As BRICS Cooperation Accelerates, Is It Time for the US to Develop a BRICS Policy?

Image: External Affairs Ministers at BRICS foreign ministers meeting, MEA Photogallery (Flickr)

An Expansion of BRICS Countries Would Increase its Negotiating Strength

When leaders of the BRICS group of large emerging economies – Brazil, Russia, India, China and South Africa – meet in Johannesburg for two days beginning on Aug. 22, 2023, foreign policymakers in Washington will no doubt be listening carefully.

The BRICS group has been challenging some key tenets of U.S. global leadership in recent years. On the diplomatic front, it has undermined the White House’s strategy on Ukraine by countering the Western use of sanctions on Russia. Economically, it has sought to chip away at U.S. dominance by weakening the dollar’s role as the world’s default currency.

And now the group is looking at expanding, with 23 formal candidates. Such a move – especially if BRICS accepts Iran, Cuba or Venezuela – would likely strengthen the group’s anti-U.S. positioning.

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, Mihaela Papa, Senior Fellow, The Fletcher School, Tufts University, Frank O’Donnell, Adjunct Lecturer in the International Studies Program, Boston College, Zhen Han, Assistant Professor of Global Studies, Sacred Heart University.

So what can Washington expect next, and how can it respond?

Our research team at Tufts University has been working on a multiyear Rising Power Alliances project that has analyzed the evolution of BRICS and the group’s relationship with the U.S. What we have found is that the common portrayal of BRICS as a China-dominated group primarily pursuing anti-U.S. agendas is misplaced.

Rather, the BRICS countries connect around common development interests and a quest for a multipolar world order in which no single power dominates. Yet BRICS consolidation has turned the group into a potent negotiation force that now challenges Washington’s geopolitical and economic goals. Ignoring BRICS as a major policy force – something the U.S. has been prone to do in the past – is no longer an option.

Reining in the America bashing

At the dawn of BRIC cooperation in 2008 – before South Africa joined in 2010, adding an “S” – members were mindful that the group’s existence could lead to tensions with policymakers who viewed the U.S. as the world’s “indispensable nation.”

As Brazil’s former Foreign Minister Celso Amorim observed at the time, “We should promote a more democratic world order by ensuring the fullest participation of developing countries in decision-making bodies.” He saw BRIC countries “as a bridge between industrialized and developing countries for sustainable development and a more balanced international economic policy.”

While such realignments would certainly dilute U.S. power, BRIC explicitly refrained from anti-U.S. rhetoric.

After the 2009 BRIC summit, the Chinese foreign ministry clarified that BRIC cooperation should not be “directed against a third party.” Indian Foreign Secretary Shivshankar Menon had already confirmed that there would be no America bashing at BRIC and directly rejected China’s and Russia’s efforts to weaken the dollar’s dominance.

Rather, the new entity complemented existing efforts toward multipolarity – including China-Russia cooperation and the India, Brazil, South Africa trilateral dialogue. Not only was BRIC envisioned as a forum for ideas rather than ideologies, but it also planned to stay open and transparent.

BRICS alignment and tensions with the US

Today, BRICS is a formidable group – it accounts for 41% of the world’s population, 31.5% of global gross domestic product and 16% of global trade. As such, it has a lot of bargaining power if the countries act together – which they increasingly do. During the Ukraine war, Moscow’s BRICS partners have ensured Russia’s economic and diplomatic survival in the face of Western attempts to isolate Moscow. Brazil, India, China and South Africa engaged with Russia in 166 BRICS events in 2022. And some members became crucial export markets for Russia.

The group’s political development – through which it has continually added new areas of cooperation and extra “bodies” – is impressive, considering the vast differences among its members.

We designed a BRICS convergence index to measure how BRICS states converged around 47 specific policies between 2009 and 2021, ranging from economics and security to sustainable development. We found deepening convergence and cooperation across these issues and particularly around industrial development and finance.

But BRICS convergence does not necessarily lead to greater tension with the United States. Our data finds limited divergence between the joint policies of BRICS and that of the U.S. on a wide range of issues. Our research also counters the argument that BRICS is China-driven. Indeed, China has been unable to advance some key policy proposals. For example, since the 2011 BRICS summit, China has sought to establish a BRICS free trade agreement but could not get support from other states. And despite various trade coordination mechanisms in BRICS, the overall trade among BRICS remains low – only 6% of the countries’ combined trade.

However, tensions between the United States and BRICS exist, especially when BRICS turns “bloc-like” and when U.S. global interests are at stake. The turning point for this was 2015, when BRICS achieved major institutional growth under Russia’s presidency. This coincided with Moscow enhancing its pivot to China and BRICS following Western sanctions over Russia’s annexation of Crimea in 2014. Russia was eager to develop alternatives to Western-led institutional and market mechanisms it could no longer benefit from.

That said, important champions of BRICS convergence are also close strategic partners to the U.S. For example, India has played a major role in strengthening the security dimension of BRICS cooperation, championing a counter-terrorism agenda that has drawn U.S. opposition due to its vague definition of terrorist actors.

Further constraints on U.S. power may emerge from BRICS transitioning to using local currencies over the dollar and encouraging BRICS candidate countries to do the same. Meanwhile, China and Russia’s efforts to engage BRICS on outer space governance is another trend for policymakers in Washington to watch.

Toward a US BRICS Policy?

So where does a more robust – and potentially larger – BRICS leave the U.S.?

To date, U.S. policy has largely ignored BRICS as an entity. The U.S. foreign and defense policymaking apparatus is regionally oriented. In the past 20 years, it has pivoted from the Middle East to Asia and most recently to the Indo-Pacific region.

When it comes to the BRICS nations, Washington has focused on developing bilateral relations with Brazil, India and South Africa, while managing tensions with China and isolating Russia. The challenge for the Biden administration is understanding how, as a group, BRICS’ operations and institutions affect U.S. global interests.

Meanwhile, BRICS expansion raises new questions. When asked about U.S. partners such as Algeria and Egypt wanting to join BRICS, the Biden administration explained that it does not ask partners to choose between the United States and other countries.

But the international demand for joining BRICS calls for a deeper reflection on how Washington pursues foreign policy.

Designing a BRICS-focused foreign policy is an opportunity for the United States to innovate around addressing development needs. Rather than dividing countries into friendly democracies and others, a BRICS-focused policy can see the Biden administration lead on universal development issues and build development-focused, close relationships that encourage a better alignment between countries of the Global South and the United States.

It could also allow the Biden administration to deepen cooperation with India, Brazil, South Africa and some of the new BRICS candidates. Areas of focus could include issues where the BRICS countries have struggled to coordinate their policy, such as AI development and governance, energy security and global restrictions on chemical and biological weapons.

Developing a BRICS policy could help re-imagine U.S. foreign policy and ensure that the United States is well positioned in a multipolar world.

The Three Causes Crushing Crypto

Bitcoin’s Throttleback Thursday Explained

Bitcoin and Ethereum had a bad day. After gaining a lot of upward momentum from late June after Blackrock, Fidelity, and Invesco filed to create bitcoin-related exchange traded funds (ETFs), the volatile assets have shown cryptocurrency investors that the bumpy ride is not yet over. What’s causing it this time? Fortunately, it is not fraud or wrongdoing creating the turbulence. Instead, three factors external to the business of trading, mining, or exchanging digital assets are at work.

 Background

On Thursday, August 17, and accelerating on August 18, the largest cryptocurrencies dropped precipitously. Bitcoin even broke down and fell below the psychologically important $26,000 US dollar price level before bouncing. While some are pointing to CME options expiration on the third Friday of each month, most are pointing to a Wall Street Journal article, and blaming Elon Musk, as the reason the asset class was nudged off a small cliff. There are other less highlighted, but important, catalysts that added to the flash-crash; these, along with the WSJ story, will be explained below.

