Duck Diving

361 Capital Market Commentary | April 20th, 2020

So, it looks like the U.S. will duck dive through this first wave of COVID-19 cases without catastrophic damage. We can’t see what the next wave looks like, or how far away it might be, but hopefully we will be more prepared to take it on. Therapy drugs are being developed and used on patients with some early success. New test kits for the virus and antibodies are being developed and rolled out as quickly as possible. And some interesting progress is being made on vaccines as the world’s scientists run toward a certain Nobel Prize.

As we swim through to the other side of this big first wave, you can feel the impatience setting in to reopen parts of the economy. It is going to happen soon as states, cities and citizens need to start rebuilding their financials and get back on stable ground again. Hopefully with safe practices and continued social distancing, we can begin to open up and operate again and repair this economy that just dropped 20M+ workers from the payrolls. Increased testing will allow the U.S. to move from a crawl to a sprint more quickly without fears of another wave of breakouts. But until we are testing close to a million people a day in the U.S., expect to see plenty of masks and a changed work environment.

For the markets, progress on therapies for infected patients (like Remdesivir), a path to much-increased testing (big ramps by Abbot and Roche) and an increased flattening of the curve in the biggest cities and states is all good news. Yes, while economic and corporate reporting data will look abysmal for March and April, economic activity will begin to return in May. Any improvement in activity as the economy moves from a crawl to a walk will be a small reward for the markets. With the Federal Reserve providing so much support in the credit markets, even the most stressed manufacturing and operating companies are able to tap the financial markets for new debt. Not everyone will make it as Neiman Marcus’ potential bankruptcy filing this month will show. But most companies will be able to hold their breath through this duck dive.

Now that the worst of the markets seem to be behind us, for investors in equities and credit, the next challenge will be to decide which companies will win and lose. The after-effects of COVID-19 will cause significant disruptions to how most businesses operate and to the cost structures to generate revenues. While some areas of healthcare will see permanent increased revenues―as government spending prepares for a future healthcare emergency―other areas of healthcare, like assisted living and rehabilitation facilities, will see much higher costs. Restaurants will lose a significant portion of their dining room square footage to social distancing while grocery stores could see a permanent increase in volumes from more at-home dining. The shift toward online retail just accelerated many years in just one month. And many organizations are about to realize how much cost savings they can generate from allowing a more mobile and work from home employee base. Large venue gatherings will take a while to return, so how will the movie theaters, concert halls and sports industry adapt to survive? And, as many industries battle in difficult environments where many participants do not survive, how much more valuable will the remaining survivors become in future years? (See the energy, retail and airline industries.) So many questions for investors, lenders, government officials and employees to consider as the world begins to reopen.

Surprisingly, Warren and Charlie are not seeing a flood of deals right now…

“Warren wants to keep Berkshire safe for people who have 90% of their net worth invested in it. We’re always going to be on the safe side. That doesn’t mean we couldn’t do something pretty aggressive or seize some opportunity. But basically we will be fairly conservative.
And we’ll emerge on the other side very strong.”

Surely hordes of corporate executives must be calling Berkshire begging for capital? “No, they aren’t,” said Mr. Munger. “The typical reaction is that people are frozen. Take the airlines. They don’t know what the hell’s doing. They’re all negotiating with the government, but they’re not calling Warren. They’re frozen. They’ve never seen anything like it. Their playbook does not have this as a possibility.”

He repeated for emphasis, “Everybody’s just frozen. And the phone is not ringing off the hook. Everybody’s just frozen in the position they’re in.”

With Berkshire’s vast holdings in railroads, real estate, utilities, insurance and other industries, Mr. Buffett and Mr. Munger may have more and better data on U.S. economic activity than anyone else, ‘Everybody’s just frozen.’

“Nobody in America’s ever seen anything else like this,” said Mr. Munger. “This thing is different. Everybody talks as if they know what’s going to happen, and nobody knows what’s going to happen.”


Dan Loeb knows why Berkshire’s phone is not ringing and he isn’t happy about it…

Daniel Loeb, the billionaire hedge fund manager, has blasted the Federal Reserve for extending its assistance to the junk bond market where companies owned by private equity groups often raise capital, saying it is “fraught with moral hazard on several fronts”.

