Author: phoffman@channelchek.com

We May Soon Know if Yellen’s “Extraordinary Measures” are Extraordinary Enough

Posted on by phoffman@channelchek.com

The Pace of the U.S. Treasury Burn Rate Toward a $0.00 Balance

The US Treasury Department is nearing its last ounce of blood as it has been bleeding operating funds. All parties know that the debt ceiling has to be raised if the country is to avoid a financial catastrophe. Still, an impasse on debt ceiling negotiations continues. While the House of Representatives has passed a borrowing cap plan, it is not expected that the Senate would agree on the spending reductions, and President Biden made clear he would not sign it.

The markets, of course, have been paying attention, but for the most part, they have chosen to ignore the drama. Anyone that has been involved in the markets for a few years knows that in the past, there have been stop-gap measures or 11th hour decisions that have avoided a US debt default.

It is Getting Close

The US Treasury reported last Thursday that it had $57.3 billion in cash on hand. As with any ongoing entity, each week, it receives revenue and pays expenses. So the daily balance runoff fluctuates by different amounts each day. A snapshot is reported each Thursday along with other US financial data. The current pace, while not a precise rate to gauge the net burn rate, is useful.

The operating balance used to pay our bills as a nation has declined from $238.5 billion at the start of May, when tax collections helped boost balances. That’s a $181.2 billion decline over 18 days, or $10 billion per day. If the pace holds, the United States balance sheet reaches zero before the June 1 date previously estimated by US Treasury Secretary Janet Yellen.

Image: @GRDector (Twitter)

How are Officials Reacting?

The US reached its Congressionally imposed borrowing cap in January. Since then, there has been a cutting back on spending, as had been announced in January by Janet Yellen. The Treasury has since been operating under an “Extraordinary Measures” plan, reducing less than critical spending to pay obligations that can not be ignored without great consequence. This bandaid approach will go on and, at this point, can only be “fixed” if the debt ceiling is raised once again by Congress.

Treasury Secretary Janet Yellen has been clear in warning lawmakers that the Treasury’s ability to avoid default could end as soon as June 1. The nation has to increase its ability to legally borrow to make its payments while its obligations exceed its revenue.

Averting a June Crisis Without Congress

While most US citizens are aware of the mid-April individual tax date, corporate tax dates are quarterly. The next time most corporations pay their estimated taxes is June 15th. If Secretary Yellen can squeeze the Treasury balances until June 15th, she will no longer be driving on fumes – instead, she will have added a little more gas, not enough to get her to the next corporate tax date.  

Another thought depends on one’s interpretation of the 14th Amendment. This amendment of the US Constitution contains several provisions, one of which is Section 4. This section states that “the validity of the public debt of the United States, authorized by law… shall not be questioned.” While the exact interpretation of this provision is a matter of legal debate, it has been suggested that it could potentially provide a legal basis for the government to continue meeting its financial obligations, even if the debt ceiling is reached.

Some argue that the 14th Amendment could empower the President to bypass the debt ceiling and ensure that the government continues to pay its debts on time, based on the principle that the United States must honor its financial obligations.

Source: US Treasury (May 18, 2023)

Stalled Talks

Although the date of $zero balance is not far off if the President and Senate doesn’t agree to the House plan, or if the House is inflexible, negotiations have moved in fits and starts with Congressional leaders meeting on and off with each other and with the Executive branch.  

If the nation does default, it will unleash global economic and financial upheaval. The full consequences are not known since it’s never happened before. Those likely to see funds come to a crawl or be turned off are:

  • Interest on the debt: While the debt itself would continue to be serviced, a stringent austerity plan could potentially result in reduced payments towards interest on the national debt.
  • Government programs and agencies: Funding for discretionary programs, such as infrastructure projects, education initiatives, environmental programs, or research grants, could be reduced or eliminated.
  • Social welfare programs: Payments for social welfare programs, such as unemployment benefits, food assistance, housing subsidies, or healthcare subsidies, may be reduced or scaled back.
  • Defense spending: Military expenditures and defense contracts may face cuts, impacting payments to defense contractors and the procurement of military equipment and services.
  • Government salaries and benefits: Austerity measures could involve salary freezes, reductions, or furloughs for government employees, including civil servants, military personnel, or elected officials.
  • Infrastructure projects: Funding for infrastructure development and maintenance, including transportation systems, highways, bridges, and public facilities, may face reductions or delays.
  • Grants to states and local governments: Payments to states and local governments for various programs, such as education, healthcare, or community development, could be reduced.

The above are not set in stone, it’s important to note that the specific impacts of an austerity plan would depend on the policies and priorities set by the government, and different austerity measures are also a matter of negotiation.

While Yellen, the Congressional Budget Office, and multiple other forecasters think the $Zero date is likely during the first two weeks of June, it’s possible that the Treasury will have enough funds to carry it through the middle of the month, which would add more time.

However, as it looks now, the US Government is running on fumes; in the past, it has not allowed itself to completely run out of gas. If today’s situation follows past history, the markets will get scared a few more times before the US leaders agree and the country is back to business as usual.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://fiscaldata.treasury.gov/datasets/daily-treasury-statement/operating-cash-balance

https://home.treasury.gov/news/press-releases/jy1483

Cathie Wood’s Non-Mainstream Inflation Concern Could Unfold as Feared

Posted on by phoffman@channelchek.com
Image: An Artificial Intelligence Rendering of Tech Investor Cathie Wood

Cathie Wood’s Deflationary Expectations May Become Reality

Before Fed Chair Powell realized inflation might not be transitory, during the Fall of 2021, Cathie Wood sounded alarm bells about the risks of great deflationary pressures not being far off. The renowned hedge fund manager and founder of ARK Funds stood far apart from her peers with this forecast. Since then, the disruptive technologies investment expert has indicated the Federal Reserve should stop raising interest rates because the economy is poised for deflation rather than inflation. As most of the world has come to accept the notion that inflation may be a problem for years to come, her thoughts have been dismissed by most economists as wishful thinking.

Wood has not budged on her position, and it may serve her and her customers well. Investment success often comes with pointing yourself in a different direction than the loud narrative is pointing you. But, in the end, you have to eventually be right, and others then have to change their tune to match the once contrarian view – after all, you will need late-comers to buy your position from you.

I have to confess, as a lifelong Fedwatcher, market analyst, and cynic, I didn’t think there was a chance in the world that she could be right. Since her October of 2021 comments, not a long period of time, We’ve all witnessed a dramatic leap in technology that reduces costs, is easy to adopt, and is progressing at an exponential rate.

Cathie Wood may not be as wrong as most people thought, perhaps she is even right. Here are just some examples of when she spoke out about her deflationary outlook:

2022-10-10: Wood wrote an open letter to the Federal Reserve accusing it of stoking ‘deflation’ and looking at the wrong economic indicators.

2023-02-02: Wood gave a speech at the Sohn Investment Conference where she said that she believes deflation is a bigger threat to the US economy than inflation.

2023-03-08: Wood appeared on CNBC’s Squawk Box where she said that she believes deflation is “the biggest risk” to the global economy.

Cathie Wood has been quoted as saying:

“Deflation is the biggest risk to the global economy.”

“The rise of artificial intelligence is leading to a productivity boom, which is driving down prices.”

Less related to disruptive technologies providing businesses a more efficient means, Wood has also argued:

“The decline of globalization is leading to a decline in demand for goods and services.”

“The aging population is leading to a decline in consumption.”

“Deflation is not a bad thing. It can lead to a more sustainable economy, with lower interest rates and less debt.”

In November of 2022, ChatGPT was unveiled by OpenAI. Most everyone paying attention, including those in related tech businesses, were stunned at how far along the technology is and the potential for quickly advancing AI platforms. Currently, ChatGPT is trained on a dataset large enough that it can generate text, translate languages, write different kinds of creative content, and answer your questions in an informative way.

In 2023, ChatGPT was released to the broader public, it broke records for sign-ups and it has continued to grow in popularity. It is now used by a wide range of people, including students, writers, and businesses. This is still a beta version they are using and getting excellent results.

While generative AI for text is only one next-generation technology, example; this still under development tool alone is world-changing powerful. And it has the potential to dramatically alter the way we interact with computers – all of which can lead to dramatic gains in efficiency and productivity. Efficiency and productivity are ingredients that can stave off inflation, they can even bring prices lower – we know this because we experienced it for decades following the tech revolution.