Smells like Musk

What could SpaceX, the company owned and run by Elon Musk, possibly have to do with a crypto selloff? On Thursday, the crypto market had a downward spike around 5 PM ET. It was just after the Wall Street Journal revealed a change in the accounting valuation of SpaceX’s crypto assets. Reportedly, SpaceX marked down the value of its bitcoin assets by a substantial $373 million over the past two years. Additionally, the company has executed on crypto asset divestitures as well. When the reduction took place is uncertain, but cryptocurrency holdings have been reduced both in terms of the amount of coins and the value each coin is held for on the books.

Elon Musk’s reputation is that of a forward thinker, and one that embraces, if not leads, technology. He has significant influence over cryptocurrency valuations, often instigating pronounced market fluctuations brought about by Musk’s influential posts on his social media company, X. The reduction coincides with a similar crypto reduction on the books of publicly held, Musk-led, Tesla (TSLA). The electric car manufacturer had previously disclosed in its annual earnings report that it had liquidated 75% of its bitcoin reserves.

While it should not be surprising that two companies stepped away from speculation on something unrelated to their business or lowered support for the still young blockchain technology, it gave a reason for a reaction to this and other festering dynamics.

Wary of Gary

The Chairman of the Securities and Exchange Commission (SEC), Gary Gensler, is viewed as a “Whack-a Mole” to crypto stakeholders that prefer more autonomy than regulation. Every time the SEC gets knocked down as a potential regulator, it resurfaces, and crypto businesses have to deal with the agency again.  

Last month, Judge Analisa Torres made a pivotal decision in a case involving payment company Ripple Labs and the Commission. Her verdict declared that a substantial portion of sales of the token XRP did not fall under the category of securities transactions. The SEC claimed it was a security. This judgement was hailed as a triumph for the crypto sector and catalyzed an impressive 20% uptick in the exchange Coinbase’s stock in a single day.

On the same Thursday as the WSJ article, the SEC showed its face again with a strong response to the earlier ruling. Judge Torres allowed the SEC’s request for an “interlocutory” appeal on her ruling. This process will involve the SEC presenting its motion, followed by Ripple’s counterarguments. This is slated to continue until mid-September. Afterward, the Judge will determine whether the agency can effectively challenge her token classification ruling in an appellate court.

The still young asset class, its exchange methods, valuation, and usage techniques, once they are more clearly defined, will serve to add stability and reduce risk and shocks in crypto and the surrounding businesses. The longer the legal system and regulatory entities take, including Congress, the longer it will take for cryptocurrencies to find the more settled mainstream place in the markets they desire.

Rate Spate

The eighteen-month-long spate of rate hikes in the U.S. and across the globe is providing an alternative investment choice instead of what are viewed as riskier assets. Coincidentally, again on Thursday, August 17, the ten-year US Treasury Note hit a yield higher than the markets have experienced in 12 years. At 4.31%, investors can lock in a known annual return for ten years that exceeds the current and projected inflation rate.

Take Away

The volatility in the crypto asset class has been dramatic – not for the weak-stomached investor. On the same day in August, three unrelated events together helped cause the asset class to spike down. These include an article in a top business news publication indicating that one of the world’s most recognized cryptocurrency advocates has reduced bitcoin’s exposure to his companies. The SEC being granted a rematch in a landmark case that it had recently lost, where the earlier outcome gave no provision for the SEC to treat cryptocurrencies like a security. And rounding out the triad of events on crypto’s throttleback Thursday, yields are up across the curve to levels not seen in a dozen years. Investor’s seeking a place to reduce risk can now provide themselves with interest payments in excess of inflation.

But despite the ups and downs, bitcoin is up 56.7% year-to-date, 11.1% over the past 12 months, 110.5% over three years, 300% over five years, and astronomical amounts over longer periods. Related companies like bitcoin miners, crypto exchanges, and blockchain companies have also experienced growth similar to that found in few other industries over the past decade.   

Paul Hoffman

Managing Editor, Channelchek

Sources

https://finance.yahoo.com/video/bitcoin-sinks-below-28k-crypto-202201698.html

https://www.barrons.com/articles/sec-crypto-regulation-ripple-coinbase-d8143058?mod=hp_DAY_5

https://www.forbes.com/sites/siladityaray/2023/08/18/bitcoin-drops-to-lowest-level-since-june-amid-wider-crypto-sell-off/?sh=28df65ce55ff

https://app.koyfin.com/share/1d479a881a

The Other BlackRock, Citadel, Bitcoin Story

Unhyped Information to Improve Investment Success

The Ripple XRP Case Creates Many Questions

New GDP Forecast Indicates Much Higher Growth With an Inflation Uptick

GDPNow from the Atlanta Federal Reserve Has a Surprising Forecast

If good news is bad, The Atlanta Federal Reserve’s GDPNow report is horrible – that’s how good it is. GDPNow is a model for estimating Gross Domestic Product (GDP). Created and published by the Federal Reserve Bank of Atlanta, it has been fairly accurate in recent years. An estimate of third-quarter US GDP released on August 15th forecasts that growth is increasing dramatically – inflation is also shown to inch up in the forecast.  

The Indicator

GDPNow uses recently published economic data to update a model to estimate GDP, a statistic that is reported with a significant lag to the input data.The output, or forecast, is an aggregation of other current economic indicators within the quarter. The data is entered into the mathematical model to calculate a GDP estimate at that specific point in time. There are still 45 days left in the third quarter, but up until now, this is what it calculated the growth to have been. As time passes and more reports are issued, more economic indicators are fed into the model. These reports come from the US Bureau of Labor Statistics, the US Census Bureau, the Institute for Supply Management, and the US Department of the Treasury. The accumulated data contributes to the historical accuracy of GDPNow’s calculations in relation to the GDP reports that the US Bureau of Economic Analysis (BEA) releases.

The Current Forecast

The GDPNow model’s latest estimates show the real GDP growth (seasonally adjusted annual rate) in the third quarter of 2023 is 5.0 percent on August 15, up from 4.1 percent where the estimate stood on August 8. Included in the model are recent releases from the US Census Bureau, the US Bureau of Labor Statistics, and the US Department of the Treasury’s Bureau of the Fiscal Service.

The model also provides other forecasts, from statistics, that will present themselves during the quarter and be finalized after the quarter ends. This includes third-quarter real Personal Consumption Expenditures (PCE). Remember that PCE is the Federal Reserve’s favored inflation gauge. The PCE inflation forecast, by this model, has been near accurate. It’s latest forecast is for it to rise to 4.4% annualized.

Take Away

There are a lot of mixed signals in the market recently, savings is down, consumer borrowing is up, interest rates out on the yield curve have finally moved up, and there are some fund managers that are extremely bearish, while bullishness is on the rise on the prospect of a soft or undetectable economic landing in the US.

The GDPNow snapshot of where a mathematical model shows where we may be now has no human intervention. It is created by a model without the kinds of bias that could cause a human to overweigh one factor over another. The most recent report shows tremendous growth and an uptick in inflation. In today’s financial marketplace, where the markets still sell-off on good economic news and rally on bad, it’s uncertain what this means for the markets. But it is important for investors to understand that others view this and weigh it in their own expectations.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.atlantafed.org/-/media/documents/cqer/researchcq/gdpnow/RealGDPTrackingSlides.pdf

https://www.imf.org/en/Capacity-Development/Training/ICDTC/Schedule/ST/2022/NWCST22-31#:~:text=Nowcasting%20refers%20to%20the%20practice,lag%2C%20such%20as%20real%20GDP.

https://www.atlantafed.org/economy-matters/economic-research/2022/07/14/pulling-back-the-curtain-on-gdpnow

Was Michael Burry Wrong to Say, “I Was Wrong to Say Sell”?