In the latest quarterly letter to investors in his $13bn-in-assets fund, Mr Loeb wrote that he was “dismayed” by the Fed’s decision to buy shares in exchange traded funds that own high-yield bonds…

“This does nothing to support an economic recovery but will simply prop up asset prices in the short term and perhaps offer a reprieve to market participants who profited handsomely for years by using excessive debt to give the illusion of high returns,” Mr Loeb wrote.

In the unsigned letter published on Thursday, Mr Loeb said he feared that the Fed’s ownership of the bonds of struggling companies could complicate debt restructuring talks and bring a political dimension to bankruptcy proceedings.

“In a free market, it is rightly the role of the many thousands of market participants to price credit risk,” the letter went on. “The socialising of this risk is fraught with moral hazard on several fronts.”


Another reason that Berkshire is quiet is because the deals being cut with the Government are so good for the companies…

@sindap: for fun, I calculated the IRR to the US taxpayer of the Delta Airlines bailout whose terms include a $3.8bn grant, a $1.6bn low interest loan and warrants for 1% of the company’s equity struck at yesterday’s closing price.

IRR to US Taxpayer

So much liquidity has entered the system recently…

Much of the Fed’s and Treasury’s rescue money is finding its way into safe liquid instruments. How long until some of this money goes looking for risk assets?

“Cumulative, government money funds had seen almost $1tr of inflows over the past seven weeks, and if we include US bank deposits this amount rises to $2tr. In our opinion, this $2tr of dollar cash is likely to gradually re-enter bond and equity markets as retail investors continue to normalize their behavior and further cover their equity underweights”


The S&P 500 doesn’t look so cheap anymore…

While the E (earnings) has taken a big estimate cut, the bounce in P (prices) have moved the combined forward P/E to new highs.

S&P 500 1 yr Fwd P/E

As companies’ earnings get hit by COVID-19, all cash deployments will get hit in 2020…

So lower capex, lower R&D, fewer acquisitions plus hits to dividends and stock repurchases. Employees and shareholders will both share in the pain of their customers.

Summary of our S&P 500 cash spending estimates
(Goldman Sachs)

Speaking of earnings, about 20% of the S&P 500 reports this week…

Most Anticipated Earnings Releases

Behold, a negative price for a commodity contract…

Below Zero

Of all the wild, unprecedented swings in financial markets since the coronavirus pandemic broke out, none has been more jaw-dropping than Monday’s collapse in a key segment of U.S. oil trading.

The price on the futures contract for West Texas crude that is due to expire Tuesday fell into negative territory — minus $37.63 a barrel. That’s right, sellers were actually paying buyers to take the stuff off their hands. The reason: with the pandemic bringing the economy to a standstill, there is so much unused oil sloshing around that American energy companies have run out of room to store it. And if there’s no place to put the oil, no one wants a crude contract that is about to come due.

Underscoring just how acute the concern over the lack of storage is, the price on the futures contract due a month later settled at $20.43 per barrel. That gap between the two contracts is by far the biggest ever.



“No one wants to give us capital because we have all destroyed capital and created economic waste.”

(Scott Sheffield, of Pioneer Natural Resources, to the Railroad Commission of Texas)

So, should the U.S. Energy industry get a Federal bailout?

There are valid economic arguments for a bailout. Energy is an important driver of investment. The last time WTI dropped significantly, in 2015-16, capital expenditures contracted and the US fell into an industrial and manufacturing recession. Employment in the oil and gas sector fell by about one-third. Some say it contributed to the discontent that pushed Donald Trump to the presidency in 2016.

But the business model for many exploration and production companies was broken before oil prices fell. Fuelled by cheap credit, US shale producers borrowed heavily to invest in drilling, causing the US energy bond market to triple in size over the past decade. The focus has been on producing quantity to conquer market share and the flood of oil has yielded low returns for equity investors, as frackers reinvested windfalls and raised top executive pay. US fracking pioneer Chesapeake Energy, for example, hasn’t generated a single year of positive free cash flow in the past decade. As debts rose along with oil supplies, a shakeout was inevitable.

A bailout would throw good money after bad, propping up an industry desperately in need of productivity gains and consolidation. Instead, the industry should be left to adapt. According to analysts at Rystad Energy, shale producers should be able to cut costs by 16 per cent this year, productivity gains that would not happen with government funding. High-cost or highly indebted small producers — and their infrastructure — should be taken over by larger, solvent companies. While that would result in bankruptcies and debt write-offs, it would reduce financing costs for those left standing. The industry would come out stronger and more profitable.