ChatGPT and other OpenAI products are still beta tests of a text program from one institution. I understand OpenAI products can also write computer code, create graphics, and carry on a conversation.  Where will OpenAI take their products next, how will the products take part in machine learning and then serve to better themselves, and how many other companies are dreaming up and developing new sources to enrich out lives at lower expense?

While Artificial Intelligence may or may not be able to lower the price of a dozen eggs, it can increase output across many industries or reduce expensive labor needs. I see examples of this in the office and at home where a search using ChatGPT can more precisely provide a response to a query than a Google internet search.

Take Away

Investors are often hurt by their ego, preventing them from rethinking and reevaluating. When exposed to new information, it’s good to take the time to reevaluate the probability of being incorrect or correct in one’s outlook.

It’s too early to know if Cathie Wood will turn out to be correct in her inflation forecasts. She lives and breathes high tech and I’m sure gets early behind-the-scenes glimpses of what has yet to come. For me, it is now easier to see how new business solutions could possibly unfold to a point where deflation becomes an issue in the world economies. I’m not sold on the idea, but I am not dismissing it as impossible either.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://ark-funds.com/articles/commentary/q3-2022-commentary-from-arks-cio/

https://www.cnbc.com/2023/03/09/cnbc-transcript-ark-invest-ceo-cio-cathie-wood-speaks-with-cnbcs-brian-sullivan-on-last-call-today.html

Federal Reserve Chairman Powell Reaffirms Commitment to Bring Inflation Down

Posted on by phoffman@channelchek.com
Image Credit: Federal Reserve (Flickr)

Ben and Jerry Discuss Interest Rates, Jobs and Inflation

Federal Reserve Chair Jerome Powell reiterated today that the Fed is committed to bringing inflation down to its 2% target. Speaking at the “Perspectives on Monetary Policy” panel at the Thomas Laubach Research Conference, Powell said that the Fed will continue to raise interest rates until inflation is under control. The current Fed Chair shared the stage with former Fed Chair Ben Bernanke; the two more or less agreed, with Bernanke seeming a bit less optimistic.

The Panel Discussion

Powell acknowledged that the Fed’s actions to raise interest rates will likely slow economic growth. However, he said that the Fed is confident that it can bring inflation down without causing a recession.

“We understand that high inflation imposes significant hardship, especially on those least able to afford the higher costs of essentials like food, housing, and transportation,” Powell said and then emphasized, “we are strongly committed to returning inflation to our 2% objective.”

Powell reassured that the Fed is closely monitoring the labor market. The event is attended by experts in the field of monetary policy, including economists, central bankers, and other policymakers. It provides an opportunity for experts to share their views on the current state of the economy and the challenges facing central banks. Powell told the attendees that the Fed is committed to keeping the labor market strong but that it will not hesitate to take further action if needed to bring inflation down.

“The labor market is very strong, and we want to see that continue,” Powell said. “But we will take the necessary steps to bring inflation down,” he cautioned.

Ben Bernanke, the former Chair of the Federal Reserve, also spoke at the conference warning that the Fed is facing a difficult challenge in trying to bring inflation down without causing a recession. Bernanke said that the Fed will need to be very careful.

“The Fed is in a difficult spot,” Bernanke said. “It needs to bring inflation down, but it also doesn’t want to cause a recession. It will need to be very careful in its actions.”

Bernanke said that the Federal Reserve is facing a “new normal” in terms of inflation. He said that the Fed will need to be more aggressive in its use of monetary policy to bring down the pace of price increases. The former Fed chair said, “The Fed is going to have to be more aggressive in its use of monetary policy than it has been in the past,” He cautioned. “It’s going to need to raise interest rates more than once this year.”

Bernanke explained to listeners, “the Fed is not trying to cause a recession. But it is willing to risk a recession if it is necessary to bring inflation down.”

The comments from Powell and Bernanke took away any question whether the Fed is committed to bringing inflation down. Most listeners came away from this feeling the Fed is likely to continue to raise interest rates and to shrink its balance sheet in an effort to cool the economy and bring inflation down. However, attendees were also assured the Fed is keenly aware of the risks of a recession and is trying to avoid it.

What Does This Mean for the Economy?

The comments from Ben Bernanke and Jerome Powell suggest that the Fed is prepared to take aggressive action to bring inflation down. This could lead to higher interest rates and slower economic growth. However, the Fed is acting in a way it hopes leads to bringing down inflation without negative growth or a recession.

The bond markets had been pricing in an easing late in the year. US Treasury rates rose as the panel discussion got underway; this suggests that the tenor of some of the comments were unexpected. It is still too early to say what the impact of the Fed’s actions will be on the economy. However, it is clear that the Fed is taking inflation seriously and is willing to take steps to bring it down.

The next Federal Open Market Committee (FOMC)  meeting will be held on June 13-14, 2023. The FOMC is the policymaking body of the Federal Reserve System. It meets every six weeks to discuss and set monetary policy, including the target for Fed Funds.  

The next FOMC meeting is expected to be a critical one, as the committee will be making its decisions in the midst of sticky inflation, a troubled banking sector, and a slowing economy.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.c-span.org/video/?528202-1/federal-reserve-chair-participates-monetary-policy-conference

Biotech M&A is Finally Rewarding Patient Investors

Posted on by phoffman@channelchek.com

The Acceleration of Biotech Acquisitions, Why it Should Continue

The pace of mergers and acquisitions (M&A) in the biotech sector has accelerated in 2023 compared to 2022 and 2021. The factors driving this increase are numerous, and there is increasing urgency on both sides, the acquirers and acquirees to find a fit. This is playing out with deal value up significantly in 2023, with noticeable acceleration as the year has progressed. During the first quarter, investors in at least eight biotech companies found themselves in enviable positions. Below is a recap of what has already happened and the perceived trend. If it continues, it could lead to 2023 seeing far more biotech deals than the previous two.

According to data from William Blair’s quarterly biopharma review, the total deal volume in the sector was elevated, although far below record highs. Total M&A value for the first quarter was $52 billion versus $88 billion for all of 2022, and $77 billion in 2021. The report shows the average deal was $630 million (versus $367 million in 2022). The upfront cash and equity has doubled from the prior year at $508 million (versus $249 million in 2022).

Later stage companies seem to be what pharmaceutical firms have the most appetite for. The phase of development of the companies most sought was Phase II or later with 100% or all of the public acquisitions in this stage. Five of the eight were in the commercial stage.  

Source: The Quarterly Rx: Q1 2023 U.S. Biopharma Recap (William Blair)

The details above are of the eight public companies that merged or were acquired during the first quarter. However, just this week alone, there have been three more biotech acquisitions announced:

  • On May 16, 2023, Merck & Co. announced that it would acquire Acceleron Pharma for $11.5 billion. Acceleron is a clinical-stage biopharmaceutical company, the acquisition will give Merck access to Acceleron’s lead drug candidate, luspatercept, which is currently in Phase 3 clinical trials for the treatment of anemia associated with chronic kidney disease.
  • On May 17, 2023, Gilead Sciences announced that it would acquire Immunomedics for $21 billion. Immunomedics is a clinical-stage biopharmaceutical company the acquisition will give Gilead access to Immunomedics’ lead drug candidate, Trodelvy, which is currently in Phase 3 clinical trials for the treatment of triple-negative breast cancer.
  • On May 18, 2023, AstraZeneca announced that it would acquire Daiichi Sankyo’s oncology business for $6.9 billion. Daiichi Sankyo’s oncology business includes a portfolio of marketed and late-stage cancer drugs. The acquisition will give AstraZeneca a broader portfolio of cancer drugs and will help the company to expand its presence in the oncology market.

What is Driving the Acceleration?

There are a number of “not-so-secret” factors that are helping the acceleration of M&A activity in the biotech sector. One factor is the increasing cost of product development. The average cost of developing a new drug has increased from $1 billion to $2.6 billion in the past decade. This has made it increasingly difficult for small and mid-sized biotech companies to develop viable candidates independent of big-pharma’s help. As a result, small companies are increasingly looking to merge, partner or be acquired by larger companies with deeper pockets.