Michael Burry Has a Huge Bet According to His Just Filed SEC 13-F Report

It looks like Michael Burry has changed his mind, again. At the beginning of 2023, Burry,  the founder of Scion Asset Management, was not positive at all on the stock market. The market then moved up in an epic rally. By late March, he announced in a tweet, “I was wrong to say sell.” Over the coming months stocks that had been beaten down the prior year, moved up significantly.

In his quarterly SEC 13-F filing today, the hedge fund manager that was portrayed in the movie “The Big Short” reported that he is more than just short the S&P 500 and Nasdaq 100. Burry held a huge leveraged short position as of June 30th. The position represents 84% of Scion’s assets under management (AUM), and is in the form of an all-or-nothing marketable options trade.

Source: Koyfin

About His Position

Burry recognized losses during the second quarter. The long positions he had put on earlier were underwater when he sold. The only conclusion is that he must have switched again from bullish to bearish – at least on these specific stocks. He then, with a broad brush, shorted large-cap stocks using stock options on ETFs. As of quarter-end 51.05% of his portfolio held puts on SPY and 42.54% held puts on QQQ.

Burry manages $1.7 billion. The puts used to short the S&P 500 ETF (SPY) and Nasdaq 100 (QQQ) is a broad brush that shows a great deal of confidence that large-cap stocks are headed lower before the options expire. It is a huge bet, while a short using puts has less downside than a straight short that, if unmanaged, can move against the owner an infinite amount, options have a window when they can be sold or exercised. If the position doesn’t work out, losses can be 100%.

Take Away

A lot can be learned from celebrity investors and fund managers. The lesson that investors may glean from Michael Burry’s first six months of 2023 is that you don’t sit in a bad position. Or, changing your mind is okay. The new positions indicate a high degree of confidence that large-cap stocks will fall apart over the coming months. It is just two positions, but they speak volumes in terms of his market call.

Paul Hoffman

Managing Editor, Channelchek

https://whalewisdom.com/filer/scion-asset-management-llc

https://www.channelchek.com/news-channel/michael-burry-suggests-he-is-now-bullish

Is Gary Gensler on His Way Out at the SEC?

The SEC May be Poised to Become more Accommodating to Cryptocurrency

In what is being reported as a developing story that can significantly impact securities and crypto regulation, rumors are circulating that SEC Chair Gary Gensler may be on the way out as head of the agency.  The reports are pointing to Hester Pierce as the most likely person to replace him. How would this impact public markets and the future state of cryptocurrency regulation? We discuss these questions and thoughts below.

Background

Whale (@whalechart) is a crypto news provider with an account on the microblogging platform X.  It is widely respected, with 363,000 followers. Whale announced this morning (August 14), “SEC Commissioner Hester Peirce is being considered to replace Gary Gensler as the head of the regulatory agency.”  This small post (or tweet) has triggered waves of speculation about the upcoming course of securities regulation for both registered products and cryptocurrencies like Bitcoin.

Ms. Peirce is known for her strong support of innovation and outside-the-box thinking. She has been a commissioner of the SEC since 2018, appointed by President Trump. Pierce is a former academic and lawyer who has specialized in securities law and financial regulation. She is known for her views on the regulation of cryptocurrencies and other emerging technologies.

What the SEC May Look Like Under Hester Pierce

Peirce, who has a reputation as being pro-innovation, has been a bold advocate for embracing disruptive technologies like cryptocurrencies and blockchain. If the rumors are accurate and she does find her way to the position of top securities cop, it could signal a shift towards a more accommodating regulatory stance, with a leader whose thoughts on fintech and digital assets are known.

If the days are indeed numbered for the SEC’s current head Gary Gensler, the traditional and digital asset markets would mainly view this as a positive. President Biden’s appointee, Gary Gensler, has been a catalyst behind the intensified scrutiny and rule-making within the overall cryptocurrency realm. His time in the position has led the SEC’s tightening its grip on digital asset exchanges and clamping down on many Initial Coin Offerings (ICOs).

Gensler has been acting to protect consumers, but many critics argue that the SEC under his lead, has been led to too much interference in free markets. With Peirce potentially in the drivers seat, the probability of the regulator embracing crypto assets in a less restrictive way increases dramatically.

Those impacted the most by a changed SEC head have weighed in already with diverse ideologies and opinions. Advocates assert that her penchant for innovation could sow the seeds for heightened financial growth. They contend that a friendlier regulatory outlook might be the medicine needed to embolden new ideas and investors to explore new opportunities – this, they say, could give the economy a lift.

Those opposed to a Hester Peirce nomination warn against a looser regulatory environment that could leave investors exposed to heightened risks. Their call is for the SEC to remain a vigilant guardian of investor interests, standing as a wall against potential deceit or market manipulation.

As the news regarding Peirce’s probable elevation continues to spread on social media and in articles like this, the pressing question many market participants are trying to discern is, will the SEC take a gentler road to new tech innovations or will it hold overly tight to its role concerning investor safety? If the change happens, there could be a celebratory bump in the value of crypto assets and others.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://publish.twitter.com/? Whale

https://foggymedia.in/blog/SEC%20Commissioner%20Hester%20Peirce%20Considered%20to%20Replace%20Gary%20Gensler/

https://cointelegraph.com/news/this-scenario-could-see-sec-gary-gensler-resign

https://coinmarketcap.com/community/articles/64d9f66a62115c7ccfb3c1ec

The Week Ahead –  SEC 13-F Filings, FOMC Minutes, Housing Numbers

The Trading Week Ahead Could See Investors Continuing to Adjust to the Flattening Yield Curve

Bill Ackman says he’s short the U.S. Treasury long bond. Michael Burry, who tends to see things before others, had been short a derivative of Treasuries two summers ago, was he involved in interest rates this most recent quarter-end? We will get a glimpse into what these two, plus Warren Buffett and a host of others, as time runs out on their 13-F filing as of the close of business on Monday.

Last week many investors went from betting on a soft-landing a few weeks ago to now thinking interest rates along the curve are too low. The impetus for the shift was the CPI and PPI reports last week had provided nothing for the Fed to stop or slow down tightening. This concerns stock market investors. Higher rates, at a minimum, are beginning to provide an attractive alternative to a stock market that has already run up above average. This is because investors can now be choosier as their cash is far more productive, even after inflation, than it has been in years. Individual companies that have great prospects, rather index ETFs where you hold the good with the bad, would seem more prudent in the current scenario.

Monday 8/14

•             13-F Day is the SEC deadline for funds that manage more than $100 million in assets, that they must divulge positions held as of the end of the previous quarter. For example, Michael Burry’s Scion Asset Management hedge fund, Warren Buffett’s Berkshire Capital Holdings, and all U.S. asset managers of size have 45 days from quarter-end to file. A very large percentage choose to file on the 45th day, August 14th is 45 days from June 30th. Investors pour through the 13_f filings of top investors looking for insights.

Tuesday 8/15

•             8:30 AM ET, The consensus for Retail Sales for July is up 0.4% after an unexpectedly poor showing in June of a gain of 0.2%. Retail sales measure the total receipts at stores that sell merchandise and related services to final consumers. Sales are by retail and food services stores.

•             8:30 AM ET, Import and Export Prices are expected to show that import prices increased 0.2% in July after falling 0.2% in June. Export prices are expected to have increased 0.1% after dropping 0.9% in June. The underlying value of this report is the measure of global inflationary trends. Import price indexes are compiled for the prices of goods that are bought in the United States but produced abroad and export price indexes are compiled for the prices of goods sold abroad but produced within the U.S.

•             4:00 AM ET, Treasury International Capital is the tracking of who holds U.S. securities, or put another way, where in the world are U.S. Stocks, U.S. Treasuries, Agencies, and Corporate Bonds. TIC has recently been watched by a wider group as it is a measure of foreign demand for our assets. The prior number (May) showed net long-term transactions abroad of U.S. securities at $25.8 billion.

Wednesday 8/16

•             7:00 AM ET, The Mortgage Bankers Association (MBA) compiles data which indicates demand for mortgages. Data from the previous week indicate a drop in their Purchasing index of 2.7%, and a decline in its Refinance index of 4.0%.