Speaking of energy stocks, Netflix now has a bigger market cap than ExxonMobil…



One of the best investors has a thought about gold in his recent investment letter…

This is a perfect environment for gold to take center stage. Fanatical debasement of money by all of the world’s central banks, super-low interest rates and gold mine operation and extraction issues (to a large extent related to the pandemic) should create a fertile ground for this most basic of all money and stores of value to reach its fair value, which we believe is literally multiples of its current price. In recent months, gold has gone up in price to some degree, but we think that it is one of the most undervalued investable assets existing today. There is nothing else that has its historical and fundamental characteristics, and we think that it is only beginning its inexorable, but impossible to time and place boundaries around, uptrend. The fact that it is so under-owned by institutional investors is astonishing to us in light of the obsessively inflationary policies being pursued by central banks around the world.

(Elliot Letter, 4/16/2020)

An amazing chart…

Hotels: occupancy rate declined 69.8% year-over-year to all-time record low

Hotel Occupancy Rate by Week of Year

American Express now owns the most Hilton Honors points…

In an effort to improve its balance sheet, Hilton sold $1 billion worth of points to its long-time partner, American Express. I wonder what sort of discount they got… maybe 50 cents on the dollar? Good news if you are an Amex loyalty customer looking to get a hotel deal in the future.

In April 2020, we pre-sold Hilton Honors points to American Express for $1.0 billion in cash. American Express and their respective designees may use the points in connection with the Hilton Honors co-branded credit cards and for promotions, rewards and incentive programs or certain other activities as they may establish or engage in from time to time. We will use the proceeds from the Hilton Honors points sale for working capital, general corporate and other purposes.


The most profitable company in Las Vegas will soon be Clorox…

Casino companies will need to significantly increase their workforces in an environment with fewer customers. Not a recipe for soaring profitability but at least the doors will be open.

When the lockdowns end, and it’s safe to do so, one of the first things I plan to do is take a trip to Las Vegas. So I was particularly interested to read the 23-page plan posted by Matt Maddox, the CEO of Wynn Resorts, on his company’s vision for how to safely reopen casinos on the Vegas strip when the time comes. The basic gist: Extensive cleaning and sanitization throughout the day of every little nook and cranny, and an effort where possible to keep customers distanced from each other. In other words, running a casino, at least in the beginning, will be extremely labor intensive and inefficient in a real capital sense.


Table Games Operations

In fact, all of these industries are going to be plowing through their cleaning supplies and hiring much more staff to do so…

Social distancing vulnerability

While many are laying off, Walmart is trying to hire 5,000 people a day…

Walmart started ramping up hiring in mid-March as sales for food and cleaning supplies surged. A 12-person team built a system to onboard new workers within 24 hours, instead of the usual two weeks, said Drew Holler, a senior vice president. The goal: Hire 5,000 people a day.

Many new hires have come from the hospitality and food-service industries, Mr. Holler said.

Don Monagan, a 26-year-old who lives in Niagara Falls, N.Y., was running the kitchen in a family-owned restaurant when the state forced all nonessential businesses to shut. Now working in a Walmart deli, he makes $16 an hour, more than he earned in his former salaried position.

“Most of us are just glad that it’s busy, and we have somewhere to work,” Mr. Monagan said.

At first, Walmart executives discussed closing some U.S. stores so they could keep shelves stocked and have enough people to run them. Instead they chose to close stores overnight for cleaning and stocking. The executives decided to hire additional workers and give cash bonuses to existing staff. The company hasn’t raised its minimum starting wage, $11 an hour.


Speaking of layoffs, this is an incredible visual…

The Historic U.S. Job Losses, in Perspective

One industry seeing a surge in customers is the National Evening News…

Tens of thousands of viewers who typically would not have time to incorporate Hartman’s Friday-night tales into their routine are now hunkered down at home and watching them regularly, as well as reports on the other evening news programs — ABC’s “World News Tonight” and NBC’s “Nightly News.” Between March 16 and April 7, about 31 million people tuned in to watch one of the three broadcast network evening shows, according to Nielsen, a massive jump of 42% from the 21.9 million who watched during the same period a year ago. Viewership is also up at PBS’ “NewsHour,” says Sara Just, the show’s executive producer, with audiences for the linear broadcast up around 34%. “We are seeing a surge.”

