Month: March 2019

Submitted by Nomura’s Bilal Hafeez

One of the issues with aggregate data whether growth, income or prices is that it masks sectoral divergences beneath the  headline. Think income inequality – what’s the point of income growth if it is all going to the 1%? That’s the challenge for many countries today. The other important one is price divergences, which we can update after yesterday’s US CPI release.  

Over the past 20 years, US prices of goods and services has gone by 56% while wages have gone up by 95%, which sounds quite good. However, when we look beneath the headline, we find that hospital services and college tuition have gone by a whopping 208% and 186%, respectively. This is much higher than wage growth, and shows that key services that enable people to move up the social ladder are being priced out of their reach. On the flipside, the price of TVs, cellphone services and toys have collapsed, so people can at least distract themselves away from their social woes.

Looking at the same data over a more recent period (since 2009), we find a similar pattern with a few differences. The most glaring is that overall prices and wages have grown at roughly the same pace (20% and 24%, respectively), so real earnings are flat. Moreover, the medical costs and college tuition continue to outpace wage growth. The one bit of good news is that the pace of college tuition costs price growth vs earnings has narrowed. Worryingly housing costs have modestly outpaced wage growth unlike before. Toys and TV prices continue to fall though!

These price divergences have deeply political and economic consequences. College education allows people to get good jobs in a globalised and automated world, while everyone is confronted with medical care costs especially as they age.

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Dennis Muilenburg, CEO of Chicago-based Boeing, reportedly asked President Trump on Tuesday morning not to ground Boeing 737 Max 8s operating throughout the country, following Sunday’s Ethiopian Airlines crash that killed 157 people, according to the New York Times. 

Early Tuesday, Dennis A. Muilenburg, the chief executive of Boeing, spoke to President Trump on the phone and made the case that the 737 Max planes should not be grounded in the United States, according to two people briefed on the conversation. –New York Times

The call between Muilenburg and Trump was confirmed by a Boeing spokesperson with Business Insider, but did not offer details on who requested the call or any other information. According to a quote by BI from the Times (which has subsequently been changed), Muilenburg only “reiterated our position that the Max is a safe aircraft.” 

Approximately 2/3 of the world’s 737 Max 8 fleet have been grounded according to the Times – with the European Union Aviation Safety Agency (EASA) the latest entity moving to ban the plane. 

And now today: pic.twitter.com/gK7TnjFU1q

— Michael McDonough (@M_McDonough) March 13, 2019

Several US senators have urged the Federal Aviation Administration (FAA) to follow suit in grounding the 737 Max 8, which is currently still considered safe to fly in the United States and Canada.  

“I write to ask that all Boeing 737 Max 8 series aircraft be grounded until their safe use has been confirmed,” wrote Sen. Dianne Feinstein (D-CA) in a Monday letter to the FAA, adding “Continuing to fly an airplane that has been involved in two fatal crashes within just six months presents an unnecessary, potentially life-threatening risk to the traveling public.” 

Mitt Romney, who blows out his birthday candles one at a time, also chimed in on Tuesday, tweeting: “the @FAANews should ground the 737 MAX 8 until we investigate the causes of recent crashes and ensure the plane’s airworthiness.” 

Out of an abundance of caution for the flying public, the @FAANews should ground the 737 MAX 8 until we investigate the causes of recent crashes and ensure the plane’s airworthiness.

— Mitt Romney (@MittRomney) March 12, 2019

President Trump, meanwhile, suggested in a Tuesday tweet before the phone call with Muilenburg that some new planes are “too complex to fly.”  

Airplanes are becoming far too complex to fly. Pilots are no longer needed, but rather computer scientists from MIT. I see it all the time in many products. Always seeking to go one unnecessary step further, when often old and simpler is far better. Split second decisions are….

— Donald J. Trump (@realDonaldTrump) March 12, 2019

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Crude rose for a third day after API reported an unexpected drop in U.S. stockpiles just as planned cuts and disruptions to OPEC output are tightening supply.

While OPEC nations like Saudi Arabia press on with planned production curbs, crises in fellow members Venezuela and Iran are also removing barrels from the market.

Additionally, the EIA in its monthly Short-Term Energy Outlook trimmed American crude output this year to 12.3 million barrels a day — 110,000 barrels lower than it had forecast previously.

API

• Crude -2.58mm (+3.00mm exp)

• Cushing -1.06mm

• Gasoline -5.85mm

• Distillates +195k

DOE

• Crude -3.86mm (+3.00mm exp)

• Cushing -672k

• Gasoline -4.62mm

• Distillates+383k

DOE confirmed API’s surprise crude draw (-3.86mm vs +3.00mm exp) and gasoline stocks tumbled further…

Even more notable, US crude production dropped in the last week, tracking the lagged oil rig count…

WTI surge up to the 2/28 highs – testing towards $58 ahead of the DOE data.