•             8:30 AM ET, Housing Starts month over month for July are expected to have increased to 1.464 million from 1.44 million in June.

•             9:15 AM ET, Industrial Production had fallen 0.5 percent for two straight months; forecasters expect a rebound of 0.3 percent in July. After falling 0.3 and 0.2 percent, manufacturing output is seen as unchanged. Capacity utilization is expected to rise to 79.1 from 78.9 percent, still below what is considered inflationary.

•             10:30 PM ET,  The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the U.S., whether produced here or abroad. The inventory level impacts prices for petroleum products.

•             2:00 PM ET,  FOMC minutes are from the meeting three weeks ago, where the Fed adjusted the overnight target upward. This report has recently been market-moving as it details the issues of debate and consensus among policymakers.

Thursday 8/17

•             8:30 AM ET, Initial Jobless Claims are expected to have fallen the week ended August 12th to 240,000 following a 21,000 jump to 248,000 last week, in the absence of inflation data, the market places adds emphasis on unexpected results in the labor market.

•             10:00 AM ET, E-Commerce Retail Sales for the second quarter are scheduled for release. During the first quarter, online retail transactions had increased by 3%.

•             4:30 AM ET, the weekly report on the Fed’s Balance Sheet is now awaited each week as it provides statistics on whether the Fed is fulfilling its quantitative tightening promise on schedule. It also  could provide an early tip-off if there is a problem within the banking system. The report from the week prior showed $8.208 trillion in assets, and bank reserve credit declining $18,685 billion.

Friday 8/18

•             10:00 AM ET, The Quarterly Services Survey is not usually a large focus, but it is the only economic number printing on what may very well be a lightly traded late summer Friday. The report includes industry information; professional, scientific, and technical services; administrative & support services; and waste management (NAICS 51, 54, and 56). Last quarter, these industries experienced 2.9% growth, or 9.7% year-on-year.

What Else

A press release dated Friday, August 11th, stated that Greg Steube, a Representative from Florida’s 17th district had filed “Articles of Impeachment Against Joseph Robinette Biden, Jr., President of the United States, For High Crimes and Misdemeanors.” What this could mean for markets, if the past is an indicator, is very little. There could be days where traders are largely distracted by news stories that may come from this, but the soundness of the U.S. or the global economy is not likely to be hanging in the balance on any outcome from the proceedings.

Paul Hoffman

Managing Editor, Channelchek

Sources

Steube.house.gov

https://www.econoday.com/articles/high-points-for-economic-data-scheduled-for-august-14-week/

https://thehill.com/homenews/house/4150478-florida-republican-rep-files-articles-of-impeachment-against-biden/

Steube.house.gov

Retail Investors Await Institutional Investors’ SEC Filings

For the Third Time This Year, Investors Get to Peak Behind the “Smart Money” Curtain

What’s smart money doing?

If retail investors weren’t always eager to know what hedge fund managers, corporate insiders, and others building positions in a stock have been doing, shows like CNBC’s Closing Bell, news sources like Investors Business Daily, and communities like Seeking Alpha would get far less attention. Next week, the most followed institutional investors are expected to make their quarter-end holdings public. This will usher in a lot of buzz around the surprise changes in holdings and even short positions in celebrity investor portfolios.

Popular SEC Filings

The most popular SEC filings from the supposed “smart money” that small investors look to for ideas are:

Form 13D – This is a filing that is required to be made by any person or group that acquires 5% or more of a company’s voting securities. The filing must disclose the person’s or group’s intentions with respect to the company, such as whether they plan to take control of the company or simply invest in it.

Investors may recall Elon Musk’s accumulation of Twitter shares was incorrectly filed on form 13-G which is for passive investors. He later had to amend his filing on 13D as his accumulation of shares was discovered to be predatory.

Form 4 – This is a filing that is required to be made by any officer, director, or 10% shareholder of a company when they buy or sell shares of the company’s stock. The filing must disclose the number of shares bought or sold, the price per share, and the date of the transaction.

This is the filing that the public used to discover that in 2021, Mark Zuckerberg sold Meta (META) shares (Facebook) almost daily for a total of $4.1 billion. The same year Jeff Bezos sold $8.8 billion worth of Amazon (AMZN) stock, mostly during the month of November.

Both of the filing types mentioned above are as needed, they don’t have a recurring season. However, another popular filing is form 13-F, these much anticipated filings occur four times each year.

Form 13F – This is a quarterly report that is required to be filed by institutional investment managers with at least $100 million in assets under management. The report discloses the manager’s equity and other public securities, including the number of shares held, the CUSIP number, and the market value.

Investors will pour over the quarter-end snapshot of the account and measure changes from the prior quarter, especially from investors like Warren Buffett, Bill Ackman, and Cathie Wood for insights. When Michael Burry filed his 13-F in mid May 2022, he had a position showing that he was short Apple (AAPL). Headlines erupted across news sources, and this certainly had an impact on the tech company’s stock price as other investors questioned its high valuation against any positions they may have had.

The Consistency of the 13-F

The SEC 13-F is a regular filing for large funds. Interested investors can generally mark their calendars for when a funds 13-F will be released. The SEC requires a quarterly report filed no later than 45 days from the calendar quarter’s ends. Most popular managers wait until the last minute, as they may not be so eager to share their funds positions any sooner than needed. This means that most 13-F filings are on February 15 (or before), May 15 (or before), August 15 (or before), and November 15 (or before). In 2023, August 15th is next Tuesday. During the second quarter of 2023 there seemed to have been significant sector rotation, and a reduction in short positions among large funds. This will make for above average interest.

Famous Investors that file a Form 13F

The legendary investor Warren Buffett is the CEO of Berkshire Hathaway. His company’s Form 13F filings are closely watched by investors around the world.

Warren Buffett, last filed a 13-F on May 15, 2023

Ray Dalio is the founder of Bridgewater Associates, one of the world’s largest hedge funds. His company’s Form 13F filings are also very popular with investors.

Ray Dalio, founder of Bridgewater Associates, last filed a 13-F on May 15, 2023

Michael Burry is the investor who famously bet against the housing market in the lead-up to the 2008 financial crisis. His company’s Form 13F filings are often seen as positions of a highly regarded contrarian.

Dr. Michael Burry, last filed a 13-F on May 15, 2023

Cathie Wood is the CEO of ARK Invest, a firm that invests in disruptive technologies. Her company’s Form 13F filings are often seen as a bellwether for the future of technology. Wood is always open and transparent about her funds holdings. This may explain why she is among the earliest filers after each quarter-end.

Cathie Wood, last filed a 13-F on July 10, 2023 for the second quarter ended June 31, 2023

Drawbacks to Using Form 13F

While Form 13F filings can be a valuable source of information for investors, it isn’t magic. And if it is going to weigh heavily as part of an investor’s selection process, some drawbacks should be considered.

The information is delayed: Form 13F filings are not real-time information. They are usually filed 45 days after the end of the quarter, so the information is already outdated by the time it is available to the public.

The information is not complete: Form 13F filings only disclose the top 10 holdings of each fund. This means that investors do not have a complete picture of the fund’s portfolio.

It is not always clear if a position is based on expectations for the one holding, or should be viewed in light of the full portfolio, balancing risk and potential reward. For example, an investment manager may be bullish on tech and long a tech megacap with a lower than average P/E ratio and as of the same filing, short a similar amount of a tech megacap with a higher P/E ratio. The fund manager may be bullish on both, and the nature of the positions may indicate an expectation that the P/E ratios are likely to move toward a similar ratio. If there is just a focus on one side (long or short), the investor may read the intentions or expectations wrong.

Take Away

As earnings season fades, the third week in August will provide a mountain of information on what institutional investors were doing during the second quarter. This is a great place to find ideas and understand any changes in flows.