At a time when the nation could really use a news figure like Walter Cronkite, his heirs are commanding the sort of attention that evening news hasn’t seen in at least a generation.

“I think it’s more than a blip,” says Andrew Heyward, the former CBS News president, who is overseeing a research project that studies innovation in local news at Arizona State University’s Walter Cronkite School of Journalism and Mass Communication. As the news grows more threatening and complex, he says, even younger viewers crave someone to help make sense of it all. These days, they are relying on ABC’s David Muir, NBC’s Lester Holt, CBS’ Norah O’Donnell and PBS’ Judy Woodruff to keep them informed — and maybe even calm.


Interest in leaving the big cities is rising…

Wealthier Americans, meanwhile, appear to be hedging their bets. Todd Richardson, vice president of sales and marketing for a real estate developer in South Florida, said in recent weeks he had seen a significant jump in inquiries for a luxury condo building being built in Boca Raton, where three-bedroom units start at $1.75 million.

In the past, he said, he typically got one or two leads a day from the Northeast. “We are right now averaging eight to 10 per day from the wealthy suburbs of New Jersey, Manhattan and Long Island,” he said, as well as other parts of the Northeast that have been hit hard by the virus. “It’s staggering.”

Based on his conversations with potential buyers and their friends, he said he expected to see a “second wave” of retirees who relocate to Florida, lured by the space and the fresh air. “The folks that currently live in New York, that stay there full time that aren’t snowbirds, they are going to be like, ‘You know what? That’s it. Density is something we don’t want to deal with anymore.’”


This award-winning ad campaign for their rail line now works even better for Germany as citizens look more to travel locally…

The display campaign advertised the “Super saver ticket” of the train on Facebook and Instagram in November 2018. The video ads showed the target group popular international travel destinations and contrasted them with similar motifs in Germany. The message of the advertisement: Why travel far and a lot of money Spend on the flight if you can reach something similarly beautiful in Germany by train? For example, instead of a transatlantic flight for over € 1,000, the ads enticed a train journey for only € 19. The Deutsche Bahn’s suggestion was accordingly: “Save yourself the flight”.

Few industries face more uncertainty right now than higher education…

Some institutions are projecting $100 million losses for the spring, and many are now bracing for an even bigger financial hit in the fall, when some are planning for the possibility of having to continue remote classes.

Administrators anticipate that students grappling with the financial and psychological impacts of the virus could choose to stay closer to home, go to less expensive schools, take a year off or not go to college at all. A higher education trade group has predicted a 15 percent drop in enrollment nationwide, amounting to a $23 billion revenue loss.

“The combination of fear for health and safety and the economic impact at the same time is one that I haven’t experienced, and I don’t think most university leaders have,” said Kent D. Syverud, the chancellor of Syracuse University.

“Will families choose to send their kids to college?” he wondered. “Will they choose to not send them or delay them? I just haven’t found anybody who has the best crystal ball to answer it.”


The future of concerts?

Tweet from @GlblCtzn

While you are stuck at home, give your body a sleep test…

Grab a Fitbit, Apple iWatch or other device which monitors your sleeping heart rate. Now compare your average sleeping heart rate versus your daily resting heart rate for the different times and ingredients that you eat for dinner. If you are like most people, you will find that sugars too close to bedtime will lead to a very unrestful sleep which will discourage your all-important REM and deep sleep. But once you find that right mix of foods and times to eat, you will be ripping out of bed in the morning once we go back to work.

So, what does the ultimate sleep-friendly diet look like? Dr. Tang recommends a large breakfast one to two hours after waking, a nutrient-dense lunch and a light dinner, all during compressed eating hours. Dr. Czeisler advises to never go to bed hungry. “If we don’t have enough food, our brains go into starvation mode. You’ll wake up in the middle of the night craving food,” he said. Dr. Czeisler added that if you enjoy a bowl of ice cream, it’s best to have it in the middle of the day to keep your blood sugar in check. And he warned about two major sleep-wreckers: caffeine and alcohol.


Finally, I know what you are watching this week…

Tweet from @darrenrovell

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