Another factor driving the acceleration of M&A activity in the biotech sector is the increasing focus on innovation. Large pharmaceutical companies don’t have the talent that exists in the universe of small biotech companies. So they are increasingly looking to acquire companies with innovative technologies. These innovations can help them provide new drugs that can compete with the blockbuster drugs coming off patent in the next few years.

Finally, the acceleration of M&A activity in the biotech sector is also being driven by the increasing consolidation of the industry. In recent years, a number of large pharmaceutical companies have merged with or acquired each other. This has led to a smaller number of bigger companies that are now dominant in the industry. These companies are increasingly looking to acquire smaller companies in order to expand their product portfolios and overall reach.

Take Away

While deals in many industries, both public and private, have decelerated to a crawl, the cash-rich pharmaceutical industry giants are tactically looking to build their portfolios of next-generation treatments. And many biotech companies are in need of a lifeline to get their pipeline products the research dollars they deserve. This dynamic has accelerated public and private deals in the industry in 2023.  

The acceleration of M&A activity in the biotech sector is a trend that is not expected to end soon. This is because the factors that are driving deals are likely to remain in place. Investors looking to explore smaller biotech companies may want to keep in mind the nuances of the average company attributes that found deals in the first quarter. Top-tier research on a number of smaller companies, provided by the sectors equity analysts at Noble Capital Markets can be found here.    Company information and data on many other biotech and life sciences companies can be discovered by going to this link.

Paul Hoffman

Managing Editor, Channelchek

Sources

file:///C:/Users/prese/Downloads/WilliamBlair-Biopharma-Quarterly-Review-Q1-2023.pdf

https://community.ionanalytics.com/ma-highlights-1q23?account_created=1

https://dkf1ato8y5dsg.cloudfront.net/uploads/79/598/mahighlights1q23-final.pdf

Trading With Artificial Intelligence – Benefits and Pitfalls

Posted on by phoffman@channelchek.com

ChatGPT-Powered Wall Street: The Benefits and Perils of Using Artificial Intelligence to Trade Stocks and Other Financial Instruments

Artificial Intelligence-powered tools, such as ChatGPT, have the potential to revolutionize the efficiency, effectiveness and speed of the work humans do.

And this is true in financial markets as much as in sectors like health care, manufacturing and pretty much every other aspect of our lives.

I’ve been researching financial markets and algorithmic trading for 14 years. While AI offers lots of benefits, the growing use of these technologies in financial markets also points to potential perils. A look at Wall Street’s past efforts to speed up trading by embracing computers and AI offers important lessons on the implications of using them for decision-making.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Pawan Jain, Assistant Professor of Finance, West Virginia University.

Program Trading Fuels Black Monday

In the early 1980s, fueled by advancements in technology and financial innovations such as derivatives, institutional investors began using computer programs to execute trades based on predefined rules and algorithms. This helped them complete large trades quickly and efficiently.

Back then, these algorithms were relatively simple and were primarily used for so-called index arbitrage, which involves trying to profit from discrepancies between the price of a stock index – like the S&P 500 – and that of the stocks it’s composed of.

As technology advanced and more data became available, this kind of program trading became increasingly sophisticated, with algorithms able to analyze complex market data and execute trades based on a wide range of factors. These program traders continued to grow in number on the largely unregulated trading freeways – on which over a trillion dollars worth of assets change hands every day – causing market volatility to increase dramatically.

Eventually this resulted in the massive stock market crash in 1987 known as Black Monday. The Dow Jones Industrial Average suffered what was at the time the biggest percentage drop in its history, and the pain spread throughout the globe.

In response, regulatory authorities implemented a number of measures to restrict the use of program trading, including circuit breakers that halt trading when there are significant market swings and other limits. But despite these measures, program trading continued to grow in popularity in the years following the crash.

HFT: Program Trading on Steroids

Fast forward 15 years, to 2002, when the New York Stock Exchange introduced a fully automated trading system. As a result, program traders gave way to more sophisticated automations with much more advanced technology: High-frequency trading.

HFT uses computer programs to analyze market data and execute trades at extremely high speeds. Unlike program traders that bought and sold baskets of securities over time to take advantage of an arbitrage opportunity – a difference in price of similar securities that can be exploited for profit – high-frequency traders use powerful computers and high-speed networks to analyze market data and execute trades at lightning-fast speeds. High-frequency traders can conduct trades in approximately one 64-millionth of a second, compared with the several seconds it took traders in the 1980s.

These trades are typically very short term in nature and may involve buying and selling the same security multiple times in a matter of nanoseconds. AI algorithms analyze large amounts of data in real time and identify patterns and trends that are not immediately apparent to human traders. This helps traders make better decisions and execute trades at a faster pace than would be possible manually.

Another important application of AI in HFT is natural language processing, which involves analyzing and interpreting human language data such as news articles and social media posts. By analyzing this data, traders can gain valuable insights into market sentiment and adjust their trading strategies accordingly.

Benefits of AI Trading

These AI-based, high-frequency traders operate very differently than people do.

The human brain is slow, inaccurate and forgetful. It is incapable of quick, high-precision, floating-point arithmetic needed for analyzing huge volumes of data for identifying trade signals. Computers are millions of times faster, with essentially infallible memory, perfect attention and limitless capability for analyzing large volumes of data in split milliseconds.

And, so, just like most technologies, HFT provides several benefits to stock markets.

These traders typically buy and sell assets at prices very close to the market price, which means they don’t charge investors high fees. This helps ensure that there are always buyers and sellers in the market, which in turn helps to stabilize prices and reduce the potential for sudden price swings.

High-frequency trading can also help to reduce the impact of market inefficiencies by quickly identifying and exploiting mispricing in the market. For example, HFT algorithms can detect when a particular stock is undervalued or overvalued and execute trades to take advantage of these discrepancies. By doing so, this kind of trading can help to correct market inefficiencies and ensure that assets are priced more accurately.

Stock exchanges used to be packed with traders buying and selling securities, as in this scene from 1983. Today’s trading floors are increasingly empty as AI-powered computers handle more and more of the work.

The Downsides

But speed and efficiency can also cause harm.

HFT algorithms can react so quickly to news events and other market signals that they can cause sudden spikes or drops in asset prices.

Additionally, HFT financial firms are able to use their speed and technology to gain an unfair advantage over other traders, further distorting market signals. The volatility created by these extremely sophisticated AI-powered trading beasts led to the so-called flash crash in May 2010, when stocks plunged and then recovered in a matter of minutes – erasing and then restoring about $1 trillion in market value.

Since then, volatile markets have become the new normal. In 2016 research, two co-authors and I found that volatility – a measure of how rapidly and unpredictably prices move up and down – increased significantly after the introduction of HFT.

The speed and efficiency with which high-frequency traders analyze the data mean that even a small change in market conditions can trigger a large number of trades, leading to sudden price swings and increased volatility.

In addition, research I published with several other colleagues in 2021 shows that most high-frequency traders use similar algorithms, which increases the risk of market failure. That’s because as the number of these traders increases in the marketplace, the similarity in these algorithms can lead to similar trading decisions.

This means that all of the high-frequency traders might trade on the same side of the market if their algorithms release similar trading signals. That is, they all might try to sell in case of negative news or buy in case of positive news. If there is no one to take the other side of the trade, markets can fail.

Enter ChatGPT

That brings us to a new world of ChatGPT-powered trading algorithms and similar programs. They could take the problem of too many traders on the same side of a deal and make it even worse.

In general, humans, left to their own devices, will tend to make a diverse range of decisions. But if everyone’s deriving their decisions from a similar artificial intelligence, this can limit the diversity of opinion.

Consider an extreme, nonfinancial situation in which everyone depends on ChatGPT to decide on the best computer to buy. Consumers are already very prone to herding behavior, in which they tend to buy the same products and models. For example, reviews on Yelp, Amazon and so on motivate consumers to pick among a few top choices.

Since decisions made by the generative AI-powered chatbot are based on past training data, there would be a similarity in the decisions suggested by the chatbot. It is highly likely that ChatGPT would suggest the same brand and model to everyone. This might take herding to a whole new level and could lead to shortages in certain products and service as well as severe price spikes.

This becomes more problematic when the AI making the decisions is informed by biased and incorrect information. AI algorithms can reinforce existing biases when systems are trained on biased, old or limited data sets. And ChatGPT and similar tools have been criticized for making factual errors.

