’s put the managers of vast pots of Californian retirement savings in a quandary.
“Returns are coming down,” said Elliot Hentov, head of policy research at State Street Global Advisors. “A lot of money is going into that space and we are seeing excess returns shrinking.”
California Public Employees’ Retirement Systems reported its PE portfolio delivered 7.7% in the fiscal year through June 2019, down from 16.1% in the previous period. The pension giant foresaw a future of shrinking private-equity earnings two years ago, when the board cut targeted margins above the FTSE All World All Cap index to 150 basis points from 300 basis points. The $388 billion asset manager has been examining new PE strategies.
“When you have so much liquidity available, naturally the price for illiquidity will come down,” Calpers Chief Investment Officer Ben Meng said.
Globally, the outperformance of PE over the S&P 500 fell to 1.07 times in 2017 from 1.69 times in 2001, according to data from PitchBook.
With so much money flooding the market, the problem is “how to achieve scale in the asset class in a very competitive, illiquid market environment,” Stephen McCourt, co-CEO of consulting firm Meketa Investment Group, told the Calpers board Nov. 18.
That’s left the biggest asset managers turning away a lot of deals even as they struggle to allocate capital earmarked for PE, according to McCourt, who advises Calpers and the California State Teachers’ Retirement System among others.
“We think we have a reached a peak in the private-equity market,” Morgan Stanley Wealth Chief Investment Officer Lisa Shalett wrote in an Oct. 28 note. “Investors tempted to chase the double-digit returns that many earned in private investment vehicles this past decade need to downgrade their expectations. The environment for private investing has gotten tougher.”
Investors can expect annual returns from private-investment funds of less than 10% in the future, below the 20%-plus that many of them delivered in past years, she predicted.
Calstrs chief investment officer Christopher Ailman is uninspired and under-invested. The second-largest U.S. pension had 9.3% of its $242.1 billion of assets in private equity as of Sept. 30, an allocation it plans to raise to 13% eventually. But Ailman is in no rush.
“Everybody is trying to chase what they perceive as the cream of the crop in private equity,” he said in a Bloomberg TV interview in November. “The median private equity portfolio return or GP return is usually actually equal or less than what you can get in public stocks.”
This is borne out by findings from Nicolas Rabener. The managing director of FactorResearch created an index of the smallest small-cap stocks and discovered in research last year that they performed in line with the U.S. Private Equity Index.
Interest in buying the equity and debt of unlisted companies, property and infrastructure has surged as the yields of $12 trillion of bonds globally fall below zero.
JPMorgan Asset Management recently touted such alternatives as a way to offset falling returns faced by traditional fund managers with 60% allocations in equity and 40% in bonds. Its strategists in November upgraded their forecast for private equity investments over a 10-15 year horizon to 8.8% from 8.25%.
And in the Nordic region, a growing number of pension funds are reworking their models to ramp up private-equity allocations.
Yet the reward for buying unlisted and hard-to-sell securities is becoming more elusive as fears over late-cycle economic risks spread.
At Hermes GPE, Peter Gale is seeking investments in fast-growing companies unfettered by the kind of large debt burden that often comes from private-equity led leveraged buyouts.
“Credit conditions are not as good as they used to be and there are so many people in the game,” said the head of private-equity investments. “Valuations have gone through the roof. Returns will have to diminish.”
And so will Private Equity fundraising.
Apparently, debt control is out of the question in this era of low interest rates. There is seemingly only one way out … and that it is MORE debt.
(Bloomberg) — Zombie companies in China. Crippling student bills in America. Sky-high mortgages in Australia. Another default scare in Argentina.
A decade of easy money has left the world with a record $250 trillion of government, corporate and household debt. That’s almost three times global economic output and equates to about $32,500 for every man, woman and child on earth.
Much of that legacy stems from policy makers’ deliberate efforts to use borrowing to keep the global economy afloat in the wake of the financial crisis. Rock bottom interest rates in the years since has kept the burden manageable for most, allowing the debt mountain to keep growing.
