The Trap is Set…

361 Capital Market Commentary | September 30th, 2019

Still much debate as to who set this spiderweb? Was it the House Democrats for President Trump, or was it Trump for Vice President Biden? Since the White House transcript and whistleblower report were released, the betting markets have moved to a 70% chance of a House impeachment vote. With Sen. McConnell saying that he will take a House Impeachment vote to a trial, this will mean that Washington D.C. will most likely shut down for all legislative purposes for the next several weeks or months. A long trial would place a Ukrainian-sized boulder in Biden’s path to the nomination. This would be good news for Sen. Warren and Mayor Buttigieg who will benefit from being either the most favorite or the most centrist candidate. Bottom line: Big web, lots of spiders and plenty more news flow to read. Joy.

The third quarter is winding to a close. It was a good one for Bonds, Gold and Defensive U.S. equity sectors. It was a difficult one for Oil, International stocks, Biotech and Energy stocks. It was also a unique quarter in that there was a complete collapse in the IPO environment. We knew that the market was increasingly getting unhealthy with all of the money-losing companies coming to market with super voting-powered share classes for the founders. But with the collapse of WeWork, disappointment of Peloton, and pulling of Endeavor, it is safe to say that the easy IPO window has closed for 2019. This will eventually be good for the markets as weak companies with poor share classes will be kept away from investors. But for now, it is a negative for the markets as it shows that the hysteria for pushing high values higher is now restrained.

Looks like the House is going to light the impeachment fuse…


Weekend odds for a House impeachment vote moved to 70%, while public opinion for impeachment moved into the high 40% range.

Impeachment of President Trump


Anyone’s guess how an impeachment trial will affect U.S. investment flows…


But for now, there exists a $1 trillion gap between money out of stocks and into bonds and cash.

2019 global fund flows


As the market enters the fourth quarter, seasonality is typically favorable once it gets through mid-October…

SP 500 seasonality

(Goldman Sachs)

U.S. economic data last week showed a continued surge in residential Housing demand…


August was VERY strong on a non-seasonally adjusted basis.

New One Family Houses Sold Total NSA

(WSJ/Daily Shot)

But away from the consumer, the GDP numbers for business spending were not optimistic…


Business Investment Contribution to GDP Growth

And south of the border, our largest and closest trading partner is slowing down significantly…



German manufacturing continues its sharp retreat…


Germany, manufacturing PMI

And Japan’s industrial data is decelerating to multi-year lows…


Japan Industrial Production

The U.S. consumer economy is now more important than ever…


US Consumer GDP

That said, one of America’s largest shopping mall tenants didn’t pay rent this month and just declared bankruptcy…


Forever 21, the California retailer that helped popularize fast fashion in the United States with its bustling stores and $5 tops, said on Sunday night that it would file for bankruptcy, a sign of the eroding power of shopping malls and the shifting tastes of young consumers.

The private, family-held company capped months of speculation about its restructuring efforts by saying that it would cease operations in 40 countries, including Canada and Japan, as part of a Chapter 11 filing. It will close up to 178 stores in the United States and up to 350 over all.

Forever 21 said that it would continue to operate its website and hundreds of stores in the United States, where it is a major tenant for mall owners, as well as stores in Mexico and Latin America.


While overall credit trends remain healthy, signs of strain are increasing in certain areas…


Fitch Ratings

A reminder that not only do inverted yield curves lead to recessions, but sometimes, recessions just happen on their own…


Yield Curves Inversion 100-year View


We are a week away from the fire hose of Q3 earnings releases…


For now, estimate cuts have slowed. It will be curious to see how this develops as earnings revisions develop.