In addition, since market crashes are relatively rare, there isn’t much data on them. Since generative AIs depend on data training to learn, their lack of knowledge about them could make them more likely to happen.

For now, at least, it seems most banks won’t be allowing their employees to take advantage of ChatGPT and similar tools. Citigroup, Bank of America, Goldman Sachs and several other lenders have already banned their use on trading-room floors, citing privacy concerns.

But I strongly believe banks will eventually embrace generative AI, once they resolve concerns they have with it. The potential gains are too significant to pass up – and there’s a risk of being left behind by rivals.

But the risks to financial markets, the global economy and everyone are also great, so I hope they tread carefully.

The Russell Reconstitution Preliminary List

Posted on by phoffman@channelchek.com
Image Credit: Channelchek (S.L)

The New Russell Indexes Unconfirmed Versions – How Investors Use Them

The preliminary list of stocks to be included in the Russell Reconstitution, and also which Russell Index, is a huge day for many stock investors and the impacted companies as well. This year, it occurs on Friday, May 19. The list, although preliminary and subject to refinements each Friday through June, includes the stocks that are believed to meet the requirements based on valuations taken on April 28. This is the first official file from the popular index provider, in addition to informing the investor public what to expect when the indexes are reconstituted. The reconstitution can be expected to impact prices as index fund managers readjust holdings. The event also, for many, redefines market-cap levels that are considered small-cap, mid-cap, and large-cap.

Background

The Russell Reconstitution is an annual event that reconfigures the membership of the Russell indexes by defining the top 3000 stocks based on market-cap (Russell 3000), then the top 1000 stocks (Russell 1000), and reclassifying the smaller 2000 stocks to form the Russell 2000 Small Cap Index. These serve as a benchmark for many institutional investors, as the indexes reflect the performance of the U.S. equity market across different market-cap classifications. The reconstitution process adds, removes, and weights stocks to ensure the indexes accurately represent the market.

The Preliminary List which will be published after the market closes on May 19, 2023, is a crucial step in the market cap reclassification process. It provides market participants with an initial glimpse into potential additions and deletions from the indexes. The stocks listed on this preliminary roster may experience increased attention from investors, as it hints at potential buying or selling pressure once the final reconstitution is completed.

The newly reconstituted indexes become live after the market close on June 23.

Implications for Investors

The release of the Russell Preliminary List on May 19 could provide opportunities for investors, including:

Enhanced Market Visibility – Companies listed on the Preliminary List may experience increased trading volumes and heightened market popularity, or even scrutiny, as investors evaluate their potential inclusion in the Russell indexes.

Potential Price Movements – Stocks slated for addition or deletion from the indexes can experience price volatility as market participants adjust their positions to align with the anticipated reconstitution changes.

Portfolio Adjustments – Active managers who track the Russell indexes may need to realign their portfolios to reflect the new index constituents, potentially triggering buying or selling activity in affected stocks.

Investor Considerations

Stock market participants should consider the following factors when analyzing the Preliminary List and its potential impact:

Final Reconstitution – The Preliminary List is subject to changes in the final reconstitution, which is typically announced in late June. Investors should monitor subsequent updates to confirm the actual index membership changes. These updates may occur as the result of faulty data or dramatic changes to the company such as a merger since the April 28 market cap snapshot.

Fundamental Analysis – As always, the fundamentals and financial health of the companies should be among the most important factors for non-index investors to consider. In the past, potential additions often presented attractive investment opportunities, while potential deletions may mean the stock gets less attention from investors.

Take Away

The release of the Preliminary List on May 19, 2023, marks a significant milestone in the Russell Reconstitution process. Investors should pay close attention to the stocks listed, as they may experience increased market visibility and potential price movements. However, it is important to remember that the Preliminary List is subject to changes. Thorough fundamental analysis, including earnings, potential growth, and liquidity assessment, is prudent for most stock investments. For information to evaluate small-cap names, look to Channelchek as a source of data on over 6,000 small cap companies.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://research.ftserussell.com/products/downloads/FTSE_FAQ_Document_Russell_US_Equity_2023.pdf

Newcrest Mining Just Agreed to Be Acquired by Newmont, Who’s Next?

Posted on by phoffman@channelchek.com

Is Further Consolidation in the Mining Sector Expected?

Two of the world’s leading gold producers have agreed to merge. In a press release this week, Newmont Mining (NEM) said it entered into a definitive agreement to acquire 100% of shares of Newcrest Mining (NCMGY). The deal represents a 30.4% premium to Newcrest stockholders above the price when Newmont first made an offer in February. While this is a huge deal that will greatly expand the world’s largest gold-producing company, investors are seeing possible opportunities in smaller mining companies. It’s likely some are quietly being targeted in 2023 for a number of important reasons. Investors interested in this industry may want to familiarize themselves with the current dynamics.

About the Newmont Newcrest Deal

Newmont, the world’s largest gold producer, is solidly moving toward becoming much larger after the board of takeover target Newcrest Mining unanimously agreed to recommend the merger bid to shareholders. Newmont projections indicate the combined entity could create annual production of 8Moz of gold and 155k tonnes of copper.

The merged company would easily control world-leading gold stocks. Newmont is also set to become a significant copper producer, with current and expected developments to provide significant production upside in the coming years, including the world-class Wafi-Golpu copper-gold project in Papua New Guinea.

Takeover Details

After rejecting Newmont’s initial February 2023 offer, the Newcrest board today elected to accept the significantly upgraded April revised proposal. The deal carries an implied equity value of US$26.2 billion and enterprise value for Newcrest of US$28.8 billion.

Current Newcrest shareholders will have 31% ownership of the combined group.

According to Newcrest’s chairman, Peter Tomsett, the transaction will combine two of the world’s leading gold producers, bringing forward significant value to Newcrest shareholders through the recognition of the company growth pipeline.

Will the Merger Trend Continue?

Higher metals prices and increased demand brought on by changing energy production and storage, post-pandemic demand, and commodities investing in an uncertain global economy have caused a number of deals in this sector already this year.  

The primary reasons to expect more consolidation within the mining sector are growing.  

The chart above created by the CRU Group shows how fragmented gold mining is relative to other metals. The top 10 largest gold miners only produce 28% of all output. Gold prices have been rising fairly steadily but spending on exploration has been stalled. Growth to create shareholder value, would most efficiently and expediently be achieved by merger and acquisition (M&A). In the current environment, buyouts of active producers with known reserves are the alternative way for larger miners to to increase their production share, replenish depleting gold reserves and… lower production costs through with far less risk and in a shorter time period.  

More Reasons to Own Mining Companies

World demand has been heightened for gold, copper, and other minerals used to store or distribute electricity. This dynamic which has been trending upward in recent years, is likely to push other financially strong mining companies, that want to satisfy new production demand now rather than through exploration and long, uncertain bureaucratic approval processes will shop for producers to increase production and grow to serve shareholders. Smaller companies that find themselves the target of an acquisition, also have a duty to serve shareholders. Often this plays out by the target company negotiating terms that are similar to the 30% gain seen in the Newmont/Newcrest deal.

What Else

Informed stock selection is key to discovering and deciding whether to invest in companies best positioned to benefit from a sector experiencing growing demand where acquisitions, in full or in part, fulfill larger company goals.

Where does an investor start to better understanding the mining sector and individual companies? Earlier this year The Channelchek Take Away Series brought to viewers a live in-depth presentation of 12 mining companies that were just coming off the huge PDAC mining conference in Canada. These presentations are available on video to be replayed – they may be the best place to begin hearing from mining company executives and a highly respected senior natural resources analyst. Click here to get started. Then visit Channelchek’s Natural Resources data of the many other companies available to discover for even more interesting, actionable opportunities.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.newmont.com/investors/news-release/news-details/2023/Newmont-Enters-into-Definitive-Agreement-to-Acquire-Newcrest/default.aspx

https://im-mining.com/category/mining-mergers-and-acquisitions/

https://www.crugroup.com/knowledge-and-insights/insights/2023/gold-sector-consolidation-has-a-long-way-to-go/

Is Your Bank Prepared for a US Debt Default?