Now, as policy makers grapple with the slowest growth since that era, a suite of options on how to revive their economies share a common denominator: yet more debt. From Green New Deals to Modern Monetary Theory, proponents of deficit spending argue central banks are exhausted and that massive fiscal spending is needed to yank companies and households out of their funk.
Fiscal hawks argue such proposals will merely sow the seeds for more trouble. But the needle seems to be shifting on how much debt an economy can safely carry.
Central bankers and policy makers from European Central Bank President Christine Lagarde to the International Monetary Fund have been urging governments to do more, arguing it’s a good time to borrow for projects that will reap economic dividends.
“Previous conventional wisdom about advanced economy speed limits regarding debt to GDP ratios may be changing,” said Mark Sobel, a former U.S. Treasury and International Monetary Fund official. “Given lower interest bills and markets’ pent-up demand for safe assets, major advanced economies may well be able to sustain higher debt loads.”
A constraint for policy makers, though, is the legacy of past spending as pockets of credit stress litter the globe.
At the sovereign level, Argentina’s newly elected government has promised to renegotiate a record $56 billion credit line with the IMF, stoking memories of the nation’s economic collapse and debt default in 2001. Turkey, South Africa and others have also had scares.
As for corporate debt, American companies alone account for around 70% of this year’s total corporate defaults even amid a record economic expansion. And in China, companies defaulting in the onshore market are likely to hit a record next year, according to S&P Global Ratings.
So called zombie companies — firms that are unable to cover debt servicing costs from operating profits over an extended period and have muted growth prospects — have risen to around 6% of non-financial listed shares in advanced economies, a multi-decade high, according to the Bank for International Settlements. That hurts both healthier competitors and productivity.
As for households, Australia and South Korea rank among the most indebted.
The debt drag is hanging over the next generation of workers too. In the U.S., students now owe $1.5 trillion and are struggling to pay it off.
Even if debt is cheap, it can be tough to escape once the load gets too heavy. While solid economic growth is the easiest way out, that isn’t always forthcoming.
Well, despite the conventional economic wisdom that public debt growth is fine as long as GDP grows at the same rate, the USA has almost always experienced higher rates of debt growth than GDP growth (YoY).
Modern Monetary Theory (MMT) makes as much sense as this 1960s/1970s photo. (Is that New York Times opinion columnist Paul Krugman??)
The US Treasury actives curve has gone achy-breaky.
That is, going out to 5 years, the US Treasury actives curve is overall flat, with undulations.
And the US dollar swaps curve is higher at 3 months than at any other point on the curve.
Here is a video of me forecasting the US Treasury yield curve.
High beta investment strategies are great … when the market is rising. But low (and negative beta) strategies seem appropriate when investors anticipate an equity market downturn.
Bloomberg — The market, it’s said, finds a way to maximize the pain. For everyone who fell in love with cyclical shares just in time for them to drop the most in two months this week, it’s an adage they can relate to.
Lurches in retail, technology and commodity stocks are spelling trouble for newly christened macro bulls, sending an exchange-traded fund that tracks high-volatility shares to its first decline since October. Back on top are health care, utilities and real estate, defensive sectors that dominated all year.
While none of the moves were huge, they stung fund managers who hoped economically sensitive industries were tickets to redemption after 71% of them trailed benchmarks through October. Betting on volatile shares has been a hallmark of late-season recovery strategies that looked like a sure thing as the S&P 500 rallied. This week was a reminder they’re not.
Among struggling equity managers, a spate of improving economic reports opened their eyes to the possibility a pivot point was at hand for cyclicals. The veil lifted, mutual funds dutifully raised overweight exposure to the highest level in two years, according to Goldman Sachs, increasing allocations toward industrials and semiconductors and away from utilities and staples.
Here is the Invesco High Beta ETF, having a historic beta (relative to the S&P 500 index) of 1.30.
The Invesco bond fund has a beta of 0.073.
Invesco’s mortgage ETF (primarily backed by agency MBS) has a beta of … -0.025 relative to the S&P 500 index.
Lastly, we have the Invesco Muni fund with a beta of 0.044.
Of course, investors can hedge market downturns using options.
And we are talking about BETA and not BETO!