SP500 EPS growth estimate cuts have abated


Morgan Stanley thinks the market is too optimistic about future earnings…


SO500 EPS Growth Is About to Go Negative

As we mentioned about new issues, it was the worst one month IPO performance in a very long time…


Median 1 month relative performance of IPOs from close

In the future, the companies underlying new IPOs will need to be much more profitable…


Share of IPOs with positive net income in year 1

Looks like a big test for the Nasdaq…


Nasdaq Composite


A volatile range of returns across the time periods for the major asset classes…


It was a risk-on month, but a risk-off quarter. Still green across the board for 2019.

Returns 09/27/2019


A big move for J.P. Morgan over the weekend to shift to European equities over U.S. equities…


There’s been a significant change of heart from JPMorgan equity strategists: U.S. stocks are no longer preferred to Euro-area equities.

“There is a tactical opportunity opening up for Euro zone to catch up,” strategists led by Mislav Matejka wrote in a note.

The 20% underperformance of the region’s stocks in dollar terms over the past 18 months, combined with investment outflows amounting to 20% of assets under management, are part of the reason the strategists upgraded the Euro-area region to overweight, while downgrading the U.S. to neutral.

The valuation discount has widened and the relative price-earnings ratio is now close to “outright cheap” territory, JPMorgan says. Value stocks have shown some signs of revival this month, and the continuation of a sector rotation from growth into value is also likely to support Euro area outperformance against the U.S., according to the strategists.


Euro zone equities underperformed US stocks by 20% over 18 months

Among the U.S. sectors, it was also risk-off for the quarter but much more random for the month…


Sectors 09/27/19


Biotech stocks need some medicine to keep from breaking this bearish trend…


iShares Biotechnology


Also in healthcare, United Healthcare makes its first 52-week low in over ten years…


Not surprising given Sen. Warren’s ascension in the polls.

UnitedHealth Hitting 1st 52-Week Lows


We talked about the WeWork bonds last week…


But now with the IPO pulled and a debt restructuring in need to save the company, even the bond holders don’t think that they will be putable at par.

WeWork bonds

Next on the WeWork restructuring to-do list is that big book of leases…


WeWork’s real estate portfolio is filled with leases that are far longer than what’s typical in the industry. Under its leases, WeWork owes a whopping $47.2 billion, according to the company’s IPO paperwork.

“The average length of the initial term of our U.S. leases is approximately 15 years,” WeWork noted in its IPO filing.

By contrast, from 2006 to 2017, the average term for leases signed by U.S. publicly traded real estate investment trusts was 6.8 years, according to Morgan Stanley.

WeWork’s long leases look particularly problematic when you consider that its client base is seeking shorter, more flexible commitments. The typical WeWork member agreement is on average less than two years, the company’s filing says.

“In many cases, our members may terminate their membership agreements with us at any time upon as little notice as one calendar month,” the company’s IPO filing says.

WeWork declined to comment on the gap between the company’s leases and its customer commitments. The company said in its S-1 filing that its annual revenue run rate was $3.3 billion.

For WeWork, taking on long-term risk is part of the value proposition they offer to both tenants and landlords, the latter seeking certainty and the former seeking flexibility.


Here is who is on the hook for some lease write-downs in NYC…


NY office owners with the most space rented to WeWork

At another crashing Unicorn, only Starbucks coffee now flows from the office barista taps…


At Uber, the company’s initial market value was roughly two-thirds of the top end of what was expected. A company once supposedly valued at $120 billion in the most optimistic projections now has a market cap of $51 billion. And many are questioning whether the money-bleeding company can succeed amid slowing growth, when investors are holding it accountable.

As a result, Uber is “turning [into] an operations company — not a product/tech company,” said one former senior employee, who declined to be named publicly, citing a separation agreement with the company…

But morale suffered as the company seemed to crack down. It stopped letting people anonymously ask questions at all-hands meetings. Starbucks showed up in coffee dispensers, and craft coffee from Stumptown, a roaster based in Portland, Ore., went away. Office supplies like giant sticky notes dried up, and the company no longer hands out “Uberversary” balloons.