Posted on by phoffman@channelchek.com

War Rooms and Bailouts: How Banks and the Fed are Preparing for a US Default – and the Chaos Expected to Follow

When you are the CEO responsible for a bank and all the related depositors and investors, you don’t take an “it’ll never happen” approach to the possibility of a U.S. debt default. The odds are it won’t happen, but if it does, being unprepared would be devastating. Banks of all sizes are getting their doomsday plans in place, and other industries are as well, but big banks, on many fronts would be most directly impacted. The following is an informative article on how banks are preparing. It’s authored by John W. Diamond the Director of the Center for Public Finance at the Baker Institute, Rice University, and republished with permission from The Conversation.  – Paul Hoffman, Managing Editor, Channelchek

Convening war rooms, planning speedy bailouts and raising house-on-fire alarm bells: Those are a few of the ways the biggest banks and financial regulators are preparing for a potential default on U.S. debt.

“You hope it doesn’t happen, but hope is not a strategy – so you prepare for it,” Brian Moynihan, CEO of Bank of America, the nation’s second-biggest lender, said in a television interview.

The doomsday planning is a reaction to a lack of progress in talks between President Joe Biden and House Republicans over raising the US$31.4 trillion debt ceiling – another round of negotiations took place on May 16, 2023. Without an increase in the debt limit, the U.S. can’t borrow more money to cover its bills – all of which have already been agreed to by Congress – and in practical terms that means a default.

What happens if a default occurs is an open question, but economists – including me – generally expect financial chaos as access to credit dries up and borrowing costs rise quickly for companies and consumers. A severe and prolonged global economic recession would be all but guaranteed, and the reputation of the U.S. and the dollar as beacons of stability and safety would be further tarnished.

But how do you prepare for an event that many expect would trigger the worst global recession since the 1930s?

Preparing for Panic

Jamie Dimon, who runs JPMorgan Chase, the biggest U.S. bank, told Bloomberg he’s been convening a weekly war room to discuss a potential default and how the bank should respond. The meetings are likely to become more frequent as June 1 – the date on which the U.S. might run out of cash – nears.

Dimon described the wide range of economic and financial effects that the group must consider such as the impact on “contracts, collateral, clearing houses, clients” – basically every corner of the financial system – at home and abroad.

“I don’t think it’s going to happen — because it gets catastrophic, and the closer you get to it, you will have panic,” he said.

That’s when rational decision-making gives way to fear and irrationality. Markets overtaken by these emotions are chaotic and leave lasting economic scars.

Banks haven’t revealed many of the details of how they are responding, but we can glean some clues from how they’ve reacted to past crises, such as the financial crisis in 2008 or the debt ceiling showdowns of 2011 and 2013.

One important way banks can prepare is by reducing exposure to Treasury securities – some or all of which could be considered to be in default once the U.S. exhausts its ability to pay all of its bill. All U.S. debts are referred to as Treasury bills or bonds.

The value of Treasurys is likely to plunge in the case of a default, which could weaken bank balance sheets even more. The recent bank crisis, in fact, was prompted primarily by a drop in the market value of Treasurys due to the sharp rise in interest rates over the past year. And a default would only make that problem worse, with close to 190 banks at risk of failure as of March 2023.

Another strategy banks can use to hedge their exposure to a sell-off in Treasurys is to buy credit default swaps, financial instruments that allow an investor to offset credit risk. Data suggests this is already happening, as the cost to protect U.S. government debt from default is higher than that of Brazil, Greece and Mexico, all of which have defaulted multiple times and have much lower credit ratings.

But buying credit default swaps at ever-higher prices limits a third key preventive measure for banks: keeping their cash balances as high as possible so they’re able and ready to deal with whatever happens in a default.

Keeping the Financial Plumbing Working

Financial industry groups and financial regulators have also gamed out a potential default with an eye toward keeping the financial system running as best they can.

The Securities Industry and Financial Markets Association, for example, has been updating its playbook to dictate how players in the Treasurys market will communicate in case of a default.

And the Federal Reserve, which is broadly responsible for ensuring financial stability, has been pondering a U.S. default for over a decade. One such instance came in 2013, when Republicans demanded the elimination of the Affordable Care Act in exchange for raising the debt ceiling. Ultimately, Republicans capitulated and raised the limit one day before the U.S. was expected to run out of cash.

One of the biggest concerns Fed officials had at the time, according to a meeting transcript recently made public, is that the U.S. Treasury would no longer be able to access financial markets to “roll over” maturing debt. While hitting the current ceiling prevents the U.S. from issuing new debt that exceeds $31.4 trillion, the government still has to roll existing debt into new debt as it comes due. On May 15, 2023, for example, the government issued just under $100 billion in notes and bonds to replace maturing debt and raise cash.

The risk is that there would be too few buyers at one of the government’s daily debt auctions – at which investors from around the world bid to buy Treasury bills and bonds. If that happens, the government would have to use its cash on hand to pay back investors who hold maturing debt.

That would further reduce the amount of cash available for Social Security payments, federal employees wages and countless other items the government spent over $6 trillion on in 2022. This would be nothing short of apocalyptic if the Fed could not save the day.

To mitigate that risk, the Fed said it could immediately step in as a buyer of last resort for Treasurys, quickly lower its lending rates and provide whatever funding is needed in an attempt to prevent financial contagion and collapse. The Fed is likely having the same conversations and preparing similar actions today.

A Self-Imposed Catastrophe

Ultimately, I hope that Congress does what it has done in every previous debt ceiling scare: raise the limit.

These contentious debates over lifting it have become too commonplace, even as lawmakers on both sides of the aisle express concerns about the growing federal debt and the need to rein in government spending. Even when these debates result in some bipartisan effort to rein in spending, as they did in 2011, history shows they fail, as energy analyst Autumn Engebretson and I recently explained in a review of that episode.

That’s why one of the most important ways banks are preparing for such an outcome is by speaking out about the serious damage not raising the ceiling is likely to inflict on not only their companies but everyone else, too. This increases the pressure on political leaders to reach a deal.

Going back to my original question, how do you prepare for such a self-imposed catastrophe? The answer is, no one should have to.

The Limits to the Artificial Intelligence Revolution

Posted on by phoffman@channelchek.com

What Will AI Never Be Good At?

Artificial intelligence (AI) is a true disruptive technology. As any informed content writer can tell you, the technology creates efficiencies by speeding up data gathering, research, and even graphics that specifically reflect the content. As an example, it is arguably quicker to use ChatGPT to provide a list of ticker symbols from company names, than it is to look them up one by one. With these small time savers, over the course of a week, far more can be produced as a result of AI tools saving a few minutes here and there.

This presents the question, what are the limits of AI – what can’t it do?

Worker Displacement

Technological revolutions have always benefitted humankind in the long run; in the short run, they have been disruptive, often displacing people who then have to retrain.

A new Goldman Sachs report says “significant disruption” could be on the horizon for the labor market. Goldman’s analysis of jobs in the U.S. and Europe shows that two-thirds of jobs could be automated at least to some degree. In the U.S., “of those occupations which are exposed, most have a significant — but partial — share of their workload (25-50%) that can be replaced,” Goldman Sachs’ analysts said in the paper.

Around the world, as many as 300 million jobs could be affected, the report says. Changes to labor markets are therefore likely – although historically, technological progress doesn’t just make jobs redundant, it also creates new ones. And the added productivity allows the masses to live wealthier lives. This clearly was the end result of the  industrial revolution, and years after the computer revolution, we are at a high rate of employment and have at our fingertips much which we never even dreamed.

The Goldman report says the use of AI technology could boost labor productivity growth and boost global GDP by as much as 7% over time.

There are few reasons to expect that the AI revolution won’t also provide more goods and services per person for a richer existence. But, what about the disruption in the interim? I was curious to know what artificial intelligence is not expected to be able to do. There isn’t much information out there, so I went to an AI source and fed it a bunch of pointed questions about its nature. Part of that nature is to not intentionally lie, I found the responses worth sharing as we will all soon be impacted by what the technology can and cannot do.

Limitations of AI that Will Persist

Artificial intelligence has come a long way in recent years and the speed of progression and adoption is accelerating. As a result, applications have become increasingly sophisticated. But, there are still many things that AI cannot do now and may never be able to do.