Investors should be cautioned that this is only a June 30th snap shot, and these holdings may have changed days later.’

Paul Hoffman

Managing Editor, Channelchek

Sources

https://fintel.io/search?search=ray+dalio+13-f

https://fintel.io/i13fs/ark-investment-management

https://whalewisdom.com/filer/scion-asset-management-llc

https://www.vrresearch.com/blog/learn-about-hedge-funds-from-13f-filings

https://www.forbes.com/sites/rachelsandler/2022/01/06/mark-zuckerberg-sold-facebook-stock-nearly-every-weekday-last-year-for-almost-11-months/?sh=6cebeeb03f71

https://www.sec.gov/Archives/edgar/data/1418091/000110465922045641/tm2212748d1_sc13da.htm

Antitode for a Potential Indexed Fund Bubble?

Equity Research Allows Investors to More Confidently Step Away from the Growing Index Valuations

Hedge Fund Managers Michael Burry and Bill Ackman have expressed deep concern over indexed funds for a years and for different reasons. Burry primarily fears a bubble growing, and Ackman agrees but also fears investors are giving away control to parties that may not have their best interests at heart. Both make understandable cases. Below we discuss the overall concerns and how an individual investor who shares their concerns may “hedge” their portfolio against these risks.

Michael Burry

“The bubble in passive investing through ETFs and index funds as well as the trend to very large size among asset managers has orphaned smaller value-type securities globally,” Michael Burry told Bloomberg News in August of 2019. “Orphaned” presumably refers to a lack of attention now paid to this market segment.

Burry’s concerns centered around the idea that the rise of passive investing could lead to distortions in the stock market. He believed that as more and more investors put their money into indexed funds, the valuations of the companies included in those indices might become disconnected from their underlying fundamentals as fund managers were required to own the index at the established weighting. In his view, this could create a bubble-like situation where certain stocks are overvalued due to indiscriminate buying driven by the popularity of index funds.

While many view this hedge fund manager, made most famous by the movie The Big Short, as a pessimist, it is easy to think of him as an optimist finding opportunity, even where there could be trouble.

As he discussed then, the rush into indexed funds has punished small cap value stocks. Burry also highlighted, “There is all this opportunity, but so few active managers.”

Bill Ackman

“We believe that it is axiomatic that while capital flows will drive market values in the short term, valuations will drive market values over the long term. As a result, large and growing inflows to index funds, coupled with their market-cap driven allocation policies, drive index component valuations upwards and reduce their potential long-term rates of return,” according to Bill Ackman in a statement which agrees with Burry’s thoughts. Bull Bill Ackman also sees another risk.

In a letter to shareholders earlier this year, the activist investor, and big boss at Pershing Square Capital, made the point that the passive funds not only follow indexes but encourage active managers to stay close to the index where investors pay for active management, but get index-like results because the fund company fears shareholder reaction if returns deviates sharply from the index benchmark.

More telling is Ackaman’s fear of proxy votes and other governance taken out the hands of the masses and bestowed on so few. Ackman believes that passive managers like Vanguard, BlackRock, and State Street hurt investors by concentrating corporate power in a small group of players “who get larger by the minute.” With 20%  or more of fund flows headed to an indexed fund or ETF, Ackman wonders who will “look out for one another’s interests?”

Actively Managed and Self-Directed Investing

The Nasdaq 100 index just reorganized in order to lessen potential risks to being overweighted in a few stocks. Surrounding this event and through the years there has been no shortage of discussion around index bubbles and why some see indexes as an eventual train wreck:

“Is There an Index Fund Bubble?” (Bloomberg, September 4, 2019)

“The Index Fund Bubble Is Coming” (The Motley Fool, January 23, 2020)

“Is the Index Fund Bubble About to Burst?” (Investopedia, March 11, 2021)

“The Index Fund Bubble Is Real, and It’s Going to Burst” (MarketWatch, April 20, 2022)

“The Index Fund Bubble Is Even Bigger Than You Think” (Barron’s, May 23, 2023)

And there is also fear in the consolidation of power into the hands of a few fund companies that could impact all of us more subtly.

While index fund investing is growing in popularity and has been rewarding, investors can prepare by scaling down these investments and making their own selections, weighting their portfolio in a way that makes more sense in light of the risks to them. This could include seeking managed funds with a manager that has a good track record over the years, but it also may mean adding stocks that are not well represented in major indexes. Investors like to use Morningstar for fund selection, for stocks information including excellent research on what Burry termed “small-cap value stocks,” and other small and microcap offerings is likely found on Channelchek.

The Forgotten Benefits of Equity Research

Informed stock market investors read equity research reports for several reasons:

Informed Decision-Making: Equity research reports provide detailed analysis and insights about a company’s financial performance, industry trends, competitive landscape, and growth prospects. Investors may save weeks putting together enough information to believe they understand an opportunity enough to make a decision.

Valuation Insights: Research reports will include valuation models that estimate a company’s intrinsic value. This can help investors understand whether a stock is overvalued, undervalued, or fairly priced, guiding their buy, sell, or hold decisions. Some research will actually provide an analyst’s price target.

Risk Assessment: Equity research reports assess the risks associated with an investment. This could include factors like regulatory changes, industry volatility, management quality, and financial stability. Understanding these risks helps investors manage their portfolios effectively.

Industry and Market Trends: Research reports not only focus on individual companies but also provide insights into broader industry trends and market dynamics. Investors can gain a better understanding of how macroeconomic factors might impact their investments.

Company Performance Analysis: Detailed financial analysis in these reports helps investors understand a company’s revenue streams, profit margins, debt levels, and growth potential. This information is crucial for evaluating a company’s overall financial health.

Competitive Landscape: Equity research reports often compare a company’s performance to its competitors. This analysis helps investors gauge a company’s competitive position within its industry.

Long-Term Investment Strategy: Investors with a long-term perspective can benefit from equity research by identifying companies with strong growth potential, sustainable competitive advantages, and solid management teams.

Industry Diversification: Research reports can make it easier for investors to diversify holdings by defining the category the company is in and even highlighting opportunities in various sectors or industries.

News Interpretation: Equity research reports can provide context and interpretation for press releases and other news including, earnings releases, and developments related to the company. This helps investors understand the potential impact on the stock price.

Investor Growth: For novice investors, equity research reports can provide valuable insights into how professionals analyze stocks and make investment decisions, enhancing their investment knowledge over time.

It’s important to note that equity research reports are typically produced by financial analysts working for brokerage firms, investment banks, or independent research firms. Investors should exercise critical thinking and compare and contrast multiple sources of information.  

Take Away

Credible professional investors make the case that the surging assets in index funds are leading to a bubble. There is also concern that control is taken out of the hands of individuals and placed in the hands of a few large companies whose corporate interests may not match individual investor interests.

Taking back control of the management of one’s portfolio may seem daunting, but quality equity research is a tool that can serve to help the selection process while at the same time increasing the self-directed investors’ understanding of what is important to watch. Channelchek is a no-cost platform leading the way in North America, providing company-sponsored research on small and microcap stocks.  

Individual stock investors may also wish to consider attending NobleCon19, in December. This investment conference is widely recognized as the place investors go to discover small emerging companies that they may act upon through their traditional brokerage account. Discover more about about NobleCon19 here.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.bloomberg.com/news/articles/2019-08-28/the-big-short-s-michael-burry-sees-a-bubble-in-passive-investing

https://www.harriman-house.com/press/full/2958#:~:text=%E2%80%9CIndex%20funds%20and%20other%20passive,is%20good%20reason%20for%20this.

https://www.marketwatch.com/story/bubble-in-passive-investing-offers-small-cap-opportunity-big-short-investor-says-2019-08-28

The Week Ahead –  Oil Prices, Consumer Prices, and Consumer Sentiment

This Trading Week Markets Will See if CPI Confirms Decelerating Inflation

After last week’s employment figures came in lower than expectations, this week the potential catalyst for a shift in monetary policy is inflation measures. July Consumer Price Index (CPI) is scheduled for release on Thursday. The June report allowed for optimism that inflation was not only moving in a favorable direction but that a sustainable downward trajectory was emerging. However, the upcoming July figures might not live up to the market celebration that followed the previous CPI report. This is because rising energy costs are likely to contribute to an increase in the year-over-year all-items CPI rate. If the core CPI annual rate does not exhibit substantial progress in its declining trend, this could set the stage for another interest rate hike as early as the September 19-20 Federal Open Market Committee (FOMC) meeting.