Deutsche Bank made the news, both in terms of an ECB warning and job cuts.
First, Deutsche Bank shares led rivals lower Wednesday after the European Central Bank warned that low interest rates could lead to excessive risk taking that could threaten the single currency area’s financial stability and noted deteriorating earnings prospects for regional lenders.
Deutsche Bank, like a number of Eurozone banks, has been crushed since peaking in 2007.
Of course, DB’s earning per share have been plunging like the German battleship Bismarck (along with the share price).
Cutting expenses is one way to increase EPS.
According to MishGEA, Deutsche Bank to Replace 18,000 Workers with Robots. Mark Matthews, head of operations for Deutsche’s corporate and investment bank, told Financial News that machine learning algorithms “massively increased productivity” and “redistribute capacity.”
The London-based news organization said that Deutsche is pushing to “automate large parts of its back-office” via a new strategy called “Operations 4.0,” as part of its $6.6 billion savings initiative over the next three years.
Matthews told FN that the machine learning tools helped to save “680,000 hours of manual work” and that it “so far used bots to process 5 million transactions in its corporate bank and perform 3.4 million checks within its investment bank.”
Of course, Meadows is referring to machine learning algorithms, not robots like in “Lost in Space.”
Now GMU finance students will understand why I force Python and Matlab on them in my classes!
To paraphrase the late Johnny Horton, “The Germans had the biggest bank that had the biggest guns.”
You gotta love The Federal Reserve. After 11 years of interest rate repression, The Fed now admits that continuing low interest rates could spark instability.
(Bloomberg) — Continuing low interest rates could dent U.S. bank profits and push bankers into riskier behavior that might threaten the nation’s financial stability, the Federal Reserve said in a report released Friday.
The latest version of the twice-yearly report, meant to flag stability threats on the Fed’s radar, highlighted the rate squeeze facing banks and insurers, noting that it could erode lending standards.
“If interest rates were to remain low for a prolonged period, the profitability of banks, insurers, and other financial intermediaries could come under stress and spur reach-for-yield behavior, thereby increasing the vulnerability of the financial sector to subsequent shocks,” the U.S. central bank said in the report.
Fed Chairman Jerome Powell suggested to lawmakers on Thursday that low interest rates might be a permanent part of the economic landscape.
“We’re in a world of much lower interest rates,” he told members of the House Budget Committee. “That seems to be driven by long-run structural things and there’s not a lot of reason to think that will change.’
Fed Governor Lael Brainless said in a statement Friday that the low-for-long environment “and the associated incentives to reach for yield and take on additional debt could increase financial vulnerabilities.”
The bulk of the work on the report was done before September’s repo market tumult, which prompted the Fed to pump reserves into the banking system to boost money market liquidity. Still, the report does briefly address problems with the short-term repurchase agreements.
“Pressures in the repo market spilled over to other markets, including the federal funds market,” the report said. “The Federal Reserve took a number of steps beginning in mid-September to maintain the federal funds rate within its target range and to ensure an ample supply of reserves. Pressures in short-term funding markets subsequently abated.”
The central bank appeared to take a more relaxed view of the rising stock market than it did in its last report in May.
While equity prices remain high relative to corporate earnings, they are consistent with the low level of interest rates, the Fed said.
“Over the past couple of years, equity prices have been high relative to forecasts of corporate earnings,” according to the report. “However, other measures of investors’ risk appetite in domestic equity markets are in the middle of their historical ranges.”
You mean like the Shiller CAPE (Cyclically Adjusted Price Earnings) ratio … that is near the level seen on Black Tuesday of 1929.
And then we have former Fed Chairs Ben Bernanke and Janet Yellen who kept The Fed Funds Target Rate (Upper Bound) at near zero from late 2007 to late 2015 (and then FINALLY raised the target rate in Dec ’15). As Meryl Streep uttered in Death Becomes Her, “NOW a warning?”
And then we had the joint rate-repression regimes of Bernanke and Yellen. Note the decline in the 10-year Treasury yield from over 4% in 2008 to under 2% today.
Yes, The Fed has suddenly come to the realization (after 11 years of low-rate policies) that low rates can spark instability.