Oil has rallied more than 25 percent this year as the Organization of Petroleum Exporting Countries and its partners show their commitment to restrain production even in the face of criticism by American President Donald Trump. Adding to the market’s upbeat tone, the U.S. government lowered its output forecast for the first time in six months on the back of slowing American drilling activity.

“On the bullish side we have a rapidly deteriorating situation in Venezuela,” said Bjarne Schieldrop, Oslo-based chief commodities analyst at SEB AB. “Further on the bull side, OPEC+ continues to deliver on pledged cuts.”

And on the surprise crude draw, WTI pushed up through %58

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The headline construction spending print was celebrated, rising a better-than-expected 1.3% MoM (the most since April 2018) in January, but below the surface the story is notably mixed.

Private Residential building spending dropped 0.3% MoM – the sixth straight monthly decline (and private residential home improvement spending fell 0.3% in Jan. to $181.3b). But the headline was saved by a surge in non-residential building spending of 2.4% MoM – the biggest jump since Jan 2016.

And it was government spending that rescued the headline as public construction rose 4.9% in Jan – the largest increase since March 2004. Government construction spending was 24.5% of total in Jan thanks to a massive surge in infrastructure spending on Highway and Street improvements…

So, the summary of today’s construction spending data is that non-governmental spending is extremely weak (the biggest YoY drop since Dec 2010), signaling a lack of confidence…

…and only government-spending is saving  the economy.

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If US debt is at $22 trillion and interest rates can barely rise above 2.60%, why can’t the US have $222 trillion in debt?

That, in a nutshell, is the generic MMT argument, which claims that the US government should dispense with a central bank altogether and resort to helicopter money to reflate the economy, a strategy that is especially popular among socialist politicians as it affords them a carte blanche to spend virtually unlimited funds obtained from the sale of debt.

Of course, this only works until it doesn’t – and it usually stops once faith in the reserve currency starts buckling. But while that has yet to happen, as the TBAC pointed out two months ago, it has not prevented a cohort of financial icons and pundits from opining on the intellectual inconsistencies of MMT. And the latest to do so, just hours after we presented the scathing criticism of Convoy Investments’ Howard Wang, was none other than Jeff Gundlach, who during his Tuesday webcast “Highway to Hell“, slammed MMT as a “crackpot” theory, and slammed the “people who have PhDs in economics” and are “actually buying the complete nonsense of MMT which is used to justify a massive socialist program.”

Lashing out at the economists who embrace MMT – who claim that just because the US borrows in its own currency, it can print dollars to cover its obligations, and can’t go broke (just like the Weimar Republic, Venezuela and Zimbabwe) – Gundlach exclaimed that “the problem with that is it’s a completely fallacious argument,” adding that MMT could lead to a “significant boycott” of long-term bonds.

“This argument is ridiculous,” he said. “It sounds good for a first-grader. What happens when the economy turns down?”

As Bloomberg notes, by lashing out at MMT, Gundlach joins an array of financiers and economists including Jerome Powell and Larry Fink who have slammed at the theory that despite being around for over a century (it was known as chartalism around the time it was put to use during the Weimar hyperinflation) got little attention until a band of socialist democrats including Alexandria Ocasio-Cortez were elected.

However, more than just a “crackpot” theory – Gundlach echoed Convoy Investment’s fears that that MMT – which is just the political cover for helicopter money – may end up being more than just a theory if the U.S. falls into a recession next year.

“That means anybody other than an incumbent president would win, which kind of means that we’re headed toward this experiment of modern monetary theory,” he said, although some have argued that Donald Trump is in fact the most MMT president the US has had yet, considering the massive surge in the US budget deficit observed during a period of economic expansion, and which has led some to ask what will happen to the US deficit when the next recession strikes.

Meanwhile speaking of America’s unsustainable debt trajectory, the basis for Gundlach’s latest presentation title “Highway to Hell“, the DoubleLine founder blamed President Donald Trump for the “shocking” growth in the U.S. debt burden, highlighting the “incredible increase” in corporate and government debt, with federal deficits only poised to grow. Gundlach’s presentation took place just weeks after the Treasury Department said total U.S. federal debt hit a fresh record above $22 trillion.

“This is something that is getting more and more attention, and I think it has to,” Gundlach said, noting that “It’s really shocking that the president ran on the promise of eliminating the national debt, and here it is at $22 trillion and going higher by about $1.5 trillion a year in a growing economy.”