One thing that AI cannot do now and may never be able to do is to truly understand human emotions and intentions. While AI algorithms can detect patterns in data and recognize certain emotional expressions, they do not have the ability to experience emotions themselves. This means that AI cannot truly understand the nuances of human communication, which can lead to misinterpretation and miscommunication.

Another limitation of AI is that it cannot replicate the creativity and intuition of humans. While AI can generate new ideas based on existing data, it lacks the ability to come up with truly original and innovative ideas. This is because creativity and intuition are often based on a combination of experience, emotion, and imagination, which are difficult to replicate in a machine.

AI also struggles with tasks that require common sense reasoning or context awareness. For example, AI may be able to identify a picture of a cat, but it may struggle to understand that a cat is an animal that can be petted or that it can climb trees. This is because AI lacks the contextual understanding that humans have built up through years of experience and interaction with the world around us.

In the realm of stocks and economics, AI has shown promise in analyzing data and making predictions, but there are still limitations to its abilities. For example, AI can analyze large datasets and identify patterns in market trends, but it cannot account for unexpected events or human behavior that may affect the market. This means that while AI can provide valuable insights, it cannot guarantee accurate predictions or prevent market volatility.

Another limitation of AI in economics is its inability to understand the complexities of social and political systems. Economic decisions are often influenced by social and political factors, such as government policies and public opinion. While AI can analyze economic data and identify correlations, it lacks the ability to understand the underlying social and political context that drives economic decisions.

A concern some have about artificial intelligence is that it may perpetuate biases that exist in the data it analyzes. This is the “garbage in, garbage out” data problem on steroids. For example, if historical data on stock prices is biased towards a certain demographic or industry, AI algorithms may replicate these biases in their predictions. This can lead to an amplified bias that proves faulty and not useful for economic decision making.

Take Away

AI has shown remarkable progress in recent years, but, as with everything that came before, there are still things that it cannot do now and may never be able to do. AI lacks the emotional intelligence, creativity, and intuition of humans, as well as common sense reasoning and social and political systems. In economics and stock market analysis, AI can provide valuable insights, but it cannot assure accurate predictions or prevent market volatility. So while companies are investing in ways to make our lives more productive with artificial intelligence and machine learning, it remains important to invest in our own human intelligence, growth and expertise.

Paul Hoffman

Managing Editor, Channelchek

Sources

OpenAI. (2021). ChatGPT [Computer software]. Retrieved from https://openai.com

https://www.cnbc.com/2023/05/16/how-generative-ai-chatgpt-will-change-jobs-at-all-work-levels.html

The Big Position – Michael Burry’s Holdings

Posted on by phoffman@channelchek.com

Michael Burry, What He Bought, What He Sold, and What He Held

I mark my calendar for the four times a year that Michael Burry is required to make his quarterly holdings public. The founder of Scion Asset Management, who gained additional fame by the portrayal of him in the movie The Big Short, is not a follower of other investors. He does his own unique number crunching and analyzing and is often at odds with mainstream investor thinking. This week he filed his 13F with the SEC, which shows his holdings of publicly traded securities as of the close of business on March 31. It is important to note that his holdings at the close of the following trading day may not be the same.

The Dramatic Holdings Shift

There has been a conspicuous shift in the holdings in Burry’s hedge fund. For the first time that I can recall, he has taken large long positions in companies domiciled in China. This includes an increase in holdings in e-commerce company JD.com Inc. (JD) and retailer Alibaba (BABA).

These positions stood at quarter-end as the largest holdings of Scion, representing 20% of securities held. Many hedge funds have gone sour on investing in Chinese tech companies, Burry isn’t necessarily a contrarian, but it is not unusual for him to be at odds with his peers. Hedge funds’ net exposure to China has dropped to 10.5% from 13.3% in January, according to data from Goldman Sachs Group Inc.’s Prime Services unit. If other large investors are early to the party, or late, that allows him to buy into weakness, or sell into strength – if he’s right.

The Big Position

How big are his positions? After purchasing Alibaba and JD.com in the final months of 2022 as China ended its zero covid 19 policy, Burry, who had held JD.com as of the previous two 13F filings, added to the holdings. His bigger stake more than tripled to 250,000 shares, worth $11 million, or 11% of his portfolio. The report shows his holdings of Alibaba had doubled.

It is not just notable that Burry is long, but that he held larger long positions than he has in many quarters.

The report, which is a snapshot taken just a couple of weeks after Silicon Valley Bank (SVB) shook investors in financial stocks, shows that Michael Burry jumped in and bought shares of smaller banks in the first quarter – where there is fear, there are knee-jerk reactions to take advantage of. In fact, he appears to have jumped into the middle of the firestorm adding long positions of First Republic, Pacific Western (PACW), Western Alliance, New York Community Bank, and Huntington Bank (HBAN) last quarter. Burry also bought other financial stocks, specifically Wells Fargo (WFC) and Capital One (COF). There is no indication if these worked out for the investors in his fund.

Energy, Commodities, and Other Long Positions

Burry also ended last quarter with new positions in energy and commodity stocks. These may be an inflation hedge trade. Holding cash during periods of higher inflation is akin to sitting still while watching money blow away. While there is no guarantee that the investment alternative to cash will do better, the sectors have a long history that supports the trade. Scion was invested in Coterra Energy (CTR), Devon Energy (DVN), and Sibanye Stillwater (SBSW).

Burry closed out the quarter with shares in various other companies including Zoom Video (ZM), The RealReal (REAL), and Signet Jewelers (SIG).

He still maintains his long-term position in Geo Group (GEO). Geo is the world’s second largest private “prison company.” Geo Group has the honor of being  Scion’s longest held position, put on sometime after the incoming administration sought to do away with privately owned prisons. Investors interested in how Geo Group navigated this challenge and is now finding other growth opportunities to utilize its assets, may wish to attend one of three no-cost roadshows in May that are part of the Noble Capital Markets and Channelchek Meet the Management Series. (Get more information here).

Closed Out and Longest Held Positions

Scion exited its positions in Wolverine Worldwide (WWW), MGM Resorts (MGM), Black Knight (BKI), Qurate Retail (QRTEA), and SkyWest (SKYW).

Source: Capedge.com

Take Away

The next Scion Asset Management 13F is expected to be filed on August 15th. While current holdings are unknown, much can be discerned from what top investment managers traded at the time. This information can help guide current thinking. When he has conviction, Michael Burry is not afraid to pull the trigger, long or short. As we have seen, when he lacks conviction, he is equally unafraid to keep his powder dry and sit on the sidelines. Inflation adds a cost to sitting on the sidelines. In late March he was very long and seemed to be gravitating toward segments that were being shunned.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.goldmansachs.com/what-we-do/FICC-and-equities/prime-services/

https://www.sec.gov/Archives/edgar/data/1649339/000090514823000408/xslForm13F_X02/primary_doc.xml

https://capedge.com/filing/1649339/0000905148-23-000408/13FHR/file/2

In the Event of an Official U.S. Bankruptcy…

Posted on by phoffman@channelchek.com

Is a U.S. Default or Bankruptcy Possible – How Would that Work?

It seems no one is talking about what would happen if the U.S. defaulted on maturing debt, yet it is within the realm of possibilities. Also not impossible is the idea of the powerful country joining the list of sovereign nations that once declared bankruptcy and survived. A retired government employee with a passion for economic history wrote a timely piece on this subject. It was originally published on the Mises Institute website on  May 12, 2023. Channelchek has shared it here with permission.

The current known federal debt is $31.7 trillion, according to the website, U.S. Debt Clock, this is about $94,726 for every man, woman, and child who are citizens as of April 24, 2023. Can you write a check right now made payable to the United States Treasury for the known share of the federal debt of each member of your family after liquidating the assets you own?

A report released by the St. Louis Federal Reserve Branch on March 6, 2023, stated a similar figure for the total known federal debt of about $31.4 trillion as of December 31, 2022. The federal debt size is so great, it can never be repaid in its current form.

Some of us have been in or known families or businesses who had financial debt that could not be paid when adjustments like reducing expenses, increasing income, renegotiating loan repayments to lender(s), and selling assets to raise money for loan repayment were not enough. The reality is that they still could not pay the debt owed to the lender(s).

This leads to filing bankruptcy under federal bankruptcy laws overseen by a federal bankruptcy court.