Monday 8/7

•             3:00 AM ET, Consumer credit is expected to increase $14.1 billion in June versus a smaller-than-expected increase of $7.3 billion in May.

Tuesday 8/8

•             6:00 AM ET, The Small Business Optimism Index has been well below the historical average of 98 for 18 months in a row. July’s consensus is 91.5 versus 91.0 in June.

•             8:30 AM ET, An International Trade in Goods and Services deficit of $65.4 billion is expected in June for total goods and services trade. This would compare with a $69.0 billion deficit in May. Advance data on the goods side of June’s report showed a $4.0 billion narrowing in the deficit.

•             10:00 AM ET, Wholesale Inventories preliminary number (second estimate) is expected down 0.3 percent, unchanged from the first estimate.

Wednesday 8/9

•             10:30 AM ET,  The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the US, whether produced here or abroad. The inventory level impacts prices for petroleum products.

Thursday 8/10

•             8:30 AM ET, The Consumer Price Index (CPI) is expected to rise 0.2 percent, which would match June. Annual rates, which in June were 3.0 percent overall and 4.8 percent for the core, are expected at 3.3 and 4.8 percent, respectively. Core prices in July are expected to hold steady at a modest monthly increase of 0.2 percent which would match June’s showing.

•             8:30 AM ET, Jobless Claims for the August 5 week are expected to come in at 230,000 versus 227,000 in the prior week, which was 6,000 higher than expected.

•             4:30 AM ET, The Fed’s Balance Sheet is expected to have decreased by $36.580 to $8.207 trillion. Market participants and Fed watchers look to this weekly set of numbers to determine, among other things if the Fed is on track with its stated quantitative tightening (QT) plan.

Friday 8/11

•             8:30 AM ET, Producer Prices in July are expected to have risen 0.2 percent on the month versus a 0.1 percent increase in June. The annual rate in July is seen as rising 0.7 percent versus June’s gain. July’s ex-food and ex-energy rate is seen at 0.2 percent on the month and 2.3 percent on the year versus June’s 0.1 percent on the month and 2.4 percent yearly rate.

•             10:00 AM ET, Consumer Sentiment in August, which in July jumped more than 7 points to 71.6, is expected to edge back .3 to 71.3.

What Else

Crude Oil futures rose to around $83 per barrel, hovering at the highest levels in four months. The main reason is the Saudi Arabia and Russia’s announcement that they would extend voluntary supply cuts through next month to bolster oil prices. Saudi Arabia said on Thursday it would extend its 1 million barrels per day production cut for another month, while Russia said it will also reduce its oil exports by 300,000 bpd in September. Saudi Arabia also said its production cuts could be extended beyond September or deepened, catching markets off guard.

Most industries are impacted by energy prices, we whether it is all conasumer prices, or core, crude oil trading impacts consumer prices.

Paul Hoffman

Managing Editor, Channelchek

Sources

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

https://us.econoday.com/byweek.asp?cust=us

Higher Rates Could Mean More Equity Financing, What Investors Should Know

How Does Additional Equity Financing Affect Existing Shareholders?

Fitch Ratings was able to do for interest rates what the Federal Reserve has been looking to do for almost two years, increase them out along the yield curve. And this changes corporate finance in a way that impacts stock market investors. The ten-year US Treasury Note has gained nearly 0.25% since Monday July 31 as a result of the Fitch credit downgrade and big-name firms like Bank of America forecasting a soft landing. Some companies looking to grow through increased financing are now faced with either substantially increased borrowing costs or going to the equity markets and diluting shareholder value. How should shareholders look at share dilution considering today’s cost of money?

Equity Financing

Try to picture management of a company you are invested in that decides it needs funds to to either expand its operations, get out in front of competitors in new and growing markets, or even ease its financial burdens. Borrowing in the public markets, when possible, is much more expensive for a public company today.  This is why investors can expect more equity financing, by management offering shares not in circulation of the company to investors under today’s conditions.

The problem with this is that there is an immediate mathematical reaction. For simplicity, imagine you’re a shareholder in a company with 10% ownership. Suddenly, the company issues more shares, raising the total number in circulation. This increase creates a phenomenon known as share dilution. It dilutes your ownership percentage and, consequently, the value of your existing shares. This dilution can spark unease among investors, potentially leading to sell-offs in excess of the dilution.

On the day the shares are made available, the impact is real, long term shareholders that trust management may think of it as smart growth financing, but those in the company for a short trade may never realize the benefits of the company’s investment in growth.     

As a company issues new shares, its earnings-per-share (EPS) – a measure of profitability – often takes a hit. Consider a company with 10 million shares and an EPS of $0.20. If it issues 5 million more shares, the total becomes 15 million shares. Even if profits stay steady, EPS drops to $0.13 due to the increased share count.

This EPS dip isn’t taken lightly; it can be viewed as reflecting shifts in a company’s financial health, affecting investor perceptions and the stock price.

Stock Price Impact

An EPS drop from equity financing can initially dampen stock prices. Yet, it’s not a one-size-fits-all scenario. If a company uses the raised capital as an investment in the future by paying off debt or fueling strategic growth, a more positive outcome than not financing in this way can occur. Later, share prices might climb, reflecting optimism about the company’s future potential.

In contrast, if a struggling company resorts to equity financing as a last resort, stock prices might continue their downward trajectory, signaling financial instability.

Key Considerations

Deciding when to issue additional shares is a strategic move that companies carefully consider based on their financial needs, growth plans, market conditions, and investor sentiment. Here are some key factors that companies often take into account when making this decision:

Capital Requirements: Companies assess their current financial needs, including expansion plans, research and development, debt repayment, acquisitions, and working capital. If traditional financing options like bank loans or internal reserves are insufficient or less favorable, issuing additional shares might be considered.

Growth Opportunities: If a company identifies significant growth opportunities that require substantial capital infusion, issuing additional shares could be an effective way to fund those initiatives. This could involve entering new markets, launching new product lines, or investing in innovative technologies.

Market Conditions: Companies closely monitor the overall stock market conditions and investor sentiment. If the market is favorable and investor confidence is high, issuing new shares might be more likely to garner positive reception and minimize potential dilution concerns.

Debt Management: If a company aims to reduce its debt burden, it might issue new shares to raise capital for paying off loans or bonds. This can improve the company’s debt-to-equity ratio and overall financial stability.

Investor Demand: If there is strong demand from institutional investors or strategic partners to invest in the company, it might signal a good opportunity to issue additional shares. This can also boost the company’s credibility and valuation.

Valuation Considerations: Companies assess their current stock valuation and evaluate whether issuing new shares is likely to be accretive or dilutive to existing shareholders. If the company’s stock is trading at a relatively high valuation, issuing shares might be more attractive.

Investor Communication: Open and transparent communication with existing shareholders is vital. Companies often engage with their investor base to gauge their opinions on potential equity financing and address concerns.

Regulatory Considerations: The regulatory environment and legal requirements related to equity issuance need to be taken into account. Companies must comply with securities regulations and fulfill disclosure obligations.

Timing: Timing is an important ingredient. Companies aim to issue shares when market conditions are favorable and the company’s financial performance is strong. However, they must also balance this with their immediate needs and long-term goals.