Gundlach also observed that the budget deficit could hit 11% of GDP in the next downturn, and predicted that he would “take the over,” suggesting that 13 percent is more likely, pointing out that as rates creep higher, the US interest as percentage of GDP is projected to “explode higher”…

… and asking rhetorically, “what happens to deficits if we enter recession?”

It may have been rhetorical, but tying it all together, Gundlach said Trump’s ramping up of the US budget and trade deficits means the “next big move for the dollar is down”, although it was unclear if that would be the catalyst that eventually culminates with the loss of faith in the dollar. That moment will come much faster, however, if the next US president decides to pursue MMT.

What happens then? This is what Convoy Investments envisions as next steps:

This would undoubtedly lead to massive inflation, spiking interest rates, and crumbling value of the dollar. While MMT directly addresses inflation, I have yet to see proponents discuss the impact on foreign exchange – the US economy doesn’t exist in a vacuum. Recently our former Fed Chairman Alan Greenspan was also asked about MMT, to which he responded, “You’d have to shut down your foreign exchange markets, people will be trying to fly out of your currency.”

If the government then pursues the MMT recommended strategy of increasing taxation in a massively inflationary economy with plummeting currency value, you’d see additional capital flights, further exacerbating inflation and currency problems. It is also interesting that MMT would reverse the roles of the Fed and the Congress, asking the Fed to keep interest rates low to promote government spending while asking the Congress to adjust taxes as necessary to keep inflation in check.

The US has earned the trust of the global markets over the last century. With the privilege of being the reserve currency comes the responsibility of a disciplined currency management. The leaders of this country have never taken the free lunch of the printing press not because they were dumb or scared, but rather because that free lunch does not exist. Dollars are traded in a free market where both the buyer and the seller need to be incentivized to make the exchange. The markets are not so dumb and naïve to blindly hold on to the dollar while the US prints its way out of fiscal trouble. The moment the US resorts to the printing press, the logical move is to ditch the dollar and all dollar denominated assets and the trust the US has built over decades will evaporate in a moment.

Convoy’s conclusion: “I believe that Modern Monetary Theory is naïve and that it would fail, but I do fear that it is like a seductive infomercial that makes hard-to-resist claims and may lead us down a fiscally destructive path. By the time we realize our mistake, it may be too late. I do not know politics well enough to predict which path we’ll end up choosing.“

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Did Howard Marks just ring the bell?

In a surprising move – if there is market upside to be leveraged – Howard Marks’ Oaktree Capital Group has agreed to sell a majority stake to Brookfield Asset Management, Canada’s largest alternative investment firm.

Brookfield will acquire a 62% stake in Oaktree in a cash and stock deal, according to a statement from the companies on Wednesday. The offer represents a premium of 12.4% per Oaktree Class A unit based on closing price on March 12

The two firms together will have approximately $475 billion of assets under management and $2.5 billion of annual fee-related revenue, the statement said. The press release notes that both Brookfield and Oaktree will continue to operate their respective businesses independently, partnering to leverage their strengths.

In an interesting sidenote on the deal, commencing in 2022, former employee-unitholders will be able to sell their remaining Oaktree units to Brookfield over time pursuant to an agreed upon liquidity schedule and approach to valuing such units at the time of liquidation, and Oaktree’s founders, senior management and current employee-unitholders will have the option to do so as well. Pursuant to this liquidity schedule, the earliest year in which Brookfield could own 100% of the Oaktree business is 2029.

Bruce Flatt, CEO of Brookfield, stated, “As we continue to strategically grow Brookfield, we are thrilled to be partnering with Oaktree and with its exceptional management team whose credit business is second to none. This transaction enables us to broaden our product offering to include one of the finest credit platforms in the world, which has a value-driven, contrarian investment style, consistent with ours.”

Howard Marks, Co-Chairman of Oaktree, stated, “The opportunity to join forces with Brookfield is ideal. Our firms share a culture that emphasizes both investing excellence and integrity, and our businesses mesh without overlapping or conflicting. The rest of Oaktree management and I are excited about the combination of support and independence we expect. We look forward to having Brookfield’s contribution to our ability to serve our clients, and to doing the same for them.”

The big question is – did Marks, who has previously noted the shrinking opportunity set in credit markets (as spreads collapse amid rising leverage), just signal the top in market exuberance, by finding a greater fool to monetize his AUM?

In a recent interview,  Marks said he doesn’t think the highs are in – at least not yet. But ultimately, he believes we will get to new “highs that lead to lows.”

GRANT WILLIAMS: There must come a point where things get out of hand. Going back to the original question of 2005, 2006, do you see any similarities in what you’re seeing and what’s starting to make your spidey sense tingle?