Sounds like the hard money lenders in Miami are retreating quickly from the residential real estate market…


Me: So, what are you doing to clear these bad assets?

Him: I have no idea. I’ll probably smack the bid wherever it is and take the hit—before someone else does. At least I won’t have to keep making condo payments and 2% property tax payments. My fund has basically stopped lending on condos and is well below 50% LTV on everything else. We’re building cash. I don’t want any more of this crap on my balance sheet!! A surprising number of my existing loans are starting to go bad. I know what my competitors underwrote, trust me, they’re in MUCH worse shape. They underwrote all sorts of nonsense that I wouldn’t ever touch. I’ll be fine, but they’re toast.

Me: …and Bank of Ozarks? Haha

Him: They underwrote the stuff the local hard money boys wouldn’t touch at 15%, but those jokers got paid fed funds plus 3 to take the risk. We should build a fund to pick at their carcass in 2 years. Good thing they just popped down a new branch in Sunset Harbor. We can use it as the REO office. Haha

Me: Why isn’t any of this showing up in the data yet?

Him: Most traditional borrowers have money and are trying to hold on. Besides, property is a slow burn process. Guys are in extreme pain, transaction volumes have collapsed, properties on offer have exploded. Eventually someone blinks, people realize where the real marks are on their assets, then they ask themselves why they are paying 10% a year to hold onto something that they’re underwater on and dropping in price. It’s going to be just like 2009. Wait 6 or 9 more months. They can take rates to zero, it won’t matter. That’s not the key cost of holding these things anyway.


In other real estate markets, farmers are now getting paid $1,000 per acre to lease their land for Solar…


U.S. farmers are embracing an alternative means of turning sunlight into revenue during a sharp downturn in crop prices: solar power.

Solar panels are being installed across the Farm Belt for personal and external use on land where growers are struggling to make ends meet. The tit-for-tat tariffs applied by the U.S. and China to each other’s goods have cut demand for American crops. Futures prices for corn, soybeans and wheat are all trading around their lowest levels since 2010. Making matters worse, record spring rainfall left many farmers no time to plant a decent crop.

The revenue that Dick and Jane Nielsen earn from the corn and soybeans they grow on 3,500 acres outside St. Paul, Minn., has dropped by about 30% over the past six years. The Nielsens are planning to make up some of the shortfall with the roughly $14,000 that a local utility has agreed to pay them annually for the next 22 years to operate an array of solar panels on 15 acres of their land.

“It’s something to live on until we’re gone,” said Mr. Nielsen, 77 years old.


Solar Farmers


If you are looking for a super high-growth industry to work, partner, supply or invest in, look no further than alternative meats…


What’s striking about Brown is his aggression. He is a David eager to head-butt Goliath. “If you could do two things of equal value for the world, and in one of them someone is trying to stop you, I would do that one,” he told me. Brown doesn’t care that plant-based meat amounts to less than 0.1 per cent of the $1.7-trillion global market for meat, fish, and dairy, or that meat contributes to the livelihoods of some 1.3 billion people. His motto, enshrined on the wall of Impossible’s office, is “Blast ahead!” During the six months that I was reporting this story, the company’s head count grew sixty per cent, to five hundred and fifty-two, and its total funding nearly doubled, to more than seven hundred and fifty million dollars. Brown laid out the math: to meet his 2035 goal, Impossible just has to double its production every year, on average, for the next 14.87 years. This means that it has to scale up more than thirty thousandfold. When I observed that no company has ever grown anywhere near that fast for that long, he shrugged and said, “We will be the most impactful company in the history of the world.”


Unbelievable fact of the week…


Amount spent globally on virtual goods within video games last year : $93,000,000,000

SuperData (Oakland, Calif.)

Binge video series of the week…


Inside Bill’s Brain is only three episodes but a fascinating look into what Bill Gates is working on now as well as stories from his past.

Inside Bill's Brain


Catch up on past Weekly Research Briefings >