Alternatives to Equity Financing: Companies explore other financing options, such as debt issuance, venture capital, private equity, or strategic partnerships. They compare these options to issuing additional shares and choose the one that aligns best with their goals.

Management’s Vision:The company’s management team plays a crucial role in the decision. They consider the company’s long-term vision, strategic goals, and the potential impact of issuing additional shares on the company’s future prospects.

The decision to issue additional shares involves management’s comprehensive evaluation of the company’s financial situation, growth prospects, market conditions, and investor sentiment. It’s a strategic move that requires careful analysis to balance the company’s short-term and long-term objectives while considering the potential impact on existing shareholders. Investors that trust management to do what is best are more comfortable with these financial decisions than those either distrusting or unfamiliar with affirms management.

Tesla as an Example

The case of Tesla (TSLA) exemplifies the nuances of equity financing. In February 2020, Tesla announced plans to issue 2.65 million equity shares. The funds were intended to enhance the company’s financial position and support various initiatives. While this move could have triggered concerns about share dilution, Tesla’s clear plan and CEO Elon Musk’s commitment to invest in these shares painted a positive picture.

Take Away

Additional equity financing is a complex decision for companies that could lead to different outcomes. Share dilution and EPS shifts can trigger investor reactions, impacting stock prices. However, a well-executed strategy can offer forward-looking investors a reason to be confident in their holdings or even a reason to increase their share number. Overall, understanding these dynamics is essential for investors and company stakeholders alike.

Paul Hoffman

Managing Editor, Channelchek

Why the Fitch Downgrade is Better for Investors

With a Longer Time Horizon, The US Credit Downgrade Helps the Market

Providing third-party research and analysis that then ranks an entity’s debt or equity outlook, including companies and sovereign nations, requires extremely high integrity. The mostly negative news headlines responding to the Fitch Ratings downgrade of the United States Long-Term issuance to AA+ from AAA is an indication of how much pressure analysts must be under to avoid issuing a downgrade. This is true whether the rating impacts the entire free world, or the stakeholders and their families of a small public company through company-sponsored research.

Most high-caliber analysts have built a model that gives them little room for pressure from the outside, either from the ranked entity, the investors, or even the financial media. It is undoubtedly easier to do nothing and cross your fingers as an analyst, but that doesn’t actually serve anyone well, including investors or the entity.

Background

In late May, while investors and other market watchers were trying to determine on which day in June the US Treasury would run out of money, Fitch, a securities rating service, placed a ratings watch on US debt which they had held at triple-A, the highest rating, indicating the lowest default risk for the issuer.

On July 31, the US Treasury unveiled an overview of its third-quarter debt issuance needs. At $1.007 trillion, it would be the largest third quarter on record. I have experience as an issuer ranked by Fitch and Moody’s while CIO of two funds that held a rating in order to meet specific investor guidelines.  Rating agencies are the first to be made aware of any changes being considered. So I suspect that Fitch, Moody’s, and S&P analysts were all aware of the details of what the Treasury planned and projected going forward. Moody’s downgraded the US back in 2011 from its lowest default risk rating. Its treatment back then was also not one of appreciation from the markets, investors, or the issuer.

This clip from the movie The Big Short attempts to show the movie-goer all the relevant pressures an analyst may be under, and why integrity is critical.

Thoughts on Ratings Move

Cathie Wood had a conversation on (Twitter) Spaces this morning with Pension & Investments’ Jennifer Ablan in an exclusive mid-year interview. Ms. Ablan asked Ms. Wood’s thoughts on the US downgrade. The Ark Invest founder didn’t hesitate to say that there is “a side that is happy to see it.” She went on to explain that it helps those managing the organization, in this case Washington, to do a better job. She explained that it  says, “legislature, let’s get your act together.” Wood, added “government spending is taxation.”

While Cathie Wood was discussing the most powerful nation in the world, the same concept should be applied to a company she holds, or you own that experiences a downgrade. It serves to help management discover weak areas they could pay more attention to and gives the investor the understanding and confidence that a third party is looking on and even consulting with management before they make any moves that may alter the rating.

Michael Kupinski, the Director of Research at Noble Capital Markets, is a veteran analyst that has undoubtedly had to ignore pressure from the outside and follow models he’s created to the path they help provide. Mr. Kupinski says, “Ratings and earnings revisions are a function of the dynamics of new, and, likely extreme, inputs on the investing continuum.” He then explained how all could benefit,  “Such revisions then present management a roadmap for the new baseline in expectations or for a course correction. As such, ratings provide a valuable currency to determine investment merits, set investment expectations, and for investors to determine risk,” said Michael Kupinski.

Take Away

Don’t shoot the messenger – instead, thank them.

A negative change in ratings, whether it be on debt issuance, equity issuance, or frankly ones own credit rating could serve to preserve something before it goes further down a bad path, and can be used as a guide to adjust and do better. While there was a lot of criticism for Fitch placing the USA on credit watch for a downgrade back in May, if they had not issued a downgrade as US Treasury issuance climbed even higher, it would cause investors to think that no one is paying attention. The outcome of not having another trusted set of eyes, on any security issuance, is weaker pricing.

Paul Hoffman

Managing Editor, Channelchek

Meet the top management and hear the compelling stories of less talked about opportunities, while mingling with analysts and knowledgeable investors at this year’s NobleCon19

Sources

Fitch US Downgrade Press Release

Cathie Wood Jennifer Ablan

Michael Kupinski

An Increased Need for Treasury Borrowing Will Impact All Markets

Stocks, Bonds, and Real Estate Markets are All Impacted By U.S. Debt Levels

Who will buy all the U.S. Treasury debt issuance? This week the Treasury Department hinted at its borrowing needs estimate for the third quarter. Its estimated need is $1 trillion-plus, the largest third-quarter need ever. At the same time, the Federal Reserve is reducing its holdings of U.S. debt by a cumulative $90 billion each month, and the U.S. dollar is on a weakening trend which reduces demand for dollar-denominated assets. There are now concerns being raised about the extent to which domestic and foreign demand for U.S. debt issuance will be able to grow to match issuance.

More details surrounding the Treasuries financing needs will be released at 8:30 on Wednesday August 2nd. The large estimate already shared in advance, $1.007 trillion, has analysts beginning to conclude that the U.S. could become hampered with a deteriorating fiscal deficit outlook amid continuing pressure to borrow more.

Two months ago, analysts at Fitch Ratings, a bond credit rating company, put the United States on Rating Watch Negative (RWN) citing, among other things, “fiscal and debt trajectories.” The initial ratings watch came at a time when there was uncertainty about whether the U.S. debt ceiling would be raised. It was not only increased, on June 2nd President Biden signed Congresses bill removing any upper limit on debt issuance until January 2025. The increase in debt, reduced number of buyers, lack of fiscal guardrails, and already higher interest rates on rollover debt could have consequences for all markets. Fitch may be prompted to replace the AAA rating on US Treasuries by assigning a lower rating.

At stake for the broader fixed-income market is that most corporate debt issuance is spread to U.S. Treasury rates of similar duration bonds. If large ongoing auctions over the third quarter deplete demand at market levels Treasury yields would have to trade higher, or government debt would face being illiquid or even default.

In the past U.S. Treasury borrowing need has been met by the perceived safety in the country’s ability to prosper and pay its debts, as well as the reliability of the U.S. dollar as a reserve currency. It’s unclear with less stable relations with China (a large holder of U.S. debt) and the BRICS nations plans to create a gold-based fiat currency, if demand will shrink or grow while U.S. debt issuance climbs.

At stake for the broader real estate market, which is heavily leveraged and therefore greatly impacted by interest rate expenses, is for the cost of borrowing to rise should demand for Treasuries not meet new issuance levels. Thirty-year residential loans are spread off ten-year Treasuries. Further increases in mortgage rates would serve to slow down real estate transactions.