HOWARD MARKS: Not similarities in the sense of specific things repeating. But I have felt that because people were traumatized by the great recession, the recovery has been the slowest one since World War II. And that has kept things moderate, which meant that we would certainly have a recession one of these days. But it would be moderate. When you don’t have a boom, you don’t have to have a bust in my belief.

But now between the tax bill, which was a shot of adrenaline into, in my opinion, an already healthy patient, and then the possibility that we’re going to see a Powell put in action, I think that we may get to highs that lead to lows.

I’m a believer in cycles. I believe they always have occurred, I think I understand why. And I think they always will occur and I try to study them. And then when I kind of got to the end of writing the book I said, well why do we have cycles? If the market goes up 10% a year on average, why doesn’t just go 10% every year? And in fact, it almost never goes up between 8 and 12. So the average is not the norm. Why not?

And the answer, I think, is excesses and corrections. So you have a trend line and most trend lines are upward sloping, but then you deviate from the trend line on the upside because of some combination of optimism and greed and wishful thinking. And then you have to have a correction to the downside. So now I’m thinking we may have more of an excess, which leads to more of a correction.

And the longer the Fed and the federal government forestall a recession by artificial means, the worse the fallout will be when one finally arrives.

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The constant fire drill that is Tesla’s business model continued for yet another day as Elon Musk has now admitted that Tesla made a mistake in announcing it would slash the prices of some of its higher end vehicles about two weeks ago. This comes days after the company reversed course on its decision to close most of its retail stores. 

Unfazed by the fact that he’s currently legally feuding with the SEC for tweets regarding business operations at Tesla, Musk again took to the social media site on Tuesday to explain that Tesla “shouldn’t have offered” lower prices on Model S and Model X vehicles. Now, Tesla is doing a full “about face” and will reinstate its normal prices for its vehicles, with the exception of the base price Model 3, on Monday. 

“In retrospect, lower price shouldn’t have been offered. Was done so because come simply couldn’t afford it. Prices revert to normal on Monday,” CEO Elon Musk said in a Tweet – flexing his outstanding planning skills and unmatched business prowess – likely in response to the public’s shift in perception to the company’s products as less than aspirational status symbols.

This abrupt pricing reversal follows reports out of China according to which outraged Tesla owners were protesting the lower prices. In addition, The Daily Mail reported that angry owners had reached out to the company after purchasing Autopilot software for $5000, soon before the prices were discounted.

On February 28, Tesla stated that Autopilot would now cost just $3000, a steep cut from what consumers had originally paid. According to Musk, the price of Autopilot will also “revert to normal” on Monday. Musk also said that Tesla was still closing some stores, despite whipsawing reports of closures, freezes, and stores remaining open, over the last two weeks. 

The company said in a blog days ago:

As a result of keeping significantly more stores open, Tesla will need to raise vehicle prices by about 3% on average worldwide. In other words, we will only close about half as many stores, but the cost savings are therefore only about half.

Potential Tesla owners will have a week to place their order before prices rise, so current prices are valid until March 18th. There will be no price increase to the $35,000 Model 3. The price increases will only apply to the more expensive variants of Model 3, as well as Model S and X.

Just days earlier, we reported that the company had frozen its previously disclosed plan of closing all of its retail stores.

Some retail stores that didn’t close were told to stop booking test drives last week. And yet, last week some of them were reportedly prompted to go back to “business as usual”, despite retail employees not having access to commission and bonuses, resulting in far lower compensation. 

Tesla currently owes lease obligations of $1.6 billion, with $1.1 billion due between now and 2023 the Wall Street Journal reported last week. This includes payments for store leases, galleries and real estate abroad. Robert Taubman, chief executive officer of Taubman Centers Inc., is quoted as saying at the Citi 2019 Global Property CEO conference: “Tesla is a company with a viable balance sheet that is going to owe a lot of landlords a lot of money.”

The decision to close down all of its retail stores and move to an online-only sales model surprised many of the company’s employees and investors, with some investors dumping the company’s shares as its “growth” aura was rapidly deflating. Pro-Tesla blog electrek called the business model changes a “chaotic situation”, saying it was “either turning into what feels like an extremely poorly managed, haphazard transition or it is intentionally made that way to push out employees like some are suspecting.”

Stated simply, Tesla has now gone back on all of the major business model changes it made just about two weeks ago, further exposing a company that can only be described as in the midst of anarchy.

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For the first time since March 4th, the S&P 500 is trading back above the much-watched 2,800 level this morning as this week’s short-squeeze surge continues unabated…

But bonds still ain’t buying it…

 

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