Chapter 7 bankruptcy is a liquidation proceeding available to consumers and businesses. It allows for assets of a debtor that are not exempt from creditors to be collected and liquidated (turned to cash), and the proceeds distributed to creditors. A consumer debtor receives a complete discharge from debt under Chapter 7, except for certain debts that are prohibited from discharge by the Bankruptcy Code.

Chapter 11 bankruptcy provides a procedure by which an individual or a business can reorganize its debts while continuing to operate. The vast majority of Chapter 11 cases are filed by businesses. The debtor, often with participation from creditors, creates a plan of reorganization under which to repay part or all its debts.

These government entities have filed for Chapter 9 federal bankruptcy:

Orange County, California, in 1994 for about $1.7 billion

Jefferson County, Alabama, in 2011 for about $5 billion

The City of Detroit, Michigan, in 2013 for about $18 billion

The Commonwealth of Puerto Rico in 2017 for $72 billion

According to the United States Courts website:

The purpose of Chapter 9 is to provide a financially-distressed municipality protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan.

Although similar to other Chapters in some respects, Chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors.

The bankruptcies of two counties, a major city, and a sovereign territory resulted in bondholders with financial losses not repaid in full as well as reforms enacted in each governmental entity. Each one emerged from bankruptcy, one hopes, humbled and better able to manage their finances.

The federal government’s best solution for bondholders, taxpayers, and other interested parties is to default, declare sovereign bankruptcy, and make the required changes to get the fiscal business in order. Default, as defined by Dictionary.com as a verb, is “to fail to meet financial obligations or to account properly for money in one’s care.”

Sovereign government defaults are not new in our lifetime with Argentina in 1989, 2001, 2014, and 2020; South Korea, Indonesia, and Thailand in 1997, known as the Asian flu; Greece in 2009; and Russia in 1998.

Possible Outcomes

Some outcomes from these defaults lead to sovereign government debt bond ratings being reduced by the private rating agencies, bondholders losing value on their holdings, debt repayments being renegotiated with lenders, many countries receiving loans with a repayment plan from the International Monetary Fund (IMF), reforms being required to nations’ entitlement programs, a number of government taxes being raised, their currency losing value on currency trading exchanges, price inflation becoming more of a reality to its citizens, and higher interest rates being offered on future government debt bond offerings.

Very few in the financial world are talking about any outcomes of a U.S. federal government debt default. One outcome from the 2011 near default was Standard & Poor’s lowering their AAA federal bond rating to AA+ where it has remained.

What organization would oversee the execution of a U.S. federal government debt default, and what authorization would they be given to deal with the situation? No suggestions are offered when its scale is numerically mind-numbing since the U.S. has used debt as its drug of choice to overdose on fiscal reality.

Some outcomes would include a lowered federal bond rating by the three private bond rating agencies, where the reality of higher interest rates being offered on newly issued federal debt cannot be ignored. Federal government spending cuts in some form will be required by the realities of economic law, which includes reducing the number of federal employees, abolishing federal agencies, reducing and reforming military budgets, selling federal government property, delegating federal programs to the states, and reforming the federal entitlement programs of Medicaid, Medicare, and Social Security. Federal government tax revenue to repay the known debt with interest will rise as a percentage of each year’s future federal budget.

One real impact from a federal government debt default would be that the U.S. dollar would no longer be the global reserve currency, with dollars in many national reserve banks coming back to the U.S. Holding dollars will be like holding a hot potato. Nations holding federal debt paper—like China ($859 billion), Great Britain ($668 billion), Japan ($1.11 trillion), and others as of the January 2023 numbers published by the U.S. Treasury—as well as many mutual funds and others will see their holdings reduced in value leading to a selling off of a magnitude one cannot imagine in scale and timing. Many mutual fund holders like retirees, city and state retirement systems, and 401(k) account holders will be impacted by this unfolding event.

The direction of an individual or business when they emerge from federal bankruptcy is hopefully humility—looking back with the perspective of mistakes made, learning from these mistakes, and moving forward with a focus to benefit their family and community.

However, cities, counties, and sovereign territories differ from individuals, families, and private businesses in emerging from federal bankruptcy. What the outcome of a federal government debt default will be is unknown. Yet its reality is before us.

About the Author:

Stephen Anderson is retired from state government service and is a graduate of The University of Texas at Austin. He currently lives in Texas. His passions are reading, writing, and helping friends and family understand economic history.

The Reasons Veteran Investors are Now Eyeing Small-Cap Stocks

Posted on by phoffman@channelchek.com

The Growing Case for Small-Cap Stocks: Is it Time to Make the Shift?

The more time that passes with small cap stocks lagging the large and mega caps, the louder very respected market voices are urging investors to move more assets to these smaller companies. The pro small cap stock outlook was reflected again in a recent Barron’s article. The piece highlighted what others continue to point out, that the large cap, S&P 500, is up nearly 8% on the year, but the gains have only been because of the performance of a few big tech stocks and the math used to measure the equity index.

A very eye-opening line in Barron’s points out that, “Apple (ticker: AAPL), Amazon.com (AMZN), Meta Platforms (META), Alphabet (GOOGL), Microsoft (MSFT), Nvidia (NVDA), and Tesla (TSLA) are up between 29% and 99% for the year.” These stocks make up a significant weighting of the large cap index, which means that much of the other large cap stocks have been negative in order to only provide an 8% return. To demonstrate how the weighting of the larger companies distorts return, just look at the Invesco S&P 500 Equal Weight ETF (RSP). This ETF weighs each stock in the S&P 500 equally. This has the effect of avoiding overweighting and one stock. This ETF is flat year-to-date. In contrast, The few tech names listed above total just under a third of the entire index.

The article also pointed out the truth that smaller names, those not in the S&P 500, have struggled. What does this mean for investors? Barron’s wrote, “They also look cheap—-and it may be time to take a nibble.” The case that others are also making is based on a number of current market setups. These include value, market history, and even macroeconomic trends that now may favor smaller companies over larger ones.

Big Tech companies like those mentioned above borrow massive amounts of money, they have been the beneficiaries of lower bond rates out on the yield curve. In addition to borrowing costs still below normal, valuing these stocks based on future earnings and comparing the expected earnings to available interest rates have caused investors to be less inclined to tie up money for ten years or more, (at 3.50%). Also, better than expected first-quarter earnings of big tech-inspired investors – product enhancements using artificial intelligence was credited with much of this.

Royce Funds’ Premier Quality Fund invests in “small cap quality.” In a recent article to investors co-lead portfolio managers Lauren Romeo and Steven McBoyle explained why, “small-cap quality looks so compelling in today’s uncertain investment environment.”  The portfolio managers wrote, “Secular changes in economic trends, interest rates, and monetary and fiscal policies are creating seismic shifts in the investment landscape. The types of companies that benefited most from the past decade’s zero interest rate, low inflation, and low nominal growth regime—specifically, mega-caps and growth stocks—are unlikely to lead going forward.” Under this backdrop, the two gave their perspective which is that, “the unfolding macro environment appears to be set for quality small caps to capture and sustain long-term outperformance over large cap” through an uncertain period that is characterized by a near certain transition.

If tech stocks again falter because rates rise, advancement slows, or competition grows, the appearance of the S&P 500 large cap index stocks performing well could diminish. “Market gains continue to be dominated by uber-caps, masking the fact that 48% of S&P 500 member stocks are down year to date,” wrote Chris Harvey, chief U.S. equity strategist at Wells Fargo, on May 12. 

Within the same index family (S&P), is the S&P 600, which is a small cap index. It is not currently having a positive year, and is down about 3%. Interestingly, the reverse argument can be made for this benchmark since it is overweighted in one specific sector. Financials, which have taken a beating this year is the largest sector weighting in the S&P 600. It accounts for just over a fifth of the performance. This has dragged the index lower, as regional banks have seen billions of depositor dollars walk out the door as savers and investors move assets to higher-yielding money-market funds. This, as we know, has caused liquidity problems at many banks, and caused some to fail.

2023 has been a challenging market for stocks despite the S&P 500 performance. It has been challenging for small caps too, but not as challenging as the S&P 600 performance would have one believe without looking under the hood. Small caps, independent of the high weighting of financials in the benchmark are positive on the year. One very real concern large cap investors are now facing is whether the flow into large cap funds have overly inflated the value, based on most stock valuation metrics, above where they would naturally trade if not for indexed funds.