The stock market would likely become bifurcated with stocks tied to big ticket items, typically bought by securing financing, weakening, and stocks that benefit from a strong dollar (higher comparative rates strengthen a native currency) could also do well. These stocks include companies that don’t have a large overseas customer base — if they are net importers, they may benefit even more. Companies that have large borrowing needs, will find their cost of capital has increased as they compete with U.S. Treasury rates. This is why small cap companies, that have very little borrowing needs, tend to perform better than large-cap companies with high debt levels in similar industries.

One Federal government expense that it can’t exercise immediate control over is the interest rate expense of its debt. Over $32 trillion in debt, spread out to mature through 30 years, now holds an average rate of near 2.50%. New debt is issued with almost double that interest rate. This is evident in the chart above that shows interest on debt from 2020 until today increased by $400 billion – with no expected change in its growth rate.

In a Tuesday note title “Treasury Tsunami,” rates strategists at Barclays Anshul Pradhan and Andres Mok wrote, the “Treasury’s latest financing estimates point to a worsening fiscal profile” and “the fiscal picture has worsened significantly since last year.” They point to the likelihood of “a sharp increase in the supply of notes and bonds over the coming quarters,” and cautioned investors against expecting “a typical end-of-cycle bond market rally.”

Whether or not the Fed continues to remain hawkish, if this recipe of greater U.S. debt issuance need continues on its trajectory, with fewer buyers, interest rates will rise. For investors with the common 60/40 portfolios, that is to say 40% in bonds, higher rates will mathematically cause prices of their fixed income holdings to decline. They may receive interest payments every six months, but if interest rates keep increasing, what others are willing to pay for that payment stream declines. In this way, bonds and other fixed income is only the place to hide if you want to be certain of declining values of your holdings.

Take Away

The Fed could stop tightening, and still there would be upward pressure on Treasury rates because of increased supply. Interestingly, this would serve to create a normally sloped yield curve (not inverted) which, according to many that were saying this year’s inverted yield curve is an unmistakable sign of impending recession, they would have another chance at being wrong again by saying an upwardly sloping yield curve is signs the market expects robust growth. Taken in the context of all of 2023s market dynamics and manipulations, neither textbook simplification fits.

If the scenario of higher rates out on the curve unfolds, a higher cost of capital will impact some industries more than others, and international companies differently than pure domestic operations. Consider this as you make your own interest rate and economic projections and adjust your holdings accordingly.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.fitchratings.com/research/sovereigns/despite-debt-limit-agreement-us-aaa-rating-remains-on-negative-watch-02-06-2023#:~:text=Fitch%20Ratings%2DNew%20York%2D02,and%20the%20outlook%20for%20medium%2D

https://fiscaldata.treasury.gov/datasets/average-interest-rates-treasury-securities/average-interest-rates-on-u-s-treasury-securities

https://www.morningstar.com/news/marketwatch/20230801306/eye-popping-borrowing-need-from-us-treasury-raises-risk-of-buyers-fatigue

What Investors Learned in July That They Can Use in August

Looking Back at the Markets in July and Forward to August

Enthusiasm for the overall stock market remained strong in July. The major indices were all up, and every S&P sector closed in positive territory. Despite the Federal Reserve which continued its monetary policy tightening, and suggestion that it is not finished, markets looked at waning inflation and still strong employment and began to believe a soft landing is now more likely. During the month Nasdaq decided to rebalance the Nasdaq 100, this was completed as of the market open on July 31. The purpose was to allow the index to better reflect price movements in the top 100 Nasdaq stocks. As with the S&P 500, the weighting of the five largest companies represented in the index, has been a concern for many investors that don’t believe the index represents the overall market moves well. On the other side of the scale, for the second month in a row, the small cap Russell 2000 index led the other popular market indexes by a wide margin.

Earnings season or second quarter reporting, which kicked off mid-July, has so far exceeded estimates for many highly followed companies; this has also kept the markets rising in July.  Whether the strong market momentum continues through August may depend on if inflation continues to show signs of coming down toward the Fed’s 2% target.

Image Credit: Koyfin

Look Back

Four broad stock market indices were positive in June. In order, the Russell 2000 Small Caps, Nasdaq 100 Large Caps, the Dow Jones Industrials, and S&P 500 Large Caps.

Small cap stocks are the big winner in June as investors went looking for value. The Russell 2000 rose 6.11%, which follows a large 8.07% gain the previous month. The smaller stocks may now have more positive impetus that could carry over into August. Just prior to the beginning of July, Goldman Sachs had estimated that based on their models, small cap stocks could rise 14% over the next 12 months.  This helped small cap stocks continue their outperformance as more investors begin to exercise caution toward the high P/E ratios in larger companies and recognize the historical value still represented in small cap company valuations.

The Nasdaq maintained its growth as big tech retained its appeal despite individual company market caps that have exceeded those of developed countries. The Nasdaq 100 was up 3.81%, following 6.49% in June. The Dow 30 Industrials made headlines for a week as it had a 13 day winning streak. It returned 3.35% during July after a 4.56% increase in June. The S&P 500 was the worst performing index at 3.11% after rising 6.47% the previous month.  All major indices are off their all time highs that were reached in Winter 2021.

Source: Koyfin

Market Sector Lookback

Of the 11 S&P market sectors (SPDRs), even the lowest performer had an above-average one-month return. The chart above reflects the three best-performing sectors and the three worst. The top performer demonstrated the strength of energy during the month as oil and natural gas prices rose.  

The energy sector had the best return at 7.77% during July.  Continued disruption as countries work toward renewables, the war in Ukraine, and even a coup in Niger all helped the sector attract investors.

Communications was second with a 5.70% return. On June 26, the White House announced internet infrastructure spending plans that helped support and should continue to help many companies in this sector.

Investors began returning to companies in the financial sector as a rebound from March and April when investors became leary after a few bank failures. Bank earnings in July showed better-than-expected performance on many of the large banks. This helped the move back into financials. The sector returned 4.81% in July.

The three worst-performing sectors also indicate the month was very positive. Consumer Staples which was third from the bottom returned a respectable 2.13%. Investors view this sector as a defensive play in times of economic uncertainty. Its move shows less interest as investors become more positive on the economic outlook.

The second to weakest performer is Real Estate. The sector has held up fairly well considering how closely its performance can be tied to interest rates. The 1.33% return in June is indicative of the entire market’s resilience yet lower probability of the sector in light of a still hawkish Fed.

Health Care is still out of favor. Investors had a lower level of interest in healthcare stocks, which are also considered defensive. Lower market volatility and a brighter economic outlook have investors less interested in defensive stocks. Also, interest rates could be affecting big pharma as dividends on the stocks become less appealing as bond yields rise.

Looking Forward

The job market is strong, inflation is tapering,  and consumers are more confident. Analysts are now expecting that companies that have been waiting for a more friendly market to go public are considering now as a good time for their IPO.

Bitcoin and other cryptocurrencies, along with stocks of crypto exchanges, are still faced with uncertain legal outcomes and regulatory positioning. Artificial intelligence as a growing component of many industries, is driving interest as investors look to uncover those companies that will benefit the most both directly (ie: selling chips) or indirectly (ie: gain efficiency).

The rotation to small caps and sectors that perform better when the economy improves has a lot of momentum heading into August. This sector has a long way to run before it catches up with the large cap sectors that it historically surpasses over time.

Take-Away

The market showed more signs of relief in July as the conversation changed from an upcoming recession to a likely soft landing. With five more months in 2023, the markets have rallied and are not showing signs of retrenching. This is especially true of small cap stocks that for the second month have handily outperformed large caps.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.barrons.com/livecoverage/stock-market-today-072723/card/dow-ends-13-day-winning-streak-as-markets-slide-E6vt9Ow8tIPvRB87SWNQ

https://www.whitehouse.gov/briefing-room/statements-releases/2023/06/26/fact-sheet-biden-harris-administration-announces-over-40-billion-to-connect-everyone-in-america-to-affordable-reliable-high-speed-internet/