The economy is not expected to get much stronger this year. Higher interest rates have already begun to stress the US economy, and banking problems are expected to cause tighter lending and consumer spending. And as mentioned a few times, the widely quoted S&P 500’s performance, is covering up what has mostly been a tough equity market.

But while large caps look expensive, for the reasons mentioned, respected experts say small caps look cheap. The S&P 600’s aggregate forward price/earnings multiple is just under 13 times – this compares with the S&P 500 which is 18 times. While on the surface, this doesn’t seem striking, it is! While the difference between 13 times and 18 times doesn’t sound wide, it marks a 30% difference. That is a massive discount. Historically the small cap index trades at a slight premium to its large-cap counterpart, but even in times of economic stress, it doesn’t trade at such a wide discount. In March of 2020, the height of pandemic risk aversion, its multiple was only 25% below the S&P 500.

Take Away

It has been a tougher year for stocks than the performance of the large cap S&P 500 would have one think without digging below the surface and netting out its largest sector weighting. The small cap S&P 600 is down, but largely because of its own largest sector weighting. This is one of the many problems inherent in how popular index investing has become. While stocks in general seem to be facing increasing headwinds, investors that selectively evaluate small cap names for inclusion in the equity portion of their portfolio may find the payoff is better than the alternatives.

Evaluating small cap opportunities is easy with  Channelchek as the platform specializes in supplying data, information, and no-nonsense research on smaller opportunities. Please feel free to explore further by scrolling up to the search bar and typing in an industry, company name, or ticker. Channelchek is a free platform designed to help investors and opportunities find each other.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.barrons.com/articles/small-cap-stocks-big-tech-15df5779?mod=hp_LEAD_2

https://www.royceinvest.com/insights/2023/2Q23/why-the-time-looks-right-for-quality?utm_source=royce-mktg&utm_medium=email&utm_campaign=insights&utm_content=txt-3

https://app.koyfin.com/share/084b52d626

The Week Ahead –  Powell Panel, Retail Numbers, Debt Ceiling Negotiations

Posted on by phoffman@channelchek.com

The Market Will Experience a Barrage of Appearances by Fed Officials

This will be another week of various regional Fed Presidents speaking and setting expectations of potential adjustments to monetary policy; this includes Jerome Powell and Former Fed Chair Ben Bernanke. Retail and consumer health could come into sharper focus during the week as major retailers report earnings and April retail sales are reported early in the week. The initial results for the Russell Reconstitution of its main indexes will be released after the close of trading on Friday. Also, late week, Fed Chair Jay Powell will make an appearance on a panel with Ben Bernanke.

Monday 5/15

  • 8:30 AM ET, The Empire State Manufacturing Index for May is expected to fall back to negative territory at minus 2.0 after April’s 35-point surge into positive ground at 10.8. This monthly survey of manufacturers in New York State is seldom market moving, but combined with other reports helps draw a picture of economic health within the region and more broadly.
  • 8:45 AM ET, Ralph Bostic, the CEO of the Atlanta Federal Reserve, will be speaking.
  • 9:15 AM ET, Neel Nashkari, the President of the Minneapolis Federal Reserve, will be speaking.
  • 12:30 PM ET, Thomas Barkin, the President of the Richmond Federal Reserve, will be speaking.

Tuesday 5/16

  • 8:15 AM ET, Loretta Mester, CEO of the Federal Reserve Bank of Cleveland, will be speaking.
  • 8:30 AM ET, April Retail Sales are expected to rise 0.7 percent versus March’s 1.0 percent decline that, much of the earlier decline was led by declines in car sales and gasoline.
  • 8:55 AM ET, Raphael Bostic will be speaking. Bostic is the CEO of the Atlanta Fed.
  • 9:15 AM ET, Industrial Production is expected to be unchanged in April after March’s 0.4 percent increase that was boosted by utilities output. Manufacturing output is seen as up 0.1 percent after falling 0.5 percent in March.
  • 10:00 AM ET, Business Inventories in March are expected to remain unchanged following a 0.2 percent build in February.
  • 10:00 AM ET, the Housing Market Index has not been experiencing the steep declines witnessed last year. After April’s previously reported 1-point gain to 45, May’s consensus is no change at 45.
  • 12:15 PM ET, John Williams, the President of the New York Federal Reserve, will be speaking.
  • 3:15 PM ET, Lorrie Logan is the President of the Federal Reserve Dallas, she will be speaking.
  • 7:00 PM ET, Raphael Bostic, will be speaking. Bostic is the CEO of the Atlanta Fed.

Wednesday 5/17

  • 7:30 AM ET, Mortgage Applications, compiled by the Mortgage Bankers’ Association will be released. compiles various mortgage loan indexes. The index measures applications at mortgage lenders. This is a leading indicator for single-family home sales and housing construction.
  • 8:30 AM ET, Housing Starts and Permits during  March edged lower to a 1.420 million annualized rate; April is expected to slip further to 1.405 million. Permits, at 1.413 million in March and, though lower than expected, very near the starts rate, is expected to rise to 1.430 million.
  • 10:30 AM ET, The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the U.S., whether produced here or abroad. The level of inventories helps determine prices for petroleum products.

Thursday 5/18

  • 8:30 AM ET, Jobless Claims Jobless claims for weekly period ended May 13 are expected to fall back to 255,000 after rising a steep 22,000 to 264,000 in the prior week.
  • 10:00 AM ET, Philadelphia Fed Manufacturing Index, The Philadelphia Fed manufacturing index has been in contraction the last nine reports and very deeply so in April at minus 31.3. May’s contraction is seen at minus 20.0.
  • 9:05 AM ET, Lorrie Logan, President of the Dallas Fed is scheduled to speak.
  • 10:00 AM, Ecommerce Retail Sales, are sales of goods and services where an order is placed by the buyer or where price and terms of sale are negotiated over the Internet, an extranet, Electronic Data Interchange (EDI) network, or other online system.
  • 10:00 AM, The Index of Leading Economic indicators, had plunged 1.2 percent in March, it is expected to fall a further 0.6 percent in April. This index has been in sharp decline and has long been signaling a pending recession.
  • 10:30 AM, The Energy Information Administration (EIA) provides weekly information on natural gas stocks in underground storage for the U.S. and five regions of the country. The level of inventories helps determine prices for natural gas products.

Friday 5/19

  • 8:30 PM ET, Import/Export Prices. Import Prices, an inflation harbinger is expected to rise 0.3 percent for April, this would end nine straight declines. Export prices are expected to rise 0.2 percent.
  • 8:45 AM, John Williams, the President of the New York Federal Reserve, will be speaking.
  • 10:00 PM ET, Consumer Sentiment looking at the first indication for May, which in April fell 1.5 points to 63.5, is expected to fall another half point to 63.0.
  • 10:00 AM ET, Quarterly Services is expected is focuses on information and technology-related service industries. These include information; professional, scientific and technical services; administrative & support services; and waste management and remediation services. These sectors correspond to three NAICS sectors (51, 54, and 56). The Quarterly Services Survey produces estimates of total operating revenue and the percentage of revenue by class of customer.
  • 11:00 AM, ET, Fed Chair Powell, is joined on a panel titled “Perspectives on Monetary Policy” by former Fed Chair Ben Bernanke.
  • 4:00 PM ET, The FTSE Russell Index reports the first list of stocks leading to the Russell’s Reconstitution in 2023.

What Else

Investment roadshows are like getting a front-row seat to information direct from management’s mouth. The most useful investor information often comes from the unplanned responses to questions during the roadshow – either asked by you, or other interested investors.

Noble Capital Markets has an expanding and interesting calendar of roadshows during the week and month. Some are in cities that are paid less attention to than the major financial centers. This week CoCrystal (COCP) will be presenting at roadshows in Miami, and Boca Raton, FL. For more details, and a complete list of roadshows and cities, Click here.

Paul Hoffman

Managing Editor, Channelchek

Sources:

https://www.federalreserve.gov/newsevents/calendar.htm

https://www.federalreserve.gov/newsevents/calendar.htm

https://www.econoday.com/

https://www.channelchek.com/news-channel/noble_on_the_road___noble_capital_markets_in_person_roadshow_series